The accompanying unaudited interim consolidated financial statements of Vertical Computer Systems, Inc. (‘we”, “our”, the “Company” or “Vertical”) have been prepared in accordance with accounting principles generally accepted in the United States of America and rules of the Securities and Exchange Commission, and should be read in conjunction with the audited consolidated financial statements and notes thereto contained in Vertical’s annual report on Form 10-K for the year ended December 31, ~~2016.~~2017. The consolidated financial statements include the accounts of the Company and its subsidiaries (collectively, “our”, “we”, the ~~“Company”~~“Company,” “Vertical”, or “VCSY”, as applicable). Vertical’s subsidiaries which currently maintain daily business operations are NOW Solutions, a 75% owned subsidiary, and SnAPPnet, Inc. (“SnAPPnet”), an 80% owned subsidiary of Vertical. Vertical’s subsidiaries which have minimal operations are Vertical do Brasil, Taladin, Inc. (“Taladin”), and Vertical Healthcare Solutions, Inc. (“VHS”), each of which a wholly-owned subsidiary of Vertical, as well as Priority Time Systems, Inc. (“Priority Time”) ~~a 70%~~, an 80% owned subsidiary, Ploinks, Inc. (“Ploinks”), ~~a 90%~~an 88% owned subsidiary and Government Internet Systems, Inc. (“GIS”), an 84.5% owned subsidiary. Vertical’s subsidiaries which are inactive include EnFacet, Inc. (“ENF”), Globalfare.com, Inc. (“GFI”), Pointmail.com, Inc. and Vertical Internet Solutions, Inc. (“VIS”), each of which is a wholly-owned subsidiary of Vertical.

In the opinion of management, all adjustments, consisting of normal recurring adjustments, necessary for a fair presentation of financial position and the results of operations for the interim periods presented have been reflected herein. The results of operations for interim periods are not necessarily indicative of the results to be expected for the full year. Notes to the consolidated financial statements which would substantially duplicate the disclosure contained in the audited financial statements as reported in the ~~2016~~2017 annual report on Form 10-K have been omitted.

On January 1, 2018, the company adopted ASU No. 2016-12,“Revenue from Contracts with Customers (Topic 606): Narrow-Scope Improvements and Practical Expedients” using the modified retrospective method applied to those contracts which were not completed as of January 1, 2018. Results for reporting periods beginning after January 1, 2018 are presented under Topic 606, while prior period amounts are not adjusted and continue to be reported in accordance with our historic accounting under Topic 605. There was no impact to the opening balance of accumulated deficit as of January 1, 2018 or revenues for the quarter ended June 30, 2018, as a result of applying Topic 606.

The Company applies a five-step approach in determining the amount and timing of revenue to be recognized: (1) identifying the contract with a customer, (2) identifying the performance obligations in the contract, (3) determining the transaction price, (4) allocating the transaction price to the performance obligations in the contract and (5) recognizing revenue when the performance obligation is satisfied. Substantially all the Company’s revenue is recognized at the time control of the products transfers to the customer.

ASC 606-10-50-5 requires that entities disclose disaggregated revenue information in categories (such as type of good or service, geography, market, type of contract, etc.). ASC 606-10-55-89 explains that the extent to which an entity’s revenue is disaggregated depends on the facts and circumstances that pertain to the entity’s contracts with customers and that some entities may need to use more than one type of category to meet the objective for disaggregating revenue.

The Company disaggregates revenue by industry as well as by country to depict the nature and economic characteristics affecting revenue. The following table presents our revenue disaggregated by industry for the three and six months ended:

The following table presents our revenue disaggregated by country for the three and six months ended:

Basic earnings per share is calculated by dividing net income (loss) available to common stockholders by the weighted average number of shares of the Company’s common stock outstanding during the period. “Diluted earnings per share” reflects the potential dilution that could occur if our share-based awards and convertible securities were exercised or converted into common stock. The dilutive effect of our share-based awards is computed using the treasury stock method, which assumes all share-based awards are exercised and the hypothetical proceeds from exercise are used to purchase common stock at the average market price during the period. The incremental shares (difference between shares assumed to be issued versus purchased), to the extent they would have been dilutive, are included in the denominator of the diluted EPS calculation. The dilutive effect of our convertible preferred stock and convertible debentures is computed using the if-converted method, which assumes conversion at the beginning of the year.

For the six months ended June 30, ~~2017~~2018 and ~~2016,~~2017, common stock equivalents related to the convertible debentures, convertible debt and preferred stock and stock derivative liability were not included in the calculation of the diluted earnings per share as their effect would be anti-dilutive.

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 For the ~~point that the product is ready for sale,~~three and are subsequently reported at the lower of unamortized cost or net realizable value. The Company considers annual amortization of capitalized software costs based on the ratio of current year revenues by product to the total estimated revenues by the product, subject to an annual minimum based on straight-line amortization over the product’s estimated economic useful life, not to exceed five years. The Company periodically reviews capitalized software costs for impairment where the fair value is less than the carrying value.

~~During the~~ six months ended June 30, ~~2017~~2018 and ~~2016,~~2017, the Company ~~capitalized an aggregate~~had 56,358,481 and 83,059,735 potential common shares under convertible notes, which were included in the calculation of ~~$0 and $250,184 respectively, related to software development.~~diluted loss per share.

In February 2016, the FASB issued ASU No. 2016-02,” Leases” (Topic 842) which includes a lessee accounting model that recognizes two types of leases - finance leases and operating leases. The standard requires that a lessee recognize on the balance sheet assets and liabilities for leases with lease terms of more than 12 months. The recognition, measurement, and presentation of expenses and cash flows arising from a lease by a lessee will depend on its classification as a finance or an operating lease. New disclosures to help investors and other financial statement users better understand the amount, timing, and uncertainty of cash flows arising from leases are also required. These disclosures include qualitative and quantitative requirements, providing information about the amounts recorded in the financial statements. ASU 2016-02 will be effective for fiscal years beginning after December 15, 2018, including interim periods within those fiscal years. The Company ~~does not expect~~is currently evaluating the effect its adoption of this standard, if any, on our consolidated financial position, results of operations or cash flows.

In May 2017, the FASB issued ASU No. 2017-09,“Compensation—Stock Compensation (Topic 718): Scope of Modification Accounting”, to provide clarity and reduce both (1) diversity in practice and (2) cost and complexity when applying the guidance in Topic 718, Compensation—Stock Compensation, to a change to the terms or conditions of a share-based payment award. The ASU provides guidance about which changes to the terms or conditions of a share-based payment award require an entity to apply modification accounting in ASC 718. The amendments are effective for fiscal years beginning after December15, 2017 and should be applied prospectively to an award modified on or after the adoption ~~of any recently issued accounting pronouncements to~~date. Early adoption is permitted, including adoption in an interim period. The Company adopted the standard on January 1, 2018 and the amendment did not have a material impact on its consolidated financial statements.

In July 2017, the ~~Company’s~~FASB issued ASU No. 2017-11,“Earnings Per Share (Topic 260); Distinguishing Liabilities from Equity (Topic 480); Derivatives and Hedging (Topic 815): (Part I) Accounting for Certain Financial Instruments with Down Round Features, (Part II) Replacement of the Indefinite Deferral for Mandatorily Redeemable Financial Instruments of Certain Nonpublic Entities and Certain Mandatorily Redeemable Noncontrolling Interests with a Scope Exception”. The ASU was issued to address the complexity associated with applying generally accepted accounting principles (GAAP) for certain financial instruments with characteristics of liabilities and equity. The ASU, among other things, eliminates the need to consider the effects of down round features when analyzing convertible debt, warrants and other financing instruments. As a result, a freestanding equity-linked financial instrument (or embedded conversion option) no longer would be accounted for as a derivative liability at fair value because of the existence of a down round feature. The amendments are effective for fiscal years beginning after December 15, 2018 and should be applied retrospectively. Early adoption is permitted, including adoption in an interim period. The Company is currently evaluating the effect its adoption of this standard, if any, on our consolidated financial position, results of operations or cash flows.

In November 2016, the FASB issued ASU 2016-18, Statement of Cash Flows - Restricted Cash (Topic 230), which amends the existing guidance relating to the disclosure of restricted cash and restricted cash equivalents on the statement of cash flows. ASU 2016-18 is effective for the fiscal year beginning after December 15, 2017, and interim periods within that fiscal year, and early adoption is permitted. The adoption of ASU 2016-18 had no effect on our Consolidated Condensed Statements of Cash Flows.

The accompanying unaudited consolidated financial statements for the six months ended June 30, ~~2017~~2018 and ~~2016~~2017 have been prepared assuming that we will continue as a going concern, and accordingly realize our assets and satisfy our liabilities in the normal course of business.

The carrying amounts of assets and liabilities presented in the consolidated financial statements do not purport to represent realizable or settlement values. As of June 30, ~~2017,~~2018, we had negative working capital of approximately ~~$21.5~~$24.2 million and defaulted on several of our debt obligations. These conditions raise substantial doubt about our ability to continue as a going concern.

Our management is continuing its efforts to attempt to secure funds through equity and/or debt instruments for our operations, expansion and possible acquisitions, mergers, joint ventures, and/or other business combinations. The Company will require additional funds to pay down its liabilities, as well as finance its expansion plans consistent with anticipated changes in operations and infrastructure. However, there can be no assurance that the Company will be able to secure additional funds and that if such funds are available, whether the terms or conditions would be acceptable to the Company and whether the Company will be able to turn into a profitable position and generate positive operating cash flow. The consolidated financial statements contain no adjustment for the outcome of this uncertainty.

The following table reflects our ~~third party~~third-party debt activity, including our convertible debt, for the six months ended June 30, ~~2017:~~2018:

During the six months ended June 30, ~~2017,~~2018, the Company ~~borrowed $180,000 from~~extended the term of certain warrants to purchase a ~~third party lender at 10% interest~~total of 11,600,000 shares of VCSY common stock (at $0.10 per ~~annum~~share) for an additional 1-year period and granted a total of ~~which $40,000 was repaid.~~

During the six months ended June 30, 2017, the Company issued a convertible debenture in the principal amount of $60,000 to a third party lender for a loan made to the Company in the same amount. The debt accrues interest at 10% per annum and is due one year from the date of issuance. Beginning six months after issuance of the debenture and provided that the lowest closing price311,099 shares of the common stock ~~for each~~ of the 5 trading days immediately preceding the conversion date has been $0.03 or higher, the holder of the respective debenture may convert the debenture into shares of common stock at a price per share of 80% of the average per share price of the Company’s common stock for the 5 trading days preceding the notice of conversion date using the 3 lowest closing prices. InPloinks, Inc. to third-party lenders in connection with certain extensions of convertible debentures in the ~~loan, the Company also~~aggregate principal amount of $1,160,000 that were issued ~~a total of 600,000 shares of common stock of the Company to the lender with the Rule 144 restrictive legend and 3-year warrants under which each lender may purchase in~~from 2015 through 2017. The due dates for all these convertible debentures were extended until October 1, 2018. The aggregate a total of 600,000 unregistered shares of common stock of the Company at a purchase price of $0.10 per share. In connection with the issuance of shares of common stock and warrants, the Company recorded a discount of $9,916 against the face value of the loan based on the relative fair market value of the ~~common stock~~Ploinks shares was determined to be $96,282 and ~~full~~was recorded as debt discount and is being amortized through the term of the convertible debenture. The incremental change in the fair ~~market~~ value of the ~~warrants. The~~extended warrants ~~are accounted for as a derivative liability. The discount is being amortized over twelve months~~was immaterial and ~~$54~~did not change the conclusion of ~~amortization expense was recognized for~~ the ~~six months ended~~debt modification.

For additional transactions after June 30, ~~2017.~~2018, please see “Subsequent Events” in Note 9.

During the six months ended June 30, 2017, $22,421 of principal, interest and legal fees under a convertible note issued in the principal amount of $90,000 was converted into 1,688,762 common shares. In May 2017, the Company amended the convertible note originally issued to a third party lender in the principal amount of $80,000 to $90,000 and cancelled a $10,000 note payable issued to the third party lender. This convertible note has been paid in full.

On January 9, 2013, NOW Solutions completed a financing transaction in the aggregate amount of $1,759,150, which amount was utilized to pay off existing indebtedness of the Company and NOW Solutions to Tara Financial Services and Robert Farias, a former employee of the Company, and all security interests granted to Tara Financial Services and Mr. Farias were cancelled.

~~In connection with this financing,~~ the Company and several of its subsidiaries entered into a loan agreement (the “Loan Agreement”), dated as of January 9, 2013 with Lakeshore Investment, LLC (“Lakeshore”) under which NOW Solutions issued a secured 10-year promissory note (the “Lakeshore Note”) bearing interest at 11% per annum to Lakeshore in the original amount of $1,759,150 and payable in equal monthly installments of $24,232 until January 31, 2022. Upon the payment of any prepayment principal amounts, the monthly installment payments ~~shall~~will be ~~proportionately~~ adjusted proportionately on an amortized rata basis.

