NOTES PAYABLE

3 Months Ended

Mar. 31, 2013

NOTE 6 - NOTES PAYABLE

Notes payable consists of the following:

	March 31, 2013			December 31, 2012

Unsecured notes payable; interest at 10% per annum; principal and accrued interest due at maturity in September 2015	$	561,000		$	561,000

Series A notes payable; interest at 8% per annum; principal and accrued interest due at extended maturity date in September 2015		150,000			150,000

Series A notes payable; interest at 8% per annum; principal and accrued interest due at maturity in October 2011 (past due)		50,000			50,000

Notes payable, interest at 25% per annum; principal and interest due September 2013		-			150,000

Less: Debt discount		(12,393	)		(13,632	)
		748,607			897,368

Less: Current portion		50,000			200,000
Long-term portion	$	698,607		$	697,368

At March 31, 2013 and December 31, 2012 accrued interest on notes payable was $327,411 and $394,281.

Private Placement of 8% Series A Notes Payable

In August 2009, the Company commenced a private placement of up to $300,000 consisting of up to 6 units. Each unit consists of a $50,000, 8% Series A Note Payable, due September 30, 2011, and a non-detachable warrant to purchase 2 million shares of the Company’s common stock. During 2009, the Company sold 4 units, issued $200,000 of 8% Series A Notes Payable, issued 8 million warrants, and raised $180,000, net of commission of $20,000. In January 2010, the Company sold 0.5 units, issued $25,000 of 8% Series A Notes Payable, issued 1 million warrants, and raised $17,500 net of commissions of $7,500. The commissions were treated as deferred finance charges and are expensed over the term of notes payable, which have been fully expensed.

The 8 million warrants in 2009 were valued at $15,450, fair value, using the Black-Scholes option pricing model to calculate the fair-value of the warrants, with the following assumptions: no dividend yield, expected volatility of between 30.9% and 34.5%, risk free interest rate between .95% and 1.06% and warrant life of approximately 2 years. The 1 million warrants in 2010 were valued at $20,143, fair value, using the Black-Scholes option pricing model to calculate the fair-value of the warrants, with the following assumptions: no dividend yield, expected volatility of 28.6 %, risk free interest rate of .84% and warrant life of approximately 2 years.

In June 2011, the maturity date on the $150,000 of the 8% Series A Notes Payable and the term on the associated 6 million warrants were extended to September 30, 2015. As a result, the warrants were revalued using the Black-Scholes option pricing model to calculate the incremental fair-value of the warrants of $21,275, with the following assumptions: no dividend yield, expected volatility of 60%, risk free interest rate of 1.52% and warrant life of approximately 1.25 years. As part of the debt extension, the lender holding the 6 million warrants agreed in writing to suspend its right to exercise these warrants until such time that the Company’s authorized shares have been increased. The authorized shares of the Company’s common stock were increased on November 12, 2012 from 175,000,000 to 425,000,000. The Company's stockholders have approved a further increase to 675,000,000 shares of common stock, which is expected to take effect in May, 2013.

The relative fair value of the warrants issued in conjunction with the 8% Series A Notes Payable have been treated as a debt discount with an offsetting credit to additional paid-in capital. The debt discount related to the warrant issuances is being accreted to interest expense over the term of the notes. When the warrants were revalued the incremental amount of $21,275 was also treated as additional debt discount and is being accreted over the new term of the 8% Series A Notes Payable. As of March 31, 2013 and 2012, the unaccreted debt discount related to warrants issued in conjunction with the 8% Series A Notes payable was $12,393 and $13,632. For the three months ended March 31, 2013 and 2012, accreted interest expense from the accretion of the debt discount was $1,239.

During the third quarter of 2011, $25,000 plus accrued interest of the 8% Series A Notes Payable were repaid and 3 million of the associated warrants expired unexercised.

Private Placement of 25% Notes Payable

In 2010, the Company issued $400,000 in notes payable in order to finance a patent infringement lawsuit (see Note 13 – Legal Matters to these condensed consolidated financial statements). The notes payable accrue interest at 25% per annum and mature upon the earlier of September 1, 2013 or the date on which the Company receives net proceeds from the patent infringement claim. In addition to the base interest of 25% per annum, the lenders are entitled to Bonus Interest equal to the following:

First monies realized by the Company from its share of the net proceeds of the lawsuit shall be allocated and paid to the Lender until the principal and base interest accruing has been fully paid.

The next monies from the net proceeds of the litigation settlement will be paid to the Company to reimburse for out-of-pocket legal costs related to the lawsuit.

The next $825,000 of proceeds will be split 50%/50% between the Company and the Lenders.

The next $1 million realized by the Company shall be allocated 90% to the Company and 10% to the Lenders.

The next $1 million realized by Company shall be allocated 85% to Company and 15% to Lenders.

All remaining proceeds realized by Company shall be allocated 80% to Company and 20% to Lenders.

The Lenders have a security interest in the Company’s patent infringement claim in which the Lender has the right to the net proceeds of this lawsuit to satisfy outstanding principal and interest under the notes.

As part of the private placement of the 25% notes payable, the Company incurred debt placement fees of $34,500 in 2010. These debt placement fees have been treated as deferred finance charges and are being amortized to interest expense over two years. For the three months ended March 31, 2013 and 2012 amortization of deferred finance charges was $0 and $4,312.

In December 2012, 250,000 of these notes payable and accrued interest of $122,397 were converted into 8,219,911 shares of the Company’s common stock. In March 2013, the remaining $150,000 of the notes payable and accrued interest of $83,895 was converted into 3 million shares of the Company’s common stock. Accrued interest of $13,895 was paid in cash.

Aggregate Maturities of Long-term Debt

Aggregate maturities of the senior secured convertible notes, convertible notes and notes payable over the next five years are as follows:

2013	$	50,000
2014		-
2015		1,621,856
2016		-
2017		-

- Definition

The entire disclosure for information about short-term and long-term debt arrangements, which includes amounts of borrowings under each line of credit, note payable, commercial paper issue, bonds indenture, debenture issue, own-share lending arrangements and any other contractual agreement to repay funds, and about the underlying arrangements, rationale for a classification as long-term, including repayment terms, interest rates, collateral provided, restrictions on use of assets and activities, whether or not in compliance with debt covenants, and other matters important to users of the financial statements, such as the effects of refinancing and noncompliance with debt covenants.

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