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Stockholders' Equity
 6 Months Ended
Jun. 30, 2011
Stockholders' Equity
5.     Stockholders’ Equity

On February 18, 2011, the Company entered into an Amended and Restated Agreement (“Amended Agreement”) with Fletcher for the purpose of modifying the terms of an agreement (“Original Agreement”) previously entered into between the Company and Fletcher on December 31, 2010.

Under the Original Agreement, Fletcher purchased $4,000,000 of the Company’s common stock (756,287 shares) at a price of approximately $5.29 per share on December 31, 2010 (the “Initial Investment”). In conjunction with the Initial Investment, Fletcher received a warrant (the “Initial Warrant”) to purchase up to $4,000,000 of the Company’s common stock at a price of approximately $5.29 per share at any time until December 31, 2019, subject to adjustment as set forth in the Initial Warrant.  Under the Original Agreement, Fletcher also received the right to make additional equity investments of up to $4,000,000 in total (the “Later Investments”) by May 2, 2011 at the average of the daily volume-weighted price of the Company’s common stock in the calendar month preceding each Later Investment notice date at prices no lower than approximately $4.76 per share and no greater than approximately $6.35 per share, subject to adjustment as set forth in the Original Agreement.    The warrants issued to Fletcher have down-round and anti-dilution provisions as of December 31, 2010, and are considered derivative liabilities recorded at fair value. The down-round provisions result in the number of shares to be issued determined on a variable that is not an input to the fair value of a “fixed-for-fixed” option.  Under the Original Agreement, Fletcher also received a second warrant (the “Second Warrant”) to purchase shares of the Company’s common stock with an aggregate purchase price of up to the total dollar amount of the Later Investments at a per-share exercise price of 120% of the per-share price paid in the final Later Investment to occur, subject to adjustment as set forth in the Second Warrant.   The Initial Warrant and the Second Warrant each also have a cashless exercise provision.

Under the Amended Agreement, the purchase price for the Initial Investment made on December 31, 2010 was increased to $5.38 per share, increasing the aggregate purchase price paid by Fletcher for the Initial Investment from $4,000,000 to $4,068,825. The Initial Warrant received by Fletcher was amended and reissued (the “Amended Initial Warrant”) entitling Fletcher to purchase newly-issued shares of common stock at $5.38 per share (the “Warrant Price”) at any time until February 18, 2020 (the “Warrant Term”), up to an aggregate purchase price of $4,300,000 (the “Warrant Amount”). Under the Amended Agreement, Fletcher also received the right to make an additional equity investments (“Later Investments”) of up to $4,068,000 (the “Aggregate Later Investment Amount”) provided notice is given to the Company prior to July 2, 2011 of Fletcher’s intention to make the Later Investment.   Fletcher did not make the Later Investment. The Second Warrant received by Fletcher was amended (the “Amended Second Warrant”, and together with the Amended Initial Warrant, the “Warrants”) to fix the Warrant Price at $5.38 per share. The Second Warrant entitles Fletcher to purchase newly-issued shares of common stock up to the aggregate purchase price of the Later Investments. The Amended Initial Warrant and the Amended Second Warrant each have a cashless exercise provision.

In connection with the Amended Agreement, the Company filed a registration statement with the Securities and Exchange Commission (“SEC”) covering the Initial Investment of 756,287 shares and 799,256 shares underlying the Initial Warrant.  The registration statement was declared effective on April 13, 2011.
 
 On March 14, 2011, the Company and Fletcher executed further amendments to the Amended and Restated Agreement and Warrants addressing stockholder approval and pricing provisions relating to Change of Control (as defined therein). The March 14, 2011 amendments were executed by the Company and Fletcher in response to an NYSE Amex inquiry, and were required to solidify NYSE Amex approval of the Company’s additional listing applications, which approval was received from NYSE Amex on March 15, 2011.
 
Certain events, such as dividends, stock splits, and other events specified in the Amended Agreement and in the Warrants may result in additional shares of Common Stock being issued to Fletcher, adjustments being made to the terms of the Later Investments, the Initial Warrant or the Second Warrant, or other results, in each case as set forth in the Amended Agreement, the Amended Initial Warrant and the Amended Second Warrant.   The terms of the Amended Agreement granted Fletcher certain participation rights in certain later equity issuances by the Company  (except for certain exclusions) and certain other rights upon a change of control, in each case as set forth in the Amended Agreement, the Amended Initial Warrant and the Amended Second Warrant.
 
Proceeds from the transaction were used primarily for sales and marketing, product development, and working capital. The Company paid WM Smith & Co., as placement agent, a cash placement fee of 6% of all cash investments received under the Amended Agreement, or in the case of the cashless exercise of the Warrants, common stock equal to 6% of the shares issued to Fletcher in conjunction with the cashless exercise.   During the first quarter of  2011, the Company paid $240,000 in accrued placement agent fees.
 
