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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

 

FORM 10-K/A

(Amendment No. 1)

 

 

 

x	ANNUAL REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the fiscal year ended December 31, 2014

 

¨	TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

Commission File Number: 000-31927

 

 

VERIFYME, INC.

(Exact name of registrant as specified in its charter)

 

 

 

Nevada		23-3023677
(State of incorporation)		(I.R.S. Employer Identification No.)

12 W. 21^st Street

New York, New York 10010

(Address of principal executive offices)

(212) 994-7002

(Registrant’s telephone number)

Securities registered under Section 12(b) of the Exchange Act: None.

Securities registered under Section 12(g) of the Exchange Act:

Common Stock, $0.001 par value

(Title of Class)

 

 

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.    Yes  ¨    No  x

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act.    Yes  ¨    No  x

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports) and (2) has been subject to such filing requirements for the past 90 days.    Yes  x    No  ¨

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes  ¨    No  x

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of the Form 10-K or any amendment of this Form 10-K.  ¨

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company. See the definitions of “large accelerated filer”, “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):

 

Large Accelerated Filer		¨		Accelerated Filer		¨
Non-Accelerated Filer		¨  (Do not check if a smaller reporting company)		Smaller reporting company		x

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes  ¨    No  x

The aggregate market value of the voting and non-voting common equity held by non-affiliates computed by reference to the price at which the common equity was last sold, or the average bid and asked price of such common equity, as of the last business day of the registrant’s most recently completed second fiscal quarter, June 30, 2014, was $8,378,241.

As of November 2, 2015, there were 5,969,187 shares of the registrant’s common stock outstanding.

 

 

 

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VERIFYME, INC.

FORM 10-K/A

TABLE OF CONTENTS

 

				Page
PART II
Item 9A.		Controls and Procedures			4
PART IV
Item 15.		Exhibits, Financial Statement Schedules			5
SIGNATURES					10
EXHIBIT INDEX					11

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EXPLANATORY NOTE

VerifyMe, Inc. (the “Company”) filed its Annual Report on Form 10-K for the fiscal year ended December 31, 2014 (the “Original Form 10-K”), with the U.S. Securities and Exchange Commission (the “SEC”) on April 16, 2015. The Company is filing this Amendment No. 1 to the Original Form 10-K (this “Form 10-K/A”) for the purpose of (i) inserting paragraph 4(d) in each of Exhibits 31.1 and 31.2, filed herewith in their entirety, and (ii) classifying certain exhibits as management compensatory plans, contracts or arrangements in the Exhibit Index, incorporated by reference to this Form 10-K/A, which were inadvertently omitted from the Original Form 10-K.

Pursuant to Rule 12b-15 under the Securities Exchange Act of 1934, as amended (the “Exchange Act”), this Form 10-K/A contains the new certifications pursuant to Sections 302 and 906 of the Sarbanes-Oxley Act of 2002. Item 9A of Part II has been restated in its entirety and Part IV has been amended and restated in its entirety to include the currently dated certifications as exhibits, in addition to the newly-classified exhibits.

No attempt has been made in this Form 10-K/A to modify or update the other disclosures presented in the Original Form 10-K, including, without limitation, the financial statements. This Form 10-K/A does not reflect events occurring after the filing of the Original Form 10-K or modify or update the disclosures in the Original Form 10-K, except as set forth in this Form 10-K/A, and should be read in conjunction with the Original Form 10-K and the Company’s other filings with the SEC.

 

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PART II

 

ITEM 9A.

CONTROLS AND PROCEDURES.

Disclosure Controls and Procedures

Our management has evaluated, under the supervision and with the participation of our Chief Executive Officer and Chief Financial Officer, the effectiveness of our disclosure controls and procedures (as defined in Rules 13a-15(e) or 15(d)-15(e) under the Exchange Act) as of the end of the period covered by this report pursuant to Rule 13a-15(b) under the Exchange Act. Based on this evaluation, our Chief Executive Officer and Chief Financial Officer concluded that, as of December 31, 2014, our disclosure controls and procedures were effective to ensure (i) that information we are required to disclose in reports that we file or submit under the Securities Exchange Act of 1934 is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms, and (ii) that such information is accumulated and communicated to management, including our Chief Executive Officer and Chief Financial Officer, in order to allow timely decisions regarding required disclosure.

Management’s Report on Internal Control Over Financial Reporting

Our management is responsible for establishing and maintaining adequate internal control over financial reporting as defined in Rule 13a-15(f) under the Securities Exchange Act of 1934 as amended. Internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.

Our management conducted an evaluation of the effectiveness of our internal controls over financial reporting as of December 31, 2014 using criteria established in Internal Control — Integrated Framework issued (1992) by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). Our management has concluded that our internal control over financial reporting was not effective as of December 31, 2014 due to staffing changes in proximity to filing the 10K.

This annual report does not include an attestation report of our registered public accounting firm regarding internal control over financial reporting. Management’s report was not subject to attestation by our registered public accounting firm pursuant to the Dodd-Frank Wall Street Reform and Consumer Protection Act, which permits us to provide only management’s report in this annual report.

Changes in Internal Control Over Financial Reporting

As of December 31, 2014, our management carried out the evaluation of the effectiveness of our disclosure controls and procedures required by Rule 13a-15(e) under the Exchange Act with the participation of our Chief Executive Officer and Chief Financial Officer. Based upon that evaluation, our Chief Executive Officer and Chief Financial Officer concluded that, as of December 31, 2014, our disclosure controls and procedures were effective to ensure that information we are required to disclose in reports that we file or submit under the Exchange Act is: (i) recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms, and (ii) accumulated and communicated to our management, including our Chief Executive Officer and Chief Financial Officer, as appropriate to allow timely decisions regarding required disclosure.

There has been no change in our internal control over financial reporting identified in connection with this evaluation that occurred during our fiscal quarter ended December 31, 2014 that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

 

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PART IV

 

Item 15.

Exhibits, Financial Statement Schedules.

(a)(1) The following documents are filed under pages F-1 through F-28 and are included as part of this Form 10-K/A:

 

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM			F-1
BALANCE SHEETS			F-2
STATEMENTS OF OPERATIONS			F-3
STATEMENT OF STOCKHOLDERS’ DEFICIT			F-4
STATEMENTS OF CASH FLOWS			F-5

(a)(2) Financial statement schedules are omitted as they are not applicable.

(a)(3) See Item 15(b) below.

 

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(b) Exhibits

 

Exhibit No.		Description
3.1		Amended and Restated Articles of Incorporation of the Company dated December 17, 2003 (filed as an exhibit to the Company’s Annual Report on Form 10-KSB filed with the Securities and Exchange Commission on March 30, 2004 and incorporated herein by reference).
3.2		Certificate of Amendment to Amended and Restated Articles of Incorporation of LaserLock Technologies, Inc., dated as of November 29, 2012 (filed as an exhibit to the Company’s Annual Report on Form 10-K filed with the Securities and Exchange Commission on April 1, 2013 and incorporated herein by reference).
3.3		Amended Certificate of Designation of Series A Preferred Stock, dated as of January 31, 2013 (filed as an exhibit to the Company’s Current Report on Form 8-K filed with the Securities and Exchange Commission on February 6, 2013 and incorporated herein by reference).
3.4		Amended and Restated Bylaws of the Company dated December 17, 2003 (filed as an exhibit to the Company’s Annual Report on Form 10-KSB filed with the Securities and Exchange Commission on March 30, 2004 and incorporated herein by reference).
3.5		Certificate of Amendment to Amended and Restated Articles of Incorporation of LaserLock Technologies, Inc., dated as of May 23, 2013 (filed as an exhibit to the Company’s Current Report on Form 8-K filed with the Securities and Exchange Commission on May 30, 2013 and incorporated herein by reference).
10.1*		Employment Agreement by and between the Company and Norman Gardner dated November 5, 2003 (filed as an exhibit to the Company’s Annual Report on Form 10-KSB filed with the Securities and Exchange Commission on March 30, 2004 and incorporated herein by reference).
10.2*		Stock Loan Agreement by and among Norman Gardner, Californian Securities, SA and Pacific Continental Securities (UK) Nominees Limited and the Company (filed as an exhibit to the Company’s Quarterly Report on Form 10-QSB filed with the Securities and Exchange Commission on November 14, 2003 and incorporated herein by reference).
10.3		Regulations S Stock Purchase Agreement, dated May 2, 2003, by and between the Company and Californian Securities, S.A. (filed as an exhibit to the Company’s Quarterly Report on Form 10-QSB filed with the Securities and Exchange Commission on August 14, 2003 and incorporated herein by reference).
10.4		Amendment to Regulation S Stock Purchase Agreement by and between the Company and Californian Securities, S.A., dated October 15, 2003 (filed as an exhibit to the Company’s Quarterly Report on Form 10-QSB filed with the Securities and Exchange Commission on November 14, 2003 and incorporated herein by reference).
10.5		Regulations S Stock Purchase Agreement, dated March 10, 2004, by and between the Company and California Securities, S.A. (filed as an exhibit to the Company’s Quarterly Report on Form 10-QSB filed with the Securities and Exchange Commission on May 17, 2004 and incorporated herein by reference).
10.6		Senior Secured Convertible Note and Warrant Purchase Agreement, dated February 13, 2006, among the Company and Nob Hill Capital Partners, L.P. (filed as an exhibit to the Company’s Current Report on Form 8-K filed with the Securities and Exchange Commission on February 17, 2006 and incorporated herein by reference).
10.7		Schedule of Purchasers who have entered into the Senior Secured Convertible Note and Warrant Purchase Agreement (filed as an exhibit to the Company’s Current Report on Form 8-K filed with the Securities and Exchange Commission on February 17, 2006 and incorporated herein by reference).
10.8		Senior Secured Convertible Promissory Note, dated February 17, 2006, by the Company in favor of Nob Hill Capital Partners, L.P. in the amount of $100,000 (filed as an exhibit to the Company’s Current Report on Form 8-K filed with the Securities and Exchange Commission on February 17, 2006 and incorporated herein by reference).
10.9		Schedule of Payees who have entered into a senior secured convertible promissory note substantially identical to the Senior Secured Convertible Promissory Note (filed as an exhibit to the Company’s Current Report on Form 8-K filed with the Securities and Exchange Commission on February 17, 2006 and incorporated herein by reference).

