Quarterly report pursuant to Section 13 or 15(d)

Fair Value Measures

v2.4.0.8
Fair Value Measures
6 Months Ended
Jun. 30, 2013
Fair Value Measures  
Fair Value Measures

11.                               Fair Value Measures

 

The following summarizes the Company’s assets and liabilities measured at fair value as of December 31, 2012:

 

 

 

 

 

Fair Value Measurements at Reporting Date Using:

 

 

 

 

 

Quoted

 

 

 

 

 

 

 

 

 

Prices

 

 

 

 

 

 

 

 

 

in Active

 

Significant

 

 

 

 

 

 

 

Markets for

 

Other

 

Significant

 

 

 

Balance as of

 

Identical

 

Observable

 

Unobservable

 

 

 

December 31,

 

Assets

 

Inputs

 

Inputs

 

Description

 

2012

 

(Level 1)

 

(Level 2)

 

(Level 3)

 

 

 

 

 

 

 

 

 

 

 

Liabilities

 

 

 

 

 

 

 

 

 

Convertible notes

 

$

8,098,000

 

$

 

$

 

$

8,098,000

 

Warrant liabilities

 

$

3,800,000

 

$

 

$

 

$

3,800,000

 

Total Liabilities

 

$

11,898,000

 

$

 

$

 

$

11,898,000

 

 

The following summarizes the Company’s assets and liabilities measured at fair value as of June 30, 2013:

 

 

 

 

 

Fair Value Measurements at Reporting Date Using:

 

 

 

 

 

Quoted

 

 

 

 

 

 

 

 

 

Prices

 

 

 

 

 

 

 

 

 

in Active

 

Significant

 

 

 

 

 

 

 

Markets for

 

Other

 

Significant

 

 

 

Balance as of

 

Identical

 

Observable

 

Unobservable

 

 

 

June 30,

 

Assets

 

Inputs

 

Inputs

 

Description

 

2013

 

(Level 1)

 

(Level 2)

 

(Level 3)

 

 

 

 

 

 

 

 

 

 

 

Liabilities

 

 

 

 

 

 

 

 

 

Convertible notes

 

$

5,855,000

 

$

 

$

 

$

5,855,000

 

Warrant liabilities

 

$

5,209,000

 

$

 

$

 

$

5,209,000

 

Total Liabilities

 

$

11,064,000

 

$

 

$

 

$

11,064,000

 

 

A summary of changes in the Convertible Notes, Second Tranche Convertible Notes, Third Tranche Convertible Notes, Investor Warrants, 2012 Warrants, Third Tranche Warrants, and the 2013 Warrants and Additional 2013 Warrants as of June 30, 2012, December 31, 2012 and June 30, 2013 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

 

2013
Warrants

 

2013 SPA
Option

 

Total

 

Balance December 31, 2011

 

$

5,327,000

 

$

1,600,000

 

$

 

$

 

$

 

$

 

$

 

$

 

$

6,927,000

 

Amortization of debt discount

 

$

132,000

 

$

 

$

 

$

 

$

 

$

 

$

 

$

 

$

132,000

 

Fair value adjustment

 

$

3,461,000

 

$

2,400,000

 

$

 

$

 

$

 

$

 

$

 

$

 

$

5,861,000

 

Balance June 30, 2012

 

$

8,920,000

 

$

4,000,000

 

$

 

$

 

$

 

$

 

$

 

$

 

$

12,920,000

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

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

 

$

 

$

(1,731,000

)

$

 

$

 

$

 

$

 

$

 

$

 

$

(1,731,000

)

Conversion of debentures

 

$

(450,000

)

$

 

$

 

$

 

$

 

$

 

$

 

$

 

$

(450,000

)

Fair value adjustment

 

$

(1,240,000

)

$

(376,000

)

$

(336,000

)

$

(653,000

)

$

(91,000

)

$

 

$

(742,000

)

$

(807,000

)

$

(4,245,000

)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

June 30, 2013

 

$

4,380,000

 

$

1,809,000

 

$

1,180,000

 

$

979,000

 

$

295,000

 

$

 

$

2,017,000

 

$

404,000

 

$

11,064,000

 

 

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 Option and Convertible Notes as of the December 31, 2012 balance sheet date, February 22, 2013 Amendment and Waiver Agreement date and the June 30, 2013 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 December 31, 2012, February 22, 2013, and June 30, 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

 

December 31,
2012

 

February 22,
2013

 

June 30,
2013

 

Stock Price

 

$

0.15

 

$

0.14

 

$

0.10

 

Exercise Price

 

$

0.15

 

$

0.15

 

$

0.098

 

Expected Life (in years)

 

3.15

 

3.00

 

2.65

 

Stock Volatility

 

100

%

100

%

100

%

Risk-Free Rate

 

0.39

%

0.40

%

0.31

%

Dividend Rate

 

0

%

0

%

0

%

Outstanding Shares of Common Stock

 

32,434,430

 

59,576,097

 

66,480,399

 

 

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 December 31, 2012, February 22, 2013, and June 30, 2013.

