IKONICS Corporation
Annual Report 2002

Plain-text annual report

Our Business Derived from the Greek word eikon, or image, the funda- mental business of the IKONICS Corporation is the creation and transfer of physical and visual images. Through processes based in photochemistry, abrasive etching, inkjet printing, chemical etching and other technologies, IKONICS participates in a diverse spectrum of markets. From tradi- tional and high-tech screen printing, to decorative and industrial etching and imaging, IKONICS Corporation con- ducts business in over 60 countries. Through its three commercial divisions, IKONICS approaches its respective markets with global perspective and a focus on emerging markets. This anticipatory perspective is illustrated in the growth and development of IKONICS' PhotoBrasive Systems Division. Launched in 1985, PhotoBrasive Systems leads the awards and recogni- tion market in abrasive etching technology, prod- uct development and sales. Having gained dom- inance within its primary markets, PhotoBrasive Systems is now working to penetrate new markets with its unique technolo- gy. Product and market advancement are assisted by cooperative agreements with the DuPont Corporation and the Aicello Corporation of Japan. Abrasive etching can be used to decorate a wide variety of objects ranging from small items such as awards and giftware to large walls and monuments. Chromaline Screen Print Products is IKONICS' largest and oldest division. Serving the screen printing industry since 1952, first as Chroma-Glo, then as The Chromaline Corporation, the Chromaline brand is recognized as a world leader in the development and sale of screen stencil supplies. Leveraging the strength of the in the Chromaline brand screen print market allows IKONICS to introduce new products, new technologies and new ways of selling into Screen printing is used for a diverse this market. In 2002 this base of applications such as textile, strategy resulted in the suc- industrial and graphics printing. cessful introduction of the Photo courtesy of TEC Graphics Inc., AccuArt family of inkjet-able Neenah, WI. substrates to the screen print and other printing markets. The AccuArt and AccuBlack products have gained recogni- tion as the highest quality products available, while AccuMark is a value leader. These products place Chomaline Screen Print Products in a leadership position in the industry trend toward digital printing. The goal of the SplitRock Technologies Division is to develop a suite of IKONICS’ patentable technologies to industries where they offer unique solutions to imaging process problems. A special focus is the application of IKONICS technology to the imaging and etching of met- als. SplitRock Technologies represents potential growth into major new markets through the creative application of core technical strengths. A new avenue for IKONICS technolo- gy is in the imaging and etching of metals. IKONICS serves a wide variety of imaging markets through three separate commercial divisions: Chromaline Screen Print Products - Photostencil products and inkjet media for professional screen printers. PhotoBrasive Systems - Photo resist films, equip- ment and supplies for commercial and industrial abrasive etching. SplitRock Technologies - Unique imaging technologies for new markets. 2002 ANNUAL REPORT IKONICS CORPORATION . I S C N O K I t h g i r y p o c s r e h t o l l A . y r t s u d n I r o f s e t a l p e m a N d n a , s y S a m e S , . c n I s c i h p a r G C E T f o y s e t r u o c s e g a m i g n i t n i r p n e e r c S : s e t o N r e v o C 2 Letter to the Shareholders films. Our AccuArt and AccuBlack films are recognized as leadership products for the printing of high contrast waterproof images, photopositives and photonegatives. These films are now joined by AccuMark, which meets the demands of the more price-sensitive user. In 2003 we will be offering multiple for- mats and prompt delivery of these films. Through our SplitRock Technologies Division we are actively exploring new markets for our technologies, particularly in the metal engraving industry. We believe that the key technologies are patentable, and see signifi- cant market potential particularly in the sig- nage and die-making industry where this technology is unique and, we believe, may offer substantial benefits over the existing methods. On a geographical basis, we see expanded sales for all our products in Asia and are plan- ning to open a training center in Singapore in the second quarter. While we are positioning for growth in 2003, the experience of the past two years has made us a leaner and more cost-conscious company. This attention to cost will continue, ensuring that increased revenues get to the bottom line. For the Board of Directors, William C. Ulland Chairman, President and CEO March 7, 2003 The year 2002 marked a return to growth and profitability for the company. For the year, sales were a record $11,797,279, a 10% increase over 2001. Earnings were $359,817 or $.29 per share compared to a loss of $.16 per share in 2001. This growth was led by an increase in sales to Asia and through our PhotoBrasive Systems division. Equally important as the financial per- formance is the foundation that was laid for future growth. In December, we changed our name to IKONICS Corporation. This reflects the expansion from our traditional base in the screen printing the Chromaline brand commands a strong posi- tion, into other markets where we are or can become technology and industry leaders. industry, where To date, our other primary market has been abrasive etching, served by our PhotoBrasive Systems Division. In 2000 and 2001 this division was severely hurt by the effects of a patent infringement suit with the Aicello Corporation of Japan. Although the suit was settled in January of 2001, it was not until 2002 that we regained market leader- ship. Our future in this industry has been strengthened by a recent technology agree- ment with DuPont Corporation. This agree- ment gives IKONICS the exclusive worldwide right to manufacture, use and sell Dupont's RapidMask™ photoresist film in the abrasive etching market. We have distributed RapidMask since February of 2000, and believe that with some product improvements and a lowering of cost, it could become the premier product in this market as well as a means to expand the market. With the assistance of DuPont, we have begun to reformulate RapidMask and I am very optimistic that we will achieve our goal of product improvement. The cost objective has already been substan- tially met. In our traditional screen printing market, the Chromaline Screen Print Products Division of IKONICS is planning for significant growth, led by our AccuArt™ Family of inkjet receptive Bill Ulland Chairman, President and CEO Table of Contents 2 Our Business 3 Letter to Shareholders 4-7 Management Discussion & Analysis 8 9 10 11 Management Report/ Independent Auditors’ Report Balance Sheets Statements of Operations / Stockholders’ Equity Statements of Cash Flows 12-16 Notes to Financial Statements 17 18 5 Year History/ Stock & Counsel Information Board of Directors & Officers 19 Our Global Markets IKONICS CORPORATION 2002 ANNUAL REPORT 3 Financial Results Management’s Discussion and Analysis of Financial Condition and Results of Operations The following management discussion and analysis focuses on those factors that had a material effect on the Company's financial results of operations and financial con- dition during 2002 and 2001 and should be read in con- nection with the Company's audited financial statements and notes thereto for the years ended December 31, 2002 and 2001. Factors that May Affect Future Results Certain statements made in this Annual Report on Form 