XOTC:MBMI Quarterly Report 10-Q Filing - 3/31/2012

Effective Date 3/31/2012

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U. S. SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

Form 10-Q

(Mark One)

S QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE QUARTERLY PERIOD ENDED MARCH 31, 2012

 

£ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE TRANSITION PERIOD FROM  _________ TO ___________

 

Commission File Number: 000-51443

 

 

  

RAPTOR NETWORKS TECHNOLOGY, INC.

(Exact name of registrant as specified in its charter)

 

Colorado   84-1573852

(State or other jurisdiction of

incorporation or organization)

 

(I.R.S. Employer

Identification No.)

 

41 Howe Lane

Freehold, New Jersey 07728

(Address of Principal Executive Offices)

 

(732) 252-5146

(registrant’s telephone number)

 

Not applicable

(Former name, former address and former fiscal year, if changed since last report)

  

 

 

Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.  Yes x    No o

 

Indicate by checkmark whether the registrant has submitted electronically and posted on its corporate Website, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of regulation S-T (paragraph 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).      Yes x    No ¨

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company.  See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

 

Large accelerate filer ¨ Accelerated filer ¨
Non-accelerated filer ¨   ( Do not check if a smaller reporting company Smaller reporting company x

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).  Yes ¨    No x

 

As of May 15, 2012, there were 198,009,290 shares of the issuer’s common stock, $0.001 par value, outstanding.

 

 

 

 
 

 

  Page
   
PART I - FINANCIAL INFORMATION  
   
Item 1.  Financial Statements  
   
Consolidated Balance Sheets as of March 31, 2012 (unaudited) and December 31, 2011 (audited) F-1
   
Consolidated Statements of Operations for the Three Months  Ended March 31, 2012 and 2011 (unaudited) F-2
   
Consolidated Statement of Stockholders’ Deficit for the Three Months  Ended March 31, 2012 (unaudited) F-3
   
Consolidated Statements of Cash Flows for the Three Months Ended March 31, 2012 and 2011 (unaudited) F-4
   
Notes to Consolidated Financial Statements (unaudited) F-5
   
Item 2.  Management’s Discussion and Analysis or Plan of Operation 1
   
Item 4T.  Controls and Procedures 4
   
PART II - OTHER INFORMATION  
   
Item 1.  Legal Proceedings 5
   
Item 1A. Risk Factors  5
   
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds 5
   
Item 3.  Defaults Upon Senior Securities 5
   
Item 4.  Mine Safety Disclosures 5
   
Item 5.  Other Information 5
   
Item 6.  Exhibits 5
   
Signatures 5
   
Exhibits Filed with this Report on Form 10-Q 6

 

i
 

  

RAPTOR NETWORKS TECHNOLOGY, INC.

CONSOLIDATED BALANCE SHEETS

 

   March 31, 2012   December 31, 2011 
   (UNAUDITED)     
ASSETS          
CURRENT ASSETS          
Cash  $-   $2,323 
           
Total current assets   -    2,323 
           
TOTAL ASSETS  $-   $2,323 
           
LIABILITIES AND STOCKHOLDERS' DEFICIT          
           
CURRENT LIABILITIES          
Accounts payable and accrued expenses   1,304,618   $1,044,056 
Detachable warrant liabilities   82,190    392,310 
Conversion option liabilities   10,820,736    11,789,870 
Senior convertible notes payable   11,012,854    11,012,854 
           
Total current liabilities   23,220,398    24,239,090 
           
TOTAL LIABILITIES   23,220,398    24,239,090 
           
COMMITMENTS AND CONTINGENCIES        - 
           
STOCKHOLDERS' DEFICIT          
Preferred stock, no par value; 5,000,000 shares authorized;          
no shares issued and outstanding   -    - 
Common stock, $0.001 par; 200,000,000 shares authorized;          
198,009,290 shares issued and outstanding   198,009    198,009 
Additional paid-in capital   66,396,438    66,396,438 
Accumulated deficit   (89,814,845)   (90,831,214)
           
Total stockholders' deficit   (23,220,398)   (24,236,767)
           
TOTAL LIABILITIES AND STOCKHOLDERS' DEFICIT  $-   $2,323 

 

The accompanying notes are an integral part of these consolidated financial statements.

 

F-1
 

 

RAPTOR NETWORKS TECHNOLOGY, INC.

CONSOLIDATED STATEMENTS OF OPERATIONS 

 

   For the Three Months Ended 
   March 31,   March 31, 
   2012   2011 
         
Continuing Operations:          
OPERATING EXPENSES          
General and administrative  $197   $11,325 
           
Total operating expenses   197    11,325 
           
Loss from Continuing Operations   (197)   (11,325)
           
OTHER INCOME (EXPENSE)          
Interest income   -    1 
Loss on sale of property and equipment   -    (1,697)
Change in fair value of conversion option and warrant liabilities   1,279,254    (1,840,624)
Amortization of discount on convertible debt   -    (159,588)
Interest expense   (262,688)   (267,590)
           
Total other income (expense)   1,016,566    (2,269,498)
           
Income (loss) before income taxes   1,016,369    (2,280,823)
           
Income tax benefit   -    - 
           
Net income (loss) from continuing operations   1,016,369    (2,280,823)
           
Discontinued operations:          
Gain on disposal of discontinued operations   -    484,156 
Loss from discontinued operations   -    (519,871)
           
Loss from discontinued operations, net of tax   -    (35,715)
           
NET INCOME (LOSS)  $1,016,369   $(2,316,538)
           
Income (loss) per share - basic          
Continuing operations  $0.01   $(0.03)
Discontinued operations  $-   $- 
Weighted average number of shares outstanding - basic   198,009,290    88,080,979 
           
Income (loss) per share - diluted          
Continuing operations  $0.01   $(0.03)
Discontinued operations  $-   $- 
Weighted average number of shares outstanding - basic   198,009,290    88,080,979 

 

The accompanying notes are an integral part of these consolidated financial statements.

 

F-2
 

 

RAPTOR NETWORKS TECHNOLOGY, INC.

CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY (DEFICIT)

FOR THE THREE MONTHS ENDED MARCH 31, 2012 

 

           Additional         
   Common Stock   Paid in   Accumulated     
   Shares   Amount   Capital   Deficit   Total 
                     
Balance, January 1, 2012   198,009,290    198,009    66,396,438    (90,831,214)   (24,236,767)
                          
Net loss   -    -    -    1,016,369    1,016,369 
                          
Balance, March 31, 2012   198,009,290   $198,009   $66,396,438   $(89,814,845)  $(23,220,398)

 

The accompanying notes are an integral part of these consolidated financial statements.

 

F-3
 

 

RAPTOR NETWORKS TECHNOLOGY, INC.

CONSOLIDATED STATEMENTS OF CASH FLOWS 

 

   For the three months ended 
   March 31,   March 31, 
   2012   2011 
CASH FLOWS FROM OPERATING ACTIVITIES:          
Net income (loss)  $1,016,369   $(2,316,538)
Adjustments to reconcile net income (loss) to net cash used in operating activities:          
Depreciation   -    4,332 
Amortization of discount on convertible debt and debt issuance costs   -    159,588 
Loss on sale of property and equipment   -    1,697 
Change in fair value of conversion option and warrant liabilities   (1,279,254)   1,840,624 
Change in inventory reserve   -    (74,703)
Changes in operating assets and liabilities:          
Accounts receivable   -    30,624 
Inventories   -    91,275 
Prepaid expenses and other assets   -    44,679 
Accounts payable and accrued liabilities   260,562    218,625 
Deferred revenue   -    (10,987)
Net cash used in operating activities   (2,323)   (10,784)
CASH FLOWS FROM INVESTING ACTIVITIES:          
Proceeds from sale of property and equipment   -    500 
Net cash provided by investing activities   -    500 
Net decrease in cash and cash equivalents   (2,323)   (10,284)
CASH AT BEGINNING OF PERIOD   2,323    82,777 
CASH AT END OF PERIOD  $-   $72,493 
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:          
Cash paid for interest  $-   $2,995 
Cash paid for income taxes  $-   $- 
SUPPLEMENTAL DISCLOSURE OF NON-CASH FINANCING AND INVESTING ACTIVITIES:          
Accrued interest payable added to principal balance  $262,688   $252,508 
Increase in debt discount for conversion option liabilities resulting from accrued interest added to principal balance  $-   $135,095 

  

F-4
 

 

  1. General

 

Basis of Presentation

 

The accompanying consolidated financial statements have been prepared by Raptor Networks Technology, Inc. (the “Company”) without audit (unless otherwise indicated) pursuant to the rules and regulations of the Securities and Exchange Commission (“SEC”).  Certain information and footnote disclosures normally included in financial statements prepared in accordance with generally accepted accounting principles have been condensed or omitted as allowed by such rules and regulations, and management believes that the disclosures are adequate to make the information presented not misleading.  These consolidated financial statements include all of the adjustments which, in the opinion of management, are necessary for a fair presentation of financial position and results of operations.  All such adjustments are of a normal and recurring nature.  The March 31, 2012 consolidated balance sheet was derived from audited financial statements as of December 31, 2011.  These financial statements should be read in conjunction with the audited financial statements at December 31, 2011 included in the Company’s most recent annual report on Form 10-K.  Results of operations for the three months ended March 31, 2012 are not necessarily indicative of the results of operations expected for the full year or for any other period. 

