NOTE 8  -

CONVERTIBLE PROMISSORY NOTE AND EMBEDDEDED DERIVATIVE LIABILITIES

 

The Company previously entered into securities purchase agreements (the "Purchase Agreement") with an investor and issued  convertible promissory notes in the amount of $60,000, $37,500 and $37,500, respectively (the "Notes").The Notes bore interest at 8% per annum and mature on August 15, October 23, 2012, and May 24, 2013, respectively. The Notes were convertible into unregistered shares of the Company's common stock (the "Common Stock"), at the Conversion Price, as defined below, in whole, or in part, at any time beginning 180 days after the issuance of the note.  The Conversion Price of the Notes was be equal to 58% multiplied by the Variable Conversion Rate which is equal to the average of the three (3) lowest closing bid prices of the Common Stock during the ten (10) trading day period prior to the date of conversion. In any event of default before the maturity date payment is immediately due in the amount 150% of the outstanding unpaid principal along with interest and any penalties.

 

The convertible notes payable dated November 15, 2011 and January 19, 2012 were amended on August 22, 2012. Under the terms of the amendments, the conversion rate was changed to 40% multiplied by the Variable Conversion Rate redefined as the lowest closing bid price during the ninety trading days prior to the date of the conversion.

 

On August 17, 2012 the Company defaulted on a Convertible Promissory Note dated November 15, 2011. As a result of the default the Company is required to pay 150% on the remaining principal amount of $44,000 and is subject to a default interest rate of 22% until paid in full. The default penalty of $22,000 is included in accrued expenses as of September 30, 2012. On October 23, 2012 the Company defaulted on a Convertible Promissory Note dated January 19, 2012.  The default penalty of $18,750 is also included in Accrued expenses as of September 30, 2012

 

In May 2012, the noteholder converted $8,000 of the November 15, 2011 convertible note into 1,481 shares of the Company's common stock.

 

In June 2012, the noteholder converted $8,000 of the November 15, 2011 convertible note into 2,930 shares of the Company's common stock.

 

In August 2012, the noteholder converted $8,000 of the November 15, 2011 convertible note into 4,598 shares of the Company's common stock.

 

In September 2012, the noteholder converted $8,800 of the November 15, 2011 convertible note into 18,334 shares of the Company's common stock.

 

As a result of the partial conversion of the notes, $61,168 was reclassified from derivative liability to additional paid in capital.

 

Interest expense on the convertible notes payable for the year ended September 30, 2012 was $96,307 including $71,122 of discount amortization.

During October and November 2012, $7,700 of principal was converted to 27,500 shares of common stock. As a result of the partial conversion of the notes, $22,221 was reclassified from derivative liability to additional paid-in capital and a gain on conversion was recognized of $12,842.

On March 8, 2013 the Company paid all of the outstanding principal, accrued interest and penalties totaling $125,000 on three outstanding convertible promissory notes.

 

Derivative analysis

 

The Notes were convertible into common stock of the Company at variable conversion rates that provided a fixed return to the note-holder. Under the terms of the notes, the Company could be required to issue additional shares in the event of a default. Due to these provisions, the conversion feature was subject to derivative liability treatment under Section 815-40-15 of the FASB Accounting Standard Codification ("Section 815-40-15") (formerly FASB Emerging Issues Task Force ("EITF") 07-5). The Notes were measured at fair value using a lattice model at each reporting period with gains and losses from the change in fair value of derivative liabilities recognized on the consolidated statement of operations. The conversion feature was recorded as a discount to the notes due to the beneficial conversion feature upon origination.

 

The repayment of the convertible notes effectively removed the derivative liability and the Company recognized a gain of approximately $123,000 and additional paid-in capital of approximately $65,000. The net gain (loss) on the change in fair value of the derivative liability was $18,055 and ($47,256) for the years ended September 30, 2013 and September 30, 2012, respectively. The derivative value of the remaining Notes at September 30, 2012, yielded a derivative liability at fair value of $ 143,678.