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, 2006
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: Common Stock, par
value $.10 per share
Securities registered under Section 12(g) of the Act: None
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: $14,888,912
The aggregate market value of the voting stock held by non-affiliates of
the registrant as of February 28, 2007 was $10,402,465, based on the closing
price for the issuer's Common Stock on such date as reported on the Nasdaq
Capital 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 -
2,017,430 issued and outstanding as of February 28, 2007.
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 2007 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 proprietary substrates for abrasive,
rotary and laser etching. The Company also markets inkjet receptive films,
ancillary chemicals, equipment and other consumables to provide a full line of
products and services to its customers. In 2006, the Company began to offer
custom etching services for silicon wafers, glass wafers and industrial ceramics
based on proprietary technology, and also began a research program with imaging
Technology international to develop digital imaging technologies for niche
industrial markets. The Company's products serve the screen printing, awards and
recognition, signage, electronics, and industrial ceramics markets, as well as
other industrial markets. On December 29, 2006, the Company acquired the image
mate(TM) line of screen print photochemical products and adhesives from Franklin
International. These products continue to be sold under the image mate brand,
primarily through established image mate distribution, although some cross
fertilization between the image mate and Chromaline brands may occur. In 2006,
the Company established the IKONICSImaging business unit, which comprises
PhotoBrasive Systems, serving the awards and recognition, and monument markets;
IKONSign Systems, serving the signage market; and Industrial Solutions, serving
industrial markets for glass, silicon, and ceramic etching, as well as providing
industrial inkjet technology.
PRODUCTS
IKONICS' core technology is the use of photochemicals to create masks or
stencils for the transfer of images. These images may be transferred using the
mask or stencil by ink through screen printing or by abrasive etching onto
various substrates. The Company also sells a proprietary metal composite
product, which can be etched using a laser, rotary engraver, or through abrasive
etching. In 2006, the Company began to produce digital image transfer technology
for certain industrial markets and applied for a related patent.
2
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
2006, 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, 2003 and 2006.
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 5.0% of sales ($742,000) on research and development in 2006
and 4.6% ($642,000) in 2005. 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 2007 and 2020. The Company also has ten 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. Over the past year, the Company has directed a larger portion of
it research and development resources towards industrial inkjettable fluids and
substrates.
In addition to its patents, the Company has various trademarks including
the "IKONICS," "Chromaline," "PhotoBrasive," "AccuArt," "Nichols" and "image
mate" trademarks. The "image mate" trademark was acquired as part of an asset
purchase from Franklin International during December 2006.
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.
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 awards and recognition
market, IKONICS commands significantly more market share in the latter. The
Company is actively
3
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. There are significant competitors, using
different technologies in new markets being entered by the Company.
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, 2007, the Company had approximately 70 full-time
employees, 66 of whom are located at the Company's headquarters in Duluth,
Minnesota and five 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.
4
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 and one in Duluth, Minnesota.
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.
5
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 Capital 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 Capital 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, 2006:
First Quarter ................... $ 8.33 $ 6.26
Second Quarter .................. 10.47 7.06
Third Quarter ................... 8.97 7.15
Fourth Quarter .................. 8.60 7.02
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
As of February 28, 2007, the Company had approximately 654 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 2006. 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 2006 and 2005 and should be read in connection with
the Company's audited financial statements and notes thereto for the years ended
December 31, 2006 and 2005.
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 costs related to Section 404 of the
Sarbanes-Oxley Act of 2002 should be higher in 2007--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.
- 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
6
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 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.
7
Deferred Tax Assets. At December 31, 2006, the Company had approximately
$145,000 of net deferred tax assets. The deferred tax assets result primarily
from temporary 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, 2006 COMPARED TO YEAR ENDED DECEMBER 31, 2005
Sales. The Company's net sales increased 6.6% to $14.9 million in 2006,
compared to net sales of $14.0 million in 2005. Sales increases were realized in
both international and domestic markets. International shipments grew 10.1%
mainly due to increased film shipments to Asia. The 5.1% domestic sales increase
was driven by both higher film and glass shipments.
Cost of Goods Sold. Cost of goods sold was $8.2 million, or 55.0% of sales,
in 2006 and $7.7 million, or 55.5% of sales, in 2005. The decrease in the cost
of sales as a percentage of sales during 2006 reflects a more favorable product
mix partially offset by rising raw material and transportation costs.
