VRTC Veritec Inc (PK)

See accompanying notes

See accompanying notes.

See accompanying notes.

See accompanying notes.

See accompanying notes

VERITEC, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
THREE AND SIX MONTHS ENDED DECEMBER 31, 2016 AND 2015
(UNAUDITED)

NOTE 1 – NATURE OF BUSINESS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

The Company

Veritec, Inc. (Veritec) was formed in the State of Nevada on September 8, 1982. Veritec’s wholly owned subsidiaries include Vcode Holdings, Inc. (Vcode®) and Veritec Financial Systems, Inc. (VTFS) (collectively the “Company”).

Nature of Business

The Company is primarily engaged in the development, marketing, sales and licensing of products and rendering of professional services related to its mobile banking solutions. Prior to its sale on September 30, 2015, the Company was also focused on its proprietary two-dimensional matrix symbology (also commonly referred to as “two-dimensional barcodes” or “2D barcodes”).

Mobile Banking Solutions

In January 12, 2009, Veritec formed VTFS, a Delaware corporation, to bring its Mobile Banking Technology, products and related professional services to market. In 2009 through 2016, the Company has had agreements with various banks, including Security First Bank (terminated in October 2010), Palm Desert National Bank (which was later assigned to First California Bank and subsequently Pacific Western Bank that terminated in June 2013), and Central Bank of Kansas City (“CBKC”). Late in the fiscal year ended June 30, 2016, the relationship between CBKC and the Company ended and the Company is currently seeking a bank to sponsor its Prepaid Card programs (see below). As a Cardholder Independent Sales Organization, Veritec is able to promote and sell Visa branded card programs. As a Third-Party Servicer, Veritec provides back-end cardholder transaction processing services for Visa branded card programs on behalf of its sponsoring bank. The Company has a portfolio of five United States and eight foreign patents. In addition, we have seven U.S. and twenty-eight foreign pending patent applications.

Barcode Technology (Sold September 30, 2015)

The Company’s Barcode Technology was originally invented by the founders of Veritec and as a product identification system for identification and tracking of manufactured parts, components and products mostly in the liquid crystal display (LCD) markets and is ideal for secure identification documents, financial cards, medical records and other high security applications. Veritec developed software to send, store, display, and read Barcode Technology on a mobile phone. On September 30, 2015, the Company sold all of its assets of its Barcode Technology, which was comprised solely of its intellectual property. The sale allows the Company to focus its efforts solely on its growing Mobile Banking Technology (See Note 7).

Other

On September 22, 2016, the Company announced that it has entered into a Non-Binding Letter of Intent (“LOI”) to acquire all of Flathead Bancorporation, Inc.’s (“FB”) issued and outstanding shares. FB is the majority owner of First Citizens Bank of Polson, Montana (“Citizens Bank”). If the Company is successful with its proposal to FB, the Company plans to use its mobile banking technology products and services with Citizens Bank. Under the proposed terms of the LOI, Veritec would acquire 9.9 percent of FB’s issued and outstanding shares for $320,000 at the closing date. Veritec plans to purchase the remaining 90.1 percent of FB’s outstanding common shares within three years of the closing date for $2,880,000. The transaction is subject to, among other things, Veritec being able to obtain funding and obtain regulatory approval from applicable banking authorities. The Company expects to complete this transaction by June 30, 2017.

On January 17, 2016, Veritec Inc. (the “Company”) entered into an agreement with Vietnam Alliance Capital (“VAC”), which is domiciled in Vietnam, to form a joint venture (“JV’) to operate a debit card business in Vietnam. The JV will be named Veritec Asia. The Company will be a 30% member in the JV and VAC will be a 70% member in the JV. Pursuant to the agreement, the Company will grant a license of certain products to the JV, and provide certain technologies and technological support to the JV. VAC will manage, control, and conduct its day-to-day business and development activities. In addition VAC has agreed to raise all funds to capitalize the JV. As of December 31, 2016, the JV has not received funding and anticipates receipt of funding in fiscal year 2017.

