10-Q 1 accesskey_10q-093009.htm ACCESSKEY IP, INC. accesskey_10q-093009.htm


UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549

FORM 10-Q

x
QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934.

FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 2009

o
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES AND EXCHANGE ACT OF 1934

For the transition period from: __________ to __________

Commission File Number: 0-053664
 
ACCESSKEY IP, INC.
(Exact name of registrant as specified in its charter)
 
 
Nevada 41-1735422
(State or other jurisdiction of    (I.R.S. Employer 
incorporation or organization)   Identification Number) 
   
8100 M4 Wyoming Blvd. NE 87113
(Address of principal executive offices)  (Zip Code)
 
 
(310) 734-4254
(Registrant's telephone number, including area code)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. x Yes  o No

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of  Regulation S-T (§232.405 of this chapter) during the preceding 12 month (or for such shorter period that the registrant was required to submit and post such files).  o Yes o No

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company.  See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.
 
Large accelerated filer o Accelerated filer o
Non-accelerated filer   o (Do not check if a smaller reporting company) Smaller reporting company x

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).  o Yes  x No

At November 9, 2009, 402,988,888 shares of the registrant's common stock (par value $0.001 per share) were outstanding.
 


 
TABLE OF CONTENTS
 
 
    Page
     
  PART I – FINANCIAL INFORMATION 3
     
ITEM 1.  Financial Statements for the quarter and nine months ended September 30, 2009 3
ITEM 2. Management's Discussion and Analysis of Financial Condition and Results of Operations 31
ITEM 3.   Quantitative and Qualitative Disclosures about Market Risk 41
ITEM 4. Controls and Procedures 41
ITEM 4T.  Controls and Procedures 41
     
  PART II – OTHER INFORMATION 42
     
ITEM 1.   Legal Proceedings 42
ITEM 1A.  Risk Factors 42
ITEM 2.   Unregistered Sales of Equity Securities and Use of Proceeds 42
ITEM 3.  Defaults upon Senior Securities 42
ITEM 4.  Submission of Matters to a Vote of Security Holders 43
ITEM 5.    Other Information 43
ITEM 6.  Exhibits 44
 
                     
 
2

 
ACCESSKEY IP, INC. AND SUBSIDIARY

PART I. - FINANCIAL INFORMATION

ITEM 1 - FINANCIAL STATEMENTS FOR QUARTER AND NINE MONTHS ENDED SEPTEMBER 30, 2009

AccessKey IP, Inc. and subsidiary
           
Consolidated balance sheets
           
(unaudited)
           
             
ASSETS
 
December 31,
   
September 30,
 
   
2008
   
2009
 
Current assets
           
Cash
  $ 227,683     $ 41,685  
Accounts receivable
    1,010,173       161,464  
Inventory
    26,994       401,552  
Notes receivable (net of reserve of $32,000 and $42,000) (Note 15)
    10,000       -  
Interest receivable (net of reserve of none and $6,942)
    3,281       -  
Prepaid expenses
    -       5,000  
Deposits
    60,000       -  
Total current assets
    1,338,131       609,701  
                 
Property and equipment (net of accumulated depreciation of none)
    -       7,500  
                 
TOTAL ASSETS
  $ 1,338,131     $ 617,201  
                 
LIABILITIES AND STOCKHOLDERS' DEFICIT
 
December 31,
   
September 30,
 
    2008     2009  
Current liabilities
               
Accounts payable
  $ 58,639     $ 76,552  
Accrued liabilities (Note 4)
    907,976       2,527,679  
Accrued liabilities to Officers (Note 4)
    110,000       13,584  
Notes payable, net of unamortized discount of none and $210,411 (Note 11)
    241,294       5,112,496  
Note payable to officer
    -       32,000  
Prepaid research and development (Note 12)
    916,290       -  
Total current liabilities
    2,234,199       7,762,311  
                 
Notes payable (Note 11)
    4,595,523       -  
Derivative liability
    633,456       1,027,396  
      5,228,979       1,027,396  
                 
Total liabilities
    7,463,178       8,789,707  
                 
Stockholders' deficit
               
Preferred stock, Series A, par value of $0.001 per share, preferred liquidation value of $10.00 per share, 1,500,000 shares authorized and 1,231,341 shares outstanding as of December 31, 2008, and as of September 30, 2009 total liquidation preference of $12,313,410
    1,231       1,231  
Preferred stock, Series B, par value of $0.001 per share, no preferred liquidation value, 1,200,000 authorized, no shares outstanding as of December 31, 2008 and 1,200,000 shares outstanding as of September 30, 2009
    -       1,200  
Common stock, par value $0.001 per share, 1,500,000,000 shares authorized and 366,776,388 shares issued and outstanding as of December 31, 2008 and 372,988,888 issued and outstanding as of September 30, 2009
    366,776       372,989  
Paid-in capital
    7,021,567       8,230,653  
Accumulated deficit
    (13,514,621 )     (16,778,579 )
Total stockholders' deficit
    (6,125,047 )     (8,172,506 )
                 
TOTAL LIABILITIES AND STOCKHOLDERS' DEFICIT
  $ 1,338,131     $ 617,201  

 
See notes to interim unaudited consolidated financial statements
3

 
AccessKey IP, Inc. and subsidiary
           
Statements of Operations
           
(unaudited)
 
Quarter ended
 
   
September 30,
 
   
2008
   
2009
 
Service revenue
  $ -     $ -  
Product sales
    174,790       151,488  
                 
Total revenues
    174,790       151,488  
                 
Cost of sales
    148,367       218,268  
                 
Gross profit
    26,423       (66,780 )
                 
Selling, general and administrative
    223,799       1,416,283  
Research & development costs
    -       -  
Bad debt expense
    -       1,257  
                 
Total operating expenses
    223,799       1,417,540  
                 
Operating income (loss)
    (197,376 )     (1,484,320 )
                 
Interest expense
    (414,405 )     (1,025,771 )
Interest income
    -       1,257  
Debt forgiveness income
    93,076       -  
Income (loss) due to change in derivative liability
    423,195       529,940  
                 
Net income (loss) before income taxes
    (95,510 )     (1,978,894 )
                 
Provision for income taxes
    -       -  
                 
Net income (loss)
  $ (95,510 )   $ (1,978,894 )
                 
Basic net income (loss) per share     nil      $ (0.01
Fully diluted net income per share
    nil      $ (0.01
                 
Weighted average number of common shares
    361,109,721       365,590,555  
Fully diluted weighted average number of common shares
    361,109,721       365,590,555  

 
See notes to interim unaudited consolidated financial statements
4

 
AccessKey IP, Inc. and subsidiary
     
Statements of Operations
     
(unaudited)
 
Nine months ended
 
   
September 30,
 
   
2008
   
2009
 
             
Service revenue
  $ -     $ 910,650  
Product sales (net of returns of none and $433,933)
    184,790       32,180  
                 
Total revenues
    184,790       942,830  
                 
Cost of sales (net of returns of none and $271,876)
    148,924       155,917  
                 
Gross profit
    35,866       786,913  
                 
Selling, general and administrative
    588,412       2,001,436  
Research & development costs
    13,625       6,000  
Bad debt expense
    -       16,942  
                 
Total operating expenses
    602,037       2,024,428  
                 
Operating income (loss)
    (566,171 )     (1,237,515 )
                 
Interest expense
    (1,209,978 )     (2,686,393 )
Interest income
    -       3,858  
Debt forgiveness income
    401,519       -  
Income due to change in derivative liability
    973,759       656,092  
                 
Net income (loss) before income taxes
    (400,871 )     (3,263,958 )
                 
Provision for income taxes
    -       (0 )
                 
Net income (loss)
  $ (400,871 )   $ (3,263,958 )
                 
Basic net income (loss) per share
    nil     $ (0.01 )
Fully diluted net income per share
    nil     $ (0.01 )
                 
Weighted average number of common shares
    354,191,872       364,242,222  
Fully diluted weighted average number of common shares
    354,191,872       364,242,222  
 

See notes to interim unaudited consolidated financial statements
 
5

 
AccessKey IP, Inc. and subsidiary
Statement of Cash Flows
(unaudited)
 
