Financing

3 Months Ended

Mar. 31, 2013

Derivative Instruments and Hedging Activities Disclosure [Abstract]

Derivative Instruments and Hedging Activities Disclosure [Text Block]

Note 3 – Financing

At March 31, 2013, financial instruments arising from our financing transactions with YA Global, an accredited investor, included shares of our Series C preferred stock issued in February 2006, Series D preferred stock issued in January 2010, a series of thirty-three secured convertible debentures issued between August 2006 and July 2012 and various warrants to purchase shares of our common stock. All of our assets are pledged to secure our obligations under the debt securities. At various times, YA Global has assigned or distributed portions of its holdings of these securities to other holders, including persons who are officers of YA Global and its related entities, as well as to other holders who are investors in YA Global’s funds.

Secured Debentures - The underlying agreements for each of the thirty-three debentures are very similar in form, except in regard to the interest rate, conversion prices, and the number of warrants that were issued in conjunction with each of the debentures. The debentures are convertible into our common stock, at the option of the holder, at the lower of a fixed conversion price per share or a percentage of the lowest volume-weighted average price (“VWAP”) for a specified number of days prior to the conversion (the “look-back period”). The conversion is limited such that the holder cannot exceed 9.99% ownership of the outstanding common stock, unless the holder waives their right to such limitation. All of the debentures are secured according to the terms of a Security Pledge Agreement dated August 23, 2006, which was entered into in connection with the first convertible debenture issued to YA Global and which provides YA Global with a security interest in substantially all of our assets. The debentures are also secured by a Patent Security Agreement dated July 29, 2008. On August 13, 2010, our wholly owned subsidiary, NeoMedia Europe GmbH, became a guarantor of all outstanding financing transactions between us and YA Global, through pledges of their intellectual property and other movable assets. As security for our obligations to YA Global, all of our Pledged Property, Patent Collateral and other collateral is affirmed through the several successive Ratification Agreements (as such terms are defined therein) which have been executed in connection with each of the 2010, 2011 and 2012 financings.

All debentures with YA Global contain provisions for acceleration of principal and interest upon default. Certain debentures also contain default interest rates and conversion prices, as reflected in the table below.

We evaluated the financing transactions in accordance with FASB ASC 815, Derivatives and Hedging, and determined that the conversion features of the Series C and Series D preferred stock and the Debentures were not afforded the exemption for conventional convertible instruments due to their variable conversion rates. The contracts have no explicit limit on the number of shares issuable so they did not meet the conditions set forth in current accounting standards for equity classification. Accordingly, either the embedded derivative instruments, including the conversion option, must be bifurcated and accounted for as derivative instrument liabilities or, as permitted by FASB ASC 815-15-25-4, Recognition of Embedded Derivatives, the instruments may be carried in their entirety at fair value.

At inception, we elected to bifurcate the embedded derivatives related to the Series C and Series D preferred stock and certain debentures, while electing the fair value option for the March 2007, August 2007, April 2008, May 2008 and April 2012 Debentures. FASB ASC 825, Financial Instruments, allows us to elect the fair value option for recording financial instruments when they are initially recognized or if there is an event that requires re-measurement of the instruments at fair value, such as a significant modification of the debt.

On May 25, 2012, the terms of the debentures held by YA Global were modified to extend the stated maturity dates to August 1, 2013 and reduce the interest rates to 9.5% per year, with interest being payable on the maturity date in cash or, provided certain equity conditions are satisfied, in shares of our Common Stock at the applicable conversion price. Because the effect of the modifications exceeded a significance threshold relative to cash flows prescribed by ASC 470-50, Debt Modifications and Extinguishments, the modifications of the amounts due under these arrangements were accounted for as extinguishments, whereby the existing debentures are considered to be retired and new debentures issued. The existing instruments were first adjusted to fair value as of May 25, 2012 using the interest rate and maturity date prior to the amendment. The fair value of the new instruments was then calculated using the modified interest rate and maturity date to determine the fair value of the instrument subsequent to the amendment. The differences in the fair values before and after the amendment were recorded as an extinguishment loss of approximately $27.5 million in the statements of operations for the three and six months ended June 30, 2012.

