Item 1. Financial Statements

IKONICS CORPORATION

BALANCE SHEETS

		March 31				December 31
		2008				2007
		(unaudited)
ASSETS
CURRENT ASSETS:
Cash and cash equivalents		$	4,050,206			$	1,230,020
Short-term investments			675,000				3,550,000
Trade receivables, less allowances of $45,000			2,126,803				2,025,257
Inventories			2,212,809				2,355,864
Deposits, prepaid expenses and other assets			302,610				130,596
Income tax refund receivable			6,207				—
Deferred income taxes			24,000				24,000
Total current assets			9,397,635				9,315,737
PROPERTY, PLANT, AND EQUIPMENT, at cost:
Land and building			1,745,750				1,631,142
Machinery and equipment			2,709,766				2,700,816
Office equipment			822,913				812,120
Vehicles			223,094				219,964
			5,501,523				5,364,042
Less accumulated depreciation			4,098,150				4,043,451
			1,403,373				1,320,591
INTANGIBLE ASSETS, less accumulated amortization of $226,448 in 2008 and $213,061 in 2007			492,825				479,888
DEFERRED INCOME TAXES			11,000				11,000
INVESTMENTS IN NON-MARKETABLE EQUITY SECURITIES			855,201				855,201
		$	12,160,034			$	11,982,417
LIABILITIES AND STOCKHOLDERS’ EQUITY
CURRENT LIABILITIES:
Accounts payable		$	568,361			$	435,572
Accrued compensation			232,676				347,691
Other accrued expenses			121,737				148,149
Income taxes payable			—				5,291
Total current liabilities			922,774				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 2,063,485 in 2008 and 2,045,961 in 2007			206,349				204,596
Additional paid-in capital			2,208,497				2,124,342
Retained earnings			8,822,414				8,716,776
Total stockholders’ equity			11,237,260				11,045,714
		$	12,160,034			$	11,982,417

See notes to condensed financial statements.

IKONICS CORPORATION

STATEMENTS OF OPERATIONS (Unaudited)

		Three Months
		Ended March 31
		2008				2007
NET SALES		$	3,780,848			$	3,507,767
COSTS AND EXPENSES:
Cost of goods sold			2,151,793				2,074,070
Selling, general and administrative			1,367,080				1,231,092
Research and development			214,855				206,272
			3,733,728				3,511,434
INCOME (LOSS) FROM OPERATIONS			47,120				(3,667	)
GAIN ON SALE OF NON-MARKETABLE EQUITY SECURITIES			—				55,159
INTEREST INCOME			43,675				32,907
INCOME BEFORE INCOME TAXES			90,795				84,399
INCOME TAX BENEFIT			(14,843	)			(54,698	)
NET INCOME		$	105,638			$	139,097
EARNINGS PER COMMON SHARE:
Basic		$	0.05			$	0.07
Diluted		$	0.05			$	0.07
WEIGHTED AVERAGE COMMON SHARES OUTSTANDING:
Basic			2,051,605				2,015,570
Diluted			2,069,129				2,064,511

See notes to condensed financial statements.

IKONICS CORPORATION

STATEMENTS OF CASH FLOWS (Unaudited)

		Three Months
		Ended March 31
		2008				2007
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income		$	105,638			$	139,097
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation			70,096				61,178
Amortization			13,428				13,428
Excess tax benefits from share-based payment arrangements			(29,636	)			(2,785	)
Tax benefit from stock option exercise			3,008				10,793
Stock based compensation			3,279				4,728
Gain on sales of vehicles			(1,725	)			(2,340	)
Gain on sale of non-marketable equity securities			—				(55,159	)
Deferred income taxes			—				9,000
Changes in working capital components:
Trade receivables			(101,546	)			191,680
Inventories			143,055				173,969
Deposits, prepaid expenses and other assets			(172,014	)			(91,575	)
Income tax refund receivable			(6,207	)			(6,860	)
Accounts payable			132,789				42,484
Accrued liabilities			(141,427	)			(202,601	)
Income taxes payable			24,345				(91,665	)
Net cash provided by operating activities			43,083				193,372
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchase of property and equipment			(159,653	)			(81,836	)
Proceeds on sale of vehicles			8,500				6,500
Purchase of intangibles			(26,365	)			(24,162	)
Proceeds on sale of short-term investments			2,875,000				—
Proceeds on sale of non-marketable equity securities			—				252,618
Net cash provided by investing activities			2,697,482				153,120
CASH FLOWS FROM FINANCING ACTIVITIES:
Excess tax benefits from share-based payment arrangements			29,636				2,785
Proceeds from exercise of stock options			49,985				25,599
Net cash provided by financing activities			79,621				28,384
NET INCREASE IN CASH AND CASH EQUIVALENTS			2,820,186				374,876
CASH AND CASH EQUIVALENTS AT BEGINNING OF PERIOD			1,230,020				253,186
CASH AND CASH EQUIVALENTS AT END OF PERIOD		$	4,050,206			$	628,062
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION:
Income taxes paid		$	7,861			$	68,528

See notes to condensed financial statements.

IKONICS CORPORATION

NOTES TO CONDENSED FINANCIAL STATEMENTS

(Unaudited)

1. Notes to Financial Statements

     The balance sheet of IKONICS Corporation (the “Company”) as of March 31, 2008, and the related statements of operations and cash flows for the three months ended March 31, 2008 and 2007, have been prepared without being audited.

     In the opinion of management, these financial statements reflect all adjustments (consisting of only normal recurring adjustments) necessary to present fairly the financial position of IKONICS Corporation as of March 31, 2008, and the results of its 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. Inventories

     The major components of inventories at March 31, 2008 and December 31, 2007 are as follows:

		Mar 31, 2008				Dec 31, 2007
Raw materials		$	1,317,547			$	1,373,835
Work-in-progress			344,593				296,998
Finished goods			1,195,095				1,308,917
Reduction to LIFO cost			(644,426	)			(623,886	)
Total Inventory		$	2,212,809			$	2,355,864

3. Earnings Per Common Share (EPS)

     Basic EPS is calculated using net income divided by the weighted average of common shares outstanding during the quarter. Diluted EPS is similar to Basic except that the weighted average 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 stock options, had been issued.

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

		Three Months Ended
		Mar 31, 2008				Mar 31, 2007
Weighted average common shares outstanding			2,051,605				2,015,570
Dilutive effect of stock options			17,524				48,941
Weighted average common and common equivalent shares outstanding			2,069,129				2,064,511

Options to purchase 35,098 and 76,321 shares of common stock were outstanding at March 31, 2008 and 2007, respectively.

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 56,173 shares of common stock are reserved for additional grants of options under the plan at March 31, 2008.

     The Company accounts for this plan under FAS 123(R), “Share-Based Payment” using the modified-prospective-transition method. Under the modified-prospective-transition method, FAS 123(R) applies to new awards and to awards that were outstanding on January 1, 2006 that are subsequently modified, repurchased, or cancelled. Under this method compensation cost in 2008 and 2007 includes cost for options granted prior to but not vested as of December 31, 2005, and options granted in 2008, 2007 and 2006.

     The Company charged compensation cost of approximately $3,300 against income for the three months ended March 31, 2008 and $4,700 for the three months ended March 31, 2007. As of March 31, 2008 there was approximately $15,000 of unrecognized compensation cost related to unvested share-based compensation awards granted. That cost is expected to be recognized over the next two 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, increased by the APIC pool, which is the amount that represents the pool of excess tax benefits available to absorb tax shortages. For the three months ended March 31, 2008, $29,636 of excess tax benefits were reported as operating and financing cash flows compared to $2,785 for the three months ended March 31, 2007. The Company’s APIC pool totaled $10,346 and $42,497 at March 31, 2008 and December 31, 2007, respectively.

     Proceeds from the exercise of stock options were $49,985 and $25,599 for the three months ended March 31, 2008 and 2007, respectively. There were no options granted during the three months ending March 31, 2008.

     Stock option activity during the three months ending March 31, 2008 was as follows:

						Weighted
						Average
						Exercise
		Shares				Price
Outstanding at beginning of period			52,622			$	4.03
Granted			—				—
Exercised			(17,524	)			2.85
Expired and forfeited			—				—
Outstanding at 3/31/08			35,098				4.62

     The aggregate intrinsic value of all options outstanding and for those exercisable at March 31, 2008 was $170,318 and $151,119, respectively.

5. Intangible Assets

     Intangible assets consist primarily of patents, licenses and covenants not to compete arising from business combinations. Intangible assets are amortized on a straight-line basis over their estimated useful lives or terms of their agreements. Estimated amortization expense for each of the next five years is $54,000 to $45,000 annually. In connection with license agreements, the Company has agreed to pay royalties ranging from 3% to 5% on the future sales of products subject to the agreements.

6. Segment Information

     The Company’s reportable segments are strategic business units that offer different products and have a varied customer base. 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 March 31, 2008:

		Domestic				Export				IKONICS Imaging				Other				Total
Net Sales		$	1,392,226			$	1,228,945			$	1,159,677			$	—			$	3,780,848
Cost of good sold			783,955				806,826				561,012				—				2,151,793
Selling, general and administrative*			291,684				111,898				349,198				614,300				1,367,080
Research and Development*			—				—				—				214,855				214,855
			1,075,639				918,724				910,210				829,155				3,733,728
Income (loss) from operations		$	316,587			$	310,221			$	249,467			$	(829,155	)		$	47,120

     For the three months ended March 31, 2007:

		Domestic				Export				IKONICS Imaging				Other				Total
Net Sales		$	1,379,347			$	986,950			$	1,141,470			$	—			$	3,507,767
Cost of good sold			800,604				723,083				550,383				—				2,074,070
Selling, general and administrative*			285,567				123,414				394,204				427,907				1,231,092
Research and Development*			—				—				—				206,272				206,272
			1,086,171				846,497				944,587				634,179				3,511,434
Income (loss) from operations		$	293,176			$	140,453			$	196,883			$	(634,179	)		$	(3,667	)

     Accounts receivable as of March 31, 2008 and December 31, 2007:

		Mar 31, 2008				Dec 31, 2007
Domestic		$	966,250			$	980,906
Export			791,647				712,936
IKONICS Imaging			376,941				356,272
Other			(8,035	)			(24,857	)
Total		$	2,126,803			$	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 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 quarter of 2007 and $44,000 for the first quarter of 2008. As of March 31, 2008, the liability for unrecognized tax benefits totaled $54,000 compared to a liability of $92,000 as of March 31, 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 had accrued approximately $6,500 of interest related to uncertain tax positions at March 31, 2008. The unrecognized tax benefits at March 31, 2008 relate to taxation of foreign export sales.

     A reconciliation of the beginning and ending amounts of unrecognized tax benefit for the first quarter of 2008 is as follows:

Balance at January 1, 2008		$	98,000
Expiration of the statute of limitations for the assessment of taxes			(44,000	)
Balance at March 31, 2008		$	54,000

     The balance of unrecognized tax benefits totaling $54,000 at March 31, 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. The Company also accrued potential interest of $1,000 related to these unrecognized tax benefits during 2008 bringing the total accrued interest to $6,500 as of March 31, 2008.

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 first quarter of 2008 and for the same period of 2007. It should be read in connection with the Company’s condensed unaudited financial statements and notes thereto included in this Form 10-QSB.

Factors that May Affect Future Results

     Certain statements made in this Quarterly Report on Form 10-QSB, including those summarized below, are forward-looking statements within the meaning of the safe harbor provisions of Section 21E of the Securities Exchange Act of 1934, as amended, that involve risks and uncertainties, and actual results may differ. Factors that could cause actual results to differ include those identified below.

	•		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 35% to 36% of pretax income for the second quarter of 2008 compared to the tax benefit of 16% recorded in the first quarter of 2008—The effective tax rate for the second 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 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 March 31, 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 March 31, 2008 will be adjusted as the statute of limitations expires or these positions are reassessed.

     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, 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 March 31, 2008 Compared to Quarter Ended March 31, 2007

     Sales. Compared to the same period in 2007, the Company’s sales increased 7.8% during the first quarter of 2008. Sales during the first quarter of 2008 were $3,781,000 versus sales of $3,508,000 during the first quarter of 2007. The $273,000 sales increase was mainly due growth in the Export business. Export sales growth was driven by increased shipments to China across all products lines. Efforts are also being made to diversify distribution in China. European shipments also grew during the first quarter of 2008 due to increased image mate^® sales.

     Cost of Goods Sold. Cost of goods sold during the first quarter of 2008 was $2,152,000, or 56.9% of sales, compared to $2,074,000, or 59.1% of sales, during the same period in 2007. The decrease in the cost of sales of 2.2% in the first quarter of 2008 reflects the additional overhead expenses incurred during the first quarter of 2007 from expenses related to the transition of the image mate product line acquired by the Company on December 29, 2006.

     Selling General and Administrative Expenses. Selling, general and administrative expenses increased to $1,367,080, or 36.2% of sales, in the first quarter of 2008, from $1,231,000, or 35.1% of sales, for the same period in 2007. The first three months of 2008 reflect additional personnel related expenses for salaries, severance agreement, insurance and travel.

     Research and Development Expenses. Research and development expenses during the first quarter of 2008 were $215,000, or 5.7% of sales, versus $206,000, or 5.9% of sales, for the same period in 2007. The increase was due to depreciation and travel expenses related to the Company’s efforts in the industrial digital inkjet market.

     Gain on Sale of Non-Marketable Equity Securities. The Company realized a gain of $55,000 on the sale of its investment in the common and preferred stock of Apprise Technologies, Inc. during the first quarter of 2007. In addition to the initial proceeds, the Company anticipates receiving additional proceeds during the fourth quarter of 2008 from the portion of the total sale price that was placed in escrow at the time of the sale related to potential indemnification obligations as part of the agreement between Apprise and its purchaser. The additional proceeds and gain recognition is expected to be approximately $40,000, however there can be no assurance given that this will occur.

     Interest Income. Interest income for the first quarter of 2008 was $44,000, compared to $33,000 for the same period in 2007. The interest income increase is due to a larger average invested balance in interest earning assets. During 2008 interest income is expected to decrease as the Company’s investment balance decreases as funds are used to construct its new facility.

     Income Taxes. For the first quarter of 2008, the Company realized an income tax benefit of $15,000 compared to income tax benefit of $55,000 for the same quarter in 2007. The 2008 first quarter benefit primarily relates to 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 first quarter benefit primarily relates to 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 quarter 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 2008. The Company expects that for the remainder of 2008, the Company will have recorded income taxes at an effective tax rate of 35% to 36%.

Liquidity and Capital Resources

     The Company has financed its operations principally with funds generated from operations and 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 $4,050,000 and $628,000 at March 31, 2008 and March 31, 2007, respectively. The Company generated $43,000 in cash from operating activities during the three months ended March 31, 2008, compared to generating $193,000 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 three months of 2008, trade receivables increased by $102,000. The increase in receivables was driven by increased export sales and 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 $143,000 due to lower finished goods levels resulting from increased sales. Deposits, prepaid expenses and other assets increased $172,000, reflecting annual insurance premiums prepaid in the first quarter of 2008 and reimbursable costs related environmental remediation on the 11 acres of land purchased during the second quarter of 2008. Accounts payable increased $133,000, primarily as a result of the timing of payments to and purchases of material from suppliers for inventory. Accrued expenses decreased $141,000, primarily reflecting the timing of compensation payments. Income taxes payable increased $24,000 and income tax refund receivable increased $6,000 due to the accrual of 2008 taxes.

     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. This reclassification had no impact on results of operations, cash flows from operations, total current assets, total assets, or stockholders’ equity.

     For the first three months of 2008, investing activities provided $2,697,000 to the Company. The Company sold $2,875,000 of short-term investments comprised of ARS during 2008 at no gain or loss. At March 31, 2008, the Company had $675,000 of ARS which were comprised entirely of AAA municipal bonds which are classified as short term investments and recorded at cost which equaled fair market value. Because of the current volatility in the ARS market, subsequent to the end of the first quarter, the Company sold the remaining $675,000 of its ARS for their cost, which equaled market value, and placed the proceeds in a money market account. The $2,875,000 received from the sale of short-term investments during the first quarter of 2008 was partially offset by

$160,000 of property and equipment purchases along with $26,000 in patent application costs that the Company records as an asset and amortizes upon successful completion of the application process.

     For the first three months of 2007, investing activities provided $153,000 to the Company. The Company received $253,000 from the sale of its Apprise investment. The cash received was partially offset by $82,000 used for the purchase of Company vehicles and equipment to improve efficiency and reduce operating costs. The Company also incurred $24,000 in patent application costs that the Company records as an asset and amortizes upon successful completion of the application process.

     The Company realized $80,000 from financing activities during the first three months of 2008 compared to $28,000 received in the same period of 2007. During the first three months of 2008, the Company received $50,000 for the issuance of 17,524 shares of common stock upon the exercise of stock options compared to $26,000 received during the first three months of 2007 for 11,401 shares of common stock issued upon the exercise of stock options. The Company also realized a $30,000 benefit during the first quarter of 2008 related to the excess tax benefit from the exercise of stock options compared to $3,000 for the same period in 2007.

     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 quarter ended March 31, 2008 or during fiscal year 2007. There was no debt outstanding under this line as of March 31, 2008 or December 31, 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