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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 the Company’s 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 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. (See the
Company’s discussion of the potential impact of the coronavirus on the Company’s future operations and financial results
in “PART II, ITEM 1A. RISK FACTORS” below).
OVERVIEW
The Company
is a Delaware corporation that, through its Guardian Laboratories division, conducts research, product development, manufacturing
and marketing of cosmetic ingredients, 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, 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 cosmetic ingredients. 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 practical 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 remained open during the entire second quarter due to its status as an “essential business,” its
sales were still negatively impacted by the pandemic. This impact was primarily the result of a decrease in orders for both its
cosmetic ingredients and its medical products. The Company’s pharmaceutical products were not impacted, and actually increased
compared with last year’s second quarter. The decrease in sales of the Company’s medical products was primarily attributable
to a decrease in orders from three of the Company’s larger medical product customers. The Company believes that these decreases
were related to the impact of the coronavirus pandemic. It is likely that the coronavirus pandemic will continue to have a negative
impact on the Company’s sales during the remainder of 2020 and possibly beyond. Although the Company does not expect its
pharmaceutical sales to be impacted, it does anticipate that sales of its medical products could continue to be impacted while
the pandemic continues.
Sales of the Company’s
cosmetic ingredients will continue to be negatively impacted commensurate with reduced customer demand for, and the consequent
reduced production of, consumer cosmetic products. The Company distributes products to marketing partners globally, and it is difficult
to anticipate what market conditions will be like in other countries where the Company’s products are sold, and how those
conditions might impact future sales of the Company’s products. It is likely that there will be a negative impact on the
Company’s sales of its cosmetic ingredients until the pandemic is contained and normal demand for, and production of, cosmetic
products return to previous levels. 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 purchased 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 was slightly
impacted due to staggered production hours during the second quarter of 2020, the Company did not have an issue with being able
to maintain sufficient inventory and production levels and was 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 second quarter of 2020 and 2019 and the first half of 2020 and
2019. 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, 2019. All references in this quarterly report
to “sales” or “Sales” shall mean “net sales” unless specifically identified as “gross
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, which is when the performance obligation is satisfied. 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 its pharmaceutical products.
RESULTS
OF OPERATIONS
Net
Sales
Net sales for the second quarter
of 2020 decreased by $324,755 (10%) when compared with the same period in 2019. Net sales for the first half of 2020 decreased
by $182,158 (3%) as compared with the corresponding period in 2019. The decrease in sales for both the second quarter of 2020 and
the first half of 2020 were attributable to changes in sales of the following product lines:
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a)
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Second quarter sales: For the second quarter of 2020, the Company’s sales of cosmetic
ingredients decreased by $330,032 (23%) when compared with the second quarter of 2020. The decrease in second quarter sales was
due primarily to a decrease of $316,700 (28%) in sales of the Company’s cosmetic ingredients to ASI. This was primarily the
result of a decrease in demand for some of the Company’s products in China. Based on information provided to the Company
by ASI, it was a result of both the softening of the market in China for cosmetic products in which the Company’s products
were being used, as well as continuing competition from lower-priced Asian competitors. The Company is continuing to work closely
with ASI to develop pricing that could enable the Company to better compete with the lower-cost Asian competitors.
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Second quarter sales to the Company’s
four other marketing partners, as well as to two small direct cosmetic ingredient customers, decreased by a net of $13,332 (5%)
compared with the second quarter of 2019. The net decrease of $13,332 was attributable to a sales increase of $50,637 (50%) to
the Company’s marketing partners in the UK and Switzerland, and an increase of $2,731 (150%) in sales to two direct cosmetic
ingredient customers. Those increases were offset by a decrease in sales of $66,700 (37%) to the Company’s marketing partners
in France and Italy and its former marketing partner in Korea. In late 2019, the Company began transitioning its Korean business
to ASI and is no longer working with its former Korean marketing partner. The Company believes that the decline in sales in Europe
was due primarily to increased competition from Asian competitors selling similar, although not necessarily identical, products
at lower prices.
The Company believes that the
sales fluctuations to the Company’s European marketing partners were 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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Six-month sales: For the first half of 2020 the Company’s sales of cosmetic ingredients
decreased by $278,894 (9%) when compared with the equivalent period in 2019. This decrease was due primarily to a decrease of $290,139
(11%) in shipments of the Company's extensive line of cosmetic ingredients to ASI. The primary reason for the decrease in sales
for the six-month period was the same as for the sales decrease in the second quarter: lower sales to ASI as the result of a reduction
in demand in China.
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Sales for the first six months of 2020 of the Company’s cosmetic ingredients to the Company’s four other marketing
partners, as well as to the two direct cosmetic ingredient customers, increased by $11,245 (2%) compared with the equivalent period
in 2019. Six-month sales to the Company’s marketing partners in the UK and France increased by a total of $91,850 (21%);
sales to the two direct cosmetic ingredient customers increased by $4,002 (115%); and sales to the Company’s marketing partners
in Switzerland, Italy and Korea, decreased by a total of $84,607 (73%). See explanation above regarding the Company’s Korean
marketing partner.
The Company believes that 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.
Because there are fees, rebates
and allowances associated with sales of the Company’s two pharmaceutical products, Renacidin and Clorpactin, discussion of
the Company’s pharmaceutical sales includes references to both gross sales (before fees, rebates and allowances) and
net sales (after fees, rebates and allowances). Net sales of the Company’s pharmaceutical products for the three-
and six-month periods ended June 30, 2020 increased by $197,710 (20%) and $348,819 (19%), respectively, compared with the corresponding
periods in 2019. These increases were due primarily to increases of $213,784 (19%) and $408,079 (19%) in gross sales of Renacidin
for the three- and six-month periods, respectively, ended June 30, 2020, and were partially offset by decreases of $16,097 (11%)
and $19,842 (7%) in gross sales of the Company’s other pharmaceutical product, Clorpactin, for the same three-and six-month
periods, respectively. The increase in gross sales for the first six months of 2020 was also partially offset by an increase of
$39,418 in fees, rebates, and allowances, while the changes in fees, rebates, and allowances for the three-month period ended June
30, 2020 compared with the same period in 2019 were insignificant.
