Convertible Debt

9 Months Ended

Sep. 30, 2012

Convertible Debt [Abstract]

Convertible Debt

Note 7 - Convertible Debt

The components of debt are summarized as follows.

	Due		September 30, 2012			December 31, 2011 (Restated)
8% convertible promissory notes		August 2017	$	5,128,520		$	-
8% convertible promissory notes		September 2017		1,500,000			-
8.75% convertible debenture		January 2012		-			172,500
10% convertible debentures		June 2012		-			600,000
Subtotal - principal			$	6,628,520		$	772,500
Less debt discount				(1,531,943	)		-
Subtotal – net of debt discount				5,096,577			772,500
Less current portion				-			(772,500	)
Total – long term debt			$	5,096,577		$	-

8% Convertible Promissory Notes

During the three months ended June 30, 2012 we entered into a Memorandum of Understanding (the “MOU”) with Melvin Lenkin, Samuel Rose and others (collectively the “Investors”). Pursuant to the MOU, we issued to the Investors demand promissory notes (collectively, the “Demand Notes”) in the aggregate principal amount of $5,000,001.  Interest accrued on the unpaid principal balance of the Demand Notes at a rate of 8.00% per annum. The principal balance of the Demand Notes, together with accrued and unpaid interest, was due and payable at any time after June 30, 2012 on demand. Pursuant to the terms of the MOU, the Company and the Investors agreed to use commercially reasonable efforts to negotiate and execute definitive agreements pursuant to which the Investors would purchase an aggregate of $10,000,000 of 8% convertible promissory notes from the Company, $5,000,000 of which was paid for by converting the outstanding principal balance of the Demand Notes, and $5,000,000 of which will be paid for in cash, in one or multiple closings by early December 2012.

On August 24, 2012, we entered into a Note Purchase Agreement (the “Purchase Agreement”) with the Investors, pursuant to which, we issued and sold to the Investors an aggregate principal amount of $5,128,520 of our 8.0% convertible promissory notes (the “ August Notes”) which are initially convertible into shares of our common stock, no par value (the “Common Stock”), at a conversion price equal to $0.40 per share of Common Stock, subject to adjustment as provided on the terms of the August Notes, and associated warrants (the “August Warrants”) to purchase, in the aggregate, 12,821,302 shares of Common Stock, subject to adjustment as provided on the terms of the August Warrants. In consideration for the issuance of the August Notes and the August Warrants, the Investors converted the aggregate principal amount outstanding, together with all accrued and unpaid interest, under our Demand Notes.

On September 28, 2012, pursuant to the Purchase Agreement, we issued and sold to the Investors an aggregate principal amount of $1,500,000 of our 8% convertible promissory notes (the “September Notes”) which are initially convertible into shares of our Common Stock, at a conversion price equal to $0.40 per share of Common Stock, subject to adjustment as provided on the terms of the September Notes, and associated warrants (the “September Warrants”) to purchase, in the aggregate, 3,750,000 shares of Common Stock, subject to adjustment as provided on the terms of the September Warrants. In consideration for the issuance of the September Notes and the September Warrants, the Investors paid us cash in the aggregate amount of $1,500,000.

The August Notes and the September Notes (in the aggregate, the “Notes”), including all outstanding principal and accrued and unpaid interest, are due and payable on the earlier of five years from date of issuance or upon the occurrence of an Event of Default (as defined in the Notes). We may prepay the Notes, in whole or in part, upon 60 calendar days prior written notice to the holders thereof. Interest accrues on the Notes at a rate of 8.0% per annum, payable during the first three years that the Notes are outstanding in shares of Common Stock, valued at the weighted average price of a share of Common Stock for the twenty consecutive trading days prior to the interest payment date, pursuant to the terms of the Notes. During the fourth and fifth years that the Notes are outstanding, interest that accrues under the Notes shall be payable in cash.

