U.S. SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-QSB
[X] QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934.
For the quarterly period ended June 30, 2004
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.
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(Exact Name of Small Business Issuer as Specified in its Charter)
Delaware 65-0393635
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(State or Other Jurisdiction of (I.R.S. Employer
Incorporation or Organization) Identification No.)
201 Main Street, Suite 1175
Fort Worth, TX 76102
(Address of principal executive offices)
(817) 348-8717
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(Registrant's Executive Office Telephone Number)
201 Main Street, Suite 1455
Fort Worth, TX 76102
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(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 [X]
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, 869,768,895 shares issued and outstanding as of March 4, 2005.
Transitional Small Business Disclosure Format (check one): Yes [ ] No [X]
1
VERTICAL COMPUTERS SYSTEMS, INC. AND SUBSIDIARIES
INDEX TO FORM 10-QSB
PART I FINANCIAL INFORMATION Page
Item 1. Condensed Consolidated Financial Statements:
Condensed Consolidated Balance Sheet (unaudited) as of 3
June 30, 2004
Condensed Consolidated Statements of Operations 5
(unaudited) for the Three and Six Months Ended June 30,
2004 and 2003
Condensed Consolidated Statements of Cash Flows 6
(unaudited) for the Six Months Ended June 30, 2004 and
2003
Notes to Condensed Consolidated Financial Statements 8
Item 2. Management's Discussion and Analysis of Financial 18
Condition and Results of Operations
Item 3. Evaluation of Disclosure Controls and Procedures 36
PART II OTHER INFORMATION
Item 1. Legal Proceedings 36
Item 2. Changes in Securities and Use of Proceeds 38
Item 3. Defaults Under Senior Securities 41
Item 4. Submission of Matters To A Vote Of Security 42
Holders
Item 5. Other Information 42
Item 6. Exhibits and Reports on Form 8-K 42
Signatures 45
2
ITEM 1. CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
Vertical Computer Systems, Inc. and Subsidiaries
Condensed Consolidated Balance Sheet
June 30, December 31,
2004 2003
Assets
Unaudited
Current Assets
Cash $ 340,273 $ 962,454
Restricted cash 102,655 102,655
Securities available for sale 9,128 9,128
Accounts receivable, net of allowance for bad debts of $ $122,473 and $121,004 515,400 982,281
Other receivable 75,085 75,085
Employee receivables 19,889 10,912
Prepaid expenses and other assets 86,237 220,784
------------ ------------
Total Current Assets 1,148,668 2,363,299
Property and equipment, net of accumulated depreciation 134,328 197,502
Other intangibles, net 1,435,018 2,051,355
Deposits and other 14,419 600
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Total Assets $ 2,732,432 $ 4,612,756
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Liabilities and Stockholder's Equity/ (Deficit)
Current liabilities
Accounts payable and accrued liabilities $ 5,245,904 $ 4,993,437
Deferred revenue 2,778,741 2,491,685
Accrued income taxes 18,000 18,000
Current portion - convertible debenture 30,000 40,000
Current portion-notes payable 4,771,482 4,226,482
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Total current liabilities 12,844,127 11,769,604
Convertible debenture 420,000 420,000
Accrued dividends 2,013,712 1,713,712
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Total liabilities $ 15,277,839 $ 13,903,316
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See accompanying notes to condensed consolidated financial statements
3
Vertical Computer Systems, Inc. and Subsidiaries
Condensed Consolidated Balance Sheet (continued)
Minority interest -- --
Stockholders' Equity (Deficit)
Series A 4% Convertible Cumulative Preferred stock; $0.001 par value;
250,000 shares authorized; 50,000 shares issued and outstanding 50 50
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 C 4% Convertible Preferred stock; $100.00 par value;
200,000 shares authorized; 50,000 shares issued and outstanding 350,000 350,000
Series D 15% Convertible Preferred stock; $0.001 Par Value;
300,000 shares authorized; 25,000 shares issued and outstanding 156,250 156,250
Common Stock; $.00001 par value; 1,000,000,000 shares authorized;
858,192,725 and 799,272,301 issued and outstanding 8,583 7,993
Additional paid-in-capital 27,205,125 26,075,405
Accumulated deficit (40,406,693) (36,065,274)
Accumulated other comprehensive income 96,278 140,016
------------ ------------
Total Stockholders' equity/(deficit) (12,545,407) (9,290,560)
Total liabilities and stockholders' equity/(deficit) $ 2,732,432 $ 4,612,756
See accompanying notes to condensed consolidated financial statements
4
Vertical Computer Systems, Inc. and Subsidiaries
Condensed Consolidated Statements of Operations
Three months ended June 30, Six Months ended June 30,
2004 2003 2004 2003
------------- ------------- ------------- -------------
Revenues
Licensing and maintenance $ 1,384,835 $ 1,327,422 $ 2,646,740 $ 2,810,289
Consulting Services 196,246 352,503 428,081 816,790
Other 31,436 9,662 66,912 7,906
------------- ------------- ------------- -------------
Total Revenues 1,612,516 1,689,587 3,141,733 3,634,985
Selling , general and administrative expenses 2,260,719 2,606,318 5,181,648 4,783,995
Goodwill Impairment -- -- 1,760,000 --
------------- ------------- ------------- -------------
Operating loss (648,203) (916,731) (3,799,915) (1,149,010)
Interest income 305 2,362 1,232 5,813
Interest expense (131,745) (110,363) (242,736) (217,516)
------------- ------------- ------------- -------------
Loss before minority interest and income taxes (779,643) (1,024,732) (4,041,419) (1,360,713)
------------- ------------- ------------- -------------
Income Tax Provision (benefit) -- 37,406 -- 117,606
------------- ------------- ------------- -------------
Loss before minority interest (779,643) (1,062,138) (4,041,419) (1,478,319)
------------- ------------- ------------- -------------
Minority interest in (income) loss of
subsidiary -- (25,879) -- (97,511)
------------- ------------- ------------- -------------
Net loss (779,643) (1,088,017) (4,041,419) (1,575,830)
------------- ------------- ------------- -------------
Dividend applicable to preferred stock (150,000) (150,000) (300,000) (300,000)
Net loss applicable to common stockholders' (929,643) (1,238,017) $ (4,341,419) $ (1,875,830)
------------- ------------- ------------- -------------
Basic and diluted loss per share (0) (0) $ (0) $ (0)
------------- ------------- ------------- -------------
Basic and diluted weighted average 857,041,277 772,227,913 844,478,216 761,827,656
------------- ------------- ------------- -------------
of common shares outstanding
Comprehensive loss and its components consist of the following:
Net loss $ (779,643) $ (1,088,017) $ (4,041,419) $ (1,575,830)
Translation adjustments 19,444 63,219 43,738 131,588
------------- ------------- ------------- -------------
Comprehensive loss $ (760,199) $ (1,024,798) $ (3,997,681) $ (1,444,242)
============= ============= ============= =============
See accompanying notes to the condensed consolidated financial statements
5
Vertical Computer Systems, Inc. and Subsidiaries
Condensed Consolidated Statements of Cash Flows
Six months ended June 30
2004 2003
Cash flows from operating activities
Net loss $(4,041,419) $(1,575,830)
Adjustments to reconcile net loss to net cash
provided by operating activities:
Minority interest in net income (loss) of Subsidiary -- 97,511
Depreciation and amortization 707,250 632,689
Goodwill Impairment 1,760,000 --
Write-off of MedData Solutions Investment 135,000 --
Non employee stock compensation 630,815 130,006
Employee compensation expense 83,494 --
Allowance for bad debts 1,469 (121,307)
Changes in operating assets and liabilities:
Accounts receivable 465,412 1,142,039
Other receivable (0) (11,580)
Receivable from officers and employees (8,977) (4,171)
Prepaid expenses 120,728 (93,070)
Accounts payable and accrued liabilities 252,468 433,261
Deferred Revenue 287,056 (142,598)
----------- -----------
Net cash provided by operating activities: 393,296 486,950
Cash flow from investing activities:
Acquisition of minority interest in Now Solutions (877,000) --
Purchase of equipment (27,739) (15,594)
----------- -----------
----------- -----------
Net cash used in investing activities (904,739) (15,594)
----------- -----------
See accompanying notes to condensed consolidated financial statements
6
Vertical Computer Systems, Inc. and Subsidiaries
Condensed Consolidated Statements of Cash Flows (Continued)
Six months ended June 30
2004 2003
Cash flow from financing activities:
Release of pledge of Cash deposit for bank loan -- 650,000
Proceeds from issuance of convertible debentures -- 190,000
Payment of convertible debentures (10,000) --
Payment of Note Payable (555,000) (1,061,413)
Proceeds from issuance of Notes Payable 500,000 237,845
Release of restricted cash -- 284,357
------------ ------------
Net cash provided by (used in) financing activities (65,000) 300,789
Effect of changes in exchange rates on cash (43,738) 131,589
------------ ------------
Net increase (decrease) in cash and cash equivalents, (622,181) 903,734
Cash and cash equivalents, beginning of period 962,454 946,035
------------ ------------
Cash and cash equivalents, end of period $ 340,273 $ 1,849,769
============ ============
Supplemental disclosures of cash flow information: Cash paid during the year
period:
Interest $ 100,302 $ 217,516
============ ============
Non-cash investing and financing activities:
Common stock and debt issued for acquisitions $ 1,018,000 $ --
============ ============
See accompanying notes to condensed consolidated financial statements
7
VERTICAL COMPUTER SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
Note 1 - Basis of Presentation
The accompanying unaudited condensed consolidated financial statements
have been prepared in accordance with generally accepted accounting principles
for interim financial information and with the instructions to Form 10-QSB and
Item 310 of Regulation S-B. Accordingly, they do not include all of the
information and footnotes required by generally accepted accounting principles
for complete financial statements. The accompanying unaudited consolidated
condensed financial statements reflect all adjustments that, in the opinion of
the management of Vertical Computer Systems, Inc. ("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, 2003.
Stock-Based Compensation
Effective January 1, 2004 the Company adopted the fair value provisions of
SFAS 123 for share based payments to employees. In accordance with transition
provisions under SFAS 148, the Company has adopted the prospective method for
transitional recognition.
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 stockholders' equity at June 30, 2004 was approximately
$12.5 million. Additionally, at June 30, 2004, the Company had negative working
capital of approximately $11.7 million (although it includes deferred revenue of
approximately $2.8 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 funds for its operations and
to pay down its liabilities, as well as finance its expansion plans consistent
with the Company's anticipated changes in operations and infrastructure.
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 financial statements contain no adjustment for the outcome of this
uncertainty.
Furthermore, the Company is exploring certain opportunities with a number
of companies to participate in marketing of its products. The exact results of
these opportunities are unknown at this time.
Note 2 - Common and Preferred Stock Transactions
In January 2004, the Company issued 1,500,000 unregistered shares of
common stock of the Company to two consultants of the Company for services (at a
fair-market value of $4,500).
8
In January 2004, the Company purchased a 5% membership interest in Now
Solutions from Stephen Parnes for $75,000 and 1,000,000 unregistered shares of
common stock of the Company (at a fair market value of $3,000). This transaction
resulted in the Company recognizing $80,000 of goodwill, which was written off
in the first quarter of 2004. The Company also paid Mr. Parnes' legal fees in
the amount of $2,000. The stock is subject to "piggy-back" registration rights
and a "lock-up" provision.
In January 2004, the Company issued 10,000,000 unregistered shares of
common stock of the Company (at a fair market value of $30,000) with
"piggy-back" registration rights and subject to a "lock-up" provision 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 unregistered shares of common stock of the Company (at a fair market
value of $12,000) with "piggy-back" registration rights stock and subject to a
"lock up" provision.
In January 2004, the Company agreed to issue 1,000,000 unregistered shares
of the Company's common stock (at a fair market value of $3,000), with "piggy
back" registration rights, in connection with a $10,000 loan made by Jim Salz to
the Company in June 2003. In April 2004, the due date on the note was extended
to August 1, 2004. In January 2005, the due date on the note was extended to
April 30, 2005. In addition, the Company issued a promissory note for $10,000
bearing interest at 10%, which was due in April 30, 2004. Mr. Salz is the
Company's corporate counsel.
In February 2004, $10,000 of principal from a convertible debenture and
$925 in interest was redeemed for a total of $10,925. This conversion was in
connection with a $100,000 debenture issued in March 2002. The holder of the
remaining $10,000 of debentures is a third party.
In February 2004, 7,500 shares of Series C preferred stock, reserved for
an employee under his employment agreement, were cancelled after he terminated
his agreement with the Company. The remaining 15,000 preferred C shares were
also cancelled since the Company determined not to utilize these shares for any
future funding activities for EnFacet. These shares of Series C preferred stock
were part of the stock purchase agreement of EnFacet, Inc., as amended. Pursuant
to the amendment, the Company had the right to substitute 400 common shares for
each share of Series C preferred stock (up to 12,000,000 shares of the Company's
common stock) in connection with the purchase of EnFacet, Inc. The Company also
had the right to cancel any Series C preferred stock for which common stock is
substituted or as otherwise specified in the amended agreement.
