NOTES TO FINANCIAL STATEMENTS
Three Months Ended March 31, 2014
(Unaudited)
NOTE 1 – DESCRIPTION OF BUSINESS
AND SUMMARY OF ACCOUNTING POLICIES
Description of Business
On May 16, 2011, the Company transferred,
through a spin-off to its then wholly owned subsidiary, Worlds Online Inc., the majority of its operations and related operational
assets. The Company retained its patent portfolio which it intends to continue to increase and to more aggressively enforce against
alleged infringers. The Company also entered into a License Agreement with Worlds Online Inc. to sublicense its patented technologies.
Basis of Presentation
The accompanying financial statements
have been prepared in conformity with accounting principles generally accepted in the United States of America ("US GAAP"),
which contemplates continuation of the Company as a going concern. The Company has always been considered a developmental stage
business, has incurred significant losses since its inception and has had minimal revenues from operations. The Company will require
substantial additional funds for development and enforcement of its patent portfolio. There can be no assurance that the Company
will be able to obtain the substantial additional capital resources to pursue its business plan or that any assumptions relating
to its business plan will prove to be accurate. The Company has not been able to generate sufficient revenue or obtain sufficient
financing which has had a material adverse effect on the Company, including requiring the Company to reduce operations. These factors
raise substantial doubt about the Company's ability to continue as a going concern. For the past year the Company has been operating
at a significantly reduced capacity, with only one full time employee, performing primarily consulting services and licensing software
and using consultants to perform any additional work that may be required.
Use of Estimates
The preparation of financial statements
in conformity with US GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and
liabilities and disclosures of contingent assets and liabilities at the date of the financial statements and the reported amounts
of revenues and expenses during the reporting period. Actual results could differ from these estimates.
Cash and Cash Equivalents
Cash and cash equivalents are comprised of highly liquid
money market instruments, which have original maturities of three months or less at the time of purchase.
Due from Related Party
Due from related party is comprised
of cash payments made by Worlds Inc. on behalf of Worlds Online Inc. for shared operating expenses.
Revenue Recognition
Effective for the second
quarter of 2011, the Company spun off its online businesses to Worlds Online Inc. The Company’s sources of revenue
after the spin off is anticipated to be from sublicenses of the patented technology by Worlds Online and any revenue that may
be generated from enforcing its patents. The
Company recognizes revenue when all of the following criteria are met: evidence of an arrangement exists such as a signed
contract, delivery has occurred, the price is fixed or determinable, and collectibility is reasonable assured. This will
usually be in the form of a receipt of a customer’s acceptance indicating the product has been completed to their
satisfaction except for development work and service revenue which is recognized when the services have been performed.
Research and Development Costs
Research and development costs are charged
to operations as incurred.
Property and Equipment
Property and equipment are stated at
cost. Depreciation is provided on a straight line basis over the estimated useful lives of the assets ranging from three to five
years. When assets are retired or disposed of, the cost and accumulated depreciation are removed from the accounts, and any resulting
gains or losses are included in income. Maintenance and repairs are charged to expense in the period incurred.
Impairment of Long Lived Assets
The Company evaluates the recoverability
of its fixed assets and other assets in accordance with section 360-10-15 of the FASB Accounting Standards Codification for disclosures
about Impairment or Disposal of Long-Lived Assets. Disclosure requires recognition of impairment of long-lived assets in the event
the net book value of such assets exceeds its expected cash flows. If so, it is considered to be impaired and is written down to
fair value, which is determined based on either discounted future cash flows or appraised values. The Company adopted the statement
on inception. No impairments of these types of assets were recognized during the three months ended March 31, 2014.
Stock-Based Compensation
The Company accounts for stock-based
compensation using the fair value method following the guidance set forth in section 718-10 of the FASB Accounting Standards Codification
for disclosure about Stock-Based Compensation. This section requires a public entity to measure the cost of employee services received
in exchange for an award of equity instruments based on the grant-date fair value of the award (with limited exceptions). That
cost will be recognized over the period during which an employee is required to provide service in exchange for the award- the
requisite service period (usually the vesting period). No compensation cost is recognized for equity instruments for which employees
do not render the requisite service.
