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<p style="font: bold 10pt Times New Roman, Times, Serif; margin: 0; text-align: justify; text-indent: 0in"><font style="font: 10pt Times New Roman, Times, Serif"><b>Note
1. Organization, Basis of Presentation and Significant Accounting Policies</b></font></p>
<p style="font: bold 10pt Times New Roman, Times, Serif; margin: 0; text-align: justify; text-indent: 0in"><font style="font: 10pt Times New Roman, Times, Serif"> </font></p>
<p style="font: 10pt Times New Roman, Times, Serif; margin: 0; text-align: justify; text-indent: 0.5in"><font style="font: 10pt Times New Roman, Times, Serif">The
accompanying unaudited interim consolidated financial statements of Vertical Computer Systems, Inc. (‘we”, “our”,
the “Company”, “Vertical” or “VCSY”) have been prepared in accordance with accounting principles
generally accepted in the United States of America and rules of the Securities and Exchange Commission, and should be read
in conjunction with the audited consolidated financial statements and notes thereto contained in Vertical’s annual report
on Form 10-K for the year ended December 31, 2014. The consolidated financial statements include the accounts of the Company and
its subsidiaries (collectively, “our”, “we”, the “Company” or “VCSY”, as applicable).
Vertical’s subsidiaries which currently maintain daily business operations are NOW Solutions, a 75% owned subsidiary, and
SnAPPnet, Inc. (“SnAPPnet”), an 80% owned subsidiary of Vertical. Vertical’s subsidiaries which have minimal operations
are Vertical do Brasil, Taladin, Inc. (“Taladin"), and Vertical Healthcare Solutions, Inc. (“VHS”), each a wholly-owned
subsidiary of Vertical, as well as Priority Time Systems, Inc. (“Priority Time”) a 70% owned subsidiary, Ploinks, Inc.
(“Ploinks”) (formerly, OptVision Research, Inc.), a 93% owned subsidiary and Government Internet Systems, Inc. (“GIS”),
an 84.5% owned subsidiary, Vertical’s subsidiaries which are inactive include EnFacet, Inc. (“ENF”), Globalfare.com,
Inc. (“GFI”), Pointmail.com, Inc. and Vertical Internet Solutions, Inc. (“VIS”), each of which is a wholly-owned
subsidiary of Vertical. In the opinion of management, all adjustments, consisting of normal recurring adjustments, necessary for
a fair presentation of financial position and the results of operations for the interim periods presented have been reflected
herein. The results of operations for interim periods are not necessarily indicative of the results to be expected for the full
year. Notes to the consolidated financial statements which would substantially duplicate the disclosure contained in the audited
financial statements as reported in the 2014 annual report on Form 10-K have been omitted.</font></p>
<p style="font: 10pt Times New Roman, Times, Serif; margin: 0; text-align: justify; text-indent: 0.5in"><font style="font: 10pt Times New Roman, Times, Serif"> </font></p>
<p style="font: 10pt Times New Roman, Times, Serif; margin: 0; text-align: justify"><font style="font: 10pt Times New Roman, Times, Serif"><b><i>Earnings
per share</i></b></font></p>
<p style="font: 10pt Times New Roman, Times, Serif; margin: 0; text-align: justify"><font style="font: 10pt Times New Roman, Times, Serif"><b><i> </i></b></font></p>
<p style="font: 10pt Times New Roman, Times, Serif; margin: 0; text-align: justify; text-indent: 0.5in"><font style="font: 10pt Times New Roman, Times, Serif">Basic
earnings per share is calculated by dividing net income (loss) available to common stockholders by the weighted average number
of shares of the Company’s common stock outstanding during the period. “Diluted earnings per share” reflects the
potential dilution that could occur if our share-based awards, stock warrants and convertible securities were exercised or converted
into common stock. The dilutive effect of our share-based awards is computed using the treasury stock method, which assumes all
share-based awards are exercised and the hypothetical proceeds from exercise are used to purchase common stock at the average
market price during the period. The incremental shares (difference between shares assumed to be issued versus purchased), to the
extent they would have been dilutive, are included in the denominator of the diluted EPS calculation. The dilutive effect of our
convertible preferred stock and convertible debentures is computed using the if-converted method, which assumes conversion at
the beginning of the year.</font></p>
<p style="font: 10pt Times New Roman, Times, Serif; margin: 0; text-align: justify"><font style="font: 10pt Times New Roman, Times, Serif"> </font></p>
<p style="font: 10pt Times New Roman, Times, Serif; margin: 0; text-align: justify; text-indent: 0.5in"><font style="font: 10pt Times New Roman, Times, Serif">For
the nine months ended September 30, 2015 and 2014, common stock equivalents related to the convertible debentures, convertible
debt and preferred stock and stock derivative liability were not included in the calculation of the diluted earnings per share
as their effect would be anti-dilutive.</font></p>
<p style="font: 10pt Times New Roman, Times, Serif; margin: 0; text-align: justify; text-indent: 0.5in"><font style="font: 10pt Times New Roman, Times, Serif"> </font></p>
<p style="font: 10pt Times New Roman, Times, Serif; margin: 0; text-align: justify"><font style="font: 10pt Times New Roman, Times, Serif"><b><i>Reclassifications</i></b></font></p>
<p style="font: 10pt Times New Roman, Times, Serif; margin: 0; text-align: justify"><font style="font: 10pt Times New Roman, Times, Serif"> </font></p>
<p style="font: 10pt Times New Roman, Times, Serif; margin: 0; text-align: justify; text-indent: 0.5in"><font style="font: 10pt Times New Roman, Times, Serif">Certain
reclassifications have been made to the prior periods to conform to the current period presentation.</font></p>
<p style="font: 10pt Times New Roman, Times, Serif; margin: 0; text-align: justify; text-indent: 0.5in"><font style="font: 10pt Times New Roman, Times, Serif"> </font></p>
<p style="font: 10pt Times New Roman, Times, Serif; margin: 0; text-align: justify; text-indent: 0in"><font style="font: normal 10pt Times New Roman, Times, Serif"><i>Capitalized
Software Costs</i></font></p>
<p style="font: 10pt Times New Roman, Times, Serif; margin: 0; text-align: justify; text-indent: 0in"><font style="font: normal 10pt Times New Roman, Times, Serif"><i> </i></font></p>
<p style="font: 10pt Times New Roman, Times, Serif; margin: 0; text-align: justify; text-indent: 0.5in"><font style="font: normal 10pt Times New Roman, Times, Serif">Software
costs incurred internally in creating computer software products are expensed until technological feasibility has been established
upon completion of a detailed program design. Thereafter, all software development costs are capitalized until the point that
the product is ready for sale, and are subsequently reported at the lower of unamortized cost or net realizable value. The Company
considers annual amortization of capitalized software costs based on the ratio of current year revenues by product to the total
estimated revenues by the product, subject to an annual minimum based on straight-line amortization over the product’s estimated
economic useful life, not to exceed five years. The Company periodically reviews capitalized software costs for impairment where
the fair value is less than the carrying value.</font></p>
<p style="font: 10pt Times New Roman, Times, Serif; margin: 0; text-align: justify; text-indent: 0.5in"><font style="font: normal 10pt Times New Roman, Times, Serif"> </font></p>
<p style="font: 10pt Times New Roman, Times, Serif; margin: 0; text-align: justify; text-indent: 0.5in"><font style="font: normal 10pt Times New Roman, Times, Serif">During
the nine months ended September 30, 2015, the Company capitalized an aggregate of $489,148 related to software development.</font><font style="font: 10pt Times New Roman, Times, Serif"> </font></p>
<p style="font: 10pt Times New Roman, Times, Serif; margin: 0"><font style="font: 10pt Times New Roman, Times, Serif">  </font></p>
<p style="font: 10pt Times New Roman, Times, Serif; margin: 0; text-align: justify; text-indent: 0.5in"><font style="font: normal 10pt Times New Roman, Times, Serif">During
the nine months ended September 30, 2014, the Company capitalized an aggregate of $298,523 related to software development and
the Company recorded impairment of $579,204 on previously capitalized software development costs.</font></p>
<p style="font: 10pt Times New Roman, Times, Serif; margin: 0; text-align: justify; text-indent: 0.5in"><font style="font: 10pt Times New Roman, Times, Serif"> </font></p>
<p style="font: bold 10pt Times New Roman, Times, Serif; margin: 0; text-align: justify; text-indent: 0in"><font style="font: 10pt Times New Roman, Times, Serif"><b><i>Recently
Issued Accounting Pronouncements</i></b></font></p>
<p style="font: bold 10pt Times New Roman, Times, Serif; margin: 0; text-align: justify; text-indent: 0in"><font style="font: 10pt Times New Roman, Times, Serif"> </font></p>
<p style="font: 10pt Times New Roman, Times, Serif; margin: 0; text-align: justify; text-indent: 0.5in"><font style="font: 10pt Times New Roman, Times, Serif">The
Company does not expect the adoption of any recently issued accounting pronouncements to have a material impact on the Company’s
financial position, operations or cash flows.</font></p>
<p style="font: bold 10pt Times New Roman, Times, Serif; margin: 0; text-align: justify; text-indent: 0in"><font style="font: 10pt Times New Roman, Times, Serif"><b>Note
2. Going Concern</b></font></p>
<p style="font: bold 10pt Times New Roman, Times, Serif; margin: 0; text-align: justify; text-indent: 0in"><font style="font: 10pt Times New Roman, Times, Serif"> </font></p>
<p style="font: 10pt Times New Roman, Times, Serif; margin: 0; text-align: justify; text-indent: 0.5in"><font style="font: 10pt Times New Roman, Times, Serif">The
accompanying unaudited consolidated financial statements for the nine months ended September 30, 2015 and 2014 have been prepared
assuming that we will continue as a going concern, and accordingly realize our assets and satisfy our liabilities in the normal
course of business.</font></p>
<p style="font: 10pt Times New Roman, Times, Serif; margin: 0; text-align: justify; text-indent: 0.5in"></p>
<p style="font: 10pt Times New Roman, Times, Serif; margin: 0; text-align: justify"><font style="font: 10pt Times New Roman, Times, Serif"> </font></p>
<p style="font: 10pt Times New Roman, Times, Serif; margin: 0; text-align: justify; text-indent: 0.5in"><font style="font: 10pt Times New Roman, Times, Serif">The
carrying amounts of assets and liabilities presented in the consolidated financial statements do not purport to represent realizable
or settlement values. As of September 30, 2015, we had negative working capital of approximately $15 million and defaulted on
several of our debt obligations. These conditions raise substantial doubt about our ability to continue as a going concern.</font></p>
<p style="font: 10pt Times New Roman, Times, Serif; margin: 0; text-align: justify; text-indent: 0.5in"><font style="font: 10pt Times New Roman, Times, Serif"> </font></p>
<p style="font: 10pt Times New Roman, Times, Serif; margin: 0; text-align: justify; text-indent: 0.5in"><font style="font: 10pt Times New Roman, Times, Serif">Our
management is continuing its efforts to attempt to secure funds through equity and/or debt instruments for our operations, expansion
and possible acquisitions, mergers, joint ventures, and/or other business combinations. The Company will require additional funds
to pay down its liabilities, as well as finance its expansion plans consistent with anticipated changes in operations and infrastructure.
