SCI Engineered Materials, Inc. - Annual Report: 2008 (Form 10-K)
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, 2008
Commission
File Number: 0-31641
SCI
ENGINEERED MATERIALS, INC.
(Exact
name of registrant as specified in its charter)
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Ohio
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31-1210318
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(State
or other jurisdiction of
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(I.R.S.
Employer
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incorporation
or organization)
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Identification
No.)
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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 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 $9,173,377 on June 30, 2008. 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 3,562,259 shares of the
Registrant’s Common Stock outstanding on February 20, 2009.
Documents
Incorporated By Reference
Portions
of our Proxy Statement for the 2009 Annual Meeting of Stockholders are
incorporated by reference in Part III.
Table of
Contents
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Page
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Part
I
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Item
1.
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Description
of Business
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3
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Item
1A.
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Risk
factors
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7
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Item
1B.
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Unresolved
Staff Comments
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10
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Item
2.
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Properties
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10
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Item
3.
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Legal
Proceedings
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10
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Item
4.
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Submission
of Matters to a Vote of Security Holders
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10
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Part
II
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Item
5.
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Market
for Registrant’s Common Equity, Related Stockholder Matters and Issuer
Purchases of Equity Securities
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11
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Item
6.
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Selected
Financial Data
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12
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Item
7.
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Management’s
Discussion and Analysis of Financial Condition and Results of
Operation
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13
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Item
7A.
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Quantitative
and Qualitative Disclosures about Market Risk
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16
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Item
8.
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Financial
Statements and Supplementary Data
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16
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Item
9.
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Changes
in and Disagreements with Accountants on Accounting and Financial
Disclosure
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16
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Item
9A.
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Controls
and Procedures
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16
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Item
9B.
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Other
Information
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17
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Part
III
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Item
10.
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Directors
and Executive Officers of the Registrant
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17
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Item
11.
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Executive
Compensation
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18
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Item
12.
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Security
Ownership of Certain Beneficial Owners and Management and Related
Stockholder Matters
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18
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Item
13.
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Certain
Relationships and Related Transactions
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18
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Item
14.
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Principal
Accountant Fees and Services
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18
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Item
15.
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Exhibits
and Financial Statement Schedules
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18
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Signatures
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22
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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.
2
PART
I
ITEM
1. DESCRIPTION
OF BUSINESS
Introduction
SCI
Engineered Materials, Inc. (“SCI” or the “Company”), formerly Superconductive
Components, Inc., an Ohio corporation, was incorporated in 1987. We
manufacture ceramic and metal sputtering targets for a variety of industrial
applications including Photonics, Thin Film Solar, Thin Film Battery,
Semiconductor, and, to a lesser extent High Temperature Superconductive (“HTS”)
materials. Our customers use our sputtering targets to produce very
thin coatings for a variety of applications. Photonics currently
represents our largest market for our targets. Thin Film Solar is an
industry that is exhibiting rapid growth and we expect this part of our business
to grow quickly. Thin Film Battery is a developing market where
manufacturers of batteries use our targets to produce very small power supplies
with small quantities of stored energy. Semiconductor is a developing
market for us.
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 (Tc of 90o 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 Tc 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 R&D 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 thin film battery, photovoltaic,
media storage, flat panel display, semiconductor, electronic, and photonic
industries.
In May of
2005, we received ISO 9001:2000 registration, an internationally recognized
milestone in our pursuit of quality. This registration enabled us to
increase our customer base which has benefited sales since the second quarter of
2005.
Over the
past two decades, we have developed considerable expertise in the development
and ramp-up of manufacturing novel materials, such as Bismuth Strontium Calcium
Copper Oxide (a superconductor), and battery and solar PVD
targets. 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.
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 Department of Development. These activities are
generally limited to funded research that is consistent with our focus on
commercial applications in our principal markets.
Business
We are a
supplier of materials to the Physical Vapor Deposition (“PVD”)
industry. Our customers need our materials to produce nano layers of
metals and oxides for advanced material systems. PVD coatings range
from every day items to complex computer processors. For example,
every day applications include transparent anti-scratch coatings on eyeglasses,
coatings on kitchen and bathroom faucets, as well as low emissivity glass for
household windows. More technically advanced applications include
semiconductors, thin film solar, flat panel displays and an emerging technology
- Thin Film Battery.
3
We are
focused on four distinct markets within the PVD industry. These
markets are Photonics, Thin Film Solar, Semiconductor and Thin Film
Battery. The Company continues to pursue niche opportunities,
specifically for the Solar market and Hard Disk Drive (“HDD”) in the
semiconductor market. We receive requests from potential customers in
other markets within the PVD industry; however, at this time we have chosen not
to pursue them. 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 issues.
The
production and sale of HTS materials was the initial focus of our operations and
these materials continue to be part of our development efforts. We
continue to work with private companies and government agencies to develop new
and improved products for future applications; however, our principal business
focus is on products positioned for near term commercialization.
Photonics
currently represents the largest market for our materials. Our
customers are continually identifying new materials that improve the utility of
optical coating. 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 materials we sell in this market. Photonic
applications continue to expand as new methods are found to manipulate light
waves to enhance the various properties of light. Currently, these
include optic devices and reflective coatings among others.
We have
developed new products for the growing Thin Film Solar (“TFS”)
market. We are well positioned in the TFS area having supplied
materials to that market for about 10 years during the early stages of TFS
development. In 2007, we added over $300,000 of new manufacturing
equipment, as well as Engineering and Sales staff to develop new materials to
support the anticipated growth of Solar. In 2008, we continued adding
equipment to make prototype orders and expect commercialization to begin in
2009. We were awarded a grant of approximately $700,000 from the Ohio
Department of Development to assist in the commercialization of
TFS. Our new materials are Transparent Conductive Oxides
(“TCO”). Every square foot of a TFS panel is coated with up to 3
layers of TCO, 1 micron thick. We continue to increase our visibility
in the global arena by attending various trade shows targeted at the Solar
market. During the fourth quarter of 2008 we added an exclusive
manufacturer’s representative for Europe.
Thin Film
Battery is a developing market where manufacturers of batteries use our targets,
especially lithium orthophosphate (Li3PO4) and lithium cobalt oxide (LiCoO) 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. We are the leading provider of
Li3PO4 and LiCoO to the emerging Thin Film Battery market. Following several
years of industry developments, some Thin Film Battery customers announced the
batteries were commercially available. Our customers anticipate the unique
properties of these batteries to be used in applications in medical devices,
integrated circuits, RFID, smart cards, hand held electronics and many other
applications.
We are
still in the early stages of developing a market presence in the Semiconductor
industry. We continue to develop innovative products for this
industry. Thus far we have experienced some success and this market
continues to hold significant potential for us. In 2008 we applied
for a patent for products targeted at this market.
We had
total annual revenues of $9.6 million, $10.8 million and $8.0 million in the
years ended December 31, 2008, 2007, and 2006, respectively. Gross
profit was $2.2 million, $2.1 million and $1.8 million in the years ended
December 31, 2008, 2007, and 2006, respectively. Some of the changes
in revenues were related to a high priced commodity that experienced a cyclical
peak in 2007. This material is expected to return to its long term
average during 2009, which may reduce revenues but have less of an effect on
gross profit.
Principal
suppliers in 2008 were Cabot Supermetals, Lattice Materials and Johnson
Matthey. In every case, we believe that suitable alternate vendors
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.
Our
largest customer represented approximately 47% of total revenues in 2008 and
more than 50% in 2007. We had contract research revenue of $157,032
and $57,779 representing 1.6% and 0.5% of total revenue for the years ended
December 31, 2008 and 2007, respectively.
4
Marketing
and Sales
In 2008 we significantly expanded our
marketing reach into Europe and Asia. Both of these areas have high
demand for Solar and Semiconductor sputtering targets. We use various
distribution channels to reach end user markets, including direct sales by our
sales persons, independent manufacturers’ representatives in the United States,
and independent distributors for international markets. 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 we upgraded in 2006 to include expanded online product inquiry
capabilities and additional product information. As mentioned
earlier, in 2007 we added a sales engineer to further drive our sales efforts in
the Solar area of the Photonics market. In 2006, we added a marketing
manager to increase our sales efforts in the Semiconductor market.
Ceramics
We are
capable of producing ceramic powders via several different processing techniques
including solid state, precipitation and combustion
synthesis. 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 metals 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 who would be capable of
supplying these materials to us as necessary. To date, we have
not experienced an interruption of raw material supplies.
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 reasonably 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 for the 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, Williams
Advanced Materials, Kurt Lesker and Plasmaterials are competing suppliers in
regard to targets. Dowa Chemicals of Japan supplies HTS
materials.
Research
and Development
We are
developing sputtering targets for semiconductor applications which could be used
to produce high K dielectric films via PVD processing. We are
developing Transparent Conductive Oxide (TCO) and transparent dielectric
materials for Thin Film Solar and wide area coating applications. We
focus our research and development efforts in areas that build on our expertise
in multi-component ceramic oxides.
Contract research revenues were
$157,032 during 2008, compared to $57,779 during 2007.
We
received notification during the fourth quarter of 2008 from the Ohio Department
of Development’s Third Frontier Advanced Energy Program of an award in the
amount of more than $700,000. This award provides support to
commercialize technologies for the manufacture of rotatable ceramic sputtering
targets for the production of transparent conductive oxide-coated glass used in
manufacturing thin film photovoltaic solar cell panels. The
work on the contract began in January of 2009.
5
During
the third quarter of 2008 we received notification from the Department of Energy
of a Notice of Financial Assistance Award in the amount of approximately
$750,000. The initial $125,000 was formally approved during
2008. The remaining balance was approved in February
2009. This award provides support for Phase II of a Small Business
Innovation Research (SBIR) award entitled “Flux Pinning Additions to
Increase Jc Performance in BSCCO-2212 Round Wire for Very High Field
Magnets.” The work on the contract began during the third quarter of
2008 and is expected to continue through August 2010.
We
received notification during the second quarter of 2008 from the Department of
Energy of a Notice of Financial Assistance Award in the amount of
$99,961. This award provides support for Phase I of an SBIR award
entitled “Homogenous BSCCO-2212 Round Wires for Very High Field Magnet
Applications.” The work on the contract began during the third
quarter of 2008 and is expected to be completed during the first half of
2009.
During the second quarter of 2007 we
received notification from the Department of Energy of a Notice of
Financial Assistance Award in the amount of $97,900. This award
provided support for Phase I of a Small Business Innovative Research (SBIR)
award entitled “Flux Pinning Additions to Increase Jc Performance in BSCCO-2212
Round Wire for Very High Field Magnets.” The work on the contract
began during the third quarter of 2007 and was completed during the first
quarter of 2008.
We intend
to continue to seek funded research opportunities within our core competencies
that maintain and expand technical understanding within our
company.
We have certain proprietary knowledge
and trade secrets related to the manufacture of ceramic oxide PVD materials and
patents covering some HTS products.
