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EQUITY TRANSACTIONS
 3 Months Ended
Sep. 30, 2012
Equity [Abstract]  
EQUITY TRANSACTIONS
4.           EQUITY TRANSACTIONS
 
Preferred Stock Series – A, B & C
 
The Company has authorized 5,000,000 shares of preferred stock, with 2,830 shares designated to Series A Preferred and 7,745 shares designated to Series B Preferred and 813 shares designated to Series C Preferred.
 
The Series A Preferred and Series C Preferred rank senior to the Series B Preferred which ranks senior to the Company’s common stock with respect to the payment of any dividends and amounts upon liquidation or dissolution. Except as required by law, the shares of preferred stock shall be voted together with the shares of common stock and not as a separate class.  In addition, so long as 35% of the aggregate amount of the shares of Series A Preferred and Series C Preferred are outstanding, the holders of the outstanding shares voting together as a separate class are entitled to elect up to four directors to the Board and separately vote on a number of defined material actions typically requiring Board approval. Respectively, holders of shares of Series A, B and C Preferred have anti-dilution protections for sale of stock below conversion rate and stock splits and other similar pro rata events.
 
Preferred Stock Private Placements
 
In June 2009, in a private placement pursuant to the Purchase Agreement dated February 9, 2009, with Mosaic Private Equity Fund (U.S.), L.P. (“MPE”), Mosaic Financial Services, LLC (“MFS”) and Mosaic Private Equity (III), Ltd., (“MPE III”), (collectively “Mosaic”), a related party (see Note 7 for further details), the Company agreed to sell 1,330 shares of its Series A Preferred and common stock purchase warrants to purchase an aggregate of 1,083,334 shares of its common stock for an aggregate purchase price of $1.3 million, of which $750,000 was paid by the cancellation of secured indebtedness of the Company owed to MFS, with the remaining $580,000 to be paid in cash.
 
In addition, Mosaic shall have the option, exercisable upon written notice to the Company at any time during the 18 consecutive month period following the closing of the private placement, to purchase up to 1,000 shares of Series B Preferred of the Company at a price per share of $1,000, subject to adjustment on a dollar for dollar basis based on funding of the cash portion of the purchase price.  As a condition of closing of this transaction, the outstanding principal balance related to Short Term Notes and Unsecured Debentures of $7.7 million was exchanged for 7,720 shares of Series B Preferred.  The Company also issued seven (7) shares of Series A Preferred to MFS at a price of $1,000 per share for shares in lieu of interest related to accrued interest on an additional $100,000 in subsequent debt funding received in 2009.
 
The Company has separately accounted for the beneficial conversion feature granted to the holders of Series A Preferred and Series B Preferred.  The value of the beneficial conversion feature related to Series A Preferred and Series B Preferred is $323,453 and $772,000, respectively which is calculated as the difference between the stated conversion price of the preferred shares and the fair market value of the common stock into which the preferred shares are convertible at the commitment date.  These issuances resulted in a beneficial conversion that is a deemed dividend distribution for accounting purposes.
 
As of December 31, 2011, the Company issued a total of 499 shares of Series A Preferred for $498,500 to Mosaic under this Purchase agreement of which 244 shares were issued during the year ending December 31, 2010 for $243,500.  Each share of Series A Preferred is convertible into 695 shares of common stock.  The Company has separately accounted for the beneficial conversion feature granted in the aggregate issuance of 499 shares of Series A Preferred.  The value of the beneficial conversion feature for the aggregate issuance of the shares is $0 and $60,656 as of December 31, 2011 and 2010, respectively, which is related to the difference between the stated conversion price of the preferred shares and the fair market value of the common stock into which the preferred shares are convertible at the commitment date.  These issuances resulted in a beneficial conversion that is a deemed dividend distribution for accounting purposes.  As part of these Series A Preferred purchases, options to purchase a cumulative total of 860 shares of the Company’s Series B Preferred vested. On December 30, 2010, options to purchase a total of 860 shares of the Company’s Series B Preferred expired unexercised. As of December 31, 2011, no shares of Series A Preferred have been converted into common stock.
 
