UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

Form 10-K

 

ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE

SECURITIES EXCHANGE ACT OF 1934

For The Fiscal Year Ended December 31, 2014

 

Commission File Number: 0-31641

 

SCI ENGINEERED MATERIALS, INC.

(Exact name of registrant as specified in its charter)

 

Ohio	31-1210318
(State or other jurisdiction of	(I.R.S. Employer
incorporation or organization)	Identification No.)

2839 Charter Street

Columbus, Ohio 43228

(Address of principal executive offices)

Registrant’s telephone number, including area code: (614) 486-0261

 

Securities registered pursuant to Section 12(b) of the Act:		None
Securities registered pursuant to Section 12(g) of the Act:		Common Stock, without par value (Title of Class)

 

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes ¨ No þ

 

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or 15(d) of the Exchange Act. Yes ¨ No þ

 

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 past 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 at least the past 90 days.

Yes þ 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 (section 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 x No ¨

 

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (section 229.405 of this chapter) is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. þ

 

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

 

Large accelerated filer ¨ Accelerated filer ¨ Non-accelerated filer ¨ Smaller reporting company þ

 

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

 

The aggregate market value of the Registrant’s common equity held by non-affiliates of the Registrant was approximately $3,583,550 on June 30, 2014. For purposes of this disclosure, shares of common stock held by persons who hold more than 10% of the outstanding shares of common stock and shares held by executive officers and directors of the registrant have been excluded because such persons may be deemed to be affiliates. This determination of executive officer or affiliate status is not necessarily a conclusive determination for other purposes.

 

There were 3,935,398 shares of the Registrant’s Common Stock outstanding on January 31, 2015.

 

Documents Incorporated By Reference

Portions of our Proxy Statement for the 2015 Annual Meeting of Stockholders are incorporated by reference in Part III.

 

  

Table of Contents		Page
Part I
Item 1.	Business	3
Item 1A.	Risk Factors	7
Item 1B.	Unresolved Staff Comments	12
Item 2.	Properties	12
Item 3.	Legal Proceedings	12
Item 4.	Mine Safety Disclosures	12
Part II
Item 5.	Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities	12
Item 6.	Selected Financial Data	13
Item 7.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	14
Item 7A.	Quantitative and Qualitative Disclosures about Market Risk	18
Item 8.	Financial Statements and Supplementary Data	18
Item 9.	Changes in and Disagreements with Accountants on Accounting and Financial Disclosure	18
Item 9A.	Controls and Procedures	18
Item 9B.	Other Information	19
Part III
Item 10.	Directors, Executive Officers and Corporate Governance	20
Item 11.	Executive Compensation	20
Item 12.	Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters	20
Item 13.	Certain Relationships and Related Transactions, and Director Independence	20
Item 14.	Principal Accountant Fees and Services	20
Item 15.	Exhibits and Financial Statement Schedules	21
	Signatures	24

 

Note Regarding Forward-Looking Statements

 

This Annual Report on Form 10-K contains forward-looking statements within the meaning of Section 21E of the Securities Exchange Act of 1934, as amended, and Section 26A of the Securities Act of 1933, as amended. The words “anticipate,” “believe,” “expect,” “estimate,” and “project” and similar words and expressions identify forward-looking statements, which speak only as of the date hereof. Investors are cautioned that such statements involve risks and uncertainties that could cause actual results to differ materially from historical or anticipated results due to many factors, including, but not limited to, the factors discussed in “Risk Factors.” The Company undertakes no obligation to publicly update or revise any forward-looking statements.

 

  

PART I

 

ITEM 1.

BUSINESS

 

Introduction

 

SCI Engineered Materials, Inc. (“SCI”, “we” or the “Company”), formerly Superconductive Components, Inc., an Ohio corporation, was incorporated in 1987.  We operate in one segment as a global supplier and manufacturer of advanced materials for Physical Vapor Deposition (“PVD”) Thin Film Applications.  We are focused on specific markets within the PVD industry (Photonics, Thin Film Solar, Glass, Thin Film Battery and Transparent Electronics).  Substantially all of our revenues were generated from customers with multi-national operations.  We have made considerable resource investment in the Thin Film Solar industry and a few customers have adopted our products.  Thin Film Battery is a developing market where manufacturers of batteries use our products to produce very small power supplies with small quantities of stored energy. Through partnerships with end users and Original Equipment Manufacturers the Company develops innovative customized solutions enabling commercial success.

 

History of the Company

 

The late Dr. Edward Funk, Sc.D., and his late wife Ingeborg founded SCI in 1987. Dr. Funk, formerly a Professor of Metallurgy at The Ohio State University and a successful entrepreneur, envisioned significant market potential for the newly discovered High Temperature Superconductivity (“HTS”) material YBCO (T_c of 90^o K). Our first product was a 99.999% pure, co-precipitated YBCO 1-2-3 powder. Over the years we expanded our product line by adding other High T_c Powders, sintered shapes, single crystal substrates, and non-superconducting sputtering targets.

 

We opened a subdivision, Target Materials Inc. (“TMI”), in 1991 to supply the increasing worldwide demand for sputtering and laser ablation targets. We became a full service manufacturer of high performance thin film materials, providing a wide selection of metals, ceramics, and alloys for sputtering targets, evaporation sources, and other Physical Vapor Deposition (“PVD”) applications. We served the Research & Development market as well as the Industrial and Decorative Coating markets. During this time, we began to manufacture targets for the Photovoltaic, Flat Panel Display, and Semiconductor industries.

 

SCI and TMI were merged in 2002. We continued to manufacture complex ceramic, metal, and alloy products for the photonic, photovoltaic, thin film battery, media storage, flat panel display, and semiconductor industries.

 

In April of 2010, we received ISO 9001:2008 registration, an internationally recognized quality standard. Prior to April 2010 we were ISO 9001:2000 registered.

 

Throughout our history, we have conducted funded research primarily under grants from entities such as the Department of Energy, the National Science Foundation, NASA, and the Ohio Development Services Agency (formally known as the Ohio Department of Development). These activities are generally limited to funded research that is consistent with our focus on near term commercial applications in our principal markets.

 

For over two and a half decades we have been developing considerable expertise in the development and manufacturing ramp-up of novel materials, such as Transparent Conductive Oxides for Thin Film Solar applications and targets for thin film batteries. Today, we serve a diverse base of domestic and multi-national corporations, universities, and leading research institutions. We actively seek to partner with organizations to provide solutions for difficult material challenges.

 

Business

 

We are a supplier of materials to the PVD industry. Our customers need our materials to produce nano layers of metals and oxides for advanced material systems. PVD coatings range from everyday items to complex computer processors. Every day applications include transparent anti-scratch coatings on eyeglasses, coatings on kitchen faucets, as well as low emissivity glass for household windows. More technically advanced applications for our products include semiconductors, thin film solar, flat panel displays, photonics and an emerging technology - Thin Film Battery.

 

 

We continue to pursue niche opportunities where our core competencies give us an advantage. We receive requests from potential customers in other markets within the PVD industry. We consider these on a case by case basis and are pursuing some opportunities that fit our core competencies and manufacturing capabilities. This disciplined approach enables us to focus on those opportunities that are the best fit for our capabilities and also offer the greatest long-term return. Considerations include our core strengths, resource requirements, and time-to-market.

 

Photonics currently represents the largest market for our materials. Our customers are continually identifying new materials that improve the utility of optical coatings. This includes improvements in their ability to focus, filter or reflect light, all of which increase the potential demand for the types and amounts of products we sell in this market. Photonic applications continue to expand as new methods are found to manipulate light waves to enhance the various applications for light.

 

We have developed products for the Thin Film Solar (“TFS”) market. We are well positioned in the TFS area having supplied materials to that market for over 15 years from the early stages of TFS development. We continue to increase our visibility in the global arena by attending various trade shows targeted at the solar market. We have added exclusive representatives for Korea, China, Taiwan and Japan. Market expansion is expected to continue in 2015 and we are poised to benefit, with minimal capital additions, as TFS grows. We see increased opportunities in foreign markets.

 

We continued to develop TCO systems for the solar and glass markets and added domestic and international customers for these products. Despite short term uncertainties, the solar industry is projected to have strong growth for the next few decades. The TFS market, which we serve, is expected to gain market share in roof applications with low weight flexible products during that period. Given current market opportunities, we continue to invest in research and development, marketing, and sales.

 

We are having tests conducted with our TCO material in display applications. In addition, we have a R&D program to develop materials for Thin Film Transistor applications in displays.

 

Thin Film Battery is a developing market where manufacturers of batteries use our targets, especially lithium orthophosphate (Li3PO4) and lithium cobalt oxide (LiCoO2) as key elements to produce power supplies with small quantities of stored energy. A typical Thin Film Battery would be produced via PVD with five or more thin layers. These batteries are often one centimeter square but only 15 microns thick. Following several years of industry developments, some Thin Film Battery customers announced their batteries are commercially available. Our customers anticipate the unique properties of these batteries could be used in applications in medical devices, integrated circuits, RFID, smart cards, hand held electronics and many other applications.

 

We continue to invest in developing new products for all current markets which include accelerating time to market.

 

For the year ended December 31, 2014, we had total revenue of $9,255,103. This was an increase of $1,278,674, or 16.0% when compared to 2013. Total revenue increased primarily due to increased volume from customer demand from our photonics customers. We shipped Transparent Conductive Oxide targets to Asia late in December 2014. Due to shipping terms related to these targets the revenue of approximately $190,000 is expected to be recognized in the first quarter of 2015. A second shipment of the same amount is expected to ship during the first quarter of 2015. We had no contract revenue in 2014 and do not anticipate any contract revenue during 2015 but will consider applying for a grant if one was available for an application we have interest in developing. We do not rely on contract revenue as a main part of our business.

 

Our largest customer represented approximately 47% of total revenues in 2014 and 38% in 2013.

 

Marketing and Sales

 

Europe and Asia, as well as the Americas, have high demand for sputtering targets. We continue to expand our global marketing reach. We have a manufacturer’s representative in the Korean market and also for Taiwan and China. We also have a distributor for Japan. We use various distribution channels to reach end user markets, including direct sales by our employees, independent manufacturers’ representatives in the United States, and independent distributors and manufacturers’ representatives for international markets. Also, the internet provides tremendous reach for new customers to be able to identify us as a source of their product needs. We have an operating website, www.sciengineeredmaterials.com, which includes online product inquiry capabilities and additional product information.

 

 

Ceramics

 

We are capable of producing ceramic powders via several different processing techniques including solid state and precipitation. Ceramic targets can also be produced in a variety of ways depending on the end user applications. Production techniques include sintering, cold isostatic pressing and hot pressing.

 

Most of our products are manufactured from component chemicals and metal oxides supplied by various vendors. If we suddenly lost the services of a supplier, there could be a disruption in our manufacturing process until the supplier was replaced. We have identified several firms as potential back-up suppliers that would be capable of supplying these materials to us as necessary.

 

Metals

 

In addition to the ceramic targets previously mentioned, we produce metal sputtering targets and backing plates. The targets are bonded to the backing plates for application in the PVD industry. These targets can be produced by casting, hot pressing and machining of metals and metal alloys depending on the application.

 

Applications for metal targets are highly varied from applying decorative coatings for end uses such as sink faucets to the production of various electronic, photonic and semiconductor products.

 

We purchase various metals of reasonable high purity (often above 99.9%) for our applications. We are not dependent on a single source for these metals and do not believe losing a vendor would materially affect our business.

 

We have continually added production processes and testing equipment to enable us to manufacture and qualify many product compositions that can be used as PVD materials.

 

Competition

 

We have a number of domestic and international competitors in both the ceramic and metal fields, many of whom have resources far in excess of our resources. Tosoh, Materion, Kurt Lesker and Heraeus are competing suppliers in regard to targets.

 

Suppliers

 

Principal suppliers in 2014 were Six Nine Metals, Sincemat Company, and Johnson Matthey. In every case, we have established alternate vendors that can be used to ensure availability of required materials. As volume grows, we may enter into alliances or purchasing contracts with these or other vendors.

 

Research and Development

 

We are developing sputtering targets for transparent electronic applications, which could be used to produce transparent thin film transistors via PVD processing. We have ongoing development for product improvements and new Transparent Conductive Oxide (TCO) for Thin Film Solar and wide area glass coating applications. We are also developing a dielectric material for Semiconductor applications and an aluminum composite for a decorative coating. We focus our research and development efforts in areas that build on our core competencies.

 

We may seek funded research opportunities within our core competencies that maintain and expand technical understanding within our company.

 

We have a collaborative program with Kent State University to evaluate our TCO materials in liquid crystal display applications.

 

We have certain proprietary knowledge and trade secrets related to the manufacture of metal oxide PVD materials and patents covering some High Temperature Superconductor products.

 

New Product Initiatives

 

We developed, produced and sold prototypes and innovative evaluation targets for glass coating applications in 2013. Successful testing of our materials was completed late in 2014. We anticipate commercializing this product in 2015.

