11. Fair Value Measures

As of December 31, 2012, the Company had Level 3 fair value measurements related to convertible notes of $8,098,000 and $3,800,000 related to warrant liabilities.

The following summarizes the Company’s assets and liabilities measured at fair value as of March 31, 2013:

			Fair Value Measurements at Reporting Date Using:
			Quoted Prices
			in Active		Significant
			Markets for		Other		Significant
	Balance as of		Identical		Observable		Unobservable
	March 31,		Assets		Inputs		Inputs
Description	2013		(Level 1)		(Level 2)		(Level 3)

Liabilities
Convertible notes	$	9,482,000	$	—	$	—	$	9,482,000
Warrant liabilities	$	12,481,000	$	—	$	—	$	12,481,000
Total Liabilities	$	21,963,000	$	—	$	—	$	21,963,000

A summary of changes in the Convertible Notes, Second Tranche Convertible Notes, Third Tranche Convertible Notes, Investor Warrants, 2012 Warrants, Third Tranche Warrants, and the 2013 Warrants and Additional 2013 Warrants as of December 31, 2012 and March 31, 2013 is as follows:

	Fair Value of 2011 Convertible Notes			Fair Value of 2011 Warrant Liabilities			Fair Value of 2012 Convertible Notes			Fair Value of 2012 Warrant Liabilities			Fair Value of Third Tranche Convertible Notes			Fair Value of Third Tranche Warrant Liabilities			2013 Warrants		2013 SPA Option		Total
Balance December 31, 2011	$	5,327,000		$	1,600,000		$	—		$	—		$	—		$	—		$	—	$	—	$	6,927,000
Amortization of debt discount	$	66,000		$	—		$	—		$	—		$	—		$	—		$	—	$	—	$	66,000
Fair value adjustment	$	3,107,000		$	2,400,000		$	—		$	—		$	—		$	—		$	—	$	—	$	5,507,000
Balance March 31, 2012	$	8,500,000		$	4,000,000		$	—		$	—		$	—		$	—		$	—	$	—	$	12,500,000

Balance December 31, 2012	$	6,510,000		$	2,000,000		$	1,588,000		$	1,800,000		$	—		$	—						$	11,898,000
Allocation of initial proceeds	$	—		$	—		$	—		$	—		$	142,000		$	108,000		$	—	$	—	$	250,000
Initial fair value adjustment	$	—		$	—		$	—		$	—		$	252,000		$	192,000		$	—	$	—	$	444,000

January 16, 2013	$	6,510,000		$	2,000,000		$	1,588,000		$	1,800,000		$	394,000		$	300,000		$	—	$	—	$	12,592,000

Amortization of debt discount	$	38,000		$	—		$	55,000		$	—		$	2,000		$	—		$	—	$	—	$	95,000
Fair value adjustment	$	(370,000	)	$	—		$	(72,000	)	$	—		$	(8,000	)	$	—		$	—	$	—	$	(450,000	)
Carrying value of old debt at modification	$	(6,178,000	)	$	—		$	(1,571,000	)	$	—		$	(388,000	)	$	—		$	—	$	—	$	(8,137,000	)
Fair value of new debt at modification	$	6,070,000		$	—		$	1,516,000		$	—		$	386,000		$	—		$	—	$	—	$	7,972,000
Modification of warrants	$	—		$	1,916,000		$	—		$	632,000		$	—		$	—		$	—	$	—	$	2,548,000
Cancellation/retirement of warrants	$	—		$	—		$	—		$	(800,000	)	$	—		$	(300,000	)	$	—	$	—	$	(1,100,000	)
Fair value of instruments at issuance	$	—		$	—		$	—		$	—		$	—		$	—		$	2,759,000	$	1,211,000	$	3,970,000

February 22, 2013	$	6,070,000		$	3,916,000		$	1,516,000		$	1,632,000		$	386,000		$	—		$	2,759,000	$	1,211,000	$	17,490,000