   
For the nine months ended
September 30,
 
   
2008
   
2009
 
Cash flow from operating activities
           
Net income (loss)
  $ (400,871 )   $ (3,263,958 )
Expenses paid with common stock
    282,520       74,374  
Expenses paid with preferred stock
    -       1,100,000  
Expenses paid with options
    -       9,623  
Change in derivative liabilities
    (973,759 )     (656,092 )
Non-cash interest expense and financing costs
    646,718       1,029,338  
(Increase) decrease in accounts receivable
    (98,142 )     848,708  
(Decrease) increase in bad debt allowance
    -       10,000  
(Decrease) increase in interest receivable reserve allowance
    -       6,942  
(Increase) decrease in interest receivable
    -       (3,661 )
(Increase) decrease in prepaid expenses
            (5,000 )
(Increase) decrease in deposits
    -       60,000  
(Decrease) increase in accounts payable
    (515,494 )     17,913  
(Decrease) increase in accrued expenses
    187,496       1,655,703  
(Decrease) increase in amounts accrued to related parties
    -       (96,416 )
(Decrease) increase in deferred revenue
    876,340       (916,290 )
(Increase) decrease in inventory
    (481,430 )     (374,558 )
Net cash provided by (used in) operating activities
    (476,622 )     (503,374 )
                 
Cash flow from investing activities
               
Note receivable from officer
    -       (10,000 )
Note receivable
    (42,000 )     -  
Payments received on note receivable from officer
    -       10,000  
Net cash provided by (used in) investing activities
    (42,000 )     -  
                 
Cash flow from financing activities
               
Repurchase of common stock
    -       (22,500 )
Loans from officers
    -       56,000  
Repayments of officer loans
    -       (24,000 )
Proceeds from loans
    1,317,567       840,000  
Payments on loans
    (645,000 )     (532,124 )
Net cash provided by financing activities
    672,567       317,376  
                 
Net cash increase (decrease)
    153,945       (185,998 )
                 
Cash at beginning of year
    22,015       227,683  
                 
Cash at end of period
  $ 175,960     $ 41,685  
                 
Supplemental information
               
Cash paid for taxes
  $ -     $ -  
Cash paid for interest expense
  $ -     $ 2,400  
    Preferred stock issued for accrued bonuses to officers   $ -     $ 36,000  

See notes to interim unaudited consolidated financial statements
 
6

 
ACCESSKEY IP, INC. AND SUBSIDIARY

NOTES TO INTERIM UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

NOTE 1 - NATURE OF BUSINESS

AccessKey IP, Inc., a Nevada corporation (the “Company” or “AccessKey”), is a public company trading under the symbol “AKYI” on the Pink Sheets.  AccessKey is a technology company that has developed proprietary encryption technology which has applications for the Internet Protocol Television (“IPTV”) industry.  Through its wholly-owned subsidiary, TeknoCreations, Inc., it has also developed inductive chargers for in-home play station gaming devices and cases with built in lithium ion batteries for portable gaming devices.

AccessKey was incorporated under the name of Tollycraft Yacht Corporation in December of 1996.  The Company changed its name to Childguard Corporation in January of 2002 and then amended its articles of incorporation to change its name to EWAN 1, Inc. on April 9, 2002.  The Company changed its name to Advanced Technetix, Inc. in September 2006 and began focusing its efforts on its existing technology.  In March 2007, the Company changed its name to AccessKey IP, Inc., a name that more accurately reflects the Company’s advanced security encryption technology.

Through its wholly-owned subsidiary, TeknoCreations, Inc., the Company has developed the InCharge inductive charger and the Tekcase.  The InCharge system enables users of Nintendo Wii, Sony PlayStation 3 or Microsoft Xbox 360 to rapidly recharge their gaming handsets through the InCharge charging base.  The Company began sales of this product in July 2008.  The Tekcase has currently been developed for use with the Nintendo DS Lite and DSi.  It is available in a plastic and leather case to protect the product and has a built in lithium ion battery which offers the user twice the playing time between charges.

NOTE 2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

The accompanying consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America (GAAP).

Principles of Consolidation and Presentation: The accompanying consolidated financial statements include the accounts of AccessKey IP, Inc. and its subsidiary, TeknoCreations, Inc. (“Tekno”), after elimination of all intercompany accounts and transactions.

Use of estimates: The preparation of the accompanying consolidated financial statements in conformity with accounting principles generally accepted in the United States requires management to make certain estimates and assumptions that directly affect the results of reported assets, liabilities, revenue, and expenses. Actual results may differ from these estimates.

Revenue Recognition:  The Company recognizes revenue when persuasive evidence of an arrangement exists, delivery has occurred or services have been rendered, the fee is fixed or determinable and collectability is probable. Our InCharge and Tekcase units are sold FOB from our shipping point.  We recognize the revenues from these sales upon shipping them.  They do not include any maintenance or service contracts; therefore none of the revenues from these sales are deferred.  The contract with CSI Digital was recognized as income under AICPA Statement of Position 97-2 (“SOP 97-2”), ASC Topic 985.  Paragraph 12 of SOP 97-2 requires that revenue from the entire arrangement be initially deferred and recognized upon product delivery.   The Company delivered the product under this agreement in the quarter ended June 30, 2009 and included all previously deferred revenues as income in the nine months ended September 30, 2009.

Tekno sales have provisions for estimated product returns and allowances based on the Company’s historical experience. This reserve allowance is currently at two percent of gross sales.  After we received a high volume of sales returns in June 2009, we reviewed this reserve allowance for adequacy.  After this review, we determined that the returns in the quarter ended June 30, 2009 were due to extraneous circumstances that should not be indicative of future returns.  Tekno sales are recorded upon the shipment of product after the receipt of purchase orders.  Customers are billed at net 45 days of billing.

Cash Equivalents: For purposes of the statements of cash flows, AccessKey considers all highly liquid debt instruments with an original maturity of three months or less to be cash equivalents.

Fair Value of Financial Instruments: AccessKey’s financial instruments consist principally of cash, accounts receivable, inventories, accounts payable and borrowings. AccessKey believes the financial instruments' recorded values approximate current values because of their nature and respective durations. The fair value of embedded conversion options and stock warrants are based on a Black-Scholes fair value calculation. The fair value of convertible notes payable has been discounted to the extent that the fair value of the embedded conversion option feature exceeds the face value of the note. This discount is being amortized over the term of the convertible note.
 
7

 
Notes Receivable:   AccessKey has issued three notes receivable to one third party.  As of September 30, 2009 all of those notes were past due and a reserve allowance for the entire amount of $42,000 has been booked. We have accrued interest income on the notes of $6,942 since the notes were made.  We have also reserved against all of this accrued interest receivable.  See Note 7.

Inventories:  AccessKey carries its inventories at cost, inclusive of freight and sales taxes.

Property and Equipment: The Company began work on a demonstration model of its set top box in the quarter ended September 30, 2009.  The costs to date have been capitalized as depreciable equipment, but it has yet to be placed in service.  Upon completion we will depreciate the cost of this unit over a 5 year period.

CONVERTIBLE NOTES PAYABLE AND DERIVATIVE LIABILITIES: AccessKey accounts for convertible notes payable and warrants in accordance with Statement of Financial Accounting Standards (SFAS) No. 133, "ACCOUNTING FOR DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITIES," ASC Topic 815. This standard requires the conversion feature of convertible debt be separated from the host contract and presented as a derivative instrument if certain conditions are met. Emerging Issue Task Force (EITF) 00-19, "ACCOUNTING FOR DERIVATIVE FINANCIAL INSTRUMENTS INDEXED TO AND POTENTIALLY SETTLED IN A COMPANY'S OWN STOCK" and EITF 05-2, "THE MEANING OF "CONVENTIONAL CONVERTIBLE DEBT INSTRUMENT" IN ISSUE NO. 00-19" were also analyzed to determine whether the debt instrument is to be considered a conventional convertible debt instrument or classified in stockholders' equity.