 

Going Concern

 

The accompanying consolidated financial statements have been prepared in conformity with accounting principles generally accepted in the United States of America, which contemplate continuation of the Company as a going concern.  The Company has incurred a net loss of $2,316,538 and a net loss from operations of $47,040 for the three months ended March 31, 2012.  Additionally, the Company also has an accumulated deficit of $86,708,586 and a working capital deficit of $20,149,847 as of March 31, 2011, of which $8,777,772 relates to the fair value of derivative financial instruments.  In September 2008, the Company shifted its principal operating model from product sales to licensing enabling a reduction in headcount, footprint and infrastructure that reduced operating expense run rates substantially.  This shift in business model has not been successful as the Company has not generated any revenues from licensing agreements until July 5, 2011, at which time the Company entered into an agreement with California Capital Equity, LLC (“CCE”) granting CCE an exclusive license (even as to the Company) leaving the Company without any continuing rights in or to its intellectual property.  For further details on this transaction we refer to the disclosures made under the heading “Subsequent Events” in this quarterly report and we refer to the Form 8-K filed by the Company on July 11, 2011.  In addition, on August 1, 2011 all of the Company’s remaining assets were sold during a public foreclosure sale.  The Company’s service contract with a government prime contractor enabling the Company to fund the development of a next generation “hybrid fabric” product provided the majority of the revenue in the quarter under review, absorbing the Company’s current expense run rates.  The funds allocated to that contract are alone insufficient to complete product development and this specific funding stream will be depleted as of the end of first quarter and will support expense run rates until June 2011.  Taking into account the current status of the U.S. Government budget, we believe it is unlikely that we will find a replacement for the expiring contract revenue prior to January 2012.

 

The items discussed above raise substantial doubts about the Company's ability to continue as a going concern.

 

Additionally, during 2010, the 2007 Notes, April 2008 Notes and July 2008 Notes (see Note 4) matured.  The Company did not pay the principal balances and accrued interest at maturity or thereafter.  As mentioned hereafter under the heading “Subsequent Events,” the noteholders exercised their right as a secured lender against the Company’s assets and held a public foreclosure sale of substantially all of the Company’s assets and acquired all of these assets at a price of $100,000, which was credited against the outstanding notes on August 1, 2011.  As a result of the public sale on August 1, 2011, the Company retains no material assets with which to continue its operations.  The Company is seeking companies or businesses with an interest in utilizing the Company as a public shell vehicle and in August 2011 has signed a non-binding “Letter of Intent” with an interested party for a possible merger.  There can be no assurance, however, that such a transaction will ultimately be consummated.

 

 

F-5
 

 

In light of these factors, management believes that a comprehensive financial restructuring with the utilization of the public shell entity as a reverse merger vehicle for a new entity is the only way to preserve any value for the public shareholders. Should such a transaction be consummated, the resultant debt for equity exchange will most likely result in a near total loss of shareholder value.   Should a restructuring be unachievable, Raptor will permanently cease operations resulting in a total loss of shareholder value.

 

The financial statements do not include any adjustments relating to the recoverability and reclassification of recorded asset amounts or amounts and classification of liabilities that might be necessary should the Company be unable to continue as a going concern.

 

Summary of Significant Accounting Policies

 

For a complete discussion of the Company’s significant accounting policies, please refer to the Company’s annual report on Form 10-K for the fiscal year ended December 31, 2010.

 

Recent Accounting Pronouncements

 

There have been no recent accounting pronouncements or changes in accounting pronouncements during the three months ended March 31, 2011, as compared to the recent accounting pronouncements disclosed in the Company’s Annual Report on Form 10-K that are of material significance, or have potential material significance, to the Company.

 

2. Inventories

 

Inventories consist of the following as of:

 

   March 31,
2012
   March 31,
2011
 
           
Raw materials  $0   $397,549 
Finished goods   0    272,344 
           
    0    669,893 
Allowance for obsolescence   (0)   (170,803)
           
Inventories, net  $0   $499,090 

 

  3. Stock-Based Compensation

 

2005 Stock Plan

 

The Company has one stock-based compensation plan, the 2005 Stock Plan (the “2005 Plan").  Under the 2005 Plan, 3,000,000 shares of stock are reserved for issuance to eligible employees, non-employee directors and certain consultants.  The 2005 Plan is administered by the board of directors or committee of the board of directors, who have sole discretion to set vesting, expiration and other terms of awards under the 2005 Plan.  As of March 31, 2011, the 2005 Plan had a total of 612,000 options outstanding and 2,288,000 shares available for future grants.

 

Non-Plan Options

 

Prior to approval of the 2005 Plan, the Company granted stock options out-of-plan.  These non-plan options provided for the periodic issuance of stock options to employees and non-employee members of the board of directors.  The vesting period for the non-plan stock options was over a three-year term, commencing on the first anniversary of the date of grant.  The maximum contractual term of stock options granted under these out-of-plan options was eight years.  As of March 31, 2011, there were 850,000 non-plan options outstanding.

 

 

F-6
 

 

 

Stock-based compensation cost is measured at the grant date, based on the fair value of the award, and is recognized as an expense over the requisite service period.  The fair value is determined using the Black-Scholes Option pricing model.

 

No options were granted during the three months ended March 31, 2011 or 2010.

 

For the three months ended March 31, 2011 and 2010, the Company recognized $0 and $54,219, respectively, of stock-based compensation costs as a result of the issuance of options to employees.  The 2010 compensation cost includes a one-time charge of $28,812 for the true-up of stock options that became fully vested during the quarter.  These costs are reflected in operating expenses.

 

Stock option activity was as follows for the three months ended March 31, 2011:

 

   Number of
Options
   Weighted-
Average
Exercise Price
   Weighted-Average
Remaining
Contract Term
(Years)
   Aggregate
Intrinsic
Value
 
                     
Outstanding, January 1, 2011   1,462,000   $1.21    2.79      
Granted   -    -           
Forfeited / Expired   -    -           
Exercised   -    -           
                     
Outstanding, March 31, 2011   1,462,000   $1.21    2.63   $- 
Exercisable, March 31, 2011   1,462,000   $1.21    2.63   $- 

 

 

As of January 1, 2011, all stock options had vested and, accordingly, all stock-based compensation cost was recognized.

 

  4. Securities Purchase Agreements

 

The Company entered into four separate securities purchase agreements (the “2006 SPA,” the “2007 SPA,” the “April 2008 SPA” and the “July 2008 SPA,” collectively the “SPAs”) with three institutional investors in connection with private placement transactions that provided for, among other things, the issuance of senior convertible notes (the “2006 Notes,” the “2007 Notes,” the “April 2008 Notes” and the “July 2008 Notes,” collectively the “Notes”), warrants to purchase shares of common stock (the “2006 Warrants,” the “2007 Warrants,” “the April 2008 Warrants,” the “July 2008 Warrants” and the “Replacement Warrants,” collectively the “Warrants”) and the issuance of common stock (the “April 2008 Stock” and the “July 2008 Stock”).  Following is a summary of the securities issued pursuant to the terms of the SPAs.

 

 

F-7
 

 

 

 

Transaction  Date of
Financing
  Initial Principal
Amount of
Notes
   Series of
Warrants
Issued
  Initial
Number of
Warrants
Issued to the
Investors
   Shares of
Common
Stock Issued
 
                      
2006 SPA  July 30, 2006 (1)  $8,804,909   L and M   39,797,031    - 
2007 SPA  July 31, 2007   3,500,000   N, O and P   6,047,886    - 
April 2008 SPA  April 1, 2008   3,125,000   Q   6,250,000    3,125,000 
July 2008 SPA  July 28, 2008   1,250,000   R   8,750,000(2)   1,250,000 
      $16,679,909       60,844,917    4,375,000 

 

(1) The information presented reflects the January 22, 2007 amendment.

