Quarterly report pursuant to Section 13 or 15(d)

CONVERTIBLE NOTES PAYABLE AND DERIVATIVE LIABILITY

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CONVERTIBLE NOTES PAYABLE AND DERIVATIVE LIABILITY
6 Months Ended
Jun. 30, 2016
Debt Disclosure [Abstract]  
CONVERTIBLE NOTES PAYABLE AND DERIVATIVE LIABILITY

NOTE 7 – CONVERTIBLE NOTES PAYABLE AND DERIVATIVE LIABILITY

 

July and September 2014 Debentures

 

On July 21, 2014, as amended on September 19, 2014 and October 20, 2014, the Company entered into a Securities Purchase Agreement whereby the Company agreed to issue convertible debentures (“July 2014 Debentures”) in the aggregate principal amount of $3,500,000, in five tranches. The July 2014 Debentures bore interest at the rate of 10% per year. The debt was due July 21, 2015.

  

Also on September 19, 2014, as amended on October 20, 2014, the Company entered into a securities purchase agreement pursuant to which it agreed to issue convertible debentures (“September 2014 Debentures”) in the aggregate principal amount of $2,500,000, in two tranches. The September 2014 Debentures bore interest at the rate of 5% per year. The debt was due September 19, 2015.

 

Both the original July 2014 Purchase Agreement Debentures and September 2014 Debentures, prior to subsequent amendment, share the following significant terms:

 

All amounts are convertible at any time, in whole or in part, at the option of the holders into shares of the Company’s common stock at a conversion price. The Notes were initially convertible into shares of the Company’s common stock at the initial Fixed Conversion Price of $11.75 per share. The Fixed Conversion Price is subject to adjustment for stock splits, combinations or similar events. If the Company makes any subsequent equity sales (subject to certain exceptions), under which an effective price per share is lower than the Fixed Conversion Price, then the conversion price will be reduced to equal such price. The Company may make the amortization payments on the debt in cash, prompting a 30% premium or, subject to certain conditions, in shares of common stock valued at 70% of the lowest volume weighted average price of the common stock for the 20 prior trading days.

 

The conversion feature of the July 2014 Debenture and the September 2014 Debenture meets the definition of a derivative and due to the reset provision to occur upon subsequent sales of securities at a price lower than the fixed conversion price, requires bifurcation and is accounted for as a derivative liability, with a discount created on the Debentures that would be amortized over the life of the Debentures using the effective interest rate method. The fair value of the embedded derivative is measured and recognized at fair value each subsequent reporting period and the changes in fair value are recognized in the Statement of Operations as Change in fair value of derivative liability. See Note 2 Fair value of financial instruments for additional information on the fair value and gains or losses on the embedded derivative.

 

In connection with each of the purchase agreements, the Company entered into a registration rights agreement with the respective investors, pursuant to which the Company agreed to file a registration statement for the resale of the shares of common stock issuable upon conversion of, or payable as principal and interest on, the respective debentures, within 45 days of the initial closing date under each agreement, and to have such registration statements declared effective within 120 days of the initial closing dates of each purchase agreement. Through subsequent modifications of the July 2014 Debentures and September 2014 Debentures, the required date to file the registration statement and the effective date of the registration statement were modified, and the registration statement filed on April 9, 2015, and became effective on June 11, 2015.

 

On January 30, 2015, the Company and certain of the Investors entered into an Amendment, Modification and Supplement to the Purchase Agreement (the “Purchase Agreement Amendment” or the “Modification”) pursuant to which the Investors agreed to purchase an additional $1,800,000 in seven Modified Closings. The Modification also eliminated the amortization payments discussed above, and provided for accrued and unpaid interest to be payable upon conversion or maturity rather than on specified payment dates. The Company was also required to open a new dispensary in Portland, Oregon through a licensed operator during the first calendar quarter of 2015 (which was later modified to April 30, 2015). The Company also had to file the Registration Statement by March 8, 2015 (later amended), and it had to be declared effective by June 15, 2015 in order to avoid default and acceleration under the Amended and Restated Debenture. As noted above, the Registration Statement was filed on April 9, 2015, and became effective June 11, 2015.

 

As part of the January 30, 2015 Modification, the parties entered into a Modified Debenture Agreement for the $200,000 that was funded at the Closing and agreed to use the same form of Modified Debenture for each of the other foregoing Modified Closings (collectively, the “Modified Debentures”). The fixed conversion price of the Modified Debenture on January 30, 2015 was the lower of $5.00 or 51% of the lowest volume weighted average price for the 20 consecutive trading days prior to the applicable conversion date. This new fixed conversion price was a dilutive issuance to the outstanding July 2014 and September 2014 Debentures, thereby triggering a reset of the older fixed conversion price. As a result of the reset to the conversion price, at January 30, 2015, the derivative liability was re-measured to a fair value of approximately $2,690,000, using a weighted probability model as estimated by management. A decrease in fair value of the derivative liability of approximately $1,072,000 was recognized as a gain on the Statement of Consolidated Comprehensive Loss, in the three months ended March 31, 2015.

 

The additional Modified Debentures under the July 2014 Debentures as of closing dates had a fixed conversion price of the lower of $1.83 or 51% of the VWAP for the last 20 days prior to the conversion. This new fixed conversion price was a dilutive issuance to the outstanding July 2014 and September 2014 Debentures, thereby triggering a reset of the previous $5 fixed conversion price. This reset resulted in the derivative liability being revalued at February 27, 2015, using a weighted probability model for a fair value of $2,720,000.

