Note F – Stock Options and Warrants

Stock Options

We currently have three non-statutory stock option plans, the Fiscal 2000 Non-statutory Stock Option Plan (the “2000 Plan”), the Fiscal 2001 Non-statutory Stock Option Plan (the “2001 Plan”) and the 2013 Equity Compensation Plan (the “2013 Plan”). All three plans have been adopted by our Board of Directors and approved by our shareholders. The 2000 Plan provides for the granting of options to purchase up to 1,000,000 common shares, and the 2001 Plan and the 2013 Plan each provide for the granting of options to purchase up to 4,000,000 common shares. Both the 2000 Plan and the 2001 Plan have options issued. Only the 2001 Plan and the 2013 Plan have options available for future issuance. We did not issue any options in the First Quarter 2014. The following stock options were previously issued and were either fully or partially expensed in the First Quarter 2014 or the First Quarter 2013.

June 2013 Stock Options

On June 20, 2013, we issued options to purchase 25,000 shares of our common stock under our 2001 Plan to a member of our Science Advisory Board (“SAB”). The SAB was put back into place in mid 2013 after being inactive for a number of years 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. We will amortize this share based payment expense over the vesting period (24 months). We recognized less than $1,000 in share based payment expense in the First Quarter 2014 and $0 in expense in the First Quarter 2013 (as these options were not issued until June 2013). As of March 31, 2014, there was less than $2,000 in unrecognized share based payment expense with 14 months remaining.

On June 25, 2013, we issued options to purchase 200,000 shares of our common stock under our 2001 Plan to our (then) executive vice president and chief compliance officer, Melissa Waterhouse (“Waterhouse”); Waterhouse was subsequently appointed as interim CEO/CFO in October 2013. 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. We will amortize this share based payment expense over the vesting period (36 months). We amortized $2,000 of this share based payment expense in the First Quarter 2014, and $0 in share based payment expense in the First Quarter 2013 (as these options were not issued until June 2013). As of March 31, 2014, there was $20,000 in unrecognized share based payment expense with 26 months remaining.

April 2013 Stock Options

On April 15, 2013, we issued options to purchase 25,000 shares of our common stock under the 2001 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. We will amortize this share based payment expense over the vesting period (24 months). We recognized less than $1,000 in share based payment expense in the First Quarter 2014m and $0 in share based payment expense in the First Quarter 2013 (as these options were not issued until April 2013). As of March 31, 2014, there was $2,000 in unrecognized share based payment expense with 12 months remaining.

On April 26, 2013, we issued options to purchase 50,000 shares of our common stock under the 2001 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. We will amortize this share based payment expense over the vesting period (24 months). We recognized $1,000 of this share based payment expense in the First Quarter 2014, and $0 in share based payment expense in the First Quarter 2013 (as these options were not issued until April 2013). As of March 31, 2014, there was $4,000 in unrecognized share based payment expense with 12 months remaining.

February 2013 Employee/Consultant Stock Options

On February 21, 2013, we issued options to purchase 102,000 shares of common stock under our 2001 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. We will amortize this share based payment expense over the vesting period of 12 months. We recognized $3,000 of this share based payment expense in the First Quarter 2014, and $4,000 in share based payment expense in the First Quarter 2013. As of March 31, 2014, there was $0 in unrecognized share based payment expense with 0 months remaining.

Imperium Financing Stock Options

On January 16, 2013, as compensation for his execution of a Personal Guarantee required under the Imperium LSA, the Company’s (then) Chief Executive Officer, Stan Cipkowski (“Cipkowski”) was awarded an option grant representing 500,000 common shares of the Company under our 2001 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 originally vested 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. This share based payment expense was originally being amortized over the vesting period of 36 months, however, on November 1, 2013, we were notified of Mr. Cipkowski’s death. Under the terms of the Cipkowski Imperium Stock Option, any unvested portion of the stock option became immediately exercisable upon Mr. Cipkowski’s death. As a result, we are no longer amortizing the Cipkowski Imperium Stock Option; rather we recognized the remaining $54,000 in expense in the three months ended December 31, 2013. Given this, we recognized $0 in expense in the First Quarter 2014, and $6,000 in expense in the First Quarter 2013. As of March 31, 2014, there was $0 in unrecognized share based payment expense with 0 months remaining.

September 2012 Employee Stock Options

On September 20, 2012, we issued 2 stock option grants to purchase 50,000 shares each (for a total of 100,000) of our common stock to 2 non-executive employees at an exercise price of $0.18 (the closing price of our 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. We will amortize this share based payment expense over the vesting period of 36 months. We recognized $2,000 of this share based payment expense in the First Quarter 2014 and $2,000 in share based payment expense in the First Quarter 2013. As of March 31, 2014, there was $8,000 in unrecognized share based payment expense with 17 months remaining.

