Line of Credit and Debt

9 Months Ended

Sep. 30, 2013

Note E – Line of Credit and Debt

Imperium Commercial Finance, LLC

On January 16, 2013 (the “Imperium Closing Date”), we entered into a 3-year Loan and Security Agreement (“LSA”) with Imperium Commercial Finance, LLC (“Imperium”), a new Senior Lender, to refinance our Line of Credit with Medallion Financial Corp (“Medallion”), see below for information on the Medallion Line of Credit.

Under the LSA, Imperium has agreed to provide the Company with up to a maximum amount of $1,500,000 (“Maximum Funding Amount”) under a revolving secured loan facility (the “Imperium Line of Credit”), which is secured by a first security interest in all of our receivables, inventory, and intellectual property rights along with a second security interest in our machinery and equipment (together the “Collateral”). The Maximum Funding Amount is subject to a discretionary borrowing base comprised of: 85% of eligible accounts receivables (excluding, without limitation, receivables remaining unpaid for more than 90 days from invoice date or 60 days from due date, contra receivables, and affiliated receivables), up to the lesser of 60% of eligible finished goods inventory at cost or 75% of appraised net orderly liquidation value of inventory, and a receivable dilution rate of less than 5% (the “Borrowing Base”).

In addition to the Imperium Line of Credit, the Imperium facility includes a discretionary Supplemental Advance of up to $500,000 (the “Imperium Supplemental Advance”). Supplemental advances, once repaid, cannot be re-borrowed, and is secured with the same Collateral as the Imperium Line of Credit.

The Imperium Line of Credit is to be used for working capital and general corporate purposes, and the Imperium Supplemental Advance is to be used for costs associated with obtaining marketing clearance of our oral fluid products and costs associated with other new market opportunities.

On the Imperium Closing Date, we paid a closing fee of $10,000 to Imperium, and granted Imperium a 7-year warrant to purchase 2,000,000 common shares of the Company at an exercise price of $0.18 (the “Imperium Warrants”) (See Part I, Item 1, Note F – Stock Options and Warrants; Imperium Financing Stock Options and Warrants). We also paid an early termination fee of $25,000 to Medallion on the Imperium Closing Date, a finder’s fee of 3% of the gross proceeds from the Imperium financing, or $60,000, and a 5-year warrant (the “Monarch Warrant”) to purchase 60,000 common shares of the Company at an exercise price of $0.18 to Monarch Capital Group, LLC (See Part I, Item 1,Note F – Stock Options and Warrants; Imperium Financing Stock Options and Warrants).

We also pay Imperium an Unused Line Fee in an amount equal to 2% (a) from and after the Imperium Closing Date through and including March 31, 2013, the Maximum Revolving Amount less the aggregate amounts outstanding to Imperium and (b) at all time from and after April 1, 2013, the Maximum Amount of $2,000,000 less the aggregate amounts outstanding to Imperium. The Unused Line Fee for each month (except for the month in which the termination occurs) is payable on the first day of each calendar month following the Imperium Closing Date; the final monthly installment of the Unused Line Fee is payable on the termination date. We also pay to Imperium a Collateral monitoring fee of $2,500 on the first day of each month during the term of the LSA.

A success fee of $175,000 (“Success Fee”) is due and payable if Imperium terminates due to an event of default, or if we terminate and pre-pay all amounts due to Imperium prior to the stated expiration date of January 16, 2016, however, the Success Fee is not due and payable if Imperium has exercised all its rights under the Imperium Warrant and sells all of the common shares underlying the Imperium Warrant on or before January 16, 2016 and if on the date that Imperium completes such sale(s), the price per share of the Company’s common shares is at least $0.70 per common share.

Under the LSA, interest on the Imperium Line of Credit and the Imperium Supplemental Advance is in cash at a rate equal to eight percent (8%) per annum and (ii) in kind (i.e., “PIK” interest) at a rate equal to two percent (2%) per annum (collectively, the “Interest Rate”), all of which “PIK” interest shall be added to and constitute a part of the aggregate principal amount of outstanding Line of Credit borrowing or aggregate principal amount of outstanding Supplemental Advances, as applicable, as and when such “PIK” interest becomes due and payable hereunder. Interest is payable on the Line of Credit and Supplemental Advance in arrears for the preceding calendar month on the first day of each calendar month.