BASIS OF PRESENTATION

The accompanying unaudited condensed consolidated financial statements have been prepared in accordance with United States of America generally accepted accounting principles (“GAAP”) for interim financial information and with the instructions to Form 10-Q. Accordingly, the condensed consolidated financial statements do not include all of the information and footnotes required for complete financial statements.

In the opinion of management, all adjustments (consisting of normal recurring accruals) considered necessary for a fair presentation have been included. Operating results for the three and six month periods ended December 31, 2016 are not necessarily indicative of the results that may be expected for the year ending June 30, 2017. The consolidated balance sheet information as of June 30, 2016 was derived from the Company’s audited consolidated financial statements as of and for the year ended June 30, 2016 included in the Company’s Annual Report on Form 10-K filed with the Securities and Exchange Commission (the “SEC”) on September 26, 2016. These financial statements should be read in conjunction with that report.

The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. Those estimates and assumptions include estimates for reserves of uncollectible accounts, analysis of impairments of long lived assets, accruals for potential liabilities and assumptions made in valuing stock instruments issued for services.

The accompanying condensed consolidated financial statements include the accounts of Veritec, VCode, and VTFS. Inter-company transactions and balances were eliminated in consolidation.

GOING CONCERN

The accompanying consolidated financial statements have been prepared assuming the Company will continue as a going concern, which contemplates the realization of assets and satisfaction of liabilities in the normal course of business. During the six months ended December 31, 2016, the Company incurred a net loss of $284,920 and used cash in operating activities of $585,246, and at December 31, 2016, the Company had a working capital deficit of $3,394,962 and a stockholders’ deficiency of $3,501,842. In addition, as of December 31, 2016, the Company is delinquent in payment of $525,972 of its notes payable and $183,874 of its notes payable-related parties. These factors, among others, raise substantial doubt about our ability to continue as a going concern. In addition, the Company’s independent registered public accounting firm, in its report on our June 30, 2016 financial statements, raised substantial doubt about the Company’s ability to continue as a going concern. The Company’s financial statements do not include any adjustments that might result from the outcome of this uncertainty be necessary should we be unable to continue as a going concern.

The Company believes it will require additional funds to continue its operations through fiscal 2017 and to continue to develop its existing projects and plans to raise such funds by finding additional investors to purchase the Company’s securities, generating sufficient sales revenue, implementing major cost reductions or any combination thereof. There is no assurance that the Company can be successful in raising such funds, generating the necessary sales or reducing major costs. Further, if the Company is successful in raising such funds from sales of equity securities, the terms of these sales may cause significant dilution to existing holders of common stock. The consolidated financial statements do not include any adjustments that may result from this uncertainty.

Use of Estimates

The preparation of consolidated financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that may affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the consolidated financial statements and reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. Those estimates and assumptions include estimates for reserves of uncollectible accounts, analysis of impairments of long lived assets, accruals for potential liabilities, and assumptions used in valuing derivatives and stock-based compensation.

Revenue Recognition

Revenues from licenses and identification cards are recognized when the product is shipped, the Company no longer has any service or other continuing obligations, and collection is reasonably assured. The process typically begins with a customer purchase order detailing its specifications so the Company can import its software into the customer's hardware. Once importation is completed, if the customer only wishes to purchase a license, the Company typically transmits the software to the customer via the Internet. Revenue is recognized at that point. If the customer requests both license and hardware, the software is imported into the hardware and once the process is complete, the product is shipped, and revenue is recognized at time of shipment. Once the software and/or other products are either shipped or transmitted, the customers do not have a right of refusal or return. Under some conditions, the customers remit payment prior to the Company having completed importation of the software. In these instances, the Company delays revenue recognition and reflects the prepayments as customer deposits.

The Company, as a processor and a distributor, recognizes revenue from transaction fees charged cardholders for the use of its issued mobile debit cards. The fees are recognized on a monthly basis after all cardholder transactions have been summarized and reconciled with third party processors.

