UNITED STATES
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 March 31, 2006.
|_| TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934:
For the transition period from _____ to _____
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Commission file number 000-28685
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VERTICAL COMPUTER SYSTEMS, INC.
-------------------------------
(Exact Name of Small Business Issuer as Specified in its Charter)
Delaware 65-0393635
-------- ----------
(State of Incorporation) (I.R.S. Employer Identification No)
201 Main Street, Suite 1175
Fort Worth, Texas 76102
(Address of Principal Executive Offices)
(817) 348-8717
(Issuer's Telephone Number)
Securities registered pursuant to section 12 (b) of the Act:
Title of each class Name of each exchange on which registered
None None
---- ----
Securities registered pursuant to section 12 (g) of the Act:
Common Stock, par value $0.00001 per share
------------------------------------------
(Title of Class)
Check whether the Issuer (1) filed all reports required to be filed by section
13 or 15(d) of the Exchange Act during the past 12 months (or for such shorter
period that the registrant was required to file such reports), and (2) has been
subject to such filing requirements for the past 90 days. Yes |X| No |_|
Indicate by check mark whether the registrant is a shell company (as defined in
Rule 12b-2 of the Exchange Act). Yes |_| No |X|
As of May 22, 2006, the issuer had 999,126,860 shares of common stock, par value
$0.00001 per share, issued and outstanding.
Transitional Small Business Disclosure Format: Yes |_| No |X|
VERTICAL COMPUTERS SYSTEMS, INC. AND SUBSIDIARIES
TABLE OF CONTENTS FORM 10-QSB
PART I FINANCIAL INFORMATION Page
Item 1. Condensed Consolidated Financial Statements:
Condensed Consolidated Balance Sheet (unaudited) as of March 31, 2006 3
Condensed Consolidated Statements of Operations (unaudited) for the Three months ended 5
March 31, 2006 and 2005
Condensed Consolidated Statements of Cash Flows (unaudited) for the Three months ended 6
March 31, 2006 and 2005
Notes to Condensed Consolidated Financial Statements 8
Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations 24
Item 3. Controls and Procedures 35
PART II OTHER INFORMATION
Item 1. Legal Proceedings 35
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds 37
Item 3. Defaults Under Senior Securities 39
Item 4. Submission of Matters To A Vote Of Security Holders 39
Item 5. Other Information 39
Item 6. Exhibits and Reports on Form 8-K 39
Signatures 40
Certifications 41
2
ITEM 1. CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
Vertical Computer Systems, Inc. and Subsidiaries
Condensed Consolidated Balance Sheet
March 31, December 31,
2006 2005
----------- ------------
Assets (Unaudited)
Current Assets
Cash $ 345,205 $ 285,366
Restricted cash --
Securities available for sale 2,760 2,760
Accounts receivable, net of allowance for bad
debts of $167,980 and $160,480 630,486 1,011,806
Other receivable 110,085 110,085
Employee receivables 48,609 47,548
Prepaid expenses and other assets 48,360 83,046
----------- -----------
Total Current Assets 1,185,505 1,540,611
----------- -----------
Property and equipment, net of
accumulated depreciation 89,512 96,703
Other intangibles, net -- 153,716
Deposits and other 11,414 10,372
----------- -----------
Total Assets $ 1,286,431 $ 1,801,402
----------- -----------
Liabilities, Convertible Preferred Stock
and Stockholder's Equity/ (Deficit)
Current liabilities
Accounts payable and accrued liabilities $ 5,571,076 $ 5,806,381
Deferred revenue 2,683,935 2,559,532
Accrued income taxes 18,000 18,000
Current portion - convertible debenture 40,000 230,000
Current portion-notes payable 1,372,119 4,140,571
----------- -----------
Total current liabilities 10,222,546 12,754,484
Non-current portion-notes payable 4,186,146 1,190,734
Accrued dividends 3,063,712 2,913,712
----------- -----------
Total liabilities $16,934,987 $16,858,930
----------- -----------
See accompanying notes to the condensed consolidated financial statements
(Continued on next page)
3
Vertical Computer Systems, Inc. and Subsidiaries
Condensed Consolidated Balance Sheet
(Continued from previous page)
March 31, December 31,
2006 2005
--------------- -----------
(Unaudited)
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
983,976,859 and 947,291,670 issued
and outstanding 9,840 9,473
Additional paid-in-capital 28,040,638 27,723,121
Accumulated deficit (44,381,379) (43,474,248)
Accumulated other comprehensive income 131,045 132,826
------------ ------------
Total Stockholders' deficit (15,648,556) (15,057,528)
------------ ------------
Total liabilities and stockholders' deficit $ 1,286,431 $ 1,801,402
============ ============
See accompanying notes to the condensed consolidated financial statements
4
Vertical Computer Systems, Inc. and Subsidiaries
Condensed Consolidated Statements of Operations
(Unaudited)
Three Months ended March 31,
2006 2005
------------- -------------
Revenues
Licensing and maintenance $ 1,251,052 $ 1,269,996
Consulting Services 261,631 277,690
Other 40,946 31,911
------------- -------------
Total Revenues 1,553,629 1,579,597
Selling , general and administrative expenses 2,163,478 1,885,295
------------- -------------
Operating loss (609,849) (305,698)
Interest income 819 687
Interest expense (148,101) (122,300)
------------- -------------
Net loss (757,131) (427,311)
------------- -------------
Dividend applicable to preferred stock (150,000) (150,000)
Net loss applicable to common stockholders' $ (907,131) $ (577,311)
------------- -------------
Basic and diluted loss per share $ (0.00) $ (0.00)
------------- -------------
Basic and diluted weighted average
of common shares outstanding 962,631,812 870,968,895
------------- -------------
Comprehensive loss and its components
consist of the following:
Net loss $ (757,131) $ (427,311)
Unrealized gain (loss) on securities
available for sale -- --
Translation adjustments 3,024 4,203
------------- -------------
Comprehensive loss $ (754,108) $ (423,108)
============= =============
See accompanying notes to the condensed consolidated financial statements
5
Vertical Computer Systems, Inc. and Subsidiaries
Condensed Consolidated Statements of Cash Flows
Three months ended March 31,
2006 2005
Cash flows from operating activities
Net loss $(757,131) $(427,311)
Adjustments to reconcile net loss to net cash
used in operating activities:
Depreciation and amortization 166,237 230,887
Non employee stock compensation 112,800 92,273
Employee stock compensation expense 15,084 --
Allowance for bad debts 7,500 7,500
Changes in operating assets and liabilities:
Accounts receivable 373,820 350,622
Receivable from officers and employees (1,061) 2,641
Prepaid expenses and other 33,644 10,339
Accounts payable and accrued liabilities 319,192 383
Deferred Revenue 124,403 254,003
--------- ---------
Net cash provided by (used in) operating activities: 394,488 521,337
Cash flow from investing activities:
Purchase of equipment (5,330) --
--------- ---------
Net cash used in investing activities (5,330) --
See accompanying notes to condensed consolidated financial statements
(Continued on next page)
6
Vertical Computer Systems, Inc. and Subsidiaries
Condensed Consolidated Statements of Cash Flows
(Continued)
Three months ended March 31,
2006 2005
Cash flow from financing activities:
Payment of notes payable (927,538) (141,616)
Proceeds from issuance of notes payable 600,000 --
--------- ---------
Net cash provided by (used in) financing activities (327,538) (141,616)
Effect of changes in exchange rates on cash (1,781) (4,626)
Net change in cash and cash equivalents 59,839 375,095
Cash and cash equivalents, beginning of period 285,366 330,780
--------- ---------
Cash and cash equivalents, end of period
$ 345,205 $ 705,875
========= =========
Supplemental disclosures of cash flow information:
Cash paid during the year period:
Interest $ 42,376 $ 44,322
========= =========
Non-cash investing and financing activities:
Conversion of convertible debentures $ 190,000 --
========= =========
Conversion of accounts payable and accrued
liabilities to note payable $ 554,497
========= =========
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 condensed
consolidated financial statements reflect all adjustments that, in the opinion
of the management of Vertical Computer Systems, Inc. and its subsidiaries
(collectively, the "Company"), are considered necessary for a fair presentation
of the financial position, results of operations, and cash flows for the periods
presented. The results of operations for such periods are not necessarily
indicative of the results expected for the full fiscal year or for any future
period. The accompanying financial statements should be read in conjunction with
the audited consolidated financial statements of the Company included in the
Company's Form 10-KSB for the year ended December 31, 2005.
Stock-Based Compensation
Effective January 1, 2004, the Company adopted the fair value
provisions of Statement of Financial Accounting Standards ("SFAS") No. 123 for
share based payments to employees. In accordance with transition provisions
under SFAS No. 148, the Company has adopted the prospective method for
transitional recognition.
Effective January 1, 2006, the Company adopted SFAS 123(R) using the
modified prospective method, which requires measurement of compensation cost for
all stock-based awards at fair value on date of grant and recognition of
compensation over the service period for awards expected to vest. The fair value
of restricted stock and restricted stock units is determined based on the number
of shares granted and the quoted price of our common stock, and the fair value
of stock options is determined using the Black-Scholes valuation model, which is
consistent with our valuation techniques previously utilized for options in
footnote disclosures required under SFAS 123, Accounting for Stock Based
Compensation, as amended by SFAS 148, Accounting for Stock-Based Compensation --
Transition and Disclosure. The estimation of stock awards that will ultimately
vest requires judgment, and to the extent actual results or updated estimates
differ from the Company's current estimates, such amounts will be recorded as a
cumulative adjustment in the period estimates are revised.
Because the fair value recognition provisions of SFAS No. 123,
Stock-Based Compensation, and SFAS No. 123(R) were materially consistent under
the Company's equity plans, the adoption of SFAS No. 123(R) did not have a
significant impact on the Company's financial position or the Company's results
of operations. Consequently, no prior periods have been restated.
Going Concern Uncertainty
The accompanying condensed consolidated financial statements for the
three months ended March 31, 2006 and 2005, 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 March 31, 2006 was
$15.6 million. Additionally, at March 31, 2006, the Company had negative working
capital of approximately $9 million (although it includes deferred revenue of
approximately $2.7 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 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 condensed consolidated financial statements contain no adjustment
for the outcome of this uncertainty.
8
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 2006, the Company issued 10,450,000 unregistered shares of
common stock of the Company to employees of Vertical and Now Solutions, Inc.
("Now Solutions"), a wholly-owned subsidiary of the Company, pursuant to
restricted stock agreements with the Company that provide for the stock to vest
over a period of one year or over three years in equal installments at the
anniversary date of the agreement.
