DERIVATIVE WARRANT LIABILITY

12 Months Ended

Dec. 31, 2011

Notes to Financial Statements

Note 6. DERIVATIVE WARRANT LIABILITY

Derivative financial instruments are recognized as a liability on the consolidated balance sheet and measured at fair value.

At December 31, 2011 and 2010, the Company had outstanding warrants to purchase 7,527,529 and 10,336,292 shares of its common stock, respectively. Included in these outstanding warrants at December 31, 2011 and 2010 are warrants to purchase 725,142 and 1,356,289 shares, respectively, that are considered to be derivative instruments since the agreements contain “down round” provisions whereby the number of shares covered by the warrants is subject to change in the event of certain dilutive stock issuances. The fair value of these derivative instruments at December 31, 2011 and 2010 was approximately $1,035,000 and $1,545,000, respectively, and is included in Derivative Warrant Liability, a current liability. Changes in fair value of the derivative financial instruments are recognized currently in the Statements of Operations as a Derivatives Gain or Loss. The changes in the fair value of the derivative warrant liability in the years ended December 31, 2011 and 2010 resulted in a loss of approximately $1,763,000 and a gain of approximately $371,000, respectively.

The primary underlying risk exposure pertaining to the warrants is the change in fair value of the underlying common stock for each reporting period. Of the total warrants exercised in 2011 and 2010, warrants to purchase 1,419,470 and 143,793 shares of Common Stock, respectively, were exercised per a cashless exercise provision.

For the years ended December 31, 2011 and 2010, warrants with down round provisions to purchase 653,150 and 143,793 shares, respectively, were exercised and certain anti-dilution rights were waived (see Note 10) which resulted in a reclassification to additional paid-in capital in the amount of approximately $2,273,000 and $200,000, respectively.

The table below presents the changes in Level 3 derivative warrant liability measured at fair value on a recurring basis.

	2011			2010
Liabilities:
Derivative warrant liability as of January 1	$	1,544,996		$	2,116,696
Total unrealized losses included in net loss (1)		2,191,147			(369,984	)
Total realized losses included in net loss (1)		978,678			(2,096	)
Total unrealized gains included in net loss (1)		(1,377,261	)		-
Total realized gains included in net loss (1)		(29,626	)		737
Reclassification of derivative warrant liability to additional paid-in capital for derivative warrants exercised		(2,272,597	)		(200,357	)
Derivative warrant liability as of December 31	$	1,035,337		$	1,544,996
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(1) Included in derivative warrant liability gain or loss in the Consolidated Statement of Operations.