 

The additional Modified Debentures under the September 2014 Debentures closed on January 29, 2015 in the amount of $100,000 and February 24, 2015 in the amount of $100,000. These Modified Debentures have a fixed conversion price of the lower of $5.00 or 51% of the VWAP for the last 20 days prior to the conversion. This new fixed conversion price was a dilutive issuance to the outstanding September 2014 Debentures, thereby triggering a reset of the previous $5.00 fixed conversion price. The resulting reset and re-measurement of the fair value of the derivative liability is included in the amounts of the change to fair value discussed above.

 

The April 17, 2015 closing under the July 2014 Modified Debentures contained a fixed conversion price of the lower of $0.88 or 51% of the VWAP for the last 40 days prior to the conversion. This new fixed conversion price was a dilutive issuance to the outstanding July 2014 and September 2014 Debentures, thereby triggering a reset of the previous $1.83 fixed conversion price. This reset resulted in the derivative liability being revalued at April 17, 2015, using a weighted probability model for a fair value of $3,287,000, for a increase in fair value of approximately $1,764,000, recognized as a loss on the Statement of Consolidated Comprehensive Loss.

 

There was additional funding of $1,300,000 of the September 2014 Modified Debentures under the closing schedule detailed above. These Modified Debentures all have a fixed conversion price of the lower of $0.88 or 51% of the VWAP for the last 40 days prior to the conversion.

 

The Directors’ convertible debentures required under the March 23, 2015 Modification, issued in the first quarter of 2015, total $150,000, and have a three year term and an interest rate of 8% per annum. They were originally convertible at a fixed conversion price of the lower of $1.83 or 51% of the VWAP for the last 20 days prior to conversion. As with the Modified Debentures, the debentures included a reset provision, which resulted in the conversion feature being bifurcated and accounted for as a derivative liability, with an initial fair value of $132,175. The director’s convertible debentures also reset on February 27, 2015 and April 17, 2015, with the changes to fair value included in the amounts disclosed above. The Directors debentures were all converted during the third quarter of 2015.

 

The Modified Debentures also included a warrant instrument granting the Investor the right to purchase shares of common stock of the Company equal to the principal amount of the applicable Modified Debenture divided by a price equal to 120% of the last reported closing price of the common stock on the applicable closing date of the Modified Debenture, with a three year term.

 

August 2015 Debentures

 

On August 14, 2015, the Company entered into a Securities Purchase Agreement whereby they agreed to issue convertible debentures in the aggregate principal amount of up to $3,979,877 to certain Investors. The initial closing in the aggregate principal amount of $650,000 occurred on August 14, 2015. An additional 11 payments were made in the total amount of $2,434,143 through December 31, 2015. The August 2015 Debentures bear interest at the rate of 10% per year. During the first quarter of 2016, an additional approximately $895,000 was funded.

 

On August 20, 2015, the Company also entered into a Securities Purchase Agreement with another Investor in the aggregate principal amount of up to $1,500,000 (collectively the “August 2015 Debentures”), which was amended on September 19, 2015, to increase the principal by an additional $200,000.

 

The August 2015 Debentures contain the following significant terms:

 

The debentures all mature in one year from the date of each individual closing.

 

All amounts are convertible at any time, in whole or in part, at the option of the holders into shares of the Company’s common stock at a fixed conversion price. The conversion price is the lower of (a) $0.75, or (b) a 49% discount to the lowest daily VWAP (as reported by Bloomberg) of the Common Stock during the 30 trading days prior to the conversion date. The Fixed Conversion Price is subject to adjustment for stock splits, combinations or similar events. If the Company makes any subsequent equity sales (subject to certain exceptions), under which an effective price per share is lower than the Fixed Conversion Price, then the conversion price will be reset to equal such price. The Company may prepay the Debentures in cash, prompting a 30% premium or, subject to certain conditions, in shares of common stock valued at 51% of the lowest volume weighted average price of the common stock of the Company for the 30 prior trading days. The premium will be recognized at such time as the Company may choose to prepay the Debentures.

 

In connection with each of the purchase agreements, the Company entered into a registration rights agreement with the respective Investors pursuant to which the Company agreed to file a registration statement for the resale of the shares of common stock issuable upon conversion of, or payable as principal and interest on, the respective debentures, within 45 days of the initial closing date under each agreement, and to have such registration statements declared effective within 120 days of the initial closing dates of each purchase agreement. The pre-effective registration statement was filed with the SEC on October 16, 2015.

 

The conversion feature of the August 2015 Debenture meets the definition of a derivative and due to the reset provision to occur upon subsequent sales of securities at a price lower than the fixed conversion price, requires bifurcation and is accounted for as a derivative liability. The derivatives related to all closings on the August 2015 debentures were initially recognized at estimated fair values of approximately $11,205,000 and created a discount on the Debentures that will be amortized over the life of the Debentures using the effective interest rate method. The fair value of the embedded derivative is measured and recognized at fair value each subsequent reporting period and the changes in fair value are recognized in the Statement of Comprehensive Income (Loss) as Change in fair value of derivative liability. For the year ended December 31, 2014, and the interim periods through September 30, 2015, the Company estimated the fair value of the conversion feature derivatives embedded in the convertible debentures based on weighted probabilities of assumptions used in the Black Scholes pricing model. The key valuation assumptions used consists, in part, of the price of the Company’s common stock, ranging from $8.81 down to $0.05; a risk free interest rate ranging from 0.41% to 0.12% and expected volatility of the Company’s common stock, ranging from 196.78% to 106.38%, and the various estimated reset exercise prices weighted by probability.

