**UNITED
      STATES**


**SECURITIES
      AND EXCHANGE COMMISSION**


**Washington,
      D.C. 20549**


**________** **_____** **____________**





**FORM
      10-KSB**





x
      ANNUAL REPORT UNDER
      SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934:


**For
      the fiscal year ended December 31, 2007.**





o
      TRANSITION REPORT
      PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF
      1934:


For
      the
      transition period from _____ to _____




**___________** **____** **__________**





Commission
      file number 0-28685


**_____________** **_______** **_____**





**VERTICAL
      COMPUTER SYSTEMS, INC.**


(Exact
      Name of Small Business Issuer as Specified in its Charter)





**Delaware**
            **65-0393635**(State
                of Incorporation)
            (I.R.S.
                EmployerIdentification
                No)





**101
      West Renner Road, Suite 300**


**Richardson,
      TX 75082**


(Address
      of Principal Executive Offices)




**(817)
      348-8717**


(Issuer’s
      Telephone Number)





Securities
      registered pursuant to section 12 (b) of the Act:





Title
                of each class
            Name
                of each exchange on which registered**None**
            **None**





Securities
      registered pursuant to section 12 (g) of the Act:





**Common
      Stock, par value $0.00001 per share**


(Title
      of
      Class)





Check
      whether the registrant: (1) has filed all reports required to be filed by
      Section 13 or 15(d) of the Exchange Act of 1934 during the past 12 months,
      (or
      for such shorter period that the registrant was required to file such reports),
      and (2) has been subject to such filing requirements for the past 90 days.
      Yes
x No
o





Check
      if
      there is no disclosure of delinquent filers in response to Item 405 of
      Regulation S-B not contained in this form, and no disclosure will be contained,
      to the best of the registrant’s knowledge, in the definitive proxy or
      information statement incorporated by reference in Part III of this Form 10-KSB
      or amendment to Form 10-KSB. Yes oNo
x




Indicate
      by check mark whether the registrant is a shell company (as defined in Rule
      12b-2 of the Exchange Act). Yes oNo
x





Issuer’s
      revenues for fiscal year ended December 31, 2007: $5,895,726





Aggregate
      market value of the voting and non-voting stock held by non-affiliates of the
      registrant: $16,433,733 based on the closing price for the common stock of
      $0.019 per share on April 15, 2008, as reported on the Over-the Counter Bulletin
      Board.





As
      of
      April 15, 2008, the issuer had 998,235,151 shares of common stock, par value
      $.00001, issued and outstanding.





Documents
      incorporated by reference: None





Transitional
      Small Business Disclosure Format: Yes oNo
x

















**VERTICAL
      COMPUTER SYSTEMS, INC. AND SUBSIDIARIES**


**FORM
      10-KSB**


**FOR
      THE FISCAL YEAR ENDED DECEMBER 31, 2007**





**TABLE
      OF CONTENTS**





PART
                I
            2**Item
                1. Description of Business**
            **2****Item
                2. Description Of Property**
            **9****Item
                3. Legal Proceedings**
            **9****Item
                4. Submission Of Matters To A Vote Of Security
                Holders**
            **11**PART
                II
            12**Item
                5. Market For Common Equity And Related Stockholder
                Matters**
            **12****Item
                6. Management’s Discussion and Analysis of Financial Condition and Results
                of Operations**
            **16****Item
                7. Consolidated Financial Statements**
            **23****Item
                8. Changes in and Disagreements with Accountants on Accounting and
                Financial Disclosure**
            **23****Item
                8A. Controls and Procedures**
            **23****Item
                8B. Other Information**
            **25**PART
                III
            26**Item
                9. Directors, Executive Officers, Promoters And Control Persons;
                Compliance With Section 16(a) Of The Exchange
                Act**
            **26****Item
                10. Executive Compensation**
            **28****Item
                11. Security Ownership Of Certain Beneficial Owners And
                Management**
            **30****Item
                12. Certain Relationships And Related
                Transactions**
            **31****Item
                13. Exhibits And Reports On Form 8-K**
            **33****Item
                14. Principal Accountant Fees and Services**
            **37**SIGNATURES
            38


CONSOLIDATED
      FINANCIAL STATEMENTS


Exhibit
                31.1
            Section
                302 Certification by Chief Executive OfficerExhibit
                31.2
            Section
                302 Certification by Principal Accounting OfficerExhibit
                32.1
            Section
                906 Certification by Chief Executive OfficerExhibit
                32.2
            Section
                906 Certification by Principal Accounting
                Officer




1


**PART
      I**





**Item
      1. Description of Business**





***Forward-Looking
      Statements and Associated Risks.*** *This
      Report contains forward-looking statements. Such forward-looking statements
      include statements regarding, among other things, (a) our projected sales and
      profitability, (b) our growth strategies, (c) anticipated trends in our
      industry, (d) our future financing plans, (e) our anticipated needs for working
      capital, (f) our lack of operational experience, and (g) the benefits related
      to
      ownership of our common stock. Forward-looking statements, which involve
      assumptions and describe our future plans, strategies, and expectations, are
      generally identifiable by use of the words* *“* *may,* *”* ** *“* *will,* *”* ** *“* *should,* *”* ** *“* *expect,* *”* ** *“* *anticipate,* *”* *&l
      t;/e m>* *“* *estimate,* *”* ** *“* *believe,* *”* ** *“* *intend,* *”* *or* *“* *project* *”* *or
      the negative of these words or other variations on these words or comparable
      terminology. This information may involve known and unknown risks,
      uncertainties, and other factors that may cause our actual results, performance,
      or achievements to be materially different from the future results, performance,
      or achievements expressed or implied by any forward-looking statements. These
      statements may be found under* *“* *Management* *’* *s
      Discussion and Analysis of Financial Condition and Results of
      Operations* *”* *and* *“* *Business,* *”* *as
      well as in this Report generally. Actual events or results may differ materially
      from those discussed in forward-looking statements as a result of various
      factors, including, without limitation, the risks outlined under* *“* *Risk
      Factors* *”* *and
      matters described in this Report generally. In light of these risks and
      uncertainties, there can be no assurance that the forward-looking statements
      contained in this report will in fact occur as projected.*





**Background**





Vertical
      Computer Systems, Inc. (“ Vertical ”,
      the
“ Company ”,
      or the
“ Registrant ” ) was
      incorporated in the State of Delaware in March 1992. The Company operated as
      a
      non-reporting public shell company until October 1999, at which time the Company
      acquired all the outstanding capital stock of Externet World, Inc., an Internet
      service provider and
      became an operating entity. In
      April
      2000, the Company acquired 100% of the outstanding common stock of Scientific
      Fuel Technology, Inc. (“ SFT ”),
      a
      company with no operations. Also in April 2000, the Company merged SFT into
      the
      Company, as a consequence of which the outstanding shares of SFT were cancelled,
      the Company became the surviving entity, and the Company assumed SFT’s reporting
      obligations pursuant
      to Section
      12g-3(a) under the Securities Exchange Act of 1934 ,
      as
      amended (the “ Exchange
      Act ”).




In
      February 2004, the Company purchased the minority interests in its 60% owned
      subsidiary, NOW Solutions LLC “NOW Solutions”), resulting in the Company’s 100%
      ownership of Now Solutions. Later in 2004, Now Solutions was converted from
      an
      LLC into a corporation.





In
      November 2005, the Company formed Taladin, Inc. (“ Taladin ”),
      a
      Texas corporation. Also in November 2005, Taladin and NOW Solutions entered
      into
      a license agreement whereby Taladin received the exclusive rights to
      commercially exploit emPath® for use by the United States federal, state and
      local governments and agencies in exchange for a license fee and royalties.





In
      January 2006, the Company opened an office in Brazil in conjunction with NOW
      Solutions to provide software development and to market the Company’s software
      to distributors in Brazil. In April 2006, the Company formed OptVision Research,
      Inc. (“OptVision Research”), a Texas corporation.




In
      April
      2007, the Company formed Vertical Healthcare Solutions, Inc. (“ VHS ”),
      a
      Texas corporation.




The
      Company’s software products that are presently being marketed are HRMS emPath®
6.4 (“ emPath® ”),
      ResponseFlashTM and SiteFlashTM. The Company has licensed, as a sublicensee, the
      rights to market IA (formerly ImmuneApp) and StatePointPlus®, and is marketing
      these products individually and collectively as a managed baseline solution
      (“ Managed
      Baseline Solution ”).
      For a
      description of these products, please see the section entitled “Business
      Overview”. NOW Solutions is marketing emPath® in the United States and Canadian
      markets. For a description of this new delivery model, please see the section
      entitled “Business Overview”. The Company intends to market its other software
      products internationally commencing in Canada, Italy and Brazil either
      directly through the Company and its subsidiaries, or through agreements with
      national and regional distributors.




**Business
      Overview**




The
      Company is a multi-national provider of Internet core technologies,
      administrative software, and software services through its distribution network
      with operations or sales in the United States, Canada, Japan, and Brazil and
      also is in active negotiations in Italy and the UK to establish a business
      presence. The Company's primary Internet core technologies include SiteFlashTM,
      ResponseFlashTM, and the Emily® XML Scripting Language, which can be used to
      build Web services. The Company's main administrative software product is
      emPath®, which is designed to handle complex Payroll and Human Resources
      challenges. Software services provided by the Company include emPath® —
delivered as a SaaS — and its Managed Baseline Solution.




2




The
      Company attempts to acquire marketing rights for products which, in the
      Company’s belief, are proven and best of breed; are profitable or on the path to
      profitability; are complementary to our other software offerings; and provide
      cross-product distribution channels. The Company’s business model combines
      complementary, integrated software products, internet core technologies, and
      a
      multinational distribution system of partners, in order to create a distribution
      matrix that we believe is capable of penetrating multiple sectors through cross
      promotion.




The
      Company’s current products address the following market segments:




**MARKET**
            
            **PRODUCT**
            
            **OWNERSHIP/**
              **LICENSOR**
            
            **LICENSEE**Human
                Resources and Payroll
            
            emPath®
            
            NOW
                SolutionsLarge
                Corporations and Universities
            
            SiteFlashTM
            
            Vertical
                ComputerGovernment
                Sector- Emergency Response
            
            ResponseFlashTM
            
            Vertical
                Computer
            
            GISPublishing
                Content
            
            NewsFlashTM
            
            Vertical
                ComputerEmily®XML Scripting Language
            
            Emily®
            
            Vertical
                ComputerSecurity
            
            IA
            
            CW
                International
            
            Vertical
                Computer SystemsIT
                Management and Compliance
            
            StatePointPlus®
            
            CW
                International
            
            Vertical
                Computer Systems




***Administrative
      Software***




The
      Company’s primary administrative software technology is emPath®, a human
      resources/payroll software, which is developed, marketed and maintained by
      its
      wholly-owned subsidiary, NOW Solutions. The Company’s administrative software is
      Web-based, meaning that it can be accessed on the Internet, and is currently
      being offered as a SaaS (Software as a Service).


The
        Company recently released a new version of emPath® (emPath® 6.4) which
        encompasses ASP.net and a new user interface which has increased customization
        capabilities. These new features, when coupled with experience gained with
        the
        product by the Brazil-based development staff (over one year), will facilitate
        substantially faster development. The
        Company is also exploring opportunities to utilize emPath®’s powerful payroll
        component to provide private label contracting to existing payroll providers
        in
        localized markets.
  The
        Company believes that its administrative software services provide customers
        with upfront cost savings and productivity increases for everyday operations,
        including competitive set-up charges and implementation times.




***Internet
      Core Technologies***




Internet
      core technologies provide the software foundation to support internet-based
      platforms for the delivery of individual software products that can be sold
      independently or combined with another software product for rapid deployment
      of
      all software products throughout the Company’s distribution system. The Company
      continues to develop specialized software applications that the Company can
      utilize in new products.




The
      Company’s primary core internet technology is SiteFlashTM. The SiteFlashTM
technology utilizes XML and publishes content on the Web, enabling the user
      to
      build and efficiently operate Websites with the unique ability to separate
      form,
      function, and content. SiteFlashTM uses an advanced component-based structure to
      separate, parse, and store the various components of even the most complex
      Web
      pages, which permits these components to be named, organized, filed and
      eventually redeployed onto the Web pages of a Website. Once all of the
      components of a Web page are converted into “ *objects* ,”
they
      can be grouped, as required by the user, into the three main types of web page
      components: content, form and function. *Content* consists
      of text, pictures or multimedia. *Form* includes
      graphics and web site colors, layout and design. *Function* refers
      to
      the activities performed by or actions executed on the Website. In this way,
      each element of a Website created using SiteFlashTM is interchangeable with any
      other similar element, and these elements may be grouped together in almost
      any
      combination to create complex Websites. This separation of form, function,
      and
      content also allows for the rapid creation of affiliated Websites. This unique
      ability is patented (U.S. Patent number 6,826,744) and has many applications
      in
      the Web arena.




3





The
      Company offers SiteFlashTM as a stand-alone product and also as a technology
      platform for products targeted at specific vertical markets. The SiteFlashTM
technology focuses on content management, e-commerce, and workflow and has
      led
      to the development of two additional software application products:
      ResponseFlashTM and NewsFlashTM. ResponseFlashTM was installed by the Metropolitan
      Emergency Communications Agency in Marion County, which includes Indianapolis,
      Indiana. NewsFlashTM is used by newspapers (e.g. La Opinion and Japan’s Hochi).
      SiteFlashTM architectural concepts enable integration with existing technological
      components within many organizations. Additional key features that differentiate
      SiteFlashTM from other products are its affiliation/syndication capability, its
      multi-lingual capability and its multi-modal (any output device including
      wireless devices such as PDAs and cellular phones) framework. Initially,
      Government Internet Systems (“ GIS ”),
      a
      majority-owned subsidiary of the Company, will focus on marketing
      ResponseFlashTM, a Web-based emergency communication system, in the homeland
      security area to all government sectors excluding the public education (i.e.,
      schools, colleges, and universities).





Currently,
      the Company is converting its SiteFlashTM product as a SaaS model with initial
      marketing efforts concentrated in the affiliate, government and publishing
      markets.




See
      “Legal Proceedings” regarding an infringement claim that the Company has
      initiated in federal court against Microsoft.




The
      second core Internet technology the Company has developed is the patent-pending
      Emily® XML scripting language, which is Java compatible. XML is a flexible
      way to create common information formats and share both the format and the
      date
      on the World Wide Web, intranets, and elsewhere. The Emily® work platform, also
      known as “the Emily® Framework”, consists of executable programs, files,
      configuration data and documentation needed to create Web-based applications
      that communicate via XML and HTTP. HTTP is the set of rules for exchanging
      files
      (text, graphic images, sound, video, and other multimedia files) on the Web. The
      Emily® Framework was developed to be an engineering package comparable to other
      Web development tools, such as Allaire Cold Fusion® or Microsoft FrontPage®. The
      primary component of the Emily® Framework is Markup Language Executive, a
      programming language that runs on Windows®, Linux and several UNIX platforms.




***Software
      Services***




In
      addition to its standard emPath® offering, NOW Solutions provides a new delivery
      model known as software-as-a-service, also referred to as SaaS. SaaS is a
      software application delivery model where the Company both develops and
      operates/hosts the application for use by its customers over the Internet.
      It is
      a low-cost way for businesses to obtain the same benefits of commercially
      licensed, internally operated software, without the associated complexity and
      high start-up costs. The term "SaaS" has become the industry adopted reference
      term, generally replacing the earlier terms "On-Demand" and "ASP" (Application
      Service Provider). The Company has completed months of testing its emPath® SaaS
      model to ensure a robust and competitive solution.




The
      Company is currently marketing IA (formerly ImmuneApp) and StatePointPlus®,
      presenting these products individually or collectively as a Managed Baseline
      Solution. IA is a security software program that allows a system
      administrator to stop the use of unauthorized programs, including unlicensed
      software, viruses, Trojans, spyware, adware and malicious code. StatePointPlus®
is an intelligent System Baseline Management patented technology that improves
      information technology management by providing a highly cost-effective complete
      inventory of network hardware, giving a complete picture of all existing
      workstations, servers, and software on a network. The technology also provides
      a
      self-healing function to reverse unauthorized changes to systems, ensuring
      that
      IT systems are in compliance with company policies and standards as well as
      government regulations, including HIPAA, Sarbanes-Oxley and ISO. The Company
      currently has exclusive rights to distribute IA, StatePointPlus® and the Managed
      Baseline Solution to all users in Brazil, and in the healthcare and government
      sectors in the United States. The Company may distribute IA,
      StatePointPlus®, and the Managed Baseline Solution to any other users on a
      non-exclusive basis, subject to registration.




**Business
      Operations and Divisions**




The
      Company’s business operations are grouped into the following divisions: NOW
      Solutions, GIS, Vertical Internet Solutions (“ VIS ”),
      EnFacet, Inc. (“EnFacet”), Globalfare.com (“ Globalfare ”),
      Pointmail.com, Inc. (“ Pointmail ”),
      Taladin, OptVision Research, VHS, minority and other limited interests, joint
      ventures, and strategic partnerships. Each of these divisions is discussed
      below.




4




***NOW
      Solutions, Inc.***




NOW
      Solutions, a Delaware corporation, is a wholly-owned subsidiary.





NOW
      Solutions specializes in end-to-end, fully integrated human resource and payroll
      solutions to large and mid-size companies. NOW Solutions has clients ranging
      from private businesses to government agencies, who typically employ 400 or
      more
      employees. NOW Solutions currently markets emPath®, which handles complex human
      resource and payroll situations where the clients may have employees from
      different unions, multiple state locations, and intricate compensation
      structures. The Company believes that the competitive advantage of emPath® is
      its speed of implementation through a formula-builder technology. NOW Solutions’
product suite is targeted to address the needs of management in today’s dynamic
      business environment and gives organizations a user friendly, multi-lingual
      (i.e., English, Canadian French, Spanish, Portuguese and Chinese) and flexible
      software solution, without the multi-million dollar implementation budgets
      of
      the major competitors.




The
      existing revenue model of NOW Solutions is based primarily upon three
      components: licensing fees, professional consulting services, and renewable
      maintenance fees. In addition, since the end of 2006, NOW Solutions has been
      offering a new delivery model for emPath®: SaaS. This delivery model provides a
      highly reliable, secure and scalable infrastructure, enabling the Company not
      only to continue servicing and expanding its current market of mid to large
      sized customers but also increase its market reach by offering a solution to
      smaller sized customers, which
      otherwise may not be able to afford an in-house solution .
      Under
      the SaaS delivery model, NOW Solutions collects monthly fees.





For
      the
      12 months ended December 31, 2007, NOW Solutions had approximately $1,206,897
      of
      total assets, revenues of approximately $5,895,726 and a net loss of
      approximately $607,943.




***Government
      Internet Systems, Inc.***




The
      Company’s 81.5% owned subsidiary, GIS, a Nevada corporation, was formerly named
      Emily® Solutions, Inc. The Company will license ResponseFlashTM to GIS to market
      and distribute this technology to government entities (excluding state
      universities and schools) in the United States. GIS seeks to enter into
      agreements to distribute other non-Company products particularly in the homeland
      security sector. The Company completed development and installation of
      ResponseFlashTM for the Metropolitan Emergency Communications Agency, in Indiana.
      The Company has submitted proposals to various other city, county and state
      governments. The Company is currently seeking funding for GIS.




For
      the
      12 months ended December 31, 2007, GIS had no assets and no material revenue
      or
      expenses.




***Vertical
      Internet Solutions, Inc***




VIS,
      a
      California corporation, is a wholly-owned subsidiary of the Company. **** VIS
      is
      responsible for marketing Emily® Solutions web technology, which includes the XML Enabler Agent and the Emily®
      programming language . The
      United States Patent and Trademark Office (“ USPTO ”)
      granted the Company a patent (No. 7,076,521) for an invention for a “Web-based
      collaborative data collection system” on July 11, 2006.    This
      patent covers various aspects of the XML Enabler Agent.  In addition, the
      Company has filed for a patent related to the Emily® programming language. This
      patent application was published in February 2003 and is still pending. The
      marketing of the Emily® Solutions web technology has been
      put on hold pending the result of the patent application.




For
      the
      12 months ended December 31, 2007, VIS had no material assets and no material
      revenue or expenses.




***EnFacet,
      Inc.***




EnFacet
      is a software company that markets NewsFlashTM. NewsFlashTM is based on
      SiteFlashTM, which is a patented technology (No. 6,826,744). NewsFlashTM caters to
      the publishing industry and newspapers in particular.




For
      the
      12 months ended December 31, 2007, EnFacet had no material assets, no revenues
      and a net loss of approximately $38,471.




5




***Globalfare.com***




In
      May
      2000, the Company acquired Globalfare.com, Inc. (“ Globalfare ”),
      a
      Nevada corporation. Globalfare is currently inactive and the Company currently
      has no plans regarding this subsidiary.




For
      the
      12 months ended December 31, 2007, Globalfare.com had no assets, no revenue
      and
      no expenses.




***Pointmail.com,
      Inc.***




In
      June
      2000, the Company acquired Pointmail.com, Inc., which owned a Web-based e-mail
      software. Pointmail is currently inactive and the Company currently has no
      plans
      regarding this subsidiary or its technology.




For
      the
      12 months ended December 31, 2007, Pointmail.com had no assets, no revenues
      and
      no expenses.




***Taladin,
      Inc.***




In
      November 2005, the Company formed Taladin, a Texas corporation. Also in November
      2005, Taladin and NOW Solutions entered into a license agreement whereby Taladin
      received the exclusive rights to commercially exploit emPath® for use by the
      United States federal, state and local governments and agencies in exchange
      for
      a license fee and royalties. Taladin has developed a module for emPath® to meet
      federal payroll guidelines for law enforcement and fire departments and has
      filed for a patent for the module. The Company is currently seeking funding
      for
      Taladin and has commenced marketing the product on a SaaS platform to sheriff’s
      departments. In
      September 2007, Taladin filed a patent application for its Fair Labor Standards
      Act (FLSA) payroll system. This FLSA payroll system has been integrated with
      Now
      Solutions’ emPath HRMS Solution.




For
      an
      update of transactions concerning Taladin fiscal year-end, please see the notes
      payable issued by Taladin in “Notes Payable” under Note 8 of the Notes to
      Consolidated Financial Statements.





For
      the
      12 months ended December 31, 2007, Taladin had no assets, no revenue and a
      net
      loss of approximately $93,434.




***OptVision
      Research, Inc***




OptVision
      Research, Inc., a Texas corporation, is a wholly-owned subsidiary of the
      Company **** and
      was
      created to support the development of the company’s fiber optic patent though
      either direct investment or government grants.




For
      the
      12 months ended December 31, 2007, OptVision had no material assets and no
      material revenue or expenses.




***Vertical
      Healthcare Solutions, Inc***




VHS,
      a
      Texas corporation, is a wholly-owned subsidiary of the Company. ****




For
      the
      12 months ended December 31, 2007, VIS had no material assets and no material
      revenue or expenses.




**Minority
      Interests and Royalty Interests**




***MedData
      Solutions, Inc.***




In
      February 2004, the Company purchased a 21% ownership interest in MedData from Robert
      Farias. MedData is no longer in business.




***iNet
      Purchasing, Inc.*** **




In
      April
      2000, the Company acquired a 2.5% minority interest in iNet and is entitled
      to a
      royalty on all iNet transactions for up to 40 years. iNet is a developer of
      Internet-based procurement services targeted at the specific needs of public
      sector purchasing in the state and local government arena through PublicBuy.net.
      In November 2001, the Company entered into a license agreement with iNet,
      pursuant to which the Emily® software and technology were licensed for use in
      connection with iNet’s e-procurement system in Texas, Maine, and Idaho in
      exchange for a 20% commission on subscription fees. In April 2005, iNet
      Purchasing was acquired by SicommNet. The Company is in the process of reviewing
      its rights pursuant to the SicommNet ownership of iNet Purchasing, Inc.




6




As
      of
      December 31, 2007, all of the iNet investments and advances paid for royalties
      were fully reserved. There have been no revenues or expenses in relation to
      the
      investments for the twelve months ended December 31, 2007.




***TranStar
      Systems, Inc.*** ****




**** TranStar
      Systems, Inc. (“ TranStar ”),
      formerly Apollo, is based in Claremont, California. TranStar is a systems
      integrator and consulting firm that is establishing an e-business platform
      focused on multiple-application smart card based solutions for credit, debit,
      payroll debit cards and other high volume informational transactions with a
      large customer base. The Company is entitled to receive 3% of any transaction
      fees and any other revenues generated by TranStar in perpetuity, although no
      royalties have been received from TransStar as of April 15, 2008.





**Strategic
      Alliances and Software Distributors**




***CW
      International, LLC*** **.** In
      March
      2006, CW International (“ CWI ”)
      entered into a sublicense agreement with the Company, enabling the Company
      to
      license software, including, IA and StatePointPlus®. In addition, NOW Solutions
      has the exclusive rights to offer IA on an ASP platform for its HRMS
      solution . Pursuant
      to the terms of the Company’s sublicense agreement, CWI granted to the Company
      the exclusive rights to distribute IA to all users in Brazil, and in the
      healthcare and government sectors in the United States. Pursuant to the terms
      of
      an amendment entered into in March 2007, CWI granted to the Company the same
      broad-ranging exclusivity rights with respect to StatePointPlus®. Also in March
      2007, the Company acquired rights from CWI to distribute a security access
      management (“ SAM ”)
      software program on a partially exclusive basis. The Company may distribute
      the
      IA, StatePointPlus®, and SAM applications to any other users on a non-exclusive
      basis.




***Infotec,
      Inc.*** **** In
      April
      2003, the Company and Infotec, a Japanese corporation, entered into a software
      reseller agreement whereby Infotec agreed to market, distribute, provide
      maintenance and technical support for the Company’s SiteFlashTM software in Japan
      and pay the Company a fee on all sales and maintenance fees. **** The
      Company is currently in discussion with Infotec concerning future
      prospects.




***LGB
      & Associates, Inc*** **.** .
      In
      November 2007, the Company and NOW Solutions entered into marketing agreements
      with LGB & Associates, Inc. (“LGB”) to market their products to the Federal
      government sector in the continental United States and Hawaii. LGB, a data
      management and data delivery solutions provider, will market the Company’s
      products.




**Competition**




The
      Company has substantial competition from software and hardware vendors, system
      integrators, and multinational corporations focused upon information technology
      and security. NOW Solutions’ competitors include PeopleSoft, Oracle, Lawson,
      Cyborg/Hewitt, Kronos, DLGL, Ultimate and SAP. The Company’s competitors in the
      network security sector include Tripwire, McAfee, Symantec, Cisco and Computer
      Associates. The Company’s competitors have longer operating histories, greater
      name recognition, larger customer bases and significantly greater financial,
      technical and marketing resources than the Company. The Company cannot guarantee
      that it will be able to compete successfully against current or future
      competitors or that competitive
      pressures will not have a material and adverse effect on the Company’s financial
      position, results of operations and cash flows.





