SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-KSB
(Mark One)
[X] Annual Report Pursuant to Section 13 or 15(d) of the Securities Exchange
Act of 1934 For the Fiscal Year Ended December 31, 2005
or
[ ] Transition Report Pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934 For the Transition Period From _______________ to
________________.
Commission file number 000-25727
IKONICS CORPORATION
(Exact name of registrant as specified in its charter)
Minnesota 41-0730027
(State or other jurisdiction of (I.R.S. employer
incorporation or organization) identification no.)
4832 Grand Avenue
Duluth, Minnesota 55807
(Address of principal executive offices) (Zip code)
Registrant's telephone number, including area code: (218) 628-2217
Securities registered under Section 12(b) of the Act: None
Securities registered under Section 12(g) of the Act: Common Stock, par
value $.10 per share
Check whether the issuer is not required to file reports pursuant to
Section 13 or 15(d) of the Exchange Act. [ ]
Check whether the issuer (1) filed all reports required to be filed by
Section 13 or 15(d) of the Exchange Act during the past 12 months (or for such
shorter period that the registrant was required to file such reports), and (2)
has been subject to such filing requirements for the past 90 days.
Yes [X] No [ ]
Check if there is no disclosure of delinquent filers in response to Item
405 of Regulation S-B contained in this form, and no disclosure will be
contained, to the best of registrant's knowledge, in definitive proxy or
information statements incorporated by reference in Part III of this Form 10-KSB
or any amendment to this Form 10-KSB. [X]
Indicate by check mark whether the registrant is a shell company (as
defined in Rule 12b-2 of the Exchange Act). Yes [ ] No [X]
The issuer's revenues for its most recent fiscal year were: $13,971,217
The aggregate market value of the voting stock held by non-affiliates of
the registrant as of February 28, 2006 was $14,749,407, based on the closing
price for the issuer's Common Stock on such date as reported on the Nasdaq
SmallCap Market. For purposes of determining this number, all officers and
directors of the issuer are considered to be affiliates of the issuer, as well
as individual stockholders holding more than 10% of the issuer's
outstanding Common Stock. This number is provided only for the purpose of this
report on Form 10-KSB and does not represent an admission by either the issuer
or any such person as to the status of such person.
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 -
1,970,792 issued and outstanding as of February 28, 2006.
Transitional Small Business Disclosure Format (check one): Yes [ ] No [X]
This Annual Report on Form 10-KSB contains forward-looking statements
within the meaning of the safe harbor provisions of Section 21E of the
Securities Exchange Act of 1934, as amended, relating to future events or the
future financial performance of the Company. Forward-looking statements are only
predictions or statements of intention subject to risks and uncertainties and
actual events or results could differ materially from those projected. Factors
that could cause actual results to differ include the risks, uncertainties and
other matters set forth below under the caption "Factors that May Affect Future
Results" and the matters set forth under the captions "Business" and
"Management's Discussion and Analysis of Financial Condition and Results of
Operations," as well as those discussed elsewhere in this Annual Report on Form
10-KSB.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the Company's definitive proxy statement for its 2005 Annual
Meeting of Shareholders are incorporated by reference in Part III.
PART I
ITEM 1. BUSINESS
GENERAL
IKONICS Corporation ("IKONICS" or the "Company") was incorporated in
Minnesota as Chroma-Glo, Inc. in 1952 and changed its name to The Chromaline
Corporation in 1982. In December 2002, the Company changed its name to IKONICS
Corporation. The Company develops, manufactures and sells light-sensitive liquid
coatings ("emulsions") and films, and distributes ink jet receptive films for
commercial and industrial applications in the United States and abroad. The
Company also markets ancillary chemicals, equipment and other consumables to
provide a full line of products and services to its customers. The Company's
products serve the screen printing and abrasive etching markets. The screen
printing products represent the Company's largest product line. These products
are used by screen printers to create stencil images. These images produce basic
designs for fabric decoration and product identification, as well as complex
designs for compact discs and electronic circuits. The abrasive etching products
are used by consumers to create architectural glass, art pieces and awards, and
in various industrial applications. The Company also sells a line of ink jet
receptive films used for the creation of photopositives and photonegatives. In
2004, the Company launched two new product lines. The first, called IKONSign
Etch, markets a complete system that allows customers the ability to easily
produce a broad array of high quality sign products at a low cost. In 2005, the
Company continued to develop new products and distribution channels for IKONSign
Etch. The second launch in 2004, called IKONImage planned to use the Company's
technology and low cost etching services to bring unique products to market and
to provide low cost etching services for the Company's customers. During 2005,
the market for this service did not develop as expected and the Company
determined that IKONImage was no longer a viable business model. Thus, IKONImage
was terminated. During 2006, the Company launched a new division called IKONICS
Industrial. IKONICS Industrial offers imaging technology to industrial markets.
PRODUCTS
IKONICS' core technology is the use of photochemicals to create and
transfer images. This technology is similar to photographic film technology
except that the Company uses organic polymers or natural protein rather than
silver to make the product photo-reactive ("light sensitive"). The products
IKONICS targets at the screen printing industry are light-sensitive films and
light-sensitive emulsions used by customers to create an image on a printing
screen; the equivalent of a printing plate in other types of printing processes.
In the abrasive etching market,
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the Company's products are also films and emulsions. These products are used to
create a stencil by decorators of glass and other hard surfaces, including
crystal, marble, metals, wood, stone and plastics. The stencil is applied
directly to the article to be decorated by the sand blasting process through a
self-adhesive feature or with a separate adhesive. The open areas of the stencil
permit the sand blast grit to erode the surface while the closed areas of the
stencil repel the sand blast grit, protecting areas of the surface being
decorated.
All of IKONICS' light sensitive products are sensitive to ultraviolet
radiation. The Company uses different chemicals to create sensitivity to light,
including a molecule which it developed internally and patented.
DISTRIBUTION
The Company currently has approximately 180 domestic and international
distributors. The Company also sells its products through direct sales to
certain end users who do not require the services of a distributor. In addition,
IKONICS markets and sells its products through magazine advertising, trade shows
and the internet.
IKONICS has a diverse customer base both domestically and abroad and does
not depend on one or a few customers for a material portion of its revenues. In
2005, no one customer accounted for more than 10% of revenues.
QUALITY CONTROL IN MANUFACTURING
In March 1994, IKONICS became the first firm in northern Minnesota to
receive ISO 9001 certification. ISO 9000 is a series of worldwide standards
issued by the International Organization for Standardization that provide a
framework for quality assurance. ISO 9001 is the most comprehensive standard of
the ISO 9000 series. The Company was recertified in 1997, 2000 and 2003.
IKONICS' quality function goal is to train all employees properly in both their
work and in the importance of their work. Internal records of quality, including
related graphs and tables, are reviewed regularly and discussions are held among
management and employees regarding how improvements might be realized. The
Company has rigorous materials selection procedures and also uses environmental
testing and screen print equipment tailored to fit customers' needs.
RESEARCH AND DEVELOPMENT/INTELLECTUAL PROPERTY
IKONICS spent 4.6% of sales ($642,000) on research and development in 2005
and 4.2% ($575,000) in 2004. In its research program, IKONICS has developed
unique light-sensitive molecules which have received two U.S. patents. These
patents expire in 2011 and 2014, respectively. In addition, the Company holds a
number of other patents related to its photopolymer chemistry that expire
between 2006 and 2020. The Company also has nine United States patent
applications pending. There can be no assurance that any patent granted to the
Company will provide adequate protection to the Company's intellectual property.
