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12. Shareholders' Equity/Deficit
 6 Months Ended
Jun. 30, 2012
Notes to Financial Statements  
NOTE 12 - Shareholders' Deficit

Series C 10% Preferred Stock

 

During 2011, holders of the Company's Series C 10% Preferred Stock (“Series C”) converted all of their Series C into common stock. Each share of Series C sold for $30, can be converted at any time into 20 shares of common stock and has voting rights of 20 shares of common stock.  In connection with the issuance of Series C, the Company issued 124,990 warrants with a life of five years to purchase a share of common stock for $2.00 per share.  The Series C has liquidation preference over common stock at a liquidation value of $30 and pays a cumulative dividend of 10% per year, payable on July 31 and December 31of each year that the Series C is outstanding.  Interest payments may be made in cash or in common stock at the discretion of the Company.  The Series C automatically convert into 20 shares of common stock when the closing price for a share of common stock is $5.00 or above and the average daily trading volume for the 10 previous trading days is above 200,000 shares.  Given the losses recorded by the Company, the stock equivalents related to the Series C are not included in the calculation of earnings per share since the effect of such inclusion would be antidilutive.

 

Since the Series C contains an embedded conversion feature, the Company performed an analysis of the Series C under ASC 815 “Derivatives and Hedging.”  This analysis determined that the embedded conversion feature was not required to be bifurcated and accounted separately from the Series C because the economic risks and characteristics of the embedded conversion feature were clearly and closely related to the economic risks and characteristics of the host contract Series C, namely the risks of the common stock.  The value of the beneficial conversion feature (“BCF”) was $26,945, which was charged to equity at the time of issuance and was not included in the calculation of earnings per share.  The BCF was calculated as the difference of the fair value of the conversion price and the intrinsic value of the preferred shares.

 

The Series C contains a share adjustment provision that provides for additional shares to be issued if the 30-day volume weighted average price of the Company’s common stock (“VWAP”) is between $1.00 and $2.00 180 days after the purchase of Series C.  If the VWAP is above $2.00, no action is taken.  If the VWAP is between $1.00 to $2.00, additional shares are issued to the holder such that the total of the number of common shares issuable upon conversion, which is the number of Series C shares times 20 (“Conversion Shares”), plus the additional shares together equals the VWAP price equals the Conversion Shares times $2.00.  If the VWAP is below $1.00 the number of additional shares are calculated as if the price were $1.00, not the actual VWAP.  Once this 180-day period passes and the Company has issued the appropriate shares, if any, then Price Protection provisions of this Agreement will expire and the Company will be completely released from any future claims by the Purchaser related to this share adjustment provision.

 

The Company determined that derivative accounting for the embedded conversion and the share adjustment features were  not required pursuant to ASC 815-10-15-74 because the features and the shares are indexed to the Company’s own stock under ASC 815-40-15 (EITF Issue 07-5); the features can be classified in shareholders’ equity under ASC 815-40 (EITF Issue 00-19, paragraphs 1-11)  and that Series C is classified as a conventional convertible so the embedded conversion feature can be classified in stockholders’ equity under ASC 815-40 (Issue 00-19, paragraphs 12-32).  The determination was made by the Company that the Series C is a conventional convertible because the freestanding warrant is indexed to the company’s own stock under ASC 815-40-15 (EITF Issue 07-5); the freestanding warrant is classified in shareholders’ equity under ASC 815-40 (Issue 00-19, paragraphs 1-32); and the financial instrument does not include embedded puts and/or calls or other features that require bifurcation from the host contract under ASC 815.

 

As of December 31, 2011, all Series C Preferred Stock had been converted into common stock.

 

Series D 10% Preferred Stock

 

The Company had 18,999 shares of its Series D 10% Preferred Stock (“Series D”) outstanding as of June 30, 2012 and December 31, 2011.  Each share of Series D sold for $30, can be converted at any time into 60 shares of common stock and has voting rights of 60 shares of common stock.  In connection with the issuance of Series D, the Company issued warrants to purchase 179,970 shares of common stock.  The warrants have a life of five years to purchase a share of common stock for $1.00 and expire between November 2015 and April 2016.  The Series D has liquidation preference over common stock at a liquidation value of $30 and pays a cumulative dividend of 10% per year, payable on July 31 and December 31 of each year that the Series D is outstanding.  Interest payments may be made in cash or in common stock at the discretion of the Company.  The Series D automatically convert into 60 shares of common stock when the closing price for a share of common stock is $5.00 or above and the average daily trading volume for the 10 previous trading days is above 200,000 shares.  Given the losses recorded by the Company, the stock equivalents related to the Series D are not included in the calculation of earnings per share since the effect of such inclusion would be antidilutive.