 

As of December 31, 2015, and for new issuances of convertible debentures during the fourth quarter of fiscal 2015, the Company estimated the fair value of the conversion feature derivatives embedded in the convertible debentures based on a Monte Carlo Simulation model (“MCS”). The MCS model was used to simulate the stock price of the Company from the valuation date through to the maturity date of the related debenture and to better estimate the fair value of the derivative liability due to the complex nature of the convertible debentures and embedded instruments. Management believes that the use of the MCS model compared to the black Scholes model as previously used would provide a better estimate of the fair value of these instruments. Beginning in the fourth quarter of 2015, using the MCS model, the Company valued these embedded derivatives using a “with-and-without method,” where the value of the Convertible Debentures including the embedded derivatives, is defined as the “with”, and the value of the Convertible Debentures excluding the embedded derivatives, is defined as the “without.” This method estimates the value of the embedded derivatives by observing the difference between the value of the Convertible Debentures with the embedded derivatives and the value of the Convertible Debentures without the embedded derivatives. The Company believes the “with-and-without method” results in a measurement that is more representative of the fair value of the embedded derivatives.

 

For each simulation path, the Company used the Geometric Brownian Motion (“GBM”) model to determine future stock prices at the maturity date. The inputs utilized in the application of the GBM model included a starting stock price ranging from $0.03 to $0.10, an expected term of each debenture remaining from the valuation date to maturity ranging from .24 years to 1.04 years, an estimated volatility of ranging from 193% to 219%, and a risk-free rate ranging from .20% to .70%. See Note 2 Fair value of financial instruments for additional information on the fair value and gains or losses on the embedded derivative.

 

For the six months ended June 30, 2016, the Company estimated the fair value of the conversion feature derivatives embedded in the convertible debentures based on an internally calculated adjustment to the MCS valuation determined at December 31, 2015. This adjustment took into consideration the changes in the assumptions, such as market value and expected volatility of the Company’s common stock, and the discount rate used in the December 31, 2015 valuation as compared to June 30, 2016. The valuation also took into consideration the term in the debentures which limits the amounts converted to not result in the investor owning more than 4.99% of the outstanding common stock of the Company, after giving effect to the converted shares. The Company believes this methodology results in a reasonable fair value of the embedded derivatives for the interim period.

 

Entry into Security Agreement

 

In connection with entry into the August 20 Purchase Agreement and August 14 Purchase Agreement, the Investors and the Company entered into a Security Agreement, dated August 21, 2015, securing the amounts underlying the August 14 Debentures and the August 20 Debentures. The Security Agreement grants a security interest in all assets and personal property of the Company, subject to certain excluded real property assets. The security interests under the Security Agreement terminated following the date that the registration statement registering the shares underlying the Convertible Debentures was declared effective, which occurred on December 15, 2015.

 

July 2015 Debenture

 

On July 10, 2015, another accredited Investor and affiliate of the July 2014 Investor (the “July 2015 Investor”) purchased a separate Convertible Debenture (the “July 2015 Debenture”) in the aggregate principal amount of $500,000, that closed in five weekly tranches between July 10 and August 15, 2015. The July 2015 Debenture is in substantially the same form as the August 14 Debentures, and does not include issuance of warrants. As such, the conversion feature was also determined to require bifurcation and derivative accounting. All amounts related to the July 2015 derivative liability are included in amounts disclosed above for the August 2015 debentures.

 

On October 14, 2015, the August 2015 Investor assigned the right to purchase August 2015 Debentures in the principal amount of $100,000 to the July 2015 Investor and the July 2015 Investor purchased such August 2015 Debentures on the same day.

 

October 2015 Debentures

 

On October 14, 2015, the Company issued seven debentures in the aggregate of $2,000,000 to a service provider (the “October 2015 Investor”) as consideration for services previously rendered to the Company on the same terms as the August 14 Debentures and August 14 Purchase Agreement (the “October 2015 Debentures” and “October 2015 Purchase Agreement”, respectively) except that the October 2015 Purchase Agreement does not provide for registration rights to the October 2015 Investor with regard to the shares underlying the October 2015 Debentures. The service provider has agreed with the Company not to convert the October 2015 Debentures for any amount in excess of fees payable for services previously rendered to the Company at the time of conversion. To the extent that the sale of shares underlying the October 2015 Debentures do not satisfy outstanding amounts payable to the service provider, such amounts will remain payable to the service provider by the Company. In the three months ending June 30, 2016, funding closed on $425,000 of the October 2015 debentures.

 

December 28, 2015 Amendment and Restriction Agreement

 

On December 28, 2015, the Company, the August 14 Investor and the August 20 Investor entered into a Debenture Amendment and Restriction Agreement (the “Agreement”), pursuant to which (1) the August 14 Investor agreed to be restricted from converting any of its convertible debentures into common stock until February 21, 2016, subject to certain limitations set forth below (the “Restriction”) and (2) the August 14 Investor agreed to assign, as of the effective date of the Agreement approximately $390,000 of its convertible debentures to the August 20 Investor in exchange for the amount of principal outstanding under such debenture plus a premium in cash from the August 20 Investor (the “Assigned Debentures”). The accrued and unpaid interest under the Assigned Debentures remained payable by the Company to the August 14 Investor.

