NOTE 9 – FAIR VALUE MEASUREMENT AND DERIVATIVES

The Company measures fair value in accordance with a fair value hierarchy that prioritizes the inputs to valuation techniques used to measure fair value. The hierarchy gives the highest priority to unadjusted quoted prices in active markets for identical assets or liabilities (Level 1 measurements) and the lowest priority to unobservable inputs (Level 3 measurements). The three levels of the fair value hierarchy are described below:

All derivatives recognized by the Company are reported as derivative liabilities on the consolidated balance sheets and are adjusted to their fair value at each reporting date. Unrealized gains and losses on derivative instruments are included in change in value of derivative liabilities on the consolidated statements of operations.  

The following two tables set forth the Company’s consolidated financial assets and liabilities measured at fair value by level within the fair value hierarchy at December 31, 2016 and 2015. Assets and liabilities are classified in their entirety based on the lowest level of input that is significant to the fair value measurement.

There were no transfers between levels during the year ended December 31, 2016.

As part of the Merger, the Company assumed debentures that are convertible into shares of common stock, which Anpath issued in July 2014 (see Note 8). The debentures conversion price will be adjusted depending on various circumstances. The conversion options embedded in these instruments contain no explicit limit to the number of shares to be issued upon settlement and as a result are classified as liabilities under ASC 815. Additionally, the Company issued in connection with the debentures 415,000 warrants to purchase the Company’s common stock.  The conversion price will be adjusted depending on various circumstances, and as there is no explicit limit to the number of shares to be issued upon settlement they are classified as liabilities under ASC 815. 

The terms of the convertible redeemable preferred stock (see Note 10) include an anti-dilution provision that requires an adjustment in the common stock conversion ratio should subsequent issuances of the Company’s common stock be issued below the instruments’ original conversion price of $0.26 per share, subject to certain defined excluded issuances. In 2015 per a modification agreement with the holder, the conversion price was reset to $0.21. Accordingly, we bifurcated the embedded conversion feature, which is shown as a derivative liability recorded at fair value on the consolidated balance sheet.

The agreement setting forth the terms of the common stock warrants issued to the holders of the convertible preferred stock (see Note 10) also includes an anti-dilution provision that requires a reduction in the warrant’s exercise price of $0.50 should the conversion ratio of the convertible preferred stock be adjusted due to anti-dilution provisions. Accordingly, the warrants do not qualify for equity classification, and, as a result, the fair value of the derivative is shown as a derivative liability on the consolidated balance sheet.

During 2016, the two debenture holders converted a total of $270,750 of their debentures for 1,289,285 shares of common stock. Pursuant to the conversion of these debentures, the Company reclassified a total of $125,975 of derivative liabilities to additional paid in capital during 2016. The changes in fair value of these derivative liabilities were recorded in the consolidated statement of operations until the date of conversion.

The following tables present a reconciliation of the beginning and ending balances of items measured at fair value on a recurring basis that use significant unobservable inputs (Level 3) and the related realized and unrealized (gains) losses recorded in the consolidated statements of operations during the period:

The Company’s derivative liabilities are valued by using Monte Carlo Simulation methods, which simulate a range of possible future stock prices and estimates the probabilities and timing of future financing events. Where possible, the Company verifies the values produced by its pricing models to market prices. Valuation models require a variety of inputs, including contractual terms, market prices, yield curves, credit spreads, measures of volatility and correlations of such inputs. These derivative liabilities do not trade in liquid markets, and as such, model inputs cannot generally be verified and do involve significant management judgment. Such instruments are typically classified within Level 3 of the fair value hierarchy. The following assumptions were used to value the Company’s derivative liabilities at December 31, 2016: dividend yield of -0-%, volatility of 63.86 – 115.9%, risk free rates of 0.85 - 1.93% and an expected term of 0.6 years to 4.0 years.

During 2016, the Company continues to refine its estimates and has updated the volatility used in its valuation models and the underlying number of shares of common stock for the derivative warrants. The net impact of these adjustments resulted in a $117,456 decrease in the fair value of derivative liabilities during the year ended December 31, 2016, which could have been reflected as part of the estimated fair value of these derivative liabilities at December 31, 2015. However, the Company recorded these true-up adjustments during 2016 given the inherent estimated nature of Level 3 fair value measures.  The Company recorded a total gain of $808,011 and loss of $131,530 for the change in fair value of all the Level 3 derivatives during the years ended December 31, 2016 and 2015, respectively.