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Ikonics 10-Q 2011 Table of Contents
U.S. SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
(Mark One)
For the Quarterly Period Ended June 30, 2011
or
For the Transition Period From to .
Commission file number 000-25727
IKONICS CORPORATION
(218) 628-2217
Issuer’s telephone number Not Applicable
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 issuer’s 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.
IKONICS Corporation
QUARTERLY REPORT ON FORM 10-Q
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PART I — FINANCIAL INFORMATION
ITEM 1. Condensed Financial Statements
IKONICS CORPORATION
CONDENSED BALANCE SHEETS
See notes to condensed financial statements
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IKONICS CORPORATION
CONDENSED STATEMENTS OF OPERATIONS (Unaudited)
See notes to condensed financial statements.
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IKONICS CORPORATION
CONDENSED STATEMENTS OF CASH FLOWS (Unaudited)
See notes to condensed financial statements.
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IKONICS CORPORATION
NOTES TO CONDENSED FINANCIAL STATEMENTS
(Unaudited)
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IKONICS CORPORATION
NOTES TO CONDENSED FINANCIAL STATEMENTS
(Unaudited)
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IKONICS CORPORATION
NOTES TO CONDENSED FINANCIAL STATEMENTS
(Unaudited)
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IKONICS CORPORATION
NOTES TO CONDENSED FINANCIAL STATEMENTS
(Unaudited)
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IKONICS CORPORATION
NOTES TO CONDENSED FINANCIAL STATEMENTS
(Unaudited)
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IKONICS CORPORATION
NOTES TO CONDENSED FINANCIAL STATEMENTS
(Unaudited)
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IKONICS CORPORATION
The information presented below in Management’s 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 management’s discussion and analysis focuses on those factors that had a
material effect on the Company’s 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 Company’s 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 Company’s
condensed unaudited financial statements included in this Form 10-Q for more information regarding
the change to the Company’s reported segments beginning in 2011.
Factors that May Affect Future Results
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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 customer’s 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
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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 Company’s 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
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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 Company’s
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 Company’s 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 Company’s 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 Company’s 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.
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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
Company’s 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 Company’s 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 Company’s 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 Company’s 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 Company’s 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 Company’s purchases of
equipment for the quarter were $115,000, mainly for equipment purchases and hardware upgrades to
the Company’s computer
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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 Company’s 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 Company’s products
would impair the Company’s ability to fund operations.
Capital Expenditures
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.
International Activity
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 Company’s operations
because the Company’s 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 Company’s 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 Company’s foreign operations as of June 30, 2011. Furthermore, the
impact of foreign exchange on the Company’s balance sheet and operating results was not material in
either 2011 or 2010.
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Future Outlook
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 Company’s 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 Company’s 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. Micromachining’s aviation sound deadening
technology has shown growth with several new customers interested in adopting the Company’s
technology, and the Company believes there are new opportunities for the machining of composite
materials for the aerospace industry. The Company’s 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 Company’s 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 Company’s business may include
acquisitions, building improvements, equipment additions, new product development and marketing
opportunities.
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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.
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Not applicable
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 Company’s 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
Company’s 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 Company’s 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 Company’s 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 Company’s internal control over financial reporting.
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PART II. OTHER INFORMATION
None
Not applicable
The Company repurchased shares as indicated in the table below during the second
quarter of 2011(1):
Not applicable
None
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 Company’s reasonable
expenses in furnishing the Exhibits.
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IKONICS CORPORATION
SIGNATURES
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.
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INDEX TO EXHIBITS
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