SCI Engineered Materials, Inc. - Quarter Report: 2021 September (Form 10-Q)

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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

(Mark One)

For the quarterly period ended September 30, 2021

or

For the transition period from                       to                       

Commission file number: 0-31641

SCI ENGINEERED MATERIALS, INC.

(Exact name of registrant as specified in its charter)

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2839 Charter Street, Columbus, Ohio 43228

(Address of principal executive offices) (Zip Code)

(614) 486-0261

(Registrant’s telephone number, including area code)

Not Applicable

(Former name, former address and former fiscal year, if changed since last report)

Securities registered pursuant to Section 12(b) of the Act:

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

Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (section 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files). Yes ☒ No ☐

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

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If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ☐

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

4,501,248 shares of Common Stock, without par value, were outstanding at October 26, 2021.

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FORM 10-Q

SCI ENGINEERED MATERIALS, INC.

Table of Contents

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PART I. FINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS

SCI ENGINEERED MATERIALS, INC.

BALANCE SHEETS

ASSETS

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

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SCI ENGINEERED MATERIALS, INC.

BALANCE SHEETS

LIABILITIES AND SHAREHOLDERS’ EQUITY

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

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SCI ENGINEERED MATERIALS, INC.

STATEMENTS OF OPERATIONS

THREE MONTHS AND NINE MONTHS ENDED SEPTEMBER 30, 2021 AND 2020

(UNAUDITED)

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

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SCI ENGINEERED MATERIALS, INC.

STATEMENTS OF SHAREHOLDERS’ EQUITY

THREE AND NINE MONTHS ENDED SEPTEMBER 30, 2021 AND 2020

(UNAUDITED)

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

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SCI ENGINEERED MATERIALS, INC.

STATEMENTS OF CASH FLOWS

NINE MONTHS ENDED SEPTEMBER 30, 2021 AND 2020

(UNAUDITED)

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

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SCI ENGINEERED MATERIALS, INC.

NOTES TO FINANCIAL STATEMENTS

Note 1.  Business Organization and Purpose

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

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Note 2.  Summary of Significant Accounting Policies

Basis of Presentation - The accompanying unaudited financial statements have been prepared in accordance with U.S. generally accepted accounting principles for interim financial information and with instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all the information and footnotes required by U.S. generally accepted accounting principles for complete financial statements. In the opinion of management, all adjustments considered necessary for fair presentation of the results of operations for the periods presented have been included. The financial statements should be read in conjunction with the audited financial statements and the notes thereto for the year ended December 31, 2020. Interim results are not necessarily indicative of results for the full year.

Use of Estimates - The preparation of financial statements in conformity with U.S. generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of 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.

Revenue Recognition -  The Company enters into contracts with its customers that generally represent purchase orders specifying general terms and conditions, order quantities and per unit product prices. The Company has determined that each unit of product purchased represents a separate performance obligation. The Company satisfies its performance obligations and recognizes revenue at a point in time when control of a unit of product is transferred to the customer. Revenue is measured as the amount of consideration the Company expects to receive in exchange for transferring products. For most product sales, transfer of control occurs when the products are shipped from the Company’s manufacturing facility to the customer. The cost of delivering products to the Company’s customers is recorded as a component of cost of products sold. Those costs may include the amounts paid to a third party to deliver the products. Any freight costs billed to and paid by a customer are included in revenue.  

The Company considers collectability of amounts due under a contract to be probable upon inception of a sale based on an evaluation of the credit worthiness of each customer. The Company sells its products typically under agreements with payment terms less than 45 days. The Company does not typically include extended payment terms or significant financing components in contracts with customers. The majority of the Company’s contracts have an obligation to transfer products within one year. Thus, the Company elects to use the practical expedient where incremental cost of obtaining a contract, such as commissions, is expensed when incurred because the amortization period for those costs is one year or less.  The Company treats shipping and handling activities that occur after control of the product transfers as fulfillment activities, and therefore, does not account for shipping and handling costs as a separate performance obligation. Customer deposits are funds received in advance from customers and are recognized as revenue when the Company has transferred control of product to the customer. Product revenues are recognized upon shipment of goods as the customer has assumed the significant risks and rewards of ownership and the Company is entitled to payment at this point. Service revenues are recognized upon completion as the customer cannot realize the benefit of the service until fully completed.

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SCI ENGINEERED MATERIALS, INC.

NOTES TO FINANCIAL STATEMENTS

Note 2.  Summary of Significant Accounting Policies (continued)

During the three months ended September 30, 2021, and 2020, all revenue was from the photonics market. During the nine months ended September 30, 2021, and 2020, revenue from the photonics market was approximately 100% and 99%, respectively. The balance of the revenue in these periods was almost entirely from the thin film solar and thin film battery markets. The top two customers represented approximately 84% and 83% of total revenue for the nine months ended September 30, 2021, and 2020, respectively. International shipments resulted in 2% and 5% of total revenue for the first nine months of 2021 and 2020, respectively.