As of the date of the May 25, 2012 modification, we have elected to carry all modified debentures at the fair value of the hybrid instrument with changes in the fair value of the debentures charged or credited to income each period.

On February 4, 2013, we entered into a Debenture Extension Agreement with YA Global to extend the maturity dates of the secured convertible debentures to August 1, 2014. Because the effect of the extension did not exceed a significance threshold relative to cash flows prescribed by ASC 470-50, Debt Modifications and Extinguishments, extinguishment accounting was not applicable.

The following table summarizes the significant terms of each of the debentures for which the entire hybrid instrument is recorded at fair value as of March 31, 2013:

							Conversion Price – Lower of Fixed Price or Percentage of VWAP for Look-back period
					Default				Anti-Dilution
Debenture		Face	Interest		Interest		Fixed		Adjusted				Default		Look-back
Issuance Year		Amount	Rate		Rate		Price		Price		%		%		Period
		(in thousands)
2006	$	5,974	9.5	%	n/a		$	2.00	$	0.00099	90	%	n/a		125 Days
2007		6,701	9.5	%	n/a		$	2.00			80%-90	%	n/a		125 Days
2008		6,468	9.5	%	20%-24	%	$	1.00-$2.00	$	0.00088-$0.00099	80%-95	%	50%-75	%	125 Days
2009		1,349	9.5	%	20	%	$	2.00	$	0.001045	95	%	50	%	125 Days
2010		3,806	9.5	%	20	%	$	0.10- $0.30	$	0.001045	95	%	50	%	60 Days
2011		1,705	9.5	%	20	%	$	0.10	$	0.001045	95	%	50	%	60 Days
2012		1,573	9.5	%	20	%	$	0.10	$	0.001045	95	%	50	%	60 Days
Total	$	27,576

For the portion of the debentures held by investors other than YA Global (which debentures were not modified on May 25, 2012) and for the Series C and Series D preferred stock, the election to carry the instruments at fair value in their entirety is not available. Accordingly, we continue to bifurcate the compound embedded derivatives related to the Series C and Series D preferred stock and these debentures and carry these financial instruments as liabilities in the accompanying balance sheet. Significant components of the compound embedded derivative include (i) the embedded conversion feature, (ii) down-round anti-dilution protection features and (iii) default, non-delivery and buy-in puts, all of which were combined into one compound instrument that is carried at fair value as a derivative liability. Changes in the fair value of the compound derivative liability are charged or credited to income each period.

The table below summarizes the significant terms of the debentures that are carried at their amortized cost and for which the compound embedded derivative is bifurcated and accounted for as a derivative liability as of March 31, 2013:

Conversion Price – Lower of Fixed Price or Percentage of VWAP for Look-back Period

Default

Anti-Dilution

Debenture

Face

Interest

Interest

Fixed

Adjusted

Look-back

Issuance Year

Amount

Rate

Rate

Price

Price

%

Period

(in thousands)

2006

$

53

10

%

n/a

$

2

0.00099

90

%

125 days

Conversions and Repayments–Our preferred stock and convertible debentures are convertible into shares of our common stock. Upon conversion of any of the convertible financial instruments in which the compound embedded derivative is bifurcated, the carrying amount of the debt, including any unamortized premium or discount, and the related derivative instrument liability are credited to the capital accounts upon conversion to reflect the stock issued and no gain or loss is recognized. For instruments that are recorded in their entirety at the fair value of the hybrid instrument, the fair value of the hybrid instrument converted is credited to the capital accounts upon conversion to reflect the stock issued and no gain or loss is recognized.

The following table provides a summary of the preferred stock conversions that have occurred since inception and the number of common shares issued upon conversion.

