Note 11: Equity Transactions

Series B Convertible Preferred Stock

There are authorized and outstanding 2,585,000 shares of Series B Convertible Preferred Stock (“Series B”). The Series B is convertible at $0.20 per common share and carries a liquidation preference of a like amount. At December 31, 2013 and 2012, the Series B had accumulated and unpaid dividends of $106,931.

Series C Convertible Preferred Stock

There were authorized and outstanding at December 31, 2012, 1,000,000 shares of Series C Convertible Preferred Stock (“Series C”). In April 2013, 500,000 shares of the Series C was converted into 500,000 shares of common stock. The remaining 500,000 shares of Series C outstanding at December 31, 2013 carries a liquidation preference of a like amount.

Common Stock

In January 2013, the Company issued 3,000,000 shares of restricted common stock to two vendors for services. The fair value of the vested portion of these shares was determined to be $192,000. In June 2013, the Company issued 1,000,000 shares of restricted common stock to one vendor for services. The fair value of the vested portion of these shares was determined to be $52,500. In November 2013, the Company issued 300,000 shares of restricted common stock to two vendors for services. The fair value of the vested portion of these shares was determined to be $12,000

During the year ended December 31, 2013, holders of Convertible Debentures with a face value of $473,684 converted their debentures into 8,266,737 shares of restricted common stock. In addition, associated with these debentures, the Company paid $59,365 in accrued interest by issuing 915,652 shares of restricted common stock.

In April 2013, a shareholder converted 500,000 shares of Series C Convertible Preferred stock into 500,000 shares of restricted common stock.

In September 2013, the Company issued a nine month unsecured note with a face value of $45,000 and 500,000 restricted shares of common stock to an affiliate of the Company in exchange for $54,325 in cash. The imputed annual rate of interest was calculated to be 18.4% and is to be repaid in nine equal monthly installments. Of the 500,000 shares issued, 312,500 shares were issued for prepaid expenses in an amount of $15,625 which is being amortized as interest expense over the life of the note and 187,500 shares were issued for cash in an amount of $9,375.

During the year ended December 31, 2012, the holders of Convertible Debentures with a face value of $2,224,212 converted their debentures into 38,816,934 shares of common stock. In addition, associated with these debentures, the Company paid $222,420 in accrued interest by issuing 3,881,777 shares of common stock.

In December 2012, the Company issued 1,400,000 shares of restricted common stock to a vendor for services. The fair value of the shares was determined to be $70,000 based upon the market value of the stock on the date of issuance. The vendor services are expected to be performed over a twelve-month period over which the fair value of these shares will be amortized.

In October 2012, the Company issued 25,000 shares of restricted common stock to a vendor for services. The fair value of the shares was determined to be $3,000 based upon the market value of the stock on the date of issuance.

In July 2012, the Company issued 50,000 shares of restricted common stock to a vendor for services. The fair value of the shares was determined to be $8,500, based upon the market value of the stock on the date of issuance.

Convertible Debentures

From February through July 2013, the Company entered into subscription agreements with accredited investors to purchase an aggregate principal amount of $917,895 of Convertible Debentures initially convertible into shares of common stock at a conversion price of $0.0573, together with five-year warrants to purchase approximately 8,010,000 common shares at an exercise price equal to $0.0745 per share.

From September through December 2013, the Company entered into subscription agreements with accredited investors to purchase an aggregate principal amount of $1,315,790 of Convertible Debentures initially convertible into shares of common stock at a conversion price of $0.045, together with five-year warrants to purchase approximately 14,620,000 common shares at an exercise price equal to $0.09 per share.

From January through March 2012, the Company entered into subscription agreements with accredited investors to purchase an aggregate principal amount of $2,350,527 of Convertible Debentures initially convertible into shares of common stock at a conversion price of $0.0573, together with five-year warrants to purchase approximately 20,511,000 common shares at an exercise price equal to $0.0745 per share.

From August through December 2012, the Company entered into subscription agreements with accredited investors to purchase an aggregate principal amount of $1,003,158 of Convertible Debentures initially convertible into shares of common stock at a conversion price of $0.099, together with five-year warrants to purchase approximately 5,066,000 common shares at an exercise price equal to $0.1287 per share.

Stock Options

As of December 31, 2013, the Company had one stock-based employee compensation plan under which it makes grants, the 2011 Equity Incentive Plan (the “EIP”) which has been approved by our Board of Directors and is subject to shareholder approval. After approval by the shareholders, the EIP provides for the grant of incentive stock options (“ISOs”), nonqualified stock options (“NQSOs”) and restricted stock awards to full-time employees (who may also be directors) and NQSOs and restricted stock awards to non-employee directors, consultants, customers, vendors or providers of services. The exercise price of any ISO may not be less than the fair market value of the common stock on the date of grant and the term shall not exceed ten years. At December 31, 2013, the Company had outstanding 15,075,000 options under the EIP and the Company’s prior Amended 2001 Stock Plan representing approximately 9% of the Company’s outstanding shares (10,510,313 of which were exercisable). Awards under the Company’s EIP generally vest over four years. Previous to shareholder approval, any grants under the EIP shall be accounted for as NQSOs.

