United Guardian Inc: Form 10-Q for the period ended Jun 30, 2023

The following discussion and analysis covers material changes in the financial condition of the Company since the year ended December 31, 2022, and a comparison of the results of operations for the second quarter of 2023 and 2022 and the first half of 2023 and 2022. 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, 2022. All references in this quarterly report to “sales” or “Sales” shall mean “net sales” unless specifically identified as “gross sales”.

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.

OVERVIEW

The Company is a Delaware corporation that, through its Guardian Laboratories division, manufactures and markets cosmetic ingredients, pharmaceuticals, and medical lubricants. The Company conducts various research and development activities. The Company’s research and development department modifies, refines, and expands the uses for existing products, with the goal of further developing the markets that its products are used in. The Company also develops new products with a focus on using natural and environmentally friendly raw materials, which is a priority for many of the Company’s cosmetic customers. All the products that the Company markets, except 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.

One of the Company’s most important product lines is its Lubrajel line of multifunctional water-based gel formulations, which are designed to provide sensory enhancement, lubrication, hydration, and texture to both personal care and medical products.

The Company’s cosmetic ingredients are marketed worldwide for cosmetic uses by five distributors, each handling a different geographic area, with the largest being U.S.-based ASI. In the last few years, to meet the growing demand for “green” and sustainable products, the Company has focused on developing and launching new products which only contain ingredients that are considered “natural”. The Lubrajel products in the new natural line have been certified by the Cosmetic Organic and Natural Standard (“COSMOS”). This standard is recognized globally by the cosmetic industry.

Renacidin and the Company’s other pharmaceutical product, Clorpactin® WCS-90, are distributed through full-line drug wholesalers and are currently marketed only in the United States. Those wholesalers in turn sell the products to pharmacies, hospitals, nursing homes, other long-term care facilities, and government agencies, primarily the VA. The Company promotes Renacidin through a dedicated website. Clorpactin WCS-90, as well as the Company’s other products, are marketed through information provided on the Company’s corporate website.

The Company’s medical lubricants, which consist of water-based gel formulations designed to provide sensory enhancement and lubrication mainly for medical device applications. Products are sold directly to end-users, or to contract manufacturers utilized by those end-users.

The Company does have competition in the marketplace for some of its products, particularly its cosmetic ingredients, some of its pharmaceutical products and its medical lubricants. These competitive products are usually sold at a lower price than the Company’s products; however, they may not compare favorably to the level of performance and quality of 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.

In recent years, the Company has elected to rely on trade secret protection to protect its intellectual property for proprietary product formulations and manufacturing methods. The Company will file for patent protection in situations where the Company believes that relying on trade secret protection alone would not provide sufficient protection. The Company owns the Lubrajel®, Renacidin®, and Clorpactin® trademarks.

The current supply chain instability has not significantly affected the ability of the Company to obtain raw materials, but it has made some of those materials more expensive and created longer lead times for some of them. The increased costs of some of these raw materials has continued to impact the Company’s gross profit margins and may continue to impact the gross profit margins in the future on certain products. In response to the rising raw material prices, the Company instituted price increases on many of its products where possible and hopes to minimize the impact on the gross margins in the future.

With the continuing uncertainty as to what the duration and future impact of the pandemic, supply chain instability and increasing interest rates 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.

CRITICAL ACCOUNTING POLICIES

As disclosed in the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2022, 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, 2022, 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, 2022, and a comparison of the results of operations for the six months ended June 30, 2023 and June 30, 2022. 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, 2022. 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 lubricants, 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 a 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 its 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.

In accordance with ASU-2016-13, the Company recognizes an allowance for credit losses for financial assets carried at amortized cost to present the net amount expected to be collected as of the balance sheet date. Such allowance is based on the credit losses expected to arise over the life of the asset.

RESULTS OF OPERATIONS

Net Sales

Net sales for the second quarter of 2023 decreased by $975,878 (27%) when compared with the same period in 2022. Net sales for the first half of 2023 decreased by $2,297,912 (31%) as compared with the corresponding period in 2022. The decrease in sales for the second quarter of 2023 and the first half of 2023 were attributable to changes in sales of the following product lines:

Cosmetic ingredients:

(a) Second quarter sales: For the second quarter of 2023, the Company’s sales of cosmetic ingredients decreased by $621,076 (45%) when compared with the second quarter of 2022. The decrease was due primarily to a net decrease of $402,586 (43%) in sales of the Company’s cosmetic ingredients to ASI when compared with the second quarter of 2022. Based on information provided by ASI, the decrease in sales was due to three main factors 1) decreased demand for the Company’s Lubrajel products in China due to slow post-COVID economic growth; 2) increased competition from lower-priced competitors, especially those from Asian producers; and 3) customers working off excess stock, maintaining lower inventory levels, and changing ordering patterns to just in time.

