ALPHA PRO TECH LTD - Quarter Report: 2023 March (Form 10-Q)

Alpha Pro Tech, Ltd.

Index

PART I. FINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS

Condensed Consolidated Balance Sheets (Unaudited)

(1) The condensed consolidated balance sheet as of December 31, 2022, has been prepared using information from the audited consolidated balance sheet as of that date.

See accompanying Notes to Condensed Consolidated Financial Statements (Unaudited).

Condensed Consolidated Statements of Income (Unaudited)

See accompanying Notes to Condensed Consolidated Financial Statements (Unaudited).

Condensed Consolidated Statements of Comprehensive Income (Unaudited)

See accompanying Notes to Condensed Consolidated Financial Statements (Unaudited).

Condensed Consolidated Statements of Shareholders’ Equity (Unaudited)

See accompanying Notes to Condensed Consolidated Financial Statements (Unaudited).

Condensed Consolidated Statements of Cash Flows (Unaudited)

See accompanying Notes to Condensed Consolidated Financial Statements (Unaudited).

Alpha Pro Tech, Ltd. (“Alpha Pro Tech,” the “Company,” “we”, “us” or “our”) is in the business of protecting people, products and environments. The Company accomplishes this by developing, manufacturing and marketing a line of building supply products for the new home and re-roofing markets and a line of disposable protective apparel for the cleanroom, industrial, pharmaceutical, medical and dental markets.

The Building Supply segment consists of construction weatherization products, such as housewrap, housewrap accessories, namely tape and flashing, and synthetic roof underlayment, as well as other woven material.

The Disposable Protective Apparel segment consists of a complete line of disposable protective garments (shoecovers, bouffant caps, coveralls, gowns, frocks and lab coats), face masks and face shields. All of our disposable protective apparel products, including face masks 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 Food and Drug Administration (“FDA”) approved facilities, regardless of the market served.

The Company’s products are sold under the "Alpha Pro Tech" brand name as well as under private label and are predominantly sold in the United States of America (“U.S.”).

The interim financial information included in this report is unaudited; however, the information reflects all adjustments (consisting of normal recurring adjustments) that are, in the opinion of management, necessary for the fair presentation of the consolidated financial position, results of operations and cash flows for the interim periods reflected herein. These interim condensed consolidated financial statements have been prepared in accordance with the rules and regulations of the Securities and Exchange Commission (“SEC”) and, therefore, omit certain information and note disclosures that would be necessary to present the statements in accordance with U.S. generally accepted accounting principles (“U.S. GAAP”). The interim condensed consolidated financial statements should be read in conjunction with the Company’s current year SEC filings, as well as the Company’s consolidated financial statements for the year ended December 31, 2022, which are included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2022 (the “2022 Form 10-K”), filed with the SEC on March 16, 2023. The results of operations for the three months ended March 31, 2023 in this Quarterly Report on Form 10-Q are not necessarily indicative of the results to be expected for the full year. The condensed consolidated balance sheet as of December 31, 2022 was prepared using information from the audited consolidated balance sheet contained in the 2022 Form 10-K; however, it does not include all disclosures required by U.S. GAAP for annual consolidated financial statements.

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 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. 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 labeling. The Company has determined as of March 31, 2023 that it had no material contract assets, and concluded that its contract liabilities (primarily rebates) had the right of offset against customer receivables. 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.

The Company previously granted stock options to employees and non-employee directors under a stock option plan (the “2004 Option Plan”). Stock options have been granted with exercise prices at or above the fair market value of the underlying shares of common stock on the date of grant. Options vest and expire according to terms established at the grant date. The 2004 Option Plan provides for a total of 5,000,000 common shares eligible for issuance. Under the 2004 Option Plan, approximately 5,009,750 options (taking into account cancelled and expired options that were added back to the plan reserve) had been granted as of December 31, 2020. Due to the cancelation and expiration of options, the 2004 Plan had 1,305,251 options available to grant at the time the 2004 Plan was replaced in 2020.

At the Company’s 2020 Annual Meeting of Shareholders, the Company’s shareholders approved the Alpha Pro Tech, Ltd. 2020 Omnibus Incentive Plan (the “2020 Incentive Plan”). The 2020 Incentive Plan provides for the grant of incentive and nonqualified stock options, stock appreciation rights, awards of restricted stock and restricted stock units, performance share awards, cash awards and other equity-based awards to employees (including officers), consultants and non-employee directors of the Company and its affiliates. A total of 1,800,000 shares of the Company’s common stock are reserved for issuance under the 2020 Incentive Plan, plus the number of shares underlying any award granted under the 2004 Option Plan that expires, terminates or is cancelled or forfeited under the terms of the 2004 Option Plan. As a result of the approval of the 2020 Incentive Plan, no future equity awards will be made pursuant to the 2004 Option Plan. Although no new awards may be granted under the 2004 Option Plan, all previously granted awards under the 2004 Option Plan will continue to be governed by the terms of the 2004 Option Plan.

