IKONICS Corporation Annual Report 2009

FY2009 Annual Report · IKONICS Corporation

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Unique. Imaging. Solutions.

4832 Grand Avenue, Duluth, MN 55807 toll free (800) 328-4261 phone (218) 628-2217 fax (218) 628-3245 website www.ikonics.com email info@ikonics.com

ISO 9001 Certified NASDAQ listed: IKNX

IKONICS Five-Year HistoryNet SalesPretax Income (Loss) Net Income (Loss) Net Cash Provided by OperationsReturn on Sales7.5%Return on AssetsReturn on Avg. Stockholders' EquityDebt to Equity8.9%Diluted EPSStock price: High Low$6.26 Close$7.53Weighted Average Common Shares Outstanding - DilutedTotal AssetsTotal LiabilitiesTotal Stockholders' EquityCapital Spending2005$13,971,217$1,256,169 $908,169 $980,0476.5%9.6%11.4%11.7%$0.46 $8.99$4.20$6.351,986,885$9,470,799 $992,294 $8,478,505 $211,276 2006$14,888,912$1,589,765 $1,123,765 $1,075,72210.5%12.3%$0.55 $10.472,027,916$10,743,461 $879,362 $9,864,099 $273,548 2007$15,824,725$1,635,775 $1,169,775 $1,697,6957.4%9.8%11.2%8.5%$0.57 $10.45$7.22$9.282,063,380$11,982,417 $936,703 $11,045,714 $609,772 2008$15,854,484$1,085,134$814,134$1,125,6685.1%6.5%7.2%9.2%$0.40 $10.50$5.25$5.742,053,733$12,486,429 $1,052,789$11,433,640 $4,472,6812009$15,121,617 $(11,360) $(307,360)$1,374,114(2.0%)(2.6%)(2.7%)8.8%$(0.16) $8.29$4.00$6.301,973,739$11,997,272 $971,186$11,026,086 $90,313$2,000,000$0$4,000,000$6,000,000$8,000,000$10,000,000$12,000,000$14,000,000$16,000,00020092008200720062005$200,000- $200,000$0$400,000- $400,000$600,000$800,000$1,000,000$1,200,00020092008200720062005Net Sales 2005 - 2009Net Income (Loss) 2005 - 20092009 Annual ReportNASDAQ Listed: IKNX WILLIAM C. ULLAND
Chairman, President & CEO

IKONICS West expansion, erected in
2008, became fully operational in 2009

Contents

Letter to Shareholders ............................................................................ 1

Management’s Discussion and Analysis of

Financial Condition and Results of Operations ........................................ 2

Critical Accounting Estimates .................................................................. 2

Results of Operations ............................................................................. 3

Market for Common Equity,

Related Stockholder Matters and

Issuer Purchases of Equity Securities ...................................................... 5

Management’s Report ............................................................................. 5

Management’s Annual Report on

Internal Control Over Financial Reporting ................................................ 6

Report of Independent

Registered Public Accounting Firm ......................................................... 6

Balance Sheets .................................................................................. 7

Statements of Operations ................................................................... 8

Statements of Stockholders’ Equity and Comprehensive Income ....... 8

Statements of Cash Flows .................................................................. 9

Notes to Financial Statements .......................................................... 10

Board of Directors/Corporate Officers ................................................... 16

IKONICS Five-Year History ........................................................ Back Cover

Corporate Profile

2009 Net Sales ................................................................ $15,121,617

Loss per common share (diluted) ............................................... $0.16

Company founded ..................................................................... 1952

Employees .....................................................................................71

NASDAQ Symbol ....................................................................... IKNX

Letter to Shareholders

2009 was a turbulent year for IKONICS. The recession negatively impacted our sales, particularly in the awards and recognition
market. The write off of our investment in Imaging Technology International (iTi) resulted in our first loss in 8 years, yet we generated
$1.4 million in cash from operations during the year and finished 2009 with a cash and short term investment balance of $2.1 million.
We continue to have no long term debt and in late 2008 completed a $4.4 million facility expansion funded totally from cash.

Sales for 2009 were $15,122,000, a 4.6% decrease from 2008. Income from operations declined by 10.4% for the year to $870,000.
Reported income for the year, after the $919,000 write off of our investment in iTi, was a loss of $307,000, or $0.16 per share,
compared to a profit of $814,000, or $0.40 per share, for 2008.

Our new businesses are contributing to growth. A Digital Texturing printer was placed at a beta site in the fourth quarter of 2009.
It is successfully operating, and we are receiving orders for fluid and substrate consumables. We have found two alternate printer
manufacturers to replace iTi, and we do not anticipate a significant disruption to this business due to an inability to obtain printers.
However, the condition of the automotive industry, the primary market for digital texturing, remains a concern.

Our abrasive machining technology of advanced materials is growing, and we continue to discover new opportunities and markets.
We expect growth in this market in 2010.

During the year, we initiated a joint research program with a major company to develop a unique protective film for one of their
products. This project is ahead of schedule and significant sales may occur in the second half of this year.

Sales of our Chromaline Screen Print Products to the domestic market ran ahead of last year in spite of a difficult market, and we
expect that trend to continue, driven by new products and an increased sales effort. Our Export business was particularly hurt by
the recession causing weak sales to Europe. We are optimistic that a recovery in Europe and continued growth in Asia will put those
sales back on the growth track.

Sales to the awards and recognition market may have bottomed out in the summer, but a robust recovery is not foreseen. We
continue to control costs and the segment is profitable for us.

I am confident that we are emerging from this difficult period stronger, smarter and with a brighter future.

For the Board of Directors,

WIllIAm C. UllAND
Chairman, President & CEO

march 23, 2010

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-K and most recent Form 10-Q on file with the SEC.

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

The following management discussion and analysis focuses on those factors that had a material effect on the Company’s financial results of operations and
financial condition during 2009 and 2008 and should be read in connection with the Company’s audited financial statements and notes thereto for the years
ended December 31, 2009 and 2008, included herein.

Factors that May Affect Future Results

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 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.

Critical Accounting Estimates

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, including development and sales of
new products and the formation of alliances with third parties, and the
effect those activities may have on the Company’s financial results—
Actual activities undertaken and the results those activities have on the
Company’s financial results may be impacted by general market conditions,
competitive conditions in the Company’s industry, unanticipated changes
in the Company’s financial position, delays in new product introductions,
lack of acceptance of new products or the inability to identify or negotiate
acceptable terms with attractive acquisition targets or alliance partners or
otherwise identify attractive business opportunities.

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

Accounts Receivable

Income Taxes

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

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 from cost when required.

