C O R P O R A T I O N
I N T E R N A T I O N A L
Letter to Shareholders
The year 2007 was our seventh consecutive year of record sales
and our third consecutive year of record earnings. For the year,
sales were $15,825,000, a 6% increase over 2006. Net income
rose by 4% over 2006 to $1,170,000 or $0.57 per share.
Sales were positively affected by our image mate® acquisition
in December 2006. Earnings growth was dampened by
our investment in new technologies and Sarbanes-Oxley
compliance expenses.
During the year we made exciting progress on two new technology
initiatives: Photo-Machining T M and Digital Texturing T M. Both,
however, have remaining hurdles to overcome before contributing
to profits.
Photo-Machining brings our core strengths of photoresist design
and manufacturing together with our broad experience in abrasive
etching to a new market, namely, the etching of electronic wafers,
industrial ceramics and other advanced materials. We are providing
this as a service to large aerospace, electronic, and industrial
materials companies. Although we are gradually building a base
of repeat customers, we are still learning how we fit into this large
and complex market place. We believe the market for our service is
significant; but we do not yet know its full scope.
Digital Texturing is a different type of project. The product is a
digitally imaged acid resist transfer film that will be used to etch
steel molds for the plastic injection molding industry. We are
currently focusing on companies that service the automotive
industry. Digital Texturing is the combination of three new
technologies to satisfy an existing demand from a market that
we believe we understand fairly well. We are developing a jetable
fluid and a patent-applied-for substrate to be used with a digital
printer being manufactured by our strategic partner, iTi (Imaging
Technology International). Linking three new technologies usually
makes a task exponentially more difficult; but we have made great
progress, as has been confirmed by our beta sites. Although the
technical challenges and financial risks are much larger than with
Photo-Machining, I believe there is less market risk and greater
opportunity with Digital Texturing.
We are currently manufacturing commercial Digital Texturing
product on prototype equipment and anticipate high volume
production equipment to be installed in the second quarter of 2008.
Presently, we are operating as a service bureau to this industry;
and we plan to sell the imaging equipment together with the
consumable fluids and substrates in late 2008 or early 2009.
Both of these efforts require investment and entail risk; but, in
my view, this type of investment is necessary so that IKONICS
can grow beyond its traditional core businesses of manufacturing
photo stencils for the screen printing industry and photoresists for
abrasive etching. Although these markets are mature, particularly
domestically, they are profitable and have further growth and profit
potential as evidenced by our image mate acquisition. I would
caution, however, that these core businesses are subject to the world
economy. For instance, the weak dollar helps our exports sales
(currently 30% of our business), while an American recession would
adversely affect the remaining 70% of the business. The slump in
the domestic automotive industry may slow our penetration into
this market; but this is a worldwide industry and we are pursuing a
global strategy.
I believe IKONICS is in the process of re-inventing itself into a
company that brings innovative high-value proprietary products to
industrial markets. I am hopeful that in 2008 we will see the start of
the economic payoff from this transformation.
For the Board of Directors,
William C. Ulland
Chairman, President & CEO
The preceding letter contains statements regarding future financial results, new products, the
success of acquisitions and other matters that involve risks and uncertainties. The Company’s
actual results could differ materially as a result of domestic and global economic conditions,
competitive market conditions, acceptance of new products, the ability to identify, complete and
successfully integrate suitable acquisitions, as well as the other factors described elsewhere in this
Annual Report and in the Company’s most recent Form 10-KSB and most recent Form 10-QSB on
file with the SEC.
I K O N I C S C o r p o r a t i o n Annual Report 2007
1
Management’s Discussion and Analysis
of Financial Condition and R esults of
Operations
The following management discussion and analysis focuses on those factors
that had a material effect on the Company’s financial results of operations
and financial condition during 2007 and 2006 and should be read in
connection with the Company’s audited financial statements and notes
thereto for the years ended December 31, 2007 and 2006, included herein.
Fac to r s t hat May Af f e c t Fu t u r e Re su l t s
Certain statements made in this Annual Report, including those
summarized below, are forward-looking statements within the meaning of
the safe harbor provisions of Section 21E of the Securities Exchange Act
of 1934, as amended, that involve risks and uncertainties, and actual results
may differ. Factors that could cause actual results to differ include those
identified below.
The Company’s belief that additional proceeds will be received from the sale of
Apprise common and preferred stock that occurred in 2007—Actual additional
proceeds received may be impacted by unanticipated expenses related to
indemnification clauses as part of the agreement between Apprise and its
purchaser.
The Company’s belief that its effective tax rate will increase by 5% in 2008—The
actual tax rate in 2008 may be affected by changes in federal and state tax
law, unanticipated changes in the Company’s financial position or the
Company’s actions which could increase or decrease its effective tax rate.
The Company’s belief that the quality of its receivables is high and that strong internal
controls are in place to maintain proper collections—This belief may be impacted
by domestic economic conditions, by economic, political, regulatory or
social conditions in foreign markets, or by the failure of the Company to
properly implement or maintain internal controls.
The belief that the Company’s current financial resources, cash generated from
operations and the Company’s capacity for debt and/or equity financing will be
sufficient to fund current and anticipated business operations and capital expenditures.
The belief that the Company’s low debt levels and available line of credit make it
unlikely that a decrease in product demand would impair the Company’s ability to
fund operations—Changes in anticipated operating results, credit availability,
equity market conditions or the Company’s debt levels may further enhance
or inhibit the Company’s ability to maintain or raise appropriate levels of
cash.
The Company’s 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, repairs or capital asset additions. The funding of planned or
unforeseen expenditures may also be affected by changes in anticipated
operating results resulting from decreased sales, lack of acceptance of new
products 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.
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, lack of
acceptance of new products or the inability to identify attractive acquisition
targets or other business opportunities.
Critical Accounting Policies
The Company prepares its financial statements in conformity with
accounting principles generally accepted in the United States of America.
Therefore, the Company is required to make certain estimates, judgments
and assumptions that the Company believes are reasonable based upon the
information available. These estimates and assumptions affect the reported
amounts of assets and liabilities at the date of the financial statements
and the reported amounts of revenues and expenses during the periods
presented. The accounting policies which IKONICS believes are the most
critical to aid in fully understanding and evaluating its reported financial
results include the following:
Accounts Receivable
The Company performs ongoing credit evaluations of its customers and
adjusts credit limits based upon payment history and the customer’s current
credit worthiness, as determined by review of the current credit information.
The Company continuously monitors collections and payments from
its customers and maintains a provision for estimated credit losses based
upon historical experience and any specific customer collection issues
that have been identified. While such credit losses have historically been
within expectations and the provisions established, the Company cannot
guarantee that it will continue to experience the same collection history that
has occurred in the past. The general payment terms are net 30-45 days for
domestic customers and net 30-90 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.
Income Taxes
At December 31, 2007, the Company had approximately $35,000 of net
deferred tax assets. The deferred tax assets result primarily from temporary
differences in accrued expenses, inventory reserves, intangible assets and
property and equipment. The Company has determined that it is more
likely than not that the deferred tax assets will be realized and that a
valuation allowance for such assets is not currently required. The Company
accounts for its uncertain tax positions under FIN 48 and the related
reserve of $92,000 as of December 31, 2007 will be adjusted as the statute of
limitations expires or these positions are reassessed.
Investments in Non-Marketable Equity Securities
Investments in non-marketable equity securities consist of a $855,201
investment in imaging Technology international (“iTi”). The Company
accounts for this investment by the cost method because iTi’s common
stock is unlisted and the criteria for using the equity method of accounting
are not satisfied. Under the cost method, the investment is assessed for
other-than-temporary impairment and recorded at the lower of cost or
I K O N I C S C o r p o r a t i o n Annual Report 2007
2
market value which requires significant judgment since there are no readily
available market values for this investment. In assessing the fair value of this
investment we consider recent equity transactions that iTi has entered into,
the status of iTi’s technology and strategies in place to achieve its objectives,
as well as iTi’s financial condition and results of operations. To the extent
there are changes in the assessment, an adjustment may need to be recorded.
Revenue Recognition
The Company recognizes revenue on sales of products when title passes
which can occur at the time of shipment or when the goods arrive at the
customer location. Freight billed to customers is included in sales. Shipping
costs are included in cost of goods sold.
Results of Operations
Year Ended December 31, 2007 Compared to Year Ended December 31, 2006
Sales
The Company’s net sales increased 6.3% to $15.8 million in 2007, compared
to net sales of $14.9 million in 2006. Sales increases were realized in both
international and domestic markets. Sales growth in 2007 was mainly due to
sales related to the image mate® line of screen printing products. The image
mate® brand was acquired in December 2006.
