Note F – Stock Option Grants / Warrant Grants

There were no stock options or warrants issued in the three and nine months ended September 30, 2013, however, the following stock options/warrants were issued prior to the three and nine months ended September 30, 2013, and have a portion of their expense recognized in either the three or nine months ended September 30, 2013 or the three or nine months ended September 30, 2012:

June 2013 Stock Options

On June 20, 2013, we issued options to purchase 25,000 shares of the Company’s common stock under our Fiscal 2001 Stock Option Plan (“2001 Option Plan”) to a member of our Science Advisory Board (“SAB”). The SAB was recently put back into place after being inactive for a number of years. New members were recently added to the SAB in our efforts to diversify our business and explore new technologies. The stock option has an exercise price of $0.14, the closing price of our common shares on June 20, 2013, and it vests over 24 months as follows: 12,500 common shares on June 20, 2014, and 12,500 common shares on June 20, 2015. The fair value of these options is $4,000 and was estimated using the Black-Scholes pricing model using the following weighted average assumptions: dividend yield of 0%; risk-free interest rate of 2.41; expected life of 10 years; and stock price volatility of 74%. We will amortize this share based payment expense over the vesting period (24 months). We recognized $3,000 in share based payment expense in the nine months ended September 30, 2013, and $0 in expense in the nine months ended September 30, 2012 (as these options were not issued until June 2013). We recognized $2,000 in share based payment expense in the three months ended September 30, 2013, and $0 in expense in the three months ended September 30, 2012, (as these options were not issued until June 2013). As of September 30, 2013, there was $3,000 in unrecognized share based payment expense with 20 months remaining.

On June 25, 2013, we issued options to purchase 200,000 shares of the Company’s common stock under our 2001 Option Plan to our (then) executive vice president and chief compliance officer, Melissa Waterhouse (“Waterhouse”). The Waterhouse stock option has an exercise price of $0.14, the closing price of our common shares on June 25, 2013 and it vests over 36 months as follows: 66,000 common shares on June 25, 2014; 66,000 common shares on June 25, 2015 and 68,000 common shares on June 20, 2016. The fair value of these options is $28,000 and was estimated using the Black-Scholes pricing model using the following weighted average assumptions: dividend yield of 0%; risk-free interest rate of 2.60; expected life of 10 years; and stock price volatility of 74%. We will amortize this share based payment expense over the vesting period (36 months). We amortized $3,000 of this share based payment expense in the nine months ended September 30, 2013 and $0 in share based payment expense in the nine months ended September 30, 2012 (as these options were not issued until June 2013). We recognized $2,000 in share based payment expense in the three months ended September 30, 2013 and $0 in share based payment expense in the three months ended September 30, 2012 (as these options were not issued until June 2013). As of September 30, 2013, there was $25,000 in unrecognized share based payment expense with 32 months remaining.

On April 15, 2013, we issued options to purchase 25,000 shares of the Company’s common stock under our 2001 Option Plan to another member of our SAB. The stock option has an exercise price of $0.16, the closing price of our common shares on April 15, 2013, and it vests over 24 months as follows: 12,500 common shares on April 15, 2014 and 12,500 common shares on April 15, 2015. The fair value of these options is $4,000 and was estimated using the Black-Scholes pricing model using the following weighted average assumptions: dividend yield of 0%; risk-free interest rate of 1.72; expected life of 10 years; and stock price volatility of 76%. We will amortize this share based payment expense over the vesting period (24 months). We recognized $1,000 in share based payment expense in the nine months ended September 30, 2013, and $0 in share based payment expense in the nine months ended September 30, 2012 (as these options were not issued until April 2013). We recognized less than $1,000 in share based payment expense in the three months ended September 30, 2013 and $0 in expense in the three months ended September 30, 2012 (as these options were not issued until April 2013). As of September 30, 2013, there was $3,000 in unrecognized share based payment expense with 18 months remaining.

On April 26, 2013, we issued options to purchase 50,000 shares of the Company’s common stock under our 2001 Option Plan to a consultant. The stock option has an exercise price of $0.18, the closing price of our common shares on April 26, 2013, and it vests over 24 months as follows: 25,000 common shares on April 26, 2014 and 25,000 common shares on April 26, 2015. The fair value of these options is $9,000 and was estimated using the Black-Scholes pricing model using the following weighted average assumptions: dividend yield of 0%; risk-free interest rate of 1.70; expected life of 10 years; and stock price volatility of 76%. We will amortize this share based payment expense over the vesting period (24 months). We recognized $2,000 of this share based payment expense in the nine months ended September 30, 2013 and $0 in share based payment expense in the nine months ended September 30, 2012 (as these options were not issued until April 2013). We recognized $1,000 in share based payment expense in the three months ended September 30, 2013, and $0 in share based payment expense in the three months ended September 30, 2012 (as these options were not issued until April 2013). As of September 30, 2013, there was $7,000 in unrecognized share based payment expense with 18 months remaining.

