(9) Convertible Debt and Other Debt

Senior Secured Convertible Debentures and Warrants

We entered into Subscription Agreements (the “Subscription Agreement”) with various individuals (each, a “Purchaser”) between July 23, 2015 and March 31, 2016, pursuant to which the Company sold Senior Secured Convertible Debentures (the “Debentures”) and warrants to purchase shares of common stock equal to 50% of the number of shares issuable pursuant to the subscription amount (the “Warrants”) for an aggregate purchase price of $6,329,549 (the “Purchase Price”).

The Company issued a principal aggregate amount of $6,962,504 in Debentures which includes a 10% original issue discount on the Purchase Price. The Debenture does not accrue any additional interest during the first year it is outstanding but accrues interest at a rate equal to 10% per annum for the second year it is outstanding. The Debenture has a maturity date of two years from issuance. The Debenture is convertible any time after its issuance date. The Purchaser has the right to convert the Debenture into shares of the Company’s common stock at a fixed conversion price equal to $8.40 per share, subject to applicable adjustments. In the second year that the Debenture is outstanding, any interest accrued shall be payable quarterly in either cash or common stock, at the Company’s discretion.

On various dates for the year ended December 31, 2017, the Company issued 61,307 shares of common stock based on the 10-day VWAP prior to quarter end to holders of the Debentures in payment of the quarterly interest accrued from the Debentures first anniversary date through June 30, 2017 for an aggregate amount of $483,054. We recognized a $218,452 gain on extinguishment of debt by calculating the difference of the shares valued on the issuance date and the amount of accrued interest through June 30, 2017.

At any time after the Issuance Date, the Company has the option, subject to certain conditions, to redeem some or all of the then outstanding principal amount of the Debenture for cash in an amount equal to the sum of (i) 120% of the then outstanding principal amount of the Debenture, (ii) accrued but unpaid interest and (iii) any liquidated damages and other amounts due in respect of the Debenture.

On September 11, 2017, we notified Debenture holders that their Debentures will be extended 180 days beyond the original maturity date as permitted in the Debenture agreement. We will continue to pay interest on the Debentures until the extended maturity date. We accounted for the Debenture extensions as debt modifications and not extinguishment of debt since the changes in fair value are not substantial in accordance with ASC 470-50. We started amortizing the remaining unamortized discount as of September 11, 2017 over the new term, which extends 180 days beyond the original maturity date.

The Company issued warrants exercisable into a total of 376,759 shares of our common stock. The Warrants issued in this transaction are immediately exercisable at an exercise price of $12.00 per share, subject to applicable adjustments including full ratchet anti-dilution in the event that we issue any securities at a price lower than the exercise price then in effect. The Warrants have an expiration period of five years from the original issue date. The Warrants are subject to adjustment for stock splits, stock dividends or recapitalizations and also include anti-dilution price protection for subsequent equity sales below the exercise price.

Subject to the terms and conditions of the Warrants, at any time commencing six months from the Final Closing, the Company has the right to call the Warrants for cancellation if the volume weighted average price of its Common Stock on the OTCQB (or other primary trading market or exchange on which the Common Stock is then traded) equals or exceeds three times the per share exercise price of the Warrants for 15 out of 20 consecutive trading days.

In connection with the Subscription Agreement and Debenture, the Company entered into Security Agreements with the Purchasers whereby the Company agreed to grant to Purchasers an unconditional and continuing, first priority security interest in all of the assets and property of the Company to secure the prompt payment, performance and discharge in full of all of Company’s obligations under the Debentures, Warrants and the other Transaction Documents.

The Company determined that the conversion feature of the Debentures met the definition of a liability in accordance with ASC 815-40 and therefore bifurcated the conversion feature on each debt agreement and accounted for it as a derivative liability. The fair value of the conversion feature was accounted for as a note discount and is amortized to interest expense over the life of the loan. The fair value of the conversion feature was reflected in the conversion option liability line in the consolidated balance sheet as of December 31, 2016.

