News Column

WAFERGEN BIO-SYSTEMS, INC. - 10-Q - Management's Discussion and Analysis of Financial Condition and Results of Operations

May 14, 2014

The following discussion highlights the principal factors that have affected our financial condition and results of operations as well as our liquidity and capital resources for the periods described.

The information contained in this Form 10-Q is intended to update the information contained in our annual report on Form 10-K for the year ended December 31, 2013 (the "Form 10-K"), as filed with the Securities and Exchange Commission, and presumes that readers have access to, and will have read, the "Management's Discussion and Analysis of Financial Condition and Results of Operations," our consolidated financial statements and the notes thereto, and other information contained in the Form 10-K. The following discussion and analysis also should be read together with our condensed consolidated financial statements and the notes thereto included elsewhere in this Form 10-Q.

Forward-Looking Statements

Information included in this Form 10-Q may contain forward-looking statements. Except for the historical information contained in this discussion of the business and the discussion and analysis of financial condition and results of operations, the matters discussed herein are forward looking statements. These forward looking statements include but are not limited to our plans for sales growth and expectations of gross margin, expenses, new product introduction, integration and potential benefits of our recent business acquisition, and our liquidity and capital needs. This information may involve known and unknown risks, uncertainties and other factors which may cause our actual results, performance or achievements to be materially different from future results, performance or achievements expressed or implied by any forward-looking statements. Forward-looking statements, which involve assumptions and describe our future plans, strategies and expectations, are generally identifiable by use of the words "may," "will," "should," "expect," "plan," "anticipate," "estimate," "believe," "intend," "contemplate," "predict," "project," "potential" or "continue" or the negative of these words or other variations on these words or comparable terminology. In addition to the risks and uncertainties described in "Risk Factors" contained in the Form 10-K, these risks and uncertainties may include consumer trends, business cycles, scientific developments, changes in governmental policy and regulation, currency fluctuations, economic trends in the United States and inflation. Forward-looking statements are based on assumptions that may be incorrect, and there can be no assurance that any projections or other expectations included in any forward-looking statements will come to pass. Our actual results could differ materially from those expressed or implied by the forward-looking statements as a result of various factors. Except as required by applicable laws, we undertake no obligation to update publicly any forward-looking statements for any reason, even if new information becomes available or other events occur in the future.

Company Overview and Background

Since beginning operations in 2003, we have been engaged in the development, manufacture and sale of systems for gene expression quantification, genotyping and stem-cell research for the life sciences and pharmaceutical drug discovery industries. Most recently, our R&D efforts have been concentrated on the commercialization of the SmartChip Target Enrichment System. Our products are aimed at researchers who perform genetic analysis and cell biology, primarily at pharmaceutical and biotech companies, academic and private research centers and diagnostics companies involved in biomarker research. We plan to provide new performance standards with significant savings of time and cost for professionals in the field of gene expression research and to facilitate biomarker discovery, toxicology and clinical research through the SmartChip products and services.

Our revenue is subject to fluctuations due to the timing of sales of high-value products and service projects, the impact of seasonal spending patterns, the timing and size of research projects our customers perform, changes in overall spending levels in the life science industry and other unpredictable factors that may affect customer ordering patterns. Any significant delays in the commercial launch or any lack or delay of commercial acceptance of new products, unfavorable sales trends in existing product lines, or impacts from the other factors mentioned above, could adversely affect our revenue growth or cause a sequential decline in quarterly revenue. Due to the possibility of fluctuations in our revenue and net income or loss, we believe that quarterly comparisons of our operating results are not a good indicator of future performance.

Since inception, we have incurred substantial operating losses. As of March 31, 2014, our accumulated deficit was $83,383,784. Losses have principally occurred as a result of the substantial resources required for the research, development and manufacturing start-up costs required to commercialize our initial products. We expect to continue to incur substantial costs for research and development activities for at least the next year as we expand and improve our core technology and its applications in the life science research market.

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Acquisition of Assets from IntegenX Inc.

