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Derivative Financial Instruments
 12 Months Ended
Dec. 31, 2011
Derivative Financial Instruments [Abstract]  
Derivative Financial Instruments

NOTE K – DERIVATIVE FINANCIAL INSTRUMENTS

The following tables summarize the components of our derivative liabilities and linked common shares as of December 31, 2011 and 2010 and the amounts that were reflected in our income related to our derivatives for the years then ended:

 

     December 31,  
     2011     2010  

Derivative liabilities:

     

Embedded derivatives derived from:

     

Senior Convertible Notes

    $ 2,521,422     $ —     

Series G Convertible Preferred Stock

      158,711       4,075,344  
  

 

 

    

 

 

  
     2,680,133       4,075,344  

Warrant derivatives

     

Senior Convertible Notes

      1,898,785        —     

Series G Convertible Preferred Stock

      2,754,375        2,287,800  
  

 

 

    

 

 

  

Warrant derivatives

      4,653,160       2,287,800  
  

 

 

    

 

 

  

Total derivative liabilities

    $ 7,333,293     $ 6,363,144  
  

 

 

    

 

 

  

Common shares linked to derivative liabilities:

     

Embedded derivatives:

     

Senior Convertible Notes

      2,673,797       —     

Series G Convertible Preferred Stock

      140,000       3,360,000  
  

 

 

    

 

 

  
     2,813,797       3,360,000  
  

 

 

    

 

 

  

Warrant derivatives

     

Senior Convertible Notes

      1,302,083       —     

Series G Convertible Preferred Stock

      2,325,000       1,800,000  
  

 

 

    

 

 

  
     3,627,083       1,800,000  
  

 

 

    

 

 

  

Total common shares linked to derivative liabilities

          6,440,880           5,160,000  
  

 

 

    

 

 

  

 

     Years ended December 31,  
     2011     2010  

Derivative income (expense):

     

Unrealized gains (losses) from fair value changes:

     

Senior Convertible Notes

    $ 468,115     $ —     

Series G Convertible Preferred Stock

      (738,606 )      (2,424,912 ) 

Warrant derivatives

      595,391       (1,213,200 ) 
  

 

 

    

 

 

  
     324,900       (3,638,112 ) 

Redemptions of Series G Convertible Preferred Stock

      4,655,239       —     
  

 

 

    

 

 

  

Total derivative income (expense)

    $ 4,980,139     $ (3,638,112 ) 
  

 

 

    

 

 

  

Our Series G Convertible Preferred Stock and Warrant Financing Transaction on October 11, 2010, Series G Convertible Preferred Stock and Warrant Settlement Transaction during April 2011, and Senior Convertible Note and Warrant Financing Transaction on November 8, 2011 gave rise to derivative financial instruments. As more fully discussed in Note Q, we entered into the Series G Convertible Preferred Stock and Warrant Financing Transaction and the Series G Convertible Preferred Stock and Warrant Settlement Transaction on October 11, 2010 and April 14, 2011, respectively. The Series G Convertible Preferred Stock embodied certain terms and features that both possessed all of the conditions of derivative financial instruments and were not clearly and closely related to the host preferred contract in terms of economic risks and characteristics. These terms and features consist of the embedded conversion option and the related down-round anti-dilution protection provision, the Company's redemption privilege and the holder's redemption privilege. Each of the redemption features also embodies the redemption premium payments. Warrants issued with this transaction and the subsequent Settlement Transaction embodied down-round anti-dilution protection and, accordingly, were not afforded equity classification. As more fully discussed in Note L, we entered into the Senior Convertible Note and Warrant Financing Transaction on November 8, 2011. The Senior Convertible Note embodied certain terms and conditions that were not clearly and closely related to the host debt agreement in terms of economic risks and characteristics. These terms and features consist of the embedded conversion options, certain redemption features and a conversion price reset feature. Warrants issued with this transaction embodied reset price protection and, accordingly, were not afforded equity classification.