Certain convertible notes payable issued by AccessKey were evaluated and determined not conventional convertible and, therefore, because of certain terms and provisions the embedded conversion option was bifurcated and has been accounted for as a derivative liability instrument. The accounting guidance also requires that the conversion feature be recorded at fair value for each reporting period with changes in fair value recorded in the consolidated statements of operations.  Several convertible notes payable were renegotiated into non-convertible notes payable in 2008 and 2009 at which time the derivative liability associated with these notes was reduced to zero.

A Black-Scholes valuation calculation was applied to the conversion features of convertible debentures at issuance dates and again as of the end of each quarter. The issuance date valuation was used for the effective debt discount that these instruments represent. The debt discount was amortized over the life of the debts using the effective interest method. The September 30, 2008, December 31, 2008 and September 30, 2009 valuation was used to record the fair value of these instruments at the end of the reporting period with any difference from prior period calculations reflected in the consolidated statement of operations.

Similarly, certain warrants issued by AccessKey were determined to meet the criteria for liability treatment under EITF 00-19.  These warrants were initially valued using a Black-Scholes valuation calculation on the dates of issuance.  They were again valued at September 30, 2008, December 31, 2008 and September 30, 2009.  These latter valuations were used to record the fair value of these instruments at the end of the reporting period with any difference from prior period calculations reflected in the consolidated statement of operations.

Stock Options:  AccessKey follows the guidance of Statement of Financial Accounting Standards (SFAS) No. 123R, "SHARE-BASED PAYMENT," ASC Topic 718, for treatment of its stock options.  The Company issued stock options in November of 2008 and did not properly reserve shares to cover the exercise of the options.  As a result, the Company did not have the ability to settle with shares and accounted for these options as a liability.  These options issued by AccessKey were initially valued using a Black-Scholes valuation calculation on the dates of issuance.  This amount was deducted as compensation expense.  They were again valued at December 31, 2008 and September 30, 2009.  These valuations were used to record the fair value of these instruments at the end of the reporting period with any difference from prior period calculations reflected in the consolidated statement of operations.  Despite increasing its number of authorized shares from 400 million to 1.5 billion, the Company has continued to treat the value of these options as a liability.  The Company issued 1 million new options on September 29, 2009 to a consultant.  The Company has reserved adequate shares to settle these options in shares and has expensed the value of these options in the quarter ended September 30, 2009.

Common Stock:  On September 25, 2009, AccessKey increased the number of authorized $0.001 par value common stock shares from 400,000,000 to 1,500,000,000.
 
8

 
Preferred Stock:  AccessKey has authorized 5,000,000 shares of preferred stock.  On June 21, 2002, the Company designated 1,500,000 of these shares as Series A Preferred Stock.  The Series A stock is entitled to common stock dividends.  The preferred stock does not have any conversion rights into common stock.  AccessKey has the right but not the obligation to redeem each share of Series A stock at a price of $10.00 per share.  In the event of voluntary or involuntary liquidation, dissolution, or winding up of the corporation, each share of Series A shall be entitled to receive from the assets of the Company $10.00 per share, which shall be paid or set apart before the payment or distribution of any assets of the corporation to the holders of the Common Stock or any other equity securities of the Company.  Holders of the preferred stock are not entitled to vote on all matters with the holders of the Common Stock.  On September 21, 2009, the Company designated 1,200,000 of these shares as Series B Convertible Preferred Stock.  Each share of Series B stock can convert into one (1) share of common stock; provided however, that no conversion shall be permitted unless (i) the Corporation's common stock is quoted for public trading in the United States or other international securities market and (ii) the Corporation's market capitalization (i.e., the number of issued and outstanding shares of common stock multiplied by the daily closing price) has exceeded Ten Million Dollars ($10,000,000) for 90 consecutive trading days.  Each outstanding share of Series B Convertible Preferred Stock has six hundred twenty five (625) votes on all matters submitted to the stockholders of the Corporation and votes with the common stock on all matters.  The Series B voting separately as a class has the right to elect three persons to serve on the Corporation’s board of directors.  The shares of Series B Convertible Preferred Stock (i) do not have a liquidation preference; (ii) do not accrue, earn, or participate in any dividends; and (iii) are not subject to redemption by the Corporation. As of September 30, 2009, the four holders of the Series B shares held majority voting control of the Company.
 
Research and Development:  AccessKey incurred expenditures for research and development of $13,625 in the nine months ended September 30, 2008 and $6,000 in the nine months ended September 30, 2009.   These costs were incurred in finalizing the Company’s AccessKey IPTV technology.

Income Taxes: Income tax expense is based on pretax financial accounting income.  Deferred tax assets and liabilities are recognized for the expected tax consequences of temporary differences between the tax bases of assets and liabilities and their reported amounts.

Net Income (Loss) Per Share: Basic net loss per share for the quarter and nine months ended September 30, 2009 includes no dilution and is computed by dividing net loss available to common stockholders by the weighted average number of common stock outstanding for the period. Diluted net loss per share does not differ from basic net loss per share since potential shares of common stock are anti-dilutive. Potential shares consist of outstanding warrants, stock options and convertible debt.  

Recently Issued Accounting Pronouncements:

In June 2009 the FASB established the Accounting Standards Codification ("Codification" or "ASC") as the source of authoritative accounting principles recognized by the FASB to be applied by nongovernmental entities in the preparation of financial statements in accordance with generally accepted accounting principles in the United States ("GAAP"). Rules and interpretive releases of the Securities and Exchange Commission ("SEC") issued under authority of federal securities laws are also sources of GAAP for SEC registrants. Existing GAAP was not intended to be changed as a result of the Codification, and accordingly the change did not impact our financial statements. The ASC does change the way the guidance is organized and presented.

Statement of Financial Accounting Standards ("SFAS") SFAS No. 165 (ASC Topic 855), "Subsequent Events", SFAS No. 166 (ASC Topic 810), "Accounting for Transfers of Financial Assets-an Amendment of FASB Statement No. 140", SFAS No. 167 (ASC Topic 810), "Amendments to FASB Interpretation No. 46(R)", and SFAS No. 168 (ASC Topic 105), "The FASB Accounting Standards Codification and the Hierarchy of Generally Accepted Accounting Principles-a replacement of FASB Statement No. 162" were recently issued. SFAS No. 165, 166, 167, and 168 have no current applicability to the Company or their effect on the financial statements would not have been significant.

Accounting Standards Update ("ASU") ASU No. 2009-05 (ASC Topic 820), which amends Fair Value Measurements and Disclosures - Overall, ASU No. 2009-13 (ASC Topic 605), Multiple-Deliverable Revenue Arrangements, ASU No. 2009-14 (ASC Topic 985), Certain Revenue Arrangements that include Software Elements, and various other ASU's No. 2009-2 through ASU No. 2009-15 which contain technical corrections to existing guidance or affect guidance to specialized industries or entities were recently issued. These updates have no current applicability to the Company or their effect on the financial statements would not have been significant.

NOTE 3 - GOING CONCERN

The Company's consolidated financial statements have been prepared on a going concern basis, which contemplates the realization of assets and liabilities and commitments in the normal course of business. In the near term, the Company expects funds generated from operations to cover its operating expenses.  The Company can give no assurance that it will be capable of sustaining profitable operations.   However, the Company has incurred a substantial amount of debt, most of which is currently in default.  As of September 30, 2009, the Company is in default on total notes due and payable of $3,931,860 plus accrued interest of $1,375,359.  The Company can give no assurance that it will be capable of paying these notes.   In addition to the defaulted notes, the Company has additional notes in the amount of $1,391,047 due within the next twelve months.
 
9

 
The Company has successfully brought its Tekcases to market and began selling them in May 2009.  It also is actively involved in bringing its TeknoVault product to market.  It anticipates these new products increasing its revenues to alleviate its working capital deficit.  Further, it is actively seeking additional capital.  The Company cannot provide any assurances that either increased revenues or new financings will occur or will raise necessary capital to support its operations over the next twelve months.

The Company incurred a loss of $3,263,958 for the nine months ended September 30, 2009.  It reported a net loss of $400,871 in the nine months ended September 30, 2008.  As of September 30, 2009, the Company had an accumulated deficit of $16,778,579.
 