The Company records compensation expense for the fair value of stock-based awards determined as of the grant date, including employee stock options and restricted stock awards, over the determined requisite service period, which is generally ratably over the vesting term.

For the three months ended March 31, 2023 and 2022, no stock options were granted under the 2004 Option Plan or the 2020 Incentive Plan. The Company recognized $3,000 and $28,000 in stock-based compensation expense for the three months ended March 31, 2023 and 2022, respectively, related to outstanding options previously granted under the 2004 Option Plan. For the three months ended March 31, 2023 and 2022, no restricted stock awards were granted under the 2020 Incentive Plan. The Company recognized $18,000 and $27,000 in compensation expense associated with outstanding restricted stock awards for the three months ended March 31, 2023 and 2022, respectively. As of March 31, 2023, $44,000 of total unrecognized compensation cost related to outstanding restricted stock awards was expected to be recognized over a weighted-average remainder period of 0.63 years.

The Company uses the Black-Scholes option-pricing model to value the options. The Company uses historical data to estimate the expected life of the options. The risk-free interest rate for periods within the contractual life of an award is based on the US Treasury yield curve in effect at the time of grant. The estimated volatility is based on historical volatility and management’s expectations of future volatility. The Company uses an estimated dividend payout of zero, as the Company has not paid dividends in the past and, at this time, does not expect to do so in the future. The Company accounts for option forfeitures as they occur. The following table summarizes stock option activity for the three months ended March 31, 2023:

As of March 31, 2023, $33,000 of total unrecognized compensation cost related to stock options was expected to be recognized over a weighted average period of 4.48 years.

Management periodically reviews new accounting standards that are issued. Management has not identified any new standards that it believes merit further discussion at this time.

As of March 31, 2023 and December 31, 2022, inventories net of reserves consisted of the following:

In 2005, Alpha ProTech Engineered Products, Inc. (a subsidiary of Alpha Pro Tech, Ltd.) entered into a joint venture with a manufacturer in India, Maple Industries and associates, for the production of building products. Under the terms of the joint venture agreement, a private company, Harmony Plastics Private Limited (“Harmony”), was created with ownership interests of 41.66% owned by Alpha ProTech Engineered Products, Inc. and 58.34% owned by Maple Industries and associates.

This joint venture positions Alpha ProTech Engineered Products, Inc. to respond to current and expected increased product demand for housewrap and synthetic roof underlayment and provides future capacity for sales of specialty roofing component products and custom products for industrial applications requiring high quality extrusion coated fabrics. In addition, the joint venture now supplies products for the Company’s Disposable Protective Apparel segment.

The capital from the initial funding and a bank loan, which is guaranteed exclusively by the individual shareholders of Maple Industries and associates and collateralized by the assets of Harmony, were utilized to purchase the original manufacturing facility in India. Harmony currently has four facilities in India (three owned and one rented), consisting of: (1) a 139,000 square foot building for manufacturing building products; (2) a 121,000 square foot building for manufacturing coated material and sewing proprietary disposable protective apparel; (3) a 23,000 square foot facility for sewing proprietary disposable protective apparel; and (4) a 159,000 square foot facility (rented) for manufacturing Building Supply segment products. All additions have been financed by Harmony with no guarantees from the Company.

In accordance with ASC 810, Consolidation, the Company assesses whether or not related entities are variable interest entities (“VIEs”). For those related entities that qualify as VIEs, ASC 810 requires the Company to determine whether the Company is the primary beneficiary of the VIE, and, if so, to consolidate the VIE. The Company has determined that Harmony is not a VIE and is, therefore, considered to be an unconsolidated affiliate.

The Company records its investment in Harmony as “equity investment in unconsolidated affiliate” in the accompanying consolidated balance sheets. The Company records its equity interest in Harmony’s results of operations as “equity in income of unconsolidated affiliate” in the accompanying consolidated statements of income. The Company periodically reviews its investment in Harmony for impairment. Management has determined that no impairment was required as of March 31, 2023, or December 31, 2022. Under the equity method, since the Company’s reporting currency is different from of Harmony’s reporting currency, the Company is required to translate our proportionate share of equity for effects of translations in foreign currency and adjust the investment accordingly and accrue the adjustment as a component of Accumulated other comprehensive loss (“AOCL”).

For the three months ended March 31, 2023 and 2022, the Company purchased $5,036,000 and $6,183,000 of inventories, respectively, from Harmony. For the three months ended March 31, 2023 and 2022, the Company sold $0 and $258,000 of inventories, respectively, to Harmony. For the three months ended March 31, 2023 and 2022, the Company recorded equity in income of unconsolidated affiliate of $109,000 and $49,000, respectively, related to Harmony.