In February 2004, in connection with a $500,000 loan made by Robert Farias
to Now Solutions, the Company issued (i) 5 year warrants to purchase 5,000,000
unregistered shares of common stock at $0.01 per share at a fair market value at
the date of issuance of $74,538 (valued using the Black-Scholes valuation
model); (ii) 5 year warrants to purchase 5,000,000 unregistered shares of common
stock of the Company at $0.02 per share at a fair market value at the date of
issuance of $74,344 (valued using the Black-Scholes valuation model); (iii) 5
year warrants to purchase 5,000,000 unregistered shares of common stock of the
Company at $0.03 per share at a fair market value at the date of issuance of
$74,200 (valued using the Black-Scholes valuation model); (iv) 5,000,000
unregistered shares of common stock of the Company (at a fair market value of
$75,000), and (v) an additional 5,000,000 unregistered shares of common stock of
the Company 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 "piggy-back" registration
rights. . Robert Farias is a director of Now Solutions, a 100% owned subsidiary
of the Company.
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 unregistered shares of the common stock of the Company (at a fair
market value of $135,000), which are subject to "piggy-back" registration
rights. As of June 31, 2004, the transaction was fully reserved. Robert Farias
is a director of Now Solutions, a 100% owned subsidiary of the Company.
In February 2004, the Company issued to Arglen Acquisitions ("Arglen")
20,000,000 unregistered shares of the common stock of the Company (at a fair
market value of $280,000), which are subject to a "lock-up" provision. These
shares were issued in connection with the closing of the Company's settlement
with Arglen. In addition, at closing, the Company cancelled 80,763,943 warrants
held by Arglen. Pursuant to the settlement agreement, the Company was also
obligated to issue 5,000,000 unregistered shares of common stock of the Company
to Arglen, due to its failure to file a SB-2 registration statement within 180
days from the settlement date.
9
In February 2004, the Company issued 500,000 unregistered shares of the
Company common stock to each lender (at a total fair market value of $14,000),
in connection with the amendment of two promissory notes each for a principal
amount of $17,500. The notes were issued in May 2003 in connection with two
loans to the Company for an aggregate amount of $30,000. The stock issued to
each lender is subject to "piggy back" registration rights and a "lock up"
provision.
In March 2004, the Company issued 5-year incentive stock options to
purchase 2,500,000 shares of common stock of the Company at an exercise price of
$0.014 per share to Sheri Pantermuehl in connection with Ms. Pantermuehl's
employment agreement to serve as CFO of the Company and Now Solutions. In
addition, Now Solutions issued 1.5% of so-called "phantom stock" of Now
Solutions to Ms. Pantermuehl. The fair market value of these warrants at the
date of issuance was $74,616 (valued using the Black-Scholes valuation model).
During the three months ended March 31, 2004, the Company granted
five-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 a "lock-up" provision. The stock
options were issued in connection with employment agreements executed in January
2004. The fair market value of these warrants at the date of issuance was $8,878
(valued using the Black-Scholes valuation model). In addition, Now Solutions
entered into agreements with these two employees pursuant to which they are
entitled to receive a total of 3% ownership interest of "phantom" stock in Now
Solutions. In September 2004, one of the employees resigned. Consequently, the
Company cancelled options to purchase 1,500,000 shares of common stock of the
Company and Now Solutions cancelled 1.5% ownership interest of "phantom" stock.
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 five-year warrants to purchase 250,000 shares of
common stock of the Company at an exercise price of $0.025 per share at a fair
market value at the date of issuance of $6,185 (valued using the Black-Scholes
valuation model).
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 unregistered shares of common stock of the Company, vested 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 September 2004, all of the
shares vested and were issued (at a fair market value of $5,190).
In June 2004, the Company issued warrants to WAMCO 32, Ltd to purchase
3,000,000 shares of the common stock Company at an exercise price of $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 fractional 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 "lock-up" provision. The fair market value of the warrants was $74,142
(valued using the Black-Scholes valuation model). These warrants were issued in
connection with the amendment of the note payable to the successor lender, WAMCO
32, Ltd.
In June 2004, a third party consultant exercised the warrant to purchase
1,170,424 shares of common stock of the Company at an exercise price of $0.037
per share. The parties also entered into an agreement whereby the Company offset
the total purchase price of the shares as full payment for outstanding debt of
$43,306 owed by the Company to the consultant.
During the six months ended June 30, 2004, incentive stock options to
purchase 2,200,000 shares of the Company ranging in price from $0.037 to $0.086
per share expired.
During the six months ended June 30, 2004, non-incentive stock options to
purchase 1,500,000 shares of the Company ranging in price from $0.041 to $0.086
per share expired.
During the six months ended June 30, 2004, warrants to purchase 11,581,344
shares of the common stock of the Company ranging in price from $0.035 to $0.11
per share expired.
10
Note 3 - Notes Payable
In January 2004, the Company issued a promissory note for $10,000 bearing
interest at 10%, which was due in April 30, 2004. This note was issued in
consideration of a $10,000 loan made by Jim Salz to the Company in June 2003. In
connection with the note, the Company agreed to issue 1,000,000 unregistered
shares of the Company's common stock (at a fair market value of $3,000), subject
to "piggy back" registration rights. In April 2004, the due date on the note was
extended to August 1, 2004. In January 2005, the due date on the note was
extended to April 30, 2005. Mr. Salz is the Company's corporate counsel.
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 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 unregistered
shares of common stock at $0.01 per share at a fair market value at the date of
issuance of $74,538 (valued using the Black-Scholes valuation model); (ii) 5
year warrants to purchase 5,000,000 unregistered shares of common stock of the
Company at $0.02 per share at a fair market value at the date of issuance of
$74,344 (valued using the Black-Scholes valuation model); (iii) 5 year warrants
to purchase 5,000,000 unregistered shares of common stock of the Company at
$0.03 per share at a fair market value at the date of issuance of $74,200
(valued using the Black-Scholes valuation model); (iv) 5,000,000 unregistered
shares of common stock of the Company (at a fair market value of $75,000); and
(v) an additional 5,000,000 unregistered shares of common stock of the Company
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 "piggy-back" registration rights. In
connection with the loan, 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 is junior to Now Solutions' present indebtedness
to WAMCO 32, Ltd and Arglen Acquisitions. Robert Farias is a director of Now
Solutions, a 100% owned subsidiary of the Company. The note is currently in
default. As of March 4, 2005, Now Solutions had made principal payments totaling
$183,000 to Robert Farias. In January 2005, WAMCO 32, Ltd. notified Mr. Farias
that pursuant to the subordination agreement executed between WAMCO 32, Ltd. and
Mr. Farias, Mr. Farias was no longer to accept payments from or to take any
collection actions against Now Solutions for the repayment of junior debt..
In February 2004, the note payable in the amount of $84,000 issued by
EnFacet to Robert Farias, dated June 1, 2001, bearing interest at 12% per annum,
unsecured, with principal and interest due on June 1, 2002 was amended by the
parties. Pursuant to the amendment Robert Farias waived any defaults on the note
and the note was amended 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 Mr. 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 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 is junior to Now Solutions' present indebtedness to
WAMCO 32, Ltd, Arglen Acquisitions, and Robert Farias in connection with the
$500,000 note. In an amendment between the parties in March 2003, the interest
rate was increased from 8% to 12% and accrued from the date the note was issued
in exchange for extending the note. Robert Farias is a director of Now
Solutions, a 100% owned subsidiary of the Company. This note is in default.
In February 2004, 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 connection with the amendment, the Company and Robert
Farias also amended the $181,583 note issued to Mr. Farias on October 17, 2002.
Pursuant to the amendment, any default on these notes was waived, and the
Company agreed to make the following payments on these 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, 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
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
11
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. Robert Farias is a
director of Now Solutions, a 100% owned subsidiary of the Company. The note is
in default.
In February 2004, the note payable in the amount of $181,584 issued to
Robert Farias in October 2003, bearing interest at 12% per annum was amended. In
connection with the amendment, the Company and Mr. Farias also amended the
$280,000 note issued to Mr. Farias on October 31, 2001. Pursuant to the
amendment, any default on these notes was waived, and the Company agreed to make
the following payments on these 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, 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. Robert Farias is a director of Now Solutions, a
100% owned subsidiary of the Company. The note is secured by 10,450,000 shares
of the Company's common stock that are owned by Mountain Reservoir Corp. to
cover any shortfall. Mountain Reservoir Corporation is a corporation controlled
by the W5 Family Trust. Mr. Wade, the President and CEO of the Company, is the
trustee of the W5 Family Trust. The note is in default.
In February 2004, the Company and a third party amended a note payable in
the amount of $90,000 dated June 26, 2003, bearing an interest of 10% annum,
with principal and interest due on March 28, 2004. In connection with the
amendment, the parties also amended the $350,000 note due February 28, 2003.
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 Mr. 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 is junior to Now
Solutions' present indebtedness to WAMCO 32, Ltd, Arglen Acquisitions, and
Robert Farias in connection with the $500,000 note. The note is default.
In February 2004, the Company, on behalf of its subsidiary EnFacet, and a
third party amended a note payable in the amount of $350,000 issued by EnFacet
bearing interest at 8% per annum and originally due on February 28, 2003. In
connection with the amendment, the parties also amended the $90,000 note issued
in June 2003. Pursuant to the amendment, the parties 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 Mr. 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 is
junior to Now Solutions' present indebtedness to WAMCO 32, Ltd, Arglen
Acquisitions, and Robert Farias in connection with the $500,000 note. The note
is default.
In February 2004, the Company completed 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 is
12
junior to Now Solutions' present indebtedness to WAMCO 32, Ltd. In addition, at
closing, the Company cancelled 80,763,943 warrants held by Arglen and issued to
Arglen 20,000,000 unregistered shares of the common stock of the Company (at a
fair market value of $280,000), which are subject to a "lock-up" provision. This
transaction resulted in the Company recognizing $1,680,000 of goodwill, which
was written off in 2004. Pursuant to the settlement agreement, the Company was
also obligated to issue an additional 5,000,000 unregistered shares of common
stock of the Company to Arglen, due to its failure to file a SB-2 registration
statement within 180 days from the settlement date. The note is in default. In
August 2004, Arglen obtained a default judgment in Los Angeles court for the
outstanding principal, plus attorney's fees and interest at the rate of 10% per
annum. The Company has filed a motion in the Delaware court to stay the
enforcement of the judgment pending resolution of the Delaware action.
In June 2004, the note payable to Coast Business Credit (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, 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) and
the related loan agreements, were amended by the Company and the successor
lender, WAMCO 32, Ltd. In August 2003, WAMCO 32, 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. As of February 28, 2005, the outstanding principal balance due on the $5.5
million note is $1,162,280 and Now Solutions is delinquent on the principal of
the note by $267,500. Now Solutions has made all interest payments as of
February 28, 2005. In connection with the amendment, Now Solutions is required
to pay WAMCO 32 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 WAMCO 32 five
year warrants to purchase 3,000,000 shares of the common stock Company at an
exercise price of $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 fractional
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 fair market value of the warrants was
$74,142 (valued using the Black-Scholes valuation model). The warrants are
subject to "piggy back" registration rights and a "lock-up" 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 were 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 the $215,000 note issued by
Now Solutions to the Company to secure $190,000 in loans made by Victor Weber to
the Company in December 2002 through September 2003 and $25,000 in expenses paid
by Mr. Weber on the behalf of the Company that were included in Accounts
Payable. Mr. Weber had the option to have the Company assign the $215,000 note
to Mr. Weber provided that Mr. Weber cancelled all other notes and the $25,000
in accounts payable. Mr. Weber elected to make this assignment in January 2004.
At that time, all other notes and the $25,000 in accounts payable owed to Mr.
Weber were cancelled. Victor Weber is a Director and President of Government
Internet Systems, Inc., a subsidiary of the Company.
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 the opinion of management, the ultimate
resolution of these matters, if any, may have a significant effect on the
financial position, operations or cash flows of the Company.
In addition, the Company is involved in the following additional ongoing
matters:
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 was
13
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 concerns
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). In November
2003, the New York Supreme Court dismissed all claims against Ross and Tinley
and stayed the Derivative Action against Arglen and Gyselen pending conclusion
of the Arbitration. The portion of the lawsuit involving Arglen and Gyselen was
settled in December 2003 and, pursuant to the settlement, dismissed in February
2004. The court dismissed the entire action against Ross and Tinley. The Company
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 of the dismissal of the action against Ross was submitted to the court
for decision. On appeal, the claims against Ross were reinstated pursuant to the
order of the Appellate Division, dated October 26, 2004. Thereafter, in November
2004, Ross filed an answer containing affirmative defenses in the Derivative
Action.
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 appealed the August
2003 court order, but subsequently abandoned its appeal.
In December 2003, the Company settled its arbitration and litigation 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. 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. In February 2004, the Company completed the
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 is junior to Now Solutions' present indebtedness to WAMCO 32,
Ltd. In addition, at closing, the Company cancelled 80,763,943 warrants held by
Arglen and issued to Arglen 20,000,000 unregistered shares of the common stock
of the Company (at a fair market value of $280,000), which is subject to a "lock
up" provision. The Company's purchase of Arglen's interest resulted in the
Company recognizing $1,680,000 of goodwill, which was written off in 2004.
Pursuant to the settlement agreement, the Company was also obligated to issue
5,000,000 unregistered shares of common stock of the Company to Arglen, due to
its failure to file a SB-2 registration statement within 180 days from the
settlement date. The note is in default. In August 2004, Arglen obtained a
default judgment in Los Angeles court for the outstanding principal, plus
attorney's fees and interest at the rate of 10% per annum. The Company has filed
a motion in the Delaware court to stay the enforcement of the judgment pending
resolution of the Delaware action.
