UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
 
FORM 10-Q
 
(Mark One)
x
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 2013
or
 
¨
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from                         to                       
 
Commission file number: 0-31641
 
SCI ENGINEERED MATERIALS, INC.
(Exact name of registrant as specified in its charter)
 
Ohio
 
31-1210318
(State or other jurisdiction of
 
(I.R.S. Employer
incorporation or organization)
 
Identification No.)
 
2839 Charter Street, Columbus, Ohio 43228
(Address of principal executive offices) (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)
 
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes   x   No   ¨
 
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (section 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).   Yes   x   No   ¨
 
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company. See the definitions of “large accelerated filer”, “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):
Large accelerated filer ¨
Accelerated filer ¨
Non-accelerated filer ¨
Smaller reporting company x
 
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).  Yes   ¨   No   x
 
3,844,898 shares of Common Stock, without par value, were outstanding at October 31, 2013.
 
  
 
FORM 10-Q
 
SCI ENGINEERED MATERIALS, INC.
 
Table of Contents
 
 
 
 
Page No.
 
 
 
 
PART I.
FINANCIAL INFORMATION
 
 
 
 
 
 
Item 1.
Financial Statements
 
 
 
 
 
 
 
Balance Sheets as of September 30, 2013 (unaudited)
 
 
 
and December 31, 2012
3
 
 
 
 
 
 
Statements of Operations for the Three and Nine Months
 
 
 
Ended September 30, 2013 and 2012 (unaudited)
5
 
 
 
 
 
 
Statements of Cash Flows for the Nine Months
 
 
 
Ended September 30, 2013 and 2012 (unaudited)
6
 
 
 
 
 
 
       Notes to Financial Statements (unaudited)
7
 
 
 
 
 
Item 2.
Management's Discussion and Analysis of Financial Condition and
 
 
 
Results of Operations
13
 
 
 
 
 
Item 3.
Quantitative and Qualitative Disclosures About Market Risk
N/A
 
 
 
 
 
Item 4.
Controls and Procedures
21
 
 
 
 
PART II.
OTHER INFORMATION
 
 
 
 
 
 
Item 1.
Legal Proceedings
N/A
 
 
 
 
 
Item 1A.
Risk Factors
N/A
 
 
 
 
 
Item 2.
Unregistered Sales of Equity Securities and Use of Proceeds
N/A
 
 
 
 
 
Item 3.
Defaults Upon Senior Securities
N/A
 
 
 
 
 
Item 4.
Mine Safety Disclosures
N/A
 
 
 
 
 
Item 5.
Other Information
N/A
 
 
 
 
 
Item 6.
Exhibits
23
 
 
 
 
 
Signatures
 
25
  
 
 
 
PART I. FINANCIAL INFORMATION
 
ITEM 1. FINANCIAL STATEMENTS
 
SCI ENGINEERED MATERIALS, INC.
 
BALANCE SHEETS
 
ASSETS
 
 
 
 
 
 
 
 
 
 
September 30,
 
 
December 31,
 
 
 
 
2013
 
 
2012
 
 
 
 
(UNAUDITED)
 
 
 
 
Current Assets
 
 
 
 
 
 
 
Cash
 
$
494,124
 
$
630,819
 
Accounts receivable, less allowance for doubtful accounts of $15,000 and $45,000, respectively
 
 
487,488
 
 
453,302
 
Inventories
 
 
1,193,231
 
 
815,075
 
Prepaid expenses
 
 
551,874
 
 
209,422
 
Total current assets
 
 
2,726,717
 
 
2,108,618
 
 
 
 
 
 
 
 
 
Property and Equipment, at cost
 
 
 
 
 
 
 
Machinery and equipment
 
 
7,125,506
 
 
7,015,504
 
Furniture and fixtures
 
 
137,911
 
 
137,911
 
Leasehold improvements
 
 
317,870
 
 
317,870
 
Construction in progress
 
 
-
 
 
12,195
 
 
 
 
7,581,287
 
 
7,483,480
 
Less accumulated depreciation and amortization
 
 
(4,676,818)
 
 
(4,254,302)
 
 
 
 
2,904,469
 
 
3,229,178
 
 
 
 
 
 
 
 
 
Other Assets
 
 
 
 
 
 
 
Deposits
 
 
17,117
 
 
15,332
 
Deferred financing fees
 
 
31,463
 
 
38,543
 
Intangibles
 
 
11,517
 
 
12,889
 
Total other assets
 
 
60,097
 
 
66,764
 
 
 
 
 
 
 
 
 
TOTAL ASSETS
 
$
5,691,283
 
$
5,404,560
 
   
The accompanying notes are an integral part of these financial statements.
 
 
3

 
SCI ENGINEERED MATERIALS, INC.
 
BALANCE SHEETS (continued)
 
LIABILITIES AND SHAREHOLDERS' EQUITY
 
 
 
September 30,
 
December 31,
 
 
 
2013
 
2012
 
 
 
(UNAUDITED)
 
 
 
 
Current Liabilities
 
 
 
 
 
 
 
Capital lease obligations, current portion
 
$
137,615
 
$
221,366
 
Notes payable, current portion
 
 
217,647
 
 
316,571
 
Accounts payable
 
 
186,407
 
 
260,531
 
Customer deposits
 
 
1,265,708
 
 
313,745
 
Accrued compensation
 
 
89,872
 
 
76,646
 
Accrued expenses and other
 
 
98,238
 
 
117,572
 
Total current liabilities
 
 
1,995,487
 
 
1,306,431
 
 
 
 
 
 
 
 
 
Capital lease obligations, net of current portion
 
 
157,601
 
 
163,331
 
Notes payable, net of current portion
 
 
948,819
 
 
1,057,104
 
Total liabilities
 
 
3,101,907
 
 
2,526,866
 
 
 
 
 
 
 
 
 
Commitments and contingencies
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Shareholders' Equity
 
 
 
 
 
 
 
Convertible preferred stock, Series B, 10% cumulative,
    nonvoting, no par value, $10 stated value, optional
    redemption at 103%; optional shareholder conversion 2 shares for 1;
    24,152 shares issued and outstanding
 
 
435,944
 
 
417,830
 
Common stock, no par value, authorized 15,000,000 shares;
    3,844,898 and 3,826,898 shares issued and outstanding, respectively
 
 
9,825,300
 
 
9,800,100
 
Additional paid-in capital
 
 
1,816,130
 
 
1,758,358
 
Accumulated deficit
 
 
(9,487,998)
 
 
(9,098,594)
 
 
 
 
2,589,376
 
 
2,877,694
 
 
 
 
 
 
 
 
 
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY
 
$
5,691,283
 
$
5,404,560
 
 
The accompanying notes are an integral part of these financial statements.
 
 
4

 
SCI ENGINEERED MATERIALS, INC.
 
