NOTE 9 - Convertible Notes Payable

The “February 2012 Notes”

On February 24, 2012, we entered into a Securities Purchase Agreement with OPKO Health Inc. pursuant to which we borrowed $1,700,000 evidenced by a 10% convertible note due two years from the date of issuance and issued warrants to purchase 8,500,000 shares of the our common stock, at an exercise price of $0.40 per share.

On February 28, 2012 and February 29, 2012, we entered in a Securities Purchase Agreement with two additional buyers pursuant to which we borrowed an additional $600,000 evidenced by notes and issued warrants to purchase an additional 3,000,000 shares of our common stock, at an exercise price of $0.40 per share. The notes and warrants contained the same terms as the notes and warrants issued to OPKO as described above.

In connection with the sale of the notes and the warrants, the Company and the collateral agent for the buyers entered into a Pledge and Security Agreement pursuant to which all of our obligations under the notes are secured by a first priority perfected security interest in all of our tangible and intangible assets, including all of our ownership interest in our subsidiaries.

The entire principal amount and any accrued and unpaid interest on the notes is due and payable in cash on the maturity date set forth in the notes.  The notes bear interest at the rate of 10% per annum.  The notes are convertible into shares of our common stock at an initial conversion price of $0.20 per share, subject to adjustment.  We may prepay any outstanding amount due under the notes, in whole or in part, prior to the maturity date.  The notes are subject to certain “Events of Defaults” which could cause all amounts due and owing thereunder to become immediately due and payable. Among other things, our failure to pay any accrued but unpaid interest when due, the failure to perform any obligation under the governing transaction documents or if any representation or warranty made by the Company in connection with the governing transaction documents proves to have been incorrect in any material respect constitutes an Event of Default under the governing transaction documents.

The Company is prohibited from effecting a conversion of the notes or exercise of the warrants, to the extent that as a result of such conversion or exercise the holder would beneficially own more than 4.99% (subject to waiver) in the aggregate of the issued and outstanding shares of the Company’s common stock, calculated immediately after giving effect to the issuance of shares of common stock upon conversion of such note or exercise of such warrant, as the case may be.

All of the warrants granted with the above notes have been exercised.

We determined that the initial fair value of the warrants was $5,221,172 based on the Black-Scholes option pricing model, which we treated as a liability with a corresponding decrease in the carrying value of the notes.  Under authoritative guidance, the carrying value of the notes may not be reduced below zero.  Accordingly, we recorded interest expense of $2,921,172 at the time of the issuance of the notes, which is the excess of the value of the warrants over the allocated fair value of the notes.  The discount related to the notes will be amortized over the term of the notes as interest expense, calculated using an effective interest method.

We determined that according to ASC 470120-30, a beneficial conversion feature existed based on the intrinsic value of the conversion feature. Due to the fact that the carrying amount of the convertible notes has been reduced to zero, based on the discount allocated from the value of the warrants referred to above, that no beneficial conversion feature is to be recorded. ASC 470-20-30-8 states that if the intrinsic value of the beneficial conversion feature is greater than the proceeds allocated to the convertible instrument, the amount of the discount assigned to the beneficial conversion feature shall be limited to the amount of the proceeds allocated to the convertible instrument.

The “March 2012 Purchase Order Note”

On March 13, 2012, we borrowed $1,000,000 and issued an accredited investor a 10% senior secured convertible promissory note (the “Purchase Order Note”).

The Company has not recorded a beneficial conversion feature on the March 2012 Purchase Order Notes due to the effective conversion price being greater than the fair value of the Company’s stock at the issuance date.

As of September 30, 2013, the Company had repaid $900,000 of the Purchase Order Note. On October 8, 2013, the holder converted the remaining amount due under the Note into 1,180,192 shares and the note was cancelled.

The “April 2012 Working Capital Note”

On April 18, 2012, we borrowed $250,000 and issued an accredited investor a 10% senior convertible promissory note (the “Working Capital Note”).  

