Notes To Condensed Consolidated Financial
Statements (Unaudited)
Note 1– Basis of Presentation
The accompanying unaudited condensed consolidated
financial statements have been prepared in accordance with generally accepted accounting principles for interim financial information
and in accordance with the rules and regulations of the U.S. Securities and Exchange Commission for quarterly reports on Form 10-Q.
Accordingly, they do not include all of the information and footnotes required by generally accepted accounting principles for
complete financial statements. In the opinion of management, all adjustments (consisting of normal recurring accruals) considered
necessary for a fair presentation have been included. Operating results for the nine-month period ended August 31, 2013, are not
necessarily indicative of the results that may be expected for the year ended November 30, 2013. For further information, refer
to the consolidated financial statements and footnotes thereto included in our Annual Report on Form 10-K for the year ended November
30, 2012.
Note 2 – Going Concern Matters and
Realization of Assets
The accompanying financial statements have
been prepared on a going concern basis, which contemplates the realization of assets and the satisfaction of liabilities in the
ordinary course of business. However, the Company has sustained substantial losses from its continuing operations in recent years
and as of August 31, 2013, the Company has negative working capital of $7,188,460 and a stockholders’ equity deficiency of
$9,031,496. In addition, the Company is unable to meet its obligations as they become due and sustain its operations. The Company
believes that its existing cash resources are not sufficient to fund its continuing operating losses, capital expenditures, lease
and debt payments and working capital requirements.
The Company may not be able to raise sufficient
additional debt, equity or other cash on acceptable terms, if at all. Failure to generate sufficient revenues, achieve certain
other business plan objectives or raise additional funds could have a material adverse effect on the Company’s results of
operations, cash flows and financial position, including its ability to continue as a going concern, and may require it to significantly
reduce, reorganize, discontinue or shut down its operations.
In view of the matters described above, recoverability
of a major portion of the recorded asset amounts shown in the accompanying balance sheet is dependent upon continued operations
of the Company which, in turn, is dependent upon the Company’s ability to meet its financing requirements on a continuing
basis, and to succeed in its future operations. The financial statements do not include any adjustments relating to the recoverability
and classification of recorded asset amounts or amounts and classification of liabilities that might be necessary should the Company
be unable to continue in its existence.
Management’s plans include:
|
1.
|
Seek to spend $25,000 each month on marketing initiatives, with the
goal of generating sufficient revenues to be operating at a positive cash flow level. The Company has instituted a plan of salary
deferrals and has signed an agreement with a lender to provide the Company with cash to cover its monthly operating cash-flow shortfall
and marketing money until December 31, 2013. One of the Company’s lenders is monitoring and supervising the additional advertising
expenditures to promote the Company’s mobile VoIP app in the belief that additional advertising will attract new subscribers
and will result in a significant increase in revenues to the Company.
|
|
2.
|
Continue to develop new uses and distribution channels for its mobile
VoIP service. The Company’s mobile VoIP application allows for low-cost calling to any landline or cell phone in the world.
In the fourth quarter of fiscal 2013, the Company plans to add the ability for a subscriber to buy telephone numbers from several
additional countries and download the number to his or her smart phone or tablet. This feature would allow for a person to call
someone who is not in the same country for the cost of a local call.
|
|
3.
|
Leverage the technology of the Company’s mobile apps to provide
inexpensive high-quality telephony services to low-tech products, such as prepaid calling cards. The Company is now selling prepaid
calling cards, which can call any phone number in the world without the connection fees or other miscellaneous charges that other
calling cards impose on a consumer.
|
7
There can be no assurance that the Company
will be able to achieve its business plan objectives or be able to achieve or maintain cash-flow-positive operating results. If
the Company is unable to generate adequate funds from operations or raise sufficient additional funds, the Company may not be able
to repay its existing debt, continue to operate its network, respond to competitive pressures or fund its operations. As a result,
the Company may be required to significantly reduce, reorganize, discontinue or shut down its operations. The financial statements
do not include any adjustments that might result from this uncertainty.
Note 3 – Recent Accounting Pronouncements
In February 2013, the FASB issued ASU No. 2013-02,
“Comprehensive Income (Topic 220): Reporting of Amounts Reclassified Out of Accumulated Other Comprehensive Income,”
an accounting standard update, which requires companies to present information about reclassifications out of accumulated other
comprehensive income in a single note or on the face of the financial statements. The updated standard is effective for fiscal
years, and interim periods within those years, beginning after December 15, 2012, with early adoption permitted. The adoption of
this updated accounting standard did not have a significant impact on our consolidated financial position, results of operations,
or cash flows.