At December 31, 2003, the Company had non-restricted cash-on-hand of
$962,454. Now Solutions' non-restricted cash-on-hand of $954,720 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 and when the
settlement was completed in February 2004, the Company and Arglen dismissed all
claims with respect to one another. As a result, the cash-on-hand of Now
Solutions became available to fund the Company's operations.
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. Now Solutions opposed the Ross motion and, on October 7, 2004, the
Court ruled in favor of Now Solutions and denied the motion for summary
judgment. Pursuant to New York State law, in the event a motion for summary
judgment in lieu of complaint is denied, the action continues and the pleadings
14
supporting the motion are deemed to constitute the complaint. Accordingly, Now
Solutions has filed an answer containing affirmative defenses and nine (9)
counterclaims against Ross. The affirmative defenses asserted by Now Solutions
include the same grounds which comprise the causes of action against Ross in the
Derivative Action, namely Ross' breach of the Asset Purchase Agreement as a
result of its failure to credit Now Solutions with adjustments at closing in an
amount not less than $3,562,201. All of the counterclaims asserted by Now
Solutions against Ross relate to the Asset Purchase Agreement and Ross' breaches
thereof. The counterclaims include: (i) breach of the covenant not to compete,
whereby Now Solutions seeks damages in excess of $10,000,000; (ii) breach of the
covenant to deliver all assets to Now Solutions at closing, whereby Now
Solutions seeks damages in an amount not less than $300,000; (iii) breach of a
certain Transitional Services Agreement (executed in conjunction with the Asset
Purchase Agreement), whereby Now Solutions seeks damages in an amount not less
than $73,129; and (iv) reasonable attorney's fees. In December 2004, Ross filed
a motion to dismiss two counterclaims: one which alleges that Ross and
Chinadotcom used Ross to breach a covenant not to compete and the second which
requested that Ross be enjoined from further competition with Now Solutions in
violation of the covenant. The motion was granted pursuant to a procedural
default. In February 2005, Now Solutions filed a motion to vacate the default
and reinstate the counterclaims, which motion is now pending.
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 monies 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. Specifically, Ross seeks a judgment against the Company:
(i) attaching the assets transferred to Arglen pursuant to the Settlement
Agreement; (ii) enjoining the Company and Now Solutions from making further
transfers to Arglen pursuant to the Arglen Note; (iii) avoiding the transfers to
the Company and Arglen or for judgment in the amount equivalent to the value of
the asserts transferred to them pursuant to the Settlement Agreement; and (iv)
appointing a receiver to take possession of the assets transferred to the
Company and Arglen pursuant to the Settlement Agreement. In July 2004, the
Company and Now Solutions filed a motion to stay the Delaware Action pending the
resolution of the parties' rights in the Derivative Action and Ross Action. In
October 2004, the motion was granted and the Delaware action has been stayed.
In December 2004, the Company was notified by the Securities Exchanges
Commission ("SEC") that the SEC has suspended trading of VCSY common stock
pursuant to an Order Filed by the SEC because the Company has been delinquent in
its periodic filing obligations under Section 13(a) of the Securities Exchange
Act of 1934 since the period ending September 30, 2003. Also in December 2004,
the Company was notified by the SEC of an administrative proceeding pursuant to
the filing of an "Order Instituting Administrative Proceedings and Notice of
Hearing Pursuant to Section 12(j) of the Securities Exchange Act of 1934" due to
the delinquency of filing of the Form 10-KSB for the year ended 2003 and the
Form 10-QSB for the first three quarters of 2004. The Company filed its Form-KSB
for the year ended 2003 on January 19, 2005.
In January 2005, Parker, Mills, and Patel filed a lawsuit to collect the
outstanding balance of $23,974 due under the promissory note issued by the
Company to Parker, Mills and Patel and for failure to pay fees for professional
services in the amount of $89,930 rendered to the Company, plus interest. The
Company intends to file a response.
Note 5 - New Accounting Pronouncements
In January 2003, the FASB issued FASB Interpretation No. 46 (FIN 46),
"Consolidation of Variable Interest Entities." FIN 46, as amended by FIN 46(R),
issued in January 2003, requires an investor with a majority of the variable
interests in a variable interest entity to consolidate the entity and also
requires majority and significant variable interest investors to provide certain
disclosures. A variable interest entity is an entity in which the equity
investors do not have a controlling financial interest or the equity investment
at risk is insufficient to finance the entity's activities without receiving
additional subordinated financial support form other parties. The provisions of
FIN 46(R) are applicable for fiscal years ending after December 15, 2004. The
Company does not have any variable interest entities that must be consolidated.
In December 2004, the FASB announced that SFAS No. 123R (revised December
2004), "Share-Based Payment," sets accounting requirements for "share-based"
compensation to employees, including employee-stock-purchase-plans (ESPPs) and
provides guidance on accounting for awards to non-employees. This Statement will
require the Company to recognize in the income statement the grant-date fair
value of stock options and other equity-based compensation issued to employees,
but expresses no preference for a type of valuation model. For public entities,
15
this Statement is effective for the first interim period beginning after June
15, 2005. The Company will adopt this Statement in the second quarter of fiscal
2005 and is evaluating this pronouncement's effect on the Company's financial
position and net income.
In December 2004, the FASB issued FASB Staff Position No. FAS109-1 ("FSP
FAS 109-1"), "Application of FASB Statement No. 109, Accounting for Income
Taxes, for the Tax Deduction on Qualified Production Activities Provided by the
American Jobs Creation Act of 2004." FSP FAS 109-1 clarifies that the deduction
will be treated as a "special deduction" as described in Statement of Financial
Accounting Standards No. 109, "Accounting for Income Taxes." As such, the
special deduction has no effect on deferred tax assets and liabilities existing
at the date of enactment. The impact of the deduction will be reported in the
period in which the deduction is claimed. The Company is currently assessing the
financial impact of FSP FAS 109-1 on its consolidated financial statements.
Note 6 - Stock Options and Warrants
Weighted
Average
Incentive Non-Statutory Exercise
Stock Options Stock Options Warrants Price
------------ ------------ ------------ ------------
------------ ------------ ------------ ------------
Outstanding at 12/31/03 11,090,000 1,500,000 164,775,710 $ 0.070
============ ============ ============ ============
Options/Warrants granted with an exercise
price of $0.01 to $0.03 5,500,000 -- 18,250,000 $ 0.019
Options/Warrants exercised -- -- -- --
Options/Warrants expired/cancelled 2,200,000 1,500,000 93,515,711 $ 0.075
------------ ------------ ------------ ------------
Outstanding at 6/30/04 14,390,000 -- 89,509,999 $ 0.107
============ ============ ============ ============
(1) The Company cancelled warrants to purchase 80,763,943 shares of common stock
issued to Arglen as part of its settlement with Arglen, which closed in February
2004.
Information relating to stock options/warrants as June 30, 2004, summarized by
exercise price, is as follows:
Warrants/Options Outstanding Exercisable
------------------------------------------ ---------------------------
Weighted
Average Weighted Weighted
Remaining Average Average
Number Contractual Exercise Number Exercise
Exercise Price Per Share Outstanding Life (Months) Price Exercisable Price
- ------------------------------------------ ------------ ------------ ------------ ------------
Incentive Stock Options
$0.01 - $0.09 14,390,000 24.12 $ 0.014 8,890,000 $ 0.016
------------ ------------ ------------ ------------ ------------
Non-statutory Stock Options
$0.01 - $0.09 -- -- $ -- -- $ --
------------ ------------ ------------ ------------ ------------
Warrants
$0.003 - $0.100 81,925,147 30.28 $ 0.099 78,491,814 $ 0.099
$0.100 - $0.350 7,584,852 8.64 0.333 7,584,852 0.333
------------ ------------ ------------ ------------ ------------
89,509,999 28.45 $ 0.119 86,076,666 $ 0.119
------------ ------------ ------------ ------------ ------------
------------ ------------ ------------ ------------ ------------
Grand total 103,899,999 27.85 $ 0.1042 94,966,666 $ 0.110
============ ============ ============ ============ ============
16
The range of assumptions used in Black Scholes options pricing mode in 2004 and
2003 were as follows:
June 30, December 31,
2004 2003
---------------- ---------------
Discount rate - bond yield rate 2.98 - 3.90% 2.61 - 3.01%
Volatility 226 - 236.6% 83 - 187%
Expected life 5 years 5 years
Expected dividend yield -- --
Note 7 - Subsequent Events
In July 2004, $20,000 of remaining principal from a convertible debenture
and $2,277 in interest was converted into 1,076,170 shares of common stock of
the Company. This conversion was in connection with a $100,000 debenture issued
in March 2002. As of March 4, 2005, $10,000 of remaining principal of the
debenture is outstanding and held by a third party.
In August 2004, TranStar made a payment of $8,000 in full satisfaction of
one of the $24,000 loans issued on April 19, 2001 and the Company cancelled the
note and returned 500,000 of TranStar's shares held as collateral.
In August 2004, the Company licensed the use of the Forums and calendar
applications of the Company's SiteFlash technology to Basix1, Inc. ("Basix1")
for use in Basix1's Enterprise Knowledge Gateway (EKG) software. Pursuant to the
terms of the license, Basix1 shall pay the Company 10% of all license fees
generated from the exploitation of Basix1's EKG software. Mr. Kensicki is a
Director of GIS and Now Solutions and is also the President of Basix1, Inc.
In September 2004, the Company and Victor Weber agreed to amend the terms
of the $215,000 note issued by Now Solutions to the Company and assigned to Mr.
Weber. Pursuant to the terms of the amendment, the Company agreed to issue
2,000,000 unregistered shares of common stock of the Company (at a fair market
value of $24,000), in exchange for amending the note. In connection with the
amendment, since the Company did not make full payment of the note by December
31, 2004, the Company issued, in January 2005, an additional 2,000,000
unregistered shares of common stock at a fair market value of $10,000 and the
note has been amended as follows: (a) the maturity date of the note shall be
extended to December 31, 2005; (b) the payment terms of the note shall be
amended so that, beginning in 2005, Now Solutions shall make (i) monthly
interest payments for all accrued interest during the previous month, (ii)
$50,000 in principal payments which will be due the end of each quarter
beginning March 31, 2005 and (iii) a final payment of all accrued interest and
principal which will be due no later than December 31, 2005. In addition, Mr.
Weber shall receive 2.5% royalty of sales by Now Solutions of its software that
exceed $8,000,000 per year up to $200,000. As of February 28, 2005, the Company
has made all interest payments.
In October 2004, the Company and Stephen Rossetti agreed to amend the
terms of a consulting agreement and the $7,500 promissory note issued in May
2003. Pursuant to the terms of the amendment, the Company issued 6,500,000
unregistered shares of common stock of the Company (at a fair market value of
$84,500), as full payment for services rendered under the consulting agreement
and the $7,500 note, which has been cancelled. As of March 4, 2005, 2,900,145 of
the 4,150,145 warrants issued for consulting services for the Company and GIS
expired. Mr. Rossetti is the CEO and a Director of GIS and Now Solutions.
In October 2004, GIS and Grant Consultants of America ("GCA") entered into
a consulting agreement to provide services concerning government grants. In
connection with the agreement, the Company issued warrants to purchase 3,000,000
shares of common stock at an exercise price of $0.0165 per share at a fair
market value at the date of issuance of $49,385 (valued using the Black-Scholes
valuation model). In the event that the GCA did not procure a government
contract for the state of Nevada within 90 days, the warrant would automatically
be cancelled. Accordingly, these warrants were automatically cancelled in
January 2005 pursuant to the terms of the agreement.
In November 2004, the United States Patent and Trademark Office granted a
patent (No. 6,826,744) for an invention for "System and Method for Generating
Web Sites In an Arbitrary Object Framework". This patent is the foundation of
the Company's SiteFlash and related technology, which are currently deployed in
ResponseFlash, NewsFlash, and UniversityFlash.
During the year ended December 31, 2004, incentive stock options to
purchase 10,340,000 shares of common stock of the Company at a price of $0.010
to $0.086 per share expired.
17
During the year ended December 31, 2004, non-incentive stock options to
purchase 1,500,000 shares of common stock of the Company at a price of $0.041 to
$0.086 per share expired.
During the year ended December 31, 2004, warrants to purchase 18,569,696
shares of common stock of the Company at a price of $0.012 to $0.35 per share
expired.
In January 2005, the Company entered into a marketing agreement with CW
International, LLC. Mr. Weber is a Director and President of Government Internet
Systems, Inc. and a member of CW International, LLC.
Effective January 26, 2005, BDO Seidman, LLP resigned as the independent
certified public accountants of the Company.
On February 2, 2005, the Company engaged Weaver and Tidwell, L.L.P.
("Weaver and Tidwell") as its principal accountant to audit the Company's
financial statements.
During the period of January 1 to March 4, 2005, no incentive stock
options to purchase shares of common stock of the Company expired.
During the period of January 1 to March 4, 2005, no non-incentive stock
options to purchase shares of common stock of the Company expired.
During the period of January 1 to March 4, 2005, warrants to purchase
4,971,644 shares of common stock of the Company at a price of $0.011 to $0.35
per share expired.
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 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, 2004. 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, 2003.
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 "Factors
Affecting the Company's Business Operating Results and Financial Condition."
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 6.3, 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
we believe is capable of penetrating multiple sectors through cross promotion.