The fair value of options granted were estimated at the date of grant using a Black-Scholes Model which includes several variables including expected life, risk free interest rate, expected stock price volatility, stock option exercise patterns and expected dividend yield. The Company also must estimate forfeitures for employee stock options. These models and assumptions are complex and may change future expenses by increasing or decreasing stock-based compensation expense. Management used the following weighted average assumptions to value stock options granted during the years ended December 31, 2013 and 2012:

	Year Ended December 31,
	2013	2012

Expected term of options	None	5 years
Exercise price	None	$0.09-$0.12
Expected volatility	None	102%
Expected dividends	None	None
Risk-free interest rate	None	0.71%
Forfeitures	None	None

In addition to the above, management estimated the forfeitures on employee options under the Option Plan would have negligible effects because such forfeitures would be a very small percentage. Management believes that options granted have been to a group of individuals that have a high desire to see the Company succeed and have aligned themselves to that end.

The expected lives used in the calculations were selected by management based on past experience, forward looking profit forecasts and estimates of what the trading price of the Company’s stock might be at different future dates. Risk-free interest rates used are the five-year U.S. Treasury rate as published for the applicable measurement dates.

Volatility is a calculation based on fluctuations in the Company’s stock price over a historical time period consistent with the estimated life of the option.

A summary of the status of the options granted under the Company’s 2011 EIP at December 31, 2013 and 2012, and changes during the years then ended is presented below:

			Outstanding Options
	Options
			Weighted		Weighted		Weighted Average
			Average		Average		Remaining
			Exercise		Fair		Contractual Term
	Shares		Price		Value		in years

Outstanding, December 31, 2011		15,795,000	$	0.20			8.20
Granted		5,246,667	$	0.12	$	0.08
Cancelled		(1,550,000)	$	0.18
Exercised		-		-
Outstanding, December 31, 2012		19,491,667	$	0.18			8.20
Granted		-		-
Cancelled		(4,416,667)	$	0.33
Exercised		-		-
Outstanding, December 31, 2013		15,075,000	$	0.14			6.94

Exercisable, December 31, 2012		9,470,417	$	0.24			6.71
Exercisable, December 31, 2013		10,510,313	$	0.15			6.45

The intrinsic value of the options outstanding under the EIP at December 31, 2013 and 2012 was 0 and 0.

A summary of the status of the options outstanding under the EIP at December 31, 2013 are presented in the table below:

		Outstanding					Exercisable
				Weighted
				Average	Weighted			Weighted
Range of				Remaining	Average			Average
Exercise		Number		Contractual	Exercise		Number	Exercise
Prices		Outstanding		Life	Price		Exercisable	Price

Options

$	0.06-0.11		3,800,000	7.42	$	0.10	3,214,583	$	0.10
$	0.12		3,805,000	8.72	$	0.12	1,189,063	$	0.12
$	0.15		6,320,000	5.95	$	0.15	4,990,000	$	0.15
$	0.24-0.90		1,150,000	4.91	$	0.28	1,116,667	$	0.28
			15,075,000	6.94	$	0.14	10,510,313	$	0.15

There were no stock options exercised during the years ended December 31, 2013 and 2012. At December 31, 2013, total unrecognized estimated employee and director compensation cost related to stock options granted is $376,982, which is expected to be recognized over the next three to four years.

Warrants

During the year ended December 31, 2013, in conjunction with the sale of Convertible Debentures, the Company issued five-year common stock purchase warrants to acquire approximately 22,629,000 shares to holders of the Debentures and 2,880,000 similar warrants as compensation to Agents. Of these warrants, approximately 10,385,000 have an exercise price of $0.0745 per share and approximately 15,124,000 have an exercise price of $0.09 per share.

During the year ended December 31, 2012, in conjunction with the sale of Convertible Debentures, the Company issued five-year common stock purchase warrants to acquire approximately 25,577,000 shares to holders of the Debentures and 7,673,000 similar warrants as compensation to Agents. Of these warrants, approximately 26,664,000 have an exercise price of $0.0745 per share and approximately 6,586,000 have an exercise price of $0.1287 per share.

In October 2012, a holder of a cashless warrant to purchase 86,340 shares of restricted common stock exercised the warrant in a cashless transaction and was issued 14,870 shares of restricted common stock. A summary of the status of the warrants granted under various agreements at December 31, 2013 and 2012, and changes during the years then ended is presented below:

	Warrants
			Weighted		Weighted
			Average		Average
			Exercise		Fair
	Shares		Price		Value

Outstanding, December 31, 2011		25,903,032	$	0.30

Granted		33,178,830	$	0.09	$	0.08
Expired		-	$	-
Exercised		(14,870)	$	0.08
Outstanding, December 31, 2012		59,066,992	$	0.18

Granted		25,509,506	$	0.08	$	0.05
Expired on exchange to new warrant		(4,024,286)	$	0.11
Issued on exchange to new warrant		7,377,582	$	0.09
Exercised		-	$	-
Outstanding, December 31, 2013		87,929,794	$	0.15

Exercisable, December 31, 2012		59,066,992	$	0.18
Exercisable, December 31, 2013		87,929,794	$	0.15

A summary of the status of the warrants outstanding at December 31, 2013 are presented in the table below:

		Outstanding					Exercisable
			Weighted
			Average		Weighted				Weighted
Range of			Remaining		Average				Average
Exercise		Number	Contractual		Exercise		Number		Exercise
Prices		Outstanding	Life		Price		Exercisable		Price

Warrants

$	0.0745	39,333,936		3.52	$	0.07		39,333,936	$	0.07
$	0.08-0.09	19,956,065		4.65	$	0.09		19,956,065	$	0.09
$	0.1287	4,222,599		3.95	$	0.13		4,222,599	$	0.13
$	0.30-0.35	24,417,194		1.14	$	0.31		24,417,194	$	0.31
		87,929,794		3.14	$	0.15		87,929,794	$	0.15