VIVEVE MEDICAL, INC. - Quarter Report: 2013 June (Form 10-Q)

Table of Contents

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

FORM 10-Q

 

x                QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934.

 

For the quarterly period ended June 30, 2013.

 

OR

 

o                   TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934.

 

For the transition period from                       to                       

 

Commission File Number: 1-11388

 

PLC SYSTEMS INC.

(Exact Name of Registrant as Specified in Its Charter)

 

 

Registrant’s telephone number, including area code: (508) 541-8800

 

Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.  Yes x  No o

 

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).  Yes x  No o

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company.  See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

 

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act)  Yes o  No x

 

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date.

 

 

 

Table of Contents

 

PLC SYSTEMS INC.

 

Index

 

Part I.	Financial Information:
	Item 1.	Financial Statements
		Condensed Consolidated Balance Sheets (unaudited)	3
		Condensed Consolidated Statements of Operations (unaudited)	4
		Condensed Consolidated Statements of Comprehensive Loss (unaudited)	5
		Condensed Consolidated Statements of Cash Flows (unaudited)	6
		Notes to Condensed Consolidated Financial Statements (unaudited)	7
	Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	24
	Item 3.	Quantitative and Qualitative Disclosures about Market Risk	31
	Item 4.	Controls and Procedures	31
Part II.	Other Information:
	Item 1A.	Risk Factors	32
	Item 6.	Exhibits	32

 

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Part I.        Financial Information

 

Item 1.       Financial Statements

 

PLC SYSTEMS INC.

CONDENSED CONSOLIDATED BALANCE SHEETS

(In thousands)

(Unaudited)

 

		June 30, 2013			December 31, 2012
ASSETS
Current assets:
Cash and cash equivalents		$	1,128		$	258
Restricted cash		500			—
Accounts receivable, net of allowance of $2 at June 30, 2013 and December 31, 2012, respectively		210			402
Inventories		161			182
Prepaid expenses and other current assets		209			178
Total current assets		2,208			1,020
Equipment, furniture and leasehold improvements, net		63			67
Other assets		4			4
Total assets		2,275			$	1,091
LIABILITIES AND STOCKHOLDERS’ EQUITY (DEFICIT)
Current liabilities:
Accounts payable		$	432		$	377
Accrued compensation		67			78
Accrued other		395			368
Deferred revenue		51			317
Total current liabilities		945			1,140
Convertible notes		5,855			8,098
Warrant and option liabilities		5,209			3,800
Commitments and Contingencies (Note 7)
Stockholders’ deficit:
Common stock, no par value, unlimited shares authorized, 66,480 shares issued and outstanding; 7,000 unissued and reserved at June 30, 2013; and 32,434 shares issued and outstanding at December 31, 2012		96,348			93,893
Additional paid in capital		1,151			1,540
Accumulated deficit		(106,977		)	(107,114		)
Accumulated other comprehensive loss		(256		)	(266		)
Total stockholders’ deficit		(9,734		)	(11,947		)
Total liabilities and stockholders’ deficit		$	2,275		$	1,091

 

The accompanying notes are an integral part of the condensed consolidated financial statements.

 

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PLC SYSTEMS INC.

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(In thousands, except per share data)

(Unaudited)

 

		Three Months Ended June 30,						Six Months Ended June 30,
		2013			2012			2013			2012
Revenues		$	372		$	363		$	721		$	383
Cost of revenues		135			211			314			224
Gross profit		237			152			407			159
Operating expenses:
Selling, general and administrative		965			564			1,650			1,225
Research and development		558			554			1,113			1,069
Total operating expenses		1,523			1,118			2,763			2,294
Loss from operations		(1,286		)	(966		)	(2,356		)	(2,135		)
Other income (expense):
Interest expense		(62		)	(116		)	(202		)	(232		)
Interest income		1			—			4			—
Foreign currency transaction gains (losses)		3			(28		)	(5		)	(14		)
Change in fair value of warrant and option liabilities		6,113			—			2,114			(2,400		)
Change in fair value of convertible notes		3,177			(354		)	1,865			(3,461		)
Other income		—			20			—			20
Loss on extinguishment of convertible notes		—			—			(1,283		)	—
Total other income (expense)		9,232			(478		)	2,493			(6,087		)
Net income (loss)		$	7,946		$	(1,444	)	$	137		$	(8,222	)
Net income (loss) per weighted average share, basic		$	0.12		$	(0.05	)	$	0.00		$	(0.27	)
Net income per weighted average share, diluted		$	0.01		$	—		$	0.00		$	—
Weighted average shares outstanding:
Basic		63,922			30,983			52,858			30,668
Diluted		137,764			—			59,960			—

 

The accompanying notes are an integral part of the condensed consolidated financial statements.

 

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PLC SYSTEMS INC.

CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)

(In thousands, except per share data)

(Unaudited)

 

		Three Months Ended June 30,						Six Months Ended June 30,
		2013			2012			2013			2012
Net income (loss)		$	7,946		$	(1,444	)	$	137		$	(8,222	)
Other comprehensive income (loss)
Foreign currency translation adjustments		10			—			10			(19		)
Other comprehensive income (loss)		10			—			10			(19		)
Comprehensive income (loss)		$	7,956		$	(1,444	)	$	147		$	(8,241	)

 

The accompanying notes are an integral part of the condensed consolidated financial statements.

 

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PLC SYSTEMS INC.

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(In thousands)

(Unaudited)

 

		Six Months Ended June 30,
		2013			2012
Cash flows from operating activities:
Net income (loss)		$	137		$	(8,222	)
Depreciation and amortization		26			20
Stock-based compensation expense		77			299
Change in fair value of warrant and liabilities		(2,114		)	2,400
Change in fair value of convertible notes		(1,865		)	3,461
Loss on extinguishment of convertible notes		1,283			—
Non-cash interest expense		95			132
Change in assets and liabilities:
Restricted cash		(500		)
Accounts receivable		194			138
Inventories		21			38
Prepaid expenses and other current assets		(28		)	44
Accounts payable		55			268
Deferred revenue		(266		)	(29		)
Accrued liabilities		15			(13		)
Net cash flows used in operating activities		(2,870		)	(1,464		)
Cash flows used for investing activities:
Purchase of property and equipment		—			(74		)
Net cash flow used for investing activities		—			(74		)
Cash flows from financing activities:
Net proceeds from sale of common stock and warrants		3,504
Net proceeds from issuance of convertible notes and warrants		250			—
Net cash provided by financing activities		3,754			—
Effect of exchange rate changes on cash and cash equivalents		(14		)	(50		)
Net (decrease) increase in cash and cash equivalents		870			(1,588		)
Cash and cash equivalents at beginning of period		258			2,585
Cash and cash equivalents at end of period		$	1,128		$	997
Supplemental disclosure of cash flow information:
Cash paid for interest		$	112		$	100
Supplemental disclosure of non-cash financing activities:
Cashless exercise of warrants		$	2,003		$	—
Cashless conversion of convertible notes		$	450		$	—

 

The accompanying notes are an integral part of the condensed consolidated financial statements.