Derivative Liability -The financial instruments issued to Fletcher had down-round and anti-dilution provisions as of December 31, 2010, which were considered a derivative liability recorded at fair value. The down-round provisions result in the number of shares to be issued determined on a variable that is not an input to the fair value of a “fixed-for-fixed” option. The Company recognized the derivative liability at the fair value at inception.  The derivative liability was considered a Level 3 liability on the fair value hierarchy as the determination of fair value includes various assumptions about the Company’s future activities and the Company’s stock prices and historical volatility as inputs. To determine the fair value of the various components of the Fletcher investments, the Company selected the binomial option model and the Monte Carlo Simulation to model the financial characteristics of the various components.   The derivative liability was initially recorded in the consolidated balance sheet upon issuance as of December 31, 2010 at a fair value of $3,866,836.   On February 18, 2011 the Company entered into certain amendments with Fletcher for the purpose of modifying the terms of the previous agreement entered into between the Company and Fletcher on December 31, 2010.  As a result of the amendments, the down-round and anti-dilution provisions were eliminated; therefore, the Company determined that the derivative liability that existed under the terms of the original agreement no longer existed.  As a result, the Company determined the fair value of the derivative liability instrument as of the modification date of February 18, 2011 and recorded the change in fair value of the derivative liability since December 31, 2010 amounting to $360,922 which is reflected in the statement of operations.   With the elimination of the derivative liability provision, the Company reclassed the fair value of the financial instruments amounting to $3,505,914 from derivative liability to additional paid in capital.

The table below provides a reconciliation of the beginning and ending balances for the derivative liability measured at fair value using significant unobservable inputs (Level 3). There were no assets as of or during the period ended June 30, 2011 measured using significant unobservable inputs.

Fair Value Measurements Using Significant Unobservable Inputs (Level 3):
 
   
Derivative
Liability
  
       
Balance, January 1, 2011
  
$
3,866,836
  
Fair
        
Change in fair value
    
(360,922)
  
Reclass to equity on date of amendment that eliminated derivative liabilities to net proceeds
    
(3,505,914)
  
Balance, June 30, 2011
  
$
-
  
 
Restricted Stock– In May 2011, the Company issued an aggregate of 82,352 restricted shares of the Company’s common stock, pursuant to the Company’s 2004 Employee Stock Option Plan, as amended, valued at $3.33 per share to the owners of ExtraDev, which the Company acquired.  Such restricted stock vests in equal installments annually over four years.  The restricted stock granted to the owners of ExtraDev was classified as consideration for the acquisition of ExtraDev at a fair value of approximately $274,000, which upon termination any unvested restricted stock shall immediately vest.  In addition, as of June 30, 2011, there are 45,000 restricted shares that will vest only upon the occurrence of certain events prior to May 3, 2012, which include, among other things a change of control of the Company or other merger or acquisition of the Company, the achievement of certain financial goals, including among other things a successful result of the Company’s patent infringement lawsuit against the European Central Bank.   These 45,000 shares, if vested, would result in the recording of stock based compensation expense of approximately $563,000, the grant date fair value, over the period beginning when any of the contingent vesting events is deemed to be probable over the expected requisite service period.  As of June 30, 2011, vesting is not considered probable and no compensation expense has been recognized related to the performance grants.
 
Stock Options – The Company records stock-based payment expense related to these options based on the grant date fair value in accordance with FASB ASC 718.     During the six months ended June 30, 2011, the Company issued an aggregate of 172,648 options to purchase its common shares at an exercise prices ranging from $3.33 to $5.52 per share to employees and non-employee directors.   The fair value of these options amounted to approximately $285,000 determined by utilizing the Black Scholes option pricing model of the options issued.  Of the options issued in May 2011, the Company issued five-year options to purchase an aggregate of 77,648 shares of the Company’s common stock, pursuant to the Company’s 2004 Employee Stock Option Plan, as amended, at an exercise price of $3.33 per share, to the owners of ExtraDev.  Such options vest in equal installments annually over four years.  The fair value of these options amounted to approximately $121,000 determined by utilizing the Black Scholes option pricing model.  Additionally, pursuant to the employment agreements with the previous owners of ExtraDev, the Company awarded earn-out options to purchase an aggregate of 450,000 shares of common stock at an exercise price of $4.50 per share that will be granted if Digital achieves certain annual revenue targets by the end of fiscal year 2016.  If the annual revenue targets are met or are deemed probable to occur, then the Company will record stock based compensation expense at the then current fair value.  As of June 30, 2011 vesting is considered remote.  All options granted to the owners of ExtraDev were classified as compensation for post combination services since the vesting of each grant is based on the length of employment, with all unvested option forfeiting upon termination of employment. Therefore, the fair value of these equity instruments was not considered a component of the purchase price of the acquisition.
 
Stock-Based Compensation - Stock-based compensation includes expense charges for all stock-based awards to employees, directors and consultants. Such awards include option grants, warrant grants, and restricted stock awards.   During the six months ended June 30, 2011, the Company had stock compensation expense of approximately $202,000 ($0.01 per share) ($205,000- 2010; $0.01 per share).

            As of June 30, 2011, there was approximately $449,000 of total unrecognized compensation costs (excluding the $563,000 that vest upon the occurrence of certain events) related to non-vested options and restricted stock granted under the Company’s stock option plans which the Company expects to vest over a period of not to exceed five years.