Cost of Goods Sold
Cost of goods sold was $8.9 million, or 56.2% of sales, in 2007 and
$8.2 million, or 55.0% of sales, in 2006. The increase in the cost of sales in
2007 as a percentage of sales reflects a less favorable product mix, rising raw
material costs and additional manufacturing overhead related to the image
mate® transition.
Selling, General and Administrative Expenses
Selling, general and administrative expenses increased to $4.7 million,
or 29.9% of sales, in 2007 from $4.5 million, or 30.2% of sales, in 2006.
The 2007 increase was due to $140,000 for additional sales personnel
compared to 2006. Sarbanes-Oxley compliance and audit related fees also
increased $96,000 in 2007 compared to 2006. The Company also incurred
an additional $43,000 expense for an international trade show which the
Company attends every other year.
Research and Development Expenses
Research and development expenses were $775,000, or 4.9% of sales, in
2007 compared to $742,000, or 5.0% of sales, in 2006. The increase is due to
higher depreciation expense related to equipment purchases and production
trial expenses to support the Company’s efforts in the industrial digital
inkjet market and increased personnel costs.
Gain on Sale of Non-Marketable Equity Securities
The Company realized a gain of $55,000 on the sale of its investment in the
common and preferred stock of Apprise Technologies, Inc. during the first
quarter of 2007. In addition to the initial proceeds, the Company anticipates
receiving additional proceeds in 2008 from the portion of the total sale
price that was placed in escrow at the time of the sale related to potential
indemnification obligations as part of the agreement between Apprise and
its purchaser. The additional proceeds and gain recognition is expected to be
approximately $40,000, however there can be no assurance given that this
will occur.
Interest Income
Interest income increased to $154,000 in 2007 from $115,000 in 2006. The
interest income increase is due to an increase in interest rates and a larger
balance of interest earning assets.
Income Taxes
The Company incurred income tax expense of $466,000 for both 2007
and 2006, or an effective rate of 28.5% during 2007 compared to 29.3%
I K O N I C S C o r p o r a t i o n Annual Report 2007
for 2006. The lower effective income tax rate in 2007 primarily relates to
derecognizing a liability of $45,000 for unrecognized tax benefits relating
to a tax year where the statute of limitations expired. The remaining income
tax provision differs from the expected tax expense primarily due to the
benefits of the domestic manufacturing deduction, tax exempt interest,
state income taxes, federal credits for research and development and
adjustments from the 2006 tax accrual estimate. The Company expects its
effective income tax rate to increase by approximately 5% in 2008 compared
to 2007, as a result of a reduction in the amount of tax exempt interest that
will be recognized from short-term investments in 2008 and because of the
non-recurring 2007 tax benefit from the reversal of a valuation allowance
maintained against a capital loss carry forward deferred tax asset.
Liquidity and Capital Resources
The Company has financed its operations principally with funds generated
from operations. These funds have been sufficient to cover the Company’s
normal operating expenditures, annual capital requirements, and research
and development expenditures.
Cash and cash equivalents were $1,230,000 and $253,000 at December
31, 2007 and 2006, respectively. The Company generated $1,698,000 in
cash from operating activities during 2007 compared to $1,076,000 of
cash generated from operating activities during 2006. Cash provided
by operating activities is primarily the result of net income adjusted for
non-cash depreciation, amortization, stock based compensation, deferred
taxes, and certain changes in working capital components discussed in the
following paragraph.
During 2007, trade receivables increased by $48,000. The increase in
receivables is primarily related to higher sales. The Company believes that
the quality of its receivables is high and that strong internal controls are in
place to maintain proper collections. Inventory levels decreased by $139,000
due to lower raw material film levels. Inventory levels at the end of 2006 were
higher than historical levels due to the Company purchasing large amounts
of film to obtain volume pricing discounts. Accounts payable increased
by $147,000, reflecting the timing of payments to suppliers. Accrued
liabilities decreased $138,000 primarily due to the reversal of a tax related
contingent liability of $108,000. Income taxes payable decreased $57,000
and the Company’s income tax receivable increased $3,000 due to timing of
estimated 2007 tax payments compared to the calculated 2007 tax liability.
The Company used $833,000 and $1,848,000 in cash for investing activities
during 2007 and 2006, respectively. In 2007, the Company purchased
$610,000 of plant equipment. Over one-half of the plant and equipment
purchases were related to the Company’s efforts in industrial digital inkjet
and photo-machining markets. Purchases were also made to improve
facilities, update systems and replace vehicles.
The Company also purchased $375,000 of short-term investments
comprised of auction rate securities during 2007. Auction rate securities
(ARS) are highly liquid investments that are reset through a “dutch auction”
process that occurs every 7 to 49 days, depending on the terms of the
individual security. At December 31, 2007, the Company had $3,550,000
of ARS which were comprised entirely of AAA municipal bonds which
are classified as short term investments and recorded at cost which equaled
fair market value. Because of the current volatility in the ARS market,
subsequent to the end of the year, the Company sold approximately
$1,900,000 of ARS for its cost, which equaled market value, and placed the
proceeds in a money market account. The Company continues to closely
monitor its remaining ARS investments of $1,650,000 for indications
of illiquidity or impairment. Management believes that the value of its
remaining ARS portfolio has not declined.
During 2007, the Company reclassified $3,175,000 of investments in ARS
from cash and cash equivalents to short term investments. Given the liquid
nature of ARS, they had previously been classified as cash equivalents on
3
both the balance sheets and in the statements of cash flows. However, given
that ARS have long-term stated maturities and that the issuers of such ARS
are under no obligation to redeem them prior to their stated maturities,
the Company has determined that its investments in such securities should
be classified as short-term available-for-sale investments, rather than as
cash equivalents. Accordingly, the 2006 statement of cash flows presents
the gross purchases and sales of these short term investment as investing
activities. This reclassification had no impact on results of operations, cash
flows from operations, total current assets, total assets, or stockholders’
equity.
During the second quarter of 2007, the Company exercised a warrant for
7,500 shares at a price of $8.50 per share to purchase an additional $63,750
of iTi stock. The Company owns approximately 8% of the total outstanding
common shares of iTi. iTi is a leader in the development of industrial
production systems based on inkjet technology, and the Company believes
iTi’s expertise fits strategically with the Company’s expertise in developing
substrates for inkjet printing and the Company’s plans to develop
proprietary industrial inkjet technologies. The Company also incurred
$48,000 in patent application costs during 2007 that the Company records
as an asset and amortizes upon successful completion of the application
process. These cash outlays were partially offset by receipt of $253,000 from
the sale of the Company’s Apprise investment and $11,500 from the sale of
two vehicles.
During 2006, the Company invested $538,000 in iTi to acquire 69,166
common shares. On December 29, 2006, the Company acquired the
image mate® line of screen printing products from Franklin International
for $533,000. The Company made $274,000 of property and equipment
purchases during 2006. The purchases were comprised of plant and research
equipment to improve efficiency and safety, reduce operating costs and
update facilities, and two automobiles.
During 2006, the Company purchased $3,200,000 of short term
investments and sold $2,635,000 of short term investments comprised of
ARS which are AAA rated municipal bonds. The Company also incurred
$28,000 in patent application costs during 2006 that it recorded as an asset
and amortizes upon successful completion of the application process.
The Company received $84,000 during 2006 from the sale of marketable
securities other than ARS and $6,000 from the sale of an automobile.
The Company realized $112,000 in cash from financing activities during
2007 compared to $223,000 received in 2006. During 2007, the Company
received $80,000 for the issuance of 35,100 shares of common stock issued
upon the exercise of stock options compared to $186,000 received during
2006 for 48,324 shares of common stock issued upon the exercise of stock
options. The Company also realized a $32,000 cash benefit during 2007
related to the excess tax benefit from the exercise of stock options compared
to a $37,000 cash benefit received in 2006.
A bank line of credit provides for borrowings of up to $1,250,000.
Borrowings under this line of credit are collateralized by accounts receivable
and inventory and bear interest at 2.00 percentage points over the 30-day
LIBOR rate. The Company did not utilize this line of credit during 2007 or
2006 and there were no borrowings outstanding as of December 31, 2007
and 2006.
The Company believes that current financial resources, its line of credit,
cash generated from operations and the Company’s capacity for debt and/
or equity financing will be sufficient to fund current and anticipated business
operations. The Company also believes that its low debt levels and available
line of credit make it unlikely that a decrease in demand for the Company’s
products would impair the Company’s ability to fund operations.
industrial digital inkjet and photo-machining markets, plant equipment
upgrades and building improvements to improve efficiency and reduce
operating costs and vehicles.
