UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

(Mark One)

For the quarterly period ended September 30, 20182019

or

For the transition period fromfrom___________ to_______________  to

Commission file number:0-31641

SCI ENGINEERED MATERIALS, INC.

(Exact name of registrant as specified in its charter)

2839 Charter Street, Columbus, Ohio 43228

(Address of principal executive offices) (Zip Code)

(614) 486-0261

(Registrant’s telephone number, including area code)

Not Applicable

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

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

Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted 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 such files). YesxNo¨

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

Large accelerated filer¨Accelerated filer¨   Non-accelerated filerxSmaller reporting companyx

Emerging growth company¨

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

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes¨Nox

4,239,3264,342,744 shares of Common Stock, without par value, were outstanding at October 30, 2018.November 1, 2019.

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

FORM 10-Q

SCI ENGINEERED MATERIALS, INC.

Table of Contents

PART I. FINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS

SCI ENGINEERED MATERIALS, INC.

BALANCE SHEETS

ASSETS

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

SCI ENGINEERED MATERIALS, INC.

BALANCE SHEETS

LIABILITIES AND SHAREHOLDERS' EQUITY

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

SCI ENGINEERED MATERIALS, INC.

STATEMENTS OF OPERATIONS

THREE MONTHS AND NINE MONTHS ENDED SEPTEMBER 30, 20182019 AND 20172018

(UNAUDITED)

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

SCI ENGINEERED MATERIALS, INC.

STATEMENTS OF CASH FLOWSSHAREHOLDERS' EQUITY

THREE AND NINE MONTHS ENDED SEPTEMBER 30, 20182019 AND 20172018

(UNAUDITED)

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

SCI ENGINEERED MATERIALS, INC.

STATEMENTS OF CASH FLOWS

NINE MONTHS ENDED SEPTEMBER 30, 2019 AND 2018

(UNAUDITED)

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

SCI ENGINEERED MATERIALS, INC

NOTES TO FINANCIAL STATEMENTS

Note 1.  Business Organization and Purpose

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

Note 2.  Summary of Significant Accounting Policies

Basis of Presentation - The accompanying unaudited financial statements have been prepared in accordance with U.S. generally accepted accounting principles for interim financial information and with instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by U.S. generally accepted accounting principles for complete financial statements. In the opinion of management, all adjustments considered necessary for fair presentation of the results of operations for the periods presented have been included. The financial statements should be read in conjunction with the audited financial statements and the notes thereto for the year ended December 31, 2017.2018. Interim results are not necessarily indicative of results for the full year.

Use of Estimates - The preparation of financial statements in conformity with U.S. generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.

Note 3.  Recent Accounting Pronouncements

Leases - In February 2016, the FASB issued ASU No. 2016-02, Leases (Topic 842), which modified. The new standard establishes a right-of-use (ROU) model that requires a lessee to record a ROU asset and a lease accountingliability on the balance sheet for both lessees and lessors to increase transparency and comparability by recognizing lease assets and lease liabilities by lessees for thoseall leases with terms longer than 12 months. Leases will be classified as either finance or operating, leases under previous accounting standards and disclosing key information about leasing arrangements. ASU 2016-02 will be effective forwith classification affecting the Company beginningpattern of expense recognition in its first quarter of 2019, and early adoption is permitted. The Company is currently evaluating the impact of adopting ASU 2016-02 on its financial statements.

income statement. In August 2015,July 2018, the FASB issued ASU No. 2015-14, “Revenue from Contracts with Customers (Topic 606) – Deferral of2018-10, Codification Improvements to Topic 842, Leases. The amendments in ASU 2018-10 clarify, correct or remove inconsistencies in the Effective Date,” which revises the effective date ofguidance provided under ASU No. 2014-09, “Revenue from Contracts with Customers (Topic 606),” (“ASU 2014-09”)2016-02 related to interim and annual periods beginning after December 15, 2017, with early adoption permitted no earlier than interim and annual periods beginning after December 15, 2016. In May 2014,sixteen specific issues identified. Also in July 2018, the FASB issued ASU 2014-09, which amends current revenue guidance.No. 2018-11, Targeted Improvements to Topic 842. This amendment provides the Company with an additional and optional transition method to adopt the new lease standard. Under this new transition method, the Company can apply the new lease standard at the adoption date and recognize a cumulative-effect adjustment to the opening balance of retained earnings in the period of adoption and present the accounting on a prospective or go-forward basis instead of applying to the earliest comparative period presented in the financial statements.  The new lease standard became effective for the Company January 1, 2019.

