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Convertible Debentures
 9 Months Ended
Jul. 31, 2012
Convertible Notes Payable [Abstract]  
Convertible Dbentures

7.   Convertible Debentures

 

Series 1 Notes

 

Under the provisions of ASC 815-40-15, “Derivatives and Hedging-Contracts in Entity’s Own Equity-Scope and Scope Exceptions,” a number of our outstanding Convertible notes are not considered indexed to our stock, as a result of an anti-dilution protection provision in these notes. The application of ASC 815-40-15, effective August 1, 2011, resulted in our accounting for these notes as derivative instruments, and they are recognized as liabilities in our consolidated balance sheets.

 

Between August 16, 2010 and February 21, 2012, the Company entered into a Securities Purchase Agreement with Asher Enterprises, Inc. in connection with the issuance of eleven (11) separate 8% convertible notes in various principal amounts, aggregating $387,500. The Company paid a total of $27,500 out of the proceeds of the notes to Asher for legal fees and expenses related to the referenced agreements. The notes generally mature in nine (9) months, commencing May 2011 through November 2012, and are convertible into shares of common stock at a discount ranging from 39% to 55% of the average of the lowest three closing bid prices of the common stock during the ten trading days prior to the conversion date. The Series I Notes contain a provision requiring an adjustment to the conversion price of the note in the event the Company issues or sells any shares of common stock, or securities convertible into or exercisable for common stock, at a price per share lower than such conversion price. Accordingly, effective August 1, 2011, the Series I Notes have been accounted for as a derivative liability, measured at fair value, with changes in fair value recognized as gain or loss for each reporting period thereafter. Asher may convert any or all of the unpaid principal note prior to the maturity date, commencing 180 days following the date of the Note. The notes are recorded at fair value, using the Binomial valuation model, and a derivative liability of $175,865 was recorded for the fiscal year ended October 31, 2011. This liability is revalued each reporting period and gains and losses are recognized in the statement of operations under “Other Income (Expense)”. As of the nine months ended July 31, 2012, this derivative liability was $50,724.

 

In February, 2012, Asher notified the Company that it had defaulted on the terms of four of its outstanding notes for failure to issue conversion shares in a timely manner. The terms of the notes provided that Asher receives a 50% increase in the principal balance of any outstanding notes at the time of any such default. Consequently, the principal amount of notes outstanding at that time increased by $45,000.

 

As of July 31, 2012, Asher has converted a total of $345,000, $45,000 and $13,800 in principal, principal penalties and accrued interest, respectively, on these notes and has received a total of 302,142,917 shares of common stock upon the conversions at prices ranging from $0.0004 to $0.0039 per share. During the nine months ended July 31, 2012, the Company expensed a total of $5,110 in accrued interest and there remains an aggregate principal balance of $42,500 due on these notes. If such Series 1 notes were converted at July 31, 2012, the Company would issue an aggregate of 26,881,720 shares of common stock the value of which would exceed, by $40,833, the principal balance due on the notes.

 

Pursuant to the terms of the Series I Notes, the Company has instructed its stock transfer agent to reserve an agreed upon number of shares of the Company’s common stock to be issued if the notes are converted. As of July 31, 2012, 467,483,761 shares have been reserved, but are not considered as issued and outstanding.

 

Fair value of financial instruments

 

The accounting standards regarding fair value of financial instruments and related fair value measurements defines financial instruments and requires disclosure of the fair value of financial instruments held by the Company. The Company considers the carrying amount of cash and other current assets and liabilities to approximate their fair values because of the short period of time between the origination of such instruments and their expected realization.

 

The Company has also adopted ASC 820-10 (“Fair Value Measurements”) which defines fair value, establishes a three-level valuation hierarchy for disclosures of fair value measurement and enhances disclosure requirements for fair value measures. The three levels are defined as follows:

 

● Level 1 inputs to the valuation methodology are quoted prices (unadjusted) for identical assets or liabilities in active markets.

 

● Level 2 inputs to the valuation methodology include quoted prices for similar assets and liabilities in active markets, and inputs that are observable for the assets or liability, either directly or indirectly, for substantially the full term of the financial instruments.

 

● Level 3 inputs to the valuation methodology are unobservable and significant to the fair value.

 

The carrying amounts of our financial instruments, including cash, accounts payable, accrued expenses and long term debt approximate fair value because of their generally short maturities.

 

The Company measured the fair value of the Series 1 Notes by using the Binomial Valuation model. As of July 31, 2012, the assumptions used to measure fair value of the liability embedded in our outstanding Series I Notes included an exercise price of $0.0016 per share, a common share price of $0.0031, a discount rate of 0.11%, and a volatility of 195%.