(2) Includes 2,500,000 Series R warrants and 6,250,000 Replacement Warrants.

 

On July 27, 2010, the Company issued an unsecured convertible note payable (the “July 2010 Note”) to one of the investors from the previous financings in the principal amount of $176,471.  All outstanding notes payable are collectively referred to as (the “Notes”).

 

The Company allocated the proceeds of the April 2008, July 2008 and July 2010 Notes to the individual financial instruments included in the transactions based on their relative estimated fair values as follows:

 

   April 2008
Notes
   July 2008
Notes
   July 2010
Notes
 
Total proceeds  $3,125,000   $1,250,000   $176,471 
Allocated to:               
Common stock   2,531,250    675,000    - 
Warrants   2,993,750    856,750    - 
Conversion option   1,002,813    142,500    97,973 
    6,527,813    1,674,250    97,973 
Debt discount   (3,125,000)   (1,250,000)   (97,973)
Cost of financing convertible notes  $3,402,813   $424,250   $- 

 

The fair value of the common stock was based on the closing market price of the Company’s common stock on the date of the transaction.  The fair values of the warrants and conversion options were based on the Black-Scholes Option pricing model.

 

All of the SPAs contain registration rights agreements which require the Company to file registration statements with the SEC for the resale of the shares of common stock underlying all of the Notes, Warrants and common stock issued.  The Company is required to maintain the effectiveness of the registration statements through the latest date at which the Notes can be converted or the Warrants can be exercised.  Notwithstanding other remedies available under the SPAs, the Company will be required to pay liquidated damages equal to 2% of the principal amount of the Notes on the date of failure and 2% of the principal amount of the Notes every 30 th day thereafter (or for a pro rated period if less than 30 days) for failure to timely file the registration statements or have them declared effective by the SEC and failure to maintain the effectiveness of the registration statements, subject to certain grace periods.  Any liquidated damages not paid timely will accrue interest at the rate of 2% per month.  Registration penalties under SPAs are capped at 12.5% of the principal amount of the respective Notes.  The maximum registration penalties under the Notes are as follows:

 

 

F-8
 

 

 

Transaction  Maximum Registration Penalty 
2006 SPA  $1,100,614 
2007 SPA   437,500 
April 2008 SPA   390,625 
July 2008 SPA   156,250 
   $2,084,989 

 

The Company is required to assess its potential liability with respect to registration rights agreements.  On May 29, 2008, the investors agreed to delay payments in connection with the registration rights agreement contained in the April 2008 SPA and the registration of the shares underlying the L-1 and L-2 warrants.  The deadline has been indefinitely extended by the investors.  As such, no liability related to the registration rights agreements has been recorded in the accompanying consolidated financial statements.

 

Significant events of default under the SPAs include:

 

  · The failure of any registration statement to be declared effective by the SEC within 60 days after the date required by the applicable registration rights agreement or the lapse or unavailability of such registration statement for more than 10 consecutive days or more than an aggregate of 30 days in any 365-day period (other than certain allowable grace periods).

 

  · The failure to issue unlegended certificates within 3 trading days after the Company receives documents necessary for the removal of the legend.

 

In January 2007, the Company amended the 2006 SPA (the “2006 Amended SPA”).  The amendments included, but were not limited to, a waiver of all fees, penalties and defaults as of January 19, 2007 which related to registration statement filing failures and/or effectiveness failures, as described in the 2006 SPA, an increase in the principal amount of the 2006 Notes from an aggregate of $5 million to an aggregate of $7.2 million, issuance of an additional 5,688,540 2006 Warrants which increased the aggregate number of shares of common stock issuable upon exercise of the Series L-1 Warrants from an aggregate of 17,065,623 shares to an aggregate of 22,754,163 shares and a reduction in the exercise price of the Series L-1 Warrants and the Series M-1 Warrants from $0.5054 per share to $0.43948 per share.  The Company did not receive any additional cash consideration for these amendments.

 

Additionally, pursuant to the terms of the 2006 Amended SPA, the Company entered into a securities purchase agreement with one of the existing institutional investors in a private placement transaction providing for, among other things, the issuance of senior convertible notes (the “2006 Amended Notes”) in the principal amount of $1.6 million, Series L-2 Warrants to purchase up to 7,281,332 shares of common stock and Series M-2 Warrants to purchase up to 2,366,433 shares of common stock.  The Series L-2 Warrants were immediately exercisable.  The Series M-2 warrants will become exercisable only upon a mandatory conversion of the 2006 Notes, as defined in the 2006 Notes.  Both the Series L-2 Warrants and Series M-2 Warrants have an exercise price of $0.43948 per share and expire on July 31, 2013.

The April 2008 SPA amended the 2007 Notes and the 2007 Warrants.  Pursuant to the 2008 SPA, the conversion prices of the 2007 Notes and the exercise price of the 2007 Warrants were reduced from $1.20 to $0.50.  The April 2008 SPA had no effect on the 2006 Notes.  The July 2008 SPA amended the exercise price of the Series Q warrants from $1.00 to $0.50.

 

The April 2008 SPA also amended the terms of the Series M-1 and M-2 Warrants to eliminate the contingency provisions and therefore, the Series M-1 and Series M-2 warrants became immediately exercisable upon the effective date of the April 2008 SPA.

 

The conversion price of the Notes and the exercise price of the Warrants are subject to customary anti-dilution provisions for stock splits and the like, and are also subject to full-ratchet anti-dilution protection such that if the Company issues or is deemed to have issued certain securities at a price lower than the then applicable conversion or exercise price, then the conversion or exercise price will immediately be reduced to such lower price.

 

 

F-9
 

 

 

The Notes and the Warrants contain certain limitations on conversion or exercise, including that a holder of those securities cannot convert or exercise those securities to the extent that upon such conversion or exercise, that holder, together with the holder’s affiliates, would own in excess of 4.99% of the Company’s outstanding shares of common stock (subject to an increase, upon at least 61-days’ notice, by the investor to the Company, of up to 9.99%).

 

Notes

 

Information relating to the Notes is as follows:

 

                      As of March 31, 2012 
Transaction  Initial
Principal
Amount
   Interest
Rate
(4), (5), (6)
   Maturity
Date
  Initial
Fixed
Conversion
Price
   Current
Fixed
Conversion
Price
   Principal
Balance
   Unamortized
Discount
   Carrying Value 
2006 Notes (1)  $8,804,909    9.25%(3)  7/31/2008  $0.44   $0.44   $4,987,137   $-   $4,987,137 
2007 Notes (2)   3,500,000    9.25%  8/1/2010  $1.21   $0.50    3,084,046    -    3,084,046 
April 2008 Notes (7)   3,125,000    10.00%  3/31/2010  $1.00   $1.00    2,288,392    -    2,288,392 
July 2008 Notes (7)   1,250,000    10.00%  7/28/2010  $1.00   $1.00    576,808    -    576,808 
July 2010 Note (7)   176,471    15.00%  7/27/2011  $1.00   $1.00    176,471    (32,658)   143,813 
   $16,856,380                     $11,112,854   $(32,658)  $11,080,196 

 

(1)All information presented reflects amendments made in January 2007.
(2)Fixed conversion price reflects the effect of anti-dilution provision as a result of the April 2008 SPA.
(3)The interest rate may be reduced to 7% at the beginning of each quarter if certain conditions are met.  No such conditions have been met to date.
(4)The interest rates for the 2006, 2007, April and July 2008 Notes increase to 15% upon the occurrence of an event of default.
(5)The interest rate on the July 2010 Note increases to 21% upon the occurrence of an event of default.
(6)Interest is calculated on the basis of a 360 day year.
(7)Interest for the first two years of the April 2008 Notes and July 2008 Notes was deducted from the proceeds.  Interest for the first year of the July 2010 Note was deducted from the proceeds.  Prepaid interest is reflected in the accompanying consolidated balance sheets.


 

The Company may elect to make monthly installment payments in cash or in shares of the Company’s common stock.

 

The maturity date of the Notes may be extended at the option of the investors so long as there is not an event of default.

 

During 2010, the 2007 Notes, April 2008 Notes and July 2008 Notes matured.  The Company did not pay the principal balances and accrued interest at maturity or thereafter.  The note holders have demanded repayment of all amounts due under the Notes.  The Company was unable to make any payments on the Notes and on August 1, 2011, the note holders foreclosed on substantially all assets of the Company.

