Debt and Fair Value of Financial Instruments

3 Months Ended

Mar. 31, 2017

Debt and Fair Value of Financial Instruments

9. Debt and Fair Value of Financial Instruments

The Company analyzes all financial instruments with features of both liabilities and equity under FASB ASC Topic No. 480, Distinguishing Liabilities From Equity and FASB ASC Topic No. 815, Derivatives and Hedging. Derivative liabilities are adjusted to reflect fair value at each period end, with any increase or decrease in the fair value being recorded in results of operations as adjustments to fair value of derivatives. The effects of interactions between embedded derivatives are calculated and accounted for in arriving at the overall fair value of the financial instruments. In addition, the fair values of freestanding derivative instruments such as warrant derivatives are valued using the Black-Scholes model.

At March 31, 2017 and December 31, 2016, the carrying value and the aggregate fair value of the Company’s warrant liability and long-term debt were as follows (in thousands):

	As of March 31, 2017				As of December 31, 2016
	Carrying Amount		Fair Value		Carrying Amount		Fair Value
Liabilities:
Warrant liability, net	$	502	$	502	$	1,210	$	1,210
Long-term debt, net	$	2,124	$	2,124	$	1,934	$	1,934

The warrants were accounted for as liabilities, with changes in the fair value included in net loss for the respective periods. Because some of the inputs to our valuation model were either not observable nor derived principally from or corroborated by observable market data by correlation or other means, the warrant liability is classified as a Level 3 in the fair value hierarchy.

Our stock price can be volatile and there could be material fluctuations in the value of the warrants in future periods.

A roll forward of our warrant liability classified as Level 3 and measured at fair value on a recurring basis is as follows (in thousands):

Balance, December 31, 2016 (audited)	$	1,210
Change in fair value of warrant liability		(708	)
Balance, March 31, 2017 (unaudited)	$	502

Warrant Liability

On September 2, 2016, we entered into a Note and Warrant Purchase Agreement with Unterberg Koller Capital Fund L.P. and William W. and Dieva L. Smith, pursuant to which the Company issued and sold to the Investors in a private placement senior subordinated promissory notes in the aggregate principal amount of $4,000,000 and five-year warrants to purchase an aggregate of 1,700,000 shares of the Company’s common stock at an exercise price of $2.74 per share that expire five years from the date of issuance. The Company completed the transactions contemplated by the Purchase Agreement and issued the Notes and Warrants on September 6, 2016. We assessed the warrants and concluded that they should be recorded as a liability.

The initial fair value of the warrant liability associated with the Note and Warrant Purchase Agreement was $2.1 million, and the fair value has decreased to $ 0.5 million as of March 31, 2017.

All changes in the fair value of warrants will be recognized in our consolidated statements of operations until they are either exercised or expire. The warrants are not traded in an active securities market and, as such, the estimated fair value as of March 31, 2017 was determined by using an option pricing model (Black-Scholes) with the following assumptions:

	As of
	March 31, 2017
Expected term	4.42
Common stock market price	$	0.93
Risk-free interest rate		2.01	%
Expected volatility		70.8	%
Resulting fair value (per warrant)	$	0.30

Expected volatility is based on historical volatility. Historical volatility was computed using monthly pricing observations for recent periods that correspond to the expected term of the warrants. We believe this method produces an estimate that is representative of our expectations of future volatility over the expected term of these warrants. We currently have no reason to believe future volatility over the expected remaining life of these warrants is likely to differ materially from historical volatility. The expected life is based on the remaining contractual term of the warrants. The risk-free interest rate is the U.S. Treasury bond rate as of the valuation date.

Short-Term Debt

On March 31, 2017, the Company entered into a short-term secured borrowing arrangement with Steven L. and Monique P. Elfman (“Elfman”) pursuant to which Elfman loaned to the Company $1,000,000 and the Company issued to Elfman a Secured Promissory Note (the “Note”) bearing interest at the rate of 18% per annum. The Note is due on or before June 23, 2017 and is secured by the Company’s accounts receivable and certain other assets. Mr. Elfman is a director of the Company.

On February 7, 2017, the Company entered into a short-term secured borrowing arrangement with William W. and Dieva L. Smith (“Smith”) and on February 8, 2017 entered into a short-term secured borrowing arrangement with Steven L. and Monique P. Elfman (“Elfman”) pursuant to which Smith and Elfman each loaned to the Company $1,000,000 and the Company issued to each of them a Secured Promissory Note (the “Notes”) bearing interest at the rate of 18% per annum. The Notes were due on March 24, 2017 and are secured by the Company’s accounts receivable and certain other assets. Messrs. Smith and Elfman are each directors of the Company, and Mr. Smith is the Chairman and Chief Executive Officer of the Company. Elfman’s Note was paid when due. On March 25, 2017, the Company entered into an Amendment to the Note issued to Smith that extended the Maturity Date of the Note to June 26, 2017.

Long-Term Debt

At March 31, 2017, the aggregate fair value and the carrying value of the Company’s long-term debt was as follows (in thousands):

	As of March 31, 2017				As of December 31, 2016
	Carrying Amount		Fair Value		Carrying Amount		Fair Value
Long-term debt - related party	$	1,062	$	1,062	$	967	$	967
Long-term debt		1,062		1,062		967		967
Total long-term debt	$	2,124	$	2,124	$	1,934	$	1,934

The carrying value of $2.1 million and $1.9 million are net of debt discount of $1.7 million and $1.9 million and debt issuance costs of $0.2 million and $0.2 million as of March 31, 2017 and December 31, 2016, respectively.

- Definition

The entire disclosure for the fair value of financial instruments (as defined), including financial assets and financial liabilities (collectively, as defined), and the measurements of those instruments as well as disclosures related to the fair value of non-financial assets and liabilities. Such disclosures about the financial instruments, assets, and liabilities would include: (1) the fair value of the required items together with their carrying amounts (as appropriate); (2) for items for which it is not practicable to estimate fair value, disclosure would include: (a) information pertinent to estimating fair value (including, carrying amount, effective interest rate, and maturity, and (b) the reasons why it is not practicable to estimate fair value; (3) significant concentrations of credit risk including: (a) information about the activity, region, or economic characteristics identifying a concentration, (b) the maximum amount of loss the entity is exposed to based on the gross fair value of the related item, (c) policy for requiring collateral or other security and information as to accessing such collateral or security, and (d) the nature and brief description of such collateral or security; (4) quantitative information about market risks and how such risks are managed; (5) for items measured on both a recurring and nonrecurring basis information regarding the inputs used to develop the fair value measurement; and (6) for items presented in the financial statement for which fair value measurement is elected: (a) information necessary to understand the reasons for the election, (b) discussion of the effect of fair value changes on earnings, (c) a description of [similar groups] items for which the election is made and the relation thereof to the balance sheet, the aggregate carrying value of items included in the balance sheet that are not eligible for the election; (7) all other required (as defined) and desired information.

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