New
Product
Initiatives
We
continue to develop TCO target materials for the fast growing Thin Film Solar
market in partnership with both original equipment manufacturers and Thin Film
Solar Cell panel fabricators. Due to our flexibility in manufacturing both
planar and rotatable target material designs, we are able to provide TCO
compositions tailored to customer requests. In addition, we have obtained
a grant from the Ohio Department of Development’s Third Frontier Advanced Energy
Program (TFAEP) to aid us in the expansion of our rotatable target production
facilities. The TFAEP grant will enable us to expedite the expansion of
our rotatable target manufacturing capacity to meet anticipated customer
demand.
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 Thin Film Batteries. Presently, there are approximately five
manufacturers of Thin Film Batteries in the United States, each in various
stages of development from prototype to commercial activity. In addition
there are several firms and research institutes conducting tests on Thin Film
Batteries. We believe this market may potentially become very large with
significant growth expected during the next two 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, and remote
sensors. Given the many potential uses for Thin Film Batteries, we
anticipate that the market for materials it produces will grow in direct
correlation 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 (but acknowledge that we are
currently at a disadvantage in terms of capital resources). We intend to
actively market our materials to Thin Film Battery producers in the upcoming
year in order maintain our strong presence in this market. Currently, we
are the leading supplier of targets to this market.
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 the 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.
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.
6
At present, we have applied for a patent for the manufacture of a precious metal
composite target that will significantly reduce the amount of precious metal
required to produce such targets that are used in the semiconductor and optics
industries. We have several customers interested in this invention and are
pursuing both domestic (US) and foreign coverage.
In the
future, we may submit additional patent applications covering various
applications, 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 do not protect our intellectual property rights
to the same extent as the laws of the United States.
Employees
We had 25
full-time employees as of December 31, 2008. Of these employees one
held a PhD in Material Science. We have never experienced 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 23 days in 2008. We have occasionally been forced to write-off
negligible amount of accounts receivable as uncollectible. 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 experienced significant operating losses in the past and may have losses in
the future.
We reported net income applicable to
common shares of $100,177 for 2008 and $307,682 for 2007. Our
accumulated deficit since inception in 1987 was $7,401,876 at December 31,
2008.
While we have been profitable in recent
years, we have financed our historical losses primarily from additional
investments and loans by our major shareholders and private offerings of common
stock and warrants to purchase common stock. We cannot assure you,
however, that we will continue to operate at a profit or that we will be able to
raise additional capital in the future to fund our operations.
7
We have limited marketing and sales
capabilities.
In late 2008, we formed an exclusive
relationship with a manufacturer’s representative in Europe. As
previously mentioned, we hired a full time sales engineer in 2007 and a full
time marketing manager in 2006 to expand our marketing activities, especially in
the solar area of the photonics market and in the semiconductor
market. 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
may need to seek additional capital in the future, which may reduce the value of
our common stock.
We reported net income applicable to
common shares of $100,177 for 2008, $307,682 for 2007 and $277,083 for
2006. We incurred substantial operating losses prior to
2006. We could be required to seek additional capital in
the future for growth and working capital purposes. There is no
assurance that new capital will be available or that it will be available on
terms that will not result in substantial dilution or reduction in value of our
common stock.
Our
competitors have far greater financial and other resources than we
have.
The
market for Physical Vapor Deposition 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 Williams Advanced Materials, Kurt Lesker and
Tosoh, all of which have more resources than us. We cannot provide
assurance that developments by others will not render our products or
technologies obsolete or less competitive.
Our revenues
depend on patents and proprietary rights that 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 do 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. We have applied for a patent for the manufacture of a
precious metal composite target that will significantly reduce the amount of
precious metal required to produce such targets that are used in the
semiconductor and optics industries. We have several customers interested
in this invention and are pursuing both domestic (US) and foreign
coverage. In the future, we may submit additional patent applications
covering various applications. The patent application we filed and
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.
8
The rapid
technological changes of our industry may adversely affect us if we do not keep
pace with advancing technology.
The Physical Vapor Deposition 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 and integrate advances in
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 additional 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 High Temperature Superconductive (HTS)
products. Additionally, the market for the Thin Film Battery
materials is still in its early stages. Some of our materials are in
early stages of development for Thin Film Solar applications. The
Thin Film Solar market is expected to grow significantly during the next few
years.
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 (“OTC Bulletin Board”). Nevertheless, our
common stock has continued to trade 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.
At the present time, our common stock
trades on the OTC Bulletin Board. Based on its trading price, our
common stock, at times, has been 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.
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.
9
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 in right 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 cannot assure you that our
operations will result in sufficient revenues to enable us to operate at
profitable levels or to generate positive cash flow sufficient to pay
dividends. We have never paid dividends on our common shares in the
past and do not expect to do so in the foreseeable future. We intend
to retain future earnings for use in the business.
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. The lease on the property expires on August 16,
2014. We believe these facilities are in good condition and
will be adequate for our needs for the foreseeable future.
We are current on all operating lease
liabilities.
ITEM
3. LEGAL
PROCEEDINGS.
Not applicable.
ITEM
4. SUBMISSION
OF MATTERS TO A VOTE OF SECURITY HOLDERS.
Not applicable.
10
PART
II
|
ITEM
5.
|
MARKET
FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER
PURCHASES OF EQUITY SECURITIES.
|
Market
for Common Stock
Our common stock currently trades on
the OTC Bulletin Board under the symbol “SCIA.” The following table
sets forth for the periods indicated the high and low bid quotations for our
common stock.
|
High
|
Low
|
|||||||
|
Fiscal
2008
|
||||||||
|
Quarter
Ended March 31, 2008
|
$ | 5.90 | $ | 2.50 | ||||
|
Quarter
Ended June 30, 2008
|
5.75 | 3.00 | ||||||
|
Quarter
Ended September 30, 2008
|
6.00 | 4.10 | ||||||
|
Quarter
Ended December 31, 2008
|
6.00 | 2.10 | ||||||
|
Fiscal
2007
|
||||||||
|
Quarter
Ended March 31, 2007
|
7.50 | 5.00 | ||||||
|
Quarter
Ended June 30, 2007
|
8.80 | 6.58 | ||||||
|
Quarter
Ended September 30, 2007
|
7.00 | 6.10 | ||||||
|
Quarter
Ended December 31, 2007
|
7.00 | 5.00 | ||||||
The quotations provided herein may
reflect inter-dealer prices without retail mark-up, markdown, or commissions,
and may not represent actual transactions.
As discussed above, at the present
time, our common stock trades on the OTC Bulletin Board. Based on its
trading price, our common stock, at times, has been considered a
“penny stock” for purposes of federal securities laws, and therefore has been
subject to certain regulations, which are summarized below.
The Securities Enforcement and Penny
Stock Reform Act of 1990 requires special disclosure relating to the market for
penny stocks in connection with trades in any stock defined as a “penny
stock.” Specifically, Rules 15g-1 through 15g-9 under the Securities
Exchange Act of 1934 (the “Exchange Act”) impose sales practice and disclosure
requirements on NASD broker-dealers who make a market in a “penny
stock.” Securities and Exchange Commission regulations generally
define a penny stock to be an equity security that has a market price of less
than $5.00 per share and is not listed on The NASDAQ SmallCap Stock Market or a
major stock exchange. These regulations affect the ability of broker-dealers to
sell the Company’s securities and also may affect the ability of purchasers of
the Company’s
common stock to sell their shares in the secondary market.
Under the penny stock regulations, a
broker-dealer selling penny stock to anyone other than an established customer
or “accredited investor,” generally, an individual with net worth in excess of
$1,000,000 or an annual income exceeding $200,000, or $300,000 together with his
or her spouse, must make a special suitability determination for the purchaser
and must receive the purchaser’s written consent to the transaction prior to
sale, unless the broker-dealer or the transaction is otherwise exempt. In
addition, the penny stock regulations require the broker-dealer to deliver,
prior to any transaction involving a penny stock, a disclosure schedule prepared
by the Commission relating to the penny stock market, unless the broker-dealer
or the transaction is otherwise exempt. A broker-dealer is also required to
disclose commissions payable to the broker-dealer and the registered
representative and current quotations for the securities. Finally, a
broker-dealer is required to send monthly statements disclosing recent price
information with respect to the penny stock held in a customer’s account and
information with respect to the limited market in
penny stocks.
11
As long as the penny stock regulations
apply to the Company’s stock, it may be difficult to trade such stock because
compliance with the regulations can delay and/or preclude certain trading
transactions. Broker-dealers may be discouraged from effecting
transactions in the Company’s stock because of the sales practice and disclosure
requirements for penny stock. This could adversely affect the liquidity and/or
price of the Company’s common stock, and impede the sale of the Company’s
stock.
Holders
of Record
As of December 31, 2008, there were
approximately 440 holders of record of our common stock and 3,560,259 shares
outstanding. There were approximately 50 holders of Series B
Preferred shares and as of December 31, 2008 there were 24,430 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, 2008, concerning shares of our common
stock that may be issued upon the exercise of options and other rights under our
existing equity compensation plans and arrangements, divided between plans
approved by our shareholders and plans or arrangements not submitted to the
shareholders for approval. 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,
warrants, and other rights.
|
Number of Securities to
be issued upon exercise
of outstanding options,
warrants and rights
(a)
|
Weighted-average exercise
price of outstanding
options, warrants 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)
|
596,250 | $ | 2.30 | 542,000 | ||||||||
|
Equity
compensation plans not approved by security holders (2)
|
17,500 | $ | 2.88 | — | ||||||||
|
Total
|
613,750 | $ | 2.31 | 542,000 | ||||||||
________________
|
(1)
|
Equity
compensation plans approved by shareholders include our 2006 Stock Option
Plan.
|
|
(2)
|
Includes
17,500 stock purchase warrants that can be used to purchase 17,500 shares
of our common stock, which were issued by us in exchange for consideration
in the form of goods and services.
|
ITEM
6. SELECTED
FINANCIAL DATA.
Not applicable.
12
|
ITEM
7.
|
MANAGEMENT’S
DISCUSSION AND ANALYSIS OF FINACIAL CONDITION AND RESULTS OF
OPERATION.
|
Overview
SCI
Engineered Materials, Inc. (“SCI” or the “Company”), formerly Superconductive
Components, Inc., an Ohio corporation, was incorporated in 1987. We
manufacture ceramic and metal sputtering targets for a variety of industrial
applications including: Photonics, Thin Film Solar, Semiconductor, Thin Film
Battery and, to a lesser extent HTS materials. Photonics currently
represents the largest market for our targets. Thin Film Solar is an
industry that is exhibiting rapid growth and we expect this market to grow
quickly. Thin Film Battery is a developing market where manufacturers
of batteries use our targets to produce very small power supplies with small
quantities of stored energy. Semiconductor is a
developing market for us. We added to our sales staff in late 2007
for the purpose of focusing on opportunities for our products in the Solar
industry. We also added staff to our Technology group during the
second half of 2007 for the development of innovative
products. During the fourth quarter of 2008 we added an exclusive
manufacturer’s representative for Europe.
