Fair Value of Financial Instruments

3 Months Ended

Mar. 31, 2013

Fair Value of Financial Instruments

5. FAIR VALUE OF FINANCIAL INSTRUMENTS

Assets and liabilities recorded at fair value in the consolidated financial statements are categorized based upon the level of judgment associated with the inputs used to measure their fair value. Hierarchical levels that are directly related to the amount of subjectivity associated with the inputs to the valuation of these assets or liabilities are as follows:

• Level 1—Observable inputs, such as quoted prices in active markets for identical assets or liabilities.

• Level 2—Observable inputs other than Level 1 prices, such as quoted prices for similar assets or liabilities, quoted prices in markets that are not active, or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the assets or liabilities.

• Level 3—Unobservable inputs that are supported by little or no market activity and that are significant to the fair value of the assets or liabilities. Level 3 assets and liabilities include those whose fair value measurements are determined using pricing models, discounted cash flow methodologies or similar valuation techniques and significant management judgment or estimation.

The following tables present the Company’s financial instruments that were measured at fair value on a recurring basis as of March 31, 2013 and December 31, 2012 by level within the fair value hierarchy (in thousands):

	March 31, 2013
	Level 1		Level 2		Level 3		Total
Financial Assets
Cash equivalents	$	4,753	$	26,310	$	—	$	31,063
Marketable securities		1,998		181,673		—		183,671
Total	$	6,751	$	207,983	$	—	$	214,734
Financial Liabilities
Derivative liability	$	—	$	—	$	3,861	$	3,861
Warrant liability		—		—		781		781
Total	$	—	$	—	$	4,642	$	4,642

	December 31, 2012
	Level 1		Level 2		Level 3		Total
Financial Assets
Cash equivalents	$	25,781	$	2,829	$	—	$	28,610
Marketable securities		1,997		116,190		—		118,187
Total	$	27,778	$	119,019	$	—	$	146,797
Financial Liability
Warrant liability	$	—	$	—	$	835	$	835

The Company had no transactions measured at fair value on a nonrecurring basis as of March 31, 2013 and December 31, 2012.

Cash Equivalents and Marketable Securities – Cash equivalents and marketable securities classified within Level 2 of the fair value hierarchy are valued based on other observable inputs, including broker or dealer quotations or alternative pricing sources. When quoted prices in active markets for identical assets or liabilities are not available, the Company relies on non-binding quotes, which are based on proprietary valuation models of independent pricing services. These models generally use inputs such as observable market data, quoted market prices for similar instruments, historical pricing trends of a security as relative to its peers and internal assumptions of the independent pricing services. The Company corroborates the reasonableness of non-binding quotes received from the independent pricing services by comparing them to quotes of identical or similar instruments from other pricing sources. During the three month ended March 31, 2013 and 2012, the Company did not record impairment charges related to its cash equivalents and marketable securities, and the Company did not have any transfers between Level 1, Level 2 and Level 3 of the fair value hierarchy.

Derivative Liability - In January 2013, the Company issued the Notes which contain an early conversion feature, whereby the Note holders have the option of converting their Notes to common shares of the Company’s stock prior to November 1, 2016 (other than conversions in connection with certain fundamental changes). In addition to the shares deliverable upon conversion, holders are entitled to receive an early conversion payment equal to $83.33 per $1,000 principal amount of Notes surrendered for conversion that may be settled, at the Company’s election, in cash or, subject to satisfaction of certain conditions, in shares of the Company’s common stock. This early conversion feature has been identified as an embedded derivative, as described in ASC 815. In accordance with ASC 815, embedded derivatives are separated from the host contract, the Notes, and carried at fair value when: (a) the embedded derivative possesses economic characteristics that are not clearly and closely related to the economic characteristics of the host contract; and (b) a separate, stand-alone instrument with the same terms would qualify as a derivative instrument. The Company has concluded that the embedded derivatives related to the early conversion feature of the Notes meet these criteria and, as such, must be valued separate and apart from the Notes and recorded at fair value at each reporting period. At each reporting period, the Company records this embedded derivative at fair value, which is included as a component of Convertible Debt on its condensed consolidated balance sheets.

The Company used a Monte Carlo simulation model to estimate the fair value of the embedded derivative related to the early conversion feature of the Notes. Within the model, the assumption was made that the Notes will be converted early if the conversion value is greater than the holding value. The model requires the following inputs: (i) price of the Company’s common stock; (ii)conversion rate of 121.1240 shares of common stock per $1,000 in principal amount of Notes, subject to adjustment; (iii) conversion price of $8.26 per share of common stock, subject to adjustment; (iv) maturity date; (v) risk-free interest rate; and (vi) estimated stock volatility.

The following table sets forth the Level 3 inputs to the Monte Carlo simulation model that were used to determine the fair value of the embedded derivative:

	Issuance Date			March 31, 2013
Stock price	$	6.88		$	7.80
Conversion rate		121.1240			121.1240
Conversion price	$	8.26		$	8.26
Maturity date		November 1, 2016			November 1, 2016
Risk-free interest rate		0.79	%		0.74	%
Estimated stock volatility		50	%		50	%

Changes in certain inputs into the model can have a significant impact on changes in the estimated fair value of the embedded derivative. The following table sets forth the estimated fair value of the embedded derivative as of the issuance date and March 31, 2013 (in thousands):

	Issuance Date		March 31, 2013
Estimated fair value of the embedded derivative	$	3,124	$	3,861

The $0.7 million increase in the estimated fair value of the embedded derivative between the issue date and March 31, 2013 represents an unrealized loss that has been recorded as loss from change in fair value of embedded derivative in the condensed consolidated statements of operations.

Warrant Liability-The valuation of the warrant liability above is discussed in Note 8.

The following tables presents the change in fair values of the Company’s Level 3 financial instruments that were measured on a recurring basis using significant unobservable inputs as of March 31, 2013 (in thousands):

Fair value at December 31, 2012	$	835
Fair value of derivative liability recorded on measurement date		3,124
Change in fair value recorded as a loss from change in fair value of derivative liability		737
Change in fair value recorded as a gain from change in fair value of warrant liability		(54	)
Fair value at March 31, 2013	$	4,642

The Company has estimated the fair value of its secured and unsecured debt obligations based upon discounted cash flows with Level 3 inputs, such as the terms that management believes would currently be available to the Company for similar issues of debt, taking into account the current credit risk of the Company and other factors. As of March 31, 2013 and December 31, 2012 the carrying values of the Company’s secured and unsecured debt obligations, excluding the Notes, approximated their fair values. The Company has estimated the fair value of the Notes to be $128.8 million at March 31, 2013 based upon Level 2 inputs, including the market price of the Notes derived from actual trades of the Notes.