Notes to Condensed Consolidated Financial Statements (Unaudited)

The following table presents the consolidated net property and equipment, goodwill and definite-lived intangible assets (“consolidated assets���assets”) by segment as of JuneSeptember 30, 2021 and December 31, 2020:

The following table summarizes the Company’s net sales by geographic region for the three and sixnine months ended JuneSeptember 30, 2021 and 2020:

Net sales by geographic region are based on the countries in which our customers are located. For the three and sixnine months ended JuneSeptember 30, 2021 and 2020, the Company did not generate sales from any single country, other than the United States, that were 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 JuneSeptember 30, 2021 and December 31, 2020:

As of JuneSeptember 30, 2021, the Company had no related party transactions, other than the Company’s transactions with its unconsolidated affiliate, Harmony. See Note 7 of these Notes to Condensed Consolidated Financial Statements (Unaudited).

Notes to Condensed Consolidated Financial Statements (Unaudited)

The Company has operating leases for the Company’s corporate office and manufacturing facilities, which expire at various dates through 2025. The Company’s primary operating lease commitments at JuneSeptember 30, 2021 related to the Company’s manufacturing facilities in Valdosta, Georgia; Nogales, Arizona; and Salt Lake City, Utah, as well as the Company’s corporate headquarters in Markham, Ontario, Canada.

As of JuneSeptember 30, 2021, the Company had operating lease right-of-use assets of $3,094,000$2,872,000 and operating lease liabilities of $3,148,000.$2,926,000. As of JuneSeptember 30, 2021, we did not have any finance leases recorded on the Company’s condensed consolidated balance sheet. Operating lease expense was approximately $221,000$265,000 and $425,000,$769,000, respectively during the three and sixnine months ended JuneSeptember 30, 2021.

The aggregate future minimum lease payments and reconciliation to lease liabilities as of JuneSeptember 30, 2021 were as follows:

As of JuneSeptember 30, 2021, the weighted average remaining lease term of the Company’s operating leases was 3.673.27 years. During the sixnine months ended JuneSeptember 30, 2021, the weighted average discount rate with respect to these leases was 4.07%.

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

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

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

Notes to Condensed Consolidated Financial Statements (Unaudited)

On March 27, 2020, President Trump signed into U.S. federal law the Coronavirus Aid, Relief, and Economic Security Act (the “CARES Act”), which is aimed at providing emergency assistance and health care for individuals, families and businesses affected by the COVID-19 pandemic and generally supporting the U.S. economy. The CARES Act, among other things, includes provisions relating to refundable payroll tax credits, deferment of employer side social security payments, net operating loss carryback periods, alternative minimum tax credit refunds, modifications to the net interest deduction limitations and technical corrections to tax depreciation methods for qualified improvement property. The CARES Act currently has minimal impact on the Company.

The Company has reviewed and evaluated whether subsequent events have occurred from the condensed consolidated balance sheet date of JuneSeptember 30, 2021 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, 2020, filed with the Securities and Exchange Commission (the “SEC”) on March 10, 2021 (the “2020 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 2021 and 2022, 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 2020 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, our most recent Quarterly Report on Form 10-Q, any Current Reports on Form 8-K furnished or filed since our most recent Annual Report on Form 10-K, and any amendments to such reports, as soon as reasonably practicable following the electronic filing of such reports with the SEC. In addition, in accordance with SEC rules, we provide 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. 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 of the 2020 Form 10-K. Our critical accounting policies and estimates include the following:

Accounts Receivable: Accounts receivable are recorded at the invoice amount and do not bear interest. The general terms for receivables is net 30 days.  The allowance for doubtful accounts is the Company’s best estimate of the amount of probable credit losses in the Company’s existing accounts receivable; however, changes in circumstances relating to accounts receivable may result in a requirement for additional allowances in the future.  The Company determines the allowance based upon historical write-off experience and known conditions about customers’ current ability to pay.  Account balances are charged against the allowance when the potential for recovery is considered remote. For new customers with no order history with the Company we may require advance payments to reduce our credit risk.

Inventories: Inventories include freight-in, materials, labor and overhead costs and are stated at the lower of cost or net realizable value. Allowances are recorded for slow-moving, obsolete or unusable inventory. We assess our inventory for estimated obsolescence or unmarketable inventory and write down the difference between the cost of inventory and the estimated net realizable value based upon assumptions about future sales and supply on-hand, if necessary. If actual market conditions are less favorable than those projected by management, additional inventory write-downs may be required.

