Table of Contents

 



 

U.S. SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

  

FORM 10-Q

(Mark One)

  

Quarterly Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934

Quarterly Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934

  

For the Quarterly Period Ended September 30, 20172018

  

oror

  

Transition Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934

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

incorporation or organization)

(I.R.S. employer

identification no.)

 

 

4832 Grand Avenue

Duluth, Minnesota

55807

(Address of principal executive offices)

(Zip code)

(218) 628-2217

Registrant’s telephone number

  

Not Applicable

(Former name, former address and former fiscal year, if changed since last report)

  

Check whether the issuer (1) filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.  Yes ☒  No ☐

  

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files.)  Yes ☒  No ☐

  

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).  Yes ☐  No ☒

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act.

  

Large accelerated filer ☐

Accelerated filer ☐

Non-accelerated filer (Do not check if a smaller reporting company)

Smaller reporting company ☒

 

Emerging growth company  

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act.

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ☐  No ☒

  

State the number of shares outstanding of each of the issuer’s classes of common equity, as of the latest practicable date: Common Stock, $.10 par value per share - 1,992,0531,983,553 shares outstanding as of November 4, 2017.1, 2018.

 




Table of Contents

IKONICS Corporation

  

QUARTERLY REPORT ON FORM 10-Q

  

 

 

PAGE NO.

PART I.

FINANCIAL INFORMATION

 

 

 

 

Item 1.

 

Condensed Financial StatementsStatements::

 

 

 

 

 

 

 

Condensed Balance Sheets as of September 30, 20172018 (unaudited) and December 31, 20162017

1

 

 

 

 

 

 

Condensed Statements of Operations for the Three Months and Nine Months Ended September 30, 20172018 and 20162017 (unaudited)

2

 

 

 

 

 

 

Condensed Statements of Cash Flows for the Nine Months Ended September 30, 20172018 and 20162017 (unaudited)

3

 

 

 

 

 

 

Notes to Condensed Financial Statements (unaudited)

4

 

 

 

 

Item 2.

 

Management’s Discussion and Analysis of Financial Condition and Results of Operations

9

12

 

 

 

 

Item 3.

 

Quantitative and Qualitative Disclosures about Market Risk

15

19

 

 

 

 

Item 4.

 

Controls and Procedures

15

19

 

 

 

PART II.

OTHER INFORMATION

16

20

 

 

 

 

SIGNATURES

21

  

  

2



Table of Contents

PART I - FINANCIAL INFORMATION

  

ITEM 1.  Condensed Financial Statements

  

IKONICS CORPORATION

CONDENSED BALANCE SHEETS

 

 

 

 

 

 

 

 

September 30,

 

December 31,

 

 

September 30,

  

December 31,

 

    

2017

    

2016

 

 

2018

  

2017

 

 

 

(unaudited)

 

 

 

 

 

(unaudited)

     

ASSETS

 

 

 

 

 

 

 

        

CURRENT ASSETS:

 

 

 

 

 

 

 

        

Cash and cash equivalents

 

$

2,001,244

 

$

1,048,713

 

 $1,559,725  $929,700 

Short-term investments

 

 

1,915,000

 

 

3,246,000

 

  2,695,000   2,895,000 

Trade receivables, less allowance of $52,000 in 2017 and $54,000 in 2016

 

 

1,644,232

 

 

2,336,501

 

Trade receivables, less allowance of $58,000 in 2018 and $53,000 in 2017

  1,975,741   2,190,260 

Inventories

 

 

2,546,309

 

 

1,986,172

 

  2,270,890   2,086,065 

Prepaid expenses and other assets

 

 

104,209

 

 

361,905

 

  210,570   168,242 

Income taxes receivable

 

 

327,733

 

 

66,181

 

  10,208   2,116 

Total current assets

 

 

8,538,727

 

 

9,045,472

 

  8,722,134   8,271,383 

PROPERTY, PLANT, AND EQUIPMENT, at cost:

 

 

 

 

 

 

 

        

Land and building

 

 

9,202,715

 

 

9,189,743

 

  9,507,589   9,207,790 

Machinery and equipment

 

 

4,980,101

 

 

4,884,814

 

  5,110,666   4,968,595 

Office equipment

 

 

1,600,760

 

 

1,566,856

 

  1,583,524   1,573,191 

Vehicles

 

 

245,679

 

 

272,144

 

  245,679   245,679 

 

 

16,029,255

 

 

15,913,557

 

  16,447,458   15,995,255 

Less accumulated depreciation

 

 

(7,561,542)

 

 

(7,001,162)

 

  (8,232,338)  (7,693,594)

 

 

8,467,713

 

 

8,912,395

 

INTANGIBLE ASSETS, less accumulated amortization of $168,511 in 2017 and $149,072 in 2016

 

 

351,108

 

 

338,127

 

 

$

17,357,548

 

$

18,295,994

 

Total property, plant, and equipment, at cost

  8,215,120   8,301,661 

INTANGIBLE ASSETS, less accumulated amortization of $143,643 as of September 30, 2018 and $174,991 as of December 31, 2017

  368,823   351,186 

Total assets

 $17,306,077  $16,924,230 

LIABILITIES AND STOCKHOLDERS' EQUITY

 

 

 

 

 

 

 

        

CURRENT LIABILITIES

 

 

 

 

 

 

 

        

Current portion of long-term debt, net

 

$

129,995

 

$

127,303

 

 $128,247  $130,899 

Accounts payable

 

 

800,698

 

 

730,386

 

  711,016   321,860 

Accrued compensation

 

 

235,340

 

 

388,600

 

  244,333   360,554 

Other accrued liabilities

 

 

116,094

 

 

67,088

 

  253,282   62,468 

Total current liabilities

 

 

1,282,127

 

 

1,313,377

 

  1,336,878   875,781 

LONG-TERM LIABILITIES

 

 

 

 

 

 

 

        

Long-term debt, less current portion, net

 

 

2,979,614

 

 

3,077,457

 

  2,854,529   2,946,518 

Deferred income taxes

 

 

446,000

 

 

446,000

 

  156,839   144,000 

Total long-term liabilities

 

 

3,425,614

 

 

3,523,457

 

  3,011,368   3,090,518 

Total liabilities

 

 

4,707,741

 

 

4,836,834

 

  4,348,246   3,966,299 

COMMITMENTS AND CONTINGENCIES

 

 

 

 

 

 

 

        

STOCKHOLDERS’ EQUITY

 

 

 

 

 

 

 

        

Preferred stock, par value $.10 per share; authorized 250,000 shares; none issued

 

 

 —

 

 

 —

 

      

Common stock, par value $.10 per share; authorized 4,750,000 shares; issued and outstanding 1,992,053 shares in 2017 and 2,018,753 shares in 2016

 

 

199,205

 

 

201,875

 

Additional paid-in-capital

 

 

2,714,861

 

 

2,732,006

 

Common stock, par value $.10 per share; authorized 4,750,000 shares; issued and outstanding 1,983,553 shares as of September 30, 2018 and December 31, 2017

  198,355   198,355 

Additional paid-in capital

  2,719,444   2,709,390 

Retained earnings

 

 

9,735,741

 

 

10,525,279

 

  10,040,032   10,050,186 

Total stockholders’ equity

 

 

12,649,807

 

 

13,459,160

 

  12,957,831   12,957,931 

 

$

17,357,548

 

$

18,295,994

 

Total liabilities and stockholders' equity

 $17,306,077  $16,924,230 

See notes to condensed financial statements.  

1

Table of Contents

IKONICS CORPORATION

CONDENSED STATEMENTS OF OPERATIONS (Unaudited)

  

Three Months Ended

  

Nine Months Ended

 
  September 30,  September 30, 
  

2018

  

2017

  

2018

  

2017

 
                 
NET SALES $4,651,358  $3,984,100  $13,357,013  $12,298,453 
                 
COST OF GOODS SOLD  3,124,539   2,660,149   8,805,460   8,441,010 
                 
GROSS PROFIT  1,526,819   1,323,951   4,551,553   3,857,443 
                 
SELLING, GENERAL AND ADMINISTRATIVE EXPENSES  1,368,845   1,305,455   4,026,791   4,209,705 
                 
RESEARCH AND DEVELOPMENT EXPENSES  179,915   168,686   490,463   519,160 
                 
INCOME (LOSS) FROM OPERATIONS  (21,941)  (150,190)  34,299   (871,422)
                 

INTEREST EXPENSE

  (23,298)  (20,832)  (67,040)  (62,475)
                 
OTHER  13,760   6,309   34,986   17,364 
                 
INCOME (LOSS) BEFORE INCOME TAXES  (31,479)  (164,713)  2,245   (916,533)
                 
INCOME TAX EXPENSE (BENEFIT)  (6,727)  (53,760)  12,399   (321,617)
                 
NET LOSS $(24,752) $(110,953) $(10,154) $(594,916)
                 
LOSS PER COMMON SHARE:                
Basic $(0.01) $(0.06) $(0.01) $(0.30)
Diluted $(0.01) $(0.06) $(0.01) $(0.30)
                 

WEIGHTED AVERAGE COMMON SHARES OUTSTANDING

                

Basic

  1,983,553   2,005,096   1,983,553   2,014,055 

Diluted

  1,983,553   2,005,096   1,983,553   2,014,055 

 

See notes to condensed financial statements.