The Lakeshore Note iswas originally secured by the assets of the Company’s subsidiaries, NOW Solutions, Priority Time, SnAPPnet, Inc. (“SnAPPnet”) and the Company’s SiteFlash™ technology, ~~and~~which were all cross-collateralized. Upon the aggregate principal payment of $290,000 toward the Lakeshore Note, the Company has the option to have Lakeshore release either the Priority Time collateral or the SiteFlash™ collateral. Upon payment of the aggregate principal of $590,000 toward the Lakeshore Note, Lakeshore shall release either the Priority Time collateral or the SiteFlash™ collateral (whichever is remaining). Upon payment of the aggregate principal of $890,000 toward the Lakeshore Note, Lakeshore shall release the SnAPPnet collateral and upon full payment of the Lakeshore Note, Lakeshore ~~shall~~will be obligated to release the NOW Solutions collateral.

As additional consideration for the loan, the Company granted a 5% interest in Net Claim Proceeds (less any attorney’s fees and direct costs) from any litigation or settlement proceeds related to the SiteFlash™ technology to Lakeshore which was increased to 8% under an amendment to the Loan Agreement in 2013. In addition, until the Note is paid in full, NOW Solutions agreed to pay Lakeshore a ~~Lakeshore~~ royalty of 6% of its annual gross revenues in excess of $5 million dollars up to a maximum of $1,759,150. Management has estimated the fair value of the royalty to be nominal as of its issuance date and no royalty was owed as of ~~September 30, 2015~~December 31, 2017 or December 31, ~~2014.~~2016.

Under an amendment of the Lakeshore Note and the Loan Agreement executed on January 31, 2013, Vertical was obligated to transfer 25% of its ownership interest in NOW Solutions in the event certain principal payments were not timely made to Lakeshore. When the last forbearance agreement with Lakeshore expired, Lakeshore became a 25% minority owner of NOW Solutions on October 1, 2013.

In December 2014, the Company and Lakeshore entered into an amendment of the Lakeshore Note and the Loan Agreement. Under the terms of the amendment, NOW Solutions agreed to make $2,500 weekly advance payments to Lakeshore to be applied to the 25% dividend of NOW Solutions’ net income after taxes in connection with Lakeshore’s 25% minority ownership interest in NOW Solutions. Within 10 business days after the Company files its periodic reports with the SEC, NOW Solutions will also make quarterly payment advances to Lakeshore based on 60% of Lakeshore’s 25% share of NOW Solutions estimated quarterly net income after taxes, less any weekly payment advances received by Lakeshore during the then-applicable quarter and the weekly $2,500 payments shall be increased or decreased based only upon any increases or decreases of maintenance and cloud-based offering fees during the then-completed quarter (but will not decrease below a minimum of $2,500 per week). NOW Solutions shall pay Lakeshore the balance of Lakeshore’s 25% of NOW’s yearly net income after taxes (less any advances) within 10 business days after the Company files it annual 10-K report with the SEC and any payments in excess of Lakeshore’s 25% of NOW yearly profit shall be credited towards future weekly advance payments. The Company also agreed to pay attorney fees of $40,000 and paid fees of $80,000 to a former consultant and employee of the Company who is a member of Lakeshore. In consideration of ~~the~~an extension Lakeshore granted to NOW Solutions to cure the default under the Lakeshore Note and the Loan Agreement, the Company transferred a 20% ownership interest in two subsidiaries to Lakeshore: Priority Time Systems, Inc., and ~~in SnAPPnet, Inc.. This resulted in an additional non-controlling interest recognized in the equity of the Company of $391,920 and $99,210 for Priority Time Systems, Inc. and~~ SnAPPnet, Inc.~~, respectively, during 2014. The Company had an option to buy back Lakeshore’s ownership interest in NOW Solutions, Priority Time and SnAPPnet, Inc. (which expired on January 31, 2015).~~

In ~~July 2015, we~~December 2017, the Vertical and NOW Solutions and Lakeshore entered into an ~~agreement with~~amendment (the “2017 Lakeshore Loan Amendment “) to ~~amend the terms of~~ the Loan Agreement and the Lakeshore ~~Note. Under~~Note issued to Lakeshore. Pursuant to the terms of ~~the~~this amendment, the Company issued 13,000,000 common shares with the Rule 144 restrictive legend, resulting in a forbearance loss of $455,000 and Ploinks agreed to issue 3,000,000 common shares of its stock to Lakeshore. The fair valueprincipal balance of the ~~Ploinks shares~~Note was ~~determined~~amended to ~~be nominal. Also~~$2,291,395, which included (a) all unpaid dividends and outstanding attorneys’ fees in ~~July 2015,~~ the ~~Company further amended~~amount of $250,000 and (b) all outstanding accrued interest in the amount of $414,364. Under the 2017 Lakeshore Loan Amendment, any existing defaults under the Lakeshore Note and related security agreements were cured, the interest rate reverted to the non-default rate of 11% interest per annum, the Lakeshore Note was re-amortized and the term of the Lakeshore Note was extended for an additional 10 years, with monthly installment payments consisting of $31,564 due on the 10^th day of each month, beginning on January 10, 2018. In addition, the security agreements for the SiteFlash assets, the assets of Priority Time, and the assets of SnAPPnet were cancelled and Lakeshore agreed to file notices of termination of all UCC lien statements in connection with these assets. The security agreement concerning the assets of NOW Solutions remain in effect and upon full payment of the Lakeshore Note, Lakeshore will release the NOW Solutions collateral. Furthermore, the interest in “Net Claim Proceeds” from the SiteFlash Assets was increased from 8% to 20% under this amendment.

The 2017 Lakeshore Loan ~~Agreement with Lakeshore. Pursuant~~Amendment also provides that if NOW Solutions makes any advance toward net income (less Vertical’s management fee and management allocations) to ~~this Agreement,~~Vertical, then NOW Solutions shall pay Lakeshore 25% share of such an advance no later than one business day after Vertical receives its 75% percent share. In the ~~Company issued 2,000,000 shares of its common stock with the Rule 144 restrictive legend resulting in a forbearance loss of $54,200 and paid $15,000~~event NOW Solutions does not make payment to Lakeshore, ~~as forbearance fees.~~the loan will be in default and NOW Solutions has five business days from discovery and notice by Lakeshore to make payment plus a penalty in the amount of 20% of the unpaid 25% share amount.

In ~~August 2015, we entered into an agreement with~~order to facilitate the execution of the 2017 Lakeshore ~~to amend~~Loan Amendment which resulted in the ~~terms~~cure of any existing defaults under the Loan Agreement and the ~~Lakeshore Note. Under~~Note, as well as the ~~terms~~release by Lakeshore of the ~~amendment,~~security interests in the SiteFlash assets and the assets of SnAPPnet and Priority Time, the Company issued ~~7,000,000~~2,500,000 VCSY common shares at a fair market value of $35,400 and 300,000 Ploinks common shares at a fair market value of $92,850 to certain third party purchasers of 600,000 shares of ~~its common stock with the Rule 144 restrictive legend resulting in~~VHS Series A Preferred Stock from a ~~forbearance loss~~member of ~~$175,700 and Ploinks agreed to issue 2,000,000 common shares of its stock to~~ Lakeshore. The ~~fair value~~Company recorded a loss on debt extinguishment of $128,250 during the ~~Ploinks shares was determined to be nominal.~~

Under the August 2015 agreement, the Company also agreed to make a $500,000 payment for amounts due to Lakeshore under the Lakeshore Note and the Loan Agreement. In the event that the Company did not make the Lakeshore $500,000 payment on or before August 21, 2015, then Lakeshore in lieu of the $500,000 payment, would obtain a purchase option (the “2015 Purchase Option”) to purchase an additional 250 shares of NOW Solutions common stock for a total purchase price of $950,000. In addition, since the Company did not make the $500,000 payment to Lakeshore on or before August 21, 2015, no further payment on the Note was due until January 1, 2016 at which time the Note plus all accrued interest were recalculated and the Note was re-amortized under the same interest rate and terms as the Note and the maturity date of the Note was extended 10 years from January 1, 2016.

~~The Lakeshore note is in default and the Company is currently evaluating solutions to resolve all issues with Lakeshore.~~year ended December 31, 2017.

During the six months ended June 30, ~~2017, NOW Solutions, a subsidiary of~~2018, the Company, ~~accrued~~through its subsidiary, declared dividends to Lakeshore of ~~$65,000.~~

~~For additional transactions after~~$90,332 of which $59,090 were paid and $31,242 were left accrued. During the six months ended June 30, 2017, ~~concerning notes payable, please see “Subsequent Events” in Note 9.~~the Company, through its subsidiary, declared dividends to Lakeshore of $65,000 which were added to the note balance as part of the December 2017 amendment discussed above.

As of June 30, ~~2017,~~2018, the Company has convertible notes and common stock warrants that qualify as derivative liabilities under ASC 815.

As of June 30, ~~2017,~~2018, the aggregate fair value of the outstanding derivative liabilities was ~~$396,674.~~$89,870. For the six months ended June 30, ~~2017,~~2018, the net gain on the change in fair value of derivative liabilities was ~~$619,898.~~$96,314.

The Company estimated the fair value of the derivative liabilities using the Black-Scholes option pricing model and the following key assumptions during ~~2017:~~2018:

FASB ASC 820, Fair Value Measurements and Disclosures, defines fair value as the exchange price that would be received for an asset or paid to transfer a liability (an exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date. FASB ASC 820 also establishes a fair value hierarchy which requires an entity to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value. FASB ASC 820 describes three levels of inputs that may be used to measure fair value:

Level 1– Quoted prices in active markets for identical assets or liabilities.

Level 2– Observable inputs other than Level 1 prices, such as quoted prices for similar assets or liabilities; or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the assets or liabilities.

Level 3– Unobservable inputs that are supported by little or no market activity and that are financial instruments whose values are determined using pricing models, discounted cash flow methodologies, or similar techniques, as well as instruments for which the determination of fair value requires significant judgment or estimation.

If the inputs used to measure the financial assets and liabilities fall within more than one level described above, the categorization is based on the lowest level of input that is significant to the fair value measurement of the instrument.

The following table provides a summary of the fair value of our derivative liabilities as of June 30, ~~2017~~2018 and December 31, ~~2016:~~2017:

The estimated fair value of short-term financial instruments, including cash, accounts receivable, accounts payable and accrued liabilities and deferred revenue approximates their carrying value due to their short-term nature. The Company uses Level 3 inputs to estimate the fair value of its derivative liabilities.

The below table presents the change in the fair value of the derivative liabilities during the six months ended June 30, 2017:

~~In May 2017,~~During the six months ended June 30, 2018, the Company ~~granted 300,000 unregistered~~issued an additional 2,500,000 VCSY common shares ~~of its common stock with the Rule 144 restrictive legend and 50,000 shares of Ploinks, Inc. common stock to~~at a ~~consultant of the Company and its subsidiaries pursuant to a consulting agreement with the Company. The aggregate~~ fair market value of ~~the VCSY common stock grant was determined to be $4,200 based on the quoted market price of VCSY stock at date of grant~~$33,000 and an additional 300,000 Ploinks ~~Inc. common stock grant was determined to be $5,400 based on a third party valuation of Ploinks stock. In addition, the Company agreed to issue up to 2,000,000~~ common shares at a fair market value of $92,850 to certain third-party purchasers of 600,000 shares of VHS Series A Preferred Stock from a member of Lakeshore. These additional shares were issued to facilitate the execution of the ~~Company~~2017 Lakeshore Loan Amendment which resulted in the cure of any existing defaults under the Loan Agreement and ~~200,000 shares~~the Note, as well as the release by Lakeshore of ~~Ploinks, Inc. common stock pursuant to restricted~~the security interests in the SiteFlash assets and the assets of SnAPPnet and Priority Time, when VHS did not meet performance ~~stock agreements with~~standards. The company recorded the ~~consultant. These shares may vest over a term~~combined fair value of ~~3 years and are based upon~~$125,850 as non-operating penalties in other income (expense) for the ~~Consultant achieving certain performance criteria.~~six months ended June 30, 2018.

During the six months ended June 30, ~~2017,~~2018, the Company ~~issued~~extended the term of certain warrants to purchase a ~~convertible debenture in the principal amount~~total of ~~$60,000 to~~11,600,000 shares of VCSY common stock (at $0.10 per share) for an additional 1-year period and granted a ~~third party lender for a loan made to the Company in the same amount. The debt accrues interest at 10% per annum and is due one year from the date~~total of ~~issuance. Beginning six months after issuance of the debenture and provided that the lowest closing price~~311,099 shares of the common stock ~~for each~~ of the 5 trading days immediately preceding the conversion date has been $0.03 or higher, the holder of the respective debenture may convert the debenture into shares of common stock at a price per share of 80% of the average per share price of the Company’s common stock for the 5 trading days preceding the notice of conversion date using the 3 lowest closing prices. InPloinks, Inc. to third-party lenders in connection with certain extensions of convertible debentures in the ~~loan,~~aggregate principal amount of $1,160,000 that were issued from 2015 through 2017. The due dates for all these convertible debentures were extended until October 1, 2018. The incremental change in the Company also issued a total of 600,000 shares of common stock of the Company to the lender with the Rule 144 restrictive legend and 3-year warrants under which each lender may purchase in aggregate a total of 600,000 unregistered shares of common stock of the Company at a purchase price of $0.10 per share. In connection with the issuance of shares of common stock and warrants, the Company recorded a discount of $9,916 against the facefair value of the ~~loan based on~~extended warrants was immaterial and did not change the ~~relative fair market value~~conclusion of the common stock and full fair market value of the warrants. The warrants are accounted for as a derivative liability. The discount is being amortized over twelve months and $54 of amortization expense was recognized for the six months ended June 30, 2017.debt modification.