The proceeds from these convertible debts were allocated between the host debt instrument and the convertible option based on the residual method. The estimated fair value of the convertible option was determined using a binomial formula, resulting in allocations to the convertible option and accounted for as a liability in the Company’s consolidated balance sheet. In accordance with the provisions of ASC 815-40, the gross proceeds are offset by debt discounts, which are amortized to interest expense over the expected life of the debt.

ASC 470-20 states that the proceeds from the issuance of debt with detachable stock warrants should be allocated between the debt and warrants on the basis of their relative fair market values. The debt discount will be amortized to interest expense over the two-year term of these loans. We amortized $3,740,746 of the debt discount to interest expense in 2016. The warrants issued in connection with the convertible debentures are classified as warrant derivative liabilities because the warrants are entitled to certain rights in subsequent financings and the warrants contain “down-round protection” and therefore, do not meet the scope exception for treatment as a derivative under ASC 815, Derivatives and Hedging, (“ASC 815”). Since “down-round protection” is not an input into the calculation of the fair value of the warrants, the warrants cannot be considered indexed to the Company’s own stock which is a requirement for the scope exception as outlined under ASC 815. The estimated fair value of the warrants was determined using the binomial model, resulting in an allocation of $2,847,624  to the total warrants out of the gross proceeds of $6,329,549. The fair value will be affected by changes in inputs to that model including our stock price, expected stock price volatility, the contractual term, and the risk-free interest rate.

We early adopted ASU 2017-11 and applied the guidance to derivative accounting. We reclassified the fair value of the warrant derivative liabilities to stockholders’ equity when we adopted ASU 2017-11.

Other convertible notes

On May 13, 2016, one lender converted an outstanding note issued on April 28, 2015 and the related accrued interest totaling $117,837 to 14,028 common shares. As of December 31, 2017, the outstanding balance on the note was zero.

On May 24, 2016, we sold an additional convertible note for $107,000 with warrants to purchase 1,667 shares of common stock at an exercise price of $16.50 per share. The purchaser has the right to convert the notes into shares of the Company’s common stock at a fixed conversion price equal to $13.50 per share, subject to applicable adjustments. The estimated fair value of the warrants was determined using the binomial model, resulting in an allocation of $12,406 to the total warrants and the recognition of a beneficial conversion feature of $7,962, both of which were recorded as a discount to the note. We evaluated the convertible note and warrants for derivative liability treatment and determined that these instruments do not include certain rights such as price protection like our previous debt financings. Accordingly, we concluded that this financing arrangement did not qualify for derivative accounting treatment. The loan was paid in full in fiscal year 2016.

On June 14, 2016, we sold an additional convertible note for $115,000 and issued 1,023 common shares to compensate the lender. On July 1, 2016, the note was modified to increase the principal amount to $200,000 and we received the remaining proceeds of $85,000 on the same date and issued 1,144 common shares as compensation to the lender. The lender has the right to convert the note into shares of the Company’s common stock at fixed conversion price equal to $13.50 per share, subject to applicable adjustments. We valued the total 2,167 common shares using the stock prices at the respective dates the note proceeds were received and recorded the relative fair value of the shares amounting to $26,000 as a debt discount to be amortized over the term of the loan. We then computed the effective conversion price of the note, noting that no beneficial conversion feature exists. We also evaluated the convertible note for derivative liability treatment and determined that the instrument does not include certain rights such as price protection like our previous debt financing. Accordingly, we concluded that this financing arrangement did not qualify for derivative accounting treatment. The loan was paid in full in fiscal year 2017.

