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Management’s Discussion and Analysis of Financial Condition and Results of Operations
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Overview
We develop and manufacture products primarily for medical applications. We market components to other equipment manufacturers for incorporation in their products and sell finished devices to physicians, hospitals, clinics and other treatment centers. Our medical products primarily serve the fluid delivery, cardiovascular and ophthalmology markets. Our other medical and non-medical products include instrumentation and disposables used in valves and inflation devices used in marine and aviation safety products.
Our products are used in a wide variety of applications by numerous customers. We encounter competition in all of our markets and compete primarily on the basis of design, product quality, price, customer service and delivery time.
Our strategy is to provide a broad selection of products in the areas of our expertise. Research and development efforts are focused on improving current products and developing highly-engineered products that meet customer needs and serve niche markets with meaningful sales potential. Proposed new products may be subject to regulatory clearance or approval prior to commercialization and the time period for introducing a new product to the marketplace can be unpredictable. We also focus on controlling costs by investing in modern manufacturing technologies and controlling purchasing processes. We have been successful in consistently generating cash from operations and have used that cash to reduce and payoff indebtedness, to fund capital expenditures, to repurchase stock and to pay dividends.
Our strategic objective is to further enhance our position in our served markets by:
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Focusing on customer needs;
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Expanding existing product lines and developing new products;
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Manufacturing products to exacting quality standards; and
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Preserving and fostering a collaborative, respectful and entrepreneurial culture.
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For the three months ended March 31, 2020, we reported revenues of $43.6 million, operating income of $11.7 million and net income of $8.9 million, up 5 percent, up 6 percent and down 6 percent, respectively, from the three months ended March 31, 2019.
Results for the three months ended March 31, 2020
Consolidated net income totaled $8.9 million, or $4.80 per basic and $4.79 per diluted share, in the first quarter of 2020. This is compared with consolidated net income of $9.4 million, or $5.09 per basic and $5.07 per diluted share, in the first quarter of 2019. The income per basic share computations are based on weighted average basic shares outstanding of 1,853,000 in the 2020 period and 1,853,000 in the 2019 period. The income per diluted share computations are based on weighted average diluted shares outstanding of 1,859,000 in the 2020 period and 1,862,000 in the 2019 period.
Consolidated revenues of $43.6 million for the first quarter of 2020 were 5 percent higher than revenues of $41.6 million for the first quarter of 2019. This increase was primarily attributable to increased volumes of our fluid delivery products partially offset by decreased volumes of our ophthalmology products.
Revenues by product line were as follows (in thousands):
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Three Months ended
March 31,
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2020
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2019
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Fluid Delivery
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$
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22,348
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$
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18,161
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Cardiovascular
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14,824
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15,420
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Ophthalmology
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863
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2,283
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Other
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5,559
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5,750
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Total
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$
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43,594
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$
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41,614
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Cost of goods sold of $23.7 million for the first quarter of 2020 was 3.5 percent higher than cost of goods sold of $22.9 million for the first quarter of 2019 primarily due to higher sales volumes. Our cost of goods sold in the first quarter of 2020 was 54.4 percent of revenues compared with 55.1 percent of revenues in the first quarter of 2019.
Gross profit of $19.9 million in the first quarter of 2020 was $1.2 million or 6.2 percent, higher than in the comparable 2019 period. Our gross profit percentage in the first quarter of 2020 was 45.5 percent of revenues compared with 44.9 percent of revenues in the first quarter of 2019. The increase in gross profit percentage in the 2020 period compared to the 2019 period was primarily related to product sales mix with higher margins.
Our first quarter 2020 operating expenses of $8.2 million were $488,000 higher than the operating expenses for the first quarter of 2019. This increase was attributable to a $589,000 increase in Research and Development, or R&D, expenses and a $213,000 increase in General and Administrative, or G&A, expenses partially offset by a $314,000 decrease in Selling expenses. The increase in R&D expenses was primarily related to increased outside services, materials and supplies costs. The increase in G&A expenses was primarily related to salaries and outside services. The decrease in Selling expenses was principally attributable to Company-mandated travel restrictions and cancelled sales conferences due to COVID-19.
Operating income in the first quarter of 2020 increased $677,000 to $11.7 million, a 6 percent increase compared to our operating income in the quarter ended March 31, 2019. Operating income was 27 percent of revenues for both the first quarter of 2020 and the first quarter of 2019.
Interest and dividend income in the first quarter of 2020 was $462,000 compared with $582,000 for the same period in the prior year. The decline in interest income was due to lower interest rates in 2020 versus 2019.
Other investment loss in the first quarter of 2020 was $997,000 compared with investment income of $211,000 in the first quarter of 2019. These amounts were attributable to unrealized losses and gains on equity investments resulting from changes
Income tax expense was $2.3 million for the first quarter of 2020 compared with $2.4 million for the first quarter of 2019. The effective tax rate for the first quarter of 2020 was 20.4 percent compared with 20.2 percent for the first quarter of 2019. We expect the effective tax rate for the remainder of 2020 to be approximately 20 percent.
Liquidity and Capital Resources
As of March 31, 2020, we had a $75.0 million revolving credit facility with a money center bank pursuant to which the lender is obligated to make advances until February 28, 2022. We had no outstanding borrowings under our credit facility at March 31, 2020. Our ability to borrow funds under the credit agreement from time to time is contingent on meeting certain covenants in the loan agreement, the most restrictive of which is the ratio of total debt to earnings before interest, income tax, depreciation and amortization. At March 31, 2020, we were in compliance with all financial covenants.
