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," or "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. 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 U.S.-based Ashland Specialty Ingredients (“ASI”)
purchases the largest volume of products from the Company. Approximately 22% of the Company’s products are sold to end users
located outside of the United States, either directly by the Company or by the Company’s other five marketing partners. Although
a significant percentage of ASI’s purchases from the Company are sold to foreign customers, all sales to ASI are considered
U.S. sales for financial reporting purposes, since all shipments to ASI are shipped to ASI’s warehouses in the U.S. A certain
percentage of those products are subsequently shipped by ASI to its foreign customers. Based on sales information provided to the
Company by ASI, in the first quarter of 2017 approximately 66% of ASI’s sales were to customers in foreign countries. In
addition, there are three customers for the Company’s medical products that take delivery of their purchases in the U.S.
but subsequently ship that product to manufacturing facilities outside the U.S. Since the Company makes those shipments to U.S.
locations, sales to those customers are considered domestic sales. In the first quarter of 2017 approximately 8% of the Company’s
medical product sales were delivered to U.S. locations for subsequent shipment by the customers to foreign manufacturing facilities,
which then produced finished products to be marketed globally.
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 functionality or properties that are similar 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’ 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, 2016, 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, 2016, 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, 2016, and a comparison of the results of operations for the three months ended March 31, 2017 and March 31, 2016. This discussion
and analysis should be read in conjunction with "Management's Discussion and Analysis of Financial Condition and Results of
Operations" included in the Company's Annual Report on Form 10-K for the year ended December 31, 2016. All references in this
quarterly report to “sales” or “Sales” shall mean Gross Sales.
RESULTS OF OPERATIONS
Gross Sales
Gross sales for the first quarter of 2017
increased by $542,146 (approximately 23%) as compared with the first quarter of 2016. The increase in sales for the
three-month period ended March 31, 2017 was primarily attributable to an increase in sales of the Company’s personal
care products and pharmaceutical products, which was partially offset by a decrease in sales of its medical and industrial
products, as follows:
|
(a)
|
Personal care products:
Sales of personal care products increased by $404,328 (approximately
37%) when compared with the same period in 2016. The increase was attributable to an increase in purchases by ASI of one of the
Company’s LUBRAJEL products for sale in China. During the first quarter of 2016 ASI had suspended its purchases of product
intended for sale in China due to an overstock situation. That situation was resolved in the fourth quarter of 2016, and since
that time ASI has resumed its purchases of product intended for sale in China on a more normalized basis.
|
Sales of the Company’s personal care products to
the Company’s other five marketing partners decreased by $38,591 (approximately 9%). The sales fluctuations to these five
other marketing partners are primarily the result of the timing of customer orders, but sales of the Company’s products in
Western Europe continue to be negatively impacted by both the continuing economic problems in Europe, as well as the strong U.S.
dollar relative to the Euro, which has made the Company’s products less competitive in Europe. There has been more competition
in Europe and Asia in the last 2-3 years than there had been in previous years, due to other 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 customers to these competitive products. From time to time it has been necessary
for the Company to lower its prices in order to retain or attract certain customers for some of its products, and this has impacted
its profit margins on those sales. To date this impact has not been significant; however, the Company expects that it will be necessary
to continue to lower its prices in certain cases, at least for the near future, in order to remain competitive in the marketplace.
Pharmaceuticals
: Pharmaceutical sales increased
by $285,387 (approximately 53%) in the first quarter of 2017 compared with the same period in 2016. This increase was due primarily
to a $285,415 (approximately 71%) increase in sales of RENACIDIN. The increase in sales was due to the company’s introduction
in April 2016 of its new 30mL single-dose version of RENACIDIN, which was not available for sale in the first quarter of 2016.
|
(b)
|
Medical (non-pharmaceutical) products:
Sales of medical products decreased by $135,279 (approximately
20%) for the first quarter of 2017 when compared with the same period in 2016. The Company believes that the decrease was primarily
due to the timing of orders, as well as the ordering patterns of many of its customers, which order large quantities of product
but may not place the same number of orders in every fiscal quarter.
|
|
(c)
|
Industrial and other products:
Sales of specialty industrial products, as well as other
miscellaneous products, decreased by $12,289 (approximately 29%) for the first quarter of 2017 compared with the same period in
2016.
|
In addition to the above changes in sales, sales rebates
and allowances increased by $18,334 (approximately 27%) for the first quarter of 2017 when compared with the same period in 2016.
This increase was primarily due to increases in sales discounts, allowances for distribution fees and allowances for outdated material
returns. These increases were partially offset by decreases in VA chargebacks.
Cost of Sales
Cost of sales as a percentage of sales increased to approximately
44% for the first quarter of 2017, up from approximately 39% for the first quarter in 2016. The increase was primarily the result
of the increase in sales of RENACIDIN, which is manufactured for the Company by a third-party manufacturer and has a lower margin
than many of the Company’s other products.
Operating Expenses
Operating expenses, consisting of selling, general, and
administrative expenses, decreased by $4,076 (approximately 1%) for the first quarter of 2017 compared with the first quarter of
2016. Operating expenses are expected to remain relatively consistent.
Research and Development Expenses
Research and development expenses increased by $12,163
(approximately 7%) for the first quarter of 2017 compared with the first quarter of 2016. The increase was related to increases
in payroll and payroll-related expenses.
Other Income
Other income increased by $9,560 (approximately 22%) for
the first quarter of 2017 compared with the first quarter of 2016. This is due to the Company recognizing a realized a loss of
$10,180 from the sale of marketable securities in the first quarter of 2016. The Company earns dividend income from both stock
and bond mutual funds.
Provision for Income Taxes
The Company's effective income tax rate was approximately
31.0% for the first quarter of 2017 and 2016 and is expected to remain consistent for the current fiscal year.
LIQUIDITY AND CAPITAL RESOURCES
Working
capital increased by $ 814,350 to $13,482,571 at March 31, 2017, up from $12,668,221 at December 31, 2016. The increase in working
capital is primarily due to increases in cash, marketable securities, and accounts receivable. The current ratio decreased to 10
to 1 at March 31, 2017, down from 13 to 1 at December 31, 2016. The decrease in the current ratio was primarily due to an increase
in accounts payable and income taxes payable.
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 2017.
The
Company generated cash from operations of $875,146 and $743,484 for the three months ended March 31, 2017 and March 31, 2016, respectively.
The increase was primarily due to the increase in net income.
Cash used in investing activities for
the three-month period ended March 31, 2017 was $54,430 while cash used in investing activities for the three-month period ended
March 31, 2016 was $562,665. The decrease was primarily due to a decrease in the amount of marketable securities purchased in the
first quarter of 2017 compared with the first quarter of 2016.
There was no cash used in financing activities for the
first quarters of 2017 and 2016.
The Company expects to continue to use its cash to make
dividend payments, purchase marketable securities, and take advantage of other market opportunities that are in the best interests
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.