 

The August 14 Investor also agreed to amend the terms of each of its debentures (other than the debentures that were assigned) such that the debenture is convertible at a 40% discount to the lowest trading price of the Company’s common stock during the 30 consecutive prior trading days rather than at a 49% discount to the lowest ‘volume weighted-average price’ during the 30 consecutive prior trading days. This was not considered to be a modification of the terms of the conversion feature, requiring evaluation of the debenture to determine if it was modified or extinguished, as the conversion feature is separately accounted for as a derivative, and is outside of the scope of the guidance on debt modifications. The change in the conversion price will be reflected in its fair value under derivative accounting.

 

As consideration for entering into the Agreement, the August 14 Investor was issued a promissory note from the Company in the principal amount of $700,000 (the “Promissory Note”). The Promissory Note has a term of ten months, accrues interest at a rate of 10% per annum, and outstanding principal and accrued interest under the Promissory Note may be pre-paid at any time by the Company without penalty. The Promissory Note is not convertible other than in an event of default, in which case it is convertible on the terms of the other debentures held by the August 14 Investor. This conversion feature was considered to be a contingent conversion feature, and therefore the conversion feature would not be bifurcated and accounted for as a derivative, as are the conversion features of all other debentures, until such time as and if the Company is in an event of default. The Promissory Note is being accounted for as a finance expense of the December 28, 2015 transaction, similar to a debt discount, and will be amortized to financing expense over the ten month life of the note (Note 8).

 

The August 20 Investor shall also acquire from the August 14 Investor an additional $650,000 of the convertible debentures held by the August 14 Investor (1) upon the declaration of effectiveness of a post-effective amendment (the “POSAM”) to the Company’s Registration Statement on Form S-1 originally filed by the Company on October 16, 2015 and declared effective by the Securities and Exchange Commission on December 15, 2015 (the “Registration Statement”) reflecting the terms of the Agreement, or (2) at the option of the August 20 Investor (the “Option”), at an earlier time. The August 14 Investor exercised the Option on January 25, 2016. The POSAM was declared effective on February 3, 2016.

 

At March 31, 2016, the Company had not paid the principal due of $9,600 on a convertible debenture which was due on March 27, 2016. The Company was in default and obtained a waiver from the lender on May 11, 2016 waiving all rights relating to the nonpayment and extending the maturity date of the convertible debenture to August 1, 2016. In the same waiver agreement, the terms of five additional convertible debentures with maturity dates in May and June of 2016 totaling $122,084 were also extended to a maturity date of August 1, 2016.

 

At June 30, 2016, the Company had not paid the total principal due of $225,700 on convertible debenture which was due on July 10, 2016. The Company was in default and obtained a waiver from the lender on August 3, 2016 waiving all rights relating to the nonpayment and extending the maturity date of the convertible debenture to October 31, 2016. In the same waiver agreement, the terms of thirteen additional convertible debentures with maturity dates in July and August of 2016 totaling approximately $1,260,000 were also extended to a maturity date of October 31, 2016. (Note 12)

 

February 10, 2016 Financing

 

On February 10, 2016, the Company entered into a Note Purchase Agreement (the “Purchase Agreement”) with an accredited investor (the “Investor”), pursuant to which the Company agreed to sell, and the Investor agreed to purchase, a promissory note (the “Note”) in the aggregate principal amount of $275,000. The closing occurred on February 11, 2016.

 

The Investor deducted a commitment fee in the amount of $25,000 at the closing. The Note bears interest at the rate of 10% per year and matures on October 31, 2016. The Company may prepay all or any part of the outstanding balance of the Note at any time without penalty. In the event that the Company or any of its subsidiaries becomes subject to bankruptcy, insolvency, liquidation, or similar proceedings or takes certain related corporate actions, all outstanding principal and accrued interest under the Note will immediately and automatically become due and payable. In addition, the Note identifies certain other events of default, the occurrence of which would entitle the Investor to declare the outstanding principal and accrued interest immediately due and payable or to convert the Note, in whole or in part, into shares of the Company’s common stock at a conversion price that is the lower of (a) $0.75, or (b) a 51% discount to the lowest daily volume weighted average price of the Company’s common stock during the 20 trading days prior to the conversion date.

 

This conversion feature was considered to be a contingent conversion feature, and therefore the conversion feature would not be bifurcated and accounted for as a derivative, as are the conversion features of all other debentures, until such time as and if the Company is in an event of default. The balance of this note is included with Notes Payable on the accompanying condensed consolidated Balance Sheet (Note 8).

 

February 18, 2016 Financing

 

On February 18, 2016, the Company entered into a securities purchase agreement (the “Purchase Agreement”) with an accredited investor (the “Investor”) pursuant to which the Company agreed to sell, and the Investor agreed to purchase, convertible debentures (the “Debentures”) in the aggregate principal amount of $420,000, in two tranches.

 

The initial closing in the aggregate principal amount of $210,000 occurred on February 18, 2016. The second closing in the amount of $210,000 occurred on March 18, 2016 ($125,000) and March 22, 2016 ($85,000). The Debentures bear interest at the rate of 10% per year and mature after one year and are subject to a financing fee of 5%.

 

Each of the Debentures are convertible at the option of the holders into shares of the common stock of the Company at a conversion price that is lower of (a) $0.75, or (b) a 40% discount to the lowest traded price of the common stock of the Company during the 30 trading days prior to the conversion date. The Company may prepay the Debentures in cash, prompting a 30% premium.

