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6. CONVERTIBLE DEBT | 12 Months Ended
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Dec. 31, 2016
Notes to Financial Statements |
NOTE 6. CONVERTIBLE DEBT | In November 2012, we initiated a private placement offering a maximum of 240 Units (as defined below) of our securities at a price of $25,000 per Unit or $6,000,000. The initial closing of the offering occurred in April 2013 as the bulk of the net proceeds of the offering were to be allocated for the asset purchase from L-3 Applied Technologies, Inc., which was finalized April 2013. Each Unit consisted of $25,000 par amount of a 10% Senior Secured Callable Convertible Promissory Note due and payable on July 31, 2015 (the “Notes”) and 37,500 warrants each of which allows the investor to purchase one share of common stock and expires on July 31, 2018. Interest was payable on the Notes at a rate of 10% per annum, and payable on July 31st and January 31st. The Notes were secured by our intellectual property such as the patents, royalties, receivables of the Company and all equipment except for the new equipment acquired with the proceeds from any future financing that is initially secured by this new equipment. The Notes called for the establishment of a sinking fund. Within 45 days of each calendar quarter 15% of the Company’s reported revenue was required to be deposited into the Company’s escrowed sinking fund account. We sold 202.96 Units for gross proceeds of $5,074,000 and issued warrants to purchase up to 7,611,000 shares of common stock in connection with the Units. Net proceeds amounted to $4,462,693 after expenses of offering totaling $611,307. In addition, the placement agent received warrants to purchase up to 1,014,800 shares of common stock valued at $165,180. The Notes were convertible, at the option of the note holder, into shares of our common stock at an initial conversion price of $0.29 (which conversion price is subject to adjustment upon the occurrence of events specified in the Notes, including stock dividends, stock splits, certain fundamental corporate transactions, and certain issuances of common stock by the Company). The warrants are exercisable into shares of common stock (the “Warrant Shares”) at an initial exercise price of $0.30 (which may be subject to certain adjustments as set forth in the warrants). We evaluated the warrants under ASC 815-40-15 due to the exercise price being adjustable upon certain events occurring. We determined that the warrants are considered indexed to our own common stock and thus meet the scope exception under FASB ASC 815-10-15-74 and are therefore not considered a derivative. The estimated fair value of the warrants, which contain reset provisions, were calculated using the Monte Carlo valuation model. We recorded the warrants’ relative fair value of $956,712 as an increase to additional paid in capital and a discount against the related debt. The Notes contained a provision whereby the conversion price is adjustable upon the occurrence of certain events, including the issuance of common stock or common stock equivalents at a price which is lower than the current conversion price. Under FASB ASC 815-40-15-5, the embedded conversion feature was not considered indexed to the Company’s own common stock and, therefore, did not meet the scope exception in FASB ASC 815-10-15 and thus needed to be accounted for as a derivative liability. The initial fair value of the embedded conversion feature was estimated at $7,316,092 and recorded as a derivative liability, resulting in an additional discount of $4,117,288. The fair value of the embedded conversion feature was estimated at the end of each quarterly reporting period using the Monte Carlo model. Inherent in the Monte Carlo Valuation model are assumptions related to expected volatility, remaining life, risk-free rate and expected dividend yield. For the Notes using a Monte Carlo model, we estimate the probability and timing of potential future financing and fundamental transactions as applicable. We applied various assumptions into the Monte Carlo Valuation models to determine the change in the fair value of the derivative liability as of the retirement dates of the Notes. The debt discount was amortized over the life of the convertible note using the effective interest method and was fully amortized upon the retirement of the convertible notes during the quarter ended June 30, 2015. In June 2015, we offered the noteholders options to convert to cash or at a reduced conversion price on the Notes from $0.29 per share provided the conversion feature was exercised prior to June 30, 2015. If the noteholder agreed to lock up the converted shares for six (6) months or an uplist to a market on the NYSE or NASDAQ Stock Market, LLC, whichever is shorter, the conversion price was reduced to $0.26 per share. Absent the lock up, the noteholder could convert at $0.275 per share. All noteholders except two converted at $0.26. Pursuant to the terms of the conversion offer, an aggregate of $3,774,000 of the Notes and $124,000 of accrued interest were converted into 14,913,968 shares of our common stock. We recognized an induced conversion cost of $930,383 related to all conversions and retirements. In addition, during the quarter ended June 30, 2015, an aggregate of $1,300,000 of the Notes and $87,500 in accrued interest were repaid in the form of cash. Convertible Notes The assumptions used in the Monte Carlo Models are as follows:
|  | June 30, |  |
|  | 2015 |  | Inception
Closing stock price |  | $ | 0.55–0.64 |  |  | $ | 0.13–0.55 |
Conversion price |  | $ | 0.29 |  |  | $ | 0.29 |
Expected volatility |  |  | 125% |  |  |  | 185%–190% |
Remaining term (years) |  |  | 0.09–0.11 |  |  |  | 2.30–2.07 |
Risk-free rate |  |  | 0.00% |  |  |  | 0.25%–0.43% |
Expected dividend yield |  |  | 0% |  |  |  | 0% |
Warrants
|  | Inception
Closing stock price |  | $ | 0.13–0.55
Conversion price |  | $ | 0.30
Expected volatility |  |  | 250%
Remaining term (years) |  |  | 5.30–5.09
Risk-free rate |  |  | 0.76%–(1.61%)
Expected dividend yield |  |  |  | 0%

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