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Derivative Financial Instruments
 3 Months Ended
Mar. 31, 2014
Derivative Instruments And Hedging Activities Disclosure [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 March 31, 2014 and December 31, 2013 and the amounts that were reflected in our income related to our derivatives for the years then ended:

 

         March 31,          December 31,  
     2014      2013  

Derivative liabilities:

      

Embedded derivatives derived from:

      

Senior Convertible Notes

    $ —         $ 47,243   
  

 

 

     

 

 

  

Warrant derivatives

      —           47,243   

Senior Convertible Notes

      858,906         840,000   

Series G Convertible Preferred Stock

      294,630         83,580   
  

 

 

     

 

 

  

Warrant derivatives

      1,153,536         923,580   
  

 

 

     

 

 

  

Total derivative liabilities

    $ 1,153,536       $   970,823   
  

 

 

     

 

 

  

 

       March 31,         December 31,  
    2014      2013  

Common shares linked to derivative liabilities:

     

Embedded derivatives:

     

Senior Convertible Notes

     743,937        1,729,647  
 

 

 

     

 

 

  
    743,937        1,729,647  
 

 

 

     

 

 

  

Warrant derivatives

     

Senior Convertible Notes

     1,562,500        1,562,500  

Series G Convertible Preferred Stock

     525,000        525,000  
 

 

 

     

 

 

  
    2,087,500        2,087,500  
 

 

 

     

 

 

  

Total common shares linked to derivative liabilities

      2,831,437         3,817,147  
 

 

 

     

 

 

  

Note: Although the Senior Convertible Notes were indexed to 743,937 common shares as of March 31, 2014, the fair value was considered nil as of March 31, 2014.

 

      Three months ended March 31,   
     2014     2013  

Derivative income (expense):

     

Unrealized gains (losses) from fair value changes:

     

Senior Convertible Notes

    $ 47,243      $ (640,562 ) 

Warrant derivatives

      (229,956 )     (459,737 ) 
  

 

 

    

 

 

  
     (182,713 )      (1,100,299 ) 

Redemptions of Senior Convertible Notes

      —          437,889  
  

 

 

    

 

 

  

Total derivative income (expense)

    $ (182,713 )    $ (662,410 ) 
  

 

 

    

 

 

  

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. We entered into a 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. These transaction have since expired. 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 Note and classified in liabilities:

 

     March 31,
2014		   December 31,
2013

Quoted market price on valuation date

    $2.29   $2.02

Contractual conversion rate

    $3.17   $3.17

Range of effective contractual conversion rates

    —     —  

Contractual term to maturity

    0.085 Years   0.33 Years

Implied expected term to maturity

    0.085 Years   0.33 Years

Market volatility:

     

Range of volatilities

    18.2% - 38.4%   47.4% - 91.2%

Range of equivalent volatilities

    27.3%   59.9% - 69.9%

Contractual interest rate

    9.0%   8.0 - 9.0%

Range of equivalent market risk adjusted interest rates

    9.08%   8.08% - 9.08%

Range of equivalent credit risk adjusted yields

    0.64%   0.67%

Risk-free rates

    0.03% - 0.05%   0.01% - 0.07%

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 three months ended March 31, 2014 and 2013.

 

     For the three months ended March 31,  
     2014     2013  

Balances at January 1

    $ 47,243     $ 1,529,583  

Issuances

     

Expirations from redemptions of host contracts reflected in income

      (47,243 )      (437,889 ) 

Changes in fair value inputs and assumptions reflected in income

        640,563  
  

 

 

    

 

 

  

Balances at March 31

    $ —        $ 1,732,257  
  

 

 

    

 

 

  

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. All remaining warrants linked to 1,725,000 shares of common stock were exercised on October 11, 2013. Therefore, the warrants linked to 1,725,000 shares of common stock were not outstanding as of March 31, 2014 and December 31, 2013. Significant assumptions and utilized in the Binomial Lattice process are as follows for the warrants as of March 31, 2014:

 

     March 31,
2013

Linked common shares

    1,725,000

Quoted market price on valuation date

    $3.26

Contractual exercise rate

    $2.4648

Term (years)

    0.53

Range of market volatilities

    33.8% - 44.4%

Risk free rates using zero coupon US Treasury Security rates

    0.04% - 0.11%

 

     March, 31,    December 31,
     2014    2013    2013

Linked common shares

    525,000    525,000    525,000

Quoted market price on valuation date

    $2.29    $3.26    $2.02

Contractual exercise rate

    $2.3793    $2.4648    $2.3793

Term (years)

    0.04    1.04    0.28

Range of market volatilities

    15.2% - 29.2%    34.1% - 45.3%    50.1% - 88.3%

Risk free rates using zero coupon US Treasury Security rates

    0.05%    0.04% - 0.14%    0.01% - 0.07%

 

     March, 31    December 31,
     2014    2013    2013

Linked common shares

    1,562,500    1,562,500    1,562,500

Quoted market price on valuation date

    $2.29    $3.26    $2.02

Contractual exercise rate

    $3.60    $3.60    $3.60

Term (years)

    3.11    4.10    3.35

Range of market volatilities

    47.9% - 66.1%    34.1% - 67.7%    51.1% - 78.2%

Risk free rates using zero coupon US Treasury Security rates

    0.05% - 0.90%    0.07% - 0.57%    0.07% - 0.78%

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

    —      —     

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 three months ended March 31, 2014 and 2013.

 

     For the three months ended March 31,  
     2014      2013  

Balances at January 1

    $ 840,000      $ 3,826,619  

Changes in fair value inputs and assumptions reflected in income

      18,906        459,737  
  

 

 

     

 

 

  

Balances at March 31

    $ 858,906      $ 4,286,356  
  

 

 

     

 

 

  

 

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.