NOTE M – DERIVATIVE FINANCIAL INSTRUMENTS

The following tables summarize the components of our derivative liabilities and linked common shares as of September 30, 2013 and December 31, 2012 and the amounts that were reflected in our income related to our derivatives for the nine-month periods ended September 30, 2013 and 2012:


	September 30, 2013		December 31, 2012
Derivative liabilities:
Embedded derivatives derived from:
Senior Convertible Notes	$	421,629	$	1,529,583

Warrant derivatives
Senior Convertible Notes		1,463,281		1,921,094
Series G Convertible Preferred Stock		1,264,651		1,905,526

		2,727,932		3,826,620

Total derivative liabilities	$	3,149,561	$	5,356,203


	September 30, 2013		December 31, 2012
Common shares linked to derivative liabilities:
Embedded derivatives:
Senior Convertible Notes		1,980,938		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		5,793,438		8,059,843


	Three months ended September 30,				Nine months ended September 30,
	2013		2012		2013		2012
Derivative income (expense):
Unrealized gains (losses) from fair value changes:

Senior Convertible Notes	$	202,034	$	2,274,033	$	244,303	$	1,174,205
Series G Convertible Preferred Stock		—		286,335		—		158,711
Warrant derivatives		438,119		2,241,494		1,098,688		379,114

		640,153		4,801,862		1,342,991		1,712,030
Redemptions of Senior Convertible Notes		230,300		—		863,651		—

Total derivative income (expense)	$	870,453	$	4,801,862	$	2,206,642	$	1,712,030

In October 2010, we completed a public offering of shares of Series G Preferred Stock and warrants to purchase common stock. In April 2011, we entered into separate agreements with two holders of the Series G Preferred Stock whereby we agreed to issue warrants to purchase additional shares of common stock to the holders in consideration of the two holders agreeing to extend by six months the dates upon which the conversion option and the redemption option with respect to the shares of Series G Preferred Stock held by them became exercisable and the date upon which the redemption price of the shares of Series G Preferred Stock held by them began to increase by 1% per month. These transactions gave rise to derivative financial instruments. 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. The warrants issued in connection with these transactions included down-round anti-dilution protection and, accordingly, were not afforded equity classification.

In November 2011 and May 2012, we issued and sold Senior Convertible Notes that included 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 in connection with these transactions included 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:


	September 30, 2013	December 31, 2012
Quoted market price on valuation date	$3.00	$2.97
Contractual conversion rate	$3.17	$3.74
Contractual term to maturity	0.58 Years	1.33 Years
Implied expected term to maturity	0.57 Years	1.24 Years
Market volatility:
Range of volatilities	24.0% - 46.2%	31.3% - 64.03%
Range of equivalent volatilities	32.2% - 37.8%	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	0.58%	0.94% - 1.03%
Risk-free rates	0.03% - 0.04%	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 September 30, 2013 and 2012.


	Nine Months ended September 30,
	2013			2012
Balances at January 1	$	1,529,583		$	2,680,133
Issuances		—			1,291,298
Expirations from redemptions of host contracts reflected in income		(863,652	)		(650,627	)
Changes in fair value inputs and assumptions reflected in income		(244,302	)		(682,289	)

Balances at September 30	$	421,629		$	2,638,515

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

In October 2010, we also issued warrants to purchase 1,800,000 shares of our common stock in connection with a public offering of our Series G Convertible Preferred Stock, and in April 2011, we issued warrants to purchase an additional 525,000 shares of our common stock to two holders of the Series G Convertible Preferred Stock in connection with the modification of the conversion and redemption features of the shares of Series G Convertible Preferred Stock held by them. Additionally, in November 2011, we issued warrants to purchase 1,302,083 shares of our common stock in connection with the sale of Senior Convertible Notes. These warrants required liability classification as derivative financial instruments because certain down-round anti-dilution protection or price protection features included in the warrants 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 September 30, 2013 and 2012 and December 31, 2012:


	September 30,		December 31, 2012
	2013	2012	December 31, 2012
Linked common shares	1,725,000	1,800,000	1,725,000
Quoted market price on valuation date	$3.00	$3.15	$2.97
Contractual exercise rate	$2.4648	$2.50	$2.4648
Term (years)	0.03	1.03	0.78
Range of market volatilities	24.0% - 31.5%	38.9% - 68.1%	33.1% - 49.17%
Risk free rates using zero coupon US Treasury Security rates	0.03%	0.06% - 0.17%	0.02% - 0.11%


	September 30,		December 31, 2012
	2013	2012	December 31, 2012
Linked common shares	525,000	525,000	525,000
Quoted market price on valuation date	$3.00	$3.15	$2.97
Contractual exercise rate	$2.4648	$2.75	$2.4648
Term (years)	0.54	1.54	1.28
Range of market volatilities	26.3% - 46.1%	38.7% - 69.2%	33.8% - 63.6%
Risk free rates using zero coupon US Treasury Security rates	0.02% - 0.04%	0.06% - 0.20%	0.02% - 0.16%


	September 30,		December 31, 2012
	2013	2012	December 31, 2012
Linked common shares	1,562,500	1,562,500	1,562,500
Quoted market price on valuation date	$3.00	$3.15	$2.97
Contractual exercise rate	$3.60	$3.60	$3.60
Term (years)	3.61	4.60	4.35
Range of market volatilities	38.2% - 60.5%	54.2% - 71.0%	39.2% - 70.2%
Risk free rates using zero coupon US Treasury Security rates	0.02% - 0.63%	0.10% - 0.47%	0.05% - 0.54%

Of the 1,302,083 common shares issuable upon exercise of the warrant issued on November 8, 2011, 434,027 of those common shares were exercisable only upon the Company’s election to require the lender to provide the additional financing. When the lender provided additional financing of $8,000,000 on May 10, 2012, the additional 434,027 of common shares became available for issuance upon exercise. 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 nine months ended September 30, 2013 and 2012.


	Nine months ended September 30,
	2013			2012
Balances at January 1	$	3,826,619		$	4,653,160
Issuances		—			363,542
Changes in fair value inputs and assumptions reflected in income		(1,098,688	)		(379,114	)

Balances at September 30	$	2,727,931		$	4,637,588

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