DERIVATIVE WARRANT LIABILITY

12 Months Ended

Dec. 31, 2012

Notes to Financial Statements

Note 7. DERIVATIVE WARRANT LIABILITY

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

At December 31, 2012 and 2011, the Company had outstanding warrants to purchase 12,540,040 and 7,527,529 shares of its common stock, respectively. Included in these outstanding warrants at December 31, 2012 and 2011 are warrants to purchase 7,360,153 and 725,142 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, 2012 and 2011 was approximately $5,585,000 and $1,035,000, 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 Gain (Loss) on Revaluation of Derivative Warrant Liability. The changes in the fair value of the derivative warrant liability for the years ended December 31, 2012, 2011 and 2010 resulted in a gain (loss) of approximately $3,684,000, $(1,763,000) and $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 2012 and 2011, warrants to purchase 1,419,470 shares of Common Stock were exercised in 2011 pursuant to a cashless exercise provision. No warrants were exercised in 2012 pursuant to a cashless exercise provision.

For the years ended December 31, 2012 and 2011, warrants with down round provisions to purchase 165,451 and 653,150 shares, respectively, were exercised and certain anti-dilution rights were waived (see Note 12) which resulted in a reclassification to additional paid-in capital in the amount of approximately $62,000 and $2,273,000, respectively.

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

	2012			2011
Liabilities:
Derivative warrant liability as of January 1	$	1,035,337		$	1,544,996
Warrants issued under Montaur credit facility		8,295,000			-
Total unrealized losses included in net loss (1)		500,000			2,191,147
Total realized losses included in net loss (1)		1,438			978,678
Total unrealized gains included in net loss (1)		(4,077,433	)		(1,377,261	)
Total realized gains included in net loss (1)		(107,681	)		(29,626	)
Reclassification of liability to additional paid-in capital for warrants		(61,520	)		(2,272,597	)
Derivative warrant liability as of December 31	$	5,585,141		$	1,035,337
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(1)Included in gain or loss on revaluation of derivative warrant liability in the Consolidated Statement of Operations.