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EX-32.1 - EXHIBIT 32.1 - XG SCIENCES INCs103790_ex32-1.htm
EX-31.1 - EXHIBIT 31.1 - XG SCIENCES INCs103790_ex31-1.htm

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington D.C. 20549

 

FORM 10-Q

 

x QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the quarterly period ended: June 30, 2016

or

¨ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the transition period from ______to______.

 

  XG SCIENCES, INC.  
  (Exact name of registrant as
specified in its
charter)
 

 

Michigan   333-209131   20-4998896
(State or other jurisdiction of
incorporation or organization)
  (Commission File No.)   (I.R.S. Employer Identification
No.)

 

3101 Grand Oak Drive

Lansing, MI 48911

 

(Address of principal executive offices) (zip code)

 

(517) 703-1110

(Issuer Telephone number)

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x No ¨

 

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes ¨ No x

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company filer. See definition of “accelerated filer” and “large accelerated filer” in Rule 12b-2 of the Exchange Act (Check one):

 

Large Accelerated Filer ¨ Accelerated Filer ¨ Non-Accelerated Filer ¨ Smaller Reporting Company x

 

Indicate by check mark whether the registrant is a shell company as defined in Rule 12b-2 of the Exchange Act. Yes ¨ No x

 

As of August 9, 2016, there were 1,155,548 shares outstanding of the registrant’s common stock.

 

 

 

  

XG SCIENCES, INC.

FORM 10-Q

JUNE 30, 2016

INDEX

 

PART I  
     
ITEM 1. FINANCIAL STATEMENTS 4
     
ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS 14
     
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK 21
     
ITEM 4. CONTROLS AND PROCEDURES 21
     
PART II  
     
ITEM 1. LEGAL PROCEEDINGS 21
     
ITEM 1A. RISK FACTORS 21
     
ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS 22
     
ITEM 3. DEFAULTS UPON SENIOR SECURITIES 22
     
ITEM 4. MINE SAFETY DISCLOSURES 22
     
ITEM 5. OTHER INFORMATION 22
     
ITEM 6. EXHIBITS 23
     
SIGNATURES 24

 

 Page 2 of 24 

 

  

FORWARD-LOOKING STATEMENTS

The information in this Quarterly Report on Form 10-Q contains “forward-looking statements” and information within the meaning of Section 27A of the Securities Act of 1933, as amended (the “Securities Act”), and Section 21E of the Securities Exchange Act of 1934, as amended (the “Exchange Act”) relating to XG Sciences, Inc., a Michigan corporation and its subsidiary, XG Sciences IP, LLC, a Michigan corporation (collectively referred to as “we”, “us”, “our”, “XG Sciences”, “XGS”, or the “Company”), which are subject to the “safe harbor” created by those sections. These forward-looking statements include, but are not limited to, statements concerning our strategy, future operations, future financial position, future revenues, projected costs, prospects and plans and objectives of management. The words “anticipates,” “believes,” “estimates,” “expects,” “intends,” “may,” “plans,” “projects,” “will,” “would” and similar expressions are intended to identify forward-looking statements, although not all forward-looking statements contain these identifying words. We may not actually achieve the plans, intentions or expectations disclosed in our forward-looking statements and you should not place undue reliance on our forward-looking statements. These forward-looking statements involve known and unknown risks and uncertainties that could cause our actual results, performance or achievements to differ materially from those expressed or implied by the forward-looking statements, including, without limitation, the risks set forth under the section entitled “Risk Factors” in Amendment No. 4 to our Registration Statement on Form S-1 (File No. 333-209131) as filed with the Securities and Exchange Commission (the “SEC”) on April 12, 2016, and declared effective on April 13, 2016.

 

 Page 3 of 24 

 

  

XG SCIENCES, INC.

CONDENSED CONSOLIDATED BALANCE SHEETS

 

   June 30,
2016
   December 31, 2015 
   (unaudited)     
ASSETS          
           
CURRENT ASSETS          
Cash  $959,787   $1,060,224 
Accounts receivable, less allowance for doubtful accounts of $10,000 at June 30, 2016 and December 31, 2015   48,483    54,413 
Inventories   216,409    229,034 
Other current assets   273,412    194,096 
    1,498,091    1,537,767 
Total current assets          
           
PROPERTY, PLANT AND EQUIPMENT, NET   3,336,428    3,753,248 
           
RESTRICTED CASH FOR LETTER OF CREDIT   195,351    195,206 
           
INTANGIBLE ASSETS, NET   447,532    411,789 
           
TOTAL ASSETS  $5,477,402   $5,898,010 
           
LIABILITIES AND STOCKHOLDERS’ DEFICIT          
           
CURRENT LIABILITIES          
Accounts payable and other liabilities  $1,075,784   $704,177 
Short-term promissory notes   363,968    497,324 
Current portion of capital lease obligations   209,647    178,487 
Total current liabilities   1,649,399    1,379,988 
           
LONG TERM LIABILITIES          
Long term portion of capital lease obligations   241,094    354,483 
Derivative liability - warrants   7,951,132    8,235,163 
Total long term liabilities   8,192,226    8,589,646 
           
TOTAL LIABILITIES   9,841,625    9,969,634 
           
STOCKHOLDERS’ DEFICIT          
Series A convertible preferred stock, 3,000,000 shares authorized, 1,814,976 and 1,800,696 shares issued and outstanding, liquidation value of $21,779,712 and $21,608,376 at June 30, 2016 and December 31, 2015, respectively   21,463,254    21,291,912 
Series B Preferred Stock, 1,500,000 shares authorized, 269,987 shares issued and outstanding, liquidation value of $4,319,792   3,651,533    3,651,533 
Common stock, no par value, 25,000,000 shares authorized, 1,122,173 and 836,544 shares issued and outstanding at June 30, 2016 and December 31, 2015, respectively   10,850,257    8,565,225 
Additional paid in capital   5,758,078    5,791,074 
Accumulated deficit   (46,087,345)   (43,371,368)
Total stockholders’ deficit   (4,364,223)   (4,071,624)
           
TOTAL LIABILITIES AND STOCKHOLDERS’ DEFICIT  $5,477,402   $5,898,010 

 

See notes to unaudited condensed consolidated financial statements.

 

 Page 4 of 24 

 

 

XG SCIENCES, INC.

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

FOR THE THREE AND SIX MONTHS ENDED JUNE 30, 2016 AND 2015 (unaudited)

 

   For the Three Months Ended
June 30,
   For the Six Months ended
 June 30,
 
   2016   2015   2016   2015 
                 
REVENUES                    
Product sales  $82,035   $81,008   $141,777   $118,313 
Grants   137,055    121,407    158,365    218,911 
Licensing revenue   25,000    25,000    50,000    50,000 
Total revenue   244,090    227,415    350,142    387,224 
                     
COST OF GOODS SOLD                    
Direct costs   25,020    30,667    57,052    52,668 
Unallocated manufacturing expenses   404,232    418,453    747,947    816,560 
Total cost of goods sold   429,252    449,120    804,999    869,228 
                     
GROSS LOSS   (185,162)   (221,705)   (454,857)   (482,004)
                     
OPERATING EXPENSES                    
Research and development   419,007    393,338    635,357    775,987 
Sales, general and administrative   625,381    1,089,107    1,721,603    2,135,971 
Total operating expenses   1,044,388    1,482,445    2,356,960    2,911,958 
                     
OPERATING LOSS   (1,229,550)   (1,704,150)   (2,811,817)   (3,393,962)
                     
OTHER INCOME (EXPENSE)                    
Incentive refund and interest income   24,073    27,173    48,223    51,628 
Interest expense   (101,196)   (545,858)   (184,997)   (1,056,685)
Gain from change in fair value of derivative liability – warrants   142,848    174,715    232,614    271,014 
Total other income (expense)   65,725    (343,970)   95,840    (734,043)
                     
NET LOSS  $(1,163,825)  $(2,048,120)  $(2,715,977)  $(4,128,005)
                     

WEIGHTED AVERAGE NUMBER OF SHARES OUTSTANDING –

Basic and diluted

   887,595    835,544    862,069    835,906 
                     
NET LOSS PER SHARE – Basic and diluted  $(1.31)  $(2.45)  $(3.15)  $(4.94)

 

See notes to unaudited condensed consolidated financial statements.

