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DERIVATIVE LIABILITY

3 Months Ended

Mar. 31, 2014

NOTE 13 – DERIVATIVE LIABILITY

In April 2008, the FASB issued a pronouncement that provides guidance on determining what types of instruments or embedded features in an instrument held by a reporting entity can be considered indexed to its own stock for the purpose of evaluating the first criteria of the scope exception in the pronouncement on accounting for derivatives. This pronouncement was effective for financial statements issued for fiscal years beginning after December 15, 2008. The adoption of these requirements can affect the accounting for warrants and many convertible instruments with provisions that protect holders from a decline in the stock price (or “down-round” provisions). For example, warrants or conversion features with such provisions are no longer recorded in equity. Down-round provisions reduce the exercise price of a warrant or convertible instrument if a company either issues equity shares for a price that is lower than the exercise price of those instruments or issues new warrants or convertible instruments that have a lower exercise price.

As of December 31, 2013, the Company had recorded a derivative liability in the amount of $9,324,000 with relation to the issuance of the Company’s 7% Convertible Notes (see “NOTE 19 – 7% CONVERTIBLE NOTES PAYABLE”) in the original principal amount of $1,850,000 in the aggregate, all of which was still outstanding as of December 31, 2013.

On January 31, 2014, the Company recalculated the value of this derivative liability to be $21,477,631 using the weighted-average Black-Scholes-Merton option pricing model, which approximates the Monte Carlo and other binomial valuation techniques, with the following assumptions; (i) dividend yield of 0%; (ii) expected volatility of 177%; (iii) risk free rate of 0.03%, (iv) stock price of $0.312, and (v) expected term of 11 months, as the Company estimates that these notes will be converted by December 31, 2014. As a result of this recalculation, the Company recorded a $12,153,631 non-cash “change in fair value of derivative” expense while also increasing the value of the Company’s derivative liability by the same amount, which resulted in the Company having a derivative liability in the amount of $21,477,631 as of January 31, 2014. Note that the outstanding principal on these 7% convertible notes was $1,850,000 as of January 31, 2014.

On February 28, 2014, the Company again recalculated the value of its derivative liability using the weighted-average Black-Scholes-Merton option pricing model, which approximates the Monte Carlo and other binomial valuation techniques, with the following assumptions; (i) dividend yield of 0%; (ii) expected volatility of 173%; (iii) risk free rate of 0.04%, (iv) stock price of $0.367, and (v) expected term of 10 months, as the Company estimates that these notes will be converted by December 31, 2014. This resulted in a derivative liability in the amount of $25,459,681, which represents an increase of $3,982,050 from the $21,477,631 as of January 31, 2014. Accordingly, the Company recorded a $3,982,050 non-cash “change in fair value of derivative” expense while also increasing the value of the Company’s derivative liability by the same amount, which resulted in the Company having a derivative liability in the amount of $25,459,681 as of February 28, 2014. Note that the outstanding principal on these 7% convertible notes was $1,850,000 as of February 28, 2014.

On March 7, 2014, one Holder of these 7% convertible notes converted $50,000 of principal into 2,000,000 shares of the Company’s common stock at a per share conversion price of $0.025. The Company used the weighted-average Black-Scholes-Merton option pricing model to calculate the value of the related derivative liability at the time of conversion using the following assumptions: (i) dividend yield of 0%; (ii) expected volatility of 180%; (iii) risk free rate of 0.06%, (iv) stock price of $0.412, and (v) expected term of 1 month. This resulted in a derivative liability of $773,002, which represents an $84,902 increase from the value as of February 28, 2014. As a result, the Company recorded an $84,902 non-cash “change in fair value of derivative” expense while also recording a corresponding increase to the Company’s derivative liability. Upon conversion of the $50,000 of principal by the Holder, the Company reclassified the $773,002 derivative liability related to the $50,000 conversion from its “derivative liability” balance sheet account and into “additional paid-in capital”. After this $50,000 conversion, the outstanding principal on these 7% convertible notes was $1,800,000.

On March 18, 2014, three (3) Holders of these 7% convertible notes converted $550,000 of principal into 22,000,000 shares of the Company’s common stock at a per share conversion price of $0.025. The Company used the weighted-average Black-Scholes-Merton option pricing model to calculate the value of the related derivative liability at the time of conversion using the following assumptions: (i) dividend yield of 0%; (ii) expected volatility of 180%; (iii) risk free rate of 0.07%, (iv) stock price of $0.69, and (v) expected term of 1 month. This resulted in a derivative liability of $14,630,031, which represents a $7,060,940 increase from the value as of February 28, 2014. As a result, the Company recorded a $7,060,940 non-cash “change in fair value of derivative” expense while also recording a corresponding increase to the Company’s derivative liability. Upon conversion of the $550,000 of principal by the Holders, the Company reclassified the $14,630,031 derivative liability related to the $550,000 conversion from its “derivative liability” balance sheet account and into “additional paid-in capital”. After this $550,000 conversion, the outstanding principal on these 7% convertible notes was $1,250,000.

On March 31, 2014, the Company recalculated the value of its derivative liability related to the $1,250,000 outstanding principal balance of these 7% convertible notes using the weighted-average Black-Scholes-Merton option pricing model, which approximates the Monte Carlo and other binomial valuation techniques, with the following assumptions; (i) dividend yield of 0%; (ii) expected volatility of 180%; (iii) risk free rate of 0.03%, (iv) stock price of $0.58, and (v) expected term of 9 months, as the Company estimates that these notes will be converted by December 31, 2014. This resulted in a derivative liability in the amount of $27,809,926, which represents an increase of $10,607,436 from the $17,202,490 as of February 28, 2014. Accordingly, the Company recorded a $10,607,436 non-cash “change in fair value of derivative” expense while also increasing the value of the Company’s derivative liability by the same amount, which resulted in the Company having a derivative liability in the amount of $27,809,926 as of March 31, 2014. Note that the outstanding principal on these 7% convertible notes was $1,250,000 as of March 31, 2014.

For the three month period ended March 31, 2014, the Company recorded a $33,888,959 non-cash “change in fair value of derivative” expense, all of which was related to its 7% convertible notes. The following is a summary of the Company’s non-cash “change in fair value of derivative” expense:

Change in fair value of derivative liability as of January 31, 2014	$	12,153,631
Change in fair value of derivative liability as of February 28, 2014		3,982,050
Change in fair value of derivative liability related to $50,000 principal conversion on March 7, 2014		84,902
Change in fair value of derivative liability related to $550,000 principal conversion on March 18, 2014		7,060,940
Change in fair value of derivative liability as of March 31, 2014		10,607,436
	$	33,888,959