In February 2006, the Company issued 5,000,000 shares of common stock
of the Company (at a fair market value of $45,000) as partial incentive for Tara
Financial Services, Inc. ("Tara Financial") to make a $450,000 loan and to
refinance approximately $1.75 million of existing debt. For details on the note
payable issued in connection with the loan, please see "Notes Payable" under
Note 3.
In February 2006, the Company issued 3,000,000 shares of the common
stock of the Company (at a fair market value of $27,000) as partial incentive
for Strategic Growth Partners, Inc. ("SGP") to make a $150,000 loan. For details
on the note payable issued in connection with the loan, please see "Notes
Payable" under Note 3.
In February 2006, the Company cancelled warrants to purchase 3,000,000
shares of common stock of the Company that had been issued to Wamco 32, Ltd
("Wamco") in connection with the acquisition of indebtedness of Now Solutions to
Wamco by Taladin, Inc. ("Taladin"), a 100% owned subsidiary of the Company. The
warrants had originally been issued in connection with a June 2004 amendment to
a note payable and security agreement.
During the three months ended March 31, 2006, the entire $190,000 of
principal under a debenture bearing no interest was converted into 24,298,094
shares of the Company's common stock in connection with a commitment fee
pursuant to an Equity Line of Credit agreement entered into in April 2003
between the Company and Cornell Capital Partners ("Cornell"). In March 2006,
$40,800 in liquidated damages claimed by Cornell in connection with the Equity
Line of Credit agreement was converted into 4,387,095 shares of common stock.
During the three months ended March 31 2006, incentive stock options to
purchase 1,500,000 shares of common stock of the Company at a price of $0.010
per share were cancelled in connection with the issuance of unregistered shares
of stock to an employee of Now Solutions pursuant to a restricted stock
agreement.
During the three months ended March 31, 2006, warrants to purchase
3,216,667 shares of common stock of the Company at a price of $0.0760 to $0.10
per share expired.
Of the 10,450,000 shares of common stock issued to employees of the
Company during the three months ended March 31, 2006, 0 shares had vested as of
March 31, 2006.
9
Note 3 - Notes Payable
------------ ----------------
March 31, December 31,
2006 2005
------------ ----------------
The $5.5 million note payable, issued by Now Solutions to Coast and purchased by
Wamco 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 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. The note was in
default. In February 2006, Taladin used the proceeds of two loans to acquire the
indebtedness of Now Solutions to Wamco for $600,000, which represented a 5%
discount from the actual amount owed, plus legal fees. In connection with the
acquisition of such indebtedness, a revenue participation agreement for the
benefit of Wamco was terminated and a warrant to purchase 3,000,000 shares of
common stock of the Company, also granted to Wamco, was cancelled. Now
Solutions' indebtedness to Wamco was secured by a first lien position against
all assets of Now Solutions and this first lien position was assigned by Wamco
to Taladin. $ -- $ 865,302
Note payable to Ross issued by Now Solutions in the amount of $1,000,000. The
note is unsecured and non-interest bearing. The note was recorded at a discount
(which will be amortized over the life of the note), payments of $250,000 and
$750,000 to be due in February 2002 and 2003, respectively. If a payment is not
received within three days from the due date, the note will begin to bear
interest at 10% per annum. In 2002, Now Solutions offset $250,000 payment
through its receivable from Ross pursuant to an agreement between Now Solutions
and Ross. Please also see "Legal Proceedings" under Note 4 for information
concerning the litigation between the Company, Now Solutions and Ross. 750,000 750,000
Note payable in the amount of $31,859 to a third-party lender, bearing
interest at an amount to be negotiated, principal and interest due on demand. 31,859 31,859
Notes payable in the amount of $27,000 to a third-party, payable upon demand. 27,000 27,000
Note payable to a third-party lender in the amount of a $239,004 bearing
interest at 13% per annum and unsecured, with a $65,000 payment made in December
2002, commencing with monthly payment of $7,500 beginning in March 2003. This
note was issued in 2002 to replace the note of $211,137 issued in August 2001 to
a third-party lender, bearing interest at 12% per annum. In March 2003, the note
was amended and the Company agreed to pay the interest and expenses responsible
by the lender for a third-party loan secured on the lender's behalf instead of
paying to the lender and the Company agreed to begin making monthly payment of
$7,500, beginning on June 1, 2003. Pursuant to the extension in December 2003,
the Company was required to make monthly installment payments of $7,500,
beginning on February 1, 2004, until the balance under the note has been paid.
The note is in default. 161,504 161,504
10
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March 31, December 31,
2006 2005
------------ ----------------
Note payable in the amount of $50,000 to a third-party lender, bearing no
interest. In March 2003, the parties entered into an amendment, whereby the
parties agreed to accrue interest beginning in October 2002 at 12% per annum.
The parties also agreed that the Company would make monthly payments of accrued
interests beginning in April 2003 and monthly principal payment of $5,000
beginning in July 2003. In connection with the note, the Company issued
three-year warrants to purchase 1,200,000 shares of its common stock at a price
of $0.003 per share. In May 2005, the Company and a third party lender amended
the terms of the note. Any existing default on the note was waived, and the
Company agreed to commence monthly payments to the lender of $2,500 in June
2005, which would be raised to $4,000 beginning in October 2005, and to pay the
lender's reasonable attorney's fees. In connection with the agreement the
Company issued 600,000 shares of common stock of the Company (at a fair market
value of $9,000) to the lender and warrants to purchase 1,200,000 shares of the
Company common stock were cancelled by the lender. The note is in default. 47,784 47,784
Note payable in the amount of $50,000 to a third-party lender, bearing interest
at the rate of 12% per annum. In March 2003, the parties entered into an
amendment, whereby the parties agreed to pay accrued interest in the amount of
$4,200 for this note and to extend the maturity date to June 1, 2004. Beginning
in July 2003, the above interest payments were to be replaced with a monthly
installment payment of $5,000, with the initial payments applied first to the
$25,000 note (issued below) and then to the $50,000 note. In connection with the
amendment, the Company issued three-year warrants to purchase 1,500,000 shares
of its common stock at a price of $0.004 per share. The note is in default. 50,000 50,000
Note payable in the amount of $25,000 to a third-party lender, bearing interest
at 12% per annum, secured by 10,000,000 shares of the Company's common stock
that are owned by Mountain Reservoir due in December 2002. In March 2003, the
parties entered into an amendment. Pursuant to the amendment, the Company agreed
to pay accrued interest in the amount of $1,170 for this $25,000 note and amend
the due date to July 1, 2005. Beginning in July 2003, the above interest
payments shall be replaced with monthly payments of $5,000 with the initial
payments applied first to the $25,000 note and then to the $50,000 (the above)
note issued. The note is in default. 12,583 12,583
Note payable in the amount of $280,000, bearing interest at 4% per annum and
issued to Robert Farias on October 31, 2001, was amended by the parties in March
2003. Pursuant to the amendment, the payment of principal was to be paid in
monthly installments in the amount of $5,000, which was to be replaced with
monthly payments of $10,000 beginning in January 2004. All interest was due on
the day the principal was to be paid in full. In exchange for the extensions,
the interest rate accrued at the rate of 12% from the date the note was issued.
In February 2004, the Company and Mr. Farias amended the $280,000 note issued to
Mr. Farias on October 31, 2001 and the $181,583 note issued to Mr. Farias on
October 17, 2002. Any default on these notes was waived, and the Company agreed
to make the following payments on these notes: (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 did not pay the amounts in a timely manner, then all amounts still owing
under these notes was considered in default and the following shall applied: (i)
all such remaining amounts were added to the secured loan amounts and were
subject to the security interest and pledge agreements under the $84,000
promissory note issued by the Company's subsidiary, EnFacet, Inc. ("Enfacet"),
to Mr. Farias on June 1, 2001; (ii) the $14,640 monthly payments to be made
under the $84,000 note were to 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 might have received due to a capital infusion or upfront licensing
fees from a reseller that was outside its normal scope of business (i.e., not
part of software sales in the regular course of business), Now Solutions was
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 had been paid in full
toward the $280,000 and $181,583 notes if the Company was not current in its
payments. The $280,000 note was also secured by SiteFlash(TM) technology owned
by the Company. In February 2006, this note and the applicable underlying
security interest were cancelled. All outstanding debt, plus interest and any
fees under the $280,000 note payable were included under a $438,795 note payable
issued to Tara Financial. For additional details on the $438,795 note and the
underlying security interest, please see the $438,795 note payable in Note 3.