The Company elected to apply the new transition method upon adoption of the new standard.  The Company also elected the available practical expedients on adoption.  The new standard did not have a material impact on the Company’s income statements. The most significant impact of the new standard was the recognition of a ROU asset and lease liability of over $500,000 as of January 1, 2019.

SCI ENGINEERED MATERIALS, INC

NOTES TO FINANCIAL STATEMENTS

Note 3.  Recent Accounting Pronouncements (continued)

Revenue Recognition - The core principle of the guidanceASC 606 is that an entity should recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. The Company’s analysis of sales contracts under ASC 606 supports the recognition of revenue at a point in time, typically when title passes to the customer upon shipment, which is consistent with the previous revenue recognition model.

The core principle of ASC 606 is supported by five steps which are listed below:

The Company adopted this guidance as of January 1, 2018 utilizing the modified retrospective approach method as applied to customer contracts that were not completed as of January 1, 2018. As a result, financial information for reporting periods beginning on or after January 1, 2018 are presented in accordance with ASC 606, while comparative financial information has not been adjusted and continues to be reported in

SCI ENGINEERED MATERIALS, INC

NOTES TO FINANCIAL STATEMENTS

Note 3. Recent Accounting Pronouncements (continued)

accordance with the Company’s revenue recognition policies prior to the adoption of ASC 606. Implementation of the standard did not have a material impact on the Company’s financial statements as the Company’s method for recognizing revenue subsequent to the implementation of ASC 606 does not vary significantly from its revenue recognition practices under the prior revenue standard. Accordingly, there was no required cumulative adjustment to retained earnings as of January 1, 2018.

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

SCI ENGINEERED MATERIALS, INC

NOTES TO FINANCIAL STATEMENTS

Note 3.  Recent Accounting Pronouncements (continued)

The Company considers collectability of amounts due under a contract to be probable upon inception of a sale based on an evaluation of the credit worthiness of each customer. The Company sells its products typically under agreements with payment terms less than 45 days. The Company does not typically include extended payment terms or significant financing components in contracts with customers. The majority of the Company’s contracts have an obligation to transfer products within one year. Sales commissions are expensed when incurred and recorded within marketing and sales expenses. The Company treats shipping and handling activities that occur after control of the product transfers as fulfillment activities, and therefore, does not account for shipping and handling costs as a separate performance obligation. Customer deposits are funds received in advance from customers and are recognized as revenue when the Company has transferred control of product to the customer.

During the three months ended September 30, 20182019 and 2017,2018, revenue from the Photonicsphotonics market was approximately 71.5%100% and 94.8%71% of total revenue, respectively. During the nine months ended September 30, 20182019 and 2017,2018, revenue from the Photonicsphotonics market was approximately 80.1%97% and 95.8%80% of total revenue, respectively. The balance of the revenue in these periods was almost entirely from the Thin Film Solarthin film solar market. The top two customers represented approximately 62.6%79% and 82.3%63% of total revenue for the nine months ended September 30, 20182019 and 2017,2018, respectively. International shipments resulted in 19.6%10% and 6.5%20% of total revenue for the first nine months of 2019 and 2018, and 2017, respectively.

Note 4.  Common Stock and Stock Options

Stock based compensationBased Compensation cost for all stock awards is based on the grant date fair value and recognized over the required service (vesting) period. Non cash stock based compensation expense was $40,491$32,765 and $51,521$40,941 for the three months ended September 30, 20182019 and 2017,2018, respectively. Non cash stock based compensation expense was $83,960$98,301 and $149,052$83,960 for the nine months ended September 30, 20182019 and 2017,2018, respectively. Unrecognized compensation expense was $37,908$17,473 as of September 30, 20182019 and will be recognized through 2023. There was no tax benefit recorded for this compensation cost as the expense primarily relates to incentive stock options that do not qualify for a tax deduction until, and only if, a qualifying disposition occurs.

