TERAWULF INC. - Quarter Report: 2020 September (Form 10-Q)

PART I - FINANCIAL INFORMATION

ITEM 1.  Condensed Financial Statements

IKONICS CORPORATION 

CONDENSED BALANCE SHEETS 

 See notes to condensed financial statements.

IKONICS CORPORATION 

CONDENSED STATEMENTS OF OPERATIONS (Unaudited) 

See notes to condensed financial statements.

IKONICS CORPORATION 

STATEMENTS OF STOCKHOLDERS’ EQUITY

THREE AND NINE MONTHS ENDED SEPTEMBER 30, 2020 and 2019 (unaudited)

For the three months ended September 30, 2020: 

For the three months ended September 30, 2019: 

For the nine months ended September 30, 2020: 

For the nine months ended September 30, 2019: 

See notes to condensed financial statements.

IKONICS CORPORATION 

CONDENSED STATEMENTS OF CASH FLOWS (Unaudited) 

See notes to condensed financial statements.

IKONICS CORPORATION

NOTES TO CONDENSED FINANCIAL STATEMENTS 

(Unaudited)

IKONICS CORPORATION

  Cautionary Note Regarding Forward-Looking Statements

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 but are not limited to statements relating to our future plans, objectives and results and the impact of the COVID-19 pandemic on our financial results and the effectiveness of the Company’s responses to the pandemic.  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, 2019, 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 2020 and the first nine months of 2020, as well as the same periods of 2019.  It should be read in connection with the Company’s condensed unaudited financial statements and notes thereto included in this Form 10-Q.

Impact of the COVID-19 Pandemic

The Company is closely monitoring the novel strain of coronavirus (COVID-19) pandemic and its impact on its business. The outbreak and continuing spread of COVID-19 has resulted in a substantial curtailment of business activities worldwide and is causing weakened economic conditions, both nationally and globally. As part of efforts to contain the spread of COVID-19, state, local and foreign governments have imposed various restrictions on the conduct of business and travel. Government restrictions, such as stay-at-home orders and quarantines and company remote work policies have led to a significant number of business closures and slowdowns. These business closures and slowdowns have already adversely impacted and will likely continue to adversely impact the Company directly, as well as cause its customers and suppliers to slow or stop production, which will likely significantly disrupt the Company's sales, production and supply chain.  For example, as a result of the COVID-19 pandemic, the Company began to experience decreased demand for its products and services during the nine months ended September 30, 2020.  The Company anticipates a significant decrease in global demand for its products and services during fourth quarter of 2020 and beyond. This significant decrease in demand will likely have a material adverse impact on the Company's business, operating results and financial condition.  The Company’s facilities continue to operate and are doing so safely, having implemented social distancing and enhanced health, safety and sanitization measures. The Company's leadership continues to address the situation and is adjusting as necessary. The Company has also implemented necessary procedures to enable a significant portion of its employee base to work remotely.  As the situation continues to evolve into a more prolonged pandemic, the Company expects the COVID-19 pandemic to have a significant adverse effect on economies and financial markets globally, potentially leading to a significant worldwide economic downturn, which could have a significant adverse effect on the Company's business, operating results and financial condition. However, the duration of these trends and the magnitude of such impacts cannot be precisely estimated at this time, as they are affected by a number of factors (some of which are outside management’s control), including those presented in Part II, Item 1A. “Risk Factors” below.  To partially mitigate the negative impact of the COVID-19 pandemic, the Company implemented cost reduction efforts including furloughing approximately 40% of the Company's workforce, reductions in board and officer compensation, suspension of the Company’s contribution to its 401(k) retirement plan and the elimination of all non-essential expenditures.

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 the Company 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 especially given the unpredictability of any effects related to the COVID-19 pandemic.  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 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 net realizable 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.  Deferred tax assets and liabilities are presented as long-term on a net basis.  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 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.  Revenue is measured based on consideration specified in the contract with a customer, adjusted for any applicable estimates of variable consideration and other factors affecting the transaction price, including noncash consideration, consideration paid or payable to customers and significant financing components.  While most of the Company’s revenue is contracted with customers through one-time purchase orders and short-term contracts, the Company does have long-term arrangements with certain customers.  Revenue from all customers is recognized when a performance obligation is satisfied by transferring control of a distinct good or service to a customer. 