The
      Company’s ability to compete will also depend upon its ability to continually
      improve its products and services, the enhancements the Company develops, the
      quality of its customer service, and the ease of use, performance, price and
      reliability of its products and services.




7





**Strategic
      Overview**




The
      Company believes that each of its business units has distinct marketing
      advantages for the niche markets it serves. The Company plans to find national
      and regional marketers and international resellers who can commercially exploit
      the Company’s products in these niche markets. By utilizing the strategic
      advantages each individual business unit possesses, the Company plans to
      leverage its strengths and exploit the network of customers, vendors, and
      support agencies that the Company has built. **** The
      Company currently seeks to use a combination of direct marketing and strategic
      partnerships to commercially exploit its products derived from SiteFlashTM,
      namely NewsFlashTM, and AffiliateFlashTM. In this way, the Company hopes to define
      the best potential markets for its SiteFlashTM products, and then license the
      product to one of the Company’s subsidiaries to exploit. At this time, the
      Company has placed both its Emily® software and international bridge network on
      hold while it concentrates on these immediate opportunities within its existing
      business units.




One
      of
      the Company’s strategies is to enter into co-marketing agreements with other
      companies, particularly those with best-of-breed products that complement its
      business units. The existing strategy with potential co-marketing partners
      is to
      segregate the co-marketing agreements whereby each business unit will have
      a
      separate agreement with the co-marketing partner for its particularly target
      market. Additionally, the business units will enter into agreements with each
      other where the opportunity exists to cross-promote/market their products.
      The
      Company believes it possesses certain competitive advantages because of its
      proprietary software. The Company is exploring various opportunities to exploit
      its proprietary software, which includes the possibility of licensing the
      software to major companies in non-competitive niche markets.




Although
      the Company’s current marketing effort focuses upon several sectors, it has
      recently concentrated on the United States federal, state and local government
      for the following reasons: (i) affiliated companies have government clients,
      which has created the potential to cross-promote/market the Company’s products
      and Web services; (ii) the Company offers products which are well-suited to
      the
      current governmental environment, in particular, the demand for cross-agency
      and
      federal, state and local interface, like ResponseFlashTM; and (iii) the increased
      security environment caused by the terrorist attacks of September 11, 2001
      necessitates improvements in secure communications and agency-to-agency contacts
      that can be facilitated by ResponseFlashTM and the
      Managed Baseline Solution.




**Proprietary
      Rights**




The
      Company relies upon a combination of contract provisions and patent, copyright,
      trademark and trade secret laws to protect its proprietary rights in its
      products and services.  The Company distributes its products and services
      under agreements that grant users or customers a license to use its products
      and
      services and relies on the protections afforded by the copyright laws to protect
      against the unauthorized reproduction of its products.  In addition, the
      Company protects its trade secrets and other proprietary information through
      agreements with employees and consultants.  NOW Solutions’ emPath® software
      technology is protected by copyright and trademark.  The USPTO granted a
      patent (No. 6,718,103) for an invention for “Transmission of Images over a
      Single Filament Fiber Optic Cable” in April 2004.  This patent is in a
      theoretical stage only and is intended to be used for transmitting images on
      fiber optics that might improve in orders of magnitude today’s capacity of fiber
      optics to transmit images and data.  The Company has filed for a
      Continuation in Part for patent number 6,718,103 to pursue possible additional
      derivative patents.  The USPTO granted the Company a patent (No. 6,826,744)
      for an invention for “System and Method for Generating Web Sites in an Arbitrary
      Object Framework” on November 30, 2004. The Company has filed for a Continuation
      in Part for this patent to pursue possible additional derivative patents. 
This patent is the foundation of the Company’s product, SiteFlash TM,
      and
      forms the basis of the ResponseFlashTM, NewsFlashTM and AffiliateFlashTM
products.  The USPTO granted the Company a patent (No. 7,076,521) for an
      invention for a “Web-based collaborative data collection system” on July 11,
      2006.  This patent covers various aspects of the XML Enabler
      Agent.  In addition, the Company has also filed for a patent related to the
      Emily® programming language. This patent application was published in February
      2003 and is still pending. In September 2007, the Company filed a patent
      application for its Fair Labor Standards Act (FLSA) payroll system. This FLSA
      payroll system has been integrated with NOW Solutions’ emPath® HRMS
      Solution.




Although
      the Company intends to protect its rights as described above, there can be
      no
      assurance that these measures will be successful. Policing unauthorized use
      of
      the Company’s products and services is difficult and the steps taken may not
      prevent the misappropriation of its technology and intellectual property rights.
      In addition, effective patent, trademark, trade secret and copyright protection
      may be unavailable or limited in certain foreign countries. The Company seeks
      to
      protect the source code of its products as a trade secret and as an unpublished
      copyright work. Source code for certain products has been or will be published
      in order to obtain patent protection or to register copyright in such source
      code. The Company believes that its products, trademarks and other proprietary
      rights do not infringe on the proprietary rights of third parties. There can
      be
      no assurance that third parties will not assert infringement claims against
      the
      Company in the future with respect to current or future features or contents
      of
      services or products or that any such assertion may not result in litigation
      or
      require the Company to enter into royalty arrangements.




8




**Regulatory
      Environment; Public Policy**




In
      the
      United States and most countries in which the Company conducts its operations,
      the Company is generally not regulated other than pursuant to laws applicable
      to
      businesses in general and value-added services specifically. In some countries,
      the Company is subject to specific laws regulating the availability of certain
      material related to, or to the obtaining of, personal information. Adverse
      developments in the legal or regulatory environment relating to the interactive
      online services and Internet industry in the United States, Europe, Asia, Latin
      America or elsewhere could have a material adverse effect on the Company’s
      business, financial condition and operating results. A number of legislative
      and
      regulatory proposals from various international bodies and foreign and domestic
      governments in the areas of telecommunications regulation, particularly related
      to the infrastructures on which the Internet rests, access charges, encryption
      standards and related export controls, content regulation, consumer protection,
      advertising, intellectual property, privacy, electronic commerce, and taxation,
      tariff and other trade barriers, among others, have been adopted or are now
      under consideration. The Company is unable at this time to predict which, if
      any, of the proposals under consideration may be adopted and, with respect
      to
      proposals that have been or will be adopted, whether they will have a beneficial
      or an adverse effect on the Company’s business, financial condition and
      operating results.




**Employees**




As
      of
      April 15, 2008, the Company has 28 full-time employees, of which 26 are employed
      at NOW Solutions (17 are employed in the United States and 9 in Canada), and
      16
      consultants (6 in Brazil). The Company is not a party to any collective
      bargaining agreements.




**Item
      2. Description Of Property**




The
      Company and NOW Solution’s headquarters are currently located at 101 West Renner
      Road, Suite 300, Richardson, Texas, and comprises approximately 2,576 square
      feet. In addition, NOW Solutions has offices at 201 Main Street, Suite 1175,
      Fort Worth, Texas, which comprises 3,450 square feet, 6205 Airport Road,
      Building A, Suite 300, Mississauga, Ontario, Canada, which
      comprises 710 square feet, and
      Rua
      Farme de Amoedo, Rio de Janeiro, Brazil ,
      which
      comprises 1,200 square feet. All of these locations are leased fr om
      third
      parties and the premises are in good condition. The Company believes that its
      facilities are adequate for its present needs and near-term growth, and that
      additional facilities will be available at acceptable rates as the Company
      needs
      them. The Company’s other subsidiaries may be reached through the Company’s
      Texas headquarters.




**Item
      3. Legal Proceedings** ****




The
      Company is involved in the following ongoing legal matters:




In
      February 2003, the Company filed a lawsuit and a derivative action in New York
      Supreme Court Case against defendants Ross
      Systems Inc. (“ Ross ”) ,
      Arglen,
      Tinley, and Gyselen.  The Company filed a derivative action on behalf
      of its subsidiary NOW Solutions when Arglen refused to authorize a lawsuit
      against any parties who were alleged to have acted against the best interest
      of
      NOW Solutions.  In conjunction with the Company’s claim, NOW Solutions
      withheld its payments on the remaining $750,000 note that was due in February
      2003 in connection with the acquisition of certain assets of Ross against the
      unpaid maintenance fees and gave notice in February 2003 to Ross of NOW
      Solutions’ claim of offset.  NOW Solutions claimed a total amount of
      approximately $3,562,000 to offset against the note, plus other
      damages.  The Company’s original claims sought damages and equitable
      relief arising out of actions of the defendants constituting breach of contract,
      fraud, conspiracy and breach of fiduciary duty in connection with certain
      transactions entered into between Ross and NOW Solutions; Ross and Arglen;
      Arglen and NOW Solutions; Gyselen and NOW Solutions; and the Company and Arglen.
      This action concerns claims of breach of contract and indemnification for
      failure to pay adjustments at the closing on the sale of assets of Ross to
      NOW
      Solutions for prepaid maintenance fees and for related relief. In November
      2003,
      the New York Supreme Court dismissed the claims against Ross and Tinley. The
      portion of the lawsuit involving Arglen and Gyselen was settled in December
      2003
      and, pursuant to the settlement, dismissed in February 2004.   The
      Company appealed the decision with regard to its claim for breach of contract
      for Ross’ failure to give the proper maintenance fee adjustment and related
      claims for offset and attorney’s fees.  On June 1, 2004, the appeal of
      the dismissal of the action against Ross was submitted to the court for
      decision.  On appeal, the claims against Ross were reinstated pursuant to
      the order of the Appellate Division, dated October 26, 2004. In November 2004,
      Ross filed an answer containing affirmative defenses in the Derivative Action.
      For information concerning the decision regarding this action and the trial
      regarding the action between NOW Solutions and Ross, please see Ross’ action
      against NOW Solutions below.




9





In
      March
      2003, Ross commenced an action in New York Supreme Court, Westchester County,
      by
      filing a motion for summary judgment in lieu of complaint against NOW Solutions
      to collect the note payable in the amount of $750,000 plus 10%
      interest.  In August 2003, the New York Supreme Court denied the
      motion and dismissed Ross’ action without prejudice.  In October 2003,
      the motion of Ross for re-argument was denied.  Ross appealed the
      August 2003 court order, but subsequently abandoned its
      appeal.   The time for Ross to appeal has run. Consequently, no
      further action will be had on this matter.





In
      March
      2004, Ross commenced an action in the New York Supreme Court by filing a motion
      for summary judgment in lieu of complaint against NOW Solutions to collect
      the
      note payable in the amount of $750,000 plus 10% interest and attorneys
      fees.  NOW Solutions filed its opposition to Ross’ motion, which was
      submitted to the court for decision on May 20, 2004.  NOW Solutions
      opposed the Ross motion and, on October 7, 2004, the Court ruled in favor of
      NOW
      Solutions and denied the motion for summary judgment. Pursuant to New York
      State
      law, in the event a motion for summary judgment in lieu of complaint is denied,
      the action continues and the pleadings supporting the motion are deemed to
      constitute the complaint. Accordingly, NOW Solutions filed an answer containing
      affirmative defenses and nine (9) counterclaims against Ross. The affirmative
      defenses asserted by NOW Solutions included the same grounds which comprise
      the
      causes of action against Ross in the Derivative Action, namely Ross’ breach of
      the Asset Purchase Agreement as a result of its failure to credit NOW Solutions
      with adjustments at closing in an amount not less than $3,562,201. All of the
      counterclaims asserted by NOW Solutions against Ross relate to the Asset
      Purchase Agreement and Ross’ breaches thereof. The counterclaims included: (i)
      breach of the covenant not to compete, whereby NOW Solutions seeks damages
      in
      excess of $10,000,000; (ii) breach of the covenant to deliver all assets to
      NOW
      Solutions at closing, whereby NOW Solutions seeks damages in an amount not
      less
      than $300,000; (iii) breach of a certain Transitional Services Agreement
      (executed in conjunction with the Asset Purchase Agreement), whereby NOW
      Solutions seeks damages in an amount not less than $73,129; and (iv) reasonable
      attorney’s fees. In February 2005, Ross’s motion to dismiss two of NOW
      Solutions’ nine counterclaims: one which alleges that Ross and CDC Corporation
      used Ross to breach a covenant not to compete and the second which requested
      that Ross be enjoined from further competition with NOW Solutions in violation
      of the covenant were granted. Thereafter, NOW Solutions filed a motion to vacate
      the default, which motion was denied over the objections of NOW Solutions,
      which
      later filed a notice of appeal of this decision. NOW Solutions’ remaining
      counterclaims remain unaffected. In November 2006, the court rendered decisions
      on three summary judgment motions whereby the court dismissed NOW Solutions’
sixth and seventh counterclaims in the NOW Solutions action, dismissed Ross’
affirmative defenses numbered first, second, fourth, and seventh through
      thirteenth in the Vertical action, and denied all other requests for relief.
      Trial commenced on both actions on March 20, 2007. On April 13, 2007, the court
      rendered decisions in both actions as follows: (1) In the action of Ross
      Systems, Inc. v. NOW Solutions, Inc. a directed verdict was granted (a) to
      Ross
      Systems on its claim for payment of the promissory note, net of certain offsets
      that the court found due to NOW Solutions on its first, second and fifth
      counterclaims, other than for the amount claimed due by NOW for maintenance
      fee
      adjustments due at the closing of the sale transaction between the parties,
      in
      the amount of $664,000; (b) to NOW Solutions on its first counterclaim for
      maintenance fee adjustments in the amount of $1,943,482; accordingly, NOW
      Solutions was awarded the net amount of $1,279,482 ($1,943,482-$664,000), plus
      statutory (simple) interest at 9% per annum from the date the claim accrued;
      and
      (c) to Ross Systems dismissing NOW’s fourth counterclaim against Ross for
      failure to deliver certain assets at closing. (2) In the action of Vertical
      Computer Systems, Inc. v. Ross Systems, Inc., et. al., the court dismissed
      Vertical’s claim on behalf of NOW Solutions for maintenance fee adjustments, as
      moot in light of its directed verdict on this issue in the Ross Systems v.
      NOW
      Solutions action, and dismissed Ross’ defenses to the Vertical action and Ross’
claim for attorney fees therein. In the action of Ross Systems, Inc. v. NOW
      Solutions, Inc., NOW Solutions and Ross each filed motions for attorney's fees
      with the court in August 2007. In September 2007, the court awarded NOW
      Solutions a judgment in the amount of $3,151,216, which consisted of $1,279,483
      for NOW Solutions’ claims (after deducting $664,000 for Ross’ claim), $912,464
      in attorneys’ fees and expenses, and $865,361 of accrued interest. NOW Solutions
      is currently seeking to collect the amounts due under the judgment. The judgment
      was entered on October 11, 2007. In November 2007, Ross gave notice of its
      intention to appeal the decision and posted a bond in the amount of the
      judgment. The Company is currently preparing for the appeal.





In
      March
      2004, Ross commenced an action in the Court of Chancery, State of Delaware
      by
      filing a summons and complaint against the Company, NOW Solutions and Arglen
      alleging a fraudulent transfer in connection with the Company’s payment of
      monies to Arglen pursuant to the settlement dated December 2003.  The
      Company and NOW Solutions filed a motion to stay the Delaware action pending
      the
      resolution of the parties’ rights in Supreme Court, New York County and
      Appellate Division. Specifically, Ross seeks a judgment against the Company:
      (i)
      attaching the assets transferred to Arglen pursuant to the 2003 Settlement;
      (ii)
      enjoining the Company and NOW Solutions from making further transfers to Arglen
      pursuant to the Arglen Note; (iii) avoiding the transfers to the Company and
      Arglen or for judgment in the amount equivalent to the value of the asserts
      transferred to them pursuant to the 2003 Settlement; and (iv) appointing a
      receiver to take possession of the assets transferred to the Company and Arglen
      pursuant to the 2003 Settlement. In July 2004, the Company and NOW Solutions
      filed a motion to stay the Delaware Action pending the resolution of the
      parties’ rights in the Derivative Action and Ross Action. In October 2004, the
      motion was granted and the Delaware action has been stayed. This action is
      subject to dismissal; however, this action has been further stayed since Ross
      has filed notice of its intention to appeal the above decision and has posted
      bond for the appeal.




10





In
      August
      2004, Arglen obtained a default judgment in Los Angeles court for the
      outstanding principal due under a $600,000 promissory note, plus attorney’s fees
      and interest at the rate of 10% per annum. In April 2005, Arglen filed a Notice
      of Filing a Foreign Judgment in Tarrant County, Texas. In August 2005, the
      Company entered into a Payout Agreement with Arglen allowing payout terms to
      the
      Company and pursuant to which the Company agreed to enter into the Agreed
      Judgment. The Agreed Judgment and Payout Agreement were entered into concerning
      a California judgment and Arglen's notice of Filing a Foreign Judgment in
      Tarrant County, Texas, which were in connection with the terms of a 2003
      settlement agreement with Arglen (the “2003 Settlement”). Pursuant to the terms
      of the Agreed Judgment and the Payout Agreement, the Company agreed to pay
      Arglen a total of $713,489, which includes the following amounts: (a) $600,000
      in principal on the promissory note issued by the Company pursuant to the
      settlement of litigation between the parties in 2003, (b) the accrued
      post-judgment interest on the California judgment from September 4, 2004 through
      September 15, 2005, at the rate of 10% per annum, which equals $61,989, and
      (c)
      attorney's fees incurred for the California and Texas judgment actions which
      were approximately $51,500. Pursuant to the terms of the Payout Agreement,
      the
      Company began making monthly interest payments on the amounts specified above
      of
      $5,945, beginning on September 15, 2005, which will be replaced by monthly
      payments of $25,000 or 10% of the Company's new sales, whichever is greater,
      beginning on February 15, 2006 until the remainder of the $713,489 is paid.
      In
      accordance with the Payout Agreement, Arglen shall not execute the Agreed
      Judgment so long as the Company continues to make its payments as
      agreed. ****





The
      IRS
      has a claim for unpaid Employment (Form 941) taxes and Federal Unemployment
      (Form 940) taxes for the period December 31, 2001 through December 31, 2005.
      As
      of August 27, 2006 the total tax, penalties and interest due was $313,839.
      In
      that matter, the Company appealed from a Notice of Intent to Levy served to
      collect this tax and on February 8, 2007, following a Due Process Hearing,
      the
      IRS determined that its decision to seek collection of the tax by levy was
      proper. On March 9, 2007, the Company filed an appeal of the IRS’s determination
      to the United States Tax Court. The Company hopes that the Court will hold
      that
      the IRS’s refusal to consider an Installment Agreement to pay the liability over
      several years was erroneous. There is no guarantee, however, that the Court
      will
      not sustain the IRS determination and will allow it to collect the tax,
      penalties and interest by levy.





On
      April
      18, 2007, the Company filed suit for patent infringement against Microsoft
      Corp.
      in the United States District Court for the Eastern District of Texas. The
      Company claims that the Microsoft .Net System infringes U.S. Patent No.
      6,826,744. On July 13, 2007, Microsoft filed an answer to the Company’s
      complaint, alleging various defenses and counterclaims. On August 2, 2007,
      the
      Company filed a reply to Microsoft’s defenses and counterclaims. The court has
      set trial for March 2009. The parties are in the process of discovery. The
      court
      has set the claim construction hearing for July 10, 2007.





In
      the
      opinion of management, the ultimate resolution of any pending matters may have
      a
      significant effect on the financial position, operations or cash flows of the
      Company. Also, the Company in the future may become involved in other legal
      actions that may have a significant effect on the financial position, operations
      or cash flows of the Company.




**Item
      4. Submission Of Matters To A Vote Of Security Holders**




None




11




**PART
      II**




**Item
      5. Market For Common Equity And Related Stockholder Matters** ****




The
      Company’s common equity is quoted on the Over-The-Counter Bulletin Board (the
“ OTCBB ”)
      under
      the symbol “VCSY”.





The
      following is the range of high and low closing bid prices of our stock, for
      the
      periods indicated below.




**High**
            
            **Low**Quarter
                Ended December 31, 2007
            
            $
            0.0200
            
            $
            0.0110Quarter
                Ended September 30, 2007
            
            $
            0.0260
            
            $
            0.0180Quarter
                Ended June 30, 2007
            
            $
            0.0300
            
            $
            0.0200Quarter
                Ended March 31, 2007
            
            $
            0.0260
            
            $
            0.0130Quarter
                Ended December 31, 2006
            
            $
            0.0210
            
            $
            0.0120Quarter
                Ended September 30, 2006
            
            $
            0.0750
            
            $
            0.0180Quarter
                Ended June 30, 2006
            
            $
            0.0520
            
            $
            0.0165Quarter
                Ended March 31, 2006
            
            $
            0.0170
            
            $
            0.0060





The
      above
      quotations reflect inter-dealer prices, without retail mark-up, mark-down or
      commission and may not represent actual transactions.




**Number
      of Holders**




As
      of
      April 15, 2008, there were approximately 1,733 holders of record of our common
      stock.




**Equity
      Securities Under Compensation Plans**




For
      information concerning Equity Compensation Plans, please see “Stock Options and
      Warrants” under Note 11 in the Notes to Consolidated Financial
      Statements.




**Dividends**




The
      Company has outstanding Series A and Series C 4% Convertible Cumulative
      Preferred stock that accrue dividends (if such dividends are declared) at a
      rate
      of 4% on a semi-annual basis. The
      total
      dividends applicable to Series A and Series C Preferred Stock were $588,000
      and
      $600,000 for the years ended December 31, 2007 and
      2006,
      respectively.  The
      Company’s Board of Directors did not declare and did not pay any dividends on its outstanding shares
      of Series
      A Preferred
      Stock or Series C
      Preferred Stock
      during 2007 or
      2006
      and has not declared or paid any dividends since 2001. The
      Company intends to retain future earnings, if any, to provide funds for use
      in
      the operation and expansion of its businesses. Accordingly, the Company does
      not
      anticipate paying cash dividends on any of its capital stock in the near
      future.




**Unregistered
      Sales of Securities**





During
      the last two years, the Company issued the following unregistered
      securities:




In
      February 2006, the Company issued 5,000,000 shares of common stock of the
      Company (at a fair market value of $45,000) as partial incentive for Tara
      Financial to make the $450,000 loan and to refinance approximately $1.75 million
      of existing debt. For details on the note payable issued in connection with
      the
      loan, please see “Notes Payable” under Note 8 of the Notes to Consolidated
      Financial Statements.




In
      February 2006, the Company issued 3,000,000 shares of the common stock of the
      Company (at a fair market value of $27,000) **** as
      partial incentive for SGP to make the $150,000 loan, the Company issued to
      SGP
      3,000,000 shares of common stock of the Company. For details on the note payable
      issued in connection with the loan, please see “Notes Payable” under Note 8
      of the Notes to Consolidated Financial Statements.




12




In
      March
      2006, $40,800 in liquidated damages claimed by Cornell
      Capital Partners (“ Cornell ”) in
      connection with a $200,000 debenture issued by the Company to Cornell in April
      2003 was converted into 4,387,095 shares of common stock.




In
      May
      2006, a third party converted 1,500 shares of Series A, 4% Convertible
      Cumulative Preferred Stock into 750,000 shares of common stock of the
      Company.




In
      July
      2006, a director of GIS sent the Company a notice of exercise to purchase a
      total of 1,250,000 shares of common stock of the Company under two warrants
      issued to the director in December 2002. The purchase price for the shares
      was
      $12,500, which was offset against outstanding interest payments due under notes
      payable issued to the director and unreimbursed expenses incurred by the
      director. These shares were issued in 2007.





In
      July
      2006, the Company issued a total of 500,000 unregistered shares of the common
      stock of the Company to two third party lenders pursuant to their exercise
      of
      warrants to purchase the shares for a total of $3,750. The purchase price was
      offset against monies owed to each lender under outstanding promissory
      notes.





In
      September 2006, the Company issued 1,000,000 unregistered shares of common
      stock
      of the Company (at a fair-market value of $18,000) to a third party lender
      in
      connection with a $50,000 loan to the Company made in September 2006.





In
      October 2006, the Company agreed to issue 1,000,000 unregistered shares of
      the
      common stock of the Company (at a fair market value of $21,000) to Mr. Weber
      in
      connection with a $100,000 loan to Taladin. These
      shares have not been issued as the Company cannot issue shares above the
      authorized amount of 1,000,000,000 shares of common stock. The
      Company is currently investigating its options in order to present its
      shareholders, as soon as practicable, with a plan whereby the Company could
      meet
      all of its outstanding obligations without exceeding its authorized shares
      of
      common stock.




In
      December 2006, the agreed to issue 3,000,000 shares of common stock of the
      Company to Mr. Rosseti in connection with refinancing an outstanding $66,000
      note payable issued to Mr. Rossetti and additional debt of approximately $56,000
      in fees owed to Markquest, Inc. **** The
      fair
      market value of the shares to be issued is $48,000. For details on the $113,734
      note payable issued in connection with the refinancing, please see “Notes
      Payable” under Note 8 of the Notes to Consolidated Financial Statements.
      These shares were issued in 2007. The Company is currently investigating its
      options in order to present its shareholders, as soon as practicable, with
      a
      plan whereby the Company could meet all of its outstanding obligations without
      exceeding its authorized shares of common stock.





During
      the year ended December 31, 2006, the entire $190,000 of principal under a
      debenture bearing no interest was converted into 24,298,094 shares of the
      Company’s common stock in connection with a commitment fee pursuant to an Equity
      Line of Credit agreement entered into in April 2003 between the Company and Cornell .





During
      the year ended December 31, 2006, the Company agreed to issue 12,525,000,
      unregistered shares of common stock of the company to employees and consultants
      of the Company and NOW Solutions pursuant to restricted stock agreements with
      the Company that provide for the stock to vest over period of one year or over
      three years in equal installments at the anniversary date of the agreement.
      All
      of these shares have been issued.





During
      the year ended December 31, 2006, the Company cancelled 3,866,666 unregistered
      shares of common stock of the Company. These shares were issued pursuant to
      restricted stock agreements executed in 2005 and 2006.





During
      the year ended December 31, 2006, 5,449,998 unregistered shares of common stock
      of the Company issued to employees and a consultant of the Company and NOW
      Solutions vested. These shares were issued pursuant to restricted stock
      agreements executed in 2005 and 2006.





During
      the year ended December 31, 2006, incentive stock options to purchase 1,500,000
      shares of common stock of the Company at a price of $0.010 per share were
      cancelled in connection with the issuance of unregistered shares of stock to
      an
      employee of NOW Solutions pursuant to a restricted stock agreement.





During
      the year ended December 31, 2006, warrants to purchase 21,966,667 shares
      of common stock of the Company at a price of $ 0.0165
      to
      $0.10 per
      share expired or were cancelled.