 

 

We continue to develop TCO target materials for the Thin Film Solar market in partnership with both original equipment manufacturers and Thin Film Solar Cell panel fabricators.  A combination of the Third Frontier Programs and the loans provided by the Ohio Department of Development and the Ohio Air Quality Development Authority have enabled us to accelerate both our development of new products and expanding our manufacturing capacity to meet demands in an evolving marketplace.

 

We are exploring opportunities in material systems utilizing zinc oxide and tin oxide doped with various materials for applications in displays and memory. There is considerable research being conducted to identify new and improved metal oxide thin film transistors (MOTFT) at the corporate and university level. These materials are a good fit with our core competencies. In addition, some of the MOTFT use the same base materials as our TCOs. Certain of the MOTFT materials could use similar or the same equipment as has been acquired for the manufacture of TCO products. We are continuing to develop additional contacts in R&D departments of several companies and at Universities focused on these areas of research.

 

We continue to pursue research and development opportunities with respect to new and innovative materials and processes to be used in connection with the production of solid state Thin Film Batteries.  Presently, there are a few manufacturers of Thin Film Batteries in the United States, each in various stages of development from prototype to commercial activity.  In addition, globally there are several firms and research institutes conducting tests on Thin Film Batteries.  We believe this market may potentially become large with growth expected during the next few years.  There are numerous applications for Thin Film Batteries, including, but not limited to, active RFID tags, battery on chip, portable electronics, medical implant devices, remote sensors and wearable devices.  Given the many potential uses for Thin Film Batteries, we anticipate that the market for materials will grow in direct proportion to the Thin Film Battery market itself.

 

We currently face competition from other producers of materials used in connection with the manufacture of Thin Film Batteries. We believe that we have certain competitive advantages in terms of quality.  We intend to actively market our materials to Thin Film Battery producers in the upcoming year in order to maintain our strong presence in this market. 

          

Intellectual Property

 

We have received a patent for Fine-Particle Bi-Sr-Ca-Cu-O Having High Phase Purity made by a Chemical Precipitation and Low-Pressure Calcination method from the United States Patent and Trademark Office.  We also have received a patent for a process to join two individual strongly linked super-conductors utilizing a melt processing technique.

 

In the future, we may submit additional patent applications covering various inventions which have been developed by us.  Because the publication of U.S. patent applications can be delayed for up to one year, they tend to lag behind actual discoveries and we may not be the first creator of inventions covered by pending patent applications or the first to file patent applications for such inventions.  Additionally, other parties may independently develop similar technologies, duplicate our technologies or, if patents are issued to us or rights licensed by us, design around the patented aspects of any technologies we developed or licensed.

 

We rely on a combination of patent and trademark law, license agreements, internal procedures and nondisclosure agreements to protect our intellectual property.  Unfortunately, these may be invalidated, circumvented or challenged.  In addition, the laws of some foreign countries in which our products may be produced or sold may not protect our intellectual property rights to the same extent as the laws of the United States.

 

Employees

 

We had 24 full-time employees as of December 31, 2014. One of these employees holds a PhD in Material Science. An additional PhD is working daily at our location with our Research & Development team through a Sponsored Research Agreement with Kent State University. This individual has expertise in application for the Display market. We have never experienced a work stoppage and consider our relations with employees to be good. The employees do not have a bargaining unit.

 

 

Environmental Matters

 

We handle all materials according to Federal, State and Local environmental regulations and include Material Safety Data Sheets (MSDS) with all shipments to customers.  We maintain a collection of MSDS sheets for all raw materials used in the manufacture of products and maintenance of equipment and insure that all personnel follow the handling instructions contained in the MSDS for each material.  We contract with a reputable fully permitted hazardous waste disposal company to dispose of the small amount of hazardous waste materials generated.

 

Collections and Write-offs

 

We collected receivables in an average of 34 days in 2014. We have occasionally been forced to write-off negligible amount of accounts receivable as uncollectible. During 2014 we wrote off a receivable of approximately $17,000. We consider credit management critical to our success.

 

Seasonal Trends

 

We have not experienced and do not expect to experience seasonal trends in future business operations.

 

ITEM  1A.

RISK FACTORS

 

We desire to take advantage of the “safe harbor” provisions of the Private Securities Litigation Reform Act of 1995. The following factors have affected or could affect actual results and could cause such results to differ materially from those expressed in any forward-looking statements made. Investors should consider carefully the following risks and speculative factors inherent in and affecting the business of SCI and an investment in our common stock.

 

We have limited marketing and sales capabilities.

 

We continue to develop our marketing in Asia. We have a manufacturing representative for the Korean market and another for the Taiwanese and Chinese markets. We also added support for Japan. We must continue to develop appropriate marketing, sales, technical, customer service and distribution capabilities, or enter into agreements with third parties to provide these services to successfully market our products. A failure to develop these capabilities or obtain third-party agreements could adversely affect us.

 

Our success depends on our ability to retain key management personnel.

 

Our success depends in large part on our ability to attract and retain highly qualified management, administrative, manufacturing, sales, and research and development personnel. Due to the specialized nature of our business, it may be difficult to locate and hire qualified personnel. The loss of services of one of our executive officers or other key personnel, or our failure to attract and retain other executive officers or key personnel could have a material adverse effect on our business, operating results and financial condition. Although we have been successful in planning for and retaining highly capable and qualified successor management in the past, there can be no assurance that we will be able to do so in the future.

 

We have a history of operating losses and may incur losses in the future.

 

For the year ended December 31, 2014, we had a loss from operations of $150,813 compared to $288,090 for the year ended December 31, 2013. We provide no assurances that we will be able to operate profitably in the future. During the second half of 2014, we incurred expenses of approximately $140,000 related to write offs of account receivables and inventory in the solar and glass markets.  To reduce our risk, for the next few periods and perhaps longer, we are requiring prepayment before supplying products to the solar market. As of December 31, 2014, we had an accumulated deficit of approximately $9,606,000. Despite the loss from operations during 2014 our cash balance increased approximately $389,000 from December 31, 2013, or 63%.

 

Management’s plans with respect to the objective of improving liquidity and profitability in future years include continuing to expand our business into new and current markets for our products, developing new products and increasing our revenue and presence in those markets. Management believes that actions that began during 2014 provide the opportunity for improved liquidity and profitability. However, no assurances are made that such actions will result in sustained profitability.

 

 

Our competitors have far greater financial and other resources than we have.

 

The market for PVD materials is a substantial market with significant competition in both ceramic and metal materials. While we believe that our products enjoy certain competitive advantages in design, function, quality, and availability, considerable competition exists from well-established firms such as Materion Corporation, Kurt Lesker, Heraeus and Tosoh, all of which have more financial resources than us. We cannot provide assurance that developments by others will not render our products or technologies obsolete or less competitive.

 

Our patents and proprietary rights may not be enforceable.

 

We rely on a combination of patent and trademark law, license agreements, internal procedures and nondisclosure agreements to protect our intellectual property. These may be invalidated, circumvented or challenged. In addition, the laws of some foreign countries in which our products may be produced or sold may not protect our intellectual property rights to the same extent as the laws of the United States. Our failure to protect our proprietary information could adversely affect us.

 

Rights we have to patents and pending patent applications may be challenged.

 

We have received, from the United States Patent and Trademark Office, a patent for Fine-Particle Bi-Sr-Ca-Cu-O Having High Phase Purity made by a Chemical Precipitation and Low-Pressure Calcination method, and have also received a patent for a process to join two individual strongly linked super-conductors utilizing a melt processing technique. In the future, we may submit additional patent applications covering various applications. The patent applications that we may file in the future may not result in patents being issued, and any patents issued may not afford meaningful protection against competitors with similar technology, and may be challenged by third parties.

 

Because U.S. patent applications are maintained in secret until patents are issued, and because publications of discoveries in the scientific or patent literature tend to lag behind actual discoveries by several months, we may not be the first creator of inventions covered by issued patents or pending patent applications or the first to file patent applications for such inventions. Moreover, other parties may independently develop similar technologies, duplicate our technologies or, if patents are issued to us or rights licensed by us, design around the patented aspects of any technologies we developed or licensed. We may have to participate in interference proceedings declared by the U.S. Patent and Trademark Office to determine the priority of inventions, which could result in substantial costs. Litigation may also be necessary to enforce any patents held by or issued to us or to determine the scope and validity of others' proprietary rights, which could result in substantial costs.

 

The rapid technological changes of our industry may adversely affect us if we do not keep pace with advancing technology.

 

The PVD market is characterized by rapidly advancing technology. Our success depends on our ability to keep pace with advancing technology and processes and industry standards. We have focused our development efforts on sputtering targets. We intend to continue to develop innovative materials and integrate those advances to the thin film coatings industry. However, our development efforts may be rendered obsolete by research efforts and technological advances made by others, and materials other than those we currently use may prove more advantageous.

 

Additional development of our products may be necessary due to uncertainty regarding development of markets.

 

Some of our products are in the early stages of commercialization and we believe that it will be several years before these products will have significant commercial end-use applications, and that significant development work may be necessary to improve the commercial feasibility and acceptance of these products. There can be no assurance that we will be able to commercialize any of the products currently under development.

 

To date, there has been no widespread commercial use of HTS products. Additionally, the market for the Thin Film Battery materials is still in its early stages. At present, we have several customers for the materials we produce for Thin Film Batteries.  Since we have begun producing materials for the Thin Film Battery market, we have experienced no problems securing the supplies needed to produce the materials.  We do not anticipate supply problems in the near future.  However, changes in production methods and advancing technologies could render our current products obsolete and new production protocols may require supplies that are less available in the marketplace, which may cause a slowing or complete halt to production as well as expanding costs which we may or may not be able to pass on to our customers. Some of our materials are in early stages of development for Thin Film Solar (TFS) applications. The TFS market is expected to grow during the next few years.

 

 

Changes in the strategies of key trade customers may adversely affect our business.

 

Our products are sold in a highly competitive global marketplace which continues to experience increased concentration. We may be negatively affected by changes in the strategies of our trade customers, such as inventory de-stocking, limitations on access to shelf space, delisting of our products, and other conditions. If we lose a key customer or if sales of our products to a key customer materially decrease, our financial condition and results of operations may be adversely affected.

 

If Thin Film Solar technology is not suitable for widespread adoption or takes longer to develop than we anticipate, our sales may not be sufficient to achieve profitability.

 

The Thin Film Solar energy market that we supply is at a relatively early stage of development, and the extent to which thin film solar modules will be widely adopted is uncertain. Although the industry has experienced rapid growth, recent overcapacity in the market has created difficulties for some of our current and potential customers in the Thin Film Solar industry. Adoption of our products by parts of this market is important to our long term growth. If the technology proves unsuitable for widespread adoption at economically attractive rates of return or if demand for Thin Film Solar modules fails to develop sufficiently or takes longer to develop than we anticipate, we may be unable to grow our business or generate sufficient sales to achieve profitability.

 

Our failure to comply with our debt covenants could have a material adverse effect on our business, financial condition or results of operations.

 

Our debt agreements contain certain covenants. A breach of any of these covenants could result in a default under the applicable agreement. In the past our lenders have granted us a waiver or amendment when we sought relief from covenants. If a default were to occur, we would likely seek a waiver of that default, attempt to reset the covenant, or refinance the instrument and accompanying obligations. If we were unable to obtain this relief, the default could result in the acceleration of the total due related to that debt obligation. If a default were to occur, we may not be able to pay our debts or borrow sufficient funds to refinance them. Any of these events, if they occur, could materially adversely affect our results of operations, financial condition, and cash flows.

 

A lack of credit and/or limited financing availability to the Company, its vendors, dealers, or end users could adversely affect our business.

 

Our liquidity and financial condition could be materially and adversely affected if our ability to borrow money from new or existing lenders to finance our operations is reduced or eliminated. Similar adverse effects may also result if we realize lessened credit availability from trade creditors. Additionally, many of our customers require availability of financing to facilitate the purchase of our products. As a result, a continuing period of reduced credit availability in the marketplace could have adverse effects on our business.

 

Environmental compliance costs and liabilities associated with our facility may have a material adverse effect on our business, financial condition, results of operations and prospects.

 

We are subject to various federal, state and local environmental and health and safety laws and regulations with respect to our operations. These laws and regulations address various matters, including asbestos, fuel oil management, wastewater discharges, air emissions, and hazardous wastes. The costs of complying with these laws and regulations and the penalties for non-compliance can be substantial. For example, with respect to leased property, we may be held liable for costs relating to the investigation and cleanup of our leased property from which there has been a release or threatened release of a regulated material as well as other properties affected by the release. In addition to these costs, which are typically not limited by law or regulation and could exceed the property’s value, we could be liable for certain other costs, including, without limitation, governmental fines and injuries to persons, property or natural resources. Further, some environmental laws create a lien on the contaminated site in favor of the government for damages and the costs it incurs in connection with the contamination. While we are not aware of any potential environmental problems, no assurances are made that such problems and costs associated with them will not arise in the future. If any of our properties were found to violate environmental laws, we may be required to expend significant amounts of time and money to rehabilitate the property, and we may be subject to significant liability. Any environmental compliance costs and liabilities incurred may have a material adverse effect on our business, financial condition, results of operations and prospects.

