News Column

NOTE 2 - MANAGEMENT PLANS

May 20, 2014

The accompanying 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 during the development stage. 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. -14- The Company believes 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 shareholders. 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. The Company is in the development stage at March 31, 2014. 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.



NOTE 3 - PATENTS AND TRADEMARK

The Company has five issued patents and filed for three additional patents for anti-counterfeiting technology. 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 three months ended March 31, 2014 and 2013, the Company capitalized patent costs of $0 and $18,443, respectively. Amortization expense for patents was $3,277 and $5,733 for the three months ended March 31, 2014 and 2013, respectively. Future estimated annual amortization over the next five years is approximately $13,100 per year for the years ended December 31, 2014 through 2018. NOTE 4 - INCOME TAXES



Income tax expense was $0 for the three months ended March 31, 2014 and 2013.

As of January 1, 2014, the Company had no unrecognized tax benefits, and accordingly, the Company did not recognize interest or penalties during 2014 related to unrecognized tax benefits. There has been no change in unrecognized tax benefits during the three months ended March 31, 2014, and there was no accrual for uncertain tax positions as of March 31, 2014. Tax years from 2010 through 2013 remain subject to examination by major tax jurisdictions. There is no income tax benefit for the losses for the three months ended March 31, 2014 and 2013, since management has determined that the realization of the net tax deferred asset is not assured and has created a valuation allowance for the entire amount of such benefits.



NOTE 5 - SENIOR SECURED CONVERTIBLE NOTES PAYABLE

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. -15- 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 March 31, 2014, the outstanding principal balance on these notes was $330,249. Accrued interest at March 31, 2014 amounted to $310,584.

In addition, if an equity financing with total proceeds of more than $5,000,000 occurs while any 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 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 6 - 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. -16-



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 7 - 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 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 $1,000,000 realized by the Company shall be allocated 90% to the Company and 10% to the Lenders. e. The next $1,000,000 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 3,000,000 shares of the Company's common stock. Accrued interest of $13,895 was paid in cash. -17-



Notes payable consists of the following:

March 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 $ 330,000 $ 330,000 Series A notes payable; interest at 8% per annum; principal and accrued interest due at maturity in October 2011 (past due) 50,000 50,000 380,000 380,000 Less: Current portion 50,000 50,000 Long-term portion $ 330,000 $ 330,000

At March 31, 2014 and December 31, 2013, accrued interest on notes payable was $328,251 and $317,344, respectively. Interest expense was $10,907 and $41,241 for the three months ended March 31, 2014 and 2013, respectively.



NOTE 8 - WARRANT LIABILITY

On December 31, 2012, the Company entered into an Investment Agreement, a Technology and Services Agreement, a Technology and Services Agreement with Zaah Technologies, Inc. ("Zaah") a Patent and Technology License Agreement, and an Asset Purchase Agreement (collectively the "Agreements"). Included in these Agreements were warrants to purchase shares 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 March 31, 2014 and December 31, 2013, the fair value of the warrant liability was $4,197,000 and $3,700,000. On January 1, 2014 the company issued 6,349,206 warrants as consideration for technology received from VerifyMe related to the December 31, 2012 Agreement. The warrants are exercisable at $.10 per share and have an exercise price of $.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 March 31, 2014, the fair value of the warrant liability was $505,000. At the time of payment, the Company made the payment, on a good faith basis, on the assumption that the technology conveyed to it 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 is patentable and licensable, the Company would be required to make, on January 1, 2015, an additional payment pursuant to December 31, 2012 Patent and Technology Agreement in the amount of Four Million Five Hundred Thousand Dollars ($4,500,000), to be paid by issuing (i) a number of Shares 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 ten cents ($0.10) per share. Based upon the current share price of $0.07 per share, this would result in the issuance of approximately an additional 70 million shares of common stock and warrants to purchase an additional 70 million shares.



