IKONICS Corporation Annual Report 2011

FY2011 Annual Report · IKONICS Corporation

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WILLIAM C. ULLAND

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 Income ............................................................................8

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

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

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

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

CORPORATE PROFILE

2011 Net Sales ................................................................................$16,780,262

Earnings per common share (diluted) ............................................................ $0.35

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

Employees ...................................................................................................... 72

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

Letter to SharehoLderS

IKONICS experienced record sales for 2011 of $16,780,000, a 2% increase from 2010. Due to competitive pressures in our screen printing business, we were unable to
pass on all of the increasing costs of our petrochemical-based raw materials. Consequently, net income declined by 37%, to $698,000, or $0.35 per share. Developing and
launching our new businesses also contributed to increased costs, but I believe these investments were wise, and we are beginning to see a return on them.

In 2006, we embarked on a mission to grow and diversify our business when we recognized that our traditional markets, though quite profitable, were mature. We evaluated
our existing technology platforms and considered improvements or additions we could make to allow us to penetrate alternative, attractive markets.

After considerable research, and some trial and error, we moved to servicing industrial markets, including mold texturing, and the machining of silicon wafers and
composite materials. We are convinced these markets represent large opportunities for Ikonics and that we have unique expertise and knowledge with which to serve them.

To our existing technology platforms of ultraviolet (UV) chemistry, film coating and construction, and technical sandblasting, we added industrial inkjet printing. To offer
customers a compelling value proposition, we needed to elevate all of these technology platforms to produce products and services that exceeded those currently in the
market. I believe that, in spite of a deep recession and major technological hurdles in chemistry, film construction and inkjet printer development, we have met those goals.
I believe we will begin to see positive progress in 2012.

Micro-Machining Solutions is our business unit that machines electronic wafers and composite materials using precision abrasive etching. This business grew substantially
in 2011 and became profitable. One of our market segments is composites where we offer substantially superior performance in important applications. Our process is
presently being used on Boeing®, Airbus®, and Gulfstream® aircraft and is being tested by other major aerospace companies for use in their manufacturing processes.
The aerospace industry has a very long sales cycle and, in some cases, suppliers are compelled to wait for a new design or process to be specified. Once specified,
however, the sales life of a product can also be very long. Our offering is hitting the market as the aerospace industry recovers from the recession and the use of
composites in aerospace manufacturing continues to grow.

Digital Texturing (DTX) is our patented technology for placing textures or patterns in the steel molds used by plastic-injection molding companies. DTX offers lower cost and
better quality than competing traditional technologies, many of which are decades old. We recently introduced ExactFlat® software to further enhance the advantages of
DTX. Although our primary focus for DTX is the automotive industry, there are many other applications of textured surfaces, representing a long-term opportunity for
IKONICS. Our chemists and engineers have done a remarkable job of developing consumables (inks and transfer films) that will be used by the DTX inkjet printers sold by
our strategic partners. The market had been waiting for our second generation, high resolution printer, which was delivered to a customer in North America in January 2012
and is currently in use. Additional DTX printer sales by our strategic partners are pending.

Our traditional businesses of manufacturing and supplying photochemical films and emulsions to the worldwide screen printing market and sand blast photoresist films
to the awards and recognition industry have funded these new initiatives. To return these enterprises to their former level of profitability we are introducing new products,
lowering fixed costs, and evaluating new distribution models. I believe an improvement in their profitability will coincide with the continued strong performance of
Micro-Machining and the commercial launch of DTX.

WILLIAM C. ULLAND

Chairman, President & CEO

March 20, 2012

ManageMent’S diScuSSion and anaLySiS of
financiaL condition and reSuLtS of operationS

markets, the Company’s ability to maintain the quality of its receivables while adding
customers in new markets and the Company’s ability to maintain its reputation for
quality products.

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 2011 and 2010 and should be read in connection with the Com-
pany’s audited financial statements and notes thereto for the years ended December
31, 2011 and 2010, 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 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 expen-
ditures. 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 avail-
ability, 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 expendi-
tures and that capital expenditures will be funded with cash generated from op-
erating 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 unfore-
seen expenditures may also be affected by changes in anticipated operating results
resulting from decreased sales, lack of acceptance of new products or increased
operating expenses or by other unexpected events affecting the Company’s financial
position.

The Company’s belief that its vulnerability to foreign currency fluctuations and
general economic conditions in foreign countries is not significant – This belief
may be impacted by economic, political and social conditions in foreign markets,
changes in regulatory and competitive conditions, a change in the amount or
geographic focus of the Company’s international sales, or changes in purchase or
sales terms.

The Company’s plans to continue to invest in research and development efforts,
expedite internal product development and invest in technological alliances, as
well as the expected focus and results of such investments – These plans and
expectations may be impacted by general market conditions, unanticipated changes
in expenses or sales, delays in the development of new products, technological ad-
vances, the ability to find suitable and willing technology partners or other changes
in competitive or market conditions.

The Company’s belief as to future sources of sales growth and profitability,
including from photo resist film, export markets and other products the Company
sells – The sources of future increases to the Company’s sales and profitability,
and the Company’s ability to increase sales or profitability at all, may be impacted
by lack of market acceptance for the Company’s products, adverse changes to the
global economy and consumer confidence, the adequacy of the Company’s intel-
lectual property protections, the Company’s ability to customize its products for new

criticaL accounting eStiMateS

The Company prepares its financial statements in conformity with accounting princi-
ples 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 – 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 experi-
ence 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 custom-
ers. 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 end 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 obsoles-
cence and records reductions from cost when required.