10- KSB, including those summarized below, are forward-look- ing statements within the meaning of the safe harbor pro- visions of Section 21E of the Securities Exchange Act of 1934, as amended, that involve risks and uncertainties, and actual results may differ. Factors that could cause actual results to differ include those identified below. • The belief that the Company's current financial resources, cash generated from operations and the Company's capacity for debt and/or equity financing will be sufficient to fund current and anticipated business operations and capital expenditures. The belief that the Company's low debt levels and available line of credit make it unlikely that a decrease in product demand would impair the Company's ability to fund operations- Changes in anticipated operating results, credit availability, equity market conditions or the Company's debt levels may further enhance or inhibit the Company's ability to main- tain or raise appropriate levels of cash. • The Company's expectation that capital expenditures in 2003 will be funded with cash generated from oper- ating activities—This expectation may be affected by changes in the Company's anticipated capital expenditure requirements resulting from unforeseen required mainte - nance or repairs. The funding of planned or unforeseen expenditures may also be affected by changes in anticipat- ed operating results resulting from decreased sales or increased operating expenses. • The Company's belief that its vulnerability to foreign currency fluctuations and general economic conditions in foreign countries is not significant— This belief may be impacted by economic, political and social conditions in foreign markets and changes in regulatory and competitive conditions or a change in the amount or geographic focus of the Company's international sales. • 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 invest- ments— These plans and expectations may be impacted by general market conditions, unanticipated changes in expenses or sales, delays in the development of new prod- ucts, technological advances, the ability to find suitable and willing technology partners or other changes in com- petitive or market conditions. • The Company's efforts to grow its international busi- ness—These efforts may be impacted by economic, politi- cal and social conditions in current and anticipated foreign markets, regulatory conditions in such markets, unantici- pated 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 opportuni- ties. Critical Accounting Policies The Company prepares the financial statements in con- formity with accounting principles generally accepted in the United States of America. Therefore, the Company is required to make certain estimates, judgments and assump- tions that the Company believes are reasonable based upon the information available. These estimates and assump- tions 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 pre- sented. The accounting policies, which IKONICS believes are the most critical to aid in fully understanding and eval- uating its reported financial results, include the following: Accounts Receivable - The Company performs ongoing credit evaluations of its customers and adjusts credit limits based upon payment history and the customer's current credit worthiness, as determined by review of the current credit information. The Company continuously monitors collections and payments from its customers and maintains a provision for estimated credit losses based upon histori- cal experience and any specific customer collection issues that have been identified. While such credit losses have historically been within expectations and the provisions established, the Company cannot guarantee that it will continue to experience the same collection history that has occurred in the past. The general payment terms are net 30-45 days for domestic customers and net 60-90 days for foreign customers. The concentration of credit risk is not significant except for a receivable from one of the Company's larger customers, which accounted for 17.6% of total receivables as of December 31, 2002. Inventory - Inventories are valued at the lower rate of cost or market value. The Company monitors its inventory 4 2002 ANNUAL REPORT IKONICS CORPORATION for obsolescence and records reductions in cost when required. Deferred Tax Assets - At December 31, 2002, the Company had approximately $200,000 of deferred tax assets. The deferred tax assets result primarily due to tim- ing differences in intangible assets and property and equip- ment. The Company has recorded a $20,000 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 deferred tax assets will be realized and that an additional valuation allowance for such assets is not currently required. Revenue Recognition - The Company recognizes revenue on products when title passes, which is usually upon ship- ment. Freight billed to customers is included in sales. Shipping costs are included in cost of goods sold. Results of Operations Year Ended December 31, 2002 Compared to Year Ended December 31, 2001. Sales - The Company's net sales increased 9.7% to $11.8 million in 2002, compared to net sales of $10.8 million in 2001. Sales in the United States increased 6.7% to $8.0 million in 2002, from $7.5 million in 2001. Sales in the United States improved somewhat from the weakness in 2001 that reflected the continuing domestic economic recession. International sales increased 15.2% to $3.8 mil- lion from $3.3 million in 2001. Sales to India and China increased in 2002 as compared to 2001. Cost of Goods Sold - Cost of goods sold was $6.8 million, or 57.7% of sales, in 2002 and $6.2 million, or 57.8% of sales, in 2001. The increase in cost of goods sold was due to a shift in the Company's product mix related to equip- ment and glass sales. The increase in cost of goods sold also reflects higher raw material costs, specifically for mylar and resins, as a result of volatile world petroleum prices. Selling, General and Administrative Expenses - Selling, general and administrative expenses decreased to $3.8 mil- lion, or 32.5% of sales, in 2002 from $4.1 million, or 38.0% of sales, in 2001. The reduction was due in part to the December 2001 expensing of the remaining $197,000 of goodwill associated with the June 2000 acquisition of Nichols & Associates, due to its impairment. In addition, expenses were lower in 2002 due to headcount reductions and lower legal fees. Research and Development Expenses - Research and development expenses were $706,000, or 6.0% of sales, in 2002 compared to $793,000, or 7.4% of sales, in 2001. The reduction was due to lower production trial costs and lower costs for lab supplies partially offset by higher payroll relat- ed costs as headcount remained steady. Financial Results Interest Expense - The Company incurred minimal interest expense on a $150,000 loan drawn from its revolving cred- it facility on June 20, 2002. This draw funded a $125,000 royalty payment to The Aicello Corporation, which was the second of two royalty payments required under a license agreement entered into with Aicello in January 2001. This loan draw was completely repaid in July 2002. Interest Income - Interest income decreased to $13,000 in 2002, compared to $35,000 for 2001. The decrease was due to the sale, in late 2001, of higher income, higher risk pre- ferred corporate bonds and the purchase of certain general revenue obligation bonds of a number of Minnesota munic- ipalities. Income Taxes - An income tax expense of $101,000 was recorded for 2002, for an effective rate of 21.9%, compared to an income tax benefit of $92,000, for an effective rate of 30.9%, for 2001. The difference in the effective rate is due to permanent differences