Quarterly report pursuant to Section 13 or 15(d)

Convertible Note and Long-Term Debt

v3.20.2
Convertible Note and Long-Term Debt
9 Months Ended
Sep. 30, 2020
Debt Disclosure [Abstract]  
Convertible Note And Long-term Debt CONVERTIBLE NOTES AND LONG-TERM DEBT
Convertible notes and long-term debt consist of the following:
September 30, 2020 December 31, 2019
Convertible Note, at fair value —  39,020,000 
Convertible Note II, at fair value 121,817,001 
Long-term debt 1,411,000  — 
Less current portion (122,679,279) (19,620,000)
Convertible notes and long-term debt, net of current portion $ 548,722  $ 19,400,000 

High Trail Convertible Note II
Background
On July 16, 2020, the Company issued a $70.0 million par value convertible note (the“Convertible Note II” or “Note II”) due July 1, 2023. The Company has elected to account for Note II using the fair value option allowed under GAAP. Interest is payable quarterly beginning October 1, 2020 at a rate of 4.5% per annum. The Convertible Note II is initially convertible at a rate of $19.00 per share, subject to change for anti-dilution adjustments and adjustments for certain corporate events.
The Convertible Note II is a senior secured obligation of the Company secured by substantially all assets of the Company and ranks senior to all unsecured debt of the Company. Any principal repayment of Note II is at 110% of the par value. Beginning October 1, 2020, the holder of the Convertible Note II may require the Company to redeem up to $3.9 million par value. Subject to certain limitations, the Company can pay some or all of the redemption in cash or shares of common stock.
The fair value of the Convertible Note II as of September 30, 2020 was $121.8 million and the contractual principal balance was $70.0 million. In electing the fair value option, the Company recognizes changes in fair value related to changes in credit risk, if any, in other comprehensive income and the remaining change in fair value in interest expense. For the three and nine months ended September 30, 2020, the fair value of the Convertible Note II increased $52.9 million, which is recorded in interest expense.
The primary reason for electing the fair value option is for simplification and cost-benefit considerations of accounting for the Convertible Note II at fair value in its entirety versus bifurcation of the embedded derivatives. The significant inputs to the valuation of the Convertible Note at fair value are Level 3 inputs since they are not observable directly. The fair value of Note II as of September 30, 2020 was determined using the subsequent settlement cost of the note. The settlement cost is calculated
as the number of shares issued in exchange for the Note II multiplied by the closing price of Workhorse common stock on October 13, 2020, which was $23.63 per share.
Subsequent Activity
On October 14, 2020, the Company exchanged the full $70.0 million outstanding principal amount of the Convertible Note II at a premium for approximately 5.2 million shares of common stock.
High Trail Convertible Note