Individually promised goods and services in a contract are considered a distinct performance obligation and accounted for separately if the customer can benefit from the individual good or service on its own or with other resources that are readily available to the customer and the good or service is separately identifiable from other promises in the arrangement.  When an arrangement includes multiple performance obligations, the consideration is allocated between the performance obligations in proportion to their estimated standalone selling price.  Costs related to products delivered are recognized in the period incurred, unless criteria for capitalization of costs are met. Costs of revenues consist primarily of direct labor, manufacturing overhead, materials and components.  The Company does not incur significant upfront costs to obtain a contract.  If costs to obtain a contract were to become material, the costs would be recorded as an asset and amortized to expense in a manner consistent with the related recognition of revenue.

The Company excludes governmental assessed and imposed taxes on revenue transactions that are invoiced to customers from revenue.  The Company includes freight billed to customers in revenue. Shipping and handling costs associated with outbound freight after control over a product has transferred to a customer are accounted for as a fulfillment cost and are included in cost of goods sold.

The timing of revenue recognition, billings and cash collections results in accounts receivable on the balance sheet.

Performance obligations.  A performance obligation is a promise in a contract to transfer a distinct good or service to the customer.  A contract’s transaction price is allocated to each distinct performance obligation in proportion to its standalone selling price and recognized as revenue when, or as, the performance obligation is satisfied.  The Company’s various performance obligations and the timing or method of revenue recognition are discussed below: 

The Company sells its products to both distributors and end-users. Each unit of product delivered under a customer order represents a distinct and separate performance obligation as the customer can benefit from each unit on its own or with other resources that are readily available to the customer and each unit of product is separately identifiable from other products in the arrangement.

The transaction price for the Company’s products is the invoiced amount.  The Company does not have variable consideration in the form of refunds, credits, rebates, price concessions, pricing incentives or other items impacting transaction price.  The purchase order pricing in arrangements with customers is deemed to approximate standalone selling price; therefore, the Company does not need to allocate proceeds on a relative standalone selling price allocation between performance obligations.  The Company applies the practical expedient in FASB ASC 606-10-50-14 and does not disclose information about remaining performance obligations that have original expected durations of one year or less. There are no material obligations that extend beyond one year. 

Revenue is recognized when transfer of control occurs as defined by the terms in the customer agreement. The Company immediately recognizes incidental items that are immaterial in the context of the contract.  The Company has also applied the practical expedient in FASB ASC 606-10-32-18 regarding the adjustment of the promised amount of consideration for the effects of a significant financing component when the customer pays for that good or service within one year or less, as the Company does not have any significant financing components in its customer arrangements as payment is received at or shortly after the point of sale, generally thirty to ninety days.

The Company estimates returns based on an analysis of historical experience if the right to return products is granted to its customers.  The Company does not record a return asset as non-conforming products are generally not returned.  The Company’s return policy does not vary by geography.  The customer has no rotation or price protection rights.  The Company is not under a warranty obligation except as described below.

Sales commissions.  Sales commissions paid to sales representatives are eligible for capitalization as they are incremental costs that would not have been incurred without entering into a specific sales arrangement and are recoverable through the expected margin on the transaction.  The Company has elected to apply the practical expedient provided by FASB ASC 340-40-25-4 and recognize the incremental costs of obtaining contracts as an expense when incurred, as the amortization period of the assets that would have otherwise been recognized is one year or less.  The Company records these costs in selling, general, and administrative expense.

Product warranty.   The Company offers warranties on various products and services. These warranties are assurance type warranties that are not sold on a standalone basis; therefore, they are not considered distinct performance obligations.  The Company estimates the costs that may be incurred under its warranties and records a liability in the amount of such costs at the time the revenue is recognized for the product sale. 