Robert Farias is a director of Now Solutions. -- 237,626
11
------------ ----------------
March 31, December 31,
2006 2005
------------ ----------------
Note payable in the amount of $181,583 issued to Robert Farias, bearing interest
at 12% per annum, was to be paid as follows: (i) an initial installment of
$10,000 payable upon execution; (ii) monthly payment of $5,000 beginning
November 5, 2002 and (iii) monthly $10,000 payment beginning May 15, 2003 until
all amounts under the note have been paid in full. This note was issued to
replace two notes previously issued; each had outstanding balance of $100,000 at
December 31, 2001. In February 2004, the Company and Mr. Farias amended the
$280,000 note issued to Mr. Farias on October 31, 2001 and the $181,583 note
issued to Mr. Farias on October 17, 2002. Any default on these notes was waived,
and the Company agreed to make the following payments on these notes: (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) all remaining past-due amounts to bring the notes current by April 20,
2004. In the event the Company did not pay the amounts in a timely manner, then
all amounts still owing under these notes was considered in default and the
following applied: (i) all such remaining amounts were added to the secured loan
amounts and were 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 were applied to the $280,000 and $181,583 notes until these notes
were to be paid in full; and (iii) with respect to cash proceeds Now Solutions
might have received 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 was 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 had been paid in full toward the
$280,000 and $181,583 notes if the Company was not current in its payments. The
note was secured by 10,450,000 shares of the Company's common stock that are
owned by Mountain Reservoir to cover any shortfall. Mountain Reservoir 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 February 2006, this
note and the applicable underlying security interests were cancelled. All
outstanding debt, plus interest and any fees under the $181,583 note payable
were included under a $955,103 note payable issued to Tara Financial. For
additional details on the $955,103 note and the underlying security interest,
please see the $955,103 note payable in Note 3. Robert Farias is a director of
Now Solutions. -- 108,034
The Company pledged its interest in a $215,000 note issued by Now Solutions to
the Company to secure this note and the $100,000, $40,000, and $50,000 notes
issued to Victor Weber and $25,000 in expense paid by Weber on behalf of the
Company that were included in trade accounts payable, who had the option to have
the Company assign the $215,000 note to Weber provided that Weber cancels all
three notes and the outstanding $25,000 in accounts payable. Weber elected to
make this assignment in January 2004. At that time, all other notes and debt
owed to Weber were cancelled. Mr. Weber is the President and a Director of GIS
and a member of CW International. The note is in default. 215,000 215,000
12
------------ ----------------
March 31, December 31,
2006 2005
------------ ----------------
Note payable in the amount of $350,000 issued by EnFacet to a third-party
lender, bearing interest at 8% per annum, unsecured, and due on February 28,
2003. EnFacet is in default subsequent to December 31, 2002. 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 were to be
paid as follows: once the Company's subsidiary, Now Solutions, had paid off the
entire balance due under the $500,000 Note issued by Now Solutions to Robert
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, would be applied to the $350,000 and $90,000 notes
on a pro-rata basis. Thereafter, the Company was to make monthly principal
payments of $76,860 applied on a pro-rata basis toward the $350,000 and $90,000
notes until all monies due under these notes were paid. In connection with the
amendment, Now Solutions entered into a security agreement with the lender to
guarantee the note. In February 2006, this note and the applicable underlying
security interest were cancelled. All outstanding debt plus interest and any
fees under the $350,000 note payable were included under a $955,103 note payable
issued to Tara Financial. For additional details on the $955,103 note and the
underlying security interest, please see the $955,103 note payable in Note 3. -- 350,000
Note payable in the amount $25,000 promissory note, bearing interest at 10% per
annum, was issued in April 2003 to a consultant of the Company's subsidiary,
EnFacet, for past services rendered. The note is payable in monthly $1,000
installments beginning in May 2003 to be replaced by $2,000 monthly installments
beginning in October 2003. The note is in default. 25,000 25,000
Note payable in the amount of $17,500, bearing no interest to a third-party
lender in consideration of a loan in the amount of $15,000, was due in June
2003. In connection with the note, the Company paid a commitment fee of $2,500
and issued five-year warrants to purchase 250,000 shares of common stock of the
Company at an exercise price of $0.0075 per share to the lender. In connection
with this and another loan for $15,000 (see below), the Company also issued
five-year warrants to purchase 250,000 shares of common stock of the Company at
an exercise price of $0.0075 per share to a third-party consultant. In February
2004, the parties amended the terms of the loan. The lender waived any default
on the note and in exchange the Company issued 500,000 unregistered shares of
the Company common stock to each lender (at a total fair market value of
$7,000), and to pay $8,750 by March 31, 2004 and $8,750 plus all accrued
interest by April 30, 2004 under the note. This note is in default. 11,000 11,000
13
------------ ----------------
March 31, December 31,
2006 2005
------------ ----------------
Note payable in the amount of $17,500, bearing no interest to a third-party
lender in consideration of a loan in the amount of $15,000, was due in June
2003. In connection with the note, the Company paid a commitment fee of $2,500
and issued five-year warrants to purchase 250,000 shares of common stock of the
Company at an exercise price of $0.0075 per share to the lender. In connection
with this and another loan for $15,000 (see above), the Company also issued
five-year warrants to purchase 250,000 shares of common stock of the Company at
an exercise price of $0.0075 per share to a third-party consultant. In February
2004, the parties amended the terms of the loan. The lender waived any default
on the note and in exchange the Company issued 500,000 unregistered shares of
the Company common stock to each lender (at a total fair market value of
$7,000), and to pay $8,750 by March 31, 2004 and $8,750 plus all accrued
interest by April 30, 2004 under the note. This note is in default. 11,000 11,000
Note payable in the amount of $10,000 issued by EnFacet to a third-party lender,
bearing interest at 8% per annum, unsecured, with principal and interest due on
June 1, 2002. The note is in default. 10,000 10,000
Note payable in the amount of $84,000 issued by EnFacet to Robert Farias, dated
June 1, 2001, bearing interest at 8% per annum, unsecured, with principal and
interest due on June 1, 2002. EnFacet was in default at December 31, 2002. In
March 2003, both parties entered into an amendment. Pursuant to the amendment,
the due date was extended to March 17, 2004 in exchange for increasing the
interest rate from 8% to 12% at which interest was accrued from the date the
note was issued. In addition, EnFacet was to make monthly payments of $1,000
commencing in April 2003. In February 2004, the Company and Robert Farias waived
any defaults on the note and agreed that the note would be payable as follows:
once the Company's subsidiary, Now Solutions, had paid off the entire balance
due under the $500,000 note issued by Now Solutions to Farias on February 13,
2004, 16% of any remaining amounts from the final $91,500 installment payment on
the $500,000 note would be applied to the $84,000 note. Thereafter, the Company
or, at the Company's option, Now Solutions, was 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 had been paid. In connection with the
amendment, Now Solutions entered into a security agreement with the lender to
guarantee the note. In February 2006, this note and the applicable underlying
security interest were cancelled. All outstanding debt plus interest and any
fees under the $84,000 note payable were included under a $955,103 note payable
issued to Tara Financial. For additional details on the $955,103 note and the
underlying security agreement, please see the $955,103 note payable in Note 3.
Robert Farias is a director of Now Solutions. -- 84,000
Note payable in the amount of $10,365 dated January 17, 2003 bearing an interest
of 10% per annum, with principal and interest due on December 5, 2003. $3,000 in
payments was made on this note in 2003. This note is in default. 7,365 7,365
Note payable in the amount of $23,030 dated March 21, 2003 bearing an interest
of 12% per annum, with principal and interest due on April 21, 2004. This note
is in default. 23,030 23,030
Note payable in the amount of $90,000 dated June 26, 2003 to a third-party
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 note. Pursuant to
the amendment, the parties waived any defaults on the note and agreed that the
note would be payable as follows: Once the Company's subsidiary, Now Solutions,
had 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, would be applied to the
$350,000 and $90,000 notes on a pro-rata basis. Thereafter, the Company would
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
had been paid. In connection with the amendment, Now Solutions entered into a
security agreement with the lender to guarantee the note. In February 2006, this
note and the applicable underlying security interest were cancelled. All
outstanding debt, plus interest and any fees under the $90,000 note payable were
included under a $955,103 note payable issued to Tara Financial. For additional
details on the $955,103 note and the underlying security interest, please see
the $955,103 note payable in Note 3. Robert Farias is a director of Now
Solutions. -- 90,000
14
------------ ----------------
March 31, December 31,
2006 2005
------------ ----------------
Note payable in the amount of $60,000 issued by GIS to a third-party dated
November 5, 2003, bearing an interest of 10% per annum, with principal and
interest due on November 5, 2004. The Company agreed to issue a 2% 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 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 stock of the
Company that are owned by Mountain Reservoir. Mountain Reservoir is a
corporation controlled by the W5 Family Trust. Mr. Wade, the President and CEO
of the Company, is the trustee of the W5 Family Trust. This note is in default. 60,006 60,006
Note Payable in the amount of $40,000 issued by GIS to a third-party dated
November 19, 2003, bearing an interest of 10% per annum, with principal and
interest due on November 19, 2004. The 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. Mountain Reservoir 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. $5,000 of this note was
not funded until January 2004. This note is in default. 40,000 40,000
Note Payable in the amount of $500,000 issued by Now Solutions, the Company's
wholly-owned subsidiary to Robert Farias. This note was secured by Now
Solutions' assets. In addition, Farias is entitled to a 5% royalty on any sales
by Now Solutions of over $8,000,000 up to $500,000. The note beared interest at
10% per annum and Now Solutions was 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 had been paid in full. In the event Now Solutions
received cash proceeds due to a capital infusion or upfront licensing fees from
a reseller that was outside its normal scope of business (i.e., not part of
software sales in the regular course of business), Now Solutions was required to
pay 50% of such proceeds remaining toward payment of the $500,000 note. In
connection with the loan, the Company issued (i) five-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
Option Valuation Model); (ii) five-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
Option Valuation Model); (iii) five-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
Option 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 $125,000). 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. 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. Robert
Farias is a director of Now Solutions. In February 2006, this note and the
applicable underlying security interest were cancelled. All outstanding debt,
plus interest and any fees under the $500,000 note payable were included under
the $359,560 note payable issued to Tara Financial. For additional details on
the $955,103 note and the underlying security interest, please see the $955,103
note payable in Note 3. Robert Farias is a director of Now Solutions. -- 317,000
15
------------ ----------------
March 31, December 31,
2006 2005
------------ ----------------
Note payable in the amount of $5,000 to Mr. James Salz, bearing interest at 10%
with principal and interest due on demand. Mr. Salz is the Company's corporate
counsel. 5,000 5,000
Note payable in the amount of $10,000 to Mr. James Salz. Mr. Salz is the
Company's corporate counsel. The note is in default. 10,000 10,000
Note Payable in the amount of $600,000 issued to Arglen by the Company pursuant
to the Company's acquisition of Arglen's 35% interest in Now Solutions. The
Company's purchase of Arglen's interest resulted in the Company recognizing
$1,680,000 of goodwill, which was written-off in 2004. The note is a no-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. When the Company did not make the April 2004 payment, the Company began
accruing interest at the rate of 10% from the inception of the note. 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. In April 2005, Arglen filed a Notice of Filing a Foreign Judgment in
Tarrant County, Texas. In August 2005, Company entered into an agreement with
Arglen allowing payout terms to the Company (the "Payout Agreement") and
pursuant to which the Company agreed to enter into an Agreed Judgment for the
Foreign Judgment in Tarrant County, Texas (the "Agreed Judgment"). The Agreed
Judgment and Payout Agreement were entered into concerning a California judgment
and Arglen's notice of Filing a Foreign Judgment in Tarrant County, Texas, which
were in connection with the 2003 settlement agreement (the "2003 Settlement").
Pursuant to the terms of the Agreed Judgment and the Payout Agreement, the
Company agreed to pay Arglen a total of $713,489, which includes the following
amounts: (a) $600,000 in principal on the promissory note issued by the Company
pursuant to the 2003 Settlement, (b) the accrued post-judgment interest on the
California judgment from September 4, 2004 through September 15, 2005, at the
rate of 10% per annum, which equals $61,989, and (c) attorney's fees incurred
for the California and Texas judgment actions which were approximately $51,500.