As of March 31, 2023, the Company’s investment in Harmony was $4,964,000, which consisted of its original $1,450,000 investment and cumulative equity in income of unconsolidated affiliate of $5,885,000, less $942,000 in repayments of an advance $77,000 in payments of dividends and $1,352,000 in AOCL on foreign currency translations.

As of March 31, 2023 and December 31, 2022, accrued liabilities consisted of the following:

The following table provides a reconciliation of both net income and the number of shares used in the computation of “basic” earnings per common share (“EPS”), which utilizes the weighted average number of common shares outstanding without regard to dilutive shares, and “diluted” EPS, which includes all such dilutive shares, for the three months ended March 31, 2023 and 2022:

Accumulated other comprehensive loss (“AOCL”), a component of shareholders' equity, consists of foreign currency translation adjustments related to foreign currency gains or losses on our unconsolidated affiliate as its functional currency is other than the U.S. dollar. The resulting foreign currency translation gains or losses are deferred as AOCL and reclassified to earnings only upon sale or liquidation of that business. The accumulated other comprehensive loss on equity in unconsolidated affiliate was $1,352,000 and $1,489,000 as of March 31, 2023 and December 31, 2022, respectively.

The Company operates through two business segments:

(1) Building Supply: consisting of a line of construction supply weatherization products. The construction supply weatherization products consist of housewrap and housewrap accessories including window and door flashing and seam tape, and synthetic roof underlayment, as well as other woven material. The majority of the Company’s equity in income of unconsolidated affiliate (Harmony) is included in the total segment income for the Building Supply segment.

(2) Disposable Protective Apparel: consisting of a complete line of disposable protective garments, including shoecovers (including the Aqua Trak® and spunbond shoecovers), bouffant caps, coveralls, frocks, lab coats, gowns and hoods, as well as face masks and face shields for the pharmaceutical, cleanroom, industrial, medical and dental markets. A portion of the Company’s equity in income of unconsolidated affiliate (Harmony) is included in the total segment income for the Disposable Protective Apparel segment.

Segment data excludes charges allocated to the principal executive office and other unallocated corporate overhead expenses and income tax. The Company evaluates the performance of its segments and allocates resources to them based primarily on net sales.

The accounting policies of the segments are the same as those described previously under Summary of Significant Accounting Policies (see Note 2).

The following table presents consolidated net sales for each segment for the three months ended March 31, 2023 and 2022:

The following table presents the reconciliation of consolidated segment income to consolidated net income for the three months ended March 31, 2023 and 2022:

The following table presents the consolidated net property and equipment, goodwill and definite-lived intangible assets (“consolidated assets”) by segment as of March 31, 2023 and December 31, 2022:

The following table summarizes the Company’s net sales by geographic region for the three months ended March 31, 2023 and 2022:

Net sales by geographic region are based on the countries in which our customers are located. For the three months ended March 31, 2023 and 2022, the Company generated approximately $45,000 and $474,000, respectively, in sales from Canada. No country other than the United States was significant to the Company’s consolidated net sales.

The following table summarizes the locations of the Company’s long-lived assets by geographic region as of March 31, 2023 and December 31, 2022:

As of March 31, 2023, the Company had no related party transactions, other than the Company’s transactions with its unconsolidated affiliate, Harmony. See Note 6 of these Notes to Condensed Consolidated Financial Statements (Unaudited).

The Company has operating leases for the Company’s corporate office and manufacturing facilities, which expire at various dates through 2025. The Company’s primary operating lease commitments at March 31, 2023 related to the Company’s manufacturing facilities in Valdosta, Georgia; Nogales, Arizona; and Salt Lake City, Utah.

As of March 31, 2023, the Company had operating lease right-of-use assets of $1,488,000 and operating lease liabilities of $1,535,000. As of March 31, 2023, the Company did not have any finance leases recorded on the Company’s condensed consolidated balance sheet. Operating lease expense was approximately $322,000, during the three months ended March 31, 2023.

The aggregate future minimum lease payments and reconciliation to lease liabilities as of March 31, 2023 were as follows:

As of March 31, 2023, the weighted average remaining lease term of the Company’s operating leases was 1.9 years. During the three months ended March 31, 2023, the weighted average discount rate with respect to these leases was 4.07%.

The Company accounts for income taxes using the asset and liability method. A valuation allowance is recorded to reduce the carrying amounts of deferred income tax assets unless it is more likely than not that such assets will be realized. The Company’s policy is to record any interest and penalties assessed by the Internal Revenue Service as a component of the provision for income taxes. The Company provides allowances for uncertain income tax positions when it is more likely than not that the position will not be sustained upon examination by the tax authority.

Alpha Pro Tech, Ltd. and its subsidiaries file income tax returns in the U.S. federal jurisdiction, and in various state and foreign jurisdictions.