Exercise of warrants	$	—		$	(844,000	)	$	—		$	—		$	—		$	—		$	—	$	—	$	(844,000	)
Fair value adjustment	$	1,130,000		$	2,014,000		$	284,000		$	326,000		$	96,000		$	—		$	884,000	$	583,000	$	5,317,000

March 31, 2013	$	7,200,000		$	5,086,000		$	1,800,000		$	1,958,000		$	482,000		$	—		$	3,643,000	$	1,794,000	$	21,963,000

Valuation — Methodology and Significant Inputs Assumptions

Fair values for the Company’s derivatives and financial instruments are estimated by utilizing valuation models that consider current and expected stock prices, volatility, dividends, market interest rates, forward yield curves and discount rates. Such amounts and the recognition of such amounts are subject to significant estimates that may change in the future. The methods and significant inputs and assumptions utilized in estimating the fair value of the Warrant Liabilities, 2013 SPA Option and Convertible Notes as of the December 31, 2012 balance sheet date, February 22, 2013 Amendment and Waiver Agreement date and the March 31, 2013 balance sheet date are discussed below. Each of the measurements is considered a Level 3 measurement as a result of at least one significant unobservable input.

2011 Warrants

A Black-Scholes-Merton option-pricing model, with dilution effects, was utilized to estimate the fair value of the 2011 Warrants as of December 31, 2012, February 22, 2013, and March 31, 2013. This model is widely used in estimating value of European options dependent upon a non-paying dividend stock and fixed inputs. This model is subject to the significant assumptions discussed below and requires the following key inputs with respect to the Company and/or instrument:

Input	December 31, 2012			February 22, 2013			March 31, 2013
Stock Price	$	0.15		$	0.14		$	0.17
Exercise Price	$	0.15		$	0.15		$	0.098
Expected Life (in years)	3.15			3.00			2.90
Stock Volatility	100		%	100		%	100		%
Risk-Free Rate	0.39		%	0.40		%	0.24		%
Dividend Rate	0		%	0		%	0		%
Outstanding Shares of Common Stock	32,434,430			59,576,097			64,389,835

2012 Warrants

$0.15 Warrants

A Black-Scholes-Merton option-pricing model, with dilution effects, was also utilized to estimate the fair value of the $0.15 Warrants as of December 31, 2012, February 22, 2013, March 31, 2013.

Input	December 31, 2012			February 22, 2013			March 31, 2013
Stock Price	$	0.15		$	0.14		$	0.17
Exercise Price	$	0.15		$	0.15		$	0.098
Expected Life (in years)	4.50			4.38			4.26
Stock Volatility	100		%	100		%	100		%
Risk-Free Rate	0.63		%	0.70		%	0.62		%
Dividend Rate	0		%	0		%	0		%
Outstanding Shares of Common Stock	32,434,430			59,576,097			64,389,835

$0.25 Warrants

A Black-Scholes-Merton option-pricing model, with dilution effects, was also utilized to estimate the fair value of the $0.25 Warrants as December 31, 2012. These warrants were canceled on February 22, 2013.

Input	December 31, 2012
Stock Price	$	0.15
Exercise Price	$	0.25
Expected Life (in years)	4.50
Stock Volatility	100		%
Risk-Free Rate	0.63		%
Dividend Rate	0		%
Outstanding Shares of Common Stock	32,434,430

Third Tranche Warrants

A Black-Scholes-Merton option-pricing model, with dilution effects, was also utilized to estimate the fair value of the Third Tranche Warrants as of January 16, 2013. These warrants were canceled on February 22, 2013.

Input	January 16, 2013
Stock Price	$	0.15
Exercise Price	$	0.15
Expected Life (in years)	5
Stock Volatility	110		%
Risk-Free Rate	0.75		%
Dividend Rate	0		%
Outstanding Shares of Common Stock	32,434,430

2013 Warrants

A Monte Carlo simulation model was utilized to estimate the fair value of the 2013 warrants as of February 22, 2013 and March 31, 2013.