The August Warrants and the September Warrants (in the aggregate, the “Warrants”) are exercisable at an exercise price of $0.60 per share of Common Stock, subject to adjustment as provided for by the terms thereof, for a period commencing on the date of issuance and ending on the earlier to occur of the date that is (i) three years after the date upon which the weighted average price of a share of Common Stock for the 90 consecutive trading days prior to such date is at least $2.00 per share, and (ii) five years after the date on which the Note to which the applicable Warrant is related has been repaid in full.

In connection with the entry into the Purchase Agreement, pursuant to the terms thereof, on August 24, 2012, (i) we granted to the Investors certain demand and piggyback registration rights with respect to the registration of certain Company securities under the Securities Act and the rules and regulations promulgated thereunder, and (ii) we granted a security interest and lien in all of our assets and rights to the Investors to secure our obligations under the Notes.

The issuance costs of approximately $121,100, plus the fair values of the conversion option derivative liability and the warrants derivative liability were recorded as a discount to the Notes. The fair value of the conversion option derivative liability on the date of issuance was approximately $982,900. The fair value of the warrants derivative liability on the date of issuance was approximately $427,900. (See Note 6 for further discussion of these derivative liabilities.) This debt discount will be amortized to other expenses in our statement of operations over the initial term of the 8% Notes.

8.75% Convertible Debenture

At maturity on January 31, 2012, we repaid the full principal of $172,500 plus accrued interest on our 8.75% convertible debenture.

10% Convertible Debentures

Our 10% convertible debentures (the “Debentures”) were issued under purchase agreements during the fiscal year ended September 30, 2009, together with warrants, for aggregate proceeds of $600,000. The total of the fair value of the warrants, as determined using the Black-Scholes pricing model, and the value of the beneficial conversion features contained in the debentures, representing the difference between the fair value of common stock issuable upon conversion at the date of purchase and the amount of proceeds allocated to the note, exceeded the proceeds received.  Accordingly, we recorded a discount on the Debentures equal to the principal amount of the Debentures.  This recorded discount on these Debentures was amortized to interest expense on the interest method through their originally scheduled maturity dates in February and March 2011.

Effective January 14, 2011, the holders of our Debentures, agreed to extend the maturity dates to June 30, 2012 and to the elimination of the prohibition of paying dividends or distributions on any of our equity securities. We agreed to amend the interest rate to 15% if paid in cash and to 18% (from 12%) if paid with shares of our common stock at the rate of one share of common stock for each $0.60 (from $0.90) of interest. We also agreed to reduce the conversion price, as defined, to $0.60, from $0.90 and to amend the volume weighted average trading price at which we could force conversion to $2.50 from $2.00. In addition, for each calendar month after February or March 2011 that these Debentures remained outstanding, we agreed to issue a bonus warrant exercisable for three years for a number of shares of our common stock equal to the 5% of the outstanding principal, divided by $0.90. These bonus warrants are exercisable at $0.90 per share.

Even though these modifications to our Debentures resulted in less than a ten percent difference in the present value of cash flows between the original terms and the modified terms, the fair value of the conversion options was substantially greater than ten percent. We have therefore, accounted for the modification of these Debentures as an extinguishment of the original debt and the establishment of new debt. The difference between the reacquisition price of the new debt and the net carrying amount of the extinguished debt was $1.4 million and was recognized as a loss in our statement of operations during the three months ended March 31, 2011, the period of amendment.

In addition, since it was probable that we would issue the bonus warrants which were part of the reacquisition costs of the new debt, at each month-end through the amended maturity date, we calculated the fair value of the bonus warrants using the Black-Scholes pricing model and recorded a derivative liability of approximately $797,000 on the date of amendment and recognized the amount as a loss in our statement of operations during the three months ended March 31, 2011, the period of amendment. The bonus warrant derivative liability does not qualify as a fair value or cash flow hedge under ASC 815 and accordingly, changes in the fair value of the derivative liability are immediately recognized in earnings and classified as a gain or loss on the derivative liability in the accompanying statements of operations (see Note 6). During the six months ended June 30, 2012, we recorded approximately $13,300 of gain in the fair value of the derivative liability.

The principal of $600,000 and accrued interest were repaid during the three months ended June 30, 2012, upon maturity.