 

The July 2010 Notes matured on July 31, 2011 and the Company did not repay the principal.

 

The 2006 and 2007 Notes are convertible into shares of common stock at the option of the holder at the lower of the fixed conversion price or the optional conversion price, defined as 90% of the arithmetic average of the weighted-average price of the common stock for the 5 consecutive trading days immediately preceding the conversion date.  However, if the weighted average price for the 20 trading days preceding the date of conversion exceeds $1.00, the conversion price is computed as 92.5% of the weighted average price of the common stock for the 5 consecutive trading days immediately preceding the conversion date.  However, the Company may, at its option, redeem in cash, up to an amount equal to 20% of the aggregate dollar trading volume of the Company’s common stock over the prior 20-trading day period on the 2007 Notes.

 

 

F-10
 

 

 

Subject to certain conditions, the Company may require the investors to convert up to 50% of the 2006 Notes at any time when the shares of the Company’s common stock are trading at or above 150% of the initial conversion price or up to 100% of the 2006 Notes at any time when the shares of the Company’s common stock are trading at or above 175% of the initial conversion price.  The 2006 Notes contain certain limitations on optional and mandatory conversion.  Under certain conditions, the Company may require investors to convert up to either 50% or 100% of the outstanding balance of the 2007 Notes at any time the Company shares are trading at or above $1.80 or $2.11, respectively.

 

The April 2008 Notes are convertible into shares of common stock at the lower of the fixed conversion price or the optional conversion price, defined as 85% of the arithmetic average of the weighted-average price of the common stock for the 5 consecutive trading days immediately preceding the conversion date.  However, following the disclosure of an SEC event, as defined in the July 2008 Notes, the conversion price will be computed using the lowest of (i) 50% of the arithmetic average of the weighted average price for the 30 trading days preceding the date of conversion; (ii) 50% of the closing price of the common stock on the trading day preceding the date of conversion; or (iii) 50% of the closing price of the common stock on the date preceding the SEC event.

 

The July 2008 Notes are convertible into shares of common stock at the lower of the fixed conversion price or the optional conversion price, defined as the lesser of (i) 85% of the arithmetic average of the weighted-average price of the common stock for the 30 consecutive trading days immediately preceding the conversion date and (ii) 85% of the arithmetic average of the weighted-average price of the common stock for the 3 lowest trading days during the 30 consecutive trading days immediately preceding the conversion date.  However, following the disclosure of an SEC event, as defined in the April 2008 Notes, the conversion price will be computed using the lowest of (i) 50% of the amounts determined as above; (ii) 50% of the closing price of the common stock on the trading day preceding the date of conversion; or (iii) 50% of the closing price of the common stock on the date preceding the SEC event.

 

The Notes are secured by a first priority perfected security interest in all of the Company's assets and the common stock of the Company’s subsidiary.  Additionally, the Notes are guaranteed by the Company’s subsidiary.

 

Significant events of default under the Notes include:

 

  · The failure of any registration statement to be declared effective by the SEC within 60 days after the date required by the applicable registration rights agreement or the lapse or unavailability of such registration statement for more than 10 consecutive days or more than an aggregate of 30 days in any 365-day period (other than certain allowable grace periods).

 

  · The suspension from trading or failure of the common stock to be listed for trading on the OTC Bulletin Board or another eligible market for more than 5 consecutive trading days or more than an aggregate of 10 trading days in any 365-day period.

 

  · The failure to issue shares upon conversion of the Notes or for more than 10 business days after the relevant conversion date or a notice of the Company’s intention not to comply with a request for conversion.

 

  · The Company’s failure to pay any amount of principal, interest, late charges or other amounts when due.

 

If there is an event of default, the investors have the right to redeem all or any portion of the Notes, at the greater of (i) up to 125% of the sum of the outstanding principal, interest and late fees, depending on the nature of the default, and (ii) the product of (a) the greater of (1) the closing sale price for the Company’s common stock on the date immediately preceding the event of default, (2) the closing sale price for the Company’s common stock on the date immediately after the event of default and (3) the closing sale price for the Company’s common stock on the date an investor delivers its redemption notice for such event of default, multiplied by (b) 130% of the number of shares into which the Notes (including all principal, interest and late fees) may be converted.

 

 

F-11
 

 

 

In the event of a default or upon the occurrence of certain fundamental transactions as defined in the 2007 Notes, the investors will have the right to require the Company to redeem the 2007 Notes at a premium.  In addition, at any time on or after August 1, 2010, the investors may accelerate the partial payment of the 2007 Notes by requiring that the Company convert at the lower of the then conversion price or a 7.5% or 10.0% discount to the recent volume weighted average price of the Company’s common stock, or at the option of the Company, redeem in cash, up to an amount equal to 20% of the aggregate dollar trading volume of the Company’s common stock over the prior 20-trading day period.

 

Warrants

 

In connection with the SPAs, the Company issued detachable warrants as follows:

 

Series of
Warrants
  Initial Number of Warrants
Issued
   Initial
Exercise
Price
   Current
Exercise
Price
   Term (4)  Additional
Warrant
Grants (6)
   Warrants Outstanding at March 31, 2012   Fair Value of Warrant Liability as of March 31, 2012   Fair Value of Warrant Liability as of December 31, 2010 
L-1 (1)   22,754,163   $0.505   $0.439   7 years   -    22,754,163   $191,135   $170,656 
L-2 (1)   7,281,332   $0.505   $0.439   7 years   -    7,281,332    61,163    54,610 
M-1 (1), (3)   7,395,103   $0.505   $0.439   7 years   -    7,395,103    62,119    55,463 
M-2 (1), (3)   2,366,433   $0.505   $0.439   7 years   -    2,366,433    19,878    17,748 
N (2)   2,909,636   $1.203   $0.500   7 years   4,090,364    7,000,000    84,700    130,900 
O (2), (5)   1,891,263   $1.203   $0.500   7 years   2,658,737    4,550,000    N/A    N/A 
P (2)   1,246,987   $1.203   $0.500   7 years   1,753,013    3,000,000    36,300    56,100 
Q (7), (8)   6,250,000   $1.000   $0.500   7 years   -    6,250,000    186,875    363,125 
R   2,500,000   $0.500   $0.500   7 years   -    2,500,000    74,750    145,250 
Replacement (9)   6,250,000   $1.000   $1.000   7 years   -    6,250,000    N/A    N/A 
    60,844,917                 8,502,114    69,347,031   $716,920   $993,852 

 

(1) All information presented reflects amendments made in January 2007.
(2) Current exercise price reflects the effect of anti-dilution provision as a result of the April 2008 SPA.
(3) The April 2008 SPA modified the warrants to eliminate the contingency provision.
(4) The term begins as of the effective date of the registration statement.
(5) The fair value of the Series O warrants has not yet been recorded since the contingency provisions have not been met.
(6) Additional warrants were granted due to the anti-dilution provisions in the 2007 SPA.
(7) Exercise price is the lesser of $0.50 or 75% of the lowest of the following:

(i)    The average of the dollar volume-weighted average price of the stock for the 15 consecutive trading days immediately following the public disclosure of an event of default;

(ii)   The lowest of the dollar volume-weighted average price of the stock during the 30 consecutive trading days ending on the date of exercise;

(iii)  The average of the dollar volume-weighted average price of the stock for the 3 consecutive trading days immediately preceding the date of exercise; or

(iv)  The average of the dollar volume-weighted average price of the stock for the 3 consecutive trading days immediately following the date of exercise.

(8) Exercise price was amended by July 2008 SPA.
(9)  The Replacement Warrants are exercisable on a one-to-one basis as the Series Q warrants are exercised.  The exercise price is the lowest of $0.50 or 75% of the lowest of the following: 

(i)   The average of the dollar volume-weighted average price of the stock for the 30 consecutive trading days immediately following the public disclosure of an event of default;

 

 

F-12
 

 

 

(ii)  The average of the dollar volume-weighted average price of the stock for the 30 consecutive trading days immediately preceding the public disclosure of an event of default;

(iii)  The average of 3 lowest volume-weighted average prices of the stock during either (i) or (ii) above.

 

The holders’ rights to exercise the 9,761,536 Series M warrants were contingent on a mandatory conversion of the 2006 Notes at the option of the Company.  A mandatory conversion for a portion of the 2006 Notes took place on July 30, 2007 entitling investors to exercise up to 7,646,361 M warrant shares.  The 2008 SPA contained a provision which removed the contingency on the remaining M warrants such that they became immediately exercisable.

