U.S. SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-QSB
(Mark One)
[X] Quarterly Report Pursuant to Section 13 or 15(d) of the Securities Exchange
Act of 1934 For the Quarterly Period Ended September 30, 2006
or
[ ] Transition Report Pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934 For the Transition Period From _______________ to
________________.
Commission file number 000-25727
IKONICS CORPORATION
(Exact name of small business issuer as specified in its charter)
Minnesota 41-0730027
(State or other jurisdiction of (I.R.S. employer
incorporation or organization) identification no.)
4832 Grand Avenue
Duluth, Minnesota 55807
(Address of principal executive offices) (Zip code)
(218) 628-2217
Issuer'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 Exchange Act during the past 12 months (or for such
shorter period that the registrant was required to file such reports), and (2)
has been subject to such filing requirements for the past 90 days.
Yes [X] No [ ]
Indicate by check mark whether the registrant is a shell company (as
defined in Rule 12b-2 of the Exchange Act). Yes [ ] No [X]
State the number of shares outstanding of each of the issuer's classes of
common equity, as of the latest practical date: Common Stock, $.10 par value -
2,010,861 shares outstanding as of November 7, 2006.
Transitional Small Business Disclosure Format (check one): Yes [ ] No [X]
IKONICS CORPORATION
QUARTERLY REPORT ON FORM 10-QSB
PAGE NO.
--------
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements:
Balance Sheets as of September 30, 2006 (unaudited) and
December 31, 2005 3
Statements of Operations for the Three Months and Nine Months
Ended September 30, 2006 and 2005 (unaudited) 4
Statements of Cash Flows for the Nine Months Ended
September 30, 2006 and 2005 (unaudited) 5
Condensed Notes to Financial Statements (unaudited) 6
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations 11
Item 3. Controls and Procedures 16
PART II. OTHER INFORMATION 17
SIGNATURES 18
2
PART I -- FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
IKONICS CORPORATION
BALANCE SHEETS
SEPTEMBER 30 DECEMBER 31
2006 2005
------------ -----------
(UNAUDITED)
ASSETS
CURRENT ASSETS:
Cash and cash equivalents $ 3,986,291 $3,412,072
Marketable securities -- 84,875
Trade receivables, less allowance for doubtful accounts of
$50,000 2,020,607 1,702,608
Inventories (Note 2) 2,269,191 2,364,056
Prepaid expenses and other assets 89,734 65,747
Deferred income taxes 99,000 99,000
----------- ----------
Total current assets 8,464,823 7,728,358
----------- ----------
PROPERTY, PLANT, AND EQUIPMENT, at cost:
Land and building 1,510,483 1,479,824
Machinery and equipment 2,548,974 2,531,734
Office equipment 1,324,791 1,280,149
Vehicles 174,803 174,803
----------- ----------
5,559,051 5,466,510
Less accumulated depreciation 4,696,064 4,514,945
----------- ----------
862,987 951,565
----------- ----------
INVESTMENTS IN NON-MARKETABLE EQUITY SECURITIES 865,160 450,790
INTANGIBLE ASSETS, less accumulated amortization of $153,174 in
2006 and $134,642 in 2005 283,868 279,086
DEFERRED INCOME TAXES 61,000 61,000
----------- ----------
$10,537,838 $9,470,799
=========== ==========
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES:
Accounts payable $ 597,023 $ 438,597
Accrued compensation 215,376 279,042
Other accrued expenses 216,736 217,912
Income taxes payable 44,247 56,743
----------- ----------
Total current liabilities 1,073,382 992,294
----------- ----------
STOCKHOLDERS' EQUITY:
Preferred stock, par value $.10 per share; authorized
250,000 shares; issued none
Common stock, par value $.10 per share; authorized
4,750,000 shares; issued and outstanding 2,010,861 shares
in 2006 and 1,962,537 in 2005 201,086 196,254
Additional paid-in capital 1,972,410 1,721,119
Retained earnings 7,290,960 6,560,236
Accumulated other comprehensive income -- 896
----------- ----------
Total stockholders' equity 9,464,456 8,478,505
----------- ----------
$10,537,838 $9,470,799
=========== ==========
See condensed notes to financial statements.
