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IKNX > SEC Filings for IKNX > Form 10-K on 5-Mar-2014All Recent SEC Filings

Show all filings for IKONICS CORP

Form 10-K for IKONICS CORP


Annual Report

Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations

The following management discussion and analysis focuses on those factors that had a material effect on the Company's financial results of operations and financial condition during 2013 and 2012 and should be read in connection with the Company's audited financial statements and notes thereto for the years ended December 31, 2013 and 2012, included herein.

Critical Accounting Policies and 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 policies and estimates which IKONICS believes are the most critical to aid in fully understanding and evaluating its reported financial results include the following:

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

Inventories. Inventories are valued at the lower of cost or market value using the last in, first out (LIFO) method. The Company monitors its inventory for obsolescence and records reductions from cost when required.

Self-Funded Medical Insurance. Beginning in January 2012, the Company moved from a fully insured to a self-funded medical insurance plan. The Company contracted with an administrative service company or a "third party administrator" to supervise and administer the program and act as the Company's fiduciary and representative. The Company has reduced its risk under this self-funded plan by purchasing both specific and aggregate stop-loss insurance coverage for individual claims and total annual claims in excess of prescribed limits. The Company records estimates for claim liabilities based on information provided by the third-party administrators, historical claims experience, the life cycle of claims, expected costs of claims incurred but not paid, and expected costs to settle unpaid claims. The Company regularly monitors its estimated insurance-related liabilities. Actual claims experience may differ from the Company's estimates. Costs related to the administration of the plan and related claims are expensed as incurred. The total liability for self-funded medical insurance was $55,000 as of December 31, 2013 and is included within other accrued liabilities in the consolidated balance sheet.

Income Taxes. At December 31, 2013, the Company had net current deferred tax assets of $150,000 and net noncurrent deferred tax liabilities of $527,000. The deferred tax assets and liabilities result primarily from temporary differences in property and equipment, accrued expenses, and inventory reserves. At December 31, 2013, the Company recorded a valuation allowance of $326,000, of which $17,000 is related to a Minnesota research and development credit and $309,000 pertains to a U.S. federal capital loss carryovers. The Company believes it is more likely than not that these deferred tax assets will not be utilized in future years. The capital loss carryover is from recording an impairment charge that occurred in 2009, it can be carried forward one year and must be offset by a capital gain. The Company has determined that is more likely than not that the remaining deferred tax assets will be realized and that an additional valuation allowance for such assets is not currently required. The Company accounts for its

uncertain tax positions under the provision of FASB ASC 740, Income Taxes. At December 31, 2013 and 2012, the Company had no reserves for uncertain tax positions.

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

(a) persuasive evidence of an arrangement (principally in the form of customer sales orders and the Company's sales invoices)

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

(c) a fixed and determinable sales price (the Company's pricing is established and is not based on variable terms, as evidenced in either the Company's invoices or the limited number of distribution agreements; the Company rarely grants extended payment terms and has no history of concessions)

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

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

Results of Operations

Year Ended December 31, 2013 Compared to Year Ended December 31, 2012

Sales. The Company's net sales increased 1.0% in 2013 to a record $17.5 million compared to net sales of $17.3 million in 2012. Domestic realized a 2.0% sales increase as sales grew from $7.1 million in 2012 to $7.3 million in 2013, as both chemical and emulsion sales were stronger in 2013 due to improved distribution in the central region of the United States. Improved film distribution in Asia also resulted in a 2.1% increase in Export sales versus 2012. IKONICS Imaging realized a 3.4% sale increase in 2013 as equipment sales improved. The equipment sales increase is partially related to the introduction of new equipment. Partially offsetting these increases was a 29.8% decrease in Micro-Machining mask sales related to the loss of a large customer. The 13.4% DTX sales decrease is related to the 2012 sale of a DTX printer. There was no sale of a DTX printer in 2013 and the Company anticipates that most future DTX printer sales will be made directly by its strategic printer manufacturing partner and not the Company.

Gross Profit. Gross profit in 2013 was $6.9 million, or 39.7% of sales, compared to $6.9 million, or 40.1% of sales in 2012. Gross margins were unfavorably impacted by an increase in Micro-Machining production costs related to the Company's efforts to improve its production capacity and capabilities and a decrease in sales volume as a large portion of Micro-Machining production costs are fixed, dropping Micro-Machining gross margins from 5.3% in 2012 to negative 54.5% in 2013. IKONICS Imaging gross margins decreased from 54.0% in 2012 to 52.3% in 2013 as higher margin mask sales decreased while lower margin equipment sales increased. These gross margin decreases were offset by an increase in DTX gross margins from 74.8% in 2012 to 82.7% in 2013 and an increase in Export gross margins from 26.8% in 2012 to 28.1% in 2013 as both divisions realized a more favorable sales mix. Increased volumes helped to improve Domestic margins to 44.1% in 2013 from 43.3% in 2012.