In January 2014, we entered into an Asset Purchase Agreement with IntegenX Inc. ("IntegenX"), pursuant to which we acquired substantially all of the assets of its product line used in connection with developing, manufacturing, marketing and selling instruments and reagents relating to library preparation for next generation sequencing, including the Apollo 324TM instrument and the PrepXTM reagents (the "Apollo Business"). The purchase price for the Apollo Business comprised (1) a cash payment of $2.0 million, (2) a $1.25 million secured promissory note (the "IntegenX Note"), (3) up to three earn-out payments payable, if at all, in 2015, 2016 and 2017, respectively (the "Earnout"), and (4) our assumption of certain liabilities, including obligations to perform under contracts and liabilities for certain accrued but unpaid vacation for certain employees.

The IntegenX Note accrues interest at 8.0% per year and is payable in a single payment of principal and accrued interest on January 6, 2017. However if, prior to the IntegenX Note's maturity, we complete an equity offering yielding net cash proceeds of at least $15.0 million, we will be required to prepay the IntegenX Note within 45 days of the closing of the equity offering. To secure our obligations under the IntegenX Note, we granted IntegenX a security interest in the assets acquired from them.

The Earnout contemplates three earn-out payments based on gross revenues from certain products of the Apollo Business ("Covered Revenues"). In particular:

If, in 2014, Covered Revenues exceed $4 million but are less than $6 million, we will pay IntegenX an amount equal to 15% of the amount by which the 2014 Covered Revenues exceed $4 million. If, in 2014, Covered Revenues exceed $6 million, we will pay IntegenX an amount equal to the sum of (i) $300,000 plus (ii) 20% of the amount by which the 2014 Covered Revenues exceed $6 million. If, in 2015, Covered Revenues exceed $4 million but are less than $6 million, we will pay IntegenX an amount equal to 10% of the amount by which the 2015 Covered Revenues exceed $4 million. If, in 2015, Covered Revenues exceed $6 million but are less than $10 million, we will pay IntegenX an amount equal to the sum of (i) $200,000 plus (ii) 15% of the amount by which the 2015 Covered Revenues exceed $6 million. If, in 2015, Covered Revenues exceed $10 million, we will pay IntegenX an amount equal to (i) $800,000 plus (ii) 20% of the amount by which the 2015 Covered Revenues exceed $10 million. If, in 2016, Covered Revenues exceed $4 million but are less than $10 million, we will pay IntegenX an amount equal to 10% of the amount by which the 2016 Covered Revenues exceed $4 million. If, in 2016, Covered Revenues exceed $10 million but are less than $15 million, we will pay IntegenX an amount equal to the sum of (i) $600,000 plus (ii) 15% of the amount by which the 2016 Covered Revenues exceed $10 million. If, in 2016, Covered Revenues exceed $15 million, we will pay IntegenX an amount equal to (i) $1.35 million plus (ii) 20% of the amount by which the 2016 Covered Revenues exceed $15 million. 20



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Results of Operations

The following table presents selected items in the condensed consolidated statements of operations for the three months ended March 31, 2014 and 2013, respectively: Three Months Ended March 31, 2014 2013 Revenue: Product $ 1,280,513$ 95,154 License and royalty 125,000 83,333 Total revenue 1,405,513 178,487 Cost of product revenue 606,573 65,588 Gross profit 798,940 112,899 Operating expenses: Sales and marketing 1,272,789 342,631 Research and development 1,366,997 1,402,080 General and administrative 811,535 660,648 Total operating expenses 3,451,321 2,405,359 Operating loss (2,652,381 ) (2,292,460 ) Other income and (expenses): Interest income 8 1,195 Interest expense (103,327 ) (880,538 ) Gain (loss) on revaluation of derivative liabilities, net 215,956 (593,717 ) Miscellaneous expense (2,771 ) (12,278 ) Total other income and (expenses) 109,866 (1,485,338 ) Net loss before provision for income taxes (2,542,515 ) (3,777,798 ) Provision for income taxes 3,100 3,712 Net loss $ (2,545,615 )$ (3,781,510 ) Product Revenue



