Quarterly report pursuant to Section 13 or 15(d)

Convertible Notes Payable

v3.3.0.814
Convertible Notes Payable
9 Months Ended
Sep. 30, 2015
Debt Disclosure [Abstract]  
Convertible Notes Payable

NOTE 11 – CONVERTIBLE NOTES PAYABLE

 

Convertible notes payable consisted of the following as of:

 

    September 30, 2015     December 31, 2014  
Short term convertible notes                
2013 and 2014 convertible notes payable   $ 350,000     $ 550,000  
Debt discount     -       (166,668 )
2015 convertible notes payable     937,864       -  
Typenex note payable     -       342,000  
Vista note payable     -       132,000  
Redwood note payable     892,500       2,184,000  
    $ 2,180,364     $ 3,041,332  
Derivative and warrant liability                
Typenex   $ -     $ 893,347  
Vista     -       195,506  
2015 convertible notes payable     569,550       -  
Redwood     270,094       850,439  
    $ 839,644     $ 1,939,292  

 

    September 30, 2015     December 31, 2014  
Investor Notes                
Typenex   $ -     $ 255,260  
Redwood     1,535,000       1,920,000  
Total Investor Notes Receivable   $ 1,535,000     $ 2,175,260  

 

Interest expense for the short term debt for the nine months ended September 30, 2015 and 2014 is summarized as follows:

 

    Nine months ended September 30, 2015     Nine Months ended September 30, 2014  
Interest expense on short term convertible notes                
2013 and 2014 convertible notes payable   $ 36,074     $ 42,551  
Debt discount     166,669       353,389  
2015 convertible notes payable     41,672       -  
Typenex note payable     10,774       1,666  
Vista note payable     21,166       14,927  
Redwood note payable     135,650       -  
    $ 412,005     $ 412,533  

 

2013 and 2014 short term convertible notes payable, net of discount

 

On June 1, 2014, the Company entered into a subscription agreement with one accredited investor for the issuance of a convertible promissory note in the aggregate principal amount of $400,000, which is convertible into shares of common stock of the Company at $0.40 per share, and a warrant entitling the holder to purchase up to an aggregate of 50,000 of shares of common stock of the Company at $0.40 per share. The warrant has a term of three years and vested immediately. The note bears interest at 12% for the first ninety days of the term and then bears interest at 18% for the next nine months. The note was due one year after issuance. In connection with this transaction, a major shareholder and a related party (the “Pledgor”) signed a pledge and security agreement, which grants a security interest in one million shares of the Company’s common stock owned by the Pledgor.

 

The Company evaluated the embedded conversion features within the convertible debt under ASC 815 “Derivatives and Hedging” and determined that neither the embedded conversion feature nor the warrants qualified for derivative accounting. Additionally, the instruments were evaluated under ASC 470-20 “Debt with Conversion and Other Options” for consideration of any beneficial conversion features. It was concluded that a beneficial conversion feature existed for the convertible debt due to the relative fair value of the warrants issued with the debt.

 

The total debt discount recorded on the note with the June 1, 2014 date of issuance was $400,000 (warrant relative fair value of approximately $42,000 and the beneficial conversion feature was approximately $358,000) which is being amortized to interest expense over the term of the note. The warrant and beneficial conversion feature was recorded as additional paid in capital.

 

The balance outstanding on the above note was $0 and $200,000 at September 30, 2015 and December 31, 2014, respectively.

 

On June 1, 2015, the Company did not repay the outstanding principal and accrued interest due on June 1, 2015. In exchange for not declaring a default on the note, and after transfer of the one million shares of the Company’s common stock owned by a related party to the lender, the Company and the note holder signed Amendment One to the note which reduced the conversion price of $0.40 per share to a price that was the average of the three (3) lowest closing bid prices per share for the last twenty (20) trading days prior to the date of the Notice of Conversion, discounted by 20%.

 

Between July 9 and July 27, 2015, the assignee converted all of the outstanding principal balance and accrued interest into 29,165,277 shares of the Company’s common stock at prices ranging from $0.008 to $0.015 per share.

 

On June 1, 2013, the Company entered into subscription agreements with five accredited investors for the issuance of convertible promissory notes in the aggregate principal amount of $550,000, which are convertible into shares of common stock of the Company at $0.25 per share, and warrants entitling the holder to purchase up to an aggregate of 1,600,000 of shares of common stock of the Company at $0.25 per share. The warrants have a term of three years and vested immediately. The notes bear interest at 8% and are due in one year. Four notes, with a value of $200,000 at December 31, 2013, were converted to stock in 2014 as disclosed in Note 14. One note, for $350,000 at December 31, 2013, was not repaid timely and went into default in 2014. The interest rate on this note rose to 12% as a consequence.

 

The Company evaluated the embedded conversion features within the convertible debt under ASC 815 “Derivatives and Hedging” and determined that neither the embedded conversion feature nor the warrants qualified for derivative accounting. Additionally, the instruments were evaluated under ASC 470-20 “Debt with Conversion and Other Options” for consideration of any beneficial conversion features. It was concluded that a beneficial conversion feature existed for the convertible debt due to the relative fair value of the warrants issued with the debt.

 

The total debt discount recorded on the note with the June 1, 2013 date of issuance was $528,058 (warrant relative fair value of approximately $253,000 and the beneficial conversion feature was approximately $275,000) which is being amortized to interest expense over the term of the note.

 

The unamortized debt discount balance at September 30, 2015 and December 31, 2014 was approximately $0 and $167,000, respectively and is being netted against the total convertible promissory notes principal amount of $350,000 and $550,000, respectively, for presentation in the accompanying Consolidated Balance Sheets.

 

For the nine months ended September 30, 2015 and 2014, the Company amortized approximately $167,000 and $353,000 (including approximately $64,000 of debt discount related to notes converted to common stock, see below), respectively, to interest expense.

 

In connection with one of the five debt issuances in 2013, the Company paid finder’s fees of approximately $42,000 as well as 140,000 common stock warrants at $0.05 per share. The warrants vest immediately and have a three year term. The fair value of the warrants was determined to be approximately $48,000 based on the Black Scholes option pricing model, using the same assumptions as those used for the warrants above, except the exercise price was $0.05 per share. The combined value of the warrants of $48,000 and cash of $42,000 amounted to approximately $90,000 which was capitalized as a deferred financing cost and is being amortized to interest expense over the life of the notes.

 

Amortization of deferred financing costs, which has been included interest expense, for the nine months ended September 30, 2015 and 2014, was approximately $0 and $28,000, respectively.

 

2015 convertible notes payable

 

LG Capital Financing – Note 1

 

On March 5, 2015, the Company entered into a securities purchase agreement with LG Capital Funding, LLC, an accredited investor (“LG”) whereby the Company issued and sold to LG an 8% convertible note (the “LG Note”) in the principal amount of $105,000 for $105,000.