3
IKONICS CORPORATION
STATEMENTS OF OPERATIONS (UNAUDITED)
THREE MONTHS NINE MONTHS
ENDED SEPTEMBER 30 ENDED SEPTEMBER 30
----------------------- -------------------------
2006 2005 2006 2005
---------- ---------- ----------- -----------
NET SALES $3,673,830 $3,462,253 $11,145,304 $10,532,775
COSTS AND EXPENSES:
Cost of goods sold 1,975,667 1,877,244 6,197,398 5,912,178
Selling, general, and administrative 1,122,399 1,028,592 3,410,574 3,359,970
Research and development 196,493 154,821 561,496 470,534
---------- ---------- ----------- -----------
3,294,559 3,060,657 10,169,468 9,742,682
---------- ---------- ----------- -----------
INCOME FROM OPERATIONS 379,271 401,596 975,836 790,093
INTEREST INCOME 32,492 15,018 82,639 40,217
---------- ---------- ----------- -----------
INCOME BEFORE INCOME TAXES 411,763 416,614 1,058,475 830,310
INCOME TAX EXPENSE 126,810 129,150 327,751 243,929
---------- ---------- ----------- -----------
NET INCOME $ 284,953 $ 287,464 $ 730,724 $ 586,381
========== ========== =========== ===========
EARNINGS PER COMMON SHARE:
Basic $ 0.14 $ 0.15 $ 0.37 $ 0.30
========== ========== =========== ===========
Diluted $ 0.14 $ 0.14 $ 0.36 $ 0.30
========== ========== =========== ===========
WEIGHTED AVERAGE COMMON SHARES
OUTSTANDING:
Basic 2,010,861 1,941,962 1,996,363 1,937,764
========== ========== =========== ===========
Diluted 2,043,981 1,986,033 2,029,732 1,980,151
========== ========== =========== ===========
See condensed notes to financial statements.
4
IKONICS CORPORATION
STATEMENTS OF CASH FLOWS (UNAUDITED)
NINE MONTHS
ENDED SEPTEMBER 30
-----------------------
2006 2005
---------- ----------
CASH FLOWS FROM OPERATING
ACTIVITIES:
Net income $ 730,724 $ 586,381
Adjustments to reconcile net income to net
cash provided by operating activities:
Depreciation 181,120 208,141
Amortization 18,532 33,342
Excess tax benefit from share-based payment
arrangement (36,712) --
Tax benefit from stock option exercise 14,055 25,850
Stock based compensation 19,021 --
Changes in working capital components:
Trade receivables (317,999) (174,681)
Inventories 94,865 14,504
Prepaid expenses and other assets (23,987) (20,469)
Accounts payable 158,426 (2,218)
Accrued liabilities (64,842) (100,105)
Income taxes payable 24,216 35,258
---------- ----------
Net cash provided by
operating activities 797,419 606,004
---------- ----------
CASH FLOWS FROM INVESTING
ACTIVITIES:
Purchase of property and equipment (92,542) (84,147)
Purchase of intangibles (23,314) (39,693)
Purchase of non-marketable equity securities (414,370) (253,330)
Proceeds from sales of marketable securities 83,979 42,694
---------- ----------
Net cash used in investing
activities (446,247) (334,476)
---------- ----------
CASH FLOWS FROM FINANCING
ACTIVITIES:
Excess tax benefits from share-based
payment arrangement 36,712 --
Proceeds from exercise of stock options 186,335 170,758
Redemption of common stock -- (115,664)
---------- ----------
Net cash provided by financing
activities 223,047 55,094
---------- ----------
NET INCREASE IN CASH AND
CASH EQUIVALENTS 574,219 326,622
CASH AND CASH EQUIVALENTS AT
BEGINNING OF PERIOD 3,412,072 2,737,460
---------- ----------
CASH AND CASH EQUIVALENTS AT
END OF PERIOD $3,986,291 $3,064,082
========== ==========
SUPPLEMENTAL DISCLOSURES OF
CASH FLOW INFORMATION:
Income taxes paid $ 289,480 $ 198,242
========== ==========
See condensed notes to financial statements.
5
IKONICS CORPORATION
CONDENSED NOTES TO FINANCIAL STATEMENTS
(Unaudited)
1. Basis of Presentation
The balance sheet of IKONICS Corporation (the "Company") as of September
30, 2006, and the related statements of operations for the three and nine
months ended September 30, 2006 and 2005, and cash flows for the nine
months ended September 30, 2006 and 2005, 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,
2006, 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-KSB for the year ended December 31, 2005.
The results of operations for interim periods are not necessarily
indicative of results that will be realized for the full fiscal year.
