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SCIO > SEC Filings for SCIO > Form 10-K on 28-Jun-2013All Recent SEC Filings

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Form 10-K for SCIO DIAMOND TECHNOLOGY CORP


28-Jun-2013

Annual Report


ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.

You should read the following discussion in conjunction with the financial statements of the Company, and the notes to those statements, included elsewhere in this Form 10-K, as well as the rest of this Annual Report on Form 10-K. The statements in this discussion regarding outlook, our expectations regarding our future performance, liquidity and capital resources and other non-historical statements in this discussion are forward-looking statements. These forward-looking statements are subject to numerous risks and uncertainties, including, but not limited to, the risks and uncertainties described in the "Risk Factors" and "Cautionary Notice Regarding Forward Looking Statements" sections of this Annual Report on Form 10-K. Our actual results may differ materially from those contained in or implied by any forward- looking statements.

GENERAL

Corporate History

We were incorporated on September 17, 2009 in the State of Nevada under the name Krossbow Holdings Corporation. Krossbow's original business plan was focused on offsetting carbon dioxide ("C02") emissions through the creation and protection of forest-based carbon "sinks." Krossbow planned to assess carbon resource potentials, prescribe and implement ecosystem restorations to develop those resources, and thereby generate carbon offset products. However, we have since abandoned that original business plan and restructured our business to focus on man-made diamond technology development. We decided to acquire existing technology and to seek to efficiently and effectively produce man-made diamond. In connection with this change in business purpose, Krossbow changed its name to Scio Diamond Technology Corporation to reflect its new business direction.

On August 5, 2011, Edward S. Adams and Michael R. Monahan, both of whom now serve on the Company's Board of Directors, acquired control of the Company through the purchase of 2,000,000 shares of the Company's issued and outstanding common stock from Jason Kropp, Krossbow's sole director and executive officer at that time, in accordance with a common stock purchase agreement among Mr. Kropp, Mr. Adams and Mr. Monahan. Concurrent with the execution of the stock purchase agreement, Mr. Kropp resigned from all positions with Krossbow, including, but not limited to, that of President, Chief Executive Officer, Chief Financial Officer, Treasurer, Secretary and Director.

On August 5, 2011, the Company executed an Asset Purchase Agreement (the "Scio Asset Purchase Agreement") with another privately-held Nevada corporation that also had the name "Scio Diamond Technology Corporation" ("Private Scio"). Under the terms of the Scio Asset Purchase Agreement, the Company purchased the name "Scio Diamond Technology Corporation" and acquired other rights from Private Scio for 13,000,000 newly issued shares of common stock of the Company. Mr. Adams and Mr. Monahan were directors of Private Scio, and Joseph D. Lancia, our former President and Chief Executive Officer, was an officer of Private Scio, and they owned 31.5%, 31.5% and 15.4%, respectively, of Private Scio. Edward S. Adams and Michael R. Monahan each acquired, directly or indirectly, 4,100,000 shares of our common stock pursuant to the Scio Asset Purchase Agreement, and Joseph D. Lancia, our former Chief Executive Officer, acquired 2,000,000 shares pursuant to the Scio Asset Purchase Agreement.

On August 31, 2011, the Company acquired certain assets of Apollo Diamond, Inc. ("ADI") (the "ADI Asset Purchase"), consisting primarily of diamond growing machines and intellectual property related thereto, for which the Company paid ADI an aggregate of $2,000,000 in a combination of cash and a promissory note to ADI with a September 1, 2012 maturity date. This promissory note had an outstanding balance of $125,000 at March 31, 2012 and was paid in full as of March 31, 2013. In connection with the ADI Asset Purchase, the Company also agreed to provide certain current and former stockholders of ADI that are accredited investors the opportunity to acquire up to approximately 16 million shares of common stock of the Company for $0.01 per share (the "ADI Offering"). Both Mr. Adams, in an executive role, and Mr. Monahan previously served in various capacities with ADI through early 2011.

