NOTE K – DERIVATIVE FINANCIAL INSTRUMENTS

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


	December 31,
	2013		2012
Derivative liabilities:
Embedded derivatives derived from:
Senior Convertible Notes	$	47,243	$	1,529,583
Series G Convertible Preferred Stock		—		—

		47,243		1,529,583
Warrant derivatives
Senior Convertible Notes		840,000		1,921,094
Series G Convertible Preferred Stock		83,580		1,905,526

Warrant derivatives		923,580		3,826,620

Total derivative liabilities	$	970,823	$	5,356,203


	December 31,
	2013		2012
Common shares linked to derivative liabilities:
Embedded derivatives:
Senior Convertible Notes		1,729,647		4,247,343
Series G Convertible Preferred Stock		—		—

		1,729,647		4,247,343

Warrant derivatives
Senior Convertible Notes		1,562,500		1,562,500
Series G Convertible Preferred Stock		525,000		2,250,000

		2,087,500		3,812,500

Total common shares linked to derivative liabilities		3,817,147		8,059,843

	Years ended December 31,
	2013		2012
Derivative income (expense):
Unrealized gains (losses) from fair value changes:
Senior Convertible Notes	$	593,001	$	1,747,133
Series G Convertible Preferred Stock		—		(115,955	)
Warrant derivatives		1,980,164		1,071,583

		2,573,165		2,702,761
Redemptions of Series G Convertible Preferred Stock		—		393,166
Redemptions of Senior Convertible Notes		889,340		536,003
Exercise of Warrants		922,875		—

Total derivative income (expense)	$	4,385,380	$	3,631,930

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 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 Note and classified in liabilities:


	December 31, 2013	December 31, 2012
Quoted market price on valuation date	$2.02	$2.97
Contractual conversion rate	$3.17	$3.74
Range of effective contractual conversion rates	—	—
Contractual term to maturity	0.33 Years	1.33 Years
Implied expected term to maturity	0.33 Years	1.24 Years
Market volatility:
Range of volatilities	47.4% – 91.2%	31.3% – 64.03%
Range of equivalent volatilities	59.9% – 69.9%	38.6% – 45.0%
Contractual interest rate	8.0 – 9.0%	8.0 – 9.0%
Range of equivalent market risk adjusted interest rates	8.08%-9.08%	9.0%-9.1%
Range of equivalent credit risk adjusted yields	0.67%	0.94% – 1.03%
Risk-free rates	0.01% – 0.07%	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 years ended December 31, 2013 and 2012.


	Years ended December 31,
	2013			2012
Balances at January 1	$	1,529,583		$	2,680,133
Issuances:
Senior Convertible Note Financing		—			1,291,298
Expirations from redemptions of Series G Convertible Preferred Stock		(889,340	)		(810,669	)
Changes in fair value inputs and assumptions reflected in income		(593,001	)		(1,631,179	)

Balances at December 31	$	47,242		$	1,529,583

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 utilized in the Binomial Lattice process are as follows as of December 31, 2013 and 2012:


	December 31,
	2013		2012
Linked common shares		—	1,725,000
Quoted market price on valuation date		—	$2.97
Contractual exercise rate		—	$2.4648
Term (years)		—	0.78
Range of market volatilities		—	33.1% – 49.17%
Risk free rates using zero coupon US Treasury Security rates		—	0.02% –0.11%

All remaining warrants linked to 1,725,000 shares of common stock were exercised on October 11, 2013.


	December 31,
	2013	2012
Linked common shares	525,000	525,000
Quoted market price on valuation date	$2.02	$2.97
Contractual exercise rate	$2.3793	$2.4648
Term (years)	0.28	1.28
Range of market volatilities	50.1% – 88.3%	33.8% – 63.6%
Risk free rates using zero coupon US Treasury Security rates	0.01% – 0.07%	0.02% – 0.16%


	December 31,
	2013	2012
Linked common shares	1,562,500	1,562,500
Quoted market price on valuation date	$2.02	$2.97
Contractual exercise rate	$3.60	$3.60
Term (years)	3.35	4.35
Range of market volatilities	51.1% – 78.2%	39.2% – 70.2%
Risk free rates using zero coupon US Treasury Security rates	0.07% – 0.78%	0.05% – 0.54%

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. 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 year ended December 31, 2013 and 2012.


	Years ended December 31,
	2013			2012
Balances at January 1	$	3,826,619		$	4,653,160
Issuances:
Series G Convertible Preferred Stock Financing		—			—
Senior Convertible Note Financing		—			363,542
Exercises:
Series G Convertible Preferred Stock Financing		(922,875	)		(118,500	)
Changes in fair value inputs and assumptions reflected in income		(1,980,164	)		(1,071,583	)

Balances at December 31	$	923,580		$	3,826,619

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.