NOTE J – DERIVATIVE FINANCIAL INSTRUMENTS

The following tables summarize the components of our derivative liabilities and linked common shares as of December 31, 2014 and December 31, 2013 and the amounts that were reflected in our income related to our derivatives for the periods then ended:


	December 31, 2014		December 31, 2013
Derivative liabilities:
Embedded derivatives derived from:
Senior Convertible Notes	$	—	$	47,243
2014 Convertible Promissory Notes		2,115,318		—

		2,115,318		47,243
Warrant derivatives
Senior Convertible Notes		111,127		840,000
Series G Convertible Preferred Stock		—		83,580

Warrant derivatives		111,127		923,580

Total derivative liabilities	$	2,226,445	$	970,823


	December 31, 2014		December 31, 2013
Common shares linked to derivative liabilities:
Embedded derivatives:
Senior Convertible Notes		—		1,729,647
2014 Convertible Promissory Notes*		3,174,604		—

		3,174,604		1,729,647

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

		1,562,500		2,087,500

Total common shares linked to derivative liabilities		4,737,104		3,817,147

*	The common shares indexed to the 2014 Convertible Promissory Notes are shares indexed to Oceanica.


	Years ended December 31,
	2014		2013
Derivative income (expense):
Unrealized gains (losses) from fair value changes:
Senior Convertible Notes	$	47,243	$	593,001
2014 Convertible Promissory Notes		141,983		—
Warrant derivatives		812,453		1,980,164

		1,001,679		2,573,165
Exercise of Warrants				922,875
Redemptions of Senior Convertible Notes		—		889,340

Total derivative income (expense)	$	1,001,679	$	4,385,380

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 transactions 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 K, 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.

During the year ended December 31, 2014, the compound embedded derivatives related to the Senior Convertible Notes were converted. As of December 31, 2014, no compound embedded derivatives were present. 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 as of December 31, 2013:


		December 31, 2013
Quoted market price on valuation date		$2.02
Contractual conversion rate		$3.17
Range of effective contractual conversion rates		—
Contractual term to maturity		0.33 Years
Implied expected term to maturity		0.33 Years
Market volatility:
Range of volatilities		47.4% - 91.2%
Range of equivalent volatilities		59.9% - 69.9%
Contractual interest rate		8.0 - 9.0%
Range of equivalent market risk adjusted interest rates		8.08% - 9.08%
Range of equivalent credit risk adjusted yields		0.67%
Risk-free rates		0.01% - 0.07%

Significant inputs and results arising from the Monte Carlo Simulations process are as follows for the share purchase options that have been bifurcated from our Monaco Notes and classified in liabilities as of December 31, 2014 and the inception dates (Tranche 1 – August 14, 2014, Tranche 2 – October 1, 2014, Tranche 3 – December 1, 2014):


Tranche 1 – August 14, 2014:	December 31, 2014	August 14, 2014
Underlying price on valuation date*	$2.50	$2.50
Contractual conversion rate	$3.15	$3.15
Contractual term to maturity	1.62 Years	2.00 Years
Implied expected term to maturity	1.51 Years	1.85 Years
Market volatility:
Range of volatilities	58.5% - 78.1%	37.0% - 62.2%
Equivalent volatilities	69.7%	51.2%
Contractual interest rate	8.0% - 11.0%	8.0% - 11.0%
Equivalent market risk adjusted interest rates	9.50%	9.50%
Range of credit risk adjusted yields	4.66% - 5.27%	3.94% - 4.45%
Equivalent credit risk adjusted yield	4.86%	4.15%


