10-Q 1 iknx-20160930x10q.htm 10-Q iknx_Current_Folio_10Q_for_Q2_Q3

 

 

U.S. SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

 

FORM 10-Q

(Mark One)

 

Quarterly Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934

 

For the Quarterly Period Ended September 30, 2016

 

or

 

Transition Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934

 

For the Transition Period From                                to                                 .

 

Commission file number 000-25727

 

IKONICS CORPORATION

(Exact name of registrant as specified in its charter)

 

Minnesota

 

41-0730027

(State or other jurisdiction of

incorporation or organization)

 

(I.R.S. employer

identification no.)

 

 

 

4832 Grand Avenue

Duluth, Minnesota

 

55807

(Address of principal executive offices)

 

(Zip code)

 

(218) 628-2217

Registrant’s telephone number

 

Not Applicable

(Former name, former address and former fiscal year, if changed since last report)

 

Check whether the issuer (1) filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.  Yes ☒  No ☐

 

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files.)  Yes ☒  No ☐

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).  Yes ☐  No ☒

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

 

Large accelerated filer ☐

 

Accelerated filer ☐

Non-accelerated filer (Do not check if a smaller reporting company) ☐

 

Smaller reporting company ☒

 

State the number of shares outstanding of each of the issuer’s classes of common equity, as of the latest practicable date: Common Stock, $.10 par value per share - 2,018,753 shares outstanding as of November 5, 2016.

 

 

 

 

 


 

IKONICS Corporation

 

QUARTERLY REPORT ON FORM 10-Q

 

 

 

PAGE NO.

PART I. 

FINANCIAL INFORMATION

 

 

 

 

Item 1. 

 

Condensed Financial Statements:

 

 

 

 

 

 

 

Condensed Balance Sheets as of September 30, 2016 (unaudited) and December 31, 2015

 

 

 

 

 

 

Condensed Statements of Operations for the Three Months and Nine Months Ended September 30, 2016 and 2015 (unaudited)

 

 

 

 

 

 

Condensed Statements of Cash Flows for the Nine Months Ended September 30, 2016 and 2015 (unaudited)

 

 

 

 

 

 

Notes to Condensed Financial Statements (unaudited)

 

 

 

 

Item 2. 

 

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

12 

 

 

 

 

Item 3. 

 

Quantitative and Qualitative Disclosures about Market Risk

19 

 

 

 

 

Item 4. 

 

Controls and Procedures

19 

 

 

 

PART II. 

OTHER INFORMATION

20 

 

 

 

 

SIGNATURES

21 

 

 

 

 

2


 

PART I - FINANCIAL INFORMATION

 

ITEM 1.  Condensed Financial Statements

 

IKONICS CORPORATION

CONDENSED BALANCE SHEETS

 

 

 

 

 

 

 

 

 

 

September 30,

 

December 31,

 

 

    

2016

  

2015

 

 

 

 

(unaudited)

 

 

 

 

ASSETS

 

 

 

 

 

 

 

CURRENT ASSETS:

 

 

 

 

 

 

 

Cash and cash equivalents

 

$

917,032

 

$

2,248,466

 

Short-term investments

 

 

3,399,000

 

 

 —

 

Trade receivables, less allowance of $52,000 in 2016 and $122,000 in 2015

 

 

2,154,232

 

 

2,165,194

 

Inventories

 

 

2,079,133

 

 

2,119,805

 

Prepaid expenses and other assets

 

 

178,521

 

 

85,648

 

Income taxes receivable

 

 

71,779

 

 

102,778

 

Total current assets

 

 

8,799,697

 

 

6,721,891

 

PROPERTY, PLANT, AND EQUIPMENT, at cost:

 

 

 

 

 

 

 

Land and building

 

 

9,189,743

 

 

6,391,555

 

Machinery and equipment

 

 

4,904,353

 

 

4,275,910

 

Office equipment

 

 

1,157,909

 

 

933,596

 

Vehicles

 

 

272,144

 

 

272,141

 

Construction in progress

 

 

398,725

 

 

2,491,432

 

 

 

 

15,922,874

 

 

14,364,634

 

Less accumulated depreciation

 

 

(6,892,090)

 

 

(6,407,304)

 

 

 

 

9,030,784

 

 

7,957,330

 

INTANGIBLE ASSETS, less accumulated amortization of $142,593 in 2016 and $123,957 in 2015

 

 

343,302

 

 

336,096

 

 

 

$

18,173,783

 

$

15,015,317

 

LIABILITIES AND STOCKHOLDERS' EQUITY

 

 

 

 

 

 

 

CURRENT LIABILITIES

 

 

 

 

 

 

 

Current portion of long-term debt

 

$

126,419

 

$

 —

 

Accounts payable

 

 

 

 

 

 

 

Trade

 

 

747,241

 

 

420,245

 

Construction

 

 

8,778

 

 

333,339

 

Accrued compensation

 

 

253,228

 

 

350,518

 

Other accrued liabilities

 

 

97,192

 

 

31,000

 

Total current liabilities

 

 

1,232,858

 

 

1,135,102

 

LONG-TERM LIABILITIES

 

 

 

 

 

 

 

Long-term debt, less current portion

 

 

3,109,647

 

 

 —

 

Deferred income taxes

 

 

385,000

 

 

385,000

 

Total long-term liabilities

 

 

3,494,647

 

 

385,000

 

Total liabilities

 

 

4,727,505

 

 

1,520,102

 

COMMITMENTS AND CONTINGENCIES

 

 

 

 

 

 

 

STOCKHOLDERS’ EQUITY

 

 

 

 

 

 

 

Preferred stock, par value $.10 per share; authorized 250,000 shares; none issued

 

 

 —

 

 

 —

 

Common stock, par value $.10 per share; authorized 4,750,000 shares; issued and outstanding 2,018,753 shares in 2016 and 2,018,253 in 2015

 

 

201,875

 

 

201,825

 

Additional paid-in-capital

 

 

2,725,384

 

 

2,703,050

 

Retained earnings

 

 

10,519,019

 

 

10,590,340

 

Total stockholders’ equity

 

 

13,446,278

 

 

13,495,215

 

 

 

$

18,173,783

 

$

15,015,317

 

 

See notes to condensed financial statements.