Pursuant to the terms of the Payout Agreement, the Company began making monthly
interest payments on the amounts specified above of $5,945, beginning on
September 15, 2005, which will be replaced by monthly payments of $25,000 or 10%
of the Company's new sales, whichever is greater, beginning on February 15, 2006
until the remainder of the $713,489 is paid. In accordance with the Payout
Agreement, Arglen shall not execute the Agreed Judgment so long as the Company
continues to make its payments as agreed. For additional details, See Note 4,
Legal Proceedings. 663,489 713,489
Note payable in the amount of $75,000 issued by the Company, bearing interest at
a rate of 6% to the law firm of Parker, Mills & Patel ("PMP") in October 2005.
The note was issued in connection with a lawsuit filed by PMP to collect the
outstanding balance of $23,974 due under the promissory note issued to them by
the Company and for failure to pay fees for professional services in the amount
of $89,930 rendered to the Company, plus interest. The $75,000 note has a
maturity date of January 31, 2008 and shall be paid in equal monthly
installments of $3,125, beginning February 1, 2006 for a period of 24 months.
Bill Mills is a Director of the Company and a partner of PMP. 69,475 75,000
16
------------ ----------------
March 31, December 31,
2006 2005
------------ ----------------
Note payable in the amount of $992,723 issued by Now Solutions, the Company's
wholly-owned subsidiary to Wolman Blair, PLLC on November 30, 2005. The note is
secured with the assets of Now Solutions and bears interest at the rate of 12%
compounded annually. The note was issued in connection with refinancing
outstanding legal fees and expenses (which where owed pursuant to the legal
services retainer agreement), together with interest accrued as of the date the
note was issued. The note is payable as follows: (a) $12,500 by December 15,
2005; (b) $30,000 by December 30, 2005; (c) $25,000 by January 10, 2006; (d)
$12,500 by January 20, 2006; (e) $25,000 by February 1, 2006; and (f) equal
monthly installments of $40,000, each, commencing March 1, 2006, and continuing
on the first day of each month thereafter, until March 1, 2008, upon which date
all outstanding principal and interest shall be due. In connection with the
loan, Now Solutions entered into a security agreement with the lender to
guarantee the note. The note is delinquent. 992, 723 992, 723
Note payable in the amount of $450,000 issued by Taladin to Tara Financial,
dated February 13, 2006. The note bears interest at the rate of 12% per annum.
The note was issued in connection with refinancing whereby Taladin acquired the
indebtedness of Now Solutions to Wamco. The note is secured by Taladin's first
lien position on the assets of Now Solutions. Tara Financial and SGP share the
first lien position, senior to all other security interests in the assets of Now
Solutions. The $450,000 note payable is payable as follows: (a) principal and
interest payments of $7,000, on the first day of the month, beginning March 1,
2006, and continuing through September 1, 2006; (b) interest only, beginning on
October 1, 2006, and continuing through December 31, 2006; (c) unpaid principal
balance and interest payments of $7,000, beginning on January 1, 2007 and
continuing through February 1, 2008; and (d) monthly payments increased $12,700,
beginning on March 1, 2008 and continuing until February 1, 2011 (the maturity
date). The $450,000 note payable by Taladin contains provisions requiring
additional principal reductions in the event sales by Now Solutions exceed
certain financial thresholds or if there is a judgment in favor of the Company
with respect to the pending Ross litigation. For additional details on the Ross
litigation, please see "Legal Proceedings" under Note 4. The $450,000 note also
contains a conversion option pursuant to which all or any portion of the unpaid
principal, plus interest, may be converted at the option of Tara Financial, into
shares of common stock of Taladin equal to a maximum of 2.5% of Taladin's
outstanding common stock at the time of conversion. As incentives to make the
loan and to refinance approximately $1.75 million of existing debt, the Company
issued 5,000,000 shares of common stock of the Company (at a fair market value
of $45,000), agreed to issue 4% of the common stock of GIS, and pay to Tara
Financial 4% of the proceeds received by the Company (including litigation
proceeds) related to the USPTO Patent No. 6,826,744 for an invention for "System
and Method for Generating Web Sites in an Arbitrary Object Framework" owned by
the Company. Furthermore, Now Solutions agreed to pay Tara Financial a 6%
royalty from gross revenues in excess of $6.5 million, up to a cap of $2,640,606. 445,250 --
Note payable in the amount of $150,000 issued by Taladin to SGP, dated February
13, 2006. The note bears interest at the rate of 12% per annum. The note was
issued in connection with refinancing whereby Taladin acquired the indebtedness
of Now Solutions to Wamco. The note is secured by Taladin's first lien position
on the assets of Now Solutions. Tara Financial and SGP share the first lien
position, senior to all other security interests in the assets of Now Solutions.
The $150,000 note payable is payable as follows: (a) principal and interest
payments of $2,334, on the first day of the month, beginning April 1, 2006, and
continuing through September 1, 2006; (b) interest only, beginning on October 1,
2006, and continuing through December 31, 2006; (c) unpaid principal balance and
interest payments of $2,334, beginning on January 1, 2007 and continuing through
February 1, 2008; and (d) monthly payments increased $4,233, beginning on March
1, 2008 and continuing until March 1, 2011 (the "Maturity Date"). The $150,000
note payable by Taladin contains provisions requiring additional principal
reductions in the event sales by Now Solutions exceed certain financial
thresholds or if there is a judgment in favor of the Company with respect to the
pending Ross litigation. For additional details on the Ross litigation, please
see "Legal Proceedings" under Note 4. As incentives to make the $150,000 loan,
the Company issued 3,000,000 shares of the common stock of the Company (at a
fair market value of $27,000) and Now Solutions agreed to pay SGP a 1.5% royalty
from its gross revenues in excess of $6.5 million, up to a cap of $150,000. 150,000 --
17
------------ ----------------
March 31, December 31,
2006 2005
------------ ----------------
Note payable in the amount of $438,795 issued by the Company to Tara Financial,
on February 13, 2006. The note bears interest at the rate of 12% per annum. The
note was issued in connection with refinancing whereby Tara Financial acquired
certain indebtedness under a $280,000 note payable, dated October 31, 2001,
issued by the Company to Robert Farias. The $438,795 note payable reflects all
outstanding debt, plus accrued interest and any fees under the $280,000 note
payable. The $280,000 note was cancelled and any underlying security interests
have been released. The $438,795 note payable is payable as follows: (a)
principal and interest payments of $5,763, on the first day of the month,
beginning March 1, 2006, and continuing through September 1, 2006; (b) interest
only beginning on October 1, 2006, and continuing through December 31, 2006; (c)
unpaid principal balance and interest payments of $5,763, beginning on January
1, 2007 and continuing until February 1, 2018 (the maturity date). The new note
is secured by an interest in certain technology developed by Adhesive Software
and owned by the Company, commonly known as "SiteFlash(TM)". 435,226 --
Note payable in the amount of $359,560, issued by Now Solutions to Tara
Financial, dated February 13, 2006. The note bears interest at the rate of 12%
per annum. The note was issued in connection with refinancing whereby Tara
Financial acquired certain indebtedness under a $500,000 note payable, dated
Febuary 13, 2004, issued by Now Solutions to Robert Farias. The $359,560 note
payable reflects all outstanding debt, plus accrued interest and any fees under
the $500,000 note payable. The $500,000 note was secured by the assets of Now
Solutions, as well as a pledge of a portion of the Company's ownership of Now
Solutions. The original $500,000 note was cancelled. In connection with the
cancellation, a royalty agreement for the benefit of Mr. Farias has also been
cancelled. The $359,560 note payable is payable as follows: (a) principal and
interest payments of $4,723, on the first day of the month, beginning March 1,
2006, and continuing through September 1, 2006; (b) interest only payments,
beginning on October 1, 2006, and continuing through December 31, 2006; (c)
unpaid principal balance and interest of $4,723, beginning on January 1, 2007
and continuing until February 1, 2018 (the maturity date). The new note is
secured by all of the assets of Now Solutions. This note payable also contains
provisions requiring additional principal reductions in the
event sales by Now Solutions exceed certain financial thresholds. 356,636 --
18
------------ ----------------
March 31, December 31,
2006 2005
------------ ----------------
Note payable in the amount of $955,103, issued by Now Solutions to Tara
Financial, dated February 13, 2006. The note bears interest at the rate of 12%
per annum, has a maturity date in the year 2018 and is payable in various
installments of principal and interest. The note was issued in connection with
refinancing whereby Tara Financial acquired certain indebtedness under the
following four notes: (a) an $84,000 note payable, issued by EnFacet, the
Company's 100% owned subsidiary to Robert Farias, dated June 1, 2001 which had
an outstanding balance at the time of the consolidation of $137,841; (b) a
$181,583 note payable issued by the Company to Robert Farias, dated October 17,
2002, which had an outstanding balance at the time of the consolidation of
$181,905; (c) a $350,000 note payable, issued by EnFacet to a third party, dated
August 15, 2001, which had an outstanding balance at the time of the
consolidation of $519,693; and (d) a $90,000 note payable issued by the Company
to a third party, dated June 26, 2003, which had an outstanding balance at the
time of the consolidation of $115,663. All four notes were cancelled and all
related security interests under these notes have been released. The $955,103
note payable is payable as follows: (a) principal and interest payments of
$12,5441, on the first day of the month, beginning March 1, 2006, and continuing
through September 1, 2006; (b) interest only payments, beginning on October 1,
2006, and continuing through December 31, 2006; (c) unpaid principal balance and
interest payments of $12,544, beginning on January 1, 2007, and continuing until
February 1, 2018 (the maturity date). The new $955,103 note payable is secured
by all of the assets of Now Solutions. This note payable also contains
provisions requiring additional principal reductions in the event sales by Now
Solutions exceed certain financial thresholds. 947,335 --
------------ ----------------
Total notes payable 5,558,265 5,331,305
Current maturities (1,372,119) (4,140,571)
------------ ----------------
Long-Term portion of notes payable $ 4,186,146 $ 1,190,734
============ ================
Note 4 - Legal Proceedings
The Company is involved in the following ongoing legal matters:
In February 2003, the Company filed a lawsuit and a derivative action
in New York Supreme Court Case against defendants Ross, 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 withheld its payments on the remaining $750,000 note that was due in
February 2003 in connection with the acquisition of certain assets of Ross
against the unpaid maintenance fees and gave notice in February 2003 to Ross of
Now Solutions' claim of offset. Now Solutions claimed a total amount of
approximately $3,562,000 to offset against the note, plus other damages. The
Company'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. This action concerns
claims of breach of contract and indemnification for failure to pay adjustments
at the closing on the sale of assets of Ross to Now Solutions for prepaid
maintenance fees and for related relief. In November 2003, the New York Supreme
Court dismissed the claims against Ross and Tinley. The portion of the lawsuit
involving Arglen and Gyselen was settled in December 2003 and, pursuant to the
settlement, dismissed in February 2004. The Company appealed the decision with
regard to its claim for breach of contract for Ross' failure to give the proper
maintenance fee adjustment and related claims for offset and attorney's fees. 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. In November 2004, Ross filed an answer containing affirmative defenses in
the Derivative Action.