Note 4 – Major Customers
`
As of August 31, 2013 and November 30,
2012, one customer constituted 36% and 29%, respectively, of our accounts receivable.
During the nine-month and three-month periods
ended August 31, 2013, one customer accounted for approximately 38% of our revenues.
During the nine-month and three-month periods
ended August 31, 2012, one customer accounted for approximately 27% and 31%, respectively, of our revenues.
Note 5 – Net Income (loss) Per Common
Share
Basic net income (loss) per share is computed
by dividing net income (loss) available to common stockholders (numerator) by the weighted average number of vested, common shares
outstanding during the period (denominator). Diluted net income (loss) per share is computed on the basis of the weighted average
number of shares of common stock outstanding plus the effect of dilutive potential common shares outstanding during the period
using the if-converted method. Dilutive potential common shares include shares issuable upon exercise of outstanding stock options,
warrants and convertible debt agreements.
|
|
Nine Months Ended
|
|
Nine Months Ended
|
|
Three Months Ended
|
|
Three Months Ended
|
|
|
Aug. 31, 2013
|
|
Aug. 31, 2012
|
|
Aug. 31, 2013
|
|
Aug. 31, 2012
|
|
|
|
|
|
|
|
|
|
Net income (loss) – numerator basic
|
|
$
|
1,314,548
|
|
|
$
|
3,605,697
|
|
|
$
|
(561,685
|
)
|
|
$
|
(779,801
|
)
|
Interest expense attributable to convertible notes, net
|
|
|
385,944
|
|
|
|
996,319
|
|
|
|
95,872
|
|
|
|
—
|
|
Net income (loss) plus interest expense attributable to convertible notes, net – numerator diluted
|
|
$
|
1,700,492
|
|
|
$
|
4,602,016
|
|
|
$
|
(465,813
|
)
|
|
$
|
(779,801
|
)
|
Weighted average common shares outstanding – denominator basic
|
|
|
556,328,538
|
|
|
|
142,897,663
|
|
|
|
729,759,164
|
|
|
|
165,563,679
|
|
Effect of dilutive securities
|
|
|
686,887,497
|
|
|
|
121,185,921
|
|
|
|
—
|
|
|
|
—
|
|
Weighted average dilutive common shares outstanding – denominator diluted
|
|
|
1,243,216,035
|
|
|
|
264,083,584
|
|
|
|
729,759,164
|
|
|
|
165,563,679
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Earnings (loss) per common share – basic
|
|
$
|
0.00
|
|
|
$
|
0.03
|
|
|
$
|
(0.00
|
)
|
|
$
|
(0.00
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Earnings (loss) per common share – diluted
|
|
$
|
0.00
|
|
|
$
|
0.02
|
|
|
$
|
(0.00
|
)
|
|
$
|
(0.00
|
)
|
Approximately 76,779,000 and 784,244,000 shares
of common stock issuable upon the exercise of our outstanding stock options, warrants or convertible debt were excluded from the
calculation of net income (loss) per share for the nine-month and three-month periods ended August 31, 2013, respectively because
the effect would be anti-dilutive. Approximately 10,165,000 and 176,868,000 shares of common stock issuable upon the exercise of
our outstanding stock options, warrants or convertible debt were excluded from the calculation of net income (loss) per share for
the nine-month and three-month periods ended August 31, 2012, respectively, because the effect would be anti-dilutive.
As of August 31, 2013, the weighted average
diluted common shares outstanding exceeds the number of authorized common shares of the Company. This excess has no effect on diluted
net income per common share for the nine months ended August 31, 2013.
8
Note 6 – Stock-Based Compensation
Plans
The Company issues stock options to its employees,
consultants and outside directors pursuant to stockholder-approved and non-approved stock option programs and records the applicable
expense in accordance with the authoritative guidance of the Financial Accounting Standards Board. This expense is a non-cash expense
and it derives from the issuance of stock options, stock purchase warrants and restricted stock. For the nine-month periods ended
August 31, 2013 and 2012, the Company recorded $20,161 and $116,294, respectively, in stock-based compensation expense related
to employees. For the three-month periods ended August 31, 2013 and 2012, the Company recorded $6,720 and $22,812, respectively,
in stock-based compensation expense related to employees. For the nine-month and three-month periods ended August 31, 2012, we
recorded approximately $76,563 and $57,500, respectively, of stock-based compensation expense related to consultants. No such expense
was recorded for the nine-month and three-month periods ended August 31, 2013. As of August 31, 2013, there was $32,877 of unrecognized
employee stock-compensation expense for previously granted unvested options that will be recognized over a two-year period.