International revenue.  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 30% of total sales during the first nine months of 2020 and 29% during the first nine months of 2019.

Results of Operations 

Quarter Ended September 30, 2020 Compared to Quarter Ended September 30, 2019 

Sales.  The Company’s 2020 third quarter sales of $3.1 million were $1.4 million, or 30.8%, lower than the 2019 third quarter sales of $4.5 million.  Each of the Company's divisions were negatively impacted by the slow down in economic activity due to the COVID-19 pandemic.  Chromaline's 2020 third quarter sales of $2.1 million decreased by 28.5% from third quarter 2019 sales of $2.9 million.  IKONICS Imaging sales for the third quarter of 2020 also decreased versus the third quarter of 2019 as 2020 IKONICS Imaging third quarter sales of $893,000 were $224,000, or 20.1%, lower than 2019 third quarter sales.  AMS also realized lower third quarter sales.  Third quarter AMS sales in 2020 were $129,000 compared to $459,000 for the same period last year, a $330,000 decrease.  DTX third quarter sales decreased from $85,000 in 2019 to $62,000 in 2020.  IKONICS anticipates that the COVID-19 outbreak will continue to adversely impact sales in the last quarter of 2020 and beyond due to decreasing demand for its products and services.

Gross Profit.  Gross profit was $874,000, or 27.9% of sales, in the third quarter of 2020 compared to $1.4 million, or 31.2% of sales, for the same period in 2019.  A decrease in sales volumes resulted in the AMS 2020 third quarter gross margin decreasing to a negative 96.7% from 25.2% in 2019. A large portion of the AMS cost structure is fixed, causing fluctuations in sales volumes to have a significant impact on its gross margin.  The Chromaline gross margin increased from 26.3% in the third quarter of 2019 to 28.1% for the third quarter of 2020 while the IKONICS Imaging gross margin increased from 43.8% in the third quarter of 2019 to 44.0% in the third quarter of 2020. A favorable sale mix more than offset the decrease in sales volume resulting in improved gross margins for both Chromaline and IKONICS Imaging.   The 2020 and 2019 third quarter DTX gross margins were 46.6% and 63.1%, respectively, as a less favorable sales mix negatively impacted the 2020 gross margin.   IKONICS anticipates that the COVID-19 outbreak will continue to adversely impact gross margins in the last quarter of 2020 and beyond due to both lower sales volumes and production levels.

Selling, General and Administrative Expenses.  Selling, general and administrative expenses were $980,000, or 31.3% of sales, in the third quarter of 2020 compared to $1.3 million, or 29.7% of sales, for the same period in 2019.  Selling, general and administrative expenses for the third quarter of 2020 decreased primarily due to a reduction in personnel, travel, trade show, promotional and consulting expenses.   Compared to 2019, the Company expects lower selling, general and administrative expenses in the last quarter of 2020 due to lower staffing levels, suspension of the Company’s contribution to its 401(k) retirement plan, decrease in promotional expenses and the elimination of all non-essential expenditures.  

Research and Development Expenses.  Research and development expenses during the third quarter of 2020 were $137,000, or 4.4% of sales, versus $218,000, or 4.8%, of sales for the same period in 2019.  Research and development expenses in the third quarter of 2020 were favorably impacted by a reduction in staffing levels.

Interest Expense.  Interest expense for the third quarter of 2020 and 2019 was $25,000 and $23,000, respectively.

Income Taxes.  For the three months ended September 30, 2020 the effective tax rate was an expense of 0.5% , compared to an expense of 1.5% for the three months ended September 30, 2019. The primary driver of the change in the Company’s effective tax rate is attributable to maintaining a full valuation allowance that was established in the fourth quarter of 2019 .  The Company recorded an income tax expense of $7,000 and $2,000 thousand for the three months ended September 30, 2020 and 2019, respectively.

