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, 2021.
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, 2021, 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.
Executive Summary
For the three months ended March 31, 2022, we had record total revenue of
$5,326,432. Higher pricing, primarily attributable to increased raw material
costs, and higher volume were key factors that contributed to the increase.
Gross profit was $994,101 for the three months ended March 31, 2022 compared to
$803,036 for the same three months in 2021. The increase was due to volume,
product mix, and improved manufacturing efficiency. The first quarter of 2021
included a reduction of expenses of approximately $151,000 related to the
Employee Retention Credit ("ERC") which was enacted in 2020.
Operating expenses were $542,407 and $377,493 for the three months ended March
31, 2022 and 2021, respectively. The first quarter of 2021 included a reduction
of expenses of approximately $105,000 related to the ERC.
Income from operations was $451,694 and $425,543 for the three months ended
March 31, 2022 and 2021, respectively. The first quarter of 2021 included a
credit of $255,507 related to the ERC.
In March 2020, the World Health Organization declared the coronavirus disease
(COVID-19) a global pandemic and recommended containment and mitigation measures
worldwide. Since then, most federal, state, and local executive orders have been
lifted. We continue to follow practical safety procedures as needed. We recently
resumed in-person meetings, participating onsite in industry trade shows, and
continuing to maintain regular contact, via phone and other electronic means,
with all customers and suppliers.
14
Table of Contents
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations (continued)
Based on ongoing conversations with customers, we do not expect to experience
any material impairments or changes in accounting judgements related to
COVID-19. Although we continue to face a period of uncertainty regarding the
ongoing impact of the COVID-19 pandemic and emergence of new variants on
projected customer demand, market conditions continue to improve. We remain
focused on taking necessary steps to respond quickly to changes in our business
through specific contingency plans. We continue to monitor the evolving
situation related to COVID-19 including guidance from federal, state, and local
public health authorities and may take additional actions based on these
recommendations.
Several issues continue to affect national and global market conditions. First,
inflation has accelerated, impacting raw material costs and transportation
expense. We have generally been able to pass on these increases to customers but
are unable to predict how future or sustained inflationary pressure may impact
our results. Second, supply chain disruptions are adversely impacting customers
in certain markets. Thus far, we have not experienced material adverse effects
regarding product shipments; however, timely deliveries and sourcing of certain
materials is of increased concern. Third, published articles and corporate
announcements continue to address the global semiconductor chip shortage, which
is anticipated to continue at least into the second half of 2022. This shortage
is affecting some of our customers which could impact the Company's revenue,
volume, and profitability. Fourth, there are increased political uncertainties
affecting global markets. Although we currently have no customers or vendors in
Russia or Ukraine, we continue to monitor the situation as some raw material
comes from Russia for the PVD industry. We continue to actively monitor these
developments, including ongoing contact with our suppliers and customers, and
adapting to their specific circumstances and forecasts.
On April 17, 2020, we 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 SBA approved our Forgiveness Application in full on January 6,
2021 and appears as gain on extinguishment of debt in the Statement of Income
during the three months ended March 31, 2021.
The Employee Retention Credit ("ERC"), as originally enacted on March 27, 2020,
by the CARES Act, was a refundable tax credit against certain employment taxes
equal to 50% of the qualified wages an eligible employer paid to employees after
March 12, 2020, and before January 1, 2021. The Taxpayer Certainty and Disaster
Tax Relief Act (the "Relief Act"), enacted on December 27, 2020, amended, and
extended the ERC. On March 1, 2021, the IRS released Notice 2021-20 to provide
guidance on the original ERC, as modified by the Relief Act. During 2021 we
filed Form 941-X to claim a credit of $105,000 on qualified wages paid in 2020.
This receivable appears on the balance sheet as of March 31, 2022, as Tax
Receivable, and as a credit to wages in the Statement of Income during the three
months ended March 31, 2021. The Relief Act extended and enhanced the ERC for
qualified wages paid after December 31, 2020, through June 30, 2021. Under the
Relief Act, eligible employers may claim a refundable tax credit against certain
employment taxes equal to 70% of the qualified wages an eligible employer paid
to employees after December 31, 2020, through June 30, 2021. As of the March 11,
2021, passage of the American Rescue Plan Act, the ERC was available for all
four quarters of 2021. However, the Infrastructure Investment and Jobs Act
enacted on November 15, 2021, ended the ERC effective September 30, 2021. During
the first quarter of 2021, we were qualified to receive the ERC. The ERC of
$150,507 on qualified wages paid in the first quarter of 2021 appears as a
credit to wages in the Statement of Income during the first quarter of 2021.
Consistent with our growth strategy, we have identified niche markets that can
benefit from our expertise in custom powder solutions, such as near-infrared
doped phosphors and short-wave infrared applications. These applications enable
extended life of phosphors for specific nighttime identification needs of
defense personnel and first responders.
New initiatives are also being pursued that utilize our vacuum hot press, cold
isostatic press, and kilns for increased production and development projects,
including diffusion bonding. We recently manufactured and sold conductive metal
oxides for direct current sputtering of Tungsten Oxide and Molybdenum Oxide
materials. We continue to invest in developing new products for all our markets
including specialty bonding processes for Aerospace customers. Those products
continue to require research and development expense to accelerate time to
market.
15
Table of Contents
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations (continued)
RESULTS OF OPERATIONS
Three months ended March 31, 2022 (unaudited) compared to three months ended
March 31, 2021 (unaudited):
Revenue
For the three months ended March 31, 2022, we had record total revenue of
$5,326,432. This was an increase of $2,304,122 compared to the three months
ended March 31, 2021. Higher pricing, primarily attributable to increased raw
material costs, and higher volume were key factors that contributed to the
increase.
