NOTE 2 - GLOBAL STRATEGIC PARTNERSHIP WITH SPI ENERGY CO., LTD.

On July 13, 2015, the Company entered into a global strategic partnership with SPI Energy Co., Ltd. (“SPI”), (formerly known as Solar Power, Inc.), which includes a Securities Purchase Agreement, a Supply Agreement, and a Governance Agreement.

Pursuant to the Securities Purchase Agreement, SPI purchased, for an aggregate purchase price of $33,390,000 a total of (i) 8,000,000 shares of common stock (the “Purchased Common Shares”) and (ii) 28,048 shares of Series C Convertible Preferred Stock (the “Purchased Preferred Shares”) which were potentially convertible, subject to the completion of projects under our Supply Agreement with SPI (as described below), into a total of up to 42,000,600 shares of Common Stock.

The aggregate purchase price for the Purchased Common Shares was based on a purchase price per share of $0.6678, and the aggregate purchase price for the Purchased Preferred Shares was determined based on a price of $0.6678 per common equivalent. Pursuant to the Securities Purchase Agreement, the Company also issued to SPI a warrant to purchase 50,000,000 shares of Common Stock for an aggregate purchase price of $36,729,000 (the “Warrant”), at a per share exercise price of $0.7346.

The Company incurred $807,807 of financing related costs in connection with the transaction. The specific costs directly attributable to the Securities Purchase Agreement have been charged against the gross proceeds of the offering.

The Company also entered into a supply agreement with SPI pursuant to which the Company agreed to sell and SPI agreed to purchase certain products and services offered by the Company from time to time, including certain energy management system solutions for solar projects (the “Supply Agreement”). Under the Supply Agreement, SPI agreed to purchase energy storage systems with a total combined power output of 40 megawatts (MW) over a four-year period. As described below, on May 4, 2017, the Company terminated the Supply Agreement.

The Company also entered into a governance agreement with SPI (the “Governance Agreement”) that provides SPI certain rights regarding the Company’s Board of Directors and other select governance rights.

Terms of the Purchased Preferred Shares

The Purchased Preferred Shares are perpetual, are not eligible for dividends, and are not redeemable. Upon any liquidation, dissolution, or winding up of the Company (a “Liquidation”) or a Fundamental Transaction (as defined in the Certificate of Designation for the Series C Preferred Stock), holders of the Purchased Preferred Shares are entitled to receive out of the assets of the Company an amount equal to the higher of (1) the Stated Value, which was $28,048,000 as of March 31, 2017 and (2) the amount payable to the holder if it had converted the shares into common stock immediately prior to the Liquidation or Fundamental Transaction, for each share of the Purchased Preferred Stock after any distribution or payment to the holders of the Series B Preferred Stock and before any distribution or payment shall be made to the holders of the Company’s existing Common Stock, and if the assets of the Company shall be insufficient to pay in full such amounts, then the entire assets to be distributed shall be ratably distributed in accordance with respective amount that would be payable on such shares if all amounts payable thereon were paid in full, which was $466,472 as of March 31, 2017.

Except as required by law or as set forth in the Certificate of Designation for the Series C Preferred Stock, the Purchased Preferred Shares do not have voting rights. While the Series C Preferred Stock is outstanding, the Company may not pay dividends on its common stock and may not redeem more than $100,000 in common stock per year.

The Purchased Preferred Shares were sold for $1,000 per share and are contingently convertible into 42,000,600 shares calculated utilizing a conversion price of $0.6678, subject to adjustment for stock splits, stock dividends, and other designated capital events. Convertibility of the Purchased Preferred Shares is dependent upon SPI making purchases of and payments for energy storage systems under the Supply Agreement as follows:

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The first one-fourth (the “Series C-1 Preferred Stock”) of the Purchased Preferred Shares only become convertible upon the receipt of final payment for five megawatts worth of solar projects that are purchased by SPI in accordance with the Supply Agreement (the “Projects”);

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The second one-fourth (the “Series C-2 Preferred Stock”) only become convertible upon the receipt of final payment for an aggregate of 15 megawatts worth of Projects;

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The third one-fourth (the “Series C-3 Preferred Stock”) only become convertible upon the receipt of final payment for an aggregate of 25 megawatts worth of Projects; and

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The last one fourth (the “Series C-4 Preferred Stock”) only become convertible upon the receipt of final payment for an aggregate of 40 megawatts worth of Projects.

