UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

 

FORM 10-Q

 

 

x

QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the quarterly period ended June 30, 2015

 

¨

TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF THE EXCHANGE ACT OF 1934

 

For the transition period from              to    

 

Commission file number: 000-54529

 

SCIO DIAMOND TECHNOLOGY CORPORATION

(Exact name of registrant as specified in its charter)

 

Nevada		45-3849662
(State or other jurisdiction of incorporation or		(I.R.S. Employer Identification No.)
organization)

 

411 University Ridge Suite D

Greenville, SC 29601

(Address of principal executive offices, including zip code)

 

(864) 751-4880

(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. x Yes ¨ 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 (§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). x Yes ¨ 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.

 

Large Accelerated Filer ¨		Accelerated Filer ¨
Non-Accelerated Filer ¨		Smaller Reporting Company x
(Do not check if smaller reporting company)

 

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

 

The number of shares of common stock, $0.001 par value, outstanding as of August 11, 2015 was 58,077,624

 

 

 

SCIO DIAMOND TECHNOLOGY CORPORATION

 

TABLE OF CONTENTS

 

		PAGE
PART I	FINANCIAL INFORMATION
ITEM 1.	FINANCIAL STATEMENTS	4
ITEM 2.	MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS	18
ITEM 3.	QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK	24
ITEM 4.	CONTROLS AND PROCEDURES	24
PART II	OTHER INFORMATION
ITEM 1.	LEGAL PROCEEDINGS	25
ITEM 1A.	RISK FACTORS	25
ITEM 2.	UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS	25
ITEM 3.	DEFAULTS UPON SENIOR SECURITIES	25
ITEM 4.	MINE SAFETY DISCLOSURES	25
ITEM 5.	OTHER INFORMATION	25
ITEM 6.	EXHIBITS	26

 

 

Special Note Regarding Forward-Looking Statements

 

Information included in this Quarterly Report on Form 10-Q contains forward-looking statements that reflect the views of the management of the Company with respect to certain future events. Forward-looking statements made by penny stock issuers such as the Company are excluded from the safe harbor in Section 21E of the Securities Exchange Act of 1934 (the “Exchange Act”). Words such as “expects,” “should,” “may,” “will,” “believes,” “anticipates,” “intends,” “plans,” “seeks,” “estimates” and similar expressions or variations of such words, and negatives thereof, are intended to identify forward-looking statements, but are not the exclusive means of identifying forward-looking statements in this report. These forward-looking statements are based on assumptions that may be incorrect, and there can be no assurance that matters anticipated in our forward-looking statements will come to pass.

 

Forward-looking statements are subject to certain risks and uncertainties which could cause actual results to differ materially from those anticipated. Such risk and uncertainties include, without limitation, those described under Risk Factors set forth in Part I, Item 1A of our Form 10-K for the fiscal year ended March 31, 2015 filed on June 29, 2015.

 

You are cautioned not to place undue reliance on forward-looking statements. You are also urged to review and consider carefully the various disclosures made in the Company’s other filings with the Securities and Exchange Commission (“SEC”), including amendments to those filings, if any. Except as may be required by applicable laws, the Company undertakes no obligation to update publicly any forward-looking statements for any reason, even if new information becomes available or other events occur in the future.

 

 

PART I - FINANCIAL INFORMATION

   

ITEM 1.

UNAUDITED CONDENSED FINANCIAL STATEMENTS

 

SCIO DIAMOND TECHNOLOGY CORPORATION

CONDENSED BALANCE SHEETS

As of June 30, 2015 and March 31, 2015

 

		June 30,				March 31,
		2015				2015
		(Unaudited)
ASSETS
Current Assets:
Cash and cash equivalents		$	176,790			$	767,214
Accounts receivable			249,058				243,929
Deferred contract costs			201,766				179,969
Inventory			294,226				295,760
Prepaid expenses			52,324				57,012
Prepaid rent			23,050				23,050
Total current assets			997,214				1,566,934
Property, plant and equipment
Facility			904,813				904,813
Manufacturing equipment			2,927,761				2,927,761
Other equipment			71,059				71,059
Construction in progress			465,984				207,252
Total property, plant and equipment			4,369,617				4,110,885
Less accumulated depreciation			(1,687,065	)			(1,543,652	)
Net property, plant and equipment			2,682,552				2,567,233
Intangible assets, net			7,854,238				8,047,948
Prepaid rent, noncurrent			13,475				19,238
Investment in joint venture – RCDC			46,380				30,041
TOTAL ASSETS		$	11,593,859			$	12,231,394
LIABILITIES AND SHAREHOLDERS’ EQUITY
Current Liabilities:
Accounts payable		$	900,022			$	708,760
Customer deposits			35,807				38,603
Deferred revenue			248,925				215,375
Accrued expenses			472,628				517,942
Total current liabilities			1,657,382				1,480,680
Notes Payable			2,500,000				2,500,000
Other liabilities			110,711				118,092
TOTAL LIABILITIES			4,268,093				4,098,772
Common stock $0.001 par value, 75,000,000 shares authorized; 57,522,124 and 56,531,499 shares issued and outstanding at June 30, 2015 and March 31, 2015, respectively			57,523				56,532
Additional paid-in capital			26,884,253				26,815,005
Accumulated deficit			(19,616,010	)			(18,738,915	)
Total shareholders’ equity			7,325,766				8,132,622
TOTAL LIABILITIES AND SHAREHOLDERS’ EQUITY		$	11,593,859			$	12,231,394

 

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

 

 

SCIO DIAMOND TECHNOLOGY CORPORATION
CONDENSED STATEMENTS OF OPERATIONS
For the Three Months Ended June 30, 2015 and 2014

(Unaudited)

 

		Three Months Ended				Three Months Ended
		June 30, 2015				June 30, 2014
Revenue
Product revenue, net		$	172,175			$	79,338
Licensing revenue			—				375,000
Revenue, net			172,175				454,338
Cost of goods sold
Cost of goods sold			415,367				374,423
Gross margin (deficit)			(243,192	)			79,915
General and administrative expenses
Salaries and benefits			202,302				396,868
Professional and consulting fees			51,943				260,235
Rent, equipment lease and facilities expense			39,013				34,147
Marketing costs			28,183				10,688
Corporate general and administrative			85,547				124,153
Depreciation and amortization			198,405				200,124
Total general and administrative expenses			605,393				1,026,215
Loss from operations			(848,585	)			(946,300	)
Other expense
Income from joint venture – RCDC			16,339				—
Interest expense			(44,849	)			(61,927	)
Net loss		$	(877,095	)		$	(1,008,227	)
Loss per share
Basic:
Weighted average number of shares outstanding			56,534,466				50,697,993
Loss per share		$	(0.02	)		$	(0.02	)
Fully diluted:
Weighted average number of shares outstanding			56,534,466				50,697,993
Loss per share		$	(0.02	)		$	(0.02	)

 

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

 

 

SCIO DIAMOND TECHNOLOGY CORPORATION
CONDENSED STATEMENTS OF CASH FLOW
For the Three Months Ended June 30, 2015 and 2014