So long as any obligations are due to Imperium under the LSA, we must maintain Net Borrowing Availability of not less than $100,000 (Net Borrowing Availability is defined as borrowing availability less the amounts due under the Imperium Line of Credit). There are also certain minimum EBITDA (Earnings Before Interest, Taxes Depreciation and Amortization) requirements. More specifically, we must have EBITDA of not less than (a) $25,000 for the Fiscal Quarter ended on or about March 31, 2013, (b) $100,000 for the Fiscal Quarter ended on or about June 30, 2013, (c) $200,000 for the Fiscal Quarter ending on or about September 30, 2013, and (d) $300,000 for the Fiscal Quarter ending on or about December 31, 2013 and for each of the Fiscal Quarters thereafter.

We incurred $435,000 in costs related to the Imperium Line of Credit, which included the costs noted previously as well as $39,000 to Imperium for their legal fees, $2,000 for Company’s legal fees and $9,000 in capitalized deferred financing costs and $290,000 as debt discount associated with the warrants issues to Imperium and Monarch (See Part I, Item 1, Note F – Stock Options and Warrants; Imperium Financing Stock Options and Warrants). With the exception of the early termination fee of $25,000 paid to Medallion, which was fully recognized in the three months ended March 31, 2013, these costs will be amortized over the term of the facility (3 years). We recognized $202,000 of these costs in the nine months ended September 30, 2013, of which $75,000 was deferred financing costs, and $0 in costs in the nine months ended September 30, 2012 (as we didn’t enter into the LSA with Imperium until January 2013). We recognized $59,000 of these costs, of which $25,000 was deferred financing costs, in the three months ended September 30, 2013 and $0 in costs in the three months ended June 30, 2012 (as we didn’t enter into the LSA with Imperium until January 2013). We incurred $93,000 in interest expense in the nine months ended September 30, 2013, and $0 in interest expense in the nine months ended September 30, 2012 (as we did not enter into the LSA with Imperium until January 2013). We incurred $35,000 in interest expense related to the Imperium Line of Credit in the three months ended September 30, 2013, and $0 in interest expense in the three months ended September 30, 2012 (as we did not enter into the LSA with Imperium until January 2013).

In an event of default, which includes but is not limited to, failure of the Company to make any payment when due, and non-compliance with the Net Borrowing Availability and minimum EBITDA requirements, the interest rate will be increased by 4% for as long as the event of default occurs. Imperium’s other remedies include, but are not limited to, termination or suspension of Imperium’s obligation to make further advances to the Company, declaration of all amounts owed to Imperium due and payable. We did not comply with the minimum EBITDA requirement for the quarter ending March 31, 2013, however, upon conferences with Imperium, on May 20, 2013, Imperium waived the EBITDA requirement for the quarter ended March 31, 2013. Imperium was paid $10,0000 for costs related to account review. We also did not comply with the EBITDA requirement for the quarter ended June 30, 2013, and as of the date of this report, we are also not in compliance with the EDBITDA requirement for the quarter ended September 30, 2013 (to be measured upon the filing of this Form 10-Q). EBITDA non-compliance constitutes an event of default under our Imperium Line of Credit. The increase in interest rate, given our current advances under the Imperium Line of Credit would not be material, however, if Imperium were to suspend or terminate further advances, or declare all amounts due and payable, this would have a material adverse effect on our business and negatively impact our ability to continue operations.

In late July 2013, Imperium notified the Company that it was reducing the Maximum Funding Amount on the Imperium Line of Credit from $1,500,000 to $1,100,000 (however, the Company must continue to maintain minimum Net Borrowing Availability of $100,000 so in essence the maximum amount available under the Imperium Line of Credit is $1,000,000) and that no further advances would be made under the Imperium Supplemental Advance. We are currently in discussions with Imperium related to the EBITDA non-compliance and any further actions they may take.

The balance on the Imperium Line of Credit was $880,000 and the balance on the supplemental advance was $200,000, for a total loan balance of $1,080,000 at September 30, 2013; there was $0 outstanding to Imperium at December 31, 2012, as we did not enter into the LSA with Imperium until January 2013. We must maintain net borrowing availability of at least $100,000, therefore, as of September 30, 2013, additional loan availability on the line of credit was $120,000 and since Imperium suspended further advances under the Supplemental Advance, there was $0 in availability under the Supplemental Advance, for a total Loan Availability of $120,000 as of September 30, 2013.

Medallion Financial Corp

On April 20, 2012 (the “Medallion Closing Date”), we entered into a Loan and Security Agreement (the “Loan Agreement”) with Medallion to refinance our Line of Credit with Rosenthal and Rosenthal, Inc (“Rosenthal”; see below for information on the Rosenthal Line of Credit).

