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UG > SEC Filings for UG > Form 10-K on 21-Mar-2013All Recent SEC Filings

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Form 10-K for UNITED GUARDIAN INC


21-Mar-2013

Annual Report


Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations.

Critical Accounting Policies

The Company's financial statements have been prepared in accordance with U.S. generally accepted accounting principles. Preparation of financial statements requires the Company to make estimates and assumptions affecting the reported amounts of assets, liabilities, revenues, and expenses and the disclosure of contingent assets and liabilities. The Company uses its historical experience and other relevant factors when developing its estimates and assumptions, which are continually evaluated. Note A, Nature of Business and Summary of Significant Accounting Policies, of the Notes to Financial Statements, included in Item 8, Financial Statements and Supplementary Data, of this Annual Report on Form 10-K includes a discussion of the Company's significant accounting policies. The following accounting policies are those that the Company considers critical to an understanding of the financial statements because their application places the most significant demands on the Company's judgment. The Company's financial results might have been different if other assumptions had been used or other conditions had prevailed.

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Marketable Securities

The Company classifies its marketable securities as available-for-sale at the time of purchase and re-evaluates such designation as of each balance sheet date. The Company's marketable securities include investments in equity and fixed income mutual funds, government securities, and corporate bonds. The Company's marketable securities are reported at fair value with the related unrealized gains and losses included in accumulated other comprehensive income
(loss), a component of stockholders' equity. Realized gains or losses on mutual funds are determined using the average cost method, while realized gains or losses on government securities and bonds are determined using the specific-identification method. Realized gains or losses on the Company's marketable securities are insignificant for the years ended December 31, 2012 and 2011. The Company evaluates its investments periodically for possible other-than-temporary impairment by reviewing factors such as the length of time and extent to which fair value had been below cost basis, the financial condition of the issuer and the Company's ability and intent to hold the investment for a period of time which may be sufficient for anticipated recovery of market value. The Company would record an impairment charge to the extent that the cost of the available-for-sale securities exceeds the estimated fair value of the securities and the decline in value is determined to be other-than-temporary. During 2012 the Company did not record an impairment charge regarding its investment in marketable securities because management believes, based on its evaluation of the circumstances, that the decline in fair value below the cost of certain of the Company's marketable securities is temporary.

Revenue Recognition

The Company recognizes revenue when products are shipped, title and risk of loss pass to customers, persuasive evidence of a sales arrangement exists, and collections are reasonably assured. Any allowances for returns are taken as a reduction in sales within the same period the revenue is recognized. Such allowances are based on historical experience as well as other factors that, in the Company's judgment, could reasonably be expected to cause sales returns or doubtful accounts to differ from historical experience.

Accounts Receivable Allowance

The Company performs ongoing credit evaluations of the Company's customers and adjusts credit limits, as determined by a review of current credit information. The Company continuously monitors collection and payments from customers and maintains an allowance for doubtful accounts based upon historical experience, the Company's anticipation of uncollectible accounts receivable and any specific customer collection issues that have been identified. While the Company's credit losses have historically been low and within expectations, the Company may not continue to experience the same credit loss rates that have historically been attained. The receivables are highly concentrated in a relatively small number of customers. Therefore, a significant change in the liquidity, financial position, or willingness to pay timely, or at all, of any one of the Company's significant customers would have a significant impact on the Company's results of operations and cash flows.

Inventory Valuation Allowance

In conjunction with the Company's ongoing analysis of inventory valuation, management constantly monitors projected demand on a product-by-product basis. Based on these projections, management evaluates the levels of write-downs required for inventory on hand and inventory on order from contract manufacturers. Although the Company believes that it has been reasonably successful in identifying write-downs in a timely manner, sudden changes in buying patterns from customers, either due to a shift in product interest and/or a complete pull back from their expected order levels, may result in the recognition of larger-than-anticipated write-downs.

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Results Of Operations

Year ended December 31, 2012 compared with the year ended December 31, 2011

Net Sales

Net sales in 2012 decreased by $512,748 (3.6%) compared with 2011. The net decrease was the result of the following changes in sales in the different product categories:

(a) Personal care products: Sales of the Company's personal care products, including cosmetic ingredients, increased by $201,641 (2.2%) for the year ended December 31, 2012 when compared with 2011. The increase was attributable primarily to an increase in sales to ASI, the Company's largest marketing partner. Sales to ASI in 2012 increased 4.5% compared with 2011. Sales to the Company's five other marketing partners showed a net decrease of $90,166 (4.9%) in 2012 compared with 2011. Sales to four of those five, all in western Europe, decreased, while sales to the Company's marketing partner in South Korea increased.

