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FAIR VALUES OF FINANCIAL INSTRUMENTS
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Sep. 30, 2014
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| Note 3 - FAIR VALUES OF FINANCIAL INSTRUMENTS | The Company measures certain financial liabilities (warrant liability, forward contract liability and derivative liabilities) at fair value on a recurring basis. The Company follows a fair value hierarchy that prioritizes the inputs to valuation techniques used to measure fair value. The hierarchy gives the highest priority to unadjusted quoted prices in active markets for identical assets and liabilities (Level 1) and the lowest priority to measurements involving significant unobservable inputs (Level 3). The three levels of the fair value hierarchy are as follows:
Level 1 Measurements are quoted prices (unadjusted) in active markets for identical assets or liabilities that the company has the ability to access at the measurement date.
Level 2 Measurements are inputs other than quoted prices included in Level 1 that are observable either directly or indirectly.
Level 3 Measurements are unobservable inputs.
Management believes that the carrying amounts of the Company’s financial instruments, consisting primarily of cash, accounts receivable, accounts payable and accrued expenses approximated their fair values at September 30, 2014 and December 31, 2013, due to their short-term nature.
Management also believes that the September 30, 2014 and December 31, 2013 interest rates associated with the notes payable approximates the market interest rates for these types of debt instruments and as such, the carrying amount of the notes payable approximates their fair value.
Common Stock Warrant Liability
The Company accounts for its common stock warrants under ASC 480, “Distinguishing Liabilities from Equity,” which requires any financial instrument, other than an outstanding share, that, at inception, embodies an obligation to repurchase the issuer’s equity shares, or is indexed to such an obligation, and it requires or may require the issuer to settle the obligation by transferring assets, would qualify for classification as a liability. The guidance required the Company’s outstanding warrants from private placements to be classified as liabilities and to be fair valued at each reporting period, with the changes in fair value recognized as a change in fair value of warranty liability in the Company’s consolidated statements of operations. Specifically, the warrants issued in connection with private placements grant the warrant holder certain anti-dilution protection providing exercise price adjustments in the event that any common stock or common stock equivalents are issued at an effective price per share that is less than the exercise price per share. Upon exercise or expiration of the warrants, the fair value of the warrant at that time will be reclassified to equity from a liability. The following table is a summary of the warrant liability activity measured at fair value using Level 3 inputs:
Forward contracts
As part of our 2013 private placement of common stock, the Company also agreed that the 38,462 shares of common stock included in the units are subject to increase and the $0.65 per share value is subject to decrease, in each case based on the level of the Company’s consolidated net revenues derived during our 2013 fiscal year (the “Make-Whole Adjustments”) (see Note 6 Common Stock for further details). The Company separately valued the forward contracts using Level 3 inputs. The fair value of the forward contracts of $115,767 was recorded as a liability and is included in accounts payable and accrued expenses on the Consolidated Balance Sheet as of December 31, 2013. The following table is a summary of the forward contract liability activity measured at fair value using Level 3 inputs:
Derivative Liability
The derivative liability relates to the conversion feature into common stock at an initial rate of 2,000 common shares for each share of Series D Preferred Stock, subject to adjustment for certain anti-dilution protection and provides exercise price adjustments in the event that any common stock or common stock equivalents are issued at an effective price per share that is less than the exercise price per share (see Note 5 Redeemable Convertible Preferred Stock for further details). Management analyzed the terms of the conversion option and concluded that the conversion feature was derivative since it met the definition of a derivative and did not qualify for any of the exceptions. The Company therefore separately valued the derivative contracts using Level 3 inputs. The fair value of the derivatives was recorded as a derivative liability on the Consolidated Balance Sheet as of September 30, 2014 and December 31, 2013. The following table is a summary of the derivative liability activity measured at fair value using Level 3 inputs:
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