You should read the following discussion and analysis together with our
unaudited condensed consolidated financial statements and the notes to our
unaudited condensed consolidated financial statements, which appear elsewhere in
this report, as well as our Annual Report on Form 10-K for the year ended
December 31, 2019, filed with the Securities and Exchange Commission (the "SEC")
on March 10, 2020 (the "2019 Form 10-K").
Special Note Regarding Forward-Looking Statements
Certain information set forth in this Quarterly Report on Form 10-Q contains
"forward-looking statements" within the meaning of federal securities laws.
Forward-looking statements include statements concerning our plans, objectives,
goals, strategies, future events, future revenues or performance, capital
expenditures, financing needs, plans or intentions and other information that is
not historical information. When used in this report, the words "estimates,"
"expects," "anticipates," "forecasts," "plans," "intends," "believes" and
variations of such words or similar expressions are intended to identify
forward-looking statements. We may make additional forward-looking statements
from time to time. We undertake no obligation to publicly update any
forward-looking statements, whether as a result of new information, future
developments or otherwise. All forward-looking statements, whether written or
oral and whether made by us or on our behalf, are expressly qualified by this
special note.
The following are some of the risks that could affect our financial performance
or that could cause actual results to differ materially from those expressed or
implied in our forward-looking statements:
? Global economic conditions could adversely affect the Company's business and
financial results.
? The effects of the COVID-19 pandemic could have a material adverse effect on
our business, financial results and results of operations.
? The loss of any large customer or a reduction in orders from any large
customer could reduce our net sales and harm our operating results.
? We rely on suppliers and contractors, and our business could be seriously
harmed if these suppliers and contractors are not able to meet our
requirements.
? Risks associated with international manufacturing could have a significant
effect on our business.
? Our joint venture may present risks that are only present when third parties
are involved.
? Our success depends in part on protection of our intellectual property, and
our failure to protect our intellectual property could adversely affect our
competitive advantage, our brand recognition and our business.
? Our industry is highly competitive, which may negatively affect our ability to
grow our customer base and generate sales.
? The Company's results are affected by competitive conditions and customer
preferences.
? The Company's growth objectives are largely dependent on the timing and market
acceptance of our new product offerings, including our ability to continually
renew our pipeline of new products and to bring those products to market.
? Security breaches and other disruptions to the Company's information
technology infrastructure could interfere with the Company's operations,
compromise information belonging to the Company and our customers and
suppliers and expose the Company to liability, which could adversely impact
the Company's business and reputation.
? The Company's future results may be affected by various legal and regulatory
proceedings and legal compliance risks.
? Our common stock price is volatile, which could result in substantial losses
for individual shareholders.
? We invest in a publicly traded entity with a common stock price that is
volatile, which could result in substantial losses for the Company.
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The foregoing list of risks is not exclusive. For a more detailed discussion of
the risk factors associated with our business , seethe risks described in Part
I, Item IA, "Risk Factors," in the 2019 Form 10-K and in Part II, Item IA, "Risk
Factors," in this Quarterly Report on Form 10-QA. These and many other factors
could affect the Company's future operating results, and financial condition and
could cause actual results to differ materially from expectations based on
forward-looking statements made in this document or elsewhere by the Company or
on its behalf.
Special Note Regarding Smaller Reporting Company Status
We are filing this report as a "smaller reporting company" (as defined in Rule
12b-2 of the Securities Exchange Act of 1934, as amended). As a result of being
a smaller reporting company, we are allowed and have elected to omit certain
information from this Management's Discussion and Analysis of Financial
Condition and Results of Operations; however, we have provided all information
for the periods presented that we believe to be appropriate.
Where to find more information about us. We make available, free of charge, on
our website (http://www.alphaprotech.com) our most recent Annual Report on Form
10-K, our most recent Quarterly Report on Form 10-Q, any Current Reports on Form
8-K furnished or filed since our most recent Annual Report on Form 10-K, and any
amendments to such reports, as soon as reasonably practicable following the
electronic filing of such reports with the SEC. In addition, in accordance with
SEC rules, we provide electronic or paper copies of our filings free of charge
upon request.