Selling, General and Administrative Expenses. Selling, general and
administrative expenses increased to $4.5 million, or 30.2% of sales, in 2006
from $4.4 million, or 31.3% of sales, in 2005. The 2006 increase was due to
$140,000 of additional trade show and advertising expenses. Salary, insurance
and pension costs also increased by $100,000. These cost increases were
partially offset by a $80,000 decrease in travel costs and a $20,000 decrease in
depreciation. The Company also incurred $40,000 in additional expenses related
to Sarbanes-Oxley compliance in 2005 as compared to 2006. The Company
anticipates that Sarbanes-Oxley compliance expenses will increase by $60,000 in
2007 as compared to 2006.
Research and Development Expenses. Research and development expenses were
$742,000, or 5.0% of sales, in 2006 compared to $642,000, or 4.6% of sales, in
2005. The increase is due to an increase in spending on new product development,
production trials, and additional research and development staff.
Interest Income. Interest income increased to $115,000 for 2006, compared
to $58,000 for 2005. The increase was primarily due to increased interest rates
and a larger average cash balance during the year.
Income Taxes. The income tax provision differs from the expected tax
expense primarily due to the benefits of the foreign sales exclusion, state
income taxes and federal tax credits for research and development. Income tax
expense in 2006 was $466,000, or an effective rate of 29.3%. Income tax expense
for 2005 was $348,000, or an effective rate of 27.7%. The lower effective rate
for 2005 was partially due to a study performed by the Company during 2005
related to its research and development activities resulting in tax credits
totaling $15,000. The Company also realized a larger benefit in 2005 related to
the foreign sales exclusion.
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 $3,428,000 and $3,412,000 at December 31,
2006 and 2005, respectively. The Company generated $1,076,000 in cash from
operating activities during 2006 compared to $980,000 of cash generated from
operating activities during 2005. Cash provided by operating activities is
primarily the result of net income adjusted for non-cash depreciation,
amortization, stock based compensation, deferred taxes, and certain changes in
working capital components discussed in the following paragraph.
8
During 2006, trade receivables increased by $274,000. The increase in
receivables is primarily related to higher sales. 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 $34,000 due
to higher raw material and finished goods inventory stock. Accounts payable
decreased by $150,000, reflecting the timing of payments to suppliers. Income
taxes payable increased by $74,000 as a result of the timing of estimated 2006
tax payments compared to the calculated 2006 tax liability.
The Company used $1,283,000 and $423,000 in cash for investing activities
during 2006 and 2005, respectively. During 2006, the Company invested $538,000
in imaging Technology international Corporation ("iTi") to acquire 69,166 common
shares. The Company owns 105,662 shares of iTi which represents 7% of the total
outstanding common shares of iTi. iTi is a leader in the development of
industrial production systems based on inkjet technology and the Company
believes iTi's expertise fits strategically with the Company's expertise in
developing substrates for inkjet printing and the Company's plans to develop
proprietary industrial inkjet technologies. On December 29, 2006, the Company
acquired the image mate(TM) line of screen printing products from Franklin
International for $533,000. Unaudited image mate sales in 2006 were estimated to
be $600,000. The acquisition included inventory, equipment, deposits under an
agreement to purchase key raw materials from Franklin International and an
agreement not to compete. The Company made $274,000 of property and equipment
purchases during 2006. 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 $28,000 in patent
application costs that it recorded as an asset and amortizes upon successful
completion of the application process. The Company received $84,000 during 2006
from the sale of marketable securities and $6,000 from the sale of an
automobile.
During 2005, the Company invested $253,000 in iTi to acquire 36,496 common
shares and warrants to purchase an additional 33,333 common shares of iTi. The
Company made $211,000 of property and equipment purchases during 2005 and
$12,000 in patent application costs. The Company received $43,000 during 2005
from the sale of marketable securities and $11,000 from the sale of automobiles.
The Company realized $223,000 in cash from financing activities during 2006
compared to $117,000 received in 2005. During 2006, the Company received
$186,000 for the issuance of 48,324 shares of common stock issued upon the
exercise of stock options compared to $233,000 received during 2005 for 57,491
shares of common stock issued upon the exercise of stock options. The Company
also realized a $37,000 cash benefit during 2006 related to the excess tax
benefit from 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, 2006. The line of credit was
also not utilized during 2005 and there were no borrowings outstanding under
this line as of December 31, 2005.