At December 31, 2009, the Company had net current deferred tax assets
of $163,000 and net noncurrent deferred tax liabilities of $162,000. The
deferred tax assets and liabilities result primarily from temporary differences
in property and equipment, accrued expenses, and inventory reserves. In
connection with the recording of an impairment charge during 2009 as
described below, the Company has recorded a deferred tax asset and
corresponding full valuation allowance in the amount of $331,000 as it is
more likely that this asset will not be realized. The deferred tax asset related
to the capital loss can be carried back three years and carried forward five
years and must be offset by a capital gain. The Company has determined
that is more likely than not that the remaining deferred tax assets will be
realized and that an additional valuation allowance for such assets in not
currently required. The Company accounts for its uncertain tax positions
under the provision of FASB ASC 740, Income Taxes, and the related liability
of $27,000 as of December 31, 2009 will be adjusted as the statute of
limitations expires or these positions are reassessed.

Investments in Non-Marketable Equity Securities

The carrying value of financial instruments, such as cash, short-term
investments, accounts receivable, accounts payable and accrued liabilities
approximate their fair value because of their short term nature. The Company
does not hold or issue financial instruments for trading purposes.

IKONICS Corporation Annual Report 2009

The Company’s investment in non-marketable securities was comprised
of shares in iTi and previously carried at cost. In the third quarter of 2009,
the Company recorded an impairment charge of $918,951, reducing the
investment in iTi to $0, because iTi was unable to fund operations, acquire
financing or negotiate the sale of the Company. iTi has since ceased
operations and is currently in the process of liquidating its assets.

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

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 depending on the agreement with the customer. The
Company sells its products to both distributors and end-users. Sales to
distributors and end-users are recorded based upon the criteria governed
by the sales, delivery, and payment terms stated on the invoices from the
Company to the purchaser. In addition to transfer of title / risk of loss, all
revenue is recorded in accordance with the criteria outlined within SAB 104
and FASB ASC 605 Revenue Recognition:

A) Persuasive evidence of an arrangement (principally in the form of
customer sales orders and the Company’s sales invoices).

B) Delivery and performance (evidenced by proof of delivery, e.g. the

C) A fixed and determinable sales price (the Company’s pricing is

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

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

Sales are reported on a net basis by deducting credits, estimated normal
returns and discounts. The Company’s return policy does not vary by
geography. The Company is not under a warranty obligation and the
customer has no rotation or price protection rights. Freight billed to
customers is included in sales. Shipping costs are included in cost of
goods sold.

Results of Operations

Year Ended December 31, 2009 Compared to Year Ended December 31, 2008

Sales

Gain on Sale of Non-Marketable Equity Securities

The Company’s net sales decreased 4.6% in 2009 to $15.1 million compared
to net sales of $15.9 million in 2008. IKONICS Imaging realized a 14.1%
sales decrease over 2008 as sales to the awards and recognition markets
continued to be negatively impacted by the slow economy. Export sales
were also down 7.0% in 2009 as the weaker global economy slowed
shipments to Europe. Partially offsetting these sales shortfalls, Domestic
sales increased 3.4% in 2009 due to increased private label film shipments.

The Company realized a gain of $29,800 during 2009 on the sale of its
investment in the common and preferred stock of Apprise Technologies, Inc.
The original sale took place during 2007. The final $29,800 received in 2009
related to a portion of the original sales price that was placed in escrow at
the time of the sale for indemnification obligations as part of the agreement
between Apprise and its purchaser. In 2008, the Company also realized a
gain of $25,000 for proceeds received from the Apprise sale.

Gross Profit

Gross profit was $6.1 million, or 40.1% of sales, in 2009 and $6.6 million,
or 41.8% of sales, in 2008. IKONICS Imaging gross profit percentage
decreased from 48.2% in 2008 to 44.3% in 2009. The IKONICS
Imaging gross profit percentage was unfavorably impacted by additional
manufacturing expenses related to startup and development of new
business initiatives discussed below in “Future Outlook” as well as higher
raw material costs and lower volumes. Export’s gross profit percentage
in 2009 was 26.5% compared to 31.7% in 2008. Export’s gross profit was
unfavorably affected by higher raw material prices and an unfavorable sales
mix. Domestic’s gross profit percentage benefited from a more favorable
sales mix as it improved from 45.3% in 2008 to 47.1% in 2009.

Selling, General and Administrative Expenses

Selling, general and administrative expenses decreased to $4.5 million, or
30.0% of sales, in 2009 from $4.9 million or 30.8% of sales in 2008. The
lower expenses level in 2009 reflects lower salaries, travel, advertising and
trade show expenses.

Research and Development Expenses

Research and development expenses in 2009 were $654,000, or 4.3%
of sales, versus $767,000, or 4.8% of sales in 2008. Research and
development costs in 2008 reflected a $69,000 expense related to
the abandonment of patent applications. During 2009, the Company
abandoned $12,700 of costs related to patent applications. The Company
records patent application costs as an asset and amortizes those costs upon
successful completion of the application process or expenses those costs
when an application is abandoned. Research and development expenses in
2009 were also favorably impacted by lower personnel expenses.

Loss on Investment in Non-Marketable Equity Securities

The Company’s investment in non-marketable securities was comprised
of shares in iTi, which historically had been carried at cost. An impairment
analysis was conducted in accordance with applicable accounting standards
in the third quarter of 2009, and the Company recorded an impairment
charge of $919,000, which represents a full write-off of the Company’s
investment in iTi to $0. During 2008, the Company’s assessment
determined there were no indicators of impairment and accordingly no
impairment was recorded. In making this assessment, the Company utilized
iTi’s financial statements, forecasted sales and cash flows, backlog and
other relevant information regarding iTi’s operations.

Interest Income

The Company earned $8,000 of interest income in 2009 compared to
$90,000 in 2008. The interest income decrease from the prior year is due to
lower investment balances in 2009 resulting from the Company’s use of cash
to finance construction of its new facility and the repurchase of a portion
of the Company’s stock. A large portion of the interest earned is related
to interest received from the Company’s short-term investments, which
consisted of $802,000 of fully insured certificates of deposit with maturities
ranging from two to twelve months as of the end of 2009. The Company’s
cash is also maintained in an insured checking account that does not
provide for interest. Instead, the account earns credits which offset banking
fees.

Income Taxes

During 2009, the Company realized income tax expense of $296,000,
compared to income tax expense of $271,000 for the same period in 2008.
The Company does not receive a tax benefit from the $919,000 loss on
investment in non-marketable equity securities since the Company has
recorded a full valuation allowance against the deferred tax asset resulting
from the loss on the capital asset impairment charge, as it is currently
more likely that the deferred tax asset will not be realized. The deferred

tax asset related to the capital loss can be carried back three years and
carried forward five years and must be offset by a capital gain. Income
tax expense in 2009 was also impacted by derecognizing a liability of
$21,000 for unrecognized tax benefits relating to a tax year where the
statute of limitations expired during the first quarter and the benefits of the
domestic manufacturing deduction, research and development tax credits,
and state income taxes. The 2008 income tax expense was impacted by
derecognizing a liability of $44,000 for unrecognized tax benefits relating to
a tax year where the statute of limitations expired during the first quarter, and
the benefits of the domestic manufacturing deduction, tax exempt interest
from auction rate securities the Company sold in 2008, and state income
taxes. The effective tax rate for 2008 was also impacted by a $55,000 state
refund related to research and development credits for the tax years of 2005,
2006, and 2007 which was recognized in 2008.

