Note 3—Fair Value of Financial Instruments and Investments

The Company categorizes its financial instruments into a three-level fair value hierarchy that prioritizes the inputs to valuation techniques used to measure fair value into three broad levels. The fair value hierarchy gives the highest priority to quoted prices in active markets for identical assets or liabilities (Level 1) and the lowest priority to unobservable inputs (Level 3). If the inputs used to measure fair value fall within different levels of the hierarchy, the category level is based on the lowest priority level input that is significant to the fair value measurement of the instrument.

Financial assets recorded at fair value on the Company’s consolidated balance sheets are categorized as follows:

Level 1: Unadjusted quoted prices for identical assets in an active market.

Level 2: Quoted prices in markets that are not active or inputs that are observable either directly or indirectly for substantially the full-term of the asset. Level 2 inputs include the following:

•

quoted prices for similar assets in active markets,

•

quoted prices for identical or similar assets in non-active markets,

•

inputs other than quoted market prices that are observable, and

•

inputs that are derived principally from or corroborated by observable market data through correlation or other means.

Level 3: Prices or valuation techniques that require inputs that are both unobservable and significant to the overall fair value measurement. They reflect management’s own assumptions about the assumptions a market participant would use in pricing the asset.

There were no transfers between levels in the fair value hierarchy during any period presented herein. The following table presents the Company’s cash and cash equivalents, and investments and including the hierarchy for its financial instruments measured at fair value on a recurring basis at June 30, 2013 and December 31, 2012:


June 30, 2013	Carrying Amount		Estimated Fair Value		Level 1		Level 2		Level 3
	(In thousands)
Assets:
Cash and cash equivalents:
Cash	$	18,692	$	18,692	$	18,692	$	—	$	—
Money market funds		19,651		19,651		19,651		—		—

Total cash and cash equivalents		38,343		38,343		38,343		—		—

Short-term investments:
Certificates of deposit		13,131		13,131		13,131		—		—

Restricted cash:
Certificates of deposit		1,655		1,655		1,655		—		—

Total	$	53,129	$	53,129	$	53,129	$	—	$	—

Liabilities:
Embedded derivatives:
Debt redemption features	$	848	$	848	$	—	$	—	$	848
Warrant liability		1,438		1,438		—		—		1,438

Total	$	2,286	$	2,286	$	—	$	—	$	2,286


December 31, 2012	Carrying Amount		Estimated Fair Value		Level 1		Level 2		Level 3
	(In thousands)
Assets:
Cash and cash equivalents:
Cash	$	14,221	$	14,221	$	14,221	$	—	$	—
Money market funds		36,111		36,111		36,111		—		—

Total cash and cash equivalents		50,332		50,332		50,332		—		—

Short-term investments:
Certificates of deposit		45,949		45,949		45,949		—		—

Restricted cash:
Certificates of deposit		2,430		2,430		2,430		—		—

Total	$	98,711	$	98,711	$	98,711	$	—	$	—


Liabilities:
Embedded derivatives:
Debt redemption features	$	848	$	848	$	—	$	—	$	848
Warrant liability		2,935		2,935		—		—		2,935

Total	$	3,783	$	3,783	$	—	$	—	$	3,783

The Company’s short-term investment in certificates of deposits at June 30, 2013 and December 31, 2012 had maturity dates of less than one year.

Level 3 Valuation

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 the Company’s financial liabilities measured at fair value on a recurring basis using significant unobservable inputs (Level 3) during the six-month period ended June 30, 2013:


	Warrant Liability			Debt Redemption Features
	(In thousands)
Level 3
Balance at December 31, 2012		2,935			848
Unrealized gain		(1,497	)		—

Balance at June 30, 2013	$	1,438		$	848

The Company determines the fair value of its warrant liability based on the Black-Sholes pricing model. Historical information is the primary basis for the selection of the expected volatility. The risk-free interest rate is selected based upon yields of United States Treasury issues with a term equal to the expected term of the warrants. The expected term is derived from the remaining contractual term of the warrant. The warrant liability is marked-to-market each reporting period with the change in fair value recorded as a gain or loss within other expense or income, net on the Company’s consolidated statements of operations.

In accordance with FASB ASC 815, Derivatives and Hedging, the Company has separately accounted for certain contingent debt features of its senior secured 2019 Notes, as described more fully in Note 7, as embedded derivative instruments, which are measured at fair value. Changes in the fair value of these embedded derivatives are recognized in earnings as a component of other income, net in the consolidated statements of operations. Key inputs into the valuation model are interest rate volatility, risk-free interest rates, bond yields, credit spreads and certain probabilities determined by management.

Disclosure of Fair Value of Financial Instruments

The Company’s financial instruments mainly consist of cash and cash equivalents, short-term investments, accounts receivable, accounts payable, other current liabilities and debt obligations. The carrying amounts of the Company’s cash equivalents, accounts receivable, current liabilities and accounts payable approximate their fair value due to the short-term nature of these instruments.

At June 30, 2013, $170.9 million in principal amount of the 2019 Notes remained outstanding, which had a carrying value of $132.3 million and a fair value of $118.2 million. The fair value of the 2019 Notes is based upon a binomial-tree model using one of more significant unobservable inputs (Level 3). Key inputs into this valuation model are interest rate volatility, risk-free interest rates, bond yields and credit spreads.

At June 30, 2013, $122.4 million in principal amount of the 2018 Convertible Notes remained outstanding, which had a carrying value of $99.1 million and a fair value of $18.4 million. The fair value of the 2018 Convertible Notes at June 30, 2013 and December 31, 2012 is based upon the quoted market prices (Level 1) at June 30, 2013 and December 31, 2012, respectively.

See Note 7 for further discussion of the 2018 Convertible Notes, the 2019 Notes and the exchange agreement.