 

The LG Note is due on the first anniversary of issuance and bears interest at the rate of 8% per annum. The LG Note is convertible, in whole or in part, into shares of Common Stock at the option of LG, at a conversion price equal to 60% of the lowest trading price of the Common Stock for the 15 trading days immediately preceding, and including, the date of conversion, subject to adjustment and further discount upon certain events, as set forth in the LG Note.

 

The Company has the right, at any time prior to the six month anniversary of the issuance date of the LG Note to redeem the outstanding LG Note at a redemption price equal to an amount between 115% and 145% of the amount of principal plus interest being redeemed, depending on the date of prepayment.

 

The convertibility of the LG Note may be limited if, upon conversion, the holder thereof or any of its affiliates would beneficially own more than 9.9% of Common Stock.

 

The Company reimbursed LG for all costs and expenses incurred by it in connection with the transactions in an amount equal to $5,000 and paid $8,000 to Carter Terry & Company for due diligence fees.

 

See Note 21 for conversions of outstanding debt subsequent to September 30, 2015. 

 

JSJ Investments Financing – Note 1

 

On March 6, 2015, the Company issued and sold to JSJ Investments Inc. (“JSJ”) a convertible note (the “JSJ Note”) in the principal amount of $100,000, for $100,000.

 

The JSJ Note is due on demand and bears interest at the rate of 12% per annum. The JSJ Note is convertible, in whole or in part, into shares of Common Stock at the option of JSJ, at a conversion price equal to the lesser of (i) 55% of the lowest trading price of the Common Stock for the 20 trading days immediately preceding the date of issuance of the JSJ Note or (ii) 55% of the lowest trading price of the Common Stock for the 20 trading days immediately preceding the date of conversion subject to adjustment and further discount upon certain events, as set forth in the JSJ Note.

 

The Company has the right to redeem the outstanding JSJ Note at a redemption price equal to 150% of the amount of principal and interest being redeemed, provided that any repayment, including at maturity, can only be made with the consent of JSJ.

 

The Company reimbursed JSJ for all costs and expenses incurred by it in connection with the transactions in an amount equal to $2,000 and paid $10,000 to Carter Terry & Company in connection with due diligence fees.

 

Since the inception of Note #1, through September 30, 2015, JSJ converted approximately $59,515 of the outstanding balance of Note #1 into 27,125,836 shares of common stock at prices based on a formula which resulted in prices from $0.0013 to $0.0033.

 

See Note 21 for conversions of outstanding debt subsequent to September 30, 2015.

 

JMJ Financial Financing

 

On March 9, 2015, the Company issued and sold to JMJ Financial (“JMJ”) a convertible note (the “JMJ Note”) in the principal amount of $100,000 for $90,000. JMJ has the right to invest an additional $400,000 on the same terms and conditions from time to time at its sole discretion.

 

Each portion funded of the JMJ Note is due on the second anniversary of funding and bears no interest for the first three months and then a one-time interest charge of 12% will be due. The JMJ Note is convertible, in whole or in part, into shares of Common Stock at the option of JMJ at a conversion price equal to the lesser of (i) $0.084 or (ii) 60% of the lowest trading price of the Common Stock for the 25 trading days immediately preceding the date of conversion subject to adjustment and further discount upon certain events, as set forth in the JMJ Note.

 

The convertibility of the JMJ Note may be limited if, upon conversion, the holder thereof or any of its affiliates would beneficially own more than 4.99% of Common Stock.

 

The Company granted JMJ piggyback registration rights on the shares issuable upon conversion of the JMJ Note. If the Company fails to include such shares, the Company shall pay JMJ liquidated damages of 25% of the outstanding principal amount of the JMJ Note, but not less than $25,000.

 

Since the inception of the JMJ Note through September 30, 2015, JMJ converted approximately $23,040 of the outstanding balance of the JMJ Note into approximately 20,000,000 shares of common stock at prices based on a formula which resulted in prices from $0.0006 to $0.0036.

 

See Note 21 for conversions of outstanding debt subsequent to September 30, 2015.

 

EMA Financial Financing

 

On March 10, 2015, the Company entered into a securities purchase agreement with EMA Financial, LLC, an accredited investor (“EMA”) whereby the Company issued and sold to EMA an 8% convertible note (the “EMA Note”) in the principal amount of $100,000 for $90,000.

 

The EMA Note is due on the first anniversary of issuance and bears interest at the rate of 10% per annum. The EMA Note is convertible, in whole or in part, into shares of Common Stock at the option of EMA at a conversion price equal to 60% of the lowest trading price of the Common Stock for the 15 trading days immediately preceding the date of conversion subject to adjustment and further discount upon certain events, as set forth in the EMA Note.

 

The Company has the right, at any time prior to the four month anniversary of the issuance date of the EMA Note, upon at least five trading days prior written notice, to redeem the outstanding EMA Note at a redemption price equal to 135% of the amount of principal and interest being redeemed.

 

The convertibility of the EMA Note may be limited if, upon conversion, the holder thereof or any of its affiliates would beneficially own more than 4.9% of Common Stock.

 

The Company granted EMA a right of first refusal on all future financings for a year from the date of issuance of the EMA Note.

 

The Company reimbursed EMA for all costs and expenses incurred by it in connection with the transactions in an amount equal to $3,500.

 

Since the inception of the EMA Note through September 30, 2015, EMA converted approximately $27,932 of the outstanding balance of the EMA Note into 17,529,855 shares of common stock at prices based on a formula which resulted in prices from $0.00108 to $0.0027.

 

See Note 21 for conversions of outstanding debt subsequent to September 30, 2015.

 

Adar Bays Financing

 

On March 20, 2015, the Company entered into a securities purchase agreement with Adar Bays, LLC, an accredited investor (“Adar”) whereby the Company issued and sold to Adar an 8% convertible note (the “Adar Note”) in the principal amount of $50,000 for $50,000.

 

The Adar Note is due on the first anniversary of issuance and bears interest at the rate of 8% per annum. The Adar Note is convertible, in whole or in part, into shares of Common Stock at the option of Adar at a conversion price equal to 65% of the lowest trading price of the Common Stock for the 15 trading days immediately preceding and including the date of conversion, subject to adjustment and further discount upon certain events, as set forth in the Adar Note.

 

The Company has the right, at any time prior to the six month anniversary of the issuance date of the Adar Note to redeem the outstanding Adar Note at a redemption price equal to 150% of the amount of principal being redeemed plus interest.

 

The convertibility of the Adar Note may be limited if, upon conversion, the holder thereof or any of its affiliates would beneficially own more than 9.9% of Common Stock.

 

The Company reimbursed Adar for all costs and expenses incurred by it in connection with the transaction in an amount equal to $2,500 and paid $4,000 to Carter Terry & Company in connection with due diligence fees.