 

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PLC SYSTEMS INC.

NOTES TO CONDENSED CONSOLIDATED UNAUDITED FINANCIAL STATEMENTS

June 30, 2013

 

1.                                      Business and Liquidity

 

PLC Systems Inc. (“PLC” or the “Company”) is a medical device company specializing in innovative technologies for the cardiac and vascular markets. Over the past five years, the Company has begun initial commercialization outside the United States of its product, RenalGuard®, which currently represents the Company’s key strategic growth initiative and primary business focus.  The RenalGuard System consists of a proprietary console and accompanying single-use sets and is designed to reduce the potentially toxic effects that contrast media can have on the kidneys when it is administered to patients during certain medical imaging procedures. The Company conducts business operations as one operating segment.

 

For the six months ended June 30, 2013, the Company incurred a loss from operations of approximately $2,356,000 and used cash in operations of approximately $2,870,000.  As of June 30, 2013, cash and cash equivalents were $1,128,000.  Management expects that quarterly losses from operations and negative cash flows will continue during 2013.  These factors raise substantial doubt about the Company’s ability to continue as a going concern. The accompanying condensed consolidated financial statements have been prepared assuming that the Company will continue as a going concern, which contemplates the realization of assets and the satisfaction of liabilities in the normal course of business. The financial statements do not include any adjustments relating to the recoverability and classification of recorded asset amounts or the amounts and classification of liabilities that might be necessary should the Company be unable to continue as a going concern.

 

Based upon the current financial condition of the Company and the expectation of continued quarterly losses from operations during 2013, management is currently investigating ways to raise additional capital that can be completed in the next several months. The Company believes that its existing resources, based on its currently projected financial results, are sufficient to fund operations through the third quarter of 2013. Based upon current and anticipated revenue projections from foreign sales of our RenalGuard product, and the anticipated costs of its U.S. clinical trial, we expect that we will need to raise additional capital during the remainder of 2013. The Company was able to raise an additional $4,040,000 in capital on February 22, 2013, through the completion of financing with Palladium Capital Advisors LLC. (see Note 9 — Sale of Common Stock).  The Company will continue to review its other expense areas to determine whether additional reductions in discretionary spending can be achieved.

 

2.                                      Basis of Presentation

 

The accompanying unaudited condensed consolidated financial statements of the Company have been prepared in accordance with generally accepted accounting principles (“GAAP”) for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X.  Accordingly, they do not include all of the information and footnotes required by generally accepted accounting principles for complete financial statements.  In the opinion of management, all adjustments (consisting of normal recurring adjustments) considered necessary for a fair presentation have been included. Operating results for the six months ended June 30, 2013 are not necessarily indicative of the results that may be expected for the year ending December 31, 2013.  These financial statements should be read in conjunction with the consolidated financial statements and footnotes thereto included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2012.

 

The preparation of financial statements in accordance with generally accepted accounting principles requires the Company to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements, and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.

 

3.                                      Inventories

 

Inventories are stated at the lower of cost (computed on a first-in, first-out method) or market value and include allocations of labor and overhead.  As of June 30, 2013 and December 31, 2012, inventories consisted of the following (in thousands):

 

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		June 30, 2013			December 31, 2012
Raw materials		$	86		$	143
Finished goods		75			39
		$	161		$	182

 

4.                                      Stock-Based Compensation

 

Stock Option Plans

 

In May 2005, the Company’s shareholders approved the 2005 Stock Incentive Plan (the “2005 Plan”).  Incentive stock options are issuable only to employees of the Company, while non-qualified stock options may be issued to non-employee directors, consultants and others, as well as to employees.  Under the 2005 Plan, the per share exercise price of incentive stock options may not be less than the fair market value of the common stock on the date the option is granted.  The 2005 Plan provides that the Company may not grant non-qualified stock options at an exercise price less than 85% of the fair market value of the Company’s common stock.

 

In June 2013, the Company’s shareholders approved the 2013 Stock Incentive Plan (the “2013 Plan”). The 2013 Plan allows for an additional 11,382,600 incentive stock options which may be issued to non-employee directors, consultants and others, as well as to employees. The 2013 Plan replaces the 2005 Plan. Under the 2013 Plan, the per share exercise price of incentive stock options may not be less than the fair market value of the common stock on the date the option is granted.  The 2013 Plan provides that the Company may not grant non-qualified stock options at an exercise price less than 85% of the fair market value of the Company’s common stock.

 

The Company grants stock options to its non-employee directors.  New non-employee directors receive an initial grant of an option to purchase shares of the Company’s common stock that generally vest in quarterly installments over three years.  Once the initial grant has fully vested, non-employee directors (other than the Chairman of the Board) receive an annual grant of an option to purchase additional shares of the Company’s common stock that generally will vest in four equal quarterly installments. The Chairman of the Board receives an annual grant of an option to purchase 45,000 shares of the Company’s common stock that generally vests in four equal quarterly installments. All such options have an exercise price equal to the fair market value of the Company’s common stock on the date of grant.

 

During the six months ended June 30, 2013, the Company did not grant any options to purchase shares of the Company’s common stock.

 

During the year ended December 31, 2011, the Company granted options to purchase 565,000 shares of the Company’s common stock to employees with performance-based vesting.  Management determined that as of June 30, 2012, it was probable that the performance conditions associated with the performance-based vesting were to be met in July 2012 with the closing of the second tranche convertible notes. Therefore, the related compensation expense was recorded in the three and six month periods ending June 30, 2012.