for allowable tax deductions, including an extraterritorial income exclusion. Liquidity and Capital Resources The Company has financed its operations principally with funds generated from operations. These funds have been sufficient to cover the Company's normal operating expen- ditures, annual capital requirements and research and development expenditures. Cash and cash equivalents were $384,000 and $544,000 at December 31, 2002 and December 31, 2001, respective- ly. The Company generated $249,000 in cash from operat- ing activities during 2002 and $356,000 during 2001. Cash generated from operating activities is primarily provided by net income or loss, as adjusted for various non cash items including deferred taxes and depreciation. Trade receiv- ables in 2002 increased $461,000, net of the allowance for doubtful accounts, reflecting substantially higher domestic sales to the abrasive etching market and higher sales to India and China, which carry longer terms of sale. Prepaid expenses decreased $28,000 in 2002. Inventories increased $166,000 during 2002, reflecting higher raw material levels and increased inventories of AccuArt film. Income tax refund receivable decreased $11,000 in 2002. Accounts payable increased $20,000 during 2002. Accrued expenses increased $57,000 in 2002, reflecting payroll related obli- gations. During 2001, the Company had a non-cash charge of $197,000 for the write-off of goodwill associated with the Nichols acquisition that was deemed to be impaired. During 2001, trade receivables decreased by $166,000, reflecting an increased effort to reduce the number of days that sales are outstanding. Prepaid expenses in 2001 decreased by a moderate $10,000. Inventories increased by $80,000 during 2001 reflecting new product launches for IKONICS CORPORATION 2002 ANNUAL REPORT 5 Financial Results the AccuArt film line and the U.V. Minder measuring devices. For 2001, the Company experienced an income tax benefit reflecting its operating loss for the year. While the Company received an income tax refund for 2001, it was lower than the refund received in 2000, as reflected in the $98,000 decrease in the Company's income tax receivable. Accounts payable decreased by $62,000 in 2001, reflecting normal variations in spending patterns. Accrued expenses decreased by $23,000 in 2001, reflecting lower payroll and fringe benefit requirements and legal fees. The Company used $336,000 and provided $116,000 in cash from investing activities during 2002 and 2001, respectively. Net cash used for investing activities was uti- lized, in part, for plant and equipment. In addition, the Company replaced its business software in 2002. These expenditures amounted to $250,000 and $259,000 in 2002 and 2001, respectively. In addition, the Company sold a number of its vehicles to reduce operating costs and gener- ated $47,000 in proceeds from such sales. During 2002, the Company purchased a license to film technology applicable to its abrasive etching business for $50,000. In addition, the Company purchased, for $50,000, a license to produce, market and sell RapidMask film, also for the abrasive etch- ing market. The Company also incurred costs of $23,000 related to the patent applications covering a number of its technologies. During the first quarter of 2001, the Company sold a portion of its securities holdings to fund the $150,000 royalty payment to Aicello and an additional investment of $75,000 in Apprise Technologies. Among other activities, Apprise is conducting research in ultravio- let light technology that complements the markets served by the Company. The Company's total interest in Apprise would amount to approximately 6.4% equity ownership of that company if all warrants were exercised. During the fourth quarter of 2001, the Company sold its preferred security stock holdings and purchased general revenue obli- gation bonds in certain municipalities and school districts. During 2001, the Company used $609,000 in cash for the purchase of marketable securities and generated $1.0 mil- lion in cash from the sale of marketable securities. Any unrealized gains or losses are included in other compre- hensive income. The Company used $73,000 in cash during 2002 for the repurchase of 23,500 shares of its outstanding common stock under its stock repurchase program. No shares were repurchased during 2001. A bank line of credit exists providing for borrowings of up to $1,250,000. Outstanding debt under this line of cred- it is collateralized by accounts receivable and inventory and bears interest at 2.25 percentage points over the 30 day LIBOR rate. The Company has not utilized this line of cred- it to a material extent and there was no debt outstanding under this line as of December 31, 2002 or 2001. The Company believes that current financial resources, cash generated from operations and the Company's capaci- ty for debt and/or equity financing will be sufficient to fund current and anticipated business operations. The Company also believes that its low debt levels and available line of credit make it unlikely that a decrease in demand for the Company's products would impair the Company's ability to fund operations. Capital Expenditures The Company spent $250,000 on capital expenditures dur- ing 2002. This spending included manufacturing equip- ment upgrades to improve efficiency and reduce operating costs, and new vehicles under its rotating replacement pol- icy. The Company also replaced its business software in order to improve internal reporting for decision-making purposes and improve the efficiency of administrative and manufacturing operations. Commitments for capital expenditures include ongoing manufacturing equipment upgrades, development equip- ment to modernize the capabilities and processes of IKON- ICS' laboratory, and research and development to improve measurement and quality control processes. These com- mitments are expected to be funded with cash generated from operating activities. International Activity The Company markets its products to over 60 countries in North America, Europe, Latin America, Asia and other parts of the world. Foreign sales were approximately 31% and 30% of total sales during 2002 and 2001, respectively. Foreign sales in 2002 reflected higher sales to India and China. 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 vulner- ability to uncertainties due to foreign currency fluctuations and general economic conditions in foreign countries is not significant. Substantially all of the Company's foreign transactions are negotiated, invoiced and paid in U.S. dollars. A portion of the Company's foreign sales are invoiced and paid in Eurodollars. IKONICS has not implemented a hedging strat- egy to reduce the risk of foreign currency translation expo- sures, which management does not believe to be significant based on the scope and geographic diversity of the Company's foreign operations as of December 31, 2002. Future Outlook IKONICS has invested over 6% of its sales dollars for the past several years in research and development. The Company plans to maintain its efforts in this area and expe- 6 2002 ANNUAL REPORT IKONICS CORPORATION dite internal product development as well as form techno- logical alliances with outside experts to ensure commer- cialization of new product opportunities. In addition to its traditional emphasis on domestic markets, the Company will continue efforts to grow its busi- ness internationally by attempting to develop new markets and expanding market share where it has already estab- lished a presence. Other future activities undertaken to expand the Company's business may include acquisitions, building expansion and additions, equipment additions, new prod- uct development and marketing