Note 7 - Notes Payable - Founders

9 Months Ended

Sep. 30, 2012

NOTE G – NOTES PAYABLE – FOUNDERS

To satisfy our short-term liquidity needs, the founding Levy family from time to time (prior to 2003) made loans to us. Jay Levy, our former director, Chairman of the Board, Treasurer and Assistant Secretary, and Jean Levy are/were the parents of Warren Levy and Ronald Levy, our former executive officers and directors. Total interest expense on all Levy loans was approximately $437,000 and $430,000 for the three months ended September 30, 2012 and 2011, respectively. Total interest expense on all Levy loans was approximately $1,318,000 and $1,263,000 for the nine months ended September 30, 2012 and 2011, respectively. As of September 30, 2012, total accrued interest on all Levy loans was $8,552,000 and the principal amount of the outstanding loans by the Levys to us totaled $14,438,000, for an aggregate owed to them of $22,990,000. These loans are collateralized by secondary security interests in our equipment and certain of our patents.

On March 10, 2011, we entered into the Settlement and Release Agreement and Amendments (the “Settlement Agreement”) by and among the Company and the Estate of Jean Levy, The Jaynjean Levy Family Limited Partnership, Dr. Warren Levy, our former president, and Dr. Ronald S. Levy, our former executive vice president (collectively, the “Levy Parties”). Pursuant to the Settlement Agreement, the Company made the following payments in the nine months ended September 30, 2011:

In March 2011, we paid (a) Dr. Warren Levy a lump-sum severance payment in the amount of $327,750; (b) Dr. Ronald Levy a lump-sum severance payment in the amount of $280,250; and (c) into escrow remaining severance payments in the aggregate amount of $304,000, $163,875 of which was released to Dr. Warren Levy and $140,125 of which was released to Dr. Ronald Levy, each in accordance with his respective employment agreement in monthly increments beginning September 2011 through February 2012;

2.	In March 2011, we paid (a) $151,268 to Dr. Warren Levy representing a portion of his vacation pay and (b) $136,736 to Dr. Ronald Levy representing a portion of his vacation pay;

Pursuant to the Settlement Agreement, the Company was obligated to make the following payments:

1.	On October 11, 2012 and November 13, 2012, we were obligated to pay an aggregate amount of $162,296: $85,241 to Dr. Warren Levy and $77,055 to Dr. Ronald Levy, in full satisfaction of their respective vacation pay; and

On November 13, 2012 and December 11, 2012, we were obligated to pay an aggregate amount of $200,000 into Rabbi Trust Accounts, $100,000 into an account for the benefit of Dr. Warren Levy and $100,000 into an account for the benefit of Dr. Ronald Levy, in full satisfaction of our obligations to each of them under the deferred compensation program.

Loan payments under the amended notes of $500,000 previously due on November 10, 2010 and $250,000 due on May 10, 2011 have been postponed under the Settlement Agreement. The new payment schedule specifies five monthly payments of $150,000 from May 2012 through September 2012.

On May 29, 2012, the Company entered into an agreement to settle its obligations to the Levys (the “Revised Settlement Agreement). Pursuant to the Revised Settlement Agreement, the Founders agreed to settle any and all outstanding obligations due from the Company in exchange for (i) two installment payments of $150,000 each due in May and June 2012, which were subsequently paid by the Company; (ii) $7,700,000 payable on or before September 30, 2012; and (iii) the issuance of 5,000,000 shares of the Company’s common stock. The Company did not meet the conditions to effectiveness under the Revised Settlement Agreement on or prior to September 30, 2012, including the payment of $8,000,000 (less the amount of the two $150,000 interim installment payments) and the issuance of 5,000,000 shares of common stock to the Levy Parties. As a result, the Revised Settlement Agreement has been terminated and is otherwise of no force and effect (other than as specifically identified) and all payments then or previously payable (and not previously paid) under the Settlement Agreement through and including September 30, 2012 became immediately due and payable as of such date. Following termination of the Revised Settlement Agreement, the full amount of the Company’s remaining payment obligations to the Levy Parties under the Settlement Agreement are principal in the aggregate amount of $14,738,000 and accrued interest, through September 30, 2012, in the aggregate amount of $8,552,000. Furthermore, as a result of the termination of the Revised Settlement Agreement, no release of any of the Levy claims has occurred and all the rights of the Levy Parties that existed under the Settlement Agreement, the related notes and with respect to their prior employment remain in full force and effect as if the Revised Settlement Agreement had not been entered into by them.

On December 21, 2012, the Company entered into an agreement (the "Second Revised Settlement Agreement") with the Levys. The Second Revised Settlement Agreement modified the Settlement Agreement. Pursuant to the Settlement Agreement, payments of $150,000 were due to the Levy Parties on each of October 11, 2012 and November 13, 2012 and a payment of $62,296 was due on December 11, 2012. According to the terms of the Second Revised Settlement Agreement, the Company paid $100,000 to the Levy Parties on December 21, 2012, which represented partial payment of the October 11, 2012 installment payment. Furthermore, under the Second Revised Settlement Agreement, the payments of each of (i) the remaining $50,000 related to the October 11, 2012 installment payment, (ii) the $150,000 installment payment due on November 13, 2012 and the $62,296 installment payment due on December 11, 2012, and (iii) the $150,000 installment payments due to the partnership on each of July 11, 2012, August 13, 2012, and September 11, 2012 under the terms of the Settlement Agreement, have been deferred until June 18, 2013. All other terms of the Settlement Agreement remain in full force and effect.

Notwithstanding the foregoing, any and all payments by the Company on account of any of the Company’s notes in favor of the Levy Parties (except the interim installment payments) remain subject to the terms and conditions of that certain Affiliate Subordination Agreement, dated September 30, 2008, among various Levy Parties, the Company and Victory Park Management, LLC, a Delaware limited liability company, as agent for all senior lenders, as the same may be amended, restated, supplemented and in effect from time to time, including pursuant to that certain Reaffirmation of Affiliate Subordination Agreement dated as of March 17, 2010, and as amended by that certain letter dated March 16, 2011 from Victory Park Management LLC regarding “Consent and Amendment” (the “Subordination Agreement”). As a result, the Company may not make additional payments to the Levy Parties unless such payments can be made in accordance with the terms of the Subordination Agreement assuming any such payment constitutes “Permitted Subordinated Debt Payments” thereunder.

- 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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