Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations
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.
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.
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, non-pharmaceutical medical products,
and proprietary specialty industrial products. All the products that the Company markets, exception for Renacidin, are produced
at its facility in Hauppauge, New York. Renacidin, a urological product, is manufactured for the Company by an outside contract
manufacturer.
The Company’s
most important product line is its Lubrajel line of water-based moisturizing and lubricating gels, which are used primarily as
ingredients in cosmetic products but are also used in medical products, primarily catheter lubricants. These products are marketed
worldwide for cosmetic uses by five marketing partners, each handling a different geographic area, with the largest being U.S.-based
ASI. 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.
Renacidin
and the Company’s other pharmaceutical product, Clorpactin®, which is also used primarily in urology, are
distributed through full-line drug wholesalers and marketed only in the United States. Those wholesalers 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 promotes Renacidin through internet advertising as well as a dedicated website. Clorpactin, as well as the Company’s
other products, are marketed through information provided on the Company’s corporate website.
The Company’s
non-pharmaceutical medical products, such as its catheter lubricants, as well as its specialty industrial products, are sold directly
to end-users, or to contract manufacturers utilized by those end-users. They are also available for marketing on a non-exclusive
basis by the Company’s marketing partners.
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 several registered trademarks, the two
most important of which are “Lubrajel” and “Renacidin.” However, regarding the 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 globally. 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,
throughout 2020 the pandemic continued to negatively impact the Company’s sales and net income, primarily as a result of
the decline in demand for the Company’s cosmetic ingredients. The Company believes that this decline in demand was caused
by both the Covid-related closures of manufacturing facilities that used the Company’s products, as well as the drop in consumer
purchases of many products in which the Company’s cosmetic ingredients are incorporated. The Company maintained production
throughout the pandemic, but orders for its cosmetic ingredients declined significantly throughout 2020. Although sales of these
products decreased slightly in the first quarter of 2021 compared with the first quarter of 2020, they increased significantly
compared with the sales levels of the third and fourth quarters of 2020. It is too early to predict what the continuing impact
of the pandemic will be on sales of these products, but until the global pandemic situation improves, it is likely that sales of
the Company’s cosmetic ingredients will continue to be negatively impacted. Because the Company has significant sales outside
the United States, sales of its cosmetic ingredients are going to be impacted not only by how the pandemic affects the United States,
but also what the course of the pandemic is in the many countries in which the products that incorporate the Company’s cosmetic
ingredients are sold.
Sales of the Company’s
medical products were also negatively impacted by the pandemic in 2020, with the Company losing one of its domestic medical customers,
and some other customers reducing their purchases. Although sales in the first quarter of 2021 were negatively impacted by the
loss of that customer, those losses were offset by an increase in sales to one of the Company’s other medical customers,
resulting in a net increase in sales of the Company’s medical products in the first quarter of 2021.
Sales of the Company’s
pharmaceutical products were not negatively impacted in 2020, and actually increased compared with 2019. Those sales were also
not negatively impacted in the first quarter of 2021 compared with the first quarter of 2020. The pandemic has not impacted the
ability of the Company to obtain raw materials and maintain production, and the Company does not anticipate that it will do so
in 2021 unless the global pandemic worsens, rather than improves.
With the continuing uncertainty
as to what the duration and future impact of the pandemic will be, the Company is unable to provide an accurate estimate or projection
as to what the continuing impact of the pandemic will be on the Company’s operations or its financial results in the future.
The Company does not expect the carrying value of its assets or its liquidity to be impaired by the coronavirus pandemic.
Critical
Accounting Policies
As
disclosed in the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2020, 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, 2020, 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, 2020, and a comparison of the results of operations for the three months ended March 31, 2021 and March 31, 2020. 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, 2020. All references in this
quarterly report to “sales” or “Sales” shall mean Net Sales unless specified otherwise.
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 2021 increased by $107,954 (approximately 3%) as compared with the first quarter of 2020. The increase in sales for the first
quarter of 2021 was primarily attributable to an increase in sales of the Company’s pharmaceutical products and medical products,
which was partially offset by a decrease in sales of the Company’s cosmetic ingredients and industrial products. 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 decreased
by $72,263 (approximately 4%) in the first quarter of 2021 compared with the same period in 2020. The decrease was primarily attributable
to a decrease in purchases of the Company’s cosmetic ingredients by ASI, whose purchases decreased by $94,765 (approximately
7%) compared with the same period in 2020, combined with a decrease in sales to the Company’s marketing partner in France,
which decreased by $92,488 (approximately 48%) compared with the same quarter in 2020.
