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| XCHC.OB > SEC Filings for XCHC.OB > Form 10-Q on 20-Aug-2008 | All Recent SEC Filings |
20-Aug-2008
Quarterly Report
Readers are cautioned not to place undue reliance on these forward-looking
statements, which reflect management's analysis only as of the date hereof. The
Company does not undertake any obligation to publicly revise these
forward-looking statements to reflect events or circumstances that arise after
the date hereof. Readers should carefully review the risk factors described in
other documents the Company files from time to time with the Securities and
Exchange Commission.
Risk Factors
An investment in our common stock is highly speculative, involves a high degree
of risk, and should be made only by investors who can afford a complete loss.
You should carefully consider the information in this report along with the risk
factors disclosed in our Form 10-KSB for the year ended December 31, 2007,
including our financial statements and the related notes, and our prior filings
of Form 10-QSB before you decide to buy or continue to hold our common stock.
Recent Developments: Going Concern and Liquidity Problems
Our auditors have included an explanatory paragraph in their audit opinion with
respect to our consolidated financial statements at December 31, 2007. The
paragraph states that our recurring losses from operations and resulting
continued dependence on access to external financing raise substantial doubt
about our ability to continue as a going concern. Furthermore, the factors
leading to and the existence of our going concern status may adversely affect
our relationship with customers and suppliers and have an adverse effect on our
ability to obtain financing.
We do not have sufficient working capital to sustain our operations. We have
been unable to generate sufficient revenues to sustain our operations. We will
have to continue to obtain funds to meet our cash requirements through business
alliances or financial transactions with third parties, the sale of securities
or other financing arrangements, or we may be required to curtail our
operations, seek a merger partner, or seek protection under federal bankruptcy
laws. Any of the foregoing may be on terms that are unfavorable to us or
disadvantageous to existing stockholders. In addition, no assurance may be given
that we will be successful in raising additional funds or entering into business
alliances.
The Company has incurred substantial costs in maintaining its status as a
reporting public company including dealing with recent SEC reviews. The Company
has also incurred substantial costs associated with raising capital for its
continued operations. Management is considering ways to reduce these costs on an
on-going basis.
The Company closed an additional convertible debt financing of $1.8 million on
July 10, 2008 as more fully discussed below. This financing does not provide
sufficient capital to alleviate concerns regarding our ability to continue as a
going concern.
The Company is considering alternatives with respect to its intellectual
property in areas outside the oil and gas industry including its GenuDot system.
In evaluating these technologies, the company may consider readdressing the
marketplace, joint ventures or outright sales of the technology.
Results of Operations
The Company generated revenues of $35,372 and $698,448 in the quarter ended
June 30, 2008 and 2007 respectively. Revenues were $378,979 and $1,014,501 in
the six months ending June 30, 2008 and 2007, respectively. The decrease in
revenues was primarily due to the completion of the down-hole tool project in
early 2008.This project provided the bulk of the revenues of the Company in 2007
and was not extended or replaced upon completion.
Research and development cost decreased to $218,929 from $597,543 for the three
months ended June 30, 2008 and 2007 respectively. Research and development
expenses were $471,015 and $851,039 for the six months ended June 30, 2008 and
2007 respectively. This reduction reflects the wind down of our efforts on the
Hexion tool though additional efforts have been put into the development of SAW
(surface acoustic wave) applications which are not yet producing revenue.
Sales and marketing expenses were $50,900 and $39,055 for the three months ended
June 30, 2008 and 2007 respectively. These costs were $120,199 for the first six
months of 2008 and $102,460 for the same period of 2007. The increase was
primarily a result of increased allocation of salaries due to focus of executive
time. These costs have increased primarily due to our thrust into the oil and
gas industry which have increased in 2008. We expect to continue to increase
sales and marketing efforts in the future as our planned products get closer to
commercialization.
General and administrative expenses decreased to $335,647 in the three months
ended June 30, 2008 from $513,337 for the same period in 2007. These costs
decreased to $762,365 in the first six months of 2008 from $1,130,372 in the
same comparable period of 2007. The decrease is primarily due to reduced salary
costs as we have lowered Company head count.
The Company's interest expense increased to $285,537 for the three months ended
June 30, 2008 from $123,258 for the same period in 2007. Interest expense was
$560,477 for the six month period ending June 30, 2008 versus $241,086 in the
same period for 2007. Interest expense has increased substantially due to two
financings completed in the second half of 2007. The increase is primarily due
to the amortization of convertible note discounts treated as interest for
accounting purposes. This non-cash charge amounted to $221,280 for the three
months ended June 30, 2008 versus $96,573 for the same period in 2007. These
non-cash charges were $442,740 in the first six months of 2008 versus $193,145
in the same period of 2007.
Liquidity and Capital Resources
During the first six months of 2008, our operations were financed primarily by a
financing arrangement closed on December 4, 2007. At June 30, 2008, we had a
working capital deficit of $1,349,969. A significant note payable with a
principal amount of $797,794 matured on August 14, 2008. The Company is in
technical default under this note and is in negotiation with the note holder to
extend the terms of this financing. However, the Company has no assurances that
an extension or restructuring of this note can be accomplished.
