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 original business plan of the Company was focused on offsetting carbon dioxide (C02) emissions through the creation and protection of forest-based carbon “sinks.” The Company has since abandoned its original business plan and restructured its business to focus on man-made diamond technology development and commercialization.

On July 13, 2011, the Board of Directors of the Company resolved to authorize a 2-for-1 forward split of its issued and outstanding common shares, whereby every one (1) old share of common stock was to be exchanged for two new shares of the Company’s common stock, effective on August 5, 2011. As a result, the issued and outstanding shares of common stock increased from 3,200,000 prior to the forward split to 6,400,000 following the forward split.  The forward split shares are payable upon surrender of certificates to the Company’s transfer agent.  The accompanying financial statements and notes give retroactive effect to the forward split for all periods presented.

Prior to October 1, 2012, the Company was a development stage company.  Developmental activities have ceased and planned principal operations have commenced.

Going Concern

The Company has generated very little revenue to date and consequently its operations are subject to all risks inherent in the establishment of a new business enterprise.  For the period from inception, September 17, 2009, through December 31, 2012, the Company has accumulated losses of $6,910,972.

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:

·                  Focused efforts on the construction and start-up of its state-of-the-art manufacturing facility in South Carolina in order to begin production and generate revenues.

·                  Ongoing solicitation of investment in the Company in the form of a private placement of common shares (and warrants to acquire common shares) to accredited investors.

·                  Responded to potential customer contacts in order to meet potential orders immediately upon production start-up.

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 March 31, 2012 and December 31, 2012 and the results of operations and cash flows for the three and nine month interim periods ended December 31, 2012 and 2011.  All 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 the year.  The balance sheet at March 31, 2012 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, 2012.

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 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:

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:

Leasehold improvements are depreciated over the lesser of the remaining term of the lease or the life of the asset (generally three to five 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.  Manufacturing equipment was placed into service beginning July 1, 2012.

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.  The components of inventories are as follows:

Intangible Assets

Intangible assets, such as 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 as of December 31, 2012.  For the quarter ended December 31, 2012 intangible assets in the amount of $6,395,923 were assigned to specific patents and considered placed in service due to their inherent nature in the Company’s manufacturing process.  These patents are being amortized over a period ranging from 6.75 years to 15.67 years.

Fair Value Measurement

Fair value is defined as the price that would be received to sell an asset or paid to transfer a liability (an exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date. The fair value hierarchy prescribed by the accounting literature contains three levels as follows:

Level 1— Quoted prices in active markets for identical assets or liabilities.

Level 2— Observable inputs other than Level 1 prices such as quoted prices for similar assets or liabilities; quoted prices in markets that are not active; or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the assets or liabilities.

Level 3— Unobservable inputs that are supported by little or no market activity and that are significant to the fair value of the assets or liabilities. Level 3 assets and liabilities include financial instruments whose value is determined using pricing models, discounted cash flow methodologies, or similar techniques, as well as instruments for which the determination of fair value requires significant management judgment or estimation.

In addition, GAAP requires the Company to disclose the fair value for financial assets on both a recurring and non-recurring basis.  On August 31, 2011, the Company issued to certain current and former stockholders of Apollo Diamond Inc. (“ADI”) that were at that time accredited investors subscription rights valued at $11,040,000 for the purchase of ADI assets disclosed in Note 2 measured at fair value on a nonrecurring basis.  The fair value of the ADI subscription rights was determined based on an appraisal which used the Black-Scholes model whose assumptions were considered by management to be a Level 3 input. During June 2012, the Company issued to certain current and former stockholders of Apollo Diamond Gemstone Corporation (“ADGC”) that are accredited investors subscription rights valued at $790,000 for the purchase of ADGC assets disclosed in Note 2 measured at fair value on a nonrecurring basis.  The fair value of the ADGC subscription rights was determined using the Black-Scholes model whose assumptions were considered by management to be a Level 3 input.

