U.S. SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-Q

(Mark One)

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

For the Quarterly Period Ended September 30, 2008

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

For the Transition Period From                      to                     .

IKONICS CORPORATION

(Exact name of registrant as specified in its charter)

Minnesota		41-0730027
(State or other jurisdiction of		(I.R.S. employer
incorporation or organization)		identification no.)
4832 Grand Avenue
Duluth, Minnesota		55807
(Address of principal executive offices)		(Zip code)

(218) 628-2217

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 þ No o

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

     State the number of shares outstanding of each of the issuer’s classes of common equity, as of the latest practical date: Common Stock, $.10 par value — 2,007,367 shares outstanding as of October 13, 2008.

      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. (Check one):

Large accelerated filer o		Accelerated filer o		Non-accelerated filer   o (Do not check if a smaller reporting company)		Smaller reporting company þ

 

 

IKONICS Corporation

QUARTERLY REPORT ON FORM 10-Q

				PAGE NO.
PART I.		FINANCIAL INFORMATION
Item 1.		Financial Statements:
		Condensed Balance Sheets as of September 30, 2008 (unaudited) and December 31, 2007			3
		Condensed Statements of Operations for the Three Months and Nine Months Ended September 30, 2008 and 2007 (unaudited)			4
		Condensed Statements of Cash Flows for the Nine Months Ended September 30, 2008 and 2007 (unaudited)			5
		Notes to Condensed Financial Statements (unaudited)			6
Item 2.		Management’s Discussion and Analysis of Financial Condition and Results of Operations			12
Item 3.		Quantitative and Qualitative Disclosures about Market Risk			20
Item 4.		Controls and Procedures			20
PART II.		OTHER INFORMATION			21
		SIGNATURES			22

PART I — FINANCIAL INFORMATION

ITEM 1. Condensed Financial Statements

IKONICS CORPORATION

		September 30				December 31
		2008				2007
		(unaudited)
ASSETS
CURRENT ASSETS:
Cash and cash equivalents		$	2,481,128			$	1,230,020
Short-term investments			—				3,550,000
Trade receivables, less allowance of $45,000			2,064,360				2,025,257
Inventories			2,104,190				2,355,864
Deposits, prepaid expenses and other assets			236,745				130,596
Income tax refund receivable			37,756				—
Deferred income taxes			24,000				24,000
Total current assets			6,948,179				9,315,737
PROPERTY, PLANT, AND EQUIPMENT, at cost:
Land and building			1,952,646				1,631,142
Machinery and equipment			2,877,682				2,700,816
Office equipment			832,886				812,120
Vehicles			241,905				219,964
Construction in progress			3,074,973				—
			8,980,092				5,364,042
Less accumulated depreciation			4,247,325				4,043,451
			4,732,767				1,320,591
INTANGIBLE ASSETS, less accumulated amortization of $256,512 in 2008 and $213,061 in 2007			404,420				479,888
DEFERRED INCOME TAXES			11,000				11,000
INVESTMENTS IN NON-MARKETABLE EQUITY SECURITIES			855,201				855,201
		$	12,951,567			$	11,982,417
LIABILITIES AND STOCKHOLDERS’ EQUITY
CURRENT LIABILITIES:
Accounts payable
Trade		$	481,411			$	435,572
Construction			711,827				—
Accrued compensation			238,934				347,691
Other accrued expenses			133,626				148,149
Income taxes payable			—				5,291
Total current liabilities			1,565,798				936,703
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 2,007,367 shares in 2008 and 2,045,961 in 2007			200,737				204,596
Additional paid-in capital			2,210,404				2,124,342
Retained earnings			8,974,628				8,716,776
Total stockholders’ equity			11,385,769				11,045,714
		$	12,951,567			$	11,982,417

See notes to condensed financial statements.

IKONICS CORPORATION

		Three Months								Nine Months
		Ended September 30								Ended September 30
		2008				2007				2008				2007
NET SALES		$	3,832,783			$	4,016,923			$	11,943,690			$	11,899,367
COSTS AND EXPENSES:
Cost of goods sold			2,178,597				2,186,892				6,798,858				6,794,437
Selling, general, and administrative			1,187,912				1,158,735				3,709,842				3,601,132
Research and development			219,071				186,295				601,781				582,503
			3,585,580				3,531,922				11,110,481				10,978,072
INCOME FROM OPERATIONS			247,203				485,001				833,209				921,295
GAIN ON SALE OF NON-MARKETABLE EQUITY SECURITIES			24,550				—				24,550				55,159
INTEREST INCOME			19,890				40,616				87,262				110,247
INCOME BEFORE INCOME TAXES			291,643				525,617				945,021				1,086,701
INCOME TAX EXPENSE			53,810				171,692				243,113				262,277
NET INCOME		$	237,833			$	353,925			$	701,908			$	824,424
EARNINGS PER COMMON SHARE:
Basic		$	0.11			$	0.17			$	0.34			$	0.41
Diluted		$	0.11			$	0.17			$	0.34			$	0.40
WEIGHTED AVERAGE COMMON SHARES OUTSTANDING :
Basic			2,070,705				2,042,113				2,066,395				2,029,110
Diluted			2,073,925				2,074,569				2,070,134				2,061,400

See notes to condensed financial statements.