Fair Value of Financial Instruments

Fair value measurements adopted by the Company are based on the authoritative guidance provided by the Financial Accounting Standards Board (“FASB”) which defines fair value as the price that would be received to sell an asset or paid to transfer a liability in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants at the measurement date. FASB authoritative guidance establishes a fair value hierarchy, which prioritizes the inputs used in measuring fair value into three broad levels as follows:

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

Level 2 - Inputs, other than the quoted prices in active markets that are observable either directly or indirectly.

Level 3 - Unobservable inputs based on the Company's assumptions.

The carrying amounts reported in the consolidated balance sheets for cash and cash equivalents, accounts receivable, and current liabilities, including notes payable and convertible notes, approximate their fair values because of the short period of time between the origination of such instruments and their expected realization and their current market rates of interest.

At December 31, 2016, the Company’s condensed consolidated balance sheet included the fair value of derivative liabilities of $182,000, which was based on Level 2 measurements. At June 30, 2016, the Company did not have any derivative liabilities.

Derivative Financial Instruments

The Company evaluates its financial instruments to determine if such instruments are derivatives or contain features that qualify as embedded derivatives. For derivative financial instruments that are accounted for as liabilities, the derivative instrument is initially recorded at its fair value and is then re-valued at each reporting date, with changes in the fair value reported in the consolidated statements of operations. The classification of derivative instruments, including whether such instruments should be recorded as liabilities or as equity, is evaluated at the end of each reporting period. Derivative instrument liabilities are classified in the balance sheet as current or non-current based on whether or not net-cash settlement of the derivative instrument could be required within 12 months of the balance sheet date.

In the case of insufficient authorized share capital available to fully settle outstanding contracts, the Company utilizes the earliest inception date sequencing method to prioritize its convertible securities. At each reporting date, the Company reviews its convertible securities to determine their classification is appropriate.

Net Income (Loss) per Common Share

Basic earnings (loss) per share are computed by dividing the net income (loss) applicable to Common Stockholders by the weighted average number of shares of Common Stock outstanding during the year. Diluted earnings (loss) per share is computed by dividing the net income (loss) applicable to Common Stockholders by the weighted average number of common shares outstanding plus the number of additional common shares that would have been outstanding if all dilutive potential common shares had been issued, using the treasury stock method. Potential common shares are excluded from the computation as their effect is antidilutive. 

For the three and six months ended December 31, 2016 and 2015, the calculations of basic and diluted loss per share are the same because potential dilutive securities would have an anti-dilutive effect. At December 31, 2016, the Company’s Series H Preferred Stock, Convertible Notes Payable and Options were antidilutive because their exercise prices and conversion prices were out of the money.

As of December 31, 2016 and 2015, we excluded the outstanding securities summarized below, which entitle the holders thereof to acquire shares of common stock, from our calculation of earnings per share, as their effect would have been anti-dilutive.

Concentrations

The Company’s cash balances on deposit with banks are guaranteed by the Federal Deposit Insurance Corporation up to $250,000. The Company may be exposed to risk for the amounts of funds held in one bank in excess of the insurance limit. In assessing the risk, the Company’s policy is to maintain cash balances with high quality financial institutions. The Company did not have cash balances in excess of the guarantee during the six months ended December 31, 2016.

Major Customers

During the three months ended December 31, 2016, the Company had two customers that represented an aggregate of 71% (59% and 12%) of our revenue. During the three months ended December 31, 2015, the Company had three customers that represented an aggregate of 59% (24%, 19% and 16%) of our revenue.

During the six months ended December 31, 2016, the Company had three customers that represented an aggregate of 71% (47%, 13%, and 10%) of our revenue. During the six months ended December 31, 2015, the Company had no customers that accounted for more than 10% of our revenue.

Foreign Revenues

During the three months ended December 31, 2016 and 2015, the Company had no foreign revenues.

During the six months ended December 31, 2016, the Company had no foreign revenues. During the six months ended December 31, 2015, foreign revenues accounted for 45% (14% Taiwan, 12% China, and 19% others) of the Company’s total revenues.

