EQUITY

9 Months Ended

Sep. 30, 2017

Notes to Financial Statements

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 A Convertible Preferred Stock

On September 15, 2017, the Company filed the Certificate of Designations of the Series A Preferred with the Delaware Secretary of State, designating 31,021 shares of the Company’s preferred stock, par value $0.01 per share, as Series A Preferred. Shares of Series A Preferred accrue dividends at a rate of 8% per annum if the Company chooses to pay accrued dividends in cash, and 10% per annum if the Company chooses to pay accrued dividends in shares of Common Stock. Each share of Series A Preferred has a liquidation preference of $1,000 per share and is convertible, at the option of the holder, into that number of shares of the Company’s Common Stock equal to the Liquidation Preference, divided by $1.15. Each holder of the Series A Preferred is entitled to vote on all matters, together with the holders of Common Stock, on an as converted basis.

Holders of Series A Preferred may elect to convert shares of Series A Preferred into Conversion Shares at any time. In the event the volume-weighted average price (“VWAP”) of the Company’s Common Stock is at least $2.15 per share for at least 20 consecutive trading days, the Company may elect to convert one-half of the shares of Series A Preferred issued and outstanding, on a pro-rata basis, into Conversion Shares, or, if the VWAP of the Company’s Common Stock is at least $2.15 for 80 consecutive trading days, the Company may convert all issued and outstanding shares of Series A Preferred into Conversion Shares. In addition, in the event of a Change of Control, the Company will have the option to redeem all issued and outstanding shares of Series A Preferred for 115% of the Liquidation Preference per share.

 On September 18, 2017, the Company offered and sold a total of 11,000 shares of Series A Preferred at a purchase price of $1,000 per share. The total net proceeds to the Company from the Series A Financing were approximately $10.9 million.

Concurrently with the Series A Financing, the Company entered into Exchange Agreements with holders of all outstanding shares of the Company's Series E Convertible Preferred Stock, all outstanding shares of the Company's Series F Convertible Preferred Stock and all outstanding shares of the Company's Series G Convertible Preferred Stock (collectively "Exchanged Preferred") pursuant to which the holders thereof agreed to cancel their respective shares of Exchanged Preferred in exchange for shares of Series A Preferred. As a result of the Preferred Stock Exchange, the Company issued to the holders of the Exchanged Preferred an aggregate total of 20,021 shares of Series A Preferred.

The Company evaluated the Preferred Stock Exchange and determined that the Preferred Stock Exchange was both an induced conversion and an extinguishment transaction. Using the guidance in ASC 260-10-S99-2, Earnings Per Share – SEC Materials – SEC Staff Announcement: The Effect on the Calculations of Earnings Per Share for a Period That Includes the Redemption or Induced Conversion of Preferred Stock and ASC 470-50, Debt – Modifications and Extinguishments, the Company recorded the fair value differential of the Exchanged Preferred as adjustments within Shareholders’ Deficit and in the computation of Net Loss Available to Common Shareholders in the computation of basic and diluted loss per share. The Company utilized the services an independent third-party valuation firm to perform the computation of the fair value of the Exchanged Preferred. Based on the fair value using these methodologies, the Company recorded approximately $1,245,000 in fair value differential as adjustments within Shareholders’ Deficit in the Company’s Condensed Consolidated Balance Sheet for the period ended September 30, 2017 and in the computation of basic and diluted loss per share in the Company’s Condensed Consolidated Statement of Operations for the three and nine months ended September 30, 2017.

The Company had 31,021 shares and 0 shares of Series A Preferred outstanding as of September 30, 2017 and December 31, 2016, respectively.  At September 30, 2017, the Company had cumulative undeclared dividends of $0.  There were no conversions of Series A Preferred into Common Stock during the nine months ended September 30, 2017. The Company issued the holders of Series A Preferred 74,036 shares of Common Stock on September 30, 2017 as payment of dividends due on that date.