 

The following table sets forth, by level within the fair value hierarchy, our financial instrument liabilities as of July 31, 2012 (See also Note 7 – Convertible Debentures – “Series 1 Notes”):

 

    Quoted 
Prices in 
Active 
Markets 
For 
Identical 
Assets		     Significant 
Other 
Observable 
Inputs		     Significant
Unobservable
Inputs		     Total   
    (Level 3)     (Level 3)     (Level 3)        
Series 1 Notes   $ —     $ —     $ 50,724     $ 50,724  
                                 
Total   $ —     $ —     $ 50,724     $ 50,724  

 

The following table sets forth a summary of changes in the fair value of our Level 3 financial instrument liability for the fiscal year ended October 31, 2011 and for the nine month period ended July 31, 2012:

 

    Fair Value 
Measurements 
Using 
Significant 
Unobservable 
Inputs 
(Level 3)		  
Balance October 31, 2011   $ 175,865  
Additions     112,885  
Net gain included in earnings     (55,195 )
Settlements     (182,831 )
Balance July 31, 2012   $ 50,724  

 

Other Convertible Notes

 

On November 10, 2010, the Company borrowed $64,868 from a stockholder on terms similar to the Asher notes. The Note matured on May 31, 2012 and bears interest at the rate of ten percent (10%) per annum. The Note is convertible into shares of common stock at a forty two percent (42%) discount to the average of the lowest three (3) closing bid prices of the common stock during the ten (10) trading days prior to the conversion date. The note holder may convert any or all of the unpaid principal note prior to the maturity date. The Company calculated the intrinsic value of the conversion feature to be $46,973 as of the date of issuance of the debentures using the same criteria as noted above, which amount has been fully amortized as of July 31, 2012. The Company has expensed $11,179 in accrued interest on the note as of July 31, 2012. If the note had been converted as of July 31, 2012, the Company would have issued a total of 36,077,864 shares of common stock the value of which would exceed, by $46,974, the principal balance due on the note. The Company is currently negotiating with the lender to settle or renegotiate the Note.

 

On March 16, 2009, a major stockholder, Mr. Anthony Frank, purchased a $75,000 convertible debenture for which the Company has expensed interest at ten percent (10%) per annum totaling $23,445 in accrued interest as of July 31, 2012. The debenture matured on March 16, 2012. The debenture was convertible at the option of the holder into the Company’s common stock at a fair market value of 75% of the lowest closing bid price per share for the twenty (20) trading days immediately preceding conversion. The intrinsic value of the beneficial conversion feature, $18,750, was amortized over the three-year life of the debenture. Effective May 1, 2012, Mr. Frank converted this loan, together with $23,466 in accrued interest, into 28,133,072 shares of common stock at a conversion price of $0.0035 per share.

 

On November 27, 2009, the Company borrowed $25,000 from an unaffiliated lender. In September 2011, the lender converted $12,500 of the principal and $2,876 in accrued interest into 8,542,222 shares of common stock. The Company issued an Amended and Restated Convertible Note for the $12,500 principal balance of the loan. The amended note matures on December 31, 2012 and bears interest at 6% and is convertible into common shares at a 55% discount to the average of the lowest three (3) closing bid prices of the common stock during the ten (10) trading days prior to the conversion date. The Company calculated the intrinsic value of the conversion feature on the remaining balance to be $10,507 as of the date of issuance of the amended note and will amortize the cost over the life of the loan. As of July 31, 2012, the Company had expensed a total of $643 in accrued interest on the remaining principal balance of $12,500. If the $12,500 balance of the note had been converted as of July 31, 2012, the Company would have issued a total of 8,960,573 shares of common stock and would have fully amortized the $5,276 remaining expense of the conversion feature.

 

On August 1, 2011, an unaffiliated party purchased a $50,000 convertible debenture that matures on August 1, 2012. The debenture was convertible at any time at the option of the holder into the Company’s common stock at a 25% discount (but not more than $0.002 per share) to the average closing bid prices of the common stock for the three (3) trading days immediately preceding conversion. The holder converted the debenture on February 1, 2012 at the conversion rate of $0.002 per share and received 50,000,000 shares of common stock. The intrinsic value of the beneficial conversion feature, $16,667, was fully amortized as of the conversion date and $1,504 in interest accrued prior to the conversion was forgiven.

 

On January 12, 2012, the Company issued an Amended and Restated 6% Convertible Note for $37,500 to Gregg Newhuis, who became a director of the company in May 2012, for proceeds received in fiscal 2010. The note, which matures on December 31, 2012, was subsequently sold to Asher Enterprises which converted the entire principal balance of the note during January and February 2012. The Company issued 28,439,685 shares of common stock on the conversions at prices ranging from $0.0011 to $0.0016 per share. The intrinsic value of the beneficial conversion feature, $37,500, was amortized in full as of the conversion date.

 

At July 31, 2012 and October 31, 2011, convertible debentures and Series 1 notes consisted of the following:

 

    July 31, 2012     October 31, 2011  
          (Audited)   
Series 1 Notes, principal and interest at 8% maturing through November 23, 2012.   $ 42,500     $ 157,500  
                 
Convertible note payable to major stockholder; principal and interest at 10% due on March 16, 2012.     —       75,000  
                 
Convertible note payable to stockholder; principal and interest at 10% due on May 31, 2012.     64,868       64,868  
                 
Convertible notes payable to various stockholders; principal and interest at 6% maturing on December 31, 2012.     12,500       62,500  
      119,868       359,868  
                 
Less current maturities     119,868       347,368  
                 
Long term portion of Convertible and Series 1 notes payable   $ —     $ 12,500