Gross Profit.  Gross profit was $2.4 million, or 26.2% of sales, in the first nine months of 2020 compared to $3.8 million, or 30.4% of sales, for the same period in 2019.  The Chromaline gross margin decreased from 25.7% in the first nine months of 2019 to 23.7% for the first nine months of 2020 while the IKONICS Imaging gross margin decreased from 45.8% in the first nine months of of 2019 to 43.9% in the first nine months of 2020.  Both the Chromaline and IKONICS Imaging gross margins in 2020 were unfavorably impacted by lower sales volumes and lower production output caused by the COVID-19 pandemic  A decrease in sales volumes resulted in the September year-to-date AMS gross margin decreasing to a negative 15.0% in 2020 from 14.3% in 2019.  A large portion of the AMS cost structure is fixed, causing sales volumes to have a significant impact on its gross margin.  The 2020 and 2019 September year-to-date DTX gross margins were 51.1% and 59.7%, respectively, as a less favorable sales mix negatively impacted the 2020 gross margin.  IKONICS anticipates that the COVID-19 outbreak will continue to adversely impact gross margins in the fourth quarter 2020 and beyond as sales volumes and production output decreases.

Selling, General and Administrative Expenses.  Selling, general and administrative expenses were $4.0 million, or 43.1% of sales, in the first nine months of 2020 compared to $4.1 million, or 32.1% of sales, for the same period in 2019.  Selling, general and administrative expenses for the first nine months of 2020 decreased primarily due to lower personnel, travel, trade show, and promotional expense.   These cost savings were partially offset by the one-time expense incurred in 2020 of $365,000 related to the Chief Executive Officer transition.  The transition costs include severance payments to the former CEO, a signing bonus, relocation expenses and executive search consulting expenses.  

Research and Development Expenses.  Research and development expenses during the first nine months of 2020 were $521,000, or 5.7% of sales, versus $668,000, or 5.3%, of sales for the same period in 2019.  Research and development expenses in the first nine months of 2019 were unfavorably impacted by an $87,000 write off of patent application costs that were previously recorded as an asset as the Company determined that it would no longer continue to pursue those patent applications.   Research and Development expenses in 2020 were also lower due to staffing reductions.   

Interest Expense.  Interest expense for the first nine months of 2020 and 2019 was $71,000 and $68,000, respectively.

Income Taxes.  For the nine months ended September 30, 2020, the effective tax rate was a benefit of 10.9%, compared to a benefit of 18.9% for the nine months ended September 30, 2019. The primary driver of the change in the Company’s effective tax rate is attributable to a tax benefit in the current period to recognize a net operating loss carryback claim.  The Company recorded an income tax benefit of $232,000 and $171,000 for the nine months ended September 30, 2020 and 2019, respectively.

Liquidity and Capital Resources 

Outside of the building expansion, for which $3.4 million in financing was obtained during 2016 and the $1.2 million Paycheck Protection loan, the Company has financed its operations principally with funds generated from operations.  These funds have historically been sufficient to cover the Company’s normal operating expenditures, annual capital requirements, and research and development expenditures.  

Cash and cash equivalents were $3.5 million and $960,000 at September 30, 2020 and December 31, 2019, respectively.  Operating activities used $630,000 in cash during the first nine months of 2020 compared to using $620,000 of cash during the same period in 2019.  Cash used in operating activities is primarily the result of net losses adjusted for non-cash depreciation, amortization, and certain changes in working capital components discussed in the following paragraph.

During the first nine months of 2020, trade receivables decreased by $1.0 million.  This decrease was due primarily to a slowdown in sales of products and services during the first nine months of 2020, as a result of the aforementioned COVID-19 pandemic.  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 $25,000 due to lower raw material levels.  Prepaid expenses and other assets decreased by $746,000 reflecting a decrease in a receivable related to the reimbursement of 2019 medical insurance costs that the Company received from its stop-loss insurance carrier.  Accrued expenses decreased $526,000, reflecting a decrease in the accrual for health insurance costs.  Accounts payable decreased by $303,000 due to the Company's cost reduction efforts and a reduction in raw material purchases in anticipation of lower sales volumes.  Income taxes receivable increased by $240,000 as the Company recognized an income tax benefit attributable to a net operating loss carryback claim.