Leases: We determine if an arrangement is a lease at inception. Operating leases are included as right-of-use (“ROU”) assets and lease liabilities on our 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 JuneSeptember 30, 2021, it had no material contract assets, and concluded that its contract liabilities (primarily rebates) had the right of offset against customer receivables. As of June 30, 2021, the Company had contract liabilities of $103,000 as a result of customer advance payments of orders connected to the COVID-19 pandemic (see “Impact of the Novel Coronavirus (COVID-19)” below).

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: the Building Supply segment, consisting of construction weatherization products, such as housewrap and synthetic roof underlayment as well as other woven material; and the Disposable Protective Apparel segment, consisting of disposable protective garments (including shoecovers, bouffant caps, coveralls, gowns, frocks and lab coats), face masks and face shields. All financial information presented in this report reflects the current segmentation.

Our target markets include pharmaceutical manufacturing, bio-pharmaceutical manufacturing, medical device manufacturing, lab animal research, high technology electronics manufacturing (which includes the semi-conductor market), medical and dental distributors, and construction, building supply and roofing distributors.

Our products are used primarily in cleanrooms, industrial safety manufacturing environments, health care facilities, such as hospitals, laboratories and dental offices, and building and re-roofing sites. Our products are distributed principally in the United States through a network consisting of purchasing groups, national distributors, local distributors, independent sales representatives and our own sales and marketing force.

Impact of the Novel Coronavirus (COVID-19)

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

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

During 2020, we encountered a number of constraints within our supply chain due to government-mandated shutdowns, raw materials shortages and shipping delays. Although we worked to alleviate these supply chain issues by securing additional supply sources, in the event of subsequent shutdowns, shortages or delays, our production and sales could be further impacted. Further, prices of raw materials have increased and we expect they may continue to 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.

As detailed below under “Results of Operations,” we witnessed a softening in the demand for our N-95 particulate respirator face maskmasks, and face shields during the sixfirst nine months of 2021 and we expect sales will continue to decline to be more in-line with pre-pandemic levels in future periods. We expect growth in pre-pandemic demand for our disposable protective garments and continued growth in Building Supply segment products although this demandthe Building Supply segment could be negatively impacted if we experiencethere is a decrease in housing starts and increased uncertainty in the housing market and the economy in general. Additionally, as supply chain issues for certain housing components not supplied by the Company, which could lead to a slowdown in new home construction.

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, including the Delta variant, 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.

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 net sales for the periods indicated:

Three months ended JuneSeptember 30, 2021 compared to three months ended JuneSeptember 30, 2020

Sales. Consolidated sales for the three months ended JuneSeptember 30, 2021 decreased to $17,806,000,$14,475,000, from $25,500,000$30,027,000 for the three months ended JuneSeptember 30, 2020, representing a decrease of $7,694,000,$15,552,000, or 30.2%51.8%. This decrease consisted of decreased sales in the Disposable Protective Apparel segment of $10,040,000,$17,956,000, partially offset by increased sales in the Building Supply segment of $2,346,000.$2,404,000.

Disposable Protective Apparel Segment

Sales for the Disposable Protective Apparel segment for the three months ended JuneSeptember 30, 2021 decreased by $10,040,000,$17,956,000, or 55.6%80.3%, to $8,008,000,$4,403,000, compared to $18,048,000$22,359,000 for the same period of 2020. This segment decrease was due to a 89.4%92.3% decrease in sales of face masks, and a 93.2%91.9% decrease in face shields partially offset byand a 36.3% increase33.1% decrease in sales of disposable protective garments. The decreases for face masks, and face shields and disposable protective garments were primarily due to increased demand resulting from the COVID-19 pandemic in the secondthird quarter of 2020. Management expects futureFuture sales of face mask and face shields are expected to be more in-linein line with pre-pandemic levels in future periods.

levels. Sales for the disposable protective garments in the secondthird quarter of 2021 were down as inventory levels in the supply chain, primarily with our major international channel partner, were higher than historical levels, as a record and up a very strong 36.3%. This represents two consecutive quartersresult of record sales for disposable protective garments asin the first and second quarter of 2021. This partner’s sales to its end users for the three and nine months ended September 30, 2021 was the previous record. This waswere significantly higher than pre-pandemic levels due to strong open orders, generated largely in 2020 primarily from our major international channel partner.2020. Open orders for the disposable protective garments are now more in line with pre-pandemic levels and sales in the coming quarters could be negatively affected as current inventory levels in the supply chain, primarily with our major international channel partner, are higher than historical.historical levels. We are working closely with all of our channel partners to uncover new end-customer sales opportunities.

