NOTE 5 – CONVERTIBLE DEBT

HEP Investments, LLC

On December 2, 2011, the Company and HEP Investments, LLC, a Michigan limited liability company (“Lender”), entered into the following documents, effective as of December 1, 2011, as amended through April 28, 2015: (i) a Loan Agreement under which the Lender has agreed to advance up to $8,500,000 to the Company, subject to certain conditions, (ii) a Convertible Secured Promissory Note in the principal amount of $8,500,000 (“Note”) (of which $6,927,200 has been advanced as of September 30, 2015)  and (iii) a Security Agreement, under which the Company granted the Lender a security interest in all of its assets and (iv) an Intellectual Property security agreement under which the Company and its subsidiaries granted the Lender a security interest in all their respective intellectual properties, including patents, in each case order to secure their respective obligations to the Lender under the Note and related documents.  In addition, the Company’s subsidiaries have guaranteed the Company’s obligations under the Note.  The Company has also made certain agreements with the Lender which shall remain in effect as long as any amount is outstanding under the Loan.  These agreements include an agreement not to make any change in the Company’s senior management, without the prior written consent of the Lender. Two representatives of the Lender will have the right to attend Board of Director meetings as non-voting observers.

During the first quarter of 2015, the Company issued to the Lender for aggregate consideration of $362,500, two 11% convertible notes, and warrants to purchase 362,500 shares of common stock, at an exercise price of $.10 for a term of five years.  The Convertible Notes accrue interest at the rate of 11% per annum, are non-amortizing, have a term of 2 years, subject to the Lender’s right to extend the term as noted above (rolling 30 day extensions of all due or past due installments until notice is given to the Company to the contrary), and are convertible, at any time prior to the maturity date into shares of common stock, at a rate equal to $.10 per share.

During the second quarter of 2015, the Company issued to the Lender for aggregate consideration of $705,000, three 11% convertible notes, and warrants to purchase 705,000 shares of common stock, at an exercise price of $.10 for a term of five years.  The Convertible Notes accrue interest at the rate of 11% per annum, are non-amortizing, have a term of 2 years, subject to the Lender’s right to extend the term as noted above (rolling 30 day extensions of all due or past due installments until notice is given to the Company to the contrary), and are convertible, at any time prior to the maturity date into shares of common stock, at a rate equal to $.10 per share.

During the third quarter of 2015, the Company issued to the Lender for aggregate consideration of $500,000, two 11% convertible notes, and warrants to purchase 500,000 shares of common stock, at an exercise price of $.10 for a term of five years.  The Convertible Notes accrue interest at the rate of 11% per annum, are non-amortizing, have a term of 2 years, subject to the Lender’s right to extend the term as noted above (rolling 30 day extensions of all due or past due installments until notice is given to the Company to the contrary), and are convertible, at any time prior to the maturity date into shares of common stock, at a rate equal to $.10 per share.

During the nine months ended September 30, 2015, the Company recorded a deferred debt discount, related to the $1,567,500 of Notes described previously, in the amount of $1,416,501, to reflect the beneficial conversion feature of the convertible debt and fair value of the warrants pursuant to Emerging Issues Task Force (“EITF”) 00-27: Application of EITF 98-5, “Accounting for Convertible Securities with Beneficial Conversion Features on Contingently Adjustable Conversion Rates,” to certain convertible instruments. In accordance with EITF 00-27, the Company valued the beneficial conversion feature and recorded the amount of $1,319,649 as a reduction to the carrying amount of the convertible debt and as an addition to paid-in capital. Additionally, the relative fair value of the warrants was calculated and recorded at $96,852 as a further reduction to the carrying amount of the convertible debt and an addition to additional paid-in capital. The Company is amortizing the debt discount over the term of the debt.   Amortization of discounts was $1,414,975 for the nine months ended September 30, 2015.   

As of September 30, 2015, amounts advanced under the Note are convertible into the Company’s restricted common stock according to the following schedule: (A) $1,652,200 at $.10 per share, (B) $2,600,000 at $.12 per share, (C) $1,285,000 at $.15 per share, (D) $640,000 at $.22 per share, and (E) $750,000 at $.30 per share, (ii) bear interest at the rate of 11% per annum and (iii) must be repaid as follows:  accrued interest must be paid on the first and second anniversary of the Note and unpaid principal not previously converted into common stock must be repaid on the second anniversary of the Note, with the provision that the first installment under the Note of $500,000 due on December 1, 2013 was initially extended to June 1, 2014.  In July 2014, the Lender agreed to rolling 30 day extensions of all due or past due installments until notice is given to the Company to the contrary.  As of September 30, 2015, a total of $2,470,000 in $.12 convertible debt has become due.   The Company determined that the modification of these Notes was not a substantial modification in accordance with ASC 470-50, “Modifications and Extinguishments.”  The Lender has converted $60,000 of the debt (convertible at $.12 per share) through the date of this report.  Any Note, that has not yet matured, may be prepaid upon sixty days written notice, provided that the Company shall be required to pay a prepayment premium equal to 5% of the amount repaid.

Other Debt

On February 7, 2014, the holders of $70,000 of 1% convertible debentures converted their debentures into 950,000 shares of the Company’s common stock.  On April 27, 2014, the holders of $70,600 of 1% convertible debentures converted their debentures into 1,088,000 shares of the Company’s common stock.  

In September 2014, the Lender of the 1% convertible debentures agreed to rolling 30 day extensions until notice is given to the Company to the contrary.  The Company determined that the modification of these Notes was not a substantial modification in accordance with ASC 470-50, “Modifications and Extinguishments.”

Amortization of the debt discount on the remaining notes was $1,414,975 and $1,285,295 for the nine months ended September 30, 2015 and 2014, respectively.