Within IKONICS, steps are taken to protect the Company's trade secrets,
including physical security, confidentiality and non-competition agreements with
employees and confidentiality agreements with vendors. In its product
development program, IKONICS is fully equipped to simulate customer uses of its
products. The Company's facilities include a walk-in environmental chamber which
simulates customer uses and storage conditions of IKONICS products for different
climatic zones.
In addition to its patents, the Company has various trademarks including
the "IKONICS," "Chromaline," "PhotoBrasive," "Accuart," and "Nichols"
trademarks.
RAW MATERIALS
The primary raw materials used by IKONICS in its production are
photopolymers, polyester films, polyvinylacetates, polyvinylalcohols and water.
The purchasing staff at the Company's headquarters leads in the identification
of both domestic and foreign sources for raw materials and negotiates price and
terms for all domestic and foreign markets. IKONICS' involvement in foreign
markets has given it the opportunity to become a global buyer of raw materials
at lower overall cost. The Company has a number of suppliers for its operations.
Some suppliers provide a significant amount of key raw materials to the Company,
but the Company believes alternative sources are available for most materials.
For those raw materials where an alternative source is not readily available,
the Company is developing contingency raw material replacement plans. To date,
there have been no significant shortages of raw materials. The Company believes
it has good supplier relations.
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COMPETITION
The Company competes in its markets based on product development
capability, quality, reliability, availability, technical support and price.
Though the screen printing market is much larger than the decorative
sandblasting market, IKONICS commands significantly more market share in the
latter. The Company is actively pursuing other markets where its image-transfer
technology may offer significant value. IKONICS has two primary competitors in
its screen printing film business, both of which are foreign-owned entities.
They are larger than IKONICS and possess greater resources than the Company in
many areas. The Company has numerous competitors in the market for screen print
emulsions many of whom are larger than IKONICS and possess greater resources.
The market for the Company's abrasive etching products has one significant
competitor. IKONICS considers itself to be the leader in this market.
GOVERNMENT REGULATION
The Company is subject to a variety of federal, state and local industrial
laws and regulations, including those relating to the discharge of material into
the environment and protection of the environment. The governmental authorities
primarily responsible for regulating the Company's environmental compliance are
the Environmental Protection Agency, the Minnesota Pollution Control Agency and
the Western Lake Superior Sanitary District. Failure to comply with the laws
promulgated by these authorities may result in monetary sanctions, liability for
environmental clean-up and other equitable remedies. To maintain compliance, the
Company may make occasional changes in its waste generation and disposal
procedures.
These laws and regulations have not had a material effect upon the capital
expenditures or competitive position of the Company. The Company believes that
it complies in all material respects with the various federal, state and local
regulations that apply to its current operations. Failure to comply with these
regulations could have a negative impact on the Company's operations and capital
expenditures and such negative impact could be significant.
EMPLOYEES
As of February 28, 2006, the Company had approximately 68 full-time
employees, 64 of whom are located at the Company's headquarters in Duluth,
Minnesota and four of whom are outside technical sales representatives in
various locations around the United States. None of the Company's employees are
subject to a collective bargaining agreement and the Company believes that its
employee relations are good.
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ITEM 2. PROPERTY
The Company primarily conducts its operations in Duluth, Minnesota. The
administrative, sales, research and development, quality and manufacturing
activities are housed in a 60,000 square-foot, four-story building, including a
basement level. The building is approximately seventy years old and has been
maintained in good condition. Shipping and distribution for the Company operates
from a 5,625 square-foot warehouse adjacent to the existing plant building that
was constructed in 1997. These facilities are owned by the Company with no
existing liens or leases. The Company also leases warehouse space at two
locations in Superior, Wisconsin.
ITEM 3. LEGAL PROCEEDINGS
None.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matters were submitted to a vote of security holders by the registrant
during the fourth quarter of the fiscal year covered by this report.
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PART II
ITEM 5. MARKET FOR COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND SMALL BUSINESS
ISSUER PURCHASES OF EQUITY SECURITIES
The Company's Common Stock is traded on the Nasdaq SmallCap Market under
the symbol IKNX. The following table sets forth, for the fiscal quarters
indicated, the high and low bid prices for the Company's Common Stock as
reported on the Nasdaq Small Cap Market for the periods indicated. The
quotations reflect inter-dealer prices without retail mark-up, mark-down or
commission, and may not represent actual transactions.
HIGH LOW
----- -----
FISCAL YEAR ENDED DECEMBER 31, 2005:
First Quarter........................ $7.35 $5.51
Second Quarter....................... 7.00 4.20
Third Quarter........................ 6.99 4.95
Fourth Quarter....................... 8.99 5.78
FISCAL YEAR ENDED DECEMBER 31, 2004:
First Quarter........................ $8.30 $4.20
Second Quarter....................... 7.67 4.48
Third Quarter........................ 7.00 5.06
Fourth Quarter....................... 8.00 5.61
As of February 28, 2006, the Company had approximately 729 shareholders.
The Company has never declared or paid any dividends on its Common Stock.
The Company did not purchase shares of its equity securities during the
fourth quarter of 2005. A total of 50,007 shares of Common Stock may yet be
purchased under the repurchase program approved by the Company's Board of
Directors in February 2005.
ITEM 6. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
The following management discussion and analysis focuses on those factors
that had a material effect on the Company's financial results of operations and
financial condition during 2005 and 2004 and should be read in connection with
the Company's audited financial statements and notes thereto for the years ended
December 31, 2005 and 2004.
FACTORS THAT MAY AFFECT FUTURE RESULTS
Certain statements made in this Annual Report on Form 10-KSB, including
those summarized below, are forward-looking statements within the meaning of the
safe harbor provisions of Section 21E of the Securities Exchange Act of 1934, as
amended, that involve risks and uncertainties, and actual results may differ.
Factors that could cause actual results to differ include those identified
below.
- The Company's belief that international sales will rebound in
2006--This belief may be impacted by economic, political and social
conditions in current and anticipated foreign markets, regulatory
conditions in such markets, unanticipated changes in expenses, changes
in purchase or sales terms, changes in the selling environment in
foreign markets, changes in competitive conditions or other barriers
to entry or expansion.
- The Company's belief that costs related to Section 404 of the
Sarbanes-Oxley Act of 2002 should be lower in 2006--This belief may be
impacted by changes in law or regulation affecting the timing of the
Company's required compliance with Section 404 or unanticipated
barriers to such compliance resulting from the Company's internal
controls or third party influences.
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- The Company's belief that the quality of its receivables is high and
that strong internal controls are in place to maintain proper
collections--This belief may be impacted by domestic economic
conditions, by economic, political, regulatory or social conditions in
foreign markets, or by the failure of the Company to properly
implement or maintain internal controls.
- The belief that the Company's current financial resources, 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 and capital expenditures. The belief that the
Company's low debt levels and available line of credit make it
unlikely that a decrease in product demand would impair the Company's
ability to fund operations--Changes in anticipated operating results,
credit availability, equity market conditions or the Company's debt
levels may further enhance or inhibit the Company's ability to
maintain or raise appropriate levels of cash.
- The Company's expectation that capital expenditures will be funded
with cash generated from operating activities--This expectation may be
affected by changes in the Company's anticipated capital expenditure
requirements resulting from unforeseen required maintenance or
repairs. The funding of planned or unforeseen expenditures may also be
affected by changes in anticipated operating results resulting from
decreased sales or increased operating expenses.
- The Company's belief that its vulnerability to foreign currency
fluctuations and general economic conditions in foreign countries is
not significant--This belief may be impacted by economic, political
and social conditions in foreign markets, changes in regulatory and
competitive conditions, a change in the amount or geographic focus of
the Company's international sales, or changes in purchase or sales
terms.