2. Inventory
The major components of inventory are as follows:
Sep 30, 2006 Dec 31, 2005
------------ ------------
Raw materials $1,585,038 $1,483,881
Work-in-progress 248,761 212,254
Finished goods 951,803 1,176,647
Reduction to LIFO cost (516,411) (508,726)
---------- ----------
Total Inventory $2,269,191 $2,364,056
========== ==========
3. Earnings Per Common Share (EPS)
Basic EPS is calculated using net income 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 dilutive potential common shares, such as shares
issuable on the exercise of options, had been issued.
6
Shares used in the calculation of diluted EPS are summarized below:
Three Months Ended
---------------------------
Sep 30, 2006 Sep 30, 2005
------------ ------------
Weighted average common shares outstanding 2,010,861 1,941,962
Dilutive effect of stock options 33,120 44,071
--------- ---------
Weighted average common and common equivalent shares outstanding 2,043,981 1,986,033
========= =========
Nine Months Ended
---------------------------
Sep 30, 2006 Sep 30, 2005
------------ ------------
Weighted average common shares outstanding 1,996,363 1,937,764
Dilutive effect of stock options 33,369 42,387
--------- ---------
Weighted average common and common equivalent shares outstanding 2,029,732 1,980,151
========= =========
Options to purchase 88,222 and 145,625 shares of common stock were
outstanding as of September 30, 2006 and 2005, respectively.
4. Stock-based Compensation
Effective January 1, 2006, we adopted Financial Accounting Standards Board
Statement No. 123 (revised 2004), "Share-Based Payment," (FAS 123(R)) using
the modified-prospective-transition method. Prior to the adoption of FAS
123(R), we accounted for stock option grants under APB Opinion No. 25,
"Accounting for Stock Issued to Employees" (the intrinsic value method),
and accordingly recognized no compensation expense for stock option grants.
Under the modified-prospective-transition method, FAS 123(R) applies to new
awards and to awards that were outstanding on January 1, 2006 that are
subsequently modified, repurchased, or cancelled. Under this method
compensation cost in 2006 includes cost for options granted prior to but
not vested as of December 31, 2005, and options granted in 2006. Prior
periods were not restated to reflect the impact of adopting the new
standard.
The adoption of FAS 123(R) lowered net income by approximately $4,600 for
the three months ended September 30, 2006, and $13,300 for the nine months
ended September 30, 2006 compared to accounting for share-based
compensation under APB No. 25. The Company has elected the alternative
(short-cut) method for calculating the pool of excess tax benefits (APIC
Pool) available to absorb tax shortages recognized subsequent to the
adoption of FAS 123(R). The Company's calculation of the APIC windfall at
January 1, 2006 was $3,000.
The following table illustrates the effect on net income and earnings per
share if we had applied the fair value recognition provisions of FAS 123R
during the periods presented. For the purposes of this pro forma
disclosure, the value of the options is estimated using a Black-Scholes
option-pricing model and amortized to expense over the options vesting
periods.
7
Three Months Nine Months
Ended Ended
Sep 30, 2005 Sep 30, 2005
------------ ------------
Net income:
As reported $287,464 $586,381
Deduct total stock-based employee compensation
expense determined under fair value based
method for all awards 5,304 15,911
-------- --------
Pro forma $282,160 $570,470
======== ========
Basic earnings per share:
As reported $ 0.15 $ 0.30
Pro forma $ 0.15 $ 0.29
Diluted earnings per share:
As reported $ 0.14 $ 0.30
Pro forma $ 0.14 $ 0.29
As of September 30, 2006 there was approximately $42,000 of unrecognized
compensation cost related to unvested share-based compensation awards
granted. That cost is expected to be recognized over the next three years.
The Company receives a tax deduction for certain stock option exercises
during the period in which the options are exercised, generally for the
excess of the prices at which the option shares are sold over the exercise
price of the options. Prior to the adoption of FAS 123(R), we reported all
tax benefits relating to the exercise of stock options as operating cash
flows in our statement of cash flows. In accordance with FAS 123(R), for
the nine months ended September 30, 2006, we began reporting the excess tax
benefits from the exercise of stock options as a reduction of operating and
an increase in financing cash flows. For the nine months ended September
30, 2006, $36,712 of excess tax benefits were reported in the statement of
cash flows.
Proceeds from the exercise of stock options were $186,335 for the nine
months ended September 30, 2006. The actual income tax benefit realized
from the exercise of stock options was $36,712 for the same period.
