Ikonics 10-Q 2011
U.S. SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
For the Quarterly Period Ended June 30, 2011
For the Transition Period From to .
Commission file number 000-25727
(Exact name of registrant as specified in its charter)
Issuers telephone number
(Former name, former address and former fiscal year, if changed since last report)
Check whether the issuer (1) filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act 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 þ No o
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.) Yes þ No o
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes o No þ
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.
State the number of shares outstanding of each of the issuers classes of common equity, as of the latest practical date: Common Stock, $.10 par value 1,983,587 shares outstanding as of August 10, 2011.
QUARTERLY REPORT ON FORM 10-Q
PART I FINANCIAL INFORMATION
ITEM 1. Condensed Financial Statements
CONDENSED BALANCE SHEETS
See notes to condensed financial statements
CONDENSED STATEMENTS OF OPERATIONS (Unaudited)
See notes to condensed financial statements.
CONDENSED STATEMENTS OF CASH FLOWS (Unaudited)
See notes to condensed financial statements.
NOTES TO CONDENSED FINANCIAL STATEMENTS
NOTES TO CONDENSED FINANCIAL STATEMENTS
NOTES TO CONDENSED FINANCIAL STATEMENTS
NOTES TO CONDENSED FINANCIAL STATEMENTS
NOTES TO CONDENSED FINANCIAL STATEMENTS
NOTES TO CONDENSED FINANCIAL STATEMENTS
The information presented below in Managements Discussion and Analysis of Financial Condition and Results of Operations contains forward-looking statements within the meaning of the safe harbor provisions of Section 21E of the Securities Exchange Act of 1934, as amended. Such statements are subject to risks and uncertainties, including those discussed under Factors that May Affect Future Results below, that could cause actual results to differ materially from those projected. Because actual results may differ, readers are cautioned not to place undue reliance on these forward-looking statements. Certain forward-looking statements are indicated by italics or by words such as anticipate, believe, continue, could, estimate, expect, intend, may, plan, potential, predict, project, should, will, would, or the negative of these terms or other comparable terminology.
The following managements discussion and analysis focuses on those factors that had a material effect on the Companys financial results of operations during the second quarter of 2011, the first six months of 2011 and for the same periods of 2010. It should be read in connection with the Companys condensed unaudited financial statements and notes thereto included in this Form 10-Q. The discussion and analysis below with respect to IKONICS Imaging sales excludes Micromaching and DTX sales for all applicable periods during 2010. See Note 6 to the Companys condensed unaudited financial statements included in this Form 10-Q for more information regarding the change to the Companys reported segments beginning in 2011.
Factors that May Affect Future Results
Critical Accounting Estimates
The Company prepares its financial statements in conformity with accounting principles generally accepted in the United States of America. Therefore, the Company is required to make certain estimates, judgments and assumptions that the Company believes are reasonable based upon the information available. These estimates and assumptions 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 periods presented. The accounting estimates, which IKONICS believes are the most critical to aid in fully understanding and evaluating its reported financial results, include the following:
Trade Receivable. The Company performs ongoing credit evaluations of its customers and adjusts credit limits based upon payment history and the customers current credit worthiness, as determined by review of the current credit information. The Company continuously monitors collections and payments from its customers and maintains a provision for estimated credit losses based upon historical experience and any specific customer collection issues that have been identified. While such credit losses have historically been within expectations and the provisions established, the Company cannot guarantee that it will continue to experience the same collection history that has occurred in the past. The general payment terms are net 30-45 days for domestic customers and net 30-90 days for foreign customers. A small percentage of the trade receivable balance is denominated in a foreign currency with no concentration in any given country. At the end of each reporting period, the Company analyzes
the receivable balance for customers paying in a foreign currency. These balances are adjusted to each quarter or year spot rate in accordance with guidance related to foreign currency matters.
Inventories. Inventories are valued at the lower of cost or market value using the last in, first out (LIFO) method. The Company monitors its inventory for obsolescence and records reductions in cost when required.