The Company believes that the net increase in sales of its personal care products was the result of improving economic conditions in Asia and North America, which resulted in new consumer product introductions utilizing its products. The overall increase in sales was almost entirely attributable to an increase in sales of the Company's extensive line of LUBRAJEL® products.

The Company's increased sales to ASI are believed to be the result of both normal fluctuations in ASI's buying patterns, as well as new consumer product introductions and new customers for the Company's products. The decrease in sales to the Company's European marketing partners is believed to be due to the continuing economic decline in the western European economies, which has resulted in a decrease in demand for personal care and cosmetic ingredients in those areas.

Total sales of all of the Company's LUBRAJEL products for both personal care and medical uses increased by $229,013 (2.0%) in 2012 compared with 2011. The unit volume of all LUBRAJEL products sold, both for personal care and medical uses, increased by approximately 2.4% in 2012 compared with 2011.

(b) Pharmaceuticals: Sales of the Company's two pharmaceutical products, RENACIDIN and CLORPACTIN, decreased by $790,512 (34.1%) for the year ended December 31, 2012 compared with 2011, with RENACIDIN accounting for almost the entire decrease. RENACIDIN accounted for approximately 8% of the Company's sales in 2012 compared with 13% in 2011. The decrease in sales of the Company's pharmaceutical products in 2011 was due to a decrease in sales of RENACIDIN. Although the Company had normal demand for the product, it was unable to fill orders during the second half of 2012 because it could not get product from its supplier. The product has been manufactured for the Company under a long-term contract with a major U.S. drug manufacturer that experienced regulatory problems in 2010 that caused it to suspend production from November 2010 until May 2011, and then experienced a production curtailment again beginning in May 2012 and continuing as of the date of this report. As a result, the Company began to allocate product to its customers beginning in May 2012, and continued to do so until its inventory was depleted on August 1, 2012. The supplier has paid the Company $518,050, which the Company believes covers most of the RENACIDIN profit the Company lost in 2012. The Company is hopeful that production will resume and that it will be able to bring in more inventory in the third quarter of 2013. The Company will not be continuing with this supplier past January 2014, and is currently working with a new supplier that will produce the product in a new single-dose unit that may increase the Company's revenue from this product in future years. The Company hopes to have the new dosage form on the market in the second half of 2014.

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(c) Medical products: Sales of the Company's medical products increased $6,628 (0.2%) in 2012 compared with 2011. Sales of the primary products in this category all increased, but those increases were partially offset by lower sales of LUBRAJEL RR, which decreased by 16.1% due to the ordering patterns of the customers for this product. The Company expects increased sales in 2013 as a result of anticipated sales of its new LUBRAJEL TF medical lubricant, which was developed for a new customer and began shipping late in 2012.

(d) Industrial and other products: Sales of the Company's industrial products, as well as other miscellaneous products, increased by $19,672 (14.7%) in 2012 when compared with 2011.

Sales were positively impacted in 2012 by a decrease of $49,822 (20.4%) in sales discounts and allowance reserves as compared with 2011. The decrease in sales discounts and allowances was mainly due to decreases in the allowance for distribution fees, rebates, and sales discounts attributable to the lower sales of RENACIDIN in 2012 as compared with 2011.

Cost of Sales

Cost of sales as a percentage of net sales in 2012 decreased to 37.7% from 39.4% in the prior year. The decrease was primarily the result of the change in the Company's product mix as a result of the lower sales of RENACIDIN in 2012 (as discussed above) and increased sales in 2012 of the Company's higher margin LUBRAJEL products, as well as a decrease in insurance expense.

Operating Expenses

Operating expenses decreased by $44,457 (1.7%) in 2012 compared with the prior year. This decrease was mainly due to a reduction in insurance expense.