13





In
      March
      2007, MRC and Victor Weber entered into a pledge agreement, whereby the MRC
      pledged 10,000,000 shares of common stock of the Company to secure the principal
      payments and interest payments on the $300,000 Note and interest payments on
      the
      $200,000 Note. MRC is a corporation controlled by the W5 Family Trust. Mr.
      Wade,
      the President and CEO of the Company, is the trustee of the W5 Family Trust.
      Mr.
      Weber is the President and a Director of Government Internet Systems, Inc.,
      a
      subsidiary of the Company, and a member of CWI.





In
      April
      2007, Luiz Valdetaro, on behalf of the Company, transferred 2,000,000
      unrestricted shares of common stock of the Company owned by Mr. Valdetaro to
      an
      officer of Tara Financial in exchange for waiving the defaults and extending
      the
      payment terms on notes payable in the amounts of $438,795, $350,560, $955,103
      and $450,000 issued to Tara Financial by the Company, NOW Solutions, and Taladin
      in February 2006. Mr. Valdetaro is the Chief Technology Officer of the Company.
      Also in April 2007, in connection with the transfer, the Company entered into
      an
      indemnity and reimbursement agreement to reimburse Mr. Valdetaro with 2,000,000
      shares within one year and pay for all costs associated with the transfer of
      shares to Tara Financial and the reimbursement of shares to Mr. Valdetaro.




In
      April
      2007, Mr. Valdetaro, on behalf of the Company, transferred 1,000,000
      unrestricted shares of common stock of the Company owned by Mr. Valdetaro to
      Clark Consulting Services, Inc. (“CCS”) in connection with a $40,000 loan made
      by CCS to the Company. The Company is also obligated to arrange for a pledge
      of
      1,000,000 shares of common stock of the Company to secure the loan. Mr.
      Valdetaro is the Chief Technology Officer of the Company. Also in April 2007,
      in
      connection with the transfer of shares to CCS, the Company entered into an
      indemnity and reimbursement agreement to reimburse Mr. Valdetaro with 1,000,000
      shares within one year and pay for all costs associated with the transfer of
      shares to CCS and the reimbursement of shares to Mr. Valdetaro.




In
      April
      2007, the Company and MRC entered into an indemnity and reimbursement agreement
      for transfer and pledges of shares of common stock of the Company. Pursuant
      to
      the agreement, MRC loaned the Company 10,000,000 shares of common stock of
      the
      Company in order for the Company to meet current obligations concerning stock
      the Company has been obligated to issue and deliver. In connection with the
      loan
      of shares to the Company, the Company agreed to reimburse MRC with up to
      10,000,000 shares of common stock of the Company and pay for all costs
      associated with such transfer and the reimbursement of shares to MRC within
      one
      year. In addition, in the event that any of the shares of common stock of the
      Company pledged by MRC on behalf of the Company in connection with promissory
      notes issued by the Company (or its subsidiaries, as applicable) are sold to
      cover a default under the respective note, the Company agreed to reimburse
      MRC
      with a number of shares equal to the number of shares sold to cover the default
      under the respective note within 1 year, and to reimburse MRC for all costs
      associated with such sales and the reimbursement of shares to MRC related to
      such sales.





In
      April
      2007, the Company issued 4,250,000 shares of common stock of the Company in
      connection with the exercise of warrants and an agreement executed in 2006.
      All
      of the foregoing shares were previously accounted for in the 10-KSB Report
      for
      the period ended December 31, 2006.





Also
      in
      April 2007, the Company issued 200,000 shares of common stock to employees
      and
      consultants of NOW Solutions in connection with restricted stock agreements
      executed in 2006, of which 66,666 shares vested during the three months ended
      March 31, 2007 and are therefore accounted for in this Report. In addition,
      the
      Company issued 2,750,000 unregistered shares of common stock of the Company
      to
      employees of the Company and NOW Solutions pursuant to restricted stock
      agreements executed in 2007, of which no shares have vested. All remaining
      unvested shares will be accounted for when these shares vest.





During
      the year ended December 31, 2007, warrants to purchase 6,894,444 shares of
      common stock of the Company at an exercise price of $0.010 to $0.10 per share
      expired.




During
        the year ended December 31, 2007, the Company granted 4,550,000 unregistered
        shares of common stock of the Company to employees and a consultant of the
        Company and NOW Solutions pursuant to restricted stock agreements. 500,000
        of
        these unrestricted shares vested immediately with the remaining shares vesting
        over a period from one to three years, as provided.
  During
        the year ended December 31, 2007, 4,589,292 unregistered shares of common
        stock
        of the Company vested. These shares were issued pursuant to restricted stock
        agreements with employees and consultants of the Company and NOW Solutions
        executed in 2005, 2006 and 2007.




14





During
      the year ended December 31, 2007, 1,369,042 unregistered shares of the common
      stock of the Company were cancelled. These shares had been issued pursuant
      to
      restricted stock agreements with employees of NOW Solutions executed in 2005
      and
      2006.





During
      the year ended December 31, 2007, 31,000 shares of common stock of the Company
      were cancelled by a third party.





In
      January 2008, the Company issued 250,000 unregistered shares of common stock
      of
      the Company to a third party lender in connection with extending the maturity
      dates of two promissory notes issued by GIS in November 2002 in the amounts
      of
      $40,000 and $60,000, respectively.




In
      February 2008, the Company issued 500,000 unregistered shares of common stock
      of
      the Company to a third party lender in connection with refinancing a $50,000
      promissory note issued in June 2002 as well as accrued interest, fees, and
      expenses incurred in connection with the refinancing.




In
      February 2008, MRC pledged 3,000,000 shares of common
      stock of the Company as collateral on a $96,946 note issued in February 2008
      to
      a third party lender. MRC is a corporation controlled by the W5 Family Trust.
      Mr. Wade, the President and CEO of the Company, is the trustee of the W5 Family
      Trust.





In
      March
      2008, MRC pledged 2,000,000 shares of common stock of the Company to secure
      a
      $75,000 promissory note payable to Parker Mills in connection with extending
      the
      maturity date until June 2009. MRC is a corporation controlled by the W5 Family
      Trust. Mr. Wade, the President and CEO of the Company, is the trustee of the
      W5
      Family Trust. Bill Mills is a Director of the Company and a partner of Parker
      Mills, LLP.





In
      March
      2008, the Company and MRC amended the indemnity and reimbursement agreement
      (entered into in April 2007) whereby the Company agreed to reimburse and
      indemnify MRC for additional shares pledged as collateral in connection with
      a
      $96,946 and a $75,000 notes. MRC is a corporation controlled by the W5 Family
      Trust. Mr. Wade, the President and CEO of the Company, is the trustee of the
      W5
      Family Trust.





For
      the
      period from January 1, 2008 to April 15, 2008, the Company issued 250,000
      unregistered shares of common stock of the Company to a director of the Company
      pursuant to a restricted stock agreement that provides for the shares to vest
      on
      the 1-year anniversary date of the agreement.




For
      the
      period from January 1, 2008 to April 15, 2008, warrants to purchase 6,000,000
      shares of common stock of the Company at an exercise price of $0.010 per share
      expired.





For
      the
      period from January 1, 2008 to April 15, 2008, 1,683,332 unregistered shares
      of
      the common stock of the Company vested. These shares were issued pursuant to
      restricted stock agreements with employees of the Company and NOW Solutions
      executed in 2006 and 2007.




Unless
      otherwise noted, the  offers,
      sales and issuances of the Company’s unregistered securities set
      forth above involved no underwriter’s discounts or commissions . In
      engaging in the transactions described above which involved the Company’s
      unregistered securities, the Company relied upon the private offering exemption
      provided under Section 4 (2)
      of
      the Securities Act of 1933, as amended, in
      that
      the transactions involved
      private offerings of the Company’s unregistered securities, the
      Company did not make a public
      offering  or sale  of
      its
      securities, the investors were either accredited or unaccredited but
      sophisticated, and the investors represented to the Company that they were
      acquiring the securities for investment purposes and  for
      their
      own accounts, and not with an eye toward further distribution. With regard
      to
      the unaccredited investors, all information required to be delivered to them
      concerning the Company, including financial statements, was in fact delivered
      to
      them.




15




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





**Management’s
      Discussion and Analysis of Financial Condition and Results of
      Operations**





The
      following discussion is a summary of the key factors management considers
      necessary or useful in reviewing the Company’s results of operations, liquidity
      and capital resources. The following discussion and analysis should be read
      together with the Consolidated Financial Statements and Notes of Vertical and
      its subsidiaries included in Item 7 of this Report, and the cautionary
      statements and risk factors included below in this item of the
      Report.




**Critical
      Accounting Policies**




**Capitalized
      Software Costs**




Software
      costs incurred internally in creating computer software products are expensed
      until technological feasibility has been established upon completion of a
      detailed program design. Thereafter, all software development costs are
      capitalized until the point that the product is ready for sale and subsequently
      reported at the lower of unamortized cost or net realizable value. The Company
      considers annual amortization of capitalized software costs based on the ratio
      of current year revenues by product to the total estimated revenues by the
      product, subject to an annual minimum based on straight-line amortization over
      the product’s estimated economic useful life, not to exceed five years. The
      Company periodically reviews capitalized software costs for impairment where
      the
      fair value is less than the carrying value. During the year ended December
      31,
      2007 and 2006, no costs were capitalized.




**Revenue
      Recognition**




Service
      revenue generated from professional consulting and training services are
      recognized as the services are performed. Maintenance revenue, including
      revenues bundled with original software product license revenues, are deferred
      and recognized over the related contract period, generally twelve months. The
      Company’s revenue recognition policies are designed to comply with American
      Institute of Certified Public Accountants Statement of Position 97-2, “Software
      Revenue Recognition” (“ SOP
      97-2 ”)
      and
      with Emerging Issues Task Force (“ EITF ”)
      issued
      No 00-21, “Revenue Arrangement with Multiple Deliverables.”




Deferred
      revenue on maintenance contracts represent cash received in advance or accounts
      receivable from systems, maintenance services, and consulting sales, which
      is
      recognized over the life of the contract.




In
      accordance with SEC Staff Accounting Bulletin No. 104 “Revenue Recognition”, the
      Company recognizes revenue from license of computer software up-front provided
      that a non-cancelable license agreement has been signed, the software and
      related documentation have been shipped, there are no material uncertainties
      regarding customer acceptance, collection of resulting receivables is deemed
      probable, and no significant other vendor obligations exist.




**Allowances
      for Doubtful Accounts**




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 estimates the amounts
      of
      potential losses.




**Deferred
      Taxes**




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 it 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 it will be able to realize its deferred tax
      assets in the future in excess of its net recorded asset, an adjustment to
      reduce the valuation allowance would increase income in the period such
      determination is made.




16




**Stock-Based
      Compensation Expense**




Effective
      January 1, 2006, the Company adopted the fair value recognition provisions
      of
      SFAS No. 123(R), using the modified prospective transition method and therefore
      has not restated results for prior periods. Under this transition method, we
      recognize compensation expense for all stock options granted prior to, but
      not
      yet vested as of January 1, 2006, based on the grant date fair value estimated
      in accordance with the original provisions of SFAS No. 123. Stock-based
      compensation expense for all stock-based compensation awards granted after
      January 1, 2006 is based on the grant date fair value estimated in accordance
      with the provisions of SFAS No. 123(R). The Company uses the Black Scholes
      option valuation model to estimate the fair value of its stock options at the
      date of grant. Historical data is used to estimate the expected price
      volatility, the expected option life and the expected forfeiture rate. The
      risk-free rate is based on the U.S. Treasury yield curve in effect at the time
      of grant for the estimated life of the option. Determining the appropriate
      fair
      value model and calculating the fair value of share-based payment awards
      requires the input of subjective assumptions. The assumptions used in
      calculating the fair value of share-based payment awards represent management’s
      best estimates, but these estimates involve inherent uncertainties and the
      application of management judgment. As a result, if factors change and the
      Company uses different assumptions, the stock-based compensation expense could
      be materially different in the future. See Note 10 to the Consolidated Financial
      Statements for a further discussion of stock-based compensation.




**Valuation
      of the Embedded and Warrant Derivatives**





The
      valuation of our embedded derivatives and warrant derivatives are determined
      primarily by the Black-Scholes option pricing model. An embedded derivative
      is a
      derivative instrument that is embedded within another contract, which under
      the
      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
      FASB Statement No. 133, as amended, Accounting for Derivative Instruments and
      Hedging Activities, these embedded derivatives are marked-to-market each
      reporting period, with a corresponding non-cash gain or loss charged to the
      current period. A warrant derivative liability is determined in accordance
      with
      Emerging Issues Task Force (“EITF”) Issue No. 00-19,
      “Accounting for Derivative Financial Instruments Indexed to, and Potentially
      Settled in, a Company’s Own Stock” (“EITF 00-19”).
      Based on EITF 00-19,
      warrants which are determined to be classified as derivative liabilities 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 charge 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.





To
      determine the fair value of our embedded derivatives, management evaluates
      assumptions regarding the probability of certain future events. Other factors
      used to determine fair value include our period end stock price, historical
      stock volatility, risk free interest rate and derivative term. 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.





**New
      Accounting Pronouncements**




On
      July
      13, 2006, the FASB issued Interpretation No. 48, “Accounting for Uncertainty in
      Income Taxes - an Interpretation of FASB Statement 109” (“FIN 48”). FIN 48
      prescribes how the Company should recognize, measure and present in the
      Company’s financial statements uncertain tax positions that have been taken or
      are expected to be taken in a tax return. Pursuant to FIN 48, the Company can
      recognize a tax benefit only if it is “more likely than not” that a particular
      tax position will be sustained upon examination or audit. To the extent the
      “more likely than not” standard has been satisfied, the benefit associated with
      a tax position is measured as the largest amount that is greater than 50% likely
      of being realized upon settlement. The Company adopted FIN 48 on January 1,
      2007. The adoption of FIN 48 did not require any restatement of the Company’s
      financial statements.




17


**Results
      of Operations**





**Year
      Ended December 31, 2007 Compared To Year Ended December 31, 2006**





***Total
      Revenues.*** The
      Company had total revenues of $5,895,726 and $6,229,944 for the years ended
      December 31, 2007 and 2006, respectively. The decrease in total revenue was
      $334,218 for the year ended December 31, 2007 representing approximately a
      5.4%
      decrease compared to the total revenue for the year ended December 31, 2006.
      Of
      the $5,895,726 for the year ended December 31, 2007 and the $6,229,944 for
      the
      year ended December 31, 2006, $5,895,726 and $6,222,752, respectively, was
      related to the business operations of NOW Solutions, a wholly-owned subsidiary
      of the Company.




Revenues
      primarily consist of fees for software licenses, and consulting and maintenance.
      The revenue from license and maintenance for the year ended December 31, 2007
      decreased by $86,922 from the same period in the prior year, representing
      approximately a 1.7% decrease, due to selling less new or upgraded software
      licenses. These sales decreases were partially offset by an increase in
      maintenance fees as contractual increases in maintenance revenues and the
      maintenance from the 2006 new software license fees offset most of the loss
      in
      maintenance revenues from customer attrition.





Consulting
      revenue for the year ended December 31, 2007 decreased by $340,132 from the
      same
      period in the prior year, representing approximately a 37.3% decrease. This
      decrease was due to fewer implementation and upgrade consulting services as
      a
      result of fewer software licenses being sold in 2007 as compared to 2006.
      Consulting revenues traditionally lag behind software license revenues as the
      implementation of new software sales takes several months. There was a slight
      increase in consulting revenues in the fourth quarter as some customers
      requested assistance in implementing emPath version 6.4 released the end of
      July
      2007.


Other
        revenue, which consists primarily of reimbursable travel expenses, hosting
        fees,
        and fees related to user conferences for the years ended December 31, 2007
        and
        2006 increased by $92,836 from the prior year, which represented approximately
        a
        55.7% increase. This increase was the result of hosting revenues beginning
        in
        2007, the Now Solutions’ user conference in 2007, partially offset by reduced
        reimbursable travel costs related to the lower consulting revenues in 2007
        as
        compared to 2006.




***Selling,
      General and Administrative Expenses.*** The
      Company had selling, general and administrative expenses of $6,637,848 and
      $7,156,711 for the years ended December 31, 2007 and 2006, respectively. The
      total selling, general and administrative expenses for the year ended December
      31, 2007 decreased by $518,863 compared to the selling, general and
      administrative expenses for the year ended December 31, 2006, representing
      approximately an 7.3% decrease. Of the $6,637,848 for the year ended December
      31, 2007 and the $7,156,711 for the year ended December 31, 2006, NOW Solutions
      accounted for $5,454,204, and $6,173,446, respectively. The decrease of $518,863
      was primarily attributed to the reduction in source code amortization as NOW
      Solutions source code was completely amortized in the first quarter of 2006,
      a
      reduction in loan commitment fees from refinancing notes payable in 2006 for
      Vertical and NOW Solutions, a reduction in NOW Solutions salaries related to
      the
      layoff of the sales department in the U.S. in March 2007, a reduction in NOW
      Solutions advertising and trade show costs, a reduction in NOW Solutions travel
      costs due to reduced sales staff and reduced consultant travel, and lower
      contract labor costs for software development and consulting at NOW Solutions.




***Operating
      Loss.*** The
      Company had an operating loss of $985,113 and $1,140,839 for the years ended
      December 31, 2007 and 2006, respectively. The operating loss decreased by
      $155,726 compared to the operating loss for the year ended December 31, 2006,
      representing a decrease of approximately 13.7%. The decrease was attributable
      to
      the combination of a reduction of $518,863 in selling, general and
      administrative expenses partially offset by the $334,218 decrease in
      revenues.




***Interest
      Expense*** **.** The
      Company had interest expense of $1,005,325 and $590,896 for the years ended
      December 31, 2007 and 2006, respectively. Interest expense increased for the
      year ended December 31, 2007 by $414,429, representing an increase of
      approximately 70.1%, compared to the same type of expense for the year ended
      December 31, 2006. The
      increase was the result of additional borrowings, the recognition of default
      interest rates on the debt in technical default, and the impact of higher
      interest rates on new and renegotiated borrowings.





***Net
      Loss.*** The
      Company had a net loss of $1,566,345 and $1,728,709 for the years ended December
      31, 2007 and 2006, respectively. Net loss for the year ended December 31, 2007
      decreased by $162,364 representing a decrease of approximately 9.4%. The
      decrease in the net loss of $162,364 was attributable to the combination of
      a
      decrease in revenues of $334,218 and the increase in interest expense of
      $414,429 and the increase of bad debt expense of $173,529, partially offset
      by
      the decrease in selling, general and administrative expenses of
      $518,863.




18




***Dividend
      Applicable to Preferred Stock.*** The
      Company has outstanding Series A 4% Convertible Cumulative Preferred Stock
      that
      accrues dividends (if such dividends are declared) 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 (if such dividends are
      declared) at a rate of 4% on a quarterly basis. The total dividends applicable
      to Series A and Series C Preferred Stock were $588,000 and $600,000 for the
      years ended December 31, 2007 and 2006, respectively. The Company did not
      declare or pay any dividends in 2007 or 2006.




***Net
      Loss Applicable to Common Stockholders.*** The
      Company had a net loss attributed to common stockholders of $2,154,345 and
      $2,328,709 for the years ended December 31, 2007 and 2006, respectively. Net
      loss applicable to common stockholders for the year ended December 31, 2007
      decreased by $174,364, representing a decrease of approximately 7.5%, compared
      to the net loss applicable to common stockholders for the year ended December
      31, 2006. The decrease in the net loss applicable to common stockholders of
      $174,364 was primarily attributable to the combination of a decrease in revenues
      of $334,218 and the increase in interest expense of $414,429 and the increase
      of
      bad debt expense of $173,529, partially offset by the decrease in selling,
      general and administrative expenses of $518,863 and a decrease in dividends
      applicable to preferred stock of $12,000.




***Net
      Loss Per Share.*** The
      Company had a net loss per share of $0.00 and $0.00 for the years ended December
      31, 2007 and 2006, respectively.





**Financial
      Condition, Liquidity, Capital Resources And Recent
      Developments**





At
      December 31, 2007, the Company had non-restricted cash-on-hand of
      $131,420.




Net
      cash
      provided by operating activities for the year ended December 31, 2007 was
      $131,005. This cash flow was primarily related to a net loss of $1,566,345
      adjusted by non-cash operating items of $394,735 (including depreciation and
      amortization of $61,962, stock compensation of $49,707, bad debt expense of
      $181,029, amortization of debt discount of $96,867, common stock issued for
      the
      extension of debt of $45,000, loan origination fee of $11,586 and the income
      effect of derivatives of $51,416), an increase in all receivables of $206,507
      and a decrease in prepaid expenses of $15,853, and increases in deferred revenue
      of $118,082 and in accounts payable and accrued liabilities of
      $1,375,187.





Net
      cash
      used in investing activities for the year ended December 31, 2007 was $56,299,
      which primarily consisted of the purchase of equipment and
      software.





Net
      cash used in financing activities for the year ended December 31, 2007
      was $16,492, consisting of issuance of new notes payable of $425,400, partially
      offset by repayment of $441,892 of notes payable.





The
      total
      change in cash and cash equivalents for the year ended December 31, 2007 when
      compared to year ended December 31, 2006 was an increase of $47,938.





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





**Contractual
      Obligations and Commercial Commitments**





As
      of
      December 31, 2007, the following contractual obligations and commercial
      commitments were outstanding:




19





Balance
                  at
              
              Due
                  in Next Five YearsContractual
                  Obligations
              
              12/31/07
              
              2008
              
              2009
              
              2010
              
              2011
              
              2012+Notes
                  payable
              
              
              5,730,312
              
              
              3,508,593
              
              
              309,573
              
              
              346,667
              
              
              273,887
              
              
              1,291,586Convertible
                  debts
              
              
              40,000
              
              
              40,000
              
              
              -
              
              
              -
              
              
              -
              
              
              -Operating
                  lease
              
              
              132,792
              
              
              87,004
              
              
              45,788
              
              
              -
              
              
              -
              
              
              -Total
              
              
              5,903,104
              
              
              3,635,597
              
              
              355,367
              
              
              346,667
              
              
              273,887
              
              
              1,291,586






Of
      the
      above notes payable of $5,730,312, the default status is as
      follows:





Notes
                Payable
            
            2007
            
            2006In
                default
            
            $
            3,344,196
            
            $
            2,263,638Current
            
            
            2,386,116
            
            
            3,464,293Total
                Notes Payable
            
            $
            5,730,312
            
            $
            5,727,931





For
      an
      update on the refinancing of the notes payable since fiscal year-end, please
      refer to “Subsequent Events” under Note 14 of the Notes to Consolidated
      Financial Statements.





**Going
      Concern Uncertainty**




The
      Company has incurred significant losses from operations for the year ended
      December 31, 2007. In addition, the Company had a working capital deficit of
      approximately $13.1 million at December
      31, 2007. The
      foregoing raises substantial doubt about the Company's ability to continue
      as a
      going concern.




Management
      of the Company is continuing its efforts to attempt to secure funds through
      equity and/or debt instruments for its operations, expansion and possible
      acquisitions, mergers, joint ventures, and/or other business combinations.
      The
      Company will require additional funds for its operations and to pay down its
      liabilities, as well as finance its expansion plans consistent with the
      Company’s anticipated changes in operations and infrastructure. The condensed
      consolidated financial statements contain no adjustment for the outcome of
      this
      uncertainty.




Furthermore,
      the Company is exploring certain opportunities with a number of companies to
      participate in co-marketing of each other’s products. The Company is proceeding
      to license its intellectual property and filed suit for patent infringement
      against Microsoft (for more details, see Item 3, “Legal Proceedings”). The exact
      results of these opportunities are unknown at this time.





**Off-Balance
      Sheet Arrangements.**





None.


20





**Risk
      Factors Related to the Company’s** **Business,
      Operating Results and Financial Condition**





We
      are
      subject to various risks that may materially harm our business, financial
      condition and results of operations. You should carefully consider the risks
      and
      uncertainties described below and the other information in this filing before
      deciding to purchase our common stock. If any of these risks or uncertainties
      actually occurs, our business, financial condition or operating results could
      be
      materially harmed. In that case, the trading price of our common stock could
      decline and you could lose all or part of your investment.





**We
      Have Historically Incurred Losses and May Continue to Do So in the
      Future**





We
      have
      historically incurred losses. For the year s
      ended
      December 31, 2007 and 2006, the
      Company had net losses of $ 1,566,345 and
      $ 1,728,709 ,
      respectively. Future losses are likely to occur. Accordingly, we have and may
      continue to experience significant liquidity and cash flow problems because
      our
      operations are not profitable. No assurances can be given that we will be
      successful in reaching or maintaining profitable operations.





**We
      Have Been Subject to a Going Concern Opinion from Our Independent Auditors,
      Which Means That We May Not Be Able to Continue Operations Unless We Obtain
      Additional Funding**





The
      report of our independent registered public accounting firm included an
      explanatory paragraph in connection with our financial statements for the years
      ended December 31, 2007 and 2006. This paragraph states that our recurring
      operating losses, negative working capital and accumulated deficit, the
      substantial funds used in our operations and the need to raise additional funds
      to accomplish our objectives raise substantial doubt about our ability to
      continue as a going concern. Our ability to develop our business plan and to
      continue as a going concern depends upon our ability to raise capital and to
      achieve improved operating results. Our financial statements do not include
      any
      adjustments that might result from the outcome of this uncertainty.





**The
      Company’s Ability to Continue as a Going Concern Is Dependent on Its Ability to
      Raise Additional Funds and to Establish Profitable Operations**





The
      accompanying consolidated financial statements for the 12 months ended December
      31, 2007 and 2006 have been prepared assuming that the Company will continue
      as
      a going concern, which contemplates the realization of assets and the
      satisfaction of liabilities in the normal course of business.





The
      carrying amounts of assets and liabilities presented in the financial statements
      do not purport to represent realizable or settlement values. The Company has
      suffered significant recurring operating losses, used substantial funds in
      its
      operations, and needs to raise additional funds to accomplish its objectives.
      Negative shareholders’ equity at December 31, 2007 was $15.2 million.
      Additionally, at December 31, 2007, the Company had negative working capital
      of
      approximately $13.1 million (although it includes deferred revenue of
      approximately $2.8 million) and has defaulted on several of its debt
      obligations. These conditions raise substantial doubt about the Company’s
      ability to continue as a going concern.





**Our
      Success Depends On Our Ability to Generate Sufficient Revenues to Pay For The
      Expenses of Our Operations**




We
      believe that our success will depend upon our ability to generate revenues
      from
      our SiteFlashTM and Emily® technology products and other products for which we
      have marketing rights, as well as increased revenues from NOW Solutions
      products, none of which can be assured. Our ability to generate revenues is
      subject to substantial uncertainty and our inability to generate sufficient
      revenues to support our operations and debt repayment could require us to
      curtail or suspend operations. Such an event would likely result in a decline
      in
      our stock price.