Income Taxes
The Company accounts for income taxes
under Section 740-10-30 of the FASB Accounting Standards Codification. Deferred income tax assets and liabilities are determined
based upon differences between the financial reporting and tax basis of assets and liabilities and are measured using the enacted
tax rates and laws that will be in effect when the differences are expected to reverse. Deferred tax assets are reduced by a valuation
allowance to the extent management concludes it is more likely than not that the assets will not be realized. Deferred tax assets
and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary
differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates
is recognized in the consolidated statements of operations in the period that includes the enactment date.
ASC 740 prescribes a comprehensive model
for how companies should recognize, measure, present, and disclose in their financial statements uncertain tax positions taken
or expected to be taken on a tax return. Under ASC 740, tax positions must initially be recognized in the financial statements
when it is more likely than not the position will be sustained upon examination by the tax authorities. Such tax positions must
initially and subsequently be measured as the largest amount of tax benefit that has a greater than 50% likelihood of being realized
upon ultimate settlement with the tax authority assuming full knowledge of the position and relevant facts.
Notes Payable
The Company has $773,279 in short term
notes outstanding at March 31, 2014 and December 31, 2013. The company has $325,000 and $225,000 in notes outstanding at March
31, 2014 and December 31, 2013, respectively.
Comprehensive Income (Loss)
The Company reports comprehensive income
and its components following guidance set forth by section 220-10 of the FASB Accounting Standards Codification which establishes
standards for the reporting and display of comprehensive income and its components in the financial statements. There were no items
of comprehensive income (loss) applicable to the Company during the period covered in the financial statements.
Loss Per Share
Net loss per common share is computed
pursuant to section 260-10-45 of the FASB ASC. Basic net loss per share is computed by dividing net loss by the weighted average
number of shares of common stock outstanding during the period. As of March 31, 2014, there were 8,600,000 options and 5,273,214
warrants whose effect is anti-dilutive and not included in diluted net loss per share for March 31, 2014. The options and
warrants may dilute future earnings per share.
Commitments and Contingencies
The Company follows subtopic 450-20
of the FASB Accounting Standards Codification to report accounting for contingencies. Certain conditions may exist as of the date
the financial statements are issued, which may result in a loss to the Company but which will only be resolved when one or more
future events occur or fail to occur. The Company assesses such contingent liabilities, and such assessment inherently involves
an exercise of judgment. In assessing loss contingencies related to legal proceedings that are pending against the Company or unasserted
claims that may result in such proceedings, the Company evaluates the perceived merits of any legal proceedings or unasserted claims
as well as the perceived merits of the amount of relief sought or expected to be sought therein.
If the assessment of a contingency indicates
that it is probable that a material loss has been incurred and the amount of the liability can be estimated, then the estimated
liability would be accrued in the Company’s financial statements. If the assessment indicates that a potentially material
loss contingency is not probable but is reasonably possible, or is probable but cannot be estimated, then the nature of the contingent
liability, and an estimate of the range of possible losses, if determinable and material, would be disclosed.
Loss contingencies considered remote
are generally not disclosed unless they involve guarantees, in which case the guarantees would be disclosed. Management does not
believe, based upon information available at this time that these matters will have a material adverse effect on the Company’s
financial position, results of operations or cash flows. However, there is no assurance that such matters will not materially and
adversely affect the Company’s business, financial position, and results of operations or cash flows.
During 2000 the Company was
involved in a lawsuit relating to unpaid consulting services. In April, 2001 a judgment against the Company was rendered for
approximately $205,000. As of March 31, 2014, and 2013 the Company recorded a reserve of $205,000 for this lawsuit, which is
included in accrued expenses in the accompanying balance sheets.
Risk and Uncertainties
The Company is subject to risks common
to companies in the technology industries, including, but not limited to, litigation, development of new technological innovations
and dependence on key personnel.
Off Balance Sheet Arrangements
The Company does not have any off-balance sheet arrangements.