 

Since conversion of the Series O warrants is contingent on a mandatory conversion of the 2007 Notes and since the exercise of the Replacement Warrants is contingent on the exercise of the Series Q warrants, the total charge was measured as of the date of issuance of the Series O warrants and the Replacement Warrants.  This charge will not be recognized until the mandatory conversion contingency has been satisfied.  The fair values of the Series O warrants and Replacement Warrants when issued were $1,493,341 and $2,725,625, respectively.

The fair value of the conversion options and the detachable warrant liabilities were calculated using the Black-Scholes Option Pricing Model with the following assumptions for the three months ended:

 

   March 31, 2011   March 31, 2010 
   2006 Notes   2007 Notes   April 2008
& July
2008 Notes
   July 2010
Notes
   2006 Notes   2007 Notes   April 2008
& July
2008 Notes
 
Stock price  $0.10   $0.10   $0.10   $0.10   $0.18   $0.18   $0.18 
Exercise price  $0.09   $0.09   $0.09   $0.09   $0.16   $0.50   $0.15 
Expected life (in years)   0.75    1.25    1.00    1.00    0.75    1.50    1.26 
Volatility   190%   162%   173%   173%   115%   167%   154%
Risk-free rate of return   0.24%   0.43%   0.30%   0.30%   0.72%   0.81%   0.57%
Expected dividend yield   0.00%   0.00%   0.00%   0.00%   0.00%   0.00%   0.00%

 

   2006
Warrants
   2007
Warrants
   April 2008
& July
2008
Warrants
       2006
Warrants
   2007
Warrants
   April 2008
& July
2008
Warrants
 
Stock price  $0.10   $0.10   $0.10       $0.18   $0.18   $0.18 
Exercise price  $0.44   $0.50   $0.50        $0.44   $0.50   $0.50 
Expected life (in years)   0.75    1.50    2.76         0.75    1.50    2.76 
Volatility   190%   155%   170%        115%   167%   142%
Risk-free rate of return   0.24%   0.55%   1.17%        0.33%   0.72%   0.15%
Expected dividend yield   0.00%   0.00%   0.00%        0.00%   0.00%   0.00%

 

 

F-13
 

 

 

Activity in the 2006 Notes and 2006 Warrants was as follows:

 

   Principal
Balance
   Discount on
Notes Payable
   Conversion
Option
Liability
   Detachable
Warrant
Liability
 
Balance, January 1, 2010  $4,448,440   $-   $2,584,949   $2,145,060 
Accrued interest added to principal balance   102,871    (64,326)*   64,326    - 
Amortization of debt discount   -    64,326*   -    - 
Change in fair value of conversion option and detachable warrant liabilities   -    -    (544,996)   (1,090,439)
Balance, March 31, 2010   4,551,311    -    2,104,279    1,054,621 
Accrued interest added to principal balance   105,249    (48,562)*   48,562    - 
Amortization of debt discount   -    48,562*   -    - 
Change in fair value of conversion option and detachable warrant liabilities   -    -    (110,976)   1,464,531 
Balance, June 30, 2010   4,656,560    -    2,041,865    2,519,152 
Accrued interest added to principal balance   107,683    (47,660)*   47,660    - 
Amortization of debt discount   -    47,660*   -    - 
Change in fair value of conversion option and detachable warrant liabilities   -    -    105,763    (1,607,800)
Balance, September 30, 2010   4,764,243    -    2,195,288    911,352 
Accrued interest added to principal balance   110,173    (50,694)*   50,694      
Amortization of debt discount   -    50,694*   -    - 
Change in fair value of conversion option and detachable warrant liabilities   -    -    120,818    (612,875)
Balance, December 31, 2010   4,874,416    -    2,366,800    298,477 
Accrued interest added to principal balance   112,721    (54,766)*   54,766    - 
Amortization of debt discount   -    54,766*   -    - 
Change in fair value of conversion option and detachable warrant liabilities   -    -    1,013,371    35,818 
Balance, March 31, 2011  $4,987,137   $-   $3,434,937   $334,295 

 

  * The entire outstanding principal balance of this note is currently due and payable in full since the maturity date of the note was July 31, 2008.  Accordingly, all discount is immediately amortized.

 

 

F-14
 

 

 

Activity in the 2007 Notes and 2007 Warrants is as follows:

 

   Principal
Balance
   Discount on
Notes Payable
   Conversion
Option
Liability
   Detachable
Warrant
Liability
 
Balance, January 1, 2010  $2,752,309   $(877,592)  $519,085   $943,000 
Accrued interest added to principal balance   63,349    (12,898)   12,898    - 
Amortization of debt discount   -    396,131    -    - 
Change in fair value of conversion option and detachable warrant liabilities   -    -    1,303    4,000 
Balance, March 31, 2010   2,815,658    (494,359)   533,286    947,000 
Accrued interest added to principal balance   64,814    (13,170)   13,170    - 
Amortization of debt discount   -    380,647    -    - 
Change in fair value of conversion option and detachable warrant liabilities   -    -    298,674    520,000 
Balance, June 30, 2010   2,880,472    (126,882)   845,130    1,467,000 
Accrued interest added to principal balance   66,313    (45,130)   45,130    - 
Amortization of debt discount   -    172,012    -    - 
Change in fair value of conversion option and detachable warrant liabilities   -    -    798,845    (769,000)
Balance, September 30, 2010   2,946,785    -    1,689,105    698,000 
Accrued interest added to principal balance   67,846    (38,890)*   38,890    - 
Amortization of debt discount   -    38,890*   -    - 
Change in fair value of conversion option and detachable warrant liabilities   -    -    (2,956)   (511,000)
Balance, December 31, 2010   3,014,631    -    1,725,039    187,000 
Accrued interest added to principal balance   69,415    (39,686)*   39,686    - 
Amortization of debt discount   -    39,686*   -    - 
Change in fair value of conversion option and detachable warrant liabilities   -    -    516,034    (66,000)
Balance, March 31, 2011  $3,084,046   $-   $2,280,759   $121,000 

 

  * The entire outstanding principal balance of this note is currently due and payable in full since the maturity date of the note was August 1, 2010.  Accordingly, all discount is immediately amortized.

 

 

F-15
 

 

 

Activity in the April 2008 Notes and 2008 Warrants is as follows:

 

   Principal
Balance
   Discount on
Notes Payable
   Conversion
Option
Liability
   Detachable
Warrant
Liability
 
Balance,January 1, 2010  $2,125,000   $(431,192)  $1,670,404   $655,625 
Amortization of debt discount   -    431,192    -    - 
Change in fair value of conversion option and detachable warrant liabilities   -    -    (52,348)   53,125 
Balance, March 31, 2010   2,125,000    -    1,618,056    708,750 
Change in fair value of conversion option and detachable warrant liabilities   -    -    (60,913)   512,500 
Balance, June 30, 2010   2,125,000    -    1,557,143    1,221,250 
Accrued interest added to principal balance   53,125    (29,974)*   29,974    - 
Amortization of debt discount   -    29,974*   -    - 
Change in fair value of conversion option and detachable warrant liabilities   -    -    (358,624)   (538,750)
Balance, September 30, 2010   2,178,125    -    1,228,493    682,500 
Accrued interest added to principal balance   54,453    (30,712)*   30,712    - 
Amortization of debt discount   -    30,712*   -    - 
Change in fair value of conversion option and detachable warrant liabilities   -    -    30,437    (319,375)
Balance, December 31, 2010   2,232,578    -    1,289,642    363,125 
Accrued interest added to principal balance   55,814    (32,235)*   32,235    - 
Amortization of debt discount   -    32,235*   -    - 
Change in fair value of conversion option and detachable warrant liabilities   -    -    444,151    (176,250)
Balance, March 31, 2011  $2,288,392   $-   $1,766,028   $186,875 

 

  * The entire outstanding principal balance of this note is currently due and payable in full since the maturity date of the note was March 31, 2010.  Accordingly, all discount is immediately amortized.