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 was $1,305,000 and $902,000 at December 31, 2009 and 2008,
respectively. In addition to its cash, the Company also held $802,000 of
short term investments as of December 31, 2009. The Company generated
$1,374,000 in cash from operating activities during 2009, compared to
generating $1,126,000 of cash from operating activities in 2008. Cash
provided by operating activities is primarily the result of the net loss adjusted
for non-cash loss and gain on investments, non cash depreciation and
amortization, deferred taxes, and certain changes in working capital
components discussed in the following paragraph.

During 2009, trade receivables decreased by $61,000. The decrease in
receivables was driven by lower sales volumes. 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 $39,000
due to lower raw material levels. Prepaid expenses and other assets
decreased $131,000 as a result of the Company prepaying for inventory at
the end of 2008 which was received in 2009. Income tax refund receivable
decreased $186,000 due to the Company receiving its 2008 income tax
refund and income tax payable increased $81,000. Accounts payable
decreased $178,000 due to of the timing of payments to and purchases
from vendors and payments made to contractors associated with the new
building. Accrued liabilities decreased $3,000.

During 2009, investing activities used $847,000. The Company invested
$1,002,000 in fully insured certificates on deposits with one $200,000
certificate of deposit maturing during 2009. Purchases of property and
equipment were $90,000, mainly for new equipment to support the
Company’s new business initiatives and research activities. Also during
2009, the Company incurred $10,000 in patent application costs that the
Company records as an asset and amortizes upon successful completion
of the application process or expenses if the application is abandoned.
The Company received proceeds of approximately $30,000 in 2009 on the
2007 sale of its investment in the common and preferred stock of Apprise
Technologies, Inc. and $26,000 for the sale of equipment and vehicles.

In 2008, investing activities used $1,004,000 in cash as the Company
completed construction on its new facility at a total cost of $4.4 million,
of which $120,000 was included in construction accounts payable as of
December 31, 2008 and had no effect on cash flows. Partially offsetting the
cash used for the new facility, the Company sold $3,550,000 of short-term
investments comprised of Auction Rate Securities (ARS). At December 31,
2008, the Company had no investment in ARS. The Company also made
the final $95,000 payment upon the delivery of its industrial digital inkjet
machine in 2008. The Company incurred $50,000 in patent application
costs during 2008 that the Company recorded as an asset and will amortize
upon successful completion of the application process or expense if the
applications are abandoned. The Company expensed $69,000 during 2008
due to abandonment of certain patent applications. The Company received
proceeds of $25,000 in 2008 on the sale of its investment in the common
and preferred stock of Apprise Technologies, Inc., and $8,500 from the sale
of a vehicle. During the fourth quarter of 2008, 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 used $124,000 in financing activities during 2009 to
repurchase 26,926 shares of its own stock. During 2008, the Company
purchased 87,857 shares of its own stock at a cost of $596,000. The
Company received $107,000 for the issuance of 35,872 shares of common
stock upon the exercise of stock options during 2008. None of the
Company’s stock options were exercised during 2009. Financing activities
in 2008 also reflect excess tax benefits of $39,000 related to the exercise of
stock options.

A bank line of credit provides for borrowings of up to $1,250,000. The line of
credit term runs from October 31, 2009 to October 30, 2010. The Company
expects to obtain a similar line of credit when the current line of credit
expires. Borrowings under this line of credit are collateralized by accounts
receivable and inventories and bear interest at 2.5 percentage points over
the 30 day lIBOR rate. The Company did not utilize this line of credit during
2009 or 2008 and there were no borrowings outstanding as of December 31,
2009 and 2008.

The Company believes that current financial resources, its line of credit,
cash generated from operations and the Company’s capacity for debt and/
or equity financing will be sufficient to fund current and anticipated business
operations. The Company also believes that its low debt levels and available
line of credit make it unlikely that a decrease in demand for the Company’s
products would impair the Company’s ability to fund operations.

Capital Expenditures

In 2009, the Company made $90,000 in capital expenditures, mainly for
equipment to support the Company’s new business initiatives and research
activities.

In 2008, the Company had $4.6 million in capital expenditures, of which
$120,000 was included in construction accounts payable. This spending
primarily consists of land acquisition and construction costs related to the
construction of a new warehouse and manufacturing facility necessary to
accommodate the Company’s new business initiatives and growth plans.
The expansion project was completed and put into operation in 2008. The
Company will continue to operate and maintain its historic facility along with
the new facility.

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. The Company expects capital expenditures in 2010 of
approximately $200,000.

International Activity

The Company markets its products in numerous countries in all regions of
the world, including North America, Europe, latin America, and Asia. The
Company’s 2009 foreign sales of $4,629,000 were approximately 30.6%
of total sales, compared to the 2008 foreign sales of $4,975,000, which
were 31.4% of total sales. The decrease in foreign sales in 2009 was mainly
due to weaker European sales resulting from a soft global economy. The
Company anticipates that its sales will increase in India and latin America as
the Company exploits opportunities in those markets. 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, 2009. Furthermore, the impact of
foreign exchange on the Company’s balance sheet and operating results
was not material in either 2009 or 2008.

Future Outlook

IKONICS has spent on average over 4% of its sales dollars for the past few

IKONICS Corporation Annual Report 2009

years in research and development and 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 commercialize new product
opportunities.

In 2009, the Company made substantial progress on its new business
initiatives. Photomachining and sound deadening were in commercial
operation supplying product to major electronics, defense and aerospace
customers. A DTX printer was placed at a beta site in the fourth quarter of
2009; it is performing to expectations and beginning to generate sales of
related consumables. The DTX program was negatively impacted by the
business failure of our printer supplier, iTi. However, the Company has made
arrangements with a manufacturer that the Company believes is financially
strong and technically adept for future machines. In 2009, the Company
produced and sold custom substrates for various inkjet applications and is
currently developing, under a research contract, a proprietary film product
for a major customer. The Company anticipates that all of these efforts will
enhance sales and profits in 2010.

In 2009, the Company’s traditional domestic screen print stencil business
grew and we expect that to continue in 2010. Sales to the awards and
recognition market of our sandblast resist films were weak in 2009, reflecting
the depressed condition of that market. This sales decline may be bottoming
out, but a strong recovery is not anticipated in 2010.

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 improvements, 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.

Recent Accounting Pronouncements

Please see Note 10 to the Company’s audited financial statements included
in this report for information about new accounting pronouncements
affecting the Company.

Market for Common Equity, Related Stockholder Matters & 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 sales prices for the Company’s Common Stock
as reported on the Nasdaq Capital market for the periods indicated.

Fiscal Year Ended December 31, 2009

High

Low

In prior years, the Company’s board of directors had authorized the repurchase
of 150,000 shares of common stock. In August 2008, the Company’s Board of
Directors approved the repurchase of an additional 100,000 shares of common
stock bringing the total shares eligible for repurchase to 250,000. A total of
214,769 shares have been repurchased under this program including 26,926
shares repurchased during 2009. The plan allows for an additional 35,231
shares to be repurchased.

