Omega Flex, Inc. 2019 Q3 Form 10-Q Summary
Business Context and Reporting Period
Omega Flex manufactures and sells flexible metal hose, proprietary fittings and accessories for residential and commercial construction, medical and pharmaceutical, transportation, petrochemical and industrial applications. Operations are managed as one segment, with manufacturing facilities in Exton, Pennsylvania and Banbury, United Kingdom. The filing covers the three and nine months ended September 30, 2019, compared with the corresponding 2018 periods. Financial statements are unaudited.
Financial Performance and Position
| Metric | Q3 2019 | Q3 2018 | 9M 2019 | 9M 2018 |
|---|---|---|---|---|
| Net sales | $28.030 million | $27.199 million | $81.627 million | $79.443 million |
| Gross profit | $17.704 million | $16.547 million | $51.386 million | $47.794 million |
| Gross margin | 63.2% | 60.8% | 63.0% | 60.2% |
| Operating profit | $4.373 million | $6.676 million | $15.108 million | $18.534 million |
| Operating margin | 15.6% | 24.6% | 18.5% | 23.3% |
| Net income attributable to Omega Flex | $3.368 million | $5.176 million | $11.733 million | $14.115 million |
| Diluted EPS | $0.33 | $0.51 | $1.16 | $1.40 |
At September 30, 2019, cash and cash equivalents were $25.158 million, investments were $22.865 million, and total current assets were $77.995 million. Total liabilities were $22.547 million and shareholders’ equity was $69.972 million. The Company had no borrowings under its $15.0 million unsecured revolving credit facility and was in compliance with its debt covenants.
Operating activities generated $9.673 million of cash during the first nine months of 2019, compared with $11.716 million in 2018. Investing activities used $8.943 million, including $1.022 million of capital expenditures and net purchases of short-term investments. Financing activities used $7.807 million for dividends. Ending cash was $25.158 million, compared with $6.445 million at September 30, 2018.
Cash dividends declared were $0.28 per share in the third quarter and $0.80 per share for the first nine months, compared with $0.24 and $0.70, respectively, in the comparable 2018 periods.
Material Changes Versus the Prior Comparable Period
- Third-quarter sales increased 3.1%; nine-month sales increased 2.8%.
- Gross margin improved by 2.4 percentage points in the quarter and 2.8 percentage points year to date, reflecting pricing actions, cost control and operating leverage.
- Operating profit declined 34.5% in the quarter and 18.5% year to date. Operating margin fell 9.0 percentage points in the quarter and 4.8 percentage points year to date.
- Third-quarter selling expense increased 26.2%, primarily due to $654,000 of atypical consulting costs related to the MediTrac product, increased staffing and higher commissions.
- General and administrative expense increased 54.8% in the quarter and 42.4% year to date. The primary drivers were higher legal and product-liability defense costs and increased incentive compensation linked to the Company’s stock price.
- Year-to-date inventory increased 31.2% to $10.466 million, primarily reflecting inventory buildup for MediTrac in anticipation of customer orders.
- The Company adopted the new lease standard on January 1, 2019, recording approximately $800,000 of operating lease assets and liabilities without a material impact on income or cash flow.
Outlook, Risks, Contingencies and Unusual Items
Management stated that demand remained sustained and that the Company maintained a dominant position in its core market. MediTrac received robust interest during its launch, but the filing does not provide formal revenue, earnings or margin guidance.
Management expects existing cash and cash equivalents to meet anticipated cash needs for at least the next twelve months. Future capital requirements will depend on revenue growth, expansion, potential acquisitions and capacity investments.
The Company is defending a putative class-action case and other product-liability claims, principally related to alleged lightning damage involving flexible gas piping products. Management believes the claims lack merit. Insurance generally covers the claims subject to deductibles or self-insured retentions ranging primarily from $25,000 to $1.0 million per claim. Aggregate maximum exposure for current open claims, excluding the putative class action, was estimated at approximately $3.2 million, while the ultimate liability, including the class action, cannot currently be estimated. Recorded liabilities for these matters were $150,000 at September 30, 2019.
Other risks include customer concentration, geographic concentration in North America, foreign currency exposure, product liability, litigation costs, changing customer demand, competition, regulatory developments and general economic conditions. One customer represented more than 10% of accounts receivable and more than 10% of total nine-month sales in both 2019 and 2018.
Stock-based compensation expense was approximately $1.745 million for the first nine months of 2019, compared with $445,000 in 2018. The phantom stock liability increased to $2.719 million at September 30, 2019, partly because of the Company’s higher stock price. No material subsequent events were reported.
Important Facts for Investors to Verify
- Whether MediTrac customer adoption converts the inventory buildup and launch-related spending into sustained sales and profit growth.
- The future magnitude and timing of legal and product-liability costs, particularly the putative class action and related insurance coverage.
- The effect of elevated incentive compensation and phantom stock liabilities on future earnings and cash payments.
- Customer concentration and the impact of any change in demand from the significant customer.
- Cash conversion, inventory levels and the Company’s continued ability to fund dividends, capital expenditures and potential expansion internally.
- Whether gross-margin improvements persist despite higher selling, administrative and engineering expenses.
- The filing’s statement that controls and procedures were effective and that no material changes to internal control over financial reporting occurred.