 

The conversion feature of the Debentures meets the definition of a derivative and due to the reset provision to occur upon subsequent sales of securities at a price lower than the fixed conversion price, requires bifurcation and is accounted for as a derivative liability.

 

March 15 2016 Financing

 

The Company entered into a Note Purchase Agreement, effective as of March 14, 2016 (the “Effective Date”), with an Investor (the “March 15 Investor”) pursuant to which the March 15 Investor purchased and the Company issued and sold a promissory note in the original principal amount of $140,000 (the “First Promissory Note”), which matures on September 14, 2016.. Upon satisfaction of certain conditions set forth in the Note Purchase Agreement, the Company will issue and sell a second promissory note in the original principal amount of $137,500 (the “Second Promissory Note”). Each Promissory Note matures six (6) months after the date of its issuance. The First Promissory Note carries an original issue discount of $12,500 (the “First Promissory Note OID”). In addition, Company agreed to pay $5,000 towards the March 15 Investor’s legal fees incurred in connection with the purchase and sale of the First Promissory Note and the Second Promissory Note, $2,500 of which was paid to the March 15 Investor prior to the Effective Date and $2,500 of which amount (the “Carried Transaction Expense Amount”) is included in the initial principal balance of the First Promissory Note. The purchase price of the First Promissory Note was $125,000, computed as follows: $140,000 initial principal balance, less the First Promissory Note OID, less the Carried Transaction Expense Amount. The Second Promissory Note, if issued, also carries an original issue discount of $12,500 (the “Second Promissory Note OID”). The purchase price of the Second Promissory Note shall be $125,000, computed as follows: $137,500 initial principal balance, less the Second Promissory Note OID (the “Second Promissory Note Purchase Price”).

 

On March 15, 2016, the Company issued and sold the First Promissory Note to the March 15 Investor. Upon satisfaction of the terms (the “Mandatory Second Promissory Note Conditions”), the Company shall issue and sell the Second Promissory Note to the March 15 Investor. The Mandatory Second Promissory Note Conditions means that each of the following conditions has been satisfied on or before the date that is ninety (90) days from the Effective Date: (i) the Share Reserve (as defined in the First Promissory Note) for the First Promissory Note shall have been established; (ii) no Event of Default (as defined in the First Promissory Note) shall have occurred under the First Promissory Note; (iii) the median daily dollar volume of the Common Stock on its principal market for the nineteen (19) Trading Days (as defined in the First Promissory Note) immediately preceding the Share Reserve Date is greater than $75,000 per Trading Day; and (iv) the Company has notified Investor in writing that it has elected to require that Investor pay the Second Promissory Note Purchase Price. If the Mandatory Second Promissory Note Conditions are not satisfied as of the date that is ninety (90) days from the Effective Date, then the March 15 Investor shall not be obligated to pay the Second Promissory Note Purchase Price and the Second Promissory Note shall not be considered a valid, binding, or enforceable obligation of the Company, and, thereafter, the Second Promissory Note shall only be issued and the Second Promissory Note Purchase Price will only be payable upon the mutual written agreement of Company and the March 15 Investor. The First Promissory Note and/or the Second Promissory Note may be prepaid at any time by the Company in the sole discretion of the Company at a 25% premium to the outstanding balance under the applicable Promissory Note.

 

In the event that the First Promissory Note and/or the Second Promissory Note is not paid in full on or before maturity by the Company, then the March 15 Investor shall have the right at any time thereafter until such time as the First Promissory Note and/or the Second Promissory Note is paid in full, at the March 15 Investor’s election, to convert (each instance of conversion being a “Conversion”) all or any part of the outstanding balance into shares (“Conversion Shares”) of fully paid and non-assessable Common Stock of the Company as per the following conversion formula: the number of Conversion Shares equals the amount being converted divided by 50% multiplied by the lowest daily volume weighted average price of the Common Stock in the twenty (20) Trading Days immediately preceding the applicable Conversion. At any time and from time to time after the March 15 Investor becoming aware of the occurrence of any event of default, the March 15 Investor may accelerate the First Promissory Note and/or the Second Promissory by written notice to the Company, with the outstanding balance of the respective Note becoming immediately due and payable in cash at 125% of the outstanding balance.

 

This conversion feature was considered to be a contingent conversion feature, and therefore the conversion feature would not be bifurcated and accounted for as a derivative, as are the conversion features of all other debentures, until such time as and if the Company is in an event of default. The balance of the First Promissory Note is included with Notes Payable on the accompanying condensed consolidated Balance Sheet (Note 8).

 

The Company is currently in default on the March 15 note (Note 12).

 

April 2016 Financing

 

On April 13, 2016, the Company entered into a note purchase agreement (the “Purchase Agreement”) with an accredited investor (the “Investor”) pursuant to which the Company agreed to sell, and the Investor agreed to purchase, a convertible promissory note (the “Note”) in the aggregate principal amount of $225,000.

 

The Note bears interest at the rate of 5% per year and matures on July 13, 2016. The Note is convertible at any time, in whole or in part, at the option of the holders into shares of the common stock of the Company at a conversion price that is the lower of (a) $0.75, or (b) a 49% discount to the lowest traded price of the common stock of the Company during the 20 trading days prior to the conversion date. The Company may prepay the Note in cash, prompting a 30% premium.

 

The Company will, within thirty (30) days, grant a security interest to the Investor and its affiliates over the Company’s assets, including its stock ownership in its subsidiary, ESWD I, LLC (but not the assets of ESWD I, LLC). Furthermore, in connection with the next $1.5 million of equity capital raised by the Company, the Company shall use one third of such funds to make principal repayment of amounts owed to the Investor, plus a redemption premium of 30% of such amounts.

