NOTE 2 – LIQUIDITY AND MANAGEMENT PLANS

As of September 30, 2014, the Company had a negative working capital balance and a cash balance of approximately $6.62 million and $1.47 million, respectively. Also as of September 30, 2014, the Company had $6.68 million, net, outstanding under its 8% Senior Secured Convertible Debentures (the “Debentures”). The Debentures were originally to mature on January 15, 2015; however, in connection with the Company’s entry into the Credit Agreement (discussed below) in January 2015. As of the date of the report, the Company has entered into an extension agreement with the holders of the Debentures which extends the maturity date until January 8, 2018. The maturity date now coincides with the maturity date of the Credit Agreement.

On January 8, 2015, the Company entered into a credit agreement with Heartland Bank (the “Credit Agreement”) which provides for a three-year senior secured term loan in an initial aggregate principal amount of $3,000,000, which principal amount may be increased to a maximum principal amount of $50,000,000 at the request of the Company, subject to certain conditions, and pursuant to an accordion advance provision in the Credit Agreement (the “Term Loan”). The availability of additional funds is generally based on the value of the Company’s proved developed producing (“PDP”) and proved undeveloped (“PUD”) reserves. The Company intends to use proceeds borrowed under the Credit Agreement to fund producing property acquisitions in North America, drill wells in the core of the Company’s lease positions and to fund working capital (See Note 13-Subsequent Events.)

As of February 23, 2015, the Company has $2.40 million in cash on hand and is currently producing approximately 70 barrels of oil equivalent (“BOE”) a day from eight economically producing wells.

On June 6, 2014, T.R. Winston executed a commitment to purchase or affect the purchase by third parties of an additional $15 million in Series A 8% Convertible Preferred Stock, to be consummated within ninety (90) days thereof. The agreement was subsequently extended and expired on February 22, 2015. On February 25, 2015, the Company and TRW agreed in principal to a replacement commitment, pursuant to which TRW has agreed to purchase or affect the purchase by third parties of an additional $7.5 million in Series A 8% Convertible Preferred Stock, to be consummated no later than February 23, 2016, with all other terms substantially the same as those of the original commitment.

The Company will require additional capital to satisfy its obligations, to fund its current drilling commitments, as well as its acquisition and capital budget plans; to help fund its ongoing overhead; and to provide additional capital to generally improve its negative working capital position. The Company anticipates that such additional funding will be provided by a combination of capital raising activities, including borrowing transactions, the sale of additional debt and/or equity securities, and the sale of certain assets and by the development of certain of the Company’s undeveloped properties via arrangements with joint venture partners. If the Company is not successful in obtaining sufficient cash to fund the aforementioned capital requirements, the Company would be required to curtail its expenditures, and may be required to restructure its operations, sell assets on terms which may not be deemed favorable and/or curtail other aspects of its operations, including deferring all or portions of the Company’s capital budget. There is no assurance that any such funding will be available to the Company on acceptable terms, if at all.

NOTE 3 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Basis of Presentation and Restatement

The condensed financial statements and accompanying footnotes are prepared in accordance with generally accepted accounting principles in the United States (“U.S. GAAP”).

The unaudited condensed financial information furnished herein reflects all adjustments, consisting solely of normal recurring items, which in the opinion of management are necessary to fairly state the financial position of the Company and the results of its operations for the periods presented.

This report should be read in conjunction with the Company’s financial statements and notes thereto included in the Company’s Form 10-K for the year ended December 31, 2013 filed with the Securities and Exchange Commission (the “SEC”) on June 11, 2014. The results of operations for the interim periods presented are not necessarily indicative of results for the entire year ending December 31, 2014. The financial statements in this Quarterly Report on Form 10-Q include the restated figures for the comparative periods in 2013, as provided in Amendment No. 1 to Form 10-Q/A to the Quarterly Report on Form 10-Q of Lilis Energy for the quarterly period ended September 30, 2013 (the “Amended Q3 2013 Report”).

In February 2015, the Company discovered an error in the valuation of the conversion derivative liability of the Company’s 8% Senior Secured Convertible Debentures (the “Debentures”) for the periods ended December 31, 2011, December 31, 2012, December 31, 2013, as well as the quarterly periods ended September 30, 2013, March 31, 2014 and June 30, 2014 (together, the “Relevant Periods”). Specifically, the calculation of the derivative liability included in the Company’s financial statements for the Relevant Periods only included the value of the price protection (anti-dilution) feature, when it should have included both the conversion option and the price protection feature embedded in the Debentures. The changes in the fair value of the derivative resulted in additional non-cash charges to the previously filed financial statements.

The Company has evaluated the effect of the error on all Relevant Periods in accordance with Staff Accounting Bulletin (“SAB”) 99 and SAB 108 and determined that the impact of the error on its previously filed annual financial statements for the fiscal years ended December 31, 2011, December 31, 2012, and December 31, 2013 was not material. However, the Company has concluded that the impact of these non-cash items in its previously filed quarterly financial statements for the fiscal quarters ended September 30, 2013, March 31, 2014 and June 30, 2014 was sufficiently material to warrant restatement of the Company’s previously filed Quarterly Reports on Form 10-Q for those periods. In addition, the Company will restate the immaterial amounts for the fiscal years ended December 31, 2011, December 31, 2012, and December 31, 2013 in its Annual Report on Form 10-K for the fiscal year ended December 31, 2014. The opening balance as of January 1, 2013 will be adjusted in the annual report on Form 10K for the fiscal year ended December 31, 2014 to reflect the restatement of the immaterial amounts for the fiscal year ended December 31, 2011 and 2012. The Company filed amended quarterly reports on Form 10-Q/A for the fiscal quarters ended September 30, 2013, March 31, 2014 and June 30, 2014 on February 23, 2015. This Quarterly Report should be read in conjunction with those amended quarterly reports on Form 10-Q/A, which resulted in retroactive changes to financial statements for those periods, including changes to net loss and net loss per common share.

Use of Estimates

The preparation of condensed financial statements in conformity with U.S. GAAP requires the Company to make a number of estimates and assumptions relating to the reported amounts of assets and liabilities and the 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 significantly from those estimates. Management evaluates estimates and assumptions on an ongoing basis using historical experience and other factors, including the current economic and commodity price environment.

The most significant financial estimates are associated with the Company’s estimated volumes of proved oil and natural gas reserves, asset retirement obligations, assessments of impairment imbedded in the carrying value of undeveloped acreage and undeveloped properties, fair value of financial instruments, estimated convertible debentures derivative liabilities, depreciation and accretion, income taxes and contingencies.