 

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10.10		Warrant, issued by the Company in favor of Nob Hill Capital Partners, L.P., dated February 13, 2006 (filed as an exhibit to the Company’s Current Report on Form 8-K filed with the Securities and Exchange Commission on February 17, 2006 and incorporated herein by reference).
10.11		Schedule of Holders to whom the Company has issued a warrant substantially identical to the Warrant (filed as an exhibit to the Company’s Current Report on Form 8-K filed with the Securities and Exchange Commission on February 17, 2006 and incorporated herein by reference).
10.12		Security Agreement, dated February 13, 2006, by and between the Company and Nob Hill Capital Partners, L.P. (filed as an exhibit to the Company’s Current Report on Form 8-K filed with the Securities and Exchange Commission on February 17, 2006 and incorporated herein by reference).
10.13		Schedule of Secured Parties who have entered into a security agreement substantially identical to the Security Agreement (filed as an exhibit to the Company’s Current Report on Form 8-K filed with the Securities and Exchange Commission on February 17, 2006 and incorporated herein by reference).
10.14*		Grant of 3,000,000 shares of the Company to Norman A. Gardner on January 3, 2006 in consideration for services provided to the Company (filed as an exhibit to the Company’s Current Report on Form 8-K filed with the Securities and Exchange Commission on January 18, 2006 and incorporated herein by reference).
10.15		LaserLock Technologies, Inc. 2013 Omnibus Equity Compensation Plan adopted on December 9, 2013 (filed as an exhibit to the Company’s Definitive Proxy Statement filed with the Securities and Exchange Commission on November 19, 2013 and incorporated herein by reference).
10.16		Option Agreement, dated as of March 23, 2012, between the Company and Gaming Partners International Corporation (filed as an exhibit to the Company’s Annual Report on Form 10-K filed with the Securities and Exchange Commission on March 31, 2014 and incorporated herein by reference).
10.17		Investment Agreement, dated as of December 31, 2012, between LaserLock Technologies, Inc. and VerifyMe, Inc. (filed as an exhibit to the Company’s Annual Report on Form 10-K filed with the Securities and Exchange Commission on April 1, 2013 and incorporated herein by reference).
10.18		Registration Rights Agreement, dated as of December 31, 2012, between LaserLock Technologies, Inc. and VerifyMe, Inc. (filed as an exhibit to the Company’s Annual Report on Form 10-K filed with the Securities and Exchange Commission on April 1, 2013 and incorporated herein by reference).
10.19		Technology and Services Agreement, dated as of December 31, 2012, between LaserLock Technologies, Inc. and VerifyMe, Inc. (filed as an exhibit to the Company’s Annual Report on Form 10-K filed with the Securities and Exchange Commission on April 1, 2013 and incorporated herein by reference).
10.20		Patent and Technology License Agreement, dated as of December 31, 2012, between LaserLock Technologies, Inc. and VerifyMe, Inc. (filed as an exhibit to the Company’s Annual Report on Form 10-K filed with the Securities and Exchange Commission on April 1, 2013 and incorporated herein by reference).
10.21		Asset Purchase Agreement, dated as of December 31, 2012, between LaserLock Technologies, Inc. and VerifyMe, Inc. (filed as an exhibit to the Company’s Annual Report on Form 10-K filed with the Securities and Exchange Commission on April 1, 2013 and incorporated herein by reference).
10.22		Technology and Services Agreement (Zaah), dated as of December 31, 2012, between LaserLock Technologies, Inc. and Zaah Technologies, Inc. (filed as an exhibit to the Company’s Annual Report on Form 10-K filed with the Securities and Exchange Commission on April 1, 2013 and incorporated herein by reference).
10.23*		Employment Agreement between LaserLock Technologies, Inc. and Norman Gardner, dated as of October 8, 2012 (filed as an exhibit to the Company’s Annual Report on Form 10-K filed with the Securities and Exchange Commission on April 1, 2013 and incorporated herein by reference).
10.24*		Employment Agreement between LaserLock Technologies, Inc. and Neil Alpert, dated as of October 8, 2012 (filed as an exhibit to the Company’s Annual Report on Form 10-K filed with the Securities and Exchange Commission on April 1, 2013 and incorporated herein by reference).
10.25*		Employment Agreement between LaserLock Technologies, Inc. and Scott McPherson, dated as of December 14, 2012 (filed as an exhibit to the Company’s Annual Report on Form 10-K filed with the Securities and Exchange Commission on April 1, 2013 and incorporated herein by reference).

 

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10.26*		Nonqualified Stock Option Grant Agreement between LaserLock Technologies, Inc. and Norman Gardner, dated as of November 21, 2012 (filed as an exhibit to the Company’s Annual Report on Form 10-K filed with the Securities and Exchange Commission on April 1, 2013 and incorporated herein by reference).
10.27*		Nonqualified Stock Option Grant Agreement between LaserLock Technologies, Inc. and Neil Alpert, dated as of November 21, 2012 (option grant on identical terms and for same amount of options as pursuant to agreement filed as Exhibit 10.26).
10.28*		Nonqualified Stock Option Grant Agreement between LaserLock Technologies, Inc. and Michael Sonnenreich, dated as of November 21, 2012 (filed as an exhibit to the Company’s Annual Report on Form 10-K filed with the Securities and Exchange Commission on April 1, 2013 and incorporated herein by reference).
10.29*		Nonqualified Stock Option Grant Agreement between LaserLock Technologies, Inc. and Constance Harriman, dated as of November 21, 2012 (option grant on identical terms and for same amount of options as pursuant to agreement filed as Exhibit 10.28).
10.30*		Nonqualified Stock Option Grant Agreement between LaserLock Technologies, Inc. and Peter Pace, dated as of November 21, 2012 (option grant on identical terms and for same amount of options as pursuant to agreement filed as Exhibit 10.28).
10.31*		Nonqualified Stock Option Grant Agreement between LaserLock Technologies, Inc. and Jonathan Weinberger, dated as of November 21, 2012 (option grant on identical terms and for same amount of options as pursuant to agreement filed as Exhibit 10.28).
10.32*		Nonqualified Stock Option Grant Agreement between LaserLock Technologies, Inc. and Paul Wolfowitz, dated as of November 21, 2012 (option grant on identical terms and for same amount of options as pursuant to agreement filed as Exhibit 10.28).
10.33		Subscription Agreement between LaserLock Technologies, Inc. and VerifyMe, Inc., dated as of January 31, 2013 (filed as an exhibit to the Company’s Current Report on Form 8-K filed with the Securities and Exchange Commission on February 6, 2013 and incorporated herein by reference).
10.34*		Nonqualified Stock Option Grant Agreement between LaserLock Technologies, Inc. and Paul Klapper, dated as of December 9, 2013 (option grant on identical terms and for same amount of options as pursuant to agreement filed as Exhibit 10.28).
10.35*		Nonqualified Stock Option Grant Agreement between LaserLock Technologies, Inc. and Michael Chertoff, dated as of May 4, 2013 (option grant on identical terms and for same amount of options as pursuant to agreement filed as Exhibit 10.28).
14.1		Code of Ethics (filed as an exhibit to the Company’s Annual Report on Form 10-K filed with the Securities and Exchange Commission on April 1, 2013 and incorporated herein by reference).
23.1		Consent of Morison Cogen LLP
31.1		Certification of Principal Executive Officer, pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
31.2		Certification of Principal Financial Officer, pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
32.1		Certification of Principal Executive Officer, pursuant to 18 U.S.C. Section 1350, as created by Section 906 of the Sarbanes-Oxley Act of 2002
32.2		Certification of Principal Financial Officer, pursuant to 18 U.S.C. Section 1350, as created by Section 906 of the Sarbanes-Oxley Act of 2002
101.INS		XBRL Instance Document, incorporated by reference to the Company’s Annual Report on Form 10-K for fiscal year ended December 31, 2014 filed with the SEC on April 16, 2015
101.SCH		XBRL Taxonomy Extension Schema Document, incorporated by reference to the Company’s Annual Report on Form 10-K for fiscal year ended December 31, 2014 filed with the SEC on April 16, 2015
101.CAL		XBRL Taxonomy Extension Calculation Linkbase Document, incorporated by reference to the Company’s Annual Report on Form 10-K for fiscal year ended December 31, 2014 filed with the SEC on April 16, 2015

 

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101.DEF		XBRL Taxonomy Extension Definition Linkbase Document, incorporated by reference to the Company’s Annual Report on Form 10-K for fiscal year ended December 31, 2014 filed with the SEC on April 16, 2015
101.LAB		XBRL Taxonomy Extension Label Linkbase, incorporated by reference to the Company’s Annual Report on Form 10-K for fiscal year ended December 31, 2014 filed with the SEC on April 16, 2015
101.PRE		XBRL Taxonomy Extension Presentation Linkbase Document, incorporated by reference to the Company’s Annual Report on Form 10-K for fiscal year ended December 31, 2014 filed with the SEC on April 16, 2015

 

*	Indicates management compensatory plan, contract or arrangement.

 

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SIGNATURES

Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized, in the City of New York, State of New York, on November 4, 2015.

 

Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated:

 

Signature				Title		Date
/s/ Paul Donfried				Chief Executive Officer and		November 4, 2015
Paul Donfried				Director (Principal Executive Officer)
/s/ Scott McPherson				Chief Financial Officer (Principal		November 4, 2015
Scott McPherson				Financial Officer)
/s/ Claudio R. Ballard				Director		November 4, 2015
Claudio R. Ballard
/s/ Jonathan Weinberger				Director		November 4, 2015
Jonathan Weinberger
/s/ Lawrence G. Schafran				Director		November 4, 2015
Lawrence G. Schafran

 

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EXHIBIT INDEX

The following exhibits are included in this Form 10-K/A (and are numbered in accordance with Item 601 of Regulation S-K).

 

Exhibit No.		Description
31.1		Certification of Principal Executive Officer, pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
31.2		Certification of Principal Financial Officer, pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
32.1		Certification of Principal Executive Officer, pursuant to 18 U.S.C. Section 1350, as created by Section 906 of the Sarbanes-Oxley Act of 2002
32.2		Certification of Principal Financial Officer, pursuant to 18 U.S.C. Section 1350, as created by Section 906 of the Sarbanes-Oxley Act of 2002

Note: This index only lists the exhibits included in this Form 10-K/A. A complete list of exhibits can be found in “Item 15. Exhibits, Financial Statement Schedules” of this Form 10-K/A.

 

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VERIFYME, INC.

(F.K.A. LASERLOCK TECHNOLOGIES, INC.)

INDEX TO FINANCIAL STATEMENTS

CONTENTS

 

		PAGE
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM			1
BALANCE SHEETS			2
STATEMENTS OF OPERATIONS			3
STATEMENTS OF STOCKHOLDERS’ DEFICIT			4
STATEMENTS OF CASH FLOWS			5
NOTES FINANCIAL STATEMENTS			6-28

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Report of Independent Registered Public Accounting Firm

 

To the Board of Directors

LaserLock Technologies, Inc. and Subsidiary

 

We have audited the accompanying balance sheets of LaserLock Technologies, Inc. and its Subsidiary as of December 31, 2014 and 2013 and the related statements of operations, changes in stockholders’ deficit, and cash flows for the years then ended. These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements based on our audits.

We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. Our audit included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control over financial reporting. Accordingly, we express no such opinion. An audit also includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

In our opinion the financial statements referred to above present fairly, in all material respects, the financial position of LaserLock Technologies, Inc. and its Subsidiary as of December 31, 2014 and 2013, and the results of their operations and their cash flows for the years then ended, in conformity with accounting principles generally accepted in the United States of America.

The accompanying financial statements have been prepared assuming that the Company will continue as a going concern. As discussed in Note 2 to the financial statements, the Company has incurred significant losses and experienced negative cash flow from operations. These conditions raise substantial doubt about the Company’s ability to continue as a going concern. The financial statements do not include any adjustments that might result from the outcome of this uncertainty.