 

1


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Table of Contents

IKONICS CORPORATION

CONDENSED STATEMENTS OF OPERATIONS (Unaudited)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

    

Three Months Ended

 

Nine Months Ended

 

 

    

September 30,

 

September 30,

 

 

    

2017

    

2016

    

2017

    

2016

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

NET SALES

 

$

3,984,100

 

$

4,607,501

 

$

12,298,453

 

$

12,817,289

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

COST OF GOODS SOLD

 

 

2,660,149

 

 

2,940,027

 

 

8,441,010

 

 

8,330,930

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

GROSS PROFIT

 

 

1,323,951

 

 

1,667,474

 

 

3,857,443

 

 

4,486,359

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

SELLING, GENERAL AND ADMINISTRATIVE EXPENSES

 

 

1,305,455

 

 

1,357,605

 

 

4,209,705

 

 

4,121,891

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

RESEARCH AND DEVELOPMENT EXPENSES

 

 

168,686

 

 

150,176

 

 

519,160

 

 

475,165

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

INCOME (LOSS) FROM OPERATIONS

 

 

(150,190)

 

 

159,693

 

 

(871,422)

 

 

(110,697)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

INTEREST EXPENSE

 

 

(20,832)

 

 

(21,721)

 

 

(62,475)

 

 

(36,720)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

OTHER

 

 

6,309

 

 

4,519

 

 

17,364

 

 

6,681

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

INCOME (LOSS) BEFORE INCOME TAXES

 

 

(164,713)

 

 

142,491

 

 

(916,533)

 

 

(140,736)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

INCOME TAX EXPENSE (BENEFIT)

 

 

(53,760)

 

 

60,225

 

 

(321,617)

 

 

(69,415)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

NET INCOME (LOSS)

 

$

(110,953)

 

$

82,266

 

$

(594,916)

 

$

(71,321)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

INCOME (LOSS) PER COMMON SHARE:

 

 

 

 

 

 

 

 

 

 

 

 

 

Basic

 

$

(0.06)

 

$

0.04

 

$

(0.30)

 

$

(0.04)

 

Diluted

 

$

(0.06)

 

$

0.04

 

$

(0.30)

 

$

(0.04)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

WEIGHTED AVERAGE COMMON SHARES OUTSTANDING

 

 

 

 

 

 

 

 

 

 

 

 

 

Basic

 

 

2,005,096

 

 

2,018,753

 

 

2,014,055

 

 

2,018,614

 

Diluted

 

 

2,005,096

 

 

2,018,842

 

 

2,014,055

 

 

2,018,614

 

See notes to condensed financial statements.

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Table of Contents

IKONICS CORPORATION

CONDENSED STATEMENTS OF CASH FLOWS (Unaudited)

  

 

 

 

 

 

 

 

    

Nine Months Ended

 

 

Nine Months Ended

 

 

September 30,

 

 

September 30,

 

 

2017

    

2016

 

 

2018

  

2017

 

 

 

 

 

 

 

 

        

CASH FLOWS FROM OPERATING ACTIVITIES:

 

 

 

 

 

 

 

        

Net loss

 

$

(594,916)

 

$

(71,321)

 

 $(10,154) $(594,916)

Adjustments to reconcile net loss to net cash provided by operating activities:

 

 

 

 

 

 

 

Adjustments to reconcile net loss to net cash provided by

        

Depreciation

 

 

634,648

 

 

552,885

 

  587,836   634,648 

Amortization

 

 

28,724

 

 

24,094

 

  27,463   28,724 

Stock based compensation

 

 

17,527

 

 

18,384

 

  10,054   17,527 

Net gain on sale and disposal of property, plant and equipment

 

 

(32,635)

 

 

(5,750)

 

     (32,635)

Deferred income taxes

  12,839    

Changes in working capital components:

 

 

 

 

 

 

 

        

Trade receivables

 

 

692,269

 

 

10,962

 

  214,519   692,269 

Inventories

 

 

(560,137)

 

 

40,672

 

  (184,825)  (560,137)

Prepaid expenses and other assets

 

 

257,696

 

 

(92,873)

 

  (42,328)  257,696 

Income tax receivable

 

 

(261,614)

 

 

31,234

 

  (8,092)  (261,614)

Accounts payable

 

 

70,312

 

 

326,996

 

  389,156   70,312 

Accrued expenses

 

 

(104,254)

 

 

(31,098)

 

  74,593   (104,254)

Net cash provided by operating activities

 

 

147,620

 

 

804,185

 

  1,071,061   147,620 

 

 

 

 

 

 

 

        

CASH FLOWS FROM INVESTING ACTIVITIES:

 

 

 

 

 

 

 

        

Purchases of property, plant, equipment and construction in progress

 

 

(189,966)

 

 

(1,966,150)

 

Purchases of property, plant, and equipment

  (501,295)  (189,966)

Proceeds from sale of property and equipment

 

 

32,635

 

 

21,000

 

     32,635 

Purchases of intangibles

 

 

(32,420)

 

 

(25,842)

 

Purchases of intangible assets

  (36,289)  (32,420)

Purchases of short-term investments

 

 

(1,915,000)

 

 

(3,399,000)

 

  (4,145,000)  (1,915,000)

Proceeds on sale of short-term investments

 

 

3,246,000

 

 

 —

 

  4,345,000   3,246,000 

Net cash provided by (used in) investing activities

 

 

1,141,249

 

 

(5,369,992)

 

  (337,584)  1,141,249 

 

 

 

 

 

 

 

        

CASH FLOWS FROM FINANCING ACTIVITIES:

 

 

 

 

 

 

 

        

Proceeds from long-term debt

 

 

 —

 

 

3,415,000

 

Payment of debt issuance costs

 

 

 —

 

 

(139,418)

 

Payments on long-term debt

 

 

(104,436)

 

 

(44,974)

 

  (103,452)  (104,436)

Repurchase of common stock

 

 

(233,787)

 

 

 —

 

     (233,787)

Proceeds from exercise of stock options

 

 

1,885

 

 

3,765

 

     1,885 

Net cash (used in) provided by financing activities

 

 

(336,338)

 

 

3,234,373

 

Net cash used in financing activities

  (103,452)  (336,338)

 

 

 

 

 

 

 

        

NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS

 

 

952,531

 

 

(1,331,434)

 

NET INCREASE IN CASH AND CASH EQUIVALENTS

  630,025   952,531 

 

 

 

 

 

 

 

        

CASH AND CASH EQUIVALENTS AT BEGINNING OF PERIOD

 

 

1,048,713

 

 

2,248,466

 

  929,700   1,048,713 

 

 

 

 

 

 

 

        

CASH AND CASH EQUIVALENTS AT END OF PERIOD

 

$

2,001,244

 

$

917,032

 

 $1,559,725  $2,001,244 

 

 

 

 

 

 

 

        

SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION

 

 

 

 

 

 

 

        

Construction in progress included in accounts payable

 

$

 —

 

$

8,778

 

Cash paid for interest

 

$

53,574

 

$

25,252

 

 $58,084  $53,574 

Cash received for income taxes, net

 

$

60,003

 

$

100,649

 

Cash paid for income taxes, net

 $7,652  $60,003 

  

See notes to condensed financial statements.

 

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Table of Contents

IKONICS CORPORATION

  

NOTES TO CONDENSED FINANCIAL STATEMENTS

  

(Unaudited)

  

1.Basis of Presentation

1.

Basis of Presentation

  

The condensed balance sheet of IKONICS Corporation (the “Company”) as of September 30, 2017,2018, and the related condensed statements of operations for the three and nine months ended September 30, 20172018 and 2016,2017, and cash flows for the nine months ended September 30, 20172018 and 2016,2017, have been prepared without being audited.

  

In the opinion of management, these statements reflect all adjustments (consisting of only normal recurring adjustments) necessary to present fairly the financial position of IKONICS Corporation as of September 30, 2017,2018, and the results of operations and cash flows for all periods presented.

  

Certain information and footnote disclosures normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States of America, have been condensed or omitted.  Therefore, these statements should be read in conjunction with the financial statements and notes thereto included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2016.2017.

  

The results of operations for interim periods are not necessarily indicative of results that will be realized for the full fiscal year.

  

2.Short-Term Investments

2.

Revenue

  

The Company’s $1.9significant accounting policies are detailed in “Note 1: Summary of Significant Accounting Policies” of the Company’s Annual Report on Form 10-K for the year ended December 31, 2017.  In May 2014, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update (ASU) 2014-09, Topic 606. Revenue from Contracts with Customers (Topic 606), and in August 2015, FASB issued ASU 2015-14, Revenue from Contracts with Customers (Topic 606): Deferral of Effective Date, which deferred the effective date of ASU 2014-09 by one year.  Topic 606 supersedes the revenue recognition requirements previously set forth in the Accounting Standards Codification (ASC) Topic 605, Revenue Recognition, and requires entities to recognize revenue when control of the promised goods or services is transferred to customers at an amount that reflects the consideration to which the entity expects to be entitled to in exchange for those goods or services.

On January 1, 2018, the Company adopted Topic 606 for all customer contracts using the modified retrospective method.  The adoption of Topic 606 did not result in a change to revenue previously recognized under prior revenue recognition rules.  The comparative information has not been restated and continues to be reported under the accounting standards in effect for those periods. The Company does not expect the adoption of the new revenue standard to have a material impact to its operating results on an ongoing basis.  A majority of the Company’s sales revenue continues to be recognized when products are shipped from its manufacturing facility.  However, depending on the individual terms of the agreement with the customer, some sales revenue may be recognized when the goods arrive at the customer’s location, the point at which control transfers. 

Changes to the Company’s significant accounting policies as a result of adopting Topic 606 are discussed below:

Revenue recognition.  Revenue is measured based on consideration specified in the contract with a customer, adjusted for any applicable estimates of variable consideration and other factors affecting the transaction price, including noncash consideration, consideration paid or payable to customers and significant financing components.  While most of the Company’s revenue is contracted with customers through one-time purchase orders and short-term contracts, the Company does have long-term arrangements with certain customers. 

4

IKONICS CORPORATION

NOTES TO CONDENSED FINANCIAL STATEMENTS

(Unaudited)

Revenue from all customers is recognized when a performance obligation is satisfied by transferring control of a distinct good or service to a customer. 

Individually promised goods and services in a contract are considered a distinct performance obligation and accounted for separately if the customer can benefit from the individual good or service on its own or with other resources that are readily available to the customer and the good or service is separately identifiable from other promises in the arrangement.  When an arrangement includes multiple performance obligations, the consideration is allocated between the performance obligations in proportion to their estimated standalone selling price.  Costs related to products delivered are recognized in the period incurred, unless criteria for capitalization of costs are met. Costs of revenues consist primarily of direct labor, manufacturing overhead, materials and components.  The Company does not incur significant upfront costs to obtain a contract.  If costs to obtain a contract were to become material, the costs would be recorded as an asset and amortized to expense in a manner consistent with the related recognition of revenue.

The Company excludes government assessed and imposed taxes on revenue generating transactions that are invoiced to customers from revenue.  The Company includes freight billed to customers in revenue. Shipping and handling costs associated with outbound freight after control over a product has transferred to a customer are accounted for as a fulfillment cost and are included in cost of goods sold.

The timing of revenue recognition, billings and cash collections results in accounts receivable on the balance sheet. 

Performance obligations.  A performance obligation is a promise in a contract to transfer a distinct good or service to the customer.  A contract’s transaction price is allocated to each distinct performance obligation in proportion to its standalone selling price and recognized as revenue when, or as, the performance obligation is satisfied.  The Company’s various performance obligations and the timing or method of revenue recognition are discussed below.