During the six months ended June 30, ~~2017, the Company entered into a subscription agreement under which a third party subscriber purchased 1,000~~2018, 320,000 shares of VCSY ~~Series A Preferred Stock for $200,000. In connection with the purchase of the VCSY Series A Preferred Stock, the subscribers also received a total of 2,000,000 shares of~~ common stock issued to employees of the Company with the Rule 144 restrictive legend, 100,000 shares of common stock of Ploinks, Inc., 2-year warrants under which the subscribers may purchase an aggregate total of 150,000 unregistered shares of common stock of the Company at a purchase price of $0.10 per share and 2-year warrants under which the subscribers may purchase an aggregate total of 150,000 unregistered shares of common stock of the Company at a purchase price of $0.20 per share. The allocated fair market value of the VCSY Series A Preferred Stock issued to the subscribers was $36,670. Each share of VCSY Series A Preferred Stock is convertible into 500 shares of the Company’s common stock. The allocated fair market value of all common shares of the Company issued to the subscribers was $22,800. The allocated fair market value of all common shares of Ploinks, Inc. issued to the subscribers was $1,196. The fair market value of all warrants issued to the subscribers was $451 (which was calculated using the Black-Sholes model). The warrants were accounted for as derivative liabilities (see Note 4).

During the six months ended June 30, 2017, the Company granted 295,500 shares of the common stock of Ploinks, Inc. to third party lenders in connection with 3 to 6-month extensions of convertible debentures in the principal amount of $1,035,000 issued in 2015 and 2016. The aggregate fair market value of the awards was determined to be $31,914 and was recorded as debt discount, and is being amortized through the term of the convertible debenture.vested.

During the six months ended June 30, ~~2017, the Company granted 3,000,000 VCSY common shares pursuant to a stock award to an employee of the Company and its subsidiaries (at a fair market value of $72,000).~~

During the six months ended June 30, 2017, $22,421 of principal, interest and legal fees under a convertible note issued in the principal amount of $90,000 was converted into 1,688,762 common shares. In May 2017, the Company had amended this convertible note originally issued to a third party lender in the principal amount of $80,000 to $90,000 and cancelled a $10,000 note payable issued to the third party lender. This convertible note has been paid in full.

During the six months ended June 30, 2017, the Company entered into a restricted stock agreement to grant 120,000 shares of the Company’s common stock with the Rule 144 restrictive legend with an employee of the Company under which the shares vest in equal installments over a 30-month period. The fair value of the shares was $2,208 based on the quoted market price of VCSY stock on the grant date and $368 was amortized to expense during the six months ended June 30, 2017.

~~During the six months ended June 30, 2017, 550,000 VCSY common shares vested under restricted stock agreements to employees and a consultant of the Company.~~

During the six months ended June 30, 2017, Ploinks, Inc. entered into a restricted stock agreement to grant 60,000 unregistered shares of the common stock of Ploinks, Inc. to an employee of the Company pursuant to a restricted stock agreement with Ploinks, Inc. These shares typically vest over a 30-month period in equal installments and the fair value of the awards is being expensed over this vesting period. The fair value of the shares was $6,480 based on a third party valuation of Ploinks stock and $1,082 was amortized to expense during the six months ended June 30, 2017.

During the six months ended June 30, 2017, the Company granted 300,000 unregistered shares of the common stock of Ploinks, Inc. to an employee of a subsidiary of the Company’s pursuant to a restricted stock agreement with the Company. 150,000 shares vested immediately upon grant of the shares (as noted below) and 150,000 shares will vest in 4 months from the date of grant. The fair value of the shares was $32,400 based on a third party valuation of Ploinks stock and $22,127 was amortized to expense during the six months ended June 30, 2017

~~During the six months ended June 30, 2017, 350,001~~2018, 209,998 shares of the common stock of Ploinks, Inc. issued under restricted stock agreements to consultants and employees of the Company and a subsidiary of the Company vested.

Stock compensation expense for the amortization of restricted stock awards was ~~$67,494~~$24,073 for the six months ended June 30, ~~2017.~~2018. As of June 30, ~~2017,~~2018, there were ~~11,695,000~~5,740,000 shares of unvested stock compensation awards to employees and ~~16,000,000~~15,500,000 shares of unvested stock compensation awards to non-employees.

Stock compensation expense for the amortization of subsidiary’s restricted stock awards was $35,244 for the six months ended June 30, 2018.

We have evaluated our convertible cumulative preferred stock under the guidance set out in FASB ASC 470-20 and accordingly classified these shares as temporary equity in the consolidated balance sheets.

For additional transactions after June 30, ~~2017~~2018 concerning stock transactions, please see “Subsequent Events” in Note 9.

During the six months ended June 30, 2018, the Company extended the term of certain warrants to purchase a total of 11,600,000 shares of VCSY common stock (at $0.10 per share) for an additional 1-year period in connection with extensions of convertible debentures in the principal amount of $1,160,000 that were issued from 2015 through 2017.

Option and warrant activities during the six months ended June 30, ~~2017~~2018 is summarized as follows:

The weighted average remaining life of the outstanding warrants as of June 30, ~~2017~~2018 was ~~1.98.~~1.10. The intrinsic value of the exercisable warrants as of June 30, ~~2017~~2018 was ~~$.0139.~~$.015.

For additional transactions after June 30, ~~2017~~2018 concerning warrants and stock options, please see “Subsequent Events” in Note 9.

~~Related~~The following table reflects our related party debt activity, including our convertible debt, ~~was $308,242 as of~~for the six months ended June 30, ~~2017 and December 31, 2016.~~2018:

As of June 30, ~~2017~~2018, and December 31, ~~2016,~~2017, the Company had accounts payable to employees for unreimbursed expenses and related party contractors in an aggregate amount of ~~$162,500~~$171,905 and ~~$139,546,~~$148,760, respectively. The payables are unsecured, non-interest bearing and due on demand.

As of June 30, 2018, and December 31, 2017, the Company has accrued payroll to certain current and former employees of $2,849,226 and $2,770,684, respectively.

On June 30, 2016, the Company amended an agreement (originally entered into in July 2010) with certain former and current employees of the Company, concerning the deferral of payroll claims of approximately $883,190 for salary earned from 2012 to June 30, 2016 and $1,652,113 for salary earned from 2001 to 2012. The deferral period ended on December 31, 2016 at which time payroll claims of approximately $878,099 for salary earned from 2012 to December 31, 2016 and $1,652,113 for salary earned from 2001 to 2012, remained unpaid and is reflected as a current liability on the Company’s consolidated financial statements.

Pursuant to the terms of the amended agreement, each current and former employee who is a party to the agreement (the “Employee(s)”) agreed to defer payment of salary from the date of the agreement (“Salary Deferral”) for a period of three months for salary earned from July 1, 2012 to June 30, 2016 and for a period of six months for salary earned from 2001 to June 30, 2012. In consideration for the Salary Deferral, the Company issued a total 3,500,000 shares of the Company’s common stock during 2016 with the Rule 144 restrictive legend (at a fair market value of $78,750) and agreed to pay each Employee a sum equal to the amount of unpaid salary at December 31, 2003 plus the amount of unpaid salary at the end of any calendar year after 2003 in which such salary was earned, plus a bonus (the “Bonus”) of nine percent interest, compounded annually until such time as the unpaid salary has been paid in full. The Company and the Employees have agreed that the Bonus will be paid from amounts anticipated to be paid to the Company in respect of specified intellectual property assets of the Company.

In order to effect the payments due under this agreement, the Company assigned to the Employees a twenty percent interest in any net proceeds (gross proceeds less attorney’s fees and direct costs) derived from infringement claims and any license fees paid by a subsidiary of the Company or third party to the Company regarding (a) U.S. patent #6,826,744 and U.S. patent #7,716,629 (plus any continuation patents) on Adhesive Software’s SiteFlash™ Technology, (b) U.S. patent #7,076,521 (plus any continuation patents) in respect of “Web-Based Collaborative Data Collection System”, and (c) U.S. patent U.S. Patent No. #8,578,266 and #9,405,736 (plus any continuation patents) in respect to “Method and System for Automatically Downloading and Storing Markup Language Documents into a Folder Based Data Structure,” and (d) any license payments made (i) by a subsidiary of the Company to the Company in connection with a licensing or distribution agreement between the Company and such subsidiary or (ii) by third party to the Company in connection with a licensing or distribution agreement between the Company and a third party.

Under the terms of this agreement, the Bonus is contingent on payment of unpaid wages. In addition, the Bonus is contingent upon generating revenues from the sources of the twenty percent interests in net proceeds assigned to the current and former employees. The interests that were assigned under the agreement for net proceeds consist of the underlying patents of the SiteFlash™ and Emily™ technologies and licensing under distribution and licensing agreements between the Company and subsidiaries and between the Company and third parties. Currently, there is no foreseeable income to be generated from these sources to which a twenty percent interest can reasonably be projected or otherwise applies to. There is no pending litigation regarding any of these patents. In addition, with respect to any licenses from Vertical to its subsidiaries, the licenses of technology underlying these patents were for a three percent royalty on gross revenues. If there were income, any payments under this agreement would likely be minimal. Currently, there is no income being generated from licensing. No subsidiary is currently offering a product to the market using these licensed technologies nor does Vertical have any agreement to license these technologies to a third party.

Since payment of the Bonus is contingent upon first paying all unpaid salary and there are no foreseeable revenues to pay the twenty percent interest in these technologies, it is doubtful at the present time that any Bonus will be paid and therefore the Bonus was not accrued as of June 30, 2018 and December 31, 2017 as this contingent liability is considered remote. Cumulative bonus interest through June 30, 2018 is $4,850,139.

On December 31, 2011, the Company and InfiniTek corporation (“InfiniTek”) entered into a settlement agreement to dismiss an action filed by the Company against InfiniTek in the Texas State District Court in Fort Worth, Texas, for breach of contract and other claims, a counter claim filed by InfiniTek against the Company for non-payment of amounts claimed the Company owed to InfiniTek, and an action filed by InfiniTek against the Company in California Superior Court in Riverside, California seeking damages for breach of contract and lost profit. Pursuant to the terms of the settlement agreement, Vertical agreed to pay InfiniTek $82,500 in three equal installments with the last payment due by or before August 5, 2012. Upon full payment, InfiniTek ~~shall~~had agreed to transfer and assign ownership of the NAVPath software developed by InfiniTek for use with NOW Solutions emPath® software application and Microsoft Dynamics NAV (formerly Navision) business solution platform. The ~~amounts in dispute were included in our accounts payable and accrued liabilities and have been adjusted to the settlement amount of $82,500 at December 31, 2011. The~~ Company ~~has~~ made $37,500 in payments due under the settlement agreement ~~as of the date of this Report~~through May 7, 2012 and each party ~~is alleging~~had alleged the other party iswas in breach of the settlement agreement. ~~We intend to resolve all disputes with InfiniTek.~~

On February 13, 2017, the Company was served with a complaint filed by Parker Mills in the Superior Court of the State of California, County of Los Angeles, Central District, for failure to make payment on the outstanding balance due under a $100,000 convertible debenture issued by the Company to Parker Mills. The plaintiff seeks payment of the principal balance due under the convertible debenture of $100,000, interest at the rate of 12% per annum, attorney’s fees and court costs. ~~The Company has $112,985 of principal and interest accrued as of March 31, 2017.~~ In June 2017, the court entered a default judgment against the Company. We intend to resolve this matter with Parker Mills. This case is styled Parker Mills, LLP v. Vertical Computer Systems, Inc., No.BC649122. William Mills is a partner of Parker Mills and the Secretary and a Director of the Company. The Company has $127,655 of principal and interest accrued as of June 30, 2018.

On April 12, 2017, NOW Solutions, Inc. was served with a Notice of Motion for Summary Judgment in Lieu of Complaint, which was filed by Derek Wolman in the Supreme Court of the State of New York in County of New York for failure to make outstanding payments on the outstanding balance due under one promissory note in the principal amount of $150,000 (issued on November 17, 2009) and one promissory note in the principal amount of $50,000 (issued on August 28, 2014), both of which were issued by NOW Solutions to Mr. Wolman. The plaintiff seeks a judgment totaling $282,299 (which includes principal and accrued interest), plus additional accrued interest from the date the complaint was filed, attorney’s fees and expenses. On September 8, 2017, the court awarded Mr. Wolman a judgment in the amount of $282,299, which accrues interest at the rate of 16% per annum plus attorney’s fees as to be determined by the court. The Company has ~~$260,286~~$325,790 of principal and accrued interest ~~accrued~~ as of June 30, ~~2017.~~2018. We intend to resolve this matter with Mr. Wolman. This case is styled Derek Wolman v. Now Solutions, Inc., No. 65/502/17.

