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XGTI > SEC Filings for XGTI > Form 10-K on 6-Mar-2014All Recent SEC Filings

Show all filings for XG TECHNOLOGY, INC.

Form 10-K for XG TECHNOLOGY, INC.


6-Mar-2014

Annual Report


Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations

The following information should be read in conjunction with the financial statements and the notes thereto contained elsewhere in this report.

The share numbers in the following discussion reflect a 1-for-25 reverse stock split that we effected March 24, 2013 as well as the 1-for-1.4 reverse stock split that we effected March 28, 2013.

Overview

xG Technology, Inc. has developed a broad portfolio of innovative intellectual property that we believe will enhance wireless communications. Our intellectual property is embedded in proprietary software algorithms that offer cognitive interference mitigation and spectrum access solutions.

Our strategy is initially to commercialize our intellectual property portfolio by developing and selling network equipment using our proprietary software algorithms to offer cognitive interference mitigation and spectrum access solutions. In the future, our strategy is for our intellectual property to be embedded by partners in a semiconductor chip that could be sold to third party equipment manufacturers and inserted in their devices and to license our intellectual property to other customers in vertical markets world-wide. Our technology roadmap currently projects this transition to begin in 2016.

The implementation of our cognitive radio intellectual property is xMax. We believe the xMax system, represents the only commercially available cognitive radio network system that is designed to include interference mitigation by spatial processing. xMax implements our proprietary interference mitigation software that can increase capacity on already crowded airwaves by improving interference tolerance, enabling the delivery of a comparatively high Quality of Service where other technologies would not be able to cope with the interference.

We believe that the xMax system will also, when in a future development operating on more than one radio channel, deliver dynamic spectrum access by scanning and finding unused or underused frequencies (unlicensed as well as licensed) and dynamically tuning to them, significantly increasing their usable capacity.

Our system is frequency agnostic although currently designed to operate within the 902 - 928 MHz license-free band. xMax is intended to serve as a mobile voice over internet protocol ("VoIP") and broadband data system that utilizes an end-to-end Internet Protocol ("IP") system architecture. The xMax product and service suite includes a line of access points, network bridges, mobile switching centers, network management systems, deployment tools, and customer support. The xMax system will allow mobile operators to utilize free, unlicensed 902 - 928 MHz ISM band spectrum (which spectrum is available in most of the Americas) instead of purchasing scarce expensive licensed spectrum. Our xMax system will also enable enterprises to set up a mobile communications network in an expeditious and cost effective manner. In addition, we believe that our xMax cognitive radio technology can also be used to provide additional capacity to licensed spectrum by identifying and utilizing unused bandwidth within the licensed spectrum.

Plan of Operations

We are executing on our sales and marketing strategy and have entered into agreements both direct with end-customers as well as with indirect channel network partners. These customer engagements primarily relate to two of our target markets in rural telecommunications and defense. Together, they comprise commitments to purchase xMax cognitive radio networking equipment, engineering services and other hardware worth approximately $34.6 million.


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Result of Operations

The following table sets forth the relationship to total revenues of principal items contained in the statement of operations of the financial statements included herewith for the fiscal years ending December 31, 2013 and December 31, 2012.

xG TECHNOLOGY, INC.
                            STATEMENTS OF OPERATIONS
                 (IN THOUSANDS EXCEPT NET LOSS PER SHARE DATA)

[[Image Removed]]                            [[Image Removed]]      [[Image Removed]]
                                                   For the Year Ended December 31,
                                                     2013                   2012
Revenue                                      $           406        $             -
Cost of revenue and operating expenses
Cost of components and personnel                         102                      -
General and administrative expenses                    5,501                  5,543
Development                                            5,468                  4,806
Stock based compensation                                 796                    554
Amortization and depreciation                          2,370                  2,063
Total cost of revenue and operating                   14,237                 12,966
expenses
Loss from operations                                 (13,831 )              (12,966 )
Other income (expense)
Other expense                                        (10,068 )
Inducement expense                                      (391 )
Interest expense, net                                 (2,227 )                 (535 )
Impairment                                              (933 )                 (286 )
Total other income (expense)                         (13,619 )                 (821 )
Loss before income tax provision                     (27,450 )              (13,787 )
Income tax provision                                       -                      -
Net loss                                     $       (27,450 )      $       (13,787 )
Basic and diluted net loss per share                   (2.86 )                (2.29 )
Weighted average number of shares                      9,598                  6,031
outstanding basic and diluted

Revenue

Our revenues for the fiscal year ended December 31, 2013 were $0.4 million compared to $0.0 million in fiscal 2012. The revenue of $323,000 resulted from sales of equipment and $83,000 from engineering and consulting services agreement.

