11. Fair Value Measurements

The Company measures certain financial assets and liabilities at fair value on a recurring basis, including cash equivalents and warrants. General accounting principles for fair value measurement established 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 and liabilities (“Level 1”) and the lowest priority to unobservable inputs (“Level 3”). The three levels of the fair value hierarchy are described below:

Level 1: Values are based on unadjusted quoted prices in active markets that are accessible at the measurement date for identical, unrestricted assets or liabilities.

Level 2: Values are based on quoted prices for similar instruments in active markets, quoted prices for identical or similar instruments in markets that are not active, or other model-based valuation techniques for which all significant assumptions are observable in the market.

Level 3: Values are generated from model-based techniques that use significant assumptions not observable in the market.

The following table sets forth the Company’s assets and liabilities measured at fair value on a recurring basis by level within the fair value hierarchy. As required by the Fair Value Measurements and Disclosures topic of the Accounting Standards Codification, assets and liabilities are classified in their entirety based on the lowest level of input that is significant to the fair value measurement.


	Fair Value Measurement Using
	Total		Quoted Prices in Active Markets for Identical Instruments (Level 1)	Significant Other Observable Inputs (Level 2)	Significant Unobservable Inputs (Level 3)
Assets at June 30, 2013:
Cash equivalents	$	21,663	21,633	—	—
Derivative asset		79	—	—	79
Total assets at fair value	$	21,742	21,633	—	79
Liabilities at June 30, 2013:
Warrants issued December 29, 2008	$	6,999	—	—	6,999
Warrants issued May 10, 2012		1,360,107	—	—	1,360,107
Derivative liability		101,936	—	—	101,936
Total liabilities at fair value:	$	1,469,042	—	—	1,469,042
Assets at December 31, 2012:
Cash equivalents	$	256,702	256,702	—	—
Derivative asset		1,736	—	—	1,736
Total assets at fair value	$	258,438	256,702	—	1,736
Liabilities at December 31, 2012:
Warrants issued December 29, 2008	$	71,581	—	—	71,581
Warrants issued May 10, 2012		2,347,902	—	—	2,347,902
Derivative liability		548,865	—	—	548,865
Total liabilities at fair value:	$	2,968,348	—	—	2,968,348

Level 1

The Company’s financial assets consist of cash equivalents invested in money market funds in the amount of $21,663 and $256,702 at June 30, 2013 and December 31, 2012, respectively. These assets are classified as Level 1 as described above and total interest income recorded for these investments was insignificant during both the six month periods ended June 30, 2013 and June 30, 2012. There were no transfers in or out of Level 1 during the period ended June 30, 2013.

Level 2

The Company does not have any financial assets or liabilities classified as Level 2.

Level 3

In conjunction with its December 29, 2008 registered direct offering, the Company issued warrants to purchase 179,241 shares of the Company’s common stock that contained a provision that required a reduction of the exercise price if certain equity events occurred. Under the provisions of general accounting principles for derivatives and hedging activities and determining whether an instrument (or embedded feature) is indexed to an entity’s own stock, such a reset provision does not meet the exemptions for equity classification and as such, the Company accounts for these warrants as derivative instruments. The calculated fair value of the warrants is classified as a liability and is periodically remeasured with any changes in value recognized in “Other income (expense)” in the Statement of Operations. General accounting principles for determining whether an instrument (or embedded feature) is indexed to an entity’s own stock became effective for the Company as of January 1, 2009. Accordingly, the fair value of the warrants as of that date was reclassified from stockholders’ equity into current liabilities.

In accordance with general accounting principles for fair value measurement, the Company’s warrants in the amount of $6,999 were measured at fair value on a recurring basis as of June 30, 2013 and were valued using Level 3 valuation inputs. A Black-Scholes model was used to value the Company’s warrants at June 30, 2013 using the following assumptions: 1) dividend yield of 0%; 2) volatility of 111.01%; 3) risk-free interest rate of 0.66%; and 4) expected life of one year.

In the Company’s May 2012 financing transaction, the Company issued subordinated convertible debentures and warrants. The optional conversion feature of the subordinated convertible debentures is classified as a derivative liability within “Warrants and debt conversion features” on the Company’s balance sheet. The warrants issued in conjunction with the Debentures and PIPE are also considered a liability. Due to the provisions included in the warrant agreements, the warrants do not meet the exemptions for equity classification and as such, the Company accounts for these warrants as derivative instruments. The warrants and derivative liability are periodically remeasured with any changes in value recognized in “Other income (expense)” in the Statement of Operations.

Per the terms of the Debentures agreement, the Company had the ability to require each holder to convert up to 50% of the Debentures if the common stock closed above $15.00, or 100% of the Debentures if the common stock closed above $20.00 (in each case, as adjusted for stock splits, recapitalizations and similar events) during a 20 consecutive trading day period and the resale registration statement had been declared effective by the SEC and was available for the issuance of the common stock upon conversion of the Debentures. In the event of any forced conversion by the Company, the minimum amount that the Company could force the holders to convert was $2.5 million of Debentures in the aggregate. This mandatory redemption clause is classified as a derivative asset within “Prepaid and other current assets” on the Company’s balance sheet. The derivative asset is periodically remeasured with any changes in value recognized in “Other income (expense)” in the Statement of Operations. Refer to Note 14 for discussion of subsequent events.

In accordance with general accounting principles for fair value measurement, the Company’s warrants, derivative liability, and derivative asset were measured at fair value on a recurring basis as of June 30, 2013 and were valued using Level 3 valuation inputs. A Monte-Carlo simulation was used to value the derivative asset and liabilities upon issuance on May 10, 2012 using the following assumptions: 1) volatility of 80%; 2) risk-free interest rate of 1.035%; and 3) a closing stock price of $3.413. The derivative asset and liabilities were revalued as of June 30, 2013 using the following assumptions: 1) volatility of 95%; 2) risk-free interest rate of 1.357%; and 3) a closing stock price of $1.55.

The significant unobservable input used in the fair value measurement of the Company’s warrants, derivative liability, and derivative asset is volatility. Significant increases (decreases) in the volatility in isolation would result in a significantly higher (lower) asset and liability fair value measurements.

The following table sets forth a summary of changes in the fair value of the Company’s Level 3 financial asset and liabilities for the six month period ended June 30, 2013:


	Derivative Asset	Total Assets	Warrants issued December 29, 2008	Warrants issued May 2012	Derivative Liability	Total Liabilities
Balance at beginning of period	$ 1,736	$ 1,736	$ 71,581	$ 2,347,902	$ 548,865	$ 2,968,348
Settlements	-	-	-	-	(1,631)	($1,631)
Revaluation	(1,657)	(1,657)	(64,582)	(987,795)	(445,298)	(1,497,675)
Balance at end of period	$ 79	$ 79	$ 6,999	$ 1,360,107	$ 101,936	$ 1,469,042

The Company currently does not have derivative instruments to manage its exposure to currency fluctuations or other business risks. The Company evaluates all of its financial instruments to determine if such instruments are derivatives or contain features that qualify as embedded derivatives. All derivative financial instruments are recognized in the balance sheet at fair value.