Edgar Filing: NEOMEDIA TECHNOLOGIES INC

Unassociated Document

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10 - Q

x	QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended September 30, 2011

o	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 0-21743

NeoMedia Technologies, Inc.

(Exact Name of Issuer as Specified In Its Charter)

Delaware	36-3680347
(State or other jurisdiction of	(I.R.S. Employer
incorporation or organization)	Identification No.)

1360 Center Drive, Suite 210, Dunwoody, GA 30338

(Address, including zip code, of principal executive offices)

678-638-0460

(Registrants’ telephone number, including area code)

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

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§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 o

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 accelerated filer o Accelerated filer o Non-accelerated filer o Smaller Reporting Company x

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

The number of outstanding shares of the registrant’s Common Stock on November 9, 2011 was 437,378,114.

NeoMedia Technologies, Inc.

Form 10-Q

For the Quarterly Period Ended September 30, 2011

Index

		Page

PART I	Financial Information	2

ITEM 1.	Financial Statements	2
ITEM 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	27
ITEM 3.	Quantitative and Qualitative Disclosures About Market Risk	34
ITEM 4.	Controls and Procedures	34

PART II	Other Information	35

ITEM 1.	Legal Proceedings	35
ITEM 1A.	Risk Factors	36
ITEM 2.	Unregistered Sales of Equity Securities and Use of Proceeds	36
ITEM 3.	Defaults Upon Senior Securities	36
ITEM 4.	(Removed and Reserved)	36
ITEM 5.	Other Information	36
ITEM 6.	Exhibits	37

Signatures		50

PART I -- FINANCIAL INFORMATION

ITEM 1. Financial Statements

NeoMedia Technologies, Inc. and Subsidiaries

Condensed Consolidated Balance Sheets (Unaudited)

(in thousands, except share and per share data)

	September 30,			December 31,
	2011			2010
ASSETS	(unaudited)
Current assets:
Cash and cash equivalents	$	250		$	80
Trade accounts receivable, net of allowance of $5 and $0		353			345
Inventories, net of allowance of $125 and $114		147			112
Prepaid expenses and other current assets		235			151
Total current assets		985			688

Property and equipment, net		90			96
Goodwill		3,418			3,418
Proprietary software, net		921			1,414
Patents and other intangible assets, net		1,835			2,048
Cash surrender value of life insurance policies		605			738
Other long-term assets		171			171
Total assets	$	8,025		$	8,573

LIABILITIES AND SHAREHOLDERS’ DEFICIT
Current liabilities:
Accounts payable	$	532		$	435
Taxes payable		-			126
Accrued expenses		11,032			9,413
Deferred revenues and customer prepayments		1,826			1,417
Note payable		110			69
Accrued purchase price guarantee		4,535			4,535
Deferred tax liability		706			706
Derivative financial instruments - warrants		433			2,213
Derivative financial instruments - Series C and D preferred stock and debentures payable		13,198			28,092
Debentures payable - carried at amortized cost		15,698			14,560
Debentures payable - carried at fair value		17,912			27,484
Total current liabilities		65,982			89,050

Commitments and contingencies (Note 6)

Series C convertible preferred stock, $0.01 par value, 27,000
shares authorized, 5,433 and 8,336 shares issued and outstanding,
liquidation value of $5,433 and $8,336		5,433			8,336
Series D convertible preferred stock, $0.01 par value, 25,000
shares authorized, 23,600 and 25,000 shares issued and outstanding,
liquidation value of $2,360 and $2,500		2,360			2,500

Shareholders’ deficit:
Common stock, $0.001 par value, 5,000,000,000 shares authorized, 345,830,364 and
25,695,392 shares issued and 345,813,951 and 25,678,978 shares
outstanding as of September 30, 2011 and December 31, 2010, respectively		346			26
Additional paid-in capital		166,873			153,974
Accumulated deficit		(232,019	)		(244,395	)
Accumulated other comprehensive loss		(171	)		(139	)
Treasury stock, at cost, 2,012 shares of common stock		(779	)		(779	)
Total shareholders’ deficit		(65,750	)		(91,313	)
Total liabilities and shareholders’ deficit	$	8,025		$	8,573

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

NeoMedia Technologies, Inc. and Subsidiaries

Condensed Consolidated Statements of Operations (Unaudited)

(in thousands, except share and per share data)

`	Three Months Ended
	September 30,			September 30,
	2011			2010

Revenues	$	528		$	338
Cost of revenues		324			236
Gross profit		204			102

Sales and marketing expenses		217			231
General and administrative expenses		830			835
Research and development costs		481			465

Operating Loss		(1,324	)		(1,429	)

Gain (loss) from change in fair value of hybrid financial instruments		17,631			(6,941	)
Gain (loss) from change in fair value of derivative liability - warrants		568			(1,105	)
Gain (loss) from change in fair value of derivative liability -
Series C and D preferred stock and debentures		43,727			(15,561	)
Interest expense related to convertible debt		(1,155	)		(595	)

Net Income (loss)		59,447			(25,631	)

Comprehensive income (loss):
Net income (loss)		59,447			(25,631	)
Other comprehensive loss -
foreign currency translation adjustment		(19	)		23

