Item 1. Business
General
IKONICS Corporation (“IKONICS” or the “Company”) was incorporated in Minnesota as Chroma-Glo, Inc. in 1952 and changed its name to The Chromaline Corporation in 1982. In December 2002, the Company changed its name to IKONICS Corporation. The Company’s two traditional businesses, Chromaline and IKONICS Imaging, have been the development, manufacture and selling of photosensitive liquids (“emulsions”) and films for the screen printing, awards and recognition industries and dye sublimation markets. These sales have been augmented with inkjet receptive films, ancillary chemicals and related equipment to provide a full line of products and services to its customers. These products are sold worldwide primarily through distributors. The Company further diversified itself by expanding its business to industrial markets. These efforts now include the Company’s Advanced Material Solutions (“AMS”) business unit which uses the Company’s proprietary processes and photoresist film for the abrasive etching of composite materials, industrial ceramics, silicon wafers, and glass wafers. The customer base for AMS is primarily the aerospace and electronics industries. Based on its expertise in ultraviolet curable fluids and inkjet receptive substrates, the Company has also developed a patented digital texturing technology (“DTX”) for putting patterns and textures into steel molds for the plastic injection molding industry. The original equipment manufacturer (“OEM”) for the Company’s DTX technology is primarily the automotive industry. The Company offers a suite of products to the mold making industry. Industrial inkjet printers, which are integral to the DTX system, are manufactured by a third party and sold by IKONICS. The Company’s business plan is to sell consumable fluids and transfer films. For most markets, these sales are direct to the mold maker. The DTX technology is also utilized in prototyping where the Company’s technology offers a unique combination of high definition, large format prints, and abrasion resistance.
Products
The Company has four primary technology platforms: ultraviolet (UV) chemistry, film coating and construction, technical abrasive etching, and industrial inkjet printing. The Company’s traditional products and new initiatives are based on these platforms and their combinations. The Company’s Chromaline and ImageMate branded products for the screen printing industry and IKONICS Imaging products for the awards and recognition market are based on UV chemistry and film coating and construction capabilities; the AMS offering is a combination of UV chemistry, film coating and construction and technical abrasive etching capabilities; DTX is a combination of UV chemistry, film coating and construction, and industrial inkjet printing. There is overlap and synergy in the market between the Chromaline, IKONICS Imaging, AMS and DTX product offerings, and the Company offers ancillary products, including equipment to provide customers with a total solution. The Company considers this combination of core technologies and product offerings to be unique.
Distribution and Customers
The Company currently has approximately 200 domestic and international distributors for its Chromaline and ImageMate screen printing emulsions and films. The Company’s abrasive etching products are mainly sold directly to end users in the awards and recognition market under the IKONICS Imaging brand. AMS products are sold either directly to users or the Company offers AMS as a service. DTX includes the sales of consumable inks and films to customers that have purchased specialized industrial inkjet printers from the Company’s strategic partner. DTX sales are primarily direct to end users. The Company markets and sells its products through magazine advertising, trade shows and the internet.
The Company has a diverse customer base both domestically and abroad, with international sales accounting for 29.4% of total sales in 2019 and 2018, and does not depend on one or a few customers for a material portion of its revenues. In 2019 and 2018, no one customer accounted for more than 10% of net sales.
Quality Control in Manufacturing
In March 1994, IKONICS became the first company in northern Minnesota to receive ISO 9001 certification. ISO 9000 is a worldwide standard issued by the International Organization for Standardization that provides a framework for quality assurance. The Company has been recertified every three years beginning in 1997. IKONICS’ quality function goal is to train all employees properly in both their work and in the importance of their work. Internal records of quality, including related graphs and tables, are reviewed regularly and discussions are held among management and employees regarding how improvements might be realized. The Company has rigorous materials selection procedures and also uses testing procedures to assure its products meet quality standards.
