ALPHA PRO TECH LTD - Quarter Report: 2023 September (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)

For the Nine Months Ended September 30, 2023

For the Nine Months Ended September 30, 2022

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 and nine months ended September 30, 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 include 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 September 30, 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 provided 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.

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 nine months ended September 30, 2023 and 2022, 46,400 and 19,600 stock options were granted under the 2020 Incentive Plan, respectively. The Company recognized $10,000 and $39,000 in stock-based compensation expense for the nine months ended September 30, 2023 and 2022, respectively, related to outstanding options previously granted under the 2004 Option Plan. For the nine months ended September 30, 2023 and 2022, 227,600 and 13,600 restricted stock awards were granted under the 2020 Incentive Plan, respectively. The Company recognized $58,000 and $80,000 in compensation expense associated with outstanding restricted stock awards for the nine months ended September 30, 2023 and 2022, respectively. As of September 30, 2023, $966,000 of total unrecognized compensation cost related to outstanding restricted stock awards was expected to be recognized over a weighted-average remainder period of 2.86 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 nine months ended September 30, 2023:

As of September 30, 2023, $161,000 of total unrecognized compensation cost related to stock options was expected to be recognized over a weighted average period of 2.75 years.

In August 2020, the FASB issued ASU 2020-06 Debt --Debt with Conversion and Other Options (Subtopic 470 and Derivatives and Hedging --Contracts in Entity's Own Equity (Subtopic 815: Accounting for Convertible Instruments and Contracts in an Entity's Own Equity, which is intended to simplify the accounting for certain financial instruments with characteristics of liabilities and equity, including convertible instruments and contracts on an entity's own equity. The guidance allows for either full retrospective adoption or modified retrospective adoption. The guidance is effective for the Company January 1, 2024 and early adoption is permitted. The Company is evaluating the impact the adoption of this guidance will have on its condensed consolidated financial statements.

In June 2016, the FASB issued ASU 2016-13, Financial Instruments --Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments, which replaces the existing incurred loss impairment model with an expected credit loss model and requires a financial asset measured at amortized cost to be presented at the net amount expected to be collected. Public business entities classified as smaller reporting companies are required to apply the provision of ASU 2016-13 with annual reporting periods after December 15, 2022. The Company adopted Topic 326 effective January 1, 2023, which did not have a material impact on the Company’s 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.

As of September 30, 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 September 30, 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 September 30, 2023 and 2022, the Company purchased $5,001,000 and $7,786,000 of inventories, respectively, from Harmony. For the nine months ended September 30, 2023 and 2022, the Company purchased $14,871,000 and $19,645,000 of inventories, respectively, from Harmony. The Company sold $66,000 of inventories to Harmony for each of the three months ended September 30, 2023 and 2022. For the nine months ended September 30, 2023 and 2022, the Company sold $266,000 and $280,000 of inventories, respectively, to Harmony.

For the three months ended September 30, 2023 and 2022, the Company recorded equity in income of unconsolidated affiliate of $180,000 and loss in income from unconsolidated affiliate of $13,000, respectively, related to Harmony. For the nine months ended September 30, 2023 and 2022, the Company recorded equity in income of unconsolidated affiliate of $392,000 and $87,000, respectively, related to Harmony.

As of September 30, 2023, the Company’s investment in Harmony was $5,116,000, which consisted of its original $1,450,000 investment and cumulative equity in income of unconsolidated affiliate of $6,168,000, less $942,000 in repayments of an advance, $77,000 in payments of dividends, and $1,483,000 in AOCL on foreign currency translations.

As of September 30, 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 and nine months ended September 30, 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 $1,483,000 and $1,489,000 as of September 30, 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 and nine months ended September 30, 2023 and 2022:

The following table presents the reconciliation of consolidated segment income to consolidated net income for the three and nine months ended September 30, 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 September 30, 2023 and December 31, 2022:

The following table summarizes the Company’s net sales by geographic region for the three and nine months ended September 30, 2023 and 2022:

Net sales by geographic region are based on the countries in which our customers are located. For the three months ended September 30, 2023 and 2022, the Company generated approximately $42,000 and $103,000, respectively, in sales from Canada. For the nine months ended September 30, 2023 and 2022, the Company generated approximately $140,000 and $1,119,000, 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 September 30, 2023 and December 31, 2022:

As of September 30, 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 2026. The Company’s primary operating lease commitments as of September 30, 2023 related to the Company’s corporate office in Aurora, Canada and its manufacturing facilities in Valdosta, Georgia; Nogales, Arizona; and Salt Lake City, Utah.

