Note 4 - Liability Attributable to Warrants

9 Months Ended

Sep. 30, 2014

Warrants Liability [Abstract]

Warrants Liability [Text Block]

4. Liability Attributable to Warrants

On January 7, 2014, we entered into a securities purchase agreement (the “SPA”) with a limited number of institutional investors, pursuant to which we issued and sold for cash an aggregate 11,299,999 shares of our common stock at a purchase price of $0.30 per share (See Note 11) (the “2014 Transaction”). We also issued warrants to the investors for no additional consideration to purchase an aggregate 5,650,001 shares of our common stock at an exercise price of $0.40 per share from January 7, 2014 through January 7, 2019.

Under certain conditions of the SPA that will expire no later than January 7, 2015, we could be required to issue a variable number of additional warrants to the investors at a below-market value exercise price. Accordingly, we have concluded that the warrants issued to the investors are not indexed to our common stock; therefore, the fair value of these warrants has been recorded as a liability.

Using a binomial pricing model, we calculated the fair value of the warrants issued to the investors on January 7, 2014 to be $1,356,000. We used the following assumptions in the binomial pricing model to derive the fair value: estimated volatility 158%; annualized forfeiture rate 0%; expected term 5 years; estimated exercise factor 3.5; risk free interest rate 1.71; and dividends 0.

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 of 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.

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 that were issued on June 18, 2013, were 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 issued at the time of the Exercise Agreement 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 at 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 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.

On August 9, 2013, we conducted the Offer to Exercise under the terms of the Exercise Agreement entered into and in connection with the June 17, 2013 transaction. In connection with the Offer to Exercise, warrants to purchase an aggregate of 305,000 shares of our common stock were exercised for which we received cash proceeds of $64,000. In consideration for the early exercise of these warrants, we issued an aggregate of 152,500 New Warrants at an exercise price of $1.00 per warrant, with a term of five years from issuance.

Using a binomial pricing model, we calculated the fair value of the New Warrants issued at the end of the Offer to Exercise to be $45,600. We used the following assumptions in the binomial pricing model: estimated volatility 171%; annualized forfeiture rate 0%; expected term 4.875 years; estimated exercise factor 4, risk free interest rate 1.31%; 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 $45,600 reduction of APIC was also recorded. Accordingly, there was no net effect on equity because of the issuance of the new warrants.

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 of 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 income (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, was either $0.20 or $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 $0.12 and $0.54 per share as of September 30, 2014 and 2013, respectively.

We used a binomial pricing model to determine the fair value of our warrants liability at September 30, 2014 and December 31, 2013, using the following assumptions:

	Estimated Volatility			Annualized Forfeiture Rate		Expected Term (Years)		Estimated Exercise Factor		Risk-Free Interest Rate			Dividends
2011 Transaction
September 30, 2014		102	%		—		1.95		3.5		0.56	%		—
December 31, 2013		102	%		—		2.67		3.5		0.51	%		—
2014 Transaction
September 30, 2014		126	%		—		4.33		3.5		1.54	%		—
December 31, 2013		—			—		—		—		—			—
ipCapital
September 30, 2014		101	%		—		2.06		4.0		0.60	%		—
December 31, 2013		108	%		—		3.79		4.0		0.53	%		—

The following table is a reconciliation of the warrants liability measured at fair value using significant unobservable inputs (Level 3) for the nine months ended September 30, 2014:

Warrants liability – December 31, 2013 fair value	$	979,800
Change in fair value of warrant liability recorded in other income		(1,665,900	)
Change in fair value of warrant liability recorded in general and administrative expense		(67,000	)
Aggregate fair value of the warrants liability associated with the 2014 Transaction warrants at issuance		1,356,000
Warrants liability – September 30, 2014 fair value	$	602,900

The following tables reconcile the number of warrants outstanding for the periods indicated:

	For the Three-Month Period Ended September 30, 2014
	Beginning Outstanding		Issued		Exercised		Cancelled / Forfeited		Ending Outstanding
2011 Transaction		10,302,500		—		—		—		10,302,500
2014 Transaction		5,650,001		—		—		—		5,650,001
ipCapital		400,000		—		—		—		400,000
Exercise Agreement		4,500,000		—		—		—		4,500,000
Consultant Warrant (1)		169,273		—		—		—		169,273
Offer to Exercise		152,500		—		—		—		152,500
		21,174,274		—		—		—		21,174,274

	For the Nine-Month Period Ended September 30, 2014
	Beginning Outstanding		Issued		Exercised			Cancelled / Forfeited			Ending Outstanding
2011 Transaction		11,302,500		—		(1,000,000	)		—			10,302,500
2014 Transaction		—		5,650,001		—			—			5,650,001
ipCapital		400,000		—		—			—			400,000
Exercise Agreement		4,500,000		—		—			—			4,500,000
Consultant Warrant (1)		312,500		—		—			(143,227	)		169,273
Offer to Exercise		152,500		—		—			—			152,500
		16,667,500		5,650,001		(1,000,000	)		(143,227	)		21,174,274

(1) Effective April 11, 2014, we cancelled our consulting agreement with a former investor relations firm. Under the terms of the agreement, 169,273 of the warrants that had been issued to such firm had vested as of the effective cancellation date.

For the Three-Month Period Ended September 30, 2013
	Beginning Outstanding		Issued		Exercised		Ending Outstanding
2011 Transaction		13,157,500		—		305,000		12,852,500
2014 Transaction		---		---		---		---
Exercise Agreement		4,500,000		—		—		4,500,000
ipCapital		400,000		—		—		400,000
Consultant Warrant (1)		—		312,500		—		312,500
Offer to Exercise		—		152,500		—		152,500
Total		18,057,500		465,000		305,000		18,217,500

For the Nine-Month Period Ended September 30, 2013
	Beginning Outstanding		Issued		Exercised		Ending Outstanding
2011 Transaction		23,075,000		—		10,222,500		12,852,500
2014 Transaction		---		---		---		---
Exercise Agreement		—		4,500,000		—		4,500,000
ipCapital		400,000		—		—		400,000
Consulting Warrant (1)		—		312,500		—		312,500
Offer to Exercise		—		152,500		—		152,500
Total		23,475,000		4,965,000		10,222,500		18,217,500