 

 

Disaster and other adverse events may seriously harm our business.

 

Our manufacturing facility may suffer harm as a result of natural or man-made disasters such as storms, earthquakes, hurricanes, tornadoes, floods, fires, terrorist attacks and other conditions. Such events may disrupt our operations, harm our operations and employees, severely damage or destroy our facility, harm our business, reputation and financial performance, or otherwise cause our business to suffer in ways that cannot currently be predicted.

 

Our business requires us to make capital expenditures to maintain and improve our facilities.

 

Our facilities sometimes require capital expenditures to address ongoing required maintenance and upgrade our capabilities. In addition, we often are required to make significant capital expenditures in order to satisfy customer requirements and to produce newly developed products.

 

Takeover defense provisions in Ohio law and our corporate governance documents may delay or prevent takeover attempts preventing our shareholders from realizing a premium on their stock.

 

Various provisions of the Ohio corporation laws as well as our corporate governance documents may inhibit changes in control not approved by our Board of Directors and may have the effect of depriving our investors of an opportunity to receive a premium over the prevailing market price of our common stock in the event of an attempted hostile takeover. In addition, the existence of these provisions may adversely affect the market price of our common stock. These provisions include:

 

·

A requirement that a special meeting of the shareholders must be called by our Board of Directors, Chairman, the President or the holders of shares with voting powers of at least fifty percent (50%);

·

Advanced notice requirements for shareholder proposals and nominations; and

·

The availability of “blank check preferred stock.”

 

Our Board of Directors can use these and other provisions to prevent, delay or discourage a change in control of the company or a change in our management. Any such delay or prevention of a change in control of management could deter potential acquirers or prevent the completion of a takeover transaction to which our shareholders could receive a substantial premium over the current market price of our common stock, which may in turn limit the price investors might be willing to pay for our common stock.

 

Provisions in our Articles of Incorporation and Code of Regulations provide for indemnification of officers and directors which could require us to divert funds away from our business and operations.

 

Our Articles of Incorporation and Code of Regulations provide for the indemnification of our officers and directors. We may be required to advance costs incurred by an officer or director to pay judgments, fines and expenses incurred by an officer or director, including reasonable attorneys’ fees, as a result of actions or proceedings in which our officers and directors are involved by reason being or having been an officer or director of our company. Funds paid in satisfaction of judgments, fines, and expenses may be funds we need for operation and growth of our business.

 

The market for our common stock is limited, and as such our shareholders may have difficulty reselling their shares when desired or at attractive market prices.

 

Our stock price and our listing may make it more difficult for our shareholders to resell shares when desired or at attractive prices. In 2001, our stock began trading on The Over the Counter Bulletin Board, now known as the OTC Markets. Our common stock trades in low volumes and at low prices. Some investors view low-priced stocks as unduly speculative and therefore not appropriate candidates for investment. Many institutional investors have internal policies prohibiting the purchase or maintenance of positions in low-priced stocks. This has the effect of limiting the pool of potential purchases of our common stock at present price levels. Shareholders may find greater percentage spreads between bid and asked prices, and more difficulty in completing transactions and higher transaction costs when buying or selling our common stock than they would if our stock were listed on a major stock exchange, such as The New York Stock Exchange or The Nasdaq National Market.

 

  

Our common stock has been subject to the Securities and Exchange Commission’s “penny stock” regulations, which may limit the liquidity of common stock held by our shareholders.

 

Effective January 28, 2015 our common stock began trading on the OTC Markets’ OTCQX Market Tier under the symbol “SCIA.” We upgraded from the OTC Markets’ OTCQB Market Tier. Based on its trading price, our common stock is considered a “penny stock” for purposes of federal securities laws, and therefore has been subject to regulations, which affected the ability of broker-dealers to sell our securities. Broker-dealers who recommend a “penny stock” to persons (other than established customers and accredited investors) must make a special written suitability determination and receive the purchaser’s written agreement to a transaction prior to sale.

 

If penny stock regulations apply to our common stock, it may be difficult to trade the stock because compliance with the regulations can delay and/or preclude certain trading transactions. Broker-dealers may be discouraged from effecting transactions in common stock because of the sales practice and disclosure requirements for penny stock. This could adversely affect the liquidity and/or price of our common stock, and impede the sale of the common stock in the secondary market.

 

The increasing costs of being a public company may strain our resources and impact our business, financial condition and results of operations.

 

As a public company, we are subject to reporting requirements of the Securities Exchange Act of 1934, as amended or the Exchange Act, the Sarbanes-Oxley Act of 2002, or the Sarbanes Oxley Act and the 2010 Dodd-Frank Wall Street Reform and Consumer Protection Act, or the Dodd-Frank Act. The Exchange Act requires that we file annual, quarterly and current reports with respect to our business and financial condition. The Sarbanes-Oxley Act requires that we maintain effective disclosure controls and procedures and internal controls for financial reporting. We are required to document and test our internal control procedures in order to satisfy the requirements of Section 404(b) of the Sarbanes-Oxley Act, which requires annual management assessments of the effectiveness of our internal controls over financial reporting. The Dodd-Frank Act requires us to audit our supply chain and report conflict minerals usage.

 

These requirements may place a strain on our systems and resources in the future and may require us to hire additional accounting and financial staff with the appropriate public company experience and technical accounting knowledge. In addition, the failure to maintain such internal controls could result in us being unable to provide timely and reliable financial information which could potentially subject us to sanctions or investigations by the Securities and Exchange Commission or events could have an adverse effect on our business, financial condition or results of operations. Although we have taken steps to maintain our internal control structure as required by the Exchange Act and the Sarbanes-Oxley Act, we cannot provide any assurances that controlled deficiencies will not occur in the future.

 

Our Articles of Incorporation authorize us to issue additional shares of stock.

 

We are authorized to issue up to 15,000,000 shares of common stock, which may be issued by our board of directors for such consideration, as they may consider sufficient without seeking shareholder approval. The issuance of additional shares of common stock in the future may reduce the proportionate ownership and voting power of current shareholders.

 

Our Articles of Incorporation authorize us to issue up to 260,000 shares of preferred stock. The issuance of preferred stock in the future could create additional securities which would have dividend and liquidation preferences prior to the outstanding shares of common stock. These provisions could also impede a non-negotiated change in control.

 

We have not paid dividends on our common stock in the past and do not expect to do so in the future.

 

We have never declared or paid cash dividends on our shares of common stock and do not expect to do so in the foreseeable future. We intend to retain future earnings for use in the business. As a result, investors must rely on sales of the common stock after price appreciation, which may not occur, as the only way to realize future gains on their investments.

 

  

ITEM 1B.

UNRESOLVED STAFF COMMENTS.

 

Not applicable.

 

ITEM 2.

PROPERTIES.

 

Our office and manufacturing facilities are located at 2839 Charter Street, Columbus, Ohio, where we occupy approximately 32,000 square feet. We moved our operations into this facility in 2004. During 2014 we renewed the lease on the property which expires on November 30, 2024.

 

We are current on all operating lease liabilities.

 

ITEM 3.

LEGAL PROCEEDINGS.

 

Not applicable.

 

ITEM 4.

MINE SAFETY DISCLOSURES

 

Not applicable.

 

PART II

 

ITEM 5.

MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES.

 

Market for Common Stock

 

Our stock began trading on the OTC Markets’ OTCQX Market Tier under the symbol “SCIA” effective January 28, 2015. We upgraded from the OTC Markets’ OTCQB Market Tier. We believe the OTCQX will provide investors transparent and convenient access to news and financial disclosure while providing long-term shareholder value.

 

The following table sets forth for the periods indicated the high and low bid quotations for our common stock.

 

		High				Low
Fiscal 2014
Quarter Ended March 31, 2014		$	3.50			$	0.86
Quarter Ended June 30, 2014			1.25				1.00
Quarter Ended September 30, 2014			1.20				0.88
Quarter Ended December 31, 2014			1.46				0.84
Fiscal 2013
Quarter Ended March 31, 2013		$	1.71			$	1.21
Quarter Ended June 30, 2013			1.79				0.21
Quarter Ended September 30, 2013			1.40				0.75
Quarter Ended December 31, 2013			1.40				0.85

 

The quotations provided herein may reflect inter-dealer prices without retail mark-up, markdown, or commissions, and may not represent actual transactions.

 

Based on its trading price, our common stock is considered a “penny stock” for purposes of federal securities laws, and therefore has been subject to certain regulations, which are summarized below.

 

Our common stock is classified as a penny stock and as such, broker dealers trading our common stock will be subject to the disclosure rules for transactions involving penny stocks, which require the broker dealer to determine if purchasing our common stock is suitable for a particular investor. The broker dealer must also obtain the written consent of purchasers to purchase our common stock. The broker dealer must also disclose the best bid and offer prices available for our stock and the price at which the broker dealer last purchased or sold our common stock. These additional burdens imposed on broker dealers may discourage them from effecting transactions in our common stock, which could make it difficult for an investor to sell their shares.

 

  

Holders of Record

 

As of December 31, 2014, there were approximately 290 holders of record of our common stock and 3,935,398 shares outstanding. At December 31, 2014 there were approximately 40 holders of Series B Preferred stock and 24,152 shares outstanding.

 

Dividends

 

We have never paid cash dividends on our common stock and do not expect to pay any dividends in the foreseeable future. We intend to retain future earnings for use in the business.

 

Equity Compensation Plan Information

 

The following table sets forth additional information as of December 31, 2014, concerning shares of our common stock that may be issued upon the exercise of options and rights under our existing equity compensation plans and arrangements approved by our shareholders. The information includes the number of shares covered by and the weighted average exercise price of, outstanding options and other rights, and the number of shares remaining available for future grants (excluding the shares to be issued upon exercise of outstanding options and other rights).

 

		Number of Securities to be issued upon exercise of outstanding options and rights (a)				Weighted-average exercise price of outstanding options and rights (b)				Number of securities remaining available for issuance under equity compensation plans (excluding securities reflected in column (a)) (c)
Equity compensation plans approved by security holders (1)			703,857			$	4.04				276,143

________________

(1)

Equity compensation plans approved by shareholders include our 2011 Stock Option Plan, 2006 Stock Option Plan and 1995 Stock Option Plan.

 

ITEM 6.

SELECTED FINANCIAL DATA.

 

Not applicable.

 

 

ITEM 7.

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.

 

Executive Summary

 

We had total revenue of $9,255,103 during 2014 compared to $7,976,429 during 2013. This was an increase of $1,278,674, or 16.0%. Revenue increased this year primarily due to increased volume from customer demand from our photonics customers.

 

Gross profit was $1,849,118 during 2014 compared to $1,536,292 during 2013. This was an increase of $312,826, or 20.4%. The increase in gross profit was related to the increase in revenue.

 

Operating expenses were $1,999,931 and $1,824,382 for the years ended December 31, 2014 and 2013, respectively. This was an increase of $175,549, or 9.6%. This increase was primarily related to higher non cash stock based compensation expense, wages and compensation, and sponsored research expense with our research and development team. In addition, there was bad debt expense of approximately $17,000 during 2014 compared to a reversal of bad debt expense of approximately $27,000 during 2013. We continue to invest in developing new products for all of our markets including transparent conductive oxide systems for applications in the thin film solar and glass markets. In late 2014 we began developing an aluminum composite for decorative coating. We also have ongoing development efforts with our thin film battery materials and transparent electronic products. These efforts include accelerating time to market for those products and involve internally financed research and development expense.

 

We had net loss after income taxes of $219,924 for the year ended December 31, 2014 compared to a net loss of $287,646 for the year ended December 31, 2013. We had loss applicable to common shares of $244,076 and $311,798 for the years ended December 31, 2014 and 2013, respectively. During the second half of 2014, we incurred expenses of approximately $140,000 related to write offs of account receivables and inventory in the solar and glass markets.  To reduce our risk, for the next few periods and perhaps longer, we are requiring prepayment before supplying products to the solar market.

 

As of December 31, 2014, cash on-hand was $1,011,956 compared to $622,727 at December 31, 2013. Net cash provided by operating activities was approximately $792,000 during 2014 compared to approximately $409,000 during 2013. We entered into new capital lease agreements of approximately $396,000 during 2014.

 

Several new customers are currently conducting extensive product testing and qualification activities. We are optimistic this will result in increased orders. Late in the third quarter of 2014 we received new orders for more than $400,000 of Transparent Conductive Oxide materials. We shipped some of these targets to Asia late in December 2014. Due to shipping terms related to these targets the revenue of approximately $190,000 is expected to be recognized during the first quarter of 2015. A second shipment of the same amount is expected to ship during the first quarter of 2015.

 

Backlog was $3.4 million at December 2014 compared to $2.6 million at September 30, 2014 and $3.4 million at December 31, 2013. Our expanded marketing initiatives, which include close contact with customers plus participation in domestic and international trade shows, remains focused on long-term global growth opportunities.