STATEMENTS OF OPERATIONS
 
THREE MONTHS AND NINE MONTHS ENDED SEPTEMBER 30, 2013 AND 2012
 
(UNAUDITED)
 
 
 
THREE MONTHS ENDED SEPT. 30,
 
NINE MONTHS ENDED SEPT. 30,
 
 
 
 
2013
 
 
2012
 
 
2013
 
 
2012
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Product revenue
 
$
1,810,044
 
$
1,926,040
 
$
4,946,251
 
$
6,387,799
 
Contract research revenue
 
 
-
 
 
56,363
 
 
90,170
 
 
181,363
 
 
 
 
1,810,044
 
 
1,982,403
 
 
5,036,421
 
 
6,569,162
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Cost of product revenue
 
 
1,393,208
 
 
1,373,258
 
 
3,971,147
 
 
5,021,258
 
Cost of contract research revenue
 
 
-
 
 
46,969
 
 
76,648
 
 
147,552
 
 
 
 
1,393,208
 
 
1,420,227
 
 
4,047,795
 
 
5,168,810
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Gross profit
 
 
416,836
 
 
562,176
 
 
988,626
 
 
1,400,352
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
General and administrative expense
 
 
250,232
 
 
247,470
 
 
785,065
 
 
818,939
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Research and development expense
 
 
112,365
 
 
62,646
 
 
254,568
 
 
230,035
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Marketing and sales expense
 
 
106,582
 
 
139,381
 
 
331,022
 
 
399,185
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
(Loss) income from operations
 
 
(52,343)
 
 
112,679
 
 
(382,029)
 
 
(47,807)
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Other (expense) income
 
 
 
 
 
 
 
 
 
 
 
 
 
Interest, net
 
 
(17,650)
 
 
(19,843)
 
 
(56,772)
 
 
(64,404)
 
(Loss) gain on disposal of equipment, net
 
 
(291)
 
 
(850)
 
 
49,397
 
 
(850)
 
 
 
 
(17,941)
 
 
(20,693)
 
 
(7,375)
 
 
(65,254)
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
(Loss) income before provision for income taxes
 
 
(70,284)
 
 
91,986
 
 
(389,404)
 
 
(113,061)
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Income tax (expense) benefit
 
 
-
 
 
(1,237)
 
 
-
 
 
24,652
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Net (loss) income
 
 
(70,284)
 
 
90,749
 
 
(389,404)
 
 
(88,409)
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Dividends on preferred stock
 
 
(6,038)
 
 
(6,038)
 
 
(18,114)
 
 
(18,114)
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
(LOSS) INCOME APPLICABLE TO COMMON SHARES
 
$
(76,322)
 
$
84,711
 
$
(407,518)
 
$
(106,523)
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Earnings per share - basic and diluted (Note 6)
 
 
 
 
 
 
 
 
 
 
 
 
 
(Loss) income per common share
 
 
 
 
 
 
 
 
 
 
 
 
 
Basic
 
$
(0.02)
 
$
0.02
 
$
(0.11)
 
$
(0.03)
 
Diluted
 
$
(0.02)
 
$
0.02
 
$
(0.11)
 
$
(0.03)
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Weighted average shares outstanding
 
 
 
 
 
 
 
 
 
 
 
 
 
Basic
 
 
3,841,963
 
 
3,817,963
 
 
3,835,997
 
 
3,812,019
 
Diluted
 
 
3,841,963
 
 
3,827,774
 
 
3,835,997
 
 
3,812,019
 
 
The accompanying notes are an integral part of these financial statements.
 
 
5

 
SCI ENGINEERED MATERIALS, INC.
 
STATEMENTS OF CASH FLOWS
 
NINE MONTHS ENDED SEPTEMBER 30, 2013 AND 2012
 
(UNAUDITED)
 
 
 
2013
 
2012
 
CASH FLOWS FROM OPERATING ACTIVITIES
 
 
 
 
 
 
 
Net loss
 
$
(389,404)
 
$
(88,409)
 
Adjustments to reconcile net loss to net cash provided by operating activities:
 
 
 
 
 
 
 
Depreciation and accretion
 
 
435,707
 
 
433,841
 
Amortization
 
 
1,372
 
 
2,107
 
Stock based compensation
 
 
101,086
 
 
102,294
 
Net (gain) loss on disposal of equipment
 
 
(49,397)
 
 
850
 
Inventory reserve
 
 
20,652
 
 
23,095
 
Credit for doubtful accounts
 
 
(30,223)
 
 
-
 
Changes in operating assets and liabilities:
 
 
 
 
 
 
 
Accounts receivable
 
 
(3,963)
 
 
(141,982)
 
Inventories
 
 
(398,808)
 
 
(421,937)
 
Prepaid expenses
 
 
(342,452)
 
 
(17,969)
 
Other assets
 
 
5,295
 
 
13,969
 
Accounts payable
 
 
(74,124)
 
 
42,977
 
Accrued expenses and customer deposits
 
 
938,986
 
 
311,786
 
Net cash provided by operating activities
 
 
214,727
 
 
260,622
 
 
 
 
 
 
 
 
 
CASH FLOWS FROM INVESTING ACTIVITIES
 
 
 
 
 
 
 
Proceeds on sale of equipment
 
 
50,050
 
 
-
 
Purchases of property and equipment
 
 
(18,392)
 
 
(563,997)
 
Net cash provided by (used in) investing activities
 
 
31,658
 
 
(563,997)
 
 
 
 
 
 
 
 
 
CASH FLOWS FROM FINANCING ACTIVITIES
 
 
 
 
 
 
 
Proceeds from notes payable
 
 
-
 
 
911,546
 
Principal payments on capital lease obligations and notes payable
 
 
(383,080)
 
 
(814,862)
 
Net cash (used in) provided by financing activities
 
 
(383,080)
 
 
96,684
 
 
 
 
 
 
 
 
 
NET DECREASE IN CASH
 
 
(136,695)
 
 
(206,691)
 
 
 
 
 
 
 
 
 
CASH - Beginning of period
 
 
630,819
 
 
798,069
 
 
 
 
 
 
 
 
 
CASH - End of period
 
$
494,124
 
$
591,378
 
 
 
 
 
 
 
 
 
SUPPLEMENTAL DISCLOSURES OF CASH
 
 
 
 
 
 
 
FLOW INFORMATION
 
 
 
 
 
 
 
Cash paid during the period for:
 
 
 
 
 
 
 
Interest
 
$
57,305
 
$
65,214
 
Income taxes
 
 
-
 
 
605
 
 
 
 
 
 
 
 
 
SUPPLEMENTAL DISCLOSURES OF NONCASH
 
 
 
 
 
 
 
FINANCING ACTIVITIES
 
 
 
 
 
 
 
Property and equipment purchased by capital lease
 
 
86,389
 
 
-
 
Increase in asset retirement obligation
 
 
6,870
 
 
6,480
 
 
The accompanying notes are an integral part of these financial statements.
 
 
6

 
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 is a global supplier and manufacturer of advanced materials for Physical Vapor Deposition Thin Film Applications. Through partnerships with end users and Original Equipment Manufacturers the Company develops innovative customized solutions enabling commercial success.

Note 2.  Summary of Significant Accounting Policies
 
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 of 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, 2012. Interim results are not necessarily indicative of results for the full year.
 
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.

Note 3.    Common Stock and Stock Options
 
 Stock Based Compensation - Compensation cost for all stock-based awards is based on the grant date fair value and recognized over the required service (vesting) period. Non cash stock based compensation expense was $ 31,355 and $ 31,415 for the three months ended September 30, 2013 and 2012, respectively. Non cash stock based compensation expense was $ 101,086 and $ 102,294 for the nine months ended September 30, 2013 and 2012, respectively. Unrecognized compensation expense was $ 430,021 as of September 30, 2013 and will be recognized through 2017. 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 four non-employee board members each received compensation of 4,500 shares of common stock of the Company during the nine months ended September 30, 2013 and 2012. The stock had an aggregate value of $ 25,200 and $ 24,060 for the nine months ended September 30, 2013 and 2012, respectively, and was recorded in general and administrative expense as non cash stock compensation expense in the financial statements.
 