19
In March 2003, Ross commenced an action in New York Supreme Court 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 New York Supreme Court denied the motion and dismissed Ross's
action without prejudice. In October 2003, the motion of Ross for re-argument
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, a minority partner of Now Solutions, pursuant to the 2003
Settlement which pertains to issues related to Now Solutions. The 2003
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. When the Company
did not make the April 2004 payment, the Company began accruing interest at the
rate of 10% from the inception of the note. The security interest of Now
Solutions' assets on the secured promissory note is junior to Now Solutions'
present indebtedness to WAMCO. 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. In December 2004, the Company recorded the expense of
issuing 5,000,000 unregistered shares to Arglen at a fair market value of
$82,273, which was based on an average share price during 11 days of August
2004. These shares were issued pursuant to the settlement agreement with Arglen
whereby the Company was obligated to issue 5,000,000 unregistered shares of
common stock of the Company to Arglen, due to its failure to file a registration
statement on Form SB-2 within 180 days from the closing date of the settlement
in February 2004. In March 2005, the Company issued these 5,000,000 shares to
Arglen. 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. In April 2005, Arglen filed a
Notice of Filing a Foreign Judgment in Tarrant County, Texas. In August 2005,
the Company entered into a Payout Agreement with Arglen allowing payout terms to
the Company and pursuant to which the Company agreed to enter into the Agreed
Judgment. The Agreed Judgment and Payout Agreement were entered into concerning
a California judgment and Arglen's notice of Filing a Foreign Judgment in
Tarrant County, Texas, which were in connection with the 2003 Settlement.
Pursuant to the terms of the Agreed Judgment and the Payout Agreement, the
Company agreed to pay Arglen a total of $713,489, which includes the following
amounts: (a) $600,000 in principal on the promissory note issued by the Company
pursuant to the 2003 Settlement, (b) the accrued post-judgment interest on the
California judgment from September 4, 2004 through September 15, 2005, at the
rate of 10% per annum, which equals $61,989, and (c) attorney's fees incurred
for the California and Texas judgment actions which were approximately $51,500.
Pursuant to the terms of the Payout Agreement, the Company began making monthly
interest payments on the amounts specified above of $5,945, beginning on
September 15, 2005, which will be replaced by monthly payments of $25,000 or 10%
of the Company's new sales, whichever is greater, beginning on February 15, 2006
until the remainder of the $713,489 is paid. In accordance with the Payout
Agreement, Arglen shall not execute the Agreed Judgment so long as the Company
continues to make its payments as agreed.
In March 2004, Ross commenced an action in the New York Supreme Court
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 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 of Now
Solutions' nine 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. In February 2005, Ross' motion was granted based upon a procedural
default. Thereafter, Now Solutions filed a motion to vacate the default, which
motion was denied over the objections of Now Solutions. Now Solutions has filed
a notice of appeal of this decision. Now Solutions' remaining seven
counterclaims remain unaffected.
20
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 January 2005, PMP filed a lawsuit in Los Angeles Superior Court to
collect the outstanding balance of $23,974 due under the promissory note issued
to them by the Company and for failure to pay fees for professional services in
the amount of $89,930 rendered to the Company, plus interest. In March 2005, the
Company filed a demurrer. In April 2005, the Company answered the complaint,
asserting various legal defenses. In October 2005, the parties entered into a
settlement agreement. Pursuant to the terms of the settlement, the Company
issued a promissory note to PMP in the amount of $75,000 with a maturity date of
January 31, 2008, bearing interest at a rate of 6% per annum, which shall be
paid in equal monthly installments of $ 3,125, beginning February 1, 2006 for a
period of 24 months. In connection with the settlement, the lawsuit was
dismissed. Bill Mills is a Director of the Company and a partner of PMP.
In the opinion of management, the ultimate resolution of any pending
matters may have a significant effect on the financial position, operations or
cash flows of the Company. Also, the Company in the future may become involved
in other legal actions that may have a significant effect on the financial
position, operations or cash flows of the Company.
Note 6 - Stock Options & Warrants
Incentive Stock Non-Statutory Warrants Weighted Average
Options Stock Options Exercise Price
------------------ ------------------ ---------------- ----------------------
Outstanding at 12/31/05 4,000,000 -- 52,111,111 0.038
================== ================== ================ ======================
Options/Warrants granted with an
exercise price of $0.01 to $0.03 -- -- -- --
Options/Warrants exercised -- -- -- 0.000
Options/Warrants expired/cancelled 1,500,000 -- 6,216,667 0.051
------------------ ------------------ ---------------- ----------------------
Outstanding at 03/31/06 2,500,000 -- 45,894,444 0.036
================== ================== ================ ======================
21
Information relating to stock options/warrants as March 31, 2006, 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 2,500,000 41.63 $ 0.014 1,000,000 $ 0.010
------------------ ----------------- ------------------- ------------------ ----------------
2,500,000 41.63 $ 0.014 1,000,000 $ 0.010
================== ================= =================== ================== ================
Non-statutory Stock Options
$0.01 - $0.09 -- -- $ -- -- $ --
------------------ ----------------- ------------------- ------------------ ----------------
-- -- $ -- -- $ --
================== ================= =================== ================== ================
Warrants
$0.003 - $0.100 45,894,444 22.87 $ 0.037 45,894,444 $ 0.037
$0.100 - $0.350 -- -- -- -- --
------------------ ----------------- ------------------- ------------------ ----------------
45,894,444 22.87 $ 0.037 45,894,444 $ 0.037
================== ================= =================== ================== ================
------------------ ----------------- ------------------- ------------------ ----------------
Grand total 48,394,444 23.84 $ 0.0356 46,894,444 $ 0.036
================== ================= =================== ================== ================
The range of assumptions used in the Black-Scholes Option Valuation Model in
2006 and 2005 were as follows
March 31, December 31,
2006 2005
------------------- -------------------------
Discount rate - bond yield rate -- 3.83%
Volatility -- 606.39%
Expected life -- 5 years
Expected dividend yield -- --
22
Restricted Stock
The following activity has occurred under the Company's existing plans:
Weighted
Average
Grant-Date
Shares Fair Value
------------- ------------
Stock awards:
Non-vested balance at December 31, 2005 4,950,000 $ 0.004727
Granted 10,450,000 0.007641
Vested 0 0
Forfeited 0 0
------------- ------------
Non-vested balance at March 31, 2006 15,400,000 $ 0.006704
============= ============
The range of assumptions used in the stock awards calculation in 2006 were as
follows:
March 31, 2006
--------------
Discount rate-bond interest rate 5.21%-5.67%
Volatility 363.07%
As of March 31, 2006, there was $85,745 of total unrecognized
compensation costs related to Stock Awards. These costs are expected to be
recognized over a weighted average period of 2.09 years.
Note 7 - Subsequent Events
In April 2006, the Company cancelled 800,000 unregistered shares of
Company's common stock in connection with the resignation and amendment of a
restricted stock agreement with a former employee of the Company. In connection
with the amendment, 200,000 unregistered shares of the Company's common stock
remain issued to the former employee, which will vest on the 1 year anniversary
date of the original restricted stock agreement, provided the former employee is
available to provide services to the Company.
In April 2006, an employee of the Company cancelled 1,500,000
unregistered shares of common stock of the Company that were issued pursuant to
a restricted stock agreement.
In April 2006, the Company issued 300,000 unregistered shares of common
stock of the Company to an employee of Now Solutions and the Company pursuant to
a restricted stock agreement between the Company and the employee that provides
for the stock to vest over three years in equal installments at the anniversary
date of the agreement.
In April 2006, the Company issued 1,000,000 shares of common stock of
the Company in connection with an amendment to an exclusive license of a patent
for an invention concerning a fiber optics technology application to the
inventor of the technology. Pursuant to an amendment, the Company also agreed to
a flat fee, plus consulting fees upon funding of OptVision Research, Inc.
("OptVision Research"), a 100% owned subsidiary of the Company.
In April 2006, the Company entered into an agreement with a third party
consultant whereby the Company agreed to issue five-year warrants to purchase
4,000,000 shares of common stock provided that the consultant procures a
qualified government contract of over $1,000,000 acceptable to the Company
within 90 days of the agreement.
During the period from April 1, 2006 to May 22, 2006, warrants to
purchase 572,222 shares of common stock of the Company at a price of $0.10 per
share expired.
In the process of preparing this Report, the Company reviewed its past
issuances of debentures, stock options, warrants, preferred stock, and common
stock. Based on its review, the Company determined that it issued 69,322,775
shares of common stock during 2005 in connection with a $200,000 debenture
issued to Cornell Capital Partners, LP (in April 2003), and an additional
24,298,094 shares of common stock issued in connection with $190,000 of
compensation debenture issued to Cornell in connection with an Equity Line of
Credit Agreement (in April 2003) during the first three months ended March 31,
2006, for a total of 93,620,869 shares of common stock.
23
As of the Date of this Report, the Company has also determined that it
currently has (i) the following shares of common stock issued, and (ii)
outstanding instruments which are convertible into the shares of common stock
indicated below in connection with stock options, warrants, and preferred shares
previously issued by the Company:
999,126,860 Common Stock Issued
43,466,660 Common Shares that may be purchased from outstanding Warrants
2,500,000 Common Shares convertible from Outstanding Options
24,250,000 Common Shares convertible from Preferred Series A
27,274 Common Shares convertible from Preferred Series B
20,000,000 Common Shares convertible from Preferred Series C
94,700 Common Shares convertible from Preferred Series D
- --------------------------------------------------------------------------------
1,090,215,494 Total Common Shares Outstanding or Accounted For/Reserved
In addition, the Company has $40,000 in outstanding debentures that it
has issued to third parties.
Accordingly, given the fact that the Company currently has
1,000,000,000 shares of common stock authorized, the Company could exceed its
authorized shares of common stock by approximately 90,000,000 shares if all of
the financial instruments described in the table above were exercised or
converted into shares of common stock (excluding the $40,000 of outstanding
debentures noted above). The Company is currently investigating its options in
order to present its shareholders, as soon as practicable, with a plan whereby
the Company could meets all of its outstanding obligations without exceeding its
authorized shares of common stock.