On July 29, 2016, we sold an additional convertible note for $100,000 and issued 1,084 common shares to compensate the lender. The lender has the right to convert the notes into shares of the Company’s common stock at a fixed conversion price equal to $13.50 per share, subject to applicable adjustments. The proceeds were allocated between the convertible note and shares of common stock based on their relative fair values. The relative fair values of the convertible note and the common shares was $87,241 and $12,759, respectively. We then computed the effective conversion price of the note, noting that the convertible debt gave rise to a beneficial conversion feature (BCF) of $12,759. The sum of the relative fair value of the common shares and the BCF of $25,518 was recorded as a debt discount to be amortized over the term of the loan. We also evaluated the convertible note for derivative liability treatment and determined that the instruments does not include certain rights such as price protection like our previous debt financings. Accordingly, we concluded that this financing arrangements did not qualify for derivative accounting treatment. The loan was paid in full in fiscal year 2017.

On September 15, 2016, we sold an additional convertible note for $500,000 and issued 6,666 common shares to compensate the lender. The lender has the right to convert the notes into shares of the Company’s common stock at a fixed conversion price equal to $13.50 per share, subject to applicable adjustments. The convertible note includes an original issue discount of $40,541 and is subject to a one-time interest of 9% or $45,000 which was recorded as a debt discount and amortized over the term of the loan. The proceeds were allocated between the convertible note and shares of common stock based on their relative fair values. The relative fair value of the convertible note was $434,028. The allocation of the gross proceeds to the shares of common stock was $65,972 and recorded as a debt discount to be amortized over the term of the loan. We then computed the effective conversion price of the note, noting that no beneficial conversion feature exists. We also evaluated the convertible note for derivative liability treatment and determined that the instrument does not include certain rights such as price protection like our previous debt financings. Accordingly, we concluded that this financing arrangement did not qualify for derivative accounting treatment. The loan was paid in full in fiscal year 2017.

On various dates during the quarter ended December 31, 2017, the Company issued convertible notes for net proceeds of $1,755,850 with the following terms: a) maturity ranging from 3 to 12 months; b) annual interest rates ranging from 5% to 12%; c) convertible to the Company’s common stock at issuance at a fixed rate of $7.50 or convertible at variable conversion rates either after 6 months after issuance or in the event of a default. Certain of these notes were issued with shares or warrants which were fair valued at issuance dates. The relative fair values of the shares or warrants issued with the notes were recorded as a debt discount and amortized over the term of the notes. We then computed the effective conversion price of the notes, noting that no beneficial conversion feature exists. We also evaluated the convertible notes for derivative liability treatment and determined that the notes did not qualify for derivative accounting treatment as of December 31, 2017.

The specific terms of the convertible notes and outstanding balances as of December 31, 2017 are listed in the tables below.

Convertible Notes

1) The loan term was extended by 180 days and further extended on January 15, 2018 by 60 days to repay in common stock. The July 22, 2015 Debentures of $2,180,000 is currently past due as of March 19, 2018.

2. The original issue discount is reflected in the first year.

3. The annual interest started accruing in the second year.

4. On October 20, 2017, Company issued to EMA Financial, LLC a 5% one year convertible note in the amount of $150,000, less $7,500 from OID and fees. The note is convertible at $7.50 per share, provided however, if the Company fails to comply with Section 1.9 of the note then the conversion price shall be 65% of the lowest sale price for the Common Stock on the Principal Market during the twenty (20) consecutive Trading Days immediately preceding the Conversion Date or the closing bid price, whichever is lower.

As of December 31, 2017, a total of approximately $291,000 convertible debentures were purchased by related parties who were members of the Company’s Board of Directors and management and their family members.

Deferred finance fees included cash commissions amounting to $621,500 and the fair value of the 2,101,786 warrants issued to the placement agent amounting to $536,908. For the year ended December 31, 2017, the Company recognized amortization expense related to the debt discounts indicated above of $1,955,193. The unamortized debt discounts as of December 31, 2017 related to the convertible debentures and other convertible notes amounted to $433,228.