 

During the year ended December 31, 2012, the Company granted options to employees to purchase 355,000 shares of the Company’s common stock, which vest ratably over a three year period and granted options to purchase 112,500 shares of the Company’s common stock to non-employee directors that vest quarterly over one year.

 

During the year ended December 31, 2012, the Company issued an aggregate of 2,083,338 shares of restricted common stock to Garden State Securities, Inc. and JFS Investments, Inc. in exchange for certain investor relations and related consulting services provided to the Company.  During the six months ended June 30, 2013, the Company issued an aggregate of 416,668 shares of common stock resulting in $56,250 of compensation expense.  These shares vested immediately but are restricted from being sold for a period of six months from the date of issuance.  The contract with Garden State Securities, Inc. and JFS Investments, Inc. terminated in February 2013. No further stock issuances will occur under this agreement.

 

As of June 30, 2013, there were 674,156 shares of common stock available to be granted under the 2005 Plan, and 11,382,600 shares of common stock available to be granted under the 2013 Plan.

 

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The following is a summary of option activity under all plans (in thousands, except per option data):

 

		Number of Options		Weighted Average Exercise Price			Average Remaining Contractual Life (Years)		Aggregate Intrinsic Value
Outstanding, December 31, 2012		5,592		$	0.21		3.21		$	6,500
Granted		—		—
Exercised		—		—
Forfeited		—		—
Expired		—		—
Outstanding, June 30, 2013		5,592		$	0.21		2.71		$	1,000
Exercisable, June 30, 2013		5,189		$	0.21		2.35		$	1,000

 

Stock-Based Compensation Expense

 

The Company recorded compensation expense related to stock options of $9,200 and $21,000 in the three and six months ended June 30, 2013, respectively, as compared to $32,000 and $53,000 in the three and six months ended June 30, 2012, respectively.  The Company also recorded compensation expense of $0 and $56,000 related to the issuance of restricted common shares during the three and six months ended June 30, 2013, respectively, as compared to $40,000 and $246,000 in the three and six months ended June 30, 2012, respectively.  As of June 30, 2013, the Company had $44,000 of total unrecognized compensation cost related to its unvested options, which is expected to be recognized over a weighted average period of 1.74 years.

 

Stock Purchase Plan

 

The Company has a 2000 Employee Stock Purchase Plan (the “Purchase Plan”) for all eligible employees whereby shares of the Company’s common stock may be purchased at six-month intervals at 95% of the average of the closing bid and ask prices of the Company’s common stock on the last business day of the relevant plan period.  Employees may purchase shares having a value not exceeding 10% of their gross compensation during an offering period, subject to certain additional limitations.  There was no activity during the three and six months ended June 30, 2013 or 2012.  At June 30, 2013, 294,461 shares were reserved for future issuance under the Purchase Plan.

 

5.                                      Revenue Recognition

 

The Company recognizes revenue when the following basic revenue recognition criteria have been met: (1) persuasive evidence of an arrangement exists; (2) delivery has occurred or services rendered; (3) the price to the buyer is fixed or determinable; and (4) collectability is reasonably assured.  Determination of criteria (3) and (4) are based on management’s judgments regarding the fixed nature of the price to the buyer charged for products delivered or services rendered and collectability of the sales price. The Company assesses credit worthiness of customers based upon prior history with the customer and assessment of financial condition. The Company’s shipping terms are customarily Free On Board (“FOB”) shipping point. The Company records revenue at the time of shipment if all other revenue recognition criteria have been met. As of June 30, 2013, the Company had deferred $51,000 of revenue related to shipments prior to March 31, 2013 to its distributor in Italy, Artech, because not all revenue recognition criteria were met.  The Company expects this revenue to be recognized in 2013.

 

6.                                      Earnings per Share

 

Basic earnings per share is calculated using the Company’s weighted-average outstanding common shares. Diluted earnings per share is calculated using: the weighted-average outstanding common shares;  the dilutive effect of applying the “if converted method” to convertible notes and investor warrants with cashless exercise provision; and the dilutive effect of applying the treasury stock method to stock options and the 2013 warrants.  In applying the if-converted method to convertible notes and investor warrants with cashless exercise provisions, the Company has adjusted net income (loss) to exclude the impact of fair value changes and interest expense associated with these instruments for the purposes of calculating diluted earnings per share. The following table reconciles net income (loss) and weighted average shares outstanding used in computing basic and diluted earnings per share;

 

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		Three Months Ended June 30,						Six Months Ended June 30,
		2013			2012			2013			2012
Net income (loss)		$	7,946		$	(1,444	)	$	137		$	(8,222	)
Change in fair value of warrants		(3,097		)	—			—			—
Change in fair value of convertible notes		(3,177		)	—			—			—
Interest expense on convertible notes		62			—			—			—
Net income (loss) available to common stockholders, plus assumed conversions		$	1,734		$	(1,444	)	$	137		$	(8,222	)
Basic weighted-average shares outstanding		63,922			30,983			52,858			30,668
Effect of dilutive securities:
Convertible notes		49,500			—			—			—
Right to shares		7,000			—			7,000			—
Warrants		17,304			—			—			—
Stock Options		38			—			102			—
Weighted-average shares-diluted		137,764			—			59,960			—
Net income per share-basic		$	0.12		$	(0.05	)	$	0.00		$	(0.27	)
Net income per share-diluted		$	0.01		—			$	0.00		—

 

For the three and six months ended June 30, 2012, 45,689,000 and 45,602,000, respectively, shares attributable to outstanding convertible notes, options and warrants were excluded from the calculation of diluted earnings per share as their effect would have been anti-dilutive.   For the three and six months ended June 30, 2013, outstanding convertible notes, options and warrants to purchase 47,777,683 and 96,337,383 shares of common stock, respectively, were excluded from the calculations of diluted earnings per share as their effect would have been anti-dilutive.

 

During the three and six months ended June 30, 2013, options and warrants to purchase 47,777,683 and 64,141,716 shares of common stock, respectively, were excluded from the calculations of diluted earnings per share as their effect would have been anti-dilutive.  In addition, when applying the “if converted” method to the convertible debt, the net impact of adding back the interest expense and eliminating the fair value changes of the convertible debt would result in a reduction in net income of $1,753,000 for the six months ended June 30, 2013.  Accordingly the impact of the issuance of 49,500,000 shares of common stock upon conversion of convertible debt was excluded from the calculations of diluted earnings per share for the six months ended June 30, 2013 as their effect would have been anti-dilutive.