Uncertain Tax Positions
The Company did not take any uncertain
tax positions and had no adjustments to unrecognized income tax liabilities or benefits pursuant to the provisions of Section 740-10-25
for the three months ended March 31, 2014 and 2013, respectively.
Subsequent Events
A Federal District Court issued
a ruling on March 13, 2014 on the Motion for Summary Judgment hearing that allows the company to proceed with its patent infringement
suit against Activision Blizzard, Inc., Blizzard Entertainment, Inc. and Activision Publishing, Inc.'s (Activision). The MSJ
hearing held October 17, 2013 addressed Activision's dispute of Worlds Inc.'s November 1995 patent priority date. The court did
not dismiss the case as requested by Activision. The Court’s ruling does prevent the company from pursuing damages for the
period prior to the U.S. Patent and Trademark Office's (USPTO) issuance of Certificates of Correction on September 24, 2013 that
amended the Company’s 6219045 and 7181790 patents to include comprehensive priority information, which specifically references
World’s November 1995 provisional patent application and confirms World’s 1995 priority date.
Recent Accounting Pronouncements
The Company has reviewed all
recently issued, but not yet effective, accounting pronouncements up to ASU 2014-05, and does not believe the future adoption of
any such pronouncements may be expected to cause a material impact on its financial condition or the results of its operations.
NOTE 2 - GOING CONCERN
The accompanying financial statements
have been prepared assuming that the Company will continue as a going concern. Since its inception, the Company has had periods
where it had only minimal revenues from operations. There can be no assurance that the Company will be able to obtain the additional
capital resources to fully implement its business plan or that any assumptions relating to its business plan will prove to be accurate.
The Company is pursuing sources of additional financing and there can be no assurance that any such financing will be available
to the Company on commercially reasonable terms, or at all. Any inability to obtain additional financing will likely have a material
adverse effect on the Company, including possibly requiring the Company to reduce and/or cease operations.
These factors raise substantial doubt
about the ability of the Company to continue as a going concern. The financial statements do not include any adjustments that might
result from the outcome of this uncertainty.
NOTE 3 - PRIVATE PLACEMENTS OF EQUITY
During the three months ended March
31, 2014, the Company issued 1,645,015 common shares by converting $224,375 of the convertible notes payable into common stock.
During the three months ended March
31, 2014, the Company issued an aggregate of 150,000 shares of common stock as payment for services rendered with an aggregate
value of $24,000.
During the three months ended March
31, 2013, the Company sold 875,000 common shares for a cash investment of $87,500. The company received $10,000 for stock issued
in 2012 and recorded as subscription receivable.
During the three months ended March
31, 2013, the Company raised $78,500 with the exercise of warrants covering 523,333 shares of its common stock at a price of $0.15
per share.
During the three months ended March
31, 2013, the Company issued an aggregate of 1,050,000 shares of common stock as payment for services rendered with an aggregate
value of $281,800, $232,037 of which was recorded as deferred compensation as of March 31, 2013.
During the three months ended March
31, 2013, the Company issued 1,500,000 common shares for a cash investment of $150,000 which was received in 2012. The shares were
not issued as of December 31, 2012, and were recorded as common stock subscribed but not yet issued at December 31, 2012.
NOTE 4 - NOTES PAYABLE
We issued an aggregate of $2.4 million
face amount of Senior Secured Convertible Notes (the “Notes”). The Notes are divided into Series A, Series B and Series
C with the Series A and B Notes aggregating to $1.95 million and the Series C Notes aggregating to $450,000. The Series A and Series
B Notes were exchanged by the return of the face amount of the Notes and for 7 million shares of common stock of the Company. The
remaining Series C Note carries a 14% annual interest rate upon default and is payable on March 13, 2016. The Company has determined
that the conversion feature of the Notes represent an embedded derivative since the Notes are convertible into a variable number
of shares upon conversion. The Notes are classified as a derivative liability and not a note payable, see Note 10 below.
