8. Derivative Instruments

Derivative instruments consist of the following:


	December 31,
	2013		2012
	(in thousands)
Amended and Restated Convertible Notes	$	10,371	$	230
Amended and Restated Reimbursement Notes		7		—
Amended and Restated Bridge Notes		960		—
Amended and Restated August 2009 Warrants		597		372
Amended and Restated June 2010 MHR Warrants		249		79
Amended and Restated August 2010 Warrants		420		277
August 2010 Investor Warrants		171		258
Amended and Restated August 2010 MHR Waiver Warrants		156		103
Amended and Restated July 2011 Warrants		482		340
July 2011 Investor Warrants		369		340
Amended and Restated July 2011 MHR Waiver Warrants		127		90
May 2013 MHR Modification Warrants		1,600		—

	$	15,509	$	2,089

Some of the Company’s outstanding derivative instruments have an exercise price reset feature. The estimated fair value of warrants and embedded conversion features that have an exercise price reset feature is estimated using the Monte Carlo valuation model. The estimated fair value of warrants that do not contain an exercise price reset feature is measured using the Black-Scholes valuation model. Inherent in both of these models are assumptions related to expected volatility, remaining life, risk-free rate and expected dividend yield. For the Monte Carlo model, we estimate the probability and timing of potential future financing and fundamental transactions as applicable.

Embedded Conversion Feature of Amended and Restated Notes. The Amended and Restated Convertible Notes, The Amended and Restated Reimbursement Notes, and The Amended and Restated Bridge Notes (collectively, the “Amended and Restated Notes”) contain a provision whereby the conversion price is adjustable upon the occurrence of certain events, including the issuance by Emisphere of common stock or common stock equivalents at a price which is lower than the current conversion price of each of the Amended and Restated Notes and lower than the then-current market price. Under FASB ASC 815-40-15-5, the embedded conversion feature of the Amended and Restated Notes is not considered indexed to the Company’s own stock and, therefore, does not meet the scope exception in FASB ASC 815-10-15 and thus needs to be accounted for as a derivative liability. The liability associated with the Amended and Restated Convertible Notes and the Amended and Restated Bridge Notes has been presented as a current liability as of December 31, 2012 and a non-current liability as of December 31, 2013, to correspond to its host contract. The liability associated with the Amended and Restated Reimbursement Notes has been presented as a current liability as of December 31, 2013 to correspond to its host contract.

Amended and Restated Convertible Notes. In addition to the foregoing, the adjustment provision of the Amended and Restated Convertible Notes does not become effective unless and until the Company were to raise $10 million through the issuance of common stock or common stock equivalents during any consecutive 24 month period. The fair value of the embedded conversion feature of the Amended and Restated Convertible Notes is estimated at the end of each quarterly reporting period using the Monte Carlo model. The assumptions used in computing the fair value as of December 31, 2013 are a closing stock price of $0.18, a conversion price of $1.25, expected volatility of 160% over the remaining term of three years and nine months, and a risk free rate of 1.13%. The fair value of the embedded conversion feature of the Amended and Restated Convertible Notes increase $10.1 million for the year ended December 31, 2013, and decreased $7.1 million and $3.8 million and for the years ended December 31, 2012 and 2011, respectively, which amounts have been recognized in the accompanying statements of operations.

Amended and Restated Reimbursement Notes. The fair value of the embedded conversion feature of the Amended and Restated Reimbursement Notes is estimated at the end of each quarterly reporting period using the Monte Carlo model. The assumptions used in computing the fair value as of December 31, 2013 are a closing stock price of $0.18, conversion price of $0.50, expected volatility of 99% over the remaining term of 4 months, and a risk free rate of 0.07.%. The fair value of the embedded conversion of the Amended and Restated Reimbursement Notes feature decreased by approximately $0.1 million from its inception date of May 7, 2013 through December 31, 2013, which has been recognized in the accompanying statements of operations.

Amended and Restated Bridge Notes. The fair value of the embedded conversion feature of the Amended and Restated Bridge Notes is estimated at the end of each quarterly reporting period using the Monte Carlo model. The assumptions used in computing the fair value as of December 31, 2013 are a closing stock price of $0.18, conversion price of $0.50, expected volatility of 160% over the remaining term of three years and nine months, and a risk free rate of 1.13.%. The fair value of the embedded conversion feature of the Amended and Restated Bridge Notes decreased by approximately $0.1 million from its inception date of May 7, 2013 through December 31, 2013, which has been recognized in the accompanying statements of operations.

