4. Liability Attributable to Warrants

On June 17, 2013, we entered into, and subsequently consummated, an Exercise Agreement (the “Exercise Agreement”) with five of the largest investors in our September 1, 2011 private placement of common stock and warrants (the “2011 Transaction”), providing for the exercise for cash by such investors of warrants to purchase an aggregate 9 million shares of our common stock, out of the approximately 17 million shares of common stock subject to warrants issued to the investors in the 2011 Transaction that remained outstanding as of such date. The approximately 5 million shares of common stock subject to warrants issued to the placement agent in the 2011 Transaction that remained outstanding as of such date were not part of the Exercise Agreement. The Company agreed under the Exercise Agreement to subsequently commence a tender offer (the “Offer to Exercise”) to provide these holders of other warrants that remained outstanding from the 2011 Transaction with the same opportunity to exercise as provided under the Exercise Agreement (See Note 18).

The warrants exercised had a remaining term of approximately 38 months, and had an exercise price of $0.26 per warrant, which was the original exercise price. We received cash proceeds of $2.34 million as a result of the warrants exercised. In consideration for the early exercise of these warrants, we issued to the five investors an aggregate of 4.5 million warrants to purchase common stock at an exercise price of $1.00 per warrant, with a term of five years from issuance (the “New Warrants”). The New Warrants were issued on June 18, 2013, are substantially similar to the investor warrants that were exercised, and, after giving effect to the amendments to such warrants described below. Such warrants have been recorded as a component of equity (additional paid-in capital “APIC”) at Level 3 fair value. Using a binomial pricing model, we calculated the fair value of the New Warrants to be $514,800. We used the following assumptions in the binomial pricing model: estimated volatility - 185%; annualized forfeiture rate - 0%; expected term – 5 years; estimated exercise factor – 1.5, risk free interest rate – 1.07%; and dividends – 0. The New Warrants were accounted for as a cost of the exercise of the warrants issued pursuant to the Exercise Agreement, as a result, a $514,800 reduction of APIC was also recorded. Accordingly there was no net effect on equity because of the issuance of the new warrants.

Immediately prior to the exercise for cash, the five investors, who held a majority of the outstanding warrants issued in the 2011 Transaction to investors (Investor Warrants), agreed to amend the entire series of such warrants to delete the following provisions: (1) the price-based anti-dilution clause; (2) our right to lower the exercise price in our discretion; and (3) a clause that mandated that we buy the warrants for cash at their Black-Scholes value in the event of certain extraordinary transactions. By virtue of a majority-rule clause in the warrants, the elimination of these provisions from the investor warrants issued in the 2011 Transaction eliminated the warrant derivative liability classification related to all of the investor warrants issued in the 2011 Transaction including those held by investors who did not exercise their warrants at the date of the amendment. The table below shows the calculation of the reduction of the warrants derivative liability

The warrants issued to the placement agent and to an intellectual property consulting firm (ipCapital Group, Inc.) were not included in the Exercise Agreement or affected by the amendment described above. The exercise price of such warrants could, in certain circumstances, be reset to below-market value. Accordingly, unlike the amended investor warrants, we have concluded that the warrants issued to the placement agent and ipCapital Group, Inc. are not indexed to our common stock; therefore, the fair value of these warrants were, and continue to be, recorded as a liability.

Under ASC 820, “Fair Value Measurement,” we re-measure the fair value of the warrants classified as a liability at every balance sheet date. As an integral part of the re-measurement process, we reevaluate each of the assumptions used, and when circumstances change or we become aware of new information affecting any of our assumptions, we adjust those assumptions accordingly. During the three months ended March 31, 2013 two investors in the 2011 private placement exercised an aggregate 462,500 warrants. While closing our books for the three months ended March 31, 2013, we reevaluated our internal assumptions based on historic and recent exercise patterns and analysis of our stock performance. Based on the work performed, we concluded that a lowering of our estimated exercise factor for the warrants issued in conjunction with the 2011 transaction from 10 to 4 was appropriate (see the assumptions used, as set forth in the tables, below).

Changes in fair value of the warrants liability are recognized in other expense, except for changes in the fair value of the warrants issued to ipCapital which are recognized as a component of general and administrative expense in the condensed consolidated statement of operations.

We used the exercise price of the warrants, as well as the fair market value of our common stock, to determine the fair value of our warrants. The exercise price for warrants issued in conjunction with the 2011 Transaction, including those issued to the placement agent ranged between $0.20 and $0.26, per share, and was $0.26 per share for the warrants issued to ipCapital. The fair market value of our common stock was $0.36 and $0.15 per share as of June 30, 2013 and 2012, respectively.

We used a binomial pricing model to determine the fair value of our warrants liability as of June 30, 2013 and December 31, 2012, the balance sheet dates, using the following assumptions:

	2011 Transaction						ipCapital
	June 30, 2013			December 31, 2012			June 30, 2013			December 31, 2012
Estimated volatility		136	%		159	%		135	%		163	%
Annualized forfeiture rate		—			—			—			—
Expected option term (years)		3.17			3.67			3.29			3.79
Estimated exercise factor		4			10			4			10
Risk-free interest rate		0.72	%		0.45	%		0.77	%		0.65	%
Dividends		—			—			—			—

The following table is a reconciliation of the warrants liability measured at fair value using significant unobservable inputs (Level 3) for the six months ended June 30, 2013:

Warrants liability – December 31, 2012 fair value	$	7,390,100
Change in fair value of warrant liability recorded in other expenses		(1,319,200	)
Change in fair value of warrant liability recorded in general and administrative expense		(14,100	)
Reclassification of warrants liability to equity from exercise of warrants (1)		(348,300	)
Reclassification of warrants liability to equity from amendment to warrants (1)		(4,391,000	)
Warrants liability – June 30, 2013 fair value	$	1,317,500

(1)

During the six-month period ended June 30, 2013, in addition to the warrant amendment, we also reduced our warrants liability by $348,300 as a result of the exercise of 917,500 warrants during such period, prior to the amendment to the warrants. The aggregate reduction in the liability, combining the warrant amendment and this exercise, was $4,739,300. See Note 13.

The following table reconciles the number of warrants outstanding for the periods ended June 30, 2013 and 2012, respectively.

	For the Three-Month Period Ended June 30, 2013
	Beginning Outstanding		Issued		Exercised		Ending Outstanding
2011 Transaction		22,612,500		—		9,455,000		13,157,500
ipCapital		400,000		—		—		400,000
Exercise Agreement		—		4,500,000		—		4,500,000
Total		23,012,500		4,500,000		9,455,000		18,057,500

	For the Six-Month Period Ended June 30, 2013
	Beginning Outstanding		Issued		Exercised		Ending Outstanding
2011 Transaction		23,075,000		—		9,917,500		13,157,500
ipCapital		400,000		—		—		400,000
Exercise Agreement		—		4,500,000		—		4,500,000
Total		23,475,000		4,500,000		9,917,500		18,057,500

	For the Three and Six-Month Period Ended June 30, 2012
	Beginning Outstanding		Issued		Exercised		Ending Outstanding
2011 Transaction		23,075,000		—		—		23,075,000
ipCapital		400,000		—		—		400,000
Total		23,475,000		—		—		23,475,000