During the first nine months of 2019, trade receivables decreased $4,000.  The Company believes that the quality of its receivables is high and that strong internal controls are in place to maintain proper collections.  Inventories increased by $527,000 due to higher finished goods levels as the Company was ramping up inventory levels to meet demand for the remainder of 2019 in addition to lower than expected sales for the first nine months of 2019.  Prepaid expenses and other assets increased by $577,000.  The increase is due to a $694,000 receivable related to the reimbursement of medical insurance costs that the Company did receive from its stop-loss insurance carrier.  Accrued expenses increased $674,000, reflecting an increase in the accrual for health insurance costs.  Accounts payable increased by $125,000 due to the timing of vendor payments.  Income taxes receivable decreased by $3,000.

During the first nine months of 2020, cash provided by investing activities was $2.1 million.  Nine certificates of deposits totaling $2.2 million matured during the first nine months of 2020.  The Company’s purchases of equipment of $150,000 were mainly for improvements to production and process capabilities and to replace a vehicle.  The Company received $18,000 in proceeds from the sale of a vehicle.  Also, during the first nine months of 2020, the Company incurred $13,000 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 2019, cash used in investing activities was $90,000.  Eighteen certificates of deposits totaling $4.4 million matured during the first nine months of 2019.  The Company purchased seventeen certificates of deposits totaling $4.2 million.  The Company’s purchases of property and equipment of $334,000 were mainly for improvements to production and process capabilities and to replace two vehicles.  The Company received $16,000 in proceeds from the sale of two vehicles and equipment.  Also, during the first nine months of 2019, the Company incurred $18,000 in patent application costs that the Company records as an asset and amortizes upon successful completion of the application process.

For the first nine months of 2020, net cash provided by investing activities was $1.1 million compared to $154,000 of cash used in financing activities during the first nine months of 2019.  The $1.2 million proceeds from debt in  2020 reflects the receipt of the PPP Loan discussed below.  Related to the Company’s financing agreement, the Company made principal payments of $108,000 and $105,000 during the first nine months of 2020 and 2019, respectively.  During the first nine months of 2019, Company repurchased 7,199 shares of its own stock for $50,000. 

.On April 18, 2020, the Company entered into a loan pursuant to the Paycheck Protection Program under the CARES Act, as administered by the U.S. Small Business Administration (the “SBA”). The loan, in the principal amount of $1,214,500 (the “PPP Loan”), was disbursed by BMO Harris Bank National Association (“Lender”) on April 22, 2020, pursuant to a Paycheck Protection Program Promissory Note and Agreement (the “Note and Agreement”).

The PPP Loan matures on the two-year anniversary of the funding date and bears interest at a fixed rate of 1.00% per annum. Monthly principal and interest payments, less the amount of any potential forgiveness (discussed below), will commence after the six-month anniversary of the funding date. The Company did not provide any collateral or guarantees in connection with the PPP Loan, nor did the Company pay any facility charge to obtain the PPP Loan. The Note and Agreement provides for customary events of default, including those relating to failure to make payment, bankruptcy, breaches of representations and material adverse effects. The Company may prepay the principal of the PPP Loan at any time without incurring any prepayment charges.

All or a portion of the PPP Loan may be forgiven by the SBA and the Lender upon application by the Company.  Subsequent to the end of the third quarter of 2020, the Company submitted an application for 100% forgiveness of the PPP Loan.  Under the CARES Act, loan forgiveness is available for the sum of documented payroll costs, covered rent payments, and covered utilities during the eight-week period beginning on the approval date of the PPP Loan. For purposes of the CARES Act, payroll costs exclude compensation of an individual employee earning more than $100,000, prorated annually. Not more than 40% of the forgiven amount may be for non-payroll costs. Forgiveness is reduced if full-time headcount declines, or if salaries and wages for employees with salaries of $100,000 or less annually are reduced by more than 25%. Although the Company currently believes that its use of the PPP Loan will meet the conditions for forgiveness of the PPP Loan, the Company cannot assure that the PPP Loan will be forgiven, in whole or in part.

