DERIVATIVE WARRANT LIABILITY

9 Months Ended

Sep. 30, 2015

Derivative Instruments and Hedging Activities Disclosure [Abstract]

DERIVATIVE WARRANT LIABILITY

NOTE 6.   DERIVATIVE WARRANT LIABILITY

On January 21, 2014, in connection with a Securities Purchase Agreement (the “SPA”) the Company entered into with Full Circle Capital Corporation (“Full Circle”) (see Note 7), for $500,000 the Company issued to Full Circle, fully-vested warrants (“Series C Warrants”), which allow Full Circle to purchase up to 1,000,000 shares of the Company’s common stock at any time on or prior to January 21, 2017 at a price of $5.50 per share. As part of the $500,000 proceeds from the issuance of the Series C Warrants, $100,000 was retained by Full Circle to cover legal and deal related expenses of future financing transactions, which was recorded as deferred financing costs.  On September 24, 2014, the Company and Full Circle entered into Amendment No. 1 to the SPA, which changed the exercise price of the warrants issuable to $4.00 per share of the Company’s common stock, and increased the amount of warrants issuable to 1,400,000 warrants to purchase shares of the Company’s common stock.

The Series C Warrants have non-standard anti-dilution protection provisions and, under certain conditions, grant the right to the holder to require the Company to adjust the warrant’s exercise price to a lower price. Accordingly, these warrants were accounted for as derivative liabilities.

The Company used the binomial pricing model and assumptions that consider, among other factors, the fair value of the underlying stock, risk-free interest rate, volatility, expected life and dividend rates in estimating fair value for the warrants considered to be derivative instruments. The Company’s common stock has been thinly traded since being delisted in the first quarter of 2014, and all conversions of debt from the January 2014 Issuance during 2014 were converted using a stock price of $5.00 per share. Using the binomial pricing model and a stock price of $5.00 per share, management utilized initial scenario stock prices of $3.00, $4.00, $6.00, and $7.00.  Initially assuming a three-year expected term, management assessed the probabilities of the stock prices for each year, with probabilities more heavily weighted toward lower stock prices, in light of the Company’s delisted status, changes in leadership, and the Company’s current inability to execute its initial financing with Full Circle.

On January 21, 2014, the value of the initial warrant derivative liability was calculated to be $1,368,908. The Company received $500,000 in cash, resulting in an initial loss on the fair value of the derivative liability of $868,908 on the grant date. The price of $5.00 per share of the Series A and Series B Warrants granted in connection with the December 2013 Issuance and the January 2014 Issuance resulted in the revaluation of the Series C Warrants granted to Full Circle and an increase to the derivative liability of $153,994.

On January 21, 2015, Full Circle executed a cashless exercise of 1,215,000 warrants in exchange for 660,263 common shares of the Company’s stock.  At the time of the cashless exercise, the fair value of the common shares was determined to be $3,314,520 based on the Company’s closing share price of $5.02 on January 21, 2015. Accordingly, the Company decreased the derivative liability by $3,314,520 and increased common stock by $660 and additional paid in capital by $3,313,860.

On May 1, 2015, the Company and Full Circle entered into Amendment No. 2 to the Series C Warrants, pursuant to which Full Circle executed a cashless exercised of 160,000 warrants and received 100,000 shares of the Company’s common stock. On May 4, 2015, Full Circle exercised its remaining warrants under the Series C Warrants to purchase 25,000 shares of the Company’s common stock for $4.00 per share. Immediately preceding Full Circle’s exercises the fair value of the Series C Warrants was determined to be $593,394. The fair value of the 125,000 common shares issued to Full Circle was determined to be approximately $468,750, based on closing prices per share of $3.75 on May 1, 2015. Accordingly, the Company decreased the derivative liability by $601,617 and increased common stock by $125 and additional paid in capital by $454,796, and $86,171 in cash received from Full Circle, net of $13,829 of settlement expenses paid. The Company recorded a net gain in the settlement of the warrant liability of $232,867 and $210,634 for the three and six months ended June 30, 2015. Following these transactions, there are no more Series C Warrants outstanding.

The underlying assumptions used in the binomial model to determine the fair value of the derivative warrant liability were:

		May 1, 2015		May 4, 2015
Current stock price	$	3.75	$	3.50
Exercise price of warrant		4.00		4.00
Risk-free interest rate		0.60 %		0.60 %
Expected dividend yield		-- %		-- %
Expected term (in years)		1.8		1.8
Expected volatility		133 %		133 %
Early exercise factor		1.33		1.33

Changes in fair value of the derivative financial instruments are recognized in the Company’s condensed consolidated statements of operations as a derivative gain or loss and are included in other income (expense).  The primary underlying risk exposure pertaining to the warrants was the change in fair value of the underlying common stock for each reporting period.

Changes in the derivative warrant liability and cumulative expense since inception are as follows:

		Liability		Cumulative Expense (Gain)
January 1, 2014	$	--	$	--
Fair value of warrants issued		1,368,908		868,908
Increase in derivative liability resulting from anti-dilution provision in agreement, with Full Circle		153,994		153,994
Increase in the fair value of warrant liability		2,371,002		2,371,002
December 31, 2014		3,893,904		3,393,904
Increase in the fair value of warrant liability		14,010		14,010
Reclassification to APIC for shares issued for Full Circle as a result of warrant exercises, net of cash received		(3,683,270)		--
Gain on settlement of derivative		(224,644)		(224,644)
Balance after all warrants were exercised	$	--	$	3,183,270

The components of the net (gain) loss on derivative liability are as follows:

		Three months ended September 30,				Nine months ended September 30,
		2015		2014		2015		2014
Fair value of warrants issued	$	--	$	--	$	--	$	868,908
Increase (decrease) in fair value of warrant liability		--		117,633		14,010		(327,511)
Gain on settlement of derivative		--		--		(224,644)		--
	$	--	$	117,633	$	(210,634)	$	541,397