As of December 31, 2012, the Company had 445,014 warrants outstanding with exercise prices of $0.70 per share. The warrants expire in 2016 and 2017.  The warrants were issued by the Company as compensation for consulting work and placement agent services, and in exchange for cash discounts on facility rent, and are valued at $0.52 per warrant using the Black-Scholes model.

The carrying value of cash and cash equivalents including restricted cash, accounts receivable, other assets and trade accounts payable approximates fair value due to the short-term nature of these instruments.

Revenue Recognition

We recognize 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.

Recent Accounting Pronouncements

In September 2011, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) 2011-08, Guidance on Testing Goodwill for Impairment.  ASU 2011-08 gives entities testing goodwill for impairment the option of performing a qualitative assessment before calculating the fair value of a reporting unit in Step 1 of the goodwill impairment test.  If entities determine, on the basis of qualitative factors, that the fair value of a reporting unit is more likely than not less than the carrying amount, the two-step impairment test would be required.  Otherwise, further testing would not be needed.  ASU 2011-08 is effective for fiscal and interim reporting periods within those years beginning after December 15, 2011.  The adoption of this accounting standard did not have a material effect on the Company’s condensed unaudited financial statements.

In July 2012 the FASB issued ASU No. 2012-02, Testing Indefinite-Lived Intangible Assets for Impairment (the revised standard).  The revised standard is intended to reduce the cost and complexity of testing indefinite-lived intangible assets other than goodwill for impairment.  It allows companies to perform a “qualitative” assessment to determine whether further impairment testing of indefinite-lived intangible assets is necessary, similar in approach to the goodwill impairment test.  The revised standard is effective for annual and interim impairment tests performed for fiscal years beginning after September 15, 2012. Early adoption is permitted.  The Company will adopt this new standard in 2013 and the Company does not anticipate that its adoption will have a significant impact on its financial statements.

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

NOTE 2 — ASSET PURCHASES

The Company purchased certain assets from ADI on August 31, 2011, consisting primarily of diamond growing machines and certain intellectual property related thereto.  The purchase price consisted of an aggregate of $2,000,000 in a combination of cash and a promissory note bearing interest at 4.00% annually, plus the subscription rights for certain current and former stockholders of ADI that are accredited investors to acquire approximately 16 million shares of common stock of the Company for $0.01 per share (the “ADI Offering”).  The Company has estimated the fair value of these ADI subscription rights to acquire shares of common stock of the Company for $0.01 per share to be $0.69 per right.  At the date of the transaction, the fair value of the subscription rights was $11,040,000, and this amount was credited to additional paid-in capital. The fair value of the ADI subscription rights was determined using the Black-Scholes model with the following assumptions: estimated volatility of 100%, risk free interest rate of 0.1%, and an expected life of 1 year.  The promissory note from this asset purchase was settled in full in December 2012.

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

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

On June 5, 2012, the Company acquired certain of the assets of ADGC (the “ADGC Asset Purchase”), consisting primarily of cultured diamond gemstone-related know-how, inventory, and various intellectual property, in exchange for $100,000 in cash and the right for certain current and former stockholders of ADGC that were at the time accredited investors to acquire up to approximately 1 million shares of common stock of the Company for $0.01 per share (the “ADGC Offering”) with the intent that the ADI Offering be conducted substantially concurrently with the ADGC Offering (collectively, the “ADI/ADGC Stockholder Offering”).  The Company paid the $100,000 cash portion of the ADGC Asset Purchase during the month of December 2012.  The ADI/ADGC Stockholder Offering began in June and was substantially completed as of December 31, 2012.  The Company has estimated the fair value of such subscription rights to be $0.79 per right.  At the date of the transaction, the aggregate fair value of such subscription rights was $790,000, and this amount was credited to additional paid-in capital. The fair value of such rights to acquire shares of common stock of the Company was determined using the Black-Scholes model with the following assumptions: estimated volatility of 100%, risk free interest rate of 0.1%, and an expected life of 3 months.

