Quarterly report pursuant to Section 13 or 15(d)

FAIR VALUE OF FINANCIAL INSTRUMENTS

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FAIR VALUE OF FINANCIAL INSTRUMENTS
9 Months Ended
Sep. 30, 2017
Derivative Instruments and Hedging Activities Disclosure [Abstract]  
FAIR VALUE OF FINANCIAL INSTRUMENTS

4.           FAIR VALUE OF FINANCIAL INSTRUMENTS

 

The Company measures the fair value of financial assets and liabilities based on the guidance of ASC 820 “Fair Value Measurements and Disclosures” which defines fair value, establishes a framework for measuring fair value, and expands disclosures about fair value measurements. ASC 820 defines fair value as the exchange price that would be received for an asset or paid to transfer a liability (an exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date. ASC 820 also establishes a fair value hierarchy, which requires an entity to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value.

 

ASC 820 describes 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 — quoted prices for similar assets and liabilities in active markets or inputs that are observable

 

  Level 3 — inputs that are unobservable based on an entity’s own assumptions, as there is little, if any, related market activity (for example, cash flow modeling inputs based on assumptions)
 

Financial liabilities as of September 30, 2017 measured at fair value on a recurring basis are summarized below:

 

    September 30,
2017
    Quoted Prices
in Active
Markets for
Identical Assets
(Level 1)
    Significant
Other
Observable
Inputs
(Level 2)
    Significant
Unobservable
Inputs
(Level 3)
 
                         
Derivative liability   $ 798,503     $     $     $ 798,503  
Warrant liability     1,474,139                   1,474,139  
Total   $ 2,272,642     $     $     $ 2,272,642  

 

Financial liabilities as of December 31, 2016 measured at fair value on a recurring basis are summarized below:

 

    December 31,
2016
    Quoted Prices
in Active
Markets for
Identical Assets
(Level 1)
    Significant
Other
Observable
Inputs
(Level 2)
    Significant
Unobservable
Inputs
(Level 3)
 
                         
Derivative liability   $ 1,234,106     $     $     $ 1,234,106  
Warrant liability     1,093,765                   1,093,765  
Total   $ 2,327,871     $     $     $ 2,327,871  

 

The Company determined that certain conversion/exercise option related to a convertible note and issued warrants did not have fixed settlement provisions and are deemed to be derivative financial instruments, since the conversion/exercise prices was subject to reset adjustment should the Company issue any option to acquire the Company’s common stock lower than the conversion /exercise price. Accordingly, the Company was required to record such conversion/exercise options as a liability and mark such derivative to fair value each reporting period. Such instrument was classified within Level 3 of the valuation hierarchy.

 

The fair value of the conversion/exercise options were calculated using a binomial lattice formula with the following assumptions during the nine months ended September 30, 2017:

 

Conversion option:

 

    September 30,  
    2017  
Common Stock Closing Price   $ 0.05 to 0.07  
Conversion Price per Share   $ 0.075 to 0.10  
Conversion Shares       21,666,666  
Call Option Value       0.034 to 0.057  
Dividend Yield       0.00 %
Volatility       208.8 to 214.3 %
Risk-free Interest Rate       1.03 to 1.47 %
Term       0.87 to 2 years  

 

Exercise option:

 

    September 30,  
    2017  
Common Stock Closing Price   $ 0.05 to 0.07  
Conversion Price per Share   $ 0.10 to 0.15  
Conversion Shares       27,000,000  
Call Option Value       0.048 to 0.072  
Dividend Yield       0.00 %
Volatility       208.8 to 214.3 %
Risk-free Interest Rate       1.62 to 1.93 %
Term       3.87 to 5 years  

 

The risk-free interest rate is the United States Treasury rate on the measurement date having a term equal to the remaining contractual life of the instrument. The volatility is a measure of the amount by which the Company’s share price has fluctuated or is expected to fluctuate. The dividend yield is 0% as the Company has not made any dividend payment and has no plans to pay dividends in the foreseeable future.

 

Level 3 liabilities are valued using unobservable inputs to the valuation methodology that are significant to the measurement of the fair value of the derivative liabilities. For fair value measurements categorized within Level 3 of the fair value hierarchy, the Company’s Chief Financial Officer, who reports to the Chief Executive Officer, determine its valuation policies and procedures.

 

The development and determination of the unobservable inputs for Level 3 fair value measurements and fair value calculations are the responsibility of the Company’s Chief Financial Officer and are approved by the Chief Executive Officer.

 

Level 3 financial liabilities consist of the derivative liabilities for which there is no current market for these securities such that the determination of fair value requires significant judgment or estimation. Changes in fair value measurements categorized within Level 3 of the fair value hierarchy are analyzed each period based on changes in estimates or assumptions and recorded as appropriate.

 

Significant observable and unobservable inputs include stock price, exercise price, annual risk free rate, term, and expected volatility, and are classified within Level 3 of the valuation hierarchy. An increase or decrease in volatility or interest free rate, in isolation, can significantly increase or decrease the fair value of the derivative liabilities. Changes in the values of the derivative liabilities are recorded as a component of other income (expense) on the Company’s condensed statements of operations.

 

The following table sets forth a summary of the changes in the fair value of the Company’s Level 3 financial liabilities that are measured at fair value on a recurring basis using significant unobservable input for the nine months ended September 30, 2017:

 

    Debt     Warrant  
    Derivative     Liability  
Balance, December 31, 2016   $ 1,234,106     $ 1,093,765  
Aggregate amount of derivative instruments issued     85,381       551,558  
Transferred in due to conversions     14,551        
Change in fair value of derivative liabilities     (535,535 )     (171,184 )
Balance, September 30, 2017   $ 798,503     $ 1,474,139  

 

The Company’s sequencing policy requires that the instruments prioritized based on issued options, warrants, preferred stock, convertible debt and other convertible instruments would be settled first. The sequencing policy also considers contingently issuable additional shares, such as the convertible notes; which have variable terms based upon the Company’s common stock price, to have an issuance date to coincide with the event giving rise to the additional shares. Using this sequencing policy, debt instruments convertible into common stock are derivative liabilities.

 

In accordance with the sequencing policy and based on ASC 815-10-15-74, stock warrants issued in connection with debt and other convertible securities are considered by the company as a derivative, as the put option underlying these warrants are “tainted” derivatives after considering the Company’s outstanding convertible notes and its sequencing policy.