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

ikon20190321_10q.htm
 
 


 

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, 2020

  

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, including area code)

  

Not Applicable 

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

  

Securities registered pursuant to Section 12(b) of the Act:

Title of each class

Trading Symbol(s)

Name of each exchange on which registered

Common Stock, par value $.10 per share

IKNX

Nasdaq Capital Market LLC

 

Indicate by check mark whether the registrant (1) filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 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 every Interactive Data File required to be submitted 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 such files.)  Yes ☒  No ☐

    

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

  

Large accelerated filer ☐

 

Accelerated filer ☐

Non-accelerated filer ☐

 

Smaller reporting company ☒

 

 

Emerging growth company  ☐

 

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ☐

 

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

 

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date: Common Stock, $.10 par value - 1,976,354 shares outstanding as of November 7, 2020.

  



  

 

 

 

IKONICS CORPORATION 

  

QUARTERLY REPORT ON FORM 10-Q

  

 

 

PAGE NO.

PART I. 

FINANCIAL INFORMATION

 

 

 

 

Item 1. 

 

Condensed Financial Statements

3

 

 

 

 

 

 

Condensed Balance Sheets as of September 30, 2020 (unaudited) and December 31, 2019

3

 

 

 

 

 

 

Condensed Statements of Operations for the Three and Nine Months Ended September 30, 2020 and 2019 (unaudited)

4

 

 

 

 

    Statements of Stockholders’ Equity for the Three and Nine Months Ended September 30, 2020 and 2019 (unaudited) 5
       

 

 

Condensed Statements of Cash Flows for the Nine Months Ended September 30, 2020 and 2019 (unaudited)

6

 

 

 

 

 

 

Notes to Condensed Financial Statements (unaudited)

7

 

 

 

 

Item 2. 

 

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

12

 

 

 

 

Item 3. 

 

Quantitative and Qualitative Disclosures about Market Risk

17

 

 

 

 

Item 4. 

 

Controls and Procedures

17

       
PART II.  OTHER INFORMATION 18
       
Item 1.   Legal Proceedings 18
       
Item 1A.   Risk Factors 18
       
Item 2.   Unregistered Sales of Equity Securities and Use of Proceeds 19
       
Item 3.   Defaults upon Senior Securities 19
       
Item 4.    Mine Safety Disclosures 19
       
Item 5.    Other Information 19
       
Item 6.    Exhibits 19

 

 

 

 

SIGNATURES

20

  

 

 

 

 

PART I - FINANCIAL INFORMATION

  

ITEM 1.  Condensed Financial Statements

  

IKONICS CORPORATION 

CONDENSED BALANCE SHEETS 

 

   

September 30,

   

December 31,

 
   

2020

   

2019

 

ASSETS

 

(unaudited)

         
                 

CURRENT ASSETS:

               

Cash and cash equivalents

  $ 3,500,883     $ 963,649  

Short-term investments

          2,205,000  

Trade receivables, less allowance of $81,000 in 2020 and $58,000 in 2019

    1,417,217       2,434,718  

Inventories

    2,155,813       2,180,536  

Prepaid expenses and other assets

    160,700       906,916  

Income taxes receivable

    241,451       1,369  

Total current assets

    7,476,064       8,692,188  
                 

PROPERTY, PLANT, AND EQUIPMENT, at cost:

               

Land and building

    9,556,586       9,556,984  

Machinery and equipment

    5,285,503       5,198,784  

Office equipment

    1,440,964       1,402,369  

Vehicles

    245,674       245,674  
      16,528,727       16,403,811  

Less accumulated depreciation

    (8,978,698 )     (8,487,827 )

Total property, plant and equipment at cost, net

    7,550,029       7,915,984  
                 

INTANGIBLE ASSETS, less accumulated amortization of $201,065 in 2020 and $181,609 in 2019

    247,983       271,369  

Total assets

  $ 15,274,076     $ 16,879,541  
                 

LIABILITIES AND STOCKHOLDERS' EQUITY

               
                 

CURRENT LIABILITIES

               

Current portion of long-term debt

  $ 3,458,519     $ 133,287  

Accounts payable

    459,129       761,641  

Accrued compensation

    355,305       382,303  

Other accrued liabilities

    158,732       657,255  

Total current liabilities

    4,431,685       1,934,486  
                 

LONG-TERM LIABILITIES

               

Long-term debt, less current portion

    478,060       2,688,357  

Total liabilities

    4,909,745       4,622,843  
                 

COMMITMENTS AND CONTINGENCIES

               
                 

STOCKHOLDERS' EQUITY

               
                 

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

           

Common stock, par value $.10 per share; authorized 4,750,000 shares; issued and outstanding 1,976,354 shares in 2020 and 2019.