 

 Page 5 of 24 

 

  

XG SCIENCES, INC.

CONDENSED CONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDERS’ (DEFICIT) (unaudited)

FOR THE SIX MONTHS ENDED JUNE 30, 2016

 

    Preferred stock (A)     Preferred stock (B)     Common stock     Additional
paid-in
     Accumulated        
    Shares     Amount     Shares     Amount     Shares     Amount     capital     deficit     Total  
Balances, December 31, 2015     1,800,696     $ 21,291,912       269,987     $ 3,651,533       836,544     $ 8,565,225     $ 5,791,074     $ (43,371,368 )   $ (4,071,624 )
Stock issued for cash     -       -       -       -       285,629       2,285,032       -       -       2,285,032  
Stock issuance fees and expenses     -       -       -       -       -       -       (336,600)       -       (336,600)  
Reclassification of Derivative Liability Warrants to Equity     -       -       -       -       -       -       51,418       -       51,418  
Warrants issued with Bridge Financings     -       -       -       -       -       -       24,060       -       24,060  
Preferred stock issued to pay capital lease obligations     14,280       171,342       -       -       -       -       -       -       171,342  
Stock based compensation expense     -       -       -       -       -       -       228,126       -       228,126  
Net loss     -       -       -       -       -       -       -       (2,715,977)       (2,715,977 )
Balances, June 30, 2016     1,814,976   $ 21,463,254       269,987   $ 3,651,533       1,122,173   $  10,850,257   $  5,758,078   $ (46,087,345)   $  (4,364,223 )

 

See notes to unaudited condensed consolidated financial statements.

 

 Page 6 of 24 

 

  

XG SCIENCES, INC.

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

FOR THE SIX MONTHS ENDED JUNE 30, 2016 AND 2015 (unaudited)

 

   2016   2015 
CASH FLOWS FROM OPERATING ACTIVITIES          
Net loss  $(2,715,977)  $(4,128,005)
Adjustments to reconcile net loss to net cash used in operating activities:          
Depreciation and amortization   456,133    427,536 
Amortization of intangible assets   17,904    14,070 
Provision for bad debts   -    5,955 
Stock based compensation expense   228,126    270,642 
Non-cash interest expense   157,903    991,103 
Gain from change in fair value of derivative liability - warrants   (232,614)   (271,014)
(Increase) Decrease in:          
Accounts receivable   5,930    (64,516)
Inventory   12,624    (77,559)
Other current and non-current assets   (79,461)   56,310 
Increase (Decrease) in:          
Accounts payable and other liabilities   371,606    (505,253)
NET CASH USED IN OPERATING ACTIVITIES   (1,777,826)   (3,280,731)
           
CASH FLOWS FROM INVESTING ACTIVITIES          
Purchases of property and equipment   (39,314)   (108,478)
Purchases of intangible assets   (53,647)   (23,429)
NET CASH USED IN INVESTING ACTIVITIES   (92,961)   (131,907)
           
CASH FLOWS FROM FINANCING ACTIVITIES          
Repayments of capital lease obligations   (2,832)   (26,588)
Repayments of short-term notes   (750,000)   - 
Advances on short-term notes   574,750    - 
Proceeds from issuance of preferred stock and warrants   -    4,319,792 
Proceeds from issuance of common stock   2,285,032    14,000 
Common stock issuance fees and expenses   (336,600)   - 
NET CASH PROVIDED BY FINANCING ACTIVITIES   1,770,350    4,307,204 
           
NET INCREASE (DECREASE) IN CASH   (100,437)   894,566 
CASH AT BEGINNING OF PERIOD   1,060,224    2,088,866 
           
CASH AT END OF PERIOD  $959,787   $2,983,432 
           
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:          
Cash paid for interest  $77,646   $65,582 
           
SUPPLEMENTAL DISCLOSURE OF NON-CASH INVESTING AND FINANCING:          
Value of preferred stock issued for AAOF capital lease obligations  $171,342   $171,343 

 

See notes to unaudited condensed consolidated financial statements.

 

 Page 7 of 24 

 

 

XG SCIENCES, INC.

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

JUNE 30, 2016

 

NOTE 1 - NATURE OF BUSINESS AND BASIS OF PRESENTATION

 

XG Sciences, Inc., a Michigan company located in Lansing, Michigan and its subsidiary, XGS IP, LLC (collectively referred to as “we”, “us”, “our”, or the “Company”) manufactures graphene nanoplatelets made from graphite, using a proprietary manufacturing process to split natural flakes of crystalline graphite into very small and thin particles, which we sell as xGnP® graphene nanoplatelets. These particles are then used in products like battery electrodes, thin sheets, films, inks and coatings that we sell to other companies. We also sell our nanoparticles in the form of bulk powders or dispersions to other companies for use as additives to make composite and other materials with specially engineered characteristics. Additionally, we license our technology to other companies in exchange for royalties and other fees.

 

Basis of Presentation

 

The accompanying interim condensed consolidated financial statements are unaudited and have been prepared in accordance with accounting principles generally accepted in the United States of America (“GAAP”) for interim financial information and the instructions to Form 10-Q and do not include all of the information and footnotes required by GAAP for complete financial statements. All intercompany transactions have been eliminated in consolidation.

 

Certain information and footnote disclosures normally included in the Company’s annual audited consolidated financial statements and accompanying notes have been condensed or omitted in these interim condensed consolidated financial statements. Accordingly, the unaudited condensed consolidated financial statements included herein should be read in conjunction with the audited consolidated financial statements for the year ended December 31, 2015, as filed with the Securities and Exchange Commission (“SEC”) on Form S-1 (Registration No. 333-209131) with an effective date of April 13, 2016.

 

The results of operations presented in this quarterly report are not necessarily indicative of the results of operations that may be expected for any future periods. In the opinion of management, these unaudited condensed consolidated financial statements include all adjustments and accruals, consisting only of normal recurring adjustments that are necessary for a fair statement of the results of all interim periods reported herein.

 

NOTE 2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

 

Going Concern

 

We have historically incurred recurring losses from operations and we may continue to generate negative cash flows as we implement our business plan. Our unaudited condensed consolidated financial statements are prepared using GAAP as applicable to a going concern, which contemplates the realization of assets and liquidation of liabilities in the normal course of business.

 

We currently do not have sufficient cash or commitments for financing to sustain our operations for the next twelve months. Our plan is to develop customer relationships and increase our revenues derived from our products and IP licensing. Although we have historically incurred operating losses, we have been able to fund such losses primarily by selling common and preferred stock and convertible notes. We expect that our cash on hand at June 30, 2016, of $959,787 and proceeds from our initial public offering of common stock (“IPO”) will sustain our operations for the next twelve months. However, we cannot make any assurances that additional financing will be available to us and, if available, completed on a timely basis, on acceptable terms, or at all.