Oil and Natural Gas Properties

The Company follows the full cost method of accounting for oil and natural gas operations whereby all costs related to the exploration, non-production-related development and acquisition of oil and natural gas reserves are capitalized.  Such costs include land acquisition costs, geological and geophysical expenses, carrying charges on non-producing properties, costs of drilling, developing and completing productive wells and/or plugging and abandoning non-productive wells, and any other costs directly related to acquisition and exploration activities.  Proceeds from property sales are generally applied as a credit against capitalized exploration and development costs, with no gain or loss recognized, unless such a sale/conveyance would significantly alter the relationship between capitalized costs and the proved reserves attributable to these costs.  A significant alteration would typically involve a sale of 25% or more of proved reserves.

The Company accounts for its unproven long-lived assets in accordance with Accounting Standards Codification (“ASC”) Topic 360-10-05, Accounting for the Impairment or Disposal of Long-Lived Assets . ASC Topic 360-10-05 requires that long-lived assets be reviewed for impairment whenever events or changes in circumstances indicate that the historical cost carrying value of an asset may no longer be appropriate.

Depletion of exploration and development costs and depreciation of wells and tangible production assets is computed using the units-of-production method based upon estimated proved oil and natural gas reserves.  Costs included in the depletion base to be amortized include (a) all proved capitalized costs including capitalized asset retirement costs net of estimated salvage values, less accumulated depletion, (b) estimated future development costs to be incurred in developing proved reserves, and (c) estimated decommissioning and abandonment/restoration costs, net of estimated salvage values, that are not otherwise included in capitalized costs.

The costs of undeveloped acreage are withheld from the depletion base until it is determined whether or not proved reserves can be assigned to the properties. When proved reserves are assigned to such properties or one or more specific properties are deemed to be impaired, the cost of such properties or the amount of the impairment is added to the full cost pool which is subject to depletion calculations.

Under the full cost method of accounting, capitalized oil and natural gas property costs less accumulated depletion and net of deferred income taxes may not exceed an amount equal to sum of: i.) The present value, discounted at 10%, of estimated future net revenues from proved oil and natural gas reserves, plus ii.) The cost of unproved properties not subject to amortization (without regard to estimates of fair value), or estimated fair value, if lower, of unproved properties that are not subject to amortization.  Should capitalized costs exceed this ceiling, an impairment expense is recognized. As of September 30, 2014, the Company tested its oil and natural gas assets under the ceiling test which yielded no impairment.

The present value of estimated future net cash flows was computed by applying a flat oil and natural gas price to forecast revenues from estimated future production of proved oil and natural gas reserves as of period-end, less estimated future expenditures to be incurred in developing and producing the proved reserves (assuming the continuation of existing economic conditions), less any applicable future taxes.

Wells in Progress

Wells in progress denotes wells that are currently in the process of being drilled or completed or otherwise under evaluation as to their potential to produce oil and natural gas reserves in commercial quantities.  Such wells continue to be classified as capitalized wells in progress and withheld from the depletion calculation and the ceiling test until such time as either proved reserves can be assigned, or the wells are otherwise abandoned.  Upon either the assignment of proved reserves or abandonment, the costs for these wells are then transferred to the full cost pool and become subject to both depletion and the ceiling test calculations in accordance with full cost accounting under S-X Rule 4-10.

Asset Retirement Obligation

The Company incurs asset retirement obligations for certain oil and natural gas assets at the time they are placed in service.  The fair values of these obligations are recorded as liabilities on a discounted basis. The costs associated with these liabilities are capitalized as part of the related assets and accretion.  Over time, the liabilities are accreted for the change in their present value.

For purposes of depletion calculations, the Company also includes estimated dismantlement and abandonment costs, net of salvage values, associated with future development activities that have not yet been capitalized as asset retirement obligations.

Oil and Natural Gas Revenue

Sales of oil and natural gas, net of any royalties, are recognized when oil and natural gas have been delivered to a custody transfer point, persuasive evidence of a sales arrangement exists, the rights and responsibility of ownership pass to the purchaser upon delivery, collection of revenue from the sale is reasonably assured, and the sales price is fixed or determinable. Virtually all of the Company’s contracts’ oil and natural gas pricing provisions are tied to a NYMEX market index, with certain local differential adjustments based on, among other factors, whether a well delivers oil or natural gas to a gathering, refinery, marketing company, or transmission line and prevailing local supply and demand conditions. The price of the oil and natural gas fluctuates to remain competitive with other local oil suppliers.

Net Loss per Common Share

Earnings (losses) per common share are computed based on the weighted average number of common shares outstanding during the period presented. Diluted earnings (losses) per share are computed using the weighted-average number of common shares outstanding plus the number of common shares that would be issued assuming exercise or conversion of all potentially dilutive common shares. Potentially dilutive securities, such as shares issuable upon the conversion of debt or preferred stock, and exercise of stock purchase warrants and options, are excluded from the calculation when their effect would be anti-dilutive. As of September 30, 2014 and 2013 shares underlying options, warrants, preferred stock and convertible debentures have been excluded from the diluted share calculations as they were anti-dilutive as a result of net losses incurred.

The Company had the following common stock equivalents at September 30, 2014 and 2013:

Recent Accounting Pronouncements

In May 2014, the FASB issued Accounting Standards Update No. 2014-09 (ASU 2014-09), which creates Topic 606, Revenue from Contracts with Customers , and supersedes the revenue recognition requirements in Topic 605, Revenue Recognition, including most industry-specific revenue recognition guidance throughout the Industry Topics of the Codification. In addition, ASU 2014-09 supersedes the cost guidance in Subtopic 605-35, Revenue Recognition—Construction-Type and Production-Type Contracts, and creates new Subtopic 340-40, Other Assets and Deferred Costs— Contracts with Customers. In summary, the core principle of Topic 606 is that an entity recognizes revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. Additionally, ASU 2014-09 requires enhanced financial statement disclosures over revenue recognition as part of the new accounting guidance. The amendments in ASU 2014-09 are effective for annual reporting periods beginning after December 15, 2016, including interim periods within that reporting period, and early application is not permitted. The Company is currently evaluating the provisions of ASU 2014-09 and assessing the impact, if any, it may have on its condensed financial position and results of operations.

In June 2014, FASB issued Accounting Standards Update 2014–12, C ompensation – Stock Compensation (Topic 718), which clarifies accounting for share–based payments for which the terms of an award provide that a performance target could be achieved after the requisite service period. That is the case when an employee is eligible to retire or otherwise terminate employment before the end of the period in which a performance target could be achieved and still be eligible to vest in the award if and when the performance target is achieved. The updated guidance clarifies that such a term should be treated as a performance condition that affects vesting. As such, the performance target should not be reflected in estimating the grant–date fair value of the award. Compensation cost should be recognized in the period in which it becomes probable that the performance target will be achieved and should represent the compensation cost attributable to the periods for which the requisite service has already been rendered. The guidance will be effective for the annual periods (and interim periods therein) ending after December 15, 2015. Early application is permitted. The Company is currently evaluating the effects of ASU 2014–12 on the condensed financial statements.