Research and Development and Intellectual Property
The Company incurred costs totaling 4.9% of sales, or $870,000, on research and development in 2019, and 3.7% of sales, or $677,000, in 2018. In its research program, IKONICS has developed ultraviolet light-sensitive chemistries used in the manufacturing of screen print stencils, photoresists for abrasive etching and acid resist and prototyping ink jet fluids and ink jet receptive films. The Company has a number of patents and patent applications on these chemistries and applications. There can be no assurance that any patent granted to the Company will provide adequate protection to the Company’s intellectual property. Within the Company, steps are taken to protect the Company’s trade secrets, including physical security, confidentiality and non-competition agreements with employees, non-disclosure agreements where applicable, and confidentiality agreements with vendors. Over the past few years, the Company has directed a larger portion of it research and development resources towards industrial inkjettable fluids and ink jet receptive substrates along with dye sublimation films. The Company has also invested significant resources for personnel and equipment to develop proprietary products and techniques for the etching of composite materials, industrial ceramics and electronic wafers.
In addition to its patents, the Company has various trademarks including the “IKONICS,” “Chromaline,” “IKONICS Imaging,” “Precision Abrasive Machining,” “SmartFlex,” “PhotoBrasive,” “AccuArt,” “Nichols,” “image mate,” “Alpha FlexTrace,” “Alpha MicroCap,”, “DTX”, “SubTHAT!” and “IKONART” trademarks.
Raw Materials
The primary raw materials used by IKONICS in its production are photopolymers, polyester films, polyvinylacetates, polyvinylalcohols and water. The Company’s purchasing staff leads in the identification of both domestic and foreign sources for raw materials and negotiates price and terms for all domestic and foreign markets. IKONICS’ involvement in foreign markets has given it the opportunity to become a global buyer of raw materials at lower overall cost. The Company has a number of suppliers for its operations. Some suppliers provide a significant amount of key raw materials to the Company, but the Company believes alternative sources are available for most materials. For those raw materials where an alternative source is not readily available, the Company has contingency raw material replacement plans. To date, there have been no significant shortages of raw materials. The Company believes it has good supplier relations.
Competition
The Company competes in its markets based on product development capability, quality, reliability, availability, technical support and price. Though the screen printing market is much larger than the awards and recognition market, IKONICS commands significantly more market share in the latter. IKONICS has two primary domestic competitors in its screen printing film business. They are larger than IKONICS and possess greater resources than the Company in many areas. The Company has numerous competitors in the market for screen print emulsions, many of whom are larger than IKONICS and possess greater resources. The market for the Company’s abrasive etching products in the awards and recognition market has one significant competitor. IKONICS considers itself to be the leader in this market. There are significant competitors, using different technologies in the new markets being entered by the Company. The primary competition for AMS is from other machining methods, most of which are well established. The primary competition for DTX comes from old, well-established technologies based on wax and screen printing and new competition from laser technologies.
Government Regulation
The Company is subject to a variety of federal, state and local industrial laws and regulations, including those relating to the discharge of material into the environment and protection of the environment. The governmental authorities primarily responsible for regulating the Company’s environmental compliance are the Environmental Protection Agency, the Minnesota Pollution Control Agency and the Western Lake Superior Sanitary District. Failure to comply with the laws promulgated by these authorities may result in monetary sanctions, liability for environmental clean-up and other equitable remedies. To maintain compliance, the Company may make occasional changes in its waste generation and disposal procedures.
These laws and regulations have not had a material effect upon the capital expenditures or competitive position of the Company. The Company believes that it complies in all material respects with the various federal, state and local regulations that apply to its current operations. Failure to comply with these regulations could have a negative impact on the Company’s operations and capital expenditures and such negative impact could be significant.
The Company also is subject to regulations from foreign governments covering the importation of certain chemicals. The Company believes that it complies in all material respects with these regulations that apply to its current products. Failure to comply with these regulations could have a negative impact on the Company’s operations and capital expenditures and such negative impact could be significant.
Employees
As of February 26, 2020, the Company had 82 total and full-time employees, 77 of whom are located at the Company’s two facilities in Duluth, Minnesota and five of whom are outside technical sales representatives in various locations in the United States. None of the Company’s employees are subject to a collective bargaining agreement and the Company believes that its employee relations are good.
Item 1A. Risk Factors
The Company’s DTX and AMS initiatives involve new technologies that might not be executed successfully and might not achieve market acceptance.
The Company’s DTX and AMS initiatives involve technologies that might never achieve market acceptance. During 2019 and 2018, the Company generated operating losses in its AMS segment while the DTX segment has realized operating income since 2015. The Company’s ability for generating profits from these initiatives will depend on its products gaining market acceptance among customers, which cannot be guaranteed. The degree of market acceptance of any new products the Company develops will depend on a number of factors, including:
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the Company’s ability to successfully develop its technologies and products to include the capabilities the Company intends;
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the Company’s ability to accurately assess the functions and features customers desire;
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the perceived effectiveness and price of the Company’s products compared to alternative products and technologies;
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the development of new products and technologies by current competitors or new competitors that might enter the Company’s markets; and
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the strength of the Company’s marketing and distribution functions.
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If new products that the Company develops do not have the capabilities the Company expects or fail to achieve an adequate level of acceptance by customers for any reason, then the Company’s AMS and DTX business units could fail to generate the revenues the Company expects and may not become profitable or sustain profitability.
If the Company’s new products and technologies do not achieve market acceptance, the Company will not realize a return on its investments in its new business initiatives.
The Company has invested, and plans to continue to invest, significant resources in its research and development efforts to develop technology for its business units. The Company spent 4.9% of sales, or $870,000, on research and development in 2019 and 3.7% of sales, or $677,000, in 2018. A substantial portion of these investments was for new products and initiatives. The Company plans to continue to invest significant resources in research and development of new products and initiatives for the foreseeable future. The Company believes successful execution of these initiatives and new products is important for its ability to grow its revenues and profits. However, if the Company fails to generate its projected revenues from these products and initiatives, the Company’s investments in these areas would not generate the profits the Company expects and its results of operations, financial condition and prospects would be materially and adversely affected.
Adverse changes to global economic conditions generally, and to the aerospace and automotive industries in particular, may harm the Company’s business.
The prospects for economic growth in the United States and other countries remain uncertain and major economies where the Company conducts business could continue or return to recessionary conditions. Economic concerns and issues such as reduced access to capital for businesses or tariffs may cause the Company’s customers to delay or reduce purchases of the Company’s products. Given the continued uncertainty concerning the global economy, the Company also faces risks that may arise from financial difficulties experienced by suppliers and customers, such as an inability to collect receivables or the continued operation of suppliers. Global or local events, such as terrorist attacks, political insurgencies, electrical grid disruptions and outages, and pandemics including further spread of the coronavirus could also disrupt our operations, the operations of our suppliers and customers, or result in economic instability.
The Company’s AMS segment focuses primarily on customers in the aerospace industry, and its DTX segment focuses primarily on customers in the automotive industry. The aerospace and automotive industries have experienced volatility in prior years in a manner similar to or greater than the global economy generally. If either or both these industries experiences difficulties that reduce demand for their products generally, the Company’s results of operations, financial condition and prospects would suffer.
The Company faces significant competition and expects to face increasing competition in many aspects of its businesses, which could cause operating results to suffer.
The Company operates in highly competitive industries that experience rapid technological and market developments, changes in customer needs, and frequent product introductions and improvements, particularly with respect to the AMS and DTX businesses. If the Company is unable to anticipate and respond to these developments, its products or technologies could become uncompetitive or obsolete. Most of the Company’s competitors in the AMS and DTX fields are larger and better capitalized than the Company with longer operating histories. These advantages could allow the Company’s competitors to invest more resources in research and development and sales and marketing than the Company, which could make the competitive products more attractive or better known to consumers than the Company’s products. In addition, because there is potential for rapid technological change in fields in which the Company operates, the Company could face competition from new sources in the future that customers find more attractive.
The Company also could face increased competition in its traditional Chromaline and IKONICS Imaging units. Capital costs for machinery necessary to operate in these industries have decreased in recent years, increasing the possibility that the Company will face new competitors. An increase in the amount of competition the Company faces, or a loss of competitiveness in any of the Company’s business units for any reason, could adversely affect its revenues and gross margins.
The Company’s failure to comply with environmental laws and regulations could harm its business and results of operations.
The manufacturing of the Company’s products requires the use of hazardous materials that are subject to a broad array of environmental laws and regulations. The Company’s failure to comply with these laws or regulations could result in:
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regulatory penalties, fines and legal liabilities;
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suspension of production;
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alteration of manufacturing processes; and
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restrictions on the Company’s operations or sales.
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The Company’s failure to manage the use, transportation, emissions, discharge, storage, recycling or disposal of hazardous materials could lead to increased costs or future liabilities. Environmental laws and regulations also could require the Company to acquire pollution abatement or remediation equipment, modify product designs or incur other expenses.
Third parties may claim the Company infringes their intellectual property rights, which could harm the Company’s business.
The Company may face claims that it infringes other parties’ intellectual rights. Regardless of a claim’s merit, claims that the Company’s products or processes infringe the intellectual property rights of others could cause the Company to incur large costs to respond to, defend, and resolve the claims, and they may divert the efforts and attention of management and technical personnel. As a result of any intellectual property rights infringement claims, the Company could be required to:
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pay infringement claims;
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stop manufacturing, using, or selling products or technology subject to infringement claims;
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develop other products or technology not subject to infringement claims, which could be time-consuming, costly or impossible; or
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license technology from the party claiming infringement, which license may not be available on commercially reasonable terms, if at all.
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These actions could harm the Company’s competitive position, result in additional expenses, or require the Company to impair its assets. If the Company alters or stops production of affected items, its ability to generate revenue could be harmed.
The Company may be unable to enforce or protect its intellectual property rights, which may harm its ability to compete and may harm its business.
The Company’s ability to enforce its patents, trademarks and other intellectual property rights is subject to general litigation risks, as well as uncertainty as to the enforceability of the Company’s intellectual property rights in various countries. If the Company seeks to enforce its rights, it could become subject to claims that its intellectual property rights are invalid, not enforceable, or licensed to the opposing party. The Company’s assertion of intellectual property rights also could result in the other party seeking to assert claims against the Company, which could harm the Company’s business. The Company’s inability to enforce its intellectual property rights for any reason could harm its competitive position and business.
If the Company is unable to protect the confidentiality of its proprietary information and know-how, the value of its technology could be adversely affected.
In addition to patented technology, the Company relies on unpatented proprietary technology, trade secrets, processes and know-how. The Company generally seeks to protect this information by confidentiality agreements with employees, consultants, advisors and third parties. These agreements may be breached, and the Company may not have adequate remedies for any such breach. In addition, the Company’s trade secrets may otherwise become known or be independently developed by competitors. To the extent that the Company’s employees, consultants or contractors use intellectual property owned by others in their work for the Company, disputes may arise as to the rights in related or resulting know-how and inventions.
The Company operates a global business that exposes it to additional risks.
The Company operates throughout the world, including in the United States, Europe, India and China. These international operations create a variety of risks and uncertainties, including:
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rapid changes in government, economic and political policies and conditions, political or civil unrest or instability, terrorism or epidemics including the coronavirus;
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fluctuations in foreign currency exchange rates;
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compliance with and changes in foreign laws and regulations, as well as U.S. laws affecting the activities of U.S. companies abroad, including the Foreign Corrupt Practices Act of 1977, as amended (the “FCPA”);
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different, complex and changing laws governing intellectual property rights, sometimes affording companies lesser protection in certain areas;
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longer accounts receivable payment cycles and difficulties in collecting accounts receivable;
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protectionist laws, tariffs and business practices that favor local producers; and
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potentially adverse tax consequences, including the complexities of foreign value added tax systems and restrictions on the repatriation of earnings.
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The occurrence of any one of these risks could negatively affect the Company’s international business and, consequently, its results of operations generally.
The Company faces risks related to sales through distributors and other third parties.
A significant portion of the Company’s sales, including nearly all sales of its Chromaline products, were conducted through third parties. Using third parties for distribution exposes the Company to many risks, including competitive pressure, concentration, credit risk and compliance risks. Distributors may sell products that compete with the Company’s products, and the loss of a distributor could reduce the Company’s revenue. Distributors may face financial difficulties, including bankruptcy, which could harm the Company’s collection of accounts receivable and financial results. Violations of the FCPA or similar laws by distributors or other third-party intermediaries could have a material impact on the Company’s business. Failing to manage risks related to the Company’s use of distributors may reduce sales, increase expenses, and weaken its competitive position.
Increases in prices and declines in the availability of raw materials could negatively impact the Company’s financial results.
Certain raw materials needed to manufacture products are obtained from a limited number of suppliers and many of the raw materials are petroleum-based. Under normal market conditions, these raw materials are generally available on the open market from a variety of producers. While alternate supplies of most key raw materials are available, supplier production outages may lead to strained supply-demand situations for certain raw materials. The substitution of key raw materials could require the Company to identify new supply sources, or reformulate and retest products or processes. From time to time, the prices and availability of these raw materials may fluctuate, which could impair the Company’s ability to procure necessary materials, or increase the cost of manufacturing products. If the prices of raw materials increase in a short period of time, the Company may be unable to pass these increases on to its customers in a timely manner or at all, which could reduce its gross margins. Like most companies in the Company’s industries, the Company does not have long-term supply contracts for most of its key raw materials, which exacerbates the foregoing risks to the Company.
If any of the Company’s current single or limited source suppliers become unavailable or inadequate, its customer relationships, results of operations and financial condition may be adversely affected.
The Company acquires certain of its materials that are critical to its operations from a limited number of third parties. Should any of the Company’s current single or limited source suppliers become unavailable or inadequate, or impose terms unacceptable to the Company such as increased pricing terms, the Company could be required to spend a significant amount of time and expense to develop alternate sources of supply, and may not be successful in doing so on acceptable terms or at all. If the Company is unable to find a suitable supplier for a particular material, it could be required to modify its existing business processes or offerings to accommodate the situation. As a result, the loss of a single or limited source supplier could adversely affect the Company’s relationship with its customers and its results of operations and financial condition.
The Company depends on one manufacturer to make and sell DTX printers. If the manufacturer ceased to make or sell DTX printers, or failed to meet quality standards, the Company’s financial results and prospects would be adversely affected.
The Company relies on one company to manufacture and sell DTX printers. If the manufacturer ceased to produce or devote resources to selling DTX printers, due to a change in company strategy, to focus on alternative initiatives, or for any other reason, the Company would need to find an alternative manufacturer and seller of DTX printers. Finding an alternative manufacturer and seller of DTX printers could result in additional costs and delays in growing the Company’s DTX business unit, which would adversely affect the Company’s financial results and prospects.
In addition, if these manufacturers failed to produce DTX printers that satisfy the Company’s quality standards, the Company’s reputation with end users could be harmed and the Company could be forced to find a new manufacturer. Either of these results also would harm the Company’s business and prospects.
The inability to attract and retain qualified personnel could adversely impact the Company’s business.
Sustaining and growing the Company’s business depends on the recruitment, development and retention of qualified employees, including management and research and development personnel. The inability to recruit and retain key personnel or the unexpected loss of key personnel may adversely affect the Company’s operations.
An active trading market for the Company’s shares of common stock may not develop.
The Company’s common stock has been listed for trading on the Nasdaq Capital Market since 1999 and persistently has experienced limited trading volume. There can be no assurance that an active public market for the Company’s shares will develop or be sustained. The lack of an active trading market could adversely affect the price and liquidity of the Company’s common stock.
The Company’s directors and officers own a large percentage of the Company’s common stock, which may allow them to collectively exert significant influence over substantially all matters requiring shareholder approval.
As of December 31, 2019, the Company’s directors and officers collectively beneficially owned approximately 14.1% of its common stock outstanding as of that date. As a result, the Company’s directors and officers could exert significant influence over all matters requiring a shareholder vote, including the election of directors, amendments to the Company’s articles of incorporation, and extraordinary transactions such as mergers or going private transactions. These ownership positions may have the effect of delaying, deterring or preventing a change in control or a change in the composition of the Company’s board of directors. In addition, substantial sales of shares beneficially owned by our directors or officers could be viewed negatively by third parties and have a negative impact on the Company’s stock price.
The price of the Company’s common stock may fluctuate significantly.
The price of the Company’s common stock has, and could continue to, fluctuate substantially in a short period of time. The price of the Company’s common stock could vary for many reasons, including the following:
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future announcements concerning the Company or its competitors;
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introduction of new products by the Company or its competitors, or the failure of the Company’s new products to meet expectations;
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the commencement of, or developments to, litigation involving the Company;
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quarterly variations in operating results, which the Company has experienced in the past and expects to experience in the future;
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business acquisitions or divestitures; or
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changes to the global economy in general, and the aerospace and automotive markets in particular.
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In addition, stock markets in general have experienced price and volume fluctuations in recent years, fluctuations that sometimes have been unrelated to the operating performance of the affected companies. These broad market fluctuations may adversely affect the market price of the Company’s common stock. The market price of the Company’s common stock could decline below its current price and the market price of the Company’s shares may fluctuate significantly in the future. These fluctuations may be unrelated to the Company’s performance.
The terms of our financing agreement contain certain financial ratio covenants that may impair our ability to conduct our business.
On April 1, 2016, the Company entered into a financing agreement with the Duluth Economic Development Authority and Wells Fargo Bank, N.A. to borrow $3.4 million. 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 manufacturing 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 Company is subject to certain customary covenants set forth in the associated covenant agreement, including a requirement to 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. As of December 31, 2019 the Company was out of compliance with the debt service coverage ratio loan covenant, but obtained a waiver for the covenant violation. The Company amended the covenant terms in February of 2020 to change the debt service coverage ratio calculation from a rolling quarterly calculation to an annual calculation beginning December 31, 2020. There is no certainty that a waiver can be obtained in the future if similar violations occur. If the Company has future violations of its covenants, and is unable to obtain appropriate waivers, and the indebtedness is accelerated, it would have an adverse effect on the Company's financial condition and future operating performance and could limit its ability to invest in other business activities.
We heavily rely on our information technology systems and are vulnerable to damage and interruption.
The Company relies on our information technology systems and infrastructure to process transactions and manage its business, including maintaining employee, client and supplier information. The Company has also engaged third parties, including cloud providers, to store, transfer and process data. The information technology systems, as well as the systems of our customers, suppliers and other partners, are vulnerable to outages and an increasing risk of deliberate intrusions to gain access to and exploit company sensitive information. Similarly, data security breaches by employees and others with or without permitted access to the Company's systems pose a risk that sensitive data may be exposed to unauthorized persons or to the public. The Company may be unable to prevent outages or security breaches in its systems that could adversely affect results of operations and cause reputational harm.
The Company’s operating results and financial condition may fluctuate on a quarterly and annual basis.
The Company’s operating results and financial condition may fluctuate from quarter to quarter and year to year, and could vary due to a number of factors, some of which are outside of the Company’s control. In addition, the Company’s actual or projected operating results may fail to match its past performance. The Company’s operating results and financial condition may fluctuate due to a number of factors, including those listed below and those identified throughout this “Risk Factors” section:
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the failure of the Company’s new products to meet expectations;
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changes to the costs of raw materials, especially petroleum-based materials;
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the entry of new competitors into the Company’s markets whether by established companies or by new companies;
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the geographic distribution of the Company’s sales;
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changes in customer preferences or needs;
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changes in the amount that the Company invests to develop or acquire new technologies;
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delays between the Company’s expenditures to develop new technologies and products and the generation of sales related thereto;
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protectionist laws and tariffs implemented by foreign governments to favor local producers
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a prolonged United States Federal or State government shutdown
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changes in the Company’s pricing policies or those of its competitors;
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changes in accounting rules and tax and other laws; and
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general economic and industry conditions that affect customer demand and product development trends.
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Due to all of the foregoing factors and the other risks discussed in this “Risk Factors” section, you should not rely on quarter-to-quarter or year-to-year comparisons of the Company’s operating results as an indicator of future performance.