(Unaudited)

 

		Three Months Ended				Three Months Ended
		June 30, 2015				June 30, 2014
Cash flows from operating activities:
Net loss		$	(877,095	)		$	(1,008,227	)
Adjustments to reconcile net loss to net cash used in operating activities:
Depreciation and amortization			339,072				410,322
Expense for stock issued in exchange for services			—				26,200
Employee stock based compensation			64,501				—
Income from joint venture – RCDC			(16,339	)			—
Inventory write-down			—				68,722
Changes in assets and liabilities:
Decrease in accounts receivable and deferred revenue			28,421				3,289
Decrease in other receivables			—				89,192
Decrease/(increase) in prepaid expenses, rent and deferred contract cost			8,501				(4,551	)
Decrease/(increase) in inventory and other assets			(20,263	)			(101,813	)
Increase in accounts payable			44,447				365,325
Decrease in customer deposits			(2,796	)			(29,835	)
Increase/(decrease) in accrued expenses			(137,314	)			78,816
Increase/(decrease) in other liabilities			(7,381	)			8,487
Net cash used in operating activities			(576,246	)			(94,073	)
Cash flows from investing activities:
Purchase of property, plant and equipment			(19,916	)			(13,152	)
Net cash used in investing activities			(19,916	)			(13,152	)
Cash flows from financing activities:
Proceeds from note payable			—				61,284
Proceeds from exercise of stock options			5,738				—
Net cash provided by financing activities			5,738				61,284
Change in cash and cash equivalents			(590,424	)			(45,941	)
Cash and cash equivalents, beginning of period			767,214				47,987
Cash and cash equivalents, end of period		$	176,790			$	2,046

 

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

 

(continued)

 

 

SCIO DIAMOND TECHNOLOGY CORPORATION
CONDENSED STATEMENTS OF CASH FLOW
For the Three Months Ended June 30, 2015 and 2014 (Unaudited)
(Continued)

 

		Three Months Ended				Three Months Ended
		June 30, 2015				June 30, 2014
Supplemental cash flow disclosures:
Cash paid for:
Interest		$	23,764			$	—
Income taxes		$	—			$	—
Non-cash financing activities:
Payment of accrued expenses with stock		$	—			$	12,000
Purchase of property, plant and equipment in accounts payable		$	(146,816	)		$	—
Purchase of property, plant and equipment in accrued expenses		$	(92,000	)		$	—

 

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

 

 

SCIO DIAMOND TECHNOLOGY CORPORATION
CONDENSED STATEMENTS OF SHAREHOLDERS’ EQUITY
For the period April 1, 2015 through June 30, 2015

(Unaudited)

 

										Additional
		Common Stock								Paid in				Accumulated
		Shares				Amount				Capital				Deficit				Total
Balance, April 1, 2015			56,531,499			$	56,532			$	26,815,005			$	(18,738,915	)		$	8,132,622
Common stock issued upon exercise of stock options			5,625				6				5,732				—				5,738
Common stock issued as incentive compensation			985,000				985				63,516				—				64,501
Net loss for the quarter ended June 30, 2015			—				—				—				(877,095	)			(877,095	)
Balance, June 30, 2015			57,522,124			$	57,523			$	26,884,253			$	(19,616,010	)		$	7,325,766

 

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

 

 

NOTE 1 — ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

 

Organization and Business

 

Scio Diamond Technology Corporation (referred to herein as the “Company”, “we”, “us” or “our”) was incorporated under the laws of the State of Nevada as Krossbow Holding Corp. on September 17, 2009. The Company’s focus is on man-made diamond technology development and commercialization.

 

Going Concern

 

The Company has generated little revenue to date and consequently its operations are subject to all risks inherent in the establishment and commercial launch of a new business enterprise. As of March 31, 2015, our cash balance was $767,214 and as of June 30, 2015 our cash balance was reduced to $176,790. This reduction was due to our operating cash needs and purchases of equipment. Our cash on hand at June 30, 2015 is not expected to be adequate to fund our operations over the fiscal year ending March 31, 2016 and we had no additional lines of credit or other bank financing arrangements other than as described in Item 1, Note 3.

 

These factors raise substantial doubt about the Company’s ability to continue as a going concern. Management has responded to these circumstances by taking the following actions:

 

·

On-going solicitation of investment in the Company in the form of private placements of common shares or debt securities;

·

Continue to explore strategic joint ventures and technology licensing agreements to expand company revenue and cash flow; and

·

Recently expanded and continue to optimize production of existing manufacturing capabilities to increase product revenues;

 

If successfully implemented, in the opinion of management, these actions will be sufficient to provide the Company with the liquidity it needs to meet its obligations and continue as a going concern. There can be no assurance, however, that the Company will successfully implement these plans. The financial statements do not include any adjustments that might be necessary if the Company is unable to continue as a going concern.

 

Accounting Basis

 

The accompanying unaudited financial statements of the Company have been prepared in accordance with accounting principles generally accepted in the United States of America (“GAAP”) for interim financial information and with the instructions to Form 10-Q and Rule 10-01 of Regulation S-X. Accordingly, certain information and footnote disclosures normally included in financial statements prepared in accordance with GAAP have been condensed or omitted pursuant to such rules and regulations.

 

In the opinion of management, the accompanying unaudited financial statements contain all adjustments (consisting only of normal recurring accruals) necessary to present fairly the Company’s financial position as of June 30, 2015 and March 31, 2015 and the results of operations and cash flows for the three month interim periods ended June 30, 2015 and 2014. The interim amounts have not been audited, and the results of operations for the interim periods herein are not necessarily indicative of the results of operations to be expected for future periods or the year. The balance sheet at March 31, 2015 has been derived from the audited financial statements at that date but does not include all of the information and footnotes required by GAAP for complete financial statements. These financial statements should be read in conjunction with the Company’s audited financial statements and notes thereto included in the Form 10-K Annual Report of the Company for the year ended March 31, 2015.

 

  

In accordance with Accounting Standards Codification (“ASC”) 323, Investments—Equity Method and Joint Ventures, the Company uses the equity method of accounting for investments in corporate joint ventures for which the Company has the ability to exercise significant influence but does not control and is not the primary beneficiary. Significant influence typically exists if the Company has a 20% to 50% ownership interest in the venture unless predominant evidence to the contrary exists. Under this method of accounting, the Company records its proportionate share of the net earnings or losses of equity method investees and a corresponding increase or decrease to the investment balances. Cash payments to equity method investees such as additional investments, loans and advances and expenses incurred on behalf of investees, as well as payments from equity method investees such as dividends, distributions and repayments of loans and advances are recorded as adjustments to investment balances. When the Company’s carrying value in an equity method investee is reduced to zero, no further losses are recorded in the Company’s financial statements unless the Company guaranteed obligations of the equity method investee or has committed additional funding.   When the equity method investee subsequently reports income, the Company will not record its share of such income until it equals the amount of its share of losses not previously recognized.  The Company evaluates its equity method investments for impairment whenever events or changes in circumstances indicate that the carrying amounts of such investments may not be recoverable.