In August 2014, the Financial Accounting Standards Board issued Accounting Standards Update 2014–15, Presentation of Financial Statements – Going Concern.   The Update provides U.S. GAAP guidance on management’s responsibility in evaluating whether there is substantial doubt about a company’s ability to continue as a going concern and about related footnote disclosures. For each reporting period, management will be required to evaluate whether there are conditions or events that raise substantial doubt about a company’s ability to continue as a going concern within one year from the date the financial statements are issued.  This Accounting Standards Update is the final version of Proposed Accounting Standards Update 2013–300—Presentation of Financial Statements (Topic 205): Disclosure of Uncertainties about an Entity’s Going Concern Presumption, which has been deleted. The Company is currently evaluating the effects of ASU 2014–15 on the condensed financial statements.

Management does not believe that these or any other recently issued, but not yet effective accounting pronouncements, if adopted, would have a material effect on the accompanying condensed financial statements.

Subsequent Events

The Company evaluates subsequent events through the date the condensed financial statements are issued.

NOTE 4 – OIL AND NATURAL GAS PROPERTIES

On September 2, 2014, the Company entered into an agreement to convey its interest in 31,725 evaluated and unevaluated net acres located in the Denver Julesburg Basin and the associated oil and natural gas production (the “Hexagon Collateral”) to its primary lender, Hexagon, LLC (“Hexagon”) in exchange for extinguishment of all outstanding debt and accrued interest obligations owed to Hexagon aggregating to $14,833,311. The conveyance assigned all assets and liabilities associated with the property, which includes PDP and PUD reserves, plugging and abandonment, and other assets and liabilities associated with the property. Pursuant to the agreement, the Company also issued to Hexagon $2.0 million in Conditionally Redeemable 6% Preferred Stock, which is recognized as temporary equity.

Under the full cost method, sales or abandonments of oil and natural gas properties, whether or not being amortized, are accounted for as adjustments of capitalized costs, with no gain or loss recognized, unless such adjustments would significantly alter the relationship between capitalized costs and proved reserves of oil and natural gas attributable to the cost center. The conveyance to Hexagon represented greater than 25 percent of the Company’s proved reserves of oil and natural gas attributable to the full cost pool, as a result, there was a significant alteration in the relationship between capitalized costs and proved reserves of oil and natural gas attributable to the full cost pool. Total capitalized costs within the full cost pool are allocated on the basis of the relative fair values of the properties sold and those retained due to substantial economic differences between the properties sold and those retained.

The following table represents an allocation of the transaction:

NOTE 5 – WELLS IN PROGRESS

As of September 30, 2014 and December 31, 2013, the Company had $6.04 million and $1.15 million of wells in progress, respectively. Wells in progress are related to certain wells in the Company’s core development program within the Northern Wattenberg field. The Company has capitalized and accrued approximately $5.70 million of costs through September 30, 2014 associated with these wells, which are currently in dispute.

The dispute relates to the Company ownership in certain wells being reduced and or eliminated from a possible farm-out.  The operator of the producing wells claims the Company entered into a farm-out which will reduce the Company’s ownership in the wells. As of February 23, 2015, the Company is currently attempting to negotiate a settlement to this dispute or will pursue litigation to resolve the dispute. The Company will continue analyzing the ownership of the wells on a periodic basis to determine if any impairment is deemed necessary. If the dispute is resolved in favor of the Company, the value of the assets will be transferred to the full cost pool and the accrual of $5.20 million will be relieved from accrued expenses.

During 2014, the Company transferred $0.47 million from wells-in progress to developed oil and natural gas properties for one of its other wells in Northern Wattenberg, when it became producing and economic. The amount transferred to producing properties represents 12.5% of the total 25% interest owned by the Company. The remaining 12.5% ownership in the well is currently being accrued at $0.50 million for the authorization for expenditure to drill the wells, since the remaining ownership is being disputed by the mineral owners. The Company purchased the rights from both royalty owners which claimed ownership of the mineral rights. The Company has secured its 12.5% ownership by paying both owners $0.10 million (total $0.20 million). The payment was recorded as an asset to obtain the right to the minerals. By securing the interest with both interest owners, the Company’s interest will remain at 25%.

The mineral owners are disputing the validity of an overriding royalty interest, and as a result, the operator of the well is currently holding revenues from the Company until the dispute is resolved. The Company believes the well is near payout and this should be resolved in the near future. The Company is currently accruing the remaining 12.5% authorization of expenditure and deferring the revenue in a suspense receivable account. As of February 23, 2015, the Company received notification that the settlement between both royalty owners has been settled. As a result, the Company is working with the operator to receive payment of its interest.

NOTE 6 - DERIVATIVES

Oil Price Hedging

The Company is exposed to fluctuations in crude oil prices for all of its production. In order to mitigate the effect of commodity price volatility and enhance the predictability of cash flows relating to the marketing of the Company’s crude oil, from time to time, the Company enters into crude oil price hedging arrangements with respect to a portion of its expected production. Realized gains and losses are recorded as income or expenses in the periods during which applicable contracts mature and settle. As of December 31, 2013, such hedges were not material and as of September 30, 2014, the Company did not maintain any commodity derivatives.

NOTE 7 - FAIR VALUE OF FINANCIAL INSTRUMENTS

The Company measures the fair value of its financial assets on a three-tier value hierarchy, which prioritizes the inputs, used in the valuation methodologies in measuring fair value:

The fair value hierarchy also requires an entity to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value.

The Company’s accounts receivable, accounts payable, accrued expenses and interest payable approximate fair value due to the short-term nature or maturity of the instruments.

Convertible Debentures Conversion Derivative Liability

As of September 30, 2014, the Company had $6.68 million, net, in remaining Debentures which are convertible at any time at the holders’ option into shares of Common Stock at $2.00 per share, or 3,364,016 underlying conversion shares. The debentures have elements of a derivative from the ability for certain adjustments, including both the conversion option and the price protection embedded in the Debentures. The conversion option allows the Debenture holders to convert their Debentures to the underlying common stock at $2.00. When the price of the common stock exceeds $2.00, it is more attractive for the Debenture holders to convert. Adversely, the price protection protects the holder of the Debenture for any capital raises with a strike price lower than $2.00 per share. The Company values this conversion liability at each reporting period using a Monte Carlo pricing model.

Common stock incentive options

The Executive Stock Incentive Options Bonus was issued on September 16, 2013 as a part of the employment agreement with the current Chief Executive Officer. The incentive bonus contains a target provision, whereby the bonus amount to be earned by the executive may vary between 0% and 300%, depending on the Company achieving certain operating milestones. The change in fair value for the common stock incentive option bonus is recorded in general and administrative expenses.