 

7.                                      Total Comprehensive Income (Loss)

 

Total comprehensive income for the three and six months ended June 30, 2013 was $7,956,000 and $147,000 as compared to a comprehensive loss of $1,444,000 and $8,241,000 in the three and six months ended June 30, 2012, respectively.  Comprehensive income (loss) is comprised of the net income/loss plus the increase/decrease in currency translation adjustment.

 

8.                                      Warranty and Preventative Maintenance Costs

 

The Company warranties its products against manufacturing defects under normal use and service during the warranty period.  The Company evaluates the estimated future unrecoverable costs of warranty and preventative maintenance services for its installed base of products on a quarterly basis and adjusts its warranty reserve accordingly.  The Company considers all available evidence, including historical experience and information obtained from supplier audits.  There was no warranty liability recorded at June 30, 2013 or December 31, 2012.

 

9.                                      Sale of Common Stock

 

On February 22, 2013, the Company entered into a Securities Purchase Agreement (the “SPA”) with a number of accredited investors, whereby the Company sold an aggregate of 26,933,333 shares of common stock at $0.15 per share (the “Purchase Price”) and issued warrants to purchase an additional 26,933,333 shares of common stock (the “Investor Warrants”) with gross proceeds to the Company of $4,040,000. After payment of the placement agent fees and other expenses, the

 

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Company received net proceeds of approximately $3,504,000.  As part of the fee for its placement agent services, the Company also issued Palladium Capital Advisors a warrant to purchase 1,885,333 shares of common stock (together with the Investor Warrant, the “2013 Warrants”) on the same terms and conditions as the investors under the SPA.  The shares of common stock sold in the offering are subject to certain piggyback registration rights as well as certain other protections, including price protection, as discussed below.

 

The SPA provides that for a period of 24 months after the later of (i) February 22, 2013, or (ii) the public announcement of FDA approval for RenalGuard for sale in the United States, and so long as the 2013 Investors hold the shares purchased pursuant to the SPA; in the event that the Company issues or sells any shares of common stock or any common stock equivalent at a price less than the Purchase Price (a “Share Dilutive Issuance”), the Company shall issue additional shares of common stock so that total amount paid by the investor to acquire the shares, divided by the number of shares held by the investor pursuant to the SPA, plus the additional shares issued as a result of a Share Dilutive Issuance, equals the price per share paid in the Share Dilutive Issuance.  This provision also extends to any common shares that are issued pursuant to an exercise of the 2013 Warrants.

 

In conjunction with the SPA, the Company entered into a Right To Shares Agreement with one of the investors.  Pursuant to this agreement, in lieu of issuing 7,000,000 of the common shares purchased by the investor, the Company shall be obligated to issue, and the investor has the right to up to 7,000,000 shares of the Company’s common stock.  No additional consideration will be paid upon the issuance of the shares and the subscription amount has been paid in full by the investor and is non-refundable.  The Company is obligated to deliver the shares to the investor within 3 days of the investor’s request for the share issuance.  If the Company fails to deliver the shares within 3 days of the request, under certain circumstances defined in the Right To Shares Agreement, the Company may be obligated to reimburse the investor in cash for losses that the investor incurs as a result of not having access to the shares (the “Buy-In Shares”).  As of June 30, 2013, the Company has reserved, but not issued 7,000,000 shares of common stock pursuant to the Right To Shares Agreement.

 

The SPA also provides the investors with the option, for a period through November 21, 2013, to purchase on the same terms and with the same rights as the February 2013 initial closing an equal number of shares of common stock and 2013 Warrants equal to up to one-half of the shares of common stock and 2013 Warrants purchased by the purchaser at the initial closing (“2013 SPA Option”). The following is a summary of the 2013 SPA Option for the six months ending June 30, 2013:

 

2013 SPA Option		Shares and Warrants		Exercise Price
Beginning balance at February 22, 2013		13,466,667		$	0.15
Add: Adjustments		—		n/a
Ending balance at June 30, 2013		13,466,667		$	0.15

 

The 2013 Warrants have a term of five-years and are immediately exercisable for an aggregate 28,818,666 shares of common stock purchased at an exercise price of $0.20 per share.  The exercise price of the 2013 Warrants shall be adjusted in the event of (a) stock splits, stock dividends, combinations, reclassifications, mergers, consolidations, distributions of assets or evidence of indebtedness, sales or transfers of substantially all assets, share exchanges or similar events, and (b) dilutive issuances of (i) common stock or (ii) common stock equivalents at an effective price per share that is lower than the then exercise price. The 2013 Warrants may be exercised on a cashless basis if at any time there is no effective registration statement within 180 days after the closing date of the private placement covering the resale of the shares of common stock underlying the 2013 Warrants. The 2013 Warrants contain limitations on the holder’s ability to exercise the 2013 Warrant in the event such exercise causes the holder to beneficially own in excess of 4.99% of the Company’s issued and outstanding common stock, subject to a discretionary increase in such limitation by the holder to 9.99% upon 61 days’ notice.  The following is a summary of the 2013 Warrants for the six months ending June 30, 2013:

 

The 2013 Warrants		Warrants		Exercise Price
Beginning balance at February 22, 2013		28,818,666		$	0.20
Add: Adjustments		—		n/a
Ending balance at June 30, 2013		28,818,666		$	0.20

 

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In June 2008, the FASB issued ASC 815-40-15 (formerly EITF 07-5, Determining Whether an Instrument (or Embedded Feature) Is Indexed to an Entity’s Own Stock), which was effective for the Company in 2009. This issued guidance requires that derivative instruments be evaluated for certain contingencies and anti-dilution provisions that would affect their equity classification as a derivative under ASC 815, Derivatives and Hedging (ASC 815) and requires the instruments to be classified as liabilities and reported at fair value.

 

Upon issuance, the 2013 Warrants and 2013 SPA Option were not considered indexed to the Company’s own stock and therefore are required to be accounted for as freestanding derivative instruments and classified as a liability.  A Monte Carlo simulation was used to estimate the fair value of the 2013 Warrants and 2013 SPA Option resulting in grant date fair values of $2,759,000 and $1,211,000, respectively (see Note 11 — Fair Value Measures). As of June 30, 2013, the 2013 Warrants have been marked to fair value resulting in a derivative liability of $2,017,000. The impact to other income for the change in fair value of the 2013 Warrants for the three and six months ended June 30, 2013 was a gain of $1,626,000 and $742,000, respectively. As of June 30, 2013, the 2013 SPA Options have been marked to fair value resulting in a derivative liability of $404,000. The impact to other income for the change in fair value of the 2013 SPA Option for the three and six months ended June 30, 2013 was a gain of $1,390,000 and $807,000, respectively.