3


 

 

IKONICS CORPORATION

CONDENSED STATEMENTS OF OPERATIONS (Unaudited)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

    

Three Months Ended

 

Nine Months Ended

 

 

    

September 30,

 

September 30,

 

 

    

2016

    

2015

    

2016

    

2015

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

NET SALES

 

$

4,607,501

 

$

4,542,730

 

$

12,817,289

 

$

12,794,167

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

COST OF GOODS SOLD

 

 

2,940,027

 

 

2,925,062

 

 

8,330,930

 

 

8,436,082

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

GROSS PROFIT

 

 

1,667,474

 

 

1,617,668

 

 

4,486,359

 

 

4,358,085

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

SELLING, GENERAL AND ADMINISTRATIVE EXPENSES

 

 

1,357,605

 

 

1,270,466

 

 

4,121,891

 

 

3,938,584

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

RESEARCH AND DEVELOPMENT EXPENSES

 

 

150,176

 

 

157,814

 

 

475,165

 

 

506,197

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

INCOME (LOSS) FROM OPERATIONS

 

 

159,693

 

 

189,388

 

 

(110,697)

 

 

(86,696)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

INTEREST EXPENSE

 

 

(21,721)

 

 

 —

 

 

(36,720)

 

 

 —

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

OTHER

 

 

4,519

 

 

825

 

 

6,681

 

 

4,031

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

INCOME (LOSS) BEFORE INCOME TAXES

 

 

142,491

 

 

190,213

 

 

(140,736)

 

 

(82,665)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

INCOME TAX EXPENSE (BENEFIT)

 

 

60,225

 

 

73,457

 

 

(69,415)

 

 

1,802

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

NET INCOME (LOSS)

 

$

82,266

 

$

116,756

 

$

(71,321)

 

$

(84,467)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

INCOME (LOSS) PER COMMON SHARE:

 

 

 

 

 

 

 

 

 

 

 

 

 

Basic

 

$

0.04

 

$

0.06

 

$

(0.04)

 

$

(0.04)

 

Diluted

 

$

0.04

 

$

0.06

 

$

(0.04)

 

$

(0.04)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

WEIGHTED AVERAGE COMMON SHARES OUTSTANDING

 

 

 

 

 

 

 

 

 

 

 

 

 

Basic

 

 

2,018,753

 

 

2,018,253

 

 

2,018,614

 

 

2,018,253

 

Diluted

 

 

2,018,842

 

 

2,018,574

 

 

2,018,614

 

 

2,018,253

 

 

See notes to condensed financial statements.

4


 

IKONICS CORPORATION

CONDENSED STATEMENTS OF CASH FLOWS (Unaudited)

 

 

 

 

 

 

 

 

 

 

    

Nine Months Ended

 

 

 

September 30,

 

 

 

2016

    

2015

 

 

 

 

 

 

 

 

 

CASH FLOWS FROM OPERATING ACTIVITIES:

 

 

 

 

 

 

 

Net loss

 

$

(71,321)

 

$

(84,467)

 

Adjustments to reconcile net loss to net cash provided by operating activities:

 

 

 

 

 

 

 

Depreciation

 

 

552,885

 

 

490,275

 

Amortization

 

 

24,094

 

 

18,831

 

Stock based compensation

 

 

18,384

 

 

16,088

 

Net gain on sale and disposal of property, plant and equipment

 

 

(5,750)

 

 

 —

 

Loss on intangible asset abandonment

 

 

 —

 

 

45,873

 

Changes in working capital components:

 

 

 

 

 

 

 

Trade receivables

 

 

10,962

 

 

(186,283)

 

Inventories

 

 

40,672

 

 

352,289

 

Prepaid expenses and other assets

 

 

(92,873)

 

 

(18,354)

 

Income tax receivable

 

 

31,234

 

 

(9,099)

 

Accounts payable

 

 

326,996

 

 

80,632

 

Accrued expenses

 

 

(31,098)

 

 

91,007

 

Net cash provided by operating activities

 

 

804,185

 

 

796,792

 

 

 

 

 

 

 

 

 

CASH FLOWS FROM INVESTING ACTIVITIES:

 

 

 

 

 

 

 

Purchases of property, plant, equipment and construction in progress

 

 

(1,966,150)

 

 

(1,195,840)

 

Proceeds from sales of equipment

 

 

21,000

 

 

 —

 

Purchases of intangibles

 

 

(25,842)

 

 

(41,639)

 

Purchases of short-term investments

 

 

(3,399,000)

 

 

(650,000)

 

Proceeds on sale of short-term investments

 

 

 —

 

 

2,191,000

 

Net cash provided by (used in) investing activities

 

 

(5,369,992)

 

 

303,521

 

 

 

 

 

 

 

 

 

CASH FLOWS FROM FINANCING ACTIVITIES:

 

 

 

 

 

 

 

Proceeds from long-term debt

 

 

3,415,000

 

 

 —

 

Payment of debt issuance costs

 

 

(139,418)

 

 

 —

 

Payments on long-term debt

 

 

(44,974)

 

 

 —

 

Proceeds from exercise of stock options

 

 

3,765

 

 

 —

 

Net cash provided by financing activities

 

 

3,234,373

 

 

 —

 

 

 

 

 

 

 

 

 

NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS

 

 

(1,331,434)

 

 

1,100,313

 

 

 

 

 

 

 

 

 

CASH AND CASH EQUIVALENTS AT BEGINNING OF PERIOD

 

 

2,248,466

 

 

1,936,214

 

 

 

 

 

 

 

 

 

CASH AND CASH EQUIVALENTS AT END OF PERIOD

 

$

917,032

 

$

3,036,527

 

 

 

 

 

 

 

 

 

SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION

 

 

 

 

 

 

 

Construction in progress included in construction accounts payable

 

$

8,778

 

$

569,843

 

 

 

 

 

 

 

 

 

SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION

 

 

 

 

 

 

 

Cash paid for interest

 

$

25,252

 

$

 —

 

Cash received (paid) for income taxes, net of  $12,807 taxes paid in 2016

 

$

100,649

 

$

(10,901)

 

 

See notes to condensed financial statements.