Note 7 – Accounts Payable and Accrued
Expenses
When the
Company sold certain subsidiaries in December 2006, the Company agreed to reimburse the purchaser for certain disputed claims on
the books of the subsidiaries, if the sold subsidiaries were required to pay such claims. At August 31, 2013 and November 30, 2012,
the Company has recorded a payable of $796,499 in conjunction with the sale of the subsidiaries. The subsidiary filed for bankruptcy
on September 23, 2008, which is still ongoing. If claims are reduced or eliminated by the subsidiaries, and the purchaser provides
the Company with appropriate documentation that the Company’s liability has been reduced, such reduction will be reflected
on the books of the Company.
Note 8 – Defined Benefit Plan
The Company received a letter dated July 27,
2011 from the Pension Benefit Guaranty Corporation, (“PBGC”), stating that the Company’s defined benefit pension
plan (the “Plan”) was terminated as of September 30, 2010, and the PBGC was appointed trustee of the Plan. Pursuant
to the agreement, the PBGC has a claim to the Company for the total amount of the unfunded benefit liabilities of the Plan plus
accrued interest. The PBGC has notified the Company that the liability is due and payable as of the termination date, and interest
accrues on the unpaid balance at the applicable rate provided under Section 6621(a) of the Internal Revenue Code. The total amount
outstanding to the PBGC at August 31, 2013 and November 30, 2012 was $1,890,789 and $1,821,464, respectively, including accrued
interest, which is recorded as a current liability. The Company made no payments to the Plan in the nine-month periods ended August
31, 2013 and 2012. The Plan covers approximately 40 former employees.
9
Note 9 – Principal Financing Arrangements
|
|
The following table summarizes components of long-term debt and capital lease obligations as of
August 31, 2013 and November 30, 2012:
|
Principal lender:
|
|
August 31, 2013
|
|
Nov. 30, 2012
|
|
Interest Rate
|
|
|
|
|
|
|
|
Note dated November 30, 2005
|
|
$
|
281,792
|
|
|
$
|
986,271
|
|
|
|
5.25
|
%
|
Note dated May 31, 2006
|
|
|
204,583
|
|
|
|
716,041
|
|
|
|
5.25
|
%
|
Note dated September 28, 2007
|
|
|
679,638
|
|
|
|
2,378,733
|
|
|
|
9.75
|
%
|
Note dated May 28, 2008
|
|
|
328,072
|
|
|
|
1,148,254
|
|
|
|
20.00
|
%
|
Note dated October 29, 2008
|
|
|
202,572
|
|
|
|
709,001
|
|
|
|
15.00
|
%
|
Note date February 15, 2009
|
|
|
115,085
|
|
|
|
402,797
|
|
|
|
20.00
|
%
|
Note dated October 6, 2009
|
|
|
1,086
|
|
|
|
3,802
|
|
|
|
5.25
|
%
|
Note dated November 5, 2009
|
|
|
6,623
|
|
|
|
23,179
|
|
|
|
5.25
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
principal lender debt
(1)
|
|
|
1,819,451
|
|
|
|
6,368,078
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Short-term borrowings
|
|
|
954,271
|
|
|
|
1,068,867
|
|
|
|
0.00% - 28.00
|
%
|
Capital lease obligations
|
|
|
7,000
|
|
|
|
7,545
|
|
|
|
12.00% - 17.00
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total short-term debt
|
|
|
2,780,722
|
|
|
|
7,444,490
|
|
|
|
|
|
Long-term debt
|
|
|
1,645,988
|
|
|
|
358,614
|
|
|
|
|
|
Total
|
|
$
|
4,426,710
|
|
|
$
|
7,803,104
|
|
|
|
|
|
(1)
Effective
February 1, 2012, the interest rate to the principal lender was revised to 0%.
Debt with Principal Lender
As of
August 31, 2013 and November 30, 2012 the Company owed its principal lender (“Lender”) $1,819,451 and $6,368,078 respectively.
All of such debt became due by its terms on September 30, 2010. We have not made payments of principal or interest when due, and
we are not in compliance with our agreements with the Lender. The Lender has not issued a default notice, and as described below,
has signed agreements to sell such debt to third party investors.
On February 3, 2012, the Lender entered into
a contract to sell such debt to JDM Group, LLC (“JDM”). JDM agreed to pay the Lender in installments over time, $1,500,000
to acquire all of the debt from the Lender. The first installment of $600,000 was due on February 15, 2012, and the
balance of $900,000 was payable on the 30th day of each month in installments of $100,000 beginning on March 30, 2012. For each
$100,000 paid to the Lender, $930,000 in debt would be reduced to the Lender. In conjunction with this agreement, the Lender agreed
to not charge any interest on the debt owed, beginning on February 1, 2012. JDM also entered into an agreement with the Company
that required the Company to pay JDM $1,700,000, without interest, in August 2013, to repay such debt to JDM assuming that JDM
had paid the full $1,500,000 to the Lender. The debt to JDM was convertible by JDM into shares of the Company’s common stock
at a conversion rate equal to a 10% discount to the volume weighted average trading price of the Company common stock for the three
trading days prior to such conversion. The conversion price was subject to a minimum conversion price of $.02 per share.