Under the Loan Agreement, Medallion provided the Company with up to $1,000,000 under a revolving secured line of credit (the “Medallion Line of Credit”), which was secured by a first security interest in all of our receivables, inventory, and intellectual property rights along with a second security interest in our machinery and equipment. The maximum amount available under the Medallion Line of Credit was subject to an Advance Rate that consisted of: 85% of eligible accounts receivable and up to 30% of eligible inventory (not to exceed $150,000).

From the loan availability on the Medallion Closing Date, we drew approximately $566,000 to pay off our Line of Credit with Rosenthal. We were charged a facility fee of 1% of the balance of the Medallion Line of Credit on the Medallion Closing Date and the same facility fee of 1% would be charged on each anniversary of the Medallion Closing Date. Under the Loan Agreement, interest on outstanding borrowings was payable monthly and was charged at an annual rate equal to 4% above the Wall Street Journal Prime rate as published from time to time. We were subject to two audits per year by Medallion (provided we were not in default) at a rate of $950.00 per person per day. Prior to the Medallion Closing Date, we also paid a non-refundable fee in the amount of $10,000 to Medallion for field exam and due diligence costs.

We incurred $20,000 in costs related to the Medallion Line of Credit. These costs were fully expensed in the nine and three months ended September 30, 2012 so, although the Medallion Line of Credit was in place for a few weeks in January 2013, there was $0 in cost expensed in the nine and three months ended September 30, 2013. We incurred $8,000 in interest expense in the nine months ended September 30, 2013 and $31,000 in interest expense in the nine months ended September 30, 2012. We incurred $0 in interest expense related to the Medallion Line of Credit in the three months ended September 30, 2013 (because the Medallion Line of Credit was refinanced in January 2013), and we incurred $8,000 in interest expense in the three months ended September 30, 2012.

The amount outstanding on the Medallion Line of Credit at December 31, 2012 was $321,000. Additional loan availability was $67,000, for a total Loan Availability of $388,000 as of December 31, 2012. On January 16, 2013, all indebtedness due to Medallion was paid in full and Medallion’s security interest in our assets were terminated, therefore the amount outstanding on the Medallion Line of Credit at September 30, 2013 was $0.

Rosenthal and Rosenthal, Inc.

In July 2009, we entered into a Financing Agreement (the “Financing Agreement”) with Rosenthal. Under the Financing Agreement, Rosenthal provided the Company with up to $1,500,000 under a revolving secured line of credit (“Rosenthal Line of Credit”). The Rosenthal Line of Credit was collateralized by a first security interest in all of the Company’s accounts receivables, inventory, and intellectual property, and a second security interest in our machinery and equipment, leases, leasehold improvements, furniture and fixtures. The maximum availability of $1,500,000 was subject to an availability formula based on certain percentages of accounts receivable and inventory, and elements of the availability formula were subject to periodic review and revision by Rosenthal. Under the Financing Agreement, we paid Rosenthal an administrative fee of $1,500 per month and an annual fee of $15,000. Under the Financing Agreement, interest was payable monthly, and was charged at variable rates (based on the Prime Rate), with minimum monthly interest of $4,000.

On February 28, 2012, we gave Rosenthal written notice of non-renewal as provided under the Financing Agreement, and in April 2012, we drew approximately $566,000 from our Medallion Line of Credit to pay off the Rosenthal Line of Credit.

We incurred $41,000 in costs related to the Rosenthal Line of Credit. These costs were amortized over the three-year term of the Rosenthal Line of Credit. We amortized $0 of these costs in the nine months ended September 30, 2013 (given the Rosenthal Line of Credit was terminated on May 30, 2012), and $7,000 of these costs in the nine months ended September 30, 2012. We amortized $0 of these costs in the three months ended September 30, 2013 (given the Rosenthal Line of Credit was terminated on May 31, 2012) and $0 in costs in the three months ended September 30, 2012.

We incurred $0 in interest expense in the nine months ended September 30, 2013 (again, given the May 2013 termination date), and $19,000 in the nine months ended September 30, 2012. We incurred $0 in interest expense in the three months ended September 30, 2013 (given the May 2012 termination date) and $0 in interest expense in the three months ended September 30, 2012. There was $0 outstanding on the Rosenthal Line of Credit at September 30, 2013 and at December 31, 2012.

