FAIR VALUE OF CONVERTIBLE PROMISSORY NOTES

9 Months Ended

Sep. 30, 2024

FAIR VALUE OF CONVERTIBLE PROMISSORY NOTES

FAIR VALUE OF CONVERTIBLE PROMISSORY NOTES

NOTE 13 – FAIR VALUE OF CONVERTIBLE PROMISSORY NOTES

Fair value of Series A and B convertible promissory notes consists of the following at September 30, 2024 and December 31, 2023 (in thousands):

	September 30, 2024			December 31, 2023
Series A subordinated convertible note at fair value	$	4,918		$	4,597
Series B senior secured convertible note at fair value		3,795			3,502
Carrying value of convertible promissory notes at fair value		8,713			8,099
Less: current portion of convertible promissory notes at fair value		(8,713	)		(8,099	)
Convertible promissory notes at fair value, less current portion	$	-		$	-

In October 2020, the Company entered into a Securities Purchase Agreement (“Purchase Agreement”) with an institutional investor (the “Investor”) for the purchase of a series of two convertible notes with an aggregate principal amount of $11.5 million. Concurrently, the Company consummated the sale to the Investor of a Series A subordinated convertible note (the “Series A Note”) with an initial principal amount of $4.6 million, including an original issue discount of $0.6 million, and a Series B senior secured convertible note (the “Series B Note,” and together with the Series A Note, the “Convertible Notes”) with an initial principal amount of $6.9 million, including an original issue discount of $0.9 million.

The Investor paid for the Series A Note by delivering $4.0 million in cash consideration and paid for the Series B Note by delivering a secured promissory note (the “Investor Note”) with an initial principal amount of $6.0 million. The Company was to receive cash in respect of the Series B Note upon cash repayment of the corresponding Investor Note. To date, $1.0 million of the Investor Note was repaid, and to the extent the Investor Note is not repaid, the remainder of the principal under the Series B Note is considered to be “restricted.”

The Series A Note matured on October 30, 2022 and is currently in default. The Series B Note was originally set to mature on October 30, 2021 but it matured earlier on the date of default of the Series A Note (the “Maturity Date”) and is also currently in default. No action by the Investor has been pursued on the Convertible Notes as of the date of this Quarterly Report.

On April 12, 2022, the Company filed a civil action in the California Superior Court against the Investor, alleging that the investor entered into the Purchase Agreement as an unregistered securities dealer and unlicensed finance lender in violation of California law. The Company’s complaint seeks rescission of the Purchase Agreement, damages, attorneys’ fees and other relief. The Investor responded to the complaint by filing a demurrer/motion to dismiss and on August 31, 2022, the Company and Investor entered into a stipulation to stay the litigation for 30 days and allow the parties to engage in further settlement discussions. The matter was unable to be resolved within the 30 days, and, pursuant to the Stipulation, the Company refiled its action in New York where a New York court will be required to apply California law to our causes of action for rescission and unfair competition. On November 18, 2022, the Company filed an amended complaint alleging six additional causes of action, including fraud, breach of contract and unfair competition. The Investor responded to the New York amended complaint by filing a motion to dismiss and on February 3, 2023, the Company filed its opposition response to the Investor’s motion to dismiss. On September 7, 2023, a hearing was held on the motion to dismiss. As of the filing date of this Quarterly Report, a ruling has not been issued by the court on the motion. Settlement discussions between the parties are ongoing.

Payment of Amounts Due under the Convertible Notes

On the Maturity Date, the Company shall pay to the Investor an amount in cash (other than the restricted portion of the Series B Note) representing all outstanding principal, Make-Whole Amount (as defined in the Convertible Notes), if any, accrued and unpaid interest and accrued and unpaid Late Charges (as defined in the Convertible Notes) on such principal. The remaining restricted amount of $5.0 million under the Series B Note has been automatically satisfied on the Maturity Date (in lieu of a cash payment) by Maturity Netting (as defined in the Investor Note described below).

Interest

The Convertible Notes shall bear no interest unless there is an occurrence, and during the continuance, of an Event of Default (as defined in the Convertible Notes). During any such Event of Default, the Convertible Notes will accrue interest at the rate of 18% per annum. See “—Events of Default” below.

Conversion; Alternate Conversion upon Event of Default

The Convertible Notes (other than the restricted portion of the Series B Note) are convertible, at the option of the Investor, into shares of Common Stock at a conversion price of $1.32 per share. The conversion price is subject to full ratchet antidilution protection upon any transaction in which the Company is deemed to have granted, issued or sold, any shares of Common Stock. If the Company enters into any agreement to issue any variable rate securities, other than a bona fide at-the-market offering or equity line of credit, the Investor has the additional right to substitute such variable price (or formula) for the conversion price.

Due to the Event of Default that has occurred under the Convertible Notes, the Investor may elect to alternatively convert the Convertible Notes at the redemption premium described therein.

Conversion Limitation

The Investor will not have the right to convert any portion of the Convertible Notes, to the extent that, after giving effect to such conversion, the Investor (and other certain related parties) would beneficially own in excess of 4.99% of the shares of Common Stock outstanding immediately after giving effect to such conversion. This limit may, from time to time, be increased, up to 9.99%, or decreased; provided that any such increase will not be effective until the 61^st day after delivery of a notice to the Company of such increase.

Events of Default

The Convertible Notes include certain customary and other Events of Default. In connection with an Event of Default, the Investor may require the Company to redeem in cash any or all of the Convertible Notes. The redemption price will be at a premium to the amount due under the Convertible Notes as described therein.

Fair Value Option for the Series A and B Notes

The Company elected the fair value option under ASC 825, “Financial Instruments,” for both the Series A and B Notes, which have been accounted for as follows: (1) the portion of the change in the liabilities’ fair value that is attributable to a change in instrument-specific credit risk in other comprehensive income; (2) the remaining change in the liabilities’ fair value in net income; (3) the excess of the fair value over the proceeds was recognized as an expense; and (4) upfront costs and fees were recognized in earnings as incurred gains and losses.

The Company recognized a loss of $614 thousand and a gain of $1.3 million attributed to the aggregate changes in fair value of the Series A and B Notes for the nine months ended September 30, 2024 and 2023, respectively, which were recorded in the unaudited condensed consolidated statements of operations.

As of September 30, 2024, the Company valued the Series A and B Notes giving consideration to the terms under the existing default. If the Company is required to settle the Series A and B Notes under those terms, the settlement would be either (i) a cash payment of $10.0 million, or (ii) the issuance of 4,145,212 shares of the Company’s common stock plus a cash payment of $9.9 million, at the option of the Investor.