UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

FORM 10-Q

 

 

[X]

QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934.

 

For the quarterly period ended March 31, 2014.

OR

 

[ ]

TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934.

 

For the transition period from ____________________ to __________________

 

Commission File Number: 1-11388

 

PLC SYSTEMS INC.

(Exact Name of Registrant as Specified in Its Charter)

  

Yukon Territory, Canada

04-3153858

(State or Other Jurisdiction ofIncorporation or Organization)

(I.R.S. Employer Identification No.)

 

 

459 Fortune Boulevard, Milford, Massachusetts

01757

(Address of Principal Executive Offices)

(Zip Code)

  

Registrant's telephone number, including area code: (508) 541-8800

 

Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes __X__ No ____

 

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes _X___ No_____

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

 

Large accelerated filer ( )

Accelerated filer ( )

   

Non-accelerated filer ( )

Smaller reporting company (X)

(Do not check if a smaller reporting company)

 

                        

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act) Yes ____ No __X__

 

Indicate the number of shares outstanding of each of the issuer's classes of common stock, as of the latest practicable date.

 

Class

Outstanding at May 12, 2014

Common Stock, no par value

124,998,195

  

 
 

 

  

 PLC SYSTEMS INC.

 

Index

 

Part I.

Financial Information:

 
       
 

Item 1.

Financial Statements

 
       
   

Condensed Consolidated Balance Sheets (unaudited)

3

       
   

Condensed Consolidated Statements of Operations (unaudited)

4

       
   

Condensed Consolidated Statements of Comprehensive Loss (unaudited)

5

       
   

Condensed Consolidated Statements of Cash Flows (unaudited)

6

       
   

Notes to Condensed Consolidated Financial Statements (unaudited)

7

       
  Item 2.

Management's Discussion and Analysis of Financial Condition and Results of Operations

28

       
 

Item 3.

Quantitative and Qualitative Disclosures about Market Risk

34

       
 

Item 4.

Controls and Procedures

35

       

Part II.

Other Information:

 
       
 

Item 1A.

Risk Factors

36

       
 

Item 6.

Exhibits

36

 

 
- 2 -

 

  

Part I.     Financial Information

Item 1.     Financial Statements

PLC SYSTEMS INC.

CONDENSED CONSOLIDATED BALANCE SHEETS

(In thousands)

(Unaudited)

 

   

March 31,
2014

   

December 31,
2013

 

ASSETS

 

Current assets:

               

Cash and cash equivalents

  $ 128     $ 769  

Restricted cash

    30       30  

Accounts receivable, net of allowance of $2 at March 31, 2014 and December 31, 2013, respectively

    257       502  

Inventories

    112       117  

Prepaid expenses and other current assets

    49       99  

Total current assets

    576       1,517  

Equipment, furniture and leasehold improvements, net

    24       37  

Other assets

    4       4  

Total assets

  $ 604     $ 1,558  

LIABILITIES AND STOCKHOLDERS’ EQUITY (DEFICIT)

 

Current liabilities:

               

Accounts payable

  $ 510     $ 425  

Accrued compensation

    47       39  

Accrued other

    468       519  

Total current liabilities

    1,025       983  

Convertible notes

    4,904       4,537  

Warrant and option liabilities

    3,691       2,680  

Commitments and contingencies (Note 12)

               

Stockholders’ deficit:

               

Common stock, no par value, unlimited shares authorized, 125,000 shares issued and outstanding; 35,666 unissued and reserved at March 31, 2014 and December 31, 2013, respectively

    97,190       97,190  

Additional paid in capital

    97       48  

Accumulated deficit

    (106,027 )     (103,615 )

Accumulated other comprehensive loss

    (276 )     (265 )

Total stockholders’ deficit

    (9,016 )     (6,642 )

Total liabilities and stockholders’ deficit

  $ 604     $ 1,558  

 

The accompanying notes are an integral part of the condensed consolidated financial statements.

 

 

 
- 3 -

 

 

PLC SYSTEMS INC.

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(In thousands, except per share data)

(Unaudited)

 

   

Three Months Ended

March 31,

 
   

2014

   

2013

 
                 

Revenues

  $ 54     $ 348  

Cost of revenues

    31       179  

Gross profit

    23       169  

Operating expenses:

               

Selling, general and administrative

    537       685  

Research and development

    459       554  

Total operating expenses

    996       1,239  

Loss from operations

    (973 )     (1,070 )

Other income (expense):

               

Interest expense

    (63 )     (140 )

Foreign currency transaction losses

    2       (8 )

Interest income

    --       4  

Change in fair value of warrant and option liabilities

    (1,011 )     (3,999 )

Change in fair value of convertible notes

    (367 )     (1,312 )

Loss on extinguishment of convertible notes

    --       (1,283 )

Total other expense

    (1,439 )     (6,738 )

Net loss

  $ (2,412 )   $ (7,808 )
                 

Net loss per weighted average share, basic

  $ (0.02 )   $ (0.19 )
                 

Weighted average shares outstanding:

               

Basic and diluted

    125,000       41,670  

 

The accompanying notes are an integral part of the condensed consolidated financial statements.

 

 

 
- 4 -

 

  

PLC SYSTEMS INC.

CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE LOSS

(In thousands, except per share data)

(Unaudited)

  

   

Three Months Ended

March 31,

 
   

2014

   

2013

 

Net loss

  $ (2,412 )   $ (7,808 )

Other comprehensive loss:

               

Foreign currency translation adjustments

    (11 )     --  

Other comprehensive loss

    (11 )     --  

Comprehensive loss

  $ (2,423 )   $ (7,808 )

 

The accompanying notes are an integral part of the condensed consolidated financial statements. 

 

 

 
- 5 -

 

  

PLC SYSTEMS INC.

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(In thousands)

(Unaudited)

 

   

Three Months Ended
March 31,

 
   

2014

   

2013

 

Cash flows from operating activities:

               

Net loss

  $ (2,412 )   $ (7,808 )

Depreciation and amortization

    13       13  

Stock-based compensation expense

    49       68  

Change in fair value of warrant and options liabilities

    1,011       3,999  

Change in fair value of convertible notes

    367       1,312  

Loss on extinguishment of convertible notes

    --       1,283  

Non-cash interest expense

    --       95  

Change in assets and liabilities:

               

Restricted cash

    --       (500 )

Accounts receivable

    245       27  

Inventories

    5       71  

Prepaid expenses and other assets

    50       (483 )

Accounts payable

    85       (39 )

Deferred revenue

    --       (69 )

Accrued liabilities

    (44 )     (127 )

Net cash flows used in operating activities

    (631 )     (2,158 )
                 

Cash flows from financing activities:

               

Net proceeds from sale of common stock and warrants

    --       3,504  

Net proceeds from issuance of convertible notes and warrants

    --       250  

Net cash provided by financing activities

    --       3,754  
                 

Effect of exchange rate changes on cash and cash equivalents

    (10 )     9  

Net (decrease) increase in cash and cash equivalents

    (641 )     1,605  

Cash and cash equivalents at beginning of period

    769       258  

Cash and cash equivalents at end of period

  $ 128     $ 1,863  
                 

Supplemental disclosure of cash flow information:

               

Cash paid for interest

    --     $ 62  

Supplemental disclosure of non-cash financing activities:

               

Cashless exercise of warrants

    --     $ 844  

 

The accompanying notes are an integral part of the condensed consolidated financial statements.

 

 

 
- 6 -

 

 

PLC SYSTEMS INC.

NOTES TO CONDENSED CONSOLIDATED UNAUDITED FINANCIAL STATEMENTS

March 31, 2014

 

1.             Business and Liquidity

 

PLC Systems Inc. (“PLC” or the “Company”) is a medical device company specializing in innovative technologies for the cardiac and vascular markets. Over the past five years, the Company has begun initial commercialization outside the United States of its product, RenalGuard®, which currently represents the Company’s key strategic growth initiative and primary business focus. The RenalGuard System consists of a proprietary console and accompanying single-use sets and is designed to reduce the potentially toxic effects that contrast media can have on the kidneys when it is administered to patients during certain medical imaging procedures. The Company conducts business operations as one operating segment.

 

For the three months ended March 31, 2014, the Company incurred a loss from operations of approximately $973,000 and used cash in operations of approximately $631,000. As of March 31, 2014, cash and cash equivalents were $128,000 and the Company's accumulated deficit was $106,027,000. Management expects that quarterly losses from operations and negative cash flows will continue during 2014. These factors raise substantial doubt about the Company’s ability to continue as a going concern. The accompanying condensed consolidated financial statements have been prepared assuming that the Company will continue as a going concern, which contemplates the realization of assets and the satisfaction of liabilities in the normal course of business. The financial statements do not include any adjustments relating to the recoverability and classification of recorded asset amounts or the amounts and classification of liabilities that might be necessary should the Company be unable to continue as a going concern.

 

Based upon the current financial condition of the Company and the expectation of continued quarterly losses from operations during 2014, management is currently investigating ways to raise additional capital that can be completed in the next several months. On April 14, 2014, the Company obtained $250,000 in funding through the sale of convertible notes and warrants. See Note 13 for additional details on the terms and conditions of this financing arrangement.

 

The Company believes that its existing resources, based on its currently projected financial results and the additional funding noted above, are sufficient to fund operations into the second quarter of 2014. Based upon current and anticipated revenue projections from foreign sales of our RenalGuard product, and the anticipated costs of its U.S. clinical trial, we expect that we will need to raise additional capital during the second quarter of 2014. Where possible, the Company has taken certain reductions in its discretionary spending. The Company will continue to review its other expense areas to determine whether additional reductions in discretionary spending can be achieved.

