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 March 29, 2015, the outstanding balance on the line of credit was $550 thousand. For the three and six months ended March 29, 2015, the total interest expense against the outstanding line of credit balance was $5 thousand and $10, respectively, due to the minimum interest requirement in the credit terms.  For the three and six months ended March 30, 2014, the total interest expense against the outstanding line of credit balance was $1 thousand and $8 thousand, respectively.

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 in 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 and six months ending March 29, 2015 the amortized interest expense related to debt issuance costs was $5 thousand and $69 thousand, respectively.

On March 26, 2015, Optex Systems Holdings filed a Certificate of Designation with respect to its Certificate of Incorporation to authorize a series of preferred stock known as “Series B Preferred Stock” under Article FOURTH thereof, with 1010 shares of Series B Preferred Stock issuable thereunder. The amendment was approved by the Company’s Board of Directors under Article FOURTH of its Certificate of Incorporation, as amended.  The stated value of each share of Series B Preferred Stock is $1,629.16, and each share of Series B Preferred Stock is convertible into shares of the Company’s common stock at a conversion price of $0.0025. Holders of the Series B Preferred Stock receive preferential rights in the event of liquidation to other classes of preferred and common stock of the Company other than the Company’s Series A Preferred Stock. Additionally, the holders of the Series B Preferred Stock are entitled to vote together with the common stock and the Series A Preferred Stock on an “as-converted” basis.

On March 29, 2015, the holders of the Company’s $1,560,000 principal amount of convertible promissory notes, issued on or about November 17, 2014, converted the entire principal amount thereof and all accrued and unpaid interest thereon, into 1,000 shares of the Company’s Series B Preferred Stock.

Conversion Feature Derivative

Optex Systems Holdings reviewed the convertible note features in relation to guidance within FASB ASC 815 “Derivatives and Hedging” and subtopic ASC 815-15 “Embedded Derivatives” and determined that 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. The company further concluded that the conversion feature of the notes required bifurcation from the notes for separate treatment 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 March 29, 2015 with the following assumptions:

The fair value for the derivative liabilities related to the convertible notes at issuance and as of March 29, 2015 is as follows:

As of March 29, 2015, due to the exchange of convertible notes for Series B preferred stock, the conversion feature was valued on the balance sheet as a derivative liability of $0 thousand. For the three months and six months ending March 29, 2015, a change in fair value of ($847) thousand and $0 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 six months ending March 29, 2015 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. There were no conversions on the notes during the three or six month period ending March 29, 2015. Due to the conversion of the notes to Series B preferred stock as of March 29, 2015, the debt discount and note balance was $0, respectively, and the unamortized debt discount was $0 on the balance sheet. During the three and six months ending March 29, 2015, note interest expense, based on the stated rate of 12% per annum, was $23 thousand and $46 thousand, respectively. The debt issuance cost expensed as interest during the three and six months ended March 29, 2015 was $4 thousand and $70 thousand, respectively. As of March 29, 2015 the unamortized balance related to the debt issuance cost was $0 on the balance sheet.