Employee Retention Credit (“ERC”) - The Company qualified for federal government assistance through ERC provisions of the Consolidated Appropriations Act of 2021 during the current fiscal year in the amount of $255,507 for the first quarter of 2021, $151,701 for the second quarter of 2021, and $153,713 for the third quarter of 2021. The purpose of the ERC is to encourage employers to keep employees on the payroll, even if they are not working during the covered period because of the coronavirus outbreak. This credit is recorded in the Statement of Operations as an offset to payroll costs in their respective expense lines. A balance of $184,861 appears as a tax receivable on the balance sheets at September 30, 2021.

American Rescue Plan Act of 2021 (“ARP”) – This act allows eligible employers with fewer than 500 employees to qualify for a tax credit for providing paid time off for each employee receiving COVID-19 vaccinations and for any time needed to recover from the vaccine. The Company received a credit of $11,042 during the third quarter of 2021.

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Note 3.  Recent Accounting Pronouncements

In June 2016, the FASB issued ASU No. 2016-13 “Credit Losses - Measurement of Credit Losses on Financial Instruments.” ASU No. 2016-13 significantly changes how entities will measure credit losses for most financial assets, including accounts and notes receivables, by replacing today’s “incurred loss” approach with an “expected loss” model under which allowances will be recognized based on expected rather than incurred losses. ASU No. 2016-13 will become effective for the Company in the first quarter of 2023. The Company is evaluating the impact that the adoption of this update will have on its financial statements.

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Note 4.  Common Stock and Stock Options

Stock Based Compensation cost for all stock awards is based on the grant date fair value and recognized over the required service (vesting) period. Non cash stock-based compensation expense was $8,670 and $31,182 for the three months ended September 30, 2021, and 2020, respectively. Noncash stock-based compensation expense was $39,233 and $93,544 for the nine months ended September 30, 2021, and 2020, respectively.

Unrecognized compensation expense was $7,487 as of September 30, 2021, and will be recognized through 2023. There was no tax benefit recorded for this compensation cost as the expense primarily relates to incentive stock options that do not qualify for a tax deduction until, and only if, a qualifying disposition occurs.

The non-employee Board members received compensation of 7,605 and 75,475 aggregate shares of common stock of the Company during the nine months ended September 30, 2021, and 2020, respectively. The stock had an aggregate value of $22,475 and $89,998 for the nine months ended September 30, 2021, and 2020, respectively, and was recorded as non-cash stock compensation expense in the financial statements.

Employees received compensation of 4,804 aggregate shares of common stock of the Company during the nine months ended September 30, 2021, which had an aggregate value of $13,211, and was recorded as noncash stock-based compensation expense in the financial statements. In addition, during the nine months ended September 30, 2021, a total of 30,181 stock options were exercised by management.

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SCI ENGINEERED MATERIALS, INC.

NOTES TO FINANCIAL STATEMENTS

Note 4.  Common Stock and Stock Options (continued)

The cumulative status of options granted and outstanding at September 30, 2021, and December 31, 2020, as well as options which became exercisable in connection with the Company’s stock option plans is summarized as follows:

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Exercise prices for options ranged from $0.84 to $1.25 at September 30, 2021. The weighted average option price for all options outstanding at September 30, 2021, was $1.07 with a weighted average remaining contractual life of 5.0 years.

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Note 5.  Preferred Stock

Dividends on the Series B preferred stock accrue at 10% annually on the outstanding shares. Dividends on the Series B preferred stock were $6,038 for the three months ended September 30, 2021, and 2020, and $18,114 for the nine months ended September 30, 2021, and 2020. The Company had accrued dividends on Series B preferred stock of $259,634 at September 30, 2021, and $265,672 at December 31, 2020. These amounts are included in Convertible preferred stock, Series B, on the balance sheet at September 30, 2021, and December 31, 2020. During June 2021, and June 2020, a dividend payment of $24,152 was made to preferred shareholders.

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Note 6.  Inventories

Inventories consisted of the following:

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SCI ENGINEERED MATERIALS, INC.