Executive
Summary
For the
year ended December 31, 2008, we had revenues of
$9,619,895. This was a decrease of $1,212,787, or 11.2%,
compared to 2007. The decrease in revenues was attributed to a
reduction in the cost of a high value raw material. We anticipate
that the cost of this raw material will continue to be lower in
2009. The order backlog at December 31, 2008 was $2.9 million, which
compared to $1.0 million at December 31, 2007.
Despite
the decrease in revenues we experienced positive benefits from product mix and
improved production efficiency. Gross profit increased 7.5% to
$2,211,477 for 2008 from $2,057,823 for 2007. Gross margin also
increased to 23.0% of total revenues for 2008 from 19.0% in 2007.
For the
year ended December 31, 2008, we recorded net income applicable to common shares
of $100,177 compared to $307,682 for 2007. This decrease can be
largely attributed to additional operating expenses of approximately $297,000
along with an increase in depreciation expense of approximately
$82,000. We continued to invest in R&D, marketing and
sales, and additional production equipment to take advantage of current and
future market opportunities. During the past 24 months we have been
actively marketing to additional customers in select markets. This
has resulted in trial and qualification orders that were shipped to customers in
the semiconductor and solar industries during 2008 that totaled approximately
10% of our revenues. We have received additional trial orders that
should ship during the first quarter of 2009.
Orders received in 2008 were
$11,675,439, compared to $10,362,995, in 2007, an increase of 13%.
Results
of Operations
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, 2008 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 licenses useful lives 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 collectibility 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 margin 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 to us. 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.
13
Year
2008 As Compared to Year 2007
Revenues
Revenues
were $9,619,895 in 2008, a decrease of $1,212,787, or 11.2%, from
2007. The revenue decline can be attributed to the ongoing purchase
of raw materials whose prices have historically experienced periods of
significant fluctuation. Cost changes for this high value raw
material are fully reflected in the final selling price which insulates us from
market risk associated with the raw material. We anticipate the cost
of this high value raw material will continue to be lower during
2009. Revenues exclusive of this high value raw material increased
approximately $750,000, or 21.5% over 2007.
Gross Profit
Reflecting positive benefits from
product mix and improved production efficiency, gross profit increased 7.5% in
2008. Gross profit in 2008 was $2,211,477 or 23.0% of total revenue
as compared to $2,057,823 or 19.0% in 2007
Marketing and Sales Expense
Marketing and sales expense increased
28.3% to $587,202 in 2008 from $457,689 in 2007. This increase was
due to the addition of sales and marketing staff and increased
travel. We added a sales engineer late in 2007 to focus efforts on
applications in the rapidly expanding Thin Film Solar market. We
continue to increase our visibility in the global arena by attending various
trade shows targeted at the Photonics, Semiconductor and Solar
markets. During the fourth quarter of 2008 we added an exclusive
manufacturer’s representative for Europe.
General and Administrative
Expense
General and administrative expense in
2008 was $966,979 compared to $884,771 in 2007, an increase of
9.3%. This increase was due to an increase in staff and professional
fees.
Research
and Development Expense
Research
and development expense for 2008 was $454,424 compared to $368,971 in 2007, an
increase of 23.2%. The increase was due to additional staff and
expense associated within the continued development efforts in the Photonic,
Solar, Thin Film Battery and Semiconductor markets, as well as research related
to the SBIRs.
Interest Income and
Expense
Interest income was $24,271 and $64,600
for 2008 and 2007, respectively. While our cash position increased
slightly in 2008, the decrease in interest rates reduced the amount of interest
earned.
Interest expense was $102,763 or 1.1%
of revenues in 2008, compared to $79,788, or 0.7% of revenues in 2007. The
increase was due to additional capital lease obligations incurred for the
purchase of production equipment for increased production capacity.
Income
Applicable To Common Shares
Income
applicable to common shares was $100,177 and $307,682 for 2008 and 2007,
respectively. Net income per common share based on the income
applicable to common shares for 2008 and 2007 was $0.03 and $0.09,
respectively. The income applicable to common shares includes the net
income from operations and the accretion of Series B preferred stock
dividends. The net income per common share before dividends on
preferred stock was $0.04 and $0.10 for 2008 and 2007,
respectively.
Dividends on the Series B preferred
stock accrue at 10% annually on the outstanding
shares. Dividends accrued on the Series B preferred stock was
$24,373 during 2008 and $24,979 in 2007.
Basic earnings for 2008 were $0.03 per
common share based on 3,530,486 average shares outstanding compared to $0.09 per
common share based on 3,461,374 weighted average shares outstanding for
2007.
14
Diluted earnings per common share for
2008 were $0.02 based on 4,035,065 average shares outstanding compared to $0.07
per share based on 4,217,936 weighted average shares outstanding for
2007.
The
following schedule represents our outstanding common shares during the period of
2009 through 2019 assuming all outstanding stock options and stock warrants are
exercised during the year of expiration. If each shareholder
exercises his or her options or warrants, it could increase our common shares by
1,693,307 to 5,255,566 by December 31, 2019. Exercise prices for
options and warrants range from $1.00 to $6.00 at January 31,
2009. Assuming all such options and warrants are exercised in the
year of expiration, the effect on shares outstanding is illustrated as
follows:
|
Options and
|
Potential
|
|||||||
|
Warrants due
|
Shares
|
|||||||
|
to expire
|
Outstanding
|
|||||||
|
2009
|
160,418 | 3,722,677 | ||||||
|
2010
|
443,389 | 4,166,066 | ||||||
|
2011
|
62,500 | 4,228,566 | ||||||
|
2012
|
170,000 | 4,398,566 | ||||||
|
2013
|
30,500 | 4,429,066 | ||||||
|
2014
|
180,000 | 4,609,066 | ||||||
|
2015
|
140,000 | 4,749,066 | ||||||
|
2016
|
37,000 | 4,786,066 | ||||||
|
2017
|
- | 4,786,066 | ||||||
|
2018
|
19,500 | 4,805,566 | ||||||
|
2019
|
450,000 | 5,255,566 | ||||||
Liquidity
and Working Capital
At
December 31, 2008, working capital was $1,786,360 compared to $1,520,218 at
December 31, 2007, an increase of $266,142. Net cash provided by
operating activities was approximately $457,000 for the twelve months ended
December 31, 2008. Net cash provided by operating activities was
approximately $995,000 for the twelve months ended December 31,
2007. Significant non-cash items including depreciation,
accretion and amortization, stock based compensation expense, inventory reserve
on excess and obsolete inventory, and allowance for doubtful accounts were
approximately $418,000 and $355,000, for the twelve months ended December 31,
2008 and 2007, respectively. Accounts receivable, inventory, prepaid
expenses and other assets increased approximately $806,000 for the twelve months
ended December 31, 2008. This increase was due to higher accounts
receivable and inventory. Inventory reserves are established for
obsolete inventory, excess inventory quantities based on our estimate of net
realizable value and for lower-of-cost or market. We believe the
inventory reserve, after its assessment of obsolete inventory, at December 31,
2008, of $49,043 will be adequate for excess inventory and a lower of
cost-or-market analysis. Accounts receivable, inventory,
prepaid expenses and other assets decreased approximately $930,000 for the
twelve months ended December 31, 2007. Accounts payable,
accrued expenses and customer deposits increased approximately $722,000 during
2008. The increase was due primarily to customer deposits
received. Accounts payable, accrued expenses and customer deposits
decreased approximately $619,000 during 2007.
Cash of approximately $140,000 and
$288,000 was used for investing activities for the twelve months ended December
31, 2008 and 2007, respectively. The amounts invested were used to
purchase machinery and equipment for increased production capacity, new product
lines and leasehold improvements for the facility. Proceeds on sale
of equipment totaled $2,000 and $19,220 during 2008 and 2007,
respectively.
Cash of
approximately $100,000 was used for financing activities during the twelve
months ended December 31, 2008. Cash payments to third parties for
capital lease obligations approximated $537,000. Proceeds received
from the exercise of common stock warrants were approximately
$68,000. Proceeds received from the exercise of common stock options
were $10,250. Cash payments for services provided for the
registration of common stock were approximately $17,000. A cash
payment related to Series B preferred stock dividend was approximately
$25,000. Proceeds received from The Ohio Department of Development
were $400,000. We incurred new capital lease obligations of
approximately $339,000 for new production equipment during 2008. We
obtained additional lease commitments of approximately $468,000 for production
equipment that should be placed in service during the first quarter of
2009.
Cash of
approximately $173,000 was used for financing activities during the twelve
months ended December 31, 2007. Principal payments to third parties
for capital lease obligations approximated $178,000, and cash payments for
services provided for the registration of common stock were approximately
$32,000. Proceeds received from the exercise of common stock options
were $9,625. Proceeds received from the exercise of common stock
warrants were approximately $27,000. We incurred new capital lease
obligations of approximately $1,067,000 for new production equipment during
2007.
15
While certain of our major shareholders
have advanced funds in the form of subordinated debt, accounts payable and
guaranteeing bank debt in the past, there is no commitment by these individuals
to continue funding us or guaranteeing bank debt in the future. We
will continue to seek new financing or equity financing
arrangements. However, we cannot be certain that it will be
successful in efforts to raise additional new funds.
Inflation
We believe that there has not been a
significant impact from inflation on our operations during the past three fiscal
years.
Future
Operating Results
We plan to place some of our larger
purchase commitments for raw materials on an annualized basis because they can
be purchased in larger quantities at reduced prices. In general, we
attempt to limit inventory price increases by making an annual commitment, and
drawing the material either as required, or on a monthly or quarterly
basis. Such annual commitments may reach $500,000 in 2009 and greater
in 2010 depending on sales volume increases. The terms of payment for
such commitments are worked out with the vendor on a case-by-case basis, but in
all cases are cancelable at our discretion without penalty.
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, 2008 and 2007 the related statements of
operations, stockholders’ equity and cash flows for the years ended December 31,
2008 and 2007, together with the independent certified public accountants’
report thereon appear beginning on Page F-1.
|
ITEM
9.
|
CHANGES
IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL
DISCLOSURE.
|
None.
|
ITEM
9A.
|
CONTROLS
AND PROCEDURES.
|
Evaluation
of Disclosure Controls and Procedures
Based on
an evaluation under the supervision and with the participation of our
management, our principal executive officer and principal financial officer have
concluded that the our disclosure controls and procedures as defined in Rules
13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934,
as amended ("Exchange Act") were effective as of December 31, 2008 to
ensure that information required to be disclosed in reports that are filed or
submitted under the Exchange Act is (i) recorded, processed, summarized and
reported within the time periods specified in the Securities and Exchange
Commission rules and forms and (ii) accumulated and communicated to our
management, including our principal executive officer and principal financial
officer, as appropriate to allow timely decisions regarding required
disclosure.
16
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 set forth in
Internal Control—Integrated 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
effective as of December 31, 2008.
Additionally,
there were no changes in our internal controls that could materially affect the
disclosure controls and procedures subsequent to the date of their evaluation,
nor were there any material deficiencies or material weaknesses in our internal
controls. As a result, no corrective actions were required or
undertaken.
|
ITEM
9B.
|
OTHER
INFORMATION
|
None.