 

There has been no public market for our securities and a public market may never develop, or, if any market does develop, it may not be sustained. Our common stock is not currently quoted on or traded on any exchange or to our knowledge, on any over-the-counter market. In the event we are unable to fund our operations from existing cash on hand, operating cash flows, additional borrowings or raising equity capital, we may be forced to reduce our expenses, slow down our growth rate, or discontinue operations.  Our condensed consolidated financial statements do not include any adjustments relating to the recoverability and classification of recorded asset amounts or the amounts and classification of liabilities that might be necessary should we be unable to continue as a going concern.

 

 Page 8 of 24 

 

  

XG SCIENCES, INC.

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

JUNE 30, 2016

 

Use of Estimates

 

The preparation of our condensed consolidated financial statements in conformity with GAAP requires us to make estimates, judgments and assumptions that affect the reported amounts of assets, liabilities, revenues and expenses, together with amounts disclosed in the related notes to the financial statements. Actual results and outcomes may differ from our estimates, judgments and assumptions. Significant estimates, judgments and assumptions used in these condensed consolidated financial statements include, but are not limited to, those related to revenues, accounts receivable and related allowances, contingencies, useful lives and recovery of long-term assets, income taxes, the fair value of stock-based compensation and derivative financial instrument liabilities. These estimates, judgments, and assumptions are reviewed periodically and the effects of material revisions in estimates are reflected in the financial statements prospectively from the date of the change in estimate.

 

Inventory

 

Inventory consists of raw materials, work-in-process and finished goods, all of which are valued at standard cost, which approximates average cost.

 

Derivative Financial Instruments

 

We do not use derivative instruments to hedge exposures to cash flow, market or foreign currency risk. The terms of convertible preferred stock and convertible notes that we issue are reviewed to determine whether or not they contain embedded derivative instruments that are required by ASC 815: “Derivatives and Hedging” to be accounted for separately from the host contract, and recorded at fair value. In addition, freestanding warrants are also reviewed to determine if they achieve equity classification. Certain warrants that we have issued did not meet the conditions for equity classification and are classified as derivative instrument liabilities measured at fair value. The fair values of these derivative liabilities are revalued at each reporting date, with the change in fair value recognized in earnings.

 

Fair Value Measurements

 

The following is a reconciliation of the beginning and ending balances for liabilities measured at fair value on a recurring basis using significant unobservable inputs (Level 3) during the six months ended June 30, 2016 and 2015:

 

   2016   2015 
         
Balance at January 1  $8,235,163   $5,000,752 
Warrants issued with private placement of Series B Preferred Stock       660,378 
Warrants issued with preferred stock sold under preemptive rights       7,881 
Warrants reclassified to equity   (51,418)    
Gain recognized in earnings   (232,613)   (271,013)
Balance at June 30  $7,951,132   $5,397,998 

 

NOTE 3 – PRIVATE PLACEMENT AND PREEMPTIVE RIGHTS

 

Private Placement

 

In April 2015, we commenced a private placement offering of up to $18,000,000 in Series B Units consisting of up to 1,125,000 shares of Series B convertible preferred stock (“Series B Preferred Stock”) and warrants to purchase common stock (the “Warrants”) at an offering price of $16.00 per Unit. The offering terminated on August 31, 2015 and as of such date, we had sold 266,987 shares of Series B Preferred Stock and Warrants to purchase 222,262 shares of common stock, for aggregate gross proceeds of $4,270,192.

 

The Series B Preferred Stock has a stated value of $16.00 per share and is convertible, at the option of the holder into common shares, at a conversion price of $16.00 per share, subject to adjustments for stock dividends, splits, combinations and similar events. The Warrants have an exercise price of $16.00 per share and expire 7 years from issuance. During the period from closing of the offering and ending on the earlier of i) December 31, 2017 and ii) the date the Company consummates the sale of new securities resulting in gross proceeds of at least $18,000,000, the holder has the right to exchange their Series B Units (Series B Preferred Stock and Warrants) into any new security sold to third parties at the same relative price per share and other terms at which such new security is sold to such third parties.

 

 Page 9 of 24 

 

  

XG SCIENCES, INC.

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

JUNE 30, 2016

 

The cash proceeds from the private placement were allocated first to the derivative liabilities resulting from warrants, at their fair values, with the residual being allocated to the Series B Preferred Stock.

 

Preemptive Rights

 

On January 15, 2014, as part of our financing agreements with Samsung Ventures (“Samsung”), Aspen Advanced Opportunity Fund LP (“AAOF”) and XGS II, LLC (“XGS II”), we agreed to allow all shareholders to purchase one share of Series A convertible preferred stock (“Series A Preferred Stock”) at a price of $12.00 per share for every two (2) shares of Series A Preferred Stock or common stock owned by the shareholder. In addition, for every two preemptive shares purchased, the Company issued the shareholder a warrant to purchase one additional share of Series A Preferred Stock with the same terms as the warrants issued to AAOF and XGS II. The Company also agreed to issue warrants with the same terms to those shareholders who exercised preemptive rights in October 2013.

 

Under the January 15, 2014 preemptive rights offering, 101,000 shares of Series A Preferred Stock were sold to existing stockholders at a price of $12.00 per share. In addition, warrants indexed to 56,054 shares of Series A Preferred Stock were issued in conjunction with these stock purchases, including 5,554 warrants related to the preemptive rights exercised in October 2013.

 

As part of our Series B Unit private placement in April 2015, shareholders and holders of our convertible notes were provided the right to purchase their pro rata share of any class of stock that the Company sells or issues. The sale of Series B Preferred Stock in the April 2015 offering triggered the preemptive rights. As of June 30, 2016, 3,100 shares of Series B Convertible Stock have been sold to existing shareholders at a price of $16.00 per share. In addition, the Warrants indexed to 2,635 shares of common stock were issued as part of the Series B Units.

 

As of June 30, 2016, the total number of warrants issued due to the preemptive rights offerings was 58,689.

 

NOTE 4 – BRIDGE FINANCINGS

 

From December 31, 2015 through April 7, 2016, the Company entered into private placement bridge financings with 14 investors, seven of whom are board members or affiliates of board members, totaling $1,124,750 (the “Bridge Financings”). The investors in the Bridge Financings received common stock warrant coverage of 30% for investments made prior to December 31, 2015 and 20% coverage thereafter.

 

During June 2016 the Company repaid i) outstanding principal of $550,000 plus accrued interest of $22,000 to the December 2015 Bridge Financing investors and ii) outstanding principal of $200,000 plus accrued interest of $5,032 to two of the March 2016 Bridge Financing investors. These investors, who are also members of the board of directors of the Company, used the proceeds from repayment of their notes, plus additional funds, to purchase 199,879 additional shares of the Company’s common stock for approximately $1.6 million.

 

 The following tables provide additional details regarding the Bridge Financings:

 

   December 2015   March 2016   April 2016   Total 
   Bridge Financing   Bridge Financing   Bridge Financing   Bridge Financing 
Face value of notes at issuance  $550,000   $530,000   $44,750   $1,124,750 
Outstanding principal on June 30, 2016  $--   $330,000   $44,750   $374,750 
Interest rate   8.0%   8.0%   8.0%   8.0%
Maturity Date   June 30, 2016    December 31, 2016    December 31, 2016      
Common Stock Warrant Shares   20,625    10,600    895    32,120 
Warrant Exercise Price  $8.00   $10.00   $10.00      
Warrant Term   5 years    5 years     5 years     5 years 

  

 Page 10 of 24 

 

  

XG SCIENCES, INC.