Comprehensive Income (loss)	$	59,428		$	(25,608	)


Net income (loss) per share, basic and diluted:
Basic	$	0.26		$	(1.13	)
Fully diluted	$	-		$	(1.13	)

Weighted average number of common shares:
Basic		226,839,514			22,678,877
Fully diluted		3,440,185,503			22,678,877

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

NeoMedia Technologies, Inc. and Subsidiaries

Condensed Consolidated Statements of Operations (Unaudited)

(in thousands, except share and per share data)

	Nine Months Ended
	September 30,			September 30,
	2011			2010

Revenues	$	1,664		$	1,206
Cost of revenues		799			830
Gross profit		865			376

Sales and marketing expenses		838			812
General and administrative expenses		2,451			2,971
Research and development costs		1,311			1,166

Operating Loss		(3,735	)		(4,573	)

Loss on extinguishment of debt		-			(6,006	)
Gain from change in fair value of hybrid financial instruments		4,203			12,611
Gain from change in fair value of derivative liability - warrants		2,263			9,751
Gain from change in fair value of derivative liability -
Series C and D preferred stock and debentures		12,457			31,263
Interest expense related to convertible debt		(2,812	)		(1,551	)

Net Income		12,376			41,495

Dividends on convertible preferred stock		-			(2,500	)

Net Income attributable to common shareholders		12,376			38,995

Comprehensive income (loss):
Net income (loss)		12,376			41,495
Other comprehensive loss -
foreign currency translation adjustment		(32	)		(27	)

Comprehensive Income	$	12,344		$	41,468


Net income (loss) per share, basic and diluted:
Basic	$	0.13		$	1.74
Fully diluted	$	-		$	(0.02	)

Weighted average number of common shares:
Basic		97,493,073			22,470,014
Fully diluted		3,222,207,099			301,266,858

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

NeoMedia Technologies, Inc. and Subsidiaries

Condensed Consolidated Statement of Shareholders’ Deficit (Unaudited)

(in thousands, except share data)

							Accumulated
					Additional		Other											Total
	Common Stock				Paid-in		Comprehensive			Accumulated			Treasury Stock					Shareholders'
	Shares		Amount		Capital		Income (Loss)			Deficit			Shares		Amount			Deficit
Balance, December 31, 2010		25,678,978	$	26	$	153,974	$	(139	)	$	(244,395	)		2,012	$	(779	)	$	(91,313	)

Shares issued for acquisition of patent rights		5,000,000		5		345		-			-			-		-			350

Shares issued upon conversions of Series C preferred stock		205,771,365		206		9,114		-			-			-		-			9,320

Shares issued upon conversions of Series D preferred stock		10,938,232		11		268		-			-			-		-			279

Shares issued upon conversions of convertible debentures		98,425,376		98		3,114		-			-			-		-			3,212

Stock-based compensation expense		-		-		58		-			-			-		-			58

Comprehensive income - foreign currency translation adjustment		-		-		-		(32	)		-			-		-			(32	)

Net income		-		-		-		-			12,376			-		-			12,376
Balance, September 30, 2011		345,813,951	$	346	$	166,873	$	(171	)	$	(232,019	)		2,012	$	(779	)	$	(65,750	)

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

NeoMedia Technologies, Inc. and Subsidiaries

Condensed Consolidated Statements of Cash Flows (Unaudited)

(in thousands)

	Nine Months Ended
	September 30,
	2011			2010
Cash Flows from Operating Activities:
Net Income	$	12,376		$	41,495
Adjustments to reconcile net income to net cash used in operating activities:
Depreciation and amortization		734			757
Loss on extinguishment of debt		-			6,006
(Gain) from change in fair value of hybrid financial instruments		(4,203	)		(12,611	)
(Gain) from change in fair value of derivative liability - warrants		(2,263	)		(9,751	)
(Gain) from change in fair value of derivative liability -
Series C and D preferred stock and debentures		(12,457	)		(31,263	)
Interest expense related to convertible debt		2,812			1,551
Interest paid on convertible debt		(1,000	)		-
Stock-based compensation expense		58			138
Increase in value of life insurance policies		133			(39	)

Changes in operating assets and liabilities
Trade and other accounts receivable		(8	)		(271	)
Inventories		(35	)		12
Prepaid expenses and other assets		(84	)		40
Accounts payable and accrued liabilities		17			(351	)
Deferred revenue and other current liabilities		409			(367	)
Net cash used in operating activities		(3,511	)		(4,654	)

Cash Flows from Investing Activities:

Acquisition of property and equipment		(6	)		(13	)
Net cash used in investing activities		(6	)		(13	)

Cash Flows from Financing Activities:
Proceeds from issuance of Series D preferred stock		-			2,500
Costs attributed to issuance of Series D convertible preferred stock		-			(100	)
Borrowing (repayment) of note payable - YA Global		-			(500	)
Borrowings under convertible debt instruments, net		3,685			2,865
Net cash provided by financing activities		3,685			4,765

Effect of exchange rate changes on cash		2			(6	)

Net increase in cash and cash equivalents		170			92

Cash and cash equivalents, beginning of period		80			198
Cash and cash equivalents, end of period	$	250		$	290