On June 5, 2012, the Company acquired substantially all of the assets of Apollo Diamond Gemstone Corporation ("ADGC") (the "ADGC Asset Purchase"), consisting primarily of lab-grown diamond gemstone-related know-how, inventory, and various intellectual property, in exchange for $100,000 in cash and the opportunity for


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certain current and former stockholders of ADGC that are accredited investors to acquire up to approximately 1 million shares of common stock of the Company for $0.01 per share (the "ADGC Offering") with the intent that ADI Offering be conducted substantially concurrently with the ADGC Offering (collectively, the "ADI/ADGC Stockholder Offering"). Mr. Adams and Mr. Monahan served in various capacities with ADGC through early 2011.

The ADI/ADGC Stockholder Offering was completed in March, 2013 and resulted in the issuance of an aggregate of 16,766,773 shares of the Company's common stock.

Business Overview

The Company's primary mission is the development of profitable and sustainable commercial production of its diamond materials, which are suitable for known, emerging and anticipated industrial, technology and consumer applications. The Company intends to pursue progressive development of its core diamond materials technologies and related intellectual property that the Company hopes will evolve into product opportunities across various applications. We believe these opportunities may be monetized though a combination of end product sales, joint ventures and licensing arrangements with third parties, and through continued development of intellectual property. Anticipated application opportunities for the Company's diamond materials include the following: precision cutting devices, diamond gemstone jewelry, power switches, semiconductor processors, optoelectronics, geosciences, water purification, and MRI and other medical science technology.

Nearly all of the Company's present production capacity is being sold for use in precision cutting devices As of March 31, 2013 we had generated $881,748 in net revenue since inception from sales of our diamond materials. To date, most of our product has been sold overseas and 100% of these sales have been to external customers. We expect continued development of an international market for our diamond materials.

See Part I, Item 1. (Business) for additional information regarding our business.

Critical Accounting Policies

We have adopted various accounting policies that govern the application of accounting principles generally accepted in the United States "GAAP". We describe our significant accounting policies in the notes to our audited financial statements as of March 31, 2013.

Some of the accounting policies involve significant judgments and assumptions by us that have a material impact on the carrying value of our assets and liabilities. We consider these accounting policies to be critical accounting policies. The judgment and assumptions we use are based on historical experience and other factors that we believe to be reasonable under the circumstances. Because of the nature of the judgments and assumptions we make, actual results could differ from these judgments and estimates and could materially affect the carrying values of our assets and liabilities and our results of operations.

The following is a summary of the more significant judgmental estimates and complex accounting principles, which represent our critical accounting policies.

Asset Purchases

The Company purchased certain assets from ADI on August 31, 2011, consisting primarily of diamond growing machines and intellectual property related thereto. The purchase price consisted of an aggregate of $2,000,000 in a combination of cash and a promissory note bearing interest at 4.00% annually and due and owing in full on September 1, 2012, plus the right for certain current and former stockholders of ADI to acquire up to approximately 16 million shares of common stock of the Company for $0.01 per share. The Company has estimated the fair value of these subscription rights to be $0.69 per right, for a total of $11,040,000 for these rights.

The following table reflects our purchase price allocation of the assets:

Machinery and equipment               $    943,685
Reactors                                 2,311,818
In-process research and development      9,784,497
Total                                 $ 13,040,000


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The Company completed a third-party valuation to determine the fair value of the assets acquired. The final amounts allocated to the assets acquired are based upon the results of that valuation appraisal.

We believe that the acquisition of these assets from ADI was not the acquisition of a "business" within the definition set forth in GAAP or Rule 11-01(d).

On June 5, 2012, the Company acquired substantially all of the assets of ADGC, consisting primarily of lab-grown diamond gemstone-related know-how, inventory, and various intellectual property, in exchange for $100,000 in cash and the opportunity for certain current and former stockholders of ADGC that are accredited investors to acquire up to approximately 1 million shares of common stock of the Company for $0.01 per share with the intent that ADI Offering be conducted substantially concurrently with the ADGC Offering. The ADI Offering and the ADGC Offering began in June 2012 and is completed. As of March 31, 2013, the Company had issued 16,766,773 shares of common stock pursuant to the ADI/ADGC Stockholder Offering.

The following table reflects our purchase price allocation of the assets:

Inventory                             $ 269,000
In-process research and development     601,000
Total                                 $ 870,000

The Company completed a third-party valuation to determine the fair value of the assets acquired as of the acquisition date. The final amounts allocated to the assets acquired are based upon the results of that valuation appraisal.