 

Union Capital Note

 

In April 2015, the Company entered into a securities purchase agreement with Union Capital, LLC, an accredited investor (“Union Capital”) whereby the Company issued and sold to Union Capital an 8% convertible note (the “Union Capital Note”) in the principal amount of $75,000 for $75,000.

 

The Union Capital Note is due on the first anniversary of issuance and bears interest at the rate of 8% per annum. The Union Capital Note is convertible, in whole or in part, into shares of Common Stock at the option of Union Capital, at a conversion price equal to 60% of the lowest trading price of the Common Stock for the 15 trading days immediately preceding, and including, the date of conversion, subject to adjustment and further discount upon certain events, as set forth in the Union Capital Note.

 

The Company reimbursed Union Capital for all costs and expenses incurred by it in connection with the transactions in an amount equal to $3,500 and paid $6,000 to Carter Terry & Company in connection with due diligence fees.

 

See Note 21 for conversions of outstanding debt subsequent to September 30, 2015.

 

JSJ Investments Financing – Note 2

 

On April 20, 2015, the Company issued and sold to JSJ Investments a convertible note (the “JSJ Note II”) in the principal amount of $112,000, for $112,000.

 

The JSJ Note II is due on demand and bears interest at the rate of 12% per annum. The JSJ Note II is convertible, in whole or in part, into shares of Common Stock at the option of JSJ, at a conversion price equal to the lesser of (i) 45% of the lowest trading price of the Common Stock for the 20 trading days immediately preceding the date of issuance of the JSJ Note II or (ii) 45% of the lowest trading price of the Common Stock for the 20 trading days immediately preceding the date of conversion subject to adjustment and further discount upon certain events, as set forth in the JSJ Note II.

 

The Company has the right to redeem the outstanding JSJ Note II at a redemption price equal to 135% to 145% of the amount of principal and interest being redeemed, provided that any repayment, including at maturity, can only be made with the consent of JSJ.

 

The Company reimbursed JSJ for all costs and expenses incurred by it in connection with the transactions in an amount equal to $2,000 and paid $8,000 to Carter Terry & Company in connection with due diligence fees.

 

Black Forest Capital LLC, Financing

 

On July 16, 2015, the Company issued and sold to Black Forest Capital LLC (“Black Forest”) a convertible note (the “Black Forest Note”) in the principal amount of $150,000 for $140,000.

 

The Black Forest Note is due on the first anniversary of funding and bears interest at a rate of 8%. The Black Forest Note is convertible, in whole or in part, into shares of Common Stock at the option of Black Forest at a conversion price equal to 60% of the lowest trading price of the Common Stock for the 20 trading days immediately preceding the date of conversion subject to adjustment and further discount upon certain events, as set forth in the Black Forest Note.

 

The Company has the right within 180 days of the date of the note to redeem the outstanding Black Forest Note at a redemption price equal to 130% of the amount of principal and interest being redeemed, provided that any repayment, including at maturity, can only be made with the consent of Black Forest.

 

The Company reimbursed Black Forest for all costs and expenses incurred by it in connection with the transactions in an amount equal to $12,000 and paid $12,000 to Carter Terry & Company in connection with due diligence fees.

 

GW Holdings Group LLC

 

On August 11, 2015, the Company issued and sold to GW Holdings Group, LLC. (“GW”) a convertible note (the “GW Note”) in the principal amount of $61,000 for $50,000.

 

The GW Note is due on the first anniversary of funding and bears interest at a rate of 8%. The GW Note is convertible, in whole or in part, into shares of Common Stock at the option of GW at a conversion price equal to 60% of the lowest trading price of the Common Stock for the 15 trading days immediately preceding the date of conversion subject to adjustment and further discount upon certain events, as set forth in the GW Note.

 

The Company has the right within 180 days of the date of the note to redeem the outstanding GW Note at a redemption price starting at 135% to 150% of the amount of principal and interest being redeemed, provided that any repayment, including at maturity, can only be made with the consent of GW.

 

The Company reimbursed GW for all costs and expenses incurred by it in connection with the transactions in an amount equal to $3,000 and paid $3,000 in connection with legal fees and an amount equal to $4,000 and paid $4,000 to Carter Terry & Company in connection with due diligence fees.

 

LG Capital Financing – Note 2

 

On August 14, 2015, the Company entered into a securities purchase agreement with LG whereby the Company issued and sold to LG an 8% convertible note (the “LG Note #2”) in the principal amount of $105,000 for $90,000.

 

The LG Note #2 is due on the first anniversary of issuance and bears interest at the rate of 8% per annum. The LG Note #2 is convertible, in whole or in part, into shares of Common Stock at the option of LG, at a conversion price equal to 60% of the lowest trading price of the Common Stock for the 15 trading days immediately preceding, and including, the date of conversion, subject to adjustment and further discount upon certain events, as set forth in the LG Note #2.

 

The Company has the right, at any time prior to the six month anniversary of the issuance date of the LG Note #2 to redeem the outstanding LG Note at a redemption price equal to an amount between 115% and 145% of the amount of principal plus interest being redeemed, depending on the date of prepayment.

 

The convertibility of the LG Note may be limited if, upon conversion, the holder thereof or any of its affiliates would beneficially own more than 9.9% of Common Stock.

 

The Company reimbursed LG for all costs and expenses incurred by it in connection with the transactions in an amount equal to $5,000 and paid $5,000 for legal fees and an amount equal to $10,000 paid $10,000 to Carter Terry & Company for due diligence fees.

 

Identification and Valuation of Derivatives in the Above Ten Notes

 

The Company evaluated the embedded derivative criteria in ASC 815, and concluded that because the above notes could be readily convertible to cash by the Investor, the conversion feature meets the definition of an embedded derivative that should be separated from the note and accounted for as a derivative liability.

 

The Company has not elected to initially and subsequently measure the note as a hybrid instrument in its entirety at fair value. Therefore, in accordance with ASC 815, the Company is accounting for all the embedded derivatives identified in the note as a single compound embedded derivative.

 

The fair value of the embedded derivative liability is measured in accordance with ASC 820, using “monte carlo simulation” modeling.

 

The compound embedded derivative was recorded as a derivative liability on the Consolidated Balance Sheet at its fair value of approximately $569,550 at September 30, 2015.

 

At inception, the carrying value of the above ten notes was as follows:

 

Face amount of note   $ 958,000  
Derivative and warrant liability     -  
    $ 958,000  

 

At September 30, 2015, the carrying value of the above ten notes was as follows:

 

Face amount of note   $ 937,864  
Derivative and warrant liability     569,550  
    $ 1,507,414  

 

Convertible Note Payable to Typenex Co-Investment, LLC

 

On September 26, 2014 (the “Effective Date”), the Company entered into a Securities Purchase Agreement with Typenex Co-Investment, LLC (“Investor” or “Lender”) whereby it sold in a private placement a 10% Collateralized Convertible Promissory note with a $550,000 principal amount, which was issued at a $50,000 discount from the face amount (the “OID”), and three warrants to purchase the Company’s Common Stock at an exercise price of $.80 per share, exercisable at various dates (the “Investor Warrants”), in exchange for $250,000 cash and two 8% Investor Notes (“Investor Note #1 and “Investor Note #2”) with principal balances of $125,000 each. The note is collateralized by the Investor Notes.

