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Management’s Discussion and Analysis of Financial Condition and Results of Operations
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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:
● Focusing on customer needs;
● Expanding existing product lines and developing new products;
● Manufacturing products to exacting quality standards; and● Preserving and fostering a collaborative, respectful and entrepreneurial culture.
For the three months ended June 30, 2019, we reported revenues of $40.1 million, operating income of $11.0 million and net income of $9.7 million, up 3 percent, down 3 percent and up 10 percent, respectively, from the three months ended June 30, 2018. For the six months ended June 30, 2019, we reported revenues of $81.7 million, operating income of $22.0 million and net income of $19.1 million, up 4 percent, down 3 percent and up 11 percent, respectively, from the six months ended June 30, 2018.
Results for the three months ended June 30, 2019
Consolidated net income totaled $9.7 million, or $5.21 per basic and $5.18 per diluted share, in the second quarter of 2019. This is compared with consolidated net income of $8.8 million, or $4.75 per basic and $4.74 per diluted share, in the second quarter of 2018. The income per basic share computations are based on weighted average basic shares outstanding of 1,854,000 in the 2019 period and 1,852,000 in the 2018 period. The income per diluted share computations are based on weighted average diluted shares outstanding of 1,864,000 in the 2019 period and 1,857,000 in the 2018 period.
Consolidated revenues of $40.1 million for the second quarter of 2019 were 3 percent higher than revenues of $38.8 million for the second quarter of 2018. This increase was primarily attributable to increased volumes of our cardiovascular 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 endedJune 30,
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Cost of goods sold of $21.5 million for the second quarter of 2019 was 10 percent higher than cost of goods sold of $19.6 million for the second quarter of 2018 primarily due to higher sales volumes, a less favorable product sales mix and increased manufacturing costs partially offset by the impact of continued cost improvement projects. Our cost of goods sold in the second quarter of 2019 was 53.6 percent of revenues compared with 50.5 percent of revenues in the second quarter of 2018.
Gross profit of $18.6 million in the second quarter of 2019 was $631,000, or 3 percent, lower than in the comparable 2018 period. Our gross profit percentage in the second quarter of 2019 was 46.4 percent of revenues compared with 49.5 percent of revenues in the second quarter of 2018. The decrease in gross profit percentage in the 2019 period compared to the 2018 period was primarily related to the less favorable product sales mix and increased manufacturing costs partially offset by cost improvement projects mentioned above.
Our second quarter 2019 operating expenses of $7.6 million were $331,000 lower than the operating expenses for the second quarter of 2018. This decrease was attributable to a $379,000 decrease in Research and Development, or R&D, expenses and a $5,000 decrease in General and Administrative, or G&A, expenses partially offset by a $53,000 increase in Selling expenses. The decrease in R&D expenses was primarily related to decreased compensation, decreased outside services and decreased materials and supplies costs. The increase in Selling expenses was principally attributable to increased compensation and commissions partially offset by decreased travel and decreased outside services.
Operating income in the second quarter of 2019 decreased $300,000 to $11.0 million, a 3 percent decrease compared to our operating income in the quarter ended June 30, 2018. Operating income was 27 percent of revenues for the second quarter of 2019 and 29 percent of revenues for the second quarter of 2018.
Other investment income in the second quarter of 2019 was $354,000 compared with an investment loss of $408,000 in the second quarter of 2018. We adopted ASU 2016-01 as of January 1, 2018 (see Note 7). For the second quarter of 2019 we recorded unrealized gains on equity investments of $354,000 as a result of increases in the market value of investments during the quarter. For the second quarter of 2018 we recorded unrealized losses on equity investments of $408,000 as a result of a drop in the market value of investments during the quarter.
Income tax expense was $2.0 million for the second quarter of 2019 compared with $2.5 million for the second quarter of 2018. The effective tax rate for the second quarter of 2019 was 17.5 percent, compared with 21.9 percent for the second quarter of 2018. The decrease in the 2019 period effective tax rate was primarily related to increased tax benefits from stock compensation and foreign sales transactions. We expect the effective tax rate for the remainder of 2019 to be approximately 20.0 percent.
Results for the six months ended June 30, 2019
Consolidated net income totaled $19.1 million, or $10.30 per basic and $10.25 per diluted share, in the first six months of 2019. This is compared with consolidated net income of $17.3 million, or $9.33 per basic and $9.31 per diluted share, in the first six months of 2018. The income per basic share computations are based on weighted average basic shares outstanding of 1,854,000 in the 2019 period and 1,853,000 in the 2018 period. The income per diluted share computations are based on weighted average diluted shares outstanding of 1,863,000 in the 2019 period and 1,856,000 in the 2018 period.
