NOTE 15 – STOCK OPTION PLAN AND WARRANTS

STOCK OPTION PLAN

The Company’s Incentive Compensation Plan (the “Plan”) provides for the issuance of qualified options to all employees and non-qualified options to directors, consultants and other service providers.

A summary of the status of stock options outstanding under the Plan as of June 30, 2015 and December 31, 2014 is as follows:

	6/30/2015					12/31/2014
	Number of Options			Weighted Average Exercise Price		Number of Options			Weighted Average Exercise Price
Outstanding at beginning of year		11,033,675		$	1.05		9,583,762		$	1.16
Granted		2,899,600		$	0.27		2,372,800		$	0.58
Exercised		-		$	-		-		$	-
Expired and Cancelled		(3,125,240	)	$	1.17		(922,887	)	$	0.99
		10,808,035					11,033,675

Outstanding, end of period		10,808,035		$	0.81		11,033,675		$	1.05

Exercisable at end of period		7,908,435		$	0.95		11,033,675		$	1.05

During the six months ended June 30, 2015, the Company granted 2,899,600 options at an exercise price of $0.27 per share valued at $414,882. Stock-based compensation expense for both the three and six months ended June 30, 2015 was $108,747. As of June 30, 2015, the unrecognized compensation cost related to all non-vested share-based compensation arrangements granted under the Plan was $320,729. Of this amount, $258,550 will be recognized during the remaining fiscal 2015 quarters.

During the six months ended June 30, 2014 the Company granted to employees 2,069,300 options valued at $1,024,170. Stock-based compensation expense for the three and six months ended June 30, 2014 was $363,560 and $614.719, respectively. As of June 30, 2014, the unrecognized compensation cost related to all non-vested share-based compensation arrangements granted under the Plan was $382,406 and will be recognized in each of the remaining fiscal 2014 quarters.

During the six months ended June 30, 2015 and 2014, there were no stock options exercised either for cash or on a cashless basis.

The fair value of each stock option granted is estimated on the date of grant using the Black-Scholes option valuation model. This model uses the assumptions listed in the table below for stock options granted in 2015. Expected volatilities are based on the historical volatility of the Company’s stock. The risk-free rate for periods within the expected life of the options is based on the U.S. Treasury yield curve in effect at the time of grant.

	6/30/2015
Weighted average fair value per option granted	$	0.1431
Risk-free interest rate		1.51	%
Expected dividend yield		0.00	%
Expected lives		2.688
Expected volatility		86.22	%

Stock options outstanding at June 30, 2015 are as follows:

Range of Exercise Prices	Options Outstanding		Weighted Average Remaining Contractual Life		Weighted Average Exercise Price		Options Exercisable
$0.01-$1.50		8,869,167		2.9	$	0.38		5,969,567
$1.51-$3.00		1,813,868		2.5	$	1.67		1,813,868
$3.01-$5.00		125,000		2.3	$	3.11		125,000
		10,808,035		2.8	$	0.81		7,908,435

Warrants

As of June 30, 2015, the Company has warrants outstanding to purchase 48,748,214 shares of the Company’s common stock, at prices ranging from $0.35 to $1.00 per share. These warrants expire at various dates through November 2020. The summary of the status of the warrants issued by the Company as of June 30, 2015 and December 31, 2014 are as follows:

	6/30/2015					12/31/2014
	Number of Warrants			Weighted Average Exercise Price		Number of Warrants			Weighted Average Exercise Price
Outstanding at beginning of year		16,446,351		$	1.45		16,688,265		$	1.44
Granted		85,615,638		$	0.41		-		$	-
Exercised		(53,095,204	)	$	0.66		-		$	-
Cashless Exercises		-		$	-		-		$	-
Expired and Cancelled		(218,571	)	$	0.66		(241,914	)	$	0.87
		48,748,214					16,446,351

Outstanding, end of period		48,748,214		$	0.50		16,446,351		$	1.45

Exercisable at end of period		48,748,214		$	0.50		16,446,351		$	1.45

Effective January 1, 2015, the Company and its landlord executed an amendment to the current lease extending the lease until July 14, 2015. Commencing on May 1, 2015, the parties agreed to a monthly base rent of $10,681 plus property taxes. The Company also agreed to pay $71,125 in rental arrears on April 30, 2015 and another $71,125 in rental arrears on July 1, 2015. Also, the parties agreed that the Company will deliver to the landlord 20,025 shares of its 12.5% convertible preferred stock which shares are convertible to common stock at the landlord’s option at .088 per preferred share. Finally, the Company issued a five year warrant to the landlord to purchase 171,454 shares of common stock at $0.64 per share.

