Omega Flex, Inc. — 2015 Second-Quarter Form 10-Q Summary
Business Context and Reporting Period
Omega Flex manufactures and sells flexible metal hose, flexible gas piping, fittings and related accessories for residential and commercial construction, general industrial, petrochemical, pharmaceutical and other markets. Products include TracPipe, TracPipe CounterStrike, AutoSnap, AutoFlare, DoubleTrac and DEF-Trac. Operations are managed as one segment, with manufacturing in Exton, Pennsylvania and Banbury, United Kingdom.
This unaudited Form 10-Q covers the three and six months ended June 30, 2015, compared with the corresponding 2014 periods. The company had 10,091,822 common shares outstanding at June 30, 2015.
Financial Performance and Key Metrics
| Metric | Three Months Ended June 30 | Six Months Ended June 30 |
|---|---|---|
| Net sales | $21.636 million, up 8.9% | $42.609 million, up 17.0% |
| Gross profit | $13.338 million | $25.728 million |
| Gross margin | 61.7%, versus 57.6% | 60.4%, versus 56.9% |
| Operating profit | $5.384 million, up 25.4% | $10.091 million, up 33.5% |
| Operating margin | 24.9%, versus 21.6% | 23.7%, versus 20.7% |
| Net income attributable to Omega Flex | $3.670 million | $6.812 million |
| Basic and diluted EPS | $0.36, versus $0.29 | $0.68, versus $0.50 |
Net income was $3.714 million for the second quarter and $6.899 million for the first six months, including income attributable to the noncontrolling interest of $44,000 and $87,000, respectively. The effective tax rate approximated the prior-year rate and expected statutory rates.
For the six months, cash provided by operating activities was $3.121 million, compared with $2.820 million in 2014. Capital expenditures were $384,000, compared with $69,000, primarily for machinery and leasehold improvements at Exton. Cash used in financing activities was $4.945 million for the special dividend paid in January 2015.
Cash and cash equivalents were $20.430 million at June 30, 2015, compared with $22.585 million at December 31, 2014. The company had no borrowings under its unsecured $15.0 million Santander revolving credit facility and was in compliance with its debt covenants. The facility matures December 31, 2019; the applicable borrowing rate at quarter-end would have been 1.63%.
Material Changes Versus the Prior Comparable Period
- Sales growth was driven primarily by higher unit volume in flexible gas piping, modest residential construction growth, newer products and increased European activity.
- Gross margins expanded due to raw-material pricing relief in the second quarter, factory efficiencies and a customer price increase implemented at the beginning of 2015. For the six-month period, higher strip-metal costs partially offset these benefits.
- Selling expense increased to $3.815 million in the second quarter and $7.590 million year to date, mainly from higher commissions and staffing costs. Selling expense was 17.6% of second-quarter sales and 17.8% year to date.
- General and administrative expense increased to $3.419 million in the second quarter and $6.696 million year to date. The year-to-date increase included $1.220 million of higher legal and insurance costs primarily related to product liability claims and coverage.
- Cash declined from year-end primarily because of the $4.945 million special dividend and payments of previously accrued raw-material purchases, incentive compensation and other expenses.
- Inventory increased to $8.236 million from $7.364 million at year-end, while total liabilities declined to $12.711 million from $21.169 million, largely reflecting payment of the dividend and accrued year-end obligations.
Outlook, Risks, Contingencies and Unusual Items
Management stated that existing cash and cash equivalents should be sufficient to meet anticipated cash needs for at least the next twelve months. No specific revenue or earnings guidance was provided. Future capital needs may depend on revenue growth, expansion, acquisitions, complementary products and additional capacity; no known material capital expenditure commitments were reported.
- Product liability claims remain a material uncertainty. Insurance generally covers claims subject to deductibles or self-insured retentions of approximately $25,000 to $250,000 per claim. Aggregate maximum exposure for current open claims was estimated at approximately $4.7 million, although the ultimate liability cannot be estimated. Recorded related liabilities were $412,000 at June 30, 2015.
- Two putative class actions concerning alleged risks associated with TracPipe CounterStrike were dismissed in 2014, primarily for lack of jurisdiction.
- The company has a $213,000 long-term asset related to an insurance-premium fraud and court-ordered restitution; the amount ultimately recoverable remains uncertain.
- One significant customer represented more than 10% of sales and accounts receivable. Sales are concentrated in the United States, creating customer and geographic concentration risk.
- Forward-looking risks include weather, construction and general economic conditions, regulatory changes, customer preferences, competition, product liability litigation and environmental matters.
- The company recorded $807,000 of phantom-stock liabilities at June 30, 2015 and had $613,000 of unrecognized compensation cost expected to be recognized through March 2018.
- The company was evaluating the future impact and transition method for the new revenue-recognition standard, effective for the company in fiscal 2018, and had not determined the effect of the inventory-measurement update effective after December 15, 2016.
Management concluded that disclosure controls and procedures were effective as of the end of the second quarter, with no material changes to internal control over financial reporting. No material subsequent events were reported through the filing date.
Important Facts for Investors to Verify
- Whether sales growth and expanded gross margins are sustainable amid raw-material price changes and construction-market conditions.
- The development, insurance coverage and ultimate financial exposure of product liability claims, including the estimated $4.7 million aggregate maximum exposure.
- The concentration represented by the significant customer and the company’s reliance on U.S. markets and independent sales organizations.
- Cash generation after special dividends, working-capital payments and increased capital expenditures.
- The recoverability of the $213,000 insurance-fraud-related asset and any future collection costs.
- The eventual accounting and financial statement impact of the pending revenue-recognition and inventory-accounting standards.