Note 2 - Stock-Based Compensation; Changes in Equity

The Company has adopted Financial Accounting Standards Board (“FASB”) Accounting Standards Codification (“ASC”) Topic 718 which requires all share-based payments to employees, including grants of employee stock options, to be recognized in the condensed consolidated financial statements based on their grant-date fair values.

The Company has applied the Black-Scholes model to value stock-based awards and issued warrants related to notes payable. That model incorporates various assumptions in the valuation of stock-based awards relating to the risk-free rate of interest to be applied, the estimated dividend yield and expected volatility of our common stock. The risk-free rate of interest is the related U.S. Treasury yield curve for periods within the expected term of the option at the time of grant. The dividend yield on our common stock is estimated to be 0%, as the Company did not issue dividends during 2014 and 2013. The expected volatility is based on historical volatility of the Company’s common stock.

The Company’s net income for the three months ended September 30, 2014 and 2013 includes approximately $17,000 and $24,000, respectively of compensation costs related to share based payments. The Company’s net income for the nine months ended September 30, 2014 and 2013 includes approximately $60,000 and $94,000, respectively of compensation costs related to share based payments. As of September 30, 2014 there is $60,000 of unrecognized compensation expense related to non-vested stock option grants and stock grants. We expect approximately $17,000 of additional stock-based compensation expense to be recognized over the remainder of 2014, $29,000 to be recognized during 2015, $11,000 to be recognized during 2016, and $3,000 to be recognized during 2017.

As of September 30, 2014, the Company had three stock-based compensation plans pursuant to which stock options were, or may be, granted. The Plans provide for the award of options, which may either be incentive stock options (“ISOs”) within the meaning of Section 422A of the Internal Revenue Code of 1986, as amended (the “Code”) or non-qualified options (“NQOs”) which are not subject to special tax treatment under the Code, as well as for stock grants.

On April 12, 2001, the Board of Directors approved for adoption, effective December 27, 2001, the 2001 Stock Option Plan (“2001 Plan”). The 2001 Plan authorizes the grant of options to purchase up to an aggregate of 119,050, shares of the Company’s Common Stock. As of September 30, 2014, options for 139,958 shares (including cancelled shares re-issued under the Plan) have been granted and were fully vested at the time of grant and options for 2,000 shares remain outstanding.

On April 24, 2002, the Board of Directors approved for adoption, effective October 12, 2002, the 2002 Stock Option Plan (“2002 Plan”). The 2002 Plan authorizes the grant of options to purchase up to an aggregate of 142,860 shares of the Company’s Common Stock. As of September 30, 2014, options for 123,430 shares have been granted and were fully vested at the time of grant and options for 27,500 shares remain outstanding.

On April 10, 2009, the Board of Directors approved for adoption, and on June 5, 2009, the shareholders of the Corporation approved, a 2009 Stock Incentive Plan (“2009 Plan”). The 2009 Plan authorizes the issuance of up to 250,000 shares of stock or options to purchase stock of the Company. As of September 30, 2014, options for 201,000 shares had been granted and options for 199,000 shares remain outstanding.

A summary of the Company’s stock option activity and related information is as follows:

		Weighted		Weighted
	Shares	Average		Average	Aggregate
	under	Exercise		Remaining Contractual	Intrinsic
	Option	Price		Life	Value
Balance at December 31, 2013	228,500	$	5.23	3.0	$	161,250
Granted	-		-
Cancelled	-		-
Exercised	-		-
Outstanding at September 30, 2014	228,500	$	5.23	2.3	$	30,090

Exercisable at September 30, 2014	120,182	$	4.92	2.0	$	30,090

On July 17, 2012, the Company entered into a Note and Warrant Purchase Agreement with BMO Equity pursuant to which (i) BMO Equity advanced to the Company the sum of $5 million and (ii) the Company issued to BMO Equity a warrant to purchase up to Four Percent (4%) of the outstanding shares of common stock of the Company on a fully-diluted basis (140,048 shares of common stock of the Company) at the price of One Cent ($0.01) per share. The term of the loan provided for in this Agreement is five and a half years. Interest is payable on the outstanding balance of the loan at the rate of 11.5% per annum.

On April 12, 2013, the Company entered into Amendment No. 1 to the Note and Warrant Purchase Agreement among the Company and BMO Equity. In the Amendment, non-compliance with financial covenants prior to the date of the Amendment were waived and the Note and Warrant Purchase Agreement was amended (i) to modify the Senior Leverage Ratio and Total Leverage Ratio requirements for the fiscal quarter ending June 30, 2013 and each quarter thereafter during the term of the Note and Warrant Purchase Agreement and (ii) to modify the definitions of EBITDA and Total Funded Debt.

On September 30, 2014, the Company received waivers from each of BMO Harris and BMO Equity for non-compliance with all the financial covenants under the Credit Agreement and the Note and Warrant Purchase Agreement.

Management of the Company is currently engaged in negotiations with BMO Harris and BMO Equity, and in financing efforts, for a long-term restructuring of the agreements with those entities under which financial covenants would be modified, additional financing provided and reduction of certain loan balances achieved. Management believes that a restructuring of these agreements will be completed during the fourth quarter 2014.

A summary of the Company’s stock warrant activity and related information is as follows:

		Weighted		Weighted
	Shares	Average		Average	Aggregate
	under	Exercise		Remaining Contractual	Intrinsic
	Warrant	Price		Life	Value
Balance at December 31, 2013	140,048	$	0.01	8.5	$	816,480
Granted
Cancelled	-		-
Exercised	-		-
Outstanding at September 30, 2014	140,048	$	0.01	7.8	$	544,787

Exercisable at September 30, 2014	-		-	-		-

A summary of the Company’s stock option activity by grant date as of September 30, 2014 is as follows:

	Options Outstanding						Options Vested
Options by Grant Date	Shares	Weighted Avg.		Remain. Life	Intrinsic Val		Shares	Weighted Avg.		Remain. Life	Intrinsic Val
Dec 2005	29,500	$	2.88	1.3	$	30,090	29,500	$	2.88	1.3	$	30,090
Dec 2010	72,000		6.14	1.3		-	39,750		5.97	1.3		-
Jan 2011	8,000		5.96	1.3		-	5,332		5.96	1.3		-
Nov 2012	109,000		5.17	3.2		-	43,600		5.17	3.2		-
Nov 2013	10,000		5.75	4.1		-	2,000		5.75	4.1		-
TOTAL	228,500	$	5.23	2.3	$	30,090	120,182	$	4.92	2.0	$	30,090

The aggregate intrinsic value in the tables above represents the total pre-tax intrinsic value (the difference between the closing price of the Company’s common stock on the last trading day of the quarter ended September 30, 2014 and the exercise price, multiplied by the number of in-the-money options) that would have been received by the option holders had all the holders exercised their options on September 30, 2014.