As of September 30, 2023, the Company had operating lease right-of-use assets of $1,210,000 and operating lease liabilities of $1,251,000. As of September 30, 2023, the Company did not have any finance leases recorded on the Company’s condensed consolidated balance sheet. Operating lease expense was approximately $922,000 during the nine months ended September 30, 2023.

The aggregate future minimum lease payments and reconciliation to lease liabilities as of September 30, 2023 were as follows:

As of September 30, 2023, the weighted average remaining lease term of the Company’s operating leases was 2.2 years. During the nine months ended September 30, 2023, the weighted average discount rate with respect to these leases was 4.55%.

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 September 30, 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 related to 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 September 30, 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 September 30, 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.

RESULTS OF OPERATIONS

The following table sets forth certain operational data as a percentage of net sales for the periods indicated:

Three and Nine months ended September 30, 2023 compared to Three and Nine months ended September 30, 2022

Sales.

Consolidated sales for the quarter ended September 30, 2023 increased to $16,053,000, from $14,722,000 for the quarter ended September 30, 2022, representing an increase of $1,331,000, or 9.0%. This increase consisted of increased sales in the Building Supply segment of $1,845,000, partially offset by decreased sales in the Disposable Protective Apparel segment of $514,000.

Building Supply segment sales for the quarter ended September 30, 2023 increased by $1,845,000, or 19.2%, to a record sales quarter of $11,449,000, compared to $9,604,000 for the quarter ended September 30, 2022. The 19.2% increase is comprised of a 25.7% increase in housewrap sales and a 164.5% increase in other woven material sales, partially offset by a 4.5% decrease in synthetic roof underlayment sales. The sales mix of the Building Supply segment for the quarter ended September 30, 2023 was approximately 43% for synthetic roof underlayment, 43% for housewrap and 14% for other woven material. That is compared to approximately 53% for synthetic roof underlayment, 41% for housewrap and 6% for other woven material for the quarter ended September 30, 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 housewrap market continues to be soft, as housing starts in the third quarter of 2023 in the United States decreased by 6.0% compared to the same period a year ago. Our sales of housewrap and accessories, which increased by 25.7% in the third quarter of 2023 over the prior-year quarter, continue to significantly outperform the market through market diversification, product development and sales team expansion. Sales of our REX Wrap® and REX Wrap Plus®, our entry-level housewrap products, were up 16.9% over the prior-year quarter, despite the major decrease in housing starts, as we have continued to form relationships with additional dealers across the country. Management is encouraged by our growth opportunities with REX™ Wrap Fortis, our premium housewrap line, as we continue to make inroads into the multi-family and commercial construction sector, evidenced by an increase of 24.8% in sales for this product in the third quarter of 2023. We also experienced a 256% increase in sales of housewrap accessories, REXTREME Window and Door Flashing and REX™ Premium Seam Tape, in the third quarter of 2023 over the prior-year quarter. Management expects that we will continue to see positive trends relative to the industry for both our entry level and premium housewrap and housewrap accessories product lines.

The synthetic roof underlayment market has also been significantly affected by the continued decrease in new home starts, economic uncertainty, and a push in the market to reduce product selling prices. Despite these pressures, synthetic roof underlayment sales also outperformed the market despite being down 4.5% in the third quarter of 2023 compared to the third quarter of 2022. Management is encouraged by the trend in synthetic roof underlayment of it outperforming the market, especially as we should see an increase in sales as excess inventory is alleviated at the dealer and distribution level. Management is excited about our launch of a new line of self-adhered roofing products in late 2023 or early 2024, which should result in revenue growth within our current customer base and allow for expansion into new markets and business segments. We continue to work closely with our customers to develop new products that increase safety and productivity.