 

March 15, 2016 Financing – Second Promissory Note

 

On or about April 20, 2016 it was mutually determined by the parties involved that the median daily dollar volumes requirement of the Mandatory Second Promissory Note Conditions was not met and the Second Promissory Note would not be issued.

 

May 2016 Financings

 

The Company received an additional $100,000 through the issuance of two convertible debentures of $50,000 each, on May 13, 2016 and May 20, 2016. The Notes bears interest at the rate of 10% per year and mature on July 13, 2016 and July 20, 2016, respectively. The Notes are convertible at any time, in whole or in part, at the option of the holders into shares of the common stock of the Company at a conversion price that is the lower of (a) $0.75, or (b) a 40% discount to the lowest traded price of the common stock of the Company during the 20 trading days prior to the conversion date. The remaining terms of the debentures are the same as all other convertible debentures, and have also been determined to require derivative accounting. The Company may prepay the Note in cash, prompting a 30% premium.

 

June 22, 2016 Financing

 

Entry into Securities Purchase Agreement and Equity Purchase Agreement

 

On June 22, 2016, the Company entered into a securities purchase agreement (the “Securities Purchase Agreement”) with an accredited investor (the “Investor”) pursuant to which the Company agreed to sell, and the Investors agreed to purchase, convertible debentures (the “Convertible Bridge Debentures”) in the aggregate principal amount of $240,000, in two tranches. The initial closing in the aggregate principal amount of $120,000 occurred on June 22, 2016, and the second closing in the aggregate principal amount of $120,000 was scheduled to occur on July 8, 2016 . As of the date these consolidated financial statements were issued, the second closing has not occurred.

 

The Convertible Commitment Debenture and the Convertible Bridge Debenture accrue interest at a rate of 10% per annum. Each of the debentures are convertible at any time, in whole or in part, at the option of the holders into shares of the Company’s common stock at a conversion price that is the lower of (a) $0.75, or (b) a 40% discount to the lowest traded price of the Company’s common stock during the 30 trading days prior to the conversion date.

 

The Company and the Investor also entered into an Equity Purchase Agreement (the “Equity Purchase Agreement”, "EQP"), pursuant to which, following the filing and declaration of effectiveness of a registration statement by the Company (the “Registration Statement”) and the availability of authorized stock, the Company may “put” its shares of common stock to the Investor at a 20% discount to lowest traded price over the prior 10 trading days for up to the higher of $50,000 or 300% of the average daily trading volume over the previous 10 trading days, for up to an aggregate of $5,000,000 in aggregates “puts”.

 

In connection with the Equity Purchase Agreement, the Company entered into a registration rights agreement (the “Registration Rights Agreement”) with the Investors, pursuant to which the Company agreed to file the Registration Statement for the resale of shares of common stock put to the Investor under the Equity Purchase Agreement, within 30 days of the closing date of the Equity Purchase Agreement, and to have such registration statements become effective within 60 days of the closing date of the Purchase Agreement.

 

The Investor shall have a right of first refusal to participate in future equity financings of the Company on the same terms as any new investors for a period of twelve months from the closing of the last Convertible Bridge Debenture. The Company also shall not enter into other variable rate transactions other than with pre-existing investors, so long as the Investors hold more than $2,000,000 in debentures of the Company, including pre-existing debentures. The Company also may not enter into any equity line of credit with any other investor during the term of the Equity Purchase Agreement, which expires on December 22, 2017.

 

No amounts have been funded under the Equity Purchase Agreement to date. The Company and the Investor have entered into a verbal agreement to terminate the EQP, and the parties are working on finalized a formal termination agreement.

 

To induce the Investor to purchase the Equity Purchase Agreement (described below), the Company issued an additional $100,000 convertible debenture, on the same terms of the Convertible Bridge Debentures to the Investor (the “Convertible Commitment Debenture”). The Company will not receive any cash for the Convertible Commitment Debentures.

 

The Company entered into a Convertible Debenture with the above Investor for an additional $10,000 on June 14, 2016. The convertible debenture is due on June 14, 2017 and accrues interest at a rate of 10% per annum. The debenture is convertible at any time, in whole or in part, at the option of the holder into shares of the Company’s common stock at a conversion price that is the lower of (a) $0.75, or (b) a 40% discount to the lowest traded price of the Company’s common stock during the 30 trading days prior to the conversion date.

 

June 30, 2016 Financing

 

On June 30, 2016, the Company entered into a securities purchase agreement (the “Securities Purchase Agreement”) with an accredited investor (the “Investor”) pursuant to which two wholly-owned subsidiaries of the Company, EWSD I, LLC (“EWSD I”) and Pueblo Agriculture Supply and Equipment, LLC (“Pueblo”, and together with EWSD I, the ‘Subsidiaries”) agreed to jointly sell, and the Investors agreed to purchase, convertible debentures (the “Convertible Debentures”) in the aggregate principal amount of $1,500,000, in six tranches over the following 90-day period. The Company guaranteed the issuance of the Convertible Debentures and, upon notice from the Investor, the Convertible Debentures are convertible in to the Common Stock of the Company. The initial closing in the aggregate principal amount of $125,000 occurred on June 30, 2016, with additional closings subsequent to June 30, 2016, of approximately $1,266,000, net, received through the issuance of these condensed consolidated financial statements. The Company agreed to pay an aggregate of the Investor’s legal fees of $40,000 ($10,000 per tranche) in connection with the closing of each of tranches three through six. The June 30, 2016 financing was subsequently assigned to a new investor (Note 12).

