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10. CONVERTIBLE NOTES PAYABLE AND FAIR VALUE MEASUREMENTS
 12 Months Ended
Dec. 31, 2014
Convertible Notes Payable And Fair Value Measurements  
10. CONVERTIBLE NOTES PAYABLE AND FAIR VALUE MEASUREMENTS

Summary:

 

As of December 31, 2014, the following summarizes principal amounts owed under convertible notes:

 

             Convertible 
             Notes Payable, 
   Amount   Discount   net of discount 
Pegasus Note  $100,000   $–   $100,000 
Gemini Master Fund – Third Amended and Restated secured bridge Note   856,325    252,070    604,255 
   $956,325   $252,070   $704,255 

 

As of December 31, 2013, the following summarizes principal amounts owed under convertible notes:

 

             Convertible 
             Notes Payable, 
   Amount   Discount   net of discount 
Pegasus Note  $100,000   $         –   $100,000 
Gemini Master Fund – Second Amended Not and Note Five   1,313,877    –    1,313,877 
Gemini Master Fund – Note 2010-3   92,449    –    92,449 
   $1,506,326   $–   $1,506,326 

  

Pegasus Note:

 

On December 19, 2009, the Company entered into a convertible promissory note for $100,000 to a new landlord in lieu of paying rent for one year for new office space. The interest is 10% per annum with the note principal and interest originally due December 18, 2010 and subsequently extended until December 31, 2012. However, if the Company receives greater than $1,000,000 of proceeds from debt or equity financing, 25% of the amount in excess of $1,000,000 shall be used to pay down the note. This note is subordinate to all existing senior indebtedness of the Company. This note is convertible at $0.33 per share and there was no beneficial conversion feature at the note date.

 

Effective December 31, 2012, the Company entered into an additional modification extending the term of the note to December 31, 2013, and waiving, through December 31, 2012, the requirement to pay down the note with financing proceeds received by the Company in the period. Per generally accepted accounting principles, this modification was treated as a debt extinguishment, but as the market price of the Company’s stock was below the conversion price at the time of the modification, there was no beneficial conversion feature that needed to be recorded.

 

Effective December 31, 2013, the Company entered into an additional modification extending the term of the note to June 30, 2014, and waiving, through December 31, 2013, the requirement to pay down the note with financing proceeds received by the Company in the period. Per generally accepted accounting principles, this modification was treated as a debt extinguishment, but as the market price of the Company’s stock was below the conversion price at the time of the modification, there was no beneficial conversion feature that needed to be recorded.

 

Effective December 31, 2014, the Company entered into an additional modification extending the term of the note to December 31, 2015, and waiving, through December 31, 2014, the requirement to pay down the note with financing proceeds received by the Company in the period. Per generally accepted accounting principles, this modification was treated as a debt extinguishment, but as the market price of the Company’s stock was below the conversion price at the time of the modification, there was no beneficial conversion feature that needed to be recorded.

 

The balance of the note as of December 31, 2014 is $100,000 with accrued and unpaid interest amounting to $50,356.

 

Gemini Third Amended and Restated Secured Bridge Note

 

At the end of 2010, the Company had a series of outstanding convertible notes to Gemini Master Fund, Ltd which were due December 31, 2011. These notes bore interest at a rate of 12% per annum and, with the exception of one note, had a conversion feature whereby, the lender, at its option, may at any time convert this loan into common stock at $0.25 per share. Interest under these notes is due on the first business day of each calendar quarter, however, upon three days advance notice, the Company may elect to add such interest to the note principal balance effectively making the interest due at note maturity. With regard to the conversion feature of these notes, the conversion rights contain price protection whereby if the Company sold equity or converted existing instruments to common stock at a price less than the effective conversion price, the conversion price will be adjusted downward to the sale price. Furthermore, if the Company issues new rights, warrants, options or other common stock equivalents at an exercise price that is less than the stated conversion price, then the conversion price shall be adjusted downward to a new price based on a stipulated formula. The holder may not convert the debt if it results in the holder beneficially holding more than 4.9% of the Company’s common stock. The note is secured by substantially all assets of the Company and its subsidiary, and is unconditionally guaranteed by the subsidiary.

 

Prior to June 30, 2010 all shares underlying the Gemini Master Fund convertible debt were subject to a lock-up agreement, and the shares were not easily convertible to cash thus, the embedded conversion option did not need to be bifurcated and recorded as a fair value derivative due to the price protection provision in the notes. Subsequent to June 30, 2010, such lock-up provisions expired and as such, the Company determined that the embedded conversion option met the definition of a derivative liability and thus must be bifurcated and recorded as a fair value derivative.

 

On December 31, 2011, the Company entered into an extension and amendment agreement modifying certain terms of all of the notes so that the terms for all the notes became equivalent. The interest rate was reduced to 10%; the conversion price was reduced from $0.25 to $0.20; and the term was extended to December 31, 2012.

 

On December 31, 2012, the Company entered into a further extension and amendment agreement pursuant to which the term of the notes was extended to December 31, 2013. As a part of this amendment, the Company agreed to cause Robert Noble, its chairman, to execute a lock-up agreement pursuant to which Mr. Noble agreed not to sell or transfer any shares of Envision common stock until a defined restriction period expires. Mr. Noble delivered such lock-up agreement. No other terms were modified, but the Company paid a $5,000 fee to cover legal and document fees which was capitalized as an asset on the balance sheet as “Debt issue costs” and was amortized over the term of the note. This change was accounted for as a debt modification but not as a debt extinguishment because the embedded conversion feature is bifurcated and treated as a derivative. As a result of this transaction, the Company had recorded $456,073 of embedded conversion option based effective interest, based on the increase in the fair value of the embedded conversion option due to the modification, which was recorded as debt discount and was amortized over the term of the loan. Further, at the modification date, a $20,000 accounts payable balance was converted into the note balance and $130,383 of accrued interest was added to the loan balance.

 

In January 2013, in conjunction with receiving funds from the Company’s private offering, and due to the price protection provisions of the notes as discussed above, the conversion price of the notes was reduced to $0.15 per share.

 

Effective February 28, 2014 the Company entered into an additional extension and amendment agreement with a simultaneous principal conversion agreement related to these convertible notes payable. With this agreement, all outstanding notes have been merged into one note, the term of the note was extended to June 30, 2015 and the beneficial holder ceiling was increased to 9.9%. No other terms of the notes were modified. These changes were accounted for as a debt modification but not as a debt extinguishment because the embedded conversion feature is bifurcated and treated as a derivative and no other debt extinguishment criteria were met. As a result of this transaction, the Company recorded $478,561 of embedded conversion option based effective interest based on the increase in the fair value of the embedded conversion option due to the modification which is recorded as debt discount and is being amortized over the remaining term of the loan. The Company further issued 1,500,000 common stock purchase warrants valued at $193,625 using the Black-Scholes valuation methodology, each with a three year term and $0.20 strike price, to the holder which was recorded as debt discount and is being amortized over the remaining term of the note. The Company agreed to pay a $6,500 fee to cover legal and document fees which is capitalized as an asset on the balance sheet as “Debt issue costs” and is being amortized over the remaining term of the note. Simultaneously, Gemini converted $550,000 of principal convertible debt, and all accrued interest through 2013, and further, the accrued interest through the conversion date for the converted debt, totaling $155,161, into 4,701,076 shares of common stock of the Company (3,666,666 shares for principal and 1,034,410 for interest) at the contracted conversion price of $0.15 per share. The conversion was recorded to equity with no gain or loss on such conversion related to the principal portion, while the Company recorded a loss of $20,689 related to the conversion of accrued interest. As an inducement to Gemini to convert the principal debt amount, the Company issued 3,727,778 common stock purchase warrants, each with a strike price of $0.20 and a three year term. These warrants are valued at $482,300 using the Black-Scholes valuation methodology and were expensed at the date of the transaction. (See Notes 12 and 13)

 

At December 31, 2014, the note had a total balance of $856,325, a net balance of $604,255, and accrued interest of $88,898.

 

Fair Value Measurements – Derivative liability:

 

The accounting guidance for fair value measurements provides a framework for measuring fair value and requires expanded disclosures regarding fair value measurements.  Fair value is defined as the price that would be received for an asset or the exit price that would be paid to transfer a liability in the principal or most advantageous market in an orderly transaction between market participants on the measurement date.  The accounting guidance established a fair value hierarchy which requires an entity to maximize the use of observable inputs, where available.  This hierarchy prioritizes the inputs into three broad levels as follows.  Level 1 inputs are quoted prices (unadjusted) in active markets for identical assets or liabilities.  Level 2 inputs are quoted prices for similar assets and liabilities in active markets or inputs that are observable for the asset or liability, either directly or indirectly through market corroboration, for substantially the full term of the financial instrument.  Level 3 inputs are unobservable inputs based on the Company’s own assumptions used to measure assets and liabilities at fair value.  An asset or liability’s classification within the hierarchy is determined based on the lowest level input that is significant to the fair value measurement.

 

Assets and liabilities measured at fair value on a recurring and non-recurring basis consisted of the following at December 31, 2013 and 2014:

 

   Carrying Value at   Fair value Measurements at December 31, 2013 
   December 31, 2013   (Level 1)   (Level 2)   (Level 3) 
Embedded Conversion Option Liability  $281,265   $–   $–   $281,265 

 

   Carrying Value at   Fair value Measurements at December 31, 2014 
   December 31, 2014   (Level 1)   (Level 2)   (Level 3) 
Embedded Conversion Option Liability  $355,611   $–   $–   $355,611 

 

The following is a summary of activity of Level 3 liabilities for the period ended December 31, 2013 and 2014:

 

Balance at December 31, 2012  $456,073 
Increase in liability due to debt modification   – 
Change in fair value   (174,808)
Balance at December 31, 2013  $281,265 
Increase in liability due to debt modification   478,561 
Change in fair value   (404,215)
Balance December 31, 2014  $355,611 

  

Changes in fair value of the embedded conversion option liability are included in other income (expense) in the accompanying consolidated statements of operations.

 

The Company estimates the fair value of the embedded conversion liability utilizing the Black-Scholes pricing model, which is dependent upon several variables such as the expected term (based on contractual term), expected volatility of our stock price over the expected term (based on historical volatility), expected risk-free interest rate over the expected term, and the expected dividend yield rate over the expected term.  The Company believes this valuation methodology is appropriate for estimating the fair value of the derivative liability.  The following table summarizes the assumptions the Company utilized to estimate the fair value of the embedded conversion option at December 31, 2014 and 2013:

 

Assumptions December 31, 2014 December 31, 2013
Expected term 0.50 0.0
Expected Volatility 174% 134%
Risk free rate 0.66% 0.02%
Dividend Yield 0.00% 0.00%

  

There were no changes in the valuation techniques during 2014. The Company did however compute the valuation of this derivative liability using a binomial lattice model noting no material differences in valuation results. The weighted average interest rate for short term notes as of December 31, 2014 was 10%.