Gross profit
Gross profit was $994,101 for the three months ended March 31, 2022 compared to
$803,036 for the same three months in 2021. This was an increase of $191,065, or
23.8%, due to higher revenue. Gross profit as a percentage of revenue (gross
margin) was 18.7% for the first quarter of 2022 compared to 26.6% for the same
period in 2021. The lower gross margin for the first quarter of 2022 compared to
a year ago was due to higher raw material pricing in the first quarter of 2022
and the Employee Retention Credit (ERC) of approximately $151,000, which reduced
cost of revenue in the first quarter of 2021.
General and administrative expense
General and administrative expense for the three months ended March 31, 2022 and
2021, was $373,188 and $287,881, respectively, an increase of 29.6%. During the
first three months of 2022 there was an increase in staff resulting in higher
compensation, while the first three months of 2021 included the ERC of $36,000.
Included in general and administrative expense was $60,824 and $62,425 for
professional fees for the three months ended March 31, 2022 and 2021,
respectively. These expenses were primarily related to SEC compliance costs for
legal, accounting and stockholder relations fees.
Research and development expense
Research and development expense for the three months ended March 31, 2022, was
$87,031 compared to $38,219 for the same period in 2021. The ERC of $39,000 was
included in the first quarter of 2021. Specialty materials are being researched
for use in niche markets which include custom applications and additive
manufacturing. Our development efforts utilize a disciplined innovation approach
focused on accelerating time to market for these applications and involve
ongoing research and development expense.
Marketing and sales expense
Marketing and sales expense was $82,188 and $51,393 for the three months ended
March 31, 2022 and 2021, respectively. There was higher travel and compensation
expense during the first quarter of 2022, including participation onsite in
industry trade shows, while the first three months of 2021 included the ERC of
approximately $30,000.
Stock compensation expense
Included in total expenses were non-cash stock-based compensation costs of
$23,299 and $21,888 for the three months ended March 31, 2022 and 2021,
respectively. Compensation expense 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 was $5,123 as of March
31, 2022 and will be recognized through 2023.
Interest
Interest expense was $6,493 and $7,638 for the three months ended March 31, 2022
and March 31, 2021, respectively. The decrease was due to the conclusion and
final payments of multiple finance leases during 2021.
16
Table of Contents
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations (continued)
Income taxes
Income tax expense was $60,800 and $90,620 for the three months ended March 31,
2022 and 2021, respectively. At December 31, 2021, the deferred tax asset was
$663,820. Management considered new evidence, both positive and negative, during
the first quarter of 2022 that could affect its view of the future realization
of deferred tax assets and determined that no valuation allowance was necessary,
and the deferred tax asset was $607,820 at March 31, 2022.
Income applicable to common stock
Income applicable to common stock for the three months ended March 31, 2022 and
2021, was $384,401 and $646,547, respectively. The income applicable to common
stock was higher for the three months ended March 31, 2021 due to the $325,300
gain on extinguishment of debt from the forgiveness of the PPP Loan and $255,507
related to the ERC previously discussed.
Liquidity and Capital Resources
Cash
As of March 31, 2022, cash on hand was $4,646,475 compared to $4,140,942 at
December 31, 2021.
Working capital
At March 31, 2022 working capital was $4,362,715 compared to $3,907,135 at
December 31, 2021, an increase of $455,580 or 11.7%. Cash increased $505,533,
receivables increased $232,092, inventories increased $190,502, and accounts
payable increased $94,916, while prepaid expenses decreased $476,202.
Cash from operations
Net cash provided by operating activities was $603,992 and $452,394 during the
three months ended March 31, 2022 and 2021, respectively. In addition to the net
income generated, this included depreciation and amortization of $124,077 and
$135,313, and non-cash stock-based compensation costs of $23,299 and $21,888 for
the three months ended March 31, 2022 and 2021, respectively. Prepaid expenses
decreased $476,202 and was related to the receipt of inventory paid for in
December 2021 and received in January 2022. Inventories increased $190,502 due
to orders received late in 2021 and during the first quarter of 2022.
Cash from investing activities
During the three months ended March 31, 2022, $79,842 was used in investing
activities for the purchase of production equipment. Cash of $319,578 was used
in investing activities during the three months ended March 31, 2021, for the
acquisition of production equipment.
Cash from financing activities
Cash of $23,783 and $43,454 was used in financing activities for principal
payments to third parties for finance lease obligations during the three months
ended March 31, 2022 and 2021, respectively. The decrease was due to the
conclusion and final payments of multiple finance leases during 2021.
Debt outstanding
Total debt outstanding was $219,435 at March 31, 2022, compared to $243,218 at
December 31, 2021, a decrease of 9.8%. As previously mentioned, cash of $23,783
was used for principal payments for finance lease obligations.
17
Table of Contents
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations (continued)
Off Balance Sheet Arrangements
We have no off-balance sheet arrangements including special purpose entities.
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, 2021, 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, income tax expense, deferred tax assets and
liabilities, realization of deferred tax assets, 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. The tax valuation allowance is based on our
consideration of new evidence, both positive and negative, that could affect our
view of the future realization of deferred tax assets. If we were to determine
we would not be able to realize all or part of the deferred tax asset in the
future, an adjustment to the deferred tax asset would be necessary which would
reduce our net income for that period. 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.
18
Table of Contents
© Edgar Online, source Glimpses
SCI ENGINEERED MATERIALS, INC. 