Second quarter sales to the Company’s four other distributors, as well as to one direct cosmetic ingredient customer, decreased by a net of $218,490 (50%) compared with the second quarter of 2022. The decrease was attributable to sales decreases of $225,182 to the Company’s distributors in the UK and Italy. These decreases were offset by an increase in sales of $6,692 to the Company’s distributors in Switzerland and France as well as one direct customer.

(b) Six-month sales: For the first half of 2023 the Company’s sales of cosmetic ingredients decreased by $1,937,090 (56%) when compared with the corresponding period in 2022. This decrease was due primarily to a net decrease in sales to ASI of $1,564,484 (59%) when compared with the second quarter of 2022. This decrease was combined with a net decrease in sales of $372,606 to the Company’s four other distributors and one direct customer. Sales to the Company’s distributors in the United Kingdom, France, and Italy and one direct customer decreased by $374,965 and sales to the Company’s distributor in Switzerland increased by $2,359.

Pharmaceuticals:

There are fees, rebates and allowances associated with sales of the Company’s two pharmaceutical products, Renacidin and Clorpactin. As a result, 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). Gross sales of the Company’s pharmaceutical products for the three- and six-month periods ended June 30, 2023 increased by $154,369 (10%) and $180,009 (6%), respectively, compared with the corresponding periods in 2022. These increases were due primarily to increases of $170,351 (13%) and $183,490 (7%) in gross sales of Renacidin for the three- and six-month periods, respectively, ended June 30, 2023. These increases were offset by decreases of $15,982 (8%) and $3,481 (1%) in gross sales of the Company’s other pharmaceutical product, Clorpactin, for the same three- and six-month periods, respectively. The Company attributes the increase in sales of Renacidin to a price increase that went into effect during the quarter combined with normal fluctuations in customer ordering patterns. The decrease in sales of Clorpactin was also believed to be caused by normal fluctuation in customer ordering patterns.

The difference between the net sales increase compared with the gross sales increase for these products is due to a combination of 1) the net increase in gross sales of those products, combined with; 2) an increase in pharmaceutical sales allowances of $16,152 (5%) for the three-month period ended June 30, 2023, and a decrease in pharmaceutical sales allowances of $87,218 (21%) for the six-month period ended June 30, 2023. These allowances typically have a direct relationship with the sales of the Company’s pharmaceutical products, however, for the six-month period ended June 30, 2023, the decrease in sales allowances was primarily due to a decrease in outdated material returns allowances.

Medical lubricants:

Sales of the Company’s medical lubricants for the three- and six-month periods ended June 30, 2023, decreased by $479,568 (50%) and $616,332 (41%), respectively, compared with the same periods in 2022. The decrease in sales for the three- and six-month periods was primarily due to one of the Company’s larger customers in China changing their ordering patterns in 2023 due to the overstocking of product while China’s Zero-COVID Mandate was in place.

Industrial and other products:

Sales of the Company's industrial products, as well as other miscellaneous products, for the three- and six-month periods ended June 30, 2023, decreased by $13,451 and $11,718, respectively, when compared with the corresponding periods in 2022. The decrease in sales for both periods was primarily due to the Company’s phase out of its industrial product line due to low sales. The second quarter of 2023 is the last period for which the Company will be reporting sales of this product line.

Cost of Sales

Cost of sales as a percentage of net sales increased to 54% in the second quarter of 2023 from 47% in the second quarter of 2022. For the first six months of 2023, cost of sales as a percentage of sales increased to 48% compared with 45% for the first six months of 2022. The increases in both periods were the result of 1) the product sales mix in 2023 compared with the same periods in 2022. The Company’s pharmaceutical products represented a larger percentage of the Company’s sales for both the three- and six-month periods ended June 30, 2023 compared with the same periods in 2022. These products carry a lower gross margin than the Company’s cosmetic products and medical lubricants, and 2) higher per unit overhead costs due to reduced production caused by lower demand for some of the Company’s products.

Operating Expenses

Operating expenses, consisting of selling and general and administrative expenses, decreased by $46,136 (7%) and $74,939 (6%) respectively, for the three- and six-month periods ended June 30, 2023 compared with the equivalent periods in 2022. The decrease in both periods was mainly due to decreases in employee bonuses and depreciation expenses.

Research and Development Expenses

Research and development expenses increased by $16,463 (15%) and $11,756 (5%), respectively, for the three- and six-month periods ended June 30, 2023, compared with the equivalent periods in 2022. The increase was primarily due to increases in payroll and payroll-related expenses.

Investment Income

Investment income decreased by $3,910 (7%) for the second quarter of 2023 compared with the second quarter of 2022 and increased by $3,172 (3%) for the first half of 2023 compared with the same period in 2022. The decrease in the second quarter was primarily due to a shift in the investment portfolio from equity and fixed income mutual funds to U.S. Treasury Bills and Certificates of Deposit, which yielded slightly less income during the second quarter of 2023 compared to the same period in 2022. The increase for the six-month period was primarily due to an increase in the overall investment portfolio.

Net Gain (loss) on Marketable Securities

For the three- and-six-month periods ended June 30, 2023, the Company recorded net gains on its marketable securities portfolio in the amount of $7,479 and $80,180, respectively. For the corresponding periods in 2022, the Company recorded net losses of $460,278 and $853,938, respectively. The reason for the fluctuation was due to 1) during 2022, the Company’s fixed income mutual funds (which made up approximately 90% of the investment portfolio) lost a significant amount of value due to increases in interest rates and those unrealized losses were recorded during 2022; and 2) a majority of those mutual funds were sold during the second quarter of 2023, and while most of the losses had already been recorded in 2022, there were some increases in market value at the time of these sales, which created unrealized gains in the current period. The Company’s management and Board of Directors are continuing to closely monitor the Company's investment portfolio and will make any adjustments they believe may be necessary or appropriate in order to minimize the future impact on the Company’s financial position that the volatility of the global financial markets may have.

Provision for Income Taxes

The Company's effective income tax rate was 21% for the first half and second quarter of both 2023 and 2022. The Company’s tax rate is expected to remain at 21% for the current fiscal year.

LIQUIDITY AND CAPITAL RESOURCES

Working capital increased from $8,596,939 at December 31, 2022 to $10,009,566 at June 30, 2023, an increase of $1,412,627. The current ratio increased from 7.3 to 1 at December 31, 2022 to 8.4 to 1 at June 30, 2023. The increase in working capital and the current ratio was primarily due to an increase in cash and prepaid income taxes. The increase in cash was primarily due to the Company changing the date of its semiannual dividend payment from June to August.

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 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 inflation on the Company's business.

The Company is in the process of upgrading its building sprinkler system and expects to incur costs of approximately $100,000 in connection with this upgrade. The project is currently in process and the Company will be making progress payments throughout the remainder of 2023.

The Company generated cash from operations of $852,247 and $1,164,601 for the first half of 2023 and 2022, respectively. The decrease from 2022 to 2023 was primarily due to the decrease in net income.

Cash provided by investing activities was $4,800,208 in the first half of 2023, compared with cash used by investing activities of $359,150 for the first half of 2022. The increase was due to an increase in the sales of the Company’s marketable securities in the first half of 2023 compared with 2022. The proceeds from these sales were primarily reinvested in short-term U.S. Treasury Bills, which are included in cash and cash equivalents.

Cash used in financing activities was $1,699,392 for the first half of 2022 and represented the payment of dividends. There were no financing activities during the first half of 2023 due to the Company shifting the declaration and payment of dividends to the third quarter of 2023.

The Company expects to continue to use its cash to make dividend payments, purchase marketable securities, and take advantage of growth opportunities that are in the best interest of the Company and its shareholders.

OFF BALANCE-SHEET ARRANGEMENTS

The Company has no off balance-sheet transactions that have, or are reasonably likely to have, a current or future impact 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.

(a) DISCLOSURE CONTROLS AND PROCEDURES

The Company’s management, including its Principal Executive Officer and Chief Financial Officer, has evaluated the design, operation, and effectiveness of the Company’s disclosure controls and procedures pursuant to Rule 13a-15 under the Securities Exchange Act of 1934 (the “Exchange Act”). There are inherent limitations to the effectiveness of any system of disclosure controls and procedures, including the possibility of human error and the circumvention or overriding of the controls and procedures. Accordingly, even effective disclosure controls and procedures can only provide reasonable assurance of achieving their control objectives. Based upon the evaluation performed by the Company’s management, including its Principal Executive Officer and Chief Financial Officer, it was determined that, as of the end of the period covered by this quarterly report, the Company’s disclosure controls and procedures were effective in providing reasonable assurance that information required to be disclosed in the reports filed or submitted pursuant to the Exchange Act is recorded, processed, summarized, and reported within the time periods specified in the rules and forms of the SEC, and that such information is accumulated and communicated to the Company’s management, including its Principal Executive Officer and Chief Financial Officer, or persons performing similar functions, as appropriate, to allow timely decisions regarding disclosures.

(b) CHANGES IN INTERNAL CONTROL OVER FINANCIAL REPORTING

The Company's Principal Executive Officer and Chief Financial Officer have determined that, during the period covered by this quarterly report, there were no changes in the Company's internal control over financial reporting that materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting. They have also concluded that there were no significant changes in the Company’s internal controls after the date of the evaluation.