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Secured Convertible Note Payable

6 Months Ended

Jun. 30, 2019

Note 2 – Secured Convertible Note Payable

Secured Convertible Note (the “Note) payable consists of the following at June 30, 2019 and December 31, 2018:

	June 30, 2019		December 31, 2018
Secured convertible note payable, at fair value	$	—	$	2,197,231
Less: Current maturities				(2,197,231	)

Secured convertible note payable, long-term	$	—	$	—

Following is an analysis of the activity in the Note during the six months ended June 30, 2019:

	Amount
Balance at December 31, 2018	$	2,197,231
Funding under the Investor Note during the period		—
Principal repaid during the period by issuance of common stock		—
Change in fair value of secured convertible note during the period		—
Exchange of secured convertible note payable for common stock		(2,197,231	)

Balance at June 30, 2019	$	—

On May 7, 2015, the Company completed the May 2015 Private Placement of a $12.0 million principal amount secured convertible note (the “Note”) and Warrant to purchase 1,800,000 shares of the Company’s common stock, $0.0001 par value. The placement agent for the Company in the transaction received a fee of 6% of cash proceeds, or $600,000, if and when the Company receives the full cash proceeds. It received $27,000 of such amount at the closing. In addition, the placement agent was granted a warrant to purchase 240,000 shares of common stock at $5.00 per share, which warrant is immediately exercisable.

The Note and Warrant were issued pursuant to a Securities Purchase Agreement, dated May 7, 2015, by and between the Company and an institutional investor (the “Investor”). The May 2015 Private Placement was made pursuant to an exemption from registration under such Act. At the closing, the Investor acquired the secured convertible note by paying $450,000 in cash and issuing a secured promissory note, secured by cash, with an aggregate initial principal amount of $9,550,000 (the “Investor Note”).

On May 4, 2017, the Investor notified the Company that it elected to effect an Investor Optional Offset under Section 7(a) of the Investor Note of the full $9,490,000 principal amount outstanding under the Investor Note against $9,490,000 in aggregate principal outstanding under the Convertible Note. It did so by surrendering and concurrently cancelling $9,490,000 in aggregate principal of the Convertible Note in exchange for the satisfaction in full and cancellation of the Investor Note. The Convertible Note had an aggregate outstanding principal balance of $11,687,231 as of the date of the exchange. The Investor requested the Company to deliver a new convertible note (the “Replacement Note”) with respect to the remaining principal balance of $2,197,231 to replace the Convertible Note. The aggregate outstanding principal balance of $11,687,231 of the Convertible Note included an approximate $2.0 million original issue discount; however, the Investor funded only $510,000 under the Investor Note. The Company had recorded the fair value of the Replacement Note assuming that the remaining par value was $2,197,231 as asserted by the Investor. The Replacement Note provided for a maturity date of May 7, 2018, a conversion price of $0.50 per share and was due in monthly installment payments through May 2018 either in cash or stock, among other terms. The Company did not repay the Replacement Note at its maturity and it was therefore in technical default. The Replacement Note was to be secured to the same extent as the Convertible Note. The Company and the Investor have negotiated a resolution of these outstanding matters regarding the default status and the issuance of the Replacement Note under the terms of the financing.

On May 23, 2019, the Company and the Investor agreed to an omnibus resolution to these outstanding matters and entered into the Exchange Agreement and Side-Letter Agreement as described below:

Exchange Agreement: Under the Exchange Agreement, the Investor exchanged all of its rights under the original securities issued in the May 2015 Private Placement (the “Original Securities”), including: (i) the Convertible Note, subject to the Optional Offset (as defined in the Investor Note), with a current balance of $2,197,231.00, (ii) the related accrued interest under the Convertible Note, with a balance of $26,107.52, (iii) the Warrant, (iv) the Security and Pledge Agreement entered into by the Company and the Investor in connection with the May 2015 Private Placement, (v) the Guaranty made in favor of the Investor in connection with the May 2015 Private Placement, and (vi) the Registration Rights Agreement entered into by the Company and the Investor in connection with the May 2015 Private Placement, for 770,485 fully paid and nonassessable shares of Common Stock and certain rights (the “Rights”) to acquire additional securities in the future, which may be exercised for additional shares of Common Stock.

As a result of the exchange transactions described above, the Investor no longer owns any of the Original Securities, including any rights thereunder, and the Company cancelled the certificate(s) and other physical documentation evidencing the Investor’s ownership of the Original Securities.

