Embedded Derivatives and Derivative Warrant Liabilities | 5. Embedded Derivatives and Derivative Warrant Liabilities 2020 Notes Embedded Derivative In June 2017, the Company issued its 12% convertible senior secured notes due 2020 (the “2020 Notes”) in exchange for its 12.0% convertible senior secured notes due 2017 (the “2017 Notes”). The 2020 Notes contain the following embedded derivatives: (i) a Make-Whole Payment (as defined in the indenture governing the 2020 Notes (the “2020 Notes Indenture”)) upon either conversion or redemption; (ii) right to redeem the outstanding principal upon a Fundamental Change (as defined in the 2020 Notes Indenture); (iii) issuer rights to convert into a limited number of shares in any given three-month period commencing nine -months from the issuance date and dependent on the stock price exceeding 150% of the then in-effect conversion price over a ten-business day period; and (iv) holder rights to convert into either shares of the Company’s common stock or pre-funded warrants upon the election of the holders of the 2020 Notes. Embedded derivatives are separated from the host contract and the 2020 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 certain embedded derivatives within the 2020 Notes meet these criteria and, as such, must be valued separate and apart from the 2020 Notes as one embedded derivative and recorded at fair value each reporting period. The Company used a binomial lattice model in order to estimate the fair value of the embedded derivative in the 2020 Notes. A binomial lattice model generates two probable outcomes, whether up or down, arising at each point in time, starting from the date of valuation until the maturity date. A lattice was initially used to determine if the 2020 Notes would be converted by the holder, called by the issuer, or held at each decision point. Within the lattice model, the following assumptions are made: (i) the 2020 Notes will be converted by the holder if the conversion value plus the holder’s Make-Whole Payment is greater than the holding value; or (ii) the 2020 Notes will be called by the issuer if (a) the stock price exceeds 150% of the then in-effect conversion price over a ten-business day period and (b) if the holding value is greater than the conversion value plus the Make-Whole Payment at the time. Using this lattice model, the Company valued the embedded derivative using a “with-and-without method”, where the value of the 2020 Notes including the embedded derivative is defined as the “with”, and the value of the 2020 Notes excluding the embedded derivative is defined as the “without”. This method estimates the value of the embedded derivative by comparing the difference in the values between the 2020 Notes with the embedded derivative and the value of the 2020 Notes without the embedded derivative. The lattice model requires the following inputs: (i) price of Gevo common stock; (ii) Conversion Rate (as defined in the 2020 Notes Indenture); (iii) Conversion Price (as defined in the 2020 Notes Indenture); (iv) maturity date; (v) risk-free interest rate; (vi) estimated stock volatility; and (vii) estimated credit spread for the Company. As of September 30, 2017 the estimated fair value of the embedded derivatives was $6.5 million. Any change in the estimated fair value of the embedded derivatives represents an unrealized gain which has been recorded as $2.2 million and $0.5 million from the change in fair value of embedded derivatives in the consolidated statements of operations for the three and nine months ended September 30, 2017, respectively. The Company recorded the estimated fair value of the embedded derivative with the 2020 Notes, net in the consolidated balance sheets. The following table sets forth the inputs to the lattice model that were used to value the embedded derivatives. September 30, June 20, 2017 2017 ( *) Stock price $ 0.62 $ 0.62 Conversion Rate per $1,000 1,358.90 1,358.90 Conversion Price $ 0.7359 $ 0.7359 Maturity date March 15, 2020 March 15, 2020 Risk-free interest rate 1.53 % 1.45 % Estimated stock volatility 80.0 % 80.0 % Estimated credit spread 28.5 % 26.0 % * - The June 20, 2017 inputs represent the initial valuation of the 2020 Notes Embedded Derivative instrument that arose due to the exchange of the 2017 Notes for the 2020 Notes. Changes in certain inputs into the lattice model can have a significant impact on changes in the estimated fair value of the embedded featured within the 2020 Notes. For example, the estimated fair value will generally decrease with: (1) a decline in the stock price; (2) decreases in the estimated stock volatility; and (3) a decrease in the estimated credit spread. 