 

The Company also assessed the provisions of the Buy-In Share feature of the Rights To Shares Agreement as an embedded derivative pursuant to ASC 815-15, Embedded Derivatives, and has concluded that the feature meets the definition of a derivative and is not clearly and closely related to the Rights To Shares equity host agreement.  The Buy-In Shares feature has been bifurcated from the Rights To Shares agreement and accounted for separately. The value of this feature was nominal as of the issuance date and June 30, 2013.

 

Allocation of SPA Proceeds

 

The Company first allocated the proceeds of the SPA to the fair value of the 2013 Warrants and 2013 SPA Option.  When the issuance costs were considered, the aggregate fair value of the 2013 Warrants and 2013 SPA Option exceeded exceeded the net proceeds of the SPA.  The Company recorded the difference as a reduction of additional paid in capital.

 

The SPA requires the Company to use $1,000,000 of the proceeds received from the SPA for investor relations.  The Company engaged an investor relations firm and made an initial payment of $500,000 on the date of the SPA closing.  The remaining $500,000 is held in escrow account and will be released to the investor relations firm on the six month anniversary of the closing.  The Company has recorded the cash held in an escrow as restricted cash on the balance sheet. The Company is amortizing the investor relations payments over the one-year estimated period of performance for the investor relations services.

 

10.                               Convertible Notes and Warrants

 

Features of the Convertible Notes and Investor Warrants

 

On February 22, 2011 (the “Original Issue Date”), the Company entered into a Securities Purchase Agreement (“Purchase Agreement”) and a 5% Senior Secured Convertible Debenture Agreement (the “Note Agreement”) with GCP IV LLC (the “Investors” or “Holders”) pursuant to which the Company agreed to issue and sell in a private placement to the Investors an aggregate principal amount of $4,000,000 of convertible notes due February 22, 2014 (the “2011 Convertible Notes”) and warrants to purchase 40,000,000 shares of common stock at $0.15 per share (the “2011 Warrants”).  Under the terms of the Securities Purchase Agreement, the Company had the opportunity to raise up to an additional $2,000,000 from the Holders in two separate $1,000,000 tranches, based upon meeting certain operational milestones within certain periods of time.  The deadline for achieving the operational milestones for the first $1,000,000 tranche expired in February 2012 without the Company achieving such milestones; however, the Investors agreed to waive both the deadline and the achievement of these milestones as a condition for the investment of the first additional $1,000,000 tranche (the “2012 Convertible Notes”) and issuance of warrants to purchase 10,000,000 shares of common stock at $0.15 per share and 10,000,000 shares of common stock at $0.25 per share (the “2012 Warrants”) which was completed on July 2, 2012.  On January 16, 2013 the Company entered into an amendment and waiver to the Purchase Agreement to provide for the issuance of an additional $250,000 of 5% Senior Secured Convertible Debentures (the “Third Tranche Convertible Notes”) maturing on January 16, 2016 and warrants exercisable for a period of five years to purchase up to 2,500,000 shares of common stock at an exercise price of $0.15 per share (the “Third Tranche Warrants”).

 

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The convertible notes and warrants and the Purchase Agreement covering both are secured by a security interest in all assets of the Company and its subsidiaries and all such obligations are guaranteed jointly and severally by the Company’s Subsidiaries. The convertible notes also contain non-financial covenants which limit the Company and its subsidiaries from incurring subsequent indebtedness, incur liens, and amend organizational documents, repurchasing or repaying other debt, paying cash dividends and entering into affiliate transactions.

 

On February 22, 2013, simultaneous with the closing of the SPA, the Company entered into an Amendment and Waiver Agreement (the “Amendment and Waiver Agreement”) with the Holder under which the Holder agreed to (a) increase the number of shares exercisable under the 2011 and 2012 Warrants from an aggregate 50,000,000 shares to 81,578,946 shares and to modify both the exercise price and the “VWAP price” of the 2011 and 2012  Warrants to $0.098 and $0.155, respectively, (b) return to the Company for forfeiture the remaining warrants previously issued to purchase an aggregate 12,500,000 shares of common stock, (c) extend the due date for the 2012 Convertible Notes from February 22, 2014 to June 30, 2015, (d) until February 22, 2014, without the prior written consent from the majority of the investors under the SPA, forbear from declaring any Event of Default (as defined in the original debenture, and (e) relinquish its right to purchase up to an additional $750,000 in debentures under the terms of the original 2011 Securities Purchase Agreement.  The terms of the individual tranches of convertible notes and warrants issued pursuant to this agreement and the impact of the Amendment and Waiver Agreement are discussed below.

 

2011 Convertible Notes

 

The Convertible Notes require payment of interest on the outstanding principal amount, in cash, at the rate of 5% per annum, payable quarterly on January 1, April 1, July 1, and October 1, beginning on the first such date following the Original Issue Date, on each conversion date (for the principal amount then being converted), on each optional redemption date (for the principal amount then being redeemed) and on the maturity date. Interest is calculated on the basis of a 360-day year and accrues daily commencing on the Original Issue Date until payment in full of the outstanding principal, together with all accrued and unpaid interest, liquidated damages and other amounts that may become due in connection with the Convertible Notes, has been made.

 

The Holders may convert the outstanding principal amount of the Convertible Notes into shares of the Company’s common stock at the conversion price of $0.10 per share (“Conversion Price”). The Conversion Price is subject to adjustment in the event of (a) stock splits, stock dividends, combinations, reclassifications, mergers, consolidations, distributions of assets or evidence of indebtedness, sales or transfers of substantially all assets, share exchanges or similar events, and (b) certain dilutive issuances of (i) common stock or (ii) common stock equivalents at an effective price per share that is lower than the then Conversion Price.

