Omega Flex, Inc. — 2017 Third-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. The company operates as one segment, with manufacturing primarily in Exton, Pennsylvania and Banbury, United Kingdom.
This unaudited Form 10-Q covers the three and nine months ended September 30, 2017, compared with the corresponding 2016 periods. The filing was signed November 6, 2017. Shares outstanding at September 30, 2017 were 10,091,822.
Key Financial Metrics
| Metric | Q3 2017 | Q3 2016 | 9M 2017 | 9M 2016 |
|---|---|---|---|---|
| Net sales | $24.9 million | $23.9 million | $74.3 million | $68.4 million |
| Gross profit | $15.2 million | $14.8 million | $44.7 million | $42.0 million |
| Gross margin | 61.0% | 61.7% | 60.1% | 61.3% |
| Operating profit | $5.9 million | $5.8 million | $16.5 million | $15.6 million |
| Operating margin | 23.7% | 24.4% | 22.3% | 22.8% |
| Net income attributable to Omega Flex | $4.0 million | $3.9 million | $11.2 million | $10.2 million |
| Basic and diluted EPS | $0.40 | $0.39 | $1.11 | $1.02 |
For the nine months, net sales increased 8.7%, operating profit increased 6.4%, and net income attributable to Omega Flex increased approximately 9.2%. The effective tax rate was approximately consistent with the prior year and expected statutory rates.
Operating expenses for the nine months included $12.4 million of selling expense, $13.3 million of general and administrative expense and $2.5 million of engineering expense. Phantom stock compensation expense increased to approximately $855,000 from $409,000, primarily reflecting the higher stock price.
Cash Flow, Balance Sheet, Debt and Liquidity
- Cash and cash equivalents were $31.6 million at September 30, 2017, compared with $35.3 million at December 31, 2016.
- Cash provided by operating activities was $9.4 million for the first nine months of 2017, up from $7.3 million in the comparable 2016 period.
- Capital expenditures were $3.0 million, including approximately $2.5 million for the February 2017 purchase of an Exton, Pennsylvania building previously leased by the company.
- Cash dividends paid totaled $10.8 million, consisting of the $8.6 million special dividend paid in January 2017 and a $2.2 million quarterly dividend paid in July 2017.
- Total assets were $71.9 million and total liabilities were $18.3 million at September 30, 2017. Shareholders’ equity was $53.7 million.
- The company had no outstanding borrowings under its unsecured $15.0 million Santander revolving credit facility and was in compliance with its debt covenants.
- Management stated that existing cash and cash equivalents should be sufficient to meet anticipated cash needs for at least the next twelve months. No material capital expenditure commitments were identified.
Material Changes Versus the Prior Comparable Period
- Third-quarter sales rose $1.0 million, or 4.1%, primarily despite higher promotional incentives and sales deductions.
- Nine-month sales growth was primarily volume-driven. Higher raw material costs reduced gross margin, although pricing actions largely offset the increase.
- Nine-month selling expense increased 5.9%, mainly from higher freight, commissions and staffing costs, while selling expense declined as a percentage of sales.
- Nine-month general and administrative expense increased 7.1%, driven by higher incentive compensation, phantom stock expense and insurance costs; lower legal and product-liability defense costs partly offset these increases.
- Foreign-currency results improved materially: other expense was $18,000 for the nine months in 2017 versus $288,000 in 2016, reflecting stabilization of the British pound after the United Kingdom’s Brexit vote.
- Property and equipment increased 59.4% to $7.0 million due primarily to the Exton building acquisition.
- The company began a regular quarterly dividend policy in 2017, declaring $0.22 per share for the second and third quarters. The September 2017 dividend of $2.2 million was payable in October.
Guidance, Outlook, Risks and Unusual Items
The filing does not provide quantitative revenue, earnings or margin guidance. Management expects cash from operations and existing liquidity to fund anticipated needs, but notes that future capital requirements will depend on revenue growth, expansion, acquisitions and facility needs.
- Pending product-liability litigation, including claims involving alleged lightning damage to flexible gas piping and a re-filed Missouri putative class action, remains a significant contingency. Management disputes the claims and is vigorously defending them.
- Insurance deductibles and self-insured retentions generally range from $25,000 to $1.0 million per claim. Aggregate potential exposure for current open claims was estimated at approximately $3.6 million, although the ultimate liability cannot be predicted. Recorded liabilities for these matters were $300,000 at September 30, 2017.
- Approximately $1.6 million of collateral remains posted in connection with an appeal of a Pennsylvania product-liability matter.
- A significant customer represented more than 10% of sales and accounts receivable; the filing states there was no significant change from the prior annual report.
- The company plans to adopt the new revenue recognition standard, ASC 606, on January 1, 2018 using the modified retrospective method and does not expect a material impact.
- The company plans to adopt the new lease standard, ASC 842, on January 1, 2019. It expects additional assets and liabilities, particularly for real estate operating leases, but had not quantified the impact.
- On October 2, 2017, Santander agreed to proposed terms for a new potential $20.0 million unsecured five-year line of credit with slightly more favorable pricing. Formal documents were still being prepared, with finalization expected by December 31, 2017.
- Disclosure controls and procedures were deemed effective, and management reported no material change in internal control over financial reporting during the quarter.
Important Facts for Investors to Verify
- Whether sales growth continues despite promotional incentives, customer concentration and exposure to construction and industrial markets.
- Whether raw material inflation pressures gross margin and whether pricing actions remain sufficient to offset those costs.
- The ultimate outcome and cash impact of pending product-liability litigation, including the estimated $3.6 million aggregate current-claim exposure.
- The sustainability of regular quarterly dividends relative to operating cash flow, capital expenditures and any acquisition or expansion plans.
- The final terms and execution status of the proposed $20.0 million Santander credit facility.
- The quantified balance-sheet impact of ASC 842 lease adoption and the actual effect of ASC 606 adoption beginning in 2018.