Side-letter Agreement: Concurrent with the Exchange Agreement, the Company and the Investor also entered into a letter agreement, dated May 23, 2019 (the “Side-Letter Agreement”). The Side-Letter Agreement provides that on November 23, 2019, the Company will, if required under the Side-letter Agreement, issue additional shares of Common Stock to the Investor based on an increase in the Number of Fully-Diluted Shares Outstanding (as defined below) of the Company from the execution date of the Exchange Agreement to the six-month anniversary of the Exchange Agreement (the “True-Up Shares”). The issuance of the True-Up Shares, if any, shall provide the Investor with Rights to acquire additional Right Shares (as defined in the Exchange Agreement) to be calculated according to the following formula:

	●	A-B= aggregate number of Right Shares
	●	A = 9.99% of shares of Common Stock outstanding on such six-month anniversary (calculated based on the Number of Fully-Diluted Shares Outstanding (as defined below))
	●	B = The shares of Common Stock Issued to the Investor contemporaneously with the Exchange Agreement

For the purposes of the Side-Letter Agreement, “Number of Fully-Diluted Shares Outstanding” means, as of any time of determination, the sum of (i) the aggregate number of issued and outstanding shares of Common Stock as of such time of determination, (ii) the aggregate maximum number of shares of Common Stock issuable on an as-converted and as-exchanged basis, as applicable (excluding any exercise of warrants to purchase Common Stock), pursuant to all capital stock and all other securities of the Company or any of its subsidiaries (excluding any warrants to purchase Common Stock and all Rights issued pursuant to the Exchange Agreement) outstanding as of such time of determination (or issuable pursuant to agreements in effect as of such time) that are at any time and under any circumstances (after issuance thereof, if applicable), directly or indirectly, convertible into or exchangeable for, or which otherwise entitles the holder thereof to acquire, Common Stock (assuming, for such purpose, that each such security is convertible or exchangeable, as applicable, at the lowest price per share for which one share of Common Stock is at any time, directly or indirectly, issuable upon the conversion or exchange, as applicable, of any such security and without regards to any limitations on conversion or exchange applicable thereto), and (iii) without duplication with clause (ii) above, the aggregate maximum number of shares of Common Stock issuable pursuant to any agreement (excluding any warrants to purchase Common Stock and all Rights issued pursuant to the Exchange Agreement) of any person with the Company or any of its subsidiaries in effect as of such time of determination (assuming, for such purpose, that the shares of Common Stock, directly or indirectly, issued pursuant to such agreement is issued at the lowest price per share for which one share of Common Stock is at any time, directly or indirectly, issuable pursuant to such agreement).

Notwithstanding the foregoing, if any warrants to purchase Common Stock are outstanding (or issuable upon conversion or exchange of securities outstanding) as of such six-month anniversary (each, an “Outstanding Warrant”), on such six-month anniversary, the Company shall issue the Investor an additional Right to acquire a warrant (the “New Warrant”) exercisable for up to 9.99% of the shares of Common Stock issuable upon exercise of all Outstanding Warrants as of such six-month anniversary (the “New Warrant Shares”). The New Warrant Shares shall be of like tenor to the Outstanding Warrants.

Pursuant to the Side-Letter Agreement, the Company also agreed that from the execution date of the Exchange Agreement until twelve (12) months from such date, the Company will not raise capital at a price that is below $0.10 per share of Common Stock (as adjusted for stock splits, stock dividends, stock combinations, recapitalizations and similar events) without the Investor’s consent.

On May 30, 2019, the Company and the Investor entered into Amendment No. 1 to Exchange Agreement (the “Amendment”). Following execution of the Exchange Agreement on May 23, 2019, the Company and the Investor became aware of an inadvertent error regarding the number of shares of Common Stock to be issued to the Investor pursuant to the Exchange Agreement. The Company and the Investor agreed to amend the Exchange Agreement so it reflects the correct number of shares of Common Stock to be issued and to ensure that the Investor does not beneficially own in excess of 9.99% of the shares of Common Stock outstanding immediately following the effective date of the Exchange Agreement. Pursuant to the Amendment, the Company and the Investor agreed that the number of shares of Common Stock to be issued to the Investor would be an aggregate of 605,816 shares, instead of the 770,485 shares stated in the Exchange Agreement.