Income Taxes. At June 30, 2011, the Company had net current deferred tax assets of $157,000 and net noncurrent deferred tax liabilities of $171,000. The deferred tax assets and liabilities result primarily from temporary differences in property and equipment, accrued expenses, and inventory reserves. In connection with the recording of a $919,000 impairment charge in 2009 related to an investment in a non-marketable equity security, the Company has recorded a deferred tax asset and corresponding full valuation allowance in the amount of $323,000 as of June 30, 2011 and December 31, 2010 as it is more likely that this asset will not be realized. The deferred tax asset related to the capital loss can be carried forward five years and must be offset by a capital gain. The Company has determined that is more likely than not that the remaining deferred tax assets will be realized and that an additional valuation allowance for such assets is not currently required. The Company accounts for its uncertain tax positions under the provision of FASB ASC 740, Income Taxes. At June 30, 2011 the Company had no reserves for uncertain tax positions.
Revenue Recognition. The Company recognizes revenue on sales of products when title passes which can occur at the time of shipment or when the goods arrive at the customer location depending on the agreement with the customer. The Company sells its products to both distributors and end-users. Sales to distributors and end-users are recorded based upon the criteria governed by the sales, delivery, and payment terms stated on the invoices from the Company to the purchaser. In addition to transfer of title / risk of loss, all revenue is recorded in accordance with the criteria outlined within the provisions regarding revenue recognition including:
Sales are reported on a net basis by deducting credits, estimated normal returns and discounts. The Companys return policy does not vary by geography. The Company is not under a warranty obligation and the customer has no rotation or price protection rights. Freight billed to customers is included in sales. Shipping costs are included in cost of goods sold.
Results of Operations
Quarter Ended June 30, 2011 Compared to Quarter Ended June 30, 2010
Sales. The Company realized an 8.0% sales increase during the second quarter of 2011 with sales of $4.6 million, compared to $4.2 million in sales during the same period in 2010. Export sales for the second quarter of 2011 were up 9.5% versus the second quarter of 2010 due to strong sales in Latin America and Asia. Second
quarter results in 2011 also benefitted from increased Micromachining and DTX sales, which grew from $146,000 in the second quarter of 2010 to $293,000 in the same period in 2011. IKONICS Imaging sales increased 5.6% during the second quarter of 2011 compared to the second quarter of 2010 due to increased film and equipment sales while Domestic shipments were flat for the quarter.
Gross Profit. Gross profit was $1.9 million, or 40.4% of sales, in the second quarter of 2011 compared to $1.8 million, or 43.1% of sales, for the same period in 2010. Domestic gross profit percentage, which decreased from 49.6% during the second quarter of 2010 to 43.5% in the second quarter of 2011, and Export gross profit percentage, which also decreased from 31.8% in the second quarter of 2010 to 26.4% in the second quarter of 2011, were both negatively impacted by a decrease in higher margin film sales. Raw material price increases have also unfavorably affected 2011 second quarter margins. Gross margins were favorably impacted by the increase in the higher margin sales related to Micromachining and DTX.
Selling, General and Administrative Expenses. Selling, general and administrative expenses were $1.3 million, or 27.6% of sales, in the second quarter of 2011, and $1.1 million, or 26.4% of sales, for the same period in 2010. The increase in selling, general and administrative expenses reflects higher personnel, promotion and consulting costs related to supporting the Companys Micromachining and DTX initiatives. Part of the higher personnel expenses are related to resources that were previously assigned to research and development, but have been reassigned to focus exclusively on Micromachining and DTX.
Research and Development Expenses. Research and development expenses during the second quarter of 2011 were $137,000, or 3.0% of sales, versus $204,000, or 4.8% of sales, for the same period in 2010. The decrease is due to lower staffing levels due to the reassignment of certain personnel to the Companys Micromachining and DTX initiatives. Additionally, legal and patent related expenses were lower in the second quarter of 2011 along with research related production trials.
Interest Income. The Company earned $4,800 of interest income in the second quarter of 2011 compared to $3,900 of interest income in the second quarter of 2010. The interest earned in second quarter of 2011 and 2010 is related to interest received from the Companys short-term investments, which consisted of fully insured certificates of deposit with maturities ranging from six to twelve months.
Income Taxes. For the second quarter of 2011, the Company realized income tax expense of $144,000, or an effective rate of 31.8%, versus $163,000, or an effective rate of 32.2% for the second quarter of 2010. The income tax provision differs from the expected tax expense primarily due to the benefits of the domestic manufacturing deduction, and federal and state credits for research and development.