An employer generally does not claim a corporate income tax deduction (which would be in an amount equal to the amount of income recognized by the employee) upon the exercise of its employee's incentive stock options (“ISOs”) unless the employee does not meet the holding period requirements and sells early, making a disqualifying disposition, or if the options otherwise do not qualify as ISOs under applicable tax laws. With non-qualified stock options (“NQSOs”), on the other hand, the employer is typically eligible to claim a deduction upon its employee's exercise of the NQSOs.

On June 7, 2022, the Company filed a lawsuit (the “Lawsuit”) in Utah naming as defendants the vendors from which the Company ordered equipment for its facility in Utah (collectively the “Defendants”). The Lawsuit relates to certain equipment ordered from Defendants and paid for by the Company, which Defendants never delivered. In the Lawsuit the Company is seeking the following relief: compensatory damages in the amount $490,000, representing the money the Company paid for the machines it never received, lost profits in the form of mask sales it could have made if Defendants had delivered the machines on the promised date, and other monetary and equitable relief. As of March 31, 2023, the Company has written off the $490,000 balance of the deposit paid for the equipment, pending any recovery in the Lawsuit. As of the date hereof, no counterclaims have been asserted against the Company. The Company believes there would not be any meritorious claims against the Company in the Lawsuit. The Lawsuit has not been resolved and the final outcome, including the potential amount of any recovery for the Company’s claims, is uncertain. Any potential recovery represents a gain contingency in accordance with ASC 450, Contingencies, that has not been recorded as the matter was not resolved as of March 31, 2023. Any recovery will be recorded when received.

The Company is subject to various pending and threatened litigation actions in the ordinary course of business. Although it is not possible to determine with certainty at this point in time what liability, if any, the Company will have as a result of such litigation, based on consultation with legal counsel, management does not anticipate that the ultimate liability, if any, resulting from such litigation will have a material effect on the Company’s financial condition and results of operations.

The Company has reviewed and evaluated whether subsequent events have occurred from the condensed consolidated balance sheet date of March 31, 2023 through the filing date of this Quarterly Report on Form 10-Q that would require accounting or disclosure and has concluded that there are no such subsequent events.

ITEM 2.   MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

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, 2022, filed with the Securities and Exchange Commission (the “SEC”) on March 16, 2023 (the “2022 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, including, without limitation, our expected orders, production levels and sales in 2023 and 2024, 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:

The foregoing list of risks is not exclusive. For a more detailed discussion of the risk factors associated with our business, see the risks described in Part I, Item IA, “Risk Factors,” in the 2022 Form 10-K. 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, 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 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 3 – “Summary of Significant Accounting Policies” in the notes to our consolidated financial statements in Item 8 of the 2022 Form 10-K. Since December 31, 2022, there have been no material changes to our critical accounting policies and estimates as described in the 2022 Form 10-K.

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.

Our products are grouped into two business segments: (i) the Building Supply segment, consisting of construction weatherization products, such as housewrap and housewrap accessories and synthetic roof underlayment as well as other woven material; and (ii) 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.

Our target markets include pharmaceutical manufacturing, bio-pharmaceutical manufacturing and 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)

After the start of the COVID-19 pandemic in early 2020, we experienced a significant surge in customer demand for our proprietary N-95 Particulate Respirator face mask product and other personal protective equipment (“PPE”) products as a result of COVID-19. We experienced a dramatic increase in revenue from sales of PPE products during 2020 and to a lesser extent during 2021, especially with respect to face masks and disposable protective garments, including shoecovers, coveralls, gowns, lab coats and bouffant caps.

In an effort to meet the unprecedented demand, and to aid communities around the world in responding to the ongoing healthcare crisis, the Company ramped up production during the first quarter of 2020 of our PPE products, in particular our N-95 face mask, which is manufactured by the Company in the United States. We addressed the growing customer demand for PPE products by increasing and improving the human, mechanical, and supply chain components behind production, but even with these increases and improvements, customer demand for PPE products exceeded industry supply from time to time.

Since 2020, we have encountered a number of constraints within our supply chain due to government-mandated shutdowns, raw materials shortages and shipping delays. Although we continue to work to alleviate these supply chain issues by securing additional supply sources, in the event of subsequent shutdowns, shortages or delays, our production and sales could be further impacted. Further, we have experienced increases in the costs of raw materials, and if the prices of raw materials continue to rise more rapidly than our sales prices, our profits may be impacted negatively.

Global shortages in important components and logistics challenges have resulted in, and will continue to cause, inflationary cost pressure in the Company’s supply chain. To date, the inflationary cost pressure has been more pronounced in the Company’s logistics costs, but these supply chain challenges have had an impact on the Company’s results of operations and ability to deliver products and services to its customers. If shortages in important supply chain materials or logistics challenges continue, the Company could fail to meet product demand. Additionally, if inflationary pressures in logistics or component costs persist, we may not be able to quickly or easily adjust pricing, reduce costs, or implement countermeasures, all of which would adversely impact our business, financial condition, results of operations, or cash flows. In addition, the war in Ukraine has further increased existing global supply chain, logistics, and inflationary challenges.