Description of the Financial Accounting and Reporting

At inception, the Company elected to account for the Note on its fair value basis, therefore, the fair value of the Note, including its embedded conversion feature, were estimated together at each periodic reporting date through May 23, 2019 which was the date the parties entered into the exchange agreement which extinguished the Note and related warrants as previously described. The Note was revalued to its estimated fair value at each periodic reporting date with any changes in the Note’s fair value being charged/credited to the statement of operations.

The Warrant issued to purchase 1,800,000 common shares in connection with the Note was treated as a derivative liability for accounting purposes due to its ratchet and anti-dilution provisions. The estimated fair value of the warrant derivative as of May 23, 2019, the date of the exchange agreement was $116,731 representing a change of $59,639 from December 31, 2018, which is included in changes in derivative fair value in the accompanying condensed statement of operations for the six months ended June 30, 2019. See Note 5.

The Exchange Agreement was treated an extinguishment of debt on the date it was entered May 23, 2019. Under the Exchange Agreement, the Investor exchanged all of its rights under the original securities issued in the May 2015 Private Placement, including: (i) the Convertible Note, subject to the Optional Offset (as defined in the Investor Note), with a current balance of $2,197,231.00, (ii) the related accrued interest under the Convertible Note, with an unpaid and accrued balance of $26,107.52, (iii) the Warrant with an estimated fair value of $116,731, (iv) the Security and Pledge Agreement entered into by the Company and the Investor in connection with the May 2015 Private Placement, (v) the Guaranty made in favor of the Investor in connection with the May 2015 Private Placement, and (vi) the Registration Rights Agreement entered into by the Company and the Investor in connection with the May 2015 Private Placement, for 605,816 fully paid and nonassessable shares of Common Stock and certain rights granted in the Side-Letter to acquire additional securities in the future, which may be exercised for additional shares of Common Stock. The Side-Letter rights/obligations represent a derivative and accordingly, its fair value was estimated and recorded at the date of Exchange Agreement and will continue to be revalued and adjusted to its estimated fair value at each periodic reporting date until it expires and/or the underlying securities are issued to the Holder.

Following is an analysis of gain on exchange of the debt and warrant obligations pursuant to the Exchange Agreement during the six months ended June 30, 2019:

	Amount
Obligations extinguished on the date of exchange, May 23, 2019:
Convertible Note balance at the date of exchange, May 23, 2019	$	2,197,231
Accrued interest on the Convertible Note at the date of exchange, May 23, 2019		28,643
Fair value of Warrant Derivative at the date of exchange, May 23, 2019		116,731
Securities issued in exchange for the obligations extinguished the date of Exchange, May 23, 2019:
605,816 Common shares issued on the date of exchange, May 23, 2019 valued at $0.121 per share, the closing market price on May 23, 2019		(73,304	)
Side-Letter derivative value estimated on the date of exchange, May 23, 2019		(107,860	)

Gain on exchange of debt and warrant obligations	$	2,161,441

In addition, the Company issued a warrant in May 2015 to purchase 240,000 shares issued as part of the placement fee in connection with the Note. The warrant contained an expiration date of May 7, 2022 and an exercise price of $5.00 per share and is subject to certain price protection and dilution provisions. Such warrant was treated as a derivative liability for accounting purposes due to its ratchet and anti-dilution provisions.

On June 4, 2019, the Company entered into an exchange agreement with the warrant holder to extinguish the original warrant including its certain price protection and dilution provisions, for a new warrant to purchase up to 50,000 common shares with a termination date of June 4, 2026 at an exercise price of $0.50 per share without any price protection or dilution provisions.

The estimated fair value of the original warrant derivative as of May 23, 2019, the date of the exchange agreement, was $37,368 representing a change of $29,795 from December 31, 2018, which is included in changes in derivative fair value in the accompanying condensed statement of operations for the six months ended June 30, 2019. See Note 5.

As a result of the exchange agreement, the Company extinguished the derivative liability of $37,368 attributable to the original warrant and recognized the estimated value of the new warrant of $7,985 as of June 4, 2019, the date of the exchange agreement. The resulting $29,383 difference been the estimated fair value of the old warrant extinguished and the new warrant issued to the holder has been recorded as a gain on exchange of debt and warrant obligations in the accompanying condensed statement of operations for the six months ended June 30, 2019.