However, there can be no assurance that the Company will be able to secure additional funds and that if such funds are available,
whether the terms or conditions would be acceptable to the Company and whether the Company will be able to turn into a profitable
position and generate positive operating cash flow. The consolidated financial statements contain no adjustment for the outcome
of this uncertainty.</font></p>
<p style="font: 10pt Times New Roman, Times, Serif; margin: 0; text-align: justify"><font style="font: 10pt Times New Roman, Times, Serif"><b>Note
3. Notes Payable</b></font></p>
<p style="font: 10pt Times New Roman, Times, Serif; margin: 0; text-align: justify; text-indent: 0.5in"><font style="font: 10pt Times New Roman, Times, Serif"> </font></p>
<p style="font: 10pt Times New Roman, Times, Serif; margin: 0; text-align: justify; text-indent: 0.5in"><font style="font: 10pt Times New Roman, Times, Serif">The
following table reflects our third party debt activity, including our convertible debt, for the nine months ended September 30,
2015:</font></p>
<p style="font: 10pt Times New Roman, Times, Serif; margin: 0; text-align: justify; text-indent: 0.5in"><font style="font: 10pt Times New Roman, Times, Serif"> </font></p>
<table cellspacing="0" cellpadding="0" align="center" style="width: 70%; border-collapse: collapse; font-size: 10pt">
<tr style="background-color: rgb(204,238,255); vertical-align: bottom">
<td style="width: 87%"><font style="font: 10pt Times New Roman, Times, Serif">December 31, 2014</font></td>
<td style="width: 1%"><font style="font: 10pt Times New Roman, Times, Serif"> </font></td>
<td style="text-align: left; width: 1%"><font style="font: 10pt Times New Roman, Times, Serif">$</font></td>
<td style="text-align: right; width: 10%"><font style="font: 10pt Times New Roman, Times, Serif">4,575,239</font></td>
<td style="text-align: left; width: 1%"><font style="font: 10pt Times New Roman, Times, Serif"> </font></td></tr>
<tr style="background-color: white; vertical-align: bottom">
<td style="text-align: left"><font style="font: 10pt Times New Roman, Times, Serif">Repayments of third party notes</font></td>
<td><font style="font: 10pt Times New Roman, Times, Serif"> </font></td>
<td style="text-align: left"><font style="font: 10pt Times New Roman, Times, Serif"> </font></td>
<td style="text-align: right"><font style="font: 10pt Times New Roman, Times, Serif">(52,448</font></td>
<td style="text-align: left"><font style="font: 10pt Times New Roman, Times, Serif">)</font></td></tr>
<tr style="background-color: rgb(204,238,255); vertical-align: bottom">
<td style="text-align: left"><font style="font: 10pt Times New Roman, Times, Serif">Borrowings from third parties</font></td>
<td><font style="font: 10pt Times New Roman, Times, Serif"> </font></td>
<td style="text-align: left"><font style="font: 10pt Times New Roman, Times, Serif"> </font></td>
<td style="text-align: right"><font style="font: 10pt Times New Roman, Times, Serif">885,333</font></td>
<td style="text-align: left"><font style="font: 10pt Times New Roman, Times, Serif"> </font></td></tr>
<tr style="background-color: white; vertical-align: bottom">
<td style="text-align: left"><font style="font: 10pt Times New Roman, Times, Serif">Stock issued for debt payments</font></td>
<td><font style="font: 10pt Times New Roman, Times, Serif"> </font></td>
<td style="text-align: left"><font style="font: 10pt Times New Roman, Times, Serif"> </font></td>
<td style="text-align: right"><font style="font: 10pt Times New Roman, Times, Serif">(258,552</font></td>
<td style="text-align: left"><font style="font: 10pt Times New Roman, Times, Serif">)</font></td></tr>
<tr style="background-color: rgb(204,238,255); vertical-align: bottom">
<td style="text-align: left"><font style="font: 10pt Times New Roman, Times, Serif">Debt discounts due to stock and warrants
issued with debt</font></td>
<td><font style="font: 10pt Times New Roman, Times, Serif"> </font></td>
<td style="text-align: left"><font style="font: 10pt Times New Roman, Times, Serif"> </font></td>
<td style="text-align: right"><font style="font: 10pt Times New Roman, Times, Serif">(153,288</font></td>
<td style="text-align: left"><font style="font: 10pt Times New Roman, Times, Serif">)</font></td></tr>
<tr style="background-color: white; vertical-align: bottom">
<td style="text-align: left"><font style="font: 10pt Times New Roman, Times, Serif">Amortization of debt discounts</font></td>
<td><font style="font: 10pt Times New Roman, Times, Serif"> </font></td>
<td style="text-align: left"><font style="font: 10pt Times New Roman, Times, Serif"> </font></td>
<td style="text-align: right"><font style="font: 10pt Times New Roman, Times, Serif">10,570</font></td>
<td style="text-align: left"><font style="font: 10pt Times New Roman, Times, Serif"> </font></td></tr>
<tr style="background-color: rgb(204,238,255); vertical-align: bottom">
<td style="text-align: left; padding-bottom: 1pt"><font style="font: 10pt Times New Roman, Times, Serif">Currency translation</font></td>
<td style="padding-bottom: 1pt"><font style="font: 10pt Times New Roman, Times, Serif"> </font></td>
<td style="border-bottom: black 1pt solid; text-align: left"><font style="font: 10pt Times New Roman, Times, Serif"> </font></td>
<td style="border-bottom: black 1pt solid; text-align: right"><font style="font: 10pt Times New Roman, Times, Serif">(624</font></td>
<td style="text-align: left; padding-bottom: 1pt"><font style="font: 10pt Times New Roman, Times, Serif">)</font></td></tr>
<tr style="background-color: white; vertical-align: bottom">
<td style="padding-bottom: 1pt"><font style="font: 10pt Times New Roman, Times, Serif">September 30, 2015</font></td>
<td style="padding-bottom: 1pt"><font style="font: 10pt Times New Roman, Times, Serif"> </font></td>
<td style="border-bottom: black 1pt solid; text-align: left"><font style="font: 10pt Times New Roman, Times, Serif">$</font></td>
<td style="border-bottom: black 1pt solid; text-align: right"><font style="font: 10pt Times New Roman, Times, Serif">5,006,230</font></td>
<td style="text-align: left; padding-bottom: 1pt"><font style="font: 10pt Times New Roman, Times, Serif"> </font></td></tr>
</table>
<p style="font: 10pt Times New Roman, Times, Serif; margin: 0; text-align: justify; text-indent: 0.5in"><font style="font: 10pt Times New Roman, Times, Serif"><i> </i></font></p>
<p style="font: 10pt Times New Roman, Times, Serif; margin: 0; text-align: justify; text-indent: 0.5in"><font style="font: 10pt Times New Roman, Times, Serif"><i>Lakeshore
Financing</i></font></p>
<p style="font: 10pt Times New Roman, Times, Serif; margin: 0; text-align: justify; text-indent: 0.5in"><font style="font: 10pt Times New Roman, Times, Serif"> </font></p>
<p style="font: 10pt Times New Roman, Times, Serif; margin: 0; text-align: justify; text-indent: 0.5in"><font style="font: 10pt Times New Roman, Times, Serif">On
January 9, 2013, NOW Solutions completed a financing transaction in the aggregate amount of $1,759,150, which amount was utilized
to pay off existing indebtedness of the Company and NOW Solutions to Tara Financial Services and Robert Farias, a former employee
of the Company, and all security interests granted to Tara Financial Services and Mr. Farias were cancelled.</font></p>
<p style="font: 10pt Times New Roman, Times, Serif; margin: 0; text-align: justify"><font style="font: 10pt Times New Roman, Times, Serif"> </font></p>
<p style="font: 10pt Times New Roman, Times, Serif; margin: 0; text-align: justify; text-indent: 0.5in"><font style="font: 10pt Times New Roman, Times, Serif">In
connection with this financing, the Company and several of its subsidiaries entered into a loan agreement (the “<u>Loan Agreement</u>”),
dated as of January 9, 2013 with Lakeshore Investment, LLC (“<u>Lakeshore</u>”) under which NOW Solutions issued a secured
10-year promissory note (the “<u>Lakeshore Note</u>”) bearing interest at 11% per annum to Lakeshore in the amount of
$1,759,150 payable in equal monthly installments of $24,232 until January 31, 2022. Upon the payment of any prepayment principal
amounts, the monthly installment payments shall be proportionately adjusted proportionately on an amortized rata basis. </font></p>
<p style="font: 10pt Times New Roman, Times, Serif; margin: 0; text-align: justify; text-indent: 0.5in"><font style="font: 10pt Times New Roman, Times, Serif"> </font></p>
<p style="font: 10pt Times New Roman, Times, Serif; margin: 0; text-align: justify; text-indent: 0.5in"><font style="font: 10pt Times New Roman, Times, Serif">The
Lakeshore Note is secured by the assets of the Company’s subsidiaries, NOW Solutions, Priority Time, SnAPPnet, Inc. (“<u>SnAPPnet</u>”)
and the Company’s SiteFlash™ technology and cross-collateralized. Upon the aggregate principal payment of $290,000 toward
the Lakeshore Note, the Company has the option to have Lakeshore release either the Priority Time collateral or the SiteFlash™
collateral. Upon payment of the aggregate principal of $590,000 toward the Lakeshore Note, Lakeshore shall release either the
Priority Time collateral or the SiteFlash™ collateral (whichever is remaining). Upon payment of the aggregate principal of
$890,000 toward the Lakeshore Note, Lakeshore shall release the SnAPPnet collateral and upon full payment of the Lakeshore Note,
Lakeshore shall release the NOW Solutions collateral.</font></p>
<p style="font: 10pt Times New Roman, Times, Serif; margin: 0; text-align: justify"></p>
<p style="font: 10pt Times New Roman, Times, Serif; margin: 0"><font style="font: 10pt Times New Roman, Times, Serif">  </font></p>
<p style="font: 10pt Times New Roman, Times, Serif; margin: 0; text-align: justify; text-indent: 0.5in"><font style="font: 10pt Times New Roman, Times, Serif">As
additional consideration for the loan, the Company granted a 5% interest in Net Claim Proceeds (less any attorney’s fees
and direct costs) from any litigation or settlement proceeds related to the SiteFlash™ technology to Lakeshore which was
increased to 8% under an amendment to the Loan Agreement in 2013. In addition, until the Note is paid in full, NOW Solutions agreed
to pay a Lakeshore royalty of 6% of its annual gross revenues in excess of $5 million dollars up to a maximum of $1,759,150. Management
has estimated the fair value of the royalty to be nominal as of its issuance date and no royalty was owed as of September 30,
2015 or December 31, 2014.</font></p>
<p style="font: 10pt Times New Roman, Times, Serif; margin: 0; text-align: justify"><font style="font: 10pt Times New Roman, Times, Serif"> </font></p>
<p style="font: 10pt Times New Roman, Times, Serif; margin: 0; text-align: justify; text-indent: 0.5in"><font style="font: 10pt Times New Roman, Times, Serif">In
December 2014, the Company and Lakeshore entered into an amendment of the Lakeshore Note and the Loan Agreement. Under the terms
of the amendment, NOW Solutions agreed to make $2,500 weekly advance payments to Lakeshore to be applied to the 25% dividend of
NOW Solutions’ net income after taxes in connection with Lakeshore’s 25% minority ownership interest in NOW Solutions.
Within 10 business days after the Company files its periodic reports with the SEC, NOW Solutions will also make quarterly payment
advances to Lakeshore based on 60% of Lakeshore’s 25% share of NOW Solutions estimated quarterly net income after taxes,
less any weekly payment advances received by Lakeshore during the then-applicable quarter and the weekly $2,500 payments shall
be increased or decreased based only upon any increases or decreases of maintenance and SaaS fees during the then-completed quarter
(but will not decrease below a minimum of $2,500 per week). NOW Solutions shall pay Lakeshore the balance of Lakeshore’s
25% of NOW’s yearly net income after taxes (less any advances) within 10 business days after the Company files it annual
10-K report with the SEC and any payments in excess of Lakeshore’s 25% of NOW yearly profit shall be credited towards future
weekly advance payments. The Company also agreed to pay attorney fees of $40,000 and paid fees of $80,000 to a former consultant
and employee of the Company who is a member of Lakeshore. In consideration of the extension to cure the default under the Lakeshore
Note and the Loan Agreement, the Company transferred a 20% ownership interest in Priority Time Systems, Inc., a 90% owned subsidiary
of VCSY, and in SnAPPnet, Inc., a 100% owned subsidiary of VCSY, to Lakeshore. This resulted in an additional noncontrolling interest
recognized in the equity of the Company of $391,920 and $99,210 for Priority Time Systems, Inc. and SnAPPnet, Inc., respectively,
during 2014.</font></p>
<p style="font: 10pt Times New Roman, Times, Serif; margin: 0; text-align: justify; text-indent: 0.5in"><font style="font: 10pt Times New Roman, Times, Serif"> </font></p>
<p style="font: 10pt Times New Roman, Times, Serif; margin: 0; text-align: justify; text-indent: 0.5in"><font style="font: 10pt Times New Roman, Times, Serif">In
July 2015, we entered into an agreement with Lakeshore to amend the terms of the Loan Agreement and the Lakeshore Note. Under
the terms of the amendment, the Company issued 13,000,000 common shares with the Rule 144 restrictive legend, resulting in a forbearance
loss of $455,000 and Ploinks, Inc. agreed to issue 3,000,000 common shares of its stock to Lakeshore. The fair value of the Ploinks
shares was determined to be nominal. Also in July 2015, the Company further amended the Lakeshore Note and the Loan Agreement
with Lakeshore. Pursuant to this Agreement, the Company issued 2,000,000 shares of its common stock with the Rule 144 restrictive
legend resulting in a forbearance loss of $54,200 and paid $15,000 to Lakeshore as forbearance fees.</font></p>
<p style="font: 10pt Times New Roman, Times, Serif; margin: 0; text-align: justify; text-indent: 0.5in"><font style="font: 10pt Times New Roman, Times, Serif"> </font></p>
<p style="font: 10pt Times New Roman, Times, Serif; margin: 0; text-align: justify; text-indent: 0.5in"><font style="font: 10pt Times New Roman, Times, Serif">In
August 2015, we entered into an agreement with Lakeshore to amend the terms of the Loan Agreement and the Lakeshore Note. Under
the terms of the amendment, the Company issued 7,000,000 shares of its common stock with the Rule 144 restrictive legend resulting
in a forbearance loss of $175,700 and Ploinks, Inc. agreed to issue 2,000,000 common shares of its stock to Lakeshore. The fair
value of the Ploinks shares was determined to be nominal.</font></p>
<p style="font: 10pt Times New Roman, Times, Serif; margin: 0; text-align: justify; text-indent: 0.5in"><font style="font: 10pt Times New Roman, Times, Serif"> </font></p>
<p style="font: 10pt Times New Roman, Times, Serif; margin: 0; text-align: justify; text-indent: 0.5in"><font style="font: 10pt Times New Roman, Times, Serif">The
Company also agreed to make a $500,000 payment for amounts due to Lakeshore under the Lakeshore Note and the Loan Agreement. In
the event that the Company did not make the Lakeshore $500,000 payment on or before August 21, 2015, then Lakeshore in lieu of
the $500,000 payment, would obtain a purchase option (the “<u>2015 Purchase Option</u>”) to purchase an additional 250
shares of NOW Solutions common stock (representing a 25% ownership interest in NOW Solutions) until December 31, 2015 as follows:
(a) 84 shares of NOW Solutions common stock currently owned by VCSY for a purchase price of $450,000 and (b) 166 shares of NOW
Solutions common stock for a purchase price of $500,000 payable to NOW Solutions.</font></p>
<p style="font: 10pt Times New Roman, Times, Serif; margin: 0; text-align: justify; text-indent: 0.5in"><font style="font: 10pt Times New Roman, Times, Serif"> </font></p>
<p style="font: 10pt Times New Roman, Times, Serif; margin: 0; text-align: justify; text-indent: 0.5in"><font style="font: 10pt Times New Roman, Times, Serif">Furthermore,
in the event that the Company did not make the $500,000 payment to Lakeshore on or before August 21, 2015, no further payment
on the Note will be due until January1, 2016 at which time the Note plus all accrued interest will be recalculated and the Note
will be re-amortized under the same interest rate and terms as the Note and the maturity date of the Note will be extended 10
years from January 1, 2016. In October 2015, Lakeshore provided notice to the Company of its intent to exercise the 2015 Purchase
Option concerning the purchase of additional common shares of NOW Solutions, then Lakeshore’s option will be cancelled and
the Company shall make a principal reduction payment in the amount of $250,000 on or before December 31, 2015.</font></p>
<p style="font: 10pt Times New Roman, Times, Serif; margin: 0; text-align: justify; text-indent: 0.5in"><font style="font: 10pt Times New Roman, Times, Serif"> </font></p>
<p style="font: 10pt Times New Roman, Times, Serif; margin: 0; text-align: justify; text-indent: 0.5in"><font style="font: 10pt Times New Roman, Times, Serif">In
the event that Lakeshore exercises the 2015 Purchase Option and purchases the additional common shares of NOW Solutions by December
31, 2015, then (a) after the second year, but before the end of the fourth year from the date Lakeshore purchases the additional
shares of NOW Solutions under the 2015 Purchase Option, the Company will have the option to purchase for cash, all of Lakeshore's
500 shares for a price equal to the greater of $4.0 Million, 60% of trailing twelve months revenue, or 2.75X EBITDA. If the Company
does not exercise its purchase option prior to the end of the fourth year from the date Lakeshore purchases the additional shares
of NOW Solutions under the 2015 Purchase Option, then Lakeshore will have a purchase option to purchase for cash, all of the Company’s
500 shares for the greater of $3.5 Million, 55% of trailing twelve months revenue, or 2.50 X EBITDA, which will expire at the
end of the seventh year from the date Lakeshore purchases the additional shares of NOW Solutions under the 2015 Purchase Option
if exercised by Lakeshore. </font></p>
<p style="font: 10pt Times New Roman, Times, Serif; margin: 0"><font style="font: 10pt Times New Roman, Times, Serif">  </font></p>
<p style="font: 10pt Times New Roman, Times, Serif; margin: 0; text-align: justify; text-indent: 0.5in"><font style="font: 10pt Times New Roman, Times, Serif">NOW
Solutions will continue to make the $2,500 weekly payment which will be applied toward Lakeshore’s share of dividends until
at least January 8, 2016. Any reconciliation payments due to Lakeshore will be deferred until January 15, 2016, at which time
all reconciliation payments due through September 30, 2015 will be paid to Lakeshore. Lakeshore agreed it will not take any action
to enforce its rights under the security agreements related to the Note, provided that the $2,500 weekly payments are made and
the January 15, 2016 reconciliation payment is timely made.</font></p>
<p style="font: 10pt Times New Roman, Times, Serif; margin: 0; text-align: justify; text-indent: 0.5in"><font style="font: 10pt Times New Roman, Times, Serif"> </font></p>
<p style="font: 10pt Times New Roman, Times, Serif; margin: 0; text-align: justify; text-indent: 0.5in"><font style="font: 10pt Times New Roman, Times, Serif">At
September 30, 2015, the Note was in default. During the nine months ended September 30, 2015, the Company paid dividends to Lakeshore
of $92,500.</font></p>
<p style="font: 10pt Times New Roman, Times, Serif; margin: 0"><font style="font: 10pt Times New Roman, Times, Serif"> </font></p>
<p style="font: 10pt Times New Roman, Times, Serif; margin: 0; text-indent: 0.5in"><font style="font: 10pt Times New Roman, Times, Serif"><i>Additional
Financing</i></font></p>
<p style="font: 10pt Times New Roman, Times, Serif; margin: 0"><font style="font: 10pt Times New Roman, Times, Serif"> </font></p>
<p style="font: 10pt Times New Roman, Times, Serif; margin: 0; text-align: justify; text-indent: 0.5in"><font style="font: 10pt Times New Roman, Times, Serif">In
March 2015, Taladin, Inc., a subsidiary of the Company, and a third party lender entered into a loan agreement under which the
lender loaned Taladin $100,000. Pursuant to the loan agreement, Taladin, issued a promissory note in the principal amount of $100,000
bearing interest at 12% per annum and due on demand.</font></p>
<p style="font: 10pt Times New Roman, Times, Serif; margin: 0; text-align: justify"><font style="font: 10pt Times New Roman, Times, Serif"> </font></p>
<p style="font: 10pt Times New Roman, Times, Serif; margin: 0; text-align: justify; text-indent: 0.5in"><font style="font: 10pt Times New Roman, Times, Serif">In
the second quarter ended June 30, 2015, the Company borrowed $60,000 from a third party lender. The note is due on demand and
bears interest at 11% per annum.</font></p>
<p style="font: 10pt Times New Roman, Times, Serif; margin: 0; text-align: justify; text-indent: 0.5in"><font style="font: 10pt Times New Roman, Times, Serif"> </font></p>
<p style="font: 10pt Times New Roman, Times, Serif; margin: 0; text-align: justify; text-indent: 0.5in"><font style="font: 10pt Times New Roman, Times, Serif">In
June 2015, the Company and Victor Weber agreed to amend certain promissory notes (the “<u>Weber Notes</u>”) issued by
the Company and NOW Solutions in the aggregate principal amount of $745,400 to Mr. Weber. Under the terms of the amendment of
the Weber Notes, the defaults were cured, the interest rate was reduced from 12% to 10% and the Company agreed to make monthly
$20,000 payments to Mr. Weber beginning September 1, 2015 until January 15, 2020 at which time all outstanding amounts under the
Weber Notes will be due. In consideration of the amendment and extension to pay the Weber Notes, Ploinks, Inc., the Company’s
subsidiary, agreed to issue 1,000,000 shares of its common stock to Mr. Weber. The fair value of these subsidiary shares was determined
to be nominal. In connection with the amendment, the Company issued 20,000,000 shares of its common stock with the Rule 144 restrictive
legend to its subsidiary, Taladin, Inc., which pledged these shares to secure payment of the Weber Note and the previous pledge
agreements with Mountain Reservoir Corporation (“MRC”) were cancelled. MRC is controlled by the W5 Family Trust. Mr.
