5. Embedded Derivatives

Convertible 2022 Notes

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 “Indenture”)); and (ii) a Coupon Make-Whole Payment (as defined in the 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 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 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 Indenture); (iii) Conversion Price (as defined in the Indenture); (iv) maturity date; (v) risk-free interest rate; (vi) estimated stock volatility; and (vii) estimated credit spread for the Company.

Inputs used to estimate the value of the embedded derivative as of June 30, 2016 were substantially similar to those used as of the period ended December 31, 2015. Changes in certain inputs into the lattice model can have a significant impact on changes in the estimated fair value of the embedded derivatives. For example, the estimated fair value of the embedded derivatives will generally decrease with: (i) a decline in the stock price; (ii) a decrease in the estimated stock volatility; and (iii) a decrease in the estimated credit spread.

Derivative Warrant Liability

In December 2013, the Company sold warrants to purchase 1,420,250 shares of the Company’s common stock (the “2013 Warrants”). In August 2014, the Company sold warrants to purchase 1,000,000 shares of the Company’s common stock (the “2014 Warrants”). In February 2015, the Company sold Series A warrants to purchase 2,216,667 shares of the Company’s common stock (the “Series A Warrants”) and Series B warrants to purchase 2,216,667 shares of the Company’s common stock (the “Series B Warrants”). In May 2015, the Company sold Series C warrants to purchase 430,000 shares of the Company’s common stock (the “Series C Warrants”). In December 2015, the Company sold Series D warrants to purchase 10,050,000 shares of the Company’s common stock (the “Series D Warrants”) and Series E warrants to purchase 8,000,000 shares of the Company’s common stock (the “Series E Warrants”). In April 2016, the Company sold 10,292,858 Series F warrants (Series F Warrants”) to purchase one share of common stock (each a “Series F Warrant”) and 20,585,716 Series H warrants, each to purchase one share of common stock (each, a “Series H Warrant”), and 6,571,429 pre-funded Series G warrant (“Series G Warrants”) to purchase one share of 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 June 30, 2016:

	Issuance Date	Expiration Date	Exercise Price			Shares Underlying Warrants on Issuance Date		Shares Issued upon Warrant Exercises as of June 30, 2016			Shares Underlying Warrants Outstanding as of June 30, 2016
2013 Warrants	12/16/2013	12/16/2018	$	3.57			1,420,250		(304,774	)		1,115,476
2014 Warrants	8/5/2014	8/5/2019	$	2.51			1,000,000		(610,771	)		389,229
Series A Warrants	2/3/2015	2/3/2020	$	0.30			2,216,667		(1,988,335	)		228,332
Series B Warrants	2/3/2015	8/3/2015	$	0.01	⁽¹⁾		2,216,667		(1,935,601	)		-
Series C Warrants	5/19/2015	5/19/2020	$	1.84			430,000		-			430,000
Series D Warrants	12/11/2015	12/11/2020	$	0.10			10,050,000		(10,006,400	)		43,600
Series E Warrants	12/11/2015	12/11/2016	$	0.01	⁽¹⁾		8,000,000		(8,000,000	)		-
Series F Warrants	4/1/2016	4/1/2021	$	0.30			10,292,858		-			10,292,858
Series G Warrants	4/1/2016	4/1/2017	$	0.01	⁽¹⁾		6,571,429		(6,571,429	)		-
Series H Warrants	4/1/2016	10/1/2016	$	0.75			20,585,716		(18,008,716	)		2,577,000
							62,783,587		(47,426,026	)		15,076,495

(1)	The exercise price is $1.00 but $0.99 of the exercise price was pre-funded upon issuance of the Series B, Series E, and Series G Warrants. Each of these series of warrants were fully exercised as of June 30, 2016.

The agreements governing the above warrants include the following terms:

the 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 warrant 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, and the Series H 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 $6.2 million and $10.5 million as of June 30, 2016 and December 31, 2015, respectively. The decrease in the estimated fair value of the Warrants is the result of exercises of warrants during the period offset by the issuance of new warrants during the priod.

During the six months ended June 30, 2016, the Company issued 42,782,210 shares of Common Stock as a result of the exercise of Series A, D, E, G and H Warrants. The Company received proceeds of $10.9 million from such exercises.

In May of 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 for 7.5 million of the outstanding Series H Warrants, from an exercise price of $0.75 per share of common stock to $0.30 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 of 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 for 3 million of the outstanding Series H Warrants, from an exercise price of $0.75 per share of common stock to $0.42 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 for 2.0 million of the outstanding Series H Warrants, from an exercise price of $0.75 per share of common stock to $0.52 per share of common stock, for the remaining term of these warrants. Ultimately, the Company adjusted the exercise price to $0.52 per share of common stock for only 1.0 million of the Series H Warrants. Except for the reduction in exercise price, the terms of these Series H Warrants remain unchanged.

In June of 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 amendment of the exercise price and the acceleration of the initial exercise date for 4,167,391 of the outstanding Series D Warrants held by such holders. Pursuant to that amendment agreement, with respect to 4,167,391 of the outstanding Series D Warrants held by those holders, the exercise price was increased from the an exercise price of $0.10 per share of common stock to $0.175 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 June 30, 2016 all of the Series H Warrants or Series D Warrants for which the exercise price had been adjusted were fully exercised.