NOTE 4 - ACCRUED EXPENSES

Accrued expenses at September 30, 2009 consist of:

   
As of September 30,
   
   
2009
   
         
Accrued interest expense
  $ 1,629,519    
Accrued judgment payable
    160,995    
Accrued payroll tax liabilities
    734,420    
Other accrued expenses
    2,745    
           
Accrued liabilities (third parties)
    2,527,679    
           
Accrued interest payable to officers
    584    
Accrued bonuses to officers
    13,000    
           
Accrued liabilities to officers
    13,584    
           
Total accrued liabilities
  $ 2,541,263    

NOTE 5 - INCOME TAXES

The Company accounts for income taxes in accordance with Statement of Financial Accounting Standards No. 109 Accounting for Income Taxes [SFAS No. 109], ASC Topic 740.  SFAS No. 109 requires the Company to provide a net deferred tax asset or liability equal to the expected future tax benefit or expense of temporary reporting differences between book and tax accounting and any available operating loss or tax credit carryforwards. At December 31, 2008 and September 30, 2009, respectively, the total of all deferred tax assets was approximately $59,226 and $26,164 and the total of the deferred tax liabilities was none for both periods. The amount of and ultimate realization of the benefits from the deferred tax assets for income tax purposes is dependent, in part, upon the tax laws in effect, the Company's future earnings, and other future events, the effects of which cannot be determined.
 
The Company did not record a provision for income tax for the quarters ended September 30, 2008 or September 30, 2009.

The Company adopted the provisions of FASB Interpretation No. 48, ASC Topic 740, Accounting for Uncertainty in Income Taxes, on January 1, 2007.  As a result of the implementation of Interpretation 48, the Company recognized approximately no increase in the liability for unrecognized tax benefits.

The Company has no tax positions at September 30, 2009 for which the ultimate deductibility is highly certain but for which there is uncertainty about the timing of such deductibility.
 
The Company recognizes interest accrued related to unrecognized tax benefits in interest expense and penalties in operating expenses.  During the quarters ended September 30, 2008 and 2009, the Company recognized no interest and penalties.  The Company had no accruals for interest and penalties at September 30, 2009.
 
The tax adjustments reconciling book income to tax income (prior to any net operating loss deductions) is as follows:

   
Quarter ended September 30,
 
   
2008
   
2009
 
             
Book income (loss)
  $ (95,510 )   $ (1,978,894 )
Temporary differences:
               
Allowance for bad debts
    -       1,257  
Accrued expenses to officers
    -       (22,416 )
Permanent differences:
               
Finance costs booked as interest expense on convertible debts
    251,590       613,830  
(Income) loss due to change in derivative liability
    (423,195 )     (529,940 )
                 
Taxable income (loss) before net operating loss deduction
  $ (267,115 )   $ (1,916,163 )
 
10

 
   
Nine Months ended September 30,
 
   
2008
   
2009
 
             
Book income (loss)
  $ (400,871 )   $ (3,282,959 )
Temporary differences:
               
Allowance for bad debts
    -       16,942  
Accrued expenses to officers
    -       (13,584 )
Permanent differences:
               
Finance costs booked as interest expense on convertible debts
    646,718       1,029,338  
(Income) loss due to change in derivative liability
    (973,759 )     (656,092 )
                 
Taxable income (loss) before net operating loss deduction
  $ (727,912 )   $ (2,906,355 )

A reconciliation of income tax expense from continuing operations at the federal statutory rate to income tax expense at the company's effective rate is as follows as of September 30:

     
2008
   
2009
   
 
Computed tax at the expected statutory rate
    0.00 %     0.00 %  
                     
 
State and local income taxes, net of federal benefit  
    0.00 %     0.00 %  
                     
 
Other Items  
    0.00 %     0.00 %  
                     
 
Income tax expense  
    0.00 %     0.00 %  

The components of income tax expense (benefit) from continuing operations for the nine months ended September 30, 2008 and 2009 were (based on a federal tax rate of 34% and a state tax rate of 7.6%):
 
   
Nine Months ended September 30,
 
   
2008
   
2009
 
Current income tax expense (benefit):
           
Federal
    -       -  
State
    -       -  
Current tax expense (benefit)
    -       -  
                 
Deferred tax expense (benefit) arising from:
               
Net operating loss carryforwards
    (2,531,448 )     (4,574,431 )
Allowance for bad debt
    -       (20,360 )
Accrued expenses to officers
    -       (5,651 )
Allowance for returns
    -       (154 )
Valuation allowance due to uncertainty of future income
    2,531,448       4,600,597  
Net deferred tax expense (benefit)
    -       -  
 
11


As of September 30, 2009, the Company has net operating loss carryforwards, approximately, of $9.8 million to reduce future federal and state taxable income.  To the extent not utilized, the carryforwards will begin to expire through 2028.  The Company's ability to utilize its net operating loss carryforwards is uncertain and thus the Company has not booked a deferred tax asset, since future profits are indeterminable.  A valuation allowance as per FAS 109 paragraph 17(e), ASC Topic 740, has been established to reduce the deferred tax asset to zero.
 
NOTE 6 - NET INCOME (LOSS) PER SHARE

The following table sets forth the computation of basic and diluted net income (loss) per share:

   
For the quarter ended September 30,
   
   
2008
   
2009
   
               
Net income (loss)
  $ (95,510 )   $ (1,978,894 )  
                   
Basic net income (loss) per share     nil      $ (0.01  
Fully diluted net income (loss) per share     nil      $ (0.01  
                   
Weighted average number of common shares
    361,109,721       365,590,555    
Fully diluted weighted average number of common shares
    361,109,721       365,590,555    
                   
                   
 
   
For the nine months ended September 30,
   
    2008     2009    
                   
Net income (loss)
  $ (400,871 )   $ (3,263,958 )  
                   
Basic net income (loss) per share
 
nil
    $ (0.01 )  
Fully diluted net income (loss) per share
 
nil
    $ (0.01 )  
                   
Weighted average number of common shares
    354,191,872       364,242,222    
Fully diluted weighted average number of common shares
    354,191,872       364,242,222    

 
As the Company incurred net losses for the quarter and nine months ended September 30, 2008 and 2009, it has excluded from the calculation of diluted net loss per share approximately 232 million shares and 130 million shares, respectively. These shares assume that all convertible notes could be converted at the market price as of September 30, 2008 and 2009, respectively.   Included in the fully diluted weighted average number of common shares for the quarter ended September 30, 2009 are outstanding warrants and options as well as the amount of shares that all remaining convertible notes could be converted into at the market price as of September 30, 2009.   As of September 30, 2009, the Company has one note that is partially convertible at the option of the holder.  The remaining debt obligations of the Company are convertible at the sole option of the Company.
 
 
12


NOTE 7 - RELATED PARTY TRANSACTIONS

On November 30, 2008, the Company entered into a Note with The Stealth Fund, LLLP. ("The Stealth Fund").  The principal balance of the note was $1,441,613.  This note superseded two notes with total principal balances of $1,373,180 that were entered into earlier in 2008.  The Company’s Chief Executive Officer, George Stevens, is an investment advisor with The Stealth Fund.  See Note 11 for additional information about this note.  In the quarter ended June 30, 2009, the Company made a $6,000 payment on this note.

As of September 30, 2009, the Company had accrued and unpaid bonuses to its officers in the total amount of $13,000.

From April through July of 2008, the Company made three loans that totaled $42,000 to Hot Web, Inc.  During this time period, the Company’s Chief Executive Officer and Chairman, George Stevens, was also the CEO and Chairman of Hot Web, Inc.  As of September 30, 2009, all of these loans were in default and the Company has set up a reserve against them.  As of August 2008, Mr. Stevens is no longer affiliated with Hot Web.

In February 2009, the Company entered into a note agreement with George Stevens in the amount of $30,000.  The note bore an interest rate of 18% per annum.  The Company immediately applied a $20,000 bonus payable due to Mr. Stevens that was accrued in 2008 against this note, leaving a net balance of $10,000.   Mr. Stevens made a payment against the note in March 2009 and paid the remaining balance of $9,747 in April 2009.