 

Input

 

December 31,
2012

 

February 22,
2013

 

June 30,
2013

 

Stock Price

 

$

0.15

 

$

0.14

 

$

0.10

 

Exercise Price

 

$

0.15

 

$

0.15

 

$

0.098

 

Expected Life (in years)

 

4.50

 

4.38

 

4.01

 

Stock Volatility

 

100

%

100

%

100

%

Risk-Free Rate

 

0.63

%

0.70

%

1.04

%

Dividend Rate

 

0

%

0

%

0

%

Outstanding Shares of Common Stock

 

32,434,430

 

59,576,097

 

66,480,399

 

 

$0.25 Warrants

 

A Black-Scholes-Merton option-pricing model, with dilution effects, was also utilized to estimate the fair value of the $0.25 Warrants as December 31, 2012. These warrants were canceled on February 22, 2013.

 

Input

 

December 31, 2012

 

Stock Price

 

$

0.15

 

Exercise Price

 

$

0.25

 

Expected Life (in years)

 

4.50

 

Stock Volatility

 

100

%

Risk-Free Rate

 

0.63

%

Dividend Rate

 

0

%

Outstanding Shares of Common Stock

 

32,434,430

 

 

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

 

 

2013 Warrants

 

A Monte Carlo simulation mode was utilized to estimate the fair value of the 2013 warrants as of February 22, 2013 and June 30, 2013.

 

Input

 

February 22,
2013

 

June 30,
2013

 

Stock Price

 

$

0.12

 

$

0.09

 

Exercise Price

 

$

0.20

 

$

0.20

 

Expected Life (in years)

 

5

 

4.65

 

Stock Volatility

 

110

%

110

%

Risk-Free Rate

 

0.84

%

1.28

%

Number of Steps

 

100,000

 

100,000

 

Outstanding Shares of Common Stock

 

59,576,097

 

66,480,399

 

 

2013 SPA Option

 

The 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 June 30, 2013.

 

A Black-Scholes-Merton option-pricing model, with dilution effects, was also utilized to estimate the fair value of the 2013 SPA Option as of February 22, 2013 and June 30, 2013.

 

Input

 

February 22,
2013

 

June 30,
2013

 

Stock Price

 

$

0.14

 

$

0.10

 

Exercise Price

 

$

0.15

 

$

0.15

 

Expected Life (in years)

 

0.75

 

0.39

 

Stock Volatility

 

110

%

110

%

Risk-Free Rate

 

0.15

%

0.07

%

Dividend Rate

 

0

%

0

%

Outstanding Shares of Common Stock

 

73,042,764

 

79,947,066

 

 

A Monte Carlo simulation model was also utilized to estimate the fair value of the 2013 SPA Option as of
February 22, 2013 and June 30, 2013.

 

Input

 

February 22,
2013

 

June 30,
2013

 

Stock Price (simulated)

 

$

0.10

 

$

0.11

 

Exercise Price

 

$

0.20

 

$

0.20

 

Expected Life (in years)

 

5.00

 

5.00

 

Stock Volatility

 

110

%

110

%

Risk-Free Rate

 

1.158

%

1.633

%

Number of Steps

 

100,000

 

100,000

 

 

2011 Convertible Notes

 

A binomial lattice model was utilized to estimate the fair value of the Convertible Notes as of December 31, 2012, February 22, 2012 and June 30, 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

 

December 31,
2012

 

February 22,
2013

 

June 30,
2013

 

Stock Price

 

$

0.15

 

$

0.14

 

$

0.10

 

Strike Price

 

$

0.10

 

$

0.10

 

$

0.10

 

Expected remaining term (in years)

 

1.15

 

2.35

 

2.00

 

Stock Volatility

 

105

%

100

%

100

%

Risk-Free Rate

 

0.17

%

0.32

%

0.36

%

Dividend Rate

 