- The Company's plans to continue to invest in research and development
efforts, expedite internal product development and invest in
technological alliances, as well as the expected focus and results of
such investments--These plans and expectations may be impacted by
general market conditions, unanticipated changes in expenses or sales,
delays in the development of new products, technological advances, the
ability to find suitable and willing technology partners or other
changes in competitive or market conditions.
- The Company's efforts to grow its international business--These
efforts may be impacted by economic, political and social conditions
in current and anticipated foreign markets, regulatory conditions in
such markets, unanticipated changes in expenses or sales, changes in
competitive conditions or other barriers to entry or expansion.
- The Company's belief as to future activities that may be undertaken to
expand the Company's business--Actual activities undertaken may be
impacted by general market conditions, competitive conditions in the
Company's industry, unanticipated changes in the Company's financial
position or the inability to identify attractive acquisition targets
or other business opportunities.
CRITICAL ACCOUNTING POLICIES
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 policies which IKONICS
believes are the most critical to aid in fully understanding and evaluating its
reported financial results include the following:
Accounts 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
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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 60-90 days for foreign customers.
Inventory. 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.
Deferred Tax Assets. At December 31, 2005, the Company had approximately
$160,000 of net deferred tax assets. The deferred tax assets result primarily
due to timing differences in accrued expenses, inventory reserves, intangible
assets and property and equipment. The Company has recorded a $27,000 valuation
allowance to reserve for items that more likely than not will not be realized.
The Company has determined that it 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.
Revenue Recognition. The Company recognizes revenue on products when title
passes which is usually upon shipment. Freight billed to customers is included
in sales. Shipping costs are included in cost of goods sold.
RESULTS OF OPERATIONS
YEAR ENDED DECEMBER 31, 2005 COMPARED TO YEAR ENDED DECEMBER 31, 2004
Sales. The Company's net sales increased 2.1% to $14.0 million in 2005,
compared to net sales of $13.7 million in 2004. Growth in 2005 was due to
increased domestic market penetration for certain film products. This domestic
growth was partially offset by lower international sales. International sales
were down by 4.1% as foreign competition in relation to pricing and products has
intensified in key markets in both Asia and Europe. The Company looks for
international sales to rebound in 2006 as new products are introduced and new
markets are developed.
Cost of Goods Sold. Cost of goods sold was $7.7 million, or 55.5% of sales,
in 2005 and $7.6 million, or 55.2% of sales, in 2004. The increase in cost of
goods sold reflects both raw material price increases as a large portion of
IKONICS' raw materials are petroleum based products and increased transportation
costs. The Company anticipates that raw material pricing will be more stable in
2006.
Selling, General and Administrative Expenses. Selling, general and
administrative expenses decreased to $4.4 million, or 31.3% of sales, in 2005
from $4.5 million, or 33.1% of sales, in 2004. The decrease was related to
$125,000 of lower trade show expenses in 2005 due to efforts to streamline the
Company's trade show presence, $30,000 less in deprecation expense and a $20,000
reduction in legal expenses. The Company also realized $40,000 in savings from
reduced marketing activities in Southeast Asia. These savings were partially
offset by $50,000 in additional costs for professional services as a result of
efforts required to comply with Section 404 of the Sarbanes-Oxley Act of 2002
and related regulations. Costs related to Section 404 of the Sarbanes-Oxley act
of 2002 should be lower in 2006. The Company also incurred an additional $60,000
of marketing and advertising expenses related to IKONSign Etch and IKONImage.
Research and Development Expenses. Research and development expenses were
$642,000, or 4.6% of sales, in 2005 compared to $575,000, or 4.2% of sales, in
2004. The increase is due to additional research and development staff and
higher trial production and legal expenses.
Interest Income. Interest income increased to $58,000 in 2005, compared to
$14,000 for 2004. The increase was primarily due to increased interest rates and
a larger investment balance.
Income Taxes. Income taxes were $348,000, or an effective rate of 27.7%,
during 2005 compared to $273,000, or an effective rate of 26.5% in 2004. The
higher effective tax rate during 2005 relates to a lower level of tax benefits
during that period from the extraterritorial income exclusion on foreign sales
as it began to phase out in 2005 and lower foreign sales compared to 2004. The
increase was partially offset by federal tax credits for research and
development.
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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 and cash equivalents were $3,412,000 and $2,737,000 at December 31,
2005 and December 31, 2004, respectively. The Company generated $980,000 in cash
from operating activities during 2005 compared to $1,262,000 of cash generated
from operating activities during 2004. Cash provided by operating activities is
primarily the result of net income adjusted for non-cash depreciation,
amortization, provision for doubtful accounts, and certain changes in working
capital components discussed in the following paragraph.
During 2005, trade receivables increased by $60,000. The increase in
receivables reflects higher sales and a reduced allowance for doubtful accounts
partially offset by improved collections. The Company believes that the quality
of its receivables is high and that strong internal controls are in place to
maintain proper collections. Inventory levels increased by $163,000, reflecting
higher raw material levels primarily due to increased raw materials for the
Company's Accuart and Accublack product lines to support sales growth. Accounts
payable decreased by $98,000, reflecting the timing of payments to suppliers.
Income taxes payable increased by $27,000 as a result of the timing of estimated
2005 tax payments compared to the calculated 2005 tax liability. Accrued
expenses decreased by $12,000 due to a reduction in an estimated sales tax
liability, partially offset by an increase in accrued compensation due to the
timing of compensation payments.
The Company used $423,000 and $255,000 in cash for investing activities
during 2005 and 2004, respectively. During 2005, the Company invested $253,000
in Imaging Technology International ("iTi") to acquire 36,496 shares and
warrants to purchase an additional 33,333 shares of iTi. At the time of the
acquisition, the 36,496 shares represented 3.6% of the total outstanding common
shares of iTi. iTi is a leader in the development of industrial production
systems based on ink jet technology and the Company believes iTi's expertise
fits strategically with the Company's expertise in developing substrates for a
wide variety of industrial printing processes. The Company made $211,000 of
property and equipment purchases during 2005. The purchases were comprised of
plant and research equipment to improve efficiency and safety, reduce operating
costs and update facilities, and two automobiles. The Company also incurred
$12,000 in patent application costs that it recorded as an asset and amortizes
upon successful completion of the application process. The Company received
$43,000 during 2005 from the sale of marketable securities and $11,000 from the
sale of automobiles.
During 2004, the Company spent $270,000 on plant equipment upgrades to
improve efficiency and safety, reduce operating costs and update facilities and
on purchases of vehicles. Also during 2004, the Company exercised warrants for
the purchase of 244,585 shares of Apprise Technologies for an aggregate exercise
price of $85,000. The Company also incurred $9,000 in patent application costs
and realized $108,000 from the sale of marketable securities.
The Company realized $117,000 in cash from financing activities during 2005
compared to $223,000 received in 2004. During 2005, the Company received
$233,000 for the issuance of 57,491 shares of common stock issued upon the
exercise of stock options compared to $223,000 received during 2004 for 58,355
shares of common stock issued upon the exercise of stock options. The Company
repurchased 25,499 shares of its common stock at a cost of $116,000 during 2005.
A bank line of credit provides for borrowings of up to $1,250,000.
Borrowings under this line of credit are collateralized by accounts receivable
and inventory and bear interest at 2.00 percentage points over the 30-day LIBOR
rate. The Company did not utilize this line of credit during the year and there
were no borrowings outstanding as of December 31, 2005. The line of credit was
also not utilized during 2004 and there were no borrowings outstanding under
this line as of December 31, 2004.
