FAIR VALUE

Financial Accounting Standards Board (“FASB”) guidance on fair value measurements, which defines fair value, establishes a framework for measuring fair value, and expands disclosures about fair value measurements for our financial assets and liabilities, as well as for other assets and liabilities that are carried at fair value on a recurring basis in our consolidated financial statements.

FASB guidance establishes a three-level fair value hierarchy based upon the assumptions (inputs) used to price assets or liabilities. The three levels of inputs used to measure fair value are as follows:

Level 1—Unadjusted quoted prices in active markets for identical assets or liabilities,

Level 2—Observable inputs other than those included in Level 1, such as quoted prices for similar assets and liabilities in active markets or quoted prices for identical assets or liabilities in inactive markets, and

Level 3—Unobservable inputs reflecting our own assumptions and best estimate of what inputs market participants would use in pricing the asset or liability.

The preferred stock warrant liability and preferred stock conversion feature are recorded separately at fair value. We are required to record these instruments at fair value at each reporting date and changes are recorded as an adjustment to earnings. The gains or losses included in earnings are reported in other income (expense) in our Statement of Operations.

The preferred stock warrant liability and preferred stock conversion feature are considered Level 3 financial instruments and are valued using the Black Scholes call option pricing formula, which approximates a binomial model for the preferred stock conversion feature. This method is among the most common and widely used valuation approaches for call options. The model relates an option's value to five variables: the current price of the underlying asset, the strike price of the option, the time to expiration or exercise of the option, a risk free interest rate, and the volatility of the underlying asset.

The following assumptions were used in the September 30, 2011valuation of the preferred stock conversion feature: the closing share price of our stock for the quarter ended September 30, 2011 discounted 15% due to the lack of marketability and liquidity, an exercise price of $0.39, expected term of 4.25 years, risk-free interest rate of 0.96% based on a 5 year U.S. Treasury and volatility of 103%.

The following assumptions were used in the September 30, 2011valuation of the preferred stock warrants: an exercise price of $2.32, expected term of 1.5 years, risk-free interest rate of 0.25% based on a 2 year U.S. Treasury and volatility of 50%.

During the three months ended September 30, 2011, the changes in the fair value of the liabilities measured using significant unobservable inputs (Level 3) were comprised of the following:



	Dollars in Thousands
	For the three months ended
	September 30, 2011
	Preferred Stock Conversion Feature		Preferred Stock Warrant Liability		Total
Beginning balance at June 1, 2011	$	7,600	$	3,000	$	10,600
Total gains or losses:
Recognized in earnings	400		200		600
Balance at September 30, 2011	$	8,000	$	3,200	$	11,200

During the nine months ended September 30, 2011, the changes in the fair value of the liabilities measured using significant unobservable inputs (Level 3) were comprised of the following:



	Dollars in Thousands
	For the nine months ended
	September 30, 2011
	Preferred Stock Conversion Feature		Warrants		Total
Beginning balance at January 1, 2011	$	1,983	$	2,351	$	4,334
Total gains or losses:
Recognized in earnings	6,017		849		6,866
Balance at September 30, 2011	$	8,000	$	3,200	$	11,200

We had no Level 3 liabilities at September 30, 2010. There were no purchases, sales, issuances or settlements of Level 3 liabilities in the three or nine months ended September 30, 2011 and 2010. The unrealized gains or losses of Level 3 liabilities are included in earnings are reported in other income (expense) in our Statement of Operations.