Revolving Note Payable

On October 28, 2016, an accredited investor (the “Investor”) purchased from us a promissory note in the aggregate principal amount of up to $2,000,000 (the “Revolving Note”) due and payable on the earlier of October 28, 2017 (the “Maturity Date”) or on the seventh business day after the closing of a Qualified Offering (as defined in the Revolving Note). Although the Revolving Note is dated October 26, 2016, the transaction did not close until October 28, 2016, when we received its initial $250,000 advance pursuant to the Revolving Note. As a result, on the same day and pursuant to the Revolving Note, we issued to the Investor a Common Stock Purchase Warrant to purchase 20,834 shares of our common stock at an exercise price per share equal to $12.00 per share. The Investor is obligated to provide us with advances of $250,000 under the Revolving Note, but the Investor shall not be required to advance more than $250,000 in any individual fifteen (15) day period and no more than $500,000 in the thirty (30) day period immediately following the date of the initial advance. We received $3,500,000 pursuant to the Revolving Note as amended of which $2,070,000 net proceeds was received in 2017 and we issued to the Investor warrants to purchase 291,667 shares of our Common Stock at an exercise price per share equal to $12.00 per share. The terms of the Warrants are identical except for the exercise date, issue date, and termination date which are based on the advance date.

The Revolving Note was amended on May 2, 2017 to increase the aggregate principal amount to $3,000,000, to issue 16,667 shares of our Common Stock to the Investor, to decrease the exercise price per share of the warrants to the lower of (i) $12.00 or (ii) the per share purchase price of the shares of our Common Stock sold in the Qualified Offering, and to change the references in the Revolving Note from “the six (6) month anniversary of October 28, 2016” to “July 25, 2017.” The fair value of the 16,667 shares issued of $149,018 was accounted for as a note discount and are amortized to interest expense over the life of the loan. We evaluated the accounting impact of the Revolving Note amendment and deemed that the amendment did not have a material impact on our consolidated financial statements.

The Revolving Note was further amended on August 18, 2017 to increase the aggregate principal amount to $3,500,000 with all other terms unchanged.

In the event that a Qualified Offering had occurred after July 25, 2017, but prior to the Maturity Date, within seven (7) Business Days of the closing of the Qualified Offering, the Company was to pay a cash fee equal to five percent (5%) of the total outstanding amount owed by the Company to the Holder as of the closing date of the Qualified Offering or, at the option of the Company, issue to the Holder a number of restricted shares of the Company’s common stock equal to (x) five percent (5%) of the total outstanding amount owed by the Company to the Holder as of the closing date of the Qualified Offering divided by (y) the purchase price provided by the documents governing the Qualified Offering. A Qualified Offering means the completion of a public offering of the Company’s securities pursuant to which the Company receives aggregate gross proceeds of at least Seven Million United States Dollars (US$7,000,000) in consideration of the purchase of its securities and resulting in, pursuant to the effectiveness of the registration statement for such offering, the Company’s common stock being traded on the NASDAQ Capital Market, NASDAQ Global Select Market or the New York Stock Exchange. A Qualified Offering did not occur on or prior to the Maturity Date.

In the event that a Qualified Offering had not occurred after July 25, 2017, but prior to the Maturity Date, within seven (7) Business Days of the closing of the Qualified Offering, the Company shall pay a cash fee equal to five percent (5%) of the total outstanding amount owed by the Company to the Holder or, at the option of the Company, issue to the Holder a number of restricted shares of the Company’s common stock equal to (x) five percent (5%) of the total outstanding amount owed by the Company to the Holder as of the Maturity Date divided by (y) the VWAP of the Company’s common stock for the last ten trading days preceding the Maturity Date. A Qualified Offering did not occur on or prior to the Maturity Date.

Interest on the principal balance of the Revolving Note shall be paid in full on the Maturity Date, unless otherwise paid prior to the Maturity Date. Interest shall be assessed as follows: (i) a one-time interest of 10% on all principal amounts advanced prior to April 28, 2017; (ii) the foregoing and 4% on any amount remaining outstanding if the principal amount is repaid between April 28, 2017 and July 28, 2017; or (iii) both of the foregoing and 4% on any amount remaining outstanding if the principal amount is repaid between July 28, 2017 and October 28, 2017.