NOTE 9- CONVERTIBLE PREFERRED STOCK

Subscription Agreement

The Company entered into a Subscription Agreement with VerifyMe, Inc. ("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 preferred stock (the "Preferred Shares") and a warrant to purchase 33,333,333 shares of the Company's common stock for $1 million at an exercise price of $0.12 per share. -18-

At any time within two years after January 31, 2013, the subscriber 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 subscriber in exchange for the price originally paid by the subscriber therefore upon the occurrence of any of the following events:(i) the consummation of any bona fide business acquisition, (ii) the incurring 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.



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, $800,000 at December 31, 2013 and $1.1 million at March 31, 2014. 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 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 March 31, 2014, and December 31, 2013 the fair value of the warrants was $2,632,000 and $2,300,000. 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. There are no arrearages on cumulative dividends.

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.



NOTE 10 - 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. -19- Liabilities measured at fair value on a recurring basis are summarized as follows: March 31, 2014 Level 1 Level 2 Level 3 Total Derivative liability related to fair value of beneficial conversion feature $ - $ 1,100,000 $ -- $ 1,100,000 Derivative liability related to fair value of warrants - - 7,334,000 7,334,000 Total $ - $ 1,100,000$ 7,334,000$ 8,434,000



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



Change in fair value of derivative liabilities 890,000

Balance at March 31, 2014$ 7,334,000 As of March 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 trade in an active securities market, therefore the embedded derivative liability was valued using the following market based inputs: Closing trade price of Common Stock $ 0.08



Series A Preferred Stock Conversion Price $ 0.03 Intrinsic value of conversion option per share $ 0.05

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 three months ended March 31, 2014.

As of March 31, 2014 the Company's outstanding warrants are 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:

March 31, 2014 Annual Dividend Yield 0.0% Expected Life (Years) 3.75 - 3.84 Risk-Free Interest Rate 1.67% Expected Volatility 250.9% Expected volatility was based primarily on historical volatility. Historical volatility was computed using daily pricing observations for recent periods. The Company believed 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. -20-



NOTE 11 - 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 1,000,000 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, per the Patatent and Technology agreement the company issued 6,349,206 shares of common stock to VerifyMe. The shares were in payment for technology received. Per the Agreement, payment of $400,000 worth of the Company's common stock was to be paid at a 10% discount to the market at time of payment. The closing price was $.07 per share discounted 10% to $.063. The $400,000 payment divided by the $.063 per share resulted in 6,349,206 shares to be issued. The entire $400,000 payment was expensed to research and development. At the time of payment, the Company made the payment, on a good faith basis, on the assumption that the technology conveyed to it 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 is patentable and licensable, the Company would be required to make, on January 1, 2015, an additional payment pursuant to December 31, 2012 Patent and Technology Agreement in the amount of Four Million Five Hundred Thousand Dollars ($4,500,000), to be paid by issuing (i) a number of Shares 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 ten cents ($0.10) per share. Based upon the current share price of $0.07 per share, this would result in the issuance of approximately an additional 70 million shares of common stock and warrants to purchase an additional 70 million shares.



The authorized shares of the Company's common stock were increased on May 23, 2013 from 425,000,000 to 675,000,000.

NOTE 12 - STOCK OPTIONS AND WARRANTS

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 this plan and created the 2003 Stock Option Plan (the "Plan"). Under the 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 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 comprehensive incentive compensation plan which will serve as the successor incentive compensation plan to the earlier plan, and provide the Company with an omnibus plan to design and structure grants of stock options, stock units, stock awards, stock appreciation rights and other stock-based awards for selected individuals in our employ or service. Our Board of Directors believes that the availability of (i) 20,000,000 new shares of our common stock, plus (ii) the number of shares of our common stock subject to outstanding grants under the 2003 Plan as of the date of the Annual Meeting, plus (iii) the number of shares of our common stock remaining available for issuance under the 2003 Plan but not subject to previously exercised, vested or paid grants, for issuance under the 2013 Plan. -21-



As of March 31, 2014, there are 24,425,996 options that have been issued, and 13,574,004 options that are available to be issued under the Plan.