**Our
      Success Depends On Our Ability to Obtain Additional
      Capital**




The
      Company has funding that is expected to be sufficient to fund its present
      operations for three months. The Company, however, will need significant
      additional funding in order to complete its business plan objectives.
      Accordingly, the Company will have to rely upon additional external financing
      sources to meet its cash requirements. Management will continue to seek
      additional funding in the form of equity or debt to meet its cash requirements.
      The Company does not have any common stock available to issue to raise money.
      However, there is no guarantee the Company will raise sufficient capital to
      execute its business plan. In the event that the Company is unable to raise
      sufficient capital, the Company’s business plan will have to be substantially
      modified and operations curtailed or ceased.


21





**We
      Have a Working Capital Deficit, Which Means That Our Current Assets** **on
      December 31, 2007 Were Not Sufficient to Satisfy Our Current Liabilities on
      That
      Date**




We
      had a
      working capital deficit of approximately $ 13.1
      million at December
      31, 2007, which
      means th at
      our
      current liabilities exceeded our current assets by approximately $ 13.1 million (although
      it includes deferred revenue of approximately $2.8 million) . Current
      assets are assets that are expected to be converted into cash within one year
      and, therefore, may be used to pay current liabilities as they become due.
      Our
      working capital deficit means that our current assets on December
      31, 2007 were not sufficient to satisfy all of our current liabilities on that
      date.




**Our
      Operating Results May Fluctuate Because of a Number of Factors, Many of Which
      Are Outside of Our Control**




Our
      operating results may fluctuate significantly as a result of variety of factors,
      many of which are outside of our control. These factors include, among others,
      the following:





·
            the
                demand for our SiteFlashTM and Emily®
technology;


·
            the
                demands for NOW Solutions’ emPath®
product;


·
            the
                level of usage of the Internet;


·
            the
                level of user traffic on our
                Websites;


·
            seasonal
                trends and budgeting cycles in
                sponsorship;


·
            incurrence
                of costs relating to the development, operation and expansion of
                our
                Internet operations;


·
            introduction
                of new products and services by us and our
                competitors;


·
            costs
                incurred with respect to
                acquisitions;


·
            price
                competition or pricing changes in the
                industry;


·
            technical
                difficulties or system failures;
                and


·
            general
                economic conditions and economic conditions specific to the Internet
                and
                Internet media.




**We
      May Have Difficulty Managing Our Growth and Integrating Recently Acquired
      Companies**




Our
      recent growth has placed a significant strain on our managerial, operational,
      and financial resources. To manage our growth, we must continue to implement
      and
      improve our operational and financial systems and to expand, train, and manage
      our employee base. Any inability to manage growth effectively could have a
      material adverse effect on our business, operating results, and financial
      condition. Acquisition transactions are accompanied by a number of risks,
      including the following:





·
            the
                difficulty of assimilating the operations and personnel of the acquired
                companies;


·
            the
                potential disruption of our ongoing business and distraction of
                management;


·
            the
                difficulty of incorporating acquired technology or content and rights
                into
                our products and media properties;


·
            the
                correct assessment of the relative percentages of in-process research
                and
                development expense which needs to be immediately written off as
                compared
                to the amount which must be amortized over the appropriate life of
                the
                asset;


·
            the
                failure to successfully develop an acquired in-process technology
                resulting in the impairment of amounts currently capitalized as intangible
                assets;


·
            unanticipated
                expenses related to technology
                integration;


·
            the
                maintenance of uniform standards, controls, procedures and
                policies;


·
            the
                impairment of relationships with employees and customers as a result
                of
                any integration of new management personnel;
                and


·
            the
                potential unknown liabilities associated with acquired
                businesses.




We
      may
      not be successful in addressing these risks or any other problems encountered
      in
      connection with these acquisitions. Our failure to address these risks could
      negatively affect our business operations through lost opportunities, revenues
      or profits, any of which would likely result in a lower stock
      price.




**Our
      Success Depends On Our Ability to Protect Our Proprietary
      Technology**




Our
      success is dependent, in part, upon our ability to protect and leverage the
      value of our original SiteFlashTM and Emily® technology products and Internet
      content, as well as our trade secrets, trade names, trademarks, service marks,
      domain names and other proprietary rights we either currently have or may have
      in the future. Given the uncertain application of existing trademark laws to
      the
      Internet and copyright laws to software development, there can be no assurance
      that existing laws will provide adequate protection for our technologies, sites
      or domain names. Policing unauthorized use of our technologies, content and
      other intellectual property rights entails significant expenses and could
      otherwise be difficult or impossible to do given the global nature of the
      Internet and our potential markets.


22





**Our
      Stock Price Has Historically Been Volatile, Which May Make It More Difficult
      for
      Shareholders to Resell Shares When They Choose To At Prices They Find
      Attractive**




The
      trading price of our common stock has been and may continue to be subject to
      wide fluctuations. The stock price may fluctuate in response to a number of
      events and factors, such as quarterly variations in operating results,
      announcements of technological innovations or new products and media properties
      by us or our competitors, changes in financial estimates and recommendations
      by
      securities analysts, the operating and stock price performance of other
      companies that investors may deem comparable, and news reports relating to
      trends in our markets. In addition, the stock market in general, and the market
      prices for Internet-related and technology-related companies in particular,
      have
      experienced extreme volatility that often has been unrelated to the operating
      performance of such companies. These broad market and industry fluctuations
      may
      adversely affect the price of our stock, regardless of our operating
      performance.




**Our
      Common Stock Is Deemed To Be “Penny Stock,” Which May Make It More Difficult for
      Investors to Sell Their Shares Due To Suitability
      Requirements**




Our
      common stock is deemed to be “penny stock” as that term is defined in
      Rule 3a51-1 promulgated under the Exchange Act. Penny stocks are
      stocks:





·
            With
                a price of less than $5.00 per
                share;


·
            That
                are not traded on a recognized national
                exchange;


·
            Whose
                prices are not quoted on the NASDAQ automated quotation system (NASDAQ
                listed stock must still have a price of not less than $5.00 per share);
                or


·
            In
                issuers with net tangible assets less than $2 million (if the issuer
                has
                been in continuous operation for at least three years) or $5 million
                (if in continuous operation for less than three years), or with average
                revenues of less than $6 million for the last three
                years.




Broker/dealers
      dealing in penny stocks are required to provide potential investors with a
      document disclosing the risks of penny stocks. Moreover, broker/dealers are
      required to determine whether an investment in a penny stock is a suitable
      investment for a prospective investor. These requirements may reduce the
      potential market for our common stock by reducing the number of potential
      investors. This may make it more difficult for investors in our common stock
      to
      sell shares to third parties or to otherwise dispose of them. This could cause
      our stock price to decline.





**The
      Company** **Will Likely Experience Losses** **for
      the Foreseeable Future**




Our
      lack
      of an extensive operating history makes prediction of future operating results
      difficult. We believe that a comparison of our quarterly results is not
      meaningful. As a result, you should not rely on the results for any period
      as an
      indication of our future performance. Accordingly, there can be no assurance
      that we will generate significant revenues or that we will attain a
      level
      of profitability in the future. We currently intend to expand and improve our
      Internet operations, fund increased advertising and marketing efforts, expand
      and improve our Internet user support capabilities and develop new internet
      technologies, products and services. As a result, we may experience significant
      losses on a quarterly and annual basis.




**Item
      7. Consolidated Financial Statements**




Please
      refer to the Audited Consolidated Financial Statements of the Company and its
      subsidiaries for the fiscal years ended December 31, 2007 and 2006, which are
      attached to this Report.


23




**Item
      8. Changes in and Disagreements with Accountants on Accounting and Financial
      Disclosure**




In
      December 2007, Weaver & Tidwell, LLP (“ Weaver
      & Tidwell ”)
      resigned as the independent certified public accountants of the Company with
      no
      disagreements on any matter of accounting principles or practices, financial
      statement disclosure, or auditing scope or procedures, which disagreements,
      if
      not resolved to Weaver & Tidwell’s satisfaction, would have caused it to
      make reference to the subject matter of the disagreements in connection with
      its
      reports for the Company’s fiscal year ended December 31, 2006. On January 16,
      2008, the Company engaged Malone & Bailey, P.C. (“ Malone
      & Bailey ”)
      as its
      principal accountant to audit the Company’s financial statements.


**Item
        8A. Controls and Procedures**




***Evaluation
        of Disclosure Controls and Procedures***





Our
      management, principally our chief financial officer and chief executive 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 Securities
      Exchange Act of 1934 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. In particular, we have identified the following material weakness
      of
      our internal controls:


-
            There
                is an over-reliance upon independent financial reporting consultants
                for review of critical accounting areas and disclosures and material
                non-standard transactions.


-
            There
                is a lack of sufficient accounting staff which results in a lack
                of
                segregation of duties necessary for a good system of internal
                control.





***Management’s
      Annual Report on Internal Control over Financial
      Reporting***





Our
      management is responsible for establishing and maintaining disclosure controls
      and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Securities
      and Exchange Act of 1934, as amended) for the company.





In
      order
      to ensure whether our internal control over financial reporting is effective,
      management has assessed such controls for its financial reporting as of December
      31, 2007. This assessment was based on criteria for effective internal control
      over financial reporting described in Internal Control – Integrated
      Framework issued by the Committee of Sponsoring Organizations of the Treadway
      Commission (“COSO”).





In
      performing this assessment, management has identified the following material
      weaknesses:





There
      is
      an absence of adequate segregation of duties relating to oversight and
      management of our systems. This resulted primarily from the fact that certain
      parts of the work of our chief financial officer are not monitored or reviewed.
      The absence of adequate segregation of duties may have an effect on the systems
      which we use in the evaluating and processing of certain accounts and areas
      and
      in the posting and recording of journal entries into certain accounts, as
      described below:





o
            Revenue
                and deferred revenue process – There was a material weakness in the
                process of recognizing revenue for the software maintenance contracts
                in
                effect during the year which resulted from the fact that there are
                certain
                calculations made by our chief financial officer which are not reviewed
                or
                approved by anyone else.


o
            Financial
                statements closing process – There was a material weakness in the
                process of closing and consolidating our financial statements which
                resulted from the fact that the work of our chief financial officer
                in
                this process (starting with processing the trial balance, through
                the
                evaluation and implementation of policies and accounting issues,
                until the
                complete production of consolidated financial statements) is not
                reviewed
                by anyone else.


o
            Treasury
                and cash process – There was a material weakness in the sub-process
                of debt management which resulted from the fact that our chief financial
                officer manages, evaluates, records and discloses all matters which
                relate
                to debts, debt issuance and renegotiation expenses, interest, etc.
                whose
                work is not reviewed by anyone else. Further, our chief financial
                officer
                relied upon financial reporting consultants as it relates to the
                accounting for loan renegotiation and loan termination
                costs.


o
            Equity
                instruments – There was a material weakness in the sub-process
                related to evaluating debt and equity instruments with conversion
                privileges to determine whether or not the instruments had embedded
                derivative components as directed in EITF 00-19. There was a material
                weakness in the sub-process related to evaluating certain equity
                instrument transactions and the accounting treatment for these
                non-standard transactions. Both of these resulted from the fact that
                our
                chief financial officer relies heavily upon financial reporting
                consultants as it relates to derivative and non-standard equity
                transactions.


24





As
      a
      result of these material weaknesses in our internal control over financial
      reporting, our management concluded that our internal control over financial
      reporting as of December 31, 2007, was not effective based on the criteria
      set
      forth by COSO in Internal Control – Integrated Framework. A material
      weakness in internal control over financial reporting is a deficiency, or a
      combination of deficiencies, in internal control over financial reporting,
      such
      that there is a reasonable possibility that a material misstatement of the
      company’s annual or interim financial statements will not be prevented or
      detected on a timely basis.





***Management’s
      Plan for Remediation of Material Weaknesses***





In
      light
      of the conclusion that our internal control over financial reporting was not
      effective, our management is in the process of implementing a plan intended
      to
      remediate such ineffectiveness and to strengthen our internal controls over
      financial reporting through the implementation of certain remedial measures,
      which include:





o
            Implementing
                a new accounting system that will allow for the consolidation of
                the
                various entities in Vertical Computer Systems along with the translation
                from local currency to reporting currency. The system will eliminate
                many
                of the manual steps in translation and
                consolidation.


o
            Improving
                the control and oversight of the duties relating to the systems we
                use in
                the evaluation and processing of certain accounts and areas in the
                posting
                and recording of journal entries into certain accounts (in which
                material
                weaknesses have been identified as described above). This improvement
                should include reviews by management of the accounting processes
                as well
                as a reorganization of some of the accounting
                functions.


o
            The
                segregation of duties relating to the processing of accounts and
                the
                recording of journal entries into certain
                accounts.




We
      have
      commenced implementing the new accounting system and will begin implementing
      additional oversight and review of certain accounts and postings. We have also
      added a degreed accountant to our staff in the first quarter of
      2008.




This
      annual report does not include an attestation report of our public accounting
      firm regarding internal control over financial reporting. Management’s report
      was not subject to attestation by our registered public accounting firm pursuant
      to temporary rules of the Securities and Exchange Commission that permit us
      to
      provide only management’s report in this annual report.




**Item
      8B. Other Information**




None.


25




**PART
      III**




**Item
      9. Directors, Executive Officers, Promoters And Control Persons; Compliance
      With
      Section 16(** **a** **)
      Of The Exchange Act**




The
      Company’s present directors and executive officers are as follows: ****




**Name**
            
            **Age**
            
            **Position**
            
            **Tenure**Richard
                S. Wade
            
            64
            
            President,
                Chief Executive Officer and Director
            
            8
                yearsWilliam
                K. Mills
            
            49
            
            Secretary
                and Director
            
            8
                yearsDavid
                Braun
            
            50
            
            Chief
                Financial Officer
            
            1
                year




**Richard
      S. Wade, President, Chief Executive Officer and Director, Chairman and Director
      of NOW Solutions**




Richard
      S. Wade is President and CEO of the Company and has been a director since
      October 1999. Before coming to Externet World, Inc. in mid-1999, and then
      transitioning to what is now the Company in late 1999, Mr. Wade held a number
      of
      executive positions with companies in the Pacific Rim from 1983 through early
      1999, including the position of Chief Operating Officer of Struthers Industries,
      Inc., a public company in the business of wireless applications. In March 1998,
      Struthers Industries, Inc. filed a petition for bankruptcy under the United
      States Bankruptcy Act. Prior to these executive positions, Mr. Wade spent over
      10 years with Duty Free Shoppers, Inc., culminating in his attaining the positions
      of president of their Mid-Pacific Division and then president of their U.S.
      Division . Prior
      to
      that, Mr. Wade was a CPA and staff auditor with Peat, Marwick &
Mitchell .
      Over
      the course of his career, Mr. Wade has accumulated experience in retail
      operations, distribution, and financial matters. Mr. Wade earned his Bachelor
      of
      Science in Accounting at Brigham Young University, a Master of Science in
      Business Policy from Columbia University Business School and
      received a certificate of recognition from the government of Guam.




**William
      K. Mills, Secretary and Director**




William
      K. Mills has been a director since December 2000. Mr. Mills is a founding
      partner of Parker Mills, LLP (formerly Parker, Mills Morin, LLP) where he
      specializes in complex commercial business representations, including
      transactional and litigation matters, such as legal malpractice, intellectual
      property and general corporate and governmental representations since 1995.
      Between 1991 and 1994, Mr. Mills was a senior attorney and partner with Lewis,
      D’Amato, Brisbois & Bisgaard, prior to which he was a senior attorney with
      Radcliff & West from 1989 to 1991, senior associate with Buchalter, Nemer
      Fields & Younger from 1987 to 1991 and an attorney with Daniels, Baratta
& Fine from 1982 to 1987. Mr. Mills holds a J.D. from UCLA Law School and an
      A.B. in American Government from Harvard College. Active in professional and
      community organizations, Mr. Mills has served as General Counsel to the
      California Association of Black Lawyers, a member of the Los Angeles County
      Bar
      Judicial Appointments Committee, and a Board Member of the John M. Langston
      Bar
      Association. Mr. Mills has also served on the boards of the Didi Hirsch Mental
      Health Foundation, the United Way’s Los Angeles Metropolitan Region Board, the
      Los Angeles City Ethics Commission, and the Los Angeles County Judicial
      Procedures Commission.




**David
      Braun, Chief Financial Officer of VCSY and NOW Solutions**





David
      Braun is an accountant with over 24 years experience in a wide variety of
      accounting and finance roles. His career includes public accounting, large
      company internal audit, financial analysis, mergers and acquisitions, SEC
      reporting, general accounting and consolidations of both domestic and
      international companies. Most recently he was the Corporate Controller for
      a
      plastics injection molding company with plants in the United States, Mexico
      and
      Ireland. Prior to that, he worked for a healthcare provider where he was
      responsible for managing 24 employees with accounting responsibility for over
      200 clinics. Previous experience includes working for a large chemicals
      manufacturing company where he assisted in implementing a worldwide version
      of
      SAP and created a finance shared services group for the US and Canada. He is
      a
      CPA and a graduate of the University of Texas at Austin.


26




**Election
      of Directors; Family Relationships; Legal Proceedings**




Directors
      are elected at the annual meeting of stockholders and serve until their
      successors have been elected and qualified. Officers are appointed by and serve
      at the discretion of the Board of Directors. There are no family relationships
      between any of the executive officers or directors. None of the Company’s
      directors have been involved in legal proceedings except as noted under the
      section of this Report entitled “Legal Proceedings.”






**Compliance
      with Section 16(a) Of The Exchange Act**




Section
      16(a) of the Exchange Act requires the Company’s officers and directors, and
      persons who own more than 10% of a registered class of the Company's equity
      securities to file reports of ownership and changes in ownership with the SEC.
      Officers, directors and greater than 10% stockholders are required by SEC
      regulations to furnish the Company with copies of all Section 16(a) forms they
      file.





To
      the
      best of the Company's knowledge, based solely on review of the copies of such
      forms furnished to it, or written representations that no other forms were
      required, the Company believes that all Section 16(a) filing requirements
      applicable to its officers, directors and greater than 10% stockholders were
      complied with during 2007 with the following exceptions: Richard Wade did not
      timely file Forms 5 in 2007 or 2008 and William Mills did not timely file Form
      5
      in 2007 or Form 4 in 2008.




**Code
      of Ethics**





We
      have
      adopted a Code of Ethics that applies to our Principal Executive Officer,
      Principal Accounting Officer and other persons performing similar functions,
      as
      well as all of our other employees and directors. This Code of Ethics was filed
      as Exhibit 14.1 to the Form 10-KSB filed for the year ended December 31,
      2003 and was updated in January 2008 with the new address for the Company’s
      corporate headquarters. This updated Code of Ethics is filed as
      Exhibit 14.1 to this Report. and is available at the its Internet website
      located at http://www.vcsy.com.




**Significant
      Employees of the Company**




**Luiz
      Valdetaro, Chief Technology Officer, Director of NOW
      Solutions**




Prior
      to
      joining the Company, Mr. Valdetaro was previously a consultant (1993-1997)
      and
      Chief Technology Officer (1997-1999) of Diversified Data Resources, a software
      company. Prior to that, Mr. Valdetaro was a Senior Systems Engineer for
      System/One and EDS, after System/One was acquired by EDS. Prior to that, Mr.
      Valdetaro was a senior systems engineer for Bank of America. Mr. Valdetaro
      is a
      graduate of Pontific Catholic University, Rio de Janeiro, Brazil with a B.S.
      in
      Electronic Engineering and a M.S. in Systems Engineering.





**Significant
      Employees of NOW Solutions, Inc.**





**Marianne
      M. Franklin, President and Chief Executive Officer**





Marianne
      M. Franklin is President and Chief Executive Officer of NOW Solutions. Ms.
      Franklin brings her experience in the payroll and human resources industry,
      which included over eight years working at Ross Systems, most recently as Vice
      President of North American sales. Prior to this function, Ms. Franklin was
      Director of Ross’ HR/Payroll Canadian Sales. Ms. Franklin’s background also
      includes two years with ADP and 13 years in the banking industry, working with
      payroll products.





**Pete
      Ashey, Executive Vice President of Business Development**





Mr.
      Ashey
      joined the NOW Solutions' leadership team in January 2007 to support NOW
      Solutions' HR initiative. Mr. Ashey brings more than 15 years of sales and
      process improvement experience from both the software market and HR outsourcing
      services industry. His prior positions include sales and solution roles at
      IBM.
      During his career, Mr. Ashey has made significant contributions to the
      development and success of leading solutions targeting the Fortune 1000
      marketplace. Mr. Ashey's responsibilities will include the expansion of NOW
      Solutions' business development effort and support of the global offering.
      His
      earlier professional experience has included VP of Sales of Pilat North America,
      and running his own Employee Assessment Practice. His consulting work has
      encompassed the United States, Canada, Venezuela and Europe, and organizations
      such as Nike, Philip Morris, Kraft, AT&T, Goodyear Tire and Rubber, Toyota
      and Bombardier.


27





**Dorothy
      Spotts, Vice President of Services and Support**





Ms.
      Spotts joined Ross Systems in April 1991 as a Support Analyst in the Customer
      Support Department progressing to Operations Manager. Subsequently, she attained
      the position of Manager of Integration Services in September 1997. In March
      1999, she was promoted to Director of Integration Services and then became
      Director of Professional Services in July 2000. Ms. Spotts’ responsibilities
      include the overall management of Application Consulting, Integration Services
      and Customer Support. Ms. Spotts graduated with a BBA from the University of
      Texas at Austin.





**Carmelina
      Uggenti, Vice President of Customer Development**





Prior
      to
      her current position, Ms. Uggenti joined Ross Systems, Inc. in January 1994
      as a
      Senior Consultant/Project Manager in the Human Resources/Payroll Professional
      Services Department. In 1998, Ms. Uggenti became responsible for the pre-sales
      organization. Ms. Uggenti has overall responsibility for NOW Solutions' global
      sales, pre-sales, professional services pre-sales and marketing.





**Laurent
      Tetard, Executive Vice President of International
      Operations**




Mr.
      Tetard joined the Company in 1999, where he oversaw business development,
      managed software design projects and handled daily operations. His
      responsibilities included working with clients and strategic partners to develop
      business plans, implement strategies and methodologies to support software
      development. Combining his education and experience, Mr. Tetard has specialized
      in managing design, implementation, documentation and installation of Internet
      compatible applications. From 1994 to 1996, Mr. Tetard was a Public Relations
      Officer with the French Air Force, in Toulouse, France. Earlier in his career,
      he completed a thesis in collaboration with the French Aeronautics and Space
      Research Center (“ ONERA ”)
      and
      served engineering internships at Aerospatiale, France. Mr. Tetard is an honor’s
      graduate of the noted French Ecole Nationale Superieure D’arts et Metiers
      (“ ENSAM ”),
      with
      a BS in Engineering and a MS in Multidisciplinary Engineering.




**Robert
      Sterpin, Vice President of Sales, Canada & U.S.
      Midwest**




Mr.
      Sterpin joined NOW Solutions in 2003. He has a varied background in sales and
      sales management starting his career with DEC (HP) and working for several
      major
      corporations such as IBM and Cincom Systems. Mr. Sterpin spent almost 5 years
      at
      Ross Systems where he was Vice President Canada and the U.S. Mid West for their
      ERP software product suite. Prior to joining NOW Solutions, he was Vice
      President Sales & Marketing for a systems integration/ consulting firm. Mr.
      Sterpin majored in Science at the University of Toronto.




**Item
      10. Executive Compensation**




The
      following table shows all the cash compensation paid by the Company, as well
      as
      certain other compensation paid or accrued, during the fiscal years ended
      December 31, 2007 and 2006 to the Company’s highest paid executive officers and
      employees, who were employed by the Company during 2007. No restricted stock
      awards, long-term incentive plan payouts or other types of compensation, other
      than the compensation identified in the chart below, were paid to these
      executive officers during these fiscal years. Except as set forth below, no
      other executive officer earned a total annual salary and bonus for any of these
      years in excess of $100,000.


28




**SUMMARY
      COMPENSATION TABLE**




The
      below
      table shows information of compensation of the named officers for the last
      two
      fiscal years:


**Annual
                  Compensation**
              
              **Long-Term
                  Compensation****Awards**
              
              **Payouts****Name
                  and**
                **Principal
                  Position**
              
              **Year**
              
              **Salary**
              
              **Bonus**
              
              **Other**
                **Annual**
                **Compensation**
              
              **Restricted**
                **Stock**
                **Award(s)**
              
              **Options/**
                **SARs**
              
              **LTIP**
                **Payouts**
              
              **All**
                **Other**
                **Compensation****($)**
              
              **($)**
              
              **($)**
              
              **($)**
              
              **(#)**
              
              **($)**
              
              **($)**Richard
                  Wade,(1)
              
              
              2007
              
              $
              300,000
              (1)
              
              -
              
              
              -
              
              
              -
              
              
              -
              
              
              -
              
              
              -President
                  and Chief
              
              
              2006
              
              $
              300,000
              
              
              -
              
              
              -
              
              
              -
              
              
              -
              
              
              -
              
              
              -Executive
                  OfficerLuiz
                  Valdetaro,(2)
              
              
              2007
              
              $
              150,000
              
              
              -
              
              
              -
              
              
              -
              
              
              -
              
              
              -
              
              
              -Chief
                  Technology
              
              
              2006
              
              $
              150,000
              
              
              -
              
              
              -
              
              
              -
              
              
              -
              
              
              -
              
              
              -OfficerJames
                  Salz(3)
              
              
              2007
              
              $
              100,000
              
              
              -
              
              
              -
              
              
              -
              
              
              -
              
              
              -
              
              
              -Corporate
                  Counsel
              
              
              2006
              
              $
              100,000
              
              
              -
              
              
              -
              
              
              9,000
              
              
              -
              
              
              -
              
              
              -


_____________




No
      stock
      options were exercised by the named executive officers during the fiscal year
      ended December 31, 2007 or 2006.




(1)
            Mr.
                Wade deferred $150,000, $150,000, $154,097, $47,218, $155,270 and
                $300,000
                of his salary in 2007, 2006, 2005, 2004, 2003 and 2002, respectively.
                Pursuant to his employment agreement, dated December 1, 2001, Mr.
                Wade, as
                President and CEO, was entitled to purchase up to 20,600,000 shares
                of
                common stock for three years at a strike price of $0.10, vesting
                in equal
                monthly amounts over a 36-month period. All of these warrants had
                expired
                atDecember
                31, 2007.




(2)
            Mr.
                Valdetaro deferred $23,750, $25,000, $50,269, $86,766 and $150,000
                of his
                salary in 2007, 2006, 2005, 2004 and 2003, respectively.




(3)
            Mr.
                Salz deferred $48,345, $55,000 and $58,333 of his salary in 2004,
                2003,
                and 2002 respectively. In January 2006, Mr. Salz was issued 1,500,000
                unregistered shares of common stock of the Company (at a fair market
                value
                of $9,000) pursuant to a restricted stock agreement with the Company
                which
                provides for the stock to vest over one year in three equal installments
                at four month intervals, of which all shares had vested at December
                31,
                2007.