During the first quarter of 2008, the Company acquired an option to
purchase a 15-acre brownfield site from the City of Duluth for approximately
$500,000. The Company is considering the construction of a manufacturing
and warehouse facility on the site. Construction is expected to begin during
the second quarter of 2008. Cost estimates for the expansion have not been
finalized.
Plans for capital expenditures include ongoing manufacturing equipment
upgrades, development equipment to modernize the capabilities and
processes of IKONICS’ laboratory, research and development to
improve measurement and quality control processes and vehicles. These
commitments are expected to be funded with cash generated from
operating activities.
International Activity
The Company markets its products to numerous countries in all regions of
the world including North America, Europe, Latin America, and Asia. The
Company’s 2007 foreign sales of $4,678,000 were approximately 29.6% of
total sales during 2007 compared to the 2006 foreign sales of $4,532,000
which were 30.4% of total sales. Foreign sales growth in 2007 was mainly
due to sales related to the image mate® line of screen printing products.
The image mate® brand was acquired in December 2006. Fluctuations in
certain foreign currencies have not significantly impacted the Company’s
operations because the Company’s foreign sales are not concentrated in
any one region of the world. The Company believes its vulnerability to
uncertainties due to foreign currency fluctuations and general economic
conditions in foreign countries is not significant.
The Company’s foreign transactions are primarily negotiated,
invoiced and paid in U. S. dollars while a portion is transacted in
Euros. IKONICS has not implemented an economic hedging
strategy to reduce the risk of foreign currency translation
exposures, which management does not believe to be significant
based on the scope and geographic diversity of the Company’s
foreign operations as of December 31, 2007. Furthermore, the
impact of foreign exchange on the Company’s balance sheet and
operating results was not material in either 2007 or 2006.
Future Outlook
IKONICS has spent on average over 4% of its sales dollars for the past
few years in research and development and in addition has made capital
expenditures related to its digital technology program. The Company
plans to maintain its efforts in this area and expedite internal product
development as well as form technological alliances with outside experts to
ensure commercialization of new product opportunities.
In addition to its traditional emphasis on domestic markets, the Company
will continue efforts to grow its business internationally by attempting
to develop new markets and expanding market share where it has already
established a presence.
Other future activities undertaken to expand the Company’s business may
include acquisitions, building expansion and additions, equipment additions,
new product development and marketing opportunities. 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.
Off-Balance Sheet Arrangements
The Company has no off-balance sheet arrangements.
Capital Expenditures
During 2007, the Company spent $610,000 on capital expenditures.
This spending primarily consists of supporting the Company’s efforts in
Recent Accounting Pronouncements
In June 2006, the Financial Accounting Standards Board (“FASB”) issued
Interpretation No. 48, Accounting for Uncertainty in Income Taxes
4
I K O N I C S C o r p o r a t i o n Annual Report 2007
(“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 attributes for the
financial statement recognition and measurement of a tax position taken
or expected to be taken in a tax return. FIN 48 also provides guidance on
derecognition, classification, interest and penalties, accounting in interim
periods, disclosure and transition. FIN 48 was effective for the Company as
of January 1, 2007. The impact of the adoption on the Financial Statements
as of January 1, 2007, was an increase in total liabilities of $137,000 and a
decrease in retained earnings of $137,000.
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. In February 2008, the FASB issued FASB
Staff Position FAS 157-2, “Effective Date of FASB Statement No. 157”
(the FSP). The FSP delayed, for one year, the effective date of SFAS 157
for all nonfinancial assets and liabilities, except those that are recognized
or disclosed in the financial statements on at least an annual basis. This
statement is effective for the Company beginning January 1, 2008. The
deferred provisions of SFAS 157 will be effective for the Company’s fiscal
year 2009. Because SFAS No. 157 does not require any new fair value
measurements or remeasurements of previously computed fair values, we do
not believe the adoption of SFAS No. 157 will have a material effect on our
results of operations or financial condition.
In February 2007, the FASB issued SFAS No. 159, The Fair Value Option
for Financial Assets and Financial Liabilities (“SFAS 159”). SFAS 159 allows
entities to measure at fair value many financial instruments and certain other
assets and liabilities that are not otherwise required to be measured at fair
value. SFAS 159 is effective for fiscal years beginning after November 15,
2007.
In December 2007, the FASB issued SFAS No. 160, “Noncontrolling
Interests in Consolidated Financial Statements” (“SFAS 160”). SFAS 160
requires all entities to report minority interests in subsidiaries as equity in the
consolidated financial statements, and requires that transactions between
entities and noncontrolling interests be treated as equity. SFAS 160 is
effective for fiscal years beginning on or after December 15, 2008, with early
adoption prohibited. The Company does not expect the adoption of this
statement will have a material impact on its financial position or results of
operations.
In December 2007, the FASB issued SFAS No. 141 (Revised) Business
Combinations (“SFAS 141(R)”). SFAS 141 (R) establishes principles and
requirements for how the acquirer of a business recognizes and measures in
its financial statements the identifiable assets acquired, the liabilities assumed,
and any noncontrolling interest in the acquiree. The statement also provides
guidance for recognizing and measuring the goodwill acquired in the business
combination and determines what information to disclose to enable users
of the financial statements to evaluate the nature and financial effects of the
business combination. SFAS 141(R) is effective for the fiscal year beginning
after December 15, 2008 with early adoption prohibited. The standard will
change the Company’s accounting treatment for business combinations on a
prospective basis.
Market for Common Equity, R elated
Stockholder Matters and Small
Business Issuer Purchases of Equity
Securities
The Company’s Common Stock is traded on the Nasdaq Capital Market
under the symbol IKNX. The following table sets forth, for the fiscal
quarters indicated, the high and low bid prices for the Company’s Common
Stock as reported on the Nasdaq Capital Market for the periods indicated.
The quotations reflect inter-dealer prices without retail mark-up, mark-down
or commission, and may not represent actual transactions.
Fiscal Year Ended December 31, 2007
First Quarter
Second Quarter
Third Quarter
Fourth Quarter
Fiscal Year Ended December 31, 2006
First Quarter
Second Quarter
Third Quarter
Fourth Quarter
High
$ 10.30
10.45
9.60
9.99
High
$ 8.33
10.47
8.97
8.60
Low
$ 7.22
8.83
8.76
8.86
Low
$ 6.26
7.06
7.15
7.02
As of February 26, 2008, the Company had approximately 667 shareholders.
The Company has never declared or paid any dividends on its Common
Stock.
The Company did not purchase shares of its equity securities during 2007 or
2006. A total of 50,007 shares of Common Stock may yet be purchased under the
repurchase program approved by the Company’s Board of Directors in August
2007.
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.
The financial statements have been audited by McGladrey & Pullen LLP, an
independent registered public accounting firm.
The Audit Committee of the Board of Directors, comprised of outside
directors, meets periodically with the independent auditors and
management to discuss the company’s internal accounting controls and
financial reporting matters. Our independent public accounting firm has
unrestricted access to the Audit Committee, without management present,
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
Jon Gerlach
Chief Financial Officer & V.P. Finance
I K O N I C S C o r p o r a t i o n Annual Report 2007
5
R eport of Independent R egistered
Public Accounting Firm
To the Stockholders and Board of Directors
IKONICS Corporation, Duluth, Minnesota
We have audited the balance sheets of IKONICS Corporation as of
December 31, 2007 and 2006, and the related statements of operations,
stockholders’ equity and comprehensive income and cash flows for the years
then ended. These financial statements are the responsibility of the Company’s
management. Our responsibility is to express an opinion on these financial
statements based on our audits.
We conducted our audits in accordance with the standards of the Public
Company Accounting Oversight Board (United States). Those standards
require that we plan and perform the audit to obtain reasonable assurance
about whether the financial statements are free of material misstatement.
An audit includes examining, on a test basis, evidence supporting the
amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made
by management, as well as evaluating the overall financial statement
presentation. We believe that our audits provide a reasonable basis for our
opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the financial position of IKONICS Corporation as of
December 31, 2007 and 2006, and the results of its operations and its cash
flows for the years then ended in conformity with U.S. generally accepted
accounting principles.
We were not engaged to examine management’s assertion about the
effectiveness of IKONICS Corporation’s internal control over financial
reporting as of December 31, 2007 included in this Annual Report and
titled “Management’s Annual Report on Internal Control over Financial
Reporting”, and accordingly, we do not express an opinion thereon.
As discussed in Note 2 to the financial statements, effective January 1,
2007 the Company adopted Financial Accounting Standards Board
Interpretation No. 48, Accounting for Uncertainty in Income Taxes.