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.
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CAPITAL EXPENDITURES
The Company spent $211,000 on capital expenditures during 2005. This
spending included plant and research equipment upgrades to improve efficiency
and safety, reduce operating costs, update facilities and vehicles.
Plans for capital expenditures include ongoing manufacturing equipment
upgrades, development equipment to modernize the capabilities and processes of
IKONICS' laboratory, and research and development to improve measurement and
quality control processes. These commitments are expected to be funded with cash
generated from operating activities.
INTERNATIONAL ACTIVITY
The Company markets its products to numerous countries in all regions of
the world including North America, Europe, Latin America, and Asia. Foreign
sales were approximately 29.4% of total sales during 2005 and 31.4% of total
sales in 2004. Foreign sales in 2005 reflect increased competition in relation
to pricing and products in both Asia and Europe. Fluctuations in 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. 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 a 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
December 31, 2005.
FUTURE OUTLOOK
IKONICS has invested on average over 4% of its sales dollars for the past
few years in research and development. The Company plans to maintain its efforts
in this area and expedite internal product development, as well as form
technological alliances with outside experts to ensure commercialization of new
product opportunities.
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.
Other future activities undertaken to expand the Company's business may
include acquisitions, building expansion and additions, equipment additions, new
product development and marketing opportunities.
RECENT ACCOUNTING PRONOUNCEMENTS
In December 2004, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standards No. 123 (revised 2004) "Share-Based
Payment" ("SFAS 123R"). SFAS 123R replaces FASB Statement No. 123 "Accounting
for Stock-Based Compensation", and supersedes APB Opinion No. 25 "Accounting for
Stock Issued to Employees." The statement establishes standards for accounting
for share-based payment transactions. Share-based payment transactions are those
in which an entity exchanges its equity instruments for goods or services, or in
which an entity incurs liabilities in exchange for goods or services, that are
based on the fair value of the entity's equity instruments or that may be
settled by the issuance of those equity instruments. SFAS 123R covers a wide
range of share-based compensation arrangements including share options,
restricted share plans, performance-based awards, share appreciation rights and
employee share purchase plans. SFAS 123R requires a public entity to measure the
cost of employee services received in exchange for an award of equity
instruments based on the fair value of the award on the grant date (with limited
exceptions). That cost will be recognized in the entity's financial statements
over the period during which the employee is required to provide services in
exchange for the award. The statement will be effective for the Company's first
quarter of 2006. The Company intends to apply the
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modified prospective method and estimates the effect of adopting this statement
will be to reduce basic and diluted earnings per share amounts by approximately
$0.01 for fiscal year 2006. The Company also expects to continue using the
Black-Scholes pricing model as allowed under SFAS 123R.
In November 2004, the FASB issued SFAS No. 151, "Inventory Costs" ("SFAS
151"). The provisions of SFAS 151 become effective for the Company for the first
quarter of 2006. SFAS 151 amends the existing guidance on the recognition of
inventory costs to clarify the accounting for abnormal amounts of idle expense,
freight, handling costs and wasted material (spoilage). Existing rules indicate
that under some circumstances, items such as idle facility expense, excessive
spoilage, double freight and rehandling costs may be so abnormal as to require
treatment as current period charges. SFAS 151 requires that allocation of fixed
production overheads to the costs of conversion be based on the normal capacity
of the production facilities. The adoption of SFAS 151 is not expected to have a
material impact on the valuation of the Company's inventory or operating
results.
11
ITEM 7. FINANCIAL STATEMENTS
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
Stockholders and Board of Directors
IKONICS Corporation
Duluth, Minnesota
We have audited the balance sheets of IKONICS Corporation as of December 31,
2005 and 2004, and the related statements of operations, stockholders' equity
and comprehensive income and cash flows for the years then ended. These
financial statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statements based on
our audits.
We conducted our audits in accordance with the standards of the Public Company
Accounting Oversight Board (United States). Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the financial position of IKONICS Corporation as of
December 31, 2005 and 2004, and the results of its operations and its cash flows
for the years then ended in conformity with U.S. generally accepted accounting
principles.
/s/ McGladrey & Pullen, LLP
Duluth, Minnesota
January 20, 2006
12
IKONICS CORPORATION
BALANCE SHEETS
DECEMBER 31, 2005 AND 2004
2005 2004
---------- ----------
ASSETS
CURRENT ASSETS:
Cash and cash equivalents $3,412,072 $2,737,460
Marketable securities 84,875 124,358
Trade receivables, less allowance for doubtful accounts
of $50,000 in 2005 and $75,000 in 2004 (Note 10) 1,702,608 1,642,904
Inventories (Notes 1 and 10) 2,364,056 2,201,282
Prepaid expenses and other assets 65,747 57,345
Deferred income taxes (Note 2) 99,000 143,000
---------- ----------
Total current assets 7,728,358 6,906,349
---------- ----------
PROPERTY, PLANT, AND EQUIPMENT, at cost:
Land and building 1,479,824 1,466,898
Machinery and equipment 2,531,734 2,442,295
Office equipment 1,280,149 1,239,811
Vehicles 174,803 175,406
---------- ----------
5,466,510 5,324,410
Less accumulated depreciation 4,514,945 4,295,580
---------- ----------
951,565 1,028,830
---------- ----------
INTANGIBLE ASSETS, less accumulated amortization of $134,642 in
2005 and $109,728 in 2004 (Note 3) 279,086 292,349
DEFERRED INCOME TAXES (Note 2) 61,000 65,000
INVESTMENTS IN NON-MARKETABLE EQUITY SECURITIES (Note 1) 450,790 197,460
---------- ----------
$9,470,799 $8,489,988
========== ==========
13
IKONICS CORPORATION
BALANCE SHEETS
DECEMBER 31, 2005 AND 2004
2005 2004
---------- ----------
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES:
Accounts payable $ 438,597 $ 536,391
Accrued compensation 279,042 263,510
Other accrued expenses (Note 9) 217,912 245,702
Income taxes payable 56,743 30,169
---------- ----------
Total current liabilities 992,294 1,075,772
---------- ----------
COMMITMENTS AND CONTINGENCIES (Note 9)
STOCKHOLDERS' EQUITY:
Preferred stock, par value $.10 per share; authorized
250,000 shares: issued none
Common stock, par value $.10 per share; authorized
4,750,000 shares: issued and outstanding 1,962,537
shares in 2005 and 1,930,545 shares in 2004 196,254 193,055
Additional paid-in capital 1,721,119 1,477,815
Retained earnings 6,560,236 5,745,662
Accumulated other comprehensive income (loss) 896 (2,316)
---------- ----------
Total stockholders' equity 8,478,505 7,414,216
---------- ----------
$9,470,799 $8,489,988
========== ==========
See notes to financial statements.
14
IKONICS CORPORATION
STATEMENTS OF OPERATIONS
YEARS ENDED DECEMBER 31, 2005 AND 2004
2005 2004
----------- -----------
NET SALES (Note 5) $13,971,217 $13,682,449
COSTS AND EXPENSES:
Cost of goods sold 7,748,707 7,556,713
Selling, general and administrative 4,383,144 4,533,294
Research and development 641,622 575,065
----------- -----------
12,773,473 12,665,072
----------- -----------
INCOME FROM OPERATIONS 1,197,744 1,017,377
INTEREST INCOME 58,425 13,974
----------- -----------
INCOME BEFORE INCOME TAXES 1,256,169 1,031,351
FEDERAL AND STATE INCOME TAXES (Note 2) 348,000 273,000
----------- -----------
NET INCOME $ 908,169 $ 758,351
=========== ===========
EARNINGS PER COMMON SHARE:
Basic $ 0.47 $ 0.40
=========== ===========
Diluted $ 0.46 $ 0.38
=========== ===========
WEIGHTED AVERAGE COMMON SHARES
ASSUMED OUTSTANDING:
Basic 1,944,330 1,906,771
=========== ===========
Diluted 1,986,885 1,982,814
=========== ===========
See notes to financial statements.