Series B Convertible Preferred Stock

The Company had 239,400 shares of Series B Convertible Preferred Stock (“Series B Preferred”) outstanding as of September 30, 2017 and December 31, 2016. At September 30, 2017 and December 31, 2016, the Company had cumulative undeclared dividends of approximately $21,000. There were no conversions of Series B Preferred into Common Stock during the nine months ended September 30, 2017 and 2016.

Series E Convertible Preferred Stock

On January 29, 2015, the Company filed the Certificate of Designations of the Series E Preferred Stock with the Delaware Secretary of State, designating 12,000 shares of the Company’s preferred stock, par value $0.01 per share, as Series E Preferred. Shares of Series E Preferred accrue dividends at a rate of 8% per annum if the Company chooses to pay accrued dividends in cash, and 10% per annum if the Company chooses to pay accrued dividends in shares of Common Stock. Each share of Series E Preferred has a liquidation preference of $1,000 per share and is convertible, at the option of the holder, into that number of shares of the Company’s Common Stock equal to the Liquidation Preference, divided by $1.90. The Series E Preferred shall be subordinate to and rank junior to the Company's Series A Preferred, Series B Preferred and all indebtedness of the Company. Each holder of the Series E Preferred is entitled to vote on all matters, together with the holders of Common Stock, on an as converted basis.

Any time after the six-month period following the issuance date, in the event the arithmetic average of the closing sales price of the Company’s Common Stock is or was at least $2.85 for twenty (20) consecutive trading days, the Company may redeem all or a portion of the Series E Preferred outstanding upon thirty (30) calendar day's prior written notice (the “Company's Redemption Notice”) in cash at a price per share of Series E Preferred equal to 110% of the liquidation preference amount plus all accrued and unpaid dividends.  Also, simultaneous with the occurrence of a change of control transaction, the Company, at its option, shall have the right to redeem all or a portion of the outstanding Series E Preferred in cash at a price per share of Series E Preferred equal to 110% of the liquidation preference amount plus all accrued and unpaid dividends.

In February 2015, the Company consummated a registered direct offering conducted without an underwriter or placement agent. In connection therewith, the Company issued 12,000 shares of Series E Preferred to certain investors at a price of $1,000 per share, with each share convertible into 526.32 shares of the Company’s Common Stock at $1.90 per share.

On December 29, 2016, the Company filed Amendment No. 1 to the Certificate of Designations, Preferences and Rights of the Series E Convertible Preferred Stock (the “Series E Amendment”) with the Delaware Division of Corporations. The Series E Amendment made the following changes to the Certificate of Designations, Preferences and Rights of the Series E Convertible Preferred Stock: (i) the Company may only make dividend payments in cash received from positive cash flow from operations; (ii) beginning on July 1, 2017, in the event the Company pays accrued dividend payments in shares of Common Stock for more than four consecutive quarterly periods, holders of shares of Series E Preferred will have the right to immediately appoint two designees to the Company’s Board of Directors (the “ Director Appointment Provision ”); (iii) dividend payments incurred on December 31, 2016 and March 31, 2017 may be paid in shares of Common Stock, without triggering the Director Appointment Provision; and (iv) the term Permitted Indebtedness (as defined in the Series E Certificate of Designations) was revised to cover permitted borrowings of up to $6.0 million.

The Company had 0 shares of Series E Preferred outstanding as of September 30, 2017 as a result of the Preferred Stock Exchange, and 12,000 shares of Series E Preferred at December 31, 2016.  At September 30, 2017 and December 31, 2016, the Company had cumulative undeclared dividends of $0.  There were no conversions of Series E Preferred into Common Stock during the nine months ended September 30, 2017 and 2016. The Company issued the holders of Series E Preferred 237,685 shares of Common Stock on September 30, 2017 as payment of dividends due on that date. For the nine months ended September 30, 2017, the Company has issued the holders of Series E Preferred 822,122 shares of Common Stock as payment of dividends due. With the payment of the quarterly dividends due September 30, 2017 to the holders of Series E Preferred in shares of Common Stock, the Director Appointment Provision became effective as of that date resulting in the Company adding two Board members as of September 15, 2017.