Amended and Restated June 2010 Warrants. In June 2010, the Company granted MHR warrants to purchase 865,000 shares of its common stock (the “June 2010 Warrants”). In connection with the Restructuring, on May 7, 2013 the Company amended and restated the Original Warrants such that the expiration date of the Original Warrant was extended to July 8, 2019 and the exercise price was reduced to $0.50 per share (as amended and restated, the “Amended and Restated August 2010 Warrants”, The exercise price of the Amended and Restated June 2010 Warrants is adjustable upon the occurrence of certain events, including the issuance by Emisphere of common stock or common stock equivalents at a price which is lower than the current exercise price of these warrants and lower than the current market price. However, the adjustment provision does not become effective unless the Company were to raise $10 million through the issuance of common stock or common stock equivalents at a price which is lower than the current conversion price of these warrants and lower than the current market price during any consecutive 24 month period. The fair value of the Amended and Restated June 2010 Warrants is estimated at the end of each quarterly reporting period using the Monte Carlo model. The assumptions used in computing the fair value of the Amended and Restated June 2010 Warrants as of December 31, 2013 are a closing stock price of $0.18, exercise price $0.50, expected volatility of 150 % over the remaining term five years and six months, and a risk-free rate of 1.90%. The fair value of the Amended and Restated June 2010 MHR Warrants increased $0.2 million for the year ended December 31, 2013 and decreased $0.3 million for the year ended December 31, 2012, and $1.1 million for the year ended December 31, 2011, respectively. These fluctuations have been recognized in the accompanying statements of operations.

Amended and Restated Warrants. Prior to the Restructuring, the Company issued to MHR warrants to purchase varying amounts of its common stocks at various times from 2009 through 2011, as described more fully below (the August 2009 Warrants, August 2010 Warrants, August 2010 MHR Waiver Warrants, July 2011 Warrants, July 2011 MHR Waiver Warrants, and collectively, the “Original Warrants”). In connection with the Restructuring, on May 7, 2013 the Company amended and restated each of the Original Warrants such that the expiration date of each Original Warrant was extended to July 8, 2019 and the exercise price was reduced to $0.50 per share (as amended and restated, the “Amended and Restated August 2009 Warrants”, “Amended and Restated August 2010 Warrants”, “Amended and Restated August 2010 MHR Waiver Warrants”, “Amended and Restated July 2011 Warrants”, “Amended and Restated July 2011 MHR Waiver Warrants”, and collectively, the “Amended and Restated Warrants”) . Under the terms of each of the Amended and Restated Warrants, as well as the August 2010 Investor Warrants, July 2011 Investor Warrants and 2013 Restructuring Warrants (collectively, the Investor Warrants, and together with the Original Warrants, the “Warrants”), the Company has an obligation to make a cash payment to the holders of each of the Warrants for any gain that could have been realized if such holder exercised the warrants and we subsequently failed to deliver a certificate representing the shares to be issued upon such exercise by the third trading day after the Warrants were exercised. Accordingly, the Warrants have been accounted for as a liability. The fair value of each of the Warrants is estimated, at the end of each quarterly reporting period, using the Black-Scholes model. The assumptions used in computing the fair value the Original Warrants as of December 31, 2013 are a closing stock price of $0.18, exercise price of $0.50 expected volatility of 153.34% over the remaining term of five years and six months, and a risk-free rate of 1.75%. The assumptions used in computing the fair value the Investor Warrants, as well as the fair value of each of the Warrants and any other relevant terms, are described below.

Amended and Restated August 2009 Warrants. In connection with an equity financing in August 2009 (the “August 2009 Financing”), Emisphere sold warrants to purchase 3.7 million shares of common stock to MHR (the “August 2009 Warrants”, and as amended and restated, the “Amended and Restated August 2009 Warrants”). The fair value of the Amended and Restated August 2009 Warrants increased $0.2 million for the year ended December 31, 2013 and decreased $0.2 million and $7.3 million for the years ended December 31, 2012 and 2011, respectively, which has been recognized in the accompanying statements of operations.

Amended and Restated August 2010 Warrants. In connection with an equity financing conducted in August 2010 (the “August 2010 Financing”), Emisphere sold warrants to purchase 2.6 million shares of common stock to MHR (the “August 2010 MHR Warrants”). The fair value of the Amended and Restated August 2010 Warrants increased $0.1 million for the year ended December 31, 2013 and decreased $0.1 million and $4.9 million for the years ended December 31, 2012 and 2011, respectively, which has been recognized in the accompanying statements of operations.