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The decrease in cosmetic ingredient
sales to ASI was partially offset by an increase in sales of those products to the Company’s marketing partners in the UK,
Italy, and Switzerland, which increased by a total of $100,520 (approximately 107%) compared with the first quarter of 2020. In
addition, there was an increase of $14,470 in direct sales to three cosmetic ingredient customers in the United States during the
first quarter of 2021.
Based on information received
from ASI, the Company believes that the decrease in sales to ASI was primarily due to the impact of the pandemic on ASI’s
customers, particularly in China. The decrease in ASI sales in China was the result of a number of factors, including (a) lower
consumer demand in China for many of the products in which the Company’s products are used; (b) manufacturing disruptions
in China resulting from the impact of the coronavirus on manufacturing facilities; and (c) excess inventory levels of the Company’s
products resulting from overstocking on the part of ASI during 2020 due to the uncertainty of being able to obtain product from
the Company during the pandemic. Since the Company’s cosmetic ingredients are marketed globally by its marketing partners
in many different countries, and since the virus continues to impact countries at different times and to very different extents,
it is difficult to project the future impact of the coronavirus pandemic on the Company’s global cosmetic ingredient sales.
Until the global crisis passes it is likely that there will continue to be a negative impact on the Company’s sales of its
cosmetic ingredients, as well as, to a lesser extent, its non-pharmaceutical medical products. However, based on sales in the first
quarter of 2021, the Company believes that sales of its cosmetic ingredients are improving, and will continue to improve during
2021 as long as the global pandemic situation improves rather than worsens.
In addition to the impact of
the pandemic on sales of the Company’s cosmetic ingredients there also continues to be significant global competition from
Asian and European competitors selling products that are chemically similar to, and competitive with, those sold by the Company,
and which are marketed at lower prices than the products manufactured by the Company. The weakening of the U.S. dollar relative
to the Euro in 2020 helped to offset the lower pricing of some of the Company’s competitors, but in the first quarter of
2021, the dollar has strengthened, which makes the Company’s products less competitive, since the Company sells its products
in dollars. Whether or not this continues during 2021 may determine whether the Company’s products become more or less competitive,
and the Company is not in a position to predict what impact, if any, this will have on the Company’s sales. The Company continues
to work closely with its marketing partners to price its products as competitively as possible and, when appropriate, to offer
additional volume discounts and more aggressive pricing to maintain and increase sales and bring in new customers. However, the
Company expects the European market to remain very competitive based on the continuing competition from lower-cost competitors,
and for that reason it is concentrating its research and development (“R&D”) efforts on developing new and unique
products that other companies do not have.
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(b)
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Pharmaceutical Products: 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 two pharmaceutical products, Renacidin and Clorpactin,
together increased from $1,038,710 in the first quarter of 2020 to $1,143,307 in the first quarter of 2021, (approximately 10%).
Gross sales of both products increased from $1,349,433 in the first quarter of 2020 to $1,383,593 in the first quarter of 2021
(approximately 3%). The difference in the net sales increase compared with the gross sales increase for these products is primarily
due to the elimination of Medicaid rebates on Renacidin in the first quarter of 2021 compared with the first quarter of 2020. These
rebates were previously incurred in connection with the Company’s participation in the Medicaid Drug Rebate Program. Due
to the overly burdensome nature of these rebates, in October 2020 the Company decided that it was no longer profitable for the
Company to continue to participate in the Medicaid Program. Accordingly, on October 30, 2020 the Company informed the Centers for
Medicare & Medicaid Services (CMS) of its intention to terminate its Medicaid Drug Rebate Agreement and its participation in
the Medicaid Program, effective December 31, 2020.
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As sales of the Company’s
pharmaceutical products increase there is typically a corresponding and proportional increase in allowances, such as for distribution
fees, VA chargebacks, Medicare rebates, sales rebates and discounts, outdated material returns, and Medicaid rebates. As a result
of the Company’s termination of the Medicaid Drug Rebate Agreement and its participation in the Medicaid Program, in the
first quarter of 2021 allowances related to sales of the Company’s pharmaceutical products decreased by $70,436 (23%), and
total allowances related to the sale of all of the Company’s products, including pharmaceuticals, decreased by a net
of $69,438 (approximately 22%), compared with the same period in 2020. While the Company will no longer be incurring Medicaid-related
rebate costs, it will continue to incur costs related to other allowances, including Medicare rebates, distribution fees, chargebacks
on VA sales, and outdated material returns.
