Stockholders' Deficiency

12 Months Ended

Dec. 31, 2013

Notes to Financial Statements

9. Stockholders' Deficiency

The Company is authorized to issue up to 50,000,000 shares of Common Stock with a par value of $0.001 per share and 1,000,000 shares of preferred stock with a par value of $0.001 per share.

Common Stock

During the year ended December 31, 2012, the Company sold an aggregate of 116,670 shares of its Common Stock to investors, for aggregate net proceeds of $525,004.

During the year ended December 31, 2013, pursuant to a private placement offering of units that commenced on October 4, 2012 (the “Private Placement”), the Company received an aggregate of $3,501,975 of proceeds related to the sale of 3,501,975 units at a price of $1.00 per unit. The aggregate amount includes $500,000, which was received from an officer, and $850,002, which was received during the fourth quarter of 2012 and classified as restricted cash as of December 31, 2012. Each unit consists of (i) one share of the Company’s Common Stock and (ii) a five-year warrant to purchase three shares of the Company’s Common Stock at an exercise price of $0.25 per share, such that warrants to purchase an aggregate of 10,505,925 shares of Common Stock were issued. Substantially all of the proceeds from the sale of the units were used by the Company to satisfy all of its obligations under the convertible notes and notes (see Notes 6 and 7). In connection with the Private Placement, an officer has entered into repurchase agreements with certain purchasers of units, pursuant to which he has agreed to repurchase, subject to certain conditions, one-half of these holder’s units at a purchase price of $1.00 per unit if the closing price of the Common Stock is less than $0.25 on five consecutive trading days at any time within one year of February 1, 2013. Cape Bear, which holds a substantial equity position in the Company, also entered into repurchase agreements with certain purchasers, other than the officer, that are substantially similar to the officer’s agreements, except that Cape Bear’s obligations are secured by a lien over certain real estate.

On March 13, 2013, the Company exchanged $761,000 of notes payable and other advances – related parties and $72,000 of accounts payable to two related parties into an aggregate of 833,000 units at a price of $1.00 per unit. Each unit consists of (i) one share of the Company’s Common Stock, and (ii) a five-year warrant to purchase two and three-quarters shares of the Company’s Common Stock at an exercise price of $0.25 per share (such that warrants to purchase an aggregate of 2,290,750 shares of Common Stock were issued). The $3,625,900 aggregate fair value of the securities issued ($2,639,700 related to the warrants and $986,200 related to the Common Stock) was credited to equity at conversion. The Company recorded a $2,792,900 extinguishment loss which represents the incremental fair value of the securities issued as compared to the carrying value of the liabilities.

Preferred Stock

Series A Preferred Stock

The Company has designated 200,000 of the 1,000,000 authorized shares of preferred stock as Series A Convertible Preferred Stock (“Series A Preferred Stock”). The Series A Preferred Stock is non-voting, has a liquidation preference equal to its purchase price, and does not pay dividends. The holders can call for the conversion of the Series A Preferred Stock at any time and are entitled to half a share of the Company’s Common Stock for each share of Series A Preferred Stock converted. As of December 31, 2013, 44,443 shares of Series A Preferred Stock are available to be issued. There is no Series A Preferred Stock outstanding as of December 31, 2013 or 2012.

Series B Preferred Stock

The Company has designated 625,000 of the 1,000,000 authorized shares of preferred stock as Series B Convertible Preferred Stock (“Series B Preferred Stock”). The Series B Preferred Stock has voting rights equal to one vote for each common share equivalent, has a liquidation preference equal to its purchase price, and receives preferred dividends equal to 7% of all outstanding shares in either cash or payment-in-kind. The holders can call for the conversion of the Series B Preferred Stock at any time and are entitled to five shares of the Company’s Common Stock for each share of Series B Preferred Stock converted. In addition, the Series B Preferred Stock is subject to weighted average anti-dilution protection whereby if shares of Common Stock are sold below the current conversion price, the conversion price is reduced pursuant to a pre-defined formula. As of December 31, 2013 and 2012, Series B holders were entitled to convert into 8.22 and 5.00 shares, respectively, of the Company’s Common Stock for each share of Series B Preferred Stock due to the anti-dilution provision. The anti-dilution provision represents a contingent beneficial conversion feature.  As of December 31, 2013, an incremental 1,359,854 shares of Common Stock are issuable at conversion of the Series B Convertible Preferred Stock as compared to the original terms.   Using the commitment date Common Stock price in effect, the commitment date value of the incremental shares is $3,432,272. However, recognition of beneficial conversion features is limited to the aggregate gross proceeds allocated to the preferred stock of $3,199,689 (422,315 shares of Series B Convertible Preferred Stock times $9.45 per share less the proceeds allocated to the warrants of $791,188) less the $1,666,967 beneficial conversion feature already recognized on the original 365,265 shares of Series B Preferred Stock (prior to the issuance of additional shares as payment-in-kind in lieu of cash dividends).  Due to these limitations, a beneficial conversion feature of $1,532,722 was recorded for the year ended December 31, 2013.

