Derivative Financial Instruments

Interest Rate Swaps

We use various financial instruments to minimize the impact of variable market conditions on our results of operations. We use interest rate swaps to minimize the impact of fluctuations of interest rate changes on our outstanding debt where LIBOR is applied. We do not enter into derivative contracts for trading or speculative purposes.

The fair values of the derivatives designated as cash flow hedges as of December 31, 2019 and 2018 on our consolidated balance sheets were as follows (in thousands):



	December 31,
	2019		2018
Assets
Prepaid expenses and other current assets	$	3	$	42
Other long-term assets	—		40
	$	3	$	82

Liabilities
Accrued expenses and other current liabilities	$	782	$	4
Derivative liabilities	8,459		3,626
	$	9,241	$	3,630

PPA Company IIIb - In September 2013, PPA IIIb entered into an interest rate swap arrangement to convert a variable interest rate debt to a fixed rate. We designated and documented its interest rate swap arrangement as a cash flow hedge. The swap’s term ends on October 1, 2020, which is concurrent with the final maturity of the debt floating interest rates reset on a quarterly basis. We evaluate and calculate the effectiveness of the hedge at each reporting date. The effective change was recorded in accumulated other comprehensive income (loss) and was recognized as interest expense on settlement. The notional amounts of the swap were zero, $24.7 million and $25.6 million as of December 31, 2019, 2018 and 2017 respectively. We measure the swap at fair value on a recurring basis. Fair value is determined by discounting future cash flows using LIBOR rates with appropriate adjustment for credit risk.

We recorded a loss of $82,000, a loss of $68,000 and a loss of $64,000 during the years ended December 31, 2019, 2018 and 2017, respectively, attributable to the change in swap’s fair value. These gains and losses were included in other income (expense), net in the consolidated statement of operations.

Pursuant to the PPA IIIb upgrade of Energy Servers, the debt was paid off along with any interest accrued and the interest swap was settled for $0.2 million in 2019 and recorded to interest expense in the consolidated statement of operations.

PPA Company V - In July 2015, PPA Company V entered into nine interest rate swap agreements to convert a variable interest rate debt to a fixed rate. The loss on the swaps prior to designation was recorded in current-period earnings. In July 2015, we designated and documented its interest rate swap arrangements as cash flow hedges. Three of these swaps matured in 2016, three will mature on December 21, 2021 and the remaining three will mature on September 30, 2031. We evaluate and calculate the effectiveness of the hedge at each reporting date. The effective change was recorded in accumulated other comprehensive income (loss) and was recognized as interest expense on settlement. The notional amounts of the swaps were $184.2 million, $186.6 million and $188.5 million as of December 31, 2019, 2018 and 2017, respectively.

We measure the swaps at fair value on a recurring basis. Fair value is determined by discounting future cash flows using LIBOR rates with appropriate adjustment for credit risk. We recorded a gain of $0.2 million, a gain of $0.1 million and a gain of $0.1 million attributable to the change in valuation during the years ended December 31, 2019, 2018 and 2017, respectively. These gains were included in other income (expense), net in the consolidated statement of operations.

The changes in fair value of the derivative contracts designated as cash flow hedges and the amounts recognized in accumulated other comprehensive income (loss) and in earnings were as follows (in thousands):



	Year ended December 31,
	2019			2018
Beginning balance	$	3,548		$	5,852
Loss (gain) recognized in other comprehensive loss	6,131			(1,729		)
Amounts reclassified from other comprehensive loss to earnings	(216		)	(369		)
Net loss (gain) recognized in other comprehensive income (loss)	5,915			(2,098		)
Gain recognized in earnings	(225		)	(206		)
Ending balance	$	9,238		$	3,548

Natural Gas Derivatives

On September 1, 2011, we entered into a natural gas fixed price forward contract with a gas supplier. This fuel forward contract is used as part of our program to manage the risk for controlling the overall cost of natural gas. Our PPA I is the only PPA Company for which natural gas was provided by us. This fuel forward contract meets the definition of a derivative under U.S. GAAP. We have not elected to designate this contract as a hedge and, accordingly, any changes in its fair value is recorded within cost of revenue in the statements of operations. The fair value of the contract is determined using a combination of factors including the counterparty’s credit rate and estimates of future natural gas prices.

For the years ended December 31, 2019, 2018 and 2017, we marked-to-market the fair value of our natural gas fixed price forward contract and recorded a loss of $0.8 million, a gain of $2.2 million and a loss of $1.0 million, respectively. For the years ended December 31, 2019, 2018 and 2017, we recorded gains of $3.6 million, $3.4 million and $4.2 million, respectively, on the settlement of these contracts. Gains and losses are recorded in cost of revenue on the consolidated statement of operations.

Embedded Derivatives

6% Convertible Promissory Notes - On December 15, 2015, January 29, 2016, and September 10, 2016, we issued $160.0 million, $25.0 million, and $75.0 million, respectively, of 6% Convertible Promissory Notes ("6% Notes") that mature in December 2020. The 6% Notes were contractually convertible at the option of the holders at a conversion price per share equal to the lower of $20.61 or 75% of the offering price of our common stock sold in an initial public offering. Upon the IPO, the options were convertible at the option of the holders at the conversion price of $11.25 per share.

The valuation of this embedded put feature was recorded as a derivative liability in the consolidated balance sheet, measured each reporting period. Fair value was determined using the binomial lattice method. We recorded a gain of $31.5 million and a loss of $18.2 million attributable to the change in valuation for the years ended December 31, 2018 and 2017, respectively. These gains and losses were included within loss on revaluation of warrant liabilities and embedded derivatives in the consolidated statement of operations. Upon the IPO, the final valuation of the conversion feature was calculated as of the date of the IPO and was reclassified from a derivative liability to additional paid-in capital. The fair value of the embedded derivatives within the notes was $178.0 million upon reclassification.

Embedded EPP Derivatives in Sales Contracts - We estimated the fair value of the embedded EPP derivatives in certain sales contracts using a Monte Carlo simulation model which considers various potential electricity price forward curves over the sales contracts' terms. We use historical grid prices and available forecasts of future electricity prices to estimate future electricity prices. The grid pricing Escalation Protection Plan ("EPP") guarantees that we provided in some of our sales arrangements represent an embedded derivative, with the initial value accounted for as a reduction in product revenue and any changes, reevaluated quarterly, in the fair market value of the derivative recorded in other income (expense), net. We recorded a loss of $2.2 million, a gain of $0.2 million and a loss of $0.3 million attributable to the change in fair value for the years ended December 31, 2019, 2018 and 2017, respectively. These gains and losses were included within loss on revaluation of warrant liabilities and embedded derivatives in the consolidated statements of operations. The fair value of these derivatives was $6.2 million, $4.0 million and $4.2 million as of December 31, 2019, 2018 and 2017, respectively.