14. Shareholders' Deficit

3 Months Ended

Mar. 31, 2013

Shareholders Deficit

NOTE 14 - Shareholders' Deficit

14.     Shareholder’s Equity

Common Stock

The Company did not sell any common stock in the three months ending March 31, 2013.

Series D 10% Preferred Stock

During 2010, the Company issued 5,700 shares of Series D 10% Preferred Stock (“Series D”) for $170,921.  Each share of Series D sold for $30, can be converted at any time into 60 shares of common stock and has voting rights equal to 60 shares of common stock.  In connection with the issuance of Series D, the Company issued warrants to purchase 179,970 shares of common stock.  The warrants have a life of five years to purchase a share of common stock for $1.00 per share.  The Series D has liquidation preference over common stock at a liquidation value equal to its par value of $30 and pays a cumulative dividend of 10% per year, payable on July 31 and December 31 of each year that the Series D is outstanding. Interest payments may be made in cash or in common stock at the discretion of the Company.  The Series D automatically convert into 60 shares of common stock when the closing price for a share of common stock is $5.00 or above and the average daily trading volume for the 10 previous trading days is above 200,000 shares.  Given the losses recorded by the Company, the stock equivalents related to the Series D are not included in the calculation of earnings per share since the effect of such inclusion would be antidilutive.

Since the Series D contains an embedded conversion feature, the Company performed an analysis of the Series C under ASC Topic 815 “Derivatives and Hedging.” This analysis determined that the embedded conversion feature was not required to be bifurcated and accounted separately from the Series D because the economic risks and characteristics of the embedded conversion feature were clearly and closely related to the economic risks and characteristics of the host contract Series D, namely the risks of the common stock.  The value of the beneficial conversion feature was $26,945 which was charged to equity at the time of issuance and was not included in the calculation of earnings per share.  The beneficial conversion feature was calculated as the difference of the FV of the conversion price and the intrinsic value of the preferred shares.

The Series D contains a share adjustment provision that provides for additional shares to be issued if the 30-day volume weighted average price of the Company’s common stock (“VWAP”) is between $0.50 and $1.00 180 days after the purchase of Series D.  If the VWAP is above $1.00, no action is taken. If the VWAP is between $0.50 to $1.00, additional shares are issued to the holder such that the total of the number of common shares issuable upon conversion, which is the number of Series D shares times 60 (“Conversion Shares”), plus the additional shares together equals the VWAP price equals the Conversion Shares times $1.00. If the VWAP is below $0.50 the number of additional shares are calculated as if the price were $0.50, not the actual VWAP.  Once this 180-day period passes and the Company has issued the appropriate shares, if any, then Price Protection provisions of this Agreement will expire and the Company will be completely released from any future claims by the Purchaser related to this share adjustment provision.

The Company determined that derivative accounting for the embedded conversion and the share adjustment features was not required pursuant to ASC Topic 815 “Derivatives and Hedging,” because these features are indexed to the Company’s own stock under ASC 815-40-15 (EITF Issue 07-5); the features can be classified in shareholders’ equity under ASC 815-40 (EITF Issue 00-19, paragraphs 1-11) and that Series D is classified as a conventional convertible so the features can be classified in stockholders’ equity under ASC 815-40 (Issue 00-19, paragraphs 12-32). The determination was made by the Company that the Series D is a conventional convertible because the freestanding warrant is indexed to the company’s own stock under ASC 815-40-15 (EITF Issue 07-5); the freestanding warrant is classified in shareholders’ equity under ASC 815-40 (Issue 00-19, paragraphs 1-32); and the financial instrument does not include embedded puts and/or calls or other features that require bifurcation from the host contract under ASC 815.

As of March 31, 2013 and December 31, 2012, 8,333 and 18,999 shares of Series D were outstanding, respectively.  During the three months ended March 31, 2013, 10,666 shares of Series D were converted into 639,960 shares of common stock, 8,094 shares of common stock were issued in connection with the price protection feature and 116,581 shares of common stock were issued for accrued dividends.

Series E 5% Preferred Stock

In October 2012, the Company raised $870,000 through the issuance of 1,000 shares of Series E 5% Preferred Stock (“Series E”) and common stock and warrants to purchase shares of common stock at $0.65 to $1.00.

On May 24, 2011, the Company entered into a Securities Purchase Agreement (the “Purchase Agreement”) with eight investors (collectively, the “Investors”) pursuant to which the Company sold 8,700 shares of a new series of convertible preferred stock designated as Series E Convertible Preferred Stock (“Original Series E”), the terms of which are set forth in the Certificate of Designations of Series E Preferred Stock (the “Certificate”), for $1,000 per share, or $8,700,000. In October 2012, the Company sold 1,000 shares of Series E for $1,000,000 (“New Series E”). The Original Series E and New Series E together are referred to herein as “Series E”.

