TERAWULF INC. quarterly report, Q3 FY2021

Business context and reporting period

Important filing identity: The supplied filing is IKONICS Corporation’s unaudited Form 10-Q for the quarter ended September 30, 2021, not a TeraWulf Inc. 10-Q. It discusses TeraWulf because IKONICS had a pending business combination with TeraWulf.

IKONICS reported four operating segments: Chromaline, IKONICS Imaging, Digital Texturing (DTX), and Advanced Material Solutions (AMS). Financial comparisons are with the three and nine months ended September 30, 2020, and balance-sheet comparisons are with December 31, 2020.

Financial performance and liquidity

At September 30, 2021, cash was $1.50 million, current assets were $5.21 million, and current liabilities were $2.20 million. Working capital was approximately $3.02 million. Long-term debt had been fully repaid in April 2021; no borrowings were outstanding on the $2.05 million bank line of credit, which was due to expire December 31, 2021 unless renewed. Cash declined $2.19 million over the first nine months, primarily reflecting $2.77 million of debt repayment, partly offset by operating cash generation. Management said available resources and expected cash flows should fund operations for more than twelve months.

Material changes versus prior period

• Q3 sales increased across all four segments. Chromaline and IKONICS Imaging were the largest contributors; Imaging also benefited from improved IKONART sales. AMS sales rose year over year in Q3 but remained lower for the nine-month period.
• Gross margin improved from 27.9% to 33.4% in Q3 and from 26.2% to 33.2% year to date, which management attributed in part to recovering sales and production volumes after COVID-related disruption.
• Net losses remained substantial. Q3 SG&A rose to $2.27 million from $0.98 million, including approximately $1.1 million of merger-related professional and stock-compensation costs. Nine-month merger-related professional and stock-compensation costs were approximately $1.9 million.
• Nine-month net loss was approximately unchanged year over year. The prior-year period included a $232,000 income-tax benefit; 2021 recorded approximately $6,000 of tax expense. IKONICS recorded a full valuation allowance against deferred tax assets.

Outlook, risks, contingencies, and unusual items

• Proposed combination: Under the pending transaction, each IKONICS share was to receive $5 in cash, one non-publicly traded contingent value right, and one share of the combined company, representing approximately 2% of its pro forma common equity for IKONICS shareholders collectively. The CVR was to entitle holders to 95% of net proceeds from qualifying sales of the IKONICS legacy business during the 18 months after closing. Closing was expected in Q4 2021, subject to approvals and other conditions; the agreement included termination rights if not completed by December 31, 2021.
• Merger costs and termination exposure: IKONICS reported significant transaction expenses. The agreement provides for a $1.2 million termination fee payable by IKONICS in certain circumstances and a $10.0 million fee payable by TeraWulf in certain circumstances. TeraWulf was to reimburse qualifying IKONICS transaction expenses at closing up to $640,000.
• Litigation: Six shareholder complaints alleged deficiencies in merger-related disclosures and sought, among other remedies, to enjoin the transaction. IKONICS said it believed the claims were without merit, but could not assure a favorable outcome; litigation could cause costs, distraction, delay, or an injunction.
• COVID-19 and operations: Management said demand was recovering toward pre-pandemic levels but warned that ongoing supply-chain disruption could impede fulfillment and materially affect results. IKONICS expected full-year 2021 results to be adversely affected, without providing quantified guidance. AMS order volumes were expected to be reduced in 2021 because of the pandemic.
• IKONICS anticipated minimal capital expenditures for the remainder of 2021. The filing also cited merger-related operating restrictions, customer and supplier uncertainty, and the risk that the transaction might not close. The company stated it had no off-balance-sheet arrangements.

Important facts for investors to verify

• Confirm the filing’s issuer: this is IKONICS’ 10-Q, not TeraWulf’s, and its results should not be treated as TeraWulf operating results.
• Check the final status and terms of the proposed combination, including closing conditions, consideration, CVR terms, and any subsequent amendments or outcomes.
• Review subsequent developments in the six merger-related lawsuits and whether they affected closing or transaction costs.
• Assess the sustainability of the sales and gross-margin recovery, especially given COVID-related supply-chain risks and AMS weakness.
• Track cash, operating cash generation, and renewal or replacement of the bank line of credit, which was scheduled to expire December 31, 2021.
• Consider the effect of merger expenses and the deferred-tax-asset valuation allowance when evaluating reported losses and future profitability.