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Item 2.
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Management's Discussion and Analysis of Financial Condition and Results of Operations
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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 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 purchased and marketed worldwide by six marketing partners, of which U.S.-based Ashland Specialty Ingredients (“ASI”)
is the largest, purchasing approximately 49% of the Company’s products during the second quarter of 2017. Although a significant
percentage of ASI’s purchases from the Company are marketed to foreign customers, all sales to ASI are considered U.S. sales
for financial reporting purposes, since all ASI orders are shipped to ASI’s warehouses in the U.S. Based on sales information
provided to the Company by ASI, in the second quarter of 2017 approximately 74% of ASI’s sales were to customers in foreign
countries. Overall, approximately 19% of the Company’s products were sold to end users located outside of the United States,
either directly by the Company or by the Company’s other five marketing partners, during the second quarter of 2017.
The Company 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. 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 second quarter of 2017 approximately 7% 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.
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, 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 second quarter of 2017 and 2016, and the first half of 2017 and
2016. 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, 2016. All references in this quarterly report
to “sales” or “Sales” shall mean Gross Sales.
RESULTS OF OPERATIONS
Gross Sales
Gross Sales for the second quarter of 2017 increased by
$1,675,704 (approximately 76%) when compared with the same period in 2016. Sales for the first half of 2017 increased by $2,217,850
(approximately 49%) as compared with the corresponding period in 2016. The changes in sales for both the second quarter of 2017
and the first half of 2017 were attributable to changes in sales of the following product lines:
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(a)
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Personal care products:
For the second quarter of 2017 the Company’s sales of personal
care products increased by $1,306,268 (approximately 131%) when compared with the second quarter of 2016, and for the first half
of 2017 the Company’s sales of personal care products increased by $1,710,596 (approximately 82%) when compared with the
same period in 2016. The increases in sales in both periods were due primarily to increases in shipments of the Company's extensive
line of personal care products to ASI, the Company's largest marketing partner. Sales to ASI increased by $1,288,897 (approximately
208%) and $1,678,272 (approximately 127%) for the three-month and six-month periods, respectively, ended June 30, 2017, compared
with the corresponding periods in 2016.
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Sales of the Company’s personal care products to
the Company’s five other marketing partners for the second quarter of 2017 increased by $22,595 (approximately 6%) compared
with the second quarter of 2016, and increased by $31,420 (approximately 4%) for the first six months of 2017 compared with
the same period in 2016. In each of those periods, increases in sales to the Company’s distributors in France and Italy were
offset by decreases in sales in the United Kingdom, Korea, and Switzerland. The largest increase was attributable to the Company’s
marketing partner in France, whose sales increased by $159,696 (approximately 346%) for the second quarter of 2017 compared with
the second quarter of 2016, and by $28,722 (approximately 11%) for the first half of 2017 compared with the same period in
2016. In addition, sales by the Company’s marketing partner in Italy increased by $4,728 (approximately 17%) for the second
quarter of 2017 compared with the second quarter of 2016, and by $22,391 (approximately 67%) for the first half of 2017 compared
with the same period in 2016. Those increases were partially offset by decreases of $127,848 (71%) and $10,287 (5%) in sales to
the Company’s marketing partner in Korea; $13,815 (13%) and $2,620 (1%) to the Company’s marketing partner in the United
Kingdom; and $166 (6%) and $6,786 (50%) to the Company’s marketing partner in Switzerland, for the three and six months,
respectively, ended June 30, 2017.
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 that are manufacturing competitive products in Asia and selling
them at much lower prices. 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.
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(b)
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Pharmaceuticals:
Pharmaceutical sales increased by $275,073 (approximately 40%) in the second
quarter of 2017 compared with the same period in 2016, and by $560,460 (approximately 46%) in the first six months of 2017 compared
with the same period in 2016. These increases were due primarily to a $272,796 (approximately 50%) increase in sales of RENACIDIN
in the second quarter of 2017, and a $558,211 (approximately 59%) increase in RENACIDIN sales for the first half of 2017 compared
with the same period in 2016. This increase was the result of the initiation in the second quarter of 2016 of sales of the Company’s
new 30mL single-dose form of Renacidin and the concurrent discontinuation of the older 500mL bottle.
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(c)
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Medical (non-pharmaceutical) products:
Sales of the Company’s medical products increased
by $93,358 (approximately 19%) for the second quarter of 2017, and decreased by $41,921 (approximately 4%) for the first half of
2017 compared with the same periods in 2016. The changes in medical product sales were primarily attributable to the ordering patterns
of the Company’s customers for these products.
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(d)
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Industrial and other products:
Sales of the Company's industrial products, as well as other
miscellaneous products, increased by $1,006 (approximately 3%) and decreased by $11,284 (approximately 14%) for the three and six
months, respectively, ended June 30, 2017, when compared with the corresponding periods ended June 30, 2016. These changes are
attributable to customer ordering patterns.
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In addition to the above changes in sales, sales allowances
for both the three- and six- month periods ended June 30, 2017 increased by $40,118 and $58,452, respectively, when compared with
the corresponding periods in 2016. The increases for both periods were due primarily to increases in sales discounts, distribution
fees and allowances for outdated material returns.
Cost of Sales
For the second quarter of 2017, cost of sales as a percentage
of sales decreased to 42.8%, from 45.5% in the second quarter of 2016. The decrease was the result of an increase in sales of higher-margin
personal care products in the second quarter of 2017 compared with the second quarter of 2016. Cost of sales as a percentage
of sales increased to 43.3% for the first half of 2017, from 41.9% for the comparable period in 2016. The increase for the
first half of 2017 was primarily the result of a higher percentage of the Company’s sales for that period being generated
by 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, decreased by $46,724 (approximately 10%) for the second quarter of 2017 compared with the comparable quarter
in 2016, and decreased by $50,800 (approximately 5%) for the first half of 2017 compared with the first half of 2016. The decreases
in operating expenses were primarily attributable to decreases in payroll and payroll related expenses. Operating expenses are
expected to remain relatively consistent for the balance of the year.
Research and Development Expenses
Research and development expenses increased by $380 (less
than 1%) for the second quarter of 2017 compared with the second quarter of 2016, and by $12,543 (approximately 4%) for the first
half of 2017 compared with the same period in 2016.
Investment Income
Investment income decreased by $10,110 (approximately 12%)
for the second quarter of 2017 compared with the comparable quarter of 2016, and decreased by $550 (less than 1%) for the first
half of 2017 compared with the first half of 2016. 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 increased from $12,668,221 at December 31, 2016 to $12,803,412 at June 30, 2017, an increase of $135,191. The current ratio
decreased from 13.1 to 1 at December 31, 2016 to 10.7 to 1 at June 30, 2017. The increase in working capital was primarily due
to an increase in in cash and accounts receivable. The decrease in the current ratio was primarily due to the increase in accrued
expenses and income taxes payable. The increase in accrued expenses was due to an increase in accruals for bonuses and the Company’s
401K contribution.
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 $2,029,152 and $524,379 for the first half of 2017 and 2016, respectively. The increase
from 2016 to 2017 was primarily due to the increase in net income.
Cash provided by investing activities
for the first half of 2017 was $176,689, and cash provided by investing activities in the first half of 2016 was $251,960. This
decrease was primarily due to a decrease in the proceeds from the sale of marketable securities in the first half of 2017 compared
with the comparable period in 2016.
Cash
used in financing activities was $1,925,066 and $1,603,871 for the first half of 2017 and 2016, respectively. This increase was
mainly due to an increase in dividends paid per share from $0.35 per share in 2016 to $0.42 per share in 2017.
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.