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9. Convertible Notes
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Dec. 31, 2014
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| Convertible Notes | ||||||||||||||||||||||||||||||||||||||||||||||
| Convertible Notes |
On July 5, 2013, the Company received from existing institutional investors net proceeds of $1,372,500 upon approval of a CE Mark certification. The Company had entered into an agreement with existing stockholders in May 2013 for an aggregate principal amount of $1,500,000 of senior secured convertible notes and warrants to purchase up to an aggregate of 1,000,000 shares of its common stock. The receipt of net proceeds of $1,372,500 was dependent upon receipt of a CE Mark certification, which occurred on July 5, 2013. The notes bore interest at the rate of 8.0% per annum and were subject to a “make-whole” upon any conversion of the notes into common stock, as if the notes being converted were outstanding to April 1, 2014. Interest was first payable on September 3, 2013 and was payable on the first trading day of each month thereafter. The notes were to mature on April 1, 2016 unless redeemed prior to that date, subject to amortization, discussed below. A noteholder could elect to have any interest due prior to April 1, 2014 added to the principal amount of a note; thereafter, interest will be paid in cash only. The warrants are exercisable one year after issuance, have an exercise price of $1.10 per share, subject to anti-dilution adjustment, and a term of five years from the date they are first exercisable. The holders of the notes and warrants will be prohibited from converting the notes into or exercising the warrants for shares of common stock if, as a result of such conversion or exercise, the holder, together with its affiliates, would own more than 4.99% or 9.99%, respectively, at the initial holder’s election, of the total number of shares of the Company’s common stock then issued and outstanding.
The Company could redeem the notes in cash at par value or in shares of stock which are priced in accordance with a pricing formula set forth in the notes, in eight equal monthly installment payments beginning on September 1, 2013, and continuing thereafter on the first business day of each month, ending on April 1, 2014. At the Company’s option, and if certain equity conditions are waived or satisfied, the Company could elect to pay these installment payments in shares of common stock, in cash, or in any combination of shares and cash. To the extent the Company paid all or any portion of an installment payment in common stock, the Company would deliver to each noteholder the amount of shares equal to the applicable installment payment being paid in shares of common stock, divided by the lower of (i) the conversion price then in effect, and (ii) 90% of the average of the 10 lowest-volume weighted-average prices of our common stock during the 20 trading day period ending two trading days prior to the applicable payment date (the “Company Conversion Price”).
All installment payments were subject to the right of each noteholder to defer payment of some or all of any installment payment to a subsequent installment date or the maturity date, and, with respect to any installment date, convert, at the then-prevailing Company Conversion Price, any amount of principal and capitalized interest up to an amount equal to four installment payments. Each noteholder could also convert, at any time, all or a portion of any deferred installment payment. The Company Conversion Price for any such deferred installment payment would be the lower of the Company Conversion Price in effect on the date of the original installment date and the Company Conversion Price then in effect.
Due to the complexity and number of embedded features within the convertible note and as permitted under under ASC 825, the Company elected to account for the convertible notes and all the embedded features (collectively, the “hybrid instrument”) under the fair value option. ASC 825 requires the entity to record the financial asset or financial liability at fair value rather than at historical cost with changes in fair value recorded in the statement of operations. In addition, it requires that upfront costs and fees related to items for which the fair value option is elected be recognized in earnings as incurred and not deferred. On the initial measurement date of July 5, 2013, the fair value of the hybrid instrument was estimated at $1,643,500, which was $143,500 higher than the principal amount of $1,500,000.
During the year ended December 31, 2013, the Company redeemed the 8% convertible notes in the principal amount of $750,000 and interest in the amount of $3,000 for an aggregate of 53,537 shares of its Series E non-voting preferred stock. Prior to the redemption, the convertible notes were revalued to fair value, resulting in a loss on revaluation of $4,640. The issuance of the 53,537 shares of the Series E non-voting preferred stock in exchange for the convertible notes resulted in a loss on extinguishment of $495,326. Also, during the fourth quarter of 2013, the balance of the convertible note in the principal amount of $298,750 was converted to common stock, resulting in an $8,148 gain from the revaluation of the portion of the note that was converted. The Company recorded $1,459,661 loss on extinguishment of convertible notes related to the conversions and redemptions during the year ended December 31, 2013 and a gain of $44,642 in the change in fair value of the converted amounts between the issuance date and the relevant conversion dates.
The Company used a Monte Carlo model to separately value the warrants issued in connection with the convertible notes in order to take into account the possibility of an adjustment to the exercise price associated with new rounds of financing in the future. The most likely exercise price of the warrants was estimated under various stock price scenarios and the noteholders’ payoffs were computed under each scenario. The present value of the mean of such payoffs represents the value of the warrant on any given valuation date. When the stock price was simulated in the model, the possible scenarios were always between the valuation date stock price and the initial exercise price of $1.10. As a result, the Company estimated the fair value of the warrant liability on the issuance date to be $587,600.
A summary of the key assumptions used by the Company in the Monte Carlo simulation model to value the hybrid instrument at each of the relevant measurement dates during the year is as follows:
Stock price – Due to the historical volatility of the stock price, a 30-day volume-weighted average stock price was used as of each valuation date.
Conversion/redemption strike price – These assumptions incorporate both the initial contractual conversion price as well as subsequent downward adjustments based on management’s estimate of the probabilities of additional future financings that would include a stock price or conversion price that is lower than the then existing conversion price.
Volatility – Given that the Company recently received CE Mark approval for Neutrolin, the volatility used in the analysis was a weighted average of 1) the Company’s historical volatility, 2) the Company’s volatility after the receipt of CE approval and 3) the volatilities of comparable companies following the receipt of product approval. The resulting volatility used in the analysis was 75%.
Term – Based on an evaluation of the terms of the agreement, management has assumed that it would be advantageous for the holders of the Convertible Notes to redeem all installments by April 2014 rather than defer them to a later date.
Probability of Event of Default or Change in Control – Management has concluded that the probability of a change in control or event of default during the term of the hybrid instrument is only 5%.
Risk-free Rate – The US Treasury Bond Rate with a term approximating the term of the instrument was used as the risk-free interest rate in the valuation.
Credit adjusted discount rate – Management believes that its debt, if rated, would be equivalent to Moody’s C rated bonds or lower.
Dividend rate - Management does not expect to pay any dividends during the term of the hybrid instrument.
The following table is a rollforward for the year ended December 31, 2013 of the carrying amount of the convertible notes for which the fair value option was elected:
All of the remaining convertible notes were converted into shares of common stock or the Company’s Series E non-voting convertible preferred stock in the fourth quarter of 2013.
The following table is a rollforward for the year ended December 31, 2013 of the carrying amount of the warrant liability that was issued during the year ended December 31, 2013 in connection with the issuance of convertible notes and Series C-1 and Series C-2 non-voting preferred stock. The warrants are accounted for as a derivative liability and are valued using a Monte Carlo simulation model in order to take into account the possibility of adjustments to the exercise price resulting from additional rounds of financing. During the year ended December 31, 2013, there were no exercises of these warrants.
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