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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 using 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. See the Company’s discussion of risk factors in “ITEM 1A. RISK
FACTORS” below for the potential impact of the coronavirus on the Company’s future operations and financial
results.
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 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. Many of the Company’s products use proprietary manufacturing processes, and the company relies primarily
on trade secret protection to protect its intellectual property.
The Company’s cosmetic ingredients
are marketed worldwide by five 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 all
of the following requirements are satisfied: (a) persuasive evidence of a sales arrangement exists; (b) products are shipped, which
is when the performance obligation is satisfied and title 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 it still maintains a number of registered trademarks, the
two most important of which are “Lubrajel” and “Renacidin”. However, in regard to protection of the Company’s
proprietary formulations and manufacturing technology the Company currently relies primarily on trade secret protection rather
than patent protection due to the current disclosure requirements needed to obtain patents, the limited protection they afford,
and the difficulty and expense of enforcing them. However, the Company may, from time to time, seek patent protection when it believes
it would be in the Company’s best interest to do so. All of the Company’s previously-issued patents have expired; however,
the Company does not believe that the expiration of those patents has had, or will have, any material impact on its sales, since
in recent years protection for the Company’s most important products has been based on trade secrets and proprietary manufacturing
methods rather than patent protection.
As discussed in Note 3 above, while the Company is continuing
to operate due to its status as an “essential business,” it is likely that the coronavirus pandemic will have a negative
impact on the Company’s sales during 2020. The Company anticipates that its sales of pharmaceuticals and medical products
will not be materially impacted, but it is likely that its sales of cosmetic ingredients will be negatively impacted commensurate
with reduced customer demand for, and the consequent reduced production of, consumer cosmetic products. In addition, the Company
distributes products to marketing partners globally, and it is difficult to assess the current conditions that exist in other countries
where the Company’s products are sold, and how those conditions will affect the sales of the Company’s products. However,
it is likely that there will be a negative impact on the Company’s sales of its cosmetic ingredients in those countries.
Since there is uncertainty as to what the duration of the pandemic will be, the Company is unable to provide any accurate estimate
or projection as to what the full impact of the coronavirus will be on the Company’s operations and financial results for
the upcoming quarters.
As of the date of this report the Company does not anticipate
that the coronavirus pandemic will affect the ability of the Company to obtain raw materials and maintain production. The Company
has price protection on its most important raw material, and has multiple sources for many of its other raw materials. The Company
also brought in additional quantities of some raw materials at the beginning of the pandemic, and as a result does not anticipate
that it will have a problem maintaining production. Although the rate of production will be impacted due to staggered production
hours, the Company does not expect that to affect its ability to maintain sufficient inventory and production levels to be able
to fulfill sales orders on a timely basis.
Critical
Accounting Policies
As
disclosed in the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2019, 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, 2019, 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, 2019, and a comparison of the results of operations for the three months ended March 31, 2020 and March 31, 2019. 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, 2019. All references in this
quarterly report to “sales” or “Sales” shall mean Net Sales.
The Company recognizes revenue from
sales of its cosmetic ingredients, medical products, and industrial products when all of the following requirements are satisfied:
(a) a valid purchase order has been received; (b) products are shipped, which is when the performance obligation is satisfied and
title and risk of loss pass to the customers; and (c) 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
Net Sales
Net sales for the first quarter of 2020 increased by $142,596
(approximately 4%) as compared with the first quarter of 2019. The increase in sales for the three-month period ended March 31,
2020 was primarily attributable to an increase in sales of the Company’s pharmaceutical products and industrial products,
which was partially offset by decreased sales of the Company’s medical products. Sales of the Company’s cosmetic ingredients
did not materially change compared with the first quarter of 2019. The changes in the sales of the products in the Company’s
different products lines were as follows:
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(a)
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Cosmetic Ingredients: Sales of the Company’s cosmetic ingredients increased by $51,138
(approximately 3%) when compared with the same period in 2019. The increase was primarily attributable to an increase in purchases
of the Company’s cosmetic ingredients by ASI, whose purchases increased by $26,561 (approximately 2%) compared with the same
period in 2019 and an increase in sales to the Company’s marketing partner in France, which increased by $87,635 (approximately
82%) compared to the same quarter in 2019.
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The increases in cosmetic ingredients sales were partially
offset by a decrease in sales to the Company’s three other marketing partners in Europe. Sales to the Company’s marketing
partners in the UK, Italy and Switzerland decreased by a total of $50,349 (approximately 35%) compared with the first quarter of
2019. In addition, during the first quarter of 2019, the Company had sales to its former marketing partner in Korea of $13,979.
The Company is no longer working with that former marketing partner, and has appointed ASI its marketing partner in Korea. In late
2019, the Company began transitioning the Korean business to ASI. In addition to the increases and decreases in sales attributable
to the Company’s European marketing partners, there was an increase of $1,270 in direct sales to two cosmetic ingredient
customers in the United States during the first quarter of 2020.
The sales fluctuations to the Company’s European
marketing partners are the result of both the timing of customer orders as well as continuing competition from companies selling
competitive products at lower prices, particularly a number of Asian manufacturers. This has resulted in a loss of some business
in Europe to these less expensive products. As a result, from time to time the Company has adjusted its prices in order to retain
or attract customers and be more competitive 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 whenever possible.