During 1995, the Company, with the approval of its shareholders, adopted a
stock incentive plan for the issuance of up to 57,750 shares of common
stock. In 1999, the Company, with the approval of its shareholders,
increased the number of shares reserved for issuance under this plan to
305,250 shares and, in 2004, increased the number of shares reserved for
issuance under this plan to 342,750 shares. The plan provides for granting
eligible participants stock options or other stock awards, as described by
the plan, at option prices ranging from 85% to 110% of fair market value at
date of grant. Options granted expire up to seven years after the date of
grant. Such options generally become exercisable over a one to three year
period. A total of 55,673 shares of common stock are reserved for
additional grants of options under the plan at September 30, 2006.
The fair value of options granted during the nine months ended September
30, 2006 was estimated using the Black-Scholes option pricing model with
the following assumptions:
Dividend yield 0.0%
Expected volatility 60.6%-63.0%
Expected life of option five years
Risk-free interest rate 4.8% - 5.0%
Fair value of each option on grant date $4.48 - $4.80
There were no options granted during the three months ended September 30,
2006.
8
Stock option activity during the nine months ended September 30, 2006 is as
follows:
Weighted
Average
Exercise
Shares Price
------- --------
Outstanding at beginning of year 130,285 $3.27
Granted 7,250 8.03
Exercised (48,324) 3.86
Expired and forfeited (989) 4.59
-------
Outstanding at September 30, 2006 88,222 3.33
=======
The aggregate intrinsic value of all options outstanding and for those
exercisable at September 30, 2006 was $396,448 and $357,090, respectively.
The following table summarizes information about stock options outstanding
at September 30, 2006:
Options Outstanding
----------------------------------------- Options Exercisable
Weighted- --------------------------
Number Average Weighted- Number Weighted-
Range of Outstanding at Remaining Average Exercisable at Average
Exercise September 30, Contractual Exercise September 30, Exercise
Price 2006 Life (years) Price 2006 Price
------------ -------------- ------------ --------- -------------- ---------
$2.00 - 2.99 58,222 1.14 $2.44 58,222 $2.44
3.00 - 3.99 11,250 1.84 3.36 7,500 3.36
4.00 - 4.99 9,250 3.58 4.32 2,916 4.32
7.00 - 8.99 9,500 4.04 7.79 1,500 7.01
------ ------
88,222 1.80 3.33 70,138 2.72
====== ======
5. Intangible Assets
Intangible assets consist primarily of patents, licenses and covenants not
to compete. Intangible assets are amortized on a straight-line basis over
their estimated useful lives or terms of their agreements. Estimated
amortization expense for each of the next five years is $25,000 annually.
In connection with license agreements, the Company has agreed to pay
royalties ranging from 3% to 5% on the future sales of products subject to
the agreements.
6. Comprehensive income
Comprehensive income includes unrealized gains and losses on the Company's
available for sale marketable securities. Total comprehensive income was
$284,953 and $287,678 for the three months ended September 30, 2006 and
2005, respectively. Total comprehensive income was $731,620 and $589,326
for the nine months ended September 30, 2006 and 2005, respectively.
9
7. Recent Accounting Pronouncements
In June 2006, the Financial Accounting Standards Board (FASB) issued
Interpretation No. 48, Accounting for Uncertainty in Income Taxes (FIN 48).
FIN 48 clarifies the accounting for uncertainty in income taxes recognized
in an enterprise's financial statements in accordance with FASB Statement
No. 109, Accounting for Income Taxes. FIN 48 prescribes a recognition
threshold and measurement attribute for the financial statement recognition
and measurement of a tax position taken or expected to be taken in a tax
return. FIN 48 also provides guidance on derecognition, classification,
interest and penalties, accounting in interim periods, disclosure and
transition. FIN 48 will be effective for the Company beginning in fiscal
2007. The Company is evaluating the interpretation to determine the effect
on our financial statements and related disclosures.
In September 2006, the FASB issued SFAS No. 157, Fair Value Measurements
("SFAS 157"). SFAS 157 defines fair value, establishes a framework for
measuring fair value in generally accepted accounting principles, and
expands disclosures about fair value measurements. This Statement applies
under other accounting pronouncements that require or permit fair value
measurements, the FASB having previously concluded in those accounting
pronouncements that fair value is the relevant measurement attribute.
Accordingly, SFAS 157 does not require any new fair value measurements.
SFAS 157 is effective for the Company beginning in fiscal year 2008. The
Company is evaluating the statement to determine the effect on the
financial statements and related disclosures.