Cash Flows
Our operations generated losses in 2007 and continued to generate losses in the
first six months of 2008. Our cash decreased by $728,881 during the six months
ended June 30, 2008 with operating activities using $658,654 of cash. This
compares with cash utilization from operations of $555,035 for the six months
ended June 30, 2007.
There were no cash flows from investing activities during the first six months
of 2008 whereas we had $840 of cash utilization from investing activities in the
six months ended June 30, 2007.
Cash flows from financing activities for the six months ending June 30, 2008
reflect a $16,000 prepayment on our La Jolla financing and financing costs of
$54,227 on our SIJ financing (see below). For the same period in 2007 we show
proceeds from a private placement of stock in the amount of $700,000 and the
payment of short term notes in the amount of $120,000.
Our working capital requirements depend on many factors including contract
extensions and new contracts. However, our primary source of working capital at
this time comes from securing investment financing. If losses continue as we
expect, we will have to obtain additional funds to meet our ongoing business
requirements.
2007 PPM Financing
During 2007, the Company raised $1,117,500 pursuant to a private placement of
its common stock ("2007 PPM"). As part of the documentation of the 2007 PPM, we
have agreed to file a registration statement with the Securities and Exchange
Commission covering the shares of common stock and the warrants provided in this
transaction. We have not yet initiated the registration process due to resource
limitations and a change in regulations affecting holding periods for restricted
stock transactions.
Convertible Debt Financing - Melissa Note
On August 15, 2006, the Company executed a long-term Promissory Note ("Melissa
Note") with Melissa CR 364 Ltd., a Texas limited partnership ("Melissa Ltd.")
providing a $1,000,000 line of credit. Melissa Ltd. is managed by a former
officer and shareholder. The principal balance of the note is $797,794 at
June 30, 2008 and the Company has agreed not to draw any further amounts on this
facility. The Melissa Note is now classified as a short term obligation of the
Company with principal and any remaining accrued interest due upon expiration,
August 14, 2008.
The Melissa Note bears interest at 10% per annum, payable quarterly. The Company
has pledged 100% of the outstanding common stock of AirGATE as security for this
obligation. At the discretion of Melissa Ltd, the Melissa Note may be converted
into restricted common stock of the Company at any time at a conversion rate
equal to $0.825 per share of the Company's common stock.
Convertible Debt Financing - La Jolla Debentures
During 2007, the Company entered into a Securities Purchase Agreement with La
Jolla Cove Investors, Inc. ("La Jolla") providing for two convertible debentures
totaling $400,000 ("Debentures") with two corresponding sets of non-detachable
warrants ("Warrants") totaling 4,000,000 shares with an exercise price of $1.00.
The Debentures accrue interest at 61/4 % until converted or the expiration of
their three year term.
The Debentures and Warrants have mandatory conversion features that became
effective in the first quarter of 2008. Unless action is taken by the Company,
La Jolla is obliged to convert an average of 10% of the face value of the
Debentures each month into a variable number of shares of the Company's common
stock. The variable number of shares is determined by a formula where the dollar
amount of the Debentures being converted is multiplied by eleven, minus the
product of the conversion price multiplied by ten times the dollar amount of the
Debentures being converted, all of which is then divided by the conversion
price. The conversion price is equal to the lesser of (i) $1.00, or (ii) 80% of
the average of the 3 lowest volume weighted average prices during the twenty
trading days prior to the conversion election. Provisions exist whereby the
Company can elect prepayment to prevent conversion if the trading price falls
below specified levels, generally $0.30 per share. Under certain provisions, if
La Jolla does not convert an average of at least 5% of the face value of the
Debentures, the Company may prepay portions of the Debentures. If La Jolla
converts a portion of the Debentures, a proportionate amount of the Warrants
must be similarly exercised.
During the first six months of 2008, the Company exercised its rights to prevent
La Jolla from converting its Debentures and elected to prepay $16,000 of the
obligation in doing so (along with additional interest and penalties). The
Company anticipates receiving additional conversion request notifications from
La Jolla. If the Company continues to prevent these conversions from occurring
by initiating pro-rata prepayment of the Debentures, the program would represent
a substantial cash requirement for the Company.
Convertible Debt Financing - SIJ Financing
On December 4, 2007, the Company entered into a Securities Purchase Agreement
("SPA") with Samson Investment Company ("Samson"), Ironman PI Fund (QP), LP
("Ironman"), and John Thomas Bridge & Opportunity Fund, LP ("Opportunity Fund")
("SIJ Investors"). In addition to the SPA, with each of the SIJ Investors, the
Company also entered into a Senior Secured Convertible Term Note-Tranche A
("Tranche A Notes") and a Tranche A Warrant ("Tranche A Warrants"). The Company,
the SIJ Investors and Tejas Securities Group, Inc. ("Tejas") also executed a
Registration Rights Agreement ("RRA"). Finally, the Company and the Investors
executed a Security Agreement and a Guaranty Agreement. Pursuant to the SPA, the
SIJ Investors agreed to provide us with a total of $3.6 million in two
$1.8 million tranches, Tranche A and Tranche B. On December 4, 2007, Tranche A
was closed.