 

 

5


 

Table of Contents

IKONICS CORPORATION

 

NOTES TO CONDENSED FINANCIAL STATEMENTS

 

(Unaudited)

 

1.Basis of Presentation

 

The condensed balance sheet of IKONICS Corporation (the “Company”) as of September 30, 2016, and the related condensed statements of operations for the three and nine months ended September 30, 2016 and 2015, and cash flows for the nine months ended September 30, 2016 and 2015, have been prepared without being audited.

 

In the opinion of management, these statements reflect all adjustments (consisting of only normal recurring adjustments) necessary to present fairly the financial position of IKONICS Corporation as of September 30, 2016, and the results of operations and cash flows for all periods presented.

 

Certain information and footnote disclosures normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States of America, have been condensed or omitted.  Therefore, these statements should be read in conjunction with the financial statements and notes thereto included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2015.

 

The results of operations for interim periods are not necessarily indicative of results that will be realized for the full fiscal year.

 

For comparability, certain 2015 amounts related to deferred tax assets and liabilities have been reclassified to conform with classifications adopted in 2016.  The reclassifications had no impact on net loss or stockholders’ equity.

 

2.Short-Term Investments

 

The Company’s $3,399,000 of short-term investments at September 30, 2016 is comprised of fifteen fully insured certificates of deposit with original maturities ranging from six to twelve months and interest rates ranging from 0.45% to 0.65%

 

3.Inventories

 

The major components of inventories are as follows:

 

 

 

 

 

 

 

 

 

 

    

Sep 30, 2016

    

Dec 31, 2015

 

 

 

 

 

 

 

 

 

Raw materials

 

$

1,606,841

 

$

1,640,098

 

Work-in-progress

 

 

364,879

 

 

375,229

 

Finished goods

 

 

1,255,502

 

 

1,336,707

 

Reduction to LIFO cost

 

 

(1,148,089)

 

 

(1,232,229)

 

 

 

 

 

 

 

 

 

Total Inventories

 

$

2,079,133

 

$

2,119,805

 

 

 

4.Earnings Per Common Share (EPS)

 

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

 

6


 

Table of Contents

IKONICS CORPORATION

 

NOTES TO CONDENSED FINANCIAL STATEMENTS

 

(Unaudited)

 

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

 

 

 

 

 

 

 

 

 

Three Months Ended

 

 

    

Sep 30, 2016

    

Sep 30, 2015

  

 

 

 

 

 

 

Weighted average common shares outstanding

 

2,018,753

 

2,018,253

 

Dilutive effect of stock options

 

89

 

321

 

Weighted average common and common equivalent shares outstanding

 

2,018,842

 

2,018,574

 

 

 

 

 

 

 

 

 

 

 

Nine Months Ended

 

 

    

Sep 30, 2016

    

Sep 30, 2015

  

 

 

 

 

 

 

Weighted average common shares outstanding

 

2,018,614

 

2,018,253

 

Dilutive effect of stock options

 

 —

 

 —

 

Weighted average common and common equivalent shares outstanding

 

2,018,614

 

2,018,253

 

 

For the three months ended September 30, 2016, options to purchase 11,418 shares of common stock with a weighted average price of $15.99 were outstanding but were excluded from the computation of common share equivalents because they were anti-dilutive. For the three months ended September 30, 2015, options to purchase 8,500 shares of common stock with a weighted average price of $17.16 were outstanding but were excluded from the computation of common share equivalents because they were anti-dilutive.

 

If the Company was in a net income position for the first nine months of 2016, 4,750 options with a weighted average exercise price of $10.58 would have been included as part of the weighted average common and common equivalent shares outstanding as the options would have been dilutive, while 11,418 options with a weighted average exercise price of $15.99 would have remained excluded as the options were anti-dilutive.    

 

If the Company was in a net income position for the first nine months of 2015, 5,918 options with a weighted average exercise price of $12.49 would have been included as part of the weighted average common and common equivalent shares outstanding as the options would have been dilutive while 6,250 options with a weighted average exercise price of $18.28 would have remained excluded as the options were anti-dilutive.  

 

 

5.Stock-Based Compensation

 

The Company maintains a stock incentive plan which authorizes the issuance of up to 442,750 shares of common stock. Of those shares, 16,168 were subject to outstanding options and 104,239 were reserved for future grants at September 30, 2016. 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 the 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.

 

The Company charged compensation cost of approximately $6,600 against income for the three months ended September 30, 2016 and approximately $5,700 for the three months ended September 30, 2015. For the first nine months of 2016, the Company charged compensation cost of approximately $18,400 and approximately $16,100 for the same period in 2015.  As of September 30, 2016, there was approximately $39,500 of

7


 

Table of Contents

IKONICS CORPORATION

 

NOTES TO CONDENSED FINANCIAL STATEMENTS

 

(Unaudited)

 

unrecognized compensation cost related to unvested share-based compensation awards. That cost is expected to be recognized over the next three years.

 

The Company receives a tax deduction for certain stock option exercises during the period in which the options are exercised, generally for the excess of the market price at the time the stock options are exercised over the exercise price of the options, which increases additional paid in capital and reduces income taxes payable.

