Bluegate analyzed the conversion
feature associated with the preferred stock for derivative accounting consideration under ASC 815-20 Accounting for Derivative
Instruments and Hedging Activities and ASC 815-15 Accounting for Derivative Financial Instruments Indexed to, and Potentially Settled
in, a Company's Own Stock. Bluegate determined the conversion feature met the criteria for classification in equity and did not
require derivative treatment under ASC 815-20 and ASC 815-15.
In accordance with ASC
470-20, Application of Issue No. 98-5 Accounting for Convertible Securities with Beneficial Conversion Features or Contingently
Adjustable Conversion Ratios, which provides guidance on the calculation of a beneficial conversion feature on a convertible instrument,
Bluegate has determined that the Series C shares issued had an aggregate beneficial conversion feature of $500,000 as of the date
of issuance, resulting in a total discount of $600,000. Bluegate recorded this beneficial conversion feature as a deemed dividend
The warrants issued
in this transaction were subject to a registration rights agreement which required Bluegate to register the underlying shares by
September 28, 2007 or pay liquidated damages of 1.5% of the purchase price of the investment each month the shares were not registered.
We filed with the Securities and Exchange Commission a Registration Statement which was effective as of August 30, 2007 with respect
to these securities. There is no liability related to the registration rights agreements.
As a result of this
transaction, net operating losses accumulated up through the change in control are limited by Internal Revenue Code Section 382
due to the change in control (see above footnote 7 Income Taxes).
When applicable, Bluegate
uses the Black-Scholes option pricing model to value stock options and warrants and the simplified method of calculating expected
term as described in ASC 718.