 

Basic and Diluted Net Loss per Share

 

Net loss per share is presented under two formats: basic net loss per common share, which is computed using the weighted average number of common shares outstanding during the period, and diluted net loss per common share, which is computed using the weighted average number of common shares outstanding, and the weighted average dilutive potential common shares outstanding, computed using the treasury stock method. Currently, for all periods presented, diluted net loss per share is the same as basic net loss per share as the inclusion of weighted average shares of non-vested restricted stock and common stock issuable upon the exercise of options and warrants would be anti-dilutive.

 

The following table summarizes the number of securities outstanding at each of the periods presented, which were not included in the calculation of diluted net loss per share as their inclusion would be anti-dilutive:

 

		June 30,
		2015				2014
Common stock options and warrants			4,063,253				8,090,878
Non-vested restricted stock			985,000				—

 

Allowance for Doubtful Accounts

 

An allowance for uncollectible accounts receivable is maintained for estimated losses from customers’ failure to make payment on accounts receivable due to the Company. Management determines the estimate of the allowance for uncollectible accounts receivable by considering a number of factors, including: (1) historical experience, (2) aging of accounts receivable and (3) specific information obtained by the Company on the financial condition and the current credit worthiness of its customers. The Company has determined that an allowance was not necessary at June 30, 2015 or March 31, 2015.

 

Inventories

 

Inventories are stated at the lower of average cost or market. The carrying value of inventory is reviewed and adjusted based upon slow moving and obsolete items. Inventory costs include material, labor, and manufacturing overhead and are determined by the “first-in, first-out” (FIFO) method. The components of inventories are as follows:

 

		June 30, 2015				March 31, 2015
Raw materials and supplies		$	60,831			$	58,390
Work in process			29,789				31,371
Finished goods			203,606				205,999
		$	294,226			$	295,760

 

During the three months ended June 2015, the Company’s products were selling for prices higher than its manufacturing costs, however, during the three months ended June 30, 2014, we experienced selling prices lower than cost and as a result we recorded a lower of cost or market write down of $68,722 for inventory produced during that period that was still on hand at June 30, 2014. The estimation of the total write-down involves management judgments and assumptions including assumptions regarding future selling price forecasts, the estimated costs to complete, disposal costs and a normal profit margin.

 

  

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 to15
Furniture and fixtures		3 to10
Engineering equipment		5 to 12

 

Leasehold improvements which are included in facility fixed assets on the balance sheet are depreciated over 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.

 

Intangible Assets

 

Acquired in-process research and development 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 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 during the three months ended June 30, 2015 or 2014.

 

Stock-based Compensation

 

Stock-based compensation expense for the value of stock options is estimated on the date of the grant using the Black-Scholes option-pricing model. The Black-Scholes model takes into account implied volatility in the price of the Company’s stock, the risk-free interest rate, the estimated life of the equity-based award, the closing market price of the Company’s stock on the grant date and the exercise price. The estimates utilized in the Black-Scholes calculation involve inherent uncertainties and the application of management judgment.

 

Concentration of Credit Risk

 

During the three months ended June 30, 2015, the Company was selling substantially all of its production to the RCDC joint venture and had a receivable from RCDC at June 30, 2015 of $249,058. The Company expects this concentration of sales to RCDC to continue in the future.

 

Revenue Recognition

 

We recognize product revenue when persuasive evidence of an arrangement exists, delivery of products has occurred, the sales price is fixed or determinable, and collectability is reasonably assured. For our Company, this generally means that we recognize revenue when we or our fabrication vendor has shipped finished product to the customer. Our sales terms do not allow for a right of return except for matters related to any manufacturing defects on our part.

 

For product sales to our joint venture partners for further processing and finishing, we currently defer all revenues when products are shipped. We currently recognize revenue at the earlier of when the joint venture partner sells the finished goods manufactured from our materials or we are paid for our goods. Licensing and development revenues are recognized in the month as detailed in appropriate licensing and development contracts. In the event that licensing funds are received prior to the contractual commitment, the Company will recognize deferred revenue (liability) for the amount received.

 

  

Recent Accounting Pronouncements

 

On May 28, 2014, the FASB issued ASU 2014-09, "Revenue from Contracts with Customers (Topic 606)," which affects any entity that either enters into contracts with customers to transfer goods or services or enters into contracts for the transfer of nonfinancial assets unless those contracts are within the scope of other standards. The guidance supersedes the revenue recognition guidance in Topic 605, "Revenue Recognition", and most industry-specific guidance throughout the Industry Topics of the Codification. The guidance also supersedes some cost guidance included in Subtopic 605-35, "Revenue Recognition- Contract-Type and Production-Type Contracts". On April 1, 2015, the FASB voted to defer the effective date of the pronouncement by one year, however an amendment to the ASU has not yet been released. ASU 2014-9, as amended, is effective for annual periods, and interim periods within those years, beginning after December 31, 2017. An entity is required to apply the amendments using one of the following two methods: i) retrospectively to each prior period presented with three possible expedients: a) for completed contracts that begin and end in the same reporting period no restatement is required, b) for completed contract with variable consideration an entity may use the transaction price at completion rather than restating estimated variable consideration amounts in comparable reporting periods and c) for comparable reporting periods before date of initial application reduced disclosure requirements related to transaction price; ii) retrospectively with the cumulative effect of initially applying the amendment recognized at the date of initial application with additional disclosures for the differences of the prior guidance to the reporting periods compared to the new guidance and an explanation of the reasons for significant changes. We are required to adopt ASU 2014-09 in the first quarter of fiscal 2018, or in the first quarter of fiscal 2019, if deferred, and we are currently assessing the impact of this pronouncement on our financial statements.

 

In August 2014, the FASB issued ASU No. 2014-15, Disclosure of Uncertainties about an Entity's Ability to Continue as a Going Concern, which requires management to assess, at each annual and interim reporting period, the entity's ability to continue as a going concern within one year after the date that the financial statements are issued and provide related disclosures. The ASU is effective for our fiscal year ending March 31, 2017, with early adoption permitted. The Company has assessed the impact of this standard and does not believe that it will have a material impact on the Company’s financial statements or disclosures.

 

In July 2015, the FASB issued ASU No. 2015-11, Simplifying the Measurement of Inventory, ("ASU 2015-11"). This new guidance requires an entity to measure inventory at the lower of cost and net realizable value. Currently, entities measure inventory at the lower of cost and market. ASU 2015-11 replaces market with net realizable value. Net realizable value is the estimated selling prices in the ordinary course of business, less reasonably predictable costs of completion, disposal, and transportation. Subsequent measurement is unchanged for inventory measured under last-in, first-out or the retail inventory method. ASU 2015-11 requires prospective adoption for inventory measurements for fiscal years beginning after December 15, 2016, and interim periods within those years for public business entities. Early application is permitted. ASU 2015-11 is therefore effective in our fiscal year beginning April 1, 2017. We are evaluating the effect that ASU 2015-11 will have on our financial statements and related disclosures.

