Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations.
You should read the following discussion and analysis together with our consolidated financial statements and the notes to our consolidated financial statements, which appear elsewhere in this report.
Special Note Regarding Forward-Looking Statements
Certain information set forth in this Annual Report on Form 10-K 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 relating to potential acquisitions 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 caution readers that these forward-looking statements speak only as of the date hereof. The Company hereby expressly disclaims any obligation or undertaking to release publicly any updates or revisions to any such statements to reflect any change in the Company’s expectations or any change in events, conditions or circumstances on which such statements are based. All forward-looking statements, whether written or oral and whether made by us or on our behalf, are expressly qualified by this special note.
Any expectations based on these forward-looking statements are subject to risks and uncertainties. These risks and other factors include, but are not limited to, those listed below and under “Risk Factors,” and elsewhere in this report. 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 Annual Report on Form 10-K as a “smaller reporting company” (as defined in Rule 12b-2 of the Securities Exchange Act of 1934, as amended) based on our public float (the aggregate market value of our common equity held by non-affiliates of the Company) as of the last business day of our second fiscal quarter of 2020. 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 and necessary to aid in an understanding of the current consolidated financial position, changes in financial position and results of operations of the Company.
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. Our estimates are subject to uncertainties associated with the ongoing COVID-19 pandemic. The application of these accounting policies on a consistent basis enables us to provide timely and reliable financial information. Our significant accounting policies and estimates are more fully described in Note 2 – “Summary of Significant Accounting Policies” in the notes to our consolidated financial statements in Item 8. Our critical accounting policies and estimates include the following:
Accounts Receivable: Accounts receivable are recorded at the invoice amount and do not bear interest. The general terms for receivables is net 30 days. The allowance for doubtful accounts is the Company’s best estimate of the amount of probable credit losses in the Company’s existing accounts receivable; however, changes in circumstances relating to accounts receivable may result in a requirement for additional allowances in the future. The Company determines the allowance based upon historical write-off experience and known conditions about customers’ current ability to pay. Account balances are charged against the allowance when the potential for recovery is considered remote. For new customers with no order history with the Company we may require advance payments to reduce our credit risk.
Inventories: Inventories include freight-in, materials, labor and overhead costs and are stated at the lower of cost or net realizable value. Allowances are recorded for slow-moving, obsolete or unusable inventory. We assess our inventory for estimated obsolescence or unmarketable inventory and write down the difference between the cost of inventory and the estimated net realizable value based upon assumptions about future sales and supply on-hand, if necessary. If actual market conditions are less favorable than those projected by management, additional inventory write-downs may be required.
Leases: We determine if an arrangement is a lease at inception. Operating leases are included as right-of-use (“ROU”) assets and lease liabilities on our consolidated balance sheet. ROU assets and lease liabilities are recognized based on the present value of the future minimum lease payments over the lease term at the commencement date. Our leases do not provide an implicit rate, and, therefore, we estimate our collateralized borrowing rate under similar terms based on the information available at the commencement date in determining the present value of future minimum lease payments. Our lease terms may include options to extend or terminate the lease when it is reasonably certain that we will exercise such options. We do not record leases on our consolidated balance sheet with a term of one year or less. We elected a package of transition practical expedients, which included not reassessing whether any expired or existing contracts are or contain leases, not reassessing the lease classification of expired or existing leases, and not reassessing initial direct costs for existing leases. We also elected a practical expedient to not separate lease and non-lease components. We did not elect the practical expedient to use hindsight in determining our lease terms or assessing impairment of our ROU assets.