Six Months Ended June 30, 2011 Compared to the Six Months Ended June 30, 2010
Sales. The Companys sales increased 3.9% during the first six months of 2011 to $8.2 million versus sales of $7.9 million during the first six months of 2010. Strong sales in Asia and Latin America drove a 6.8% Export sales increase for the first six months of 2011 compared to the same period in 2010. DTX and Micromachining sales also grew 88.6% from $280,000 in the first half of 2010 to $528,000 in the same period of 2011. IKONICS Imaging sales increased 2.6% during the first six months of 2011 compared to the first six months of 2010 due to increased film and equipment sales. Partially offsetting these sales increases was a 5.0% Domestic sales decrease. Domestic sales in 2010 benefitted from a large private label film sale which did not occur in 2011.
Gross Profit. Gross profit for the first six months of 2011 was $3.3 million, or 40.3% of sales, compared to $3.3 million, or 41.8% of sales, for the same period in 2010. Export and Domestic gross profit percentage decreased by 5.0% and 4.6%, respectively, during the first half of 2011 compared to the same period in 2010. The decrease in higher margin film sales along with raw material price increases have unfavorably affected the gross profit percentage for Export and Domestic. Higher margin DTX and Mircomachining sales partially offset the Export and Domestic gross margin decreases.
Selling, General and Administrative Expenses. Selling, general and administrative expenses were $2.6 million, or 31.7% of sales, in the first half of 2011 compared to $2.3 million, or 29.3% of sales, for the same period in 2010. The increase in selling, general and administrative expenses reflects higher personnel, promotion and consulting costs related to supporting the Companys Micromachining and DTX initiatives. Part of the higher personnel expenses are related to resources that were previously assigned to research and development, but have been reassigned to focus exclusively on Micromachining and DTX.
Research and Development Expenses. Research and development expenses during the first half of 2011 were $237,000, or 2.9% of sales, versus $365,000, or 4.6% of sales, for the same period in 2010. The decrease is due to lower staffing levels due to the reassignment of certain personnel to the Companys Micromachining and DTX initiatives. Additionally, legal and patent related expenses were lower in 2011 along with research related production trials.
Interest Income. The Company earned $9,300 of interest income during the first half of 2011 compared to $7,400 of interest income for the same period in 2010. The interest earned in first six months of 2011 and 2010 is related to interest received from the Companys short-term investments, which consisted of fully insured certificates of deposit with maturities ranging from six to twelve months.
Income Taxes. During the first six months of 2011, the Company realized an income tax expense of $135,000, or an effective rate of 27.9%, compared to income tax expense of $141,000, or an effective rate of 22.3%, for the same period in 2010. The income tax provision for 2011 and 2010 differs from the expected tax expense due to the benefits of the domestic manufacturing deduction, and federal and state credits for research and development. Additionally, the effective tax rate for the first six months of 2010 was impacted by derecognizing a liability for unrecognized tax benefits relating to a tax year where the statute of limitations expired during the first six months. A $27,000 liability was derecognized in the first half of 2010. During the first half of 2010, the Company also recorded an out-of-period tax benefit adjustment of $15,000 relating to December 31, 2009 estimates for tax credits as well as the receipt of interest of approximately $13,000 related to Minnesota state income tax returns. The Company expects that for the remainder of 2011, the Company will record the provision for income taxes at an effective tax rate of 35% to 36%.
Liquidity and Capital Resources
The Company has financed its operations principally with funds generated from operations. These funds have been sufficient to cover the Companys normal operating expenditures, annual capital requirements, and research and development expenditures.
Cash on hand was $1,103,000 and $1,068,000 at June 30, 2011 and 2010, respectively. The Company used $84,000 in cash from operating activities during the six months ended June 30, 2011, compared to generating $662,000 of cash from operating activities during the same period in 2010. Cash used in or provided by operating activities is primarily the result of net income adjusted for non-cash depreciation, amortization, and certain changes in working capital components discussed in the following paragraph.