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(c)
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Medical Products: Sales of non-pharmaceutical medical products increased by $76,830
(approximately 14%) for the first quarter of 2021 when compared with the same period in 2020. The increase was primarily due to
an increase in orders from one of the Company’s larger direct customers located in China, which was partially offset by the
loss of one domestic medical product customer. During the first quarter of 2020, the customer in China had not placed any orders
due to the coronavirus pandemic. With the economy in China now beginning to stabilize, the Company is hopeful that orders from
China will begin to return to previous levels.
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(d)
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Specialty Industrial Products: Sales of specialty industrial products, as well as
other miscellaneous products, decreased by $1,210 (approximately 3%) for the first quarter of 2021 compared with the same period
in 2020. The decrease was primarily due to the timing of customer orders.
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Cost
of Sales
Cost of sales as a percentage
of net sales decreased to approximately 40% for the first quarter of 2021, down from approximately 42% for the first quarter in
2020. The decrease was primarily the result of a decrease in overhead expenses driven by decreases in payroll and payroll-related
expenses combined with the benefit received from the Employee Retention Credit recorded in the first quarter of 2021. (See Operating
Expenses below for information relating to the Employee Retention Credit).
Operating
Expenses
Operating expenses, consisting
of selling, general, and administrative expenses, decreased by $58,148 (approximately 11%) for the first quarter of 2021 compared
with the first quarter of 2020. The decrease was mainly due to decreases in payroll and payroll-related expenses.
In connection with the decrease
in employee-related payroll costs, during the first quarter of 2021 the Company qualified for the Employee Retention Credit (“ERC”)
under the modified provisions of the Consolidations Appropriations Act, which was signed into law on December 27, 2020. For 2021,
the ERC provides employers a refundable federal tax credit equal to 70% of the first $10,000 of qualified wages and benefits paid
to retained employees between January 1, 2021 and June 30, 2021. Credits may be claimed immediately by reducing payroll taxes sent
to the Internal Revenue Service (“IRS”). To the extent that the credit exceeds employment withholdings, the employer
may request a refund of prior taxes paid.
In the first quarter of 2021,
the Company recorded a total ERC of approximately $163,000, of which approximately $44,000 was utilized towards first quarter payroll
taxes. The remaining $119,000 is due to be refunded by the IRS and is included in prepaid expenses and other current assets.
Research
and Development Expenses
R&D expenses decreased by
$19,446 (approximately 18%) for the first quarter of 2021 compared with the first quarter of 2020. The decrease was primarily due
to a decrease in payroll-related costs as a result of the ERC recorded in the first quarter of 2021.
Investment
Income
Investment income decreased by
$4,307 (approximately 10%) for the first quarter of 2021 compared with the first quarter of 2020. The decrease was primarily due
to a decrease in interest income from U.S. Treasury Bills. In the first quarter of 2020, the Company recognized interest income
on the maturity of its U.S. Treasury Bills.
Net loss on Marketable Securities
Net loss on marketable securities
decreased by $284,548 (approximately 80%) for the first quarter of 2021 compared with the first quarter of 2020. 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. The net unrealized loss in the first quarter of 2021 is the result
of normal market fluctuations primarily driven by losses in the Company’s fixed income mutual funds.
Provision for Income Taxes
The Company's effective income
tax rate was approximately 21% for the first quarter of 2021 and 2020, and is expected to remain at 21% for the current fiscal
year.
LIQUIDITY
AND CAPITAL RESOURCES
Working
capital increased by $1,249,939 to $11,082,265 at March 31, 2021, up from $9,832,326 at December 31, 2020. The increase in working
capital was primarily due to increases in marketable securities and accounts receivable. The current ratio increased to 8.1 to
1 at March 31, 2021, up from 8.0 to 1 at December 31, 2020. The increase in the current ratio was primarily due to an increase
in marketable securities and accounts receivable.
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’s long-term liquidity position will be dependent on its ability to generate sufficient cash
flow from profitable operations.
The Company
has no material commitments for future capital expenditures and no material cash requirements of immediate concern.
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.
The
Company generated cash from operations of $990,206 and $1,287,295 for the three months ended March 31, 2021 and March 31, 2020,
respectively. The decrease was due primarily to an increase in accounts receivable.
Cash used
in investing activities for the three months ended March 31, 2021 was $719,601 compared with $1,545,416 for the three months
ended March 31, 2020. The decrease was primarily due to a decrease in the amount of marketable securities purchased in the
first quarter of 2021 compared with the first quarter of 2020.
There was no cash used in financing
activities for the first quarters of 2021 and 2020.
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.
CONTRACTUAL
OBLIGATIONS AND COMMITMENTS
The information
to be reported under this item is not required of smaller reporting companies.