Revenue Recognition: Net sales includes revenue from products and shipping and handling charges, net of estimates for product returns and any related sales incentives. Our customer contracts have a single performance obligation: transfer control of products to customers. Revenue is measured as the amount of consideration that we expect to receive in exchange for transferring control of products. All revenue is recognized when we satisfy our performance obligations under the applicable contract. We recognize revenue in connection with transferring control of the promised products to the customer, with revenue being recognized at the point in time when the customer obtains control of the products, which is generally when title passes to the customer upon delivery to a third party carrier for FOB shipping point arrangements and to the customer for FOB destination arrangements, at which time a receivable is created for the invoice sent to the customer. Shipping and handling activities are performed prior to the customer obtaining control of the goods, and are accounted for as fulfillment activities and are not a promised good or service. Shipping and handling charges billed to customers are included in revenue. Shipping and handling costs, associated with the distribution of the Company’s product to the customers, are recorded in cost of goods sold and are recognized when control of the product is transferred to the customer, which is at the time products are delivered to the 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 labelling. The Company has determined that, as of December 31, 2020, it had no material contract assets, and concluded that its contract liabilities (primarily rebates) had the right of offset against customer receivables. As of December 31, 2020, the Company had contract liabilities of $209,000 as a result of customer advance payments of orders connected to the COVID-19 pandemic (see “Impact of the Novel Coronavirus (COVID-19)” below). No such contract liabilities existed as of December 31, 2019.
Sales Returns, Rebates and Allowances: Sales are reduced for any anticipated sales returns, rebates and allowances based on historical experience. Since our return policy is only 90 days and our products are not generally susceptible to external factors such as technological obsolescence or significant changes in demand, we are able to make a reasonable estimate for returns. We offer end-user product specific and sales volume rebates to select distributors. Our rebates are based on actual sales and are accrued monthly.
Stock-Based Compensation: The Company accounts for stock-based awards using Financial Accounting Standards Board (“FASB”) Accounting Standards Codification (“ASC”) 718, Stock Compensation. ASC 718 requires companies to record compensation expense for the value of all outstanding and unvested share-based payments, including employee stock options and similar awards.
The fair values of stock option grants are determined using the Black-Scholes option-pricing model and are based on the following assumptions: expected stock price volatility based on historical data and management’s expectations of future volatility, risk-free interest rates from published sources, expected term based on historical data, and no dividend yield, as the Board of Directors currently has no plans to pay dividends in the foreseeable future. The Company accounts for option forfeitures as they occur. The Black-Scholes option-pricing model was developed for use in estimating the fair value of traded options that have no vesting restrictions and that are fully transferable. In addition, the option-pricing model requires the input of highly subjective assumptions, including expected stock price volatility. Our stock options have characteristics significantly different from those of traded options, and changes in the subjective input assumptions can materially affect the fair value of such options.
OVERVIEW
Alpha Pro Tech is in the business of protecting people, products and environments. We accomplish this by developing, manufacturing and marketing a line of high-value, disposable protective apparel products for the cleanroom, industrial, pharmaceutical, medical and dental markets. We also manufacture a line of building supply construction weatherization products. Our products are sold under the “Alpha Pro Tech” brand name, as well as under private label.
Our products are grouped into two business segments: (i) the Building Supply segment, consisting of construction weatherization products, such as housewrap 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.
Previously, face masks and face shields were included in a separate business segment called Infection Control. All of our disposable protective apparel, including face masks and face shields, are sold through similar distribution channels, are single-use and disposable, have the purpose of protecting people, products and environments, and have to be produced in FDA approved facilities, regardless of the market served. Based on these similarities, we determined that it would be best to consolidate the Infection Control segment into the Disposable Protective Apparel segment beginning with the first quarter of 2019. All financial information presented in this report reflects the current segmentation.
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)
In March 2020, the World Health Organization declared the outbreak of COVID-19 a pandemic. COVID-19 continues to spread throughout the U.S. and the world and has resulted in authorities implementing numerous measures to contain the virus, including travel bans and restrictions, quarantines, shelter-in-place orders, and business limitations and shutdowns. COVID-19 has had, and we expect the virus to continue to have, a number of effects, both positive and negative, on our business operations and financial condition.
We have experienced a significant surge in customer demand for our proprietary N-95 Particulate Respirator face mask product 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 the year of 2020, 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 began ramping 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 have addressed the growing customer demand for PPE products by increasing and improving the human, mechanical, and supply chain components behind production. Even with these increases and improvements, customer demand for PPE products, face masks in particular, continues to exceed industry supply in many instances, and we believe that this may continue for some time.