/s/ MORISON COGEN LLP

 

Bala Cynwyd, Pennsylvania

April 15, 2015

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Balance Sheets

 

		December 31, 2014				December 31, 2013
ASSETS
CURRENT ASSETS
Cash and cash equivalents		$	63,956			$	1,285,973
Accounts receivable, net of allowance of $0 at December 31, 2014 and 2013			—				3,573
Inventory			97,360				34,271
Prepaid expenses			181,086				189,474
TOTAL CURRENT ASSETS			342,402				1,513,291
PROPERTY AND EQUIPMENT
Capital equipment, net of accumulated depreciation of $161,205 and $91,952 as of December 31, 2014 and 2013			74,821				144,074
OTHER ASSETS
Deposits			37,197				37,197
Patents and Trademark, net of accumulated amortization of $118,502 and $105,393 as of December 31, 2014 and 2013			107,586				120,695
			144,783				157,892
TOTAL ASSETS		$	562,006			$	1,815,257
LIABILITIES AND STOCKHOLDERS’ DEFICIT
CURRENT LIABILITIES
Accounts payable and accrued expenses		$	5,217,770			$	316,785
Accrued interest - related parties			43,215				16,667
Deferred revenue			16,667				—
Embedded derivative liability			—				800,000
Senior convertible notes payable — related parties			114,000				—
Notes payable			812,553				50,000
TOTAL CURRENT LIABILITIES			6,204,205				1,183,452
LONG-TERM LIABILITIES
Warrant liability		$	6,370,709			$	6,000,000
Accrued interest - related parties			112,885				300,677
Senior secured convertible notes payable - related parties			—				330,249
TOTAL LONG-TERM LIABILITIES			6,483,594				6,630,926
TOTAL LIABILITIES			12,712,799				7,814,378
CONTINGENCIES
STOCKHOLDERS’ DEFICIT
Convertible Preferred Stock, $ .001 par value; 75,000,000 shares authorized; 21,111,111 shares issued and outstanding as of December 31, 2014 and 2013			633,333				633,333
Common stock, $ .001 par value; 675,000,000 shares authorized; 337,374,052 shares issued and 307,578,149 outstanding at December 31, 2014 and 319,862,042 shares issued and 290,066,139 outstanding at December 31, 2013			337,374				319,862
Additional paid in capital			24,713,294				22,938,983
Treasury stock, at cost (29,795,903 shares at December 31, 2014 and 2013)			(113,389	)			(113,389	)
Accumulated deficit			(37,696,405	)			(29,777,910	)
STOCKHOLDERS’ DEFICIT			(12,125,793	)			(5,999,121	)
TOTAL LIABILITIES AND STOCKHOLDERS’ DEFICIT		$	562,006			$	1,815,257

The accompanying notes are an integral part to these financial statements.

 

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Statements of Operations

For the Years Ended and 2014

 

		Year Ended December 31, 2014				Year Ended December 31, 2013
NET REVENUE
Sales		$	116,265			$	3,140
Royalties			8,333				—
TOTAL NET REVENUE			124,598				3,140
COST OF SALES			113,024				2,710
GROSS PROFIT			11,574				430
OPERATING EXPENSES
General and administrative			811,916				762,668
Legal and accounting			344,903				475,948
Payroll expenses (a)			1,611,376				9,485,339
Research and development			10,590,271				655,840
Sales and marketing			218,443				261,804
Total operating expenses			13,576,909				11,641,599
(LOSS) BEFORE OTHER INCOME			13,565,335				(11,641,169	)
OTHER INCOME (EXPENSE)
Interest income			—				—
Interest expense			(199,364	)			(127,825	)
Loss on extinguishment of debt			(82,000	)			(1,221,875	)
Change in fair value of warrants			5,128,204				(604,209	)
Change in fair value of embedded derivative liability			800,000				200,000
Fair value of warrants in excess of consideration for convertible preferred stock			—				(2,995,791	)
			5,646,840				(4,749,700	)
LOSS BEFORE INCOME TAX BENEFIT			(7,918,495	)			(16,390,869	)
INCOME TAX BENEFIT			—				—
NET LOSS			(7,918,495	)			(16,390,869	)
Less: Deemed dividend distribution			—				(1,000,000	)
NET LOSS APPLICABLE TO COMMON STOCKHOLDERS		$	(7,918,495	)		$	(17,390,869	)
BASIC		$	(.03	)		$	(0.07	)
DILUTED		$	(.03	)		$	(0.07	)
WEIGHTED AVERAGE COMMON SHARES OUTSTANDING
BASIC			303,748,409				250,043,403
DILUTED			303,748,409				250,043,403

(a) - includes share based compensation of $860,235 for the year ended December 31, 2014 and $8,619,137 for the year ended December 31, 2013

The accompanying notes are an integral part to these financial statements.

 

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Statement of Changes in Stockholders’ Equity (Deficit)

For the Years Ended and 2014

 

		Convertible Preferred Stock								Common Stock								Additional Paid-In Capital								Deficit Accumulated During the
		Number of Shares				Amount				Number of Shares				Amount								Treasury Stock				Development Stage				Total
Balance at December 31, 2012			—			$	—				218,448,109			$	248,244			$	11,387,929			$	(113,389	)		$	(13,387,041	)		$	(1,864,257	)
Issuance of shares of preferred stock			33,333,333			$	1,000,000				—				—				—				—				—				1,000,000
Conversion of shares of preferred stock to common stock			(12,222,222	)		$	(366,667	)			12,222,222				12,222				354,445				—				—				—
Issuance of shares of common stock			—				—				4,811,111				4,811				230,189				—				—				235,000
Shares issued for conversion of notes payable and accrued interest			—				—				18,275,000				18,275				1,871,725				—				—				1,890,000
Exercise of options			—				—				3,335,000				3,335				14,584				—				—				17,919
Exercise of warrants			—				—				1,000,000				1,000				9,000				—				—				10,000
Fair value of employee stock options			—				—				—				—				8,619,136				—				—				8,619,136
Deemed dividend distribution			—				—				—				—				(1,000,000	)			—				—				(1,000,000	)
Exercise of warrants			—				—				6,000,000				6,000				53,999				—				—				59,999
			—				—				25,974,697				25,975				1,397,976				—				—				1,423,951
Net loss for the year ended June 30, 2013			—				—				—				—				—				—				(16,390,869	)			(16,390,869	)
Balance at December 31, 2013			21,111,111				633,333				290,066,139				319,862				22,938,983				(113,389	)			(29,777,910	)			(5,999,121	)
Issuance of shares of common stock for services			—				—				6,349,206				6,349				393,651				—				—				400,000
Cashless exercise of options			—				—				2,714,285				2,714				(2,714	)			—				—				0
Fair value of employee stock options			—				—				—				—				860,235				—				—				860,235
Issuance of shares of common stock for settlement of debt			—				—				8,448,519				8,449				498,139				—				—				506,588
Forgiveness of related party debt			—				—				—				—				25,000				—				—				25,000
Net loss for the year ended December 31, 2014			—				—				—				—				—				—				(7,918,495	)			(7,918,495	)
Balance at December 31, 2014			21,111,111			$	633,333				307,578,149			$	337,374			$	24,713,294			$	(113,389	)		$	(37,696,405	)		$	(12,125,793	)

The accompanying notes are an integral part to these financial statements.

 

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Statements of Cash Flows

For the Years Ended and 2014

 

		Year Ended December 31, 2014				Year Ended December 31, 2013
CASH FLOWS FROM OPERATING ACTIVITIES
Net loss			(7,918,495	)			(16,390,869	)
Adjustments to reconcile net loss to net cash used in operating activities
Fair value of options issued in exchange for services			860,235				8,619,137
Accretion of discount on notes payable			202,377				3,718
Change in fair value warrant liability			(5,128,204	)			604,209
Change in fair value of embedded derivative liability			(800,000	)			(200,000	)
Fair value of warrants in excess of consideration for convertible preferred stock			—				2,995,791
Fair value of stock in excess of converted notes payable and accrued interest			82,000				1,221,875
Amortization and depreciation			82,362				81,929
Stock and warrants issued in exchange for technology			5,736,089				—
(Increase) decrease in assets
Accounts receivable			3,573				(100	)
Inventory			(63,089	)			(14,291	)
Prepaid expenses			8,388				560,526
Deposits			—				(37,197	)
Increase (decrease) in liabilities
Accounts payable and accrued expenses			4,898,080				(233,497	)
Deferred revenue			16,667				—
Net cash used in operating activities		$	(2,020,017	)		$	(2,788,769	)
CASH FLOWS FROM INVESTING ACTIVITIES
Purchase of property and equipment			—				(10,573	)
Purchase of intangibles			—				(21,954	)
Net cash used in investing activities			—				(32,527	)
CASH FLOWS FROM FINANCING ACTIVITIES
Proceeds from issuance of preferred stock			—				1,000,000
Proceeds from issuance of common stock			—				235,000
Proceeds from exercise of stock options			—				17,919
Proceeds from exercise of warrants			—				10,000
Proceeds from issuance of notes payable			798,000				—
Repayments of notes payable			—				(150,000	)
Net cash provided by financing activities			798,000				1,112,919
NET DECREASE IN CASH AND CASH EQUIVALENTS			(1,222,017	)			(1,708,377	)
CASH AND CASH EQUIVALENTS - BEGINNING OF YEAR			1,285,973				2,994,350
CASH AND CASH EQUIVALENTS - END OF YEAR		$	63,956			$	1,285,973
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION
Cash paid during the year for:
Interest		$	—			$	13,895
Income taxes		$	—			$	—
SUPPLEMENTAL DISCLOSURE OF NON-CASH INVESTING AND FINANCING ACTIVITIES
Fair value of stock issued for conversion of notes payable and accrued interest		$	506,588			$	2,092,075
Fair value of stock issued for conversion of preferred stock to common stock		$	—			$	366,667
Accretion of discount on preferred stock as deemed dividend distribution		$	—			$	1,000,000
Fair value of beneficial conversion feature		$	—			$	1,500,000
Conversion of warrant in lieu of cash repayment of notes payable		$	—			$	60,000
Fair value of warrants issued as debt discount		$	211,576			$	—
Forgiveness of related party debt		$	25,000				—

The accompanying notes are an integral part to these financial statements.

 

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NOTE 1 – SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Nature of the Business

LaserLock Technologies, Inc. (the “Company”) was incorporated in the State of Nevada on November 10, 1999. The Company is based in Washington, D.C. and its common stock is traded on the OTCQB under the ticker symbol “LLTI”. A high-tech solutions company in the field of authenticating people and products, LaserLock offers state-of-the-art solutions to combat identity fraud and counterfeiting utilizing multi-factor authentication and a suite of security pigments for governments, health care providers, the gaming industry, the financial services industry and high-end retailers.

The Company invests in developing new proprietary color shifting inks that it believes will allow it to penetrate broader markets and result in increased revenues. The Company refines its technologies and their applications, and now has what it believes to be one of the most cost effective and efficient authentication technologies available. Its most recent technology takes advantage of the new ubiquitous energy efficient fluorescent lighting to change the color of ink, resulting in numerous potential new applications ranging from credit cards to drivers licenses, passports, stock certificates, clothing labels, currency, ID cards, and tax stamps. The technologies can also be used to protect DVDs, apparel, pharmaceuticals, and virtually any other physical product.

The Company’s digital solution is a multi-platform (iOS and Android) strong authentication solution that integrates biometrics and geo-location tagging. The solution completely eliminates passwords and the inherently weak security they provide. The solution also removes the user complexity associated with having to manage many complex passwords. The solution can be delivered either as a high availability cloud service, managed by the Company, or as licensed software product for operation on the client’s premises.

The solution integrates three independent authentication factors – something you have (for instance a smartphone), something you know (for instance a color gesture swipe) and something you are (for instance your facial geometry)—into a simple, fast, intuitive solution. The system can also accurately determine the precise location of the individual using a variety of mechanisms including GPS, cell tower triangulation, IP or WIFI address. Because the solution incorporates biometrics it completely eliminates the possibility that users might share their authentication credentials. The combination of biometrics and geolocation provides extremely strong transactional evidence, making it nearly impossible for an end-user to refute having been part of a transaction.

The Company’s activities are subject to significant risks and uncertainties, including the need to secure additional funding to operationalize the Company’s current technology.

Basis of Presentation

The accompanying financial statements are presented in accordance with accounting principles generally accepted in the United States of America.

Use of Estimates

The preparation of financial statements in conformity with accounting principles generally accepted in the United States requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from these estimates.