Broker fees amounting to $296,500, the one-time interest of $350,000 and the relative fair value of the 291,667 warrants issued to the Investor amounting to $1,148,275 were recorded as debt discounts and amortized over the term of the revolving note. The unamortized debt discounts related to the Revolving Note were fully amortized as of December 31, 2017.

The Revolving Note was still outstanding as of December 31, 2017 and is currently past due. We continue to accrue interest on the note.

The following table provides a summary of the changes in convertible debt and revolving note payable, net of unamortized discounts, during 2017:

Other Notes

On January 20, 2016 we borrowed $50,000 from an individual with no interest or fees. We paid back the loan in March 2016.

On February 8, 2016 we signed a Merchant Agreement with a lender. Under the agreement we received $100,000 in exchange for third position rights to all customer receipts until the lender is paid $129,900, which is collected at the rate of $927 per business day. The Company paid $2,000 in fees in connection with this loan. We received an additional $125,000 in June 2016 under the existing Merchant Agreement of which $48,420 was used to pay off the prior loan. The lender provided an additional $70,000 on August 16, 2016. As of December 31, 2017, the outstanding balance on this note was zero.

On May 9, 2016 we signed a promissory note with a lender. Under the agreement we received $200,000 net of a $6,000 original issue discount and we repaid $206,000 on August 25, 2016. In connection with this promissory note, we issued warrants exercisable into 3,333 shares of our common stock. The warrants issued in this transaction are immediately exercisable at an exercise price of $16.50 per share. The warrants have an expiration period of three years from the original issue date. The warrants are subject to adjustment for stock splits, stock dividends or recapitalizations. The warrants were recorded as a component of our Stockholders’ Equity. The estimated fair value of the warrants was determined using the binomial model, resulting in an allocation of $27,349 to the total warrants and recorded as a discount to the note to be amortized over the term of the loan. We evaluated the warrants for derivative liability treatment and determined that these instruments do not include certain rights such as price protection like our previous debt financings. Accordingly, we concluded that these instruments did not qualify for derivative accounting treatment. In August 2016, the lender extended the maturity date of the note from August 11, 2016 to August 25, 2016. Consequently, a penalty interest of $41,200 was added to the principal amount and settled through the issuance of 3,335 common shares. As of December 31, 2016, the outstanding balance on this note was zero.

On February 15, 2017, we received six-month, non-convertible loans in the aggregate of $220,000 from two accredited investors. We agreed to issue each investor 5,667 shares of restricted common stock. The loans earn no interest but carry a 10% original issue discount fee. We recorded the fair value of the shares amounting to $43,616 as debt discounts that will be amortized to interest expense during the term of the loans. We received a one-month extension on one loan and two one-month extensions on the other. Each extension required a 10% fee to the lender. We treated these extensions as loan extinguishments and accordingly wrote off the original debt and recorded new debt to include the extension fees as part of the principal amount. The extension fees of $33,000 to extend the loans were recorded as losses on extinguishment of debt in the consolidated financial statements. Both loans were paid off entirely by October 31, 2017. We amortized the entire $63,616 of debt discounts in the year ended December 31, 2017.

On March 14, 2017, we received an eight-month, non-convertible loan of $250,000 from a privately-held investment firm. The loan earned an annual interest rate of 10% and included a 10% original issue discount. We also agreed to issue the investor 8,333 shares of restricted common stock. We recorded the fair value of the shares amounting to $46,748 as a debt discount that will be amortized to interest expense during the term of the loan. We amortized the entire $76,748 of the debt discount in the year ended December 31, 2017. In the event of default and at the option of the holder, the loan was convertible into common stock at a 35% discount to the lowest closing stock price for the 15 trading days prior to conversion. We paid the loan entirely by the maturity date so derivative accounting was triggered from the conversion option.