18
Results of Operations
Three and Six Month Periods Ended June 30, 2004 Compared To The Three and
Six Months Ended June 30, 2003
Total Revenues. The Company had total revenues of $1,612,516 and
$1,689,587 in the three months ended June 30, 2004 and 2003, respectively. The
decrease in total revenue was $77,071 for the three months ended June 30, 2004
representing approximately a 4.6% decrease compared to the total revenue for the
three months ended June 30, 2003. Of the $1,612,516 in the three months ended
June 30, 2004 and the $1,689,587 in the three months ended June 30, 2003
$1,521,190 and $1,645,830, 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 and the
remaining 40% interest in January and 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 June 30, 2004
increased by $57,413 from the same period in the prior year, representing
approximately 4.3% increase, due to licensing by the Company of its SiteFlash
and ResponseFlash technology compare to no licensing by the Company in the
second quarter of 2003. Consulting revenue in the three months ended June 30,
2004, decreased by $156,257 from the same period in the prior year, which
represented approximately a 44.3% decrease, due to converting less existing
clients from the classic version of Now Solutions emPath software to version 6.2
compared to prior year. Other revenue in the three months ended June 30, 2004
increased by $21,773 from the same period in the prior year, which represented
approximately 225% increase.
The Company had total revenues of $3,141,733 and $3,634,985 in the six
months ended June 30, 2004 and 2003, respectively. The decrease in total revenue
was $493,252 for the six months ended June 30, 2004 representing a 13.6%
decrease compared to the total revenue for the six months ended June 30, 2003.
Of the $3,141,733 in the six months ended June 30, 2004 and the $3,634,985 in
the six months ended June 30, 2003, $3,044,214 and $3,573,613, 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 and the remaining 40% interest in January and
February 2004. The total revenues primarily consist of software licenses,
consulting and maintenance fees. The revenue from license and maintenance in the
six months ended 2004 decreased by $163,549 from the same period in the prior
year, representing approximately a 5.8% decrease, due to selling less new or
upgraded software licenses. Consulting revenue in the six months ended June 30,
2004, decreased by $388,709, from the same period in the prior year, which
represented approximately a 47.6% decrease, due to implementing fewer new
clients and converting fewer existing clients from the classic version of Now
Solutions emPath software to version 6.2. Other revenue in the six months ended
June 30, 2004 increased by $59,006 from the same period in the prior year, which
represented approximately a 746% increase.
Selling, General and Administrative Expenses. The Company had selling,
general and administrative expenses of $2,260,719 and $2,606,318 for the three
months ended June 30, 2004 and 2003, respectively. The total operating expenses
in the three months ended June 30, 2004 decreased by $345,599 compared to the
operating expenses in the three months ended June 30, 2003, representing
approximately a 13.3% decrease. Of the $2,260,719 in the three months ended June
30, 2004 and the $2,606,318 in the three months ended June 30, 2003, Now
Solutions accounted for $1,742,711 and $1,565,985, respectively. The decrease of
$345,599 was primarily attributable a reduction in cost associated with
obtaining debenture funding and decreases in legal and other professional fees.
The Company had selling, general and administrative expenses of $5,181,648
and $4,783,995 in the six months ended June 30, 2004 and 2003, respectively. The
total operating expenses in the six months ended June 30, 2004 increased by
$397,653 compared to the operating expenses in the six months ended June 30,
2003, representing approximately a 8.3% increase. Of the $5,181,648 in the six
months ended June 30, 2004 and the $4,783,995 in the six months ended June 30,
2003, Now Solutions accounted for $3,490,031 and $3,217,252, respectively. The
$397,653 increase was primarily attributable to fees paid to Robert Farias for
the $500,000 note payable issued to Now Solutions in February of 2004 and fees
paid for various loan extensions. These fees totaled approximately $440,000 and
were all paid in the form of common stock or warrants. In addition, the Company
acquired Robert Farias' interest in MedData Solutions for 9 million shares of
common stock in the first quarter of 2004. At the time of the transaction, the
common stock had a value of $135,000. The Company wrote-off its investment in
MedData Solutions in the first quarter of 2004 as well as its remaining balance
of organizational cost. These increases were partially offset by a reduction in
cost associated with obtaining debenture funding and decreases in legal and
other professional fees in the second quarter.
Goodwill Impairment. In the first quarter of 2004 the Company acquired
Stephen Parnes' 5% interest and Arglen's 30% interest in Now Solutions. These
transactions resulted in the recognition of $1,760,000 of goodwill. The Company
19
assessed the carrying value of this goodwill for impairment as March 31, 2004 in
accordance with Statement of Financial Accounting Standards No. 142, "Goodwill
and Other Intangible Assets" ("SFAS No. 142") and in connection with this
assessment determined its goodwill was fully impaired. As a result, the Company
wrote-off the entire carrying value of the goodwill in the first quarter of
2004.
Operating Loss. The Company had an operating loss of $648,203 and $916,731
in the three months ended June 30, 2004 and 2003, respectively. The operating
loss decreased by $268,528 compared to the operating loss in the three months
ended June 30, 2003, representing a decrease of approximately 29.3%. The
decrease was primarily attributable to a decrease in the operating expenses of
$345,599 as described in the above paragraph (Selling, General and
Administrative Expenses) that was partially offset by a decrease in revenues of
$77,071.
The Company had an operating loss of $3,799,915 and $1,149,010 in the six
months ended June 30, 2004 and 2003, respectively. The operating loss increased
by $2,650,905 compared to the operating loss in the six months ended June 30,
2003, representing an increase of approximately 231%. The increase was primarily
attributable to the write-off of goodwill associated with acquiring the minority
interest in Now Solutions, a decrease in revenues of $493,252 and an increase in
the operating expenses of $397,653 as described in the above paragraph (Selling,
General and Administrative Expenses).
Interest Expense. The Company had an interest expense of $131,745 and
$110,363 for the three months ended June 30, 2004 and 2003, respectively.
Interest expense increased in 2004 by $21,383, representing an increase of
approximately 19%, compared to the three months ended June 30, 2003. The
increase was related to new borrowings.
The Company had an interest expense of $242,736 and $217,516 for the six
months ended June 30, 2004 and 2003, respectively. Interest expense increased in
2004 by $25,220, representing an increase of approximately 11.33%, compared to
the six months ended June 30, 2003. The increase was related to new borrowings.
Minority Interest. In the first quarter of 2004, the Company acquired the
minority interest in Now Solutions. The minority interest in Now Solutions net
income for the three months ended June 30, 2003 was $25,879. The minority
interest was based upon 40% minority ownership in Now Solutions on net profit of
Now Solutions. .
The minority interest in Now Solutions net income for the six months ended
June 30, 2003 was $97,511.
Net Loss. The Company had a net loss of $779,643 and $1,088,017 for the
three months ended June 30, 2004 and 2003, respectively. Net loss as of June 30,
2004 decreased by $308,374, representing a decrease of approximately 28.3%. The
decrease of $308,374 was primarily attributable to a decrease in the operating
expenses of $345,599 as described in the above paragraph (Selling, General and
Administrative Expenses) that was partially offset by a decrease in revenues of
$77,071.
The Company had a net loss of $4,041,419 and $1,575,830 for the six months
ended June 30, 2004 and 2003, respectively. Net loss as of June 30, 2004
increased by $2,465,589, representing an increase of approximately 156%. The
increase of $2,465,589 was primarily attributable to the write-off of goodwill
associated with acquiring the minority interest in Now Solutions, a decrease in
revenues of $493,252 and an increase in the operating expenses of $397,653 as
described in the above paragraph (Selling, General and Administrative Expenses).
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 cumulative 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 $150,000 for the three months ended June 30,
2004 and 2003, respectively.
The total dividends applicable to Series A and Series C preferred stock
were $300,000 and $300,000 for the six months ended June 30, 2004 and 2003,
respectively.
Net Loss Available to Common Stockholders. The Company had a net loss
attributed to common stockholders of $929,643 and $1,238,017 for the three
months ended June 30, 2004 and 2003, respectively. Net loss attributed to common
stockholders decreased by $308,374, representing a decrease of approximately
25%, compared to the net loss attributed to common stockholders in the three
months ended June 30, 2003. The decrease of $308,374 was primarily attributable
to a decrease in the operating expenses of $345,599 as described in the above
paragraph (Selling, General and Administrative Expenses) that was partially
offset by a decrease in revenues of $77,071.
20
The Company had a net loss attributed to common stockholders of $4,341,419
and $1,875,830 for the six months ended June 30, 2004 and 2003, respectively.
Net loss attributed to common stockholders increased by 2,465,589, representing
a decrease of approximately 131%, compared to the net loss attributed to common
stockholders in the six months ended June 30, 2003. The increase of $2,465,589
was primarily attributable to the write-off of goodwill associated with
acquiring the minority interest in Now Solutions, a decrease in revenues of
$493,252 and an increase in the operating expenses of $397,653 as described in
the above paragraph (Selling, General and Administrative Expenses).
Net Loss Per Share. The Company had a net loss per share of $0.00 and
$0.00 for the three months ended June 30, 2004 and 2003, respectively. The
Company had a net loss per share of $0.00 and $0.00 for the six months ended
June 30, 2004 and 2003, respectively.
Liquidity And Capital Resources
At June 30, 2004, the Company had non-restricted cash-on-hand of $340,273
and $102,655 of restricted cash-on-hand relating to a letter of credit required
by a customer of Now Solutions.
Net cash generated from operating activities for the six months ended June
30, 2004 was $393,296. This positive cash flow was primarily related to a net
loss of $4,041,419 adjusted by total non-cash items of $3,318,028 (including
depreciation and amortization of $707,250, the impairment of goodwill of
$1,760,000, expenses paid by the issuance of common stock, warrants and stock
options totaling $630,815 and the write-off of the MedData Solutions investment
of $135,000), increases in all current liabilities items of $539,524, a decrease
in accounts receivables of $465,412 and a decrease in prepaid expenses of
$120,728.
Net cash used in investing activities for the six months ended June 30,
2004 was approximately $1,922,737 which consisted of the acquisition of the
minority interests in Now Solutions totaling $1,760,000, the investment in
MedData Solutions of $135,000 and of purchase of equipment and software of
$27,737.
Net cash generated from financing activities for the six months ended June
30, 2004 was $535,000, consisting of proceeds from issuing notes payable of
approximately $1,100,000. This was partially offset by the repayment of notes
payables of $555,000 and the repayment of convertible debentures of $10,000.
The total change in cash and cash equivalents for the six months ended
June 30, 2004 when compared to six months ended June 30, 2003 was a decrease of
$1,509,496.
From 1999 to the acquisition of the minority owners of Now Solutions in
February 2004, the Company had been primarily dependent on external cash to
support its operations. Until February 2004, the Company had financed its
operations through the sale of securities, including common and preferred stock,
convertible debts, and notes payable. Since the Company became the 100% owner of
Now Solutions, it has been able to fund a substantial portion of its operations
internally.
As of the date of this filing, the Company believes that it had sufficient
funds available to fund its operations only for one month, should the Company be
unable to obtain any relief on its debt structure during such time. Therefore,
the Company needs to raise additional funds through selling securities,
obtaining loans and/or renegotiating the terms of its existing debt. The
Company's inability to raise such funds will significantly jeopardize its
ability to continue operations.
Balance at Due in Next Five Years
Contractual Obligations 06/30/04 2004 2005 2006 2007 2008
- ----------------------------------------------------------------------------------------------------------
Notes payable 4,771,482 3,622,882 1,148,600
Convertible debts 450,000 30,000 30,000 390,000
Operating lease 509,795 80,928 133,748 140,544 60,852 93,723
---------- ---------- ---------- ---------- ---------- ----------
Total 5,731,277 3,733,810 1,312,348 530,544 60,852 93,723
========== ========== ========== ========== ========== ==========
21
In November 2001, Parker Mills & Patel, the former general counsel of the
Company, made advances of approximately $30,000 to third party venders on behalf
of the Company. In exchange, PMP received a 6% promissory note due January 2002.
At December 31, 2003, the outstanding balance of $23,974 was in default. These
warrants expired in November 2004. In January 2005, Parker, Mills, and Patel
filed a lawsuit to collect the outstanding balance of $23,974 due under the
promissory note issued by the Company to Parker, Mills and Patel and for failure
to pay fees for professional services in the amount of $89,930 rendered to the
Company, plus interest. The Company intends to file a response. William Mills, a
partner at the law firm, is also a director of the Company.
In March 2003 the Company issued a note payable to a third party for past
due consulting services in the amount of $23,030 dated March 21, 2003 bearing an
interest of 12% per annum, with principal and interest due on April 21, 2004.
This note is in default.
In April 2003, a new Equity Line of Credit Agreement was executed between
the Company and Cornell Capital Partners, L.P., whereby up to $10,000,000 worth
of the Company's common stock could have been purchased. The Company is in
default of this agreement. The Equity Line of Credit Agreement contained a
commitment fee of $190,000, payable in a convertible debenture, which was issued
to Cornell Capital Partners, L.P., and contained a placement fee of $10,000,
payable to the third party placement agent. In July 2003, the Company issued
2,049,180 shares of common stock as payment of the $10,000 placement fee. As of
March 4, 2005, no debentures have been converted.
In April 2003, the Company issued $200,000 of convertible debentures to
Cornell Capital Partners, L.P. 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 $45,000, with contribution to
paid-in capital. As of March 4, 2005, no debentures have been converted.
In April 2003, the Company issued a note payable in the amount of $25,000,
bearing interest at 10% per annum, to a consultant of the Company's subsidiary,
EnFacet, Inc., for past services rendered. The note was payable in monthly
$1,000 installments beginning in May 2003 and was replaced by $2,000 monthly
installments beginning in October 2003. The note is in default.