 

At any time after February 2012, and upon entering into a change of control transaction or Fundamental Transaction, as defined in the Debenture Agreement, the Company may deliver a notice to the Holders of its irrevocable election to redeem all of the then outstanding principal of the Convertible Notes for cash in an amount equal to the sum of (a) the greater of (i) the outstanding amount of the Convertible Notes divided by the Conversion Price on the date of the mandatory default amount, as defined in the Purchase Agreement, is either (A) demanded or (B) paid in full, whichever has a lower conversion price, multiplied by the Volume Weighted Average Price (“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 Notes, plus 100% of accrued and unpaid interest, and (b) all other amounts, costs, expenses and liquidated damages due under the various agreements covering issuance of the Convertible Notes. Such amount would include the liquidated damages due under the default provision of the Purchase Agreement.

 

Due to the Amendment and Waiver agreement, the Company is required to repay, in cash, any outstanding principal amount of the Convertible Notes on June 30, 2015 and is not permitted, except upon entering into a change of control transaction or fundamental transaction as noted above, to prepay any portion of the principal amount without prior written consent of the Holders.

 

2011 Warrants

 

On February 22, 2011, in connection with the issuance of the 2011 Convertible Notes, the Company issued warrants for the purchase of up to 40,000,000 shares of common stock at the exercise price of $0.15 per share and with an expiration date of February 22, 2016 (the “Warrants”). On February 22, 2013, as per the terms of the Amendment and Waiver Agreement,

 

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the Company canceled the original warrants and re-issued new warrants for the purchase of up to 65,263,156 shares of common stock at an exercise price of $0.098 per share.

 

The 2011 Warrants are exercisable by a cashless exercise to purchase shares of the Company’s common stock (the “Warrant Shares”). The Exercise Price of the Warrants shall be adjusted in the event of (a) stock splits, stock dividends, combinations, reclassifications, mergers, consolidations, distributions of assets or evidence of indebtedness, sales or transfers of substantially all assets, share exchanges or similar events, and (b) certain dilutive issuances of (i) common stock or (ii) common stock equivalents at an effective price per share that is lower than the then Exercise Price.

 

In connection with a Fundamental Transaction, as defined in the Purchase Agreement, that is an all-cash transaction, the Company shall have the right to purchase from the Holders all, but not less than all, of the unexercised portion of the Warrants by paying in cash to the Holders an amount equal to 30% of the Exercise Price multiplied by the number of shares of Common Stock for which the Warrants are exercisable immediately prior to such change of control transaction.

 

During the six months ended June 30, 2013, 29,085,523 of the 2011 Warrants were exercised pursuant to the cashless exercise provisions resulting in the issuance of 10,695,967 shares of common stock.

 

The following is a summary of the 2011 Warrants outstanding for the six months ending June 30, 2013:

 

		2011 Warrants		Exercise Price
Beginning balance — December 31, 2012		40,000,000		$	0.15
Less: Canceled		(40,000,000	)	0.15
Add: Issued		65,263,156		0.098
Less: Exercised		(29,085,523	)	0.098
Ending Balance — June 30, 2013		36,177,633		$	0.098

 

2012 Convertible Notes

 

The 2012 Convertible Notes contains the same terms as the 2011 Convertible Notes and require payment of interest at the rate of 5% per annum, payable quarterly and mature on July 2, 2015.  The Second Tranche Convertible Notes provide the Investors the option at any time prior to the repayment of the notes to convert any portion of the outstanding Second Tranche balance into fully-paid and non-assessable restricted shares of common stock of the Company at an initial conversion price of $0.10 per share (the “Conversion Price”). The Conversion Price is subject to adjustment in the event of (a) stock splits, stock dividends, combinations, reclassifications, mergers, consolidations, distributions of assets or evidence of indebtedness, sales or transfers of substantially all assets, share exchanges or similar events, and (b) certain dilutive issuances of (i) common stock or (ii) common stock equivalents at an effective price per share that is lower than the then Conversion Price.

 

The Second Tranche Convertible Notes may be redeemed at the option of the Company on the same terms as the Convertible Notes only in connection with a change of control or other fundamental transaction of the Company and subject to the satisfaction of other conditions including, without limitation, that the shares issuable upon conversion of the debentures are freely tradable and that there is no event of default.

 

2012 Warrants

 

On July 2, 2012, in conjunction with the issuance of the 2012 Convertible Notes, the Company issued warrants for the purchase of up to 20,000,000 shares of common stock with five year terms.  The warrants were issued to allow the Investors to purchase up to 10,000,000 shares of common stock at an initial purchase price of $0.15 per share and the remaining 10,000,000 shares of common stock at an initial purchase price of $0.25 per share. The terms of the 2012 Warrants are identical to those of the 2011 Warrants, except that the 2012 Warrants are exercisable for a period of five years from the date of issuance and contain different exercise prices. On February 22, 2013, as per the terms of the Amendment and Waiver Agreement, the Company canceled the original warrants and re-issued new warrants for the purchase of up to 16,315,790 shares of common stock at an initial purchase price of $0.098. The following is a summary of the 2012 Warrants outstanding for the six months ending June 30, 2013:

 

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$0.15 Warrants		Warrants		Exercise Price
Beginning balance at December 31, 2012		10,000,000		$	0.15
Less: Canceled		(10,000,000	)	0.15
Add: Issued		16,315,790		0.098
Less: Exercised		—		—
Ending balance at June 30, 2013		16,315,790		$	0.098

 

$0.25 Warrants		Warrants		Exercise Price
Beginning balance at December 31, 2012		10,000,000		$	0.25
Less: Canceled		(10,000,000	)	0.25
Ending balance at June 30, 2013		—		$	—

 

Third Tranche Convertible Notes

 

The Third Tranche Convertible Notes, which were issued on January 16, 2013, contains the same terms as the 2011 and 2012 Convertible Notes and require payment of interest at the rate of 5% per annum, payable quarterly and mature on January 16, 2016.  The Third Tranche Convertible Notes provide the Investors the option at any time prior to the repayment of the notes to convert any portion of the outstanding Third Tranche balance into fully-paid and non-assessable restricted shares of common stock of the Company at an initial conversion price of $0.10 per share (the “Conversion Price”). The Conversion Price is subject to adjustment in the event of (a) stock splits, stock dividends, combinations, reclassifications, mergers, consolidations, distributions of assets or evidence of indebtedness, sales or transfers of substantially all assets, share exchanges or similar events, and (b) certain dilutive issuances of (i) common stock or (ii) common stock equivalents at an effective price per share that is lower than the then Conversion Price.