/s/ McGladrey & Pullen, LLP
Duluth, Minnesota
March 20, 2008
Management’s Annual Report on
Internal Control Over Financial
Reporting
Our management is responsible for establishing and maintaining adequate
internal control over financial reporting as defined in Rules 13a-15(f) and
15d-15f under the Exchange Act. Our internal control system is designed
to provide reasonable assurance to our management and board of directors
regarding the reliability of financial reporting and the preparation of
financial statements for external purposes in accordance with generally
accepted accounting principles. Our internal control over financial
reporting includes those policies and procedures that:
•
•
•
Pertain to the maintenance of records that, in reasonable detail,
accurately and fairly reflect the transactions and dispositions of the
assets of the company;
Provide reasonable assurance that transactions are recorded as
necessary to permit preparation of financial statements in accordance
with generally accepted accounting principles, and that receipts and
expenditures of the company are being made only in accordance with
authorizations of management and directors of the company; and
Provide reasonable assurance regarding prevention or timely detection
of unauthorized acquisition, use or disposition of the company’s assets
that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting
may not prevent or detect misstatements. Also, projections of any evaluation
of effectiveness to future periods are subject to the risk that controls may
become inadequate because of changes in conditions, or that the degree of
compliance with the policies or procedures may deteriorate.
Management assessed the effectiveness of our internal control over
financial reporting as of December 31, 2007. In making this assessment,
management used the criteria set forth by the Committee of Sponsoring
Organizations of the Treadway Commission (COSO) in Internal Control
– Integrated Framework. Based on management’s assessment and those
criteria, management believes that, as of December 31, 2007, the Company
maintained effective internal control over financial reporting.
This annual report does not include an attestation report of the Company’s
registered public accounting firm regarding internal control over financial
reporting. Our management’s report on the effectiveness of the design and
operation of our internal control over financial reporting was not subject to
attestation by the Company’s registered public accounting firm pursuant to
temporary rules of the Securities and Exchange Commission that permit
the Company to provide only management’s report in this annual report.
William C. Ulland
Chairman, President & CEO
Jon Gerlach
Chief Financial Officer & V.P. Finance
6
I K O N I C S C o r p o r a t i o n Annual Report 2007
ASSETS
CURRENT ASSETS:
BALANCE SHEETS: DECEMBER 31, 2007 AND 2006
2007
2006
Cash and cash equivalents .......................................................................................................................................
$ 1,230,020
Short-term investments
Trade receivables, less allowance of $45,000 in 2007 and $70,000 in 2006 (Notes 6 and 10) .............................................
Inventories (Notes 1 and 10) ....................................................................................................................................
Deposits, prepaid expenses and other assets (Note 3) .................................................................................................
Deferred income taxes (Note 2) ................................................................................................................................
3,550,000
2,025,257
2,355,864
130,596
24,000
$ 253,186
3,175,000
1,976,893
2,494,876
232,255
97,000
Total current assets ................................................................................................................................................
9,315,737
8,229,210
PROPERTY, PLANT, AND EQUIPMENT, at cost:
Land and building ..................................................................................................................................................
Machiner y and equipment .......................................................................................................................................
Office equipment ...................................................................................................................................................
Vehicles ................................................................................................................................................................
Less accumulated depreciation .................................................................................................................................
INTANGIBLE ASSETS, less accumulated amortization of $213,061 in 2007 and $159,352 in 2006 (Notes 3 and 4) .......................
DEFERRED INCOME TAXES (Note 2) ...................................................................................................................................
INVESTMENTS IN NON-MARKETABLE EQUITY SECURITIES (Note 1) .........................................................................................
LIABILITIES AND STOCKHOLDERS’ EQUITY
CURRENT LIABILITIES:
1,631,142
2,700,816
812,120
219,964
5,364,042
4,043,451
1,320,591
479,888
11,000
855,201
1,500,271
2,396,867
817,406
203,816
4,918,360
3,926,440
991,920
485,421
48,000
988,910
$ 11,982,417
$ 10,743,461
2007
2006
Accounts payable ...................................................................................................................................................
$ 435,572
$ 288,449
Accrued compensation ............................................................................................................................................
Other accrued expenses (Note 2) ..............................................................................................................................
Income taxes payable .............................................................................................................................................
Total current liabilities ...........................................................................................................................................
347,691
148,149
5,291
936,703
324,082
172,381
94,450
879,362
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 2,045,961 shares in 2007 and 2,010,861 shares in 2006 (Note 7) ............................................
Additional paid-in capital .......................................................................................................................................
Retained earning....................................................................................................................................................
204,596
2,124,342
8,716,776
Total stockholders’ equity ........................................................................................................................................
11,045,714
201,086
1,979,012
7,684,001
9,864,099
$ 11,982,417
$ 10,743,461
See notes to financial statements.
I K O N I C S C o r p o r a t i o n Annual Report 2007
7
STATEMENTS OF OPERATIONS: YEARS ENDED DECEMBER 31, 2007 AND 2006
2007
2006
NET SALES ....................................................................................................................................................................
$ 15,824,725
$ 14,888,912
COSTS AND EXPENSES
Cost of goods sold ..................................................................................................................................................
$ 8,887,612
$ 8,181,814
Selling, general and administrative ..........................................................................................................................
4,735,419
4,490,381
Research and development ......................................................................................................................................
775,049
742,406
INCOME FROM OPERATIONS .............................................................................................................................................
GAIN ON SALE OF NON-MARKETABLE EQUITY SECURITIES ......................................................................................................
INTEREST INCOME ..........................................................................................................................................................
14,398,080
13,414,601
1,426,645
55,159
153,971
1,474,311
—
115,454
INCOME BEFORE INCOME TAXES ........................................................................................................................................
1,635,775
1,589,765
FEDERAL AND STATE INCOME TAXES (Note 2) ......................................................................................................................
466,000
466,000
NET INCOME ..................................................................................................................................................................
$ 1,169,775
$ 1,123,765
EARNINGS PER COMMON SHARE:
Basic ....................................................................................................................................................................
Diluted .................................................................................................................................................................
WEIGHTED AVERAGE COMMON SHARES:
Basic ....................................................................................................................................................................
Diluted .................................................................................................................................................................
$ 0.58
$ 0.57
$ 0.56
$ 0.55
2,033,045
2,063,380
2,000,017
2,027,916
See notes to financial statements.
STATEMENTS OF STOCKHOLDERS’ EQUITY AND COMPREHENSIVE INCOME: YEARS ENDED DECEMBER 31, 2007 AND 2006
Common Stock
Shares Amount
Additional
Paid-in
Capital
Retained
Earnings
Accumulated
Other
Comprehensive
Income (Loss)
Additional
Paid-in
Capital
BALANCE AT DECEMBER 31, 2005
1,962,537
$ 196,254
$ 1,721,119
$ 6,560,236
$ 896
$ 8,478,505
Net income
Unrealized loss on available-for-sale securities
Total comprehensive income
Exercise of stock options
Tax benefit resulting from stock option exercises
Stock based compensation and related tax benefit
—
—
—
48,324
—
—
—
—
—
4,832
—
—
—
—
—
181,503
14,055
62,335
1,123,765
—
—
—
—
—
BALANCE AT DECEMBER 31, 2006
2,010,861
201,086
1,979,012
7,684,00
Cumulative effect to prior year retained earnings
related to the adoption of FIN 48 (Note 2)
Net income and comprehensive income
Exercise of stock options
Tax benefit resulting from stock option exercises
Stock based compensation and related tax benefit
—
—
35,100
—
—
—
—
3,510
—
—
—
—
76,212
18,208
50,910
(137,000)
1,169,775
—
—
—
—
(896)
—
—
—
—
—
—
—
—
—
—
1,123,765
(896)
1,122,869
186,335
14,055
62,335
9,864,099
(137,000)
1,169,775
79,722
18,208
50,910
BALANCE AT DECEMBER 31, 2007
2,045,961
$ 204,596
$ 2,124,342
$ 8,716,776
— $ 11,045,714
See notes to financial statements.
8
I K O N I C S C o r p o r a t i o n Annual Report 2007
STATEMENTS OF CASH FLOWS YEARS ENDED DECEMBER 31, 2007 AND 2006
2007
2006
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income ............................................................................................................................................................
$ 1,169,775
$ 1,123,765
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation ......................................................................................................................................................
Amortization .....................................................................................................................................................
Excess tax benefit from share-based payment arrangements ....................................................................................
Tax benefit from stock option exercise ..................................................................................................................
Stock based compensation...................................................................................................................................
Gain on sale of vehicles ......................................................................................................................................
Gain on sale of non-marketable equity securities ...................................................................................................
Deferred income taxes ........................................................................................................................................