The Company believes that the
increase in Renacidin sales was the result of its increased marketing efforts for Renacidin, primarily its launch of a new Renacidin
website and the initiation of internet advertising, and that the decrease in Clorpactin sales was due to both normal fluctuations
in sales as well as a possible decrease in the use of Clorpactin in hospital settings as a result of the focus on the treatment
of Covid-19 patients in many hospitals.
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3.
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Medical (non-pharmaceutical) products:
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Sales of the Company’s medical
products for the three- and six-month periods ended June 30, 2020, decreased by $180,244 (22%) and $251,555 (18%), respectively.
The decrease in sales for both periods was primarily attributable to a decrease in orders from three of the Company’s larger
direct medical product customers. The Company believes that these decreases were related to the impact of the coronavirus pandemic,
and that with some countries beginning to emerge from the pandemic it is anticipated that these orders will gradually increase,
and that orders that were expected in the first half of the year and were delayed by the coronavirus may be received in the second
half of the year if normal operations resume.
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4.
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Industrial and other products:
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Sales of the Company's industrial
products, as well as other miscellaneous products, for the three- and six-month periods ended June 30, 2020, decreased by $12,189
(30%) and $528 (less than 1%), respectively, when compared with the corresponding periods in 2019. The decrease in sales for the
three-month period was primarily due to a decrease in orders from one of the Company’s industrial product customers located
in California. The Company believes that the coronavirus pandemic may have been the cause of that decrease in orders.
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, all of which increase proportionally
as sales of those products increase. During the first half of 2020, the allowances for all the Company’s products increased
by a net of $44,869 (approximately 8%) 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 decreased from 45% in the second quarter of 2019 to 43% in the second quarter of 2020. For the first six months of
2020, cost of sales as a percentage of sales decreased from 43% to 42% compared with the first six months of 2019. The decreases
in both periods were the result of lower production and overhead costs during the second quarter of 2020 due to decreased production
during that period as a result of the Coronavirus pandemic.
Operating
Expenses
Operating expenses, consisting
of selling and general and administrative expenses, increased by $9,541 (2%) for the second quarter of 2020, and decreased by $22,146
(2%) for the first six months of 2020, compared with comparable periods in 2019. The increase in operating expenses for the second
quarter of 2020 were primarily attributable to certain payroll related expenses and licensing fees. The decrease in operating expenses
for the first six months of 2020 were primarily due to decreases in certain employee fringe benefit costs and professional fees.
Operating expenses are expected to remain relatively consistent for the remainder of the year.
Research
and Development Expenses
Research and development expenses
increased by $14,720 (16%) for the second quarter of 2020 compared with the second quarter of 2019, and increased by $23,794 (12%)
for the first six months of 2020 compared with the first six months of 2019. The increases in both periods was primarily due to
an increase in payroll and payroll related expenses.
Investment
Income
Investment income decreased by
$1,622 (3%) for the second quarter of 2020 compared with the second quarter of 2019, and decreased by $1,722 (2%) for the first
half of 2020 compared with the same period in 2019. These decreases were due to a decrease in dividend income from stock and bond
mutual funds compared to the same periods in 2019.
Net
gain on marketable securities
Net gain on marketable securities
increased by $300,330 (346%) for the second quarter of 2020 compared with the second 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 during
the second quarter of 2020 the Company recovered all of the $356,595 in unrealized losses it had recognized in the first quarter,
and ended the second quarter with an unrealized gain of approximately $25,728 as a result of the market rebounding from the impact
of the Coronavirus during the second quarter of 2020.
For the first half of 2020, the
net gain on marketable securities decreased by $313,459 (91%), compared with the same period in 2019. The primary reason for the
decrease was that during the first six months of 2019, the Company recognized a realized gain on the sale of marketable securities
in the amount of $247,499, compared with the comparable six-month period in 2020, where the realized gain on securities sold was
$4,856.
Provision
for Income Taxes
The Company's effective income
tax rate was 21% for the first half 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 decreased from $10,224,222 at December 31, 2019 to $10,087,615 at June 30, 2020, a decrease of $136,607. The current ratio
decreased from 8.6 to 1 at December 31, 2019 to 6.0 to 1 at June 30, 2020. The decrease in working capital and the current ratio
was primarily due to a decrease in accounts receivable and an increase in accrued expenses and income taxes payable. The increase
in accrued expenses was primarily due to an increase in accruals for bonuses, the Company’s 401(k) contribution, and insurance.
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 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 $3,183,479 and $2,642,812 for the first half of 2020 and 2019, respectively. The increase
from 2019 to 2020 was primarily due to the decrease in accounts receivable and the increase in income taxes payable.
Cash used
in investing activities for the first half of 2020 was $95,802, and cash provided by investing activities in the first half of
2019 was $242,704. The decrease was primarily due to the timing of marketable security sales and reinvestments in 2020 compared
with 2019.
Cash
used in financing activities was $1,928,969 and $2,524,946 for the first half of 2020 and 2019, respectively. The decrease was
due to a decrease in dividends paid from $0.55 per share in 2019 to $0.42 per share in 2020.
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 may arise that are in the best interest of the Company and its shareholders.
In connection with the coronavirus
pandemic it is possible that certain customer invoices may remain 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.