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Alpha Pro Tech Ltd (APT): Expensive Executives

February 11, 2011 | About:
Last week I discussed Lakeland Industries, Inc (LAKE) here, a company that manufacturers and markets disposable safety garments and accessories. I have also come across Alpha Pro Tech, Ltd (APT) which operates in the same space and is also a microcap (Market Cap around $40m). I was initially attracted to the company by its lack of debt, low P/E (7.3x ex-cash), share repurchase program and low price in relation to NCAV. It wasn’t until I found this note in its recent 10-Q that I gave up investigating further:

The Chief Executive Officer and President are each entitled to a bonus equal to 5% of the pre-tax profits of the Company, excluding bonus expense.
I have often given up on companies when I find situations of executives being paid outrageous amounts, but it is truly a rare occasion that that I come across a situation structure in this manner. In the company’s defence, the CEO and President chose to forgo their bonuses in 2010, but let’s look at the effect a resumption in their bonuses would have on the company.

The company has TTM EPS of $0.21. Pre-tax, this is $0.31 (TTM Pre-tax earnings of $7.21m over average shares o/s of 22.915m). If the President and CEO each took their 5% bonuses, this would reduce pre-tax earnings to $0.279. The average effective tax rate for the last four quarters was 36.55%. Using that figure and the new pre-tax earnings, we would get EPS of $0.177. Using the P/E ex-cash of 7.3x, this would translate to $1.29 and then we would add back the cash and get a value per share of $1.50.

$1.50 is a 14% decline from its recent $1.74 (the price on publication may differ from what this was written). A 14% decline would knock $5.4million off the market cap of this company if the P/E held steady. The only way the value of the company would stay stable would be for a concomitant multiple expansion.

I am sure there are a lot of ways to look at this situation, and I have presented only one scenario (for example, perhaps it would make more sense to use normalized earnings and average P/E multiples for the company). Other scenarios may make the situation look better or worse than the one I have presented, but the fact remains that poor corporate governance policies (and executive compensation is a big part of these) can have a real, practical effect on an investment.

I should also note that this is not a sitaution where the company’s executives are paid little by way of salary and options. In 2009, the top four executives earned a combined total of $3.34 million, of which $1.6 million was salary. This is a year when the company earned a total of $9.0 million, so the executive compensation outside of their bonuses comprised approximately 10.4% of net income. Including the bonuses, the figure is closer to 19.4%!

Talk to Frank about APT

Author Disclosure: No Position

About the author:

Frank Voisin
Frank is an entrepreneur who owned four restaurants by the time he was twenty. He sold his businesses and returned to school, completing a concurrent Law / MBA degree. At the same time, he successfully completed all three levels of the CFA exams. He now invests full time with a focus on value investing. Frank Voisin writes about value investing topics at http://www.frankvoisin.com.

Visit Frank Voisin's Website


Rating: 5.0/5 (3 votes)

Voters:

Comments

tarverdr
Tarverdr - 3 years ago


I would hope that someone would buy this company, fire management, unlock the value that it has to

offer.
kfh227
Kfh227 premium member - 3 years ago


I wish the bonus structure were based on FCF, not Earnings. If earnings go negative, do the execs have to pay the company?

So, in reality (under these scenarios), two different outcomes occur:

(1)

2011: pre-tax earnings: -$1 million (They blew alot of money to fix things since their regard system does not punish them for doing so. They also know what this means come 2012 ... which follows.

(2)

2012:

pre-tax earnings: +$3 million (They have less expenditures because they spent alot of money in 2011)

So, that is a net of $2 million over 2 years, but their reward is based on $3 million.

There needs to be reason to think this is not true and that this instead occurs:

(1)

2011: pre-tax earnings: -$0.1 million (They spent what they had to and things were negative. To help shareholders, they did not spend more even though doing so could benefit them personally)

(2)

2012:

pre-tax earnings: +$2.1 million (They have more expenditures than under the previous scenario but they held off on them for as long as possible.)

So, that is a net of $2 million over 2 years, but their reward is based on $2.1 million.

The CEO and president, if they are unscrupulous, could actually "work the system" to fill their pockets with cash.

Just a scenario. Probably will not happen. But there needs to be reason to think that this will not happen.

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