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
The Company spent $274,000 on capital expenditures during 2006. 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, research and development to improve measurement and quality
control processes and vehicles. These commitments are expected to be funded with
cash generated from operating activities.
9
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 30.4% of total sales during 2006 and 29.4% of total
sales in 2005. Foreign sales in 2006 reflect increased shipments to Asia.
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 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
December 31, 2006.
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 June 2006, the Financial Accounting Standards Board ("FASB") issued
Interpretation No. 48, Accounting for Uncertainty in Income Taxes ("FIN 48").
FIN 48 clarifies the accounting for uncertainty in income taxes recognized in an
enterprise's financial statements in accordance with FASB Statement No. 109,
Accounting for Income Taxes. FIN 48 prescribes a recognition threshold and
measurement attribute for the financial statement recognition and measurement of
a tax position taken or expected to be taken in a tax return. FIN 48 also
provides guidance on derecognition, classification, interest and penalties,
accounting in interim periods, disclosure and transition. FIN 48 will be
effective for the Company beginning in fiscal 2007. The Company does not expect
this interpretation will have a material effect on its financial statements and
related disclosures.
In September 2006, the FASB issued SFAS No. 157, Fair Value Measurements
("SFAS 157"). SFAS 157 defines fair value, establishes a framework for measuring
fair value in generally accepted accounting principles, and expands disclosures
about fair value measurements. This Statement applies under other accounting
pronouncements that require or permit fair value measurements, the FASB having
previously concluded in those accounting pronouncements that fair value is the
relevant measurement attribute. Accordingly, SFAS 157 does not require any new
fair value measurements. SFAS 157 is effective for the Company beginning in
fiscal year 2008. The Company is evaluating the statement to determine the
effect on its financial statements and related disclosures.
10
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,
2006 and 2005, 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, 2006 and 2005, and the results of its operations and its cash flows
for the years then ended in conformity with U.S. generally accepted accounting
principles.
As discussed in Note 1 to the financial statements, effective January 1, 2006
the Company adopted Statement of Financial Accounting Standards No. 123 (Revised
2004), "Share-Based Payment".
/s/ McGladrey & Pullen, LLP
Duluth, Minnesota
March 21, 2007
11
IKONICS CORPORATION
BALANCE SHEETS
DECEMBER 31, 2006 AND 2005
2006 2005
----------- ----------
ASSETS
CURRENT ASSETS:
Cash and cash equivalents $ 3,428,186 $3,412,072
Marketable securities -- 84,875
Trade receivables, less allowance for doubtful
accounts of $50,000 (Note 10) 1,976,893 1,702,608
Inventories (Notes 1 and 10) 2,494,876 2,364,056
Deposits, prepaid expenses and other assets (Note 3) 232,255 65,747
Deferred income taxes (Note 2) 97,000 99,000
----------- ----------
Total current assets 8,229,210 7,728,358
----------- ----------
PROPERTY, PLANT, AND EQUIPMENT, at cost:
Land and building 1,500,271 1,479,824
Machinery and equipment 2,396,867 2,531,734
Office equipment 817,406 1,280,149
Vehicles 203,816 174,803
----------- ----------
4,918,360 5,466,510
Less accumulated depreciation 3,926,440 4,514,945
----------- ----------
991,920 951,565
----------- ----------
INTANGIBLE ASSETS, less accumulated amortization of $159,351 in
2006 and $134,642 in 2005 (Notes 3 and 4) 485,421 279,086
DEFERRED INCOME TAXES (Note 2) 48,000 61,000
INVESTMENTS IN NON-MARKETABLE EQUITY SECURITIES (Note 1) 988,910 450,790
----------- ----------
$10,743,461 $9,470,799
=========== ==========
12
IKONICS CORPORATION
BALANCE SHEETS
DECEMBER 31, 2006 AND 2005
2006 2005
----------- ----------
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES:
Accounts payable $ 288,449 $ 438,597
Accrued compensation 324,082 279,042
Other accrued expenses 172,381 217,912
Income taxes payable 94,450 56,743
----------- ----------
Total current liabilities 879,362 992,294
----------- ----------
COMMITMENTS AND CONTINGENCIES (Note 4)
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 2,010,861 shares
in 2006 and 1,962,537 shares in 2005 201,086 196,254
Additional paid-in capital 1,979,012 1,721,119
Retained earnings 7,684,001 6,560,236
Accumulated other comprehensive income -- 896
----------- ----------
Total stockholders' equity 9,864,099 8,478,505
----------- ----------
$10,743,461 $9,470,799
=========== ==========
See notes to financial statements.