Portions of the Company's operating expenses are directly attributable to the research and development that the Company performs. In 2012 and 2011, the Company incurred approximately $693,000 and $637,000, respectively, in research and development expenses, which are included in operating expenses. The increase in R&D costs incurred in 2012 was primarily attributable to increases in payroll costs. No portion of the research and development expenses was directly paid by the Company's customers.

Other Income (Expense)

Other income (net) increased $92,121 (12.5%) for the year ended December 31, 2012 when compared with 2011. The increase was mainly attributable to $518,050 in income the Company accrued from the settlement of a claim for damages between the Company and its RENACIDIN supplier. The claim resulted from the temporary suspension of production of the Company's RENACIDIN product by its supplier at the end of 2011 due to production problems unrelated to RENACIDIN. Production is not expected to resume until the third quarter of 2013. As a result, the Company and its supplier entered into a settlement agreement whereby the Company would be compensated for most of its lost profits caused by its inability to bring in inventory. The $518,050 reimburses the Company for most of the profit the parties agreed the Company would have received from RENACIDIN sales in 2012 had it not been for the production curtailment. The settlement agreement also provides for continuing payments to the Company until production resumes or until the Company's contract with the supplier ends in January 2014. In 2011 the Company recognized $385,182 in income from a previous production curtailment by the same supplier that negatively impacted RENACIDIN sales in 2011. Further information on that previous production curtailment can be found in the Company's Annual Report on Form 10-K for 2011.

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The Company earns interest income from money market funds and bonds, and dividend income from both stock and bond mutual funds. Other income was reduced in 2012 by a decrease in investment income of $7,635, which primarily resulted from lower interest rates and dividend returns compared with 2011.

The Company also had a net loss on the sale of assets of $14,861 in 2012 compared to a net gain of $18,251 in 2011.

Provision for Income Taxes

The provision for income taxes decreased by $59,220 (2.7%) in 2012 compared with 2011. This decrease was mainly due to income tax refunds for research and development tax credits for the years 2008 through 2010. The Company's effective income tax rate was approximately 30% in 2012 and 31% in 2011, and is lower than the federal statutory rate of 34% primarily due to the additional tax deduction for domestic production activities as well as the utilization of research and development tax credits.

Liquidity and Capital Resources

Working capital decreased from $12,895,448 at December 31, 2011 to $11,795,895 at December 31, 2012, a decrease of $1,099,553 (8.5%). The current ratio increased to 15.25 to 1 at December 31, 2012 from 12.97 to 1 at December 31, 2011. The decrease in working capital was due to a decrease in marketable securities, which was partially used to fund a special dividend that the Company paid in December 2012. The increase in the current ratio was primarily the result of a decrease in accounts payable.

Accounts receivable (net of allowance for doubtful accounts) as of December 31, 2012 decreased by $635,813 as compared with 2011. The average period of time that an account receivable was outstanding was approximately 35 days in 2012 and in 2011. The Company has a bad debt reserve of $29,000 and $18,000 for 2012 and 2011, respectively, and believes that the net balance of its accounts receivable is fully collectable as of December 31, 2012.

The Company does not maintain a line of credit with a financial institution because the Company has no foreseeable need for a line of credit, and therefore management believes that the cost of maintaining a line of credit cannot be justified, especially considering the strong financial condition of the Company.

The Company generated cash from operations of $5,380,747 in 2012 compared with $4,437,129 in 2011. The increase in 2012 was primarily due to decreases in accounts receivable and inventories.

Net cash provided by investing activities was $1,527,819 for the year ended December 31, 2012 when compared with net cash used in investing activities of $1,183,593 for the year ended December 31, 2011. This increase was mainly due to proceeds from the sale of marketable securities in 2012.

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Cash used in financing activities was $6,251,158 and $3,677,151 during the years ended December 31, 2012 and 2011, respectively. The increase was mainly due to a special dividend of $0.50 per share the Company paid in December 2012 due to uncertainty regarding the tax treatment of qualified dividends after December 31, 2012.

The Company believes that its working capital is sufficient to support its operating requirements for the next fiscal year. The Company's long-term liquidity position will be dependent upon its ability to generate sufficient cash flow from profitable operations. The Company has no material commitments for future capital expenditures.

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.

NEW ACCOUNTING PRONOUNCEMENTS

See Note "A" to the financial statements regarding new accounting pronouncements.

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