The sales mix of the Disposable Protective Apparel segment for the three months ended June 30, 2021 was approximately 85% for disposable protective garments, 11% for face masks and 4% for face shields. This sales mix is compared to approximately 28% for disposable protective garments, 47% for face masks and 25% for face shields for the three months ended June 30, 2020.

The sales mix of the Disposable Protective Apparel segment for the three months ended September 30, 2021 was approximately 69% for disposable protective garments, 23% for face masks and 8% for face shields. This sales mix is compared to approximately 20% for disposable protective garments, 60% for face masks and 20% for face shields for the three months ended September 30, 2020.

Building Supply Segment

Building Supply segment sales for the three months ended JuneSeptember 30, 2021 increased by $2,346,000,$2,404,000, or 31.5%31.4%, to $9,798,000,a quarterly record of $10,072,000, compared to $7,452,000$7,668,000 for the three months ended JuneSeptember 30, 2020. We have had back to back quarterly record sales as the second quarter of 2021 was the previous highest quarter on record. Also, the first quarter of 2021 was a record first quarter in the Building Segment. In addition, sales increased by over 30% in each of the second and third quarters of 2021 compared to the prior year comparative quarter. The Building Supply segment increase during the three months ended September 30, 2021 was primarily due to a 35.6%35.9% increase in sales of synthetic roof underlayment, a 29.1%25.7% increase in sales of housewrap and a 19.6%26.7% increase in sales of other woven material compared to the same period of 2020.

The sales mix of the Building Supply segment for the three months ended JuneSeptember 30, 2021 was approximately 48%50% for synthetic roof underlayment, 43% for housewrap and 9%7% for other woven material. This compared to approximately 46%49% for synthetic roof underlayment, 44% for housewrap and 10%7% for other woven material for the three months ended JuneSeptember 30, 2020. 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®.

Building Supply segment sales remained strong in the secondthird quarter of 2021 bolsteredshowed continued significant growth due to strong demand for both our synthetic roof underlayment and housewrap products. Synthetic roof underlayment sales increased by 35.9% compared to the third quarter of 2020 due to the increase in inventory requirements at the dealer level, as well as the expansion of new home construction. The housewrap family of products continued grow with a stronger than expected25.7% year-over-year increase due to growth in new market share as well as high demand for new home construction. The synthetic roof underlayment sales increaseOur system of 35.6% was attributed to both an increaseselling housewrap with associated accessories is becoming increasingly accepted in the growth of the brand coupled with demand from product shortages in the market. Our Housewrap family of products remained strong with a 29.1% increase, driven by the new home construction market.

Management is optimistic about continued growth in this segmentfor the future as open ordersthe demand for our synthetic roof underlay and housewrapBuilding Supply products looks to remain very strong. As a result of our continued optimism, we haveManagement has committed to increasing production capacity offor this segment by investing approximately $4.0 million in new equipment, a part of which is expected to bebecame operational in the latter part of the third and fourth quartersquarter of 2021.2021, which contributed to the record sales quarter. As a result of a delay in the relevant supply chain, the finalmost expensive piece of equipment is now anticipated to arrive in the latter part of the fourth quarter of 2021 and is expected to be operational in the first quarter of 2022.

SixNine months ended JuneSeptember 30, 2021 compared to sixnine months ended JuneSeptember 30, 2020

Consolidated sales for the sixnine months ended JuneSeptember 30, 2021 decreased to $40,967,000$55,442,000 from $43,654,000$73,681,000 for the sixnine months ended JuneSeptember 30, 2020, representing a decrease of $2,687,000,$18,239,000, or 6.2%24.8%. This decrease consisted of decreased sales in the Disposable Protective Apparel Segment of $5,817,000$23,772,000 and increased sales in the Building Supply segment of $3,130,000.$5,533,000.

Disposable Protective Apparel Segment

Sales for the Disposable Protective Apparel segment for the sixnine months ended JuneSeptember 30, 2021 decreased by $5,817,000,$23,772,000, or 20.3%46.6%, to $22,829,000,$27,232,000, compared to $28,646,000$51,004,000 for the same period of 2020. This segment decrease was due to a 50.0%71.4% decrease in sales of face masks, a 52.3%69.6% decrease in sales of face shields and a 38.4%15.9% increase in sales of disposable protective garments, all primarily due to customer demand associated with the pandemic.

The sales mix of the Disposable Protective Apparel segment for the sixnine months ended JuneSeptember 30, 2021 was 59%61% for disposable protective garments, 29%28% for masks and 12%11% for shields. This sales mix is compared to 34%28% for disposable protective garments, 46%52% for masks and 20% for shields for the sixnine months ended JuneSeptember 30, 2020.