3. Convertible Notes

6 Months Ended

Jun. 30, 2014

Notes to Financial Statements

3. Convertible Notes

On May 30 2014, the Company entered into a Note Purchase and Security Agreement with Lattice Funding, LLC (“Lender”), a Pennsylvania limited liability company affiliated with Cantone Asset Management, LLC. The Company delivered a secured promissory note (the “Note”) in the principal sum of $1,500,000, bearing interest at 8% per annum and maturing on May 15, 2017. Interest on the Note is payable quarterly. Outstanding principal may be converted into restricted common stock. The Company also executed UCC financing statements, securing the Note with proceeds of certain agreements.

Each $10,000 of note principal is convertible into 75,000 common shares at an exercise price of $0.133333 per share any time after November 30, 2014, to be adjusted for splits, reorganizations, stock dividends and similar corporate events (anti-dilution provisions).  If the market price of Lattice common equals or exceeds twice the exercise price and certain other conditions are met, the Company may call the Note at face value for the purpose of forcing conversion of the balance of the Note into common stock.

The Convertible Notes contain a provision whereby the conversion price is adjustable upon the occurrence of certain events, including the issuance of common stock or common stock equivalents at a price which is lower than the current conversion price. Under FASB ASC 815-40-15-5, the embedded conversion feature is not considered indexed to the Company’s own stock and, therefore, does not meet the scope exception in FASB ASC 815-10-15 and thus needs to be accounted for as a derivative liability. The initial fair value at May 30 2014 of the embedded conversion feature was estimated at $1,223,923 and recorded as a derivative liability, resulting in a net carrying value of the note at May 30, 2014 of $276,077 ($1,500,000 face value less $1,223,923 debt discount). On June 30 2014 the derivative was valued at $991,054 which resulted in derivative income of $232,869. The debt discount was amortized using the effective interest method and was $1,189,925 at June 30, 2014 resulting in a finance charge of $33,998 included in the statement of operations. The fair value of the embedded conversion feature is estimated at the end of each quarterly reporting period using the Monte Carlo model.

The debt discount is being amortized over the life of the convertible note using the effective interest method.

Inherent in the Monte Carlo Valuation model are assumptions related to expected volatility, remaining life, risk-free rate and expected dividend yield.  For the Convertible Notes using a Monte Carlo model, we estimate the probability and timing of potential future financing and fundamental transactions as applicable.  The assumptions used by the Company are summarized below:

Convertible Notes

	June 30, 2014		Inception
Closing stock price	$	0.11	$	0.13
Conversion price	$	0.13	$	0.13
Expected volatility		135%		135%
Remaining term (years)		2.88		2.96
Risk-free rate		0.83%		0.77%
Expected dividend yield		0%		0%

Convertible notes consist of the following at June 30, 2013 and December 31, 2012:

	June 30, 2014			December 31, 2013
Convertible notes	$	1,500,000		$	–
Discount on convertible notes		(1,223,923	)		–
Accumulated amortization of discount		33,998			–
Total convertible notes	$	310,075		$	–