Cost of Revenue and Operating Expenses
Cost of Components and Personnel

Cost of components and personnel was $0.1 million in the year ended December 31, 2013 compared to $0.0 million in fiscal 2012 as the Company recorded no revenue and thus no cost of components and personnel in the year ending December 31, 2012. Cost of components and personnel of $98,000 is based on the cost of components and the time allocated to building the products sold and $4,000 is based on the cost of the time allocated towards the engineering and consulting services agreements.

General and Administrative Expenses

General and administrative expenses are the expenses of operating the business on a daily basis and include salary and benefit expenses and payroll taxes, as well as the costs of trade shows, marketing programs, promotional materials, professional services, facilities, general liability insurance, and travel. General and administrative expenses remained the same at $5.5 million in the year ended December 31, 2013 and 2012, respectively. We had a decrease in payroll expense through an adjustment to the fair market value of the


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accrued bonus which was offset by an increase in a variety of expenses. Over time, we expect our administrative expenses to increase in absolute dollars due to continued growth in headcount to support our business and operations as a public company.

Development

Development expenses consist primarily of salary and benefit expenses and payroll taxes, as well as costs for prototypes, facilities and travel. Development increased $0.7 million, or 14%, from $4.8 million in the year ended December 31, 2012 to $5.5 million in the year ended December 31, 2013.

The increases are due to additional costs related to producing and testing equipment as the Company's products became available for sale on September 30, 2013. Over time, we expect our development costs to increase as we continue making significant investments in developing new products and working on enhancement of our technology with existing products.

Stock Based Compensation

Stock based compensation increased $0.3 million, or 45%, from $0.5 million in the year ended December 31, 2012 to $0.8 million in the year ended December 31, 2013. The increase arose from the increase in the number of employees and directors of the Company who received option grants in fiscal 2013.

We had approximately $1.2 million of unrecognized stock-based compensation expense related to unvested stock options, net of estimated forfeitures, as of December 31, 2013, which we expect to be recognized over the next three years.

Amortization and Depreciation

Amortization and depreciation expenses increased $0.3 million, or 14.3%, from $2.1 million in the year ended December 31, 2012 to $2.4 million in the year ended December 31, 2013. The increase is attributed to the xMax products becoming available for sale as of September 30, 2013. As of this date, the Company began to amortize all capitalized costs associated with these products for the remainder of the year. The Company did not take amortization on these products during 2012.

Other Income (Expense)

Other expenses were $13.6 million and $0.8 million for the year ended December 31, 2013 and 2012, respectively. Approximately $10.1 million of the increase is a result of the independent directors of the Company authorizing a onetime agreement on September 30, 2013, whereby we issued to MBTH 1,599,453 shares of our common stock and a warrant to purchase 1,363,636 shares of our common stock at an exercise price of $6.87 per share for the difference in price between the shares issued to them in March 2013 at a price of $13.30 per share in exchange for the conversion of its 2011 Convertible Note and the $5.50 purchase price for shares sold in our initial public offering in July 2013. Additionally, the Modified Strike Price, agreed upon between the Company and MBTH in January 2013, of $13.30 per share for the two options representing 571,428 underlying shares granted to MBTH in February 2011 has been lowered to $5.50.

Inducement expense for the year ended December 31, 2013 was $0.4 million. The inducement expense represents the estimated fair value of warrants given to non-related parties in relation with the conversion of the Bridge Loan.

Interest expense for the year ended December 31, 2013 was $2.2 million compared to $0.5 million for the year ended December 31, 2012, an increase of $1.7 million or 316%. The increase was partially due to the higher interest and fees incurred on the Bridge Loan for 2013 compared to the May 2011 Convertible note in 2012; the fee was amortized over a shorter period of one year based on the contractual obligation of the Bridge Loan; $0.7 million from the six month minimum interest recorded in connection with the increase interest rate; $0.4 million from the accretion of the debt discount recorded as interest expense; and $0.6 million in interest expense resulted from the Bridge Loan being convertible into new shares at 95% of the price of any future equity financing due to the difference between the IPO price of $5.50 and $5.225 in 2013.