PART
III
|
ITEM
10.
|
DIRECTORS
AND EXECUTIVE OFFICERS OF THE
REGISTRANT.
|
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 2009 Annual
Meeting of Shareholders scheduled to be held on June 10, 2009, 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.
17
|
ITEM
11.
|
EXECUTIVE
COMPENSATION.
|
The information required by this item
is included under the caption “Executive Compensation” in our
proxy statement relating to our 2009 Annual Meeting of Shareholders scheduled to
be held on June 10, 2009, 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 2009
Annual Meeting of Shareholders scheduled to be held on June 10, 2009, and is
incorporated herein by reference.
|
ITEM
13.
|
CERTAIN
RELATIONSHIPS
AND RELATED TRANSACTIONS.
|
The information required by this item
is included under the caption “Certain Relationships and Related
Transactions” in our proxy statement relating to our 2009 Annual Meeting
of Shareholders scheduled to be held on June 10, 2009, 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 Registered independent
public accounting firm for the year ended December 31, 2008” in our proxy
statement relating to our 2009 Annual Meeting of Shareholders scheduled to be
held on June 10, 2009, 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)
|
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(b)
|
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(c)
|
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).
|
18
|
4(d)
|
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(e)
|
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).
|
|
|
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)
|
Lease
Agreement between Superconductive Components, Inc. and Duke Realty Ohio
dated as of September 29, 2003, with Letter of Understanding dated
February 17, 2004 (Incorporated by reference to Exhibit 10(a) to the
Company’s Quarterly Report on Form 10-QSB, filed on March 31,
2004)
|
|
|
10(c)
|
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)
|
|
|
10(d)
|
License
Agreement with Sandia Corporation dated February 26, 1996 (Incorporated by
reference to Exhibit 10(f) to the Company’s Form 10-SB Amendment No. 1,
filed on January 3, 2001)
|
|
|
10(e)
|
Nonexclusive
License with The University of Chicago (as Operator of Argonne National
Laboratory) dated October 12, 1995 (Incorporated by reference to Exhibit
10(g) to the Company’s Form 10-SB Amendment No. 1, filed on January 3,
2001)
|
|
|
10(f)
|
Nonexclusive
License with The University of Chicago (as Operator of Argonne National
Laboratory) dated October 12, 1995 (Incorporated by reference to Exhibit
10(h) to the Company’s Form 10-SB Amendment No. 1, filed on January 3,
2001)
|
|
|
10(g)
|
Ohio
Department of Development Third Frontier Action Fund Award dated February
20, 2004 (Incorporated by reference to Exhibit 10(o) to the Company’s
Annual Report on Form 10-KSB, filed on March 30, 2004)
|
|
|
10(h)
|
Description
of the Material Terms of the Superconductive Components, Inc. 2005
Executive Bonus Plan (Incorporated by reference to Exhibit 10 to the
Company’s Current Report on Form 8-K, filed on April 20,
2005)
|
|
|
10(i)
|
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(j)
|
Department
of Energy Award dated July 21, 2005 (Incorporated by reference to Exhibit
10(k) 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)
|
19
|
10(k)
|
Subscription
Agreement between the Company and the Estate of Edward R. Funk, dated
October 14, 2005 (Incorporated by reference to Exhibit 10(o) 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(l)
|
Subscription
Agreement between the Company and the Estate of Ingeborg V. Funk, dated
October 14, 2005 (Incorporated by reference to Exhibit 10(p) 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(m)
|
Subscription
Agreement between the Company and Robert H. Peitz, dated October 14, 2005
(Incorporated by reference to Exhibit 10(q) 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(n)
|
Warrant
to purchase common stock of Superconductive Components, Inc. issued to the
Estate of Edward R. Funk, dated October 19, 2005 (Incorporated by
reference to Exhibit 10(r) to the Company’s Registration Statement Form on
SB-2 (Registration No. 333-131605), filed on February 6, 2006, and amended
by Pre-effective Amendment No. 1 filed March 23, 2006)
|
|
|
10(o)
|
Warrant
to purchase common stock of Superconductive Components, Inc. issued to the
Estate of Ingeborg V. Funk, dated October 19, 2005 (Incorporated by
reference to Exhibit 10(s) 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(p)
|
Warrant
to purchase common stock of Superconductive Components, Inc. issued to
Robert H. Peitz, effective October 19, 2005 (Incorporated by reference to
Exhibit 10(t) 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(q)
|
Conversion
Agreement between the Company and the Estate of Edward R. Funk, dated
October 14, 2005 (Incorporated by reference to Exhibit 10(u) 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(r)
|
Conversion
Agreement between the Company and the Estate of Ingeborg V. Funk, dated
October 14, 2005 (Incorporated by reference to Exhibit 10(v) 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(s)
|
Description
of purchase order received from an existing customer (Incorporated by
reference to the Company’s Current Report on Form 8-K, filed January 24,
2007).
|
|
|
10(t)
|
Ohio
Department of Development Third Frontier Advanced Energy Program Award
(Incorporated by reference to the Company’s Current Report on Form 8-K,
filed December 16,
2008).
|
20
|
10(u)
|
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).
|
|
|
99.1
|
Press
Release dated February 26, 2009, entitled “SCI Engineered Materials, Inc.,
Reports Fourth Quarter and Full-Year 2008
Results.”
|
|
23
|
*
|
Consent
of Independent Registered 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.
|
_____________
* Filed
herewith
21
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
26, 2009
|
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 26th day of
February 2009.
|
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) |
|
|
Robert J. Baker*
|
Director
|
|
|
Robert
J. Baker
|
||
|
Edward W. Ungar*
|
Director
|
|
|
Edward
W. Ungar
|
||
|
Robert H. Peitz*
|
Director
|
|
|
Robert
H. Peitz
|
||
|
Walter J. Doyle*
|
Director
|
|
|
Walter
J. Doyle
|
|
*By:
|
/s/ Daniel
Rooney
|
|
Daniel
Rooney,
Attorney-in-Fact
|
22
INDEX
TO FINANCIAL STATEMENTS
|
Page
|
||
|
Report
of Independent Registered Public Accounting Firm
|
F-1
|
|
|
Balance
Sheets
|
F-2
|
|
|
Statements
of Operations
|
F-4
|
|
|
Statements
of Shareholders’ Equity
|
F-5
|
|
|
Statements
of Cash Flows
|
F-6
|
|
|
Notes
to Financial Statements
|
F-8
|
Report of Independent
Registered Public Accounting Firm
To the
Board of Directors and Shareholders
SCI
Engineered Materials, Inc.
Columbus,
Ohio
We have audited the accompanying
balance sheets of SCI Engineered Materials, Inc. as of December 31, 2008 and
2007, and the related statements of operations, shareholders' equity and cash
flows for each of the two years in the period ended December 31,
2008. 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 audits.
We conducted our audits 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. 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 audits provide 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 SCI Engineered Materials, Inc. as of December 31, 2008 and
2007, and the results of its operations and its cash flows for each of the two
years in the period ended December 31, 2008 in conformity with accounting
principles generally accepted in the United States of America.
|
/s/
MALONEY + NOVOTNY LLC
|
Canton,
Ohio
February
26, 2009
F-1
PART
I. FINANCIAL INFORMATION
ITEM
1. FINANCIAL STATEMENTS
SCI
ENGINEERED MATERIALS, INC.
BALANCE
SHEETS
DECEMBER
31, 2008 AND 2007
ASSETS
|
2008
|
2007
|
|||||||
|
Current
Assets
|
||||||||
|
Cash
|
$ | 1,399,050 | $ | 1,182,086 | ||||
|
Accounts
receivable
|
||||||||
|
Trade,
less allowance for doubtful accounts of $24,700
|
464,016 | 219,222 | ||||||
|
Contract
|
109,717 | 65,954 | ||||||
|
Other
|
3,423 | 550 | ||||||
|
Inventories
|
1,264,433 | 756,999 | ||||||
|
Prepaid
expenses
|
42,562 | 21,148 | ||||||
|
Total
current assets
|
3,283,201 | 2,245,959 | ||||||
| Property and Equipment, at cost | ||||||||
|
Machinery
and equipment
|
4,192,516 | 3,386,778 | ||||||
|
Furniture
and fixtures
|
107,998 | 74,222 | ||||||
|
Leasehold
improvements
|
313,951 | 301,551 | ||||||
|
Construction
in progress
|
144,682 | 599,753 | ||||||
| 4,759,147 | 4,362,304 | |||||||
|
Less
accumulated depreciation
|
(2,469,030 | ) | (2,185,277 | ) | ||||
| 2,290,117 | 2,177,027 | |||||||
|
Other
Assets
|
||||||||
|
Deposits
|
29,002 | 18,639 | ||||||
|
Intangibles
|
34,254 | 29,202 | ||||||
|
Total
other assets
|
63,256 | 47,841 | ||||||
|
TOTAL
ASSETS
|
$ | 5,636,574 | $ | 4,470,827 | ||||
The
accompanying notes are an integral part of these financial
statements.
F-2
SCI
ENGINEERED MATERIALS, INC.
BALANCE
SHEETS
DECEMBER
31, 2008 AND 2007
LIABILITIES AND
SHAREHOLDERS' EQUITY
|
2008
|
2007
|
|||||||
|
Current
Liabilities
|
||||||||
|
Capital
lease obligation, current portion
|
$ | 285,408 | $ | 259,714 | ||||
|
Note
payable, current portion
|
20,386 | - | ||||||
|
Accounts
payable
|
249,309 | 160,468 | ||||||
|
Accrued
contract expenses
|
52,525 | 47,702 | ||||||
|
Customer
deposits
|
700,118 | 19,483 | ||||||
|
Accrued
compensation
|
94,167 | 138,190 | ||||||
|
Accrued
expenses and other
|
94,928 | 100,184 | ||||||
|
Total
current liabilities
|
1,496,841 | 725,741 | ||||||
|
Capital
lease obligation, net of current portion
|
622,769 | 846,433 | ||||||
|
Note
payable, net of current portion
|
379,614 | - | ||||||
|
Total
liabilities
|
2,499,224 | 1,572,174 | ||||||
|
Commitments
and contingencies
|
- | - | ||||||
|
Shareholders'
Equity
|
||||||||
|
Convertible
preferred stock, Series B, 10% cumulative, nonvoting no par value, $10
stated value, optional redemption at 103%; 24,430 and 24,566 issued and
outstanding respectively
|
373,647 | 375,861 | ||||||
|
Common
stock, no par value, authorized 15,000,000 shares; 3,560,259 and 3,474,338
shares issued and outstanding respectively
|
9,180,183 | 9,061,378 | ||||||
|
Additional
paid-in capital
|
985,396 | 987,840 | ||||||
|
Accumulated
deficit
|
(7,401,876 | ) | (7,526,426 | ) | ||||
| 3,137,350 | 2,898,653 | |||||||
|
TOTAL
LIABILITIES AND SHAREHOLDERS' EQUITY
|
$ | 5,636,574 | $ | 4,470,827 | ||||
The
accompanying notes are an integral part of these financial
statements.