 

Results of Operations

 

Year 2014 As Compared to Year 2013

 

Revenue

 

We had total revenue of $9,255,103 during 2014 compared to $7,976,429 during 2013. This was an increase of $1,278,674, or 16.0%. Revenue increased this year primarily due to increased volume from customer demand from our photonics customers. Sales to these customers have been inconsistent from year to year. During the first half of 2013 a customer experienced a periodic inventory adjustment which reduced revenue. This customer made up approximately 47% of our revenue during 2014 compared to 38% during 2013. Contract revenue was $0 and $90,170 for the years ended December 31, 2014 and 2013, respectively. All grant work was completed in 2013. We do not rely on contract revenue as a main part of our business and do not believe that this reduction will have an adverse effect on our business.

 

 

Revenue from product sales is recognized based on the shipping terms upon shipment to customers. Provisions for discounts and rework costs for returns are established when products are shipped based on historical experience. Customer deposits represent cash received in advance of revenue earned.

 

Revenue from contract research provided for third parties is recognized on the percentage of completion method. Contract research revenue is recognized during the period qualifying expenses are incurred for the research that is performed as set forth under the terms of the grant award agreements.

 

Gross Profit

 

Gross profit was $1,849,118 during 2014 compared to $1,536,292 during 2013. This was an increase of $312,826, or 20.4%. The increase in gross profit was related to the aforementioned increase in revenue. Gross profit was 20.0% of total revenue in 2014 compared to 19.3% in 2013.

 

General and Administrative Expense

 

General and administrative expense for the year ended December 31, 2014 increased to $1,191,982 from $1,052,181 for the year ended December 31, 2013, or 13.3%. General and administrative expense for 2014 included higher non-cash stock based compensation expense of approximately $40,000, wages and compensation of approximately $27,000 and professional fees of approximately $13,000. In addition, there was bad debt expense of approximately $17,000 during 2014 compared to a reversal of bad debt expense of approximately $27,000 during 2013.

 

Professional Fees

 

Included in general and administrative expense was $205,112 and $192,474 for professional fees for the years ended December 31, 2014 and 2013, respectively. These expenses were primarily related to SEC compliance costs for legal, accounting and stockholder relations’ fees.

 

Research and Development Expense

 

Research and development expense for 2014 was $307,083 compared to $324,035 for 2013, a decrease of 5.2%. The decrease was due primarily to lower compensation benefits expense of approximately $14,000, and lower non cash stock based compensation expense of $19,000. These reductions were offset by higher expense related to development efforts of approximately $16,000. All research grant work was completed during 2013. As they related to contract research revenue certain research and development expenses were included in cost of revenue in 2013.

 

Marketing and Sales Expense

 

Marketing and sales expense for the year ended December 31, 2014 increased 11.8% to $500,866 from $448,166 for 2013. This increase was related to higher non cash stock based compensation expense of approximately $17,000 and travel expense of approximately $24,000.

 

Stock Compensation Expense

 

Included in operating expenses were non cash stock based compensation costs of $172,673 and $134,701 for the years ended December 31, 2014 and 2013, respectively. Compensation cost for all stock-based awards is based on the grant date fair value and recognized over the required service (vesting) period. Unrecognized non cash stock based compensation expense related to operating expense was $511,895 as of December 31, 2014 to be recognized through 2019.

 

Interest

 

Interest was $66,933 and $73,245 for the years ended December 31, 2014 and 2013, respectively. The decrease was due to continued payments reducing principal balances.

 

 

Loss Applicable to Common Stock

 

Loss applicable to common stock was $244,076 for the year ended December 31, 2014 compared to a loss of $311,798 for the year ended December 31, 2013. The higher gross profit in 2014 primarily contributed to the improvement. We had $172,995 and $134,701 in non-cash stock compensation expenses during 2014 and 2013, respectively. These charges had a material effect on our Statement of Operations.

 

Common Stock

 

The following schedule represents our outstanding common stock during the period of 2015 through 2024 assuming all outstanding stock options are exercised during the year of expiration. Based on outstanding shares at December 31, 2014, if each shareholder exercises his or her options, it would increase our common shares by 703,857 to 4,639,255 by December 31, 2024. Assuming all such options are exercised in the year of expiration, the effect on shares outstanding is illustrated as follows:

 

		Options				Potential				Weighted
		due to				shares				Average
Year		expire				outstanding				Exercise Price
2015			130,000				4,065,398			$	3.02
2016			31,000				4,096,398			$	3.25
2018			6,000				4,102,398			$	3.10
2019			364,500				4,466,898			$	6.00
2024			172,357				4,639,255			$	0.84

 

Liquidity and Capital Resources

 

Cash

 

As of December 31, 2014, cash on-hand was $1,011,956. Cash was $622,727 at December 31, 2013. Cash flow from operations increased to $791,994 from $408,874 for the year ended December 31, 2014. We believe, based on forecasted sales and expenses, that cash flow from operations will be adequate to sustain operations at least through December 31, 2015.

 

Working Capital

 

At December 31, 2014 working capital was $889,649 compared to $917,900 at December 31, 2013, a decrease of $28,251 or 3.1% from year end 2013. Cash increased approximately $389,000 during the year ended December 31, 2014. Accounts receivable decreased approximately $166,000 due to higher shipments late in 2013 compared to the same time period in 2014. Customer deposits increased approximately $176,000 due to orders received during the fourth quarter of 2014 and scheduled to ship during the first half of 2015. Current capital lease obligations increased by approximately $42,000 due to new capital leases incurred during 2014, while current notes payable increased by approximately $51,000 due to a note’s final payment becoming due in 2015.

 

Cash from Operations

 

Net cash provided by operating activities was approximately $792,000 and $409,000 for the years ended December 31, 2014 and 2013, respectively. In addition to the changes in various current assets and liabilities mentioned above, non-cash expenses for depreciation, accretion and amortization decreased to approximately $515,000 during 2014 from $573,000 during 2013, a decrease of 10.1%. Included in expenses were non cash stock based compensation costs of $172,995 and $134,701, and non-cash inventory adjustments of approximately $57,000 and $35,000 for the years ended December 31, 2014 and 2013, respectively. During 2013 there was a net gain on disposal of equipment of approximately $74,000. A non cash charge during 2012 of $30,000 increased the allowance for doubtful accounts at December 31, 2012 and was subsequently reversed in 2013.

 

Cash from Investing Activities

 

Cash of approximately $58,000 was used for investing activities during the year ended December 31, 2014. Cash of approximately $35,000 was provided by investing activities during 2013. Proceeds on sale of equipment were approximately $75,000 and purchases of property and equipment was approximately $40,000 during 2013. The amounts invested were used to purchase machinery and equipment for increased production capacity and new product lines.

 

 

Cash from Financing Activities

 

Cash of approximately $345,000 was used in financing activities for the year ended December 31, 2014. Principal payments to third parties for capital lease obligations and notes payable approximated $396,000. Proceeds from sale of common stock were $50,400. Cash of approximately $452,000 was used in financing activities towards principal payments to third parties for capital lease obligations and notes payable during 2013.

 

Debt Outstanding

 

Total debt outstanding remained stable at December 31, 2014 compared to December 31, 2013. We paid cash of approximately $396,000 towards principal amounts of capital lease obligations and notes payable during 2014. We incurred new capital lease obligations of approximately $396,000 for new production equipment during 2014.

 

Liquidity

 

We have forecasted revenues and related costs as well as investing plans and financing needs to determine liquidity to meet cash flow requirements and believe we will have sufficient liquidity at least through December 31, 2015.  This forecast was based on current cash levels and debt obligations, and our best estimates of revenues primarily from existing customers and gave consideration to the continued and possible increased levels of uncertainty in demand in the markets in which we operate.  Our ability to maintain current operations is dependent upon our ability to achieve these forecasted results, which we believe will occur. 

 

Critical Accounting Policies

 

The preparation of financial statements and related disclosures in conformity with accounting principles generally accepted in the United States requires management to make judgments, assumptions and estimates that affect the amounts reported in the Financial Statements and accompanying notes. Note 2 to the Financial Statements in the Annual Report on Form 10-K for the year ended December 31, 2014 describes the significant accounting policies and methods used in the preparation of the Financial Statements. Estimates are used for, but not limited to, the accounting for the allowance for doubtful accounts, inventory allowances, property and equipment depreciable lives, patents and license useful lives, revenue recognition, tax valuation allowance, stock based compensation and assessing changes in which impairment of certain long-lived assets may occur. Actual results could differ from these estimates. The following critical accounting policies are impacted significantly by judgments, assumptions and estimates used in the preparation of the Financial Statements. The allowance for doubtful accounts is based on our assessment of the collectability of specific customer accounts and the aging of the accounts receivable. If there is a deterioration of a major customer’s credit worthiness or actual defaults are higher than our historical experience, our estimates of the recoverability of amounts due us could be adversely affected. Inventory purchases and commitments are based upon future demand forecasts. If there is a sudden and significant decrease in demand for our products or there is a higher risk of inventory obsolescence because of rapidly changing technology and customer requirements, we may be required to increase our inventory allowances and our gross profit could be adversely affected. Depreciable and useful lives estimated for property and equipment, licenses and patents are based on initial expectations of the period of time these assets and intangibles will provide benefit. Changes in circumstances related to a change in our business, change in technology or other factors could result in these assets becoming impaired, which could adversely affect the value of these assets.

 

Inflation

 

We believe there has not been a significant impact from inflation on our operations during the past three fiscal years.

 

Safe Harbor Statement under the Private Securities Litigation Reform Act of 1995

 

This document contains forward-looking statements that reflect the views of management with respect to future events and financial performance. These forward-looking statements are subject to certain uncertainties and other factors that could cause actual results to differ materially from such statements. See “Risk Factors” above. These uncertainties and other factors include, but are not limited to, the words “anticipates,” “believes,” “estimates,” “expects,” “plans,” “projects,” “targets” and similar expressions which identify forward-looking statements. You should not place undue reliance on these forward-looking statements, which speak only as of the date the statements were made. We undertake no obligation to publicly update or revise any forward-looking statements.

 

  

ITEM 7A.

QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.

 

Not applicable

 

ITEM 8.

FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.

 

Our balance sheets as of December 31, 2014 and 2013, and the related statements of operations, shareholders’ equity and cash flows for the years ended December 31, 2014 and 2013, together with the Reports of Independent Registered Public Accounting Firms thereon appear beginning on Page F-1.

 

ITEM 9.

CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE.

 

After careful deliberation, effective May 7, 2014, the Audit Committee approved the engagement of GBQ LLC (“GBQ”) as the Company's independent registered public accounting firm for the year ended December 31, 2014. The Audit Committee also informed Crowe Horwath LLP (“Crowe”) that it was dismissed as the Company’s independent registered public accounting firm effective May 7, 2014.

 

Crowe's audit report on the Company's consolidated financial statements as of and for the years ended December 31, 2013 and 2012, did not contain an adverse opinion or a disclaimer of opinion and were not qualified or modified as to uncertainty, audit scope or accounting principles.

 

During the years ended December 31, 2013 and 2012, and in the subsequent interim period through May 7, 2014, there were (i) no disagreements between the Company and Crowe on any matter of accounting principles or practices, financial statement disclosure or auditing scope or procedure, which disagreements, if not resolved to the satisfaction of Crowe, would have caused Crowe to make reference to the subject matter of the disagreement in their reports on the financial statements for such years, and (ii) no "reportable events" as that term is defined in Item 304(a)(1)(v) of Regulation S-K.

 

The Company provided Crowe with a copy of the disclosures it made on Form 8-K (the "Report") prior to the time the Report was filed with the Securities and Exchange Commission (the "SEC").

 

The Company requested that Crowe furnish a letter addressed to the SEC stating whether or not it agrees with the statements made herein. Crowe’s letter dated May 9, 2014 confirmed its agreement.

 

In deciding to engage GBQ, the Audit Committee reviewed auditor independence and existing commercial relationships with GBQ, and concluded that GBQ had no commercial relationship with the Company that would impair its independence. During the years ended December 31, 2013 and 2012, and in the subsequent interim period through May 7, 2014 neither the Company nor anyone acting on its behalf had consulted with GBQ on any of the matters or events set forth in Item 304(a)(2) of Regulation S-K.

 

ITEM 9A.

CONTROLS AND PROCEDURES.

