Omega Flex, Inc. Form 10-Q Summary
Business context and reporting period
Omega Flex manufactures and sells flexible metal hose, flexible gas piping and related accessories through a single operating segment. Its products serve residential and commercial construction, general industrial, petrochemical, pharmaceutical and other markets. Manufacturing is conducted in Exton, Pennsylvania and Banbury, United Kingdom. This unaudited report covers the three months ended March 31, 2017, compared with the three months ended March 31, 2016.
Key financial metrics
| Metric | Q1 2017 | Q1 2016 | Change |
|---|---|---|---|
| Net sales | $25.607 million | $20.626 million | +24.1% |
| Gross profit | $15.336 million | $12.492 million | +22.8% |
| Gross margin | 59.9% | 60.6% | -0.7 percentage points |
| Operating profit | $6.204 million | $4.021 million | +54.3% |
| Operating margin | 24.2% | 19.5% | +4.7 percentage points |
| Net income attributable to Omega Flex | $4.138 million | $2.643 million | +56.4% |
| Basic and diluted EPS | $0.41 | $0.26 | +$0.15 |
| Net cash from operating activities | $(0.176) million | $2.059 million | $(2.235) million |
Cash and cash equivalents were $23.987 million at March 31, 2017, down from $35.318 million at December 31, 2016. The company had no borrowings under its unsecured $15.0 million revolving credit facility, which matures December 31, 2019, and was in compliance with debt covenants. Total assets were $63.702 million and total shareholders’ equity was $50.379 million at quarter-end.
Cash used in investing activities was $2.675 million, primarily reflecting the approximately $2.5 million purchase of an Exton, Pennsylvania building. Cash used in financing activities was $8.578 million for payment of the special $0.85-per-share dividend declared in December 2016. Management stated that existing cash and cash equivalents should be sufficient for anticipated investing and other cash needs for at least the next 12 months.
Material changes versus the prior comparable period
- Sales increased $4.981 million, or 24.1%, with growth in most areas and stronger activity from several major customers that had weakened in the first quarter of 2016.
- Gross margin declined modestly because of higher prices for certain core raw materials, although manufacturing efficiencies substantially offset the pressure.
- Selling expense increased 11.8% to $4.306 million, but declined to 16.8% of sales from 18.7%, primarily because variable freight and commission costs grew more slowly than revenue.
- General and administrative expense increased 2.9% to $4.018 million, while its percentage of sales declined to 15.7% from 18.9%. Lower legal and product-liability defense costs partly offset higher incentive compensation and insurance costs.
- Operating profit increased $2.183 million, reflecting revenue growth and operating leverage. Q1 2017 also included $74,000 of phantom-stock compensation income versus $130,000 of expense in Q1 2016.
- Operating cash flow was negative despite higher earnings because receivables and inventory increased and the company paid accrued compensation and sales incentives from the prior year. March 2017 was the company’s strongest sales month to date, increasing quarter-end receivables.
- Property and equipment increased $2.565 million from year-end, primarily because of the Exton building acquisition. Accrued compensation and dividends payable declined substantially as prior-year obligations were paid.
Guidance, outlook, risks and unusual items
The filing does not provide quantitative revenue or earnings guidance. Management expects existing cash resources to meet anticipated cash needs for at least the next 12 months, but future capital requirements will depend on revenue growth, expansion, acquisitions and capacity investments.
- Pending product-liability and lightning-subrogation litigation remains a material uncertainty. The company disputes the claims and is defending them vigorously. Estimated aggregate exposure for current open claims is approximately $3.6 million within applicable insurance deductibles or retentions, although ultimate liability cannot be estimated and future costs could materially affect results or liquidity.
- Approximately $1.6 million was posted as collateral for an ongoing appeal and is included in other long-term assets. Litigation-related liabilities recorded at March 31, 2017 were $294,000.
- One customer represented more than 10% of both quarterly net sales and accounts receivable, creating customer-concentration risk. No customer exceeded 10% of first-quarter 2016 sales.
- Key estimates include revenue incentives, receivable collectibility, inventory valuation, goodwill, product-liability reserves, phantom-stock compensation and income taxes. The filing states that actual results could differ materially from these estimates.
- The company does not use market-risk hedges and held no speculative or trading instruments. Management reported effective disclosure controls and no material change in internal control over financial reporting.
- Adoption of the new revenue standard was expected to have no significant impact, while the company was still evaluating the future impact of the new lease standard.
Important facts for investors to verify
- Whether the strong sales growth and improved operating margin persist beyond the first quarter.
- The timing and collectibility of the elevated accounts receivable balance and the resulting effect on operating cash flow.
- Future dividend policy and the effect of recurring special dividends on liquidity.
- The outcome, timing and potential cost of pending litigation, including the Missouri case and the Pennsylvania appeal.
- Customer concentration, raw-material pricing and the company’s ability to preserve its approximately 60% gross margin.
- The impact of adopting revenue and lease accounting standards and any future capital spending or acquisition plans.