As described below, because EnSync terminated the Supply Agreement, it is no longer possible for SPI to satisfy the conditions that would have enabled it to convert any shares of the Series C Preferred Stock into shares of EnSync common stock.

Terms of the Warrant

The Warrant entitles SPI to purchase 50,000,000 shares of the Company’s common stock for an aggregate exercise price of $36,729,000, or $0.7346 per share, subject to adjustment for stock splits, stock dividends, and other designated capital transactions. The Warrant may not be partially exercised.

The Warrant would have become exercisable only once SPI purchased and paid for 40 megawatts of Projects. Prior to exercise, the Warrant provided SPI with no voting rights.

As of March 31, 2017, no purchases had been made under the Supply Agreement and the Warrant was therefore not vested or exercisable. As described below, because EnSync terminated the Supply Agreement, it is no longer possible for the Warrant to become exercisable. The closing price of the Company’s common stock at March 31, 2017 was $0.61, which was below the exercise price of the Warrant, as such, the Warrant was out-of-the-money at that date.

Terms of the Supply Agreement

Pursuant to the Supply Agreement, the Company agreed to sell and SPI agreed to purchase products and services offered by the Company from time to time, including energy management system solutions for solar projects. Pursuant to the Supply Agreement the Company agreed to sell and SPI agreed to purchase products and related services that have an aggregated total of at least 5 megawatts of energy storage rated power output within the first year of the Supply Agreement, 15 megawatts within the first two years, 25 megawatts within the first three years, and 40 megawatts within the first four years of the Supply Agreement.

Termination of Supply Agreement

SPI never made any purchases under the Supply Agreement. Due to SPI’s failure to meet its purchase obligations, on May 4, 2017 the Company terminated the Supply Agreement. As a result of the termination of the Supply Agreement, it is no longer possible for SPI to satisfy the conditions that would have enabled it to convert the Purchased Preferred Shares or exercise the Warrant.

Accounting for the Securities Purchase Agreement and the Supply Agreement

At closing of the SPI transaction on July 13, 2015, the Company recognized the fair value of the Purchased Common Shares ($6.8 million, determined by reference to the closing price of the Company’s common stock on the NYSE MKT) as an increase to equity. The Company also recognized as equity the fair value of the Series C Preferred Stock ignoring the contingent convertibility on the closing date. The closing date fair value of the Series C Preferred Stock ignoring the contingent convertibility of those shares was estimated at $13.3 million. This price was determined using the Option-Pricing Method (“OPM”) as described in the AICPA Accounting and Valuation Guide entitled Valuation of Privately-Held-Company Equity Securities Issued as Compensation and a “with” and “without” methodology to bifurcate the Series C Preferred conversion feature. The OPM model treats the various equity securities as call options on the total equity value contingent upon each securities strike price or participation rights. At closing of the transaction, the Black-Scholes inputs utilized for the OPM model were: (i) an aggregate equity value of $122.8 million, estimated based on the back-solve methodology to reconcile the closing common stock price ($0.85) as of the valuation date; (ii) a term of four years, in alignment with the terms of the Supply Agreement; (iii) a risk free rate of 1.4%, from the Federal Reserve Board’s H.15 release as of the transaction date; (iv) a volatility of 101.3%, based on the volatility of the Company’s publicly traded stock price; and (v) the performance vesting requirements of the Purchased Preferred Shares were expected to be met.

Offering expenses of $807,807 were recognized as a reduction of the offering proceeds. The specific costs directly attributable to the Securities Purchase Agreement have been charged against the gross proceeds of the offering.