Critical Accounting Policies and Estimates
The preparation of our financial statements in conformity with U.S. generally
accepted accounting principles ("U.S. GAAP") requires us to make estimates and
assumptions that affect the reported amounts of assets and liabilities, the
disclosure of contingent assets and liabilities at the dates of the financial
statements and the reported amounts of net sales and expenses during the periods
reported. We base estimates on past experience and on various other assumptions
that are believed to be reasonable under the circumstances. The application of
these accounting policies on a consistent basis enables us to provide timely and
reliable financial information. Our significant accounting policies and
estimates are more fully described in Note 2 - "Summary of Significant
Accounting Policies" in the notes to our condensed consolidated financial
statements in Part I, Item 8 of the 2019 Form 10-K. Our critical accounting
policies and estimates include the following:
Accounts Receivable: Accounts receivable are recorded at the invoice amount and
do not bear interest. The general terms for receivables is net 30 days. The
allowance for doubtful accounts is the Company's best estimate of the amount of
probable credit losses in the Company's existing accounts receivable; however,
changes in circumstances relating to accounts receivable may result in a
requirement for additional allowances in the future. The Company determines the
allowance based upon historical write-off experience and known conditions about
customers' current ability to pay. Account balances are charged against the
allowance when the potential for recovery is considered remote. For new
customers with no order history with the Company we may require advance payments
to reduce our credit risk.
Inventories: Inventories include freight-in, materials, labor and overhead costs
and are stated at the lower of cost or net realizable value. Allowances are
recorded for slow-moving, obsolete or unusable inventory. We assess our
inventory for estimated obsolescence or unmarketable inventory and write down
the difference between the cost of inventory and the estimated net realizable
value based upon assumptions about future sales and supply on-hand, if
necessary. If actual market conditions are less favorable than those projected
by management, additional inventory write-downs may be required.
Leases: We determine if an arrangement is a lease at inception. Operating leases
are included as right-of-use ("ROU") assets and lease liabilities on our
condensed consolidated balance sheet. ROU assets and lease liabilities are
recognized based on the present value of the future minimum lease payments over
the lease term at the commencement date. Our leases do not provide an implicit
rate, and, therefore, we estimate our incremental borrowing rate based on the
information available at the commencement date in determining the present value
of future minimum lease payments. Our lease terms may include options to extend
or terminate the lease when it is reasonably certain that we will exercise such
options. We do not record leases on our condensed consolidated balance sheet
with a term of one year or less. We elected a package of transition practical
expedients, which included not reassessing whether any expired or existing
contracts are or contain leases, not reassessing the lease classification of
expired or existing leases, and not reassessing initial direct costs for
existing leases. We also elected a practical expedient to not separate lease and
non-lease components. We did not elect the practical expedient to use hindsight
in determining our lease terms or assessing impairment of our ROU assets.
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Revenue Recognition: Net sales includes revenue from products and shipping and
handling charges, net of estimates for product returns and any related sales
incentives. Our customer contracts have a single performance obligation-transfer
control of products to customers. Revenue is measured as the amount of
consideration that we expect to receive in exchange for transferring control of
products. All revenue is recognized when we satisfy our performance obligations
under the applicable contract. We recognize revenue in connection with
transferring control of the promised products to the customer, with revenue
being recognized at the point in time when the customer obtains control of the
products, which is generally when title passes to the customer upon delivery to
a third party carrier for FOB shipping point arrangements and to the customer
for FOB destination arrangements, at which time a receivable is created for the
invoice sent to the customer. Shipping and handling activities are performed
prior to the customer obtaining control of the goods and are accounted for as
fulfillment activities and are not a promised good or service. Shipping and
handling charges billed to customers are included in revenue. Shipping and
handling costs, associated with the distribution of the Company's product to the
customers, are recorded in cost of goods sold and are recognized when control of
the product is transferred to the customer, which is at the time the products
are delivered to or picked up by the customer. We estimate product returns based
on historical return rates and estimate rebates based on contractual agreements.
Using probability assessments, we estimate sales incentives expected to be paid
over the term of the contract. Sales taxes and value added taxes in foreign and
domestic jurisdictions that are collected from customers and remitted to
governmental authorities are accounted for on a net basis and, therefore, are
excluded from net sales. The Company manufactures certain private label goods
for customers and has determined that control does not pass to the customer at
the time of manufacture, based upon the nature of the private labelling. The
Company determined that it had no material contract assets, and concluded that
its contract liabilities (primarily rebates) had the right of offset against
customer receivables. As of March 31, 2020, we had contract liabilities of
$7,161,000 as a result of customer advance payments of orders connected to the
COVID-19 pandemic. No such contract liabilities existed as of December 31,
2019.See Note 10 and Note 11 of these Notes to Condensed Consolidated Financial
Statements (Unaudited) for information on revenue disaggregated by type and by
geographic region.
Sales Returns, Rebates and Allowances: Sales are reduced for any anticipated
sales returns, rebates and allowances based on historical experience. Since our
return policy is only 90 days and our products are not generally susceptible to
external factors such as technological obsolescence or significant changes in
demand, we are able to make a reasonable estimate for returns. We offer end-user
product specific and sales volume rebates to select distributors. Our rebates
are based on actual sales and are accrued monthly.