The Company sells its products to both distributors and end-users. Each unit of product delivered under a customer order represents a distinct and separate performance obligation as the customer can benefit from each unit on its own or with other resources that are readily available to the customer and each unit of product is separately identifiable from other products in the arrangement.

The transaction price for the Company’s products is the invoiced amount.  The Company does not have variable consideration in the form of refunds, credits, rebates, price concessions, pricing incentives or other items impacting transaction price.  The purchase order pricing in arrangements with customers is deemed to approximate standalone selling price; therefore, the Company does not need to allocate proceeds on a relative standalone selling price allocation between performance obligations.  The Company applies the practical expedient in paragraph 606-10-50-14 and does not disclose information about remaining performance obligations that have original expected durations of one year or less.  There are no material obligations that extend beyond one year. 

Revenue is recognized when transfer of control occurs as defined by the terms in the customer agreement.  The Company immediately recognizes incidental items that are immaterial in the context of the contract.  The Company has applied the practical expedient in paragraph 606-10-25-16A and does not assess if immaterial items are promised goods or services.  The Company has also applied the practical expedient in paragraph 606-10-32-18 regarding the adjustment of the promised amount of consideration for the effects of a significant financing component when the customer pays for that good or service within one year or less, as the Company does not have any significant financing components in its customer arrangements as payment is received at or shortly after the point of sale, generally 30 to 90 days.

5

IKONICS CORPORATION

NOTES TO CONDENSED FINANCIAL STATEMENTS

(Unaudited)

The Company estimates returns based on an analysis of historical experience if the right to return products is granted to its customers.  The Company does not record a return asset as non-conforming products are generally not returned.  The Company’s return policy does not vary by geography.  The customer has no rotation or price protection rights.

Trade receivables.  Trade receivables include amounts invoiced and currently due from customers. The amounts due are stated at their net estimated realizable value.  The Company records an allowance for doubtful accounts to provide for the estimated amount of receivables that will not be collected. The allowance is 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 considers 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.

Sales commissions.  Sales commissions paid to sales representatives are eligible for capitalization as they are incremental costs that would not have been incurred without entering into a specific sales arrangement and are recoverable through the expected margin on the transaction.  The Company has elected to apply the practical expedient provided by ASC 340-40-25-4 and recognize the incremental costs of obtaining contracts as an expense when incurred, as the amortization period of the assets that would have otherwise been recognized is one year or less.  The Company records these costs in selling, general, and administrative expense.

Product warranties.   The Company offers warranties on various products and services. These warranties are assurance type warranties that are not sold on a standalone basis; therefore, they are not considered distinct performance obligations.  The Company estimates the costs that may be incurred under its warranties and records a liability in the amount of such costs at the time the revenue is recognized for the product sale. 

International revenue.  The Company markets its products to numerous countries in North America, Europe, Latin America, Asia and other parts of the world.  Foreign sales were approximately 29% of total sales during the first nine months of 2018 compared to 33% of sales for the first nine months of 2017.

3.

Short-Term Investments

The Company’s $2.7 million of short-term investments at September 30, 20172018 is comprised of eighteleven fully insured certificates of deposit with original maturities ranging fromof six to twelve months and interest rates ranging from 0.65%1.80% to 1.25%2.05%.

  

6

3.Inventories

IKONICS CORPORATION

NOTES TO CONDENSED FINANCIAL STATEMENTS

(Unaudited)

4.

Inventories

  

The major components of inventories are as follows:

  

 

 

 

 

 

 

 

    

Sep 30, 2017

    

Dec 31, 2016

 

 Sep 30, 2018  Dec 31, 2017 

 

 

 

 

 

 

 

        

Raw materials

 

$

1,731,599

 

$

1,438,471

 

 $1,644,515  $1,428,924 

Work-in-progress

 

 

406,683

 

 

355,208

 

  375,122   423,186 

Finished goods

 

 

1,570,450

 

 

1,319,856

 

  1,490,116   1,416,547 

Reduction to LIFO cost

 

 

(1,162,423)

 

 

(1,127,363)

 

  (1,238,863)  (1,182,592)

 

 

 

 

 

 

 

        

Total Inventories

 

$

2,546,309

 

$

1,986,172

 

 $2,270,890  $2,086,065 

  

  

4.Earnings Per Common Share (EPS)

5.

Earnings Per Common Share (EPS)

  

Basic EPS is calculated using net income (loss)loss divided by the weighted average of common shares outstanding.  Diluted EPS is similar to Basic EPS except that the weighted average number of common shares outstanding is increased to include the number of additional common shares that would have been outstanding if the potential dilutive common shares, such as those shares subject to options, had been issued.

  

4


Table of Contents

IKONICS CORPORATION

NOTES TO CONDENSED FINANCIAL STATEMENTS

(Unaudited)

Shares used in the calculation of diluted EPS are summarized below:

  

 

 

 

 

 

 

Three Months Ended

 

 

Three Months Ended

 

    

Sep 30, 2017

    

Sep 30, 2016

  

 Sep 30, 2018  Sep 30, 2017 

 

 

 

 

 

        

Weighted average common shares outstanding

 

2,005,096

 

2,018,753

 

  1,983,553   2,005,096 

Dilutive effect of stock options

 

 —

 

89

 

      

Weighted average common and common equivalent shares outstanding

 

2,005,096

 

2,018,842

 

  1,983,553   2,005,096 

  

  

 

 

 

 

 

 

Nine Months Ended

 

 

Nine Months Ended

 

    

Sep 30, 2017

    

Sep 30, 2016

  

 Sep 30, 2018  Sep 30, 2017 

 

 

 

 

 

        

Weighted average common shares outstanding

 

2,014,055

 

2,018,614

 

  1,983,553   2,014,055 

Dilutive effect of stock options

 

 —

 

 —

 

      

Weighted average common and common equivalent shares outstanding

 

2,014,055

 

2,018,614

 

  1,983,553   2,014,055 

  

If the Company was in a net income position for the three and nine months ended September 30, 2018,  5,000 options outstanding with a weighted average exercise price of $8.76 would have been included as part of the weighted average common and common equivalent shares outstanding as the options would have been dilutive while 13,000 options outstanding with a weighted average exercise price of $14.94 would have remained excluded as the options were anti-dilutive. 

If the Company was in a net income position for the three months ended September 30, 2017, all 18,168 options outstanding with a weighted average exercise price of $13.81 would have remained excluded as the options were anti-dilutiveFor the three months ended September 30, 2016, options to purchase 11,418 shares of common stock with a weighted average price of $15.99 were outstanding but were excluded from the computation of common share equivalents because theyas the options were anti-dilutive.

  

If the Company was in a net income position for the first nine months of 2017, 2,250 options outstanding with a weighted average exercise price of $8.91 would have been included as part of the weighted average common and common equivalent shares outstanding as the options would have been dilutive while 15,918 options outstanding with a weighted average exercise price of $14.51 would have remained excluded as the options were anti-dilutive.   anti-dilutive.

7

Table of Contents

IKONICS CORPORATION

  

If the Company was in a net income position for the first nine months of 2016, 4,750 options with a weighted average exercise price of $10.58 would have been included as part of the weighted average common and common equivalent shares outstanding as the options would have been dilutive, while 11,418 options with a weighted average exercise price of $15.99 would have remained excluded as the options were anti-dilutive.NOTES TO CONDENSED FINANCIAL STATEMENTS

  

(Unaudited)

5.Stock-Based Compensation

6.

Stock-Based Compensation

  

The Company maintains a stock incentive plan which authorizes the issuance of up to 442,750 shares of common stock. Of those shares, 18,16818,000 were subject to outstanding options and 101,989102,157 were reserved for future grants at September 30, 2017.2018. 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 the 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.

  

The Company charged compensation cost of approximately $6,000$3,600 against income for the three months ended September 30, 20172018 and approximately $6,600$6,000 for the three months ended September 30, 2016.2017. For the first

5


Table of Contents

IKONICS CORPORATION

NOTES TO CONDENSED FINANCIAL STATEMENTS

(Unaudited)

nine months of 2017,2018, the Company charged compensation cost of approximately $17,500$10,100 and approximately $18,400$17,500 for the same period in 2016.2017.  As of September 30, 2017,2018, there was approximately $23,000$16,200 of unrecognized compensation cost related to unvested share-based compensation awards. 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 market price at the time the stock options are exercised over the exercise price of the options.

  

Proceeds from the exercise of 250 stock options were approximately $2,000 for the nine months ended September 30, 2017 while proceeds from the exercise of 500 stock2017.  There were no options were approximately $4,000 forexercised during the nine months ended September 30, 2016.2018.    

  

The fair value of options granted during the nine months ended September 30, 20172018 and 20162017 was estimated using the Black-Scholes option pricing model with the following assumptions:

  

 

 

 

 

 

    

2017

    

2016

 

 

2018

  

2017

 

Dividend yield

 

0%

 

0%

 

 0%  0% 

Expected volatility

 

41.3%

 

42.4%

 

 40.0%  41.3% 

Expected life of option

 

Five Years

 

Five Years

 

Expected life of option (in years)

 5  5 

Risk-free interest rate

 

1.8%

 

1.3%

 

 2.8%  1.8% 

Fair value of each option on grant date

 

$ 3.43

 

$ 4.02

 

 $ 3.38  $ 3.43 

  

There were 2,2502,750 and 4,5002,250 options granted during each of the nine months ended September 30, 2018 and 2017, and 2016, respectively. respectively while 2,918 options expired during the nine months ended September 30, 2018.

8

Table of Contents

IKONICS CORPORATION

NOTES TO CONDENSED FINANCIAL STATEMENTS

(Unaudited)

  

Stock option activity during the nine months ended September 30, 20172018 was as follows:

  

 

 

 

 

 

 

 

 

    

 

    

 

 

 

 

 

 

 

Weighted

 

 

 

 

 

Average

 

 

 

 

 

Exercise

 

 

    

Shares

    

Price

 

Outstanding at January 1, 2017

 

16,168

 

$

14.40

 

Granted

 

2,250

 

 

8.91

 

Exercised

 

(250)

 

 

7.54

 

Outstanding at September 30, 2017

 

18,168

 

$

13.81

 

Exercisable at September 30, 2017

 

10,499

 

$

15.41

 

      

Weighted

 
      

Average

 
      

Exercise

 
  

Shares

  

Price

 

Outstanding at January 1, 2018

  18,168  $13.81 

Granted

  2,750   8.63 

Exercised

      

Expired and forfeited

  (2,918)  12.56 
Outstanding at September 30, 2018  18,000   13.22 
Exercisable at September 30, 2018  12,247  $15.09 

  

The aggregate intrinsic value of all options outstanding and for those exercisable at September 30, 20172018 was approximately $1,000$3,800 and $0,$500, respectively.

  

  

6


Table of Contents

IKONICS CORPORATION

NOTES TO CONDENSED FINANCIAL STATEMENTS

(Unaudited)

6.Segment Information

7.

Segment Information

  

The Company’s reportable segments are strategic business units that offer different products and have varied customer bases.  There are five reportable segments:  Domestic, Export, IKONICS Imaging, Digital Texturing (DTX) and Advanced Material Solutions (AMS).  Domestic sells screen printing film, emulsions, and inkjet receptive film to distributors located in the United States and Canada.  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 and Canada.  AMS provides sound deadening and weight reduction technology to the aerospace industry along with products and services for etched composites, ceramics, glass and silicon wafers.  DTX includes products and customers related to patented and proprietary inkjet technology used for mold texturing and prototyping. Export sells primarily the same products as Domestic and the IKONICS Imaging products not related to AMS or DTX. The accounting policies applied to determine the segment information are the same as those described in the Company’s Annual Report on Form 10-K for the year ended December 31, 2016.2017.

  

Management evaluates the performance of each segment based on the components of divisional income.income (loss).  Assets and liabilities are not allocated to segments, except for trade receivables which are allocated based on the previous segmentation.  Financial information with respect to the reportable segments follows:

  

For the three months ended September 30, 2018:

  

IKONICS

 
          

IKONICS

                 
  

Domestic

  

Export

  

Imaging

  

DTX

  

AMS

  

Unalloc.

  

Total

 
Net sales $1,893,513  $1,320,594  $810,240  $158,862  $468,149  $  $4,651,358 
Cost of goods sold  1,151,121   1,055,901   466,763   30,279   420,475      3,124,539 
Gross profit  742,392   264,693   343,477   128,583   47,674      1,526,819 
Selling, general and administrative*  346,137   127,647   256,094   42,922   91,876   504,169   1,368,845 
Research and development*  -   -   -   -   -   179,915   179,915 
Income (loss) from operations $396,255  $137,046  $87,383  $85,661  $(44,202) $(684,084) $(21,941)

9

IKONICS CORPORATION

NOTES TO CONDENSED FINANCIAL STATEMENTS

(Unaudited)

For the three months ended September 30, 2017:

  

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

IKONICS

 

 

IKONICS

 

 

 

 

 

 

 

 

 

IKONICS

 

 

 

 

 

 

 

 

 

 

 

 

 

         

IKONICS

                 

 

Domestic

 

Export

 

Imaging

 

DTX

 

AMS

 

Unalloc.

 

Total

 

 

Domestic

  

Export

  

Imaging

  

DTX

  

AMS

  

Unalloc.

  

Total

 

Net sales

 

$

1,790,331

 

$

1,083,594

 

$

731,289

 

$

121,255

 

$

257,631

 

$

 

$

3,984,100

 

 $1,790,331  $1,083,594  $731,289  $121,255  $257,631  $  $3,984,100 

Cost of goods sold

 

 

1,026,311

 

 

819,728

 

 

417,882

 

 

59,293

 

 

336,935

 

 

 

 

2,660,149

 

  1,026,311   819,728   417,882   59,293   336,935      2,660,149 

Gross profit (loss)

 

 

764,020

 

 

263,866

 

 

313,407

 

 

61,962

 

 

(79,304)

 

 

 

 

1,323,951

 

  764,020   263,866   313,407   61,962   (79,304)     1,323,951 

Selling, general and administrative*

 

 

315,941

 

 

131,100

 

 

287,087

 

 

44,805

 

 

91,442

 

 

435,080

 

 

1,305,455

 

  315,941   131,100   287,087   44,805   91,442   435,080   1,305,455 

Research and development*

 

 

 

 

 

 

 

 

 

 

 

 

168,686

 

 

168,686

 

  -   -   -   -   -   168,686   168,686 

Income (loss) from operations

 

$

448,079

 

$

132,766

 

$

26,320

 

$

17,157

 

$

(170,746)

 

$

(603,766)

 

$

(150,190)

 

 $448,079  $132,766  $26,320  $17,157  $(170,746) $(603,766) $(150,190)

 

For the threenine months ended September 30, 2016:2018:

  

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

IKONICS

 

 

IKONICS

 

 

 

 

 

 

 

 

 

IKONICS

 

 

 

 

 

 

 

 

 

 

 

 

 

         

IKONICS

                 

    

Domestic

 

Export

 

Imaging

 

DTX

 

AMS

 

Unalloc.

 

Total

 

 

Domestic

  

Export

  

Imaging

  

DTX

  

AMS

  

Unalloc.

  

Total

 

Net sales

 

$

1,981,212

 

$

1,273,923

 

$

879,712

 

$

195,890

 

$

276,764

 

$

 —

 

$

4,607,501

 

 $5,229,971  $3,686,815  $2,736,544  $341,850  $1,361,833  $  $13,357,013 

Cost of goods sold

 

 

1,115,507

 

 

956,953

 

 

413,385

 

 

49,924

 

 

404,258

 

 

 —

 

 

2,940,027

 

  3,137,858   2,904,558   1,467,420   89,283   1,206,341      8,805,460 

Gross profit (loss)

 

 

865,705

 

 

316,970

 

 

466,327

 

 

145,966

 

 

(127,494)

 

 

 

 

1,667,474

 

Gross profit

  2,092,113   782,257   1,269,124   252,567   155,492      4,551,553 

Selling, general and administrative*

 

 

330,578

 

 

169,858

 

 

260,810

 

 

35,595

 

 

94,993

 

 

465,771

 

 

1,357,605

 

  965,754   388,205   772,299   110,370   274,136   1,516,027   4,026,791 

Research and development*

 

 

 —

 

 

 —

 

 

 —

 

 

 —

 

 

 —

 

 

150,176

 

 

150,176

 

  -   -   -   -   -   490,463   490,463 

Income (loss) from operations

 

$

535,127

 

$

147,112

 

$

205,517

 

$

110,371

 

$

(222,487)

 

$

(615,947)

 

$

159,693

 

 $1,126,359  $394,052  $496,825  $142,197  $(118,644) $(2,006,490) $34,299 

 

7


Table of Contents

IKONICS CORPORATION

NOTES TO CONDENSED FINANCIAL STATEMENTS

(Unaudited)

For the nine months ended September 30, 2017:

  

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

IKONICS

 

 

IKONICS

 

 

 

 

 

 

 

 

 

IKONICS

 

 

 

 

 

 

 

 

 

 

 

 

 

         

IKONICS

                 

 

Domestic

 

Export

 

Imaging

 

DTX

 

AMS

 

Unalloc.

 

Total

 

 

Domestic

  

Export

  

Imaging

  

DTX

  

AMS

  

Unalloc.

  

Total

 

Net sales

 

$

4,910,856

 

$

3,510,691

 

$

2,664,330

 

$

707,730

 

$

504,846

 

$

 

$

12,298,453

 

 $4,910,856  $3,510,691  $2,664,330  $707,730  $504,846  $  $12,298,453 

Cost of goods sold

 

 

2,887,111

 

 

2,755,371

 

 

1,394,675

 

 

453,712

 

 

950,141

 

 

 

 

8,441,010

 

  2,887,111   2,755,371   1,394,675   453,712   950,141      8,441,010 

Gross profit (loss)

 

 

2,023,745

 

 

755,320

 

 

1,269,655

 

 

254,018

 

 

(445,295)

 

 

 

 

3,857,443

 

  2,023,745   755,320   1,269,655   254,018   (445,295)     3,857,443 

Selling, general and administrative*

 

 

1,001,434

 

 

516,958

 

 

824,692

 

 

130,301

 

 

292,562

 

 

1,443,758

 

 

4,209,705

 

  1,001,434   516,958   824,692   130,301   292,562   1,443,758   4,209,705 

Research and development*

 

 

 

 

 

 

 

 

 

 

 

 

519,160

 

 

519,160

 

  -   -   -   -   -   519,160   519,160 

Income (loss) from operations

 

$

1,022,311

 

$

238,362

 

$

444,963

 

$

123,717

 

$

(737,857)

 

$

(1,962,918)

 

$

(871,422)

 

 $1,022,311  $238,362  $444,963  $123,717  $(737,857) $(1,962,918) $(871,422)

  

For the nine months ended September 30, 2016:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

IKONICS

 

 

 

 

 

 

 

 

 

 

IKONICS

 

 

 

 

 

 

 

 

 

 

 

 

 

 

    

Domestic

    

Export

    

Imaging

    

DTX

    

AMS

    

Unalloc.

    

Total

 

Net sales

 

$

5,278,456

 

$

3,470,693

 

$

2,997,006

 

$

306,246

 

$

764,888

 

$

 —

 

$

12,817,289

 

Cost of goods sold

 

 

3,067,112

 

 

2,654,611

 

 

1,378,287

 

 

120,410

 

 

1,110,510

 

 

 —

 

 

8,330,930

 

Gross profit (loss)

 

 

2,211,344

 

 

816,082

 

 

1,618,719

 

 

185,836

 

 

(345,622)

 

 

 

 

4,486,359

 

Selling, general and administrative*

 

 

1,034,975

 

 

472,510

 

 

759,863

 

 

109,968

 

 

322,182

 

 

1,422,393

 

 

4,121,891

 

Research and development*

 

 

 —

 

 

 —

 

 

 —

 

 

 —

 

 

 —

 

 

475,165

 

 

475,165

 

Income (loss) from operations

 

$

1,176,369

 

$

343,572

 

$

858,856

 

$

75,868

 

$

(667,804)

 

$

(1,897,558)

 

$

(110,697)

 


*The Company does not allocate all general and administrative expenses or any research and development expenses to its operating segments for internal reporting.

The Company does not allocate all general and administrative expenses or any research and development expenses to its operating segments for internal reporting.

  

Trade receivables by segment as of September 30, 20172018 and December 31, 20162017 were as follows:

  

 

 

 

 

 

 

 

    

Sep 30, 2017

    

Dec 31, 2016

 

 Sep 30, 2018  Dec 31, 2017 

 

 

 

 

 

 

 

        

Domestic

 

$

817,124

 

$

1,206,866

 

 $928,122  $1,119,228 

Export

 

 

374,744

 

 

551,803

 

  460,788   558,872 

IKONICS Imaging

 

 

223,990

 

 

363,602

 

  243,912   238,813 

DTX

 

 

88,151

 

 

52,935

 

  7,162   64,278 

AMS

 

 

190,113

 

 

177,374

 

  356,295   238,848 

Unallocated

 

 

(49,890)

 

 

(16,079)

 

  (20,538)  (29,779)

 

 

 

 

 

 

 

        

Total

 

$

1,644,232

 

$

2,336,501

 

 $1,975,741  $2,190,260 

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IKONICS CORPORATION 

7.Income Taxes

NOTES TO CONDENSED FINANCIAL STATEMENTS

(Unaudited)

8.

Income Taxes

The federal Tax Cut and Jobs Act of 2017 (the “Tax Reform Act”) was enacted December 22, 2017.  Effective January 1, 2018, the Tax Reform Act reduced statutory corporate income tax rates from 35% to 21% in addition to other tax changes including re-valuation of deferred tax assets and liabilities as of December 31, 2017.  

For the first nine months of 2018, the Company realized an income tax expense of $12,000, which reflects the new federal corporate rate of 21% versus the income tax benefit of $322,000 or an effective rate of 35.1%, for the first nine months of 2017.  The Company’s effective rate for 2018 relates to the higher year-to-date pre-tax income generated and the related impact of discrete events and non-deductible permanent items.  The 2017 tax benefit for the first nine months was due to the year-to-date net loss. The income tax provision for the 2018 and 2017 periods differ from the expected benefit due to credits for research and development and other non-deductible items.

  

The Company’s federal net operating loss carryforward and research and development credit carryover as of September 30, 2018 was $141,000 and $27,000, respectively, and will begin to expire in 2037.  The Company’s gross state net operating loss carryforwards and research and development credit carryover as of September 30, 2018 was $61,000 and $115,000, respectively and begin to expire in 2026. 

The valuation allowance balance of $91,000 at September 30, 2018, relates entirely to Minnesota research and development credit carryforwards that the Company reports a liability for unrecognizeddoes not expect to utilize and begin to expire in 2028. 

It has been the Company’s policy to recognize interest and penalties related to uncertain tax benefits taken or expected to be taken when they are uncertain.positions in income tax expense.  As of September 30, 20172018 and September 30, 2016,December 31, 2017, there was no liability for unrecognized tax benefits.

  

The Company is subject to taxation infederal and state taxation. As of September 30, 2018, with few exceptions, the United States and various states.  The material jurisdictions that areCompany is no longer subject to examination byprior to tax authorities primarily include Minnesota and the United States, in each case for tax years 2014, 2015, and 2016.year 2014. 

  

 

8

11


IKONICS CORPORATION

  

The information presented below in Management’s Discussion and Analysis of Financial Condition and Results of Operations contains forward-looking statements within the meaning of the safe harbor provisions of Section 21E of the Securities Exchange Act of 1934, as amended.  Statements that are not historical or current facts, including statements about beliefs and expectations, are forward-looking statements. These forward-looking statements include statements relating to our future plans and objectives and results. Such statements are subject to risks and uncertainties, including those discussed elsewhere in this report and under the heading “Risk Factors” in Part I, Item 1A of our Annual Report on Form 10-K for the year ended December 31, 2016,2017, as updated in our subsequent reports filed with the SEC, which could cause actual results to differ materially from those projected.  Because actual results may differ, readers are cautioned not to place undue reliance on these forward-looking statements.

  

ITEM 2.  Management’s Discussion and Analysis of Financial Condition and Results of Operations

  

The following management’s discussion and analysis focuses on those factors that had a material effect on the Company’s financial results of operations during the third quarter of 20172018 and first nine months of 2017,2018, as well as the same periods of 2016.2017.  It should be read in connection with the Company’s condensed unaudited financial statements and notes thereto included in this Form 10-Q.

  

Critical Accounting Estimates

  

The Company prepares its financial statements in conformity with accounting principles generally accepted in the United States of America.  Therefore, the Company is required to make certain estimates, judgments and assumptions that the Company believes are reasonable based upon the information available.  These estimates and assumptions affect the reported amounts of assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the periods presented.  The accounting estimates, which IKONICS believes are the most critical to aid in fully understanding and evaluating its reported financial results, include the following:

  

Trade Receivables.  The Company performs ongoing credit evaluations of its customers and adjusts credit limits based upon payment history and the customer’s current credit worthiness, as determined by review of the current credit information.  The Company continuously monitors collections and payments from its customers and maintains a provision for estimated credit losses based upon historical experience and any specific customer collection issues that have been identified.  While such credit losses have historically been within expectations and the provisions established, the Company cannot guarantee that it will continue to experience the same collection history that has occurred in the past.  The general payment terms are net 30-45 days for domestic customers and net 30-90 days for foreign customers.  A small percentage of the trade receivables balance is denominated in a foreign currency with no concentration in any given country.  At the end of each reporting period, the Company analyzes the receivable balance for customers paying in a foreign currency.  These balances are adjusted to each quarter or year-end spot rate in accordance with the Financial Accounting Standards Board (“FASB”) FASB ASC 830, Foreign Currency Matters.  The Company also maintains a provision for any customer related returns based upon historical experience of actual returns and any specifically identified product issues, refunds or credits.

  

Inventories.  Inventories are valued at the lower of cost or market value using the last in, first out (LIFO) method.  The Company monitors its inventory for obsolescence and records reductions from cost when required.

  

Income 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.  Deferred tax assets and liabilities are presented as long-term on a net basis.  The Company follows the accounting standard on accounting for uncertainty in income taxes, which addresses the determination of whether tax benefits claimed or expected to be claimed on a tax return should be recorded in the financial statements.  Under this guidance, the Company may recognize the tax

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benefit from an uncertain tax position only if it is more likely than not that the tax position will be sustained on examination by taxing authorities, based on the technical merits of the position.  The tax benefits recognized in the financial statements from such a position are measured based on the largest benefit that has a greater than 50 percent likelihood of being realized upon ultimate settlement.  The guidance on accounting for uncertainty in income taxes also addresses derecognition, classification, interest and penalties on income taxes, and accounting in interim periods.

 

12

Revenue.  In May 2014, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update (ASU) 2014-09, Topic 606. Revenue Recognition.  from Contracts with Customers (Topic 606), and in August 2015, FASB issued ASU 2015-14, Revenue from Contracts with Customers (Topic 606): Deferral of Effective Date, which deferred the effective date of ASU 2014-09 by one year.  Topic 606 supersedes the revenue recognition requirements previously set forth in the Accounting Standards Codification (ASC) Topic 605, Revenue Recognition, and requires entities to recognize revenue when control of the promised goods or services is transferred to customers at an amount that reflects the consideration to which the entity expects to be entitled to in exchange for those goods or services.

On January 1, 2018, the Company adopted Topic 606 for all customer contracts using the modified retrospective method.  The adoption of Topic 606 did not result in a change to revenue previously recognized under prior revenue recognition rules.  The comparative information has not been restated and continues to be reported under the accounting standards in effect for those periods. The Company recognizesdoes not expect the adoption of the new revenue standard to have a material impact to its operating results on an ongoing basis.  A majority of the Company’s sales revenue continues to be recognized when products are shipped from its manufacturing facility.  However, depending on the individual terms of products when title passes, which can occur at the time of shipment oragreement with the customer, some sales revenue may be recognized when the goods arrive at the customer’s location, the point at which control transfers. 

Changes to the Company’s significant accounting policies as a result of adopting Topic 606 are discussed below:

Revenue recognition.  Revenue is measured based on consideration specified in the contract with a customer, location dependingadjusted for any applicable estimates of variable consideration and other factors affecting the transaction price, including noncash consideration, consideration paid or payable to customers and significant financing components.  While most of the Company’s revenue is contracted with customers through one-time purchase orders and short-term contracts, the Company does have long-term arrangements with certain customers.  Revenue from all customers is recognized when a performance obligation is satisfied by transferring control of a distinct good or service to a customer. 

Individually promised goods and services in a contract are considered a distinct performance obligation and accounted for separately if the customer can benefit from the individual good or service on its own or with other resources that are readily available to the customer and the good or service is separately identifiable from other promises in the arrangement.  When an arrangement includes multiple performance obligations, the consideration is allocated between the performance obligations in proportion to their estimated standalone selling price.  Costs related to products delivered are recognized in the period incurred, unless criteria for capitalization of costs are met. Costs of revenues consist primarily of direct labor, manufacturing overhead, materials and components.  The Company does not incur significant upfront costs to obtain a contract.  If costs to obtain a contract were to become material, the costs would be recorded as an asset and amortized to expense in a manner consistent with the related recognition of revenue.

The Company excludes governmental assessed and imposed taxes on revenue transactions that are invoiced to customers from revenue.  The Company includes freight billed to customers in revenue. Shipping and handling costs associated with outbound freight after control over a product has transferred to a customer are accounted for as a fulfillment cost and are included in cost of goods sold.

The timing of revenue recognition, billings and cash collections results in accounts receivable on the agreement withbalance sheet. 

13

Performance obligations.  A performance obligation is a promise in a contract to transfer a distinct good or service to the customer.  A contract’s transaction price is allocated to each distinct performance obligation in proportion to its standalone selling price and recognized as revenue when, or as, the performance obligation is satisfied.  The Company’s various performance obligations and the timing or method of revenue recognition are discussed below. 

The Company sells its products to both distributors and end-users. SalesEach unit of product delivered under a customer order represents a distinct and separate performance obligation as the customer can benefit from each unit on its own or with other resources that are readily available to distributorsthe customer and end-userseach unit of product is separately identifiable from other products in the arrangement.

The transaction price for the Company’s products is the invoiced amount.  The Company does not have variable consideration in the form of refunds, credits, rebates, price concessions, pricing incentives or other items impacting transaction price.  The purchase order pricing in arrangements with customers is deemed to approximate standalone selling price; therefore, the Company does not need to allocate proceeds on a relative standalone selling price allocation between performance obligations.  The Company applies the practical expedient in paragraph 606-10-50-14 and does not disclose information about remaining performance obligations that have original expected durations of one year or less. There are recorded based upon the criteria governedno material obligations that extend beyond one year. 

Revenue is recognized when transfer of control occurs as defined by the sales, delivery, and payment terms stated onin the invoices fromcustomer agreement. The Company immediately recognizes incidental items that are immaterial in the context of the contract.  The Company has also applied the practical expedient in paragraph 606-10-32-18 regarding the adjustment of the promised amount of consideration for the effects of a significant financing component when the customer pays for that good or service within one year or less, as the Company does not have any significant financing components in its customer arrangements as payment is received at or shortly after the point of sale, generally 30 to the purchaser.  In addition to transfer of title / risk of loss, all revenue is recorded in accordance with the criteria outlined within Staff Accounting Bulletin No. 104 and FASB ASC 605, Revenue Recognition:90 days.

  

(a)

persuasive evidence of an arrangement (principally in the form of customer sales orders and the Company’s sales invoices);

(b)

delivery and performance (evidenced by proof of delivery, e.g. the shipment of film and substrates with bill of lading used for proof of delivery for FOB shipping point terms, and the carrier booking confirmation report used for FOB destination terms).  Once the finished product is shipped and physically delivered under the terms of the invoice and sales order, the Company has no additional performance or service obligations to complete;

(c)

a fixed and determinable sales price (the Company’s pricing is established and is not based on variable terms, as evidenced in either the Company’s invoices or the limited number of distribution agreements; the Company rarely grants extended payment terms and has no history of concessions); and

(d)

a reasonable likelihood of payment (the Company’s terms are standard, and the Company does not have a substantial history of customer defaults or non-payment).

SalesThe Company estimates returns based on an analysis of historical experience if the right to return products is granted to its customers.  The Company does not record a return asset as non-conforming products are reported on a net basis by deducting credits, estimated normal returns and discounts.generally not returned.  The Company’s return policy does not vary by geography.  The customer has no rotation or price protection rightsrights.

Trade receivables.  Trade receivables include amounts invoiced and currently due from customers. The amounts due are stated at their net estimated realizable value.  The Company records an allowance for doubtful accounts to provide for the Companyestimated amount of receivables that will not be collected. The allowance is 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 considers 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 under a warranty obligation.  Freight billedreceived according to customers is included in sales.  Shipping costs are included in cost of goods sold.agreed-upon terms.

  

Sales commissions.  Sales commissions paid to sales representatives are eligible for capitalization as they are incremental costs that would not have been incurred without entering into a specific sales arrangement and are recoverable through the expected margin on the transaction.  The Company has elected to apply the practical expedient provided by ASC 340-40-25-4 and recognize the incremental costs of obtaining contracts as an expense when incurred, as the amortization period of the assets that would have otherwise been recognized is one year or less.  The Company records these costs in selling, general, and administrative expense.

Product warranties.   The Company offers warranties on various products and services. These warranties are assurance type warranties that are not sold on a standalone basis; therefore, they are not considered distinct performance obligations.  The Company estimates the costs that may be incurred under its warranties and records a liability in the amount of such costs at the time the revenue is recognized for the product sale. 

International revenue.   The Company markets its products to numerous countries in North America, Europe, Latin America, Asia and other parts of the world.  Foreign sales were approximately 29% of total sales during the first nine months of 2018 compared to 33% of sales for the first nine months of 2017. 

14

Results of Operations

  

Quarter Ended September 30, 20172018 Compared to Quarter Ended September 30, 20162017

  

Sales.    Sales decreased 13.5%increased 16.7% during the third quarter of 2018 to record third quarter sales of $4.7 million, compared to $4.0 million during the same period in 2017.  Third quarter sales were favorably impacted by AMS sales which grew by $211,000, or 81.7% from $258,000 during the third quarter of 2017 to $4.0 million, compared$468,000 in the third quarter of 2018.  Most of this increase is related to $4.6 million duringincreased sales to AMS’s largest customer who is expected to maintain similar sales levels for the same period in 2016.  Third quarter sales were unfavorably impacted by $191,000, or 9.6%, Domestic sales decrease as soft market conditions resulted in lower sales across all  product lines.remainder of 2018.  Export sales also realized a 14.9%21.9% sales decreaseincrease in the third quarter as sales fellincreased from $1.3 million in 2016 to $1.1 million in 2017 to $1.3 million in 2018, mainly due mainly to the timing ofhigher sales into Asia.Asia which is partially timing related.  IKONICS Imaging sales decreasedincreased from $880,000 in the third quarter of 2016 to $731,000 in 2017.  The $148,000, or 16.9%, decrease in sales is related to lower sales of high margin film products compared to the prior year.  Part of the IKONICS Imaging sales shortfall is timing related and we anticipate that it will be recovered in the fourth quarter of 2017.  DTX film sales were also down for the third quarter of 2017 compared to the same period in 2016 as sales decreased by $75,000, or 38.1%. During the third quarter of 2017, AMS sales were down $19,000, or 6.9%, versus the same period last year.

Gross Profit.  Gross profit was $1.3 million, or 33.2% of sales, in the third quarter of 2017 compared to $1.7 million, or 36.2%$810,000 in the third quarter of 2018, a 10.8% increase.  IKONICS Imaging sales for the third quarter of 2018 benefitted from both improved film and equipment sales.  DTX sales were favorably impacted by a $78,000 film shipment which occurs approximately every other year as DTX 2018 third quarter sales of $159,000 were $38,000, or 31.0%, higher than the same period in 2016.  The gross profit as a percentage of2017.  Domestic sales decreased due to lower sales levels across all divisions.  Additionally, a less favorable sales mix negatively impacted the 2017grew from $1.8 million in third quarter margin dueof 2017 to $1.9 million in the decrease in salesthird quarter of IKONICS Imaging and DTX high margin film products.

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2018, a 5.8% increase.

 

Selling, General and Administrative ExpensesGross Profit.  Selling, general and administrative expenses were $1.3Gross profit was $1.5 million, or 32.8% of sales, in the third quarter of 20172018 compared to $1.4$1.3 million, or 29.5%33.2% of sales, for the same period in 2016.2017.  The 2018 third quarter gross margin was negatively impacted by an increase in lower margin Export sales into Asia along with 2018 third quarter production cost increases.  The 2018 third quarter margin decrease was partially offset  by increased AMS sales volumes as the AMS gross margin improved from a negative 30.8% in third quarter of 2017 to a positive 10.2% in the third quarter of 2018.  A large portion of the AMS cost structure is fixed, causing sales volumes to have a significant impact on its gross margin.  The 2018 third quarter DTX gross margin also improved over the same period last year due an increase in higher margin film shipments.

Selling, General and Administrative Expenses.  Selling, general and administrative expenses were $1.4 million, or 29.4% of sales, in the third quarter of 2018 compared to $1.3 million, or 32.8% of sales, for the same period in 2017.  The third quarter 2018 increase in selling, general and administrative expense is primarily related to higher health insurance expenses, partially offset by lower promotional and travel and Export personnel expenses.

  

Research and Development Expenses.  Research and development expenses during the third quarter of 20172018 were $180,000, or 3.9% of sales, versus $169,000, or 4.2% of sales, versus $150,000, or 3.3% of sales, for the same period in 2016.2017.  The higher 2017increase in 2018 third quarter costs wereis due to patent related legal expenses along with increased production trialhigher health insurance expenses.

  

Interest Expense.  Interest expense for the third quarter of 20172018 was $21,000$23,000 compared to interest expense of $22,000$21,000 during the third quarter of 2016.2017.  The interest expense is related to a $3.4 million financing agreement the Company entered into during 2016 to finance the construction of a 27,300-square foot building and related equipment for use in the Company’s manufacture of sound deadening technology used in the aerospace industry and products consisting of etched composites, ceramics, glass and silicon wafers.

  

Income Taxes. For the third quarter of 2017,2018, the Company realized an income tax benefit of $7,000, or an effective rate of 21.4% which reflects the new federal rate of 21% enacted December 22, 2017 through the Tax Cut and Jobs Act, compared to the income tax benefit of $54,000, or an effective rate of 32.6%, compared to income tax expense of $60,000 or an effective rate of 42.3% for the same period in 2016.2017.  The decrease in the quarterly effective tax rate for 20172018 over 20162017 is primarily due to the impact of non-deductible items and pre-tax profit for the quarter in 2016 and its related impact on the forecasted annuallower federal tax rate.  In 2017, the unfavorable non-deductible items decreased the effective tax rate due to estimated pre-tax losses.  The income tax benefit and provision for the 20172018 and 20162017 periods differ from expected tax benefit due to unfavorable non-deductible items offset by the generation of research and development tax credits.

  

15

Nine Months Ended September 30, 20172018 Compared to the Nine Months Ended September 30, 20162017

  

Sales.  Sales decreased 4.0%increased 8.6% during the first nine months of 2018 to $13.4 million compared to $12.3 million during the same period in 2017.  AMS sales for the first nine months of 2018 increased by $857,000, or 169.8%, compared to the same period last year, as the Company realized increased sales from its largest customer.  The customer maintained expected activity level for the entire 2018 period while AMS sales during the first nine months of 2017 to $12.3 million, compared to $12.8 million during the same period in 2016.  A more competitive market for artwork film sales along with overall soft market conditions resulted inwere unfavorably affected by a temporary decrease in orders from its largest customer.  Domestic sales also increased from $5.3$4.9 million in the first nine months of 20162017 to $4.9$5.2 million in 2017.  Compared to the first nine months of 2016, IKONICS Imaging sales decreased by $333,000 to $2.7 million in 2017.  Part of the 2017 IKONICS Imaging sales decrease is timing related.  Additionally, IKONICS Imaging sales in the first nine months of 2016 were favorably impacted2018, a $319,000, or 6.5%, sales increase due to improved emulsion and film sales, while Export sales for the first nine month of 2018 increased by a large initial order from a new customer.  AMS$176,000, or 5.0%,  due to higher sales decreased by $260,000,to both the Middle East and Latin America.  Equipment sales increases resulted in IKONICS Imaging sales growing $72,000, or 34.0%, for2.7% in the first nine months of 2017 versus2018 compared to the same period in 2016 due to the temporary decrease in orders from AMS’s largest customer during the second quarter of 2017.  Beginning in the third quarter of 2017, the customer resumed its normal order pattern which is expected to continue for the remainder of 2017.   Partially offsetting these sales decreases was a $401,000, or 131.1% increase in DTX due to the sale of two DTX printers and improved consumable sales.  Export sales also realized a 1.2% sales increaseSales for the first nine months  of 2018 were unfavorably impacted by a $366,000, or 51.7%, DTX sales decrease as 2017 asDTX sales increased by $40,000.benefitted from $320,000 in sales of two DTX printers.  There were no printer sales during the first nine months of 2018, and the Company does not anticipate any new DTX printer sales until 2019.

 

Gross Profit.  Gross profit was $3.9$4.6 million, or 31.4%34.1% of sales, in the first nine months of 20172018 compared to $4.5$3.9 million, or 35.0%31.4% of sales, for the same period in 2016.2017. AMS increased sales volumes benefitted the 2018 gross margin, as the AMS gross margin improved from a negative 88.2% in first nine months of 2017 to a positive 11.4% in 2018.  A large portion of the AMS cost structure is fixed, causing sales volumes to have a significant impact on its gross margin.  The 2018 DTX gross profit as a percentage of sales decreased duemargin improved to lower sale volumes and a less favorable sales mix.  Low margin Export sales comprised 28.5% of total 2017 sales compared to 27.1% of total sales73.9% from 35.9% in the first nine months of 2016 while higher margin IKONICS Imaging sales comprised 21.7% of total sales during2017, as the first nine months of 2017 versus 23.4% of total sales for the same period in 2016.  The gross margin percentage for the first nine months of 2017 was also unfavorably impactednegatively affected by the sale of two low margin DTX printers.  The IKONICS Imaging,  Domestic, and Export gross margins were negatively affected by higher production costs  for the first nine months of 2018 compared to the same period last year.

  

Selling, General and Administrative Expenses.  Selling, general and administrative expenses were $4.2$4.0 million, or 34.2%30.1% of sales, in the first nine months of 20172018 compared to $4.1$4.2 million, or 32.2%34.2% of sales, for the same period in 2016.2017.  The increase2018 decrease in selling, general and administrative expense is related to the Company’s cost reduction initiative.  The Company realized lower travel, promotional, consulting and salary expenses reflects promotional and trade show expenses for both Export and IKONICS Imaging in addition towhich were partially offset by higher international sales consultinghealth insurance expenses.

  

Research and Development Expenses.  Research and development expenses during the first nine months of 20172018 were $490,000, or 3.7% of sales, versus $519,000, or 4.2% of sales, versus $475,000, or 3.7% of sales, for the same period in 2016.2017.  The increasedecrease in expenses for the first nine months of 2017 was2018 costs is due to patent related legal expenses along with increasedlower production trial expenses.  The Company incurred additional production trial expenses in 2017 related to the development of its new SubTHAT! film product.

  

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Interest Expense.  Interest expense for the first nine months of 20172018 was $62,000$67,000 compared to interest expense of $37,000$62,000 during the first nine months of 2016.2017.  The interest expense is related to a $3.4 million financing agreement the Company entered into during 2016 to finance the construction of a 27,300-square foot building as well as related equipment for use in the Company’s manufacture of sound deadening technology used in the aerospace industry and products consisting of etched composites, ceramics, glass and silicon wafers.

  

Income Taxes.  For the first nine months of 2017,2018, the Company realized income tax expense of $12,000, or an effective rate of 552.3% which reflects the new federal corporate rate of 21% versus the income tax benefit of $322,000 or an effective rate of 35.1%, comparedfor the first nine months of 2017. The Company’s increased effective rate for 2018 relates to the higher year-to-date pre-tax income generated and the related impact of discrete events and non-deductible permanent items.  The 2017 year-to-date third quarter tax benefit of $69,000 or an effective rate of 49.3%, for the same period in 2016.  The decrease in the effective tax rate for 2017 over 2016 is primarilywas due to higher pre-tax loss for the current year and the impact of non-deductible items.year-to-date net loss. The income tax benefitprovision for the 20172018 and 20162017 periods differ from the expected tax benefit due to unfavorable non-deductible items, offset by the generation ofcredits for research and development tax credits.and other non-deductible items

  

16

 

Liquidity and Capital Resources

  

Outside of the building expansion, for which $3.4 million in financing was obtained during 2016, 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 $2.0$1.6 million and $1.0 million$930,000 at September 30, 20172018 and December 31, 2016,2017, respectively.  Operating activities provided $148,000$1.1 million in cash during the first nine months of 20172018 compared to $804,000$148,000 of cash provided by operating activities during the same period in 2016.2017.  Cash provided by operating activities is primarily the result of a net income or loss adjusted for non-cash depreciation, amortization, gain on sale and disposal of property, and certain changes in working capital components discussed in the following paragraph.

During the first nine months of 2018, the timing of collections resulted in a $215,000 decrease in trade receivables.  The Company believes that the quality of its receivables is high and that strong internal controls are in place to maintain proper collections.  Inventories increased by $185,000 due to higher raw material and finished goods levels as the Company is increasing inventory levels to meet expected fourth quarter sales demand.  Prepaid expenses and other assets increased by $42,000, reflecting prepayments on annual software license agreements.  Accounts payable increased by $389,000 due to the timing of vendor payments for recent large raw materials purchases.  Accrued expenses increased by $75,000, reflecting an increase in the accrual for health insurance costs while income taxes receivable increased by $8,000 due to the timing of estimated tax payments compared to the calculated 2018 tax liability.

  

During the first nine months of 2017, the timing of collections resulted in a $692,000 decrease in trade receivables.  The Company believes that the quality of its receivables is high and that strong internal controls are in place to maintain proper collections.  Inventories increased by $560,000 due to higher raw material and finished goods levels as the Company is increasing inventory levels for fourth quarter sales.levels.  Prepaid expenses and other assets decreased $258,000.  The prepaid expense balance at December 31, 2016 included prepayments related to two DTX printers which have since been sold.were sold in 2017.  Accounts payable increased $70,000 due to the timing of vendor payments mainly related to raw material purchases.  Accrued expenses decreased $104,000, reflecting the timing of compensation payments while income taxes receivable increased $262,000 due to the timing of estimated tax payments compared to the calculated 2017 tax liability.

 

During the first nine months of 2016,2018, cash used in investing activities was $338,000.  Eighteen certificates of deposits totaling $4.3 million matured during the timingfirst nine months of collections resulted in an $11,000 decrease in trade receivables.2018.  The Company believespurchased seventeen certificates of deposits totaling $4.1 million.  The Company’s purchases of property and equipment of $501,000 were mainly for building upgrades and improvements to production and process capabilities. Also, during the first nine months of 2018, the Company incurred $36,000 in patent application costs that the qualityCompany records as an asset and amortizes upon successful completion of its receivables is high and that strong internal controls are in place to maintain proper collections.  Inventories decreased by $41,000 due to lower raw material and finished goods levels.  Prepaid expenses and other assets increased $93,000, reflecting insurance premiums and annual software license fees paid in advance.  Accounts payable increased $327,000 due to the timing of vendor payments mainly related to raw material purchases.  Accrued expenses decreased $31,000, reflecting the timing of compensation payments while income taxes receivable decreased $31,000 due to the timing of estimated tax payments compared to the calculated 2016 tax liability.application process.

  

During the first nine months of 2017, cash provided by investing activities was $1.1 million.  The Company obtained proceeds from 14 certificates of deposits totaling $3.2 million and purchased eight certificates of deposits totaling $1.9 million.  The Company’s purchases of property and equipment of $190,000 were mainly for improvements to production and process capabilities and two vehicles. Also, during the first nine months of 2017, the Company incurred $32,000 in patent application costs that the Company has recorded as an asset and will amortize upon successful completion of the application process.  In addition the Company sold three vehicles for $33,000. 

  

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During the first nine months of 2016, cash used in investing activities was $5.4 million.  The Company purchased 15 certificates of deposits totaling $3,399,000.  The Company’s cash purchases of property and equipment were $1,966,000.  Total building expansion expenditures for 2016 were $1,393,000.  Expenditures on the new ERP system in the first nine months of 2016 were $209,000, of which $9,000 was included as part of construction payable and not as cash used in investing activities.  The remaining capital expenditures were mainly for upgrades to improve AMS production and process capabilities. Also during the first nine months of 2016, the Company incurred $26,000 in patent application costs that the Company records as an asset and amortizes upon successful completion of the application process.  In addition, the Company sold equipment for $21,000. 

Related to the Company’s loan, the Company made principal payments of $103,000 and $104,000 during the first nine months of 2017.  2018 and 2017, respectively.  

During the first nine months of 2017, the Company received $2,000 from financing activities from the issuance of 250 shares of common stock due to the exercise of stock options while the Company repurchased 26,950 shares of its own stock during the first nine months of 2017 for $234,000. 

  

During the first nine months of 2016, the Company received $3.2 million from financing activities.   The Company secured a loan of $3.4 million to finance the expansion of its AMS facility.  The Company paid $139,000 in debt issuance costs to obtain the loan initially and has made principal payments of $45,000.   During the first nine months of 2016, the Company received $4,000 from the issuance of 500 shares of common stock from the exercise of stock options. 

As part of the $3.4 million loan obtained in 2016, the Company is required to maintain a debt service coverage ratio calculated as of the last day of each calendar quarter on a rolling four-quarter basis.  As of September 30, 2017, the Company’s was in compliance with the required debt service coverage ratio.

A bank line of credit exists providing for borrowings of up to $2,050,000 and expires on September 30, 2019.  The line of credit is collateralized by the Company’s assets and bears interest at 1.8 percentage points over the 30‑day30-day LIBOR rate.  The Company did not utilize this line of credit during the first nine months of 20172018 or 20162017, and there were no borrowings outstanding as of September 30, 20172018 and December 31, 2016.2017.  There are no financial covenants related to the line of credit. 

  

The Company believes that current financial resources, its line of credit, cash generated from operations and secured through debt financing, and short termshort-term investments, along with the Company’s capacity for additional debt and/or equity financing will be sufficient to fund current and anticipated business operations.  The Company also believes that it is unlikely that a temporary decrease in demand for the Company’s products would impair the Company’s ability to fund operations given its excess cash and available line of credit.

  

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Capital Expenditures

  

Through the first nine months of 2017,2018, the Company incurred $190,000$501,000 of capital expenditures mainly for upgrades to the heating system at the Company’s main Duluth, Minnesota location, and for improvements to production and process capabilities and the purchase of two vehicles.

capabilities.  The Company expects additional capital expenditures in 20172018 of approximately $75,000 mainly$115,000 including an additional $25,000 related to the heating system upgrade.  The remaining 2018 capital expenditures are expected to be primarily for processproduction and productionsafety improvements.  Currently, the Company expects to fund its capital expenditures with existing cash and cash generated from operating activities. 

