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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 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, 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 VA.
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 (a) persuasive evidence of a sales arrangement exists; (b) products are shipped, which is also the time
when title, control, and risk of loss pass to the customers; and (c) 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 US 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 and nine months ended September 30, 2018 and September 30,
2017. 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, 2017. All references in this quarterly report
to “sales” or “Sales” shall mean Gross Sales.
The Company
recognizes revenue from sales of its 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 third quarter
of 2018 increased by $295,041 (approximately 9%) compared with the third quarter of 2017. Gross sales for the nine months ended
September 30, 2018 increased by $1,339,008 (approximately 13%) as compared with the corresponding period in 2017. The increases
in sales for the three and nine months ended September 30, 2018 were attributable to changes in sales of the following product
lines:
Personal care products:
For
the third quarter of 2018 sales of the Company’s personal care products increased by $229,855 (approximately 14%) when compared
with the third quarter of 2017, primarily due to increases in sales to the Company’s largest marketing partner, ASI, along
with increased sales to the Company’s marketing partners in France, the United Kingdom and Switzerland. Sales to ASI in the
third quarter increased by $388,987 (approximately 35%), which the Company believes was due to the timing of orders. Sales to the
Company’s marketing partner in France increased by $93,832 (approximately 86%). Sales to the Company’s marketing partner
in the United Kingdom increased by $21,355 (approximately 28%), and sales to the Company’s marketing partner in Switzerland
increased by $2,664 (approximately 519%). Offsetting those increases was a decrease in sales of $263,336 (approximately 95%) to
the Company’s marketing partner in South Korea, and a decrease of $24,424 (100%) to the Company’s marketing partner
in Italy. The Company has been informed by its marketing partner for Korea that the decreases in sales in Korea for both the third
quarter and the first nine months of the year were the result of the increased difficulty being experienced by Korean customers
for the Company’s products in exporting their finished products to China. The decrease in Italy is due primarily to the timing
of orders, since the market for the Company’s products in Italy is small and orders are placed infrequently. There was also
a $10,777 net increase in sales to some of the Company’s direct customers for its personal care products.
For the nine-month period ended
September 30, 2018 sales of the Company’s personal care products increased by $893,935 (approximately 17%) when compared
with the same period in 2017, with sales to ASI increasing by $947,053 (approximately 23%). The increase was due primarily to higher
sales to ASI in the first three quarters of 2018 compared with those same quarters in 2017. Nine-month sales to the Company’s
five other marketing partners decreased by $49,116 (approximately 4%), with increases in the United Kingdom and France, offset
by decreases in Switzerland, Korea and Italy. The nine-month changes in sales were as follows: sales to the Company’s marketing
partner in the United Kingdom increased by $104,181 (approximately 41%); sales to the Company’s marketing partner in France
increased by $97,498 (approximately 24%); sales to the Company’s marketing partner in Switzerland decreased by $295 (approximately
4%); sales to the Company’s marketing partner in South Korea decreased by $229,317 (approximately 46%), and sales to the
Company’s marketing partner in Italy decreased by $21,183 (approximately 26%). There was also a $4,002 net reduction in sales
to some of the Company’s direct customers for its personal care products.
The sales fluctuations to the
Company’s five other marketing partners (other than ASI) 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.
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(a)
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Pharmaceuticals:
For the third quarter of 2018 sales of the Company’s pharmaceutical
products increased by $78,082 (approximately 7%) when compared with the third quarter of 2017. For the nine-month period ended
September 30, 2018 sales of the Company’s pharmaceutical products increased by $419,367 (approximately 15%) when compared
with the first nine months of 2017, primarily due to sales of RENACIDIN increasing by $67,152 (approximately 7%) for the three-month
period and by $398,246 (approximately16%) for the nine-month period.
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(b)
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Medical (non-pharmaceutical) products:
Sales of the Company’s medical products decreased
by $14,203 (approximately 3%) for the third quarter of 2018 and increased by $19,527 (approximately 1%) for the nine-month period
ended September 30, 2018 compared with the comparable periods in 2017. The decrease in medical product sales for the third quarter
and the increase for the nine-month period was primarily attributable to the ordering patterns and stocking levels of three of
the primary customers for these products. Sales of these products have been inconsistent on a quarter to quarter basis for the
past 3 years due to the large quantities per order and the relative infrequency of these orders.
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(c)
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Industrial and other products:
Sales of the Company's industrial products, as well as other
miscellaneous products, increased by $1,307 (approximately 3%) and by $6,179 (approximately 6%) for the three and nine months,
respectively, ended September 30, 2018, when compared to the corresponding periods in 2017. These changes are attributable to customer
ordering patterns.
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In addition to the above changes
in sales, sales allowances increased by $58,831 and $185,207 for the three and nine-month periods, respectively, ended September
30, 2018, when compared with the corresponding periods in 2017. This increase was primarily due to increases in allowances for
distribution fees, outdated material returns attributable to the Company’s pharmaceuticals, and rebates paid to distributors
of certain products.
Cost of Sales
For the third quarter of 2018,
cost of sales as a percentage of net sales increased to approximately 37%, from 35% in the third quarter of 2017, and decreased
to approximately 40% for the nine-months ended September 30, 2018 compared with 42% for the comparable period in 2017. The
increase for the third quarter of 2018 as compared with third quarter of 2017 was due to lower sales of one of the Company’s
higher-margin products. The decrease for the first nine months of 2018 as compared with the comparable period in 2017, was primarily
due to lower per unit manufacturing costs resulting from the allocation of the Company’s fixed overhead costs over a larger
number of production units in the first nine months of 2018 compared with the comparable period in 2017. This was due to an increase
in demand for the Company’s products in 2018, which resulted in greater production and greater production efficiencies.
Operating Expenses
Operating expenses consist
of selling, general and administrative expenses. Operating expenses increased by $81,073 (approximately 18%) for the third quarter
of 2018 compared with the comparable quarter in 2017, and by $257,522 (approximately 20%) for the nine months ended September 30,
2018 compared with the nine months ended September 30, 2017. The increases for the third quarter and the first nine months of 2018
were primarily attributable to increases in consulting expenses, payroll, and payroll related expenses. Operating expenses are
expected to remain relatively consistent for the remainder of the year.
Research and Development
Expenses
Research and development expenses
decreased by $61,230 (approximately 38%) for the third quarter of 2018, and by $216,285 (approximately 43%) for the first nine
months of 2018 compared with the comparable periods in 2017. These decreases were mainly due to a decrease in payroll and payroll
related expenses.
Other Income
Other income increased by $22,943
(approximately 20%) for the third quarter of 2018 compared with the comparable quarter of 2017 and decreased by $164,409 (approximately
69%) for the first nine months of the year compared with the same period in 2017. These changes were mainly due to decreases in
dividend income from both stock and bond mutual funds in both periods, combined with realized and unrealized gains and losses.
Unrealized gains and losses are recognized in accordance with the adoption of ASU 2016-01 “Recognition and Measurement of
Financial Assets and Financial Liabilities.” The standard requires changes in fair market value of equity investments to
be recognized in net income. In the prior periods in 2017 these changes in fair value were recognized in accumulated other comprehensive
income (see Note 5). The Company adopted this standard in the first quarter of 2018.
Provision for income
taxes
The Company's effective income
tax rate was approximately 21% for the first nine months of 2018 and 31% for the first nine months 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 from $10,428,139 at December 31, 2017 to $11,993,435 at September 30, 2018, an increase of $1,565,296. The current
ratio increased from 8.3 to 1 at December 31, 2017 to 10.6 to 1 at September 30, 2018. The increase in working capital was primarily
due to an increase in marketable securities. The increase in the current ratio was primarily due to an increase in marketable securities
and a decrease in accounts 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 2018.
The
Company generated cash from operations of $3,908,470 and $3,214,348 for the nine months ended September 30, 2018 and September
30, 2017, respectively. The increase in cash from operations was primarily due to an increase in net income.
Cash used
in investing activities for the nine-month period ended September 30, 2018 and September 30, 2017 was $ 1,616,477 and $1,070,104
respectively. The increase was primarily due to the increase in purchases of marketable securities for the nine-month period ended
September 30, 2018 compared to the same period in 2017.
Cash
used in financing activities was $2,291,294 and $1,925,066 for the nine months ended September 30, 2018 and September 30, 2017,
respectively. The increase was due to an increase in the dividends paid per share from $0.42 per share in 2017 to $0.50 per share
in 2018.
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.