Current Activity
The fair value of the Convertible Note (the “Convertible Note”) as of September 30, 2020 and December 31, 2019 was zero and $39.0 million, respectively, and the contractual principal balance as of September 30, 2020 and December 31, 2019 was zero and $40.5 million, respectively. In electing the fair value option, the Company recognizes changes in fair value related to changes in credit risk, if any, in other comprehensive income and the remaining change in fair value in interest expense. Fair value adjustments for the nine months ended September 30, 2020 were approximately $74.1 million, which included a $1.1 million adjustment to other comprehensive income attributed to changes in credit risk and a $75.2 million adjustment to interest expense. The change related to credit risk was primarily caused by an increase in credit rating yield for comparable companies during the first quarter of 2020.
During the three months ended September 30, 2020, $18.5 million par value of the Convertible Note was converted to 6.1 million shares of common stock resulting in a loss of $14.9 million, which is recorded in interest expense. During the nine months ended September 30, 2020, the remaining $40.5 million par value of the Convertible Note was converted in full to 14.4 million shares of common stock, resulting in a loss of $35.9 million, which is recorded in interest expense.
Background
On December 9, 2019, the Company issued a $41.0 million par value Convertible Note due November 2022, with a stated interest rate of 4.5% per annum. The Company elected to account for the Convertible Note using the fair value option allowed under GAAP. Interest is payable quarterly beginning February 1, 2020. The Convertible Note is initially convertible at a rate of $3.05 per share subject to change for anti-dilution adjustments for certain corporate events.
Any principal repayment of the Convertible Note is at 112% of the par value. Beginning March 1, 2020, the holder of the Convertible Note may require the Company to redeem up to $1.5 million par value (“Redemption Payment”) of the Convertible Note monthly. Subject to certain limitations, the Company at its discretion can pay some or all of Redemption Payment in cash or shares of common stock.
The Convertible Note is a senior secured obligation of the Company secured by substantially all assets of the Company and ranks senior to all unsecured debt of the Company. The Convertible Note contains certain covenants, including that we maintain a minimum of $8.0 million of liquidity, calculated as unrestricted, unencumbered cash and cash equivalents.
The primary reason for electing the fair value option is for simplification and cost-benefit considerations of accounting for the Convertible Note (the hybrid financial instrument) at fair value in its entirety versus bifurcation of the embedded derivatives. The significant inputs to the valuation of the Convertible Note at fair value are Level 3 inputs since they are not observable directly. The fair value was determined using a binomial lattice valuation model, which is widely used for valuing convertible notes. The significant assumptions used in the model are the credit spread and volatility of the Company's common stock.
The Convertible Note was originally issued with 15.5 million warrants to purchase common stock of the Company at an initial exercise price of $3.05. The Convertible Note and the warrants were determined to be freestanding instruments and were accounted for separately. The warrants were only exercisable at the option of the Company following the full or partial redemption of the Convertible Note. The percentage of the warrants exercisable upon full or partial redemption of the Convertible Note is equal to a percentage of the original principal amount redeemed at such time. Therefore, as the principal balance of the Convertible Note was fully converted during the period, the number of warrants exercisable as of September 30, 2020 is zero.
Paycheck Protection Program Term Note
On April 14, 2020, the Company entered into a Paycheck Protection Program Term Note (“PPP Term Note” or the “Note”) with PNC Bank, N.A. (“PNC”) under the Paycheck Protection Program of the recently enacted Coronavirus Aid, Relief, and Economic Security Act ("CARES Act"). The Company received total proceeds of $1.4 million from the PPP Term Note, which is due on April 13, 2022. In accordance with the requirements of the CARES Act, the Company used the proceeds primarily for payroll costs. Interest accrues on the Note at the rate of 1.0% per annum. The Company may apply to PNC for forgiveness of the amount due on the Note which shall be an amount equal to the sum of payroll costs, mortgage interest, rent obligations and covered utility payments incurred during the eight weeks following disbursement on the Note.
Neither principal nor interest shall be due or payable during the period from April 14, 2020 through the six-month anniversary of the date of the Note. On November 15, 2020, the outstanding principal of the Note that is not forgiven shall convert to an amortizing term loan and shall be due and payable in equal monthly installments until April 13, 2022. Additionally, on November 15, 2020, all accrued interest that is not forgiven shall be due and payable.
The Company has elected to account for the PPP Term Note as debt and will accrue interest over the term of the Note. During the three and nine months ended September 30, 2020, the Company did not make any repayments or apply for forgiveness of any amount due on the Note.
As of October 30, 2020, the Company applied for forgiveness of the full amount due on the Note.

Purchase Warrants

In December 31, 2018, the Company entered into a Credit Agreement (the "Credit Agreement"), with Marathon Asset Management, LP. In conjunction with entering into the Credit Agreement, the Company issued Common Stock Purchase Warrants (“Initial Warrants”) to purchase 8.1 million shares of common stock at an exercise price of $1.25 per share. The Credit Agreement was paid in 2019. Until December 31, 2020, the Company must issue additional Warrants to the Lenders equal to 10%, in the aggregate, of any additional equity issuances on substantially the same terms and conditions of the Initial Warrants, except that (i) the expiration date shall be five years from the issuance date, (ii) the exercise price shall be equal to 110% of the issuance price per share in the relevant issuance, and (iii) the holder shall be entitled to exercise the warrant on a cashless basis at any time.

The Initial Warrants are classified as liability financial instruments and required to be marked-to-market at each balance sheet date with a corresponding charge to interest expense. The Initial Warrants were exercised during the nine months ended September 30, 2020, resulting in the issuance of 8.1 million shares of common stock. The Initial Warrants were marked-to-market at each exercise date, which resulted in a charge to interest expense of $12.2 million for the nine months ended September 30, 2020. As of September 30, 2020 and December 31, 2019, the warrant liability for the Initial Warrants was zero and $16.3 million, respectively. Any additional warrants issued in connection with the Credit Agreement have been classified as equity instruments and are not required to be marked-to-market at each balance sheet date.