Series F Convertible Preferred Stock

In September 2016, we filed the Certificate of Designations, Preferences, and Rights of the Series F Convertible Preferred Stock (the “Certificate of Designations”) with the Delaware Division of Corporations, designating 2,000 shares of our preferred stock as Series F Convertible Preferred Stock (“Series F Preferred”). Shares of Series F Preferred rank junior to shares of Series A Preferred, Series B Preferred and Series E Preferred, as well as our existing indebtedness, and accrue dividends at a rate of 10% per annum, payable on a quarterly basis in shares of Common Stock.

Each share of Series F Preferred has a liquidation preference of $1,000 per share (“Liquidation Preference”), and is convertible, at the option of the holder, into that number of shares of the Company’s Common Stock equal to the Series F Liquidation Preference, divided by $1.50 (the “Series F Conversion Shares”).

Any time after the six-month period following the issuance date, in the event the arithmetic average of the closing sales price of the Company’s Common Stock is or was at least $2.50 for twenty (20) consecutive trading days, the Company may redeem all or a portion of the Series F Preferred outstanding upon thirty (30) calendar days prior written notice in cash at a price per share of Series F Preferred equal to 110% of the Series F Liquidation Preference, plus all accrued and unpaid dividends.  Also, simultaneous with the occurrence of a Change of Control transaction (as defined in the Certificate of Designations), the Company, at its option, shall have the right to redeem all or a portion of the outstanding Series F Preferred in cash at a price per share of Series F Preferred equal to 110% of the Liquidation Preference Amount plus all accrued and unpaid dividends.

In September 2016, the Company offered and sold 2,000 shares of Series F Preferred for $1,000 per share (the “Series F Financing”), resulting in gross proceeds to the Company of $2,000,000 net of issuance costs of approximately $21,000.

The Company had 0 shares of Series F Preferred outstanding as of September 30, 2017 as a result of the Preferred Stock Exchange, and 2,000 shares of Series F Preferred at December 31, 2016.  At September 30, 2017 and December 31, 2016, the Company had cumulative undeclared dividends of $0. There were no conversions of Series F Preferred into Common Stock during the nine months ended September 30, 2017 and 2016. The Company issued the holders of Series F Preferred 39,139 shares of Common Stock on September 30, 2017 as payment of dividends due on that date. For the nine months ended September 30, 2017, the Company has issued the holders of Series F Preferred 135,855 shares of Common Stock as payment of dividends due.

Series G Convertible Preferred Stock

In December 27, 2016, the Company filed the Certificate of Designations, Preferences, and Rights of the Series G Convertible Preferred Stock with the Delaware Division of Corporations, designating 6,120 shares of the Company’s preferred stock, par value $0.01 per share, as Series G Convertible Preferred Stock (“Series G Preferred”). Shares of Series G Preferred rank junior to the Company’s Series A Preferred, Series B Preferred, Series E Preferred, Series F Preferred as well as the Company’s existing indebtedness, and accrue dividends at a rate of 10% per annum, payable on a quarterly basis in shares of the Company’s common stock, par value $0.01 per share. Each share of Series G Preferred has a liquidation preference of $1,000 per share (“Series G Liquidation Preference”), and is convertible, at the option of the holder, into that number of shares of the Company’s Common Stock equal to the Series G Liquidation Preference, divided by $1.50.

Any time after the six-month period following the issuance date, in the event the arithmetic average of the closing sales price of the Company’s Common Stock is or was at least $2.50 for twenty (20) consecutive trading days, the Company may redeem all or a portion of the Series G Preferred outstanding upon thirty (30) calendar days prior written notice in cash at a price per share of Series G Preferred equal to 110% of the Series G Liquidation Preference, plus all accrued and unpaid dividends.  Also, simultaneous with the occurrence of a Change of Control transaction (as defined in the Certificate of Designations), the Company, at its option, shall have the right to redeem all or a portion of the outstanding Series G Preferred in cash at a price per share of Series G Preferred equal to 110% of the Liquidation Preference Amount plus all accrued and unpaid dividends.