Income Taxes – At December 31, 2011, the Company had net current deferred
tax assets of $144,000 and net noncurrent deferred tax liabilities of $338,000.
The deferred tax assets and liabilities result primarily from temporary differences
in property and equipment, accrued expenses, and inventory reserves. In connec-
tion with the recording of an impairment charge that occurred prior to 2010 as
described below, the Company has recorded a deferred tax asset and correspond-
ing full valuation allowance in the amount of $323,000 as it is more likely that this
asset will not be realized. The fully reserved $323,000 deferred tax asset related
to the capital loss can be carried back two years and carried forward four 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 Com-
pany accounts for its uncertain tax positions under the provision of FASB ASC 740,
Income Taxes. At December 31, 2011 and 2010 the Company had no reserves for
uncertain tax positions. The Company had recorded a liability of $27,000 related to
an uncertain tax position which was eliminated during 2010.

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 ar-
rive 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,

IKONICS CORPORATION | 2011 ANNUAL REPORTand 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 shipment
of film and substrates with bill of lading used for proof of delivery for FOB
shipping point terms, and the carrier booking confirmation report used for
FOB destination terms). Once the finished product is shipped and physically
delivered under the terms of the invoice and sales order, the Company has
no additional performance or service obligations to complete

c.) a fixed and determinable sales price (the Company’s pricing is established

and is not based on variable terms, as evidenced in either the Company’s in-
voices 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
customer has no rotation or price protection rights and the Company is not under a
warranty obligation except for a minimal obligation related to six months of service
on the DTX printer sold in 2010. Freight billed to customers is included in sales.
Shipping costs are included in cost of goods sold.

reSuLtS of operationS
YEAR ENDED DECEMBER 31, 2011 COMPARED TO YEAR ENDED DECEMBER 31, 2010

Sales – The Company’s net sales increased 1.6% in 2011 to a record $16.8
million compared to net sales of $16.5 million in 2010. Stronger sales in Asia and
Latin America drove a 2.5% Export sales increase for 2011. These increases were
partially offset by weaker European sales. IKONICS Imaging realized a 3.8% sales
increase over 2010 due to increased film sales. In 2011, the Company determined
that Micro-Machining and DTX financial information would not be included under
the IKONICS Imaging segment. See Note 5 in the notes to the financial statements
included in this Annual Report for a more detailed discussion on this transition. DTX
and Micro-Machining sales were down 3.2% compared to last year. Sales in 2010
were favorably impacted by a DTX printer sale while no DTX printers were sold in
2011 because the Company’s printer suppliers were experiencing manufacturing
difficulties with a second generation printer. Strong Micro-Machining sales partially
offset the DTX sales shortfall. Domestic Chromaline sales were similar to last year
as increased emulsion sales were offset by lower film sales.

Gross Profit – Gross profit in 2011 was $6.7 million, or 40.0% of sales, com-
pared to $6.8 million, or 41.1% of sales in 2010. Domestic and Export gross profit
percentage decreased by 4.7% and 4.3%, respectively, during 2011 compared to
2010. Raw material price increases along with a decrease in higher margin film
sales have unfavorably affected the gross profit percentage for both Export and
Domestic. Higher margin DTX and Mirco-Machining sales along with an increase in
higher margin IKONICS Imaging film sales partially offset the Export and Domestic
gross margin decreases.

Selling, General and Administrative Expenses – Selling, general and adminis-
trative expenses were $5.2 million, or 30.8% of sales, in 2011 compared to $4.6
million, or 27.7% of sales in 2010. The increase in selling, general and administra-
tive expenses reflects higher personnel, promotion and consulting costs related to
supporting the Company’s Micro-Machining and DTX initiatives along with increased
sales efforts in awards and recognition market. Approximately $170,000 of the
higher personnel expenses are related to resources that were previously assigned to
research and development, but have been reassigned to focus exclusively on Micro-
Machining and DTX.

Research and Development Expenses – Research and development expenses
in 2011 were $512,000, or 3.1% of sales, versus $696,000, or 4.2% of sales, in
2010. The decrease is due to lower staffing levels due to the reassignment of cer-
tain personnel to the Company’s Micro-Machining and DTX initiatives. Additionally,
legal and patent related expenses were lower in 2011 along with research related
production trials.

Interest Income – The Company earned $17,300 of interest income in 2011
compared to $19,700 in 2010. The interest earned in 2011 and 2010 is related
to interest received from the Company’s short-term investments, which consist of
fully insured certificates of deposit with remaining maturities ranging from 1 to 12
months.

Income Taxes – During 2011, the Company realized income tax expense of
$345,000, or an effective rate of 33.1%, compared to income tax expense of
$440,000, or an effective rate of 28.3% in 2010. The income tax provision for
2011 and 2010 differs from the expected tax expense due to the benefits of the
domestic manufacturing deduction and federal and state credits for research and
development. Additionally, the effective tax rate in 2010 was impacted by derecog-
nizing a $27,000 liability for unrecognized tax benefits relating to a tax year where
the statute of limitations expired during the year. During 2010, the Company also
recorded an out-of-period tax benefit adjustment of $15,000 relating to prior year
tax credits as well as the receipt of interest of approximately $13,000 related to
Minnesota state income tax returns.

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 $1,867,000 and $1,291,000 at December 31, 2011 and 2010, respec-
tively. In addition to its cash, the Company also held $1,835,000 of short term in-
vestments as of December 31, 2011 and $2,218,000 of short-term investments as
of December 31, 2010. The Company generated $794,000 in cash from operating
activities during 2011, compared to generating $1,601,000 of cash from operat-
ing activities in 2010. Cash provided by operating activities is primarily the result
of the net income adjusted for non cash depreciation and amortization, deferred
taxes, and certain changes in working capital components discussed in the following
paragraph.