As of December 31, 2013 and 2012, the Company had accrued contractual dividends of $279,380 and $261,084, respectively, related to the Series B Preferred Stock. On January 1, 2014, 2013 and 2012, the Company issued 29,564, 27,630 and 25,823 shares of Series B convertible preferred stock valued at $279,380, $261,084 and $244,001, respectively, representing approximately $0.66 in value per share of Series B Preferred Stock outstanding on each date, to the Series B convertible preferred stock owners as payment in kind for dividends.

Series C Preferred Stock

On October 17, 2011, the Company filed a Certificate of Designation of Preferences, Rights and Limitations with the Secretary of State of the State of Delaware fixing the rights, preferences and restrictions of a newly formed class of Series C Preferred Stock. The Certificate of Designation designates 10,000 shares of the Company's preferred stock as Series C Preferred Stock to be issued at an original issue price of $100 per share. The Series C Preferred Stock has voting rights equal to one vote for each share held, has a liquidation preference equal to its purchase price, and has certain redemption rights available at the option of the holder. The holder can make a mandatory redemption request at any time on or after the earliest of (i) January 15, 2013, (ii) any date prior to January 15, 2013 on which the Convertible Notes are declared by the holders thereof to be, or automatically become, due and payable on an event of default, acceleration event or otherwise, (iii) immediately prior to an Asset Transfer or Acquisition, or (iv) the date on which the Convertible Notes are no longer outstanding. The Series C Preferred Stock is non- convertible and does not pay dividends.

On October 17, 2011, the Company received net cash proceeds of $1,000,000 for the sale of 10,000 shares of Series C Preferred Stock to a greater than 10% stockholder of the Company (the “Series C Holder”). Since certain of the Company’s preferred shares contain redemption rights which are not solely within the Company’s control, these issuances of preferred stock were initially presented as temporary equity. In connection with the issuance, the investor received five-year immediately exercisable warrants to purchase 270,000 shares of the Company’s Common Stock at an exercise price of $2.90 per share and which had a relative fair value of $526,522 on the date of grant. The $526,522 relative fair value was recorded as a discount against the Series C Preferred Stock and was initially amortized as deemed dividends over the period through January 15, 2013.

On October 31, 2012, the Company entered into a letter agreement (the “Series C Letter”) with the Series C Holder relating to its Series C Preferred Stock. Pursuant to the Series C Letter, the Series C Holder agreed to exchange (the “Exchange”) all its shares of Series C Preferred Stock for Common Stock of the Company if (i) the Company receives at least $4 million in proceeds from qualifying private placements of Common Stock (as defined) on or prior to December 31, 2012 (the “Private Placements”) and (ii) all the Company’s Convertible Notes due December 31, 2012 and all the Company’s Notes due January 15, 2013 cease to be outstanding, and would not be replaced with other debt securities, other than debt securities issued to lenders approved by the Series C Holder. If the Exchange had occurred, for each share of Series C Preferred exchanged, the Series C Holder would have received a number of shares of Common Stock equal to $100 divided by the weighted average price of the shares of Common Stock sold in the Private Placements. However, the Company failed to raise the funds required in the Series C Letter.

On February 13, 2013, the Company received a Notice of Redemption of Series C Preferred Stock. As a result of the Convertible Notes coming due and not being paid on December 31, 2012, the Company accelerated the accretion rate of the deemed dividend on the Redeemable Preferred Stock – Series C and reclassified the Redeemable Preferred Stock – Series C from temporary equity to current liabilities. The Company recorded Series C deemed dividends of $433,606 during the year ended December 31, 2012. As of December 31, 2012, the discount associated with the Series C Preferred Stock was fully amortized.

