NOTE 5. FAIR VALUE MEASUREMENTS

Financial Instruments and Fair Value

The Company accounts for financial instruments in accordance with ASC 820, “Fair Value Measurements and Disclosures” (“ASC 820”). ASC 820 establishes a fair value hierarchy that prioritizes the inputs to valuation techniques used to measure fair value. The hierarchy gives the highest priority to unadjusted quoted prices in active markets for identical assets or liabilities (Level 1 measurements) and the lowest priority to unobservable inputs (Level 3 measurements). The three levels of the fair value hierarchy under ASC 820 are described below:

Level 1 – Unadjusted quoted prices in active markets that are accessible at the measurement date for identical, unrestricted assets or liabilities;

Level 2 – Quoted prices in markets that are not active or financial instruments for which all significant inputs are observable, either directly or indirectly; and

Level 3 – Prices or valuations that require inputs that are both significant to the fair value measurement and unobservable.

The financial instruments recorded in the Company’s consolidated balance sheets consist primarily of cash and cash equivalents, restricted cash, debt and accounts payable. The carrying amounts of the Company’s cash and cash equivalents and accounts payable approximate fair value due to their short-term nature. The fair value of the Company’s debt approximates its carrying value due to their variable interest rates, which are indexed to market, market conditions and variability in pricing from multiple lenders and term of debt and are classified as Level 1 within the fair value hierarchy.

In estimating the fair value of the Company’s Hercules and Discover derivative liabilities, the Company used the Binomial Lattice options pricing model at inception and on each subsequent valuation date. Based on the fair value hierarchy, in 2015, the Company classified the Hercules and Discover derivative liability within Level 3. In 2014, the Company’s derivative liabilities included its March 2014 Warrants and November 2014 convertible promissory note side letter, all of which had been recorded as a liability at fair value, and were revalued at each measurement date until extinguishment of the liability, with changes in the fair value of the instruments included in the consolidated statements of operations as non-operating expense.

The following table presents the Company’s liabilities that are measured and recognized at fair value on a recurring basis classified under the appropriate level of the fair value hierarchy as of December 31, 2015 ($ in thousands). The Company had no assets or liabilities that were measured at fair value as of December 31, 2014.

	As of December 31,
	2015		Fair Value Hierarchy at December 31, 2015
			Quoted prices in		Significant other		Significant
	Total carrying and		active markets		observable inputs		unobservable
	estimated fair value		(Level 1)		(Level 2)		inputs (Level 3)
Liabilities:
Series D Preferred Stock Derivative Liability	$	6,529	$	-	$		$	6,529
Derivative liability related to Hercules Warrants	$	84	$	-	$	-	$	84

Hercules Warrants

The following table sets forth a summary of changes in the estimated fair value of the Company’s Hercules Warrant derivative liability for the period from January 1, 2015 through December 31, 2015 ($ in thousands):

	Fair Value Measurements of
	Hercules
	Common Stock Warrants
	Using Significant
	Unobservable Inputs (Level 3)
Balance at January 1, 2015		—
Warrants issued with July 2015 debt financing	$	315
Change in estimated fair value of liability classified warrants		(231)
Balance at December 31, 2015	$	84

Series D Preferred Stock

The following table sets forth a summary of changes in the estimated fair value of the Company’s Series D Preferred Stock derivative liability for the period from January 1, 2015 through December 31, 2015 ($ in thousands):

	Fair Value Measurements of
	Series D Preferred Stock
	Derivative Liability
	Using Significant
	Unobservable Inputs (Level 3)
Balance at January 1, 2015		—
Series D Preferred Stock derivative liability at inception- July 28, 2015 ($9.0 million financing)	$	5,930
Series D Preferred Stock derivative liability at inception- September 29, 2015 ($3.0 million financing)		2,077
Series D Preferred Stock conversions		(1,836)
Change in estimate fair value of Series D Preferred Stock derivative liability		358
Balance at December 31, 2015	$	6,529

March 2014 Warrants

Until its amendment, on August 13, 2014, the March 2014 warrants derivative liability was classified within Level 3 because they were valued using the Monte-Carlo model (as these warrants include down-round protection clauses), which utilize significant inputs that are unobservable in the market. The following table summarizes the changes in the Company’s derivative liability measured at fair value using significant unobservable inputs (Level 3) from January 1, 2014 through December 31, 2014 ($ in thousands):

	Level 3
Balance at January 1, 2014	$	-
Derivative warrants issued to investors in connection with the March 2014 Financing		7,404
Reclassification into additional paid in capital due to Amendment Agreement		(7,882)
Derivative issued in connection with convertible promissory note		670
Settlement of derivative liability of convertible promissory note		(750)
Fair value adjustment at reclassification, included in statement of operations		558
Balance at December 31, 2014	$	-

The table below outlines the key inputs in valuing the March 2014 warrants derivative liability.

				As of August 13, 2014
				(Restated
Unobservable inputs	As of March 10, 2014			Warrant Date)
Volatility		82.90	%		74.8	%
Risk free interest rate		0.40% - 0.60	%		0.46% - 0.52	%
Expected term, in years		2.50			2.03-2.08
Dividend yield		0	%		0	%
Probability and timing of down-round triggering event		63.5% for on August 1, 2014; 33.5% for on October 1, 2014; and 3% for every six months from September 10, 2014			63.5% for on September 1, 2014; 33.5% for on October 1, 2014; and 3% for every six months from September 10, 2014
Stock Price	$	3.04		$	4.11

During November 2014, the Company issued a convertible promissory note and side letter to an existing investor (See Note 15). As a result of this transaction the Company recognized a derivative liability of $0.7 million. The initial fair value was determined by calculating the probability and timing of future scenarios. Unobservable inputs included 100% of the volume weighted average price (“VWAP”) over a set period of time as well as 5% discount off VWAP over the same period of time. On November 20, 2014, the date the derivative liability was extinguished (See Note 15), the Company used the known closing price of the financing of $2.50 per share to calculate fair value on that date and recognized an increase in the derivative liability of $80,000 which was recorded in the consolidated statement of operations.

Sensitivity of Level 3 measurements to changes in significant unobservable inputs

The inputs to estimate the fair value of the Company’s derivative liabilities at December 31, 2015, included the risk-free interest rate, expected volatility, dividend yield, dividend period, expected life and the market price of the Company’s stock.

Significant changes in any of these inputs in isolation can result in a significant change in the fair value measurement. Generally, a positive change in the market price of the Company’s shares of common stock, and an increase in the volatility of the Company’s shares of common stock, or an increase in the remaining term of the warrant or Series D Preferred Stock, or an increase of a probability of a down-round triggering event would each result in a similar change in the estimated fair value of the Company’s warrants and Series D Preferred Stock and thus an increase in the associated derivative liabilities and vice-versa. An increase in the risk-free interest rate or a decrease in the positive differential between the warrant’s exercise price and the market price of the Company’s shares of common stock would result in a decrease in the estimated fair value measurement of the warrants and thus a decrease in the associated derivative liability. The Company has not, nor plans to, declare dividends on its shares of common stock, and thus, there is no change in the estimated fair value of the warrants or Series D Preferred Stock due to the dividend assumption.