InOn July 2017, the United States Patent and Trademark office issued a patent (Patent No. 9710425) for the invention titled “Mobile Proxy Server for Internet Server Having a Dynamic IP Address” for Claims 1-20. The term “IP” stands for “Internet Protocol,” which is the principal communications protocol for the Internet. This patented technology is incorporated in the Ploinks SPC™ and the Company’s core communication platform.

~~In July 2017, the Company granted 500,000 unregistered shares of its common stock with the Rule 144 restrictive legend and 30,000 shares of common stock of Ploinks, Inc.~~25, 2018, Taladin executed an amendment to a ~~consultant~~pledge agreement (the “Amended Pledge Agreement”) with a third-party lender. The Company and NOW Solutions also executed an amendment of certain promissory notes (the “Notes”) issued to the lender by the Company and ~~its subsidiaries pursuant to a consulting agreement with~~NOW Solutions in the ~~Company.~~aggregate principal amount of $715,000. The outstanding balance due under the Notes as of June 30, 2018, including interest, was $2,093,334 (plus $280,000 in penalties).

~~During~~Under the ~~period that runs from July 1, 2017 through August 21, 2017,~~original pledge agreement, Taladin pledged 20,000,000 shares (the “Pledged Shares”) of the ~~Company~~Company’s common stock to the lender to secure obligations under the Notes, as amended, consisting of (a) promissory note issued ~~a convertible debenture~~by NOW Solutions in the principal amount of ~~$50,000 to a third party lender for a loan made~~$215,000 issued on September 4, 2003 and assigned to the ~~Company~~lender effective on January 4, 2004, (b) the promissory note issued by VCSY in the ~~same amount.~~principal amount of $200,000 issued on October 24, 2006 and (c) the promissory note issued by VCSY in the principal amount of $300,000 issued on March 5, 2007.

Terms of the Amended Pledge Agreement. Under the terms of the Amended Pledge Agreement, in lieu of selling the Pledged Shares pursuant to the original terms of the pledge agreement, Taladin and the lender agreed that Taladin, or a party acting on Taladin’s behalf, may purchase a total of 10,000,000 shares of the Pledged Shares from Taladin at a purchase price of $0.015 per share over a certain period of time. The ~~debt accrues~~Company made $150,000 in payments to the lender and all rights to 10,000,000 shares of the Pledged Stock will be retained by Taladin.

Terms of the Amendment of the Notes. Under the terms of the amendment to the Notes, all defaults under the Notes are deemed cured; however, the default interest rate of 16% will continue to apply, subject to the terms of the amendment of the Notes. The Notes have been amended as follows: (a) $125,000 will applied to the currently outstanding penalties in the amount of $280,000 which will be deemed to be paid in full (and the remaining $155,000 in penalties will be cancelled) and (b) a payment of $25,000 will be applied toward the Notes; (c) beginning on September 1, 2018, and continuing on the first day of each month thereafter, the Company shall make $25,000 monthly installments payments until January 31, 2020 (the “Maturity Date”) at which time all outstanding amounts under the Notes will be due; (d) upon an additional payment of $175,000, the annual interest rate for all of the Notes will be reduced to an annual interest rate of 12%, provided that if, at any time the delinquent monthly payments exceed $75,000, the annual interest rate will be raised to an annual interest rate of 16%.

In August 2018, a third-party lender loaned $55,000 to the Company. The loan bears interest at 10% per annum and is due ~~one year from~~on demand.

In August 2018, a third-party lender loaned $120,000 to the date of issuance. Beginning six months after issuance of the debenture and provided that the lowest closing price of the common stock for each of the 5 trading days immediately preceding the conversion date has been $0.03 or higher, the holder of the debenture may convert the debenture into shares of common stock at a price per share of 80% of the average per share price of the Company’s common stock for the 5 trading days preceding the notice of conversion date using the 3 lowest closing prices.Company. In connection with the loan, the Company issued a promissory note to the lender in the principal amount of $120,000, bearing interest at 10% per annum, which is due in 90 days from the date the promissory note was issued. The Company also issued a ~~total of 500,000~~3-year warrant to purchase 1,200,000 shares of the Company’s common stock ~~of the Company to the lender with the Rule 144 restrictive legend and 3-year warrants under which the lender may purchase up to 500,000 unregistered shares of common stock of the Company~~ at ~~a purchase price of $0.10 per share.~~

During the period that runs from July 1, 2017 through August 21, 2017, the Company entered into a subscription agreement under which a third party subscriber purchased 300 shares of VCSY Series A Preferred Stock for $60,000. In connection with the purchase of the VCSY Series A Preferred Stock, the subscriber also received a total of 600,000 shares of common stock of the Company with the Rule 144 restrictive legend, 30,000 shares of common stock of Ploinks, Inc., 2-year warrants under which the subscriber may purchase an aggregate total of 45,000 unregistered shares of common stock of the Company at a purchase price of $0.10 per share and 2-year warrants under which the subscriber may purchase an aggregate total of 45,000 unregistered shares of common stock of the Company at a purchaseexercise price of $0.20 per share.

During the period that runs from July 1, ~~2017 through~~2018 to August 21, ~~2017, the Company granted 4,500~~2018, 250,000 shares of VCSY common stock ~~of Ploinks, Inc. to a third party lender in connection with a 6-month extension of a convertible debenture in the principal amount of $15,000~~ issued ~~in 2016.~~

During the period that runs from July 1, 2017 through August 21, 2017, the Company made payments of $126,500 of principal and interest due under a convertible debenture in the principal amount of $115,000 issued by the Company to a third party lender. This convertible debenture has been paid in full.

~~During the period that runs from July 1, 2017 through August 21, 2017, 250,000 VCSY common shares issued under restricted stock agreements~~ to an employee of a subsidiary of the Company vested.

During the period that runs from July 1, ~~2017 through~~2018 to August 21, ~~2017,~~2018, 80,000 ~~common~~ shares of the common stock of Ploinks, Inc. issued under restricted stock agreements to an employee of a subsidiary of the Company vested.

During the period that runs from July 1, 2018 to August 21, 2018, the Company extended the term of certain warrants to purchase a total of 500,000 shares of VCSY common stock (at $0.10 per share) for an additional 1-year period and granted 9,100 shares of the common stock of Ploinks, Inc. to third-party lenders in connection with certain extensions of convertible debentures in the principal amount of $65,000 that were issued in 2016 and 2017. The due dates for all these convertible extensions were extended until October 1, 2018. The incremental change in the fair value of the extended warrants was immaterial and did not change the conclusion of the debt modification.

The Company is planning to hold its Annual Meeting of Stockholders at 11:00 am (Central Standard Time) on November 27, 2018 at the Company’s office building. At the Annual Meeting, the Company may make observations regarding its financial performance and outlook.

Stockholders wishing to nominate a director or present a proposal to be considered at the Annual Meeting must timely submit a written notice to the Corporate Secretary of the Company at its executive offices. In addition, any stockholder proposals submitted for inclusion in the Company’s proxy materials for the Annual Meeting must be timely received by the Corporate Secretary and will be subject to the requirements of the proxy rules adopted under the Securities Exchange Act of 1934, as amended, the Company’s charter and bylaws, and Delaware law.

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations.

The following discussion is a summary of the key factors management considers necessary or useful in reviewing the Company’s results of operations, liquidity and capital resources. The following discussion and analysis should be read together with the accompanying Unaudited Consolidated Financial Statements, and the cautionary statements and risk factors included below in Item 1A of Part II of this Report.

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 are subsequently reported at the lower of unamortized cost or net realizable value. The Company considers annual amortization of capitalized software costs based on the ratio of current year revenues by product to the total estimated revenues by the product, subject to an annual minimum based on straight-line amortization over the product’s estimated economic useful life, not to exceed five years. The Company periodically reviews capitalized software costs for impairment where the fair value is less than the carrying value. During the six months ended June 30, ~~2017~~2018 and ~~2016,~~2017, $0 and ~~$250,184~~$0 of internal costs were capitalized, respectively.

~~Our revenue recognition policies~~On January 1, 2018, the company adopted ASU No. 2016-12,“Revenue from Contracts with Customers (Topic 606): Narrow-Scope Improvements and Practical Expedients” using the modified retrospective method applied to those contracts which were not completed as of January 1, 2018. Results for reporting periods beginning after January 1, 2018 are ~~in accordance with standards on software revenue recognition, which include guidance on revenue arrangements with multiple deliverables~~presented under Topic 606, while prior period amounts are not adjusted and ~~arrangements that include the right~~continue to ~~use of software stored on another entity’s hardware.~~

In the case of non-software arrangements, we apply the guidance on revenue arrangements with multiple deliverables and wherein multiple elements are allocated to each element based on the element’s relative fair value. Revenue allocated to separate elements is recognized for each elementbe reported in accordance with our historic accounting ~~policies described below. If we cannot account~~under Topic 605. There was no impact to the opening balance of accumulated deficit or revenues for ~~items included in a multiple-element arrangement as separate units of accounting, they are combined and accounted for~~the quarter ended June 30, 2018 as a ~~single unit~~result of ~~accounting~~applying Topic 606.

The Company applies a five-step approach in determining the amount and ~~generally~~timing of revenue to be recognized: (1) identifying the contract with a customer, (2) identifying the performance obligations in the contract, (3) determining the transaction price, (4) allocating the transaction price to the performance obligations in the contract and (5) recognizing revenue when the performance obligation is satisfied. Substantially all the Company’s revenue is recognized asat the ~~undelivered items or services are provided~~time control of the products transfers to the customer.

Consulting. We provide consulting services, primarily implementation and training services, to our clients using a time and materials pricing methodology. The Company prices its delivery of consulting services on a time and materials basis where the customer is either charged an agreed-upon daily rate plus out-of-pocket expenses or an hourly rate plus out-of-pocket expenses. In this case, the Company is paid fees and other amounts generally on a monthly basis or upon the completion of the deliverable service and recognizes revenue as the services are performed.

Software License. We sell concurrent perpetual software licenses to our customers. The license gives the customer the right to use the software without regard to a specific term. We recognize the license revenue upon execution of a contract and delivery of the software, provided the license fee is fixed and determinable, no significant production, modification or customization of the software is required, and collection is considered probable by management. When the software license arrangement requires the Company to provide consulting services that are essential to the functionality of the software, the product license revenue is recognized upon the acceptance by the customer and consulting fees are recognized as services are performed.

Software licenses are generally sold as part of a multiple-element arrangement that may include maintenance and, under a separate agreement, consulting services. The consulting services are generally performed by the Company, but the customer may use a third-party to perform the consulting services. We consider these separate agreements as being negotiated as a package. The Company determines whether there is vendor specific objective evidence of fair value (’‘VSOEFV’’) for each element identified in the arrangement, to determine whether the total arrangement fees can be allocated to each element. If VSOEFV exists for each element, the total arrangement fee is allocated based on the relative fair value of each element. In cases where there is not VSOEFV for each or if it is determined that services are essential to the functionality of the software being delivered, we initially defer revenue recognition of the software license fees until VSOEFV is established or the services are performed. However, if VSOEFV is determinable for all of the undelivered elements, and assuming the undelivered elements are not essential to the delivered elements, we will defer recognition of the full fair value related to the undelivered elements and recognize the remaining portion of the arrangement value through application of the residual method. Where VSOEFV has not been established for certain undelivered elements, revenue for all elements is deferred until those elements have been delivered or their fair values have been determined. Evidence of VSOEFV is determined for software products based on actual sales prices for the product sold to a similar class of customer and based on pricing strategies set forth in the Company’s standard pricing list. Evidence of VSOEFV for consulting services is based upon standard billing rates and the estimated level of effort for individuals expected to perform the related services. The Company establishes VSOEFV for maintenance agreements using the percentage method such that VSOEFV for maintenance is a percentage of the license fee charged annually for a specific software product, which in most instances is 18% of the portion of arrangement fees allocated to the software license element.

Maintenance Revenue. In connection with the sale of a software license, a customer may elect to purchase software maintenance services. Most of the customers that purchase software licenses from us also purchase software maintenance services. These maintenance services are typically renewed on an annual basis. We charge an annual maintenance fee, which is typically a percentage of the initial software license fee and may be increased from the prior year amount based on inflation or other agreed upon percentage. The annual maintenance fee generally is paid to the Company at the beginning of the maintenance period, and we recognize these revenues ratably over the term of the related contract.