opportunities. Accounting Pronouncements In August 2001, the Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting Standards (SFAS) No. 143, "Accounting for Asset Retirement Obligations." The provisions of SFAS 143 apply to all enti- ties that incur obligations associated with the retirement of tangible long-lived assets. This statement is effective for financial statements issued for fiscal years beginning after June 15, 2002 and will become effective for the Company commencing with our 2003 fiscal year. This accounting pro- nouncement is not expected to have a significant impact on our financial position or results of operations. In April 2002, the FASB issued Statement of Financial Accounting Standards No. 145, "Rescission of FASB Statements No. 4, 44 and 64, Amendment of FASB Statement No. 13, and Technical Corrections." SFAS 145 rescinds and amends certain previous standards related pri- marily to debt and leases. The most substantive amendment requires sale-leaseback accounting for certain lease modifi- cations that have economic effects that are similar to sale- leaseback transactions. The provisions of SFAS 145 related to the rescission of SFAS 4 are effective for financial state - ments issued for fiscal years beginning after May 15, 2002 and will become effective for the Company commencing with our 2003 fiscal year. The provisions of SFAS 145 relat- ed to the rescission of SFAS 13 became effective for trans- actions occurring after May 15, 2002. All other provisions of SFAS 145 are effective for financial statements issued on or after May 15, 2002. This accounting pronouncement is not expected to have a significant impact on our financial position or results of operations. In June 2002, the FASB issued Statement of Financial Accounting Standards No. 146, "Accounting for Costs Associated with Exit or Disposal Activities." SFAS 146 addresses financial accounting and reporting for costs asso- ciated with exit or disposal activities and nullifies EITF Issue No. 94-3. This SFAS requires that a liability for a cost associated with an exit or disposal activity be recorded at fair value when the liability is incurred. SFAS 146 is effec- Financial Results tive for exit or disposal activities that are initiated after December 31, 2002. This accounting pronouncement is not expected to have a significant impact on our financial posi- tion or results of operations. In December 2002, the FASB issued Statement of Financial Accounting Standards No. 148, "Accounting for Stock-Based Compensation - Transition and Disclosure." SFAS 148 amends SFAS 123, "Accounting for Stock-Based Compensation," to provide alternative methods of transi- tion for an entity that voluntarily changes to the fair value based method of accounting for stock-based compensation. It also amends the disclosure provisions of that statement. The disclosure provisions of this statement are effective for the December 31, 2002 financial statements. Market for Registrant’s Common Equity and Related Stockholder Matters The Company's Common Stock is traded on the Nasdaq SmallCap Market under the symbol IKNX. The following table sets forth, for the fiscal quarters indicated, the high and low bid prices for the Company's Common Stock as reported on both markets for the periods indicated. The quotations reflect inter-dealer prices without retail mark- up, mark-down or commission, and may not represent actual transactions. Fiscal Year Ended December 31, 2002: First Quarter Second Quarter Third Quarter Fourth Quarter Fiscal Year Ended December 31, 2001: First Quarter Second Quarter Third Quarter Fourth Quarter High $3.25 3.27 3.49 5.10 $5.25 5.00 4.20 3.80 Low $2.95 3.00 2.85 3.25 $4.63 3.25 3.20 2.62 As of February 26, 2003, the Company had approxi- mately 450 shareholders of record. The Company has never declared or paid any dividends on its Common Stock. MANAGEMENT’S REPORT The financial statements of IKONICS Corporation have been prepared by company management who are responsible for their content. These statements have been prepared in accordance with accounting principles generally accepted in the United States of America and, where appropriate, reflect estimates based on judgements of management. IKONICS maintains a system of internal controls. Our system provides reasonable assurance that assets are pro- tected, transactions are appropriately reported, and estab- lished procedures are followed. The financial statements have been audited by Deloitte IKONICS CORPORATION 2002 ANNUAL REPORT 7 To the Stockholders and Board of Directors of IKONICS Corporation, We have audited the accompanying balance sheet of IKON- ICS Corporation (formerly The Chromaline Corporation) as of December 31, 2002, and the related statements of oper- ations, stockholders' equity and cash flows for the year then ended. These financial statements are the responsi- bility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audit. We conducted our audit in accordance with auditing standards generally accepted in the United States of America. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence sup- porting the amounts and disclosures in the financial state- ments. An audit also includes assessing the accounting principles used and significant estimates made by manage - ment, as well as evaluating the overall financial statement presentation. We believe that our audit provides a reason- able basis for our opinion. In our opinion, the 2002 financial statements referred to above present fairly, in all material respects, the finan- cial position of IKONICS Corporation as of December 31, 2002, and the results of its operations and its cash flows for the year then ended in conformity with accounting princi- ples generally accepted in the United States of America. McGladrey & Pullen LLP Duluth, Minnesota January 30, 2003 Financial Results & Touche LLP and McGladrey & Pullen LLP, independent auditors. The Audit Committee of the Board of Directors, com- prised of outside directors, meets periodically with the independent auditors and management to discuss the com- pany’s internal accounting controls and financial reporting matters. The independent auditors have unrestricted access to the Audit Committee, without management pres- ent, to discuss the results of their audit, the adequacy of internal accounting controls, and the quality of financial reports. William C. Ulland Chairman, President & CEO Jeffery A. Laabs Chief Financial Officer INDEPENDENT AUDITORS’ REPORTS To the Stockholders and Board of Directors of IKONICS Corporation, We have audited the accompanying balance sheet of IKON- ICS Corporation (formerly The Chromaline Corporation) as of December 31, 2001 and the related statements of opera- tions, stockholders' equity, and cash flows for the year then ended. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audit. We conducted our audit in accordance with auditing standards generally accepted in the United States of America. Those standards require that we plan and perform the audit to obtain reasonable assurance that the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presenta - tion. We believe our audit provides a reasonable basis for our opinion. In our opinion, the 2001 financial statements referred to above present fairly, in all material respects, the finan- cial position of IKONICS Corporation as of December 31, 2001 and the results of its operations and its cash flows for the years then ended, in conformity with accounting prin- ciples generally accepted in the United States of America. Deloitte & Touche LLP Minneapolis, Minnesota February 6, 2002 8 2002 ANNUAL REPORT IKONICS CORPORATION BALANCE SHEETS December 31, 2002 and 2001 ASSETS CURRENT ASSETS: Financial Results 2002 2001 Cash and cash equivalents Marketable securities Trade receivables, less allowance for doubtful accounts of $100,000 in 2002 and 2001 Inventories Prepaid expenses and other assets Income tax refund receivable Deferred taxes (Note 3) Total current assets PROPERTY, PLANT, AND EQUIPMENT, at cost: Land and building Machinery and equipment Office equipment Vehicles Less accumulated depreciation INTANGIBLE ASSETS (Note 4) DEFERRED TAXES (Note 3) OTHER ASSETS (Note 1) LIABILITIES AND STOCKHOLDERS' EQUITY CURRENT LIABILITIES: Accounts payable Accrued compensation Other accrued expenses STOCKHOLDERS' EQUITY: Total current liabilities Preferred stock, par value $.10 per share; authorized 250,000 shares; issued none Common stock, par value $.10 per share; authorized 4,750,000 shares; issued and outstanding 1,248,127 shares-2002, 1,271,627 shares-2001 Additional paid-in capital Retained earnings Accumulated other comprehensive loss Total stockholders' equity See notes to financial statements. $ 384,107 246,094 1,933,769 1,771,905 89,937 122,469 82,000 4,630,281 1,355,588 2,231,478 1,144,564 167,102 4,898,732 3,694,105 1,204,627 271,751 118,000 187,500 $ 6,412,159 $ 317,229 204,624 23,643 545,496 124,813 1,269,489 4,483,895 (11,534) 5,866,663 $ 6,412,159 $ 543,679) 237,154) 1,472,982) 1,605,670) 118,178) 133,030) 68,000) 4,178,693) 1,355,588) 2,189,159) 1,036,077) 223,265) 4,804,089) 3,501,330) 1,302,759) 166,490) 213,000) 187,500) $ 6,048,442) $ 297,556) 143,338) 27,508) 468,402) 127,163) 1,293,460) 4,170,246) (10,829) 5,580,040) $6,048,442) IKONICS CORPORATION 2002 ANNUAL REPORT 9 Financial Results STATEMENTS OF OPERATIONS YEARS ENDED DECEMBER 31, 2002 AND 2001 NET SALES COSTS AND EXPENSES: Cost of goods sold Selling, general, and administrative Research and development 2002 $11,797,279 6,808,130 3,835,097 706,343 11,349,570 2001 $ 10,752,133) 6,209,505) 4,081,635) 793,484) 11,084,624) INCOME (LOSS) FROM OPERATIONS 447,709 (332,491) INTEREST INCOME 13,108 34,590) INCOME (LOSS) BEFORE INCOME TAXES 460,817 (297,901) FEDERAL AND STATE INCOME TAXES (BENEFIT) (Note 3) NET INCOME (LOSS) EARNINGS (LOSS) PER SHARE: Basic Diluted WEIGHTED AVERAGE COMMON SHARES ASSUMED OUTSTANDING: Basic Diluted STATEMENTS OF STOCKHOLDERS’ EQUITY Common Stock BALANCE AT DECEMBER 31, 2000 Net loss Unrealized gain on available-for-sale investments Total comprehensive income BALANCE AT DECEMBER 31, 2001 Net income Unrealized gain on available-for-sale investments Total comprehensive income Purchase and retirement of 23,500 shares of common stock BALANCE AT DECEMBER 31, 2002 See notes to financial statements. 101,000 $ 359,817 $ 0.29 $ 0.29 1,252,020 1,252,809 (92,000) $ (205,901) $ (0.16) $ (0.16) 1,271,627) 1,271,627) Shares 1,271,627 Amount 127,163 Additional Paid-in Capital 1,293,460 Accumulated Other Comprehensive Income (Loss) (10,833) Retained Earnings 4,376,147 (205,901) 1,271,627 127,163 1,293,460 4,170,246 359,817 4 (10,829) (705) Total Equity 5,785,937) (205,901) 4) (205,897) 5,580,040) 359,817) (705) 359,112) (23,500) 1,248,127 (2,350) $124,163 (23,971) (46,168) $1,269,489 $4,483,895 (72,489) $(11,534) $5,866,663) 10 2002 ANNUAL REPORT IKONICS CORPORATION Financial Results STATEMENTS OF CASH FLOWS YEARS ENDED DECEMBER 31, 2002 AND 2001 CASH FLOWS FROM OPERATING ACTIVITIES: Net income (loss) Adjustments to reconcile net income (loss) to net cash provided by operating activities: 2002 2001 $ 359,817 $(205,901) Depreciation Amortization Write-off of goodwill Gain on sale of property and equipment Provision for doubtful accounts Deferred income taxes Changes in working capital components: (Increase) decrease in: Trade receivables Inventories Prepaid expenses and other assets Income taxes refund receivable (Decrease) increase in: Accounts payable Accrued expenses Net cash provided by operating activities CASH FLOWS FROM INVESTING ACTIVITIES: Purchase of property and equipment Proceeds on sale of property and equipment Purchase of intangibles Purchases of marketable securities Proceeds from sale of marketable securities Purchase of investments Net cash (used in)/provided by investing activities CASH FLOWS FROM FINANCING ACTIVITIES: Repurchase of company stock NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS CASH AND CASH EQUIVALENTS AT BEGINNING OF YEAR CASH AND CASH EQUIVALENTS AT END OF YEAR SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION - Cash paid (refunded) for income taxes Cash paid for interest See notes to financial statements. 314,364 18,178 (13,116) 60,183 81,000 (520,970) (166,235) 28,241 10,561 19,673 57,421 249,117 (250,366) 47,250 (123,439) (9,645) (336,200) (72,489) (159,572) 543,679 $ 384,107 $ (5,472) $ 503 366,367 15,678) 196,647) (10,172) 121,690) (117,000) 44,374) (79,677) 10,191) 98,080) (61,525) (22,717) 356,035) (259,230) 23,375) (609,386) 1,036,392) (75,000) 116,151) 472,186) 71,493) $ 543,679) $ 57,133) $ 0) IKONICS CORPORATION 2002 ANNUAL REPORT 11 Financial Results NOTES TO FINANCIAL STATEMENTS Years Ended December 31, 2002 and 2001 1. Summary of Significant Accounting Policies Description of Business - IKONICS Corporation (the Company), formerly The Chromaline Corporation, develops and manufactures high-quality photochemical imaging sys- tems for sale primarily to a wide range of printers and dec- orators of surfaces. Customers' applications include tex- tiles, billboards, electronics, glassware, fine china, and many other industrial and commercial applications. The Company's principal markets are throughout the United States. In addition, the Company sells to Western Europe, Latin America, Asia, and other parts of the world. The Company extends credit to its customers, all on an unse- cured basis, on terms that it establishes for individual cus- tomers. Forty-four percent and forty percent, respectively, of the Company's accounts receivable at December 31, 2002 and 2001 are due from foreign customers. The foreign receivables are composed primarily of open credit arrange - ments with terms ranging from 45 to 90 days. One cus- tomer accounted for 17.6% of total receivables at December 31, 2002. No receivable from a single customer exceeded 10% of total receivables at December 31, 2001. No single customer represented greater than 10% of total revenue in 2002 or 2001. A summary of the Company's significant accounting policies follows: Cash Equivalents - The Company considers all highly liq- uid debt instruments purchased with a maturity of three months or less to be cash equivalents. Cash equivalents consist of money market funds in which carrying value approximates market value because of the short maturity of these instruments. Marketable Securities - Marketable securities are classified as available-for-sale securities and consist primarily of municipal revenue bonds that will be held for indefinite periods of time, including securities that may be sold in response to changes in market interest or prepayment rates, needs for liquidity, or changes in the availability or yield of alternative investments. These securities are car- ried at fair market value with changes in fair value record- ed in comprehensive income. Trade Receivables - Trade receivables are carried at origi- nal invoice amount less an estimate made for doubtful receivables based on a review of all outstanding amounts on a monthly basis. Management determines the allowance for doubtful accounts by regularly evaluating individual cus- tomer receivables and considering a customer's financial condition, credit history, and current economic conditions. Trade receivables are written off when deemed uncol- lectible. Recoveries of trade receivables previously written off are recorded when received. Accounts are considered past due if payment is not received according to agreed- upon terms. Inventories - Inventories are stated at