Note 4 – Senior Secured Convertible Notes

On March 13, 2013, (the “Initial Closing Date’), in connection with its offering of Senior Secured Convertible Notes (the “Notes”) the Company entered into a securities purchase agreement (the “Purchase Agreement”) and issued a Note to one investor in the principal amount of $210,000. The Notes are collateralized by all of the assets of the Company and bear interest at a rate of 15% per annum, compounded quarterly. Principal and accrued interest on the Notes are convertible into shares of the Company’s common stock at an initial conversion price of $1.50 per share (the “Initial Conversion Price”). Principal and accrued interest on the Notes are due and payable twenty-four (24) months from the date of the Purchase Agreement (the “Maturity Date”). The investor also initially received a warrant exercisable for a period of five years from issuance to purchase 1,400,000 shares of the Company’s common stock (the “Warrant Shares”) at an initial exercise price of $1.50 per share. The warrant contains certain cashless exercise provisions. The Note and Warrant Shares are subject to certain registration rights. Subsequent to the Initial Closing Date, the Company revised the terms of the Offering to increase the number of warrants to 1,050,000 per $105,000 invested, and issued an additional 700,000 warrants to the investor. As a result of issuing the additional warrants, for the nine months ending September 30, 2013, the Company recorded a charge of $35,000 related to the modification of the note.

Between June 20, 2013 and June 24, 2013, the Company sold additional Notes and entered into and consummated an Amended and Restated Securities Purchase Agreement, with two accredited investors, whereby the Company sold additional Notes in the aggregate principal amount of $525,000. The investors also received warrants exercisable for a period of five years from issuance to purchase an aggregate of 5,250,000 Warrant Shares at an exercise price of $1.50 per share.

The Initial Conversion Price and the exercise price of the Warrant Shares are subject to full-ratchet price protection in the event that the Company issues or sells, or is deemed to have issued or sold, subject to certain standard exceptions, any shares of its common stock or securities convertible into common stock for consideration per share less than the Initial Conversion Price. As such, the Company determined that the conversion option and warrants, as originally issued, did not contain fixed settlement provisions due to price protection adjustments based on certain subsequent equity issuances. As such, the Company was required to record the conversion option and warrants as derivative liabilities and mark to market all such derivatives to fair value each reporting period through September 30, 2013.

The cumulative gross proceeds of the Notes in the amount of $735,000, for the nine months ending September 30, 2013, were recorded net of a debt discount of $438,375. The debt discount consisted of $430,500 related to the fair value of the warrants and $7,875 related to the fair value of the embedded conversion option. The warrants and conversion option were valued using a compound option model that includes characteristics of both a binomial lattice and the Black-Scholes formula and measured at fair value on a recurring basis through September 30, 2013 (See Note 3). The debt discount of $438,375 is being accreted over the term of the Notes. Accordingly, the Company recorded a charge of $60,560 and $90,156 to interest expense for the three months and nine months ended September 30, 2013, respectively.