 

There are currently no other accounting standards that have been issued but not yet adopted by the Company that will have a significant impact on the Company’s financial position, results of operations or cash flows upon adoption.

 

NOTE 2 — INTANGIBLE ASSETS

 

Acquired in-process research and development 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.

 

Intangible assets consist of the following:

				June 30,				March 31,
		Life		2015				2015
Patents, gross		6.75 – 19.46		$	8,135,063			$	8,135,063
In-process research and development		Indefinite			1,832,370				1,832,370
					9,967,433				9,967,433
Accumulated amortization					(2,113,195	)			(1,919,485	)
Net intangible assets				$	7,854,238			$	8,047,948

 

Total amortization expense for the quarter ending June 30, 2015 and 2014 was $193,710 and $193,710, respectively.

 

 

 

Total annual amortization expense of finite lived intangible assets is estimated to be as follows:

 

Fiscal Year Ending
Nine months ending March 31, 2016		$	581,130
March 31, 2017			774,840
March 31, 2018			774,840
March 31, 2019			774,840
March 31, 2020			595,159
Thereafter		$	2,521,059

 

NOTE 3 — NOTES PAYABLE

 

On December 16, 2014 the Company entered into a Loan Agreement (the “HGI Loan Agreement”) and a Security Agreement (the “HGI Security Agreement”) with Heritage Gemstone Investors, LLC (“HGI”) providing for a $2,000,000 secured non-revolving line of credit (the “HGI Loan”). The HGI Loan, which is represented by a Promissory Note dated as of December 15, 2014 (the “HGI Note”), matures on December 15, 2017. Borrowings accrue interest at the rate of 7.25% per annum and the Company intends to make monthly interest payments. On December 18, 2014, $2,000,000 was drawn on the HGI Loan. The Company utilized funds drawn on the HGI Loan to repay its existing indebtedness to Platinum and to continue to fund its ongoing operations. The HGI Loan Agreement contains a number of restrictions on the Company’s business, including restrictions on its ability to merge, sell assets, create or incur liens on assets, make distributions to its stockholders and sell, purchase or lease real or personal property or other assets or equipment. The HGI Loan Agreement contains standard provisions relating to a default and acceleration of the Company’s payment obligations thereunder upon the occurrence of an event of default, which includes, among other things, the failure to pay principal, interest, fees or other amounts payable under the agreement when due; failure to comply with specified agreements, covenants or obligations; cross-default with other indebtedness; the making of any material false representation or warranty; commencement of bankruptcy or other insolvency proceedings by or against the Company; and failure by the Company to maintain a book net worth of at least $4,000,000 at all times. The Company’s obligations under the HGI Loan Agreement are not guaranteed by any other party. The Company may prepay borrowings without premium or penalty upon notice to HGI as provided in the HGI Loan Agreement. The HGI Loan Agreement requires the Company to enter into the HGI Security Agreement. Under the HGI Security Agreement, the Company grants HGI a first priority security interest in the Company’s inventory, equipment, accounts and other rights to payments and intangibles as security for the HGI Loan.

 

Also on December 16, 2014, the Company entered into an agreement for the Sale and Lease of Growers (the “Grower Sale-Lease Agreement”) with HGI to allow for the expansion of current growers and the purchase of new growers. Pursuant to the Grower Sale-Lease Agreement, the Company agreed to a sale-leaseback arrangement for certain diamond growers produced by the Company during the term of the Grower Sale-Leaseback Agreement by which the Company will sell diamond growers to HGI and then lease the growers back from HGI. The term of the Grower Sale-Leaseback Agreement is ten years. For the new and upgraded growers, the direct profit margin generated from the growers will be split between the Company and HGI in accordance with the Grower Sale-Lease Agreement. The Grower Sale-Lease Agreement requires the Company to operate and service the growers, and requires HGI to up-fit certain existing growers and to make capital improvements to the new growers under certain circumstances. At the end of the Grower Sale-Leaseback Agreement, the Company takes ownership of the leased equipment. The Company will also have the right to repurchase the leased growers upon the occurrence of certain events prior to the expiration of the Grower Sale-Leaseback Agreement.

 

As of June 30, 2015, HGI has advanced the Company $300,000 to fund improvements to our current growers that will expand manufacturing capacity in our production facility. In addition, HGI has advanced the Company $200,000 for the purchase of new grower equipment under the Sale-Leaseback Agreement. As of June 30, 2015, the Company considers both of these advances totaling $500,000 as notes payable. The Company anticipates completing the grower expansion and new equipment purchases during the first half of the fiscal year ending March 31, 2016.

 

  

NOTE 4 — CAPITAL STOCK

 

The authorized capital of the Company is 75,000,000 common shares with a par value of $ 0.001 per share.

 

The Company had 57,522,124 shares of common stock issued and outstanding as of June 30, 2015. This total includes 985,000 shares of non-vested restricted stock.

 

The Company had 3,028,045 warrants outstanding with a weighted average exercise price of $1.45 per share as of June 30, 2015. 2,538,750 warrants expired and none were issued in the three months ended June 30, 2015. 2,352,500 warrants will expire during the next six months of 2015 while the balance of the warrants will expire in 2017 and 2018 if not exercised.

 

NOTE 5 — SHARE-BASED COMPENSATION

 

The Company currently has one equity-based compensation plan under which stock-based compensation awards can be granted to directors, officers, employees and consultants providing bona fide services to or for the Company. The Company’s 2012 Share Incentive Plan was adopted on May 7, 2012 (the “2012 Share Incentive Plan” or “Plan”) and allows the Company to issue up to 5,000,000 shares of its common stock pursuant to awards granted under the 2012 Share Incentive Plan. The Plan permits the granting of stock options, stock appreciation rights, restricted or unrestricted stock awards, phantom stock, performance awards, other stock-based awards, or any combination of the foregoing. The only awards that have been issued under the Plan are stock options. Because the Plan has not been approved by our shareholders, all such stock option awards are non-qualified stock options.

 

On May 7, 2015, the Board of Directors of the Company approved restricted stock awards for Mr. Gerald McGuire, the Company President and Chief Executive Officer and Mr. Jonathan Pfohl, the Company Chief Financial Officer. Mssrs. McGuire and Pfohl were granted 400,000 and 385,000 restricted shares of stock, respectively that will vest on July 1, 2018. The restricted shares are valued at $1.03, the closing price of the Company’s stock on May 7, 2015. The Company recognizes compensation expense for the restricted stock awards on a straight line basis over the vesting period. The Company recognized $42,555 in compensation expenses for these awards during the three months ended June 30, 2015. Also on May 7, 2015, the Board of Directors granted Renaissance Diamond Inc. a restricted stock award of 200,000 shares that only vests based on the attainment of specific performance criteria. The Company does not anticipate recognizing any financial impact for this restricted stock award until it is deemed likely that the performance criteria will be met.