Stock-Based Compensation: The Company accounts for stock-based awards using
Financial Accounting Standards Board ("FASB") Accounting Standards Codification
("ASC") 718, Stock Compensation. ASC 718 requires companies to record
compensation expense for the value of all outstanding and unvested share-based
payments, including employee stock options and similar awards.
The fair values of stock option grants are determined using the Black-Scholes
option-pricing model and are based on the following assumptions: expected stock
price volatility based on historical data and management's expectations of
future volatility, risk-free interest rates from published sources, expected
term based on historical data and no dividend yield, as the Board of Directors
currently has no plans to pay dividends in the foreseeable future. The Company
accounts for option forfeitures as they occur. The Black-Scholes option-pricing
model was developed for use in estimating the fair value of traded options that
have no vesting restrictions and that are fully transferable. In addition, the
option-pricing model requires the input of highly subjective assumptions,
including expected stock price volatility. Our stock options have
characteristics significantly different from those of traded options, and
changes in the subjective input assumptions can materially affect the fair value
of such options.
OVERVIEW
Alpha Pro Tech is in the business of protecting people, products and
environments. We accomplish this by developing, manufacturing and marketing a
line of high-value, disposable protective apparel products for the cleanroom,
industrial, pharmaceutical, medical and dental markets. We also manufacture a
line of building supply construction weatherization products. Our products are
sold under the "Alpha Pro Tech" brand name, as well as under private label.
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Our products are grouped into two business segments: the Building Supply
segment, consisting of construction weatherization products, such as housewrap
and synthetic roof underlayment as well as other woven material; and the
Disposable Protective Apparel segment, consisting of disposable protective
garments (including shoecovers, bouffant caps, coveralls, gowns, frocks and lab
coats), face masks and face shields. All financial information presented in this
report reflects the current segmentation.
Previously, face masks and face shields were included in a separate business
segment called Infection Control. All of our disposable protective apparel,
including face masks (including the Company's proprietary N-95 Particulate
Respiratory face mask) and face shields, are sold through similar distribution
channels, are single-use and disposable, have the purpose of protecting people,
products and environments, and have to be produced in FDA approved facilities,
regardless of the market served. Based on these similarities we determined that
it would be best to consolidate the Infection Control segment into the
Disposable Protective Apparel segment beginning with the first quarter of
2019.
Our target markets include pharmaceutical manufacturing, bio-pharmaceutical
manufacturing, medical device manufacturing, lab animal research, high
technology electronics manufacturing (which includes the semi-conductor market),
medical and dental distributors, and construction, building supply and roofing
distributors.
Our products are used primarily in cleanrooms, industrial safety manufacturing
environments, health care facilities, such as hospitals, laboratories and dental
offices, and building and re-roofing sites. Our products are distributed
principally in the United States through a network consisting of purchasing
groups, national distributors, local distributors, independent sales
representatives and our own sales and marketing force.
Impact of the Novel Coronavirus (COVID-19)
In March 2020, the World Health Organization declared the outbreak of COVID-19 a
pandemic, which continues to spread throughout the U.S. and the world and has
resulted in authorities implementing numerous measures to contain the virus,
including travel bans and restrictions, quarantines, shelter-in-place orders,
and business limitations and shutdowns. COVID-19 has had, and we expect the
virus to continue to have, a number of effects, both positive and negative, on
our business operations and financial condition.
We have experienced a significant surge in customer demand for our proprietary
N-95 Particulate Respirator face mask product, face shield products and other
personal protective equipment ("PPE") products as a result of COVID-19. We
experienced a dramatic increase in revenue from sales of these products during
the first quarter and expect additional increases for the remainder of 2020, and
even beyond. We have seen significant increases not only in near-term demand,
but also in longer-term ongoing purchase orders that have request dates that
extend into the first half of 2021.
In an effort to meet the unprecedented demand, and to aid communities around the
world in responding to the ongoing healthcare crisis, we began ramping up
production during the first quarter of 2020 of our N-95 face mask, which is
manufactured by the Company in the United States with material sourced
domestically. As of May 1, 2020, the Company has booked approximately $46.8
million in orders for the Company's N-95 face mask since January 27, 2020. We
fulfilled approximately $3.7 million of the orders in the first quarter of 2020,
which was slightly below the previously estimated forecast of $4.0 million,
primarily as a result of delays at our manufacturing facility in Utah following
an earthquake in March. The Utah facility has returned to normal operations. At
this time, we expect the remaining backlog of N-95 face mask orders with request
dates in 2020 to be fulfilled by the end of the year. Approximately 8% of
booked orders have request dates in 2021.
