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Derivative Financial Instruments
 6 Months Ended
Jun. 30, 2012
Derivative Financial Instruments [Abstract]  
DERIVATIVE FINANCIAL INSTRUMENTS

NOTE M – DERIVATIVE FINANCIAL INSTRUMENTS

The following tables summarize the components of our derivative liabilities and linked common shares as of June 30, 2012 and December 31, 2011 and the amounts that were reflected in our income related to our derivatives for the three-month and six-months periods ended June 30, 2012 and 2011:

 

                 
    June 30,
2012		     December 31,
2011		  

Derivative liabilities:

                

Embedded derivatives derived from:

                

Senior Convertible Notes

   $ 4,912,547     $ 2,521,422  

Series G Convertible Preferred Stock

     286,335       158,711  
   

 

 

    

 

 

  
      5,198,882       2,680,133  
   

 

 

    

 

 

  

Warrant derivatives

                

Senior Convertible Notes

     3,191,407       1,898,785  

Series G Convertible Preferred Stock

     3,687,675       2,754,375  
   

 

 

    

 

 

  

Warrant derivatives

     6,879,082       4,653,160  
   

 

 

    

 

 

  

Total derivative liabilities

   $ 12,077,964     $ 7,333,293  
   

 

 

    

 

 

  

Common shares linked to derivative liabilities:

                

Embedded derivatives:

                

Senior Convertible Notes

     5,305,800       2,673,797  

Series G Convertible Preferred Stock

     140,000       140,000  
   

 

 

    

 

 

  
      5,445,800       2,813,797  
   

 

 

    

 

 

  

Warrant derivatives

                

Senior Convertible Notes

     1,562,500       1,302,083  

Series G Convertible Preferred Stock

     2,325,000       2,325,000  
   

 

 

    

 

 

  
      3,887,500       3,627,083  
   

 

 

    

 

 

  

Total common shares linked to derivative liabilities

     9,333,300       6,440,880  
   

 

 

    

 

 

  

 

 

                                 
    Three months ended June 30,     Six months ended June 30,  
    2012     2011     2012     2011  

Derivative income (expense):

                                

Unrealized gains (losses) from fair value changes:

                                

Senior Convertible Notes

   $ (1,611,725 )    $ —       $ (1,099,828 )    $ —    

Series G Convertible Preferred Stock

     (88,697 )      476,637       (127,624 )      (445,347 ) 

Warrant derivatives

     (1,512,479 )      227,925       (1,862,380 )      (139,275 ) 
   

 

 

    

 

 

    

 

 

    

 

 

  

Total derivative income (expense)

   $ (3,212,901 )    $ 704,562     $ (3,089,832 )    $ (584,622 ) 
   

 

 

    

 

 

    

 

 

    

 

 

  

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 Transactions on November 8, 2011 and May 10, 2012 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 I, we entered into the Senior Convertible Note and Warrant Financing Transactions on November 8, 2011 and May 10, 2012. The Senior Convertible Notes 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 Notes and classified in liabilities:

 

         
    June 30,
2012		   December 31,
2011

Quoted market price on valuation date

   $3.725   $2.74

Contractual conversion rate

   $3.17 - $3.74   $3.74

Range of effective contractual conversion rates

   $3.17 - $4.07   $2.74 - $2.89

Contractual term to maturity

   1.84 - 1.98 Years   2.33 Years

Implied expected term to maturity

   1.47 - 1.49 Years   2.06 Years

Market volatility:

        

Range of volatilities

   28.8% - 73.7%   55.6% - 101.8%

Range of equivalent volatilities

   44.4% - 64.3%   78.9% - 84.3%

Contractual interest rate

   8.0% - 9.0%   8.0%

Range of equivalent market risk adjusted interest rates

   8.0% - 9.1%   8.0%-8.1%

Range of equivalent credit risk adjusted yields

   1.35% - 1.55%   3.1% - 3.5%

Risk-free rates

   0.04% - 0.21%   0.01% - 0.25%

The effective contractual conversion rates give effect to the impending conversion price reset related to the Additional Notes, six months from their inception date, 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 $3.54 — $3.70 as of June 30, 2012 and $2.49 - $2.63 as of December 31, 2011. The mean prices derived from the stochastic process were multiplied by 110% which is a contractual provision for computing the reset price.