 

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Comprehensive Income

The Company follows Financial Accounting Standards Board Accounting Standards Codification (“FASB ASC”) 220 in reporting comprehensive income. Comprehensive income is a more inclusive financial reporting methodology that includes disclosure of certain financial information that historically has not been recognized in the calculation of net income. Since the Company has no items of other comprehensive income (loss), comprehensive income (loss) is equal to net income (loss).

Fair Value of Financial Instruments

The Company’s financial instruments consist of cash, accounts payable and accrued expenses and notes payable. The carrying value of cash, accounts payable and accrued expenses approximate their fair value because of their short maturities. The Company believes the carrying amount of its notes payable and convertible debt approximates its fair value based on rates and other terms currently available to the Company for similar debt instruments.

Cash and Cash Equivalents

For purposes of reporting cash flows, the Company considers all cash accounts, which are not subject to withdrawal restrictions or penalties, and certificates of deposit and commercial paper with original maturities of 90 days or less to be cash or cash equivalents.

Concentration of Credit Risk Involving Cash and Cash Equivalents

The Company’s cash and cash equivalents are held at two financial institutions. At times, the Company’s deposits may exceed Federal Deposit Insurance Corporation (FDIC) coverage limits. The Company has not experienced any losses from maintaining cash accounts in excess of federally insured limits.

Inventory

Inventory principally consists of penlights and pigments and is stated at the lower of cost (determined by the first-in, first-out method) or market.

Property and Equipment

Property and equipment is stated at cost. Depreciation is computed using the straight-line method over the estimated useful lives of the assets, principally five to seven years. Maintenance and repairs of property are charged to operations, and major improvements are capitalized. Upon retirement, sale, or other disposition of property and equipment, the costs and accumulated depreciation are eliminated from the accounts, and any resulting gain or loss is included in operations.

Patents and Trademark

The Company has filed eleven patent applications relating to the company technology. Currently we have 7 U.S. patents, 4 U.S. applications pending for allowance, and 5 foreign applications pending for allowance. The Company has also purchased a trademark. Costs associated with the registration and legal defense of the patents have been capitalized and are amortized on a straight-line basis over the estimated lives of the patents which were determined to be17 to 20 years.

 

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Long-Lived Assets

The Company evaluates the recoverability of its long-lived assets in accordance with ASC 360 “Property, Plant, and Equipment.” The Company reviews long-lived assets for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. Recoverability of long-lived assets are measured by a comparison of the carrying amount of an asset to future cash flows expected to be generated by the asset, undiscounted and without interest or independent appraisals. If such assets are considered to be impaired, the impairment to be recognized is measured by the amount by which the carrying amount of the asset exceeds the fair value of the assets.

Deferred Financing Costs

Costs incurred in securing long-term debt are deferred and amortized, as a charge to interest expense, over the term of the related debt. In the case of long-term debt modifications, the Company follows the guidance provided by ASC 470-50, “Debt – Modification and Extinguishments.”

Convertible Notes Payable

Convertible notes payable, for which the embedded conversion feature does not qualify for derivative treatment, are evaluated to determine if the effective or actual rate of conversion per the terms of the convertible note agreement is below market value. In these instances, the Company accounts for the value of the beneficial conversion feature (BCF) as a debt discount, which is then accreted to interest expense over the life of the related debt using the straight-line method which approximates the effective interest method.

Derivative Instruments

The Company evaluates its convertible debt, warrants or other contracts to determine if those contracts or embedded components of those contracts qualify as derivatives to be separately accounted for in accordance with Topic 480 of the FASB ASC and Topic 815 of the FASB Accounting Standards Codification. The result of this accounting treatment is that the fair value of the embedded derivative, if required to be bifurcated, is marked-to-market at each balance sheet date and recorded as a liability. The change in fair value is recorded in the Statement of Operations as a component of other income or expense. Upon conversion or exercise of a derivative instrument, the instrument is marked to fair value at the conversion date and then that fair value is reclassified to equity.

In circumstances where the embedded conversion option in a convertible instrument is required to be bifurcated and there are also other embedded derivative instruments in the convertible instrument that are required to be bifurcated, the bifurcated derivative instruments are accounted for as a single, compound derivative instrument.

The classification of derivative instruments, including whether such instruments should be recorded as liabilities or as equity, is re-assessed at the end of each reporting period. Equity instruments that are initially classified as equity that become subject to reclassification are reclassified to liability at the fair value of the instrument on the reclassification date. Derivative instrument liabilities will be classified in the balance sheet as current or non-current based on whether net-cash settlement of the derivative instrument is expected within 12 months of the balance sheet date.

Revenue Recognition

In accordance with Securities and Exchange Commission (“SEC”) Staff Accounting Bulletin (“SAB”) No. 104, Revenue Recognition (Codified in FASB ASC 605), the Company recognizes revenue when (i) persuasive evidence of a customer or distributor arrangement exists, (ii) a retailer, distributor or wholesaler receives the goods and acceptance occurs, (iii) the price is fixed or determinable, and (iv) collectability of the revenue is reasonably assured. Subject to these criteria, the Company recognizes revenue from product sales, consisting mainly of pigments and penlights, upon shipment to the customer. Royalty revenue is recognized upon receipt of notification from a customer that the Company’s product has been used in the customer’s production process.

Income Taxes

The Company follows FASB ASC 740 when accounting for income taxes, which requires an asset and liability approach to financial accounting and reporting for income taxes. Deferred income tax assets and liabilities are computed annually for temporary differences between the financial statements and tax bases of assets and liabilities that will result in taxable or deductible amounts in the future based on

 

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enacted tax laws and rates applicable to the periods in which the differences are expected to affect taxable income. Valuation allowances are established when necessary to reduce deferred tax assets to the amount expected to be realized. Income tax expense is the tax payable or refundable for the period plus or minus the change during the period in deferred tax assets and liabilities. Tax years from 2011 through 2013 remain subject to examination by major tax jurisdictions.

Stock-based Payments

The Company accounts for stock-based compensation under the provisions of ASC 718, Compensation—Stock Compensation (“ASC 718”), which requires the measurement and recognition of compensation expense for all stock-based awards made to employees and directors based on estimated fair values on the grant date. The Company estimates the fair value of stock-based awards on the date of grant using the Black-Scholes model. The value of the portion of the award that is ultimately expected to vest is recognized as expense over the requisite service periods using the straight-line method.

The Company accounts for stock-based compensation awards to non-employees in accordance with ASC 505-50, Equity-Based Payments to Non-Employees (“ASC 505-50”). Under ASC 505-50, the Company determines the fair value of the warrants or stock-based compensation awards granted as either the fair value of the consideration received or the fair value of the equity instruments issued, whichever is more reliably measurable.

All issuances of stock options or other equity instruments to non-employees as consideration for goods or services received by the Company are accounted for based on the fair value of the equity instruments issued. Any stock options issued to non-employees are recorded as an expense and additional paid-in capital in stockholders’ equity over the applicable service periods.

Advertising Costs

Advertising costs are expensed as incurred. Advertising costs were approximately $62,835 and $53,979 for the years ended December 31, 2014 and 2013 and are included in sales and marketing expenses.

Research and Development Costs

In accordance with FASB ASC 730, research and development costs are expensed when incurred. Research and development costs for the years ended December 31, 2014 and 2013 were $10,590,271 and $655,840.

Basic and Diluted Net Income per Share of Common Stock

The Company follows FASB ASC 260 when reporting Earnings Per Share resulting in the presentation of basic and diluted earnings per share. Since the Company reported a net loss for years ended December 31, 2014 and 2013, common stock equivalents, including convertible preferred stock, convertible debt, stock options and warrants were anti-dilutive; therefore, the amounts reported for basic and dilutive loss per share during the years were the same.

 

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Segment Information

The Company is organized and operates as one operating segment wherein the Company’s patented technologies are utilized to address counterfeiting issues. In accordance with ASC 280, Segment Reporting, the chief operating decision-maker has been identified as the Chief Executive Officer, who reviews operating results to make decisions about allocating resources and assessing performance for the entire Company. Since the Company operates in one segment and provides one group of similar products, all financial segment and product line information required by ASC 280 can be found in the consolidated financial statements.

Recently Adopted Accounting Pronouncements

In June 2014, the FASB issued Accounting Standards Update No. 2014-10, Development State Entities (Topic 915), Elimination of Certain Financial Reporting Requirements, Including an Amendment to Variable Interest Entities Guidance in Topic 810, Consolidation. The amendments in this update remove

 

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the definition of a development stage entity from the Master Glossary of the Accounting Standard Codification, thereby removing the financial reporting distinction that previously required development stage entities to (1) present inception-to-date information in the statements of income, cash flow, and stockholder equity, (2) label the financial statements as those of a development stage entity, (3) disclose a description of the development stage activities in which the entity is engaged, and (4) disclose the first year in which the entity is no longer a development stage entity that in prior years it had been in the development stage.

The amendments also clarify that the guidance in Topic 275, Risks and Uncertainties, is applicable to entities that have not commenced planned principle operations.

The amendments related to the elimination of inception-to-date information and the other remaining disclosure requirements of Topic 915 should be applied retrospectively except for the clarification to Topic 275, which must be applied prospectively. For public business entities, those amendments are effective for annual reporting periods beginning after December 15, 2014, and interim periods therein.

For public business entities, the amendment eliminating the exception to the sufficiency-of-equity-at-risk criterion for development stage entities in paragraph 810-10-15-16 should be applied retrospectively for annual reporting periods beginning after December 15, 2015, and interim periods therein.

Early application of each of the amendments is permitted for any annual reporting period or interim period for which the entity’s financial statements have not yet been issued (public business entities) or made available for issuance (other entities). Upon adoption entities will no longer present or disclose any information required by Topic 915.

The Company adopted the amendment retrospectively commencing with the interim period ending June 30, 2014.

Recently Issued Accounting Pronouncements Not Yet Adopted

In August 2014, the FASB issued ASU 2014-15, Presentation of Financial Statements – Going Concern (Subtopic 205-40), Disclosure of Uncertainties about an Entity’s Ability to Continue as a Going Concern. The amendments in this Update provide guidance about management’s responsibility to evaluate whether there are conditions or events, considered in the aggregate, that raise substantial doubt about the entity’s ability to continue as a going concern within one year after the date that the financial statements are issued and to provide related footnote disclosures. Substantial doubt about an entity’s ability to continue as a going concern exists when relevant conditions and events, considered in the aggregate, indicate that it is probable that the entity will be unable to meet its obligations as they become due within one year after the date that the financial statements are issued. The amendments in this Update are effective for the annual period ending after December 15, 2016, and for annual periods and interim periods thereafter. The Company is currently evaluating the potential impact of this standard.

 

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Reclassifications

Certain amounts in the 2013 statement of operations have been reclassified in order for them to conform with the 2014 presentation.

NOTE 2 – MANAGEMENT PLANS

The accompanying consolidated financial statements have been prepared assuming that the Company will continue as a going concern. The Company has incurred significant losses and experienced negative cash flow from operations. These conditions raise substantial doubt about the Company’s ability to continue as a going concern. The financial statements do not include any adjustments that might result from the outcome of this uncertainty.

The Company does not believe that its existing cash resources will not be sufficient to sustain operations during the next twelve months. The Company currently needs to generate revenue in order to sustain its operations. In the event that the Company cannot generate sufficient revenue to sustain its operations, the Company will need to reduce expenses or obtain financing through the sale of debt and/or equity securities. The issuance of additional equity would result in dilution to existing stockholders. If the Company is unable to obtain additional funds when they are needed or if such funds cannot be obtained on terms acceptable to the Company, the Company may be unable to execute upon the business plan or pay costs and expenses as they are incurred, which could have a material, adverse effect on the business, financial condition and results of operations.