 

The following sets forth the restricted stock outstanding as of June 30, 2014:

 

Restricted Stock		Shares
Restricted stock outstanding March 31, 2015			—
Granted			985,000
Vested			—
Expired/cancelled			—
Restricted stock outstanding June 30, 2015			985,000

 

On May 7, 2015, the Board of Directors granted Renaissance Diamond Inc. non-qualified stock options for 333,333 shares of common stock. These options will vest on June 29, 2016 if the RCDC joint venture attains specific performance criteria. The strike price of these options will be set at fifty percent of the market closing price upon vesting. The options will need to be exercised within 60 days of vesting.

 

In addition, on May 7, 2015, the Company granted seven non-executive employees options to purchase a total of 685,000 shares of the Company’s stock. The vesting schedule for these options call for 33.3% to vest upon the first, second and third anniversaries of the grant date. The exercise price of $1.03 per share is equal to the closing price of a share of the Company’s common stock on the date of grant. Using the Black-Scholes option pricing model, management has estimated these options had a value of $0.98 per option on the date of the grant. The Black-Scholes model assumptions used were: Expected dividend yield, 0.00%; Risk-free interest rate, 2.18%; Expected life in years, 10.0; Expected volatility, 124.3%; Forfeiture rate, 25.0%. None of these options were vested upon issuance and the Company recognized $21,946 in compensation costs for these options during the three months ending June 30, 2015.

 

  

The following sets forth the employee options to purchase shares of the Company’s stock issued and outstanding as of June 30, 2015 and does not include options granted to Renaissance Diamond Inc.:

 

Options		Shares				Weighted- Average Exercise Price				Weighted-Average Remaining Contractual Term
Employee options outstanding March 31, 2015			232,500			$	0.35				1.45
Granted			685,000				1.03				9.86
Exercised			(5,625	)			.33				—
Expired/cancelled			(210,000	)			0.83				—
Employee options outstanding June 30, 2015			701,875			$	0.87				7.80
Exercisable at June 30, 2015			17,500			$	0.48				0.85

 

A summary of the status of non-vested employee options as of June 30, 2015 and changes during the three months ended June 30, 2015 is presented below.

						Weighted Average
						Grant-Date
Non-vested Shares		Shares				Fair Value
Non-vested at March 31, 2015			209,375				0.21
Granted			685,000				0.98
Vested			—				—
Expired/cancelled: non-vested			(210,000	)			0.76
Non-vested at June 30, 2015			684,375			$	0.81

 

The following table summarizes information about employee stock options outstanding by price range as of June 30, 2015:

 

				Options Outstanding												Options Exercisable
Range of  Exercise Price				Number Outstanding				Weighted Average Remaining Contractual Life (years)				Weighted Average Exercise Price				Number of  Shares				Weighted Average Exercise Price
$	1.03				535,000				9.86			$	1.03				—			$	—
$	0.80				7,500				0.02				0.80				5,500				0.80
$	0.33				159,375				1.24				0.33				12,000				0.33
					701,875				7.80			$	0.87				17,500			$	0.48

 

At June 30, 2015, unrecognized compensation cost related to non-vested employee awards was $558,636. This cost is only expected to be recognized if certain performance metrics are attained over a weighted average period of 2.85 years.

 

NOTE 6 — RELATED PARTIES

 

See NOTE 8 for discussion of revenues recognized from the RCDC joint venture.

 

NOTE 7 – LITIGATION

 

We are subject, from time to time, to various claims, lawsuits or actions that arise in the ordinary course of business. As of June 30, 2015 there were no material outstanding claims by the Company or against the Company.

 

On May 16, 2014, the Company received a subpoena issued by the SEC ordering the provision of documents and related information concerning various corporate transactions between the Company and its predecessors and other persons and entities.  The Company continues to cooperate with this inquiry.

 

  

NOTE 8 — INVESTMENT IN RCDC JOINT VENTURE

 

On December 18, 2014 the Company entered into an arrangement with Renaissance Diamonds, Inc. (“Renaissance”) through the execution of a limited liability company agreement (the “LLC Agreement”) of Renaissance Created Diamond Company, LLC, a Florida limited liability company (“RCDC”), pursuant to which the Company and Renaissance are each 50% members of RCDC.

 

The LLC Agreement provides that RCDC is a manager-managed limited liability company, and each of the Company and Renaissance will appoint one manager, with both such managers appointing a third manager.  The managers will manage the day-to-day operations of RCDC, subject to certain customary limitations on managerial actions that require the consent of the Company and Renaissance, including but not limited to making or guaranteeing loans, distributing cash or other property to the members of RCDC, entering into affiliate transactions, amending or modifying limited liability company organizational documents, and entering into major corporate events, such as a merger, acquisition or asset sale. The arrangement was entered into in order to facilitate the development of procedures and recipes for, and to market and sell, lab-grown fancy-colored diamonds.  Pursuant to the LLC Agreement, the arrangement will last three years, unless terminated earlier, with the option to automatically renew for additional two-year periods. The Company made an initial $1,000 investment in RCDC and was granted a 50% equity stake. RCDC has the right of first refusal to purchase diamond gemstones from the Company, including rough diamond preforms or processed stones.  Renaissance may sell seed stock to RCDC for production by the Company.  RCDC purchase rough diamond material produced by the Company finishes the rough gemstones and, in turn, sells the finished stones to various retailers and other participants in the market for gemstones.  Profits generated by RCDC’s operations will be distributed between the Company and Renaissance according to the terms of the LLC Agreement.

 

Through June 30, 2015 the operations of RCDC have been focused on the development and processing of diamond material into finished Gemstone material and establishing sales and distribution channels for the finished goods. During the three months ended June 30, 2015, the Company sold product to RCDC valued at $156,800. The Company defers recognition of revenues and expenses on these sales to RCDC until finished goods are sold by RCDC or RCDC pays the Company for its purchases. For the three months ended June 30, 2015, the Company recognized $123,250 in revenue for product sold to RCDC. As of June 30, 2015, the Company has deferred $248,925 of revenue and $201,766 of expenses related to our sales to RCDC. The Company anticipates recognizing this deferred revenue and expense at the earlier date of RCDC selling through its inventory or the Company collects its receivables from RCDC.

 

The Company utilizes the equity method of accounting for its investment in RCDC. As such, the Company recognized $16,339 as its proportional shares of RCDC’s net income during the three months ended June 30, 2015 as other income.

 

Rollforward of the Company’s ownership interest in the joint venture for the three months ended June 30, 2015:

Balance of ownership interest in joint venture at March 31,2015		$	30,041
Aggregate fiscal 2016 equity gain – share of joint venture income			16,339
Balance of ownership interest in joint venture at June 30, 2015		$	46,380
Cumulative recognized income on ownership interest in joint venture at June 30, 2015		$	45,380

 

Selected financial results for RCDC for the three months ended June 30, 2015 are as follows:

Revenues		$	260,299
Expenses			227,622
Net Income		$	32,677
Total Assets		$	611,259
Total Liabilities		$	518,499
Total Partners Capital			92,760
Total Liabilities and Partner Capital		$	611,259

 

  

NOTE 9 — SUBSEQUENT EVENTS

 

On, July 1, 2015, the Renaissance Diamond Inc. was granted restricted stock awards for 550,000 shares that only vest based on the attainment of specific performance criteria. The Company will not recognize any financial impact for these restricted stock awards unless the performance criteria are met.