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(b)
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Pharmaceuticals: Net pharmaceutical sales increased by $151,109 (approximately 17%) in the
first quarter of 2020 compared with the same period in 2019. Gross sales of Renacidin increased by $194,295 (approximately 19%),
and gross sales of the Company’s other pharmaceutical product, Clorpactin WCS-90, decreased by $3,745 (approximately 3%),
with the overall increase in gross pharmaceutical sales being partially reduced by pharmaceutical-related fees, rebates, and allowances
of $39,441. The increase in Renacidin sales was the result of an increase in purchases by the drug wholesalers, while the small
decrease in Clorpactin sales was due primarily to the timing of orders.
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(c)
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Medical (non-pharmaceutical) products: Sales of medical products decreased by $71,312 (approximately
12%) for the first quarter of 2020 when compared with the same period in 2019. The decrease was primarily due to the lack of orders
in the first quarter of 2020 from one of the Company’s larger direct customers located in China due to the coronavirus pandemic.
With the economy in China now beginning to emerge from the coronavirus pandemic, customers’ orders that were expected in
the first quarter are now expected in the second quarter of 2020.
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(d)
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Industrial and other products: Sales of specialty industrial products, as well as other
miscellaneous products, increased by $11,661 (approximately 38%) for the first quarter of 2020 compared with the same period in
2019. The increase was primarily due to an increase in sales to one customer who purchases one of the Company’s specialty
industrial products.
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As a result of the increase in the sales of the Company’s
pharmaceutical products there was an increase in allowances for distribution fees, VA chargebacks, Medicaid and Medicare rebates,
sales rebates and discounts, and outdated material returns. The fees, rebates, and allowances attributable to the company’s
pharmaceutical products increase proportionately as sales of those products increase. During the first quarter of 2020, the allowances
for all the Company’s products increased by a net of $38,425 (approximately 14%) compared with the same period in 2019, primarily
due to the increase in Renacidin sales.
Cost of Sales
Cost of sales as a percentage of net sales increased to
approximately 42% for the first quarter of 2020, up from approximately 41% for the first quarter in 2019. The increase was primarily
the result of the increase in sales of Renacidin, which carries a higher cost to manufacture than some of the Company’s other
products. The Company did not experience any significant impact on costs of sales due to COVID-19.
Operating Expenses
Operating expenses, consisting of selling, general,
and administrative expenses, decreased by $31,687 (approximately 6%) for the first quarter of 2020 compared with the first quarter
of 2019. The decrease was mainly due to decreases in computer services, consulting fees and certain employee fringe benefits. The
Company did not experience any significant impact on selling, general, and administrative expenses due to COVID-19.
Research and Development
Expenses
Research and development (“R&D”) expenses
increased by $9,073 (approximately 9%) for the first quarter of 2020 compared with the first quarter of 2019. The increase was
due to increases in payroll and payroll-related expenses. The Company did not experience any significant impact on its R&D
work, or its R&D expenses, due to COVID-19.
Investment Income
Investment income decreased by $100 (less than 1%) for
the first quarter of 2020 compared with the first quarter of 2019. The Company did not experience any significant impact on its
investment income due to COVID-19.
Net (loss) gain on Marketable Securities
Net (loss) gain on marketable securities decreased by $613,789
(approximately 239%) for the first quarter of 2020 compared with the first quarter of 2019. In the first quarter of 2020, there
was an unrealized loss of $356,595 that resulted from the decrease in value of the Company’s marketable securities due to
the negative impact of the coronavirus epidemic on the stock and bond markets. Those markets took a steep drop in the first few
weeks of 2020 after COVID-19 reached the United States. Since that time the market has been slowly recovering, and while it is
not possible to predict future market performance overall, as of the date of this report the Company had recovered a substantial
amount of the first quarter unrealized losses. In the first quarter of 2019, there had been a realized gain of $257,194, which
was the result of the stock market rebounding from a steep drop that occurred in the fourth quarter of 2018.
Provision for Income Taxes
The Company's effective income tax rate was approximately
21% for the first quarter of 2020 and 2019. The Company’s tax rate is expected to remain at 21% for the current fiscal year.
LIQUIDITY
AND CAPITAL RESOURCES
Working
capital increased by $745,766 to $10,969,988 at March 31, 2020, up from $10,224,222 at December 31, 2019. The increase in working
capital was primarily due to increases in marketable securities. The current ratio decreased to 8.0 to 1 at March 31, 2020, down
from 8.6 to 1 at December 31, 2019. The decrease in the current ratio was primarily due to an increase in income taxes payable
and accrued 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 material capital expenditures for the remainder of 2020. The Company intends to utilize its
available cash and assets primarily for its continued organic growth and potential future strategic transactions, as well as to
mitigate the potential impact of COVID-19 on the Company's business.
The
Company generated cash from operations of $1,287,295 and $1,531,654 for the three months ended March 31, 2020 and March 31, 2019,
respectively. The decrease was due to the increase in inventories and decrease in deferred income taxes.
Cash used in investing activities for
the three-month period ended March 31, 2020 was $1,545,416, compared with $1,582,533 for the three-month period ended March 31,
2019. The decrease was primarily due to a decrease in the amount of marketable securities purchased in the first quarter of 2020
compared with the first quarter of 2019.
There was no cash used in financing activities for the
first quarters of 2020 and 2019.
The Company expects to continue to use its cash to make
dividend payments, purchase marketable securities, and take advantage of other market opportunities that may arise that are in
the best interests of the Company and its shareholders.
In connection with the coronavirus pandemic it is possible
that certain customers of the Company may have their invoices outstanding longer than they have in the past, either due to slower
payments from their customers, or as a result of having to shut down their business from time to time. However, the vast majority
of the Company’s customers are large companies, and the Company does not expect to have to increase its bad debt reserve,
and anticipates that its invoices will be paid with minimal delays.
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.