The non-employee Board members received compensation of 52,48735,725 and 66,60952,487 aggregate shares of common stock of the Company during the nine months ended September 30, 20182019 and 2017,2018, respectively. The stock had an aggregate value of $73,380$89,995 and $58,984$73,379 for the nine months ended September 30, 20182019 and 2017,2018, respectively, and was recorded as non-cash stock compensation expense in the financial statements.

The cumulative status of options granted and outstanding at September 30, 2018,2019, and December 31, 2017,2018, as well as options which became exercisable in connection with the Company’s stock option plans is summarized as follows:

SCI ENGINEERED MATERIALS, INC

NOTES TO FINANCIAL STATEMENTS

Note 4.  Common Stock and Stock Options (continued)

Employee Stock Options

During the nine months ended September 30, 2019, a total of 31,788 stock options were exercised. The Company’s new President, Mr. Jeremy Young, received a loan from the Company in the amount of $14,952 in February 2019 to enable him to exercise 17,800 stock options. Per a Promissory Note signed by Mr. Young this loan is to be repaid in two installments with the final installment due January 1, 2020. The first installment of $7,475 was repaid in February 2019 and the balance is recorded on the balance sheet as a Note Receivable as of September 30, 2019.

Exercise prices for options ranged from $0.84 to $6.00$1.25 at September 30, 2018.2019. The weighted average option price for all options outstanding at September 30, 2018,2019, was $4.24$1.03 with a weighted average remaining contractual life of 2.66.7 years. There were no non-employee director stock options outstanding during 2018 or 2017.2019 and 2018.

Note 5.  Preferred Stock

Dividends on the Series B preferred stock accrue at 10% annually on the outstanding shares. Dividends on the Series B preferred stock were $6,038 for the three months ended September 30, 20182019 and 20172018, and $18,114 for the nine months ended September 30, 20182019 and 2017.2018. The Company had accrued dividends on Series B preferred stock of $259,634 at September 30, 2018,2019, and $265,672 at December 31, 2017.2018. These amounts are included in Convertible preferred stock, Series B, on the balance sheet at September 30, 20182019, and December 31, 2017. In July2018. During the first nine months of 2019 and 2018, a cash dividend in the amountpayment of $24,152 was paidmade to Series B preferred shareholders of record as of June 30, 2018.record.

SCI ENGINEERED MATERIALS, INC

NOTES TO FINANCIAL STATEMENTS

Note 6.  Inventories

Note 7.  Earnings Per Share

Basic income per share is calculated as income applicable to common shareholders divided by the weighted average of common shares outstanding. Diluted earnings per share is calculated as diluted income applicable to common shareholders divided by the diluted weighted average number of common shares. Diluted weighted average number of common shares gives effect to all dilutive potential common shares outstanding during the period using the treasury stock method and convertible preferred stock using the if-converted method. Diluted earnings per share exclude all diluted potential shares if their effect is anti-dilutive. For the three and nine months ended September 30, 2018 and 2017, allAll convertible preferred stock and common stock options listed in Note 4 that were out-of-the-money or anti-dilutive were excluded from diluted earnings per share.