On July 1, 2009, the Company entered into a consulting agreement with Grant Stevens, the son of the Company’s CEO.  The contract calls for Grant Stevens to act as sales manager for the Company at a fee of $4,000 per month.  He was also issued 500,000 shares of the Company’s restricted common stock (valued at $6,000) under the terms of the agreement.  This contract can be cancelled by either party with 30 days notice.

In July 2009, George Stevens loaned the Company $24,000.  This note was unsecured and bore a flat interest rate of 10%.  The Company paid the loan back in full along with interest of $2,400 in September 2009.

In August 2009, Mark Kasok loaned the Company $32,000.  This note is unsecured and bears an interest rate of 12%.  As of September 30, 2009, the Company has accrued interest of $584 on this note.

On September 21, 2009, George Stevens, Bruce Palmer, Craig Erickson and Mark Kasok (all officers of the Company and/or its wholly-owned subsidiary) were each issued 300,000 shares of Series B Convertible Preferred Stock at a value of $284,000 each.  The value was arrived at by taking the total market capitalization of the Company on the date of issuance (approximately $4.4m) and assuming the value of voting control of the Company to be equal to approximately 25% of this value, or $1.1m. The Company intends on having a third party appraisal on these shares prior to the end of the year. This appraisal will likely result in an adjustment to this value.  The voting rights of these preferred shares were equal to 625 votes per share, or a total of 750,000,000 votes.  This action gave the four officers majority voting control of the Company.
 
 
13

 
NOTE 8 - SEGMENT INFORMATION

SFAS No. 131 "Disclosures about Segments of an Enterprise and Related Information," ASC Topic 280, requires that a publicly traded company must disclose information about its operating segments when it presents a complete set of financial statements. The Company has two segments, the parent company (AccessKeyIP, Inc.) and TeknoCreations, Inc., a wholly-owned subsidiary.  The balance sheet and statement of operations for each segment (and the total consolidated amounts) are shown below:

AccessKey IP, Inc. and subsidiary
                 
Segment-by-segment balance sheets
                 
         
Tekno-
   
Consolidated
 
ASSETS
 
AccessKey
   
Creations
   
September 30, 2009
 
                   
Current assets
                 
Cash
  $ 5,458     $ 36,227     $ 41,685  
Accounts receivable
    88,000       73,464       161,464  
Inventory
    -       401,552       401,552  
Notes receivable (net of reserve)
    -               -  
Interest receivable
    -               -  
Prepaid expenses
    5,000               5,000  
Deposits
    -       -       -  
Total current assets
    98,458       511,243       609,701  
                         
Property and equipment
    7,500       -       7,500  
                         
TOTAL ASSETS
  $ 105,958     $ 511,243     $ 617,201  
                         
                         
LIABILITIES AND STOCKHOLDERS' DEFICIT
                       
                         
Current liabilities
                       
Accounts payable
  $ 40,740     $ 35,812     $ 76,552  
Accrued liabilities
    2,523,680       17,583       2,541,263  
Notes payable, net of unamortized discount
    4,841,866       270,630       5,112,496  
Note payable to officer
    -       32,000       32,000  
Total current liabilities
    7,406,286       356,025       7,762,311  
                         
Intercompany balance
    (1,358,925 )     1,358,925       -  
Derivative liability
    1,027,396       -       1,027,396  
                         
                         
Stockholders' deficit
                       
Series A preferred stock
    1,231       -       1,231  
Series B convertible preferred stock
    1,200               1,200  
Common stock
    372,989       -       372,989  
Paid-in capital
    8,230,653       -       8,230,653  
Accumulated deficit
    (15,574,872 )     (1,203,707 )     (16,778,579 )
Total stockholders' deficit
    (6,968,799 )     (1,203,707 )     (8,172,506 )
                         
TOTAL LIABILITIES AND STOCKHOLDERS' DEFICIT
  $ 105,958     $ 511,243     $ 617,201  
 
 
14

 
AccessKey IP, Inc. and subsidiary
           
Segment-by-Segment Statements of Operations
           
 
      Quarter ended September 30, 2008    
September 30,
2008
   
Quarter ended September 30, 2009
   
September 30, 2009
 
   
AccessKey
   
TeknoCreations
   
Consolidated
   
AccessKey
   
TeknoCreations
   
Consolidated
 
                                     
Service Revenues
  $ -     $ -     $ -     $ -     $ -     $ -  
Product sales
    -       174,790       174,790       -       151,488       151,488  
                                                 
Total revenues
    -       174,790       174,790       -       151,488       151,488  
                                                 
Cost of sales
    -       148,367       148,367       -       218,268       218,268  
                                                 
Gross profit
    -       26,423       26,423       -       (66,780 )     (66,780 )
                                                 
Selling, general and administrative
    63,323       160,476       223,799       1,217,606       198,677       1,416,283  
Bad debt expense
    -       -       -       1,257       -       1,257  
                                                 
Total expenses
    63,323       160,476       223,799       1,218,863       198,677       1,417,540  
                                                 
Operating loss
    (63,323 )     (134,053 )     (197,376 )     (1,218,863 )     (265,457 )     (384,320 )
                                                 
Interest expense
    (323,910 )     (90,495 )     (414,405 )     (984,090 )     (41,681 )     (1,025,771 )
Interest income
    -       -       -       1,257       -       1,257  
Debt forgiveness income
    93,076       -       93,076       -       -       -  
Income (loss) due to change in derivative liability
    345,669       77,526       423,195       314,767       215,173       529,940  
                                                 
Net income (loss) before income taxes
    51,512       (147,022 )     (95,510 )     (1,886,929 )     (91,965 )     (1,978,894 )
                                                 
Provision for income taxes
    -       -       -       -       -       -  
                                                 
Net income (loss)
  $ 51,512     $ (147,022 )   $ (95,510 )   $ (1,886,929 )   $ (91,965 )   $ (1,978,894 )
 
15

 
AccessKey IP, Inc. and subsidiary
           
Segment-by-Segment Statements of Operations
           
 
   
Nine months ended September 30, 2008
   
September 30,
2008
   
Nine months ended September 30, 2009
   
September 30, 2009
 
   
AccessKey
   
TeknoCreations
   
Consolidated
   
AccessKey
   
TeknoCreations
   
Consolidated
 
                                     
Service Revenues
  $ -     $ -     $ -     $ 910,650     $ -     $ 910,650  
Product sales (net of returns of none and $433,933)
    -       184,790       184,790       -       32,180       32,180  
                                                 
Total revenues
    -       184,790       184,790       910,650       32,180       942,830  
                                                 
Cost of sales (net of returns of none and $271,876)
    -       148,924       148,924       -       155,917       155,917  
                                                 
Gross profit
    -       35,866       35,866       910,650       (123,737 )     786,913  
                                                 
Selling, general and administrative
    186,161       402,251       588,412       1,408,666       592,820       2,001,486  
Research & development costs
    13,000       625       13,625       6,000       -       6,000  
Bad debt expense
    -       -       -       16,942       -       16,942  
                                                 
Total expenses
    199,161       402,876       602,037       1,431,608       592,820       2,024,428  
                                                 
Operating income (loss)
    (199,161 )     (367,010 )     (566,171 )     579,042       (716,557 )     (137,515 )
                                                 
Interest expense
    (978,373 )     (231,605 )     (1,209,978 )     (2,626,349 )     (60,044 )     (2,686,393 )
Interest income
    -       -       -       3,858       -       3,858  
Debt forgiveness income
    401,519       -       401,519       -       -       -  
Income (loss) due to change in derivative liability
    858,614       115,145       973,759       389,478       266,614       656,092  
                                                 
Net income (loss) before income taxes
    82,599       (483,470 )     (400,871 )     (2,753,791 )     (509,987 )     (3,263,958 )
                                                 
Provision for income taxes
    -       -       -       -       -       -  
                                                 
Net income (loss)
  $ 82,599     $ (483,470 )   $ (400,871 )   $ (2,753,791 )   $ (509,987 )   $ (3,263,958 )
 
16


NOTE 9 - LEASE OBLIGATION

The Company is not currently obligated under any lease agreement.  The corporate officers use their personal office space to conduct the business of the Company.

The total rent expense for the quarters and nine months ended September 30, 2008 and 2009 was none.