the lower of cost or market using the last-in, first-out (LIFO) method. If the first-in, first-out cost method had been used, inventories would have been approximately $224,000 and $212,000 higher than reported at December 31, 2002 and 2001, respectively. The major components of inventory are as fol- lows: Raw materials Work-in-progress Finished goods Reduction to LIFO cost Total inventory 2002 $ 735,006 257,813 1,003,342 (224,256) $ 1,771,905 2001 $ 638,424 236,493 942,301 (211,548) $ 1,605,670 Depreciation - Depreciation of property and equipment is computed using the straight-line method over the follow- ing estimated useful lives: Building Machinery and equipment Office equipment Vehicles Years 25 5 5 3 Intangibles Assets - Intangible assets consist primarily of patents, licenses and covenants not to compete arising from business combinations. Intangible assets are amor- tized on a straight-line basis over their estimated useful lives or terms of their agreement. Other Assets - Other assets consist of a $187,500 equity investment in Apprise Technologies, Inc. This investment is accounted for on the cost method. One of the Company's directors is the CEO of Apprise Technologies, Inc. Impairment of Long-Lived Assets - Management periodi- cally reviews the carrying value of long-term assets for potential impairment by comparing the carrying value of these assets to the estimated undiscounted future cash flows expected to result from the use of these assets. Should the sum of the related, expected future net cash flows be less than the carrying value, an impairment loss would be measured. An impairment loss would be meas- ured by the amount by which the carrying value of the asset exceeds the fair value of the asset with fair value being determined using discounted cash flows. To date, other than the goodwill impairment discussed in Note 4, 12 2002 ANNUAL REPORT IKONICS CORPORATION management has determined that no other impairment of these assets exists. Revenue Recognition - The Company recognizes revenue on products when title passes, which is usually upon ship- ment. Freight billed to customers is included in sales. Shipping costs are included in cost of goods sold. Deferred Taxes - Deferred taxes are provided on a liability method whereby deferred tax assets are recognized for deductible temporary differences. Operating loss and tax credit carryforwards and deferred tax liabilities are recog- nized for taxable temporary differences. Temporary differ- ences are the differences between the reported amounts of assets and liabilities and their tax bases. Deferred tax assets are reduced by a valuation allowance when, in the opinion of management, it is more likely than not that some portion or all of the deferred tax assets will not be realized. Deferred tax assets and liabilities are adjusted for the effects of changes in tax laws and rates on the date of enactment. Comprehensive Income - The Company's comprehensive income consists of net income and unrealized holding gains and losses on marketable securities. Earnings Per Common Share (EPS) - Basic EPS is calcu- lated using net income divided by the weighted average of common shares outstanding during the year. Diluted EPS is similar to Basic except that the weighted average of com- mon shares outstanding is increased to include the number of additional common shares that would have been out- standing if the dilutive potential common shares, such as options, had been issued. Shares used in the calculation of diluted EPS are sum- marized below: Weighted average common shares outstanding Dilutive effect of stock options Weighted average common & common equivalent shares outstanding 2002 2001 1,252,020 789 1,271,627 0 1,252,809 1,271,627 Options to purchase 150,029 and 144,075 shares of common stock were outstanding during the years ended December 31, 2002 and 2001, respectively. The options to purchase were excluded from the computation of common stock equivalents because they were anti-dilutive for the year ended December 31, 2001. Financial Results 7. The Company accounts for those plans under the recog- nition and measurement principles of APB Opinion No. 25, “Accounting for Stock Issued to Employees,” and related interpretations. Accordingly, no stock-based employee compensation cost has been recognized, as all options granted under those plans had an exercise price equal to the market value of the underlying common stock on the date of grant. The following table illustrates the effect on net income and earnings per share had compensation cost for all of the stock-based compensation plans been deter- mined based on the grant date fair values of awards (the method described in FASB Statement No. 123, “Accounting for Stock-Based Compensation”): Years Ended December 31, Net income (loss): As reported 2002 2001 $359,817 $(205,901) Deduct total stock-based employee compensation expense determined under fair value based method or all awards 110,365 119,050 Pro forma $249,452 $(324,959) Basic earnings (loss) per share: As reported Pro forma Diluted earnings (loss) per share: As reported Pro forma $ $ $ $ 0.29 0.20 0.29 0.20 $ $ $ $ (0.16) (0.26) (0.16) (0.26) Use of Estimates - The preparation of the financial state - ments in conformity with accounting principles generally accepted in the United States of America requires manage - ment to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. Foreign Operations - The Company markets in Europe, Latin America, Asia, and other parts of the world. Foreign sales approximated 31% and 30% of total sales in 2002 and 2001, respectively. Line of Credit - The Company has a $1,250,000 bank line of credit that provides for working capital financing. This line of credit is subject to annual renewal on each May 1, is collateralized by trade receivables and inventory, and bears interest at 2.25% points over 30-day LIBOR. There was no outstanding balance at December 31, 2002 and 2001. Employee Stock Plans - The Company has a stock-based compensation plan, which is described more fully in Note Reclassification - Certain reclassifications were made to the 2001 financial statements to conform to the 2002 pres- IKONICS CORPORATION 2002 ANNUAL REPORT 13 Financial Results entation. These reclassifications had no impact on net income or stockholders' equity as previously reported. Accounting Pronouncements - In August 2001, the Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting Standards (SFAS) No. 143, "Accounting for Asset Retirement Obligations." The provisions of SFAS 143 apply to all entities that incur obli- gations associated with the retirement of tangible long- lived assets. This statement is effective for financial state - ments issued for fiscal years beginning after June 15, 2002 and will become effective for the Company commencing with our 2003 fiscal year. This accounting pronouncement is not expected to have a significant impact on our finan- cial position or results of operations. In April 2002, the FASB issued Statement of Financial Accounting Standards No. 145, "Rescission of FASB Statements No. 4, 44 and 64, Amendment of FASB Statement No. 13, and Technical Corrections." SFAS 145 rescinds and amends certain previous standards related pri- marily to debt and leases. The most substantive amendment requires sale-leaseback accounting for certain lease modifi- cations that have economic effects that are similar to sale- leaseback transactions. The provisions of SFAS 145 related to the rescission of SFAS 4 are effective for financial state - ments issued for fiscal years beginning after May 15, 2002 and will become effective for the Company commencing with our 2003 fiscal year. The provisions of SFAS 145 relat- ed to the rescission of SFAS 13 became effective for