2022 Notes Embedded Derivative In July 2012, the Company issued 7.5% convertible senior notes due July 2022 (the “2022 Notes”) which contain the following embedded derivatives: (i) rights to convert into shares of the Company’s common stock, including upon a Fundamental Change (as defined in the indenture governing the 2022 Notes (the “2022 Notes Indenture”)); and (ii) a Coupon Make-Whole Payment (as defined in the 2022 Notes Indenture) in the event of a conversion by the holders of the 2022 Notes prior to July 1, 2017. Embedded derivatives are separated from the host contract, the 2022 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 within the 2022 Notes meet these criteria and, as such, must be valued separate and apart from the 2022 Notes as one embedded derivative and recorded at fair value each reporting period. The Company used a binomial lattice model in order to estimate the fair value of the embedded derivative in the 2022 Notes. A binomial lattice model generates two probable outcomes, whether up or down, arising at each point in time, starting from the date of valuation until the maturity date. A lattice was initially used to determine if the 2022 Notes would be converted, called or held at each decision point. Within the lattice model, the following assumptions are made: (i) the 2022 Notes will be converted early if the conversion value is greater than the holding value; or (ii) the 2022 Notes will be called if the holding value is greater than both (a) the Redemption Price (as defined in the 2022 Notes Indenture) and (b) the conversion value plus the Coupon Make-Whole Payment at the time. If the 2022 Notes are called, then the holders will maximize their value by finding the optimal decision between (1) redeeming at the Redemption Price and (2) converting the 2022 Notes. Using this binomial lattice model, the Company valued the embedded derivative using a “with-and-without method”, where the value of the 2022 Notes including the embedded derivative is defined as the “with”, and the value of the 2022 Notes excluding the embedded derivative is defined as the “without”. This method estimates the value of the embedded derivative by looking at the difference in the values between the 2022 Notes with the embedded derivative and the value of the 2022 Notes without the embedded derivative. The lattice model requires the following inputs: (i) price of Gevo common stock; (ii) Conversion Rate (as defined in the 2022 Notes Indenture); (iii) Conversion Price (as defined in the 2022 Notes Indenture); (iv) maturity date; (v) risk-free interest rate; (vi) estimated stock volatility; and (vii) estimated credit spread for the Company. As of September 30, 2017 and December 31, 2016, the estimated fair value of the embedded derivatives was zero. Any decline in the estimated fair value of the embedded derivatives represents an unrealized gain which has been recorded as gain from change in fair value of embedded derivatives in the consolidated statements of operations. The Company recorded the estimated fair value of the embedded derivative with the 2022 notes, net in the consolidated balance sheets. Derivative Warrant Liability The following warrants were sold by the Company (all share totals have been adjusted to reflect reverse stock-splits, if applicable): • In December 2013, the Company sold warrants to purchase 71,013 shares of the Company’s common stock (the “2013 Warrants”). • In August 2014, the Company sold warrants to purchase 50,000 shares of the Company’s common stock (the “2014 Warrants”). • In February 2015, the Company sold Series A warrants to purchase 110,833 shares of the Company’s common stock (the “Series A Warrants”) and Series B warrants to purchase 110,883 shares of the Company’s common stock (the “Series B Warrants”). • In May 2015, the Company sold Series C warrants to purchase 21,500 shares of the Company’s common stock (the “Series C Warrants”). • In December 2015, the Company sold Series D warrants to purchase 502,500 shares of the Company’s common stock (the “Series D Warrants”) and Series E warrants to purchase 400,000 shares of the Company’s common stock (the “Series E Warrants”). • In April 2016, the Company sold Series F warrants to purchase 514,644 shares of the Company’s common stock (the “Series F Warrants”) and Series H warrants to purchase 1,029,286 shares of the Company’s common stock (the “Series H Warrants”), and pre-funded Series G warrants (the “Series G Warrants”) to purchase 328,571 shares of the Company’s common stock, pursuant to an underwritten public offering. • In September 2016, the Company sold Series I • In February 2017, the Company sold Series K