    197,635       197,635  

Additional paid-in-capital

    2,732,100       2,721,962  

Retained earnings

    7,434,596       9,337,101  

Total stockholders' equity

    10,364,331       12,256,698  

Total liabilities and stockholders' equity

  $ 15,274,076     $ 16,879,541  

 

 

 See notes to condensed financial statements.

 

 

IKONICS CORPORATION 

CONDENSED STATEMENTS OF OPERATIONS (Unaudited) 

  

   

Three Months Ended

   

Nine Months Ended

 
   

September 30,

   

September 30,

 
   

2020

   

2019

   

2020

   

2019

 
                                 

NET SALES

  $ 3,134,984     $ 4,530,361     $ 9,204,615     $ 12,655,463  
                                 

COST OF GOODS SOLD

    2,261,205       3,118,299       6,792,709       8,805,853  
                                 

GROSS PROFIT

    873,779       1,412,062       2,411,906       3,849,610  
                                 

SELLING, GENERAL AND ADMINISTRATIVE EXPENSES

    979,773       1,347,404       3,963,100       4,068,230  
                                 

RESEARCH AND DEVELOPMENT EXPENSES

    136,520       218,467       521,334       667,774  
                                 

LOSS FROM OPERATIONS

    (242,514 )     (153,809 )     (2,072,528 )     (886,394 )
                                 

INTEREST EXPENSE

    (24,592 )     (22,799 )     (70,699 )     (67,589 )
                                 

OTHER INCOME

    39       16,225       8,722       49,722  
                                 

LOSS BEFORE INCOME TAXES

    (267,067 )     (160,383 )     (2,134,505 )     (904,261 )
                                 

INCOME TAX EXPENSE (BENEFIT)

    6,929       2,361       (232,000 )     (170,775 )
                                 

NET LOSS

  $ (273,996 )   $ (162,744 )   $ (1,902,505 )   $ (733,486 )
                                 

LOSS PER COMMON SHARE

                               

Basic

  $ (0.14 )   $ (0.08 )   $ (0.96 )   $ (0.37 )

Diluted

  $ (0.14 )   $ (0.08 )   $ (0.96 )   $ (0.37 )
                                 

WEIGHTED AVERAGE COMMON SHARES OUTSTANDING

                               

Basic

    1,976,354       1,978,926       1,976,354       1,981,568  

Diluted

    1,976,354       1,978,926       1,976,354       1,981,568  

  

 

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: 

                                   

Total

 
                   

Additional

           

Stock-

 
   

Common Stock

   

Paid-in

   

Retained

   

holders’

 
   

Shares

   

Amount

   

Capital

   

Earnings

   

Equity

 
                                         

BALANCE AT JUNE 30, 2020

    1,976,354     $ 197,635     $ 2,729,338     $ 7,708,592     $ 10,635,565  
                                         

Net loss

                      (273,996 )     (273,996 )

Stock based compensation

                2,762             2,762  
                                         

BALANCE AT SEPTEMBER 30, 2020

    1,976,354     $ 197,635     $ 2,732,100     $ 7,434,596     $ 10,364,331  

 

 

For the three months ended September 30, 2019: 

                                   

Total

 
                   

Additional

           

Stock-

 
   

Common Stock

   

Paid-in

   

Retained

   

holders’

 
   

Shares

   

Amount

   

Capital

   

Earnings

   

Equity

 
                                         

BALANCE AT JUNE 30, 2019

    1,980,811     $ 198,081     $ 2,723,099     $ 9,601,979     $ 12,523,159  
                                         

Net loss

                      (162,744 )     (162,744 )

Common stock repurchased

    (4,457 )     (446 )     (6,118 )     (22,063 )     (28,627 )