Other woven material sales increased in the third quarter of 2023 compared to the same period of 2022 by 164.5%, primarily due to increased sales to our major customer. We do not expect other woven material to be a growth driver in the remainder of 2023, as these products only represent approximately 12% of the Building Supply segment sales.

Management expects additional growth in the building supply segment. While housing starts may be trending down nationally, we have continually grown market share. We will build on our success within the multi-family and commercial segment and the single-family segment.

Disposable Protective Apparel segment sales for the quarter ended September 30, 2023 decreased by $514,000, or 10.0%, to $4,604,000, compared to $5,118,000 for the same period of 2022. This segment experienced an increase of 5.1% in sales of disposable protective garments, offset by a 60.6% decrease in sales of face masks and a 73.8% decrease in sales of face shields.

The sales mix of the Disposable Protective Apparel segment for the quarter ended September 30, 2023 was approximately 91% for disposable protective garments, 7% for face masks and 2% for face shields. This sales mix is compared to approximately 78% for disposable protective garments, 15% for face masks and 7% for face shields for the quarter ended September 30, 2022.

Sales of disposable protective garments in the third quarter of 2023 were up 5.1% as our channel partners and our end customers are continuing to work through their inventory. In addition, our sales have been positively affected as we can now meet face-to-face with our distribution partners and end-customers, something we have not been able to do since 2020. Face mask and face shield sales are still suffering from the COVID-19 residual excess inventories at the distributor level.

Consolidated sales for the nine months ended September 30, 2023 decreased to $45,967,000 from $49,756,000 for the nine months ended September 30, 2022, representing a decrease of $3,789,000, or 7.6%. This decrease consisted of decreased sales in the Building Supply segment of $41,000 and decreased sales in the Disposable Protective Apparel Segment of $3,748,000.

Building Supply segment sales for the nine months ended September 30, 2023 decreased by $41,000, or 0.1%, to $30,616,000, compared to $30,657,000 for the same period of 2022. Sales of housewrap increased by 12.2%, sales of other woven material increased by 1.4% and sales of synthetic roof underlayment decreased by 11.2% compared to the same period of 2022. Management is encouraged by the 12.2% increase in housewrap sales, especially since housing starts are down 12.6% year to date.

The sales mix of the Building Supply segment for the nine months ended September 30, 2023 was 42% for synthetic roof underlayment, 46% for housewrap and 12% for other woven material. This compared to 47% for synthetic roof underlayment, 41% for housewrap and 12% for other woven material for the nine months ended September 30, 2022.

Disposable Protective Apparel segment sales for the nine months ended September 30, 2023 decreased by $3,748,000, or 19.6%, to $15,351,000, compared to $19,099,000 for the same period of 2022. This segment decrease was due to a 71.5% decrease in sales of face masks, and an 81.2% decrease in sales of face shields, partially offset by a 7.7% increase in sales of disposable protective garments.

Sales of disposable protective garments for the nine months ended September 30, 2023 were up 7.7%, for the reasons as discussed above in the three months ended September 30, 2023 section. Face mask and face shield sales continue to be affected by excess inventories at the distributor level and in the marketplace.

The sales mix of the Disposable Protective Apparel segment for the nine months ended September 30, 2023 was 90% for disposable protective garments, 7% for face masks and 3% for face shields. This sales mix is compared to 67% for disposable protective garments, 21% for face masks and 12% for face shields for the nine months ended September 30, 2022.

Gross Profit. Gross profit increased by $1,217,000, or 25.3%, to $6,035,000 for the quarter ended September 30, 2023, from $4,818,000 for the quarter ended September 30, 2022. The gross profit margin was 37.6% for the quarter ended September 30, 2023, compared to 32.7% for the quarter ended September 30, 2022.

Gross profit increased by $251,000, or 1.5%, to $17,123,000 for the nine months ended September 30, 2023, from $16,872,000 for the same period of 2022. The gross profit margin was 37.3% for the nine months ended September 30, 2023, compared to 33.9% for the same period of 2022.

