XML 39 R11.htm IDEA: XBRL DOCUMENT

6. CONVERTIBLE DEBT

6 Months Ended

Jun. 30, 2013

In November 2012 the Company initiated a Private Placement offering a maximum of 240 Units of the Company’s securities at a price of $25,000 per Unit or $6,000,000. The initial closing of the offering occurred in April 2013 as the bulk of the net proceeds of the offering were to be allocated for the asset purchase from L-3 Applied Technologies, Inc., which agreement was not finalized until April 2013. Each Unit consists of $25,000 par amount of a 10% Senior Secured Callable Convertible Promissory Note due and payable on July 31, 2015 and 37,500 warrants each of which allows the investor to purchase one share of common stock and expires on July 31, 2018. Interest is payable on the Notes at a rate of 10% per annum, compounded annually, and payable on July 31st and January 31st. The Notes are secured by the Company's intellectual property such as the Patents, royalties, receivables of the Company and all equipment except for the new equipment acquired with the proceeds from any future financing that is initially secured by this new equipment. The Notes call for the establishment of a sinking fund. Within 45 days of each calendar quarter 15% of the Company’s reported revenue will be deposited into the Company’s escrowed sinking fund account.

As of June 30, 2013 the Company sold 194.96 Units for gross proceeds of $4,874,000. Net proceeds amounted to $4,286,690 after expenses of offering totaling $587,310. In addition the placement agent received 974,800 warrants valued at $143,700.

The convertible notes are convertible into shares of our common stock at an initial conversion price of $.29 (which conversion price is subject to adjustment upon the occurrence of events specified in the Convertible Notes, including stock dividends, stock splits, certain fundamental corporate transactions, and certain issuances of common stock by the Company).

The Warrants are exercisable into shares of Common Stock (the "Warrant Shares") at an initial exercise price of $0.30 (which may be subject to certain adjustments as set forth in the Warrants).

The Company evaluated the warrants under ASC 815-40-15 due to the exercise price being adjustable upon certain events occurring. The company determined that the warrants are considered indexed to the Company’s own stock and thus meet the scope exception under FASB ASC 815-10-15-74 and are therefore not considered a derivative. The estimated fair value of the warrants, which contain reset provisions, were calculated using the Monte Carlo valuation model. The Company recorded the warrant’s relative fair value of $867,512 as an increase to additional paid in capital and a discount against the related debt.

The Convertible Notes contain a provision whereby the conversion price is adjustable upon the occurrence of certain events, including the issuance of common stock or common stock equivalents at a price which is lower than the current conversion price. Under FASB ASC 815-40-15-5, the embedded conversion feature is not considered indexed to the Company’s own stock and, therefore, does not meet the scope exception in FASB ASC 815-10-15 and thus needs to be accounted for as a derivative liability. The fair value of the embedded conversion feature was estimated at $6,874,538 and recorded as a derivative liability, resulting in an additional discount of $4,006,488 to the convertible notes and a finance charge of $2,868,050 included in the statement of operations. The fair value of the embedded conversion feature is estimated at the end of each quarterly reporting period using the Monte Carlo model.

The debt discount is being amortized over the life of the convertible note using the effective interest method.

Inherent in the Monte Carlo Valuation model are assumptions related to expected volatility, remaining life, risk-free rate and expected dividend yield. For the Convertible Notes and Warrants using a Monte Carlo model, we estimate the probability and timing of potential future financing and fundamental transactions as applicable. The assumptions used by the Company are summarized below:

Convertible Notes

	June 30, 2013			Inception
Closing stock price	$	0.57		$	0.13-0.55
Conversion price	$	0.29		$	0.29
Expected volatility		190	%		185%-190	%
Remaining term (years)		2.08			2.30-2.09
Risk-free rate		0.38	%		0.25%-0.39	%
Expected dividend yield		0	%		0	%

Warrants

	June 30, 2013			Inception
Closing stock price	$	0.57		$	0.13-0.55
Exercise price	$	0.30		$	0.30
Expected volatility		250	%		250	%
Remaining term (years)		5.08			5.30-5.09
Risk-free rate		1.42			0.76%-1.40	%
Expected dividend yield		0	%		0	%

Convertible notes consist of the following at June 30, 2013 and December 31, 2012:

	June 30, 2013			December 31, 2012

Convertible notes	$	4,874,000		$	-
Discount on convertible notes		(4,874,000	)		-
Accumulated amortization of discount		8,817			-
Total convertible notes	$	8,817		$	-