Changes in working capital components, net of effects of business acquisition:
276,942
53,709
(31,997)
18,208
18,913
(7,341)
(55,159)
110,000
242,833
24,710
(36,712)
14,055
25,623
(640)
—
15,000
Trade receivables ...............................................................................................................................................
(48,364)
(274,285)
Inventories ........................................................................................................................................................
Prepaid expenses and other assets .......................................................................................................................
Accounts payable ...............................................................................................................................................
Accrued liabilities ..............................................................................................................................................
Income taxes payable .........................................................................................................................................
139,012
101,659
147,123
(137,623)
(57,162)
34,101
(16,508)
(150,148)
(491)
74,419
Net cash provided by operating activities ..............................................................................................................
1,697,695
1,075,722
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchases of property and equipment .......................................................................................................................
(609,772)
(273,548)
Proceeds from sale of vehicles .................................................................................................................................
11,500
6,000
Business acquisition (Note 3) ...................................................................................................................................
—
(532,921)
Purchase of intangibles ...........................................................................................................................................
(48,176)
(28,045)
Purchase of short-term investments .........................................................................................................................
(375,000)
(3,200,000)
Proceeds from sale of short-term investments ............................................................................................................
Purchase of non-marketable equity securities ............................................................................................................
Proceeds from sale of non-marketable equity securities ..............................................................................................
Proceeds from sale of marketable equity securities .....................................................................................................
—
(63,750)
252,618
—
2,635,000
(538,120)
—
83,979
Net cash used in investing activities .....................................................................................................................
(832,580)
(1,847,655)
CASH FLOWS FROM FINANCING ACTIVITIES:
Excess tax benefit from share-based payment arrangement .........................................................................................
Proceeds from exercise of stock options.....................................................................................................................
Net cash provided by financing activities ..............................................................................................................
NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS ................................................................................................
CASH AND CASH EQUIVALENTS AT BEGINNING OF YEAR .........................................................................................................
31,997
79,722
111,719
976,834
253,186
36,712
186,335
223,047
(548,886)
802,072
CASH AND CASH EQUIVALENTS AT END OF YEAR ...................................................................................................................
$ 1,230,020
$ 253,186
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION
Cash paid for income taxes ......................................................................................................................................
$ 433,953
$ 362,526
See notes to financial statements.
I K O N I C S C o r p o r a t i o n Annual Report 2007
9
NOTES TO FINANCIAL STATEMENTS: YEARS ENDED DECEMBER 31, 2007 AND 2006
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Description of Business and Foreign Export Sales - IKONICS Corporation
(the Company) develops and manufactures high-quality photochemical
imaging systems for sale primarily to a wide range of printers and decorators
of surfaces. Customers’ applications are primarily screen printing and
abrasive etching. The Company’s principal markets are throughout the
United States. In addition, the Company sells to Western Europe, Latin
America, Asia, and other parts of the world. The Company extends credit
to its customers, all on an unsecured basis, on terms that it establishes for
individual customers.
Foreign export sales approximated 29.6% of net sales in 2007 and 30.4% of
net sales in 2006. The Company’s accounts receivable at December 31, 2007
and 2006 due from foreign customers were 35.2% and 39.5%, respectively.
The foreign export receivables are composed primarily of open credit
arrangements with terms ranging from 30 to 90 days. No single customer
represented greater than 10% of net sales in 2007 or in 2006.
A summary of the Company’s significant accounting policies follows:
Cash Equivalents - The Company considers all highly liquid debt instruments
purchased with a maturity of three months or less to be cash equivalents.
Cash equivalents consist of money market funds in which the carrying
value approximates market value because of the short maturity of these
instruments.
Short-Term Investments - Short-term investments consist of auction rate
securities that are comprised of AAA rated government municipal variable
rate bonds. We consider our short-term investments to be “available-for-sale”
securities. At December 31, 2007 and 2006, cost was equal to fair value and
no amount of unrealized gain or loss was included as a separate component
of shareholders’ equity.
Trade Receivables – Trade receivables are carried at original invoice amount
less an estimate made for doubtful receivables based on a review of all
outstanding amounts on an on-going basis. Management determines the
allowance for doubtful accounts by regularly evaluating individual customer
receivables and considering a customer’s financial condition, credit history,
and current economic conditions. Trade receivables are written off when
deemed uncollectible. Recoveries of trade receivables previously written off
are recorded when received. Accounts are considered past due if payment is
not received according to agreed-upon terms.
Inventories - Inventories are stated at the lower of cost or market using the
last-in, first-out (LIFO) method. If the first-in, first-out cost method had been
used, inventories would have been approximately $624,000 and $535,000
higher than reported at December 31, 2007 and 2006, respectively. The
major components of inventories are as follows:
2007
2006
Raw materials ..........................................
$ 1,373,835
$ 1,577,165
Work-in-progress .....................................
Finished goods .........................................
Reduction to LIFO cost ..............................
296,998
1,308,917
(623,886)
225,033
1,227,806
(535,128)
Total inventories ......................................
$ 2,355,864
$ 2,494,876
Depreciation - Depreciation of property, plant and equipment is computed
using the straight-line method over the following estimated useful lives:
Years
Building ...................................................................15-40
Machinery and equipment .....................................5-10
Office equipment ....................................................3-10
Vehicles ...................................................................3
Intangible Assets– Intangible assets consist primarily of patents, licenses and
covenants not to compete arising from business combinations. Intangible
assets are amortized on a straight-line basis over their estimated useful
lives or agreement terms. Intangible assets with finite lives are assessed
for impairment whenever events or circumstances indicate the carrying
value may not be fully recoverable by comparing the carrying value of the
intangibles to their future undiscounted cash flows. To the extent there is
impairment, analysis is performed based on several criteria, including, but
not limited to, revenue trends, discounted operating cash flows and other
operating factors to determine the impairment amount.
As of December 31, 2007 the remaining estimated weighted average useful
lives of intangible assets are as follows:
Years
Patents ....................................................................4.0
Licenses ...................................................................7.5
Non-compete agreements ......................................6.5
Investments in non-marketable equity securities consist of an $855,201 investment
in imaging Technology international (“iTi”). The Company accounts for
this investment by the cost method because the common stock of the
corporation is unlisted and the criteria for using the equity method of
accounting are not satisfied. Under the cost method, the investment is
assessed for other-than-temporary impairment and recorded at the lower
of cost or market value which requires significant judgment since there are
no readily available market values for this investment. In assessing the fair
value of this investment the Company considers recent equity transactions
that iTi has entered into, the status of iTi’s technology and strategies
in place to achieve its objectives, as well as iTi’s financial condition and
results of operations. To the extent there are changes in the assessment, an
adjustment may need to be recorded. As of December 31, 2006 investments
in non-marketable equity securities consisted of a $791,450 investment in
imaging Technology international (“iTi”) and a $197,460 equity investment
in Apprise Technologies, Inc (Apprise). During February 2007, Apprise
was acquired by Eco Lab Incorporated for cash. The Company realized a
gain of approximately $55,000 on the $253,000 cash payment received in
2007 related to the Apprise sale. The Company may recover an additional
payment in 2008 from the Apprise sale as defined in the sales agreement.
Fair Value of Financial Instruments – The carrying amounts of financial
instruments, including cash, cash equivalents, short-term investments,
accounts receivable, accounts payable, and accrued liabilities approximate
fair value due to the short maturity of these instruments. The carrying value
of the non-marketable equity securities approximated their estimated fair
value based on management’s knowledge of recent sales prices of the non-
marketable equity securities.
Revenue Recognition - The Company recognizes revenue on sales of products
when title passes which can occur at the time of shipment or when the goods
arrive at the customer location. Freight billed to customers is included in
sales. Shipping costs are included in cost of goods sold.
Deferred Taxes - Deferred taxes are provided on a liability method whereby
deferred tax assets are recognized for deductible temporary differences and
operating loss and tax credit carryforwards and deferred tax liabilities are
recognized for taxable temporary differences. Temporary differences are the
differences between the reported amounts of assets and liabilities and their
tax bases. Deferred tax assets are reduced by a valuation allowance when,
in the opinion of management, it is more likely than not that some portion
or all of the deferred tax assets will not be realized. Deferred tax assets and
liabilities are adjusted for the effects of changes in tax laws and rates on the
date of enactment.
I K O N I C S C o r p o r a t i o n Annual Report 2007
10
Comprehensive Income - The Company’s comprehensive income consists
of net income and net unrealized holding gains and losses on marketable
securities, net of taxes. There were no net unrealized holding gains and
losses on marketable securities available for sale at December 31, 2007 and
2006. Total comprehensive income was $1,169,775 and $1,122,869 for years
ended December 31, 2007 and 2006 respectively. There are no amounts
in comprehensive income related to foreign exchange activity, since such
amounts were not significant for either 2007 or 2006.