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

The Company is in the process of obtaining appraisals of the assets acquired and expects to adjust the purchase price allocation no later than March 31, 2013, as necessary.

During the three months ended December 31, 2012, the Company issued 1,336,708 shares of common stock pursuant to the ADI/ADGC Stockholder Offering and on that date the Company had issued 14,337,473 shares under the ADI and ADGC subscription rights.  On December 31, 2012 a maximum of 2,662,527 shares remained available to be issued as part of the ADI/ADGC Stockholder Offering.  The Company is in the process of matching ADI and ADGC records with subscription documents submitted by former ADI and ADGC shareholders and expects to be completed by March 31, 2013.  As of February 11, 2013 a total of 15,576,973 shares had been issued under these rights.

NOTE 3 — INTANGIBLE ASSETS

During the three months ended December 31, 2012, the Company evaluated its patent portfolio and allocated $6,359,924 of acquired in-process research and development to specific patents that are being used by the Company for its manufacturing operations. These patents were considered in service by the Company during the quarter and the values assigned are being amortized on a straight-line basis over the remaining effective lives of the patents.

Intangible assets consist of the following:

Total amortization expense during the three and nine months ended December 31, 2012 was $156,106.  There was no amortization expense for the three months ended December 31, 2011.

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

NOTE 4 — NOTES PAYABLE

In conjunction with the purchase of certain assets from ADI on August 31, 2011, the Company entered into a promissory note bearing interest at 4.00% annually.  The promissory note was paid in full during the month of December 2012.

NOTE 5 — CAPITAL STOCK

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

In December 2009, the Company issued 2,000,000 shares of common stock, at a price of $0.002 per share, for total cash proceeds of $4,000.

In January through March 2010, the Company issued 4,400,000 shares of common stock, post 2-for-1 forward split, at a price of $0.005 per share for total cash proceeds of $22,000.

During the three months ended September 30, 2011, the Company issued 18,717,570 shares of common stock.  On August 5, 2011, 3,200,000 shares were issued in a 2-for-1 forward split from Krossbow Holding Corp. shareholders.  As part of a private placement, 2,517,570 shares were issued at a price of $0.70 per share for total cash proceeds, net of fees, of $1,679,064.  13,000,000 shares were issued at a market value price of $0.02 per share to purchase the name “Scio Diamond Technology Corporation” (the “Scio name”) for a total purchase price of $260,000.  The Company purchased the Scio name from a privately-held Nevada corporation named Scio Diamond Technology Corporation (“Private Scio”).  The Company and Private Scio are entities under common control.  ASC 805-50-30-5 states that when accounting for a transfer of assets between entities under common control, the entity that receives the asset shall initially measure the recognized asset at the carrying amount in the accounts of the transferring entity at the date of the transfer.  As the Scio name acquired had no carrying value, the value of the shares given to purchase the Scio name were recorded as a deemed distribution so that the accounting basis of the Scio name remained at zero.  In addition, the Company issued 17 million subscription rights with an exercise price of $0.01 per share to certain current and former stockholders of ADI and ADGC as part of the ADI and ADGC asset purchases discussed in Note 2.

During the three months ended December 31, 2011, the Company issued 3,908,000 shares at a price of $0.70 per share for total cash proceeds, net of fees, of $2,672,059.  In January 2012, the Company issued 1,875,500 shares of common stock at a price of $0.70 for total net cash proceeds of $94,499.

During the three months ending June 30, 2012, Company issued 2,538,750 units, each consisting of one share of common stock and one warrant for the purchase of a share of common stock at a strike price of $1.60 at a unit price of $0.80 for total net cash proceeds of $1,998,920.

During the three months ending September 30, 2012, Company issued 2,040,000 units, each consisting of one share of common stock and one warrant for the purchase of a share of common stock at a strike price of $1.60 at a unit price of $0.80 for total net cash proceeds of $1,624,257.

During the three months ended September 30, 2012, the Company issued 13,000,765 shares under the ADI and ADGC subscription rights.

