Derivative Instruments and Fair Value Measurements

3 Months Ended

Mar. 31, 2013

Derivative Instruments and Hedging Activities Disclosure [Abstract]

Derivative Instruments and Fair Value Measurements

Derivative Instruments and Fair Value Measurements

We measure our financial assets and liabilities in accordance with Fair Value Measurements and Disclosures under GAAP, which maximizes the use of observable inputs and minimizes the use of unobservable inputs when measuring fair value. GAAP describes three different valuation techniques to be used in determining fair value for financial assets and liabilities: the market, income or cost approaches. The three valuation techniques are consistent with generally accepted valuation methodologies. The hierarchy which prioritizes the inputs used to measure fair value from market based assumptions to entity specific assumptions are as follows:

Level 1: Inputs based on quoted market prices for identical assets or liabilities in active markets at the measurement date.

Level 2: Observable inputs other than quoted prices included in Level 1, such as quoted prices for similar assets and liabilities in active markets; quoted prices for identical or similar assets and liabilities in markets that are not active; or other inputs that are observable or can be corroborated by observable market data.

Level 3: Inputs reflect management’s best estimate of what market participants would use in pricing the asset or liability at the measurement date. The inputs are unobservable in the market and significant to the instrument’s valuation.

Our derivative instruments are measured on their respective origination dates, at the end of each reporting period and at other points in time when necessary, such as modifications, using Level 3 inputs under accounting guidance for measuring fair value. We do not report any financial assets or liabilities that we measure using Level 1 or Level 2 inputs and there were no transfers in or out of Level 3 inputs for all periods reported.

The derivatives and their respective fair values measured using Level 3 inputs are as follows:

	December 31, 2012		March 31, 2013
Derivative instruments classified as current liabilities:
Warrant contracts issued on October 27, 2006	$	597,000	$	616,000
Warrant contracts issued January 24, 2013	—		601,000
Warrant Series “B” contracts issued on February 18, 2011	3,000		1,000
Total derivatives	$	600,000	$	1,218,000

We determined the fair values of the derivative instrument liabilities associated with certain warrant contracts primarily based on option-pricing mathematical models generally referred to as “Black-Scholes” and “Monte Carlo” option-pricing models. These models determine the value of the derivative instruments based on complex mathematical formulas that assume that returns on our underlying stock are normally-distributed and that risk-free interest rates and stock volatilities will remain constant over the term of the contract. We use the Black-Scholes model to calculate the value of the derivative instrument liabilities associated with warrant contracts in which the contractual terms are fixed. For derivative warrant contracts that incorporate contingent terms, including exercise price reset provisions (the warrants issued on October 27, 2006 and January 24, 2013), we utilize the Monte Carlo model which is similar to the Black-Scholes model; however, the Monte Carlo model simulates several thousand possible (but random) price paths for the underlying value of the derivative instruments. These random price paths were then averaged to determine the value of the derivative instruments as of the reporting date.

The following table summarizes the changes in the fair value for the derivative instrument liabilities using Level 3 inputs:

	October 2006 Warrants		February 2011 "B" Warrants			January 2013 Warrants			Total Derivatives
Balance at December 31, 2012	$	597,000	$	3,000		$	—		$	600,000
Origination of derivative instrument	—		—			705,000			705,000
Fair value adjustments resulting from change in value of underlying asset and passage of time recognized in earnings	19,000		(2,000		)	(104,000		)	(87,000		)
Balance at March 31, 2013	$	616,000	$	1,000		$	601,000		$	1,218,000

The fair value of derivative instrument liabilities measured with Level 3 inputs are revalued quarterly. The assumptions used in the calculations under our option pricing models for the following periods were as follows:

	October 2006 Warrants	February 2011 “B” Warrants	January 2013 Warrants
December 31, 2012:
Annual volatility (1)	52.9%	53.3%	N/A
Risk-free rate	0.21%	0.36%	N/A
Dividend rate	—%	—%	N/A
Closing price of Quantum stock	$0.68	$0.68	N/A
Conversion / exercise price	$0.83	$6.00	N/A
March 31, 2013:
Annual volatility (1)	44.8%	50.2%	73.7%
Risk-free rate	0.14%	0.36%	.07%-0.77%
Dividend rate	—%	—%	—%
Closing price of Quantum stock	$0.62	$0.62	$0.62
Conversion / exercise price	$0.62	$6.00	$1.00

(1) Annual volatility is based on the historical average of our identified peer group for a period consistent with the remaining term of the contract.