IKONICS CORPORATION

		Nine Months
		Ended September 30
		2008				2007
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income		$	701,908			$	824,424
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation			219,271				203,981
Amortization			43,451				40,282
Excess tax benefit from share-based payment arrangement			(39,319	)			(31,997	)
Stock based compensation			13,939				14,185
Gain on sale of vehicles			(1,725	)			(7,341	)
Loss on intangible asset abandonment			66,746				—
Gain on sale of non-marketable equity securities			(24,550	)			(55,159	)
Deferred income taxes			—				9,000
Changes in working capital components:
Trade receivables			(39,103	)			(120,974	)
Inventories			251,674				488,268
Prepaid expenses and other assets			(106,149	)			45,553
Income taxes receivable			(37,756	)			—
Accounts payable			45,839				164,506
Accrued liabilities			(123,280	)			(142,089	)
Income taxes payable			38,417				(48,377	)
Net cash provided by operating activities			1,009,363				1,384,262
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchases of property, equipment and construction in progress			(2,926,395	)			(545,500	)
Proceeds from sale of vehicles			8,500				11,500
Purchase of intangibles			(34,729	)			(39,935	)
Purchase of short-term investments			—				(375,000	)
Proceeds from sale of short-term investments			3,550,000				—
Purchase of non-marketable equity securities			—				(63,750	)
Proceeds from sale of non-marketable equity securities			24,550				252,618
Net cash provided (used in) investing activities			621,926				(760,067	)
CASH FLOWS FROM FINANCING ACTIVITIES:
Excess tax benefit from share-based payment arrangement			39,319				31,997
Repurchase of common stock			(526,212	)			—
Proceeds from exercise of stock options			106,712				71,722
Net cash provided by (used in) financing activities			(380,181	)			103,719
NET INCREASE IN CASH AND CASH EQUIVALENTS			1,251,108				727,914
CASH AND CASH EQUIVALENTS AT BEGINNING OF PERIOD			1,230,020				253,186
CASH AND CASH EQUIVALENTS AT END OF PERIOD		$	2,481,128			$	981,100
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION
Cash paid for income taxes		$	284,348			$	342,653
SUPPLEMENTAL SCHEDULE OF NONCASH INVESTING AND FINANCING ACTIVITIES
Construction payables incurred for building expansion		$	711,827			$	—

See notes to condensed financial statements.

IKONICS CORPORATION

NOTES TO CONDENSED FINANCIAL STATEMENTS

(Unaudited)

1.		Basis of Presentation
		The balance sheet of IKONICS Corporation (the “Company”) as of September 30, 2008, and the related statements of operations for the three and nine months ended September 30, 2008 and 2007, and cash flows for the nine months ended September 30, 2008 and 2007, 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, 2008, 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-KSB for the year ended December 31, 2007.
		The results of operations for interim periods are not necessarily indicative of results that will be realized for the full fiscal year.
2.		Inventory
		The major components of inventory are as follows:

		Sep 30, 2008				Dec 31, 2007
Raw materials		$	1,334,984			$	1,373,835
Work-in-progress			322,261				296,998
Finished goods			1,177,419				1,308,917
Reduction to LIFO cost			(730,474	)			(623,886	)
Total Inventory		$	2,104,190			$	2,355,864

IKONICS CORPORATION

NOTES TO CONDENSED FINANCIAL STATEMENTS

(Unaudited)

3.		Earnings Per Common Share (EPS)
		Basic EPS is calculated using net income 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 dilutive potential common shares, such as those shares subject to options, had been issued.
		Shares used in the calculation of diluted EPS are summarized below:

		Three Months Ended
		Sep 30, 2008				Sep 30, 2007
Weighted average common shares outstanding			2,070,705				2,042,113
Dilutive effect of stock options			3,220				32,456
Weighted average common and common equivalent shares outstanding			2,073,925				2,074,569

		Nine Months Ended
		Sep 30, 2008				Sep 30, 2007
Weighted average common shares outstanding			2,066,395				2,029,110
Dilutive effect of stock options			3,739				32,290
Weighted average common and common equivalent shares outstanding			2,070,134				2,061,400

4.		Stock-based Compensation
		The Company has a stock incentive plan for the issuance of up to 342,750 shares of common stock. 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 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. A total of 46,673 shares of common stock are reserved for additional grants of options under the plan at September 30, 2008.
		The Company charged compensation cost of $5,900 against income for the three months ended September 30, 2008 and $4,700 against income for the three months ended September 30, 2007. For the first nine months of 2008 and 2007, the Company charged compensation cost of approximately $14,000 against income. As of September 30, 2008 there was approximately $39,000 of unrecognized compensation cost related to unvested share-based compensation awards granted. 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 increased the APIC pool, which is the amount that represents the pool of excess tax benefits available to absorb tax shortages. For the nine months ended September 30, 2008, $39,319 of excess tax benefits were reported as operating and financing cash flows compared to $31,997 for the nine months ended September 30, 2007. The Company’s APIC pool totaled $111,029 and $71,709 at September 30, 2008 and December 31, 2007, respectively.
		Proceeds from the exercise of stock options were $106,712 and $71,722 for the nine months ended September 30, 2008 and 2007, respectively.