During the three months ending December 31, 2012, Company issued 312,500 units, each consisting of one share of common stock and one warrant for the purchase of a share of common stock at a strike price of $1.60 at a unit price of $0.80 for total net cash proceeds of $250,000.

During the three months ended December 31, 2012, the Company issued 1,336,708 shares of common stock pursuant to the ADI/ADGC Stockholder Offering.

The Company had 45,241,793 shares of common stock issued and outstanding as of December 31, 2012 of which 1,000,000 were held in treasury.

As of December 31, 2012, the Company had 445,014 warrants outstanding with exercise prices of $.70 per share.  The warrants expire in 2016 and 2017.  The warrants were issued by the Company as compensation for consulting work and placement agent services, and in exchange for cash discounts on facility rent are valued at $.52 per warrant using the Black-Scholes model.

The assumptions used and the calculated fair value of the warrants issued is as follows:

NOTE 6 — SHARE-BASED COMPENSATION

On November 30, 2012, the Company’s former Chief Executive Officer and former Chief Financial Officer resigned from the Company.  Pursuant to agreements entered into in connection with their respective resignations, an aggregate of 2,725,000 unvested and an aggregate of 1,400,000 vested stock options, for a total of 4,125,000 stock options, previously granted to these officers were forfeited.  The financial impact of these forfeitures is a reduction of stock based compensation of $221,719 during the three months ended December 31, 2012. In addition, the Chief Executive Officer surrendered 1,000,000 share of common stock with $0.001 par value to the Company, which are held in treasury.

On December 5, 2012, the Company granted to Stephen D. Kelley, its then newly-appointed Chief Executive Officer options to purchase a total of 3,200,000 shares of the Company’s stock at $1.01 per share, which was equal to the closing price on the date of the grant.  Of the 3,200,000 stock options, 600,000 stock options vested immediately upon employment and 2,600,000 stock options were to vest upon the achievement of specific management objectives including employment tenure, cumulative cash flow and cumulative revenue.  As of the date of grant, management of the Company anticipated that the average term of the options granted to Mr. Kelley would be five years, and the Company reserved a pool of shares to be issued upon exercise of such options.  Using the Black-Scholes option pricing model, management determined that the options issued on December 5, 2012 had a value of $0.75 per option on the date of the grant, and total compensation costs of $512,500 were recognized for certain of these options as of December 31, 2012.  Compensation expense for the remaining options would have been immediately recognized when management determined that the relevant objectives had become reasonably probable to occur.  As discussed below in Note 8, Mr. Kelley resigned from the Company effective January 24, 2013.  No options granted to Mr. Kelley had been exercised as of his date of resignation, and accordingly pursuant to his stock option award agreement, all his stock options were forfeited on that date.  The Company anticipates that $62,500 of the stock option expense recognized in the three months ending December 2012 will be reversed in the fiscal quarter ending March 31, 2013.

On December 14, 2012, the Company granted the four then existing members of its Board of Directors options to purchase a total of 250,000 shares of the Company’s stock as compensation for serving on the Board during 2012.  These options were fully vested on the date granted.  The grant price of $1.02 was equal to the closing price on the date of grant.  Using the Black-Scholes option pricing model, management has determined the options issued on December 14, 2012 had a value of $0.63 per option on the date of the grant.  Total compensation costs of $157,500 have been recognized for these options as of December 31, 2012.

For the three and nine months ended December 31, 2012 and 2011, the Company recognized $457,230 and $1,724,979 and $0 and $0, respectively, as compensation cost for options issued, and recorded related deferred tax asset of $0 for all periods.

The assumptions used and the calculated fair value of the December 5, 2012 options are as follows:

The assumptions used and the calculated fair value of the December 14, 2012 options are as follows:

At December 31, 2012, unrecognized compensation cost related to non-vested awards was $2,095,326.  Of this amount $1,887,500 was related to options granted to Stephen D. Kelley, our former Chief Executive Officer.