  

International Activity

  

The Company markets its products to numerous countries in North America, Europe, Latin America, Asia and other parts of the world.  Foreign sales were approximately 33.7%29.3% of total sales during the first nine months of 20172018 compared to 29.7%32.8% of total sales for the same period in 2016.first nine months of 2017.  Foreign sales increased in 2017 due towere favorably impacted by the sale of two DTX printers totaling $320,000 into Europe along with improved consumableEurope.  There were no DTX printer sales to Latin America.  Fluctuationsin 2018 and none are anticipated in the fourth quarter of 2018.  The fluctuations of certain foreign currencies have not significantly impacted the Company’s operations, as the Company’s foreign sales are not concentrated in any one region of the world, although a strong U.S. dollar does make the Company’s products less competitive internationally.  The Company believes its vulnerability due to uncertainties due toin foreign currency fluctuations and general economic conditions in foreign countries is not significant.

  

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The Company’s foreign transactions are primarily negotiated, invoiced and paid in U.S. dollars, althoughwhile a portion is transacted in Euros.  IKONICSThe Company has not implemented an economic hedging strategy to reduce the risk of foreign currency translation or transaction exposures, as management does not believe this to be a significant risk based on the scope and geographic diversity of the Company’s foreign operations as of September 30, 2017.2018.  Furthermore, the impact of foreign exchange on the Company’s balance sheet and operating results was not material in either 20172018 or 2016.2017.

  

Future Outlook

  

IKONICS has spent an average of approximately 4.0% of annual sales in research and development and has made capital expenditures related to new products and programs.  The Company plans to maintain its efforts in these areas to expedite internal product development as well as to form technological alliances with outside entities to commercialize new product opportunities.

  

The Company continues to make progress on its AMS business initiative.  Although AMS experienced a short-term drop ininitiative as demonstrated by its sales duringfor the first sixnine months of 2017 due to temporary inventory overstocking by a major customer, these sales have returned to expected levels in the third quarter of 2017, and the Company anticipates continued growth over the long term.2018.  The Company has twothree long-term sales agreements in place for its technology with major aerospace companies and is negotiating a third.companies.  In anticipation of this growing business, the Company increased its AMS capacity with a 27,300 square foot expansion at its Morgan Park site in 2016.

  

The Company is also continuing to pursue DTX-related business initiatives andinitiatives.  Despite lower sales for the first nine months of 2018, the Company expects increasedincreasing consumable sales as a result of the sale of two DTX printers in the second quarter of 2017.  However, additional DTX printer sales are not expected until 2019.  In addition to making efforts towards growing the inkjet technology business, the Company offers a range of products for creating texture surfaces and has introduced a fluid for use in prototyping.  The Company is currently working on production improvements to enhance its customer offerings.  The Company has been awarded European, Japanese, and United States patents on its DTX technologies.  The Company has also modified its DTX technology to facilitate entry into the market for prototyping. 

  

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Both the Domestic and IKONICS Imaging units remain profitable in mature markets. Although these business units require aggressive strategies to grow market share, both are developing new products and business relationships that we believe will contribute to growth.  In October 2017, the Company introduced SubTHAT!™, a patent-pending product for the dye-sublimation market.  Response to SubTHAT!™ has been very encouraging, andhowever the Company receivedfulfilled a $258,000 purchaseSubTHAT!™ initial stocking order for SubTHAT!™ in the fourth quarter of 2017 and does not expect to receive an order of that magnitude in 2018.   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. However, the strong U.S. dollar has made this challenging.

  

Other future activities undertaken to expand the Company’s business may include acquisitions, building improvements, equipment additions, new product development and marketing opportunities.

 

Recent Accounting Pronouncements

  

In May 2014, the Financial Accounting Standards Board (“FASB”) issued ASU No. 2014-09, Revenue from Contracts with Customers.  ASU 2014-09 supersedes the revenue recognition requirements in Revenue Recognition (Topic 605), and requires entities to recognize revenue in a way that depicts the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled to in exchange for those goods or services.  In August 2015, the FASB issued ASU 2015-14, Revenue from Contracts with Customers: Deferral of the Effective Date, which defers the adoption of ASU 2014-09 to annual reporting periods beginning after December 15, 2017, including interim reporting periods within that reporting period. Earlier application is permitted only as of annual reporting periods beginning after December 15, 2016, including interim reporting periods within that reporting period.   The standard permits two methods of adoption: retrospectively to each prior reporting period presented (full retrospective method), or retrospectively with the cumulative effect of initially applying the guidance recognized at the date of initial application (the cumulative catch-up transition method).  The standard also requires expanded disclosures relating to the nature, amount, timing,

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and uncertainty of revenue and cash flows arising from contracts with customers. Additionally, qualitative and quantitative disclosures are required about customer contracts, significant judgments and changes in judgments, and assets recognized from the costs to obtain or fulfill a contract.  While the Company is still in the process of evaluating the effect of adoption on its financial statements and is currently assessing its contracts with customers, the Company anticipates that it will expand its financial statement disclosures in order to comply with the new standard.  The Company has established a timeline and process to evaluate the impact, transition and disclosure requirements of the ASU and believes the timeline is sufficient to allow the Company to effectively implement the new standard in the first quarter of 2018.  The Company has not yet concluded on a transition method upon adoption, but plans to select a transition method in the fourth quarter of 2017.

During February 2016, the FASB issued ASU No. 2016-02, Leases. ASU No. 2016-02 was issued to increase transparency and comparability among organizations by recognizing all lease transactions (with terms in excess of 12 months) on the balance sheet as a lease liability and a right-of-use asset (as defined). ASU No. 2016-02 is effective for fiscal years beginning after December 15, 2018, including interim periods within those fiscal years, with earlier application permitted.  Upon adoption, the lessee will apply the new standard retrospectively to all periods presented or retrospectively using a cumulative effect adjustment in the year of adoption. The Company is currently assessingevaluating the effect thatimpact of this standard and does not expect the adoption of ASU No. 2016-02 willto have a material impact on its financial statements.

  

In March 2016, the FASB issued ASU No. 2016-09, Compensation—Stock Compensation (Topic 718). This standard makes several modifications to Topic 718 related to the accounting for forfeitures, employer tax withholding on share-based compensation and the financial statement presentation of excess tax benefits or deficiencies. ASU 2016-09 also clarifies the statement of cash flows presentation for certain components of share-based awards. The standard is effective for interim and annual reporting periods beginning after December 15, 2016, although early adoption is permitted. The Company adopted ASU No. 2016-09 in 2017 with minimal impact on the financial statements.

Off-Balance Sheet Arrangements

  

The Company has no off-balance sheet arrangements.

  

ITEM 3.  Quantitative and Qualitative Disclosures about Market Risk

  

Not applicable

  

ITEM 4.  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 Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934 (the “Exchange Act”)).  Based on this evaluation, the principal executive officer and principal financial officer concluded that the Company’s disclosure controls and procedures are effective to ensure that information required to be disclosed by the Company in reports that it files or submits under the Exchange Act is (i) recorded, processed, summarized and reported within the time periods specified in SEC rules and forms and (ii) accumulated and communicated to the Company’s management, including its principal executive officer and principal financial officer, as appropriate to allow timely decisions regarding required disclosure.

  

There was no change in the Company’s internal control over financial reporting identified in connection with the evaluation required by Rule 13a-15(d) and Rule 15d-15(d) of the Exchange Act that occurred during the period covered by this report that has materially affected, or is reasonably likely to materially affect, the Company’s internal control over financial reporting.

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19


PART II.OTHER INFORMATION

ITEM 1.

ITEM 1.              Legal Proceedings

  

None

ITEM 1A.

ITEM 1A.           Risk Factors

  

Not applicable

ITEM 2.

Unregistered Sales of Equity Securities and Use of Proceeds

  

ITEM 2.              Unregistered Sales of Equity Securities and Use of Proceeds

The Company repurchased shares as indicated in the table below during the third quarter of 2017(1)Not applicable

  

 

    

 

 

 

 

 

(c) Total Number of

 

 

 

 

(a) Total

 

(b) Average

 

Shares Purchased as

 

(d) Maximum Number

 

 

Number

 

Price

 

Part of Publicly

 

of Shares that May

 

   

of Shares

 

Paid per

 

Announced

 

Yet Be Purchased Under

 

    

Purchased

    

Share

    

Plans or Programs

    

The Plans or Programs

July 1, 2017 through July 31, 2017

 

 

$

 

 

Aug. 1, 2017 through Aug. 31, 2017

 

25,000

 

$

8.75

 

25,000

 

75,000

Sep. 1, 2017 through Sep. 30, 2017

 

 

$

 

 

 

 

25,000

 

 

 

 

25,000

 

 

(1)

In prior years, the Company’s board of directors had authorized the repurchase of 250,000 shares of common stock.   A total of 219,589 shares were repurchased under this program including 1,950 shares repurchased during the second quarter of 2017.  As of August 2 2017 the plan allowed for an additional 30,411 shares to be repurchased.  On August 3, 2017, the Company’s board of directors approved a new repurchase authorization for 100,000 shares of the Company’s common stock, which replaces all prior authorizations.  Shares repurchased under this new authorization may be made through open market and privately negotiated transactions from time to time.  The new share repurchase authorization does not have an expiration date.

ITEM 3.

ITEM 3.              Defaults upon Senior Securities

  

Not applicable

ITEM 4.

ITEM 4.              Mine Safety Disclosures

  

Not applicable

ITEM 5.

ITEM 5.              Other Information

  

None

  

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ITEM 6.

ITEM 6.              Exhibits

  

The following exhibits are filed as part of this Quarterly Report on Form 10-Q for the quarterly period ended September 30, 2017:2018:

  

  

Copies of Exhibits will be furnished upon request and payment of the Company’s reasonable expenses in furnishing the Exhibits.

  

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IKONICS CORPORATION

  

SIGNATURES

  

In accordance with the requirements of the Securities Exchange Act of 1934, the registrant caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.

  

 

IKONICS CORPORATION

 

 

 

 

DATE: November 14, 201713, 2018

By:

/s/ Jon Gerlach

 

 

Jon Gerlach,

 

 

Chief Financial Officer, and

Vice President of Finance

 

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