We have encountered over the last several months 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 (which have improved since the second quarter of 2020) by securing additional supply sources, in the event of subsequent shutdowns, shortages or delays, our production and sales could be further impacted. Further, we expect that prices of raw materials may rise more rapidly in the current environment than our sales prices, which could decrease our profits.
We are continuing to serve our customers while taking every precaution to provide a safe work environment for our employees. We have enacted enhanced operating protocols to assure the safety and well-being of our employees, placed restrictions on non-essential travel, and otherwise adjusted work schedules to maximize our capacity while adhering to recommended precautions such as social distancing. We believe that we may have to take further actions that we determine are in the best interests of our employees or as required by federal, state, or local authorities. Although we will continue to adhere to restrictions imposed by local governments in the jurisdictions in which we operate, government regulations have impacted workforce availability and expense in certain of the Company’s manufacturing facilities, and we expect this to continue for some time. While this remains a fluid situation, all of our U.S. manufacturing sites are currently operating at or above normal production rates.
COVID-19 has resulted in a downturn in the global financial markets and a slowdown in the global economy. This economic environment may impact some of our customers’ ability to pay or lead them to request extended payment terms, and we have experienced cost increases from some of our suppliers. And, despite the tremendous surge in demand for our PPE products in recent months, we expect that demand for our Building Supply segment products could be negatively impacted if we experience a decrease in housing starts and increased uncertainty in the housing market and the economy in general, although to date we have not experienced any material negative impact in our Building Supply segment.
The impact of the COVID-19 pandemic continues to unfold. Overall, the increase in sales of our PPE products resulting from the pandemic has had a positive impact on our 2020 financial results. The extent of the pandemic’s effect on our future operational and financial performance will depend in large part on future developments. Future developments include 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 and rapidly evolving situation, we are unable to predict with any certainty the likely impact of the COVID-19 pandemic on our future operations
OUTLOOK FOR 2021
In 2021, we expect the market for our products to normalize in some respects, although we believe that sales will remain strong as compared to historical levels. More specifically:
|
●
|
So far in 2021, we are witnessing a softening in the demand for NIOSH-approved N-95 particulate respirator face masks manufactured by smaller companies like Alpha Pro Tech, creating some uncertainty in the market. Factors contributing to this include (i) increased availability of N-95 face masks resulting from manufacturers ramping up production capacity and actual production, especially in the early months of the pandemic, (ii) increased competition, driven by more manufacturers entering the N-95 face mask market since the pandemic began in 2020, as well as Emergency Use Authorization in the U.S. that has allowed foreign manufactured, non-NIOSH approved KN-95 face masks, among others, to gain prevalence, (iii) decreased demand from some distributors and their ultimate consumers in light of high levels of stockpiled inventory, resulting from a rush to obtain face masks in the early months of the pandemic, and (iv) the improvement in outlook with respect to the duration, scope and severity of the pandemic and the rollout and availability of vaccines. As a result of these factors, we expect that face mask sales, specifically sales of our N-95 particulate respirator face mask, in the first quarter of 2021 will be materially lower than in the fourth quarter of 2020, although we should still show revenue growth as compared to the first quarter of 2020. Additionally, we expect that, due to certain of these factors, specifically the improvement in outlook with respect to the pandemic and the growing number of individuals being vaccinated to protect against COVID-19, face mask sales may continue to decline in future periods.
|
|
●
|
We expect that face shield sales will remain at levels higher than those experienced before the COVID-19 pandemic.
|
|
●
|
Open orders for our disposable protective garments remain at historically high levels. The Company’s joint venture through which these products are manufactured has ramped up production capacity in order to respond to this demand.
|
|
●
|
Based on open orders for both our synthetic roof underlayment and housewrap products, we expect continued growth in our Building Supply segment, and the Company has committed to investing approximately $4.0 million in new equipment to increase production capacity of this segment. However, economic uncertainty resulting from the COVID-19 pandemic remains and could negatively impact demand for these products longer-term.
|
Management will continue to carefully monitor the current dynamic market conditions and work to respond to them swiftly and effectively.