13
IKONICS CORPORATION
STATEMENTS OF OPERATIONS
YEARS ENDED DECEMBER 31, 2006 AND 2005
2006 2005
----------- -----------
NET SALES (Note 6) $14,888,912 $13,971,217
COSTS AND EXPENSES:
Cost of goods sold 8,181,814 7,748,707
Selling, general and administrative 4,490,381 4,383,144
Research and development 742,406 641,622
----------- -----------
13,414,601 12,773,473
----------- -----------
INCOME FROM OPERATIONS 1,474,311 1,197,744
INTEREST INCOME 115,454 58,425
----------- -----------
INCOME BEFORE INCOME TAXES 1,589,765 1,256,169
FEDERAL AND STATE INCOME TAXES (Note 2) 466,000 348,000
----------- -----------
NET INCOME $ 1,123,765 $ 908,169
=========== ===========
EARNINGS PER COMMON SHARE:
Basic $ 0.56 $ 0.47
=========== ===========
Diluted $ 0.55 $ 0.46
=========== ===========
WEIGHTED AVERAGE COMMON SHARES:
Basic 2,000,017 1,944,330
=========== ===========
Diluted 2,027,916 1,986,885
=========== ===========
See notes to financial statements.
14
IKONICS CORPORATION
STATEMENTS OF STOCKHOLDERS' EQUITY AND COMPREHENSIVE INCOME
YEARS ENDED DECEMBER 31, 2006 AND 2005
ACCUMULATED TOTAL
COMMON STOCK ADDITIONAL OTHER STOCK-
-------------------- PAID-IN RETAINED COMPREHENSIVE HOLDERS'
SHARES AMOUNT CAPITAL EARNINGS INCOME (LOSS) EQUITY
--------- -------- ----------- ---------- ------------- ----------
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
Net income -- -- -- 1,123,765 -- 1,123,765
Unrealized loss on available-for-sale securities -- -- -- -- (896) (896)
----------
Total comprehensive income -- -- -- -- -- 1,122,869
Exercise of stock options 48,324 4,832 181,503 -- -- 186,335
Tax benefit resulting from stock option exercises -- -- 14,055 -- -- 14,055
Stock based compensation and related tax benefit -- -- 62,335 -- -- 62,335
--------- -------- ----------- ---------- ------- ----------
BALANCE AT DECEMBER 31, 2006 2,010,861 $201,086 $1,979,012, $7,684,001 $ -- $9,864,099
========= ======== =========== ========== ======= ==========
See notes to financial statements.
15
IKONICS CORPORATION
STATEMENTS OF CASH FLOWS
YEARS ENDED DECEMBER 31, 2006 AND 2005
2006 2005
----------- ----------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income $ 1,123,765 $ 908,169
Adjustments to reconcile net income to net cash provided by
operating activities:
Depreciation 242,833 269,549
Amortization 24,710 24,914
Excess tax benefit from share-based payment arrangement (36,712) --
Tax benefit from stock option exercise 14,055 35,781
Stock based compensation 25,623 --
(Gain) Loss on sale of vehicles (640) 7,992
Deferred income taxes 15,000 48,000
Changes in working capital components, net of effects of
business acquisition:
Trade receivables (274,285) (59,704)
Inventories 34,101 (162,774)
Prepaid expenses and other assets (16,508) (8,402)
Accounts payable (150,148) (97,794)
Accrued expenses (491) (12,258)
Income taxes payable 74,419 26,574
----------- ----------
Net cash provided by operating activities 1,075,722 980,047
----------- ----------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchases of property and equipment (273,548) (211,276)
Proceeds on sale of vehicles 6,000 11,000
Business acquisition (Note 3) (532,921) --
Purchase of intangibles (28,045) (11,651)
Purchase of non-marketable equity securities (538,120) (253,330)
Proceeds from sale of marketable securities 83,979 42,695
----------- ----------
Net cash used in investing activities (1,282,655) (422,562)
----------- ----------
CASH FLOWS FROM FINANCING ACTIVITIES:
Excess tax benefit from share-based payment arrangement 36,712 --
Proceeds from exercise of stock options 186,335 232,791
Redemption of common stock -- (115,664)
----------- ----------
Net cash provided by financing activities 223,047 117,127
----------- ----------
NET INCREASE IN CASH AND CASH EQUIVALENTS 16,114 674,612
CASH AND CASH EQUIVALENTS AT BEGINNING OF YEAR 3,412,072 2,737,460
----------- ----------
CASH AND CASH EQUIVALENTS AT END OF YEAR $ 3,428,186 $3,412,072
=========== ==========
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION
Cash paid for income taxes $ 362,526 $ 237,645
=========== ==========
See notes to financial statements.