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

JUNE 30, 2016

 

The Bridge Financing Warrants issued in December 2015 inadvertently provided the holder with the right to exchange their warrants on a price per share basis into a new security on the same relative price per share terms as any new securities sold to third parties resulting in gross proceeds of at least $18,000,000. As a result of these exchange rights, the December 2015 Bridge Financing warrants did not achieve equity classification at inception and were recorded as derivative liabilities, at fair value. During the second quarter of 2016, the warrant holders agreed to waive their exchange rights at which time the warrants were reclassified to equity and $52,676 of derivative liabilities related to such December 2015 Bridge Financing warrants was reclassified to equity.

 

The following table reconciles the Bridge Financings balance recorded on the balance sheet at June 30, 2016:

 

   2016 
     
Balance at January 1  $550,000 
Proceeds from Bridge Financings received January through April 7   574,750 
Subtotal   1,124,750 
Proceeds allocated to warrants – liability   (52,676)
Proceeds allocated to warrants – equity   (24,059)
Accrued interest January through June 30   92,985 
Payoff of principal ($750,000) and accrued interest   (777,032)
Balance at June 30, 2016  $363,968 

 

NOTE 5 – DERIVATIVE LIABILITY WARRANTS

 

As of June 30, 2016, all 1,197,617 derivative liability classified warrants issued to AAOF, XGS II, and holders of Series A and Series B Preferred Stock have vested.

 

Shares indexed to derivative liabilities as of June 30, 2016 and December 31, 2015 were as follows:

 

   Type of
shares
indexed
  Exercise
Price
   June
 30, 2016
   December
31, 2015
 
                
Warrants issued with Secured Convertible Notes  Series A PS  $6.40    833,333    833,333 
Warrants issued with equipment financing leases  Series A PS  $6.40    83,333    83,333 
Warrants issued with Series A preemptive rights  Series A PS  $6.40    56,054    56,054 
Warrants issued with Series B preemptive rights  Common  $16.00    2,635    2,635 
Warrants issued with Series B Units  Common  $16.00    222,262    222,262 
Warrants issued with Bridge Financings  Common  $8.00        20,625 
Total shares indexed to derivative liabilities           1,197,617    1,218,242 

  

The following table summarizes the fair value of the derivative liabilities as of June 30, 2016 and December 31, 2015:

 

   June 30, 2016   December 31,2015 
         
Warrants issued with Secured Convertible Notes  $6,565,326   $6,743,997 
Warrants issued with equipment financing leases   656,535    674,397 
Warrants issued with preemptive rights   444,984    457,265 
Warrants issued with 2015 Series B Unit private placement   284,287    306,828 
Warrants issued with Bridge Financings       52,676 
           
Total derivative liabilities  $7,951,132   $8,235,163 
 Page 11 of 24 

 

  

XG SCIENCES, INC.

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

JUNE 30, 2016

 

The Company estimated the fair value of their warrant derivative liabilities as of June 30, 2016 and December 31, 2015, using a lattice model and the following assumptions:

 

   June 30, 2016   December 31, 2015 
Fair value of underlying stock   $7.63 - $12.64    $7.63 - $12.64 
Equivalent risk free interest rate   0.68%- 0.79%    1.06%- 1.39% 
Expected term (in years)   5.84- 7.55    5.01- 8.05 
Equivalent stock price volatility   39.03%- 39.21%    38.00%- 38.61% 
Expected dividend yield        

 

The fair value of the warrants is estimated using a binomial lattice model. Equivalent amounts reflect the net results of multiple modeling simulations that the lattice model applies to underlying assumptions. Because the Company’s common stock is not publicly traded on a national exchange or to our knowledge, an over-the-counter market, the expected volatility of the Company’s stock was developed using historical volatility for a peer group for a period equal to the expected term of the warrants. The fair value of the warrants will be significantly influenced by the fair value of our common stock, stock price volatility and the risk free interest components of the lattice technique. Changes in the fair value of Derivative Liabilities, carried at fair value, are reported as “Change in fair value of derivative liability - warrants” in the Statement of Operations, and were as follows:

 

   Three months ended June 30, 
   2016   2015 
Warrants issued with Secured Convertible Notes  $103,084   $120,833 
Warrants issued with equipment financing leases   10,308    12,083 
Warrants issued with preemptive rights   7,197    8,580 
Warrants issued with 2015 private placement   22,259    33,219 
Total Derivative Gain  $142,848   $174,715 

 

   Six months ended June 30, 
   2016   2015 
Warrants issued with Secured Convertible Notes  $178,671   $203,333 
Warrants issued with equipment financing leases   17,862    20,333 
Warrants issued with preemptive rights   12,281    14,129 
Warrants issued with 2015 private placement   22,541    33,219 
Warrants issued with Bridge Financings   1,259     
           
Total Derivative Gain  $232,614   $271,014 

 

NOTE 6 – OTHER COMMON STOCK WARRANTS

 

In addition to the warrants described in Note 5, we had 42,694 warrants to purchase common stock that were issued in 2012 and prior years which are accounted for as equity instruments. As of June 30, 2016, the remaining warrants, all of which are exercisable, have exercise prices ranging from $8.00 to $12.00 and expire at various dates through 2027, as follows:

 

Date Issued  Expiration Date  Exercise Price   Number of 
Warrants
 
            
7/1/2009  7/1/2019  $8.00    6,000 
10/8/2012  10/8/2027  $12.00    5,000 
            11,000 

 

NOTE 7 - INCENTIVE STOCK OPTION PLAN

 

We have established an incentive stock option plan (the “Plan”) under which the Company may grant key employees and directors options to purchase common stock of the Company at not less than fair market value as of the grant date. Options for up to 600,000 shares may be awarded under the Plan. Each option is exercisable into one share of common stock of the Company. The Plan expires in December 2017. The fair value of the options granted was estimated on the dates of grant using the Black Scholes option-pricing model. As of June 30, 2016, 419,750 option shares have been granted and are outstanding, of which 221,824 are exercisable at an exercise price of $12.00. Vesting of the options ranges from immediately to 20% per year, with most options vesting on a straight-line basis over a three or four year period from the date issued. Rights to exercise the options vest immediately upon a change in control of the Company or termination of the employee’s continuous service due to death or disability. The options expire at various dates through October 2023.

 

 Page 12 of 24 

 

  

XG SCIENCES, INC.

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

JUNE 30, 2016

 

NOTE 8 – CAPITAL LEASES

 

As of June 30, 2016 and December 31, 2015, we have capital lease obligations as follows:

 

   June 30, 2016   December 31, 2015 
         
Capital lease obligations  $555,433   $682,564 
Unamortized warrant discount   (104,692)   (149,594)
Net obligations   450,741    532,970 
Short-term portion of obligations   (209,647)   (178,487)
           
Long-term portion of obligations  $241,094   $354,483 

 

The 83,333 common stock warrants issued as consideration for the equipment financing leases are recorded as derivative liabilities at fair value. The initial value of these warrants was recorded as a reduction of the capital lease obligation and is being amortized as part of the effective interest cost on the capital lease obligations.