RESULTS OF OPERATIONS
The following table sets forth certain operational data as a percentage of sales for the years indicated:
|
|
2020
|
|
|
2019
|
|
Net sales
|
|
|
100.0
|
%
|
|
|
100.0
|
%
|
Gross profit
|
|
|
49.2
|
%
|
|
|
36.4
|
%
|
Selling, general and administrative expenses
|
|
|
17.7
|
%
|
|
|
28.6
|
%
|
Income from operations
|
|
|
30.8
|
%
|
|
|
6.5
|
%
|
Income before provision for income taxes
|
|
|
31.4
|
%
|
|
|
7.9
|
%
|
Net income
|
|
|
26.4
|
%
|
|
|
6.4
|
%
|
Fiscal Year 2020 Compared to Fiscal Year 2019
Sales. Consolidated sales for the year ended December 31, 2020 increased to a record $102,700,000, from $46,665,000 for the year ended December 31, 2019, representing an increase of $56,035,000, or 120.1%. This increase consisted of increased sales in the Disposable Protective Apparel segment of $52,031,000 and increased sales in the Building Supply segment of $4,004,000.
Disposable Protective Apparel Segment
Sales for the Disposable Protective Apparel segment for the year ended December 31, 2020 increased by $52,031,000, or 259.0%, to a record $72,120,000, compared to $20,089,000 for 2019. This segment increase was due to a 1,262% increase in sales of face masks, a 631.2% increase in face shields and a 23.7% increase in sales of disposable protective garments. The sales mix of the Disposable Protective Apparel segment for the year ended December 31, 2020 was approximately 58% for face masks, 15% for face shields and 27% for disposable protective garments. This sales mix is compared to approximately 15% for face masks, 8% for face shields and 77% for disposable protective garments for the year ended December 31, 2019.
The increase in face mask sales was primarily attributable to increased sales of our proprietary N-95 Particulate Respirator face mask resulting from increased customer demand associated with the COVID-19 pandemic. Face masks had a record year in 2020, surpassing the prior Company sales record set in 2009 during the H1N1 pandemic, by a multiple of 2.4 times. Face mask sales grew during each quarter of 2020. Fourth quarter face mask sales were $15.4 million compared to $13.4 million in the third quarter of 2020, $8.5 million in the second quarter of 2020 and $4.5 million in the first quarter of 2020. Face shields also had a record year in 2020, with a very significant increase compared to the prior record set in 2009, by a multiple of 2.9 times. The disposable protective garments line sales increased an impressive 23.7% in 2020 and the Company’s joint venture, Harmony, has ramped up production capacity to facilitate our current higher than historical open orders. Although open orders are strong, revenue growth could be impacted by longer than normal shipping and port times which is occurring in early 2021 across all markets shipping from international production facilities.
Building Supply Segment
Building Supply segment sales for the year ended December 31, 2020 increased by $4,004,000, or 15.1%, to a record $30,580,000, compared to $26,576,000 for the year ended December 31, 2019. The Building Supply segment increase was primarily due to an increase in sales of synthetic roof underlayment of 16.4%, an increase in sales of housewrap of 12.5% and an increase of other woven material of 20.2% compared to 2019.
The sales mix of the Building Supply segment for the year ended December 31, 2020 was approximately 48% for synthetic roof underlayment, 43% for housewrap and 9% for other woven material. This compared to approximately 47% for synthetic roof underlayment, 44% for housewrap and 9% for other woven material for the year ended December 31, 2019. Our synthetic roof underlayment product line includes REX SynFelt®, REX TECHNOply® and TECHNO SB®, and our housewrap product line consists of REX Wrap®, REX Wrap® Plus and REX Wrap Fortis®.
