Omega Flex, Inc. — Q3 2020 Form 10-Q Summary
Business context and reporting period
Omega Flex manufactures and sells flexible metal hose, corrugated tubing, proprietary fittings, and accessories for residential and commercial construction, industrial, healthcare, petrochemical, transportation, and other applications. The company operates as one segment, with manufacturing facilities in Pennsylvania, Texas, and the United Kingdom, and sells primarily through distributors, wholesalers, and OEMs.
This unaudited Form 10-Q covers the three and nine months ended September 30, 2020, compared with the corresponding 2019 periods. The filing was signed October 30, 2020. The company had 10,094,322 common shares outstanding at September 30, 2020.
Financial results and key metrics
| Metric | Q3 2020 | Q3 2019 | 9M 2020 | 9M 2019 |
|---|---|---|---|---|
| Net sales | $27.087 million | $28.030 million | $74.171 million | $81.627 million |
| Gross profit | $17.266 million | $17.704 million | $46.297 million | $51.386 million |
| Gross margin | 63.7% | 63.2% | 62.4% | 63.0% |
| Operating profit | $6.379 million | $4.373 million | $17.110 million | $15.108 million |
| Operating margin | 23.6% | 15.6% | 23.1% | 18.5% |
| Net income attributable to Omega Flex | $4.817 million | $3.368 million | $12.732 million | $11.733 million |
| Basic and diluted EPS | $0.48 | $0.33 | $1.26 | $1.16 |
For Q3, sales declined 3.4%, while operating profit increased 45.9% and attributable net income increased approximately 43.1%. For the first nine months, sales declined 9.1%, while operating profit increased 13.3% and attributable net income increased approximately 8.5%.
Q3 selling expense declined 25.9% to $3.991 million, general and administrative expense declined 12.3% to $5.951 million, and engineering expense declined 18.7% to $0.945 million. The company attributed the reductions primarily to lower commissions, travel and trade-show spending, reduced legal and product-liability defense costs, and lower experimental-material costs. Q3 results also benefited from the absence of $654,000 of atypical consulting costs recorded in Q3 2019.
Nine-month income tax expense was $4.188 million versus $3.896 million in 2019. Net interest was an expense of $46,000 in 2020 versus interest income of $685,000 in 2019, reflecting lower invested cash balances and temporary borrowing during the second quarter.
Cash flow, balance sheet, debt, and liquidity
- Cash and cash equivalents were $18.577 million at September 30, 2020, up from $16.098 million at December 31, 2019.
- Operating cash flow was $11.341 million for the first nine months, compared with $9.673 million in 2019.
- Capital expenditures were $381,000, compared with $1.022 million in 2019.
- Dividends paid were $8.479 million, compared with $7.807 million in 2019. The company declared a regular quarterly dividend of $0.28 per share in September 2020.
- Total assets were $63.386 million and total liabilities were $21.588 million at September 30, 2020. Shareholders’ equity was $41.798 million.
- The company had no outstanding borrowings under its unsecured $15 million revolving credit facility at September 30, 2020. It temporarily borrowed the full $15 million during the second quarter to preserve liquidity during the COVID-19 crisis and repaid the amount before quarter-end.
- The company received $2.453 million under the Paycheck Protection Program in April 2020 but repaid the loan by May 7, 2020 after subsequent government guidance regarding publicly traded companies with other financing resources.
- Management stated that cash and available borrowing capacity should be sufficient to meet anticipated needs for at least the next twelve months.
Material changes versus the prior comparable period
- Revenue decreased because of lower unit volume, partially offset by pricing actions intended to offset material-cost pressure and protect margins.
- Q3 gross margin improved to 63.7% from 63.2%, but nine-month gross margin decreased to 62.4% from 63.0%, principally because lower production during the COVID-19-affected second quarter reduced labor and overhead absorption.
- Operating margins expanded substantially because expense reductions more than offset the decline in sales.
- Legal and product-liability defense costs declined materially following a slowdown and favorable summary judgment in a Missouri putative class action during the third quarter. Plaintiffs appealed the dismissal.
- Accounts receivable declined to $16.319 million from $17.047 million at year-end, while inventories increased to $11.429 million from $11.078 million. The allowance for credit losses declined to $1.013 million from $1.433 million.
- Accumulated dividends declared during the first nine months totaled $8.479 million, compared with $8.074 million in 2019.
Guidance, outlook, risks, contingencies, and unusual items
The filing does not provide quantitative full-year revenue or earnings guidance. Management reported that sales progressively improved after the early part of the second quarter and that the company maintained a reasonable level of sales and profitability, but cautioned that 2020 results were not necessarily indicative of full-year or future performance.
- COVID-19 remains the principal operating uncertainty, with potential effects on employees, customers, suppliers, distribution channels, demand, production, staffing, supply chains, and remote-work capabilities. Management stated that the duration, severity, and overall financial impact cannot be reasonably estimated.
- One customer represented more than 10% of accounts receivable and more than 10% of sales in both 2020 and 2019, creating customer-concentration risk.
- Pending product-liability and other claims generally carry insurance deductibles or retentions of approximately $25,000 to $2.000 million per claim. Aggregate maximum exposure for current open claims, excluding the Missouri class action, was estimated at approximately $7.1 million, although the ultimate liability cannot be estimated.
- The company recorded a reserve of approximately $452,000 for United Kingdom legal costs, against an estimated potential loss of £200,000 to £500,000.
- Recorded liabilities for litigation-related matters were $214,000 at September 30, 2020. The company stated that these amounts primarily represent accrued legal costs and anticipated settlements.
- No goodwill impairment triggering event was identified during the first nine months, but a prolonged pandemic could require an interim impairment test and potentially result in an impairment charge.
- Operating lease liabilities totaled $534,000, including $275,000 current, with future minimum payments of $534,000.
- The company had 13,252 unvested phantom stock units and a related liability of $3.283 million at September 30, 2020. Remaining unrecognized compensation cost was $1.474 million, expected to be recognized through August 2023.
- Management reported effective disclosure controls and no material change in internal control over financial reporting.
Most important facts for investors to verify
- Whether COVID-19 caused renewed volume, production, staffing, or supply-chain disruption after September 30, 2020.
- Whether the company can sustain the Q3 operating margin improvement despite lower year-to-date sales and reduced production absorption.
- The status and potential financial exposure of the Missouri class-action appeal and other product-liability claims.
- The continuing significance of the customer representing more than 10% of sales and receivables.
- Future dividend decisions, including whether regular dividends will continue at the $0.28-per-share rate and whether special dividends will be declared.
- Cash generation, utilization of the $15 million credit facility, and compliance with debt covenants.
- Potential goodwill impairment, phantom-stock cash requirements, lease payments, and other contractual obligations.