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, the largest of which is U.S.-based ASI. 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, 2017, 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, 2017, 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, 2017, and a comparison of the results of operations for the three months ended March 31, 2018 and March 31, 2017. 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, 2017. All references in this
quarterly report to “sales” or “Sales” shall mean Gross Sales.
The Company recognizes revenue from
sales of it’s personal care, medical, and industrial products when those products are shipped, as long as a valid purchase
order has been received and future collection of the sale amount is reasonably assured. These products are shipped “Ex-Works”
from the Company’s facility in Hauppauge, NY, and it is at this time that risk of loss and responsibility for the shipment
passes to the customer. Sales of these products are deemed final, and there is no obligation on the part of the Company to repurchase
or allow the return of these goods unless they are defective.
The Company’s pharmaceutical
products are shipped via common carrier upon receipt of a valid purchase order, with, in most cases, the Company paying the shipping
costs. The Company assumes responsibility for the shipment arriving at its intended destination. Sales of pharmaceutical products
are final and revenue is recognized at the time of shipment. Pharmaceutical products are returnable only at the discretion of the
Company unless (a) they are found to be defective; (b) the product is damaged in shipping; or (c) the product is outdated (but
not more than one year after their expiration date, which is a return policy which conforms to standard pharmaceutical industry
practice). The Company estimates an allowance for outdated material returns based on gross sales of their pharmaceutical products.
RESULTS OF OPERATIONS
Gross Sales
Gross sales for the first quarter of 2018 increased by
$794,225 (approximately 28%) as compared with the first quarter of 2017. The increase in sales for the three-month period ended
March 31, 2018 was primarily attributable to an increase in sales of the Company’s personal care products, as well as increased
sales of the Company’s pharmaceutical products. Sales of the Company’s medical and industrial products did not materially
change compared with the first quarter of 2017. The changes in the sales of the products in the Company’s different products
lines were as follows:
|
(a)
|
Personal care products:
Sales of the Company’s personal care products increased by
$638,181 (approximately 43%) when compared with the same period in 2017. The increase was primarily attributable to an increase
in purchases by ASI of the Company’s personal care ingredients, in particular the LUBRAJEL products, including increases
in purchases by ASI for sale in China.
|
Sales of the Company’s personal care products to
the Company’s other five marketing partners increased by $75,775 (approximately 20%). Sales to the Company’s marketing
partners in the UK, Korea, France and Italy increased in aggregate by approximately 21%, while sales to the Company’s marketing
partner in Switzerland decreased by approximately 1%. 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 and Asia continue to be
negatively impacted by increased competition from companies selling imitations of the Company’s products at lower prices,
particularly Asian companies that are manufacturing competitive products to the Company’s LUBRAJEL product line. 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
adjust its prices, as needed, in order to retain or attract certain customers for some of its products, and over the past year
the Company has become more aggressive in competing with some of the lower-priced products. Although there has been some impact
on the Company’s profit margins on those sales, to date this impact has not been significant. The Company intends to continue
to aggressively compete with these products in order to remain competitive.
|
(b)
|
Pharmaceuticals:
Pharmaceutical sales increased by $152,945 (approximately 19%) in the first
quarter of 2018 compared with the same period in 2017. This increase was due primarily to an increase of $156,060 (approximately
23%) in RENACIDIN sales.
|
|
(c)
|
Medical (non-pharmaceutical) products:
Sales of medical products increased by $4,132 (less
than 1%) for the first quarter of 2018 when compared with the same period in 2017.
|
|
|
|
|
(d)
|
Industrial and other products:
Sales of specialty industrial products, as well as other
miscellaneous products, decreased by $1,033 (approximately 3%) for the first quarter of 2018 compared with the same period in 2017.
|
In addition to the above changes in sales, sales allowances
and returns increased by $61,101 (approximately 71%) for the first quarter of 2018 when compared with the same period in 2017.
This increase was primarily due to increases in distribution fees charged by product distributors and rebates for products purchased
through certain distributors.
Cost of Sales
Cost of sales as a percentage of net sales decreased to
approximately 41% for the first quarter of 2018, down from approximately 45% for the first quarter in 2017. The decrease was primarily
the result of the increase in sales of the Company’s LUBRAJEL line of products, which carry a higher profit margin than some
of the Company’s other products, as well as a decrease in overhead expenses related to plant repairs and maintenance, payroll,
and payroll-related expenses.
Operating Expenses
Operating expenses, consisting of selling, general, and
administrative expenses, increased by $60,634 (approximately 13%) for the first quarter of 2018 compared with the first quarter
of 2017. The increase was mainly due to increases in plant repairs and maintenance, payroll, and payroll-related expenses.
Research and Development Expenses
Research and development expenses decreased by $88,065
(approximately 46%) for the first quarter of 2018 compared with the first quarter of 2017. The decrease was due to decreases in
payroll and payroll-related expenses.
Other Income
Other income decreased by $154,077 (approximately 291%)
for the first quarter of 2018 compared with the first quarter of 2017. This is due to the Company recognizing a realized loss of
$12,837 from the trade-in of equipment, as well as an unrealized loss on marketable securities recognized in the first quarter
of 2018 in accordance with the adoption of ASU 2016-01 “Recognition and Measurement of Financial Assets and Financial Liabilities”.
In accordance with this standard, changes in fair market value of equity investments should be recognized in net income. In the
first quarter of 2017, these changes in fair value were recognized in accumulated other comprehensive income.
Provision for Income Taxes
The Company's effective income tax rate was approximately
21% for the first quarter of 2018 and 31% for the first quarter of 2017. The Company’s tax rate is expected to remain at
21% for the current fiscal year
LIQUIDITY AND CAPITAL RESOURCES
Working
capital increased by $ 1,081,969 to $11,510,108 at March 31, 2018, up from $10,428,139 at December 31, 2017. The increase in working
capital is primarily due to increases in cash and marketable securities. The current ratio decreased to 7 to 1 at March 31, 2018,
down from 8.3 to 1 at December 31, 2017. The decrease in the current ratio was primarily due to an increase in accrued expenses
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 material capital expenditures for the remainder of 2018.
The
Company generated cash from operations of $1,670,181 and $875,146 for the three months ended March 31, 2018 and March 31, 2017,
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, 2018 was $1,323,754 while cash used in investing activities for the three-month period ended
March 31, 2017 was $54,430. The increase was primarily due to an increase in the amount of marketable securities purchased in the
first quarter of 2018 compared with the first quarter of 2017.
There was no cash used in financing activities for the
first quarters of 2018 and 2017.
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.