Recent Accounting Pronouncements

In May 2014, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update (ASU) No. 2014-09, Revenue from Contracts with Customers. ASU 2014-09 is a comprehensive revenue recognition standard that will supersede nearly all existing revenue recognition guidance under current U.S. GAAP and replace it with a principle based approach for determining revenue recognition. Under ASU 2014-09, revenue is recognized when a customer obtains control of promised goods or services and is recognized in an amount that reflects the consideration which the entity expects to receive in exchange for those goods or services. In addition, the standard requires disclosure of the nature, amount, timing, and uncertainty of revenue and cash flows arising from contracts with customers. The FASB has recently issued ASU 2016-08, ASU 2016-10, ASU 2016-11, ASU 2016-12, and ASU 2016-20 all of which clarify certain implementation guidance within ASU 2014-09. ASU 2014-09 is effective for interim and annual periods beginning after December 15, 2017. Early adoption is permitted only in annual reporting periods beginning after December 15, 2016, including interim periods therein. The standard can be adopted either retrospectively to each prior reporting period presented (full retrospective method), or retrospectively with the cumulative effect of initially applying the guidance recognized at the date of initial application (the cumulative catch-up transition method). The Company is currently in the process of analyzing the information necessary to determine the impact of adopting this new guidance on its financial position, results of operations, and cash flows. The Company will adopt the provisions of this statement in the quarter beginning July 1, 2018.

In February 2016, the FASB issued ASU No. 2016-02, Leases . ASU 2016-02 requires a lessee to record a right of use asset and a corresponding lease liability on the balance sheet for all leases with terms longer than 12 months. ASU 2016-02 is effective for all interim and annual reporting periods beginning after December 15, 2018. Early adoption is permitted. A modified retrospective transition approach is required for lessees for capital and operating leases existing at, or entered into after, the beginning of the earliest comparative period presented in the financial statements, with certain practical expedients available. The Company is currently evaluating the expected impact that the standard could have on its financial statements and related disclosures.

In March 2016, the FASB issued the ASU 2016-09,  Compensation - Stock Compensation (Topic 718) : Improvements to Employee Share-Based Payment Accounting. The amendments in this ASU require, among other things, that all income tax effects of awards be recognized in the income statement when the awards vest or are settled. The ASU also allows for an employer to repurchase more of an employee's shares than it can today for tax withholding purposes without triggering liability accounting and allows for a policy election to account for forfeitures as they occur. The amendments in this ASU are effective for fiscal years beginning after December 15, 2016, including interim periods within those fiscal years. Early adoption is permitted for any entity in any interim or annual period. The Company is currently evaluating the expected impact that the standard could have on its financial statements and related disclosures.

Other recent accounting pronouncements issued by the FASB, including its Emerging Issues Task Force, the American Institute of Certified Public Accountants, and the Securities and Exchange Commission did not or are not believed by management to have a material impact on the Company's present or future consolidated financial statements.

NOTE 2 – INTANGIBLE ASSETS AND CONTINGENT EARNOUT LIABILITY

On September 30, 2014, the Company acquired certain assets and liabilities of Tangible Payments LLC, a Maryland Limited Liability Company for an aggregate purchase price of $192,500, including an earnout payment of $155,000. The earnout payment is payable on a monthly basis from the net profits derived from the acquired assets commencing three months after the closing. From the date of the acquisition and up to December 31, 2016, there was no net profit derived from the acquired assets and accordingly, no payments were made on the earnout. The earnout payment is accelerated and the balance of the earnout payment shall be due in full at such time as Veritec receives equity investments aggregating $1.3 million.

The Company assigned $192,500 of the purchase price to contract commitments which are amortized over a three year period. As of December 31, 2016 and June 30, 2016, the unamortized balance of contract commitments was $48,120 and $80,208, respectively. For the three and six months ended December 31, 2016 and 2015, the Company recorded $16,042 and $32,088, and $16,042 and $32,083, of amortization expense respectively, related to this intangible which is included in general and administrative expense in the accompanying Condensed Consolidated Statements of Operations.