During the first six months of 2011, trade receivables increased by $343,000. The increase in receivables was driven by higher sales volumes especially in Export where customers typically have longer payment terms. The Company believes that the quality of its receivables is high and that strong internal controls are in place to maintain proper collections. Inventories increased by $380,000 due to increased raw material purchases. The higher raw material purchases were due to the timing of a large restocking order, an increase in order quantities to take advantage of volume discounts and new raw materials necessary to support the manufacture and sale of the Companys new products. Prepaid expenses and other assets increased $38,000 reflecting prepaid insurance premiums. Accounts payable increased $21,000 due to of the timing of payments to and purchases from vendors. Accrued expenses decreased $71,000, reflecting the timing of compensation payments while the impact from income taxes payable increased cash by $4,000.
During the first half of 2011, investing activities used $170,000. The Companys purchases of equipment for the quarter were $115,000, mainly for equipment purchases and hardware upgrades to the Companys computer
network. Also during the first quarter of 2011, the Company incurred $42,000 in patent application costs that the Company records as an asset and amortizes upon successful completion of the application process. The Company invested $1,828,000 in fully insured certificates of deposits with nine certificates of deposit totaling $1,814,000 maturing during the first six months of 2011.
During the first half of 2010, investing activities used $933,000. The Company invested $1,207,000 in fully insured certificates of deposits with two $200,000 certificates of deposit maturing during the first six months of 2010. Purchases of property and equipment were $122,000, mainly for three vehicles and equipment purchases. The Company received $19,000 from vehicle sales. Also during the first six months of 2010, the Company incurred $23,000 in patent application costs that the Company records as an asset and amortizes upon successful completion of the application process.
During the first six months of 2011, the Company received $66,000 from financing activities as the Company received $68,000 from the issuance of 10,500 shares of common stock from the exercise of stock options. The Company used $2,100 in financing activities during the first half of 2011 to repurchase 270 shares of its own stock. During the first six months of 2010, the Company received $34,000 from financing activities from the issuance of 7,750 shares of common stock upon the exercise of stock options.
A bank line of credit exists providing for borrowings of up to $1,250,000. The line of credit term runs from October 31, 2010 to October 30, 2011. The Company expects to obtain a similar line of credit when the current line of credit expires. The line of credit is collateralized by trade receivables and inventories and bears interest at 2.5 percentage points over the 30-day LIBOR rate. The Company did not utilize this line of credit during the first six months of 2011 or 2010, and there were no borrowings outstanding as of June 30, 2011 and 2010. There are no financial covenants related to the line of credit.
The Company believes that current financial resources, its line of credit, cash generated from operations and the Companys capacity for debt and/or equity financing will be sufficient to fund current and anticipated business operations. The Company also believes that its low debt levels and available line of credit make it unlikely that a decrease in demand for the Companys products would impair the Companys ability to fund operations.
Through the first six months of 2011, the Company had $115,000 in capital expenditures. Capital expenditures during the first six months were mainly for equipment and computer network upgrades. The Company expects capital expenditures in 2011 of approximately $650,000. Plans for capital expenditures include two mandatory elevator upgrades, manufacturing equipment upgrades to improve quality and increase production and a vehicle. These commitments are expected to be funded with cash on hand and cash generated from operating activities.
The Company markets its products to numerous countries in North America, Europe, Latin America, Asia and other parts of the world. Foreign sales were approximately 34% of total sales during the first six months of 2011 compared to 33% of sales during the same period in 2010. Higher volumes in Asia and Latin American positively impacted 2011 first half sales volumes. Fluctuations of certain foreign currencies have not significantly impacted the Companys operations because the Companys foreign sales are not concentrated in any one region of the world and the majority of international sales are conducted in U.S. dollars. The Company believes its vulnerability to uncertainties due to foreign currency fluctuations and general economic conditions in foreign countries is not significant.
The Companys foreign transactions are primarily negotiated, invoiced and paid in U.S. dollars, while a portion is transacted in Euros. IKONICS has not implemented an economic hedging strategy to reduce the risk of foreign currency translation exposures, which management does not believe to be significant based on the scope and geographic diversity of the Companys foreign operations as of June 30, 2011. Furthermore, the impact of foreign exchange on the Companys balance sheet and operating results was not material in either 2011 or 2010.
