Note 5 - Convertible Notes

12 Months Ended

Dec. 31, 2014

5.	Convertible Notes

On September 4, 2013, the Company issued convertible promissory notes (“Convertible Notes”) with total aggregate proceeds of $4.3 million. The Convertible Notes accrued interest at 8% per annum and matured on or after March 31, 2014 upon written notice from a majority of the outstanding Convertible Note holders (the "Maturity Date").

In connection with the issuance of the Convertible Notes, the Company incurred $36,000 of financing costs which were recorded in other current assets. The Company also reimbursed the lenders $10,000 for financing costs which was recorded as a discount on the Convertible Notes. The Convertible Notes included various embedded conversion and redemption features as further described below. The Company recorded approximately $1.4 million as the fair value of the combined embedded derivative liability upon issuance on September 4, 2013, with a corresponding amount recorded as debt discount. The debt discount was amortized to interest expense over the life of the Convertible Notes. As of December 31, 2014 and 2013, the fair value of the combined embedded derivative liability was $0 and $1.4 million, respectively. Amounts recorded for issuance costs and embedded features were amortized to interest expense over the life of the Convertible Notes, approximately seven months. Changes in the estimated fair value of the embedded features was recorded in earnings in the period in which they occurred.

The Convertible Notes provided for conversion upon maturity at the holder's option and mandatory conversion upon a reverse acquisition. Both of these features provided for the conversion of the outstanding principal of the Convertible Notes, plus accrued interest into Series C Preferred Stock at $1.15 per share. In the event the Company issued or sold equity securities prior to the Maturity Date with aggregate proceeds of not less than $7.0 million, the Convertible Notes plus all accrued interest would automatically convert into either (i) the newly issued equity securities at 75% of the cash price per share paid by the investors in the new equity securities; or (ii) shares of Series C Preferred Stock at $1.15 per share. In accordance with ASC 815, the Company determined that this embedded mandatory conversion feature should be separately accounted for as a freestanding financial instrument as the conversion feature was a substantial contingent call option.

In the event the Company issued or sold equity securities prior to the Maturity Date with aggregate proceeds less than $7.0 million, the Convertible Notes plus all accrued interest could be converted at the option of the holders into the newly issued equity securities at 75% of the cash price per share paid by the investors in the new equity securities. In accordance with ASC 815, the Company determined that this embedded conversion feature should be separately accounted for as a freestanding financial instrument as the conversion feature was a substantial contingent call option.

In the event of a change in control of the Company prior to the Maturity Date, the Company had the option to prepay the Convertible Notes at 1.5 times principal, plus accrued interest. In accordance with ASC 815, the Company determined that this embedded redemption feature should be separately accounted for as a freestanding financial instrument as the conversion feature was a substantial contingent call option.

The Convertible Notes included a call feature, at the Company's option, whereby the Convertible Notes could be prepaid at 1.5 times principal, plus accrued interest. In accordance with ASC 815, the Company determined that this embedded redemption feature should be separately accounted for as a freestanding financial instrument.

The Convertible Notes included a put feature, at the option of the holders, whereby upon a breach of the Note Agreement, repayment of the Convertible Notes could be accelerated at 1.5 times principal, plus accrued interest. In accordance with ASC 815, the Company determined that this embedded redemption feature should be separately accounted for as a free-standing financial instrument. The Convertible Notes also included an additional put feature, at the option of the holders, whereby upon an event of default, the repayment of the Convertible Notes could be accelerated in the amount of the outstanding principal, plus accrued interest. In accordance with ASC 815, the Company determined that this embedded redemption feature did not require separate accounting as a freestanding financial instrument.

The embedded features requiring separate accounting were combined and valued upon issuance using a single income valuation approach. The Company estimated the fair value of the combined embedded derivative identified above using a "with and without" income valuation approach. Under this approach, the Company estimated the present value of the fixed interest rate debt based on the fair value of similar debt instruments excluding the embedded features. This amount was then compared to the fair value of the debt instrument including the embedded features using a probability weighted approach by assigning each embedded derivative feature a probability of occurrence, with consideration provided for the settlement amount including conversion discounts, prepayment penalties, the expected life of the liability and the applicable discount rate.

Upon issuance on September 4, 2013 and as of December 31, 2013, the Company ascribed a probability to the mandatory conversion feature upon a financing of not less than $7.0 million of 85% and 100%, respectively. As of September 4, 2013 and December 31, 2013 the Company ascribed a probability to the call feature upon a change in control of 15% and 0%, respectively. For all other features included in the combined embedded derivative, the Company estimated a 0% probability of occurrence as of September 4, 2013 and December 31, 2013. From December 31, 2013 to the conversion of the Convertible Notes into Series D Preferred Stock, as described below, the estimates of these probabilities did not change. The Company classified the liability within Level 3 of the fair value hierarchy as the probability factor is an unobservable input and significant to the valuation model.

On May 13, 2014, The Company received gross proceeds of approximately $25.0 million from the issuance of Series D Preferred Stock to new and existing investors at a price per share of $0.588656. In aggregate, 52,813,827 shares of Series D Preferred Stock were issued, including 10,344,201 shares for the conversion of $4.6 million of Convertible Notes and accrued interest at a conversion price of $0.4414 per share. In connection with the conversion of the debt, the compound embedded derivative liability, which had a fair value of $1.5 million, was written-off. There was no gain or loss recognized upon conversion of the Convertible Notes.

- Definition

The entire disclosure for information about short-term and long-term debt arrangements, which includes amounts of borrowings under each line of credit, note payable, commercial paper issue, bonds indenture, debenture issue, own-share lending arrangements and any other contractual agreement to repay funds, and about the underlying arrangements, rationale for a classification as long-term, including repayment terms, interest rates, collateral provided, restrictions on use of assets and activities, whether or not in compliance with debt covenants, and other matters important to users of the financial statements, such as the effects of refinancing and noncompliance with debt covenants.

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