15
IKONICS CORPORATION
STATEMENTS OF STOCKHOLDERS' EQUITY AND COMPREHENSIVE INCOME
YEARS ENDED DECEMBER 31, 2005 AND 2004
ACCUMULATED TOTAL
COMMON STOCK ADDITIONAL OTHER STOCK-
------------------- PAID-IN RETAINED COMPREHENSIVE HOLDERS'
SHARES AMOUNT CAPITAL EARNINGS INCOME (LOSS) EQUITY
--------- -------- ---------- ---------- ------------- ----------
BALANCE AT DECEMBER 31, 2003 1,872,190 $187,219 $1,207,083 $4,987,311 $(13,263) $6,368,350
Net income -- -- -- 758,351 -- 758,351
Unrealized gain on available-for-sale securities -- -- -- -- 10,947 10,947
----------
Total comprehensive income -- -- -- -- -- 769,298
Exercise of stock options 58,355 5,836 217,100 -- -- 222,936
Tax benefit resulting from stock option exercises -- -- 53,632 -- -- 53,632
--------- -------- ---------- ---------- -------- ----------
BALANCE AT DECEMBER 31, 2004 1,930,545 193,055 1,477,815 5,745,662 (2,316) 7,414,216
Net income -- -- -- 908,169 -- 908,169
Unrealized gain on available-for-sale securities -- -- -- -- 3,212 3,212
----------
Total comprehensive income -- -- -- -- -- 911,381
Exercise of stock options 57,491 5,749 227,042 -- -- 232,791
Common stock repurchased (25,499) (2,550) (19,519) (93,595) -- (115,664)
Tax benefit resulting from stock option exercises -- -- 35,781 -- -- 35,781
--------- -------- ---------- ---------- -------- ----------
BALANCE AT DECEMBER 31, 2005 1,962,537 $196,254 $1,721,119 $6,560,236 $ 896 $8,478,505
========= ======== ========== ========== ======== ==========
See notes to financial statements.
16
IKONICS CORPORATION
STATEMENTS OF CASH FLOWS
YEARS ENDED DECEMBER 31, 2005 AND 2004
2005 2004
---------- ----------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income $ 908,169 $ 758,351
Adjustments to reconcile net income to net cash
provided by operating activities:
Depreciation 269,549 351,418
Amortization 24,914 24,574
Loss on sale of vehicles 7,992 --
Deferred income taxes 48,000 (14,000)
Tax benefit from stock option exercise 35,781 53,632
Changes in working capital components:
Trade receivables (59,704) 216,576
Inventories (162,774) (394,049)
Prepaid expenses and other assets (8,402) 15,915
Accounts payable (97,794) 271,647
Accrued expenses (12,258) 74,388
Income taxes payable 26,574 (96,597)
---------- ----------
Net cash provided by operating activities 980,047 1,261,855
---------- ----------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchases of property and equipment (211,276) (270,089)
Proceeds on sale of vehicles 11,000 --
Purchase of intangibles (11,651) (8,906)
Purchase of non-marketable equity securities (253,330) (84,626)
Proceeds from sale of marketable securities 42,695 108,496
---------- ----------
Net cash used in investing activities (422,562) (255,125)
---------- ----------
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from exercise of stock options 232,791 222,936
Redemption of common stock (115,664) --
---------- ----------
Net cash provided by financing activities 117,127 222,936
---------- ----------
NET INCREASE IN CASH AND CASH EQUIVALENTS 674,612 1,229,666
CASH AND CASH EQUIVALENTS AT BEGINNING OF YEAR 2,737,460 1,507,794
---------- ----------
CASH AND CASH EQUIVALENTS AT END OF YEAR $3,412,072 $2,737,460
========== ==========
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION
Cash paid for income taxes $ 237,645 $ 330,188
========== ==========
See notes to financial statements.
17
IKONICS CORPORATION
NOTES TO FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 2005 AND 2004
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Description of Business - IKONICS Corporation (the Company) develops and
manufactures high-quality photochemical imaging systems for sale primarily
to a wide range of printers and decorators of surfaces. Customers'
applications are primarily screen printing and abrasive etching. The
Company's principal markets are throughout the United States. In addition,
the Company sells to Western Europe, Latin America, Asia, and other parts
of the world. The Company extends credit to its customers, all on an
unsecured basis, on terms that it establishes for individual customers.
The Company markets in Europe, Latin America, Asia, and other parts of the
world. Foreign sales approximated 29.4% of total sales in 2005 and 31.4% of
total sales in 2004. Forty-two percent and forty percent, respectively, of
the Company's accounts receivable at December 31, 2005 and 2004 are due
from foreign customers. The foreign receivables are composed primarily of
open credit arrangements with terms ranging from 45 to 90 days. No single
customer represented greater than 10% of net sales in 2005 or in 2004.
Segment information is not presented since all of the Company's revenue is
attributed to a single reporting segment.
A summary of the Company's significant accounting policies follows:
Cash Equivalents - The Company considers all highly liquid debt instruments
purchased with a maturity of three months or less to be cash equivalents.
Cash equivalents consist of putable variable rate municipal bonds backed by
a letter of credit and money market funds in which the carrying value of
both instruments approximates market value because of the short maturity of
these instruments.
Marketable Securities - Marketable securities are classified as
available-for-sale and consist primarily of municipal revenue bonds that
will be held for indefinite periods of time, including securities that may
be sold in response to changes in market interest or prepayment rates,
needs for liquidity, or changes in the availability or yield of alternative
investments. These securities are carried at fair market value with changes
in fair value, net of tax, recorded in other comprehensive income.
One of these municipal bonds has been in a continuous loss position for
over 12 months. The fair value of the municipal bond that has been in a
continuous loss position for 12 months or more at December 31, 2005 is
$35,011 with an unrealized loss of $1,916. The unrealized loss is due to
changes in interest rates, and, as such, is considered to be temporary by
the Company.
Trade Receivables - Trade receivables are carried at original invoice
amount less an estimate made for doubtful receivables based on a review of
all outstanding amounts on an on-going basis. Management determines the
allowance for doubtful accounts by regularly evaluating individual customer
receivables and considering a customer's financial condition, credit
history, and current economic conditions. Trade receivables are written off
when deemed uncollectible. Recoveries of trade receivables previously
written off are recorded when received. Accounts are considered past due if
payment is not received according to agreed-upon terms.
18
Inventories - Inventories are stated at the lower of cost or market using
the last-in, first-out (LIFO) method. If the first-in, first-out cost
method had been used, inventories would have been approximately $509,000
and $348,000 higher than reported at December 31, 2005 and 2004,
respectively. The major components of inventories are as follows:
2005 2004
---------- ----------
Raw materials $1,483,881 $1,260,457
Work-in-progress 212,254 268,419
Finished goods 1,176,647 1,019,952
Reduction to LIFO cost (508,726) (347,546)
---------- ----------
Total inventories $2,364,056 $2,201,282
========== ==========
Depreciation - Depreciation of property, plant and equipment is computed
using the straight-line method over the following estimated useful lives:
Years
-----
Building 15-40
Machinery and equipment 5-10
Office equipment 5-10
Vehicles 3
Intangibles Assets- Intangible assets consist primarily of patents,
licenses and covenants not to compete arising from business combinations.