Notes payable at March 31, 2014 consist
of the following:
|
|
|
|
|
|
Unsecured note payable to a shareholder bearing 8% interest.
|
|
|
|
|
Entire balance of principal and unpaid interest due on demand
|
|
$
|
124,230
|
|
|
|
|
|
|
Unsecured note payable to a shareholder bearing 10% interest
|
|
|
|
|
Entire balance of principal and unpaid interest due on demand
|
|
$
|
649,049
|
|
|
|
|
|
|
Promissory notes
|
|
$
|
325,000
|
|
Total current
|
|
$
|
1,098,279
|
|
|
|
|
|
|
2014
|
|
$
|
1,098,279
|
|
2015
|
|
$
|
-0-
|
|
2016
|
|
$
|
-0-
|
|
2017
|
|
$
|
-0-
|
|
2018
|
|
$
|
-0-
|
|
|
|
$
|
1,098,279
|
|
We
issued promissory notes in the amount of $100,000 during the three months ended March 31, 2014. We had issued promissory notes
in the amount of $225,000 during the year ended December 31, 2013. One of the Promissory Notes in the amount $50,000 was in lieu
of payment of cash for an outstanding balance due to a consultant of the Company. The promissory notes carry a 6% annual interest
rate and are payable upon the earlier of (a) 24 months from the date of the promissory note or (b) the Company reaching a settlement(s)
on a patent infringement claim(s) and receiving an aggregate of at least $2 million net proceeds from such settlement(s).
The holders of the promissory notes
shall receive repayment in the full face amount of the note from the initial $500,000 the Company actually receives from the net
proceeds of its patent infringement claim(s) or from the net proceeds of a public offering. In addition the holder shall receive
a preferred return (i) in an amount equal to up to 200% of the initial face amount of the note out of available cash by sharing
with all other investors in this series of notes in the allocation of 50% of the available cash received by the Company form $2M
- $4M and (ii) in an amount equal to up to 100% of the initial face amount of the note out of available cash by sharing with all
other investors in this series of notes in the allocation of 25% of the available cash received by the Company from $4M - $6M.
In other words, if the Company collects $6M in the net proceeds of available cash, the holder will receive a return equal to 400%
of its investment.
NOTE 5 – STOCK OPTIONS
During the three months ended March
31, 2014, the Company issued 450,000 options to the Company’s directors. The directors, Bernard Stolar, Robert Fireman and
Edward Gildea each received 100,000 options for serving as board members in 2014. Edward Gildea joined the board on January 10,
2014 and received an additional 150,000 options for joining the Company’s board.
During the three months ended March
31, 2014, the company extended the expiration date on the CEO’s 7,500,000 options. They were set to expire on March 31, 2014
but were extended two years to March 31, 2016. No stock options or warrants were exercised during the three months ended March
31, 2014.
During the three months ended March
31, 2013, the Company issued 4,535,714 warrants as part of the senior secured convertible notes. No stock options were issued.
During the three months ended March 31, 2013, 523,333 stock options were exercised for cash proceeds of $78,500.
During the three months ended March
31, 2014, the Company recorded an option expense of $1,186,310, equal to the estimated fair value of the options at the date of
grants. The fair market value was calculated using the Black-Scholes options pricing model, assuming approximately 0.93% risk-free
interest, 0% dividend yield, 210% volatility, and expected life of 5 years for the Director’s options and 2 years for the
CEO’s options.
Stock Warrants and Options
|
Stock warrants/options outstanding and exercisable on March 31, 2014 are as follows:
|
|
|
|
Exercise Price per Share
|
Shares Under Option/warrant
|
Remaining Life in Years
|
|
|
|
|
|
|
|
|
|
|
Outstanding
|
|
|
|
|
|
|
|
$
|
1.00
|
|
|
4,535,714
|
|
|
3.96
|
|
$
|
0.19
|
|
|
200,000
|
|
|
3.75
|
|
$
|
0.155
|
|
|
200,000
|
|
|
4.75
|
|
$
|
0.15
|
|
|
737,500
|
|
|
0.75
|
|
$
|
0.14
|
|
|
250,000
|
|
|
4.97
|
|
$
|
0.115
|
|
|
300,000
|
|
|
3.58
|
|
$
|
0.11
|
|
|
150,000
|
|
|
1.05
|
|
$
|
0.076
|
|
|
7,500,000
|
|
|
2.00
|
|
$
|
|
|
|
|
|
|
|
|
|
Exercisable
|
|
|
|
|
|
|
|
$
|
1.00
|
|
|
4,535,714
|
|
|
3.96
|
|
$
|
0.19
|
|
|
200,000
|
|
|
3.75
|
|
$
|
0.15
|
|
|
737,500
|
|
|
0.75
|
|
$
|
0.115
|
|
|
300,000
|
|
|
3.58
|
|
$
|
0.11
|
|
|
150,000
|
|
|
1.05
|
|
$
|
0.076
|
|
|
7,500,000
|
|
|
2.00
|
|
NOTE 6 - INCOME TAXES
At March 31, 2014, the Company had federal
and state net operating loss carry forwards of approximately $42,121,000 that expire in various years through the year 2034.
Due to operating losses, there is no
provision for current federal or state income taxes for the three months ended March 31, 2014 and 2013.
Deferred income taxes reflect the net
tax effects of temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and
the amount used for federal and state income tax purposes.
The Company’s deferred tax asset
at March 31, 2014 consists of net operating loss carry forwards calculated using federal and state effective tax rates equating
to approximately $16,427,000 less a valuation allowance in the amount of approximately $16,427,000. Because of the Company’s
lack of earnings history, the deferred tax asset has been fully offset by a valuation allowance. The valuation allowance increased
by approximately $54,000 and $86,000 for the three months ended March 31, 2014 and 2013, respectively.
The Company’s total deferred tax
asset as of March 31, 2014 is as follows:
Net operating loss carry forwards
|
|
$
|
16,427,000
|
|
Valuation allowance
|
|
|
(16,427,000
|
)
|
|
|
|
|
|
Net deferred tax asset
|
|
$
|
—
|
|
The reconciliation of income taxes computed at the federal
and state statutory income tax rate to total income taxes for the three months ended March 31, 2014 and 2013 is as follows:
|
|
|
2014
|
|
|
|
2013
|
|
Income tax computed at the federal statutory rate
|
|
|
34
|
%
|
|
|
34
|
%
|
Income tax computed at the state statutory rate
|
|
|
5
|
%
|
|
|
5
|
%
|
Valuation allowance
|
|
|
(39
|
%)
|
|
|
(39
|
%)
|
Total deferred tax asset
|
|
|
0
|
%
|
|
|
0
|
%
|
NOTE 7 - COMMITMENTS AND CONTINGENCIES
The Company is committed to an employment
agreement with its President and CEO, Thom Kidrin. The agreement, dated as of August 30, 2012, is for five years with a one-year
renewal option held by Mr. Kidrin. The agreement provides for a base salary of $175,000, which increases 10% on September
1 of each year; a monthly car allowance of $500; an annual bonus equal to 2.5% of Pre-Tax Income (as defined in the agreement);
an additional bonus as follows: $75,000, if Pre-Tax Income for the year is between 150% and 200% of the prior fiscal year’s
Pre-Tax Income or (B) $100,000, if Pre-Tax Income for the year is between 201% and 250% of the prior fiscal year’s Pre-Tax
Income or (C) $200,000, if Pre-Tax Income for the year is 251% or greater than the prior fiscal year’s Pre-Tax Income, but
in no event shall this additional bonus exceed five (5%) percent of Pre-Tax Income for such year; payment of up to $10,000 in life
insurance premiums; options to purchase 7.5 million shares of Worlds Inc. common stock at an exercise price of $0.076 per
share, all of which vested on August 30, 2012; a death benefit of at least $2 million dollars; and a payment equal to 2.99 times
his base amount (as defined in the agreement) in the event of a Change of Control (as defined in the agreement). The agreement
also provides that Mr. Kidrin can be terminated for cause (as defined in the agreement) and that he is subject to restrictive covenants
for 12 months after termination.