F-3
SCI
ENGINEERED MATERIALS, INC.
STATEMENTS
OF OPERATIONS
YEARS
ENDED DECEMBER 31, 2008 AND 2007
|
2008
|
2007
|
|||||||
|
TOTAL
REVENUE
|
$ | 9,619,895 | $ | 10,832,682 | ||||
|
TOTAL
COST OF REVENUE
|
7,408,418 | 8,774,859 | ||||||
|
GROSS
PROFIT
|
2,211,477 | 2,057,823 | ||||||
|
GENERAL
AND ADMINISTRATIVE EXPENSE
|
966,979 | 884,771 | ||||||
|
RESEARCH
AND DEVELOPMENT EXPENSE
|
454,424 | 368,971 | ||||||
|
MARKETING
AND SALES EXPENSE
|
587,202 | 457,689 | ||||||
|
INCOME
FROM OPERATIONS
|
202,872 | 346,392 | ||||||
|
OTHER
INCOME (EXPENSE)
|
||||||||
|
Interest
income
|
24,271 | 64,600 | ||||||
|
Interest
expense
|
(102,763 | ) | (79,788 | ) | ||||
|
Gain
on sale of equipment
|
2,000 | 3,287 | ||||||
|
Miscellaneous,
net
|
(1,830 | ) | (1,830 | ) | ||||
| (78,322 | ) | (13,731 | ) | |||||
|
INCOME
BEFORE PROVISION FOR INCOME TAX
|
124,550 | 332,661 | ||||||
|
INCOME
TAX EXPENSE
|
- | - | ||||||
|
NET
INCOME
|
124,550 | 332,661 | ||||||
|
DIVIDENDS
ON PREFERRED STOCK
|
(24,373 | ) | (24,979 | ) | ||||
|
INCOME
APPLICABLE TO COMMON SHARES
|
$ | 100,177 | $ | 307,682 | ||||
|
EARNINGS
PER SHARE - BASIC AND DILUTED
|
||||||||
|
(Note 2)
|
||||||||
|
NET
INCOME PER COMMON SHARE BEFORE DIVIDENDS ON PREFERRED
STOCK
|
||||||||
|
Basic
|
$ | 0.04 | $ | 0.10 | ||||
|
Diluted
|
$ | 0.03 | $ | 0.08 | ||||
|
NET
INCOME PER COMMON SHARE AFTER DIVIDENDS ON PREFERRED STOCK
|
||||||||
|
Basic
|
$ | 0.03 | $ | 0.09 | ||||
|
Diluted
|
$ | 0.02 | $ | 0.07 | ||||
|
WEIGHTED
AVERAGE SHARES OUTSTANDING
|
||||||||
|
Basic
|
3,530,486 | 3,461,374 | ||||||
|
Diluted
|
4,035,065 | 4,217,936 | ||||||
The
accompanying notes are an integral part of these financial
statements.
F-4
SCI
ENGINEERED MATERIALS, INC.
STATEMENTS
OF SHAREHOLDERS' EQUITY
YEARS ENDED DECEMBER 31,
2008 AND 2007
|
Convertible
|
Additional
|
|||||||||||||||||||
|
Preferred Stock,
|
Common
|
Paid-In
|
Accumulated
|
|||||||||||||||||
|
Series B
|
Stock
|
Capital
|
Deficit
|
Total
|
||||||||||||||||
|
Balance
12/31/06
|
$ | 360,146 | $ | 9,007,817 | $ | 995,586 | $ | (7,859,087 | ) | $ | 2,504,462 | |||||||||
|
Accretion
of cumulative dividends
|
24,979 | - | (24,979 | ) | - | - | ||||||||||||||
|
Common
stock conversion from preferred stock (Note 5)
|
(9,264 | ) | 9,264 | - | - | - | ||||||||||||||
|
Stock
based compensation expense (Note 2H)
|
- | - | 17,233 | - | 17,233 | |||||||||||||||
|
Proceeds
from exercise of stock warrants (Note 5)
|
- | 26,909 | - | - | 26,909 | |||||||||||||||
|
Proceeds
from exercise of stock options (Note 5)
|
- | 9,625 | - | - | 9,625 | |||||||||||||||
|
Private
placement and SB-2 registration
|
- | (32,255 | ) | - | - | (32,255 | ) | |||||||||||||
|
Common
stock issued
|
- | 40,018 | - | - | 40,018 | |||||||||||||||
|
Net
income
|
- | - | - | 332,661 | 332,661 | |||||||||||||||
|
Balance
12/31/07
|
$ | 375,861 | $ | 9,061,378 | $ | 987,840 | $ | (7,526,426 | ) | $ | 2,898,653 | |||||||||
|
Accretion
of cumulative dividends
|
24,373 | - | (24,373 | ) | - | - | ||||||||||||||
|
Common
stock conversion from preferred stock (Note 5)
|
(2,021 | ) | 2,021 | - | - | - | ||||||||||||||
|
Stock
based compensation expense (Note 2H)
|
- | - | 21,929 | - | 21,929 | |||||||||||||||
|
Proceeds
from exercise of stock warrants (Note 5)
|
- | 68,021 | - | - | 68,021 | |||||||||||||||
|
Proceeds
from exercise of stock options (Note 5)
|
- | 10,250 | - | - | 10,250 | |||||||||||||||
|
Private
placement and SB-2 registration
|
- | (16,906 | ) | - | - | (16,906 | ) | |||||||||||||
|
Common
stock issued
|
- | 55,419 | - | - | 55,419 | |||||||||||||||
|
Payment
of cumulative dividends
|
(24,566 | ) | - | - | - | (24,566 | ) | |||||||||||||
|
Net
income
|
- | - | - | 124,550 | 124,550 | |||||||||||||||
|
Balance
12/31/08
|
$ | 373,647 | $ | 9,180,183 | $ | 985,396 | $ | (7,401,876 | ) | $ | 3,137,350 | |||||||||
The
accompanying notes are an integral part of these financial
statements.
F-5
SCI
ENGINEERED MATERIALS, INC.
STATEMENTS
OF CASH FLOWS
YEARS
ENDED DECEMBER 31, 2008 AND 2007
|
2008
|
2007
|
|||||||
|
CASH
FLOWS FROM OPERATING ACTIVITIES
|
||||||||
|
Net
income
|
$ | 124,550 | $ | 332,661 | ||||
|
Adjustments
to reconcile net income to net cash provided by operating
activities:
|
||||||||
|
Depreciation
and accretion
|
371,125 | 289,096 | ||||||
|
Amortization
|
3,088 | 3,089 | ||||||
|
Stock
based compensation
|
77,348 | 57,251 | ||||||
|
Gain
on sale of equipment
|
(2,000 | ) | (3,287 | ) | ||||
|
Increase
(decrease) in inventory reserve
|
(33,116 | ) | 6,296 | |||||
|
Changes
in allowance for doubtful accounts
|
- | (300 | ) | |||||
|
Changes
in operating assets and liabilities:
|
||||||||
|
(Increase)
decrease in assets:
|
||||||||
|
Accounts
receivable
|
(291,430 | ) | 207,280 | |||||
|
Inventories
|
(474,318 | ) | 426,437 | |||||
|
Prepaid
expenses
|
(21,414 | ) | 26,318 | |||||
|
Other
assets
|
(18,503 | ) | 269,780 | |||||
|
Increase
(decrease) in liabilities:
|
||||||||
|
Accounts
payable
|
88,841 | (136,693 | ) | |||||
|
Accrued
expenses and customer deposits
|
632,867 | (482,586 | ) | |||||
|
Total
adjustments
|
332,488 | 662,681 | ||||||
|
Net
cash provided by operating activities
|
457,038 | 995,342 | ||||||
|
CASH
FLOWS FROM INVESTING ACTIVITIES
|
||||||||
|
Proceeds
on sale of equipment
|
2,000 | 19,220 | ||||||
|
Purchases
of property and equipment
|
(142,332 | ) | (307,589 | ) | ||||
|
Net
cash used in investing activities
|
(140,332 | ) | (288,369 | ) | ||||
|
CASH
FLOWS FROM FINANCING ACTIVITIES
|
||||||||
|
Proceeds
from exercise of common stock options
|
10,250 | 9,625 | ||||||
|
Proceeds
from exercise of common stock warrants
|
68,021 | 26,909 | ||||||
|
Proceeds
from note payable
|
400,000 | - | ||||||
|
Payment
for accumulated dividends on preferred stock
|
(24,566 | ) | - | |||||
|
Payments
related to registration of common stock
|
(16,906 | ) | (32,255 | ) | ||||
|
Principal
payments on capital lease obligations
|
(536,541 | ) | (177,660 | ) | ||||
|
Net
cash used in financing activities
|
(99,742 | ) | (173,381 | ) | ||||
The
accompanying notes are an integral part of these financial
statements.
F-6
SCI
ENGINEERED MATERIALS, INC.
STATEMENTS
OF CASH FLOWS (CONTINUED)
YEARS
ENDED DECEMBER 31, 2008 AND 2007
|
2008
|
2007
|
|||||||
|
NET
INCREASE IN CASH
|
$ | 216,964 | $ | 533,592 | ||||
|
CASH - Beginning of
period
|
1,182,086 | 648,494 | ||||||
|
CASH - End of
period
|
$ | 1,399,050 | $ | 1,182,086 | ||||
|
SUPPLEMENTAL
DISCLOSURES OF CASH FLOW INFORMATION
|
||||||||
|
Cash
paid during the years for:
|
||||||||
|
Interest,
net
|
$ | 102,763 | $ | 79,788 | ||||
|
Income
taxes
|
$ | - | $ | - | ||||
|
SUPPLEMENTAL
DISCLOSURES OF NONCASH FINANCING ACTIVITIES
|
||||||||
|
Property
and equipment purchased by capital lease
|
$ | 338,571 | $ | 1,067,315 | ||||
|
Property
and equipment accrued asset retirement obligation increase
|
$ | 3,312 | $ | 3,312 | ||||
|
SUPPLEMENTAL
DISCLOSURES OF NONCASH OPERATING ACTIVITIES
|
||||||||
|
Stock
based compensation expense
|
$ | 77,348 | $ | 57,251 | ||||
The
accompanying notes are an integral part of these financial
statements.
F-7
SCI
ENGINEERED MATERIALS, INC.
