Derivative Financial Instruments

9 Months Ended

Sep. 30, 2012

9. Derivative Financial Instruments

Effective January 1, 2009, the Company adopted provisions of ASC Topic 815-40, “Derivatives and Hedging: Contracts in Entity’s Own Equity” (“ASC Topic 815-40”). ASC Topic 815-40 clarifies the determination of whether an instrument issued by an entity (or an embedded feature in the instrument) is indexed to an entity’s own stock, which would qualify as a scope exception under ASC Topic 815-10.

Synergy Derivative Financial Instruments

Based upon the Company’s analysis of the criteria contained in ASC Topic 815-40, Synergy has determined that certain warrants issued in connection with sale of its common stock must be classified as derivative instruments. In accordance with ASC Topic 815-40, these warrants are also being re-measured at each balance sheet date based on estimated fair value, and any resultant changes in fair value is being recorded in the Company’s statement of operations. The Company estimates the fair value of certain warrants using the Black-Scholes option pricing model in order to determine the associated derivative instrument liability and change in fair value described above. The range of assumptions used to determine the fair value of the warrants at each period end during the periods indicated below were:

	January 1, 2012 to May 9, 2012 (1)		Nine Months Ended September 30, 2011
Estimated fair value of Synergy common stock	$4.05-$4.75		$2.56-$3.30
Expected warrant term	2.4 - 5.7 years		5 - 7 years
Risk-free interest rate	0.32%-1.33	%	1.18%-2.5	%
Expected volatility	60	%	90	%
Dividend yield	—		—

(1) Synergy’s assets and liabilities have been deconsolidated as of May 9, 2012 and as a result there was no derivative instrument liability on the balance sheet as of September 30 2012. Changes in fair values of Synergy derivative instruments have been recorded through May 9, 2012.

Estimated fair value of stock is the closing market price of the Company’s common stock on the date of warrant issuance and at the end of each reporting period when the derivative instruments are marked to market. Expected volatility is based on historical volatility of Synergy’s common stock. The warrants have a transferability provision and based on guidance provided in SAB 107 for instruments issued with such a provision, Synergy used the full contractual term as the expected term of the warrants. The risk free rate is based on the U.S. Treasury security rates for maturities consistent with the expected remaining term of the warrants and the date of grant or quarterly revaluation.

Certain of Synergy’s warrants issued during the nine months ended September 30, 2011 contained a price protection clause which variable term required the Company to use a binomial model to determine fair value. There were no such price protected warrants issued during the nine months ended September 30, 2012. The range of assumptions used to determine the fair value of the warrants was as follows:

	Jan 1 to May 9, 2012	Nine months ended, September 30, 2011
Estimated fair value of stock	$3.28 - $4.50	$2.72 - $3.78
Expected warrant term	4.4 — 4.6 years	6.59 - 7 years
Risk-free interest rate	0.72% - 1.03%	1.18% - 2.50%
Expected volatility	60%	90%
Dividend yield	—	—

In the Binomial model, the assumption for estimated fair value of the stock is based on a Black-Scholes based apportionment of the unit price paid for the shares and warrants issued in Synergy’s most recent registered direct offerings, which resulting stock prices were deemed to be arms-length negotiated prices. Expected volatility is based on historical volatility of Synergy’s common stock. The warrants have a transferability provision and based on guidance provided in SAB 107 for instruments issued with such a provision, Synergy used the full contractual term as the expected term of the warrants. The risk free rate is based on the U.S. Treasury security rates for maturities consistent with the expected remaining term of the warrants.

The following table sets forth the components of changes in the Synergy’s derivative financial instruments liability balance for the periods indicated:

Date	Description	Warrants		Derivative Instrument Liability
12/31/2010	Balance of derivative financial instruments liability	728,469		$	3,487,959
3/31/2011	Fair value of new warrants issued during the quarter	210,000		$	1,312,673
3/31/2011	Change in fair value of warrants during the quarter recognized as other expense in the statement of operations	—		$	338,715
3/31/2011	Balance of derivative financial instruments liability	938,469		$	5,139,347
6/30/2011	Fair value of new warrants issued during the quarter	611,207		$	2,607,827
6/30/2011	Exercise of warrants during the quarter	(80,000	)	$	(486,328	)
6/30/2011	Change in fair value of warrants during the quarter recognized as other expense in the statement of operations	—		$	697,660
6/30/2011	Balance of derivative financial instruments liability	1,469,676		$	7,958,506
9/30/2011	Fair value of new warrants issued during the quarter	40,458		$	285,128
9/30/2011	Change in fair value of warrants during the quarter recognized as other income in the statement of operations	—		$	(4,382,796	)
9/30/2011	Balance of derivative financial instruments liability	1,510,134		$	3,860,838
12/31/2011	Fair value of new warrants issued during the quarter	1,810,294		$	3,082,203
12/31/2011	Reclass of derivative liability to equity during the quarter	(1,055,268	)	$	(1,707,317	)
12/31/2011	Change in fair value of warrants during the quarter recognized as other income in the statement of operations	—		$	(1,910,610	)
12/31/2011	Balance of derivative financial instruments liability	2,265,160		$	3,325,114
3/31/2012	Change in fair value of warrants during the quarter recognized as other income in the statement of operations	—		(7,946		)
3/31/2012	Balance of derivative financial instruments liability	2,265,160		3,317,168

5/9/12	Change in fair value of warrants during the quarter recognized as other income in the statement of operations	—		439,116
5/9/12	Reclassification due to deconsolidation	(2,265,160	)	(3,756,284		)

9/30/2012	Balance of derivative financial instruments liability	—		—

Synergy Fair Value Measurements

The following table presents the Company’s liabilities that are measured and recognized at fair value on a recurring basis classified under the appropriate level of the fair value hierarchy as of December 31, 2011 and September 30, 2012:

Description	Quoted Prices in Active Markets for Identical Assets and Liabilities (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)		Balance as of December 31, 2011		Quoted Prices in Active Markets for Identical Assets and Liabilities (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)		Balance as of September 30, 2012
Derivative liabilities related to Warrants	$	—	$	—	$	3,325,114	$	3,325,114	$	—	$	—	$	—	$	—	*

The following table sets forth a summary of changes in the fair value of the Company’s Level 3 liabilities for the six months ended September 30, 2012:

Description	Balance at December 31, 2011		Fair Value of warrants upon issuance		Unrealized (gains) or losses		Balance as of September 30, 2012 (*)
Derivative liabilities related to Warrants	$	3,325,114	$	—	$	—	$	—

(*) Synergy’s assets and liabilities have been deconsolidated as of May 9, 2012 and as a result there was no derivative instrument liability on the Callisto’s balance sheet as of September 30 2012. Changes in fair values of Synergy derivative instruments have been recorded through May 9, 2012.

The unrealized gains or losses on the derivative liabilities are recorded as a change in fair value of derivative liabilities in the Company’s statement of operations. A financial instrument’s level within the fair value hierarchy is based on the lowest level of any input that is significant to the fair value measurement. At each reporting period, the Company reviews the assets and liabilities that are subject to ASC Topic 815-40. At each reporting period, all assets and liabilities for which the fair value measurement is based on significant unobservable inputs or instruments which trade infrequently and therefore have little or no price transparency are classified as Level 3.

CALLISTO PHARMACEUTICALS INC 10-Q