If sufficient revenues are not generated to sustain operations or additional funding cannot be obtained in the short term, the Company will need to reduce monthly expenditures to a level that will enable the Company to continue until such funds can be obtained.

Successful completion of the Company’s development program, and the attainment of profitable operations are dependent upon future events, including obtaining adequate financing to fulfill its development activities and achieving a level of sales adequate to support the Company’s cost structure. However, there can be no assurances that the Company will be able to secure additional equity investment or achieve an adequate sales level.

 

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NOTE 3 – PROPERTY AND EQUIPMENT

Equipment consists of the following:

 

		December 31,				December 31,
		2014				2013
Furniture and Fixtures		$	219,871			$	219,871
Equipment			16,155				16,155
			236,026				236,026
Less: Accumulated depreciation			161,205				91,952
		$	74,821			$	144,074

Depreciation of property and equipment was $69,253 and $68,839, respectively, for the years ended December 31, 2014 and 2013.

NOTE 4 – PATENTS AND TRADEMARK

The Company has seven issued patents, four U.S. applications pending, and five foreign applications pending for allowance. Accordingly, costs associated with the registration of these patents and legal defense have been capitalized and are amortized on a straight-line basis over the estimated lives of the patents (17 to 20 years). During the years ended December 31, 2014 and 2013, the Company capitalized $0 and $21,954 of patent costs.

 

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NOTE 5 – INCOME TAXES

The Company follows FASB ASC 740-10-10 whereby an entity recognizes deferred tax assets and liabilities for future tax consequences or events that have been previously recognized in the Company’s financial statements or tax returns. The measurement of deferred tax assets and liabilities is based on provisions of enacted tax law. The effects of future changes in tax laws or rates are not anticipated.

At December 31, 2014 the Company has a net operating loss (“NOL”) that approximates $26.0 million. Consequently, the Company may have NOL carryforwards available for federal income tax purposes, which would begin to expire in 2019. Due to changes in ownership, a portion of the NOL carryforward may be subject to certain annual limitations imposed under Section 382 of the Internal Revenue Code. Deferred tax assets would arise from the recognition of anticipated utilization of these net operating losses to offset future taxable income.

The income tax benefit (provision) consists of the following:

 

		Year Ended				Year Ended
		December 31,				December 31,
		2014				2013
Current		($	5,505,000	)		$	1,837,000
Deferred			(372,000	)			3,284,000
Change in valuation allowance			5,877,000				(5,121,000	)
		$	—			$	—

The following is a reconciliation of the tax derived by applying the U.S. Federal Statutory Rate of 35% to the earnings before income taxes and comparing that to the recorded tax provisions:

 

		2014								2013
		Amount				%				Amount				%
U.S federal income tax benefit at federal statutory rate		$	(2,771,000	)			(35	)		$	(5,718,000	)			(35	)
State tax, net of federal tax effect			(463,000	)			(6	)			(956,000	)			(6	)
			—				—				—				—
Deductible share based compensation			—				—				(318,000	)			(2	)
Non-deductible changes in derviative liability and share based transactions			(2,639,000	)			(33	)			1,895,000				12
Other			(4,000	)			—				(24,000	)
Change in valuation allowance			5,877,000				74				5,121,000				31
		$	—				—			$	—				—

The primary components of the Company’s December 31, 2014 and 2013 deferred tax assets, liabilities and related valuation allowance are as follows:

 

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		December 31,				December 31,
		2014				2013
Deferred tax asset for NOL carryforwards		$	10,649,000			$	5,144,000
Deferred tax liability for intangibles			(165,000	)			(165,000	)
Share based compensation			4,205,000				3,683,000
Non deductible accrued expenses			—				150,000
Valuation allowance			(14,689,000	)			(8,812,000	)
		$	—			$	—

Management has determined that the realization of the net deferred tax asset is not assured and has created a valuation allowance for the entire amount of such benefits.

The Company follows FASB ASC 740-10, which provides guidance for the recognition and measurement of certain tax positions in an enterprise’s financial statements. Recognition involves a determination whether it is more likely than not that a tax position will be sustained upon examination with the presumption that the tax position will be examined by the appropriate taxing authority having full knowledge of all relevant information.

The Company’s policy is to record interest and penalties associated with unrecognized tax benefits as additional income taxes in the consolidated statement of operations. As of December 31, 2014 and 2013, the Company had no unrecognized tax benefits. There were no changes in the Company’s unrecognized tax benefits during the years ended December 31, 2014 and 2013. The Company did not recognize any interest or penalties during 2014 and 2013 related to unrecognized tax benefits.

 

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NOTE 6 – SENIOR SECURED CONVERTIBLE NOTES PAYABLE – RELATED PARTIES

In February 2006, the Company commenced a private placement of up to $800,000 principal amount of 10% senior secured convertible promissory notes due twelve months from the date of issue to certain Company shareholders and other accredited investors. As of December 31, 2006, the Company completed this private placement by selling all notes payable totaling $800,000. The notes are secured by a first priority lien on all of the tangible and intangible personal property of the Company. In May 2007, the due date of these notes was extended to August 2008 and the interest rate increased to 12% per annum during the extension period. In June 2011, the interest rate on all of the notes was reset to 10% and $596,500 of the notes and accrued interest was extended until September 15, 2015. During the fourth quarter of 2012 the remaining $178,749 of unextended notes and the associated accrued interest were extended to September 30, 2015. In June 2013, $225,000 of these notes payable plus accrued interest of $181,125 were converted into 7.4 million shares of the Company’s common stock, which was valued at $1,628,000. The excess of the fair value of the Company’s common stock over the value of the notes payable and accrued interest was recorded as loss on extinguishment of debt in accordance with FASB ASC 470-50.

During the fourth quarter of 2013, $220,000 of senior convertible notes plus accrued interest of $395,000, were converted into 7,900,000 shares of common stock. Since this transaction was with related parties, the conversion was treated as a capital transaction in accordance with FASB ASC 470-50-40-3.

As of December 31, 2014 and December 31, 2013, the outstanding principal balance on these notes was $114,000 and $330,249. Accrued interest at December 30, 2014 and December 31, 2013 amounted to $112,885 and $300,677.

During the second quarter of 2014, $216,249 of principal of the Company’s outstanding senior convertible notes held by a significant shareholder of the Company, plus accrued interest of $208,339, were converted into 8,448,519 shares of common stock. The excess of the fair value of the Company’s common stock over the value of the notes payable and accrued interest, $82,000, was recorded as loss on extinguishment of debt in accordance with FASB ASC 470-50.

As of December 31, 2014, the outstanding principal balance on these notes was $114,000. Accrued interest at December 31, 2014 amounted to $112,885.

If an equity financing with total proceeds of more than $5,000,000 occurs while any of these notes are outstanding, holders of notes will have the right, at their option, to convert the outstanding principal and interest of the notes into shares of common stock at a discount of 30% of the price per share in the qualified financing. Since the embedded conversion feature is contingent upon the occurrence of the qualified financing, the value of the contingent conversion feature, if beneficial, will be recognized if the triggering event occurs and the contingency is resolved.

NOTE 7 – CONVERTIBLE NOTES PAYABLE

During 2007, the Company commenced a private placement of up to $400,000 principal amount of 10% Convertible Promissory Notes originally due in August 2008 (the “Notes”). The Company raised $375,000 under this private placement in 2007 and the remaining $25,000 was raised in 2008. Previously $260,000 of the Notes were converted into shares of the Company’s common stock. Holders of Notes will have the right, at their option, to convert the outstanding principal and interest of the Notes into shares of the Company’s Series A Preferred Stock at any time and from time to time at the option of the holder at the initial conversion price of $0.005333 per share. It is the intention, however, that the option holder will convert the Notes into shares of the Company’s common stock. The Notes are unsecured.

In accordance with ASC 470, a beneficial conversion feature of $375,000 and $25,000 was required to be recorded in 2007 and 2008, respectively, since the fair value of the Company’s common stock at the date of issuance ($0.016 per share) was greater than the conversion price of $0.005333 per share. The value of the beneficial conversion feature was recorded to additional paid-in capital with the offset to discount on notes payable. The debt discount was accreted to interest expense over the one-year original term of the notes.

In August 2009, noteholders exercised their option to convert $260,000 of the notes payable plus accrued interest into 48,750,000 shares of common stock. The noteholder of the remaining $140,000 under this convertible note issue agreed to extend the maturity date of these notes to September 30, 2015 at an interest rate of 10% per annum. Additionally, the noteholder agreed in writing to suspend its right to convert its note until such as the Company’s authorized shares have been increased. Remaining shares to be potentially issued under this convertible note issue is 26,250,000.

On March 19, 2013, the investor holding $140,000 of convertible notes transferred $14,000 of the $140,000 convertible notes to the Vice Chairman of the Company. Also on March 19, 2013, the investor agreed to convert $28,000 of the investor’s remaining $126,000 of convertible notes into 5,250,000 shares of the Company’s common stock.

On March 19, 2013, the Vice Chairman of the Company agreed to convert $14,000 of convertible notes into 2,625,000 of the Company’s common stock.

During the fourth quarter of 2013, the remaining $98,000 of convertible notes plus accrued interest of $87,150 were converted into 12,375,000 shares of common stock. Since this conversion was with a related party it was treated as a capital transaction in accordance with FASB ASC 470-50-40-3.

NOTE 8 – NOTES PAYABLE

During the fourth quarter of 2013, all of the $561,000 of unsecured notes payable, less 9,914 of unamortized discount, plus accrued interest of $83,715 was converted into 4,473,333 shares of common stock plus a cash repayment of $150,000. Since this conversion was with a related party it was treated as a capital transaction in accordance with FASB ASC 470-50-40-3.

Private Placement of 8% Series A Notes Payable

In August 2009, the Company commenced a private placement of up to $300,000 consisting of up to 6 units. Each unit consists of a $50,000, 8% Series A Note Payable, due September 30, 2011, and a non-detachable warrant to purchase 2 million shares of the Company’s common stock. During 2009, the Company sold 4 units, issued $200,000 of 8% Series A Notes Payable, issued 8 million warrants, and raised $180,000, net of commission of $20,000. In January 2010, the Company sold .5 units, issued $25,000 of 8% Series A Notes Payable, issued 1 million warrants, and raised $17,500 net of commissions of $7,500. The commissions were treated as deferred finance charges and fully expensed over the term of notes payable.

The 8 million warrants in 2009 were valued at $15,450, fair value, using the Black-Scholes option pricing model to calculate the fair-value of the warrants, with the following assumptions: no dividend yield, expected volatility of between 30.9% and 34.5%, risk free interest rate between .95% and 1.06% and warrant life of approximately 2 years. The 1 million warrants in 2010 were valued at $20,143, fair value, using the Black-Scholes option pricing model to calculate the fair-value of the warrants, with the following assumptions: no dividend yield, expected volatility of 28.6 %, risk free interest rate of .84% and warrant life of approximately 2 years.

In June 2011, the maturity date on the $150,000 of the 8% Series A Notes Payable and the term on the associated 6 million warrants were extended to September 30, 2015. As a result, the warrants were revalued using the Black-Scholes option pricing model to calculate the incremental fair-value of the warrants of $21,275, with the following assumptions: no dividend yield, expected volatility of 60%, risk free interest rate of 1.52% and warrant life of approximately 1.25 years. As part of the debt extension, the lender holding the 6 million warrants agreed in writing to suspend its right to exercise these warrants until such time that the Company’s authorized shares have been increased. The authorized shares of the Company’s common stock were increased on May 23, 2013 from 425,000,000 to 675,000,000.