Supplemental cash flow information:
Interest paid during the period	$	1		$	1
Series C preferred stock converted to common stock	$	9,320		$	273
Series D preferred stock converted to common stock	$	279		$	-
Convertible Debentures converted to common stock	$	3,212		$	-
Deemed dividend on Series D preferred stock issued	$	-		$	2,500
Shares issued for acquisition of patent rights	$	350		$	-

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

NeoMedia Technologies, Inc. and Subsidiaries

Notes to Condensed Consolidated Financial Statements

(Unaudited)

Note 1 - General

Business – NeoMedia Technologies, Inc., a Delaware corporation (“NeoMedia”, and also referred to herein as “us”, “we” and “our”), is an innovator and a global market leader in 2D mobile barcode technology and solutions that enable the mobile barcode ecosystem world-wide. NeoMedia strives to harness the power of the mobile phone with state-of-the art mobile barcode technology. With this technology, mobile phones with cameras become barcode scanners and this enables a range of applications including consumer oriented marketing and advertising, mobile ticketing and couponing, and business-to-business commercial track and trace solutions.

As a technology pioneer in the global mobile barcode industry, our suite of products, services and IP portfolio allows us to offer a comprehensive end-to-end mobile barcode solution. We offer barcode management and infrastructure technology solutions, barcode reader solutions and IP licensing, as well as mobile couponing and ticketing products and services. NeoMedia has been a pioneer in the mobile barcode field since the mid 1990s, and during that time has spearheaded the development of a robust IP portfolio that encompasses many preferred mobile barcode implementations. We have an IP portfolio currently consisting of over sixty issued and pending patents.

Going Concern – We have historically incurred net losses from operations and we expect that we will continue to have negative cash flows as we implement our business plan. There can be no assurance that our continuing efforts to execute our business plan will be successful and that we will be able to continue as a going concern. The accompanying consolidated financial statements have been prepared in conformity with accounting principles generally accepted in the United States of America (“US GAAP”), which contemplates our continuation as a going concern. Net income for the nine months ended September 30, 2011 and 2010, respectively, was $12.4 million and $41.5 million, of which $18.9 million and $47.6 million, respectively, were net gains related to our financing instruments. Net cash used by operations during the nine months ended September 30, 2011 and 2010 was $3.5 million and $4.7 million, respectively. At September 30, 2011, we have an accumulated deficit of $232.0 million. We also have a working capital deficit of $65.0 million, of which $47.2 million is related to our financing instruments, including $18.3 million related to the fair value of warrants and those debentures that are recorded as hybrid financial instruments, and $28.9 million related to the amortized cost carrying value of certain of our debentures and the fair value of the associated derivative liabilities. We also have a continuing purchase price guarantee obligation of $4.5 million associated with an acquisition of a business in 2006, which we subsequently sold in 2007.

The items discussed above raise substantial doubt about our ability to continue as a going concern.

We currently do not have sufficient cash or commitments for financing, to sustain our operations for the next twelve months. We will require additional financing in order to execute our operating plan and continue as a going concern. Our management’s plan is to attempt to secure adequate funding to bridge the commercialization of our patent licensing and barcode ecosystem businesses. We cannot predict whether this additional financing will be in the form of equity, debt, or another form and we may not be able to obtain the necessary additional capital on a timely basis, on acceptable terms, or at all. In the event that these financing sources do not materialize, or that we are unsuccessful in increasing our revenues and profits, we may be unable to implement our current plans for expansion, repay our debt obligations as they become due or respond to competitive pressures, any of which circumstances would have a material adverse effect on our business, prospects, financial condition and results of operations. Should our lender, YA Global Investments, L.P. (“YA Global”) choose not to provide us with continued financing, or if we do not find alternative sources of financing to fund our operations or if we are unable to generate significant product revenues, we only have sufficient funds to sustain our current operations through approximately December 8, 2011.

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

Note 2 - Summary of Significant Accounting Policies

The accompanying unaudited financial statements have been prepared in accordance with US GAAP for interim financial information and Rule 8.03 of Regulation S-X. They do not include all of the information and footnotes required by US GAAP for complete financial statements. In the opinion of management, all adjustments, consisting only of normal recurring adjustments, considered necessary for a fair presentation have been included. The results of operations for the periods presented are not necessarily indicative of the results to be expected for the full year. For further information, refer to our financial statements as of December 31, 2010 and 2009, and for the years then ended, including notes thereto in the Company’s Annual Report on Form 10-K for the year ended December 31, 2010.

Basis of Presentation – The consolidated financial statements include the accounts of NeoMedia Technologies, Inc. and our wholly-owned subsidiaries. We operate as one reportable segment. All significant intercompany accounts and transactions have been eliminated.

Use of Estimates – The preparation of consolidated financial statements in conformity with US GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. Changes in facts and circumstances may result in revised estimates, which are recorded in the period in which they become known.