IKONICS has spent on average over 4% of its sales dollars for the past few years in research and development; in the first half of 2011 this dropped to 3%. The 2011 first half reduction is due to the Company moving to commercialize its new technologies (Micro Machining and Industrial Inkjet Solutions). Two chemists who were intimately involved in the development of these technologies have been made their Product Managers. This reassignment puts the Companys technical people, with their broad product knowledge, directly in contact with industrial customers, who demand technical sales and support. In connection with the reassignment of these two chemists, the Company began including their compensation in selling, general and administrative expenses. As new research projects are identified, the Company anticipates that its Research and Development staff will grow to meet these needs and spending will return to historic levels.
The new technologies of Micromachining and Industrial Inkjet (DTX) grew rapidly during the first half of 2011 and represented a small but increasing portion of the Companys sales. For the first half of 2011 their combined sales were 88% percent above the first six months of 2010, and the Company anticipates further strong growth. Micromachinings aviation sound deadening technology has shown growth with several new customers interested in adopting the Companys technology, and the Company believes there are new opportunities for the machining of composite materials for the aerospace industry. The Companys machining of electronic wafers is also showing increased profitability. The Company believes Micromachining offers a unique value proposition, which the industry is just beginning to recognize.
DTX is a proprietary system for putting textures into steel molds for the plastic injection mold making; the primary end customer is automotive. The Company sells inkjet fluid and custom made substrates for use by printers supplied by the Company and its strategic partners, Colour Scanner Technology GMBH and the Trans Tech division of Illinois Tool Works Inc. IKONICS was awarded a European patent on its DTX technology in 2010 and has a patent pending in North America and Japan. The first DTX printer was sold in 2010 to a domestic customer, and it is generating consumable sales. Several potential customers, world-wide, have evidenced interest in this technology, and the Company anticipates sales once its strategic partners have printers available. The Companys strategic partners have been reluctant to manufacture these specialized printers until market demand became evident; the Company believes that this is now evident and printers are in production.
In 2010, the Company developed and applied for a patent on its I-HE photo resist film for the etching of electronic wafers and developed I-XE low silicone photo resist film for the aerospace industry. Both films have been well received and have begun to generate profitable sales which the Company believes will continue in the second half of 2011.
Domestically, the Company has combined its Chromaline Screen Print Product and its IKONICS Imaging units under one leadership. These have been profitable mature markets and require aggressive strategies to grow market share. Although there will be challenges, the Company believes these businesses will continue to grow and prosper.
In addition to its traditional emphasis on domestic markets, the Company will continue efforts to grow its business internationally by attempting to develop new markets and expanding market share where it has already established a presence.
The Company believes that its traditional businesses will show steady growth worldwide and that its new businesses will display accelerated growth.
Other future activities undertaken to expand the Companys business may include acquisitions, building improvements, equipment additions, new product development and marketing opportunities.
Recent Accounting Pronouncements
The Company does not expect that the adoption of recent accounting pronouncements will have a material impact on its financial statements.
Off Balance Sheet Arrangements
The Company has no off-balance sheet arrangements.
As of the end of the period covered by this report, the Company conducted an evaluation, under the supervision and with the participation of the principal executive officer and principal financial officer, of the Companys disclosure control and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934 (the Exchange Act)). Based on this evaluation, the principal executive officer and principal financial officer concluded that the Companys disclosure controls and procedures are effective to ensure that information required to be disclosed by the Company in reports that it files or submits under the Exchange Act is (i) recorded, processed, summarized and reported within the time periods specified in SEC rules and forms and (ii) accumulated and communicated to the Companys management, including its principal executive officer and principal financial officer, as appropriate to allow timely decisions regarding required disclosure.
There was no change in the Companys internal control over financial reporting identified in connection with the evaluation required by Rule 13a-15(d) and Rule 15d-15(d) of the Exchange Act that occurred during the period covered by this report that has materially affected, or is reasonably likely to materially affect, the Companys internal control over financial reporting.
PART II. OTHER INFORMATION
The Company repurchased shares as indicated in the table below during the second quarter of 2011(1):
The following exhibits are filed as part of this Quarterly Report on Form 10-Q for the quarterly period ended June 30, 2011:
Copies of Exhibits will be furnished upon request and payment of the Companys reasonable expenses in furnishing the Exhibits.
In accordance with the requirements of the Securities Exchange Act of 1934, the registrant caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
INDEX TO EXHIBITS