 

On May 14, 2014, the Company filed a proxy statement with the Securities and Exchange Commission describing the form of a proposed merger transaction. The proposed transaction is expected to result in the sale of the Company’s Renal Guard business to GCP IV LLC in exchange for the cancellation of 95% of the Company’s outstanding convertible notes and a release of liens on substantially all of the Company’s assets. Subsequently, a wholly-owned subsidiary of the Company would merge with and into Viveve, Inc. (“Viveve”), with Viveve surviving the merger. The holders of the remaining 5% of the Company’s outstanding convertible notes will receive shares of common stock in exchange for the convertible notes prior to the transaction. Additionally, the holders of the Company’s outstanding warrants (excluding warrants potentially issuable upon exercise of the September SPA Option) will receive two-thirds (2/3) of a common share in exchange for each warrant share held prior to the transaction. The proposed transaction is subject to shareholder approval prior to consummation.

 

2.             Basis of Presentation

 

The accompanying unaudited condensed consolidated financial statements of the Company have been prepared in accordance with generally accepted accounting principles (“GAAP”) for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by generally accepted accounting principles for complete financial statements. In the opinion of management, all adjustments (consisting of normal recurring adjustments) considered necessary for a fair presentation have been included. Operating results for the three months ended March 31, 2014 are not necessarily indicative of the results that may be expected for the year ending December 31, 2014. These financial statements should be read in conjunction with the consolidated financial statements and footnotes thereto included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2013.

 

The preparation of financial statements in accordance with generally accepted accounting principles requires the Company to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements, and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.

 

 
- 7 -

 

 

3.             Inventories

 

Inventories are stated at average cost (computed on a first-in, first-out method) and include allocations of labor and overhead. As of March 31, 2014 and December 31, 2013, inventories consisted of the following (in thousands):

 

   

March 31,

2014

   

December 31,

2013

 

Raw materials

  $ 85     $ 80  

Finished goods

    27       37  
    $ 112     $ 117  

 

4.             Stock-Based Compensation

 

Stock Option Plans

 

In May 2005, the Company’s shareholders approved the 2005 Stock Incentive Plan (the “2005 Plan”). Incentive stock options are issuable only to employees of the Company, while non-qualified stock options may be issued to non-employee directors, consultants and others, as well as to employees. Under the 2005 Plan, the per share exercise price of incentive stock options may not be less than the fair market value of the common stock on the date the option is granted. The 2005 Plan provides that the Company may not grant non-qualified stock options at an exercise price less than 85% of the fair market value of the Company’s common stock.

 

In June 2013, the Company’s shareholders approved the 2013 Stock Incentive Plan (the “2013 Plan”). The 2013 Plan allows for an additional 11,382,600 incentive stock options which may be issued to non-employee directors, consultants and others, as well as to employees. Under the 2013 Plan, the per share exercise price of incentive stock options may not be less than the fair market value of the common stock on the date the option is granted. The 2013 Plan provides that the Company may not grant non-qualified stock options at an exercise price less than 85% of the fair market value of the Company’s common stock.

 

The Company grants stock options to its non-employee directors. New non-employee directors receive an initial grant of an option to purchase shares of the Company’s common stock that generally vest in quarterly installments over three years. Once the initial grant has fully vested, non-employee directors (other than the Chairman of the Board) receive an annual grant of an option to purchase additional shares of the Company’s common stock that generally will vest in four equal quarterly installments. The Chairman of the Board receives an annual grant of an option to purchase 45,000 shares of the Company’s common stock that generally vests in four equal quarterly installments. All such options have an exercise price equal to the fair market value of the Company’s common stock on the date of grant.

 

During the three months ended March 31, 2014, the Company did not grant any options to purchase shares of the Company’s common stock.

 

During the year ended December 31, 2013, the Company granted options to employees to purchase 5,050,000 shares of the Company’s common stock, which vest ratably over a three year period. Certain of these grants were issued to former employees to replace 502,000 options that were cancelled during the year ended December 31, 2013. Additionally, the Company granted 589,000 options to non-employee directors that vest quarterly over a one year period.

 

During the year ended December 31, 2013, the Company issued an aggregate of 416,668 shares of restricted common stock to Garden State Securities, Inc. and JFS Investments, Inc. in exchange for certain investor relations and related consulting services to the Company.  These shares vested immediately but were restricted from being sold for a period of six months from the date of issuance.  The contracts with Garden State Securities, Inc. and JFS Investments, Inc. terminated in February 2013. No further stock issuances will occur under these agreements. The issuance of these shares resulted in recording $56,000 of compensation expense during the three months ended March 31, 2013.

 

As of March 31, 2014, there were 1,317,000 shares of common stock available to be granted under the 2005 Plan, and 6,266,000 shares of common stock available to be granted under the 2013 Plan.

 

The following is a summary of option activity under all plans (in thousands, except per option data):

 

   

Number of

Options

   

Weighted Average Exercise

Price

   

Average Remaining Contractual Life (Years)

   

Aggregate

Intrinsic Value

 

Outstanding, December 31, 2013

    10,086     $ 0.15                  

Granted

    --       --                  

Exercised

    --       --                  

Forfeited

    --       --                  

Cancelled

    --       --                  

Outstanding, March 31, 2014

    10,086     $ 0.15       5.31     $ 0  

Exercisable, March 31, 2014

    5,773     $ 0.19       2.35     $ 0  

 

 

 
- 8 -

 

 

Stock-Based Compensation Expense

 

The Company recorded compensation expense related to stock options of $49,000 in the three months ended March 31, 2014, as compared to $12,000 in the three months ended March 31, 2013. The Company also recorded compensation expense of $56,000 related to the issuance of restricted common shares during the three months ended March 31, 2013. As of March 31, 2014, the Company had $284,000 of total unrecognized compensation cost related to its unvested options, which is expected to be recognized over a weighted average period of 1.59 years. 

 

Stock Purchase Plan

 

The Company has a 2000 Employee Stock Purchase Plan (the “Purchase Plan”) for all eligible employees whereby shares of the Company’s common stock may be purchased at six-month intervals at 95% of the average of the closing bid and ask prices of the Company’s common stock on the last business day of the relevant plan period. Employees may purchase shares having a value not exceeding 10% of their gross compensation during an offering period, subject to certain additional limitations. There was no activity during the three months ended March 31, 2014 or 2013. At March 31, 2014, 294,461 shares were reserved for future issuance under the Purchase Plan.

 

5.             Revenue Recognition

 

The Company recognizes revenue when the following basic revenue recognition criteria have been met: (1) persuasive evidence of an arrangement exists; (2) delivery has occurred or services rendered; (3) the price to the buyer is fixed or determinable; and (4) collectability is reasonably assured. Determination of criteria (3) and (4) are based on management’s judgments regarding the fixed nature of the price to the buyer charged for products delivered or services rendered and collectability of the sales price. The Company assesses credit worthiness of customers based upon prior history with the customer and assessment of financial condition. The Company’s shipping terms are customarily Free On Board (“FOB”) shipping point. The Company records revenue at the time of shipment if all other revenue recognition criteria have been met.

 

As of March 31, 2014 and 2013, we had deferred revenue balances of $0 and $248,000, respectively, related to shipments to our distributor in Italy, Artech, because not all revenue recognition criteria were met. During the three months ended March 31, 2014 and 2013, we recognized $0 and $106,000, respectively, in revenue previously deferred upon the receipt of cash.

 

6.             Loss per Share

 

In the three months ended March 31, 2014 and 2013, basic and diluted loss per share have been computed using only the weighted average number of common shares outstanding during the period without giving effect to any potential future issuances of common stock related to stock option programs, Rights To Shares Agreement (see Note 9), investor warrants or convertible notes, since their inclusion would be antidilutive.

 

For the three months ended March 31, 2014 and March 31, 2013, 248,336,287 and 166,739,613 shares, respectively, attributable to outstanding warrants, convertible notes, Rights To Shares Agreements and stock options were excluded from the calculation of diluted earnings per share because the effect would have been antidilutive.

 

7.             Total Comprehensive Loss

 

Total comprehensive loss for the three months ended March 31, 2014 was $2,423,000 as compared to $7,808,000 in the three months ended March 31, 2013. Comprehensive loss is comprised of the net loss plus the increase or decrease in the foreign currency translation adjustment.

 

 

 
- 9 -

 

  

8.             Warranty and Preventative Maintenance Costs

 

The Company warranties its products against manufacturing defects under normal use and service during the warranty period. The Company evaluates the estimated future unrecoverable costs of warranty and preventative maintenance services for its installed base of products on a quarterly basis and adjusts its warranty reserve accordingly. The Company considers all available evidence, including historical experience and information obtained from supplier audits. There was no warranty liability recorded at March 31, 2014 or December 31, 2013.

 

9.             Sale of Common Stock

 

September 2013 Financing

 

On September 18, 2013 the Company entered into a Securities Purchase Agreement (the “September SPA”) with a number of accredited investors, whereby the Company sold an aggregate of 29,166,668 shares of common stock at $0.06 per share (the “September Purchase Price”) and issued warrants to purchase an additional 29,166,668 shares of common stock (the “September Investor Warrants”) with gross proceeds to the Company of $1,750,000. After payment of the placement agent fees and other expenses, the Company received net proceeds of approximately $1,575,000. As part of the fee for its placement agent services, the Company also issued Palladium Capital Advisors a warrant to purchase 1,485,333 shares of common stock (together with the September Investor Warrants, the “September 2013 Warrants”) on the same terms and conditions as the investors under the September SPA. The shares of common stock sold in the offering are subject to certain piggyback registration rights as well as certain other protections, including price protection, as discussed below.