0

%

0

%

0

%

Outstanding Shares of Common Stock

 

32,434,430

 

59,576,097

 

66,480,399

 

Effective discount rate

 

13.1

%

13.2

%

13.2

%

Probability of forced redemption

 

20

%

20

%

20

%

 

2012 Convertible Notes

 

A binomial lattice model was also utilized to estimate the fair value of the 2012 Convertible Notes as of December 31, 2012, February 22, 2012 and June 30, 2013. This model requires the following key inputs with respect to the Company and/or instrument:

 

Input

 

December 31,
2012

 

February 22,
2013

 

June 30,
2013

 

Stock Price

 

$

0.15

 

$

0.14

 

$

0.10

 

Exercise Price

 

$

0.10

 

$

0.10

 

$

0.10

 

Expected remaining term (in years)

 

2.50

 

2.35

 

2.01

 

Stock Volatility

 

100

%

100

%

100

%

Risk-Free Rate

 

0.31

%

0.32

%

0.36

%

Dividend Rate

 

0

%

0

%

0

%

Outstanding Shares of Common Stock

 

32,434,430

 

59,576,097

 

66,480,399

 

Effective discount rate

 

13.2

%

13.2

%

13.2

%

Probability of forced redemption

 

20

%

20

%

20

%

 

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, 2012, February 22, 2012 and June 30, 2013. This model requires the following key inputs with respect to the Company and/or instrument:

 

Input

 

January 16,
2013

 

February 22,
2013

 

June 30,
2013

 

Stock Price

 

$

0.15

 

$

0.14

 

$

0.10

 

Exercise Price

 

$

0.10

 

$

0.10

 

$

0.10

 

Expected remaining term (in years)

 

3

 

2.90

 

2.55

 

Stock Volatility

 

100

%

100

%

100

%

Risk-Free Rate

 

0.36

%

0.39

%

0.52

%

Dividend Rate

 

0

%

0

%

0

%

Outstanding Shares of Common Stock

 

32,434,430

 

59,576,097

 

66,480,399

 

Effective discount rate

 

13.2

%

13.2

%

13.2

%

Probability of forced redemption

 

20

%

20

%

20

%

 

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;

 

·                  The expected future stock prices of the Company’s stock were modeled to include the effect of dilution upon conversion of the instruments to shares of common stock;

 

·                  Stock volatility was estimated by considering (i) the annualized monthly volatility of the Company’s stock price during the historical period preceding the respective valuation dates and measured over a period corresponding to the remaining life of the instruments (monthly data set is more relevant given the extremely thin trading volume of the Company’s common stock) and (ii) the annualized daily volatility of comparable companies’ stock price during the historical period preceding the respective valuation dates and measured over a period corresponding to the remaining life of the instrument. Historic prices of the Company and comparable companies’ common stock were used to estimate volatility as the Company did not have traded options as of the valuation dates;

 

·                  Based upon the Company’s historical operations and management’s expectations for the foreseeable future, the Company’s stock was assumed to be a non-dividend-paying stock;

 

·                  The risk-free interest rate is based on the U.S. Treasury Yield curve in effect as of the valuation date for the expected term;

 

·                  With respect to the 2011 Convertible Notes, 2012 Convertible Notes and Third Tranche Convertible Notes, the Company is expected to pay all accrued interest due to the Holders on each Interest Payment Date;

 

·                  With respect to the 2011 Convertible Notes, 2012 Convertible Notes and Third Tranche Convertible Notes, based upon management’s expectations for a change of control or fundamental transaction to occur prior to the maturity date of the 2011 Convertible Notes, 2012 Convertible Notes and Third Tranche Convertible Notes, a low probability of a forced redemption;

 

·                  Upon a change of control redemption, the change of control redemption amount shall equal to the sum of:

 

I.                the greater of:

 

(i)            the outstanding amount of the debt divided by the Conversion Price on the date of the mandatory default amount 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 debt, plus 100% of accrued and unpaid interest, and

 

II.           all other amounts, costs, expenses and liquidated damages due under the various agreements covering issuance of the debt.

 

Additionally, it is assumed that no amounts are due pursuant to clause (II) above in any period and that the stock price at each respective node represents a reasonable approximation of the VWAP requirements.

 

The changes in fair value between reporting periods are related to the changes in the price of the Company’s common stock as of the measurement dates, the volatility of the Company’s common stock during the remaining term of the instrument, changes in the conversion price and effective discount rate.