The gross profit margin in 2023 has been positively affected by ocean freight rates which have come down since the latter part of 2022. Management expects the gross profit margin to be in a similar range throughout the balance of 2023, although the sales mix could affect gross margin.

Selling, General and Administrative Expenses. Selling, general and administrative expenses increased by $417,000, or 10.5%, to $4,387,000 for the quarter ended September 30, 2023, from $3,970,000 for the quarter ended September 30, 2022. As a percentage of net sales, selling, general and administrative expenses increased to 27.3% for the quarter ended September 30, 2023, from 27.0% for the same period of 2022.

The change in expenses by segment for the quarter ended September 30, 2023 was as follows: Disposable Protective Apparel expenses were down $24,000, or 2.1%; Building Supply expenses were up $324,000, or 20.1%; and corporate unallocated expenses were up $117,000, or 9.6%. The decrease in the Disposable Protective Apparel segment expenses was primarily related to decreased employee compensation. The increase in the Building Supply segment expenses was primarily related to increased employee compensation, insurance, travel expenses, commission and general factory expenses, partially offset by general office expenses. The increase in corporate unallocated expenses was primarily due to employee compensation.

Selling, general and administrative expenses increased by $934,000, or 7.6%, to $13,275,000 for the nine months ended September 30, 2023, from $12,341,000 for the nine months ended September 30, 2022. As a percentage of net sales, selling, general and administrative expenses increased to 28.9% for the nine months ended September 30, 2023, up from 24.8% for the same period of 2022.

The change in expenses by segment for the nine months ended September 30, 2023 was as follows: Disposable Protective Apparel expenses were down $80,000, or 2.2%; Building Supply expenses were up $909,000, or 18.6%; and corporate unallocated expenses were up $105,000, or 2.8%. The decrease in the Disposable Protective Apparel segment expenses was primarily related to decreased employee compensation, partially offset by increased marketing expenses. The increase in the Building Supply segment expenses was related to increased employee compensation, marketing, travel, insurance and general factory expenses, partially offset by decreased commission and general office expenses. The increase in corporate unallocated expenses was primarily due to increased professional fees and general office expenses, partially offset by decreased insurance expenses.

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 $96,000 was accrued for the three months ended September 30, 2023, compared to $36,000 for the three months ended September 30, 2022. A total of $216,000 has been accrued for the nine months ended September 30, 2023, compared to $186,000 for the same period of 2022.

Depreciation and Amortization. Depreciation and amortization expense increased by $24,000, or 11.9%, to $225,000 for the quarter ended September 30, 2023, from $201,000 for the quarter ended September 30, 2022. Depreciation and amortization expense increased by $46,000, or 7.2%, to $687,000 for the nine months ended September 30, 2023, from $641,000 for the same period of 2022. 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 $776,000, or 119.9%, to $1,423,000 for the quarter ended September 30, 2023, compared to $647,000 for the quarter ended September 30, 2022. The increased income from operations was primarily due to an increase in gross profit of $1,217,000, partially offset by an increase in selling, general and administrative expenses of $417,000 and an increase in depreciation and amortization expense of $24,000. Income from operations as a percentage of net sales for the quarter ended September 30, 2023 was 8.9%, compared to 4.4% for the same period of 2022.

Income from operations decreased by $729,000, or 18.7%, to $3,161,000 for the nine months ended September 30, 2023, compared to $3,890,000 for the same period of 2022. The decreased income from operations was primarily due to an increase in selling, general and administrative expenses of $934,000 and an increase in depreciation and amortization expense of $46,000, partially offset by an increase in gross profit of $251,000. Income from operations as a percentage of net sales for the nine months ended September 30, 2023 was 6.9%, compared to 7.8% for the same period of 2022.

Other Income. Other income increased by $387,000, to $402,000 for the quarter ended September 30, 2023, compared to $15,000 for the same period of 2022. The increase was primarily due to an increase in equity in income of unconsolidated affiliate of $193,000 and an increase in interest income of $194,000.