The
      below
      table shows information of outstanding equity awards of the named officers
      at
      the end of 2007:




**OUTSTANDING
                EQUITY AWARDS AT FISCAL YEAR-END (2007)****Option
                Awards**
            
            **Stock
                Awards****Name**
            
            **Number of 
                Securities  Underlying  Unexercised  Options (#) 
                Exercisable**
            
            **Number of 
                Securities  Underlying  Unexercised  Options (#) 
                non-exercisable**
            
            **Equity 
                Incentive  Plan  Awards:  Number of  Securities
                Underlying  Unexercised  Unearned  Options (#)**
            
            **Option 
                Exercise  Price ($)**
            
            **Option 
                Expiration  Date**
            
            **Number of
                Shares or Units of Stock  That Have 
                Not Vested**
              **(#)**
            
            **Market 
                Value of  Shares or  Units of 
                Stock That**
              **Have Not 
                Vested  ($)**
            
            **Equity 
                Incentive  Plan Awards:  Number of  Unearned 
                Shares,  Units or  Other Rights That
                Have Not  Vested  (#)**
            
            **Equity
                Incentive  Plan Awards:  Market or Payout  Value  of
                 Unearned  Shares,  Units or  Other 
                Rights That Have Not  Vested ($)**David
                Braun
              Chief
                Financial Officer (1)
            
            
            —
            
            
            —
            
            
            —
            
            
            —
            
            
            
            
            
            800,000
            
            
            —
            
            
            800,000
            
            
            —




(1)
            Pursuant
                to a restricted stock agreement with the Company, Mr. Braun, the
                CFO of
                the Company, was issued 800,000 unregistered shares of common stock
                of the
                Company (at a fair market value of $16,800 in March 2007, which provides
                for the stock to vest over three years in three equal installments,
                of
                which 0 shares had vested at December 31, 2007. As of April 15, 2008,
                266,666 shares have vested. In addition, 200,000 unregistered shares
                of
                common stock of the Company (at a fair market value of $1,400), which
                had
                been issued to Mr. Braun pursuant to a prior restricted stock agreement
                executed in 2006, had vested at December 31,
                2007.


29




**Stock
      Option Plan.**





In
      December 1999, the Company established a stock option plan (the “ Plan ”)
      whereby the Company may grant both Incentive Stock Options (within the meaning
      of Section 422 and the Internal Revenue Code of 1986, as amended) and
      non-statutory options. Under the Plan, the Company may issue up to 50,000,000
      shares (adjusted post stock split). Most options issued are non-assignable,
      non-transferable, vest on the date of grant, and expire between three and five
      years from the date of grant.





**Director
      Compensation**




The
      below
      table provides compensation for all non-employee directors in 2007:


**DIRECTOR
                  COMPENSATION****Name**
              
              **Fees Earned**
                **or Paid in**
                **Cash**
              
              **Stock**
                **Awards**
              
              **Option
                  Awards**
              
              **Non-Equity**
                **Incentive Plan**
                **Compensation**
              
              **Nonqualified**
                **Deferred**
                **Compensation**
                **Earnings**
              
              **All Other**
                **Compensation**
              
              **Total****($)**
              
              **($)**
              
              **($)**
              
              **($)**
              
              **($)**
              
              **(#)**
              
              **($)**William
                  Mills
              
              
              30,000
              
              
              —
              
              
              —
              
              
              —
              
              
              —
              
              
              —
              
              
              30,000





No
      options or warrants were granted as director compensation during the fiscal
      years ended 2007 or 2006. Non-employee directors are entitled to receive $3,500
      per meeting in 2006 and $2,500 per month in 2007.





**Employment
      Agreements**





In
      December 2001, the Company executed a 3-year employment agreement **** with
      Richard Wade pursuant to which Mr. Wade serves as Chief Executive Officer and
      President of the Company, under which Mr. Wade will receive an annual base
      salary of $300,000, and the issuance of 5-year warrants to purchase 20,000,000
      shares of the Company’s common stock at an exercise price of $0.10 per share and
      5-year warrants to purchase 600,000 shares of the Company’s common stock at an
      exercise price of $0.10 per share. The warrants vested over a 36-month period
      in
      equal amounts on a monthly basis from the date of issuance. Of the warrants
      to
      purchase 20,600,000 shares of common stock of the Company, all had expired
      at
      December 1, 2007. Mr. Wade is also entitled to an annual bonus from a bonus
      pool
      for executives equal to 5% of the Company’s taxable income (without deduction
      for depreciation). Mr. Wade’s share of the bonus pool is equal to the percentage
      of his annual base compensation to the total of the combined annual base
      compensation of all executives in the pool. In the event the agreement is
      terminated by Mr. Wade’s death, his estate shall be entitled to compensation
      accrued to the time of death plus the lesser of one year’s base compensation or
      the compensation due through the remainder of the employment term. In the event
      of termination by the Company without cause, Mr. Wade would receive base
      compensation for the remainder of the employment term. Mr. Wade deferred
      $150,000 and $150,000 of his salary in 2007 and 2006.




**Item
      11. Security Ownership Of Certain Beneficial Owners And
      Management**





**Security
      Ownership By Named Executive Officers, Directors And Beneficial Owners**





The
      following table sets forth certain information regarding the beneficial
      ownership of the shares of common stock as of April 10, 2008, by each of our
      directors and executive officers and any person or entity, known by us to be
      the
      beneficial owner of more than 5% of the outstanding shares of common stock.
      The
      table also shows the beneficial ownership of our stock by all directors and
      executive officers as a group. The table includes the number of shares subject
      to outstanding options and warrants to purchase shares of common stock. The
      percentages are based on 998,235,151shares of common stock outstanding as of
      April 10, 2008, together with options, warrants or other securities convertible
      or exchangeable by the beneficial owners into shares of common stock within
      60
      days of April 10, 2008.


30


**Title
                  of**
                **Class**
              
              **Name
                  and Address of Beneficial Owner****(1)**
              
              **Shares**
                **of Common Stock Beneficially**
                **Owned**
              
              **Percent**
                **of
                  Class**Common
              
              
              Richard
                  Wade
              
              
              98,590,206
              (2)
              
              9.89
              %Common
              
              
              William
                  K. Mills
              
              
              283,333
              (3)
              
              *Common
              
              
              All
                  Directors and Executive Officers as a group (2 persons)
              
              
              98,873,539
              
              
              9.91
              %


__________________________________


*
            Less
                than 1%.




(1)
            Unless
                otherwise indicated, the address of each director and officer is
                c/o
                Vertical Computer Systems, Inc., 101 West Renner Road, Suite 300,
                Richardson, TX 75082.


(2)
            Includes
                90,370,050 shares owned by Mountain Reservoir Corporation (“MRC”), a
                corporation controlled by the W5 Family Trust, of which Richard W.
                Wade is
                a trustee. MRC pledged 10,000,000 shares of common stock of the Company
                as
                collateral on a $25,000 note issued in August 2002. MRC pledged 4,000,000
                and 3,000,000 shares of common stock of the Company as collateral
                on a
                $60,000 note and a $40,000 note, respectively, that were issued by
                the
                Company in November 2003. MRC pledged 5,000,000 shares of common
                stock of
                the Company as collateral on a $200,000 note issued in October 2006
                to Mr.
                Weber. Also in October 2006, MRC pledged 5,000,000 shares of common
                stock
                of the Company as collateral on a $215,000 note issued by NOW Solutions
                to
                the Company and assigned to Mr. Weber in October 2005. MRC pledged
                10,000,000 shares of common stock of the Company as collateral on
                a
                $300,000 note issued in March 2007 to Mr. Weber and as collateral
                on the
                interest payments due under the $200,000 note issued in October 2006.
                MRC
                pledged 3,000,000 shares of common stock of the Company as collateral
                on a
                $96,946 note issued in February 2008 to a third party lender. MRC
                pledged
                2,000,000 shares of common stock of the Company as collateral on
                a $75,000
                note issued to Parker Mills LLP in October 2005. In addition, the
                Company
                is obligated to reimburse MRC for 10,000,000 shares of common stock
                of the
                Company pursuant to an indemnity and reimbursement agreement for
                the
                10,000,000 shares loaned by MRC to the Company in April
                2007.


(3)
            Includes
                250,000 shares of common stock of the Company issued in February
                2008 by
                the Company to Mr. Mills pursuant to a restricted stock agreement
                in
                connection with services as a director and officer of the
                Company.




**** **Item
      12. Certain Relationships And Related Transactions**




Mr.
      Victor Weber is a Director and President of GIS and an equity owner of CWI.
      Mr. Sean Chumura is an equity owner of CWI and an employee of the
      Company. In March 2006, CWI licensed certain software, including IA (formerly
      ImmuneApp) and StatePointPlus® to us
      on a
      partially exclusive basis to sell and support.





In
      October 2006, NOW Solutions amended a consulting agreement with Markquest,
      Inc.
      Mr. Rossetti is Executive Vice-President of Government Affairs, Chairman, CEO
      and Director of GIS, Director of NOW Solutions and an officer of
      Markquest.




We
      are in
      default in paying a $215,000 promissory note collateralized by a portion of
      certain revenues and owed to Victor Weber. In 2006, MRC (a company affiliated
      with Mr. Richard Wade) pledged 5,000,000 common shares to secure the note.
      MRC
      is a corporation controlled by the W5 Family Trust. Mr. Wade, our President
      and
      CEO, is the trustee of the W5 Family Trust. For additional details on the
      amendment to this note, please see "Notes Payable" under Note 8 in the Notes
      to
      Consolidated Financial Statements.




In
      October 2006, we borrowed $200,000 under a promissory note, bearing interest
      at
      10% per annum, due in September 2007 and collateralized by a portion of
      certain revenues, from Mr. Weber. The note is in default.




In
      October 2006, Taladin issued to Mr. Weber a $100,000 promissory note, bearing
      interest at 12% per annum and due in October 2011. The note was issued in
      connection with a refinancing whereby Taladin acquired the indebtedness of
      NOW
      Solutions to Wamco. The note is secured by Taladin’s first lien position on the
      assets of NOW Solutions. Tara Financial, SGP, and Weber share the first lien
      position, senior to all other security interests in the assets of NOW Solutions.
      The note is payable as follows: principal and interest payments of $1,556,
      beginning on January 1, 2007 and continuing through February 1, 2008
      and monthly principal and interest payments of $2,822, beginning on March
      1, 2008 and continuing until March 1, 2011. The $100,000 note payable by Taladin
      contains provisions requiring additional principal reductions in the event
      sales
      by NOW Solutions exceed certain financial thresholds or if there is a judgment
      in favor of the Company with respect to the pending Ross litigation. For
      additional details on the Ross litigation, please see “Litigation” under Note 15 in
      the
      Notes to Consolidated Financial Statements .
      As
      incentives to make the $100,000 loan, the Company agreed to issue 1,000,000
      unregistered shares of the common stock of the Company (which were booked in
      2006 at a fair market value of $21,000) to Mr. Weber, and NOW Solutions agreed
      to pay Mr. Weber a 0.5% royalty from its gross revenues in excess of $6.5
      million, up to a cap of $100,000. The common shares of the Company have not
      been
      issued as the Company cannot issue shares above the authorized amount of
      1,000,000,000 shares of common stock. The Company is currently investigating
      its
      options in order to present its shareholders, as soon as practicable, with
      a
      plan whereby the Company could meet all of its outstanding obligations without
      exceeding its authorized shares of common stock. For
      additional details on this note, please see “Notes Payable ”
under
      Note 10 in the Notes to Consolidated Financial Statements.




31




In
      April
      2007, we paid Mr. Rossetti 3,000,000 common shares (at a fair market value
      of
      $48,000) in connection with an agreement entered into concerning loans and
      monies owed to Mr. Rossetti and Markquest. Mr. Rossetti is Executive
      Vice-President of Government Affairs, Chairman, CEO and Director of GIS,
      Director of NOW Solutions and an officer of Markquest, Inc.




In
      March
      2007, the Company borrowed $300,000 under a promissory note, bearing interest
      at
      12% per annum and due in September 2007, from Mr. Weber. In connection with
      the
      note, MRC pledged 10,000,000 shares of common stock of the Company. The note
      is
      in default.




In
        April
        2007, Luiz Valdetaro, on behalf of the Company, transferred 2,000,000 common
        shares owned by him to Tara Financial in exchange for waiving the defaults
        and
        extending the payment terms on notes payable to Tara of $438,795, $350,560,
        $955,103 and $450,000. Mr. Valdetaro is our Chief Technology Officer. We
        agreed
        to reimburse Mr. Valdetaro with 2,000,000 shares within one year and pay
        for any
        related costs. This obligation is currently owed to Mr.
        Valdetaro.


In
        April
        2007, Mr. Valdetaro, on behalf of the Company, transferred 1,000,000 common
        shares owned by him to CCS in connection with a $40,000 loan from CCS. Also
        in April 2007, in connection with the transfer of shares to CCS, the Company
        entered into an indemnity and reimbursement agreement to reimburse Mr. Valdetaro
        with 1,000,000 shares within one year and pay for all costs associated with
        the
        transfer of shares to CCS. This obligation is currently owed to Mr.
        Valdetaro.





In
      April
      2007, the Company and MRC entered into an indemnity and reimbursement agreement
      for transfer and pledges of shares of common stock of the Company. Pursuant
      to
      the agreement, MRC loaned the Company 10,000,000 shares of common stock of
      the
      Company in order for the Company to meet current obligations concerning stock
      the Company has been obligated to issue and deliver to various parties.




In
        connection with a loan of 10,000,000 shares by MRC to the Company, we agreed
        to
        reimburse MRC with up to 10,000,000 shares of common stock of the Company
        within
        one year and pay for all costs associated with such transfer.
  In
        July
        2007, the Company borrowed $46,586 from Stephen Rossetti with interest of
        10%
        per annum and due on demand. In December 2007, the Company reached an agreement
        with Markquest and Stephen Rossetti related to the $113,734 note issued in
        December 2006, the $46,586 loan by Mr. Rossetti in July 2007, and $36,000
        in
        fees owed to Markquest. The agreement canceled the $113,734 note and the
        Company
        issued a $213,139 promissory note to Markquest, bearing interest at 10% per
        annum which incorporated all of the amounts plus accrued interest. The note
        is
        to be paid in monthly interest payments of accrued interest beginning in
        February 2008 and monthly accrued interest and principal payments of $4,500
        beginning in August 2008. Mr. Rossetti is Executive Vice-President of Government
        Affairs, Chairman, CEO and Director of GIS, Director of NOW Solutions and
        an
        officer of Markquest. For additional details on this note, please see “Notes
        Payable” under Note 8 in
        the
        Notes to Consolidated Financial Statements.
 
 In
        August
        2007, the Company borrowed $30,400 from Victor Weber with interest of 12%
        per
        annum and principal and interest due on demand. Mr. Weber is the President
        and a
        Director of GIS and a member of CWI.
 
 For
        additional related transactions with certain parties, please see “Subsequent
        Events” under Note 14 in the Notes to Consolidated Financial
        Statements.


32




**Item
      13. Exhibits And Reports On Form 8-K** ****




The
      following documents are filed as part of this report:




**(a)**
            **Exhibits:**


**Exhibit
                  No.**
              
              **Description**
              
              **Location**2.1
              
              Certificate
                  of Ownership and Merger Merging Scientific Fuel Technology, Inc.
                  into
                  Vertical Computer Systems, Inc.
              
              Incorporated
                  by reference to Exhibit 2.1 to the Company’s Form 10-KSB filed on April
                  14, 20063.1
              
              Original
                  Unamended Certificate of Incorporation of Vertical Computer Systems,
                  Inc.
                  (f/k/a Xenogen Technology, Inc.)
              
              Incorporated
                  by reference to Exhibit 3.1 to the Company’s Form 10-KSB filed on April
                  14, 20063.2
              
              Certificate
                  of Amendment of Certificate of Incorporation (change name to Vertical
                  Computer Systems, Inc.)
              
              Incorporated
                  by reference to Exhibit 3.2 to the Company’s Form 10-KSB filed on April
                  14, 20063.3
              
              Certificate
                  of Amendment of Certificate of Incorporation (2000)
              
              Incorporated
                  by reference to Exhibit 3.3 to the Company’s Form 10-KSB filed on April
                  14, 20063.4
              
              Amended
                  and Restated By-Laws of the Company
              
              Incorporated
                  by reference to Exhibit 3.4 to the Company’s Form 10-KSB filed on April
                  14, 20064.1
              
              Certificate
                  of Designation of 4% Cumulative Redeemable Series A Preferred
                  Stock
              
              Incorporated
                  by reference to Exhibit 4.1 to the Company’s Form 10-KSB filed on April
                  14, 20064.2
              
              Certificate
                  of Designation of 10% Cumulative Redeemable Series B Preferred
                  Stock
              
              Incorporated
                  by reference to Exhibit 4.2 to the Company’s Form 10-KSB filed on April
                  14, 20064.3
              
              Certificate
                  of Designation of 4% Cumulative Redeemable Series C Preferred
                  Stock
              
              Incorporated
                  by reference to Exhibit 4.3 to the Company’s Form 10-KSB filed on April
                  14, 20064.4
              
              Certificate
                  of Designation of 15% Cumulative Redeemable Series D Preferred
                  Stock
              
              Incorporated
                  by reference to Exhibit 4.4 to the Company’s Form 10-KSB filed on April
                  14, 20064.5
              
              Form
                  of Warrant
              
              Incorporated
                  by reference to Exhibit 10.96 to the Company’s Form 10-KSB filed on August
                  7, 2003
  33
  **Exhibit No.**
              
              **Description**
              
              **Location**4.6
              
              Form
                  of Cashless Exercise Warrant
              
              Incorporated
                  by reference to Exhibit 4.55 to the Company’s Form 10KSB filed on March
                  31, 20054.7
              
              Form
                  of Restricted Stock Agreement
              
              Incorporated
                  by reference to Exhibit 4.7 to the Company’s Form 10-KSB filed on April
                  14, 200610.1
              
              1999
                  Stock Option Plan of the Company
              
              Incorporated
                  by reference to Exhibit 10.1 to the Company’s Form 10-KSB filed on April
                  14, 200610.2
              
              Promissory
                  Note, dated August 30, 2002, between the Company and a third party
                  lender
              
              Incorporated
                  by reference to Exhibit 10.2 to the Company’s Form 10-KSB filed on April
                  17, 200710.3
              
              Form
                  of Debenture
              
              Incorporated
                  by reference to Exhibit 10.3 to the Company’s Form 10-KSB filed on April
                  17, 200710.4
              
              Employment
                  Agreement as of December 1, 2001 between the Company and Richard
                  Wade
              
              Incorporated
                  by reference to Exhibit 10.6 to the Company’s Form 10-KSB filed on April
                  17, 200710.5
              
              Warrant
                  Agreement as of December 19, 2001 between the Company and Richard
                  Wade
              
              Incorporated
                  by reference to Exhibit 10.7 to the Company’s Form 10-KSB filed on April
                  17, 200710.6
              
              Warrant
                  Agreement as of December 19, 2001 between the Company and Richard
                  Wade
              
              Incorporated
                  by reference to Exhibit 10.8 to the Company’s Form 10-KSB filed on April
                  17, 200710.7
              
              Equity
                  Line of Credit Agreement, dated April 14, 2003, between the Company
                  and
                  Cornell Capital Partners, L.P
                
                (a)
                  Equity Line of Credit Agreement,
                (b)
                  Registration Rights Agreement
                (c)
                  Compensation Debenture
              
              Incorporated
                  by reference to Exhibit 10.104 to the Company’s Form 10-KSB filed on
                  August 7, 200310.8
              
              Letter
                  Payout Agreement, dated August 24, 2004 entered into by the
                  Company.
              
              Incorporated
                  by reference to Exhibit 99.1 to the Company’s Form 8-K filed on August 31,
                  2005
 34
 
  **Exhibit No.**
                  
                  **Description**
                  
                  **Location**
 10.9
              
              Form
                  of Agreed Judgment
              
              Incorporated
                  by reference to Exhibit 99.2 to the Company’s Form 8-K filed on August 31,
                  200510.10
              
              Settlement
                  Agreement and Promissory Note, dated October 19, 2005 between the
                  Company
                  and Parker Mills Morin, LLP
              
              Incorporated
                  by reference to Exhibit 10.41 to the Company’s Form 10-KSB filed on April
                  14, 200610.11
              
              Amended
                  and Restated Term Secured Promissory Note in the principal amount
                  of
                  $600,000.00, payable by NOW Solutions to Taladin, Inc.
              
              Incorporated
                  by reference to Exhibit 10.1 to the Company’s Form 8-K filed on February
                  24, 2006
  10.12
              
              Secured
                  Term Promissory Note in the principal amount of $450,000.00, payable
                  by
                  Taladin, Inc. to Tara Financial Services, Inc.
              
              Incorporated
                  by reference to Exhibit 10.2 to the Company’s Form 8-K filed on February
                  24, 200610.132
              
              Secured
                  Term Promissory Note in the principal amount of $150,000.00, payable
                  by
                  Taladin, Inc. to Strategic Growth Partners, Inc.
              
              Incorporated
                  by reference to Exhibit 10.3 to the Company’s Form 8-K filed on February
                  24, 200610.14
              
              Agreement
                  dated as of February 13, 2006 among Tara Financial Services, Inc., as
                  lender, NOW Solutions, the Company, Robert Farias, and Robert
                  Mokhtarian
              
              Incorporated
                  by reference to Exhibit 10.4 to the Company’s Form 8-K filed on February
                  24, 200610.15
              
              Secured
                  Term Promissory Note in the principal amount of $359,559.90, payable
                  by
                  NOW Solutions to Tara Financial Services, Inc.
              
              Incorporated
                  by reference to Exhibit 10.5 to the Company’s Form 8-K filed on February
                  24, 200610.16
              
              Secured
                  Term Promissory Note in the principal amount of $438,795.31, payable
                  by
                  the Company to Tara Financial Services, Inc.
              
              Incorporated
                  by reference to Exhibit 10.6 to the Company’s Form 8-K filed on February
                  24, 200610.17
              
              Secured
                  Term Promissory Note in the principal amount of $955,103.30, payable
                  by
                  NOW Solutions to Tara Financial Services, Inc.
              
              Incorporated
                  by reference to Exhibit 10.7 to the Company’s Form 8-K filed on February
                  24, 200610.18
              
              Secured
                  Term Promissory Note, dated October 27, 2006, in the principal
                  amount of
                  $100,000, payable by Taladin to Victor T. Weber.
              
              Incorporated
                  by reference to Exhibit 10.46 to the Company’s Form 10-KSB filed on April
                  17, 200714.1
              
              Code
                  of Ethics
              
              Provided
                  herewith
 35
  **Exhibit No.**
                
                **Description**
                
                **Location**
 21.1
              
              Subsidiaries
                  of the Company
              
              Incorporated
                  by reference to Exhibit 21.1 to the Company’s Form 10-KSB filed on April
                  17, 200731.1
              
              Certification
                  of Chief Executive Officer Pursuant to Section 302 of the Sarbanes-Oxley
                  Act of 2002, dated April 18, 2008
              
              Provided
                  herewith31.2
              
              Certification
                  ofChief
                  Financial Officer****Pursuant
                  to Section 302 of the Sarbanes-Oxley Act of 2002, dated April 18,
                  2008
              
              Provided
                  herewith32.1
              
              Certification
                  of Chief Executive Officer Pursuant to Section 906 of the Sarbanes-Oxley
                  Act of 2002, datedApril
                  18, 2008
              
              Provided
                  herewith32.2
              
              Certification
                  ofChief
                  Financial Officer****Pursuant
                  to Section 906 of the Sarbanes-Oxley Act of 2002, dated April 18,
                  2008
              
              Provided
                  herewith




**(b)**  **Reports
      on Form 8-K:**




On
      March
      5, 2007, the Company closed two series of transactions having the effect of
      amending the sublicense agreement between the Company and its subsidiaries
      and
      CWI and obtaining financing from Mr. Weber to secure exclusive rights for the
      Company and CWI to distribute StatePointPlus® (a software product owned by
      TrueBaseline) to government agencies and the healthcare industry in the United
      States and Canada and to all users in Brazil.





In
      order
      to obtain the exclusive rights for StatePointPlus®, Mr. Weber made payments of
      $500,000 to TrueBaseline on behalf of the Company and CWI. In order to maintain
      the exclusive rights, CWI and the Company must make certain additional payments
      by July 31, 2008. Thereafter, the Company must make certain average monthly
      minimum payments to TrueBaseline, which increase on a yearly basis, in order
      to
      retain the partial exclusivity rights during the term of the Sublicense
      Agreement.




For
      the
      territory of Italy, the Company also obtained the rights to distribute IA to
      all
      users in the health care industry and all users in any federal, state and local
      government agencies or their equivalents in Italy. In addition, the Company
      acquired from CWI partial exclusivity rights for a security access management
      software program that functions as an ID verification system. The Company has
      the exclusive rights to distribute SAM to all users in government agencies
      and
      the healthcare and casino industries in the United States and Canada. In order
      to retain these exclusivity rights for SAM and for IA in Italy, the Company
      must
      achieve minimum monthly gross revenues (for SAM and IA in Italy, as applicable),
      which increase on a yearly basis during the term of the Sublicense Agreement.





In
      connection with the $500,000 payment of fees by Mr. Weber to obtain the partial
      exclusivity rights for StatePointPlus®, the Company issued an additional note
      payable in the amount of $300,000 (the “$300,000 Note”) to Mr. Weber. In
      addition, the payment terms of the $200,000 Note payable (the “$200,000 Note”)
      issued on October 24, 2006 by the Company to Mr. Weber were extended for an
      additional 60 days. Both the $200,000 Note and the $300,000 Note may be paid
      from certain revenues derived from StatePointPlus® by CWI and the Company if and
      to the extent such funds are available. Accrued interest shall be paid on a
      monthly basis by the Company, or from revenues derived from StatePointPlus® if
      such funds are available. To secure the principal payments and interest payments
      on the $300,000 Note and interest payments on the $200,000 Note, MRC pledged
      10,000,000 shares of common stock of the Company. MRC is a corporation
      controlled by the W5 Family Trust. Mr. Wade, the President and CEO of the
      Company, is the trustee of the W5 Family Trust. Mr. Weber is the President
      and a
      Director of Government Internet Systems, Inc., a subsidiary of the Company, and
      a
      member of CWI .





On
      September 11, 2007, the New York Supreme Court awarded attorney's fees in the
      amount of $912,464 to NOW Solutions (the wholly owned subsidiary of the Company)
      in the action of Ross Systems, Inc. v. NOW Solutions, Inc. The award was made
      pursuant to motions for attorneys' fees filed in August 2007 by NOW Solutions
      and Ross Systems, Inc.


