ALPHA PRO TECH LTD annual report, FY2019

Alpha Pro Tech, Ltd. — FY2019 Form 10-K

Reporting period: Fiscal year ended December 31, 2019; comparisons are with FY2018. The filing is an annual report, not a standalone fourth-quarter report. Alpha Pro Tech develops and sells building weatherization products and disposable protective apparel, including face masks and shields. In 2019, it combined its former Infection Control segment with Disposable Protective Apparel; prior-year segment figures are presented on the current basis.

Financial performance

Metric	FY2019	FY2018	Change
Net sales	$46.665 million	$46.624 million	Up $41,000, or 0.1%
Gross profit / margin	$16.972 million / 36.4%	$17.711 million / 38.0%	Profit down 4.2%; margin down 1.6 percentage points
Operating income / margin	$3.022 million / 6.5%	$3.874 million / 8.3%	Down 22.0%
Income before taxes	$3.680 million	$4.414 million	Down 16.6%
Net income / margin	$3.000 million / 6.4%	$3.625 million / 7.8%	Down 17.2%
Basic and diluted EPS	$0.23	$0.26	Down $0.03

• Segment sales: Building Supply rose 2.1% to $26.576 million; Disposable Protective Apparel fell 2.4% to $20.089 million. U.S. sales were $45.748 million; international sales were $917,000.
• Cash flow: Operating activities provided $3.101 million, compared with $2.000 million in 2018. Investing used $1.142 million, including $1.296 million of capital spending; financing used $2.418 million, primarily for share repurchases.
• Liquidity and balance sheet: Year-end cash was $6.548 million, working capital $24.660 million, and the current ratio 12:1. Total assets were $38.091 million and total liabilities $4.864 million. The balance sheet includes $3.219 million of operating lease liabilities recognized following adoption of ASC 842.
• Debt: No borrowings or other debt were outstanding at year-end. The company had a $3.5 million asset-based credit facility expiring May 2020, with no year-end usage; management said available cash and the facility should meet foreseeable working-capital and planned capital needs.
• Share repurchases: The company repurchased 683,910 shares for $2.548 million in 2019 and had $2.152 million available under the program at year-end. It has never paid a dividend and said it had no foreseeable plans to do so.

Changes and management commentary

• Building Supply growth was led by synthetic roof underlayment, up 11.5%, including 36.3% growth in the TECHNO product family. Other woven material sales fell 24.3%, primarily because a large customer had excess inventory and slower end-customer orders.
• Disposable Protective Apparel sales declined due to slightly lower garment sales, weaker face-mask demand during a less severe flu season, and a nonrecurring face-shield sale in 2018.
• Gross margin was pressured by the end of U.S. Generalized System of Preferences tariff-free treatment for certain products, a shift toward lower-margin economy products, introductory pricing for TECHNO SB 25, and increased rebates. The company raised TECHNO SB pricing late in 2019.
• Other income rose to $658,000, including a $231,000 gain on marketable securities and $359,000 of equity income from Harmony Plastics, the company’s 41.66%-owned Indian joint venture. Equity income declined from $587,000 in 2018.
• Operating cash flow benefited from lower receivables and prepaid expenses, partly offset by a $1.425 million inventory increase. Building Supply inventory rose 32.4% to $5.695 million.

Outlook, risks and unusual items

• Management expected FY2020 gross margin in the mid-to-high 30% range, excluding any improvement from increased N-95 respirator sales. It expected continued growth from the TECHNO family and anticipated other woven material sales to the affected large customer would return to prior levels in 2020.
• After year-end, the company reported a significant surge in N-95 respirator demand related to the novel coronavirus outbreak, with expected revenue increases in the first quarter and potentially through 2020. The filing cautions that the duration and effects were uncertain; supply-chain disruptions, including restrictions affecting China, could impair product availability. The outbreak also contributed to volatility in the company’s share price.
• Other principal risks include dependence on major customers and a limited number of overseas suppliers and contractors, international manufacturing and joint-venture risks, tariffs and trade barriers, intense competition, customer order variability, product acceptance, intellectual-property protection, cybersecurity incidents, and possible litigation liabilities. Two customers each represented 20% of 2019 sales; one represented 18% of year-end receivables.
• ASC 842 adoption increased reported assets and liabilities by approximately $3.455 million at transition. The company reported pending and threatened ordinary-course litigation but did not expect it to have a material effect. It also held marketable securities in one publicly traded entity and was exposed to that investment’s share-price movements.
• Management concluded disclosure controls and internal control over financial reporting were effective at year-end. The independent auditor gave an unqualified opinion on the financial statements; no auditor attestation on internal control was required or provided.

Investor verification priorities

1. Track whether the post-year-end N-95 demand translated into sustained sales, margins and cash generation, and whether production and supply capacity kept pace.
2. Confirm renewal or replacement of the credit facility that expired in May 2020 and review subsequent liquidity and capital-allocation decisions.
3. Monitor gross-margin recovery, tariff costs, TECHNO pricing and mix, rebates, and the expected rebound in other woven material orders.
4. Assess inventory growth and concentration in Harmony and other suppliers, including the effects of any supply disruption or change in customer demand.
5. Review the large-customer concentrations, Harmony’s results and related-party purchases, and the valuation volatility of the marketable-securities investment.