 

The September SPA provides that for a period of 24 months after the later of (i) September 18, 2013, or (ii) the public announcement of FDA approval for RenalGuard for sale in the United States, and so long as the investors hold the shares purchased pursuant to the September SPA, if the Company issues or sells any shares of common stock or any common stock equivalent at a price less than the September Purchase Price (a “Share Dilutive Issuance”), the Company shall issue additional shares of common stock so that total amount paid by the investor to acquire the shares, divided by the number of shares held by the investor pursuant to the September SPA, plus the additional shares issued as a result of a Share Dilutive Issuance, equals the price per share paid in the Share Dilutive Issuance. This provision also extends to any common shares that are issued pursuant to an exercise of the September 2013 Warrants.

 

In conjunction with the September 2013 SPA, the Company entered into a Right To Shares Agreement with one of the investors. Pursuant to this agreement, in lieu of issuing 16,666,667 of the common shares purchased by the investor, the Company shall be obligated to issue, and the investor has the right to up to 16,666,667 shares of the Company’s common stock. No additional consideration will be paid upon the issuance of the shares and the subscription amount has been paid in full by the investor and is non-refundable. The Company is obligated to deliver the shares to the investor within 3 days of the investor’s request for the share issuance. If the Company fails to deliver the shares within 3 days of the request, under certain circumstances defined in the Right To Shares Agreement, the Company may be obligated to reimburse the investor in cash for losses that the investor incurs as a result of not having access to the shares (the “Buy-In Shares”). As of March 31, 2014, the Company has reserved, but not issued 16,666,667 shares of common stock pursuant to the Right To Shares Agreement.

 

The September SPA also provides the investors with the option, for a period through June 18, 2014, to purchase on the same terms and with the same rights as the September 2013 SPA up to 50% of the shares of common stock purchased by the purchaser at the initial closing (“September 2013 SPA Option”). The investors would also receive a warrant for every option share exercised with the same terms as the warrants issued in the September SPA. To date, no shares have been purchased under the September 2013 SPA Option. The following is a summary of the September 2013 SPA Option for the three months ended March 31, 2014:

 

September 2013 SPA Option

 

Shares

   

Exercise

Price

 

Beginning balance at December 31, 2013

    14,583,334     $ 0.06  
                 

Ending balance at March 31, 2014

    14,583,334     $ 0.06  

 

 

 
- 10 -

 

 

The September 2013 Warrants have a term of five-years and are immediately exercisable for an aggregate 30,625,001 shares of common stock purchased at an exercise price of $0.08 per share. The exercise price of the September 2013 Warrants shall be adjusted in the event of (a) stock splits, stock dividends, combinations, reclassifications, mergers, consolidations, distributions of assets or evidence of indebtedness, sales or transfers of substantially all assets, share exchanges or similar events, and (b) dilutive issuances of (i) common stock or (ii) common stock equivalents at an effective price per share that is lower than the then exercise price. The September 2013 Warrants may be exercised on a cashless basis if at any time there is no effective registration statement within 180 days after the closing date of the private placement covering the resale of the shares of common stock underlying the September 2013 Warrants. The September 2013 Warrants contain limitations on the holder’s ability to exercise the September 2013 Warrants in the event such exercise causes the holder to beneficially own in excess of 4.99% of the Company’s issued and outstanding common stock, subject to a discretionary increase in such limitation by the holder to 9.99% upon 61 days’ notice. To date, none of the September 2013 Warrants have been exercised. The following is a summary of the September 2013 Warrants for the three months ended March 31, 2014:

 

The September 2013 Warrants

 

Warrants

   

Exercise

Price

 

Beginning balance at December 31, 2013

    30,625,001     $ 0.08  
                 

Ending balance at March 31, 2014

    30,625,001     $ 0.08  

 

In June 2008, the FASB issued ASC 815-40-15 (formerly EITF 07-5, Determining Whether an Instrument (or Embedded Feature) Is Indexed to an Entity’s Own Stock), which was effective for the Company in 2009. This issued guidance requires that derivative instruments be evaluated for certain contingencies and anti-dilution provisions that would affect their equity classification as a derivative under ASC 815, Derivatives and Hedging (ASC 815) and requires the instruments to be classified as liabilities and reported at fair value.

 

Upon issuance, the September 2013 Warrants and the September 2013 SPA Option were not considered indexed to the Company’s own stock and therefore are required to be accounted for as freestanding derivative instruments and classified as a liability. A Monte Carlo simulation was used to estimate the fair value of the September 2013 Warrants and September 2013 SPA Option resulting in grant date fair values of $1,807,000 and $1,166,000, respectively (see Note 10 – Fair Value Measurements). As of March 31, 2014, the September 2013 Warrants have been marked to fair value resulting in a derivative liability of $842,000. The impact to other income (expense) for the change in fair value of the September 2013 Warrants for the three months ended March 31, 2014 was a loss of $215,000. As of March 31, 2014, the September 2013 SPA Options have been marked to fair value resulting in a derivative liability of $351,000. The impact to other income (expense) for the change in fair value of the September 2013 SPA Option for the three months ended March 31, 2014 was a loss of $59,000.

 

The Company also assessed the provisions of the Buy-In Share feature of the Rights To Shares Agreement as an embedded derivative pursuant to ASC 815-15, Embedded Derivatives, and has concluded that the feature meets the definition of a derivative and is not clearly and closely related to the Rights To Shares equity host agreement. The Buy-In Shares feature has been bifurcated from the Rights To Shares agreement and accounted for separately. The value of this feature was nominal as of the issuance date and March 31, 2014.

 

Allocation of SPA Proceeds

 

The Company first allocated the proceeds of the September SPA to the fair value of the September 2013 Warrants and September 2013 SPA Option. When the issuance costs were considered, the aggregate fair value of the September 2013 Warrants and September 2013 SPA Option exceeded the net proceeds of the September SPA. The Company first recorded the difference as a reduction of additional paid in capital to the extent available, with the reminder accounted for as a reduction in common stock.

 

February 2013 Financing

 

On February 22, 2013, the Company entered into a Securities Purchase Agreement (the “February SPA”) with a number of accredited investors, whereby the Company sold an aggregate of 26,933,333 shares of common stock at $0.15 per share (the “February Purchase Price”) and issued warrants to purchase an additional 26,933,333 shares of common stock (the “February Investor Warrants”) with gross proceeds to the Company of $4,040,000. After payment of the placement agent fees and other expenses, the Company received net proceeds of approximately $3,504,000. As part of the fee for its placement agent services, the Company also issued Palladium Capital Advisors a warrant to purchase 1,885,333 shares of common stock (together with the Investor Warrant, the “February 2013 Warrants”) on the same terms and conditions as the investors under the February SPA. The shares of common stock sold in the offering are subject to certain piggyback registration rights as well as certain other protections, including price protection, as discussed below.

 

The February SPA provides that for a period of 24 months after the later of (i) February 22, 2013, or (ii) the public announcement of FDA approval for RenalGuard for sale in the United States, and so long as the investors hold the shares purchased pursuant to the February SPA; in the event that the Company issues or sells any shares of common stock or any common stock equivalent at a price less than the Purchase Price (a “Share Dilutive Issuance”), the Company shall issue additional shares of common stock so that total amount paid by the investor to acquire the shares, divided by the number of shares held by the investor pursuant to the February SPA, plus the additional shares issued as a result of a Share Dilutive Issuance, equals the price per share paid in the Share Dilutive Issuance. This provision also extends to any common shares that are issued pursuant to an exercise of the February 2013 Warrants. As required under the terms of the February SPA, in connection with the September SPA, the Company issued to the investors in the February 2013 Financing an additional 40,400,001 shares of Common Stock due to these anti-dilutive provisions being triggered by the lower purchase price for shares issued in the September SPA.

 

 

 
- 11 -

 

  

In conjunction with the February SPA, the Company entered into a Right To Shares Agreement with one of the investors. Pursuant to this agreement, in lieu of issuing 7,000,000 of the common shares purchased by the investor, the Company shall be obligated to issue, and the investor has the right to up to 7,000,000 shares of the Company’s common stock. No additional consideration will be paid upon the issuance of the shares and the subscription amount has been paid in full by the investor and is non-refundable. The Company is obligated to deliver the shares to the investor within 3 days of the investor’s request for the share issuance. If the Company fails to deliver the shares within 3 days of the request, under certain circumstances defined in the Right To Shares Agreement, the Company may be obligated to reimburse the investor in cash for losses that the investor incurs as a result of not having access to the shares (the “Buy-In Shares”). As of March 31, 2014, the Company has reserved, but not issued 19,000,000 shares of common stock pursuant to the Right To Shares Agreement, as adjusted for the anti-dilution issuance described above.

 

The February SPA also provided the investors with the option, for a period through November 21, 2013, to purchase on the same terms and with the same rights as the February 2013 SPA up to 50% of the shares of common stock purchased by the purchaser at the initial closing (“February 2013 SPA Option”). The investors would also receive a warrant for every option share exercised with the same terms as the warrant issued in the February SPA. No shares were purchased or exercised under the February 2013 SPA Option prior to the expiration date.