36


NOW
      Solutions is in the process of entering the judgment in the total amount of
      $2,191,946, plus statutory (simple) interest at 9% per annum from the date
      the
      claim accrued. (Subsequent to the filing of the foregoing 8-K, the judgment
      was
      entered on October 11, 2007 for a total amount of $3,151,215, which includes
      interest fees through the date of the award of the judgment).





On
      December 7, 2007, Weaver & Tidwell, LLP resigned as the
      independent registered public accountants of the Company.





(i)
            Weaver
                & Tidwell’s report on the Company’s financial statements for either of
                the two fiscal years ended December 31, 2006 and 2005 did not contain
                an
                adverse opinion or a disclaimer of opinion, and was not qualified
                as to
                audit scope or accounting principles. However, Weaver & Tidwell’s
                report did include a paragraph regarding the Company's ability to
                continue
                as a going concern for either of these two fiscal
                years.





(ii)
            The
                decision to change accountants was not recommended or approved by
                the
                board of directors of the Company or the audit committee of the board
                of
                directors of the Company, as Weaver & Tidwell resigned. The Company’s
                board of directors will continue to recommend and approve the engagement
                of any new accountant.





(iii)
            During
                the Company’s two most recent fiscal years (the years ended December 31,
                2006 and 2005) and subsequent interim periods (from January 1, 2007
                through the date of Weaver & Tidwell’s resignation), there were no
                disagreements on any matter of accounting principles or practices,
                financial statement disclosure, or auditing scope or procedures,
                which
                disagreements, if not resolved to Weaver & Tidwell’s satisfaction,
                would have caused it to make reference to the subject matter of the
                disagreements in connection with its reports. During the Company’s two
                most recent fiscal years (the years ended December 31, 2006 and 2005)
                and
                subsequent interim periods (from January 1, 2007 through the date
                of
                Weaver & Tidwell’s resignation), Weaver & Tidwell did not advise
                the Company of any of the matters identified in paragraph (a)(1)(iv)
                of Item 304 of Regulation S-B.





On
      January 16, 2008, Vertical Computer Systems, Inc. engaged Malone & Bailey,
      P.C. as its principal accountant to audit its financial statements. The
      Company did not consult Malone & Bailey on any matters described in
      paragraph (a)(2)(i) or (ii) of Item 304 of Regulation S-B during the
      Company’s two most recent fiscal years or any subsequent interim period prior to
      engaging Malone & Bailey.




Also
      in
      January 2008, the Company relocated its corporate headquarters to 101 W. Renner
      Road, Suite 300, Richardson, Texas 75082. The Company and its subsidiary, NOW
      Solutions, Inc., will continue to utilize the office located at 201 Main Street,
      Suite 1175, Fort Worth, TX 76102.





**Item
      14. Principal Accountant Fees and Services**





***Audit
      Fees.*** The
      aggregate fees billed for professional services rendered by the Company’s
      principal accounting firms of Malone & Bailey, PC and Weaver and
      Tidwell, L.L.P., were $99,500 and $94,850 for the audit of the Company’s annual
      financial statements for 2007 and 2006, which included the reviews of the
      financial statements in the Company’s Forms 10-QSB for the applicable
      fiscal year.




***Tax
      Fees*** .
      The
      principal accounting firms of Malone and Bailey, PC and Weaver and Tidwell,
      L.L.P. did not provide any tax services in 2007 and 2006. The aggregate fees
      billed in the fiscal years ended 2007 and 2006 for professional services
      rendered by Hartman, Leito, and Bolt, LLP for tax advice, tax planning and
      tax
      return preparation were $12,500 and $18,016. In addition, BDO Dunwoody LLP
      in
      Toronto billed $8,758 and $8,757 in Canadian dollars for tax advice, tax
      planning and tax return preparation for the years ended 2007 and 2006,
      respectively. Dickstein Shapiro Moran & Oshinsky LLP billed $11,955 and
      $16,376 and for tax advice and tax planning for the years ended 2007 and 2006,
      respectively.




***All
      Other Fees.*** Other
      than the services described above, the aggregate fees billed for services
      rendered by the either principal accountant was $0 and $0, respectively, for
      the
      fiscal years ended 2007 and 2006.


37




**SIGNATURES**




In
      accordance with the requirements of the Exchange Act, as amended, the Registrant
      has caused this report to be signed on its behalf by the undersigned, thereunto
      duly authorized.




**VERTICAL
                COMPUTER SYSTEMS, INC.**April
                21, 2008
            By:
            /s/
*Richard
                Wade*Richard
                Wade, President andChief
                Executive OfficerApril
                  21, 2008
            By:
            /s/
*David
                Braun*David
                BraunChief
                Financial
                Officer





In
      accordance with the Exchange Act, this Report has been signed below by the
      following persons or on behalf of the Registrant and in the capacities on the
      dates indicated.




**DIRECTORS:**April
                  21, 2008
            By:
            /s/
*Richard
                Wade*Richard
                Wade,
                DirectorApril
                  21, 2008
            By:
            /s/
*William
                Mills*William
                Mills,
                Director




38




**VERTICAL
      COMPUTER SYSTEMS, INC. AND SUBSIDIARIES**





**INDEX
      TO CONSOLIDATED FINANCIAL STATEMENTS**





Reports
                of Independent Registered Public Accounting Firms
            F-2/3Consolidated
                Financial StatementsConsolidated
                Balance Sheet
            F-4Consolidated
                Statements of Operations
            F-5Consolidated
                Statements of Stockholders’ Deficit
            F-6Consolidated
                Statements of Cash Flows
            F-8Notes
                to Consolidated Financial Statements
            F-9




F-1




**Report
      of Independent Registered Public Accounting Firm**





Board
      of
      Directors


Vertical
      Computer Systems, Inc.


Richardson,
      Texas





We
      have
      audited the accompanying consolidated balance sheet of Vertical Computer
      Systems, Inc. as of December 31, 2007 and the related consolidated statements
      of
      operations, stockholders’ deficit, and cash flows for the year then ended. These
      consolidated financial statements are the responsibility of the Company's
      management. Our responsibility is to express an opinion on these consolidated
      financial statements based on our audit.





We
      conducted our audit in accordance with the standards of the Public Company
      Accounting Oversight Board (United States). Those standards require that we
      plan
      and perform an audit to obtain reasonable assurance about whether the financial
      statements are free of material misstatement. The Company is not required to
      have, nor were we engaged to perform, an audit of its internal control over
      financial reporting. Our audit included consideration of internal control over
      financial reporting as a basis for designing audit procedures that are
      appropriate in the circumstances, but not for the purpose of expressing an
      opinion on the effectiveness of the Company’s internal control over financial
      reporting. Accordingly, we express no such opinion. An audit also includes
      examining, on a test basis, evidence supporting the amounts and disclosures
      in
      the financial statements, assessing the accounting principles used and
      significant estimates made by management, as well as evaluating the overall
      financial statement presentation. We believe that our audit provides a
      reasonable basis for our opinion.





In
      our
      opinion, the financial statements referred to above present fairly, in all
      material respects, the financial position of Vertical Computer Systems, Inc.
      as
      of December 31, 2007 and the results of operations and cash flows for the year
      then ended, in conformity with accounting principles generally accepted in
      the
      United States of America.





The
      accompanying financial statements have been prepared assuming that Vertical
      Computer Systems, Inc. will continue as a going concern. As discussed in Note
      2
      to the financial statements, Vertical Computer Systems, Inc. suffered losses
      from operations and has a working capital deficiency, which raises substantial
      doubt about its ability to continue as a going concern. Management’s plans
      regarding those matters also are described in Note 2. The financial statements
      do not include any adjustments that might result from the outcome of this
      uncertainty.





We
      also
      have audited the adjustments described in Note 3 that were applied to restate
      the 2006 financial statements to correct an error. In our opinion, such
      adjustments are appropriate and have been properly applied. We were not engaged
      to audit, review, or apply any procedures to the 2006 financial statements
      of
      Vertical Computer Systems, Inc. other than with respect to the adjustments
      and,
      accordingly, we do not express an opinion or any other form of assurance on
      the
      2006 financial statements taken as a whole.






Malone
      & Bailey, PC


www.malone-bailey.com


Houston,
      Texas


April
      21,
      2008




F-2





**Report
      of Independent Registered Public Accounting Firm**





Board
      of
      Directors


Vertical
      Computer Systems, Inc. and Subsidiaries


Richardson,
      Texas




We
      have
      audited, before the effects of the adjustments for the correction for the error
      described in Note 3, the accompanying consolidated statements of operations,
      stockholders' deficit and cash flows of Vertical Computer Systems, Inc. and
      Subsidiaries for the year ended December 31, 2006 (the 2006 financial statements
      before the effects of the adjustments discussed in Note 3 are not presented
      herein). These consolidated financial statements are the responsibility of
      the
      Company's management. Our responsibility is to express an opinion on these
      consolidated financial statements based on our audit.




We
      conducted our audit in accordance with the standards of the Public Company
      Accounting Oversight Board (United States). Those standards require that we
      plan
      and perform the audits to obtain reasonable assurance about whether the
      consolidated financial statements are free of material misstatement. The Company
      is not required to have nor were we engaged to perform, audits of their internal
      control over financial reporting. Our audit included consideration of internal
      control over financial reporting as a basis for designing audit procedures
      that
      are appropriate in the circumstances, but not for the purpose of expressing
      an
      opinion on the effectiveness of the Company's internal control over financial
      reporting. Accordingly we express no such opinion. An audit includes examining,
      on a test basis, evidence supporting the amounts and disclosures in the
      consolidated financial statements, assessing the accounting principles used
      and
      significant estimates made by management, as well as evaluating the overall
      consolidated financial statement presentation. We believe that our audits
      provide a reasonable basis for our opinion.




In
      our
      opinion, except for the error described in Note 3, the consolidated financial
      statements referred to above present fairly, in all material respects, the
      results of their operations and cash flows of Vertical Computer Systems, Inc.
      and Subsidiaries for the year ended December 31, 2006 in conformity with
      accounting principles generally accepted in the United States of
      America.




We
      were
      not engaged to audit, review, or apply any procedures to the adjustments for
      the
      correction of the error described in Note 3 and, accordingly, we do not express
      an opinion or any other form of assurance about whether such adjustments are
      appropriate and have been properly applied. Those adjustments were audited
      by
      Malone & Bailey, PC.




The
      accompanying consolidated financial statements have been prepared assuming
      the
      Company will continue as a going concern. As discussed in Note 2 to the
      consolidated financial statements, the Company has suffered recurring
      significant operating losses and at December 31, 2006, the Company had negative
      working capital of approximately $10.3 million, a stockholders’ deficit of $16.9
      million, and had defaulted on several of its debt obligations. These conditions
      raise substantial doubt about the Company’s ability to continue as a going
      concern. Management’s plans in regard to these matters are also described in
      Note 2. The consolidated financial statements do not include any adjustments
      that might result from the outcome of this uncertainty.






/s/ Weaver
      and Tidwell L.L.P.


Weaver
      and Tidwell L.L.P.


Fort
      Worth, Texas


April
      16,
      2007




F-3




**VERTICAL
      COMPUTER SYSTEMS, INC.**





**CONSOLIDATED
      BALANCE SHEET**





December
                31,2007**Assets**Current
                assets:Cash
            
            $
            131,420Accounts
                receivable, net of allowance for bad debts of $349,009
            
            
            962,772Employee
                receivables
            
            
            25,414Prepaid
                expenses and other current assets
            
            
            25,439Total
                current assets
            
            
            1,145,045Property
                and equipment, net of accumulated depreciation of $970,867
            
            
            80,708Deposits
                and other assets
            
            
            10,416Total
                assets
            
            $
            1,236,169**Liabilities
                and Stockholder’s Deficit**Current
                liabilities:Accounts
                payable and accrued liabilities
            
            $
            7,604,988Deferred
                revenue
            
            
            2,777,604Derivative
                liabilities
            
            
            291,584Current
                portion-convertible debentures
            
            
            40,000Current
                portion-notes payable
            
            
            3,508,593Total
                current liabilities
            
            
            14,222,769Non-current
                portion – notes payable
            
            
            2,221,719Total
                liabilities
            
            
            16,444,488**Stockholders’
                Deficit**Series
                A 4% Convertible Cumulative Preferred stock; $0.001 par value; 250,000
                shares authorized; 48,500 shares issued and outstanding;
            
            
            49Series
                B 10% Convertible Preferred stock; $0.001 par value; 375,000 shares
                authorized; 7,200 shares issued and outstanding;
            
            
            45,000Series
                C 4% Convertible Preferred stock; $100 par value; 200,000 shares
                authorized; 50,000 shares issued and outstanding;
            
            
            350,000Series
                D 15% Convertible Preferred stock; $0.001 par value; 300,000 shares
                authorized; 25,000 shares issued and outstanding;
            
            
            156,250Common
                stock: $.00001 par value, 1,000,000,000 shares authorized 991,485,149
                shares issued and outstanding
            
            
            9,915Additional
                paid-in capital
            
            
            27,974,390Accumulated
                deficit
            
            
            (43,855,590
            )Accumulated
                other comprehensive income - foreign currency translation
            
            
            111,667Total
                stockholders’ deficit
            
            
            (15,208,319
            )Total
                liabilities and stockholders’ deficit
            
            $
            1,236,169





*See
      accompanying notes to consolidated financial statements*




F-4




**VERTICAL
      COMPUTER SYSTEMS, INC.**





**CONSOLIDATED
      STATEMENTS OF OPERATIONS**





Years
                ended December 31,2007
            
            2006RevenuesLicensing
                and maintenance
            
            $
            5,065,095
            
            $
            5,152,017Consulting
                Services
            
            
            571,176
            
            
            911,308Other
            
            
            259,455
            
            
            166,619Total
                Revenues
            
            
            5,895,726
            
            
            6,229,944Selling
                , general and administrative expenses
            
            
            6,637,848
            
            
            7,156,711Depreciation
                and amortization
            
            
            61,962
            
            
            206,572Bad
                debt expense
            
            
            181,029
            
            
            7,500Operating
                expenses
            
            
            6,880,839
            
            
            7,370,783Operating
                loss
            
            
            (985,113
            )
            
            (1,140,839
            )Gain
                on derivative
            
            
            51,416
            
            
            -Gain
                on settlement of debt
            
            
            370,749
            
            
            -Interest
                income
            
            
            1,928
            
            
            3,026Interest
                expense
            
            
            (1,005,325
            )
            
            (590,896
            )Net
                loss
            
            
            (1,566,345
            )
            
            (1,728,709
            )Dividend
                applicable to preferred stock
            
            
            (588,000
            )
            
            (600,000
            )Net
                loss applicable to common stockholders
            
            $
            (2,154,345
            )
            $
            (2,328,709
            )Basic
                and diluted loss per share
            
            $
            (0.00
            )
            $
            (0.00
            )Basic
                and diluted weighted average
            
            
            990,378,049
            
            
            983,001,187of
                common shares outstandingComprehensive
                loss and its componentsconsist
                of the following:Net
                loss
            
            $
            (1,566,345
            )
            $
            (1,728,709
            )Translation
                adjustments
            
            
            (10,276
            )
            
            12,126Comprehensive
                loss
            
            $
            (1,576,621
            )
            $
            (1,716,583
            )





*See
      accompanying notes to consolidated financial statements*




F-5




**VERTICAL
      COMPUTER SYSTEMS, INC.**


**STATEMENTS
      OF STOCKHOLDERS’ DEFICIT**


**TWO
      YEARS ENDED DECEMBER 31, 2007**





Additional
            
            
            
            OtherCommon
                Stock
            
            Preferred
                Stock
            
            Paid-in
            
            Accumulated
            
            ComprehensiveShares
            
            Amount
            
            Shares
            
            Amount
            
            Capital
            
            Deficit
            
            Income
            
            TotalBalance
                at 12/31/05
            
            
            947,291,670
            
            **$**
            9,473
            
            
            132,200
            
            **$**
            551,301
            
            **$**
            27,723,121
            
            **$**
            (40,560,536
            )
            **$**
            132,826
            
            **$**
            (12,143,815
            )Issuing
                common shares for incentive to make loans and refinance
                debt
            
            
            13,000,000
            
            
            130
            
            
            
            
            
            
            
            
            158,870
            
            
            
            
            
            
            
            
            159,000Issuing
                restricted stock, net of cancellations
            
            
            5,449,998
            
            
            55
            
            
            
            
            
            
            
            
            79,705
            
            
            
            
            
            
            
            
            79,760Issuing
                common shares upon conversion of convertible debentures
            
            
            24,298,094
            
            
            242
            
            
            
            
            
            
            
            
            189,757
            
            
            
            
            
            
            
            
            189,999Issuing
                common shares upon damages claimed with an equity line of
                credit
            
            
            4,387,095
            
            
            44
            
            
            
            
            
            
            
            
            40,756
            
            
            
            
            
            
            
            
            40,800Conversion
                of 1,500 of preferred A to common shares
            
            
            750,000
            
            
            8
            
            
            (1,500
            )
            
            (2
            )
            
            (6
            )
            
            
            
            
            
            
            
            -Issuing
                common shares upon debt forgiveness
            
            
            1,750,000
            
            
            18
            
            
            
            
            
            
            
            
            16,231
            
            
            
            
            
            
            
            
            16,249Other
                comprehensive incometranslation
                adjustment
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            (10,883
            )
            
            (10,883
            )Net
                Loss
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            (1,728,709
            )
            
            
            
            
            (1,728,709
            )Balance
                12/31/06 (restated)
            
            
            996,926,857
            
            **$**
            9,970
            
            
            130,700
            
            **$**
            551,299
            
            **$**
            28,208,434
            
            **$**
            (42,289,245
            )
            **$**
            121,943
            
            **$**
            (13,397,599
            )




*See
      accompanying notes to consolidated financial statements*




F-6




**VERTICAL
      COMPUTER SYSTEMS, INC.**


**STATEMENTS
      OF STOCKHOLDERS’ DEFICIT**


**TWO
      YEARS ENDED DECEMBER 31, 2007**





Additional
            
            
            
            OtherCommon
                Stock
            
            Preferred
                Stock
            
            Paid-in
            
            Accumulated
            
            ComprehensiveShares
            
            Amount
            
            Shares
            
            Amount
            
            Capital
            
            Deficit
            
            Income
            
            TotalBalances
                at 12/31/06 (restated)
            
            
            996,926,857
            
            **$**
            9,970
            
            
            130,700
            
            **$**
            551,299
            
            **$**
            28,208,434
            
            **$**
            (42,289,245
            )
            **$**
            121,943
            
            **$**
            (13,397,599
            )Issuance
                of restricted stock for services,  net of
                cancellations
            
            
            4,589,292
            
            
            45
            
            
            
            
            
            
            
            
            49,662
            
            
            
            
            
            
            
            
            49,707Shares
                loaned to the company by officer
            
            
            (13,000,000
            )
            
            (130
            )
            
            
            
            
            
            
            
            (342,870
            )
            
            
            
            
            
            
            
            (343,000
            )Shares
                issued to note holder for extension of maturity of debt
            
            
            2,000,000
            
            
            20
            
            
            
            
            
            
            
            
            44,980
            
            
            
            
            
            
            
            
            45,000Shares
                issued to note holder in consideration of note payable
            
            
            1,000,000
            
            
            10
            
            
            
            
            
            
            
            
            14,184
            
            
            
            
            
            
            
            
            14,194Abandoned
                shares returned
            
            
            (31,000
            )
            
            —
            
            
            
            
            
            
            
            
            —
            
            
            
            
            
            
            
            
            —Other
                comprehensive income translation adjustment
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            (10,276
            )
            
            (10,276
            )Net
                loss
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            (1,566,345
            )
            
            
            
            
            (1,566,345
            )Balances
                12/31/07
            
            
            991,485,149
            
            **$**
            9,915
            
            
            130,700
            
            **$**
            551,299
            
            **$**
            27,974,390
            
            **$**
            (43,855,590
            )
            **$**
            111,667
            
            **$**
            (15,208,319
            )




*See
      accompanying notes to consolidated financial statements*





F-7




**VERTICAL
      COMPUTER SYSTEMS, INC.**





**CONSOLIDATED
      STATEMENTS OF CASH FLOWS**





Years
                ended December 31,2007
            
            2006Cash
                flows from operating activities:Net
                loss
            
            $
            (1,566,345
            )
            $
            (1,728,709
            )Adjustments
                to reconcile net loss to net cash provided by operating
                activities:Depreciation
                and amortization
            
            
            61,962
            
            
            206,572Amortization
                of debt discount
            
            
            96,867
            
            
            —Stock
                compensation
            
            
            49,707
            
            
            295,809Shares
                issued for extension of debt
            
            
            45,000
            
            
            —Gain
                on derivatives
            
            
            (51,416
            )
            
            —Bad
                debt expense
            
            
            181,029
            
            
            7,500Loan
                origination costs included in notes payable
            
            
            11,586
            
            
            —Changes
                in operating assets and liabilities:Accounts
                receivable
            
            
            (292,517
            )
            
            140,399Receivable
                from officers and employees
            
            
            86,010
            
            
            (38,462
            )Prepaid
                expense and other assets
            
            
            15,853
            
            
            41,710Accounts
                payable and accrued liabilities
            
            
            1,375,187
            
            
            1,029,560Deferred
                revenue
            
            
            118,082
            
            
            99,990Net
                cash provided by operating activities
            
            
            131,005
            
            
            54,370Cash
                flows from investing activities:Proceeds
                from sale of investment
            
            
            2,760
            
            
            —Purchase
                of equipment
            
            
            (59,059
            )
            
            (39,765
            )Net
                cash used in investing activities
            
            
            (56,299
            )
            
            (39,765
            )Cash
                flows from financing activities:Payment
                of notes payable
            
            
            (441,892
            )
            
            (1,222,606
            )Proceeds
                from issuance of notes payable
            
            
            425,400
            
            
            1,017,000Net
                cash used in financing activities
            
            
            (16,492
            )
            
            (205,606
            )Effect
                of changes in exchange rates on cash
            
            
            (10,276
            )
            
            (10,882
            )Net
                increase (decrease) in cash and cash equivalents,
            
            
            47,938
            
            
            (201,882
            )Cash
                and cash equivalents,****beginning
                of period
            
            
            83,482
            
            
            285,366Cash
                and cash equivalents, end of period
            
            $
            131,420
            
            $
            83,484





*See
      accompanying notes to consolidated financial statements*





F-8




**VERTICAL
      COMPUTER SYSTEMS, INC.**





**NOTES
      TO CONSOLIDATED FINANCIAL STATEMENTS**





**Note
      1. Organization, Basis of Presentation and Significant Accounting Policies**





**Nature
      of Business**





Vertical
      Computer Systems, Inc. was incorporated in Delaware in March 1992. The
      Company is a multinational provider of administrative software services,
      Internet core technologies, and derivative software application products through
      its distribution network. The Company’s business model combines complementary,
      integrated software products, internet core technologies, and a multinational
      distribution system of partners, in order to create a distribution matrix that
      is capable of penetrating multiple sectors through cross selling its products
      and services. The Company is operating one business segment.





**Basis
      of Presentation**





The
      consolidated financial statements include the accounts of the Company and its
      wholly subsidiaries, EnFacet, Inc. (“ ENF ”), **** Globalfare.com,
      Inc. (“ GFI ”),
      Pointmail.com, Inc. (“ PMI ”),
      Vertical Internet Solutions (“ VIS ”),
      and
      Vertical Healthcare Solutions (“ VHS ”),
      all
      of which are inactive; NOW Solutions, Inc. (“ NOW
      Solutions ”);
      OptVision Research, Inc. (“ OVR ”),
      which
      is a newly established entity with minor activities; Taladin, Inc.
      (“ Taladin ”),
      a
      newly established entity with minor activities; and Government Internet Systems,
      Inc. (“ GIS ”),
      a
      entity with minor activities. To date, the Company has generated revenues
      primarily from software license, consulting fees and maintenance agreements
      from
      NOW Solutions, its 100% owned subsidiary.





**Principles
      of Consolidation**





The
      consolidated financial statements include the accounts of the Company and its
      subsidiaries. Equity investments in which we exercise significant influence,
      but
      do not control and are not the primary beneficiary, are accounted for using
      the
      equity method of accounting. Investments in which we do not exercise significant
      influence over the investee are accounted for using the cost method of
      accounting. All intercompany accounts and transactions have been
      eliminated.





**Cash
      and Cash Equivalents**





Cash
      equivalents are highly liquid investments with an original maturity of three
      months or less.




**Revenue
      Recognition**





Service
      revenue generated from professional consulting and training services are
      recognized as the services are performed. Maintenance revenue, including
      revenues bundled with original software product license revenues, are deferred
      and recognized over the related contract period, generally twelve months. The
      Company’s revenue recognition policies are designed to comply with American
      Institute of Certified Public Accountants Statement of Position 97-2, “Software
      Revenue Recognition” and with Emerging Issues Task Force No 00-21, “Revenue
      Arrangement with Multiple Deliverables.”





Amounts
      billed or collected in advance of the period in which the related product or
      service qualifies for revenue recognition are recorded as deferred revenue
      on
      the Consolidated Balance Sheets.





In
      accordance with SEC Staff Accounting Bulletin No. 104 “Revenue Recognition”, the
      Company recognizes revenue from license of computer software up-front, provided
      that a non-cancelable license agreement has been signed, the software and
      related documentation have been shipped, there are no material uncertainties
      regarding customer acceptance, collection of resulting receivable is deemed
      probable, and no significant other vendor obligation exists.





Other
      revenue consists of hosting fees, reimbursement for out of pocket expenses
      in
      accordance with EITF No. 01-14 and fees related to user conferences.




F-9


**VERTICAL
        COMPUTER SYSTEMS, INC.**




**Valuation
      of the Embedded and Warrant Derivatives**





The
      valuation of our embedded derivatives and warrant derivatives are determined
      primarily by the Black-Scholes option pricing model and the Lattice model.
      An
      embedded derivative is a derivative instrument that is embedded within another
      contract, which under the 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 FASB Statement No. 133, as amended,
      Accounting for Derivative Instruments and Hedging Activities, these embedded
      derivatives are marked-to-market each reporting period, with a corresponding
      non-cash gain or loss charged to the current period. A warrant derivative
      liability is determined in accordance with Emerging Issues Task Force Issue
      No. 00-19,
      “Accounting for Derivative Financial Instruments Indexed to, and Potentially
      Settled in, a Company’s Own Stock.” Based on EITF 00-19,
      warrants which are determined to be classified as derivative liabilities 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.





To
      determine the fair value of our embedded derivatives, management evaluates
      assumptions regarding the probability of certain future events. Other factors
      used to determine fair value include our period end stock price, historical
      stock volatility, risk free interest rate and derivative term. 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.