Richard Wade, the President and CEO of the Company, is the trustee of the W5 Family Trust. These 20,000,000 common shares
are held in treasury.</font></p>
<p style="font: 10pt Times New Roman, Times, Serif; margin: 0; text-align: justify"><font style="font: 10pt Times New Roman, Times, Serif"> </font></p>
<p style="font: 10pt Times New Roman, Times, Serif; margin: 0; text-align: justify; text-indent: 0.5in"><font style="font: 10pt Times New Roman, Times, Serif">Also
in June 2015, Mr. Weber was issued 10,000,000 common shares as forbearance resulting in a forbearance loss of $249,000 and 10,000,000
common shares as repayment of $100,000 of accrued interest resulting in a loss on extinguishment of $150,000.  In July 2015,
Mr. Weber was issued 15,000,000 common shares (at a fair market value of $408,000) as repayment of accrued interest and principal
$259,010 owed under a judgment, resulting in a loss on extinguishment of $148,985.  These shares were issued to Mr. Weber
in lieu of payments due under an agreement between the Company and Victor Weber to pay off a judgment held by Mr. Weber against
the Company.</font></p>
<p style="font: 10pt Times New Roman, Times, Serif; margin: 0; text-align: justify"><font style="font: 10pt Times New Roman, Times, Serif"> </font></p>
<p style="font: 10pt Times New Roman, Times, Serif; margin: 0; text-align: justify; text-indent: 0.5in"><font style="font: 10pt Times New Roman, Times, Serif">In
August 2015, the Company issued 556,522 shares of its common stock with the Rule 144 restrictive legend to a third party lender
at a fair market value of $13,913 as repayment of debt and accrued interest of $11,130 resulting in a loss on extinguishment of
$2,783.</font></p>
<p style="font: 10pt Times New Roman, Times, Serif; margin: 0; text-align: justify"><font style="font: 10pt Times New Roman, Times, Serif"> </font></p>
<p style="font: 10pt Times New Roman, Times, Serif; margin: 0; text-align: justify; text-indent: 0.5in"><font style="font: 10pt Times New Roman, Times, Serif">In
August 2015, the Company granted stock awards to an employee consisting of 3,000,000 shares of its common stock with the Rule
144 restrictive legend (at a fair market value of $84,000), 60,000 shares of preferred stock of VHS and 200,000 shares of common
stock of Ploinks, Inc. in connection with a loan modification agreement to pay off accrued interest in the amount of $62,575 related
to certain loans made by the employee to the Company and its affiliates. This resulted in a loss on extinguishment of $21,425.
The fair value of the VHS and Ploinks shares was determined to be nominal.</font></p>
<p style="font: 10pt Times New Roman, Times, Serif; margin: 0; text-align: justify"><font style="font: 10pt Times New Roman, Times, Serif"> </font></p>
<p style="font: 10pt Times New Roman, Times, Serif; margin: 0; text-align: justify; text-indent: 0.5in"><font style="font: 10pt Times New Roman, Times, Serif">In
the third quarter ended September 30, 2015, the Company borrowed $150,000 from a third party lender. The note is due on demand.
The company made payment of $50,000 on this loan during the third quarter ended September 30, 2015.</font></p>
<p style="font: 10pt Times New Roman, Times, Serif; margin: 0; text-align: justify; text-indent: 0.5in"><font style="font: 10pt Times New Roman, Times, Serif"> </font></p>
<p style="font: 10pt Times New Roman, Times, Serif; margin: 0; text-align: justify; text-indent: 0.5in"><font style="font: 10pt Times New Roman, Times, Serif">During
the third quarter ended September 30, 2015, the Company borrowed $25,333 from a third party lender. The notes are due on demand
and bear interest at 11%. The Company made payments of $2,448 during the third quarter ended September 30, 2015. </font></p>
<p style="font: 10pt Times New Roman, Times, Serif; margin: 0"><font style="font: 10pt Times New Roman, Times, Serif">  </font></p>
<p style="font: 10pt Times New Roman, Times, Serif; margin: 0; text-align: justify; text-indent: 0.5in"><font style="font: 10pt Times New Roman, Times, Serif"><i>Convertible
Debentures</i></font></p>
<p style="font: 10pt Times New Roman, Times, Serif; margin: 0; text-align: justify"><font style="font: 10pt Times New Roman, Times, Serif"> </font></p>
<p style="font: 10pt Times New Roman, Times, Serif; margin: 0; text-align: justify; text-indent: 0.5in"><font style="font: 10pt Times New Roman, Times, Serif">During
the nine months ended September 30, 2015, the Company issued $550,000 of convertible debentures to various third party lenders
for loans made to the Company in the aggregate amount of $550,000. The debt accrues interest at 10% per annum and is due one year
from the date of issuance. Beginning six months after issuance of the respective debenture, the holder of the debenture may convert
the debenture into shares of common stock at a price per share of either (a) 80% of the average per share price of the Company’s
common stock for the 5 trading days preceding the notice of conversion date using the 3 lowest closing prices or (b) 75% of the
average per share closing bid price of the Company’s common stock during the 10 trading days prior to the notice of conversion
date using the lowest 5 closing bid prices per share (which shall not be lower than $0.03 per share). In connection with the loans,
the Company also issued a total of 6,000,000 shares of common stock of the Company to the lenders and 3-5 year warrants under
which each lender may purchase in aggregate a total of 5,500,000 shares of common stock of the Company at a purchase price of
between $0.05-$0.10 per share (of which one warrant for 1,000,000 includes a cashless warrant exercise provision). In connection
with the issuance of common stock and warrants, the Company recorded a discount of $153,288 against the face value of the loans
based on the relative fair market value of the common stock and warrants. The discount is being amortized over twelve months and
$10,570 of amortization expense was recognized for the nine months ended September 30, 2015.</font></p>
<p style="font: 10pt Times New Roman, Times, Serif; margin: 0; text-align: justify"><font style="font: 10pt Times New Roman, Times, Serif"> </font></p>
<p style="font: 10pt Times New Roman, Times, Serif; margin: 0; text-align: justify; text-indent: 0.5in"><font style="font: 10pt Times New Roman, Times, Serif">For
additional transactions after September 30, 2015, please see “Subsequent Events” in Note 8.</font></p>
<p style="font: 10pt Times New Roman, Times, Serif; margin: 0; text-align: justify"><font style="font: 10pt Times New Roman, Times, Serif"><b>Note
4. Derivative Liability and Fair Value Measurements</b></font></p>
<p style="font: 10pt Times New Roman, Times, Serif; margin: 0; text-align: justify"><font style="font: 10pt Times New Roman, Times, Serif"><b> </b></font></p>
<p style="font: 10pt Times New Roman, Times, Serif; margin: 0 0 0 0.5in; text-align: justify"><font style="font: 10pt Times New Roman, Times, Serif"><i>Derivative
liability</i></font></p>
<p style="font: 10pt Times New Roman, Times, Serif; margin: 0; text-align: justify"><font style="font: 10pt Times New Roman, Times, Serif"> </font></p>
<p style="font: 10pt Times New Roman, Times, Serif; margin: 0; text-align: justify; text-indent: 0.5in"><font style="font: 10pt Times New Roman, Times, Serif">In
March 2015, pursuant to an indemnity and reimbursement agreement executed between Mr. Valdetaro and the Company, we issued 1,000,000
shares of our common stock to reimburse Mr. Valdetaro for 1,000,000 shares of common stock with the Rule 144 restrictive legend
transferred to Lakeshore on the Company’s behalf in connection with an extension granted by Lakeshore in August 2013. The
issuance of these shares eliminated the derivative liability associated with the value of these shares. The fair market value
of these shares on the date of issuance was $38,000 and resulted in the resolution of derivative liabilities. Mr. Valdetaro is
the CTO of the Company.</font></p>
<p style="font: 10pt Times New Roman, Times, Serif; margin: 0; text-align: justify"><font style="font: 10pt Times New Roman, Times, Serif"> </font></p>
<p style="font: 10pt Times New Roman, Times, Serif; margin: 0; text-align: justify; text-indent: 0.5in"><font style="font: 10pt Times New Roman, Times, Serif">In
March 2015, pursuant to two indemnity and reimbursement agreements executed between MRC and the Company, we issued a total of
2,809,983 shares of our common stock with the Rule 144 restrictive legend to reimburse MRC.  Of these shares, the Company
was obligated to reimburse MRC with 1,309,983 shares of common stock that had been pledged by MRC and sold by a third party lender
in 2009, 500,000 shares of common stock that had been wrongfully converted by the same lender in 2014, and 1,000,000 shares of
common stock that had been transferred to another third party lender in 2013 on the Company’s behalf for a loan made by the
lender.  MRC assigned its claim against the third party lender for the lender’s wrongful conversion of 500,000 common
shares to the Company and we are pursuing the claim in the third party lender’s bankruptcy proceeding.  The issuance
of these shares eliminated the derivative liability associated with the value of these shares.   The fair market value
of these shares on the date of issuance was $112,399 of which $92,399 resulted in the resolution of derivative liabilities and
$20,000 was recognized as stock reimbursement expense during the three months ended March 31, 2015.</font></p>
<p style="font: 10pt Times New Roman, Times, Serif; margin: 0; text-align: justify; text-indent: 0.5in"><font style="font: 10pt Times New Roman, Times, Serif"> </font></p>
<p style="font: 10pt Times New Roman, Times, Serif; margin: 0; text-align: justify; text-indent: 0.5in"><font style="font: 10pt Times New Roman, Times, Serif">In
March 2015, 1,000,000 shares of common stock pledged by an officer of the company (through a company he controls) to secure payment
of a $50,000 past due loan by a third party lender were eliminated as part of the derivative liability as the lender did not exercise
their rights to obtain the stock. The derivative liability associated with this obligation of $12,000 was written-off to (gain)
loss on derivative liability during the three months ended March 31, 2015.</font></p>
<p style="font: 10pt Times New Roman, Times, Serif; margin: 0; text-align: justify"><font style="font: 10pt Times New Roman, Times, Serif"> </font></p>
<p style="font: 10pt Times New Roman, Times, Serif; margin: 0; text-align: justify; text-indent: 0.5in"><font style="font: 10pt Times New Roman, Times, Serif">These
contractual commitments to replace all of the shares associated with the derivative liability in 2014 was evaluated under FASB
ASC 815-40, Derivatives and Hedging and was determined to have characteristics of a liability and therefore constituted a derivative
liability under the above guidance. 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. As of September 30, 2015, the derivative liability has been eliminated
since the shares have been issued or the obligation to issue the shares has been resolved. As of December 31, 2014, the aggregate
fair value of the derivative liabilities was $51,719.</font></p>
<p style="font: 10pt Times New Roman, Times, Serif; margin: 0; text-align: justify; text-indent: 0.5in"><font style="font: 10pt Times New Roman, Times, Serif"> </font></p>
<p style="font: 10pt Times New Roman, Times, Serif; margin: 0; text-align: justify; text-indent: 0.5in"><font style="font: 10pt Times New Roman, Times, Serif">The
aggregate change in the fair value of derivative liabilities resulted in a loss of $78,680 and a gain of $194,381 for the nine
months ended September 30, 2015 and 2014, respectively.</font></p>
<p style="font: 10pt Times New Roman, Times, Serif; margin: 0; text-align: justify"><font style="font: 10pt Times New Roman, Times, Serif"> </font></p>
<p style="font: 10pt Times New Roman, Times, Serif; margin: 0; text-align: justify; text-indent: 0.5in"><font style="font: 10pt Times New Roman, Times, Serif">The
valuation of our embedded derivatives is determined by using the VCSY stock price at each measurement date. As such, our derivative
liabilities have been classified as Level 1.</font></p>
<p style="font: 10pt Times New Roman, Times, Serif; margin: 0; text-align: justify"><font style="font: 10pt Times New Roman, Times, Serif"> </font></p>
<p style="font: 10pt Times New Roman, Times, Serif; margin: 0; text-align: justify; text-indent: 0.5in"><font style="font: 10pt Times New Roman, Times, Serif"><i>Fair
value measurements</i></font></p>
<p style="font: 10pt Times New Roman, Times, Serif; margin: 0; text-align: justify"><font style="font: 10pt Times New Roman, Times, Serif"><i> </i></font></p>
<p style="font: 10pt Times New Roman, Times, Serif; margin: 0; text-align: justify; text-indent: 0.5in"><font style="font: 10pt Times New Roman, Times, Serif">FASB
ASC 820, Fair Value Measurements and Disclosures, defines fair value as the exchange price that would be received for an asset
or paid to transfer a liability (an exit price) in the principal or most advantageous market for the asset or liability in an
orderly transaction between market participants on the measurement date. FASB ASC 820 also establishes a fair value hierarchy