16
IKONICS CORPORATION
NOTES TO FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 2006 AND 2005
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Description of Business and Foreign Sales - 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.
Foreign sales approximated 30.4% of total sales in 2006 and 29.4% of total
sales in 2005. Thirty-nine percent and forty-four percent, respectively, of
the Company's accounts receivable at December 31, 2006 and 2005 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 2006 or in 2005.
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 types of instruments approximate market value because of the short
maturity of these instruments.
Marketable Securities - Marketable securities were classified as
available-for-sale and consist primarily of municipal revenue bonds that
were 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 were carried at fair market value with
changes in fair value, net of tax, recorded in other comprehensive income.
There were no marketable securities at December 31, 2006.
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.
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 $535,000
and $509,000 higher than reported at December 31, 2006 and 2005,
respectively. The major components of inventories are as follows:
2006 2005
---------- ----------
Raw materials $1,577,165 $1,483,881
Work-in-progress 225,033 212,254
Finished goods 1,227,806 1,176,647
Reduction to LIFO cost (535,128) (508,726)
---------- ----------
Total inventories $2,494,876 $2,364,056
========== ==========
17
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 3-10
Vehicles 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 agreement terms. Remaining estimated useful lives on intangible
assets range from 5 to 14 years. 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
of the intangibles to their 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 $791,450 investment in
imaging Technology international ("iTi"). The Company acquired an
additional 69,166 common shares of iTi during 2006. The Company currently
owns 105,662 common shares of iTi which represents 7% of the total
outstanding common shares of iTi. iTi is a leader in the development of
industrial production systems based on inkjet technology and the Company
believes iTi's expertise fits strategically with the Company's expertise in
developing substrates for inkjet printing and its plan to develop
proprietary industrial inkjet technology. The Company has a $197,460 equity
investment in Apprise Technologies, Inc. As of December 31, 2006, the
Company's ownership of Apprise's common and preferred stock represented
approximately 4.95% of the outstanding shares of Apprise. 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. During February 2007,
Apprise was acquired by Eco Lab Incorporated for cash. The Company realized
a gain of approximately $55,000 on the first payment from the transaction.
The Company also expects to receive an additional $40,000 in 2008 at which
time an additional gain will be recognized. Cash received in February 2007
was $253,000.
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 approximated their estimated fair value
based on management's knowledge of recent sales prices of the
non-marketable equity securities.
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.
18
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:
2006 2005
--------- ---------
Weighted average common shares outstanding 2,000,017 1,944,330
Dilutive effect of stock options 27,899 42,555
--------- ---------
Weighted average common and common
equivalent shares outstanding 2,027,916 1,986,885
========= =========
Options to purchase 88,222 and 130,285 shares of common stock were
outstanding as of December 31, 2006 and 2005, respectively.
Employee Stock Plan - Effective January 1, 2006, the Company adopted
Financial Accounting Standards Board Statement No. 123 (revised 2004),
"Share-Based Payment," (FAS 123(R)) using the
modified-prospective-transition method. Prior to the adoption of FAS
123(R), we accounted for stock option grants under APB Opinion No. 25,
"Accounting for Stock Issued to Employees" (the intrinsic value method),
and accordingly recognized no compensation expense for stock option grants.
Under the modified-prospective-transition method, FAS 123(R) applies to new
awards and to awards that were outstanding on January 1, 2006 that are
subsequently modified, repurchased, or cancelled. Under this method
compensation cost in 2006 includes cost for options granted prior to but
not vested as of December 31, 2005, and options granted in 2006. Prior
periods were not restated to reflect the impact of adopting the new
standard.
The adoption of FAS 123(R) lowered net income by approximately $25,600 for
the year ended December 31, 2006, compared to accounting for share-based
compensation under APB No. 25. The Company has elected the alternative
(short-cut) method for calculating the pool of excess tax benefits (APIC
Pool) available to absorb tax shortages recognized subsequent to the
adoption of FAS 123(R). The Company's calculation of the APIC windfall at
January 1, 2006 was $3,000.