 

The note is separated into three Conversion Eligible Tranches (discussed under Lender Conversion below) of the following amounts:

 

Initial Tranche   $ 275,000  
First Subsequent Tranche     137,500  
Second Subsequent Tranche     137,500  
    $ 550,000  

 

The note accrues interest at 10%, and is repayable in eight monthly installments beginning March 26, 2015, until the Maturity Date of October 26, 2015 (“Installment Dates”). At each of the Installment Dates, the Company is required to pay to the Lender the applicable “Installment Amount” due on such date. Installment Amount means $68,750 ($550,000 ÷ 8), plus the sum of any accrued and unpaid interest that has been added to the lowest-numbered then-current Conversion Eligible Tranche as of the applicable Installment Date and accrued and unpaid late charges that have been added to the lowest-numbered then current Conversion Eligible Tranche, if any, under the note as of the applicable Installment Date, and any other amounts accruing or owing to Lender under the note as of such Installment Date, provided, however, that if the remaining amount owing under all then-existing Conversion Eligible Tranches or otherwise with respect to the note as of the applicable Installment Date is less than the Installment Amount set forth above, then the Installment Amount for such Installment Date (and only such Installment Amount) will be reduced by the amount necessary to cause such Installment Amount to equal such outstanding amount.

 

Installment Conversions

 

At the option of the Company or the Lender, payments of each Installment Amount may be made (a) in cash, or (b) by converting such Installment Amount into a number of shares of Common Stock (“Installment Conversion Shares”) derived by dividing the portion of the applicable Installment Amount being converted by the Installment Conversion Price) an “Installment Conversion”), or (c) by any combination of the foregoing, so long as the cash is delivered to the Lender on the applicable Installment Date and the Installment Conversion Shares are delivered to the Lender on or before the applicable delivery date.

 

The Installment Conversion Price is the lesser of (i) the Lender Conversion Price (defined under Lender Conversion below), and (ii) 70% (the “Conversion Factor”) of the average of the three (3) lowest Closing Bid Prices in the twenty (20) Trading Days immediately preceding the applicable Conversion (the “Market Price”), provided that if at any time the average of the three (3) lowest Closing Bid Prices in the twenty (20) Trading Days immediately preceding any date of measurement is below $0.40, then the then-current Conversion Factor will be reduced to 65% for all future conversions (subject to other reductions). Additionally, if at any time after the Effective Date, Borrower is not DWAC Eligible, then the then-current Conversion Factor will automatically be reduced by 5% for all future Conversions. If at any time after the Effective Date, the Conversion Shares are not OTC Eligible, then the then-current Conversion Factor will automatically be reduced by an additional 5% for all future conversions.

 

On the date that is twenty (20) trading days (a “True-Up Date”) from each date Borrower delivers Free Trading (as defined below) Installment Conversion Shares to the Lender, there will be a true-up where the Company will deliver to the Lender additional Installment Conversion Shares (“True-Up Shares”) if the Installment Conversion Price as of the True-Up Date is less than the Installment Conversion Price used in the applicable Installment Notice. In such event, the Company must deliver to the Lender within three (3) trading days of the True-Up Date (the “True-Up Share Delivery Date”) a number of True-Up Shares equal to the difference between the number of Installment Conversion Shares that would have been delivered to the Lender on the True-Up Date based on the Installment Conversion Price as of the True-Up Date and the number of Installment Conversion Shares originally delivered to the Lender pursuant to the applicable Installment Notice.

 

The Company evaluated the note under the requirements of ASC 480 Distinguishing Liabilities From Equity, and concluded that the note does not fall within the scope of ASC 480. The Company evaluated the Installment Conversion feature under the requirements of ASC 815 Derivatives and Hedging. Due to the existence of the antidilution provision which reduces the Lender Conversion Price in the event of subsequent Dilutive Issuances by the Company (see Lender Conversionbelow), the Installment Conversion feature does not meet the definition of “indexed to” the Company’s stock, and the scope exception to ASC 815’s derivative accounting provisions does not apply.

 

The Company evaluated the embedded derivative criteria in ASC 815, and concluded that because the Common Stock that would be delivered by the Company if an Installment Conversion is elected (including True-Up Shares) would be readily convertible to cash by the Investor, the Installment Conversion feature meets the definition of an embedded derivative that should be separated from the note and accounted for as a derivative liability.

 

During the nine months ended September 30, 2015, the Company converted the required Installment Amounts into shares of the Company’s common stock. Using the formula outlined above, the Company made installment payments of approximately $279,272, by issuing approximately 20,577,648 shares of the Company’s common stock to the Lender.

 

On August 31, 2015, the Lender provided the true up notice, as discussed about, for the June 26, 215 installment, installment #4 and the July 26, 2015 installment, installment #5. Consequently the Company issued 5,767,145 additional shares of the Company’s common stock based on the Lender’s calculation of the installment #4 true up and 2,646,216 shares of the Company’s common stock based on the Lender’s calculation of the installment #5 true up.

 

See Note 21 for conversions of outstanding debt subsequent to September 30, 2015.

 

Lender Conversion

 

The Lender has the right at any time after the Effective Date until the outstanding balance of the note has been paid in full, including without limitation (i) until any Optional Prepayment Date or at any time thereafter with respect to any amount that is not prepaid, and (ii) during or after any Fundamental Default Measuring Period, at its election, to convert (each instance of conversion is referred to as a “Lender Conversion”) all or any part of the outstanding balance into shares (“Lender Conversion Shares”) of the Company’s common stock, of the portion of the outstanding balance being converted (the “Conversion Amount”) divided by the “Lender Conversion Price” of $0.80, subject to potential future adjustments described below.

 

The conversion by the Lender of any portion of the outstanding balance is only exercisable in three (3) tranches (each, a “Tranche”), consisting of (i) an initial Tranche in an amount equal to $275,000 and any interest, costs, fees or charges accrued thereon or added thereto under the terms of the note and the other Transaction Documents (as defined in the Securities Purchase Agreement) (the “Initial Tranche”), and (ii) two (2) additional Tranches, each in the amount of $137,500, plus any interest, costs, fees or charges accrued thereon or added thereto under the terms of the note and the other Transaction Documents (each, a “Subsequent Tranche”).

