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Convertible Debentures

9 Months Ended

Sep. 30, 2011

Note 3 – Convertible Debentures

On December 20, 2005, the Company issued $25 million in aggregate principal amount of senior subordinated convertible debentures (the "Debentures") due and payable in quarterly installments of $2.8 million which commenced December 2008. However, the holder, at its election, could defer each quarterly payment one time, for a 24 month period. As the holder had elected to defer some quarterly installments, the outstanding principal of the Debentures at December 31, 2010 was $8.3 million. As of December 31, 2010, the interest rate on the Debentures was 1.375% and the accrued interest was $29,000.

At the issuance date, the Debentures were convertible by the holder at any time into 1,315,789 common shares. The Company also issued 394,737 warrants in connection with the issuance of the Debentures; these warrants had an expiration date of December 20, 2010 and an exercise price of $19.00 at the issuance date. The exercise price, number of convertible shares and warrants were subject to adjustment upon certain events, such as the sale of equity securities by the Company. After the issuance date, the Company sold 6.1 million shares through various offerings at a price below $19.00 which adjusted the conversion and warrant price to $16.22. The change in warrant price increased the number of warrants to 462,461. In December 2010, the holders of the warrants exercised their right to purchase 462,461 shares of common stock, which resulted in the settlement of the stock warrants liability.

As of December 31, 2010, the Debentures were convertible into 513,845 shares. In February 2011, the holder of the Debentures converted the remaining $8.3 million principal balance into 514,086 shares of the Company's common stock at a conversion price of $16.21 per share. On the conversion date, the common stock had a fair value of $9.3 million, which was based on the closing market price. This conversion resulted in a gain of $1.0 million, which is included in "gain (loss) on embedded derivatives and warrants" in the consolidated statement of operations.

Interest paid with cash and principal converted into shares of common stock are as follows (in thousands):


	Nine Months Ended September 30, 2011				Nine Months Ended September 30, 2010
	Value		Shares		Value		Shares
Conversion of principal into shares of common stock	$	8,333		514	$	—		—
Interest paid with cash		17		N/A		91		N/A

Total debenture payments	$	8,350		514	$	91		—

Until the conversion of the remaining principal balance in February 2011, the principal balance was convertible by the holder at any time into common shares. In addition, after eighteen months from the issue date, the Company could have required that a specified amount of the principal of the Debentures be converted if certain conditions were satisfied for a period of 20 consecutive trading days. To determine a fair value of this forced conversion, the Company applied a Z factor, which is a theoretical measurement of the probability of this occurrence. The probability used as of December 31, 2010 was 21.5% for forced conversion of 50% of the conversion option at 135% of the original exercise price, and 4.7% for forced conversion of the remaining conversion option at 175% of the original exercise price.

The Company accounted for the conversion options in the Debentures and the associated warrants as derivative liabilities in accordance with the Derivatives and Hedging Topic of the FASB ASC. The discount at the issuance date attributable to the aggregate fair value of the conversion options and warrants and the issuance costs totaling $9.2 million was amortized using the effective interest method over the term of the Debentures. The remaining unamortized discount was $47,000 at December 31, 2010. For the three months ended September 30, 2011 and 2010, $0 and $20,000, respectively, and $6,000 and $41,000 for the nine months ended September 30, 2011 and 2010, respectively, of the discount and prepaid fees were amortized. Upon conversion of the remaining principal balance of the Debentures into shares of the Company's common stock in February 2011, the remaining unamortized discount was written off and is included in "amortization of debt discount and prepaid debt costs" in the consolidated statement of operations.

The change in fair value on revaluation of the conversion rights and warrant liabilities represents the difference between the fair value at the end of the current period or conversion date and the fair value at the beginning of the current period using the value calculated by the Black-Scholes pricing model. The net fair value of the liability for the holder's and Maxwell's conversion rights at December 31, 2010 was a liability of $2.1 million which is included in "long-term debt, excluding current portion" in the consolidated balance sheet. The effect of the fair market value adjustment for the three months ended September 30, 2011 and 2010 was a $0 and $814,000 loss, respectively, and a $78,000 and $3.7 million gain for the nine months ended September 30, 2011 and 2010, respectively, which is recorded as "gain (loss) on embedded derivatives and warrants" in the consolidated statement of operations.

The fair value of the embedded conversion options was estimated on December 31, 2010 using the Black-Scholes valuation model with the following assumptions:


Black-Scholes Assumptions:
Conversion / exercise price	$	16.22
Market price	$	18.89
Expected dividends		—
Expected volatility		52.6	%
Average risk-free interest rate		0.25	%
Expected term/life (in years)		0 .7

As long as the Debentures were outstanding, the Company was required to maintain a minimum cash balance of $8.0 million. This amount was classified as restricted cash at December 31, 2010. The cash restriction was released in February 2011 when the outstanding principal amount of the convertible debentures was converted to shares of the Company's common stock.