Stock based compensation

                2,490             2,490  
                                         

BALANCE AT SEPTEMBER 30, 2019

    1,976,354     $ 197,635     $ 2,719,471     $ 9,417,172     $ 12,334,278  

 

 

For the nine months ended September 30, 2020: 

                                   

Total

 
                   

Additional

           

Stock-

 
   

Common Stock

   

Paid-in

   

Retained

   

holders’

 
   

Shares

   

Amount

   

Capital

   

Earnings

   

Equity

 
                                         

BALANCE AT DECEMBER 31, 2019

    1,976,354     $ 197,635     $ 2,721,962     $ 9,337,101     $ 12,256,698  
                                         

Net loss

                      (1,902,505 )     (1,902,505 )

Stock based compensation

                10,138             10,138  
                                         

BALANCE AT SEPTEMBER 30, 2020

    1,976,354     $ 197,635     $ 2,732,100     $ 7,434,596     $ 10,364,331  

 

 

For the nine months ended September 30, 2019: 

                                   

Total

 
                   

Additional

           

Stock-

 
   

Common Stock

   

Paid-in

   

Retained

   

holders’

 
   

Shares

   

Amount

   

Capital

   

Earnings

   

Equity

 
                                         

BALANCE AT DECEMBER 31, 2018

    1,983,553     $ 198,355     $ 2,723,024     $ 10,189,651     $ 13,111,030  
                                         

Net loss

                      (733,486 )     (733,486 )
Common stock repurchased     (7,199 )     (720 )     (9,883 )     (38,993 )     (49,596 )

Stock based compensation

                6,330             6,330  
                                         

BALANCE AT SEPTEMBER 30, 2019

    1,976,354     $ 197,635     $ 2,719,471     $ 9,417,172     $ 12,334,278  

 

 

See notes to condensed financial statements.

 

IKONICS CORPORATION 

CONDENSED STATEMENTS OF CASH FLOWS (Unaudited) 

 

   

Nine Months Ended

 
   

September 30,

 
   

2020

   

2019

 

CASH FLOWS FROM OPERATING ACTIVITIES:

               

Net loss

  $ (1,902,505 )   $ (733,486 )

Adjustments to reconcile net loss to net cash used in operating activities:

               

Depreciation

    499,899       476,906  

Amortization

    27,445       33,662  

Stock based compensation

    10,138       6,330  

Net gain on sale and disposal of equipment

    (2,325 )     (8,481 )      
       Deferred income taxes           (183,000 )

Loss on intangible asset abandonment

    16,906       87,122  

Changes in working capital components:

               

Trade receivables

    1,017,501       3,775  

Inventories

    24,723       (526,853 )

Prepaid expenses and other assets

    746,216       (577,492 )

Income tax receivable

    (240,082 )     2,768  

Accounts payable

    (302,512 )     124,992  

Accrued expenses

    (525,521 )     674,194  

Net cash used in operating activities

    (630,117 )     (619,563 )
                 

CASH FLOWS FROM INVESTING ACTIVITIES:

               

Purchases of property and equipment

    (149,916 )     (333,535 )

Proceeds from sales of equipment

    18,297       15,596  

Purchases of intangible assets

    (12,976 )     (17,528 )

Purchases of short-term investments

          (4,165,000 )

Proceeds on sale of short-term investments

    2,205,000       4,410,000  

Net cash provided by (used in) investing activities

    2,060,405       (90,467 )
                 

CASH FLOWS FROM FINANCING ACTIVITIES:

               
Proceeds from debt     1,214,500        

Payment on long-term debt

    (107,554 )     (104,772 )
Repurchase of common stock           (49,596 )

Net cash provided by (used in) financing activities

    1,106,946       (154,368 )
                 

NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS

    2,537,234       (864,398 )
                 

CASH AND CASH EQUIVALENTS AT BEGINNING OF PERIOD

    963,649       1,623,137  
                 

CASH AND CASH EQUIVALENTS AT END OF PERIOD

  $ 3,500,883     $ 758,739  
                 

SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION

               

Cash paid for interest

  $ 56,834     $ 59,889  

Cash paid for income taxes, net

  $ 8,082     $ 9,457  

  

See notes to condensed financial statements.