We are nearing completion of our phase 1 ramp up plan on N-95 face mask
production, and we are in the process of preparing for a phase 2 expansion that
will involve building additional proprietary N-95 Particulate Respiratory face
mask production lines to further increase capacity. The phase 2 expansion is
expected to be operational by late summer 2020. The fulfillment forecast
described above does not take into account increased production capacity from
the phase 2 ramp up plan.
We have also seen a significant increase in orders of the Company's face shield
products since January 27, 2020, with orders totaling over $13.3 million as of
May 1, 2020. Approximately $1.3 million of face shield orders (net of rebates)
were fulfilled in the first quarter of 2020. At this time, we expect the
remaining backlog of face shield orders with request dates in 2020 to be
fulfilled by the end of the year. Approximately 14% of booked orders have
request dates in 2021.
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Our other PPE product lines, which include coveralls, gowns, lab coats,
shoecovers and bouffant caps, have also seen a significant increase in demand,
which primarily began in early March and has continued into May. We expect
increased demand for these products to continue.
With the increase in demand has come a number of challenges. Although we remain
committed to allocating the necessary resources and procuring the necessary raw
materials in an effort to meet the unprecedented demand for our PPE products, we
have experienced issues with raw material shortages and supply chain delays due,
in large part, to government regulation and mandated closures around the world.
For example, our joint venture in India that manufacturers the Company's PPE
lines that include coveralls, gowns, lab coats, shoecovers and bouffant caps
remains under a country-wide, government mandated closure that started in late
March and has now been extended through May 18, 2020. Although we believe that
we have back-up options for raw material sourcing and manufacturing, those may
be limited, and we expect some continued supply chain disruptions to impact
sales in these and other product lines. Additionally, as we experience shortages
of some PPE, or as we satisfy requests for products from government entities
under the U.S. Defense Production Act (the "DPA") and otherwise, our traditional
customer base may seek to fill orders with our competitors, which could
adversely affect our relationships with these customers. Likewise, suppliers of
our raw materials who are subject to requests under the DPA may be unable to
fulfill our orders for those raw materials, or such fulfillment could be
delayed. Government regulation may also impact our ability to supply and ship
our products to certain customers, which could lead to cancellation of some
orders. Further, we expect the prices of raw materials to rise more rapidly than
our sales prices, therefore decreasing the net revenue per item that we expect
to receive.
The majority of the products that we manufacture are deemed essential by the
various jurisdictions in which we operate. We have implemented significant
protective measures throughout our facilities, including travel and visitor
restrictions, work from home policies, employee screenings, social distancing
and use of face coverings as we continue to service our customers. While this
remains a fluid situation, all of our U.S. manufacturing sites are currently
operating, with the majority of them at or above normal production rates.
We are continuing to serve our customers while taking every precaution to
provide a safe work environment for our employees. We have enacted enhanced
operating protocols to assure the safety and well-being of our employees, placed
restrictions on non-essential travel and otherwise adjusted work schedules to
maximize our capacity while adhering to recommended precautions such as social
distancing and complying with shelter-in-place orders. We believe that we may
have to take further actions that we determine are in the best interests of our
employees or as required by federal, state or local authorities. Although we
will continue to adhere to restrictions imposed by local governments in the
jurisdictions in which we operate, government regulations have impacted
workforce availability and expense in certain of the Company's manufacturing
facilities, and we expect this to continue for some time.
COVID-19 has resulted in a downturn in the global financial markets and a
slowdown in the global economy. This economic environment may impact some of
our customers' ability to pay or lead them to request extended payment terms,
and we may experience cost increases from some of our suppliers. And, despite
the tremendous surge in demand for our PPE products in recent months, we expect
that demand for our Building Supply segment products could be negatively
impacted by decreased housing starts and increased uncertainty in the housing
market and the economy in general.
The impact of the COVID-19 pandemic continues to unfold. The pandemic had a
positive impact on our first quarter results. The extent of the pandemic's
effect on our future operational and financial performance will depend in large
part on future developments, which cannot be predicted with confidence at this
time. Future developments include the duration, scope and severity of the
pandemic, the actions taken to contain or mitigate its impact, the impact on
governmental programs and budgets, the development of treatments or vaccines,
and the resumption of widespread economic activity. Due to the inherent
uncertainty of the unprecedented and rapidly evolving situation, we are unable
to predict with any confidence the likely impact of the COVID-19 pandemic on our
future operations.