Earnings Per Common Share (EPS) - Basic EPS is calculated using net income
divided by the weighted average of common shares outstanding during
the year. Diluted EPS is similar to Basic EPS except that weighted average
of common shares outstanding are increased to include the number of
additional common shares that would have been outstanding if all dilutive
potential common shares, such as options, had been issued.
Shares used in the calculation of diluted EPS are summarized below:
Weighted average common shares outstanding
2007
2006
2,033,045
2,000,017
Dilutive effect of stock options ....................
30,335
27,899
2. INCOME TAXES
Income tax expense for the years ended December 31, 2007 and 2006
consists of the following:
2007
2006
Current
Federal ..........................................................
$ 317,000
$ 401,000
State .............................................................
39,000
50,000
Deferred .........................................................
110,000
15,000
356,000
451,000
$ 466,000
$ 466,000
The expected provision for income taxes, computed by applying the U.S.
federal income tax rate of 35% in 2007 and 2006 to income before taxes, is
reconciled to income tax expense as follows:
2007
2006
Expected provision for federal income taxes ........
$ 572,500
$ 556,400
State income taxes, net of federal benefit ..............
32,800
36,300
Weighted average common and common
equivalent shares outstanding .....................
2,063,380
2,027,916
Reversal of uncertain tax positions .....................
Reversal of valuation allowance .........................
(27,000)
(45,000)
—
—
Options to purchase 52,622 and 88,222 shares of common stock were
outstanding as of December 31, 2007 and 2006, respectively.
Employee Stock Plan - Effective January 1, 2006, the Company adopted
Financial Accounting Standards Board Statement No. 123 (revised 2004),
“Share-Based Payment,” (FAS 123(R)) using the modified-prospective-
transition method. Prior to the adoption of FAS 123(R), the Company
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.
Use of Estimates - The preparation of the financial statements in conformity
with accounting principles generally accepted in the United States of
America requires management to make estimates and assumptions that
affect the reported amounts of assets and liabilities and disclosure of
contingent assets and liabilities at the date of the financial statements and
the reported amounts of revenues and expenses during the reporting period.
Actual results could differ from those estimates.
Foreign Currency Translation - Foreign currency transactions and translation
adjustments did not have a significant effect on the Balance Sheet or the
Statements of Stockholders’ Equity and Comprehensive Income and Cash
Flows for 2007 and 2006.
Reclassification - The Company has reclassed certain investments in auction
rate securities (ARS) in 2006 to conform with the 2007 presentation of
cash and cash equivalents and short term investments. As a result of this
reclassification, cash and cash equivalents was reduced by and short term
investments were increased by $3,175,000 at December 31, 2006. The gross
purchases and sales of these short term investments have been included in
the investing activities on the statement of cash flows. This reclassification
had no impact on results of operations, cash flows from operations, total
current assets, total assets, or stockholders’ equity.
Extraterritorial income exclusion ........................
— (49,400)
Domestic manufacturers deduction .....................
(10,500)
(11,100)
Non-deductible meals and entertainment ...........
15,000
16,400
Tax-exempt interest..........................................
(43,400)
(39,000)
R&D Credit ......................................................
(14,700)
(13,600)
Other ..............................................................
(13,700)
(30,000)
$ 466,000
$ 466,000
Deferred tax assets consist of the following as of December 31, 2007 and 2006:
2006
2007
Property and equipment and other assets ............
$ 13,000
$ 38,000
Accrued vacation .................................................
18,000
Other accrued expenses .....................................
Inventories ......................................................
Allowance for doubtful accounts ........................
Allowance for sales returns ................................
Intangible assets ..............................................
Capital loss carr yfor ward ..................................
—
—
5,000
11,000
—
14,000
19,000
49,000
12,000
18,000
7,000
10,000
27,000
Less valuation allowance ...................................
— (27,000)
61,000
180,000
Deferred tax liabilities:
Inventories
Intangible assets
Prepaid expenses
61,000
153,000
9,000
15,000
2,000
—
—
8,000
$ 35,000
$ 145,000
The deferred tax amounts described above have been included in the
accompanying balance sheet as of December 31, 2007 and 2006 as follows:
2006
2007
Current assets .....................................................
$ 24,000
$ 97,000
Noncurrent assets................................................
11,000
48,000
$ 35,000
$ 145,000
I K O N I C S C o r p o r a t i o n Annual Report 2007
11
On January 1, 2007, the Company adopted the provisions of Financial
Standards Accounting Board Interpretation No 48, Accounting for
Uncertainty in Income Taxes (“FIN 48”). As a result of the implementation
of FIN 48, the Company recorded a liability for unrecognized tax benefits
of $137,000, which was accounted for as a reduction in retained earnings
as of January 1, 2007 for the cumulative effect of a change in accounting
principle as provided for by FIN 48. The balance of the unrecognized tax
benefits at adoption, exclusive of interest, was $122,000. During the first
quarter of 2007, the statute of limitations for the relevant taxing authority
to examine and challenge the tax position for an open year expired, resulting
in a decrease in income tax expense of $45,000 for 2007. As of December
31, 2007, the liability for unrecognized tax benefits totaled $92,000 and is
included in other accrued expenses.
Prior to 2007 the Company determined its tax contingencies in accordance
with SFAS No. 5, Accounting for Contingencies, or SFAS 5. The Company
recorded estimated tax liabilities to the extent the contingencies were
probable and could be reasonably estimated.
The Company is subject to taxation in the United States and various states.
The material jurisdictions that are subject to examination by tax authorities
primarily include Minnesota and the United States, for tax years 2004, 2005,
2006, and 2007.
It is the Company’s policy beginning in 2007 to recognize interest and
penalties related to uncertain tax positions in income tax expense. The
Company had accrued approximately $14,000 of interest related to
uncertain tax positions at December 31, 2007. The unrecognized tax
benefits at December 31, 2007 relate to taxation of foreign export sales.
A reconciliation of the beginning and ending amounts of unrecognized tax
benefit is as follows:
Balance at Januar y 1, 2007 ...................................................
$ 137,000
Expiration of the statute of limitations for the assessment of taxes ..
Balance at December 31, 2007 ..............................................
(45,000)
$ 92,000
The balance of unrecognized tax benefits totaling $92,000 at December 31,
2007, if reversed, would decrease the provision for income taxes and increase
net income by the same amount and reduce the Company’s effective tax
rate. The Company also accrued potential interest of $6,000 related to
these unrecognized tax benefits during 2007, and in total, as of December
31, 2007, the Company recorded a liability for potential interest of $13,700.
We expect our unrecognized tax benefit to be reduced by approximately
$42,000 during the next twelve months as a result of the expiration of the
statute of limitations for the assessment of taxes.
3. BUSINESS COMBINATION
On December 29, 2006, the Company acquired certain assets of Franklin
International Inc. (Franklin) related to the image mate® line of screen
printing products. The acquisition was accounted for under the purchase
method of accounting. Accordingly, the assets acquired were recorded at
their fair market value. The assets acquired included lab equipment, raw
materials and finished goods inventory, and a non-compete agreement with
Franklin. The costs allocated to the non-compete agreement are amortized
on a straight-line basis over its seven year term. In connection with the
acquisition, the Company entered into an agreement to prepay for inventory
purchases from Franklin, which are expected to be utilized over three years.
The fair market value of the assets acquired resulted in the following
purchase price allocation:
Cash price paid for assets .......................................................
$ 528,921
Acquisition costs incurred ......................................................
4,000
Total purchase price ..........................................................
$ 532,921
Purchase Price Allocation
Inventor y .............................................................................
$ 164,921
Deposit for inventor y purchases ..............................................
150,000
Equipment ............................................................................
15,000
Non-compete agreement ........................................................
203,000
$ 532,921
If the acquisition had occurred on January 1, 2006, the unaudited pro forma
impact on revenues would have been to increase revenues by approximately
$600,000 for the year ended December 31, 2006. The unaudited proforma
net income and earnings per common share would not have been
significantly different than to the amounts reported in the Company’s
financial statements for 2006.
4. INTANGIBLE ASSETS
Intangible assets consist primarily of patents, licenses and covenants not to compete arising from business combinations. Intangible assets are amortized on a
straight-line basis over their estimated useful lives or terms of their agreement, whichever is shorter. No impairment adjustments to intangible assets were made
during the year ended December 31, 2007 or 2006.
Intangible assets at December 31, 2007 and 2006 consist of the following:
Amortized intangible assets:
Patents ............................................................................