 

The Third Tranche Convertible Notes may be redeemed at the option of the Company on the same terms as the 2011 and 2012 Convertible Notes only in connection with a change of control or other fundamental transaction of the Company and subject to the satisfaction of other conditions including, without limitation, that the shares issuable upon conversion of the debentures are freely tradable and that there is no event of default.

 

Third Tranche Warrants

 

On January 16, 2013, in connection with the Third Tranche Convertible Notes, the Company issued warrants for the purchase of up to 2,500,000 shares of common stock with five year terms.  The warrants were issued to allow the Investors to purchase up to 2,500,000 shares of common stock at an initial purchase price of $0.15 per share. On February 22, 2013, per the terms of the Amendment and Waiver Agreement, the Third Tranche Warrants were canceled. The following is a summary of the 2012 Warrants outstanding for the six months ending June 30, 2013:

 

Third Tranche Warrants		Warrants		Exercise Price
Beginning balance at December 31, 2012		—		$	—
Add: Issued		2,500,000		$	0.15
Less: Canceled warrants		(2,500,000	)	0.15
Ending balance at June 30, 2013		—		$	—

 

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Accounting for the 2011 Convertible Notes, 2012 Convertible Notes, Third Tranche Convertible Notes, 2011 Warrants, 2012 Warrants, and Third Tranche Warrants

 

2011 Convertible Notes, 2012 Convertible Notes, and Third Tranche Convertible Notes

 

The Company has determined that the 2011 Convertible Notes, 2012 Convertible Notes and Third Tranche Convertible Notes constitute a hybrid instrument that has the characteristics of a debt host contract containing several embedded derivative features that would require bifurcation and separate accounting as a derivative instrument pursuant to the provisions of ASC 815. The Company has identified all of the derivatives associated with each convertible note.  As permitted under ASC 825-10-10 — Financial Instruments, as it relates to the fair value option, the Company has elected, as of the original issuance date of each convertible note, to measure the 2011 Convertible Notes, 2012 Convertible Notes, and the Third Tranche Convertible Notes in their entirety at fair value with changes in fair value recognized in the Consolidated Statement of Operations as either a gain or loss until the notes are settled.  As such, the Company has appropriately valued the embedded derivatives as a single hybrid contract together with the convertible notes. This election was made by the Company after determining the aggregate fair value of the convertible notes to be more meaningful in the context of the Company’s financial statements than if separate fair values were assigned to each of the multiple embedded instruments contained in the convertible notes.

 

Pursuant to the guidance of ASC 815-40-15 (formerly EITF 07-5, Determining Whether an Instrument (or Embedded Feature) Is Indexed to an Entity’s Own Stock), the 2011 Warrants, 2012 Warrants and Third Tranche Warrants were not considered indexed to the Company’s own stock.  As a result these instruments have been account for as freestanding derivative instruments and classified as a liability recorded at fair value at each reporting period.

 

The Amendment and Waiver Agreement triggered a greater than 10% change in the present value of cash flows of the convertible notes and associated warrants.  As a result, the Company has treated the Amendment and Waiver Agreement as a debt extinguishment where the carrying value of the convertible notes and warrants prior to the amendment were removed from the Company’s books and the fair value of the amended convertible notes and warrants was recorded.  The resulting difference in value was recorded as a $1,283,000 loss on the extinguishment of debt.  The impact to each of the convertible notes and associated warrants is discussed below.

 

2011 Convertible Notes and 2011 Warrants

 

Upon issuance of the 2011 Convertible Notes, the Company allocated the proceeds received to the 2011 Convertible Notes and 2011 Warrants on a relative fair value basis. As a result of such allocation, the Company determined the initial carrying value of the Notes to be $3,208,000. The debt discount in the amount of $792,000 (resulting from the allocation of proceeds) was being amortized to interest expense using the effective interest method over the expected term of the 2011 Convertible Notes.  The carrying value of the 2011 Convertible Notes has been adjusted to fair value each reporting period.  During the three and six months ended June 30, 2012 the Company amortized $66,000 and $132,000 of the debt discount and recorded a $3,107,000 and $354,000 adjustment to the fair value of the notes as a component of other income (expense), respectively.

 

As a result of the Amendment and Waiver Agreement the carrying value of the 2011 Warrants was adjusted at February 22, 2013 to reflect the revised terms.  As of June 30, 2013, the 2011 Warrants have been marked to fair value resulting in a derivative liability of $1,809,000.  The impact to other income (expense) for the change in fair value of the 2011 Warrants for the three and six months ended June 30, 2013 was a gain of $2,118,000 and $104,000, respectively.

 

The Company has accounted for the Amendment and Waiver Agreement as an extinguishment of debt at February 22, 2013.  The fair value of the 2011 Convertible Notes prior to the extinguishment was replaced by the fair value of the amended 2011 Convertible Notes, resulting in a fair value of $6,070,000 as of February 22, 2013.  In connection with the extinguishment of the debt as of February 22, 2013, the Company had amortized $38,000 of the debt discount and wrote off the remaining debt discount of $265,000.  As of June 30, 2013, the 2011 Convertible Notes have been marked to fair value resulting in a derivative liability of $4,380,000.  The impact to other income (expense) for the loss on extinguishment and adjustments to fair value for the three and six months ended June 30, 2013 was a gain of $2,370,000 and $1,718,000, respectively.

 

During the three and six months ended June 30, 2013 certain holders of the 2011 Convertible Notes converted $300,000 of convertible note principal into 3,000,000 shares of common stock. The conversion resulted in the reclassification of $450,000 of the 2011 Convertible Notes at fair value being reclassified as a component of common stock in stockholders’

 

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equity.

 

During the three and six months ended June 30, 2013 certain holders of the 2011 Warrants exercised warrants to purchase 20,335,524 and 29,085,523, respectively, shares of common stock pursuant to the cashless exercise provisions resulting in the issuance of 7,478,226 and 10,695,967, respectively, shares of the Company’s common stock.  The cashless exercise resulted in the reclassification of $1,159,125 and $2,002,674, respectively, in the exercise date fair value of the 2011 Warrants exercised as a component of common stock in stockholders’ equity.

