Quarterly report pursuant to Section 13 or 15(d)

Derivative Liabilities

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Derivative Liabilities
3 Months Ended
Mar. 31, 2014
Notes to Financial Statements  
Derivative Liabilities

Convertible notes payable and underlying warrants

 

As discussed in Note 6 under Bridge Financing, we previously issued convertible notes payable that provided for the issuance of warrants to purchase our common stock at a future date. The conversion term for the convertible notes was variable based on certain factors. The number of warrants to be issued was based on the future price of our common stock.

  

As of December 31, 2012 and through June 17, 2013, the number of warrants to be issued was indeterminate. Due to the fact that the number of warrants issuable was indeterminate, the equity environment was tainted and the fair value of all of the warrants underlying the convertible notes payable was recorded as a derivative liability. The fair values of the variable maturity conversion feature (“VMCO”) and the additional share issuance feature (“ASID”) were recorded as derivative liabilities on the issuance date.

 

On June 17, 2013, we converted all of the outstanding convertible notes payable into shares of our common stock, and issued the warrants underlying the convertible notes payable. At that time, the derivative liabilities related to the VMCO and ASID totaling $7,792,657 were reclassified to additional paid-in capital.

 

Private Placement Shares and Warrants

 

We completed a private placement in September 2011 for the sale of units consisting of shares of common stock and warrants to purchase our common stock. Both the common shares and the warrants contain anti-dilutive, or down round, price protection. We recorded derivative liabilities related to the down round price protection on the common shares and the warrants.

 

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.

 

Allonge

 

As discussed in Note 6 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, we provided allonges which consisted of the accrued interest on each convertible note payable as of January 31, 2012. The allonges were 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.

 

On June 17, 2013, the number of common shares issuable under the allonges was determined to be 527,679 and these shares were issued in July 2013.

 

Non-employee Warrants

 

As discussed in Note 7 under Warrants, we previously accounted for warrants issued to non-employees as derivative liabilities. On June 17, 2013, the equity environment was no longer tainted and the value of the derivative liabilities related to the non-employee warrants totaling $176,555 were reclassified to additional paid-in capital.

 

Summary

 

The fair values of our 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, 2014 and December 31, 2013, we recorded current derivative liabilities of $76,097 and $106,176, respectively, which are detailed by instrument type in the table below.

 

The net change in fair value of the derivative liabilities for the three months ended March 31, 2014 and 2013 was a loss of $30,079 and a gain of $1,001,550, respectively.

  

The following table presents the derivative liabilities by instrument type as of March 31, 2014 and December 31, 2013:

 

Derivative Value by Instrument Type  

March 31,

2014

   

December 31,

2013

 
Common Stock and Warrants   $ 76,097     $ 106,176  
    $ 76,097     $ 106,176  

 

The following table presents details of our derivative liabilities from December 31, 2013 to March 31, 2014:

 

Balance December 31, 2013   $ 106,176  
Change in fair value of derivative liabilities     (30,079)  
Balance March 31, 2014   $ 79,097  

 

An independent valuation expert 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 our derivative liabilities are as follows:

 

For issuances of notes, common stock and warrants:

 

· Stock prices on all measurement dates were based on the fair market value
· Down round protection is based on the subsequent issuance of common stock at prices less than $1.00 per share and warrants with exercise prices less than $1.00 per share
· The probability of a future equity financing event triggering the down round protection was estimated at 0%
· Computed volatility of 115.5%
· Risk free rate of 0.21%