On January 8, 2015, in conjunction with the sale of units consisting of convertible preferred stock, Company, issued warrants (the “Initial Warrant”) to acquire 8.56 shares of the Company’s common stock, par value, $0.00005 per share (“common stock”), at an exercise price of $0.64 per share. In addition, the Company agreed to issue to each of the investors in the first round of financing an additional warrant to acquire (the “Additional Warrant” and together with the Initial Warrant, the “Warrants”) to acquire 3.64 shares of the Company’s common stock at an exercise price of $0.64 per share. The Additional Warrants issued are exercisable for an aggregate of 946,400 shares of the Company’s common stock. The Warrants expire on the fifth anniversary of their issuance, may be exercised on a cashless basis, are subject to full ratchet price anti-dilution protection and entitled to registration rights as set forth below.

Due to the anti-dilution provisions of some of the outstanding warrants before the January 8, 2015 transaction, the exercise price on 15,512,057 warrants has been reduced to $0.35 and the number of shares of common stock into which the warrants are now exercisable has been adjusted such that the warrants are now exercisable into 54,400,204 shares of common stock.

In addition to the foregoing, the members of the Company’s then Board of Directors agreed to receive 1,103,880 shares of preferred stock, 826,806 Initial Warrants and 351,586 Additional Warrants in exchange for previously issued convertible notes (including principal and accrued and unpaid interest) (the “Notes”) held by the directors or affiliated entities as follows: (i) 71,211 Units, 609,566 Initial Warrants and 259,208 Additional Warrants were issued to Edward B. Smith, III, the Company’s Chief Executive Officer, in exchange for an aggregate of $284,844 of notes, (ii) 10,084 Units, 86,317 Initial Warrants and 36,705 Additional Warrants were issued to Morris Garfinkle in exchange for $40,335 of notes; (iii) 5,211 Units, 44,606 Initial Warrants and 18,968 Additional Warrants were issued to each of Mark Hershhorn and Brian Israel in exchange for an aggregate of $20,844 of notes, respectively; and (v) 4,873 Units, 41,712 Initial Warrants and 17,737 Additional Warrants were issued to CKS Warehouse, an entity in which Mr. Hershhorn owns a controlling interest, in exchange for an aggregate of $19,491of principal and interest on notes.

On February 9, 2015, the Company closed a second round of a private placement offering in which investors received the Initial Warrants to acquire 8.56 shares of the Company’s common stock, par value, $0.00005 per share (“common stock”), at an exercise price of $0.64 per share all pursuant to separate Securities Purchase Agreements entered into with each investor (the “Securities Purchase Agreements”). In addition, the Company issued to each of the investors in the first and second rounds of financing an additional warrant for each Unit acquired (the “Additional Warrant” and together with the Initial Warrant, the “Warrants”) to acquire 3.64 shares of the Company’s common stock at an exercise price of $0.64 per share. The Initial Warrants issued in the second closing are exercisable for 1,070,000 shares of the Company’s common stock and the Additional Warrants issued in the second closing are exercisable for an aggregate of 455,000 shares of the Company’s common stock. The sale was part of a private placement offering (the “Offering”) in which the Company offered for sale a maximum of 5,000,000 units (gross proceeds of $20,000,000). Prior to the second closing, the Company raised gross proceeds of $1,040,000 in the initial closing of the Offering issued Initial Warrants to acquire 2,225,600 shares of common stock and Additional Warrants to acquire 946,400 shares of common stock. The Warrants expire on the fifth anniversary of their issuance, may be exercised on a cashless basis, are subject to full ratchet price anti-dilution protection and entitled to registration rights.

The fair values for the Company’s derivative liabilities related to the Warrants (5 year warrants at $1.00, $0.35, and $0.64, with a full reset feature) issued is $129,923. The derivative instruments were valued as of June 30, 2015 with the following assumptions:

The Holder would automatically exercise the warrants at a stock price above the exercise price (some warrants adjusted the exercise price to $1.00), with the target exercise price dropping as expiration approaches,

The projected annual volatility was based on the Company’s historical volatility between 124% and 126%,

An event of default would occurred 5% of the time, increasing to 0.10% per month,

Dilutive/Full Reset events projected to occur based on future projected capital needs (capital funds raised were projected in prior quarters of 2013 – future financings are projected going forward in September 2015) resulting in the weighted conversion price dropping from the initial conversion price (no reset events have occurred).