 

 

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, 2020, and the related condensed statements of operations for the three and nine months ended September 30, 2020 and 2019, the condensed statements of stockholders' equity for the three and nine months ended September 30, 2020 and 2019, and condensed cash flows for the nine months ended September 30, 2020 and 2019, 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, 2020, 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, 2019.

  

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

 

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, and its ability to continue to renew the maturity date of the bank line of credit.

 

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's 2020 results of operations will be adversely affected. The Company has developed a plan to mitigate the impact of COVID-19 which includes the implementation of a series of specific and identified cost reductions, in addition to actions already taken, including further reducing its direct and indirect operating costs. 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 financial statements.

 

The Company has evaluated subsequent events occurring after the date of the financial statements for events requiring recording or disclosure in the financial statements.  As a result of the novel strain of COVID-19 pandemic effect on the Company’s business as well as the businesses of its customers and suppliers, a significant decline in the Company’s business has occurred and that decline is expected to continue.  Although the Company continues to operate, the Company has experienced a significant decrease in sales activity, and the future financial impact and duration cannot be reasonably estimated at this time.

 

 

2.

Inventories

  

The major components of inventories as of September 30, 2020 and December 31, 2019 were as follows:

  

   

Sep 30, 2020

   

Dec 31, 2019

 
                 

Raw materials

  $ 1,477,132     $ 1,667,154  

Work-in-progress

    449,592       419,906  

Finished goods

    1,517,561       1,449,854  

Reduction to LIFO cost

    (1,288,472 )     (1,356,378 )
                 

Total Inventories

  $ 2,155,813     $ 2,180,536  

  

  

 

3.

Earnings Per Common Share (EPS)

  

Basic EPS is calculated using net loss divided by the weighted average of common shares outstanding.  Diluted EPS is calculated similarly 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.  The options disclosed in Note 5 have been excluded from the computation because of their antidilutive effect. 

 

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

  

   

Three Months Ended

 
   

Sep 30, 2020

   

Sep 30, 2019

 
                 

Weighted average common shares outstanding

    1,976,354       1,978,926  

Dilutive effect of stock options

           

Weighted average common and common equivalent shares outstanding

    1,976,354       1,978,926  

  

 

 

IKONICS CORPORATION

  

NOTES TO CONDENSED FINANCIAL STATEMENTS 

  

(Unaudited)

 

      Nine Months Ended  
   

Sep 30, 2020

   

Sep 30, 2019

 
                 

Weighted average common shares outstanding

    1,976,354       1,981,568  

Dilutive effect of stock options

           

Weighted average common and common equivalent shares outstanding

    1,976,354       1,981,568  

 

If the Company was in a net income position for the three and nine months ended September 30, 2020, all 17,500 options outstanding with a weighted average exercise price of $6.97 would have remained excluded from the computation of common share equivalents as the options were anti-dilutive. 

 

If the Company was in a net income position for the three and nine months ended September 30, 2019, all 16,000 options outstanding with a weighted average exercise price of $12.17 would have remained excluded from the computation of common share equivalents as the options were anti-dilutive. 

 

 

4.

Stock-Based Compensation

  

The Company maintains the 2019 Equity Incentive Plan (the “2019 Plan”). The 2019 Plan replaced the 1995 Incentive Stock Option Plan (the "1995 Plan) upon its ratification by shareholders in April 2019.   The 1995 plan authorized the issuance of up to 442,750 shares of common stock.  Of those shares, 5,000 were subject to outstanding options as of September 30, 2020.  Awards granted under the 1995 Plan will remain in effect until they are exercised or expire according to their terms.    At the time the 2019 Plan was approved, there were 102,157 shares reserved for future grants under the 1995 Plan which will no longer be available for future grants.  

 

Under the terms of the 2019 Plan, the number of shares of common stock that may be the subject of awards and issued under the 2019 Plan was initially set at 102,157.  Subsequent to the approval of the 2019 Plan, 11,750 outstanding options granted under the 1995 Plan were forfeited.  Under the terms of the 2019 Plan, those forfeited options are added back to the 2019 Plan reserve pool.  As of September 30, 2020, 13,250 options have been granted under the 2019 Plan, 750 of which have been forfeited, bringing the number of shares of common stock available for future awards under the 2019 Plan to 101,407.

