7. CONVERTIBLE DEBT

12 Months Ended

Dec. 31, 2011

7. CONVERTIBLE DEBT

On September 15, 2010, Biomoda entered into a Securities Purchase Agreement with two institutional investors (collectively, the “Purchasers”), pursuant to which the Company sold in a private placement transaction (the “Financing”) for $500,000 in cash (i) $560,000 in principal amount of convertible notes (“Notes”), that matured on August 31, 2011, with a conversion price equal to the lesser of $0.25 or 80% of the average of the three lowest daily VWAPs for the 20 consecutive trading days prior to the date on which a Purchaser elects to convert all or part of its Note and (ii) 5-Year Warrants to purchase an aggregate of 2,000,000 shares of common stock with an exercise price of $0.25 per share. The Notes also include provisions that protect the holders from declines in the Company’s stock price. The interest rate is 10% per annum and accrues until either the maturity date or conversion of the Notes into shares of Biomoda common stock.

Biomoda paid an origination fee of $15,000 to the Purchasers and an additional $5,000 to the Purchasers for their legal fees, which has been treated as a deferred financing cost and was amortized over the term of the Notes. The proceeds from the Notes cannot be used to pay off any debt or advances from shareholders.

The 2,000,000 warrants include provisions that protect the holders from declines in the Company’s stock price that could result in modification of the exercise price under the warrant based on a variable that is not an input to the fair value of a “fixed-for-fixed” option as defined under FASB ASC Topic No. 815-40. As a result, these warrants were not indexed to the Company’s own stock. See Note 10 for further discussion of the treatment of these warrants.

Due to the Notes’ conversion feature, the actual number of shares of common stock that would be required if a conversion of the Notes was made through the issuance of common stock cannot be predicted, and Biomoda could be required to issue an amount of shares that may cause it to exceed its authorized common share amount. As a result, the conversion feature requires derivative accounting treatment and was bifurcated from the Note and “marked to market” each reporting period through the consolidated income statement.

On the date of the transaction, the 2,000,000 warrants issued in connection with the Notes had an estimated fair value of $492,518. The conversion feature had an estimated value of $651,368. See Note 10 for further discussion.

The fair value of the warrants and the conversion option in excess of the principal amount of the Notes of $643,886 was expensed immediately as additional interest expense.

The following table details the accounting for the Notes at inception

Principal amount	$	560,000
Less: original issue discount		(60,000	)
Less: discount for conversion feature and fair value of warrants		(500,000	)
Carrying amount at inception	$	-

The discounts on the Notes were accreted over their term. During the years ended December 31, 2011 and 2010, the Company recognized $390,058 and $169,942 respectively, of interest expense related to the accretion of the discounts.

The Purchasers contacted the Company to notify it of their intention to convert their Notes at the VWAP price that at the time of contact was calculated at $0.0501, and on March 11, 2011, the Company and the Purchasers agreed to extend the look-back provision of the VWAP from 20 days to 40 days from the date of conversion.

As of December 31, 2011, the $560,000 principal balance of the convertible notes and $37,519 in accrued interest were converted into 27,175,810 shares of the Company’s common stock and the derivative liabilities were settled upon conversion.

- Definition

The entire disclosure for short-term debt.

+ References+ Details

BIOMODA INC/NM 10-K