Note 11 – 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 December 31, 2018 and 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, 2018 and 2017:

The Company reclassified the derivative liability previously reported at December 31, 2017 as long term to current liability. In September 2018, the Company’s board of directors approved two reverse stock splits of the Company’s common stock, one of which was effected on November 12, 2018 (the second was not effected) and which provided sufficient authorized and unissued shares to allow for otherwise equity classified instruments to be classified in equity. As a result, the fair value of these instruments was evaluated for reclassification. As a result of the evaluation, during 2018, the Company reclassified the derivative liabilities previously reported as a current liability to derivative income.

On October 4, 2019, the Board of Directors authorized the issuance and sale of certain shares of Series K Convertible Preferred Stock to Alcimede LLC pursuant to the terms of an Exchange Agreement. The Board considered all options to secure additional financing required to continue operations and determined this authorization to be necessary to secure needed financing in the required time frame. As a result of this authorization, as of the date of filing this report, the Company believes that it has the ability to have sufficient authorized shares of its common stock to cover all potentially dilutive common shares outstanding.

For embedded conversion options, the Company determined the fair value as of December 31, 2018 by comparing the discounted conversion price per share (85% of market price, subject to a floor in certain cases) 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.

During 2018, the Company extended the exercise period of the Series B Warrants twice, once to March 21, 2019 and the second time to June 21, 2019 and recorded an additional discount on the Series B Warrants of approximately $8.6 million as a result of the extensions, $6.4 million of which is included in interest expense in 2018. The Company used the Black Scholes model to calculate the fair value of the warrants as of the modification dates. Using the pre-modification term and related assumptions of risk free rates ranging from 1.91-2.32%, volatility ranging from 184.0-296.3% and weighted average remaining life of .33 years, and the post-modification term and related assumptions of risk free rates ranging from 2.09-2.56%, volatility ranging from 208.2-249.1% and weighted average remaining life of .65 years, the change in the fair value of the warrant instruments as a result of the modifications was estimated on each date.

The following table reconciles the changes in the liabilities categorized within Level 3 of the fair value hierarchy for the year ended December 31, 2018:

*In addition to the gain on change in fair value of debentures and warrants of $15.2 million during the year ended December 31, 2018, the Company recorded a loss on the exchange of convertible debentures into shares of its Series I-2 Preferred Stock of approximately $1.5 million, as more fully discussed in Note 13.

During 2018, subsequent to the board approval of the reverse splits and the resulting reclassification of the warrants from liabilities to equity and in some cases subsequent to the November 12, 2018 reverse stock split, the conversion of certain convertible notes and preferred stock and or the exercise of warrants triggered a further reduction in the exercise prices of any debentures and warrants containing ratchet features that had not already ratcheted down to their floor. In accordance with US GAAP, the incremental fair value of the debentures and warrants was measured, ignoring the down-round provision, using Black Scholes. The incremental value of $231.8 million and $53.3 million was recorded as a deemed dividend for the years ended December 31, 2018 and 2017, respectively. The following assumptions were utilized in the valuation models to determine the incremental value and fair value changes: risk free rates ranging from 2.47-2.98%, volatility ranging from 167-257% and a weighted-average remaining life of 2.87 years. Deemed dividends are also discussed in Notes 2 and 3.

For the year ended December 31, 2018, total gain realized on instruments valued using Level 3 valuations was $15.2 million. For the year ended December 31, 2017, total loss realized on instruments valued using Level 3 valuations was $12.4 million. In addition, during the year ended December 31, 2018, the Company recorded a loss on the exchange of convertible debentures into shares of its Series I-2 Preferred Stock of approximately $1.5 million.