The Plan is administered by a committee of the Board of Directors ("Stock Option 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 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 to non-employees. Options granted under the agreements are expensed when the related service or product is provided.

FASB ASC 718-10-55, Staff Accounting Bulletin No. 107 (SAB 107) and Staff Accounting Bulletin No. 110 (SAB 110), regarding Share-Based Payments, express the views of the staff regarding the use of the "simplified" method in developing an estimate of expected term of 'plain vanilla' share options and allows usage of the simplified method for share option grants. The guidance allows public companies which do not have historically sufficient experience to provide a reasonable estimate to continue use of the "simplified" method for estimating the expected term of plain vanilla share option grants after December 31, 2007. SAB 110 is effective January 1, 2008. The Company has adopted the simplified method for estimating the expected term of share option grants because it does not have sufficient historical exercise data to provide a reasonable basis upon which to estimate expected term. The simplified method is based on the average of the vesting tranches and the contractual life of each grant. 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 assumption used in calculating the fair value represents management's best estimates and involve inherent uncertainties and judgment. On July 16, 2012, the Company issued an option to purchase 200,000 shares of the Company's common stock at an exercise price of $.05, with a term of ten years, to a consultant. The fair value of options issued was $11,638. 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 133%, risk-free interest rate of 1.5% and expected option life of ten years. These options granted were fully vested as of the date of the agreement. As a result, the Company recorded $11,638 of consulting expense for the year ended December 31, 2012. On November 21, 2012, the Company issued options to purchase an aggregate of 2,000,000 shares of the Company's common stock at an exercise price of $.05, with a term of ten years, to the Chief Executive Officer and the Chief Operating Officer. The fair value of options issued was $89,538 and was expensed immediately. -22- On November 21, 2012, the Company issued options to purchase an aggregate of 10,000,000 shares of the Company's common stock at an exercise price of $.05, with a term of ten years, to the five members of the Board of Directors. The fair value of options issued was $447,689 of which $223,844 was expensed immediately and the remainder was expensed over 2013. Expense for the three months ended March 31, 2013 was $55,194. All of the options issued on November 21, 2012 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 131%, risk-free interest rate of 1.7% and expected option life of ten years. 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 $.05, with a term of ten years. The options vest as follows: 250,000 immediately, 250,000 in one year and 500,000 in two years 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 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 three months ended March 31, 2014 and 2013 was $7,669, and $34,305, respectively. 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 $.05, with a term of ten years. The options vest as follows: 200,000 in one year, 200,000 in two years and 100,000 in three years. 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 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 $.05, with a term of ten years, to a member of the Board of Directors. The options vest 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 for the three months ended March 31, 2014 and 2013 was $43,394 and $230,830, respectively. 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 $.05, with a term of ten years, to the a member of the Board of Directors. 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 months ended March 31, 2014 was $56,712. 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 $.15, 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. 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 three months ended March 31, 2014 was $18,492. -23- 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 $.15, 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 three months ended March 31, 2014 was $14,794. 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 $.05, with a term of ten years, to one of the Board of Directors. The fair value of options issued was $599,893 of which all was expensed immediately. All of the options issued on March 28, 2014 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 February 7, 2014, 6,000,000 options of the company were exercised as part of a cashless exercise of options. Based on a stock price of $.07 per share and an exercise price of $.05 per share 6,000,000 options were received and 1,714,285 shares of stock were issued. On February 25, 2014, 6,000,000 options of the company were exercised by the Company's Chief Executive Officer as part of a cashless exercise of options. Based on a stock price of $.06 per share and an exercise price of $.05 per share 6,000,000 options were received and 1,000,000 shares of stock were issued. -24-



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 $0.00125

Outstanding, December 31, 2012 82,807,221 to $0.20

$ 0.01 0.10 to Granted 38,144,444 0.15 0.03 0.00125 Exercised (9,435,000 ) - 0.07 - Expired - - - 0.00125