RESULTS OF OPERATIONS
The following table sets forth certain operational data as a percentage of net
sales for the periods indicated:
For the Three Months
Ended March 31,
2020 2019
Net sales 100.0 % 100.0 %
Gross profit 47.1 % 39.0 %
Selling, general and administrative expenses 22.6 % 29.9 %
Income from operations
23.5 % 8.1 %
Income before provision for income taxes 23.8 % 11.9 %
Net income 29.4 % 9.9 %
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For the three months ended March 31, 2020, compared to the three months ended
March 31, 2019
Sales. Consolidated sales for the three months ended March 31, 2020 increased to
$18,154,000, from $12,304,000 for the quarter ended March 31, 2019, representing
an increase of $5,850,000, or 47.5%. This increase consisted of increased sales
in the Building Supply segment of $1,059,000 and by increased sales in the
Disposable Protective Apparel segment of $4,791,000.
Building Supply segment sales for the three months ended March 31, 2020
increased by $1,059,000, or 16.3%, to $7,557,000, compared to $6,498,000 for the
three months ended March 31, 2019. The Building Supply segment increase was
primarily due to a 14.4% increase in our core building products, including an
increase in sales of synthetic roof underlayment of 12.1% and an increase in
sales of housewrap of 20.0%. Sales of other woven material increased by 26.4%
compared to the same period of 2019. The sales mix of the Building Supply
segment for the three months ended March 31, 2020 was approximately 45% for
synthetic roof underlayment, 45% for housewrap and 9% for other woven material.
This compared to approximately 46% for synthetic roof underlayment, 44% for
housewrap and 10% for other woven material for the three months ended March 31,
2019. Our synthetic roof underlayment product line includes REX™, TECHNOply™ and
TECHNO SB®, and our housewrap line consists of REX™ Wrap, REX™ Wrap Plus and
REX™ Wrap Fortis.
The increase in our synthetic roof underlayment sales were attributable to the
expansion of program purchases on our expanded line of products, particularly on
our TECHNO family of spunbond based (SB) products, with the one step roofing
market. We have experienced an overall increase in market share due to our
ability of supporting shortened lead times with our U.S. based manufacturing and
our vertical integration as a result of our joint venture. The housewrap side of
our business has also experienced an increase as we expand our distribution
reach with the additional accessory items we have added to the system sell. Our
full line of wraps, seam tape and window flashings has given us an additional
reach to new distribution outlets. Sales of other woven material increased as a
result of our largest customer in this category increasing its order volume with
us.
We expect continued growth in this market segment longer term but do anticipate
a softer market short term as a result of the COVID-19 pandemic.
Sales for the Disposable Protective Apparel segment for the three months ended
March 31, 2020 increased by $4,791,000, or 82.5%, to $10,597,000, compared to
$5,806,000 for the same period of 2019. This segment increase was due to a
$3,673,000 or 419.3% increase in sales of face masks, a 235.3% increase in face
shields and a 5.1% increase in sales of disposable protective garments. The
increase in face mask sales can be attributed to increased sales of our N-95
Particulate Respirator due to the COVID-19 pandemic. The increase in face shield
sales was also due to the pandemic. On a comparative basis, the first quarter of
2019 was also strong, being the second best quarter in the same number of years.
Disposable protective apparel sales in the first quarter of 2020 was 23.0%
higher than the average quarter of the past two years. The company's joint
venture in India that manufacturers the disposable protective garment lines,
which has historically been the primary supply source for these products,
remains under a country-wide, government mandated closure that started in late
March and has now been extended through May 18, 2020. Customer demand for
disposable protective garments remains strong, but the Company does expect some
short term impact on sales as a result of the India mandated closure, which
could impact order fulfillment and top line growth. The sales mix of the
Disposable Protective Apparel segment for the three months ended March 31, 2020
was approximately 45% for disposable protective garments, 43% for face masks and
12% for face shields. This compared to approximately 78% for disposable
protective garments, 15% for face masks and 7% for face shields for the three
months ended March 31, 2019.
Gross Profit. Gross profit increased by $3,750,000, or 78.1%, to $8,554,000 for
the three months ended March 31, 2020, from $4,804,000 for the same period of
2019. The gross profit margin was 47.1% for the three months ended March 31,
2020, compared to 39.0% for the three months ended March 31, 2019. Gross profit
margin was positively affected by the significant change in product mix, with a
surge in customer demand in light of the COVID-19 pandemic for face masks, in
particular the N-95 Particulate Respirator face mask, and face shields, which
generally have a higher gross profit margin than our other products. The Company
expects these higher gross profit margin products to be in high demand for at
least the rest of 2020.
Selling, General and Administrative Expenses. Selling, general and
administrative expenses increased by $427,000, or 11.6%, to $4,102,000 for the
three months ended March 31, 2020, from $3,675,000 for the three months ended
March 31, 2019. As a percentage of net sales, selling, general and
administrative expenses decreased to 22.6% for the three months ended March 31,
2020, from 29.9% for the same period of 2019. The increase in selling, general
and administrative expenses was primarily the result of increased employee
compensation for both the Building and Disposable Protective Apparel segments,
increased professional fees, increased accrued bonuses and increased payroll
taxes, partially offset by decreased trade show expenses.
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The change in expenses by segment, comparing the three months ended March 31,
2019 to the three months ended March 31, 2020, was as follows: Disposable
Protective Apparel increased by $60,000, or 5.0%; corporate unallocated expenses
increased by $446,000, or 42.9%; and Building Supply decreased by $79,000, or
5.5%. The increase in the Disposable Protective Apparel segment expenses was
related to increased employee compensation and higher testing costs for the
manufacture of face masks. The increase in corporate unallocated expenses was as
a result of increased professional fees, increased accrued bonuses as well as
increased payroll taxes. The decrease in the Building Supply segment expenses
was primarily as a result decreased trade show expenses, partially offset by
increased employee compensation.
In accordance with the terms of his employment agreement, the Company's current
President and Chief Executive Officer is entitled to an annual bonus equal to 5%
of the pre-tax profits of the Company, excluding bonus expense. A bonus amount
of $227,000 was accrued for the three months ended March 31, 2020, compared to
$77,000 for the three months ended March 31, 2019.
Depreciation and Amortization. Depreciation and amortization expense increased
by $55,000, or 43.3%, to $182,000 for the three months ended March 31, 2020,
from $127,000 for the three months ended March 31, 2019. The increase was
primarily attributable to increased depreciation for machinery and equipment in
the Building Supply segment.
Income from Operations. Income from operations increased by $3,268,000, or
326.1%, to $4,270,000 for the three months ended March 31, 2020, compared to
$1,002,000 for the same period of 2019. The increased income from operations was
primarily due to an increase in gross profit of $3,750,000, partially offset by
an increase in selling, general and administrative expenses of $427,000, and an
increase in depreciation and amortization expense of $55,000. Income from
operations as a percentage of net sales for the three months ended March 31,
2020 was 23.5%, compared to 8.1% for the same period of 2019.
Other Income. Other income decreased by $415,000, or 109.4%, to $44,000 for the
three months ended March 31, 2020, from $459,000 for the same period of 2019.
The decrease was primarily due to a loss on marketable securities for the three
months ended March 31, 2020 compared to a gain on marketable securities during
the same period of 2018, for a net change of $229,000, and a decrease in equity
in income of unconsolidated affiliate of $190,000, partially offset by an
increase in interest income of $4,000.
The fluctuations in the Company's marketable securities were primarily
attributable to changes in the fair value of the securities recognized during
the period. For the three months ended March 31, 2020, the Company's investments
were negatively impacted by the COVID-19 pandemic, which resulted in a sharp
downturn in the markets during the quarter. Management expects that any future
market volatility, whether from COVID-19 or other factors, will result in
continued volatility in the investment portfolio.
Other income consisted of equity in income of unconsolidated affiliate of
$87,000, a loss on marketable securities of $59,000 and interest income of
$16,000 for the three months ended March 31, 2020. Other income consisted
primarily of equity in income of unconsolidated affiliate of $277,000, a gain on
marketable securities of $170,000 and interest income of $12,000 for the three
months ended March 31, 2019.
Income before Provision (Benefit) for Income Taxes. Income before provision
(benefit) for income taxes for the three months ended March 31, 2020 was
$4,314,000, compared to income before provision for income taxes of $1,461,000
for the same period of 2019, representing an increase of $2,853,000 or 195.3%.
This increase in income before provision for income taxes was primarily due to
an increase in income from operations of $3,268,000, partially offset by a
decrease in other income of $415,000.
Provision (Benefit) for Income Taxes. The provision (benefit) for income taxes
for the three months ended March 31, 2020 was a tax benefit of $1,028,000,
compared to a tax provision of $243,000 for the same period of 2019. The
provision for income taxes consisted of an estimated nonrecurring tax benefit of
$2.0 million in the first quarter of 2020 as a result of the exercise of
disqualified Incentive Stock Options ("ISOs") and the exercise of Non-Qualified
Stock Options ("NQSOs"), partially offset by tax expense of an estimated $1.0
million. The estimated effective tax rate was negative 23.8% for the three
months ended March 31, 2020, compared to 16.6% for the three months ended March
31, 2019. Excluding the estimated nonrecurring tax benefit of $2.0 million, the
estimated effective tax rate was 22.5% for the three months ended March 31,
2020. The Company does not record a tax provision on equity in income of
unconsolidated affiliate, which reduces the effective tax rate.
