Quarterly report pursuant to Section 13 or 15(d)

Derivative Liabilities

v2.4.0.6
Derivative Liabilities
3 Months Ended
Mar. 31, 2013
Notes to Financial Statements  
NOTE 4 - Derivative Liabilities

As discussed in Note 5 under Bridge Financing, the Company issued convertible notes payable that provide for the issuance of warrants to purchase its common stock at a future date. The conversion term for the convertible notes is variable based on certain factors. The number of warrants to be issued is based on the future price of the Company’s common stock. As of March 31, 2013 and December 31, 2012, the number of warrants to be issued is indeterminate. Due to the fact that the number of warrants issuable is indeterminate, the equity environment is tainted and all additional warrants and convertible debt are included in the value of the derivative. Pursuant to ASC 815-15 “Embedded Derivatives”, the fair values of the VMCO and the ASID were recorded as derivative liabilities on the issuance date.

 

As discussed in Note 6 under Common Stock, the Company completed a private placement in September 2011. The private placement structure consisted of a series of identical subscription agreements for the sale of units comprised of shares of the Company’s common stock at a price of $1.50 per share and an equivalent number of warrants at an exercise price of $2.00. Both the common shares and the warrants contain anti-dilutive, or down round, price protection.  Pursuant to ASC 815-15 Embedded Derivatives and ASC 815-40 Contracts in Entity’s Own Equity, the Company recorded a derivative liability for the warrants issued in the transactions.

 

In October 2012, the exercise price of the warrants was reduced from $2.00 per share to $0.50 per share as a result of the price protection guarantee contained in the warrant agreement.

 

The down round price protection on the common shares expired in August 2012, and the down round price protection for the warrants terminates when the warrants expire or are exercised.

 

As discussed in Note 5 under Bridge Financing, all note holders with convertible notes payable maturing in February 2012 extended the maturity date through May 2012. As consideration to the note holders for the extension of the maturity date, the Company provided allonges which consisted of the accrued interest on each convertible note payable as of January 31, 2012. The allonges are convertible into shares of common stock at the latest financing price. The value of the allonges was recorded as a derivative liability at the issuance date.

 

As discussed in Note 6 under Warrants, the Company accounts for warrants issued to non-employees as derivative liabilities.

 

The fair values of the Company’s derivative liabilities are estimated at the issuance date and are revalued at each subsequent reporting date using a Monte Carlo simulation discussed below. At March 31, 2013 and December 31, 2012, the Company recorded current derivative liabilities of $4,194,373 and $3,074,504. The net change in fair value of the derivative liabilities for the periods ended March 31, 2013 and 2012 was a loss of $1,001,550 and $460,487, respectively, which were reported as other income/(expense) in the consolidated statements of operations.

 

The following table presents the derivative liabilities by instrument type as of March 31, 2013 and December 31, 2012:

 

Derivative Value by Instrument Type   March 31, 2013     December 31, 2012  
Convertible Bridge Notes   $ 3,911,699     $ 2,850,085  
Common Stock and Warrants     154,342       129,378  
Non-employee Warrants     128,332       95,041  
    $ 4,194,373     $ 3,074,504  

 

The following table presents details of the Company’s derivative liabilities from December 31, 2012 to March 31, 2013:

 

    Total  
Balance December 31, 2011   $ 1,573,859  
Issuances in derivative value due to new security issuances of notes     5,352,404  
Issuances in derivative value due to allonges     118,633  
Issuances in derivative value due to vesting of non-employee warrants     485,700  
Adjustment to derivative liability due to note repayment     (167,827 )
Adjustment to derivative liability due to note conversion     (3,323,084 )
Adjustment to derivative liability due to warrant expiration     (1,318 )
Change in fair value of derivative liabilities     (963,863 )
Balance December 31, 2012     3,074,504  
Issuances in derivative value due to new security issuances of notes     133,725  
Issuances in derivative value due to vesting of non-employee warrants     12,581  
Adjustment to derivative liability due to note repayment     (15,406 )
Change in fair value of derivative liabilities     988,969  
Balance March 31, 2013   $ 4,194,373  

 

The Company calculated the fair value of the compound embedded derivatives using a complex, customized Monte Carlo simulation model suitable to value path dependent American options. The model uses the risk neutral methodology adapted to value corporate securities. This model utilized subjective and theoretical assumptions that can materially affect fair values from period to period.

 

Key inputs and assumptions used in valuing the Company’s derivative liabilities are as follows:

 

For issuances of notes, common stock and warrants:

 

s Stock prices on all measurement dates were based on the fair market value

s Down round protection is based on the subsequent issuance of common stock at prices less than $0.50 per share and warrants less than $0.50 per share

s The probability of future financing was estimated at 100%

s Computed volatility ranging from 87.7% to 88.4%

s Risk free rates ranging from 0.07% to 0.25%

 

For issuances of non-employee warrants:

 

s Computed volatility of 88.1%

s Risk free rates ranging from 0.35% to 0.42%

s Expected life (years) ranging from 2.73 to 3.52

 

See Note 8 for a discussion of fair value measurements.