Despite the challenges of 2020, our Building Supply segment experienced a record year with growth across all our product lines. Our TECHNO family of synthetic roof underlayment products showed continued growth as a result of strong sales of our TECHNO SB®25 product line, which was instrumental in the 16.4% growth of this product family in 2020. Housewrap sales hit record levels in 2020. In 2020, we added housewrap accessories, namely flashing and tape products, to our portfolio of housewrap sales, which opened up new market distribution and aided in the increase of housewrap sales of 12.5%. Sales of both synthetic roof underlayment and housewrap have benefitted from an increase in new home construction during 2020 and management’s determination to expand the Company’s distribution reach to cover the new home growth. Our sales of other woven materials increased in 2020, with an increase of 20.2% as our historically largest customer returned to its normal buying patterns.
At the end of 2020, our open orders for both the synthetic roof underlayment and housewrap product lines were at higher than historical levels and as a result, we anticipate growth into 2021. Given the uncertainty of the economy as a result of the COVID-19 pandemic, growth could be negatively affected in 2021, however to date we have not experienced any material negative impact in our Building Supply segment. Management expects continued growth in this segment and has committed to investing approximately $4.0 million in new equipment to increase production capacity of this segment.
Gross Profit. Gross profit increased by $33,510,000, or 197.4%, to $50,482,000 for the year ended December 31, 2020, from $16,972,000 for the year ended December 31, 2019. The gross profit margin was 49.2% for the year ended December 31, 2020, compared to 36.4% for the year ended December 31, 2019. The gross profit margin was positively affected by the significant change in product mix, which was altered due to a surge in customer demand as a result of the COVID-19 pandemic for face masks, in particular our N-95 Particulate Respirator face mask, and face shields, which generally have a higher gross profit margin than our other products.
The gross profit margin in 2020 was significantly higher than historical levels, but management believes that gross profit margin could be negatively affected in 2021 as a result of potential changes in product mix and changes in distribution channels associated with the pandemic, as well as expected increases in raw material costs, resin in particular, as well as ocean freight and other transportation costs.
Selling, General and Administrative Expenses. Selling, general and administrative expenses increased by $4,823,000, or 36.1%, to $18,171,000 for the year ended December 31, 2020, from $13,348,000 for the year ended December 31, 2019. The increase in expenses was largely due to the pandemic response. However, as a percentage of net sales, selling, general and administrative expenses decreased to 17.7% for the year ended December 31, 2020, down from 28.6% for 2019, primarily as a result of the growth in net sales due to the pandemic.
The change in expenses by segment for the year ended December 31, 2020 was as follows: Disposable Protective Apparel was up $2,038,000, or 48.1%; Building Supply was up $155,000, or 3.0%; and corporate unallocated expenses were up $2,630,000, or 67.6%. The increase in the Disposable Protective Apparel segment expenses was related to increased employee compensation, increased factory expenses and increased commissions as a result of increased sales, primarily due to the pandemic. The increase in the Building Supply segment expenses was related to increased employee compensation, increased commission and increased insurance costs, partially offset by decreased marketing and travel expenses. The increase in corporate unallocated expenses was primarily due to increased accrued bonuses, increased public company expenses and increased professional fees.
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 $1,000,000 was accrued for the year ended December 31, 2020, compared to $194,000 for the year ended December 31, 2019.
Depreciation and Amortization. Depreciation and amortization expense increased by $127,000, or 21.12%, to $729,000 for the year ended December 31, 2020, from $602,000 for the year ended December 31, 2019. The increase was primarily attributable to increased depreciation for machinery and equipment in the Building Supply segment and to a lesser extent increased depreciation for machinery and equipment in the Disposable Protective Apparel segment, as well as increased corporate depreciation related to computer technology.
Income from Operations. Income from operations increased by $28,560,000, or 945.1%, to $31,582,000 for the year ended December 31, 2020, compared to $3,022,000 for the year ended December 31, 2019. The increased income from operations was primarily due to an increase in gross profit of $33,510,000, partially offset by an increase in selling, general and administrative expenses of $4,823,000 and an increase in depreciation and amortization expense of $127,000. Income from operations as a percentage of net sales for the year ended December 31, 2020 was 31.0%, compared to 6.5% for the same period of 2019.