The cash received by the Company in excess of the fair value of the Purchased Common Shares and the nonconvertible attribute of the Purchased Preferred Shares was recorded as deferred revenue of $13,290,000. This amount was allocated to the Supply Agreement under which the Company expects to perform in the future. The deferred revenue will be recognized as revenue as sales occur under the Supply Agreement.

Because the Purchased Preferred Shares will only become convertible when the Company receives final payment for the stated purchases under the Supply Agreement, the value of the conversion option on each tranche of Series C Preferred Stock will be recognized as a sales incentive (a reduction of revenue) and an addition to equity as purchases that lead towards convertibility of that tranche occur, so long as the Company believes it is probable that the particular tranche will become convertible, pursuant to guidance in FASB ASC Topic 605-50, “Revenue Recognition – Customer Payments and Incentives.”

Because the Warrant will only vest and become exercisable if SPI makes sufficient purchases under the Supply Agreement, the same guidance provides that the fair value of the Warrant be recognized as a sales incentive (a reduction of revenue) and an addition to equity as sales occur, so long as the Company believes it is probable that SPI will make sufficient purchases during the term of the Warrant for the Warrant to vest.

As SPI does not face a penalty for not purchasing Projects under the Supply Agreement beyond the convertibility of the Purchased Preferred Shares and the exercisability of the Warrant, FASB ASC Topic 505-50, “Equity – Equity-Based Payments to Non-Employees,” requires that the fair value of each tranche of Series C Preferred Stock be updated at each reporting date until that tranche vests according to its terms, and that the fair value of the Warrant be updated at each reporting date until the Warrant vests according to its terms.

As of March 31, 2017, the value of the conversion option on the Series C Preferred Stock was estimated to be $185,000 and the value of the Warrant was estimated to be $214,000, which was determined using the Option-Pricing Method (“OPM”) as described in the AICPA Accounting and Valuation Guide entitled Valuation of Privately-Held-Company Equity Securities Issued as Compensation and a “with” and “without” methodology to bifurcate the Series C Preferred conversion feature. The OPM model treats the various equity securities as call options on the total equity value contingent upon each security’s strike price or participation rights. At March 31, 2017, the Black-Scholes inputs utilized for the OPM model were: (i) an aggregate equity value of $64.4 million, estimated based on the back-solve methodology to reconcile the closing common stock price ($0.61) as of the valuation date; (ii) a term of 2.25 years, in alignment with the terms of the Supply Agreement; (iii) a risk free rate of 1.33%, from the Federal Reserve Board’s H.15 release as of the transaction date; (iv) a volatility of 101.2%, based on the volatility of the Company’s publicly traded stock price; and (v) the performance vesting requirements of the equity instruments were expected to be met.

As no sales under the Supply Agreement occurred prior to March 31, 2017, no revenue has been recognized pursuant to the Supply Agreement, and no amounts related to the convertibility option on the Series C Preferred Stock or the Warrant have been reflected in the financial statements.

Terms of Governance Agreement

In connection with the closing of the SPI transaction and pursuant to the Securities Purchase Agreement, the Company entered into a Governance Agreement with SPI (the “Governance Agreement”). Under the Governance Agreement, for so long as SPI holds at least 10,000 Purchased Preferred Shares or 25 million shares of Common Stock or Common Stock equivalents (the “Requisite Shares”) SPI had the right to initially nominate one director to the Company’s board of directors and to nominate additional directors as it completed and paid for Projects under the Supply Agreement and the Purchased Preferred Shares became convertible; provided in no event is SPI entitled to nominate a number of directors to the Board that would represent a percentage of the Board greater than the percentage determined by dividing the number of Common Stock Equivalents held by SPI by the sum of (A) the total shares of the Company’s Common Stock outstanding and (B) the number of shares of Common Stock into which the Preferred Stock held by SPI is convertible.