In April 2010, we completed a sale of 150 shares of Series A Preferred in a private placement to an accredited investor for an aggregate amount of $150,000 (before deducting expenses and fees related to the private placement).  A consent and waiver was obtained from the majority of the Series A Preferred holders and a waiver was obtained from a majority of the Series B Preferred holders as required in the certificate of designation. Each share of Series A Preferred is convertible into 695 shares of the Company’s common stock for a total of 104,250 shares, on an as converted basis. As of December 31, 2011, no shares of Series A Preferred have been converted into common stock. As of September 30, 2012, all of the 150 Series A Preferred shares issued in April 2010 have been converted into 104,250 shares of common stock.
 
In May 2010, we filed a Certificate of Designation to designate 813 shares of the Company’s preferred stock in Series C Preferred. The rights of the Series C Preferred are identical to Series A Preferred and each share of Series C Preferred is convertible into 556 shares of the Company’s common stock.  A consent and waiver was obtained from the majority of the Series A Preferred holders and the majority of the Series B Preferred holders as required in the certificate of designation. Subsequently, the Company issued 813 shares of the Company’s Series C Preferred at a price of $1,000 per share to an existing vendor in exchange for extinguishment of $300,000 in vendor’s secured payable and additional consideration in the form of a modification in vendor terms that are favorable to the Company and additional debt financing at terms that are significantly below market for the Company.  As a result of the transaction, the Company recognized a loss on extinguishment of debt of $512,500 as presented on the consolidated statement of operations.
 
The table below summarizes the Company’s outstanding convertible preferred stock as of September 30, 2012 and December 31, 2011:
 
   
September 30, 2012
    
December 31, 2011
  
         
(Unaudited)
                          
                                     
Convertible Preferred Stock
  
Number of
Preferred Shares
    
Number of
Common Shares
if Converted
    
Weighted Average
Conversion Price
    
Number of
Preferred Shares
    
Number of
Common Shares
if Converted
    
Weighted Average
Conversion Price
  
                                     
Series A Preferred
     1,406       1,292,492     $ 1.09       1,556       1,396,742     $ 0.95  
Series B Preferred
     5,384       2,993,504     $ 1.80       5,409       3,007,404     $ 1.80  
Series C Preferred
     813       451,750     $ 1.80       813       451,750     $ 1.80  
  Total
     7,603       4,737,746     $ 1.61       7,778       4,855,896     $ 1.51  

Common Stock
 
As of December 31, 2009, all of the authorized shares of the Company’s common stock were issued and outstanding.  In January 2010, the Company increased the number of authorized shares of its’ common stock to 16,666,667 in order to meet the reserve requirements of the convertible and other dilutive securities issued, as well as additional capacity for future equity transactions.
 
In April 2010, the Company issued 27,778 common shares for issuance costs on a secured debt transaction in a private placement (see Note 3 for further details).
 
In March 2011, the Company’s Board approved an amended and restated certificate of incorporation affecting a 1 for 180 reverse stock split of the Company’s issued and outstanding shares of common stock, effective as of April 15, 2011, (see Note 1 – Reverse Stock Split for further details).
 
In May 2012, the Company’s Board of Directors (“the Board”) and a majority of the Company’s shareholders approved an amended and restated articles of incorporation effectuating an increase in the number of authorized common shares of the Company from 16,666,667 to 35,000,000.  As required, a consent and waiver was obtained from the majority of the Series A and Series C Preferred holders in accordance with the certificate of designation.

Stock Warrants

In connection with the issuance of shares of Series A Preferred to Mosaic in 2009, the Company also issued warrants to purchase shares of common stock. The holder has the right to purchase up to 1,083,334 shares of our common stock at an exercise price equal to $0.09 per share, subject to certain adjustments for stock splits and other similar pro rata events.  The warrants may be exercised on a cashless basis at any time until June 30, 2019.  As of September 30, 2012, no warrants have been exercised.
 