Medallion Line of Credit Stock Options

As a condition to the Medallion Line of Credit, Cipkowski and our (then) 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 our 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 Plan, at an exercise price of $0.18, the closing price of our common shares on the date of the grant. The option grants originally vested 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 $45,000 each (for a total of $90,000), and was estimated utilizing the Black-Scholes option-pricing model.

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 2001 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) remained exercisable until November 6, 2013 under the terms of Urquhart’s stock option agreement, however the options were never exercised and on November 7, 2013, the 82,500 remaining Urquhart options were cancelled. We amortized $0 in share based payment expense in the First Quarter 2014 and $4,000 in the First Quarter 2013 however this was offset by the reversal indicated above. As of March 31, 2014, there was $0 in unrecognized share based payment expense with 0 months remaining related to the Urquhart grant.

On November 1, 2013, we were notified of Mr. Cipkowski’s death. Under the terms of the Cipkowski Medallion Stock Option, any unvested portion of the stock option became immediately exercisable upon Mr. Cipkowski’s death. As a result, we are no longer amortizing the Cipkowski Medallion Stock Option; rather we recognized the remaining $23,000 in expense in the three months ended December 31, 2013. We amortized $0 in share based payment expense in the First Quarter 2014 and $4,000 in the First Quarter 2013. As of March 31, 2014, there was $0 in unrecognized share based payment expense with 0 months remaining related to the Cipkowski grant.

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 was 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 2001 Plan, at an exercise price of $0.18, the closing price of our 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 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 $2,000 in share based payment expense in the First Quarter 2014, and $2,000 in share based payment expense in the First Quarter 2013. As of March 31, 2014, there was $9,000 in unrecognized share based payment expense with 12 months remaining.

Warrants

We did not issue any warrants in the First Quarter 2014. The following warrants were previously issued and were either fully or partially expensed in the First Quarter 2014 or the First Quarter 2013.

Imperium Warrants

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. We are capitalizing this cost as debt issuance costs amortized over the term of the Imperium LSA (3 years). We amortized $24,000 of this debt discount in the First Quarter 2014 and $24,000 in deferred financing cost in the First Quarter 2013. As of March 31, 2014, there was $169,000 in unrecognized cost related to the Imperium Warrant with 21 months remaining.

Monarch Capital LLC Warrants

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. We are capitalizing this cost as deferred financing cost amortized over the term of the Imperium LSA, or over 36 months. We amortized $1,000 of this deferred financing cost in the First Quarter 2014 and $1,000 in deferred financing cost in the First Quarter 2013. As of March 31, 2014, there was $5,000 in unrecognized deferred financing cost related to the Monarch Warrant with 21 months remaining.

Series A Debenture Holder Warrants

On October 7, 2013, we entered into another Agreement to the Series A Debenture (the “2013 Series A Debenture Amendment”) with thirty of the thirty-two holders of Series A Debentures (the “Debenture Holders”) (representing $634,500 of Series A Debentures). One of the Debenture Holders (representing $10,500 in Series A Debentures) did not wish to extend and we used cash on hand and net proceed from another bridge loan with Cantone Asset Management to pay the principal amount due to this Debenture Holder. One of the Debenture Holders transferred their investment to another existing Debenture Holder. An extension period of either 6 or 12 months was at the election of the Debenture Holder. 27 of the 30 Debenture Holders (representing $543,500 of Series A Debentures) elected to extend for a period of 12 months. The other 3 (representing $91,000 in Series A Debentures) elected to extend for a period of 6 months. The 27 Holders that elected to extend for a 12-month period were each issued a warrant to purchase 1 share of common stock for each $1.00 that was extended. We issued 2-year warrants to purchase 543,500 shares of our common stock at an exercise price of $0.14 (the average closing sale price of our common shares for the 5 days business days ending October 7, 2013) to these 27 Holders (the “2013 Holder Warrants”). The fair value of the Debenture Holder warrants $76,000, and was estimated utilizing the Black-Scholes option-pricing model. We are amortizing this cost over the term of the Series A Debenture extension, or 12 months. We recognized $19,000 in expense in the First Quarter 2014 and $0 in expense in the First Quarter 2014 (as the Debenture Holder warrants were not issued until October 2013). As of March 31, 2014, there was $25,000 in unrecognized debt issuance expense with 4 months remaining.