 

NOTE 9 - RELATED PARTY TRANSACTIONS

 

We have a licensing agreement for exclusive use of patents and pending patents with Michigan State University (“MSU”), a shareholder of the Company via the MSU Foundation. During the three and six months ended June 30, 2016 and 2015 we incurred expenses of $12,500 and $25,000, respectively. We have also entered into product licensing agreements with certain other shareholders. No royalty revenue or expenses have been recognized related to these agreements during the six months ended June 30, 2016 and 2015.

 

Beginning in 2014, POSCO Corporation (“POSCO”), one of our shareholders, has a contractual obligation to pay us a minimum of $100,000 per year to license certain technologies we license from MSU. This obligation is due annually on February 28 of the following year. We record this license revenue at a rate of $25,000 per quarter. POSCO is disputing that they are obligated to pay the royalties. A petition for arbitration has been filed for this matter by the Company on March 9, 2016. On July 7 we received a letter from the International Court of Arbitration and they have assigned an arbitrator to the case. No assessment or decision has made by the arbitrator as of the filing date of these financial statements. An allowance in the amount of $125,000 and $100,000 has been recorded at June 30, 2016 and December 31, 2015, respectively, to reflect an estimate of the portion of the 2016, 2015 and 2014 royalties that we believe may not be collectible. The accrued royalty and allowance are netted together and reflected in other current assets on the condensed consolidated balance sheet.

 

The financing arrangements as previously disclosed were provided by AAOF and XGS II, two private funds that were formed for the sole purpose of investing in the Company by two investors affiliated with ASC-XGS, LLC, a shareholder of the Company. Pursuant to the Company’s Shareholders’ Agreement dated March 18, 2013 (as amended on February 26, 2016), a principal of each private fund serves as a director of the Company.

 

The Bridge Financings discussed in Note 4 above include loans from entities controlled by existing shareholders. Three of these shareholders are also directors of the Company. In conjunction with these short-term borrowings, the Company issued Warrants (see also discussed in Note 5).

 

NOTE 10 – SUBSEQUENT EVENTS

 

During the period from July1 through August 9, 2016, we received common stock proceeds of $267,000 for the sale of 33,375 shares.

 

 Page 13 of 24 

 

  

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

 

Forward-Looking Statements

 

In this Quarterly Report on Form 10-Q, unless otherwise indicated, the words “we”, “us”, “our”, “XG”, “XGS”, “XG Sciences” or the “Company” refer to XG Sciences, Inc. and its wholly owned subsidiary, XG Sciences IP, LLC, a Michigan limited liability company.

 

Introduction

 

The following discussion and analysis should be read in conjunction with the unaudited condensed consolidated financial statements, and the notes thereto included herein. The information contained below includes statements of the Company’s or management’s beliefs, expectations, hopes, goals and plans that, if not historical, are forward-looking statements subject to certain risks and uncertainties that could cause actual results to differ materially from those anticipated in the forward-looking statements. For a discussion on forward-looking statements, see the information set forth in the introductory note to this quarterly report on Form 10-Q under the caption “Forward-Looking Statements”, which information is incorporated herein by reference.

 

Overview of our Business

 

XG Sciences was formed in May 2006 for the purpose of commercializing certain technology to produce graphene nanoplatelets. First isolated and characterized in 2004, graphene is a single layer of carbon atoms configured in an atomic-scale honeycomb lattice. Among many noted properties, graphene is harder than diamonds, lighter than steel but significantly stronger, and conducts electricity better than copper. Graphene nanoplatelets are particles consisting of multiple layers of graphene. Graphene nanoplatelets have unique capabilities for energy storage, thermal conductivity, electrical conductivity, barrier properties, lubricity and the ability to impart strength when incorporated into plastics or other matrices.

 

We believe the unique properties of graphene and graphene nanoplatelets will enable numerous new product applications and the market for such products will quickly grow to be a significant market opportunity. Our business model is to design, manufacture and sell advanced materials we call xGnP® graphene nanoplatelets and value-added products based on these nanoplatelets. We currently have hundreds of customers trialing our products for numerous applications, including, but not limited to lithium ion batteries, supercapacitors, thermal shielding and heat transfer, inks and coatings, printed electronics, construction materials, composites, and military uses.

 

We target our xGnP® nanoplatelets for use in a range of large and growing end-use markets. Our proprietary manufacturing processes allow us to produce nanoplatelets with varying performance characteristics that can be tuned to specific end-use applications based on customer requirements. We currently offer three commercial “grades” of bulk materials, each of which is available in various particle sizes, which allows for surface areas ranging from 50 to 800 square meters of surface area per gram of material depending on the product. Other grades may be made available, depending on the needs for specific applications. In addition to selling bulk graphene nanoplatelets, we also offer the following value added products that contain our graphene nanoplatelets in various forms.

 

  1. Energy storage materials. These consist of specialty advanced materials that have been formulated for specific applications in the energy storage segment. Chief among these is our proprietary, specially formulated silicon-graphene composite material (also referred to as “SiG” or “XG SiG®”) for use in lithium-ion battery anodes. XG SiG® targets the never-ending need for higher battery capacity and longer life. In several customer trials, our SiG material has demonstrated the potential to increase battery energy storage capacity by 3-5x what is currently available with conventional lithium ion batteries today. Additionally, we offer various bulk materials for use as conductive additives for cathodes and anodes in li-ion batteries, as an additive to anode slurries for lead-carbon batteries and are investigating the use of our materials as part of other battery components.

 

 Page 14 of 24 

 

 

 

  2. XG Leaf®. XG Leaf is a family of sheet products for a variety of thermal management and other applications. XG Leaf® is ideally suited for use in thermal management in portable electronics, which may include cell phones, tablets and notebook PC’s. As these devices continue to adopt faster electronics, higher data management capabilities, brighter displays with ever increasing definition, they generate more and more heat. Managing that heat is a key requirement for the portable electronics market and our XG Leaf® product line is well suited to address the need. These sheets are made using special formulations of xGnP® graphene nanoplatelets as precursors, along with other materials for specific applications. There are several different types of XG Leaf® available in various thicknesses, depending on the end-use requirements for thermal conductivity, electrical conductivity, or resistive heating.

 

  3. Inks and Coatings. These consist of specially-formulated dispersions of xGnP® together with solvents, binders, and other additives to make electrically or thermally conductive products designed for printing or coating and which are showing promise in diverse customer applications such as advanced packaging, electrostatic dissipation and thermal management.

 

We sell products to customers around the world and have sold materials to over 1,000 customers (entities that have purchased our materials) in 47 countries since 2008. Some of these customers are research organizations and some are commercial organizations. Because graphene is a new material, our customers are developing new uses for our products and initially purchase them in quantities consistent with development purposes. A few of our customers have indicated to us that they have introduced commercial products that use our materials, but our customers are under no obligation to report to us on the usage of our materials. Our customers have included well-known automotive and OEM suppliers around the world, world-scale lithium ion battery manufacturers in the US, South Korea and China, diverse specialty material companies, as well as many others. We have also licensed some of our base manufacturing technology to other companies and we consider technology licensing a component of our business model. Our licensees include POSCO and Cabot Corporation, who further extend our technology through their customer networks. Ultimately, we expect to benefit in terms of royalties on sales of xGnP® produced and sold by our licensees.