SCI ENGINEERED MATERIALS, INC

NOTES TO FINANCIAL STATEMENTS

Note 7. Earnings Per Share (continued)

The following is provided to reconcile the earnings per share calculations:

Note 8.  NotesNote Payable

During 2010,October of 2019, the Company applied and was approvedrenewed its line of credit with Huntington Bank for a 166 Direct Loan to borrow up to $744,250$1 million. The line of credit bears interest at 0.5 percentage points over the Prime Commercial Rate with the Ohio Departmentan expiration date of Development (ODOD), now known as the Ohio Development Services Agency (ODSA). This loan was finalized in February 2011. The term of the loan is 84 months at a fixed interest rate of 3%. There is also a 0.25% annual servicing fee charged monthlyOctober 5, 2020. At September 30, 2019, no amounts were drawn on the outstanding principal balance. Asline of September 30, 2018 there was an outstanding balance of $81,889 on this loan. A payment of approximately $10,400, including principal, interest and servicing fee was paid in October 2018. The Company expects to make the final payment of approximately $71,900 in November 2018. This loan is subject to certain covenants, including job creation and retention. On July 21, 2014, the Company and ODSA signed a second amendment relating to the job creation and retention. The Company was in compliance with all covenants at September 30, 2018. During 2010, the Company also applied and was approved for a 166 Direct Loan through the Advanced Energy Program with the Ohio Air Quality Development Authority (OAQDA) to borrow up to approximately $1.4 million. This maximum commitment by the OAQDA was subsequently reduced to $368,906 on March 20, 2012. A final payment of approximately $50,400 was made as scheduled during February 2018 and this loan was repaid in full.credit.

SCI ENGINEERED MATERIALS, INC

NOTES TO FINANCIAL STATEMENTS

Note 9.  Income Taxes

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

Deferred tax assets and liabilities result from temporary differences in the recognition of income and expense for tax and financial reporting purposes. A full valuation allowance has been recorded against the realizabilityrealization of the net deferred tax assets at September 30, 20182019 and December 31, 2017.2018.  The Company has net operating loss carryforwards available for federal and state tax purposes of approximately $4,900,000$3,800,000 which expire in varying amounts through 2037.2038.

Note 10. Operating Lease

The Company entered into an operating lease with a third party on March 18, 2014 for its headquarters in Columbus, Ohio. The terms of the lease include monthly payments ranging from $8,700 to $9,700 with a maturity date of November 30, 2024. The Company has the option to extend the lease period for an additional five years beyond the original expiration date. There are no restrictions or covenants associated with the lease. The lease costs were approximately $78,400 during the nine months ended September 30, 2019.

The following is a maturity analysis, by year, of the annual undiscounted cash outflows of the operating lease liabilities as of September 30, 2019:

SCI ENGINEERED MATERIALS, INC

NOTES TO FINANCIAL STATEMENTS

Note 11. Finance Leases

The Company leases certain equipment under finance leases. Future minimum lease payments, by year, with the present value of such payments, as of September 30, 2019, are shown in the following table.

The equipment under finance lease at September 30, 2019, and December 31, 2018, is included in the accompanying balance sheets as follows:

These assets are amortized over a period of ten years using the straight-line method and amortization is included in depreciation expense.

The finance leases are structured such that ownership of the leased asset reverts to the Company at the end of the lease term. Accordingly, leased assets are depreciated using the Company's normal depreciation methods and lives.  Ownership of certain assets were transferred to the Company in accordance with the terms of the leases and these assets have been excluded from the leased asset disclosure above.

The Company entered into a finance lease obligation during September 2019 for the purchase of new production and testing equipment in the amount of $78,950.

Item 2.   Management's Discussion and Analysis of Financial Condition and Results of Operations

The following discussion should be read in conjunction with the Financial Statements and Notes contained herein and with those in our Form 10-K for the year ended December 31, 2017.2018.

Except for the historical information contained herein, the matters discussed in this Quarterly Report on Form 10-Q include certain forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended, which are intended to be covered by the safe harbors created thereby. Those statements include, but may not be limited to, all statements regarding our intent, belief, and expectations, such as statements concerning our future profitability and operating and growth strategy. Words such as “believe,” “anticipate,” “expect,” “will,” “may,” “should,” “intend,” “plan,” “estimate,” “predict,” “potential,” “continue,” “likely” and similar expressions are intended to identify forward-looking statements. Investors are cautioned that all forward-looking statements contained in this Quarterly Report on Form 10-Q and in other statements we make involve risks and uncertainties including, without limitation, the factors set forth under the caption “Risk Factors” included in our Annual Report on Form 10-K for the year ended December 31, 2017,2018, and other factors detailed from time to time in our other filings with the Securities and Exchange Commission. One or more of these factors have affected, and in the future could affect our business and financial condition and could cause actual results to differ materially from plans and projections. Although we believe the assumptions underlying the forward-looking statements contained herein are reasonable, there can be no assurance that any of the forward-looking statements included in this Quarterly Report on Form 10-Q will prove to be accurate. In light of the significant uncertainties inherent in the forward-looking statements included herein, the inclusion of such information should not be regarded as a representation by us or any other person that our objectives and plans will be achieved.