 
7

 
SCI ENGINEERED MATERIALS, INC.
NOTES TO FINANCIAL STATEMENTS
 
Note 3.  Common Stock and Stock Options (continued)
 
The cumulative status of options granted and outstanding at September 30, 2013, and December 31, 2012, as well as options which became exercisable in connection with the Company’s stock option plans is summarized as follows:
 
Employee Stock Options
 
 
 
 
 
Weighted
 
 
 
 
 
 
Average
 
 
 
Stock Options
 
Exercise Price
 
 
 
 
 
 
 
 
 
Outstanding at January 1, 2012
 
 
736,750
 
$
4.52
 
Expired
 
 
(144,500)
 
 
1.59
 
Outstanding at December 31, 2012
 
 
592,250
 
$
5.23
 
Expired
 
 
(250)
 
 
1.00
 
Outstanding at September 30, 2013
 
 
592,000
 
$
5.23
 
Options exercisable at December 31, 2012
 
 
322,250
 
$
4.59
 
Options exercisable at September 30, 2013
 
 
367,000
 
$
4.76
 
 
Non-Employee Director Stock Options
 
 
 
 
 
Average
 
 
 
Stock Options
 
Exercise Price
 
 
 
 
 
 
 
 
 
Outstanding at January 1, 2012
 
 
250,000
 
$
3.87
 
Outstanding at December 31, 2012
 
 
250,000
 
$
3.87
 
Expired
 
 
(30,000)
 
 
1.00
 
Outstanding at September 30, 2013
 
 
220,000
 
$
4.26
 
Options exercisable at December 31, 2012
 
 
250,000
 
$
3.87
 
Options exercisable at September 30, 2013
 
 
220,000
 
$
4.26
 
 
Exercise prices for options ranged from $ 2.40 to $ 6.00 at September 30, 2013. The weighted average option price for all options outstanding was $ 4.97 with a weighted average remaining contractual life of 3.4 years.

Note 4.  Preferred Stock
 
Pursuant to the terms of the preferred stock, the Board of Directors voted not to authorize the payment of a cash dividend on convertible preferred stock, Series B, to shareholders of record as of December 31, 2012. Dividends on the Series B preferred stock accrue at 10 % annually on the outstanding shares. Accrued dividends on the Series B preferred stock were $ 6,038 for the three months ended September 30, 2013 and 2012 and $ 18,114 for the nine months ended September 30, 2013 and 2012. The Company had accrued dividends on Series B preferred stock of $ 187,178 at September 30, 2013, and $ 169,064 at December 31, 2012. These amounts are included in Convertible preferred stock, Series B on the balance sheet at September 30, 2013 and December 31, 2012.
 
 
8

 
SCI ENGINEERED MATERIALS, INC.
NOTES TO FINANCIAL STATEMENTS
 
Note 5.  Inventories
 
Inventories consisted of the following:
 
 
September 30,
 
 
December 31,
 
 
 
 
2013
 
 
2012
 
 
 
(unaudited)
 
 
 
 
Raw materials
 
$
477,863
 
$
346,613
 
Work-in-process
 
 
704,128
 
 
408,491
 
Finished goods
 
 
131,892
 
 
159,971
 
Inventory reserve
 
 
(120,652)
 
 
(100,000)
 
 
 
$
1,193,231
 
$
815,075
 

Note 6.  Earnings Per Share
 
Basic income (loss) per share is calculated as income available to (loss applicable 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 gives effect to all dilutive potential common shares outstanding during the period using the treasury stock method and convertible preferred stock using the if-converted method. Diluted earnings per share exclude all diluted potential shares if their effect is anti-dilutive. For the three months ended September 30, 2013, and the nine months ended September 30, 2013 and 2012, all convertible preferred stock and common stock options listed in Note 3 were excluded from diluted earnings per share due to being out-of-the-money or anti-dilutive. The following is provided to reconcile the earnings per share calculations:   
               
 
 
Three months ended Sept. 30,
Nine months ended Sept. 30,
 
 
 
2013
 
2012
 
2013
 
2012
 
(Loss) income applicable to common shares
 
$
(76,322)
 
$
84,711
 
$
(407,518)
 
$
(106,523)
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Weighted average common shares outstanding – basic
 
 
3,841,963
 
 
3,817,963
 
 
3,835,997
 
 
3,812,019
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Effect of dilution
 
 
-
 
 
9,811
 
 
-
 
 
-
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Weighted average shares outstanding - diluted
 
 
3,841,963
 
 
3,827,774
 
 
3,835,997
 
 
3,812,019
 
 
 
9

 
SCI ENGINEERED MATERIALS, INC.
NOTES TO FINANCIAL STATEMENTS
 
Note 7.  Notes Payable
 
On August 8, 2013, the Company issued a Promissory Note (the “Note”) in the amount of $ 128,257 to The Huntington National Bank, as Lender, with a maturity date of August 5, 2016. This Note replaced an existing promissory note to the Huntington National Bank which had a balance of $128,257, monthly payments of approximately $5,600, including interest, with remaining principal due at the maturity date of February 28, 2014 .
 
The Note is collateralized by the Company’s inventories, equipment and accounts receivable. Among other items, the Note provides for the following:
 
 
 
-
Interest subject to change from time to time based on changes in LIBOR. The interest rate applied to the unpaid principal balance is at a rate of 4 percentage points over LIBOR. Under no circumstance will the interest rate be less than 5 % per annum or more than the maximum rate allowed by applicable law.
 
 
 
 
 
 
-
Monthly payments of approximately $3,800, including interest, beginning in September 2013.
 
As of September 30, 2013 there was an outstanding balance of $125,052 on this Note. 
 
The Company’s revolving line of credit arrangement with its senior lender expired on April 13, 2012. There was no balance outstanding under this arrangement at maturity. 
 
During 2010, the Company applied and was approved for a 166 Direct Loan to borrow up to $ 744,250 with the Ohio Department of Development (ODOD), now known as the Ohio Development Services Agency (ODSA). This loan was finalized in February 2011. The term of the loan is 84 months at a fixed interest rate of 3 %. There is also a 0.25 % annual servicing fee charged monthly on the outstanding principal balance. Payments of approximately $ 10,500 , including interest and servicing fee, were payable monthly. On August 13, 2013, ODSA and the Company agreed to a modification to the payment schedule. Interest and servicing payments of $1,656 are due monthly from August 2013 through January 2014. Beginning in February 2014, monthly payments of approximately $10,500, including principal, interest and servicing fee are due through October 2018. A final payment of approximately $71,900 is due November 2018.    The loan is collateralized by the related project equipment. As of September 30, 2013 there was an outstanding balance of $ 611,520 on this loan.     
 