**Concentration
      of Credit Risk**





The
      Company maintains its cash in bank deposit accounts, which, at times, may exceed
      federally insured limits. The Company has not experienced any such losses in
      these accounts. Substantially all of our revenue was derived from recurring
      maintenance fees related to our payroll processing software.





**Property
      and Equipment**





Property
      and equipment are stated at cost. Depreciation is computed primarily utilizing
      the straight-line method over the estimated economic life of three to five
      years. Maintenance, repairs and minor renewals are charged directly to expenses
      as incurred. Additions and betterment to property and equipment are capitalized.
      When assets are disposed of, the related cost and accumulated depreciation
      thereon are removed from the accounts and any resulting gain or loss is included
      in the statement of operations.





**Impairment
      of Long-Lived Assets**





Effective
      January 1, 2002, the Company began applying the provisions of Statement of
      Financial Accounting Standard No. 144, “Accounting for the Impairment or
      Disposal of Long-Lived Assets.” SFAS No. 144 requires that long-lived
      assets be reviewed for impairment whenever events or changes in circumstances
      indicate that the carrying amount of an asset may not be recoverable through
      the
      estimated undiscounted cash flows expected to result from the use and eventual
      disposition of the assets. Whenever any such impairment exists, an impairment
      loss will be recognized for the amount by which the carrying value exceeds
      the
      fair value. During 2007 and 2006, there was no impairment of long-lived assets
      due to the minimal value of such assets.





**Stock-based
      Compensation**





Effective
      January 1, 2006, the Company adopted SFAS 123(R) using the modified prospective
      method, which requires measurement of compensation cost for all stock-based
      awards at fair value on date of grant and recognition of compensation over
      the
      service period for awards expected to vest. The fair value of restricted stock
      and restricted stock units is determined based on the number of shares granted
      and the quoted price of our common stock, and the fair value of stock options
      is
      determined using the Black-Scholes valuation model, which is consistent with
      our
      valuation techniques previously utilized for options in footnote disclosures
      required under SFAS 123, Accounting for Stock Based Compensation, as amended
      by
      SFAS 148, Accounting for Stock-Based Compensation — Transition and Disclosure.
      The estimation of stock awards that will ultimately vest requires judgment,
      and
      to the extent actual results or updated estimates differ from the Company’s
      current estimates, such amounts will be recorded as a cumulative adjustment
      in
      the period estimates are revised.





Because
      the fair value recognition provisions of SFAS No. 123, Stock-Based
      Compensation, and SFAS No. 123(R) were materially consistent under the
      Company’s equity plans, the adoption of SFAS No. 123(R) did not have a
      significant impact on the Company’s financial position or the Company’s results
      of operations.




F-10




**VERTICAL
        COMPUTER SYSTEMS, INC.**


**Allowance
      for Doubtful Accounts**





We
      establish an allowance for bad debts through a review of several factors
      including historical collection experience, current aging status of the customer
      accounts, and financial condition of our customers. We do not generally require
      collateral for our accounts receivable. Our allowance for doubtful accounts
      was
      $349,009 as of December 31, 2007.





Included
      in our allowance for doubtful accounts, we have fully reserved for a $110,085
      receivable related to an amount due from Ross (see Note 13).





**Income
      Taxes**





The
      Company provides for income taxes in accordance with Statements of Financial
      Accounting Standards No. 109, “Accounting for Income Taxes.” SFAS 109
      requires a company to use the asset and liability method of accounting for
      income taxes.





Under
      the
      asset and liability method, deferred income taxes are recognized for the tax
      consequences of “temporary differences” by applying enacted statutory tax rates
      applicable to future years to differences between the financial statement
      carrying amounts and the tax basis of existing assets and liabilities. A
      valuation allowance is provided when management cannot determine whether it
      is
      more likely than not the deferred tax asset will be realized. Under SFAS 109,
      the effect on deferred income taxes of a change in tax rates is recognized
      in
      income in the period that includes the enactment date.





On
      July 13, 2006, the FASB issued Interpretation No. 48, “Accounting for
      Uncertainty in Income Taxes—an Interpretation of FASB Statement 109.” FIN 48
      prescribes how the Company should recognize, measure and present in the
      Company’s financial statements uncertain tax positions that have been taken or
      are expected to be taken in a tax return. Pursuant to FIN 48, the Company can
      recognize a tax benefit only if it is “more likely than not” that a particular
      tax position will be sustained upon examination or audit. To the extent the
      “more likely than not” standard has been satisfied, the benefit associated with
      a tax position is measured as the largest amount that is greater than 50% likely
      of being realized upon settlement. The Company adopted FIN 48 on January 1,
      2007. The adoption of FIN 48 did not require any restatement of the Company’s
      financial statements.





**Earnings
      Per Share**





Statement
      of Financial Accounting Standards FASB No. 128, “Earnings per Share”, which
      replaces the calculation of primary and fully diluted earnings (loss) per share
      with basic and diluted earnings (loss) per share, is used to calculate earnings
      per share. Basic earnings (loss) per share includes no dilution and is computed
      by dividing income (loss) available to common stockholders by the weighted
      average number of shares outstanding during the period. Diluted earnings (loss)
      per share reflect the potential dilution of securities that could share in
      the
      earnings of an entity, similar to fully diluted earnings (loss) per share.
      As of
      December 31, 2007, all outstanding convertible debts and warrants and options
      outstanding were excluded in the calculation of diluted loss per share because
      they were anti-dilutive.





**Fair
      Value of Financial Instruments**





For
      certain of the Company’s instruments, including cash and cash equivalents,
      accounts receivable and accrued expenses, the carrying amounts approximate
      fair
      value due to the short maturity of these instruments. The carrying value of
      the
      Company’s long-term debt approximates its fair value based on the quoted market
      prices for the same or similar issues or the current rates offered to the
      Company for debt of the same remaining maturities. The fair value of the note
      payable to stockholder cannot be estimated due to its related party nature.





**Use
      of Estimates**





The
      preparation of financial statements in conformity with accounting principles
      generally accepted in the United States of America requires management to make
      estimates and assumptions that affect the reported amounts of assets and
      liabilities and disclosure of contingent assets and liabilities at the date
      of
      financial statements and the reported amounts of revenue and expenses during
      the
      reporting period. Among the more significant estimates included in these
      financial statements are the estimated allowance for doubtful accounts
      receivable, valuation allowance for deferred tax assets, impairment of
      long-lived assets and intangible and the valuation of warrants and restricted
      stock grants. Actual results could materially differ from those estimates.




F-11
 
  **VERTICAL
          COMPUTER SYSTEMS, INC.**


**Cash
      Reimbursements**





The
      Company records reimbursement by its customers for out-of-pocket expense as
      part
      of consulting and other services revenue in accordance with the Emerging Issues
      Task Force Issue No.
      01-14 “Income
      Statement Characterization of Reimbursements Received for Out of Pocket Expense
      Incurred.”





**Reclassifications**




Certain
      reclassifications have been made to the prior periods to conform to the current
      period presentation.





**Note
      2. Going Concern Uncertainty**





The
      accompanying consolidated financial statements for 2007 and 2006 have been
      prepared assuming that the Company will continue as a going concern which
      contemplates the realization of assets and the satisfaction of liabilities
      in
      the normal course of business.





The
      carrying amounts of assets and liabilities presented in the financial statements
      do not purport to represent realizable or settlement values. The Company has
      suffered significant recurring operating losses, used substantial funds in
      its
      operations, and needs to raise additional funds to accomplish its objectives. Negative
      stockholders’ equity at December 31, 2007 was $15.2 million. Additionally,
      at December 31, 2007, the Company had negative working capital of approximately
      $13.1 million (although it includes deferred revenue of approximately $2.8
      million) and has defaulted on several of its debt obligations. These conditions
      raise substantial doubt about the Company’s ability to continue as a going
      concern.




Management
      of the Company is continuing its efforts to attempt to secure funds through
      equity and/or debt instruments for its operations, expansion and possible
      acquisitions, mergers, joint ventures, and/or other business combinations.
      The
      Company will require additional funds for its operations and to pay down its
      liabilities, as well as finance its expansion plans consistent with the
      Company’s anticipated changes in operations and infrastructure. The consolidated
      financial statements contain no adjustment for the outcome of this
      uncertainty.




**Note
      3. Restatement**





During
      the preparation process for our annual report on Form 10-KSB for 2007, we
      concluded that the Company dividends on our cumulative preferred shares were
      never officially declared and, as a result, should not have been recorded as
      a
      liability in our previous balance sheets. The impact on each balance sheet
      was
      approximately $600,000 per year. The schedule below accurately reflects the
      restated balance sheet as of December 31, 2006. Under FAS No. 128, earnings
      per
      share available to common shareholders is adjusted to reflect cumulative
      preferred stock dividends. As a result, there is no restatement related to
      previously reported income statements.





December
                31, 2006As
                PreviouslyReported
            
            Adjustments
            
            As
                RestatedAccrued
                dividends
            
            
            3,513,712
            
            
            (3,513,712
            )
            
            —Total
                liabilities
            
            $
            18,192,874
            
            
            
            
            $
            14,679,162Accumulated
                deficit
            
            
            (45,802,957
            )
            
            3,513,712
            
            
            (42,289,245
            )Total
                stockholders’ deficit
            
            $
            (16,911,311
            )
            
            
            
            $
            (13,397,599
            )




F-12




**VERTICAL
        COMPUTER SYSTEMS, INC.**




**Note
      4. Related Party Transactions**





Mr.
      Victor Weber is a Director and President of GIS and an equity owner of CWI.
      Mr.
      Sean Chumura is an equity owner of CWI and an employee of the Company. In March
      2006, CWI licensed certain software, including IA (formerly ImmuneApp) and
      StatePointPlus® to us on a partially exclusive basis to sell and support.





In
      October 2006, NOW Solutions amended a consulting agreement with Markquest,
      Inc.
      Mr. Rossetti is Executive Vice-President of Government Affairs, Chairman, CEO
      and Director of GIS, Director of NOW Solutions and an officer of Markquest.





We
      are in
      default in paying a $215,000 promissory note collateralized by a portion of
      certain revenues and owed to Victor Weber. In 2006, MRC (a company affiliated
      with Mr. Richard Wade) pledged 5,000,000 common shares to secure the note.
      MRC
      is a corporation controlled by the W5 Family Trust. Mr. Wade, our President
      and
      CEO, is the trustee of the W5 Family Trust. For
      additional details on the amendment to this note, please see “Notes Payable”
under Note 8.





In
      October 2006, we borrowed $200,000 under a promissory note, bearing interest
      at
      10% per annum, due in September 2007 and collateralized by a portion of certain
      revenues, from Mr. Weber . The
      note
      is in default.




In
      October 2006, Taladin issued to Mr. Weber a $100,000 promissory note, bearing
      interest at 12% per annum and due in October 2011. The note was issued in
      connection with a refinancing whereby Taladin acquired the indebtedness of
      NOW
      Solutions to Wamco. The note is secured by Taladin’s first lien position on the
      assets of NOW Solutions. Tara Financial, SGP, and Weber share the first lien
      position, senior to all other security interests in the assets of NOW Solutions.
      The note is payable as follows: principal and interest payments of $1,556,
      beginning on January 1, 2007 and continuing through February 1, 2008 and monthly
      principal and interest payments of $2,822, beginning on March 1, 2008 and
      continuing until March 1, 2011. The $100,000 note payable by Taladin contains
      provisions requiring additional principal reductions in the event sales by
      NOW
      Solutions exceed certain financial thresholds or if there is a judgment in
      favor
      of the Company with respect to the pending Ross litigation. For additional
      details on the Ross litigation, please see “Litigation” under Note 13 in
      the
      Notes to Consolidated Financial Statements .
      As
      incentives to make the $100,000 loan, the Company agreed to issue 1,000,000
      unregistered shares of the common stock of the Company (which was recorded
      as a
      discount to the debt) to Mr. Weber, and NOW Solutions agreed to pay Mr. Weber
      a
      0.5% royalty from its gross revenues in excess of $6.5 million, up to a cap
      of
      $100,000. The common shares of the Company have not been issued as the Company
      cannot issue shares above the authorized amount of 1,000,000,000 shares of
      common stock. For
      additional details on this note, please see “Notes Payable ”
under
      Note 8.




In
      April
      2007, we issued Mr. Rossetti 3,000,000 common shares (at a fair market value
      of
      $48,000) in connection with an agreement entered into concerning loans and
      monies owed to Mr. Rossetti and Markquest. Mr. Rossetti is Executive
      Vice-President of Government Affairs, Chairman, CEO and Director of GIS,
      Director of NOW Solutions and an officer of Markquest, Inc.





In
      March
      2007, the Company borrowed $300,000 under a promissory note, bearing interest
      at
      12% per annum and due in September 2007, from Mr. Weber. In connection with
      the
      note, MRC pledged 10,000,000 shares of common stock of the Company. The note
      is
      in default.





In
      April
      2007, Luiz Valdetaro, on behalf of the Company, transferred 2,000,000 common
      shares owned by him to Tara Financial in exchange for waiving the defaults
      and
      extending the payment terms on notes payable to Tara of $438,795, $350,560,
      $955,103 and $450,000. Mr. Valdetaro is our Chief Technology Officer. We agreed
      to reimburse Mr. Valdetaro with 2,000,000 shares within one year and pay for
      any
      related costs. This obligation is currently owed to Mr. Valdetaro.





In
      April
      2007, Mr. Valdetaro, on behalf of the Company, transferred 1,000,000 common
      shares owned by him to CCS in connection with a $40,000 loan from CCS. Also
      in April 2007, in connection with the transfer of shares to CCS, the Company
      entered into an indemnity and reimbursement agreement to reimburse Mr. Valdetaro
      with 1,000,000 shares within one year and pay for all costs associated with
      the
      transfer of shares to CCS. This obligation is currently owed to Mr.
      Valdetaro.





In
      April
      2007, the Company and MRC entered into an indemnity and reimbursement agreement
      for transfer and pledges of shares of common stock of the Company. Pursuant
      to
      the agreement, MRC loaned the Company 10,000,000 shares of common stock of
      the
      Company in order for the Company to meet current obligations concerning stock
      the Company has been obligated to issue and deliver to various
      parties.





In
      connection with a loan of 10,000,000 shares by MRC to the Company, we agreed
      to
      reimburse MRC with up to 10,000,000 shares of common stock of the Company within
      one year and pay for all costs associated with such transfer.




F-13


**VERTICAL
        COMPUTER SYSTEMS, INC.**




In
      July
      2007, the Company borrowed $46,586 from Stephen Rossetti with interest of 10%
      per annum and due on demand. In December 2007, the Company reached an agreement
      with Markquest and Stephen Rossetti related to the $113,734 note issued in
      December 2006, the $46,586 loan by Mr. Rossetti in July 2007, and $36,000 in
      fees owed to Markquest. The agreement canceled the $113,734 note and the Company
      issued a $213,139 promissory note to Markquest, bearing interest at 10% per
      annum which incorporated all of the amounts plus accrued interest. The note
      is
      to be paid in monthly interest payments of accrued interest beginning in
      February 2008 and monthly accrued interest and principal payments of $4,500
      beginning in August 2008. Mr. Rossetti is Executive Vice-President of Government
      Affairs, Chairman, CEO and Director of GIS, Director of NOW Solutions and an
      officer of Markquest. For additional details on this note, please see “Notes
      Payable” under Note 8.





In
      August
      2007, the Company borrowed $30,400 from Victor Weber with interest of 12% per
      annum and principal and interest due on demand. Mr. Weber is the President
      and a
      Director of GIS and a member of CWI.





For
      additional related party transactions subsequent to December 31, 2007, please
      see “Subsequent Events” under Note 14.





**Note
      5. Derivative** **liabilities**





During
      2007, two officers of the Company loaned a total of 13 million shares of
      unrestricted stock to the Company (see Note 4). This stock was used to satisfy
      certain obligations of the Company. In connection with the loans, the Company
      signed an agreement to replace the shares within one year. These loans were
      evaluated under FAS 133 and EITF 00-19 and were determined under EITF 00-19
      to
      have characteristics of a liability and therefore derivative liabilities under
      FAS 133. Each reporting period, this derivative liability is marked-to-market
      with the non-cash gain or loss recorded in the period as a gain or loss on
      derivatives. At December 31, 2007, the aggregate derivative liability was
      $169,000.





During
      2002 and 2003, the Company issued convertible debentures with a conversion
      features based on the market value of the stock at the date of conversion.
      The
      conversion features were evaluated under FAS 133 and EITF 00-19 and were
      determined under EITF 00-19 to have characteristics of a liability and therefore
      a derivative liability under FAS 133. The conversion prices were variable which
      caused the Company to conclude it was possible at some point in the future
      to
      not have available the number of common shares required to share settle all
      common stock equivalent instruments. This caused warrants not subject to FAS
      123
      and all other convertible debt to also be classified as derivative liabilities
      under FAS 133. Each reporting period, this derivative liability is
      marked-to-market with the non-cash gain or loss recorded in the period as a
      gain
      or loss on derivatives. At December 31, 2007, the aggregate derivative liability
      was $122,584.





The
      valuation of our embedded derivatives and warrant derivatives are determined
      primarily by the Black-Scholes option pricing model and the Lattice
      model.





**Note
      6. Property and Equipment**





Property
      and equipment consist of the following:




2007Equipment
                (3-5 year life)
            
            $
            923,060Leasehold
                improvements (5 year life)
            
            
            87,712Furniture
                and fixtures (3-5 year life)
            
            
            40,803Total
            
            
            1,051,575Accumulated
                depreciation
            
            
            (970,867
            )$
            80,708





Depreciation
      expense for 2007 and 2006 was $61,962 and $52,856, respectively.





**Note
      7. Accounts Payable and Accrued Expenses**





Accounts
      payable and accrued liabilities consist of the following:




F-14


**VERTICAL
        COMPUTER SYSTEMS, INC.**




2007Accounts
                payable
            
            $
            2,441,543Accrued
                payroll
            
            
            2,179,853Accrued
                payroll tax and penalties
            
            
            769,374Accrued
                Interest
            
            
            1,294,281Accrued
                liabilities - Other
            
            
            919,937$
            7,604,988





Accrued
      payroll primarily consists of deferred compensation for several executives
      who
      agreed to defer a portion of their salaries due to cash flow constraints.
      Accrued liabilities - other primarily consists of accrued sales and other taxes,
      and other accrued expenses. Accrued payroll tax and penalties related to unpaid
      payroll taxes, interest and penalties for prior years.





**Note
      8. Notes Payable and Convertible Debts**





December
                312007Note
                payable toRoss,
                unsecured and bearing interest at 10%. In September 2007, the court
                awarded a judgment against Ross that exceeds this amount. Refer to
                “Litigation” under Note 13.
            
            $
            750,000Note
                payable of $31,859 to a third-party lender, unsecured, bearing interest
                at
                10%, principal and interest due on demand.
            
            31,859Notes
                payable of $27,000 to a third-party, unsecured and non-interest
                bearing.
            
            27,000Note
                payable bearing interest at 13% per annum and unsecured.
                The note is in default.
            
            161,504Note
                payable of $50,000 to a third-party lender, bearing interest at 12%
                per
                annum. The note was in default. After December 31, 2007, MRC agreed
                to
                pledge 3,000,000 common shares to secure the note. Please see “Subsequent
                Events” under Note 14 for subsequent events concerning this
                note.
            
            35,568Note
                payable of $50,000 to a third-party lender, bearing interest at 12%
                per
                annum. The note has been in default since April 1, 2003.
            
            50,000Note
                payable of $25,000 to a third-party lender, bearing interest at 12%
                per
                annum, secured by 10,000,000 common shares owned by MRC due in December
                2002. MRC is a corporation controlled by the W5 Family Trust. Mr.
                Wade,
                the President and CEO of the Company, is the trustee of the W5 Family
                Trust. The note has been in default since April 1, 2003.
            
            12,583Note
                payable of $215,000 owed Victor Weber. The note bears interest at
                12%. In
                connection with the note, MRC pledged 5,000,000 common shares. MRC
                is a
                corporation controlled by the W5 Family Trust. Mr. Wade, the President
                and
                CEO of the Company, is the trustee of the W5 Family Trust. Mr. Weber
                is
                the President and a Director of GIS, a subsidiary of the Company,and
                a member of CWI.
                The note is in default.
            
            215,000Note
                payable of $25,000, bearing interest at 10% per annum, dated April
                2003.
                The note is in default.
            
            25,000Note
                payable of $17,500,bearing
                interest at 10%.This
                note is in default.
            
            11,000Note
                payable of $17,500, bearing interest at 10%. This note is in default.
            
            11,000




F-15


**VERTICAL
        COMPUTER SYSTEMS, INC.**




Note
                payable of $10,000 bearing interest at 8% per annum, unsecured, and
                due on
                June 1, 2002. This note is in default.
            
            10,000Note
                payable of $10,365 dated January 17, 2003bearing
                interest at 10% per annum, due on December 5, 2003. This note is
                in
                default.****
            
            7,365Note
                  payable of $23,030 dated March 21, 2003bearing
                  interest at 12% per annum, due on April 21, 2004. The note is in
                  default.
            
            23,030Note
                payable of $60,000 dated November 5, 2003, bearing interest at 10%
                per
                annum, due on November 5, 2004. The note is secured by 4,000,000
                common
                shares owned by MRC. MRC is a corporation controlled by the W5 Family
                Trust. Mr. Wade, the President and CEO of the Company, is the trustee
                of
                the W5 Family Trust. This note was in default.Please
                see “Subsequent Events” under Note 14 for subsequent events concerning
                this note.
            
            60,006Note
                payable of $40,000 dated November 19, 2003, bearing interest at 10%
                per
                annum, and due on November 19, 2004. The note is secured by 3,000,000
                common shares of the Company owned by MRC. MRC is a corporation controlled
                by the W5 Family Trust. Mr. Wade, the President and CEO of the Company,
                is
                the trustee of the W5 Family Trust. This note was in default.Please
                see “Subsequent Events” under Note 14 for subsequent events concerning
                this note.
            
            40,000Note
                payable of $5,000 to Mr. James Salz, unsecured, bearing interest
                at 10%
                per annum and due on demand. Mr. Salz is the Company’s corporate
                counsel.
            
            5,000Note
                payable of $10,000 to Mr. James Salz, unsecured, bearing interest
                at 10%
                per annum. Mr. Salz is the Company’s corporate counsel. The note is in
                default.
            
            10,000Note
                payable originally for $600,000 issued to Arglen Acquisitions,
                LLC.
                In August 2005, the Company agreed to pay Arglen a total of $713,489,
                which includes unpaid interest and various fees. Pursuant to the
                terms of
                the Payout Agreement, the Company is currently obligated to make
                monthly
                payments on the amount specified above of $25,000 or 10% of the Company's
                new sales, whichever is greater, until the remainder of the $713,489
                is
                paid.For
                additional details, see Note 13, “Litigation”.
            
            148,489Note
                payable of $75,000 bearing interest at 6% to the law firm Parker
                Mills
                dated October 2005. The note was due January 31, 2008 and shall be
                paid in
                equal monthly installments of $3,125, beginning February 1, 2006
                for a
                period of 24 months. Bill Mills is a company director and also a
                partner
                of Parker Mills. After December 31, 2007, MRC agreed to pledge 2,000,000
                common shares to secure the note. The note was in default. Please
                see
                “Subsequent Events” under Note 14 for subsequent events concerning this
                note.
            
            58,318Note
                payable of $992,723 to Wolman Blair, PLLC dated November 30, 2005.
                The
                note is secured with the assets of NOW Solutions and bears a default
                interest rate of 18%. The note is payable as follows: equal monthly
                installments of $40,000, each, commencing March 1, 2006, and continuing
                on
                the first day of each month thereafter, until March 1, 2008, upon
                which
                date all outstanding principal and interest shall be due. In April
                2007,
                the Company prevailed in a lawsuit against Ross and the Company is
                entitled to collect attorney fees from Ross, which will be applied
                to a
                portion of this note. For more details on legal proceedings between
                the
                Company, NOW Solutions and Ross, please refer to “Litigation” under Note
                13. The note is in default.
            
            992,723




F-16


**VERTICAL
        COMPUTER SYSTEMS, INC.**


Note
                payable of $450,000 to Tara Financial, dated February 13, 2006. The
                note
                bears interest at 12% per annum. The note is currently payable as
                follows:
                (a) unpaid principal balance and interest payments of $7,000, beginning
                on
                January 1, 2007 and continuing through February 1, 2008; and (b)
                monthly
                payments increased to $12,700, beginning on March 1, 2008 and continuing
                until February 1, 2011. The $450,000 note payable by Taladin contains
                provisions requiring additional principal reductions in the event
                sales by
                NOW Solutions exceed certain financial thresholds or from net proceeds
                collected from any judgment, settlement, or decree in favor of the
                Company
                with respect to the pending Ross litigation. For additional details
                on the
                Ross litigation, please see “Litigation” under Note 13. The $450,000 note
                also contains a conversion option pursuant to which all or any portion
                of
                the unpaid principal, plus interest, may be converted at the option
                of
                Tara Financial, into shares of common stock of Taladin equal to a
                maximum
                of 2.5% of Taladin’s outstanding common stock at the time of
                conversion.
            
            384,914Note
                payable of $150,000 owed to SGP, dated February 13, 2006. The note
                bears
                interest at 12% per annum. The note is payable as follows: (a) unpaid
                principal balance and interest payments of $2,334, beginning on January
                1,
                2007 and continuing through February 1, 2008; and (b) monthly payments
                increased $4,233, beginning on March 1, 2008 and continuing until
                March 1,
                2011. The $150,000 note payable by Taladin contains provisions requiring
                additional principal reductions in the event sales by NOW Solutions
                exceed
                certain financial thresholds or from net proceeds collected from
                any
                judgment, settlement, or decree in favor of the Company with respect
                to
                the pending Ross litigation. For additional details on the Ross
                litigation, please see “Litigation” under Note 13. The note is in
                default.
            
            121,062`Note
                payable of $438,795 to Tara Financial, dated February 13, 2006. The
                note
                bears interest at 12% per annum. The note is payable as follows:
                unpaid
                principal balance and interest payments of $5,763, beginning on January
                1,
                2007 and continuing until February 1, 2018. The new note is secured
                by an
                interest in certain technology developed by Adhesive Software and
                owned by
                the Company, commonly known as “SiteFlashTM”.
            
            404,360Note
                payable of $359,560 to Tara Financial, dated February 13, 2006. The
                note
                bears interest at 12% per annum And is payable as follows: unpaid
                principal balance and interest of $4,723, beginning on January 1,
                2007 and
                continuing until February 1, 2018 (the maturity date). The note is
                secured
                by all of the assets of NOW Solutions. This note payable also contains
                provisions requiring additional principal reductions in the event
                sales by
                NOW Solutions exceed certain financial thresholds.
            