10
IKONICS CORPORATION
The information presented below in Management's Discussion and Analysis of
Financial Condition and Results of Operations contains forward-looking
statements within the meaning of the safe harbor provisions of Section 21E of
the Securities Exchange Act of 1934, as amended. Such statements are subject to
risks and uncertainties, including those discussed under "Factors that May
Affect Future Results" below, that could cause actual results to differ
materially from those projected. Because actual results may differ, readers are
cautioned not to place undue reliance on these forward-looking statements.
Certain forward-looking statements are summarized below.
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 2006, the nine months ended September 30, 2006 and
the same periods of 2005. It should be read in connection with the Company's
unaudited financial statements and notes thereto included in this Form 10-QSB.
FACTORS THAT MAY AFFECT FUTURE RESULTS
Certain statements made in this Quarterly Report on Form 10-QSB, including
those summarized below, are forward-looking statements within the meaning of the
safe harbor provisions of Section 21E of the Securities Exchange Act of 1934, as
amended, that involve risks and uncertainties, and actual results may differ
from those presented. Factors that could cause actual results to differ include
those identified below following each summarized forward-looking statement.
- The Company's belief that the quality of its receivables is high and
that strong internal controls are in place to maintain proper
collections--This belief may be impacted by domestic economic
conditions, by economic, political, regulatory or social conditions in
foreign markets, or by the failure of the Company to properly
implement or maintain strong internal controls.
- The belief that the Company's current financial resources, its line of
credit, cash generated from operations and the Company's capacity for
debt and/or equity financing will be sufficient to fund current and
anticipated business operations. The belief that the Company's low
debt levels and available line of credit make it unlikely that a
decrease in product demand would impair the Company's ability to fund
operations--Changes in anticipated operating results, credit
availability, equity market conditions or the Company's debt levels
may further enhance or inhibit the Company's ability to maintain or
raise appropriate levels of cash.
- The Company's expectations as to the level and use of planned capital
expenditures and that capital expenditures will be funded with cash
generated from operating activities--This expectation may be affected
by changes in the Company's anticipated capital expenditure
requirements resulting from unforeseen required maintenance or
repairs. The funding of planned or unforeseen expenditures may also be
affected by changes in anticipated operating results resulting from
decreased sales or increased operating expenses or by other unexpected
events affecting the Company's financial position.
- The Company's belief that its vulnerability to foreign currency
fluctuations and general economic conditions in foreign countries is
not significant--This belief may be impacted by economic, political
and social conditions in foreign markets, changes in regulatory and
competitive conditions, a change in the amount or geographic focus of
the Company's international sales, or changes in purchase or sales
terms.
11
- The Company's plans to continue to invest in research and development
efforts, expedite internal product development and invest in
technological alliances, as well as the expected focus and results of
such investments--These plans and expectations may be impacted by
general market conditions, unanticipated changes in expenses or sales,
delays in the development of new products, technological advances, the
ability to find suitable and willing technology partners or other
changes in competitive or market conditions.
- The Company's efforts to grow its international business--These
efforts may be impacted by economic, political and social conditions
in current and anticipated foreign markets, regulatory conditions in
such markets, unanticipated changes in expenses or sales, changes in
competitive conditions or other barriers to entry or expansion.
- The Company's belief as to future activities that may be undertaken to
expand the Company's business--Actual activities undertaken may be
impacted by general market conditions, competitive conditions in the
Company's industry, unanticipated changes in the Company's financial
position or the inability to identify attractive acquisition targets
or other business opportunities.
CRITICAL ACCOUNTING POLICIES
The Company prepares its financial statements in conformity with accounting
principles generally accepted in the United States of America. Therefore, the
Company is required to make certain estimates, judgments and assumptions that
the Company believes are reasonable based upon the information available. These
estimates and assumptions affect the reported amounts of assets and liabilities
at the date of the financial statements and the reported amounts of revenues and
expenses during the periods presented. The accounting policies, which IKONICS
believes are the most critical to aid in fully understanding and evaluating its
reported financial results, include the following:
Accounts Receivable. The Company performs ongoing credit evaluations of its
customers and adjusts credit limits based upon payment history and the
customer's current credit worthiness, as determined by review of the current
credit information. The Company 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 Company's general payment terms are net 30-45 days for domestic
customers and net 60-90 days for foreign customers.
Inventory. Inventories are valued at the lower of cost or market value
using the last in, first out (LIFO) method. The Company monitors its inventory
for obsolescence and records reductions in cost when required.