The gross value of the warrants was determined using the Black-Scholes option pricing model using the following assumptions on the issuance date: expected stock price volatility of 441.2%, risk free rate of return of 3.5%; dividend yield of 0%, and a ten (10) year term.  The net value of the warrant was recorded based on its relative value of $420,487, net of related offering costs on a pro rata basis for all shares involved.
 
In December 2010, as part of the private placement of convertible debentures, the investor received a warrant to purchase 250,000 shares of the Company’s common stock (see Note 4 for further details).  The warrant is exercisable for a period of three (3) years from the date of issuance at an initial exercise price of $1.73, subject to adjustment.  The fair value of the warrants was determined using the Black-Scholes option pricing model using the following assumptions on the issuance date:  expected stock price volatility of 443.9%, risk free rate of 0.87%, dividend yield of 0%, and a three (3) year term.  The net value of the warrant was recorded based on its relative value of $138,263. The investor may exercise the warrant on a cashless basis if the shares of common stock underlying the warrant are not then registered pursuant to an effective registration statement.  The outstanding warrants are subject certain anti-dilution protection clauses which provide exercise price adjustments in the event that any common stock or common stock equivalents are issued at an effective price per share that is less than the exercise price per share.  Accordingly, the stock warrants were classified as a warrant liability on the consolidated balance sheet as of December 31, 2010.  In May 2011, all of the warrants were cancelled and exchanged as part of the May 2011 private placement (see Note 3 for further details).
 
As part of the private placements of convertible debentures in 2011, the investors received warrants to purchase an aggregate total of 2,014,657 shares of the Company’s common stock (see Note 3 for further details).  The warrants are exercisable for a period of three years from the date of issuance at an initial exercise price of $1.512, subject to adjustment.  The estimated fair value of these warrants was determined to be $639,189 using the Lattice stock option pricing model on the issuance date, assuming that there will be no dividends, using the applicable exercisable periods, a risk-free interest rate range of (0.33% - 0.93%), and an expected stock volatility range of (65.3% - 82.1%). The investor may exercise the warrant on a cashless basis if the shares of common stock underlying the warrant are not then registered pursuant to an effective registration statement.  The outstanding warrants are subject certain anti-dilution protection clauses which provide exercise price adjustments in the event that any common stock or common stock equivalents are issued at an effective price per share that is less than the exercise price per share.  Accordingly, the stock warrants are classified as a warrant liability on the accompanying consolidated balance sheets as of September 30, 2012 and December 31, 2011.
 
As part of the modifications to the 2011 convertible debentures in June, July and September 2012, the exercise period of warrants to purchase an aggregate total of 1,300,368 shares of the Company’s common stock (see Note 3 for further details) were extended from three to five years from the date of issuance at an initial exercise price of $1.512, subject to adjustment.
 
As part of the private placements of convertible debentures in November 2011, the placement agents received warrants to purchase an aggregate total of 129,412 shares of the Company’s common stock (see Note 3 for further details).  The warrants are exercisable for a period of three years from the date of issuance at an initial exercise price of $1.26 and $1.52 for 58,824 and 70,588 shares, respectively, subject to adjustment.  The estimated fair value of these warrants was determined to be $10,755 using the Lattice stock option pricing model on the issuance date, assuming that there will be no dividends, using the applicable exercisable periods, a risk-free interest rate of 0.41%, and an expected volatility of 65.3%.  The placement agent may exercise the warrant on a cashless basis if the shares of common stock underlying the warrant are not then registered pursuant to an effective registration statement.  The outstanding warrants are subject certain anti-dilution protection clauses which provide exercise price adjustments in the event that any common stock or common stock equivalents are issued at an effective price per share that is less than the exercise price per share.  Accordingly, the stock warrants are classified as a warrant liability on the accompanying consolidated balance sheets as of September 30, 2012 and December 31, 2011.
 
