Note 17 – Derivative Financial Instruments and Fair Value

In accordance with ASC 820, “Fair Value Measurements and Disclosures,” the Company applies fair value accounting for all financial assets and liabilities and non-financial assets and liabilities that are recognized or disclosed at fair value in the financial statements on a recurring basis. Fair value is defined as the price that would be received from selling an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. When determining the fair value measurements for assets and liabilities, which are required to be recorded at fair value, the Company considers the principal or most advantageous market in which it would transact and the market-based risk measurements or assumptions that market participants would use in pricing the asset or liability, such as risks inherent in valuation techniques, transfer restrictions and credit risk. Fair value is estimated by applying the following hierarchy, which prioritizes the inputs used to measure fair value into three levels and bases the categorization within the hierarchy upon the lowest level of input that is available and significant to the fair value measurement:

The estimated fair value of financial instruments is determined by the Company using available market information and valuation methodologies considered to be appropriate. At June 30, 2018 and December 31, 2017, the carrying value of the Company’s accounts receivable, accounts payable and accrued expenses approximate their fair values due to their short-term nature.

The following table sets forth the financial assets and liabilities carried at fair value measured on a recurring basis as of December 31, 2017 and June 30, 2018:

For the three and six months ended June 30, 2018, total income (loss) on instruments valued using Level 3 valuations was $44.2 million and ($95.6) million, respectively.

The Company utilized the following methods to value its derivative liabilities for the six months ended June 30, 2018: (i) for embedded conversion options valued at $507,438, the Company determined the fair value by comparing the discounted conversion price per share (85% of market price) multiplied by the number of shares issuable at the balance sheet date to the actual price per share of the Company’s common stock multiplied by the number of shares issuable at that date with the difference in value recorded as a liability; (ii) for warrants valued at $102.4 million, the Company determined the fair value by using a binomial model and monte carlo simulations; and (iii) for warrants valued at $12,999 and embedded conversion options valued at $56,803, the Company determined the fair value using the Black-Scholes option pricing model. In addition, the Company valued the modification in the term of the March 2017 Series B Warrants at $256,417 using the Black-Scholes option pricing model. All inputs for the derivative liabilities are observable and, therefore, there is no sensitivity in the valuation to unobservable inputs.

The following table reconciles the changes in the liabilities categorized within Level 3 of the fair value hierarchy for the six months ended June 30, 2018:

*In addition to the loss on change in fair value of debentures and warrants, during the six months ended June 30, 2018, the Company recorded a loss on the exchange of convertible debentures into shares of its Series I-2 Preferred Stock of $651,560.

The increase in the fair value of the derivative liabilities is primarily due to the increase in the number of warrants issuable as a result of ratchet provisions and the increase in the spread between the price of the Company’s common stock and the exercise prices of the derivatives. Because the exercise price of a significant portion of the Company’s outstanding warrants is at $0.0018 per share on June 30, 2018, and subject to further reduction in the event of future issuances at lower than $0.0018 per share, the fair value of the warrants increased significantly during the six months ended June 30, 2018.