During 2011, trade receivables increased by $298,000. The increase in receivables
was driven by increased Export sales which have longer payment terms and slightly
slower collections than Domestic sales. Inventory levels increased $264,000 due
to higher levels of raw materials. The raw materials increase is related to the timing
of the delivery of large raw material shipments at year end and higher raw material

costs. The Company also requires increased levels of raw materials to support
new products. The $19,000 increase in prepaid expenses and other assets is
related to the timing of insurance payments for 2012. Accounts payable increased
$108,000 due to of the timing of payments to and purchases from vendors while
accrued liabilities decreased $39,000 due to the timing of the Company’s payroll.
Income taxes payable decreased $7,000 and the Company’s income tax receivable
increased $59,000 due to timing of estimated 2011 tax payments compared to the
calculated 2011 tax liability.

During 2011, investing activities used $289,000. The Company’s purchases of
property and equipment for the year were $622,000. These purchases were mainly
for equipment to upgrade the capabilities of the Company’s DTX and Micro-Machin-
ing operations, equipment to improve product quality and capacity, mandatory eleva-
tor improvements, one vehicle and hardware to upgrade the Company’s computer
network. Also during 2011, the Company incurred $60,000 in patent application
costs that the Company records as an asset and amortizes upon successful comple-
tion of the application process. The Company also invested $2,446,000 in twelve
fully insured certificates of deposits during 2011. Fourteen certificates of deposit
totaling $2,829,000 matured in 2011.

During 2010, investing activities used $1,637,000. The Company invested
$2,621,000 in fully insured certificates of deposits with six $200,000 certificates
of deposit maturing during 2010. Purchases of property and equipment totaled
$189,000. These capital expenditures were mainly for production equipment and
three vehicles for sales persons. The Company received $22,000 from vehicle and
equipment sales during 2010. Also during 2010, the Company incurred $54,000 in
patent application costs.

During 2011, the Company received $71,000 from financing activities as the Com-
pany received $73,000 from the issuance of 11,500 shares of common stock from
the exercise of stock options. The Company used $2,100 in financing activities
during 2011 to repurchase 270 shares of its own stock. During 2010, the Company
received $23,000 from financing activities. The Company received $37,000 from
the issuance of 8,500 shares of common stock from the exercise of stock options
and the Company repurchased 2,200 shares of it own stock for $15,000.

A bank line of credit exists providing for borrowings of up to $1,250,000. The line
of credit term runs from October 31, 2011 to October 30, 2012. The Company
expects to obtain a similar line of credit when the current line of credit expires. The
line of credit is collateralized by trade receivables and inventory and bears interest
at 2.5 percentage points over the 30 day LIBOR rate. The Company did not utilize
this line of credit during 2011 and 2010 and there were no borrowings outstanding
as of December 31, 2011 and 2010. There are no financial covenants related to
the line of credit.

The Company believes that current financial resources, its line of credit, cash gener-
ated 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 abil-
ity to fund operations.

capitaL expenditureS

In 2011, the Company had $622,000 in capital expenditures. Capital expenditures
in 2011 were for equipment to upgrade the capabilities of the Company’s DTX and
Micro-Machining operations, equipment to improve product quality and capac-
ity, mandatory elevator improvements, one vehicle and hardware to upgrade the
Company’s computer network. In addition, the Company transferred $227,000 of

DTX equipment from inventory to equipment during the year. The DTX equipment
was purchased for inventory in 2010. Instead of offering the DTX equipment for
sale, the Company decided it would be necessary to keep the equipment for product
testing and customer demonstrations.

In 2010, the Company had $189,000 in capital expenditures. These capital expen-
ditures were mainly for production equipment and three vehicles for sales persons.

The Company expects capital expenditures in 2012 of approximately $550,000
and includes expenditures for manufacturing equipment upgrades and capacity in-
creases and vehicles for sales personnel. It also includes $150,000 in expenditures
to complete the mandatory elevator upgrades and an equipment upgrade project
which were both started in 2011. These commitments are expected to be funded
with cash generated from operating activities.

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 2011 for-
eign sales of $5,556,000 were approximately 33.1% of total sales, compared to the
2010 foreign sales of $5,421,000, which were 32.8% of total sales. The increase
in foreign sales in 2011 was primarily due to growth of 3.3% Asia and Latin America
while 2011 European sales were down 7.5% compared to last year. The Company
is exposed to the risk of changes in social, political, and economic conditions inher-
ent in foreign operations, and the Company’s results of operations are affected by
fluctuations in foreign currency exchange rates. Fluctuations in 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, 2011. Furthermore, the impact of foreign exchange on the Company’s balance
sheet and operating results was not material in either 2011 or 2010.

future outLook

IKONICS has spent on average over 3%- 4% of its sales dollars for the past few
years in research and development and has made capital expenditures related to its
DTX and Micro-Machining programs. 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 2011, the Company made substantial progress on its new Micro-Machining busi-
ness initiatives. During the year, Micro-Machining sales grew, became profitable and
manufacturing capacity was increased. Micro-Machining is also in the process of
being qualified for production by three major aerospace companies. Although the
sales cycle with these customers is long, once specified as a process or component,
the life of the business can be very long term. The recognition by the industry of the
Company’s unique ability to machine composite materials is coinciding with increas-
ing demand for composite materials by the aerospace industry.

In addition, the Company made substantial progress in 2011 on its DTX business
initiatives. A DTX first generation printer was sold to a customer beta site in the
fourth quarter of 2010; it is performing to expectations and generating sales for the

IKONICS CORPORATION | 2011 ANNUAL REPORTIn prior years, the Company’s board of directors had publicly announced the authori-
zation of the Company to repurchase 250,000 shares of common stock. A total of
217,239 shares have been repurchased under this program including 270 shares
repurchased during 2011. The plan allows for an additional 32,761 shares to be
repurchased and does not have an expiration date.