When the first payment of $600,000 by JDM was
due to the Lender in February 2012, JDM sold the required installment payment of $600,000 of such debt to other parties in exchange
for cash, which was then paid to the Lender. The Company then issued 15,833,713 shares of common stock to settle $350,000 of such
debt with the other parties, and the Company issued two new convertible notes aggregating $300,000 to such other parties. As
a result of the first $600,000 payment to the Lender, the liability to the Lender was reduced by approximately $5,580,000.
10
The Company made the $100,000 payment due to
the Lender on March 30, 2012 on behalf of JDM, and JDM signed over to the Company a $930,000 debt reduction that was assigned to
JDM by the Lender. JDM assigned the $100,000 payment due on April 30, 2012 to a third-party investor for a payment to
the lender of $100,000, and an additional $930,000 of debt reduction was achieved with the Lender. The Company granted the new
investor the ability to convert the debt into stock at a 37.5% discount to the market price of the Company’s common stock,
as defined in the agreement. Subsequent to such assignment, JDM asked the lender for a deferral of the monthly payments and did
not make any of the monthly payments due on May 30, 2012 or thereafter, leaving $700,000 remaining to pay to the Lender under this
agreement. As a result of the $800,000 in payments to the Lender under this agreement, the Company achieved a reduction in the
debt to the Lender of $7,340,000.
As the Company is experiencing financial difficulties
and JDM granted the Company a concession by extending the term of the debt and reducing the amount of debt the Company was required
to pay, the Company accounted for such transaction as a troubled debt restructuring under ASC 470-60. As the total future cash
payments to JDM are less than the carrying value, an adjustment was made to the carrying value of the debt to reflect the portion
of the debt that had been cancelled due to the cash payments made during the three-month period ended February 29, 2012 and a gain
from troubled debt restructuring was recognized of $4,779,634.
On February 6, 2013, the Lender cancelled its
agreement with JDM and entered into a contract to sell all remaining debt due by the Company to another party, NetCapital.com,
LLC. (“NCC”) for a price of $350,000 on the condition that the Company also issue three-year warrants to the Lender
to purchase 10 million shares of common stock of the Company at a price of $0.01 per share. The Company issued such
warrants on February 15, 2013 and valued them at approximately $35,000 using the Black-Scholes method with an interest rate of
1%, volatility of 264%, zero dividends and expected term of three years.
NCC assigned 100% of its right, title and interest
in, to and under the Assignment Agreement to 112359 Factor Fund, LLC (the “Fund”) in exchange for the Fund's agreement
to satisfy the payment obligations due under the Assignment Agreement.
Effective February 15, 2013, the Company entered
into a securities purchase agreement with the Fund pursuant to which the Company issued to the Fund (i) an amended convertible
debenture in the principal amount of $1,000,000 (“Amended Note 1”) and (ii) a second amended convertible debenture
in the principal balance of $1,000,000 (“Amended Note 2” and together with Amended Note 1, the “Amended Notes”). The
Amended Notes were sold to the Fund, in exchange for the Fund’s assumption and payment of the Assignment Agreement, payment
to the Company of $150,000, the agreement to cancel the remainder of the Debt that was assigned by the Lender to the Fund, and
the agreement to purchase and cancel an existing convertible debenture in the amount of approximately $35,000.
Absent earlier redemption the Amended Notes
mature on December 31, 2014. Interest accrues on the unpaid principal and interest on the notes at a rate per annum
equal to 6% for Amended Note 1 and 2% for Amended Note 2.
Principal and interest payments on Amended
Note 1 can be made at any time by the Company, with a 30% prepayment premium, or the Fund can elect at any time to convert any
portion of Amended Note 1 into shares of common stock of the Company at 100% of the market price (as defined) subject to a limit
of 4.99% of the Company’s outstanding shares of common stock. In February 2013 the Fund converted $78,690 of principal
into 39,345,576 shares of common stock. During the second fiscal quarter of 2013, the Fund converted $238,599 of principal
into 105,994,289 shares of common stock. During the third quarter of fiscal 2013, the Fund converted $284,800 of principal into
134,568,734 shares of common stock.