Tranche 2 – October 1, 2014:	December 31, 2014	October 1, 2014
Underlying price on valuation date*	$2.50	$2.50
Contractual conversion rate	$3.15	$3.15
Contractual term to maturity	1.75 Years	2.00 Years
Implied expected term to maturity	1.60 Years	1.79 Years
Market volatility:
Range of volatilities	60.1% - 80.5%	58.6% - 75.3%
Equivalent volatilities	70.4%	68.00%
Contractual interest rate	8.0% - 11.0%	8.0% - 11.0%
Equivalent market risk adjusted interest rates	9.50%	9.25%
Range of credit risk adjusted yields	4.66% - 5.27%	3.97% - 4.61%
Equivalent credit risk adjusted yield	4.91%	4.24%


Tranche 3 – December 1, 2014:	December 31, 2014	December 1, 2014
Underlying price on valuation date*	$2.50	$2.50
Contractual conversion rate	$3.15	$3.15
Contractual term to maturity	1.92 Years	2.00 Years
Implied expected term to maturity	1.72 Years	1.76 Years
Market volatility:
Range of volatilities	59.8% - 78.1%	61.8% - 79.8%
Equivalent volatilities	69.5%	72.2%
Contractual interest rate	8.0% - 11.0%	8.0% - 11.0%
Equivalent market risk adjusted interest rates	9.25%	9.25%
Range of credit risk adjusted yields	4.66% - 5.27%	4.29% - 4.84%
Equivalent credit risk adjusted yield	4.91%	4.52%

The instrument is convertible into shares of the Company’s subsidiary, Oceanica, which is not a publicly-traded entity. Therefore its shares do not trade on a public exchange. As a result, the underlying value must be based on private sales of the subsidiary’s shares because that is the best indicator of the value of the shares. There has been a sale of Oceanica’s shares in which a private investor accumulated 24% of the shares of which their last purchase price was for $2.50 per share in December 2013. Accordingly the underlying price used in the MCS calculations for the inception dates and quarter ended December 31, 2014 was $2.50.

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, 2014 and 2013.


	For the years ended December 31,
	2014			2013
Balances at January 1	$	47,243		$	1,529,583
Issuances		—			—
Expirations from redemptions of host contracts reflected in income		(47,243	)		(889,339	)
Changes in fair value inputs and assumptions reflected in income		—			(593,001	)

Balances at December 31	$	—		$	47,243

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.

The following table reflects the issuances of the Share Purchase Option derivatives and changes in fair value inputs and assumptions for these derivatives during the year ended December 31, 2014.


	December 31, 2014
Balances at January 1	$	—
Issuances		1,985,079
Changes in fair value inputs and assumptions reflected in income		130,239

Balances at December 31	$	2,115,318

The fair value of all Share Purchase Option 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.

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 December 31, 2014 and December 31, 2013.

All remaining warrants linked to 525,000 shares of common stock expired unexercised on April 13, 2014. Therefore, the warrants linked to 525,000 shares of common stock were not outstanding as of December 31, 2014. Significant assumptions and utilized in the Binomial Lattice process are as follows for the warrants linked to 525,000 shares of common stock as of December 31, 2013:


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

Significant assumptions and utilized in the Binomial Lattice process are as follows for the warrants linked to 1,562,500 shares of common stock as of December 31, 2014 and December 31, 2013:


	December, 31
	2014	2013
Linked common shares	1,562,500	1,562,500
Quoted market price on valuation date	$0.93	$2.02
Contractual exercise rate	$3.60	$3.60
Term (years)	2.40	3.35
Range of market volatilities	59.9% - 73.9%	51.1% - 78.2%
Risk free rates using zero coupon US Treasury Security rates	0.04% - 0.67%	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 years ended December 31, 2014 and 2013.


	Years ended December 31,
	2014			2013
Balances at January 1	$	923,580		$	3,826,619
Issuances:
Series G Convertible Preferred Stock Financing		—			—
Senior Convertible Note Financing		—			—
Exercises:
Series G Convertible Preferred Stock Financing		—			(922,875	)
Changes in fair value inputs and assumptions reflected in income		(812,453	)		(1,980,164	)

Balances at December 31	$	111,127		$	923,580

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.