COVID-19 and other factors have 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 have experienced cost increases from some of our suppliers. Additionally, we expect that demand for our Building Supply segment products could be negatively impacted as the overall market for housing starts has decreased and there is increased uncertainty in the housing market and the economy in general, although to date the negative impact on our Building Supply segment has been limited.

Overall, the increase in sales of our PPE products resulting from the pandemic had a positive impact on our 2021 and, to a lesser extent, 2022 financial results. The extent of the pandemic’s effect on our future operational and financial performance will depend in large part on future developments, including the duration, scope and severity of the pandemic and new variants, the actions taken to contain or mitigate its impact, the impact on governmental programs and budgets, the development of treatments or vaccines, and the efficacy of mass vaccinations, and the resumption of widespread economic activity in certain sectors. Due to the inherent uncertainty of the unprecedented evolving situation, we are unable to predict with any certainty 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:

Three months ended March 31, 2023 compared to three months ended March 31, 2022

Sales. Consolidated sales for the quarter ended March 31, 2023 decreased to $13,800,000, from $17,661,000 for the quarter ended March 31, 2022, representing a decrease of $3,861,000, or 21.9%. This decrease consisted of decreased sales in both the Building Supply segment of $1,606,000 and the Disposable Protective Apparel segment of $2,255,000.

Building Supply Segment

Building Supply segment sales for the quarter ended March 31, 2023 decreased by $1,606,000, or 15.7%, to $8,631,000, compared to $10,237,000 for the quarter ended March 31, 2022. The Building Supply segment decrease during the quarter ended March 31, 2023 was primarily due to a 6.9% decrease in sales of housewrap, a 28.7% decrease in sales of synthetic roof underlayment and a 5.6% decrease in sales of other woven material.

The sales mix of the Building Supply segment for the quarter ended March 31, 2023 was approximately 41% for synthetic roof underlayment, 45% for housewrap and 14% for other woven material. That is compared to approximately 48% for synthetic roof underlayment, 40% for housewrap and 12% for other woven material for the quarter ended March 31, 2022. Our synthetic roof underlayment product line primarily includes REX SynFelt®, REX TECHNOply® and TECHNO SB®, and our housewrap product line primarily consists of REX Wrap®, REX Wrap Plus® and REX™ Wrap Fortis. Housewrap accessories consist of REXTREME Window and Door Flashing and REX™ Premium Seam Tape.

The Building Supply segment showed some weakness in sales in the first quarter of 2023, due to a significant decrease in demand for new home starts as a result of interest rates hikes and economic uncertainty, as well as high levels of inventory on the dealer and distributor side. In the first quarter of 2023, single family housing starts were down 28.6% compared to the same period a year ago. Overall, sales of housewrap products and accessories were down only 6.9%, which is much better than the slowdown in housing starts. Sales of our REX Wrap® and REX Wrap Plus®, our entry level housewrap products, were down 13.0%, despite the major decrease in housing starts as we have continued to acquire new dealers across the country. Management is encouraged by our growth opportunities in REX™ Wrap Fortis, our premium housewrap line, as we continue to make inroads into the multi-family and commercial construction sector as evidenced by an increase of 21.6% in sales in the first quarter of 2023. This is also evident with a 65% increase in sales of housewrap accessories, REXTREME Window and Door Flashing and REX™ Premium Seam Tape, in the first quarter of 2023. Based on product information provided to a growing number of architects who could specify our products as well as the number of jobs we are specified on and the growth of additional bids taking place, Management expects that we will see positive trends relative to the industry for both our entry level and premium housewrap product lines.

Synthetic roof underlayment sales have been significantly affected by the factors mentioned above as well as a push in the market to reduce product selling prices. Synthetic roof underlayment sales were down 28.7% in the first quarter of 2023 compared to the first quarter of 2022, while our actual volume shipped has not been affected nearly as much due to price reductions. Management believes that as we move into the year, we should see a rebound in sales as inventory is alleviated at the dealer and distribution levels. In addition, we are preparing to launch our new line of self-adhered roofing products which we expect will bring additional revenue to our current synthetic roof underlayment line of products.

There is uncertainty in the economy in relation to interest rates and a possible recession and the continued slowdown in building that could impact the Building Supply segment, but we are encouraged regarding the future growth potential for this segment.

Disposable Protective Apparel Segment

Sales for the Disposable Protective Apparel segment for the quarter ended March 31, 2023 decreased by $2,255,000, or 30.4%, to $5,169,000, compared to $7,424,000 for the same period of 2022. This segment experienced an increase of 10.6% in sales of disposable protective garments, offset by a 75.2% decrease in sales of face masks and an 81.0% decrease in sales of face shields.

