18. Restatement of financial statements

3 Months Ended

Mar. 31, 2013

Accounting Changes and Error Corrections [Abstract]

18. Restatement of financial statements

18.      Restatement of financial statements

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”.

These Series E contain “full ratchet-down” liquidity protection that provides that if the Company issues securities for less than the existing conversion price for the Series E Preferred Stock or the strike price of the Series E warrants, then the conversion price for Series E Preferred Stock will be lowered to that lower price. Also, the strike price for Series E warrants will be decreased to that lower price and the number of Series E warrants will be increased such that the product of the original strike price times the original quantity equals the lower strike price times the higher quantity.

In preparing the financial statements for 2012, the Company has determined that the warrants for these financings included certain embedded derivative features as set forth in ASC 815, “Derivatives and Hedging,” (“ASC 815”) and that this conversion feature of the Series E was not an embedded derivative because this feature was clearly and closely related to the host (Series E) as defined in ASC 815. These derivative liabilities were initially recorded at their estimated FV on the date of issuance and are subsequently adjusted each quarter to reflect the estimated fair value at the end of each period, with any decrease or increase in the estimated fair value of the derivative liability for each period being recorded as other income or expense. Since the value of the embedded derivative feature for the related warrants was higher than the value of both Series E transactions, there was no beneficial conversion feature recorded for either transaction, and the excess of the value of the embedded derivative feature over the value of the transaction was recorded in each period on the Statement of Operations.

As the result of this determination, the Company had incorrectly accounted for the derivative liabilities embedded in the Series E and related warrants issued in the year 2011. The consolidated balance sheet as of March 31, 2012 and the related consolidated statements of operations for the three months then ended were restated to reflect the correct treatment.   

The flowing table presents the effect of the restatement adjustment on the accompanying consolidated balance sheet as of March 31, 2012:

		As of March 31, 2012
Consolidated Balance Sheet as of March 31, 2012		As Previously Reported			Restated			Net Adjustment
Derivative liability	$	–		$	13,841,450		$	13,841,450
Other current liabilities		5,768,527			5,768,527			–
Total current liabilities	$	5,768,527		$	19,609,977		$	13,841,450
Shareholder's deficit
Series D 10% Preferred Stock	$	19		$	19		$	–
Series E 5% Preferred Stock		9			9			–
Common stock		88,157			88,157			–
Additional paid-in capital		42,315,939			33,615,948			(8,699,991	)
Accumulated deficit		(44,541,282	)		(49,682,741	)		(5,141,459	)
Total Shareholder's deficit	$	(2,137,158	)	$	(15,978,608	)	$	(13,841,450	)

The flowing table presents the effect of the restatement adjustment on the accompanying consolidated statement of operations for the three months ended March 31, 2012:

		Three Months Ended March 31, 2012
		As
Consolidated Statement of Operations		Previously						Net
for Three Months Ended March 31, 2012		Reported			Restated			Adjustment
Loss from operations	$	2,352,168		$	2,352,168		$	–
Other (income)/expenses
Adjustments to fair value of derivative securities		–			(2,047,405	)		(2,047,405	)
Other (income)/expenses		–			–			–
Interest expense		126,573			2,405			(124,168	)
Total other (income)/expenses		126,573			(2,045,000	)		(2,171,573	)
Net loss		(2,478,742	)		(307,168	)		2,171,573
Preferred dividends		–			124,168			124,168
Net loss attributable to common shareholders	$	(2,478,742	)	$	(431,336	)	$	2,047,405
Basic and diluted loss attributable to common shareholders per share	$	(0.03	)	$	–		$	0.03
Basic weighted average shares outstanding		88,157,055			88,157,055			–
Fully-diluted weighted average shares outstanding		88,157,055			109,407,055			21,250,000

The FV of these derivative liabilities is calculated using the Black Scholes pricing model that is based on the closing price of the common stock, the strike price of the underlying instrument, the risk-free interest rate for the applicable remaining life of the underlying instrument (i.e., the U.S. treasury rate for that period) and the historical volatility of the Company’s common stock. These FV results are extremely sensitive to all these input variables, particularly the closing price of the company’s common stock and the volatility of the Company’s common stock. Accordingly, the FV of these derivative liabilities are subject to significant changes.