Amended Note 2 converts into shares of common
stock of the Company in an amount equal to the lesser of the outstanding balance of Amended Note 2 divided by $0.01, or 9.99% of
the then-current issued and outstanding shares of common stock. Any principal or interest amount can be paid in cash.
During the second quarter of fiscal 2013,
the Fund lent the company amounts of $50,000, $35,000 and $12,000 and refinanced them with another note of $665,000 (the
“New Note”) on June 19, 2013. The New Note also provided cash to purchase two outstanding convertible debenture
for $99,360, $60,000 in cash for operations in June 2013, and $40,000 in cash each month for the months of July 2013 through
December 2013, and cost the Company $68,640 in finders fees and legal fess, and $100,000 in an issuance discount. The New
Note has similar terms, due dates and conversion features as the Amended Notes and accrues interest at a rate per annum equal
to 6% and has an effective interest rate of 86%. The company received an aggregate of $80,000 in cash under the New Note in
July and August 2013.
In conjunction with the New Note, the Company
agreed to implement a salary deferral plan to reduce the cash expenditures for personnel, to limit its cash expenditures to certain
pre-approved items, and to accrue an additional fee to the Fund of $150,000, which is included in other income (expense) and has
been added to the principal balance of Amended Note 1. The Fund agreed to limit its sales of the Company’s common
stock, to not engage in any short transactions involving the Company’s common stock, and to not require the Company to increase
its authorized shares of common stock for a certain time period, even though the Financing documents require the Company to reserve
authorized shares for issuance to the Fund, if the Fund desires to convert existing debt into shares of common stock.
11
The conversion features embedded in the Amended
Notes and New Note were evaluated to determine if such conversion features should be bifurcated from its host instrument and accounted
for as a freestanding derivative. The conversion feature in Amended Note 1 and the New Note is accounted for as a derivative liability.
The Company estimated the fair value of this derivative based on information from sources knowledgeable in the area. The fair value
of the derivative liability associated with Amended Note 1 and the New Note was recognized as a discount to the debt instrument
and the discount is being amortized over the expected life of the notes. Amended Note 2 is convertible into common stock at a determinable
number of shares and the conversion option is not a derivative liability. The Amended Notes and New Note are classified as long-term
debt with a carrying value of $1,637,688 at August 31, 2013.
The Amended Notes and New Note are secured
by a blanket lien on substantially all of the Company’s assets pursuant to the terms of security agreements executed by the
Company and its subsidiaries in favor of the Fund. In addition, the Company’s chief executive officer and chief
information officer pledged their combined voting control of the Company pursuant to a stock pledge agreement executed by the two
officers in favor of the Fund, to further secure the Company’s obligations under the Amended Notes. If an event
of default occurs under the security agreement, the stock pledge agreement, the Amended Notes or the New Note, the secured parties
have the right to accelerate payments under such promissory notes and, in addition to any other remedies available to them, to
foreclose upon the assets securing such promissory notes.
As the Company is experiencing financial difficulties
and the Fund granted the Company a concession by extending the term of the debt and reducing the amount of debt the Company was
required to pay, the Company accounted for the Amended Notes transaction as a troubled debt restructuring under ASC 470-60. As
the total future cash payments to the Fund were less than the carrying value, an adjustment was made to the carrying value of the
debt to reflect the portion of the debt that had been cancelled due to the cash payments made during the nine-month period ended
August 31, 2013 and a gain from troubled debt restructuring was recognized of $2,714,461.
In connection with the financings with the
Lender and the Fund, the Company has agreed to certain restrictive covenants, including, among others, that the Company will not
declare or pay any dividends, issue any preferred stock without the Fund’s permission, redeem any of its preferred stock
or other equity interests, dissolve, liquidate or merge with any other party unless, in the case of a merger, the Company is the
surviving entity, materially alter or change the scope of the Company’s business, incur any indebtedness except as defined
in the agreement, or assume, guarantee, endorse or otherwise become directly or contingently liable in connection with any other
party’s obligations. In conjunction with the assignment of the debt from the Lender to the Fund, the Fund is late
on paying to the Lender a final payment of $100,000, which under the current agreement between the Lender, the Fund and the Company,
will result in a debt reduction to the Company of approximately $1,800,000, and a transfer of all liens from the Lender to the
Fund. The Lender has not sent a default notice and the Fund has indicated to the Lender that the final $100,000 payment is anticipated
to be made when the Company is more financially stable. To secure the payment of all obligations to the lender, the Company entered
into a security agreement that assigns and grants to the Lender and the Fund a continuing security interest and first lien on all
of the assets of the Company and its subsidiaries.
