WARRANT LIABILITY

6 Months Ended

Jan. 25, 2014

WARRANT LIABILITY

In connection with the issuance of the Company’s Series B Convertible Preferred Stock on March 15, 2013, the Company issued a warrant that contains a “down round” anti-dilution adjustment. This warrant is referred to as the “Series A Preferred Stock Coverage Warrant”, and it may be exercised to purchase up to 5,468,127 shares of common stock at an exercise price of $0.01 per share. The Series A Preferred Stock Coverage Warrant may only be exercised, in whole or in part, upon conversion of the Company’s Series A Convertible Preferred Stock. The “down round” anti-dilution adjustment provides for the number of shares underlying the warrant to be increased if the Company issues or sells any additional shares of common stock at a price per share less than the then applicable conversion price of the Series A Convertible Preferred Stock (or Series A Convertible Preferred Stock dividend). Because this down-round provision is a guarantee of value, the Series A Preferred Stock Coverage Warrant is required to be classified as a derivative for accounting purposes, and reported as a liability and marked to market at each balance sheet date.

The original amount of the liability related to the Series A Preferred Stock Coverage Warrant was $3,782,697 and was recorded as a warrant liability on the Issuance Date. Because the Series A Preferred Stock Coverage Warrant was recorded as a warrant liability, the portion of proceeds from the sale of the Series B Convertible Preferred Stock that was recorded as equity was reduced accordingly.

The Company estimates the value of the warrant liability upon the issuance of the Series A Preferred Stock Coverage Warrant and at each balance sheet date using the binomial lattice model to allocate total enterprise value to the warrant. The following table is a roll-forward of the warrant liability:

Level 3 Change in Fair Value
Level 3 fair value of warrant liability at March 15, 2013 (issuance date)	$	3,783,000
(Gain) as a result of change in fair value		(381,000)
Level 3 fair value of warrant liability at July 27, 2013		3,402,000
Loss as a result of change in fair value		814,000
Level 3 fair value as of October 26, 2013		4,216,000
Loss as a result of change in fair value		773,000
Level 3 fair value as of January 25, 2014	$	4,989,000

The loss on the warrant liability for the three and six months ended January 25, 2014 was $773,000 and $1,587,000 and is included in the accompanying consolidated statement of operations.

The warrant liability is measured at fair value using certain estimated inputs, which are classified within Level 3 of the valuation hierarchy. The following assumptions were used in the fair value measurement as of January 25, 2014, October 26, 2013, July 27, 2013 and March 15, 2013 (issuance date):

	January 25, 2014			October 26, 2013			July 27, 2013			(issuance date) March 15, 2013
Fair value of underlying stock – per share	$	0.26		$	0.22		$	0.18		$	0.20
Risk-free interest rate		2.04	%		2.04	%		2.04	%		2.04	%
Expected life (years)		15			15			15			15
Expected volatility		70	%		70	%		70	%		70	%
Dividend yield		0.0	%		0.0	%		0.0	%		0.0	%

FREDERICK'S OF HOLLYWOOD GROUP INC /NY/ 10-Q