For Year Ended
Dec. 31, 2011

Total Number of
Shares Purchased

Average Price
Paid per Share

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

Maximum Number
of Shares that
May Yet Be Pur-
chased Under the
Plans or Programs

Jan. 1 – Apr. 30

May 1 – May 31

June 1 – Dec. 31

270

$7.70

270

33,031

32,761

ManageMent’S report

The financial statements of IKONICS Corporation have been prepared by Company
management who are responsible for their content. These statements have been
prepared in accordance with accounting principles generally accepted in the United
States of America and, where appropriate, reflect estimates based on judgements of
management.

The financial statements have been audited by McGladrey & Pullen LLP, an indepen-
dent 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 regis tered 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

JON GERLACH

Chairman, President & CEO

Chief Financial Officer & V.P. Finance

Company of related consumables. In January 2012, the Company placed a second
generation DTX printer with a North America mold maker and has been informed by
its DTX printer manufacturing partner, Colour Scanner Technology GMBH, of other
pending orders. In February of 2012, the Company announced a partnership and
distribution agreement with Tri-D Technology to provide ExacFlat software for placing
textures on 3D molds. The Company believes, that coupled with DTX, this technol-
ogy provides the mold maker with the fastest, most accurate and cost effective way
to apply decorative features to 3D mold. The Company was also awarded a Euro-
pean patent on its DTX technology in 2010 and a U. S. patent in 2012. Additional
U. S. and European patent applications, as well as a Japanese patent application,
are currently being examined by the respective patent offices.

In 2011, the Company’s traditional domestic screen print stencil business was flat.
The Company anticipates growth in this area in 2012 with an improving economy
and new sales efforts. Sales to the awards and recognition market of the Com-
pany’s sandblast resist films rebounded in 2011 with the improving economy, and
the Company expects that trend to continue in 2012.

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

off-baLance Sheet arrangeMentS

The Company has no off-balance sheet arrangements.

recent accounting pronounceMentS

None

Market for coMMon equity, reLated StockhoLder
MatterS and 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, 2011:

First Quarter

Second Quarter

Third Quarter

Fourth Quarter

Fiscal Year Ended December 31, 2010:

First Quarter

Second Quarter

Third Quarter

Fourth Quarter

High

Low

$ 8.94

$ 6.90

8.75

8.50

8.77

7.46

7.25

7.30

$ 7.16

$ 6.30

7.50

7.32

8.00

6.52

6.40

6.91

As of February 23, 2012, the Company had approximately 633 shareholders. The
Company has never declared or paid any dividends on its Common Stock.

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.

Management assessed the effectiveness of our internal control over financial reporting as of December 31, 2011. 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 assess-
ment and those criteria, management believes that, as of December 31, 2011, the Company maintained effective internal control over financial reporting.

WILLIAM C. ULLAND

JON GERLACH

Chairman, President & CEO

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, 2011 and 2010, and the related statements of income, stockholders’ equity,
and cash flows for the years then ended. These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on
these financial statements based on our audits.

We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and
perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. The Company is not required to have, nor were
we engaged to perform an audit of its internal control over financial reporting. Our audit included consideration of internal control over financial reporting as a basis for
designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal con-
trol over financial reporting. Accordingly, we express no such opinion. An audit also includes examining, on a test basis, evidence supporting the amounts and disclosures
in the financial statements, 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, 2011 and
2010, and the results of its operations and its cash flows for the years then ended, in conformity with U.S. generally accepted accounting principles.

/s/ McGladrey & Pullen, LLP
Minneapolis, Minnesota
March 6, 2012

IKONICS CORPORATION | 2011 ANNUAL REPORTbaLance SheetS
DECEMBER 31, 2011 AND 2010
aSSetS
CURRENT ASSETS:

2011

2010

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

1,867,165

Short-term investments ...............................................................................................................................

Trade receivables, less allowance of $51,000 in 2011 and $60,000 in 2010 (Notes 5, 7, and 8) .......................

Inventories (Notes 1 and 8) ..........................................................................................................................

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

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

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

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

PROPERTY, PLANT, AND EQUIPMENT, AT COST:

Land and building .......................................................................................................................................

Machinery and equipment ...........................................................................................................................

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

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

Less accumulated depreciation ....................................................................................................................

1,835,003

2,180,947

2,234,834

82,923

59,322

144,000

8,404,194

5,982,799

3,021,053

662,160

235,000

9,901,012

4,464,110

5,436,902

Intangible assets, less accumulated amortization of $427,454 in 2011 and $376,983 in 2010 (Note 3) .................

326,362

LiabiLitieS and StockhoLderS’ equity
CURRENT LIABILITIES:

14,167,458

2011

Accounts Payable .......................................................................................................................................

549,532

Accrued Compensation ...............................................................................................................................

Other accrued liabilities (Note 2) ..................................................................................................................

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

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

Deferred Income Taxes (Note 2)

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

244,173

45,210

838,915

338,000

1,176,915

1,291,383

2,217,990

1,883,428

2,198,064

63,965

157,000

7,811,830

5,888,445

2,455,238

642,100

234,650

9,220,433

4,207,500

5,012,933

317,168

13,141,931

2010

441,830

282,196

45,868

8,090

777,984

171,000

948,984

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 1,984,587
shares in 2011 and 1,973,357 shares in 2010 (Note 6)

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

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

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

198,459

2,363,150

10,428,934

12,990,543

14,167,458

197,336

2,263,176

9,732,435

12,192,947

13,141,931

See notes to financial statements

StateMentS of incoMe
YEARS ENDED DECEMBER 31, 2011 AND 2010

NET SALES ...............................................................................................................................................