trans- actions occurring after May 15, 2002. All other provisions of SFAS 145 are effective for financial statements issued on or after May 15, 2002. This accounting pronouncement is not expected to have a significant impact on our financial position or results of operations. In June 2002, the FASB issued Statement of Financial Accounting Standards No. 146, "Accounting for Costs Associated with Exit or Disposal Activities." SFAS 146 addresses financial accounting and reporting for costs asso- ciated with exit or disposal activities and nullifies EITF Issue No. 94-3. This SFAS requires that a liability for a cost associated with an exit or disposal activity be recorded at fair value when the liability is incurred. SFAS 146 is effec- tive for exit or disposal activities that are initiated after December 31, 2002. This accounting pronouncement is not expected to have a significant impact on our financial posi- tion or results of operations. In December 2002, the FASB issued Statement of Financial Accounting Standards No. 148, "Accounting for Stock-Based Compensation - Transition and Disclosure." SFAS 148 amends SFAS 123, "Accounting for Stock-Based Compensation," to provide alternative methods of transi- tion for an entity that voluntarily changes to the fair value based method of accounting for stock-based compensation. It also amends the disclosure provisions of SFAS 123. The disclosure provisions of SFAS 148 are effective for the December 31, 2002 financial statements. 2. STOCKHOLDERS' EQUITY During the year ended December 31, 2002, the Company repurchased 23,500 shares of its common stock for $72,489, which shares now constitute authorized but unissued shares. The Company did not repurchase any shares during the year ended December 31, 2001. 3. INCOME TAXES Income tax (benefit) expense for the years ended December 31, 2002 and 2001 consists of the following: Current: 2002 $ 10,000 10,000 20,000 81,000 $ 101,000 2001 $ 26,600 (1,600) 25,000 (117,000) $ (92,000) Federal State Deferred The expected provision for income taxes, computed by applying the U.S. federal income tax rate of 34% to income before taxes, is reconciled to income tax (benefit) expense as follows: Expected provision for federal income taxes $ 161,200 $(101,000) 2002 2001 State income taxes, net of federal benefit Extraterritorial income exclusion Meals and entertainment Other 10,100 (78,800) 13,600 (5,100) $ 101,000 (1,600) 5,300 11,600 (6,300) $ (92,000) Deferred tax assets consist of the following as of December 31, 2002 and 2001: Property and equipment and other assets Accrued vacation Inventory Allowance for doubtful accounts Allowance for sales returns Intangible assets Capital loss carryforward Other Valuation allowance 2002 2001 $ 61,000 27,000 12,000 36,000 7,000 57,000 20,000 0 (20,000) $ 200,000 $ 86,000 24,000 49,000 37,000 7,000 73,000 20,000 5,000 (20,000) $ 281,000 4. INTANGIBLE ASSETS In June 2000, the Company acquired certain assets and assumed certain liabilities of Nichols & Associates. In 14 2002 ANNUAL REPORT IKONICS CORPORATION Financial Results conditions inherent in foreign operations, and the Company's results of operations are affected by fluctuations in foreign currency exchange rates. No single foreign coun- try accounted for more than 10% of the Company's net sales for 2002 and 2001. Net sales by geographic area are presented by attributing revenues from external customers on the basis of where the products are sold. Net sales by geographic area: United States International 2002 $ 8,045,967 3,751,312 $11,797,279 2001 $ 7,526,493 3,225,640 $10,752,133 7. STOCK OPTIONS During 1995, the Company adopted a stock incentive plan for the issuance of up to 38,500 shares of common stock. In 1999, the Company increased the number of shares reserved for issuance under this plan to 203,500 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. Dividend yield Expected volatility Expected life of option Risk-free interest rate Fair value of each option on grant date 2002 2001 0.0% 0.0% 72.5% 74.4% 5 years 5 years 4.4% 4.7% $ 2.00 $2.91 A summary of the status of the Company's stock option plan as of December 31, 2002 and 2001 and changes dur- ing the years ending on those dates is presented below: 2002 Weighted Average Exercise Shares Price 2001 Weighted Average Exercise Price Shares 142,920 $6.20 3.17 26,079 89,450 $7.13 4.66 55,125 (18,970) 4.14 (1,655) 5.45 Outstanding at beginning of year Granted Exercised Expired Outstanding at end of year 150,029 5.93 142,920 6.20 accordance with SFAS No. 121, “Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed Of,” the Company evaluated the net book value of the recorded goodwill against the estimated future cash flows and determined the goodwill was impaired and thus written off during the year ended December 31, 2001. The Company expensed $197,000 under selling, general and administrative expense in 2001 as a result of goodwill impairment. Intangible assets at December 31, 2002 consist of the following: As of December 31, 2002 Gross Carrying Accumulated Amount Amortization $132,717 100,000 100,000 $332,717 $(41,800) (2,500) ( 16,666) $(60,966) $ 18,178 $ 23,600 23,600 23,600 23,600 23,600 Amortized intangible assets: Patents Licenses Non-compete agreement Amortized intangible assets: For the year ended Dec. 31, 2002 Estimated amortization expense: For the year ended Dec. 31, 2003 For the year ended Dec. 31, 2004 For the year ended Dec. 31, 2005 For the year ended Dec. 31, 2006 For the year ended Dec. 31, 2007 In connection with the license agreements, the Company has agreed to pay royalties ranging from 3% to 5% on the future sales of products subject to the agreements. 5. PENSION PLAN The Company has established a salary deferral plan under Section 401(k) of the Internal Revenue Code. The plan allows eligible employees to defer up to 15% of their com- pensation. Such deferrals accumulate on a tax-deferred basis until the employee withdraws the funds. The Company contributes 5% of each eligible employee's com- pensation. Total pension expense for the years ended December 31, 2002 and 2001 was approximately $145,000 and $138,000, respectively. 6. GEOGRAPHIC INFORMATION The Company manages and operates its business on the basis of one reportable segment. See Note 1 for a brief description of the Company's business. As of December 31, 2002, the Company had operations established in various countries throughout the world. The Company is exposed to the risk of changes in social, political, and economic IKONICS CORPORATION 2002 ANNUAL REPORT 15 Financial Results The following table summarizes information about stock options outstanding at December 31, 2002: Options Outstanding Options Exercisable Range of Exercise Price $3.13 - 3.44 4.60 5.06 - 5.25 6.56 7.22 - 7.84 8.18 9.00 - 9.20 Number Outstanding at December 31, 2002 26,079 44,625 9,475 28,000 8,300 20,350 13,200 150,029 Weighted- Average Remaining Contractual Life 4.42 3.31 3.49 2.32 2.78 3.32 3.96 3.36 Weighted- Average Exercise Price $3.17 4.60 5.10 6.56 7.47 8.18 9.15 5.93 Number Exercisable at December 31, 2002 Weighted- Average Exercise Price 22,105 8,808 21,324 8,300 20,350 13,200 94,087 $4.60 5.10 6.56 7.47 8.18 9.15 6.75 10. CONTINGENCIES The Company has entered into licensing agreements which require them to make royalty payments on sales of certain products. Royalty payments range from 3% to 5% of net sales on these products. The Company incurred $119,792 of expense under these agreements during 2002 as com- pared to $103,125 during 2001. 