During 2010, the Company also applied and was approved for a 166 Direct Loan through the Advanced Energy Program with the Ohio Air Quality Development Authority (OAQDA) to borrow up to approximately $ 1.4 million (this maximum commitment by the OAQDA was subsequently reduced to $ 368,906 on March 20, 2012). The interest rate was 3 % at December 31, 2011 and increased to 10 % effective with the first amendment dated March 20, 2012. A second amendment dated June 12, 2012 returned the interest rate to 3 % effective April 10, 2012. There is also an annual servicing fee of $ 1,600 charged quarterly. The loan is being amortized over 84 months through March 2018. Payments were interest only through March 2012. Thereafter, payments of approximately $ 17,300 , including interest and servicing fee, are payable quarterly. The loan is collateralized by the related project equipment. As of September 30, 2013 there was an outstanding balance of $ 282,786 on this loan.
 
 
10

 
SCI ENGINEERED MATERIALS, INC.
NOTES TO FINANCIAL STATEMENTS
 
Note 7.           Notes Payable (continued)
 
An Intercreditor Agreement exists as part of the above mentioned loans with agencies of the State of Ohio. The OAQDA and ODOD agree to shared lien and security interest through mutual covenants. These covenants include, but are not limited to, the creation of an agreed upon number of jobs, filing of quarterly and annual reports and various financial covenants. The Company expects to maintain compliance with all covenants through September 30, 2014.
 
During 2006, the Company was approved for a 166 Direct Loan from the Ohio Department of Development, now known as the Ohio Development Services Agency (ODSA), in the amount of $ 400,000 . These funds were received in July of 2008 and were used for the purchase of production equipment and to reduce the Company’s capital lease obligations on certain equipment. The term of the loan is 84 months at a fixed interest rate of 3 %. There is also a 0.25 % annual servicing fee to be charged monthly on the outstanding principal balance. Payments of approximately $ 6,100 , including interest and servicing fee, were payable monthly. On August 8, 2013, ODSA and the Company agreed to a modification to the payment schedule. Interest and servicing payments of approximately $400 are due monthly from August 2013 through January 2014. Beginning in February 2014, monthly payments of approximately $6,100, including principal, interest and servicing fee are due through July 2015. A final payment of approximately $42,200 is due August 2015. The loan is collateralized by the related project equipment. As of September 30, 2013 the loan had a balance of $147,108. This loan is also subject to certain covenants, including job creation and retention. On March 5, 2013, the Company signed a First Amendment to the Loan Agreement, which changed the number of jobs to be created. The Company expects to maintain compliance with all covenants through September 30, 2014.

Note 8.  Income Taxes
 
Following is the income tax (expense) benefit for the three and nine months ended September 30:
 
 
 
Three months ended
 
Nine months ended
 
 
 
September 30,
 
September 30,
 
 
 
2013
 
2012
 
2013
 
2012
 
Federal - deferred
 
$
-
 
$
-
 
$
-
 
$
-
 
State and local
 
 
-
 
 
(1,237)
 
 
-
 
 
24,652
 
 
 
$
-
 
$
(1,237)
 
$
-
 
$
24,652
 
 
The tax benefit for the nine months ended September 30, 2012 was due to the reversal of an accrual.   Deferred tax assets and liabilities result from temporary differences in the recognition of income and expense for tax and financial reporting purposes. A full valuation allowance has been recorded against the realizability of the net deferred tax assets at September 30, 2013 and December 31, 2012.  The Company has net operating loss carryforwards available for federal and state tax purposes of approximately $ 4,000,000 which expire in varying amounts through 2031 .
 
 
11

 
 
  SCI ENGINEERED MATERIALS, INC.
NOTES TO FINANCIAL STATEMENTS
 
Note 9.   Liquidity
 
Management has forecasted the Company’s revenues and related costs as well as its investing plans and financing needs to determine its liquidity to meet cash flow requirements and believes it will have sufficient liquidity at least through September 30, 2014. This forecast was based on current cash levels and debt obligations, and management’s best estimates of revenues primarily from existing customers and gave consideration to the continued and possible increased levels of uncertainty in demand in the markets in which the Company operates.  The Company’s ability to maintain current operations is dependent upon its ability to achieve these forecasted results, which management believes will occur. 
 
The Company does not currently have any available sources of additional external funding. The Company’s revolving line of credit arrangement with its senior lender expired on April 13, 2012. There was no balance outstanding under this arrangement at maturity. The Company did not have the need to draw on the revolving line of credit since the original commitment date of January 13, 2009. The Company does not anticipate the need for a similar credit facility during the remainder of 2013; although management may pursue revolving credit arrangements as working capital requirements increase.   The Company’s ability to obtain a new line of credit, if deemed necessary, is not certain.  
 
During the second quarter of 2013 the Company enacted various cost cutting measures which included management wage reductions and reduced work hours where feasible.   Should projected sales levels fall below the minimum levels expected to be achievable by management, additional cost reduction actions could be instituted which might facilitate the continued operation of the Company.   The achievement of such reductions and the timing of their impact are not readily predictable.  
 
During the third quarter of 2013, the Company replaced an existing Promissory Note with The Huntington National Bank with a new Promissory Note which extended the maturity date from February 2014 to August 2016.   The Company also agreed to payment schedule modifications with the Ohio Development Services Agency for two loans as discussed in Note 7.
 
 
12

 
Item 2.   Management's Discussion and Analysis of Financial Condition and Results of Operations
 
The following discussion should be read in conjunction with the Financial Statements and Notes contained herein and with those in our Form 10-K for the year ended December 31, 2012.
 
Except for the historical information contained herein, the matters discussed in this Quarterly Report on Form 10-Q include certain forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended, which are intended to be covered by the safe harbors created thereby.   Those statements include, but may not be limited to, all statements regarding our intent, belief, and expectations, such as statements concerning our future profitability and operating and growth strategy.   Words such as “believe,” “anticipate,” “expect,” “will,” “may,” “should,” “intend,” “plan,” “estimate,” “predict,” “potential,” “continue,” “likely” and similar expressions are intended to identify forward-looking statements.   Investors are cautioned that all forward-looking statements contained in this Quarterly Report on Form 10-Q and in other statements we make involve risks and uncertainties including, without limitation, the factors set forth under the caption “Risk Factors” included in our Annual Report on Form 10-K for the year ended December 31, 2012, and other factors detailed from time to time in our other filings with the Securities and Exchange Commission.   One or more of these factors have affected, and in the future could affect our business and financial condition and could cause actual results to differ materially from plans and projections.   Although we believe the assumptions underlying the forward-looking statements contained herein are reasonable, there can be no assurance that any of the forward-looking statements included in this Quarterly Report on Form 10-Q will prove to be accurate.   In light of the significant uncertainties inherent in the forward-looking statements included herein, the inclusion of such information should not be regarded as a representation by us or any other person that our objectives and plans will be achieved.
 
Any forward-looking statement speaks only as of the date on which such statement is made, and we undertake no obligation to update any forward-looking statement or statements to reflect events or circumstances after the date on which such statements are made or reflect the occurrence of unanticipated events, unless necessary to prevent such statements from becoming misleading.   New factors emerge from time to time and it is not possible for us to predict all factors, nor can it assess the impact of each such factor on the business or the extent to which any factor, or combination of factors, may cause actual results to differ materially from those contained in any forward-looking statements.

 

Overview

SCI Engineered Materials, Inc. (“SCI”, “we” or the “Company”), formerly Superconductive Components, Inc., an Ohio corporation, was incorporated in 1987.   The Company is a global supplier and manufacturer of advanced materials for Physical Vapor Deposition Thin Film Applications.   Through partnerships with end users and Original Equipment Manufacturers the Company develops innovative customized solutions enabling commercial success.   Photonics currently represents the largest market for our targets.   We have made considerable resource investment in the solar industry and we expect adoption of our products by current and new customers.   Thin Film Battery is a developing market where manufacturers of batteries use our products to produce very small power supplies with small quantities of stored energy.   
 
