COMMON STOCK AND WARRANTS - Note 7

6 Months Ended

Jun. 30, 2013

Common Stock And Warrants - Note 7

COMMON STOCK AND WARRANTS - Note 7

7. COMMON STOCK AND WARRANTS

In May 2013, we raised $5.85 million before issuance costs of approximately $362,000 from the sale of 2.6 million shares of common stock and warrants to purchase up to an aggregate of 2.0 million shares of our common stock in a registered direct offering. The warrants have an exercise price of $2.886 per share, a five year term, and are exercisable beginning on the date of issuance. Each warrant to purchase a share of common stock may also be exchanged during its term for a number of shares of common stock (but not more than one share of common stock for each warrant so exchanged) with a value determined by a negotiated formula if, among other things, our common stock is then trading at a price at or lower than the warrant exercise price per share. Subject to limitations in the warrants, we may require the warrants be exercised for cash if the closing bid price of our stock is over $3.61 for 20 consecutive trading days and the average daily dollar volume over that period is equal to or exceeds $300,000.

Based on the terms of the agreement, we have determined that the warrant instruments should be classified as a liability given that the warrants could result in the issuance of a variable number of common shares based on a conditional exercise provision that is outside of our control at any point when the share price of our common stock is equal to or less than the stated exercise price of $2.886 per share. At the date of issuance, and as of June 30, 2013, our common stock was trading at a value less than the stated exercise price, as such upon expiration of the 45 day lock up period, the holders may elect to exchange the warrants for a variable number of shares of common stock as determined by a negotiated formula included in the warrant agreement. However, the agreement contains a limit that restricts the number of shares that may be issued under this exchange provision, such that we will not issue any more common shares than could be issued on a one-for-one basis upon exercise of the warrants. As of June 30, 2013, based upon the terms of the agreement and the quoted market price of our common stock, if the exchange feature were to be fully exercised, we would be required to issue approximately 1,490,000 shares of common stock, equal to an estimated fair market value of $3,755,000, which we believe is the best indication of the fair value of the warrant obligation as of June 30, 2013. Changes in the market value of our common stock will increase or decrease the number of shares to be issued under this exchange feature; however the aggregate fair market value of shares to be issued under this provision will not change significantly due to the negotiated and fixed exchange formula in the agreement. Due to the limiting provisions on the exchange agreement, the maximum number of shares of common stock that we could be required to issue is 1,976,352.

At each balance sheet date, we will evaluate the fair value of the warrants and any change in value will be recorded as a non-operating gain or loss on the statement of operations. We will re-assess the appropriate valuation model for determining the estimated fair value of the warrant instruments, which may include a binomial valuation model to take into consideration the other features of the warrants. Determination of the fair market value of the warrant instruments includes consideration of Level 3 inputs. Level 3 inputs are unobservable inputs for which there is little or no market data, which requires us to develop our own assumptions, which are significant to the measurement of the fair values.