The following table provides a summary of the fair values of assets and liabilities measured at fair value (in thousands):

September 30, 2014:

December 31, 2013:

The following table provides a summary of changes in fair value of the Company’s Level 3 financial assets and liabilities:

The Company did not have any transfers of assets or liabilities between Level 1, Level 2 or Level 3 of the fair value measurement hierarchy during the three and nine months ended September 30, 2014 or 2013.

10% Term Loans

Prior to September 2, 2014, the Company had three term loans with Hexagon, its senior lender, with an aggregate outstanding principal amount of approximately $19.83 million. The loans required the Company to make monthly payments of $0.23 million consisting of interest and principal. On May 19, 2014, the Company received an extension from Hexagon of the maturity date under its term loans, from May 16, 2014 to August 15, 2014. In connection with the extension, the Company paid a forbearance fee of $0.25 million which was recorded as deferred financing cost and amortized over the extension period of the term loans.

On May 30, 2014, the Company entered into the First Settlement Agreement with Hexagon, which provided for the settlement of all amounts outstanding under the term loans. In connection with the execution of the First Settlement Agreement, the Company made an initial cash payment of $5.0 million reducing the total principal and interest due under the term loan from $19.83 million to $14.83 million. The First Settlement Agreement required the Company to make an additional cash payment of $5.0 million (the “Second Cash Payment”) by August 15, 2014, and at that time issue to Hexagon (i) a two-year $6.0 million unsecured note (the “Replacement Note”), bearing interest at an annual rate of 8%, requiring principal and interest payments of $90,000 per month, and (ii) 943,208 shares of unregistered Common Stock (the “Shares”). The parties also agreed that if the Second Cash Payment was not made by June 30, 2014, an additional $1.0 million in principal would be added to the Replacement Note, and if the Replacement Note was not retired by December 31, 2014, the Company would issue an additional 1.0 million shares of Common Stock to Hexagon. The first settlement agreement was superseded by the final settlement agreement which is discussed below.

On September 2, 2014, the Company entered into the Final Settlement Agreement with Hexagon which replaced the First Settlement Agreement, pursuant to which, in exchange for full extinguishment of all amounts outstanding under the term loans (approximately $14.83 million in principal and interest as of the settlement date), the Company assigned Hexagon the Hexagon Collateral, which consisted of approximately 32,000 net acres including 17 producing wells that consisted of several economic wells which secured properties with PDP reserves and PUD reserves with a carrying value of approximately $16.5 million. The Company also conveyed $0.97 million in asset retirement obligations (“ARO”) for the 17 active and several non-producing wells. In addition to the conveyance of oil and natural gas property, the Company issued to Hexagon $2,000,000 in 6% Conditionally Redeemable Preferred Stock with a par value of $0.0001, stated value of $1,000 and dividends paid on a quarterly basis. As a result of this conveyance, the Company recorded a loss on conveyance of property during the three and nine months ended September 30, 2014 of approximately $2.7 million.

8% Convertible Debentures

In numerous separate private placement transactions between February 2011 and October 2013, the Company issued an aggregate of approximately $15.6 million of Debentures, secured by mortgages on several of its properties. The Debentures are currently convertible at the holders' option into shares of Common Stock at $2.00 per share, subject to certain adjustments which include a convertible option and price protection, and bear interest at an annualized rate of 8%, payable quarterly on each May 15, August 15, November 15 and February 15 in cash or, at the Company's option subject to certain conditions, in shares of Common Stock. The interest option price is calculated using a 10 day VWAP discounted by 10% and applied to the outstanding interest.

On January 31, 2014, the Company entered into a "Conversion Agreement" with all of the holders of the Debentures. Pursuant to the terms of the Conversion Agreement, $9.00 million in Debentures (approximately $8.85 million of principal and $0.15 million in interest) was converted by the holders to shares of common stock at a conversion price of $2.00 per share of Common Stock. In addition, the Company issued warrants to the Debenture holders to purchase one share of Common Stock for each share issued in connection with conversion of the Debentures, at an exercise price equal to $2.50 per share (see Inducement Expense, discussed below).  As of September 30, 2014, the Company had $6.68 million, net, remaining Debentures which are convertible at any time at the holders’ option into shares of Common Stock at $2.00 per share, subject to certain adjustments, including the requirement to reset the conversion price based upon any subsequent equity offering at a lower price per share amount.

During September 30, 2014 and December 31, 2013, the Company valued the conversion feature associated with the Debentures at $1.54 million and $0.61 million, respectively. The Company used the following inputs to calculate the valuation of the derivative as of September 30, 2014: volatility 70%; conversion price $2.00; stock price $2.25; and present value of conversion feature $0.47 per convertible share. For the year ended December 31, 2013, the Company valued the derivative using the following inputs: volatility 70%, stock price $2.32, conversion price $4.25, risk free rate 0.38%, and present value of conversion feature of $0.17 per convertible share. The Company utilized a Monte Carlo model to value both conversion features.

The Company’s failure to meet its obligations under the First Settlement Agreement with Hexagon constituted a default under the term loans, which in turn triggered an event of default under the Debentures. However, the holders of the Debentures waived their right to declare a default in respect of that matter.

The Debentures were to mature on January 15, 2015; however, as of the date of this filing, the Company has received waivers from each Debenture holders extending the maturity date thereunder to match the maturity date of the Credit Agreement to January 8, 2018.

Convertible Debenture Interest

During the nine months ended September 30, 2014, the Company elected to fund their interest payment for their convertible debentures with stock and issued 70,000 shares valued at $0.15 million which is an add back to accrued expense in the cash flow and further disclosed in the supplemental disclosure. The interest was accrued for past interest from November 15, 2013 to January 2014.

Inducement Expense

On January 31, 2014, the Company entered into a Debenture Conversion Agreement (the “Conversion Agreement”) with all of the holders of the Debentures.  Under the terms of the Conversion Agreement, $9.0 million of the approximately $15.6 million in Debentures outstanding as of January 30, 2014 immediately converted to shares of common stock at a price of $2.00 per common share.  As additional inducement for the conversions, the Company issued warrants to the converting Debenture holders to purchase one share of Common Stock, at an exercise price equal to $2.50 per share (the “Warrants”), for each share of Common Stock issued upon conversion of the Debentures. Utilizing Black Scholes option price model, with a 3 year life and 65% volatility, risk free rate of 0.2%, and the market price of $3.05. The Company recorded an inducement expense of $6.61 million, during the nine months ended September 30, 2014 for the warrants issued to induce the convertible debentures to convert their debt to Common Stock. T.R. Winston acted as the investment banker for the Conversion Agreement and was compensated by issuing 225,000 shares of the Company’s common stock and valued at a market price of $3.05 per share. During the nine months ended September 30, 2014, the Company valued the investment banker compensation at $0.69 million, which was expensed immediately.