NOTES
TO FINANCIAL STATEMENTS
|
Note
1.
|
Business
Organization and Purpose
|
SCI
Engineered Materials, Inc. (“SCI” or the “Company”), formerly Superconductive
Components, Inc., an Ohio corporation, was incorporated in 1987. The
Company manufactures ceramic and metal sputtering targets for a variety of
industrial applications including: Photonics, Thin Film Solar, Thin Film
Battery, Semiconductor, and, to a lesser extent High Temperature Superconductive
(HTS) materials. Photonics currently represents the Company’s largest
market for its targets. Thin Film Solar is an industry that is
exhibiting rapid growth. Thin Film Battery is a developing market
where manufacturers of batteries use the Company’s targets to produce very small
power supplies with small quantities of stored energy. Semiconductor
is a developing market.
|
Note
2.
|
Summary
of Significant Accounting Policies
|
|
|
A.
|
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 and excess inventory quantities based
on management’s estimate of net realizable value. The inventory
reserve decreased $33,116 during 2008 and increased $6,296 during
2007.
|
The
Company enters into cancelable purchase commitment arrangements with some
suppliers. Estimated purchase commitments to these suppliers
approximate $237,000 and $122,000 at December 31, 2008 and 2007,
respectively. The Company can cancel these commitments at the
Company’s discretion without penalty.
|
B.
|
Property
and Equipment - Property and equipment are carried at
cost. Depreciation is provided on the straight-line method
based on the estimated useful lives of the assets for financial reporting
purposes and allowable accelerated methods for tax
purposes. Useful lives range from ten years on certain
furniture and fixtures and leasehold improvements to three years on
computer equipment. Depreciation expense totaled $367,812 and
$285,784 for the years ended December 31, 2008 and 2007,
respectively. Expenditures for renewals and betterments are
capitalized and expenditures for repairs and maintenance are charged to
operations as incurred. Construction in process at December 31,
2008, consists primarily of two pieces of equipment that will be placed in
service in the first quarter of 2009 at a total cost of approximately
$150,000. Construction in process at December 31, 2007, consists primarily
of a piece of equipment that was placed in service
in January 2008 at a total cost of approximately
$550,000.
|
|
|
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
have been no such impairment
adjustments.
|
|
C.
|
Research
and Development - Research and development costs are expensed as
incurred. Research and development expenses for the years ended
December 31, 2008 and 2007 were $454,424 and $368,971,
respectively. The increase was due to an increase in staff and
continued development of efforts associated with applications in Photonic,
Thin Film Solar, Thin Film Battery and Semiconductor markets as well as
research related to Small Business Innovation Research
projects.
|
F-8
SCI
ENGINEERED MATERIALS, INC.
NOTES
TO FINANCIAL STATEMENTS
|
Note
2.
|
Summary
of Significant Accounting Policies
(Continued)
|
|
|
D.
|
Equipment
- In 2004, the Company received funds of $517,935 from the Ohio Department
of Development’s Third Frontier Action Fund (TFAF) for the purchase of
equipment related to the grant’s purpose. In a separate
contract with the Department of Energy the Company received $27,500 for
the purchase of equipment related to the contract’s
purpose. The Company has elected to record the funds disbursed
as a contra asset; therefore, the assets are not reflected in the
Company’s financial statements. As assets were purchased, the
liability initially created when the cash was received was reduced with no
revenue recognized or fixed asset recorded on the balance
sheet. As of December 31, 2008, the Company had disbursed the
entire amount received. The grant and contract both provide
that as long as the Company performs in compliance with the
grant/contract, the Company retains the rights to the
equipment. Management states that the Company will be in
compliance with the requirements and, therefore, will retain the equipment
at the end of the grant/contract in
2009.
|
|
|
E.
|
Licenses
- The Company has secured licenses to produce various superconductive
materials for periods up to the expiration of the applicable
patents. The license fees, included in “Other Assets” on the
balance sheet, are being amortized over the expected life of the agreement
or applicable patent, which is seventeen years. Cost and
accumulated amortization of licenses at December 31, 2008 were $21,000 and
$16,489, respectively. Cost and accumulated amortization of
licenses at December 31, 2007 were $21,000 and $15,230,
respectively. Amortization expense was $1,259 for the years
ended December 31, 2008 and 2007. Amortization expense is
estimated to be $1,259 for each of the next three years and $734 in
2012.
|
|
|
F.
|
Patent
- The Company has secured patents for manufacturing processes used in its
operations. Costs incurred to secure the patents have been
capitalized, included in “Other Assets” on the balance sheet, and are
being amortized over the life of the patents. Cost and
accumulated amortization of the patents at December 31, 2008 were $46,009
and $16,266 respectively. Cost and accumulated amortization of
the patents at December 31, 2007 were $37,689 and $14,437
respectively. Amortization expense was $1,830 for the years
ended December 31, 2008 and 2007. Amortization expense is
estimated to be at least $2,300 for each of the next five years due to the
amortization of an additional patent which had cost at December 31, 2008
and was applied for in January
2009.
|
|
|
G.
|
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 recognized for net operating loss carryforwards, 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.
|
F-9
SCI
ENGINEERED MATERIALS, INC.
NOTES
TO FINANCIAL STATEMENTS
|
Note
2.
|
Summary
of Significant Accounting Policies
(Continued)
|
|
|
H.
|
Stock
Based Compensation - In December 2004, the FASB issued SFAS 123 (Revised),
“Shared Based Payment” (SFAS 123R). SFAS 123R replaced SFAS
123, and superseded APB Opinion No. 25. Effective January 1,
2006, the Company adopted the fair value recognition provisions of SFAS
123R and related interpretations using the modified-prospective transition
method. Under this method, compensation cost recognized in 2008
and 2007 includes compensation cost for all stock-based awards granted on
or subsequent to January 1, 2006, based on the grant date fair value
estimated in accordance with the provisions of SFAS
123R.
|
|
|
For
the twelve months ended December 31, 2008 and 2007, there was $77,348 and
$57,251 respectively, of stock based compensation cost included in the
determination of net income as reported. Expense includes
$55,419 in common stock issued to directors and two officers during
2008. The 2007 expense includes $40,018 in common stock issued
to directors.
|
|
I.
|
Net
Income Per Common Share - Net income per common share amounts are based on
the weighted average number of shares
outstanding.
|
|
|
J
|
.
|
Statements
of Cash Flows - For purposes of the statements of cash flows, the Company
considers all highly liquid investments purchased with maturity of three
months or less to be cash. No such investments were
purchased.
|
|
K.
|
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 had four major customers in 2008 and 2007, which accounted for
revenue of approximately $7,000,000 and $9,100,000, respectively. These
customers totaled approximately $210,000 and $120,000 of the trade
accounts receivable at December 31, 2008 and 2007 respectively.
The largest customer represented approximately 47% of total revenues in
2008 and over 50% of total revenues in
2007.
|
|
|
L
|
.
|
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. Actual results could differ from those
estimates.
|
|
|
M.
|
Fair
Value - 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
11).
|
F-10
SCI
ENGINEERED MATERIALS, INC.
NOTES
TO FINANCIAL STATEMENTS
|
Note
2.
|
Summary
of Significant Accounting Policies
(Continued)
|
|
N.
|
Revenue
Recognition - Revenue from product sales is recognized 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.
|
|
O.
|
Accounts
Receivable - The Company extends unsecured credit to customers under
normal trade agreements, which require payment within 30
days. Accounts greater than 90 days past due, which amounted to
$0 as of December 31, 2008 and 2007, are considered
delinquent. The Company does not charge interest on delinquent
trade accounts receivable. Accounts greater than one year past
due are placed on non-accrual status. 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 $24,700 as of December
31, 2008 and 2007. The estimate is based upon management’s review of
delinquent accounts and an assessment of the Company’s historical evidence of
collections. Bad debt expense was $0 for the years ended December 31,
2008 and 2007. Specific accounts are charged directly to the reserve when
management obtains evidence of a customer’s insolvency or otherwise determines
that the account is uncollectible. Charge-offs of specific accounts
for the years ended December 31, 2008 and 2007 totaled $0 each
year.
|
P.
|
Intangible
Assets - The Company accounts for Intangible Assets in accordance with
Statement of Financial Accounting Standards No. 142, “Goodwill and Other
Intangible Assets” (“SFAS 142”). SFAS 142 requires certain
intangible assets to be tested for impairment under certain circumstances,
and written off when impaired, rather than being amortized as previous
standards required. There were no impairment adjustments for
the years ended December 31, 2008 and
2007.
|
F-11
SCI
ENGINEERED MATERIALS, INC.
NOTES
TO FINANCIAL STATEMENTS
|
Note
2.
|
Summary
of Significant Accounting Policies
(Continued)
|
|
Q.
|
Recently
Issued Accounting Standards -
|
Fair
Value Measurements - In September 2006, the
FASB issued Statement of Financial Accounting Standards No. 157 (“SFAS 157”),
“Fair Value Measurements”, effective for the Company beginning on January 1,
2008. This Statement defines fair value, establishes a framework for measuring
fair value, and expands disclosures about fair value measurements. This
statement establishes a fair value hierarchy that distinguishes between
valuations obtained from sources independent of the entity and those from the
entity’s own unobservable inputs that are not corroborated by observable market
data. SFAS 157 expands disclosures about the use of fair value to measure assets
and liabilities in interim and annual periods subsequent to initial recognition.
The disclosures focus on the inputs used to measure fair value and for recurring
fair value measurements using significant unobservable inputs, the effect of the
measurements on earnings or changes in net assets for the period. The Company
adopted SFAS 157 on January 1, 2008 and it did not have a material impact on the
financial statements. The Company has deferred the application of
SFAS No. 157 related to non-financial assets and liabilities.
Fair
Value Option for Financial Assets and Financial Liabilities - In February 2007, the
FASB issued Statement of Financial Accounting Standards No. 159 (“SFAS 159”),
“The Fair Value Option for Financial Assets and Financial Liabilities”,
effective for the Company beginning on January 1, 2008. This Statement provides
entities with an option to report selected financial assets and liabilities at
fair value, with the objective to reduce both the complexity in accounting for
financial instruments and the volatility in earnings caused by measuring related
assets and liabilities differently. Adoption on January 1, 2008 did
not have a material effect on the Company since the Company did not elect to
measure any financial assets or liabilities at fair value.
In
June 2006, the Financial Accounting Standards Board (FASB) issued
Financial Interpretation (FIN) No. 48, “Accounting for Uncertainty in
Income Taxes — an Interpretation of FASB Statement No. 109.” FIN
No. 48 addresses the accounting for uncertainty in income taxes recognized
in an enterprise’s financial statements in accordance with Statement of
Financial Accounting Standards (SFAS) No. 109, “Accounting for Income
Taxes.” FIN No. 48 prescribes specific criteria for the financial statement
recognition and measurement of the tax effects of a position taken or expected
to be taken in a tax return. This interpretation also provides guidance on
de-recognition of previously recognized tax benefits, classification of tax
liabilities on the balance sheet, recording interest and penalties on tax
underpayments, accounting in interim periods, and disclosure
requirements.
The
Company adopted the provisions of FIN No. 48 on January 1, 2007. The
implementation of FIN No. 48 did not have a material effect on the
Company’s financial statements. The Company has net operating loss carry
forwards (NOLS) and a valuation allowance to offset any tax effects. The
Company has no unrecognized tax benefits and therefore, there is no anticipated
effect on the Company’s effective tax rate. 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, 2007 and
2008.
F-12
SCI
ENGINEERED MATERIALS, INC.
