Convertible Debentures

9 Months Ended

Jul. 31, 2014

Convertible Notes Payable [Abstract]

Convertible Debentures

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 an unaffiliated lender in connection with the issuance of eleven (11) separate 8% convertible notes in various principal amounts, aggregating $387,500. As of September 14, 2012, the lender had converted all of the $387,500 in principal notes, plus $45,000 and $15,500 in principal penalties and accrued interest, respectively, on such notes and received a total of 663,219 shares of common stock upon the conversions at prices ranging from $0.20 to $1.95 per share.

Between July 18, 2013 and January 9, 2014, the Company entered into three new Securities Purchase Agreements with the lender, for total proceeds of $117,500, and paid a total of $7,500 out of the proceeds of the notes to lender for legal fees and expenses related to the referenced agreements. The notes mature between April 22, 2014 and October 13, 2014 and are convertible into shares of common stock at a discount of 39% 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, the Series I Notes are 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. The notes were recorded at fair value, using the Binomial valuation model, and a derivative liability of $26,314 has been recorded for the fiscal period ended July 31, 2014. This liability will be revalued each reporting period and gains and losses will be recognized in the statement of operations under “Other Income (Expense)”.

In July 2014, the lender notified the Company that it had defaulted on the terms of its outstanding notes for failure to pay the remaining $6,900 principal balance due on a note that had matured as of June 20, 2014. The terms of the notes provided that the lender receive a 50% increase in the principal balance of any outstanding notes at the time of any such default. Consequently, the lender penalized the Company $3,450 on the remaining balance of that particular note and agreed to waive the penalty on a $32,500 principal note outstanding at that time.

Pursuant to the terms of the Series I Notes, the Company initially instructed its stock transfer agent to reserve 2,400,000 shares of the Company’s common stock to be issued if the notes are converted. Between January 27, 2014 and July 31, 2014, the lender converted $84,190 of such notes, plus $1,700 in accrued interest, and received a total of 1,950,454 shares of common stock at conversion prices ranging from $0.079 to $0.018 per share. The balance of 449,546 shares was reserved as of July 31, 2014. On August 19, 2014, the Company instructed its transfer agent to reserve an additional 2,000,000 shares of common stock to cover future conversions of notes. Shares held in reserve are not considered as issued and outstanding. If the remaining Series I Notes had been converted as of July 31, 2014, the Company would have issued a total of 3,242,598 shares of common stock the value of which would exceed, by $33,892 the principal balance due on the notes.

The lender converted an additional $14,945 in Series I Notes in August 2014. See Note 11 – “Subsequent Events.”

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 fair value framework 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 and accrued expenses approximate fair value because of their generally short maturities.

The Company measured the fair value of the Series 1 Note by using the Binomial Valuation model. As of July 31, 2014, the assumptions used to measure fair value of the liability embedded in our outstanding Series I Note included an exercise price of $0.0183 per share, a common share price of $0.03, a discount rate of 0.02% or 0.03%, and a volatility of 141% or 183%.

The anti-dilution liability is calculated by an approximate number of shares multiplied by the quoted market price of the Company’s common stock at the measurement date.

The following table sets forth, by level within the fair value hierarchy, our financial instrument liabilities as of July 31, 2014 (See also Note 7 – Convertible Debentures – “Series 1 Notes”):

	Quoted Prices in Active Markets For Identical Assets		Significant Other Observable Inputs		Significant Unobservable Inputs
	(Level 1)		(Level 2)		(Level 3)		Total
Anti-dilution liability	$	1,401	$	—	$	—	$	1,401
Derivative liability	$	—	$	—	$	26,314	$	26,314
Total	$	1,401	$	—	$	26,314	$	27,715

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, 2013 and for the nine month period ended July 31, 2014:

	Fair Value Measurements Using Significant Unobservable Inputs (Level 3)
Balance October 31, 2013	$	75,557
Additions		31,615
Net gain included in earnings		(24,012	)
Settlements		(56,846	)
Balance July 31, 2014	$	26,314

Other Convertible Notes

On November 10, 2010, the Company entered into a convertible note for $64,868 with a stockholder. 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 was fully amortized as of 2012. The Company has expensed $24,152 in accrued interest on the note as of July 31, 2014. If the note had been converted as of July 31, 2014, the Company would have issued a total of 4,172,186 shares of common stock the value of which would exceed, by $46,973 the principal balance due on the note. The Company is currently negotiating with the lender to settle or renegotiate the Note.

At July 31, 2014 and October 31, 2013, without taking into effect any unamortized discounts, convertible debentures and Series 1 notes consisted of the following:

	July 31, 2014		October 31, 2013
Series 1 Notes, principal and interest at 8% maturing through October 13, 2014	$	36,760	$	85,000
Convertible note payable to stockholder; principal and interest at 10% due on May 31, 2012.		64,868		64,868
		101,628		149,868
Less current maturities		101,628		149,868
Long-term portion of Convertible and Series 1 notes payable	$	—	$	—

Of the above notes, $69,128 was past due as of July 31, 2014. The Company’s outstanding notes mature as follows for the year ending October 31:

2014	$	101,628
Thereafter		—
	$	101,628