Note 10: Senior Secured Convertible Notes

On March 11, 2020, the Company and the Investors entered into the SPA pursuant to which the Company agreed to sell and issue (1) the 2020 Convertible Notes and $11,000,000 funding amount (reflecting an original issue discount of $2,750,000) and (2) the Warrants, for consideration consisting of (i) a cash payment of $7,000,000, and (ii) the Investor Notes in the principal amount of $4,000,000. Andy Heyward, the Company’s Chairman and Chief Executive Officer, participated as an Investor and invested $1,000,000 in connection with the Financing, all of which was paid at the closing and not pursuant to an Investor Note.

The closing of the sale and issuance of the 2020 Convertible Notes, the Warrants and the Placement Agent Warrants occurred on March 17, 2020. The maturity date of the 2020 Convertible Notes is September 30, 2021 and the maturity date of the Investor Notes is March 11, 2060.

The SPA contains certain representations and warranties, covenants and indemnities customary for similar transactions

In addition, pursuant to the terms of the SPA, the 2020 Convertible Notes and the Warrants, the Company agreed that the following will apply or become effective only following Stockholder Approval: (1) the conversion price of the 2020 Convertible Notes shall be reduced to $0.21 per share and may be further reduced to any amount and for any period of time deemed appropriate by the board of directors of the Company (the “Board of Directors”), (2) the exercise price of the Warrants shall be immediately reduced to $0.21 per share and may be further reduced to any amount and for any period of time deemed appropriate by the Board of Directors, (3) the 2020 Convertible Notes and Warrants shall each have full ratchet anti-dilution protection for subsequent financings (subject to certain exceptions), (4) existing warrant holders that are participating in the Financing (representing warrants to purchase an aggregate of 8,715,229 shares of Company Common Stock) will have their existing warrants’ exercise prices reduced to $0.21 and (5) the investors shall have a most favored nations right which provides that if the Company enters into a subsequent financing, then the Investors (together with their affiliates) at their sole discretion shall have the ability to exchange their 2020 Convertible Notes on a $1 for $1 basis into securities issued in the new transaction. Additionally, in the event that any warrants or options (or any similar security or right) issued in a subsequent financing include any terms more favorable to the holders thereof (less favorable to the Company) than the terms of the Warrants, the Warrants shall be automatically amended to include such more favorable terms.

On May 15, 2020, the Company received necessary Stockholder Approval in connection with the Nasdaq proposals described above. As a result, the conversion price of the 2020 Convertible Notes and the exercise price of the Warrants were each reduced to $0.21. In addition, existing warrant holders that participated in the Financing (representing warrants to purchase an aggregate of 9,172,463 shares of Common Stock) also had their existing warrants’ exercise prices reduced to $0.21.

Amortization of Principal

The 2020 Convertible Notes provide that the Company will repay the principal amount of 2020 Convertible Notes in equal monthly installments of 1/12th of the principal amount of the 2020 Convertible Notes beginning October 31, 2020 and the last business day of each calendar month anniversary thereafter (each an “Installment Date”). On each Installment Date, assuming the Equity Conditions described below are met and Stockholder Approval has been obtained, all or some of the Installment Amount (as defined in the 2020 Convertible Notes) shall be converted into shares of Common Stock, provided however that the Company may elect prior to any Installment Date to pay all or a portion of the installment amount in cash, under certain conditions in the SPA.

Any holder of a 2020 Convertible Note may, by notice to the Company, accelerate future installment payments to any applicable Installment Date, in which case the Company will deliver shares of Common Stock for the conversion of such accelerated payments (the “Accelerated Amount”), regardless of whether the Installment Amount scheduled to be paid on such applicable Installment Date shall be paid in cash, shares of Common Stock or a combination thereof. In the event that the Investor delivers one or more such notices of acceleration, the aggregated Accelerated Amount shall not be greater than six (6) times such Investor’s pro rata amount.

If the Company fails to redeem the Company Redemption Amount on the applicable Installment Date by payment of the Company Installment Redemption Price on such date, then at the option of the Investor designated in writing to the Company (any such designation shall be deemed a “Conversion Notice” pursuant to the 2020 Convertible Notes), (i) the Investor shall have the rights set forth in the 2020 Convertible Notes as if the Company failed to pay the applicable Company Installment Redemption Price and all other rights as an Investor in the 2020 Convertible Notes (including, without limitation, such failure constituting an Event of Default described in the 2020 Convertible Notes) and (ii) the Investor may require the Company to convert all or any part of the Company Redemption Amount at the Company Conversion Price as in effect on the applicable Installment Date.

Subject to certain beneficial ownership limitations, until the Company Installment Redemption Price is paid in full, the Company Redemption Amount may be converted, in whole or in part, by the Investor into Common Stock. In the event the Investor elects to convert all or any portion of the Company Redemption Amount prior to the applicable Installment Date as set forth in the immediately preceding sentence, the Company Redemption Amount so converted shall be deducted in reverse order starting from the final Installment Amount to be paid on the final Installment Date, unless the Investor otherwise indicates and allocates among any Installment Dates in the applicable Conversion Notice.