NOTES TO FINANCIAL STATEMENTS

Note 7.  Earnings Per Share

Basic income per share is calculated as income applicable to common shareholders divided by the weighted average of common shares outstanding. Diluted earnings per share is calculated as diluted income applicable to common shareholders divided by the diluted weighted average number of common shares. Diluted weighted average number of common shares gives effect to all dilutive potential common shares outstanding during the period using the treasury stock method and convertible preferred stock using the if-converted method. Diluted earnings per share exclude all diluted potential shares if their effect is anti-dilutive. All convertible preferred stock and common stock options listed in Note 4 that were out-of-the-money or anti-dilutive were excluded from diluted earnings per share. The following is provided to reconcile the earnings per share calculations:

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Note 8.   Notes Payable

On April 17, 2020, the Company entered into an unsecured promissory note under the Paycheck Protection Program (the “PPP”), with a principal amount of $325,300. The PPP was established under the Coronavirus Aid, Relief, and Economic Security Act (the “CARES Act”) and administered by the U.S. Small Business Administration (the “SBA”). The term of the PPP loan was two years. The interest rate on this loan was 1.0% per annum, which was deferred for the first six months of the term of the loan. After the initial six-month deferral period or until forgiveness of the loan was approved, the loan required monthly payments of principal and interest until maturity with respect to any portion of the PPP loan which was not forgiven. Under the terms of the CARES Act, PPP loan recipients are eligible to apply for, and be granted, forgiveness for all or a portion of loans granted under the PPP. Such forgiveness was subject to limitations and ongoing rulemaking by the SBA, based on the use of loan proceeds for payroll costs and mortgage interest, rent or utility costs and the maintenance of employee and compensation levels. The Company applied for forgiveness of the entire amount of the loan during the fourth quarter of 2020, and the SBA approved the Forgiveness Application in full during the first quarter of 2021. This amount is included in the Statement of Operations as gain on extinguishment of debt in the first quarter of 2021.

The Company had a line of credit with Huntington National Bank for $1 million which was closed during the third quarter of 2021. It had an expiration date of October 5, 2021. No amounts were drawn on this line of credit during 2021.  

The Company commenced a line of credit with Fifth Third Bank for $1 million during August of 2021. The line of credit bears interest equal to the rate of interest per annum established by Fifth Third Bank as its Prime Rate. This line of credit has a maturity date of August 29, 2022. At September 30, 2021, no amounts were drawn on the line of credit.

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Note 9.  Income Taxes

The provision for income taxes for the three and nine months ended September 30, 2021, is based on our projected annual effective tax rate for fiscal year 2021, adjusted for permanent differences and specific items that are required to be recognized in the period in which they are incurred. The provision for income taxes was $200,189 and $0 for the three months ended September 30, 2021, and 2020 respectively, and $338,282 and $1,900 for the nine months ended September 30, 2021, and 2020 respectively.

The federal effective tax rate was 17.8% for the nine months ended September 30, 2021. The difference compared to the federal statutory rate of 21% was due primarily to a tax benefit of $325,300 from the PPP loan forgiveness.

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SCI ENGINEERED MATERIALS, INC.

NOTES TO FINANCIAL STATEMENTS

Note 9.  Income Taxes (continued)

Following is the income tax expense for the three and nine months ended September 30:

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Deferred tax assets and liabilities result from temporary differences in the recognition of income and expense for tax and financial reporting purposes. A valuation allowance of $0 has been recorded against the realizability of the net deferred tax asset at September 30, 2021, and December 31, 2020. The Company had net operating loss carryforwards available for federal and state tax purposes of approximately $3,700,000 at December 31, 2020, which expire in varying amounts through 2035.

As of December 31, 2020, management determined that there was sufficient positive evidence to conclude that it was more likely than not that deferred taxes of $1,019,317 were realizable in part because the Company achieved four consecutive years of pretax income, expects profits to continue for the foreseeable future and implemented new efficiencies in the Company’s manufacturing process. As of each reporting date, management considers new evidence, both positive and negative, that could affect its view of the future realization of deferred tax assets. Accordingly, management determined that no valuation allowance was necessary, and the deferred tax asset was $703,132 at September 30, 2021.

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Note 10. Operating Lease

The Company entered into an operating lease with a third party on March 18, 2014, for its headquarters in Columbus, Ohio. The terms of the lease include monthly rental payments ranging from $9,200 to $9,700 with a maturity date of November 30, 2024. The Company has the option to extend the lease period for an additional five years beyond the original expiration date. There are no restrictions or covenants associated with the lease. The lease costs were approximately $82,600 and $80,900 during the nine months ended September 30, 2021, and 2020, respectively.

The following is a maturity analysis, by year, of the annual undiscounted cash outflows of the operating lease liabilities as of September 30, 2021:

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SCI ENGINEERED MATERIALS, INC.

NOTES TO FINANCIAL STATEMENTS

Note 11. Finance Leases

The Company leases certain equipment under finance leases. Future minimum lease payments, by year, with the present value of such payments, as of September 30, 2021, are shown in the following table.

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