We believe that the acquisition of these assets from ADGC was not the acquisitions of a "business" within the definition set forth in GAAP or Rule 11-01(d).

Property, Plant and Equipment



Depreciation of property, plant and equipment is on a straight line basis
beginning at the time it is placed in service, based on the following estimated
useful lives:



                          Years
Machinery and equipment   3-15
Furniture and fixtures    3-10
Engineering equipment     5-12

Leasehold improvements are depreciated at the lesser of the remaining term of the lease or the life of the asset (generally three to seven years).

Expenditures for major renewals and betterments that extend the useful lives of property and equipment are capitalized. Expenditures for maintenance and repairs are charged to expense as incurred.

After initial recognition, tangible assets acquired that are used in commercialization activities are accounted for in accordance with their nature. Financial Accounting Standards Board ("FASB") Accounting Standards Codification ("ASC") 360 requires that these assets be classified as indefinite-lived until the completion or abandonment of the associated commercialization efforts, at which time the asset would be considered to be placed in service and the entity would determine the assets' appropriate useful lives. The Company placed the reactors acquired from ADI (the primary tangible assets) in service during the fiscal year ended March 31, 2013. This is coincided with the commencement of commercial services for the Company.

Intangible Assets

Intangible assets, such as acquired in-process research and development "IPRD" costs, are considered to have an indefinite useful life until such time as they are put into service at which time they will be amortized on a straight-line basis over the shorter of their economic or legal useful life. Management's estimate of useful life of any


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patents when placed in service is a critical judgment. Management evaluates indefinite life intangible assets for impairment on an annual basis and on an interim basis if events or changes in circumstances between annual impairment tests indicate that the asset might be impaired. The ongoing evaluation for impairment of its indefinite life intangible assets requires significant management estimates and judgment. Management reviews definite life intangible assets for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. There were no impairment charges as of March 31, 2013.

During the fiscal year ended March 31, 2013, management of the Company conducted a strategic review of its intellectual property portfolio and determined that a substantial portion of the portfolio should be considered for placement in service due to the inherent value of the patents to the on-going manufacturing operations. As a result, intangible assets in the amount of $7,534,063 previously classified as IPRD were assigned to specific patents and considered placed in service. These patents are being amortized over a period ranging from 6.75 years to 15.67 years corresponding to their remaining life.

The Company continues to classify the remaining patent portfolio as IPRD and believes that the IPRD has alternative future use and value. At such time that production begins and commercialization of this portion of the intellectual property portfolio begins, then the segmentation and bifurcation of the remaining IPRD asset to finite-lived commercialized intellectual property assets will be considered. Applicable accounting guidance requires an indefinite life for IPRD assets until such time as the commercialization can be reasonably estimated at which time the assets will be available for their intended use. At such time as those requirements are met, we believe that consideration of the legal life of the intellectual property protection should be of considerable importance in determining the useful life. Upon commercialization and determination of the useful life of the intellectual property assets, consideration will be given to the eventual expiration of the intellectual property rights underlying certain critical aspects of our manufacturing process.

RESULTS OF OPERATIONS

Fiscal Year Ended March 31, 2013 Compared to the Fiscal Year Ended March 31, 2012

Our net loss for the fiscal year ended March 31, 2013 was ($7,282,352), compared to net losses of ($2,066,900) for the fiscal year ended March 31, 2012.

During the fiscal year ended March 31, 2013, we incurred total expenses of $8,176,622, compared to total expenses of $2,137,936 during the fiscal year ended March 31, 2012. The increase is primarily the result of our commencement of commercial operations and includes an increase in the cost of goods sold to $1,349,109 in the fiscal year ended March 31, 2013 from zero in the fiscal year ended March 31, 2013; $1,996,426 in expenses associated with awards made under our 2012 Share Incentive Plan, which was adopted during the fiscal year ended March 31, 2013; and $947,306 in expenses associated with indemnification of certain members of our Board of Directors as described in Item 13- Certain Relationships and Related Transactions and Director Independence.