NOTE 8 - RELATED PARTY TRANSACTIONS
On May 16, 2011, the Company transferred,
through a spin-off to its then wholly owned subsidiary, Worlds Online Inc., the majority of its operations and related operational
assets. The Company retained its patent portfolio which it intends to continue to increase and to more aggressively enforce against
alleged infringers. The Company also entered into a License Agreement with Worlds Online Inc. to sublicense its patented technologies.
Due from related party is comprised
of cash payments made by Worlds Inc. on behalf of Worlds Online Inc. for shared operating expenses. The balance due at March 31,
2014 is $287,050.
NOTE 9 - PATENTS
Worlds Inc. currently has nine
patents, 6,219,045 - 7,181,690 - 7,493,558 – 7,945,856, - 8,082,501, – 8,145,998 – 8,161,383, – 8,407,592
and 8,640,028. On March 30, 2012, the Company filed a patent infringement lawsuit against Activision Bizzard Inc., Blizzard Entertainment
Inc. and Activision Publishing Inc. in the United States District Court for the District of Massachusetts. Susman Godfrey LLP is
lead counsel for the Company. The costs to prosecute those parties that the Company and our legal counsel believe to be infringing
on said patents were capitalized under patents until a resolution is reached.
A Federal District Court issued
a ruling on March 13, 2014 on the Motion for Summary Judgment hearing that allows the company to proceed with its patent infringement
suit against Activision Blizzard, Inc., Blizzard Entertainment, Inc. and Activision Publishing, Inc.'s (Activision). The
MSJ hearing held October 17, 2013 addressed Activision's dispute of Worlds Inc.'s November 1995 patent priority date. The court
did not dismiss the case as requested by Activision. The Court’s ruling does prevent the company from pursuing damages for
the period prior to the U.S. Patent and Trademark Office's (USPTO) issuance of Certificates of Correction on September 24, 2013
that amended the Company’s 6,219,045 and 7,181,790 patents to include comprehensive priority information, which specifically
references World’s November 1995 provisional patent application and confirms World’s 1995 priority date.
In early October 2013, Activision
Publishing, Inc., a subsidiary of Activision Blizzard, Inc. filed a lawsuit claiming patent infringement against Worlds
Inc. and Worlds Online Inc., in the U.S. District Court for the Central District of California. Activision alleges that
Worlds violates U.S. Patent No. 6,014,145 entitled “Navigation with optimum viewpoints in three-dimensional workspace
interactive displays having three-dimensional objects with collision barriers” and U.S. Patent No. 5,883,628 entitled
“Climability: property for objects in 3-D virtual environments.” The Company believes Activision/
Blizzards' suit against Worlds Inc. is without merit and an attempt to apply pressure to Worlds due our lawsuit against them.
Worlds' parent patent pre-dates Activision/ Blizzards' patents by more than one year.
There can be no assurance that the
Company will be successful in its ability to prosecute its IP portfolio or that we will be able to acquire additional patents.
NOTE
10 – DERIVATIVE LIABILITIES
On March 20, 2013 the Company entered
into strategic financing agreements with several institutional investors that could provide the Company with up to $2.3 million
of debt financing based upon the amount of conversions and redemptions. The transaction documents provide, among other things,
that (i) the investors will receive five year warrants in an amount equal to 100% of the number of shares of our common stock the
investors would receive if the Notes (defined below) were converted on March 13, 2013, at an exercise price of $0.50 per share,
(ii) $1.950 million of the funds will deposited in one of our bank accounts but will be subject to a control account agreement
which will provide that the Company can only withdraw funds from the account as the investors convert or redeem the Notes, (iii)
the investors have demand and piggy-back registration rights for the shares of common stock underlying the warrants and Notes,
(iv) the Notes will be secured by a first priority security interest in all of our assets, other than our patents, (v) each investor
may not convert any Note or exercise any warrants if doing so will cause the investor to own more than 4.99% of our outstanding
common stock at any time, although under certain circumstances they can each own up to 9.99% of our outstanding common stock, (vi)
we paid $40,000 of the investors’ legal fees incurred with respect to this transaction, and (vii) for the next three years
the investors have a right to participate in up to 50% of any of our future financings. The warrants and Notes contain standard
anti-dilution provisions and the Securities Purchase Agreements contains standard covenants for a financing of this nature. In
the event the Company acquires any subsidiaries while the Notes are outstanding, such subsidiaries will be obligated to guaranty
the Notes and any other obligations we owe to the investors pursuant to the transaction documents.