NOTE 3 – NOTES PAYABLE

Notes payable

Notes payable includes accrued interest and consists of the following at December 31, 2016 and June 30, 2016:

(a) At June 30, 2016, convertible notes totaled $195,655. During the six months ended December 31, 2016, accrued interest of $4,730 was added to principal. At December 31, 2016, convertible notes totaled $200,385. The notes are unsecured, and interest accrues at rates ranging from 5% to 8% per annum. At December 31, 2016, $164,507 of the notes are in default, and are convertible at a conversion price of $0.30 per share into 548,356 shares of the Company’s common stock. The balance of $35,878 is due on demand, and is convertible at a conversion price of $0.08 per share into 448,475 shares of the Company’s common stock.

(b) At June 30, 2016, notes payable totaled $352,729. During the six months ended December 31, 2016, accrued interest of $8,739 was added to principal. At December 31, 2016, the notes payable totaled $361,465. $327,185 of notes are secured by the Company’s intellectual property, and $34,280 of notes are unsecured. Interest accrues at rates ranging from 6.5% to 10% per annum. At December 31, 2016, the Company was in default on the notes totaling $361,465.

Notes payable-related party

Notes payable-related includes accrued interest and consists of the following at December 31, 2016 and June 30, 2016:

(c) The Matthews Group (see Note 7) is owned 50% by Ms. Van Tran, the Company’s CEO, and 50% by Larry Johanns, a significant shareholder of the Company. At June 30, 2016, convertible notes due to The Matthews Group totaled $669,648. During the six months ended December 31, 2016, $427,000 of convertible notes were issued to The Matthews Group, and accrued interest of $42,591 was added to principal. At December 31, 2016, convertible notes due to The Matthews Group totaled $1,136,489. The notes are unsecured, interest accrues at rates ranging from 8% to 10% per annum, and are due on demand. At December 31, 2016, the notes are convertible at a conversion price of $0.08 per share into 14,206,113 shares of the Company’s common stock. During the three and six months ended December 31, 2016, the market price on the date some of the notes were issued was in excess of the conversion price, and as a result the Company recorded a beneficial conversion feature on issuance of the notes of $8,750 and $16,250, respectively, which is included as interest expense .

(d) At June 30, 2016, notes payable due to The Matthews Group totaled $216,648. During the six months ended December 31, 2016, $219,883 of notes payable were issued to The Matthews Group, and accrued interest of $17,876 was added to principal. At December 31, 2016, notes payable due to The Matthews Group totaled $454,407. The notes are unsecured, accrued interest at 10% per annum, and are due on demand. The notes were made in relation to a management services agreement with The Matthews Group (see Note 7).

(e) At June 30, 2016, convertible notes due other related parties totaled $237,725. During the six months ended December 31, 2016, accrued interest of $8,163 was added to principal. At December 31, 2016 convertible notes due other related parties totaled $245,978. The notes are unsecured and accrue interest at rates ranging from 8% to 10% per annum. At December 31, 2016, $183,874 of the notes are in default, and the balance of $62,104 is due on demand. At December 31, 2016, $183,874 of the notes are convertible at a conversion price of $0.30 per share into 612,913 shares of the Company’s common stock, $23,505 of the notes are convertible at a conversion price of $0.10 per share into 235,050 shares of the Company’s common stock, and $38,599 of the notes are convertible at a conversion price of $0.08 per share into 472,488 shares of the Company’s common stock.

(f) On September 21, 2016, the Company entered into a settlement agreement with an individual who was a former officer of the Company.  The individual had loaned the Company $250,000 in prior years and was also issued 500,000 shares of common stock for services.  The Company alleged that the individual used the Company's intellectual property without approval.   Under the terms of the settlement agreement, the individual agreed to relinquish a convertible note payable and unpaid interest aggregating $364,686, and return 500,000 shares of common stock previously issued to him.  In turn, the Company agreed to release and discharge the individual against all claims arising on or prior to the date of the settlement agreement.  The Company recorded a gain on the settlement of $364,686 in the accompanying condensed consolidated statement of operations for the six months ended December 31, 2016. As of December 31, 2016, the 500,000 shares have not been relinquished. When the Company receives the shares, it will record a cancellation of shares.