 

The Initial Tranche corresponds to the initial cash proceeds of $250,000 plus $25,000 of the OID, and may be converted any time subsequent to the Effective Date. The first Subsequent Tranche corresponds to Investor Note #1 plus $12,500 of the OID, and the second Subsequent Tranche corresponds to Investor Note #2 plus $12,500 of the OID. The Lender’s right to convert any portion of any of the Subsequent Tranches is conditioned upon the Lender’s payment in full of the Investor Note corresponding to such Subsequent Tranche (upon the satisfaction of such condition, such Subsequent Tranche becomes a “Conversion Eligible Tranche”). The Initial Tranche was immediately a Conversion Eligible Tranche at the Effective Date.

 

The Company evaluated the note under the requirements of ASC 815, Derivatives and Hedging. Due to the existence of the anti-dilution provision which reduces the Lender Conversion Price in the event of subsequent dilutive issuances by the Company described above, the Lender Conversion feature does not meet the definition of “indexed to” the Company’s stock, and the scope exception to ASC 815’s derivative accounting provisions does not apply.

 

The Company also evaluated the embedded derivative criteria in ASC 815, and concluded that the default and remedy provisions of the note (see Default Provisions below) cause the Lender Conversion feature to meet the net settlement criterion in ASC 815. Based on the Lender Conversion feature meeting all the embedded derivative criteria in ASC 815, the Lender Conversion feature meets the definition of an embedded derivative that should be separated from the note and accounted for as a derivative liability.

 

The Company evaluated the Company’s option to settle the Lender Conversion in cash in the event the Lender elects to convert subsequent to the occurrence of an Event of Default under the requirements of ASC 815, and included that it meets the definition of an embedded derivative that should be separated from the note and accounted for as a derivative liability.

 

The Company evaluated the Lender Conversion Delay provision under the requirements of ASC 815 and concluded it meets the definition of an embedded derivative that should be separated from the note and accounted for as a derivative liability.

 

The Company evaluated the embedded derivative criteria in ASC 815, and concluded that because certain of the Events of Default under the note are factors that are unrelated to a deterioration of the creditworthiness of the Company, the Events of Default and Default Interest provisions of the note are not considered clearly and closely related to the characteristics of debt. Based on meeting all the criteria in the definition, the Company concluded that the Events of Default and Default Interest provisions each meet the definition of an embedded derivative that should be separated from the note and accounted for as a derivative liability.

 

Company Prepayment Option

 

So long as no Event of Default has occurred subsequent to the effective date, the Company may at any time up to the maturity date optionally prepay, in full, the outstanding balance of the note at a price of 125% of the aggregate principal amount of the note, plus accrued and unpaid interest, if any, at the date of prepayment (“Optional Prepayment Amount”).

 

The Company evaluated the embedded derivative criteria in ASC 815, and concluded that the Company’s prepayment option is not the type of call option that meets the definition of an embedded derivative. However, the Optional Prepayment Liquidated Damages clause does meet the definition of an embedded derivative that should be separated from the note and accounted for as a derivative liability.

 

Investor Warrants

 

The Investor Warrants allow the Investor to purchase the number of shares of common stock (“Warrant Shares”) equal to the purchase price allocated to each Investor Warrant divided by the market price of the Company’s common stock immediately preceding the date each Investor Warrant first becomes exercisable, as such the number may be adjusted from time to time pursuant to the antidilution provisions of the Investor Warrant.

 

The Purchase Price allocated to each Investor Warrant at inception was:

 

Investor Warrant #1:   $ 275,000  
Investor Warrant #2:     137,500  
Investor Warrant #3:     137,500  
    $ 550,000  

 

The Market Price applicable to Investor Warrant #1, determined as of the effective date, was $.65 per share. Accordingly as of September 30, 2014, the maximum number of shares of the Company’s common stock Investor Warrant # 1 is exercisable into is 423,076 shares. The market price applicable to Investor Warrants #2 and #3 will be determined as of the related Investor Warrant’s “Exercisable Date” (defined below), so the number of shares into which Investor Warrants #2 and #3 are exercisable is not determinable as of December 31, 2014. Had all of the Investor Warrants been exercisable as of December 31, 2014, the maximum number of shares of the Company’s common stock the Investor Warrants could be exercised into, based on the $.65 per share market price on that date, would be 846,153, which may ultimately be higher or lower.

 

The term of each Investor Warrant began on September 27, 2014 and expires on the fifth anniversary from each Investor Warrant becomes exercisable (the “Exercisable Date”). Investor Warrant #1 is exercisable at any time from September 27, 2014, and it expires September 27, 2019. The Exercisable Dates for Investor Warrant #2 and Investor Warrant #3 occur once the full outstanding balance of Investor Note #1 and Investor Note #2, respectively, has been paid to Company, and they expire on the fifth anniversary of their respective Exercisable Date.

 

The exercise price of the Investor Warrants is $.80 per share of the Company’s common stock, as may be adjusted from time to time pursuant to the antidilution provisions of the Warrants.

 

The Investor Warrants are exercisable by the Investor in whole or in part, as either a cash exercise or as a “cashless” exercise.

 

On September 18, 2015, the Lender notified the Company of their intention to exercise their warrant exercisable into 71,342 shares of common stock at a price determined by a formula which resulted in the Company issuing 20,800,157 shares of the Company’s common stock to the Lender.

 

The Company evaluated the warrants under ASC 480 Distinguishing Liabilities From Equity and ASC 815 Derivatives and Hedging. Due to the existence of the antidilution provision, which reduces the Exercise Price and Conversion Price in the event of subsequent Dilutive Issuances, the Investor Warrants are not indexed to the Company’s common stock, and the Company determined that the Warrants meet the definition of a derivative under ASC 815.

 

Accordingly, the warrants were recorded as derivative liabilities in the Consolidated Balance Sheets at their fair value of approximately $183,000 at the date of issuance. The fair value of the warrants is measured in accordance with ASC 820 Fair Value Measurement, using “monte carlo simulation” modeling.

 

The fair value of the warrants as of September 30, 2015 and December 31, 2014 was $0. At each subsequent reporting date, when the fair value of the warrants is remeasured, the changes in the fair value will be reported in the Consolidated Statements of Operations.

 

The Company has not elected to initially and subsequently measure the note as a hybrid instrument in its entirety at fair value. Therefore, in accordance with ASC 815, the Company is accounting for all the embedded derivatives identified in the note as a single compound embedded derivative. The compound embedded derivative was recorded as a derivative liability on the Consolidated Balance Sheet at its fair value of approximately $279,000 at the date of issuance of the note. The fair value of the embedded derivative liability is measured in accordance with ASC 820, using “monte carlo simulation” modeling.

 

The fair value of the compound embedded derivative liability as of September 30, 2015 and December 31, 2014 was $0 and $893,347, respectively. At each subsequent reporting date, when the fair value of the embedded derivative liability is remeasured, the changes in the fair value will be recorded in the Consolidated Statements of Operations.