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”). Related to the Company’s Loan, the Company made principal payments of $108,000 during the first nine months of 2020 and $105,000 during the first nine months of 2019.  

The Company is subject to certain customary covenants set forth in the Loan, including a requirement that the Company maintain a debt service coverage ratio of not less than 1.25 to 1.00.  As of December 31, 2019, the Company was not in compliance with the debt service coverage ratio covenant, but obtained a waiver for the non-compliance.  There is no certainty that a waiver can be obtained in the future if similar violations occur.  The Company amended the covenant terms in February of 2020 to change the debt service coverage ratio calculation from a rolling quarterly calculation to an annual calculation beginning December 31, 2020.  If the Company has future violations of its covenants, and is unable to obtain appropriate waivers, it could have a significant adverse effect on the Company's liquidity.  The Company believes that any adverse effect of such a possible outcome is mitigated by its strong working capital including cash and cash equivalents of $3.5 million along with the Company's $2.0 million available line of credit as of September 30, 2020.  However, the Company cannot reasonably estimate the future financial impact on its operations or working capital position given the recent downturn in business due to the coronavirus (COVID-19) pandemic.    

A bank line of credit providing for borrowings of up to $2,050,000 expires August 30, 2021.  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 2020 or 2019, and there were no borrowings outstanding as of September 30, 2020 or December 31, 2019.  There are no financial covenants related to the line of credit.   

The Company relies on cash flow generated from operations and available borrowings under its bank line of credit to fund its working capital and other operating and investing needs.  The Company’s ability to borrow under the bank line of credit is based on its continued compliance with its debt service coverage ratio covenant, as defined.

The full extent of the effect of the COVID-19 pandemic on the Company’s customers, supply chain and business cannot be reasonably assessed at this time although the Company expects its full year 2020 results of operations to be adversely affected. The Company has developed a plan to mitigate the impact of COVID-19 which includes permanent reductions to the Company's workforce, reductions in board and officer compensation, suspension of the Company’s contribution to its 401(k) retirement plan and the elimination of all non-essential expenditures.  The impact of COVID-19 on the Company’s operating results will depend on future developments, which are highly uncertain and cannot be predicted, including governmental and business reactions to the pandemic.

Based on the Company’s current cash position, and expected future cash flows, the Company believes it will have sufficient cash to fund its operations beyond twelve months from the date of the issuance of the accompanying unaudited condensed consolidated financial statements.

Capital Expenditures 

Through the first nine months of 2020, the Company incurred $150,000 of capital expenditures mainly for improvements to production and process capabilities and to replace a vehicle.

The Company was planning additional capital expenditures in 2020 of approximately $200,000 including improvements to the Company's production capabilities, process improvements, information technology upgrades and two replacement vehicles.  With the recent downturn in business related to the COVID-19 pandemic, the Company anticipates that additional capital expenditures in 2020 will be minimal.  Currently, the Company expects to fund its capital expenditures with existing cash 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 30% of total sales during the first nine months of 2020 and 29% during the first nine months of 2019.   The 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 due to uncertainties in 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.  The Company has not implemented an economic hedging strategy to reduce the risk of foreign currency translation or transaction 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.  Furthermore, the impact of foreign exchange on the Company’s balance sheet and operating results was not material in either 2020 or 2019.

Future Outlook

See the discussion under the heading “Impact of the COVID-19 Pandemic” above for the Company’s discussion of the COVID-19 pandemic.

IKONICS has spent an average of approximately 5% of annual sales in research and development and has made capital expenditures related to new products and programs.  The Company plans to maintain its efforts in these areas to expedite internal product development as well as to form technological alliances with outside entities to commercialize new product opportunities.

The Company is also continuing to pursue DTX-related business initiatives.  In addition to making efforts towards growing the inkjet technology business, the Company offers a range of products for creating texture surfaces and has introduced a fluid for use in prototyping.  The Company is currently working on production improvements as part of its joint development agreement with AKK, a German manufacturer of high quality printers, to enhance its customer offerings.  The Company has been awarded European, Japanese, and United States patents on its DTX technologies.  The Company has also modified its DTX technology to facilitate entry into the market for prototyping. 