Stock-Based Compensation - FASB ASC 718, Stock Compensation, requires that all stock-based compensation be recognized as an expense in the financial statements and that such cost be measured at the grant date fair value of the award. We account for modifications of the terms of existing option grants as exchanges of the existing equity instruments for new instruments. The fair value of the modified option at the grant date is compared with the value at that date of the original option immediately before its terms are modified. Any excess fair value of the modified option over the original option is recognized as additional compensation expense.

Basic and Diluted Net Income (Loss) Per Share – Basic net income (loss) per share is computed by dividing net income (loss) attributable to common shareholders by the weighted average number of shares of common stock outstanding during the period. During the three and nine months ended September 30, 2011, we reported net income per share and included dilutive instruments in the fully diluted net income per share calculation. During the three months ended September 30, 2010, we reported a net loss per share, and as such, basic and diluted loss per share were equivalent. During the nine months ended September 30, 2010, we reported net income per share and included dilutive instruments in the fully diluted net income per share calculation.

The following is a reconciliation of the numerator and denominator of the basic and diluted net income (loss) per share calculations for each period:

	Three Months Ended September 30,						Nine Months Ended September 30,
	2011			2010			2011			2010
	(in thousands except share and per share data)
Numerator:
Net income (loss)	$	59,447		$	(25,631	)	$	12,376		$	41,495
Adjustments to reconcile net income to income (loss)
applicable to common stockholders:
Accretion of Series D Preferred stock		-			-			-			(2,500	)
Numerator for basic earnings per share - income available
to common stockholders		59,447			(25,631	)		12,376			38,995

Effect of dilutive securities:
Adjustment for change in fair value of derivative liability
Series C and D preferred stock and debentures		(43,727	)		-			(12,457	)		(31,263	)
Adjustment for change in fair value of derivative liability-
warrants		(568	)		-			(2,263	)		(9,751	)
Adjustment for change in fair value of hybrid financial
instruments		(17,631	)		-			(4,203	)		(12,611	)
Adjustment for loss on extinguishment of debt
(excluding non-dilutive instrument)		-			-			-			5,643
Adjustment for interest expense related to convertible debt		1,152			-			2,802			1,515
		(60,774	)		-			(16,121	)		(46,467	)
Numerator for diluted earnings per share-
income available for common stockholders
after assumed conversions of debentures and
exercise of warrants	$	(1,327	)	$	(25,631	)	$	(3,745	)	$	(7,472	)

Denominator for diluted earnings per share - adjusted weighted
average shares after assumed conversions and exercise of options:
Weighted average shares used to compute basic EPS		226,839,514			22,678,877			97,493,073			22,470,014
Effect of dilutive securities:
Employee stock options		-			-			-			99,337
Derivative warrants		1,910,389			-			-			-
Convertible debentures		2,616,568,043			-			2,529,846,469			204,313,469
Convertible preferred stock		594,867,557			-			594,867,557			74,384,038
Dilutive potential common shares		3,213,345,989			-			3,124,714,026			278,796,844

Denominator for diluted earnings per share-adjusted weighted
average shares and assumed conversions		3,440,185,503			22,678,877			3,222,207,099			301,266,858

Basic earning per share	$	0.26		$	(1.13	)	$	0.13		$	1.74
Diluted earnings per share	$	(0.00	)	$	(1.13	)	$	(0.00	)	$	(0.02	)

The above table includes only dilutive instruments and their effects on earnings per common share.

The following outstanding stock options, warrants, convertible debt and convertible preferred securities for the three and nine months ended September 30, 2011 and 2010, are anti-dilutive and therefore have been excluded from diluted net income (loss) per share:

	Three Months Ended September 30,				Nine Months Ended September 30,
	2011		2010		2011		2010
Stock options		1,076,981		1,099,557		1,076,981		823,171
Warrants		27,684,611		17,621,125		27,845,000		14,412,242
Convertible debt		-		213,076,644		-		-
Convertible preferred stock		-		74,698,729		-		-
		28,761,591		306,496,055		28,921,981		15,235,413

Inventories – Inventories are stated at the lower of cost or market and are comprised of barcode-reading equipment at our NeoMedia Europe location. Cost is determined using the first-in, first-out method.

Recent Accounting Pronouncements - The following Accounting Standards Codification Updates have recently been issued:

Pronouncement	Issued	Title

ASU No. 2011-08	September 2011	Intangibles—Goodwill and Other (Topic 350): Testing Goodwill for Impairment

ASU No. 2011-09	September 2011	Compensation—Retirement Benefits—Multiemployer Plans (Subtopic 715-80): Disclosures about an Employer’s Participation in a Multiemployer Plan

To the extent appropriate, the guidance in the above Accounting Standards Codification Updates is already reflected in our consolidated financial statements and management does not anticipate that these accounting pronouncements will have any material future effect on our consolidated financial statements.

Note 3 – Financing

At September 30, 2011, our financing transactions with YA Global, an accredited investor, included shares of our Series C preferred stock issued in February 2006, Series D preferred stock issued in January 2010, a series of twenty eight secured convertible debentures issued between August 2006 and September 2011 and various warrants to purchase shares of our common stock. All of our assets are pledged to secure our obligations under these securities. At various times, YA Global has assigned or distributed portions of its holdings of these securities to other holders, including persons who are officers of YA Global and its related entities, as well as to other holders who are investors in YA Global’s funds. As of September 30, 2011, approximately $1,862,500 has been assigned or distributed by YA Global to other holders, which represents approximately 5% of YA Global’s holdings.