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
Forward-Looking Statements.
This Form 10-QSB contains forward-looking statements within the meaning
of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the
Exchange Act. Such statements include the Company's beliefs, expectations,
hopes, goals and plans regarding the future, including but not limited to
statements regarding the Company's strategy, competition, development plans,
financing, revenue and operations. Forward-looking statements often can be
identified by the use of terms such as "may," "will," "expect," "anticipate",
"estimate," or "continue," or the negative thereof. Such forward-looking
statements speak only as of the date made. Any forward-looking statements
represent management's best judgment as to what may occur in the future.
However, forward-looking statements are subject to risks, uncertainties, and
important factors beyond the control of the Company that could cause actual
results and events to differ materially from historical results of operations
and events and those presently anticipated or projected. The Company disclaims
any obligation subsequently to revise any forward-looking statements to reflect
events or circumstances after the date of such statement or to reflect the
occurrence of anticipated or unanticipated events.
Management's Discussion and Analysis or Plan of Operation
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 accompanying Condensed Consolidated Financial Statements
of the Company, and the cautionary statements and risk factors included below in
this item of the report.
Business Overview
The Company is a multi-national provider of Internet core technologies,
administrative software, and derivative software application products through
its distribution network. The Company's primary Internet core technologies
include SiteFlash(TM), ResponseFlash(TM), and the Emily(R) XML Scripting
Language, which can be used to build Web services. The Company's main
administrative software product is emPath(R), which is designed to handle the
most complex Payroll and Human Resources challenges.
24
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.
The Company's current products address the following market segments:
MARKET PRODUCT OWNERSHIP LICENSEE
------------------------------------- ------------- ----------------- ---------------------------
Human Resources and Payroll emPath 6.3 Now Solutions Now Solutions
Large Corporations and Universities SiteFlash Vertical Computer Vertical Computer
Government Sector- Emergency Response ResponseFlash Vertical Computer GIS
Publishing Content NewsFlash Vertical Computer EnFacet
Emily XML Scripting Language Emily Vertical Computer Vertical Internet Solutions
Results of Operations
Three Months Ended March 31, 2006 Compared To Three Months Ended March
31, 2005
Total Revenues. The Company had total revenues of $1,553,629 and
$1,579,597 in the three months ended March 31, 2006 and 2005, respectively. The
decrease in total revenues was $25,968 for the three months ended March 31, 2006
representing a 1.6% decrease compared to the total revenues for the three months
ended March 31, 2005. Of the $1,553,629 in revenues for the three months ended
March 31, 2006 and the $1,579,597 in revenues for the three months ended March
31, 2005, $1,550,670 and $1,550,352, respectively, was related to the business
operations of Now Solutions, a wholly-owned subsidiary of the Company.
The total revenues primarily consist of software licenses, consulting
and maintenance fees. The revenue from license and maintenance in the three
months ended March 31, 2006 decreased by $18,944 from the same period in the
prior year, representing a 1.5% decrease. Consulting revenue in the three months
ended March 31, 2005, decreased by $16,059, from the same period in the prior
year, which represented a 5.8% decrease, due to decreases in installations at
new customers. Other revenue in the three months ended March 31, 2006 increased
by $9,035 from the same period in the prior year. Other revenue consists
primarily of reimbursable travel expense.
Selling, General and Administrative Expenses. The Company had selling,
general and administrative expenses of $2,163,478 and $1,885,295 in the three
months ended March 31, 2006 and 2005, respectively. The total operating expenses
in the three months ended March 31, 2006 increased by $278,183 compared to the
operating expenses in the three months ended March 31, 2005, representing a
14.8% increase. Of the $2,163,478 in expenses for the three months ended March
31, 2006 and the $1,885,295 in expenses for the three months ended March 31,
2005, Now Solutions accounted for $1,767,054 and $1,434,498, respectively.
The increase is attributable to fees associated with obtaining $600,000
of new loans and refinancing approximately $1.75 million of existing debt.
$72,000 of the costs associated with the debt restructuring were paid by issuing
common stock. In addition, Now Solutions has increased its U.S. sales force in
an effort to improve sales performance in the U.S.
Interest Expense. The Company had an interest expense of $148,101 and
$122,300 for the three months ended March 31, 2006 and 2005, respectively.
Interest expense increased in 2006 by $25,801, representing an increase of
21.1%, compared to the same type of expense in three months ended March 31,
2005. This increase was due to the new financing and higher interest rates being
paid on the refinanced debt.
Net Loss. The Company had a net loss of $757,131 and $427,311 as of
March 31, 2006 and 2005, respectively. Net loss increased by $329,820,
representing an increase of 77.2%. The increase of $329,820 was primarily
attributable to the combination of a decrease in revenues by $25,968 and an
increase of selling, general and administrative expenses by $278,183 and an
increase in interest expense of $25,801.
25
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 March 31,
2006 and 2005, respectively.
Net Loss Available to Common Stockholders. The Company had a net loss
attributed to common stockholders of $907,131 and $557,311 for the three months
ended March 31, 2006 and 2005, respectively. Net loss attributed to common
stockholders increased by $329,820, representing an increase of 57.1%, compared
to the net loss attributed to common stockholders in the three months ended
March 31, 2005.
Net Loss Per Share. The Company had a net loss per share of $0.00 and
$0.00 for the three months ended March 31, 2006 and 2005, respectively.
Liquidity And Capital Resources
At March 31, 2006, the Company had non-restricted cash-on-hand of
$345,205.
Net cash generated from operating activities for the three months ended
March 31, 2006 was $394,488. This positive cash flow was primarily related to a
net loss of $757,131 adjusted by total non-cash items of $301,621 (including
depreciation and amortization of $166,237, stock compensation of $127,884 and
allowance for bad debt of $7,500), decreases in all receivables items of
$372,759, an increase in deferred revenue of $124,403, a decrease in prepaid
expenses and other assets of $33,644 and an increase in accounts payable and
accrued liabilities of $319,192. The increase in accounts payable and accrued
liabilities was offset by converting $554,497 of accounts payable and accrued
liabilities into notes payable. With these conversions, accounts payable and
accrued expenses decreased by $235,305.
Net cash used in investing activities for the three months ended March
31, 2006 was $5,330 which consists of the purchase of equipment.
Net cash used for financing activities for the three months ended March
31, 2006 was $327,538. $927,538 of notes payable were repaid. These repayments
were partially offset by the issuance of $600,000 of new notes.
The total change in restricted and non-restricted cash and cash
equivalents for the three months ended March 31, 2006 when compared to three
months ended March 31, 2005 was a decrease of $360,670.
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 does not have sufficient
funds available to fund its operations and repay its debt obligations under
their existing terms. 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 and/or
renegotiate the terms of its existing debt will significantly jeopardize its
ability to continue operations.
Contractual Obligations Balance at Due in Next Five Years
03/31/06 2006 2007 2008 2009 2010+
----------------------------- ------------- ------------ ------------- ------------- ------------- ------------
Notes payable 5,558,265 1,795,274 679,741 783,029 623,027 1,677,193
Convertible debts 40,000 40,000
Operating lease 269,185 113,732 61,730 53,556 40,167
------------- ------------ ------------- ------------- ------------- ------------
Total 5,867,450 1,949,006 741,471 836,585 663,194 1,677,193
============= ============ ============= ============= ============= ============
26
Of the above notes payable of $5,558,265, the default situation is as
follows:
Notes Payable 03/31/06 12/31/05
---------- ----------
In default $1,498,132 $3,540,093
Current 4,060,133 1,791,212
---------- ----------
Total Notes Payable $5,558,265 $5,331,305
========== ==========
Going Concern Uncertainty
The accompanying condensed consolidated financial statements for the
three months ended March 31, 2006 and 2005, 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 March 31, 2006 was
$15.6 million. Additionally, at March 31, 2006, the Company had negative working
capital of approximately $9 million (although it includes deferred revenue of
approximately $2.7 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 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 condensed consolidated financial statements contain no adjustment
for the outcome of this uncertainty.
Furthermore, the Company is exploring certain opportunities with a
number of companies to participate in 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 March 31, 2006, there
are no material gains or losses requiring separate disclosure.
Dividends
The Company has outstanding Series A and Series C 4% Convertible
Cumulative Preferred stock that accrue dividends at a rate of 4% on a
semi-annual basis.
27
Related Party Transactions
In November 2003, Mountain Reservoir pledged 4,000,000 shares of common
stock to secure a loan of $60,000 to GIS, which issued a $60,000 note payable on
November 5, 2003 bearing interest at 10% per annum, and was due November 5,
2004. Mountain Reservoir 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 November 2003, Mountain Reservoir pledged 3,000,000 shares of common
stock to secure a loan of $40,000 to GIS, which issued a $40,000 note payable on
November 19, 2003 bearing interest at 10% per annum, and was due November 19,
2004. Mountain Reservoir is a corporation controlled by the W5 Family Trust. Mr.
Wade, the President and CEO of the Company, is the trustee of the W5 Family
Trust.
In January 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. The note is in default.
Also 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. 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. In exchange for
amending the payment terms, the Company issued 2,000,000 unregistered shares of
common stock of the Company (at a fair market value of $24,000) and Now
Solutions agreed to pay a 2.5% royalty of sales by Now Solutions of its software
that exceed $8,000,000 per year up to a maximum of $200,000. In January 2005,
the Company issued an additional 2,000,000 unregistered shares of common stock
to Mr. Weber at a fair market value of $10,000 pursuant to the amendment. For
additional details on this note, please see "Notes Payable" under Note 3. The
note is in default. Mr. Weber is the President and a Director of GIS and a
member of CW International, LLC.
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 bearing interest at 10% per annum, secured by its assets. In
connection with the loan, Now Solutions agreed to pay Mr. Farias a 5% royalty on
any sales by Now Solutions over $8,000,000 up to a maximum of $500,000. In
connection with the loan, the Company issued (i) 5-year warrants to purchase
5,000,000 shares of common stock at $0.01 per share; (ii) 5-year warrants to
purchase 5,000,000 shares of common stock of the Company at $0.02 per share;
(iii) 5-year warrants to purchase 5,000,000 shares of common stock of the
Company at $0.03 per share; (iii) a total of 10,000,000 unregistered shares of
common stock of the Company. 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. During 2004 and 2005, Now Solutions had made principal payments
totaling $183,000 to Robert Farias. In February 2006, this note and the
applicable underlying security interest were cancelled. All outstanding debt,
plus interest and any fees under the $500,000 note payable were included under
the $359,560 note payable issued to Tara Financial. For additional details on
the $500,000 note payable and the $359,560 note and the underlying security
interest, please see "Notes Payable" under Note 3. Robert Farias is a director
of Now Solutions.