First Quarter

Second Quarter

Third Quarter

Fourth Quarter

$ 5.80

$ 4.00

6.87

7.98

8.29

4.35

5.50

6.30

Fiscal Year Ended December 31, 2008

High

Low

First Quarter

Second Quarter

Third Quarter

Fourth Quarter

$ 10.50

$ 9.03

9.60

8.68

6.97

7.08

6.46

5.25

As of February 23, 2010, the Company had approximately 630 shareholders.
The Company has never declared or paid any dividends on its Common
Stock.

Management’s Report

For Year Ended
Dec. 31, 2009

Total Number
of Shares
Purchased

Average
Price Paid
per Share

Jan. 1 – Jan. 31

Feb. 1 - Feb. 28

mar. 1 – mar. 31

may 1 – may 31

6,226

10,101

10,599

26,926

$4.29

4.21

5.15

$4.60

Total Number of
Shares Purchased
as Part of Publicly
Announced Plans
or Programs

Maximum Number
of Shares that May
Yet be Purchased
Under The Plans
or Programs

6,226

10,101

10,599

26,926

55,931

45,830

35,231

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 registered 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

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-15(f)
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, 2009. 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, 2009, the Company maintained effective internal
control over financial reporting.

This annual report does not include an attestation report of the Company’s independent registered public accounting firm regarding internal control over
financial reporting. Our management’s report of the effectiveness on the design and operation of our internal control over financial reporting was not subject
to attestation by the Company’s independent 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

Report of Independent Registered Public Accounting Firm

To the Board of Directors and Stockholders
IKONICS Corporation

We have audited the accompanying balance sheets of IKONICS Corporation as of December 31, 2009 and 2008, and the related statements of operations,
stockholders’ equity and comprehensive income and cash flows for each of the two years in the period ended December 31, 2009. 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,
2009 and 2008, and the results of its operations and its cash flows for the two years in the period ended December 31, 2009 in conformity with U.S. generally
accepted accounting principles.

We were not engaged to examine management’s assessment of the effectiveness of IKONICS Corporation’s internal control over financial reporting as of
December 31, 2009 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.

/s/ McGladrey & Pullen, LLP
Duluth, Minnesota
March 2, 2010

IKONICS Corporation Annual Report 2009

Assets
CURRENT ASSETS:

Balance Sheets: December 31, 2009 & 2008

2009

2008

Cash (Note 7) .............................................................................................................................................

$ 1,304,586

$ 901,738

Short-Term Investments .............................................................................................................................

Trade receivables, less allowance of $78,000 in 2009 and $56,000 in 2008 (Notes 5, 7, and 9) ...................

Inventories (Notes 1 and 9) .........................................................................................................................

Deposits, prepaid expenses and other assets ............................................................................................

Income tax refund receivable ......................................................................................................................

802,165

2,015,798

2,070,602

61,337

Deferred income taxes (Note 2)..................................................................................................................

163,000

2,077,158

2,109,164

192,201

185,869

96,000

Total current assets....................................................................................................................................

6,417,488

5,562,130

PROPERTy, PlANT, AND EQUIPmENT, AT COST:

land and building ......................................................................................................................................

machinery and equipment ..........................................................................................................................

Office equipment ........................................................................................................................................

Vehicles .....................................................................................................................................................

less accumulated depreciation ..................................................................................................................

INTANGIBlE ASSETS, less accumulated amortization of $325,576 in 2009 and $270,325 in 2008 (Note 3)......

5,883,794

2,456,218

741,895

241,006

9,322,913

4,088,669

5,234,244

345,540

INVESTmENTS IN NON-mARKETABlE EQUITy SECURITIES (Note 1) ..............................................................

5,928,275

2,430,857

763,595

241,905

9,364,632

3,762,569

5,602,063

403,285

918,951

Liabilities & Stockholders’ Equity
CURRENT lIABIlITIES:

Accounts payable

$11,997,272

$12,486,429

2009

2008

Trade ....................................................................................................................................................

$ 286,610

$ 344,783

Construction .........................................................................................................................................

Accrued compensation .............................................................................................................................

Other accrued expenses (Note 2) ..............................................................................................................

Income taxes payable ...............................................................................................................................

Total current liabilities ................................................................................................................................

DEFERRED INCOmE TAXES (Note 2) ...............................................................................................................

Total liabilities ............................................................................................................................................

337,365

104,408

80,803

809,168

162,000

971,186

120,000

335,126

109,880

909,789

143,000

1,052,789

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 1,967,057 shares in 2009 and 1,993,983 shares in 2008 (Note 6)...........

Additional paid-in capital ...........................................................................................................................

Retained earnings ....................................................................................................................................

196,706

2,198,289

8,631,091

199,398

2,202,888

9,031,354

Total stockholders’ equity ..........................................................................................................................

11,026,086

11,433,640

$ 11,997,272

$ 12,486,429

See notes to financial statements.

Statements of Operations: Years Ended December 31, 2009 & 2008

2009

2008

NET SAlES ..................................................................................................................................................

$ 15,121,617

$ 15,854,484

COST OF GOODS SOlD ..............................................................................................................................

9,054,771

9,228,187

GROSS PROFIT ............................................................................................................................................

6,066,846

6,626,297

SEllING GENERAl AND ADmINISTRATIVE EXPENSES ...............................................................................

4,543,448

4,888,842

RESEARCH AND DEVElOPmENT COSTS ....................................................................................................

653,747

767,083

INCOmE FROm OPERATIONS ......................................................................................................................

GAIN ON SAlE OF NON-mARKETABlE EQUITy SECURITIES ......................................................................

lOSS ON INVESTmENT IN NON-mARKETABlE EQUITy SECURITIES

5,197,195

5,655,925

869,651

29,762

(918,951)

970,372

24,550

INTEREST INCOmE ......................................................................................................................................

8,178

90,212

INCOmE (lOSS) BEFORE INCOmE TAXES ...................................................................................................

(11,360)

1,085,134

FEDERAl AND STATE INCOmE TAXES (NOTE 2) ..........................................................................................

296,000

271,000

NET INCOmE (lOSS) ....................................................................................................................................

$ (307,360)

$ 814,134

EARNINGS (lOSS) PER COmmON SHARE:

Basic ......................................................................................................................................................

$ (0.16)

$ 0.40

Diluted ....................................................................................................................................................

$ (0.16)

$ 0.40

WEIGHTED AVERAGE COmmON SHARES:

Basic ......................................................................................................................................................

1,973,739

2,050,462

Diluted ....................................................................................................................................................

1,973,739

2,053,733

SEE noTES To FinAnCiAl STATEmEnTS.