On February 21, 2013, we issued options to purchase 77,000 shares of common stock under our 2001 Option Plan to 1 executive officer (Waterhouse), 13 non-executive employees of the Company, and 1 consultant at an exercise price of $0.26, the closing price of our common shares on February 21, 2013 (the “February 2013 Stock Options”). The February 2013 Stock Options vest 100% on the 12 month anniversary of the date of the grant, or on February 21, 2014. The fair value of the February 2013 Stock Options is $27,000 and was estimated using the Black-Scholes pricing model using the following weighted average assumptions: dividend yield of 0%; risk-free interest rate of 1.99; expected life of 10 years; and stock price volatility of 82%. We will amortize this share based payment expense over the vesting period of 12 months. We recognized $17,000 of this share based payment expense in the nine months ended September 30, 2013, and $0 in share based payment expense in the nine months ended September 30, 2012 (as these stock options were not issued until February 2013). We recognized $7,000 in share based payment expense in the three months ended September 30, 2013 and $0 in share based payment expense in the three months ended September 30, 2012 (as these stock options were not issued until Feb 2013). As of September 30, 2013, there was $9,000 in unrecognized share based payment expense with 4 months remaining.

On January 16, 2013, in connection with the Imperium Line of Credit, we granted Imperium a 7-year warrant to purchase 2,000,000 common shares of the Company at an exercise price of $0.18, the closing price of our common shares on January 16, 2013 (the “Imperium Warrant”). The Imperium Warrant was 100% (or 2,000,000 common shares) exercisable on the date of issuance. The fair value of the Imperium Warrant is $290,000 and was estimated using the Black-Scholes pricing model using the following weighted average assumptions: dividend yield of 0%; risk-free interest rate of 1.84; expected life of 7 years; and stock price volatility of 82%. We are capitalizing this cost as deferred financing cost amortized over the term of the Imperium LSA (3 years). We amortized $72,000 of this debt discount cost in the nine months ended September 30, 2013 and $0 in deferred financing cost in the nine months ended September 30, 2012 (as the Imperium Warrant was not issued until January 2013). We amortized $24,000 of this deferred financing cost in the three months ended September 30, 2013 and $0 in deferred financing cost in the three months ended September 30, 212 (as the Imperium Warrant was not issued until January 2016). As of September 30, 2013, there was $217,000 in unrecognized cost related to the Imperium Warrant with 27 months remaining.

On January 16, 2013, as compensation for his execution of a Personal Guarantee required under the Imperium LSA, our (then) Chief Executive Officer, Stan Cipkowski (“Cipkowski”) was awarded an option grant representing 500,000 common shares of the Company under our 2001 Option Plan, at an exercise price of $0.15, the closing price of our common shares on January 16, 2013 (the “Cipkowski Imperium Stock Option”). The Cipkowski Imperium Stock Option vests over 36 months in equal installments as follows: 165,000 common shares on January 16, 2014, 165,000 common shares on January 16, 2015 and 170,000 common shares on January 16, 2016. The fair value of the Cipkowski Imperium Stock Option is $73,000 and was estimated using the Black-Scholes pricing model using the following weighted average assumptions: dividend yield of 0%; risk-free interest rate of 1.84; expected life of 10 years; and stock price volatility of 82%. This share based payment expense was being amortized over the vesting period of 36 months in the nine months ended September 30, 2013. We recognized $18,000 in share based payment expense in the nine months ended September 30, 2013 and $0 in share based payment expense in the nine months ended September 30, 2012 (as the Cipkowski Imperium Stock Option was not granted until January 2013). We recognized $6,000 in share based payment expense in the three months ended September 30, 2013 and $0 in share based payment expense in the three months ended September 30, 2012 (as the Cipkowski Imperium Stock Option was not granted until January 2013). As of September 30, 2013, there was $54,000 in unrecognized share based payment expense related to the Cipkowski Imperium Stock Option with 27 months remaining. (See Part I, Item I, Note G – Subsequent Events to view the disclosure related to the death of Mr. Cipkowski on October 31, 2013).