Other Income. Other income increased by $8,000, or 1.2%, to $666,000 for the year ended December 31, 2020, from $658,000 for the year ended December 31, 2019. The increase was primarily due to an increase in equity in income of unconsolidated affiliate of $351,000, partially offset by a loss on marketable securities for the year ended December 31, 2020 compared to a gains on marketable securities during the year ended December 31, 2019, for a net change of $293,000, and a decrease in interest income of $50,000.
Other income consisted primarily of equity in income of unconsolidated affiliate of $710,000, a loss on marketable securities of $62,000 and interest income of $18,000 for the year ended December 31, 2020. Other income consisted of equity in income of unconsolidated affiliate of $359,000, a gain on marketable securities of $231,000 and interest income of $68,000 for the year ended December 31, 2019.
Income before Provision for Income Taxes. Income before provision for income taxes for the year ended December 31, 2020 was $32,248,000, compared to income before provision for income taxes of $3,680,000 for 2019, representing an increase of $28,568,000, or 776.3%. This increase in income before provision for income taxes was due to an increase in income from operations of $28,560,000 and an increase in other income of $8,000.
Provision for Income Taxes. The provision for income taxes for the year ended December 31, 2020 was $5,162,000, compared to $680,000 for 2019. The provision for income taxes included an estimated nonrecurring tax benefit of $2.0 million in the first quarter of 2020 as a result of the exercise of disqualified Incentive Stock Options and the exercise of Non-Qualified Stock Options. The estimated effective tax rate was 16.0% for the year ended December 31, 2020, compared to 18.5% for the year ended December 31, 2019. Excluding the estimated nonrecurring tax benefit of $2.0 million, the estimated effective tax rate was 22.2% for the year ended December 31, 2020. 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 year ended December 31, 2020 was $27,086,000, compared to net income of $3,000,000 for the year ended December 31, 2019, representing an increase of $24,086,000, or 8,028.7%. The increase in net income was largely associated with the COVID-19 pandemic. Net income for 2020 significantly exceeded the Company’s previous net income record of $9.0 million for the year ended December 31, 2009, which resulted primarily from increased sales due to the H1N1 pandemic. The net income increase comparing the years ended December 31, 2020 and 2019 was due to an increase in income before provision for income taxes of $32,248,000, partially offset by an increase in provision for income taxes of $4,482,000. As mentioned above, a tax benefit from stock options exercised positively impacted net income in the first quarter of 2020. Net income as a percentage of net sales for the year ended December 31, 2020 was 26.4%, and net income as a percentage of net sales for 2019 was 6.4%. Basic earnings per common share for the year ended December 31, 2020, and 2019 were $2.01 and $0.23, respectively. Diluted earnings per common share for the year ended December 31, 2020 and 2019 were $1.94 and $0.23, respectively.
LIQUIDITY AND CAPITAL RESOURCES
As of December 31, 2020, the Company had cash of $23,292,000 and working capital of $49,451,000. As of December 31, 2020, the Company’s current ratio (current assets/current liabilities) was 9:1, compared to a current ratio of 11:1 as of December 31, 2019. Cash increased by 255.7%, or $16,744,000, to $23,292,000 as of December 31, 2020, compared to $6,548,000 as of December 31, 2019, and working capital increased by $25,689,000 from $23,762,000 as of December 31, 2019. The increase in cash from December 31, 2019 was due to cash provided by operating activities of $18,274,000, partially offset by cash used in investing activities of $862,000 and cash used in financing activities of $668,000.
We previously had a $3,500,000 credit facility with Wells Fargo Bank, consisting of a line of credit with interest at prime plus 0.5%. This credit line expired in May 2020, and the Company decided not to renew. The Company has continued its relationship with Wells Fargo, with the exception of the line of credit. The Company determined that the credit line is not necessary at this time, as it had not been used in several years, and the Company currently has sufficient funding from operations.
