13. Borrowings

6 Months Ended

Jun. 30, 2015

Convertible Notes Payable

On September 12, 2011, Xtreme raised $2,360,000 in convertible notes (the “9/12 Notes”). The 9/12 Notes bear an interest rate of 12% per annum and matured on September 12, 2013. Under the convertible note agreements, the lender has the right to convert all or any part of the outstanding and unpaid principal and interest into shares of the Company’s Common Stock; provided however, that in no event shall the lender be entitled to convert any portion of the 9/12 Notes that would result in the beneficial ownership by it and its affiliates to be more than 9.99% of the outstanding shares of the Company’s Common Stock. The 9/12 Notes are convertible at a fixed conversion price of $0.28 per share. In addition, Xtreme issued warrants (the “Warrants”) to acquire 6,810,269 shares of the Company’s Common Stock at a strike price of $0.28 per share. The Warrants expire on September 12, 2016. The conversion price of the 9/12 Notes and Warrants will be reduced in the event the Company issues or sells any shares of Common Stock less than the conversion price.

Xtreme delayed scheduled payments on the 9/12 Notes for the seven months ending December 31, 2012. As a result the remaining 9/12 Notes totaling $151,466 as of June 30, 2015 remain in default.

The conversion features of the 9/12 Notes and Warrants are accounted for as derivative liabilities at the date of issuance and adjusted to fair value through earnings at each reporting date, due to anti-dilution reset features. The fair value was estimated on the date of grant using a binomial option-pricing model that incorporated the following weighted-average assumptions: expected dividend yield of 0%; expected volatility of 290%; risk-free interest rate of 0.05% and an expected holding period of 24 months for the 9/12 Notes and 60 months for the Warrants. The resulting values, at the date of issuance, were allocated to the proceeds received and applied as a discount to the face value of the 9/12 Notes and Warrants. Xtreme recorded a derivative expense on the 9/12 Notes of $649,212 at inception and a further derivative expense on the Warrants of $2,431,437 at inception based on the guidance in ASC 815-10 and ASC 815-40-15 due to a reset feature on the exercise price.

On December 31, 2014, Massive recognized a derivative liability for the 9/12 Notes and Warrants of $56,263, $0 in redemptions and no change in fair value for the three and six month periods ended June 30, 2015 resulting in a derivative liability of $56,263 at June 30, 2015.

On December 31, 2013, Massive recognized a derivative liability for the 9/12 Notes and Warrants of $63,747 at December 31, 2014, $0 in redemptions and no change in fair value for the three and six month periods ended June 30, 2015, resulting in a derivative liability of $63,747 at June 30, 2015.

As of June 30, 2015 and December 31, 2014, the balance of the 9/12 Notes is $151,466.

On May 1, 2014, in connection with the acquisition of Wunderkind (See Note 3 - Acquisitions), the Company issued the Wunderkind Note in the amount of $5,500,000, plus interest of 0.5% compounded annually. All outstanding and unpaid principal, together with any then unpaid and accrued interest and other amounts payable thereunder are due and payable at the option of the holder, subsequent to May 1, 2015, unless this Wunderkind Note is previously converted. Pursuant to section 2.1 of the Wunderkind Note, Wunderkind will have the right to convert all or part of the outstanding principal on the note into a number of shares of the Company Common Stock equal to 45% of the total shares of Company common stock issued and outstanding on a fully diluted basis (or the appropriate pro rata amount, in case of conversion of part of the outstanding principal) on the date of conversion.