Conversions –Our preferred stock and convertible debentures are convertible into shares of our common stock. However, the conversion of each of these securities is limited such that the holder cannot exceed 9.99% beneficial ownership of our common stock, unless the holder waives their right to such limitation. Cumulatively, as of September 30, 2011, the holders of our Series C preferred stock have converted 16,567 shares of the original 22,000 shares of Series C preferred stock into 204,815,226 shares of common stock and holders of our Series D preferred stock have converted 1,399 shares of the original 25,000 shares of Series D preferred stock into 10,938,232 shares of common stock. YA Global has converted $888,000 of principal and accrued interest on those debentures into 76,334,719 shares of our common stock. Holders, other than YA Global, converted $1,399,759 of principal and accrued interest on the debentures into 114,224,052 shares of common stock.

Debenture Interest Payments– On December 23, 2010 and again on February 18, 2011, we made payments of $1.0 million each of accrued interest, related to the March 27, 2007 debenture, to YA Global.

Secured Debentures - The underlying agreements for each of the twenty eight debentures issued to YA Global are essentially the same, except in regard to the interest rate, varying conversion prices per share, and the number of warrants that were issued in conjunction with each of the debentures. The debentures are convertible into our common stock, at the option of the holder, at the lower of a fixed conversion price per share or a percentage of the lowest volume-weighted average price (“VWAP”) for a specified number of days prior to the conversion (the “look-back period”). The conversion is limited such that the holder cannot exceed 9.99% ownership, unless the holder waives their right to such limitation. All of the debentures are secured according to the terms of a Security Pledge Agreement dated August 23, 2006, which was entered into in connection with the first convertible debenture issued to YA Global and which provides YA Global with a security interest in substantially all of our assets. The debentures are also secured by a Patent Security Agreement dated July 29, 2008. On August 13, 2010 our wholly owned subsidiary, NeoMedia Europe GmbH, became a guarantor of all outstanding financing transactions between us and YA Global, through pledges of their intellectual property and other movable assets. As security for our obligations to YA Global, all of our Pledged Property, Patent Collateral and other collateral is affirmed through the several successive Ratification Agreements which have been executed in connection with each of the 2010 and 2011 financings.

2011 Financing Transactions - Between January 10, 2011and September 15, 2011 we entered into seven Securities Purchase Agreements to issue and sell nine debentures to YA Global in the aggregate principal amount of $3,950,000. The debentures are convertible, at the option of the holder, at a conversion price equal to the lesser of (i) $0.10 or (ii) 95% of the lowest closing bid price of our common stock for the 60 trading days preceding the date of conversion. The debentures bear interest at 14% and mature on July 29, 2012. The debentures provided net proceeds of $3,685,000 after payment of $265,000 in fees. We have the right to redeem a portion or all amounts outstanding under the debentures at a redemption premium of 10%, plus accrued interest. In connection with the six debentures issued prior to June 30, 2011, we also issued warrants to YA Global to purchase 1,250,000, 1,250,000, 1,000,000, 1,000,000, 1,000,000 and 3,000,000 shares of common stock, respectively. In addition, we issued warrants to YA Global to purchase 1,000,000 shares of common stock on September 15, 2011. The warrants issued from January 2011 through April 2011 initially had an exercise price of $0.10 per share, and the warrants issued subsequently, an exercise price of $0.15 per share. However, as a result of the anti-dilution protection in these warrants, the subsequent issuance of additional debentures to YA Global reset the exercise price of the warrants to 95% of the lowest closing bid price of our common stock for the 60 days preceding the issuance date of the debentures. All warrants issued during 2011 have a term of five years.

At inception, a summary of the allocation of the components of the new debentures and warrants issued this quarter was as follows:

	July 13, 2011			August 12, 2011			September 15, 2011
	debenture			debenture			debenture
				(in thousands)

Gross proceeds	$	450		$	350		$	450
Structuring and due diligence fee		(37	)		(37	)		(25	)
	$	413		$	313		$	425

Derivative liabilities:
Investor warrants	$	-		$	-		$	(28	)
Compound derivative		(1,242	)		(868	)		(303	)
Total derivative liabilities		(1,242	)		(868	)		(331	)

Day one derivative loss		829			555			-
Convertible debenture-initial carrying value		-			-			(94	)
	$	(413	)	$	(313	)	$	(425	)

The compound derivatives were valued using the Monte Carlo Simulation valuation method. Significant assumptions used to value the compound derivatives as of inception of the financings included exercise estimates/behaviors and the following significant estimates:

	July 13, 2011 Financing			August 12, 2011 Financing			September 15, 2011 Financing

Conversion price	$	0.0128		$	0.0128		$	0.0247
Equivalent volatility		188	%		187	%		183	%
Equivalent interest risk		14.00	%		14.00	%		14.00	%
Equivalent credit risk		7.19	%		7.20	%		7.63	%

The warrants are valued using the binomial option valuation methodology. Significant assumptions used to value the warrants as of their inception included the following significant estimates:

	September 15, 2011

Exercise price	$	0.028
Expected life	5 years
Estimated volatility		290	%
Risk free rate of return		0.15	%
Dividend yield		--

For the risk-free rates of return, we use the published yields on zero-coupon Treasury Securities with maturities consistent with the term of the warrants and volatility is based upon our expected stock price volatility over the term of the warrants.