8. CONCENTRATION OF CREDIT RISK The Company maintains its cash balances primarily in one financial institution. As of December 31, 2002, the bal- ance exceeded the Federal Deposit Insurance Corporation coverage. The Company reduces its exposure to credit risk by maintaining such balances with financial institutions that have high credit ratings. Accounts receivable are financial instruments that also expose the Company to concentration of credit risk. The large number of customers comprising the Company's cus- tomer base and their dispersion across different geograph- ic areas limits such exposure. In addition, the Company routinely assesses the financial strength of its customers and maintains an allowance for doubtful accounts that management believes will adequately provide for credit losses. Concentration of credit risk with respect to trade receivables is not significant except for a receivable from one of its largest customers, which accounted for 17.6% of total receivables as of December 31, 2002. 9. LEASE COMMITMENTS As of December 31, 2002, the Company was obligated under non-cancelable operating lease agreements for cer- tain equipment. Future minimum lease payments for non- cancelable operating leases with initial or remaining terms in excess of one year are as follows: 2003 2004 2005 $26,112 $19,661 $ 4,989 The Company also leases buildings on a month-to-month basis. Total rental expense for all equipment and building operating leases was $77,040 in 2002 and $80,512 in 2001. 16 2002 ANNUAL REPORT IKONICS CORPORATION 5 Year History Net Sales Pretax Income (Loss) Net Income (Loss) Net Cash Provided by Operations Return on Sales Return on Assets Return on Avg. Stockholders' Equity Debt to Equity Net Cash Provided by Operations per Diluted Share Diluted EPS Stock price: High Low Close Financial Results 1998 9,740,481 1,372,531 880,531 507,411 1999 $ 10,382,227 $ 1,234,794 $ 803,793 $ 1,096,463 2000 $ 10,367,270 $ 364,007 255,007 $ 182,527 $ 2001 $ 10,752,133 (297,901) $ (205,901) $ 356,035 $ $ $ $ $ 2002 $ 11,797,279 $ 460,817 $ 359,817 249,117 $ 9.0% 16.7% 20.1% 8.2% $ 0.39 7.7% 13.1% 15.3% 8.8% $ 0.84 $ 2.5% 4.0% 4.5% 9.6% 0.14 $ 0.68 $ 9.44 $ 6.36 $ 6.82 $ 0.62 $ 8.41 $ 6.14 $ 7.25 $ 0.20 $ 7.50 $ 4.00 $ 4.88 $ $ $ $ $ -1.9% -3.4% -3.6% 8.4% 0.28 $ 3.0% 5.6% 6.3% 9.3% 0.20 ( 0.16) 5.25 2.62 3.00 $ 0.29 5.10 $ 2.85 $ 3.30 $ Weighted Average Shares Outstanding Weighted Average Shares & Equivalent Shares Outstanding* 1,286,658 1,297,432 1,297,519 1,305,995 1,295,239 1,301,311 1,271,627 1,271,627 1,252,020 1,252,809 Total Assets Total Liabilities Total Stockholders' Equity Capital Spending $ $ $ $ 5,260,643 400,810 4,859,833 508,676 $ 6,159,003 497,528 $ $ 5,661,475 491,269 $ $ 6,338,581 552,644 $ $ 5,785,937 230,379 $ $ 6,048,442 468,402 $ $ 5,580,040 259,230 $ $ 6,412,159 545,496 $ $ 5,866,663 250,366 $ *Share & per share amounts have been adjusted for the 10% stock dividend on 12/31/99. COMMON STOCK IKONICS Corporation common stock is traded on the Nasdaq SmallCap Market (ticker symbol: IKNX). For investment and stock information, contact: Jeff Laabs, CFO IKONICS Corporation 4832 Grand Avenue Duluth, MN 55807 PH: 218-628-2217 e-mail: jlaabs@ikonics.com TRANSFER AGENT Wells Fargo Shareowner Services 161 North Concord Exchange South St. Paul, MN 55075-1139 Shareholders with questions on stock holdings, transfer requirements and address changes contact Wells Fargo Bank at 651-450-4058 or 651-306-4341. AUDITOR McGladrey & Pullen LLP 700 Missabe Building 227 W. First Street Duluth, MN 55802 218-727-5025 COUNSEL Hanft Fride 1000 U.S. Bank Place 130 W. Superior Street Duluth, MN 55802 218-722-4766 IKONICS CORPORATION 2002 ANNUAL REPORT 17 Board of Directors/Officers Board of Directors Charles H. Andresen Attorney/Shareholder Andresen, Haag, Paciotti, & Butterworth P.A. Duluth, MN Director Since 1979 Rondi Erickson CEO/Director Apprise Technologies, Inc. Duluth, MN Director Since 2000 David O. Harris President David O. Harris, Inc. Minneapolis, MN Director Since 1965 H. Leigh Severance President Severance Capital Management Denver, CO Director Since 2000 Gerald W. Simonson Venture Capital Investor President Omnetics Connector Corp. Minneapolis, MN Director Since 1978 William C. Ulland Chairman of the Board, President & CEO IKONICS Corporation Duluth, MN Director Since 1972 Officers From left to right: Bill Ulland, Claude Piguet, Toshi Komatsu, Jeff Laabs, Bob Banks. Robert D. Banks Vice-President, International Claude Piguet Executive Vice-President Toshifumi Komatsu Vice-President, Technology Jeffery A. Laabs Chief Financial Officer William C. Ulland Chairman of the Board, President & CEO ADDITIONAL FINANCIAL INFORMATION Stockholders of record automatically receive quarterly earnings information, and street name holders may do so upon written request. For a copy of the Form 10-KSB, as filed with the Securities and Exchange Commission, and other financial infor- mation available at no charge to stockholders, please contact: Jeff Laabs, Chief Financial Officer IKONICS Corporation 4832 Grand Avenue, Duluth, MN 55807 PH: 218-628-2217 • E-mail: jlaabs@ikonics.com ANNUAL MEETING The Company’s annual meeting will be held April 24, 2003 at 1:00 p.m. at the Kitchi Gammi Club, 831 East Superior Street, Duluth, MN. 18 2002 ANNUAL REPORT IKONICS CORPORATION For the last 30 years, IKONICS has worked hard to develop an international sales program, resulting in current sales to more than 60 countries. Currently, one third of our total sales come from the international markets and represent screen print and abrasive etching products as well as inkjet-able substrates. Across the Americas, in Asia, Europe, Africa and parts of the Middle East, IKONICS has built time-tested business relationships that fuel the com- aggressive pany's growth goals. IKONICS' inter- national success can be to attributed patient, persistent relationship building that has resulted in a strong dealer net- work. Our sales force, chemists and techni- cians travel regularly with our internation- al dealers, reinforcing product knowledge and gathering market information. Bob Banks, VP, International, is shown visiting the Taj Mahal in Agra, India, with representa- tives from IKONICS Indian Master Distributor. It is impossible to visit each business using IKONICS products around the world. Instead, we work hand-in-hand with its dealers exhibiting in regional trade fairs. This cooperation further cements the compa- ny/dealer bond. But more importantly, IKONICS accesses a Our Global Markets large number of product users. Trade fairs provide critical market information, maximize dealer efforts, and give us a chance to be face-to-face with as many customers as possi- ble. IKONICS offers further technical support through regional training seminars. We have taught seminars in English and Spanish, and through local dealers, have uti- lized native speakers in the region we are serving. This year, IKONICS is opening a permanent training facility in Southeast Asia, an area of high demand and high potential. Our plan is to use this base to attract new dealers and seize direct sales opportu- nities. Communications tech- nology has simplified our work with our global dealer network. Certainly, tele- phone calls and dealer vis- its are key to maintaining relationships, but IKONICS also uses e-mail and the web to speed communica- tion worldwide. Product announcements, technical updates, and mass mailings are now accomplished with the stroke of a key. Abrasive etching is an emerging technol- ogy in international markets. IKONICS plans to expand the penetration of the PhotoBrasive Systems product line. Our newest international growth opportunity is with our PhotoBrasive line of products. We are attempting to access markets previously untouched or underserved. Our market efforts will focus on our newest technologies, RapidMask™ and other self adhesive films. IKONICS CORPORATION 2002 ANNUAL REPORT 19 

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