Note 5 – Convertible Notes Payable

Convertible notes payable consisted of the following:

A. Notes Payable Issued for Cash

As part of the Company’s financing activities, the Company issued convertible notes payable in exchange for cash. These notes payable were unsecured, bear interest at a rate of 10% per annum, mature in nine months up to one year from the date of issuance, and are convertible to common stock at an average conversion rate of $3.40 per share, subject to certain beneficial ownership limitations (with a maximum ownership limit of 4.99%) and standard anti-dilution provisions. As of December 31, 2020, the outstanding balance of these notes amounted to $24,085,000.

In January 2021, the Company issued similar notes payable in exchange for cash of $1,205,000. On February 16, 2021 in accordance with the note agreements upon completion of the equity offering discussed in Note 7, these notes were mandatorily converted at a conversion rate of $3.40 per share into 7,438,235 shares of the Company’s common stock.

B. Notes Payable Issued for Settlement Agreements

In fiscal 2019 and 2020, the Company issued its convertible notes payable to resolve claims and disputes pertaining to certain debt and equity instruments issued by the Company in prior years. The notes were unsecured, bear interest at a rate of 10%, mature in nine months up to one year from the date of issuance, and are convertible to common stock at a conversion rate of $3.40 per share, as adjusted, subject to certain beneficial ownership limitations (with a maximum ownership limit of 4.99%) and standard anti-dilution provisions. As of December 31, 2020, outstanding balance of these notes payable for settlement agreements amounted to $2,528,000.

On February 16, 2021 in accordance with the note agreements upon completion of the equity offering discussed in Note 7, these notes were mandatorily converted at a conversion rate of $3.40 per share into 743,529 shares of the Company’s common stock.

C. Notes Payable Issued for Forbearance Agreements

On June 23, 2020, the Company entered into Standstill and Forbearance Agreements (collectively, the “Forbearance Agreements”) with the holders of $13.2 million aggregate principal amount of the Convertible Notes (the “Default Notes”), which were in default. Pursuant to the Forbearance Agreements, the holders of the Default Notes agreed to forbear from exercising their rights and remedies under the Default Notes (including declaring such Default Notes (together with any default amounts and accrued and unpaid interest) immediately due and payable) until the earlier of (i) the date that the Company completes a future financing in the amount of $15 million and, in connection therewith, commences listing on NASDAQ (collectively, the “New Financing”) or (ii) January 31, 2021 (the “Termination Date”). As of December 31, 2020, outstanding balance of the notes payable amounted to $3,849,000.

On February 16, 2021 in accordance with the note agreements upon completion of the equity offering discussed in Note 7, these notes were mandatorily converted at a conversion rate of $3.40 per share into 1,132,059 shares of the Company’s common stock.

D. Notes Payable issued for Consulting Agreements

In prior years, the Company issued its convertible notes payable in exchange for consulting services. These notes payable are unsecured, bear interest at a rate of 10% per annum, mature in nine months up to one year from the date of issuance, and are convertible to common stock at an average conversion rate of $3.40 per share, subject to certain beneficial ownership limitations (with a maximum ownership limit of 4.99%) and standard anti-dilution provisions. As of December 31, 2020, outstanding balance of these notes payable amounted to $360,000.

In January 2021, the Company issued similar notes payable of $720,000 in exchange for consulting services. In addition, the Company also issued a note payable of $525,000 in exchange for the cancellation of unpaid consulting fees that was recorded as part of accrued expenses as of December 31, 2020.

On February 16, 2021 in accordance with the note agreements upon completion of the equity offering discussed in Note 7, these notes in the aggregate amount of $1,605,000 were mandatorily converted at a conversion rate of $3.40 per share into 472,059 shares of the Company’s common stock.

As of December 31, 2020, the Company accrued interest of $4,838,000 related to these convertible notes payable. During the period ended September 30, 2021, the Company accrued interest of $696,000. As a result of the mandatory conversion of the Company’s notes payable, on February 16, 2021, total accrued interest amounted to $5,527,000 were converted to 1,627,647 shares of common stock.

As a result, total notes payable of $33,272,000 and accrued interest of $5,527,000 for a total of $38,799,000 were mandatorily converted to 11,413,322 shares of common stock.

Adoption of ASU 2020-06

In fiscal 2020, the Company recorded a note/debt discount of $4,745,000 to account for the beneficial conversion feature that existed on the date of issuance for the above convertible notes payable. The debt discount is being amortized to interest expense over the term of the corresponding convertible notes payable. At December 31, 2020, the Company had recorded an unamortized note/debt discount of $4,519,000.

On January 1, 2021 the Company chose to adopt Accounting Standards Update (“ASU”) 2020-06, Debt-Debt with Conversion and Other Options (Subtopic 470-20) and Derivatives and Hedging-Contracts in Entity’s Own Equity (Subtopic 815-40): Accounting for Convertible Instruments and Contracts in an Entity’s Own Equity. Under ASU 2020-06, the embedded conversion features are no longer required to be separated from the host contract for convertible instruments with conversion features that are not required to be accounted for as derivatives under Topic 815, or that do not result in substantial premiums accounted for as paid-in capital.

As a result of the adoption of ASU 2020-06, the Company extinguished the previously recorded debt discount of $4,745,000 by charging the opening additional paid in capital at January 1, 2021. In addition, the Company also adjusted accumulated deficit to account for the derecognition of the $226,000 interest expense due to the amortization of the debt discount that was recorded in fiscal 2020. As a result of these adjustments, the unamortized debt discount of $4,519,000 was extinguished.