Note 7 - Derivative Warrant Liability

9 Months Ended

Sep. 30, 2012

Notes

Note 7 - Derivative Warrant Liability

NOTE 7 – DERIVATIVE WARRANT LIABILITY

On February 9, 2011, we issued five-year warrants to purchase 262,750 shares of our common stock at an exercise price of $12.00 per share in conjunction with the private placement as of that date.  If we issue common stock or common stock equivalents at a price per share less than the exercise price of the warrants, the exercise price of the warrants is decreased to equal the price at which the common stock or common stock equivalents were issued.  The exercise price cannot be reduced below $9.00 per share. We determined that the potential adjustment to the exercise price of the warrants exceeded the economic dilution suffered and therefore the warrants are not to be considered indexed to our common stock and caused the warrants to be a derivative liability. Derivative financial instruments are classified as liabilities and carried at fair value at each reporting date, with changes reflected in the statements of operations.

On June 22, 2011, the exercise price of the warrants was reduced from $12.00 per share to $11.00 per share as a result of the issuance of the convertible debentures at a conversion price of $11.00 per share as described in Note 5. 

On January 24, 2012, the exercise price of the warrants was further reduced to $9.00 per share in conjunction with the private placement as described in Note 8.  As a result, we recognized the difference in the fair value of the warrants of $46,444 as of that date as an additional unrealized fair value change in the derivative gain for the three months ended March 31, 2012.  As a result of this reduction, the exercise price no longer has the potential for further adjustment, and we determined that the warrants no longer represented a derivative liability, and the remaining balance of the derivative liability was recognized as a derivative gain in the amount of $639,227.

The following table summarizes the components of changes in our derivative warrant liabilities during the three and nine months ended September 30, 2012 and 2011:

	Three months ended September 30,		Nine months ended September 30,
	2012	2011	2012	2011
Beginning balance	$               -	$      1,442,386	$     592,783	$                   -
Derivative recognized upon issuance	-	-	-	2,090,648
Fair value changes due to repricing, included in income	-	-	46,444	39,503
Unrealized fair value changes, included in income	-	(502,724)	(639,227)	(1,190,489)
Total unrealized gain, included in income	-	(502,724)	(592,783)	(1,150,986)
Ending balance	$               -	$         939,662	$                 -	$       939,662

The Company uses the Black-Scholes option valuation model to measure the fair value of the warrants, and based on the following assumptions, a summary of the fair values are as follows:

	January 24, 2012	September 30, 2012
Trading market price	$                       4.15	$                       9.40
Expected life (years)	4.04	4.86
Equivalent volatility	81.0%	99.5%
Expected dividend rate	0.00%	0.00%
Risk-free interest rate	0.66%	2.24%