The following is an analysis of options to purchase shares of the Company’s stock issued and outstanding:

The intrinsic value of options outstanding and of options exercisable at December 31, 2012 was $543,275 and $317,255, respectively.

NOTE 7 — RELATED PARTIES

The Company incurred expenses of $30,410 and $86,433 for professional and consulting services provided by AdamsMonahan, LLP, a firm in which our board members, Edward S. Adams and Michael R. Monahan, are partners, for the three and nine months ended December 31, 2012, respectively.  For the three and nine months ended December 31, 2011, the Company did not incur expenses for professional and consulting services provided by AdamsMonahan, LLP.

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

The Company purchased certain assets from ADI on August 31, 2011, consisting primarily of diamond growing machines and intellectual property related thereto.  The purchase price consisted of an aggregate of $2,000,000 in a combination of cash and a promissory note bearing interest at 4.00% annually and due and owing in full on September 1, 2012, plus the right for certain current and former stockholders of ADI to acquire approximately 16 million shares of common stock of the Company for $0.01 per share.  These rights were valued at $11,040,000 in total using the Black-Scholes model.  Both Mr. Adams, in an executive role, and Mr. Monahan previously served in various capacities with ADI through early 2011.

On June 5, 2012, the Company acquired substantially all of the assets of ADGC, consisting primarily of cultured diamond gemstone-related know-how, inventory, and various intellectual property, in exchange for $100,000 in cash and the opportunity for certain current and former stockholders of ADGC that are accredited investors to acquire up to approximately 1 million shares of common stock of the Company for $0.01 per share.  These rights were valued at $790,000 in total using the Black-Scholes model.    Mr. Adams and Mr. Monahan served in various capacities with ADGC through early 2011.

The ADI Offering and the ADGC Offering began in June 2012 and has been substantially completed at December 31, 2012 except for ongoing efforts relating to matching of ADI and ADGC records and subscription documents submitted to the Company.

NOTE 8 — SUBSEQUENT EVENTS

Our former Chief Executive Officer, Stephen D. Kelley, resigned from his office effective January 24, 2013.  None of the 3,200,000 stock options previously granted to Mr. Kelley had been exercised as of his date of resignation and all of the stock options previously granted to Mr. Kelley were forfeited under the terms of his stock option award agreement.  The Company anticipates that $62,500 of the stock option expense recognized in the three months ending December 2012 will be reversed in the fiscal quarter ending March 31, 2013.

On January 31, 2013, the Company executed an employment letter with its existing Chief Operating Officer under which he agreed to serve as the Company’s Chief Executive Officer effective February 1, 2013.  In connection with his appointment, Mr. McMahon was granted 1,500,000 stock options, of which 271,250 vested on February 1, 2013 and the remainder are to vest upon the achievement of specific objectives including employment tenure, cumulative cash flow and cumulative revenue.

Going Concern

The Company has generated very little revenue to date and consequently its operations are subject to all risks inherent in the establishment of a new business enterprise.  For the period from inception, September 17, 2009, through December 31, 2012, the Company has accumulated losses of $6,910,972.

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:

·                  Focused efforts on the construction and start-up of its state-of-the-art manufacturing facility in South Carolina in order to begin production and generate revenues.

·                  Ongoing solicitation of investment in the Company in the form of a private placement of common shares (and warrants to acquire common shares) to accredited investors.

·                  Responded to potential customer contacts in order to meet potential orders immediately upon production start-up.

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 March 31, 2012 and December 31, 2012 and the results of operations and cash flows for the three and nine month interim periods ended December 31, 2012 and 2011.  All 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 the year.  The balance sheet at March 31, 2012 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, 2012.

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 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:

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:

Leasehold improvements are depreciated over the lesser of the remaining term of the lease or the life of the asset (generally three to five 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.  Manufacturing equipment was placed into service beginning July 1, 2012.

