IKONICS Corporation

2015 IKONICS Annual Report

Through processes based in photochemistry, abrasive etching, chemical etching and other technologies, IKONICS participates in a diverse spectrum of markets. From traditional and high-tech screen printing, to decorative and industrial etching.

Issue link: http://ikonics.uberflip.com/i/656035

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Page 15 of 47

14 distributor, JDS Industries. Lower IKONICS Imaging glass sales related to a change in glass suppliers also contributed to the sales decrease. IKONICS Imaging's previous glass supplier discontinued selling through distributors. Export sales in 2015 decreased $353,000, or 6.7%, compared to 2014 as sales were negatively impacted by the weaker European economy and stronger U.S. dollar. European and Asian sales were most affected by the strong U.S. dollar. Lower film and emulsion sales in 2015 resulted in a $239,000, or 3.0%, decrease in Domestic sales versus the same period in 2014. Partially offsetting these sales decreases was a $301,000, or 92% increase in AMS sales as the Company has begun to receive repeatable production orders which the Company expects to continue through 2016. DTX sales also increased $54,000 or 12.7% in 2015 versus 2014 as a result of higher film sales. Gross Profit. Gross profit in 2015 was $6.1 million, or 35.0% of sales, compared to $6.7 million, or 36.3% of sales in 2014. The 2014 gross margin percentage benefited from the initial stocking order from JDS Industries. That initial stocking order was mainly comprised of film products, which have higher gross margins. Export's 2015 gross margin was down due to a decrease in higher margin sales to Europe. An improved sales mix offset lower Domestic volumes resulting in a higher 2015 gross margin compared to 2014. The DTX gross margin improved to 46.5% in 2015 from 13.4% in 2014. The 2015 DTX gross margin improvement is related to higher volumes and lower personnel and depreciation expenses. The AMS 2015 gross margin percentage improved versus 2014 due to an increase in volume. In 2016, the Company expects AMS production costs to increase and gross profit in the aggregate to decrease in the short term due to the completion of the building expansion to improve AMS production capacity and capabilities as the Company plans for additional repeat production orders. Selling, General and Administrative Expenses. Selling, general and administrative expenses were $5.3 million, or 30.0% of sales, in 2015 compared to $5.1 million, or 27.7% of sales, in 2014. The increase in selling, general and administrative expenses reflects higher travel and trade show expenses for domestic markets in addition to consulting expenses related the Company's ERP system selection process and employee training. Selling, general, and administrative expenses in 2014 benefitted from a $46,000 net gain on a sale of assets including a $49,000 gain recorded on a land sale. Research and Development Expenses. Research and development expenses in 2015 were $660,000, or 3.8% of sales, versus $665,000, or 3.6% of sales, in 2014. The 2015 decrease is related to lower production trial and chemical costs partially offset by a $46,000 expense from the abandonment of patent applications. The Company records patent application costs as an asset and amortizes those costs upon successful completion of the application process or expenses those costs when an application is abandoned. Income Taxes. During 2015, the Company realized income tax expense of $90,000, or an effective rate of 40.0%, compared to income tax expense of $270,000, or an effective rate of 29.4%, for the same period in 2014. The decrease in income tax expense from 2014 is primarily due to lower profitability in 2015. The increase in the effective tax rate is mainly driven by a decrease in the domestic manufacturing deduction from lower profitability in 2015. Additionally, the one-time valuation allowance release of $17,000 incurred in 2014, which did not recur in 2015, and higher rate impact of non-deductible items resulting from significantly lower pre-tax book income in 2015 also contributed the 2015 effective tax rate increase. The income tax provision for the 2015 and 2014 periods differs from the expected tax rate due to the benefits of the domestic manufacturing deduction, 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, and research and development expenditures. Cash and cash equivalents were $2.2 million and $1.9 million at December 31, 2015 and 2014, respectively. In addition to its cash, the Company also held $1.8 million of short-term investments as of December 31, 2014. The Company held no short-term investments as of December 31, 2015. The Company generated $1,466,000 in cash from operating activities during 2015, compared to generating $917,000 of cash from operating activities in 2014. 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.

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