Selling, General and Administrative Expenses. Selling, general and administrative expenses were $5.4 million, or 30.7% of sales, in 2013 compared to $5.3 million, or 30.5% of sales, in 2012. The increase in selling, general and administrative expenses reflects increased personnel and travel costs for Micro-Machining related to improving, implementing and promoting its new technologies and higher selling and promotional expenses for Domestic to support sales initiatives in the Domestic screen markets. These increases have been partially offset by a decrease in IKONICS Imaging selling expenses resulting from lower staffing levels.

Research and Development Expenses. Research and development expenses in 2013 were $649,000, or 3.7% of sales, versus $630,000, or 3.6% of sales, in 2012. The cost increase is related to higher personnel and supply expenses. Research and development expense in 2012 was impacted by a $23,000 abandonment of patent applications. The Company records patent application costs as an asset and amortizes those costs upon successful completion of the application process or expenses those costs when an application is abandoned. There were no expenses related to the abandonment of patent application costs in 2013.

Interest Income. The Company earned $7,000 of interest income in 2013 compared to $12,000 in 2012. The interest earned in 2013 and 2012 is related to interest received from the Company's short-term investments, which consist of fully insured certificates of deposit with original maturities ranging from 6 to 12 months.

Income Taxes. During 2013, the Company realized income tax expense of $245,000, or an effective rate of 26.4%, compared to income tax expense of $351,000, or an effective rate of 33.6%, for the same period in 2012. The Company's income tax expense and effective rate in 2013 was favorably impacted by 2012 tax law changes related to research and development credits. Since the tax law changes reinstating the credit were enacted in the first quarter of 2013, the resulting tax benefit was not allowed to be included in the Company's 2012 tax provision under Generally Accepted Accounting Principles. Accordingly, the benefit was recognized in 2013. The income tax provision for the 2013 and 2012 periods also differs from the expected tax expense due to the benefits of the domestic manufacturing deduction, 2013 credits for research and development and other non-deductible items.

Liquidity and Capital Resources

The Company has financed its operations principally with funds generated from operations. These funds have been sufficient to cover the Company's normal operating expenditures, annual capital requirements, research and development expenditures, and a one-time dividend distribution in 2012.

Cash and cash equivalents were $1,704,000 and $968,000 at December 31, 2013 and 2012, respectively. In addition to its cash, the Company also held $1,465,000 of short term investments as of December 31, 2013 and $1,443,000 of short-term investments as of December 31, 2012. The Company generated $1,467,000 in cash from operating activities during 2013, compared to generating $1,182,000 of cash from operating activities in 2012. Cash provided by operating activities is primarily the result of the net income adjusted for non-cash depreciation and amortization, deferred taxes, and certain changes in working capital components discussed in the following paragraph.

During 2013, inventories decreased by $124,000. Lower raw material levels are related to the timing of purchases and efforts to tighten inventory volumes. The $21,000 decrease in prepaid expenses and other assets is related to timing of insurance payments while trade receivables decreased by $9,000. Accounts payable decreased $62,000 due to the timing of payments to and purchases from vendors while accrued liabilities decreased $5,000. Income taxes payable decreased $62,000 and income tax receivable increased $16,000 due to the timing of estimated 2013 tax payments compared to the calculated 2013 tax liability.

During 2012, inventories increased by $444,000. In addition to increased finished goods levels, part of the inventory increase is related to increased raw material purchases to take advantage of volume discounts and to protect against future price increases. The trade receivables decrease of $121,000 is related to improved collections. The $42,000 increase in prepaid expenses and other assets is related to the purchases of equipment utilized for sales promotion. Accounts payable increased $44,000 due to the timing of payments to and purchases from vendors while accrued liabilities increased $58,000 due to the timing of the Company's payroll and customer prepayments. Income

taxes payable increased $84,000 and the Company's income tax receivable decreased $59,000 due to timing of estimated 2012 tax payments compared to the calculated 2012 tax liability

During 2013, investing activities used $820,000. Purchases of property and equipment were $763,000. The majority of these purchases were made to improve Micro-Machining capabilities. Equipment purchases were also made to upgrade research and development equipment and facilities, including improvements to both DTX equipment and equipment and facilities related to screen printing and IKONICS Imaging. The Company realized $36,000 in proceeds from the sale of two vehicles. Also in 2013, the Company incurred $71,000 in patent application costs that the Company records as an asset and amortizes upon successful completion of the application process. The Company also invested $1,815,000 in twelve fully insured certificates of deposit during 2013. Twelve certificates of deposit totaling $1,793,000 matured during 2013.