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 $2,826 (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 $1,413 (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 unregistered shares of the Company common stock
to each lender (at a total fair market value of $14,000), 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 "lock up" provision. These notes are currently in default.
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 in default.
In August 2003, the Company obtained an extension until November 2003 and
waivers of default for two notes of $50,000 and $25,000 issued by the Company to
a third party for loans in June and August 2002, respectively. The notes are in
default.
In November 2003, GIS issued a note payable to a third party in the amount
of $60,000 bearing an interest of 10% per annum, with principal and interest due
on November 5, 2004. The Company agreed to issue a 2% ownership interest of its
subsidiary, Government Internet Systems, Inc. to the third party in connection
with this note. In addition, 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 unregistered shares of Company's common stock (with a
fair market value of $5,000). The note is secured by 4,000,000 shares of common
22
stock of the Company that are 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 85% of Government Internet Systems, Inc., and will issue
a 2% ownership interest from its share of stock in GIS. This note is in default.
In November 2003, GIS issued a note payable to a third party in the amount
of $40,000 bearing an interest of 10% per annum, with principal and interest due
on November 19, 2004. The Company agreed to issue a 1.5% ownership interest of
its subsidiary, GIS to the third party in connection with this note. In
addition, 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 unregistered shares of Company's common stock (with a fair market
value of $4,000). The note is secured by 3,000,000 shares of common stock of the
Company that are 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 85% of Government Internet Systems, Inc., and will issue
a 1.5% ownership interest from its share of stock in GIS. $5,000 of this note
was not funded until January 2004. This note is in default.
In December 2003, the Company amended a note payable to a third party
lender in the amount of $239,004 bearing interest at 13% per annum and
unsecured, which was issued in 2002 to replace the note of $211,137 issued in
August 2001 to a third party lender. Pursuant to the extension in December 2003,
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. A
$65,000 payment was made in December 2002. In March 2003, the note had been
amended whereby the Company agreed to pay the interest and expenses responsible
by the lender for a third party loan secured on the lender's behalf. The note is
in default.
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 March
4, 2005, 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 Company is currently in default of its
obligation to redeem the note.
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 was due in two payments, the
first payment of $250,000 was due in February 2002 and the final payment of
$750,000 was 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
not less than $3,562,000 to offset against the note.
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 was
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 concerns
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). In November
2003, the New York Supreme Court dismissed all claims against Ross and Tinley
and stayed the Derivative Action against Arglen and Gyselen pending conclusion
of the Arbitration. The portion of the lawsuit involving Arglen and Gyselen was
23
settled in December 2003 and, pursuant to the settlement, dismissed in February
2004. The court dismissed the entire action against Ross and Tinley. The Company
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 of the dismissal of the action against Ross was submitted to the court
for decision. On appeal, the claims against Ross were reinstated pursuant to the
order of the Appellate Division, dated October 26, 2004. Thereafter, in November
2004, Ross filed an answer containing affirmative defenses in the Derivative
Action.
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 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. Now Solutions opposed the Ross motion and, on October 7, 2004, the
Court ruled in favor of Now Solutions and denied the motion for summary
judgment. Pursuant to New York State law, in the event a motion for summary
judgment in lieu of complaint is denied, the action continues and the pleadings
supporting the motion are deemed to constitute the complaint. Accordingly, Now
Solutions has filed an answer containing affirmative defenses and nine (9)
counterclaims against Ross. The affirmative defenses asserted by Now Solutions
include the same grounds which comprise the causes of action against Ross in the
Derivative Action, namely Ross' breach of the Asset Purchase Agreement as a
result of its failure to credit Now Solutions with adjustments at closing in an
amount not less than $3,562,201. All of the counterclaims asserted by Now
Solutions against Ross relate to the Asset Purchase Agreement and Ross' breaches
thereof. The counterclaims include: (i) breach of the covenant not to compete,
whereby Now Solutions seeks damages in excess of $10,000,000; (ii) breach of the
covenant to deliver all assets to Now Solutions at closing, whereby Now
Solutions seeks damages in an amount not less than $300,000; (iii) breach of a
certain Transitional Services Agreement (executed in conjunction with the Asset
Purchase Agreement), whereby Now Solutions seeks damages in an amount not less
than $73,129; and (iv) reasonable attorney's fees. In December 2004, Ross filed
a motion to dismiss two counterclaims: one which alleges that Ross and
Chinadotcom used Ross to breach a covenant not to compete and the second which
requested that Ross be enjoined from further competition with Now Solutions in
violation of the covenant. The motion was granted pursuant to a procedural
default. In February 2005, Now Solutions filed a motion to vacate the default
and reinstate the counterclaims, which motion is now pending.
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. Specifically, Ross seeks a judgment against the Company,: (i)
attaching the assets transferred to Arglen pursuant to the Settlement Agreement;
(ii) enjoining the Company and Now Solutions from making further transfers to
Arglen pursuant to the Arglen Note; (iii) avoiding the transfers to the Company
and Arglen or for judgment in the amount equivalent to the value of the asserts
transferred to them pursuant to the Settlement Agreement; and (iv) appointing a
receiver to take possession of the assets transferred to the Company and Arglen
pursuant to the Settlement Agreement. In July 2004, the Company and Now
Solutions filed a motion to stay the Delaware Action pending the resolution of
the parties' rights in the Derivative Action and Ross Action. In October 2004,
the motion was granted and the Delaware Action has been stayed.
The $5.5 million note payable, issued by Now Solutions to Coast and
purchased by WAMCO 32, 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
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. As of February 28, 2005, the outstanding principal balance due on the $5.5
million note is $1,162,280 and Now Solutions is delinquent on the principal of
the note by $267,500. Now Solutions has made all interest payments as of
February 28, 2005.
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 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
24
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 was 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 the $215,000 note issued by Now Solutions to the
Company to secure $190,000 in loans made by Victor Weber to the Company in 2003
and $25,000 in expenses paid by Mr. Weber on the behalf of the Company that were
included in Trade Accounts Payable. Mr. Weber had the option to have the Company
assign the $215,000 note to Mr. Weber provided that Mr. Weber forgives all of
the Company's outstanding debt and cancels all underlying notes in connection
with the debt. Mr. Weber elected to make this assignment in January 2004. At
that time, all other notes and debts due Mr. Weber were cancelled. Now Solutions
has made all interest payments as of February 28, 2005. Victor Weber is a
Director and President of Government Internet Systems, Inc., a subsidiary of the
Company.
In December 2003, the Company settled its arbitration and litigation 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. 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. In February 2004, the Company completed the
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 is junior to Now Solutions' present indebtedness to WAMCO 32,
Ltd. In addition, at closing, the Company cancelled 80,763,943 warrants held by
Arglen and issued to Arglen 20,000,000 unregistered shares of the common stock
of the Company (at a fair market value of $280,000), which is subject to a "lock
up" provision. The Company's purchase of Arglen's interest resulted in the
Company recognizing $1,680,000 of goodwill, which was written off in 2004.
Pursuant to the settlement agreement, the Company was also obligated to issue
5,000,000 unregistered shares of common stock of the Company to Arglen, due to
its failure to file a SB-2 registration statement within 180 days from the
settlement date. The note is in default. In August 2004, Arglen obtained a
default judgment in Los Angeles court for the outstanding principal, plus
attorney's fees and interest at the rate of 10% per annum. The Company has filed
a motion in the Delaware court to stay the enforcement of the judgment pending
resolution of the Delaware action.
In January 2004, Victor Weber elected to make the assignment of a $215,000
promissory note due December 31, 2004, issued by Now Solutions to the Company in
September 2003. In connection with the assignment, the notes payable for
$100,000, $50,000 and $40,000 issued to Mr. Weber as well as $25,000 of Trade
Accounts Payable to Mr. Weber were cancelled. The interest on the $215,000 note
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. In September 2004, the Company and Victor
Weber agreed to amend the terms of the $215,000 note issued by Now Solutions to
the Company and assigned to Mr. Weber. Pursuant to the terms of the amendment,
the Company agreed to issue 2,000,000 unregistered shares of common stock of the
Company (at a fair market value of $24,000), in exchange for amending the note.
In connection with the amendment, since the Company did not make full payment of
the note by December 31, 2004, the Company issued, in January 2005, an
additional 2,000,000 unregistered shares of common stock at a fair market value
of $10,000 and the note has been amended as follows: (a) the maturity date of
the note shall be extended to December 31, 2005; (b) the payment terms of the
note shall be amended so that, beginning in 2005, Now Solutions shall make (i)
monthly interest payments for all accrued interest during the previous month,
(ii) $50,000 in principal payments which will be due the end of each quarter
25
beginning March 31, 2005 and (iii) a final payment of all accrued interest and
principal which will be due no later than December 31, 2005. In addition, Mr.
Weber shall receive 2.5% royalty of sales by Now Solutions of its software that
exceed $8,000,000 per year up to $200,000. As of February 28, 2005, the Company
has made all interest payments. Victor Weber is a Director and President of
Government Internet Systems, Inc., a subsidiary of the Company.
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 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 unregistered
shares of common stock at $0.01 per share at a fair market value at the date of
issuance of $74,538 (valued using the Black-Scholes valuation model); (ii) 5
year warrants to purchase 5,000,000 unregistered shares of common stock of the
Company at $0.02 per share at a fair market value at the date of issuance of
$74,344 (valued using the Black-Scholes valuation model); (iii) 5 year warrants
to purchase 5,000,000 unregistered shares of common stock of the Company at
$0.03 per share at a fair market value at the date of issuance of $74,200
(valued using the Black-Scholes valuation model); (iv) 5,000,000 unregistered
shares of common stock of the Company (at a fair market value of $75,000); and
(v) an additional 5,000,000 unregistered shares of common stock of the Company
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 "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 is junior to Now Solutions' present indebtedness to
WAMCO 32, Ltd and Arglen. Robert Farias is a director of Now Solutions, a 100%
owned subsidiary of the Company. The note is in default. As of March 4, 2005,
Now Solutions had made principal payments totaling $183,000 to Robert Farias. In
January 2005, WAMCO 32, Ltd. notified Mr. Farias that pursuant to the
subordination agreement executed between WAMCO 32, Ltd. and Mr. Farias, Mr.
Farias was no longer to accept payments from or to take any collection actions
against Now Solutions for the repayment of junior debt.
In February 2004, the note payable in the amount of $84,000 issued by
EnFacet to Robert Farias, dated June 1, 2001, bearing interest at 12% per annum,
unsecured, with principal and interest due on June 1, 2002 was amended by the
parties. Pursuant to the amendment Robert Farias waived any defaults on the note
and the note was amended 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 Mr. 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 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 is junior to Now Solutions' present indebtedness to
WAMCO 32, Ltd, Arglen Acquisitions, and Robert Farias in connection with the
$500,000 note. In an amendment between the parties in March 2003, the interest
rate was increased from 8% to 12% and accrued from the date the note was issued
in exchange for extending the note. Robert Farias is a director of Now
Solutions, a 100% owned subsidiary of the Company. This note is in default.
In February 2004, 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 connection with the amendment, the Company and Robert
Farias also amended the $181,583 note issued to Mr. Farias on October 17, 2002.
Pursuant to the amendment, any default on these notes was waived, and the
Company agreed to make the following payments on these 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, 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
26
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. Robert Farias is a
director of Now Solutions, a 100% owned subsidiary of the Company. The note is
in default.
In February 2004, the note payable in the amount of $181,584 issued to
Robert Farias in October 2003, bearing interest at 12% per annum was amended. In
connection with the amendment, the Company and Mr. Farias also amended the
$280,000 note issued to Mr. Farias on October 31, 2001. Pursuant to the
amendment, any default on these notes was waived, and the Company agreed to make
the following payments on these 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, 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. Robert Farias is a director of Now Solutions, a
100% owned subsidiary of the Company. The note is secured by 10,450,000 shares
of the Company's common stock that are owned by Mountain Reservoir Corp. to
cover any shortfall. Mountain Reservoir Corporation is a corporation controlled
by the W5 Family Trust. Mr. Wade, the President and CEO of the Company, is the
trustee of the W5 Family Trust. The note is in default.
In February 2004, the Company and a third party amended a note payable in
the amount of $90,000 dated June 26, 2003, bearing an interest of 10% annum,
with principal and interest due on March 28, 2004. 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 Mr. 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 is junior to Now Solutions' present indebtedness to WAMCO 32, Ltd, Arglen
Acquisitions, and Robert Farias in connection with the $500,000 note. This note
is in default.
In February 2004, the Company, on behalf of its subsidiary EnFacet, and a
third party amended a note payable in the amount of $350,000 issued by EnFacet
bearing interest at 8% per annum and originally due on February 28, 2003.
Pursuant to the amendment, the parties 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 Mr. 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 is junior to Now
Solutions' present indebtedness to WAMCO 32, Ltd, Arglen Acquisitions, and
Robert Farias in connection with the $500,000 note. This note is in default.
In February 2004, the Company completed 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 is
junior to Now Solutions' present indebtedness to WAMCO 32, Ltd. In addition, at
closing, the Company cancelled 80,763,943 warrants held by Arglen and issued to
Arglen 20,000,000 unregistered shares of the common stock of the Company (at a
fair market value of $280,000), which are subject to "lock-up" provisions . This
transaction resulted in the Company recognizing $1,680,000 of goodwill, which
was written off in 2004. Pursuant to the settlement agreement, the Company was
27
also obligated to issue an additional 5,000,000 unregistered shares of common
stock of the Company to Arglen, due to its failure to file a SB-2 registration
statement within 180 days from the settlement date. The note is in default. In
August 2004, Arglen obtained a default judgment in Los Angeles court for the
outstanding principal, plus attorney's fees and interest at the rate of 10% per
annum. The Company has filed a motion in the Delaware court to stay the
enforcement of the judgment pending resolution of the Delaware action.