The following table presents our product revenue for the three months ended March 31, 2014 and 2013, respectively:

Three Months Ended March 31, 2014 2013 % Change $ 1,280,513$ 95,154 1,246%



For the three months ended March 31, 2014, product revenue increased by $1,185,359, or 1,246%, as compared to the three months ended March 31, 2013. The increase is primarily due to additional sales of SmartChip Real-Time PCR Systems and SmartChip Target Enrichment Systems (launched in mid-2013) in the three months ended March 31, 2014, representing 48% of our product revenue. Sales from the newly-acquired Apollo Business accounted for 37% of our product revenue in the three months ended March 31, 2014, compared to none in the comparable 2013 period. There was also a significant increase in sales of our Real-Time PCR Chip panels, which represented 14% of revenue in the three months ended March 31, 2014 compared to 9% in the comparable 2013 period.

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License and Royalty Revenue

The following table presents our license and royalty revenue for the three months ended March 31, 2014 and 2013, respectively:

Three Months Ended March 31, 2014 2013 % Change $ 125,000$ 83,333 50%



For the three months ended March 31, 2014, license and royalty revenue increased by $41,667, or 50%, as compared to the three months ended March 31, 2013. This revenue was generated by an agreement signed at the beginning of February 2013, expected to generate revenue of $500,000 annually for three years. The increase reflects revenue recognition for one additional month in the three months ended March 31, 2014.

Cost of Product Revenue

The following table presents the cost of our product revenue for the three months ended March 31, 2014 and 2013, respectively:

Three Months Ended March 31, 2014 2013 % Change $ 606,573$ 65,588 825%



Cost of product revenue includes the cost of products paid to third party vendors and raw materials, labor and overhead for products manufactured internally, and reserves for warranty and inventory obsolescence.

For the three months ended March 31, 2014, cost of product revenue increased by $540,985, or 825%, as compared to the three months ended March 31, 2013. The increase related primarily to the increase in product revenue, offset by the lower margin in the three months ended March 31, 2013, in which 88% of product revenue was generated by one low margin system sale.

Sales and Marketing

The following table presents our sales and marketing expenses for the three months ended March 31, 2014 and 2013, respectively:

Three Months Ended March 31, 2014 2013 % Change $ 1,272,789$ 342,631 271%



Sales and marketing expenses consist primarily of compensation costs of our sales and marketing team, commissions, and the costs associated with various marketing programs.

For the three months ended March 31, 2014, sales and marketing expenses increased by $930,158, or 271%, as compared to the three months ended March 31, 2013. The increase resulted primarily from increases in headcount, largely due to our hiring employees from the Apollo Business, increased commissions due to increased revenue, amortization expense and the scale-up of marketing activities, including one trade show.

We expect our sales and marketing expenses for the remainder of 2014 to remain at a similar level to that of the first quarter.

Research and Development

The following table presents our research and development expenses for the three months ended March 31, 2014 and 2013, respectively:

Three Months Ended March 31, 2014 2013 % Change $ 1,366,997$ 1,402,080 (3)% 22



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Research and development expenses consist primarily of salaries and other personnel-related expenses, laboratory supplies and other expenses related to the design, development, testing and enhancement of our products. Research and development expenses are expensed as they are incurred.

For the three months ended March 31, 2014, research and development expenses decreased $35,083, or 3%, as compared to the three months ended March 31, 2013. The decrease resulted primarily from reductions in the costs of depreciation and expensed materials and reagents, offset by increases in headcount, most notably due to our hiring employees from the Apollo Business.

We believe a substantial investment in research and development is essential in the long term to remain competitive and expand into additional markets. Accordingly, we expect our research and development expenses to remain at a high level of total expenditures for the foreseeable future.

General and Administrative

The following table presents our general and administrative expenses for the three months ended March 31, 2014 and 2013, respectively:

Three Months Ended March 31, 2014 2013 % Change $ 811,535$ 660,648 23%



General and administrative expenses consist primarily of personnel costs for finance, human resources, business development, and general management, as well as professional fees, such as expenses for legal and accounting services.

For the three months ended March 31, 2014, general and administrative expenses increased $150,887, or 23%, as compared to the three months ended March 31, 2013. The increase resulted primarily from increases in professional fees, mostly related to the acquisition of the Apollo Business and investor relations.

Should the Company's proposed increase of 3,000,000 shares available for award under our 2008 Stock Incentive Plan be approved at our Annual Stockholders' Meeting scheduled for May 29, 2014, our Chief Executive Officer will become entitled to receive approximately 850,000 stock options, vesting over three years commencing on March 8, 2012, on that date. Based on a closing stock price of $1.80, this would entail recording a one-time, non-cash charge of approximately $800,000 in the three months ending June 30, 2014 (the charge being directly proportional to the closing stock price). This one-off charge aside, we expect our general and administrative expenses for the remainder of 2014 to remain at a similar level to that of the first quarter, although they may be adversely affected by legal and other professional services relating to fund-raising activities.

Interest Income

The following table presents our interest income for the three months ended March 31, 2014 and 2013, respectively:

Three Months Ended March 31, 2014 2013 % Change $ 8$ 1,195 (99)%



The interest income is solely earned on cash balances held in interest-bearing bank accounts.

For the three months ended March 31, 2014, interest income decreased by $1,187, or 99%, as compared to the three months ended March 31, 2013. The decrease was mainly due to the absence of cash invested in interest-bearing accounts in Malaysia, with banks in the U.S. paying negligible interest in both periods.

Interest Expense

The following table presents interest expense for the three months ended March 31, 2014 and 2013, respectively:

Three Months Ended March 31, 2014 2013 % Change $ 103,327$ 880,538 (88)% 23



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For the three months ended March 31, 2014, interest expense decreased $777,211, or 88%, as compared to the three months ended March 31, 2013. The decrease was due to the absence of charges for 5% interest and amortization of the debt discount and loan origination fees related to the convertible promissory notes ("CPNs") in the aggregate principal amount of $15,275,000 issued in the May 2011 Private Placement and converted into equity securities on August 27, 2013. This decrease was offset by interest on the $5,200,000 in long-term debt issued to Malaysian Technology Development Corporation Sdn. Bhd. ("MTDC"), an investor in WaferGen Biosystems (M) Sdn. Bhd. ("WGBM"), our now-dissolved Malaysian subsidiary (the "MTDC Notes"), and on the IntegenX Note. Both are being amortized using the effective yield method, which weights the interest charges towards the latter stages of the contractual term of the debt. We expect that the 8% interest on the IntegenX Note, along with the amortization charges, will result in interest expense of approximately $450,000 in 2014, with increased expense in 2015 and subsequent years.

Gain (Loss) on Revaluation of Derivative Liabilities, Net

The following table represents the gain (loss) on revaluation of derivative liabilities, net for the three months ended March 31, 2014 and 2013, respectively: Three Months Ended March 31, 2014 2013 % Change $ 215,956$ (593,717) N/A



Our derivative liabilities arise due to the cash settlement provisions in certain warrants and unit warrants and the variable number of shares of our common stock that may be issued upon the exercise of those warrants with certain anti-dilution protection and, until the time of their settlement in 2013, upon the exchange of Series A and Series B Convertible Preference Shares ("CPS") of WGBM, and under the conversion element of our CPNs.

The net gain from revaluation of derivative liabilities for the three months ended March 31, 2014, was $215,956, compared to a net loss of $593,717 for the three months ended March 31, 2013. Gains and losses are directly attributable to revaluations of all of our derivative liabilities and result primarily from a net decrease or increase, respectively, in our stock price in the period. Our closing stock price was $2.00 on March 31, 2014, unchanged from December 31, 2013, and $5.96 on March 31, 2013, compared to $2.98 on December 31, 2012. The gain in the 2014 period arose principally due to the decrease in remaining term, whereas in the 2013 period the loss was caused principally by the increase in our stock price. With the present number of outstanding warrants accounted for as liabilities, at our closing stock price of $2.00 on March 31, 2014, an increase in our share price of $0.10 would generate a revaluation loss of approximately $200,000; conversely, a decrease in our share price of $0.10 would generate a revaluation gain of approximately $200,000.

Future gains or losses on revaluation will result primarily from net decreases or increases, respectively, in our stock price during the reporting period. Derivative liabilities will also decrease as the remaining term of each instrument diminishes.

Miscellaneous Expense

The following table presents miscellaneous expense for the three months ended March 31, 2014 and 2013, respectively:

Three Months Ended March 31, 2014 2013 % Change $ 2,771$ 12,278 (77)%



For the three months ended March 31, 2014, we recorded miscellaneous expense of $2,771, compared to an expense of $12,278 for the three months ended March 31, 2013. Miscellaneous income or expense is the result of net foreign currency exchange gains or losses which, until it was dissolved in November 2013, arose mainly in WGBM, principally due to revaluation of the inter-company account at the balance sheet date. WGBM had a net receivable on its dollar denominated balances, so if the value of the Malaysian Ringgit decreased against the dollar, income was recorded, whereas if it increased against the dollar, an expense was recorded. Foreign currency exchange gains and losses also arise on our subsidiary in Luxembourg, and on U.S. expenses denominated in foreign currencies. Following the liquidation of WGBM, miscellaneous income and expense is not expected to be significant in future periods.

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Provision for Income Taxes

The following table presents the provision for income taxes for the three months ended March 31, 2014 and 2013, respectively:

Three Months Ended March 31, 2014 2013 % Change $ 3,100$ 3,712 (16)%



For the three months ended March 31, 2014 and 2013, we recorded a charge of $3,100 and $3,712, respectively, for U.S. state income taxes. We have provided a full valuation allowance against our net deferred tax assets.

Headcount

Our consolidated headcount as of May 12, 2014, comprised 42 regular employees, 41 of whom were employed full-time, compared to 28 regular employees as of December 31, 2013, all of whom were employed full-time.

Liquidity and Capital Resources

From inception through March 31, 2014, we have raised a total of $3,665,991 from the issuance of notes payable, $66,037 from the sale of Series A Preferred Stock, $1,559,942 from the sale of Series B Preferred Stock, $31,226,191, net of offering costs, from the sale of common stock and warrants, $8,842,256, net of offering costs, from the sale of CPS of our now-dissolved Malaysian subsidiary, $1,842,760, net of origination fees, from a secured term loan, $27,492,876, net of offering costs and liquidated damages for late registration, from the sale of the Series A-1 Convertible Preferred Stock, convertible promissory notes and warrants in the May 2011 Private Placement, and $13,393,162, net of offering costs, from the sale of common stock, Series 1 Convertible Preferred Stock and warrants in the 2013 Private Placement. We also had, as of March 31, 2014, MTDC Notes with a principal amount of $5,200,000 and the IntegenX Note with a stated value of $1,273,611 outstanding. As of March 31, 2014, we had $6,418,685 in unrestricted cash and cash equivalents, and working capital of $5,399,984.

Net Cash Used in Operating Activities

We experienced negative cash flow from operating activities for the three months ended March 31, 2014 and 2013, in the amounts of $2,204,839 and $1,745,601, respectively. The cash used in operating activities in the three months ended March 31, 2014, was due to cash used to fund a net loss of $2,545,615, adjusted for non-cash expenses related to depreciation and amortization, stock-based compensation, gains on revaluation of derivative liabilities, inventory provision, interest converted to principal on long-term debt and amortization of debt discount totaling $81,673, and cash provided by a change in working capital of $259,103. The cash used in operating activities in the three months ended March 31, 2013, was due to cash used to fund a net loss of $3,781,510, adjusted for non-cash expenses related to depreciation and amortization, stock-based compensation, losses on revaluation of derivative liabilities, inventory provision, interest converted to principal on convertible promissory notes and amortization of debt discount totaling $1,758,328, and cash provided by a change in working capital of $277,581. The increase in cash used in the three months ended March 31, 2014, compared to 2013, was driven primarily by the increase in the net operating loss from $2,292,460 to $2,652,381.

Net Cash Used in Investing Activities

We used $85,122 in the three months ended March 31, 2014, and $20,713 in the three months ended March 31, 2013, to acquire property and equipment. Further, in the three months ended March 31, 2014, we used $2,000,000 to acquire the Apollo Business.

Net Cash Provided by Financing Activities

There were no financing activities in the three months ended March 31, 2014 or 2013.

Availability of Additional Funds

We believe funds available at March 31, 2014, along with our revenue, will fund our operations into the fourth quarter of 2014. To continue our operations thereafter, we expect we will need to raise further capital, through the sale of additional securities or otherwise, to support our future operations. Our operating needs include the planned costs to operate our business, including amounts required to fund working capital and capital expenditures. At the present time,

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we have no material commitments for capital expenditure. Our future capital requirements and the adequacy of our available funds will depend on many factors, most notably our ability to successfully commercialize our SmartChip products and services.

While we believe we have sufficient cash to fund our operating, investing and financing activities into the fourth quarter of 2014, we expect that additional capital will be needed to sustain our operations and repay our outstanding debt obligations thereafter. We may be unable to raise sufficient additional capital when we need it on favorable terms, or at all. The conversion of our MTDC Notes, and the sale of equity or convertible debt securities in the future, may be dilutive to our stockholders, and debt financing arrangements may require us to pledge certain assets and enter into covenants that could restrict certain business activities or our ability to incur further indebtedness, and may contain other terms that are not favorable to us or our stockholders. If we are unable to obtain needed capital we may not be able to continue our efforts to develop and commercialize our SmartChip products and services and may be forced to significantly curtail or suspend our operations.

Principles of Consolidation

The consolidated financial statements of WaferGen Bio-systems, Inc. include the accounts of Wafergen, Inc., WaferGen Biosystems Europe S.a.r.l., our Luxembourg subsidiary and, prior to its liquidation, WaferGen Biosystems (M) Sdn. Bhd., our Malaysian subsidiary. All significant inter-company transactions and balances are eliminated in consolidation.

Critical Accounting Policies and Estimates

Deferred Tax Valuation Allowance

We believe sufficient uncertainties exist regarding the future realization of deferred tax assets, and, accordingly, a full valuation allowance is required, amounting to approximately $30,000,000 at December 31, 2013. In subsequent periods, if and when we generate pre-tax income, a tax expense will not be recorded to the extent that the remaining valuation allowance can be used to offset that expense. Once a consistent pattern of pre-tax income is established or other events occur that indicate that the deferred tax assets will be realized, additional portions or all of the remaining valuation allowance will be reversed back to income. Should we generate pre-tax losses in subsequent periods, a tax benefit will not be recorded and the valuation allowance will be increased.

Inventory Valuation

Inventories are stated at the lower of cost and market value. We perform a detailed assessment of inventory on a regular basis, which includes, among other factors, a review of projected demand requirements, product pricing, product expiration and product lifecycle. As a result of this assessment, we record provisions for potentially excess, obsolete or impaired goods, when appropriate, in order to reduce the reported amount of inventory to its net realizable value. If actual demand and market conditions are less favorable than those projected by management, additional inventory write-downs may be required.

Warranty Reserve

Our standard warranty agreement is one year from shipment for SmartChip cyclers and dispensers and Apollo systems. We accrue for anticipated warranty costs upon shipment of these products. Our warranty reserve is based on management's judgment regarding anticipated rates of warranty claims and associated repair costs, and we update our assessment quarterly.

Stock-Based Compensation

We measure the fair value of all stock option and restricted stock awards to employees on the grant date, and record the fair value of these awards, net of estimated forfeitures, as compensation expense over the service period. The fair value of options is estimated using the Black-Scholes valuation model, and of restricted stock is based on the Company's closing share price on the measurement date. Amounts expensed with respect to options were $54,061 and $104,718, net of estimated forfeitures, for the three months ended March 31, 2014 and 2013, respectively. These sums exclude the compensation expense for restricted stock awards, for which the fair value is based on our closing stock price on the grant date for directors and employees, and on the dates on which performance of services is recognized for consultants. There were no options granted during the three months ended March 31, 2014 or 2013.

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The grant date fair value of options are estimated using the following assumptions:

Risk-Free Interest Rate. This is the U.S. Treasury rate for the day of the grant having a term equal to the expected term of the option. An increase in the risk-free interest rate will increase the fair value and the related compensation expense.

Expected Term. This is the period of time over which the award is expected to remain outstanding and is based on management's estimate, taking into consideration the vesting terms, the contractual life, and historical experience. An increase in the expected term will increase the fair value and the related compensation expense.

Expected Volatility. This is a measure of the amount by which our common stock price has fluctuated or is expected to fluctuate. We apply 50% weighting to our own historic volatility and 50% to the historic volatility of a group of publicly traded companies over the retrospective period corresponding to the expected term of the options on the measurement date. Since the 2013 Exchange, we have applied a reduced weighting to our own historic volatility during the period in which we were highly leveraged. The group of publicly traded companies is selected from the same industry or market index, with extra weighting attached to those companies most similar in terms of business activity, size and financial leverage. An increase in the expected volatility will increase the fair value and the related compensation expense.

Dividend Yield. We have not made any dividend payments and do not plan to pay dividends in the foreseeable future. An increase in the dividend yield will decrease the fair value and the related compensation expense.

Forfeiture Rate. This is a measure of the amount of awards that are expected to not vest. An increase in the estimated forfeiture rate will decrease the related compensation expense.

Derivative Liabilities

Our derivative liabilities arise due to the cash settlement provisions in certain warrants and unit warrants and the variable number of shares of our common stock that may be issued upon the exercise of those warrants with certain anti-dilution protection and, until the time of their settlement in 2013, upon the exchange of Series A and Series B CPS of our Malaysian subsidiary, and under the conversion element of our CPNs. We evaluate the liability for those warrants for which no anti-dilution adjustment is projected prior to the expiration date using the Black-Scholes valuation model, and all other derivatives using a Monte Carlo Simulation approach, using critical assumptions provided by management reflecting conditions at the valuation dates.

Our derivatives are revalued at each balance sheet date, and at the time of issuance and settlement, and are estimated using the following assumptions:

Risk-Free Interest Rate. This is the U.S. Treasury rate for the measurement date having a term equal to the weighted average expected remaining term of the instrument. An increase in the risk-free interest rate will increase the fair value and the associated derivative liability.

Expected Remaining Term. This is the period of time over which the instrument is expected to remain outstanding and is based on management's estimate, taking into consideration the remaining contractual life, historical experience and the possibility of liquidation. An increase in the expected remaining term will increase the fair value and the associated derivative liability.

Expected Volatility. This is a measure of the amount by which our common stock price has fluctuated or is expected to fluctuate. We apply 50% weighting to our own historic volatility and 50% to the historic volatility of a group of publicly traded companies over the retrospective period corresponding to the expected remaining term of the instrument on the measurement date. Since the 2013 Exchange, the Company has applied a reduced weighting to its own historic volatility during the period in which it was highly leveraged. The group of publicly traded companies is selected from the same industry or market index, with extra weighting attached to those companies most similar in terms of business activity, size and financial leverage. An increase in the expected volatility will increase the fair value and the associated derivative liability.

Dividend Yield. We have not made any dividend payments and do not plan to pay dividends in the foreseeable future. An increase in the dividend yield will decrease the fair value and the associated derivative liability.

Off-Balance Sheet Arrangements

We have no off-balance sheet arrangements that have or are reasonably likely to have a current or future effect on our financial condition, changes in financial condition, revenues or expenses, result of operations, liquidity, capital expenditures or capital resources that is material to stockholders.

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Recent Accounting Pronouncements

See the "Recent Accounting Pronouncements" in Note 2 to the Condensed Consolidated Financial Statements in Part I, Item 1 for information related to the issuance of new accounting standards in the first quarter of 2014, none of which had a material impact on our condensed consolidated financial statements.


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Source: Edgar Glimpses