On July 15, 2013 we entered into Amendment
and Exchange Agreements with each of the existing holders of our Series A, B and C Senior Secured Convertible Notes and related
warrants to purchase our common stock, which securities were originally issued pursuant to that certain Securities Purchase Agreement
dated as of March 14, 2013 (“Securities Purchase Agreement”), by and among us and such holders.
Each Exchange Agreement provides for, among other things,
that:
|
(i)
|
Various restrictive provisions of the Securities Purchase Agreement and the Class C Senior Secured Convertible Notes were either eliminated by amendment or waived;
|
|
(ii)
|
the related warrants, initially exercisable into an aggregate of 4,535,714 shares of Common Stock at an initial exercise price of $0.50, were exchanged for new warrants, initially exercisable into an aggregate of 4,535,714 shares of Common Stock at an initial exercise price of $1.00; and
|
|
(iii)
|
the Series A and B Senior Secured Convertible Notes, with an aggregate original principal amount of $1,950,000, were exchanged for an aggregate of 7 million shares of our common stock and the payment by the Company to such holders of an aggregate of approximately $1,951,400 (the remaining cash amount held in a control account pursuant to the terms and conditions of the Series A and B Senior Secured Convertible Notes)
|
The Company has determined that the
conversion feature of the Note represent an embedded derivative since the Note is convertible into a variable number of shares
upon conversion. Accordingly, the Note is not considered to be conventional debt under EITF 00-19 and the embedded conversion feature
must be bifurcated from the debt host and accounted for as a derivative liability. Accordingly, the fair value of this derivative
instrument has been recorded as a liability on the balance sheet with the corresponding amount recorded as a discount to the Note.
Such discount will be accreted from the grant date to the maturity date of the Note. The change in the fair value of the derivative
liability will be recorded in other income or expenses in the statement of operations at the end of each period, with the offset
to the derivative liability on the balance sheet. The beneficial conversion feature included in the Note resulted in an initial
debt discount of $450,000 and an initial loss on the valuation of derivative liabilities of $96,119 based on the initial fair value
of the derivative liability of $546,119. The fair value of the embedded derivative liability was calculated at grant date utilizing
the following assumptions:
Grant Date
|
|
Fair Value
|
|
Term
(Years)
|
|
Assumed Conversion Price
|
|
Market Price on Grant Date
|
|
Volatility Percentage
|
|
Risk-free
Rate
|
3/20/13
|
|
$
|
546,119
|
|
|
|
3.0
|
|
|
$
|
0.326
|
|
|
$
|
0.465
|
|
|
|
238
|
%
|
|
|
0.0038
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
During the three months ended March
31, 2014, $224,375 of the convertible notes was converted into 1,645,015 shares of the Company’s common stock. $225,188 in
convertible notes remain outstanding.
At March 31, 2014, the Company revalued
the embedded derivative liability. For the period from December 31, 2013 to March 31, 2014, the Company decreased the derivative
liability of $429,296 by $242,694 resulting in a derivative liability of $186,602 at March 31, 2014.
The fair value of the embedded derivative
liability was calculated at March 31, 2014 utilizing the following assumptions:
Date
|
|
Fair Value
|
|
Term
(Years)
|
|
Assumed Conversion Price
|
|
Market Price
|
|
Volatility Percentage
|
|
Risk-free
Rate
|
|
3/31/14
|
|
|
$
|
186,602
|
|
|
|
1.97
|
|
|
$
|
0.15
|
|
|
$
|
0.156
|
|
|
|
179
|
%
|
|
|
0.0093
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|