 

The Company and the Subsidiaries also entered into a Security Agreement (the “Security Agreement”) and Parent Guarantee (the “Guarantee”), securing a lien for the Investor on EWSD I’s assets on a secondary basis to the primary lien holder and securing a lien for the Investor on Pueblo’s assets on a primary basis and with the Company guaranteeing all obligations of EWSD I and Pueblo to the Investor. Pursuant to the Security Agreement, the Company agreed to, within 14 calendar days, negotiate and enter into an Intercreditor Agreement among the other secured creditors of the Company and EWSD I. The Company subsequently entered into a Subordination Agreement, which replaced the Intercreditor Agreement, on August 23, 2016.

 

The Convertible Debentures accrue interest at a rate of 10% per annum. Each of the debentures are convertible at any time into shares of common stock of the Company, in whole or in part, at the option of the holders into shares of the Company’s common stock at a conversion price that is the lower of (a) $0.75, or (b) a 40% discount to the lowest traded price of the Company’s common stock during the 30 trading days prior to the conversion date.

 

The Investor shall have a right of first refusal to participate in future equity financings of the Company on the same terms as any new investors for a period of twelve months from the closing of the last Convertible Debenture. The Company and the Subsidiaries also shall not enter into other variable rate transactions other than with pre-existing investors, so long as the Investors hold more than $2,000,000 in debentures of the Company, including pre-existing debentures.

 

The conversion feature of the Debentures meets the definition of a derivative and due to the reset provision to occur upon subsequent sales of securities at a price lower than the fixed conversion price, requires bifurcation and is accounted for as a derivative liability.

 

The derivatives related to the above convertible debentures were initially recognized at their estimated fair values as described previously, which amounted to approximately $4,932,000 in the six months ended June 30, 2016 and $1,885,000 for the same period of 2015. The resulting debt discount is amortized as over the life of the convertible debenture, or until conversion if earlier, which resulted in amortization expense of $2,086,000 and $6,050,000, for the three months ended June 30, 2016 and 2015, respectively. Additionally, the current year closings to convertible debentures resulted in the calculated fair value of the debt being greater than the face amounts of the debt by approximately $2,627,000, with this excess amount being immediately expensed as financing costs. Financing costs for the six months ended June 30, 2015, were approximately $3,061,000. The fair value of the embedded derivative consisting of all related convertible debentures is measured and recognized at fair value each subsequent reporting period and the changes in fair value for all derivatives for six months ended June 30, 2016 and 2015, resulted in a gain of approximately $9,320,000 and $3,053,000, respectively, which are recognized in the condensed consolidated Statement of Comprehensive Income (Loss) as Change in fair value of derivative liability.

 

Related Party Financing

 

One of the directors on the Company’s Board entered into three separate subordinated convertible promissory notes convertible at $0.01 with the Company on March 4, 2016, March 10, 2016 and March 15, 2016, respectively, each in the principal amount of $25,000, for a total of $75,000. Also on March 15, 2016, another of the Company’s directors entered into a subordinated convertible promissory note convertible at $0.01 with the Company in the principal amount of $25,000, and two other of the Company’s directors each entered into a subordinated convertible promissory note convertible at $0.01 with the Company in the principal amount of $2,500. All of the foregoing convertible promissory notes have three year terms and an interest rate of 8% per annum. The debentures were evaluated to determine if the conversion feature fell within the guidance for derivative accounting, and as the debentures are convertible at a fixed conversion price, and do not include a the reset provision to occur upon subsequent sales of securities at a price lower than the fixed conversion price, the Company concluded the conversion feature did not qualify as a derivative.

 

In connection with their funding of the Notes (collectively the “Notes”), the directors each receive a warrant, exercisable for a period of three (3) years from the date of Notes, to purchase an amount of Company Common Stock equal to 50% of the principal sum under each of the director notes, at an exercise price equal to 200% of the applicable Conversion Price. The exercise price of the warrants is $0.02. The warrants were determined to have a fair value of $42,000, calculated with the Black Sholes Merton model, with the following key valuation assumptions: estimated term of three years, annual risk-free rate of .93%, and annualized expected volatility of 172%.

 

Conversions

 

During the six months ended June 30, 2016 and 2015, respectively, approximately $1,904,000 and $4,000,000 of principal and approximately $14,000 and $27,000, of accrued interest were converted into approximately 2,648,938,000 and 12,383,229 of the Company’s common shares at an average price of $0.0007 and $0.74, based on 51% of the calculated VWAP. Upon conversion, the derivative fair value for the amounts converted were re-measured through the date of conversion, with the conversion date fair value reclassified to equity, amounting to approximately $3,200,000 and $1,160,000 in the six months ended June 30, 2016 and 2015, respectively. As a result of the conversions, the resulting decrease of fair value of approximately $1,885,000 of the related debt discount was recognized on the Condensed Consolidated Statement of Comprehensive Income (Loss).