NOTE 10 - GUARANTEES

The Company from time to time enters into certain types of contracts that contingently require the Company to indemnify parties against third-party claims. These contracts primarily relate to: (i) divestiture agreements, under which the Company may provide customary indemnifications to purchasers of the Company's businesses or assets; and (ii) certain agreements with the Company's officers, directors and employees, under which the Company may be required to indemnify such persons for liabilities arising out of their employment relationship.

The terms of such obligations vary. Generally, a maximum obligation is not explicitly stated. Because the obligated amounts of these types of agreements often are not explicitly stated, the overall maximum amount of the obligation cannot be reasonably estimated. Historically, the Company has not been obligated to make significant payments for these obligations, and no liabilities have been recorded for these obligations on its balance sheet as of September 30, 2009.

NOTE 11 - NOTES PAYABLE AND DERIVATIVE LIABILITIES

The following are descriptions of our various notes payable.  Some of the notes described below have been superseded by new notes which are also described.  As of September 30, 2009, the following notes payable are outstanding:

   
Amount
 
Due Date
 
The Nutmeg Group, L.L.C.
  $ 44,781  
In default
 
Nutmeg MiniFund II, LLLP
    4,997  
In default
 
Nutmeg Lightning Fund, LLLP
    48,320  
In default
 
Nutmeg October 2005, LLLP
    114,770  
In default
 
Nutmeg/Michael Fund, LLLP
    227,376  
In default
 
Nutmeg/Fortuna Fund LLLP
    589,808  
In default
 
Nutmeg/Patriot Fund, LLLP
    722,950  
In default
 
Nutmeg/Mercury Fund, LLLP
    1,050,553  
In default
 
Nutmeg MiniFund, LLLP
    120,612  
In default
 
The Stealth Fund, LLLP
    1,007,693  
In default
 
Physicians Healthcare Management Group, Inc.
    715,015  
January 28, 2010
 
Altholtz Irrevocable Trust
    200,000  
January 15, 2010
 
Micro Pipe Fund I, LLC
    205,402  
September 1, 2010
 
Micro Pipe Fund I, LLC (note with subsidiary)
    270,630  
September 1, 2010
 
             
Total principal balance of notes outstanding
  $ 5,322,907      

10% $250,000 Convertible Note – Superseded by an 18% $270,630 Note (not convertible)

On October 29, 2007, the Company’s wholly-owned subsidiary, TeknoCreations, Inc., entered into a Secured Convertible Note (the "Note") with Micro Pipe Fund I, LLC.  The principal balance of the note was $250,000 and it bore an interest rate of 10% per annum and had a maturity date of October 29, 2008.  The note is an obligation of the Company's subsidiary but the Company has informally agreed to allow conversion into its common stock. The Company assumes no obligation to repay this debt. Payments under the Note were to commence in February 2008, with monthly payments of interest and 1/12 of outstanding principal.  The Company was in default under this original note and entered into a Superseding Secured Note with a principal balance of $270,630 with an interest rate of 18% per annum and a maturity date of September 1, 2010.  Under the terms of the new note, TeknoCreations signed a new Pledge and Security Agreement on all of its assets to the lender.
 
17

 
The original $250,000 convertible note granted the holder the right to convert all amounts owed under the note into common shares of the Company. As such, the Company accounted for the conversion option in the debenture as a derivative liability in accordance with ASC Topic 815, SFAS 133, "ACCOUNTING FOR DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITIES," EITF 00-19, "ACCOUNTING FOR DERIVATIVE FINANCIAL INSTRUMENTS INDEXED TO AND POTENTIALLY SETTLED IN A COMPANY'S OWN STOCK" and EITF No. 05-2, "THE MEANING OF "CONVENTIONAL CONVERTIBLE DEBT INSTRUMENT" IN ISSUE NO. 00-19." The Company attributed beneficial conversion features to the convertible debt using the Black-Scholes Option Pricing Model. The fair value of the conversion feature was included as a discount to debt on the Company’s balance sheet up to the proceeds received, with any excess charged to interest and financing expense. The discount was amortized over the life of each debenture using the interest method.   The valuation was made upon the date of issuance of the original note and each quarter thereafter with the change in value being recorded as additional expense (in the case of an increase in the valuation of the conversion feature) or as income (in the case of a decrease in the value).  Upon entering into the Superseding Secured Note, the balance of the valuation of the conversion feature ($215,173) was recognized as income.
 
The following tables describe the valuation of the conversion feature of the original note:

Approximate risk free rate upon issuance
4.16%
 
Average expected life
1 year
 
Dividend yield
0%
 
Volatility
158%
 
Estimated fair value of conversion feature on date of note
$ 358,518
 
Estimated fair value of conversion feature as of December 31, 2008
$ 266,614
 
Estimated fair value of conversion feature as of June 30, 2009 (amount recognized as income in the quarter ended September 30, 2009
$ 215,173
 
 
The Company recorded the fair value of the conversion feature as a discount to the convertible debt in the accompanying balance sheet up to the proceeds received, with the excess of $108,518 charged to interest expense. The Company reported income of $215,173 in other income for the change in value in the quarter ended September 30, 2009 when this note was superseded by a non-convertible note ($266,614 in income was recorded in the nine months ended September 30, 2009 due to the changes in valuation and superseding of this note). The value of the derivative liability as of September 30, 2009 was none.

$1,441,613 Note Dated November 30, 2008

On November 30, 2008, the Company entered into a Note (the "Note") with The Stealth Fund, LLLP.  The principal balance of the note was $1,441,612.52.  This note superseded two notes with total principal balances of $1,373,180 that were entered earlier in 2008.  The Company’s Chief Executive Officer, George Stevens, is an investment advisor with The Stealth Fund.

The note calls for interest to be measured as a function of the common stock price of the Company.  Interest is to be paid quarterly calculated as follows:  Subject to certain ceilings in the amounts (creating the Maximum Interest, as set forth below), the amount of interest payable under the Note will approximate the amount of profit that the Holder would have made with a stock investment of a like amount, instead of the purchase of this Note. Specifically, the parties have made the assumption that the Note Amount would have acquired a specified number of shares the “Applicable Shares”, which term shall mean, at any time, the principal balance of the Note, divided by $0.0075. In other words, the Note Amount, divided by $0.0075 results in the beginning number of Applicable Shares, upon which the calculation of theoretical profit is made. The amount of interest payable to the Holder is a function of stock price increases, if any, times this number of Applicable Shares, subject to the Maximum Interest and the Minimum Interest, as set forth below. If the share price doubles, then the Holder should double its money, earning, as interest, an amount equal to the stock price increase on the Applicable Shares, in addition to being repaid the amount of the Note. Significantly, as the price goes up, the value of this Note increases accordingly. However, the number of shares for the Company to repurchase the Note, remains constant, equal to the Applicable Shares, which, if paid in stock, at the election of the Company, would be at a 25% discount. The following formula creates that result.  The outstanding principal balance of this Note shall bear interest, payable quarterly, in an amount equal to the product (X) of the following formula: X= (Y-Y1) x (Z). Y is the greater of (a) the closing bid price of the Company’s common stock on the Interest Date or (b) the average closing bid price for Common Stock on the five trading days immediately prior to the Interest Date; Y1 is the pricing used for the preceding Interest Date or other applicable prior pricing Interest Date and Z is the number of Applicable Shares. For purposes of the first Interest Date computation, $0.0075 shall be used as the Y1. Until there is any payment of Principal on the Note, Z, the number of Applicable Shares, shall be 117,231,940. Other than for the first Interest Date computation, Y1 shall never be less than the Y1 for any preceding Interest Date computation (no double benefit for price increases, followed by a price decrease followed by another price increase). For purposes of this computation, pricing shall be as reported on pinksheets.com on such dates (or other analogous reporting source agreed upon by both parties if pinksheets.com is no longer reporting the Company’s common stock price). Notwithstanding the preceding, the Interest for any quarter shall not be less than 2½% (the “Minimum Interest”) of the Principal balance at the beginning of the quarter. Notwithstanding the preceding, Y shall not be greater than 125% of the Y1 (the “Maximum Interest”).
 