The relative fair value of the warrants issued in conjunction with the 8% Series A Notes Payable have been treated as a debt discount with an offsetting credit to additional paid-in capital. The debt discount related to the warrant issuances is being accreted to interest expense over the term of the notes. When the warrants were revalued the incremental amount of $21,275 was also treated as additional debt discount and is being accreted over the new term of the 8% Series A Notes Payable. As of December 31, 2012 the unaccreted debt discount related to warrants issued in conjunction with the 8% Series A Notes payable was $13,632.

During the third quarter of 2011, $25,000 plus accrued interest of the 8% Series A Notes Payable were repaid and 3 million of the associated warrants expired unexercised.

During the fourth quarter of 2013, the remaining series A notes payable of $150,000 was reduced by $60,000 for the exercise of 6,000,000 warrants into 6,000,000 shares of common stock. The balance of $90,000 plus accrued interest of $49,000 was converted into 1,226,363 shares of common stock. Since this conversion was with a related party it was treated as a capital transaction in accordance with FASB ASC 470-50-40-3.

Private Placement of 25% Notes Payable

In 2010, the Company issued $400,000 in notes payable in order to finance a patent infringement lawsuit (see Note 15 - Contingencies to these consolidated financial statements). The notes payable accrue interest at 25% per annum and mature upon the earlier of September 1, 2013 or the date on which the Company receives net proceeds from the patent infringement claim. In addition to the base interest of 25% per annum, the lenders are entitled to Bonus Interest equal to the following:

 

a.

First monies realized by the Company from its share of the net proceeds of the lawsuit shall be allocated and paid to the Lender until the principal and base interest accruing has been fully paid.

 

b.

The next monies from the net proceeds of the litigation settlement will be paid to the Company to reimburse for out-of-pocket legal costs related to the lawsuit.

 

c.

The next $825,000 of proceeds will be split 50%/50% between the Company and the Lenders.

 

d.

The next $1 million realized by the Company shall be allocated 90% to the Company and 10% to the Lenders.

 

e.

The next $1 million realized by Company shall be allocated 85% to Company and 15% to Lenders.

 

f.

All remaining proceeds realized by Company shall be allocated 80% to Company and 20% to Lenders.

The Lenders have a security interest in the Company’s patent infringement claim in which the Lender has the right to the net proceeds of this lawsuit to satisfy outstanding principal and interest under the notes.

As part of the private placement of the 25% notes payable, the Company incurred debt placement fees of $34,500 in 2010. These debt placement fees have been treated as deferred finance charges and were being amortized to interest expense over two years. The remainder of amortization $13,625 was recorded the years ended December 31, 2012.

In December 2012, 250,000 of these notes payable and accrued interest of $122,397 were converted into 8,219,911 shares of the Company’s common stock. In March 2013, the remaining $150,000 of the notes payable and accrued interest of $70,000 were converted into 3 million shares of the Company’s common stock. Accrued interest of $13,895 was paid in cash.

Notes payable consists of the following as of December 31:

		December 31, 2014				December 31, 2013
Unsecured notes payable due to related parties; interest at 10% per annum; principal and accrued interest due at maturity in September 2015		$	114,000			$	330,249
Series A notes payable; interest at 8% per annum; principal and accrued interest due at maturity in October 2011 (past due)			50,000				50,000
Notes payable; interest at 8% per annum; principal and accrued interest due at December 1, 2014 (past due)			650,000				—
Notes payable, interest at 5% and 8% per annum; principal and interest due April 2015			123,000				—
Less: Debt discount			(10,447	)			—
			926,553				380,249
Less: Current portion			926,553				50,000
Long-term portion		$	—			$	330,249

At December 31, 2014 and 2013 accrued interest on notes payable was $155,992 and $317,344.

The notes payable balance as of December 31, 2014 includes a Series A note payable in the amount of $50,000 with interest of 8% per annum. This note matured in October 2011 and is past due. Accrued interest associated with this note was $20,667 as of December 31, 2014. The Company has been unable to locate this shareholder.

On June 10, 2014, the Company issued a note payable for $250,000, which included fully vested warrants to purchase 1,000,000 shares of the Company’s common stock at an exercise price of $0.10 per share, expiring in five years. The warrants were valued at $39,650 using Black-Scholes option pricing model to calculate the grant-date fair value of the warrants, with the following assumptions: no dividend yield, expected volatility of 248.2%, risk free interest rate of 1.67% and expected life of 5 years. The relative fair value of the warrants was $34,222 and was recorded as a discount to the notes payable in accordance with FASB ASC 835-30-25, Recognition, and is being accreted over the term of the note payable for financial statement purposes. For the year ended December 31, 2014, $34,222 was accreted through interest expense. The note and accrued interest at 8% per annum was originally due on December 11, 2014, but the Company received approval to extend the maturity until December 31, 2014. As of December 31, 2014 the note is in default. The warrants are subject to anti-dilutive adjustments and are therefore classified as a liability in accordance with FASB ASC 815. The warrant liability is re-valued at each reporting period with the change in fair value recorded through earnings. As of December 31, 2014, the fair value of the warrant liability was $17,741 and the note payable balance was $250,000. This note is in default.

 

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On August 5, 2014, the Company issued notes payable for $100,000, which included fully vested warrants to purchase 600,000 shares of the Company’s common stock at an exercise price of $0.05 per share, expiring in five years. The warrants were valued at $29,725 using Black-Scholes option pricing model to calculate the grant-date fair value of the warrants, with the following assumptions: no dividend yield, expected volatility of 233.8%, risk free interest rate of 1.67% and expected life of 5 years. The relative fair value of the warrants was $22,914 and was recorded as a discount to the notes payable in accordance with FASB ASC 835-30-25, Recognition, and is being accreted over the term of the note payable for financial statement purposes. For the year ended December 31, 2014, $22,914 was accreted through interest expense. The note and accrued interest at 8% per annum were due in full on December 1, 2014. As of December 31, 2014 the note is in default. The warrants are subject to anti-dilutive adjustments and are therefore classified as a liability in accordance with FASB ASC 815. The warrant liability is re-valued at each reporting period with the change in fair value recorded through earnings. As of December 31, 2014, the fair value of the warrant liability was $11,178 and the note payable balance was $100,000. This note is in default.

On August 12, 2014, the Company issued notes payable for $50,000, which included fully vested warrants to purchase 300,000 shares of the Company’s common stock at an exercise price of $0.05 per share, expiring in five years. The warrants were valued at $26,817 using Black-Scholes option pricing model to calculate the grant-date fair value of the warrants, with the following assumptions: no dividend yield, expected volatility of 233.8%, risk free interest rate of 1.67% and expected life of 5 years. The relative fair value of the warrants was $17,455 and was recorded as a discount to the notes payable in accordance with FASB ASC 835-30-25, Recognition, and is being accreted over the term of the note payable for financial statement purposes. For the year ended December 31, 2014, $17,455 was accreted through interest expense. The note and accrued interest at 8% per annum were due in full on December 1, 2014. As of December 31, 2014 the note is in default. The warrants are subject to anti-dilutive adjustments and are therefore classified as a liability in accordance with FASB ASC 815. The warrant liability is re-valued at each reporting period with the change in fair value recorded through earnings. As of December 31, 2014, the fair value of the warrant liability was $5,585 and the note payable balance was $50,000. This note is in default.

On August 14, 2014, the Company issued notes payable for $100,000, which included fully vested warrants to purchase 600,000 shares of the Company’s common stock at an exercise price of $0.05 per share, expiring in five years. The warrants were valued at $47,676 using Black-Scholes option pricing model to calculate the grant-date fair value of the warrants, with the following assumptions: no dividend yield, expected volatility of 233.8%, risk free interest rate of 1.67% and expected life of 5 years. The relative fair value of the warrants was $32,274 and was recorded as a discount to the notes payable in accordance with FASB ASC 835-30-25, Recognition, and is being accreted over the term of the note payable for financial statement purposes. For the year ended December 31, 2014, $32,274 was accreted through interest expense. The note and accrued interest at 8% per annum were due in full on December 1, 2014. As of December 31, 2014 the note is in default. The warrants are subject to anti-dilutive adjustments and are therefore classified as a liability in accordance with FASB ASC 815. The warrant liability is re-valued at each reporting period with the change in fair value recorded through earnings. As of December 31, 2014, the fair value of the warrant liability was $11,226 and the note payable balance was $100,000. This note is in default.

 

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On September 8, 2014, the Company issued notes payable for $150,000, which included fully vested warrants to purchase 900,000 shares of the Company’s common stock at an exercise price of $0.05 per share, expiring in five years. The warrants were valued at $62,544 using Black-Scholes option pricing model to calculate the grant-date fair value of the warrants, with the following assumptions: no dividend yield, expected volatility of 233.8%, risk free interest rate of 1.67% and expected life of 5 years. The relative fair value of the warrants was $44,140 and was recorded as a discount to the notes payable in accordance with FASB ASC 835-30-25, Recognition, and is being accreted over the term of the note payable for financial statement purposes. For the year ended December 31, 2014, $44,140 was accreted through interest expense. The note and accrued interest at 8% per annum were due in full on December 1, 2014. As of December 31, 2014 the notes are in default. The warrants are subject to anti-dilutive adjustments and are therefore classified as a liability in accordance with FASB ASC 815. The warrant liability is re-valued at each reporting period with the change in fair value recorded through earnings. As of December 31, 2014, the fair value of the warrant liability was $17,385 and the note payable balance was $150,000. This note is in default.

On December 5, 2014, the Company issued a note payable for $23,000 to a stockholder, which bears interest at 5.0% and is due on April 5, 2015. This note is in default.

On December 31, 2014, the Company issued a note payable for $100,000, which include fully vested warrants to purchase 600,000 shares of the Company’s common stock at an exercise price of $0.05 per share expiring in five years. The warrants were valued at $11,812 using the Black-Scholes option pricing model to calculate the grant-date fair value of the warrants, with the following assumptions: no dividend yield, expected volatility of 229.0%, risk free interest rate of 1.68% and expected life of 5 years. The relative fair value of the warrants was $10,563 and was recorded as a discount to the notes payable in accordance with FASB ASC 835-30-25, Recognition, and is being accreted over the term of the note payable for financial statement purposes. For the year ended December 31, 2014, $116 was accreted through interest expense. The note and accrued interest at 8% per annum were due in full on April 1, 2015. This note is currently in default. The warrants are subject to anti-dilution adjustments and are therefore classified as a liability in accordance with FASB ASC 815. The warrant liability is revalued at each reporting period with the change in fair value recorded through earnings. As of December 31, 2014, the fair value of the warrant liability was $11,812 and the note payable balance was $89,553, net of a discount of $10,447. This note is in default.

 

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NOTE 9 – WARRANT LIABILITY

On December 31, 2012, the Company entered into an Investment Agreement, a Technology and Service Agreement, a Patent and Technology License Agreement and an Asset Purchase Agreement with VerifyMe, and on the same date entered into a Technology and Service Agreement with Zaah Technologies, Inc. (collectively with the VerifyMe agreements, the “Agreements”). Contemplated by those Agreements were warrants issuances by the Company for the purchase of the Company’s common stock.

The warrants associated with these Agreements are subject to anti-dilution adjustments outlined in the Agreements. In accordance with FASB ASC 815, the warrants were classified as a liability in the total amount of $2.4 million at December 31, 2012. In addition, the warrants must be valued every reporting period and adjusted to market with the increase or decrease being adjusted through earnings. As of December 31, 2014 and December 31, 2013, the fair value of the warrant liability was $787,544 and $3,700,000.