  

The February 2013 Warrants have a term of five-years and were immediately exercisable for an aggregate 28,818,666 shares of common stock purchased at an exercise price of $0.20 per share. The exercise price of the 2013 Warrants shall be adjusted in the event of (a) stock splits, stock dividends, combinations, reclassifications, mergers, consolidations, distributions of assets or evidence of indebtedness, sales or transfers of substantially all assets, share exchanges or similar events, and (b) dilutive issuances of (i) common stock or (ii) common stock equivalents at an effective price per share that is lower than the then exercise price. Due to the September SPA, certain anti-dilution rights were triggered, resulting in the issuance of an additional 43,228,001 warrants with an exercise price of $0.08. All previously issued warrants related to the February 2013 financing have been repriced to $0.08. The February 2013 Warrants may be exercised on a cashless basis if at any time there is no effective registration statement within 180 days after the closing date of the private placement covering the resale of the shares of common stock underlying the February 2013 Warrants. The February 2013 Warrants contain limitations on the holder’s ability to exercise the February 2013 Warrant in the event such exercise causes the holder to beneficially own in excess of 4.99% of the Company’s issued and outstanding common stock, subject to a discretionary increase in such limitation by the holder to 9.99% upon 61 days’ notice. The following is a summary of the February 2013 Warrants for the three months ended March 31, 2014:

 

The February 2013 Warrants

 

Warrants

   

Exercise

Price

 

Beginning balance at December 31, 2013

    72,046,667     $ 0.08  
                 

Ending balance at March 31, 2014

    72,046,667     $ 0.08  

 

In June 2008, the FASB issued ASC 815-40-15 (formerly EITF 07-5, Determining Whether an Instrument (or Embedded Feature) Is Indexed to an Entity’s Own Stock), which was effective for the Company in 2009. This issued guidance requires that derivative instruments be evaluated for certain contingencies and anti-dilution provisions that would affect their equity classification as a derivative under ASC 815, Derivatives and Hedging (ASC 815) and requires the instruments to be classified as liabilities and reported at fair value.

 

Upon issuance, the February 2013 Warrants and February 2013 SPA Option were not considered indexed to the Company’s own stock and therefore are required to be accounted for as freestanding derivative instruments and classified as a liability. A Monte Carlo simulation was used to estimate the fair value of the February 2013 Warrants and February 2013 SPA Option resulting in grant date fair values of $2,759,000 and $1,211,000, respectively (see Note 10 – Fair Value Measurements). As of March 31, 2014, the February 2013 Warrants have been marked to fair value resulting in a derivative liability of $1,981,000. The impact to other income (expense) for the change in fair value of the February 2013 Warrants for the three months ended March 31, 2014 and 2013 was a loss of $540,000 and $884,000, respectively. As of each reporting period, the February 2013 SPA warrants have been marked to fair value. The impact to other income (expense) for the change in fair value of the February 2013 SPA Option for the three months ended March 31, 2013 was a loss of $583,000.

   

 
- 12 -

 

  

The Company also assessed the provisions of the Buy-In Share feature of the Rights To Shares Agreement as an embedded derivative pursuant to ASC 815-15, Embedded Derivatives, and has concluded that the feature meets the definition of a derivative and is not clearly and closely related to the Rights To Shares equity host agreement. The Buy-In Shares feature has been bifurcated from the Rights To Shares agreement and accounted for separately. The value of this feature was nominal as of the issuance date and March 31, 2014.

 

Allocation of SPA Proceeds

 

The Company first allocated the proceeds of the February SPA to the fair value of the February 2013 Warrants and February 2013 SPA Option. When the issuance costs were considered, the aggregate fair value of the February 2013 Warrants and February 2013 SPA Option exceeded exceeded the net proceeds of the February SPA. The Company recorded the difference as a reduction of additional paid in capital.

 

The February SPA requires the Company to use $1,000,000 of the proceeds received from the February SPA for investor relations. The Company engaged an investor relations firm and made an initial payment of $500,000 on the date of the February SPA closing. During the quarters ended September 30, 2013 and December 31, 2013 the Company paid an additional $250,000 and $220,000, respectively. The Company has recorded the remaining $30,000 cash held in escrow as restricted cash on the Condensed Consolidated Balance Sheet at March 31, 2014.

 

10.          Convertible Notes and Warrants

 

Features of the Convertible Notes and Investor Warrants

 

On February 22, 2011 (the “Original Issue Date”), the Company entered into a Securities Purchase Agreement (“Purchase Agreement”) and a 5% Senior Secured Convertible Debenture Agreement (the “Note Agreement”) with GCP IV LLC (the “Investors” or “Holders”) pursuant to which the Company agreed to issue and sell in a private placement to the Investors an aggregate principal amount of $4,000,000 of convertible notes due February 22, 2014 (the “2011 Convertible Notes”) and warrants to purchase 40,000,000 shares of common stock at $0.15 per share (the “2011 Warrants”). Under the terms of the Purchase Agreement, the Company had the opportunity to raise up to an additional $2,000,000 from the Holders in two separate $1,000,000 tranches, based upon meeting certain operational milestones within certain periods of time. The deadline for achieving the operational milestones for the first $1,000,000 tranche expired in February 2012 without the Company achieving such milestones; however, the Investors agreed to waive both the deadline and the achievement of these milestones as a condition for the investment of the first additional $1,000,000 tranche (the “2012 Convertible Notes”) and issuance of warrants to purchase up to 10,000,000 shares of common stock at $0.15 per share and warrants to purchase up to 10,000,000 shares of common stock at $0.25 per share (the “2012 Warrants”) which was completed on July 2, 2012.  On January 16, 2013 the Company entered into an amendment and waiver to the Purchase Agreement to provide for the issuance of an additional $250,000 of 5% Senior Secured Convertible Debentures (the “Third Tranche Convertible Notes”) maturing on January 16, 2016 and warrants exercisable for a period of five years to purchase up to 2,500,000 shares of common stock at an exercise price of $0.15 per share (the “Third Tranche Warrants”).

 

The convertible notes and warrants and the Purchase Agreement covering both are secured by a security interest in all assets of the Company and its subsidiaries and all such obligations are guaranteed jointly and severally by the Company's subsidiaries. The convertible notes also contain non-financial covenants which limit the Company and its subsidiaries from incurring subsequent indebtedness, incurring liens, and amending organizational documents, repurchasing or repaying other debt, paying cash dividends and entering into affiliate transactions.

 

On February 22, 2013, simultaneous with the closing of the February SPA, the Company entered into an Amendment and Waiver Agreement (the “February Amendment and Waiver Agreement”) with the Holder under which the Holder agreed to (a) increase the number of shares exercisable under the 2011 and 2012 Warrants from an aggregate 50,000,000 shares to 81,578,946 shares and to modify both the exercise price and the Volume Weighted Average Price (“VWAP price”) of the 2011 and 2012  Warrants to $0.098 and $0.155, respectively, (b)  return to the Company for forfeiture the remaining warrants previously issued to purchase an aggregate 12,500,000 shares of common stock, (c)  extend the due date for the 2012 Convertible Notes from February 22, 2014 to June 30, 2015, (d) until February 22, 2014, without the prior written consent from the majority of the investors under the February SPA, forbear from declaring any Event of Default (as defined in the original debenture), and (e) relinquish its right to purchase up to an additional $750,000 in debentures under the terms of the original Purchase Agreement.

 

 

 
- 13 -

 

 

 

On September 18, 2013, simultaneous with the closing of the September SPA, the company entered into an Amendment and Waiver Agreement (“the September Amendment and Waiver Agreement”) under which the holders of the term debentures have agreed to (a) extend the payment due date for the interest on the debentures to June 30, 2015, modify the conversion price for the debentures to $0.06, and set the VWAP Price of the warrants originally issued in 2011 and 2012 to $0.3705.

 

As of March 31, 2014 and December 31, 2013, the maturity date principal of convertible debt was $4,494,355 and is due in June 2015. The Company has also accrued approximately $ 206,000 and $144,000 of interest payable to the convertible note holders at March 31, 2014 and December 31, 2013, respectively. The terms of the individual tranches of convertible notes and warrants issued pursuant to this agreement and the impact of the Amendment and Waiver Agreements are discussed below.

 

2011 Convertible Notes

 

The September Amendment and Waiver Agreement extends the payment due date for the interest on the debentures to June 30, 2015. Interest is calculated on the basis of a 360-day year and accrues daily commencing on the Original Issue Date until payment in full of the outstanding principal, together with all accrued and unpaid interest, liquidated damages and other amounts that may become due in connection with the 2011 Convertible Notes, has been made.

 

The Holders may convert the outstanding principal amount of the Convertible Notes into shares of the Company’s common stock at the conversion price of $0.06 per share as per the September 2013 Amendment and Waiver Agreement. The conversion price is subject to adjustment in the event of (a) stock splits, stock dividends, combinations, reclassifications, mergers, consolidations, distributions of assets or evidence of indebtedness, sales or transfers of substantially all assets, share exchanges or similar events, and (b) certain dilutive issuances of (i) common stock or (ii) common stock equivalents at an effective price per share that is lower than the then conversion price.