Current accounting principles that are provided in ASC 815 - Derivatives and Hedging require derivative financial instruments to be classified in liabilities and carried at fair value with changes recorded in income. In addition, the standards do not permit an issuer to account separately for individual derivative terms and features embedded in hybrid financial instruments that require bifurcation and liability classification as derivative financial instruments. Rather, such terms and features must be bundled together and fair valued as a single, compound embedded derivative. We have selected the Monte Carlo Simulations valuation technique to fair value the compound embedded derivative because we believe that this technique is reflective of all significant assumption types, and ranges of assumption inputs, that market participants would likely consider in transactions involving compound embedded derivatives. Such assumptions include, among other inputs, interest risk assumptions, credit risk assumptions and redemption behaviors in addition to traditional inputs for option models such as market trading volatility and risk free rates. We have selected Binomial Lattice to fair value our warrant derivatives because we believe this technique is reflective of all significant assumption types market participants would likely consider in transactions involving freestanding warrants derivatives. The Monte Carlo Simulations technique is a level three valuation technique because it requires the development of significant internal assumptions in addition to observable market indicators.

 

Significant inputs and results arising from the Monte Carlo Simulations process are as follows for the compound embedded derivative that has been bifurcated from our Senior Convertible Note and classified in liabilities:

 

     December 31,
2011		    November 8,
2011 (Issuance)

Quoted market price on valuation date

    $2.74    $2.90

Contractual conversion rate

    $3.74    $3.74

Range of effective contractual conversion rates

    $2.74 - $2.89    $2.94 - $3.08

Contractual term to maturity

    2.33 Years    2.48 Years

Implied expected term to maturity

    2.06 Years    2.09 Years

Market volatility:

      

Range of volatilities

    55.6% - 101.8%    52.1% - 133.9%

Range of equivalent volatilities

    78.9% - 84.3%    84.5% - 94.7%

Contractual interest rate

    8.0%    8.0%

Range of equivalent market risk adjusted interest rates

    8.0% - 8.1%    8.0%

Range of equivalent credit risk adjusted yields

    3.1% - 3.5%    3.4% - 4.0%

Risk-free rates

    0.01% - 0.25%    0.01% - 0.25%

The effective contractual conversion rates give effect to the impending conversion price reset on May 8, 2012 and were derived using a Random-Walk Brownian Motion Stochastic Process. In this process, the expected mean selling price of the Company's common stock on the reset date was estimated at a range of $2.49 - $2.63 as of December 31, 2011 and $2.67 - $2.80 as of November 8, 2011. The mean prices derived from the stochastic process were multiplied by 110% which is a contractual provision for computing the reset price on May 8, 2012.

Significant inputs and results arising from the Monte Carlo Simulations process are as follows for the compound embedded derivative that has been bifurcated from our Series G Convertible Preferred Stock and classified in liabilities:

 

     December 31,    October 11,
     2011    2010    2010 (Issuance)

Quoted market price on valuation date

    $2.74    $2.78    $1.78

Contractual conversion rate

    $1.78    $1.78    $1.78

Implied expected term

    0.46 Years    0.81 Years    1.19 Years

Market volatility:

         

Range of volatilities

    49.5% - 101.8%    57.6% - 73.2%    53.7% - 73.8%

Equivalent volatility

    74.1%    61.5%    58.2%

Market risk adjusted interest rate:

         

Range of rates

    13.0% - 32.0%    8.0% - 33.0%    8.0% - 32.2%

Equivalent market risk adjusted interest rate

    15.3%    13.5%    12.7%

Credit risk adjusted yield rate:

         

Range of rates

    3.1% - 3.7%    3.4% - 4.8%    3.9% - 4.8%

Equivalent credit-risk adjusted yield rate

    3.1%    3.5%    4.0%

Risk free rates using zero coupon US Treasury Security rates:

         

Range of rates

    0.12% - 0.25%    0.29% - 0.64%    0.27% - 0.64%

During the period April 4-8, 2011 and on October 14, 2011, investors redeemed $750,000 and $2,800,000, respectively, stated value of our Series G Convertible Preferred Stock. On the redemption dates, the compound embedded derivatives were adjusted to their fair values of $676,718 and $3,978,521, respectively, which amounts were recorded in income. The following table reflects the issuances of compound embedded derivatives, redemptions and changes in fair value inputs and assumptions related to the compound embedded derivatives during the years ended December 31, 2011 and 2010.