 

The process of “designing-in” new materials is a relatively complex process that involves the use of relatively small amounts of the new material in laboratory and engineering development for an extended period of time. Following successful development, we expect customers that incorporate our materials into their products will then order much larger quantities of material to support commercial production. Thus, while many of our customers are currently purchasing our materials in kilogram (one or two pound) quantities, we expect many of our customers will require tons or even hundreds of tons of material when they commercialize products that incorporate our materials. The majority of our customers are still in the development stage and our product sales thus consist mainly of orders for relatively small quantities of materials being used in a variety of research or development activities and in early phase limited commercial applications. 

 

 

 

 

 

 

The above graphs show total orders and customers based on actual purchases of our materials and do not include free samples or materials used in joint development programs. The average order size for the six months ending June 30, 2016 was $865, as compared to $600 for the full year 2015, which indicates that most of these orders were for materials that were not yet incorporated into large-volume commercial products.

 

We currently have five customers who are using our materials in their products and actively selling them to their customers or actively promoting them for future sales. We anticipate seeing the average order size for these customers increase in the second half of 2016 and into 2017 as their demand grows. In addition, we have another five customers who have indicated that they expect to begin shipping product incorporating our materials in the second half of 2016, and have another seven customers who have indicated an intent to commercialize in the second half of 2016 and into the first quarter of 2017. We also have tens of customers with whom we are working that have not yet indicated an exact date for commercialization, but for whom we believe have the potential to contribute to revenue in 2017. As a result, we expect to begin shipping significantly greater quantities of our products in the second half of 2016 and into 2017. Based on the status of current discussions with such customers, we believe that we will continue to ramp revenue as 2016 progresses and that we will be able to recognize approximately $2-4 million of revenue in 2016 and approximately $10-25 million of revenue in 2017.

 

 Page 15 of 24 

 

  

The following are examples of commercial and development uses of our products:

 

  Construction company demonstrating less than one weight percent of our product in construction material composites improves flexural strength by more than 30%, and

 

  Large oil and lubricant supplier showing gear and friction improvements when incorporated into industrial and automotive greases, and

 

  Engineering design firm for automotive manufacturers found 20% reduction in operating temperature and in thermal uniformity when XG Leaf® replaces standard cooling fins in lithium ion battery packs’, and

 

  Auto manufacturer showing increased tensile and flexural strength and reduced weight in automotive composites, and

 

  Battery manufacturers demonstrating improved cycle life and energy storage when used as additives in lead acid batteries.

 

The markets that we serve are large and rapidly growing. For example, as shown in the figure below (Avicenne Energy, “The Rechargeable Battery Market, 2014–2025”, July 2015), the market for materials used in lithium ion battery anodes is currently approximately $1 billion, but is expected to approximately double over the next ten years. We believe our ability to address next generation anode materials represents a significant opportunity for us.

 

 

According to Prismark Partners, LLC, a leading electronics industry consulting firm specializing in advanced materials, the 2014 market for finished graphitic heat spreaders as sold to the OEM and EMS companies with adhesive, PET, and/or copper backing for selected portable applications was $600 million, and is expected to reach $900 million in 2018. The market is currently in a significant expansion period driven by the demand for portable devices. In a press release dated March 3, 2015, Gartner, Inc., a leading research organization, estimated the 2014 global cell phone market at 1.88 billion units. Every cell phone has some form of thermal management system, and we believe many of the new smart phones being developed can benefit from the thermal management properties of our XG Leaf® product line. In August 2015, International Data Corporation (IDC) in their Worldwide Quarterly Tablet Tracker, estimated the global shipment of tablets in 2015 at 212 million units. Thus, we believe our XG Leaf® product line is well positioned to address a very large and rapidly growing market.

 

 Page 16 of 24 

 

  

Operating Segment

 

We have one reportable operating segment that manufactures xGnP® graphene nanoplatelets and value-added products produced therefrom, conducts research on graphene nanoplatelets and related products, and licenses our technology as appropriate. As of June 30, 2016 we shipped products on a worldwide basis, but all of our assets were located within the United States.

 

Results of Operations for the Three and Six Months Ended June 30, 2016 Compared with the Three and Six Months Ended June 30, 2015

 

The following table summarizes the results of our operations for the three and six months ended June 30, 2016 and 2015.

 

 

Summary Income Statement  For the Three Months Ended June 30,       For the Six Months Ended June 30,     
   2016   2015   Change   2016   2015   Change 
Revenues                              
Product Sales  $82,035   $81,008   $1,027   $141,777   $118,313    23,464 
Grants   137,055    121,407    15,648    158,365    218,911    (60,546)
Licensing Revenue   25,000    25,000    -    50,000    50,000    - 
Total Revenues   244,090    227,415    16,675    350,142    387,224    (37,082)
                               
Cost of Goods Sold   429,252    449,120    (19,868)   804,999    869,228    (64,229)
                               
Gross Loss   (185,162)   (221,705)   36,543    (454,857)   (482,004)   27,147 
                               
Research & Development Expense   419,007    393,338    25,669    635,357    775,987    (140,630)
Sales, General & Administative Expense   625,381    1,089,107    (463,726)   2,058,203    2,135,971    (414,368)
Total Operating Expense   1,044,388    1,482,445    (438,057)   2,693,560    2,911,958    (554,998)
                               
Operating Loss   (1,229,550)   (1,704,150)   474,600    (3,148,417)   (3,393,962)   582,145 
                               
Other Income (Expense)   65,725    (343,970)   409,695    95,840    (734,043)   829,883 
                               
Net Loss  $(1,163,825)  $(2,048,120)  $884,295   $(3,052,577)  $(4,128,005)  $1,412,028 

 

Product sales consist of two broad categories: (1) material sold to customers for research or development purposes; and (2) production orders for customers. Typically, the order sizes for the first category are relatively small, however we expect orders in the second category to be much larger in the future. In the six months ended June 30, 2016, product sales increased by $23,464, or 19.8%. The main reason for the increase was customers moving through development programs towards commercialization, requiring larger quantities of our materials for advanced testing and pilot production activities.

 

We ship our products from our Lansing manufacturing facilities to customers around the world. During the six months ended June 30, 2016, we shipped materials to customers in 21 different countries, versus 23 countries during the six months ended June 30, 2015. Shipments to South Korea accounted for approximately 38% and 13% of total product revenues during the six months ended June 30, 2016 and 2015. No other countries accounted for more than 10% of product revenue in each of these respective periods.

 

The table below shows a comparison of orders received, both domestic and international. The table also includes the average order size for product sales reflected in our Statement of Operations. These numbers indicate that our customer base remains active with development or research projects that use our materials and indicate the breadth of our geographic coverage. The average order size for the product revenue reflected in our statement of operations increased 65% for the three months ended June 30, 2016 as compared to the same period in 2015. For the six months ended June 30, 2016, the increase was 54% as compared to the same period in 2015. Although the average size of these orders is still relatively small, we are encouraged that the trend is increasing. The current average order size indicates that most of our orders are for R&D and development activity. We expect that our average order size will begin to increase significantly once our customers begin to commercialize products that incorporate our materials within them.