The following table illustrates the effect on net income and earnings per
share if we had applied the fair value recognition provisions of FAS 123(R)
during the period prior to its effective date. For the purposes of this pro
forma disclosure, the value of the options is estimated using a
Black-Scholes option-pricing model and amortized to expense over the
vesting periods of the options.
19
Year Ended
December 31,
2005
------------
Net income:
As reported $908,169
Deduct total stock-based employee compensation
expense determined under fair value based
method for all awards 21,214
--------
Pro forma $886,955
========
Basic earnings per common share:
As reported $ 0.47
Pro forma $ 0.46
Diluted earnings per common share:
As reported $ 0.46
Pro forma $ 0.45
As of December 31, 2006, there was approximately $36,000 of unrecognized
compensation cost related to unvested share-based compensation awards
granted. That cost is expected to be recognized over the next three years.
The Company receives a tax deduction for certain stock option exercises
during the period in which the options are exercised, generally for the
excess of the prices at which the option shares are sold over the exercise
price of the options. Prior to the adoption of FAS 123(R), the Company
reported all tax benefits relating to the exercise of stock options as
operating cash flows in our statement of cash flows. In accordance with FAS
123(R), for the year ended December 31, 2006, we began reporting the excess
tax benefits from the exercise of stock options as a reduction of operating
and an increase in financing cash flows. For the year ended December 31,
2006, $36,712 of excess tax benefits was reported in the statement of cash
flows.
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 2006
and 2005.
20
2. INCOME TAXES
Income tax expense for the years ended December 31, 2006 and 2005 consists
of the following:
2006 2005
-------- --------
Current:
Federal $401,000 $262,000
State 50,000 38,000
-------- --------
451,000 300,000
Deferred 15,000 48,000
-------- --------
$466,000 $348,000
======== ========
The expected provision for income taxes, computed by applying the U.S.
federal income tax rate of 35% in 2006 and 2005 to income before taxes, is
reconciled to income tax expense as follows:
2006 2005
-------- --------
Expected provision for federal income taxes $556,400 $439,700
State income taxes, net of federal benefit 36,300 25,700
Extraterritorial income exclusion (49,400) (64,700)
Domestic manufacturers deduction (11,100) --
Non-deductible meals and entertainment 16,400 13,600
Tax-exempt interest (39,000) (18,100)
R&D Credit (13,600) (29,000)
Other (30,000) (19,200)
-------- --------
$466,000 $348,000
======== ========
Deferred tax assets consist of the following as of December 31, 2006 and
2005:
2006 2005
-------- --------
Property and equipment and other assets $ 38,000 $ 40,000
Accrued vacation 19,000 14,000
Other accrued expenses 49,000 47,000
Inventories 12,000 20,000
Allowance for doubtful accounts 18,000 18,000
Allowance for sales returns 7,000 7,000
Intangible assets 10,000 21,000
Capital loss carryforward 27,000 27,000
-------- --------
180,000 194,000
Less valuation allowance (27,000) (27,000)
-------- --------
153,000 167,000
Deferred tax liabilities:
Prepaid expenses 8,000 7,000
-------- --------
$145,000 $160,000
======== ========
The deferred tax amounts described above have been included in the
accompanying balance sheet as of December 31, 2006 and 2005 as follows:
2006 2005
-------- --------
Current assets $ 97,000 $ 99,000
Noncurrent assets 48,000 61,000
-------- --------
$145,000 $160,000
======== ========
21
3. PURCHASE OF ASSETS
On December 29, 2006, the Company acquired certain assets of Franklin
International Inc. (Franklin) related to the image mate (TM) line of screen
printing products. The acquisition was accounted for under the purchase
method of accounting. Accordingly, the assets acquired were recorded at
their fair market value. The assets acquired include lab equipment, raw
materials and finished goods inventory, and a non-compete agreement with
Franklin. The costs allocated to the non-compete agreement will be
amortized on a straight-line basis over its seven year term. In connection
with the acquisition, the Company entered into an agreement to prepay for
inventory purchases from Franklin, which are expected to be utilized over
three years.