 

     Years ended December 31,  
     2011     2010  

Balances at January 1, 2011

    $ 4,075,344     $ —     

Issuances:

     

Series G Convertible Preferred Stock Financing

      —          1,650,432  

Senior Convertible Note Financing

      2,989,537       —     

Expirations from redemptions of Series G Convertible Preferred Stock

      (4,655,239 )      —     

Changes in fair value inputs and assumptions reflected in income

      270,491       2,424,912  
  

 

 

    

 

 

  

Balances at December 31, 2011

    $ 2,680,133     $ 4,075,344  
  

 

 

    

 

 

  

 

The fair value of the compound embedded derivative is significantly influenced by our trading market price, the price volatility in trading and the interest components of the Monte Carlo Simulation technique.

On October 11, 2010, we also issued warrants to acquire 1,800,000 of our common shares in connection with the Series G Convertible Preferred Stock Financing. During April 4-8, 2011, we issued warrants to acquire 525,000 of our common shares in connection the Series G Convertible Preferred Stock and Warrant Settlement Transaction. Finally, on November 8, 2011, we issued warrants to acquire 1,302,083 of our common shares in connection with the Senior Convertible Note Financing Transaction. These warrants required liability classification as derivative financial instruments because certain down-round anti-dilution protection or price protection features included in the warrant agreements are not consistent with the concept of equity. We applied the Binomial Lattice valuation technique in estimating the fair value of the warrants because we believe that this technique is most appropriate and reflects all of the assumptions that market participants would likely consider in transactions involving the warrants, including the potential incremental value associated with the down-round anti-dilution protections.

The Binomial Lattice technique is a level three valuation technique because it requires the development of significant internal assumptions in addition to observable market indicators. Significant assumptions and utilized in the Binomial Lattice process are as follows for both the issuance dates of the warrants and December 31, 2011 and 2010:

 

     December 31,    October 11,
     2011    2010    2010 (Issuance)

Linked common shares

    1,800,000    1,800,000    1,800,000

Quoted market price on valuation date

    $2.74    $2.78    $1.78

Contractual exercise rate

    $2.50    $2.50    $2.50

Term (years)

    1.78    2.78    3.00

Range of market volatilities

    56.8% - 101.6%    57.6% - 73.2%    54.3% - 74.6%

Risk free rates using zero coupon US Treasury Security rates

    0.02% - 0.25%    0.12% - 1.02%    0.12% - 0.54%

 

     December 31,
2011		    April 14, 2011
2011 (Issuance)

Linked common shares

    525,000    525,000

Quoted market price on valuation date

    $2.74    $3.36

Contractual exercise rate

    $2.75    $2.75

Term (years)

    2.28    3.00

Range of market volatilities

    56.9% - 94.0%    59.5% - 73.0%

Risk free rates using zero coupon US Treasury Security rates

    0.02% - 0.25%    0.07% - 1.27%

 

     December 31,
2011		    November 8,
2011 (Issuance)

Linked common shares

    1,302,083    1,302,083

Quoted market price on valuation date

    $2.74    $2.90

Contractual exercise rate

    $4.32    $4.32

Term (years)

    5.35    5.50

Range of volatilities

    67.2% - 87.5%    67.7% - 95.1%

Risk free rates using zero coupon US Treasury Security rates

    0.02% - 0.83%    0.01% - 0.92%

Custom lattice variable: Probability of exercisability (434,027 linked common shares)

    60.0%    60.0%

 

Of the 1,302,083 common shares accessible from the warrant issued on November 8, 2011, 434,027 of those common shares are accessible only based upon the Company's election to require the lender to provide the additional financing. The lattice custom variable is the probability that management will elect to receive this funding. Based upon all current facts and circumstances, that probability is 60%.

The following table reflects the issuances of derivative warrants and changes in fair value inputs and assumptions related to the derivative warrants during the year ended December 31, 2011 and 2010.

 

     Years ended December 31,  
     2011     2010  

Balances at January 1, 2011

    $ 2,287,800     $ —     

Issuances:

     

Series G Convertible Preferred Stock Financing

      906,150       1,074,600  

Senior Convertible Note Financing

      2,054,601       —     

Changes in fair value inputs and assumptions reflected in income

      (595,391 )      1,213,200  
  

 

 

    

 

 

  

Balances at December 31, 2011

    $ 4,653,160     $ 2,287,800  
  

 

 

    

 

 

  

The fair value of all warrant derivatives is significantly influenced by our trading market price, the price volatility in trading and the risk free interest components of the Binomial Lattice technique.