16,780,262

16,517,338

2011

2010

COST OF GOODS SOLD ...............................................................................................................................

10,070,852

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

SELLING, GENERAL AND ADMINSTRATIVE EXPENSES .......................................................................................

RESEARCH AND DEVELOPMENT EXPENSES ....................................................................................................

INCOME FROM OPERATIONS ........................................................................................................................

INTEREST INCOME .....................................................................................................................................

INCOME BEFORE INCOME TAXES ..................................................................................................................

FEDERAL AND STATE INCOME TAXES (NOTE 2) ...............................................................................................

NET INCOME .............................................................................................................................................

EARNINGS PER COMMON SHARE:

6,709,410

5,171,147

512,259

5,683,406

1,026,004

17,253

1,043,257

345,000

698,257

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

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

0.35

WEIGHTED AVERAGE COMMON SHARES:

9,713,054

6,804,284

4,574,452

695,593

5,270,045

1,534,239

19,681

1,553,920

440,000

1,113,920

0.56

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

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

1,981,848

1,986,041

1,971,717

1,973,447

See notes to financial statements.

StateMentS of StockhoLderS’ equity
YEARS ENDED DECEMBER 31, 2011 AND 2010

Balance At December 31, 2009

1,967,057

196,706

2,198,289

8,631,091

11,026,086

Common Shares

Stock Amount

Additional Paid-In
Capital

Retained Earnings

Total Stockholders’
Equity

Net Income

Exercise of stock options

Comon Stock Repurchased

8,500

(2,200)

Tax benefit resulting from stock option exercises

Stock based compensation and related tax benefit

850

(220)

36,890

(2,334)

914

29,417

Balance At December 31, 2010

1,973,357

197,336

2,263,176

Net income

Exercise of stock options

Common stock repurchased

11,500

(270)

Tax benefit resulting from stock option exercises

Stock based compensation and related tax benefit

1,150

(27)

72,060

(294)

1,518

26,690

1,113,920

(12,576)

9,732,435

698,257

(1,758)

37,740

(15,130)

914

29,417

12,192,947

698,257

73,210

(2,079)

1,518

26,690

Balance At December 31, 2011

See noteS to financial StatementS.

1,984,587

198,459 $

2,363,150

10,428,934

12,990,543

IKONICS CORPORATION | 2011 ANNUAL REPORT
StateMentS of caSh fLowS
YEARS ENDED DECEMBER 31, 2011 AND 2010

CASH FLOW FROM OPERATING ACTIVITIES:

2011

2010

Net Income ....................................................................................................................................................

698,257

1,113,920

ADJUSTMENTS TO RECONCILE NET INCOME TO NET CASH PROVIDED BY OPERATING ACTIVITIES:

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

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

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

Gain on sale of equipment and vehicles ............................................................................................................

Loss on intangible asset abandonment .............................................................................................................

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

CHANGES IN WORKING CAPITAL COMPONENTS:

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

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

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

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

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

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

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

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

CASH FLOWS FROM INVESTING ACTIVITIES:

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

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

Purchases of intangibles .................................................................................................................................

Purchases of short-term investments ...............................................................................................................

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

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

CASH FLOWS FROM FINANCING ACTIVITIES:

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

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

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

415,821

50,471

26,690

(1,353)

805

180,000

(297,519)

(263,809)

(18,958)

(59,322)

107,702

(38,681)

(6,572)

793,532

(621,598)

10,200

(60,470)

(2,446,359)

2,829,346

(288,881)

(2,079)

73,210

71,131

402,027

51,407

29,417

(13,766)

31,372

15,000

132,370

(127,462)

(2,628)

155,220

(113,709)

(71,799)

1,601,369

(189,150)

22,200

(54,407)

(2,621,393)

1,205,568

(1,637,182)

(15,130)

37,740

22,610

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

575,782

(13,203)

CASH AT BEGINNING OF YEAR .................................................................................................................................

1,291,383

1,304,586

CASH AT END OF YEAR ..........................................................................................................................................

1,867,165

SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION

Cash paid for income taxes, net of refunds received of $4,090 and $81,422, respectively ....................................

230,894

SUPPLEMENTAL SCHEDULE OF NONCASH OPERATING AND INVESTING ACTIVITIES

Equipment transferred from inventory to property, plant and equipment ...............................................................

227,039

See notes to financial statements

1,291,383

531,799

noteS to financiaL StateMentS
YEARS ENDED DECEMBER 31, 2011 AND 2010

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. Custom-
ers’ 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 33.1% of net sales in 2011 and 32.8% of net
sales in 2010. The Company’s accounts receivable at December 31, 2011 and
2010 due from foreign customers were 35.9% and 38.5% of total accounts receiv-
able, respectively. The foreign export receivables are composed primarily of open
credit arrangements with terms ranging from 30 to 90 days. No single customer or
foreign country represented greater than 10% of net sales in 2011 or in 2010.

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 6, 2012, 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 $1,835,000 and
$2,218,000 of fully insured certificates of deposit with remaining maturities ranging
from one to twelve months as of December 31, 2011 and 2010, respectively.

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 consid-
ered 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 end 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 Cash Flows for 2011
and 2010.

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 (FIFO) cost method had been used,
inventories would have been approximately $1,213,000 and $993,000 higher than
reported at December 31, 2011 and 2010, respectively. The major components of
inventories, net of the allowance for obsolescence, are as follows:

Raw Materials

Work-in-progress

Finished goods

Reduction to LIFO cost

Total Inventories

2011

2010

1,811,219

1,403,875

338,284

1,298,616

(1,213,285)

294,006

1,493,226

(993,043)

2,234,834

2,198,064

Depreciation - Depreciation of property, plant and equipment is computed using
the straight-line method over the following estimated useful lives:

Buildings ............................................