The sales mix of the Disposable Protective Apparel segment for the quarter ended March 31, 2023 was approximately 85% for disposable protective garments, 11% for face masks and 4% for face shields. This sales mix is compared to approximately 53% for disposable protective garments, 31% for face masks and 16% for face shields for the quarter ended March 31, 2022.

Sales of disposable protective garments in the first quarter of 2023 were up 10.6% as our channel partners and our end customers are working through their inventory and their ordering patterns return to normal. Face mask and face shield sales are still suffering from the COVID-19 residual excess inventories at the distributor level. Comparatively, sales of face masks and face shields were inordinately high during the first quarter of 2022 due to the ongoing demand for COVID-19 products.

During the three months ended March 31, 2023, our Disposable Protective Apparel sales and marketing team presented at numerous national trade shows and distributor meetings for the first time in three years. We are at a point where our team is now directly interacting with our channel partners and end-customers on a regular basis. We are also engaged in many product demonstrations and evaluations in the marketplace. To that end, we just signed an agreement with a larger channel partner and together, we expect to open new doors leading to organic growth.

Gross Profit. Gross profit decreased by $1,460,000, or 22.7%, to $4,982,000 for the quarter ended March 31, 2023, from $6,442,000 for the quarter ended March 31, 2022. The gross profit margin was 36.1% for the quarter ended March 31, 2023, compared to 36.5% for the quarter ended March 31, 2022.

The gross profit margin is being negatively affected by inventory purchased during last year, which incurred high ocean freight and other transportation costs. Ocean freight rates have come down significantly since the latter part of the fourth quarter but our lower cost inventory will start to be sold in the coming months. Management expects the gross profit margin to improve in 2023, although continuing inflationary pressures could affect such improvements.

Selling, General and Administrative Expenses. Selling, general and administrative expenses increased by $7,000, or 0.2%, to $4,313,000 for the quarter ended March 31, 2023, from $4,306,000 for the quarter ended March 31, 2022. As a percentage of net sales, selling, general and administrative expenses increased to 31.3% for the quarter ended March 31, 2023, from 24.4% for the same period of 2022, primarily as a result of lower net sales.

The change in expenses by segment for the quarter ended March 31, 2023 was as follows: Disposable Protective Apparel was up $22,000, or 1.8%; Building Supply was up $174,000, or 10.2%; and corporate unallocated expenses were down $189,000, or 13.9%. The increase in the Disposable Protective Apparel segment expenses was primarily related to marketing and sales travel expenses, partially offset by decreased employee compensation. The increase in the Building Supply segment expenses was related to increased employee compensation, insurance and travel expenses, partially offset by decreased commission expense. The decrease in corporate unallocated expenses was primarily due to decreased accrued bonuses, stock option and restricted stock expenses and foreign exchange expense.

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, up to a maximum of $1.0 million. A bonus amount of $37,000 was accrued for the quarter ended March 31, 2023, compared to $104,000 for the quarter ended March 31, 2022.

Depreciation and Amortization. Depreciation and amortization expense increased by $31,000, or 14.6%, to $243,000 for the quarter ended March 31, 2023, from $212,000 for the quarter ended March 31, 2022. The increase was primarily attributable to increased depreciation for machinery and equipment in the Building Supply segment.

Income from Operations. Income from operations decreased by $1,498,000, or 77.9%, to $426,000 for the quarter ended March 31, 2023, compared to $1,924,000 for the quarter ended March 31, 2022. The decreased income from operations was primarily due to a decrease in gross profit of $1,460,000, an increase in selling, general and administrative expenses of $7,000 and an increase in depreciation and amortization expense of $31,000. Income from operations as a percentage of net sales for the quarter ended March 31, 2023 was 3.1%, compared to 10.9% for the same period of 2022.

Other Income. Other income increased by $217,000, to $267,000 for the quarter ended March 31, 2023, from $50,000 for the same period of 2022. The increase was primarily due to an increase in equity in income of unconsolidated affiliate of $60,000 and an increase in interest income of $157,000.

Income before Provision for Income Taxes. Income before provision for income taxes for the quarter ended March 31, 2023 was $693,000, compared to income before provision for income taxes of $1,974,000 for the same period of 2022, representing a decrease of $1,281,000, or 64.9%. This decrease in income before provision for income taxes was due to a decrease in income from operations of $1,498,000, partially offset by an increase in other income of $217,000.

Provision for Income Taxes. The provision for income taxes for the quarter ended March 31, 2023 was $141,000, compared to $452,000 for the same period of 2022. The estimated effective tax rate was 20.3% for the quarter ended March 31, 2023, compared to 22.9% for the quarter ended March 31, 2022. The Company does not record a tax provision on equity in income of unconsolidated affiliate, which reduces the effective tax rate.