August 2010 Investor Warrants. Also in connection with the August 2010 Financing, Emisphere sold warrants to purchase 2.6 million shares of common stock to unrelated investors (the “August 2010 Warrants”). On January 12, 2011, one of the unrelated investors notified the Company of its intention to exercise 0.2 million warrants. The Company received proceeds of $0.2 million from the exercise of these warrants. The Company calculated the fair value of the 0.2 million exercised warrants on January 12, 2011 using the Black-Scholes option pricing model. The assumptions used in computing the fair value as of January 12, 2011 are a closing stock price of $2.25, expected volatility of 107.30% over the remaining contractual life of four years and seven months and a risk-free rate of 1.99%. The fair value of the 0.2 million exercised warrants decreased by approximately $28,000 for the period from January 1, 2011 through January 12, 2011 which has been recognized in the accompanying statements of operations. The assumptions used in computing the fair value of the remaining August 2010 Warrants as of December 31, 2013 are a closing stock price of $0.18, exercise price of $1.26, expected volatility of 165.11% over the remaining term of one year and eight months, and a risk-free rate of 0.38%. The fair value of the August 2010 Investor Warrants decreased by $0.1 million, $0.1 million and $4.5 million for the years ended December 31, 2013, 2012 and 2011, respectively, which has been recognized in the accompanying statements of operations.

Amended and Restated August 2010 MHR Waiver Warrants. Also in connection with the August 2010 Financing, the Company entered into a waiver agreement with MHR, pursuant to which MHR waived certain anti-dilution adjustment rights under the Convertible Notes and certain warrants issued by the Company to MHR that would otherwise have been triggered by the August 2010 Financing. As consideration for such waiver, the Company issued to MHR warrants to purchase 975,000 shares of its common stock (the “August 2010 Waiver Warrants”). The fair value of the Amended and Restated August 2010 Waiver Warrants decreased by $0.1 million, $0.4 million and $1.8 million for the years ended December 31, 2013, 2012 and 2011, respectively, which has been recognized in the accompanying statements of operations.

Amended and Restated July 2011 MHR Warrants. In connection with an equity financing conducted in July 2011 (the “July 2011 Financing”), Emisphere sold warrants to purchase 3.01 million shares of common stock to MHR (the “July 2011 MHR Warrants”. The fair value of the Amended and Restated July 2011 MHR Warrants increased $0.1 million for the year ended December 31, 2013 and decreased $0.01 million and $1.8 for the years ended December 31, 2012 and 2011, which has been recorded in the accompanying statements of operations.

July 2011 Investor Warrants. Also in connection with the July 2011 Financing, Emisphere sold warrants to purchase 3.01 million shares of common stock to unrelated investors (the “July 2011 Warrants”). As of December 31, 2013, all of the July 2011 Warrants were exercisable at $1.09 per share and had an expiration date of July 6, 2016. The assumptions used in computing the fair value of the July 2011 Warrants as of December 31, 2013 are a closing stock price of $0.18, exercise price of $1.09, expected volatility of 182.79% over the remaining term of two years and six months, and a risk-free rate of 0.63%. The fair value of the July 2011 Investor Warrants increased $28 thousand for the year ended December 31, 2013 and decreased $0.03 million for the year ended December 31, 2012, which has been recorded in the statements of operations.

Amended and Restated July 2011 MHR Waiver Warrants. Also in connection with the July 2011 Financing, the Company entered into a waiver agreement with MHR, pursuant to which MHR waived certain anti-dilution adjustment rights under the Convertible Notes and certain warrants issued by the Company to MHR that would otherwise have been triggered by the July 2011 Financing. As consideration for such waiver, the Company issued to MHR warrants to purchase 795,000 shares of its common stock (the “July 2011 Waiver Warrants”). The fair value of the Amended and Restated July 2011 MHR Waiver Warrants increased $37 thousand for the year ended December 31, 2013 and decreased $33 thousand and $0.5 million for the years ended December 31, 2013 and 2012 respectively, which has been recorded in the statements of operations.

2013 Restructuring Warrants. As described in Note 7 above, on May 7, 2013 the Company issued to MHR warrants to purchase 10 million shares of its common stock (the “2013 Restructuring Warrants”) as part of the Restructuring. The assumptions used in computing the fair value of the 2013 Restructuring Warrants as of December 31, 2013 are a closing stock price of $0.18, exercise price of $0.50, expected volatility of 153.34% over the remaining term of five years and six months and a risk free rate of 1.75.% The fair value of the 2013 Restructuring Warrants decreased by $0.5 million for the from its inception date of May 7, 2013 through December 31, 2013, which has been recognized in the accompanying statements of operations.