IKONICS CORPORATION

NOTES TO CONDENSED FINANCIAL STATEMENTS

(Unaudited)

The fair value of options granted during the nine months ended September 30, 2008 was estimated using the Black-Scholes option pricing model with the following assumptions:

Dividend yield		0%
Expected volatility		55.0%-56.3%
Expected life of option		Five Years
Risk-free interest rate		3.00%-3.25%
Fair value of each option on grant date		$3.44 - $4.05

		There were no options granted during the nine months ended September 30, 2007.
		Stock option activity during the nine months ended September 30, 2008 was as follows:

						Weighted
						Average
						Exercise
		Shares				Price
Outstanding at beginning of period			52,622			$	4.03
Granted			10,250				7.38
Exercised			(35,872	)			2.97
Expired and forfeited			(750	)			7.01
Outstanding at 9/30/08			26,250				6.69

		The aggregate intrinsic value of all options outstanding and for those exercisable at September 30, 2008 was $45,490 and $33,969, respectively. The total intrinsic value of options exercised was $211,363 and $218,976 for the nine month period ended September 30, 2008 and 2007, respectively.
5.		Building Expansion Project
		In April 2008, the Company acquired an 11 acre property for $366,000 and began construction on a new 35,000 square foot manufacturing and warehouse facility. The new facility is necessary to accommodate the Company’s new business initiatives and growth plans and is expected to be completed by the end of 2008. The entire project, including the purchase of the land, is expected to cost $4,500,000. Through September 30, 2008 the Company had incurred costs of $3,441,000 of which $711,827 was included in construction accounts payable.

IKONICS CORPORATION

NOTES TO CONDENSED FINANCIAL STATEMENTS

(Unaudited)

6.		Segment Information
		The Company’s reportable segments are strategic business units that offer different products and have varied customer bases. There are three reportable segments: Domestic, Export, and IKONICS Imaging. 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. It is also entering the market for etched ceramics, glass and silicon wafers; and is developing and selling proprietary inkjet technology. Export sells primarily the same products as Domestic and IKONICS Imaging to foreign customers. The accounting policies applied to determine the segment information are the same as those described in the summary of significant accounting policies included in the Company’s Annual Report on Form 10-KSB for the year ended December 31, 2007.
		Management evaluates the performance of each segment based on the components of divisional income, and with the exception of accounts receivable, does not allocate assets and liabilities to segments. Financial information with respect to the reportable segments follows:
		For the three months ended September 30, 2008:

										IKONICS
		Domestic				Export				Imaging				Other				Total
Net Sales		$	1,770,792			$	1,070,894			$	991,097			$	—			$	3,832,783
Cost of goods sold			907,877				749,647				521,073				—				2,178,597
Selling, general and administrative*			316,160				116,687				297,583				457,482				1,187,912
Research and development*			—				—				—				219,071				219,071
			1,224,037				866,334				818,656				676,553				3,585,580
Income (loss) from operations		$	546,755			$	204,560			$	172,441			$	(676,553	)		$	247,203

For the three months ended September 30, 2007:

										IKONICS
		Domestic				Export				Imaging				Other				Total
Net Sales		$	1,741,960			$	1,267,710			$	1,007,253			$	—			$	4,016,923
Cost of goods sold			946,154				777,616				463,122				—				2,186,892
Selling, general and administrative*			288,455				93,382				348,110				428,788				1,158,735
Research and development*			—				—				—				186,295				186,295
			1,234,609				870,998				811,232				615,083				3,531,922
Income (loss) from operations		$	507,351			$	396,712			$	196,021			$	(615,083	)		$	485,001

IKONICS CORPORATION

NOTES TO CONDENSED FINANCIAL STATEMENTS

(Unaudited)

For the nine months ended September 30, 2008:

										IKONICS
		Domestic				Export				Imaging				Other				Total
Net Sales		$	4,962,181			$	3,650,622			$	3,330,887			$	—			$	11,943,690
Cost of goods sold			2,655,735				2,464,993				1,678,130				—				6,798,858
Selling, general and administrative*			902,912				318,190				973,622				1,515,118				3,709,842
Research and development*			—				—				—				601,781				601,781
			3,558,647				2,783,183				2,651,752				2,116,899				11,110,481
Income (loss) from operations		$	1,403,534			$	867,439			$	679,135			$	(2,116,899	)		$	833,209

For the nine months ended September 30, 2007:

										IKONICS
		Domestic				Export				Imaging				Other				Total
Net Sales		$	4,933,275			$	3,637,174			$	3,328,918			$	—			$	11,899,367
Cost of goods sold			2,764,261				2,465,928				1,564,248				—				6,794,437
Selling, general and administrative*			850,825				334,182				1,081,295				1,334,830				3,601,132
Research and development*			—				—				—				582,503				582,503
			3,615,086				2,800,110				2,645,543				1,917,333				10,978,072
Income (loss) from operations		$	1,318,189			$	837,064			$	683,375			$	(1,917,333	)		$	921,295

Accounts receivable by segment as of September 30, 2008 and December 31, 2007 were as follows:

		Sep 30, 2008				Dec 31, 2007
Domestic		$	1,105,555			$	980,906
Export			651,763				712,936
IKONICS Imaging			307,665				356,272
Other			(623	)			(24,857	)
Total		$	2,064,360			$	2,025,257

7.		Income Taxes
		On January 1, 2007, the Company adopted the provisions of Financial Standards Accounting Board Interpretation No. 48, Accounting for Uncertainty in Income Taxes (“FIN 48”). As a result of the