Outstanding, December 31, 2013 111,516,665 to 0.20

0 Granted 6,349,209 0.10 0.01 Exercised - Expired (700,000 ) .07 -.20 - $0.01 to Outstanding, March 31, 2014 117,165,874 $.20 $ 0.10 $0.01 to Exercisable, March 31, 2014 117,165,874 $.20 $ 0.10



Weighted Average Remaining Life,

Exercisable, March 31, 2014 (years) 6.5 A summary of incentive stock option transactions for employees since December 31, 2012 is as follows: Weighted Average Option/Warrant Exercise Exercise Shares Price Price 0.00125

Outstanding, December 31, 2012 15,766,667 to 0.10

$ 0.06000 0.05 - Granted 45,500,000 0.15 0.04 0.00125 Exercised (900,000 ) - 0.15 - Expired/Returned (500,000 ) - - .05 to

Outstanding, December 31, 2013 59,866,667 .15

0.05 Granted 6,000,000 .05 .01 Exercised (12,000,000 ) .05 .01 Expired/Returned - - - $0.05 to Outstanding, March 31, 2014 53,866,667 $0.15 $ 0.05 $0.05 to Exercisable, March 31, 2014 45,366,667 $0.15 $ 0.06



Weighted Average Remaining Life,

Exercisable, March 31, 2014 (years) 9.3



NOTE 13 - OPERATING LEASES

For the three months ended March 31, 2014 and 2013, total rent expense under leases amounted to $17,727 and $0, respectively, and is included in general and administrative expense. At March 31, 2014, the Company was obligated under various non-cancelable operating lease arrangements for property as follows: 2014 $ 54,234 2015 74,637 2016 31,605 $ 160,476 -25-



NOTE 14 - RELATED PARTY TRANSACTIONS

At March 31, 2014, five shareholders of the Company held $330,249 of the senior secured convertible notes payable.

At March 31, 2014, five shareholders of the Company were owed accrued interest of $328,251 related to the senior secured convertible notes payable.

NOTE 15 - 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. Settlement negotiations are ongoing.



NOTE 16 - SUBSEQUENT EVENTS

The Company has developed agreements with each of the note holders, with the exception of one holder that maintains a $50,000 note, to exchange their debt for an equity position. The Company expects to eliminate all of the current debt with the exception of the $50,000 note during the second quarter of 2014. The Company expects to exchange $330,249 of debt plus $307,281 of accrued interest for 12,750,619 shares of common stock. -26-



ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.

Cautionary Statements Regarding Forward-Looking Statements

This report contains "forward-looking statements" within the meaning of Section 27A of the Securities Act of 1933, as amended (the "Securities Act"), and Section 21E of the Securities Exchange Act of 1934, as amended (the "Exchange Act"). All statements other than statements of historical facts included or incorporated by reference in this quarterly report on Form 10-Q, including without limitation, statements regarding our future financial position, business strategy, budgets, projected revenues, projected costs and plans and objective of management for future operations, are forward-looking statements. In addition, forward-looking statements generally can be identified by the use of forward-looking terminology such as "may," "will," "expects," "intends," "plans," "projects," "estimates," "anticipates," or "believes" or the negative thereof or any variation thereon or similar terminology or expressions. We have based these forward-looking statements on our current expectations and projections about future events. These forward-looking statements are not guarantees and are subject to known and unknown risks, uncertainties and assumptions about us that may cause our actual results, levels of activity, performance or achievements to be materially different from any future results, levels of activity, performance or achievements expressed or implied by such forward-looking statements. Important factors that could cause actual results to differ materially from our expectations include, but are not limited to: our ability to raise additional capital, the absence of any operating history or revenue, our ability to attract and retain qualified personnel, our dependence on third party developers who we cannot control, our ability to develop and introduce a new service to the market in a timely manner, market acceptance of our services, our limited experience in a relatively new industry, the ability to successfully develop licensing programs and generate business, rapid technological change in relevant markets, unexpected network interruptions or security breaches, changes in demand for current and future intellectual property rights, legislative, regulatory and competitive developments, intense competition with larger companies, general economic conditions, and "Item 2 - Management's Discussions and Analysis of Financial Condition and Results of Operation" below. All subsequent written and oral forward-looking statements attributable to us, or persons acting on our behalf, are expressly qualified in their entirety by the foregoing. Except as required by law, we assume no duty to update or revise our forward-looking statements.