 

Proceeds from the exercise of 500 stock options were approximately $4,000 for the nine months ended September 30, 2016. No stock options were exercised during the nine months ended September 30, 2015.

 

The fair value of options granted during the nine months ended September 30, 2016 and 2015 was estimated using the Black-Scholes option pricing model with the following assumptions:

 

 

 

 

 

 

 

 

    

2016

    

2015

 

Dividend yield

 

0%

 

0%

 

Expected volatility

 

42.4%

 

42.3% - 42.4%

 

Expected life of option

 

Five Years

 

Five Years

 

Risk-free interest rate

 

1.3%

 

1.4% - 1.5%

 

Fair value of each option on grant date

 

$ 4.02

 

$5.43 - $6.14

 

 

There were 4,500 and 7,250 options granted during each of the nine months ended September 30, 2016 and 2015, respectively. 

 

Stock option activity during the nine months ended September 30, 2016 was as follows:

 

 

 

 

 

 

 

 

 

    

 

    

 

 

 

 

 

 

 

Weighted

 

 

 

 

 

Average

 

 

 

 

 

Exercise

 

 

    

Shares

    

Price

 

Outstanding at January 1, 2016

 

12,168

 

$

15.47

 

Granted

 

4,500

 

 

10.75

 

Exercised

 

(500)

 

 

7.53

 

Outstanding at September 30, 2016

 

16,168

 

$

14.40

 

Exercisable at September 30, 2016

 

6,417

 

$

15.41

 

 

The aggregate intrinsic value of all options outstanding and for those exercisable at September 30, 2016 was approximately $4,000 and $1,000, respectively.

 

 

6.Long-Term Debt

 

On April 1, 2016, the Company entered into a financing agreement (the “Financing Agreement”) under which the Duluth Economic Development Authority (the “Issuer”) agreed to sell $3,415,000 of its Tax Exempt Industrial Revenue Bonds, Series 2016 (IKONICS Project) (the “Bonds”) to Wells Fargo Bank, National Association (the “Bank”), and the Bank agreed to lend to the Company the proceeds received from the sale of the Bonds (the “Loan”).

 

8


 

Table of Contents

IKONICS CORPORATION

 

NOTES TO CONDENSED FINANCIAL STATEMENTS

 

(Unaudited)

 

The closing of the sale of the Bonds occurred on April 29, 2016. The proceeds from the Loan were used to finance the construction of  a 27,300-square foot building as well as related equipment for use in the Company’s manufacture of sound deadening technology used in the aerospace industry and products consisting of etched composites, ceramics, glass and silicon wafers, to be located in Duluth, Minnesota (the “Project”).

 

The Loan requires monthly payments of approximately $18,000, including interest. The Loan bears interest at a rate of 2.14% per year, payable monthly, and matures on April 1, 2041. Including debt costs of approximately $139,000, the Loan’s effective interest rate is 2.77% per year.

 

The Loan is subject to mandatory purchase provisions, under which any owners of the Bonds (the “Owners”) may tender the Bonds to the Issuer on April 1, 2021, which would result in the Company repaying the outstanding loan principal and any outstanding accrued and unpaid interest to the Issuer at that time. If in the event the Bonds are not repurchased on April 1, 2021, the Bonds shall be subject to the interest rate and redemption provisions set forth in the associated covenant agreement.

 

Subject to limitations in the associated covenant agreement, the Company may cause a redemption of the Bonds, in whole or in part, in authorized denominations at the redemption prices set forth in the Financing Agreement, together with any accrued or unpaid interest to the date of redemption. The Bonds are also subject to redemption in whole in the event of certain extraordinary events related to the Project.

 

The Company is subject to certain customary covenants set forth in the associated covenant agreement, including a requirement that the Company maintain a debt service coverage ratio as of the end of each calendar quarter of not less than 1.25 to 1.00 on a rolling four-quarter basis.

 

The remaining principal payments required under the agreement for years ended December 31, and the current and long‑term portion of the principal, are as follows:

 

 

 

 

 

 

2016

    

$

35,000

 

2017

 

 

140,000

 

2018

 

 

143,000

 

2019

 

 

146,000

 

2020

 

 

149,000

 

Thereafter

 

 

2,757,000

 

Total Principal

 

 

3,370,000

 

Less: Unamortized debt issuance costs

 

 

134,000

 

Less: Current portion

 

 

126,000

 

Long-term portion

 

$

3,110,000

 

 

In connection with the agreement, the Company incurred debt issuance costs of approximately $139,000 during the nine months ended September 30, 2016, which were deferred and are being amortized over the term of the Financing Agreement. Amortization of debt issuance costs was approximately $5,000 for the nine months ended September 30, 2016 and is included in interest expense. Debt issuance costs of $121,000 and $13,000 are netted against long-term debt and current portion of long‑term debt, respectively as of September 30, 2016. Amortization of debt costs is expected to be approximately $3,000 for the remainder of 2016 and approximately $12,000 annually for each of the next four years.

 

In addition to the $3,415,000 in indebtedness pursuant to the Loan, the Company has a bank line of credit providing for borrowings of up to $2,050,000, expiring on May 31, 2017 that bears interest at 1.8 percentage

9


 

Table of Contents

IKONICS CORPORATION

 

NOTES TO CONDENSED FINANCIAL STATEMENTS

 

(Unaudited)

 

points over the 30‑day LIBOR rate.  The Company did not utilize this line of credit during the first nine months of 2016 or 2015 and there were no borrowings outstanding as of September 30, 2016 and December 31, 2015.  There are no financial covenants related to the line of credit.

 

Both the $3,415,000 financing pursuant to the Loan and the line of credit are collateralized by substantially all assets of the Company.

