12. DERIVATIVE FINANCIAL INSTRUMENTS |
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| Derivative Financial Instruments | |||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
| Derivative financial instruments |
The Company evaluates its convertible debt, warrants or other contracts to determine if those contracts or embedded components of those contracts qualify as derivatives to be separately accounted for in accordance with paragraph 810-10-05-4 of the FASB Accounting Standards Codification and paragraph 815-40-25 of the FASB Accounting Standards Codification. The result of this accounting treatment is that the fair value of the embedded derivative is marked-to-market each balance sheet date and recorded as a liability. The change in fair value is recorded in the Consolidated Statement of Operations as other income or expense. Upon conversion or exercise, as applicable, of a derivative instrument, the instrument is marked to fair value at the conversion date and then that fair value is reclassified to equity.
Warrant Liability
During the year ended June 30, 2013, the Company determined that it did not have sufficient authorized shares of common stock to settle its equity indexed instruments. Accordingly, the Company recorded a warrant liability in the amount of $8,228,882 as of March 31, 2013. The following table summarizes the Companys activity and fair value calculations of its derivative warrants.
Certain of the Companys warrants were valued using the Black-Scholes option pricing model with the following assumptions:
The derivatives at June 30, 2012 included embedded derivatives deriving from the Companys Asher notes issued in 2010 which had variable conversion rates based on market prices and reset provisions to the exercise price and conversion price if the Company issued equity or other derivatives at a price less than the exercise price set forth in the notes. Since the Asher notes converted at a percent of market, there was an indeterminable number of shares that could be issued upon conversion.
Warrants that have a sliding scale exercise price were valued using a binomial lattice option valuation technique using the following assumptions:
The Company estimates expected term based on the contractual remaining term, allocated among twelve equal intervals for purposes of calculating other inputs such as volatility and risk-free rate. Volatility is based upon historical stock prices over ranges of dates consistent with the projected term of the warrant. The risk free rates represent yields on zero-coupon U.S. Treasury Securities, over the remaining term of the warrant. Exercise price is based upon the varying exercise price of the warrant over the remaining term.
Compound Embedded Derivatives
The Companys Asher Notes issued in 2010 had variable conversion rates and reset provisions to the conversion price if the Company issued equity or other derivatives at a price less than the conversion price as set forth in such notes. These features resulted in a derivative liability in our financial statements. In addition, due to the indeterminate number of shares to be issued upon conversion of the Asher Notes, the outstanding warrants and preferred shares became tainted derivatives since they may not be equity settled. The Asher Notes were converted to equity during the year ending June 30, 2013.
The Company determined that the compound embedded derivative in its secured convertible note with Sonoran Pacific Resources (see note 11 item (5)) requires bifurcation and liability classification as a derivative financial instrument because it was not considered clearly and closely related to the host debt instrument and was not considered indexed to the Companys own stock. The value of the related liability is $304,699 at June 30, 2014 and was determined to be di minimis at June 30, 2013. The $304,699 change in the fair value of the liability is included in change in fair value of derivative liabilities on the accompanying consolidated statements of operations. The value of the embedded derivative was determined using a flexible Monte Carlo simulation. The variables in the model included; the future stock price, conversion factor, interest conversion factor, and market capitalization prior to and following conversion.
Certain other of the Companys convertible debt includes embedded conversion features or other embedded derivative instruments that were not determined to require bifurcation and liability classification or the value of which was immaterial to the consolidated financial statements.
The following table summarizes the Companys activity and fair value calculations of its compound embedded derivatives:
Compound Embedded Derivatives
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