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 June 30, 2016

or

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

For the Transition Period From                                to                                 .

Commission file number 000-25727

IKONICS CORPORATION

(Exact name of registrant as specified in its charter)

(218) 628-2217

Registrant’s telephone number

Not Applicable

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

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

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

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

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

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

IKONICS Corporation

QUARTERLY REPORT ON FORM 10-Q

PART I - FINANCIAL INFORMATION

ITEM 1.  Condensed Financial Statements

IKONICS CORPORATION

CONDENSED BALANCE SHEETS

See notes to condensed financial statements.

IKONICS CORPORATION

CONDENSED STATEMENTS OF OPERATIONS (Unaudited)

See notes to condensed financial statements.

IKONICS CORPORATION

CONDENSED STATEMENTS OF CASH FLOWS (Unaudited)

See notes to condensed financial statements.

1.Basis of Presentation

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

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

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

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

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

2.Short-Term Investments

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

3.Inventories

The major components of inventories are as follows:

4.Earnings Per Common Share (EPS)

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

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

For the three months ended June 30, 2016, options to purchase 11,418 shares of common stock with a weighted average price of $15.99 were outstanding but were excluded from the computation of common share equivalents because they were anti-dilutive. For the three months ended June 30, 2015, options to purchase 6,250 shares of common stock with a weighted average price of $18.28 were outstanding but were excluded from the computation of common share equivalents because they were anti-dilutive.

If the Company was in a net income position for the first six months of 2016, 4,750 options with a weighted average exercise price of $10.59 would have been included as part of the weighted average common and common equivalent shares outstanding as the options would have been dilutive, while 11,418 options with a weighted average exercise price of $15.99 would have remained excluded as the options were anti-dilutive.    

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

5.Stock-Based Compensation

The Company maintains a stock incentive plan which authorizes the issuance of up to 442,750 shares of common stock. Of those shares, 16,168 were subject to outstanding options and 104,239 were reserved for future grants at June 30, 2016. The plan provides for granting eligible participants stock options or other stock awards, as described by the plan, at option prices ranging from 85% to 110% of fair market value at the date of grant.  Options granted expire up to seven years after the date of grant.  Such options generally become exercisable over a one- to three-year period.

The Company charged compensation cost of approximately $6,500 against income for the three months ended June 30, 2016 and approximately $5,700 for the three months ended June 30, 2015. For the first six months of 2016, the Company charged compensation cost of approximately $11,800 and approximately $10,400 for the same period in 2015.  As of June 30, 2016, there was approximately $46,000 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.

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

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

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

Stock option activity during the six months ended June 30, 2016 was as follows:

The aggregate intrinsic value of all options outstanding and for those exercisable at June 30, 2016 was approximately $3,000 and $1,000, respectively.

6.Long-Term Debt

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

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

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

The Loan is subject to mandatory purchase provisions, under which any owners of the Bonds (the “Owners”) must tender the Bonds to the Issuer on April 1, 2021 and the Issuer, using solely funds furnished by the Company for such purpose, will purchase the Bonds at a purchase price of 100% of the principal amount of the outstanding Bonds, plus accrued and unpaid interest thereon. In the event the Bonds are not repurchased on April 1, 2021, the Bonds shall be subject to the interest rate and redemption provisions set forth in the associated covenant agreement.

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

The Company is subject to certain customary covenants set forth in the associated covenant agreement, including a requirement that the Company maintain a debt service coverage ratio as of the end of each calendar quarter of not less than 1.25 to 1.00 on a rolling four-quarter basis. At June 30, 2016 the Company was in compliance with all financial and non-financial covenants under the Financing Agreement. 

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

In connection with the agreement, the Company incurred debt issuance costs of approximately $139,000 during the six months ended June 30, 2016, which were deferred and are being amortized over the term of the Financing Agreement. Amortization of debt issuance costs was approximately $2,000 for the six months ended June 30, 2016 and is included in interest expense. Debt issuance costs of $124,000 and $13,000 are netted against long-term debt and current portion of long‑term debt, respectively as of June 30, 2016. Amortization of debt costs is expected to be approximately $9,000 in 2016 and approximately $12,000 annually for each of the next four years.