 

On August 7, 2015, the Company reached an amendment to the separation, waiver and release agreement executed on December 4, 2012 with our former Chief Executive Officer, Mr. Joseph Lancia. This amendment allows for no further severance payments to Mr. Lancia and will result in the company reversing $137,561 in accrued severance expenses in the quarterly financial results ending September 30, 2015.

  

On August 13, 2015, the Board of Directors of the Company approved restricted stock awards for Mr. Gerald McGuire, the Company President and Chief Executive Officer and Mr. Jonathan Pfohl, the Company Chief Financial Officer. Mssrs. McGuire and Pfohl were granted 400,000 and 150,000 restricted shares of stock, respectively that will vest on July 1, 2018. The restricted shares are valued at the closing price of the Company’s stock on August 13, 2015. The Company will recognize compensation expense for these restricted stock awards on a straight line basis over the vesting period.

 

END NOTES TO FINANCIALS

 

 

ITEM 2.               MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

 

CAUTIONARY STATEMENT REGARDING FORWARD-LOOKING STATEMENTS

 

Information included in this Quarterly Report Form 10-Q contains forward-looking statements that reflect the views of the management of the Company with respect to certain future events. Forward-looking statements made by penny stock issuers such as the Company are excluded from the safe harbor in Section 21E of the Securities Exchange Act of 1934. Words such as “expects,” “should,” “may,” “will,” “believes,” “anticipates,” “intends,” “plans,” “seeks,” “estimates” and similar expressions or variations of such words, and negatives thereof, are intended to identify forward-looking statements, but are not the exclusive means of identifying forward-looking statements in this report. These forward-looking statements are based on assumptions that may be incorrect, and there can be no assurance that matters anticipated in our forward-looking statements will come to pass.

 

Forward-looking statements are subject to certain risks and uncertainties which could cause actual results to differ materially from those anticipated. Such risk and uncertainties include, without limitation, those described below under Item 1A - Risk Factors and the following: (1) the Company has limited cash resources and if it is not able to obtain further financing required for continuing operations, marketing, product development, and research its business operations will fail, (2) the Company has not generated substantial revenues, and as a result, faces a high risk of business failure, (3) the Company’s lack of diversification and dependence on material customers increases the risks associated with the Company’s business and an investment in the Company, and the Company’s financial condition may deteriorate rapidly if it fails to succeed in developing the Company’s business and expanding our customer base, (4) the Company may not effectively execute the Company’s business plan or manage the Company’s potential future business development, (5) the Company’s business could be impaired if it fails to comply with applicable regulations, (6) the Company has had significant turnover in management and may not be able to attract and maintain key management personnel to manage the Company or laboratory scientists to carry out the Company’s business operations, which could have a material adverse effect on the Company’s business, (7) the market for lab-grown diamond may not develop as anticipated, (8) competition may adversely affect our business, (9) the Company may expend a substantial amount of time and resources in connection with the Securities and Exchange Commission’s (“SEC”) recent subpoena, potential inquiries or legal actions in connection with its filings with the SEC or otherwise, which may impair the Company’s ability to raise capital and to operate its business, and (10) such other risks and uncertainties as have been disclosed or are hereafter disclosed from time to time in the Company’s filings with the SEC, including, without limitations described under Risk Factors set forth in Part I, Item 1A of the Company’s Form 10-K for the fiscal year ended March 31, 2015.

 

You are cautioned not to place undue reliance on forward-looking statements. You are also urged to review and consider carefully the various disclosures made in the Company’s other filings with the Securities and Exchange Commission, including any amendments to those filings. Except as may be required by applicable laws, the Company undertakes no obligation to update publicly any forward-looking statements for any reason, even if new information becomes available or other events occur in the future.

 

GENERAL

 

We were incorporated on September 17, 2009 in the State of Nevada under the name Krossbow Holdings Corporation (“Krossbow”). Krossbow did not implement its original business plan and decided to acquire existing technology 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 acquired control of the Company through the purchase of shares of the Company’s issued and outstanding common stock from Jason Kropp, Krossbow’s sole director and executive officer at that time. Messrs. Monahan and Adams served on the Company’s Board of Directors until their resignations form the Board on June 30, 2013, and June 23, 2014, respectively. Additionally, on August 5, 2011, the Company executed an 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 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.

 

  

On August 31, 2011, the Company acquired certain assets of ADI, consisting primarily of diamond growing machines and intellectual property related thereto, for which the Company paid ADI an aggregate of $2,000,000. In connection with the ADI Asset Purchase, the Company also agreed to provide certain current and former stockholders of ADI qualifying as accredited investors the opportunity to acquire up to approximately 16 million shares of common stock of the Company for $0.01 per share.

 

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 qualifying as accredited investors to acquire up to approximately 1 million shares of common stock of the Company for $0.01 per share.

 

In December 2011, the Company began a build-out of its Greenville, South Carolina production facility. Construction was largely completed in March 2012 and equipment was moved from ADI’s former facility in Massachusetts to South Carolina over the first calendar quarter of 2012. The Company began initial production with ten diamond growing machines in July 2012. Our initial production was focused on industrial cutting tool products supplied to a single customer. Since March 2013, the Company has expanded its product focus to include gemstone diamond material.

 

On September 16, 2013, the Company entered into the Grace Rich Agreements to form a joint venture with operations in the People’s Republic of China to deploy at least 100 Scio designed diamond growing machines. Under the Grace Rich Agreements, the Company has agreed to license its proprietary technology for the manufacture of diamond gemstones of agreed upon specifications. In exchange for the license, the Company will receive licensing and development revenue and a 30% ownership position in the joint venture. In addition to the licensed technology, the Grace Rich Agreements include obligations for the Company to provide and be compensated for technology consulting services to the joint venture to support the start-up of operations. The Company is not required to make any on-going funding contributions to the joint venture and its ownership stake cannot be reduced from 30%.

 

On December 16, 2014, the Company entered into the Grower Sale-Lease Agreement with HGI. Pursuant to the Grower Sale-Lease Agreement, the Company agreed to a sale-leaseback arrangement for certain diamond growers produced by the Company during the term of the Grower Sale-Leaseback Agreement by which the Company will sell diamond growers to HGI and then lease the growers back from HGI. The direct profit margin generated from the growers will be split between the Company and HGI in accordance with the Grower Sale-Lease Agreement. The Grower Sale-Lease Agreement requires the Company to operate and service the growers, and requires HGI to up-fit certain existing growers and to make capital improvements to the new growers under certain circumstances. The Company will also have the right to repurchase the leased growers upon the occurrence of certain events.

 

On December 18, 2014 entered into an arrangement with Renaissance creating RCDC. The Company and Renaissance are each 50% members of RCDC. The arrangement was entered into in order to facilitate the development of procedures and recipes for, and to market and sell, lab-grown fancy-colored diamonds. RCDC will purchase rough diamond material from the Company and process and finish the material into finished gemstones for sale to various retailers and other participants in the market for gemstones. Profits generated by RCDC's operations will be distributed between the Company and Renaissance according to the terms of the LLC Agreement.

