Quarterly report pursuant to Section 13 or 15(d)

Convertible Debt and Other Debt

v3.5.0.2
Convertible Debt and Other Debt
9 Months Ended
Sep. 30, 2016
Debt Disclosure [Abstract]  
Convertible Debt and Other Debt

  6) 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 $0.28 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.

 

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.

 

The Company issued warrants exercisable into a total of 11,302,766 shares of our common stock. The Warrants issued in this transaction are immediately exercisable at an exercise price of $0.40 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 OTC QB Market (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 are 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 condensed consolidated balance sheets.

 

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 condensed 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 $2,768,527 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 will continue to classify the fair value of the warrants as a liability until the warrants are exercised, expire or are amended in a way that would no longer require these warrants to be classified as a liability, whichever comes first.

 

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 420,849 common shares. As of September 30, 2016, the outstanding balance on the note was zero.

 

On May 24, we sold an additional convertible note for $107,000 with warrants to purchase 50,000 shares of common stock at an exercise price of $0.55 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 $0.45 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.

 

On June 14, 2016, we sold an additional convertible note for $115,000 and issued 30,667 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 34,333 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 $0.45 per share, subject to applicable adjustments. We valued the total 65,000 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.

 

On July 29, 2016, we sold an additional convertible note for $100,000 and issued 32,500 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 $0.45 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.

 

On September 15, 2016, we sold an additional convertible note for $500,000 and issued 200,000 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 $0.45 per share, subject to applicable adjustments. The convertible note includes an original issue discount of $40,541 and is subject to annual interest of 9%. 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 specific terms of the convertible debts and outstanding balances as of September 30, 2016 are listed in the table below.

 

Fixed Rate Convertible Notes

 

Inception Date   Term   Loan
Amount
    Outstanding
Balance
    Original
Issue
Discount
    Interest
Rate
    Deferred
Finance
Fees
    Discount
related
to fair
value of
conversion
feature
and
warrants/shares
 
July 22, 2015   24 months   $ 2,180,000     $ 2,180,000     $ 218,000 1     10 %2   $ 388,532     $ 2,163,074  
September 25, 2015   24 months     1,100,000       1,100,000       110,000 1     10 %2     185,956       1,022,052  
October 2, 2015   24 months     150,000       150,000       15,000 1     10 %2     26,345       140,832  
October 6, 2015   24 months     30,000       30,000       3,000 1     10 %2     5,168       26,721  
October 14, 2015   24 months     50,000       50,000       5,000 1     10 %2     8,954       49,377  
November 2, 2015   24 months     250,000       250,000       25,000 1     10 %2     43,079       222,723  
November 10, 2015   24 months     50,000       50,000       5,000 1     10 %2     8,790       46,984  
November 12, 2015   24 months     215,000       215,000       21,500 1     10 %2     38,518       212,399  
November 20, 2015   24 months     200,000       200,000       20,000 1     10 %2     37,185       200,000  
December 4, 2015   24 months     170,000       170,000       17,000 1     10 %2     37,352       170,000  
December 11, 2015   24 months     360,000       360,000       36,000 1     10 %2     75,449       360,000  
December 18, 2015   24 months     55,000       55,000       5,500 1     10 %2     11,714       55,000  
December 31, 2015   24 months     100,000       100,000       10,000 1     10 %2     20,634       100,000  
January 11, 2016   24 months     100,000       100,000       10,000 1     10 %2     24,966       80,034  
January 20, 2016   24 months     50,000       50,000       5,000 1     10 %2     9,812       40,188  
January 29, 2016   24 months     300,000       300,000       30,000 1     10 %2     60,887       239,113  
February 26, 2016   24 months     200,000       200,000       20,000 1     10 %2     43,952       156,048  
March 10, 2016   24 months     125,000       125,000       12,500 1     10 %2     18,260       106,740  
March 18, 2016   24 months     360,000       360,000       36,000 1     10 %2     94,992       265,008  
March 24, 2016   24 months     106,667       106,667       10,667 1     10 %2     15,427       91,240  
March 31, 2016   24 months     167,882       167,882       16,788 1     10 %2     2,436       165,446  
April 5, 2016   24 months     10,000       10,000       1,000 1     10 %2     -       10,000  
May 24, 2016   7 months     100,000       100,000       7,000       0 %     -       20,368  
June 15, 2016   6 months     40,000       40,000       -       12 %     -       3,680  
June 17, 2016   6 months     40,000       40,000       -       12 %     -       3,899  
June 22, 2016   6 months     35,000       35,000       -       12 %     -       3,373  
July 6, 2016   6 months     85,000       85,000       -       12 %     -       15,048  
July 29, 2016   6 months     100,000       100,000       -       12 %     -       25,518  
September 15, 2016   8 months     500,000       500,000       40,541       9 %     -       65,972  
                                                     
        $ 7,229,549     $ 7,229,549     $ 680,496             $ 1,158,408     $ 6,060,837  

 

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

2 The annual interest starts accruing in the second year.

 

The closings above on March 10, 24, and 31, 2016 included $264,667 of proceeds received from related parties.

 

At any time after six months from the Inception Date, the Company has the right to prepay the above Debentures in cash for 120% of the principal amount outstanding and any accrued interest. As of September 30, 2016, a total of approximately $291,000 convertible debentures were purchased by related parties who were members of the Company’s Board of Directors.

 

The following table provides a summary of the changes in convertible debt, net of unamortized discount, during 2016:

 

    2016  
Balance at January 1,   $ 277,342  
Issuance of convertible debt, face value     2,509,045  
Original issue discount     (189,496 )
Debt discount from derivative liabilities (embedded conversion option and warrants)     (1,153,817 )
Debt discount from shares and warrants issued with the notes     (117,137 )
Debt discount from beneficial conversion feature     (20,721 )
Deferred financing fees     (270,732 )
Conversion of debentures to common shares     (100,000)  
Accretion of interest and amortization of debt discount to interest expense through September 30,     2,808,261  
Balance at September 30,     3,742,745  
Less: current portion     2,664,334  
Convertible debt, long-term portion   $ 1,078,411  

 

Other Notes

 

On January 6, 2016 we signed a Merchant Agreement with a lender. Under the agreement we received $250,000 in exchange for rights to all customer receipts until the lender is paid $322,500, which is collected at the rate of $1,280 per business day. The payments were secured by second position rights to all customer receipts until the loan has been paid in full. $138,840 of the proceeds were used to pay off the outstanding balance of a previous loan from another lender. The Company recognized a gain on the settlement of the previous loan of $5,044 which was credited to interest expense. The Company paid $2,500 in fees in connection with this loan. We received an additional $93,161 in June 2016 under the existing Merchant Agreement. The note was still outstanding as of September 30, 2016 with a balance of $105,125.

 

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 note was still outstanding as of September 30, 2016 with a balance of $4,620 after payments of $56,841. The lender provided an additional $70,000 on August 16, 2016. We repaid a portion of the $70,000 with $49,200 remaining as outstanding as of September 30, 2016.

 

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 100,000 shares of our common stock. The warrants issued in this transaction are immediately exercisable at an exercise price of $0.55 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 100,049 common shares. As of September 30, 2016, the outstanding balance on this note was zero.

 

On August 26, 2016 we signed a Merchant Agreement with a lender. Under the agreement we received $122,465 net proceeds in exchange for rights to all customer receipts which is collected at the rate of $1,386 per business day. The note was still outstanding as of September 30, 2016 with a balance of $89,201.