Overview

We were incorporated in Nevada in November 1999. We are a technology development company that delivers product and document authentication and security. We plan to develop and market technologies in a variety of applications in the security fields. We believe that the technologies we own will enable businesses to reconstruct their overall approaches to corporate security - from counterfeit identification to employee or customer monitoring. Potential applications of our technologies are available in different types of products and industries including gaming, apparel, tobacco, perfume, compact disks, pharmaceuticals, event and transportation tickets, driver's licenses, insurance cards, passports, computer software, DVDs, and credit cards. We intend to generate sales through licenses of our technology or through direct sales of our technology to end-users. We have five issued patents and submitted three additional applications relating to our technology. These patents seek to accomplish non-intrusive document and product authentication in order to reduce losses caused by unpermitted document reproduction or by product counterfeiting. The technologies involve the utilization of invisible or color shifting/changing inks, which are compatible with today's printing machines. The inks may be used with certain printing systems such as offset, flexographic, silkscreen, gravure, and laser. Based upon the Company's experience, we believe that the ink technologies may be incorporated into existing manufacturing processes. -27- Strategic Outlook

We believe that the security and authentication industries will continue to grow over time, especially as counterfeiting becomes easier with advances in technology. Within the market, we intend to provide our products to government bodies, and merchants in the consumer products, gaming and financial services industries. Sustained spending on technology, our ability to raise additional financing, and the continued growth of the security and authentication markets are all external conditions that may affect our ability to execute our business plan. In addition, certain potential customers may view our small size and limited financial resources as a negative even if they prefer our products to those of our competitors. Our primary strategic objective over the next 12-24 months is to successfully market our products and generate revenue that is sufficient to cover our operating expenses and support additional growth over the next several years. We plan to achieve this objective through a targeted marketing program. As we grow, we intend to hire professionals to develop new products and market our products. We believe that our near-term success will depend particularly on our ability to develop customer awareness and confidence in our products. Since we have limited capital resources, we will need to closely manage our expenses and conserve our cash by continually monitoring any increase in expenses and reducing or eliminating unnecessary expenditures. Our prospects must be considered in light of the risks, expenses and difficulties encountered by companies in the development stage, particularly given that we operate in rapidly evolving markets, that we have limited financial resources, and face an uncertain economic environment. We may not be successful in addressing such risks and difficulties.



Results of Operations

Comparison of the Three Months Ended March 31, 2014 and 2013

The following discussion analyzes our results of operations for the three months ended March 31, 2014 and 2013. The following information should be considered together with our financial statements for such period and the accompanying notes thereto.



Net Loss for Three Months Ended March 31, 2014 and 2013

Net Revenue/Net Loss

We are a development stage company and have not generated significant revenue since our inception. For the three months ended March 31, 2014 and 2013, we generated net revenues of $0 and $3,140 respectively. Our net loss decreased $12,476,939 to $3,429,708 for the three months ended March 31, 2014 compared to $15,906,647 for the three months ended March 31, 2013. The result of the decrease in expenses was primarily due to the fair value adjustments to the warrant liability and embedded derivative liability associated with the Investment Agreement entered into on December 31, 2012 and the Subscription Agreement entered into on January 31, 2013. The increase in the fair value of these liabilities as of March 31, 2014 was not as much as the increase on March 31, 2013 and thus the associated expense was not as high. -28- Cost of Sales



For the three months ended March 31, 2014 and 2013, we incurred costs of sales of $0 and $2,710, respectively.