Payment of Investor’s Notes

The Company will receive the applicable portion of the Investor Notes Principal due upon each voluntary or mandatory prepayment of the Investor Notes. The Investors may, at their option and at any time, voluntarily prepay the Investor Notes, in whole or in part. The Investor Notes are also subject to mandatory prepayment, in whole or in part, upon the occurrence of one or more of the mandatory prepayment events. The Company may require an investor to prepay the Investor Notes provided certain conditions are met including but not limited to the following: Stockholder Approval has been obtained, and no Event of Default as defined in the terms of the 2020 Convertible Notes took place.

The Investor Notes also contain certain offset rights of the Company and the Investors, which if exercised, would reduce the amount outstanding under 2020 Convertible Notes and the Investor Notes by the same amount and, accordingly, the cash proceeds received by the Company from the investors. These offset rights are triggered by specific occurrences that could jeopardize an Investor’s investment.

On the maturity date of the 2020 Convertible Notes, the outstanding principal amount owed by an Investor to the Company under such Investor Note shall be satisfied and cancelled in exchange for the cancellation of an equal amount owed the Company to such Investor under the related 2020 Convertible Notes.

The Company reports the Investor Notes and the respective portion of the Convertible Notes that may be offset against the Investor Notes on a “gross” basis, i.e. as an asset and a liability, respectively.

Optional Redemption at Company’s Election

At any time after the date of issuance of the 2020 Convertible Notes, the Company will have the right to redeem a portion or all of the 2020 Convertible Notes in cash at prices depending on certain conditions as described in the SPA.

Conversion of the 2020 Convertible Notes

Each 2020 Convertible Note is convertible, at the option of the holder, into shares of Common Stock at an initial conversion price of $1.375, subject to adjustment as provided in the 2020 Convertible Notes; provided, however, upon receipt of Stockholder Approval, the conversion price shall be $0.21, subject to adjustment as provided in the 2020 Convertible Notes.

On or after the date Stockholder Approval is obtained, if the Company issues or sells, or the Company publicly announces the issuance or sale of, any shares of Common Stock, or convertible securities or options issuable or exchangeable into Common Stock (a “New Issuance”), under which such Common Stock is sold for a consideration per share less than the Conversion Price then in effect, the Conversion Price of the 2020 Convertible Notes will be adjusted to the New Issuance price in accordance with the formulas provided in the 2020 Convertible Notes. Any such adjustment will not apply with respect to the issuance of Excluded Securities (as defined in the 2020 Convertible Notes). Upon Stockholder Approval, the Conversion Price may be further reduced to any amount and for any period of time deemed appropriate by the Board of Directors.

The Company classified the detachable warrants as derivative financial liabilities that are recorded at fair value on a recurring basis separately from debt. The Company classified investors’ and Company’s conversion options as a compound embedded derivative liability recorded separately from the debt. The amount of debt discount arising from the separate accounting of the above financial instruments at March 17, 2020 was $10,729,852.

On May 15, 2020 stockholders of the Company approved the reduction of the Conversion Price to $0.21. During the three months ended June 30, 2020 the Investors converted their 2020 Convertible Notes in accordance with the terms of the agreement. $105,000 of the 2020 Convertible Notes were converted on June 6, 2020 with the remainder of $13,645,000 converted on June 23, 2020. As part of the conversion accounting, the Company increased the equity by the sum of the carrying amounts of the debt and separated conversion option liabilities, with no gain or loss recognized. Overall amount credited to equity per the above accounting treatment was 1,990,413 on June 6, 2020 and 169,845,316 on June 23, 2020.

The Company estimated that the fair value of the investor’s conversion options and the fair value of Company’s conversion options at March 17, 2020 and March 31, 2020 were immaterial. The estimated fair value of the investor’s conversion options associated with $105,000 of debt immediately before the conversion on June 6, 2020 was 1,990,408. The estimated fair value of the investor’s conversion options associated with $13,645,000 of debt immediately before the conversion on June 12, 2020 was $169,845,321. The Company estimated that the fair value of Company’s conversion option on both conversion dates was immaterial. During the three months ended June 30, 2020, the Company recognized a revaluation loss of $171,835,729 associated with the 2020 Convertible Notes conversion options. Additionally, the Company recognized revaluation loss associated with detachable warrants of $208,760,698.

Company’s interest expense associated with the 2020 Convertible Notes was $401,814 and $ 1,033,666, respectively for the three and six months ended June 30, 2020. The interest expense included $631,852 excess of discount over the 2020 Convertible Notes’ principal. The discount is mainly attributable to detachable warrants and 20% original issuance discount. The amount of unamortized discount at June 30, 2020 is $0 Company recognizes interest expense associated with 2020 Convertible Notes using the effective interest rate method.

On June 23, 2020 the Company received $3,600,000, net of expenses, from the payment of the Investor Notes Principal.

Between June 10 and June 23, 2020, the 2020 Convertible Notes were converted and repaid through the issuance of 65,476,190 shares of Common Stock.