 

 

F-16
 

 

 

Activity in the July 2008 Notes and Warrants is as follows:

 

   Principal
Balance
   Discount on
Notes Payable
   Conversion
Option
Liability
   Detachable
Warrant
Liability
 
Balance, Januaary 1, 2010  $850,000   $(364,583)  $668,161   $262,250 
Amortization of debt discount   -    156,250    -    - 
Change in fair value of conversion option and detachable warrant liabilities   -    -    (20,939)   21,250 
Balance, March 31, 2010   850,000    (208,333)   647,222    283,500 
Amortization of debt discount   -    156,250    -    - 
Change in fair value of conversion option and detachable warrant liabilities   -    -    (42,684)   205,000 
Balance, June 30, 2010   850,000    (52,083)   604,538    488,500 
Conversion of notes to common stock   (150,000)   -    (113,286)   - 
Amortization of debt discount   -    52,083    -    - 
Change in fair value of conversion option and detachable warrant liabilities   -    -    (96,442)   (215,500)
Balance, September 30, 2010   700,000    -    394,810    273,000 
Conversion of notes to common stock   (150,000)   -    (90,016)   - 
Accrued interest added to principal balance   12,250    (6,909)*   6,909    - 
Amortization of debt discount   -    6,909*   -    - 
Change in fair value of conversion option and detachable warrant liabilities   -    -    13,079    (127,750)
Balance, December 31, 2010   562,250    -    324,782    145,250 
Accrued interest added to principal balance   14,558    (8,408)*   8,408    - 
Amortization of debt discount   -    8,408*   -    - 
Change in fair value of conversion option and detachable warrant liabilities   -    -    112,235    (70,500)
Balance, March 31, 2011  $576,808   $-   $445,425   $74,750 

 

  * The entire outstanding principal balance of this note is currently due and payable in full since the maturity date of the note was July 28, 2010.  Accordingly, all discount is immediately amortized.

 

 

F-17
 

 

 

Activity for the July 2010 Notes is as follows:

 

   Principal
Balance
   Discount on
Notes Payable
   Conversion
Option
Liability
 
Balance, July 27, 2010 (Inception)  $176,471   $(97,973)  $97,973 
Amortization of debt discount   -    16,329    - 
Change in fair value of conversion option liability   -    -    1,559 
Balance, September 30, 2010   176,471    (81,644)   99,532 
Amortization of debt discount   -    24,493    - 
Change in fair value of conversion option liability   -    -    2,406 
Balance, December 31, 2010   176,471    (57,151)   101,938 
Amortization of debt discount   -    24,493    - 
Change in fair value of conversion option liability   -    -    31,765 
Balance, March 31, 2011  $176,471   $(32,658)  $133,703 

 

A summary of the balances as of March 31, 2011 is as follows:

 

  Principal
Balance
   Discount on
Notes Payable
   Conversion
Option
Liability
   Detachable
Warrant
Liability
 
2006 Notes  $4,987,137   $-   $3,434,937   $334,295 
2007 Notes   3,084,046    -    2,280,759    121,000 
April 2008 Notes   2,288,392    -    1,766,028    186,875 
July 2008 Notes   576,808    -    445,425    74,750 
July 2010 Notes   176,471    (32,658)   133,703    - 
Balance, March 31, 2011  $11,112,854   $(32,658)  $8,060,852   $716,920 

 

 

F-18
 

 

 

  5. Warrants

 

Warrants granted to investors, brokers and other service providers are summarized as follows:

 

   Warrant   Weighted
Average
 
   Shares   Exercise Price 
Outstanding at January 1, 2011   70,514,126   $0.51 
Granted   -    - 
Cancelled/forfeited   -    - 
Exercised   -    - 
Outstanding at March 31, 2011   70,514,126   $0.51 

 

The following tables summarize warrants outstanding at March 31, 2011:

 

Range   Number   Weighted
Average Life
  Weighted
Average Exercise
Price
   Number
Exercisable
 
                     
$0.43-1.20    70,514,126   2.85 years  $0.51    59,714,126 

 

Series  Issue Date  Outstanding at
January 1,
2011
   Granted   Exercised /
Forfeited
   Outstanding at
December 31, 2011
 
                    
L-1  July 2006 & January 2007   22,754,163    -    -    22,754,163 
L-2  July 2006 & January 2007   7,281,332    -    -    7,281,332 
M-1  July 2006 & January 2007   7,395,103    -    -    7,395,103 
M-2  July 2006 & January 2007   2,366,433    -    -    2,366,433 
N  July 2007   7,000,000    -    -    7,000,000 
O  July 2007   4,550,000    -    -    4,550,000 
P  July 2007   3,000,000    -    -    3,000,000 
Q  April 2008   6,250,000    -    -    6,250,000 
Replacement  July 2008   6,250,000    -    -    6,250,000 
R  July 2008   2,500,000    -    -    2,500,000 
Miscellaneous  2003 - 2007   1,167,095    -    -    1,167,095 
       70,514,126    -    -    70,514,126 

 

In connection with the April 1, 2008 SPA, the Company will issue warrants to purchase 250,000 shares of the Company’s common stock at an exercise price of $0.50.  All placement agent warrants are immediately exercisable once issued.  The placement agent warrants were measured at fair value using the Black-Scholes option pricing model.  During the three months ended March 31, 2011 and 2010, the Company amortized $0 and $5,015, respectively, of debt issuance costs.

 

 

F-19
 

 

 

  6. Fair Value Disclosures

 

ASC 820-10 establishes a fair value hierarchy that prioritizes the inputs to valuation techniques used to measure fair value.  The hierarchy gives the highest priority to unadjusted quoted prices in active markets for identical assets or liabilities (Level 1 measurements) and the lowest priority to unobservable inputs (Level 3 measurements).  The three levels of the fair value hierarchy under ASC 820-10 are described below:

 

  Level 1 Unadjusted quoted prices in active markets that are accessible at the measurement date for identical, unrestricted assets or liabilities;
  Level 2 Quoted prices in markets that are not active, or inputs that are observable, either directly or indirectly, for substantially the full term of the asset or liability; and
  Level 3 Prices or valuation techniques that require inputs that are both significant to the fair value measurement and unobservable (supported by little or no market activity).

 

The following table sets forth the Company’s financial assets and liabilities measured at fair value by level within the fair value hierarchy.  As required by ASC 820-10, assets and liabilities are classified in their entirety based on the lowest level of input that is significant to the fair value measurement.

 

The table below sets forth a summary of the fair values of the Company’s financial assets and liabilities as of March 31, 2011.

 

   Total   Level 1   Level 2   Level 3 
LIABILITIES:                    
Conversion option liabilities  $8,060,852   $-   $-   $8,060,852 
Detachable warrant liabilities   716,920    -    -    716,920 
   $8,777,772   $-   $-   $8,777,772 

 

The Company’s detachable warrant and conversion option liabilities are valued using pricing models and the Company generally uses similar models to value similar instruments.  Where possible, the Company verifies the values produced by its pricing models to market prices.  Valuation models require a variety of inputs, including contractual terms, market prices, yield curves, credit spreads, measures of volatility and correlations of such inputs.  These financial liabilities do not trade in liquid markets, and as such, model inputs cannot generally be verified and do involve significant management judgment.  Such instruments are typically classified within Level 3 of the fair value hierarchy.  The conversion option and detachable warrant liabilities are included in current liabilities in the accompanying consolidated balance sheets.  The change in fair value of the conversion option and detachable warrant liabilities is included as a component of other income (expense) in the consolidated statements of operations.

 

 

F-20
 

 

  7. Commitments and Contingencies

 

In October 2008, the Company rendered possession of its prior operating facility to the landlord.  In November 2009, the Company settled the matter for $216,000 plus simple interest at 10 percent per annum.  The Company paid $7,000 on the date of the agreement.  Beginning January 15, 2010 and continuing through January 15, 2012, the Company will make monthly payments of $9,000.  A final payment of $6,106 is due on February 15, 2012.  On July 25, 2011, the Company entered into another settlement agreement with the landlord for one final payment of $40,000.  The balance due on the lease on the settlement date was $75,040.  Accordingly, the Company recorded a gain on the settlement of the lease of $35,040 in the third quarter of 2011.

 

On August 1, 2011, the Company terminated the lease of its existing facility effective August 31, 2011.

 

  8. Subsequent Events

 

The following subsequent events have occurred through the filing date of this report, October 13, 2011.

 

On July 31, 2011, the July 2010 Notes matured and the Company did not repay the principal balance.

 

Effective July 1, 2011, the Company sold an exclusive, worldwide, perpetual, irrevocable, fully paid, transferable and sub-licensable right and license in all of the Company’s registered patent and patent applications for $384,000.  The license is exclusive even to the Company, such that the Company no longer has any rights to its intellectual property.

 

On June 17, 2011, Raptor Acquisition, LLC, a wholly-owned subsidiary of California Capital Equity, LLC (“CCE”) purchased all of the convertible notes payable from the previous note holders in an outside transaction.  On July 6, 2011, CCE provided the Company with notice of default on the notes payable and demanded repayment in full.  They also informed the Company of their intent to exercise their rights and remedies against the Company’s assets.  On August 1, 2011, CCE, in its capacity as a secured lender, held a public foreclosure sale of substantially all of the Company’s assets.  CCE was the only bidder and the assets of the Company were acquired for $100,000, which amount was credited against outstanding notes.