Deferred Tax Assets. At September 30, 2006, the Company had approximately
$160,000 of net deferred tax assets. The net deferred tax assets result
primarily from timing differences in intangible assets and property and
equipment. The Company has recorded a $27,000 valuation allowance to reserve for
items that will more likely than not be realized. The Company has determined
that it is more likely than not that the remaining net deferred tax assets
reflected on the balance sheet will be realized and that an additional valuation
allowance for such assets is not currently required.
Revenue Recognition. The Company recognizes revenue on products when title
passes, which is usually upon shipment. Freight billed to customers is included
in sales. Shipping costs are included in cost of goods sold.
RESULTS OF OPERATIONS
QUARTER ENDED JUNE 30, 2006 COMPARED TO QUARTER ENDED JUNE 30, 2005
Sales. The Company realized 6.1% sales growth during the third quarter of
2006 with sales of $3.7 million, compared to $3.5 million in sales during the
same period in 2005. International sales for the third quarter
12
of 2006 increased by $125,000 compared to the same period in 2005 due to
stronger Asian sales. Domestic sales also increased by $87,000 due to an
increase in glass and equipment shipments.
Cost of Goods Sold. Cost of goods sold during the third quarter of 2006 was
$2.0 million, or 53.8% of sales, compared to $1.9 million, or 54.2% of sales,
during the same period in 2005. The decrease as a percentage of sales was the
result of a more favorable product mix partially offset by an increase in raw
material and transportation costs.
Selling, General and Administrative Expenses. Selling, general and
administrative expenses were $1.1 million, or 30.5% of sales, in the third
quarter of 2006 versus $1.0 million, or 29.7% of sales, for the same period in
2005. Selling, general and administrative expenses increased during the third
quarter of 2006 due to higher trade show and promotional expenses.
Research and Development Expenses. Research and development expenses during
the third quarter of 2006 were $196,000, or 5.3% of sales, versus $155,000, or
4.5% of sales, for the same period in 2005. The increase is due to spending on
new product and additional research and development staff.
Interest Income. Interest income for the third quarter of 2006 was $32,000
compared to $15,000 for the same period in 2005. The interest income increase is
due to an increase in interest rates and a larger balance of interest earning
assets.
Income Taxes. The income tax provision differs from the expected tax
expense primarily due to the benefits of the foreign sales exclusion, state
income taxes and federal tax credits for research and development. For the third
quarter of 2006, income tax expense was $127,000, or an effective rate of 30.8%
versus $129,000, or an effective rate of 31.0% for third quarter of 2005.
NINE MONTHS ENDED SEPTEMBER 30, 2006 COMPARED TO THE NINE MONTHS ENDED SEPTEMBER
30, 2005
Sales. Compared to the same period in 2005, the Company's sales increased
5.8% during the first nine months of 2006. Sales during the first nine months of
2006 were $11.1 million versus sales of $10.5 million during the first nine
months of 2005. Sales growth was realized in both the domestic and international
markets. The $320,000 domestic sales increase was due to stronger film and glass
sales while the $290,000 international sales increase was mainly related to
Asian sales growth.
Cost of Goods Sold. Cost of goods sold during the first nine months of 2006
was $6.2 million, or 55.6% of sales, compared to $5.9 million, or 56.1% of
sales, during the same period in 2005. The decrease in the cost of sales during
the first nine months of 2006 as a percentage of sales reflects a more favorable
product mix partially offset by rising raw material and transportation costs.
Selling, General and Administrative Expenses. Selling, general and
administrative expenses for the first nine months of 2006 and 2005 were $3.4
million for each year. Increased promotional spending in 2006 was offset by
Sarbanes Oxley compliance related expenses incurred during the first nine months
of 2005.
Research and Development Expenses. Research and development expenses during
the nine months of 2006 were $561,000, or 5.0% of sales, versus $471,000, or
4.5% of sales, for the same period in 2005. The increase is due to an increase
in spending on new product development, production trials and additional
research and development staff.
Interest Income. Interest income for the first nine months of 2006 was
$83,000 compared to $40,000 for the same period in 2005. The interest income
increase is due to an increase in interest rates and a larger balance of
interest earning assets.
Income Taxes. The income tax provision differs from the expected tax
expense primarily due to the benefits of the foreign sales exclusion, state
income taxes and federal tax credits for research and development. For the first
nine months of 2006, income tax expense was $328,000, or an effective rate of
31.0%. Income tax expense
13
for the first nine months of 2005 was $244,000, or an effective rate of 29.4%.