which requires an entity to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair
value. FASB ASC 820 describes three levels of inputs that may be used to measure fair value: </font></p>
<p style="font: 10pt Times New Roman, Times, Serif; margin: 0"><font style="font: 10pt Times New Roman, Times, Serif">  </font></p>
<p style="font: 10pt Times New Roman, Times, Serif; margin: 0 0 0 0.5in; text-align: justify"><font style="font: 10pt Times New Roman, Times, Serif"><i>Level
1 </i>– Quoted prices in active markets for identical assets or liabilities.</font></p>
<p style="font: 10pt Times New Roman, Times, Serif; margin: 0 0 0 0.5in; text-align: justify"><font style="font: 10pt Times New Roman, Times, Serif"><i> </i></font></p>
<p style="font: 10pt Times New Roman, Times, Serif; margin: 0 0 0 0.5in; text-align: justify"><font style="font: 10pt Times New Roman, Times, Serif"><i>Level
2 </i>– Observable inputs other than Level 1 prices, such as quoted prices for similar assets or liabilities; or other inputs
that are observable or can be corroborated by observable market data for substantially the full term of the assets or liabilities.</font></p>
<p style="font: 10pt Times New Roman, Times, Serif; margin: 0 0 0 0.5in; text-align: justify"><font style="font: 10pt Times New Roman, Times, Serif"> </font></p>
<p style="font: 10pt Times New Roman, Times, Serif; margin: 0 0 0 0.5in; text-align: justify"><font style="font: 10pt Times New Roman, Times, Serif"><i>Level
3 </i>– Unobservable inputs that are supported by little or no market activity and that are financial instruments whose values
are determined using pricing models, discounted cash flow methodologies, or similar techniques, as well as instruments for which
the determination of fair value requires significant judgment or estimation.</font></p>
<p style="font: 10pt Times New Roman, Times, Serif; margin: 0 0 0 0.5in"><font style="font: 10pt Times New Roman, Times, Serif"><i> </i></font></p>
<p style="font: 10pt Times New Roman, Times, Serif; margin: 0; text-align: justify; text-indent: 0.5in"><font style="font: 10pt Times New Roman, Times, Serif">If
the inputs used to measure the financial assets and liabilities fall within more than one level described above, the categorization
is based on the lowest level of input that is significant to the fair value measurement of the instrument.</font></p>
<p style="font: 10pt Times New Roman, Times, Serif; margin: 0; text-align: justify; text-indent: 0.5in"><font style="font: 10pt Times New Roman, Times, Serif"> </font></p>
<p style="font: 10pt Times New Roman, Times, Serif; margin: 0; text-indent: 0.5in"><font style="font: 10pt Times New Roman, Times, Serif">The
following table provides a summary of the fair value of our derivative liabilities as of September 30, 2015 and December 31, 2014:</font></p>
<p style="font: 10pt Times New Roman, Times, Serif; margin: 0; text-indent: 0.5in"><font style="font: 10pt Times New Roman, Times, Serif">  </font></p>
<table cellspacing="0" cellpadding="0" style="width: 100%; border-collapse: collapse; font-size: 10pt">
<tr style="vertical-align: bottom">
<td nowrap="nowrap"><font style="font: 10pt Times New Roman, Times, Serif"> </font></td>
<td nowrap="nowrap" style="padding-bottom: 1pt"><font style="font: 10pt Times New Roman, Times, Serif"> </font></td>
<td colspan="10" nowrap="nowrap" style="border-bottom: black 1pt solid; text-align: center"><font style="font: 10pt Times New Roman, Times, Serif">Fair
value measurements on a recurring basis</font></td>
<td nowrap="nowrap" style="padding-bottom: 1pt"><font style="font: 10pt Times New Roman, Times, Serif"> </font></td></tr>
<tr style="vertical-align: bottom">
<td nowrap="nowrap"><font style="font: 10pt Times New Roman, Times, Serif"> </font></td>
<td nowrap="nowrap" style="padding-bottom: 1pt"><font style="font: 10pt Times New Roman, Times, Serif"> </font></td>
<td colspan="2" nowrap="nowrap" style="border-bottom: black 1pt solid; text-align: center"><font style="font: 10pt Times New Roman, Times, Serif">Level
1</font></td>
<td nowrap="nowrap" style="padding-bottom: 1pt"><font style="font: 10pt Times New Roman, Times, Serif"> </font></td>
<td nowrap="nowrap" style="padding-bottom: 1pt"><font style="font: 10pt Times New Roman, Times, Serif"> </font></td>
<td colspan="2" nowrap="nowrap" style="border-bottom: black 1pt solid; text-align: center"><font style="font: 10pt Times New Roman, Times, Serif">Level
2</font></td>
<td nowrap="nowrap" style="padding-bottom: 1pt"><font style="font: 10pt Times New Roman, Times, Serif"> </font></td>
<td nowrap="nowrap" style="padding-bottom: 1pt"><font style="font: 10pt Times New Roman, Times, Serif"> </font></td>
<td colspan="2" nowrap="nowrap" style="border-bottom: black 1pt solid; text-align: center"><font style="font: 10pt Times New Roman, Times, Serif">Level
3</font></td>
<td nowrap="nowrap" style="padding-bottom: 1pt"><font style="font: 10pt Times New Roman, Times, Serif"> </font></td></tr>
<tr style="background-color: rgb(204,238,255); vertical-align: bottom">
<td style="width: 61%"><font style="font: 10pt Times New Roman, Times, Serif">As of September 30, 2015:</font></td>
<td style="width: 1%"><font style="font: 10pt Times New Roman, Times, Serif"> </font></td>
<td style="text-align: left; width: 1%"><font style="font: 10pt Times New Roman, Times, Serif"> </font></td>
<td style="text-align: right; width: 10%"><font style="font: 10pt Times New Roman, Times, Serif">  </font></td>
<td style="text-align: left; width: 1%"><font style="font: 10pt Times New Roman, Times, Serif"> </font></td>
<td style="width: 1%"><font style="font: 10pt Times New Roman, Times, Serif"> </font></td>
<td style="text-align: left; width: 1%"><font style="font: 10pt Times New Roman, Times, Serif"> </font></td>
<td style="text-align: right; width: 10%"><font style="font: 10pt Times New Roman, Times, Serif">   </font></td>
<td style="text-align: left; width: 1%"><font style="font: 10pt Times New Roman, Times, Serif"> </font></td>
<td style="width: 1%"><font style="font: 10pt Times New Roman, Times, Serif"> </font></td>
<td style="text-align: left; width: 1%"><font style="font: 10pt Times New Roman, Times, Serif"> </font></td>
<td style="text-align: right; width: 10%"><font style="font: 10pt Times New Roman, Times, Serif">  </font></td>
<td style="text-align: left; width: 1%"><font style="font: 10pt Times New Roman, Times, Serif"> </font></td></tr>
<tr style="background-color: white; vertical-align: bottom">
<td><font style="font: 10pt Times New Roman, Times, Serif">Liabilities</font></td>
<td><font style="font: 10pt Times New Roman, Times, Serif"> </font></td>
<td style="text-align: left"><font style="font: 10pt Times New Roman, Times, Serif"> </font></td>
<td style="text-align: right"><font style="font: 10pt Times New Roman, Times, Serif"> </font></td>
<td style="text-align: left"><font style="font: 10pt Times New Roman, Times, Serif"> </font></td>
<td><font style="font: 10pt Times New Roman, Times, Serif"> </font></td>
<td style="text-align: left"><font style="font: 10pt Times New Roman, Times, Serif"> </font></td>
<td style="text-align: right"><font style="font: 10pt Times New Roman, Times, Serif"> </font></td>
<td style="text-align: left"><font style="font: 10pt Times New Roman, Times, Serif"> </font></td>
<td><font style="font: 10pt Times New Roman, Times, Serif"> </font></td>
<td style="text-align: left"><font style="font: 10pt Times New Roman, Times, Serif"> </font></td>
<td style="text-align: right"><font style="font: 10pt Times New Roman, Times, Serif"> </font></td>
<td style="text-align: left"><font style="font: 10pt Times New Roman, Times, Serif"> </font></td></tr>
<tr style="background-color: rgb(204,238,255); vertical-align: bottom">
<td style="padding-left: 9pt"><font style="font: 10pt Times New Roman, Times, Serif">Stock derivative – 0 shares</font></td>
<td><font style="font: 10pt Times New Roman, Times, Serif"> </font></td>
<td style="text-align: left"><font style="font: 10pt Times New Roman, Times, Serif">$</font></td>
<td style="text-align: right"><font style="font: 10pt Times New Roman, Times, Serif">-</font></td>
<td style="text-align: left"><font style="font: 10pt Times New Roman, Times, Serif"> </font></td>
<td><font style="font: 10pt Times New Roman, Times, Serif"> </font></td>
<td style="text-align: left"><font style="font: 10pt Times New Roman, Times, Serif">$</font></td>
<td style="text-align: right"><font style="font: 10pt Times New Roman, Times, Serif">-</font></td>
<td style="text-align: left"><font style="font: 10pt Times New Roman, Times, Serif"> </font></td>
<td><font style="font: 10pt Times New Roman, Times, Serif"> </font></td>
<td style="text-align: left"><font style="font: 10pt Times New Roman, Times, Serif">$</font></td>
<td style="text-align: right"><font style="font: 10pt Times New Roman, Times, Serif">-</font></td>
<td style="text-align: left"><font style="font: 10pt Times New Roman, Times, Serif"> </font></td></tr>
<tr style="background-color: white; vertical-align: bottom">
<td><font style="font: 10pt Times New Roman, Times, Serif"> </font></td>
<td><font style="font: 10pt Times New Roman, Times, Serif"> </font></td>
<td style="text-align: left"><font style="font: 10pt Times New Roman, Times, Serif"> </font></td>
<td style="text-align: right"><font style="font: 10pt Times New Roman, Times, Serif"> </font></td>
<td style="text-align: left"><font style="font: 10pt Times New Roman, Times, Serif"> </font></td>
<td><font style="font: 10pt Times New Roman, Times, Serif"> </font></td>
<td style="text-align: left"><font style="font: 10pt Times New Roman, Times, Serif"> </font></td>
<td style="text-align: right"><font style="font: 10pt Times New Roman, Times, Serif"> </font></td>
<td style="text-align: left"><font style="font: 10pt Times New Roman, Times, Serif"> </font></td>
<td><font style="font: 10pt Times New Roman, Times, Serif"> </font></td>
<td style="text-align: left"><font style="font: 10pt Times New Roman, Times, Serif"> </font></td>
<td style="text-align: right"><font style="font: 10pt Times New Roman, Times, Serif"> </font></td>
<td style="text-align: left"><font style="font: 10pt Times New Roman, Times, Serif"> </font></td></tr>
<tr style="background-color: rgb(204,238,255); vertical-align: bottom">
<td><font style="font: 10pt Times New Roman, Times, Serif">As of December 31, 2014:</font></td>
<td><font style="font: 10pt Times New Roman, Times, Serif"> </font></td>
<td style="text-align: left"><font style="font: 10pt Times New Roman, Times, Serif"> </font></td>
<td style="text-align: right"><font style="font: 10pt Times New Roman, Times, Serif"> </font></td>
<td style="text-align: left"><font style="font: 10pt Times New Roman, Times, Serif"> </font></td>
<td><font style="font: 10pt Times New Roman, Times, Serif"> </font></td>
<td style="text-align: left"><font style="font: 10pt Times New Roman, Times, Serif"> </font></td>
<td style="text-align: right"><font style="font: 10pt Times New Roman, Times, Serif"> </font></td>
<td style="text-align: left"><font style="font: 10pt Times New Roman, Times, Serif"> </font></td>
<td><font style="font: 10pt Times New Roman, Times, Serif"> </font></td>
<td style="text-align: left"><font style="font: 10pt Times New Roman, Times, Serif"> </font></td>
<td style="text-align: right"><font style="font: 10pt Times New Roman, Times, Serif"> </font></td>
<td style="text-align: left"><font style="font: 10pt Times New Roman, Times, Serif"> </font></td></tr>
<tr style="background-color: white; vertical-align: bottom">
<td><font style="font: 10pt Times New Roman, Times, Serif">Liabilities</font></td>
<td><font style="font: 10pt Times New Roman, Times, Serif"> </font></td>
<td style="text-align: left"><font style="font: 10pt Times New Roman, Times, Serif"> </font></td>
<td style="text-align: right"><font style="font: 10pt Times New Roman, Times, Serif"> </font></td>
<td style="text-align: left"><font style="font: 10pt Times New Roman, Times, Serif"> </font></td>
<td><font style="font: 10pt Times New Roman, Times, Serif"> </font></td>
<td style="text-align: left"><font style="font: 10pt Times New Roman, Times, Serif"> </font></td>
<td style="text-align: right"><font style="font: 10pt Times New Roman, Times, Serif"> </font></td>
<td style="text-align: left"><font style="font: 10pt Times New Roman, Times, Serif"> </font></td>
<td><font style="font: 10pt Times New Roman, Times, Serif"> </font></td>
<td style="text-align: left"><font style="font: 10pt Times New Roman, Times, Serif"> </font></td>
<td style="text-align: right"><font style="font: 10pt Times New Roman, Times, Serif"> </font></td>
<td style="text-align: left"><font style="font: 10pt Times New Roman, Times, Serif"> </font></td></tr>
<tr style="background-color: rgb(204,238,255); vertical-align: bottom">
<td style="padding-left: 9pt"><font style="font: 10pt Times New Roman, Times, Serif">Stock derivative – 4,309,983 shares</font></td>
<td><font style="font: 10pt Times New Roman, Times, Serif"> </font></td>
<td style="text-align: left"><font style="font: 10pt Times New Roman, Times, Serif">$</font></td>
<td style="text-align: right"><font style="font: 10pt Times New Roman, Times, Serif">51,719</font></td>
<td style="text-align: left"><font style="font: 10pt Times New Roman, Times, Serif"> </font></td>