18

 
As a result of the above interest calculations, the Company could be obligated to pay a maximum interest rate of 25% per quarter, and at no times shall pay less than 2.5% per quarter.  For the year ended December 31, 2008, the Company accrued interest expense of 2.5% per quarter on this Note.  The total accrued interest on this Note on 12/31/08 was $72,081.  Under the terms of the Note, this amount is added to the principal of the note as of December 31, 2008.  The adjusted principal balance of this note with The Stealth Fund as of December 31, 2008 was $1,513,693.  The Company made a $500,000 payment against this note in the quarter ended March 31, 2009, so the adjusted balance as of March 31, 2009 was $1,013,693.

Under the terms of the note agreement, the maximum interest rate applied on this note with The Stealth Fund for the quarter ended March 31, 2009.  The Company accrued $185,475 in interest on this note for the quarter ended March 31, 2009.  As a result of not paying this interest amount, which was due in April of 2009, the Company defaulted on the note and is now subject to a minimum interest rate of 18% under the terms of the note.  The Company accrued interest at this rate for the quarter ended September 30, 2009 which was equal to $45,616 for the quarter (the Company’s stock price did not rise in the current quarter, so the note was not subject to the aforementioned interest calculations).

$157,663 Note Dated August 22, 2008 – Superseded by a $205,402 Note Dated September 1, 2009

On August 22, 2008, the Company entered into a Note (the "Note") with Micro Pipe Fund I, LLC. ("Micro Pipe").  The principal balance of the note was $157,662.83.  This note was superseded by a $205,402 note dated September 1, 2009.  The revised note balance reflected the original note balance plus accrued interest.  The August 22, 2008 note called for interest calculations identical to the $1,441,613 note above.  The superseding note has a one year term with an annual interest rate of 18%.  The Company has the right, but not the obligation, to settle this note through the issuance of common stock.  The price of such conversion (which can be made any time after March 1, 2010) shall be the lesser of $0.007 and 70% of the average closing bid price on the five trading days immediately prior to conversion.

Warrants to Micropipe

On November 12, 2008, the Company issued warrants to purchase 20 million shares of common stock to MicroPipe.  The warrants have a strike price of $0.01 per share and can be exercised through November 12, 2013.  The warrants were issued in lieu of interest payments.

The following tables describe the valuation of the warrants:

Approximate risk free rate upon issuance
3.75%
 
Average expected life
5.0 years
 
Dividend yield
0%
 
Volatility
204%
 
Estimated fair value of conversion feature on date of warrants
$ 195,895
 
Estimated fair value of conversion feature as of September 30, 2009
$ 185,029
 

The Company recorded the value of the warrants as interest expense. The Company reported an expense of $3,206 for the change in value in the quarter ended September 30, 2009 (net expense of $8,944 was recorded in the nine months ended September 30, 2009 due to the change in value). The value of the derivative liability as of September 30, 2009 was $185,029.

Note Restructurings

The following 7 notes were restructured into 9 new note agreements on December 23, 2008:

Date of Original Note
 
Note Holder
 
Original Note Amount
   
             
September 5, 2006
 
The Nutmeg Group
 
$
1,637,000.00
   
September 14, 2007
 
Nutmeg/Mercury Fund
   
585,607.88
   
September 14, 2007
 
The Nutmeg Group
   
103,962.37
   
November 5, 2007
 
Philly Financial
   
175,292.72
   
November 5, 2007
 
Sam Wayne
   
136,438.08
   
November 27, 2007
 
Financial Alchemy
   
5,934.72
   
November 27, 2007
 
The Nutmeg Group
   
25,200.00
   
               
   
Total Principal
 
$
2,669,435.77
   
 
19

 
The new notes, all dated December 23, 2008, were entered into with the following entities:

New Note Holders
 
New Note Balance
   
         
The Nutmeg Group, L.L.C.
 
$
42,648.90
   
Nutmeg MiniFund II, LLLP
   
4,758.82
   
Nutmeg Lightning Fund, LLLP
   
46,019.00
   
Nutmeg October 2005, LLLP
   
109,304.96
   
Nutmeg/Michael Fund, LLLP
   
216,548.19
   
Nutmeg/Fortuna Fund LLLP
   
561,721.98
   
Nutmeg/Patriot Fund, LLLP
   
688,523.65
   
Nutmeg/Mercury Fund, LLLP
   
1,000,526.57
   
Nutmeg MiniFund, LLLP
   
114,868.96
   
           
Total New Principal on December 22, 2008
 
$
2,784,921.03
   

The new notes superseded the original notes.

The terms of all nine new notes are identical (hereinafter referred to as the “New Notes”).

The New Notes call for interest to be measured as a function of the common stock price of the Company.  Interest is to be paid quarterly calculated as follows:  Subject to certain ceilings in the amounts (creating the Maximum Interest, as set forth below), the amount of interest payable under the New Notes will approximate the amount of profit that the Holder would have made with a stock investment of a like amount, instead of the purchase of this Note. Specifically, the parties have made the assumption that the Note Amount would have acquired a specified number of shares the “Applicable Shares”, which term shall mean, at any time, the principal balance of the Note, divided by $0.0075. In other words, the Note Amount, divided by $0.0075 results in the beginning number of Applicable Shares, upon which the calculation of theoretical profit is made. The amount of interest payable to the Holder is a function of stock price increases, if any, times this number of Applicable Shares, subject to the Maximum Interest and the Minimum Interest, as set forth below. If the share price doubles, then the Holder should double its money, earning, as interest, an amount equal to the stock price increase on the Applicable Shares, in addition to being repaid the amount of the New Notes. Significantly, as the price goes up, the value of these New Notes increase accordingly. However, the number of shares for the Company to repurchase the New Notes, remains constant, equal to the Applicable Shares, which, if paid in stock, at the election of the Company, would be at a 25% discount. The following formula creates that result.  The outstanding principal balance of these New Notes shall bear interest, payable quarterly, in an amount equal to the product (X) of the following formula: X= (Y-Y1) x (Z). Y is the greater of (a) the closing bid price of the Company’s common stock on the Interest Date or (b) the average closing bid price for Common Stock on the five trading days immediately prior to the Interest Date; Y1 is the pricing used for the preceding Interest Date or other applicable prior pricing Interest Date and Z is the number of Applicable Shares. For purposes of the first Interest Date computation, $0.0075 shall be used as the Y1. Until there is any payment of Principal on the Note, Z, the number of Applicable Shares, shall be 371,322,804. Other than for the first Interest Date computation, Y1 shall never be less than the Y1 for any preceding Interest Date computation (no double benefit for price increases, followed by a price decrease followed by another price increase). For purposes of this computation, pricing shall be as reported on pinksheets.com on such dates (or other analogous reporting source agreed upon by both parties if pinksheets.com is no longer reporting the Company’s common stock price). Notwithstanding the preceding, the Interest for any quarter shall not be less than 2½% (the “Minimum Interest”) of the Principal balance at the beginning of the quarter. Notwithstanding the preceding, Y shall not be greater than 125% of the Y1 (the “Maximum Interest”).
 
 As a result of the above interest calculations, the Company could be obligated to pay a maximum interest rate of 25% per quarter, and at no times shall pay less than 2.5% per quarter.  For the year ended December 31, 2008, the Company accrued interest expense of 2.5% per quarter on these New Notes.  The total accrued interest on the New Notes on through December 31, 2008 was $139,246.  Under the terms of the New Notes, this amount is added to the principal of the notes as of December 31, 2008.  The adjusted principal balance of the New Notes is $2,924,167 as of September 30, 2009.

Each of the aforementioned New Notes was entered into by the Company with a stipulation by the Company that stated that the Company executed the New Notes under the stipulation that it did not agree with the interest calculations.  The New Notes were executed as written because the Company and the holders agreed that it was in the best interest of both parties to do so.  However, both parties agreed that they should renegotiate the interest calculations under the New Notes.  These calculations shall be tied to a profit-sharing calculation tied to stock appreciation, but under less onerous terms as written in the New Note documents.  Although we were actively attempting to renegotiate these notes, we are currently unable to renegotiate our notes with the Nutmeg Group who hold a substantial amount of our notes payable (as of September 30, 2009 the total principal balance on these notes was equal to $2,784,921). On March 25, 2009, the SEC froze the assets of the Nutmeg Group, LLC and other related entities.  This action may negatively impact our ability to renegotiate these notes.
 