Net cash provided by operating activities of $18,274,000 for the year ended December 31, 2020 was due to net income of $27,086,000, impacted primarily by the following: stock-based compensation expense of $375,000, depreciation and amortization expense of $729,000, loss on marketable securities of $62,000, equity in income of unconsolidated affiliate of $710,000, operating lease expense net of accretion of $357,000, an increase in accounts receivable of $4,745,000, an increase in prepaid expenses of $2,638,000, an increase in inventory of $5,446,000, an increase in accounts payable and accrued liabilities of $3,355,000 and an increase in lease liabilities of $367,000.
Accounts receivable increased by $4,745,000, or 110.5%, to $9,037,000 as of December 31, 2020, from $4,292,000 as of December 31, 2019. The increase in accounts receivable was related to increased sales. The number of days that sales remained outstanding as of December 31, 2020, calculated by using an average of accounts receivable outstanding and annual revenue, was 34 days, the same as of December 31, 2019.
Inventory increased by $5,446,000, or 48.2%, to $16,749,000 as of December 31, 2020, from $11,303,000 as of December 31, 2019. The increase was primarily due to an increase in inventory for the Disposable Protective Apparel segment of $5,890,000, or 105.0%, to $11,498,000, partially offset by a decrease in inventory for the Building Supply segment of $444,000, or 7.8%, to $5,250,000.
Prepaid expenses increased by $2,638,000, or 73.5%, to $6,225,000 as of December 31, 2020, from $3,587,000 as of December 31, 2019. The increase was primarily due to prepayments for machinery and equipment for the Building Supply segment and, to a lesser extent for the Disposable Protective Apparel segment, as well as prepaid inventory.
Right-of-use assets as of December 31, 2020 increased by $357,000 to $3,535,000 from $3,178,000 as of December 31, 2019 as a result of amortization of the balance.
Lease liabilities as of December 31, 2020 increased by $367,000 to $3,586,000 from $3,219,000 as of December 31, 2019. The recording of the lease liabilities was the result of adopting ASC 842, Leases. The increase in the lease liabilities was primarily the result of renewing our Nogales, Arizona lease in December 2020 and the assumption we will continue to lease that facility for at least 5 years.
Accounts payable and accrued liabilities as of December 31, 2020 increased by $3,355,000, or 236.1%, to $4,776,000, from $1,421,000 as of December 31, 2019. The increase was primarily due to an increase in accounts payable as a result of increased raw material purchases, an increase in accrued liabilities, and an increase in accrued bonuses.
Customer advance payment of orders as of December 31, 2020 was $209,000, which was the result of customer deposits for future dated PPE orders in response to the COVID-19 pandemic. There were no advance payments of this nature as of December 31, 2019.
Net cash used in investing activities was $862,000 for the year ended December 31, 2020, compared to net cash used in investing activities of $1,142,000 for the same period of 2019. Investing activities for the year ended December 31, 2020 consisted of the purchase of property and equipment of $1,135,000 for both the Building Supply segment and the Disposable Apparel Products segment and proceeds from the sale of marketable securities of $273,000. Investing activities for the year ended December 31, 2019 consisted of the purchase of property and equipment of $1,296,000 and proceeds from the sale of marketable securities of $154,000.
Net cash used in financing activities was $668,000 for the year ended December 31, 2020, compared to net cash used in financing activities of $2,418,000 for the same period of 2019. Net cash used in financing activities for the year ended December 31, 2020 resulted from the payment of $2,666,000 for the repurchase of common stock, mainly offset by proceeds of $1,998,000 from the exercise of stock options. Net cash used in financing activities for the year ended December 31, 2019 resulted from the payment of $2,548,000 for the repurchase of common stock, partially offset by proceeds of $130,000 from the exercise of stock options.