 

 

7.Segment Information

 

The Company’s reportable segments are strategic business units that offer different products and have varied customer bases.  There are five reportable segments:  Domestic, Export, IKONICS Imaging, Digital Texturing (DTX) and Advanced Material Solutions (AMS).  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.  AMS provides sound deadening and weight reduction technology to the aerospace industry along with products and services for etched composites, ceramics, glass and silicon wafers.  DTX includes products and customers related to patented and proprietary inkjet technology used for mold texturing and prototyping. Export sells primarily the same products as Domestic and the IKONICS Imaging products not related to AMS or DTX. The accounting policies applied to determine the segment information are the same as those described in the Company’s Annual Report on Form 10-K for the year ended December 31, 2015.

 

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

 

For the three months ended September 30, 2016:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

IKONICS

 

 

 

 

 

 

 

 

 

 

IKONICS

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Domestic

 

Export

 

Imaging

 

DTX

 

AMS

 

Unalloc.

 

Total

 

Net sales

 

$

1,981,212

 

$

1,273,923

 

$

879,712

 

$

195,890

 

$

276,764

 

$

 

$

4,607,501

 

Cost of goods sold

 

 

1,115,507

 

 

956,953

 

 

413,385

 

 

49,924

 

 

404,258

 

 

 

 

2,940,027

 

Gross profit (loss)

 

 

865,705

 

 

316,970

 

 

466,327

 

 

145,966

 

 

(127,494)

 

 

 

 

1,667,474

 

Selling, general and administrative*

 

 

330,578

 

 

169,858

 

 

260,810

 

 

35,595

 

 

94,993

 

 

465,771

 

 

1,357,605

 

Research and development*

 

 

 

 

 

 

 

 

 

 

 

 

150,176

 

 

150,176

 

Income (loss) from operations

 

$

535,127

 

$

147,112

 

$

205,517

 

$

110,371

 

$

(222,487)

 

$

(615,947)

 

$

159,693

 

 

For the three months ended September 30, 2015:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

IKONICS

 

 

 

 

 

 

 

 

 

 

IKONICS

 

 

 

 

 

 

 

 

 

 

 

 

 

 

    

Domestic

 

Export

 

Imaging

 

DTX

 

AMS

 

Unalloc.

 

Total

 

Net sales

 

$

1,924,930

 

$

1,367,780

 

$

892,811

 

$

188,074

 

$

169,135

 

$

 —

 

$

4,542,730

 

Cost of goods sold

 

 

1,115,154

 

 

1,038,354

 

 

398,520

 

 

71,986

 

 

301,048

 

 

 —

 

 

2,925,062

 

Gross profit (loss)

 

 

809,776

 

 

329,426

 

 

494,291

 

 

116,088

 

 

(131,913)

 

 

 

 

1,617,668

 

Selling, general and administrative*

 

 

321,810

 

 

147,370

 

 

259,976

 

 

44,649

 

 

78,986

 

 

417,675

 

 

1,270,466

 

Research and development*

 

 

 —

 

 

 —

 

 

 —

 

 

 —

 

 

 —

 

 

157,814

 

 

157,814

 

Income (loss) from operations

 

$

487,966

 

$

182,056

 

$

234,315

 

$

71,439

 

$

(210,899)

 

$

(575,489)

 

$

189,388

 

 

10


 

Table of Contents

IKONICS CORPORATION

 

NOTES TO CONDENSED FINANCIAL STATEMENTS

 

(Unaudited)

 

For the nine months ended September 30, 2016:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

IKONICS

 

 

 

 

 

 

 

 

 

 

IKONICS

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Domestic

 

Export

 

Imaging

 

DTX

 

AMS

 

Unalloc.

 

Total

 

Net sales

 

$

5,278,456

 

$

3,470,693

 

$

2,997,006

 

$

306,246

 

$

764,888

 

$

 

$

12,817,289

 

Cost of goods sold

 

 

3,067,112

 

 

2,654,611

 

 

1,378,287

 

 

120,410

 

 

1,110,510

 

 

 

 

8,330,930

 

Gross profit (loss)

 

 

2,211,344

 

 

816,082

 

 

1,618,719

 

 

185,836

 

 

(345,622)

 

 

 

 

4,486,359

 

Selling, general and administrative*

 

 

1,034,975

 

 

472,510

 

 

759,863

 

 

109,968

 

 

322,182

 

 

1,422,393

 

 

4,121,891

 

Research and development*

 

 

 

 

 

 

 

 

 

 

 

 

475,165

 

 

475,165

 

Income (loss) from operations

 

$

1,176,369

 

$

343,572

 

$

858,856

 

$

75,868

 

$

(667,804)

 

$

(1,897,558)

 

$

(110,697)

 

 

For the nine months ended September 30, 2015:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

IKONICS

 

 

 

 

 

 

 

 

 

 

IKONICS

 

 

 

 

 

 

 

 

 

 

 

 

 

 

    

Domestic

    

Export

    

Imaging

    

DTX

    

AMS

    

Unalloc.

    

Total

 

Net sales

 

$

5,414,229

 

$

3,823,195

 

$

2,777,684

 

$

385,130

 

$

393,929

 

$

 —

 

$

12,794,167

 

Cost of goods sold

 

 

3,163,486

 

 

2,940,707

 

 

1,308,007

 

 

214,080

 

 

809,802

 

 

 —

 

 

8,436,082

 

Gross profit (loss)

 

 

2,250,743

 

 

882,488

 

 

1,469,677

 

 

171,050

 

 

(415,873)

 

 

 

 

4,358,085

 

Selling, general and administrative*

 

 

961,707

 

 

439,361

 

 

758,399

 

 

134,892

 

 

256,645

 

 

1,387,580

 

 

3,938,584

 

Research and development*

 

 

 —

 

 

 —

 

 

 —

 

 

 —

 

 

 —

 

 

506,197

 

 

506,197

 

Income (loss) from operations

 

$

1,289,036

 

$

443,127

 