Consolidated revenues of $81.7 million for the first six months of 2019 were 4 percent higher than revenues of $78.2 million for the first six months of 2018. This increase was primarily attributable to increased volumes of our cardiovascular products partially offset by decreased volumes of our ophthalmology products.
Revenues by product line were as follows (in thousands):
Cost of goods sold of $44.4 million for the first six months of 2019 was $4.4 million higher than in the comparable 2018 period. The primary contributor to the increase in our cost of goods sold was increased volumes, a less favorable product sales mix and increased manufacturing costs partially offset by the impact of continued cost improvement projects in the first six months of 2019. Our cost of goods sold in the first six months of 2019 was 54.4 percent of revenues compared with 51.2 percent of revenues in the first six months of 2018.
Gross profit of $37.3 million in the first six months of 2019 was $879,000, or 2 percent, lower than in the comparable 2018 period. Our gross profit percentage in the first six months of 2019 was 45.6 percent of revenues compared with 48.8 percent of revenues in the first six months of 2018. The decrease in gross profit percentage in the 2019 period compared to the 2018 period was primarily related to the less favorable product sales mix and increased manufacturing costs partially offset by cost improvement projects mentioned above.
Operating expenses of $15.3 million for the first six months 2019 were $251,000 lower than the operating expenses for the first six months of 2018. This decrease was comprised of a $622,000 decrease in R&D expenses, a $47,000 decrease in G&A expenses and a $418,000 increase in Selling expenses. The decrease in R&D expenses was primarily related to decreased compensation, decreased outside services and decreased materials and supplies costs partially offset by increased regulatory costs. The decrease in G&A expenses for the first six months of 2019 was principally attributable to decreased outside services partially offset by increased information technology costs. The increase in Selling expenses was principally attributable to increased compensation and commissions partially offset by decreased travel and decreased outside services.
Operating income in the first six months of 2019 decreased $628,000 to $22.0 million, a 3 percent decrease from our operating income in the six months ended June 30, 2018. Operating income was 27 percent of revenues in the first six months of 2019 and 29 percent of revenues in the first six months of 2018.
Interest and dividend income for the first six months of 2019 was $854,000, compared with $742,000 for the same period in the prior year. Increased levels of investment and increased interest rates were the primary reasons for the increase.
Other investment income for the first six months of 2019 was $681,000 compared with an investment loss of $1.2 million in the first six months of 2018. We adopted ASU 2016-01 as of January 1, 2018 (see Note 7). For the first six months of 2019 we recorded unrealized gains on equity investments of $681,000 as a result of increases in the market value of these investments during the 2019 period. For the first six months of 2018 we recorded unrealized losses on equity investments of $1.2 million as a result of declines in the market value of these investment during the 2018 period.
Income tax expense for the first six months of 2019 was $4.4 million compared to income tax expense of $4.9 million for the same period in the prior year. The effective tax rate for the first six months of 2019 was 18.8 percent, compared with 22.1 percent for the first six months of 2018. The decrease in the 2019 period effective tax rate was primarily related to increased tax benefits from stock compensation and foreign sales transactions.
Liquidity and Capital Resources
As of June 30, 2019, 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 June 30, 2019. 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 June 30, 2019, we were in compliance with all financial covenants
At June 30, 2019, we had a total of $98.2 million in cash and cash equivalents, short-term investments and long-term investments, an increase of $8.8 million from December 31, 2018. The principal contributor to this increase was operating results.
Cash flows from operating activities of $24.1 million for the six months ended June 30, 2019 were primarily comprised of net income plus the net effect of non-cash expenses, increases in other non-current liabilities and increases in accounts payable and accrued liabilities partially offset by increases in accounts receivable and increases in inventories. During the six months of 2019, we expended $10.0 million for the addition of property and equipment, $45.8 million for the purchase of investments and $5.0 million for dividends. During the same period, maturities of investments generated $28.1 million in cash.
At June 30, 2019, we had working capital of $122.1 million, including $49.6 million in cash and cash equivalents and $25.6 million in short-term investments. The $10.1 million increase in working capital during the first six months of 2019 was primarily related to an increase in short-term investments and accounts receivable. This increase was partially offset by decreases in cash and cash-equivalents and increases in accounts payable and accrued liabilities. The increase in short-term investments was primarily related to operating results and the decrease in cash and cash equivalents. The increase in accounts receivable was primarily related to increased revenues for the second quarter of 2019 as compared to the fourth quarter of 2018. The increases in accounts payable and accrued liabilities are primarily related to the timing of payments for replenishment of inventories and operating expenses.
We believe that our $98.2 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 continue to increase during the remainder of 2019
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 2019, 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, and the increase in cash, cash equivalents, and investments during the remainder of 2019. 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: 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.