warrants to purchase 6,250,000 shares of the Company’s common stock (the “Series K Warrants”) and Series M warrants to purchase 6,250,000 shares of the Company’s common stock (the “Series M Warrants”), and pre-funded Series L warrants (the “Series L Warrants”) to purchase 570,000 shares of the Company’s common stock, pursuant to an underwritten public offering. The following table sets forth information pertaining to shares issued upon the exercise of such warrants as of September 30, 2017: Issuance Date Expiration Date Exercise Price as of September 30, 2017 Shares Underlying Warrants on Issuance Date Shares Issued upon Warrant Exercises as of September 30, 2017 Shares Underlying Warrants Outstanding as of September 30, 2017 2013 Warrants 12/16/2013 12/16/2018 $ 9.03 71,013 15,239 55,774 2014 Warrants 8/5/2014 8/5/2019 $ 6.88 50,000 30,538 19,462 Series A Warrants 2/3/2015 2/3/2020 $ 0.68 110,833 99,416 11,417 Series B Warrants 2/3/2015 8/3/2015 - (1) 110,833 96,795 - Series C Warrants 5/19/2015 5/19/2020 $ 5.55 21,500 - 21,500 Series D Warrants 12/11/2015 12/11/2020 $ 2.00 502,500 501,570 930 Series E Warrants 12/11/2015 12/11/2016 - (1) 400,000 400,000 - Series F Warrants 4/1/2016 4/1/2021 $ 2.00 514,644 233,857 280,787 Series G Warrants 4/1/2016 4/1/2017 - (1) 328,571 328,571 - Series H Warrants 4/1/2016 10/1/2016 - (1) 1,029,286 900,436 - Series I Warrants 9/13/2016 9/13/2021 $ 11.00 712,503 - 712,503 Series J Warrants 9/13/2016 9/13/2017 - (1) 185,000 185,000 - Series K Warrants 2/17/2017 2/17/2022 $ 0.60 6,250,000 150,000 6,100,000 Series L Warrants 2/17/2017 2/17/2018 - (1) 570,000 570,000 - Series M(A) Warrants 2/17/2017 11/17/2017 $ 2.35 2,305,000 - 2,305,000 Series M(B) Warrants 2/17/2017 (2) 11/17/2017 $ 0.60 3,945,000 (2) 3,500,000 445,000 17,106,683 7,011,422 9,952,373 (1) Warrants have either been fully exercised and/or expired as of September 30, 2017. (2) In September 2017, 3,945,000 Series M warrants were repriced to $0.60. Of those warrants that were repriced, 3,500,000 were exercised in the third quarter of 2017, providing proceeds of $2.1 million. The agreements governing the above warrants include the following terms: • certain warrants have exercise prices which are subject to adjustment for certain events, including the issuance of stock dividends on the Company’s common stock and, in certain instances, the issuance of the Company’s common stock or instruments convertible into the Company’s common stock at a price per share less than the exercise price of the respective warrants; • warrant holders may exercise the warrants through a cashless exercise if, and only if, the Company does not have an effective registration statement then available for the issuance of the shares of its common stock. If an effective registration statement is available for the issuance of its common stock a holder may only exercise the warrants through a cash exercise; • the exercise price and the number and type of securities purchasable upon exercise of the warrants are subject to adjustment upon certain corporate events, including certain combinations, consolidations, liquidations, mergers, recapitalizations, reclassifications, reorganizations, stock dividends and stock splits, a sale of all or substantially all of the Company’s assets and certain other events; and • in the event of an “extraordinary transaction” or a “fundamental transaction” (as such terms are defined in the respective warrant agreements), generally including any merger with or into another entity, sale of all or substantially all of the Company’s assets, tender offer or exchange offer, or reclassification of its common stock, in which the successor entity (as defined in the respective warrant agreements) that assumes the successor entity is not a publicly traded company, the Company or any successor entity will pay the warrant holder, at such holder’s option, exercisable at any time concurrently with or within 30 days after the consummation of the extraordinary transaction or fundamental transaction, an amount of cash equal to the value of such holder’s warrants as determined in accordance with the Black Scholes option pricing model and the terms of the respective warrant agreement. In some circumstances, the Company or successor entity may be obligated to make such payments regardless of whether the successor entity that assumes the warrants is a publicly traded company. Based on these terms, the Company has determined that the 2013 Warrants, the 2014 Warrants, the Series A Warrants, the Series C Warrants, the Series D Warrants, the Series F Warrants, the Series I Warrants, the Series K Warrants, and the Series M Warrants (together, the “Warrants”) qualify as derivatives and, as such, are presented as derivative warrant liability on the consolidated balance sheets and recorded at fair value each reporting period. The fair value of the Warrants was estimated to be $2.1 million and $2.7 million as of September 30, 2017 and December 31, 2016, respectively. The decrease in the derivative warrant liability is the result of the decline in the Company’s stock price. During the nine months ended September 30, 2017, the Company issued 150,000 shares of common stock as a result of the exercise of Series K Warrants, 570,000 shares of common stock as a result of the exercise of Series L Warrants and 3,500,000 shares of common stock as a result of the exercise of Series M Warrants, resulting in a total proceeds of approximately $2.2 million. In addition, in September 2017, a s permitted by Section 2(a) of the Series M Warrants agreement the Board of Directors of the Company approved a voluntarily reduction of the exercise price of the Series M Warrants exercisable into 3,945,000 shares of the Company’s common stock from an exercise price of $2.35 per share of common stock to $0.60 per share of common stock, for the remaining term of these warrants. Except for the reduction in exercise price, the terms of these Series M Warrants remained unchanged. In September 2017, In October 2017, the Board of Directors of the Company approved voluntarily reductions of the exercise price of additional Series M Warrants exercisable into 1,185,000 shares of the Company’s common stock from an exercise price of $2.35 per share of common stock to $0.65 per share of common stock, and Series M Warrants exercisable into 300,000 shares of the Company’s common stock from an exercise price of $2.35 per share of common stock to $0.60 per share of common stock. Except for the reduction in exercise price, the terms of these Series M Warrants remained unchanged. In October 2017, the Company issued 1,930,000 shares of common stock as a result of the exercise of Series M Warrants, for which the price had been reset, and the Company received proceeds of approximately $1.2 million from these exercises. As a result, as of October 31, 2017, all of the Series M Warrants for which the exercise price had been adjusted were fully exercised. In May 2016, as permitted by Section 2(a) of the Series H Warrant agreement, the Board of Directors of the Company approved a voluntary reduction of the exercise price of Series H Warrants exercisable into 375,000 shares of the Company’s common stock, from an exercise price of $15.00 per share of common stock to $6.00 per share of common stock, for the remaining term of these warrants. Except for the reduction in exercise price, the terms of these Series H Warrants remain unchanged. In June 2016, as permitted by Section 2(a) of the Series H Warrant agreement, the Board of Directors of the Company approved a voluntary reduction of the exercise price of Series H Warrants exercisable into 150,000 shares of the Company’s common stock, from an exercise price of $15.00 per share of common stock to $8.40 per share of common stock, for the remaining term of these warrants. The Board of Directors of the Company also approved a voluntary reduction of the exercise price of Series H Warrants exercisable into 100,000 shares of the Company’s common stock, from an exercise price of $15.00 per share of common stock to $10.40 per share of common stock, for the remaining term of these warrants. Ultimately, the Company adjusted the exercise price to $10.40 per share of common stock for Series H Warrants exercisable into 50,000 shares of the Company’s common stock. Except for the reduction in exercise price, the terms of these Series H Warrants remain unchanged. In June 2016, as permitted by Section 9 of the Series D Warrant agreement, the Company agreed with certain holders of the Series D Warrants to the amend the exercise price and accelerate the initial exercise date for Series D Warrants exercisable into 208,370 shares of the Company’s common stock held by such holders. Pursuant to that amendment, with respect to these Series D Warrants held by those holders, the exercise price was increased from an exercise price of $2.00 per share of common stock to $3.50 per share of common stock, for the remaining term of these warrants and the initial exercise date was changed from June 11, 2016 to June 8, 2016. Except for the change in exercise price and the initial exercise date, the terms of these Series D Warrants remained unchanged. As of September 30, 2017, all of the Series H Warrants and Series D Warrants for which the exercise price had been adjusted were fully exercised. |