 

Both the warrant derivative and embedded derivative liabilities are classified as current liabilities in the Consolidated Balance Sheets, and changes in their fair value are reported as a separate line item in the Consolidated Statements of Operations. The change in fair value of the warrant and embedded derivative liabilities for the nine months ended September 30, 2015 and 2014 was $893,347 and $0, respectively, which was recorded as a separate line item, change in fair value of derivative liabilities, on the Consolidated Statements of Operations.

 

At inception, the total proceeds of $500,000 received by the Company for the note and Investor warrants, was allocated first to the Investor Warrant and embedded derivative liabilities at their initial fair values determined at the issuance date. The residual proceeds after that allocation were then applied to the note.

 

Accordingly, the initial carrying amount of the note is approximately $39,000, derived as follows:

 

Face amount of note   $ 550,000  
Original issuance discount     (50,000 )
Allocation to Investor Warrants     (182,000 )
Allocated to embedded derivatives     (279,000 )
    $ 39,000  

 

At September 30, 2015, the carrying value of the note was as follows:

 

Face amount of note   $ -  
Derivative and warrant liability     -  
    $ -  

 

At December 31, 2014, the carrying value of the note was as follows:

 

Face amount of note   $ 342,000  
Derivative and warrant liability     893,347  
    $ 1,235,347  

 

Investor Notes

 

The Company issued two Investor Notes on September 26, 2014. The principal of each Investor Note is $125,000. Interest accrues on the unpaid principal balance under the Investor Notes at a rate of eight percent (8%) per annum until the full amount of the principal and fees has been paid. The entire unpaid principal balance and all accrued and unpaid interest under each Investor Note is due and payable thirteen (13) months from the date the Investor Note was entered into, which is October 26, 2015. However, the Investor may elect, in its sole discretion, to extend the maturity dates for up to thirty (30) days by delivering written notice of such election to the Company at any time prior to the maturity date. The Investor may, with Company’s consent, prepay, without penalty, all or any portion of the outstanding balance of each Investor Note along with any accrued but unpaid interest at any time prior to the maturity date.

 

The Investor Notes contain certain default provisions such as the Investor’s failure to make any payment when due and payable, its failure to observe or perform any other covenant, obligation, condition or agreement contained in the Investor Note; or upon involuntary bankruptcy by the Investor, and such petition is not dismissed within sixty (60) days, or a receiver, trustee, liquidator, assignee, custodian, sequestrator or other similar official is appointed to take possession of any of the assets or properties of Investor.

 

The Investor Notes are recorded as a current asset at cost, together with accrued interest thereon, in the Consolidated Balance Sheets. Interest income on the Investor Notes reported in the Consolidated Statements of Operations for the nine months ended September 30, 2015 and 2014 was approximately $4,600 and $0, respectively.

 

During the nine months ended September 30, 2015, the investor indicated that they did not plan on putting any additional funds into the Company. The Company wrote off the remaining balance of the investor note from Typenex of $265,179 and recorded the write-off in the line item, change in fair value of derivative liabilities, on the Consolidated Statements of Operations.

 

Convertible Note Payable to Vista Capital Investments, LLC

 

On October 9, 2014, the Company entered into a Securities Purchase Agreement with Vista Capital Investments, LLC, (“Investor”, “Holder” or “Lender”) an accredited investor for the issuance of a convertible note in the aggregate principal amount of $200,000, in exchange for $100,000 in cash at closing, additional amounts due to the Company at the investor’s discretion and $20,000 of original issue discount interest.

 

The note is separated into three Conversion Eligible Tranches (discussed under Lender Conversion below) of the following amounts:

 

Initial Consideration   $ 100,000  
Subsequent Consideration     100,000  
    $ 200,000  

 

The note bears interest at 10% per annum and the unpaid principal and interest is on the initial consideration is due in full in one year from October 9, 2014 and the unpaid principal and interest on the subsequent consideration is due in full one year from the date the subsequent consideration is paid to the Company.

 

Lender Conversion

 

At the option of the Holder, at any time or times on or after the Issuance Date payments, the lender shall be entitled to convert any portion of the outstanding and unpaid Conversion Amount into fully paid and non-assessable shares of the common stock of the Company at the Conversion Price. The Conversion amount means the original principal amount and unpaid interest to be converted at the date of conversion.

 

The Conversion Price is the lesser of (i) $.80 or (ii) 70% (the “Conversion Factor”) of the average of the three (3) lowest Closing Bid Prices in the twenty (20) consecutive Trading Days immediately preceding the applicable Conversion Date on which the Holder elects to convert all or part of this Note. If the average of the three (3) lowest Closing Bid Prices in the twenty (20) Trading Days immediately preceding the applicable Conversion Date on which the Holder elects to is less than $0.40, the Conversion price shall be the lesser of (a) $0.80 or (b) 65% of the average of the 3 lowest closing bid prices for the twenty (20) consecutive Trading days immediately preceding the applicable Conversion Date on which the Holder elects to convert all or part of this Note.

 

The Company evaluated the note under the requirements of ASC 815 Derivatives and Hedging. Due to the existence of the antidilution provision which reduces the Lender Conversion Price in the event of subsequent Dilutive Issuances by the Company described above, the Lender Conversion feature does not meet the definition of “indexed to” the Company’s stock, and the scope exception to ASC 815’s derivative accounting provisions does not apply.

 

The Company also evaluated the embedded derivative criteria in ASC 815, and concluded that the default and remedy provisions of the note (see Default Provisions below) cause the Lender Conversion feature to meet the net settlement criterion in ASC 815. Based on the Lender Conversion feature meeting all the embedded derivative criteria in ASC 815, the Lender Conversion feature should be separated from the note and accounted for as a derivative liability.

 

The Company evaluated the Company’s option to settle the Lender Conversion in cash in the event the Lender elects to convert subsequent to the occurrence of an Event of Default under the requirements of ASC 815, and concluded that it meets the definition of an embedded derivative that should be separated from the note and accounted for as a derivative liability.

 

The Company evaluated the Lender Conversion Delay provision under the requirements of ASC 815 and concluded it meets the definition of an embedded derivative that should be separated from the note and accounted for as a derivative liability.

 

The Company evaluated the embedded derivative criteria in ASC 815, and concluded that because certain of the Events of Default under the note are factors that are unrelated to a deterioration of the creditworthiness of the Company, the Events of Default and Default Interest provisions of the note are not considered clearly and closely related to the characteristics of debt. Based on meeting all the criteria in the definition, the Company concluded that the Events of Default and Default Interest provisions each meet the definition of an embedded derivative that should be separated from the note and accounted for as a derivative liability.

 

Company Prepayment Option

 

At any time within the 180 day period immediately following the Issuance Date, the Company shall have the option, upon 10 business days’ notice to the Holder, to prepay the entire remaining outstanding principal amount of this Note in cash, provided, that (i) the Company shall pay Holder 125% of the Outstanding Balance, (ii) such amount must be paid in cash on the next business day following such 10 business day notice period, and (iii) the Holder may still convert this Note pursuant to the terms hereof at all times until such prepayment amount has been received in full.