Effective January 1, 2015 the Company entered into a Consulting Agreement with Jeffery Consulting Group, LLC pursuant to which Jeffery Consulting will provide assistance with operational improvements including manufacturing processes, strategic and tactical advice with respect to the Company’s sales and marketing initiatives, and provide customer introductions and strategic sales opportunities. In consideration of services rendered by Jeffrey Consulting, the Company issued a warrant to purchase 1,250,000 shares of common stock at $0.35 per share. The warrant vested 500,000 shares upon the mutual execution of this agreement, and 250,000 shares each at the three month, six month, and nine month anniversaries of this agreement. The fair value of the warrants issued is estimated on the date of grant using the Black-Scholes valuation model. The assumptions used in the model included the historical volatility of the Company’s stock of 84.52%, and the risk-free rate for periods within the expected life of the warrant based on the U.S. Treasury yield curve in effect of 1.07%. For the three months ended March 31, 2015 the Company recognized compensation expense of $128,880. The Company also agreed to accrue $5,000 per month which becomes payable to Jeffrey Consulting once the Company has raised $3 million in additional capital.

On February 9, 2015, Edward B. Smith, III and Morris Garfinkle were issued warrants exercisable for 31,000,000 and 5,500,000 shares of common stock, respectively, in consideration of the services to be provided to the Company as Chief Executive Officer of the Company and Chairman of the Board, respectively. The exercise price of these warrants is $0.45 per share. The fair value of the warrants issued is estimated on the date of grant using the Black-Scholes valuation model. The assumptions used in the model included the historical volatility of the Company’s stock of 81.99%, and the risk-free rate for periods within the expected life of the warrant based on the U.S. Treasury yield curve in effect of 0.85%. For the six months ended June 30, 2015 the Company recognized compensation expense of $3,749,259.

On April 29, 2015, the Company sent a proposal to all warrant holders (as of September 30, 2014) an offer to participate in a warrant exchange program whereby each warrant holder will be able to 1) exchange their warrants for common stock, on a cashless basis, at a reduced exercise price of $0.00005 per share, 2) if applicable, receive the right to 17.5% more warrants and a two year extension on all of their warrants in return for waiving their anti-dilution rights on a one-time basis for the exchange, or 3) elect to take advantage of (1) and (2) by (i) exchanging a portion of their Warrants that they so designate for shares of Common Stock in accordance with the applicable terms in (1) and (ii) the remainder of the Warrant not exchanged will be retained and amended pursuant to the applicable provisions of (2). As of April 29, 2015 there were 55,334,490 warrants outstanding that were eligible to participate in the proposal inclusive of 38,888,147 warrants associated with anti-dilution provisions resulting from the January 8, 2015 private placement.

As of June 30, 2015, the results of this exchange were warrant holders elected to receive 52,110,896 shares of Common Stock under alternative (1). The Company recorded a loss on exchange of warrants in the amount of $12,959,654.

Warrant holders elected to receive 318,750 additional warrants under alternative (2).

Finally, warrant holders elected to receive a combination of 974,826 shares of Common Stock and 73,125 warrants under alternative (3). The Company recognized a warrant expense of $259,662.

As a result, the Company recorded a common stock payable of $13,762,260 as of June 30, 2015.

On May 14, 2015 the Company entered into a Consulting Agreement with E.B. Smith Jr. (father of the Company’s CEO and largest shareholder, Edward B. Smith, III) pursuant to which E.B. Smith Jr. will provide advice with respect to the Company’s marketing initiatives, provide customer introductions and investigating strategic transactions. In consideration of services rendered by E.B. Smith Jr., the Company issued warrants to purchase 750,000 shares of common stock at $0.35 per share. The warrants will vest 450,000 shares upon the mutual execution of this agreement and then in 150,000 share increments at the three month and six month anniversaries of this agreement.

On May 14, 2015 the Company entered into a Consulting Agreement with Terme Bancorp pursuant to which Terme Bancorp will provide advice with respect to the Company’s marketing initiatives, provide customer introductions and investigating strategic transactions. In consideration of services rendered by Terme Bancorp, the Company issued warrants to purchase 1,250,000 shares of common stock at $0.35 per share. The warrants will vest 750,000 shares upon the mutual execution of this agreement and then in 250,000 share increments at the three month and six month anniversaries of this agreement.

There were no warrants granted during the six months ended June 30, 2014. Also during this period there were no warrants exercised either for cash or on a cashless basis.