$

711,278

 

$

36,158

 

$

(672,518)

 

$

(1,893,777)

 

$

(86,696)

 

 


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

 

Trade receivables by segment as of September 30, 2016 and December 31, 2015 were as follows:

 

 

 

 

 

 

 

 

 

 

    

Sep 30, 2016

    

Dec 31, 2015

 

 

 

 

 

 

 

 

 

Domestic

 

$

1,094,858

 

$

1,206,077

 

Export

 

 

467,452

 

 

528,372

 

IKONICS Imaging

 

 

327,855

 

 

341,980

 

DTX

 

 

52,039

 

 

26,314

 

AMS

 

 

242,749

 

 

164,639

 

Unallocated

 

 

(30,721)

 

 

(102,188)

 

 

 

 

 

 

 

 

 

Total

 

$

2,154,232

 

$

2,165,194

 

 

 

8.Income Taxes

 

The Company reports a liability for unrecognized tax benefits taken or expected to be taken when they are uncertain.  As of September 30, 2016 and December 31, 2015, there was no liability for unrecognized tax benefits.

 

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, in each case for tax years 2013, 2014, and 2015.

 

 

11


 

IKONICS CORPORATION

 

The information presented below in Management’s Discussion and Analysis of Financial Condition and Results of Operations contains forward-looking statements within the meaning of the safe harbor provisions of Section 21E of the Securities Exchange Act of 1934, as amended.  Statements that are not historical or current facts, including statements about beliefs and expectations, are forward-looking statements. These forward-looking statements include statements relating to our future plans and objectives and results. Such statements are subject to risks and uncertainties, including those discussed elsewhere in this report and under the heading “Risk Factors” in Part I, Item 1A of our Annual Report on Form 10-K for the year ended December 31, 2015, as updated in our subsequent reports filed with the SEC, which could cause actual results to differ materially from those projected.  Because actual results may differ, readers are cautioned not to place undue reliance on these forward-looking statements.

 

ITEM 2.  Management’s Discussion and Analysis of Financial Condition and Results of Operations

 

The following management’s discussion and analysis focuses on those factors that had a material effect on the Company’s financial results of operations during the third quarter of 2016 and first nine months of 2016, as well as the same periods of 2015.  It should be read in connection with the Company’s condensed unaudited financial statements and notes thereto included in this Form 10-Q.

 

Critical Accounting Estimates

 

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:

 

Trade Receivables.  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 trade receivables 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 the Financial Accounting Standards Board (“FASB”) ASC 830, Foreign Currency Matters.  The Company also maintains a provision for any customer related returns based upon historical experience of actual returns and any specifically identified product issues, refunds or credits.

 

Inventories.  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.

 

Income 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.  The Company follows the accounting 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

12


 

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 recognized 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.

 

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 Staff Accounting Bulletin No. 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 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 customer has no rotation or price protection rights and the Company is not under a warranty obligation.  Freight billed to customers is included in sales.  Shipping costs are included in cost of goods sold.

 

Results of Operations

 

Quarter Ended September 30, 2016 Compared to Quarter Ended September 30, 2015

 

Sales.    The Company realized a 1.4% sales increase during the third quarter of 2016 with sales of $4.6 million, compared to $4.5 million in sales during the same period in 2015.  Third quarter sales were favorably impacted by an AMS sales increase due to growth from its composite machining.  AMS sales for the third quarter of 2016  increased by 63.6% from $169,000 in 2015 to $277,000.  Domestic sales also realized a 2.9% sales increase in the third quarter as sales grew from $1.9 million in 2015 to $2.0 million in 2016 mainly due to stronger emulsion sales.  DTX sales increased to $196,000 in the third quarter of 2016, a 4.2% increase over the same period in 2015.  Partially offsetting these sale increases was a $94,000, or 6.9%, decrease in Export sales for the third quarter of 2016 versus the same period in 2015 mainly related to weaker sales to both Asia and Latin America.    IKONICS Imaging also posted lower sales in the third quarter of 2016 with a 1.5%, or $13,000, sales decrease compared to the third quarter of 2015. 

 

Gross Profit.  Gross profit was $1.7 million, or 36.2% of sales, in the third quarter of 2016 compared to $1.6 million, or 35.6% of sales, for the same period in 2015.  The gross profit as a percentage of sales increased in third quarter of 2016 over the same period in 2015 due to improved sales mix.  Lower margin Export sales

13


 

comprised 27.6% of total 2016 third quarter sales compared to 30.1% of total sales in the third quarter of 2015.  The 2016 third quarter gross margin percentage was also favorably impacted by higher AMS sales volumes.   

 

Selling, General and Administrative Expenses.  Selling, general and administrative expenses were $1.4 million, or 29.5% of sales, in the third quarter of 2016 compared to $1.3 million, or 28.0% of sales, for the same period in 2015.    The increase in third quarter selling, general and administrative expense in 2016 versus the same period in 2015 is related to an increase in higher Exports sales expenses related to Asian markets along with an increase in travel costs. 

 

Research and Development Expenses.  Research and development expenses during the third quarter of 2016 were $150,000, or 3.3% of sales, versus $158,000, or 3.5% of sales, for the same period in 2015.  The lower 2016 third quarter costs were related to a decrease in production trial run expenses.

 

Interest Expense.  Interest expense for the third quarter of 2016 was $22,000.  The interest expense is related to a $3.4 million financing agreement the Company entered into during the second quarter of 2016 to finance the construction of a 27,300-square foot building as well as related equipment for use in the Company’s manufacture of sound deadening technology used in the aerospace industry and products consisting of etched composites, ceramics, glass and silicon wafers, to be located in Duluth, Minnesota.  See note 6 to the condensed financial statements for additional detail about the financing agreement.  There was no interest expense in 2015.