 

Since the Series D contains an embedded conversion feature, the Company performed an analysis of the Series C under ASC 815 “Derivatives and Hedging.”  This analysis determined that the embedded conversion feature was not required to be bifurcated and accounted separately from the Series D because the economic risks and characteristics of the embedded conversion feature were clearly and closely related to the economic risks and characteristics of the host contract Series D, namely the risks of the common stock.  The value of the BCF was $26,945 which was charged to equity at the time of issuance and was not included in the calculation of earnings per share.  The BCF was calculated as the difference of the fair value of the conversion price and the intrinsic value of the preferred shares.

 

The Series D contains a share adjustment provision that provides for additional shares to be issued if the thirty-day volume weighted average price of the Company’s common stock (“VWAP”) is between $0.50 and $1.00 180 days after the purchase of Series D.  If the VWAP is above $1.00, no action is taken.  If the VWAP is between $0.50 to $1.00, additional shares are issued to the holder such that the total of the number of common shares issuable upon conversion, which is the number of Series D shares times 60 (“Conversion Shares”), plus the additional shares together equals the VWAP price equals the Conversion Shares times $1.00.  If the VWAP is below $0.50 the number of additional shares are calculated as if the price were $0.50, not the actual VWAP.  Once this 180-day period passes and the Company has issued the appropriate shares, if any, then Price Protection provisions of this Agreement will expire and the Company will be completely released from any future claims by the Purchaser related to this share adjustment provision.  The price protection provisions have expired.

 

The Company determined that derivative accounting for the embedded conversion and the share adjustment features was not required pursuant to ASC 815-10-15-74 because these features are indexed to the Company’s own stock under ASC 815-40-15 (EITF Issue 07-5); the features can be classified in shareholders’ equity under ASC 815-40 (EITF Issue 00-19, paragraphs 1-11)  and that Series D is classified as a conventional convertible so the features can be classified in stockholders’ equity under ASC 815-40 (Issue 00-19, paragraphs 12-32).  The determination was made by the Company that the Series D is a conventional convertible because the freestanding warrant is indexed to the company’s own stock under ASC 815-40-15 (EITF Issue 07-5); the freestanding warrant is classified in shareholders’ equity under ASC 815-40 (Issue 00-19, paragraphs 1-32); and the financial instrument does not include embedded puts and/or calls or other features that require bifurcation from the host contract under ASC 815.

 

As of June 30, 2012 there were 18,999 shares of Series D Preferred Stock outstanding.   

 

Series E 5% Preferred Stock

 

On May 24, 2011, the Company entered into a Securities Purchase Agreement (the “Purchase Agreement”) with eight investors (collectively, the “Investors”) pursuant to which the Company sold the Investors 8,700 shares of a new series of convertible preferred stock designated as Series E Convertible Preferred Stock (the “Series E”), the terms of which are set forth in the Certificate of Designations of Series E Preferred Stock (the “Certificate”), for $1,000 per share, or $8,700,000 in the aggregate. As of June 30, 2012 and December 31, 2011, there were 8,475 and 8,500 shares of Series E outstanding.

 

In connection with the sale of the Preferred Shares, the Company also agreed to issue to the Investors (a) warrants (“A Warrants”) to purchase up to one additional share of Common Stock for each share of Common Stock issuable upon conversion of the Preferred Shares, and (b) warrants (“B Warrants”) to purchase up to .50 additional shares of Common Stock for each share of Common Stock issuable upon conversion of the Preferred Shares. The Warrants are exercisable for five years commencing on the date of first issuance and are exercisable only for cash if there is an effective registration statement covering the resale of the shares issuable upon exercise of the Warrants. In the absence of such a registration statement, the Warrants are exercisable for cash or on a cashless basis at the option of the holder thereof. The exercise price of the A Warrant is $0.30 per share and the B Warrant has an exercise price of $0.30 per share, subject in each case to full ratchet anti-dilution protection. The exercise price of the A Warrant was originally $0.65 and the exercise price of the B Warrant was originally $1.00 but were adjusted pursuant to the full ratchet anti-dilution protection when $249,999 of notes were issued on April 4, 2012 that contained a $0.30 conversion feature.