 
13

 
Item 2.   Management's Discussion and Analysis of Financial Condition and Results of Operations (continued)
 
Executive Summary
 
Total revenue and product revenue increased for the second consecutive quarter during the three months ended September 30, 2013.   Based on the backlog at September 30, 2013, we anticipate revenue to increase for a third consecutive quarter during the last three months of 2013.   Product bookings during the third quarter were the highest quarter in 2013 leaving us with a backlog of $3.4 million at September 30, 2013.   Product revenue was $1,810,044 during the three months ended September 30, 2013.   This was $115,996 less than the third quarter of 2012.   D uring August 2012, a customer announced it was reorganizing its manufacturing operations which impacted our shipments during 2013.   We had no shipments to this customer during the third quarter of 2013 compared to approximately $153,000 during the third quarter of 2012.
   
Gross profit was $416,836 for the three months ended September 30, 2013 compared to $562,176 for the third quarter of 2012.   Gross profit as a percentage of revenue was 23.0% for the third quarter of 2013 compared to 28.4% for the third quarter of 2012.   The decreases were primarily related to less revenue due to the customer reorganization previously mentioned and product mix.  
 
Specific cost reductions, which included management wages, were implemented during the second quarter of 2013 in response to customer order patterns during the first half of this year.   Compensation expenses were approximately $37,000 lower during the third quarter of 2013 compared to the same period in 2012.    We continue to invest in developing new products for the solar and glass industries including transparent conductive oxide systems and transparent electronics which have led to new customers for these products.   These efforts include accelerating time to market.
 
For the three months ended September 30, 2013, we had a loss from operations of $52,343 compared to income from operations of $112,679 for the three months ended September 30, 2012.   We had a loss applicable to common shares of $76,322 for the three months ended September 30, 2013, compared to income applicable to common shares of $84,711 for the third quarter of 2012.  
 
We invested approximately $105,000 in new equipment during the first nine months of 2013 and approximately $590,000 during the full-year 2012.   Investment in equipment is expected to be less for 2013 versus last year.   Given identified market opportunities, we continue to invest in    internally financed research and development, marketing, and sales for all of our markets.
 
Previous investments have resulted in ongoing production orders with periodic releases and intermittent repeat orders from several customers, as well as trial and qualification orders that were shipped to customers in the solar and glass industries during the last two years.   We continue to work closely with all of our customers and are positioned to meet their near term product requirements.
 
 
14

 
Item 2.   Management's Discussion and Analysis of Financial Condition and Results of Operations (continued)
 
RESULTS OF OPERATIONS
 
Three and nine months ended September 30, 2013 (unaudited) compared to three and nine months ended September 30, 2012 (unaudited):
 
                Revenue
 
For the three months ended September 30, 2013, we had total revenue of $1,810,044.   This was a decrease of $172,359, or 8.7%, compared to the three months ended September 30, 2012.   Product revenue decreased $115,996, or 6.0% for the three months ended September 30, 2013 from the same period in 2012.   The decreases were primarily related to the customer reorganization previously mentioned, product mix and no contract revenue.   Contract revenue was $0 in the third quarter of 2013 compared to $56,000 in the same time period in 2012.   Our final grant drew to a close during the second quarter of 2013.   
 
For the nine months ended September 30, 2013, we had total revenue of $5,036,421.   This was a decrease of $1,532,741, or 23.3%, compared to the nine months ended September 30, 2012.   Product revenue decreased $1,441,548, or 22.6%, primarily due to three factors.   A periodic inventory adjustment by one of our large customers occurred during the first half of 2013.   This customer represented 30% of our revenue in the first nine months of 2013 compared to 51% during the first nine months of 2012.   We resumed shipping product at normal levels to this customer late in the first quarter of 2013.   Secondly, during August 2012, another customer announced it was reorganizing its manufacturing operations which impacted our shipments.   We had no shipments to this customer during the first nine months of 2013 compared to approximately $406,000 during the first nine months of 2012.   Thirdly, product revenue was also impacted due to the lower cost of a high priced raw material despite an increase in units shipped during the nine months ended September 30, 2013, compared to the same time period in 2012.   The impact of these factors was partially offset by increased shipments to existing and new customers.  
 
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 was recognized on the percentage of completion method.   Contract research revenue was recognized during the period qualifying expenses were incurred for the research that was performed as set forth under the terms of the grant award agreements.  
 
                Gross Profit
 
Gross profit was $416,836 for the three months ended September 30, 2013 compared to $562,176 for the same three months in 2012.   This was a decrease of $145,340, or 25.9%.   Gross profit as a percentage of revenue was 23.0% for the third quarter of 2013 compared to 28.4% for the same period in 2012.   The decreases can be attributed to the customer reorganization previously mentioned and product mix.    
 
Gross profit was $988,626 for the nine months ended September 30, 2013 compared to $1,400,352 for the same nine months in 2012.   This was a decrease of $411,726 or 29.4%.   The decrease in gross profit was attributed primarily to the customer that experienced an inventory adjustment during the first quarter of 2013, the customer that halted operations in 2012 and product mix.
 
 
15

 
Item 2.   Management's Discussion and Analysis of Financial Condition and Results of Operations (continued)
   
Gross profit as a percentage of revenue was 19.6% for the first nine months of 2013 compared to 21.3% for the same period in 2012.   The decrease can be attributed to the lower gross profit and product mix.
 
General and Administrative Expense
 
General and administrative expense for the three months ended September 30, 2013 was $250,232 compared to $247,470 for the three months ended September 30, 2012, an increase of 1.1%.   The third quarter of 2013 included higher professional fees and travel expenses of approximately $14,000 compared to the third quarter of 2012.   These increases were partially offset by lower compensation expenses of approximately $6,000.            
 
General and administrative expense for the nine months ended September 30, 2013 decreased to $785,065 from $818,939 for the nine months ended September 30, 2012, or 4.1%.   The first nine months of 2013 included lower professional fees of approximately $16,000 compared to the first nine months of 2012 and the reduction of the allowance for doubtful accounts which adjusted bad debt expense by approximately $27,000.
 
Professional Fees
 
Included in general and administrative expense was approximately $37,000 and $33,000 for professional fees for the three months ended September 30, 2013 and 2012, respectively, and approximately $148,000 and $164,000 for the nine months ended September 30, 2013 and 2012, respectively.   Legal expenses were higher by approximately $4,000 during the third quarter compared to the same period in 2012.   The year to date decrease was due primarily to lower accounting fees.   These continued expenses were related to SEC compliance costs for legal, accounting and stockholder relations fees.
 
Research and Development Expense
 
Research and development expense for the three months ended September 30, 2013 was $112,365 compared to $62,646 for the same period in 2012, an increase of 79.4%.   The increase was primarily due to the final contract drawing to a close during the second quarter of 2013 and thus costs classified as internal R&D expense as opposed to cost of goods sold.   
 