 

At any time after February 2012, and upon entering into a change of control transaction or Fundamental Transaction, as defined in the Debenture Agreement, the Company may deliver a notice to the Holders of its irrevocable election to redeem all of the then outstanding principal of the 2011 Convertible Notes for cash in an amount equal to the sum of (a) the greater of (i) the outstanding amount of the 2011 Convertible Notes divided by the conversion price on the date of the mandatory default amount, as defined in the Purchase Agreement, is either (A) demanded or (B) paid in full, whichever has a lower conversion price, multiplied by the VWAP of the date of the mandatory default amount is either (x) demanded or otherwise due or (y) paid in full, whichever has higher VWAP, plus all accrued and unpaid interest, or (ii) 130% of the outstanding principal amount of the Notes, plus 100% of accrued and unpaid interest, and (b) all other amounts, costs, expenses and liquidated damages due under the various agreements covering issuance of the Convertible Notes. Such amount would include the liquidated damages due under the default provision of the Purchase Agreement.

 

Due to the February 2013 Amendment and Waiver Agreement, the Company is required to repay, in cash, any outstanding principal amount of the 2011 Convertible Notes on June 30, 2015 and is not permitted, except upon entering into a change of control transaction or fundamental transaction as noted above, to prepay any portion of the principal amount without prior written consent of the Holders.

 

2011 Warrants

 

On February 22, 2011, in connection with the issuance of the 2011 Convertible Notes, the Company issued warrants for the purchase of up to 40,000,000 shares of common stock at the exercise price of $0.15 per share and with an expiration date of February 22, 2016 (the “2011 Warrants”). On February 22, 2013, as per the terms of the February Amendment and Waiver Agreement, the Company canceled the original warrants and re-issued new warrants for the purchase of up to 65,263,156 shares of common stock at an exercise price of $0.098 per share.

 

The 2011 Warrants are exercisable by a cashless exercise to purchase shares of the Company’s common stock. The Exercise Price of the 2011 Warrants shall be adjusted in the event of (a) stock splits, stock dividends, combinations, reclassifications, mergers, consolidations, distributions of assets or evidence of indebtedness, sales or transfers of substantially all assets, share exchanges or similar events, and (b) certain dilutive issuances of (i) common stock or (ii) common stock equivalents at an effective price per share that is lower than the then Exercise Price.

 

In connection with a Fundamental Transaction, as defined in the Purchase Agreement, that is an all-cash transaction, the Company shall have the right to purchase from the Holders all, but not less than all, of the unexercised portion of the Warrants by paying in cash to the Holders an amount equal to 30% of the Exercise Price multiplied by the number of shares of Common Stock for which the Warrants are exercisable immediately prior to such change of control transaction.

 

 

 
- 14 -

 

  

The following is a summary of the 2011 Warrants outstanding for the three months ended March 31, 2014:

 

   

2011

Warrants

   

Exercise
Price

 

Beginning balance – December 31, 2013

    17,940,780     $ 0.098  

Less: Canceled

    --       --  

Add: Issued

    --       --  

Less: Exercised

    --       --  

Ending Balance – March 31, 2014

    17,940,780     $ 0.098  

 

2012 Convertible Notes

 

The 2012 Convertible Notes contain the same terms as the 2011 Convertible Notes and require payment of interest at the rate of 5% per annum, payable upon the maturation of the debenture and mature on July 2, 2015. The 2012 Convertible Notes provide the Investors the option at any time prior to the repayment of the notes to convert any portion of the balance into fully-paid and non-assessable restricted shares of common stock of the Company at a conversion price of $0.06 per share as per the September 2013 Amendment and Waiver Agreement. The conversion price is subject to adjustment in the event of (a) stock splits, stock dividends, combinations, reclassifications, mergers, consolidations, distributions of assets or evidence of indebtedness, sales or transfers of substantially all assets, share exchanges or similar events, and (b) certain dilutive issuances of (i) common stock or (ii) common stock equivalents at an effective price per share that is lower than the then conversion price.  

 

The 2012 Convertible Notes may be redeemed at the option of the Company on the same terms as the 2011 Convertible Notes only in connection with a change of control or other fundamental transaction of the Company and subject to the satisfaction of other conditions including, without limitation, that the shares issuable upon conversion of the debentures are freely tradable and that there is no event of default.  

 

2012 Warrants

 

On July 2, 2012, in conjunction with the issuance of the 2012 Convertible Notes, the Company issued warrants for the purchase of up to 20,000,000 shares of common stock with five year terms.  The warrants were issued to allow the Investors to purchase up to 10,000,000 shares of common stock at an initial purchase price of $0.15 per share and the remaining 10,000,000 shares of common stock at an initial purchase price of $0.25 per share. The terms of the 2012 Warrants are identical to those of the 2011 Warrants, except that the 2012 Warrants are exercisable for a period of five years from the date of issuance and contain different exercise prices. On February 22, 2013, as per the terms of the February Amendment and Waiver Agreement, the Company canceled the original warrants and re-issued new warrants for the purchase of up to 16,315,790 shares of common stock at an initial purchase price of $0.098.

 

The following is a summary of the 2012 Warrants outstanding at March 31, 2014:

 

   

2012

Warrants

   

Exercise

Price

 

Beginning balance at December 31, 2013

    7,065,255     $ 0.098  

Less: Canceled

    --       --  

Add: Issued

    --       --  

Less: Exercised

    --       --  

Ending balance at March 31, 2014

    7,065,255     $ 0.098  

  

Third Tranche Convertible Notes

 

The Third Tranche Convertible Notes, which were issued on January 16, 2013, contain the same terms as the 2011 and 2012 Convertible Notes and require payment of interest at the rate of 5% per annum, payable upon the maturation of the debenture on January 16, 2016.  The Third Tranche Convertible Notes provide the Investors the option at any time prior to the repayment of the notes to convert any portion of the outstanding Third Tranche balance into fully-paid and non-assessable restricted shares of common stock of the Company at a conversion price of $0.06 per share. The conversion price is subject to adjustment in the event of (a) stock splits, stock dividends, combinations, reclassifications, mergers, consolidations, distributions of assets or evidence of indebtedness, sales or transfers of substantially all assets, share exchanges or similar events, and (b) certain dilutive issuances of (i) common stock or (ii) common stock equivalents at an effective price per share that is lower than the then conversion price.

 

 

 
- 15 -

 

  

The Third Tranche Convertible Notes may be redeemed at the option of the Company on the same terms as the 2011 and 2012 Convertible Notes only in connection with a change of control or other fundamental transaction of the Company and subject to the satisfaction of other conditions including, without limitation, that the shares issuable upon conversion of the debentures are freely tradable and that there is no event of default.  

 

Third Tranche Warrants

 

On January 16, 2013, in connection with the Third Tranche Convertible Notes, the Company issued warrants for the purchase of up to 2,500,000 shares of common stock with five year terms.  The warrants were issued to allow the Investors to purchase up to 2,500,000 shares of common stock at an initial purchase price of $0.15 per share. On February 22, 2013, per the terms of the Amendment and Waiver Agreement, the Third Tranche Warrants were canceled.

 

Accounting for the 2011 Convertible Notes, 2012 Convertible Notes, Third Tranche Convertible Notes, 2011 Warrants, 2012 Warrants, and Third Tranche Warrants

 

2011 Convertible Notes, 2012 Convertible Notes, and Third Tranche Convertible Notes

 

The Company has determined that the 2011 Convertible Notes, 2012 Convertible Notes and Third Tranche Convertible Notes constitute hybrid instruments that have the characteristics of a debt host contract containing several embedded derivative features that would require bifurcation and separate accounting as a derivative instrument pursuant to the provisions of ASC 815. The Company has identified all of the derivatives associated with each convertible note. As permitted under ASC 825-10-10 – Financial Instruments, as it relates to the fair value option, the Company has elected, as of the original issuance date of each convertible note, to measure the 2011 Convertible Notes, 2012 Convertible Notes, and the Third Tranche Convertible Notes in their entirety at fair value with changes in fair value recognized in the Consolidated Statements of Operations as either a gain or loss until the notes are settled. As such, the Company has appropriately valued the embedded derivatives as a single hybrid contract together with the convertible notes. This election was made by the Company after determining the aggregate fair value of the convertible notes to be more meaningful in the context of the Company’s financial statements than if separate fair values were assigned to each of the multiple embedded instruments contained in the convertible notes.

 

Pursuant to the guidance of ASC 815-40-15 (formerly EITF 07-5, Determining Whether an Instrument (or Embedded Feature) Is Indexed to an Entity’s Own Stock), the 2011 Warrants, 2012 Warrants and Third Tranche Warrants were not considered indexed to the Company’s own stock. As a result these instruments have been account for as freestanding derivative instruments and classified as a liability recorded at fair value at each reporting period.

 

The February 2013 and September 2013 Amendment and Waiver Agreements triggered greater than 10% changes in the present value of cash flows of the convertible notes and associated warrants. As a result, the Company has treated the Amendment and Waiver Agreements as debt extinguishments where the carrying value of the convertible notes and warrants prior to the amendments were removed from the Company’s books and the fair value of the amended convertible notes and warrants was recorded. The resulting difference in value was recorded as an aggregate $1,283,000 loss on the extinguishment of debt during the three months ended March 31, 2013. The impact to each of the convertible notes and associated warrants is discussed below.

 

2011 Convertible Notes and 2011 Warrants

 

Upon issuance of the 2011 Convertible Notes, the Company allocated the proceeds received to the 2011 Convertible Notes and 2011 Warrants on a relative fair value basis. As a result of such allocation, the Company determined the initial carrying value of the Notes to be $3,208,000. The debt discount in the amount of $792,000 (resulting from the allocation of proceeds) was being amortized to interest expense using the effective interest method over the expected term of the 2011 Convertible Notes.  The carrying value of the 2011 Convertible Notes has been adjusted to fair value each reporting period. 