	Preferred		Preferred		Preferred		Common
	shares		shares		shares		shares
	issued		converted		remaining		issued
	(in thousands)
Series C preferred stock		22		17		5		273,382
Series D preferred stock		25		22		10		245,162

The outstanding principal and accrued interest for the debentures as of March 31, 2013 is reflected in the following table in addition to the principal and interest converted since inception and the number of common shares issued upon conversion.

	Outstanding		Principal and
	principal and		accrued interest		Common
	accrued interest at		converted since		Shares
	March 31, 2013		inception		Issued
	(in thousands)
Debentures		$40,762		$11,069		2,804,842

Warrants - YA Global holds warrants to purchase shares of our common stock that were issued in connection with the convertible debentures and the Series C and Series D preferred stock. The warrants are exercisable at a fixed exercise price which, from time to time, has been reduced due to anti-dilution provisions when the Company has entered into subsequent financing arrangements with a lower price. The exercise prices may be reset again in the future if we subsequently issue stock or enter into a financing arrangement with a lower price. In addition, upon each adjustment in the exercise price, the number of warrant shares issuable is adjusted to the number of shares determined by multiplying the warrant exercise price in effect prior to the adjustment by the number of warrant shares issuable prior to the adjustment divided by the warrant exercise price resulting from the adjustment.

The warrants issued to YA Global do not meet all of the established criteria for equity classification in FASB ASC 815-40, Derivatives and Hedging – Contracts in Entity’s Own Equity, and accordingly, are recorded as derivative liabilities at fair value. Changes in the fair value of the warrants are charged or credited to income each period.

Effective February 1, 2013, 1.4 billion of the 1.9 billion warrants held by YA Global were cancelled and the remaining 500 million had their exercise price reduced to $0.0001 per share. These changes resulted in a decrease in fair value of the warrants of approximately $1.64 million as reflected in the gain/(loss) from change in fair value of derivative liability-warrants.

 Fair value disclosures

Bifurcated Embedded Derivative Instruments – Series C and Series D preferred stock and Convertible Debentures held by investors other than YA Global - For financings in which the embedded derivative instruments are bifurcated and recorded separately, the compound embedded derivative instruments are valued using a Monte Carlo Simulation methodology because that model embodies certain relevant assumptions (including, but not limited to, interest rate risk, credit risk, and conversion/redemption privileges) that are necessary to value these complex derivatives.

The conversion price in each of the convertible debentures is subject to adjustment for down-round, anti-dilution protection. Accordingly, if we sell common stock or common share indexed financial instruments below the stated or variable conversion price of the debenture, the conversion price adjusts to that lower amount.

The assumptions included in the calculations are highly subjective and subject to interpretation. Assumptions used as of March 31, 2013 included exercise estimates/behaviors and the following other significant estimates: (i) Preferred Stock: remaining term of 1.34 years, equivalent volatility of 127%, equivalent interest rate of 8%, equivalent credit-risk adjusted rate of 6.6% and anti-dilution adjusted conversion price of $0.0010670, (ii) Convertible Debentures: Anti-dilution adjusted conversion price of $0.001045. Equivalent amounts reflect the net results of multiple modeling simulations that the Monte Carlo Simulation methodology applies to underlying assumptions.