Statements of Stockholders’ Equity & Comprehensive Income: Years Ended December 31, 2009 & 2008

BAlANCE AT DECEmBER 31, 2007

Net income and comprehensive income

Exercise of stock options

Tax benefit resulting from stock option exercises

Common Stock

Shares Amount

Additional
Paid-in
Capital

Retained

Total Stockholders’

Earnings

Equity

2,045,961

$ 204,596

$ 2,124,342

$ 8,716,776

$ 11,045,714

—

35,872

(87,850)

—

3,587

(8,785)

—

814,134

—

814,134

106,712

(499,556)

(596,477)

—

4,389

—

59,168

103,125

(88,136)

4,389

59,168

Stock based compensation and related tax benefit

—

BAlANCE AT DECEmBER 31, 2008

Net loss and comprehensive income

Common stock repurchased

1,993,983

$ 199,398

$ 2,202,888

$ 9,031,354

$ 11,433,640

—

(26,926)

(2,692)

(28,249)

(307,360)

(92,903)

(307,360)

(123,844)

Stock based compensation and related tax benefit

—

23,650

—

23,650

BAlANCE AT DECEmBER 31, 2009

1,967,057

$ 196,706

$ 2,198,289

$ 8,631,091

$ 11,026,086

SEE noTES To FinAnCiAl STATEmEnTS.

IKONICS Corporation Annual Report 2009

Statements of Cash Flows: Years Ended December 31, 2009 & 2008

2009

2008

CASH FlOWS FROm OPERATING ACTIVITIES:

Net income (loss) ......................................................................................................................................

$ (307,360) $ 814,134

Adjustments to reconcile net income (loss) to net cash provided by operating activities:

Depreciation..........................................................................................................................................

424,573

304,434

Amortization ..........................................................................................................................................

55,251

Excess tax benefit from share-based payment arrangement ..................................................................

Stock based compensation ...................................................................................................................

loss (gain) on sale of equipment and vehicles .......................................................................................

loss on intangible asset abandonment ..................................................................................................

—

23,650

8,059

12,700

57,264

(39,319)

19,849

(1,725)

69,462

Gain on sale of non-marketable equity securities ...................................................................................

(29,762)

(24,550)

loss on investment in non-marketable equity securities .........................................................................

918,951

—

Deferred income taxes ..........................................................................................................................

(48,000)

82,000

CHANGES IN WORKING CAPITAl COmPONENTS:

Trade receivables ..................................................................................................................................

Inventories ............................................................................................................................................

Prepaid expenses and other assets .......................................................................................................

Income tax refund receivable .................................................................................................................

61,360

38,562

130,864

185,869

Accounts payable .................................................................................................................................

(178,173)

Accrued liabilities ..................................................................................................................................

Income taxes payable ...........................................................................................................................

(3,233)

80,803

(51,901)

246,700

(61,605)

(185,869)

(90,789)

(50,834)

38,417

Net cash provided by operating activities .......................................................................................

1,374,114

1,125,668

CASH FlOWS FROm INVESTING ACTIVITIES:

Purchases of property and equipment..........................................................................................................................

(90,313)

(4,472,681)

Proceeds from sale of equipment and vehicles...........................................................................................................

25,500

8,500

Purchase of intangibles....................................................................................................................................................

(10,206)

(50,123)

Purchase of short-term investments..............................................................................................................................

(1,002,165)

—

Proceeds from sale of short-term investments............................................................................................................

200,000

3,550,000

Purchase of non-marketable equity securities............................................................................................................

—

Proceeds from sale of non-marketable equity securities..........................................................................................

29,762

(63,750)

24,550

Net cash used in investing activities .....................................................................................................

(847,422)

(1,003,504)

CASH FlOWS FROm FINANCING ACTIVITIES:

Excess tax benefit from share-based payment arrangement..............................................................................

—

39,319

Repurchase of common stock ..................................................................................................................

(123,844)

(596,477)

Proceeds from exercise of stock options ...................................................................................................

—

106,712

Net cash (used in) provided by financing activities ..........................................................................

(123,844)

(450,446)

NET INCREASE (DECREASE) IN CASH ......................................................................................................................

402,848

(328,282)

CASH AT BEGINNING OF yEAR ................................................................................................................................

901,738

1,230,020

CASH AT END OF yEAR ............................................................................................................................................

$ 1,304,586

$ 901,738

SUPPlEmENTAl SCHEDUlE OF NONCASH INVESTING AND FINANCING ACTIVITIES:

Construction payables incurred for building expansion ...............................................................................

$ — $ 120,000

SUPPlEmENTAl DISClOSURE OF CASH FlOW INFORmATION:

Cash paid for income taxes .......................................................................................................................

$ 96,380

$ 377,348

See notes to financial statements.

Notes to Financial Statements: Years Ended December 31, 2009 & 2008

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
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 30.6% of net sales in 2009 and 31.4%
of net sales in 2008. The Company’s accounts receivable at December
31, 2009 and 2008 due from foreign customers were 36.7% and 42.1%,
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 2009 or in 2008.

The Company considers events or transactions that occur after the balance
sheet date but before the financial statements are issued to provide
additional evidence relative to certain estimates or to identify matters that
require additional disclosure. Subsequent events have been evaluated
through march 2, 2010, the date the financial statements were issued.

A summary of the Company’s significant accounting policies follows:

Short-Term Investments – Short-term investments consist of $802,165 of
fully insured certificates of deposit with maturities ranging from two to twelve
months as of the end of 2009. The company held no short-term investments
at December 31, 2008.

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.

A small percentage of the accounts receivable balance is denominated in
a foreign currency with no concentration in any given country. At the end
of each reporting period, the Company analyzes the receivable balance
for customers paying in a foreign currency. These balances are adjusted
to each quarter or year spot rate in accordance with FASB ASC 830,
Foreign Currency matters. 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 2009 and 2008.

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 $893,000 and $856,000
higher than reported at December 31, 2009 and 2008, respectively. During
2009 and 2008, certain inventory quantities were reduced, which resulted
in liquidations of lIFO inventory layers. The liquidations decreased cost of
goods sold by approximately $59,000 in 2009 and $45,000 in 2008. The
major components of inventories are as follows:

Raw materials

Work-in-progress

Finished goods

2009

2008

1,333,549

$ 1,447,063

277,876

324,361

1,351,736

1,194,148

Reduction to lIFO cost

(892,559)

(856,408)

Total inventories

$ 2,070,602

$ 2,109,164

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
the undiscounted cash flows are less than the carrying value, 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.

Years

Patents ............................................ 10.0

licenses ................................................ 6.0

Non-compete agreements.................. 4.5

Investments in non-marketable equity securities at December 31, 2008
consisted of a $919,000 investment in imaging Technology international
(“iTi”) and was previously carried at cost. In the third quarter of 2009,
the Company recorded an impairment charge of $919,000, reducing the
investment in iTi to $0, because iTi was unable to fund operations, acquire
financing or negotiate the sale of the Company. iTi has since ceased
operations and is currently in the process of liquidating its assets.