 

Order Summary  For the Three Months Ended June 30,       For the Six Months Ended June 30,     
   2016   2015   Change   2016   2015   Change 
                         
Number of orders - domestic   74    70    4    155    142    13 
Number of orders - international   73    54    19    142    112    30 
Number of orders - total   147    124    23    297    254    43 
Average order size for product sales recorded in our Statement of Operations  $973   $588   $385   $865   $561   $304 
              65%             54%

 

Grant revenues of $158,365 and $218,911 during the six months ended June 30, 2016 and 2015, respectively, consisted entirely of revenue from the Phase II SBIR grant from the US Department of Energy. This Phase II SBIR was a grant awarded from the DOE as a follow-on for continued development of the materials investigated under the Phase I program entitled “Low-cost, High-Energy Si/Graphene Anodes for Li-Ion Batteries.” This award was for a total of $999,899 to fund a research project over a planned two-year period commencing in January 2014 and originally expiring December 2015. A no cost contract extension had been approved with a new expiration date of June 22, 2016. The grant has been billed in full and is now considered completed. All grant revenues are recorded as time and expenses are incurred according to the grant contracts.

 

 Page 17 of 24 

 

  

Cost of Goods Sold

 

We use a standard cost system to estimate the direct costs of products sold. Direct costs include estimates of raw material costs, packaging, freight charges net of those billed to customers, and an allocation for direct labor and manufacturing overhead. Because of the nature of our production processes, there is a substantial fixed manufacturing expense requirement that represents the ongoing cost of maintaining production facilities that are not directly related to products sold, so we use a “full capacity” allocation of overhead based on an estimate of what product costs would be if the manufacturing facilities were operating on a full-time basis and producing products at the designed capacity. This estimate involves estimating both the level of expenses as well as production amounts as if the manufacturing facility were operating on a continuous, three-shift, production basis.

 

The following table shows the relationship of direct costs to product sales for the three and six months ended June 30, 2016 and 2015:

 

 

Gross Profit Summary  For the Three Months Ended June 30,       For the Six Months Ended June 30,     
   2016   2015   Change   2016   2015   Change 
                         
Product Sales  $82,035   $81,008   $1,027   $141,777   $118,313   $23,464 
Direct Costs   25,020    30,667    (5,647)   57,052    52,668    4,384 
Direct Cost Margin  $57,015   $50,341   $(4,620)  $84,725   $65,645   $27,850 
% of Sales   69.5%   62.1%        59.8%   55.5%     
Unallocated Manufacturing Expense   404,232    418,453    (14,221)   747,947    816,560    (68,613)
Gross Loss on Product Sales  $(347,217)  $(368,112)  $20,895   $(663,222)  $(750,915)  $87,693 

 

We believe that the fluctuations in direct cost from period to period are not indicative of overall performance or of future margins because of the relatively small size of our sales in comparison to our future expectations. Direct costs vary depending on the size of an order, the specific products being ordered, and other factors like shipping destination.

 

Costs associated with grant revenues tend to be a mixture of facilities use, management time, labor from scientists, technicians and manufacturing personnel, and some supplies. Because of the difficulty of developing and maintaining an administrative system to gather direct costs for grants, together with the relatively small size of grant revenues, we do not track direct costs for grant revenues as a separate cost category. Therefore, we do not calculate direct cost margins associated with grant revenues but, rather, we view these revenues as being supported by indirect corporate expenses.

 

 Page 18 of 24 

 

  

Costs associated with licensing revenue tend to be a mixture of IP costs as well as management and administrative expenses that are indirect in nature. As such, we do not assign direct costs to licensing revenues. Where revenues from a license agreement can be assigned to specific product revenues, we classify these revenues as product sales and, using our standard cost system, assign direct costs to those sales.

 

The remaining “non-direct” costs of operating our manufacturing facilities are recorded as unallocated manufacturing expenses. These expenses include personnel costs, rent, utilities, indirect supplies, depreciation, and related indirect expenses. Unallocated manufacturing expenses are expensed as incurred. We allocate these costs as direct product costs on the basis of the proportion of these expenses that would be representative product costs if we were operating our factory at full capacity.

 

For the six months ended June 30, 2016, unallocated manufacturing expenses decreased by $68,613 or 8.4% from the comparable period in 2015. The largest part of this decrease was due to decreased payroll, tax and benefit costs as compared with the prior year.

 

Research and Development Expenses

 

Research and development expenses totaled $635,357 for the six months ended June 30, 2016. This is a decrease of $140,630 or 18% from the previous year. The largest part of this decrease was due to reduced payroll, tax and benefit costs as compared with the prior year.

 

Selling, General and Administrative Expenses

 

During the first six months of 2016 we incurred selling, general and administrative expenses (SGA) of $1.7 million. This is a decrease of $414,368 or 19% from the same period in the prior year. This decrease was driven by a reduction in payroll and related expenses as well as a reduction in professional fees. Common stock issuance costs incurred in 2016 for legal, accounting, and other fees were $336,600 and these expenses are recorded as an offset to proceeds as part of additional paid in capital on the balance sheet. As we continue to grow and gain traction in the marketplace our SGA expenses will fluctuate but should stabilize and become more fixed in nature as we achieve economies of scale.

 

Other Income (Expense)

 

The following table shows a comparison of other income and expense by major component for the three and six months ended June 30, 2016 and 2015:

 

Other Income (Expense)  For the Three Months Ended June 30,       For the Six Months Ended June 30,     
   2016   2015   Change   2016   2015   Change 
                         
Incentive Refund & Interest Income  $24,073   $27,173   $(3,100)  $48,224   $51,628   $(3,404)
Interest Expense   (101,196)   (545,858)   444,662    (184,997)   (1,056,685)   871,688 
Gain from change in fair value of derivative liability - warrants   142,848    174,715    (31,867)   232,613    271,014    (38,401)
                               
Total  $65,725   $(343,970)  $409,695   $95,840   $(734,043)  $829,883 

 

Interest expense for the three and six months ended June 30, 2016 was substantially lower than the same period(s) prior year because the convertible notes outstanding in 2015 were converted to stock on December 31, 2015.

 Page 19 of 24 

 

  

Cash Flow Summary

 

The following condensed cash flow statement compares cash flow from operating, investing and financing activities for the six months ended June 30, 2016 and 2015. Net cash used by operating activities decreased by 46% during the six months ended June 30, 2016 as compared to the same period in 2015, because of reduced operating expenses, as discussed above.

 

 

   Six Months Ended June 30   Change 2015 - 2016 
   2016   2015   $   % 
Cash, beginning of period  $1,060,224   $2,088,866   $(1,028,642)   (49.2)
Net Cash provided (used) by:                    
Operating activities   (1,777,826)   (3,280,731)   1,502,905    (45.8)
Investing Activities   (92,961)   (131,907)   (38,946)   (29.5)
Financing Activities   1,770,350    4,307,204    (2,536,854)   (58.9)
Net increase (decrease) in cash   (100,437)   894,566    (995,003)   (111.2)
Cash, end of period  $959,787   $2,983,432   $(2,023,645)   (67.8)

 

Investment activities for the six months ended June 30, 2016 included net capital expenditures for the purchase of property and equipment of $39,314 and $53,647 for intellectual property as compared with $108,478 for property and equipment and $23,429 for intellectual property during the corresponding period in 2015. These levels of capital expenditures are significantly lower than expected in the future as we begin to ramp up our production capacity to meet customer orders. Therefore, these expenditures should not be interpreted as indicative of future expenditures in this area.

 

Liquidity and Capital Expenditures

 

Ongoing cash flow from operations has been negative throughout our history. In addition, we have invested significant amounts in research and manufacturing capabilities. We anticipate that we will need to invest further to support ongoing operations for a minimum of another one to two years. We believe that cash on hand of $959,787 as of June 30, 2016 is sufficient to finance our business through the end of September 2016. Our registration statement on Form S-1 for our IPO was declared effective on April 13, 2016, and we are now in the process of conducting our IPO. We expect that our cash on hand at June 30, 2016, of $959,787 and proceeds from our initial public offering of common stock (“IPO”) will sustain our operations for the next twelve months. Our plan is also to further develop customer relationships and increase our revenues derived from our products and IP licensing.