While most of our customers pay for their annual maintenance at the beginning of the maintenance period, a few customers have payment terms that allow them to pay for their annual maintenance on a quarterly or monthly basis. If the annual maintenance fee is not paid at the beginning of the maintenance period (or at the beginning of the quarter or month for those few maintenance customers), we will ratably recognize the maintenance revenue if management believes the collection of the maintenance fee is imminent. Otherwise, we will defer revenue recognition until the time that the maintenance fee is paid by the customer. We normally continue to provide maintenance service while awaiting payment from customers. When the payment is received, revenue is recognized for the period that revenue was previously deferred. This may result in volatility in software maintenance revenue from period to period.

Cloud-based offering. We have contracted with third parties to provide new and existing customers with hosting facilities providing all infrastructure and allowing us to offer our currently sold software, emPath® and SnAPPnet™, on a service basis. However, a contractual right to take possession of the software license or run it on another party’s hardware is not granted to the customer. We refer to the delivery method to give functionality to new customers utilizing this service as cloud-based. Since the customer is not given contractual right to take possession of the software, the scope of ASC 350-40 does not apply. A customer using cloud-based software can enter into an agreement to purchase a software license at any time. We generate revenue from cloud-based offering as the customer utilizes the software over the Internet.

We will provide consulting services to customers in conjunction with the cloud-based offering. The rate for such service is based on standard hourly or daily billing rates. The consulting revenue is recognized as services are performed. Customers utilizing their own computer to access cloud-based functionality are charged a fee equal to the number of employees paid each month multiplied by an agreed-upon rate per employee. The revenue is recognized as the cloud-based services are rendered each month.

The Company maintains allowances for doubtful accounts, for estimated losses resulting from the inability of its customers to make required payments. If the financial condition of our customers were to deteriorate, resulting in an impairment of their ability to make payments, additional allowances may be required. We review delinquent accounts at least quarterly to identify potential doubtful accounts, and together with customer follow-up, estimate the amounts of potential losses.

The Company records a valuation allowance to reduce the deferred tax assets to the amount that management believes is more likely than not to be realized in the foreseeable future, based on estimates of foreseeable future taxable income and taking into consideration historical operating information. In the event management estimates that the Company will not be able to realize all or part of its net deferred tax assets in the foreseeable future, a valuation allowance is recorded through a charge to income in the period such determination is made. Likewise, should management estimate that the Company will be able to realize its deferred tax assets in the future in excess of its net recorded assets, an adjustment to reduce the valuation allowance would increase income in the period such determination is made.

We account for share-based compensation in accordance with the provisions of share-based payments, 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. Equity instruments issued to other than employees are valued at the earlier of a commitment date or upon completion of the services, based on the fair value of the equity instruments, and are recognized as expense over the service period.

The valuation of our embedded derivatives is determined by using the Company’s quoted stock price. An embedded derivative is a derivative instrument that is embedded within another contract, which under a convertible note (the host contract) includes the right to convert the note by the holder, certain default redemption right premiums and a change of control premium (payable in cash if a fundamental change occurs). In accordance with the guidance on derivative instruments, embedded derivatives are marked-to-market each reporting period, with a corresponding non-cash gain or loss charged to the current period. The practical effect of this has been that when our stock price increases so does our derivative liability, resulting in a non-cash loss that reduces our earnings and earnings per share. When our stock price declines, we record a non-cash gain, increasing our earnings and earnings per share.

The fair value recorded for the derivative liability varies from period to period. This variability may result in the actual derivative liability for a period either above or below the estimates recorded on our consolidated financial statements, resulting in significant fluctuations in other income (expense) because of the corresponding non-cash gain or loss recorded.

In May 2017, the FASB issued ASU No. 2017-09,“Compensation—Stock Compensation (Topic 718): Scope of Modification Accounting”, to provide clarity and reduce both (1) diversity in practice and (2) cost and complexity when applying the guidance in Topic 718, Compensation—Stock Compensation, to a change to the terms or conditions of a share-based payment award. The ASU provides guidance about which changes to the terms or conditions of a share-based payment award require an entity to apply modification accounting in ASC 718. The amendments are effective for fiscal years beginning after December15, 2017 and should be applied prospectively to an award modified on or after the adoption ~~of any recently issued accounting pronouncements to~~date. Early adoption is permitted, including adoption in an interim period. The Company adopted the standard on January 1, 2018 the amendment did not have a material impact on its consolidated financial statements.

In July 2017, the ~~Company’s~~FASB issued ASU No. 2017-11,“Earnings Per Share (Topic 260); Distinguishing Liabilities from Equity (Topic 480); Derivatives and Hedging (Topic 815): (Part I) Accounting for Certain Financial Instruments with Down Round Features, (Part II) Replacement of the Indefinite Deferral for Mandatorily Redeemable Financial Instruments of Certain Nonpublic Entities and Certain Mandatorily Redeemable Noncontrolling Interests with a Scope Exception”. The ASU was issued to address the complexity associated with applying generally accepted accounting principles (GAAP) for certain financial instruments with characteristics of liabilities and equity. The ASU, among other things, eliminates the need to consider the effects of down round features when analyzing convertible debt, warrants and other financing instruments. As a result, a freestanding equity-linked financial instrument (or embedded conversion option) no longer would be accounted for as a derivative liability at fair value as a result of the existence of a down round feature. The amendments are effective for fiscal years beginning after December 15, 2018 and should be applied retrospectively. Early adoption is permitted, including adoption in an interim period. The Company is currently evaluating the effect its adoption of this standard, if any, on our consolidated financial position, results of operations or cash flows.

Three and six months ended June 30, ~~2017~~2018 compared to three and six months ended June 30, ~~2016~~2017

Total Revenues. We had total revenues of ~~$959,606~~$1,014,451 and ~~$969,659~~$959,606 for the three months ended June 30, ~~2017~~2018 and ~~2016,~~2017, respectively. The ~~decrease~~increase in total revenues was ~~$10,053~~$54,845 for the three months ended June 30, ~~2017~~2018 representing a ~~1.0% decrease~~5.7% increase compared to the total revenues for the three months ended June 30, ~~2016.~~2017. Substantially all of the revenues for the three months ended June 30, ~~2017~~2018 were related to the business operations of NOW Solutions.

Total revenues for the three months ended June 30, ~~2017~~2018 and ~~2016~~2017 primarily consist of fees derived from software licenses, consulting services, software maintenance and Cloud-based offerings. Software licensing fees in the three months ended June 30, 2018 increased by $88,884 from the same period in the prior year. The revenue increase in Software licensing is primarily related to a licensing upgrade for one customer in Canada. Software maintenance in the three months ended June 30, ~~2017~~2018 decreased by ~~$32,549~~$17,080 or ~~4.0%~~2.2% from the same period in the prior year. The revenue decrease in software maintenance is primarily due to decreases with existing customer maintenance agreements in the US partially offset by increases in Canadian maintenance revenue and the effects of ~~unfavorable~~favorable currency rate ~~changes on our Canadian maintenance revenue.~~changes. Consulting revenue, in the three months ended June 30, ~~2017~~2018 increased by ~~$37,778~~$11,829 from the same period in the prior year, which represents a ~~57.3%~~11.4% increase. This increase was due to more demand for version upgrades and enhancements to existing customer accounts in our ~~Canadian~~US operations during the second quarter of ~~2017.~~2018. Cloud-based revenues were ~~$65,964~~$27,790 for the three months ended June 30, ~~2017~~2018 compared to ~~$81,183~~$65,964 for the same period in the prior year, representing a ~~$15,219~~$38,174 decrease or ~~18.7%~~57.9%. The decrease is primarily related to the loss of ~~one of our SnAPPnet customers.~~SAAS customers in the US and Canada. Other revenue in the three months ended June 30, ~~2017 decreased~~2018 increased by ~~$580 or 80.6%~~$9,386 from the same period in the prior year. Other revenue consists primarily of reimbursable travel expenses, currency gains and losses and other miscellaneous revenues.

We had total revenues of ~~$1,902,349~~$2,085,979 and ~~$1,922,602~~$1,902,349 in the six months ended June 30, ~~2017~~2018 and ~~2016,~~2017, respectively. The ~~decrease~~increase in total revenues was ~~$20,253~~$183,630 representing a ~~1.1% decrease.~~9.7% increase. Substantially all of the revenues for the six months ended June 30, ~~2017~~2018 were related to the business operations of NOW Solutions.

Total revenues for the six months ended June 30, ~~2017~~2018 and ~~2016~~2017 primarily consist of fees derived from software licenses, consulting services, software maintenance and cloud-based offerings. The revenue from new software licenses ~~decreased $11,483~~increased $99,564 compared to that for the six months ended June 30, ~~2016 due~~2017. The revenue increase in Software licensing is primarily related to ~~the sale of our employee self-service module to an existing customer during the six months ended June 30, 2016.~~a licensing upgrade for two customers in Canada. Software maintenance in the six months ended June 30, ~~2017~~2018 decreased by ~~$32,832~~$21,117 or ~~2.0%~~1.3% from the same period in the prior year. The revenue decrease in software maintenance is primarily due to ~~the loss or reduction of~~decreases with existing customer maintenance agreements in the US ~~and Canada~~partially offset by increases in Canadian maintenance revenue and the effects of ~~unfavorable~~favorable currency rate ~~changes on our Canadian maintenance revenue.~~changes. Consulting revenue, in the six months ended June 30, ~~2017,~~2018, increased by ~~$28,495~~$127,348 or ~~19.3%~~72.2% from the same period in the prior year. This increase was primarily a result of more demand for version upgrades and enhancements to existing customer accounts ~~in our Canadian operations~~ during the first six months of ~~2016.~~2018. Cloud-based revenues were ~~$125,667~~$89,052 for the six months ended June 30, ~~2017~~2018 compared to ~~$124,466~~$125,667 for the same period in the prior year, representing a ~~$1,201~~$36,615 decrease or ~~1.0%.~~29.1% Other revenue in the six months ended June 30, ~~2017 decreased~~2018 increased by ~~$5,634 or 66.0%~~$14,450 from the same period in the prior year. Other revenue consists primarily of reimbursable travel expenses, currency gains and losses and other miscellaneous revenues.

Cost of Revenues.We had direct costs associated with our revenues of $391,037 for the three months ended June 30, 2018, compared to $439,243 for the three months ended June 30, ~~2017, compared to $376,308 for the three months ended June 30, 2016.~~2017. The ~~increase~~decrease in cost of revenues of ~~$62,935~~$48,206 represents a ~~16.7% increase.~~11.0% decrease. The ~~increase~~decrease in direct cost of revenues was primarily due to ~~an increased~~a decrease in payroll and related benefits. During the three months ended June 30, ~~2017~~2018 and ~~2016,~~2017, $0 and ~~$106,257~~$0 of internal costs were capitalized, respectively.

For the six months ended June 30, ~~2017,~~2018, direct costs of revenues were ~~$812,795~~$753,514 compared to ~~$764,464~~$812,795 for the same period in ~~2016~~2017 resulting in ~~an increase~~a decrease of ~~$48,331~~$59,281 or ~~6.3%~~7.3%. The ~~increase~~decrease in direct cost of revenues was primarily due to ~~increased~~decreased payroll and related benefits. During the six months ended June 30, ~~2017~~2018 and ~~2016,~~2017, $0 and ~~$250,184~~$0 of internal costs were capitalized, respectively.

Selling, General and Administrative Expenses. We had selling, general and administrative expenses of ~~$897,074~~$738,929 and ~~$808,832~~$897,074 in the three months ended June 30, ~~2017~~2018 and ~~2016,~~2017, respectively. The ~~increase~~decrease of ~~$88,242~~$158,145 is ~~10.9% more~~17.6% less than the same period in ~~2016.~~2017. The ~~increase~~decrease is primarily due to ~~increased~~decreased payroll and related benefits, non-cash stock compensation and lower legal and professional ~~fees somewhat~~expense partially offset by ~~decreased~~higher consulting expense and ~~legal fees.~~penalties.

For the six months ended June 30, ~~2017,~~2018, we had ~~$1,979,259~~$1,639,372 compared to ~~$1,476,648~~$1,979,259 for the six months ended June 30, ~~2016.~~2017. The ~~$502,611~~$339,887 or ~~34.0% increase~~17.2% decrease is primarily due to ~~increased~~decreased payroll and related benefits, ~~in 2017 as the company is no longer capitalizing payroll costs related to our Ploinks, Inc. development team.~~non-cash stock compensation, penalties and legal expense partially offset by higher consulting expense.

Depreciation and Amortization. We had depreciation and amortization expense of ~~$325~~$788 and $325 for the three months ended June 30, ~~2017~~2018 and ~~2016,~~2017, respectively. Depreciation expense relates to depreciation of long lived assets. Amortization expenses relates to the amortization of intangible assets such as acquired software, customer lists and websites.

For the six months ended June 30, ~~2017,~~2018, we had ~~$650~~$1,576 compared to ~~$433~~$650 for the six months ended June 30, ~~2016.~~2017. Depreciation expense relates to depreciation of long lived assets. Amortization expenses relates to the amortization of intangible assets such as acquired software, customer lists and websites.