Intangible assets are amortized on a straight-line basis over their
estimated useful lives or terms of their agreement. Intangible assets with
finite lives are assessed for impairment whenever events or circumstances
indicate the carrying value may not be fully recoverable by comparing the
carrying value to future undiscounted cash flows. To the extent there is
impairment, analysis is performed based on several criteria, including, but
not limited to, revenue trends, discounted operating cash flows and other
operating factors to determine the impairment amount
Investments in Non-Marketable Equity Securities - Investments in
non-marketable equity securities consist of a $253,330 investment in
Imaging Technology International ("iTi"). The Company acquired 36,496
shares and warrants to purchase an additional 33,333 shares of iTi during
the second quarter of 2005. At the time of the acquisition, the 36,496
shares represented 3.6% of the total outstanding common shares of iTi. iTi
is a leader in the development of industrial production systems based on
ink jet technology and the Company believes iTi's expertise fits
strategically with the Company's expertise in developing substrates for a
wide variety of industrial printing processes. The Company also has a
$197,460 equity investment in Apprise Technologies, Inc., including 244,585
shares acquired for $84,626 during the fourth quarter of 2004, from
exercised warrants. As of December 31, 2005, the Company's ownership of
Apprise's common and preferred stock represented approximately 4.95% of the
outstanding shares of Apprise. One of the Company's directors is the CEO of
Apprise Technologies, Inc. The Company accounts for these investments by
the cost method because the common stock of each corporation is unlisted
and the criteria for using the equity method of accounting are not
satisfied. The Company reviews these investments for impairment annually
and writes them down whenever the recorded amount exceeds estimated fair
market value.
Fair Value of Financial Instruments - The carrying amounts of financial
instruments, including cash, cash equivalents, accounts receivable,
accounts payable, and accrued liabilities approximate fair value due to the
short maturity of these instruments. The carrying value of the
non-marketable equity securities approximates the estimated fair value
based on management's knowledge of recent sales prices of the
non-marketable equity securities.
19
Revenue Recognition - The Company recognizes revenue on sales of products
when title passes which is usually upon shipment. Freight billed to
customers is included in sales. Shipping costs are included in cost of
goods sold.
Deferred Taxes - Deferred taxes are provided on a liability method whereby
deferred tax assets are recognized for deductible temporary differences and
operating loss and tax credit carryforwards and deferred tax liabilities
are recognized for taxable temporary differences. Temporary differences are
the differences between the reported amounts of assets and liabilities and
their tax bases. Deferred tax assets are reduced by a valuation allowance
when, in the opinion of management, it is more likely than not that some
portion or all of the deferred tax assets will not be realized. Deferred
tax assets and liabilities are adjusted for the effects of changes in tax
laws and rates on the date of enactment.
Comprehensive Income - The Company's comprehensive income consists of net
income and net unrealized holding gains and losses on marketable
securities, net of taxes.
Earnings Per Common Share (EPS) - Basic EPS is calculated using net income
divided by the weighted average of common shares outstanding during the
year. Diluted EPS is similar to Basic except that the weighted average of
common shares outstanding is increased to include the number of additional
common shares that would have been outstanding if the dilutive potential
common shares, such as options, had been issued.
Shares used in the calculation of diluted EPS are summarized below:
2005 2004
--------- ---------
Weighted average common shares outstanding 1,944,330 1,906,771
Dilutive effect of stock options 42,555 76,043
--------- ---------
Weighted average common and common equivalent shares outstanding 1,986,885 1,982,814
========= =========
Options to purchase 130,285 and 195,891 shares of common stock were
outstanding as of December 31, 2005 and 2004, respectively.
Employee Stock Plan - The Company has a stock-based compensation plan,
which is described more fully in Note 7. The Company accounts for this plan
under the recognition and measurement principles of APB Opinion No. 25,
Accounting for Stock Issued to Employees, and related interpretations.
Accordingly, no stock-based employee compensation cost has been recognized,
as all options granted under the plan had an exercise price equal to the
market value of the underlying common stock on the date of grant. The
following table illustrates the effect on net income and earnings per share
had compensation cost been determined based on the grant date fair values
of awards (the method described in FASB Statement No. 123, Accounting for
Stock-Based Compensation):
20
Years Ended December 31,
------------------------
2005 2004
-------- --------
Net income:
As reported $908,169 $758,351
Deduct total stock-based employee compensation
expense determined under fair value based method
for all awards 21,214 29,875
-------- --------
Pro forma $886,955 $728,476
======== ========
Basic earnings per share:
As reported $ 0.47 $ 0.40
Pro forma $ 0.46 $ 0.38
Diluted earnings per share:
As reported $ 0.46 $ 0.38
Pro forma $ 0.45 $ 0.37
Use of Estimates - The preparation of the financial statements in
conformity with accounting principles generally accepted in the United
States of America requires management to make estimates and assumptions
that affect the reported amounts of assets and liabilities and disclosure
of contingent assets and liabilities at the date of the financial
statements and the reported amounts of revenues and expenses during the
reporting period. Actual results could differ from those estimates.
Foreign Currency Translation - Foreign currency transactions and
translation adjustments did not have a significant effect on the Statements
of Stockholders' Equity and Comprehensive Income and Cash Flows for 2005
and 2004.
2. INCOME TAXES
Income tax expense for the years ended December 31, 2005 and 2004 consists
of the following:
2005 2004
-------- --------
Current:
Federal $262,000 $248,000
State 38,000 39,000
-------- --------
300,000 287,000
Deferred 48,000 (14,000)
-------- ---------
$348,000 $273,000
======== ========
The expected provision for income taxes, computed by applying the U.S.
federal income tax rate of 35% in 2005 and 2004 to income before taxes, is
reconciled to income tax expense as follows:
2005 2004
-------- --------
Expected provision for federal income taxes $439,700 $361,100
State income taxes, net of federal benefit 25,700 20,200
Extraterritorial income exclusion (64,700) (94,400)
Non-deductible meals and entertainment 13,600 18,700
Tax-exempt interest (18,100) (9,800)
R&D Credit (29,000) (12,800)
Other (19,200) (10,000)
--------- ---------
$348,000 $273,000
======== ========
21
Deferred tax assets consist of the following as of December 31, 2005 and
2004:
2005 2004
-------- --------
Property and equipment and other assets $ 40,000 $ 38,000
Accrued vacation 14,000 15,000
Other accrued expenses 47,000 57,000
Inventories 20,000 44,000
Allowance for doubtful accounts 18,000 27,000
Allowance for sales returns 7,000 7,000
Intangible assets 21,000 27,000
Capital loss carryforward 27,000 46,000
-------- --------
194,000 261,000
Less valuation allowance (27,000) (46,000)
--------- ---------
167,000 215,000
Deferred tax liabilities:
Prepaid expenses 7,000 7,000
-------- --------
$160,000 $208,000
======== ========
The deferred tax amounts described above have been included in the
accompanying balance sheet as of December 31, 2005 and 2004 as follows:
2005 2004
-------- --------
Current assets $ 99,000 $143,000
Noncurrent assets 61,000 65,000
-------- --------
$160,000 $208,000
======== ========
3. INTANGIBLE ASSETS
Intangible assets consist primarily of patents, licenses and covenants not
to compete arising from business combinations. Intangible assets are
amortized on a straight-line basis over their estimated useful lives or
terms of their agreement, whichever is shorter. During 2005, application
costs for two patents with total capitalized costs of $30,341 were expensed
as it was determined that these projects had no future value. No impairment
adjustments to intangible assets were made during the year ended December
31, 2004.
