Note 7 - Debt Financing

Credit Facility – Avidbank

On May 22, 2014, the Company amended its revolving credit facility with Avidbank. The new renewable revolving maturity date is May 21, 2016. The facility provides up to $1 million in financing against eligible receivables and subject to meeting certain covenants including an asset coverage ratio test for up to two years. The material terms of the amended revolving credit facility are as follows:

As of December 28, 2014, the outstanding balance on the line of credit was $0. For the three months ended December 28, 2014, the total interest expense against the outstanding line of credit balance was $5 thousand due to the minimum interest requirement in the credit terms.  For the three months ended December 29, 2013, the total interest expense against the outstanding line of credit balance was $8 thousand.

Issuance of Convertible Notes

On November 17, 2014, Optex Systems Holdings entered into a Subscription Agreement (the “Agreement”) to sell up to $2.1 million principal amount of convertible promissory notes (“Notes”) to several accredited investors (the “Investors”) in a private placement pursuant to which the Investors purchased a series of Notes with an aggregate principal amount of $1,550 thousand. An additional convertible promissory note for $10 thousand was issued to the placement agency in consideration for placement services on the transaction. The terms are consistent for each of the notes issued as follows:

Pursuant to a Registration Rights Agreement, of even date, between the Company and the Investors, Optex Systems Holdings is obligated to file a registration statement with the Securities and Exchange Commission (“SEC”) registering the shares underlying the Notes for public resale by January 17, 2015 and cause such registration statement to be effective by March 17, 2015.  The Company is subject to certain liquidated damages in the event it does not satisfy such obligations and other obligations under such Registration Rights Agreement.

All of the noteholders have waived the Company’s obligations to file a registration statement by January 17, 2015 and to effect a reverse split of its common stock by February 17, 2015.

Sileas Corp., the controlling shareholder of Optex Systems Holdings, also entered into a Make Whole Agreement, of even date, with the Investors for the benefit of the Company, pursuant to which, unless and until Optex Systems Holdings’ common stock is listed on the NASDAQ Capital Market, it will make payment to the investors of interest on the Notes, on any date on which interest is due and payable under the Notes, from the date of payment until the maturity date of the Notes. There is no corresponding agreement between Sileas and Optex Systems Holdings, and thus no related party transaction.

The securities sold to the investors were not registered under the Securities Act of 1933, as amended (the “Securities Act”), or the securities laws of any state, and were offered and sold in reliance on the exemption from registration afforded by Section 4(a)(2) under the Securities Act and/or Regulation D promulgated thereunder and corresponding provisions of state securities laws, which exempt transactions by an issuer not involving any public offering. The Investors are “accredited investors” as such term is defined in Regulation D promulgated under the Securities Act. 

Optex incurred $74 thousand in debt issuance costs, for investment banking, legal and placements fee services, inclusive of the $10 thousand supplemental convertible note issued for placement fees. These costs are reflected the balance sheet and cash flow statement as debt issuance costs and are amortized to interest expense across the term of the notes based on the effective interest method. For the three months ending December 28, 2014 the amortized interest expense related to debt issuance costs was $5 thousand and the unamortized debt issuance costs was $69 thousand.

Conversion Feature Derivative

Optex Systems Holdings reviewed the convertible note features in relation to the applicable GAAP standards and determined that the conversion option did not meet the criteria as a freestanding financial instrument under the scope of ASC 480-10, as the conversion option was not entered into separately from the notes and was not separately exercisable from the notes. Based on guidance within FASB ASC 815 “Derivatives and Hedging” and subtopic ASC 815-15 “Embedded Derivatives” the company determined that the convertible notes were hybrid instrument whereas the conversion feature attached to the notes was an embedded derivative which was not closely and clearly related to the debt, as the changes in the fair value of the convertible stock and the interest rates on the debt were based on different economic factors. Under subtopic ASC 815-40“Contracts in Entity’s own Equity”, it was further determined that the conversion option was not indexed to the Company’s own stock due to the anti-dilution protection which provided for a full ratchet reset of the conversion price. Based on the review, it was determined that the conversion feature of the notes required bifurcation from the debt host, the notes, and separately treated as a derivative liability on the balance sheet and measured at fair value pursuant to FASB ASC 820-10-35-37 “Fair Value in Financial Instruments”.

The derivative liabilities are recognized in the consolidated balance sheet at fair value and marked to market on each conversion and reporting period. The estimated fair value of the derivative liabilities is calculated using the Monte Carlo simulation model and such estimates are revalued at each balance sheet date, with changes in fair value charged to other income or expense.

The convertible notes were valued at note issuance and as of December 28, 2014 with the following assumptions:

The recommended fair value for the derivative liabilities related to the convertible notes at issuance and as of December 28, 2014 is as follows:

As of December 28, 2014, the conversion feature was valued on the balance sheet as a derivative liability of $6,127 thousand. For the three months ending December 28, 2014, the change in fair value of $847 thousand was recorded in other expenses as a change in fair value for derivatives.

A summary of the total expenses reflected in the consolidated statement of operations related to the convertible notes for the three months ending December 28, 2014 is as follows:

As of November 17, 2014, at note inception, the fair market value of the conversion derivative exceeded the value of the convertible notes, thus a debt discount equal to the face value of the notes was established at ($1,560) thousand and the beginning note balance net of the discount was zero. The debt discount is amortized across the life of the notes using the effective interest method. As of December 28, 2014 the note balance was $1,560, the unamortized debt discount was ($1,527) and the convertible notes payable (net of discount) is reflected as $33 thousand on the balance sheet.