 

The Company accounted for the February 2013 Amendment and Waiver Agreement as an extinguishment of debt at February 22, 2013. The fair value of the 2011 Convertible Notes prior to the extinguishment was replaced by the fair value of the amended 2011 Convertible Notes, resulting in a fair value of $6,070,000 as of February 22, 2013. In connection with the extinguishment of the debt as of February 22, 2013, the Company had amortized $38,000 of the debt discount and wrote off the remaining debt discount of $265,000.

 

 

 
- 16 -

 

  

The Company has also accounted for the September 2013 Amendment and Waiver Agreement as an extinguishment of debt at September 18, 2013. The fair value of the 2011 Convertible Notes prior to the extinguishment was replaced by the fair value of the amended 2011 Convertible Notes, resulting in a fair value of $4,920,000 as of September 18, 2013.

 

As of March 31, 2014, the 2011 Convertible Notes have been marked to fair value resulting in a derivative liability of $3,490,000. The impact to other income (expense) for the adjustments to fair value for the three months ended March 31, 2014 was a loss of $200,000.

 

As a result of the February 2013 Amendment and Waiver Agreement the carrying value of the 2011 Warrants was adjusted at February 22, 2013 to reflect the revised terms. As of March 31, 2014, the 2011 Warrants have been marked to fair value resulting in a derivative liability of $358,000. The impact to other income (expense) for the adjustments to fair value for the three months ended March 31, 2014 was a loss of $179,000. The impact to other income (expense) for the loss on extinguishment and adjustments to fair value for the three months ended March 31, 2013 was a loss of $1,916,000 and $2,014,000, respectively.

 

During the three months March 31, 2013, certain holders of the 2011 Warrants exercised warrants to purchase 8,749,999 shares of common stock pursuant to the cashless exercise provisions resulting in the issuance of 3,217,741, shares of the Company’s common stock. The cashless exercise resulted in the reclassification of $844,000 in the exercise date fair value of the 2011 Warrants exercised as a component of the common stock balance within stockholders’ equity in the consolidated balance sheet.

 

2012 Convertible Notes and 2012 Warrants

 

Upon issuance of the 2012 Convertible Notes, the Company allocated the proceeds received to the Second Tranche Convertible Notes and 2012 Warrants on a relative fair value basis. As a result of such allocation, the Company determined the initial carrying value of the Second Tranche Convertible Notes to be $417,000.  The debt discount in the amount of $583,000 (resulting from the allocation of proceeds) was being amortized to interest expense using the effective interest method over the expected term of the 2012 Convertible Notes. The carrying value of the 2012 Convertible Notes has been adjusted to fair value each reporting period.

 

The Company has accounted for the February 2013 Amendment and Waiver Agreement as an extinguishment of debt at February 22, 2013. The fair value of the 2012 Convertible Notes prior to the extinguishment was replaced by the fair value of the amended 2012 Convertible Notes, resulting in a fair value of $1,516,000 as of February 22, 2013. In connection with the extinguishment of debt as of February 22, 2013, the Company had amortized $55,000 of the debt discount and wrote off the remaining debt discount of $462,000.

 

The Company has also accounted for the September 2013 Amendment and Waiver Agreement as an extinguishment of debt at September 18, 2013. The fair value of the 2012 Convertible Notes prior to the extinguishment was replaced by the fair value of the amended 2012 Convertible Notes, resulting in a fair value of $1,390,000 as of September 18, 2013. As of March 31, 2014, the 2012 Convertible Notes have been marked to fair value resulting in a derivative liability of $1,130,000. The impact to other income (expense) for the adjustments to fair value for the three months ended March 31, 2014 was a loss of $120,000.  

 

As a result of the February 2013 Amendment and Waiver Agreement the carrying value of the 2012 Warrants was adjusted at February 22, 2013 to reflect the revised terms. As of March 31, 2014, the 2012 Warrants have been marked to fair value resulting in a derivative liability of $159,000. The impact to other income (expense) for the adjustments to fair value for the three months ended March 31, 2014 was a loss of $18,000. The impact to other income (expense) for the loss on extinguishment and adjustments to fair value for the three months ended March 31, 2013 was a gain of $168,000 and a loss of $326,000, respectively.

 

Third Tranche Convertible Notes and Third Tranche Warrants

 

Upon issuance of the Third Tranche Convertible Notes in January 2013, the Company allocated the proceeds received to the Third Tranche Convertible Notes and Third Tranche Warrants on a relative fair value basis. As a result of such allocation, the Company determined the initial carrying value of the Third Tranche Convertible Notes to be $142,000.  The Third Tranche Convertible Notes were immediately marked to fair value, resulting in a derivative liability in the amount of $394,000. The debt discount in the amount of $108,000 (resulting from the allocation of proceeds) was being amortized to interest expense using the effective interest method over the expected term of the Convertible Notes.

 

 

 
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The Company has accounted for the February 2013 Amendment and Waiver Agreement as an extinguishment of debt at February 22, 2013. The fair value of the Third Tranche Convertible Notes prior to the extinguishment was replaced by the fair value of the amended Third Tranche Convertible Notes, resulting in a fair value of $386,000 as of February 22, 2013. In connection with the extinguishment of debt as of February 22, 2013, the Company had amortized $2,000 of the debt discount and wrote off the remaining debt discount of $106,000.

 

The Company has accounted for the September 2013 Amendment and Waiver Agreement as an extinguishment of debt at September 18, 2013. The fair value of the Third Tranche Convertible Notes prior to the extinguishment was replaced by the fair value of the amended Third Tranche Convertible Notes, resulting in a fair value of $361,000 as of September 18, 2013. As of March 31, 2014, the Third Tranche Convertible Notes have been marked to fair value resulting in a derivative liability of $284,000. The impact to other income (expense) for the adjustments to fair value was a loss of $47,000.

 

Upon issuance of the Third Tranche Warrants, the Company allocated $108,000 of the initial proceeds to the Third Tranche Warrants and immediately marked them to fair value resulting in a derivative liability of $300,000.  The Third Tranche Warrants were canceled during 2013. The impact to other income (expense) for the three months ended March 31, 2013 was a gain of $108,000.

 

11.          Fair Value Measures

 

The following summarizes the Company’s assets and liabilities measured at fair value as of December 31, 2013:

 

           

Fair Value Measurements at Reporting Date Using:

 
   

Balance as of December 31,

   

Quoted Prices

in Active

Markets for

Identical

Assets

   

Significant

Other

Observable

Inputs

   

Significant

Unobservable

Inputs

 

Description

 

2013

   

(Level 1)

   

(Level 2)

   

(Level 3)

 
                                 

Liabilities

                               

Convertible notes

  $ 4,537,000     $     $     $ 4,537,000  

Warrant and option liabilities

  $ 2,680,000     $     $     $ 2,680,000  

Total Liabilities

  $ 7,217,000     $     $     $ 7,217,000  

 

The following summarizes the Company’s assets and liabilities measured at fair value as of March 31, 2014:

 

           

Fair Value Measurements at Reporting Date Using:

 
   

Balance as of

March 31,

   

Quoted Prices

in Active

Markets for

Identical

Assets

   

Significant

Other

Observable

Inputs

   

Significant

Unobservable

Inputs

 

Description

 

2014

   

(Level 1)

   

(Level 2)

   

(Level 3)

 
                                 

Liabilities

                               

Convertible notes

  $ 4,904,000     $     $     $ 4,904,000  

Warrant and option liabilities

  $ 3,691,000     $     $     $ 3,691,000  

Total Liabilities

  $ 8,595,000     $     $     $ 8,595,000  

 

 

 
- 18 -

 

 

A summary of changes in the 2011 Convertible Notes, 2012 Convertible Notes, Third Tranche Convertible Notes, 2011 Warrants, 2012 Warrants, Third Tranche Warrants, and the February 2013 Warrants, February 2013 SPA Options, September 2013 Warrants, and September 2013 SPA Options as of December 31, 2012, February 22, 2013, September 18, 2013 and March 31, 2014 is as follows:

 

   

Fair

Value of

2011
Convertible

Notes

   

Fair

Value of

2011 Warrant Liabilities

   

Fair

Value of

2012 Convertible Notes

   

Fair

Value of

2012 Warrant Liabilities

   

Fair Value of Third Tranche Convertible Notes

   

Fair Value of Third Tranche Warrant Liabilities

   

February
2013 Warrants

   

February

2013 SPA Option

   

September 2013 Warrants

   

September 2013 SPA Options

   

Total

 

Balance December 31, 2012

  $ 6,510,000     $ 2,000,000     $ 1,588,000     $ 1,800,000     $     $     $     $     $     $     $ 11,898,000  

Allocation of initial proceeds

  $     $     $     $     $ 142,000     $ 108,000     $     $     $     $     $ 250,000  

Initial fair value adjustment

  $     $     $     $     $ 252,000     $ 192,000     $     $     $     $     $ 444,000  
                                                                                         

January 16, 2013

  $ 6,510,000     $ 2,000,000     $ 1,588,000     $ 1,800,000     $ 394,000     $ 300,000     $     $     $     $     $ 12,592,000  
                                                                                         

Amortization of debt discount

  $ 38,000     $     $ 55,000     $     $ 2,000     $     $     $     $     $     $ 95,000  

Fair value adjustment

  $ (370,000 )   $     $ (72,000 )   $     $ (8,000 )   $     $     $     $     $     $ (450,000 )