<td><font style="font: 10pt Times New Roman, Times, Serif"> </font></td>
<td style="text-align: left"><font style="font: 10pt Times New Roman, Times, Serif">$</font></td>
<td style="text-align: right"><font style="font: 10pt Times New Roman, Times, Serif">-</font></td>
<td style="text-align: left"><font style="font: 10pt Times New Roman, Times, Serif"> </font></td>
<td><font style="font: 10pt Times New Roman, Times, Serif"> </font></td>
<td style="text-align: left"><font style="font: 10pt Times New Roman, Times, Serif">$</font></td>
<td style="text-align: right"><font style="font: 10pt Times New Roman, Times, Serif">-</font></td>
<td style="text-align: left"><font style="font: 10pt Times New Roman, Times, Serif"> </font></td></tr>
</table>
<p style="font: 10pt Times New Roman, Times, Serif; margin: 0; text-indent: 0.5in"><font style="font: 10pt Times New Roman, Times, Serif"> <i> </i></font></p>
<p style="font: 10pt Times New Roman, Times, Serif; margin: 0; text-align: justify; text-indent: 0.5in"><font style="font: 10pt Times New Roman, Times, Serif">The
estimated fair value of short-term financial instruments, including cash, accounts receivable, accounts payable and accrued liabilities
and deferred revenue approximates their carrying value due to their short-term nature. The estimated fair value of our long-term
borrowings approximates carrying value since the related rates of interest approximate current market rates.</font></p>
<p style="font: 10pt Times New Roman, Times, Serif; margin: 0; text-align: justify"><font style="font: 10pt Times New Roman, Times, Serif"><b>Note
5. Common and Preferred Stock Transactions</b></font></p>
<p style="font: 10pt Times New Roman, Times, Serif; margin: 0; text-align: justify; text-indent: 0.5in"><font style="font: 10pt Times New Roman, Times, Serif"> </font></p>
<p style="font: 10pt Times New Roman, Times, Serif; margin: 0; text-align: justify; text-indent: 0.5in"><font style="font: 10pt Times New Roman, Times, Serif">In
February 2015, after holding an annual stockholder meeting, the Company filed an amendment of its certificate of incorporation
in the state of Delaware to increase the authorized number of shares of common stock to 2,000,000,000.</font></p>
<p style="font: 10pt Times New Roman, Times, Serif; margin: 0; text-align: justify; text-indent: 0.5in"><font style="font: 10pt Times New Roman, Times, Serif"> </font></p>
<p style="font: 10pt Times New Roman, Times, Serif; margin: 0; text-align: justify; text-indent: 0.5in"><font style="font: 10pt Times New Roman, Times, Serif">In
March 2015, in connection with a $100,000 loan to Taladin, Ploinks, Inc. agreed to issue 1,000,000 shares of its common stock
to the third party lender. The fair value of these subsidiary shares was determined to be nominal.</font></p>
<p style="font: 10pt Times New Roman, Times, Serif; margin: 0; text-align: justify"><font style="font: 10pt Times New Roman, Times, Serif"> </font></p>
<p style="font: 10pt Times New Roman, Times, Serif; margin: 0; text-align: justify; text-indent: 0.5in"><font style="font: 10pt Times New Roman, Times, Serif">In
March 2015, pursuant to an indemnity and reimbursement agreement executed between Mr. Valdetaro and the Company, we issued 1,000,000
shares of our common stock to reimburse Mr. Valdetaro for 1,000,000 shares of common stock with the Rule 144 restrictive legend
transferred to Lakeshore on the Company’s behalf in connection with an extension granted by Lakeshore in August 2013. The
issuance of these shares eliminated the derivative liability associated with the value of these shares. The fair market value
of these shares on the date of issuance was $38,000 and resulted in the resolution of derivative liabilities.</font></p>
<p style="font: 10pt Times New Roman, Times, Serif; margin: 0; text-align: justify; text-indent: 0.5in"><font style="font: 10pt Times New Roman, Times, Serif"> </font></p>
<p style="font: 10pt Times New Roman, Times, Serif; margin: 0; text-align: justify; text-indent: 0.5in"><font style="font: 10pt Times New Roman, Times, Serif">In
March 2015, pursuant to two indemnity and reimbursement agreements executed between Mountain Reservoir Corporation (“MRC”)
and the Company, we issued a total of 2,809,983 shares of our common stock with the Rule 144 restrictive legend to reimburse MRC. 
Of these shares, the Company was obligated to reimburse MRC with 1,309,983 shares of common stock that had been pledged by MRC
and sold by a third party lender in 2009, 500,000 shares of common stock that had been wrongfully converted by the same lender
in 2014, and 1,000,000 shares of common stock that had been transferred to another third party lender in 2013 on the Company’s
behalf for a loan made by the lender.  MRC has assigned its claim against the third party lender for the lender’s wrongful
conversion of 500,000 common shares to the Company and we are pursuing the claim in the third party lender’s bankruptcy proceeding. 
The issuance of these shares eliminated the derivative liability associated with the value of these shares.   The fair
market value of these shares on the date of issuance was $112,399 of which $92,399 resulted in the resolution of derivative liabilities
and $20,000 was recognized as stock reimbursement expense during the nine months ended September 30, 2015.</font></p>
<p style="font: 10pt Times New Roman, Times, Serif; margin: 0; text-align: justify; text-indent: 0.5in"><font style="font: 10pt Times New Roman, Times, Serif"> </font></p>
<p style="font: 10pt Times New Roman, Times, Serif; margin: 0; text-align: justify; text-indent: 0.5in"><font style="font: 10pt Times New Roman, Times, Serif">In
June 2015, pursuant to an agreement between the Company and Victor Weber to pay off a judgment held by Mr. Weber against the Company,
we issued a total of 20,000,000 shares of our common stock with the Rule 144 restrictive legend to Mr. Weber at a fair market
value of $499,000. Of these 20,000,000 common shares, 10,000,000 common shares were issued as forbearance resulting in a forbearance
loss of $249,000 and 10,000,000 common shares as repayment of $100,000 payment due under the agreement resulting in a loss on
extinguishment of $150,000. For additional details about the judgment and the agreement, please “Legal Proceedings”
under Note 7. </font></p>
<p style="font: 10pt Times New Roman, Times, Serif; margin: 0"><font style="font: 10pt Times New Roman, Times, Serif">  </font></p>
<p style="font: 10pt Times New Roman, Times, Serif; margin: 0; text-align: justify; text-indent: 0.5in"><font style="font: 10pt Times New Roman, Times, Serif">In
June 2015, in connection with an amendment concerning certain promissory notes issued by the Company and NOW Solutions to Mr.
Weber in the aggregate principal amount of $735,400, the Company issued 20,000,000 shares of its common stock with the Rule 144
restrictive legend to its subsidiary, Taladin, Inc., which pledged these shares to secure payment of the notes to Weber. The previous
pledge agreements between MRC and Mr. Weber were cancelled. These shares are held in treasury.</font></p>
<p style="font: 10pt Times New Roman, Times, Serif; margin: 0; text-align: justify; text-indent: 0.5in"><font style="font: 10pt Times New Roman, Times, Serif"> </font></p>
<p style="font: 10pt Times New Roman, Times, Serif; margin: 0; text-align: justify; text-indent: 0.5in"><font style="font: 10pt Times New Roman, Times, Serif">In
June 2015, the Company issued 10,000,000 common shares with the Rule 144 restrictive legend to its consolidated subsidiary NOW
Solutions. These shares are held in treasury.</font></p>
<p style="font: 10pt Times New Roman, Times, Serif; margin: 0; text-align: justify; text-indent: 0.5in"><font style="font: 10pt Times New Roman, Times, Serif"> </font></p>
<p style="font: 10pt Times New Roman, Times, Serif; margin: 0; text-align: justify; text-indent: 0.5in"><font style="font: 10pt Times New Roman, Times, Serif">In
July 2015, the Company issued 13,000,000 common shares with the Rule 144 restrictive legend resulting in a forbearance loss of
$455,000 and Ploinks, Inc. agreed to issue 3,000,000 common shares of its stock to Lakeshore. The fair value of the Ploinks shares
was determined to be nominal.</font></p>
<p style="font: 10pt Times New Roman, Times, Serif; margin: 0; text-align: justify; text-indent: 0.5in"><font style="font: 10pt Times New Roman, Times, Serif"> </font></p>
<p style="font: 10pt Times New Roman, Times, Serif; margin: 0; text-align: justify; text-indent: 0.5in"><font style="font: 10pt Times New Roman, Times, Serif">In
July 2015, the Company issued 15,000,000 shares of its common stock with the Rule 144 restrictive legend to Mr. Weber at a fair
market value of $408,000 as repayment of a $265,000 payment due under the agreement pursuant to an agreement between the Company
and Victor Weber to pay off a judgment held by Mr. Weber against the Company, This resulting in a loss on extinguishment of $148,985.
For additional details about the judgment and the agreement, please “Legal Proceedings” under Note 7.</font></p>
<p style="font: 10pt Times New Roman, Times, Serif; margin: 0; text-align: justify"><font style="font: 10pt Times New Roman, Times, Serif"> </font></p>
<p style="font: 10pt Times New Roman, Times, Serif; margin: 0; text-align: justify; text-indent: 0.5in"><font style="font: 10pt Times New Roman, Times, Serif">In
July 2015, the Company paid a $15,000 forbearance fee and issued 2,000,000 shares of its common stock with the Rule 144 restrictive
legend resulting in a forbearance loss of $54,200 to Lakeshore in consideration of Lakeshore’s forbearance from taking any
action concerning the existing defaults under the Lakeshore Note and the Loan Agreement.</font></p>
<p style="font: 10pt Times New Roman, Times, Serif; margin: 0; text-align: justify; text-indent: 0.5in"><font style="font: 10pt Times New Roman, Times, Serif"> </font></p>
<p style="font: 10pt Times New Roman, Times, Serif; margin: 0; text-align: justify; text-indent: 0.5in"><font style="font: 10pt Times New Roman, Times, Serif">In
August 2015, the Company issued 7,000,000 shares of its common stock with the Rule 144 restrictive legend resulting in a forbearance
loss of $175,700 to Lakeshore. In connection with the amendment, and in lieu of a $500,000 payment the Company was obligated to
make under the amendment, Lakeshore also obtained a purchase option (the “2015 Purchase Option”) to purchase an additional
250 shares of NOW Solutions common stock (representing a 25% ownership interest in NOW Solutions) until December 31, 2015 as follows:
(a) 84 shares of NOW Solutions common stock currently owned by VCSY for a purchase price of $450,000 and (b) 166 shares of NOW
Solutions common stock for a purchase price of $500,000 payable to NOW Solutions. In the event that Lakeshore exercises the 2015
Purchase Option and purchases the additional common shares of NOW Solutions, then (a) after the second year, but before the end
of the fourth year from the date Lakeshore purchases the additional shares of NOW Solutions under the 2015 Purchase Option, the
Company will have the option to purchase for cash, all of Lakeshore's 500 shares for a price equal to the greater of $4.0 Million,
60% of trailing twelve months revenue, or 2.75X EBITDA. If the Company does not exercise its purchase option prior to the end
of the fourth year from the date Lakeshore purchases the additional shares of NOW Solutions under the 2015 Purchase Option, then
Lakeshore will have a purchase option to purchase for cash, all of the Company’s 500 shares for the greater of $3.5 Million,
55% of trailing twelve months revenue, or 2.50 X EBITDA, which will expire at the end of the seventh year from the date Lakeshore
purchases the additional shares of NOW Solutions under the 2015 Purchase Option if exercised by Lakeshore.</font></p>
<p style="font: 10pt Times New Roman, Times, Serif; margin: 0; text-align: justify; text-indent: 0.5in"><font style="font: 10pt Times New Roman, Times, Serif"> </font></p>
<p style="font: 10pt Times New Roman, Times, Serif; margin: 0; text-align: justify; text-indent: 0.5in"><font style="font: 10pt Times New Roman, Times, Serif">In
August 2015, the Company issued 556,522 shares of its common stock with the Rule 144 restrictive legend to a third party lender
at a fair market value of $13,913 as repayment of debt and accrued interest of $11,130 resulting in a loss on extinguishment of
$2,783.</font></p>
<p style="font: 10pt Times New Roman, Times, Serif; margin: 0; text-align: justify; text-indent: 0.5in"><font style="font: 10pt Times New Roman, Times, Serif"> </font></p>
<p style="font: 10pt Times New Roman, Times, Serif; margin: 0; text-align: justify; text-indent: 0.5in"><font style="font: 10pt Times New Roman, Times, Serif">In
August 2015. the Company granted stock awards to an employee consisting of 3,000,000 shares of its common stock with the Rule
144 restrictive legend (at a fair market value of $84,000), 60,000 shares of preferred stock of VHS and 200,000 shares of common
stock of Ploinks, Inc. in connection with a loan modification agreement to pay off accrued interest in the amount of $62,575 related
to certain loans made by the employee to the Company and its affiliates. This resulted in a loss on extinguishment of $21,425.
