Derivative Liabilities

3 Months Ended

Mar. 31, 2013

Derivative Liabilities [Abstract]

Derivative Liabilities

Note 5 - Derivative Liabilities

8% Convertible Promissory Notes – Conversion Option and Warrants

During the three months ended March 31, 2013, we issued 8% convertible promissory notes (the “8% Notes”). See Note 6 for further discussion. The 8% Notes met the definition of a hybrid instrument, as defined in the ASC Topic 815 “Derivatives and Hedging” (“ASC 815”). The hybrid instrument was composed of a debt instrument, as the host contract, and an option to convert the debt outstanding under the terms of the 8% Notes, into shares of our common stock. The 8% Notes were issued with a warrant to purchase shares of our common stock. Both the conversion option and the warrants are derivative liabilities. The conversion option derives its value based on the underlying fair value of the shares of our common stock which is not clearly and closely related to the underlying host debt instrument since the economic characteristics and risk associated with the conversion option derivative are based on the common stock fair value. The warrants do not qualify as equity under ASC 815. Accordingly, changes in the fair value of these warrant and conversion option liabilities are immediately recognized in earnings and classified as a change in fair value in the statement of operations.

We determined the fair value of the conversion option and warrant derivative liabilities on the various dates of issuance and recorded these fair values as a discount to the debt and a derivative liability. The fair value of the conversion option derivative liability on the dates of issuance during the three months ended March 31, 2013 and the aggregate fair value of all the conversion options on March 31, 2013 was approximately $545,400 and $4.8 million, respectively. The increase in fair value of $3.6 million was recorded as a change in derivative liability in the statement of operations during the three months ended March 31, 2013. The fair value of the warrants derivative liability on the various dates of issuance during the three months ended March 31, 2013 and the aggregate fair value of all the warrants issued on March 31, 2013 was approximately $249,200 and $2.3 million, respectively. The increase in fair value of $1.8 million was recorded as a change in fair value of derivative liability in the statement of operations during the three months ended March 31, 2013.

The estimated fair values of the derivative liabilities for the conversion options on the 8% Notes issued during the three months ended March 31, 2013 and the warrants issued therewith, were computed by a third party using Monte Carlo simulations based on the following ranges for each assumption:

	At Issuances			March 31, 2013
Volatility		50.0	%		50.0	%
Risk-free interest rate		0.4	%		0.3	%
Dividend yield		0.0	%		0.0	%
Expected life		2.4 to 2.6 years			2.4 years

Placement Agent Warrants

We issued warrants to the placement agents for the sale of our 10% convertible preferred stock, to purchase 58,352 shares of 10% convertible preferred stock at $10 per share. Since the underlying 10% convertible preferred stock is redeemable by the holder after three years from the date of purchase, we recorded the fair value of the warrants at issuance, as a liability on our balance sheet and we re-measure this warrant liability at each reporting date, with changes in fair value recognized in earnings each reporting period. We estimated the initial fair value of this derivative liability by using the Black-Scholes option pricing model with the following assumptions - (i) no dividend yield, (ii) an expected volatility of 129%, (iii) a risk-free interest rate 2.1%, and (iv) an expected life of five years. The fair value of the warrant liability at March 31, 2013 and December 31, 2012 was approximately $216,000 and $81,700, respectively and we recognized a charge to our statement of operations for the change in fair value of the warrant liability for the three months ended March 31, 2013 of $134,300.

Accounting for Fair Value Measurements

We are required to disclose the fair value measurements required by Accounting for Fair Value Measurements. The derivative liabilities recorded at fair value in the balance sheet as of March 31, 2013 and December 31, 2012 is categorized based upon the level of judgment associated with the inputs used to measure its fair value. Hierarchical levels, defined by Accounting for Fair Value Measurements are directly related to the amount of subjectivity associated with the inputs to fair valuation of the liability is as follows:

Level 1 -	Inputs are unadjusted, quoted prices in active markets for identical assets or liabilities at the measurement date;
Level 2 -	Inputs other than Level 1 inputs that are either directly or indirectly observable; and
Level 3 -	Unobservable inputs, for which little or no market data exist, therefore requiring an entity to develop its own assumptions.

Additional Disclosures Regarding Fair Value Measurements

The carrying value of cash and cash equivalents, accounts receivable and accounts payable approximate their fair value due to the short-term maturity of those items.

The fair value of our debt, which approximates its carrying value, as of March 31, 2013 and December 31, 2012 was estimated at $6.8 million and $5.7 million, respectively. Factors that we considered when estimating the fair value of our debt include market conditions, liquidity levels in the private placement market, variability in pricing from multiple lenders and term of debt. The level would be considered as level 2.

The following table summarizes the financial liabilities measured at fair value on a recurring basis as of March 31, 2013 and December 31, 2012, segregated by the level of the valuation inputs within the fair value hierarchy utilized to measure fair value:

	As of March 31, 2013
							Derivative
							Liabilities at
	Level 1		Level 2		Level 3		Fair Value
8% Convertible promissory notes:
Conversion option	$	-	$	-	$	4,790,000	$	4,790,000
Warrants		-		-		2,310,000		2,310,000
Derivative liabilities - Current		-		-		7,100,000		7,100,000
Placement agent warrants - Non-current		-		-		216,016		216,016
Derivative liabilities - Total	$	-	$	-	$	7,316,016	$	7,316,016

	As of December 31, 2012
							Derivative
							Liabilities at
	Level 1		Level 2		Level 3		Fair Value
8% Convertible promissory notes:
Conversion option	$	-	$	-	$	610,000	$	610,000
Warrants		-		-		220,000		220,000
Derivative liabilities - Current		-		-		830,000		830,000
Placement agent warrants - Non-current		-		-		81,716		81,716
Derivative liabilities - Total	$	-	$	-	$	911,716	$	911,716

The following table is a reconciliation of the derivative liabilities for which Level 3 inputs were used in determining fair value during the three months ended March 31, 2013 and 2012:

	For the Three Months Ended March 31, 2013
							Credited to
							Common
	Balance -		Fair Value of				Stock		Balance -
	January 1,		Derivative		Change in		Upon Issuance		March 31,
	2013		Liability		Fair Value		of Warrants		2013
8% Convertible promissory notes:
Conversion option	$	610,000	$	545,425	$	3,634,575	$	-	$	4,790,000
Warrants		220,000		249,151		1,840,849		-		2,310,000
Derivative liabilities - Current		830,000		794,576		5,475,424		-		7,100,000
Placement agent warrants - Non-current		81,716		-		134,300		-		216,016
Derivative liabilities - Total	$	911,716	$	794,576	$	5,609,724	$	-	$	7,316,016

	For the Three Months Ended March 31, 2012
								Credited to
								Common
	Balance -		Fair Value of					Stock			Balance -
	January 1,		Derivative		Change in			Upon Issuance			March 31,
	2012		Liability		Fair Value			of Warrants			2012
12% Convertible revolving credit agreement:
Conversion option	$	113,271	$	-	$	13,800		$	-		$	127,071
10% convertible preferred stock:
Warrants		1,875,463		-		-			(1,875,463	)		-
10% convertible debentures:
Warrants		70,343		-		(10,805	)		(38,093	)		21,445
Derivative liabilities - Current		2,059,077		-		2,995			(1,913,556	)		148,516
Placement agent warrants - Non-current		487,555		-		(242,558	)		-			244,997
Derivative liabilities - Total	$	2,546,632	$	-	$	(239,563	)	$	(1,913,556	)	$	393,513