Annual report pursuant to Section 13 and 15(d)

Derivative Liability and Fair Value Measurements

v2.4.0.8
Derivative Liability and Fair Value Measurements
12 Months Ended
Dec. 31, 2013
Derivative Instruments and Hedging Activities Disclosure [Abstract]  
Derivative Liability and Fair Value Measurements
Note 17 – Derivative Liability and Fair Value Measurements
 
The Company recognized a derivative liability for the warrants to purchase 186,480 shares of its common stock issued in connection with the $800,000 convertible senior secured debenture issued on March 21, 2013. These warrants have a cashless exercise provision effective six months after the issuance date and an exercise price that is subject to adjustment in the event of subsequent equity sales at a lower purchase price (subject to certain exceptions) within the first six months. In accordance with ASC 820-10-35 we measured the derivative liability using a Black-Scholes pricing model at the March 21, 2013 issuance date. On September 21, 2013, the exercise price adjustment feature expired causing the warrants to no longer require derivative accounting treatment. Accordingly the derivative liability was marked to market on September 21, 2013 and the fair value of $526,245 related to these warrants was reclassified to Additional Paid-in Capital. See Note 23: Warrants for additional information on the warrants issued.
 
The Company recognized a derivative liability for the warrants to purchase 38,168 shares of its common stock issued in connection with the $200,000 convertible senior secured debenture issued on July 15, 2013. These warrants have a cashless exercise provision effective six months after the issuance date and an exercise price that is subject to adjustment in the event of subsequent equity sales at a lower purchase price (subject to certain exceptions) within the first six months. In accordance with ASC 815-10-25, we measured the derivative liability using a Monte Carlo Options Lattice pricing model at the July 15, 2013 issuance date and subsequently remeasured the liability on December 31, 2013. See Note 23: Warrants for additional information on the warrants issued.
 
The Company recognized a derivative liability for the warrants to purchase 6,004,288 shares of its common stock issued in connection with the equity offering and related debt conversions issued on August 5, 2013. These warrants have a cashless exercise provision and an exercise price that is subject to adjustment in the event of subsequent equity sales at a lower purchase price (subject to certain exceptions) along with full-ratchet anti-dilution provisions. In accordance with ASC 815-10-25, we measured the derivative liability using a Lattice pricing model at the August 5, 2013 issuance date and subsequently remeasured the liability on December 31, 2013. See Note 23: Warrants for additional information on the warrants issued.
 
The Company recognized a derivative liability for the warrants to purchase 127,717 shares of its common stock issued in connection with obtaining the permission of the Company’s senior debt holders for its August 5, 2013 public equity offering. These warrants have a cashless exercise provision effective six months after the issuance date and an exercise price that is subject to adjustment in the event of subsequent equity sales at a lower purchase price (subject to certain exceptions) within the first six months. In accordance with ASC 815-10-25, we measured the derivative liability using a Lattice pricing model at the August 5, 2013 issuance date and subsequently remeasured the liability on December 31, 2013. On September 21, 2013 the exercise price adjustment feature expired for 102,357 of these warrants, causing these warrants to no longer require derivative accounting treatment. Accordingly the associated derivative liability was marked to market on September 21, 2013 and these warrants were reclassified to Additional Paid-in Capital. The remaining 25,360 warrants were subsequently remeasured as December 31, 2013. See Note 23: Warrants for additional information on the warrants issued.
 
Accordingly, at the end of each quarterly reporting date the derivative fair market value is remeasured and adjusted to current market value. The total derivative liability was revalued to $12,035,816 based on the closing price of our common shares as of December 31, 2013, resulting in a loss of  $3,575,278 on the derivative’s valuation for the year ending December 31, 2013 and $-0- for the same period in 2012.
 
The Company concluded that the Put embedded in the senior secured convertible debentures in the event of the Company’s default under the Debenture had such minimal value that it did not record an additional and separate liability for this contingency. Both debentures were repaid in full on August 5, 2013.
 
The Company has adopted ASC Topic 820 (originally issued as SFAS 157, “Fair Value Measurements”) for financial instruments measured at fair value on a recurring basis. ASC Topic 820 defines fair value, establishes a framework for measuring fair value in accordance with accounting principles generally accepted in the United States and expands disclosures about fair value measurements.
 
Fair value is defined as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. ASC Topic 820 establishes a three-tier fair value hierarchy which prioritizes the inputs used in measuring fair value. The hierarchy gives the highest priority to unadjusted quoted prices in active markets for identical assets or liabilities (level 1 measurements) and the lowest priority to unobservable inputs (level 3 measurements). These tiers include:
 
-     Level 1, defined as observable inputs such as quoted prices for identical instruments in active markets;
-     Level 2, defined as inputs other than quoted prices in active markets that are either directly or indirectly observable such as quoted prices for similar instruments in active markets or quoted prices for identical or similar instruments in markets that are not active; and
-     Level 3, defined as unobservable inputs in which little or no market data exists, therefore requiring an entity to develop its own assumptions, such as valuations derived from valuation techniques in which one or more significant inputs or significant value drivers are unobservable.
 
We measure certain financial instruments at fair value on a recurring basis. Assets and liabilities measured at fair value on a recurring basis are as follows at December 30, 2013:
 
 
 
Total
 
(Level 1)
 
(Level 2)
 
Level (3)
 
Assets
 
$
 
$
 
$
 
$
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Total assets measured at fair value
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Liabilities
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Derivative Liability
 
 
12,035,816
 
 
 
 
 
 
12,035,816
 
Total liabilities measured at fair value (Long-Term)
 
$
12,035,816
 
$
 
$
 
$
12,035,816
 
 
 
 
December
31, 2013
 
December
31, 2012
 
Fair value – beginning of period
 
$
 
$
 
Warrants issue
 
 
9,067,283
 
 
 
Reclassification of warrant liabilities to Additional Paid-in Capital
 
 
(526,245)
 
 
 
Reclassification of warrant exercises to Additional Paid-in Capital
 
 
(80,500)
 
 
 
Change in fair value
 
 
3,575,278
 
 
 
 
 
 
 
 
 
 
 
Fair value – end of period
 
$
12,035,816
 
$
 
 
For year ending December 30, 2013, the Monte Carlo Options Lattice pricing model was used to estimate the fair value of warrants issued during this period. The following summary table shows the assumptions used to compute the fair value of the warrants granted during 2013 at issuance and as of December 31, 2013 is:
 
 
 
December 31, 2013
 
 
At Issuance
 
Assumptions for Pricing Model:
 
 
 
 
 
 
 
 
Expected term in years
 
 
4.2 to 4.6
 
 
 
4.62 to 5.0
 
Volatility range for years 1 to 5
 
 
56
%
 
 
61 to 110
%
Risk-free interest rate
 
 
1.75
%
 
 
0.77 to 1.41
%
Expected annual dividends
 
 
None
 
 
 
None
 
 
 
 
 
 
 
 
 
 
Value of warrants issued:
 
 
 
 
 
 
 
 
Fair value of warrants
 
$
12,035,816
 
 
$
9,067,283