Subsequent to the quarter ended June 30, 2008, we closed on the Tranche B
financing and received $1.8 million from the SIJ Investors. As more fully
disclosed on the Form 8-K we filed with the SEC on July 10, 2008, due to market
considerations, the Tranche B financing terms were materially renegotiated from
those set forth in the SPA.
The Tranche B Notes obligate the Company to repay to the SIJ Investors the
aggregate principal amount of $1.8 million, together with interest at 8% per
annum. Principal on these notes is due five years after issuance. Interest on
the notes accrues and is payable quarterly, although the Company has the option
to add accrued and unpaid interest to the outstanding principal amount of the
notes. The Tranche B Notes are convertible at the option of the Investors at a
conversion price of $0.07. An automatic conversion feature also exists at this
same conversion price, and is applicable upon the Company's achieving certain
commercialization milestones. As additional consideration for the Tranche B
Notes, the Company issued 16,714,286 common shares to the SIJ Investors and
300,000 shares (which may increase to 500,000 if the contract is extended to
December 2008) to a designated financial advisor.
The Company also issued warrants as partial consideration for placement services
in arranging both tranches of the SIJ financing. In this regard, the Company
issued, or committed to issue, warrants for the purchase of up to 4,169,000
shares of X-Change common stock at prices ranging from $0.07 to $0.60 per share.
All shares of the Company's common stock issued or issuable to the SIJ
investors, as well as shares issuable to Tejas upon exercise of their warrant
rights, are subject to the RRA. Pursuant to the RRA, the Company agreed to
register all such shares upon request of an SIJ Investor, provided that no
demand may be made within 180 days of the date of the closing.
The obligations of the Company under the SIJ Financings are secured by a lien on
and security interest in all of AirGATE Technology Inc.'s assets as well as a
guarantee by AirGATE.
Going Concern
In connection with our Form 10-KSB for the year ended December 31, 2007, our
Independent Registered Public Accountants included a paragraph in their opinion
that referred to doubts about our ability to continue as a going concern.
Several conditions and events cast doubt concerning the Company's ability to
continue as a going concern. The Company is dependent upon the expected cash
flow of ongoing development contracts, and requires additional financing in
order to fund its business activities on an ongoing basis. The Company has taken
steps to provide additional financing to the Company and is actively in
discussions with a number of capital sources. While management believes that the
actions already taken or planned may mitigate the adverse conditions and events
which raise doubt about the validity of the going concern assumption used in
preparing these financial statements, there can be no assurance that these
actions will be successful or that the Company will have sufficient funds to
continue its operations.
Off-Balance Sheet Arrangements
The Company does not have any off-balance sheet arrangements.
Item 4T Controls and Procedures
The Company's chief executive officer and chief financial officer are
responsible for establishing and maintaining disclosure controls and procedures
for the Company.
(a) Evaluation of Disclosure Controls and Procedures
Under the supervision and with the participation of our management, including
our principal executive officer and chief financial officer, we evaluated the
effectiveness of the design and operation of our disclosure controls and
procedures, as defined in Rules 13a-15(e) and 15d-15(e) under the Securities
Exchange Act of 1934 ("Exchange Act"), as of September 30, 2007. In making this
assessment, management used the framework set forth in the report entitled
Internal Control-Integrated Framework issued by the Committee of Sponsoring
Organizations of the Treadway Commission, or COSO. The COSO framework summarizes
each of the components of a company's internal control system, including (i) the
control environment, (ii) risk assessment, (iii) control activities,
(iv) information and communication, and (v) monitoring. Based on this
evaluation, our principal executive officer and our chief financial officer
concluded that, as of the end of the period covered by this report, our
disclosure controls and procedures were not effective and not adequately
designed to ensure that the information required to be disclosed by us in the
reports we submit under the Exchange Act is recorded, processed, summarized and
reported within the time periods specified in the applicable rules and forms and
that such information was accumulated and communicated to our chief executive
officer and chief financial officer, in a manner that allowed for timely
decisions regarding required disclosure.
Based on our evaluation, management has concluded that our internal control over
financial reporting was not effective as of June 30, 2008. Management has
determined that (i) we are unable to maintain the proper segregation of various
accounting and finance duties because of our small size and limited resources,
(ii) much of the financial closing process is done off-line on electronic
spreadsheets that are maintained on individual computers and (iii) based on our
staffing limitations, we rely on our Chief Financial Officer to provide a
significant amount of our compensating controls.
The Company will continue to periodically assess the cost versus benefit of
adding the resources that would improve segregation of duties and additional
accounting resources necessary to assure adequate compliance. Currently, with
the concurrence of the board of directors, the Company does not consider the
benefits to outweigh the costs of adding additional staff in light of the
limited number of transactions related to the Company's operations.
(b) Changes in Internal Controls
During the period ended June 30, 2008, there was no change in internal control
over financial reporting that has materially affected, or is reasonably likely
to materially affect our internal control over financial reporting.
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