As part of the private placement of convertible debentures in January 2012, the investor received warrants to purchase a total of 48,000 shares of the Company’s common stock (see Note 3 for further details).  The warrants are exercisable for a period of three years from the date of issuance at an initial exercise price of $1.512, subject to adjustment.  The estimated fair value of these warrants was determined to be $6,741 using the Lattice stock option pricing model on the issuance date, assuming that there will be no dividends, using the applicable exercisable periods, a risk-free rate of return of 0.40%, and an expected stock volatility of 62.2%. As part of the June 2012 amendment to the debenture agreement, the exercise period of the warrants were extended from three years to five years.  The investor may exercise the warrant on a cashless basis if the shares of common stock underlying the warrant are not then registered pursuant to an effective registration statement.  The outstanding warrants are subject certain anti-dilution protection clauses which provide exercise price adjustments in the event that any common stock or common stock equivalents are issued at an effective price per share that is less than the exercise price per share.  Accordingly, the stock warrants are classified as a warrant liability on the accompanying consolidated balance sheets as of September 30, 2012.
 
As part of the private placement of convertible debentures in July 2012, the investor received warrants to purchase a total of 285,716 shares of the Company’s common stock (see Note 3 for further details).  The warrants are exercisable for a period of five years from the date of issuance at an initial exercise price of $1.512, subject to adjustment.  The estimated fair value of these warrants was determined to be $108,838 using the Lattice stock option pricing model on the issuance date, assuming that there will be no dividends, using the applicable exercisable periods, a risk-free rate of return of 0.62%, and an expected stock volatility of 100.7%. The investor may exercise the warrant on a cashless basis if the shares of common stock underlying the warrant are not then registered pursuant to an effective registration statement.  The outstanding warrants are subject certain anti-dilution protection clauses which provide exercise price adjustments in the event that any common stock or common stock equivalents are issued at an effective price per share that is less than the exercise price per share.  Accordingly, the stock warrants are classified as a warrant liability on the accompanying consolidated balance sheets as of September 30, 2012.
 
Expected Stock Volatility
 
Volatility is a measure of the tendency of investment returns to vary around a long-term average rate. Historical volatility is an appropriate starting point for setting this assumption. Companies should also consider how future experience may differ from the past. This may require using other factors to adjust historical volatility, such as implied volatility, peer-group volatility and the range and mean-reversion of volatility estimates over various historical periods. The peer-group utilized consisted of nine companies in 2011, in the same or similar industries as the Company. In addition, if a best estimate cannot be made, management should use the mid-point in the range of reasonable estimates for volatility. The Company estimates the volatility of its common stock in conjunction with the Company’s issuance of financing instruments and volatility is calculated utilizing the historical and estimated future volatility of the Company and its peer-group.
 
Risk-Free Rate of Return
 
The risk-free rate is based on the U.S. Treasury yield curve in effect at the time of grant for the estimated life of the option/warrant.
 
Expected Dividends
 
The Company has never paid any cash dividends on its common stock and does not anticipate paying any cash dividends in the foreseeable future. Consequently, it uses an expected dividend yield of zero.
 
Expected Term
 
The Company uses the related exercise period of the warrant or option as the expected term.
 
A summary of the warrants issued in connection with financing transactions is presented in the table below:
 
   
Number of
Shares
    
Weighted Average Exercise Price
  
             
Outstanding and Exercisable at December 31, 2011
     3,227,402     $ 1.03  
                 
Granted (unaudited)
     333,716     $ 1.51  
Exercised (unaudited)
     -     $ -  
Cancelled, forfeited or expired (unaudited)
     -     $ -  
                 
Outstanding and Exercisable at September 30, 2012 (unaudited)
     3,561,118     $ 1.08  

The following table summarizes information about warrants outstanding and exercisable as of September 30, 2012:
 
   
Outstanding
    
Exercisable
  
                                     
Range of Exercise Price
  
Number of
Shares
    
Weighted Average
Exercise Price
    
Weighted Average
Remaining Life
(Years)
    
Number of
Shares
    
Weighted Average
Exercise Price
    
Weighted Average
Remaining Life
(Years)
  
                                     
$0.09
     1,083,333     $ 0.09       6.75       1,083,333     $ 0.09       6.75  
                                                 
  $1.26 - $1.52
     2,477,785     $ 1.51       3.52       2,477,785     $ 1.51       3.52