Under the terms of the Conversion Agreement, the balance of the Debentures may be converted to common stock on the terms provided in the Conversion Agreement (including the terms related to the warrants) at the holder’s option, subject to receipt of shareholder approval as required by NASDAQ continued listing requirements. The Company intends to present proposals to approve the conversion of the remaining outstanding Debentures at its 2015 annual meeting of shareholders.

NOTE 9 - COMMITMENTS and CONTINGENCIES

Environmental and Governmental Regulation

At September 30, 2014, there were no known environmental or regulatory matters which are reasonably expected to result in a material liability to the Company. Many aspects of the oil and gas industry are extensively regulated by federal, state, and local governments in all areas in which the Company has operations. Regulations govern such things as drilling permits, environmental protection and air emissions/pollution control, spacing of wells, the unitization and pooling of properties, reports concerning operations, land use, royalty rates and various other matters including taxation. Oil and natural gas industry legislation and administrative regulations are periodically changed for a variety of political, economic, and other reasons. As of September 30, 2014 the Company had not been fined or cited for any violations of governmental regulations that would have a material adverse effect upon the financial condition of the Company.

Legal Proceedings

The Company may from time to time be involved in various legal actions arising in the normal course of business. In the opinion of management, the Company’s liability, if any, in these pending actions would not have a material adverse effect on the financial position of the Company. The Company’s general and administrative expenses would include amounts incurred to resolve claims made against the Company.

Parker v. Tracinda Corporation , Denver District Court, Case No. 2011CV561. In November 2012, the Company filed a motion to intervene in garnishment proceedings involving Roger Parker, the Company’s former Chief Executive Officer and Chairman. The Defendant, Tracinda, served various writs of garnishment on the Company to enforce a judgment against Mr. Parker seeking, among other things, shares of unvested restricted stock. The Company asserted rights to lawful set-offs and deductions in connection with certain tax consequences, which may be material to the Company. The underlying judgment against Mr. Parker was appealed to the Colorado Court of Appeals and, by Order dated October 17, 2013, that Court reversed the trial court with respect to Mr. Parker’s claims of waiver, estoppel and mitigation of damages and remanded with instruction to enter judgment for Mr. Parker. The Court of Appeals also ordered the trial court to conduct further proceedings to determine the amount of damages to award Mr. Parker on his breach of contract claim. The trial court conducted a later hearing and found in its Findings of Fact, Conclusions of Law and Order dated January 9, 2015, in favor of Mr. Parker on his claim for breach of contract, awarding him $6,981,302.60. Tracinda’s Motion for Amendment of the Court’s January 9 Findings and Conclusions is pending.

In re Roger A. Parker: Tracinda Corp. v. Recovery Energy, Inc. and Roger A. Parker , United States Bankruptcy Court for the District of Colorado, Case No. 13-10897-EEB. On June 10, 2013, Tracinda Corp. (“Tracinda”) filed a complaint (Adversary No. 13-01301 EEB) against the Company and Roger Parker in connection with the personal bankruptcy proceedings of Roger Parker, alleging that the Company improperly failed to remit to Tracinda certain property in connection with a writs of garnishment issued by the Denver District Court (discussed above). The Company filed an answer to this complaint on July 10, 2013. A trial date has not been set and, by Order dated February 2, 2015, the Bankruptcy Court ordered that the Adversary Proceeding be held in abeyance pending final resolution of the state-court action (2011CV561). The Company is unable to predict the timing and outcome of this matter.

From time to time the Company is involved in legal proceedings arising in the ordinary course of business. The Company believes there is no other litigation pending that could have, individually or in the aggregate, a material adverse effect on its results of operations or financial condition.

NOTE 10 - SHAREHOLDERS’ EQUITY

January 2014 Private Placement

In January 2014, the Company entered into and closed a series of subscription agreements with accredited investors, pursuant to which the Company issued an aggregate of 2,959,125 units, with each unit consisting of (i) one share of the Common Stock and (ii) one three-year warrant to purchase one share of Common Stock, at an exercise price equal to $2.50 per share (together, the “Units”), for a purchase price of $2.00 per Unit, for aggregate gross proceeds of $5,918,250 (the “January Private Placement”).  The warrants are not exercisable for six months following the closing of the January Private Placement. As of February 23, 2015, the underlying common shares have not been registered. The warrants still can be exercised without an effective registration statement on file. The Company will be filing a registration statement during the year 2015. The Company valued the warrants within the Unit, utilizing a Black Scholes Option Pricing Model using a volatility calculation of 65%, and 3 year term, the relative fair value allocated to warrants were approximately $1.69 million. The Company paid $1.06 million in financing fees to T.R. Winston.

Series A 8% Convertible Preferred Stock

On May 30, 2014, the Company consummated a private placement of 7,500 shares of Series A Preferred, along with detachable warrants to purchase up to 1,556,016 shares of Common Stock at an exercise price of $2.89 per share, for aggregate proceeds of $7.50 million. The Series A Preferred has a par value of $0.0001 per share, a stated value of $1,000 per share, a conversion price of $2.41 per share, and a liquidation preference to any junior securities. Except as otherwise required by law, holders of Series A Preferred shall not be entitled to voting rights, except with respect to proposals to alter or change adversely the powers, preferences or rights given to the Series A Preferred, authorize or create any class of stock ranking senior to the Series A Preferred as to dividends, redemption or distribution of assets upon liquidation, amend its certificate of incorporation or other charter documents in any manner that adversely affects any rights of the Preferred Stock holder, or increase the number of authorized Series A Preferred Stock. The holders of the Series A Preferred are entitled to receive a dividend payable, at the election of the Company (subject to certain conditions as set forth in the Certificate of Designations), in cash or shares of Common Stock, at a rate of 8% per annum payable a day after the end of each quarter. The Series A Preferred is convertible at any time at the option of the holders, or at the Company’s discretion when Common Stock trades above $7.50 for ten consecutive days with a daily dollar trading volume above $300,000. In addition, the Company has the right to redeem the shares of Series A Preferred, along with any accrued and unpaid dividends, at any time, subject to certain conditions as set forth in the Certificate of Designations. In addition, holders of the Series A Preferred can require the Company to redeem the Series A Preferred upon the occurrence of certain triggering events, including (i) failure to timely deliver shares of Common Stock after valid delivery of a notice of conversion by the holder; (ii) failure to have available a sufficient number of authorized and unreserved shares of Common Stock to issue upon conversion; (iii) the occurrence of certain change of control transactions; (iv) the occurrence of certain events of insolvency; and (v) the ineligibility of the Company to electronically transfer its shares via the Depository Trust Company or another established clearing corporation.