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.  The components of inventories are as follows:

Intangible Assets

Intangible assets, such as 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 as of December 31, 2012.  For the quarter ended December 31, 2012 intangible assets in the amount of $6,395,923 were assigned to specific patents and considered placed in service due to their inherent nature in the Company’s manufacturing process.  These patents are being amortized over a period ranging from 6.75 years to 15.67 years.

Fair Value Measurement

Fair value is defined as the price that would be received to sell an asset or paid to transfer a liability (an exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date. The fair value hierarchy prescribed by the accounting literature contains three levels as follows:

Level 1— Quoted prices in active markets for identical assets or liabilities.

Level 2— Observable inputs other than Level 1 prices such as quoted prices for similar assets or liabilities; quoted prices in markets that are not active; or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the assets or liabilities.

Level 3— Unobservable inputs that are supported by little or no market activity and that are significant to the fair value of the assets or liabilities. Level 3 assets and liabilities include financial instruments whose value is determined using pricing models, discounted cash flow methodologies, or similar techniques, as well as instruments for which the determination of fair value requires significant management judgment or estimation.

In addition, GAAP requires the Company to disclose the fair value for financial assets on both a recurring and non-recurring basis.  On August 31, 2011, the Company issued to certain current and former stockholders of Apollo Diamond Inc. (“ADI”) that were at that time accredited investors subscription rights valued at $11,040,000 for the purchase of ADI assets disclosed in Note 2 measured at fair value on a nonrecurring basis.  The fair value of the ADI subscription rights was determined based on an appraisal which used the Black-Scholes model whose assumptions were considered by management to be a Level 3 input. During June 2012, the Company issued to certain current and former stockholders of Apollo Diamond Gemstone Corporation (“ADGC”) that are accredited investors subscription rights valued at $790,000 for the purchase of ADGC assets disclosed in Note 2 measured at fair value on a nonrecurring basis.  The fair value of the ADGC subscription rights was determined using the Black-Scholes model whose assumptions were considered by management to be a Level 3 input.

As of December 31, 2012, the Company had 445,014 warrants outstanding with exercise prices of $0.70 per share. The warrants expire in 2016 and 2017.  The warrants were issued by the Company as compensation for consulting work and placement agent services, and in exchange for cash discounts on facility rent, and are valued at $0.52 per warrant using the Black-Scholes model.

The carrying value of cash and cash equivalents including restricted cash, accounts receivable, other assets and trade accounts payable approximates fair value due to the short-term nature of these instruments.

Revenue Recognition

We recognize 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.

Recent Accounting Pronouncements

In September 2011, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) 2011-08, Guidance on Testing Goodwill for Impairment.  ASU 2011-08 gives entities testing goodwill for impairment the option of performing a qualitative assessment before calculating the fair value of a reporting unit in Step 1 of the goodwill impairment test.  If entities determine, on the basis of qualitative factors, that the fair value of a reporting unit is more likely than not less than the carrying amount, the two-step impairment test would be required.  Otherwise, further testing would not be needed.  ASU 2011-08 is effective for fiscal and interim reporting periods within those years beginning after December 15, 2011.  The adoption of this accounting standard did not have a material effect on the Company’s condensed unaudited financial statements.

In July 2012 the FASB issued ASU No. 2012-02, Testing Indefinite-Lived Intangible Assets for Impairment (the revised standard).  The revised standard is intended to reduce the cost and complexity of testing indefinite-lived intangible assets other than goodwill for impairment.  It allows companies to perform a “qualitative” assessment to determine whether further impairment testing of indefinite-lived intangible assets is necessary, similar in approach to the goodwill impairment test.  The revised standard is effective for annual and interim impairment tests performed for fiscal years beginning after September 15, 2012. Early adoption is permitted.  The Company will adopt this new standard in 2013 and the Company does not anticipate that its adoption will have a significant impact on its financial statements.

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

The assumptions used and the calculated fair value of the December 5, 2012 options are as follows:

The assumptions used and the calculated fair value of the December 14, 2012 options are as follows: