10.	Fair Value Measurements

Fair value measurements are market-based measurements, not entity-specific measurements. Therefore, fair value measurements are determined based on the assumptions that market participants would use in pricing the asset or liability. We follow a three-level hierarchy to prioritize the inputs used in the valuation techniques to derive fair values. The basis for fair value measurements for each level within the hierarchy is described below:

	Level 1: Quoted prices in active markets for identical assets or liabilities.

	Level 2: Quoted prices for similar assets or liabilities in active markets; quoted prices for identical or similar instruments in markets that are not active; and model-derived valuations in which all significant inputs are observable in active markets.

	Level 3: Valuations derived from valuation techniques in which one or more significant inputs are unobservable in active markets.

The following table provides a summary of the recognized assets and liabilities that we measure at fair value on a recurring basis:

	Balance as of		Basis of Fair Value Measurements
	September 30, 2015		Level 1		Level 2		Level 3
Liabilities:
Warrant liability	$	12,527,000	$	—	$	—	$	12,527,000

	Balance as of		Basis of Fair Value Measurements
	December 31, 2014		Level 1		Level 2		Level 3
Assets:
Cash equivalents	$	8,144,000	$	8,144,000	$	—	$	—
Liabilities:
Warrant liability	$	9,793,000	$	—	$	—	$	9,793,000

We use quoted market prices to determine the fair value of our cash equivalents, which consist of money market funds that are classified in Level 1 of the fair value hierarchy.

Warrants with exercise price reset features (down-round protection) are accounted for as liabilities, with changes in the fair value included in net income (loss) for the respective periods. Because some of the inputs to our valuation model are either not observable or are not derived principally from or corroborated by observable market data by correlation or other means, the warrant liability is classified as Level 3 in the fair value hierarchy.

Our stock price can be volatile and there could be material fluctuations in the value of warrants in future periods.

Warrant Liability

In connection with the October 2014 Securities Purchase Agreement, the Company issued common stock purchase warrants (the October Warrants) to certain institutional investors with certain exercise price reset features. Each warrant has an initial exercise price of $0.5771 per share, is exercisable six months and one day after the date of issuance and expires five years from the date on which it is initially exercisable. Pursuant to the second closing of the May 2015 Securities Purchase Agreement, the exercise price of these warrants was reset to $0.3263. The initial fair value of the liability associated with these warrants was $10.0 million. The fair value of the October Warrants was $4.4 million as of September 30, 2015 and $9.8 million as of December 31, 2014.

In May 2015, the Company entered into a Securities Purchase Agreement with certain institutional investors pursuant to which the Company agreed to sell up to $25 million of units, with each unit consisting of one share of its common stock and one warrant to purchase one share of its common stock, in a registered direct offering. The May 2015 Securities Purchase Agreement contemplated two closings, the first of which occurred on May 8, 2015, the second of which occurred upon satisfaction of certain conditions precedent, including, but not limited to, receipt of required stockholder approval, on August 27, 2015. Each warrant issued at the initial closing (the May 2015 Warrants) has an initial exercise price of $1.02 per share, is exercisable six months and one day after the date of issuance and expires five years from the date on which it is initially exercisable. Each warrant issued at the second closing (the August 2015 Warrants) has an initial exercise price of $0.401 per share, and expires five years from the date of issuance. The initial fair value of the liability associated with the May 2015 Warrants was $14.3 million, and the fair value decreased to $6.3 million as of September 30, 2015. The initial fair value of the liability associated with the August 2015 Warrants was $1.6 million, and the fair value increased to $1.9 million as of September 30, 2015.

	As of September 30, 2015				As of December 31, 2014
October 2014 Warrants
Expected term	4.5 years				5.3 years
Common stock market price		$	0.34		$	0.49
Risk-free interest rate			1.37	%		1.65	%
Expected volatility			90 - 120	%		90.00	%
Resulting fair value (per warrant)		$	0.25		$	0.38

	As of September 30, 2015				As of December 31, 2014
May 2015 Warrants
Expected term	5.1 years					—
Common stock market price		$	0.34			—
Risk-free interest rate			1.37	%		—
Expected volatility			90 - 120	%		—
Resulting fair value (per warrant)		$	0.25			—

	As of September 30, 2015				As of December 31, 2014
August 2015 Warrants
Expected term	4.91 years					—
Common stock market price		$	0.34			—
Risk-free interest rate			1.37	%		—
Expected volatility			90 - 120	%		—
Resulting fair value (per warrant)		$	0.25			—

Expected volatility is based on both historical and implied volatility. Historical volatility was computed using daily pricing observations for recent periods that correspond to the expected term of the warrants while implied volatility was computed using publicly traded options of Cytori as well as Cytori’s peer companies. We believe this method produces an estimate that is representative of our expectations of future volatility over the expected term of these warrants. We currently have no reason to believe future volatility over the expected remaining life of these warrants is likely to differ materially from historical volatility. The expected life is based on the remaining contractual term of the warrants. The risk-free interest rate is the U.S. Treasury bond rate as of the valuation date. The fair value of these warrants also incorporates our assumptions about future equity issuances and their impact to the down-round protection feature.

Fluctuations in the fair value of the warrants are impacted by unobservable inputs, most significantly the assumption with regards to future equity issuances and its impact to the down-round protection feature. Significant increases (decreases) in this input in isolation would result in a significantly higher (lower) fair value measurement.

The following table summarizes the change in our Level 3 warrant liability value:

	Nine months ended
Warrant liability	September 30, 2015

Beginning balance	$	9,793,000
Issuance of warrants		15,979,000
Exercised warrants		(8,257,000	)
Change in fair value		(4,988,000	)
Ending balance	$	12,527,000

The main drivers for the change in the fair value of warrants at September 30, 2015, were issuance of new warrants, exercise of issued warrants and changes in our stock price, as compared to the stock price at December 31, 2014.