In addition to the $3,415,000 in indebtedness pursuant to the Loan, the Company has a bank line of credit providing for borrowings of up to $2,050,000, expiring on May 31, 2017 that bears interest at 1.8 percentage points over the 30‑day LIBOR rate.  The Company did not utilize this line of credit during the first six months of 2016 or 2015 and there were no borrowings outstanding as of June 30, 2016 and December 31, 2015.  There are no financial covenants related to the line of credit.

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

7.Segment Information

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

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

For the three months ended June 30, 2016:

For the three months ended June 30, 2015:

For the six months ended June 30, 2016:

For the six months ended June 30, 2015:

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

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

8.Income Taxes

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

The Company is subject to taxation in the United States and various states.  The material jurisdictions that are subject to examination by tax authorities primarily include Minnesota and the United States, in each case for tax years 2013, 2014, and 2015.

IKONICS CORPORATION

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

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

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

Critical Accounting Estimates

The Company prepares its financial statements in conformity with accounting principles generally accepted in the United States of America.  Therefore, the Company is required to make certain estimates, judgments and assumptions that the Company believes are reasonable based upon the information available.  These estimates and assumptions affect the reported amounts of assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the periods presented.  The accounting estimates, which IKONICS believes are the most critical to aid in fully understanding and evaluating its reported financial results, include the following:

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

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

Income Taxes.  Deferred taxes are provided on a liability method whereby deferred tax assets are recognized for deductible temporary differences and operating loss and tax credit carryforwards and deferred tax liabilities are recognized for taxable temporary differences.  Temporary differences are the differences between the reported amounts of assets and liabilities and their tax bases.  Deferred tax assets are reduced by a valuation allowance when, in the opinion of management, it is more likely than not that some portion or all of the deferred tax assets will not be realized.  Deferred tax assets and liabilities are adjusted for the effects of changes in tax laws and rates on the date of enactment.  The Company follows the accounting standard on accounting for uncertainty in income taxes, which addresses the determination of whether tax benefits claimed or expected to be claimed on a tax return should be recorded in the financial statements.  Under this guidance, the Company may recognize the tax

benefit from an uncertain tax position only if it is more likely than not that the tax position will be sustained on examination by taxing authorities, based on the technical merits of the position.  The tax benefits recognized in the financial statements from such a position are measured based on the largest benefit that has a greater than 50 percent likelihood of being realized upon ultimate settlement.  The guidance on accounting for uncertainty in income taxes also addresses derecognition, classification, interest and penalties on income taxes, and accounting in interim periods.

Revenue Recognition.  The Company recognizes revenue on sales of products when title passes which can occur at the time of shipment or when the goods arrive at the customer location depending on the agreement with the customer.  The Company sells its products to both distributors and end-users.  Sales to distributors and end-users are recorded based upon the criteria governed by the sales, delivery, and payment terms stated on the invoices from the Company to the purchaser.    In addition to transfer of title / risk of loss, all revenue is recorded in accordance with the criteria outlined within Staff Accounting Bulletin No. 104 and FASB ASC 605, Revenue Recognition:

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

Results of Operations

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

Sales.    The Company realized a 9.8% sales decrease during the second quarter of 2016 with sales of $4.2 million, compared to $4.7 million in sales during the same period in 2015.  Second quarter sales were unfavorably impacted by weaker sales to both Asian and Latin American countries as Export sales decreased 28.7% to $1.0 million in the second quarter of 2016 compared to $1.3 million during the same period in 2015.  Domestic also posted lower sales in the second quarter of 2016 with an 8.0%, or $168,000, sales decrease versus the second quarter of 2015 as sales were down across all product groups.  DTX sales decreased from $102,000 in the second quarter of 2015 to $33,000 in the same period in 2016 due to a temporary decrease in demand for film from its largest customer.  Partially offsetting these sales decreases was a $154,000, or 137.5%, AMS sales increase due to growth for its composite machining.  IKONICS Imaging also posted an $8,000, or 0.9%, sales increase in the second quarter of 2016 as sales grew to $1.0 million versus $991,000 for the same period last year.