Any forward-looking statement speaks only as of the date on which such statement is made, and we undertake no obligation to update any forward-looking statement or statements to reflect events or circumstances after the date on which such statements are made or reflect the occurrence of unanticipated events, unless necessary to prevent such statements from becoming misleading. New factors emerge from time to time and it is not possible for us to predict all factors, nor can it assess the impact of each such factor on the business or the extent to which any factor, or combination of factors, may cause actual results to differ materially from those contained in any forward-looking statements.

Overview

SCI Engineered Materials, Inc. (“SCI”, “we” or the “Company”), formerly Superconductive Components, Inc., an Ohio corporation, was incorporated in 1987.  We operate in one segment as a global supplier and manufacturer of advanced materials for Physical Vapor Deposition (“PVD”) Thin Film Applications.  We are focused on specific markets within the PVD industry (Photonics, Thin Film Solar, Glass and Transparent Electronics).  Substantially all of our revenues are generated from customers with multi-national operations.  Sales to Photonics customers fluctuate from time to time and currently represent a substantial amount of our revenue. We have made considerable resource investments in the Thin Film Solar marketapplications and several new customers have recently adopted our products.  ThroughThe Company develops innovative customized solutions enabling commercial success through collaboration with end users and Original Equipment Manufacturers we develop innovative customized solutions enabling commercial success.Manufacturers.

Item 2.   Management'sManagement’s Discussion and Analysis of Financial Condition and Results of Operations (continued)

Executive Summary

For the three months ended September 30, 2018,2019, we had total revenue of $2,652,635.$3,255,201. This was an increase of $674,621,$602,566, or 34.1%22.7%, compared to the three months ended September 30, 2017.2018. For the nine months ended September 30, 2018,2019, we had total revenue of $7,043,244.$10,012,187. This was an increase of $1,781,816,$2,968,943, or 33.9%42.2%, compared to the nine months ended September 30, 2017,2018. Volume and also exceeded the total revenue of $6,801,365 for all of 2017. Volume waspricing were higher in our photonics market during 2019. We expect revenue for the full year 2019 to exceed full year 2018. We anticipate revenue to be lower in the fourth quarter of 2019 compared to recent quarters as a result of product mix and continued uncertainties concerning the thin film solar market as well as in our photonics market. Orders for thin film solar products accelerated throughout the first nine months of 2018 resulting in increased quarter end backlog. We are encouraged by developments in the global thin film solar market, led by manufacturing installations coming on line and announcements of new projects. We are actively working to extend our presence in this growing market and expect this increased volume in our thin film solar market to continue through at least the first half of next year.China.

Gross profit was $665,884,$458,520 for the three months ended September 30, 20182019 compared to $370,919$665,884 for the same three months in 2017. This was an increase of $294,965, or 79.5%. Gross profit as a percentage of revenue was 25.1% for the third quarter of 2018 compared to 18.8% for the same period in 2017. Gross profit wasand $1,849,491 and $1,917,425 for the nine months ended September 30, 2019 and 2018, compared to $1,170,751 for the same period in 2017. This was an increase of $746,674, or 63.8%. Gross profit as a percentage of revenue was 27.2% for the first nine months of 2018 compared to 22.3% for the same period in 2017.respectively.

