Omega Flex, Inc. — Fiscal 2018 Form 10-K Summary
Reporting period: Fiscal year ended December 31, 2018. The filing is an annual report, not a quarterly filing, but it includes unaudited fourth-quarter information. Omega Flex manufactures and sells flexible metal hose and accessories as one operating segment, with primary exposure to residential and commercial construction and general industrial markets.
Business Context
- Core products include TracPipe and CounterStrike flexible gas piping, AutoFlare and AutoSnap fittings, DoubleTrac and DEF-Trac containment piping, and the newly launched MediTrac corrugated medical tubing.
- Products are manufactured primarily in Exton, Pennsylvania, and Banbury, England, and are sold mainly through independent representatives, distributors, wholesalers and OEMs.
- North America represented approximately 90% of sales. Ferguson Enterprises represented approximately 13%–15% of sales and 19%–22% of accounts receivable during the relevant periods.
Financial Performance and Liquidity
| Metric | 2018 | 2017 | Change |
|---|---|---|---|
| Net sales | $108.313 million | $101.799 million | +6.4% |
| Gross profit | $66.096 million | $61.766 million | +7.0% |
| Gross margin | 61.0% | 60.7% | +0.3 percentage points |
| Operating profit | $26.366 million | $24.217 million | +8.9% |
| Operating margin | 24.3% | 23.8% | +0.5 percentage points |
| Net income attributable to Omega Flex | $20.139 million | $15.662 million | +28.6% |
| Basic and diluted EPS | $2.00 | $1.55 | +29.0% |
| Cash flow from operations | $21.058 million | $18.048 million | +16.7% |
| Capital expenditures | $1.924 million | $3.093 million | −37.8% |
- Approximate 2018 net margin was 18.6%, compared with 15.4% in 2017.
- Cash and cash equivalents were $32.392 million, and short-term investments were $14.944 million, totaling $47.336 million of liquid resources.
- Working capital was $55.217 million, compared with $45.372 million in 2017; the implied current ratio was approximately 4.0 times.
- The Company had no borrowings under its $15.0 million unsecured revolving credit facility, which matures December 1, 2022, and was in compliance with debt covenants.
- Total assets were $86.836 million and shareholders’ equity was $66.321 million at December 31, 2018.
- Dividends declared increased to $0.94 per share from $0.66 per share. Regular quarterly dividends totaled approximately $9.486 million, and total dividends paid, including the foreign subsidiary’s noncontrolling-interest dividend, were $9.775 million.
Material Changes Versus 2017
- Sales growth reflected higher unit volume and pricing actions implemented to offset increased material costs.
- Nickel and other core component costs increased, but pricing actions helped maintain relatively stable margins.
- Engineering expense increased 46.2% to $4.813 million, primarily due to experimental materials, staffing and consulting related to MediTrac development.
- Selling expense increased 4.6%, while general and administrative expense decreased 0.5%. Selling expense as a percentage of sales declined to 15.8% from 16.1%, and general and administrative expense declined to 16.4% from 17.6%.
- Interest income increased to $488,000 from $117,000 as the Company invested excess cash in short-term instruments.
- Income tax expense declined to $6.451 million from $8.450 million, reflecting the Tax Cuts and Jobs Act, including the reduction in the U.S. corporate tax rate to 21%. The 2017 amount included a one-time charge primarily related to unremitted foreign earnings.
- Cash decreased by $5.546 million, primarily because the Company purchased short-term investments, paid dividends and funded capital projects. Operating cash generation increased by $3.010 million.
- Fourth-quarter 2018 sales were $28.870 million, gross profit was $18.302 million and net income attributable to Omega Flex was $6.024 million, compared with $27.464 million, $17.081 million and $4.476 million, respectively, in fourth-quarter 2017.
Outlook, Risks and Unusual Items
- MediTrac completed several beta sites during 2018, with full commercialization expected to commence in 2019. Management stated that the product can materially improve installation efficiency relative to rigid copper pipe.
- Management believes existing cash and cash equivalents will satisfy anticipated cash needs for at least the next twelve months. Future requirements may depend on growth, expansion, acquisitions and complementary product investments.
- The Company is highly dependent on TracPipe and CounterStrike flexible gas piping, exposing it to product, code, distributor, competitive, construction-cycle and commodity-price risks.
- Raw-material supply is generally considered sufficient, but the Company relies on one or two sources for certain key materials and components, including stainless steel and fittings. Price increases may not always be recoverable through customer pricing.
- Pending product-liability and other claims primarily relate to alleged lightning damage involving flexible gas piping. The Company believes the claims lack merit and is defending them. Estimated maximum exposure within insurance deductibles or retentions for open claims was approximately $1.7 million, while recorded liabilities were $150,000.
- A prior Pennsylvania case was settled and closed in August 2018; a $1.6 million cash bond associated with the appeal was returned in May 2018. A putative class action filed in Missouri remained pending.
- Brexit could increase logistics, customs and material costs for the U.K. operation, although management did not expect the impact to be material. The Company stockpiled supplies and planned to stage some finished goods in European warehouses.
- The Company adopted ASC 606 using the modified retrospective method with no material impact. Adoption of the lease standard on January 1, 2019 was expected to increase operating lease assets and liabilities by approximately $800,000, with no material effect on earnings or cash flows.
- The independent auditor issued unqualified opinions on the financial statements and internal control over financial reporting. Management concluded that disclosure controls and internal controls were effective.
Investor Verification Items
- Verify the sustainability of sales growth, pricing benefits and gross-margin performance amid stainless-steel, nickel, copper and component-cost volatility.
- Track MediTrac commercialization, customer adoption, required approvals and its contribution to revenue and profitability.
- Assess customer and channel concentration, particularly Ferguson Enterprises and the independent distributor network.
- Monitor the pending class action, other product-liability claims, insurance retentions and any changes to recorded reserves.
- Review construction activity, housing starts, interest rates, seasonality and macroeconomic conditions affecting demand.
- Confirm the impact of ASC 842 lease adoption and the Company’s continuing cash investment and dividend policies.
- Evaluate Brexit, foreign-currency exposure and the Company’s reliance on concentrated manufacturing locations and key suppliers.