Incentive Compensation / Stock Option Plans

The 2009 Incentive Compensation Plan (the “2009 Plan”) was approved on May 15, 2009 and June 4, 2009, and the increase in the total number of shares of Common Stock issuable pursuant to the 2009 Plan to 2,881,425 was approved on October 4, 2010 and September 20, 2011 by the Board of Directors and Stockholders, respectively.

The 2009 Plan imposes individual limitations on the amount of certain awards. Under these limitations during any fiscal year of the Company, the number of options, stock appreciation rights, shares of restricted stock, shares of deferred stock, performance shares and other stock based-awards granted to any one participant under the 2009 Plan may not exceed 250,000 shares, subject to adjustment in certain circumstances. The maximum amount that may be paid out as performance units in any 12-month performance period is an aggregate value of $2,000,000, and the maximum amount that may be paid out as performance units in any performance period greater than 12 months is an aggregate value of $4,000,000. The maximum term of each option or stock appreciation right, the times at which each option or stock appreciation right will be exercisable, and provisions requiring forfeiture of unexercised options or stock appreciation rights at or following termination of employment generally are fixed by the board of directors or committee of the Company’s board of directors designated to administer the 2009 Plan (the “Committee”), except that no option or stock appreciation right may have a term exceeding ten years. The exercise price per share subject to an option and the grant price of a stock appreciation rights are determined by the Committee, but in the case of an incentive stock option (ISO) must not be less than the fair market value of a share of Common Stock on the date of grant.

Stock Options

Grants

During the year ended December 31, 2013, the Company granted options to purchase an aggregate of 935,500 shares of Common Stock to certain employees and directors. These options vest over a one year or three year period, have a term of 10 years, and contain an exercise price between $.30 and $1.60  per share. The options were granted under a previously approved plan and had an aggregate grant date fair value of $624,645.

During the year ended December 31, 2012, the Company granted options to purchase an aggregate of 416,000 shares of Common Stock to certain employees and directors. These options vest over a three year period, have a term of 10 years, and contain an exercise price between $4.95 and $6.99 per share. The options were granted under a previously approved plan and had an aggregate grant date fair value of $1,674,903.

On March 30, 2012, the Company granted four Directors options to purchase an aggregate of 60,000 shares of Common Stock under the 2009 Plan with an exercise price of $6.99 per share for an aggregate grant date value of $315,926.  The options vest over a three year period and have a term of ten years.

On March 30, 2012, the Company granted options to employees to purchase an aggregate of 30,000 shares of Common Stock under the 2009 Plan with an exercise price of $6.99. The options have an aggregate grant date value of $157,963, vest over a three year period and have a term of ten years.

On October 15, 2012, the Company granted employees options to purchase an aggregate of 76,000 shares of Common Stock under the 2009 Plan at an exercise price of $4.95 per share for an aggregate grant date value of $279,991.  The options vest over a three year period and have a term of ten years.

On October 15, 2012, the Company granted an option to an officer of the Company to purchase 250,000 shares of Common Stock under the 2009 Plan at an exercise price of $4.95 per share for an aggregate grant date value of $921,023.  The options vest over a three year period and have a term of ten years.

On February 15, 2013, the Company granted options to employees to purchase an aggregate of 330,500 shares of Common Stock under the 2009 Plan at an exercise price of $1.60 per share for an aggregate grant date value of $395,041. The options vest over a three year period and have a term of ten years.

On June 19, 2013, the Company granted an option to a director to purchase 100,000 shares of Common Stock under the 2009 Plan at an exercise price of $1.45 per share for a grant date value of $109,600.  The option vests over a three year period and has a term of ten years.

On October 30, 2013, the Company granted options to directors to purchase 405,000 shares of Common Stock under the 2009 Plan at an exercise price of $0.30 per share for a grant date value of $89,220.  The options vest over a one year period and has a term of ten years.

On December 23, 2013, the Company granted options to employees to purchase an aggregate of 100,000 shares of Common Stock under the 2009 Plan at an exercise price of $0.53 per share for an aggregate grant date value of $30,783. The options vest over a three year period and have a term of ten years.

Exercises

On January 6, 2012, a former officer was issued 92,858 shares of Common Stock pursuant to a cashless exercise of a stock option to purchase 105,450 shares of Common Stock with an exercise price of $.80 per share.

On May 4, 2012, the Company received $26,662 in proceeds from the exercise of options to purchase 4.166 shares of Common Stock at $2.80 per share and 4,166 shares of Common Stock at $3.60 per share.