 

On August 1, 2011, the Company terminated the lease of its existing facility effective August 31, 2011.

 

On August 19, 2011 the Company signed a non binding letter of intent for a merger transaction with an interested partner. The merger is contingent on the outcome of due diligence and a definitive Merger Agreement to be agreed upon by all parties, including the current note-holder, in the near future. There can be no guarantee that this transaction will be consummated. Management believes that a comprehensive financial restructuring with the utilization of the public shell entity as a reverse merger vehicle for a new entity is the only way to preserve any value for the public shareholders. Should such a transaction be consummated, the resultant debt for equity exchange will most likely result in a near total loss of shareholder value.   Should a restructuring be unachievable, Raptor will permanently cease operations resulting in a total loss of shareholder value.

 

 

F-21
 

 

 

ITEM 2.MANAGEMENT’S DISCUSSION AND ANALYSIS OR PLAN OF OPERATION.

 

“Safe Harbor” Statement under the Private Securities Litigation Reform Act of 1995:  this report contains forward-looking statements, including statements concerning future conditions in the network switching industry, our future business, financial condition, operating strategies and operational and legal risks.  These forward-looking statements generally include the plans and objectives of management for future operations, including plans and objectives relating to our future economic performance, and can generally be identified by the use of the words “plan,” “estimate,” “expect,” “believe,” “should,” “would,” “could,” “anticipate,” “may,” “forecast,” “project,” “pro forma,” “goal,” “continues,” “intend,” “seek” or variations of those terms and other similar expressions, including their use in the negative.  The forward-looking statements and associated risks may include, relate to or be qualified by other important factors, including, without limitation:

 

·our inability to continue as a going concern,
·our inability to raise additional capital,
·lower sales and revenues than forecast,
·our inability to carry out our marketing and sales plans,
·unexpected costs and operating deficits,
·our failure to establish relationships with and capitalize upon access to new customers,
·litigation and administrative proceedings involving us or our products,
·adverse publicity and news coverage,
·adverse economic conditions,
·entry of new and stronger competitors,
·changes in interest rates and inflationary factors, and
·other specific risks that may be referred to in this report or in other reports that we have issued.

 

These forward-looking statements necessarily depend upon assumptions and estimates that may prove to be incorrect.  Although we believe that the assumptions and estimates reflected in the forward-looking statements are reasonable, we cannot guarantee that we will achieve our plans, intentions or expectations.  The forward-looking statements involve known and unknown risks, uncertainties and other factors that may cause actual results to differ in significant ways from any future results expressed or implied by the forward-looking statements.  Except as required by law, we undertake no duty to update any forward-looking statement after the date of this report, either to conform any statement to reflect actual results or to reflect the occurrence of unanticipated events.

 

Any of the factors described above, elsewhere in this report, or in the “Risk Factors” section of our most recent annual report on Form 10-K could cause our financial results, including our net income (loss) or growth in net income (loss) to differ materially from prior results, which in turn could, among other things, cause the price of our common stock to fluctuate substantially.

 

Current Business Outlook

 

On December 5, 2011, we entered into a Stock Purchase Agreement, dated effective as of December 2, 2011 (“Stock Purchase Agreement”), with Raptor Resources Holdings Inc. ("Raptor Resources") (RRHI:QB) (formerlyLantis Laser Inc. (LLSR.QB)) pursuant to which we agreed to issue Raptor Resources 109,928,311 shares of our common stock or 55% of our issued and outstanding shares of common stock in exchange for 5,000,000 shares of unregistered Raptor Resources common stock. All officers and directors of Raptor resigned at the time of execution of the Stock Purchase Agreement. Raptor Resources intends to effect a 1:10 reverse stock split, own 80% of the fully diluted shares of Raptor's common stock on a post-split basis, change the name of Raptor to Mabwe Minerals Inc. and have the company engaged in the exploration and mining of gold and other industrial minerals and will not have any involvement with the historical business of Raptor. We are a majority owned subsidiary of Raptor Resources.

 

1
 

  

Overview

 

We were organized under the laws of the State of Colorado on January 22, 2001 under the name Pacific InterMedia, Inc. We originally were engaged in the business of offering EDGAR filing services to companies outsourcing the formatting and electronic filing of registration statements, periodic reports and other forms with the U. S. Securities and Exchange Commission (“SEC” or the “Commission”), but generated minimal revenues from these operations. On October 17, 2003, we completed a business combination transaction with Raptor Networks Technology, Inc., a California corporation (“Raptor”), whereby we acquired all of the issued and outstanding capital stock of Raptor in a cashless common stock share-for-share exchange in which Raptor became our wholly-owned subsidiary. Upon the completion of this acquisition transaction, we changed our name to Raptor Networks Technology, Inc. (the “Company”), terminated our EDGAR filing services operations and, by and through our subsidiary Raptor, became engaged in the data network switching industry.

 

On December 5, 2011, we entered into a Stock Purchase Agreement, dated effective as of December 2, 2011 (“Stock Purchase Agreement”), with Raptor Resources Holdings Inc. ("Raptor Resources") (RRHI:QB) (formerlyLantis Laser Inc. (LLSR.QB)) pursuant to which we agreed to issue Raptor Resources 109,928,311 shares of our common stock or 55% of our issued and outstanding shares of common stock in exchange for 5,000,000 shares of unregistered Raptor Resources common stock. All officers and directors of Raptor resigned at the time of execution of the Stock Purchase Agreement. Raptor Resources intends to effect a 1:10 reverse stock split, own 80% of the fully diluted shares of Raptor's common stock on a post-split basis, change the name of Raptor to Mabwe Minerals Inc. and have the company engaged in the exploration and mining of gold and other industrial minerals and will not have any involvement with the historical business of Raptor. We are a majority owned subsidiary of Raptor Resources. 

 

Going Concern Qualification

 

We have a limited operating history with minimal sales and have incurred cumulative net losses of $89,814,648 through March 31, 2012.  

 

As mentioned before under the heading “Subsequent events” in this quarterly report the Company sold an exclusive right to its registered patents effective July 1, 2011 and on August 1, 2011 all of the Company’s remaining assets were sold during a public foreclosure sale leaving the Company without any rights to its intellectual property and without any assets and then entered into a Stock Purchase Agreement with Raptor Resources effective December 2, 2011 under which we exchanged shares of common stock and became a majority owned subsidiary of Raptor Resources.

 

These conditions, among others, raise substantial doubt about our ability to continue as a going concern and our independent registered public accounting firm has qualified their opinions with respect to our consolidated financial statements to include an explanatory paragraph related to our ability to continue as a going concern in their reports for each of our fiscal years ended December 31, 2003 through December 31, 2011.

 

Our consolidated financial statements have been prepared on a going concern basis, which contemplates the realization of assets and satisfaction of liabilities in the normal course of business.  The accompanying financial statements do not reflect any adjustments which might be necessary if we are unable to continue as a going concern.

  

CRITICAL ACCOUNTING POLICIES

 

Critical Accounting Estimates and Judgments

 

Our consolidated financial statements are prepared in accordance with accounting principles generally accepted in the United States of America (“GAAP”).  The preparation of our financial statements requires our management to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues, expenses and related disclosures.  We base our estimates on historical experience and various other assumptions that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources.  Actual results may differ from these estimates under different assumptions or conditions.  The significant accounting policies that are believed to be the most critical to aid in fully understanding and evaluating the reported financial results include the valuation of inventories, derivative financial instruments and stock-based compensation and the recoverability of deferred income tax assets.

 

2
 

 

Inventories

 

We determine our inventory value at the lower of average cost or market.  When required, a provision is made to reduce excess and obsolete inventories to estimated net realizable value.  We had no inventory as of March 31, 2012 from $499,090 as of March 31, 2011.

 

Derivative Financial Instruments

 

Our senior convertible notes are classified as non-conventional convertible debt.  In the case of non-conventional convertible debt, we bifurcate our embedded derivative instruments and record them at their fair value as of the inception date of the agreement and at fair value as of each subsequent balance sheet date.  Any change in fair value will be recorded as non-operating, non-cash income or expense at each reporting date.  If the fair value of the derivatives is higher at the subsequent balance sheet date, we will record a non-operating, non-cash charge.  If the fair value of the derivative is lower at the subsequent balance sheet date, we will record non-operating, non-cash income.