General and Administrative Expenses

General and administrative expenses increased $40,894 to $124,761 for the three months ended March 31, 2014 from $83,867 for the three months ended March 31, 2013. The increase was primarily attributable to results from the hiring of employees and the opening of an office in Washington D.C.



Legal and Accounting

Legal and accounting fees increased $19,758 to $132,195 for the three months ended March 31, 2014 from $112,437 for the three months ended March 31, 2013. The increase in legal and accounting fees in 2014 was primarily related to legal fees associated with business development contracts underway during the first quarter of 2014. Payroll Expenses

Payroll expenses were $1,074,680 for the three months ended March 31, 2014, an increase of $507,180 from $567,500 for the three months ended March 31, 2013. The increase resulted primarily from an issuance of 6,000,000 warrant to a board member during the three months ended March 31, 2014.



Research and Development

Research and development expenses were $845,729 and $137,500, respectively, for the three months ended March 31, 2014 and 2013, an increase of $708,229. The increase in research and development expenses was due to primarily to warrants and shares of stock issued in the quarter ended March 31, 2014 related to the patent and technology service agreement entered into on December 31, 2012.



Sales and Marketing

Sales and marketing expenses for the three months ended March 31, 2014 were $51,436 as compared to $47,321 for the three months ended March 31, 2013, a decrease of $4,115. The expenses consisted largely of expenses for marketing new and existing technology.

Interest Expense

During the three months ended March 31, 2014, the Company incurred interest expense of $10,907, as compared to $41,241 for the three months ended March 31, 2013, a decrease of $30,334. The decrease in interest expense directly correlates to the notes payable that have been converted into common stock during 2013.

Liquidity and Capital Resources

As of the date of this report, we had cash on hand of $461,322.

Net cash used in operating activities for the three months ended March 31, 2014 decreased to $706,632 from $746,163 for the three months ended March 31, 2013 a decrease of $39,531. The net cash used in operating activities is expected to remain at the current level until revenue is generated as the Company looks to market and develop its new and existing line of products.



Net cash used in investing activities, consisting of equipment purchases and patent costs, was $25,772 for the three months ended March 31, 2013.

-29- Net cash provided by financing activities was $0 and $1,262,919 for the three months ended March 31, 2014 and 2013. The net cash provided by financing activities for the three months ended March 31, 2013 relates to $1 million from the sale of the Company's preferred stock and a warrant, and $262,919 in proceeds received from the issuance of common stock and exercise of stock options. The Company is in the development stage. During the three months ended March 31, 2014 and 2013, the Company's operational resources were used primarily to fund general and administrative expenses, hire employees and expand the continuing sales and marketing program. As we have not realized significant revenues since our inception, we have financed our operations through public and private offerings of debt and equity securities. We do not currently maintain a line of credit or term loan with any commercial bank or other financial institution. The following sets forth our primary sources of capital during the previous two years.



The following agreements were executed on December 31, 2012 and provided the Company with $2 million in funding.

Investment Agreement

The Company entered into an Investment Agreement with VerifyMe, Inc. ("VerifyMe") on December 31, 2012 (the "Investment Agreement"). Under the terms of the Investment Agreement, VerifyMe purchased 22,222,222 shares of the Company's common stock as well as a warrant to purchase 22,222,222 shares of the Company's common stock for $1 million. In addition, a Subscription Agreement (discussed below) was to be entered into on or before January 31, 2013.



Registration Rights Agreement

In connection with the Investment Agreement, the Company entered into a Registration Rights Agreement with VerifyMe (the "Registration Rights Agreement"), pursuant to which VerifyMe has the right to demand at any time on or after four months after December 31, 2012, that the Company file a registration statement relative to shares owned by VerifyMe.

After receiving extensions to the required timing, the Company filed a Form S-1 Registration Statement with respect to the shares owned by VerifyMe on August 5, 2013 in accordance with the terms of the Registration Rights Agreement.