            335,666Note
                payable of $955,103 to Tara Financial, dated February 13, 2006. The
                note
                bears interest at 12% per annum, due in 2018 and payable in monthly
                installments. of $12,544, beginning on January 1, 2007, and continuing
                until February 1, 2018 (the maturity date). The note is secured by
                all of
                the assets of NOW Solutions. This note payable also contains provisions
                requiring additional principal reductions in the event sales by NOW
                Solutions exceed certain financial thresholds.
            
            890,543Note
                payable of $51,000 dated September 2006 to a third party lender,
                bearing
                interest at 10% per annum. In connection with the loan, the Company
                issued
                1,000,000 common shares (at a fair-market value of $18,000). The
                note is
                in default.
            
            28,357Note
                payable of $200,000 issued to Mr. Weber, dated October 24, 2006.
                The note
                bears interest at 12% per annum. The Company shall pay accrued interest
                from the previous month on a monthly basis and make minimum payments
                on
                the balance of the note as follows: (a) $60,000 is due 6 months from
                the
                date of the note, (b) $30,000 is due 7 months from the date of the
                note,
                (c) $30,000 is due 8 months from the date of the note; (d) $30,000
                is due
                9 months from the date of the note; and (e) all outstanding principal
                and
                interest then outstanding is due 11 months from the date of the note.
                In
                March 2007, the payment dates for this note were extended by sixty
                (60)
                days. The note may be paid from gross revenues derived from
                StatePointPlus® after the payment of license and exclusivity fees to
                TrueBaseline for StatePoinPlus® to the extent such funds become available.
                In connection with the note, MRC pledged 5,000,000 shares of common
                stock
                of the Company to secure the note to the Company. In addition, to
                secure
                the principal payments and interest payments on a $300,000 note issued
                to
                Mr. Weber and the interest payments on this note payable, MRC pledged
                10,000,000 shares of common stock of the Company. MRC is a corporation
                controlled by the W5 Family Trust. Mr. Wade, the President and CEO
                of the
                Company, is the trustee of the W5 Family Trust. Mr. Weber is the
                President
                and a Director of GIS and a member of CWI. The note is in
                default.
            
            200,000




F-17


**VERTICAL
        COMPUTER SYSTEMS, INC.**


Note
                payable of $100,000 issued by Taladin to Mr. Weber, dated October
                27,
                2006. The note bears interest at 12% per annum. The note is secured
                by
                Taladin’s first lien position on the assets of NOW Solutions. Tara
                Financial, SGP and Mr. Weber share the first lien position, senior
                to all
                other security interests in the assets of NOW Solutions. The $100,000
                note
                payable is currently payable as follows: (a) unpaid principal balance
                and
                interest payments of $1,556, beginning on January 1, 2007 and continuing
                through February 1, 2008; and (b) monthly payments increased $2,822,
                beginning on March 1, 2008 and continuing until March 1, 2011 (the
                “Maturity
                Date”).
                The $100,000 note payable by Taladin contains provisions requiring
                additional principal reductions in the event sales by NOW Solutions
                exceed
                certain financial thresholds or from net proceeds collected from
                any
                judgment, settlement, or decree in favor of the Company with respect
                to
                the pending Ross litigation. For additional details on the Ross
                litigation, please see “Litigation” under Note 13. Mr. Weber is the
                President and a Director of GIS and a member of CWI.
            
            76,426Note
                payable of $300,000 due to Mr. Weber, bearing interest at 12% per
                annum
                and due in March 2008. The note may be paid from gross revenues derived
                from StatePointPlus® after the payment of license and exclusivity fees to
                TrueBaseline for StatePointPlus® to the extent such funds become
                available. In addition, to secure the principal payments and interest
                payments on this note and the interest payments on the $200,000 note
                issued to Mr. Weber, MRC pledged 10,000,000 shares of common stock
                of the
                Company. MRC is a corporation controlled by the W5 Family Trust.
                Mr. Wade,
                the President and CEO of the Company, is the trustee of the W5 Family
                Trust. Mr. Weber is the President and a Director of GIS and a member
                of
                CWI.
            
            300,000Note
                payable of $40,000 due to CCS, bearing interest at 12% per annum,
                and due
                in July 2007. The Company or an individual acting on the Company’s behalf
                is also obligated to arrange for a pledge of 1,000,000 shares of
                common
                stock of the Company to secure the loan. The note is in default.
                Please
                see “Subsequent Events” under Note 14 for subsequent events concerning
                this note.
            
            40,000Note
                payable, dated August 2007, for $20,000 to a third party lender,
                unsecured, bearing interest at 12% per annum, due on
                demand.
            
            20,000Note
                payable, dated August 2007, for $30,400 to Victor Weber, bearing
                interest
                at 12% per annum, due on demand. . Mr. Weber is the President and
                a
                Director of GIS and a member of CWI.
            
            30,400Note
                payable, dated December 2008, for $213,139, issued to Markquest,
                bearing
                interest at 10% per annum, payable with accrued interest beginning
                in
                February 2008 and monthly accrued interest and principal payments
                of
                $4,500 beginning in August 2008. This note was consists of amounts
                due
                under a $113,734 note issued to Stephen Rossetti in December 2006,
                which
                was cancelled, and $46,586 owed under a loan by Mr. Rossetti in July
                2007
                and $36,000 in fees owed to Markquest, plus accrued interest. Mr.
                Rossetti
                is Executive Vice-President of Government Affairs, Chairman, CEO
                and
                Director of GIS, Director of NOW Solutions and an officer of
                Markquest.
            
            213,139Total
                notes payable
            
            5,730,312Current
                maturities
            
            (3,508,593
            )Long-Term
                portion of notes payable
            
            $
            2,221,719





F-18


**VERTICAL
        COMPUTER SYSTEMS, INC.**




Future
      minimum payments for the next five years are as follows:





**Year**
            
            **Amount**2008
            
            $
            3,508,5932009
            
            
            309,5792010
            
            
            346,6672011
            
            
            273,8872012
            
            
            186,5972013+
            
            
            1,104,989Total
                notes payable
            
            $
            5,730,312




**Convertible
      Debentures**





Convertible
                debentures dated March 29, 2002, bearing interest at 5%, convertible
                into
                shares of the Company’s common stock at the debt holder’s choice of either
                120% of the closing bid price on the date of agreement or 80% of
                the
                lowest closing bid price five days prior to the conversion. The debenture
                is convertible at the option of the holder at any time after purchase.
                Principal and interest were due at maturity on March 28, 2004. This
                debenture was originally issued in the principal amount of
                $100,000.
            $
            10,000In
                December 2003, the Company issued a debenture in the amount of $30,000
                to
                a third party. The Company received net proceeds of $26,000 for the
                debenture. The debt accrues interest at 5% per annum and was due
                December
                2005. The holder may convert the debenture into shares of common
                stock at
                100% of the closing price for the preceding trading day after the
                Company
                receives notice of conversion.
            
            30,000Total
                convertible debentures
            
            40,000Current
                maturities
            
            40,000Long-term
                portion of convertible debentures
            $
            —




**Note
      9. Income Taxes**


We
        account for income taxes in accordance with Statement of Financial Standards
        No.
        109, “Accounting for Income Taxes,” which uses the asset and liability method of
        accounting for income taxes. Deferred income taxes are recognized for the
        tax
        consequences of “temporary differences” by applying enacted statutory tax rate
        applicable to future years to differences between the financial statement
        carrying amounts and the tax basis of existing assets and liabilities and
        result
        primarily form differences in methods used to amortize intangible assets.
        A
        valuation allowance is provided when management cannot determine whether
        it is
        more likely than not that the deferred tax asset will be realized. The effect
        on
        deferred income taxes of the change in tax rates is recognized in income
        in the
        period that includes the enactment date. The difference between the statutory
        tax rate and the effective tax rate is the valuation allowance.




Temporary
      difference between the financial statement carrying amount and tax bases of
      assets and liabilities that give rise to deferred tax assets relate to the
      following:





December
                31,2007Net
                operating loss carry-forward
            
            $
            10,753,000Valuation
                allowance
            
            
            (10,753,000
            )$
            —




F-19


**VERTICAL
        COMPUTER SYSTEMS, INC.**




At
      December 31, 2007, the Company had available net operating loss carry-forwards
      of approximately $21.6 million for federal tax purposes and $15.6 million for
      state tax purposes, which expire in varying amounts through 2027 and 2012,
      respectively.





**Note
      10. Stockholders’ Equity**





**2006**





**Common
      Stock**





In
      February 2006, the Company issued 5,000,000 common shares (at a fair market
      value of $45,000) as partial incentive for Tara Financial to make the $450,000
      loan and to refinance approximately $1.75 million of existing debt. For details
      on the note payable issued in connection with the loan, please see “Notes
      Payable” under Note 8.





In
      February 2006, the Company issued 3,000,000 common shares (at a fair market
      value of $27,000) **** as
      partial incentive for SGP to make the $150,000 loan. For details on the note
      payable issued in connection with the loan, please see “Notes Payable” under
      Note 8.





In
      May
      2006, a third party converted 1,500 shares of Series A, 4% Convertible
      Cumulative Preferred Stock into 750,000 shares of common stock.





In
      July
      2006, the Company issued a total of 500,000 common shares to two third party
      lenders pursuant to their exercise of warrants to purchase the shares for a
      total of $3,750, which was offset against prior monies owed to each
      lender.





In
      July
      2006, a director of GIS exercised warrants to purchase 1,250,000 common shares
      for $12,500, which was offset against prior monies owed to the director. These
      shares were issued in 2007.





In
      September 2006, the Company issued 1,000,000 common shares (at a fair-market
      value of $18,000) to a third party lender in connection with a $50,000 loan
      made
      at that time.





In
      October 2006, the Company agreed to issue 1,000,000 common shares (at a fair
      market value of $21,000) to Mr. Weber in connection with a $100,000 loan. These
      shares have not been issued.




In
      2007,
      the Company issued 3,000,000 common shares to Mr. Rossetti for refinancing
      an
      outstanding $66,000 note payable and other obligations for a new loan of
      $113,734. **** The
      fair
      market value of the shares to be issued is $48,000.





During
      2006, a $190,000 debenture was converted into 24,298,094 common
      shares.




During
      2006, $40,800 in liquidated damages claimed by Cornell in connection with a
      $200,000 debenture issued by the Company to Cornell in April 2003 was converted
      into 4,387,095 common shares.





During
      2006, the Company agreed to issue 12,525,000 common shares to employees and
      consultants for services. The stock will vest over one to three years. Of these
      shares, all shares were issued during 2006 except for 200,000 issued in 2007.





During
      2006, 3,866,666 common shares held by employees were cancelled.





During
      2006, 5,449,998 common shares issued to employees and consultants under vesting
      agreements in 2005 and 2006 vested in 2006.





**Preferred
      Stock**





Since
      inception, the Company has paid no cash dividends to the stockholders of Series
      A and Series C preferred stock.





During
      2006, one employee resigned. Consequently, NOW Solutions cancelled 1.5%
      ownership interest of “phantom stock”.





During
      2006, a third party converted 1,500 shares of Series A, 4% Convertible
      Cumulative Preferred Stock into 750,000 common shares.




F-20


**VERTICAL
        COMPUTER SYSTEMS, INC.**




**2007**





**Common
      Stock**





In
      April
      2007, Luiz Valdetaro, on behalf of the Company, transferred 2,000,000
      unrestricted shares of common stock of the Company owned by Mr. Valdetaro to
      an
      officer of Tara Financial in exchange for waiving the defaults and extending
      the
      payment terms on several notes payable in the amounts of $438,795, $350,560,
      $955,103 and $450,000 issued to Tara Financial by the Company, NOW Solutions,
      and Taladin in February 2006. Also in April 2007, in connection with the
      transfer, the Company entered into an indemnity and reimbursement agreement
      to
      reimburse Mr. Valdetaro with 2,000,000 shares within one year and pay for all
      costs associated with the transfer of shares to Tara Financial and the
      reimbursement of shares to Mr. Valdetaro. Mr. Valdetaro is the Chief Technology
      Officer of the Company. This transaction was evaluated under FAS 133 and EITF
      00-19 and was determined under EITF 00-19 to have characteristics of a liability
      and therefore a derivative liability under FAS 133.





Also
      in
      April 2007, Mr. Valdetaro, on behalf of the Company, transferred 1,000,000
      unrestricted shares of common stock of the Company owned by Mr. Valdetaro to
      CCS
      in connection with a $40,000 loan made by CCS to the Company. The Company is
      also obligated to arrange for a pledge of 1,000,000 shares of common stock
      of
      the Company to secure the loan. Also in April 2007, in connection with the
      transfer of shares to CCS, the Company entered into an indemnity and
      reimbursement agreement to reimburse Mr. Valdetaro with 1,000,000 shares within
      one year and pay for all costs associated with the transfer of shares to CCS
      and
      the reimbursement of shares to Mr. Valdetaro. Mr. Valdetaro is the Chief
      Technology Officer of the Company. This transaction was evaluated under FAS
      133
      and EITF 00-19 and was determined under EITF 00-19 to have characteristics
      of a
      liability and therefore a derivative liability under FAS 133.





In
      April
      2007, the Company and MRC entered into an indemnity and reimbursement agreement
      for transfer and pledges of shares of common stock of the Company. Pursuant
      to
      the agreement, MRC loaned the Company 10,000,000 shares of common stock of
      the
      Company in order for the Company to meet current obligations concerning stock
      the Company has been obligated to issue and deliver. In connection with the
      loan
      of shares to the Company, the Company agreed to reimburse MRC with up to
      10,000,000 shares of common stock of the Company and pay for all costs
      associated with such transfer and the reimbursement of shares to MRC within
      one
      year. In addition, in the event that any of the shares of common stock of the
      Company pledged by MRC on behalf of the Company in connection with promissory
      notes issued by the Company (or its subsidiaries, as applicable) are sold to
      cover a default under the respective note, the Company agreed to reimburse
      MRC
      with a number of shares equal to the number of shares sold to cover the default
      under the respective note within 1 year, and to reimburse MRC for all costs
      associated with such sales and the reimbursement of shares to MRC related to
      such sales. This transaction was evaluated under FAS 133 and EITF 00-19 and
      was
      determined under EITF 00-19 to have characteristics of a liability and therefore
      a derivative liability under FAS 133.





During
      2007, the Company granted 4,550,000 unregistered shares of common stock of
      the
      company to employees and consultants of the Company and NOW Solutions pursuant
      to restricted stock agreements. 500,000 of these unrestricted shares vested
      immediately with the remaining shares vesting over a period from one to three
      years, as provided.





During
      2007, 1,369,042 unregistered shares of common stock of the Company were
      cancelled pursuant to restricted stock agreements between the Company and
      employees of NOW Solutions. These shares were not vested at the date of
      cancellation and had never been issued.





During
      2007, 4,589,292 unregistered shares of common stock issued to employees and
      consultants of the Company and NOW Solutions vested. These shares were issued
      pursuant to restricted stock agreements executed in 2005-2007.





**Preferred
      Stock**





Although
      no dividends have been declared, the cumulative total of preferred stock
      dividends due to these shareholders upon declaration is $4,101,712.





**Note
      11. Stock Options and Warrants**





In
      December 1999, the Company established a stock option plan allowing grants
      of
      both Incentive Stock Options (within the meaning of Section 422 and the Internal
      Revenue Code of 1986, as amended) and non-statutory options. The Company can
      issue up to 50,000,000 shares. Most options issued are non-assignable,
      non-transferable, vested on the date of grant, and expire three to five years
      from the date of grant. The plan expires in December 15, 2009.




F-21


**VERTICAL
        COMPUTER SYSTEMS, INC.**




**2006**





There
      were no non-statutory stock options, incentive stock options or warrants granted
      in 2006.





During
      2006, incentive stock options to purchase 1,500,000 common shares at $0.01
      per
      share were cancelled in connection with the issuance of common shares to an
      employee.





During
      2006, warrants to purchase 21,966,667 common shares at $0.0165 to $0.10 per
      share expired or were cancelled.





**2007**





There
      were no non-statutory stock options, incentive stock options or warrants granted
      in 2007.





During
      2007, warrants to purchase 6,894,444 common shares at $0.01 to $0.10 per share
      expired.





Option
      and warrant activities in 2006 and 2007 are summarized as follows:





Incentive Stock
              Options
            
            Non-Statutory
              Stock Options
            
            Warrants
            
            Weighted
              Average Exercise
              PriceOutstanding
                at 12/31/05
            
            
            4,000,000
            
            
            —
            
            
            52,111,111
            
            
            0.039Options/Warrants
                granted
            
            
            —
            
            
            —
            
            
            —
            
            
            —Options/Warrants
                exercised
            
            
            —
            
            
            —
            
            
            1,750,000
            
            
            0.009Options/Warrants
                expired/cancelled
            
            
            1,500,000
            
            
            —
            
            
            21,966,667
            
            
            0.045Outstanding
                at 12/31/06
            
            
            2,500,000
            
            
            —
            
            
            28,394,444
            
            
            0.034Options/Warrants
                granted
            
            
            —
            
            
            —
            
            
            —
            
            
            —Options/Warrants
                exercised
            
            
            —
            
            
            —
            
            
            —
            
            
            —Options/Warrants
                expired/cancelled
            
            
            —
            
            
            —
            
            
            6,894,444
            
            
            0.092Outstanding
                at 12/31/07
            
            
            2,500,000
            
            
            —
            
            
            21,500,000
            
            
            0.017




Information
      relating to stock options/warrants at December 31, 2007, summarized by exercise
      price, is as follows:





Warrants/Options
                Outstanding
            
            ExercisableWeightedAverage
            
            Weighted
            
            
            
            WeightedRemaining
            
            Average
            
            
            
            AverageNumber
            
            Contractual
            
            Exercise
            
            Number
            
            ExerciseExercise
                Price Per Share
            
            Outstanding
            
            Life (Months)
            
            Price
            
            Exercisable
            
            PriceIncentive
                Stock Options$0.01
                - $0.09
            
            
            2,500,000
            
            
            14.17
            
            $
            0.014
            
            
            2,500,000
            
            $
            0.0142,500,000
            
            
            14.17
            
            $
            0.014
            
            
            2,500,000
            
            $
            0.014Warrants$0.003
                - $0.100
            
            
            21,500,000
            
            
            10.63
            
            $
            0.017
            
            
            21,500,000
            
            $
            0.01721,500,000
            
            
            10.63
            
            $
            0.017
            
            
            21,500,000
            
            $
            0.017Grand
                total
            
            
            24,000,000
            
            
            11.00
            
            $
            0.0168
            
            
            24,000,000
            
            $
            0.0168




F-22


**VERTICAL
        COMPUTER SYSTEMS, INC.**




**Note
      12. Supplemental Disclosure of Cash Flow Information**





Supplemental
      cash flow information for the years ended December 31, 2007 and 2006 are as
      follows:





December
                31,2007
            
            2006Cash
                paid for interest
            
            $
            440,565
            
            $
            310,033




Non-cash
      activities for the years ended December 31, 2007 and 2006 were as
      follows:





December
                31,2007
            
            2006Conversion
                of debentures to 24,298,094 shares of common stock
            
            $
            —
            
            $
            189,999Conversion
                of accounts payable and accrued liabilities to notes
                payable
            
            
            52,811
            
            
            602,2314,387,095
                shares of common stock issued for damages claimed with an equity
                line of
                credit
            
            
            —
            
            
            40,800Issuance
                of 13,000,000 shares of common stock for incentive to refinance debt
                and
                obtain new debt
            
            
            —
            
            
            159,000Shares
                loaned to the Company by stockholder
            
            
            343,000
            
            
            —Issuance
                of 1,750,000 shares of common stock for debt forgiveness
            
            
            —
            
            
            16,250395,811
            
            $
            1,088,280





**Note
      13. Commitments and Contingencies**





**Commitments**





The
      Company leases various office spaces which leases run from February 2004 through
      September 2009. The Company had future minimum rental payments are as
      follows:





*Years ending December 31,*
            
            *Amount*2008
            
            
            87,0042009
            
            
            45,748Total
            
            $
            132,792





Rental
      expense for the years ended December 31, 2007 and 2006 was $211,564 and
      $151,145, respectively.





**Commitments
      Related to NOW Solutions**





Effective
      on October 1, 2005, NOW Solutions began paying the Company a monthly management
      fee of $20,000, plus all direct costs associated with the NOW Solutions’
management and operations incurred by the Company.




F-23


**VERTICAL
        COMPUTER SYSTEMS, INC.**




**Royalties**





On
      December 16, 1999, the Company acquired the software rights to Emily, an
      XML computer language, for $5,000. As part of the agreement, the Company agreed
      to pay royalties every six months, based on the net sales of products sold
      that were developed using the Emily computer language. Royalties range from
      1%
      to 5% of net sales. There were no sales for the years ended December 31, 2007
      and 2006, respectively.





**Payroll
      Taxes**





The
      Company has filed all payroll tax returns but has not made all related tax
      payments since 2003. The Company has accrued the payroll tax payments and
      approximately $125,000 for any related penalties and interest that may be
      assessed by the Internal Revenue Service. Management believes that the $125,000
      is sufficient to cover the penalties and interest that may be assessed. NOW
      Solutions has filed all payroll tax returns and made all payroll tax payments.
      For additional details, please see “Litigation” below.





**Litigation**





The
      Company is involved in the following ongoing legal matters:




In
      February 2003, we sued Ross
      Systems Inc. (“ Ross ”) ,
      Arglen,
      Tinley, and Gyselen. We then stopped payments on the remaining $750,000 note
      that was due in February 2003 in connection with the acquisition of certain
      assets of Ross. The actions against Tinley, Arglen and Gyselen were dismissed
      or
      settled in December 2003. In September 2007, the court awarded us a judgment
      of
      $3,151,216, which we are seeking to collect. In November 2007, Ross gave notice
      of its intention to appeal the decision and posted a bond in the amount of
      the
      judgment. The $750,000 note payable and accrued interest are still shown on
      our
      books until Ross’s appeal is settled.





In
      August
      2004, Arglen obtained a default judgment in a court for a past due $600,000
      promissory note, plus fees and interest. We agreed to pay Arglen $713,489 and
      we
      began making monthly interest payments on the amounts specified above of $5,945,
      beginning on September 15, 2005, which will be replaced by monthly payments
      of
      $25,000 or 10% of the Company's new sales, whichever is greater, beginning
      on
      February 15, 2006 until the remainder of the $713,489 is paid.





The
      IRS
      has a claim for unpaid payroll taxes of $313,839 from 2001 - 2005. On March
      9,
      2007, we filed an appeal with the United States Tax Court, seeking an
      installment payout agreement. This action is still pending.





On
      April
      18, 2007, we sued Microsoft Corp. for patent infringement and trial is set
      for
      March 2009.





In
      the
      opinion of management, the ultimate resolution of any pending matters may have
      a
      significant effect on our financial position, operations or cash
      flows.





**Note
      14. Subsequent Events**




In
      January 2008, the Company and TranStar amended the terms of a $250,000 note
      issued in April 2003, whereby accrued interest of $118,219 was added to the
      principal amount and the maturity date was extended to September 2009. Also
      in
      January 2008, the Company and TranStar amended the terms of a $24,000 note
      issued in May 2001, whereby accrued interest of $15,564 was added to the
      principal amount and the maturity date was extended until June
      2009.





In
      January 2008, we issued 250,000 common shares to a third party lender as payment
      the extension of the maturity dates of two promissory notes for $60,000 and
      $40,000 until June 2008.





In
      February 2008, we refinanced a $50,000 note issued in June 2002 by issuing
      500,000 common shares and replacing that old note with a new $96,946 promissory
      note, bearing interest at 12% per annum and due in September 2008. In connection
      with the refinancing, MRC pledged 3,000,000 Company common shares as collateral.
      MRC is a corporation controlled by the W5 Family Trust. Mr. Wade, the President
      and CEO of the Company, is the trustee of the W5 Family Trust.





In
      February 2008, the Company issued 250,000 common shares to William Mills for
      his
      services as a director and secretary. The shares vest in February 2009.





In
      March
      2008, Parker Mills and the Company amended the payment terms of a $75,000 note
      issued in October 2005 by extending the maturity date to June 2009. In
      connection with the amendment, MRC
      pledged 2,000,000 shares of common
      stock of the Company as collateral on the note. MRC is a corporation controlled
      by the W5 Family Trust. Mr. Wade, the President and CEO of the Company, is
      the
      trustee of the W5 Family Trust. Bill Mills is a Director of the Company and
      a
      partner of Parker Mills.




F-24


**VERTICAL
        COMPUTER SYSTEMS, INC.**




In
      March
      2008, the Company and MRC amended their indemnity and reimbursement agreement
      whereby the Company agreed to reimburse and indemnify MRC for additional shares
      pledged as collateral in connection with the $96,946 and $75,000
      note s .
      MRC is
      a corporation controlled by the W5 Family Trust. Mr. Wade, the President and
      CEO
      of the Company, is the trustee of the W5 Family Trust.





For
      the
      period from January 1, 2008 to April 13, 2008, warrants to purchase 6,000,000
      shares of common stock of the Company at an exercise price of $0.010 per share
      expired.





For
      the
      period from January 1, 2008 to April 13, 2008, 1,683,332 unregistered shares
      of
      the common stock of the Company vested. These shares were issued pursuant to
      restricted stock agreements with employees of the Company and NOW Solutions
      executed in 2006 and 2007.





As
      of the
      Date of this Report for the year ended December 31, 2007, the Company has also
      determined that it currently has (i) the following shares of common stock
      issued, and (ii) outstanding instruments which are convertible into the shares
      of common stock indicated below in connection with stock options, warrants,
      and
      preferred shares previously issued by the Company or agreements with the
      Company:





998,235,151
            
            Common
                Stock Issued15,500,000
            
            Common
                Shares that may be purchased from outstanding Warrants2,500,000
            
            Common
                Shares convertible from Outstanding Options24,250,000
            
            Common
                Shares convertible from Preferred Series A stock (48,500 shares
                outstanding)27,274
            
            Common
                Shares convertible from Preferred Series B stock (7,200 shares
                outstanding)20,000,000
            
            Common
                Shares convertible from Preferred Series C (50,000 shares
                outstanding)94,700
            
            Common
                Shares convertible from Preferred Series D (25,000 shares
                outstanding)1,000,000
            
            Common
                Shares that the Company has agreed to issue pursuant to agreements13,000,000
            
            Common
                Shares that the Company has agreed to issue within 1 year to an employee
                of the Company and an entity beneficially owned by an Executive of
                the
                Company pursuant to agreements1,074,607,125
            
            **Total
                Common Shares Outstanding and Accounted
                For/Reserved**





In
      addition, the Company has $40,000 in outstanding debentures that it has issued
      to third parties.





Accordingly,
      given the fact that the Company currently has 1,000,000,000 shares of common
      stock authorized, the Company could exceed its authorized shares of common
      stock
      by approximately 75,000,000 shares if all of the financial instruments described
      in the table above were exercised or converted into shares of common stock
      (excluding the $40,000 of outstanding debentures noted above).




F-25