Machinery and equipment ...................

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

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

Years

15-40

5-10

3-10

Intangible Assets – Intangible assets consist 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 compar-
ing 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.

As of December 31, 2011 the remaining estimated weighted average useful lives of
intangible assets are as follows:

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

Licenses ............................................

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

Years

15.2

4.6

2.5

Fair Value of Financial Instruments – The carrying amounts of financial instru-
ments, 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 ar-
rive 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 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

IKONICS CORPORATION | 2011 ANNUAL REPORT

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 pay-
ment 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)

Deferred Taxes - Deferred taxes are provided on a liability method whereby
deferred tax assets are recognized for deductible temporary differences and operat-
ing 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. The Company follows the account-
ing standard on accounting for uncertainty in income taxes, which addresses the
determination of whether tax benefits claimed or expected to be claimed on a tax
return should be recorded in the financial statements. Under this guidance, the
Company may recognize the tax benefit from an uncertain tax position only if it is
more likely than not that the tax position will be sustained on examination by taxing
authorities, based on the technical merits of the position. The tax benefits recog-
nized in the financial statements from such a position are measured based on the
largest benefit that has a greater than 50 percent likelihood of being realized upon
ultimate settlement. The guidance on accounting for uncertainty in income taxes
also addresses derecognition, classification, interest and penalties on income taxes,
and accounting in interim periods.

Earnings (loss) per Common Share (EPS) - Basic EPS is calculated using net in-
come 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.

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. Signif-
icant estimates include the allowance for doubtful accounts receivable, the reserve
for inventory obsolescence and the valuation allowance for deferred tax assets.

2. INCOME TAXES

Income tax expense for the years ended December 31, 2011 and 2010 consists of
the following:

2011

2010

Current:

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

162,000

428,000

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

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

3,000

165,000

180,000

(3,000)

425,000

15,000

345,000

440,000

The expected provision for income taxes, computed by applying the U.S. fed eral
income tax rate of 35% in 2011 and 2010 to income before taxes, is reconciled to
income tax expense as follows:

2011

2010

Expected provision for federal income taxes .

365,100

544,000

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

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

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

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

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

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

2,200

(18,600)

20,700

(15,900)

(8,500)

(2,100)

(27,000)

(50,100)

20,400

(16,600)

(28,600)

345,000

440,000

Net deferred tax liabilities consist of the following as of December 31, 2011 and
2010:

2011

2010

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

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

23,000

21,000

2011

2010

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

107,000

113,000

Weighted average common shares out-
standing ...............................................

1,981,848

1,971,717

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

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

8,000

10,000

12,000

11,000

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

4,193

1,730

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

323,000

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

1,986,041

1,973,447

Less valuation allowance ............................

(323,000)

148,000

157,000

At December 31, 2011, options to purchase 5,000 shares of common stock with a
weighted average exercise price of $8.08 were outstanding, but were excluded from
the computation of common share equivalents because they were anti-dilutive. At
December 31, 2010, options to purchase 16,250 shares of common stock with a
weighted average exercise price of $7.89 were outstanding, but were excluded from
the computation of common share equivalents because they were anti-dilutive.

Deferred tax liabilities:

Property and equipment and other assets ....

(305,000)

(160,000)

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

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

(32,000)

(5,000)

(11,000)

Net deferred tax liabilities ...........................

(194,000)

(14,000)

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

The deferred tax amounts described above have been included in the accompanying
balance sheet as of December 31, 2011 and 2010 as follows:

Current Assets

Noncurrent liabilities

2011

144,000

(338,000)

(194,000)

2010

157,000

(171,000)

(14,000)

tax asset will not be realized. The deferred tax asset and valuation allowance at
December 31, 2011 and December 31, 2010 was $323,000. As of December 31,
2011 the remaining deferred tax asset related to the capital loss can be carried
back one year and carried forward three years and must be offset by a capital gain.

It has been the Company’s policy to recognize interest and penalties related to
uncertain tax positions in income tax expense. As of December 31, 2011 and 2010,
there was no liability for unrecognized tax benefits.

At December 31, 2011 and 2010, the Company established a valuation allowance
against its deferred tax asset related to the Company’s $919,000 loss on its invest-
ment in non-marketable equity securities since it is more likely that the deferred

The Company is subject to taxation in the United States and various states. The ma-
terial jurisdictions that are subject to examination by tax authorities primarily include
Minnesota and the United States, for tax years 2008, 2009, 2010 and 2011.

3. INTANGIBLE ASSETS

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. The
Company wrote off costs related to patent applications of $1,000 in 2011 and $31,000 in 2010. No other impairment adjustments to intangible assets were made during
the years ended December 31, 2011 or 2010.

Intangible assets at December 31, 2011 and 2010 consist of the following:

December 31, 2011

December 31, 2010

Gross Carrying Amount

Accumulated Amortization

Gross Carrying Amount

Accumulated Amortization

Amortized intangible assets:

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

$ 350,816

(130,166)

291,151

(123,489)

Licenses ...................................................................

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

100,000

303,000

(75,628)

(221,660)

100,000

303,000

(67,500)

(185,994)

$ 753,816

(427,454)

694,151

(376,983)

Aggregate amortization expense:

For the years ended December 31

2011

2010

Estimated amortization expense for the years ending December 31:

$50,471

$51,407

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

$48,000

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

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

2015 ..................................................

2016 ..................................................

44,000

15,000

11,000

8,000

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 $94,000 of expense under these agreements during 2011, and $87,000 during 2010 which have been included in selling, general and administrative
expenses in the Statements of Income.

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,
2011 and 2010 was approximately $194,000 and $188,000, respectively.