 

Income Taxes. For the third quarter of 2016, the Company realized income tax expense of $60,000, or an effective rate of 42.3%, versus income tax expense of $73,000, or an effective rate of 38.6%, for the third quarter of 2015.  The increase in the effective tax rate for the third quarter of 2016 over the third quarter of 2015 is primarily due to the lower earnings for the quarter, causing the non-deductible items to have a more significant rate impact. The income tax provision for the 2016 and 2015 periods differ from expected tax expense (benefit) due to unfavorable non-deductible items offset by the generation of research and development tax credits.

 

Nine Months Ended September 30, 2016 Compared to the Nine Months Ended September 30, 2015

 

Sales.  The Company’s sales during the first  nine months of 2016 of  $12.8 million were flat with sales for the first nine months of 2015.  AMS posted a $371,000, or 94.2%, sales increase due to growth for its composite machining.  IKONICS Imaging sales also increased by 7.9% for the period from $2.8 million in 2015 to $3.0 million in 2016, mainly related to the acquisition of a new customer.  Partially offsetting these sales increases was  a drop in Export sales.  Compared to the first nine months of 2015, Export sales for the same period in 2016 decreased $353,000, or 9.2%, as sales were down across all regions except for Europe.    Domestic also realized lower sales for the first nine months of 2016 with a $136,000, or 2.5%, sales decrease versus the first nine months of 2015 as sales were down across all product groups.  DTX sales decreased 20.5% from $385,000 in the first nine months of 2015 to $306,000 in the same period in 2016 due to a decrease in demand for film from its largest customer in the first quarter of 2016. 

 

Gross Profit.   Gross profit was $4.5 million, or 35% of sales, in the first nine months of 2016 compared to $4.4 million, or 34.1% of sales, for the same period in 2015.  IKONICS Imaging gross margin for 2016 was favorably impacted by higher sales volumes, and an increase in higher margin film sales as its nine-month gross margin percentage increased from 52.9% in 2015 to 54.0% in 2016.  Despite lower volumes, the DTX gross margin improved to 60.7% in the first nine months of 2016 from 44.4% in the comparable period of 2015 due to lower personnel and depreciation expenses while improved AMS sales volumes resulted in higher gross margins.  Domestic and Export gross margin percentages for the first nine months of 2016 also improved slightly compared to the same period in 2015.  Lower raw material costs resulted in Domestic’s gross margin improving from 41.6% in 2015 to 41.9% and Export’s gross margin improving to 23.5% in 2016 from 23.1% in  2015. 

 

Selling, General and Administrative Expenses.  Selling, general and administrative expenses were $4.1 million, or 32.2% of sales, in the first nine months of 2016 compared to $3.9 million, or 30.8% of sales, for the same period in 2015.  The increase in selling, general and administrative expenses reflects promotional and trade show expenses for both Domestic and AMS markets in addition to higher Exports sales expenses related to Asia.

 

14


 

Research and Development Expenses.    Research and development expenses during the first nine months of 2016 were $475,000, or 3.7% of sales, versus $506,000, or 4.0% of sales, for the same period in 2015. In 2015 the Company incurred a $46,000 expense related to the abandonment of 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.    

 

Interest Expense.  Interest expense for the first nine months of 2016 was $37,000.  The interest expense is related to a $3.4 million financing agreement the Company entered into during the second quarter of 2016 to finance the construction of a 27,300-square foot building as well as related equipment for use in the Company’s manufacture of sound deadening technology used in the aerospace industry and products consisting of etched composites, ceramics, glass and silicon wafers, to be located in Duluth, Minnesota.  See note 6 to the condensed financial statements for additional detail about the financing agreement.  There was no interest expense in 2015.

 

Income Taxes.  For the first nine months of 2016, the Company realized an income tax benefit of $69,000, or an effective rate of 49.3%, compared to income tax expense of $2,000, or an effective rate of 2.2%, for the same period in 2015.  The increase in the effective tax rate for 2016 over 2015 is primarily due to higher estimated pre-tax income for the year and the impact of non-deductible items.  In 2016, the unfavorable non-deductible items increased the effective tax rate, while they decreased the 2015 effective tax rate due to estimated pre-tax losses.  The income tax provision for the 2016 and 2015 periods differ from expected tax expense (benefit) due to unfavorable non-deductible items and generation of research and development tax credits.

 

Liquidity and Capital Resources

 

Outside of the building expansion, for which $3.4 million in financing was obtained during 2016, the Company has financed its operations principally with funds generated from operations.  These funds have been sufficient to cover the Company’s normal operating expenditures, annual capital requirements, and research and development expenditures.

 

Cash and cash equivalents were $917,000 and $2.2 million at September 30, 2016 and December 31, 2015, respectively.  Operating activities provided $804,000 in cash during the first nine months of 2016 compared to $797,000 of cash provided by operating activities during the same period in 2015.  Cash provided by operating activities is primarily the result of a net loss adjusted for non-cash depreciation, amortization, gain and loss on sale and disposal of property, and certain changes in working capital components discussed in the following paragraph.

 

During the first nine months of 2016, the timing of collections resulted in a $11,000 decrease in trade receivables.  The Company believes that the quality of its receivables is high and that strong internal controls are in place to maintain proper collections.    Inventories decreased by $41,000 due to lower raw material and finished goods levels.  Prepaid expenses and other assets increased $93,000, reflecting insurance premiums and annual software license fees paid in advance.  Accounts payable increased $327,000 due to the timing of vendor payments mainly related to raw material purchases.  Accrued expenses decreased $31,000, reflecting the timing of compensation payments while income taxes receivable decreased $31,000 due to the timing of estimated tax payments compared to the calculated 2016 tax liability.

