CONVERTIBLE NOTES

3 Months Ended

Sep. 30, 2013

6. CONVERTIBLE NOTES

Prior to the closing of the Share Exchange Agreement, Deep Core issued the convertible notes in exchange for an aggregate of $3,365,000 in proceeds. Pursuant to the agreement, Deep Core was obligated to repay the outstanding principal balance and accrued interest of the convertible notes by June 23, 2012 at an interest rate of 10% per annum, provided, however, that, upon closing of the Share Exchange Agreement while the convertible notes principal balance and unpaid accrued interest of the would automatically convert into shares of our common stock at a conversion price of $0.40 per share.

Upon closing of the Share Exchange on May 3 2012, the outstanding principal balance and unpaid accrued interest of the convertible notes were all converted at a conversion price of $0.40 per share.

On August 29, 2012, the Company entered into a securities purchase agreement with two investors providing for the issuance of an aggregate principal value of $1,000,000 of a 6% senior convertible note and common stock purchase warrants to purchase an aggregate of 1,666,667 shares of common stock in exchange for the aggregate for $1,000,000 (the “August 2012 Notes”).

The August 2012 Notes are due three years from August 29, 2012, the date of issuance. The August 2012 Notes may be converted at any time at the option of the investors into shares of the Company’s common stock at a conversion price of $0.60 per share. The August 2012 Notes bear interest at the rate of 6% per annum at inception, and increased to 12% per annum on March 31, 2013 since the Company had not consummated a primary public offering of its securities with gross proceeds of at least $6,000,000 on or before that date. Should the Company’s common stock not be listed for trading on the Nasdaq Capital Market or the Nasdaq Global Market by January 15, 2014, the interest rate will further increase to 15% per annum. Last, in the event of default the rate will increase to 18%. Interest is payable quarterly in cash and may be payable in shares of the Company’s common stock if certain conditions are met, including but not limited to, the condition that the Company is not in default and the daily trading volume for the Company’s common stock exceeds 25,000 shares per trading day. The Company has the option to redeem the August 2012 Notes at 115% of the outstanding principal together with any accrued but unpaid interest at any time if certain conditions are met. The August 2012 Notes are secured by the Company’s oil and gas properties.

The warrants grant the each investor the right to purchase up to a number of shares of common stock equal to 100% of the shares underlying the principal amount of the convertible notes issued to each respective investor and have an exercise price of $0.85 per share, are exercisable immediately upon issuance and have a term of exercise of five years from August 29, 2012, the date of issuance.

Pursuant to ASC 470-20 Accounting for Convertible Securities with Beneficial Conversion Features or Contingently Adjustable Conversion Ratios, the Company determined that a beneficial conversion feature is present for the convertible notes issued during the period ended September 30, 2012 using the intrinsic value in the convertible notes adjusted for amounts allocated to the warrant valuation. The intrinsic value of the convertible notes amounted to $909,958 based on the fair market value of common stock on the respective dates of issuance.

Since the combined value of the warrants ($443,291) plus the intrinsic value of the August 2012 Notes ($909,958) exceeds the fair value of the proceeds received from the issuance of the debt ($1,000,000), the Company is limited to the amount of the proceeds when recording the beneficial conversion feature as debt discount. Using a pro rata contribution, the Company allocated the proceeds first to the warrant valuation in the amount of approximately $443,291 and the remainder to the beneficial conversion feature in the amount of $556,709. The Company immediately amortized the debt discount of $1,000,000 during the prior year since the debt was convertible upon issuance.

On December 6, 2012, the Company entered into a securities purchase agreement with an investor providing for the issuance of an aggregate principal value of $500,000 of a 6% senior convertible note and common stock purchase warrants to purchase an aggregate of 833,333 shares of common stock in exchange for the aggregate for $500,000 (the “December 2012 Note”).

The December 2012 Note is due three years from December 6, 2012, the date of issuance. The December 2012 Note may be converted at any time at the option of the investors into shares of the Company’s common stock at a conversion price of $0.60 per share. The December 2012 Note bears interest at the rate of 6% per annum inception, and increased to 12% per annum on March 31, 2013 since the Company had not consummated a primary public offering of its securities with gross proceeds of at least $6,000,000 on or before that date. Should the Company’s common stock is not be listed for trading on the Nasdaq Capital Market or the Nasdaq Global Market by January 15, 2014 the interest rate will further increase to 15% per annum. Last, in the event of default the rate will increase to 18%. Interest is payable quarterly in cash and may be payable in shares of the Company’s common stock if certain conditions are met, including but not limited to, the condition that the Company is not in default and the daily trading volume for the Company’s common stock exceeds 25,000 shares per trading day. The Company has the option to redeem the December 2012 Note at 115% of the outstanding principal together with any accrued but unpaid interest at any time if certain conditions are met. The December 2012 Note is secured by the Company’s oil and gas properties.

Pursuant to ASC 470-20 Accounting for Convertible Securities with Beneficial Conversion Features or Contingently Adjustable Conversion Ratios, the Company determined that a beneficial conversion feature is present for the convertible notes issued during the prior year using the intrinsic value in the December 2012 Note adjusted for amounts allocated to the warrant valuation. The intrinsic value of the December 2012 Note amounted to $909,958 based on the fair market value of common stock on the respective dates of issuance.

Since the combined value of the warrants ($236,446) plus the intrinsic value of the December 2012 Note ($319,779) exceeded the fair value of the proceeds received from the issuance of the debt ($500,000), the Company is limited to the amount of the proceeds when recording the beneficial conversion feature as debt discount. Using a pro rata contribution, the Company allocated the proceeds first to the warrant valuation in the amount of approximately $236,446 and the remainder to the beneficial conversion feature in the amount of $263,554. The Company immediately amortized the debt discount of $500,000 during the prior year since the debt was convertible upon issuance.

On February 8, 2013, the Company entered into a securities purchase agreement with an investor providing for the issuance of an aggregate principal value of $1,000,000 of a 15% senior convertible note and common stock purchase warrants to purchase an aggregate of 2,000,000 shares of common stock in exchange for the aggregate for $1,000,000. The convertible notes will become due and payable three years from February 8, 2013, the date of issuance. The convertible note may be converted at any time at the option of the investors into shares of the Company’s common stock at a conversion price of $0.50 per share. The warrants grant the each investor the right to purchase up to a number of shares of common stock equal to 100% of the shares underlying the principal amount of the convertible notes issued to each respective investor and have an exercise price of $0.60 per share, are exercisable immediately upon issuance and have a term of exercise of five years from February 8, 2013.

The assumptions used in the Black-Scholes option pricing model for the Warrants were as follows:

	Risk-free interest rate	0.74%
	Expected volatility of common stock	103%
	Dividend yield	0.00%
	Expected life of warrants and conversion feature	5 years

- Definition

The entire disclosure for information about short-term and long-term debt arrangements, which includes amounts of borrowings under each line of credit, note payable, commercial paper issue, bonds indenture, debenture issue, own-share lending arrangements and any other contractual agreement to repay funds, and about the underlying arrangements, rationale for a classification as long-term, including repayment terms, interest rates, collateral provided, restrictions on use of assets and activities, whether or not in compliance with debt covenants, and other matters important to users of the financial statements, such as the effects of refinancing and noncompliance with debt covenants.

+ References+ Details

Heavy Earth Resources, Inc. 10-Q