Operating expenses were $519,187,$391,649 and $386,410$519,187 for the three months ended September 30, 2019 and 2018, respectively and 2017, respectively. This was an increase of $132,777, or 34.4%. Operating expenses were$1,442,519 and $1,353,025 and $1,134,217 for the nine months ended September 30, 2019 and 2018, respectively. The transition costs related to our new President and 2017, respectively. This was an increase of $218,808, or 19.3%.

For the three months ended September 30, 2018, we had net income of $144,126, comparedCEO working closely with our former President and CEO led to net loss of $25,353 for the three months ended September 30, 2017. For the nine months ended September 30, 2018, we had net income of $542,373, compared to $3,520 for the nine months ended September 30, 2017. The impact of recently enacted tariffs imposed by the U.S. Government is currently having an immaterial impact on our gross profit and net income.

We expect revenue in the fourth quarter of 2018 to be higher compared to the third quarter of 2018. If our expectations come to fruition, second half revenue in 2018 would exceed first half revenue by 40% or more. We expect gross profit and net income in the fourth quarter of 2018 to be higher than the third quarter of 2018 and contribute to record net income for the full-year 2018. Backlog has continued to increase since June 30, 2018 and includes a few new substantial orders involving relatively low margin business expected to ship in the fourth quarter of 2018.

Customer deposits increased nearly 700% to $3,259,836 at September 30, 2018 from $407,956 at December 31, 2017, due to orders received from our thin film solar market and photonics market customersexpenses during 2018. Customer deposits represent cash received in advance of revenue earned. These orders are expected to ship during the remainder of 2018 and the first half of 2019. Our former President and CEO retired in June of 2019 and these expenses are expected to continue to be lower for the remainder of this year.

We have new materials under development that may replace the Cadmium Sulfide buffer layer in CIGS solar cells. These materials were tested at Case Western Reserve University during the second half of 2017 and the results support the use of our innovative material in thin film solar applications that could lead to higher efficiencies. We are working with customers through product trials and qualifications to accelerate their application to market.adoption of these materials. We continue to invest in developing new products for all of our markets including transparent conductive oxide systems for the thin film solar and display markets as well as with our transparent electronic products. These efforts include accelerating time to market for thoseThose products and involve research and development expense.expense to accelerate time to market.

SCI’s patent titled “Display having a transparent conductive oxide layer comprising metal doped zinc oxide applied by sputtering” (US patent No. 9,927,667)A bonding facility and on-site training was issued on March 27, 2018. The transparent conductive oxides (TCOs) we developed in this patent have excellent electro-optical performance, high transmittance, high conductivity and good chemical resistance. This patent has various applications that include LCDs, micro LED, OLED, smart windows & mirrors, AR/VR goggles, e-papers, and wearable electronics. Our clients, in relevant applications, are entitled to use the patent number when referring to the devices covered by the patent and benefit from it. We believe the TCOs claimed and protectedcompleted in the patent have widesecond quarter of 2019 pursuant to a joint agreement with publicly owned Konfoong Materials International Co., LTD (KFMI). KFMI will bond rotatable thin film solar Aluminum Zinc Oxide cylinders produced in Columbus, Ohio for thin film solar customers in China. This arrangement is intended to enable us to provide an advantage to thin film solar customers in China and innovative applications which can put SCIto also enhance our access to this growing market. We will continue to produce the ceramic portion of the end product in a unique positionour facility in the market as well as bring us additional business opportunities.Columbus. We will continue to exercise control over our trade secrets and proprietary property through assiduous scrutiny of our Intellectual Property. Our products for photonics and thin film solar customers in areas other than China will continue to be bonded at our manufacturing facility in Columbus.

Item 2.   Management'sManagement’s Discussion and Analysis of Financial Condition and Results of Operations (continued)

RESULTS OF OPERATIONS

Three and nine months ended September 30, 20182019 (unaudited) compared to three and nine months ended September 30, 20172018 (unaudited):

Revenue

For the three months ended September 30, 2018,2019, we had total revenue of $2,652,635.$3,255,201. This was an increase of $674,621,$602,566, or 34.1%22.7%, compared to the three months ended September 30, 2017.2018. For the nine months ended September 30, 2018,2019, we had total revenue of $7,043,244$10,012,187 compared to $5,261,428$7,043,244 for the same period in 2017.2018. This was an increase of $1,781,816$2,968,943 or 33.9%42.2%, compared to the nine months ended September 30, 2017.2018. Volume and pricing were higher in our photonics market and volume was higherlower in our thin film solar market and photonics market. We expect revenue in the fourth quarter of 2018 to be higher compared to the third quarter of 2018. If our expectations come to fruition, second half revenue in 2018 would exceed first half revenue by 40% or more.

