• Filing Date: 2016-11-15
  • Form Type: 10-Q/A
  • Description: Quarterly report (Amendment)
v3.5.0.2
5. DERIVATIVE LIABILITY
9 Months Ended
Sep. 30, 2016
Derivative Instruments and Hedging Activities Disclosure [Abstract]  
DERIVATIVE LIABILITY

The embedded conversion feature in the convertible debt instruments (the “Notes”) that the Company issued beginning in July 2014 (See Note 4), and became convertible beginning in July 2015, qualified it as a derivative instrument since the number of shares issuable under the note is indeterminate based on guidance under ASC 815, Derivatives and Hedging. The conversion feature of these convertible promissory notes has been characterized as a derivative liability beginning in July 2015 to be re-measured at the end of every reporting period with the change in value reported in the statement of operations.

 

The valuation of the derivative liability attached to the convertible debt was determined by management using a binomial pricing model that values the derivative liability within the notes. Using the results from the model, the Company recorded a derivative liability of $1,086,000 for the fair value of the convertible feature included in the Company’s convertible debt instruments as of September 30, 2016. The derivative liability recorded for the convertible feature created a debt discount of $1,437,000, which is being amortized over the remaining term of the notes using the effective interest rate method and is included in convertible notes on the balance sheet. Interest expense related to the amortization of this debt discount for the nine months ended September 30, 2016, was $186,081. Additionally, $444,000 of debt discount was charged to interest expense during the nine months ended September 30, 2016, representing the amount of debt discount in excess of the convertible debt. A total of $514,067 of the debt discount was charged to interest expense during the three months ended September 30, 2016 related to convertible debt converted during the period.

 

Key inputs and assumptions used to value the embedded conversion feature in the month the Notes became convertible were as follows:

 

·The average value of a share of Company stock in the month the Notes became convertible, the measurement date - ranging from $0.0756 - $0.1172 (per the over-the-counter market quotes);
·The average conversion price of all Notes issued in their month of issuance, with such conversion price determined based on 80% of the average over-the-counter market price for the 30 days preceding the one-year anniversary of all Notes in that month’s pool;
·The number of shares into which Notes in pool would convert - face amount of the Notes in that month’s pool divided by the average conversion price for Notes included in that month’s pool;
·Risk free rate - 2.5%;
·Dividend yield - 0.0%;
·Assumed annual volatility of Company stock – 128.6%; and
·The Company would be unable to repay the notes within their term.

 

Additional key inputs and assumptions used to value the embedded conversion feature as of September 30, 2016:

 

·The value of a share of Company stock on September 30, 2016, the measurement date - $0.0674 (per the over-the-counter market quotes);
·Conversion price - $0.0554, based on 80% of the average quoted market price for the Company’s common stock for the 30-day period ended September 30, 2016; and
·Number of shares into which Notes would convert - face value of Notes divided by $0.0554.

 

The following table summarizes the derivative liability included in the consolidated balance sheet:

 

Derivative liability as of December 31, 2015  $1,484,000 
Change in fair value of derivative liability   (658,000)
Derivative on new loans   989,000 
Reduction due to debt conversions   (729,000)
Derivative liability as of September 30, 2016  $1,086,000