NOTE 12—DERIVATIVE AND OTHER FINANCIAL INSTRUMENTS AND FAIR VALUE MEASUREMENTS

Derivatives

Real Alloy may use forward contracts and options, as well as contractual price escalators, to reduce the risks associated with its metal, natural gas and certain currency exposures. Generally, we enter into master netting arrangements with our counterparties and offset net derivative positions with the same counterparties against amounts recognized for the right to reclaim cash collateral or the obligation to return cash collateral under those arrangements in our condensed consolidated balance sheets. For classification purposes, Real Alloy records the net fair value of each type of derivative position expected to settle in less than one year (by counterparty) as a net current asset or liability and each type of long-term position as a net long-term asset or liability.

Metal hedging

As metal is purchased to fill fixed-price customer sales orders at Real Alloy, London Metal Exchange (“LME”) future swaps or forward contracts are sold. As sales orders are priced, LME future or forward contracts may be purchased. These derivatives generally settle within six months. Real Alloy can also buy put option contracts for managing metal price exposures. Option contracts require the payment of a premium, which is recorded as a realized loss upon settlement or expiration of the option contract. Upon settlement of put option contracts, Real Alloy receives cash and recognizes a related gain if the LME closing price is less than the strike price of the put option. If the put option strike price is less than the LME closing price, no amount is paid and the option expires. As of September 30, 2015, Real Alloy had 30.7 thousand metric tons of metal buy and sell derivative contracts.

Natural gas hedging

To manage the price exposure for natural gas purchases, Real Alloy may fix the future price of a portion of its natural gas requirements by entering into financial hedge agreements. Under these swap agreements, payments are made or received based on the differential between the monthly closing price on the New York Mercantile Exchange (“NYMEX”) and the contractual hedge price. Natural gas cost can also be managed through the use of cost escalators included in some long-term supply contracts with customers, which limits exposure to natural gas price risk. As of September 30, 2015, Real Alloy had 2.1 trillion British thermal unit forward buy contracts.

Currency exchange hedging

From time to time, Real Alloy may enter into currency forwards, futures, call options and similar derivative financial instruments to limit its exposure to fluctuations in currency exchange rates. As of September 30, 2015, no currency derivative contracts were outstanding.

Credit risk

Real Alloy is exposed to losses in the event of nonperformance by the counterparties to the derivative financial instruments discussed above; however, management does not anticipate any nonperformance by the counterparties. The counterparties are evaluated for creditworthiness and risk assessment prior to initiating trading activities with the brokers and periodically throughout each year while actively trading. As of September 30, 2015, no cash collateral was posted or held.

The table below presents gross amounts of recognized assets and liabilities, the amounts offset in the unaudited condensed consolidated balance sheets and the net amounts of assets and liabilities presented therein. As of September 30, 2015, there were no amounts subject to an enforceable master netting arrangement or similar agreement that have not been offset in the unaudited condensed consolidated balance sheets.

	Fair Value of Derivatives
	as of September 30, 2015
(In millions)	Asset			Liability
Metal	$	0.6		$	(1.1	)
Natural gas		—			(0.3	)
Total		0.6			(1.4	)
Effect of counterparty netting arrangements		(0.6	)		0.6
Net derivatives as classified in the condensed consolidated balance sheet	$	—		$	(0.8	)

The following table presents details of the fair value of Real Alloy’s derivative financial instruments as of September 30, 2015, as recorded in the unaudited condensed consolidated balance sheets:

		September 30,
(In millions)	Balance Sheet Location	2015
Derivative liabilities
Metal	Accrued liabilities	$	0.5
Natural gas	Accrued liabilities		0.3
Total		$	0.8

Common stock warrant liability

Common stock warrant liability is a derivative liability related to the anti-dilution and pricing protection provisions of the Warrants. The fair value of the common stock warrant liability is based on a Monte Carlo simulation that utilizes various assumptions, including estimated volatility of 50% and an expected term of 4.7 years as of September 30, 2015, and 52% volatility and an expected term of 5.8 years as of December 31, 2014, along with a 25% equity raise probability assumption and a 15% equity raise price discount assumption in the periods following December 31, 2015. Significant decreases in the expected term or the equity raise probability and related assumptions would result in a decrease in the estimated fair value of the common stock warrant liability, while significant increases in the expected term or the equity raise probability and related assumptions would result in an increase in the estimated fair value of the common stock warrant liability. However, the most significant input in determining the fair value of the common stock warrant liability is the price of our common stock on the measurement date. A 10% increase or decrease in any or all of the unobservable inputs would not have a material impact on the estimated fair value of the common stock warrant liability.

Fair values

Derivative contracts are recorded at fair value using quoted market prices and significant other observable inputs. Fair value is defined as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. The fair value hierarchy distinguishes between (1) market participant assumptions developed based on market data obtained from independent sources (observable inputs) and (2) an entity’s own assumptions about market participant assumptions developed based on the best information available in the circumstances (unobservable inputs). The fair value hierarchy consists of three broad levels, which gives the highest priority to unadjusted quoted prices in active markets for identical assets or liabilities (Level 1) and the lowest priority to unobservable inputs (Level 3). The three levels of the fair value hierarchy are described below:

Level 1—Unadjusted quoted prices in active markets that are accessible at the measurement date for identical, unrestricted assets or liabilities.

