EQUITY

9 Months Ended

Sep. 30, 2012

Notes to Financial Statements

Note 6 - EQUITY

 The Company’s Articles of Incorporation, as amended, authorize the issuance of two classes of stock to be designated “common stock” and “preferred stock”. The preferred stock may be divided into such number of series and with the rights, preferences, privileges and restrictions as the Board of Directors may determine.

Series B Convertible Redeemable Preferred Stock

 The Company had 239,400 shares of Series B Convertible Redeemable Preferred (“Series B Preferred”) outstanding as of September 30, 2012 and December 31, 2011.  At September 30, 2012 and December 31, 2011, the Company had cumulative undeclared dividends of approximately $21,000 and $187,000, respectively.  There were no conversions of Series B Preferred into common stock during the nine months ended September 30, 2012 or 2011.

Common Stock

The following table summarizes common stock activity for the nine months ended September 30, 2012:

	Common Stock
Shares outstanding at December 31, 2011		67,988,916
Shares issued pursuant to warrants and options exercised for cash		7,028,871
Shares issued pursuant to cashless warrants exercised		1,361,547
Shares outstanding at September 30, 2012		76,379,334

During the nine months ended September 30, 2012, the Company issued 24,924 shares of common stock pursuant to the exercise of 24,924 options for cash proceeds of approximately $7,000.  During the nine months ended September 30, 2012, the Company issued 7,003,947 shares of common stock pursuant to the exercise of 7,003,947 warrants for cash proceeds of approximately $3,502,000. During the nine months ended September 30, 2012, the Company issued 1,361,547 shares of common stock pursuant to the cashless exercise of 2,460,725 warrants.

Warrants 

The following table summarizes warrant activity for the following periods:

	Warrants			Weighted- Average Exercise Price
Balance at December 31, 2011		28,453,760		$	0.52
Granted		300,000		$	0.91
Expired / Canceled		(12,000	)	$	0.50
Exercised		(9,464,672	)	$	0.50
Balance at September 30, 2012		19,277,088		$	0.56

 During the nine months ended September 30, 2012, there were 2,460,725 warrants exercised pursuant to cashless transactions and 12,000 warrants expired. During the nine months ended September 30, 2012, there were 7,003,947 warrants exercised for cash resulting in cash proceeds to the Company of approximately $3,502,000. The Company issued 1,361,547 shares of its common stock pursuant to cashless warrant exercises and 7,003,947 shares of its common stock pursuant to warrants exercised for cash.

During the nine months ended September 30, 2012, the Company issued to Vocel a warrant to purchase 150,000 shares of the Company’s common stock (“Purchaser Warrant”).  The Purchaser Warrant is exercisable at $0.88 per share and vests 100% at such time as the Company has derived $500,000 of gross revenue from the sale or license of the purchased intellectual property (“Warrant Vesting Date”).  The Purchaser Warrant is exercisable for a period of three years from the Warrant Vesting Date. The Purchaser Warrant did not vest during the nine months ended September 30, 2012.

During the nine months ended September 30, 2012, the Company issued to certain consultants warrants to purchase 50,000 shares of the Company’s common stock. Such warrants were issued upon the attainment of certain performance conditions, are exercisable at $1.10 per share and have a three year term. The Company determined the grant date fair value of these warrants using the Black-Scholes option–pricing model to be approximately $25,000. Such expense is recorded in the Company’s Condensed Consolidated Statement of Operations for the three and nine months ended September 30, 2012 as a component of general and administrative expense.

During the three months ended September 30, 2012, the Company issued to certain consultants warrants to purchase 100,000 shares of the Company’s common stock. Such warrants are exercisable at $0.98 per share and have a two year term from the date of issuance. The warrants will vest 100% at such time as the Company has derived $1.5 million of gross revenue from the consultant’s efforts.

 As of September 30, 2012, warrants to purchase 19,277,088 shares of common stock at prices ranging from $0.50 to $1.67 were outstanding. All warrants are exercisable as of September 30, 2012, and expire at various dates through December 2016, with the exception of an aggregate of 250,000 warrants, which becomes exercisable only upon the attainment of specified events.