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 stockholders' equity at June 30, 2004 was approximately
$12.5 million. Additionally, at June 30, 2004, the Company had negative working
capital of approximately $11.7 million (although it includes deferred revenue of
approximately $2.8 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 funds for its operations and
to pay down its liabilities, as well as finance its expansion plans consistent
with the Company's anticipated changes in operations and infrastructure.
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 financial statements contain no adjustment for the outcome of this
uncertainty.
Furthermore, the Company is exploring certain opportunities with a number
of companies to participate in marketing of its products. The exact results of
these opportunities are unknown at this time.
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 June 30, 2004, 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 January 2004, the Company agreed to issue 1,000,000 unregistered shares
of the Company's common stock (at a fair market value of $3,000), subject to
"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 was due in April 30, 2004. In
April 2004, the due date on the note was extended to August 1, 2004. In January
2005, the due date on the note was extended to April 30, 2005. Mr. Salz is the
Company's corporate counsel.
In January 2004, Victor Weber elected to make the assignment of a $215,000
promissory note due December 31, 2004, issued by Now Solutions to the Company in
September 2003. In connection with the assignment, the notes payable for
$100,000, $50,000 and $40,000 issued to Mr. Weber as well as $25,000 of Trade
Accounts Payable to Mr. Weber were cancelled. The interest on the $215,000 note
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. In September 2004, the Company and Victor
Weber agreed to amend the terms of the $215,000 note issued by Now Solutions to
the Company and assigned to Mr. Weber. Pursuant to the terms of the amendment,
28
the Company agreed to issue 2,000,000 unregistered shares of common stock of the
Company (at a fair market value of $24,000), in exchange for amending the note.
In connection with the amendment, since the Company did not make full payment of
the note by December 31, 2004, the Company issued, in January 2005, an
additional 2,000,000 unregistered shares of common stock at a fair market value
of $10,000 and the note has been amended as follows: (a) the maturity date of
the note shall be extended to December 31, 2005; (b) the payment terms of the
note shall be amended so that, beginning in 2005, Now Solutions shall make (i)
monthly interest payments for all accrued interest during the previous month,
(ii) $50,000 in principal payments which will be due the end of each quarter
beginning March 31, 2005 and (iii) a final payment of all accrued interest and
principal which will be due no later than December 31, 2005. In addition, Mr.
Weber shall receive 2.5% royalty of sales by Now Solutions of its software that
exceed $8,000,000 per year up to $200,000. As of February 28, 2005, the Company
has made all interest payments. Victor Weber is a Director and President of
Government Internet Systems, Inc., a subsidiary of the Company.
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 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 unregistered
shares of common stock at $0.01 per share at a fair market value at the date of
issuance of $74,538 (valued using the Black-Scholes valuation model); (ii) 5
year warrants to purchase 5,000,000 unregistered shares of common stock of the
Company at $0.02 per share at a fair market value at the date of issuance of
$74,344 (valued using the Black-Scholes valuation model); (iii) 5 year warrants
to purchase 5,000,000 unregistered shares of common stock of the Company at
$0.03 per share at a fair market value at the date of issuance of $74,200
(valued using the Black-Scholes valuation model); (iv) 5,000,000 unregistered
shares of common stock of the Company (at a fair market value of $75,000); and
(v) an additional 5,000,000 unregistered shares of common stock of the Company
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 "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 is junior to Now Solutions' present indebtedness to
WAMCO 32, Ltd and Arglen. Robert Farias is a director of Now Solutions, a 100%
owned subsidiary of the Company. The note is in default. As of March 4, 2005,
Now Solutions had made principal payments totaling $183,000 to Robert Farias. In
January 2005, WAMCO 32, Ltd. notified Mr. Farias that pursuant to the
subordination agreement executed between WAMCO 32, Ltd. and Mr. Farias, Mr.
Farias was no longer to accept payments from or to take any collection actions
against Now Solutions for the repayment of junior debt..
In February 2004, the note payable in the amount of $84,000 issued by
EnFacet to Robert Farias, dated June 1, 2001, bearing interest at 12% per annum,
unsecured, with principal and interest due on June 1, 2002 was amended by the
parties. Pursuant to the amendment Robert Farias waived any defaults on the note
and the note was amended 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 Mr. 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 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 is junior to Now Solutions' present indebtedness to
WAMCO 32, Ltd, Arglen Acquisitions, and Robert Farias in connection with the
$500,000 note. In an amendment between the parties in March 2003, the interest
rate was increased from 8% to 12% and accrued from the date the note was issued
in exchange for extending the note. Robert Farias is a director of Now
Solutions, a 100% owned subsidiary of the Company. This note is in default.
In February 2004, 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 connection with the amendment, the Company and Robert
Farias also amended the $181,583 note issued to Mr. Farias on October 17, 2002.
Pursuant to the amendment, any default on these notes was waived, and the
Company agreed to make the following payments on these 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, all amounts still owing
under these notes will be considered in default and the following shall apply:
29
(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. Robert Farias is a
director of Now Solutions, a 100% owned subsidiary of the Company. The note is
in default.
In February 2004, the note payable in the amount of $181,584 issued to
Robert Farias in October 2003, bearing interest at 12% per annum was amended. In
connection with the amendment, the Company and Mr. Farias also amended the
$280,000 note issued to Mr. Farias on October 31, 2001. Pursuant to the
amendment, any default on these notes was waived, and the Company agreed to make
the following payments on these 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, 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. Robert Farias is a director of Now Solutions, a
100% owned subsidiary of the Company. The note is secured by 10,450,000 shares
of the Company's common stock that are owned by Mountain Reservoir Corp. to
cover any shortfall. Mountain Reservoir Corporation is a corporation controlled
by the W5 Family Trust. Mr. Wade, the President and CEO of the Company, is the
trustee of the W5 Family Trust. The note is in default.
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 unregistered shares of the common stock of the Company (at a fair
market value of $135,000), which are subject to "piggy-back" registration
rights. As of March 31, 2004, the transaction was fully reserved. Robert Farias
is a director of Now Solutions, a 100% owned subsidiary of the Company.
In August 2004, the Company licensed the use the Forums and calendar
applications of the Company's SiteFlash technology to Basix1, Inc. ("Basix1")
for use in Basix1's Enterprise Knowledge Gateway (EKG) software. Pursuant to the
terms of the license, Basix1 shall pay the Company 10% of all license fees
generated from the exploitation Basix1's EKG software. Mr. Kensicki is a
Director of GIS and Now Solutions and is also the President of Basix1, Inc.
In October 2004, the Company and Stephen Rossetti agreed to amend the
terms of a consulting agreement and the $7,500 promissory note issued in May
2003. Pursuant to the terms of the amendment, the Company issued 6,500,000
unregistered shares of common stock of the Company (at a fair market value of
$84,500), as full payment for services rendered under the consulting agreement
and the $7,500 note, which has been cancelled. As of March 4, 2005, 2,900,145 of
the 4,150,145 warrants issued for consulting services for the Company and GIS
expired. Mr. Rossetti is the CEO and a Director of GIS and Now Solutions.
In January 2005, the Company entered into a marketing agreement with CW
International, LLC. Mr. Weber is a Director and President of Government Internet
Systems, Inc. and a member of CW International, LLC.
30
Critical Accounting Policies
Use of Estimates
The preparation of financial statements in conformity with accounting
principles generally accepted in the United States of America requires
management to make estimates and assumptions that affect the reported amounts of
assets and liabilities and disclosure of contingent assets and liabilities at
the date of financial statements and the reported amounts of revenue and
expenses during the reporting period. Among the more significant estimates
included in these financial statements are the estimated allowance for doubtful
accounts receivable and the deferred income tax asset allowance. Actual results
could materially differ from those estimates.
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 six months ended June 30,
2004 and 2003, 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 2003, the Company determined
that there was a $2,873,997 of impairment in goodwill, of which $1,610,524 was
located in Now Solutions and $1,263,473 in the Company itself. For the six
months ended June 30, 2004, the Company determined that there was a $1,760,000
of impairment in goodwill, all of which located in the Company.
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."
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. 104 "Revenue
Recognition", the Company recognizes revenue from license of computer software
"up-front" provided 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.
31
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 January 2003, the FASB issued FASB Interpretation No. 46 (FIN 46),
"Consolidation of Variable Interest Entities." FIN 46, as amended by FIN 46(R),
issued in January 2003, requires an investor with a majority of the variable
interests in a variable interest entity to consolidate the entity and also
requires majority and significant variable interest investors to provide certain
disclosures. A variable interest entity is an entity in which the equity
investors do not have a controlling financial interest or the equity investment
at risk is insufficient to finance the entity's activities without receiving
additional subordinated financial support form other parties. The provisions of
FIN 46(R) are applicable for fiscal years ending after December 15, 2004. The
Company does not have any variable interest entities that must be consolidated.
In December 2004, the FASB announced that SFAS No. 123R (revised December
2004), "Share-Based Payment," sets accounting requirements for "share-based"
compensation to employees, including employee-stock-purchase-plans (ESPPs) and
provides guidance on accounting for awards to non-employees. This Statement will
require the Company to recognize in the income statement the grant-date fair
value of stock options and other equity-based compensation issued to employees,
but expresses no preference for a type of valuation model. For public entities,
this Statement is effective for the first interim period beginning after June
15, 2005. The Company will adopt this Statement in the second quarter of fiscal
2005 and is evaluating this pronouncement's effect on the Company's financial
position and net income.
In December 2004, the FASB issued FASB Staff Position No. FAS109-1 ("FSP
FAS 109-1"), "Application of FASB Statement No. 109, Accounting for Income
Taxes, for the Tax Deduction on Qualified Production Activities Provided by the
American Jobs Creation Act of 2004." FSP FAS 109-1 clarifies that the deduction
will be treated as a "special deduction" as described in Statement of Financial
Accounting Standards No. 109, "Accounting for Income Taxes." As such, the
special deduction has no effect on deferred tax assets and liabilities existing
at the date of enactment. The impact of the deduction will be reported in the
period in which the deduction is claimed. We are currently assessing the
financial impact of FSP FAS 109-1 on our consolidated financial statements.
Factors Affecting the Company's Business, Operating Results and Financial
Condition
We are subject to various risks that may materially harm our business,
financial condition and results of operations. You should carefully consider the
risks and uncertainties described below and the other information in this filing
before deciding to purchase our common stock. If any of these risks or
uncertainties actually occurs, our business, financial condition or operating
results could be materially harmed. In that case, the trading price of our
common stock could decline and you could lose all or part of your investment.
We Have Historically Incurred Losses and May Continue to Do So in the
Future
We have historically incurred losses. In the six months ended June 30,
2004 and the year ended December 31, 2003, we had net losses applicable to
common stockholders of $(4,341,419) and $(7,118,407), 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.
32
We Have Been Subject to a Going Concern Opinion from Our Independent
Auditors, Which Means That We May Not Be Able to Continue Operations
Unless We Obtain Additional Funding
The report of our independent registered public accounting firm included
an explanatory paragraph in connection with our financial statements for the
year ended December 31, 2003. This paragraph states that our recurring operating
losses, negative working capital and accumulated deficit, the substantial funds
used in our operations and the need to raise additional funds to accomplish our
objectives raise substantial doubt about our ability to continue as a going
concern. Our ability to develop our business plan and to continue as a going
concern depends upon our ability to raise capital and to achieve improved
operating results. Our financial statements do not include any adjustments that
might result from the outcome of this uncertainty.
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 and six
months ended June 30, 2004 and 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 June 30, 2004 was approximately
$12.5 million. Additionally, at June 30, 2004, the Company had negative working
capital of approximately $11.7 million (although it includes deferred revenue of
approximately $2.8 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 attempt to secure
funds through equity and/or debt instruments for its operations, expansion and
possible acquisitions, mergers, joint ventures, and/or other business
combinations. The Company will require additional funds for its operations and
to pay down its liabilities, as well as finance its expansion plans consistent
with the Company's anticipated changes in operations and infrastructure.
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.
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.
33
We Have a Working Capital Deficit, Which Means That Our Current Assets on
June 30, 2004 Were Not Sufficient to Satisfy Our Current Liabilities on
that Date
We had a working capital deficit of approximately $11.7 million at June
30, 2004, which means that our current liabilities exceeded our current assets
by approximately $11.7 million. Current assets are assets that are expected to
be converted into cash within one year and, therefore, may be used to pay
current liabilities as they become due. Our working capital deficit means that
our current assets at June 30, 2004 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.
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. 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.
34
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.
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.
35
ITEM 3. CONTROLS AND PROCEDURES
(A) Evaluation Of Disclosure Controls And Procedures
As of the end of the period covered by this report, the Company carried
out an evaluation, under the supervision and with the participation of the
Company's Principal Executive Officer and Principal Financial Officer, of the
effectiveness of the design and operation of the Company's disclosure controls
and procedures. The Company's disclosure controls and procedures are designed to
provide a reasonable level of assurance of achieving the Company's disclosure
control objectives. The Company's Principal Executive Officer and Principal
Accounting Officer have concluded that the Company's disclosure controls and
procedures are, in fact, effective at this reasonable assurance level as of the
of period covered.