The table below summarizes the significant terms of each of the debentures as of September 30, 2011:

					Conversion Price – Lower of Fixed Price or
				Default	Percentage of VWAP for Preceding Period
	Face		Interest	Interest	Fixed		Default	Preceding
Debenture Issue Date	Amount	Maturity	Rate	Rate	Price	%	%	Period

August 24, 2006	$ 5,000,000	7/29/2012	10%	n/a	$2.00	90%	n/a	125 Days
December 29, 2006	$ 2,500,000	7/29/2012	10%	n/a	$2.00	90%	n/a	125 Days
March 27, 2007	$ 6,168,693	7/29/2012	13%	n/a	$2.00	90%	n/a	125 Days
August 24, 2007	$ 1,775,000	7/29/2012	14%	n/a	$2.00	80%	n/a	125 Days
April 11, 2008	$ 390,000	7/29/2012	15%	24%	$1.50	80%	75%	125 Days
May 16, 2008	$ 500,000	7/29/2012	15%	24%	$1.50	80%	50%	125 Days
May 29, 2008	$ 790,000	7/29/2012	15%	24%	$1.00	80%	50%	125 Days
July 10, 2008	$ 137,750	7/29/2012	15%	24%	$1.00	80%	50%	125 Days
July 29, 2008	$ 2,325,000	7/29/2012	14%	24%	$2.00	95%	50%	125 Days
October 28, 2008	$ 2,325,000	7/29/2012	14%	20%	$2.00	95%	50%	125 Days
May 1, 2009	$ 258,037	7/29/2012	14%	20%	$2.00	95%	50%	125 Days
June 5, 2009	$ 715,000	7/29/2012	14%	20%	$2.00	95%	50%	125 Days
July 15, 2009	$ 535,000	7/29/2012	14%	20%	$2.00	95%	50%	125 Days
August 14, 2009	$ 475,000	7/29/2012	14%	20%	$2.00	95%	50%	125 Days
May 27, 2010	$ 2,006,137	7/29/2012	14%	20%	$0.30	95%	50%	60 Days
August 13, 2010	$ 550,000	7/29/2012	14%	20%	$0.20	95%	50%	60 Days
September 29, 2010	$ 475,000	7/29/2012	14%	20%	$0.20	95%	50%	60 Days
October 28, 2010	$ 400,000	7/29/2012	14%	20%	$0.20	95%	50%	60 Days
December 15, 2010	$ 450,000	7/29/2012	14%	20%	$0.10	95%	50%	60 Days
January 10, 2011	$ 450,000	7/29/2012	14%	20%	$0.10	95%	50%	60 Days
February 8, 2011	$ 650,000	7/29/2012	14%	20%	$0.10	95%	50%	60 Days
March 11, 2011	$ 450,000	7/29/2012	14%	20%	$0.10	95%	50%	60 Days
April 13, 2011	$ 450,000	7/29/2012	14%	20%	$0.10	95%	50%	60 Days
May 31, 2011	$ 450,000	7/29/2012	14%	20%	$0.10	95%	50%	60 Days
June 28, 2011	$ 250,000	7/29/2012	14%	20%	$0.10	95%	50%	60 Days
July 13, 2011	$ 450,000	7/29/2012	14%	20%	$0.10	95%	50%	60 Days
August 12, 2011	$ 350,000	7/29/2012	14%	20%	$0.10	95%	50%	60 Days
September 15, 2011	$ 450,000	7/29/2012	14%	20%	$0.10	95%	50%	60 Days

All debentures with YA Global contain provisions for acceleration of principal and interest upon default. Certain debentures also contain default interest rates and conversion prices, as reflected in the table above.

In our evaluation of these financing transactions, we concluded that the conversion features were not afforded the exemption for conventional convertible instruments due to the variable conversion rate, and they did not otherwise meet the conditions set forth in current accounting standards for equity classification. Because equity classification was not available for the conversion features, we elected to bifurcate the compound derivatives, and carry them as derivative liabilities, at fair value. Each compound derivative consists of (i) the embedded conversion feature, (ii) down-round anti-dilution protection features, and (iii) default, non-delivery and buy-in puts which were combined into one compound instrument that is carried as a component of derivative liabilities.

Fair Value Considerations - In accordance with FASB ASC 815, Derivatives and Hedging, we determined that the conversion features of the Series C and Series D preferred stock, and the Debentures met the criteria of embedded derivatives and that the conversion features of these instruments required bifurcation and accounting as derivative instrument liabilities. Changes in the fair value of the compound derivative liability, including the embedded conversion option, are charged or credited to income each period. As permitted by FASB ASC 815-15-25-4, Recognition of Embedded Derivatives, we elected not to bifurcate the embedded derivatives in the March 2007, August 2007, April 2008 or May 2008 Debentures and accordingly, these convertible instruments are being carried in their entirety at their fair values, with the changes in the fair value of the debentures charged or credited to income each period.