The conversion features of the Wunderkind Note are accounted for as derivative liabilities at the date of issuance and adjusted to fair value through earnings at each reporting date, due to anti-dilution reset features as well as the feature that provides for conversion into a variable number of shares equal to 45% of the total amount of outstanding shares, on a diluted basis. The fair value was estimated on the date of grant using a Monte Carlo valuation model that has been updated to incorporate the following weighted-average assumptions as of June 30, 2015: expected volatility of 70%; risk-free interest rate of 0.28%, an expected life of the option to convert in years of 1.0 and an expected expiration date of June 30, 2016. The resulting values were allocated to the dilutive and non-dilutive conversion features. The resulting values were allocated to the dilutive and non-dilutive conversion features. The Company recorded a gain on change in fair value on the Wunderkind Note of $388,000 and $1,796,000 for the three and six month period ended June 30, 2015, respectively, due to a change in fair value of the convertible features. As of June 30, 2014 the fair value was estimated using a Monte Carlo valuation model that has been updated to incorporate the following weighted-average assumptions: expected volatility of 70%; risk-free interest rate of 0.11%, an expected life of the option to convert in years of 0.8 and an expected expiration date of May 1, 2015. The Company recorded a gain on change in fair value on the Wunderkind Note of $2,019,000 for the three and six month period ended June 30, 2014.

On April 24, 2015, the Company entered into a First Amendment to Convertible Promissory Note (the “Amendment”), which amends the Wunderkind Note. The Amendment provides that until the Wunderkind Note is paid in full, the note holder will have the right to convert all or part of the outstanding principal of the note into a number of shares of the Company’s common stock equal to 45% of the total shares of common stock issued and outstanding on a fully-diluted basis on the date of conversion. Additionally, the Amendment provides that the note holders may convert the accrued interest under the note into common stock at the same ratio as the principal bears to the 45% at the same time as the conversion of principal.

As of June 30, 2015 and December 31, 2014, the balance of the Wunderkind Note is $5.5M and $5.5M.

On March 23, 2015, the Company closed on private offerings of secured convertible promissory notes (each a “March 2015 Note” and collectively, the “March 2015 Notes”) in the aggregate amount of $636,310 to multiple investors including the Company’s Chairman of the Board of Directors and Chief Executive Officer (Ron Downey) and Chief Creative Officer (Derek Ellis). The offerings, made pursuant to note subscription agreements, represent initial closings in the Company’s private placement of up to $2,000,000 (the “Original Private Placement”).

On May 28, 2015, the Company revised the terms of the Original Private Placement. While the Original Private Placement is still for an aggregate of up to $2,000,000, it includes sales of both revised secured convertible promissory notes (each a “Revised Note” and collectively, the “Revised Notes”) and warrants for that number of shares of Company common stock (the “May 2015 Warrant Shares”) equal to five times the amount of the Revised Notes (each a “May 2015 Warrant” and collectively, the “May 2015 Warrants”) pursuant to note and warrant subscription agreements (the “Note and Warrant Subscription Agreements”). The Note and Warrant Subscription Agreements contain certain customary representations and warranties.

On May 28, 2015, each of the investors in the Original Private Placement, entered into an Exchange Agreement whereby all outstanding principal and accrued but unpaid interest under their March 2015 Notes were exchanged and converted into the Revised Notes and corresponding May 2015 Warrants (Revised Note for an equivalent of $526,085 and May 2015 Warrant for 2,630,425 shares of Company common stock for Mr. Downey, and a Revised Note for an equivalent of $77,939 and May 2015 Warrant for 389,693 shares of Company common stock for Mr. Ellis). In addition, on May 28, 2015, the Company closed on the equivalent of a total of $371,505 in Revised Notes and 1,857,523 May 2015 Warrants to other investors including, among others, the Company's Chief Financial Officer (Antaine Furlong) and Senior Vice President, People, Culture and Operations (Monique Ellis).

The Revised Notes are secured by a first priority lien on all the Company’s assets pursuant to a security agreement among the Company and the Revised note holders. The Revised Notes bear interest at an annual rate of 12% and mature on the first to occur of (the “Maturity Date”) (i) certain change in control transactions (each a “Deemed Liquidation Event”), (ii) the closing of the next issuance and sale of capital stock of the Company resulting in gross proceeds to the Company of at least $2,000,000 (a “Qualified Financing”), and (iii) the date that is 60 days after the Revised Note holder gives written notice to the Company demanding payment in full.