5. SEGMENT INFORMATION

The Company’s reportable segments are strategic business units that offer different products and have varied customer bases. In previous years, there were three report-
able segments: Domestic, Export and IKONICS Imaging. Domestic sells screen printing film, emulsions and inkjet receptive film to distributors located in the United States
and Canada. IKONICS Imaging sells photo resistant film, art supplies, glass, metal medium and related abrasive etching equipment to end user customers located in the
United States and Canada. The IKONICS Imaging segment also included products and customers for etched composites, ceramics, glass and silicon wafers along with

IKONICS CORPORATION | 2011 ANNUAL REPORT

sound deadening technology to the aerospace industry, which beginning in 2011 the Company now defines as Micro-Machining. In addition, IKONICS Imaging included
products and customers related to proprietary inkjet technology used for mold texturing and referred to by the Company as Digital Texturing (DTX). Export sells primarily
the same products as Domestic and the IKONICS Imaging products not related to Micro-Machining or DTX. Beginning in 2011, the Company no longer includes Micro-
Machining and DTX financial information under the IKONICS Imaging segment. The financial information for Micro-Machining and DTX are combined into a new segment
called “Other.” As the Company is unable to provide comparable 2010 financial information for the newly defined segments, the Company will disclose in 2011 both the
new basis and previous basis of segment reporting. The accounting policies applied to determine the segment information are the same as those described in the summary
of significant accounting policies included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2010.

Management evaluates the performance of each segment based on the components of divisional income, and does not allocate assets and liabilities to segments except for
accounts receivables which is allocated based on the previous segmentation. Financial information with respect to the reportable segments follows:

For the year ended December 31, 2011 (previous segment method):

Domestic

Export

IKONICS Imaging

Unallocated*

Total

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

$ 6,680,562

$ 5,556,455

$ 4,543,245

Cost of goods sold ..........................................

Gross profit ....................................................

Selling, general and Administrative* .................

Research and Development* ............................

3,824,866

2,855,696

1,241,502

4,123,833

1,432,622

581,517

2,122,153

2,421,092

1,888,043

1,460,085

512,259

$ 16,780,262

10,070,852

6,709,410

5,171,147

512,259

Income (loss) from Operations .........................

$ 1,614,194

851,105

533,049

$ (1,972,344)

1,026,004

For the year ended December 31, 2010 (previous segment method):

Domestic

Export

IKONICS Imaging

Unallocated*

Total

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

$ 6,653,723

$ 5,420,601

$ 4,443,014

Cost of goods sold ..........................................

Gross profit ....................................................

Selling, general and Administrative* .................

Research and Development* ............................

3,497,971

3,155,752

973,623

3,792,335

1,628,266

571,826

2,422,748

2,020,266

1,128,508

1,900,495

695,593

$ 16,517,338

9,713,054

6,804,284

4,574,452

695,593

Income (loss) from Operations .........................

$ 2,182,129

$ 1,056,440

891,758

$ (2,596,088)

1,534,239

For the year ended December 31, 2011 (new segment method):

Domestic

Export

IKONICS
Imaging

Other

Unallocated*

Total

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

6,680,562

5,556,445

3,582,268

960,977

Cost of goods sold .........................................

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

Selling, general and Administrative* .................

Research and Development* ............................

3,824,866

2,855,696

1,241,502

4,123,833

1,432,622

581,517

1,718,846

1,863,422

1,136,907

403,307

557,670

751,136

1,460,085

512,259

$ 16,780,262

10,070,852

6,709,410

5,171,147

512,259

Income (loss) from Operations ........................

1,614,194

851,105

726,515

(193,466)

(1,972,344)

1,026,004

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

Accounts receivable related to the “Other” segment are included in IKONICS Imaging. Accounts receivable by segment as of December 31, 2011 and December 31, 2010
were as follows:

2011

2010

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

997,937

874,535

Export ............................................................

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

Other, net of allowances ..................................

783,788

427,252

(28,030)

725,007

325,334

(41,448)

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

$ 2,180,947

$ 1,883,428

6. STOCK OPTIONS

Black-Scholes option pricing model with the following assumptions:

The Company has a stock incentive plan for the issuance of up to 442,750 shares
of common stock. 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
three year period. A total of 119,823 shares of common stock are reserved for ad-
ditional grants of options under the plan at December 31, 2011.

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

2011

Expected volatility ..................................... 40.5%- 41.3%

2010

45.2%

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

Five years

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

1.0% - 2.0%

Fair values of each option on grant date .....

$2.75 - $2.83

2.5%

$3.08

Under the plan, the Company charged compensation cost of $26,690 and $29,417
against income in 2011 and 2010, respectively.

There were 9,000 options and 4,000 options granted during 2011 and 2010,
respectively.

As of December 31, 2011, there was approximately $32,000 of unrecognized
compensation cost related to unvested share-based compensation awards granted
which is expected to be recognized over the next three years.

Proceeds from the exercise of stock options were $73,210 for 2011 and $37,740
for 2010.

The fair value of options granted during 2011 and 2010 were estimated using the

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 2%.

A summary of the status of the Company’s stock option plan as of December 31, 2011 and changes during the year then ended is presented below:

Options

Outstanding at January 1, 2011

Granted

Exercised

Expired and Forfeited

Outstanding at December 31, 2011

Vested or expected to vest at December 31, 2011

Exercisable at December 31, 2011

Weighted Average Exercise Price

Contractual Term (years)

Aggregate Intrinsic Value

Weighted Average Remaining

40,500

9,000

(11,500)

(3,250)

34,750

16,916

6.38

7.66

6.37

7.82

6.58

6.50

2.75

1.92

45,695

24,111

The weighted-average grant date fair value of options granted was $2.82 and $3.08 for the years ended December 31, 2011 and 2010, respectively. The total intrinsic
value of options exercised was $20,687 for the year ended December 31, 2011 and $24,945 for the year ended December 31, 2010.