 Stock-Based Compensation

 As of September 30, 2012, the Company had two active stock-based compensation plans for employees and nonemployee directors, which authorize the granting of various equity-based incentives including stock options and restricted stock.

 The Company estimates the fair value of its stock options using a Black-Scholes option-pricing model, consistent with the provisions of ASC No. 718, Compensation – Stock Compensation. The fair value of stock options granted is recognized to expense over the requisite service period. Stock-based compensation expense for all share-based payment awards is recognized using the straight-line single-option method. Stock-based compensation expense is reported in operating expenses based upon the departments to which substantially all of the associated employees report and credited to “Additional paid-in capital”.  Stock-based compensation expense related to equity options was approximately $145,000 and $426,000 for the three and nine months ended September 30, 2012, respectively.  Stock-based compensation related to equity options was approximately $70,000 and $210,000 for the three and nine months ended September 30, 2011, respectively. 

 ASC 718 requires the use of a valuation model to calculate the fair value of stock-based awards. The Company has elected to use the Black-Scholes option-pricing model, which incorporates various assumptions including volatility, expected life, and interest rates. The Company is required to make various assumptions in the application of the Black-Scholes option-pricing model. The Company has determined that the best measure of expected volatility is based on the historical weekly volatility of the Company’s common stock. Historical volatility factors utilized in the Company’s Black-Scholes computations for the nine months ended September 30, 2012 and 2011 ranged from 99% to 135%. The Company has elected to estimate the expected life of an award based upon the SEC approved “simplified method” noted under the provisions of Staff Accounting Bulletin No. 110. The expected term used by the Company during the nine months ended September 30, 2012 and 2011 was 5.9 years. The difference between the actual historical expected life and the simplified method was immaterial.  The interest rate used is the risk free interest rate and is based upon U.S. Treasury rates appropriate for the expected term. Interest rates used in the Company’s Black-Scholes calculations for the nine months ended September 30, 2012 and 2011 was 2.6%. Dividend yield is zero as the Company does not expect to declare any dividends on the Company’s common stock in the foreseeable future.

 In addition to the key assumptions used in the Black-Scholes model, the estimated forfeiture rate at the time of valuation is a critical assumption.  The Company has estimated an annualized forfeiture rate of approximately 0% for corporate officers, 4% for members of the Board of Directors and 6% for all other employees.  The Company reviews the expected forfeiture rate annually to determine if that percent is still reasonable based on historical experience.

 In January of 2010, the Company issued 847,258 shares of restricted stock to members of management and the Board of Directors.  These shares will vest quarterly over a three-year period.  The restricted shares were issued as compensation for the cancellation of 1,412,096 options held by members of management and the Board of Directors.  The Company evaluated the exchange in accordance with ASC 718 and determined there was no incremental cost to be recorded in conjunction with the exchange as the fair value of the options surrendered at the modification date exceeded the fair value of the restricted shares issued at the modification date. The stock-based compensation expense related to these restricted stock grants was approximately $9,000 and $28,000 for the three and nine months ended September 30, 2012, respectively and was $10,000 and $30,000 for the three and nine months ended September 30, 2011, respectively.

 During March 2011, the Company granted 880,000 performance units to certain key employees that grant the holder the right to receive compensation based on the appreciation in the Company’s common stock in the event of transfer of control of the Company ("Performance Units").  As the vesting of the Performance Units is contingent upon the sale of the Company, the expense associated with the granting of the Performance Units was not material.  The Performance Units issued to such key employees were terminated and exchanged for options to purchase a total of 435,000 shares of common stock during the nine months ended September 30, 2012.

 A summary of the activity under the Company’s stock option plans is as follows:

	Options			Weighted-Average Exercise Price
Balance at December 31, 2011		1,707,713		$	0.76
Granted		1,437,500		$	0.89
Expired/Cancelled		(68,892	)	$	0.83
Exercised		(24,924	)	$	0.29
Balance at September 30, 2012		3,051,397		$	0.82

 The weighted-average grant date fair value of options granted during the nine months ended September 30, 2012 was $0.71.