The fair market value of the assets acquired resulted in the following
purchase price allocation:
Cash price paid for assets $528,921
Acquisition costs incurred 4,000
--------
Total purchase price $532,921
========
Purchase Price Allocation
Inventory $164,921
Deposit for inventory purchases 150,000
Equipment 15,000
Noncompete agreement 203,000
--------
$532,921
========
If the acquisition had occurred on January 1, 2005, the unaudited pro forma
impact on revenues would have been to increase revenues by approximately
$600,000 for each of the years ended December 31, 2005 and 2006. The
unaudited proforma net income and earnings per common share would not have
been significant to the amounts reported in the Company's financial
statements for such years.
4. 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, 2006.
Intangible assets at December 31, 2006 and 2005 consist of the following:
December 31, 2006 December 31, 2005
----------------------------- -----------------------------
Gross Carrying Accumulated Gross Carrying Accumulated
Amount Amortization Amount Amortization
-------------- ------------ -------------- ------------
Amortized intangible assets:
Patents $241,773 $ (81,022) $213,728 $ (71,102)
Licenses 100,000 (35,000) 100,000 (26,875)
Non-compete agreement 303,000 (43,330) 100,000 (36,664)
-------- --------- -------- ---------
$644,773 $(159,352) $413,728 $(134,642)
======== ========= ======== =========
2006 2005
------- -------
Aggregate amortization expense:
For the year ended December 31 $24,710 $24,914
22
Estimated amortization expense for the year ended December 31:
2007 $53,710
2008 53,710
2009 53,710
2010 53,710
2011 53,710
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 $119,000 of expense under these
agreements during 2006, and $108,000 during 2005.
5. RETIREMENT 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 retirement expense for the
years ended December 31, 2006 and 2005 was approximately $163,000 and
$150,000, respectively.
6. SEGMENT INFORMATION
The Company's reportable segments are strategic business units that offer
different products and have a varied customer base. There are three
reportable segments: Domestic, Export, and IKONICS Imaging. Domestic sells
screen printing film, emulsions, and inkjet receptive film which is sold to
distributors located in the United States. IKONICS Imaging sells photo
resistant film, art supplies, glass, metal medium and related abrasive
etching equipment to end user customers located in the United States. It is
also entering the market for etched ceramics, glass and silicon wafers; and
is developing and selling proprietary inkjet technology. Export sells
primarily the same products as Domestic and IKONICS Imaging to foreign
customers. The accounting policies applied to determine the segment
information are the same as those described in the summary of significant
accounting policies.
Management evaluates the performance of each segment based on the
components of divisional income, and with the exception for accounts
receivable, does not allocate assets and liabilities to segments. Financial
information with respect to the reportable segments follows:
For the year ended December 31, 2006
IKONICS
DOMESTIC EXPORT** IMAGING OTHER TOTAL
---------- ---------- ---------- ---------- -----------
Net sales $5,777,987 $4,531,605 $4,579,320 $ -- $14,888,912
Cost of good sold 3,803,598 2,955,011 2,143,205 -- 8,181,814
Selling, general and
administrative* 965,695 395,619 1,479,464 1,649,603 4,490,381
Accounts receivable 842,144 780,599 384,748 (30,598) 1,976,893
For the year ended December 31, 2005
IKONICS
DOMESTIC EXPORT** IMAGING OTHER TOTAL
---------- ---------- ---------- ---------- -----------
Net sales $5,512,880 $4,115,198 $4,343,139 $ -- $13,971,217
Cost of good sold 3,071,175 2,669,605 2,007,927 -- 7,748,707
Selling, general and
administrative* 935,424 445,852 1,381,117 1,620,751 4,383,144
Accounts receivable 696,615 748,002 290,305 (32,314) 1,702,608
23
* The company does not allocate all general and administrative expenses to
its operating segments for internal reporting.
** In 2006 and 2005, 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 2006 and 2005.
30.4% and 29.4%, respectively, of the Company's net sales at December 31,
2006 and 2005 are from foreign customers.
7. 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 55,673 shares of common stock are reserved for
additional grants of options under the plan at December 31, 2006.
Under the plan, the Company charged compensation cost of $25,623 against
income and recognized a total income tax benefit in the income statement of
$26,482 for 2006. No compensation cost or income tax benefit was recognized
in the income statement for share-based compensation in 2005.