 

2012 Convertible Notes and 2012 Warrants

 

Upon issuance of the 2012 Convertible Notes, the Company allocated the proceeds received to the Second Tranche Convertible Notes and 2012 Warrants on a relative fair value basis.  As a result of such allocation, the Company determined the initial carrying value of the Second Tranche Convertible Notes to be $417,000.  The debt discount in the amount of $583,000 (resulting from the allocation of proceeds) was being amortized to interest expense using the effective interest method over the expected term of the Convertible Notes. The carrying value of the 2011 Convertible Notes has been adjusted to fair value each reporting period.

 

The Company has accounted for the Amendment and Waiver Agreement as an extinguishment of debt at February 22, 2013.  The fair value of the 2012 Convertible Notes prior to the extinguishment was replaced by the fair value of the amended 2012 Convertible Notes, resulting in a fair value of $1,516,000 as of February 22, 2013. As of June 30, 2013, the 2012 Convertible Notes have been marked to fair value resulting in a derivative liability of $1,180,000.  In connection with the extinguishment of the debt as of February 22, 2013, the Company had amortized $55,000 of the debt discount and wrote off the remaining debt discount of $462,000.  The impact to other income (expense) for the loss on extinguishment and adjustments to fair value was a gain of $620,000 and $463,000 for the three and six months ended June 30, 2013, respectively.

 

As a result of the Amendment and Waiver Agreement the carrying value of the 2012 Warrants was adjusted at February 22, 2013 to reflect the revised terms.  As of June 30, 2013, the 2012 Warrants have been marked to fair value resulting in a derivative liability of $979,000. The impact to other income (expense) for the three and six months ended June 30, 2013 was a gain of $979,000 and $21,000, respectively.

 

Third Tranche Convertible Notes and Third Tranche Warrants

 

Upon issuance of the Third Tranche Convertible Notes in January 2013, the Company allocated the proceeds received to the Third Tranche Convertible Notes and Third Tranche Warrants on a relative fair value basis.  As a result of such allocation, the Company determined the initial carrying value of the Third Tranche Convertible Notes to be $142,000.  The Third Tranche Convertible Notes were immediately marked to fair value, resulting in a derivative liability in the amount of $394,000. The debt discount in the amount of $108,000 (resulting from the allocation of proceeds) was being amortized to interest expense using the effective interest method over the expected term of the Convertible Notes.

 

The Company has accounted for the Amendment and Waiver Agreement as an extinguishment of debt at February 22, 2013.  The fair value of the Third Tranche Convertible Notes prior to the extinguishment was replaced by the fair value of the amended Third Tranche Convertible Notes, resulting in a fair value of $386,000 as of February 22, 2013.  As of June 30, 2013, the Third Tranche Convertible Notes have been marked to fair value resulting in a derivative liability of $295,000.  In connection with the extinguishment of the debt as of February 22, 2013, the Company had amortized $2,000 of the debt discount and wrote off the remaining debt discount of $106,000.  The impact to other income (expense) was a gain of $187,000 and $101,000 for the three and six months ended June 30, 2013, respectively.

 

Upon issuance of the Third Tranche Warrants, the Company allocated $108,000 of the initial proceeds to the Third Tranche Warrants and immediately marked them to fair value resulting in a derivative liability of $300,000.  As of June 30, 2013, the Third Tranche Warrants have been canceled as per the terms of the Amendment and Waiver Agreement. The impact to other income (expense) for the three and six months ended June 30, 2013 was a gain of $187,000 and $101,000, respectively.

 

11.                               Fair Value Measures

 

The following summarizes the Company’s assets and liabilities measured at fair value as of December 31, 2012:

 

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					Fair Value Measurements at Reporting Date Using:
					Quoted
					Prices
					in Active			Significant
					Markets for			Other			Significant
		Balance as of			Identical			Observable			Unobservable
		December 31,			Assets			Inputs			Inputs
Description		2012			(Level 1)			(Level 2)			(Level 3)
Liabilities
Convertible notes		$	8,098,000		$	—		$	—		$	8,098,000
Warrant liabilities		$	3,800,000		$	—		$	—		$	3,800,000
Total Liabilities		$	11,898,000		$	—		$	—		$	11,898,000

 

The following summarizes the Company’s assets and liabilities measured at fair value as of June 30, 2013:

 

					Fair Value Measurements at Reporting Date Using:
					Quoted
					Prices
					in Active			Significant
					Markets for			Other			Significant
		Balance as of			Identical			Observable			Unobservable
		June 30,			Assets			Inputs			Inputs
Description		2013			(Level 1)			(Level 2)			(Level 3)
Liabilities
Convertible notes		$	5,855,000		$	—		$	—		$	5,855,000
Warrant liabilities		$	5,209,000		$	—		$	—		$	5,209,000
Total Liabilities		$	11,064,000		$	—		$	—		$	11,064,000

 

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 June 30, 2012, December 31, 2012 and June 30, 2013 is as follows:

 

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		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		$	132,000		$	—		$	—		$	—		$	—		$	—		$	—		$	—		$	132,000
Fair value adjustment		$	3,461,000		$	2,400,000		$	—		$	—		$	—		$	—		$	—		$	—		$	5,861,000
Balance June 30, 2012		$	8,920,000		$	4,000,000		$	—		$	—		$	—		$	—		$	—		$	—		$	12,920,000
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		$	—		$	(1,731,000	)	$	—		$	—		$	—		$	—		$	—		$	—		$	(1,731,000	)
Conversion of debentures		$	(450,000	)	$	—		$	—		$	—		$	—		$	—		$	—		$	—		$	(450,000	)
Fair value adjustment		$	(1,240,000	)	$	(376,000	)	$	(336,000	)	$	(653,000	)	$	(91,000	)	$	—		$	(742,000	)	$	(807,000	)	$	(4,245,000	)
June 30, 2013		$	4,380,000		$	1,809,000		$	1,180,000		$	979,000		$	295,000		$	—		$	2,017,000		$	404,000		$	11,064,000

 

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 June 30, 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 June 30, 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			June 30, 2013
Stock Price		$	0.15		$	0.14		$	0.10
Exercise Price		$	0.15		$	0.15		$	0.098
Expected Life (in years)		3.15			3.00			2.65
Stock Volatility		100		%	100		%	100		%
Risk-Free Rate		0.39		%	0.40		%	0.31		%
Dividend Rate		0		%	0		%	0		%
Outstanding Shares of Common Stock		32,434,430			59,576,097			66,480,399

 

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