 

The Company evaluated the embedded derivative criteria in ASC 815, and concluded that the Company’s prepayment option is not the type of call option that meets the definition of an embedded derivative. However, the Optional Prepayment Liquidated Damages clause does meet the definition of an embedded derivative that should be separated from the note and accounted for as a derivative liability.

 

Investor Warrants

 

In addition, warrants entitling the investor to purchase 199,396 shares of the Company’s common stock at a price driven by the market price of the Company’s stock at the date of conversion. The warrants have a term of five years and vest immediately.

 

The exercise price of the Investor Warrants is $.80 per share of the Company’s common stock, as may be adjusted from time to time pursuant to the antidilution provisions of the warrants.

 

The Investor Warrants are exercisable by the Investor in whole or in part, as either a cash exercise or as a “cashless” exercise.

 

The Company evaluated the warrants under ASC 480 Distinguishing Liabilities from Equity and ASC 815 Derivatives and Hedging. Due to the existence of the antidilution provision, which reduces the Exercise Price and Conversion Price in the event of subsequent Dilutive Issuances, the Investor Warrants are not indexed to the Company’s common stock, and the Company determined that the warrants meet the definition of a derivative under ASC 815. Accordingly, the warrants were recorded as derivative liabilities in the Consolidated Balance Sheets at their fair value of approximately $183,000 at the date of issuance. The fair value of the warrants is measured in accordance with ASC 820 Fair Value Measurement, using “monte carlo simulation” modeling.

 

The fair value of the warrants as of September 30, 2015 and December 31, 2014 was $0. At each subsequent reporting date, if the fair value of the warrants is remeasured, the changes in the fair value will be reported in the Consolidated Statements of Operations. See Note 21 regarding exercise of warrants for the Company’s common stock.

 

The Company has not elected to initially and subsequently measure the note as a hybrid instrument in its entirety at fair value. Therefore, in accordance with ASC 815, the Company is accounting for all the embedded derivatives identified in the note as a single compound embedded derivative.

 

The total proceeds of $100,000 received by the Company for the note and Investor Warrants, was allocated first to the Investor Warrant and embedded derivative liabilities at their initial fair values determined at the issuance date. The residual proceeds after that allocation was then applied to the note.

 

Accordingly, the carrying amount of the note at inception is approximately $100,000, derived as follows:

 

Face amount of note   $ 100,000  
Allocated to embedded derivatives     -  
    $ 100,000  

 

Repayment of Note

 

In April 2015, the Company received notice from the Holder of their intent to convert a portion of their outstanding convertible debt, approximately $117,000, into shares of the Company’s common stock. Using the formula provided for in the related convertible debt agreement, this lender received approximately 4,656,000 shares of the Company’s common stock. In addition, in April 2015, this convertible debt holder notified the Company of their intention to exercise their warrant exercisable into 199,396 at a price determined by a formula which resulted in the Company issuing 3,647,023 shares of the Company’s common stock to the convertible debt holder.

 

The fair value of the compound embedded derivative liability as of September 30, 2015 and December 31, 2014 was $0.

 

Both the warrant derivative and embedded derivative liabilities are classified as current liabilities in the Consolidated Balance Sheets, and changes in their fair value are reported in general and administrative expense in the Consolidated Statements of Operations.

 

The change in fair value of the warrant and embedded derivative liabilities for the nine months ended September 30, 2015 and 2014 was $0, respectively, which was recorded as a separate line item, change in fair value of derivative liability, on the Consolidated Statements of Operations.

 

At September 30, 2015, the carrying value of the note was as follows:

 

Face amount of note   $ -  
Derivative and warrant liability     -  
    $ -  

 

At December 31, 2014, the carrying value of the note was as follows:

 

Face amount of note   $ 132,000  
Derivative and warrant liability     195,506  
    $ 327,506  

 

Convertible Note Payable to the Redwood Group of Investors

 

On October 17, 2014, the Company entered into a Securities Purchase Agreement with Redwood Management LLC, Redwood Fund II LLC and Redwood Fund III, LLC, (“Redwood Group of Investors”), all accredited investors, for the issuance of original issue discount senior secured convertible debentures in the aggregate principal amount of $3,520,000, in exchange for $3,520,000 in secured investor notes payable to the Company, less the initial subscription amount of $712,500 which resulted in initial cash at closing of $622,500 to the Company. The debentures include a 5% original issue discount and bear interest at 12% per annum. The secured investor notes payable to the Company are secured by equity interests in one of the Redwood Group of Investors held by members thereof pursuant to a security agreement.

 

The Company will pay aggregate commissions to an investment advisor under the terms of an agreement disclosed in note 18 in connection with the placement described herein in the amount of $253,000 payable as funds are received by the Company under the terms of the agreement.

 

Principal Payments

 

Principal payments (“Amortization Amount”) on the notes are due starting approximately nine months from the date of the note, on April 15, 2015, in various amounts as contained in the notes and can be paid in cash, with a 30% premium over payments made in shares of the Company’s common stock, or in issuances of the Company common stock. The final payment was due on October 17, 2015. The note payable maturity date has passed. The debt has been classified as current on the accompanying Consolidated Balance Sheet.

 

Amortization Payment Conversions

 

Each Amortization Payment shall be made at the option of the Company and be made in cash or in the common stock of the Company pursuant to the Amortization Conversion Rate.

 

The Amortization Conversion Rate means the lower of the Conversion Price, $0.4634, or 65% of the lowest VWAP (“Volume Weight Average Price”) for the 20 consecutive Trading Days ending on the Trading Day that is immediately prior to the applicable Amortization Payment Date.

 

The Company evaluated the note under the requirements of ASC 480 Distinguishing Liabilities from Equity and concluded that the note does not fall within the scope of ASC 480. The Company evaluated the Installment Conversion feature under the requirements of ASC 815 Derivatives and Hedging. Due to the existence of the antidilution provision which reduces the Lender Conversion Price in the event of subsequent Dilutive Issuances by the Company (see Lender Conversion below), the Installment Conversion feature does not meet the definition of “indexed to” the Company’s stock, and the scope exception to ASC 815’s derivative accounting provisions does not apply. The Company evaluated the embedded derivative criteria in ASC 815, and concluded that because the Common Stock that would be delivered by the Company if an Installment Conversion is elected (including True-Up Shares) would be readily convertible to cash by the Investor, the Installment Conversion feature meets the definition of an embedded derivative that should be separated from the note and accounted for as a derivative liability.

 

Lender Conversion

 

The Redwood Group of Investors has the right at any time after the Issue Date until the outstanding balance of the note has been paid in full, at its election, to convert (each instance of conversion is referred to as a “Lender Conversion”) all or any part of the outstanding balance into shares (“Conversion Shares”) of the Company’s common stock of the portion of the outstanding balance being converted (the “Conversion Amount”) divided by the “Lender Conversion Price” of $0.4634, subject to potential future adjustments described below.