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,
with principal and interest due on June 1, 2002 was amended whereby the assets
of Now Solutions secured the note. In February 2006, this note and the
applicable underlying security interest were cancelled. All outstanding debt
plus interest and any fees under the $84,000 note payable were included under
the $955,103 note payable issued to Tara Financial. For additional details on
$84,000 note and the $955,103 note and underlying security interest, please see
"Notes Payable" under Note 3. Robert Farias is a director of Now Solutions.
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. The $280,000 note was secured by the asset of Now Solutions and by the
SiteFlash(TM) technology owned by the Company. In February 2006, this note and
the applicable underlying security interest were cancelled. All outstanding
debt, plus interest and any fees under the $280,000 note payable were included
under the $438,795 note payable issued to Tara Financial. For additional details
on the $280,000 note and the $438,795 note and underlying security interest,
please see "Notes Payable" under Note 3. Robert Farias is a director of Now
Solutions.
28
In February 2004, the note payable in the amount of $181,583 issued to
Robert Farias in October 2003, bearing interest at 12% per annum was amended.
The note was also secured by 10,450,000 shares of the Company's common stock
that are owned by Mountain Reservoir to cover any shortfall. Mountain Reservoir
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 February 2006,
this note and the applicable underlying security interest were cancelled. All
outstanding debt, plus interest and any fees under the $181,583 note payable
were included under the $955,103 note payable issued to Tara Financial. For
additional details on the $181,583 note and the $955,103 note and underlying
security interest, please see "Notes Payable" under Note 3. Robert Farias is a
director of Now Solutions.
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.
In August 2004, the Company licensed the use of the Forums and calendar
applications of the Company's SiteFlash(TM) technology to Basix1 Inc. ("Basix1")
for use in Basix1's EKG software. Pursuant to the terms of the license, Basix1
is obligated to pay the Company 10% of all license fees generated from the
exploitation Basix1's EKG software. Also in August 2004, the Company and its
subsidiaries have entered into various marketing and co-marketing agreements
with Basix1. Charles Kensicki, the President of Basix1, is currently a Director
of GIS and of Now Solutions and the President of Taladin.
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. Mr. Rossetti is Executive
Vice-President of Government Affairs, Chairman, CEO and Director of GIS,
Director of Now Solutions and an officer of Markquest, Inc.
In January 2005, the Company entered into a marketing agreement with CW
International whereby CW International will be entitled to receive a percentage
of fees for new customers of the Company generated by CW International's
efforts. Mr. Weber is a Director and President of GIS and a member of CW
International.
Also in January 2005, PMP filed a lawsuit in Los Angeles Superior Court
to collect the outstanding balance of $23,974 due under the promissory note
issued to them by the Company and for failure to pay fees for professional
services in the amount of $89,930 rendered to the Company, plus interest. In
March 2005, the Company filed a demurrer. In April 2005, the Company answered
the complaint, asserting various legal defenses. In October 2005, the parties
entered into a settlement agreement. Pursuant to the terms of the settlement,
the Company issued a promissory note to PMP in the amount of $75,000 with a
maturity date of January 31, 2008, bearing interest at a rate of 6% per annum,
which shall be paid in equal monthly installments of $3,125, beginning February
1, 2006 for a period of 24 months. In connection with the settlement, the
lawsuit was dismissed. Bill Mills is a Director of the Company and a partner of
PMP.
In May 2005, Now Solutions and Robert Farias entered into an agreement
whereby Mr. Farias' would provide consulting and design specification services.
Pursuant to this agreement, Mr. Farias shall receive an hourly fee and 2% of all
sales of the Now Solutions' products specifically designed and sold within the
context of the agreement up to the earlier of either (a) four (4) years after
the execution of this Agreement or (b) Contractor's receipt of one million
dollars ($1,000,000) in commissions. In December 2005, Now Solutions assigned
this agreement to Taladin. Mr. Farias is a director of Now Solutions.
In August 2005, Mr. Salz made a $5,000 payment to a third party
pursuant to an agreement and promissory note on the Company's behalf. Mr. Salz
is the Company's corporate counsel.
In September 2005, Now Solutions entered into a consulting agreement
with Markquest, Inc. Mr. Rossetti is Executive Vice-President of Government
Affairs, Chairman, CEO and Director of GIS, Director of Now Solutions and an
officer of Markquest, Inc.
In May 2006, CW International, LLC ("CWI") entered into a sublicense
agreement with the Company to license software, including, Immune App to the
Company on a partially exclusive basis. Pursuant to the terms of the agreement,
the Company has acquired exclusive rights for all users in Brazil and in the
healthcare industry in the United States and Canada, as well as for governmental
users who are governmental subdivisions or units below the federal or state
government in the United States and their equivalents in Canada. The Company may
distribute the software to any other users on a non-exclusive basis. In
addition, Now Solutions has the exclusive rights to offer Immune App on an ASP
platform for its HRMS solution. Mr. Weber is a Director and President of GIS and
a member of CWI.
29
Also in May 2006, in connection with the sublicense agreement with CWI,
the Company acquired the rights to be a value-added reseller of
StatePointPlus(R). As a value-added reseller, the Company may market and
distribute the software. The Company may register prospective customers for six
months on an exclusive basis. Mr. Weber is a Director and President of GIS and a
member of CWI.
Critical Accounting Policies
Use of Estimates
The preparation of financial statements in conformity with accounting
principles generally accepted in the United States 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 three months ended March
31, 2006 and 2005, 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 2004, in accordance with
Financial Accounting Standard No. 142 ("SFAS No 142"), the Company determined
that there was $1,760,000 impairment in goodwill, all of which was located in
the Company. During the three months ended March 31, 2006, the Company
determined that there was no impairment in goodwill, since all goodwill in the
Company had been written-off.
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
("EITF") issued No 00-21, "Revenue Arrangement with Multiple Deliverables."
Deferred revenue on maintenance contracts represent cash received in
advance which is recognized over the life of the contract.
30
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 receivables
is deemed probable, and no significant other vendor obligations exist.
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.
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 ("APB") 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 SFAS No. 115 "Accounting for Certain Investments in Debt and
Equity Securities".
New Accounting Pronouncements
In January 2003, the Financial Accounting Standard Board (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
from 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.
Risk 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 review the
risks and uncertainties described below and the other information in this
Report. 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 Are in Default or Delinquent Under Some Of Our Notes Payable,
Certain Of Which Are Secured By Pledges Of Our Assets
As noted above under Note 3 to our Condensed Consolidated Financial
Statements, the Company is currently in default or delinquent under the terms of
some of its notes payable. While the terms of these notes vary, they typically
permit the holder thereof to call the entire principal amount, plus accrued
interest thereunder, due and payable upon the occurrence of an event of default.
Further, certain of these notes are secured by different assets of the Company,
including Now Solutions' assets which secure the various notes payable.
Notwithstanding the foregoing, it is uncertain at this time what action, if any,
will be taken by the holders of these notes that are in default or delinquent.
While the Company is attempting to cure these defaults or bring delinquent notes
current, it can offer no assurances that such attempts will be successful. These
conditions raise substantial doubt about the Company's ability to continue as a
going concern.
We Have Historically Incurred Losses And May Continue To Do So In The
Future
We have historically incurred losses. In the three months ended March
31, 2006 and the year ended December 31, 2005, the Company had net losses
applicable to common shareholders of $907,131 and $2,106,764, 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.
31
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, 2005. 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 condensed consolidated financial statements for the
three months ended March 31, 2006 and 2005 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 March 31, 2006 was
$15.6 million. Additionally, at March 31, 2006, the Company had negative working
capital of approximately $9 million (although it includes deferred revenue of
approximately $2.7 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 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 condensed 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 our SiteFlash and Emily technology products and other products we
have marketing rights to, as well as 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 and debt repayment 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 three months. 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, the Company's business plan will have to be substantially
modified and operations curtailed or suspended.
32
We Have A Working Capital Deficit, Which Means That Our Current Assets
On March 31, 2006 Were Not Sufficient To Satisfy Our Current
Liabilities On That Date
We had a working capital deficit of approximately $9 million at March
31, 2006, which means that our current liabilities exceeded our current assets
by approximately $9 million (although it includes deferred revenue of
approximately $2.7 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 on March 31, 2006 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 Websites;
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.
33
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 Shareholders To Resell Their Shares When They Choose To
At Prices They 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 Exchange Act. 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 million (if
the issuer has been in continuous operation for at least three
years) or $5 million (if in continuous operation for less than
three years), or with average revenues of less than $6 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.
34
ITEM 3. CONTROLS AND PROCEDURES
(a) Evaluation Of Disclosure Controls And Procedures
The Company's Principal Executive Officer and Principal Financial
Officer, after evaluating the effectiveness of the Company's disclosure controls
and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Exchange
Act) as of the end of the period covered by this Report, have concluded that as
of such date, the Company's disclosure controls and procedures were adequate and
effective to ensure that material information relating to the Company that is
required to be disclosed by the Company in Reports that it files or submits
under the Exchange Act, is recorded, processed, summarized and reported within
the time periods specified in SEC rules and accumulated and communicated to the
Company's management, including its Principal Executive Officer and Principal
Financial Officer, to allow timely decisions regarding required disclosure.
(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 Accounting Officer have determined that there are no
changes to the Company's internal controls over financial reporting that have
materially affected, or are reasonably likely to materially effect, the
Company's internal controls over financial reporting.
PART II
OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
The Company is involved in the following ongoing legal matters:
In February 2003, the Company filed a lawsuit and a derivative action
in New York Supreme Court Case against defendants Ross, Arglen, Tinley, and
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 withheld its payments on the
remaining $750,000 note that was due in February 2003 in connection with the
acquisition of certain assets of Ross against the unpaid maintenance fees and
gave notice in February 2003 to Ross of Now Solutions' claim of offset. Now
Solutions claimed a total amount of approximately $3,562,000 to offset against
the note, plus other damages. The Company'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. This action concerns claims of breach of contract and indemnification
for failure to pay adjustments at the closing on the sale of assets of Ross to
Now Solutions for prepaid maintenance fees and for related relief. In November
2003, the New York Supreme Court dismissed the claims against Ross and Tinley.