The fair value of the VHS and Ploinks shares was determined to be nominal.</font></p>
<p style="font: 10pt Times New Roman, Times, Serif; margin: 0; text-align: justify; text-indent: 0.5in"><font style="font: 10pt Times New Roman, Times, Serif"> </font></p>
<p style="font: 10pt Times New Roman, Times, Serif; margin: 0; text-align: justify; text-indent: 0.5in"><font style="font: 10pt Times New Roman, Times, Serif">In
September 2015, the Company issued 2,250,000 shares of its common stock with the Rule 144 restrictive legend to employees of the
Company and its subsidiaries (at a fair market value of $54,750), pursuant to restricted stock agreements under which the shares
vest in equal installments over a 24-30 month period. $9,808 was recognized as compensation expense related to these shares during
the three months ended September 30, 2015. As of September 30, 2015, $44,942 remains to be amortized over the remaining vesting
period.</font></p>
<p style="font: 10pt Times New Roman, Times, Serif; margin: 0; text-align: justify"><font style="font: 10pt Times New Roman, Times, Serif"> </font></p>
<p style="font: 10pt Times New Roman, Times, Serif; margin: 0; text-align: justify; text-indent: 0.5in"><font style="font: 10pt Times New Roman, Times, Serif">In
September 2015, the Company issued 800,000 shares of common stock of Ploinks, Inc. to employees of the Company and its subsidiaries,
pursuant to restricted stock agreements under which the shares vest in equal installments over a 24-30 month period. The fair
value of the Ploinks shares was determined to be nominal. </font></p>
<p style="font: 10pt Times New Roman, Times, Serif; margin: 0; text-align: justify; text-indent: 0.5in"><font style="font: 10pt Times New Roman, Times, Serif"> </font></p>
<p style="font: 10pt Times New Roman, Times, Serif; margin: 0; text-align: justify; text-indent: 0.5in"><font style="font: 10pt Times New Roman, Times, Serif">During
the nine months ended September 30, 2015, the Company issued $550,000 of convertible debentures to various third party lenders
for loans made to the Company in the aggregate amount of $550,000. The debt accrues interest at 10% per annum and is due one year
from the date of issuance. Beginning six months after issuance of the respective debenture, the holder of the debenture may convert
the debenture into shares of common stock at a price per share of either (a) 80% of the average per share price of the Company’s
common stock for the 5 trading days preceding the notice of conversion date using the 3 lowest closing prices or (b) 75% of the
average per share closing bid price of the Company’s common stock during the 10 trading days prior to the notice of conversion
date using the lowest 5 closing bid prices per share (which shall not be lower than $0.03 per share). In connection with the loans,
the Company also issued a total of 6,000,000 shares of common stock of the Company to the lenders and 3-5 year warrants under
which each lender may purchase in aggregate a total of 5,500,000 shares of common stock of the Company at a purchase price of
between $0.05-$0.10 per share (of which one warrant for 1,000,000 includes a cashless warrant exercise provision). In connection
with the issuance of common stock and warrants, the Company recorded a discount of $153,288 against the face value of the loans
based on the relative fair market value of the common stock and warrants. The discount is being amortized over twelve months and
$10,570 of amortization expense was recognized for the nine months ended September 30, 2015.</font></p>
<p style="font: 10pt Times New Roman, Times, Serif; margin: 0; text-align: justify; text-indent: 0.5in"><font style="font: 10pt Times New Roman, Times, Serif"> </font></p>
<p style="font: 10pt Times New Roman, Times, Serif; margin: 0; text-align: justify; text-indent: 0.5in"><font style="font: 10pt Times New Roman, Times, Serif">For
additional common stock and preferred stock transactions after September 30, 2015, please see “Subsequent Events” in
Note 8.</font></p>
<p style="font: 10pt Times New Roman, Times, Serif; margin: 0; text-align: justify"><font style="font: 10pt Times New Roman, Times, Serif"> </font></p>
<p style="font: 10pt Times New Roman, Times, Serif; margin: 0; text-align: justify; text-indent: 0.5in"><font style="font: 10pt Times New Roman, Times, Serif">We
have evaluated our convertible cumulative preferred stock under the guidance set out in FASB ASC 470-20 and have accordingly classified
these shares as temporary equity in the consolidated balance sheets.</font></p>
<p style="font: 10pt Times New Roman, Times, Serif; margin: 0; text-align: justify"><font style="font: 10pt Times New Roman, Times, Serif"><b>Note
6. Related Party Transactions</b></font></p>
<p style="font: 10pt Times New Roman, Times, Serif; margin: 0; text-align: justify"><font style="font: 10pt Times New Roman, Times, Serif"><b> </b></font></p>
<p style="font: 10pt Times New Roman, Times, Serif; margin: 0; text-align: justify; text-indent: 0.5in"><font style="font: 10pt Times New Roman, Times, Serif">In
March 2015, pursuant to an indemnity and reimbursement agreement executed between Mr. Valdetaro and the Company, we issued 1,000,000
shares of our common stock with the Rule 144 restrictive legend to reimburse Mr. Valdetaro for 1,000,000 shares of common stock
transferred to Lakeshore on the Company’s behalf in connection with an extension granted by Lakeshore in August 2013. The
issuance of these shares eliminated the derivative liability associated with the value of these shares. The fair market value
of these shares on the date of issuance was $38,000 and resulted in the resolution of derivative liabilities.</font></p>
<p style="font: 10pt Times New Roman, Times, Serif; margin: 0; text-align: justify; text-indent: 0.5in"><font style="font: 10pt Times New Roman, Times, Serif"> </font></p>
<p style="font: 10pt Times New Roman, Times, Serif; margin: 0; text-align: justify; text-indent: 0.5in"><font style="font: 10pt Times New Roman, Times, Serif">In
March 2015, pursuant to two indemnity and reimbursement agreements executed between Mountain Reservoir Corporation (“MRC”)
and the Company, we issued a total of 2,809,983 shares of our common stock with the Rule 144 restrictive legend to reimburse MRC. 
Of these shares, the Company was obligated to reimburse MRC with 1,309,983 shares of common stock that had been pledged by MRC
and sold by a third party lender in 2009, 500,000 shares of common stock that had been wrongfully converted by the same lender
in 2014, and 1,000,000 shares of common stock that had been transferred to another third party lender in 2013 on the Company’s
behalf for a loan made by the lender.  MRC assigned its claim against the third party lender for the lender’s wrongful
conversion of 500,000 common shares to the Company and we are pursuing the claim in the third party lender’s bankruptcy
proceeding.  The issuance of these shares eliminated the derivative liability associated with the value of these shares.  
The fair market value of these shares on the date of issuance was $112,399 of which $92,399 resulted in the resolution of derivative
liabilities and $20,000 was recognized as stock reimbursement expense during the nine months ended September 30, 2015.</font></p>
<p style="font: 10pt Times New Roman, Times, Serif; margin: 0; text-align: justify"><font style="font: 10pt Times New Roman, Times, Serif"><b>Note
7. Legal Proceedings </b></font></p>
<p style="font: 10pt Times New Roman, Times, Serif; margin: 0; text-align: justify"><font style="font: 10pt Times New Roman, Times, Serif"><b> </b></font></p>
<p style="font: 10pt Times New Roman, Times, Serif; margin: 0 0 0 0.5in; text-align: justify"><font style="font: 10pt Times New Roman, Times, Serif">We
are involved in the following ongoing legal matters:</font></p>
<p style="font: 10pt Times New Roman, Times, Serif; margin: 0; text-align: justify; text-indent: 0.5in"><font style="font: 10pt Times New Roman, Times, Serif"> </font></p>
<p style="font: 10pt Times New Roman, Times, Serif; margin: 0; text-align: justify; text-indent: 0.5in"><font style="font: 10pt Times New Roman, Times, Serif">On
December 31, 2011, the Company and InfiniTek corporation (“InfiniTek”) entered into a settlement agreement to dismiss
an action filed by the Company against InfiniTek in the Texas State District Court in Fort Worth, Texas, for breach of contract
and other claims, a counter claim filed by InfiniTek against the Company for non-payment of amounts claimed the Company owed to
InfiniTek, and an action filed by InfiniTek against the Company in California Superior Court in Riverside, California seeking
damages for breach of contract and lost profit. Pursuant to the terms of the settlement agreement, Vertical agreed to pay InfiniTek
$82,500 in three equal installments with the last payment due by or before August 5, 2012. Upon full payment, InfiniTek shall
transfer and assign ownership of the NAVPath software developed by InfiniTek for use with NOW Solutions emPath® software
application and Microsoft Dynamics NAV (formerly Navision) business solution platform. The amounts in dispute were included in
our accounts payable and accrued liabilities and have been adjusted to the settlement amount of $82,500 at December 31, 2011.
The Company has made $37,500 in payments due under the settlement agreement as of the date of this Report and each party is alleging
the other party is in breach of the settlement agreement. We are currently seeking to resolve all disputes with InfiniTek. </font></p>
<p style="font: 10pt Times New Roman, Times, Serif; margin: 0"><font style="font: 10pt Times New Roman, Times, Serif">  </font></p>
<p style="font: 10pt Times New Roman, Times, Serif; margin: 0; text-align: justify; text-indent: 0.5in"><font style="font: 10pt Times New Roman, Times, Serif">On
February 4, 2014, Victor Weber filed a lawsuit against Vertical, MRC and Richard Wade in the District Court of Clark County, Nevada
for failure to make payment of the outstanding balance due under a $275,000 promissory note issued by Vertical to Mr. Weber. On
July 24 2014, the court granted plaintiff’s motion for summary judgment against defendants. The judgment was filed on September
18, 2014. In June 2015, the Company and Mr. Weber entered into an agreement to pay off the $365,000 outstanding balance under
the judgment, which included $275,000 in principal, accrued interest, attorney’s fees and court costs. Under the terms of
the agreement, the Company issued 10,000,000 shares of its common stock with the Rule 144 restrictive legend to Mr. Weber at a
fair market value of $250,000 in consideration of Mr. Weber’s forbearance in not taking any action to enforce the judgment.
The Company also agreed to make payments of $100,000 by June 15, 2015 and $265,000 by July 15, 2015, or in the alternative, the
Company had the option to issue another 10,000,000 shares of the Company’s common stock with the Rule 144 restrictive legend
in lieu of making the $100,000 payment and issue an additional 15,000,000 shares of the Company’s common stock with the Rule
144 restrictive legend in lieu of making the $265,000 payment. On June 15, 2015, the Company issued 10,000,000 shares with the
Rule 144 restrictive legend at a fair market value of $250,000 to Mr. Weber as repayment of a $100,000 payment resulting in a
loss on extinguishment of $150,000. On July 15, 2015, the Company issued 15,000,000 shares with the Rule 144 restrictive legend
at a fair market value of $408,000 to Mr. Weber as repayment of the $265,000 payment. Pursuant to the agreement, Mr. Weber filed
disposition documents that the judgment has been satisfied and this matter is resolved.</font></p>
<p style="font: 10pt Times New Roman, Times, Serif; margin: 0; text-align: justify; text-indent: 0.5in"><font style="font: 10pt Times New Roman, Times, Serif"> </font></p>
<p style="font: 10pt Times New Roman, Times, Serif; margin: 0; text-align: justify; text-indent: 0.5in"><font style="font: 10pt Times New Roman, Times, Serif">On
October 20, 2014, Michael T. Galvan and Michelle Bates (“<u>Galvan & Bates</u>”) filed a lawsuit in the Court of
Chancery in the State of Delaware seeking to have the court compel the Company to hold a shareholder meeting for the purpose of
electing all directors of the Company, designating the time and place of a meeting and other details reasonably necessary to hold
such a meeting, attorney costs and fees (including reasonable attorney’s fees), and such other relief as the court deems
proper. Galvan and Bates are stockholders of the Company. This case is styled Michael T. Galvan and Michelle Bates v. Vertical
Computer Systems, Inc., No. 10234. The Company held an annual meeting of shareholders on February 25, 2015. This matter is resolved.</font></p>
<p style="font: 10pt Times New Roman, Times, Serif; margin: 0; text-align: justify"><font style="font: 10pt Times New Roman, Times, Serif"><b>Note
8. Subsequent Events</b></font></p>
<p style="font: 10pt Times New Roman, Times, Serif; margin: 0; text-align: justify"><font style="font: 10pt Times New Roman, Times, Serif"><b> </b></font></p>
<p style="font: 10pt Times New Roman, Times, Serif; margin: 0; text-align: justify; text-indent: 0.5in"><font style="font: 10pt Times New Roman, Times, Serif">In
October 2015 the Company issued $50,000 of convertible debentures to a third party lender for a $50,000 loan made to the Company.