The Company realized a gain of $29,800 during 2009 on the sale of its
investment in the common and preferred stock of Apprise Technologies,
Inc. The original sale took place during 2007. The final $29,800 received in
2009 was related to a portion of the original sales price that was placed in
escrow at the time of the sale for indemnification obligations as part of the
agreement between Apprise and its purchaser. In 2008, the Company also
realized a gain of $25,000 for proceeds received from the Apprise sale.

Fair Value of Financial Instruments – The carrying amounts of financial
instruments, including cash, short-term investments, accounts receivable,
accounts payable, and accrued liabilities approximate fair value due to the
short maturity of these instruments.

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 depending on the agreement
with the customer. The Company sells its products to both distributors and
end-users. Sales to distributors and end-users are recorded based upon
the criteria governed by the sales, delivery, and payment terms stated on
the invoices from the Company to the purchaser. In addition to transfer of
title /risk of loss, all revenue is recorded in accordance with the criteria
outlined within SAB 104 and FASB ASC 605 Revenue Recognition:

A) Persuasive evidence of an arrangement (principally in the form of

customer sales orders and the Company’s sales invoices, as generally
there is no other formal agreement underlying the sale transactions)

B) Delivery and performance (evidenced by proof of delivery, e.g. the
shipment of film and substrates with bill of lading used for proof
of delivery for FOB shipping point terms, and the carrier booking
confirmation report used for FOB destination terms). Once the finished

IKONICS Corporation Annual Report 2009

product is shipped and physically delivered under the terms of the
invoice and sales order, the Company has no additional performance or
service obligations to complete

2. Income Taxes

Income tax expense for the years ended December 31, 2009 and 2008
consists of the following:

C) A fixed and determinable sales price (the Company’s pricing is

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

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.

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

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

2009

2008

2009

2008

Current

Federal ........................................................

$325,000

$211,000

State ...........................................................

19,000

(22,000)

Deferred ..........................................................

(48,000)

344,000

189,000

82,000

$296,000

$271,000

The expected provision (benefit) for income taxes, computed by applying
the U.S. federal income tax rate of 35% in 2009 and 2008 to income before
taxes, is reconciled to income tax expense as follows:

2009

2008

Expected provision (benefit) for federal
income taxes ........................................................................

$(5,000)

$379,800

State income taxes, net of federal benefit ..................

15,300

20,800

Reversal of uncertain tax positions ............................

(21,000)

(44,000)

Domestic manufacturers deduction...........................

(12,800)

(18,200)

Non-deductible meals, entertainment,
and life insurance ........................................................

Valuation allowance for capital loss on investment
in non-marketable equity securities ..........................

16,300

18,400

331,000

—

Tax-exempt interest ....................................................

—

(10,500)

R&D Credit ..................................................................

(14,800)

(85,800)

Other ...........................................................................

(13,000)

10,500

$296,000

$271,000

Net deferred tax assets (liabilities) consist of the following as of December 31,
2009 and 2008:

Weighted average common shares
outstanding ....................................................

1,973,739

2,050,462

Accrued vacation .......................................................

$ 23,000

2009

2008

Dilutive effect of stock options ........................

—

3,271

Inventories ..................................................................

114,000

Weighted average common and common
equivalent shares outstanding ........................

1,973,739

2,053,733

If the Company was in a net income position in 2009, 28,000 options with a
weighted average exercise price of $4.83 would have been included as part
of the weighted average common as the options would have been dilutive.
In 2008, options to purchase 7,250 shares of common stock with a weighted
average exercise price of $8.22 were outstanding, but were excluded from
the computation of common share equivalents because they were anti-
dilutive.

Employee Stock Plan - The Company accounts for employee stock options
under the provision of ASC 718 Compensation – Stock Compensation.

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. Significant estimates
include the allowance for doubtful accounts receivable, and the reserve for
inventory obsolescence.

Allowance for doubtful accounts ...............................

Allowance for sales returns ........................................

18,000

11,000

Capital loss carryforward ..........................................

331,000

61,000

11,000

9,000

6,000

less valuation allowance ...........................................

(331,000)

—

$166,000

110,000

Deferred tax liabilities:

Property and equipment and other assets ..........

(160,000)

(143,000)

Intangible assets .....................................................

Prepaid expenses....................................................

(3,000)

(2,000)

(6,000)

(8,000)

Net deferred tax assets (liabilities) ............................

$ 1,000

$ (47,000)

The deferred tax amounts described above have been included in the accompanying
balance sheet as of December 31, 2009 and 2008 as follows:

2009

2008

Current assets ..........................................

$ 163,000

$ 96,000

Noncurrent assets (liabilities) .....................

(162,000)

(143,000)

$ 1,000)

$ (47,000)

At December 31, 2009, the Company established a valuation allowance
against its deferred tax asset related to the Company’s $919,000 loss on its
investment in non-marketable equity securities since it is more likely that the
deferred tax asset will not be realized. The deferred tax asset related to the
capital loss can be carried back three years and carried forward five years
and must be offset by a capital gain.

The Company accounts for its uncertain tax positions under the provisions
of FASB ASC 740, Income Taxes. During 2009 and 2008, the statute of
limitations for the relevant taxing authority to examine and challenge the
tax position for open years expired, resulting in decreases in income tax
expense of $21,000 in 2009 and $44,000 in 2008. As of December 31,
2009, the liability for unrecognized tax benefits totaled $27,000 compared to
a liability of $48,000 as of December 31, 2008. The liability for unrecognized
tax benefits is included in other accrued liabilities.

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 2006, 2007,
and 2008.

It has been the Company’s policy to recognize interest and penalties
related to uncertain tax positions in income tax expense. The Company had
accrued approximately $8,000 of interest related to uncertain tax positions at

3. Intangible Assets

December 31, 2009. The unrecognized tax benefits at December 31, 2009
relate to taxation of foreign export sales.

A reconciliation of the beginning and ending amounts of unrecognized tax
benefit for 2009 and 2008 is as follows:

Balance at January 1, 2008 .................................................

$ 92,000

Expiration of the statute of limitations for the
assessment of taxes ............................................................

Balance at December 31, 2008 ..................................................

Expiration of the statute of limitations for the
assessment of taxes ............................................................

(44,000)

48,000

(21,000)

Balance at December 31, 2009 ..................................................

$ 27,000

The balance of unrecognized tax benefits totaling $27,000 at December
31, 2009, 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 expects the remaining $27,000
unrecognized tax benefit to be fully reversed during the next twelve months
as a result of the expiration of the statutes of limitations for the assessment
of taxes.

Intangible assets consist of patents, patent applications, licenses and covenants not to compete arising from business combinations. Capitalized patent
application costs are included with patents. Intangible assets are amortized on a straight-line basis over their estimated useful lives or terms of their agreement,
whichever is shorter. In 2009 the Company wrote off $13,000 of expenses related to patent applications compared to $69,000 written off in 2008. No other
impairment adjustments to intangible assets were made during the year ended December 31, 2009 or 2008.