 

During the first nine months of 2015, the increase in sales for the third quarter along with the timing of collections resulted in a $186,000 increase in trade receivables.  The Company believes that the quality of its receivables is high and that strong internal controls are in place to maintain proper collections.   Inventories decreased by $352,000 due to efforts to more tightly manage inventory levels.   Prepaid expenses and other assets increased $18,000, reflecting insurance premiums paid in advance.  Accounts payable increased $81,000 due to the timing of vendor payments.  Accrued expenses increased $91,000, reflecting the timing of compensation payments while income taxes receivable increased $9,000 due to the timing of estimated tax payments and the volume of taxable income.

 

During the first nine months of 2016, cash used in investing activities was $5.4 million.  The Company purchased fifteen certificates of deposits totaling $3,399,000.  The Company’s cash purchases of property and equipment were $1,966,000.  Total building expansion expenditures for 2016 were  $1,393,000.  Expenditures on the new ERP system in the first nine months of 2016 were $209,000, of which $9,000 was included as part of

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construction payable and not as cash used in investing activities.  The remaining capital expenditures were mainly for upgrades to improve AMS production and process capabilities. Also during the first nine months of 2016, the Company incurred $26,000 in patent application costs that the Company records as an asset and amortizes upon successful completion of the application process.  In addition, the Company sold equipment for $21,000.    

 

During the first nine months of 2015, cash provided by investing activities was $304,000.  Fourteen certificates of deposits totaling $2.2 million matured during the first nine months of 2015.  The Company purchased three certificates of deposits totaling $650,000 during the same period.  The Company’s purchases of property and equipment were $1.2 million, of which, $408,000 was related to the building expansion.  The remaining capital expenditures were mainly for upgrades to improve AMS production and process capabilities, a new ERP system, and costs associated with mandatory elevator upgrades.  Also during the first nine months of 2015, the Company incurred $42,000 in patent application costs that the Company records as an asset and amortizes upon successful completion of the application process.

 

During the first nine months of 2016, the Company received $3.2 million from financing activities.   The Company secured a loan of $3,415,000 to finance the expansion of its AMS facility.  Related to securing the loan, the Company paid $139,000 in debt issuance costs and made principal payments of $45,000.   During the first nine months of 2016, the Company received $4,000 from the issuance of 500 shares of common stock from the exercise of stock options.  There were no exercises of stock options during the first nine months of 2015 or any other financing activities.

 

On April 1, 2016, the Company entered into a financing agreement to borrow $3,415,000.  The proceeds from the loan were used to finance the construction of a 27,300-square foot building as well as related equipment for use in the Company’s manufacture of sound deadening technology used in the aerospace industry and products consisting of etched composites, ceramics, glass and silicon wafers, to be located in Duluth, Minnesota.  The Loan requires monthly payments of approximately $18,000, including interest. The Loan bears interest at a rate of 2.14% per year, payable monthly, and matures on April 1, 2041.    The Loan is subject to mandatory purchase provisions, under which any owners of the Bonds (the “Owners”) may tender the Bonds to the Issuer on April 1, 2021, which would result in the Company repaying the outstanding loan principal and any outstanding accrued and unpaid interest to the Issuer at that time. If in the event the Bonds are not repurchased on April 1, 2021, the Bonds shall be subject to the interest rate and redemption provisions set forth in the associated covenant agreement.    Including debt costs of approximately $139,000, the Loan’s effective interest rate is 2.77% per year.  The Company is subject to certain customary covenants set forth in the associated covenant agreement, including a requirement that the Company maintain a debt service coverage ratio as of the end of each calendar quarter of not less than 1.25 to 1.00 on a rolling four-quarter basis.

    

A bank line of credit exists providing for borrowings of up to $2,050,000 and expires on May 31, 2017.  The line of credit is collateralized by the Company’s assets and bears interest at 1.8 percentage points over the 30-day LIBOR rate.  The Company did not utilize this line of credit during the first nine months of 2016 or 2015 and there were no borrowings outstanding as of September 30, 2016 and December 31, 2015.  There are no financial covenants related to the line of credit. 

 

The Company believes that current financial resources, its line of credit, cash generated from operations and secured through debt financing, and short term investments, along with the Company’s capacity for additional debt and/or equity financing will be sufficient to fund current and anticipated business operations.  The Company also believes that it is unlikely that a decrease in demand for the Company’s products would impair the Company’s ability to fund operations given its excess cash and available line of credit.

 

Capital Expenditures

 

Through the first nine months of 2016, the Company incurred $1.6 million of capital expenditures, of which $9,000 is included in construction accounts payable.  A majority of the expenditures were related to the AMS building expansion.  The remaining capital expenditures were for upgrades to improve AMS production and process capabilities, as well as for a new ERP system. 

 

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The Company expects additional capital expenditures in 2016 of approximately $60,000.  The building expansion was completed during the nine months ended September 30, 2016 and no additional significant expenditures related to the expansion project are anticipated.  The Company will incur additional costs related to the installation of its new ERP system, which is expected to be completed in 2016, along with capital expenditures to improve AMS capacity and capabilities.  The Company expects to fund its capital expenditures with existing cash, short-term investments and cash generated from operating activities. 

 

International Activity

 

The Company markets its products to numerous countries in North America, Europe, Latin America, Asia and other parts of the world.  Foreign sales were approximately 27.1% of total sales during the first nine months of 2016 compared to 29.9% of total sales for the same period in 2015.  Except for Europe, the Company realized lower sales across all areas.  Fluctuations of certain foreign currencies have not significantly impacted the Company’s operations, as the Company’s foreign sales are not concentrated in any one region of the world, although a strong U.S. dollar does make the Company’s products less competitive internationally.  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, though a portion is transacted in Euros.  IKONICS has not implemented an economic hedging strategy to reduce the risk of foreign currency translation exposures, as management does not believe this to be a significant risk based on the scope and geographic diversity of the Company’s foreign operations as of September 30, 2016.  Furthermore, the impact of foreign exchange on the Company’s balance sheet and operating results was not material in either 2016 or 2015.