Derivative financial instruments arising from the issuance of convertible financial instruments are initially recorded, and continuously carried, at fair value. Upon conversion of any of the convertible financial instruments, the carrying amount of the debt, including any unamortized premium or discount, and the related derivative instrument liability are credited to the capital accounts upon conversion to reflect the stock issued and no gain or loss is recognized.

Bifurcated Embedded Derivative Instruments – Series C and Series D preferred stock and Convertible Debentures - For financings recorded in accordance with FASB ASC 815-15-25-1, the compound embedded derivative instruments are valued using a Monte Carlo Simulation methodology because that model embodies certain relevant assumptions (including, but not limited to, interest rate risk, credit risk, and conversion/redemption privileges) that are necessary to value these complex derivatives.

The conversion price in each of the convertible debentures is subject to adjustment for down-round, anti-dilution protection. Accordingly, if we sell common stock or common share indexed financial instruments below the stated or variable conversion price in the agreement, the conversion price adjusts to that lower amount.

The assumptions included in the calculations are highly subjective and subject to interpretation. Assumptions used as of September 30, 2011 included exercise estimates/behaviors and the following other significant estimates:

		Remaining		Equivalent	Equivalent
	Conversion	Term	Equivalent	Interest-Risk	Credit-Risk
	Prices	(years)	Volatility	Adjusted Rate	Adjusted Rate

Series C preferred stock	$ 0.0131	0.84	180%	8.00%	7.63%
Series D preferred stock	$ 0.0131	0.84	180%	8.00%	7.63%

August 24, 2006	$ 0.0122	0.84	180%	10.00%	7.63%
December 29, 2006	$ 0.0122	0.84	180%	10.00%	7.63%
July 10, 2008	$ 0.0108	0.84	180%	15.00%	7.63%
July 29, 2008	$ 0.0128	0.84	180%	14.00%	7.63%
October 28, 2008	$ 0.0128	0.84	180%	14.00%	7.63%
May 1, 2009	$ 0.0128	0.84	180%	14.00%	7.63%
June 5, 2009	$ 0.0128	0.84	180%	14.00%	7.63%
July 15, 2009	$ 0.0128	0.84	180%	14.00%	7.63%
August 14, 2009	$ 0.0128	0.84	180%	14.00%	7.63%
May 27, 2010	$ 0.0128	0.84	180%	14.00%	7.63%
August 13, 2010	$ 0.0128	0.84	180%	14.00%	7.63%
September 29, 2010	$ 0.0128	0.84	180%	14.00%	7.63%
October 28, 2010	$ 0.0128	0.84	180%	14.00%	7.63%
December 15, 2010	$ 0.0128	0.84	180%	14.00%	7.63%
January 10, 2011	$ 0.0128	0.84	180%	14.00%	7.63%
February 8, 2011	$ 0.0128	0.84	180%	14.00%	7.63%
March 11, 2011	$ 0.0128	0.84	180%	14.00%	7.63%
April 13, 2011	$ 0.0128	0.84	180%	14.00%	7.63%
May 31, 2011	$ 0.0128	0.84	180%	14.00%	7.63%
June 28, 2011	$ 0.0128	0.84	180%	14.00%	7.63%
July 13, 2011	$ 0.0128	0.84	180%	14.00%	7.63%
August 12, 2011	$ 0.0165	0.84	180%	14.00%	7.63%
September 15, 2011	$ 0.0165	0.84	180%	14.00%	7.63%

Equivalent amounts reflect the net results of multiple modeling simulations that the Monte Carlo Simulation methodology applies to underlying assumptions.

Due to the variable component of the conversion price, rapid fluctuations in the trading market price may result in significant variations to the calculated conversion price. For each debenture, we analyze the ratio of the conversion price (as calculated based on the percentage of VWAP for the appropriate look back period) to the trading market price for a period of time equal to the term of the debenture to determine the average ratio for the term of the note. Each quarter, the ratio in effect on the date of the valuation is compared with the average ratio over the term of the debenture to determine if the calculated conversion price is representative of past trends or if it is considered unrepresentative due to a large fluctuation in the stock price over a short period of time. If the calculated conversion price results in a ratio that deviates significantly from the average ratio over the term of the agreement, the average ratio of the conversion price to the trading market price is then multiplied by the current trading market price to determine the variable conversion price for use in the fair value calculations. This variable conversion price is then compared with the fixed conversion price and, as required by the terms of the debentures, the lower of the two amounts is used as the conversion price in the Monte Carlo Simulation model used for valuation purposes. On September 30, 2011, the fixed conversion price for each of the debentures was equal to or higher than the calculated variable conversion price. Accordingly, the variable conversion price was used in the Monte Carlo Simulation model. This analysis is performed each quarter to determine if the calculated conversion price is reasonable for purposes of determining the fair value of the embedded conversion features (for instruments recorded under FASB ASC 815-15-25-1) or the fair value of the hybrid instrument (for instruments recorded under FASB ASC 815-15-25-4).