Level 2—Inputs other than quoted prices included within Level 1 that are observable for the asset or liability, either directly or indirectly, including quoted prices for similar assets or liabilities in active markets; quoted prices for identical or similar assets or liabilities in markets that are not active; inputs other than quoted prices that are observable for the asset or liability (e.g., interest rates); and inputs that are derived principally from or corroborated by observable market data by correlation or other means.

Level 3—Inputs that are both significant to the fair value measurement and unobservable.

We endeavor to utilize the best available information in measuring fair value. Where appropriate, valuations are adjusted for various factors such as liquidity, bid/offer spreads, and credit considerations. Such adjustments are generally based on available market evidence and unobservable inputs. Financial assets and liabilities are classified in their entirety based on the lowest level of input that is significant to the fair value measurement. The following tables set forth financial assets and liabilities and their level in the fair value hierarchy that are accounted for at fair value on a recurring basis as of September 30, 2015 and December 31, 2014:

		Estimated Fair Value
(In millions)	Fair Value Hierarchy	September 30, 2015			December 31, 2014
Derivative assets	Level 2	$	0.6		$	—
Derivative liabilities	Level 2		(1.4	)		—
Net derivative liabilities		$	(0.8	)	$	—
Common stock warrant liability	Level 3	$	(7.6	)	$	(5.6	)

The common stock warrant liability is the only asset or liability measured at fair value on a recurring basis using significant unobservable inputs (Level 3) as of September 30, 2015 and 2014. Please see Note 6—Common Stock Warrant Liability for a reconciliation from the beginning balance to the ending balance of the common stock warrant liability for the three and nine months ended September 30, 2015 and 2014.

Both realized and unrealized gains and losses on derivative financial instruments are included within losses on derivative financial instruments in the unaudited condensed consolidated statements of operations. The following table presents realized losses on derivative financial instruments during the three and nine months ended September 30, 2015:

	Three Months Ended September 30,		Nine Months Ended September 30,
(In millions)		2015		2015
Metal	$	1.5	$	2.2
Natural gas		—		—
Total	$	1.5	$	2.2

Other Financial Instruments

The following tables present the carrying values and fair value estimates of other financial instruments as of September 30, 2015 and December 31, 2014:

		September 30, 2015
(In millions)	Fair Value Hierarchy	Carrying Amount		Estimated Fair Value
Assets
Cash and cash equivalents	Level 1	$	44.9	$	44.9
Restricted cash held in escrow (other current assets)	Level 1		3.9		3.9
Loans receivable, net (other noncurrent assets)	Level 3		1.2		1.2
Liabilities
Long-term debt:
Senior Secured Notes	Level 1	$	290.3	$	315.7
Asset-Based Facility	Level 2		54.9		54.9
Capital leases	Level 3		4.5		4.5
Redeemable Preferred Stock	Level 3	$	21.2	$	20.5

		December 31, 2014
(In millions)	Fair Value Hierarchy	Carrying Amount		Estimated Fair Value
Assets
Continuing operations:
Cash and cash equivalents	Level 1	$	62.0	$	62.0
Loans receivable, net (other noncurrent assets)	Level 3		1.2		1.2
Discontinued operations:
Cash and cash equivalents	Level 1		1.0		1.0
Liabilities
Discontinued operations:
Line of credit	Level 3	$	1.0	$	1.0
Long-term debt	Level 3		13.6		13.6

The Company used the following methods and assumptions to estimate the fair value of each financial instrument as of September 30, 2015 and December 31, 2014:

Cash and cash equivalents and restricted cash held in escrow

Cash and cash equivalents and restricted cash held in escrow are recorded at historical cost. The carrying value is a reasonable estimate of fair value as these instruments have short-term maturities and market interest rates.

Loans receivable, net

Loans receivable, net, consists of commercial real estate loans. The estimated fair value considers the collateral coverage of assets securing the loans and estimated credit losses, as well as variable interest rates, which approximate market interest rates.

Long-term debt – Senior Secured Notes

The estimated fair value of the Senior Secured Notes as of September 30, 2015 is based on observable market prices.

Long-term debt – Asset-Based Facility

The estimated fair value of the Asset-Based Facility as of September 30, 2015 is based on market characteristics, including interest rates and maturity dates generally consistent with market terms.

Long-term debt – Capital leases

The estimated fair value of the capital leases as of September 30, 2015 is based on market characteristics of the equipment leases, including interest rates and payment terms generally consistent with market terms.

Redeemable Preferred Stock

The carrying value of Redeemable Preferred Stock is based on the estimated fair value of the instrument at issuance, calculated using a discounted cash flow analysis using the Hull & White model, with a term of sixty-six months, assuming either the holder will put or the issuer will call at the redemption date. The cash dividend yield and the Redeemable Preferred Stock, including the payment-in-kind Redeemable Preferred Stock, were discounted at the spot rate plus a 14.2% credit spread adjustment to a zero coupon yield curve, which is being accreted to redemption value over the period preceding the holder’s right to mandatorily redeem the instrument, or sixty-six months from issuance, using the effective interest method. An increase in the discount rate would result in a decrease in the estimated fair value of the redeemable preferred stock, while a decrease in the discount rate would result in an increase in the estimated fair value of the redeemable preferred stock. There have been no significant changes in the fair value of the Redeemable Preferred Stock subsequent to issuance.