Due to the variability of the conversion prices, fluctuations in the trading market price of our common stock may result in significant variations to the calculated conversion price. For each debenture, we analyze the ratio of the conversion price (as calculated based on the percentage of VWAP for the appropriate look-back period) to the trading market price for a period of time equal to the term of the debenture to determine the average ratio for the term of the note. Each quarter, the ratio in effect on the date of the valuation is compared with the average ratio over the term of the debenture to determine if the calculated conversion price is representative of past trends or if it is considered unrepresentative due to a large fluctuation in the Common Stock price over a short period of time. If the calculated conversion price results in a ratio that deviates significantly from the average ratio over the term of the agreement, the average ratio of the conversion price to the trading market price is then multiplied by the current trading market price to determine the variable conversion price for use in the fair value calculations. This variable conversion price is then compared with the fixed conversion price and, as required by the terms of the debentures, the lower of the two amounts is used as the conversion price in the Monte Carlo Simulation model used for valuation purposes. On March 31, 2013, the fixed conversion price for each of the debentures was equal to or higher than the calculated variable conversion price. Accordingly, the variable conversion price was used in the Monte Carlo Simulation model. This analysis is performed each quarter to determine if the calculated conversion price is reasonable for purposes of determining the fair value of the embedded conversion features (for instruments recorded under FASB ASC 815-15-25-1) or the fair value of the hybrid instrument (for instruments recorded under FASB ASC 815-15-25-4).

The following tables reflects the face value of the instruments, their amortized carrying value and the fair value of the separately-recognized compound embedded derivative, as well the number of common shares into which the instruments are convertible as of March 31, 2013 and December 31, 2012.

March 31, 2013							Embedded		Common
	Face		Carrying		Accrued		Conversion		Stock
	Value		Value		Interest		Feature		Shares
	(in thousands)
Series C preferred stock	$	4,840	$	4,840		0	$	2,277		4,535,769
Series D preferred stock	$	348	$	348		0		164		326,242
Debentures:
2006	$	53	$	53	$	7		5		60,917
Total	$	53	$	53	$	7	$	2,446		4,922,928

December 31, 2012							Embedded		Common
	Face		Carrying		Accrued		Conversion		Stock
	Value		Value		Interest		Feature		Shares
	(in thousands)
Series C preferred stock	$	4,840	$	4,804	$	-	$	1,988		923,953
Series D preferred stock	$	348	$	348	$	-		143		66,457
Debentures:
2006	$	53	$	53	$	7		16		11,871
Total	$	53	$	53	$	7	$	16		1,002,281

The terms of the embedded conversion features in the convertible instruments presented above provide for variable conversion rates that are indexed to our quoted common stock price. As a result, the number of indexed shares is subject to continuous fluctuation. For presentation purposes, the number of shares of common stock into which the embedded conversion feature of the Series C and Series D preferred stock was convertible as of March 31, 2013 and December 31, 2012 was calculated as face value plus assumed dividends (if declared), divided by the lesser of the fixed rate or the calculated variable conversion price using the 125 day look-back period. The number of shares of common stock into which the embedded conversion feature in the convertible debentures was convertible as of March 31, 2013 and December 31, 2012 was calculated as the face value of each instrument divided by the variable conversion price using the appropriate look-back period.

As discussed above, on February 4, 2013, the terms of the debentures held by YA Global were modified to extend the stated maturity dates to August 1, 2014 and those debentures are accounted for as hybrid instruments and are carried in their entirety at fair value. The debentures outstanding at March 31, 2013 of $53,000 shown above represent a portion of the debentures issued to YA Global which had previously been transferred by YA Global to other parties. These debentures were not modified and continued to mature on July 29, 2012. At March 31, 2013 the debentures had not yet been converted or repaid.

Changes in the fair value of derivative instrument liabilities related to the bifurcated embedded derivative features of convertible instruments not carried at fair value are reported as “Gain (loss) from change in fair value of derivative liability – Series C and Series D preferred stock and debentures” in the accompanying consolidated statements of operations.

	Three months ended March 31,
	2013			2012
	(in thousands)
Series C preferred stock	$	(289	)	$	(15,117	)
Series D preferred stock		(21	)		(3,292	)
Debentures:
2006		11			(21,885	)
2008		-			(14,741	)
2009		-			(5,450	)
2010		-			(11,935	)
2011		-			(13,721	)
2012		-			(3,508	)
Gain (loss) from change in fair value of derivative liability	$	(299	)	$	(89,649	)

Hybrid Financial Instruments Carried at Fair Value – Since inception, the March 2007, August 2007, April 2008, May 2008 and April 2012 convertible debentures have been recorded in their entirety at fair value as hybrid instruments in accordance with FASB ASC 815-15-25-4 with subsequent changes in fair value charged or credited to income each period. As of May 25, 2012, we elected the fair value option for all other convertible debentures held by YA Global upon a re-measurement date that was triggered by significant modifications of the financial instruments.