 

The Company charged compensation cost of approximately $10,100 against the loss for the nine months ended September 30, 2020 and approximately $6,300 for the nine months ended September 30, 2019.   As of September 30, 2020, there was approximately $28,300 of 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.

 

 No stock options were exercised during the nine months ended September 30, 2020 or September 30, 2019.

 

There were 10,000 options granted during the nine months ended September 30, 2020 and there were 3,250 options granted during the nine months ended September 30, 2019.  The fair value of options granted during the nine months ended September 30, 2020 and 2019 were estimated using the Black Scholes option pricing model with the following assumptions:

 

   

2020

   

2019

 

Dividend yield

    0       0  

Expected volatility

    40.3 %     37.5 %

Expected life of option (years)

    10       5  

Risk-free interest rate

    1.4 %     1.7 %

Fair value of each option on grant date

  $ 2.90     $ 2.53  

  

Stock option activity during the nine months ended September 30, 2020 was as follows:

 

           

Weighted

 
           

Average

 
           

Exercise

 
   

Shares

   

Price

 

Outstanding at January 1, 2020

    19,250     $ 11.32  

Granted

    10,000       5.67  

Exercised

           

Expired and forfeited

    (11,750 )     12.99  

Outstanding at September 30, 2020

    17,500     $ 6.97  

Exercisable at September 30, 2020

    5,332     $ 9.19  

  

There was no aggregate intrinsic value to the options outstanding and exercisable at September 30, 2020.

 

 

IKONICS CORPORATION

  

NOTES TO CONDENSED FINANCIAL STATEMENTS 

  

(Unaudited)

 

 

5.

Segment Information

  

The Company’s reportable segments are strategic business units that offer different products and have varied customer bases.  There are four reportable segments:  Chromaline, IKONICS Imaging, Digital Texturing (DTX) and Advanced Material Solutions (AMS).  Chromaline sells screen printing film, emulsions, and inkjet receptive film primarily to distributors and some end users.  IKONICS Imaging sells photo resistant film, art supplies, glass, and related abrasive etching equipment to both end users and distributors.  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.   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, 2019.

  

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

  

For the three months ended September 30, 2020: 

   

IKONICS

 
           

IKONICS

                                 
   

Chromaline

   

Imaging

   

DTX

   

AMS

   

Unalloc.

   

Total

 

Net sales

  $ 2,051,047     $ 893,064     $ 62,024     $ 128,849     $     $ 3,134,984  

Cost of goods sold

    1,474,881       499,750       33,143       253,431             2,261,205  

Gross profit (loss)

    576,166       393,314       28,881       (124,582 )           873,779  

Selling general and administrative*

    234,884       180,285       27,567       51,644       485,393       979,773  

Research and development*

                            136,520       136,520  

Income (loss) from operations

  $ 341,282     $ 213,029     $ 1,314     $ (176,226 )   $ (621,913 )   $ (242,514 )

    

For the three months ended September 30, 2019: 

   

IKONICS

 
           

IKONICS

                                 
   

Chromaline

   

Imaging

   

DTX

   

AMS

   

Unalloc.

   

Total

 

Net sales

  $ 2,869,664     $ 1,117,209     $ 84,661     $ 458,827     $     $ 4,530,361  

Cost of goods sold

    2,115,702       628,325       31,217       343,055             3,118,299  

Gross profit

    753,962       488,884       53,444       115,772             1,412,062  

Selling general and administrative*

    452,592       248,780       41,866       89,597       514,569       1,347,404  

Research and development*

                            218,467       218,467  

Income (loss) from operations

  $ 301,370     $ 240,104     $ 11,578     $ 26,175     $ (733,036 )   $ (153,809 )

 

For the nine months ended September 30, 2020: 

   

IKONICS

 
           

IKONICS

                                 
   

Chromaline

   

Imaging

   

DTX

   

AMS

   

Unalloc.

   

Total

 

Net sales

  $ 5,635,373     $ 2,488,963     $ 223,606     $ 856,673     $     $ 9,204,615  

Cost of goods sold

    4,300,512       1,397,458       109,235       985,504             6,792,709  

Gross profit (loss)

    1,334,861       1,091,505       114,371       (128,831 )           2,411,906  

Selling general and administrative*

    1,027,239       683,720       91,999       211,788       1,948,354       3,963,100  

Research and development*

                            521,334       521,334  

Income (loss) from operations

  $ 307,622     $ 407,785     $ 22,372     $ (340,619 )   $ (2,469,688 )   $ (2,072,528 )

 

For the nine months ended September 30, 2019: 

   

IKONICS

 
           

IKONICS

                                 
   

Chromaline

   

Imaging

   

DTX

   

AMS

   

Unalloc.