The Governance Agreement provides that for so long as SPI holds the Requisite Shares, the Company will not take any of the following actions without the affirmative vote of SPI: (a) change the conduct by the Company’s business; (b) change the number or manner of appointment of the directors on the board; (c) cause the dissolution, liquidation or winding-up of the Company or the commencement of a voluntary proceeding seeking reorganization or other similar relief; (d) other than in the ordinary course of conducting the Company’s business, cause the incurrence, issuance, assumption, guarantee or refinancing of any debt if the aggregate amount of such debt and all other outstanding debt of the Company exceeds $10 million; (e) cause the acquisition, repurchase or redemption by the Company of any securities junior to the Purchased Preferred Shares; (f) cause the acquisition of an interest in any entity or the acquisition of a substantial portion of the assets or business of any entity or any division or line of business thereof or any other acquisition of material assets, in any such case where the consideration paid exceeds $2 million, or cause the Company to engage in other Fundamental Transactions (as defined in the certificate of designation of preferences, rights and limitations of the Series C Convertible Preferred Stock); (g) cause the entering into by the Company of any agreement, arrangement or transaction with an affiliate that calls for aggregate payments (other than payment of salary, bonus or reimbursement of reasonable expenses) in excess of $120,000; (h) cause the commitment to capital expenditures in excess of $7 million during any fiscal year; (i) cause the selection or replacement of the auditors of the Company; (j) enter into of any partnership, consortium, joint venture or other similar enterprise involving the payment, contribution, or assignment by the Company or to the Company of money or assets greater than $5 million; (k) amend or otherwise change its Articles of Incorporation or by-laws or equivalent organizational documents of the Company or any subsidiary in any manner that materially and adversely affects any rights of SPI; (l) amend or otherwise change the Articles of Incorporation or by-laws or equivalent organizational documents of any Subsidiary in any manner; (m) grant, issue or sell any equity securities (with certain limited exceptions); (n) declare, set aside, make or pay any dividend or other distribution, payable in cash, stock, property or otherwise, with respect to any of its capital stock; provided, however, that the dividends called for by Section 3(b) of the Certificate of Designation of Preferences, Rights and Limitations of the Company’s Series B Convertible Preferred Stock shall nonetheless continue to accrue and accumulate on each share of the Company’s Series B Convertible Preferred Stock; (o) reclassify, combine, split or subdivide, directly or indirectly, any of its capital stock; (p) permit any item of material intellectual property to lapse or to be abandoned, dedicated, or disclaimed, fail to perform or make any applicable filings, recordings or other similar actions or filings, or fail to pay all required fees and taxes required or advisable to maintain and protect its interest in such intellectual property; or (q) enter into any contract, arrangement, understanding or other similar agreement with respect to any of the foregoing.

Additionally, the Governance Agreement provides a preemptive right to SPI in the case of issuances of equity securities. As of June 30, 2016, SPI owned approximately 17% of the Company’s outstanding common stock. As of March 31, 2017, SPI did not own any shares of the Company’s outstanding common stock.

On August 30, 2016, SPI entered into a share purchase agreement (the “Share Purchase Agreement”) with Melodious Investments Company Limited (“Melodious”) pursuant to which SPI sold to Melodious all of the Purchased Common Shares, all 7,012 outstanding shares of Series C-1 Preferred Stock and 4,341 shares of Series C-2 Preferred Stock for a total purchase price of $17.0 million (which is equal to the price SPI paid for such securities). The Share Purchase Agreement provides that if the purchased shares of Series C-1 Preferred Stock and Series C-2 Preferred Stock are not converted into shares of common stock within six months following the closing date, Melodious will have the right to require SPI to repurchase such shares for a price equal to approximately 102% of the price paid by Melodious for such shares (plus 10% interest accrued from the closing date). As of March 31, 2017, Melodious had not elected to exercise such right. Following the sale of such securities, SPI continues to hold the Requisite Shares, and the Governance Agreement remains in effect.