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Note 4—Fair Value of Financial Instruments
Financial assets and liabilities are measured at fair value, which is defined 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. Valuation techniques used to measure fair value must maximize the use of observable inputs and minimize the use of unobservable inputs. The following is a fair value hierarchy based on three levels of inputs, of which the first two are considered observable and the last unobservable, that may be used to measure fair value:
·Level 1 — Quoted prices in active markets for identical assets or liabilities.
·Level 2 — Inputs other than Level 1 that are observable, either directly or indirectly, such as quoted prices for similar assets or liabilities; quoted prices in markets that are not active; or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the assets or liabilities.
·Level 3 — Unobservable inputs that are supported by little or no market activity and that are significant to the fair value of the assets or liabilities.
As of October 31, 2011 and 2010, cash and cash equivalents were comprised of cash in checking accounts.
In conjunction with the June Private Placement, the Company issued warrants with derivative features. These instruments are accounted for as derivative liabilities (see Note 7).
The Company used Level 3 inputs for its valuation methodology for the warrant derivative liabilities. The estimated fair values were determined using a Monte Carlo option pricing model based on various assumptions (see Note 7). The Company’s derivative liabilities are adjusted to reflect estimated fair value at each period end, with any decrease or increase in the estimated fair value being recorded in other income or expense accordingly, as adjustments to fair value of derivative liabilities.
At October 31, 2011 and July 31, 2011, the estimated fair values of the liabilities measured on a recurring basis are as follows:
Fair Value Measurements at October 31, 2011
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Balance at October,
31, 2011
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Quoted Prices in
Active Markets
(Level 1)
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|
Significant Other
Observable Inputs
(Level 2)
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|
Significant Other
Unobservable
Inputs (Level 3)
|
|
|
Warrant derivative liability — Series A and Series C Warrants
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|
$
|
872,967
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|
—
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|
—
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|
$
|
872,967
|
|
|
|
|
|
|
|
|
|
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|
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Fair Value Measurements at July 31, 2011
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|
|
Balance at July,
31, 2011
|
|
Quoted Prices in
Active Markets
(Level 1)
|
|
Significant Other
Observable Inputs
(Level 2)
|
|
Significant Other
Unobservable
Inputs (Level 3)
|
|
|
Warrant derivative liability — Series A and Series C Warrants
|
|
$
|
4,850,385
|
|
—
|
|
—
|
|
$
|
4,850,385
|
|
|
|
|
|
|
|
|
|
|
|
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The following table presents the activity for liabilities measured at estimated fair value using unobservable inputs for the three months ended October 31, 2011:
Fair Value Measurements Using Significant Unobservable Inputs (Level 3)
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Warrant Derivative Liability
|
|
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Beginning balance at July 31, 2011
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|
$
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4,850,385
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|
|
|
|
|
|
|
Issuances
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|
—
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|
|
|
|
|
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Adjustments to estimated fair value
|
|
(3,977,418
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)
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|
|
|
|
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Ending balance at October 31, 2011
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|
$
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872,967
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During the period ended October 31, 2011, the estimated fair value of derivative liabilities decreased by $3,977,418, which was recorded as other income during the three months ended October 31, 2011.
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