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Note 5 – Derivatives
The Company has determined that certain warrants the Company has issued contain provisions that protect holders from future issuances of the Company’s common stock at prices below such warrants’ respective exercise prices and these provisions could result in modification of the warrants’ exercise price based on a variable that is not an input to the fair value of a “fixed-for-fixed” option as defined under FASB ASC Topic No. 815 – 40. The warrants granted in connection with the issuance of the Company’s Stock Offering and 2012 Common Stock Offering, the Convertible Notes (previously issued and converted) and the placement agent warrants contain anti-dilution provisions that provide for a reduction in the exercise price of such warrants in the event that future common stock (or securities convertible into or exercisable for common stock) is issued (or becomes contractually issuable) at a price per share (a “Lower Price”) that is less than the exercise price of such warrant at the time. The amount of any such adjustment is determined in accordance with the provisions of the warrant agreement and depends upon the number of shares of common stock issued (or deemed issued) at the Lower Price and the extent to which the Lower Price is less than the exercise price of the warrant at the time.
Activities for derivative warrant instruments during the three months ended March 31, 2013 were as follows:
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Units
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Fair Value
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Balance, December 31, 2012
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5,146,338
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$ |
3,574,958
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Change in fair value
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-
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(1,334,512
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)
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Balance, March 31, 2013
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5,146,338
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$
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2,240,446
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The fair values of the derivative warrants were calculated using a modified binomial valuation model with the
following assumptions at March 31, 2013 and December 31, 2012.
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December 31,
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March 31,
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2012
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2013
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Market value of common stock on measurement date (1)
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$1.17
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$1.17
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Adjusted exercise price
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$0.48 - $0.81
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$0.78 - $2.475
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Risk free interest rate (2)
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1.24%
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Warrant lives in years
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4 months/5 years
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1 months/4.7 years
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Expected volatility (3)
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125% - 161%
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161%
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Expected dividend yield (4)
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-
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-
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Probability of stock offering in any period over 5 years (5)
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25%
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25% - 40%
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(1)
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The market value of common stock is based on an enterprise valuation.
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(2)
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The risk-free interest rate was determined by management using the Treasury Bill as of the respective measurement date.
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(3)
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Because the Company does not have adequate trading history to determine its historical trading volatility, the volatility factor was estimated by management using the historical volatilities of comparable companies in the same industry and region.
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(4)
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Management determined the dividend yield to be 0% based upon its expectation that it will not pay dividends for the foreseeable future.
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(5)
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Management has determined that the probability of a stock offering is 25% - 40% for each quarter of the next five years.
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