On June 28, 2012, the holder of the Working Capital Note exchanged such Note for the June 2012 Convertible Notes described below.

The “June 2012 Working Capital Notes”

On June 13, 2012, we borrowed $200,000 and issued accredited investors a 10% promissory notes (the “June 2012 Working Capital Notes”). .

On June 28, 2012, the holders of the June 2012 Working Capital Notes exchanged such notes for the June 2012 Convertible Notes described below.

The “June 2012 Convertible Notes”

On June 28, 2012, we issued $455,274 of 10% convertible promissory notes (the “June 2012 Convertible   Notes”) and warrants (the “June 2012 Warrants”) to purchase 2,250,000 shares of our common stock to the holders of the Working Capital Notes and June 2012 Working Capital Notes with an aggregate amount of principal and accrued interest due as of such date equal to the aggregate principle amount of the June 2012 Convertible   Notes. The Working Capital Notes and June 2012 Working Capital Notes were cancelled.

The June 2012 Convertible Notes mature June 28, 2014. We may prepay any outstanding amounts owing under the June 2012 Convertible Notes, in whole or in part, at any time prior to the maturity date. The entire remaining principal amount and all accrued but unpaid or unconverted interest is due and payable on the earlier of the Maturity Date or the occurrence of an Event of Default (each as defined in the June 2012 Convertible Notes). The June 2012 Convertible Notes are convertible into shares of our common stock at an initial conversion price of $0.20 per share.

The Company is prohibited from effecting a conversion of the June 2012 Convertible Notes or exercise of the June 2012 Warrants, to the extent that as a result of such conversion or exercise, the holder would beneficially own more than 4.99% (subject to waiver) in the aggregate of the issued and outstanding shares of the Company’s common stock, calculated immediately after giving effect to the issuance of shares of common stock upon conversion of the June 2012 Convertible Note or exercise of the June 2012 Warrants, as the case may be.

The June 2012 Warrants are exercisable immediately, expire ten years after the date of issuance and have an initial exercise price of $0.40 per share. The June 2012 Warrants are exercisable in cash or through a “cashless exercise”. We determined that the initial fair value of the June 2012 Warrants was $1,036,042 based on the Black-Scholes option pricing model, which we treated as a liability with a corresponding decrease in the carrying value of the June 2012 Convertible Notes.  Under authoritative guidance, the carrying value of the June 2012 Convertible Notes may not be reduced below zero.  Accordingly, we recorded interest expense of $580,768, which is the excess of the value of the June 2012 Warrants over the allocated fair value of the June 2012 Convertible Notes, at the date of the issuance.  The discount related to the June 2012 Convertible Notes will be amortized over the term of the Notes as interest expense, calculated using an effective interest method.

We determined that according to ASC 470120-30, a beneficial conversion feature existed based on the intrinsic value of the conversion feature. Due to the fact that the carrying amount of the convertible notes has been reduced to zero, based on the discount allocated from the value of the warrants referred to above, that no beneficial conversion feature is to be recorded. ASC 470-20-30-8 states that if the intrinsic value of the beneficial conversion feature is greater than the proceeds allocated to the convertible instrument, the amount of the discount assigned to the beneficial conversion feature shall be limited to the amount of the proceeds allocated to the convertible instrument.

The “June 2013 Convertible Note”

On June 20, 2013, we borrowed $50,000 and issued a convertible promissory note (the “June 2013 Convertible Note”) which matures one year from its issue date. We may prepay any outstanding amounts owing under the June 2013 Convertible Note, in whole or in part, at any time prior to the maturity date. The entire remaining principal amount and all accrued but unpaid or unconverted interest is due and payable on the earlier of the Maturity Date or the occurrence of an Event of Default (each as defined in the June 2013 Convertible Note). The June 2013 Convertible Note is convertible into shares of our common stock at a conversion price equal to the lower of $0.55 per share or 60% of the lowest trade price in the 25 trading days previous to the conversion. The Company repaid the Note in its entirety in September 2013.