 

Pursuant to the Certificate, the Preferred Shares bear a dividend of 5%, payable quarterly in cash, or, if the dividend shares are registered for resale, in shares of the Company’s Common Stock. The effective conversion rate for the Preferred Shares was originally is $0.40 per share of Common Stock, but has been adjusted to $0.30 pursuant to the full ratchet anti-dilution protection mentioned above. The Preferred Shares have voting rights on an as-converted to Common Stock basis, with the Investors (subject to certain exceptions) having the right to elect two members to the Company’s Board of Directors (“BOD”) for so long as at least 50% of the total number of Preferred Shares purchased pursuant to the Purchase Agreement are outstanding, and the right to elect one member to the Company’s BOD for so long as least 25% but less than 50% of the total number of Preferred Shares issued pursuant to the Purchase Agreement are outstanding. The Company is required to redeem any unconverted Preferred Shares on the fifth anniversary of the date of first issuance of the Preferred Shares, and has the right to require conversion at any time if the average daily trading value for any 20 consecutive trading days exceeds $250,000 and the weighted average price per share is at least $2.50 for each of those 20 consecutive trading days.

 

To secure the Company’s obligation to redeem the Preferred Shares, the Company entered into a Security Agreement dated May 24, 2011, pursuant to which the Company agreed to grant the holders of the Preferred Shares a first priority security interest in all of its assets.

 

The Company filed a registration statement with the SEC covering the resale of the shares (a) issuable upon conversion of the Preferred Shares or exercise of the Warrants, (b) issued as dividends payable in shares of Common Stock pursuant to the Certificate, and (c) issuable upon exercise of the Placement Agent Warrants. This registration statement was declared effective on February 13, 2012. Upon the occurrence of certain events set forth in the Purchase Agreement, including the failure to timely file the registration statement or have the registration statement timely declared effective, the Company will pay to the Investors cash of 1% of the aggregate purchase price of the Series E Preferred Stock and Warrants for each 30-day period during such default; provided, however, that the payments will not exceed 10% of the aggregate purchase price.

 

As of June 30, 2012 there were 8,475 shares of Series E Preferred Stock outstanding.   

 

Common Stock

 

During the six months ended June 30, 2012, the Company did not raise funds from the issuance of common stock.

 

Stock Options

 

During the six months ended June 30, 2012, the Company cancelled 4,660,994 options for employees whose employment had been terminated and granted 2,300,000 options to Jerold Rubinstein, the Company’s new Chairman of the Board and Chief Executive Officer on June 28, 2012, pursuant to an employment contract. These options have a strike price of $0.35, which is the closing price of the Company’s common stock on the day of grant, a five-year life and vest monthly over a twelve-month period unless the employment contract is terminated for any reason, at which time the options vest in full. The Black Scholes value of these options was $448,800 which is being amortized over the twelve month vesting period starting July 1, 2012; accordingly, no expense was recognized for the three and six months ended June 30, 2012.  The following assumptions were used for the Black Scholes calculation to determine this expense:

 

Estimated fair value of underlying common stock     $0.35  
Remaining life     5.0  
Risk-free interest rate     0.69%  
Expected volatility     80%  
Dividend yield     –  

 

 

The following table sets forth the activity of our stock options:

 

