Stockholders' Equity

3 Months Ended

Jul. 01, 2011

Stockholders' Equity

Note 7.  Stockholders’ Equity

Warrants

At March 31, 2011, the Company had the following warrants outstanding and exercisable:

	Shares (000’s)	Exercise Price
Convertible Note – 2nd Tranche	713	$  1.7000
2007 Warrants	630	$  1.7900
2010 Warrants	267	$  1.4040
Total	1,610

At July 1, 2011, the Company had the following warrants outstanding and exercisable:

	Shares (000’s)	Exercise Price
Convertible Note – 2nd Tranche	713	$  1.7000
2007 Warrants	630	$  1.7900
2010 Warrants	267	$  1.4040
Total	1,610

In fiscal years 2005 and 2006, warrants (the Convertible Note Warrants) were issued in connection the issuance of convertible debt.  The convertible debt has all been subsequently converted into Class A Common Stock.  The Convertible Note Warrants were issued in two tranches with 712,682 shares still outstanding at July 1, 2011 and March 31, 2011.  The exercise price for the Convertible Note Warrants was originally $1.744, subject to adjustment based on a formula contained in the convertible note agreement if Class A Common Stock was issued below the $1.744 exercise price.  Such adjustments cannot reduce the exercise price below $1.70 without obtaining shareholder approval. The price was reduced to $1.70 and the number of warrants was correspondingly increased to 712,682 shares in June 2010 as a result of the issuance of Class A Common Stock to the MEDC and MSF at a price of $0.54 per share.

On September 14, 2007, the Company completed a private placement (the 2007 Offering). Each unit sold by the Company in the 2007 Offering consisted of four (4) shares of the Company’s Class A Common Stock, par value $0.001 per share (the 2007 Offering Shares) and one (1) five year warrant exercisable for one share of Class A Common Stock at an exercise price of $1.85 (each a 2007 Warrant). The Company sold a total of 741,332 units consisting of 2,965,332 (2007) Offering Shares and 741,332 (2007) Warrants, of which 33,000 units consisting of 132,000 (2007) Offering Shares and 33,000 (2007) Warrants were to related parties at the prevailing closing stock price of $1.83 per share, for an aggregate purchase price of $4.5 million.  The offer and sale of the 2007 Offering Shares and 2007 Warrants were made pursuant to Rule 506 promulgated pursuant to the Securities Act and each of the investors was an accredited investor as defined by Rule 501 promulgated pursuant to the Securities Act.  The exercise price for the 2007 Warrants is subject to adjustment based on a formula contained in the Private Placement agreement, if Class A Common Stock is issued in the future below the $1.85 exercise price.  The exercise price was reduced to $1.79 in June 2010 as a result of the issuance of Class A Common Stock to the MEDC and MSF at a price of $0.54 per share.  In addition, the number of warrants increased by 24,095 as a result of the change in exercise price.  Future adjustments cannot reduce the exercise price below $1.79.

As described in Note 6, on November 29, 2010, the Company issued 267,196 warrants to Robin Risser and Steve Williamson (the 2010 Warrants).  Each warrant is exercisable over a five year period for one share of the Company’s Class A Common Stock at an exercise price of $1.404 subject to adjustment, based on a formula in the Warrant Agreements, if Class A Common Stock is issued in the future below the $1.404 exercise price.  Future adjustments cannot reduce the exercise price below $1.17.  As a result of the exercise price reset feature, the fair value of the warrants is recorded as a liability.

As a result of adopting the FASB’s guidance, effective April 1, 2009, on how an entity should evaluate whether an instrument is indexed to its own stock, the Company’s outstanding warrants, which previously were treated as equity, were no longer afforded equity treatment because of their exercise price reset features.  At the effective date the Company was required to adjust its balance sheet to reflect the incremental impact of treating the Convertible Note and 2007 Warrants as liabilities since their original issuance date.  On April 1, 2009, the Company reclassified $2,619,000 of previously recorded debt discount from additional paid-in-capital, as a cumulative effect adjustment, and recorded the initial recognition of a $294,000 warrant liability, to reflect the fair value of the warrants on that date.  These adjustments resulted in a $2,325,000 decrease to the accumulated deficit.  The fair value liability of the Convertible Note and 2007 Warrants decreased to approximately $112,000 as of March 31, 2010.

As discussed above, the exercise price of the 2007 Warrants is no longer variable since the exercise price floor of $1.79 was reached.  Consequently, the fair value of the 2007 Warrants as of May 2010 (approximately $32,000) was reclassified to equity and recorded as Additional Paid in Capital.  The fair value of the Convertible Note and 2010 Warrants was approximately $58,000 at July 2, 2010.  During the three months ended July 2, 2010, the Company recorded other income of $54,000 for the change in fair value of the warrant liability.

The fair value of the Convertible Note and 2010 Warrants was approximately $240,000 at July 1, 2011 and $732,000 at March 31, 2011.  During the three months ended July 1, 2011, the Company recorded other income of $492,000 for the change in fair value of the warrant liability

The fair value of the warrants was estimated using the Monte Carlo option pricing model using the following assumptions:

	July 1, 2011	July 2, 2010
Expected term (in years)	0.2 – 4.4	1.2 – 2.2
Volatility	41.23% - 69.52%	59.09% - 80.29%
Expected dividend	--	--
Risk-free interest rate	0.83% - 2.0%	0.83% - 1.16%

Expected volatility is based primarily on historical volatility using the weekly stock price for the most recent period equivalent to the term of the warrants.  A dividend yield of zero has been assumed based on the Company’s actual past experience and the fact that the Company does not anticipate paying a dividend on its shares in the future.  The Company has based its risk-free interest on the implied yield available on U.S. Treasury issues with equivalent expected term.

During Q1 2012, the Company compared the fair values determined using the Monte Carlo simulation model with that using a lattice model, which is generally a preferred model when instruments contain non-standard features such as the reset features contained in our warrants, noting no significant differences in warrant values.

The inputs used to determine the fair value of the warrants are classified as Level 3 inputs in the FASB’s fair value hierarchy, primarily regarding the computation of historical volatility. Management classified these as Level 3 measurements as they are based on unobservable inputs and involve management judgment.

The following chart represents the activity in the Company’s Level 3 warrants during the periods ended July 1, 2011 and March 31, 2011.

	For Periods Ended
	July 1, 2011			March 31, 2011
Level 3 Warrants, beginning of period	$	732,000		$	112,000
Addition – Related Party 2010 Warrants, initial fair value		--			161,000
Transfer to Additional Paid in Capital		--			(32,000	)
Change in fair value of warrant liability		(492,000	)		491,000
Level 3 Warrants, end of period	$	240,000		$	732,000

Preferred Stock

In prior 10K’s and 10Q’s, the Company showed 40,000 shares of Class A convertible preferred stock outstanding on the Balance Sheet at zero value.  After a review of historical conversion detail, it was determined that these 40,000 shares were in fact converted to Class A Common Stock and should not be shown as a separate line item in Shareholders’ Equity.  In the Company’s 10Q for Q1 2012 this line was removed.