Licenses ...........................................................................
Non-compete agreements ...................................................
December 31, 2007
December 31, 2006
Gross Carr ying Amount
Accumulated
Amortization
Gross Carr ying Amount
Accumulated
Amortization
$ 289,949
100,000
303,000
$ 692,949
$ (90,939)
(43,126)
(78,996)
$ (213,061)
$ 241,773
100,000
303,000
$ 644,773
$ (81,022)
(35,000)
(43,330)
$ (159,352)
Aggregate amortization expense
2007
2006
For the years ended December 31 ......................
$ 53,709
$24,710
12
I K O N I C S C o r p o r a t i o n Annual Report 2007
Estimated amortization expense for the years ended December 31:
2008 ...................................................................................
$ 54,000
2009 ...................................................................................
2010 ...................................................................................
2011 ...................................................................................
2012 ...................................................................................
54,000
52,000
45,000
45,000
In connection with the license agreements, the Company has agreed to
pay royalties ranging from 3% to 5% on the sales of products subject to
the agreements. The Company incurred $101,000 of expense under these
agreements during 2007, and $119,000 during 2006.
5. RETIREMENT PLAN
The Company has established a salary deferral plan under Section 401(k) of
the Internal Revenue Code. Such deferrals accumulate on a tax-deferred
basis until the employee withdraws the funds. The Company contributes 5%
of each eligible employee’s compensation. Total retirement expense for the
years ended December 31, 2007 and 2006 was approximately $176,000 and
$163,000, respectively.
6.SEGMENT INFORMATION
The Company’s reportable segments are strategic business units that
offer different products and have a varied customer base. There are three
reportable segments: Domestic, Export, and IKONICS Imaging. Domestic
sells screen printing film, emulsions, and inkjet receptive film which is sold
to distributors located in the United States. IKONICS Imaging sells photo
resistant film, art ➥ supplies, glass, metal medium and related abrasive
etching equipment to end user customers located in the United States. It
is also entering the market for etched ceramics, glass and silicon wafers;
and is developing and selling proprietary inkjet technology. Export sells
primarily the same products as Domestic and IKONICS Imaging to foreign
customers. The accounting policies applied to determine the segment
information are the same as those described in the summary of significant
accounting policies.
Management evaluates the performance of each segment based on the
components of divisional income, and with the exception for accounts
receivable, does not allocate assets and liabilities to segments. Financial
information with respect to the reportable segments follows:
Domestic
Export*
IKONICS Imaging
Other
Total
FOR THE YEAR ENDED DECEMBER 31, 2007
Net sales ....................................................................................
$ 6,680,384
$ 4,677,898
$ 4,466,443
— $ 15,824,725
Cost of good sold.........................................................................
Selling, general and administrative ...............................................
Research and development ...........................................................
3,700,504
1,129,823
—
3,142,597
433,966
—
2,044,511
1,403,092
—
—
1,768,538
775,049
8,887,612
4,735,419
775,049
Income from operations ...............................................................
$ 1,850,057
$ 1,101,335
$ 1,018,840
$ (2,543,587)
$ 1,426,645
FOR THE YEAR ENDED DECEMBER 31, 2006
Net sales ....................................................................................
$ 5,777,987
$ 4,531,605
$ 4,579,320
$ — $ 14,888,912
Cost of good sold.........................................................................
3,083,598
2,955,011
Selling, general and administrative ...............................................
965,695
395,619
Research and development ...........................................................
—
—
2,143,205
1,479,464
—
—
1,649,603
742,406
8,181,814
4,490,381
742,406
Income from operations ...............................................................
$ 1,728,694
$ 1,180,975
$ 956,651
$ (2,392,009)
$ 1,474,311
ACCOUNTS RECEIVABLE AS OF DECEMBER 31, 2007 AND DECEMBER 31, 2006
Domestic .................................................................................................
Export* ..................................................................................................
IKONICS Imaging ........................................................................................
Other .....................................................................................................
Dec 31, 2007
$ 980,906
712,936
356,272
(24,857)
Dec 31, 2006
$ 842,144
780,599
384,748
(30,598)
Total ......................................................................................................
$ 2,025,257
$ 1,976,893
* In 2007 and 2006, the Company marketed its products in various countries throughout the world. The Company is exposed to the risk of changes in social, political,
and economic conditions inherent in foreign operations, and the Company’s results of operations are affected by fluctuations in foreign currency exchange rates. No
single foreign countr y accounted for more than 10% of the Company’s net sales for 2007 and 2006.
Sales to foreign customers were 29.6% and 30.4% of the Company’s net sales for 2007 and 2006, respectively.
I K O N I C S C o r p o r a t i o n Annual Report 2007
13
7. STOCK OPTIONS
The Company has stock incentive plan for the issuance of up 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 56,173 shares of
common stock are reserved for additional future grants of options under the
plan at December 31, 2007.
Under the plan, the Company charged compensation cost of $18,913 and
$25,623 against income and recognized a total income tax benefit in the
income statement of $8,963 and $26,482 in 2007 and 2006, respectively.
As of December 31, 2007, there was approximately $16,000 of unrecognized
compensation cost related to unvested share-based compensation awards
granted which is expected to be recognized over the next two 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. In accordance with FAS 123(R), the excess tax benefits from
the exercise of stock options is reported as a reduction of operating and an
increase in financing cash flows. For the year ended December 31, 2007
and 2006, $31,997 and $36,712 of excess tax benefits was reported in the
statement of cash flows, respectively.
There were no options granted during 2007. The fair value of share-based
payment awards granted in 2006 was estimated using the Black-Scholes
option pricing model with the following assumptions:
2006
Dividend yield ......................................................0.0%
Expected volatility ..............................................60.6 - 63.0%
Expected life of option .......................................Five years
Risk-free interest rate .........................................4.8-5.0%
SFAS 123R specifies that initial accruals be based on the estimated number
of instruments for which the requisite service is expected to be rendered.
Therefore, the Company is required to incorporate a preexisting forfeiture
rate based on the historical forfeiture expense and prospective actuarial
analysis, estimated at 2%.
A summary of the status of the Company’s stock option plan as of
December 31, 2007 and changes during the year then ended is presented
below:
Options
Shares
Weighted Average
Exercise Price
Weighted Average
Remaining Contractual Term
(years)
Aggregate Intrinsic Value
Outstanding at Januar y 1, 2007 ...........................................
Granted ...........................................................................
88,222
—
Exercised ..........................................................................
(35,100)
Expired and for feited .........................................................
Outstanding at December 31, 2007 ......................................
Vested or expected to vest at December 31, 2007 ..................
Exercisable at December 31, 2007 ........................................
(500)
52,622
52,622
44,871
$3.33
—
2.27
4.32
4.03
4.03
$ 3.58
1.13
1.13
0.83
$ 264,728
$ 264,728
$245,921
The weighted-average grant-date fair value of options granted was $4.58 for the year ended December 31, 2006. The total intrinsic value of options exercised
was $237,949 and $227,175 for the years ended December 31, 2007 and 2006, respectively.
The following table summarizes information about stock options outstanding at December 31, 2007:
Range of Exercise Price
Number Outstanding at
December 31, 2007
Weighted- Average Remaining
Contractual Life (years)
Weighted- Average Exercise
Price
Number Exercisable at
December 31, 2007
Weighted- Average Exercise
Price
OP T I O N S O U T S T A N D I N G
O P T I O N S E X E R C I S A B L E
$ 2.00 - 2.99
$ 3.00 -3.99
$ 4.00 -4.99
$ 7.00 - 7.99
23,622
11,250
8,250
9,500
52,622
0.31
0.59
2.32
2.79
1.13
$ 2.73
3.36
4.32
7.79
$ 4.03
23,622
11,250
5,333
4,666
44,871
$ 2.73
3.36
4.32
7.54
$ 3.58
14
I K O N I C S C o r p o r a t i o n Annual Report 2007
the Company does not believe the adoption of SFAS No. 157 will have a
material effect on its results of operations or financial condition.
In February 2007, the FASB issued SFAS No. 159, The Fair Value Option
for Financial Assets and Financial Liabilities (“SFAS 159”). SFAS 159 allows
entities to measure at fair value many financial instruments and certain other
assets and liabilities that are not otherwise required to be measured at fair
value. SFAS 159 is effective for fiscal years beginning after November 15,
2007.
In December 2007, the FASB issued SFAS No. 160, “Noncontrolling
Interests in Consolidated Financial Statements” (“SFAS 160”). SFAS 160
requires all entities to report minority interests in subsidiaries as equity in the
consolidated financial statements, and requires that transactions between
entities and noncontrolling interests be treated as equity. SFAS 160 is
effective for fiscal years beginning on or after December 15, 2008, with early
adoption prohibited. The Company does not expect the adoption of this
statement will have a material impact on its financial position or results of
operations.