On January 16, 2013, as part of their finder’s fee compensation, we issued Monarch Capital Group, LLC (“Monarch”) a 5-year warrant representing 3% of the Imperium Warrant, or a 5-year warrant to purchase 60,000 common shares of the Company, also at a strike price of $0.18, the closing price of our common shares on January 16, 2013 (the “Monarch Warrant”). The Monarch Warrant was 100% (or 60,000 common shares) exercisable on the date of issuance. The fair value of the Monarch Warrant is $9,000 and was estimated using the Black-Scholes pricing model using the following weighted average assumptions: dividend yield of 0%; risk-free interest rate of 1.84; expected life of 5 years; and stock price volatility of 82%. We are capitalizing this cost as deferred financing cost amortized over the term of the Imperium LSA, or over 36 months. We amortized $2,000 of this deferred financing cost in the nine months ended September 30, 2013 and $0 in deferred financing cost in the nine months ended September 30, 2012 (as the Monarch Warrant was not issued until January 2013). We amortized $1,000 of deferred financing cost in the three months ended September 30, 2013, and $0 in deferred financing cost in the three months ended September 30, 2012 (as the Monarch Warrant was not issued until January 2013). As of September 30, 2013, there was $7,000 in unrecognized deferred financing cost related to the Monarch Warrant with 27 months remaining.

On September 20, 2012, we issued 2 stock option grants to purchase 50,000 shares each (for a total of 100,000) of the Company’s common stock to 2 non-executive employees at an exercise price of $0.18 (the closing price of the Company’s common shares on the date of the grant) (“September 2012 Stock Options”). The September 2012 Stock Options vest over 36 months in installments as follows: 33,000 common shares on September 20, 2013, 33,000 common shares on September 20, 2014 and 34,000 common shares on September 20, 2015. The fair value of the September 2012 Stock Options is $18,000 and was estimated using the Black-Scholes pricing model using the following weighted average assumptions: dividend yield of 0%; risk-free interest rate of 1.80; expected life of 10 years; and stock price volatility of 85%. We will amortize this share based payment expense over the vesting period of 36 months. We recognized $5,000 of this share based payment expense in the nine months ended September 30, 2013, and less than $1,000 in share based payment expense in the nine months ended September 30, 2012. We recognized $2,000 in share based payment expense in the three months ended September 30, 2013, and less than $1,000 in share based payment expense in the three months ended September 30, 2012. As of September 30, 2013, there was $12,000 in unrecognized share based payment expense with 23 months remaining.

As a condition to the Medallion Line of Credit, Cipkowski and our controller J. Duncan Urquhart (“Urquhart”) were each required to execute Validity Guarantees (the “Validity Guarantees”). Under the Validity Guarantees, Cipkowski and Urquhart provided representations and warranties with respect to the validity of our receivables as well as guaranteeing the accuracy of our reporting to Medallion related to the Company’s receivables. As compensation for their execution of the Validity Guarantees, on April 20, 2012, Cipkowski and Urquhart were each awarded an option grant representing 250,000 common shares of the Company under our 2001 Option Plan, at an exercise price of $0.18, the closing price of our common shares on the date of the grant. The option grants vest over 36 months as follows: 82,500 common shares on April 20, 2013, 82,500 common shares on April 20, 2014 and 85,000 common shares on April 20, 2015. The fair value of the Cipkowski and Urquhart stock option grants was estimated utilizing the Black-Scholes option-pricing model. The following weighted average assumptions were used: dividend yield of 0%; risk-free interest rate of 1.99; expected life of 10 years; and stock price volatility of 88%. The value of each of these 2 stock option grants was $45,000 (for a total of $90,000).

This share based payment expense was to be recognized over the vesting period of 36 months. However, on August 6, 2013, Urquhart was terminated from employment and 167,500 stock options (the unvested portion of his stock option grant) was cancelled and returned to the Fiscal 2001 Stock Option Plan. The share based payment expense of $13,000 recorded through August 2013 for these unvested options was reversed and no further expense incurred. 82,500 stock options (the vested portion) remains exercisable for a 3-month period under the terms of Urquhart’s stock option agreement. Given this, the Company did recognize $4,000 in share based payment expense for the vested options in the nine months ended September 30, 2013, and $2,000 in share based payment expense in the nine months ended September 30, 2012. Recognized expense for the vested options was $1,000 in the three months ended September 30, 2013 and September 30, 2012.

The share based payment expense related to the Cipkowski Medallion Line of Credit Stock Options was amortized over the vesting period of 36 months in the nine months ended September 30, 2013. We recognized $11,000 in share based payment expense in the nine months ended September 30, 2013 and $8,000 in share based payment expense in the nine months ended September 30, 2012. We recognized $4,000 in share based payment expense in the three months ended September 30, 2013 and $4,000 in share based payment expense in the three months ended September 30, 2012. As of September 30, 2013, there was $23,000 in unrecognized share based payment expense related to the Cipkowski Medallion Line of Credit Stock Option with 18 months remaining. (See Part I, Item I, Note G – Subsequent Events to view the disclosure related to the death of Mr. Cipkowski on October 31, 2013).

