Note 5 - Convertible Debentures

9 Months Ended

Sep. 30, 2014

Notes

Note 5 - Convertible Debentures

NOTE 5 – CONVERTIBLE DEBENTURES

            Through September 30, 2014, we have financed our operations through the issuance of various convertible debentures.  For the nine months ended September 30, 2014, we received cash proceeds of $997,235 from the issuance of new convertible debentures.  We also issued new convertible debentures for $95,000 in services, the transfer of $50,000 from stockholder advances, the transfer of accrued interest payable of $30,731 and original issue discount of $46,000.

The debentures are generally unsecured and bear interest ranging from 6% to 22% per annum, with maturities ranging from two months to two years.  The outstanding principal and accrued interest of the debentures are convertible into shares of the Company’s common stock at a fixed conversion price ranging from $0.0025 to $30.00 per share or variable discounted pricing based on the market price of the Company’s common stock.

We evaluated the convertible debentures in accordance with ASC Topic 815, “Derivatives and Hedging,” and determined that the conversion feature of the convertible promissory notes with variable conversion prices were not afforded the exemption for conventional convertible instruments due to their variable conversion rates.  The notes have no explicit limit on the number of shares issuable so they did not meet the conditions set forth in current accounting standards for equity classification. We elected to recognize the notes under paragraph 815-15-25-4, whereby there would be a separation into a host contract and derivative instrument. We elected to initially and subsequently measure the notes in their entirety at fair value, with changes in fair value recognized in earnings.  We recorded a derivative liability and debt discount representing the imputed interest associated with the embedded derivative. 

For those convertible debentures with fixed conversion prices, we recorded a beneficial conversion feature at the inception of the debt to additional paid-in capital and to debt discount where the conversion price was less that the market price of the stock.

The debt discount is amortized over the life of the note and recognized as interest expense.  For the nine months ended September 30, 2014 and 2013, we amortized debt discount of $1,068,942 and $203,919, respectively, to interest expense.  The derivative liability is adjusted periodically according to the stock price fluctuations and was $2,642,968 and $2,104,849 at September 30, 2014 and December 31, 2013, respectively.  For purpose of estimating the fair value of the convertible debentures, we used the Black Scholes option valuation model.

At September 30, 2014, the convertible debentures and related accrued interest payable were convertible into approximately 241,019,000 shares of our common stock.

As of September 30, 2014, several of the convertible debentures are delinquent.  We believe we have good relationships with the debenture holders, and continue to have discussions with them regarding the extension of maturity dates.

During the nine months ended September 30, 2014, we had the following activity in the accounts related to the convertible debentures:

	Derivative Liability	Debt Discount	Gain (Loss) on Derivative Liability	Gain on Extinguishment of Debt	Interest Expense
Balance at December 31, 2013	$2,104,849	$(408,194)
Adjustment to derivative liability	(1,093,610)	-	$1,093,610	$-	$-
New debt – debt discount	2,208,054	(801,502)	(1,448,052)	-	-
New debt – original issue discount	-	(4,500)	-	-	-
New debt – beneficial conversion feature	-	(730,073)	-	-	-
Amortization of debt discount to interest    expense	-	1,061,124	-	-	(1,061,124)
Debt conversions and repayments	(576,325)	95,175	-	(470,480)	-
Balance at September 30, 2014	$2,642,968	$(787,970)	$354,442	$(470,480)	$(1,061,124)

In estimating the fair value of the derivatives and calculating the adjustment to the derivative liability as of September 30, 2014, we used the Black-Scholes pricing model with the following range of assumptions:

Market price of stock	$0.0189
Risk-free interest rate	0.02% - 0.58%
Expected life in years	0.25 - 1.93
Dividend yield	0%
Expected volatility	266.99% - 514.66%