On December 29, 2016, the Company accepted subscription forms from certain accredited investors to purchase a total of 1,625 shares of Series G Preferred for $1,000 per share (the “Series G Financing”), resulting in gross proceeds to the Company of $1,625,000, net of issuance cost of approximately $11,000. In addition, the Company also received executed exchange agreements from the Investors pursuant to which the Company exchanged an aggregate total of 3,383,830 shares of common stock held by the Investors for an aggregate total of 4,396 shares of Series G Preferred.

The Company had 0 shares of Series G Preferred outstanding as of September 30, 2017 as a result of the Preferred Stock Exchange, and 6,021 shares of Series G Preferred at December 31, 2016.  At September 30, 2017 and December 31, 2016, the Company had cumulative undeclared dividends of $0.  There were no conversions of Series G Preferred into Common Stock during the nine months ended September 30, 2017 and 2016. The Company issued the holders of Series G Preferred 117,832 shares of Common Stock on September 30, 2017 as payment of dividends due on that date. For the nine months ended September 30, 2017, the Company has issued the holders of Series G Preferred 409,002 shares of Common Stock as payment of dividends due.

Common Stock

 The following table summarizes Common Stock activity for the nine months ended September 30, 2017:

	Common Stock
Shares outstanding at December 31, 2016		91,846,795
Shares issued as payment of stock dividend on Series A Preferred		74,036
Shares issued as payment of stock dividend on Series E Preferred		822,122
Shares issued as payment of stock dividend on Series F Preferred		135,855
Shares issued as payment of stock dividend on Series G Preferred		409,002
Shares issued pursuant to option exercises		322,000
Shares outstanding at September 30, 2017		93,609,810

Warrants

The following table summarizes warrant activity for the following periods:

	Warrants			Weighted- Average Exercise Price
Balance at December 31, 2016		175,000		$	0.84
Granted		—			—
Expired/Canceled		(25,000	)		1.10
Exercised		—			—
Balance at September 30, 2017		150,000		$	0.80

As of September 30, 2017, warrants to purchase 150,000 shares of Common Stock at an exercise price of $0.80 were outstanding. These 150,000 warrants become exercisable only upon the attainment of specified events. The intrinsic value of warrants outstanding at September 30, 2017 was approximately $104,000.

Stock-Based Compensation

The 1999 Plan was adopted by the Company’s Board of Directors on December 17, 1999. Under the terms of the 1999 Plan, the Company could, originally, issue up to 350,000 non-qualified or incentive stock options to purchase Common Stock of the Company. During the year ended December 31, 2014, the Company subsequently amended and restated the 1999 Plan whereby it increased the share reserve for issuance to approximately 7.0 million shares of the Company’s Common Stock.  The 1999 Plan prohibits the grant of stock option or stock appreciation right awards with an exercise price less than fair market value of Common Stock on the date of grant. The 1999 Plan also generally prohibits the “re-pricing” of stock options or stock appreciation rights, although awards may be bought-out for a payment in cash or the Company’s stock. The 1999 Plan permits the grant of stock based awards other than stock options, including the grant of “full value” awards such as restricted stock, stock units and performance shares. The 1999 Plan permits the qualification of awards under the plan (payable in either stock or cash) as “performance-based compensation” within the meaning of Section 162(m) of the Internal Revenue Code. The number of options issued and outstanding and the number of options remaining available for future issuance are shown in the table below. On July 1, 2014, the Company began soliciting written consents from its shareholders to approve an amendment to the Company’s 1999 Stock Option Plan to increase the number of shares authorized for issuance thereunder from approximately 4.0 million to approximately 7.0 million (the “Amendment”).  As of July 21, 2014, the Company had received written consents approving the Amendment from over 50% of the Company’s stockholders. As such, the Amendment was approved. The number of authorized shares available under the plan for issuance at September 30, 2017 was 6,240,781. The number of available shares under the plan for issuance at September 30, 2017 was 124,263.