      Options Outstanding        Options Exercisable 
      Options Outstanding       Range of Exercise Prices       Weighted Average Remaining Life in Years       Weighted Average Exercise Price       Options Exercisable       Weighted Average Remaining Life in Years       Weighted Average Exercise Price  
As of December 31, 2010     10,269,852       $0.14 - $3.50       2.4     $ 0.94       8,512,684       2.0     $ 0.94  
Cancelled     (3,110,000 )     –       –     $ 0.43       (3,110,000 )     –     $ 0.00  
Exercised                                                        
Granted     5,010,000       $0.54       5.0     $ 0.54       3,355,000       5.0     $ 0.54  
As of December 31, 2011     12,169,852       $0.14 - $1.50       3.2     $ 0.49       8,757,684       3.2     $ 0.40  
Cancelled     (7,376,329 )     –       –       –       (4,660,994 )     –       –  
Exercised     –       –       –       –       –       –       –  
Granted     2,300,000       $0.35       5.0     $ 0.35       –       –       –  
As of June 30, 2012     7,093,523        $0.35 -$0.54       3.7     $ 0.47       4,096,690       2.8     $ 0.52  

 

 

Warrants

 

During the six months ended June 30, 2012, the Company issued five-year warrants to purchase 833,330 shares at $0.40 in connection with a note payable for $249,999. During this period, the Company issued warrants to purchase 3,000,000 shares of its common stock at $0.30 with a five-year life in connection with a non-exclusive agreement with an investment bank for advisory services related to funding and capital structure. In addition, this investment bank received warrants to purchase 1,000,000 shares of ProElite common stock at $0.35 with a five-year life. The Black Scholes value of the warrants issued to the investment bank was $1,274,000, which is being recognized over a twelve month period starting June 1, 2012; accordingly, $106,167 was recognized as an expense during the three and six months ended June 30, 2012.  The following assumptions were used for the Black Scholes calculation to determine this expense:

 

Estimated fair value of underlying common stock     $0.55  
Remaining life     5.0  
Risk-free interest rate     0.74%  
Expected volatility     84%  
Dividend yield     –  

 

A summary of the warrants:

 

       Warrants Outstanding         Warrants Exercisable 
      Warrants Outstanding       Range of Exercise Prices       Weighted Average Remaining Life in Years       Weighted Average Exercise Price       Warrants Exercisable       Weighted Average Remaining Life in Years       Weighted Average Exercise Price  
As of December 31, 2010     2,472,676       $1.00 - $2.00       4.4     $ 1.37       2,472,676       4.4     $ 1.37  
Exercised     –       –       –       –       –       –       –  
Granted     57,057,569       $0.65 - $1.00       4.5     $ 0.75       57,057,569       4.5     $ 0.75  
As of December 31, 2011     59,530,245       $0.65 - $2.00       3.5     $ 2.00       59,530,245       3.5     $ 2.00  
Exercised     –       –       –       –       –       –       –  
Ratchet-down impact     56,991,667       $0.30       –     $ 0.30       56,991,667       –     $ 0.30  
Granted     3,833,330       $0.30 - $0.40       4.9     $ 0.32       3,000,000       4.9     $ 0.32  
As of June 30, 2012     120,355,242       $0.30 - $2.00       3.9     $ 0.40       119,521,912       3.9     $ 0.40  

 

The exercise price of the A Warrant for Series E Preferred was originally $0.65 and the exercise price of the B Warrant for Series E Preferred was originally $1.00, but both warrants were adjusted pursuant to the full ratchet anti-dilution protection when $249,999 of notes were issued on April 4, 2012 that contained a $0.30 conversion feature.

 

Calculations of the ratchet-down impact:

 

       Original    After Ratchet Down  
      Shares  x       Strike  =      

Aggregate Exercise

Price

       Shares  x       Strike  =       Aggregate Exercise
Price		  
                                                 
Series A warrants     21,750,000     $ 0.65     $ 14,137,500       47,125,000     $ 0.30     $ 14,137,500  
Series B warrants     10,875,000     $ 1.00     $ 10,875,000       36,250,000     $ 0.30     $ 10,875,000  
Placement agent warrant     3,600,000     $ 0.65     $ 2,340,000       7,800,000     $ 0.30     $ 2,340,000  
Broker-dealer warrant     1,000,000     $ 0.65     $ 650,000       2,166,667     $ 0.30     $ 650,000  
Advisory warrant     750,000     $ 0.65     $ 487,500       1,625,000     $ 0.30     $ 487,500  
      37,975,000                       94,966,667                  
                                                 
 Additional warrants from ratchet-down         56,991,667