 

Evaluation of Disclosure Controls and Procedures

 

Our management, with the participation of the Company’s Principal Executive Officer and Principal Accounting Officer, has evaluated the effectiveness of the Company’s 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, as amended (the “Exchange Act”)) as of the end of the period covered by this report. In designing and evaluating the disclosure controls and procedures, management recognized that any controls and procedures, no matter how well designed and operated, can only provide reasonable assurance of achieving the desired control objectives and management is required to apply its judgment in evaluating the cost-benefit relationship of possible controls and procedures. Due to a segregation of duties material weakness described below, and based on this evaluation, the Company’s Principal Executive Officer and Principal Accounting Officer have concluded that as of December 31, 2014, the Company’s disclosure controls and procedures were not effective, at the reasonable assurance level, in recording, processing, summarizing and reporting, on a timely basis, information required to be disclosed by the Company in the reports that it files or submits under the Exchange Act and in ensuring that information required to be disclosed by the Company in the reports that it files or submits under the Exchange Act is accumulated and communicated to the Company’s management, including the Principal Executive Officer and Principal Accounting Officer, as appropriate to allow timely discussions regarding required disclosure. Until we are able to hire additional employees, we will continue to report to the Audit Committee and the Board of Directors at least monthly (and more often as necessary). We believe this will continue to mitigate this weakness. This reporting includes balance sheets, statements of operations, statements of cash flows, and other detail supporting these statements. Accordingly, we believe that the financial statements included in this report fairly present, in all material respects, our financial condition, results of operations, changes in shareholder’s equity and cash flows for all periods presented.

 

Inherent Limitations Over Internal Controls

 

Our internal control over financial reporting is designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. Our internal control over financial reporting includes those policies and procedures that: (i) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of our assets; (ii) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures are being made only in accordance with authorizations of management and directors; and (iii) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of assets that could have a material effect on the financial statements.

 

Management, including our Chief Executive Officer and Chief Financial Officer, does not expect that our internal controls will prevent or detect all errors and all fraud. A control system, no matter how well designed and operated, can provide only reasonable, not absolute, assurance that the objectives of the control system are met. Further, the design of a control system must reflect the fact that there are resource constraints, and the benefits of controls must be considered relative to their costs. Because of the inherent limitations in all control systems, no evaluation of internal controls can provide absolute assurance that all control issues and instances of fraud, if any, have been detected. Also, any evaluation of the effectiveness of controls in future periods are subject to the risk that those internal controls may become inadequate because of changes in business conditions, or that the degree of compliance with the policies or procedures may deteriorate.

 

Management's Annual Report on Internal Control over Financial Reporting

 

Our management is responsible for establishing and maintaining adequate internal control over financial reporting (as defined in Rule 13a-15(f) under the Securities Exchange Act of 1934, as amended). Management conducted an evaluation of the effectiveness of our internal control over financial reporting based on the criteria established in the Internal Control – Integrated Framework (2013 Framework) issued by the Committee of Sponsoring Organizations of the Treadway Commission ("COSO"). Based on this evaluation, management has concluded that our internal control over financial reporting was not effective as of December 31, 2014. The matter involving internal controls over financial reporting that management considered to be a material weakness under the standards of the Public Company Accounting Oversight Board (PCAOB) was insufficient segregation of duties consistent with control objectives. Management is aware of the risks associated with the lack of segregation of duties due to the small number of employees currently working with general administrative and financial matters. Due to our size and nature, segregation of all conflicting duties may not always be possible and may not be economically feasible. However, to the extent possible, the initiation of transactions, the custody of assets and the recording of transactions should be performed by separate individuals.

 

In order to remediate this weakness, we will need to hire additional employees. Although we will periodically reevaluate this situation, at this point we consider that the risks associated with such lack of segregation of duties and the potential benefits of adding employees to segregate such duties are not cost justified. Until we are able to hire additional employees, we will continue to report to the Audit Committee and the Board of Directors at least monthly (and more often as necessary). We believe this will continue to mitigate this weakness. This reporting includes balance sheets, statements of operations, statements of cash flows, and other detail supporting these statements.

 

This annual report does not include an attestation report of our registered public accounting firm regarding internal control over financial reporting. Our report was not subject to attestation by our registered public accounting firm pursuant to rules of the Securities and Exchange Commission that permits us to provide only management’s report in this annual report.

 

Changes in Internal Control over Financial Reporting

 

There were no changes in the Company’s internal control over financial reporting (as such term is defined in Exchange Act Rule 13a-15(f) and Rule 15d-15(f)) that occurred in the last fiscal quarter that materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.

 

ITEM 9B.

OTHER INFORMATION

 

None.

 

 

PART III

 

ITEM 10.

DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE.

 

The information required by this item is included under the captions, “Election of Directors,” “Executive Officers” and “Section 16(a) Beneficial Ownership Reporting Compliance” in our proxy statement relating to our 2015 Annual Meeting of Shareholders scheduled to be held on June 11, 2015, and is incorporated herein by reference.

 

We have a Business Conduct Policy applicable to all employees of SCI. Additionally, the Chief Executive Officer ("CEO") and all senior financial officers, including the principal financial officer, the principal accounting officer or controller, or any person performing a similar function (collectively, the "Senior Financial Officers") are bound by the provisions of our code of ethics relating to ethical conduct, conflicts of interest, and compliance with the law. The code of ethics is posted on our website at http://www.sciengineeredmaterials.com/investors /main/corpgov.htm.

 

We intend to satisfy the disclosure requirement under Item 10 of Form 8-K regarding any amendment to, waiver of, any provision of this code of ethics by posting such information on our website at the address and location specified above.

 

ITEM 11.

EXECUTIVE COMPENSATION.

 

The information required by this item is included under the caption “Executive Compensation” in our proxy statement relating to our 2015 Annual Meeting of Shareholders scheduled to be held on June 11, 2015, and is incorporated herein by reference.

 

ITEM 12.

SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS.

 

The information required by this item is included under the captions “Ownership of Common Stock by Directors and Executive Officers” and “Ownership of Common Stock by Principal Shareholders” in our proxy statement relating to our 2015 Annual Meeting of Shareholders scheduled to be held on June 11, 2015, and is incorporated herein by reference.

 

ITEM 13.

CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE.

 

The information required by this item is included under the caption “Certain Relationships and Related Transactions, and Director Independence” in our proxy statement relating to our 2015 Annual Meeting of Shareholders scheduled to be held on June 11, 2015, and is incorporated herein by reference.

 

ITEM 14.

PRINCIPAL ACCOUNTANT FEES AND SERVICES.

 

The information required by this item is included under the caption “Fees of the Independent Public Accounting Firms for the year ended December 31, 2014” in our proxy statement relating to our 2015 Annual Meeting of Shareholders scheduled to be held on June 11, 2015, and is incorporated herein by reference.

 

 

ITEM 15.

EXHIBITS AND FINANCIAL STATEMENT SCHEDULES.

 

Exhibit		Exhibit
Number		Description
3(a)		Certificate of Second Amended and Restated Articles of Incorporation of Superconductive Components, Inc. (Incorporated by reference to Exhibit 3(a) to the Company’s initial Form 10-SB, filed on September 28, 2000)
3(b)		Restated Code of Regulations of Superconductive Components, Inc. (Incorporated by reference to Exhibit 3(b) to the Company’s initial Form 10-SB, filed on September 28, 2000)
3(c)		Amendment to Articles of Incorporation recording the change of the corporate name to SCI Engineered Materials, Inc.  (Incorporated by reference to Exhibit 3.1 to the Company’s Quarterly Report on Form 10-QSB filed November 7, 2007).
4(a)		SCI Engineered Materials, Inc. 2011 Stock Incentive Plan (Incorporated by reference to the Company’s Definitive Proxy Statement for the 2011  Annual Meeting of Shareholders held on June 10, 2011, filed April 28,  2011).
4(b)		Superconductive Components, Inc. 2006 Stock Incentive Plan (Incorporated by reference to Appendix A to the Company’s Definitive Proxy Statement for the 2006 Annual Meeting of Shareholders held on June 9, 2006, filed May 1, 2006).
4(c)		Description of the Material Terms of the Stock Option Grant and Cash Bonus Plan for Executive Officers (Incorporated by reference to the Company’s Current Report on Form 8-K, dated June 19, 2006, filed June 23, 2006)
4(d)		Form of Incentive Stock Option Agreement under the Superconductive Components, Inc. 2006 Stock Incentive Plan (Incorporated by reference to Exhibit 10.1 to the Company’s Current Report on Form 8-K dated June 19, 2006, filed June 23, 2006).
4(e)		Form of Non-Statutory Stock Option Agreement under the Superconductive Components, Inc. 2006 Stock Incentive Plan  (Incorporated by reference to Exhibit 10.2 to the Company’s Current Report  on Form 8-K dated June 19, 2006, filed June 23, 2006).
4(f)		Description of the Material Terms of the Stock Option Grant for Executive Officers and Board of Directors (Incorporated by reference to the Company’s Current Report on Form 8-K dated January 2, 2009, filed January 6, 2009).
4(g)		Fourth Amended and Restated 1995 Stock Option Plan (Incorporated by reference to Exhibit 4(a) to the Company’s Registration Statement on Form S-8 (Registration No. 333-97583), filed on August 2, 2002)
4(h)		Form of Non-Statutory Stock Option Agreement Under the Superconductive Components, Inc. Fourth Amended and Restated 1995 Stock Option Plan (Incorporated by reference to Exhibit 10.1 to the Company’s Current Report on Form 8-K, filed on December 22, 2005)

 

 

10(a)		Employment Agreement entered into as of February 26, 2002, between Daniel Rooney and the Company (Incorporated by reference to Exhibit 10(a) to the Company’s Registration Statement on Form SB-2 (Registration No. 333-131605), filed on February 6, 2006, and amended by Pre-effective Amendment No. 1 filed March 23, 2006)
10(b)	*	First Amendment to Lease between SCI Engineered Materials, Inc. and Ohio Industrial Owner I, LLC dated March 10, 2014.
10(c)		Business Loan Agreement between the Company and The Huntington National Bank, dated as of January 13, 2009 (Incorporated by reference to the Company’s Current Report on Form 8-K, filed January 23, 2009).
10(d)		Notification from the Ohio Department of Development Third Frontier Photovoltaic Program of grant to be awarded dated December 17, 2009 (Incorporated by reference to the Company’s Current Report on Form 8-K, filed December 22, 2009).
10(e)		Description of amendment to the Loan Agreement between the Company and The Ohio Air Quality Development Authority (Incorporated by reference to the Company’s Current Report on Form 8-K, dated March 26, 2012).
10(f)		Description of amendment to the Loan Agreement between the Company and the Ohio Department of Development (Incorporated by reference to the Company’s Current Report on Form 8-K, dated April 9, 2012).
10(g)		Description of amendment to the Loan Agreement between the Company and The Ohio Air Quality Development Authority (Incorporated by reference to the Company’s Current Report on Form 8-K, filed July 10, 2012).
10(h)		Description of resolution to the Loan Agreement between the Company and The Ohio Air Quality Development Authority (Incorporated by reference to the Company’s Current Report on Form 8-K, filed October 19, 2012).
10(i)		Description of Business Loan Agreement between the Company and The Huntington National Bank, dated as of October 15, 2012 (Incorporated by reference to the Company’s Current Report on Form 8-K, filed October 19, 2012).
10(j)		Description of amendment to the Loan Agreement between the Company and the Ohio Development Services Agency, formerly known as the Department of Development (Incorporated by reference to the Company’s Current Report on Form 10-K, dated March 19, 2013).
10(k)		Description of modification to payment schedules between the Company and the Ohio Development Services Agency, formerly known as the Ohio Department of Development and Description of Business Loan Agreement between the Company and The Huntington National Bank dated as of October 8, 2013 (Incorporated by reference to the Company’s Current Report on Form 8-K, dated August 12, 2013).
10(l)		Description of amendment to Loan Documents between the Company and the Ohio Air Quality Development Authority dated as of December 20, 2013 (Incorporated by reference to the Company’s Current Report on Form 8-K, dated December 26, 2013).

 

 

10(m)		Description of amendment to the Loan Agreement between the Company and the Ohio Development Services Agency, formerly known as the Ohio Department of Development (Incorporated by reference to the Company’s Current Report on Form 8-K, dated July 24, 2014).
10(n)		Description of notice of transfer of common stock (Incorporated by reference to the Company’s Current Report on Form 8-K, dated January 28, 2015).
14(a)		SCI Engineered Materials Code of Ethics for the Chief Executive Officer and Chief Financial Officer (Incorporated by reference to the Company’s Current Report via the Company’s website at www.sciengineeredmaterials.com)
23	*	Consent of Independent Registered Public Accounting Firm
23.1	*	Consent of Independent Registered Public Accounting Firm
24	*	Powers of Attorney.
31.1	*	Rule 13a-14(a) Certification of Principal Executive Officer.
31.2	*	Rule 13a-14(a) Certification of Principal Financial Officer.
32.1	*	Section 1350 Certification of Principal Executive Officer.
32.2	*	Section 1350 Certification of Principal Financial Officer.
99.1		Press Release dated February 11, 2015, entitled “SCI Engineered Materials, Inc., Reports 2014 Fourth Quarter and Full-Year  Results.”
101		The Company’s Annual Report on Form 10-K for the year ended December 31, 2014, formatted in XBRL (eXtensible Business Reporting  Language): (i) Consolidated Balance Sheets at December 31, 2014 and  December 31, 2013 (ii) Consolidated Statements of Operations for the  year ended December 31 2014 and 2013, (iii)  Consolidated Statement of Changes in Equity for the years ended December 31, 2014 and December 2013, (iv) Consolidated Statements of Cash Flows for the year ended December 31, 2014 and 2013, and (v) Notes to Financial  Statements.

