Fair Value of Financial Instruments

6 Months Ended

Jun. 30, 2011

Fair Value of Financial Instruments

Fair Value of Financial Instruments

Note 3.  Fair Value of Financial Instruments

Accounting for fair value measurements involves a single definition of fair value, along with a conceptual framework to measure fair value, with fair value defined as “the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date.” The fair value measurement hierarchy consists of three levels:

· Level one—quoted market prices in active markets for identical assets or liabilities

· Level two—inputs other than level one inputs that are either directly or indirectly observable, and

· Level three—unobservable inputs developed using estimates and assumptions which are developed by the reporting entity and reflect those assumptions that a market participant would use.

We apply valuation techniques that (1) place greater reliance on observable inputs and less reliance on unobservable inputs and (2) are consistent with the market approach, the income approach and/or the cost approach, and include enhanced disclosures of fair value measurements in our financial statements.

The carrying values of cash and cash equivalents, accounts receivable, other current assets, accounts payable, accrued expenses, and other current liabilities approximate their fair values due to the short maturity of these instruments.  See Note 10 for debt fair value, which also approximates carrying value. See Note 11 for preferred stock and preferred stock warrants, and Note 13 for common stock warrants.

The following tables show information regarding assets and liabilities measured at fair value on a recurring basis as of June 30, 2011, and December 31, 2010:

	Fair Value Measurements at Reporting Date Using
	Balance as of June 30, 2011		Quoted prices in Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)
Current Assets
Cash and cash equivalents	$	5,376,784	$	5,376,784	$	—	$	—
Long Term Assets
Restricted cash	3,202,856		3,202,856		—		—
Total Assets	$	8,579,640	$	8,579,640	$	—	$	—
Current Liabilities
Mandatorily redeemable convertible preferred stock	$	529,545	$	—	$	—	$	529,545
Common stock warrant liability	2,132,760		—		—		2,132,760
Total Liabilities	$	2,662,305	$	—	$	—	$	2,662,305

	Fair Value Measurements at Reporting Date Using
	Balance as of December 31, 2010		Quoted prices in Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)
Current Assets
Cash and cash equivalents	$	10,865,760	$	10,865,760	$	—	$	—
Long Term Assets
Restricted cash	3,228,933		3,228,933		—		—
Total Assets	$	14,094,693	$	14,094,693	$	—	$	—
Liabilities
Mandatorily redeemable convertible preferred stock	$	2,900,170	$	—	$	—	$	2,900,170
Preferred stock warrant liability - current	1,009,388		—		—		1,009,388
Common stock warrant liability	3,242,600		—		—		3,242,600
Total Current Liabilities	7,152,158		—		—		7,152,158
Long Term Liabilities
Preferred stock warrant liability - long term	864,012		—		—		864,012
Total Liabilities	$	8,016,170	$	—	$	—	$	8,016,170

There were no significant transfers between levels in the periods ended June 30, 2011, or December 31, 2010.

Financial assets or liabilities are considered Level 3 when their fair values are determined using pricing models, discounted cash flow methodologies or similar techniques and at least one significant model assumption or input is unobservable.  The following table provides a summary of the changes in fair value of our financial liabilities measured at fair value on a recurring basis using significant unobservable inputs (Level 3) during the three and six months ended June 30, 2011:

	Three months ended June 30, 2011
	Mandatorily Redeemable Convertible Preferred Stock			Preferred Stock Warrant Liability			Common Stock Warrant Liability			Total
Beginning balance March 31, 2011	$	283,964		$	710,537		$	3,801,115		$	4,795,616
Issued	677,516			—			—			677,516
Conversions to Common Stock	(377,192		)	—			—			(377,192		)
Redemptions	(262,800		)	—			—			(262,800		)
Exercises	—			(710,537		)	(164,379		)	(874,916		)
Adjustment to fair value	208,057			—			(1,503,976		)	(1,295,919		)
Transfers in and or out of Level 3	—			—			—			—
Balance as of June 30, 2011	$	529,545		$	—		$	2,132,760		$	2,662,305