 

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.

 

  

While the Company’s product offering continue to include industrial products, as of June 30, 2015 substantially all of the Company’s production capacity is being sold as gemstone materials. As of June 30, 2015, we had generated $3,198,457 in net revenue since inception from sales of our diamond materials and licensing of our technology.

 

RESULTS OF OPERATIONS

 

Three Month Period Ended June 30, 2015 Compared to the Three Month Period Ended June 30, 2014

 

During the three months ended June 30, 2015, we recorded product revenue of $172,175 compared to $79,338 during the three months ended June 30, 2014. This $92,837 increase was due to increased product sales and per unit prices. The Company received $375,000 in development fees from the Grace Rich joint venture during the three months ended June 30, 2014 that were not received during the three months ended June 30, 2015 resulting in a decrease in total revenue for the comparable periods. Total revenue for the three months ended June 30, 2015 was $172,175, compared to $454,338 in net revenue during the three months ended June 20, 2014.

 

Cost of goods sold was $415,367 for the three months ended June 30, 2015 versus $374,423 for the three months ended June 30, 2014. Cost of goods sold includes direct and indirect labor costs of $106,293 during the three months ended June 30, 2015 and $96,905 during the three months ended June 30, 2014. Depreciation expense of $140,668 and $150,316 was recorded in cost of goods sold during the three months ended June 30, 2015 and 2014, respectively. The overall increase in cost of goods sold was due increases in product sales during the three months ended June 30, 2015 versus the three months ended June 30, 2014.

 

Gross margin (deficit) was $(243,192) for the three months ended June 30, 2015 versus $79,915 for the three months ended June 30, 2014. The gross margin for the three months ended June 30, 2014 included $375,000 of development fees that were received not received during the comparable three months ended June 30, 2015. Adjusting for these development fees, results in a gross deficit for the three months ended June 30, 2105 of $(243,192) versus $(295,085) for the three months ended June 20, 2014.

 

Salary and benefit expenses recognized as general and administrative expenses were $202,302 and $396,868 for the three months ended December 31, 2014 and 2013, respectively. This decrease of $194,566 is primarily the result of the Company recognizing $275,000 in executive severance during the three months ended June 30, 2014, offset by $64,501 in stock based compensation for employees during the three months ended June 30, 2015.

 

Professional and consulting fees were $51,943 compared to $260,235 for the three months ended June 30, 2015 and 2014, respectively. This decrease is primarily due to reduced legal expense due to the settlement of litigation in June 2014.

 

The other components of our general and administrative expenses were relatively consistent between the three months ended June 30, 2015 and 2014. Rent, equipment lease and facilities expenses were $39,013 and $34,147, respectively; marketing costs were $28,183 and $10,688, respectively; corporate general and administrative expenses were $85,547 and $124,153, respectively and depreciation and amortization expenses were $198,405 and $200,124, respectively.

 

We have continued to generate limited revenue to offset our expenses, and so we have incurred net losses. Our net loss for three month period ended June 30, 2015 was $877,095, compared to a net loss of $1,008,227 during the three months ended June 30, 2014. Our net loss per share for the three month period ended June 30, 2015 was $(0.02) per share, compared to a net loss per share of $(0.02) for the three months ended June 30, 2014. The weighted average number of shares outstanding was 56,534,466 and 50,697,993, respectively, for the three month periods ended June 30, 2015 and 2014.

 

FINANCIAL CONDITION

 

At June 30, 2015, we had total assets of $11,593,859, compared to total assets of $12,231,394 at March 31, 2015. We had cash of $176,790 at June 30, 2015 compared to cash of $767,214 at March 31, 2015.

 

  

Total liabilities at June 30, 2015 were $4,268,093, compared to total liabilities of $4,098,772 at March 31, 2015. Total liabilities at June 30, 2015 were comprised primarily of accounts payable, accrued expenses, customer deposits deferred revenue and notes payables. The increase in total liabilities is primarily due to our increased accounts payable. Accounts payable increased $191,262 largely due to expenses related to construction in progress.

 

The Company had negative working capital (defined as current assets less current liabilities) of $(660,168) at June 30, 2015 versus $86,254 at March 31, 2015. This decrease in working capital resulted from the Company’s increase in accounts payable and deferred revenue and the decrease in cash during the three months ended June 30, 2015.

 

Total shareholders’ equity was $7,325,766 at June 30, 2015, compared to $8,132,622 at March 31, 2015. Shareholders’ equity decreased $806,856 during the period due to our operating net loss and was offset by additional paid in capital from common stock issued as incentive compensation.

 

CASH FLOWS

 

Operating Activities

 

We have not generated positive cash flows from operating activities. For the three months ended June 30, 2015, net cash flows used in operating activities were $(576,246) compared to $(94,073) for three months ended June 30, 2014. The net cash flow used in operating activities for the three months ended June 30, 2015 consists primarily of a net loss of $(877,095) offset by depreciation and amortization of $339,072, employee stock based compensation of $64,501, income from joint venture of $(16,339), decrease in accounts receivable of $28,421, increases in accounts payable of $44,447, decrease in accrued expenses of $(137,314), net increases in other current assets of $(11,762), and a net decrease in other current liabilities of $(10,177).

 

Investing Activities

 

For the three month periods ended June 30, 2015 and 2014, net cash flows used in investing activities were $(258,731), and $(13,152), respectively. These amounts consist of the purchase of property, plant and equipment. The increase in cash used during the three months ended June 30, 2016 is due to the Company’s capacity expansion program.

 

Financing Activities

 

We have financed our operations primarily through the issuance of equity and debt securities. For the three month periods ended June 30, 2015 and June 30, 2014, we generated $5,738 and $61,284, respectively, from financing activities

 

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.

 

As of March 31, 2015, our cash balance was $767,214 and as of June 30, 2015 our cash balance was reduced to $176,790. This reduction was due to our operating cash needs and purchases of equipment. Our cash at June 30, 2015 is not expected to be adequate to fund our operations over the fiscal year ending March 31, 2016. As of June 30, 2015, we had no additional lines of credit or other bank financing arrangements other than as described in Item 1, Note 3. Generally, we have financed operations through June 30, 2015 through the proceeds of sales of our common stock and borrowings under our existing credit facilities. The Company is pursuing additional issuances of equity capital or debt to meet operating cash 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 and could result in the shutdown of operations.

 

MATERIAL COMMITMENTS AND ARRANGEMENTS

 

On December 16, 2014, the Company entered into an agreement for the sale and lease of growers with HGI. Pursuant to the Grower Sale-Lease Agreement, the Company agreed to a sale-leaseback arrangement for certain diamond growers produced by the Company during the term of the Grower Sale-Leaseback Agreement by which the Company will sell diamond growers to HGI and then lease the growers back from HGI. The direct profit margin generated from the growers will be split between the Company and HGI in accordance with the Grower Sale-Lease Agreement. The Grower Sale-Lease Agreement requires the Company to operate and service the growers, and requires HGI to up-fit certain existing growers and to make capital improvements to the new growers under certain circumstances. The Company will also have the right to repurchase the leased growers upon the occurrence of certain events.