Technology and Service Agreement

In connection with the Investment Agreement, the Company entered into a Technology and Service Agreement with VerifyMe (the "Technology and Service Agreement "), pursuant to which VerifyMe purchased warrants of the Company to purchase 22,222,222 shares of the Company's common stock for $1 million. Additionally, the Company executed a services agreement with Zaah Technologies, Inc. ("Zaah") concurrently with this agreement (the "Zaah Technology and Service Agreement"). The Company is to use up to $550,000 of the proceeds from the Technology and Service Agreement for the purpose of the Company's hiring (i) a full-time Chief Technology Officer or Chief Information Officer and (ii) two full-time business developers.



Technology and Service Agreement with Zaah

Under the Zaah Technology and Service Agreement, Zaah will provide the Company (a) twelve (12) months of technical support, (b) up to twelve (12) days of meetings annually between the respective management teams of the Company and Zaah, (c) updates to technology as agreed in writing between the Company and Zaah, and (d) twelve (12) months of technical hosting. -30-



The Company is required to pay Zaah the following:

(a) $450,000 on the date of the agreement (December 31, 2012), consisting of

$250,000 in cash and warrants to purchase 4,444,444 shares of common stock under a cashless exercise initially at an exercise price of $0.045 on the terms set forth under the warrants issued by the Company to Zaah, dated as of December 31, 2012,



(b) $100,000, accrued in full as of the date of the agreement, but payable

in twelve (12) months from the date hereof to a designee of Zaah's

selection, with a right to convert (at Zaah's sole discretion, from time

to time at any time) to shares of common stock at the prevailing market

price per share of common stock (which, as long as the common stock is

listed, shall be the closing price on the last trading day prior to such

issuance or sale of the common stock as traded on a national securities

exchange, the NASDAQ Global Market, the NASDAQ Capital Market, or another nationally recognized trading system (including Pink OTC Markets, Inc.)), and



(c) a commission of 10% of the revenue generated by any Company transaction

originated through the efforts of Zaah, as substantiated by a written agreement between the Company and Zaah, specifically referencing the transaction in which Zaah is entitled to such commission, payable by the Company to Zaah in cash. Such payment shall be made on the earlier of (i) the date of the signing of such transaction, (ii) the date of the closing of such transaction, or (iii) any date on which any funds are paid to the Company in respect to such transaction.



Patent and Technology License Agreement

In connection with the Investment Agreement, the Company entered into a Patent and Technology License Agreement with VerifyMe, pursuant to which VerifyMe granted the Company exclusive and non-exclusive licenses relative to a specific list of patents in return for the following:



(a) Payment 1, payable upon execution of the agreement on December 31, 2012:

The sum of One Hundred Thousand Dollars ($100,000), to be paid by

issuing (i) a number of shares of common stock, of the Company equal to

(x) $100,000 divided by (y) $0.045 (2,222,222 shares) and (ii) cashless

exercise warrants to purchase an equal number of shares exercisable at a

price of Ten Cents ($0.10) per share with a term of five (5) years.



(b) Payment 2, payable on January 1, 2014: The sum of Four Hundred Thousand

Dollars ($400,000), to be paid by issuing (i) a number of shares equal to (x) $400,000 divided by (y) a price which equals a 10% discount to market and (ii) cashless exercise warrants to purchase an equal number of shares exercisable at a price of Ten Cents ($0.10) per share with a term of five (5) years. (c) Payment 3, payable on January 1, 2015: The sum of Four Million Five Hundred Thousand Dollars ($4,500,000), to be paid by issuing (i) a number of shares equal to (x) $4,500,000 divided by (y) a price which



equals a 10% discount to market and (ii) cashless exercise warrants to

purchase an equal number of shares exercisable at a price of Ten Cents ($0.10) per share with a term of five (5) years. (d) Future Payments Contingent: The Company's payment of Payment 2 and



Payment 3 is contingent. To the extent that VerifyMe does not develop

and license to the Company at a time subsequent to Payment 1, further

technology and/or a further patent right related to the local, mobile

and cloud based biometric security systems, then any payments not

already paid, will not longer be due to VerifyMe, this nonperformance

being a likelihood, more likely than not. -31- Asset Purchase Agreement In connection with the Investment Agreement, the Company entered into an Asset Purchase Agreement with VerifyMe, pursuant to which the Company purchased trademark rights, software and a domain name at a purchase price of $100,000 to be paid by issuing shares equal to $100,000/0.045 (2,222,222 shares) and cashless exercise warrants to purchase an equal number of shares at an exercise price of ten cents per share with a term of five years.