Because these debentures are carried in their entirety at fair value, the value of the embedded conversion feature is embodied in those fair values. At inception, the March 2007, August 2007, April 2008 and May 2008 debentures were valued using the common stock equivalent approach. For the April 26, 2012 debenture and, effective May 25, 2012 for all other debentures, the Company changed its method of estimating the fair value of the hybrid instrument to consider the present value of the cash flows of the instrument, using a risk-adjusted interest rate, enhanced by the value of the conversion option, valued using a Monte Carlo model. This method was considered by our management to be the most appropriate method of encompassing the credit risk and exercise behavior that a market participant would consider when valuing the hybrid financial instrument. Inputs used to value the hybrid instruments as of March 31, 2013 included: (i) present value of future cash flows for the debenture using a risk adjusted interest rate of 6.64%, (ii) remaining term of 1.34 years, (iii) equivalent volatility of 126%, equivalent interest rate of 9.5%, equivalent credit-risk adjusted rate of 6.64% and anti-dilution adjusted conversion prices ranging from $0.000880- $0.001045.

The following table reflects the face value of the financial instruments, the fair value of the hybrid financial instrument and the number of common shares into which the instruments are convertible as of March 31, 2013 and December 31, 2012.

					Common
March 31, 2013	Face		Fair		Stock
	Value		Value		Shares
	(in thousands)
Debentures:
2006	$	5,974	$	11,852		8,962,027
2007		6,701		14,654		11,184,898
2008		6,468		13,835		10,600,859
2009		1,349		2,833		2,114,786
2010		3,806		6,553		4,949,323
2011		1,705		2,379		1,404,486
2012		1,573		2,297		1,545,805
Total	$	27,576	$	54,403		40,762,184

					Common
December 31, 2012	Face		Fair		Stock
	Value		Value		Shares
	(in thousands)
Debentures:
2006	$	6,180	$	14,758		5,196,283
2007		6,856		17,172		6,098,480
2008		6,468		15,492		5,487,497
2009		1,644		3,565		1,243,390
2010		3,806		7,178		2,512,724
2011		1,954		3,080		1,084,237
2012		1,979		3,047		1,073,527
Total	$	28,887	$	64,292		22,696,138

Changes in the fair value of convertible instruments that are carried in their entirety at fair value are reported as “Gain (loss) from change in fair value of hybrid financial instruments” in the accompanying consolidated statements of operations. The changes in fair value of these hybrid financial instruments were as follows:

	Three months ended March 31,
	2013			2012
	(in thousands)
2006	$	1,887		$	-
2007		2,329			(25,057	)
2008		1,657			-6,113
2009		(74	)		-
2010		623			-
2011		249			-
2012		103			-
Gain (loss) from changes in fair value of hybrid instruments	$	6,774		$	(31,170	)

Warrants - The following table summarizes the warrants outstanding, their fair value and their exercise price after adjustment for anti-dilution provisions:

			March 31, 2013						December 31, 2012
			Anti-Dilution						Anti-Dilution
			Adjusted						Adjusted
	Expiration		Exercise				Fair		Exercise				Fair
	Year		Price		Warrants		Value		Price		Warrants		Value
Warrants issued with preferred stock:					(in thousands)						(in thousands)
Series D preferred stock		2017		0.000100		87,368	$	101		0.00684		328,947	$	709
Warrants issued with debentures:
2008		2015		0.000100		238,079		267		0.00684		896,382		1,691
2010		2015		0.000100		81,350		91		0.00684		306,287		571
2011		2016		0.000100		58,246		66		0.00684		219,298		453
2012		2017		0.000100		34,947		40		0.00684		131,579		263
Total						499,990	$	565				1,882,493	$	3,687

