NOTE 18—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, Real Alloy enters into master netting arrangements with counterparties and offsets 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 the 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 noncurrent asset or liability.

Metal hedging

As metal is purchased to fill fixed-price customer sales orders at RAEU, London Metal Exchange (“LME”) future swaps or forward contracts may be sold. As sales orders are priced, LME future or forward contracts may be purchased, which contracts 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 December 31, 2015, Real Alloy had 24.6 thousand metric tonnes 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 December 31, 2015, Real Alloy had 1.9 trillion of 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 December 31, 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 December 31, 2015, no cash collateral was posted or held.

The table below presents gross amounts of recognized assets and liabilities, the amounts offset in the consolidated balance sheets and the net amounts of assets and liabilities presented therein. As of December 31, 2015, there were no amounts subject to enforceable master netting arrangements or similar agreements that have not been offset in the consolidated balance sheets.

	Fair Value of Derivatives
	as of December 31, 2015
(In millions)	Asset			Liability
Metal	$	0.2		$	(0.3	)
Natural gas		—			(0.6	)
Total		0.2			(0.9	)
Effect of counterparty netting arrangements		(0.2	)		0.2
Net derivatives as classified in the consolidated balance sheets	$	—		$	(0.7	)

The following table presents details of the fair value of Real Alloy’s derivative financial instruments as of December 31, 2015, as recorded in the consolidated balance sheets:

		December 31,
(In millions)	Balance Sheet Location	2015
Derivative liabilities
Metal	Accrued liabilities	$	0.1
Natural gas	Accrued liabilities		0.6
Total		$	0.7

Common stock warrant liability

Common stock warrant liability is considered a derivative liability as a result of 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 49.9% and an expected term of 4.4 years as of December 31, 2015, along with a 60% equity raise probability at a 15% discount to the 10-Day volume weighted average price (“VWAP”) assumption in the periods following December 31, 2015, and 52.0% volatility and an expected term of 5.8 years as of December 31, 2014, along with a 25% equity raise probability at a 15% discount to the 10-Day VWAP assumption in the periods following December 31, 2014. 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 December 31, 2015 and 2014:

		Estimated Fair Value
	Fair Value	December 31,
(In millions)	Hierarchy	2015			2014
Derivative assets	Level 2	$	0.2		$	—
Derivative liabilities	Level 2		(0.9	)		—
Net derivative liabilities		$	(0.7	)	$	—
Common stock warrant liability	Level 3	$	(6.9	)	$	(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 December 31, 2015 and 2014. Please see Note 10—Common Stock Warrant Liability for a reconciliation from the beginning to the ending balance of the common stock warrant liability for the years ended December 31, 2015, 2014 and 2013.

Both realized and unrealized gains and losses on derivative financial instruments are included within losses on derivative financial instruments in the consolidated statements of operations. The following table presents realized losses on derivative financial instruments during the year ended December 31, 2015:

	Year Ended December 31,
(In millions)		2015
Metal	$	2.9
Natural gas		0.5
Total	$	3.4

Other Financial Instruments

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

		December 31, 2015
(In millions)	Fair Value Hierarchy	Carrying Amount		Estimated Fair Value
Assets
Cash and cash equivalents	Level 1	$	35.7	$	35.7
Financing receivable	Level 2		32.7		32.7
Restricted cash held in escrow (other current assets)	Level 1		3.9		3.9
Loans receivable, net (other assets)	Level 3		1.1		1.1
Liabilities
Long-term debt:
Senior Secured Notes	Level 1	$	290.7	$	310.9
Asset-Based Facility	Level 2		19.6		22.0
Redeemable Preferred Stock	Level 3	$	21.9	$	18.7

		December 31, 2014
(In millions)	Fair Value Hierarchy	Carrying Amount		Estimated Fair Value
Assets
Continuing operations:
Cash and cash equivalents	Level 1	$	61.9	$	61.9
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 December 31, 2015 and 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.

Financing receivable

Financing receivable represents the net amount due from the sale and transfer of trade accounts receivable under the Factoring Facility. The carrying value is a reasonable estimate of fair value as the financing receivable is generally outstanding for no more than thirty days and the counterparty is a large creditworthy financial institution.

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 December 31, 2015 is based on observable market prices.

Long-term debt – Asset-Based Facility

The estimated fair value of the Asset-Based Facility as of December 31, 2015 is based on market characteristics, including interest rates and maturity dates 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 an original 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 17.5% 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.

Line of credit – discontinued operations

The line of credit was a short-term borrowing facility, used primarily to support ongoing operations of NABCO. The carrying value was a reasonable estimate of fair value, as this instrument had a short-term maturity and a market interest rate.

Long-term debt – discontinued operations

NABCO’s long-term debt included term loans, the fair value of which was based on the market characteristics of the individual loan terms, including interest rates, scheduled principal amortization and maturity dates, generally consistent with market terms.

The Company’s Level 3 assets and liabilities are determined using valuation techniques that incorporate unobservable inputs that require significant judgment or estimation. The following tables present quantitative information about the valuation techniques and unobservable inputs applied to Level 3 fair value measurements as of December 31, 2015 and 2014:

	December 31, 2015
(In millions)	Estimated Fair Value		Valuation Technique	Unobservable Input	Input Value
Common stock warrant liability	$	6.9	Monte Carlo Simulation	Volatility		49.9	%
				Expected term	4.4 years
				Equity raise probability		60	%
				Issue price discount to fair value		15	%
Redeemable Preferred Stock	$	18.7	Discounted cash flow	Credit spread		17.5	%
				Redemption period	56 months

	December 31, 2014
(In millions)	Estimated Fair Value		Valuation Technique	Unobservable Input	Input Value
Common stock warrant liability	$	5.6	Monte Carlo Simulation	Volatility		52.0	%
				Expected term	5.8 years
				Equity raise probability		25	%
				Issue price discount to fair value		15	%

Significant unobservable inputs used in the fair value measurement of the common stock warrant liability include volatility, expected term, the probability of an equity raise, and the offering price discount to fair value, presuming the equity raise is a rights offering. The December 31, 2015 and 2014 estimated fair values were determined using a Monte Carlo simulation. Significant decreases in volatility, expected term or the equity raise probability would result in a decrease in the estimated fair value of the common stock warrant liability, while significant increases in volatility, expected term or the equity raise probability would result in an increase in the estimated fair value of the common stock warrant liability. The primary driver in the estimated fair value of the common stock warrant liability is the measurement date common stock price.

Significant unobservable inputs used in the fair value measurement of the Redeemable Preferred Stock include the estimated credit spread and redemption period. The Company used these unobservable inputs in a discounted cash flow model to estimate the fair value as of December 31, 2015. Decreases in the redemption period and credit spread would result in an increase in the estimated fair value of the Redeemable Preferred Stock, while increases in the redemption period and credit spread would result in a decrease in the estimated fair value of the Redeemable Preferred Stock.