NOTE 11 - DERIVATIVE LIABILITIES

6 Months Ended

Jun. 30, 2013

Derivative Instruments and Hedging Activities Disclosure [Abstract]

NOTE 11 - DERIVATIVE LIABILITIES

NOTE 11 – DERIVATIVE LIABILITIES

1) Derivative liabilities due to variable conversion ratio

On March 20, 2013 the Company entered into strategic financing agreements with several institutional investors that could provide the Company with up to $2.3 million of debt financing based upon the amount of conversions and redemptions. The transaction documents provide, among other things, that (i) the investors will receive five year warrants in an amount equal to 100% of the number of shares of our common stock the investors would receive if the Notes (defined below) were converted on March 13, 2013, at an exercise price of $0.50 per share, (ii) $1.950 million of the funds will deposited in one of our bank accounts but will be subject to a control account agreement which will provide that the Company can only withdraw funds from the account as the investors convert or redeem the Notes, (iii) the investors have demand and piggy-back registration rights for the shares of common stock underlying the warrants and Notes, (iv) the Notes will be secured by a first priority security interest in all of our assets, other than our patents, (v) each investor may not convert any Note or exercise any warrants if doing so will cause the investor to own more than 4.99% of our outstanding common stock at any time, although under certain circumstances they can each own up to 9.99% of our outstanding common stock, (vi) we paid $40,000 of the investors’ legal fees incurred with respect to this transaction, and (vii) for the next three years the investors have a right to participate in up to 50% of any of our future financings. The warrants and Notes contain standard anti-dilution provisions and the Securities Purchase Agreements contains standard covenants for a financing of this nature. In the event the Company acquires any subsidiaries while the Notes are outstanding, such subsidiaries will be obligated to guaranty the Notes and any other obligations we owe to the investors pursuant to the transaction documents.

The Company has determined that the conversion feature of the Notes represent an embedded derivative since the Notes are convertible into a variable number of shares upon conversion. Accordingly, the Notes are not considered to be conventional debt under EITF 00-19 and the embedded conversion feature must be bifurcated from the debt host and accounted for as a derivative liability. Accordingly, the fair value of this derivative instrument has been recorded as a liability on the balance sheet with the corresponding amount recorded as a discount to the Notes. Such discount will be accreted from the grant date to the maturity date of the Notes. The change in the fair value of the derivative liability will be recorded in other income or expenses in the statement of operations at the end of each period, with the offset to the derivative liability on the balance sheet. The beneficial conversion feature included in the Notes resulted in an initial debt discount of $2,400,000 and an initial loss on the valuation of derivative liabilities of $915,510 based on the initial fair value of the derivative liability of $3,315,510. The fair value of the embedded derivative liability was calculated at grant date utilizing the following assumptions:

Grant Date	Fair Value	Term (Years)	Assumed Conversion Price	Market Price on Grant Date	Volatility Percentage	Risk-free Rate
3/20/13	$3,315,510	3.0	$0.326	$0.465	238%	0.0038

At June 30, 2013, the Company revalued the embedded derivative liability. For the period from the grant date to June 30, 2013, the Company decreased the derivative liability of $3,315,510 by $998,875 resulting in a derivative liability of $2,316,636 at June 30, 2013.

The fair value of the embedded derivative liability was calculated at June 30, 2013 utilizing the following assumptions:

Fair Value	Term (Years)	Assumed Conversion Price	Volatility Percentage	Risk-free Rate
$2,316,636	2.72	$0.328	247%	0.0036

The carrying value of the Notes was $221,370 as of June 30, 2013. The Company recorded interest expense related to this note of $90,533 and amortization of the debt discount in the amount of $221,370 during the period ended June 30, 2013.

2) Derivative liabilities due to ratchet features of the warrants

On March 20, 2013, the Company issued 4,535,714 warrants (the “Warrants”) as part of the senior secured convertible notes. Pursuant to the warrants agreements, if and whenever on or after the grant date of the Warrants, the Company issued or sold, or in accordance with the warrants agreements is deemed to have issued or sold, any shares of Common Stock (including the issuance or sale of shares of Common Stock owned or held by or for the account of the Company, but excluding any Excluded Securities issued or sold or deemed to have been issued or sold) for a consideration per share (the “New Issuance Price”) less than a price equal to the Exercise Price of the Warrants in effect immediately prior to such issue or sale or deemed issuance or sale (“Dilutive Issuance”), then immediately after such Dilutive Issuance, the Exercise Price then in effect shall be reduced to an amount equal to the New Issuance Price.

The Company has determined that the ratchet features of the Warrants represent an embedded derivative since the Warrants are exercisable into a variable number of shares upon exercise. Accordingly, the Warrants are not considered to be conventional warrants under EITF 00-19 and the embedded ratchet feature must be accounted for as a derivative liability. Accordingly, the fair value of this derivative instrument has been recorded as a liability on the balance sheet with the corresponding amount recorded as derivative expenses. The change in the fair value of the derivative liability will be recorded in other income or expenses in the statement of operations at the end of each period, with the offset to the derivative liability on the balance sheet. The ratchet feature included in the Warrants resulted in an initial derivative expenses of $2,092,336 on the grant date based on the initial fair value of the derivative liability. The fair value of the embedded derivative liability was calculated at grant date utilizing the following assumptions:

Grant Date	Fair Value	Term (Years)	Exercise Price	Market Price on Grant Date	Volatility Percentage	Risk-free Rate
3/20/13	$2,092,336	5.0	$0.50	$0.465	238%	0.0038

At June 30, 2013, the Company revalued the embedded derivative liability. For the period from the grant date to June 30, 2013, the Company decreased the derivative liability of $2,092,336 by $608,631 resulting in a derivative liability of $1,483,705 at June 30, 2013.

The fair value of the embedded derivative liability was calculated at June 30, 2013 utilizing the following assumptions:

Fair Value	Term (Years)	Exercise Price	Volatility Percentage	Risk-free Rate
$1,483,705	4.72	$0.50	247%	0.0036