   

Total

 

Net sales

  $ 8,006,121     $ 3,164,143     $ 290,022     $ 1,195,177     $     $ 12,655,463  

Cost of goods sold

    5,949,536       1,714,835       116,810       1,024,672             8,805,853  

Gross profit

    2,056,585       1,449,308       173,212       170,505             3,849,610  

Selling general and administrative*

    1,364,685       819,284       111,232       266,107       1,506,922       4,068,230  

Research and development*

                            667,774       667,774  

Income (loss) from operations

  $ 691,900     $ 630,024     $ 61,980     $ (95,602 )   $ (2,174,696 )   $ (886,394 )

 


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

 

 

IKONICS CORPORATION

  

NOTES TO CONDENSED FINANCIAL STATEMENTS 

  

(Unaudited)

  

Trade receivables by segment as of September 30, 2020 and December 31, 2019 were as follows:

  

   

Sep 30, 2020

   

Dec 31, 2019

 
                 

Chromaline

  $ 1,082,145     $ 1,916,066  

IKONICS Imaging

    299,256       304,791  

DTX

    34,314       13,919  

AMS

    68,026       252,363  

Unallocated

    (66,524 )     (52,421 )
                 

Total

  $ 1,417,217     $ 2,434,718  

  

  

 

6.

Income Taxes

  

 

The Company records its interim provision for income taxes by applying its estimated annual effective tax rate to the year-to-date pre-tax income and adjusting for discrete tax items recorded in the period. Deferred income taxes result from temporary differences between the reporting of amounts for financial statement purposes and income tax purposes. These differences relate primarily to different methods used for income tax reporting purposes, including for depreciation and amortization, warranty and vacation accruals, and deductions related to allowances for doubtful accounts receivable and inventory reserves. The provision for income taxes included current federal and state income tax expense, as well as deferred federal and state income tax expense. 

 

Management assesses the available positive and negative evidence to estimate whether sufficient future taxable income will be generated to permit use of the existing deferred tax assets. A significant piece of objective negative evidence evaluated was the cumulative loss incurred over the three-year period ended September 30, 2020. Such objective evidence limits the ability to consider other subjective evidence, such as our projections for future growth.

 

On the basis of this evaluation, as of September 30, 2020, a full valuation allowance has been recorded to reserve for deferred tax assets entirely, which are not expected to be realized.  The valuation allowance will be reevaluated on a quarterly basis and may change if estimates of future taxable income during the carryforward period is increased or if objective negative evidence in the form of cumulative losses is no longer present and additional weight is given to subjective evidence such as our projections for growth

 

On March 27, 2020, the Coronavirus Aid, Relief, and Economic Security Act (the "CARES Act") was signed into law. The CARES Act is a tax-and-spending package intended to provide economic relief to address the impact of the COVID-19 pandemic. The CARES Act includes several tax provisions that, among other things, allow businesses to carry back NOLs arising in 2018, 2019, and 2020 to the five prior tax years. The tax effect of a change in tax law or rates on taxes payable or refundable for a prior year should be recognized as of the enactment date as tax expense (benefit) for the current year. Accordingly, the Company has recorded a tax benefit in the current period to recognize certain eligible net operating loss carryback claims.

 

The effective tax rate for the three months ended September 30, 2020 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

 

The effective tax rate for the nine months ended September 30, 2020 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.

 

 

IKONICS CORPORATION

  

NOTES TO CONDENSED FINANCIAL STATEMENTS 

  

(Unaudited)

 

The Company recognizes the financial statement benefit of a tax position only after determining that the relevant tax authority is more-likely -than-not to sustain the position following an audit. For tax positions meeting the more-likely-than-not threshold, the amount recognized in the condensed consolidated financial statements is the largest benefit that has a greater than 50% likelihood of being realized upon ultimate settlement with the relevant tax authority. As of September 30, 2020, the Company has no unrecognized tax benefits.