In connection with the sale of the Series E, the Company also agreed to issue to the Investors (a) warrants (“A Warrants”) to purchase up to one additional share of Common Stock for each share of Common Stock issuable upon conversion of the Preferred Shares, and (b) warrants (“B Warrants”) to purchase up to 0.50 additional shares of Common Stock for each share of Common Stock issuable upon conversion of the Preferred Shares. The Warrants are exercisable for five years commencing on the date of first issuance and are exercisable only for cash if there is an effective registration statement covering the resale of the shares issuable upon exercise of the Warrants. In the absence of such a registration statement, the Warrants are exercisable for cash or on a cashless basis at the option of the holder thereof. For the Original Series E, exercise price of the A Warrant was $0.65 per share and the B Warrant had an exercise price of $1.00 per share, subject in each case to full ratchet anti-dilution protection.

The Original Series E were adjusted pursuant to the full ratchet anti-dilution protection when $249,999 of notes were issued on April 4, 2012 that contained a $0.30 conversion feature, so that the Original Series E now has a conversion price of $0.30 and an exercise price of $0.30 for the warrants. The New Series E were issued with a conversion and exercise price of $0.30 for the warrants. The impact of this ratchet-down provision in April 2012 increased the number of shares that would be issued upon conversion on that date from 21,125,000 shares of common stock to 28,166,667 and to increased the number of shares that would be issued upon full exercise of the warrants on that date from 37,975,000 shares of common stock to 94,966,667. If the Company issues equity securities in the future below $0.30, this full-ratchet anti-dilution protection will, absent a waiver of this protection, result in significant amounts of additional stock and warrants.

Pursuant to the Certificate, the Series E bears a dividend of 5%, payable quarterly in cash, or, if the dividend shares are registered for resale, in shares of the Company’s common stock. The effective conversion rate for the Original Series E was $0.40 per share of Common Stock, subject to full ratchet anti-dilution protection, which was triggered in April 2012 so that the conversion rate for the Original Series E and the New Series E is $0.30. The Series E has voting rights on an as-converted to Common Stock basis, with the Investors (subject to certain exceptions) having the right to elect two members to the Company’s Board of Directors for so long as at least 50% of the total number of Series E purchased pursuant to the Purchase Agreement are outstanding, and the right to elect one member to the Company’s Board of Directors for so long as at least 25% but less than 50% of the total number of Series E issued pursuant to the Purchase Agreement are outstanding. The Company is required to redeem any unconverted Series E on the fifth anniversary of the date of first issuance of the Original Series E and the New Series E, and has the right to require conversion at any time if the average daily trading value for any 20 consecutive trading days exceeds $250,000 and the weighted average price per share is at least $2.50 for each of those twenty consecutive trading days.

To secure the Company’s obligation to redeem the Series E, the Company entered into a Security Agreement, pursuant to which the Company has agreed to grant the holders of the Series E a first priority security interest in all of its assets.

The Company filed a registration statement with the SEC covering the resale of the shares (a) issuable upon conversion of the Preferred Shares or exercise of the Warrants, (b) issued as dividends payable in shares of Common Stock pursuant to the Certificate, and (c) issuable upon exercise of the Placement Agent Warrants. This registration statement was declared effective in February 2012.  Upon the occurrence of certain events set forth in the Purchase Agreement, including the failure to timely file the registration statement or have the registration statement timely declared effective, the Company will pay to the Investors cash equal to 1% of the aggregate purchase price of the Series E Preferred Stock and Warrants for each 30-day period during such default; provided, however, that the payments will not exceed 10% of the aggregate purchase price. The Company intends to file a post-effective amendment as soon as possible after the filing of this Quarterly Report on Form 10-Q.

As of March 31, 2013 and December 31, 2012, 9,450 shares of Series E were outstanding.

Stock Options

During 2012, the Company cancelled 4,660,994 options for employees whose employment had been terminated and granted 2,300,000 options to Jerold Rubinstein, the Company’s new Chairman of the Board and CEO on June 28, 2012, pursuant to an employment contract, 450,000 options to a director and 300,000 options to an officer. These options have a strike price of $0.35 - $0.38, which were the closing prices of the Company’s common stock on the day of grant and a five-year life. Mr. Rubinstein’s options vest monthly over a 12-month period unless the employment contract is terminated for any reason, at which time the options vest in full. The director’s options vest ratably over a 36-month period, and the officer’s options vest one third at grant, one third after the first year and one third after the second year. The Black Scholes value of these options was $706,250 which is being amortized over the respective vesting periods.  The following assumptions were used for the Black Scholes calculation to determine this expense:

Estimated fair value of underlying common stock	$0.35 - $0.38
Remaining life	5.0
Risk-free interest rate	0.69% - 0.80%
Expected volatility	80% - 89%
Dividend yield	–

The following table sets forth the activity of our stock options to purchase common stock:

	Options Outstanding					Options Exercisable
	Options Outstanding		Range of Exercise Prices	Weighted Average Remaining Life in Years	Weighted Average Exercise Price	Options Exercisable		Weighted Average Remaining Life in Years	Weighted Average Exercise Price
As of December 31, 2011	12,169,852		$0.14 - $1.50	3.2	$0.49	8,757,684		3.2	$0.40
Cancelled	(7,276,329	)	–	–	–	(4,660,994	)	–	–
Exercised	–		–	–	–	–		–	–
Granted	3,050,000		$0.35 - $0.38	4.5	$0.36	1,634,333		4.5	$0.36
As of December 31, 2012	7,943,523		$0.35 -$0.54	3.3	$0.46	5,731,023		2.9	$0.48
Cancelled	–		–	–	–	–		–	–
Exercised	–		–	–	–	–		–	–
Granted	–		–	–	–	–		–	–
Vested	–		–	–	–	1,312,500		–	–
As of March 31, 2013	7,943,523		$0.35 -$0.54	3.1	$0.46	7,043,523		3.0	$0.46

Warrants

During 2012, the Company issued warrants to purchase 5,000,000 shares of common stock at $0.30 in connection with the sale of 1,000 shares of Series E. The Original Series E were adjusted pursuant to the full ratchet anti-dilution protection when $249,999 of notes were issued on April 4, 2012 that contained a $0.30 conversion feature, so that the Original Series E now has an exercise price of $0.30 for the warrants. The New Series E was issued with an exercise price of $0.30 for the warrants. The Company also issued six five-year warrants to purchase 13,530,000 shares at $0.38 to $0.75 in connection with consulting and advisory contracts. The Black Scholes value of these warrants is $4,133,690, which is being recognized over the 12 months of the contracts.  The following assumptions were used for the Black Scholes calculation to determine this expense:

Estimated fair value of underlying common stock	$0.38 - $0.75
Remaining life	5.0
Risk-free interest rate	0.74% - 1.80%
Expected volatility	84% - 132%
Dividend yield	–

During 2011, the Company issued warrants to purchase 52,709,283 shares of common stock in connection with the sale of common and preferred stock. These warrants have strike prices from $0.65 to $1.00 per share, vest upon issuance and a life of five years.  These warrants contained full ratchet-down antidilution protection. In connection with the sale of the Series E preferred shares, we issued placement agent warrants that permit the placement agent or its designees to purchase for a five-year period, 3,600,000 shares of Common Stock at $0.65 per share. We also issued to a financial advisor warrants to purchase 1,000,000 shares of our Common Stock of which 950,000 shares were directed to Cary Sucoff and 50,000 shares were directed to Francis Anderson and to another financial advisor warrants to purchase 750,000 shares of our common stock on substantially similar terms. The shares underlying these warrants contain full ratchet-down antidilution protection.

The exercise price of the A Warrant for Series E Preferred was originally $0.65 and the exercise price of the B Warrant for Series E Preferred was originally $1.00, but both warrants were adjusted with a strike price of $0.30 and the number of warrants were increased pursuant to the full ratchet anti-dilution protection when $249,999 of notes were issued on April 4, 2012 that contained a $0.30 conversion feature.

Calculations of the ratchet-down impact as of April 4, 2012:

	Original						After Ratchet Down
	Shares  x		Strike  =		Aggregate Exercise Price		Shares  x		Strike  =		Aggregate Exercise Price
Series A warrants		21,750,000	$	0.65	$	14,137,500		47,125,000	$	0.30	$	14,137,500
Series B warrants		10,875,000	$	1.00	$	10,875,000		36,250,000	$	0.30	$	10,875,000
Placement agent warrant		3,600,000	$	0.65	$	2,340,000		7,800,000	$	0.30	$	2,340,000
Broker-dealer warrant		1,000,000	$	0.65	$	650,000		2,166,667	$	0.30	$	650,000
Advisory warrant		750,000	$	0.65	$	487,500		1,625,000	$	0.30	$	487,500
		37,975,000						94,966,667
Additional warrants from ratchet-down								56,991,667

A summary of the warrants:

	Warrants Outstanding				Warrants Exercisable
	Warrants Outstanding	Range of Exercise Prices	Weighted Average Remaining Life in Years	Weighted Average Exercise Price	Warrants Exercisable	Weighted Average Remaining Life in Years	Weighted Average Exercise Price
As of December 31, 2011	59,530,245	$0.65 - $2.00	3.5	$2.00	59,530,245	3.5	$2.00
Exercised	–	–	–	–	–	–	–
Ratchet-down impact	56,991,667	$0.30	–	$0.30	56,991,667	–	$0.30
Granted	15,763,330	$0.30 - $0.75	4.6	$0.38	10,388,330	4.6	–
As of December 31, 2012	132,285,242	$0.30 - $2.00	3.5	$0.40	126,910,242	3.5	$0.38
Cancelled	–	–	–	–	–	–	–
Exercised	–	–	–	–	–	–	–
Granted	–	–	–	–	–	–	–
Vested	–	–	–	–	2,530,000	–	–
As of March 31, 2013	132,285,242	$0.30 - $2.00	3.3	$0.38	129,440,242	3.2	$0.38