(B) Changes In Internal Controls Over Financial Reporting
In connection with the evaluation of the Company's internal controls
during the Company's last fiscal quarter, the Company's Principal Executive
Officer and Principal Financial Officer have determined that there are no
changes to the Company's internal controls over financial reporting that has
materially affected, or is reasonably likely to materially effect, the Company's
internal controls over financial reporting.
PART II
OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
The Company is, from time to time, involved in various lawsuits generally
incidental to its business operations, consisting primarily of collection
actions and vendor disputes. In the opinion of management, the ultimate
resolution of these matters, if any, may have a significant effect on the
financial position, operations or cash flows of the Company.
In addition, the Company is involved in the following additional ongoing
matters:
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 was
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 concerns
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). In November
2003, the New York Supreme Court dismissed all claims against Ross and Tinley
and stayed the Derivative Action against Arglen and Gyselen pending conclusion
of the Arbitration. The portion of the lawsuit involving Arglen and Gyselen was
settled in December 2003 and, pursuant to the settlement, dismissed in February
2004. The court dismissed the entire action against Ross and Tinley. The Company
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 of the dismissal of the action against Ross was submitted to the court
for decision. On appeal, the claims against Ross were reinstated pursuant to the
order of the Appellate Division, dated October 26, 2004. Thereafter, in November
2004, Ross filed an answer containing affirmative defenses in the Derivative
Action.
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 appealed the August
2003 court order, but subsequently abandoned its appeal.
In December 2003, the Company settled its arbitration and litigation 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. 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. In February 2004, the Company completed the
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 is junior to Now Solutions' present indebtedness to WAMCO 32,
Ltd. In addition, at closing, the Company cancelled 80,763,943 warrants held by
Arglen and issued to Arglen 20,000,000 unregistered shares of the common stock
of the Company (at a fair market value of $280,000), which is subject to a "lock
up" provision. The Company's purchase of Arglen's interest resulted in the
Company recognizing $1,680,000 of goodwill, which was written off in 2004.
Pursuant to the settlement agreement, the Company was also obligated to issue
5,000,000 unregistered shares of common stock of the Company to Arglen, due to
its failure to file a SB-2 registration statement within 180 days from the
settlement date. The note is in default. In August 2004, Arglen obtained a
default judgment in Los Angeles court for the outstanding principal, plus
attorney's fees and interest at the rate of 10% per annum. The Company has filed
a motion in the Delaware court to stay the enforcement of the judgment pending
resolution of the Delaware action.
At December 31, 2003, the Company had non-restricted cash-on-hand of
$962,454. Now Solutions' non-restricted cash-on-hand of $954,720 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 and when the
settlement was completed in February 2004, the Company and Arglen dismissed all
claims with respect to one another. As a result, the cash-on-hand of Now
Solutions became available to fund the Company's operations.
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. Now Solutions opposed the Ross motion and, on October 7, 2004, the
Court ruled in favor of Now Solutions and denied the motion for summary
judgment. Pursuant to New York State law, in the event a motion for summary
judgment in lieu of complaint is denied, the action continues and the pleadings
supporting the motion are deemed to constitute the complaint. Accordingly, Now
Solutions has filed an answer containing affirmative defenses and nine (9)
counterclaims against Ross. The affirmative defenses asserted by Now Solutions
include the same grounds which comprise the causes of action against Ross in the
Derivative Action, namely Ross' breach of the Asset Purchase Agreement as a
result of its failure to credit Now Solutions with adjustments at closing in an
amount not less than $3,562,201. All of the counterclaims asserted by Now
Solutions against Ross relate to the Asset Purchase Agreement and Ross' breaches
thereof. The counterclaims include: (i) breach of the covenant not to compete,
whereby Now Solutions seeks damages in excess of $10,000,000; (ii) breach of the
covenant to deliver all assets to Now Solutions at closing, whereby Now
Solutions seeks damages in an amount not less than $300,000; (iii) breach of a
certain Transitional Services Agreement (executed in conjunction with the Asset
Purchase Agreement), whereby Now Solutions seeks damages in an amount not less
than $73,129; and (iv) reasonable attorney's fees. In December 2004, Ross filed
a motion to dismiss two counterclaims: one which alleges that Ross and
Chinadotcom used Ross to breach a covenant not to compete and the second which
requested that Ross be enjoined from further competition with Now Solutions in
violation of the covenant. The motion was granted pursuant to a procedural
default. In February 2005, Now Solutions filed a motion to vacate the default
and reinstate the counterclaims, which motion is now pending.
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 monies to Arglen pursuant to the settlement dated December 2003. The
Company and Now Solutions have filed a motion to stay the Delaware action
37
pending the resolution of the parties' rights in Supreme Court, New York County
and Appellate Division. Specifically, Ross seeks a judgment against the Company:
(i) attaching the assets transferred to Arglen pursuant to the Settlement
Agreement; (ii) enjoining the Company and Now Solutions from making further
transfers to Arglen pursuant to the Arglen Note; (iii) avoiding the transfers to
the Company and Arglen or for judgment in the amount equivalent to the value of
the asserts transferred to them pursuant to the Settlement Agreement; and (iv)
appointing a receiver to take possession of the assets transferred to the
Company and Arglen pursuant to the Settlement Agreement. In July 2004, the
Company and Now Solutions filed a motion to stay the Delaware Action pending the
resolution of the parties' rights in the Derivative Action and Ross Action. In
October 2004, the motion was granted and the Delaware action has been stayed.
In December 2004, the Company was notified by the Securities Exchanges
Commission ("SEC") that the SEC has suspended trading of VCSY common stock
pursuant to an Order Filed by the SEC because the Company has been delinquent in
its periodic filing obligations under Section 13(a) of the Securities Exchange
Act of 1934 since the period ending September 30, 2003. Also in December 2004,
the Company was notified by the SEC of an administrative proceeding pursuant to
the filing of an "Order Instituting Administrative Proceedings and Notice of
Hearing Pursuant to Section 12(j) of the Securities Exchange Act of 1934" due to
the delinquency of filing of the Form 10-KSB for the year ended 2003 and the
Form 10-QSB for the first three quarters of 2004. The Company filed its Form-KSB
for the year ended 2003 on January 19, 2005.
In January 2005, Parker, Mills, and Patel filed a lawsuit to collect the
outstanding balance of $23,974 due under the promissory note issued by the
Company to Parker, Mills and Patel and for failure to pay fees for professional
services in the amount of $89,930 rendered to the Company, plus interest. The
Company intends to file a response.
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS
In January 2004, the Company issued 1,500,000 unregistered shares of
common stock of the Company to two consultants of the Company for services (at a
fair-market value of $4,500).
In January 2004, the Company purchased a 5% membership interest in Now
Solutions from Stephen Parnes for $75,000 and 1,000,000 unregistered shares of
common stock of the Company (at a fair market value of $3,000). This transaction
resulted in the Company recognizing $80,000 of goodwill, which was written off
in the first quarter of 2004. The Company also paid Mr. Parnes' legal fees in
the amount of $2,000. The stock is subject to "piggy-back" registration rights
and a "lock-up" provision.
In January 2004, the Company issued 10,000,000 unregistered shares of
common stock of the Company (at a fair market value of $30,000) with
"piggy-back" registration rights and subject to a "lock-up" provision 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 unregistered shares of common stock of the Company (at a fair market
value of $12,000) with "piggy-back" registration rights stock and subject to a
"lock up" provision.
In January 2004, the Company agreed to issue 1,000,000 unregistered shares
of the Company's common stock (at a fair market value of $3,000), subject to
"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 was due in April 30, 2004. In
April 2004, the due date on the note was extended to August 1, 2004. In January
2005, the due date on the note was extended to April 30, 2005. Mr. Salz is the
Company's corporate counsel.
In February 2004, $10,000 of principal from a convertible debenture and
$925 in interest was redeemed for a total of $10,925. In July 2004, $20,000 of
principal and $2,277 in interest was converted into 1,076,170 shares of common
stock of the Company. These debentures were originally part of a $100,000
convertible debenture issued in March 2002. The holder of the remaining $10,000
of debentures is a third party.
In February 2004, 7,500 shares of Series C preferred stock, reserved for
an employee under his employment agreement, were cancelled after he terminated
his agreement with the Company. The remaining 15,000 preferred C shares were
also cancelled since the Company determined not to utilize these shares for any
future funding activities for EnFacet. These shares of Series C preferred stock
were part of the stock purchase agreement of EnFacet, Inc., as amended. Pursuant
to the amendment, the Company had the right to substitute 400 common shares for
each share of Series C preferred stock (up to 12,000,000 shares of the Company's
common stock) in connection with the purchase of EnFacet, Inc. The Company also
had the right to cancel any Series C preferred stock for which common stock is
substituted or as otherwise specified in the amended agreement.
38
In February 2004, in connection with a $500,000 loan made by Robert Farias
to Now Solutions, the Company issued (i) 5 year warrants to purchase 5,000,000
unregistered shares of common stock at $0.01 per share at a fair market value at
the date of issuance of $74,538 (valued using the Black-Scholes valuation
model); (ii) 5 year warrants to purchase 5,000,000 unregistered shares of common
stock of the Company at $0.02 per share at a fair market value at the date of
issuance of $74,344 (valued using the Black-Scholes valuation model); (iii) 5
year warrants to purchase 5,000,000 unregistered shares of common stock of the
Company at $0.03 per share at a fair market value at the date of issuance of
$74,200 (valued using the Black-Scholes valuation model); (iv) 5,000,000
unregistered shares of common stock of the Company (at a fair market value of
$75,000), and (v) an additional 5,000,000 unregistered shares of common stock of
the Company 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 "piggy-back" registration
rights. Robert Farias is a director of Now Solutions, a 100% owned subsidiary of
the Company.
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 unregistered shares of the common stock of the Company (at a fair
market value of $135,000), which are subject to "piggy-back" registration
rights. As of March 31, 2004, the transaction was fully reserved. Robert Farias
is a director of Now Solutions, a 100% owned subsidiary of the Company.
In February 2004, the Company issued to Arglen Acquisitions ("Arglen")
20,000,000 unregistered shares of the common stock of the Company (at a fair
market value of $280,000), which is subject to a "lock-up" provision. These
shares were issued in connection with the closing of the Company's settlement
with Arglen. In addition, at closing, the Company cancelled 80,763,943 warrants
held by Arglen. Pursuant to the settlement agreement, the Company was also
obligated to issue 5,000,000 unregistered shares of common stock of the Company
to Arglen, due to its failure to file a SB-2 registration statement within 180
days from the settlement date.
In February 2004, the Company issued 500,000 unregistered shares of the
Company common stock to each lender (at a total fair market value of $14,000),
in connection with the amendment of two promissory notes each for a principal
amount of $17,500. The notes were issued in May 2003 in connection with two
loans to the Company for an aggregate amount of $30,000. The stock issued to
each lender is subject to "piggy back" registration rights and a "lock up"
provision.
In March 2004, the Company issued 5-year incentive stock options to
purchase 2,500,000 shares of common stock of the Company at an exercise price of
$0.014 per share to Sheri Pantermuehl in connection with Ms. Pantermuehl's
employment agreement to serve as CFO of the Company and Now Solutions. In
addition, Now Solutions issued 1.5% of so-called "phantom stock" of Now
Solutions to Ms. Pantermuehl. The fair market value of these warrants at the
date of issuance was $74,616 (valued using the Black-Scholes valuation model).
During the three months ended March 31, 2004, the Company granted
five-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 a "lock-up" provision. The stock
options were issued in connection with employment agreements executed in January
2004. The fair market value of these warrants at the date of issuance was $8,878
(valued using the Black-Scholes valuation model). In addition, Now Solutions
entered into agreements with these two employees pursuant to which they are
entitled to receive a total of 3% ownership interest of "phantom" stock in Now
Solutions. In September 2004, one of the employees resigned. Consequently, the
Company cancelled options to purchase 1,500,000 shares of common stock of the
Company and Now Solutions cancelled 1.5% ownership interest of "phantom" stock.
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 five-year warrants to purchase 250,000 shares of
common stock of the Company at an exercise price of $0.025 per share at a fair
market value at the date of issuance of $6,185 (valued using the Black-Scholes
valuation model).
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 unregistered shares of common stock of the Company, vested 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 September 2004, all of the
shares vested and were issued (at a fair market value of $5,190).
39
In June 2004, the Company issued warrants to WAMCO 32, Ltd to purchase
3,000,000 shares of the common stock Company at an exercise price of $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 fractional 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 "lock-up" provision. The fair market value of the warrants was $74,142
(valued using the Black-Scholes valuation model). These warrants were issued in
connection with the amendment of the note payable to the successor lender, WAMCO
32, Ltd.
In June 2004, a third party consultant exercised the warrant to purchase
1,170,424 shares of common stock of the Company at an exercise price of $0.037
per share. The parties also entered into an agreement whereby the Company offset
the total purchase price of the shares as full payment for outstanding debt of
$43,306 owed by the Company to the consultant.
In September 2004, the Company and Victor Weber agreed to amend the terms
of the $215,000 note issued by Now Solutions to the Company and assigned to Mr.