At March 31, 2020, we had a total of $96.4 million in cash and cash equivalents, short-term investments and long-term investments, a decrease of $4.2 million from December 31, 2019. The principal contributor to this decrease was stock buybacks of $9.2 million.
Cash flows from operating activities of $12.9 million for the three months ended March 31, 2020 were primarily comprised of net income plus the net effect of non-cash expenses and increases in accrued income and other taxes partially offset by increases in accounts receivable. During the first three months of 2020, we expended $12.4 million for the purchase of investments, $3.6 million for the addition of property and equipment, $9.2 million in stock buybacks and $2.9 million for dividends. During the same period, maturities and sales of investments generated $14.3 million in cash.
At March 31, 2020, we had working capital of $115.1 million, including $44.1 million in cash and cash equivalents and $18.6 million in short-term investments. The $6.0 million decrease in working capital during the first three months of 2020 was primarily related to decreases of short term investments of $5.2 million.
We believe that our $96.4 million in cash, cash equivalents, short-term investments and long-term investments, along with cash flows from operations and available borrowings of up to $75.0 million under our credit facility, will be sufficient to fund our cash requirements for at least the foreseeable future, including the costs associated with the planned expansion of one of our manufacturing facilities. We believe that our strong financial position would allow us to access equity or debt financing should that be necessary. Additionally, we believe that our cash and cash equivalents, short-term investments and long-term investments, as a whole, will increase during the remainder of 2020.
COVID-19 Impact
In March 2020, the World Health Organization declared the outbreak of COVID-19 a pandemic, which continues to spread throughout the United States and the world and has resulted in the implementation of numerous measures to contain the virus, including travel bans and restrictions, quarantines, shelter-in-place orders, and business limitations and shutdowns. Although we are unable to predict accurately the full impact that COVID-19 will have on our results of operations, financial condition, liquidity, and cash flows due to numerous uncertainties, including the duration and severity of the pandemic and containment measures, our compliance with these measures has affected our day-to-day operations and could disrupt our business and operations, as well as those of our key customers, suppliers, and other counterparties, for an indefinite period of time. To help protect the health and well-being of our employees and communities, some of our employees have been working remotely, and we have implemented additional health and safety measures in our facilities. In addition, many of our customers may have implemented similar measures in their facilities, which may delay the timing of some orders and deliveries.
Although such disruptions did not have a material adverse impact on our financial results for the first quarter of fiscal 2020, revenue in the current quarter and subsequent quarters of 2020 could be affected by the impact of the global pandemic. OEM customers and end users of our products could experience financial distress, mass illness, supply chain disruptions and government prohibitions that could impact purchases of products from us. Illnesses, government prohibitions and supply chain disruptions could also impact our ability to fulfill orders.
Our business may be adversely impacted as a result of the pandemic’s global economic impact. For example, we may be unable to collect receivables from those customers significantly impacted by COVID-19. Also, a decrease in orders in a given period could negatively affect our revenues in future periods, particularly if experienced on a sustained basis. We will continue to evaluate the nature and extent of the impact of COVID-19 to our business.
Forward-Looking Statements
Statements in this Management’s Discussion and Analysis and elsewhere in this Quarterly Report on Form 10-Q that are forward looking are based upon current expectations, and actual results or future events may differ materially. Therefore, the inclusion of such forward-looking information should not be regarded as a representation by us that our objectives or plans will be achieved. Such statements include, but are not limited to, our effective tax rate for the remainder of 2020, our ability to fund our cash requirements for the foreseeable future with our current assets, long-term investments, cash flow and borrowings under the credit facility, our access to equity and debt financing, the impact of the COVID-19 pandemic on our business and operations, and the increase in cash, cash equivalents, and investments during the remainder of 2020. Words such as “expects,” “believes,” “anticipates,” “intends,” “should,” “plans,” and variations of such words and similar expressions are intended to identify such forward-looking statements. Forward-looking statements contained herein involve numerous risks and uncertainties, and there are a number of factors that could cause actual results or future events to differ materially, including, but not limited to, the following: the risk that the COVID-19 pandemic could lead to material delays and cancellations of, or reduced demand for, procedures in which our products are utilized; curtailed or delayed capital spending by hospitals and other healthcare providers; disruption to our supply chain; closures of our facilities; delays in training; delays in gathering clinical evidence; diversion of management and other resources to respond to the COVID-19 outbreak; the impact of global and regional economic and credit market conditions on healthcare spending; the risk that the COVID-19 virus disrupts local economies and causes economies in our key markets to enter prolonged recessions; changing economic, market and business conditions; acts of war or terrorism; the effects of governmental regulation; the impact of competition and new technologies; slower-than-anticipated introduction of new products or implementation of marketing strategies; implementation of new manufacturing processes or implementation of new information systems; our ability to protect our intellectual property; changes in the prices of raw materials; changes in product mix; intellectual property and product liability claims and product recalls; the ability to attract and retain qualified personnel; and the loss of, or any material reduction in sales to, any significant customers. In addition, assumptions relating to budgeting, marketing, product development and other management decisions are subjective in many respects and thus susceptible to interpretations and periodic review which may cause us to alter our marketing, capital expenditures or other budgets, which in turn may affect our results of operations and financial condition. The forward-looking statements in this Quarterly Report on Form 10-Q are made as of the date hereof, and we do not undertake any obligation, and disclaim any duty, to supplement, update or revise such statements, whether as a result of subsequent events, changed expectations or otherwise, except as required by applicable law.