Intangible assets at December 31, 2009 and 2008 consist of the following:

December 31, 2009

December 31, 2008

Gross Carrying
Amount

Accumulated
Amortization

Gross Carrying
Amount

Accumulated
Amortization

Amortized intangible assets:

Patents .........................................................................

$ 268,116

$ (115,872)

$ 270,610

$ (104,412)

licenses ........................................................................

Non-compete agreements ...............................................

100,000

303,000

(59,376)

(150,328)

100,000

303,000

(51,251)

(114,662)

$ 671,116

$ (325,576)

$ 673,610

$ (270,325)

Aggregate amortization expense

2009 2008

Estimated amortization expense for the years ended December 31:

For the years ended December 31

$ 55,251

$ 57,264

2010 ..........................................................................

$54,000

2011 ..........................................................................

46,000

2012 ..........................................................................

46,000

2013 ..........................................................................

41,000

2014 ..........................................................................

12,000

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 $74,000 of expense under these agreements during 2009, and $102,000 during 2008.

IKONICS Corporation Annual Report 2009

4. 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 up to 5% of each eligible employee’s compensation. Total retirement expense for the years
ended December 31, 2009 and 2008 was approximately $175,000 and $186,000, respectively.

5. 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, 2009

Net sales ...............................................................................

$ 6,788,355

$ 4,628,855

$ 3,704,407

Cost of good sold .................................................................

3,589,054

3,400,896

2,064,821

Gross Profit ...........................................................................

3,199,301

1,227,959

1,639,586

$ 15,121,617

9,054,771

6,066,846

Selling, general and administrative ........................................

944,273

552,616

1,112,485

1,934,074

4,543,448

Research and development ..................................................

653,747

Income (loss) from operations ...............................................

$ 2,255,028

$ 675,343

$ 527,101

$ (2,587,821)

$ 869,651

For the year Ended December 31, 2008

Net sales ...............................................................................

$ 6,568,160

$ 4,974,782

$ 4,311,542

Cost of good sold .................................................................

3,594,781

3,399,714

2,233,692

Gross Profit ...........................................................................

2,973,379

1,575,068

2,077,850

$ 15,854,484

9,228,187

6,626,297

Selling, general and administrative ........................................

1,196,859

467,883

1,257,360

1,966,740

4,888,842

Research and development ..................................................

767,083

Income (loss) from operations ...............................................

$ 1,776,520

$ 1,107,185

$ 820,490

$ (2,733,823)

$ 970,372

Accounts Receivable as of December 31, 2009 & December 31, 2008

Dec 31, 2009 Dec 31, 2008

Domestic .......................................................................................................................

$ 976,967

$ 957,617

Export* ..........................................................................................................................

IKONICS Imaging ...........................................................................................................

740,547

331,117

874,068

276,718

Other .............................................................................................................................

(32,833)

(31,245)

Total ..............................................................................................................................

$ 2,015,798

$ 2,077,158

* in 2009 and 2008, the Company marketed its products in various countries throughout the world. The Company is exposed to the risk of changes in social, political, and economic conditions

inherent in foreign operations, and the Company’s results of operations are affected by fluctuations in foreign currency exchange rates. no single foreign country accounted for more than 10% of

the Company’s net sales for 2009 and 2008.

Sales to foreign customers were 30.6% and 31.4% of the Company’s net sales for 2009 and 2008, respectively.

6. Stock Options

The Company has a stock incentive plan for the issuance of up to 442,750
shares of common stock including the 100,000 additional shares approved
by the shareholders at the April 24, 2009 annual meeting. 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 129,073 shares of common stock are reserved
for additional grants of options under the plan at December 31, 2009.

Under the plan, the Company charged compensation cost of $23,650 and
$19,849 against income in 2009 and 2008, respectively.

As of December 31, 2009, there was approximately $54,000 of unrecognized
compensation cost related to unvested share-based compensation awards
granted which is expected to be recognized over the next three years.

were no options exercised. The Company’s APIC pool totaled $111,029 at
December 31, 2009 and 2008.

Proceeds from the exercise of stock options were $106,712 for 2008. There
were no options exercised in 2009.

The fair value of options granted during 2009 and 2008 were estimated using
the Black-Scholes option pricing model with the following assumptions:

Dividend yield .............................................

2009

2008

Expected volatility .....................................

47.2%

55.0%-56.3%

Expected life of option ..............................

Five years

Risk-free interest rate ...............................

Fair value of each option on grant date

2.0%

$2.10

3.00%-3.25%

$3.44-$4.05

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 FASB ASC 718, 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, 2008, $39,319 of excess tax benefits was reported in the statement of
cash flows, respectively. In 2009 there were no excess tax benefits as there

There were 21,750 options and 10,250 options granted during 2009 and
2008, respectively.

FASB ASC 718, Compensation – Stock Compensation 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 3%.

A summary of the status of the Company’s stock option plan as of December 31, 2009 and changes during the year then ended is presented below:

Options

Outstanding at January 1, 2009 ...................................

Granted ........................................................................

Exercised .....................................................................

Expired and forfeited ...................................................

Outstanding at December 31, 2009 .............................

Vested or expected to vest at December 31, 2009 ......

Exercisable at December 31, 2009 .............................

Weighted Average
Exercise Price

Weighted Average
Remaining Contractual
Term (years)

Aggregate Intrinsic
Value

26,250

21,750

(2,500)

45,500

17,666

$6.69

5.00

6.14

$ 5.91

$ 6.43

3.02

1.31

$ 24,872

$ 9,788

The weighted-average grant date fair value of options granted was $2.10 and $3.74 for the year ended December 31, 2009 and 2008, respectively. The total
intrinsic value of options exercised was $211,363 for the year ended December 31, 2008. There were no options exercised in 2009.

The following table summarizes information about stock options outstanding at December 31, 2009:

Range of Exercise
Price

$ 4.00 - 4.99

$ 5.00 - 5.99

$ 6.00 - 6.99

$ 7.00 - 8.99

Options Outstanding
Weighted- Average
Remaining Contractual
Life (years)

Number Outstanding at
December 31, 2009

Options Exercisable

Weighted- Average
Exercise Price

Number Exercisable at
December 31, 2009

Weighted- Average
Exercise Price

7,000

21,000

5,250

12,250

45,500

0.32

4.31

3.58

2.11

3.02

$ 4.32

$ 5.00

$ 6.71

$ 8.05

$ 5.91

7,000

1,750

8,916

17,666

$ 4.32

$ 6.71

$ 8.04

$ 6.43

IKONICS Corporation Annual Report 2009

7. Concentration of Credit Risk

The Company maintains its cash balances primarily at one financial
institution in a fully insured checking account that does not provide for
interest. Instead, the account earns credits which offset banking fees.

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.

8. Lease Expense

The Company leased a building 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.
The lease expired on February 1, 2009. Total rental expense for all
equipment and building operating leases was $6,000 in 2009 and $74,000
in 2008.

9. 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
October 31, is collateralized by trade receivables and inventories, and
bears interest at 2.5 percentage points over 30-day lIBOR. There were no
outstanding borrowings under this line of credit at December 31, 2009 and
2008.