Research and development expense for the nine months ended September 30, 2013 was $254,568 compared to $230,035 for the same period in 2012, an increase of 10.7%.   We expect internal R&D expense to be higher in 2013 compared to 2012 as all research grant work has ceased. The first nine months of 2012 included higher costs related to developing innovative transparent conductive oxide systems to further align our activities with customer needs. These expenses were lower by approximately $42,000 in the first nine months of 2013 compared to the same time period in 2012.   These research and development endeavors have moved us beyond the scope of our current federal and state grants and awards.  
 
 
16

 
Item 2.   Management's Discussion and Analysis of Financial Condition and Results of Operations (continued)
 
Marketing and Sales Expense  
 
Marketing and sales expense for the three months ended September 30, 2013 decreased 23.5% to $106,582 from $139,381 for the same period in 2012.   Compensation expenses were lower by approximately $21,000 during the third quarter of 2013.   In addition, commissions to our outside manufacturing sales representatives and travel expense were lower by approximately $11,000.
 
Marketing and sales expense for the nine months ended September 30, 2013 decreased 17.1% to $331,022 from $399,185 for the same period in 2012.   This decrease was related to lower compensation expenses of approximately $43,000 as well as lower travel expense and commissions to our outside manufacturing sales representatives of approximately $20,000.
                               
Stock Compensation Expense
 
Included in operating expenses were non cash stock based compensation costs of $31,355 and $31,415 for the three months ended September 30, 2013 and 2012, respectively, and $101,086 and $101,271 for the nine months ended September 30, 2013 and 2012, respectively.   Compensation cost for all stock-based awards is based on the grant date fair value and recognized over the required service (vesting) period .   Unrecognized non cash stock based compensation expense related to operating expense was $430,021 as of September 30, 2013 and will be recognized through 2017.    
 
Interest, net
 
Interest, net was $17,650 and $19,843 for the three months ended September 30, 2013 and 2012, respectively and $56,772 and $64,404 for the nine months ended September 30, 2013 and 2012, respectively.   The decrease was due to continued payments reducing principal balances.   The second quarter of 2012 included a higher interest rate on one of the loans from an agency of the State of Ohio which was subsequently reduced.         
 
Income Tax Benefit  
 
Income tax benefit for the nine months ended September 30, 2012 was $24,652 which was due to the reversal of an accrual.   There is no provision for income taxes in 2013 as we have net operating loss carryforwards available of approximately $4,000,000 which expire in varying amounts through 2031.   
 
Loss/Income Applicable to Common Shares
 
Loss applicable to common shares was $76,322 for the three months ended September 30, 2013 compared to income applicable to common shares of $84,711 for the three months ended September 30, 2012.   Loss applicable to common shares was $407,518 for the nine months ended September 30, 2013 compared to $106,523 for the nine months ended September 30, 2012.   The lower gross profit in 2013, as previously mentioned, primarily contributed to the loss applicable to common shares.
 
 
17

 
Item 2.   Management's Discussion and Analysis of Financial Condition and Results of Operations (continued)
 
Common Shares
 
The following schedule represents our outstanding common stock during the period of 2013 through 2019 assuming all outstanding stock options are exercised during the year of expiration.   Based on outstanding shares at September 30, 2013, if each shareholder exercises his or her options, it would increase our common shares by 812,000 to 4,656,898 by December 31, 2019.   Assuming all such options are exercised in the year of expiration, the effect on shares outstanding is illustrated as follows:  
 
 
 
Options
due to
expire
 
Potential
shares
outstanding
 
 
Weighted
average
exercise
price
 
2013
 
-
 
3,844,898
 
 
-
 
2014
 
180,000
 
4,024,898
 
$
4.36
 
2015
 
140,000
 
4,164,898
 
$
2.97
 
2016
 
36,000
 
4,200,898
 
$
3.25
 
2017
 
-
 
4,200,898
 
 
-
 
2018
 
6,000
 
4,206,898
 
$
3.10
 
2019
 
450,000
 
4,656,898
 
$
6.00
 
 
                Liquidity and Capital Resources
 
Cash
 
As of September 30, 2013 cash on hand was $494,124.   Cash on-hand was $342,911 at June 30, 2013 and $630,819 at December 31, 2012.   We believe, based on forecasted sales and expenses that cash flow from operations will be adequate to sustain operations at least through September 30, 2014.   
 
Working Capital
 
At September 30, 2013 working capital was $731,230 compared to $549,616 at June 30, 2013 and $802,187 at December 31, 2012, a decrease of $70,957 or 8.8% from year end 2012.   As discussed below cash decreased approximately $137,000 during the nine months ended September 30, 2013.   Accounts receivable increased approximately $34,000.   Inventories increased approximately $378,000, prepaid expenses increased approximately $342,000 and customer deposits increased approximately $952,000 due to orders received during the third quarter and scheduled to ship during the fourth quarter.   Accounts payable decreased approximately $74,000.   Current capital lease obligations decreased by approximately $84,000 while current notes payable decreased by approximately $99,000 due to the refinancing of the Huntington National Bank promissory note that was due to mature on February 28, 2014.   The new promissory note matures in August 2016.
 
 
18

 
Item 2.   Management's Discussion and Analysis of Financial Condition and Results of Operations (continued)
 
Cash from Operations
 
Net cash provided by operating activities was approximately $215,000 for the nine months ended September 30, 2013 and approximately $261,000 for the nine months ended September 30, 2012.   In addition to the changes in various current assets and liabilities mentioned above, non cash expenses for depreciation, accretion and amortization was $437,000 during the first nine months of 2013 versus $436,000 during the first nine months of 2012.   Included in expenses were non cash stock based compensation costs of approximately $101,000 and $102,000 for the nine months ended September 30, 2013 and 2012, respectively.   There was net gain on disposal of equipment during the first nine months of 2013 of approximately $49,000.   Accounts receivable increased by approximately $34,000, partially due to a decrease in allowance for doubtful accounts of approximately $30,000.      
 
Cash from Investing Activities
 
Cash of approximately $32,000 was provided by investing activities during the nine months ended September 30, 2013.   Cash of approximately $564,000 was used for investing activities during the nine months ended September 30, 2012.   The amounts invested were used to purchase machinery and equipment for increased production capacity and new product lines.   Proceeds on sale of equipment were approximately $50,000 for the nine months ended September 30, 2013.  
 
                Cash from Financing Activities
 
Cash of approximately $383,000 was used in financing activities for principal payments to third parties for capital lease obligations and notes payable during the nine months ended September 30, 2013.   We incurred a new capital lease obligation of approximately $86,000 for new production equipment during the first nine months of 2013.
 
During the nine months ended September 30, 2012 cash of approximately $97,000 was provided by financing activities.   Principal payments to third parties for capital lease obligations and notes payable approximated $815,000.   Proceeds from notes payable were approximately $912,000 of which $462,000 was received from the Ohio Department of Development and used to pay towards the Promissory Note from The Huntington National Bank.
 
Debt Outstanding
 
Total debt outstanding decreased during the first nine months of 2013 from approximately $1,758,000 to approximately $1,462,000, or 16.9%.   We paid cash of approximately $383,000 towards principal amounts of capital lease obligations and notes payable during the first nine months of 2013.
 
Liquidity
 
We have forecasted revenues and related costs as well as investing plans and financing needs to determine liquidity to meet cash flow requirements and believe we will have sufficient liquidity at least through September 30, 2014. This forecast was based on current cash levels and debt obligations, and our best estimates of revenues primarily from existing customers and gave consideration to the continued and possible increased levels of uncertainty in demand in the markets in which we operate.  Our ability to maintain current operations is dependent upon our ability to achieve these forecasted results, which we believe will occur. 
 
