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Derivative Financial Instruments
 3 Months Ended
Mar. 31, 2013
Derivative Financial Instruments [Abstract]  
DERIVATIVE FINANCIAL INSTRUMENTS

NOTE L – DERIVATIVE FINANCIAL INSTRUMENTS

The following tables summarize the components of our derivative liabilities and linked common shares as of March 31, 2013 and December 31, 2012 and the amounts that were reflected in our income related to our derivatives for the three-month periods ended March 31, 2013 and 2012:

 

                 
    March 31,
2013		     December 31,
2012		  

Derivative liabilities:

                

Embedded derivatives derived from:

                

Senior Convertible Notes

   $ 1,732,257     $ 1,529,583  
   

 

 

    

 

 

  

Warrant derivatives

                

Senior Convertible Notes

     1,973,281       1,921,094  

Series G Convertible Preferred Stock

     2,313,075       1,905,526  
   

 

 

    

 

 

  
      4,286,356       3,826,620  
   

 

 

    

 

 

  

Total derivative liabilities

   $ 6,018,613     $ 5,356,203  
   

 

 

    

 

 

  

 

                 
    March 31,
2013		     December 31,
2012		  

Common shares linked to derivative liabilities:

                

Embedded derivatives:

                

Senior Convertible Notes

     3,456,315       4,247,343  
   

 

 

    

 

 

  

Warrant derivatives

                

Senior Convertible Notes

     1,562,500       1,562,500  

Series G Convertible Preferred Stock

     2,250,000       2,250,000  
   

 

 

    

 

 

  
      3,812,500       3,812,500  
   

 

 

    

 

 

  

Total common shares linked to derivative liabilities

     7,268,815       8,059,843  
   

 

 

    

 

 

  

 

                 
    Three months ended March 31,  
    2013     2012  

Derivative income (expense):

                

Unrealized gains (losses) from fair value changes:

                

Senior Convertible Notes

   $ (640,562 )    $ 511,897  

Series G Convertible Preferred Stock

     —         (38,927 ) 

Warrant derivatives

     (459,737 )      (349,901 ) 
   

 

 

    

 

 

  
      (1,100,299 )      123,069  

Redemptions of Senior Convertible Notes

     437,889       —    
   

 

 

    

 

 

  

Total derivative income (expense)

   $ (662,410 )    $ 123,069  
   

 

 

    

 

 

  

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 N, 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 H, 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:

 

         
    March 31,
2013		   December 31,
2012

Quoted market price on valuation date

   $3.26   $2.97

Contractual conversion rate

   $3.17   $3.74

Contractual term to maturity

   1.08 Years   1.33 Years

Implied expected term to maturity

   0.98 - 0.99 Years   1.24 Years

Market volatility:

        

Range of volatilities

   33.6% - 72.0%   31.3% - 64.03%

Range of equivalent volatilities

   37.3% - 47.9%   38.6% - 45.0%

Contractual interest rate

   8.0% - 9.0%   8.0% - 9.0%

Range of equivalent market risk adjusted interest rates

   8.02% - 9.08%   9.0%-9.1%

Range of equivalent credit risk adjusted yields

   1.47% - 1.13%   0.94% - 1.03%

Risk-free rates

   0.04% - 0.14%   0.02% - 0.16%

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 March 31, 2013 and 2012.

 

                 
   

Three Months ended

March 31,

  
    2013     2012  

Balances at January 1

   $ 1,529,583     $ 2,680,133  

Issuances

     —            

Expirations from redemptions of host contracts reflected in income

     (437,889 )      —    

Changes in fair value inputs and assumptions reflected in income

     640,563       (472,970 ) 
   

 

 

    

 

 

  

Balances at March 31

   $ 1,732,257     $ 2,207,163  
   

 

 

    

 

 

  

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 March 31, 2013 and 2012 and December 31, 2012:

 

             
    March 31,   December 31,
2012
    2013   2012  

Linked common shares

   1,725,000   1,800,000   1,725,000

Quoted market price on valuation date

   $3.26   $3.11   $2.97

Contractual exercise rate

   $2.4648   $2.50   $2.4648

Term (years)

   0.53   1.53   0.78

Range of market volatilities

   33.8% - 44.4%   40.8% - 77.7%   33.1% - 49.17%

Risk free rates using zero coupon US Treasury Security rates

   0.04% - 0.11%   0.05% - 0.26%   0.02% - 0.11%

 

             
    March 31,   December 31,
2012
    2013   2012  

Linked common shares

   525,000   525,000   525,000

Quoted market price on valuation date

   $3.26   $3.11   $2.97

Contractual exercise rate

   $2.4648   $2.75   $2.4648

Term (years)

   1.04   2.04   1.28

Range of market volatilities

   34.1% - 45.3%   42.7% - 78.3%   33.8% - 63.6%

Risk free rates using zero coupon US Treasury Security rates

   0.04% - 0.14%   0.09% - 0.33%   0.02% - 0.16%

 

             
    March 31,   December 31,
2012
    2013   2012  

Linked common shares

   1,562,500   1,302,083   1,562,500

Quoted market price on valuation date

   $3.26   $3.11   $2.97

Contractual exercise rate

   $3.60   $4.32   $3.60

Term (years)

   4.10   5.11   4.35

Range of market volatilities

   34.1% - 67.7%   49.0% - 77.4%   39.2% - 70.2%

Risk free rates using zero coupon US Treasury Security rates

   0.07% - 0.57%   0.07% - 1.04%   0.05% - 0.54%

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

   —     90%   —  

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 three months ended March 31, 2013 and 2012.

 

                 
    Three months ended March 31,  
    2013     2012  

Balances at January 1

   $ 3,826,619     $ 4,653,160  

Changes in fair value inputs and assumptions reflected in income

     459,737       349,901  
   

 

 

    

 

 

  

Balances at March 31

   $ 4,286,356     $ 5,003,061  
   

 

 

    

 

 

  

 

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.