_____________

* Filed herewith

 

  

SIGNATURES

 

Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.

 

	SCI ENGINEERED MATERIALS, INC.
Date:  February 11, 2015	By:	/s/ Daniel Rooney
		Daniel Rooney, Chairman of the Board of Directors, President and Chief Executive Officer

Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Registrant and in the capacities indicated on the 11^th day of February 2015.

 

	Signature		Title
	/s/ Daniel Rooney		Chairman of the Board of Directors, President, and
			Chief Executive Officer
			(principal executive officer)
	/s/ Gerald S. Blaskie		Vice President and Chief Financial Officer
	Gerald S. Blaskie		(principal financial officer and principal accounting officer)
	Laura F. Shunk*		Director
	Laura F. Shunk
	Edward W. Ungar*		Director
	Edward W. Ungar
	Robert H. Peitz*		Director
	Robert H. Peitz
	Emily Lu*		Director
	Emily Lu
*By:	/s/ Daniel Rooney
	Daniel Rooney, Attorney-in-Fact

 

 

INDEX TO FINANCIAL STATEMENTS

 

 

	Page
Report of Independent Registered Public Accounting Firms	F-1
Balance Sheets	F-3
Statements of Operations	F-5
Statements of Shareholders’ Equity	F-6
Statements of Cash Flows	F-7
Notes to Financial Statements	F-8

 

 

Report of Independent Registered Public Accounting Firm

 

Board of Directors and Shareholders

SCI Engineered Materials, Inc.

Columbus, Ohio

 

We have audited the accompanying balance sheet of SCI Engineered Materials, Inc. (the “Company”) as of December 31, 2014 and the related statement of operations, shareholders’ equity, and cash flows for the year then ended. These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements based on our audit.

 

We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. Our audit included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control over financial reporting. Accordingly, we express no such opinion. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audit provides a reasonable basis for our opinion.

 

In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of the Company as of December 31, 2014, and the results of its operations and its cash flows for the year then ended in conformity with U.S. generally accepted accounting principles.

 

GBQ Partners LLC

Columbus, Ohio

February 11, 2015

 

 

Report of Independent Registered Public Accounting Firm

 

Board of Directors and Shareholders

SCI Engineered Materials, Inc.

Columbus, Ohio

 

We have audited the accompanying balance sheet of SCI Engineered Materials, Inc. (the “Company”) as of December 31, 2013 and the related statements of operations, shareholders’ equity, and cash flows for the year then ended. These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements based on our audit.

 

We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. Our audit included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control over financial reporting. Accordingly, we express no such opinion. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audit provides a reasonable basis for our opinion.

 

In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of the Company as of December 31, 2013, and the results of its operations and its cash flows for the year then ended in conformity with U.S. generally accepted accounting principles.

 

Crowe Horwath LLP

Columbus, Ohio

March 4, 2014

  

 

PART I.  FINANCIAL INFORMATION

 

ITEM 1. FINANCIAL STATEMENTS

 

SCI ENGINEERED MATERIALS, INC.

 

BALANCE SHEETS

 

DECEMBER 31, 2014 AND 2013

 

ASSETS
		2014				2013
Current Assets
Cash		$	1,011,956			$	622,727
Accounts receivable
Trade, less allowance for doubtful accounts of $15,000			457,642				632,011
Other			10,710				2,066
Inventories			1,678,609				1,709,740
Prepaid expenses			89,467				56,298
Total current assets			3,248,384				3,022,842
Property and Equipment, at cost
Machinery and equipment			7,478,909				7,116,055
Furniture and fixtures			139,110				137,911
Leasehold improvements			326,745				317,870
Construction in progress			1,815				2,093
			7,946,579				7,573,929
Less accumulated depreciation and amortization			(5,205,675	)			(4,781,362	)
			2,740,904				2,792,567
Other Assets
Deposits			18,532				15,645
Deferred financing fees			19,665				29,104
Intangibles			9,229				11,059
Total other assets			47,426				55,808
TOTAL ASSETS		$	6,036,714			$	5,871,217

 

The accompanying notes are an integral part of these financial statements.

 

 

SCI ENGINEERED MATERIALS, INC.

 

BALANCE SHEETS (continued)

 

DECEMBER 31, 2014 AND 2013

 

LIABILITIES AND SHAREHOLDERS' EQUITY

 

		2014				2013
Current Liabilities
Capital lease obligations, current portion		$	145,896			$	104,010
Notes payable, current portion			298,209				247,679
Accounts payable			424,539				456,111
Customer deposits			1,281,573				1,105,655
Accrued compensation			93,392				75,815
Accrued expenses and other			115,126				115,672
Total current liabilities			2,358,735				2,104,942
Capital lease obligations, net of current portion			339,191				132,739
Notes payable, net of current portion			610,568				908,787
Total liabilities			3,308,494				3,146,468
Commitments and contingencies
Shareholders' Equity
Convertible preferred stock, Series B, 10% cumulative,
nonvoting, no par value, $10 stated value, optional
redemption at 103%;  optional shareholder conversion 2 shares for 1;
24,152 shares issued and outstanding			466,134				441,982
Common stock, no par value, authorized 15,000,000 shares;
3,935,398 and 3,852,898 shares issued and outstanding, respectively			9,907,990				9,833,620
Additional paid-in capital			1,960,260				1,835,387
Accumulated deficit			(9,606,164	)			(9,386,240	)
Total shareholders' equity			2,728,220				2,724,749
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY		$	6,036,714			$	5,871,217

 

The accompanying notes are an integral part of these financial statements.

 

 

SCI ENGINEERED MATERIALS, INC.

 

STATEMENTS OF OPERATIONS

 

YEARS ENDED DECEMBER 31, 2014 AND 2013

 

		2014				2013
Total revenue		$	9,255,103			$	7,976,429
Total cost of revenue			7,405,985				6,440,137
Gross profit			1,849,118				1,536,292
General and administrative expense			1,191,982				1,052,181
Research and development expense			307,083				324,035
Marketing and sales expense			500,866				448,166
Loss from operations			(150,813	)			(288,090	)
Interest, net			(66,933	)			(73,245	)
(Loss) gain on disposal of equipment			(2,709	)			73,689
Other (expense) income			(69,642	)			444
Loss before income taxes			(220,455	)			(287,646	)
Income tax benefit			531				-
Net loss			(219,924	)			(287,646	)
Dividends on preferred stock			(24,152	)			(24,152	)
LOSS APPLICABLE TO COMMON STOCK		$	(244,076	)		$	(311,798	)
Earnings per share - basic and diluted
(Note 6)
Loss per common share
Basic		$	(0.06	)		$	(0.08	)
Diluted		$	(0.06	)		$	(0.08	)
Weighted average shares outstanding
Basic			3,873,986				3,839,117
Diluted			3,873,986				3,839,117

 

The accompanying notes are an integral part of these financial statements.

 

 

SCI ENGINEERED MATERIALS, INC.

 

STATEMENTS OF SHAREHOLDERS' EQUITY

 

YEARS ENDED DECEMBER 31, 2014 AND 2013

 

		Convertible								Additional
		Preferred Stock,				Common				Paid-In				Accumulated
		Series B				Stock				Capital				Deficit				Total
Balance 1/1/13		$	417,830			$	9,800,100			$	1,758,358			$	(9,098,594	)		$	2,877,694
Accretion of cumulative dividends			24,152				-				(24,152	)			-				-
Stock based compensation expense (Note 2J)			-				-				101,181				-				101,181
Common stock issued (Note 6)			-				33,520				-				-				33,520
Net loss			-				-				-				(287,646	)			(287,646	)
Balance 12/31/13		$	441,982			$	9,833,620			$	1,835,387			$	(9,386,240	)		$	2,724,749
Accretion of cumulative dividends			24,152				-				(24,152	)			-				-
Stock based compensation expense (Note 2J)			-				-				149,025				-				149,025
Common stock issued (Note 6)			-				74,370				-				-				74,370
Net loss			-				-				-				(219,924	)			(219,924	)
Balance 12/31/14		$	466,134			$	9,907,990			$	1,960,260			$	(9,606,164	)		$	2,728,220

 

The accompanying notes are an integral part of these financial statements.

 

 

SCI ENGINEERED MATERIALS, INC.
STATEMENTS OF CASH FLOWS
YEARS ENDED DECEMBER 31, 2014 AND 2013

 

		2014				2013
CASH FLOWS FROM OPERATING ACTIVITIES
Net loss		$	(219,924	)		$	(287,646	)
Adjustments to reconcile net loss to net cash
provided by operating activities:
Depreciation and accretion			512,968				571,528
Amortization			1,830				1,830
Stock based compensation			172,995				134,701
Loss (gain) on disposal of equipment			2,709				(73,689	)
Inventory reserve			56,563				34,863
Change in allowance for doubtful accounts			-				(30,223	)
Changes in operating assets and liabilities:
Accounts receivable			165,725				(150,552	)
Inventories			(25,433	)			(929,528	)
Prepaid expenses			(33,169	)			153,124
Other assets			6,552				9,126
Accounts payable			(31,572	)			195,580
Accrued expenses and customer deposits			182,750				779,760
Net cash provided by operating activities			791,994				408,874
CASH FLOWS FROM INVESTING ACTIVITIES
Proceeds on sale of equipment			1,750				75,050
Purchases of property and equipment			(59,399	)			(40,470	)
Net cash (used in) provided by investing activities			(57,649	)			34,580
CASH FLOWS FROM FINANCING ACTIVITIES
Proceeds from sale of common stock			50,400				-
Principal payments on capital lease obligations and notes payable			(395,516	)			(451,546	)
Net cash used in financing activities			(345,116	)			(451,546	)
NET INCREASE (DECREASE) IN CASH		$	389,229			$	(8,092	)
CASH - Beginning of year			622,727				630,819
CASH - End of year		$	1,011,956			$	622,727
SUPPLEMENTAL DISCLOSURES OF CASH
FLOW INFORMATION
Cash paid during the year for:
Interest		$	67,869			$	73,934
Income taxes		$	-			$	-
SUPPLEMENTAL DISCLOSURES OF NONCASH
INVESTING AND FINANCING ACTIVITIES
Property and equipment purchased by capital lease		$	396,165			$	86,389
Increase in asset retirement obligation		$	10,200			$	9,420

 

The accompanying notes are an integral part of these financial statements.

 

 

SCI ENGINEERED MATERIALS, INC.

NOTES TO FINANCIAL STATEMENTS

 

Note 1. Business Organization and Purpose

 

SCI Engineered Materials, Inc. (“SCI”, “we” or the “Company”), formerly Superconductive Components, Inc., an Ohio corporation, was incorporated in 1987.  The Company operates in one segment as a global supplier and manufacturer of advanced materials for Physical Vapor Deposition (“PVD”) Thin Film Applications.  The Company is focused on specific markets within the PVD industry (Photonics, Thin Film Solar, Glass, Thin Film Battery and Transparent Electronics).  Substantially, all of the Company’s revenues were generated from customers with multi-national operations.  Through partnerships with end users and Original Equipment Manufacturers the Company develops innovative customized solutions enabling commercial success.

 

Note 2. Summary of Significant Accounting Policies

 

A. Cash - The Company considers all highly liquid investments purchased with an original maturity of three months or less to be cash.

 

B. Fair Value of Financial Instruments - The estimated fair value of amounts reported in the financial statements have been determined using available market information and valuation methodologies, as applicable (see Note 9).

 

C. Concentrations of Credit Risk - The Company’s cash balances, which are at times in excess of federally insured levels, are maintained at a large regional bank and a global investment banking group, and are continually monitored to minimize the risk of loss. The Company grants credit to most customers, who are varied in terms of size, geographic location and financial strength. Customer balances are continually monitored to minimize the risk of loss.

 

The Company’s two largest customers accounted for 47% and 32% of total revenue in 2014. These two customers represented 42% of the accounts receivable trade balance at December 31, 2014. The Company expects to collect all outstanding accounts receivables as of December 31, 2014 from these customers.

 

The Company’s two largest customers accounted for 38% and 37% of total revenue in 2013. These two customers represented 61% of the accounts receivable trade balance at December 31, 2013. The Company subsequently collected all outstanding accounts receivables as of December 31, 2013 from these customers.

 

D. Accounts Receivable - The Company extends unsecured credit to customers under normal trade agreements which require payment within 30 days. The Company does not charge interest on delinquent trade accounts receivable. Unless specified by the customer, payments are applied to the oldest unpaid invoice. Accounts receivable are presented at the amount billed.

 

Management estimates an allowance for doubtful accounts, which was approximately $15,000 as of December 31, 2014 and 2013. This estimate is based upon management’s review of delinquent accounts and an assessment of the Company’s historical evidence of collections. Specific accounts are charged directly to the reserve or bad debt expense when management obtains evidence of a customer’s insolvency or otherwise determines that the account is uncollectible. Bad debt expense was $17,256 and ($26,929) during 2014 and 2013, respectively. The credit during 2013 included a reversal of bad debt expense recorded in 2012.