 

The Company’s financial projections show that the Company may need to raise an additional $15,000,000 or more before it is capable of achieving sustainable cash flow from operations. We intend that the primary means for raising such funds will be through our currently ongoing IPO. However, we cannot make any assurance that we will be able to raise these funds or that the terms and conditions of future financing will be workable or acceptable for the Company and its shareholders.

 

We also currently forecast a need for additional capital expenditures to execute on our business plan. The amount and timing of such expenditures will be dependent on the timing and magnitude of sales orders received from customers, but we currently anticipate a need to invest approximately $1,000,000 to $6,000,000 during the next twelve months. We plan to fund these investments through a mixture of capital lease financing, debt financing, and from the proceeds of our IPO. If we are unable to obtain such financing, we may be forced to curtail our investment activities and this may limit our ability to grow our revenues as fast as we would like.

 

Additionally, we anticipate that as our sales increase we will need to invest funds in working capital to support additional inventory and accounts receivable. Taken together, these multiple cash requirements will likely exceed our cash flow from operations for at least one to two more years.

 

Although there can be no guarantee of successful funding in the future, we intend to pursue the sale of additional equity securities, as well as additional debt or lease financing in the future, until such time as ongoing revenues allow us to generate a positive monthly cash flow from the business sufficient to cover our cash requirements.

 

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In the event we are unable to fund our operations from existing cash on hand, operating cash flows, or additional debt or equity capital, we may be forced to reduce our expenses by curtailing operations, slow down our growth rate, or discontinue operations. Our condensed consolidated financial statements do not include any adjustments relating to the recoverability and classification of recorded asset amounts or the amounts and classification of liabilities that might be necessary should we be unable to continue as a going concern.

 

Critical Accounting Estimates

 

In preparing the consolidated financial statements in accordance with accounting principles generally accepted in the United States of America (“U.S. GAAP”), we have adopted various accounting policies. Our most significant accounting policies are disclosed in Note 2 to the consolidated financial statements included in our registration statement on Form S-1 for the year ended December 31 2015, which became effective April 13, 2016.

 

The preparation of the consolidated financial statements in conformity with U.S. GAAP requires us to make estimates and assumptions that affect the amounts reported in the consolidated financial statements and accompanying notes. Our estimates and assumptions, including those related to inventories, intangible assets, property, plant and equipment, legal proceedings, research and development, warranty obligations, product liability, fair valued liabilities, sales returns and discounts, and income taxes are updated as appropriate, which in most cases is at least quarterly. We base our estimates on historical experience, or various judgements about the reported values of assets, liabilities, revenues and expenses. Actual results may materially differ from these estimates.

 

Item 3. Quantitative and Qualitative Disclosures about Market Risk

 

Smaller reporting companies are not required to provide this information.

 

Item 4. Controls and Procedures

 

(a) Evaluation of disclosure controls and procedures. At the conclusion of the period ended June 30, 2016, we carried out an evaluation, under the supervision and with the participation of our management, including our Principal Executive Officer/Principal Financial Officer, of the effectiveness of the design and operation of our disclosure controls and procedures (as such term is defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934 (the “Exchange Act”)). Based upon that evaluation, our Principal Executive Officer/Principal Financial Officer concluded that as of June 30, 2016, our disclosure controls and procedures were effective and 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 Principal Executive Officer/Principal Financial Officer, in a manner that allowed for timely decisions regarding required disclosure.

 

We do not expect that our disclosure controls and procedures will prevent all errors and all instances of fraud. Disclosure controls and procedures, no matter how well conceived and operated, can provide only reasonable, not absolute, assurance that the objectives of the disclosure controls and procedures are met. Further, the design of disclosure controls and procedures must reflect the fact that there are resource constraints, and the benefits must be considered relative to their costs. Because of the inherent limitations in all disclosure controls and procedures, no evaluation of disclosure controls and procedures can provide absolute assurance that we have detected all our control deficiencies and instances of fraud, if any. The design of disclosure controls and procedures also is based partly on certain assumptions about the likelihood of future events, and there can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions.

 

(b) Changes in internal controls. There were no changes in our internal control over financial reporting that occurred during our last fiscal quarter that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

 

PART II - OTHER INFORMATION

 

Item 1. Legal Proceedings.

 

Beginning in 2014, POSCO, one of our licensees and a shareholder, has had a contractual obligation to pay us a minimum fee of $100,000 per year to license certain technologies. This obligation is due annually on February 28 of the following year. We record this license revenue at a rate of $25,000 per quarter. POSCO is disputing that they are obligated to pay the royalties. A petition for arbitration has been filed for this matter by the Company on March 9, 2016. On July 7 we received a letter from the International Court of Arbitration and they have assigned an arbitrator to the case. No assessment or decision has made by the arbitrator as of the issuance date of this report.

 

Item 1A. Risk Factors.

 

Smaller reporting companies are not required to provide this information.

 

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Item 2. Unregistered Sales of Equity Securities and Use of Proceeds.

  

During the three months ended June 30, 2016, we issued 8% promissory notes in an aggregate amount of $44,750 which mature on December 31, 2016 and issued 5 year warrants to purchase 895 shares of common stock having a strike price of $10.00 per share.

 

No underwriters were utilized and no commissions or fees were paid with respect to any of the above transactions. These persons were the only offerees in connection with these transactions. We relied on Section 4(a)(2) and/or Rule 506 of Regulation D of the Securities Act for the transactions set forth above since none of the transactions involved any public offering.

 

Item 3. Defaults Upon Senior Securities.

 

None.

 

Item 4. Mine Safety Disclosures.

 

None.

 

Item 5. Other Information.

 

None.

 

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Item 6. Exhibits.

 

EXHIBIT
NUMBER
  DESCRIPTION   LOCATION
         

31.1

 

 

  Certifications of the Chief Executive Officer and Principal Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002   Filed herewith
         
32.1   Certification Pursuant To 18 U.S.C. Section 1350, As Adopted Pursuant To Section 906 of the Sarbanes-Oxley Act Of 2002*   Furnished herewith
         
101. INS   XBRL Instance Document   Filed herewith
         
101. CAL   XBRL Taxonomy Extension Calculation Link base Document   Filed herewith
         
101. DEF   XBRL Taxonomy Extension Definition Link base Document   Filed herewith
         
101. LAB   XBRL Taxonomy Label Link base Document   Filed herewith
         
101. PRE   XBRL Extension Presentation Link base Document   Filed herewith
         
101. SCH   XBRL Taxonomy Extension Scheme Document   Filed herewith

 

 Page 23 of 24 

 

  

SIGNATURES

 

Pursuant to the requirements of the Securities Exchange Act of 1934, as amended, the registrant has duly caused this Quarterly Report on Form 10-Q to be signed on its behalf by the undersigned, thereunto duly authorized.

 

XG SCIENCES, INC.

 

Dated: August 9, 2016 By:   /s/ Philip L. Rose
  Name:   Philip L. Rose
  Title:   Chief Executive Officer, President,
Treasurer, Principal Executive Officer and
Principal Financial Officer
       
Dated: August 9, 2016 By:   /s/ Corinne Lyon
  Name:   Corinne Lyon
  Title:   Controller and Principal Accounting Officer

 

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