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Note 5 - Convertible Debt

3 Months Ended

Mar. 31, 2014

NOTE 5 - CONVERTIBLE DEBT

July 2012 Convertible Debentures - In July 2012, the Company issued convertible debentures (“July Notes”) with an aggregate face value of $215,300 Canadian Dollars ($195,342 as of March 31, 2014). The July Notes mature in July 2014, bear interest at an annual rate of 10%, and are convertible at the option of the holders into Units, each consisting of a) one share of common stock and b) one warrant to purchase one share of common stock at 0.40 Canadian Dollars per share (“Unit”). The number of Units issuable upon conversion of the notes is determined by dividing the then outstanding principal and accrued but unpaid interest by a) 0.35 Canadian Dollars if a Liquidity Event, as defined in the debenture agreements, occurs within six months of the closing of the offering of the notes, or b) 0.32 Canadian Dollars if a Liquidity Event does not occur within six months of the closing of the offering of the July Notes.

The Company recorded a beneficial conversion feature based on the intrinsic value of the conversion feature equal to the excess of the fair value of one Unit over the conversion rate of 0.32 Canadian Dollars. The fair value of one Unit was estimated based on the most recent sale of common stock in a private placement immediately preceding the issuance of the July Notes and, for the warrant contained in one Unit, using a Black Scholes valuation model and the following assumptions: volatility – 50.50%, risk free rate - 0.22%, dividend rate – 0.00%. The Company recorded a discount against the debt for the beneficial conversion feature totaling $84,788, which is being amortized into interest expense through the maturity dates of the July Notes. For the three months ended March 31, 2014 and 2013, respectively, the Company recorded amortization of the discount of $10,599 for both periods, respectively. As of March 31, 2014, the net carrying value of the July Notes totaled $181,211, net of unamortized discount of $14,131. For the three months ended March 31, 2014 and 2013, respectively, interest expense on the July Notes of $4,884 and $5,341, respectively, was recorded.

In connection with the issuance of the July Notes, the Company paid transactions fees to brokers consisting of cash of $85,237, and warrants to purchase 43,497 shares over a two-year period for an exercise price of 0.40 Canadian Dollars. The Company estimated the fair value of the warrants using a Black Scholes valuation model and the following assumptions: volatility – 50.49%, risk free rate – 0.22%, dividend rate – 0.00%.

The Company allocated a portion of the fair value of the consideration totaling $52,869, to debt issuance costs, which was capitalized and is being amortized into interest expense over the two-year terms of the July Notes. The remaining portion of the fair value of the transactions costs, totaling $36,126 was allocated to equity, treated as equity issuance costs, and recorded against additional paid in capital. Amortization of debt issuance costs on the Notes of $6,609 and $6,609, respectively was recorded for the three months ended March 31, 2014and 2013, respectively.

September 2012 Convertible Debentures - In September 2012, the Company issued convertible debentures (“September Notes”) with an aggregate face value of $330,900. The September Notes mature in September 2014, bear interest at an annual rate of 10%, and are convertible at the option of the holders into Units, each consisting of a) one share of common stock and b) one warrant to purchase one share of common stock at $0.40 per share (“Unit”). The number of units issuable upon conversion of the notes is determined by dividing the then outstanding principal and accrued but unpaid interest by a) $0.35 if a Liquidity Event, as defined in the debenture agreements, occurs within six months of the closing of the offering of the notes, or b) $0.32 if a Liquidity Event does not occur within six months of the closing of the offering of the September Notes.

The Company recorded a beneficial conversion feature based on the intrinsic value of the conversion feature equal to the excess of the fair value of one Unit over the conversion rate of $0.32. The fair value of one Unit was estimated based on the most recent sale of common stock in a private placement immediately preceding the issuance of the Notes and, for the warrant contained in one Unit, using a Black Scholes valuation model and the following assumptions: volatility – 50.50%, risk free rate – 0.22%, dividend rate – 0.00%. The Company recorded a discount against the debt for the beneficial conversion feature totaling $115,712, which is being amortized into interest expense through the maturity dates of the September Notes. For the three months ended March 31, 2014 and 2013, respectively, the Company recorded amortization of the discount for both periods of $31,750, respectively. As of March 31, 2014, the net carrying value of the September Notes totaled $239,295, net of unamortized discount of $24,107. For the three months ended March 31, 2014 and 2013 interest expense on the September Notes was recorded of $8,273 for both periods, respectively.