The fair value of share-based payment awards was estimated using the
Black-Scholes option pricing model with the following assumptions:
2006 2005
------------ ----------
Dividend yield 0.0% 0.0%
Expected volatility 60.6 - 63.0% 63.2%
Expected life of option five years five years
Risk-free interest rate 4.8-5.0% 3.9%
A summary of the status of the Company's stock option plan as of December
31, 2006 and changes during the year then ended is presented below:
Weighted
Average
Weighted Remaining Aggregate
Average Contractual Intrinsic
Options Shares Exercise Price Term (years) Value
------- -------- -------------- ------------ ---------
Outstanding at January 1, 2006 130,285 $3.27
Granted 7,250 8.03
Exercised (48,324) 3.86
Expired and forfeited (989) 4.50
------- -----
Outstanding at December 31, 2006 88,222 3.33 1.55 $392,710
======= ===== ==== ========
Vested or expected to vest at December 31, 2006 87,722 3.33 1.55 $392,710
======= ===== ==== ========
Exercisable at December 31, 2006 73,888 $2.75 1.12 $370,356
======= ===== ==== ========
24
The weighted-average grant-date fair value of options granted was $4.58 and
$2.44 for the years ended December 31, 2006 and 2005, respectively. The
total intrinsic value of options exercised was $227,175 and $109,345 for
the years ended December 31, 2006 and 2005, respectively.
The following table summarizes information about stock options outstanding
at December 31, 2006:
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 2006 Life (years) Price 2006 Price
-------- -------------- ------------ --------- -------------- ---------
$2.00 - 2.99 58,222 0.89 $2.44 58,222 $2.44
3.00 - 3.99 11,250 1.59 3.36 11,250 3.36
4.00 - 4.99 9,250 3.32 4.32 2,916 4.32
7.00 - 7.99 9,500 3.79 7.79 1,500 7.01
------ ---- ----- ------ -----
88,222 1.55 $3.33 73,888 $2.75
====== ==== ===== ====== =====
8. CONCENTRATION OF CREDIT RISK
The Company maintains its cash balances primarily in one financial
institution. As of December 31, 2006, 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 accounted for more than 10%
of total receivables as of December 31, 2006.
9. 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 $21,000 in 2006 and $30,000 in 2005. On February 1, 2007 the
Company entered into a one year lease agreement for additional warehouse
space at a cost of $5,750 per month or $69,000 per year.
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, 2006 and
2005.
11. ACCOUNTING PRONOUNCEMENTS
In June 2006, the Financial Accounting Standards Board (FASB) issued
Interpretation No. 48, Accounting for Uncertainty in Income Taxes (FIN 48).
FIN 48 clarifies the accounting for uncertainty in income taxes recognized
in an enterprise's financial statements in accordance with FASB Statement
No. 109, Accounting for Income Taxes. FIN
25
48 prescribes a recognition threshold and measurement attributes for the
financial statement recognition and measurement of a tax position taken or
expected to be taken in a tax return. FIN 48 also provides guidance on
derecognition, classification, interest and penalties, accounting in
interim periods, disclosure and transition. FIN 48 will be effective for
the Company beginning in fiscal 2007. Management does not expect this
interpretation will have a material effect on the Company's financial
statements and related disclosures.
In September 2006, the FASB issued SFAS No. 157, Fair Value Measurements
(SFAS 157). SFAS 157 defines fair value, establishes a framework for
measuring fair value in generally accepted accounting principles, and
expands disclosures about fair value measurements. This Statement applies
under other accounting pronouncements that require or permit fair value
measurements, the FASB having previously concluded in those accounting
pronouncements that fair value is the relevant measurement attribute.
Accordingly, SFAS 157 does not require any new fair value measurements.
SFAS 157 is effective for the Company beginning in fiscal year 2008.
Management is evaluating the statement to determine the effect, if any, on
the financial statements and related disclosures.
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 (a) recorded, processed, summarized and
reported within the time periods specified in SEC rules and forms and (b)
accumulated and communicated to the Company's management, including the
principal executive officer and principal financial officer, 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 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 2007 Annual Meeting of Shareholders under the captions "Election of
Directors--Director Compensation," "Summary Compensation Table," "Outstanding
Equity Awards at Fiscal Year-End" 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 2007 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, AND DIRECTOR
INDEPENDENCE
The information included in the Company's definitive proxy statement for
the 2006 Annual Meeting of Shareholders under the captions "Certain
Relationships and Related Transactions" and "Election Directors" 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, 2006:
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 Current Report on Form 8-K
filed with the Commission on February 22, 2007 (File 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).)
10.5 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, 2007.
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, 2007.
/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
10.5 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