The portion of the lawsuit involving Arglen and Gyselen was settled in December
2003 and, pursuant to the settlement, dismissed in February 2004. The Company
appealed the decision with regard to its claim for breach of contract for Ross'
failure to give the proper maintenance fee adjustment and related claims for
offset and attorney's fees. 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. In November 2004, Ross filed an answer
containing affirmative defenses in the Derivative Action.
In March 2003, Ross commenced an action in New York Supreme Court 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 New York Supreme Court denied the motion and dismissed Ross's
action without prejudice. In October 2003, the motion of Ross for re-argument
was denied. Ross appealed the August 2003 court order, but subsequently
abandoned its appeal.
35
In December 2003, the Company settled its arbitration and litigation
with Arglen, a minority partner of Now Solutions, pursuant to the 2003
Settlement which pertains to issues related to Now Solutions. The 2003
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. When the Company
did not make the April 2004 payment, the Company began accruing interest at the
rate of 10% from the inception of the note. The security interest of Now
Solutions' assets on the secured promissory note is junior to Now Solutions'
present indebtedness to WAMCO. 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. In December 2004, the Company recorded the expense of
issuing 5,000,000 unregistered shares to Arglen at a fair market value of
$82,273, which was based on an average share price during 11 days of August
2004. These shares were issued pursuant to the settlement agreement with Arglen
whereby the Company was obligated to issue 5,000,000 unregistered shares of
common stock of the Company to Arglen, due to its failure to file a registration
statement on Form SB-2 within 180 days from the closing date of the settlement
in February 2004. In March 2005, the Company issued these 5,000,000 shares to
Arglen. 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. In April 2005, Arglen filed a Notice of Filing a Foreign Judgment
in Tarrant County, Texas In August 2005, the Company entered into a Payout
Agreement with Arglen allowing payout terms to the Company and pursuant to which
the Company agreed to enter into the Agreed Judgment. The Agreed Judgment and
Payout Agreement were entered into concerning a California judgment and Arglen's
notice of Filing a Foreign Judgment in Tarrant County, Texas, which were in
connection with the 2003 Settlement. Pursuant to the terms of the Agreed
Judgment and the Payout Agreement, the Company agreed to pay Arglen a total of
$713,489, which includes the following amounts: (a) $600,000 in principal on the
promissory note issued by the Company pursuant to the 2003 Settlement, (b) the
accrued post-judgment interest on the California judgment from September 4, 2004
through September 15, 2005, at the rate of 10% per annum, which equals $61,989,
and (c) attorney's fees incurred for the California and Texas judgment actions
which were approximately $51,500. Pursuant to the terms of the Payout Agreement,
the Company began making monthly interest payments on the amounts specified
above of $5,945, beginning on September 15, 2005, which will be replaced by
monthly payments of $25,000 or 10% of the Company's new sales, whichever is
greater, beginning on February 15, 2006 until the remainder of the $713,489 is
paid. In accordance with the Payout Agreement, Arglen shall not execute the
Agreed Judgment so long as the Company continues to make its payments as agreed.
In March 2004, Ross commenced an action in the New York Supreme Court
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 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 of Now
Solutions' nine 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. In February 2005, Ross' motion was granted based upon a procedural
default. Thereafter, Now Solutions filed a motion to vacate the default, which
motion was deined over the objections of Now Solutions. Now Solutions has filed
a notice of appeal of this decision. Now Solutions' remaining seven
counterclaims remain unaffected.
36
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 January 2005, PMP filed a lawsuit in Los Angeles Superior Court to
collect the outstanding balance of $23,974 due under the promissory note issued
to them by the Company and for failure to pay fees for professional services in
the amount of $89,930 rendered to the Company, plus interest. In March 2005, the
Company filed a demurrer. In April 2005, the Company answered the complaint,
asserting various legal defenses. In October 2005, the parties entered into a
settlement agreement. Pursuant to the terms of the settlement, the Company
issued a promissory note to PMP in the amount of $75,000 with a maturity date of
January 31, 2008, bearing interest at a rate of 6% per annum, which shall be
paid in equal monthly installments of $3,125, beginning February 1, 2006 for a
period of 24 months. In connection with the settlement, the lawsuit was
dismissed. Bill Mills is a Director if the Company and a partner of PMP.
In the opinion of management, the ultimate resolution of any pending
matters may have a significant effect on the financial position, operations or
cash flows of the Company. Also, the Company in the future may become involved
in other legal actions that may have a significant effect on the financial
position, operations or cash flows of the Company.
ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
In January 2006, the Company issued 10,450,000 unregistered shares of
common stock of the Company to employees of Vertical and Now Solutions pursuant
to restricted stock agreements with the Company that provide for the stock to
vest over period of one year or over three years in equal installments at the
anniversary date of the agreement.
In February 2006, the Company issued 5,000,000 shares of common stock
of the Company (at a fair market value of $45,000) as partial incentive for Tara
Financial to make the $450,000 loan and to refinance approximately $1.75 million
of existing debt. For details on the note payable issued in connection with the
loan, please see "Notes Payable" under Note 3.
In February 2006, the Company issued 3,000,000 shares of the common
stock of the Company (at a fair market value of $27,000) as partial incentive
for SGP to make the $150,000 loan, the Company issued to SGP 3,000,000 shares of
common stock of the Company. For details on the note payable issued in
connection with the loan, please see "Notes Payable" under Note 3.
In February 2006, the Company cancelled warrants to purchase 3,000,000
shares of common stock of the Company that had been issued to Wamco in
connection with a June 2004 amendment to a note payable and security agreement.
During the three months ended March 31, 2006, the entire $190,000 of
principal under a debenture bearing no interest was converted into 24,298,094
shares of the Company's common stock in connection with a commitment fee
pursuant to an Equity Line of Credit agreement entered into in April 2003
between the Company and Cornell. In March 2006, $40,800 in liquidated damages
claimed by Cornell in connection with the Equity Line of Credit agreement were
converted into 4,387,095 shares of common stock.
During the three months ended March 31 2006, incentive stock options to
purchase 1,500,000 shares of common stock of the Company at a price of $0.010
per share were cancelled in connection with the issuance of unregistered shares
of stock to an employee of Now Solutions.
During the three months ended March 31, 2006, warrants to purchase
3,216,667 shares of common stock of the Company at a price of $0.0760 to $0.10
per share expired.
In April 2006, the Company cancelled 800,000 unregistered shares of
common stock of the Company in that were issued pursuant to restricted stock
agreement when the employee resigned.
In April 2006, an employee of the Company cancelled 1,500,000
unregistered shares of common stock of the Company in that were issued pursuant
to restricted stock agreement.
37
In April 2006, the Company amended a restricted stock agreement with a
former employee of the Company and Now Solutions. Pursuant to the terms of the
restricted stock agreement, the Company issued 200,000 unregistered shares of
the common stock of the Company, which will vest on the anniversary date of the
execution of the original restricted stock agreement.
In April 2006, the Company issued 300,000 unregistered shares of common
stock of the Company to an employee of Now Solutions and the Company pursuant to
a restricted stock agreement between the Company and the employee that provides
for the stock to vest over three years in equal installments at the anniversary
date of the agreement.
In April 2006, the Company issued 1,000,000 shares of common stock of
the Company in connection with an amendment to an exclusive license of a patent
for an invention concerning a fiber optics technology application to the
inventor of the technology. Pursuant to an amendment, the Company also agreed to
a flat fee, plus consulting fees upon funding of OptVision Research.
During the period from April 1, 2006 to May 22, 2006, warrants to
purchase 572,222 shares of common stock of the Company at a price of $0.10 per
share expired.
Unless otherwise noted, the offers, sales and issuances of the
Company's unregistered securities set forth above involved no underwriter's
discounts or commissions. In engaging in the transactions described above which
involved the Company's unregistered securities, the Company relied upon the
private offering exemption provided under Section 4(2) of the Securities Act of
1933, as amended, in that the transactions involved private offerings of the
Company's unregistered securities, the Company did not make a public offering or
sale of its securities, the investors were either accredited or unaccredited but
sophisticated, and the investors represented to the Company that they were
acquiring the securities for investment purposes and for their own accounts, and
not with an eye toward further distribution. With regard to the unaccredited
investors, all information required to be delivered to them concerning the
Company, including financial statements, was in fact delivered to them.
38
ITEM 3. DEFAULTS UNDER SENIOR SECURITIES
None.
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
The following documents are filed as part of this report:
(a) Exhibits
Exhibit No. Description Location
- ----------- ----------- --------
31.1 Certification of Chief Executive Officer Pursuant to Provided herewith
Section 302 of the Sarbanes-Oxley Act of 2002, dated
May 22, 2006
31.2 Certification of Principal Accounting Officer Provided herewith
Pursuant to Section 302 of the Sarbanes-Oxley Act of
2002, dated May 22, 2006
32.1 Certification of Chief Executive Officer Pursuant to Provided herewith
Section 906 of the Sarbanes-Oxley Act of 2002, dated
May 22, 2006
32.2 Certification of Principal Accounting Officer Pursuant Provided herewith
to Section 906 of the Sarbanes-Oxley Act of 2002,
dated May 22, 2006
(b) Reports on Form 8-K:
On February 24, 2006, the Company filed a Current Report on Form 8-K to disclose
the transaction described below.
On February 22, 2006, the Company closed two series of transactions having the
effect of restructuring and extending the maturities of existing indebtedness of
the Company and its wholly-owned subsidiaries. As a prelude to the transactions,
the Company established a new wholly-owned subsidiary, Taladin.
In the first series of transactions, Taladin secured financing in the aggregate
amount of $600,000, which amount was utilized to acquire the existing
indebtedness of Now Solutions, from Wamco. The new financing, evidenced by two
secured promissory notes, has a maturity date in the year 2011.
In the second series of transactions, the Company and two of its subsidiaries
(including Now Solutions) consolidated aggregate indebtedness in the amount of
$1.75 million into three new promissory notes having maturities in the year
2018. The promissory notes payable by Now Solutions contain provisions requiring
additional principal reductions in the event sales exceed certain financial
thresholds.
39
SIGNATURES
Pursuant to the requirements of the Exchange Act, the Registrant has
duly caused this Report to be signed on its behalf by the undersigned thereunto
duly authorized.
Date: May 22, 2006
VERTICAL COMPUTER SYSTEMS, INC.
By: /s/ Richard Wade
-----------------------------------------
Richard Wade
President and Chief Executive Officer
By: /s/ Luiz Valdetaro
-----------------------------------------
Luiz Valdetaro
Principal Accounting Officer
40