Short-Term Borrowings
As of August 31, 2013 and November 30, 2012,
short-term borrowings are:
|
|
|
|
August 31,
2013
|
|
November 30, 2012
|
|
Interest Rate
|
|
|
|
|
|
|
|
|
|
Demand notes payable to Chief Executive Officer
|
|
a)
|
|
$
|
581,007
|
|
|
$
|
502,426
|
|
|
|
12% - 24
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Other demand notes
|
|
b)
|
|
|
167,514
|
|
|
|
118,642
|
|
|
|
0% to 28
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Convertible notes
|
|
c)
|
|
|
205,750
|
|
|
|
447,799
|
|
|
|
0% to 12
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
$
|
954,271
|
|
|
$
|
1,068,867
|
|
|
|
|
|
|
a)
|
Demand notes payable to the Company’s Chief Executive Officer
total $581,007 and $502,426, at August 31, 2013 and November 30, 2012, respectively, at annual interest rates of 12% and 24%.
|
12
|
b)
|
Short-term borrowings at November 30, 2012 include three demand notes
of $50,000, $18,000 and $18,000 at a zero percent interest rate and a past-due note of $32,642 that is in default at an annual
interest rate of 14%. Short-term borrowings at August 31, 2013 include the above four notes and an additional demand note at a
zero percent interest rate in the amount of $9,000 and two working capital loans of $23,333, with an annual interest rate of 28%,
and $16,538, with an annual interest rate of 18%.
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c)
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Short-term borrowings at August 31, 2013 also include three convertible
notes (the “Convertible Notes”) at annual interest rates ranging from 0% to 8%, totaling $205,750. The Convertible
Notes consist of two notes totaling $138,000 that we issued in exchange for cash payments to our Company and one note totaling
$67,750 that we issued in exchange for existing non-convertible notes payable. Conversion features allow the holders of the Convertible
Notes to convert into shares of our common stock at a discount to the trading price of our common stock, as defined, ranging from
42% to 55%. For a limited period of time before a conversion notice is submitted, the Company has the right to pre-pay some or
all of the Convertible Notes at a 15% to 50% premium to the principal amount that is retired.
Short-term borrowings at November
30, 2012 also include eleven convertible notes (the “2012 Convertibles”) at annual interest rates ranging from 0% to
12%, totaling $447,799. The 2012 Convertibles consist of six notes totaling $239,499 that we issued in exchange for cash payments
to our Company, one note of $19,000 that we issued in exchange for services rendered, and four notes totaling $189,300 that we
issued in exchange for existing non-convertible notes payable. Conversion features allow the holders of the 2012 Convertibles to
convert into shares of our common stock at a discount to the trading price of our common stock, as defined, ranging from 10% to
55%. For a limited period of time before a conversion notice is submitted, the Company has the right to pre-pay some or all of
the 2012 Convertibles at a 15% to 50% premium to the principal amount that is retired.
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The conversion features embedded in the convertible
notes were evaluated to determine if such conversion feature should be bifurcated from its host instrument and accounted for as
a freestanding derivative. In one of the three Convertible Notes outstanding at August 31, 2013, and in six of the eleven 2012
Convertibles, the conversion feature was accounted for as a derivative liability. The derivatives associated with the Convertible
Notes and the 2012 Convertibles were recognized as a discount to the debt instrument and the discount is amortized over the expected
life of the notes with any excess of the derivative value over the note payable value recognized as additional interest expense
at the issuance date. Two of the three Convertible Notes and five of the eleven 2012 Convertibles are convertible into common stock
at a fixed price and the conversion option is not a derivative liability.
The derivative
liability for the convertible notes was calculated using the Black Scholes method over the expected terms of the convertible debentures,
with a risk free rate of 1% and volatility of 283% as of August 31, 2013 and a risk free rate of 1% and volatility of 243% as of
November 30, 2012. In accordance with authoritative guidance, the embedded derivatives are revalued at each balance sheet date
and marked to fair value with the corresponding adjustment as a gain or loss on the change in the fair value of the derivatives,
which were recorded as other income or expense in our consolidated statement of income (loss). As of August 31, 2013 and November
30, 2012, the fair value of such derivatives, including derivatives associated with long-term debt, totaled $412,351 and $361,760.
During the nine-month periods ended August 31, 2013 and 2012, the Company recognized income arising from the change in fair value
of the derivatives of $185,844 and $108,406 respectively. During the three-month periods ended August 31, 2013 and 2012, the Company
recognized a gain (loss) arising from the change in fair value of the derivatives of $60,178 and $(27,275), respectively.