The lower effective rate for the first nine months of 2005 was partially due to
a study performed by the Company during the first quarter of 2005, related to
its research and development activities resulting in tax credits totaling
$15,000. The tax credits resulted in a net income tax benefit during the first
nine months of 2005 of $9,000.
LIQUIDITY AND CAPITAL RESOURCES
The Company has financed its operations principally with funds generated
from operations and employee stock option exercises. 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 $4.0 million and $3.1 million at September
30, 2006 and September 30, 2005, respectively. The Company generated $797,000 in
cash from operating activities during the nine months ended September 30, 2006,
compared to $606,000 during the same period in 2005. The increase in cash from
operating activities is primarily due to the increase in net income and changes
in working capital components as discussed below. Cash provided by operating
activities is primarily the result of net income adjusted for non-cash
depreciation, amortization, tax effect of stock options, stock based
compensation, and certain changes in working capital components.
During the first nine months of 2006, trade receivables increased by
$318,000. The increase in receivables was driven by higher sales volumes and the
timing of collections. The Company believes that the quality of its receivables
is high and that strong internal controls are in place to maintain proper
collections. Inventory levels decreased $95,000 due to lower finished good
levels. Prepaid expenses increased $24,000, reflecting annual insurance premiums
prepaid in the first quarter of 2006. Accounts payable increased $158,000,
primarily as a result of the timing of payments to and purchases of material
from suppliers for inventory. Accrued expenses decreased $65,000, primarily
reflecting the timing of compensation and other miscellaneous payments. The
$24,000 income taxes payable increase reflects the timing of estimated 2006 tax
payments compared to 2006 calculated tax liability.
For the first nine months of 2006, the Company used $446,000 in investing
activities. This included exercising warrants to buy an additional 43,333 shares
of stock in Imaging Technology International at $7.50 per share and 10,833
shares at $8.25 per share for a total cash outlay of $414,000. The Company owns
approximately 6% of the outstanding shares of Imaging Technology International
(iTi). Also during the first nine months of 2006, the Company received $84,000
from the sale of marketable securities and purchased $93,000 of plant equipment
to improve efficiency, and reduce operating costs. The Company also incurred
$23,000 in patent application costs that the Company recorded as an asset and
amortizes upon successful completion of the application process. During the
first nine months of 2005, the Company invested $253,000 in iTi, received
$43,000 from the sale of marketable securities, purchased $84,000 in capital
equipment, and incurred $40,000 in patent application costs.
The Company realized $223,000 in cash from financing activities during the
first nine months of 2006 compared to $55,000 received in the same period in
2005. During the first nine months of 2006, the Company received $186,000 for
the issuance of 48,324 shares of common stock upon the exercise of stock options
compared to $171,000 received during the first nine months of 2005 for 43,151
shares of common stock issued upon the exercise of stock options. The Company
also realized a $37,000 cash benefit during the first nine months of 2006
related to the excess tax benefit from the exercise of stock options. During the
first nine months of 2005 the Company repurchased 25,499 shares of common stock
at a cost of $116,000.
A bank line of credit exists providing for borrowings of up to $1,250,000.
Outstanding debt under this line of credit is collateralized by accounts
receivable and inventory and bears interest at 2.00 percentage points over the
30-day LIBOR rate. The Company did not utilize this line of credit during the
first nine months of 2006 and there were no borrowings outstanding as of
September 30, 2006. The line of credit was also not utilized during 2005, and
there were no borrowings outstanding under this line as of September 30, 2005.
The Company believes that current financial resources, its line of credit,
cash generated from operations and the Company's capacity for debt and/or equity
financing will be sufficient to fund current and anticipated
14
business operations. The Company also believes that its low debt levels and
available line of credit make it unlikely that a decrease in demand for the
Company's products would impair the Company's ability to fund operations.
CAPITAL EXPENDITURES
Through September 30, 2006, the Company has spent $93,000 on capital
expenditures. This spending primarily consists of plant equipment upgrades and
building improvements to improve efficiency and reduce operating costs.
The Company plans for additional capital expenditures during 2006 to
include ongoing manufacturing equipment upgrades, development equipment to
modernize the capabilities and processes of the Company's research and
development laboratory to improve measurement and quality control processes.
Total 2006 planned capital expenditures are expected to be similar to prior
years and are expected to be funded with 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 30% of total sales during the first nine months of 2006 and 29% of
total sales for the same period in 2005. Fluctuations of certain foreign
currencies have not significantly impacted the Company's operations because the
Company's foreign sales are not concentrated in any one region of the world. The
Company believes its vulnerability to uncertainties due to foreign currency
fluctuations and general economic conditions in foreign countries is not
significant.