Intangible assets at December 31, 2005 and 2004 consist of the following:
December 31, 2005 December 31, 2004
----------------------------- -----------------------------
Gross Carrying Accumulated Gross Carrying Accumulated
Amount Amortization Amount Amortization
-------------- ------------ -------------- ------------
Amortized intangible assets:
Patents $213,728 $ (71,102) $202,077 $ (60,980)
Licenses 100,000 (26,875) 100,000 (18,750)
Non-compete agreement 100,000 (36,664) 100,000 (29,998)
-------- --------- -------- ---------
$413,728 $(134,642) $402,077 $(109,728)
======== ========= ======== =========
22
2005 2004
------- -------
Aggregate amortization expense:
For the year ended December 31 $24,914 $24,574
Estimated amortization expense for the year ended December 31:
2006 $24,709
2007 24,709
2008 24,709
2009 24,709
2010 24,709
In connection with the license agreements, the Company has agreed to pay
royalties ranging from 3% to 5% on the future sales of products subject to
the agreements. The Company incurred $108,000 of expense under these
agreements during 2005, and $104,000 during 2004.
4. PENSION PLAN
The Company has established a salary deferral plan under Section 401(k) of
the Internal Revenue Code. Such deferrals accumulate on a tax-deferred
basis until the employee withdraws the funds. The Company contributes 5% of
each eligible employee's compensation. Total pension expense for the years
ended December 31, 2005 and 2004 was approximately $150,000 and $149,000,
respectively.
5. GEOGRAPHIC INFORMATION
The Company manages and operates its business on the basis of one
reportable segment. See Note 1 for a brief description of the Company's
business. In 2005 and 2004, the Company marketed its products in various
countries throughout the world. The Company is exposed to the risk of
changes in social, political, and economic conditions inherent in foreign
operations, and the Company's results of operations are affected by
fluctuations in foreign currency exchange rates. No single foreign country
accounted for more than 10% of the Company's net sales for 2005 and 2004.
Net sales by geographic area are presented by attributing revenues from
external customers on the basis of where the products are sold.
2005 2004
----------- -----------
Net sales by geographic area:
United States $ 9,856,019 $ 9,391,501
International 4,115,198 4,290,948
----------- -----------
$13,971,217 $13,682,449
=========== ===========
23
6. STOCK OPTIONS
During 1995, the Company, with the approval of its shareholders, adopted a
stock incentive plan for the issuance of up to 57,750 shares of common
stock. In 1999, the Company, with the approval of its shareholders,
increased the number of shares reserved for issuance under this plan to
305,250 shares and, in 2004, increased the number of shares reserved for
issuance under this plan to 342,750 shares. The plan provides for granting
eligible participants stock options or other stock awards, as described by
the plan, at option prices ranging from 85% to 110% of fair market value at
date of grant. Options granted expire up to seven years after the date of
grant. Such options generally become exercisable over a one to three year
period. A total of 61,934 shares of common stock are reserved for
additional grants of options under the plan at December 31, 2005.
The proforma fair value disclosure in Note 1 was estimated using the
Black-Scholes option pricing model with the following assumptions:
2005 2004
---------- ----------
Dividend yield 0.0% 0.0%
Expected volatility 63.2% 60.0%
Expected life of option five years five years
Risk-free interest rate 3.9% 3.4%
Fair value of each option on grant date $2.44 $3.77
A summary of the status of the Company's stock option plan as of December
31, 2005 and 2004 and changes during the years then ended is presented
below:
2005 2004
------------------ ------------------
Weighted Weighted
Average Average
Exercise Exercise
Shares Price Shares Price
------- -------- ------- --------
Outstanding at beginning of year 195,891 $3.67 252,161 $3.67
Granted 10,250 4.32 3,000 7.01
Exercised (57,491) 4.05 (58,355) 3.82
Expired and forfeited (18,365) 5.66 (915) 3.06
------- -------
Outstanding at end of year 130,285 3.27 195,891 3.67
======= =======
The following table summarizes information about stock options outstanding
at December 31, 2005:
Options Outstanding Options Exercisable
----------------------------------------- --------------------------
Weighted-
Number Average Weighted- Number Weighted-
Range of Outstanding at Remaining Average Exercisable at Average
Exercise December 31, Contractual Exercise December 31, Exercise
Price 2005 Life (years) Price 2005 Price
------------ -------------- ------------ --------- -------------- ---------
$2.00 - 2.99 60,825 1.89 $2.44 55,410 $2.42
3.00 - 3.99 42,440 0.91 3.21 38,690 3.19
4.00 - 4.99 10,250 4.32 4.32 -- --
5.00 - 5.99 9,570 0.31 5.45 9,570 5.45
6.00 - 6.99 4,950 0.31 6.00 4,950 6.00
7.00 - 7.99 2,250 3.33 7.01 750 7.01
------- -------
130,285 1.61 3.27 109,370 3.15
======= =======
24
7. CONCENTRATION OF CREDIT RISK
The Company maintains its cash balances primarily in one financial
institution. As of December 31, 2005, the balance exceeded the Federal
Deposit Insurance Corporation coverage. The Company reduces its exposure to
credit risk by maintaining such balances with financial institutions that
have high credit ratings.
Accounts receivable are financial instruments that also expose the Company
to concentration of credit risk. The large number of customers comprising
the Company's customer base and their dispersion across different
geographic areas limits such exposure. In addition, the Company routinely
assesses the financial strength of its customers and maintains an allowance
for doubtful accounts that management believes will adequately provide for
credit losses. Concentration of credit risk with respect to trade
receivables is not significant. No one customer accounts for more than 10%
of total receivables as of December 31, 2005.
8. LEASE EXPENSE
The Company leases buildings on a month-to-month basis and equipment as
needed. Total rental expense for all equipment and building operating
leases was $29,617 in 2005 and $56,052 in 2004.
9. CONTINGENCIES
In 2003, the Company identified a probable underpayment of sales tax. As of
December 31, 2005 and 2004, the Company had accrued $130,000 and $160,000,
respectively, for the future payment of such unpaid taxes.
10. LINE OF CREDIT
The Company has a $1,250,000 bank line of credit that provides for working
capital financing. This line of credit is subject to annual renewal on each
May 1, is collateralized by trade receivables and inventory, and bears
interest at 2.00 percentage points over 30-day LIBOR. There were no
outstanding borrowings under this line of credit at December 31, 2005 and
2004.
11. ACCOUNTING PRONOUNCEMENTS
In December 2004, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standards No. 123 (revised 2004)
"Share-Based Payment" ("SFAS 123R"). SFAS 123R replaces FASB Statement No.
123 "Accounting for Stock-Based Compensation", and supersedes APB Opinion
No. 25 "Accounting for Stock Issued to Employees." The statement
establishes standards for accounting for share-based payment transactions.
Share-based payment transactions are those in which an entity exchanges its
equity instruments for goods or services, or in which an entity incurs
liabilities in exchange for goods or services, that are based on the fair
value of the entity's equity instruments or that may be settled by the
issuance of those equity instruments. SFAS 123R covers a wide range of
share-based compensation arrangements including share options, restricted
share plans, performance-based awards, share appreciation rights and
employee share purchase plans. SFAS 123R requires a public entity to
measure the cost of employee services received in exchange for an award of
equity instruments based on the fair value of the award on the grant date
(with limited exceptions). That cost will be recognized in the entity's
financial statements over the period during which the employee is required
to provide services in exchange for the award. The statement will be
effective for the Company's first quarter of 2006. The Company intends to
apply the modified prospective method and estimates the effect of adopting
this statement will be to reduce basic and diluted earnings per share
amounts by approximately $0.01 for fiscal year 2006. The Company also
expects to continue using the Black-Scholes pricing model as allowed under
SFAS 123R.