Revenue from sales are recognized when the Company meets its performance obligations. Revenue from product sales is recognized based on shipping terms or upon shipment to customers. Provisions for discounts and rework costs for returns are established when products are shipped based on historical experience. Customer deposits represent cash received in advance of revenue earned.during 2019.

Gross Profit

Gross profit was $665,884$458,520 for the three months ended September 30, 20182019 compared to $370,919$665,884 for the same three months in 2017.2018. This was an increasea decrease of $294,965,$207,364, or 79.5%31.1%. Gross profit as a percentage of revenue (gross margin) was 25.1%14.1% for the third quarter of 20182019 compared to 18.8%25.1% for the same period in 2017.2018. Gross profit was $1,917,425$1,849,491 for the nine months ended September 30, 20182019 compared to $1,170,751$1,917,425 for the first nine months of 2017.2018. This was an increasea decrease of $746,674$67,934 or 63.8%3.5%. Gross margin was 27.2%18.5% for the first nine months of 20182019 compared to 22.3%27.2% for the same period in 2017.2018. The increasedecrease in gross profit andwas primarily due to product mix including lower volume in our thin film solar market previously mentioned. A certain raw material related to the increased volume in our photonics market had an increase in pricing which contributed to a lower gross margin was attributed to increased revenue as well as improved product mix.which impacted overall gross margin.

General and Administrative Expense

General and administrative expense for the three months ended September 30, 2019 and 2018, was $247,984 and 2017 were $310,464, and $244,062, respectively, an increasea decrease of 27.2%20.1%. This increasedecrease was primarily related to higherlower compensation of approximately $74,000. The third quarter of 2017 included lower compensation$67,000, principally due to cost cutting measures which were instituted latethe retirement in 2016. The third quarterJune of 2018 included lower non-cash stock compensation expense by approximately $12,000 compared to the third quarter2019 of 2017.our former President and CEO.

General and administrative expense for the nine months ended September 30, 2019 and 2018, was $957,420 and 2017 were $840,171, and $754,612, respectively, an increase of 11.3%14.0%. This increase was primarily related to higher compensation of approximately $152,000.$15,000, higher director compensation of $37,000, higher professional fees of $30,000 and start-up training costs at KFMI in China of approximately $11,000. The transition of our new President and CEO working closely with our former President and CEO led to increased expenses during the first nine monthshalf of 2017 included2019. Our former CEO retired in June of 2019 and these expenses are expected to continue to be lower compensation due to cost cutting measures previously mentioned. The first nine monthsfor the remainder of 2018 included lower non-cash stock compensation expense by approximately $67,000 compared to the same time period in 2017.this year.

Professional Fees

Included in general and administrativetotal expense was $35,022,$39,799 and $42,118$35,022 for professional fees for the three months ended September 30, 20182019 and 2017,2018, respectively and $130,657,$160,252 and $139,350$130,657 for professional fees for the nine months ended September 30, 20182019 and 2017,2018, respectively. These continuedongoing expenses were primarily related to SEC compliance costs for legal, accounting and stockholder relations fees.fees as well as costs associated with the transition of our new President and CEO.