Gross Profit.  Gross profit was $1.5 million, or 36.3% of sales, in the second quarter of 2016 compared to $1.6 million, or 35.2% of sales, for the same period in 2015.  The gross profit as a percentage of sales increased in second quarter of 2016 over the same period in 2015 due to improved sales mix.  Lower margin Export sales

comprised 22.7% of total 2016 second quarter sales compared to 28.7% of total sales in the second quarter of 2015.  The 2016 second quarter gross margin percentage was also favorably impacted by higher AMS sales volumes.   

Selling, General and Administrative Expenses.  Selling, general and administrative expenses were $1.3 million, or 31.6% of sales, in the second quarter of 2016 compared to $1.3 million, or 26.9% of sales, for the same period in 2015.    The increase in second quarter selling, general and administrative expense as a percentage in 2016 versus the same period in 2015 is related to an increase in AMS promotional efforts along with higher Exports sales expenses related to Asian markets.

Research and Development Expenses.  Research and development expenses during the second quarter of 2016 were $147,000, or 3.5% of sales, versus $193,000, or 4.1% of sales, for the same period in 2015. In second quarter of 2015 the Company incurred a $46,000 expense related to the abandonment of patent applications.   The Company records patent application costs as an asset and amortizes those costs upon successful completion of the application process or expenses those costs when an application is abandoned.

Interest Expense.  Interest expense for the second quarter of 2016 was $15,000.  The interest expense is related to a $3.4 million financing agreement the Company entered into during the second quarter of 2016 to finance the construction of a 27,300-square foot building as well as related equipment for use in the Company’s manufacture of sound deadening technology used in the aerospace industry and products consisting of etched composites, ceramics, glass and silicon wafers, to be located in Duluth, Minnesota.  See note 6 to the condensed financial statements for additional detail about the financing agreement.  There was no interest expense in 2015.

Income Taxes.  For the first six months of 2016, the Company realized an income tax benefit of $130,000, or an effective rate of 45.8%, compared to income tax benefit of $72,000, or an effective rate of 26.3%, for the same period in 2015.  The increase in the effective tax rate for 2016 over 2015 is primarily due to the impact of non‑deductible items.  In 2016, the unfavorable non‑deductible items increased the effective tax rate, while they decreased the 2015 effective tax rate due to forecasted pre‑tax losses.  The income tax provision for the 2016 and 2015 periods differ from expected tax benefit due to unfavorable non-deductible items, generation of research and development tax credits, and a favorable domestic manufacturing deduction in 2015.

Six Months Ended June 30, 2016 Compared to the Six Months Ended June 30, 2015

Sales.  The Company’s sales decreased 0.5% during the first six months of 2016 to $8.2 million versus sales of $8.3 million during the first six months of 2015.  Compared to the first six months of 2015, Export sales for the same period in 2016 decreased $259,000, or 10.5%, as sales were down across all regions except for Europe.    Domestic also realized lower sales for the first half of 2016 with a $192,000, or 5.5%, sales decrease versus the first six months of 2015 as sales were down across all product groups.  DTX sales decreased 44.0% from $197,000 in the first half of 2015 to $110,000 in the same period in 2016 due to a temporary decrease in demand for film from its largest customer.  Partially offsetting these sales decreases was a $263,000, or 117.1%, AMS sales increase due to growth for its composite machining.  IKONICS Imaging sales increased by 12.3% for the period from $1,885,000 to $2,117,000, mainly related to the acquisition of a new customer. 