Bad Debt Expense (Recovery).We had bad debt ~~recovery~~expense for the three months ended June 30, ~~2017~~2018 of ~~$13,645~~$70,131 compared to bad debt ~~expense~~recovery of ~~$5,789~~$13,645 for the three months ended June 30, ~~2016.~~2017. Bad debt recovery relates to the collection of customer accounts greater than 90 days past due previously expensed. Bad debt expense is related to the allowance of customer accounts greater than 90 days past due.

For the six months ended June 30, ~~2017,~~2018, we had bad debt recovery of ~~$64,667~~$23,012 compared to bad debt ~~expense~~recovery of ~~$11,927~~$64,667 for the six months ended June 30, ~~2016.~~2017. Bad debt recovery relates to the collection of customer accounts greater than 90 days past due previously expensed. ~~Bad debt expense is related to the allowance of customer accounts greater than 90 days past due.~~

Gain (loss) on Derivative Liability. Derivative liabilities are adjusted each quarter using the Black-Scholes option pricing model. The ~~gain~~loss on derivative liabilities was $45,218 for the three months ended June 30, 2018 compared to a gain of $280,431 for the three months ended June 30, ~~2017 compared to a loss of $139,747 for the three months ended June 30, 2016.~~2017. The gain on derivative liabilities was $96,314 for the six months ended June 30, 2018 compared to a gain of $619,898 for the six months ended June 30, ~~2017 compared to a loss of $111,035 for the six months ended June 30, 2016.~~

~~Gain (Loss) on Debt Extinguishment~~. We had a $35,969 gain on debt extinguishment for the three and six months ended June 30, 2016. The 2016 gain related to the fair market value from the issuance of 5 million shares with the Rule 144 restrictive legend of VCSY common stock given as consideration for payment of $130,000 of principal on an outstanding note payable.2017.

Forbearance Fees. Forbearance fees relate to fees charged by our lenders on loans in default. Forbearance fees for the three months ended June 30, ~~2017~~2018 were ~~$3,000~~$0 compared to ~~$6,000~~$3,000 for the three months ended June 30, ~~2016.~~2017. The fees for the three months ended June 30, 2018 were related to forbearance of a NOW Solutions note payable. The fees for the three months ended June 30, 2017 ~~and 2016~~ are related to forbearance of a VCSY note payable.

Forbearance fees for the six months ended June 30, ~~2017~~2018 were ~~$6,000~~$0 compared to ~~$17,100~~$6,000 for the six months ended June 30, ~~2016.~~2017. The fees for the six months ended June 30, 2018 were related to forbearance of a NOW Solutions note payable. The fees for the six months ended June 30, 2017 are related to forbearance of a VCSY note payable.

Non-operating Penalties. Non-operating penalties for the three months ended June 30, 2018 were $125,850 compared to $0 for the three months ended June 30, 2017. The fees for the three months ended June 30, 2018 were related to the issuance of an additional 2,500,000 VCSY common shares at a fair market value of $33,000 and an additional 300,000 Ploinks common shares at a fair market value of $92,850 to certain third-party purchasers of 600,000 shares of VHS Series A Preferred Stock. These additional shares were issued to facilitate the execution of the 2017 Lakeshore Loan Amendment which resulted in the cure of any existing defaults under the Loan Agreement and the Note, as well as the release by Lakeshore of the security interests in the SiteFlash assets and the assets of SnAPPnet and Priority Time, when VHS did not meet performance standards.

Non-operating penalties for the six months ended June 30, 2018 were $125,850 compared to $0 for the six months ended June 30, 2017. The fees for the six months ended June 30, ~~2016 are~~2018 were related to forbearance of ~~two VCSY~~a NOW Solutions note ~~payables.~~payable. These additional shares were issued to facilitate the execution of the 2017 Lakeshore Loan Amendment which resulted in the cure of any existing defaults under the Loan Agreement and the Note, as well as the release by Lakeshore of the security interests in the SiteFlash assets and the assets of SnAPPnet and Priority Time, when VHS did not meet performance standards.

Interest Expense. We had interest expense of ~~$460,592~~$498,769 and ~~$526,078~~$460,592 for the three months ended June 30, ~~2017~~2018 and ~~2016,~~2017, respectively. Interest expense ~~decreased~~increased in ~~2017~~2018 by ~~$65,486~~$38,177 representing an increase of ~~12.4%~~8.3% compared to the same expense in the three months ended June 30, ~~2016.~~2017. The ~~decrease~~increase was ~~primarily due~~related to ~~the elimination of high~~default interest on ~~an accounts payable balance.~~NOW Solutions senior secured note payable.

For the six months ended June 30, ~~2017,~~2018, we had interest expense of ~~$1,018,603~~$908,489 compared to ~~$903,045~~$1,018,603 for the same period in ~~2016,~~2017, representing a ~~$115,558~~$110,114 or ~~12.8% increase~~10.8% decrease for the period. The ~~increase~~decrease is primarily due to ~~new debt interest and amortization of~~fully amortized debt discounts on convertible debt issued with stock and warrants.

Net ~~Income (loss).~~Loss before non-controlling interest and income taxes.We had a net loss before non-controlling interest and income ~~tax~~taxes of $856,268 and $546,551 for the three months ended June 30, 2018 and 2017, respectively. The net loss for the three months ended June 30, 2018 was due to the factors discussed above for revenues, cost of revenues, selling, general and administrative expenses, depreciation and amortization and bad debts which essentially gave us an operating loss of $186,434. The loss was increased by interest expense, ~~of $546,551~~non-operating penalties and a loss on derivative liabilities, resulting in a net loss before non-controlling interest and income ~~tax expense~~taxes of ~~$857,443~~$856,268 for the three months ended June 30, ~~2017 and 2016, respectively.~~2018. The net loss for the three months ended June 30, 2017 was due to the factors discussed above for revenues, cost of revenues, ~~and~~ selling general and administrative expenses, depreciation and amortization and bad debts which essentially gave us operating loss of $363,391. This was increased by interest expense and forbearance fees and reduced by a gain on derivative liabilities, resulting in a net loss before non-controlling interest and income taxes of $546,551 for the three months ended June 30, 2017.

We incurred net losses before non-controlling interest and income taxes of $1,223,490 and $1,230,377 for the six months ended June 30, 2018 and 2017, respectively. The changes were due to the reasons discussed above for revenues, cost of revenues, selling, general and administrative expenses, depreciation and amortization and bad debts which essentially gave us an operating loss of $285,471. This loss was increased by interest expense, non-operating penalties and reduced by a gain on derivative liabilities, resulting in a net loss before non-controlling interest and income taxes of $ 1,223,490 for the three months ended June 30, 2018. The net loss for the three months ended June 30, ~~2016~~2017 was due to the factors discussed above for revenues, cost of revenues, ~~and~~ selling, general and administrative expenses, depreciation and amortization and bad debts which essentially gave us operating loss of ~~$221,595.~~$825,688. This loss was increased by ~~a loss on derivative liabilities,~~interest expense and forbearance fees ~~and interest expense~~ and reduced by a gain on ~~debt extinguishment,~~derivative liabilities, resulting in a net loss before non-controlling interest and income taxes of ~~$857,443~~$1,230,377 for the three months ended June 30, ~~2016.~~

We incurred net losses before non-controlling interest and income tax expense of $1,230,377and $1,326,063 for the six months ended June 30, 2017 and 2016, respectively. The changes were due to the reasons discussed above.2017.

Income Tax Provision (Benefit). We had an income tax benefit of $54,541 and income tax expense of $133,995 for the three and six months ended June 30, 2018, respectively. We had an income tax provision of $84,289 and $120,199 for the three and six months ended June 30, ~~2017, respectively. The~~2017. Income taxes are related to US and foreign income ~~tax provision is related to~~taxes of NOW Solutions, a 75% owned subsidiary of the Company. ~~The income tax provision is related to US and foreign income tax. We had an income tax provision of $27,196 and $102,756 for the three and six months ended June 30, 2016.~~

Dividends Applicable to Preferred Stock.We have 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 ~~$154,933~~$155,600 and ~~$147,000~~$154,933 for the three months ended June 30, ~~2017~~2018 and ~~2016,~~2017, respectively and ~~$306,405~~$311,200 and ~~$294,000~~$306,405 for the six months ended June 30, 2018 and 2017, ~~and 2016,~~ respectively.

Net Loss Available to Common Stockholders. We had a net loss attributed to common stockholders of ~~$740,241~~$915,676 and ~~$1,051,831~~$740,241 for the three months ended June 30, ~~2017~~2018 and ~~2016,~~2017, respectively. Net loss attributed to common stockholders was due to the factors discussed above.

We had a net loss attributed to common stockholders of ~~$1,620,120~~$1,604,700 and ~~$1,752,159~~$1,620,120 for the six months ended June 30, ~~2017~~2018 and ~~2016,~~2017, respectively. Net loss available to common stockholders was due to the factors discussed above.

Net Loss Per Share. We had a net loss per share of $0.00 and $0.00 for the six months ended June 30, 2018 and 2017, ~~and 2016,~~ respectively.

At June 30, ~~2017,~~2018, we had non-restricted cash-on-hand of ~~$79,375~~$101,164 compared to ~~$190,448~~$62,084 at December 31, ~~2016.~~2017.

Net cash used in operating activities for the six months ended June 30, ~~2017~~2018 was ~~$508,202~~$35,384 compared to net cash used in operating activities of ~~$84,680~~$508,202 for the six months ended June 30, ~~2016.~~2017.

A large portion of our cash (and revenue) comes from software maintenance. When we bill and collect for software maintenance, we record a liability in deferred revenue and recognize income ratably over the maintenance period. Deferred revenue decreased ~~$171,747~~$196,552 or ~~10.1%~~11.2% from the balance at December 31, ~~2016.~~2017. The decrease was due to a higher number of customers on calendar year maintenance agreements which results in higher deferred revenue in December.

Our accounts receivable trade decreased from ~~$367,278~~$349,002 at December 31, ~~2016~~2017 to ~~$128,161~~$108,911 (net of allowance for bad debts) at June 30, ~~2017.~~2018. The decrease is a result of seasonal fluctuations in the timing of billing for software maintenance which typically yields higher receivables in December compared to June.

The combined accounts payable to related parties and accounts payable and accrued liabilities went from ~~$12,075,298~~$14,271,154 at December 31, ~~2016~~2017 to ~~$13,033,408~~$15,294,128 at June 30, ~~2017.~~2018. The increase is primarily related to an increase in accrued interest and accrued payroll. The resulting balance at June 30, ~~2017~~2018 is 55140 times more than the balance in accounts receivable. This is one of the reasons why we do not have sufficient funds available to fund our operations and repay our debt obligations under their existing terms, as described below.

We used cash to invest in equipment and the development of software products for the six months ended June 30, ~~2017~~2018 and June 30, ~~2016~~2017 of $0 and ~~$253,985,~~$0, respectively. Most of the equipment was computer equipment and peripherals for upgraded network servers to increase the productivity of our software developers and new personal computers for developers, consultants and sales personnel. Software development relates to the development of new products.

For the six months ended June 30, 2018, we had $160,000 of new debt funding and repaid $64,782 in debt funding and paid $59,090 in dividends. For the six months ended June 30, 2017, we had $240,000 of new debt funding, $200,000 in equity funding and repaid $44,705 in debt funding. ~~For the six months ended June 30, 2016, we had $696,900 of new debt funding, repaid $210,199 to lenders and paid $150,000 of dividends to non-controlling shareholders of NOW Solutions.~~

The total change in cash for the six months ended June 30, ~~2017~~2018 was ~~a decrease~~an increase of ~~$111,073.~~$39,080.

As of the date of the filing of this Report, we do not have sufficient funds available to fund our operations and repay our debt obligations under their existing terms. Therefore, we need to raise additional funds through selling securities, obtaining loans, renegotiating the terms of our existing debt and/or increasing sales with our new products. Our inability to raise such funds or renegotiate the terms of our existing debt will significantly jeopardize our ability to continue operations.

Of the above notes payable and convertible debentures, the default status is as follows:

The carrying amounts of assets and liabilities presented in the financial statements do not purport to represent realizable or settlement values. We had a net loss attributable to common stock holders of ~~$1,620,120~~$1,604,700 and ~~$1,752,159~~$1,620,120 for the six months ended June 30, ~~2017~~2018 and ~~2016,~~2017, respectively and have historically incurred losses. Since December 31, 2009, we have used substantial funds in further developing our product line and in conducting present and new operations, and we need to raise additional funds and/or generate additional revenue through our existing businesses, including the licensing of our intellectual property, to accomplish our objectives. Additionally, at June 30, ~~2017,~~2018, we had negative working capital of approximately ~~$21.5~~$24.2 million (although this figure includes deferred revenue of approximately $1.6 million) and have defaulted on several of our debt obligations. These conditions raise substantial doubt about our ability to continue as a going concern.