The Company estimates the fair value of its stock options using a Black-Scholes option-valuation 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 is reported in general and administrative, sales and marketing, engineering and customer service expense 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 $238,000 and $718,000 for the three and nine months ended September 30, 2017, respectively. Stock-based compensation expense related to equity options was approximately $243,000 and $718,000 for the three and nine months ended September 30, 2016, respectively. Stock-based compensation expense related to options to purchase shares of the Company’s Common Stock issued to certain members of the Company’s Board of Directors in return for their service (disclosed more fully below) was approximately $35,000 and $105,000 for the three and nine months ended September 30, 2017, respectively. Stock-based compensation expense related to options to purchase shares of the Company’s Common Stock issued to certain members of the Company’s Board of Directors in return for their service was approximately $49,000 and $139,000 for the three and nine months ended September 30, 2016, respectively.

ASC No. 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-valuation 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-valuation 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, 2017 and 2016 ranged from 58% to 103%. 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, 2017 and 2016 was 5.17 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, 2017 and 2016 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, 4.1% for members of the Board of Directors and 6.0% for all other employees.  The Company reviews the expected forfeiture rate annually to determine if that percent is still reasonable based on historical experience.

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

	Options			Weighted-Average Exercise Price
Balance at December 31, 2016		6,506,843		$	1.21
Granted		35,000		$	1.05
Expired/Cancelled		(103,325	)	$	1.63
Exercised		(322,000	)	$	0.71
Balance at September 30, 2017		6,116,318		$	1.22

The intrinsic value of options exercisable at September 30, 2017 was approximately $2,039,000.  The aggregate intrinsic value for all options outstanding as of September 30, 2017 was approximately $2,197,000. The weighted-average grant-date per share fair value of options granted during the nine months ended September 30, 2017 was $0.56. At September 30, 2017, the total remaining unrecognized compensation cost related to unvested stock options amounted to approximately $1,055,000 which will be recognized over a weighted-average period of 1.5 years.

In September 2016, the Company issued an aggregate of 168,000 options to purchase shares of the Company’s Common Stock to certain members of the Company’s Board of Directors in return for their service from January 1, 2017 through December 31, 2017. Such options will vest at the rate of 14,000 options per month on the last day of each month during the 2017 year. The options have an exercise price of $1.37 per share and a term of 10 years. The Company began recognition of compensation based on the grant-date fair value ratably over the 2017 requisite service period.

In May 2016, the Company issued an aggregate of 16,000 options to purchase shares of the Company’s Common Stock to a new member of the Company’s Board of Directors in return for their service from May 2016 through December 31, 2016. Such options vest at the rate of 2,000 options per month on the last day of each month during the 2016 year. The options have an exercise price of $1.29 per share and a term of 10 years. Pursuant to this issuance, the Company recorded compensation based on the grant-date fair value ratably over the 2016 requisite service period.

In September 2015, the Company issued an aggregate of 144,000 options to purchase shares of the Company’s Common Stock to certain members of the Company’s Board of Directors in return for their service from January 1, 2016 through December 31, 2016. Such options vest at the rate of 12,000 options per month on the last day of each month during the 2016 year. The options have an exercise price of $1.73 per share and a term of 10 years. Pursuant to this issuance, the Company recorded compensation based on the grant-date fair value ratably over the 2016 requisite service period.

Stock-based compensation related to equity options, including options granted to certain members of the Company’s Board of Directors, has been classified as follows in the accompanying condensed consolidated statements of operations (in thousands):

	Three Months Ended  September 30,				Nine months Ended  September 30,
	2017		2016		2017		2016
Cost of revenue	$	5	$	5	$	14	$	14
General and administrative		163		180		493		529
Sales and marketing		55		56		165		165
Research and development		50		51		151		151
Total	$	273	$	292	$	823	$	859