Gross Profit.   Gross profit was $2.8 million, or 34.3% of sales, in the first half of 2016 compared to $2.7 million, or 33.2% of sales, for the same period in 2015.  IKONICS Imaging gross margin for 2016 was favorably impacted by higher sales volumes, and an increase in higher margin film sales as its six-month gross margin percentage increased from 51.7% in 2015 to 54.4% in 2016.  Despite lower volumes, the DTX gross margin improved to 36.1% in the first half of 2016 from 27.9% in first half of 2015 due to lower personnel and depreciation expenses while improved AMS sales volumes resulted in higher gross margins.  Compared to the same period in 2015, the Domestic 2016 gross margin for the first six months was negatively impacted by lower volumes as Domestic’s gross margin decreased from 41.3% in 2015 to 40.8% in 2016 while Export’s gross margin at 22.7% in the first half of 2016 was similar to the 22.5% Export gross margin for the first half of 2015. 

Selling, General and Administrative Expenses.  Selling, general and administrative expenses were $2.8 million, or 33.7% of sales, in the first six months of 2016 compared to $2.7 million, or 32.3% of sales, for the same period in 2015.  The increase in selling, general and administrative expenses reflects promotional and trade show expenses for both Domestic and AMS markets in addition to higher Exports sales expenses related to Asia.

Research and Development Expenses.    Research and development expenses during the first half of 2016 were $325,000, or 4.0% of sales, versus $348,000, or 4.2% of sales, for the same period in 2015. In 2015 the Company incurred a $46,000 expense related to the abandonment of patent applications.   The Company records patent application costs as an asset and amortizes those costs upon successful completion of the application process or expenses those costs when an application is abandoned.    

Interest Expense.  Interest expense for the first six months of 2016 was $15,000.  The interest expense is related to a $3.4 million financing agreement the Company entered into during the second quarter of 2016 to finance the construction of a 27,300-square foot building as well as related equipment for use in the Company’s manufacture of sound deadening technology used in the aerospace industry and products consisting of etched composites, ceramics, glass and silicon wafers, to be located in Duluth, Minnesota.  See note 6 to the condensed financial statements for additional detail about the financing agreement.  There was no interest expense in 2015.

Income Taxes.  For the first six months of 2016, the Company realized an income tax benefit of $130,000, or an effective rate of 45.8%, compared to income tax benefit of $72,000, or an effective rate of 26.3%, for the same period in 2015.  The increase in the effective tax rate for 2016 over 2015 is primarily due to the impact of non-deductible items.  In 2016, the unfavorable non-deductible items increased the effective tax rate, while they decreased the 2015 effective tax rate due to forecasted pre-tax losses.  The income tax provision for the 2016 and 2015 periods differ from expected tax benefit due to unfavorable non-deductible items, generation of research and development tax credits, and a favorable domestic manufacturing deduction in 2015.

Liquidity and Capital Resources

Outside of the building expansion, for which $3.4 million in financing was obtained in the second quarter of 2016, the Company has primarily 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 $801,000 and $2.2 million at June 30, 2016 and December 31, 2015, respectively.  Operating activities provided $528,000 in cash during the first six months of 2016 compared to $469,000 of cash provided by operating activities during the same period in 2015.  Cash used in operating activities is primarily the result of a net loss adjusted for non-cash depreciation, amortization, loss on sale and disposal of property, and certain changes in working capital components discussed in the following paragraph.

During the first six months of 2016, the decrease in sales along with the timing of collections resulted in a $354,000 decrease in trade receivables.  The Company believes that the quality of its receivables is high and that strong internal controls are in place to maintain proper collections.    Inventories increased by $96,000 due to higher raw material levels.  Prepaid expenses and other assets increased $56,000, reflecting insurance premiums paid in advance.  Accounts payable increased $90,000 due to the timing of vendor payments.  Accrued expenses increased $45,000, reflecting the timing of compensation payments while income taxes receivable increased $29,000 due to the timing of estimated tax payments compared to the calculated 2016 tax liability.

During the first six months of 2015, the timing of collections resulted in a $59,000 increase in trade receivables.  The Company believes that the quality of its receivables is high and that strong internal controls are in place to maintain proper collections.   Inventories decreased by $267,000 due to the timing of raw material purchases and efforts to more tightly manage finished inventory levels.   Prepaid expenses and other assets increased $60,000, reflecting insurance premiums paid in advance.  Accounts payable increased $225,000 due to the timing of vendor payments.   Accrued expenses decreased $18,000, reflecting the timing of compensation payments while income taxes receivable increased $83,000 due to the timing of estimated tax payments and the volume of taxable income.

During the first six months of 2016, cash used in investing activities was $5,244,000.  The Company purchased fifteen certificates of deposits totaling $3,399,000.  The Company’s cash purchases of property and equipment were $1,844,000.  Total building expansion expenditures were $1,395,000, but $23,000 of the expenditures were included as part of construction payable and not as cash used in investing activities.  Similarly,

expenditures on the new ERP system in the first six months of 2016 were $171,000 of which $37,000 was included as part of construction payable and not as cash used in investing activities.  The remaining capital expenditures were mainly for upgrades to improve AMS production and process capabilities. Also during the first six months of 2016, the Company incurred $22,000 in patent application costs that the Company records as an asset and amortizes upon successful completion of the application process.  In addition, the Company sold equipment for $21,000.    

During the first six months of 2015, cash used in investing activities was $37,000.  Nine certificates of deposits totaling $1,211,000 matured during the first half of 2015.  The Company purchased three certificates of deposits totaling $650,000.  The Company’s purchases of property and equipment were $568,000, mainly for upgrades to improve AMS production and process capabilities along with costs associated with mandatory elevator upgrades.  Also during the first six months of 2015, the Company incurred $30,000 in patent application costs that the Company records as an asset and amortizes upon successful completion of the application process.  

During the first six months of 2016 the Company received $3,268,000 from financing activities.   The Company secured a loan of $3,415,000 to finance the expansion of its AMS facility.  Related to the securing the loan, the Company paid $139,000 in debt issuance costs and made a principal payment of $11,000.   During the first six months of 2016, the Company received $4,000 from the issuance of 500 shares of common stock from the exercise of stock options.  There were no exercises of stock options during the first six months of 2015 or any other financing activities, resulting in no cash from or used for financing activities.

On April 1, 2016, the Company entered into a financing agreement to borrow $3,415,000.  The proceeds from the loan were used to finance the construction of a 27,300-square foot building as well as related equipment for use in the Company’s manufacture of sound deadening technology used in the aerospace industry and products consisting of etched composites, ceramics, glass and silicon wafers, to be located in Duluth, Minnesota.  The Loan requires monthly payments of approximately $18,000, including interest. The Loan bears interest at a rate of 2.14% per year, payable monthly, and matures on April 1, 2041. Including debt costs of approximately $139,000, the Loan’s effective interest rate is 2.77% per year.  The Company is subject to certain customary covenants set forth in the associated covenant agreement, including a requirement that the Company maintain a debt service coverage ratio as of the end of each calendar quarter of not less than 1.25 to 1.00 on a rolling four-quarter basis. At June 30, 2016, the Company was in compliance with all financial and non-financial covenants under the financing agreement. 

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

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

Capital Expenditures

Through the first six months of 2016, the Company incurred $1,784,000 of capital expenditures, of which $60,000 is included in construction accounts payable.  Most the expenditures were related to the AMS building expansion.  The remaining capital expenditures were for upgrades to improve AMS production and process capabilities, and as well as for a new ERP system. 

The Company expects additional capital expenditures in 2016 of approximately $250,000.  The building expansion was completed during the six months ended June 30, 2016 and no additional significant expenditures related to the expansion project are anticipated.  The Company will incur additional costs related to the installation of its new ERP system, which is expected to be completed in 2016, along with capital expenditures to improve AMS capacity and capabilities.  Other expenditures will be incurred to enhance emulsion and film production along with