First Niagara Bank Mortgage Consolidation Loan (“Mortgage Consolidation Loan”)

On February 23, 2011, we amended and extended our Mortgage Consolidation Loan with First Niagara Bank (“First Niagara”). The amended Mortgage Consolidation Loan continues to be secured by our facility in Kinderhook, New York as well as various pieces of machinery and equipment. All other terms of the Mortgage Consolidation Loan remained unchanged, including compliance with a covenant (measured monthly) to maintain a certain level of liquidity (defined as any combination of cash, marketable securities or borrowing availability under one or more credit facilities other than the Mortgage Consolidation Loan).

The amended Mortgage Consolidation Loan had a maturity date of March 1, 2013, and had a 6-year (72 month) amortization. The principal amount of the amended Mortgage Consolidation Loan was $815,000 with a fixed interest rate of 8.25%. The monthly payment of principal and interest was $14,000 and payments commenced on March 1, 2011. We were required to make a $15,000 principal payment at the time of closing of the amended Mortgage Consolidation Loan. We also incurred approximately $2,000 in costs associated with this amendment, which were legal costs incurred by First Niagara and passed on to the Company. We amortized less than $1,000 of this expense in each of the nine months ended September 30, 2013 and September 30, 2012. We amortized $0 of these costs in the three months ended September 30, 2013 and less than $1,000 of this expense in the three months ended September 30, 2012.

On March 8, 2013, we entered into a Second Amendment to Loan Agreement (the “Second Mortgage Consolidation Loan Amendment”) with First Niagara. Under the Second Mortgage Consolidation Loan Amendment, the Mortgage Consolidation Loan was recast into a 4-year fully amortizing note with a one-year term through March 1, 2014. The interest rate was increased from 8.25% to 9.25% and the monthly payment was reduced to $14,115 from $14,437. We were required to make a principal reduction payment of $25,000 at the time of closing. All other terms of the Mortgage Consolidation Loan remained unchanged.

The balance on the Mortgage Consolidation Loan was $493,000 at September 30, 2013 and $608,000 at December 31, 2012. We recognized $37,000 and $43,000 in interest expense in the nine months ended September 30, 2013 and September 30, 2012, respectively. Interest expense recognized was $12,000 in the three months ended September 30, 2013, and $14,000 in the three months ended September 30, 2012.

Copier Leases

In May 2007, we purchased a copier through an equipment lease with RICOH in the amount of $17,000. The term of the lease was five years with an interest rate of 14.11%. In April 2012, we notified RICOH that we were opting to purchase the copier for $1.00 as provided in our lease. The amount outstanding on this lease was $0 at September 30, 2013 and at December 31, 2012.

In October 2010, we purchased a copier through an equipment lease with Marlin Leasing in the amount of $4,000. The term of the lease is 3 years with an interest rate of 14.46%. The amount outstanding on this lease was less $0 at September 30, 2013 and less than $1,000 at December 31, 2012.

Debenture Financing

In August 2008, we completed an offering of Series A Debentures (“Series A Debentures”) and received gross proceeds of $750,000. The net proceeds of the offering of Series A Debentures were $631,000 after $54,000 of placement agent fees and expenses, legal and accounting fees of $63,000 and $2,000 of state filing fees.

The Series A Debentures accrued interest at a rate of 10% per annum (payable by the Company semi-annually). As placement agent, Cantone Research, Inc. (“Cantone”) received a placement agent fee of $52,500, or 7% of the gross principal amount of Series A Debentures sold. In addition, we issued Cantone a warrant to purchase 30,450 shares of the Company’s common stock at an exercise price of $0.37 per share and a warrant to purchase 44,550 shares of the Company’s common stock at an exercise price of $0.40 per share (See Part I, Item 1, Note F – Stock Options and Warrants; Cantone Research Inc. Warrants).

We incurred $131,000 in expenses related to the offering, including $12,000 in expense related to warrants issued to Cantone. We amortized $0 of this expense and $19,000 of this expense (of which a little under $2,000 was related to share based payment expense related to the Cantone warrants) in the nine months ended September 30, 2013 and September 30, 2012, respectively, and $0 and $3,000 of this expense (of which less than $1,000 was share based payment expense related to the Cantone warrants) in the three months ended September 30, 2013 and September 30, 2012, respectively.

The unamortized balance was $0 as of September 30, 2013 and December 31, 2012 (as the Series A Debentures matured on August 1, 2012).