In December 2007, the FASB issued SFAS No. 141 (Revised) Business
Combinations (“SFAS 141(R)”). SFAS 141 (R) establishes principles and
requirements for how the acquirer of a business recognizes and measures in
its financial statements the identifiable assets acquired, the liabilities assumed,
and any noncontrolling interest in the acquiree. The statement also provides
guidance for recognizing and measuring the goodwill acquired in the business
combination and determines what information to disclose to enable users
of the financial statements to evaluate the nature and financial effects of the
business combination. SFAS 141(R) is effective for the fiscal year beginning
after December 15, 2008 with early adoption prohibited. The standard will
change the Companys’ accounting treatment for business combinations on a
prospective basis.
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 information available at no charge to
stockholders, please contact:
Jon Gerlach, Chief Financial Officer
IKONICS Corporation
4832 Grand Avenue, Duluth, MN 55807
Phone: (218) 628-2217
eMail: jgerlach@ikonics.com
Annual Meeting
The Company’s annual meeting will be held
April 24, 2008 at 1:00 p.m. at the Kitchi Gammi Club,
831 East Superior Street, Duluth, MN
8. CONCENTRATION OF CREDIT RISK
The Company maintains its cash balances primarily in two financial
institutions. As of December 31, 2007, the balances exceeded the Federal
Deposit Insurance Corporation coverage. The Company reduces its
exposure to credit risk by maintaining such balances with financial
institutions that have high credit ratings.
Accounts receivable are financial instruments that also expose
the Company to concentration of credit risk. The large number
of customers comprising the Company’s customer base and their
dispersion across different geographic areas limits such exposure.
In addition, the Company routinely assesses the financial strength
of its customers and maintains an allowance for doubtful accounts
that management believes will adequately provide for credit losses.
Concentration of credit risk with respect to trade receivables is not
significant. No one customer accounted for more than 10% of total
receivables as of December 31, 2007 and 2006.
9. LEASE EXPENSE
The Company leases buildings on a month-to-month basis and equipment as
needed. On February 1, 2007 the Company entered into a lease agreement
for additional warehouse space at a cost of $5,750 per month or $69,000
per year. The lease expires on February 1, 2009. Total rental expense for all
equipment and building operating leases was $72,000 in 2007 and $21,000
in 2006.
10. LINE OF CREDIT
The Company has a $1,250,000 bank line of credit that provides for working
capital financing. This line of credit is subject to annual renewal on each
May 1, is collateralized by trade receivables and inventory, and bears interest
at 2.00 percentage points over 30-day LIBOR. There were no outstanding
borrowings under this line of credit at December 31, 2007 and 2006.
11. EMERGING 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 attributes for the
financial statement recognition and measurement of a tax position taken
or expected to be taken in a tax return. FIN 48 also provides guidance on
derecognition, classification, interest and penalties, accounting in interim
periods, disclosure and transition. FIN 48 was effective for the Company as
of January 1, 2007. The impact of the adoption on the Financial Statements
as of January 1, 2007, was an increase in total liabilities of $137,000 and a
decrease in retained earnings of $137,000.
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. In February 2008, the FASB issued FASB
Staff Position FAS 157-2, “Effective Date of FASB Statement No. 157”
(the FSP). The FSP delayed, for one year, the effective date of FAS 157
for all nonfinancial assets and liabilities, except those that are recognized
or disclosed in the financial statements on at least an annual basis. This
statement is effective for the Company beginning January 1, 2008. The
deferred provisions of FAS 157 will be effective for the Company’s fiscal
year 2009. Because SFAS No. 157 does not require any new fair value
measurements or remeasurements of previously computed fair values,
I K O N I C S C o r p o r a t i o n Annual Report 2007
15
Board of Directors
Charles H. Andresen
Attorney
Andresen & Butterworth P.A.
Duluth, MN
Director Since 1979
Rondi Erickson
Co-Owner
Nokomis Restaurant
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
President
Omnetics Connector Corporation
Minneapolis, MN
Director Since 1978
Corporate Officers
William C. Ulland
Chairman, President & CEO
IKONICS Corporation
Duluth, MN
Director Since 1972
William C. Ulland
Chairman, President & CEO
Claude Piguet
Executive Vice President
Jon Gerlach
Vice President, Finance, CFO
Toshifumi Komatsu
Vice President, Technology
Parnell Thill
Vice President, Marketing
Robert D. Banks
Vice President, International
16
I K O N I C S C o r p o r a t i o n Annual Report 2007
Net Sales 2003 - 2007
Net Income 2003 - 2007
$16,000,000
$14,000,000
$12,000,000
$10,000,000
$8,000,000
$6,000,000
$4,000,000
$2,000,000
$1,200,000
$1,000,000
$800,000
$600,000
$400,000
$200,000
2003
2004
2005
2006
2007
2003
2004
2005
2006
2007
I K O N I C S F i v e - Y e a r H i s t o r y
2 0 0 3
2 0 0 4
2 0 0 5
2 0 0 6
2 0 0 7
Net Sales
Pretax Income
Net Income
$1 2, 10 5, 127
$1 3, 68 2, 449
$1 3, 97 1, 217
$1 4, 88 8, 912
$ 15 ,8 2 4, 7 25
$ 6 3 2, 4 1 6
$ 1 ,0 3 1 , 3 51
$ 1 ,2 5 6 , 1 69
$ 1 ,5 8 9 , 7 65
$1,635,775
$5 03, 4 16
$7 58, 3 51
$9 08, 1 69
$1 ,1 23 ,7 65
$ 1, 16 9 ,7 75
Net Cash Provided by Operations
$ 1 ,4 0 0 , 7 56
$ 1 ,2 6 1 , 8 55
$ 9 8 0, 0 4 7
$ 1 ,0 7 5 , 7 22
$1,697,695
Return on Sales
Return on Assets
Return on Avg. Stockholders' Equity
Debt to Equity
Diluted EPS
Stock price: High
Low
Close
4 . 2%
7 . 0%
8 . 2%
1 3 .0 %
$ 0 .2 7
$ 5 .5 6
$ 2 .0 3
$ 4 .2 0
5 . 5%
8 . 9%
1 1 .0 %
1 4 .5 %
$ 0 .3 8
$ 8 .3 0
$ 4 .4 8
$ 7 .3 5
6 . 5%
9 . 6%
1 1 .4 %
1 1 .7 %
$ 0 .4 6
$ 8 .9 9
$ 4 .2 0
$ 6 .3 5
7 . 5%
1 0 .5 %
1 2 .3 %
8 . 9%
$ 0 .5 5
$ 1 0 .4 7
$ 6 .2 6
$ 7 .5 3
7.4%
9.8%
11.2%
8.5%
$0.57
$10.45
$7.22
$9.28
Weighted Average Common Shares Outstanding - Diluted
1 , 89 5 , 1 0 6
1 , 98 2 , 8 1 4
1 , 98 6 , 8 8 5
2 , 02 7 , 9 1 6
2,063,380
Total Assets
Total Liabilities
Total Stockholders' Equity
Capital Spending
$ 7 ,1 9 4 , 6 84
$ 8 ,4 8 9 , 9 88
$ 9 ,4 7 0 , 7 99
$ 1 0 ,7 4 3 , 46 1
$11,982,417
$ 8 2 6, 3 3 4
$ 1 ,0 7 5 , 7 72
$ 9 9 2, 2 9 4
$ 8 7 9, 3 6 2
$936,703
$ 6 ,3 6 8 , 3 5 0
$ 7 ,4 1 4 , 2 1 6
$ 8 ,4 7 8 , 5 0 5
$ 9 ,8 6 4 , 0 9 9
$11,045,714
$ 2 4 4, 5 7 3
$ 2 7 0, 0 8 9
$ 2 1 1, 2 7 6
$ 2 7 3, 5 4 8
$609,772
Share & per share amounts have been adjusted for the 2004 three-for-two stock split. All share and per share information presented has been adjusted as if the stock split occurred on the earliest date presented
C O R P O R A T I O N
IKON ICS Cor porati on
4 8 3 2 G ran d Ave nu e, D ulut h, MN 55807
1 (8 00) 328- 426 1 ph : ( 2 18 ) 62 8 -22 1 7 fx : (218) 628 -324 5
w w w. ikon ics.c om i nfo@ ikon ic s. com
ISO 9 0 01 C ERTI FIE D NA SDAQ LIS TED: IK N X
Copyright ©2008 IKONICS Corporation. All rights reserved 0 8 0 3 0 1