 

The Company evaluated the note under the requirements of ASC 815 Derivatives and Hedging. Due to the existence of the antidilution provision which reduces the Lender Conversion Price in the event of subsequent Dilutive Issuances by the Company described above, the Lender Conversion feature does not meet the definition of “indexed to” the Company’s stock, and the scope exception to ASC 815’s derivative accounting provisions does not apply. The Company also evaluated the embedded derivative criteria in ASC 815, and concluded that the default and remedy provisions of the note (see Default Provisions below) cause the Lender Conversion feature to meet the net settlement criterion in ASC 815. Based on the Lender Conversion feature meeting all the embedded derivative criteria in ASC 815, the Lender Conversion feature meets the definition of an embedded derivative that should be separated from the note and accounted for as a derivative liability.

 

The Company evaluated the Lender Conversion Delay provision under the requirements of ASC 815 and concluded it meets the definition of an embedded derivative that should be separated from the note and accounted for as a derivative liability.

 

The Company evaluated the embedded derivative criteria in ASC 815, and concluded that because certain of the Events of Default under the note are factors that are unrelated to a deterioration of the creditworthiness of the Company, the Events of Default and Default Interest provisions of the note are not considered clearly and closely related to the characteristics of debt. Based on meeting all the criteria in the definition, the Company concluded that the Events of Default and Default Interest provisions each meet the definition of an embedded derivative that should be separated from the note and accounted for as a derivative liability.

 

During the nine months ended September 30, 2015, the Company received notices from the Redwood Group of Investors of their intent to convert a portion of their outstanding convertible debt, approximately $1,411,679, into shares of the Company’s common stock. Using the formula provided for in the related convertible debt agreement, this lender received approximately 140,351,127 shares of the Company’s common stock.

 

See Note 21 for conversions of outstanding debt subsequent to September 30, 2015.

 

Company Prepayment Option

 

At any time upon ten (10) days written notice to the Redwood Group of Investors, the Company may prepay any portion of the principal amount of this Debenture, including any accrued or unpaid interest. If the Company exercises its right to prepay the Debenture, the Company shall make payments to the Redwood Group of Investors of an amount in cash equal to the sum of the then outstanding principal amount of this Debenture and accrued interest multiplied by 130%. The Redwood Group of Investors may continue to convert the Debenture from the date the notice of the prepayment is given until the date of the prepayment.

 

The Company evaluated the embedded derivative criteria in ASC 815, and concluded that the Company’s prepayment option is not the type of call option that meets the definition of an embedded derivative. However, the Optional Prepayment Liquidated Damages clause does meet the definition of an embedded derivative that should be separated from the note and accounted for as a derivative liability.

 

The embedded derivative liability is classified as current liabilities in the Consolidated Balance Sheets, and changes in their fair value are reported as a separate line item in the Consolidated Statements of Operations. The change in fair value of the embedded derivative liability related to this note for the nine months ended September 30, 2015 and 2014 was $580,345 and $0, respectively, which was recorded as a separate line item, change in fair value of derivative liabilities, on the Consolidated Statements of Operations.

 

At September 30, 2015, the carrying value of the note was as follows:

 

Face amount of note   $ 892,500  
Derivative and warrant liability     270,094  
    $ 1,162,594  

 

At December 31, 2014, the carrying value of the note was as follows:

 

Face amount of note   $ 2,184,000  
Derivative and warrant liability     850,439  
    $ 3,034,439  

 

At each subsequent reporting date, when the fair value of the embedded derivative liability is remeasured and changes in the fair value will be recorded in the Consolidated Statements of Operations.

 

The embedded derivative liability is classified as current liability in the Consolidated Balance Sheets, and changes in their fair value are reported in the Consolidated Statements of Operations.

 

Purchaser Notes

 

The Company issued three Purchaser Notes on October 17, 2014. The total principal of the Purchaser Notes is $2,631,503. The note will not bear interest for the benefit of the Company. The entire unpaid principal balance under each Purchaser Note is due and payable thirteen (11) months from the date the Purchaser Note was entered into, which is September 17, 2015. However, the Redwood Group of Investors may elect, in their sole discretion, to extend the maturity dates for up to thirty (30) days by delivering written notice of such election to Company at any time prior to the maturity date. The Redwood Group of Investors may, with Company’s consent, prepay without penalty all or any portion of the outstanding balance of each Purchaser Note at any time prior to the maturity date.

 

The Purchaser Notes contain certain default provisions such as the Redwood Group of Investors failure to make any payment when due and payable, its failure to observe or perform any other covenant, obligation, condition or agreement contained in the Purchaser Note, or upon involuntary bankruptcy by the Investor and such petition is not dismissed within sixty (60) days, or a receiver, trustee, liquidator, assignee, custodian, sequestrator or other similar official is appointed to take possession of any of the assets or properties of Investor.

 

The Purchaser shall be entitled to deduct and offset any amount owing by the Company under the Debenture from any amount owed by the Redwood Group of Investors under the Purchaser notes.

 

The Purchaser Notes are recorded as current investments, under Investor Notes Receivable at cost in the Consolidated Balance Sheets. As stated above, there is no interest income on the Purchaser Notes for the nine months ended September 30, 2015 and 2014.

 

Fair Value Measurement

 

As discussed above, the convertible notes contain conversion features, warrants and default provisions that result in embedded derivatives. The Company has recorded the fair value of each derivative as described above and is included in the derivative liabilities included in the current liabilities in the Consolidated Balance Sheets as of September 30, 2015 and December 31, 2014.

 

In arriving at fair-value estimates, the Company utilizes the most observable inputs available for the valuation technique employed. If a fair-value measurement reflects inputs at multiple levels within the fair value hierarchy, the fair-value measurement is characterized based upon the lowest level input. For the Company, recurring fair-value measurements are performed for the derivative liability.

 

The derivative liability is recognized in the balance sheet at fair value. Changes in the fair value of the derivative liability are reported in the Consolidated Statements of Operations. The Company does not have any liabilities that reduce risk associated with hedging exposure and has not designated the derivative liability as a hedge instrument.

 

The Company did not have any derivatives valued using Level 1 and Level 2 inputs as of September 30, 2015 and December 31, 2014. The fair values and corresponding classifications under the appropriate levels of the fair value hierarchy of the outstanding derivative liability recorded as recurring liabilities in the Consolidated Balance Sheets consisted of the following:

 

    Level     September 30, 2015     December 31, 2014  
                         
Included in current liabilities: Derivative Liability     3     $ 839,644     $ 1,939,292  

 

    Valuation   Unobservable
    Technique   Input
         
Included in current liabilities:        
Derivative Liability        
    Monte Carlo Pricing Model   Prevailing interest rates Company’s stock volatility Expected term

 

There have been no transfers between Level 1, Level 2, or Level 3 categories.