Series A Debenture Extension

The Series A Debentures matured on August 1, 2012. On July 25, 2012, we entered into a Placement Agent Agreement (the “Agent Agreement”) with Cantone. Under the terms of the Agent Agreement, Cantone acted as our exclusive placement agent in connection with an amendment of the Series A Debentures. Under the amendment, the term of Series A Debentures was extended to reflect a due date of August 1, 2013, and the interest rate during the extension period was increased from 10% to 15% per annum, due quarterly in arrears.

As compensation for their placement agent services, Cantone received a cash fee of 5% of the gross amount of existing Series A Debentures, or $37,500 Cantone also received 1% of the gross amount of Series A Debentures, or $7,500, as a non-accountable expense allowance and we reimbursed Cantone $5,000 in legal fees incurred in connection with the amendment of the Series A Debentures. These costs, totaling $50,000 were amortized over the term of the extension (12 months). We amortized $29,000 of this expense in the nine months ended September 30, 2013, and $8,000 of expense in the nine months ended September 30, 2012. We amortized $4,000 of this expense in the three months ended September 30, 2013, and $8,000 of expense in the three months ended September 30, 2012.

The warrants issued to Cantone (in connection with their services as placement agent in the original Series A Debenture financing) were also amended to reflect a purchase price of $0.17 per share and a new term of three (3) years (See Part I, Item 1, Note F – Stock Options and Warrants; Cantone Research Inc. Warrants). We incurred $12,000 in share based payment expense related to this amendment, which was fully expensed in three months ended September 30, 2012.

On July 30, 2012, we entered into a Bridge Loan Agreement and Note (the “Bridge Loan”) with Cantone Asset Management, LLC (“CAM”). The Bridge Loan is in the amount of $150,000 and was used to pay $100,000 to those Holders of Series A Debentures that did not wish to amend/extend the Series A Debentures and $50,000 was used to pay placement agent fees and expenses indicated in the previous paragraph.

The maturity date of the Bridge Loan was August 1, 2013 bearing simple interest in advance of 15%. In addition to the interest, on August 1, 2012, we instructed our transfer agent to issue CAM restricted stock of the Company equal to 10% of the gross amount of existing Series A Debentures, or $15,000 using a value of $0.17 per common share. On August 8, 2012, 88,235 restricted common shares were issued to CAM.

On July 31, 2012, we entered into an Agreement to the Series A Debenture (the “Series A Debenture Amendment”) with thirty-two of the thirty-seven holders of Series A Debentures (the “Debenture Holders”) (representing $645,000 of Series A Debentures). As previously indicated, the Series A Debenture Amendment extended the due date of the Series A Debentures to August 1, 2013 and increased the interest rate to 15% per annum, payable quarterly in arrears. All other terms of the Series A Debentures remained unchanged. Five of the Debenture Holders (representing $105,000 in Series A Debentures) did not wish to extend the Series A Debentures and we used proceeds of $100,000 from the Bridge Loan and $5,000 paid directly from the Company to pay principal amounts due to these non-extending Debenture Holders.

We recognized $89,000 in interest expense in the nine months ended September 30, 2013, of which $19,000 was related to a subsequent further extension of the Series A Debentures (See Item I, Part I, Note G; Subsequent Events for more information on the further extension of the Series A Debentures). We recognized $44,000 in interest expense in the nine months ended September 30, 2012. We recognized $30,000 in interest expense in the three months September 30, 2013, of which $20,000 was related to the subsequent further extension of the Series A Debentures, and $6,000 in interest expense in the three months ended September 30, 2012.

We had $49,000 in accrued interest expense at September 30, 2013 and $26,000 in accrued interest expense at December 31, 2012.The accrued interest expense at September 30, 2013 included $20,000 of accrued interest related to the subsequent further extension of the Series A Debentures and $26,000 related to interest due on the CAM Note through September 30, 2013.

The Series A Debentures were further amended in October 2013. See Item I, Part I, Note G; Subsequent Event.

- Definition

The entire disclosure for information about short-term and long-term debt arrangements, which includes amounts of borrowings under each line of credit, note payable, commercial paper issue, bonds indenture, debenture issue, own-share lending arrangements and any other contractual agreement to repay funds, and about the underlying arrangements, rationale for a classification as long-term, including repayment terms, interest rates, collateral provided, restrictions on use of assets and activities, whether or not in compliance with debt covenants, and other matters important to users of the financial statements, such as the effects of refinancing and noncompliance with debt covenants.

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