Our management is continuing its efforts to attempt to secure funds through equity and/or debt instruments for our operations, expansion and possible acquisitions, mergers, joint ventures and/or other business combinations. We will require additional funds to pay down our liabilities, as well as finance our expansion plans consistent with our anticipated changes in operations and infrastructure. However, there can be no assurance that we will be able to secure additional funds and that if such funds are available, whether the terms or conditions would be acceptable to us and whether we will be able to turn into a profitable position and generate positive operating cash flow. The consolidated financial statements contain no adjustment for the outcome of this uncertainty.

Our management, principally our chief executive officer (who is also currently serving as our Principal Accounting Officer), evaluated the effectiveness of our disclosure controls and procedures as of the end of the period covered by this report. Based on that evaluation, our management concluded that our disclosure controls and procedures as of the end of the period covered by this report were not effective such that the information required to be disclosed by us in reports filed under the Exchange Act is (i) recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms and (ii) accumulated and communicated to our management, including our chief executive officer and chief financial officer, as appropriate to allow timely decisions regarding disclosure.

Management’s annual report on internal control over financial reporting associated with our business is set forth on Form 10-K for the year ended December 31, ~~2016,~~2017, as filed on ~~April 24, 2017.~~May 10, 2018.

There have been no material changes in our internal control over financial reporting since our reporting on Form 10-K for the year ended December 31, ~~2016.~~2017.

On February 13, 2017, the Company was served with a complaint filed by Parker Mills in the Superior Court of the State of California, County of Los Angeles, Central District, for failure to make payment on the outstanding balance due under a $100,000 convertible debenture issued by the Company to Parker Mills. ~~The Company has $112,985 of principal and interest accrued as of March 31, 2017.~~ The plaintiff seeks payment of the principal balance due under the convertible debenture of $100,000, interest at the rate of 12% per annum, attorney’s fees and court costs. In June 2017, the court entered a default judgment against the Company. We intend to resolve this matter with Parker Mills. This case is styled Parker Mills, LLP v. Vertical Computer Systems, Inc., No.BC649122. William Mills is a partner of Parker Mills and the Secretary and a Director of the Company. The Company has $127,655 of principal and interest accrued as of June 30, 2018.

A description of the risks associated with our business, financial condition, and results of operations is set forth on Form 10-K for the year ended December 31, ~~2016,~~2017, as filed on ~~April 24, 2017.~~May 10, 2018.

~~In May 2017,~~During the six months ended June 30, 2018, the Company ~~granted 300,000 unregistered~~issued an additional 2,500,000 VCSY common shares ~~of its common stock with the Rule 144 restrictive legend and 50,000 shares of Ploinks, Inc. common stock to~~at a ~~consultant of the Company and its subsidiaries pursuant to a consulting agreement with the Company. The aggregate~~ fair market value of ~~the VCSY common stock grant was determined to be $4,200 based on the quoted market price of VCSY stock at date of grant~~$33,000 and an additional 300,000 Ploinks ~~Inc. common stock grant was determined to be $5,400 based on a third party valuation of Ploinks stock. In addition, the Company agreed to issue up to 1,000,000~~ common shares at a fair market value of $92,850 to certain third-party purchasers of 600,000 shares of VHS Series A Preferred Stock from a member of Lakeshore. These additional shares were issued to facilitate the execution of the ~~Company~~2017 Lakeshore Loan Amendment which resulted in the cure of any existing defaults under the Loan Agreement and ~~100,000 shares~~the Note, as well as the release by Lakeshore of ~~Ploinks, Inc. common stock pursuant to restricted~~the security interests in the SiteFlash assets and the assets of SnAPPnet and Priority Time, when VHS did not meet performance ~~stock agreements with~~standards. The company recorded the ~~consultant. These shares may vest over a term~~combined fair value of ~~3 years and are based upon~~$125,850 as non-operating penalties in other income (expense) for the ~~Consultant achieving certain performance criteria.~~six months ended June 30, 2018.

During the six months ended June 30, 2017, the Company granted 3,000,000 VCSY common shares pursuant to a stock award to an employee of the Company and its subsidiaries (at a fair market value of $72,000).

During the six months ended June 30, 2017, $22,421 of principal, interest and legal fees under a convertible note issued in the principal amount of $90,000 was converted into 1,688,762 common shares. In May 2017, the Company had amended this convertible note originally issued to a third party lender in the principal amount of $80,000 to $90,000 and cancelled a $10,000 note payable issued to the third party lender. This convertible note has been paid in full.

~~During the six months ended June 30, 2017, 550,000 VCSY common shares vested under restricted stock agreements to employees and a consultant of the Company.~~

InOn July ~~2017, the Company granted 500,000 unregistered shares of its common stock with the Rule 144 restrictive legend and 30,000 shares of common stock of Ploinks, Inc.~~25, 2018, Taladin executed an amendment to a ~~consultant~~pledge agreement with a third-party lender. The Company and NOW Solutions also executed an amendment of certain promissory notes issued to the lender by the Company and ~~its subsidiaries pursuant to a consulting agreement with~~NOW Solutions in the ~~Company.~~

~~During the period that runs from July 1, 2017 through August 21, 2017, the Company issued a convertible debenture in the~~aggregate principal amount of ~~$50,000 to a third party lender for a loan made~~$715,000. Under the terms of the Amended Pledge Agreement, in lieu of selling the Pledged Shares pursuant to the ~~Company in the same amount. The debt accrues interest at 10% per annum and is due one year from the date of issuance. Beginning six months after issuance~~original terms of the ~~debenture~~pledge agreement, Taladin and ~~provided~~the lender agreed that ~~the lowest closing price of the common stock for each of the 5 trading days immediately preceding the conversion date has been $0.03~~Taladin, or ~~higher, the holder of the debenture~~a party acting on Taladin’s behalf, may convert the debenture into shares of common stock at a price per share of 80% of the average per share price of the Company’s common stock for the 5 trading days preceding the notice of conversion date using the 3 lowest closing prices. In connection with the loan, the Company also issuedpurchase a total of ~~500,000~~10,000,000 shares of ~~common stock of~~ the ~~Company to the lender with the Rule 144 restrictive legend and 3-year warrants under which the lender may purchase up to 500,000 unregistered shares of common stock of the Company~~Pledged Shares from Taladin at a purchase price of ~~$0.10~~$0.015 per ~~share.~~share over a certain period of time. The Company made $150,000 in payments to the lender and all rights to 10,000,000 shares of the Pledged Stock will be retained by Taladin.

During the period that runs from July 1, ~~2017 through~~2018 to August 21, ~~2017, the Company entered into a subscription agreement under which a third party subscriber purchased 300~~2018, 250,000 shares of VCSY ~~Series A Preferred Stock for $60,000. In connection with the purchase~~common stock issued to an employee of ~~the VCSY Series A Preferred Stock, the subscriber also received~~ a ~~total of 600,000 shares of common stock~~subsidiary of the Company with the Rule 144 restrictive legend, 30,000 shares of common stock of Ploinks, Inc., 2-year warrants under which the subscriber may purchase an aggregate total of 45,000 unregistered shares of common stock of the Company at a purchase price of $0.10 per share and 2-year warrants under which the subscriber may purchase an aggregate total of 45,000 unregistered shares of common stock of the Company at a purchase price of $0.20 per share.vested.

During the period that runs from July 1, ~~2017 through~~2018 to August 21, ~~2017, the Company granted 4,500~~2018, 80,000 shares of the common stock of Ploinks, Inc. ~~to a third party lender in connection with a 6-month extension of a convertible debenture in the principal amount of $15,000 issued in 2016.~~

~~During the period that runs from July 1, 2017 through August 21, 2017, 250,000 VCSY common shares~~ issued under restricted stock agreements to an employee of a subsidiary of the Company vested.

During the period that runs from July 1, ~~2017 through~~2018 to August 21, ~~2017, 80,000~~2018, the Company extended the term of certain warrants to purchase a total of 500,000 shares of VCSY common stock (at $0.10 per share) for an additional 1-year period and granted 9,100 shares of the common stock of Ploinks, Inc. to third-party lenders in connection with certain extensions of convertible debentures in the principal amount of $65,000 that were issued ~~under restricted stock agreements to an employee~~in 2016 and 2017. The due dates for all these convertible extensions were extended until October 1, 2018. The incremental change in the fair value of the ~~Company vested.~~extended warrants was immaterial and did not change the conclusion of the debt modification.

Note payable, amended, of ~~$1,759,150~~$2,291,395, issued by NOW Solutions to Lakeshore Investment, LLC, dated January 9, 2013. The note is secured with the assets of NOW Solutions ~~Priority Time Systems, SnAPPnet, and the SiteFlash™ assets~~ and bears a default interest rate of 16%. As of August 21, ~~2017,~~2018, the outstanding principle and accrued interest currently due under the note is ~~$1,952,253.~~$2,291,918.

Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.

Delaware	65-0393635
(State of incorporation)	(I.R.S. Employer Identification No.)

	June 30,		December 31,		June 30,		December 31,
	2017		2016		2018		2017
Assets
Current assets
Cash	$	79,375	$	190,448	$	101,164	$	62,084
Accounts receivable, net of allowance for bad debts of $75,524 and $139,705 as of June 30, 2017 and December 31, 2016, respectively		239,117		367,278
Accounts receivable, net of allowance for bad debts of $207,947 and $234,439						108,911		349,002
Prepaid expenses and other current assets		14,660		10,355		19,803		5,312
Total current assets		333,152		568,081		229,878		416,398

Property and equipment, net of accumulated depreciation of $1,043,962 and $1,043,397 as of June 30, 2017 and December 31, 2016, respectively		4,454		5,097
Intangible assets, net of accumulated amortization of $319,505 and $319,513 as of June 30, 2017 and December 31, 2016, respectively		6,690		6,690
Property and equipment, net of accumulated depreciation of $1,043,390 and $1,044,936						7,710		9,211
Intangible assets, net of accumulated amortization of $319,423 and $319,504						6,690		6,690
Deposits and other		7,997		8,064		7,884		8,037

Total assets	$	352,293	$	587,932	$	252,162	$	440,336

Liabilities and Stockholders’ Deficit
Current liabilities:
Accounts payable and accrued liabilities	$	13,033,408	$	12,075,298	$	15,122,223	$	14,122,394
Accounts payable to related parties		162,500		139,546		171,905		148,760
Deferred revenue		1,612,517		1,794,264		1,555,869		1,752,421
Derivative liabilities		396,674		1,014,192		89,870		159,537
Convertible debentures, net of unamortized discounts of $43,034 and $354,785 as of June 30, 2017 and December 31, 2016, respectively		1,261,966		899,428
Convertible debentures, net of unamortized discounts of $39,552 and $75,705						1,200,448		1,164,295
Notes payable		5,078,987		4,953,717		6,028,846		3,775,703
Notes payable and convertible debt to related parties		308,242		308,242		308,242		308,242
Total current liabilities		21,854,294		21,184,687		24,477,403		21,431,352

Non-current portion – notes payable						—		2,158,140

Total liabilities		21,854,294		21,184,687		24,477,403		23,589,492

	June 30,			December 31,
	2017			2016
Series A 4% Convertible Cumulative Preferred stock; $0.001 par value; 250,000 shares authorized; 52,500 shares issued and outstanding as of June 30, 2017 and 51,500 issued and outstanding as of December 31, 2016		10,103,169			10,066,499
Series B 10% Convertible Cumulative Preferred stock; $0.001 Par Value; 375,000 shares authorized; 7,200 shares issued and outstanding		246			246
Series C 4% Convertible Cumulative Preferred stock; $100.00 par value; 200,000 shares authorized; 50,000 shares issued and outstanding		200,926			200,926
Series D 15% Convertible Cumulative Preferred stock; $0.001 Par Value; 300,000 shares authorized; 25,000 shares issued and outstanding		852			852
		10,305,193			10,268,523

Stockholders’ Deficit
Common Stock; $.00001 par value; 2,000,000,000 shares authorized 1,175,980,201 issued and 1,135,980,201 outstanding as of June 30, 2017 and 1,167,841,439 issued and 1,127,841,439 outstanding as of December 31, 2016		11,760			11,679
Treasury stock: 40,000,000 as of June 30, 2017 and December 31, 2016		(400	)		(400	)
Additional paid-in-capital		23,863,405			23,672,153
Accumulated deficit		(56,331,390	)		(55,017,675	)
Accumulated other comprehensive income – foreign currency translation		389,816			424,996

Total Vertical Computer Systems, Inc. stockholders’ deficit		(32,066,809	)		(30,909,247	)

Non-controlling interest		259,615			43,969
Total stockholders’ deficit		(31,807,194	)		(30,865,278	)

Total liabilities and stockholders’ deficit	$	352,293		$	587,932

(Continued from previous page)

	June 30,			December 31,
	2018			2017
Series A 4% Convertible Cumulative Preferred stock; $0.001 par value; 250,000 shares authorized; 52,800 shares issued and outstanding		10,255,185			10,255,185
Series B 10% Convertible Cumulative Preferred stock; $0.001 Par Value; 375,000 shares authorized; 7,200 shares issued and outstanding		246			246
Series C 4% Convertible Cumulative Preferred stock; $100.00 par value; 200,000 shares authorized; 50,000 shares issued and outstanding		200,926			200,926
Series D 15% Convertible Cumulative Preferred stock; $0.001 Par Value; 300,000 shares authorized; 25,000 shares issued and outstanding		852			852
		10,457,209			10,457,209