 

This Company is not currently under examination in any jurisdiction. In the event of any future tax assessments, the Company has elected to record the income taxes and any related interest and penalties as income tax expense on the statement of operations.

 

 

7.

Long-Term Debt

 

Duluth Economic Development Authority Loan

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”).

  

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 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.  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.  The Company believes it will be in violation of the debt service coverage ratio, and there is no certainty that a waiver will be obtained for the violations.  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.  Additionally, certain holders of the Bonds issued in 2016 have the ability to redeem the Bonds beginning in April 2020.  Therefore, as of September 30, 2020 the Company reclassified the entire Loan from long-term debt to a short-term liability.   

 

Paycheck Protection Program Loan

On April 18, 2020, 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.  Under the CARES Act, loan forgiveness is available for the sum of documented payroll costs, covered rent payments, and covered utilities during an eight or twenty four-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%.  Subsequent to the end of the third quarter of 2020, the Company submitted an application for 100% forgiveness of the PPP Loan.  The Company cannot assure that the PPP Loan will be forgiven, in whole or in part.

 

The Company accounts for the PPP Loan as debt in accordance with Financial Accounting Standards Board (FASB) Accounting Standards Codification (ASC) 470, Debt and accrues interest in accordance with the interest method under FASB ASC 835-30.  If the loan is forgiven in part or in whole, and legal release is received, the Company will reduce the liability by the amount forgiven and record a gain on extinguishment in the statement of operations.

 

Line of Credit

The Company also has a bank line of credit providing for borrowings of up to $2,050,000 which expires on August 30, 2021 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. 

 

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

 

 

 

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.

 

 

Nine Months Ended September 30, 2020 Compared to Nine Months Ended September 30, 2019 
 
Sales.  The Company’s 2020 first nine months sales of $9.2 million were $3.5 million, or 27.3%, lower than the 2019 first nine month sales of $12.7 million due to the slowdown in economic activity related to the COVID-19 pandemic.   Chromaline 2020 sales for the first nine months of $5.6 million decreased by 29.6% from the 2019 year-to-date September sales of $8.0 million.  IKONICS Imaging 2020 sales for first nine months of $2.5 million were $675,000, or 21.3% lower than sales for the first nine months of 2019.  AMS sales for the first nine months decreased from $1.2 million in 2019 to $857,000 in 2020, a 28.3% decrease.  DTX sales also decreased in the first nine months of 2020 from $290,000 in 2019 to $224,000 in 2020.  IKONICS anticipates that the COVID-19 outbreak will continue to adversely impact sales in all of its divisions in the fourth quarter of 2020 and beyond due to decreasing demand for its products and services.
 

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

  

ITEM 1.

Legal Proceedings

  

None

  

ITEM 1A.

Risk Factors

  

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.

 

 

ITEM 2.

Unregistered Sales of Equity Securities and Use of Proceeds

 

Not applicable

  

ITEM 3.

Defaults upon Senior Securities

  

Not applicable

  

ITEM 4.

Mine Safety Disclosures

  

Not applicable

  

ITEM 5.

Other Information

  

None

  

ITEM 6.

Exhibits

  

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

  

Exhibit

 

Description

 

3.1

 

Restated Articles of Incorporation of Company, as amended. (Incorporated by reference to the like numbered Exhibit to the Company’s Registration Statement on Form 10-SB filed with the Commission on April 7, 1999 (File No. 000-25727).)

 

3.2

 

Amended and Restated By-Laws of the Company, as amended. (Incorporated by reference to Exhibit 3.1 to the Company’s Current Report on Form 8-K filed on April 30, 2018 (File No. 000-25757).)

 

31.1

 

Rule 13a-14(a)/15d-14(a) Certifications of CEO

 

31.2

 

Rule 13a-14(a)/15d-14(a) Certifications of CFO

 

32

 

Section 1350 Certifications

 

101

 

Interactive Data Files Pursuant to Rule 405 of Regulation S-T

  

 

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.

  

 

IKONICS CORPORATION

 

 

 

 

DATE: November 12, 2020

By:

/s/ Jon Gerlach

 

 

Jon Gerlach,

 

 

Chief Financial Officer, and

 

 

Vice President of Finance

  

 

  

20