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Net Income. Net income for the three months ended March 31, 2020 was $5,342,000,
compared to net income of $1,218,000 for the same period of 2019, representing
an increase of $4,124,000, or 338.6%. The net income increase was due to an
increase in income before benefit for income taxes of $2,853,000 and by a
decrease in provision for income taxes of $1,271,000. As mentioned above, a tax
benefit from stock options exercised has positively impacted net income in the
first quarter of 2020. Net income as a percentage of net sales for the three
months ended March 31, 2020 was 29.4%, and net income as a percentage of net
sales for the three months ended March 31, 2019 was 9.9%. Basic earnings per
common share for the three months ended March 31, 2020 and 2019 were $0.41 and
$0.09, respectively. Diluted earnings per common share for the three months
ended March 31, 2020 and 2019 were $0.39 and $0.09, respectively.
LIQUIDITY AND CAPITAL RESOURCES
As of December 31, 2019, the Company had cash of $17,365,000 and working capital
of $31,624,000, representing an increase in working capital of $6,964,000 from
$24,660,000 as of December 31, 2019. As of March 31, 2020, the Company's current
ratio (current assets/current liabilities) was 4:1, compared to a 12:1 current
ratio as of December 31, 2019. The change in current ratio is as a result of
customer advance payments for future dated PPE orders. Cash increased by 165.2%,
or $10,817,000 to $17,365,000 as of March 31, 2020, compared to $6,548,000 as of
December 31, 2019. Approximately $7.2 million of the increase in cash can be
attributable to prepayments on future PPE sales. The increase in cash from
December 31, 2019 was due to cash provided by operating activities of
$9,342,000, cash provided by financing activities of $1,716,000 and cash used in
investing activities of $241,000.
We have a $3,500,000 credit facility with Wells Fargo Bank, consisting of a line
of credit with interest at prime plus 0.5%. As of March 31, 2020, the prime
interest rate was 3.25%. This credit line will expire in May 2020, and we do
expect to renew it. The available line of credit is based on a formula of
eligible accounts receivable and inventories. Our borrowing capacity on the line
of credit was $3,500,000 as of March 31, 2020. As of March 31, 2020, we did not
have any borrowings under this credit facility and do not anticipate using it in
the near future. The credit facility includes customary financial and
non-financial debt covenants. As of March 31, 2020 we believe that we are in
compliance with all such covenants.
Net cash provided by operating activities of $9,342,000 for the three months
ended March 31, 2020 was due to net income of $5,342,000, impacted primarily by
the following: stock-based compensation expense of $91,000, depreciation and
amortization expense of $182,000, loss on marketable securities of $59,000,
equity in income of unconsolidated affiliate of $87,000, operating lease expense
net of accretion of $224,000, an increase in accounts receivable of $3,986,000,
an increase in prepaid expenses of $650,000, a decrease in inventory of
$155,000, an increase in accounts payable and accrued liabilities of $8,233,000
and a decrease in lease liabilities of $221,000.
Accounts receivable increased by $3,986,000, or 92.0%, to $8,278,000 as of March
31, 2020, from $4,292,000 as of December 31, 2019. The increase in accounts
receivable was primarily related to increased sales in the first quarter of 2020
and to extended payment terms that we offer on many Building Supply segment
sales through the end of the first quarter of 2020 to remain competitive, as our
competition also offers these extended payment terms. The number of days that
sales remained outstanding as of March 31, 2020, calculated by using an average
of accounts receivable outstanding and annual revenue, was 33 days, compared to
34 days as of December 31, 2019.
Inventory decreased by $155,000, or 1.4%, to $11,148,000 as of March 31, 2020,
from $11,303,000 as of December 31, 2019. The decrease was primarily due to a
decrease in inventory for the Disposable Protective Apparel segment of $269,000,
or 4.8%, to $5,339,000, partially offset by an increase in inventory for the
Building Supply segment of $114,000, or 2.0%, to $5,809,000.
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Prepaid expenses increased by $650,000, or 18.1%, to $4,237,000 as of March 31,
2020, from $3,587,000 as of December 31, 2019. The increase was primarily due to
a tax benefit, partially offset by decreases in deposits for the purchase of
inventory.
Right-of-use assets as of March 31, 2020 decreased by $224,000 to $2,954,000
from $3,178,000 as of December 31, 2019, as a result of amortization of the
balance.
Lease liabilities as of March 31, 2020 decreased by $220,000 to $2,999,000 from
$3,219,000 as of December 31, 2019. The recording of the lease liabilities was
the result of adopting ASC 842, Leases. The decrease in the lease liabilities
was the result of lease payments made during the quarter.
Accounts payable and accrued liabilities as of March 31, 2020 increased by
$1,070,000, or 75.3%, to $2,491,000, from $1,421,000 as of December 31, 2019.
The increase was primarily due to an increase in accounts payable as a result of
increased raw material purchases.