Other income increased by $1,305,000, to $941,000 for the nine months ended September 30, 2023, from a loss of $364,000 for the same period of 2022. The increase was primarily due to an increase in equity in income of unconsolidated affiliate of $305,000 and an increase in interest income of $510,000. In addition, there was a loss on fixed assets of $490,000 in 2022 due to equipment for the Disposable Protective Apparel segment that was not delivered. The Company has filed a lawsuit in this matter (see Part II, Item 1, “Legal Proceedings,” for more information).

Income before Provision for Income Taxes. Income before provision for income taxes for the quarter ended September 30, 2023 was $1,825,000, compared to income before provision for income taxes of $662,000 for the same period of 2022, representing an increase of $1,163,000, or 175.7%. This increase in income before provision for income taxes was due to an increase in income from operations of $776,000 and an increase in other income of $387,000.

Income before provision for income taxes for the nine months ended September 30, 2023 was $4,102,000, compared to income before provision for income taxes of $3,526,000 for the same period of 2022, representing an increase of $576,000, or 16.3%. This increase in income before provision for income taxes was due to an increase in other income of $1,305,000, partially offset by a decrease in income from operations of $729,000.

Provision for Income Taxes. The provision for income taxes for the quarter ended September 30, 2023 was $395,000, compared to $159,000 for the same period of 2022. The estimated effective tax rate was 21.6% for the quarter ended September 30, 2023, compared to 24.0% for the quarter ended September 30, 2022. The Company does not record a tax provision on equity in income of unconsolidated affiliate, which reduces the effective tax rate.

The provision for income taxes for the nine months ended September 30, 2023 was $974,000, compared to $808,000 for the same period of 2022. The estimated effective tax rate was 23.7% for the nine months ended September 30, 2023, compared to 22.9% for the nine months ended September 30, 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 September 30, 2023 was $1,430,000, compared to net income of $503,000 for the same period of 2022, representing an increase of $927,000, or 184.3%. The net income increase between the third quarters of 2023 and 2022 was due to an increase in income before provision for income taxes of $1,163,000, partially offset by an increase in provision for income taxes of $236,000. Net income as a percentage of net sales for the quarter ended September 30, 2023 was 8.9%, and net income as a percentage of net sales for the same period of 2022 was 3.4%. Basic and diluted earnings per common share for the quarter ended September 30, 2023 and 2022 were $0.12 and $0.04, respectively.

Net income for the nine months ended September 30, 2023 was $3,128,000, compared to net income of $2,718,000 for the same period of 2022, representing an increase of $410,000, or 15.1%. The net income increase between the 2023 and 2022 periods was due to an increase in income before provision for income taxes of $576,000, partially offset by an increase in provision for income taxes of $166,000. Net income as a percentage of net sales for the nine months ended September 30, 2023 was 6.8%, and net income as a percentage of net sales for the same period of 2022 was 5.5%. Basic and diluted earnings per common share for the nine months ended September 30, 2023 and 2022 were $0.26 and $0.21, respectively.

LIQUIDITY AND CAPITAL RESOURCES

As of September 30, 2023, the Company had cash and cash equivalents (“cash”) of $18,163,000 and working capital of $50,705,000. As of September 30, 2023, the Company’s current ratio (current assets/current liabilities) was 27:1, compared to a current ratio of 22:1 as of December 31, 2022. Cash increased by 11.5%, or $1,873,000 to $18,163,000 as of September 30, 2023, compared to $16,290,000 as of December 31, 2022, and working capital increased by $549,000 from $50,156,000 as of December 31, 2022. The increase in cash from December 31, 2022, was due to cash provided by operating activities of $4,929,000, partially offset by cash used in investing activities of $487,000 and cash used in financing activities of $2,569,000.

Net cash provided by operating activities of $4,929,000 for the nine months ended September 30, 2023 was due to net income of $3,128,000, as adjusted primarily by the following: stock-based compensation expense of $68,000, depreciation and amortization expense of $687,000, equity in income of unconsolidated affiliate of $392,000, operating lease expense net of accretion of $515,000, an increase in accounts receivable of $2,066,000, a decrease in accounts receivable related party of $599,000, an increase in prepaid expenses of $344,000, a decrease in inventory of $2,871,000, a decrease in accounts payable and accrued liabilities of $302,000, and a decrease in lease liabilities of $523,000, all compared to December 31, 2022.