Weber. Pursuant to the terms of the amendment, the Company agreed to issue
2,000,000 unregistered shares of common stock of the Company (at a fair market
value of $24,000), in exchange for amending the note. In connection with the
amendment, since the Company did not make full payment of the note by December
31, 2004, the Company issued, in January 2005, an additional 2,000,000
unregistered shares of common stock at a fair market value of $10,000 and the
note has been amended as follows: (a) the maturity date of the note shall be
extended to December 31, 2005; (b) the payment terms of the note shall be
amended so that, beginning in 2005, Now Solutions shall make (i) monthly
interest payments for all accrued interest during the previous month, (ii)
$50,000 in principal payments which will be due the end of each quarter
beginning March 31, 2005 and (iii) a final payment of all accrued interest and
principal which will be due no later than December 31, 2005. In addition, Mr.
Weber shall receive 2.5% royalty of sales by Now Solutions of its software that
exceed $8,000,000 per year up to $200,000. As of February 28, 2005, the Company
has made all interest payments. Mr. Weber is the President and a Director of
Government Internet Systems, Inc.
In October 2004, the Company and Stephen Rossetti agreed to amend the
terms of a consulting agreement and the $7,500 promissory note issued in May
2003. Pursuant to the terms of the amendment, the Company issued 6,500,000
shares of common stock of the Company (at a fair market value of $84,500),
subject to Rule 144 Regulation, as full payment for services rendered under the
consulting agreement and the $7,500 note, which has been cancelled. As of March
4, 2005, 2,900,145 of the 4,150,145 warrants issued for consulting services for
the Company and GIS expired. Mr. Rossetti is the CEO and a Director of GIS and
Now Solutions.
In October 2004, GIS and Grant Consultants of America ("GCA") entered into
a consulting agreement to provide services concerning government grants. In
connection with the agreement, the Company issued warrants to purchase 3,000,000
shares of common stock at an exercise price of $0.0165 per share at a fair
market value at the date of issuance of $49,385 (valued using the Black-Scholes
valuation model). In the event that the GCA did not procure a government
contract for the state of Nevada within 90 days, the warrant would automatically
be cancelled. Accordingly, these warrants were automatically cancelled in
January 2005 pursuant to the terms of the agreement.
In November 2004, the United States Patent and Trademark Office granted a
patent (No. 6,826,744) for an invention for "System and Method for Generating
Web Sites In an Arbitrary Object Framework". This patent is the foundation of
the Company's SiteFlash and related technology, which are currently deployed in
ResponseFlash, NewsFlash, and UniversityFlash.
During the year ended December 31, 2004, incentive stock options to
purchase 10,340,000 shares of common stock of the Company at a price of $0.010
to $0.086 per share expired.
During the year ended December 31, 2004, non-incentive stock options to
purchase 1,500,000 shares of common stock of the Company at a price of $0.041 to
$0.086 per share expired.
During the year ended December 31, 2004, warrants to purchase 18,569,696
shares of common stock of the Company at a price of $0.012 to $0.35 per share
expired.
During the period of January 1 to March 4, 2005, no incentive stock
options to purchase shares of common stock of the Company expired.
During the period of January 1 to March 4, 2005, no non-incentive stock
options to purchase shares of common stock of the Company expired.
40
During the period of January 1 to March 4, 2005, warrants to purchase
4,971,644 shares of common stock of the Company at a price of $0.011 to $0.35
per share expired.
ITEM 3. DEFAULT UNDER SENIOR SECURITIES
The $5.5 million secured promissory note, bearing interest at 9% per
annum, issued by Now Solutions to Coast and purchased by WAMCO 32, Ltd., as
amended in June 2004, is currently delinquent. The security interest of Now
Solutions' assets on the secured promissory note is senior to Now Solutions'
present indebtedness to Arglen and Robert Farias. Now Solutions has made all
interest payments as of February 28, 2005 but it is $267,501 delinquent in
principle payments. The Company has not received a notice of default from WAMCO
32, Ltd. The Company is in discussions with the holder of the note to resolve
the outstanding payments.
The 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 is junior to Now Solutions' present
indebtedness to WAMCO 32, Ltd. The note is currently in default. In August 2004,
Arglen obtained a default judgment in Los Angeles court. The Company and Now
Solutions owe interest and legal fees in addition to the principal outstanding
on the note. The Company has filed a motion in the Delaware court to stay the
enforcement of the judgment pending resolution of the Delaware action.
The interest bearing secured promissory note in the amount of $500,000
providing for payments of $91,500 beginning in October 2004, issued by Now
Solutions to Mr. Farias in connection with the loan to Now Solutions is
currently in default. The security interest of Now Solutions' assets on the
secured promissory note is junior to Now Solutions' present indebtedness to
WAMCO 32, Ltd and Arglen. As of March 4, 2005, Now Solutions had made principal
payments totaling $183,000 to Robert Farias. In January 2005, WAMCO 32, Ltd.
notified Mr. Farias that pursuant to the subordination agreement executed
between WAMCO 32, Ltd. and Mr. Farias, Mr. Farias was no longer to accept
payments from or to take any collection actions against Now Solutions for the
repayment of junior debt. The Company is in discussions with the holder of the
note to resolve the outstanding payments. Mr. Farias is a director of Now
Solutions, a 100% owned subsidiary of the Company.
The $84,000 promissory note, bearing interest at 12% per annum, as
amended, issued by Enfacet, Inc. to Robert Farias in June 2001 is currently in
default. The security interest of Now Solutions' assets on the secured
promissory note is junior to Now Solutions' present indebtedness to WAMCO 32,
Ltd, and Arglen and the Robert Farias $500,000 promissory note. Mr. Farias is a
director of Now Solutions, a 100% owned subsidiary of the Company.
The $350,000 promissory note, bearing interest at 8% per annum, as
amended, issued by Enfacet, Inc. to a third party in August 2001 is currently in
default. The security interest of Now Solutions' assets on the secured
promissory note is junior to Now Solutions' present indebtedness to WAMCO 32,
Ltd, Arglen, and the Robert Farias $500,000 promissory note.
The $90,000 promissory note, bearing interest at 10% per annum, as
amended, issued by the Company to a third party in June 2003 is currently in
default. The security interest of Now Solutions' assets on the secured
promissory note is junior to Now Solutions' present indebtedness to WAMCO 32,
Ltd, Arglen, and the Robert Farias $500,000 promissory note.
The $280,000 promissory note, bearing interest at 12% per annum and issued
to Robert Farias on October 31, 2001, as amended by the parties, is currently in
default. The security interest of Now Solutions' assets on the secured
promissory note is junior to Now Solutions' present indebtedness to WAMCO 32,
Ltd, and Arglen, the Robert Farias $500,000 promissory note, and the $84,000,
$350,000, and $90,000 promissory notes. The security interest of the Company's
SiteFlash technology assets owned by the Company is the only security interest
that has been granted by the Company. Mr. Farias is a director of Now Solutions,
a 100% owned subsidiary of the Company.
The $181,584 promissory note, bearing interest at 12% per annum, as
amended, issued by the Company to Robert Farias in October 2003 is currently in
default. The security interest of Now Solutions' assets on the secured
promissory note is junior to Now Solutions' present indebtedness to WAMCO 32,
Ltd, Arglen, the Robert Farias $500,000 promissory note, and the $84,000,
41
$350,000, and $90,000 promissory notes. Mr. Farias is a director of Now
Solutions, a 100% owned subsidiary of the Company. The note is also secured by
10,450,000 shares of the Company's common stock that are owned by MRC to cover
any shortfall. MRC is a corporation controlled by the W5 Family Trust. Mr. Wade,
the President and CEO of the Company, is the trustee of the W5 Family Trust.
In April 2003, a new Equity Line of Credit Agreement was executed between
the Company and Cornell Capital Partners, L.P., whereby up to $10,000,000 worth
of the Company's common stock could have been purchased. The Company is in
default of this agreement. The Equity Line of Credit Agreement contained a
commitment fee of $190,000, payable in a convertible debenture, which was issued
to Cornell, and contained a placement fee of $10,000, payable to the third party
placement agent. In July 2003, the Company issued 2,049,180 shares of common
stock as payment of the $10,000 placement fee. As of March 4, 2005, no
debentures have been converted.
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
Exhibit No. Description Location
- ----------- ----------- --------
4.55 Form of Cashless Exercise Warrant Incorporated by reference to
Exhibit 4.55 to the Company's
Form 10-KSB filed on January 18,
2005
Loan, agreement, between the
10.111 Company and a third party lender Incorporated by reference to
(a) Term Sheet, dated June 25, Exhibit 10.111 to the Company's
2003 Form 10-QSB for the quarter
(b) $90,000 note, dated June 26, ended March 31, 2003, filed on
2003 June 22, 2004
(c) Pledge Agreement, dated June
26, 2003
Loan and Cancellation Agreement,
10.112 dated July 1, 2003, between the Incorporated by reference to
Company and Victor Weber Exhibit 10.112 to the Company's
Form 10-QSB for the quarter
(a) Term Sheet ended March 31, 2003 filed on
(b) $100,000 Promissory Note June 22, 2004
(c) $40,000 Promissory Note
Loan Agreement, dated September
10.113 4, 2003, between the Company and Incorporated by reference to
Victor Weber Exhibit 10.113 to the Company's
Form 10-QSB for the quarter
(a) Term Sheet ended March 31, 2003 filed on
June 22, 2004
(b) $50,000 Promissory Note
42
Exhibit No. Description Location
- ----------- ----------- --------
10.114 $500,000 Farias Loan Agreement
between Now Solutions and the Incorporated by reference to
Company and Robert Farias, dated Exhibit 10.114 to the Company's
February 13, 2004 Form 10-QSB for the quarter
(a) Loan Agreement ended March 31, 2003 filed on
(b) Promissory Note, issued by June 22, 2004
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 Incorporated by reference to
Acquisitions, LLC and the Company Exhibit 10.115 to the Company's
Form 10-QSB for the quarter
(a) Arglen Settlement Agreement, ended March 31, 2003 filed on
dated December 4, 2004 June 22, 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 Incorporated by reference to
Solutions, Inc. and Vertical Exhibit 10.116 to the Company's
Computer Systems, Inc. and Sheri Form 10-QSB for the quarter
Pantermuehl, dated March 1, 2004 ended March 31, 2003 filed on
June 22, 2004
Loan Amendment, dated June 15,
10.117 2004 between WAMCO 32 Ltd. and Incorporated by reference to
the Company and Now Solutions Exhibit 10.117 to the Company's
Form 10-KSB filed on January 18,
(a) Amendment Number Five to Loan 2005
and Security Agreement
(b) Amended and Restated Secured
Term Promissory Note
10.118 Weber Loans Amendment, between Incorporated by reference to
the Company and Victor Weber, Exhibit 10.118 to the Company's
dated September 28, 2004 Form 10-KSB filed on January 18,
2005
10.119 Amendment to Consulting Agreement Incorporated by reference to
and $7,500 Promissory Note, Exhibit 10.119 to the Company's
between the Company and Stephen Form 10-KSB filed on January 18,
Rossetti, dated October 12, 2004 2005
14.1 Code of Ethics Incorporated by reference to
Exhibit 10.119 to the Company's
Form 10-KSB filed on January 18,
2005
31.1 Certification of Chief Attached herewith
Executive Officer Pursuant to
Section 302 of the Sarbanes-Oxley
Act of 2002, dated March 7, 2005
31.2 Certification of Chief Financial Attached herewith
Officer Pursuant to Section 302 of
the Sarbanes-Oxley Act of 2002,
dated March 7, 2005
43
32.1 Certification of Chief Attached herewith
Executive Officer Pursuant to
Section 906 of the Sarbanes-Oxley
Act of 2002, dated March 7, 2005
32.2 Certification of Chief Financial Attached herewith
Officer Pursuant to Section 906 of
the Sarbanes-Oxley Act of 2002,
dated March 7, 2005
99.1 Consent Letter dated February 4, Incorporated by reference to
2005, from BDO Seidman, LLP Exhibit 99.1 filed on Form at
8-K/A on February 4, 2005.
(b) Reports on Form 8-K:
On January 28, 2004, the Company filed a report on Form 8K
concerning 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, 2004, the Company filed a report on Form 8-K for a
change of address for its principal executive offices to Fort Worth,
Texas.
On April 28, 2004, 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.
On August 2, 2004, the Company filed a report on Form 8-K for an
amendment of the note payable issued by Now Solutions, Inc., to
Coast Business Credit and purchased by WAMCO 32, Ltd., in the
principal amount of $5,500,000.
On December 6, 2004, the Company filed a report on Form 8-K for the
following:
(a) Notice of an Order by the SEC of suspended trading
of the common stock of the Company.
(b) Notice of Order by the SEC Instituting
Administrative Proceedings and Notice of Hearing.
(c) Grant of a patent by the United States Patent and
Trademark Office (No. 6,826,744) for an invention
for "System and Method for Generating Web Sites In
an Arbitrary Object Framework" on November 30,
2004.
On January 28, 2005, the Company filed a report on Form 8-K that BDO
Seidman, LLP, the Company's auditor, had resigned.
On January 28, 2005, the Company filed an amended report on Form
8-K/A that BDO Seidman, LLP, the Company's auditor, had resigned.
On February 4, 2005, the Company filed an amended report on Form
8-K/A that BDO Seidman, LLP, the Company's auditor, had resigned.
On February 4, 2005, the Company filed a report on Form 8-K that the
Company engaged Weaver and Tidwell, L.L.P. as its principal
accountant to audit the Company's financial statements.
44
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: March 7, 2005 VERTICAL COMPUTER SYSTEMS, INC.
By: /s/ Richard Wade
-------------------------------------
Richard Wade
President and Chief Executive Officer
By: /s/ Sheri Pantermuehl
-------------------------------------
Sheri Pantermuehl
Chief Financial Officer
45