Net Income. Net income for the quarter ended March 31, 2023 was $552,000, compared to net income of $1,522,000 for the same period of 2022, representing a decrease of $970,000, or 63.7%. The net income decrease comparing the first quarter of 2023 and 2022 was due to a decrease in income from operations of $1,498,000 partially offset by an increase in other income of $217,000, resulting in a decrease in income before provision for income taxes of $1,281,000, partially offset by a decrease in provision for income taxes of $311,000. Net income as a percentage of net sales for the quarter ended March 31, 2023 was 4.0%, and net income as a percentage of net sales for the same period of 2022 was 8.6%. Basic earnings per common share for the quarter ended March 31, 2023 and 2022 were $0.05 and $0.12, respectively. Diluted earnings per common share for the quarter ended March 31, 2023 and 2022 were $0.05 and $0.12, respectively.

LIQUIDITY AND CAPITAL RESOURCES

As of March 31, 2023, the Company had cash and cash equivalents (“cash”) of $13,821,000 and working capital of $50,086,000. As of March 31, 2023, the Company’s current ratio (current assets/current liabilities) was 31:1, compared to a current ratio of 22:1 as of December 31, 2022. Cash decreased by 15.2%, or $2,469,000 to $13,821,000 as of March 31, 2023, compared to $16,290,000 as of December 31, 2022, and working capital decreased by $70,000 from $50,156,000 as of December 31, 2022. The decrease in cash from December 31, 2022, was due to cash used in operating activities of $1,697,000, cash used in investing activities of $289,000 and cash used in financing activities of $483,000.

Net cash used in operating activities of $1,697,000 for the three months ended March 31, 2023 was due to net income of $552,000, as adjusted primarily by the following: stock-based compensation expense of $22,000, depreciation and amortization expense of $243,000, equity in income of unconsolidated affiliate of $109,000, operating lease expense net of accretion of $237,000, an increase in accounts receivable of $3,024,000, a decrease in accounts receivable related party of $865,000, a decrease in prepaid expenses of $190,000, a decrease in inventory of $303,000, a decrease in accounts payable and accrued liabilities of $737,000, and a decrease in lease liabilities of $239,000, all compared to December 31, 2022.

Accounts receivable increased by $2,159,000, or 31.0%, to $9,132,000 as of March 31, 2023, from $6,973,000 as of December 31, 2022. The increase in accounts receivable was primarily related to increased payment terms to our major international channel partner and to higher sales in March 2023 compared to December 2022. The number of days that sales remained outstanding as of March 31, 2023, calculated by using an average of accounts receivable outstanding and annual revenue, was 40 days, compared to 35 days as of December 31, 2022.

Inventory decreased by $303,000, or 1.2%, to $24,094,000 as of March 31, 2023, from $24,397,000 as of December 31, 2022. The decrease was due to a decrease in inventory for the Disposable Protective Apparel segment of $181,000, or 1.3%, to $14,204,000 and a decrease in inventory for the Building Supply segment of $122,000, or 1.2%, to $9,890,000.

Prepaid expenses decreased by $190,000, or 3.9%, to $4,712,000 as of March 31, 2023, from $4,902,000 as of December 31, 2022. The decrease was primarily due to decreased prepaid inventory, partially offset by increased prepayments for insurance.

Right-of-use assets as of March 31, 2023, decreased by $237,000 to $1,488,000 from $1,725,000 as of December 31, 2022, as a result of amortization of the balance.

Lease liabilities as of March 31, 2023, decreased by $239,000 to $1,535,000 from $1,774,000 as of December 31, 2022. The decrease in the lease liabilities was the result of lease payments made during the year.

Accounts payable and accrued liabilities as of March 31, 2023 decreased by $737,000, or 48.9%, to $770,000, from $1,507,000 as of December 31, 2022. The decrease was primarily due to a decrease in accrued bonuses and payroll.

Net cash used in investing activities was $289,000 for the three months ended March 31, 2023, compared to net cash used in investing activities of $133,000 for the same period of 2022. Investing activities for the three months ended March 31, 2023 and 2022 consisted of the purchase of property and equipment.

Net cash used in financing activities was $483,000 for the three months ended March 31, 2023, compared to net cash used in financing activities of $756,000 for the same period of 2022. Net cash used in financing activities for the three months ended March 31, 2023 resulted from the payment of $833,000 for the repurchase of common stock partially offset by the proceeds of $350,000 from the exercise of stock options. Net cash used in financing activities for the three months ended March 31, 2022 resulted from the payment of $756,000 for the repurchase of common stocks.