The Company continues to make progress on its AMS business.  The Company has three long-term sales agreements in place for its technology with major aerospace companies.  However, based on customer communications, the Company anticipates reduced order volume for the remainder of 2020 and into 2021 due to the COVID-19 pandemic.  

Both the Chromaline and IKONICS Imaging units operate in mature markets.  Although these business units require aggressive strategies to grow market share, both are developing new products and business relationships that the Company believes will contribute to growth.  Early in 2019, the Company introduced its new IKONART® product to positive reviews and is generating sales.  IKONART® provides a new way to make custom reusable stencils for the creative arts markets.  In addition to its traditional emphasis on domestic markets, the Company will continue efforts to grow its business internationally by attempting to develop new markets and expanding market share where it has already established a presence. However, the strong U.S. dollar has made international growth challenging.

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

Recent Accounting Pronouncements 

In June 2016, the FASB issued ASU No. 2016-13, Measurement of Credit Losses on Financial Instruments, which revises guidance for the accounting for credit losses on financial instruments within its scope, and in November 2018, issued ASU No. 2018-19 and in April 2019, issued ASU No. 2019-04 and in May 2019, issued ASU No. 2019-05, and in November 2019, issued ASU No. 2019-11, which amended the standard. The new standard introduces an approach, based on expected losses, to estimate credit losses on certain types of financial instruments and modifies the impairment model for available-for-sale debt securities. The new approach to estimating credit losses (referred to as the current expected credit losses model) applies to most financial assets measured at amortized cost and certain other instruments, including trade and other receivables, loans, held-to-maturity debt securities, net investments in leases and off-balance-sheet credit exposures. This ASU is effective for fiscal years beginning after December 15, 2022, including interim periods within those fiscal years, with early adoption permitted. Entities are required to apply the standard’s provisions as a cumulative-effect adjustment to retained earnings as of the beginning of the first reporting period in which the guidance is adopted. The Company is still evaluating the impact of this ASU.

Off Balance Sheet Arrangements 

The Company has no off-balance sheet arrangements.  

ITEM 3.  Quantitative and Qualitative Disclosures about Market Risk

Not applicable

ITEM 4.  Controls and Procedures

As of the end of the period covered by this report, the Company conducted an evaluation, under the supervision and with the participation of the principal executive officer and principal financial officer, of the Company’s disclosure control and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934 (the “Exchange Act”)).  Based on this evaluation, the principal executive officer and principal financial officer concluded that the Company’s disclosure controls and procedures are effective to ensure that information required to be disclosed by the Company in reports that it files or submits under the Exchange Act is (i) recorded, processed, summarized and reported within the time periods specified in SEC rules and forms and (ii) accumulated and communicated to the Company’s management, including its principal executive officer and principal financial officer, as appropriate to allow timely decisions regarding required disclosure.

There were no changes to the Company's internal control over financial reporting that occurred during the first nine months of 2020 that has materially affected, or is reasonably likely to materially affect, the Company's internal control over financial reporting. 

PART II. OTHER INFORMATION

None

You should carefully review and consider the information regarding certain factors which could materially affect the Company's business, financial condition or future results set forth under the heading “Risk Factors” in the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 2019.  There have been no material changes or additions to the Company's risk factors discussed in such report, which could materially affect the Company’s business, financial condition, or future results, with the exception of the following new risk factor: 

A public health crisis or global outbreak of disease, including the pandemic caused by coronavirus disease 2019 (“COVID-19”) has had, and we believe will continue to have, a negative effect on the Company's operations, supply chain and workforce, creating business disruptions that could have a material adverse impact on the Company’s financial condition, results of operations and cash flows.