Impairment charges for the year ended December 31, 2013 was $896,000 for property & equipment and $37,000 for intangible assets. For the year ended December 31, 2012, $18,000 was related to intangible assets and $268,000 for property & equipment.


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Net Loss

For the year ended December 31, 2013, the Company had a net loss of $27.5 million, as compared to a net loss of $13.8 million for the year ended December 31, 2012, or an increase of $13.7 million. The increase in net loss is due mainly to the one-time agreement with MBTH and increases of inducement expense and interest expenses discussed above.

Deferred Revenue - Related Party

On October 16, 2013, the Company completed the first delivery of our xMax comprehensive cognitive radio system, shipping equipment required to fulfill the $155,000 purchase order that was received from rural broadband provider Walnut Hill Telephone Company on November 26, 2012. Larry Townes is Chairman of Townes Tele-Communications, Inc., the parent company of Walnut Hill Telephone Company. Given that Larry Townes is a director of xG Technology, the sale of equipment to Walnut Hill Telephone Company is considered to be a related party transaction. Due to Walnut Hill Telephone Company waiting for the equipment to meet certain technical specifications, the revenue from this transaction is considered deferred revenue as of December 31, 2013.

On December 16, 2013, the Company sold our xMax comprehensive cognitive radio system to Haxtun Telephone Company for $301,000 to fulfill a purchase order that was received on November 24, 2012. Larry Townes is Chairman of Townes Tele-Communications, Inc., the parent company of Haxtun Telephone Company. Given that Larry Townes is a director of xG Technology, the sale of equipment to Haxtun Telephone Company is considered to be a related party transaction. Due to Haxtun Telephone Company waiting for the equipment to meet certain technical specifications, the revenue from this transaction is considered deferred revenue as of December 31, 2013.

Liquidity and Capital Resources

Our operations primarily have been funded through cash generated by financing. Cash comprises cash in hand and demand deposits. Our cash balances were as follows:

[[Image Removed]] [[Image Removed]] [[Image Removed]] December 31, 2013 $'000 2012 $'000 Cash 5,517 271

Our operations primarily have been funded through cash generated by debt and equity financing. During 2013, the Company relied upon additional investment through proceeds from the IPO, Second Offering, Bridge Loan and convertible notes payable.

We have incurred net losses of $27.5 million and $13.8 million in the years ended December 31, 2013 and 2012, respectively. Additionally, we have incurred negative operating cash flows including cash used in operations of $14.4 million and $5.6 million in the years ended December 31, 2013 and 2012, respectively. Of the $14.4 million, approximately 10.1 million was a result of the independent directors of the Company authorizing a onetime agreement on September 30, 2013, whereby we issued to MBTH 1,599,453 shares of our common stock and a warrant to purchase 1,363,636 shares of our common stock at an exercise price of $6.87 per share for the difference in price between the shares issued to them in March 2013 at a price of $13.30 per share in exchange for the conversion of its 2011 Convertible Note and the $5.50 purchase price for shares sold in our initial public offering in July 2013.

Our future capital requirements may vary materially from those currently planned and will depend on many factors, including our rate of revenue growth, the timing and extent of spending to support development efforts, the timing of new product introductions, market acceptance of our products and overall economic conditions. The ability of the Company to continue as a going concern is dependent upon its ability to raise additional capital, obtain other means of financing, and to fulfill its existing backlog. As of March 6, 2014, the Company has a total backlog of $34.6 million. The ability to recognize revenue and ultimately cash receipts, on the existing backlog is contingent upon, but not limited to, acceptable performance of the delivered equipment and services.


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Initial Public Offering

On July 24, 2013, the Company closed its initial public offering of 1,337,792 shares of common stock, par value $0.00001 per share, and warrants to purchase 668,896 shares of common stock, at a purchase price to the public of $5.50 per share and $0.01 per warrant, for net proceeds to the Company, after deducting underwriter discounts and offering expenses, of $6,750,673. The warrants have an exercise price of $6.87 per share, are exercisable immediately and will expire five years from the date of issuance. Feltl and Company and Aegis Capital Corp acted as joint underwriters for the offering.