 

 

SCI ENGINEERED MATERIALS, INC.

NOTES TO FINANCIAL STATEMENTS

 

Note 2. Summary of Significant Accounting Policies (continued)

 

E. Inventories - Inventories are stated at the lower of cost or market on an acquired or internally produced lot basis, and consist of raw materials, work-in-process and finished goods. Cost includes material, labor, freight and applied overhead. Inventory reserves are established for obsolete inventory, lower of cost or market, and excess inventory quantities based on management’s estimate of net realizable value. The Company had an inventory reserve of $191,426 at December 31, 2014, and $134,863 at December 31, 2013.

 

F. Property and Equipment - Property and equipment are carried at cost. Depreciation is provided using the straight-line method based on the estimated useful lives of the assets. Useful lives range from three years on computer equipment to sixteen years on certain equipment. Leasehold improvements are amortized over the shorter of the estimated useful life or the term of the lease. Depreciation expense totaled $502,768 and $562,108 for the years ended December 31, 2014 and 2013, respectively. Expenditures for renewals and betterments are capitalized and expenditures for repairs and maintenance are charged to operations as incurred.

 

Long-lived assets are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount may not be recoverable. If the fair value is less than the carrying amount of the asset, a loss is recognized for the difference. There was no property and equipment considered impaired during 2014 or 2013.

 

G. Deferred Financing Costs - Deferred financing costs are amortized over the term of the related debt using the straight-line method, the result of which is not materially different from the use of the interest method.  Deferred financing costs were $29,104 and $38,543 at December 31, 2014 and 2013, respectively.  The related amortization of these costs for the years ended December 31, 2014 and 2013 was $9,439 and is included in interest expense on the statements of operations.

 

H. Intangible Assets - The Company reviews intangible assets for impairment and performs detailed testing whenever impairment indicators are present. If necessary, an impairment loss is recorded for the excess of carrying value over fair value. There were no intangible assets considered impaired during 2014 or 2013.

 

The Company has secured patents for manufacturing processes used in its operations. Costs incurred to secure the patents have been capitalized and are being amortized over the life of the patents. Cost and accumulated amortization of the patents at December 31, 2014 were $36,473 and $27,244 respectively. Cost and accumulated amortization of the patents at December 31, 2013 were $36,473 and $25,414 respectively. Amortization expense was approximately $1,830 for the years ended December 31, 2014 and 2013. Amortization expense is estimated to be at least $1,829 for each of the next four years and at least $637 for the following year.

 

 

SCI ENGINEERED MATERIALS, INC.

NOTES TO FINANCIAL STATEMENTS

 

Note 2. Summary of Significant Accounting Policies (continued)

 

I. Revenue Recognition - Revenue from product sales is recognized based on shipping terms and upon shipment to customers. Provisions for discounts and rework costs for returns are established when products are shipped based on historical experience. Customer deposits represent cash received in advance of revenue earned.

 

Revenue from contract research provided for third parties is recognized on the percentage of completion method. Contract research revenue is recognized during the period in which qualifying expenses are incurred for the research that is performed as set forth under the terms of the grant award agreements.

 

J. Stock Based Compensation - Compensation cost for all stock-based awards is based on the grant date fair value and is recognized over the required service (vesting) period. Non cash stock based compensation expense was $172,995 and $134,701 for the years ended December 31, 2014 and 2013, respectively. Non cash stock based compensation expense includes $23,970 for stock grants awarded to the non-employee board members in 2014 and $33,520 for stock grants awarded in 2013 to the non-employee board members and the Chief Executive Officer. Unrecognized compensation expense was $511,895 as of December 31, 2014 and will be recognized through 2019. There was no tax benefit recorded for this compensation cost as the expense primarily relates to incentive stock options that do not qualify for a tax deduction until, and only if, a qualifying disposition occurs.

 

K. Research and Development - Research and development costs are expensed as incurred. Research and development expense for the years ended December 31, 2014 and 2013 was $307,083 and $324,035, respectively. The Company continues to develop innovative metal oxide systems to further align activities with customer needs and late in 2014 began developing an aluminum product for a new application.  

 

L. Income Taxes - Income taxes are provided for by utilizing the asset and liability method which requires the recognition of deferred tax assets and liabilities for the expected future tax consequences of temporary differences between the carrying amounts and the tax bases of assets and liabilities using presently enacted tax rates. Deferred tax assets are reduced by a valuation allowance which is established when “it is more likely than not” that some portion or all of the deferred tax assets will not be recognized.

 

M. Use of Estimates - The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Estimates are used for, but not limited to, the accounting for the allowance for doubtful accounts, inventory allowances, property and equipment depreciable lives, patents and licenses useful lives, revenue recognition, tax valuation, stock based compensation and assessing changes in which impairment of certain long-lived assets may occur. Actual results could differ from those estimates.

 

 

SCI ENGINEERED MATERIALS, INC.

NOTES TO FINANCIAL STATEMENTS

Note3.

Inventories

 

Inventories consist of the following at December 31:

 

		2014				2013
Raw materials		$	814,307			$	1,174,945
Work-in-process			842,760				532,044
Finished goods			212,968				137,614
			1,870,035				1,844,603
Reserve for obsolete inventory			(191,426	)			(134,863	)
		$	1,678,609			$	1,709,740

      

Note 4. Notes Payable

 

On August 8, 2013, the Company issued a Promissory Note (the “Note”) in the amount of $128,257 to The Huntington National Bank, as Lender, with a maturity date of August 5, 2016. This Note replaced an existing promissory note to The Huntington National Bank.

 

The Note is collateralized by a blanket lien on all of the Company’s assets including, without limitation, inventory, equipment and accounts receivable. Among other items, the Note provides for the following:

 

-

Interest subject to change from time to time based on changes in LIBOR. The interest rate applied to the unpaid principal balance is at a rate of 4 percentage points over LIBOR. Under no circumstance will the interest rate be less than 5% per annum or more than the maximum rate allowed by applicable law.

 

-

Monthly payments of approximately $3,800, including interest, beginning in September 2013.

 

The interest rate on the Note was 5% at December 31, 2014 and 2013. As of December 31, 2014 there was an outstanding balance of $73,764 on this Note. The Company expects to maintain compliance with all covenants of this Note through at least December 31, 2015.

 

During 2010, the Company applied and was approved for a 166 Direct Loan to borrow up to $744,250 with the Ohio Department of Development (ODOD), now known as the Ohio Development Services Agency (ODSA). This loan was finalized in February 2011. The term of the loan is 84 months at a fixed interest rate of 3%. There is also a 0.25% annual servicing fee charged monthly on the outstanding principal balance. On August 13, 2013, ODSA and the Company agreed to a modification to the payment schedule. Interest and servicing payments of $1,656 were paid monthly from August 2013 through January 2014. Beginning in February 2014, monthly payments of approximately $10,500, including principal, interest and servicing fee are due through October 2018. A final payment of approximately $71,900 is due November 2018. The loan is collateralized by the related project equipment. As of December 31, 2014 there was an outstanding balance of $513,246 on this loan. This loan is also subject to certain covenants, including job creation and retention. On July 21, 2014, the Company and ODSA signed a second amendment relating to the job creation and retention. The Company expects to maintain compliance with all covenants of this loan through at least December 31, 2015.

 

 

SCI ENGINEERED MATERIALS, INC.

NOTES TO FINANCIAL STATEMENTS

 

Note 4. Notes Payable (continued)

 

During 2010, the Company also applied and was approved for a 166 Direct Loan through the Advanced Energy Program with the Ohio Air Quality Development Authority (OAQDA) to borrow up to approximately $1.4 million (this maximum commitment by the OAQDA was subsequently reduced to $368,906 on March 20, 2012). On December 20, 2013, OAQDA and the Company signed a Fourth Amendment to the Loan Documents and agreed to a modification to the payment schedule. Interest and servicing payments of $2,121 were payable quarterly from October 2013 through March 2014. Beginning in June 2014, quarterly payments of approximately $17,300, including principal, interest at 3% and servicing fees are due through December 2017. A final payment of approximately $50,400 is due February 2018. This loan is also subject to certain covenants, including job creation. Included in the above amendment is a waiver for the job creation commitment, due to market conditions, for the duration of the term of the Loan Agreement. The Company expects to maintain compliance with all covenants of this loan at least through December 31, 2015. The loan is collateralized by the related project equipment. As of December 31, 2014 there was an outstanding balance of $238,256 on this loan.

 

An Intercreditor Agreement exists as part of the above mentioned loans with agencies of the State of Ohio. The OAQDA and ODSA agree to shared lien and security interest through mutual covenants. These covenants include, but are not limited to, the creation of an agreed upon number of jobs, filing of quarterly and annual reports and various financial covenants. The Company expects to maintain compliance with all covenants of these loans through at least December 31, 2015.

 

During 2006, the Company was approved for a 166 Direct Loan from the Ohio Department of Development, now known as the ODSA, in the amount of $400,000. These funds were received in July of 2008 and were used for the purchase of production equipment and to reduce the Company’s capital lease obligations on certain equipment. The term of the loan is 84 months at a fixed interest rate of 3%. There is also a 0.25% annual servicing fee to be charged monthly on the outstanding principal balance. On August 8, 2013, ODSA and the Company agreed to a modification to the payment schedule. Interest and servicing payments of approximately $400 were paid monthly from August 2013 through January 2014. Beginning in February 2014, monthly payments of approximately $6,100, including principal, interest and servicing fee are payable through July 2015. A final payment of approximately $42,200 is due August 2015. The loan is collateralized by the related project equipment. As of December 31, 2014 the loan had a balance of $83,511. This loan is also subject to certain covenants, including job creation and retention. The Company expects to maintain compliance with all covenants of this loan through the remainder of this loan.

 

 

SCI ENGINEERED MATERIALS, INC.

NOTES TO FINANCIAL STATEMENTS

 

Note 4. Notes Payable (continued)

 

Notes payable at December 31 is included in the accompanying balance sheets as follows:

 

		2014				2013
Huntington National Bank		$	73,764			$	115,052
ODSA 166 Direct Loan			513,246				611,520
OAQDA 166 Direct Loan			238,256				282,786
ODSA 166 Direct Loan			83,511				147,108
Total notes payable			908,777				1,156,466
Less current portion			298,209				247,679
Notes payable, net of current portion		$	610,568			$	908,787

 

Annual maturities of notes payable, for the next five years, are as follows:

 

2015		$	298,209
2016			206,829
2017			181,847
2018			221,892
2019			-

 

Note 5. Lease Obligations

 

Operating

 

The Company leases its facilities and certain office equipment under agreements classified as operating leases expiring at various dates through 2024. Rent expense, which includes various monthly rentals for the years ended December 31, 2014 and 2013 totaled $166,641 and $150,328, respectively. Future minimum lease payments at December 31, 2014 are as follows:

 

2015		$	100,359
2016			102,078
2017			104,044
2018			106,291
2019 and beyond			655,528
Total minimum lease payments		$	1,068,300

 

 

SCI ENGINEERED MATERIALS, INC.

NOTES TO FINANCIAL STATEMENTS

 

Note 5. Lease Obligations (continued)

 

Capital

 

The Company also leases certain equipment under capital leases. Future minimum lease payments, by year, with the present value of such payments, as of December 31, 2014 are shown in the following table.

 

2015		$	167,806
2016			138,466
2017			103,354
2018			86,122
2019			39,513
Total minimum lease payments			535,261
Less amount representing interest			50,174
Present value of minimum lease payments			485,087
Less current portion			145,896
Capital lease obligations, net of current portion		$	339,191

 

The equipment under capital lease at December 31 is included in the accompanying balance sheets as follows:

 

		2014				2013
Machinery and equipment		$	881,538			$	762,223
Less accumulated depreciation and amortization			258,035				292,868
Net book value		$	623,503			$	469,355

 

These assets are amortized over a period of ten years using the straight-line method and amortization is included in depreciation expense.

 

The capital leases are structured such that ownership of the leased asset reverts to the Company at the end of the lease term. Accordingly, leased assets are depreciated using the Company's normal depreciation methods and lives.  In 2014, ownership of certain assets were transferred to the Company in accordance with the terms of the leases and these assets have been excluded from the leased asset disclosure above.

 

 

SCI ENGINEERED MATERIALS, INC.

NOTES TO FINANCIAL STATEMENTS

 

Note 6. Common and Preferred Stock

 

Common Stock

 

During 2014, the non-employee board members received 22,500 shares of common stock of the Company with an aggregate value of $23,970. This was recorded as non-cash stock compensation expense in the financial statements. Also, late in 2014, through a subscription agreement, a non-employee director purchased 60,000 shares of common stock of the Company with a value of $50,400.

 

During 2013, the non-employee board members received 24,000 shares of common stock of the Company with an aggregate value of $31,320. In addition, the Chief Executive Officer received 2,000 shares of common stock of the Company with a value of $2,200. These transactions were recorded as non-cash stock compensation expense in the financial statements.

