Financial Instruments

6 Months Ended

Jun. 30, 2016

NOTE 13 – FINANCIAL INSTRUMENTS

Fair Value Measurements

Fair value is defined as the price that would be received from selling an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. When determining the fair value measurements for assets and liabilities that are required to be recorded at fair value, the Company considers the principal or most advantageous market in which it would transact and the market-based risk measurements or assumptions that market participants would use in pricing the asset or liability, such as inherent risk, transfer restrictions and credit risk.

The Company applies the following fair value hierarchy, which prioritizes the inputs used to measure fair value into three levels and bases the categorization within the hierarchy upon the lowest level of input that is available and significant to the fair value measurement:

Level 1 – Quoted prices in active markets for identical assets or liabilities.

Level 2 – Observable inputs other than quoted prices in active markets for identical assets and liabilities, quoted prices for identical or similar assets or liabilities in inactive markets, 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 – Inputs that are generally unobservable and typically reflect management’s estimates of assumptions that market participants would use in pricing the asset or liability.

During the six months ended June 30, 2016 and the year ended December 31, 2015, the SNC Note (which the Company elected to be accounted for at fair value), the bifurcated embedded option in other convertible notes and the warrant liabilities were valued using Level 3 inputs. The changes in fair value of the SNC Note, the bifurcated embedded option in the convertible notes and the warrant liability during the six months ended June 30, 2016 and the year ended December 31, 2015 are reflected in the changes in fair value of derivative and other fair valued instruments in the Company’s statement of operations.

As of June 30, 2016 the fair value of the convertible subordinated debt was determined using a discounted cash flow model. The fair value of the November 2013 Warrants and the bifurcated embedded option in the convertible notes were determined using various Monte Carlo simulations.

The following table summarizes our financial assets and liabilities measured at fair value as presented in the balance sheets as of June 30, 2016 and December 31, 2015 (in thousands):

	June 30, 2016						December 31, 2015
	Level 1		Level 2		Level 3		Level 1		Level 2		Level 3

Liabilities:
Subordinated debt	$	—	$	—	$	263	$	—	$	—	$	—
Bifurcated option in convertible notes	$	—	$	—	$	3,821	$	—	$	—	$	—
Warrant liabilities	$	—	$	—	$	1,582	$	—	$	—	$	—

The following is a summary of activity of Level 3 liabilities for the six months ended June 30, 2016:

	SNC Note		Bifurcated embedded option in convertible notes			Warrant liabilities
Balance at December 31, 2015	$	-	$	-		$	-
Recapitalization		249		3,842			1,439
Issuance of additional debt				88			206
Conversion of notes into share of common stock
Losses (gains) included in net loss		14		(109	)		(63	)
Balance at June 30, 2016	$	263	$	3,821		$	1,582

VERITEQ 10-Q