DERIVATIVE LIABILITY

9 Months Ended

Sep. 30, 2014

DERIVATIVE LIABILITY.

DERIVATIVE LIABILITY

4. DERIVATIVE LIABILITY

The conversion feature of the Loan Agreement was determined to be an embedded derivative under ASC 815 as the exercise price is subject to downward adjustment as discussed in Note 3 above and, therefore, does not meet the “fixed-for-fixed” criteria. As a result, the conversion feature of the convertible Loan Agreement is required to be bifurcated and classified as a derivative liability recorded at an initial fair value and subsequently marked-to-market each period with the changes in fair value reported in the Company’s results of operations. The initial fair value measurement of the derivative liability as determined on the date of each advance has been recognized as a debt discount and will be amortized over the life of the Loan Agreement.

The fair value of the derivative liability as of September 30, 2014 has been calculated using the Black-Scholes option pricing model with the following assumptions:

Risk-free interest rate	1.07%
Expected life of derivative liability	2.25 years
Expected volatility	87.85%
Dividend rate	0.00%

The change in the derivative liability related to the conversion feature is as follows:

	Derivative
	Liability
Fair value of derivative liability at December 31, 2013	$	2,169,408
Fair value of $2,000,000 drawdown	1,555,806
Fair value of $3,000,000 drawdown	1,691,319
Change in fair value of derivative liability	(1,604,657		)
Fair value of derivative liability at September 30, 2014	$	3,811,876

As discussed in Note 3 above, the potential for downward adjustment of the exercise price expires on November 13, 2014 and the exercise price will remain fixed at $2.60 for the remainder of the term of the Loan Agreement.  As a result, the conversion feature will no longer qualify as an embedded derivative instrument and the fair value of the derivative as of November 13, 2014 will be reclassified to equity with no further mark-to-market adjustments.