The warrants are valued using a binomial lattice option valuation methodology because that model embodies all of the significant relevant assumptions that address the features underlying these instruments. Significant assumptions used in this model as of March 31, 2013 included an expected life equal to the remaining term of the warrants, an expected dividend yield of zero, estimated volatility ranging from 47% to 176%, and risk-free rates of return of 0.07% to 0.77%. For the risk-free rates of return, we use the published yields on zero-coupon treasury securities with maturities consistent with the remaining term of the warrants and volatility is based upon our expected common stock price volatility over the remaining term of the warrants. As a result of the repricing on February 1, 2013, the exercise price of the warrants is currently $.0001. The anti-dilution provisions are still applicable so in the future the fixed exercise price of the warrants may be reset to equal to the lowest price of any subsequently issued common share indexed instruments with a conversion price below the current exercise price of the warrant.

Changes in the fair value of the warrants are reported as "(Gain) loss from change in fair value of derivative liability - warrants" in the accompanying consolidated statement of operations. The changes in the fair value of the warrants were as follows:

:

	Three months ended March 31,
	2013		2012
Warrants issued with preferred stock:	(in thousands)
Series D preferred stock		608		(6,871	)
Warrants issued with debentures:
2007		-		(3,337	)
2008		1,424		(18,543	)
2010		480		(6,342	)
2011		387		(4,577	)
2012		223		(1,818	)
Total	$	3,122	$	(41,488	)

Reconciliation of changes in fair value – Assets and liabilities measured at fair value are classified in their entirety based on the lowest level of input that is significant to their fair value measurement. Our derivative financial instruments that are measured at fair value on a recurring basis are all measured at fair value using Level 3 inputs. Level 3 inputs are unobservable inputs that are supported by little or no market activity and that are significant to the fair value of the assets or liabilities.

The following represents a reconciliation of the changes in fair value of financial instruments measured at fair value using Level 3 inputs and changes in the fair value of hybrid instruments carried at fair value during the three months ended March 31, 2013:

	Compound
	Embedded		Warrant			Hybrid
	Derivatives		Derivatives			Instruments			Total
Beginning balance, December 31, 2012:	$	2,147	$	3,687		$	64,292		$	70,126
Fair value adjustments:
Compound embedded derivatives		299		-			-			299
Warrant derivatives		-		(3,122	)		-			(3,122	)
Hybrid instruments		-		-			(6,774	)		(6,774	)
Conversions:
August 24, 2006 financing		-		-			(516	)		(516	)
December 29, 2006 financing		-		-			(503	)		(503	)
March 27, 2007 financing		-		-			(190	)		(190	)
July 15, 2009 financing		-		-			(614	)		(614	)
August 14, 2009 financing		-		-			(192	)		(192	)
April 13, 2011 financing		-		-			(199	)		(199	)
October 25, 2011 financing		-		-			(37	)		(37	)
December 8, 2011 financing		-		-			(217	)		(217	)
March 26, 2012 financing		-		-			(141	)		(141	)
June 1, 2012 financing		-		-			(506	)		(506	)
Ending balance, March 31, 2013	$	2,446	$	565		$	54,403		$	57,414

Estimating fair values of derivative financial instruments requires the development of significant and subjective estimates that may, and are likely to, change over the duration of the instrument with related changes in internal and external market factors. In addition, valuation techniques are sensitive to changes in the trading market price of our common stock, which has a high estimated historical volatility. Because derivative financial instruments are initially and subsequently carried at fair values, our income will reflect the volatility in these estimate and assumption changes.

Subsequent events

Subsequent to March 31, 2013, holders of convertible debentures have converted $320,302of principal and accrued interest on those debentures into 654,690,200 shares of our common stock. In addition, one holder of our series C preferred shares converted their preferred shares into 41,237,113 shares of our common stock.