20


Under the terms of the note agreements, the maximum interest rate applied on these notes for the quarter ended March 31, 2009.  The Company accrued $835,476 in interest on these notes for the quarter ended March 31, 2009.   As a result of not paying this interest amount, which was due in April of 2009, the Company defaulted on the note and is now subject to a minimum interest rate of 18% under the terms of the note.  The Company accrued interest at this rate for the quarters ended June 30, 2009 and September 30, 2009 which was equal to $131,588 for each quarter.

$640,000 Convertible Note Dated January 28, 2009 – Superseded by a $715,015 Amended Convertible Note Dated July 31, 2009

On January 28, 2009, the Company entered into a note agreement with Physicians Healthcare Management Group, Inc., a Nevada corporation (“PhyHealth”).  Under the terms of the agreement, PhyHealth made a one year loan of $640,000 to the Company.  The Company is required to make payments of $150,000 on April 15, 2009, June 15, 2009 and September 15, 2009. The payment due on April 15, 2009 was not made as of the date of this filing. The remaining balance due, along with accrued interest at 10%, is payable on January 28, 2010.  The Company may prepay the note at 110% of the outstanding principal amount.  At any time, PhyHealth may convert up to $300,000 of the outstanding principal balance of the note into fully paid and non-assessable shares of the Company’s common stock.  The conversion price shall be equal to 50% of the lesser of the following:  a)  $.0125; b) the closing bid price for common stock on the trading day one day prior to PhyHealth notifying the Company of its intention to convert; c) the average closing bid price for the common stock on the five trading days immediately prior to PhyHealth notifying the Company of its intention to convert, or if a registration statement is not effective on the 180 day anniversary of closing (“d” and “e” not otherwise applying); d) the closing bid price for the common stock on the 180 day anniversary of closing; e) the average closing bid price for the common stock on the five trading days immediately prior to the 180 day anniversary of closing.  The Company failed to make the required payments in April and June and was in default on this note when it entered into an Amended Convertible Note dated July 31, 2009.  The amended note revised the principal balance of the note to $715,015, which represented the original principal balance ($640,000), accrued interest of $45,015 and a penalty of $30,000.  The conversion feature on $300,000 remained the same, but the interest rate was adjusted to 22%.  The entire balance is due and payable on January 28, 2010.  The Company also agreed to issue to the lender 15,000,000 shares of its common stock.  As of September 30, 2009, these shares were not issued to the lender but the Company has recorded a liability of $187,500 to reflect this obligation.
 
The following tables describe the valuation of the conversion feature of the portion of the note that can be converted ($300,000):

Approximate risk free rate upon issuance
0.48%
 
Average expected life
1 year
 
Dividend yield
0%
 
Volatility
203%
 
Estimated fair value of conversion feature on date of note
$ 473,062
 
Estimated fair value of conversion feature as of September 30, 2009
$ 354,717
 

The Company recorded the fair value of the conversion feature as a discount to the convertible debt in the accompanying balance sheet up to the proceeds received.  The Company reported income of $32,589 for the change in value in the quarter ended September 30, 2009 (income of $118,347 was recorded for the nine months ended September 30, 2009 due to the valuation change). The value of the derivative liability as of September 30, 2009 was $354,717.

The Company also issued warrants to purchase 20 million shares of common stock to PhyHealth.  The warrants have a strike price of $0.005 per share and can be exercised through December 31, 2013.  These warrants were cancelled and 25 million new warrants were issued with the same price and expiration date.  However, should the Company default on its note with PhyHealth, the total exercise price of the warrants is reduced from a total of $125,000 (25,000,000 warrants at $0.005 per share) to a total of $100.  Further, the number of warrants will triple from 25 million to 75 million.  Thus, should the Company not pay PhyHealth $797,361 on January 28, 2010 (the total amount of principal and the accrued interest projected to be owed as of the due date), the Company will be required to issued 75 million shares of its common stock to PhyHealth at a total price of $100 (subject to the contractual limit of PhyHealth owning no more than 4.99% of the Company’s outstanding common stock).

The following tables describe the valuation of the original 20 million warrants:

Approximate risk free rate upon issuance
1.70%
 
Average expected life
4.8 year
 
Dividend yield
0%
 
Volatility
203%
 
Estimated fair value of conversion feature on date of warrants
$ 176,687
 
Estimated fair value of conversion feature recorded as income in the quarter ended September 30, 2009 as a result of the cancellation of these warrants
$ 188,917
 
 
21


The Company recorded the value of the warrants as a discount to the convertible debt in the accompanying balance sheet up to the proceeds received (less the discount recorded associated with the convertible feature in the note), with the excess of $9,749 charged to interest expense. The Company reported income of $188,917 in the quarter ended September 30, 2009 as a result of these warrants being cancelled.

The following tables describe the valuation of the new 25 million warrants:

Approximate risk free rate upon issuance
2.53%
 
Average expected life
4.4 year
 
Dividend yield
0%
 
Volatility
160.759%
 
Estimated fair value of conversion feature on date of warrants
$ 332,548
 
Estimated fair value of conversion feature as of September 30, 2009
$ 236,287
 

The Company recorded the value of the warrants as additional interest expense on the note.  The Company reported income of $96,261 in the quarter ended September 30, 2009 as a result of the decrease in the value of these warrants in the quarter.  The derivative liability associated with these warrants as of September 30, 2009 was $236,287.

$200,000 Note Payable Dated April 3, 2009 – Superseded by a $200,000 Note Payable Dated September 1, 2009

On April 3, 2009, the Company entered into a note agreement with The Melanie S. Altholtz Irrevocable Trust (“Altholtz”).  Under the terms of the agreement, the Company was to make principal payments to Altholtz in the amounts of $100,000 on July 3, 2009 and July 15, 2009 along with accrued interest of 12% for the three month period (not an annualized interest rate).  The Company failed to make the required payments and as of July 3, 2009 was in default under the note agreement.  The Company entered into a Superseding Note for $200,000 which calls for interest to accrue at the rate of 6% every three months.  The Company also agreed to a $50,000 penalty on this note as a result of the default under a Forbearance Agreement entered into with the noteholder.

The Company also issued warrants to purchase 5 million shares of common stock to Altholtz.  The warrants have a strike price of $0.015 per share and can be exercised through April 3, 2014.

The following tables describe the valuation of the warrants:

Approximate risk free rate upon issuance
1.87%
 
Average expected life
5.0 year
 
Dividend yield
0%
 
Volatility
190%
 
Estimated fair value of conversion feature on date of warrants
$ 67,735
 
Estimated fair value of conversion feature as of September 30, 2009
$ 45,920
 

The Company recorded the value of the warrants as a discount to the convertible debt in the accompanying balance sheet. The Company reported an expense of $151 for the change in value from the date of issuance to the end of the quarter on September 30, 2009 (total net income of $21,815 was reported for the nine months ended September 30, 2009). The value of the derivative liability as of September 30, 2009 was $45,920.
 
22


The following table summarizes our derivative liability and the income (expense) due to the changes in our derivative liability for the quarter and nine months ended September 30, 2009:


   
 
   
 
   
Income (Expense) due to change in derivative liability
 
   
Derivative Liability
Balance as of
   
Derivative Liability
Balance as of
   
For quarter
ended
   
For nine months ended
   
For quarter
ended
   
For
nine months ended
 
   
December 31, 2008
   
September 30, 2009
   
September 30, 2008
   
September 30, 2008
   
September 30, 2009
   
September 30, 2009
 
                                     
Micropipe note with TeknoCreations
    266,614       -       38,763       76,382       215,173       266,614  
PhyHealth note
    -       354,717       -               32,589       118,347  
Micropipe warrants
    176,084       185,029       -               (3,206 )     (8,944 )
PhyHealth warrants (cancelled)
    -       -       -               188,917       176,687  
PhyHealth warrants (new)
    -       236,287       -               96,261       96,261  
Old warrants (expired in July 2009)
    2,248       -       -               -