We have had limited revenue to offset our expenses, and so we have incurred net losses. During the fiscal year ended March 31, 2013, we recorded revenue net of returns and allowances of $881,748 from the sale of materials produced and gemstones acquired from ADGC. During the fiscal year ended March 31, 2012, we received grant income of $75,000 which was included in other income on the statement of operations. Our net loss per share for the fiscal year ended March 31, 2013 was ($0.19) per share, compared to a net loss per share of ($0.12) per share for the fiscal year ended March 31, 2012. The weighted average number of shares outstanding was 37,971,035 and 17,401,174, respectively, for the fiscal years ended March 31, 2013 and 2012.

FINANCIAL CONDITION

At March 31, 2013, we had total assets of $15,256,450 compared to total assets of $14,323,173 at March 31, 2012. This increase in assets was primarily related to increases in accounts receivable, inventory, property, plant and equipment, and the ADGC Asset Purchase. We had cash of $223,257 at March 31, 2013 compared to $808,516 at March 31, 2012. The decrease is due to the continuing use of cash to support Company operations.


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Total liabilities at March 31, 2013 were $1,066,544 compared to total liabilities of $723,501 at March 31, 2012. Total liabilities as of March 31, 2013 were comprised primarily of accounts payable and accrued expenses. This increase is the result of the Company's initiation of operations during the fiscal year.

Total shareholders' equity was $14,189,906 at March 31, 2013, compared to $13,599,672 at March 31, 2012. Shareholders' equity increased during the year primarily due to issuance of stock in connection with the ADI and ADGC Asset Purchases. Other components of the change in stockholders' equity related to sales and issuances of common stock, allocation of Company stock for indemnification purposes, and net losses during the period.

CASH FLOWS

Operating Activities

We have not generated positive cash flows from operating activities. For the year ended March 31, 2013, net cash flows used in operating activities were ($3,369,239), consisting primarily of a net loss of ($7,282,352) offset by non-cash stock cash stock based compensation in the amount of $1,996,426, allocation of stock for indemnification purposes in the amount of $830,000, depreciation and amortization of $859,983, and an increase in current liabilities of $430,370 offset by an increase in current assets ($362,899), compared to net cash flows used in operating activities for the year ended March 31, 2012 of ($1,375,519).

Investing Activities

For the year ended March 31, 2013, net cash flows used in investing activities were ($1,114,420), consisting primarily of the purchases of property, plant, and equipment. Net cash flows used in investing activities were ($1,396,520) for the year ended March 31, 2012.

Financing Activities

We have financed our operations primarily through advancements or the issuance of equity and debt instruments. For the years ended March 31, 2013 and March 31, 2012, we generated $3,861,400 and $3,579,622 from financing activities, respectively.

LIQUIDITY AND CAPITAL RESOURCES

We expect that working capital requirements will continue to be funded through a combination of our existing funds, further issuances of securities, and future credit facilities or corporate borrowings. Our working capital requirements are expected to increase in line with the growth of our business. Effective June 21, 2013, we entered into a $1,000,000 secured credit facility to provide near-term liquidity for working capital requirements. See Note 12- Subsequent Events for further details.

Existing cash of $223,257 as of March 31, 2013, is not expected to be adequate to fund our operations over the next fiscal year ending March 31, 2014. As of March 31, 2013, we had no lines of credit or other bank financing arrangements. Generally, we have financed operations through March 31, 2013 through the proceeds of sales of our common stock. Thereafter, we expect we will need to raise additional capital and generate revenues to meet operating requirements.

Additional issuances of equity or convertible debt securities will result in dilution to our current stockholders. Such securities might have rights, preferences or privileges senior to our common stock. Additional financing may not be available upon acceptable terms, or at all. If adequate funds are not available or are not available on acceptable terms, we may not be able to take advantage of prospective new business endeavors or opportunities, which could significantly and materially restrict our business operations.

OFF BALANCE SHEET ARRANGEMENTS

As of the date of this Annual Report, we do not have any off-balance sheet arrangements that have or are reasonably likely to have a current or future effect on our financial condition, changes in financial condition, revenues or expenses, results of operations, liquidity, capital expenditures or capital resources that are material to investors.


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