NOTES
TO FINANCIAL STATEMENTS
|
Note
2.
|
Summary
of Significant Accounting Policies
(Continued)
|
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 2005 through 2008 remain
open to examination by the major taxing jurisdictions in which we operate,
although no material changes to unrecognized tax positions are expected within
the next twelve months. The Company does, however, have prior year net operating
losses which remain open for examination.
|
Note
3.
|
Inventories
|
Inventories consist of the following at
December 31:
|
2008
|
2007
|
|||||||
|
Raw
materials
|
$ | 299,750 | $ | 392,937 | ||||
|
Work-in-process
|
754,097 | 205,528 | ||||||
|
Finished
goods
|
259,629 | 240,693 | ||||||
| 1,313,476 | 839,158 | |||||||
|
Less
reserve for obsolete inventory
|
49,043 | 82,159 | ||||||
| $ | 1,264,433 | $ | 756,999 | |||||
|
Note
4.
|
Lease
Obligations
|
|
|
Operating
|
|
|
The
Company leases its facilities and certain office equipment under
agreements classified as operating leases expiring through
2014. Rent expense which includes various monthly rentals for
the years ended December 31, 2008 and 2007, totaled $141,798 and $145,514,
respectively. Future minimum lease payments at December 31,
2008 are as follows:
|
|
2009
|
$ | 113,578 | ||
|
2010
|
109,146 | |||
|
2011
|
109,146 | |||
|
2012
|
108,484 | |||
|
2013
|
108,484 | |||
|
2014
and beyond
|
67,949 | |||
| $ | 616,787 |
F-13
SCI
ENGINEERED MATERIALS, INC.
NOTES
TO FINANCIAL STATEMENTS
|
Note
4.
|
Lease
Obligations (continued)
|
|
|
Capital
|
|
|
The
Company also leases certain equipment under capital leases. The
future minimum lease payment, by year, with the present value of such
payments, as of December 31, 2008 is as
follows:
|
|
2009
|
$ | 345,826 | ||
|
2010
|
293,754 | |||
|
2011
|
269,670 | |||
|
2012
|
101,636 | |||
|
2013
|
14,720 | |||
|
Total
minimum lease payments
|
1,025,606 | |||
|
Less
amount representing interest
|
117,429 | |||
|
Present
value of minimum lease payments
|
908,177 | |||
|
Less
current portion
|
285,408 | |||
|
Long-term
capital lease obligations
|
$ | 622,769 |
The
equipment under capital lease at December 31 is included in the accompanying
balance sheet under the following captions:
|
2008
|
2007
|
|||||||
|
Machinery
and equipment
|
$ | 1,544,263 | $ | 1,342,273 | ||||
|
Less
accumulated depreciation
|
328,182 | 154,813 | ||||||
|
Net
book value
|
$ | 1,216,081 | $ | 1,187,460 | ||||
These
assets are amortized over three to ten years using the straight-line method and
amortization is included in depreciation expense.
|
Note
5.
|
Common
and Preferred Stock
|
Common
Stock
In 2008,
proceeds of $10,250 were received from the exercising of 7,500
options. The exercise price for these options ranged from $1.00 to
$1.50. Proceeds from 68,021 warrants exercised were
$68,021.
6,000
stock options were exercised during 2007 resulting in proceeds of
$9,625. The exercise price for these options ranged from $1.50 to
$2.125. Proceeds from 26,909 warrants exercised were
$26,909.
F-14
SCI
ENGINEERED MATERIALS, INC.
NOTES
TO FINANCIAL STATEMENTS
|
Note
5.
|
Common
and Preferred Stock (continued)
|
Preferred
Stock
Shares of
preferred stock authorized at December 31, 2008 and 2007 and outstanding at
December 31, 2008 were as follows:
|
Shares
|
Shares
|
|||||||
|
Authorized
|
Outstanding
|
|||||||
|
Cumulative
Preferred Stock
|
10,000 | - | ||||||
|
Voting
Preferred Stock
|
125,000 | - | ||||||
|
Non-Voting
Preferred Stock
|
125,000 | (a) | 24,430 | (b) | ||||
|
|
(a)
|
Includes
700 shares of Series A Preferred Stock and 100,000 shares of Series B
Preferred Stock authorized for
issuance.
|
|
(b)
|
Series
B Preferred Stock outstanding at December 31, 2007 was 24,566
shares.
|
Shareholders
converted 136 shares of Series B Preferred Stock into 272 shares of common stock
during 2008. A shareholder converted 619 shares of Series B Preferred
Stock into 1,238 shares of common stock in 2007.
In June
1995, the Company completed an offering of 215 shares of $1,000 stated value
1995 Series A 10% non-voting convertible preferred stock. In January
1996, the Company completed an offering of 70,000 shares of $10 stated value
1995 Series B 10% non-voting convertible preferred stock. The Series
A shares are convertible to common shares at the rate of $6.00 per share and
Series B shares at the rate of $5.00 per share. At the Company’s
option, Series A and Series B shares are redeemable at 103% of the stated value
plus the amount of any accrued and unpaid cash dividends.
The
Company redeemed the Series A preferred stock in 2003. During 2008, a
Series B cash dividend of $24,566 was paid to shareholders of record as of
December 31, 2007. During 2007 no Series B cash dividend was
paid. At December 31, 2008 and 2007 the Company had accrued
dividends on Series B preferred stock of $122,018 and $122,830,
respectively. These amounts are included in convertible preferred
stock, Series B on the balance sheet at December 31, 2008 and 2007.
Earnings Per
Share
|
|
Basic
income per share is calculated as income available to common stockholders
divided by the weighted average of common shares
outstanding. Diluted earnings per share is calculated as
diluted income available to common stockholders divided by the diluted
weighted average number of common shares. Diluted weighted
average number of common shares has been calculated using the treasury
stock method for Common Stock equivalents, which includes Common Stock
issuable pursuant to stock options and Common Stock
warrants.
|
F-15
SCI
ENGINEERED MATERIALS, INC.
NOTES
TO FINANCIAL STATEMENTS
|
Note
5.
|
Common
and Preferred Stock (continued)
|
|
|
Following
is a summary of preferred stock, Series B, employee and director stock
options and warrants, at December 31, 2008 and
2007.
|
|
December
31,
|
December
31,
|
|||||||
|
2008
|
2007
|
|||||||
|
Options
|
596,250 | 584,250 | ||||||
|
Warrants
|
557,057 | 625,078 | ||||||
|
Preferred
Series B
|
24,430 | 24,566 | ||||||
| 1,177,737 | 1,233,894 | |||||||
|
|
The
following is provided to reconcile the earnings per share
calculations:
|
|
2008
|
2007
|
|||||||
|
Income
applicable to common shares
|
$ | 100,177 | $ | 307,682 | ||||
|
Weighted
average common shares outstanding - basic
|
3,530,486 | 3,461,374 | ||||||
|
Effect
of dilutions - stock options and warrants
|
504,579 | 756,562 | ||||||
|
Weighted
average shares outstanding - diluted
|
4,035,065 | 4,217,936 | ||||||
|
Note
6.
|
Stock
Option Plans
|
On June
9, 2006, shareholders approved the Superconductive Components, Inc. 2006 Stock
Incentive Plan (the “2006 Plan”), which replaced the 1995 Stock Option Plan
(“the 1995 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, 2008 there were 58,000 stock
options outstanding from the 2006 Plan. On September 29, 1995, the
Company adopted the 1995 Stock Option Plan (the “1995 Plan”) as incentive to key
employees, directors and consultants. As of December 31, 2008 there
were 538,250 stock options outstanding from the 1995 Plan, which expire at
various dates through 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 may be granted, subject to the
execution of stock option agreements.
F-16
SCI
ENGINEERED MATERIALS, INC.
NOTES
TO FINANCIAL STATEMENTS
|
Note
6.
|
Stock
Option Plans (continued)
|
The
cumulative status at December 31, 2008 and 2007 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
|
||||||||
|
Average
|
||||||||
|
Stock Options
|
Exercise Price
|
|||||||
|
Outstanding
at December 31, 2006
|
343,750 | $ | 2.09 | |||||
|
Granted
|
- | - | ||||||
|
Expired
|
- | - | ||||||
|
Forfeited
|
(500 | ) | 3.25 | |||||
|
Outstanding
at December 31, 2007
|
343,250 | $ | 2.08 | |||||
|
Granted
|
21,000 | 3.10 | ||||||
|
Exercised
|
- | - | ||||||
|
Forfeited
|
(1,500 | ) | 3.10 | |||||
|
Outstanding
at December 31, 2008
|
362,750 | $ | 2.14 | |||||
|
Shares
exercisable at December 31, 2007
|
313,650 | $ | 1.97 | |||||
|
Shares
exercisable at December 31, 2008
|
321,050 | $ | 2.00 | |||||
Non-Employee Director Stock
Options
|
Weighted
|
||||||||
|
Average
|
||||||||
|
Stock Options
|
Exercise Price
|
|||||||
|
Outstanding
at December 31, 2006
|
247,000 | $ | 2.48 | |||||
|
Granted
|
- | - | ||||||
|
Exercised
|
(6,000 | ) | 1.60 | |||||
|
Expired
|
- | - | ||||||
|
Forfeited
|
- | - | ||||||
|
Outstanding
at December 31, 2007
|
241,000 | 2.51 | ||||||
|
Granted
|
- | - | ||||||
|
Exercised
|
(7,500 | ) | 1.37 | |||||
|
Expired
|
- | - | ||||||
|
Forfeited
|
- | - | ||||||
|
Outstanding
at December 31, 2008
|
233,500 | $ | 2.54 | |||||
|
Shares
exercisable at December 31, 2007
|
241,000 | $ | 2.51 | |||||
|
Shares
exercisable at December 31, 2008
|
233,500 | $ | 2.54 | |||||
F-17
SCI
ENGINEERED MATERIALS, INC.
NOTES
TO FINANCIAL STATEMENTS
|
Note
6.
|
Stock
Option Plans (continued)
|
Exercise
prices range from $1.00 to $4.00 for options at December 31, 2008 and
2007. The weighted average option price for all options outstanding
was $2.30 with a weighted average remaining contractual life of 4.6 years at
December 31, 2008. The weighted average option price for all options
outstanding was $2.26 with a weighted average remaining contractual life of 5.4
years at December 31, 2007.
The
weighted average fair values at date of grant for options granted during 2008
was $2.83 and was estimated using the Black-Scholes option valuation model with
the following weighted average assumptions:
|
Expected
life in years
|
10.0 | |||
|
Interest
rate
|
5 | % | ||
|
Volatility
|
100.65 | % | ||
|
Dividend
yield
|
0 | % |
|
Note
7.
|
Purchase
Commitments
|
|
|
Equipment
purchases commitments approximated $468,000 at December 31, 2008 and
$159,000 at December 31, 2007.
|
In
addition, estimated purchase commitments for inventories approximated $237,000
and $122,000 (see Note 2A) at December 31, 2008 and 2007.
F-18
SCI
ENGINEERED MATERIALS, INC.