The Company's foreign transactions are primarily negotiated, invoiced and
paid in U.S. dollars while a portion is transacted in Euros. IKONICS has not
implemented a hedging strategy to reduce the risk of foreign currency
translation exposures, which management does not believe to be significant based
on the scope and geographic diversity of the Company's foreign operations as of
September 30, 2006.
FUTURE OUTLOOK
IKONICS has invested on average over 4% of its sales dollars for the past
few years in research and development. The Company plans to maintain its efforts
in this area and expedite internal product development as well as form
technological alliances with outside experts to ensure commercialization of new
product opportunities.
In addition to its traditional emphasis on domestic markets, the Company
will continue efforts to grow its business internationally by attempting to
develop new markets and expanding market share where it has already established
a presence.
Other future activities which may be undertaken to expand the Company's
business may include acquisitions, building expansion and additions, equipment
additions, new product development and marketing opportunities.
RECENT ACCOUNTING PRONOUNCEMENTS
In June 2006, the Financial Accounting Standards Board (FASB) issued
Interpretation No. 48, Accounting for Uncertainty in Income Taxes (FIN 48). FIN
48 clarifies the accounting for uncertainty in income taxes recognized in an
enterprise's financial statements in accordance with FASB Statement No. 109,
Accounting for Income Taxes. FIN 48 prescribes a recognition threshold and
measurement attribute for the financial statement recognition and measurement of
a tax position taken or expected to be taken in a tax return. FIN 48 also
provides guidance on derecognition, classification, interest and penalties,
accounting in interim periods, disclosure and transition. FIN 48 will be
effective for the Company beginning in fiscal 2007. The Company is evaluating
the interpretation to determine the effect on our financial statements and
related disclosures.
15
In September 2006, the FASB issued SFAS No. 157, Fair Value Measurements
("SFAS 157"). SFAS 157 defines fair value, establishes a framework for measuring
fair value in generally accepted accounting principles, and expands disclosures
about fair value measurements. This Statement applies under other accounting
pronouncements that require or permit fair value measurements, the FASB having
previously concluded in those accounting pronouncements that fair value is the
relevant measurement attribute. Accordingly, SFAS 157 does not require any new
fair value measurements. SFAS 157 is effective for the Company beginning in
fiscal year 2008. The Company is evaluating the statement to determine the
effect on the financial statements and related disclosures.
ITEM 3. 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 recorded, processed, summarized and reported
within the time periods specified in SEC rules and forms.
There was no change in the Company's internal control over financial
reporting identified in connection with the evaluation required by Rule
13a-15(d) and Rule 15d-15(d) of the Exchange Act that occurred during the period
covered by this report that has materially affected, or is reasonably likely to
materially affect, the Company's internal control over financial reporting.
16
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
None
ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
None
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
Not applicable
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None
ITEM 5. OTHER INFORMATION
None
ITEM 6. EXHIBITS
The following exhibits are filed as part of this Quarterly Report on Form
10-QSB for the quarterly period ended September 30, 2006:
Exhibit Description
------- -----------
3.1 Restated Articles of Incorporation of Company, as amended.(1)
3.2 By-Laws of the Company, as amended.(1)
31.1 Rule 13a-14(a)/15d-14(a) Certifications of CEO
31.2 Rule 13a-14(a)/15d-14(a) Certifications of CFO
32 Section 1350 Certifications
Copies of Exhibits will be furnished upon request and payment of the
Company's reasonable expenses in furnishing the Exhibits.
----------
(1) Incorporated by reference to the like numbered Exhibit to the Company's
Registration Statement on Form 10-SB (File No. 000-25727).
17
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 13, 2006 By: /s/ Jon Gerlach
------------------------------------
Jon Gerlach,
Chief Financial Officer and
Vice President of Finance
18
INDEX TO EXHIBITS
Exhibit Description Page
------- ----------- ----
3.1 Restated Articles of Incorporation of Company, as amended... Incorporated by reference
3.2 By-Laws of the Company, as amended.......................... Incorporated by reference
31.1 Rule 13a-14(a)/15d-14(a) Certifications of CEO.............. Filed Electronically
31.2 Rule 13a-14(a)/15d-14(a) Certifications of CFO.............. Filed Electronically
32 Section 1350 Certifications................................. Filed Electronically