10. Emerging Accounting Pronouncements

In June 2009, the Financial Accounting Standards Board (“FASB”) issued the
FASB Accounting Standards Codification (the “Codification”), the authoritative
guidance for GAAP. The Codification, which changes the referencing of
financial standards, became effective for interim and annual periods ending
on or after September 15, 2009. The Codification is now the single official
source of authoritative U.S. GAAP (other than guidance issued by the SEC),
superseding existing FASB, American Institute of Certified Public Accountants,
Emerging Issues Task Force (“EITF”), and related literature. Only one level of
authoritative U.S. GAAP now exists. All other literature is considered non-
authoritative. The Codification does not change U.S. GAAP. The Company
adopted the Codification during the quarter ended September 30, 2009.
The adoption of the Codification did not have any substantive impact on the
Company’s financial statements or related footnotes.

Fair Value Measurement - Effective January 1, 2008, the Company adopted
guidance issued by the FASB with respect to assessing fair value for the
Company’s financial and non-financial assets and liabilities. In February 2008,
the FASB issued updated guidance related to fair value measurements.
The updated guidance provided a one year deferral of the effective date of
the original guidance as it relates to non-financial assets and non-financial
liabilities, except those that are recognized or disclosed in the financial
statements at fair value at least annually. Therefore, the Company adopted the
provisions of the updated guidance for non-financial assets and non-financial
liabilities effective January 1, 2009, and such adoption did not have a material
impact on the Company’s results of operations or financial condition. The
Company’s only financial instruments measured at fair value on a nonrecurring
basis were its auction rate securities, which were sold during the second
quarter of 2008 at cost and its investment in iTi. The Company’s nonfinancial
assets include property, plant and equipment and intangible assets comprised
of patents and non-competes. The guidance affects how the fair value of
these assets is determined when determining if the assets are impaired.
Refer to footnote 1 for further discussion on the Company’s impairment on its
investment in non-marketable equity securities.

Business Combinations - In January 2009, the Company adopted
authoritative guidance issued by the FASB for business combinations. This
guidance 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 non-controlling interest
in the acquiree. The authoritative guidance 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. Additional guidance was provided for recognizing changes in
an acquirer’s existing income tax valuation allowances and tax uncertainty
accruals that result from a business combination transaction as adjustments
to income tax expense. The adoption of the guidance by the Company had no
impact on the Company’s current financial condition or results of operations,
as the Company did not enter into any business combinations.

In April 2009, the FASB issued updated guidance related to business
combinations. The guidance amends and clarifies the original guidance to
address application issues regarding initial recognition and measurement,
subsequent measurement and accounting and disclosure of assets
and liabilities arising from contingencies in a business combination. In
circumstances where the acquisition-date fair value for a contingency cannot
be determined during the measurement period and it is concluded that it
is probable that an asset or liability exists as of the acquisition date and the
amount can be reasonably estimated, a contingency is recognized as of the
acquisition date based on the estimated amount. The guidance is effective
for assets or liabilities arising from contingencies in business combinations
for which the acquisition date is on or after the beginning of the first annual
reporting period beginning on or after December 15, 2008. The adoption of
the guidance had no impact on the Company’s financial condition or results of
operations.

Consolidations - In January 2009, the FASB revised the accounting
treatment for noncontrolling minority interests of partially-owned subsidiaries.
Noncontrolling minority interests represent the portion of earnings that is not
within the parent company’s control. These amounts are now required to be
reported as equity instead of as a liability on the balance sheet. The adoption
of the guidance had no impact on the Company’s financial condition or results
of operations.

Financial Instruments - In April 2009, the FASB issued authoritative fair
value disclosure guidance for financial instruments. The guidance requires
disclosures for interim reporting periods of publicly traded companies as
well as in annual financial statements. The guidance also requires those
disclosures in summarized financial information at interim reporting periods.
The Company adopted the guidance during the quarter ended June 30,
2009. The adoption of the guidance did not have a significant impact on the
Company’s financial statements or related footnotes.

Subsequent Events - In may 2009, the FASB issued authoritative guidance
for subsequent events, which establishes general standards of accounting for
and disclosure of events that occur after the balance sheet date but before
financial statements are issued or are available to be issued. The guidance
sets forth the circumstances under which an entity should recognize events or
transactions occurring after the balance sheet date in its financial statements.
The guidance also requires the disclosure of the date through which an entity
has evaluated subsequent events and whether that date represents the date
the financial statements were issued or were available to be issued. During
the quarter ended June 30, 2009, we adopted the guidance. The adoption
of the guidance did not have a significant impact on the Company’s financial
statements or related footnotes.

Revenue Recognition - In October 2009, the FASB issued updated revenue
recognition guidance. Under this guidance, Companies are no longer required
to obtain vendor specific objective evidence or third-party evidence of fair
value for each deliverable in an arrangement with multiple elements, and
where evidence is not available may not estimate the proportion of the selling
price attributable to each deliverable. The Company currently does not have
any specific arrangements that are within the scope of the updated guidance
and thus the Company does not believe the adoption of this guidance will have
a material impact to its financial statements.

Variable Interest Entity - In December 2009, the FASB issued guidance
which amends FASB Interpretation No. 46(R) issued in June 2009. The new
guidance requires a qualitative approach to identifying a controlling financial
interest in a variable interest entity (“VIE”), and requires ongoing assessment
of whether an entity is a VIE and whether an interest in a VIE makes the
holder the primary beneficiary of the VIE. The guidance is effective for annual
reporting periods beginning after November 15, 2009. The Company does not
expect the adoption of the guidance to have a material impact on its financial
statements.

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-K, 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 29, 2010 1:30p.m.

Canal Park lodge
250 Canal Park Drive
Duluth, minnesota 55802

Board of Directors

Corporate Officers

WIllIAm C. UllAND

Chairman, President & CEO

ClAUDE PIGUET

Executive Vice President

JON GERlACH

Vice President, Finance, CFO

PARNEll THIll

Vice President, marketing

ROBERT D. BANKS

Vice President, International

DAVID O. HARRIS

RONDI C. ERICKSON

lOCKWOOD CARlSON

CHARlES H. ANDRESEN

H. lEIGH SEVERANCE

GERAlD W. SImONSON

WIllIAm C. UllAND

President
David O. Harris, Inc.
minneapolis, mN
Director Since 1965

Co-Owner
Nokomis Restaurant
Duluth, mN
Director Since 2000

President
Carlson Consulting Group
minneapolis, mN
Director Since 2009

Attorney
Andresen & Butterworth P.A.
Duluth, mN
Director Since 1979

President
Severance Capital management
Denver, CO
Director Since 2000

President
Omnetics Connector Corporation
minneapolis, mN
Director Since 1978

Chairman, President & CEO
IKONICS Corporation
Duluth, mN
Director Since 1972

IKONICS Corporation Annual Report 2009

WILLIAM C. ULLAND
Chairman, President & CEO