Carrying value of old debt at modification

  $ (6,178,000 )   $     $ (1,571,000 )   $     $ (388,000 )   $     $     $     $     $     $ (8,137,000 )

Fair value of new debt at modification

  $ 6,070,000     $     $ 1,516,000     $     $ 386,000     $     $     $     $     $     $ 7,972,000  

Modification of warrants

  $     $ 1,916,000     $     $ 632,000     $     $     $     $     $     $     $ 2,548,000  

Cancellation/retirement of warrants

  $     $     $     $ (800,000 )   $     $ (300,000 )   $     $     $     $     $ (1,100,000 )

Fair value of instruments at issuance

  $     $     $     $     $     $     $ 2,759,000     $ 1,211,000     $     $     $ 3,970,000  
                                                                                         

February 22, 2013

  $ 6,070,000     $ 3,916,000     $ 1,516,000     $ 1,632,000     $ 386,000     $     $ 2,759,000     $ 1,211,000     $     $     $ 17,490,000  
                                                                                         

Exercise of warrants

  $     $ (844,000 )   $     $     $     $     $     $     $     $     $ (844,000 )

Fair value adjustment

  $ 1,130,000     $ 2,014,000     $ 284,000     $ 326,000     $ 96,000     $     $ 884,000     $ 583,000     $     $     $ 5,317,000  
                                                                                         

March 31, 2013

  $ 7,200,000     $ 5,086,000     $ 1,800,000     $ 1,958,000     $ 482,000     $     $ 3,643,000     $ 1,794,000     $     $     $ 21,963,000  
                                                                                         

Balance at December 31, 2013

  $ 3,290,000     $ 179,000     $ 1,010,000     $ 141,000     $ 237,000     $     $ 1,441,000     $     $ 627,000     $ 292,000     $ 7,217,000  
                                                                                         

Fair value adjustment

  $ 200,000     $ 179,000     $ 120,000     $ 18,000     $ 47,000     $     $ 540,000     $     $ 215,000     $ 59,000     $ 1,378,000  
                                                                                         

March 31, 2014

  $ 3,490,000     $ 358,000     $ 1,130,000     $ 159,000     $ 284,000     $     $ 1,981,000     $     $ 842,000     $ 351,000     $ 8,595,000  

 

 

 
- 19 -

 

 

Valuation – Methodology and Significant Inputs Assumptions

 

Fair values for the Company’s derivatives and financial instruments are estimated by utilizing valuation models that consider current and expected stock prices, volatility, dividends, market interest rates, forward yield curves and discount rates. Such amounts and the recognition of such amounts are subject to significant estimates that may change in the future. The methods and significant inputs and assumptions utilized in estimating the fair value of the warrant liabilities, 2013 SPA Options and Convertible Notes as of the December 31, 2012 balance sheet date, February 22, 2013 Amendment and Waiver Agreement date, September 18, 2013 Amendment and Waiver agreement, and the March 31, 2014 balance sheet date are discussed below. Each of the measurements is considered a Level 3 measurement as a result of at least one significant unobservable input.

 

2011 Warrants

 

A Black-Scholes-Merton option-pricing model, with dilution effects, was utilized to estimate the fair value of the 2011 Warrants as of February 22, 2013, March 31, 2013 and December 31, 2013. This model is widely used in estimating value of European options dependent upon a non-paying dividend stock and fixed inputs. This model is subject to the significant assumptions discussed below and requires the following key inputs with respect to the Company and/or instrument:

 


Input

 

February 22,

2013

   

March 31,

2013

   

December 31,

2013

 

Stock Price

  $ 0.14     $ 0.17     $ 0.04  

Exercise Price

  $ 0.15     $ 0.098     $ 0.098  

Expected Life (in years)

    3.00       2.90       2.15  

Stock Volatility

    100

%

    100

%

    95

%

Risk-Free Rate

    0.40

%

    0.24

%

    0.21

%

Dividend Rate

    0

%

    0

%

    0

%

Outstanding Shares of Common Stock

    59,576,097       64,389,835       160,664,862  

 

Based on the potential impact of the proposed merger transaction (see Note 13), the valuation of the 2011 Warrants as of March 31, 2014 was performed utilizing a Monte-Carlo simulation. This model was employed to more effectively incorporate the potential impact of the proposed transaction and the effect on the outstanding warrants. This includes the potential common stock for warrants exchange as contemplated in the proposed transaction, occurring at June 30, 2014, and the potential that the warrants are held for the remainder of their term. This model requires the following key inputs with respect to the Company and/or instrument:

 

   

March 31,
2014

 

Input

       

Stock Price (simulated)

  $ 0.04  

Strike Price

  $ 0.098  

Expected remaining term (in years)

    1.89  

Stock Volatility

    95

%

Risk-Free Rate

    0.41

%

Dividend Rate

    0

%

  

 
- 20 -

 

 

2012 Warrants

 

$0.15 Warrants

 

A Black-Scholes-Merton option-pricing model, with dilution effects, was also utilized to estimate the fair value of the $0.15 Warrants as of February 22, 2013, March 31, 2013 and December 31, 2013.

 


Input

 

February 22,

2013

   

March 31,

2013

   

December 31,

2013

 

Stock Price

  $ 0.14     $ 0.17     $ 0.04  

Exercise Price

  $ 0.15     $ 0.098     $ 0.098  

Expected Life (in years)

    4.38       4.26       3.50  

Stock Volatility

    100

%

    100

%

    100

%

Risk-Free Rate

    0.70

%

    0.62

%

    1.02

%

Dividend Rate

    0

%

    0

%

    0

%

Outstanding Shares of Common Stock

    59,576,097       64,389,835       160,664,862  

 

Based on the potential impact of the proposed merger transaction (see Note 13), the valuation of the 2012 Warrants as of March 31, 2014 was performed utilizing a Monte-Carlo simulation. This model was employed to more effectively incorporate the potential impact of the proposed transaction and the effect on the outstanding warrants. This includes the potential common stock for warrants exchange as contemplated in the proposed transaction, occurring at June 30, 2014, and the potential that the warrants are held for the remainder of their term. This model requires the following key inputs with respect to the Company and/or instrument:

 

Input  

March 31,
2014

 

Stock Price (simulated)

  $ 0.04  

Strike Price

  $ 0.098  

Expected remaining term (in years)

    3.26  

Stock Volatility

    95

%

Risk-Free Rate

    1.01

%

Dividend Rate

    0

%

 

Third Tranche Warrants

 

A Black-Scholes Merton option-pricing model, with dilution effects, was also utilized to estimate the fair value of the Third Tranche Warrants as of January 16, 2013. These warrants were canceled on February 22, 2013. 

   

Input

 

January 16,

2013

 

Stock Price

  $ 0.15  

Exercise Price

  $ 0.15  

Expected Life (in years)

    5  

Stock Volatility

    110

%

Risk-Free Rate

    0.75

%

Dividend Rate

    0

%

Outstanding Shares of Common Stock

    32,434,430  

  

 
- 21 -

 

 

February 2013 Warrants

 

A Monte Carlo simulation model was utilized to estimate the fair value of the February 2013 warrants as of February 22, 2013, March 31, 2013, December 31, 2013 and March 31, 2014. Based on the potential impact of the proposed merger transaction (see Note 13), the valuation of the February 2013 Warrants as of March 31, 2014 incorporated the potential impact of the proposed transaction and the effect on the outstanding February 2013 warrants. This includes the potential common stock for warrants exchange as contemplated in the proposed transaction, occurring at June 30, 2014, and the potential that the warrants are held for the remainder of their term. This model requires the following key inputs with respect to the Company and/or instrument:

 

Input

 

February 22,

2013

   

March 31,

2013

   

December 31,

2013

   

March 31,
2014

 

Stock Price

  $ 0.12     $ 0.16       0.04     $ 0.04  

Exercise Price

  $ 0.20     $ 0.20       0.08     $ 0.08  

Expected Life (in years)

    5       4.90       4.15       3.89  

Stock Volatility

    110

%

    110

%

    100

%

    100

%

Risk-Free Rate

    0.84

%

    0.75

%

    1.34

%

    1.27

%

Number of Steps

    100,000       100,000       100,000       100,000  

Outstanding Shares of Common Stock

    59,576,097       64,389,835       160,664,862       160,664,862  

 

February 2013 SPA Option

 

The February 2013 SPA option, upon exercise, allows the investor to purchase one share of common stock and one common stock warrant. The option was valued using multiple valuation models, including a Black-Scholes-Merton option-pricing model, with dilution effects, to estimate the fair value of the option to purchase the common share, and a Monte Carlo simulation to determine the estimated fair value of the warrant that would be issued at the time of exercise. These models were used to estimate the fair value of the option at February 22, 2013 and March 31, 2013.

 

Input

 

February 22,

2013

   

March 31,

2013

 

Stock Price

  $ 0.14     $ 0.17  

Exercise Price

  $ 0.15     $ 0.15  

Expected Life (in years)

    0.75       0.64  

Stock Volatility

    110

%

    110

%

Risk-Free Rate

    0.15

%

    0.84

%

Dividend Rate

    0

%

    0

%

Outstanding Shares of Common Stock

    73,042,764       77,856,502  

 

A Monte Carlo simulation model was also utilized to estimate the fair value of the February 2013 SPA Option as of February 22, 2013 and March 31, 2013.