Item 2.   Management'sManagement’s Discussion and Analysis of Financial Condition and Results of Operations (continued)

Research and Development Expense

Research and development expense for the three months ended September 30, 20182019, was $98,514$80,203 compared to $90,927$98,514 for the same period in 2017, an increase2018, a decrease of 8.3%18.6%. This increase wasThe decrease is primarily related to increased compensation and benefits in addition to ongoing research.less compensation. Research and development expense for the nine months ended September 30, 20182019, was $252,049$283,672 compared to $252,714$252,049 for the same period in 2017. We2018, an increase of 12.5%. This increase was principally due to ongoing research as we continue to invest in developing new productsapplications for all of our markets including an innovative buffer layer for Thin Filmthin film solar cells, transparent conductive oxide systems for applications in transparent electronics and thin film solar applications.solar. These efforts include accelerating time to market for those productsapplications and involve ongoing research and development expense.

Marketing and Sales Expense

Marketing and sales expense was $110,209$63,462 and $51,421$110,209 for the three months ended September 30, 20182019 and 2017,2018, respectively. This was an increasea decrease of $58,788$46,747 or 114.3%42.4%. This increasedecrease was primarily related to higher wageslower compensation and benefits of approximately $32,000, sales rep commissions of approximately $13,000 and travel costs of approximately $11,000.$43,000.

Marketing and sales expense was $260,805$201,427 and $126,891$260,805 for the nine months ended September 30, 20182019 and 2017,2018, respectively. This was an increasea decrease of $133,914$59,378 or 105.5%22.8%. This increasedecrease was primarily related to higher wages and benefitslower compensation of approximately $91,000, sales rep commissions$42,000 due to the allocation of approximately $25,000,salary expenses for our new President and travel expenses of approximately $17,000.

These higherCEO who previously was also engaged in marketing and sales expensesactivities. In addition, commissions were directly relatedlower by approximately $16,000 compared to implementation of our growth strategy.the same time period in 2018.

Stock Compensation Expense

Included in total expenses were non-cash stock based compensation costs of $40,941$32,765 and $51,521$40,941 for the three months ended September 30, 20182019 and 2017,2018, respectively, and $83,960$98,301 and $149,052$83,960 for the nine months ended September 30, 20182019 and 2017,2018, respectively. This decrease is a result of stock options becoming fully vested in 2018.increase was primarily related to higher director compensation. Compensation costexpense for all stock-based awards is based on the grant date fair value and recognized over the required service (vesting) period. Unrecognized non-cash stock based compensation expense related to operating expense was $37,908$17,473 as of September 30, 20182019 and will be recognized through 2023.

Interest

Interest expense was $4,539 for the three months ended September 30, 2019 and $18,020 for the nine months ended September 30, 2019. Interest income was $2,015 for the three months ended September 30, 2018 compared to interest expense of $9,862 for the three months ended September 30, 2017.2018. Interest expense was $10,949 and $32,066 for the nine months ended September 30, 2018 and 2017, respectively. The improvement2018. Interest expense during 2019 was higher due to lower principal balances on our debt and increased earned income on higher cash balances. Interestthe new operating lease standard that became effective January 1, 2019 which reclasses a portion of rent expense is expected to continue to decrease as we anticipate paying the entire remaining balance of $81,889 on our note payable during the fourth quarter of 2018.interest expense.

Income/LossIncome Applicable to Common SharesStock

Income applicable to common sharesstock for the three months ended September 30, 2019 and 2018, was $56,294 and $138,088, compared to a loss of $31,391 for the three months ended September 30, 2017.respectively. Income applicable to common sharesstock for the nine months ended September 30, 2019 and 2018 was $365,978 and $524,259, compared to a lossrespectively.

Liquidity and Capital Resources

Cash

As of $14,594 for the nine months ended September 30, 2017.2019, cash on hand was $1,694,890. Cash on-hand was $1,802,839 at December 31, 2018. The improvementlower cash balance was due to higher revenuepurchases of inventory as well as an in-plant office structured mezzanine and gross profit.production equipment.

Common Stock

The following schedule represents our outstanding common stock during the period of 2018 through 2028 assuming all outstanding stock options are exercised during the year of expiration. Based on outstanding shares at September 30, 2018, if each shareholder exercises his or her options, it would increase our common shares by 417,166 to 4,656,492 by December 31, 2028. Assuming all such options are exercised in the year of expiration, the effect on shares outstanding is illustrated as follows: