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DERIVATIVE LIABILITY AND FAIR VALUE MEASUREMENTS
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9 Months Ended |
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Jun. 30, 2012
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| Derivative Liability And Fair Value Measurements | |
| DERIVATIVE LIABILITY AND FAIR VALUE MEASUREMENTS |
NOTE 6 – DERIVATIVE LIABILITY AND FAIR VALUE MEASUREMENTS
Effective July 31, 2009, the Company adopted ASC Topic No. 815-40 which defines determining whether an instrument (or embedded feature) is solely indexed to an entity’s own stock. As of June 30, 2012, the Company has two different groups of securities outstanding which contain certain provisions which result in these securities not being solely indexed to the Company’s own stock and are not afforded equity treatment.
On January 15, 2010 the Company issued 5,583,336 warrants (the “Class H” Warrants) with an exercise price of $0.55 to warrant holders that had exercised warrants during the period at $0.18. On December 30, 2010, the Company issued 2,520,000 warrants (the “Class I” Warrants) with an exercise price of $0.55 that were attached to shares sold to a group of institutional and accredited investors for gross proceeds of $1,050,000. The exercise price of both sets of warrants are subject to certain “reset” provisions in the event the Company subsequently issues common stock, stock warrants, stock options or convertible debt with a stock price, exercise price or conversion price lower than $0.18 for the Class H Warrants and $0.25 for the Class I Warrants. If these provisions are triggered, the exercise price of all the warrants will be reduced. Due to the “reset” provisions of the warrants, the warrants are not considered to be solely indexed to the Company’s own stock and are not afforded equity treatment.
The fair value of the derivative liability was calculated using a Lattice Model that values the compound embedded derivatives based on future projections of the various potential outcomes. The assumptions that are analyzed and incorporated into the model include the conversion feature with the full ratchet and weighted average anti-dilution reset, expectations of future stock price performance and expectations of future issuances based on the Company’s prior stock history, prior issuances of stock, and expected capital requirements. Probabilities were assigned to various scenarios in which the reset provisions would go into effect and weighted accordingly.
The total fair value of the Class H Warrants, amounting to $2,868,242, has been recognized as a derivative liability on the date of issuance with all future changes in the fair value of these warrants being recognized in earnings in the Company’s statement of operations under the caption “Other income (expense) – Gain (loss) on derivative liability” until such time as the warrants are exercised or expire. Because the Class H Warrants were issued in conjunction with common stock that had been exchanged for warrants with an exercise price of $0.18, the fair value on the date of issuance includes the net cash proceeds from the sale of stock of $1,005,000 and the fair value of the $0.18 warrants which were forfeited valued at $2,867,856 on the date of exercise.
On January 15, 2012, the reset provisions included in the Class H warrants expired. As a result, the warrants are deemed to be indexed solely to the Company’s own stock as of that date and therefore are eligible to be included within permanent equity. On January 15, 2012, the Company assessed the fair market value of the derivative prior to expiration and recorded a corresponding gain of $51,769 based on the decrease in fair market value since December 31, 2011. The Company then reclassified the $3,454,094 fair market value of the derivative liability for the reset provision on the date of expiration to shareholders’ equity in accordance with ASC 815-15-35.
The total fair value of the Class I Warrants, amounting to $528,847, has been recognized as a derivative liability on the date of issuance with all future changes in the fair value of these warrants being recognized in earnings in the Company’s Statement of Operations under the caption “Other income (expense) – Gain (loss) on warrant derivative liability” until such time as the warrants are exercised or expire. The total cash proceeds of $1,050,000 were first applied to the warrants with the remaining $521,153 allocated to the common shares and recorded in additional paid-in capital.
On December 16, 2011 the Company sold 1,833,342 shares of common stock and 916,678 Class J warrants to a group of institutional and accredited investors for gross proceeds of $1,100,000. As part of the sale, the Company agreed to protect investors against any potential decrease in the price of a later offering made by the Company (the “Ratchet Provision”); that is, if the Company issues shares at a price per share (the “Lower Price”) below $0.60 per share (the “Benchmark Price”) then the Company has agreed to issue each investor a predetermined number of additional shares (“Ratchet Shares”) without additional payment from the investor. The Ratchet Shares will lower each investor’s effective purchase price to be equal to either the Lower Price or $0.50 per share (the “Floor Price”), whichever is higher. This provision will last for one year or will end sooner in the event (i) the Company receives $1,000,000 or more in proceeds for the sale of Common Stock at a price equal or greater to the Benchmark Price and (ii) the Company’s trading price exceeds $1.10 for ten consecutive trading days.
As a result, the Company has bifurcated the above mentioned Ratchet Provision and recorded a derivative liability. The fair value of the derivative liability was calculated using a Lattice Model that values the compound embedded derivatives based on future projections of the various potential outcomes. The assumptions that are analyzed and incorporated into the model include expectations of additional potential shares to be issued under the provision, the expectations of future stock price performance, expectations of future issuances based on the Company’s prior stock history, prior issuances of stock, and expected capital requirements. Probabilities were assigned to various scenarios in which the reset provisions would go into effect and weighted accordingly.
Out of the total $1,100,000 raised in the offering, the Company has allocated $141,470 of the proceeds to the Ratchet Provision derivative liability based on the total fair value on the date of issuance. The $141,470 has been recognized as a derivative liability on the date of issuance with all future changes in the fair value of this derivative being recognized in earnings in the Company’s Statement of Operations under the caption “Other income (expense) – Gain (loss) on derivative liability” until such time as the Ratchet Provision expires. The remaining proceeds of $958,530 have been allocated to the common stock and warrants based on their relative fair market values (see Note 7).
ASC 815 requires Company management to assess the fair market value of certain derivatives at each reporting period and recognize any change in the fair market value as an other income or expense item. The Company’s only assets or liabilities measured at fair value on a recurring basis are its derivative liabilities associated with the Ratchet Provision, and Class I warrants. At June 30, 2012, the Company revalued the derivatives and determined that, during the nine months ended June 30, 2012, the Company’s derivative liability decreased by $496,899 to $2,084,021 (excluding the decrease in liability related to the reclassification of the fair market value of the Class H warrants as described above but including the $51,769 gain associated with their revaluation prior to reclassification). The Company recognized a corresponding gain on derivative liability in conjunction with this revaluation.
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