	Six months ended June 30, 2011
	Mandatorily Redeemable Convertible Preferred Stock			Preferred Stock Warrant Liability			Common Stock Warrant Liability			Total
Beginning balance December 31, 2010	$	2,900,170		$	1,873,400		$	3,242,600		$	8,016,170
Issued	1,830,768			—			—			1,830,768
Conversions to Common Stock	(3,232,344		)	—			—			(3,232,344		)
Redemptions	(1,192,705		)	—			—			(1,192,705		)
Exercises	—			(1,915,133		)	(167,690		)	(2,082,823		)
Adjustment to fair value	223,656			41,733			(942,150		)	(676,761		)
Transfers in and/or out of Level 3	—			—			—			—
Balance as of June 30, 2011	$	529,545		$	—		$	2,132,760		$	2,662,305

The warrant liabilities are marked-to-market each reporting period with the change in fair value recorded as a gain or loss within Non-cash interest in our consolidated statement of operations until they are exercised, expire or other facts and circumstances lead the liability to be reclassified as an equity instrument.  The fair value of the warrant liabilities are determined each reporting period by utilizing a third-party valuation completed using a Black-Scholes option pricing model that takes into account volatility as well as estimated probabilities of possible outcomes provided by us and the valuation analyst (unobservable inputs).

The preferred stock is recorded at fair value with changes in fair value recorded as gains or losses within Non-cash-interest.  The fair value of the preferred stock is determined at each reporting period by utilizing a third-party valuation completed using a Black-Scholes option pricing model that takes into account volatility as well as estimated probabilities of possible outcomes provided by us and the valuation analyst (unobservable inputs.)

Valuation—Methodology and Significant Assumptions

The estimate of the fair value of the securities noted above as of the valuation date is based on the rights and privileges afforded to each class of equity.  The valuation of derivative instruments utilized certain estimates and judgments that affect the fair value of the instruments.  Fair values for our derivatives are estimated by utilizing valuation models that consider current and expected stock prices, volatility, dividends, forward yield curves and discount rates.  Such amounts and the recognition of such amounts are subject to significant estimates which may change in the future.

In estimating the fair value of the preferred stock and warrants, the following methods and significant input assumptions were applied:

Methods

A Black-Scholes option pricing model was utilized to estimate the fair value of the mandatorily redeemable convertible preferred stock, preferred stock warrants and common stock warrants on June 30, 2011, and December 31, 2010.  The option pricing model relies on financial theory to allocate value among different classes of stock based upon a future “claim” on value.  The equity claim of the securities is equivalent to a series of call options at various breakpoints, which are determined by the necessary equity required for the diluted common stock price to reach the exercise price of the different equity instruments.  The change in option values represents the equity that is to be allocated among the different classes of stocks.  In estimating the fair value of the preferred stock, preferred stock warrants and common stock warrants, the following significant inputs and assumptions were applied as of June 30, 2011, and December 31, 2010:

Inputs	June 30, 2011		December 31, 2010
Equity value based on stock closing price at reporting date	$	33,728,782	$	46,035,791
Exercise price	$	1,000	$	1,000
Time to maturity	3 - 5 years		3 - 5 years
Stock volatility	88% - 92%		89% - 92%
Risk-free rate	0.81% - 1.76%		1.02% - 2.01%
Dividend rate	0%		0%
Non-exercise period	NA		NA

Significant Assumptions

· Due to the difficult nature of accurately estimating a potential exit event, we calculated the fair value using both a 3-year and a 5-year model. The fair values used are an average of value calculated using these two maturities.

· Stock volatility was estimated by annualizing the daily volatility of our stock price during the historical period preceding the valuation date and measured over a period corresponding to the remaining life of the instruments.  Historic stock prices were used to estimate volatility as we did not have trade options as of the valuation dates.

· Based on our historical operations and management expectations for the near future, our stock was assumed to be a non-dividend paying stock.

· The quoted market price of our stock was utilized in the valuations because the derivative guidance requires the use of quoted market prices without considerations of blockage discounts, i.e., an amount or percentage deducted from the current market price of a publicly traded security to reflect the decrease in the per share value of a block of those securities that is of a size that could not be sold in a reasonable period of time given normal trading volume.

The quoted market price of our stock as of the measurement dates and expected future stock prices were assumed to reflect the dilution upon conversion of the instruments to shares of common stock.