The following table summarizes information about stock options outstanding at December 31, 2011:

Range of Exercise Price

Number Outstanding at

Weighted-Average Remain-

Weighted-Average Exercise

Number Exercisable at

Weighted-Average Exercise

December 31, 2011

ing Contractual Life (years)

Price

December 31, 2011

Price

Options Outstanding

Options Exercisable

13,000

4,250

17,500

34,750

2.31

1.58

3.36

2.75

5.00

6.71

7.73

6.58

6,500

4,250

6,166

16,916

5.00

6.71

7.95

6.50

$5.00-$5.99

$6.00-$6.99

$7.00-$8.99

IKONICS CORPORATION | 2011 ANNUAL REPORT7. CONCENTRATION OF CREDIT RISK

The Company maintains its cash balances primarily at one financial institution in a partially 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 cus-
tomer 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. 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 30, is col-
lateralized 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, 2011 and 2010. There are no financial covenants related to the line of credit.

COMMON STOCK

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 informa-
tion avail able 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 26, 2012 1:00 p.m.

Kitchi Gammi Club
831 E. Superior Street
Duluth, MN 55802

IKONICS Corporation common stock is traded on the Nasdaq Capital Market under
the symbol IKNX. For investment and stock information contact:

JON GERLACH
Chief Financial Officer

IKONICS Corporation
4832 Grand Avenue, Duluth, MN 55807
Phone: (218) 628-2217
email: jgerlach@ikonics.com

TRANSFER AGENT

WELLS FARGO SHAREOWNER SERVICES
PO Box 64854
St. Paul, MN 55164-0854

Shareholders with questions on stock holdings, transfer requirements and address
changes contact Wells Fargo Bank at: (800) 468-9716

AUDITOR

MCGLADREY & PULLEN LLP
801 Nicolet Mall, Suite 110 West Tower
Minneapolis, MN 55802
(612) 573-8750

COUNSEL

HANFT FRIDE
1000 U.S. Bank Place
130 W. Superior Street
Duluth, MN 55802
(218) 722-4766

board of directorS

corporate officerS

DAVID O. HARRIS

President

David O. Harris, Inc

Minneapolis, MN

WILLIAM C. ULLAND

Chairman, President & CEO

Director Since 1965

CLAUDE PIGUET

Executive Vice President

JON GERLACH

Vice President, Finance, CFO

PARNELL THILL

Vice President, Marketing

ROBERT D. BANKS

Vice President, International

RONDI C. ERICKSON

Co-Owner

Nokomis Restaurant

Duluth, MN

Director Since 2000

LOCKWOOD CARLSON

President

Carlson Consulting Group

Minneapolis, MN

Director Since 2009

CHARLES H. ANDRESEN

Attorney

Andresen & Butterworth P.A.

Duluth, MN

Director Since 1979

H. LEIGH SEVERANCE

President

Severance Capital Management

Denver, CO

Director Since 2000

GERALD W. SIMONSON

President

Omnetics Connector Corporation

Minneapolis, MN

Director Since 1978

WILLIAM C. ULLAND

Chairman, President & CEO

IKONICS Corporation

Duluth, MN

Director Since 1972

IKONICS CORPORATION | 2011 ANNUAL REPORT$18,000,000

$16,000,000

$14,000,000

$12,000,000

$10,000,000

$8,000,000

$6,000,000

$4,000,000

$2,000,000

Net Sales 2007 - 2011

Net Income (Loss) 2007 - 2011

$1,400,000

$1,200,000

$1,000,000

$800,000

$600,000

$400,000

$200,000

- $200,000

- $400,000

2007

2008

2009

2010

2011

2007

2008

2009

2010

2011

IKONICS Five-Year History

2007

2008

2009

2010

2011

Net Sales

Pretax Income (Loss)

Net Income (Loss)

$15,824,725

$15,854,484

$15,121,617

$16,517,338

$16,780,262

$1,635,775

$1,085,134

$(11,360)

$1,553,920

$1,043,257

$1,169,775

$814,134

$(307,360)

$1,113,920

$698,257

Net Cash Provided by Operations

$1,697,695

$1,125,668

$1,374,114

$1,601,369

$793,532

Return on Sales

Return on Assets

Return on Avg. Stockholders' Equity

Debt to Equity

Diluted EPS

Stock price: High

Low

7.4%

9.8%

11.2%

8.5%

$0.57

$10.45

$7.22

$9.28

5.1%

6.5%

7.2%

9.2%

$0.40

$10.50

$5.25

$5.74

(2.0%)

(2.6%)

(2.7%)

8.8%

$(0.16)

$8.29

$4.00

$6.30

6.7%

8.5%

9.6%

7.8%

$0.56

$8.00

$6.30

$7.25

4.2%

4.9%

5.5%

9.1%

$0.35

$8.94

$6.90

$7.57

Weighted Average Common Shares Outstanding - Diluted

2,063,380

2,053,733

1,973,739

1,973,447

1,986,041

Total Assets

Total Liabilities

Total Stockholders' Equity

Capital Spending

$11,982,417

$12,486,429

$11,997,272

$13,141,931

$14,167,458

$936,703

$1,052,789

$971,186

$948,984

$1,176,915

$11,045,714

$11,433,640

$11,026,086

$12,192,947

$12,990,543

$609,772

$4,472,681

$90,313

$189,150

$621,598

4832 Grand Avenue Duluth, MN 55807 ph: (218) 628-2217 toll-free: (800) 328-4261 e: info@ikonics.com web: www.ikonics.com