NOTE 4 - DERIVATIVE LIABILITIES

From time to time, the Company issues convertible notes payable with embedded conversion features and options to purchase common stock. Pursuant to the FASB authoritative guidance on determining whether an instrument (or embedded feature) is indexed to an entity’s own stock, when there are insufficient authorized shares, the obligation for the exercise of the convertible instrument should be classified as a liability and measured at fair value. In December 2016, the Company determined that there were not sufficient authorized shares of common stock available for issuance upon conversion of certain of its convertible notes. As a result, in December 2016, the Company recorded a charge for the fair value of the derivative liabilities of $182,000. The conversion feature of the notes is re-measured at the end of every reporting period with the change in value reported in the consolidated statement of operations.

The derivative liability was valued at the following dates using a Black-Scholes-Merton model with the following assumptions:

The risk-free interest rate was based on rates established by the Federal Reserve Bank. The Company used its own historical stock’s volatility as the estimated volatility. The expected life of the conversion feature of the notes or options was based on the estimated remaining terms of the notes or options, or expected settlement date for notes due on demand or that have matured. The expected dividend yield was based on the fact that the Company has not customarily paid dividends to its holders of common stock in the past and does not expect to pay dividends to holders of its common stock in the future.

NOTE 5 - STOCKHOLDERS’ DEFICIENCY

As of December 31, 2016 and June 30, 2016, 145,000 shares of common stock with an aggregate value of $12,500 have not been issued and are reflected as common shares to be issued in the accompanying condensed consolidated balance sheet.

At December 31, 2016, the Company had 2,500,000 of options outstanding and exercisable. The options expire in February, 2020, and are exercisable at $0.08 per share. There were no options granted during the six months ended December 31, 2016 and the Company recognized no stock-based compensation expense related to stock options during the three and six months ended December 31, 2016 and 2015, respectively. As of December 31, 2016, there was no remaining unrecognized compensation costs related to stock options, and the intrinsic value of these options was $50,000.

Additional information regarding options outstanding as of December 31, 2016 is as follows:

The weighted-average remaining contractual life of stock options outstanding and exercisable at December 31, 2016 is 3.25 years.

NOTE 7 – RELATED PARTY TRANSACTIONS

The Matthews Group is owned 50% by Ms. Van Tran, the Company’s CEO/Executive Chair and a director, and 50% by Larry Johanns, a significant stockholder of the Company. The Company has relied on The Matthews Group for funding (see Notes 1 and 3).

During the six months ended December 31, 2016, The Matthews Group loaned the Company $427,500 of convertible notes. At December 31, 2016, convertible notes of $1,136,489 are due The Matthews Group (see Note 3).

The Company has a management services agreement with The Matthews Group to manage all facets of the Company’s previous barcode technology operations, on behalf of The Matthews Group, through May 30, 2017. The Matthews Group bears the risk of loss from the barcode operations and has the right to the residual benefits of the barcode operations. In consideration, the Company earns a fee of 20% of all revenues from the barcode technology operations. During the three and six months ended December 31, 2016, the Company recorded revenue related to this agreement of $52,430 and $75,330, respectively. Pursuant to the management services agreement, all cash flow (all revenues collected less direct costs paid) of the barcode technology operations is retained by the Company as proceeds from unsecured notes payable due The Matthews Group. During the six months ended December 31, 2016, cash flow loans of $219,883 were made to the Company at 10% interest per annum and due on demand. At December 31, 2016, cash flow loans of $454,407 are due to The Matthews Group (see Note 3).

At various times throughout the Company’s history, the Company received various unsecured, non-interest bearing, due on demand advances from its Chief Executive Officer, Ms. Van Tran, a related party. The balances due Ms. Tran as of December 31, 2016 and June 30, 2016 were $96,110 and $96,110, respectively. These advances have been classified as accounts payable, related pa rty on the accompanying condensed consolidated balance sheets.

The Company leases its office facilities from Ms. Tran. For both the three and six months ended December 30, 2016 and 2015, rental payments to Ms. Van Tran totaled $12,750 and $25,500, respectively.