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:

 

             
    June 30,   December 31,
    2012   2011   2011

Quoted market price on valuation date

   $3.725   $3.13   $2.74

Contractual conversion rate

   $1.78   $1.78   $1.78

Implied expected term

   0.33 Years   0.74 Years   0.46 Years

Market volatility:

            

Range of volatilities

   46.5% - 72.9%   61.8%-71.9%   49.5% - 101.8%

Equivalent volatility

   51.7%   67.4%   74.1%

Market risk adjusted interest rate:

            

Range of rates (including premiums)

   18.0% - 35.0%   8.0%-32.0%   13.0% - 32.0%

Equivalent market risk adjusted interest rate

   20.3%   12.4%   15.3%

Credit risk adjusted yield rate:

            

Range of rates

   1.4% - 3.3%   2.2%-3.3%   3.1% - 3.7%

Equivalent credit-risk adjusted yield rate

   1.4%   2.3%   3.1%

Risk free rates using zero coupon US Treasury

            

Security rates:

            

Range of rates

   0.04% - 0.10%   0.19%-0.81%   0.12% - 0.25%

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 periods ended June 30, 2012 and 2011.

 

                 
    Six Months ended June 30,  
    2012     2011  

Balances at January 1

   $ 2,680,133     $ 4,075,344  

Issuances:

     1,291,298          

Expirations from redemptions of host contracts reflected in income

     —         (676,718 ) 

Changes in fair value inputs and assumptions reflected

in income

     1,227,451       1,122,065  
   

 

 

    

 

 

  

Balances at June 30

   $ 5,198,882     $ 4,520,691  
   

 

 

    

 

 

  

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 June 30, 2012, June 30, 2011 and December 31, 2011:

 

             
    June 30,   December 31,
    2012   2011   2011

Linked common shares

   1,800,000   1,800,000   1,800,000

Quoted market price on valuation date

   $3.725   $3.13   $2.74

Contractual exercise rate

   $2.50   $2.50   $2.50

Term (years)

   1.28   2.28   1.78

Range of market volatilities

   48.7% - 73.1%   61.0% - 72.8%   56.8% - 101.6%

Risk free rates using zero coupon US Treasury Security rates

   0.04% - 0.27%   0.03% - 0.81%   0.02% - 0.25%
     
    June 30,   December 31,
    2012   2011   2011

Linked common shares

   525,000   525,000   525,000

Quoted market price on valuation date

   $3.725   $3.13   $2.74

Contractual exercise rate

   $2.75   $2.50   $2.75

Term (years)

   1.79   2.28   2.28

Range of market volatilities

   48.9% - 72.2%   61.0% - 72.8%   56.9% - 94.0%

Risk free rates using zero coupon US Treasury Security rates

   0.04% - 0.27%   0.03% - 0.81%   0.02% - 0.25%

 

         
    June 30,
2012		   December 31,
2011

Linked common shares

   1,562,500   1,302,083

Quoted market price on valuation date

   $3.725   $2.74

Contractual exercise rate

   $3.60   $4.32

Term (years)

   4.86   5.35

Range of volatilities

   48.8% - 72.5%   67.2%-87.5%

Risk free rates using zero coupon US Treasury Security rates

   0.09% - 0.72%   0.02% - 0.83%

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

   —   60.0%

Of the 1,302,083 common shares accessible from the warrant issued on November 8, 2011, 434,027 of those common shares were 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 was 60% as of December 31, 2011. When the lender provided additional financing of $8,000,000 on May 10, 2012, the additional 434,027 of common shares became accessible. Warrants indexed to an additional 260,417 were issued in conjunction with the additional financing.

The following table reflects the issuances of derivative warrants and changes in fair value inputs and assumptions related to the derivative warrants during the six months ended June 30, 2012 and 2011.

 

                 
    Six months ended June 30,  
    2012     2011  

Balances at January 1

   $ 4,653,160     $ 2,287,800  

Issuances

     363,542       906,150  

Changes in fair value inputs and assumptions reflected in income

     1,862,380       139,275  
   

 

 

    

 

 

  

Balances at June 30

   $ 6,879,082     $ 3,333,225  
   

 

 

    

 

 

  

 

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.