In November 2004, the FASB issued SFAS No. 151, "Inventory Costs" ("SFAS
151"). The provisions of SFAS 151 become effective for the Company for the
first quarter of 2006. SFAS 151 amends the existing guidance on the
recognition of inventory costs to clarify the accounting for abnormal
amounts of idle expense, freight, handling costs, and wasted material
(spoilage). Existing rules indicate that under some circumstances, items
such as idle facility expense, excessive spoilage, double freight, and
rehandling costs may be so abnormal as to require treatment as current
period charges. SFAS 151 requires that allocation of fixed production
overheads to the costs of conversion be based on the normal capacity of the
production
25
facilities. The adoption of SFAS 151 is not expected to have a material
impact on the valuation of the Company's inventory or operating results.
26
ITEM 8. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
Not applicable.
ITEM 8A. CONTROLS AND PROCEDURES
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 Rule 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 recorded, processed, summarized and reported
within the time periods specified in SEC rules and forms.
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 and that has materially affected, or is reasonable likely
to materially affect, the Company's internal control over financial reporting.
ITEM 8B. OTHER INFORMATION
None.
PART III
ITEM 9. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
The information included in the Company's definitive proxy statement for
the 2006 Annual Meeting of Shareholders under the captions "Election of
Directors," "Executive Officers" and "Section 16(a) Beneficial Ownership
Reporting Compliance" is incorporated by reference. The following information
completes the Company's response to this Item 9.
The Company has adopted a code of ethics that applies to the Company's
Chief Executive Officer, Chief Financial Officer, Controller and other employees
performing similar functions. This code of ethics is filed as Exhibit 14 to this
report. The Company intends to satisfy the disclosure requirement under Item 10
of Form 8-K regarding an amendment to, or a waiver from, this code of ethics by
posting such information on its Web site which is located at www.ikonics.com.
ITEM 10. EXECUTIVE COMPENSATION
The information included in the Company's definitive proxy statement for
the 2006 Annual Meeting of Shareholders under the captions "Election of
Directors--Director Compensation," "Summary Compensation Table," "Option Grants
in Last Fiscal Year," "Aggregate Option Exercises in Last Fiscal Year and Fiscal
Year-End Option Values" and "Employment Contracts; Termination of Employment and
Change-In-Control Arrangements" is incorporated by reference.
ITEM 11. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND
RELATED STOCKHOLDER MATTERS
The information included in the Company's definitive proxy statement for
the 2006 Annual Meeting of Shareholders under the captions "Security Ownership
of Principal Shareholders and Management" and "Equity Compensation Plan
Information is incorporated by reference in response to this Item 11.
27
ITEM 12. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The information included in the Company's definitive proxy statement for
the 2006 Annual Meeting of Shareholders under the caption "Certain Relationships
and Related Transactions" is incorporated by reference.
ITEM 13. EXHIBITS
The following exhibits are filed as part of this Annual Report on Form
10-KSB for the fiscal year ended December 31, 2005:
Exhibit Description
------- -----------
3.1 Restated Articles of Incorporation of Company, as amended.
(Incorporated by reference to the like numbered Exhibit to the
Company's Registration Statement on Form 10-SB filed with the
Commission on April 7, 1999 (Registration No. 000-25727).)
3.2 By-Laws of the Company, as amended. (Incorporated by reference to the
like numbered Exhibit to the Company's Registration Statement on Form
10-SB filed with the Commission on April 7, 1999 (Registration No.
000-25727).)
4 Specimen of Common Stock Certificate. (Incorporated by reference to
the like numbered Exhibit to Amendment No. 1 to the Company's
Registration Statement on Form 10-SB filed with the Commission on May
26, 1999 (Registration No. 000-25727).)
10.1 IKONICS Corporation 1995 Stock Incentive Plan, as amended.
(Incorporated by reference to Exhibit B to the Company's proxy
statement for its 2004 Annual Meeting of Shareholders filed with the
Commission on March 29, 2004 (File No. 000-25727).)
10.2 2006 Bonus Program. (Incorporated by reference to the description of
this Program included in the Current Report on Form 8-K filed with
Commission on February 21, 2006 (File No. 000-25727).)
10.5 Revolving Credit Agreement dated April 30, 1999 between the Company
and M&I Bank. (Incorporated by reference to the like numbered Exhibit
to Amendment No. 1 to the Company's Registration Statement on Form
10-SB filed with the Commission on May 26, 1999 (Registration No.
000-25727).)
14 Code of Ethics. (Incorporated by reference to the like numbered
Exhibit to the Company's Annual Report on Form 10-KSB for the year
ended December 31, 2003 (File No. 000-25727).)
23 Consent of Independent Registered Public Accounting Firm
24 Powers of Attorney.
31.1 Rule 13a-14(a)/15d-14(a) Certifications of CEO.
31.2 Rule 13a-14(a)/15d-14(a) Certifications of CFO.
32 Section 1350 Certifications.
ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES
The information included in the Company's definitive proxy statement for
the 2006 Annual Meeting of Shareholders under the caption "Audit and Non-Audit
Fees" is incorporated by reference.
28
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the registrant has duly caused this report to be signed on
its behalf by the undersigned, thereunto duly authorized on March 21, 2006.
IKONICS CORPORATION
By /s/ William C. Ulland
-------------------------------------
William C. Ulland, Chairman,
Chief Executive Officer and President
Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following persons on behalf of the
registrant and in the capacities indicated on March 21, 2006.
/s/ William C. Ulland
-------------------------------------
William C. Ulland, Chairman, Chief
Executive Officer and President
(Principal Executive Officer)
/s/ Jon Gerlach
-------------------------------------
Jon Gerlach, Chief Financial Officer
and Vice President of Finance
(Principal Financial and Accounting
Officer)
-------------------------------------
Charles H. Andresen* Director
-------------------------------------
Rondi Erickson* Director
-------------------------------------
H. Leigh Severance* Director
-------------------------------------
Gerald W. Simonson* Director
-------------------------------------
David O. Harris* Director
----------
* William C. Ulland, by signing his name hereto, does hereby sign this
document on behalf of each of the above named Directors of the registrant
pursuant to powers of attorney duly executed by such persons.
/s/ William C. Ulland
----------------------------------------
William C. Ulland, Attorney-in-Fact
29
INDEX TO EXHIBITS
Exhibit Description Page
------- ----------- ----
3.1 Restated Articles of Incorporation of Company, as amended... Incorporated by Reference
3.2 By-Laws of the Company, as amended.......................... Incorporated by Reference
4 Specimen of Common Stock Certificate........................ Incorporated by Reference
10.1 IKONICS Corporation 1995 Stock Incentive Plan, as amended... Incorporated by Reference
10.2 2006 Bonus Program.......................................... Incorporated by Reference
10.5 Revolving Credit Agreement dated April 30, 1999 between the
Company and M&I Bank........................................ Incorporated by Reference
14 Code of Ethics.............................................. Incorporated by Reference
23 Consent of Independent Registered Public Accounting Firm... Filed Electronically
24 Powers of Attorney.......................................... Filed Electronically
31.1 Rule 13a-14(a)/15d-14(a) Certifications of CEO.............. Filed Electronically
31.2 Rule 13a-14(a)/15d-14(a) Certifications of CFO.............. Filed Electronically
32 Section 1350 Certifications................................. Filed Electronically