 

To determine the fair value of the derivative instruments, we make certain assumptions regarding the expected term of exercise.  Because the expected term of the warrants impacts the volatility and risk-free interest rates used in the Black-Scholes calculations, these must be selected for the same time period as the expected term of the warrants.

 

Deferred Income Taxes

 

We record a valuation allowance to reduce the deferred tax assets to the amount that is more likely than not to be realized.  We have considered estimated future taxable income an ongoing tax planning strategies in assessing the amount needed for the valuation allowance.

 

RESULTS OF OPERATIONS

 

Comparison of Results of Operations for the Three Months Ended March 31, 2012 and 2011

 

The following table sets forth selected financial data regarding our financial position and operating results for the three months ended March 31, 2012 and 2011.  This data should be read in conjunction with our consolidated financial statements and related notes thereto beginning on page F-1 of this report.

 

   2012   2011   Change (S)   Change (%) 
 
REVENUE, NET  $0   $353,110   $(353,110)   -100%
COST OF SALES   0    191,481    (191,481)   -100%
GROSS PROFIT   0    161,629    (161,629)   -100%
OPERATING EXPENSES                    
Salary expense and salary related costs   0    112,740    (112,740)   -100%
Research and development   0    5,429    (5,429)   -100%
Selling, general and administrative   0    90,500    (90,500)   -100%
Total operating expenses   0    208,669    (208,669)   -100%
Loss from operations   0    (47,040)   47,040    -100%
OTHER INCOME (EXPENSE)                    
Interest income   1    1    0    0%
Loss on disposal of property and equipment   0    (1,697)    1,697    -100%
Change in fair value of conversion option and warrant liabilities   1,279,254    -1,840,624    3,119,878    -170%
Amortization of discount on convertible debt   0    -159,588    159,588    -100%
Interest expense   -262,688    -267,590    4,902    -2%
Total other income (expense)   1,016,566    (2,269,498)   3,284,368    -145%
Income (loss) before income taxes   1,016,566    (2,316,538)   3,333,104    -144%
Income tax (provision) benefit   -    -    -    0 
NET INCOME (LOSS)  $1,016,566   $(2,316,538)  $3,333,104    -144%

  

Net Revenues

 

As a result of the prior sale of our assets prior to our becoming a majority owned subsidiary of Raptor Holdings, we have not engaged in any business in the first quarter of 2012. We expect to commence the exploration and mining of gold and industrial minerals in the second or third quarter of 2012.

 

3
 

  

Gross Profit

 

As a result of the prior sale of our assets prior to our becoming a majority owned subsidiary of Raptor Holdings, we have not engaged in any business in the first quarter of 2012. We expect to commence the exploration and mining of gold and industrial minerals in the second or third quarter of 2012.

 

Operating Expenses

 

As a result of the prior sale of our assets prior to our becoming a majority owned subsidiary of Raptor Holdings, we have not engaged in any business in the first quarter of 2012. We expect to commence the exploration and mining of gold and industrial minerals in the second or third quarter of 2012.

  

Liquidity and Capital Resources

 

Our independent registered public accounting firm has qualified their opinion with respect to our consolidated financial statements to include an explanatory paragraph related to our ability to continue as a going concern in their reports for each of our fiscal years ended December 31, 2012 and 2011.  Reports of independent registered public accounting firms questioning a company's ability to continue as a going concern generally are viewed very unfavorably by analysts and investors.  There are a number of risks and challenges associated with such a qualified report including, but not limited to, a significant impediment to our ability to raise additional capital or seek financing from entities that will not conduct such transactions in the face of such increased level of risk of insolvency and loss, increased difficulty in attracting talent and the diversion of the attention of executive officers and other key employees to raising capital or financing rather than devoting time to the day-to-day operations of our business.  We urge potential investors to review the report of our independent registered public accounting firm included in the Company’s annual report on Form 10-K for the year ended December 31, 2011 and our consolidated financial statements and related notes beginning on page F-1 of this Report and to seek independent advice concerning the substantial risks related thereto before making a decision to invest in us, or to maintain an investment in us.

   

ITEM 4T.  CONTROLS AND PROCEDURES.

 

Evaluation of Disclosure Controls and Procedures.  Our Chief Executive Officer and our Chief Financial Officer (currently the same person), after evaluating the effectiveness of our “disclosure controls and procedures” (as defined in the Securities Exchange Act of 1934 (Exchange Act) Rules 13a-15(e) or 15d-15(e)) as of the end of the period covered by this quarterly report, have concluded that our disclosure controls and procedures are not effective based on their evaluation of these controls and procedures required by paragraph (b) of Exchange Act Rules 13a-15 or 15d-15 on the basis that we have not been funded sufficiently for us to employ an additional person to serve as our Chief Financial Officer.

 

Changes in Internal Control over Financial Reporting.  There were changes in our internal control over financial reporting identified in connection with the evaluation required by paragraph (d) of Exchange Act Rules 13a-15 or 15d-15 that occurred during our last fiscal quarter that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting since Al Pietrangelo has assumed the positions of CEO and CFO to replace our former CEO and CFO.

 

Inherent Limitations on Effectiveness of Controls.  Our management, including our Chief Executive Officer and our Chief Financial Officer (who are the same person, Al Pietrangelo) does not expect that our disclosure controls or our internal control over financial reporting will prevent all errors and all fraud. A control system, no matter how well conceived and operated, can provide only reasonable, not absolute, assurance that the objectives of the control system are met. Further, the design of a control system must reflect the fact that there are resource constraints, and the benefits of controls must be considered relative to their costs. Because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, within the Company have been detected. These inherent limitations include the realities that judgments in decision-making can be faulty, and that breakdowns can occur because of a simple error or mistake. Additionally, controls can be circumvented by the individual acts of some persons, by collusion of two or more people or by management override of the controls. The design of any system of controls also is based in part upon certain assumptions about the likelihood of future events, and there can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions; over time, controls may become inadequate because of changes in conditions, or the degree of compliance with policies or procedures may deteriorate. Because of the inherent limitations in a cost-effective control system, misstatements due to error or fraud may occur and not be detected.

 

4
 

  

PART II - OTHER INFORMATION

 

ITEM 1.  LEGAL PROCEEDINGS.

 

From time to time, we may be involved in various claims, lawsuits, disputes with third parties, actions involving allegations of discrimination or breach of contract actions incidental to the operation of our business.  Except as referred to above, we are not currently involved in any litigation which we believe could have a materially adverse effect on our financial condition or results of operations.

 

ITEM 1A. RISK FACTORS

 

Not Applicable.

 

ITEM 2.   UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS.

 

None.

 

ITEM 3.  DEFAULTS UPON SENIOR SECURITIES.

 

See Form 8-K filed on August 4, 2011.

 

ITEM 4.  MINE SAFETY DISCLOSURES.

 

None.

 

ITEM 5.  OTHER INFORMATION.

 

None. 

 

ITEM 6.  EXHIBITS.

 

Exhibits

 

Exhibit

Number

  Description
     
31.1   Certification of the Chief Executive Officer Required by Rule 13a-14(a) of the Securities Exchange Act of 1934, as amended, as Adopted Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
     
31.2   Certification of the Chief Financial Officer Required by Rule 13a-14(a) of the Securities Exchange Act of 1934, as amended, as Adopted Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
     
32.1   Certification of the Chief Executive Officer Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
     
32.2   Certification of the Chief Financial Officer Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002

 

5
 

 

SIGNATURES

 

In accordance with the requirements of the Exchange Act, the registrant caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.

 

  RAPTOR NETWORKS TECHNOLOGY, INC.  
       
Date:  May 21, 2012 By: /s/ Al Pietrangelo  
    Al Pietrangelo  
    Chief Executive Officer  
    (principal executive officer)  
       
Date: May 21, 2012 By: /s/ Al Pietrangelo  
    Al Pietrangelo  
    Chief Financial Officer and Secretary  
    (principal financial and accounting officer)  

 

 

6
 

 

EXHIBITS FILED WITH THIS QUARTERLY REPORT ON FORM 10-Q

 

31.1 Certification of the Chief Executive Officer Required by Rule 13a-14(a) of the Securities Exchange Act of 1934, as amended, as Adopted Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
31.2 Certification of the Chief Financial Officer Required by Rule 13a-14(a) of the Securities Exchange Act of 1934, as amended, as Adopted Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
32.1 Certification of the Chief Executive Officer Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
32.2 Certification of the Chief Financial Officer Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002

  

7

 

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