On March 21, 2017, we received an eight-month, non-convertible loan of $170,000 from an accredited investor. The loan earns an annual interest rate of 10% and includes a 10% original issue discount. We also agreed to issue the investor 5,667 shares of restricted common stock. We recorded the fair value of the shares amounting to $35,079 as a debt discount that will be amortized to interest expense during the term of the loan. The loan still remains outstanding as of December 31, 2017 with a balance of $170,000. The lender extended the term to December 31, 2017 and further to March 31, 2018 in exchange for a total of 9,500 shares of common stock. We amortized $44,841 of debt discounts in the year ended December 31, 2017. The unamortized debt discount as of December 31, 2017 was $7,238.

On April 19, 2017, we received a 7-month non-convertible loan of $250,000 from a privately-held investment firm. The loan earned an annual interest rate of 10% and included a 10% original issue discount. We agreed to issue 833 shares at closing. Until the loan was repaid, we agreed that over the next one hundred eighty (180) days to issue 2,500 shares to the Investor every sixty (60) days for a total issuance of 8,333 shares. We recorded the fair value of the 8,333 shares amounting to $43,687 as a debt discount that was amortized to interest expense during the term of the loan. We amortized $68,687  of debt discounts in the year ended December 31, 2017. The unamortized debt discount as of December 31, 2017 was zero. In the event of default and at the option of the holder, the loan was convertible into common stock at a 35% discount to the lowest closing stock price for the 15 trading days prior to conversion. We paid the loan entirely by the maturity date so derivative accounting was triggered from the conversion option.

On May 19, 2017, we received a 45-day non-convertible loan of $630,000 from a private investor. The loan provides guaranteed interest of $63,000 and has an origination fee of $32,000. We paid a broker $31,500 in connection with this loan. The unamortized debt discount as of December 31, 2017 was zero. We used these proceeds to pay off in full our September 2016 loan of $589,189. The loan remains outstanding and is currently past due. We continue to accrue interest at a 20% annual rate from the maturity date.

On August 1, 2017, we signed a non-convertible installment loan with a lender. Under the agreement we received a loan of $75,000 with a weekly repayment of $3,500 until payment in full. The loan includes $18,750 representing an original issue discount, interest and fees resulting in a total payable of $93,750. The loan remains outstanding as of December 31, 2017 with a balance of approximately $16,750.

On September 12, 2017, we received a 9-month non-convertible loan of $225,000 from a privately-held investment firm. The loan earns an annual interest rate of 10%. The Company paid total fees of $25,000 including original issue discount and other costs related to this loan. We agreed to issue 3,333 shares at closing. We recorded the fair value of the shares as a debt discount that will be amortized to interest expense during the term of the loan. We amortized $15,311 of debt discounts in the year ended December 31, 2017. The unamortized debt discount as of December 31, 2017 was $22,689. In the event of default and at the option of the holder, the loan is convertible into common stock at a 35% discount to the average of the two lowest daily volume weighted average closing stock price for the 20 trading days prior to conversion.

Merchant Agreements

We have signed various Merchant Agreements which entitle the lenders to our customer receipts. We accounted for the Merchant Agreements as loans under ASC 860 because while we provided rights to current and future receipts, we still had control over the receipts. The following table shows our Merchant Agreements as of December 31, 2017.

1) The Company recognized a gain in fiscal year 2016 on the settlement of the previous loan of $5,044 which was credited to interest expense.

We amortized $312,870 and $40,802 of debt discounts during the years ended December 31, 2017 and 2016, respectively for all non-convertible notes. The total unamortized discount for all non-convertible notes as of December 31, 2017 was $48,194.

Related Party Notes

During the year ended December 31, 2016, the Company received advances from certain officers of the Company amounting to $20,000. These advances were non-interest bearing and payable on demand. As of December 31, 2016 there are no outstanding notes to related parties.