 

On December 18, 2014 entered into an arrangement with Renaissance creating RCDD. The Company and Renaissance are each 50% members of RCDC. The arrangement was entered into in order to facilitate the development of procedures and recipes for, and to market and sell, lab-grown fancy-colored diamonds. RCDC will purchase rough Diamond material from the Company and process and finish the material into finished gemstones for sale to various retailers and other participants in the market for gemstones. Profits generated by RCDC's operations will be distributed between the Company and Renaissance according to the terms of the LLC Agreement.

 

OFF-BALANCE SHEET ARRANGEMENTS

 

As of the date of this Quarterly 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.

 

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 filed with our Form 10-K for the fiscal year ended March 31, 2015.

 

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 judgmental estimates and complex accounting principles, which represent our critical accounting policies.

 

Revenue Recognition

 

We recognize product revenue when persuasive evidence of an arrangement exists, delivery of products has occurred, the sales price is fixed or determinable, and collectability is reasonably assured. For our Company, this generally means that we recognize revenue when we or our fabrication vendor has shipped finished product to the customer. Our sales terms do not allow for a right of return except for matters related to any manufacturing defects on our part.

 

  

For product sales to our joint venture partners for further processing and finishing, we currently defer all revenues when products are shipped. We currently recognize revenue at the earlier of when the joint venture partner sells the finished goods manufactured from our materials or we are paid for our goods. Licensing and development revenues are recognized in the month as detailed in appropriate licensing and development contracts. In the event that licensing funds are received prior to the contractual commitment, The Company will recognize deferred revenue (liability) for the amount received.

 

Inventories

 

Inventories are stated at the lower of average cost or market. The carrying value of inventory is reviewed and adjusted based upon slow moving and obsolete items. Inventory costs include material, labor, and manufacturing overhead and are determined by the “first-in, first-out” (FIFO) method. The components of inventories include raw materials and supplies, work in process and finished good.

 

The Company has periodically experienced selling prices that were lower than cost and as a result has recorded a lower of cost or market write down to the value of our inventory. The estimation of the total write-down to inventory involves management judgments and assumptions, including assumptions regarding future selling price forecasts, the estimated costs to complete and disposal costs.

 

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 to 15
Furniture and fixtures		3 to 10
Engineering equipment		5 to 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.

 

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 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.

 

A substantial portion of the Company’s patent portfolio is considered in service due to the inherent value of the patents to our on-going manufacturing operations. Through June 30, 2015, the Company has allocated $8,135,063 to patents that are being amortized over a period ranging from 6.75 years to 19.46 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. 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.

 

ITEM 3.

QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

 

Not applicable.

 

ITEM 4.

CONTROLS AND PROCEDURES

 

Disclosure Controls and Procedures

 

Disclosure controls and procedures refer to controls and other procedures designed to ensure that information required to be disclosed by the Company in the reports that it files or submits under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the SEC rules and forms, and that such information is accumulated and communicated to the Company’s management, including its Chief Executive Officer and Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosure. As of June 30, 2015, we carried an evaluation, under the supervision and with the participation of our management, including our Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of our disclosure controls and procedures as defined in Exchange Act Rule 13a-15. We applied our judgment in the process of reviewing these controls and procedures, which, by their nature, can provide only reasonable assurance regarding our control objectives. Based upon that evaluation, our Chief Executive Officer and Chief Financial Officer have concluded that our disclosure controls and procedures were not effective as of June 30, 2015 due to the significant deficiency discussed below.

 

Remediation of Significant Deficiency in Internal Controls over Financial Reporting

 

In connection with the evaluation described above, management identified the following significant deficiency in our internal control over financial reporting, which is common in small companies. This deficiency identified by our Chief Executive Officer and Chief Financial Officer as of June 30, 2015 is:

 

·

Due to our small size, we have limited segregation of duties in certain areas of our financial reporting and other accounting processes and procedures.

 

A material weakness (within the meaning of PCAOB Auditing Standard No. 5) is a deficiency, or a combination of deficiencies, in internal control over financial reporting, such that there is a reasonable possibility that a material misstatement of our annual or interim financial statements will not be prevented or detected on a timely basis. A significant deficiency is a deficiency, or a combination of deficiencies, in internal control over financial reporting that is less severe than a material weakness, yet important enough to merit attention by those responsible for oversight of our financial reporting.

 

During the period covered by this quarterly report on Form 10-Q, we have not been able to remediate the significant deficiency identified above. In addition, we plan to take additional steps during our fiscal year ending March 31, 2016:

 

·

Management is working with our outsourced accounting vendor to provide enhanced separation of duties amongst the personnel participating in our accounting function.

 

Changes in Internal Controls

 

Other than described above in connection with our ongoing remediation efforts, there were no changes in our internal control over financial reporting (as defined in Rule 13a-15(f) under the Exchange Act) that occurred during our quarter ended June 30, 2015, that materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

 

 

PART II - OTHER INFORMATION

 

ITEM 1.

LEGAL PROCEEDINGS

 

We are subject, from time to time, to various claims, lawsuits or actions that arise in the ordinary course of business. As of June 30, 2015 there were no material outstanding claims by the Company or against the Company.

 

In May 2014, the Company received a subpoena issued by the SEC ordering the provision of documents and related information concerning various corporate transactions between the Company and its predecessors and other persons and entities.  The Company is fully cooperating with this ongoing inquiry.

 

ITEM 1A.

RISK FACTORS

 

Not applicable (the Company is a smaller reporting company).

 

ITEM 2.

UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS

 

None.

 

ITEM 3.

DEFAULTS UPON SENIOR SECURITIES

 

Not applicable.

 

ITEM 4.

MINE SAFETY DISCLOSURES

 

Not applicable.

 

ITEM 5.

OTHER INFORMATION

 

None.

 

 

ITEM 6.

EXHIBITS

 

The following exhibits are filed as part of this Report:

 

31.1

Rule 13a-14(a) Certification of the Chief Executive Officer.*

 

31.2

Rule 13a-14(a) Certification of the Chief Financial Officer.*

 

32

Section 1350 Certifications of the Chief Executive Officer and Chief Financial Officer.*

 

101

The following materials from the Quarterly Report on Form 10-Q for the quarter ended June 30, 2015, formatted in eXtensible Business Reporting Language (XBRL); (i) Balance Sheets; (ii) Statements of Operations; (iii) Statements of Shareholders’ Equity; (iv) Statements of Cash Flow; and (v) Notes to the Unaudited Financial Statements*

 

 

*

Filed herewith.

 

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.

 

	SCIO DIAMOND TECHNOLOGY CORPORATION.
Dated:  August 14, 2015	/s/ Gerald McGuire
	By: Gerald McGuire
	Its:  Chief Executive Officer
Dated:  August 14, 2015	/s/ Jonathan Pfohl
	By: Jonathan Pfohl
	Its:  Chief Financial Officer