Customer advance payment of orders as of March 31, 2020 was $7,161,000, which is
a result of customer deposits for future-dated PPE orders, in response to the
COVID-19 pandemic. There were no advance payments of this nature as of December
31. 2019.
Net cash used in investing activities was $241,000 for the three months ended
March 31, 2020, compared to net cash used in investing activities of $142,000
for the same period of 2019. Investing activities for the three months ended
March 31, 2020 consisted of the purchase of property and equipment of $288,000
primarily for the Building Supply segment and proceeds from the sale of
marketable securities of $47,000. Investing activities for the quarter ended
March 31, 2019 consisted of the purchase of property and equipment of $152,000
and proceeds from the sale of marketable securities of $10,000.
Net cash provided by financing activities was $1,716,000 for the three months
ended March 31, 2020, compared to net cash used in financing activities of
$948,000 for the same period of 2019. Net cash provided by financing activities
for the three months ended March 31, 2020 resulted from proceeds of $1,841,000
from the exercise of stock options, partially offset by the payment of $125,000
for the repurchase of common stock. Net cash used in financing activities for
the quarter ended March 31, 2019 resulted from the payment of $1,008,000 for the
repurchase of common stock, partially offset by proceeds of $60,000 from the
exercise of stock options.
As of March 31, 2020, we had $2,027,000 available for additional stock purchases
under our stock repurchase program. For the three months ended March 31, 2020,
we repurchased 35,100 shares of common stock at a cost of $125,000. As of March
31, 2020, we had repurchased a total of 17,922,917 shares of common stock at a
cost of $35,493,000 through our repurchase program. We retire all stock upon
repurchase. Future repurchases are expected to be funded from cash on hand and
cash flows from operating activities.
We believe that our current cash balance and the funds available under our
credit facility will be sufficient to satisfy our projected working capital and
planned capital expenditures for the foreseeable future.
Recent Accounting Pronouncements
In February 2016, the FASB issued ASU 2016-02, Leases, which introduces the
recognition of lease assets and lease liabilities by lessees for those leases
classified as operating leases under previous guidance. The update is effective
for annual reporting periods beginning after December 15, 2018, including
interim periods within those reporting periods, with early adoption permitted.
The original guidance required application on a modified retrospective basis
with the earliest period presented. In August 2018, the FASB issued ASU 2018-11,
Targeted Improvements to ASC 842, which includes an option to not restate
comparative periods in transition and elect to use the effective date of ASC
842, Leases, as the date of initial application of transition. Based on the
effective date, we adopted this ASU beginning on January 1, 2019 and elected the
transition option provided under ASU 2018-11. This standard had a material
effect on our consolidated balance sheet with the recognition of new
right-of-use assets and lease liabilities for all operating leases, as these
leases typically have a non-cancelable lease term of greater than one year. Upon
adoption, both assets and liabilities on our consolidated balance sheet
increased by approximately $3,455,000. We have elected a package of transition
practical expedients which include not reassessing whether any expired or
existing contracts are or contain leases, not reassessing the lease
classification of expired or existing leases, and not reassessing initial direct
costs for existing leases. We have also elected a practical expedient to not
separate lease and non-lease components. We did not elect the practical
expedient to use hindsight in determining the lease terms or assessing
impairment of the ROU assets. See also Note 13 to the Consolidated Financial
Statements, which appear elsewhere in this report.
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In June 2016, the FASB issued ASU 2016-13 Financial Instruments - Credit Losses
(Topic 326): Measurement of Credit Losses on Financial Instruments. ASU 2016-13
requires an organization to measure all expected credit losses for financial
assets held at the reporting date based on historical experience, current
conditions and reasonable and supportable forecasts. ASU 2016-13 is effective
for public entities for the annual periods, including interim periods within
those annual periods, beginning after December 15, 2019. This guidance is
applicable to the Company's fiscal year beginning January 1, 2020. Adoption of
the new standard did not have a material impact on our condensed consolidated
financial statements.
In June 2018, the FASB issued ASU 2018-07, Compensation - Stock Compensation
(Topic 718), Improvements to Nonemployee Share-Based Payment Accounting. This
ASU is intended to simplify aspects of share-based compensation issued to
non-employees by making the guidance consistent with accounting for employee
share-based compensation. ASU 2018-07 is effective for annual periods beginning
after December 15, 2018 and interim periods within those annual periods, with
early adoptions permitted but no earlier than an entity's adoption date of ASC
Topic 606. The new guidance is required to be applied retrospectively with the
cumulative effect recognized at the date of initial application. We adopted the
provisions of this ASU in the first quarter of 2019. Adoption of the new
standard did not have a material impact on our condensed consolidated financial
statements.
Management periodically reviews new accounting standards that are issued.
Management has not identified any other new standards that it believes merit
further discussion at this time.
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