Accounts receivable increased by $1,467,000, or 21.0%, to $8,440,000 as of September 30, 2023, from $6,973,000 as of December 31, 2022. The increase in accounts receivable was primarily related to higher sales in September 2023 compared to December 2022. The number of days that sales remained outstanding as of September 30, 2023, calculated by using an average of accounts receivable outstanding and annual revenue, was 44 days, compared to 35 days as of December 31, 2022.

Inventory decreased by $2,871,000, or 11.8%, to $21,526,000 as of September 30, 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 $516,000, or 3.6%, to $13,869,000 and a decrease in inventory for the Building Supply segment of $2,355,000, or 23.5%, to $7,657,000.

Prepaid expenses decreased by $344,000, or 7.0%, to $4,558,000 as of September 30, 2023, from $4,902,000 as of December 31, 2022. The decrease was primarily due to decreased prepaid inventory.

Right-of-use assets as of September 30, 2023, decreased by $515,000 to $1,210,000 from $1,725,000 as of December 31, 2022, as a result of amortization of the balance.

Lease liabilities as of September 30, 2023, decreased by $523,000 to $1,251,000 from $1,774,000 as of December 31, 2022. The decrease in lease liabilities was the result of lease payments made during the nine months ended September 30, 2023.

Accounts payable and accrued liabilities as of September 30, 2023, decreased by $302,000, or 20.0%, to $1,205,000, from $1,507,000 as of December 31, 2022. The decrease was primarily due to a decrease in trade payable.

Net cash used in investing activities was $487,000 for the nine months ended September 30, 2023, compared to net cash used in investing activities of $349,000 for the same period of 2022. Investing activities for the nine months ended September 30, 2023 and 2022 consisted of the purchase of property and equipment.

Net cash used in financing activities was $2,569,000 for the nine months ended September 30, 2023, compared to net cash used in financing activities of $2,772,000 for the same period of 2022. Net cash used in financing activities for the nine months ended September 30, 2023 resulted from the payment of $2,979,000 for the repurchase of common stock and $30,000 for treasury stock excise tax, partially offset by $440,000 in proceeds from the exercise of stock options. Net cash used in financing activities for the nine months ended September 30, 2022 resulted from the payment of $2,832,000 for the repurchase of common stock, partially offset by $60,000 in proceeds from the exercise of stock options.

As of September 30, 2023, we had $1,217,000 available for additional stock purchases under our stock repurchase program. During the nine months ended September 30, 2023, we repurchased 724,110 shares of common stock at a cost of $2,979,000. As of September 30, 2023, we had repurchased a total of 20,384,727 shares of common stock at a cost of approximately $49,337,000 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

In August 2020, the FASB issued ASU 2020-06 Debt --Debt with Conversion and Other Options (Subtopic 470 and Derivatives and Hedging --Contracts in Entity's Own Equity (Subtopic 815: Accounting for Convertible Instruments and Contracts in an Entity's Own Equity, which is intended to simplify the accounting for certain financial instruments with characteristics of liabilities and equity, including convertible instruments and contracts on an entity's own equity. The guidance allows for either full retrospective adoption or modified retrospective adoption. The guidance is effective for the Company January 1, 2024 and early adoption is permitted. The Company is evaluating the impact the adoption of this guidance will have on its condensed consolidated financial statements.

In June 2016, the FASB issued ASU 2016-13, Financial Instruments --Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments, which replaces the existing incurred loss impairment model with an expected credit loss model and requires a financial asset measured at amortized cost to be presented at the net amount expected to be collected. Public business entities classified as smaller reporting companies are required to apply the provision of ASU 2016-13 with annual reporting periods after December 15, 2022. The Company adopted Topic 326 effective January 1, 2023, which did not have a material impact on the Company’s 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.

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 September 30, 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 September 30, 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 related to 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 September 30, 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 June 22, 2023, the Company announced that the Board of Directors had authorized a $2,000,000 expansion of the Company’s existing share repurchase program. All 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 $50,520,000 of common stock, of which $1,217,000 was available for repurchase as of September 30, 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.