Hybrid Financial Instruments Carried at Fair Value – 2007 and 2008 Convertible Debentures - The March 2007, August 2007, April 2008 and May 2008 convertible debentures are recorded in accordance with FASB ASC 815-15-25-4 and the entire hybrid instrument was initially recorded at fair value, with subsequent changes in fair value charged or credited to income each period. These financial instruments are valued using the common stock equivalent approach. The common stock equivalent is calculated using the shares indexed to the debentures valued at the market price of our stock and the present value of the coupon.

The shares indexed to the debentures are calculated using the variable conversion price based on the 125 day look-back period and the present value of the coupon from inception of the debentures to the revised maturity date of July 29, 2012.

Current Period Valuations - On January 5, 2010, the terms of all of the debentures issued prior to that date were modified to increase the look-back period used to calculate the variable conversion price per share for all debentures to a period of 125 days and to extend the stated maturity date to July 29, 2012, which increased our future anticipated cash flows related to those instruments. Because that increase exceeded the threshold prescribed by FASB ASC 470-50, Debt Modifications and Extinguishments, the modification of the amounts due under these instruments was accounted for as an extinguishment. Accordingly, the original convertible debentures were considered extinguished and the revised convertible debentures were recorded at their fair value, resulting in an extinguishment loss of approximately $5.6 million.

For our Series C and Series D preferred stock and our convertible debentures, the following table reflects the face value of the instruments and, as appropriate, either their amortized cost carrying value and the fair value of the separately-recognized compound embedded derivative or, for those debentures recorded in their entirety at fair value, their fair value, as well as for each of the instruments the number of common shares (in thousands) into which the instruments are convertible as of September 30, 2011 and December 31, 2010.

							Embedded				Common
September 30, 2011	Face		Carrying		Accrued		Conversion				Stock
	Value		Value		Interest		Feature		Fair Value		Shares
	(in thousands)

Series C preferred stock	$	5,433	$	5,433	$	-	$	1,203	$	-		414,707
Series D preferred stock	$	2,360	$	2,360	$	-		522		-		180,160

August 24, 2006	$	5,000	$	5,000	$	2,251		1,817		-		594,315
December 29, 2006		2,500		2,500		1,127		907		-		297,257
March 27, 2007		6,169		n/a		n/a		n/a		10,553		505,631
August 24, 2007		1,775		n/a		n/a		n/a		3,783		164,352
April 11, 2008		390		n/a		n/a		n/a		835		36,111
May 16 ,2008		500		n/a		n/a		n/a		1,064		46,296
May 29, 2008		790		n/a		n/a		n/a		1,677		73,148
July 10, 2008		138		138		68		81		-		19,015
July 29, 2008		2,325		2,325		1,035		807		-		262,540
October 23, 2008		2,325		2,325		953		813		-		256,111
May 1, 2009		258		258		118		68		-		32,215
June 5, 2009		715		690		235		277		-		74,194
July 15, 2009		535		535		168		188		-		54,930
August 14, 2009		475		475		144		167		-		48,337
May 27, 2010		2,006		740		378		1,828		-		186,246
August 13, 2010		550		78		87		474		-		49,775
September 29, 2010		475		59		67		403		-		42,319
October 28, 2010		400		44		52		337		-		35,301
December 15, 2010		450		47		50		373		-		39,067
January 10, 2011		450		35		46		370		-		38,716
February 8, 2011		650		47		59		528		-		55,359
March 11, 2011		450		27		35		362		-		37,907
April 13, 2011		450		196		30		357		-		37,462
May 31, 2011		450		52		21		351		-		36,815
June 28, 2011		250		7		9		193		-		20,243
July 13, 2011		450		12		14		340		-		35,561
August 12, 2011		350		7		7		190		-		21,456
September 15, 2011		450		101		3		242		-		27,430
Total	$	31,726	$	15,698	$	6,957	$	13,198	$	17,912		3,722,976

							Embedded				Common
December 31, 2010	Face		Carrying		Accrued		Conversion				Stock
	Value		Value		Interest		Feature		Fair Value		Shares
	(in thousands)

Series C preferred stock	$	8,336	$	8,336	$	-	$	6,706	$	-		125,348
Series D preferred stock	$	2,500	$	2,500	$	-		1,918		-		36,819

August 24, 2006	$	5,000	$	5,000	$	1,876		5,007		-		109,154
December 29, 2006		2,500		2,500		940		2,502		-		54,596
March 27, 2007		7,459		n/a		n/a		n/a		17,905		118,391
August 24, 2007		1,775		n/a		n/a		n/a		4,888		31,696
April 11, 2008		390		n/a		n/a		n/a		1,106		6,964
May 16 ,2008		500		n/a		n/a		n/a		1,392		8,929
May 29, 2008		790		n/a		n/a		n/a		2,193		14,107
July 10, 2008		138		138		51		180		-		3,387
July 29, 2008		2,325		2,325		792		2,381		-		46,873
October 23, 2008		2,325		2,325		709		2,279		-		46,873
May 1, 2009		258		258		92		237		-		5,249
June 5, 2009		715		668		158		771		-		13,139
July 15, 2009		535		535		111		404		-		9,719
August 14, 2009		475		475		93		482