4. Fair Value of Financial Assets and Liabilities – Derivative Instruments

The guidance regarding fair value measurements prioritizes the inputs used in measuring fair value and establishes a three-tier value hierarchy that distinguishes among the following:

		Level 1—Valuations based on unadjusted quoted prices in active markets for identical assets or liabilities that the Company has the ability to access.
		Level 2—Valuations based on quoted prices for similar assets or liabilities in active markets, quoted prices for identical or similar assets or liabilities in markets that are not active and models for which all significant inputs are observable, either directly or indirectly.
		Level 3—Valuations based on inputs that are unobservable and significant to the overall fair value measurement.

Liabilities are classified based on the lowest level of input that is significant to the fair value measurements. The Company has not transferred any liabilities between the classification levels.

The Company estimates fair values of derivative liabilities utilizing Level 3 inputs. The Company uses the Monte Carlo and Black-Scholes valuation models for derivatives which embodies all of the requisite assumptions (including trading volatility, remaining term to maturity, market price, strike price, risk-free rates) necessary to determine fair value of these instruments. The Company’s derivative liabilities are marked-to-market with the changes in fair value recorded as a component of change in fair value of derivative liabilities in the Company’s consolidated statements of operations. Estimating fair values of derivative liabilities requires the use of significant and subjective inputs that may, and are likely to, change over the duration of the instrument with related changes in internal and external market factors.

The recurring fair value measurements of the Company’s derivative liabilities at December 31, 2017 and 2016 consisted of the following:



	Quoted Prices in
	Active Markets		Significant Other		Significant
	for Identical		Observable Inputs		Unobservable
	Items (Level 1)		(Level 2)		Inputs (Level 3)		Total
December 31, 2017
Liabilities
June 2016 offering warrant liability	$	-	$	-	$	32,000	$	32,000
November 2016 offering warrant liability		-		-		260,000		260,000
Total liabilities	$	-	$	-	$	292,000	$	292,000

December 31, 2016
Liabilities
June 2016 offering warrant liability	$	-	$	-	$	274,000	$	274,000
Dilutive financing derivative liability		-		-		126,000		126,000
November 2016 offering warrant liability		-		-		2,043,000		2,043,000
Total liabilities	$	-	$	-	$	2,443,000	$	2,443,000

The following table sets forth a summary of changes in the fair value of the Company's derivative liabilities:



	June 2016		Dilutive		November 2016
	Offering		Financing		Offering		Total
	Warrant		Derivative		Warrant		Derivative
	Liability		Liability		Liability		Liabilities
Balance, December 31, 2016	$	274,000	$	126,000	$	2,043,000	$	2,443,000
Changes in estimated fair value		(242,000)		(104,000)		(1,664,000)		(2,010,000)
Exercised warrants		-		-		(119,000)		(119,000)
Settlement of liability		-		(22,000)		-		(22,000)
Balance, December 31, 2017	$	32,000	$	-	$	260,000	$	292,000

In connection with an issuance of warrants exercisable for an aggregate of 106,383 shares of common stock in a registered public offering, the Company incurred the June 2016 offering warrant liability (see Note 10). The fair value of the June 2016 offering warrant liability on each measurement date was estimated using the Black-Scholes valuation model. This method of valuation involves using inputs such as the fair value of the Company’s common stock, stock price volatility, risk–free interest rates and dividend yields. Due to the nature of these inputs, the valuation of the warrants is categorized within Level 3 of the fair value hierarchy. The assumptions used consisted of the following:



	December 31, 2017			December 31, 2016
Volatility		125	%		118	%
Expected term (years)		3.42			4.42
Risk-free interest rate		2.01	%		1.80	%
Dividend yield		0.00	%		0.00	%
Exercise price		$22.50			$22.50
Common stock closing price		$1.01			$4.40

In connection with an issuance of warrants exercisable for an aggregate of 533,500 shares of common stock in an underwritten public offering, the Company incurred the November 2016 offering warrant liability (see Note 10). The fair value of the November 2016 offering warrant liability on each measurement date was estimated using the Monte Carlo valuation model. This method of valuation involves using inputs such as the fair value of the Company’s common stock, stock price volatility, contractual term of the warrants, risk–free interest rates and dividend yields. Due to the nature of these inputs, the valuation of the warrants is categorized within Level 3 of the fair value hierarchy. The assumptions used consisted of the following:



	December 31, 2017			December 31, 2016
Volatility		107	%		112	%
Expected term (years)		3.89			4.89
Risk-free interest rate		2.08	%		1.91	%
Dividend yield		0.00	%		0.00	%
Exercise price (1)		$0.57			$7.50
Common stock closing price		$1.01			$4.40

(1) In connection with the Company’s April 2017 1-for-10 reverse stock split, the exercise price of the warrants was adjusted downward to $1.00 per share. In September 2017, the exercise price of the warrants was further adjusted downward to $0.57 per share in connection with the issuance of 523,210 shares of the Company’s common stock to the shareholders who were party to the Common Stock Issuance Agreement. The exercise price of the warrants is subject to further adjustment upon future dilutive issuances of the Company’s common stock and stock combination events as defined in the warrant agreements (see Note 10).

Dilutive Financing Derivative Liability

The dilutive financing derivative liability was originally recorded on the Company’s balance sheet on April 8, 2016 in connection with the Company’s entry into a Common Stock Issuance Agreement (“CSIA”) with certain former holders of the Company’s Series B redeemable convertible preferred stock, pursuant to which the Company was obligated to issue its common stock for no consideration to the shareholders who were party to the CSIA upon dilutive issuances of the Company’s common stock (see Note 9). As of December 31, 2016, the maximum number of shares that the Company could issue under the rules of the NYSE American and the terms of the CSIA was 28,684 shares. As of December 31, 2016, the dilutive financing liability was valued at $126,000 based on the closing market price of the Company’s common stock of $4.40 per share multiplied by the 28,684 shares available to be issued. On June 27, 2017, the Company and the holders entered into an amendment to the CSIA (the “CSIA Amendment”) under which the 28,684 common shares were issued to the holders on June 29, 2017. The CSIA Amendment removed the condition which required the CSIA to be treated as a derivative liability. Accordingly, the fair value of the shares were marked-to-market through June 29, 2017, at $22,000, and then reclassified from a liability to equity.