As of March 31, 2023, we had $1,362,000 available for additional stock purchases under our stock repurchase program. During the three months ended March 31, 2023, we repurchased 200,000 shares of common stock at a cost of $833,000. As of March 31, 2023, we had repurchased a total of 19,660,617 shares of common stock at a cost of approximately $47,158,000 through our repurchase program which commenced in 1999. 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 expected cash flow from operations will be sufficient to satisfy our projected working capital and planned capital expenditures for the foreseeable future.

Recent Accounting Pronouncements

Management periodically reviews new accounting standards that are issued. Management has not identified any new standards that it believes merit further discussion at this time.

ITEM 3.  QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

As a smaller reporting company, we are not required to provide the information otherwise required by this Item.

ITEM 4.  CONTROLS AND PROCEDURES

Evaluation of Disclosure Controls and Procedures.

Under the supervision and with the participation of our management, including our President and Chief Executive Officer (principal executive officer) and our Chief Financial Officer (principal financial officer), we evaluated the effectiveness of the design and operation of our disclosure controls and procedures (as such term is defined in Rule 13a-15(e) and Rule 15d-15(e) under the Securities Exchange Act of 1934 (the “Exchange Act”)) as of March 31, 2023, pursuant to the evaluation of these controls and procedures required by Rule 13a-15 of the Exchange Act. Disclosure controls and procedures are the controls and other procedures that we have designed to ensure that we record, process, summarize and report in a timely manner the information that we must disclose in reports that we file with or submit to the SEC under the Exchange Act, and such controls include, without limitation, controls and procedures designed to ensure that information required to be disclosed is accumulated and communicated to our management, including our Chief Executive Officer and Chief Financial Officer, as appropriate to allow for timely decisions regarding required disclosure.

In designing and evaluating our disclosure controls and procedures, we recognize that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving the desired control objectives and that we are required to apply our judgment in evaluating the cost-benefit relationship of possible controls and procedures.

Based on the evaluation, our principal executive officer and principal financial officer concluded that our disclosure controls and procedures were effective at the reasonable assurance level as of the end of the period covered by this report.

Changes in Internal Control Over Financial Reporting

During the quarter to which this report relates, there was no change in our internal control over financial reporting (as such term is defined in Rule 13a-15(f) and Rule 15d-15(f) under the Exchange Act) that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

PART II.  OTHER INFORMATION

ITEM 1.  LEGAL PROCEEDINGS

On June 7, 2022, the Company filed a lawsuit (the “Lawsuit”) in Utah naming as defendants the vendors from which the Company ordered equipment for its facility in Utah (collectively the “Defendants”). The Lawsuit relates to certain equipment ordered from Defendants and paid for by the Company, which Defendants never delivered. In the Lawsuit the Company is seeking the following relief: compensatory damages in the amount $490,000, representing the money the Company paid for the machines it never received, lost profits in the form of mask sales it could have made if Defendants had delivered the machines on the promised date, and other monetary and equitable relief. As of March 31, 2023, the Company has written off the $490,000 balance of the deposit paid for the equipment, pending any recovery in the Lawsuit. As of the date hereof, no counterclaims have been asserted against the Company. The Company believes there would not be any meritorious claims against the Company in the Lawsuit. The Lawsuit remains unresolved and the final outcome, including the potential amount of any recovery for the Company’s claims, is uncertain. Any potential recovery represents a gain contingency in accordance with ASC 450, Contingencies, that has not been recorded as the matter was not resolved as of March 31, 2023. Any recovery will be recorded when received. 

The Company is subject to various pending and threatened litigation actions in the ordinary course of business. Although it is not possible to determine with certainty at this point in time what liability, if any, the Company will have as a result of such litigation, based on consultation with legal counsel, management does not anticipate that the ultimate liability, if any, resulting from such litigation will have a material effect on the Company’s financial condition and results of operations.

ITEM 1A.  RISK FACTORS

A list of factors that could materially affect our business, financial condition or operating results is described in Part I, Item 1A, “Risk Factors” in the 2022 Form 10-K. There have been no material changes to our risk factors from those disclosed in Part I, Item 1A, “Risk Factors” in the 2022 Form 10-K.

ITEM 2.  UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS

ISSUER PURCHASES OF EQUITY SECURITIES

The following table sets forth purchases made by or on behalf of the Company or any “affiliated purchaser,” as defined in Rule 10b-18(a)(3) of the Exchange Act:

(1) On December 15, 2022, the Company announced that the Board of Directors had authorized a $2,000,000 expansion of the Company’s existing share repurchase program. All of the shares included in this table were purchased pursuant to this program. Since the inception of the share repurchase program in 1999, the Company has authorized the repurchase of $48,520,000 of common stock, of which $1,362,000 was available for repurchase as of March 31, 2023. The share repurchase plan expires on December 15, 2024.

UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS

We did not sell any unregistered equity securities during the periods covered by this Quarterly Report on Form 10-Q.

ITEM 6.  EXHIBITS

SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.