Item 2. Management's Discussion and Analysis
of Financial Condition and Results of Operations
FORWARD-LOOKING STATEMENTS
Statements made in this Form 10-Q which are not purely
historical are forward-looking statements with respect to the goals, plans, objectives, intentions, expectations, financial condition,
results of operations, future performance and business of the Company. Forward-looking statements may be identified by the use
of such words as “believes”, “may”, “will”, “should”, “intends”, “plans”,
“estimates”, “anticipates”, or other similar expressions.
Forward-looking
statements involve inherent risks and uncertainties, and important factors (many of which are beyond our control) could cause actual
results to differ materially from those set forth in the forward-looking statements. In addition to those specific risks and uncertainties
set forth in the Company's reports currently on file with the SEC, some other factors that may affect the future results of operations
of the Company are: the development of products that may be superior to those of the Company; changes in the quality or composition
of the Company's products; lack of market acceptance of the Company's products; the Company's ability to develop new products;
general economic or industry conditions; changes in intellectual property rights; changes in interest rates; new legislation or
regulatory requirements; conditions of the securities markets; the Company's ability to raise capital; changes in accounting principles,
policies or guidelines; financial or political instability; acts of war or terrorism; and other economic, competitive, governmental,
regulatory and technical factors that may affect the Company's operations, products, services and prices.
Accordingly,
results actually achieved may differ materially from those anticipated as a result of such forward-looking statements, and those
statements speak only as of the date they are made.
The Company does not undertake, and specifically disclaims, any obligation to update any forward-looking statements to reflect events or circumstances occurring after the date of such statements.
OVERVIEW
The Company is a Delaware corporation that, through its Guardian Laboratories division, conducts research, product development, manufacturing and marketing of cosmetic ingredients, personal and health care products, pharmaceuticals, medical products, and proprietary specialty industrial products. All of the products that the Company manufactures, with the exception of RENACIDIN
®
, are produced at its facility in Hauppauge, New York, and are marketed through marketing partners, distributors, wholesalers, direct advertising, mailings, and trade exhibitions. Its most important product line is its LUBRAJEL
®
line of water-based moisturizing and lubricating gels, which are used primarily as ingredients in cosmetic products, as well as medical lubricants. The Company’s research and development department is actively working on the development of new products to expand the Company’s line of personal care products. Some of the Company’s products have patent protection, and others are produced using proprietary manufacturing processes.
The Company’s personal care products are marketed worldwide by six marketing partners, of which Ashland Specialty Ingredients (“ASI”) purchases the largest volume of products from the Company. Approximately 37% of the Company’s products are sold, either directly or through the Company’s marketing partners, to end users located outside of the United States.
The Company also sells two pharmaceutical products for
urological uses. Those products are sold primarily in the United States through the major drug wholesalers, which in turn sell
the products to pharmacies, hospitals, nursing homes and other long-term care facilities, and to government agencies, primarily
the United States Department of Veterans Affairs.
The Company's non-pharmaceutical medical products (referred
to hereinafter as "medical products"), such as its catheter lubricants, as well as its specialty industrial products,
are sold directly by the Company to the end users or to contract manufacturers utilized by the end users, although they are available
for sale on a non-exclusive basis by its marketing partners, as well.
While
the Company does have competition in the marketplace for some of its products, particularly its cosmetic ingredients, some of its
pharmaceutical and medical products have some unique characteristics, and do not have direct competitors. However, these products
may have indirect competition from other products that are not marketed as direct competitors to the Company’s products but
may have similar functions or properties to the Company’s products.
The Company recognizes revenue when products are shipped, title and risk of loss pass to the customers, persuasive evidence of a sales arrangement exists, and collections are reasonably assured. An allowance for returns, based on historical experience, is taken as a reduction of sales within the same period the revenue is recognized.