IKONICS CORPORATION

NOTES TO CONDENSED FINANCIAL STATEMENTS

(Unaudited)

		implementation of FIN 48, the Company recorded a liability for unrecognized tax benefits of $137,000, which was accounted for as a reduction in retained earnings as of January 1, 2007 for the cumulative effect of a change in accounting principle as provided for by FIN 48. The balance of the unrecognized tax benefits at adoption, exclusive of interest, was $122,000. During the first quarter of 2007 and 2008, the statute of limitations for the relevant taxing authority to examine and challenge the tax position for an open year expired, resulting in decreases in income tax expense of $45,000 for the first nine months of 2007 and $44,000 for the nine months of 2008. As of September 30, 2008, the liability for unrecognized tax benefits totaled $54,000 compared to a liability of $96,000 as of September 30, 2007. The liability for unrecognized tax benefits is included in other accrued expenses.
		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, for tax years 2005, 2006, and 2007.
		It has been the Company’s policy since 2007 to recognize interest and penalties related to uncertain tax positions in income tax expense. The Company also accrued potential interest of $3,000 related to these unrecognized tax benefits during the first nine months of 2008 bringing the total accrued interest to $8,500 as of September 30, 2008. The unrecognized tax benefits at September 30, 2008 relate to taxation of foreign export sales.
		A reconciliation of the beginning and ending amounts of unrecognized tax benefit for the first nine months of 2008 is as follows:

Balance at December 31, 2008		$	98,000
Expiration of the statute of limitations for the assessment of taxes			(44,000	)
Balance at September 30, 2008		$	54,000

The balance of unrecognized tax benefits totaling $54,000 at September 30, 2008, if reversed, would decrease the provision for income taxes and increase net income by the same amount and reduce the Company’s effective tax rate.

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. Such statements are subject to risks and uncertainties, including those discussed under “Factors that May Affect Future Results” below, that 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. Certain forward-looking statements are indicated by italics.

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 2008, the nine months ended September 30, 2008 and the same periods of 2007. It should be read in connection with the Company’s unaudited financial statements and notes thereto included in this Form 10-Q and the Company’s audited financial statements, including related notes, Management’s Discussion and Analysis of Financials Condition and Results of Operations contained in the Company’s 2007 Annual Report on Form 10-KSB.

Factors that May Affect Future Results

	•		The Company’s belief that additional proceeds will be received from the sale of Apprise common and preferred stock that occurred in 2007—Actual additional proceeds received may be impacted by unanticipated expenses related to indemnification clauses as part of the agreement between Apprise and its purchaser.
	•		The Company’s expectation that its effective tax rate will return to 30% to 31% of pretax income for the last quarter of 2008 compared to the tax rate of 25.7% recorded in the first nine month of 2008—The effective tax rate for the fourth quarter of 2008 may be affected by changes in federal and state tax law, unanticipated changes in the Company’s financial position or the Company’s actions could increase or decrease its effective tax rate.
	•		The Company’s belief that the quality of its receivables is high and that strong internal controls are in place to maintain proper collections—This belief may be impacted by domestic economic conditions, by economic, political, regulatory or social conditions in foreign markets, or by the failure of the Company to properly implement or maintain internal controls.
	•		The Company’s belief that the total cost of its new facility construction project will be $4.5 million and depreciation expense will increase by $130,000 annually upon occupancy of the new facility—Actual construction costs and future depreciation expense may increase or decrease due to changes in construction costs, changes to the building design, regulatory changes and changes in accounting rules.
	•		The belief that the Company’s current financial resources, 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 and capital expenditures. The belief that the Company’s low debt levels and available line of credit make it unlikely that a decrease in product demand would impair the Company’s ability to fund operations—Changes in anticipated operating results, credit availability, equity market conditions or the Company’s debt levels may further enhance or inhibit the Company’s ability to maintain or raise appropriate levels of cash.
	•		The Company’s expectations as to the level and use of planned capital expenditures and that capital expenditures will be funded with cash on hand and cash generated from operating activities—This

			expectation may be affected by changes in the Company’s anticipated capital expenditure requirements resulting from unforeseen required maintenance, repairs, capital asset additions or increases in construction costs. The funding of planned or unforeseen expenditures may also be affected by changes in anticipated operating results resulting from decreased sales, lack of acceptance of new products or increased operating expenses or by other unexpected events affecting the Company’s financial position.
	•		The Company’s belief that its vulnerability to foreign currency fluctuations and general economic conditions in foreign countries is not significant—This belief may be impacted by economic, political and social conditions in foreign markets, changes in regulatory and competitive conditions, a change in the amount or geographic focus of the Company’s international sales, or changes in purchase or sales terms.
	•		The Company’s plans to continue to invest in research and development efforts, expedite internal product development and invest in technological alliances, as well as the expected focus and results of such investments—These plans and expectations may be impacted by general market conditions, unanticipated changes in expenses or sales, delays in the development of new products, technological advances, the ability to find suitable and willing technology partners or other changes in competitive or market conditions.
	•		The Company’s efforts to grow its international business—These efforts may be impacted by economic, political and social conditions in current and anticipated foreign markets, regulatory conditions in such markets, unanticipated changes in expenses or sales, changes in competitive conditions or other barriers to entry or expansion.
	•		The Company’s belief as to future activities that may be undertaken to expand the Company’s business—Actual activities undertaken may be impacted by general market conditions, competitive conditions in the Company’s industry, unanticipated changes in the Company’s financial position, lack of acceptance of new products or the inability to identify attractive acquisition targets or other business opportunities.

Critical Accounting Policies

     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, which IKONICS believes are the most critical to aid in fully understanding and evaluating its reported financial results, include the following:

     Accounts Receivable. 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

     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 in cost when required.

     Income Taxes. At September 30, 2008, the Company had $35,000 of net deferred tax assets. The deferred tax assets result primarily from temporary differences in accrued expenses, inventory reserves, intangible assets and

property and equipment. The Company has determined that it is more likely than not that the deferred tax assets will be realized and that a valuation allowance for such assets is not currently required. The Company accounts for its uncertain tax positions under FIN 48 and the related reserve of $54,000 as of September 30, 2008 will be adjusted as the statute of limitations expires, these positions are reassessed, or other positions arise.

     Investments in Non-Marketable Equity Securities. Investments in non-marketable equity securities consist of a $855,201 investment in imaging Technology international (“iTi”). The Company accounts for this investment by the cost method because iTi’s common stock is unlisted and the criteria for using the equity method of accounting are not satisfied. Under the cost method, the investment is assessed for other-than-temporary impairment and recorded at the lower of cost or market value which requires significant judgment since there are no readily available market values for this investment. In assessing the fair value of this investment we consider recent equity transactions that iTi has entered into, the status of iTi’s technology and strategies in place to achieve its objectives, as well as iTi’s financial condition and results of operations. To the extent there are changes in the assessment in the future, an adjustment may need to be recorded.

     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. Freight billed to customers is included in sales. Shipping costs are included in cost of goods sold.

Results of Operations

Quarter Ended September 30, 2008 Compared to Quarter Ended September 30, 2007

     Sales. The Company realized a 4.6% sales decrease during the third quarter of 2008 with sales of $3.8 million, compared to $4.0 million in sales during the same period in 2007. Export sales were 15.5% lower during the third quarter of 2008 versus the same period in 2007 due to lower shipments to Southeast Asia. IKONICS Imaging sales for the third quarter of 2008 were also down 1.6% versus the third quarter of 2007 as glass and equipment shipments fell short of 2007 levels. Domestic Chromaline shipments increased 1.7% during the third quarter of 2008 over the same period in 2007 due to higher image mate™ shipments.

     Cost of Goods Sold. Cost of goods sold during the third quarter of 2008 was 56.8% of sales compared to 54.4% of sales during the same period in 2007, and was approximately $2.2 million for each period. The Export third quarter cost of goods sold as a percentage of sales increased from 61.3% in 2007 to 70.0% in 2008 due to a less favorable product mix. The IKONICS Imaging cost of goods sold as a percentage of sales also increased to 52.6% during the third quarter of 2008 compared to 46.0% in the same period in 2007 as the business segment has incurred additional manufacturing expenses related to startup and development of new business initiatives. Domestic Chromaline’s cost of goods sold as a percentage of sales decreased from 54.3% in the third quarter of 2007 to 51.3% for the same period in 2008. The decrease in the Domestic cost of goods sold is related to manufacturing improvements for some of the Company’s film and emulsion products.

     Selling, General and Administrative Expenses. Selling, general and administrative expenses were 31.0% of sales in the third quarter of 2008 compared to 28.8% of sales for the same period in 2007, and were approximately $1.2 million for each period. Lower personnel costs were offset by increased travel expenses.

     Research and Development Expenses. Research and development expenses during the third quarter of 2008 were $219,000, or 5.7% of sales, versus $186,000, or 4.6% of sales, for the same period in 2007. The increase is due to a $67,000 expense recognized in connection with 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. The $67,000 abandonment was partially offset by lower salary expenses.

     Gain on Sale of Non-Marketable Equity Securities. The Company realized a gain of $25,000 during the third quarter of 2008 on the sale of its investment in the common and preferred stock of Apprise Technologies, Inc. The sale took place during the first quarter of 2007 at which time a $55,000 gain was recognized. The $25,000 payment is related to a portion of the original sales price that was placed in escrow at the time of the sale for

indemnification obligations as part of the agreement between Apprise and its purchaser. The Company expects to receive additional proceeds and a related gain in the first quarter of 2009. The amount received in the first quarter of 2009 is expected to be slightly less than amount received in the third quarter of 2008, however there can be no assurance that this will occur.

     Interest Income. Interest income for the third quarter of 2008 was $20,000 compared to $41,000 for the same period in 2007. The interest income decrease is due to a lower investment balance as the Company is using cash to finance the construction of its new facility and a decrease in interest rates resulting from the Company moving excess cash out of auction rate securities. As of September 30, 2008, the Company did not own any auction rate securities.

     Income Taxes. For the third quarter of 2008, the Company realized income tax expense of $54,000, or an effective rate of 18.5% versus $172,000, or an effective rate of 32.7% for the third quarter of 2007. The 2008 third quarter effective tax rate decrease is due to a $55,000 state refund related to research and development credits for the tax years of 2005, 2006, and 2007.