 
19

 
Item 2.   Management's Discussion and Analysis of Financial Condition and Results of Operations (continued)
 
 
We do not currently have any available sources of additional external funding. Our revolving line of credit arrangement with our senior lender expired on April 13, 2012. There was no balance outstanding under this arrangement at maturity. We did not have the need to draw on the revolving line of credit since the original commitment date of January 13, 2009. We do not anticipate the need for a similar credit facility in 2013; although we may pursue revolving credit arrangements as working capital requirements increase.   Our ability to obtain a new line of credit, if deemed necessary, is not certain.
 
During the second quarter of 2013 we enacted various cost cutting measures which included management wage reductions and reduced work hours where feasible.   Should projected sales levels fall below the minimum levels expected to be achievable, additional cost reduction actions could be instituted, which might facilitate the continued operation of the Company.   The achievement of such reductions and the timing of their impact are not readily predictable.
 
During the third quarter of 2013, the Company replaced an existing Promissory Note with The Huntington National Bank with a new Promissory Note which extended the maturity date from February 2014 to August 2016.   The Company also agreed to payment schedule modifications with the Ohio Development Services Agency for two loans as discussed in Note 7.
    
Off Balance Sheet Arrangements
 
We have no off balance sheet arrangements including special purpose entities.
 
 
20

 
Item 2.   Management's Discussion and Analysis of Financial Condition and Results of Operations (continued)
 
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 our Annual Report on Form 10-K for the year ended December 31, 2012 describes the significant accounting policies and methods used in the preparation of the Financial Statements.   Estimates are used for, but not limited to, accounting for the allowance for doubtful accounts, inventory allowances, property and equipment depreciable lives, patents and licenses useful lives, revenue recognition, tax valuation, stock based compensation and assessing changes in which impairment of certain long-lived assets may occur.   Actual results could differ from these estimates.   The following critical accounting policies are impacted significantly by judgments, assumptions and estimates used in the preparation of the Financial Statements.   The allowance for doubtful accounts is based on our assessment of the collectability of specific customer accounts and the aging of the accounts receivable.   If there is a deterioration of a major customer’s credit worthiness or actual defaults are higher than our historical experience, our estimates of the recoverability of amounts due us could be adversely affected.   Inventory purchases and commitments are based upon future demand forecasts. If there is a sudden and significant decrease in demand for our products or there is a higher risk of inventory obsolescence because of rapidly changing technology and customer requirements, we may be required to increase our inventory allowances and our gross 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 benefit 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.
 
Item 4. Controls and Procedures
 
               Evaluation of Disclosure Controls and Procedures
 
Our management, with the participation of the Company’s Chief Executive Officer and Chief Financial Officer, has evaluated the effectiveness of the Company’s disclosure controls and procedures (as such term is defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended (the “Exchange Act”)) as of the end of the period covered by this report. In designing and evaluating the disclosure controls and procedures, management recognized that any controls and procedures, no matter how well designed and operated, can only provide reasonable assurance of achieving the desired control objectives and management is required to apply its judgment in evaluating the cost-benefit relationship of possible controls and procedures.   Due to a segregation of duties material weakness described below, and based on this evaluation, the Company’s Chief Executive Officer and Chief Financial Officer have concluded that as of September 30, 2013, the Company’s disclosure controls and procedures were not effective, at the reasonable assurance level, in recording, processing, summarizing and reporting, on a timely basis, information required to be disclosed by the Company in the reports that it files or submits under the Exchange Act and in ensuring that information required to be disclosed by the Company in the reports that it files or submits under the Exchange Act is accumulated and communicated to the Company’s management, including the Chief Executive Officer and Chief Financial Officer, as appropriate to allow timely discussions regarding required disclosure.   Until we are able to hire additional employees, we will continue to report to the Audit Committee and the Board of Directors at least monthly (and more often as necessary).   We believe this will continue to mitigate this weakness.   This reporting includes balance sheets, statements of operations, statements of cash flows, and other detail supporting these statements.   Accordingly, we believe that the financial statements included in this report fairly present, in all material respects, our financial condition, results of operation, changes in shareholder’s equity and cash flows for all periods presented.
   
 
21

 
Item 4.   Controls and Procedures (continued)
 
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 is 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 previously disclosed a material weakness in internal control over financial reporting in its annual report on Form 10-K, filed on March 19, 2013 for the year ended December 31, 2012, relating to insufficient segregation of duties consistent with control objectives.   Management is aware of the risks associated with the lack of segregation of duties due to the small number of employees currently working with general administrative and financial matters.   Due to our size and nature, segregation of all conflicting duties may not always be possible and may not be economically feasible.   However, to the extent possible, the initiation of transactions, the custody of assets and the recording of transactions shall be performed by separate individuals. In order to remediate this weakness, we will need to hire additional employees.   Although we will periodically reevaluate this situation, at this point we consider that the risks associated with such lack of segregation of duties and the potential benefits of adding employees to segregate such duties are not cost justified.   Until we are able to hire additional employees, we will continue to report to the Audit Committee and the Board of Directors at least monthly (and more often as necessary).   We believe this will continue to mitigate this weakness.   This reporting includes balance sheets, statements of operations, statements of cash flows, and other detail supporting these statements.  
 
 
22

 
Item 4.   Controls and Procedures (continued)
 
Changes in Internal Controls over Financial Reporting
 
There were no changes in our internal controls over financial reporting for the three months ended September 30, 2013 that materially affected or were reasonably likely to materially affect our disclosure controls and procedures.   Additionally, there were no changes in our internal controls that could materially affect our disclosure controls and procedures subsequent to the date of their evaluation.    
 
Part II.    Other Information
 
Item 6.   Exhibits
 
 
3.1
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)
 
 
 
 
3.2
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)
 
 
 
 
3.3
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).
 
 
 
 
4.1
SCI Engineered Materials, Inc. 2011 Stock Incentive Plan (Incorporated by reference to the Company’s Definitive Proxy Statement for the 2011 Annual Meeting of Shareholders held on June 10, 2011, filed April 28, 2011).
 
 
 
 
4.2
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).
 
 
 
 
4.3
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)
 
 
 
 
4.4
F orm of Incentive Stock Option Agreement under the Superconductive Components, Inc. 2006 Stock Incentive Plan (Incorporated by reference to Exhibit 10.1 to the Company’s Current Report on Form 8-K dated June 19, 2006, filed June 23, 2006).
 
 
 
 
4.5
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).
 
 
 
 
4.6
Description of the Material Terms of the Stock Option Grant for Executive Officers and Board of Directors (Inc orporated by reference to the Company’s Current Report on Form 8-K dated January 2, 2009, filed January 6, 2009).
 
 
23

 
Item 6.   Exhibits (continued)
 
 
4.7
Fourth Amended and Restated 1995 Stock Option Plan (Incorporated by reference to Exhibit 4(a) to the Company’s Registration Statement on Form S-8 (Registration No. 333-97583), filed on August 2, 2002)
 
 
 
 
4.8
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)
 
 
 
 
10.1
Description of amendment to the Loan Agreement between the Company and The Ohio Air Quality Development Authority (Incorporated by reference to the Company’s Current Report on Form 8-K, filed March 26, 2012).
 