NOTES
TO FINANCIAL STATEMENTS
|
Note
8.
|
Note
Payable
|
During
the third quarter of 2006, the Company met with the Development Financing
Advisory Council (DFAC) of the Ohio Department of Development (ODOD) and applied
for a loan from the Innovation Ohio Loan Fund. The Company was
subsequently approved for a 166 Direct Loan from the ODOD in the amount of
$400,000. These funds were received in July of 2008. The
proceeds were used to reduce the balance on outstanding capital lease
obligations. The term of the loan is 84 months at an interest rate of
3%. There is also a one-quarter percent annual servicing fee to be charged
monthly on the outstanding principal balance. During each of the
first 12 months the Company will make only monthly servicing fee and interest
payments. During months 13 through 84, the Company will make monthly
servicing fee, interest and principal payments. The loan principal
balance will be fully amortized over the last 72 months. The Note is
secured by a Security Agreement granting the Lender a security interest in the
project equipment. The future minimum payment, year by year, with the
present value of such payments, as of December 31, 2008, is as
follows:
|
2009
|
$ | 33,303 | ||
|
2010
|
73,808 | |||
|
2011
|
73,649 | |||
|
2012
|
73,486 | |||
|
2013
|
73,319 | |||
|
2014
and beyond
|
121,811 | |||
|
Total
minimum note payments
|
449,376 | |||
|
Less
amount representing interest
|
49,376 | |||
|
Present
value of minimum note payments
|
400,000 | |||
|
Less
current portion
|
20,386 | |||
|
Long-term
note payable obligation
|
$ | 379,614 |
Note 9. Warrants
Issued and Vested
The
cumulative status at December 31, 2008 of warrants issued and vested is
summarized as follows:
|
Issue
|
Expiration
|
Warrant
|
|||||||||||||||||
|
Issued
|
Vested
|
Consideration
|
Date
|
Date
|
Price
|
||||||||||||||
| 150,000 | 150,000 |
Subordinated
Notes Payable
|
01/2000 | 01/2010 | $ | 2.50 | (a) | ||||||||||||
| 122,918 | 122,918 |
Private
Equity Offering
|
05/2004 | 05/2009 | 2.88 | (b) | |||||||||||||
| 17,500 | 17,500 |
Consulting
Services
|
05/2004 | 05/2009 | 2.88 | (b) | |||||||||||||
| 20,000 | 20,000 |
Revolving
Promissory Note
|
11/2004 | 11/2009 | 2.50 | (b) | |||||||||||||
| 246,639 | 246,639 |
Private
Equity Offering
|
10/2005 | 10/2010 | 3.00 | (b) | |||||||||||||
|
|
(a)
|
–
At fair market value.
|
|
|
(b)
|
–
Above fair market value.
|
F-19
SCI
ENGINEERED MATERIALS, INC.
NOTES
TO FINANCIAL STATEMENTS
Note 9. Warrants
Issued and Vested (continued)
The
cumulative status at December 31, 2007 of warrants issued and vested is
summarized as follows:
|
Issue
|
Expiration
|
Warrant
|
|||||||||||||||||
|
Issued
|
Vested
|
Consideration
|
Date
|
Date
|
Price
|
||||||||||||||
| 150,000 | 150,000 |
Subordinated
Notes Payable
|
01/2000 | 01/2010 | $ | 2.50 | (c) | ||||||||||||
| 148,302 | (a) | 58,021 |
Convertible
Promissory Note
|
06/2003 | 06/2008 | 1.00 | (d) | ||||||||||||
| 10,000 | (b) | 10,000 |
Lease
Guarantee
|
06/2003 | 06/2008 | 1.00 | (d) | ||||||||||||
| 122,918 | 122,918 |
Private
Equity Offering
|
05/2004 | 05/2009 | 2.88 | (d) | |||||||||||||
| 17,500 | 17,500 |
Consulting
Services
|
05/2004 | 05/2009 | 2.88 | (d) | |||||||||||||
| 20,000 | 20,000 |
Revolving
Promissory Note
|
11/2004 | 11/2009 | 2.50 | (d) | |||||||||||||
| 246,639 | 246,639 |
Private
Equity Offering
|
10/2005 | 10/2010 | 3.00 | (d) | |||||||||||||
(a) – The
Company issued 148,302 warrants to purchase common stock of the Company subject
to vesting. As a result of the conversion of the promissory notes on
May 13, 2004, no additional vesting accrued and the number of shares of common
stock issuable under the warrants was fixed at 84,930. 26,909
warrants were exercised in 2007.
(b)
– The Company issued 10,000 warrants to purchase common stock
of the Company subject to vesting. The warrants vested according to
the following schedule: (i) 4,600 on the date of grant; and (ii) 5,400 vested at
a rate of 150 per month for 36 months.
(c) –
At fair market value.
(d
)– Above fair market value.
F-20
SCI
ENGINEERED MATERIALS, INC.
NOTES
TO FINANCIAL STATEMENTS
|
Note
10.
|
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.
|
2008
|
2007
|
|||||||
|
Deferred
tax assets
|
||||||||
|
NOL
Carryforward
|
$ | 1,898,000 | $ | 2,173,000 | ||||
|
UNICAP
|
22,000 | 12,000 | ||||||
|
Allowance
for doubtful accounts
|
9,000 | 9,000 | ||||||
|
Reserve
for obsolete inventory
|
19,000 | 31,000 | ||||||
|
Property
and equipment
|
(109,000 | ) | (62,000 | ) | ||||
| 1,839,000 | 2,163,000 | |||||||
|
Valuation
allowance
|
1,839,000 | 2,163,000 | ||||||
|
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
$1,839,000 and $2,163,000 at December 31, 2008 and 2007,
respectively.
The
Company has net operating loss carryovers available for federal and state tax
purposes of approximately $5,000,000 and $5,700,000, at December 31, 2008 and
2007 respectively, which expire in varying amounts through 2026.
For the
years ended December 31, 2008 and 2007, a reconciliation of the statutory rate
and effective rate for the provisions for income taxes consists of the
following:
|
Percentage
|
||||||||
|
2008
|
2007
|
|||||||
|
Federal
statutory rate
|
34.0 | 34.0 | ||||||
|
Valuation
allowance
|
(34.0 | ) | (34.0 | ) | ||||
|
Effective
rate
|
- | % | - | % | ||||
|
2008
|
2007
|
|||||||
|
Current
expense
|
$ | - | $ | - | ||||
|
Deferred
expense:
|
||||||||
|
NOL
utilization/expiration
|
(275,000 | ) | (69,000 | ) | ||||
|
Other
temporary differences
|
(49,000 | ) | (20,000 | ) | ||||
|
Change
in valuation allowance
|
324,000 | 89,000 | ||||||
|
Total
|
$ | - | $ | - | ||||
F-21
SCI
ENGINEERED MATERIALS, INC.
NOTES
TO FINANCIAL STATEMENTS
|
Note
11.
|
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 debt and current maturities of long-term
debt: Amounts reported in the balance sheet approximate fair
market value due to the short maturity of these
instruments.
|
|
|
·
|
Long-term
capital lease obligations: Amounts reported in the balance sheet
approximate fair value as the interest rates on these obligations range
from 5.9% to 18.5%.
|
|
|
·
|
Long-term
note payable obligation: Amount reported in the balance sheet approximates
fair value as the interest rate on this obligation is subject to change
from time to time based on changes in an independent index which is the
LIBO rate. The index at the inception of the note was 0.386%
per annum. The interest rate to be applied to the unpaid
principal balance during this note will be at a rate of 3.500 percentage
points over the index range.
|
Note
12.
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
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 December 31, 2006
|
$ | 5,722 | ||
|
Increase
in present value of the obligation (accretion expense in the corresponding
amount charged against earnings)
|
3,312 | |||
|
Balance
at December 31, 2007
|
$ | 9,034 | ||
|
Increase
in present value of the obligation (accretion expense in the corresponding
amount charged against earnings)
|
3,312 | |||
|
Balance
at December 31, 2008
|
$ | 12,346 |
F-22
SCI
ENGINEERED MATERIALS, INC.
NOTES
TO FINANCIAL STATEMENTS
|
Note
13.
|
Subsequent
Events
|
After
December 31, 2008 the Company entered into lease agreements for additional
production equipment in the amount of approximately $468,000. The
equipment was received and the leases commenced in January 2009.
On
January 2, 2009, the Stock Option and Compensation Committee (the “Committee”)
of the Board of Directors of the Company approved the grant of options to
purchase a total of 450,000 shares of the Company’s common stock, effective
January 2, 2009, to the Company’s Chief Executive Officer and three other
executive officers. The Committee also approved the grant of options
to purchase 90,000 shares to the four non-employee board
members. Pursuant to the terms of the agreements, the options have an
exercise price of $6.00 per share, the closing price of the Company’s common
stock as reported on the OTC Bulletin Board regulated quotation service on
January 2, 2009.
On
January 15, 2009 the Board of Directors approved the payment of one year of
accrued dividends on convertible preferred stock, Series B, to shareholders of
record as of December 31, 2008. Payment is expected to be made June
30, 2009.
In
January of 2009 the Company received $36,847 from the Ohio Department of
Development’s Third Frontier Action Fund for additional equipment related to the
grant (see Note 2D).
The
Company converted a provisional patent application filed in March of 2008 to a
non-provisional application in January 2009. In January 2009 the Company
also filed for foreign coverage of the invention.
On
January 22, 2009, the Company issued a Promissory Note dated as of January 13,
2009, to The Huntington National Bank, as Lender, pursuant to a Business Loan
Agreement dated as of January 13, 2009. The Note is secured by a
Commercial Security Agreement granting the Lender a security interest in the
Company’s inventory, equipment and accounts.
Among
other items, the Note provides for the following:
|
|
·
|
At
no time shall the outstanding balance of the principal sum of the
Revolving Loan exceed the lesser of (1) $1,000,000 or (2) an amount equal
to the sum of 80% of Eligible Accounts plus the lesser of (A) 50% of
Eligible inventory or (B) $200,000.
|
|
|
·
|
Interest
on the note is subject to change from time to time based on changes in an
independent index which is the LIBO rate. The index at the
inception of the note was 0.386% per annum. The interest rate
to be applied to the unpaid principal balance during this note will be at
a rate of 3.500 percentage points over the
index.
|
|
|
·
|
All
accrued interest is payable monthly. The outstanding principal
and accrued interest owed on the Note matures on January 1,
2010.
|
F-23
SCI
ENGINEERED MATERIALS, INC.
NOTES
TO FINANCIAL STATEMENTS
|
Note
13.
|
Subsequent
Events (continued)
|
During
the third quarter of 2008 we received notification from the Department of Energy
of a Notice of Financial Assistance Award in the amount of approximately
$750,000. The initial $125,000 was formally approved during
2008. The remaining balance was approved in February
2009. This award provides support for Phase II of a Small Business
Innovation Research award entitled “Flux Pinning Additions to Increase Jc
Performance in BSCCO-2212 Round Wire for Very High Field
Magnets.” The work on the contract began during the third quarter of
2008 and is expected to continue through August 2010.
F-24