As of December 31, 2020, we had $4,486,000 available for additional stock purchases under our stock repurchase program. For the year ended December 31, 2020, we repurchased 223,100 shares of common stock at a cost of $2,666,000. As of December 31, 2020, we had repurchased a total of 18,110,917 shares of common stock at a cost of $38,034,000 through our repurchase program. We retire all stock upon repurchase. Future repurchases are expected to be funded from cash on hand and cash flows from operating activities
We believe that our current cash balance will be sufficient to satisfy our projected working capital and planned capital expenditures for the foreseeable future. We have made approximately $4,000,000 in commitments for capital investments to increase our production capacity in our Building supply segment, of which $1,191,000 has been made in deposits as of December 31, 2020.
Off- Balance Sheet Arrangements
None
Related Parties
During 2020, the Company had no related party transactions, other than the Company’s transactions with its non-consolidated affiliate, Harmony. See Note 7 – “Equity Investments in Unconsolidated Affiliate” in the notes to our consolidated financial statements in Item 8 for more information on our relationship with our non-consolidated affiliated Harmony Plastics Private Limited.
New Accounting Standards
In February 2016, the FASB issued ASU 2016-02, Leases, which introduces the recognition of lease assets and lease liabilities by lessees for those leases classified as operating leases under previous guidance. The update is effective for annual reporting periods beginning after December 15, 2018, including interim periods within those reporting periods, with early adoption permitted. The original guidance required application on a modified retrospective basis with the earliest period presented. In August 2018, the FASB issued ASU 2018-11, Targeted Improvements to ASC 842, which includes an option to not restate comparative periods in transition and elect to use the effective date of ASC 842, Leases, as the date of initial application of transition. Based on the effective date, we adopted this ASU beginning on January 1, 2019 and elected the transition option provided under ASU 2018-11. This standard had a material effect on our consolidated balance sheet with the recognition of new right-of-use assets and lease liabilities for all operating leases, as these leases typically have a non-cancelable lease term of greater than one year. Upon adoption, both assets and liabilities on our consolidated balance sheet increased by approximately $3,455,000. We elected a package of transition practical expedients, which included not reassessing whether any expired or existing contracts are or contain leases, not reassessing the lease classification of expired or existing leases, and not reassessing initial direct costs for existing leases. We also elected a practical expedient to not separate lease and non-lease components. We did not elect the practical expedient to use hindsight in determining the lease terms or assessing impairment of the ROU assets. See also Note 12 of these Notes to Consolidated Financial Statements in Item 8 for more information.
In June 2016, the FASB issued ASU 2016-13 Financial Instruments - Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments. ASU 2016-13 requires an organization to measure all expected credit losses for financial assets held at the reporting date based on historical experience, current conditions and reasonable and supportable forecasts. ASU 2016-13 is effective for public entities for the annual periods, including interim periods within those annual periods, beginning after December 15, 2019. This guidance is applicable to the Company’s fiscal year beginning January 1, 2020. Adoption of the new standard did not have a material impact on our consolidated financial statements.
In June 2018, the FASB issued ASU 2018-07, Compensation - Stock Compensation (Topic 718), Improvements to Nonemployee Share-Based Payment Accounting. This ASU is intended to simplify aspects of share-based compensation issued to non-employees by making the guidance consistent with accounting for employee share-based compensation. ASU 2018-07 is effective for annual periods beginning after December 15, 2018 and interim periods within those annual periods, with early adoption permitted but no earlier than an entity’s adoption date of ASC Topic 606, Revenue form Contracts with Customers. The new guidance is required to be applied retrospectively with the cumulative effect recognized at the date of initial application. We adopted the provisions of this ASU in the first quarter of 2019. Adoption of the new standard did not have a material impact on our consolidated financial statements.
In December 2019, the FASB issued ASU No. 2019-12, Income Taxes (Topic 740): Simplifying the Accounting for Income Taxes, which is intended to simplify various aspects related to accounting for income taxes. ASU 2019-12 removes certain exceptions to the general principles in Topic 740 and also clarifies and amends existing guidance to improve consistent application. This guidance is effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2020, with early adoption permitted. The Company is currently evaluating the impact of this standard on its consolidated financial statements and related disclosures.
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.