In connection with the issuance of the September Notes, the Company paid cash transactions fees to brokers totaling $30,456. The Company allocated a portion of the transaction fees totaling $19,806, to debt issuance costs, which was capitalized and is being amortized into interest expense over the two-year terms of the September Notes. The remaining portion of the fair value of the transactions costs, totaling $10,650 was allocated to equity, treated as equity issuance costs, and recorded against additional paid in capital. Amortization of debt issuance costs on the September Notes of $2,476 was recorded for both periods for the three months ended March 31, 2014 and 2013, respectively.

October and November 2012 Convertible Debentures - In October and November 2012, the Company issued convertible debentures (“October and November Notes”) with an aggregate face value of $624,372 of which $313,440 represented a conversion of notes payable- related parties to the Founders. The October and November Notes mature in October and November 2014, bear interest at an annual rate of 10%, and are convertible at the option of the holders into Units, each consisting of a) one share of common stock and b) one warrant to purchase one share of common stock at $0.40 per share (“Unit”). The number of units issuable upon conversion of the October and November Notes is determined by dividing the then outstanding principal and accrued but unpaid interest by a) $0.35 if a Liquidity Event, as defined in the debenture agreements, occurs within six months of the closing of the offering of the October and November Notes, or b) $0.32 if a Liquidity Event does not occur within six months of the closing of the offering of the October and November Notes.

The Company recorded a beneficial conversion feature based on the intrinsic value of the conversion feature equal to the excess of the fair value of one Unit over the conversion rate of $0.32. The fair value of one Unit was estimated based on the most recent sale of common stock in a private placement immediately preceding the issuance of the Notes and, for the warrant contained in one Unit, using a Black Scholes valuation model and the following assumptions: volatility – 50.50%, risk free rate –0.22%, dividend rate – 0.00%. The Company recorded a discount against the debt for the beneficial conversion feature totaling $254,004, which is being amortized into interest expense through the maturity dates of the October and November Notes. For the three months ended March 31, 2014 and 2013, the Company recorded amortization of the discount of $31,750 for both periods, respectively. As of March 31, 2014 the net carrying value of the October and November Notes totaled $552,955, net of unamortized discount of $182,587. For the three months ended March 31, 2014 and 2013 interest expense on the October and November Notes of $15,609 was recorded for both periods, respectively.

In connection with the issuance of the October and November Notes, the Company paid no cash transactions fees to brokers.

The following is a summary of convertible debentures outstanding as of March 31, 2014:

	Face Value		Initial Discount			Accumulated Amortization		Carrying Value
July Notes	$	195,342	$	(84,788	)	$	70,657	$	181,210
September Notes		330,900		(115,712	)		89,080		304,268
October and November Notes		159,000		(55,889	)		20,524		123,635
November – Related Party Notes		465,372		(198,115	)		162,063		429,320
Total	$	1,150,614	$	(454,504	)	$	342,317	$	1,038,433

Convertible Promissory Note - In March 2014, the Company borrowed $100,000 from an accredited investor pursuant to a six month convertible promissory note bearing interest at 10% per year. The note is convertible at $.165 per share with the same warrant coverage as for the shares privately sold as set forth above. The Company incurred $5,000 of debt issuance costs representing commission paid to broker-dealers who assisted this transaction. The entire principal balance of this Note, together with all unpaid interest accrued thereon, shall be due and payable on September 24, 2014 (the “Maturity Date”). Upon payment in full of all principal and interest payable hereunder, this Note shall be surrendered to the Company for cancellation. The principal amount of this Note may be converted in increments of $10,000 into common stock of the Company at a price of $.165 per share (the “Conversion Shares”). Upon conversion, the Holder shall receive, in addition to certificates for the Conversion Shares, a five-year warrant to purchase at $.50 per share an amount of shares of common stock equal to 25% of the number of Conversion Shares.