The debt accrues interest at 10% per annum and is due one year from the date of issuance. Beginning six months after issuance
of the respective debenture, the lender may convert the debenture into shares of common stock at a price per share of 80% of the
average per share price of the Company’s common stock for the 5 trading days preceding the notice of conversion date using
the 3 lowest closing prices. In connection with the loan, the Company also issued a total of 500,000 shares of common stock of
the Company to the lender and a 3 year warrant under which the lender may purchase a total of 500,000 shares of common stock of
the Company at a purchase price of $0.10 per share.</font></p>
<p style="font: 10pt Times New Roman, Times, Serif; margin: 0; text-align: justify"><font style="font: 10pt Times New Roman, Times, Serif"> </font></p>
<p style="font: 10pt Times New Roman, Times, Serif; margin: 0; text-align: justify; text-indent: 0.5in"><font style="font: 10pt Times New Roman, Times, Serif">In
October 2015, the Company and a third party lender entered into an agreement concerning loans made by the lender to the Company
during 2015 for $65,833, which bear interest at 12% per annum and are due on demand.  In connection with this agreement,
the Company issued 1,500,000 shares of VCSY common stock with the Rule 144 restrictive legend at a fair market value of $29,250.</font></p>
<p style="font: 10pt Times New Roman, Times, Serif; margin: 0; text-align: justify; text-indent: 0.5in"><font style="font: 10pt Times New Roman, Times, Serif"> </font></p>
<p style="font: 10pt Times New Roman, Times, Serif; margin: 0; text-align: justify; text-indent: 0.5in"><font style="font: 10pt Times New Roman, Times, Serif">In
October 2015, the Company and a third party lender entered into an amendment of a forbearance agreement concerning a $100,000
and $50,000 note issued by the Company under which the Company issued 1,000,000 shares of VCSY common stock with the Rule 144
restrictive legend at a fair market value of $20,000 as a forbearance fee and 7,000,000 shares of VCSY common stock with the Rule
144 restrictive legend at a fair market value of $140,000 to cancel $63,907 of accrued interest due under both notes.</font></p>
<p style="font: 10pt Times New Roman, Times, Serif; margin: 0; text-align: justify"><font style="font: 10pt Times New Roman, Times, Serif"> </font></p>
<p style="font: 10pt Times New Roman, Times, Serif; margin: 0; text-align: justify; text-indent: 0.5in"><font style="font: 10pt Times New Roman, Times, Serif">In
October 2015, the Company and a third party lender entered into a forbearance agreement concerning certain notes in the aggregate
principal amount of $1,288,919 issued by the Company to the lender under which the Company issued 1,500,000 shares of VCSY common
stock with the Rule 144 restrictive legend as a forbearance fee.</font></p>
<p style="font: 10pt Times New Roman, Times, Serif; margin: 0; text-align: justify"><font style="font: 10pt Times New Roman, Times, Serif"><b><i>Earnings
per share</i></b></font></p>
<p style="font: 10pt Times New Roman, Times, Serif; margin: 0; text-align: justify"><font style="font: 10pt Times New Roman, Times, Serif"><b><i> </i></b></font></p>
<p style="font: 10pt Times New Roman, Times, Serif; margin: 0; text-align: justify; text-indent: 0.5in"><font style="font: 10pt Times New Roman, Times, Serif">Basic
earnings per share is calculated by dividing net income (loss) available to common stockholders by the weighted average number
of shares of the Company’s common stock outstanding during the period. “Diluted earnings per share” reflects
the potential dilution that could occur if our share-based awards, stock warrants and convertible securities were exercised or
converted into common stock. The dilutive effect of our share-based awards is computed using the treasury stock method, which
assumes all share-based awards are exercised and the hypothetical proceeds from exercise are used to purchase common stock at
the average market price during the period. The incremental shares (difference between shares assumed to be issued versus purchased),
to the extent they would have been dilutive, are included in the denominator of the diluted EPS calculation. The dilutive effect
of our convertible preferred stock and convertible debentures is computed using the if-converted method, which assumes conversion
at the beginning of the year.</font></p>
<p style="font: 10pt Times New Roman, Times, Serif; margin: 0; text-align: justify"><font style="font: 10pt Times New Roman, Times, Serif"> </font></p>
<p style="font: 10pt Times New Roman, Times, Serif; margin: 0; text-align: justify; text-indent: 0.5in"><font style="font: 10pt Times New Roman, Times, Serif">For
the nine months ended September 30, 2015 and 2014, common stock equivalents related to the convertible debentures, convertible
debt and preferred stock and stock derivative liability were not included in the calculation of the diluted earnings per share
as their effect would be anti-dilutive.</font></p>
<p style="font: 10pt Times New Roman, Times, Serif; margin: 0; text-align: justify"><font style="font: 10pt Times New Roman, Times, Serif"><b><i>Reclassifications</i></b></font></p>
<p style="font: 10pt Times New Roman, Times, Serif; margin: 0; text-align: justify"><font style="font: 10pt Times New Roman, Times, Serif"> </font></p>
<p style="font: 10pt Times New Roman, Times, Serif; margin: 0; text-align: justify; text-indent: 0.5in"><font style="font: 10pt Times New Roman, Times, Serif">Certain
reclassifications have been made to the prior periods to conform to the current period presentation.</font></p>
<p style="font: 10pt Times New Roman, Times, Serif; margin: 0; text-align: justify; text-indent: 0in"><font style="font: normal 10pt Times New Roman, Times, Serif"><i>Capitalized
Software Costs</i></font></p>
<p style="font: 10pt Times New Roman, Times, Serif; margin: 0; text-align: justify; text-indent: 0in"><font style="font: normal 10pt Times New Roman, Times, Serif"><i> </i></font></p>
<p style="font: 10pt Times New Roman, Times, Serif; margin: 0; text-align: justify; text-indent: 0.5in"><font style="font: normal 10pt Times New Roman, Times, Serif">Software
costs incurred internally in creating computer software products are expensed until technological feasibility has been established
upon completion of a detailed program design. Thereafter, all software development costs are capitalized until the point that
the product is ready for sale, and are subsequently reported at the lower of unamortized cost or net realizable value. The Company
considers annual amortization of capitalized software costs based on the ratio of current year revenues by product to the total
estimated revenues by the product, subject to an annual minimum based on straight-line amortization over the product’s estimated
economic useful life, not to exceed five years. The Company periodically reviews capitalized software costs for impairment where
the fair value is less than the carrying value.</font></p>
<p style="font: 10pt Times New Roman, Times, Serif; margin: 0; text-align: justify; text-indent: 0.5in"><font style="font: normal 10pt Times New Roman, Times, Serif"> </font></p>
<p style="font: 10pt Times New Roman, Times, Serif; margin: 0; text-align: justify; text-indent: 0.5in"><font style="font: normal 10pt Times New Roman, Times, Serif">During
the nine months ended September 30, 2015, the Company capitalized an aggregate of $489,148 related to software development.</font></p>
<p style="font: 10pt Times New Roman, Times, Serif; margin: 0; text-align: justify; text-indent: 0.5in"><font style="font: normal 10pt Times New Roman, Times, Serif">  </font></p>
<p style="font: 10pt Times New Roman, Times, Serif; margin: 0; text-align: justify; text-indent: 0.5in"><font style="font: normal 10pt Times New Roman, Times, Serif">During
the nine months ended September 30, 2014, the Company capitalized an aggregate of $298,523 related to software development and
the Company recorded impairment of $579,204 on previously capitalized software development costs.</font></p>
<p style="font: bold 10pt Times New Roman, Times, Serif; margin: 0; text-align: justify; text-indent: 0in"><font style="font: 10pt Times New Roman, Times, Serif"><b><i>Recently
Issued Accounting Pronouncements</i></b></font></p>
<p style="font: bold 10pt Times New Roman, Times, Serif; margin: 0; text-align: justify; text-indent: 0in"><font style="font: 10pt Times New Roman, Times, Serif"> </font></p>
<p style="font: 10pt Times New Roman, Times, Serif; margin: 0; text-align: justify; text-indent: 0.5in"><font style="font: 10pt Times New Roman, Times, Serif">The
Company does not expect the adoption of any recently issued accounting pronouncements to have a material impact on the Company’s
financial position, operations or cash flows.</font></p>
<p style="font: 10pt Times New Roman, Times, Serif; margin: 0; text-align: justify; text-indent: 0.5in"><font style="font: 10pt Times New Roman, Times, Serif">The
following table reflects our third party debt activity, including our convertible debt, for the nine months ended September 30,
2015:</font></p>
<p style="font: 10pt Times New Roman, Times, Serif; margin: 0; text-align: justify; text-indent: 0.5in"><font style="font: 10pt Times New Roman, Times, Serif"> </font></p>
<table cellspacing="0" cellpadding="0" align="center" style="width: 70%; border-collapse: collapse; font-size: 10pt">
<tr style="background-color: rgb(204,238,255); vertical-align: bottom">
<td style="width: 87%"><font style="font: 10pt Times New Roman, Times, Serif">December 31, 2014</font></td>
<td style="width: 1%"><font style="font: 10pt Times New Roman, Times, Serif"> </font></td>
<td style="text-align: left; width: 1%"><font style="font: 10pt Times New Roman, Times, Serif">$</font></td>
<td style="text-align: right; width: 10%"><font style="font: 10pt Times New Roman, Times, Serif">4,575,239</font></td>
<td style="text-align: left; width: 1%"><font style="font: 10pt Times New Roman, Times, Serif"> </font></td></tr>
<tr style="background-color: white; vertical-align: bottom">
<td style="text-align: left"><font style="font: 10pt Times New Roman, Times, Serif">Repayments of third party notes</font></td>
<td><font style="font: 10pt Times New Roman, Times, Serif"> </font></td>
<td style="text-align: left"><font style="font: 10pt Times New Roman, Times, Serif"> </font></td>
<td style="text-align: right"><font style="font: 10pt Times New Roman, Times, Serif">(52,448</font></td>
<td style="text-align: left"><font style="font: 10pt Times New Roman, Times, Serif">)</font></td></tr>
<tr style="background-color: rgb(204,238,255); vertical-align: bottom">
<td style="text-align: left"><font style="font: 10pt Times New Roman, Times, Serif">Borrowings from third parties</font></td>
<td><font style="font: 10pt Times New Roman, Times, Serif"> </font></td>
<td style="text-align: left"><font style="font: 10pt Times New Roman, Times, Serif"> </font></td>
<td style="text-align: right"><font style="font: 10pt Times New Roman, Times, Serif">885,333</font></td>
<td style="text-align: left"><font style="font: 10pt Times New Roman, Times, Serif"> </font></td></tr>
<tr style="background-color: white; vertical-align: bottom">
<td style="text-align: left"><font style="font: 10pt Times New Roman, Times, Serif">Stock issued for debt payments</font></td>
<td><font style="font: 10pt Times New Roman, Times, Serif"> </font></td>
<td style="text-align: left"><font style="font: 10pt Times New Roman, Times, Serif"> </font></td>
<td style="text-align: right"><font style="font: 10pt Times New Roman, Times, Serif">(258,552</font></td>
<td style="text-align: left"><font style="font: 10pt Times New Roman, Times, Serif">)</font></td></tr>
<tr style="background-color: rgb(204,238,255); vertical-align: bottom">
<td style="text-align: left"><font style="font: 10pt Times New Roman, Times, Serif">Debt discounts due to stock and warrants
issued with debt</font></td>
<td><font style="font: 10pt Times New Roman, Times, Serif"> </font></td>
<td style="text-align: left"><font style="font: 10pt Times New Roman, Times, Serif"> </font></td>
<td style="text-align: right"><font style="font: 10pt Times New Roman, Times, Serif">(153,288</font></td>
<td style="text-align: left"><font style="font: 10pt Times New Roman, Times, Serif">)</font></td></tr>
<tr style="background-color: white; vertical-align: bottom">
<td style="text-align: left"><font style="font: 10pt Times New Roman, Times, Serif">Amortization of debt discounts</font></td>
<td><font style="font: 10pt Times New Roman, Times, Serif"> </font></td>
<td style="text-align: left"><font style="font: 10pt Times New Roman, Times, Serif"> </font></td>
<td style="text-align: right"><font style="font: 10pt Times New Roman, Times, Serif">10,570</font></td>
<td style="text-align: left"><font style="font: 10pt Times New Roman, Times, Serif"> </font></td></tr>
<tr style="background-color: rgb(204,238,255); vertical-align: bottom">
<td style="text-align: left; padding-bottom: 1pt"><font style="font: 10pt Times New Roman, Times, Serif">Currency translation</font></td>
<td style="padding-bottom: 1pt"><font style="font: 10pt Times New Roman, Times, Serif"> </font></td>
<td style="border-bottom: black 1pt solid; text-align: left"><font style="font: 10pt Times New Roman, Times, Serif"> </font></td>
<td style="border-bottom: black 1pt solid; text-align: right"><font style="font: 10pt Times New Roman, Times, Serif">(624</font></td>
<td style="text-align: left; padding-bottom: 1pt"><font style="font: 10pt Times New Roman, Times, Serif">)</font></td></tr>
<tr style="background-color: white; vertical-align: bottom">
<td style="padding-bottom: 1pt"><font style="font: 10pt Times New Roman, Times, Serif">September 30, 2015</font></td>
<td style="padding-bottom: 1pt"><font style="font: 10pt Times New Roman, Times, Serif"> </font></td>
<td style="border-bottom: black 1pt solid; text-align: left"><font style="font: 10pt Times New Roman, Times, Serif">$</font></td>
<td style="border-bottom: black 1pt solid; text-align: right"><font style="font: 10pt Times New Roman, Times, Serif">5,006,230</font></td>
<td style="text-align: left; padding-bottom: 1pt"><font style="font: 10pt Times New Roman, Times, Serif"> </font></td></tr>
</table>
<p style="font: 10pt Times New Roman, Times, Serif; margin: 0; text-indent: 0.5in"><font style="font: 10pt Times New Roman, Times, Serif">The
following table provides a summary of the fair value of our derivative liabilities as of September 30, 2015 and December 31, 2014:</font></p>
<p style="font: 10pt Times New Roman, Times, Serif; margin: 0; text-indent: 0.5in"><font style="font: 10pt Times New Roman, Times, Serif"> </font></p>
<table cellspacing="0" cellpadding="0" style="width: 100%; border-collapse: collapse; font-size: 10pt">
<tr style="vertical-align: bottom">
<td nowrap="nowrap"><font style="font: 10pt Times New Roman, Times, Serif"> </font></td>
<td nowrap="nowrap" style="padding-bottom: 1pt"><font style="font: 10pt Times New Roman, Times, Serif"> </font></td>
<td colspan="10" nowrap="nowrap" style="border-bottom: black 1pt solid; text-align: center"><font style="font: 10pt Times New Roman, Times, Serif">Fair
value measurements on a recurring basis</font></td>
<td nowrap="nowrap" style="padding-bottom: 1pt"><font style="font: 10pt Times New Roman, Times, Serif"> </font></td></tr>
<tr style="vertical-align: bottom">
<td nowrap="nowrap"><font style="font: 10pt Times New Roman, Times, Serif"> </font></td>
<td nowrap="nowrap" style="padding-bottom: 1pt"><font style="font: 10pt Times New Roman, Times, Serif"> </font></td>
<td colspan="2" nowrap="nowrap" style="border-bottom: black 1pt solid; text-align: center"><font style="font: 10pt Times New Roman, Times, Serif">Level
1</font></td>
<td nowrap="nowrap" style="padding-bottom: 1pt"><font style="font: 10pt Times New Roman, Times, Serif"> </font></td>
<td nowrap="nowrap" style="padding-bottom: 1pt"><font style="font: 10pt Times New Roman, Times, Serif"> </font></td>
<td colspan="2" nowrap="nowrap" style="border-bottom: black 1pt solid; text-align: center"><font style="font: 10pt Times New Roman, Times, Serif">Level
2</font></td>
<td nowrap="nowrap" style="padding-bottom: 1pt"><font style="font: 10pt Times New Roman, Times, Serif"> </font></td>
<td nowrap="nowrap" style="padding-bottom: 1pt"><font style="font: 10pt Times New Roman, Times, Serif"> </font></td>