 

Preferred Stock

 

Shares of preferred stock authorized and outstanding at December 31, 2014 and 2013 were as follows:

 

		Shares				Shares
		Authorized				Outstanding
Cumulative Preferred Stock			10,000				-
Voting Preferred Stock			125,000				-
Cumulative Non-Voting Preferred Stock			125,000	(a)			24,152

 

 

(a)

Includes 700 shares of Series A Preferred Stock and 100,000 shares of Convertible Series B Preferred Stock authorized for issuance.

 

In January 1996, the Company completed an offering of 70,000 shares of $10 stated value 1995 Series B 10% cumulative non-voting convertible preferred stock. The shares are convertible to common shares at the rate of $5.00 per share. At the Company’s option, the Series B shares are redeemable at 103% of the stated value plus the amount of any accrued and unpaid cash dividends.

 

On December 10, 2014, the Board of Directors voted to authorize the payment of a cash dividend on convertible preferred stock, Series B, to shareholders of record as of December 31, 2014. The decision to pay this dividend was predicated on the Company’s improved cash position. The payment of approximately $24,000 is expected to be disseminated during June 2015. The Board of Directors had previously voted not to authorize the payment of a cash dividend on convertible preferred stock, Series B, to shareholders of record as of December 31, 2013. At December 31, 2014 and 2013 the Company had accrued dividends on Series B preferred stock of $217,368 and $193,216, respectively. These amounts are included in convertible preferred stock, Series B on the balance sheet at December 31, 2014 and 2013.

 

 

SCI ENGINEERED MATERIALS, INC.

NOTES TO FINANCIAL STATEMENTS

 

Note 6. Common and Preferred Stock (continued)

 

Earnings Per Share

 

Basic income (loss) per share is calculated as income available (loss attributable) to common shareholders divided by the weighted average of common shares outstanding. Diluted earnings per share is calculated as diluted income available (loss attributable) to common stockholders divided by the diluted weighted average number of common shares outstanding. Diluted weighted average number of common shares gives effect to all dilutive potential common shares outstanding during the period using the treasury stock method and convertible preferred stock using the if-converted method. Diluted earnings per share exclude all diluted potential shares if their effect is anti-dilutive. For the years ended December 31, 2014 and 2013, all convertible and preferred stock and common stock options listed in Note 7 were excluded from diluted earnings per share due to being out-of-the-money or anti-dilutive.

 

Following is a summary of employee and director outstanding stock options outstanding and preferred stock, Series B at December 31.

 

		2014				2013
Options			703,857				706,500
Preferred Stock, Series B			24,152				24,152
			728,009				730,652

 

The following is provided to reconcile the earnings per share calculations:

 

 

		2014				2013
Loss applicable to common stock		$	(244,076	)		$	(311,798	)
Weighted average common shares outstanding - basic			3,873,986				3,839,117
Effect of dilutions - stock options			-				-
Weighted average shares outstanding - diluted			3,873,986				3,839,117

 

Note 7. Stock Option Plans

 

On June 10, 2011, shareholders approved the SCI Engineered Materials, Inc. 2011 Stock Incentive Plan (the “2011 Plan”). The Company adopted the 2011 Plan as incentive to key employees, directors and consultants under which options to purchase up to 250,000 shares of the Company’s common stock may be granted, subject to the execution of stock option agreements. Incentive stock options may be granted to key employees of the Company and non-statutory options may be granted to directors who are not employees and to consultants and advisors who render services to the Company. Options may be exercised for periods up to 10 years from the date of grant at prices not less than 100% of fair market value on the date of grant. As of December 31, 2014 there were no stock options outstanding from the 2011 Plan.

 

 

SCI ENGINEERED MATERIALS, INC.

NOTES TO FINANCIAL STATEMENTS

 

Note 7. Stock Option Plans (continued)

 

On June 9, 2006, shareholders approved the Superconductive Components, Inc. 2006 Stock Incentive Plan. The Company adopted the 2006 Plan as incentive to key employees, directors and consultants under which options to purchase up to 600,000 shares of the Company’s common stock may be granted, subject to the execution of stock option agreements. Incentive stock options may be granted to key employees of the Company and non-statutory options may be granted to directors who are not employees and to consultants and advisors who render services to the Company. Options may be exercised for periods up to 10 years from the date of grant at prices not less than 100% of fair market value on the date of grant. As of December 31, 2014 there were 573,857 stock options outstanding from the 2006 Plan which expire at various dates through November 2024.

 

On September 29, 1995, the Company adopted the 1995 Stock Option Plan as incentive to key employees, directors and consultants. As of December 31, 2014 there were 130,000 stock options outstanding from the 1995 Plan which expire at various dates through December 2015. The Company adopted the 1995 Plan as incentive to key employees, directors and consultants under which options to purchase up to 900,000 shares of the Company’s common stock were available to be granted, subject to the execution of stock option agreements.

 

The cumulative status at December 31, 2014 and 2013 of options granted and outstanding, as well as options which became exercisable in connection with the Stock Option Plans is summarized as follows:

 

Employee Stock Options

 

						Weighted				Weighted
						Average				Average				Aggregate
						Exercise				Contractual				Intrinsic
		Stock Options				Price				Term (yrs)				Value
Outstanding at January 1, 2013			592,250			$	5.23
Forfeited			(105,500	)			5.37
Expired			(250	)			1.00
Outstanding at December 31, 2013			486,500			$	5.20
Granted			172,357				0.84
Expired			(55,000	)			2.78
Outstanding at December 31, 2014			603,857			$	4.18				5.3			$	-
Options exercisable at December 31, 2014			285,700			$	5.26				3.3			$	-
Options exercisable at December 31, 2013			304,250			$	4.73				3.5			$	-
Options expected to vest			318,157			$	3.20				7.2			$	-

 

 

SCI ENGINEERED MATERIALS, INC.

NOTES TO FINANCIAL STATEMENTS

 

Note 7. Stock Option Plans (continued)

 

Non-Employee Director Stock Options

 

						Weighted				Weighted
						Average				Average				Aggregate
						Exercise				Contractual				Intrinsic
		Stock Options				Price				Term (yrs)				Value
Outstanding at January 1, 2013			250,000			$	3.87
Expired			(30,000	)			1.00
Outstanding at December 31, 2013			220,000			$	4.26
Expired			(120,000	)			5.15
Outstanding at December 31, 2014			100,000			$	3.20				0.6			$	-
Options exercisable at December 31, 2014			100,000			$	3.20				0.6			$	-
Options exercisable at December 31, 2013			220,000			$	4.26				0.7			$	-

 

Information related to the weighted average fair value of nonvested stock options for the year ended December 31, 2014 is as follows:

 

						Average
						Exercise
		Stock Options				Price
Employee Stock Options
Nonvested  options  at  January 1, 2014			182,250			$	6.00
Granted			172,357				0.84
Vested			(36,450	)			6.00
Nonvested options at December 31, 2014			318,157			$	3.20

 

Exercise prices range from $0.84 to $6.00 for options at December 31, 2014. The weighted average option price for all options outstanding was $4.04 with a weighted average remaining contractual life of 4.7 years at December 31, 2014. The weighted average option price for all options outstanding was $4.91 with a weighted average remaining contractual life of 3.0 years at December 31, 2013.

 

The weighted average fair value at date of grant for options granted during 2014 was $0.84, and was estimated using the Black-Scholes option valuation model with the following weighted average assumptions:

 

Expected life in years		5.0
Interest rate		1.57%
Volatility		60.01%
Dividend yield		0%

 

 

SCI ENGINEERED MATERIALS, INC.

NOTES TO FINANCIAL STATEMENTS

 

Note 8. Income Taxes

Deferred tax assets and liabilities result from temporary differences in the recognition of income and expense for tax and financial reporting purposes. Significant components of the Company’s deferred tax assets and liabilities are as follows at December 31.

 

		2014				2013
Deferred tax assets
NOL carryforwards		$	1,505,000			$	1,376,000
General business credits carryforwards			186,000				199,000
Stock based compensation			80,000				80,000
UNICAP			79,000				94,000
Allowance for doubtful accounts			5,000				6,000
Reserve for obsolete inventories			69,000				49,000
Reserve for asset retirement			22,000				18,000
Property and equipment			(197,000	)			(134,000	)
			1,749,000				1,688,000
Valuation allowance			(1,749,000	)			(1,688,000	)
Net		$	-			$	-

 

A valuation allowance has been recorded against the realizability of the net deferred tax asset such that no value is recorded for the asset in the accompanying financial statements. The valuation allowance totaled $1,749,000 and $1,688,000 at December 31, 2014 and 2013, respectively.

 

The Company has net operating loss carryforwards available for federal and state tax purposes of approximately $4,300,000 and $4,000,000 at December 31, 2014 and 2013, respectively, which expire in varying amounts through 2034.

 

For the years ended December 31, 2014 and 2013, a reconciliation of the statutory rate and effective rate for the provisions for income taxes consists of the following:

 

		Percentage
		2014				2013
Federal statutory rate			(35.0	)%			(35.0	)%
State/city tax			(0.3	)			0.0
Non-deductible expense			24.2				12.9
Valuation allowance			11.3				22.1
Effective rate			0.2	%			0.0	%

 

 

SCI ENGINEERED MATERIALS, INC.

NOTES TO FINANCIAL STATEMENTS

 

Note 8. Income Taxes (continued)

 

Components of income taxes are as follows:

 

		2014				2013
Current		$	(531	)		$	-
Deferred:
NOL utilization/expiration			(129,000	)			21,000
General business credits			13,000				(17,000	)
Other temporary differences			54,000				(34,000	)
Change in valuation allowance			62,000				30,000
Total		$	(531	)		$	-

 

The Company follows guidance issued by the Financial Accounting Standards Board (“FASB ASC 740”) with respect to accounting for uncertainty in income taxes.  A tax position is recognized as a benefit only if it is “more-likely-than-not” that the tax position would be sustained in a tax examination, with a tax examination being presumed to occur.  The amount recognized is the largest amount of tax benefit that is greater than fifty percent likely of being realized on examination.  For tax positions not meeting the “more-likely-than-not” test, no tax benefit is recorded.

 

The Company has no unrecognized tax benefits under guidance related to tax uncertainties. The Company does not anticipate the unrecognized tax benefits will significantly change in the next twelve months. Any tax penalties or interest expense will be recognized in income tax expense. No interest and penalties related to unrecognized tax benefits were accrued at December 31, 2014 and 2013.

 

The Company files income tax returns in the U.S. federal jurisdiction and various state and local jurisdictions. The Company is open to federal and state tax audits until the applicable statute of limitations expire. There are currently no federal or state income tax examinations underway for the Company. The tax years 2011 through 2013 remain open to examination by the major taxing jurisdictions in which the Company operates.

 

Note 9. Fair Value of Financial Instruments

 

The fair value of financial instruments represents the price that would be received to sell an asset or paid to transfer a liability (an exit price), and not the price that would be paid to acquire an asset or received to assume a liability (an entry price). Significant differences can arise between the fair value and carrying amount of financial instruments that are recognized at historical cost amounts.

 

The following methods and assumptions were used by the Company in estimating fair value disclosures for financial instruments:

 

·

Cash and cash equivalents, short-term notes payable and capital lease obligations and current maturities of long-term notes payable and capital lease obligations: Amounts reported in the balance sheet approximate fair market value due to the short maturity of these instruments.

 

 

SCI ENGINEERED MATERIALS, INC.

NOTES TO FINANCIAL STATEMENTS

 

Note 9. Fair Value of Financial Instruments (continued)

 

·

Long-term note payable obligations: Amounts reported in the balance sheet approximate fair value as the interest rates on the obligations range from 3% to 7.5%, which approximates current fair market rates.

 

Note 10. Asset Retirement Obligation

 

Included in machinery and equipment is various production equipment, which per the Company’s building lease, is required to be removed upon termination of the related lease. Included in accrued expenses in the accompanying balance sheet is the asset retirement obligation that represents the expected present value of the liability to remove this equipment. There are no assets that are legally restricted for purposes of settling this asset retirement obligation.

 

Following is a reconciliation of the aggregate retirement liability associated with the Company’s obligation to dismantle and remove the machinery and equipment associated with its lease:

 

Balance at January 1, 2013		$	40,858
Increase in present value of the obligation
(accretion expense in the corresponding amount
charged against earnings)			9,420
Balance at December 31, 2013		$	50,278
Increase in present value of the obligation
(accretion expense in the corresponding amount
charged against earnings)			10,200
Balance at December 31, 2014		$	60,478

 

Note 11. Liquidity

 

Management has forecasted revenues and related costs as well as investing plans and financing needs to determine liquidity to meet cash flow requirements and believes the Company will have sufficient liquidity at least through December 31, 2015.  This forecast was based on current cash levels and debt obligations, and the best estimates of revenues primarily from existing customers and gave consideration to the continued and possible increased levels of uncertainty in demand in the markets in which the Company operates.  The Company’s ability to maintain current operations is dependent upon its ability to achieve these forecasted results, which the Company believes will occur.