Annual report pursuant to Section 13 and 15(d)

Fair Value Measurement

Fair Value Measurement
12 Months Ended
Dec. 31, 2018
Fair Value Disclosures [Abstract]  
Fair Value Measurement



The Company adopted the provisions of Accounting Standards Codification subtopic 825-10, Financial Instruments (“ASC 825-10”) on January 1, 2008. ASC 825-10 defines fair value 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 required or permitted to be recorded at fair value, the Company considers the principal or most advantageous market in which it would transact and considers assumptions that market participants would use when pricing the asset or liability, such as inherent risk, transfer restrictions, and risk of nonperformance. ASC 825-10 establishes a fair value hierarchy that requires an entity to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value. ASC 825-10 establishes three levels of inputs that may be used to measure fair value:


Level 1 – Quoted prices in active markets for identical assets or liabilities.


Level 2 – Observable inputs other than Level 1 prices such as quoted prices for similar assets or liabilities; quoted prices in markets with insufficient volume or infrequent transactions (less active markets); or model-derived valuations in which all significant inputs are observable or can be derived principally from or corroborated by observable market data for substantially the full term of the assets or liabilities.


Level 3 – Unobservable inputs to the valuation methodology that are significant to the measurement of fair value of assets or liabilities.


All items required to be recorded or measured on a recurring basis are based upon level 3 inputs.


To the extent that valuation is based on models or inputs that are less observable or unobservable in the market, the determination of fair value requires more judgment. In certain cases, the inputs used to measure fair value may fall into different levels of the fair value hierarchy. In such cases, for disclosure purposes, the level in the fair value hierarchy within which the fair value measurement is disclosed and is determined based on the lowest level input that is significant to the fair value measurement.


Upon adoption of ASC 825-10, there was no cumulative effect adjustment to beginning retained earnings and no impact on the financial statements.


The carrying value of the Company’s cash and cash equivalents, accounts receivable, accounts payable, short-term borrowings (including convertible notes payable), and other current assets and liabilities approximate fair value because of their short-term maturity.


As of December 31, 2018 and 2017, the Company did not have any items that would be classified as level 1 or 2 disclosures.


The Company recognizes its derivative liabilities as level 3 and values its derivatives using the methods discussed in note 6. While the Company believes that its valuation methods are appropriate and consistent with other market participants, it recognizes that the use of different methodologies or assumptions to determine the fair value of certain financial instruments could result in a different estimate of fair value at the reporting date. The primary assumptions that would significantly affect the fair values using the methods discussed in Notes 4 and 5 are that of volatility and market price of the underlying common stock of the Company.


As of December 31, 2018 and 2017, the Company did not have any derivative instruments that were designated as hedges.


The combined derivative and warrant liability as of December 31, 2018 and 2017, in the amounts of $2,256,631 and $7,793,732, respectively, have a level 3 classification.


The following table provides a summary of changes in fair value of the Company’s Level 3 financial liabilities for the two years ended December 31, 2018:








Balance, January 1, 2017   $ —       $ —    
Initial fair value of debt derivative at note issuance     —         3,383,913  
Initial fair value of warrant liability at issuance     3,407,900          
Mark-to-market at December 31, 2017     2,731,734       1,073,729  
Transfers out of Level 3 upon conversion or payoff of notes payable     (279,999)       (1,826,267)  
Balance, December 31, 2017   $ 5,859,635     $ 2,631,375  
Total (gains) losses                
Initial fair value of debt derivative at note issuance     —         4,403,740  
Mark-to-market at December 31, 2018:     —         (1,333,636 )
Transfers out of Level 3 upon conversion or payoff of notes payable or cancellation of warrant     (5,859,635 )     (3,368,855 )
Balance, December 31, 2018   $ —       $ 2,332,624  
Net gain for the period included in earnings relating to the liabilities held during the period ended December 31, 2018   $ —       $ 1,333,636  


Fluctuations in the Company’s stock price are a primary driver for the changes in the derivative valuations during each reporting period. During the period ended December 31, 2018, the Company’s stock price increased significantly from initial valuations. As the stock price increases for each of the related derivative instruments, the value to the holder of the instrument generally increases. Stock price is one of the significant unobservable inputs used in the fair value measurement of each of the Company’s derivative instruments.


As described in Notes 7 and 8, the Company issued convertible notes and warrants that contained conversion features and a reset provisions. The accounting treatment of derivative financial instruments requires that the Company record fair value of the derivatives as of the inception date and to fair value as of each subsequent reporting date.