In September 2013, the Company sold an additional promissory note for an aggregate purchase price of $50,000 for the same terms as above.

The “August 2013 Convertible Note”

On August 26, 2013, the Company entered into a Securities Purchase Agreement (the “Securities Purchase Agreement”) with an investor (the “Buyer”) pursuant to which the Company (i) borrowed $2,000,000 and issued a 10% secured convertible promissory note (the “August 2013 Note”) due one year from the date of issuance (the “Maturity Date”) and issued (ii) warrants (the “August 2013 Warrants”) to purchase 10,000,000 shares of the Company’s common stock.

The August 2013 Note is convertible into shares of the Company’s common stock at an initial conversion price of $0.20 per share, subject to adjustment.  The Company may prepay any outstanding amount due under the August 2013 Note, in whole or in part, prior to the Maturity Date.  The August 2013 Note is subject to certain “Events of Defaults” which could cause all amounts due and owing thereunder to become immediately due and payable. Among other things, the Company's failure to pay any accrued but unpaid interest when due, the failure to perform any obligation under the Transaction Documents (as defined below) or a determination that any representation or warranty made by the Company in connection with the Transaction Documents shall prove to have been incorrect in any material respect shall constitute an Event of Default under the Transaction Documents.

The August 2013 Warrants are immediately exercisable and expire ten years after the date of issuance.  The August 2013 Warrants have an initial exercise price of $0.40 per share.   The August 2013 Warrants are exercisable in cash or by way of a cashless exercise while a registration statement covering the shares of Common Stock issuable upon exercise of the Warrants or an exemption from registration is not available. We determined that the initial fair value of the August 2013 Warrants was $2,488,983 based on the Black-Scholes option pricing model, which we treated as a liability with a corresponding decrease in the carrying value of the August 2013 Note.  Under authoritative guidance, the carrying value of the August 2013 Note may not be reduced below zero.  Accordingly, we recorded interest expense of $488,983, which is the excess of the value of the August 2013 Warrants over the allocated fair value of the August 2013 Note, at the date of the issuance.  The discount related to the August 2013 Note will be amortized over the term of the Notes as interest expense, calculated using an effective interest method.

The Company is prohibited from effecting a conversion of the August 2013 Note or exercise of the August 2013 Warrants to the extent that as a result of such conversion or exercise, the Buyer would beneficially own more than 4.99% (subject to waiver) in the aggregate of the issued and outstanding shares of the Company’s common stock, calculated immediately after giving effect to the issuance of shares of common stock upon conversion of the August 2013 Note or exercise of the Warrants, as the case may be.

In connection with the sale of the August 2013 Note and the August 2013 Warrants, the Company, the Buyer and the collateral agent for other secured creditors of the Company (including our Chairman, Roberto Prego-Novo) agreed to enter into an Amended and Restated Pledge and Security Agreement (the “Security Agreement” and, collectively with the Securities Purchase Agreement, the Note and the Warrant, the “Transaction Documents”) pursuant to which all of the Company’s obligations under the August 2013 Note are secured by a perfected security interest in all of the tangible and intangible assets of the Company, including all of its ownership interest in its subsidiaries, pari pasu, with the previous secured creditors, all of which is subordinated to the accounts receivable lender to the Company.  Further, pursuant to the Security Agreement, the Note holder, the collateral agent and the prior secured creditors agreed to further subordinate the granted security interest to a security interest previously granted to another investor in the Company.

The Company has granted the Note holder “piggy-back” registration rights with respect to the shares of common stock underlying the August 2013 Note and the shares of common stock underlying the August 2013 Warrants for a period of twelve (12) months from the date of closing.

 The following table sets forth a summary of all the outstanding convertible promissory notes at September 30, 2013: