Convertible Notes Payable

3 Months Ended

Sep. 30, 2014

Convertible Notes Payable

Convertible Notes Payable

4.    CONVERTIBLE NOTES PAYABLE

At June 30, 2007, the Company reclassified an accounts payable account to a vendor in the amount of $154,429 to a note payable. The monthly payment on the note is $3,342 per month and bears annual interest at the rate of 10% per annum. At June 30, 2014, the outstanding principal and accrued interest balance was $49,799. During the quarter ended September 30, 2014, the Company wrote off $49,799 pertaining to this liability, due to the statute of limitations having expired, and reported this amount as a gain on extinguishment of debt.

On March 25, 2013, the Company entered into a convertible promissory note (the “March 2013 Note”) in the amount of $100,000, at which time an initial advance of $50,000 was received to cover operational expenses. The lender advanced an additional $20,000 on April 16, 2013, an additional $15,000 on May 1, 2013 and an additional $15,000 on May 16, 2013, for a total draw of $100,000. The terms of the March 2013 Note allow the lender to convert all or part of the outstanding balance plus accrued interest, at any time after the effective date, at a conversion price of the lower of (a) $0.015 per share, or (b) 50% of the lowest trade price of Common Stock recorded on any trade day after the effective date of the agreement. The March 2013 Note bears interest at a rate of 10% per year and matures on September 25, 2015. On May 23, 2014, the lender converted $17,000 of the $100,000 outstanding balance and accrued interest of $1,975 into 4,743,699 shares of common stock. On October 14, 2014, the lender converted $17,000 of the $83,000 outstanding balance and accrued interest of $2,645 into 4,911,370 shares of common stock. The balance of the March 2013 Note, as of September 30, 2014 is $66,000.

On May 16, 2013, the Company signed a convertible promissory note (the “May 2013 Note”) in the amount of $100,000, at which time an initial advance of $10,000 was received to cover operational expenses. The lender advanced an additional $20,000 on June 3, 2013, an additional $25,000 on July 2, 2013, an additional $10,000 on September 3, 2013 and an additional $35,000 on February 18, 2014, for a total draw of $100,000. The terms of the May 2013 Note allow the lender to convert all or part of the outstanding balance plus accrued interest, at any time after the effective date, at a conversion price of the lower of (a) $0.015 per share, or (b) 50% of the lowest trade price of Common Stock recorded on any trade day after the effective date of the agreement. The Company recognized a discount on the May 2013 Note in the amount of $20,000, due to the beneficial conversion feature. This discount is being recognized over twelve months, beginning on the date of each tranche payment. As of September 30, 2014, the Company included $46,331 in interest expense related to the discount. The Company recorded debt discount of $23,669 related to the conversion feature of the May 2013 Note, along with derivative liabilities. The May 2013 Note bears interest at a rate of 10% per year and matures on November 16, 2015.

On March 4, 2014, the Company entered into a convertible promissory note (the “March 2014 Note”) in the amount of $250,000, at which time an initial advance of $25,000 was received to cover operational expenses. The lender advanced an additional $20,000 on March 17, 2014 and an additional $30,000 on April 2, 2014, for a total draw of $75,000. The terms of the March 2014 Note allow the lender to convert all or part of the outstanding balance plus accrued interest, at any time after the effective date, at a conversion price of the lower of (a) $0.012 per share, or (b) 50% of the lowest trade price of Common Stock recorded on any trade day after the effective date of the agreement. The Company recorded a debt discount of $59,506 related to the beneficial conversion feature of the March 2014 Note, along with derivative liabilities. This discount is recognized over 18 months, beginning on the date of each tranche payment. As of September 30, 2014, the Company included $15,494 in interest expense related to the discount. The March 2014 Note bears interest at a rate of 10% per year and matures 18 months from the effective date of each advance.

On April 16, 2014, the Company entered into a convertible promissory note (the “April 2014 Note”) in the amount of $300,000, at which time an initial advance of $40,000 was received to cover operational expenses. The lender advanced an additional $55,000 on April 30, 2014, an additional $40,000 on May 16, 2014, an additional $40,000 on June 2, 2014 and an additional $35,000 on June 30, 2014, for a total draw of $210,000. The terms of the April 2014 Note allow the lender to convert all or part of the outstanding balance plus accrued interest, at any time after the effective date, at a conversion price of the lower of (a) $0.012 per share, or (b) 50% of the lowest trade price of Common Stock recorded on any trade day after the effective date of the agreement. The Company recorded a debt discount of $251,994 related to the conversion feature of the April 2014 Note, along with derivative liabilities. This discount is recognized over 18 months, beginning on the date of each tranche payment. As of September 30, 2014, the Company included $48,006 in interest expense related to the discount. The April 2014 Note bears interest at a rate of 10% per year and matures 18 months from the effective date of each advance.

On September 5, 2014, the Company entered into a convertible promissory note (the “September 2014 Note”) in the amount of $250,000, at which time an initial advance of $40,000 was received to cover operational expenses. The lender advanced an additional $10,000 on September 17, 2014, an additional $30,000 on October 1, 2014 and an additional $40,000 on October 16, 2014, for a total draw of $120,000. The terms of the September 2014 Note allow the lender to convert all or part of the outstanding balance plus accrued interest, at any time after the effective date, at a conversion price of the lower of (a) $0.015 per share, or (b) 50% of the lowest trade price of Common Stock recorded on any trade day after the effective date of the agreement. The Company recorded a debt discount of $47,934 related to the conversion feature of the April 2014 Note, along with derivative liabilities. As of September 30, 2014, the Company included $2,066 in interest expense related to the discount. The September 2014 Note bears interest at a rate of 10% per year and matures 18 months from the effective date of each advance.

ASC Topic 815 provides guidance applicable to convertible debt issued by the Company in instances where the number into which the debt can be converted is not fixed.  For example, when a convertible debt converts at a discount to market based on the stock price on the date of conversion, ASC Topic 815 requires that the embedded conversion option of the convertible debt be bifurcated from the host contract and recorded at their fair value. In accounting for derivatives under accounting standards, the Company recorded a liability of $1,600,545 representing the estimated present value of the conversion feature considering the historic volatility of the Company’s stock, and a discount of $383,104 representing the imputed interest associated with the embedded derivative. The discount is amortized over the life of the convertible debt, and the derivative liability is adjusted periodically according to stock price fluctuations. At the time of conversion, any remaining derivative liability will be charged to additional paid-in capital.

For purpose of determining the fair market value of the derivative liability, the Company used Black Scholes option valuation model. The significant assumptions used in the Black Scholes valuation of the derivative are as follows:

Stock price on the valuation dates	$	0.0153
Conversion price for the debt	$	0.004 - 0.00555
Dividend yield		0%
Years to maturity		2 months - 18 months
Risk free rate		0.13% - 0.36%
Expected volatility		145.49% - 162.05%

Following is the five year maturity schedule for our convertible notes payable:

Year ended June 30,	Principle		Discount			Net Book Value
2015	$	100,000	$	(13,303	)	$	86,697
2016	$	508,000	$	(333,733	)	$	174,267
2017	$	—	$	—		$	—
2018	$	—	$	—		$	—
2019	$	—	$	—		$	—

Fair value of financial instruments

The Company’s financial instruments, including cash and cash equivalents, accounts receivable, accounts payable and accrued liabilities are carried at cost, which approximates their fair value, due to the relatively short maturity of these instruments. As of September 30, 2014 and 2013, the Company’s capital lease obligations and notes payable have stated borrowing rates that are consistent with those currently available to the Company and, accordingly, the Company believes the carrying value of these debt instruments approximates their fair value.

Fair value is defined as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. ASC Topic 820 established a three-tier fair value hierarchy which prioritizes the inputs used in measuring fair value. The hierarchy gives the highest priority to unadjusted quoted prices in active markets for identical assets or liabilities (level 1measurements) and the lowest priority to unobservable inputs (level 3 measurements). These tiers include:

• Level 1, defined as observable inputs such as quoted prices for identical instruments in active markets;

• Level 2, defined as inputs other than quoted prices in active markets that are either directly or indirectly observable such as quoted prices for similar instruments in active markets or quoted prices for identical or similar instruments in markets that are not active; and

• Level 3, defined as unobservable inputs in which little or no market data exists, therefore requiring an entity to develop its own assumptions, such as valuations derived from valuation techniques in which one or more significant inputs or significant value drivers are unobservable.

We measure certain financial instruments at fair value on a recurring basis. Assets and liabilities measured at fair value on a recurring basis are as follows at September 30, 2014:

	Total		(Level 1)		(Level 2)		(Level 3)
Assets	$	—	$	—	$	—	$	—
Total assets measured at fair value	$	—	$	—	$	—	$	—
Liabilities
Derivative liability		1,600,545		—		—		1,600,545
Convertible notes, net of discount		260,964		—		—		260,964
Total liabilities measured at fair value	$	1,861,509	$	—	$	—	$	1,861,509

Assets and liabilities measured at fair value on a recurring basis are as follows at September 30, 2013:

	Total		(Level 1)		(Level 2)		(Level 3)
Assets	$	—	$	—	$	—	$	—
Total assets measured at fair value	$	—	$	—	$	—	$	—
Liabilities
Derivative liability		—		—		—		—
Convertible notes, net of discount		161,845		—		—		161,845
Total liabilities measured at fair value	$	161,845	$	—	$	—	$	161,845