During 2012, investing activities used $172,000. Purchases of property and equipment were $567,000, mainly for manufacturing equipment, mandatory elevator upgrades and three vehicles. The Company realized $59,000 in proceeds from the sale of three vehicles and on a like-kind equipment exchange. Also in 2012, the Company incurred $57,000 in patent application costs that the Company records as an asset and amortizes upon successful completion of the application process. The Company also invested $1,858,000 in nine fully insured certificates of deposit during 2012. Eleven certificates of deposit totaling $2,250,000 matured during 2012.

In 2013 and 2012, the Company received $89,000 from financing activities from the issuance of 13,695 and 13,888 shares, respectively, of common stock from the exercise of stock options. In 2012, the Company also declared and paid a one-time special cash dividend of $1.00 per share. The total dividend paid was $1,998,000.

A bank line of credit exists providing for borrowings of up to $1,250,000 through May 31, 2015. The Company expects to obtain a similar line of credit when the current line of credit expires. The line of credit is collateralized by trade receivables and inventories and bears interest at 2.5 percentage points over the 30-day LIBOR rate. The Company did not utilize this line of credit during 2013 and 2012 and there were no borrowings outstanding as of December 31, 2013 and 2012. There are no financial covenants related to the line of credit.

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

Capital Expenditures

During 2013, the Company had $763,000 of capital expenditures. The majority of these purchases were made to improve Micro-Machining capabilities. Equipment purchases were also made to upgrade research and development equipment and facilities, including improvements to both DTX equipment and equipment and facilities related to screen printing and IKONICS Imaging in addition to a vehicle for sales personnel.

In 2012, the Company had $567,000 of capital expenditures. Capital expenditures in 2012 were mainly for manufacturing equipment upgrades to increase capacity and improve product quality. The Company also incurred expenditures related to mandatory elevator upgrades and the purchase of three vehicles.

The Company expects capital expenditures in 2014 of approximately $600,000. The planned expenditures primarily will be for mandatory elevator upgrades, manufacturing equipment necessary for anticipated Micro-Machining aerospace business, other manufacturing equipment upgrades and vehicles for sale personnel. These commitments are expected to be funded with cash generated from operating activities.

International Activity

The Company markets its products in numerous countries in all regions of the world, including North America, Europe, Latin America, and Asia. The Company's 2013 foreign sales of $5,642,000 were approximately 32.3% of total sales, compared to the 2012 foreign sales of $5,523,000, which were 31.9% of total sales. The foreign sales increase in 2013 was primarily due to an increase in Asian sales from improved distribution.

The Company's foreign transactions are primarily negotiated, invoiced and paid in U.S. dollars, while a portion is transacted in Euros. IKONICS has not implemented an economic hedging strategy to reduce the risk of foreign currency translation exposures, which management does not believe to be significant based on the scope and geographic diversity of the Company's foreign operations as of December 31, 2013. Furthermore, the impact of foreign exchange on the Company's balance sheet and operating results was not material in either 2013 or 2012.

Future Outlook

IKONICS has spent on average approximately 4% of its sales dollars for the past few years in research and development and has made capital expenditures related to its DTX and Micro-Machining programs. The Company plans to maintain its efforts in this area to expedite internal product development as well as to form technological alliances with outside experts to commercialize new product opportunities.

The Company continues to make progress on its new Micro-Machining business initiative. The Company has entered into agreements with several major aerospace companies to determine the feasibility of using its unique technologies in the production of military and commercial aircraft. The Company is currently supplying products to the aerospace industry for use in the construction of new generation commercial aircraft. Although sequestration of the Department of Defense budget and delays in the launching of new commercial aircraft fleets could adversely affect some of these sales, progress is being made on a number of in-house feasibility projects, and the Company believes that several of these could lead to ongoing business. In anticipation of this business, the Company is expanding its Micro-Machining capacity and patent applications.

The Company is also continuing to make progress on its DTX business initiatives. In addition to its growing 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 with its DTX customers on training, production optimization, and product improvements. The Company has been awarded European, Japanese and United States patents on its DTX technologies. The Company has modified its DTX technology to enter the market for prototyping and 3D printing.

Domestically, both the Domestic Chromaline Screen Print Product and its IKONICS Imaging units remain profitable mature markets and require aggressive strategies to grow market share. Although there will be challenges, the Company believes these businesses will continue to grow and prosper. In addition to its traditional emphasis on domestic markets, the Company will continue efforts to grow its business internationally by attempting to develop new markets and expanding market share where it has already established a presence.

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

Off-Balance Sheet Arrangements

The Company has no off-balance sheet arrangements except for a one-year storage lease at $1,500 per month.

Recent Accounting Pronouncements


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