 

Input

 

February 22,

2013

   

March 31,

2013

 

Stock Price (simulated)

  $ 0.10     $ 0.66  

Exercise Price

  $ 0.20     $ 0.20  

Expected Life (in years)

    5.00       5.0  

Stock Volatility

    110

%

    110

%

Risk-Free Rate

    1.158

%

    1.025

%

Number of Steps

    10,000       10,000  

  

September 2013 Warrants

 

A Monte Carlo simulation model was utilized to estimate the fair value of the September 2013 warrants as of December 31, 2013 and March 31, 2014. Based on the potential impact of the proposed merger transaction (see Note 13), the valuation of the September 2013 Warrants as of March 31, 2014 incorporated the potential impact of the proposed transaction and the effect on the outstanding September 2013 warrants. This includes the potential common stock for warrants exchange as contemplated in the proposed transaction, occurring at June 30, 2014, and the potential that the warrants are held for the remainder of their term. This model requires the following key inputs with respect to the Company and/or instrument:

 

Input

 

December 31,

2013

   

March 31,
2014

 

Stock Price

  $ 0.04     $ 0.04  

Exercise Price

  $ 0.08     $ 0.08  

Expected Life (in years)

    4.72       4.47  

Stock Volatility

    100

%

    100

%

Risk-Free Rate

    1.61

%

    1.51

%

Number of Steps

    100,000       100,000  

  

 
- 22 -

 

 

September 2013 SPA Option

 

The September 2013 SPA option, upon exercise, allows the investor to purchase one share of common stock and one common stock warrant. The option was valued using multiple valuation models, including a Black-Scholes-Merton option-pricing model, with dilution effects, to estimate the fair value of the option to purchase the common share, and a Monte Carlo simulation to determine the estimated fair value of the warrant that would be issued at the time of exercise. These models were used to estimate the fair value of the option at December 31, 2013 and March 31, 2014.

 

Input

 

December 31,

2013

   

March 31,
2014

 

Stock Price

  $ 0.04     $ 0.04  

Exercise Price

  $ 0.06     $ 0.06  

Expected Life (in years)

    0.463       0.217  

Stock Volatility

    100

%

    100

%

Risk-Free Rate

    0.10

%

    0.05

%

Dividend Rate

    0

%

    0

%

Outstanding Shares of Common Stock

    160,664,862       160,664,862  

 

A Monte Carlo simulation model was also utilized to estimate the fair value of the 2013 SPA Option as of December 31, 2013 and March 31, 2014.

 

Input

 

December 31,

2013

   

March 31,
2014

 

Stock Price (simulated)

  $ 0.04     $ 0.04  

Exercise Price

  $ 0.08     $ 0.08  

Expected Life (in years)

    0.463       0.217  

Stock Volatility

    100 %     100

%

Risk-Free Rate

    0.10 %     0.05

%

Number of Steps

    10,000       10,000  

  

2011 Convertible Notes

 

A binomial lattice model was utilized to estimate the fair value of the Convertible Notes as of, February 22, 2013, March 31, 2013 and December 31, 2013. The binomial model considers the key features of the Convertible Notes, as noted above, and is subject to the significant assumptions discussed below. First, a discrete simulation of the Company’s stock price, without effects of dilution due to the conversion feature, was conducted at each node and throughout the expected life of the instrument. Second, a discrete simulation of the Company’s stock price, with effects of dilution due to the conversion feature, was conducted at each node and throughout the expected life of the instrument. Third, based upon the simulated stock price with dilution effect, an analysis of the higher position of a conversion position, redemption position, or holding position (i.e. fair value of the respective future nodes value discounted using the applicable discount rate) was conducted relative to each node until a final fair value of the instrument is conducted at the node representing the measurement date. This model requires the following key inputs with respect to the Company and/or instrument:

 

Input

 

February 22,

2013

   

March 31, 2013

   

December 31,
2013

 

Stock Price

  $ 0.14     $ 0.17     $ 0.04  

Strike Price

  $ 0.10     $ 0.10     $ 0.06  

Expected remaining term (in years)

    2.35       2.25       1.50  

Stock Volatility

    100

%

    100

%

    95

%

Risk-Free Rate

    0.32

%

    0.28

%

    0.25

%

Dividend Rate

    0

%

    0

%

    0

%

Outstanding Shares of Common Stock

    59,576,097       64,389,835       160,664,862  

Effective discount rate

    13.2

%

    11.6

%

    19.6

%

Probability of forced redemption

    20

%

    20

%

    20

%

  

 
- 23 -

 

 

Based on the potential impact of the proposed merger transaction (see Note 13), the valuation of the 2011 Convertible Notes as of March 31, 2014 was performed utilizing a Monte-Carlo simulation. This model was employed to more effectively incorporate the potential impact of the proposed transaction and the effect on the outstanding convertible notes. This included increasing the probability of a transaction occurring during a period of time during the year ended December 31, 2014 (50% assumed possibility of a transaction during this time, versus 20% outside of this range). This model requires the following key inputs with respect to the Company and/or instrument:

 

Input  

March 31,
2014

 

Stock Price (simulated)

  $ 0.04  

Strike Price

  $ 0.06  

Expected remaining term (in years)

    1.25  

Stock Volatility

    95

%

Risk-Free Rate

    0.2

%

Dividend Rate

    0

%

Effective discount rate

    23.9

%

Probability of forced redemption or transaction event

    20% - 50

%

 

2012 Convertible Notes

 

A binomial lattice model was also utilized to estimate the fair value of the 2012 Convertible Notes as of February 22, 2013, March 31, 2013 and December 31, 2013. This model requires the following key inputs with respect to the Company and/or instrument:

 

Input

 

February 22,
2013

   

March 31,

2013

   

December 31,

2013

 

Stock Price

  $ 0.14     $ 0.17     $ 0.04  

Exercise Price

  $ 0.10     $ 0.10     $ 0.06  

Expected remaining term (in years)

    2.35       2.25       1.50  

Stock Volatility

    100

%

    100

%

    95

%

Risk-Free Rate

    0.32

%

    0.28

%

    0.26

%

Dividend Rate

    0

%

    0

%

    0

%

Outstanding Shares of Common Stock

    59,576,097       64,389,835       160,664,862  

Effective discount rate

    13.2

%

    13.2

%

    19.6

%

Probability of forced redemption

    20

%

    20

%

    20

%

 

Based on the potential impact of the proposed merger transaction (see Note 13), the valuation of the 2012 Convertible Notes as of March 31, 2014 was performed utilizing a Monte-Carlo simulation. This model was employed to more effectively incorporate the potential impact of the proposed transaction and the effect on the outstanding convertible notes. This included increasing the probability of a transaction occurring during a period of time during the year ended December 31, 2014 (50% assumed possibility of a transaction during this time, versus 20% outside of this range). This model requires the following key inputs with respect to the Company and/or instrument:

 

Input  

March 31,
2014

 

Stock Price (simulated)

  $ 0.04  

Strike Price

  $ 0.06  

Expected remaining term (in years)

    1.25  

Stock Volatility

    95

%

Risk-Free Rate

    0.2

%

Dividend Rate

    0

%

Effective discount rate

    32.5

%

Probability of forced redemption or transaction event

    20% - 50

%

  

 
- 24 -

 

 

Third Tranche Convertible Notes

 

A binomial lattice model was also utilized to estimate the fair value of the Tranche Three Convertible Notes as of January 16, 2013, February 22, 2013, March 31, 2013 and December 31, 2013. This model requires the following key inputs with respect to the Company and/or instrument:

 

Input

 

January 16,

2013

   

February 22,

2013

   

March 31,

2013

   

December 31,

2013

 

Stock Price

  $ 0.15     $ 0.14     $ 0.17     $ 0.04  

Exercise Price

  $ 0.10     $ 0.10     $ 0.10     $ 0.06  

Expected remaining term (in years)

    3       2.90       2.80       2.04  

Stock Volatility

    100

%

    100

%

    100

%

    95

%

Risk-Free Rate

    0.36

%

    0.39

%

    0.34

%

    0.40

%

Dividend Rate

    0

%

    0

%

    0

%

    0

%

Outstanding Shares of Common Stock

    32,434,430       59,576,097       64,389,835       160,664,862  

Effective discount rate

    13.2

%

    13.2

%

    13.2

%

    21.3

%

Probability of forced redemption

    20

%

    20

%

    20

%

    20

%

 

Based on the potential impact of the proposed merger transaction (see Note 13), the valuation of the Tranche Three Convertible Notes as of March 31, 2014 was performed utilizing a Monte-Carlo simulation. This model was employed to more effectively incorporate the potential impact of the proposed transaction and the effect on the outstanding convertible notes. This included increasing the probability of a transaction occurring during a period of time during the year ended December 31, 2014 (50% assumed possibility of a transaction during this time, versus 20% outside of this range). This model requires the following key inputs with respect to the Company and/or instrument: 

 

   

March 31,
2014

 

Input

       

Stock Price (simulated)

  $ 0.04  

Strike Price

  $ 0.06  

Expected remaining term (in years)

    1.25  

Stock Volatility

    95

%

Risk-Free Rate

    0.4

%

Dividend Rate

    0

%

Effective discount rate

    32.5

%

Probability of forced redemption or transaction event

    20% - 50

%

 

The following are significant assumptions utilized in developing the inputs:

 

 

The Company’s common stock shares are traded on the OTC Bulletin Board and, accordingly, the stock price input is based upon bid prices as of the valuation dates due to the extremely thin trading volume, broker-driven market (vs. exchange market) and the wide bid/ask spread as of the valuation date;