Nine Months Ended September 30, 2008 Compared to the Nine Months Ended September 30, 2007

     Sales. The Company’s sales increased 0.3% during the first nine months of 2008 compared to the first nine months of 2007, and was approximately $11.9 million for each period. Domestic Chromaline realized a 0.6% sales increase during the first nine months of 2008 over the corresponding period for 2007 due to a rise in image mate™ shipments. Export realized a 0.4% sales increase during the first nine months of 2008 over the corresponding period for 2007 as European sales increases were partially offset by lower sales to China. IKONICS Imaging shipments were flat for the first nine months of 2008 versus the same period in 2007.

     Cost of Goods Sold. Cost of goods sold during the first nine months of 2008 was 56.9% of sales compared to 57.1% of sales during the same period in 2007, and was approximately $6.8 million for each period. The decrease in the cost of sales during the first nine months of 2008 as a percentage of sales reflects a decrease in the Domestic Chromaline’s cost of goods sold as a percentage of sales from 56.0% in 2007 to 53.5% for 2008 due to manufacturing efficiencies. Export’s costs of good sold decreased slightly from 67.8% during the first nine months of 2007 to 67.5% over the corresponding period for 2008. The IKONICS Imaging cost of goods sold as a percentage of sales increased to 50.4% during the first nine months of 2008 compared to 47.0% in the same period in 2007 as the business segment has incurred additional manufacturing expenses related to startup and development of new business initiatives.

     Selling, General and Administrative Expenses. Selling, general and administrative expenses increased to $3.7 million, or 31.1% of sales, in the first nine months of 2008, from $3.6 million or 30.3% of sales, for the same period in 2007. The first nine months of 2008 reflect additional personnel related expenses for a severance agreement and insurance, partially offset by lower advertising and trade show expenses.

     Research and Development Expenses. Research and development expenses during the first nine months of 2008 were $602,000, or 5.0% of sales, versus $583,000, or 4.9% of sales, for the same period in 2007. The increase is due to a $67,000 expense related to 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. The $67,000 abandonment was partially offset by lower salary expenses.

     Gain on Sale of Non-Marketable Equity Securities. The Company realized a gain of $25,000 during the first nine months of 2008 on the sale of its investment in the common and preferred stock of Apprise Technologies, Inc. The sale took place during the first quarter of 2007 at which time a $55,000 gain was recognized. The $25,000 payment is related to a portion of the original sales price that was placed in escrow at the time of the sale for indemnification obligations as part of the agreement between Apprise and its purchaser. The Company expects to receive additional proceeds and a related gain in the first quarter of 2009. The amount received in the first quarter of 2009 is expected to be slightly less than amount received in the first nine months of 2008, however there can be no assurance that this will occur.

     Interest Income. Interest income for the first nine months of 2008 was $87,000 compared to $110,000 for the same period in 2008. The interest income decrease is due to a lower investment balance as the Company is using cash to finance the construction of its new facility and a decrease in interest rates resulting from the Company moving excess cash out of auction rate securities. As of September 30, 2008, the Company did not own any auction rate securities.

     Income Taxes. During the first nine months of 2008, the Company realized an income tax expense of $243,000, or an effective rate of 25.7%, compared to income tax expense of $262,000, or an effective rate of 24.1%, for the same period in 2007. The effective tax rate for the first nine months of 2008 was significantly impacted by derecognizing a liability of $44,000 for unrecognized tax benefits relating to a tax year where the statute of limitations expired during the first quarter, and the benefits of the domestic manufacturing deduction, tax exempt interest, and state income taxes. The 2007 effective tax rate for the first nine months was significantly impacted by derecognizing a liability of $45,000 for unrecognized tax benefits relating to a tax year where the statute of limitations expired during the first quarter. During the first nine months of 2007, the Company also recorded a tax benefit adjustment of $9,000 relating to the December 31, 2006 tax accrual estimate. A net benefit of $7,000 was also realized from the reversal of the valuation allowance offsetting the capital loss carryforward and utilization of a portion of the carryforward when the initial proceeds were received from the sale of the Apprise investment. The remaining carryforward is expected to be fully utilized when the additional anticipated proceeds are received in 2009. The effective tax rate increased in the first nine months of 2008 due to a decrease in tax exempt interest and state tax increases. These increases were partially offset by a $55,000 state refund related to research and development credits for the tax years of 2005, 2006, and 2007 which was recognized during the third quarter of 2008. The Company expects a fourth quarter effective tax rate of 30% to 31% as the effective tax rate will be favorably impacted by the extension of the federal tax credit for research and development. The federal research development credit was extended in the fourth quarter of 2008.

Liquidity and Capital Resources

     The Company has financed its operations principally with funds generated from operations and to a lesser extent employee stock option exercises. 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 $2.5 million and $1.0 million at September 30, 2008 and September 30, 2007, respectively. The Company generated $1,009,000 in cash from operating activities during the nine months ended September 30, 2008, compared to generating $1,384,000 of cash from operating activities during the same period in 2007. Cash provided by operating activities is primarily the result of net income adjusted for non-cash depreciation, amortization, and certain changes in working capital components.

     During the first nine months of 2008, trade receivables increased by $39,000. The increase in receivables was driven by the timing of collections. The Company believes that the quality of its receivables is high and that strong internal controls are in place to maintain proper collections. Inventory levels decreased $252,000 due to lower finished goods levels. Deposits, prepaid expenses and other assets increased $106,000, reflecting annual insurance premiums paid in the first quarter of 2008 and reimbursable costs related to environmental remediation on the 11 acres of land purchased during the second quarter of 2008. Accounts payable increased $46,000, primarily as a result of the timing of payments to and purchases of material from suppliers for inventory. Accrued expenses decreased $123,000, primarily reflecting the timing of compensation payments. Excluding the effects of stock based compensation, income taxes payable decreased $34,000 and income taxes receivable increased $38,000 reflecting the timing of 2008 estimated tax payments.

     During 2007, the Company reclassified $3,550,000 of investments in auction rate securities (ARS) from cash and cash equivalents to short term investments. ARS are investments that are reset through a “dutch auction” process that occurs every 7 to 49 days, depending on the terms of the individual security. Given the historically liquid nature of ARS, they had previously been classified as cash equivalents on both the balance sheet and in the statements of cash flows. However, given that ARS have long-term stated maturities and that the issuers of such ARS are under no obligation to redeem them prior to their stated maturities, the Company determined that its

investments in such securities should be classified as short-term available-for-sale investments, rather than as cash equivalents. Accordingly, the Company’s 2007 and 2008 statements of cash flows present the gross purchases and sales of these short term investments as investing activities. The reclassification of the 2007 Statement of Cash Flows had no impact on results of operations, cash flows from operations, total current assets, total assets, or stockholders’ equity.

     For the first nine months of 2008, investing activities provided $622,000 to the Company. The Company sold $3,550,000 of short-term investments comprised of ARS during the first nine months of 2008 at no gain or loss. At September 30, 2008, the Company had no investment in ARS. The $3,550,000 received from the sale of short-term investments during the first nine months of 2008 was partially offset by $2,926,000 of property and equipment purchases, including the purchase of 11 acres of land during the second quarter of 2008 for $366,000 to be used for a warehouse and manufacturing facility expansion. During the first nine months of 2008 the Company also incurred costs of $3,100,000 related to the expansion project, of which $712,000 were included in construction accounts payable as of September 30, 2008 and had no effect on cash flows. The expansion project is expected to be completed by the end of 2008 at a total cost of $4.5 million. The Company anticipates funding this project with available cash. The Company also made the final $95,000 payment upon the second quarter delivery of its industrial digital inkjet machine during the first nine months of 2008. The Company incurred $35,000 in patent application costs during the first nine months of 2008 that the Company records as an asset and amortizes upon successful completion of the application process. The Company realized a $25,000 gain during the first nine months of 2008 on the sale of its investment in the common and preferred stock of Apprise Technologies, Inc., and $8,500 from the sale of a vehicle.

     For the first nine months of 2007, the Company used $760,000 in investing activities. The Company purchased $546,000 of plant equipment. Approximately one-half of the equipment purchases were related to the Company’s efforts in industrial digital inkjet and photo-machining markets. Purchases were also made to improve facilities, update systems and replace vehicles. The Company also purchased $375,000 of short-term investments comprised of auction rate securities during this period. The Company exercised a warrant for 7,500 shares at a price of $8.50 per share to purchase an additional $64,000 of Imaging Technology International (iTi) stock. The Company currently owns approximately 7% of the outstanding shares of iTi. The Company also incurred $40,000 in patent application costs that the Company records as an asset and amortizes upon successful completion of the application process. These cash outlays were partially offset by receipt of $253,000 from the sale of the Company’s Apprise investment and $12,000 from the sale of two vehicles.

     The Company used $380,000 in cash from financing activities during the first nine months of 2008 compared to $104,000 received in the same period in 2007. During the first nine months of 2008, the Company purchased 74,466 shares of its own stock at a cost of $526,000. The Company’s previously announced repurchase plan allows for an additional 75,541 shares to be repurchased. The Company received $107,000 for the issuance of 35,872 shares of common stock upon the exercise of stock options during the first nine months of 2008 compared to $72,000 received during the first nine months of 2007 for 32,100 shares of common stock issued upon the exercise of stock options. Financing activities also reflect excess tax benefits of $39,000 and $32,000 in 2008 and 2007, respectively, related to the exercise of stock options.

     A bank line of credit exists providing for borrowings of up to $1,250,000. Outstanding debt under this line of credit is collateralized by accounts receivable and inventory and bears interest at 2.00 percentage points over the 30-day LIBOR rate. The Company did not utilize this line of credit during the first nine months of 2008 and there were no borrowings outstanding as of September 30, 2008. The line of credit was also not utilized during 2007, and there were no borrowings outstanding under this line as of September 30, 2007.

     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

     Through September 30, 2008, the Company had $3.6 million in capital expenditures for 2008, of which $712,000 is included in construction accounts payable. This spending primarily consists of land acquisition and construction costs related to the construction of a new warehouse and manufacturing facility necessary to accommodate the Company’s new business initiatives and growth plans. The expansion project is expected to be completed by the end of 2008 at a total cost of $4.5 million. The Company will continue to operate and maintain its current facility along with the new facility. Upon occupancy of the new facility, depreciation expense is expected to increase by $130,000 annually, but will be partially offset by a decrease in rental expense. The Company anticipates funding this project with available cash.

     In addition to expenditures related to the new facility the Company plans for other capital expenditures during 2008 to include ongoing manufacturing equipment upgrades, development equipment to modernize the capabilities and processes of the Company’s research and development laboratory to improve measurement and quality control processes. Non-construction capital expenditures are expected to be approximately $100,000 for the remaining three months of the year and will be funded with 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 31% of total sales during the first nine months of both 2008 and 2007. Fluctuations of certain foreign currencies have not significantly impacted the Company’s operations because the Company’s foreign sales are not concentrated in any one region of the world. The Company believes its vulnerability to uncertainties due to 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. IKONICS has not implemented a 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 September 30, 2008.

Future Outlook

     IKONICS has invested on average over 4% of its sales dollars for the past several years in research and development. The Company plans to maintain its efforts in this area and expedite internal product development as well as form technological alliances with outside sources to ensure commercialization of new product opportunities.

     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 expansion and additions, equipment additions, new product development and marketing opportunities.

Recent Accounting Pronouncements

     In September 2006, the FASB issued SFAS No. 157, “Fair Value Measurements” (“SFAS 157”). SFAS 157 defines fair value, establishes a framework for measuring fair value in generally accepted accounting principles, and expands disclosures about fair value measurements. This Statement applies under other accounting pronouncements that require or permit fair value measurements, the FASB having previously concluded in those accounting pronouncements that fair value is the relevant measurement attribute. Accordingly, SFAS 157 does not require any new fair value measurements. In February 2008, the FASB issued FASB Staff Position FAS 157-2, “Effective Date of FASB Statement No. 157” (the “FSP”). The FSP delayed, for one year, the effective date of SFAS 157 for all nonfinancial assets and liabilities, except those that are recognized or disclosed in the financial statements on at least an annual basis. This statement was effective for the Company beginning January 1, 2008. The deferred provisions of SFAS 157 will be effective for the Company’s fiscal year 2009. The Company’s only financial instruments measured at fair value on a recurring basis were its auction rate securities, which were sold

during the second quarter of 2008 at cost. Accordingly, the adoption of SFAS 157 did not have a material effect on the Company’s disclosures to the financial statements. The Company’s investments in non-marketable equity securities are tested for other than temporary impairment, however, to date, there has not been an impairment and accordingly these investments are carried at cost.

     In February 2007, the FASB issued SFAS No. 159, “The Fair Value Option for Financial Assets and Financial Liabilities” (“SFAS 159”). SFAS 159 allows entities to measure at fair value many financial instruments and certain other assets and liabilities that are not otherwise required to be measured at fair value. SFAS 159 was effective for the Company on January 1, 2008, and its adoption did not affect its financial condition, results of operations, or disclosures

     In December 2007, the FASB issued SFAS No. 160, “Noncontrolling Interests in Consolidated Financial Statements” (“SFAS 160”). SFAS 160 requires all entities to report minority interests in subsidiaries as equity in the consolidated financial statements, and requires that transactions between entities and noncontrolling interests be treated as equity. SFAS 160 is effective for fiscal years beginning on or after December 15, 2008, with early adoption prohibited. The Company does not expect the adoption of this statement will have a material impact on its financial position or results of operations.

     In December 2007, the FASB issued SFAS No. 141 (Revised), “Business Combinations” (“SFAS 141(R)”). SFAS 141 (R) establishes principles and requirements for how the acquirer of a business recognizes and measures in its financial statements the identifiable assets acquired, the liabilities assumed, and any noncontrolling interest in the acquiree. The statement also provides guidance for recognizing and measuring the goodwill acquired in the business combination and determines what information to disclose to enable users of the financial statements to evaluate the nature and financial effects of the business combination. SFAS 141(R) is effective for the fiscal year beginning after December 15, 2008 with early adoption prohibited. The standard will change the Company’s accounting treatment for business combinations, if any, on a prospective basis.

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 was no change in the Company’s internal control over financial reporting identified in connection with the evaluation required by Rule 13a-15(d) and Rule 15d-15(d) of the Exchange Act that occurred during the period covered by this report 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

     Not applicable

ITEM 2. Unregistered Sales of Equity Securities and Use of Proceeds

     Issuer Purchases of Equity Securities (1)

										(c) Total Number of
										Shares Purchased as				(d) Maximum Number of
		(a) Total Number								Part of Publicly				Shares that May
		of				(b) Average Price				Announced Plans				Yet Be Purchased Under
		Shares Purchased				Paid per Share				or Programs				The Plans or Programs
July 1, 2008 through July 31, 2008			—				—				—				—
August 1, 2008 through August 31, 2008			3,335			$	8.06				3,335				146,672
September 1, 2008 through September 30, 2008			71,131			$	7.02				71,131				75,541
			74,466			$	7.07				74,466

ITEM 3. Defaults upon Senior Securities

     Not applicable

ITEM 4. Submission of Matters to a Vote of Security Holders

     None

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, 2008:

Exhibit		Description
3.1		Restated Articles of Incorporation of Company, as amended.1
3.2		By-Laws of the Company, as amended.1
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

     Copies of Exhibits will be furnished upon request and payment of the Company’s reasonable expenses in furnishing the Exhibits.

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.

INDEX TO EXHIBITS

Exhibit		Description		Page
3.1		Restated Articles of Incorporation of Company, as amended		Incorporated by reference
3.2		By-Laws of the Company, as amended.		Incorporated by reference
31.1		Rule 13a-14(a)/15d-14(a) Certifications of CEO.		Filed Electronically
31.2		Rule 13a-14(a)/15d-14(a) Certifications of CFO.		Filed Electronically
32		Section 1350 Certifications.		Filed Electronically