Stockholders’ Deficit
Common Stock; $.00001 par value; 2,000,000,000 shares authorized 1,190,915,201 issued and 1,150,915,201 outstanding as of June 30, 2018 and 1,188,095,201 issued and 1,148,095,201 outstanding as of December 31, 2017		11,911			11,883
Treasury stock: 40,000,000 as of June 30, 2018 and December 31, 2017		(400	)		(400	)
Additional paid-in-capital		24,902,525			24,609,424
Accumulated deficit		(59,381,416	)		(58,087,916	)
Accumulated other comprehensive income – foreign currency translation		429,332			339,051

Total Vertical Computer Systems, Inc. stockholders’ deficit		(34,038,048	)		(33,127,958	)

Non-controlling interest		(644,402	)		(478,407	)
Total stockholders’ deficit		(34,682,450	)		(33,606,365	)

Total liabilities and stockholders’ deficit	$	252,162		$	440,336

	Three Months Ended June 30,						Six Months Ended June 30,
	2017			2016			2017			2016
Revenues
Licensing and software	$	517		$	—		$	517		$	12,000
Software maintenance		789,264			821,813			1,596,776			1,629,608
Cloud-based offering		65,964			81,183			125,667			124,466
Consulting services		103,721			65,943			176,492			147,997
Other		140			720			2,897			8,531
Total revenues		959,606			969,659			1,902,349			1,922,602

Cost of revenues		(439,243	)		(376,308			(812,795	)		(764,464	)

Gross profit		520,363			593,351			1,089,554			1,158,138

Operating expenses:
Selling, general and administrative expenses		897,074			808,832			1,979,259			1,476,648
Depreciation and amortization		325			325			650			433
Bad debt expense (recovery)		(13,645	)		5,789			(64,667	)		11,927
Total operating expenses		883,754			814,946			1,915,242			1,489,008

Operating Loss		(363,391	)		(221,595	)		(825,688	)		(330,870	)

Other Income (Expense):
Gain (loss) on derivative liabilities		280,431			(139,747	)		619,898			(111,035	)
Gain on debt extinguishment		—			35,969			—			35,969
Forbearance fees		(3,000	)		(6,000	)		(6,000	)		(17,100	)
Interest income		1			8			16			18
Interest expense		(460,592	)		(526,078	)		(1,018,603	)		(903,045	)

Net loss before non-controlling interest and income tax expense		(546,551	)		(857,443	)		(1,230,377	)		(1,326,063	)
Income tax expense		84,289			27,196			120,199			102,756
Net loss before non-controlling interest		(630,840	)		(884,639	)		(1,350,576	)		(1,428,819	)
Net loss (income) attributable to non-controlling interest		45,532			(20,192	)		36,861			(29,340	)
Net loss attributable to Vertical Computer Systems, Inc.		(585,308	)		(904,831	)		(1,313,715	)		(1,458,159	)
Dividends applicable to preferred stock		(154,933	)		(147,000	)		(306,405	)		(294,000	)
Net loss available to common stockholders	$	(740,241	)	$	(1,051,831	)	$	(1,620,120	)	$	(1,752,159	)

											Additional						Other			Non-
	Common Stock				Treasure Stock						Paid-in			Accumulated			Comprehensive			controlling
	Shares		Amount		Shares			Amount			Capital			Deficit			Interest			Interest			Total
Balances at December 31, 2016		1,167,841,439	$	11,679		(40,000,000	)		(400	)	$	23,672,153		$	(55,017,675	)	$	424,996		$	43,969		$	(30,865,278	)
Amortization of restricted stock awards		—		—		—			—			67,494			—			—			—			67,494
Shares issued for vested restricted stock awards		550,000		5		—			—			(5	)		—			—			—			—
Shares issued for conversion of convertible debentures		1,688,762		17		—			—			22,404			—			—			—			22,421
Shares issued for convertible debentures		600,000		6		—			—			7,068			—			—			—			7,074
Settlement of derivative liability upon conversion of debt		—		—		—			—			19,566			—			—			—			19,566
Shares issued to an employee		3,000,000		30		—			—			71,970			—			—			—			72,000
Issuance of subsidiary shares for services		—		—		—			—			123,997			—			—			(2,705	)		121,292
Dividends declared but unpaid to non-controlling interest holders		—		—		—			—			—			—			—			(65,000	)		(65,000	)
Shares and subsidiary shares issued for equity subscriptions		2,000,000		20		—			—			164,055			—			—			(1,196	)		162,879
Other comprehensive income translation adjustment		—		—		—			—			—			—			(35,180	)		—			(35,180	)
Issuance of shares for services		300,000		3		—			—			4,197			—			—			—			4,200
Issuance of subsidiary shares for debt extensions		—		—		—			—			35,441			—			—			(3,527	)		31,914
Adjustment to non-controlling interest		—		—		—			—			(324,935	)		—			—			324,935			—
Net loss		—		—		—			—			—			(1,313,715	)		—			(36,861	)		(1,350,576	)
Balances at June 30, 2017		1,175,980,201	$	11,760		(40,000,000	)		(400	)	$	23,863,405		$	(56,331,390	)	$	389,816		$	259,615		$	(31,807,194	)

	Common Stock				Treasure Stock						Additional Paid-in Capital			Accumulated Deficit			Other Comprehensive Income		Non-controlling Interest			Total
	Shares		Amount		Shares			Amount			Additional Paid-in Capital			Accumulated Deficit			Other Comprehensive Income		Non-controlling Interest			Total
Balances at December 31, 2017		1,188,095,201	$	11,883	$	(40,000,000	)	$	(400	)	$	24,609,424		$	(58,087,916	)	$	339,051	$	(478,407	)	$	(33,606,365	)
Amortization of restricted stock awards		—		—		—			—			24,073			—			—		—			24,073
Amortization of subsidiary restricted stock awards		—		—		—			—			35,246			—			—		—			35,246
Shares issued for vested restricted stock awards		320,000		3		—			—			(3	)		—			—		—			—
Issuance of subsidiary shares for debt extensions		—		—		—			—			100,694			—			—		(4,412	)		96,282
Issuance of subsidiary shares for services		—		—		—			—			3,046			—			—		(3,046	)		—
Issuance of shares for subsidiary non-operating penalties		2,500,000		25		—			—			32,975			—			—		—			33,000
Issuance of subsidiary shares for subsidiary non-operating penalties		—		—		—			—			97,070			—			—		(4,220	)		92,850
Dividends paid to non-controlling interest holders		—		—		—			—			—			—			—		(59,090	)		(59,090	)
Dividends declared but unpaid to non-controlling interest holders		—		—		—			—			—			—			—		(31,242	)		(31,242	)
Other comprehensive income translation adjustment		—		—		—			—			—			—			90,281		—			90,281
Net loss		—		—		—			—			—			(1,293,500	)		—		(63,985	)		(1,357,485	)
Balances at June 30, 2018		1,190,915,201	$	11,911		(40,000,000	)		(400	)	$	24,902,525		$	(59,381,416	)	$	429,332	$	(644,402	)	$	(34,682,450	)

	Three Months Ended June 30,				Six Months Ended June 30,
Industry	2018		2017		2018		2017

Agriculture	$	70,617	$	87,453	$	142,737	$	184,904
Automotive		7,197		6,948		14,538		14,001
Distribution		25,440		15,434		47,975		32,552
Education		191,647		180,717		434,953		324,115
Financial Services		20,643		17,746		43,689		36,609
Government		113,719		109,769		264,147		227,695
Healthcare		348,673		287,426		639,212		591,028
Manufacturing		63,753		53,780		121,523		107,087
Manufacturing Services		8,507		13,621		19,363		20,761
Media		29,112		26,360		58,139		53,148
Oil and Gas		50,016		48,748		100,952		95,083
Pulp and Paper Distribution		23,416		33,233		47,329		65,750
Pulp and Paper Manufacturing		5,078		4,513		10,264		9,099
Engineering		—		33,820		34,777		67,408
Food Services		4,247		3,932		8,493		7,864
Government Contractor		52,386		35,589		97,888		64,728
Other		—		517		—		517
Total revenues	$	1,014,451	$	959,606	$	2,085,979	$	1,902,349

	Three Months Ended June 30,				Six Months Ended June 30,
Country	2018		2017		2018		2017

Canada	$	695,942	$	583,366	$	1,362,413	$	1,143,623
United States		318,509		376,240		723,566		758,726
Total revenues	$	1,014,451	$	959,606	$	2,085,979	$	1,902,349

December 31, 2016	$	5,853,145
Borrowings from third parties		240,000
Repayments of third party notes		(44,705	)
Conversion of convertible debt principal to common stock		(19,213	)
Debt discounts due valuation of derivative liabilities		(21,495	)
Debt discounts due to convertible debt extensions		(31,914	)
Debt discounts due to issuance of warrants and common stock		(7,074	)
Amortization of debt discounts		372,210
Effect of currency exchange		(1	)
June 30, 2017	$	6,340,953

December 31, 2017	$	7,098,138
Borrowings on third party notes		160,000
Repayments of third party notes		(64,782	)
Debt discounts due to parent stock and warrants and subsidiary stock issued with debt and derivative liabilities from convertible debt		(122,929	)
Amortization of debt discounts		159,085
Effect of currency exchange		(218	)
June 30, 2018	$	7,229,294

	~~2017~~		2018
Expected dividends		0	%0%
Expected terms (years)		~~0.07~~0.01 - 3.00
Volatility		~~103%~~94% - ~~118~~	%110%
Risk-free rate		~~1.24%~~2.11% - ~~1.55~~	%2.63%

	Fair value measurements on a recurring basis
	Level 1		Level 2		Level 3
As of June 30, 2017:
Liabilities
Derivative liabilities – convertible debt and warrants	$	—	$	—	$	396,674

As of December 31, 2016:
Liabilities
None	$	—	$	—	$	1,014,192

Fair value as of December 31, 2016	$	1,014,192
Additions recognized as debt discounts		21,495
Additions recognized in equity financing		451
Reduction due to settlement upon conversion		(19,566	)
Gain on change in fair value of derivatives		(619,898	)
Fair value as of June 30, 2017	$	396,674

Fair value as of December 31, 2017	$	159,537
Additions recognized as debt discounts		26,647
Gain on change in fair value of derivatives		(96,314	)
Fair value as of June 30, 2018	$	89,870

	Incentive Stock Options		Non-Statutory Stock Options		Warrants		Weighted Average Exercise Price		Incentive Stock Options		Non-Statutory Stock Options		Warrants		Weighted Average Exercise Price
Outstanding at December 31, 2016		—		—		14,850,000	$	0.100
Outstanding at December 31, 2017										—		—		16,340,000	$	0.101
Options/Warrants granted		—		—		900,000	$	0.117		—		—		—		—
Options/Warrants exercised		—		—		—		—		—		—		—		—
Options/Warrants expired/cancelled		—		—		—		—		—		—		—		—
Outstanding at June 30, 2017		—		—		15,750,000	$	0.101
Outstanding at June 30, 2018										—		—		16,340,000	$	0.101

	Balance at		Due in Next Five Years								Balance at		Due in Next Five Years
Contractual Obligations	June 30, 2017		2017		2018		2019		2020	2021+	June 30, 2018		2018		2019		2020		2021		2022+
Notes payable	$	5,287,229	$	5,287,229	$	—	$	—	$	$	$	6,237,088	$	6,237,088	$	—	$	—	$	—	$	—
Convertible debenture		1,405,000		1,345,000		60,000		—				1,340,000		1,340,000		—		—		—		—
Operating lease		102,607		41,580		61,027		—				35,825		23,157		8,445		4,223		—		—
Total	$	6,794,836	$	6,673,809	$	121,027	$	—	$	$	$	7,612,914	$	7,600,246	$	8,445	$	4,223	$	—	$	—

	June 30, 2017		December 31, 2016		June 30, 2018		December 31, 2017

In default	$	5,247,229	$	4,901,950	$	5,616,588	$	3,390,190
Not in default		1,445,000		1,614,222		1,960,500		4,091,895

Total Notes Payable	$	6,692,229	$	6,516,172	$	7,577,088	$	7,482,085

Exhibit No.		Description	Location

31.1		Certification of Principal Executive Officer and Principal Accounting Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002, dated August 21, ~~2017~~2018	Provided herewith

32.1		Certification of Principal Executive Officer and Principal Accounting Officer Pursuant Chief Executive Officer Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, dated August 21, ~~2017~~2018	Provided herewith

101.INS*	101.INS	XBRL Instance Document	Provided herewith

	VERTICAL COMPUTER SYSTEMS, INC.

August 21, ~~2017~~2018	By:	/s/ Richard Wade
		Richard Wade
		President and Chief Executive Officer (Principal Executive Officer and Principal Accounting Officer)