Fair Value Measurements and Financial Instruments

9 Months Ended

Sep. 30, 2014

Fair Value Disclosures [Abstract]

Fair Value Measurements and Financial Instruments

The Company accounts for certain of our outstanding warrants issued in fiscal 2010 and 2012 (“2010 Warrants” and “2012 Warrants”) as derivative liabilities.

Based on the accounting guidance with regard to 2010 Warrants and 2012 Warrants, management concluded these instruments are required to be accounted for as derivatives due to a ratchet down protection feature.  Under ASC 815, the Company records the fair value of these warrants (derivatives) on its Condensed Consolidated Balance Sheets, at fair value, with changes in the values reflected in the Condensed Consolidated Statements of Operations as “Change in fair value of instruments”.  Under “Derivative liabilities – warrants”, the 2010 Warrants and 2012 warrants derivative liabilities balance was $38,750 and $26,505 as of September 30, 2014 and December 31, 2013, respectively, in the Condensed Consolidated Balance Sheet.

ASC 820 defines fair value as the price that would be received for an asset or paid to transfer a liability (an exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date.  ASC 820 also establishes a fair value hierarchy which requires an entity to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value. ASC 820 describes three levels of inputs that may be used to measure fair value: Level 1 – Quoted prices in active markets for identical assets or liabilities; Level 2 – Observable inputs other than Level 1 prices, such as quoted prices for similar assets or liabilities; or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the assets or liabilities; and Level 3 – Unobservable inputs that are supported by little or no market activity and require significant judgment or estimation, pricing models, discounted cash flow methodologies, or similar techniques.  ASC 820 further requires that each asset and liability measured at fair value be classified as Level 1, 2, or 3 in its entirety.  If the inputs used to measure the financial assets and liabilities fall within more than one level described above, the categorization is based on the lowest level input that is significant to the fair value measurement of the instrument.  At September 30, 2014 all of the Company’s derivative liabilities and earn-out liabilities were classified as Level 3.

Level 3 Valuation Techniques

Determining fair value of warrants, given the Company’s stage of development and financial position, is highly subjective and identifying appropriate measurement criteria and models is subject to uncertainty.  The Company valued the embedded derivative component using a lattice model.  This model incorporates transaction details such as the Company’s stock price, contractual terms, maturity, market interest rates, as well as assumptions about future financings, volatility, and holder behavior as of the date of issuance and each balance sheet date.

The 2010 Warrants and 2012 Warrants contain reset provisions.  The fair value of the warrants issued by the Company in connection with these transactions has been estimated using a Monte Carlo simulation under the following assumptions:

	September 30, 2014
Share Price	$	1.05
Strike Price	$	0.75
Risk-free Rate		0.13	%
Volatility (Annual)		67	%
Number of Assumed Financings		1
Total Warrants Outstanding		25,703,219
Total Common Shares Outstanding		16,980,787
Time to Maturity (Years)	.87 to 1.15

The foregoing inputs into the 2010 Warrants, 2012 Warrants and Promissory Notes are reviewed quarterly and are subject to change based primarily on Management’s assessment of the probability of the events described occurring.  Accordingly, changes to these assessments could materially affect the valuations.

The fair value of the Earn-Out Liability has been estimated using assumptions based on our updated operating forecasts for the Company as well as discounted interest rate methodologies.

Financial Assets and Liabilities Measured at Fair Value on a Recurring Basis

Financial assets and liabilities measured at fair value on a recurring basis are summarized below and disclosed on the balance sheet under Derivative liabilities – Warrants and Earn-Out Liability:

December 31, 2013
	Fair Value		Level 1		Level 2		Level 3		Total
Derivative liability - warrants		26,505		-		-		26,505		26,505
Convertible notes		142,089		-		-		142,089		142,089
	$	168,594	$	-	$	-	$	168,594	$	168,594

September 30, 2014
	Fair Value		Level 1		Level 2		Level 3		Total
Derivative liability - warrants		54,292		-		-		54,292		54,292
	$	54,292	$	-	$	-	$	54,292	$	54,292

The table below provides a summary of the changes in fair value, including net transfers, in and/or out, of financial assets and liabilities measured at fair value on a recurring basis using significant unobservable inputs (Level 3) during the nine months ended September 30, 2014:

Fair Value Measurements Using Level 3 Inputs
	Derivative Liability
	Convertible
	Notes			Warrants			Total
Balance - December 31, 2013	$	142,089			26,505		$	168,594
Additions during the period		-			-			-
Total Unrealized (gains) or losses include in net loss		(5,945	)		100,154			94,209
Settlements during the period		(136,144	)		-			(136,144	)
Transfers in and/or out of Level 3		-			-			-
Balance - March 31, 2014	$	-			126,659		$	126,659
Additions during the period		-			-			-
Total Unrealized (gains) or losses include in net loss		-			(33,617	)		(33,617	)
Settlements during the period		-			-			-
Transfers in and/or out of Level 3		-			-			-
Balance - June 30, 2014	$	-			93,042		$	93,042
Additions during the period		-			-			-
Total Unrealized (gains) or losses include in net loss		-			(38,750	)		(38,750	)
Settlements during the period		-			-			-
Transfers in and/or out of Level 3		-			-			-
Balance - September 30, 2014	$	-			54,292		$	54,292

Changes in fair value of our Level 3 earn-out liablity as of September 30, 2014 were as follows (in thousands):

Fair Value Measurements Using Level 3 Inputs
	Earn-out
	Liability			Total
Balance - December 31, 2013	$	-		$	-
Additions during the period		846,885			846,885
Total Unrealized (gains) or losses include in net loss		-			-
Settlements during the period		-			-
Transfers in and/or out of Level 3		-			-
Balance - December 31, 2013		846,885			846,885
Additions during the period		-			-
Total Unrealized (gains) or losses include in net loss		104,101			104,101
Settlements during the period		-			-
Transfers in and/or out of Level 3		-			-
Balance - June 30, 2014	$	950,986		$	950,986
Reduction as a result of measurement period adjustment		(238,987	)		(238,987	)
Total Unrealized (gains) or losses include in net loss		(141,371	)		(141,371	)
Settlements during the period		-			-
Transfers in and/or out of Level 3		-			-
Balance - September 30, 2014	$	570,628		$	570,628

In connection with the acquisition of SMS Masterminds, Inc. (see Note 1), we entered into an earn-out payment relating to fifteen percent of the earning generated by the SMS after the acquisition and an aditional earn-out payment tied to the EBITDA of the Company after the acquisition of SMS, of up to $2,000,000 in aggregate.