The Series A Preferred is classified as equity based on the following criteria: i) the redemption of the instrument at the control of the Company; ii) the instrument is convertible into a fixed amount of shares at a conversion price of $2.41; iii) the instrument is closely related to the underlying Company’s common stock; iv) the conversion option is indexed to the Company’s stock; v) the conversion option cannot be settled in cash and only can be redeemed at the discretion of the Company; vi) and the Series A Preferred is not considered convertible debt.

In connection with the issuance of the Series A Preferred, the Company also issued a warrant for 50% of the amount of shares of Common Stock into which the Series A Preferred is convertible.

In connection with issuance of the Series A Preferred, the beneficial conversion feature (“BCF”) was valued at $2.25 million and the fair value of the warrant were valued at $1.35 million. The BCF was valued at $3.6 million was considered a deemed dividend and the full amount was expensed immediately.

The Company determined the transaction created a beneficial conversion feature which is calculated by taking the net proceeds of $6.79 million and valuing the warrants as of May 2014, utilizing a Black Scholes option pricing model. The inputs for the pricing model are: $2.48 market price per share; exercise price of $2.89 per share; expected life of 3 years; volatility of 70%; and risk free rate of 0.20 %. The Company calculated the total consideration given to be $8.40 million comprised of $5.50 million for the Series A Preferred and $1.30 million for the warrants. The Company deemed the value of the beneficial conversion feature to be $2.21 million and immediately accreted that amount as a deemed dividend. As of September 30, 2014, the Company has accrued a cumulative dividend for $0.11 million, which was paid fully on October 1, 2014. 

Conditionally Redeemable 6% Preferred Stock

In August 2014, the Company designated 2,000 shares of its authorized preferred stock as “Conditionally Redeemable 6% Preferred Stock” (“Redeemable Preferred”). The Redeemable Preferred has the same par value and stated value characteristics and liquidation preferences of the Series A preferred stock, yet the 6% Conditionally Redeemable Preferred is not convertible into common stock or any other securities of the Company. Except as otherwise required by law, holders of the Redeemable Preferred shall not be entitled to voting rights.

The Redeemable Preferred Stock bears a 6% dividend per annum, payable quarterly, and is redeemable at face value (plus any accrued and unpaid dividends) at any time at the Company’s option, or at the Holders option upon the Company’s achievement of certain production and reserves thresholds. As of September 30, 2014, the Company accrued $0.01 million of accrued dividends during the period. In September 2014, the 2,000 shares of Redeemable Preferred Stock were issued pursuant to the Settlement Agreement with Hexagon at a value of $2.0 million.

Consulting Agreement with Market Development Consulting Group, Inc. (“MDC”)

In January 2014, the Company entered into a consulting agreement with MDC, a public relations company. The agreement provided for the issuance by the Company of 90,000 shares of Common Stock, 350,000 warrants to purchase common shares, and cash of $0.1 million a month.

The 90,000 shares of Common Stock were issued on February 7, 2014 with an original market price of $3.35 for a total value of $0.30 million. The fair value of the shares amortized over the life of the contract, or until December 31, 2014 which were revalued at each reporting period. As of September 30, 2014, the Company had 25,322 shares remaining to vest at a value of $0.06 million. During the three and nine months ended September 30, 2014, the Company amortized the non-cash consulting expense for the Common Stock issued of $0.06 million and $0.20 million, respectively.

The 350,000 warrants were valued using the Black Scholes option pricing model with the following inputs: (i) 350,000 warrants to purchase common stock; (ii) assumed stock price $2.33; (iii) strike price $4.25 for 100,000 and $2.33 for 250,000 warrants; volatility 45%; risk free rate of 0.20%; and expected life of 5 years. The valuation yielded a value of $0.40 million. The warrant value vested immediately and was recognized as stock based non-employee compensation.

Investment Banking Agreement

During the year ended December 31, 2013, the Company was party to a one-year, non-exclusive investment banking agreement with T.R. Winston, pursuant to which the Company issued to T.R. Winston 100,000 common shares, and 900,000 common stock purchase warrants. All warrants have a term of three years and a strike price of $4.25 per share, risk free rate of 0.20%, common stock price $1.880, volatility 63% valued at $0.26 million and amortized over the life of the contract. As of September 30, 2014, the full $0.26 million has been expensed through general and administrative expenses.

Consulting Agreement with Bristol Capital

On September 2, 2014, the Company entered into a Consulting Agreement (the “Consulting Agreement”) with Bristol Capital, LLC (“Bristol”). Pursuant to the Consulting Agreement, Bristol agreed to assist the Company in general corporate activities including but not limited to strategic planning; management and business operations; introductions to further its business goals; advice and services related to the Company’s growth initiatives; and any other consulting or advisory services the Company reasonably requests that Bristol provide to the Company. The Consulting Agreement has a term of three years. In connection with the Consulting Agreement and as compensation for the services to be provided by Bristol thereunder, the Company issued to Bristol a warrant to purchase up to 1,000,000 shares of Common Stock at an exercise price of $2.00 per share (the “Bristol Warrant”). In addition, the Company issued to Bristol an option to purchase up to 1,000,000 shares with no forfeitures provisions. The Bristol Option is intended as an alternative to the Bristol Warrant, and will automatically terminate upon and to the extent the Bristol Warrant is exercised. Likewise, if and to the extent the Bristol Option is exercised, the Bristol Warrant will terminate. If the Company has not registered the Common Shares underlying the Bristol Warrants within six months following the execution of the Consulting Agreement, Bristol may elect to terminate the Bristol Warrant and retain the Bristol Option, or to terminate the Bristol Option and retain the Bristol Warrant, but in either case may only retain either the Warrant or the Option. In no event will Bristol have the right to exercise, in whole or in part, the Bristol Warrant and/or Bristol Option for a number of shares in excess of 1,000,000. Each of the Bristol Warrant and the Bristol Option (whichever ultimately remains outstanding) has a term of five years. The Consulting Agreement does not include any cash payment. The Company used a Black Scholes option pricing model to value the warrants/options using the following variables: (i) warrants/options issued 1,000,000 total (as stated above, the Company will only issue a total of 1,000,000 shares of Common Stock under the option or the warrant, but no more than 1,000,000 shares in the aggregate); (ii) stock price $1.47; (iii) exercise price $ 2.00; expected life of 5 years; volatility of 60%; risk free rate of 0.20% for a total value of $0.62 million, which was expensed immediately. The warrants/options did not have any cancellation or forfeiture provisions in the contract and as a result, the amounts were fully recognized at the date of issuance.

The weighted average remaining contract life of the warrants, as of September 30, 2014, was 1.09 years. These warrants are valued at $63.17 million. These warrants are cash warrants and the holders must pay the Company the full exercise price in cash. The intrinsic value of the warrants as of September 30, 2014 is $0.25 million.