<td colspan="2" nowrap="nowrap" style="border-bottom: black 1pt solid; text-align: center"><font style="font: 10pt Times New Roman, Times, Serif">Level
3</font></td>
<td nowrap="nowrap" style="padding-bottom: 1pt"><font style="font: 10pt Times New Roman, Times, Serif"> </font></td></tr>
<tr style="background-color: rgb(204,238,255); vertical-align: bottom">
<td style="width: 61%"><font style="font: 10pt Times New Roman, Times, Serif">As of September 30, 2015:</font></td>
<td style="width: 1%"><font style="font: 10pt Times New Roman, Times, Serif"> </font></td>
<td style="text-align: left; width: 1%"><font style="font: 10pt Times New Roman, Times, Serif"> </font></td>
<td style="text-align: right; width: 10%"><font style="font: 10pt Times New Roman, Times, Serif">  </font></td>
<td style="text-align: left; width: 1%"><font style="font: 10pt Times New Roman, Times, Serif"> </font></td>
<td style="width: 1%"><font style="font: 10pt Times New Roman, Times, Serif"> </font></td>
<td style="text-align: left; width: 1%"><font style="font: 10pt Times New Roman, Times, Serif"> </font></td>
<td style="text-align: right; width: 10%"><font style="font: 10pt Times New Roman, Times, Serif">   </font></td>
<td style="text-align: left; width: 1%"><font style="font: 10pt Times New Roman, Times, Serif"> </font></td>
<td style="width: 1%"><font style="font: 10pt Times New Roman, Times, Serif"> </font></td>
<td style="text-align: left; width: 1%"><font style="font: 10pt Times New Roman, Times, Serif"> </font></td>
<td style="text-align: right; width: 10%"><font style="font: 10pt Times New Roman, Times, Serif">  </font></td>
<td style="text-align: left; width: 1%"><font style="font: 10pt Times New Roman, Times, Serif"> </font></td></tr>
<tr style="background-color: white; vertical-align: bottom">
<td><font style="font: 10pt Times New Roman, Times, Serif">Liabilities</font></td>
<td><font style="font: 10pt Times New Roman, Times, Serif"> </font></td>
<td style="text-align: left"><font style="font: 10pt Times New Roman, Times, Serif"> </font></td>
<td style="text-align: right"><font style="font: 10pt Times New Roman, Times, Serif"> </font></td>
<td style="text-align: left"><font style="font: 10pt Times New Roman, Times, Serif"> </font></td>
<td><font style="font: 10pt Times New Roman, Times, Serif"> </font></td>
<td style="text-align: left"><font style="font: 10pt Times New Roman, Times, Serif"> </font></td>
<td style="text-align: right"><font style="font: 10pt Times New Roman, Times, Serif"> </font></td>
<td style="text-align: left"><font style="font: 10pt Times New Roman, Times, Serif"> </font></td>
<td><font style="font: 10pt Times New Roman, Times, Serif"> </font></td>
<td style="text-align: left"><font style="font: 10pt Times New Roman, Times, Serif"> </font></td>
<td style="text-align: right"><font style="font: 10pt Times New Roman, Times, Serif"> </font></td>
<td style="text-align: left"><font style="font: 10pt Times New Roman, Times, Serif"> </font></td></tr>
<tr style="background-color: rgb(204,238,255); vertical-align: bottom">
<td style="padding-left: 9pt"><font style="font: 10pt Times New Roman, Times, Serif">Stock derivative – 0 shares</font></td>
<td><font style="font: 10pt Times New Roman, Times, Serif"> </font></td>
<td style="text-align: left"><font style="font: 10pt Times New Roman, Times, Serif">$</font></td>
<td style="text-align: right"><font style="font: 10pt Times New Roman, Times, Serif">-</font></td>
<td style="text-align: left"><font style="font: 10pt Times New Roman, Times, Serif"> </font></td>
<td><font style="font: 10pt Times New Roman, Times, Serif"> </font></td>
<td style="text-align: left"><font style="font: 10pt Times New Roman, Times, Serif">$</font></td>
<td style="text-align: right"><font style="font: 10pt Times New Roman, Times, Serif">-</font></td>
<td style="text-align: left"><font style="font: 10pt Times New Roman, Times, Serif"> </font></td>
<td><font style="font: 10pt Times New Roman, Times, Serif"> </font></td>
<td style="text-align: left"><font style="font: 10pt Times New Roman, Times, Serif">$</font></td>
<td style="text-align: right"><font style="font: 10pt Times New Roman, Times, Serif">-</font></td>
<td style="text-align: left"><font style="font: 10pt Times New Roman, Times, Serif"> </font></td></tr>
<tr style="background-color: white; vertical-align: bottom">
<td><font style="font: 10pt Times New Roman, Times, Serif"> </font></td>
<td><font style="font: 10pt Times New Roman, Times, Serif"> </font></td>
<td style="text-align: left"><font style="font: 10pt Times New Roman, Times, Serif"> </font></td>
<td style="text-align: right"><font style="font: 10pt Times New Roman, Times, Serif"> </font></td>
<td style="text-align: left"><font style="font: 10pt Times New Roman, Times, Serif"> </font></td>
<td><font style="font: 10pt Times New Roman, Times, Serif"> </font></td>
<td style="text-align: left"><font style="font: 10pt Times New Roman, Times, Serif"> </font></td>
<td style="text-align: right"><font style="font: 10pt Times New Roman, Times, Serif"> </font></td>
<td style="text-align: left"><font style="font: 10pt Times New Roman, Times, Serif"> </font></td>
<td><font style="font: 10pt Times New Roman, Times, Serif"> </font></td>
<td style="text-align: left"><font style="font: 10pt Times New Roman, Times, Serif"> </font></td>
<td style="text-align: right"><font style="font: 10pt Times New Roman, Times, Serif"> </font></td>
<td style="text-align: left"><font style="font: 10pt Times New Roman, Times, Serif"> </font></td></tr>
<tr style="background-color: rgb(204,238,255); vertical-align: bottom">
<td><font style="font: 10pt Times New Roman, Times, Serif">As of December 31, 2014:</font></td>
<td><font style="font: 10pt Times New Roman, Times, Serif"> </font></td>
<td style="text-align: left"><font style="font: 10pt Times New Roman, Times, Serif"> </font></td>
<td style="text-align: right"><font style="font: 10pt Times New Roman, Times, Serif"> </font></td>
<td style="text-align: left"><font style="font: 10pt Times New Roman, Times, Serif"> </font></td>
<td><font style="font: 10pt Times New Roman, Times, Serif"> </font></td>
<td style="text-align: left"><font style="font: 10pt Times New Roman, Times, Serif"> </font></td>
<td style="text-align: right"><font style="font: 10pt Times New Roman, Times, Serif"> </font></td>
<td style="text-align: left"><font style="font: 10pt Times New Roman, Times, Serif"> </font></td>
<td><font style="font: 10pt Times New Roman, Times, Serif"> </font></td>
<td style="text-align: left"><font style="font: 10pt Times New Roman, Times, Serif"> </font></td>
<td style="text-align: right"><font style="font: 10pt Times New Roman, Times, Serif"> </font></td>
<td style="text-align: left"><font style="font: 10pt Times New Roman, Times, Serif"> </font></td></tr>
<tr style="background-color: white; vertical-align: bottom">
<td><font style="font: 10pt Times New Roman, Times, Serif">Liabilities</font></td>
<td><font style="font: 10pt Times New Roman, Times, Serif"> </font></td>
<td style="text-align: left"><font style="font: 10pt Times New Roman, Times, Serif"> </font></td>
<td style="text-align: right"><font style="font: 10pt Times New Roman, Times, Serif"> </font></td>
<td style="text-align: left"><font style="font: 10pt Times New Roman, Times, Serif"> </font></td>
<td><font style="font: 10pt Times New Roman, Times, Serif"> </font></td>
<td style="text-align: left"><font style="font: 10pt Times New Roman, Times, Serif"> </font></td>
<td style="text-align: right"><font style="font: 10pt Times New Roman, Times, Serif"> </font></td>
<td style="text-align: left"><font style="font: 10pt Times New Roman, Times, Serif"> </font></td>
<td><font style="font: 10pt Times New Roman, Times, Serif"> </font></td>
<td style="text-align: left"><font style="font: 10pt Times New Roman, Times, Serif"> </font></td>
<td style="text-align: right"><font style="font: 10pt Times New Roman, Times, Serif"> </font></td>
<td style="text-align: left"><font style="font: 10pt Times New Roman, Times, Serif"> </font></td></tr>
<tr style="background-color: rgb(204,238,255); vertical-align: bottom">
<td style="padding-left: 9pt"><font style="font: 10pt Times New Roman, Times, Serif">Stock derivative – 4,309,983 shares</font></td>
<td><font style="font: 10pt Times New Roman, Times, Serif"> </font></td>
<td style="text-align: left"><font style="font: 10pt Times New Roman, Times, Serif">$</font></td>
<td style="text-align: right"><font style="font: 10pt Times New Roman, Times, Serif">51,719</font></td>
<td style="text-align: left"><font style="font: 10pt Times New Roman, Times, Serif"> </font></td>
<td><font style="font: 10pt Times New Roman, Times, Serif"> </font></td>
<td style="text-align: left"><font style="font: 10pt Times New Roman, Times, Serif">$</font></td>
<td style="text-align: right"><font style="font: 10pt Times New Roman, Times, Serif">-</font></td>
<td style="text-align: left"><font style="font: 10pt Times New Roman, Times, Serif"> </font></td>
<td><font style="font: 10pt Times New Roman, Times, Serif"> </font></td>
<td style="text-align: left"><font style="font: 10pt Times New Roman, Times, Serif">$</font></td>
<td style="text-align: right"><font style="font: 10pt Times New Roman, Times, Serif">-</font></td>
<td style="text-align: left"><font style="font: 10pt Times New Roman, Times, Serif"> </font></td></tr>
</table>
<p style="font: 10pt Times New Roman, Times, Serif; margin: 0; text-indent: 0.5in"></p>
20000
3200
562373
VCSY
4575239
5006230
885333
-258552
-153288
153288
-624
150000
25333
1759150
550000
60000
745400
100000
50000
65833
100000
50000
1288919
Monthly
Monthly
24232
20000
P10Y
P30M
P24M
<p><font style="font: 10pt Times New Roman, Times, Serif">Secured by the assets of the Company’s subsidiaries, NOW Solutions,
Priority Time, SnAPPnet, Inc. (“SnAPPnet”) and the Company’s SiteFlash™ technology and cross-collateralized.
Upon the aggregate principal payment of $290,000 toward the Lakeshore Note, the Company has the option to have Lakeshore release
either the Priority Time collateral or the SiteFlash™ collateral. Upon payment of the aggregate principal of $590,000 toward
the Lakeshore Note, Lakeshore shall release either the Priority Time collateral or the SiteFlash™ collateral (whichever
is remaining). Upon payment of the aggregate principal of $890,000 toward the Lakeshore Note, Lakeshore shall release the SnAPPnet
collateral and upon full payment of the Lakeshore Note, Lakeshore shall release the NOW Solutions collateral.</font></p>
290000
590000
890000
0.05
0.08
0.06
5000000
20000
15000
391920
99210
2500
40000
80000
92500
0.12
0.10
175700
249000
455000
54200
100000
63907
11130
3000000
2250000
800000
84000
54750
<p><font style="font: 10pt Times New Roman, Times, Serif">The holder of the debenture may convert the debenture into shares of
common stock at a price per share of either (a) 80% of the average per share price of the Company’s common stock for the
5 trading days preceding the notice of conversion date using the 3 lowest closing prices or (b) 75% of the average per share closing
bid price of the Company’s common stock during the 10 trading days prior to the notice of conversion date using the lowest
5 closing bid prices per share (which shall not be lower than $0.03 per share).</font></p>
<p><font style="font: 10pt Times New Roman, Times, Serif">The lender may convert the debenture into shares of common stock at
a price per share of 80% of the average per share price of the Company’s common stock for the 5 trading days preceding the
notice of conversion date using the 3 lowest closing prices.</font></p>
P3Y
P5Y
P3Y
5500000
500000
0.10
0.05
0.10
2000000000
140000
41387
53171
-2303250
-1251554
-950664
-860091
-64203
-30439
-36588
21620
<p style="font: 10pt Times New Roman, Times, Serif; margin: 0; text-align: justify; text-indent: 0.5in"><font style="font: 10pt Times New Roman, Times, Serif">The
Company also agreed to make a $500,000 payment for amounts due to Lakeshore under the Lakeshore Note and the Loan Agreement. In
the event that the Company did not make the Lakeshore $500,000 payment on or before August 21, 2015, then Lakeshore in lieu of
the $500,000 payment, would obtain a purchase option (the “<u>2015 Purchase Option</u>”) to purchase an additional
250 shares of NOW Solutions common stock (representing a 25% ownership interest in NOW Solutions) until December 31, 2015 as follows:
(a) 84 shares of NOW Solutions common stock currently owned by VCSY for a purchase price of $450,000 and (b) 166 shares of NOW
Solutions common stock for a purchase price of $500,000 payable to NOW Solutions.</font></p>
<p style="font: 10pt Times New Roman, Times, Serif; margin: 0; text-align: justify; text-indent: 0.5in"><font style="font: 10pt Times New Roman, Times, Serif">  </font></p>
<p style="font: 10pt Times New Roman, Times, Serif; margin: 0; text-align: justify; text-indent: 0.5in"><font style="font: 10pt Times New Roman, Times, Serif">In
the event that Lakeshore exercises the 2015 Purchase Option and purchases the additional common shares of NOW Solutions by December
31, 2015, then (a) after the second year, but before the end of the fourth year from the date Lakeshore purchases the additional
shares of NOW Solutions under the 2015 Purchase Option, the Company will have the option to purchase for cash, all of Lakeshore's
500 shares for a price equal to the greater of $4.0 Million, 60% of trailing twelve months revenue, or 2.75X EBITDA. If the Company
does not exercise its purchase option prior to the end of the fourth year from the date Lakeshore purchases the additional shares
of NOW Solutions under the 2015 Purchase Option, then Lakeshore will have a purchase option to purchase for cash, all of the Company’s
500 shares for the greater of $3.5 Million, 55% of trailing twelve months revenue, or 2.50 X EBITDA, which will expire at the
end of the seventh year from the date Lakeshore purchases the additional shares of NOW Solutions under the 2015 Purchase Option
if exercised by Lakeshore.</font></p>
<p style="font: 10pt Times New Roman, Times, Serif; margin: 0; text-align: justify; text-indent: 0.5in"><font style="font: 10pt Times New Roman, Times, Serif">The
Company also agreed to make a $500,000 payment for amounts due to Lakeshore under the Lakeshore Note and the Loan Agreement. In
the event that the Company did not make the Lakeshore $500,000 payment on or before August 21, 2015, then Lakeshore in lieu of
the $500,000 payment, would obtain a purchase option (the “<u>2015 Purchase Option</u>”) to purchase an additional
250 shares of NOW Solutions common stock (representing a 25% ownership interest in NOW Solutions) until December 31, 2015 as follows:
(a) 84 shares of NOW Solutions common stock currently owned by VCSY for a purchase price of $450,000 and (b) 166 shares of NOW
Solutions common stock for a purchase price of $500,000 payable to NOW Solutions.</font></p>
<p style="font: 10pt Times New Roman, Times, Serif; margin: 0; text-align: justify; text-indent: 0.5in"><font style="font: 10pt Times New Roman, Times, Serif">  </font></p>
<p style="font: 10pt Times New Roman, Times, Serif; margin: 0; text-align: justify; text-indent: 0.5in"><font style="font: 10pt Times New Roman, Times, Serif">In
the event that Lakeshore exercises the 2015 Purchase Option and purchases the additional common shares of NOW Solutions by December
31, 2015, then (a) after the second year, but before the end of the fourth year from the date Lakeshore purchases the additional
shares of NOW Solutions under the 2015 Purchase Option, the Company will have the option to purchase for cash, all of Lakeshore's
500 shares for a price equal to the greater of $4.0 Million, 60% of trailing twelve months revenue, or 2.75X EBITDA. If the Company
does not exercise its purchase option prior to the end of the fourth year from the date Lakeshore purchases the additional shares
of NOW Solutions under the 2015 Purchase Option, then Lakeshore will have a purchase option to purchase for cash, all of the Company’s
500 shares for the greater of $3.5 Million, 55% of trailing twelve months revenue, or 2.50 X EBITDA, which will expire at the
end of the seventh year from the date Lakeshore purchases the additional shares of NOW Solutions under the 2015 Purchase Option
if exercised by Lakeshore.</font></p>
0.25
9808
P30M
P24M
1000000
7000000
250
84
166