14. Shareholders' Deficit

9 Months Ended

Sep. 30, 2013

Shareholders Deficit

NOTE 14 - Shareholders' Deficit

Common Stock

Following a majority vote of shareholders to approve, an information statement was distributed to shareholders of record as of June 30, 2013. After the appropriate waiting period after such mailing, the authorized number of shares was increased from 500,000,000 to 1,000,000,000 in August 2013. During the nine months ended September 30, 2013, the Company issued a total of 331,549,242 shares of Common Stock, resulting in an increase in outstanding shares from 89,083,677 shares as of December 31, 2012 to 420,966,252 shares as of September 30, 2013: 

	Number of
	Shares
Outstanding shares as of December 31, 2012		89,083,677
Exchange of Series E Preferred for common stock		157,499,999
Exchange of Series E Preferred warrants for common stock		102,326,388
Exchange of certain debts for common stock		34,999,984
Shares issued for financial advisory agreement		21,025,000
Sales of common stock		13,916,665
Conversion of Series D Preferred into common stock		1,413,850
Other		700,689
Outstanding shares as of September 30, 2013		420,966,252

Series C 10% Preferred Stock

There were no shares of Series C 10% Preferred Stock outstanding as of September 30, 2013 or December 31, 2012.

Series D 10% Preferred Stock

As of September 30, 2013 and December 31, 2012, 0 and 18,999 shares of Series D were outstanding, respectively.  Each share of Series D sold for $30, could be converted at any time into 60 shares of common stock and had 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 had liquidation preference over common stock at a liquidation value equal to its par value of $30 and paid a cumulative dividend of 10% per year. 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. During the nine months ended September 30, 2013, 18,999 shares of Series D were converted into a total of 1,413,850 shares of common stock: 1,139,940 shares for direct conversion of the Series D into common stock, 252,797 shares for dividends and 21,113 for the price protection feature.

Series E 5% Preferred Stock

As of September 30, 2013 and December 31, 2012, there were 0 and 9,450 shares of Series E were outstanding, respectively. On May 6, 2013 all shares of Series E were exchanged for 157,499,999 shares of common stock and were extinguished, thereby removing the “overhang” created by the terms of the Series E that provided for the conversion price into common stock to be reduced to the price of any subsequent financing done at a lower price. 

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 were exercisable for five years commencing on the date of first issuance. 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. All of the Series E have been converted into the Company’s common stock.

Stock Options

On March 27, 2013 the Board approved an option to the Company’s CEO to purchase 25,000,000 shares of common stock at $0.03 and an option to the Company’s Secretary to purchase 6,000,000 shares of common stock at $0.03. These options have a five-year life and vested in the three months ended June 30, 2013, resulting in Black Scholes option expense of $824,600 for this quarter. The Black Scholes expense for these March 27, 2013 options was calculated using the following assumptions. The fair value of the underlying common stock was based on the sale of 13,916,665 shares of common stock at $0.03 by the Company during the three months ended June 30, 2013.

Estimated fair value of underlying common stock	$0.03
Remaining life	5.0
Risk-free interest rate	0.35%
Expected volatility	141%
Dividend yield	–

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 Black Scholes expense for these 2012 options was calculated using the following assumptions. The fair value of the underlying common stock was determined by closing price on the Bulletin Board stock exchange.

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
			Weighted			Weighted
			Average	Weighted		Average	Weighted
		Range of	Remaining	Average		Remaining	Average
	Options	Exercise	Life in	Exercise	Options	Life in	Exercise
	Outstanding	Prices	Years	Price	Exercisable	Years	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	31,000,000	$0.03	4.5	$0.03	31,000,000	4.5	$0.03
As of September 30, 2013	38,943,523	$0.03 -$0.54	4.1	$0.12	36,731,023	4.1	$0.11

Warrants

On March 27, 2013 the Board approved warrants to three financial advisors to purchase 17,391,667 shares of common stock at $0.03. These warrants have a five-year life and vested during the three months ended June 30, 2013, resulting in Black Scholes warrant expense of $462,618 for this quarter. The Black Scholes expense for these March 27, 2013 warrants was calculated using the following assumptions. The fair value of the underlying common stock was based on the sale of 13,916,665 shares of common stock at $0.03 by the Company during the three months ended June 30, 2013.

Estimated fair value of underlying common stock	$0.03
Remaining life	5.0
Risk-free interest rate	0.35%
Expected volatility	141%
Dividend yield	–

In May 2013 Series E warrants, along with related warrants with similar terms, were exchanged for 102,326,388 shares of common stock and these warrants were extinguished, thereby removing the “overhang” created by the full-ratchet provisions of these warrants that would have increased the number of warrants outstanding and reduced the strike price of these warrants to the price of any subsequent financing done at a lower price. This exchange of common stock for the Series E warrants resulted in a fair value charge of $3,069,792 in the three and six months ended June 30, 2013. These 102,326,388 shares of common stock were valued at $0.03 per share, which was the price at which the Company sold 13,916,665 shares during three months ended June 30, 2013, resulting in the charge for $3,069,792.

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 Black Scholes expense for these 2012 warrants was calculated using the following assumptions. The fair value of the underlying common stock was determined by closing price on the Bulletin Board stock exchange. 

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	–

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		(97,869,997	)		$0.30		2.7		$0.30		(93,994,997	)		2.7		$0.30
Exercised		–			–		–		–		–			–		–
Granted		17,391,667			$0.03		4.5		$0.03		17,391,667			4.5		$0.03
As of September 30, 2013		51,806,912			$0.03 - $2.00		3.5		$0.44		50,306,912			3.5		$0.44