On January 1, 2014, the Company issued warrants to purchase 6,349,206 shares of the Company’s common stock as consideration for technology received from VerifyMe under to the Patent and Technology License Agreement dated December 31, 2012. The warrants are exercisable at $0.10 per share. The warrants are subject to anti-dilution adjustments outlined in the Agreement. In accordance with FASB ASC 815, the warrants were classified as a liability with an initial fair value of $444,000, which was immediately expensed as research and development costs. In addition, the warrants must be valued every reporting period and adjusted to market with the increase or decrease being adjusted through earnings. As of December 31, 2014, the fair value of the warrant liability was $121,209.

The Company made the payment of warrants to VerifyMe on a good faith basis, based on the assumption that the technology conveyed to the Company would be patentable and licensable. The Company has not reached a conclusion that the technology will be patentable and licensable, and can provide no assurance to this effect.

Should the Company ultimately conclude that the technology received from VerifyMe is patentable and licensable, the Company would be required to make, on January 1, 2015, an additional payment pursuant to Patent and Technology Agreement in the amount of $4,500,000, to be paid by issuing (i) a number of shares of common stock equal to (x) $4,500,000 divided by (y) a price which equals a 10% discount to the market price at the time of issuance and (ii) warrants to purchase an equal number of shares of common stock exercisable at a price of $0.10 per share. Based upon the current share price of $0.04 per share, this would result in the issuance of approximately an additional 125 million shares of common stock and warrants to purchase an additional 125 million shares. The $4,500,000 was accrued at December 31, 2014. The number of warrants to be issued based on a stock price of $0.02 at December 31, 2014 was 250 million warrants. The warrants were valued at $4,892,089 using the Black-Scholes pricing model to calculate the grant-date fair value of the warrants with the following assumptions: no dividend yield, expected volatility of 229.1%, risk free interest rate of 1.65% and expected life of five years.

NOTE 10 – CONVERTIBLE PREFERRED STOCK

Subscription Agreement

The Company entered into a Subscription Agreement with VerifyMe on January 31, 2013 (the “Subscription Agreement”). Under the terms of the Subscription Agreement, VerifyMe subscribed to purchase 33,333,333 shares of the Company’s Series A preferred stock (the “Preferred Stock”) and a warrant to purchase 33,333,333 shares of the Company’s common stock at an exercise price of $0.12 per share, for $1 million.

 

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At any time before January 31, 2015, VerifyMe has the right, but not the obligation, to require the Company to repurchase all, but not less than all, of the capital stock of the Company and warrants exercisable for capital stock of the Company held by VerifyMe in exchange for the price originally paid by VerifyMe therefor upon the occurrence of any of the following events:(i) the consummation of any bona fide business acquisition, (ii) the incurrence of any indebtedness by the Company in an amount in excess of $2 million, (iii) the issuance or sale of any security having a preference on liquidation senior to common stock, or (iv) the sale by the Company of capital stock or warrants exercisable for its capital stock at a price below $0.03 per share. This right has not been exercised.

In accordance with FASB ASC 480 and 815, the Preferred Stock has been classified as permanent equity and was valued at $1 million at January 31, 2013.

The conversion feature of the Preferred Stock is an embedded derivative, which is classified as a liability in accordance with FASB ASC 815 and was valued in accordance with FASB ASC 470 as a beneficial conversion feature at a fair value of $1 million at January 31, 2013, $0 at December 31, 2014 and $800,000 at December 31, 2013. This was classified as an embedded derivative liability and a discount to Preferred Stock. Because the Preferred Stock can be converted at any time, the full amount of the original fair value was accreted and classified as a reduction to the discount on Preferred Stock and a deemed dividend distribution in the full amount of $1 million, in 2013.

The warrants associated with the Preferred Stock were also classified as a liability since they are subject to anti-dilutive adjustments outlined in the warrant agreement and valued at a fair market value of $2,995,791 at January 31, 2013. Because this amount was entirely in excess of the transaction price, this amount was recorded as a charge to expenses of $2,995,791 in 2013. In addition, the warrants must be valued every reporting period and adjusted to market with the increase or decrease being adjusted through earnings. As of December 31, 2014 and December 31, 2013, the fair value of the warrants was $494,939 and $2,300,000, respectively.

The Preferred Stock has a preference in liquidation that the holders of the Preferred Stock are to be paid out of assets available for distribution prior to holders of common stock. The Preferred Stockholders may cast the number of votes equal to the number of whole shares of common stock into which the shares of Preferred Stock can be converted. In addition, the Preferred Stockholders are to be paid dividends, based on the number of shares of Preferred Stock as if the shares had been converted to common shares, prior to the common stockholders receiving a dividend.

The conversion price of the shares of Preferred Stock is currently $0.03 per share.

In August 2013, VerifyMe elected to convert in a cashless transaction an equal number of shares of Preferred Stock valued at $366,667 to 12,222,222 shares of common stock.

 

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NOTE 11 – FAIR VALUE OF FINANCIAL INSTRUMENTS

Derivative Liabilities

For purposes of determining whether certain instruments are derivatives for accounting treatment, the Company follows the accounting standard that provides guidance for determining whether an equity-linked financial instrument, or embedded feature, is indexed to an entity’s own stock. The standard applies to any freestanding financial instruments or embedded features that have the characteristics of a derivative, and to any freestanding financial instruments that are potentially settled in an entity’s own common stock.

Liabilities measured at fair value on a recurring basis are summarized as follows:

 

		Level 1				Level 2				Level 3				Total
Derivative liability related to fair value of beneficial conversion feature		$	—			$	—			$	—			$	—
Derivative liability related to fair value of warrants			—				—				6,370,709				6,370,709
Total		$	—			$	—			$	6,370,709			$	6,370,709

The following table details the approximate fair value measurements within the fair value hierarchy of the Company’s derivative liabilities using Level 3 inputs:

 

		Total
Balance at January 1, 2014		$	6,000,000
Additional Warrants issued January 2014			444,000
Additional Warrants issued June 2014			34,222
Additional Warrants issued 3rd Quarter 2014			166,791
Additional Warrants Issued 4th Quarter 2014			4,903,900
Change in fair value of derivative liabilities			(5,178,204	)
Balance at December 31, 2014		$	6,370,709

As of December 31, 2014, the beneficial conversion feature of the Preferred Stock is treated as an embedded derivative liability and changes in the fair value were recognized in earnings. The Preferred Stock shares are convertible into shares of the Company’s common stock, which did traded in an active securities market, therefore the embedded derivative liability was valued using the following market based inputs:

 

Closing trade price of Common Stock		$	0.02
Series A Preferred Stock Conversion price		$	0.03
Intrinsic value of conversion option per share		$	—

 

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The Company has no assets that are measured at fair value on a recurring basis. There were no assets or liabilities measured at fair value on a non-recurring basis during the year ended December 31, 2014.

As of December 31, 2014, the Company’s outstanding warrants were treated as derivative liabilities and changes in the fair value were recognized in earnings. These common stock purchase warrants did not trade in an active securities market, and as such, the Company estimated the fair value of these warrants using Black-Scholes and the following assumptions:

 

		December 31, 2014
Annual Dividend Yield			0.0%
Expected Life (Years)			3.0 - 4.69
Risk-Free Interest Rate			1.10% -1.65%
Expected Volatility			174.8% - 203.6%

Expected volatility was based primarily on historical volatility. Historical volatility was computed using daily pricing observations for recent periods. The Company believes this method produced an estimate that was representative of the Company’s expectations of future volatility over the expected term of these warrants. The Company had no reason to believe future volatility over the expected remaining life of these warrants was likely to differ materially from historical volatility. The expected life was based on the remaining contractual term of the warrants. The risk-free rate was based on the U.S. Treasury rate that corresponded to the expected term of the warrants.

NOTE 12 – STOCKHOLDERS’ EQUITY

In January and February 2013, the Company received $185,000 from the sale of 3,700,000 units from private placements consisting of shares of the Company’s common stock and warrants to purchase shares of the Company’s common stock at an exercise price of $0.10 per share. The shares and warrants were sold in units with each unit comprised of one share and one warrant at a purchase price of $.05 per unit.

In January 2013, the Company commenced private placements consisting of shares of the Company’s common stock and warrants to purchase shares of the Company’s common stock at an exercise price of $0.12 per share. The shares and warrants were sold in units with each unit comprised of one share and one warrant at a purchase price of $.045 per unit. The company sold 1,111,111 units and raised $50,000.

On February 1, 2013, an investor exercised a warrant to purchase 1 million shares of the Company’s common stock that raised $10,000 for the Company.

In February and March 2013, four investors exercised options to purchase 3,335,000 shares of the Company’s common stock that raised $17,919 for the Company.

On January 1, 2014, under the terms of the Patent and Technology License Agreement, the Company issued 6,349,206 shares of common stock to VerifyMe, in addition to the warrants described in Note 8 above. The shares were issued in payment for the technology received. Under the agreement, $400,000 worth of the Company’s common stock was to be paid by the Company to VerifyMe at a 10% discount to the market at time of payment. The closing price was $0.07 per share discounted 10% to $0.063. The $400,000 payment divided by the $0.063 per share resulted in 6,349,206 shares to be issued. The entire $400,000 payment was expensed to research and development.

During the second quarter of 2014, $216,249 of principal of the Company’s outstanding senior convertible notes plus accrued interest of $208,339, were converted into 8,448,519 shares of common stock. The excess of the fair value of the Company’s common stock over the value of the notes payable and accrued interest, $82,000, was recorded as loss on extinguishment of debt in accordance with FASB ASC 470-50.

 

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NOTE 13 – STOCK OPTIONS

During 1999, the Board of Directors (“Board”) of the Company adopted, with the approval of the stockholders, a Stock Option Plan. In 2000, the Board superseded that plan and created a new Stock Option Plan, pursuant to which it is authorized to grant options to purchase up to 1.5 million shares of common stock. On December 17, 2003, the Board, with approval of the stockholders, superseded the 2000 plan and created the 2003 Stock Option Plan (the “2003 Plan”). Under the 2003 Plan the Company is authorized to grant options to purchase up to 18,000,000 shares of common stock to the Company’s employees, officers, directors, consultants, and other agents and advisors. The Plan is intended to permit stock options granted to employees under the Plan to qualify as incentive stock options under Section 422 of the Internal Revenue Code of 1986, as amended (“Incentive Stock Options”). All options granted under the 2003 Plan, which are not intended to qualify as Incentive Stock Options, are deemed to be non-qualified options (“Non-Statutory Stock Options”).

During 2013, our Board adopted a new omnibus incentive compensation plan that was ratified by the shareholders at the 2013 annual meeting, (the “2013 Plan”) which will serve as the successor incentive compensation plan to the 2003 Plan, and will provide the Company with an comprehensive plan to design and structure grants of stock options, stock units, stock awards, stock appreciation rights and other stock-based awards for our employees, non-employee directors and certain consultants and advisors. Our Board of Directors believes that the availability of (i) 20,000,000 new shares of our common stock, plus (ii) the 1,274,004 shares of our common stock available for issuance under the 2003 Plan, will be sufficient to meet the objective.

As of December 31, 2014, there are 23,225,996 options that have been issued, and 14,774,004 options that are available to be issued under the Plan.

The 2013 Plan is administered by a committee of the Board (“Compensation Committee”) which determines the persons to whom awards will be granted, the number of awards to be granted and the specific terms of each grant, including the vesting thereof, subject to the provisions of the plan.

In connection with Incentive Stock Options, the exercise price of each option may not be less than 100% of the fair market value of the common stock on the date of the grant (or 110% of the fair market value in the case of a grantee holding more than 10% of the outstanding stock of the Company). The aggregate fair market value (determined at the time of the grant) of stock for which an employee may exercise

 

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Incentive Stock Options under all plans of the company shall not exceed $1,000,000 per calendar year. If any employee shall have the right to exercise any options in excess of $100,000 during any calendar year, the options in excess of $100,000 shall be deemed to be Non-Statutory Stock Options, including prices, duration, transferability and limitations on exercise.