In the event of a Deemed Liquidation Event, the Company will pay each Revised Note holder an additional purchase premium equal to 100% of the principal amount of such holder’s Revised Note. In the event any of the Revised Notes remain outstanding and unpaid after the Maturity Date, the Company will pay the Revised Note holder monthly liquidated damages payments equal to 1% of the original principal amount of the Revised Note for each month that such Revised Note remains unsatisfied, up to a cap of 12%. If not sooner repaid, as of the close of business on the day immediately preceding the closing of a Qualified Financing, each Revised Note holder will have the option to convert the principal and accrued but unpaid interest on their Revised Note into shares of the securities sold in the Qualified Financing at a 20% discount to the lowest price paid by any investor in the Qualified Financing.

The 2015 Warrants are exercisable for $0.08 per Warrant Share. Each May 2015 Warrant vests 50% on November 28, 2015 and 50% on May 28, 2016 if on each such date the May 2015 Warrant holder has not made demand for payment on the holder’s Revised Note. Each May 2015 Warrant fully vests upon a sale of the Company and if demand is made on the Revised Note, the unvested portion of each May 2015 Warrant immediately terminates. The fair value of the May 2015 Warrants was estimated at May 28, 2015 using a Black-Scholes option pricing model that incorporated the following weighted-average assumptions: expected volatility of 70%; risk-free interest rate of 1.51%, and an expected term of 5 years. The resulting value was allocated to the May 2015 Warrants in the amount of $189,000.

The conversion feature of the Revised Notes are accounted for as a derivative liability at fair value on the date of issuance and accreted into the convertible note at each reporting date, due to the feature that provides for conversion into a variable number of shares upon the occurrence of a Qualified Financing. The fair value was estimated at May 28, 2015 using a Monte Carlo valuation model that incorporated the following weighted-average assumptions: expected volatility of 70%; risk-free interest rate of 0.26%, an expected life to convert in years of 1.0 and the likelihood of a Qualified Offering of 60%. The resulting value, was allocated to the conversion feature on the date the note was revised in the amount of $233,000. The conversion feature was then reduced through accretion into the convertible note through quarter end, resulting in a June 30, 2015 derivative liability balance of $216,817.

As of June 30, 2015 the balance of the Revised Notes is $986,119.

The following tables illustrate the fair value adjustments that were recorded related to the derivative financial instruments associated with the convertible debenture financings:

	June 30, 2015
Derivative liability	December 31, 2014		New Borrowings		Fair Value Adjustments			Adjustments		Total
March 2015 note conversion feature	$	-	$	144,000	$	-		$	72,817	$	216,817
Orbach warrant liability		16,390		-		(8,250	)		-		8,140
Wunderkind conversion feature		2,434,000		-		(2,184,000	)		-		250,000
9/12 Warrant liability		63,747		-		-			-		63,747
9/12 Note liability		56,263		-		-			-		56,263
	$	2,570,400	$	144,000	$	(2,192,250	)	$	72,817	$	594,967

The derivative income of $2,192,250, included within the Consolidated Income Statement, is the net result of $0 in redemptions and warrant expense, and fair value adjustments of $2,192,250.

Short-term borrowings

On October 24, 2014, the Company entered into a Note and Warrant Purchase Agreement with Gil Orbach (the “Investor”) to issue a $1,000,000 in principal amount promissory note and warrants to purchase an aggregate of 100,000 shares of common stock, $0.001 par value per share of the Company (the “Common Stock”). The note bears interest at a rate of 10.0% per annum and will mature on October 24, 2015. The note holds first precedence with regard to any other creditors, instruments, or contractual obligations of the Company, and cannot be subordinated without the written approval of the Investor. In the event that a party other than Investor or his affiliate (which specifically includes any entity controlled by Zachary Venegas or Scott Ogur) acquires 20% or more of the equity or assets of the Company (a “Change in Control”), the Investor may demand that the principal and interest for one year shall become immediately due and payable. The warrants expire three years after their initial issuance date and may be exercised for a purchase price equal to $0.25 per share of Common Stock, subject to customary antidilution adjustments. In the event of a Change in Control, the exercise price of the warrant shall reset to $0.05 per share and the number of shares of Common Stock underlying the warrant shall increase to 550,000.

As of June 30, 2015 and December 31, 2014, the balance of the Orbach Note is $1M and $1M, respectively.

Massive Interactive, Inc. 10-Q