Input	February 22, 2013			March 31, 2013
Stock Price	$	0.12		$	0.16
Exercise Price	$	0.20		$	0.20
Expected Life (in years)	5			4.90
Stock Volatility	110		%	110		%
Risk-Free Rate	0.84		%	0.75
Number of Steps	100,000			100,000
Outstanding Shares of Common Stock	59,576,097			64,389,835

2013 SPA Option

The 2013 SPA option, upon exercise, allows the investor to purchase one share of common stock and one common stock warrant. The option was valued using multiple valuation models, including a Black-Scholes-Merton option-pricing model, with dilution effects, to estimate the fair value of the option to purchase the common share, and a Monte Carlo simulation to determine the estimated fair value of the warrant that would be issued at the time of exercise. These models were used to estimate the fair value of the option at February 22, 2013 and March 31, 2013.

A Black-Scholes-Merton option-pricing model, with dilution effects, was also utilized to estimate the fair value of the 2013 SPA Option as of February 22, 2013 and March 31, 2013.

Input	February 22, 2013			March 31, 2013
Stock Price	$	0.14		$	0.17
Exercise Price	$	0.15		$	0.15
Expected Life (in years)	0.75			0.64
Stock Volatility	110		%	110		%
Risk-Free Rate	0.15		%	0.84		%
Dividend Rate	0		%	0		%
Outstanding Shares of Common Stock	73,042,764			77,856,502

A Monte Carlo simulation model was also utilized to estimate the fair value of the 2013 SPA Option as of February 22, 2013 and March 31, 2013.

Input	February 22, 2013			March 31, 2013
Stock Price (simulated)	$	0.10		$	0.66
Exercise Price	$	0.20		$	0.20
Expected Life (in years)	5.00			5.00
Stock Volatility	110		%	110		%
Risk-Free Rate	1.158		%	1.025		%
Number of Steps	10,000			10,000

2011 Convertible Notes

A binomial lattice model was utilized to estimate the fair value of the Convertible Notes as of December 31, 2012, February 22, 2012 and March 31, 2013. The binomial model considers the key features of the Convertible Notes, as noted above, and is subject to the significant assumptions discussed below. First, a discrete simulation of the Company’s stock price, without effects of dilution due to the conversion feature, was conducted at each node and throughout the expected life of the instrument. Second, a discrete simulation of the Company’s stock price, with effects of dilution due to the conversion feature, was conducted at each node and throughout the expected life of the instrument. Third, based upon the simulated stock price with dilution effect, an analysis of the higher position of a conversion position, redemption position, or holding position (i.e. fair value of the respective future nodes value discounted using the applicable discount rate) was conducted relative to each node until a final fair value of the instrument is conducted at the node representing the measurement date. This model requires the following key inputs with respect to the Company and/or instrument:

Input	December 31, 2012			February 22, 2013			March 31, 2013
Stock Price	$	0.15		$	0.14		$	0.17
Strike Price	$	0.10		$	0.10		$	0.10
Expected remaining term (in years)	1.15			2.35			2.25
Stock Volatility	105		%	100		%	100		%
Risk-Free Rate	0.17		%	0.32		%	0.28		%
Dividend Rate	0		%	0		%	0		%
Outstanding Shares of Common Stock	32,434,430			59,576,097			64,389,835
Effective discount rate	13.1		%	13.2		%	11.6		%
Probability of forced redemption	20		%	20		%	20		%

2012 Convertible Notes

A binomial lattice model was also utilized to estimate the fair value of the 2012 Convertible Notes as of December 31, 2012, February 22, 2012 and March 31, 2013.. This model requires the following key inputs with respect to the Company and/or instrument:

Input	December 31, 2012			February 22, 2013			March 31, 2013
Stock Price	$	0.15		$	0.14		$	0.17
Exercise Price	$	0.10		$	0.10		$	0.10
Expected remaining term (in years)	2.50			2.35			2.25
Stock Volatility	100		%	100		%	100		%
Risk-Free Rate	0.31		%	0.32		%	0.28		%
Dividend Rate	0		%	0		%	0		%
Outstanding Shares of Common Stock	32,434,430			59,576,097			64,389,835
Effective discount rate	13.2		%	13.2		%	13.2		%
Probability of forced redemption	20		%	20		%	20		%

Third Tranche Convertible Notes

A binomial lattice model was also utilized to estimate the fair value of the Tranche Three Convertible Notes as of January 16, 2012, February 22, 2012 and March 31, 2013. This model requires the following key inputs with respect to the Company and/or instrument:

Input	January 16, 2013			February 22, 2013			March 31, 2013
Stock Price	$	0.15		$	0.14		$	0.17
Exercise Price	$	0.10		$	0.10		$	0.10
Expected remaining term (in years)	3			2.90			2.80
Stock Volatility	100		%	100		%	100		%
Risk-Free Rate	0.36		%	0.39		%	0.34		%
Dividend Rate	0		%	0		%	0		%
Outstanding Shares of Common Stock	32,434,430			59,576,097			64,389,835
Effective discount rate	13.2		%	13.2		%	13.2		%
Probability of forced redemption	20		%	20		%	20		%

The following are significant assumptions utilized in developing the inputs:

· The Company’s common stock shares are traded on the OTC Bulletin Board and, accordingly, the stock price input is based upon bid prices as of the valuation dates due to the extremely thin trading volume, broker-driven market (vs. exchange market) and the wide bid/ask spread as of the valuation date;

· The expected future stock prices of the Company’s stock were modeled to include the effect of dilution upon conversion of the instruments to shares of common stock;

· Stock volatility was estimated by considering (i) the annualized monthly volatility of the Company’s stock price during the historical period preceding the respective valuation dates and measured over a period corresponding to the remaining life of the instruments (monthly data set is more relevant given the extremely thin trading volume of the Company’s common stock) and (ii) the annualized daily volatility of comparable companies’ stock price during the historical period preceding the respective valuation dates and measured over a period corresponding to the remaining life of the instrument. Historic prices of the Company and comparable companies’ common stock were used to estimate volatility as the Company did not have traded options as of the valuation dates;

· Based upon the Company’s historical operations and management’s expectations for the foreseeable future, the Company’s stock was assumed to be a non-dividend-paying stock;

· The risk-free interest rate is based on the U.S. Treasury Yield curve in effect as of the valuation date for the expected term;

· With respect to the 2011 Convertible Notes, 2012 Convertible Notes and Third Tranche Convertible Notes, the Company is expected to pay all accrued interest due to the Holders on each Interest Payment Date;

· With respect to the 2011 Convertible Notes, 2012 Convertible Notes and Third Tranche Convertible Notes, based upon management’s expectations for a change of control or fundamental transaction to occur prior to the maturity date of the 2011 Convertible Notes, 2012 Convertible Notes and Third Tranche Convertible Notes, a low probability of a forced redemption;

· Upon a change of control redemption, the change of control redemption amount shall equal to the sum of:

I. the greater of:

(i) the outstanding amount of the debt divided by the Conversion Price on the date of the mandatory default amount is either (A) demanded or (B) paid in full, whichever has a lower conversion price, multiplied by the VWAP of the date of the mandatory default amount is either (x) demanded or otherwise due or (y) paid in full, whichever has higher VWAP, plus all accrued and unpaid interest, or

(ii) 130% of the outstanding principal amount of the debt, plus 100% of accrued and unpaid interest, and

II. all other amounts, costs, expenses and liquidated damages due under the various agreements covering issuance of the debt.

Additionally, it is assumed that no amounts are due pursuant to clause (II) above in any period and that the stock price at each respective node represents a reasonable approximation of the VWAP requirements.

The changes in fair value between reporting periods are related to the changes in the price of the Company’s common stock as of the measurement dates, the volatility of the Company’s common stock during the remaining term of the instrument, changes in the conversion price and effective discount rate.