 

Warrants

 

The warrants issued under all debentures, and other agreements, are summarized below:

 

Date issued   Number of
warrants
    Exercise
price
    December 18,
2015 re-price
    Fair Value at issuance  
July 2014 Modified Debentures                                
January 30, 2015     40,552       4.93       .06     $ 159,601  
February 26, 2015     45,537       2.20       .06       79,904  
March 13, 2015     21,151       2.36       .06       39,965  
March 16, 2015     10,575       2.36       .06       19,981  
March 20, 2015     41,946       1.79       .06       59,942  
March 27, 2015     75,758       1.98       .06       119,888  
April 2, 2015     60,386       1.66       .06       74,025  
April 2, 2015     30,193       1.66       .06       37,012  
April 10, 2015     107,914       1.39       .06       112,460  
April 17, 2015     41,667       1.20       .06       37,680  
April 24, 2015     127,119       1.18       .06       112,635  
April 24, 2015     21,186       1.18       .06       18,772  
May 1, 2015     156,250       .96       .06       113,133  
May 7, 2015     134,615       .78       .06       79,234  
May 8, 2015     42,000       .75       .06       23,768  
May 15, 2015     200,000       .75       .06       113,365  
May 22, 2015     250,000       .60       .06       113,366  
May 29, 2015     258,621       .58       .06       112,537  
June 5, 2015     288,462       .52       .06       120,738  
June 12, 2015     930,233       .43       .06       303,246  
June 19, 2015     3,448,276       .29       .06       751,159  
September 2014 Modified Debentures                                
January 28, 2015     18,038       5.54       .06       80,156  
February 13, 2015     57,870       1.73       .06       96,689  
April 2, 2015     181,159       1.66       .06       222,109  
April 24, 2015     90,579       1.10       .06       80,548  
May 15, 2015     200,000       .75       .06       113,365  

 

Date issued   Number of
warrants
    Exercise
price
    December 18,
2015 re-price
    Fair Value at issuance  
June 12, 2015     1,744,186       .43       .06       570,248  
                                 
August 2015 Debentures                                
August 24, 2015     6,666,667       .06               321,757  
September 18, 2015     588,235       .17               82,804  
October 28, 2015     4,166,667       .12               363,306  
November 16, 2015     1,785,714       .07               92,798  
November 23, 2015     2,083,333       .06               68,988  
November 30,2015     2,500,000       .05               81,988  
December 7, 2015     6,250,000       .02               163,382  
December 17, 2015     10,000,000       .02               76,376  
                                 
Directors                                
January 5, 2015     129,305       .40               39,901  
January 30, 2015     129,917       .40               39,916  
February 2, 2015     237,778       .22               16,619  
March 4, 2016     1,250,000       .02               10,000  
March 10, 2016     1,250,000       .02               10,000  
March 15, 2016     1,250,000       .02               10,000  
March 15, 2016     1,250,000       .02               10,000  
March 15, 2016     125,000       .02               1,000  
March 15, 2016     125,000       .02               1,000  
April 20, 2016     1,041,663       .02               4,000  
                                 
June 8, 2016     5,000,000       .01               4,425  
June 8, 2016     2,691,250       .01               2,381  
June 8, 2016     1,500,000       .01               1,327  
June 8, 2016     3,343,750       .01               2,959  
                                 
Other Agreements                                
December 18, 2015     4,000,000       .50               76,000  
April 13, 2016     500,000       .03               3,869  
May 5, 2016     590,625       .01               3,477  
June 8, 2016     2,678,571       .01               2,265  
                                 
Total     69,757,748                     $ 5,256,064  

 

Effective September 18, 2015, the holder of the September 2014 Debentures and the Company agreed to amend its September 2014 Warrants, to reduce the exercise price of the warrants to purchase an aggregate of 2,291,832 shares of the Company’s common stock to six cents per share. Additionally, the holder of the July 2014 Debentures and the Company agreed to amend its July 2014 Warrants, to reduce the exercise price of the warrants to purchase an aggregate of 6,332,441 shares of Common Stock to six cents per share. As a result of the amendment, the fair value of the warrants was remeasured as of September 18, 2015, for an additional fair value of approximately $38,000 recognized as a financing expense. During the year ended December 31, 2015, approximately 2,292,000 warrants were exercised for cash proceeds of $137,510 at an average exercise price of $0.06.

 

During the three and six months ended June 30, 2016 and 2015, there were no warrants exercised.

 

The Company determined at issuance that the warrants were properly classified in equity as there is no cash settlement provision and the warrants have a fixed exercise price and, therefore, result in an obligation to deliver a known number of shares.

 

The Company adopted a sequencing policy that reclassifies contracts, with the exception of stock options, from equity to assets or liabilities for those with the earliest inception date first. Any future issuance of securities, as well as period-end reevaluations, will be evaluated as to reclassification as a liability under our sequencing policy of earliest inception date first until all of the convertible debentures are either converted or settled.

 

The Company reevaluated the warrants as of June 30, 2016 and determined that they did not have a sufficient number of authorized and unissued shares to settle all existing commitments, and the fair value of the warrants for which there was insufficient authorized shares, were reclassified out of equity to a liability. Under the sequencing policy, of the approximately 67,466,000 warrants outstanding at June 30, 2016, it was determined there was not sufficient authorized shares for approximately 53,970,000 of the outstanding warrants. The fair value of these warrants was re-measured on June 30, 2016 using the Black Scholes Merton Model, with key valuation assumptions used that consist of the price of the Company’s stock on June 30, 2016, a risk free interest rate based on the average yield of a 2 or 3 year Treasury note and expected volatility of the Company’s common stock, resulting in the fair value for the Warrant liability of approximately $6,000. The resulting change in fair value of approximately $441,000 and $931,000 was recognized as a gain in the Condensed consolidated statement of comprehensive income(loss).