NOTE 11 - SHARE BASED AND OTHER COMPENSATION

Share-Based Compensation

In September 2012, the Company adopted the 2012 Equity Incentive Plan (the “EIP”). The EIP was amended by the stockholders on June 27, 2013 to increase the number of shares of Common Stock available for grant under the EIP from 900,000 shares to 1,800,000 shares and again on November 13, 2013 to increase the number of shares of Common Stock available for grant under the EIP from 1,800,000 shares to 6,800,000 shares and to increase the number of shares of Common Stock eligible for grant under the EIP in a single year to a single participant from 1,000,000 shares to 3,000,000 shares. Each member of the board of directors and the management team has been periodically awarded restricted stock grants, and in the future may be awarded such grants under the terms of the EIP.

The value of employee services received in exchange for an award of equity instruments are based on the grant-date fair value of the award, recognized over the period during which an employee is required to provide services in exchange for such award.

During the nine months ended September 30, 2014, the Company granted 324,428 shares of restricted common stock and 1,500,000 stock options, to employees, directors and consultants, which 2,212,084 shares of restricted common stock and stock options that had previously been granted under the EIP were forfeited in connection with the termination of certain employees, directors and consultants. The 1,500,000 options to purchase common stock were subsequently forfeited upon the resignation of Robert A. Bell, ex-COO/ President. As a result, the Company currently has 1,852,928 restricted shares and 3,600,000 options to purchase common shares outstanding to employees and directors. The restricted shares are included in the outstanding share count in the balance sheet and at the front of this document, yet they are currently on a vesting schedule based on service. Some of the options vest based on time and other options to purchase common stock are vested based certain operating thresholds.

The Company recognized a restricted stock share based compensation expense of approximately $2.67 million, net of a credit of $0.31 million for cancelled Plan shares and options for the nine months ended September 30, 2014. The elements of share based compensation are as follows:

As of September 30, 2014, total unrecognized compensation cost related to unvested stock grants was approximately $0.18 million, which is expected to be recognized over a weighted-average remaining service period of 1years. 

Employment and Separation Agreements

W. Phillip Marcum

In April 2014, the Company entered into a separation agreement (the “Marcum Agreement”) with W. Phillip Marcum, its Former Chief Executive Officer, in connection with his resignation from his positions with the Company. The Marcum Agreement provides, among other things, that, consistent with his resignation for good reason under his Employment Agreement, the Company would pay him 12 months of severance through payroll continuation, in the gross amount of $220,000, less all applicable withholdings and taxes, that all stock options held by Mr. Marcum as of the time of his termination would immediately vest, and that Mr. Marcum would remain eligible to receive any performance bonus granted by the Company to its senior executives with respect to Company and/or executive performance in 2013. In addition, the Marcum Agreement provides that the Company would pay Mr. Marcum $150,000 in accrued base salary for his service in 2013, less all applicable withholdings and taxes, in exchange for Mr. Marcum’s forfeiture of the 93,750 shares of unvested restricted common stock of the Company that was issued to Marcum in June 2013 in lieu of such base salary. Mr. Marcum may elect to apply amounts payable under the Marcum Agreement against his commitment to invest $125,000 in the Company’s previously disclosed private offering, upon shareholder approval of the participation of the Company’s officers and directors in that offering. The Marcum Agreement also contains certain mutual non-disparagement covenants, as well as certain mutual confidentiality, non-solicitation and non-compete covenants. In addition, Mr. Marcum and the Company each mutually released and discharged all known and unknown claims against the other and their respective representatives that they had or presently may have, including claims relating to Mr. Marcum’s employment. The Marcum Agreement effectively terminated the previously disclosed Employment Agreement entered into between Mr. Marcum and the Company, dated as of June 25, 2013 and all items were immediately accrued.

In connection with the Marcum Agreement, the Company reversed the 200,000 unvested options previously issued to Mr. Marcum valued at $0.07 million, and reissued fully vested options, which it valued utilizing the Black Scholes option pricing model at $0.41 million. The Company used a Black Scholes option pricing model to value the 200,000 options which Mr. Marcum retained using the following variables: i) 200,000 options; ii) stock price $ 3.50; iii) strike price $1.60; volatility 65%; and a total value of $0.41 million which is expensed immediately since under the terms of his separation agreement, the Company is not to be provided any additional services.

Robert A. Bell

On August 1, 2014, the Company entered into a separation agreement with Robert A. Bell, its former president and chief operating officer (the “Separation Agreement”). The Separation Agreement provides, among other things, that the Company would pay to Mr. Bell an aggregate of $100,000 in cash and issue to Mr. Bell 66,667 shares of Common Stock, in addition to satisfying the Company’s outstanding obligation to pay Mr. Bell $100,000 in cash and issue to Mr. Bell 33,333 shares of Common Stock. The Separation Agreement also contains certain mutual covenants, and reaffirms the survival of certain confidentiality provisions contained in the Employment Agreement dated as of May 1, 2014 between the Company and Mr. Bell. In addition, Mr. Bell and the Company each mutually released and discharged all known and unknown claims against the other and their respective representatives that they had or presently may have, including claims relating to Mr. Bell’s employment. The total amount was fully expensed as of September 30, 2014 for $0.26 million.

In connection with the termination of his employment, Mr. Bell forfeited the 1,500,000 stock options that were unvested at the time of his termination and the Company reversed $0.30 million.

A .Bradley Gabbard

In May 2014, in connection with his resignation as CFO of the Company, A. Bradley Gabbard forfeited the 200,000 options that were unvested at the time of his termination. At the date of his resignation, the Company recorded a credit of $0.07 million into the shareholder employee compensation expense account. Additionally, Mr. Gabbard forfeited his respective 52,084 shares of unvested restricted stock, for which the Company recorded a reversal of $0.07 million.

Board of Directors

In October 2013, the Company granted each of its independent directors 200,000 non-statutory options to purchase Common Stock at an exercise price of $2.05, equal to the closing price at October 24, 2013. The options vest one-third for the next three years on the anniversary grant date. The value of the 600,000 options at grant date was $0.64 million and will be amortized over the vesting period.

In connection with execution of an amended independent agreement, each director also agreed to receive 31,250 shares of restricted common stock in lieu of a portion of their cash salaries, to vest on April 15, 2014. During the three and nine months ended September 30, 2104, the Company recognized $0.05 million and $0.20 million, respectively.

The average life of the options is 3 years and has no intrinsic value as of September 30, 2014.

As of September 30, 2014, the Company has 3,600,000 options outstanding which have an unrecognized expense to be expensed over the next 25 months of $0.50 million.

NOTE 12- RELATED PARTY TRANSACTIONS

Abraham Mirman

Transactions between the Company and Abraham Mirman

The Company’s Chief Executive Officer (“CEO”) is an indirect owner of a group which converted approximately $0.22 million of Debentures in connection with the $9.00 million of Debentures converted in January 2014,and was paid $0.01 million in interest at the time of the Debenture conversion.