Over-allotment Option

On August 19, 2013, the underwriters exercised in full their over-allotment option to purchase an additional 200,668 shares of common stock and warrants to purchase 100,334 shares of common stock with an exercise price of $6.87, at a purchase price to the public of $5.50 per share and $0.01 per warrant, for net proceeds to the Company, after deducting underwriter discounts, of $1,027,349.

Convertible Notes Payable

During the year ended December 31, 2013, the Company drew down $450,000 under the convertible notes payable to related party, compared to $10.3 million for 2012. On January 16, 2013, principal in excess of $15 million and any accrued interest and fees related to the Convertible notes were converted into the Bridge Loan balance discussed below.

Bridge Loan

During 2013, the Company drew down $5.0 million under the Bridge Loan. On August 22, 2013, the Company refinanced approximately $1,013,000 of liabilities previously paid by MBTH during 2013 on behalf of the Company through the Bridge Loan and incurred an origination fee of approximately $50,000. On August 7, 2013, the Company repaid $125,000 to a non-related investor for investment into the Bridge Loan.

On August 22, 2013, the Company issued 2,187,529 common shares for the conversion of the balance of approximately $11,429,000 in principal and accrued interest and fees at a price per share of $5.225.

Secondary Offering

On November 18, 2013, the Company closed its secondary public offering of 5,715,000 shares of common stock, par value $ 0.00001 per share, at a purchase price to the public of $1.75 per share, for net proceeds to the Company, after deducting underwriter discounts and offering expenses, of $9,146,888. In connection with the offering, the Company issued warrants to the underwriters to purchase 171,450 shares of common stock, for an aggregate price of $100. The warrants have an exercise price of $2.1875 per share and are exercisable immediately and will expire five years from the date of issuance.

Over-allotment Option

On December 12, 2013, the underwriters made a partial exercise of their over-allotment option in which they purchased an additional 255,000 shares of common stock at a purchase price to the public of $1.75 per share, for net proceeds to the Company, after deducting underwriter discounts, of $415,013. The underwriters had an option to purchase up to 857,250 shares of common stock or 15% of the total number of shares offered within 45 days after the closing of the Offering.

Cash Flows

The following table sets forth the major components of our statements of cash
flows data for the periods presented.

[[Image Removed]]           [[Image Removed]]              [[Image Removed]]
                            Year Ended December 31, 2013   Year Ended December 31, 2012
                                       $'000                          $'000
Net cash used in                         (14,395 )                       (5,561 )
operating activities
Net cash used in                          (2,896 )                       (5,006 )
investment activities
Net cash inflow from                      22,537                         10,705
financing activities
Net increase in cash                       5,246                            138


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Operating Activities

Net cash used in operating activities for the year ended December 31, 2013 totaled $14.4 million as compared to $5.6 million for the year ended December 31, 2012. Of the $14.4 million, approximately 10.1 million was a result of the independent directors of the Company authorizing a onetime agreement on September 30, 2013, whereby we issued to MBTH 1,599,453 shares of our common stock and a warrant to purchase 1,363,636 shares of our common stock at an exercise price of $6.87 per share for the difference in price between the shares issued to them in March 2013 at a price of $13.30 per share in exchange for the conversion of its 2011 Convertible Note and the $5.50 purchase price for shares sold in our initial public offering in July 2013. The cash used in operating activities consisted principally of the net loss from operations.

Investing Activities

Net cash used in investing activities for the year ended December 31, 2013 was $2.9 million as compared to $5.0 million for the year ended December 31, 2012. This represents capital expenditures primarily associated with the investment in product and technology development and our patent portfolio.

We have invested in product and technology development and our patent portfolio, with $2.6 million accounted for as investment in intangible assets in the year ended December 31, 2013, and $4.5 million in the year ended December 31, 2012. In addition, the Company's investment in property and equipment, comprising the purchase of testing and manufacturing equipment, of $0.3 million in the year ended December 31, 2013 decreased by $0.2 million, or 43%, from $0.5 million in the year ended December 31, 2012.