The following agreement was executed on January 31, 2013 and provided the Company with $1 million in funding:

Subscription Agreement

VerifyMe subscribed to purchase 33,333,333 shares of the Company's preferred stock and a warrant to purchase 33,333,333 shares of the Company's common stock for $1 million at an exercise price of $0.12. This agreement was executed on January 31, 2013. In January and February 2013, the Company received $185,000 from the sales 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 as of the date of this report.



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.

Since our inception, we have focused on developing and implementing our business plan. Our business plan is dependent on our ability to raise capital through private placements of our common stock and/or preferred stock, through the possible exercise of outstanding options and warrants, through debt financing and/or through a future public offering of our securities. There is no assurance that we will raise sufficient capital in order to meet our goals of implementing a sales and marketing effort to introduce our products. -32- Our existing cash resources will not be sufficient to sustain our operations during the next twelve months, and we may need to raise additional funds. We intend to raise such financing through private placements and/or the sale of debt and equity securities. The issuance of additional equity would result in dilution to our existing shareholders. If we are unable to obtain additional funds when they are needed or if such funds cannot be obtained on terms favorable to us, we may be unable to execute our business plan or pay our costs and expenses as they are incurred, which could have a material, adverse effect on our business, financial condition and results of operations. Even if we are successful in raising sufficient capital, our ability to continue in business as a viable going concern can only be achieved when our revenues reach a level that sustains our business operations. While it is impossible to predict the amount of revenues, if any, that we may receive from our products, we presently believe, based solely on our internal projections, that we will generate revenues sufficient to fund our planned business operations if the products are marketed effectively in accordance with our plans. There can be no assurance that we will raise sufficient proceeds, or any proceeds, for us to implement fully our proposed business plan. Moreover, there can be no assurance that even if our products are marketed effectively, that we will generate revenues sufficient to fund our operations. In either situation, we may not be able to continue our operations and our business might fail.



Off-Balance Sheet Arrangements

As of March 31, 2014, we did not have any relationships with unconsolidated entities or financial partners, such as entities often referred to as structured finance or special purpose entities, established for the purpose of facilitating off-balance sheet arrangements or other contractually narrow or limited purposes. As such, we are not materially exposed to any financing, liquidity, market or credit risk that could arise if we had engaged in such relationships.



Critical Accounting Policies

Our financial statements are impacted by the accounting policies used and the estimates and assumptions made by management during their preparation. We have identified below the accounting policies that are of particular importance in the presentation of our financial position, results of operations and cash flows and which require the application of significant judgment by management. 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 Accounting Standards Codification 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 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 or not net-cash settlement of the derivative instrument is expected within 12 months of the balance sheet date.



Stock-based Compensation

We account for stock-based compensation under the provisions of FASB ASC Topic 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. We estimate 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.



We account for stock-based compensation awards to non-employees in accordance with FASB ASC Topic 505-50, Equity-Based Payments to Non-Employees ("ASC 505-50"). Under ASC 505-50, we determine 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 using variable accounting through the vesting dates based on the fair value of the options at the end of each period. -33- Revenue Recognition In accordance with Securities and Exchange Commission ("SEC") Staff Accounting Bulletin No. 104, Revenue Recognition (Codified in FASB ASC 605), we recognize 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) collectibility of the sales revenues 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.



Recently Issued Accounting Pronouncements

Recently issued accounting pronouncements are discussed in Note 1 of the Notes to Consolidated Financial Statements contained elsewhere in this report.


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