On November 12, 2012, a former officer was issued 63,129 shares of Common Stock pursuant to a cashless exercise of a stock option to purchase 17,575 shares of Common Stock (14,676 net shares) at an exercise price of $0.80 per share and a stock option to purchase 100,000 shares of Common Stock (48,453 net shares) at an exercise price of $2.50 per share.

There were no options exercised during the year ended December 31, 2013.

The aggregate intrinsic value of options exercised was $0  and $932,795 for the years ended December 31, 2013 and 2012, respectively.

Valuation and Amortization

Option valuation models require the input of highly subjective assumptions.  The fair value of the stock-based payment awards is estimated utilizing the Black-Scholes option model.  The volatility component of this calculation is derived from the historical trading prices of  the Company’s own Common Stock.  The Company accounts for the expected life of options in accordance with the “simplified” method which enables the use of the simplified method for “plain vanilla” share options as defined in Staff Accounting Bulletin No. 107.  The risk-free interest rate was determined from the implied yields of U.S. Treasury zero-coupon bonds with a remaining life consistent with the expected term of the options.

In addition, the Company is required to estimate the expected forfeiture rate and only recognize expense for those shares expected to vest.  In estimating the Company’s forfeiture rate, the Company analyzed its historical forfeiture rate, the remaining lives of unvested options, and the number of vested options as a percentage of total options outstanding.  If the Company’s actual forfeiture rate is materially different from its estimate, or if the Company reevaluates the forfeiture rate in the future, the stock-based compensation expense could be significantly different from what the Company has recorded in the current period.  The Company estimated forfeitures related to option grants at a weighted average annual rate of  4% and 5% per year for options granted during the years ended December 31, 2013 and 2012, respectively.
 

In applying the Black-Scholes option pricing model to stock options granted, the Company used the following weighted average assumptions:

	For The Twelve Months Ended
	December 31,
	2013	2012
Risk free interest rate	1.13% to 2.03%	.88% to 1.33%
Dividend yield	0.00%	0.00%
Expected volatility	162.0% to 175.0%	163.7% to 172.2%
Expected life in years	5.5 to 6.0	6.00

The weighted average fair value of the stock options granted during the years ended December 31, 2013 and 2012 was $0.91 and $5.39 per share, respectively.

Stock-based compensation expense related to stock options was recorded in the  consolidated statements of operations as a component of selling, general and administrative expenses and totaled $558,286 and $556,148 for the years ended December 31, 2013 and 2012, respectively.

As of December 31, 2013, stock-based compensation expense related to stock options of $1,693,482 remains unamortized, including $801,913 which is being amortized over the weighted average remaining period of 1.7 years.  The remaining $891,569 is related to a performance based option where vesting is currently deemed to be improbable and no amount is being amortized.

Summary

A summary of the stock option activity during the years ended December 31, 2013 and 2012 is presented below:

						Weighted
				Weighted		Average
				Average		Remaining
	Number of			Exercise		Life		Intrinsic
	Options			Price		In Years		Value
Outstanding, January 1, 2012		2,165,925		$	2.89
Granted		416,000			5.39
Exercised		(231,357	)		1.62
Forfeited		(166,669	)		4.03
Outstanding, January 1, 2013		2,183,899		$	3.42
Granted		935,500			0.91
Exercised		-			-
Forfeited		(576,249	)		3.96
Outstanding, December 31, 2013		2,543,150		$	2.37	6.0	$	-
Exercisable, December 31, 2013		1,235,650		$	2.73	3.8	$	-

The following table presents information related to stock options at December 31, 2013:

		Options Outstanding				Options Exercisable
		Weighted				Weighted		Weighted
Range of		Average		Outstanding		Average		Average		Exercisable
Exercise		Exercise		Number of		Exercise		Remaining Life		Number of
Price		Price		Options		Price		In Years		Options
$	0.30 - $2.20	$	1.11		1,354,400	$	0.57		0.6		485,900
$	2.21 - $3.80		3.23		757,750		2.95		4.0		507,750
$	3.81 - $6.99		4.79		431,000		4.59		7.8		242,000
		$	2.37		2,543,150	$	2.73		3.8		1,235,650

Warrants 

Valuation

In applying the Black-Scholes option pricing model to stock warrants granted, the Company used the following weighted average assumptions:

	2013	2012
Risk free interest rate	.74% to 1.39%	.67%
Dividend yield	0.00%	0.00%
Expected volatility	146.0% to 166.7%	163.7%
Expected life in years	5.00	10.00

Grants

On October 15, 2012, the Company granted a consultant a ten-year warrant to purchase 30,000 shares of Common Stock at an exercise price of $4.95 per share.  The warrant had a grant date value of $115,049 which will be recognized over the three year vesting period.