Financing Activities

Our net cash provided by financing activities for the year ended December 31, 2013 was $22.5 million as compared to $10.7 million for 2012, which primarily consisted of proceeds from further advances under convertible promissory notes issued by the Company and proceeds from issuance of common stock. The Company raised $7.8 million through the IPO and IPO over allotment, $9.6 million through the second offering and second offering over allotment, drew down $5.0 million under the Bridge Loan and $0.5 million under the convertible notes payable to related party during 2013. Also note holders converted the May 2011 shareholders note of $15 million and the Bridge Loan of $11.4 million during 2013.

During the year ended December 31, 2012, net financing activities consisted primarily of proceeds from further advances under the May 2011 Shareholder Loan. Proceeds from convertible promissory notes issued to MBTH under the May 2011 Shareholder Loan totaled $10.3 million. Proceeds from the issuance of new shares amounted to $0.4 million.

Subsequent Events

The cancellation of the Company's common stock on the London Stock Exchange's AIM Market became effective January 3, 2014. On December 20, 2013, the shareholders approved the cancellation of admission to trading the Company's common stock on the London Stock Exchange's AIM Market.

On January 7, 2014, the Company received $1,350,000 from MBTH. As of December 31, 2013, this amount was recorded as a due from a related party.

Off-Balance Sheet Arrangements

As of December 31, 2013 and 2012 we had no off-balance sheet arrangements.

Recent Accounting Pronouncements

The Company does not believe that recently issued accounting pronouncements will have a material impact on its financial statements.

Critical Accounting Policies and Estimates

Critical accounting estimates are those that management deems to be most important to the portrayal of our financial condition and results of operations, and that require management's most difficult, subjective or complex judgments, due to the need to make estimates about the effects of matters that are inherently uncertain. We have identified our critical accounting estimates which are discussed below.


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Use of Estimates

The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, disclosures of contingent assets and liabilities at the date of the financial statements and revenue and expenses during the reporting period. Actual results could differ from those estimates. The Company's significant estimates include the valuation of stock based charges and the valuation of inventory reserves.

Accounts Receivable

The Company extends credit to its customers. Accounts receivable are recorded at the invoiced amount and do not bear interest. The allowance for doubtful accounts is the Company's best estimate for the amount of probable credit losses in the Company's existing accounts receivable. The Company establishes an allowance of doubtful accounts based upon factors surrounding the credit risk of specific customers and other information. Receivable balances are reviewed on an aged basis and account balances are charged off against the allowance after all means of collection have been exhausted and the potential for recovery is considered remote. The Company does not require collateral on accounts receivable.

Intangible Assets

Capitalized software costs incurred in the design and development of software for sale to others as a separate product or embedded in a product and sold as part of the product as a whole are charged to expense until technological feasibility is established, and amortized on a straight-line basis over five years, beginning when the products are offered for sale or the enhancements are integrated into the products. Management is required to use its judgment in determining whether capitalized software costs meet the criteria for immediate expense or capitalization, in accordance with GAAP. The unamortized capitalized costs of a computer software product are compared to the net realizable value of that product and any excess is written off.

The significant estimates and assumptions involved in determining the net realizable value of our capitalized software costs are the estimated future cash flows from the product which are the estimated future gross revenues reduced by the estimated future costs of completing the product including the costs of maintenance. These estimates are based upon anticipated results and trends including customer demand for the Company's products and the necessary skill level and man-hours needed to complete the products. The Company believes these estimates are reasonable under the current circumstances. The risk of material misstatement of these accounting estimates varies with the subjectivity associated with these estimates; including the assumption the Company has the know-how to create such products and the availability of relevant personnel to complete such products that customer's desire. By their nature, estimates are subject to an inherent degree of uncertainty. Actual results may differ from management's estimates.

Patent and licenses are measured initially at purchase cost and are amortized on a straight line basis over their useful lives which range between 18.5 to 20 years.

Revenue Recognition

The Company recognizes revenues when persuasive evidence of an arrangement exists, services have been rendered, the price is fixed and determinable, and collectability is reasonably assured. Revenues from management and consulting, time-and-materials service contracts, maintenance agreements and other services are recognized as the services are provided or at the time the goods are shipped . . .

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