As another condition to the financing, Edmund Jaskiewicz, our President and Chairman of the Board (“Jaskiewicz”) was required to execute another Subordination Agreement (“Subordination Agreement”) related to the Jaskiewicz Debt (the $124,000 currently owed to Jaskiewicz by the Company). Under the Subordination Agreement, the Jaskiewicz Debt is not payable, was junior in right to the Medallion Line of Credit and no payment could be accepted or retained by Jaskiewicz for the Jaskiewicz Debt unless and until we paid and satisfied in full any obligations to Medallion. As compensation for his execution of the Subordination Agreement, on April 20, 2012, Jaskiewicz was awarded an option grant representing 150,000 common shares of the Company under the Company’s Fiscal 2001 stock option plan, at an exercise price of $0.18, the closing price of the Company’s common shares on the date of the grant. The option grant vests over 36 months as follows: 49,500 common shares on April 20, 2013, 49,500 common shares on April 20, 2014 and 51,000 common shares on April 20, 2015. The fair value of the Jaskiewicz stock option grant was estimated utilizing the Black-Scholes option-pricing model. The following weighted average assumptions were used: dividend yield of 0%; risk-free interest rate of 1.99; expected life of 10 years; and stock price volatility of 88%. The value of the stock option grant totaled $27,000 and we will recognize this share-based payment expense over the vesting period of 36 months. We recognized $7,000 in share based payment expense in the nine months ended September 30, 2013 and $4,000 in share based payment expense in the nine months ended September 30, 2012. We recognized $2,000 in share based payment expense in both the three months ended September 30, 2013 and September 30, 2012. As of September 30, 2013, there was $13,000 in unrecognized share based payment expense with 18 months remaining.

In connection with their services as placement agent in the Company’s Series A Debenture offering, on July 17, 2008, we issued Cantone a 4-year warrant to purchase 30,450 shares of our common stock at an exercise price of $0.37 per share, the closing price of our common shares on July 17, 2008 (the “July 2008 CRI Warrant”). The July 2008 CRI Warrant was 100% exercisable on July 17, 2008. The fair value of the July CRI Warrant was $5,000. We recognized this share based payment expense over the term of the Series A Debenture, or over 48 months. We recognized $0 in expense in the nine and three months ended September 30, 2013 (as 100% of the expense was recognized prior to December 31, 2012), and less than $1,000 in share based payment expense in the nine and three months ended September 30, 2012.

On August 4, 2008, we issued Cantone another 4-year warrant to purchase 44,550 shares of our common stock at an exercise price of $0.40 per share, the closing price of our common shares on August 4, 2008 (the “August 2008 CRI Warrant”). The August 2008 CRI Warrant was 100% exercisable on August 4, 2008. The fair value of the August 2008 CRI Warrant was $7,000. We recognized this share based payment expense over the term of the Series A Debenture, or over 48 months. We recognized $0 in expense in the nine and three months ended September 30, 2013 (as 100% of the expense was recognized prior to December 31, 2012), and less than $1,000 in share based payment expense in the nine and three months ended September 30, 2012.

The Cantone Research Inc. Warrants (“CRI Warrants”) were amended on July 31, 2012 in connection with the extension and amendment of the Series A Debentures; more specifically they were amended to reflect an exercise price of $0.17 per share and a new term of 36 months. The CRI Warrant is now exercisable through July 31, 2015 (see Part I, Item 1, Note E – Line of Credit and Debt; Series A Debenture Extension). The fair value of the amended CRI Warrant is $12,000 and was estimated utilizing the Black-Scholes pricing model using the following weighted average assumptions: dividend yield of 0%; risk-free interest rate of 1.51; expected life of 3 years; and stock price volatility of 77%. We recognized $12,000 (or the full expense) in share based payment expense in the three and nine months ended September 30, 2012. As of September 30, 2013, there is $0 remaining in expense related to the CRI Warrant.

On August 1, 2012, we entered into a Consulting Agreement (“Consulting Agreement”) with Cantone Asset Management, LLC (“CAM”). The Consulting Agreement commenced August 1, 2012 and ends on August 1, 2013. Under the terms of the Consulting Agreement, CAM will provide the Company with financial advisory services and advice related to debt refinancing. On August 1, 2012, we issued CAM a 3-year warrant to purchase 300,000 shares of our common stock at an exercise price of $0.16 per share, the closing price of the Company’s common shares on August 1, 2012 (the “CAM Warrant”). The fair value of the CAM Warrants is $48,000 and was estimated utilizing the Black-Scholes pricing model using the following weighted average assumptions: dividend yield of 0%; risk-free interest rate of 1.56; expected life of 3 years; and stock price volatility of 77%. We recognized $48,000 (or the full expense) in share based payment expense in the three and nine months ended September 30, 2012. As of September 30, 2013, there is $0 remaining in share based payment expense related to the CAM Warrant.