Over
the years the Company has been issued many patents and trademarks and intends, whenever possible, to make efforts to obtain patents
in connection with its product development program. Most of the patents that the Company has been issued have expired; however,
the Company does not believe that the expiration of those patents will have any material effect on its sales, since the Company’s
most important products rely on trade secrets and proprietary manufacturing methods rather than patent protection.
Critical
Accounting Policies
As
disclosed in the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2015, the discussion and analysis
of the Company’s financial condition and results of operations are based on its financial statements, which have been prepared
in conformity with GAAP. The preparation of those financial statements required the Company to make estimates and assumptions that
affect the carrying value of assets, liabilities, revenues and expenses reported in those financial statements. Those estimates
and assumptions can be subjective and complex, and consequently actual results could differ from those estimates and assumptions.
The Company’s most critical accounting policies relate to revenue recognition, concentration of credit risk, investments,
inventory, and income taxes. Since December 31, 2015, there have been no significant changes to the assumptions and estimates related
to those critical accounting policies.
The
following discussion and analysis covers material changes in the financial condition of the Company since the year ended December
31, 2015, and a comparison of the results of operations for the second quarter of 2016 and 2015, and the first half of 2016 and
2015. This discussion and analysis should be read in conjunction with "Management's Discussion and Analysis or Plan of Operation"
included in the Company's Annual Report on Form 10-K for the year ended December 31, 2015.
RESULTS OF OPERATIONS
Net sales for the second quarter of 2016 decreased by $1,984,926
(48.1%) when compared with the same period in 2015. Net sales for the first half of 2016 decreased by $4,094,743 (48.2%) as compared
with the corresponding period in 2015. The changes in net sales for both the second quarter of 2016 and the first half of 2016
were attributable to changes in sales of the following product lines:
|
|
(a)
|
Personal care products:
For the second quarter of 2016 the Company’s sales of personal
care products decreased by $2,169,373 (68.6%) when compared with the second quarter of 2015, and for the first half of 2016 the
Company’s sales of personal care products decreased by $4,544,993 (68.7%) when compared with the same period in 2015. The
decreases in sales in both periods were due primarily to decreases in shipments of the Company's extensive line of personal care
products to ASI, the Company's largest marketing partner. Sales to ASI alone decreased by 77.4% and 77.1% for the three-month and
six-month periods, respectively, ended June 30, 2016, compared with the corresponding periods in 2015. The Company has been informed
by ASI that this decline in purchases was almost entirely the result of (1) overly optimistic order forecasts by some of ASI’s
customers in China, which resulted in ASI purchasing more inventory than it needed, and (2) a regulatory issue in China that was
unrelated to the Company’s LUBRAJEL product but which resulted in temporarily curtailing the production of some cosmetic
products that included LUBRAJEL as one of their ingredients. The regulatory issue involved the use of an ingredient other than
Lubrajel that was not approved in China, and the companies that had been marketing those products are in the process of reformulating
them to comply with Chinese regulations. As a result of this regulatory issue, as well as the overly optimistic sales forecasts
by some of ASI’s customers, ASI accumulated significant excess inventory that it has gradually been working off. ASI has
further informed the Company that based upon the current forecasts that ASI is receiving from its customers in China, ASI’s
purchases of LUBRAJEL for China are expected to resume at the end of the third quarter or beginning of the fourth quarter of 2016,
but the Company anticipates that sales levels will be lower than they had been in the third quarter of 2015 and first 9 months
of 2015. The Company is working closely with ASI to rebuild sales of LUBRAJEL in China. In addition, the Company is evaluating
other ways in which it can increase global sales of its personal care products, and be as competitive as possible in light of the
additional competition that the Company has experienced in the personal care market over the past 2-3 years.
|
Sales of the Company’s personal care products to
the Company’s five other marketing partners for the second quarter of 2016 decreased by a net of $106,731 (24.1%) compared
with the second quarter of 2015, and decreased by a net $85,056 (10.5%) for the first six months of 2016 compared with the same
period in 2015. In each of those periods, increases in sales to two of the distributors were offset by decreases to three others,
with the largest change being attributable to the Company’s Korean marketing partner, whose sales decreased by $97,075 (34.9%)
for the second quarter of 2016 compared with the second quarter of 2015, and by $211,884 (48.2%) for the first half of 2016 compared
with the same period in 2015. That marketing partner had experienced unusually strong sales in the first half of 2015 that were
not repeated in the first half of 2016, with some of that reduction being attributable to the timing of orders.
In the second quarter of 2016 sales to the Company’s
marketing partners in the United Kingdom and Italy increased, while sales to its marketing partners in France and Switzerland decreased,
resulting in a net decrease in sales of $9,656 (5.9%) compared with the second quarter of 2015. For the six months ended June 30,
2016 sales to the Company’s marketing partners in the United Kingdom and France increased, while sales to its marketing partners
in Italy and Switzerland decreased, resulting in a net increase in sales of $126,828 (34%) compared with the same period in 2015.
The Company’s sales in Western Europe continue
to be negatively impacted by (a) the continuing economic problems in Europe; (b) the strong U.S. dollar relative to the Euro, which
has made the Company’s products less competitive in Europe, and (c) increased competition. For the past few years the Company
has been experiencing additional competition from Asian companies selling imitations of the Company’s products at much lower
prices, particularly a Korean company that is manufacturing imitations of the Company’s products in China. This has resulted
in a loss of some business to these competitive products. As a result, from time to time it has been necessary, and will continue
to be necessary, for the Company to lower its prices in specific cases in order to retain or attract customers, and this has impacted
its profit margins on those sales. The Company intends to continue to work with its marketing partners to take whatever steps are
necessary to try to recover the business it has lost to these lower-priced products, including continuing to reduce prices on a
case by case basis, as needed, in order to remain as competitive as possible.
|
|
(b)
|
Pharmaceuticals:
Pharmaceutical sales increased by $254,505 (59.6%) in the second quarter
of 2016 compared with the same period in 2015, and by $359,186 (41.9%) in the first six months of 2016 compared with the same period
in 2015. These increases were due primarily to a $241,967 (79.1%) increase in sales of RENACIDIN in the second quarter of 2016
compared with the same period in 2015. This was due to the introduction of a new 30 mL container in early April. Because of two
prior RENACIDIN production curtailments by the Company’s previous contract manufacturer, the volume of RENACIDIN being sold
is still below historical levels but has been increasing. In December 2015 the Company received approval by the U.S. Food and Drug
Administration to market RENACIDIN in a new, easy-to-use single-dose plastic 30mL bottle, which replaced the older 500mL glass
bottle that it had been selling for many years. Sales of the new 30mL bottle started at the beginning of April 2016, and since
that time the Company has experienced a steady increase in RENACIDIN sales. The Company has been actively promoting the new product
to urologists, pharmacists and patients.
|
|
|
(c)
|
Medical (non-pharmaceutical) products:
Sales of the Company’s medical products decreased
by $23,473 (4.5%) for the second quarter of 2016, and increased by $127,817 (12.2%) for the first half of 2016 compared with the
same periods in 2015. The changes in medical product sales were primarily attributable to the ordering patterns of the Company’s
customers for these products.
|
|
|
|
|
|
|
(d)
|
Industrial and other products:
Sales of the Company's industrial products, as well as other
miscellaneous products, decreased by $25,371 (41.1%) and decreased by $7,566 (8.9%) for the three and six months, respectively,
ended June 30, 2016, when compared with the corresponding periods ended June 30, 2015. These changes are attributable to customer
ordering patterns.
|
In addition to the above changes in sales, net sales allowances
increased by $20,826 for the three months and increased by $30,073 for the six months, respectively, ended June 30, 2016, when
compared with the corresponding periods in 2015. The increase for the three-month period and decrease for the six-month period
were both due primarily to increases or decreases in chargebacks paid to the U.S. Department of Veterans Affairs and allowances
for distribution fees.
Cost of Sales
For the second quarter of 2016, cost of sales as a percentage
of sales increased to 47.1%, from 34.0% in the second quarter of 2015. Cost of sales as a percentage of sales increased to 43.3%
for the first half of 2016, from 36.3% for the comparable period in 2015. The increases for the second quarter of 2016 and
for the first half of 2016 were primarily the result of a higher percentage of the Company’s sales for those periods coming
from its pharmaceutical products, primarily RENACIDIN, which is manufactured for the Company by a third party manufacturer and,
for that reason, has a lower margin than many of the Company’s other products.
Operating Expenses
Operating expenses, consisting of selling, general and
administrative expenses, increased by $21,338 (4.8%) for the second quarter of 2016 compared with the comparable quarter in 2015,
and increased by $27,967 (3.1%) for the first half of 2016 compared with the first half of 2015. The increases in operating expenses
were primarily attributable to some additional expenses for advertising and sales promotions for its new single-dose form of RENACIDIN.
Operating expenses are expected to remain relatively consistent.
Research and Development Expenses
Research and development expenses increased by $1,354 (0.9%)
for the second quarter of 2016 compared with the second quarter of 2015, and by $12,612 (3.9%) for the first half of 2016 compared
with the same period in 2015. The increases relate to increases in payroll and payroll-related expenses.
Investment Income
Investment income increased by $10,012 for the second quarter
of 2016 compared with the comparable quarter of 2015, and decreased by $130 for the first half of 2016 compared with the first
half of 2015. These increases were mainly due to fluctuations in dividend income from both stock and bond mutual funds.
Provision for Income Taxes
The Company's effective income tax rate remained approximately
31.0% for all periods presented, and is expected to remain consistent for the current fiscal year.
LIQUIDITY AND CAPITAL RESOURCES
Working
capital decreased from $
13,529,593
at December 31, 2015 to $13,101,036 at June 30, 2016, a
decrease of $428,557. The current ratio decreased from 14.7 to 1 at December 31, 2015 to 11.6 to 1 at June 30, 2016. The decrease
in working capital was primarily due to a decrease in marketable securities and an increase in accrued expenses. The decrease in
the current ratio was primarily due to the increase in accrued expenses. The increase in accrued expenses was due to an increase
in accruals for payroll and payroll-related expenses.
The Company believes that its working capital is, and will
continue to be, sufficient to support its operating requirements for at least the next twelve months. The Company does not expect
to incur any significant capital expenditures for the remainder of 2016.
The
Company generated cash from operations of $524,379 and $3,061,313 for the first half of 2016 and 2015, respectively. The decrease
was primarily due to the decrease in net income.
Cash provided by investing activities
for the first half of 2016 was $251,960, and cash used in investing activities in the first half of 2015 was $927,431. This increase
was primarily due to a decrease in the purchases of marketable securities in the first half of 2016 compared with the comparable
period in 2015.
Cash
used in financing activities was $1,603,871 and $2,298,219 for the first half of 2016 and 2015, respectively. This decrease was
mainly due to a decrease in dividends paid per share from $0.50 per share in 2015 to $0.35 per share in 2016.
|
|
|
The Company expects to continue to use its cash to make dividend payments, to purchase marketable
securities, and to take advantage of other opportunities that are in the best interest of the Company and its shareholders, should
they arise.
|
OFF BALANCE SHEET ARRANGEMENTS
|
|
|
The Company has no off balance sheet transactions that have, or are reasonably likely to have,
a current or future effect on the Company’s financial condition, changes in financial condition, revenues or expenses, results
of operations, liquidity, capital expenditures or capital resources.
|
CONTRACTUAL OBLIGATIONS AND COMMITMENTS
|
|
|
The information to be reported under this item is not required of smaller reporting companies.
|