The Company issued Non-Statutory Stock Options pursuant to contractual agreements with non-employees. Options granted under the agreements are expensed when the related service or product is provided.

Determining the appropriate fair value of stock-based awards requires the input of subjective assumptions. The Company uses the Black-Scholes option pricing model to value its stock option awards. The assumptions used in calculating the fair value represent management’s best estimates and involve inherent uncertainties and judgments.

On January 22, 2013, the Company issued options to an employee to purchase 1,000,000 shares of the Company’s common stock at an exercise price of $0.05 per share, with a term of ten years. The options vest as follows: 250,000 immediately, 250,000 on the first anniversary of the grant date and 500,000 on the second anniversary of the grant date. The Company used the Black-Scholes option pricing model to calculate the grant-date fair value of the warrants, with the following assumptions: no dividend yield, expected volatility of 222%, risk-free interest rate of 1.9% and expected option life of ten years. The fair value of the options issued was $99,972, of which $25,000 was expensed immediately and the remainder is being expensed over the vesting terms. The total expense for the years ended December 31, 2014 and 2013 was $26,500 and $12,600.

On February 25, 2013, the Company issued options to an employee to purchase 500,000 shares of the Company’s common stock at an exercise price of $0.05 per share, with a term of ten years. The options vest as follows: 200,000 on the first anniversary of the grant date, 200,000 on the second anniversary of the grant date and 100,000 on the third anniversary of the grant date. The Company used the Black-Scholes option pricing model to calculate the grant-date fair value of the warrants, with the following assumptions: no dividend yield, expected volatility of 259%, risk-free interest rate of 1.9% and expected option life of ten years. The fair value of options issued was $89,998. The total expense recognized for the three months ended March 31, 2013 was $5,000. The employee was dismissed and the options were cancelled during the three months ended June 30, 2013. The total expense recognized of $5,000 was reversed upon cancellation of the options.

On March 13, 2013, the Company issued an option to purchase 2,000,000 shares of the Company’s common stock at an exercise price of $0.05 per share, with a term of ten years, to a member of the Board. The options vested 50% immediately and 50% on March 13, 2014. The Company used the Black-Scholes option pricing model to calculate the grant-date fair value of the warrants, with the following assumptions: no dividend yield, expected volatility of 235%, risk-free interest rate of 2.0% and expected option life of ten years. The fair value of the option issued was $439,963 of which $219,982 was expensed immediately and the remainder will be expensed over one year. The total expense recognized for the years ended December 31, 2014 and 2013 was $43,394 and $55,447.

 

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On May 4, 2013, the Company issued an option to purchase 2,000,000 shares of the Company’s common stock at an exercise price of $0.05 per share, with a term of ten years, to a member of the Board. The options vest 50% immediately and 50% on May 4, 2014. The Company used the Black-Scholes option pricing model to calculate the grant-date fair value of the warrants, with the following assumptions: no dividend yield, expected volatility of 235%, risk-free interest rate of 1.78% and expected option life of ten years. The fair value of the option issued was $460,000 of which $230,000 was expensed immediately and the remainder will be expensed over one year. The total expense for the three and years ended December 31, 2014 and 2013 was $78,137 and $57,973.

Effective October 8, 2012, the Company entered into a three year agreement with the then Vice Chairman of the Board of the Company, with an annual compensation of $200,000 per year. In addition, upon execution of the agreement the Company agreed to issue 10 year options to the then Vice Chairman to purchase 5% of the shares of the Company’s fully diluted common stock at an exercise price of $.05 per share, subsequent to the Company receiving funding of $2.5 million. The Company raised the $2.5 million in funding and on June 25, 2013, the Company issued the Vice Chairman 19 million 10 year options in satisfaction of the 5% of the shares of the Company’s fully diluted common stock clause. The Company used the Black-Scholes option pricing model to calculate the grant-date fair value of the warrants, with the following assumptions: no dividend yield, expected volatility of 146.1%, risk-free interest rate of 2.6% and expected option life of ten years. The fair value of options issued was $3,767,700, which was expensed immediately.

Effective October 16, 2012, the Company entered into a three year agreement with the then President and current Chief Executive Officer of the Company with an annual compensation of $200,000 per year. In addition, upon execution of the agreement the Company agreed to issue 10 year options to the President to purchase 5% of the shares of the Company’s fully diluted common stock at an exercise price of $.05 per share, subsequent to the Company receiving funding of $2.5 million and on June 25, 2013, the Company issued the President and Chief Executive Officer 19 million 10 year options in satisfaction of the 5% of the shares of the Company’s fully diluted common stock clause. The Company used the Black-Scholes option pricing model to calculate the grant-date fair value of the warrants, with the following assumptions: no dividend yield, expected volatility of 146.1%, risk-free interest rate of 2.6% and expected option life of ten years. The fair value of options issued was $3,767,700, which was expensed immediately.

On September 30, 2013, the Company issued an option to purchase 1,000,000 shares of the Company’s common stock at an exercise price of $0.15 per share, with a term of ten years, to the Company’s Chief Operating Officer. The options vest 50% after the first year and 50% at the end of 24 months after the grant date. The Company used the Black-Scholes option pricing model to calculate the grant-date fair value of the warrants, with the following assumptions: no dividend yield, expected volatility of ranging from 268.4% to 272.8%, risk-free interest rate of 1.39% and expected option life ranging from 10 years. The fair value of the option issued was $99,840. The total expense for the years ended December 31, 2014 and 2013 was $62,395 and $18,903, respectively.

 

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On December 2, 2013, the Company issued an option to purchase 1 million shares of the Company’s common stock at an exercise price of $0.15 per share, with a term of ten years, to the Company’s Chief Financial Officer. The options vest 50% after the first year and 50% at the end of 24 months. The Company used the Black-Scholes option pricing model to calculate the grant-date fair value of the warrants, with the following assumptions: no dividend yield, expected volatility of ranging from 266.1%, risk-free interest rate of 2.64% and expected option life of 10 years. The fair value of the option issued was $79,994, which will be expensed over the vesting term. The total expense for the years ended December 31, 2014 and 2013 was $49,916 and $15,123, respectively.

On March 28, 2014, the Company issued options to purchase an aggregate of 6,000,000 shares of the Company’s common stock at an exercise price of $0.05 per share, with a term of ten years, to a member of the Board of Directors. The fair value of options issued was $599,893 of which all was expensed immediately. These options were valued using the Black-Scholes option pricing model to calculate the grant-date fair value of the options, with the following assumptions: no dividend yield, expected volatility of 229%, risk-free interest rate of 2.73% and expected option life of ten years.

On March 28, 2014 at the urging of the Company’s previous Chairman, Michael Sonnenreich, and after discussion by the Board and suggestions by Board Observers attending the meeting, the Board unanimously voted to extend the exercise period of all existing 10 year options, for a full ten years (as opposed to six months) regardless of their status with the Company. This charge was memorialized and sent in writing to previous Directors by then general counsel Morgan, Lewis & Bockius.

 

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The following tables summarize non-employee stock option/warrant activity of the Company since December 31, 2012:

 

										Weighted Average
		Option/Warrant				Exercise				Exercise
		Shares				Price				Price
Outstanding, December 31, 2012			82,807,221			$	0.00125 to $0.20			$	0.01
Granted			38,144,444				0.10 - 0.15				0.03
Exercised			(9,435,000	)			0.00125 - 0.07				—
Expired			—				—				—
Outstanding, December 31, 2013			111,516,665				0.00125 to 0.20				0.09
Granted			10,349,209				0.05 - 0.10				0.01
Exercised			—				—				—
Expired			(700,000	)			—				—
*Outstanding, December 31, 2014			121,165,874			$	0.01 to $.20			$	0.10
*Exercisable, December 31, 2014			121,165,874			$	0.01 to $.20			$	0.10
Weighted Average Remaining Life, Exercisable, December 31, 2014 (years)			5.7

* Does not include 250,000,000 warrants that are due to be issued on January 1, 2015. The warrants has a fair value of $4,892,089 and are reflected in warrant liabilities on the balance sheet as of December 31, 2014 and the corresponding expense is reflected in research and development expense.

A summary of incentive stock option transactions for employees since December 31, 2013 is as follows:

 

		Option/Warrant Shares				Exercise Price				Weighted Average Exercise Price
Outstanding, December 31, 2012			15,766,667			$	0.00125 to $0.10			$	0.06
Granted			45,500,000				0.05 - 0.15				0.04
Exercised			(900,000	)			0.00125				—
Expired			(500,000	)			0.05				—
Outstanding, December 31, 2013			59,866,667				0.00125 to 0.15				0.06
Granted			6,000,000				0.05				0.01
Exercised			(12,000,000	)			0.05				0.01
Expired			—				—				—
Outstanding, December 31, 2014			53,866,667			$	0.05 - $0.15			$	0.05
Exercisable, December 31, 2014			51,366,667			$	0.05 - $0.15			$	0.06
Weighted Average Remaining Life, Exercisable, December 31, 2014 (years)			8.3

 

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NOTE 14 – OPERATING LEASES

For the year ended December 31, 2014 and 2013, total rent expense under leases amounted to $65,950 and $59,272. At December 31, 2014, the Company was obligated under various non-cancelable operating lease arrangements for property as follows:

 

2015			74,637
2016			31,605
		$	106,242

NOTE 15 – RELATED PARTY TRANSACTIONS

During the fourth quarter of 2013, the company converted outstanding debt owed to shareholders into 25,974,697 shares of common stock (See Notes 6,7,8).

At December 31, 2014 and 20123, two and five shareholders of the Company held $114,000 and $330,249 of the senior secured convertible notes payable and were owed accrued interest of $112,505 and 300,677.

One shareholder held $140,000 of convertible notes payable as of December 31, 2012, that was satisfied by December 31, 2013.

At December 31, 2014, two stockholders of the Company held $114,000 in principal of the Company’s senior secured convertible notes payable, and were owed accrued interest of $112,505 related to such notes.

NOTE 16 – CONTINGENCIES

In October 2010, the Company filed suit in the Western District of Pennsylvania against WS Packaging Group, Inc. (“WS”) alleging that WS infringed on one of the Company’s patents in the manufacture of MONOPOLY game pieces on behalf of McDonald’s Corp. On June 4, 2012, both WS and the Company filed a stipulation to dismiss the action without prejudice and enter into settlement negotiations. There are no ongoing negotiations.

NOTE 17 – SUBSEQUENT EVENTS

On February 10, 2015, the Company issued a note payable for $25,000, bearing interest at 5.0% to an accredited investor and director of the Company. The note is due on June 10, 2015.

On February 15, 2015, a Board member advised the Company that her two year term as a Director expired on February 21, 2015 and that she would not stand for re-election or continue to serve as a director.

On February 26, 2015, a Board member advised the Company that he was resigning from the Board of Directors.

At December 31, 2014, three stockholders of the Company held $323,000 in principal of the Company’s notes payable, and were owed accrued interest of $31,845 related to such notes.

 

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On March 27, 2015, the Company issued a note payable for $111,102, bearing interest at 8.0% to an accredited investor. The note is due on June 25, 2015. On March 20, 2014, VerifyMe waived its contractual rights as it relates to this transaction.

On March 30, 2015, the Company was advised by the United States Patent and Trademark Office (“USPTO”) that its petition for an unintentional delayed payment for an unpaid maintenance fee to reinstate its patent was granted by the USPTO. The patent, for a counterfeiting ink detection system, was granted on November 2, 2004.

 

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