The pandemic caused by COVID-19 was first reported in Wuhan, China, in December 2019 and has since spread to all geographic regions where the Company’s products are produced and sold. The global, regional and local spread of COVID-19 has resulted in significant global mitigation measures, including government-directed quarantines, social distancing and shelter-in-place mandates, travel restrictions and/or bans, and restricted access to certain corporate facilities and manufacturing sites. Uncertainty with respect to the severity and duration of the pandemic, coupled with a significant drop in oil prices that began in early March 2020 driven by a collapse in demand due to the global spread of COVID-19 combined with increased supply from oil producers, has contributed to the volatility and disruption of financial markets. While the severity and duration of the COVID-19 pandemic remain uncertain, impacts to the Company may include, but are not limited to: fluctuations in the Company’s stock price due to market volatility; a decrease in demand for the Company’s products; reduced profitability; supply chain disruptions impeding the Company’s ability to ship and/or receive product; potential interruptions or limitations to manufacturing operations imposed by local, state or federal governments; shortages of key raw materials; workforce absenteeism and distraction; labor shortages; customer credit concerns; cyber security and data accessibility disruptions due to remote working arrangements; reduced sources of liquidity; increased borrowing costs; and potential asset impairment charges. Business disruptions and market volatility resulting from the COVID-19 pandemic could continue to have a material adverse impact on the Company’s results of operations, financial condition and cash flows.

The Company received funding under the Coronavirus Aid, Relief and Economic Security (CARES) Act and there is no guarantee that the Company will not become subject to penalties or that the Company will be able to attain loan forgiveness, in whole or in part.

On April 18, 2020, the Company executed a promissory note in favor of BMO Harris Bank evidencing an unsecured loan in the aggregate principal amount of $1,214,500, which was made pursuant to the Paycheck Protection Program, or the PPP. The PPP was established under the CARES Act, which was enacted on March 27, 2020, and is administered by the U.S. Small Business Administration, or the SBA. All the funds under the loan were disbursed to the Company on April 22, 2020. The Company intends to use all proceeds from the loan to retain employees, maintain payroll and make rental and utility payments.

The promissory note provides for a fixed interest rate of one percent per year with a maturity date of April 18, 2022. Monthly principal and interest payments due on the loan are deferred for a six-month period beginning from the date of disbursement. The loan may be prepaid by the Company at any time prior to April 18, 2022 with no prepayment penalties or premiums.

Under the terms of the CARES Act, loan recipients can apply for and be granted forgiveness for all or a portion of the loans granted under the PPP.  Subsequent to the end of the third quarter of 2020, the Company submitted an application for 100% forgiveness of the PPP Loan.  Such forgiveness will be subject to approval by the SBA and the lender and determined, subject to limitations, based on factors set forth in the CARES Act, including verification of the use of loan proceeds for payment of payroll costs and payments of mortgage interest, rent and utilities. In the event the loan, or any portion thereof, is forgiven, the amount forgiven is applied to outstanding principal. The terms of any forgiveness may also be subject to further regulations and guidelines that the SBA may adopt. If the loan is not forgiven, the Company will be required to repay the outstanding principal, along with accrued interest. The Company has and will continue to carefully monitor all qualifying expenses and other requirements necessary to attain loan forgiveness; however, no assurance is provided that the Company will ultimately obtain forgiveness of the PPP loan in whole or in part.

The PPP loan application required the Company to certify, among other things, that the current economic uncertainty made the PPP loan request necessary to support our ongoing operations. On April 18, 2020, the SBA, in consultation with the Department of Treasury, issued new guidance stating that it is unlikely that a public company with substantial market value and access to capital markets will be able to make the required certification in good faith. The Company made the certification in good faith after analyzing its financial situation and access to capital and believe that it has satisfied all eligibility criteria for the PPP loan, but the SBA guidance and criteria is subject to interpretation and if the Company is found to be ineligible, the Company could be subject to significant penalties and required to repay the loan. If the Company becomes subject to penalties or is not able to attain loan forgiveness, it could result in harm to its business, results of operation and financial condition.

Not applicable

Not applicable

Not applicable

None

The following exhibits are filed as part of this Quarterly Report on Form 10-Q for the quarterly period ended September 30, 2020:

IKONICS CORPORATION

SIGNATURES 

In accordance with the requirements of the Securities Exchange Act of 1934, the registrant caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.