On February 15, 2013, the Company granted vested five-year warrants to purchase an aggregate of 408,345 shares of Common Stock at an exercise price of $1.00 per share to investors who purchased shares in private placements at $4.50 per share during 2012. The warrants had an issuance date fair value of $487,200 which was expensed immediately.

See Note 7 – Notes Payable for details regarding warrants granted in connection with the issuances of notes payable.

See Note 9 – Stockholders’ Deficiency – Common Stock for details regarding warrants granted in connection with the Private Placement and the conversion of related party notes payable, other advances and accounts payable into equity.

The weighted average fair value of the stock warrants granted during the years ended December 31, 2013 and 2012, respectively, was $1.34 and $3.83 per share.

Exercise

During the year ended December 31, 2012, the Company issued an aggregate of 1,465,578 shares of Common Stock to three holders of warrants who elected to exercise 2,353,744 warrants on a “cashless” basis under the terms of the warrants.  The warrants had exercise prices of $1.60 per share (471,628 net shares), $3.00 per share (701,388 net shares) and $2.90 per share (292,562 net shares).

During the year ended December 31, 2013, the Company issued an aggregate of 10,342,931 shares of Common Stock to several holders of warrants who elected to exercise warrants to purchase 12,505,023 shares of Common Stock on a "cashless" basis under the terms of the warrants. The warrants had exercise prices of $0.25 per share (11,346,675 gross shares), $0.35 per share (750,000 gross shares), and $1.00 per share (408,348 gross shares).

The aggregate intrinsic value of the warrants exercised was $16,983,736 and $10,316,439 for the years ended December 31, 2013 and 2012, respectively.

Stock-based compensation expense related to the mark-to-market adjustment for consultant warrants for the year ended December 31, 2013 was recorded in the  consolidated statements of operations as a component of selling, general and administrative expenses and totaled $(17,718). During the years ended December 31, 2013 and 2012, the Company recorded stock-based compensation expense of $490,420 and $4,794, respectively, related to warrants  As of December 31, 2013, stock-based compensation expense related to warrants of $583,481 remains unamortized, including $1,864 which is being amortized over the weighted average remaining period of 0.5 years.  The remaining $576,840 is related to a performance based warrant where vesting is currently deemed to be improbable and no amount is being amortized.

A summary of the stock warrant activity during the years ended December 31, 2013 and 2012, respectively, is presented below:

				Weighted		Average
				Average		Remaining
	Number of			Exercise		Life		Intrinsic
	Warrants			Price		In Years		Value
Outstanding, January 1, 2012		2,916,590		$	2.53
Granted		30,000		$	2.90
Exercised		(2,353,744	)	$	1.60
Forfeited		-		$	-
Outstanding, January 1, 2013		592,846		$	3.01
Granted		14,255,023		$	0.28
Exercised		(12,505,023	)	$	0.28
Forfeited		-			-
Outstanding, December 31, 2013		2,342,846		$	0.94	3.9	$	37,918
Exercisable, December 31, 2013		2,072,846		$	0.66	4.0	$	37,918

The following table presents information related to stock warrants at December 31, 2013:

		Warrants Outstanding				Warrants Exercisable
		Weighted				Weighted		Weighted
Range of		Average		Outstanding		Average		Average		Exercisable
Exercise		Exercise		Number of		Exercise		Remaining Life		Number of
Price		Price		Warrants		Price		In Years		Warrants
$	0.25 - $0.35	$	0.24		1,750,000	$	0.24		4.2		1,750,000
$	0.36 - $3.00		2.91		562,846		2.91		2.7		312,846
$	3.01 - $4.95		4.95		30,000		4.95		3.8		10,000
$	0.25 - $4.95	$	0.94		2,342,846	$	0.66		4.0		2,072,846

Services Contributed

Effective January 1, 2013, an executive officer of the Company waived payment for services contributed during 2013. As a result, the Company imputed the value of the services contributed and recorded salary expense $350,000 for year ended December 31, 2013, respectively, with a corresponding credit to stockholders’ deficiency.