Long-term Debt
On November
23, 2011, the Company entered into an agreement with an unsecured lender under which the Company assigned a total of six unsecured
convertible notes (the “Notes”) with a carrying value of $292,148 and a face value of $400,004 to a new unsecured third-party
lender. The Notes had a stated 6% interest rate and were due at various dates during 2012. Such notes also contained embedded beneficial
conversion features for an undeterminable number of shares, which was bifurcated and accounted for as a derivative liability calculated
using the Black Scholes method described above and was valued at $497,667 on November 23, 2011.
Upon such
assignment, the Company and the new lender restructured the terms of the outstanding notes, creating one new convertible note (the
“New Note”) with a face value of $400,004, an interest rate of 6% and a three-year term stating that all principal
and accrued interest shall be due on November 23, 2014. Additionally, the New Note contained a beneficial conversion feature allowing
the new lender to convert any outstanding principal balance in to shares of the Company’s common stock at a rate of $0.006
per share.
13
As the
Company is experiencing financial difficulties and the creditor has granted a concession by extending the term of the notes, the
Company accounted for such transaction as a troubled debt restructuring under ASC 470-60. As the total future cash payments of
the New Note are greater than the carrying value, no adjustment was made to the carrying value of the debt. The New Note had an
effective interest rate of 16.4%, which represented the rate that equated the present value of the total future cash payments to
the carrying value of the debt. The New Note had a carrying value of $359,089 and $344,954 at February 28, 2013 and November 30,
2012, respectively. On March 15, 2013 the Company issued 67,260,000 shares of its common stock in full payment of the New Note,
pursuant to a conversion notice received by the Company.
Capital Lease Obligation
The Company has one capital lease obligation
that is payable in quarterly installments of $2,305, ending on February 2, 2016 of which $7,000 is classified as a short-term liability
and $8,300 as long-term debt.
Note 10 – Income Taxes
At November 30, 2012, the Company had net operating
loss carryforwards for federal income tax purposes of approximately $30,800,000 that expire in the years 2013 through 2032. The
Company has provided an allowance for the full value of the related deferred tax asset since it is more likely than not that none
of such benefit will be realized. Utilization of the net operating losses may be subject to annual limitations provided by Section
382 of the Internal Revenue Code and similar state provisions.
Under Section 108(a) of the Internal Revenue
Code, the gain of $2,714,461 and $6,338,601 in the nine-month periods ended August 31, 2013 and 2012, respectively, that is attributable
to debt forgiveness is not included in taxable income to the Company, as the Company is deemed insolvent for tax purposes. No
such gain was recorded in the three-month periods ended August 31, 2013 and 2012. Consequently, the Company has recorded no income
tax expense in either of the nine-month or three-month periods ended August 31, 2013 and 2012.
Note 11 – Related Party Transactions
In connection with software development costs,
we paid fees to a third-party intellectual property development firm (the “Consultant”) of $143,500 and $144,000, respectively,
for the nine-month periods ended August 31, 2013 and 2012, and $48,000 for the three-month periods ended August 31, 2013 and 2012.
One of our officers performed work for the Consultant, including the function of distributing such funds to appropriate vendors,
for which he was not compensated. The fees for software development services performed by the Consultant were deemed to be operating
costs.
At August 31, 2013 and November 30, 2012, we
owed our chief executive officer $883,436 and $732,575 respectively for loans he provided to the Company, unpaid salary and unpaid
business expenses.
At August 31, 2013 and November 30, 2012, we
owed our chief information officer $29,947 and $24,557, respectively, for unpaid salary and unpaid business expenses.
During the nine-months ended August 31, 2013,
the Company sold to its chief executive officer a warrant to purchase 25,333,333 shares of common stock, par value $0.001, of the
Company and its chief information officer a warrant to purchase 20,000,000 shares of common stock. The Company received, in the
aggregate, cash payments totaling $68,000. The warrants have a ten-year life and exercise price of $0.005. During the quarter ended
August 31, 2012 the Company converted debt owed the chief executive officer of $18,500 into 1,500,000 shares at a price of $0.012
per share.
14
Note 12 – Equity
As discussed
in Note 9, we entered into various transactions where we issued convertible notes to third parties in exchange for existing notes
payable with various lenders. Such convertible notes allowed the new debt holders to convert outstanding debt principal into shares
of the Company’s common stock at a discount to the trading price of the common stock. To the extent, if any, that there was
a beneficial conversion feature associated with these debts, the beneficial conversion feature was bifurcated from the host instrument
and accounted for as a freestanding derivative. As a result of such conversions, during the first quarter of fiscal 2013 a total
of $195,903 of outstanding debt principal was converted into 122,217,067 shares of the Company’s common stock. During the
second quarter of fiscal 2013, a total of $289,007 of outstanding debt principal was converted into 143,766,382 shares of the Company’s
common stock. During the third quarter of fiscal 2013, a total of $303,880 of outstanding debt principal was converted into 134,568,734
shares of the Company’s common stock.
During the first quarter of fiscal 2013, one
debt holder converted outstanding debt payable of $75,000 into 2,500,000 shares of our common stock, a second converted a debt
payable of $6,000 into 6,000,000 shares of our common stock and a third converted a debt payable of $25,000 into 5,000,000 shares
of our common stock. During the second quarter of fiscal 2013, one debt holder converted outstanding debt payable of $361,592 into
67,260,000 shares of our common stock. A second debt holder converted outstanding debt payable of $12,500 for 5,000,000 shares
of our common stock. During the third quarter of fiscal 2013, one holder of convertible debt converted outstanding debt payable
of $19,000 for 9,500,000 shares of our common stock.
On August 30, 2013, the Company filed
a certificate of amendment of its certificate of incorporation in which the Board of Directors designated a Series D of the Company’s
previously authorized preferred stock with a par value per share of $0.001 (the “Series D Preferred”). The number of
shares of Series D Preferred was set at 51 shares. The Series D Preferred shares have dividend rights equal to common stock on
a share-for-share basis, but no liquidation rights. Each one (1) share of the Series D Preferred has voting rights equal to (x)
0.019607 multiplied by the total issued and outstanding shares of Common Stock eligible to vote at the time of the respective vote
(the “Numerator”), divided by (y) 0.49, minus (z) the Numerator. As a result, the holders of the Series D Preferred
Stock have voting control of the Company.
All 51 shares of the Series D Preferred were
issued to the Company’s chief executive officer and chief information officer (the “Officers”) in exchange for
the 51 outstanding shares of the Company’s Series C Preferred Stock held by the Officers. The terms of the Series D Preferred
Stock are substantially identical to the terms of the Series C Preferred Stock, except that the redemption date has been changed.
The Company shall redeem all shares of Series D Preferred, in cash, for $1.00 per share on the earlier to occur of (1) the first
anniversary of the date upon which all obligations of the Company to 112359 Factor Fund, LLC (and/or its assign(s)) have been satisfied
in full, or (2) December 31, 2019.
Note 13 – Fair Value
The Fair Value Measurements Topic of the FASB
Accounting Standards Codification establishes a fair value hierarchy that prioritizes the inputs to valuation techniques used to
measure fair value. The hierarchy gives the highest priority to unadjusted quoted prices in active markets for identical assets
or liabilities (Level 1 measurements) and the lowest priority to measurements involving significant unobservable inputs (Level
3 measurements). The three levels of the fair value hierarchy are as follows:
-
Level 1: inputs are quoted prices (unadjusted) in active
markets for identical assets or liabilities that the company has the ability to access at the measurement date.
-
Level 2: inputs are inputs other than quoted prices included
within Level 1 that are observable for the asset or liability, either directly or indirectly.
-
Level 3: inputs are unobservable inputs for the asset or
liability.
15
Under the Fair Value Measurements Topic of
the FASB Accounting Standards Codification, we base fair value on 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. It is our policy to maximize
the use of observable inputs and minimize the use of unobservable inputs when developing fair value measurements, in accordance
with the fair value hierarchy. Fair value measurements for assets and liabilities where there exists limited or no observable market
data and, therefore, are based primarily upon management’s own estimates, are often calculated based on current pricing policy,
the economic and competitive environment, the characteristics of the asset or liability and other such factors. Therefore, the
results cannot be determined with precision and may not be realized in an actual sale or immediate settlement of the asset or liability.
Additionally, there may be inherent weaknesses in any calculation technique, and changes in the underlying assumptions used, including
discount rates and estimates of future cash flows that could significantly affect the results of current or future value.
Derivative Liability
The table below presents the amounts of
liabilities measured at fair value on a recurring basis as of August 31, 2013 and November 30, 2012.
The fair value of the derivatives that
are traded in less active over-the counter markets are generally measured using pricing models with market observable inputs such
as interest rates and equity index levels. These measurements are classified as Level 2 within the fair value of hierarchy.
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Total
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(Level 1)
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(Level 2)
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(Level 3)
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August 31, 2013
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|
|
|
|
|
|
|
|
|
|
|
|
|
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Derivative liability
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|
$
|
412,351
|
|
|
|
—
|
|
|
$
|
93,836
|
|
|
$
|
318,515
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
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November 30, 2012
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|
|
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|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
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Derivative liability
|
|
$
|
361,760
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|
|
|
—
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|
|
$
|
361,760
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|
|
|
—
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16