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Liabilities

6 Months Ended

Jun. 30, 2017

3. Liabilities

Note Payable

In November 2014, the Company issued for cash of $100,000 an unsecured note payable and a five-year warrant with an exercise price of $0.09 per share for the purchase of up to 50,000 shares of common stock. The terms of the note were a repayment of $115,000 if paid by February 18, 2015 and, if paid thereafter, the principal balance of the note was to be increased to $137,982 as of October 1, 2015 and interest accrues at 20% from October 1, 2015 until paid. During the six months ended June 30, 2017, $25,000 principal of this note was assigned to a third party who paid a like amount to the holder of the note. The balance of the note outstanding at June 30, 2017, $112,982, continues to accrue interest at 20%.

Notes Payable- Related Parties

During the six months ended June 30, 2016, two affiliates of the Company advanced to the Company cash in an accumulated amount of $35,000 in exchange for six-month 10% promissory notes. The balance of the notes remain $35,000 at June 30, 2017.

Convertible Debentures

As of June 30, 2017, the Company has issued and outstanding fixed rate Convertible Debentures (“Debentures”) with original terms of three months to one year, an interest rate ranging from 10-20% per year and an original issue discount ranging from 5% to 10% which, at the option of the holder, may convert into common stock at initial conversion prices ranging from $0.01 to $0.099 per share.

The Debentures were issued with detachable five year cashless Holders Warrants that allow the holders to purchase one share of stock for each two shares available under the converted Debentures at an exercise price ranging from $0.02 to $0.1287 per share. In addition, the Company issued five-year cashless Agent Warrants equal to 10% of the total number of shares issuable under the Debentures and Holders Warrants at exercise prices ranging from $0.0745 to $0.1287 per share. For debentures issued through June 30, 2013, at the option of the Debenture holder, the terms of the Debentures and Holders Warrants are subject to an exchange feature in the event that the Company issues securities with terms more favorable than those of the then outstanding Debentures and Holders Warrants. Debentures issued subsequent to June 30, 2013 do not contain such an exchange clause. During the six months ended June 30, 2017, Debentures with an accumulated principal balance of $150,000 and $13,767 of accrued interest were assigned to a third party note holder. The new notes contain variable conversion rates discussed below. The gross amount of Debentures with fixed conversion rates outstanding is $5,977,082 as of June 30, 2017.

During the six months ended June 30, 2017, the Company has issued and outstanding Convertible Debentures (“Variable Debentures”) with original terms of 9 months to one year, interest rates ranging from 0-10% per year and original issue discounts ranging from 0-10% which contain variable conversion rates ranging from discounts of 40-50% of the Company’s common stock based on the Company’s common stock trading prices ranging from 10-25 days previous to conversion. The Variable Debentures contain prepayment options which enable the Company to prepay the notes for periods of 0-180 days subsequent to issuance at premiums ranging from 0-50%. The gross amount of Variable Debentures outstanding is $472,449 as of June 30, 2017.

As of June 30, 2017 and December 31, 2016, the balances of the Debentures and Variable Debentures are as follows:


	June 30, 2017			December 31, 2016

Balance at beginning of period	$	6,415,305		$	6,174,760
Issuance of debentures for cash		123,750			320,000
Issuance of debentures for services		21,250			15,000
Issuance of debentures for forbearance		16,064			65,282
Debentures repaid in cash		(669	)		-
Debentures converted to common stock		(164,936	)		(291,754	)
Debentures exchanged for new debentures		38,767			132,017
Convertible debt		6,449,531			6,415,305
Less unamortized costs of financing		249,988			203,444
Convertible debt, net of unamortized costs	$	6,199,543		$	6,211,861

Convertible debt in default	$	6,068,243		$	5,991,570

Secured Convertible Note

During the six months ended June 30, 2017, the Company issued for cash of $300,000 Secured Convertible Debentures (the “Secured Debentures”) to two accredited investors. The terms of the Debentures are for three years, a conversion price of $0.01 per share and an annual interest rate of 8%. The secured interest is on all of the assets of the Company. In addition, the Company issued to the holder of $150,000 Secured Debentures, five year common stock purchase warrants to purchase up to 8,000,000 shares of common stock with exercise prices of $0.02 per share. The value of these warrants, $584, was determined using the Black Sholes option pricing model and was reflected as a discount to the Secured Debenture.

Derivative Liability

Since the Company issued Convertible Debentures which included Holders Warrants, Agent Warrants and a conversion option that includes a possible exchange feature in the event of a future financing on terms more favorable than those of the existing warrants and debentures, this results in the warrants and conversion feature of the debentures being recorded as a liability and measured at

fair value. In addition, outstanding Variable Debentures contain variable conversion rates based on unknown future prices of the Company’s common stock resulting in a conversion feature. The Company measures these warrants and conversion features using the Black Scholes option pricing model. The period over which the Company will be required to evaluate the fair value of the warrants is approximately five years and the period over which the Company will be required to evaluate the fair value of the conversion features are six to twelve months or conversion.

The assumptions used in determining fair value represent management’s best estimates, but these estimates involve inherent uncertainties and the application of management’s judgment. As a result, if factors change, including changes in the market value of the Company’s common stock, managements’ assessment of the probability of a more favorably priced future financing or significant fluctuations in the volatility of the trading market for the Company’s common stock, the Company’s fair value estimates could be materially different in the future.

The Company computes the fair value of the derivative liability at each reporting period and the change in the fair value is recorded as non-cash expense or non-cash income. The key component in the value of the derivative liability is the Company’s stock price, which is subject to significant fluctuation and is not under the Company’s control. Therefore, the resulting effect on net loss is subject to significant fluctuation and

will continue to be so until the Company’s Debentures, which the convertible feature is associated with, are converted into common stock or paid in full with cash. Assuming all other fair value inputs remain constant, the Company will record non-cash expense when its stock price increases and non-cash income when its stock price decreases.

In addition, since the number of shares issuable under the Variable Debentures are undeterminable, the Company may be required to issue shares in excess of the number of shares authorized by its shareholders. As a result, when the Company determines that is does not have sufficient shares to meet the obligations of derivative unexercised debentures, warrants and options, the derivatives must be valued using the Black Scholes option pricing model and a liability is recorded as though the obligations would be settled using some means other than stock. For the six months ended June 30, 2017, the Company determined that it was over committed to the number of shares issuable on the exercise of outstanding debentures, stock options and warrants for approximately 3,706,000,000 shares.

As of June 30, 2017 and December 31, 2016, the balances of the Derivative Liability are as follows:

							Commitment
							In Excess of
	Warrants			Conversion Feature			Authorized Stock			Total

Balance at January 1, 2016	$	60,420		$	495,473		$	64,428		$	620,321

Liability on issuance of debt and warrants		44,394			697,256			-			741,650
Change in fair value at year end		(22,378	)		718,458			-			696,080
Elimination of liability on conversion		-			(1,232,151	)		-			(1,232,151	)
Over commitment of stock		-			-			(5,972	)		(5,972	)
Balance at December 31, 2016	$	82,436		$	679,036		$	58,456		$	819,928

Liability on issuance of debt and warrants		4,268			762,134			-			766,402
Change in fair value at year end		(71,602	)		355,833			-			284,231
Elimination of liability on conversion		-			(607,914	)		-			(607,914	)
Over commitment of stock		-			-			(39,397	)		(39,397	)
Balance at June 30, 2017	$	15,102		$	1,189,089		$	19,059		$	1,223,250

Debentures with warrants attached issued subsequent to June 30, 2013 did not contain an exchange provision and were accounted for using the equity method of valuing the note and warrant.