 
 
 
10.2
Description of amendment to the Loan Agreement between the Company and the Ohio Department of Development (Incorporated by reference to the Company’s Current Report on Form 8-K, filed April 9, 2012).
 
 
 
 
10.3
Description of amendment to the Loan Agreement between the Company and The Ohio Air Quality Development Authority (Incorporated by reference to the Company’s Current Report on Form 8-K, filed July 10, 2012).
 
 
 
 
10.4
Description of amendment to the Loan Agreement between the Company and The Ohio Air Quality Development Authority (Incorporated by reference to the Company’s Current Report on Form 8-K, filed October 19, 2012).
 
 
 
 
10.5
Description of Business Loan Agreement between the Company and The Huntington National Bank dated as of October 15, 2012 (Incorporated by reference to the Company’s Current Report on Form 8-K, filed October 19, 2012).
 
 
 
 
10.6
Description of amendment to the Loan Agreement between the Company and the Ohio Development Services Agency, formerly known as the Ohio Department of Development (Incorporated by reference to the Company’s Current Report on Form 8-K, dated March 19, 2013).
 
 
 
 
10.7
Description of modification to payment schedules between the Company and the Ohio Development Services Agency, formerly known as the Ohio Department of Development and Description of Business Loan Agreement between the Company and The Huntington National Bank dated as of October 8, 2013 (Incorporated by reference to the Company’s Current Report on Form 8-K, dated August 12, 2013).
 
 
 
 
22.1
Description of matters submitted to vote of security holders (Incorporated by reference to the Company’s Current Report on Form 8-K, dated June 17, 2013).
 
 
 
 
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 and Certification of Principal Financial Officer.*
 
 
24

 
Item 6.   Exhibits (continued)
 
 
99.1
Press Release dated November 4, 2013, entitled “SCI Engineered Materials, Inc. Reports Third Quarter 2013 Results.”
 
 
 
 
101
The Company’s Quarterly Report on Form 10-Q for the quarter ended September 30, 2013, formatted in XBRL (eXtensible Business Reporting Language): (i) Consolidated Balance Sheets at September 30, 2013 and December 31, 2012 (ii) Consolidated Statements of Operations for the three and nine months ended September 30, 2013 and 2012, (iii) Consolidated Statements of Cash Flows for the nine months ended September 30, 2013 and 2012, (iv) Notes to Financial Statements.
 
 
 
 
 
* Filed with this report
 
Signatures
 
Pursuant to the requirements 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:   November 4, 2013
/s/ Daniel Rooney
 
Daniel Rooney, Chairman of the Board of Directors, President and Chief Executive Officer
 
(Principal Executive Officer)
 
 
 
/s/ Gerald S. Blaskie
 
Gerald S. Blaskie, Vice President and Chief Financial Officer
 
(Principal Financial Officer and Principal Accounting Officer)
 
 
25

 

Exhibit 31.1
CERTIFICATION OF CHIEF EXECUTIVE OFFICER
PURSUANT TO SECTION 302 OF THE SARBANES-OXLEY ACT OF 2002
 
I, Daniel Rooney, certify that:
 
 
1.
I have reviewed this Quarterly Report on Form 10-Q of SCI Engineered Materials, Inc.;
 
 
2.
Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report;
 
 
3.
Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report;
 
 
4.
The registrant’s other certifying officer(s) and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f) for the registrant and have:
 
 
a)
Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared;
 
 
b)
Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, 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;
 
 
c)
Evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and
 
 
d)
Disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s most recent fiscal quarter (the registrant’s fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting; and
 
 
5.
The registrant’s other certifying officer(s) and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant’s auditors and the audit committee of the registrant’s board of directors (or persons performing the equivalent functions):
 
 
a)
All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financial information; and
 
 
b)
Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal control over financial reporting.
 
Date: November 4, 2013
/s/ Daniel Rooney
 
Daniel Rooney
 
Chairman of the Board of Directors,
 
President and Chief Executive Officer
 
(Principal Executive Officer)
 
 
 

Exhibit 31.2
CERTIFICATION OF CHIEF FINANCIAL OFFICER
PURSUANT TO SECTION 302 OF THE SARBANES-OXLEY ACT OF 2002
 
I, Gerald S. Blaskie, certify that:
 
 
1.
I have reviewed this Quarterly Report on Form 10-Q of SCI Engineered Materials, Inc.;
 
 
2.
Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report;
 
 
3.
Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report;
 
 
4.
The registrant’s other certifying officer(s) and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f) for the registrant and have:
 
 
a)
Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared;
 
 
b)
Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, 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;
 
 
c)
Evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and
 
 
d)
Disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s most recent fiscal quarter (the registrant’s fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting; and
 
 
5.
The registrant’s other certifying officer(s) and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant’s auditors and the audit committee of the registrant’s board of directors (or persons performing the equivalent functions):
 
 
a)
All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financial information; and
 
 
b)
Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal control over financial reporting.
 
Date: November 4, 2013
/s/ Gerald S. Blaskie
 
Gerald S. Blaskie
 
Vice President and Chief Financial Officer
 
(Principal Financial Officer and Principal Accounting Officer)
 
 
 

Exhibit 32.1
 
CERTIFICATION PURSUANT TO
18 U.S.C. SECTION 1350,
AS ADOPTED PURSUANT TO
SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002
 
In connection with the Quarterly Report of SCI Engineered Materials, Inc.   (the “Company”) on Form 10-Q for the period ending September 30, 2013 as filed with the Securities and Exchange Commission on the date hereof (the “Report”), I, Daniel Rooney, Chairman of the Board of Directors, President and Chief Executive Officer of the Company, certify, pursuant to 18 U.S.C. § 1350, as adopted pursuant to § 906 of the Sarbanes-Oxley Act of 2002, that:
 
(1)            The Report fully complies with the requirements of section 13(a) or 15(d) of the Securities Exchange Act of 1934; and
 
(2)           The information contained in the Report fairly presents, in all material respects, the financial condition and result of operations of the Company.
 
 
/s/ Daniel Rooney
 
Daniel Rooney
 
Chairman of the Board of Directors,
 
President and Chief Executive Officer of
 
SCI Engineered Materials, Inc.
 
(Principal Executive Officer)
 
November 4, 2013
 
CERTIFICATION PURSUANT TO
18 U.S.C. SECTION 1350,
AS ADOPTED PURSUANT TO
SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002
 
In connection with the Quarterly Report of SCI Engineered Materials, Inc. (the “Company”) on Form 10-Q for the period ending September 30, 2013 as filed with the Securities and Exchange Commission on the date hereof (the “Report”), I, Gerald S. Blaskie, Vice President and Chief Financial Officer of the Company, certify, pursuant to 18 U.S.C. § 1350, as adopted pursuant to § 906 of the Sarbanes-Oxley Act of 2002, that:
 
(1)           The Report fully complies with the requirements of section 13(a) or 15(d) of the Securities Exchange Act of 1934; and
 
(2)           The information contained in the Report fairly presents, in all material respects, the financial condition and result of operations of the Company.
 
 
/s/ Gerald S. Blaskie
 
Gerald S. Blaskie
 
Vice President and Chief Financial Officer of
 
SCI Engineered Materials, Inc. (Principal Financial Officer and Principal Accounting Officer)
 
November 4, 2013