4. Long-term debt - convertible notes

9 Months Ended

Sep. 30, 2011

4. Long-term debt - convertible notes

Since January 2010, the Company has issued $805,139 in convertible notes. The debt bears interest at rates from 20% to 30% per annum, compounded monthly, and is due two years from the date the cash is received. Due dates range from January 2012 to September 8, 2013. In addition, the debt and related accrued interest is convertible into the Company’s common stock at a rate equal to the closing price of the Company’s stock on the day the cash is received, which is the date of the note. Conversion rates range from $0.22 - $0.74.

Cash proceeds of $510,000 were received from existing shareholders, the Company’s CEO converted amounts owed to him totaling $79,717 into covertible notes and the Company issued notes totaling $215,422 in exchange for services.

As noted above, the debt and related accrued interest is convertible into the Company’s common stock, and originally, this conversion rate was equal to the closing price of the Company’s stock on the day the cash was received. As additional money was received from the same individuals who had loaned money in the first and second quarters of 2010, the conversion rate for all notes from these individuals was negotiated downward to reflect the Company’s common stock price at a date near the day the additional cash was received in the third quarter of 2010. ASC 470-50-40-6 requires an exchange of debt instruments with substantially different terms to be treated as a debt extinguishment. The modification of terms on these notes met the definition of significant because the change in the fair value of the embedded conversion option was more than 10 percent of the carrying amount of the original debt instrument immediately before and after the modification of terms.

According to ASC 470-50, the difference between the net carrying value and the price paid to acquire the debt instruments is recorded as a gain or loss. In the Company’s situation, the acquisition price was calculated as the present value of the principal (using a 1% risk-free interest rate) plus the fair value of the conversion option (calculated using the Black-Scholes Method), less the embedded beneficial conversion feature. Since this acquisition price was greater than the notes’ carrying value, a loss on extinguishment of $157,413 was recorded during the quarter ended September 30, 2010.

The Company has recorded a beneficial conversion feature in accordance with FASB ASC 470-20. The Company measures the embedded beneficial conversion feature by allocating a portion of the proceeds equal to the intrinsic value of the embedded beneficial conversion feature to additional paid-in capital. Intrinsic value is calculated as the difference between the effective conversion price and the fair value of the common stock into which the debt is convertible, multiplied by the number of shares into which the debt is convertible. A beneficial conversion feature totaling $57,378 was recorded as loan discount since January 2010. The loan discount will be amortized over the life of the convertible note. For the nine months ended September 30, 2011 and 2010, $23,418 and $4,594 of amortization of loan discount was recorded as interest expense, respectively.

A premium of $157,411 on the convertible notes was also recorded as part of the modification of terms. This premium is the present value of the principal (using a 1% risk-free interest rate) plus the fair value of the conversion option (calculated using the Black-Scholes Method) and will be amortized over the life of the loans. For the nine months ended September 30, 2011 and 2010, $73,789 and $18,717 of amortization of premium was recorded to additional paid in capital, respectively.

The following weighted average assumptions were used to calculate the options granted: term of 1.5-1.83 years, risk-free interest rate of 0.375% - 1%, volatility ranging of 110% and a weighted fair value ranging from $0.18 - $0.36.

Another feature of the convertible notes is that interest is guaranteed for the two year period contingent on early repayment or conversion of the debt. Total interest for the notes outstanding at September 30, 2011 is $588,594 of which $253,082 has been included as interest payable on the accompanying September 30, 2011 balance sheet. The difference of $335,512 represents a contingent liability at September 30, 2011. Management has determined that early repayment or conversion of the convertible notes is remote at this time, so the contingency has not been recorded.

The following cash outlays would be required in 2012 and 2013 should repayment of the convertible debt and related interest be in cash:

Quarter ending March 31, 2012:	$	423,148
Quarter ending June 30, 2012:	$	255,030
Quarter ending September 30, 2012	$	314,843
Quarter ending December 31, 2012	$	91,341
Quarter ending March 31, 2013	$	162,087
Quarter ending June 30, 2013	$	19,828
Quarter ending September 30, 2013	$	127,457
Total potential cash outlay:	$	1,393,734

CPC OF AMERICA INC 10-Q