Last week I discussed Lakeland Industries, Inc (NASDAQ: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