During the January 2014 private placement, Mr. Mirman entered into a subscription agreement with the Company to invest $0.50 million, for which Mr. Mirman will receive 250,000 shares of stock and 250,000 warrants. The subscription agreement will not be consummated until a shareholder meeting is conducted to allow executives and board directors the ability to participate in the offering.

During the May Private Placement, Mr. Mirman invested $0.25 million, for which Mr. Mirman received 250 shares of Series A Preferred and 51,867 warrants.

In September 2013, the Company appointed Abraham Mirman as its President and in April 2014 he was appointed to serve as the Company’s Chief Executive Officer. Prior to joining the Company, Mr. Mirman was employed by TRW as its Managing Director of Investment Banking and until September 2014 continued to devote a portion of his time to serving in that role. In connection with the appointment of Mr. Mirman, the Company and TRW amended the investment banking agreement in place between the Company and TRW at that time to provide that, upon the receipt by the Company of gross cash proceeds or drawing availability of at least $30,000,000, measured on a cumulative basis and including certain restructuring transactions, subject to the Company’s continued employment of Mr. Mirman, TRW would receive from the Company a lump sum payment of $1.00 million. Mr. Mirman’s compensation arrangements with TRW provided that upon TRW’s receipt from the Company of the lump sum payment, TRW would make a payment of $1.00 million to Mr. Mirman. The Board determined in September 2014 that the criteria for the lump sum payment had been met. Mr. Mirman also received, as part of his compensation arrangement with TRW, the 100,000 common shares of the Company that were issued to TRW in conjunction with the investment banking agreement.

G. Tyler Runnells

Transactions between the Company and G. Tyler Runnels

The Company has participated in several transactions with TRW, of which G. Tyler Runnels, currently a member of the Company’s directors, is the majority owner of TRW. Mr. Runnels also beneficially holds more than 5% of the Company’s common stock, including the holdings of TRW and his personal holdings, and has personally participated in certain transactions with the Company.

On January 22, 2014, the Company paid TRW a commission equal to $486,000 (equal to 8% of gross proceeds at the closing of the January Private Placement). Of this $486,000 commission, $313,750 was paid in cash and $172,250 was paid in 86,125 Units. In addition, the Company paid TRW a non-accountable expense allowance of $182,250 (equal to 3% of gross proceeds at the closing of the January Private Placement) in cash. If the participation of certain of the Company’s current and former officers and directors is approved by the Company’s shareholders, the Company will pay TRW an additional commission equal to $0.06 million (equal to 8% of gross proceeds from the sale of Units of the Company’s officers and directors agreed to purchase in the January Private Placement), and the Company will pay TRW a non-accountable expense allowance of $0.02 million (equal to 3% of gross proceeds of the Units members of the Company’s officers and board of directors agreed to purchase in the January Private Placement). The Units issued to TRW were the same Units sold in the January Private Placement and were invested in the January Private Placement.

On January 31, 2014, the Company entered into a Debenture Conversion Agreement (the “Conversion Agreement”) with all of the holders of the Debentures.  Under the terms of the Conversion Agreement, $9.0 million of the approximately $15.6 million in Debentures outstanding as of January 30, 2014 immediately converted to shares of common stock at a price of $2.00 per common share.  As additional inducement for the conversions, the Company issued warrants to the converting Debenture holders to purchase one share of Common Stock, at an exercise price equal to $2.50 per share (the “Warrants”), for each share of Common Stock issued upon conversion of the Debentures. T.R. Winston acted as the investment banker for the Conversion Agreement and was compensated by issuing 225,000 shares of the Company’s common stock and valued at a market price of $3.05 per share. During the nine months ended September 30, 2014, the Company valued the investment banker compensation at $0.69 million, which was expensed immediately.

On May 19, 2014, the Company and the holders of the Debentures agreed to extend the maturity date under the Debentures until August 15, 2014, and on June 6, 2014, they agreed to further extend the maturity date under the Debentures from August 15, 2014 to January 15, 2015. In January 2015, the Company has entered into an extension agreement which extends the maturity date until January 8, 2018. The maturity date now coincides with the maturity date of the Credit Agreement.

On March 28, 2014, the Company and TRW entered into a Transaction Fee Agreement in connection the May Private Placement. Pursuant to the Transaction Fee Agreement, the Company agreed to compensate TRW 5% of the gross proceeds of the May Private Placement, plus a $25,000 expense reimbursement. On April 29, 2014, the Company and TRW amended the Transaction Fee Agreement to increase TRW’s compensation to 8% of the gross proceeds, plus an additional 1% of the gross proceeds as a non-accountable expense reimbursement in addition to the $25,000 originally contemplated.

On October 6, 2014, the Company entered into a letter agreement (the “Waiver”) with the holders of its Debentures. Pursuant to the Waiver, the holders of the Debentures agreed to waive any Event of Default (as that term is defined in the Debentures) that may have occurred prior to the date of the Waiver, including any default in connection with the Hexagon term loan, and to rescind and annul any acceleration or right to acceleration that may have been triggered thereby. In exchange for the Waiver, the Company agreed that TRW, as representative for the holders of the Debentures, would have the right to nominate two qualified individuals to serve on the Company’s Board. Mr. Runnells is one of the qualified nomination designees which TRW has elected to place on the board.

On May 30, 2014, the Company paid TRW a commission equal to $600,000 (equal to 8% of gross proceeds at the closing of the May Private Placement). Of this $600,000 commission, $51,850 was paid in cash to TRW, $94,150 was paid in cash to other brokers designated by TRW, and $454,000 was paid in shares of Preferred Stock. In addition, the Company paid TRW a non-accountable expense allowance of $75,000 (equal to 1% of gross proceeds at the closing of the May Private Placement) in cash.

From May 2013 until March 2014, the Company was party to a one-year, non-exclusive investment banking agreement with T.R. Winston, pursuant to which the Company issued to T.R. Winston 100,000 common shares, and 900,000 common stock purchase warrants. All warrants have a term of three years and a strike price of $4.25 per share, risk free rate of 0.20%, common stock price $1.880, volatility 63% valued at $0.26 million and amortized over the life of the contract. As of September 30, 2014, the full $0.26 million has been expensed through general and administrative expenses.

On June 6, 2014, T.R. Winston executed a commitment to purchase or affect the purchase by third parties of an additional $15 million in Series A 8% Convertible Preferred Stock, to be consummated within ninety (90) days thereof. The agreement was subsequently extended and expired on February 22, 2015. On February 25, 2015, the Company and TRW agreed in principal to a replacement commitment, pursuant to which TRW has agreed to purchase or affect the purchase by third parties of an additional $7.5 million in Series A 8% Convertible Preferred Stock, to be consummated no later than February 23, 2016, with all other terms substantially the same as those of the original commitment.