Omega Flex, Inc. — 2016 Third-Quarter Form 10-Q Summary
Business context and reporting period
Omega Flex manufactures and sells flexible metal hose, flexible gas piping and related fittings for residential and commercial construction, general industrial, petrochemical, pharmaceutical and other markets. Products are manufactured in the United States and United Kingdom and sold primarily through independent sales representatives, wholesalers and distributors. The company reports one operating segment.
This filing covers the three and nine months ended September 30, 2016. The condensed consolidated financial statements are unaudited and prepared under U.S. GAAP.
Financial performance and condition
| Metric | Q3 2016 | Q3 2015 | 9M 2016 | 9M 2015 |
|---|---|---|---|---|
| Net sales | $23.942 million | $24.556 million | $68.408 million | $67.165 million |
| Gross profit | $14.777 million | $15.286 million | $41.958 million | $41.014 million |
| Gross margin | 61.7% | 62.2% | 61.3% | 61.1% |
| Operating profit | $5.847 million | $6.377 million | $15.561 million | $16.468 million |
| Net income attributable to Omega Flex | $3.888 million | $4.232 million | $10.244 million | $11.044 million |
| Basic and diluted EPS | $0.39 | $0.42 | $1.02 | $1.09 |
- Q3 sales decreased 2.5%, primarily because of lower unit volume. Nine-month sales increased 1.9%, primarily from higher unit volume.
- Q3 operating profit declined 8.3%; nine-month operating profit declined 5.5%. Nine-month general and administrative expense increased 14.0%, driven mainly by higher legal and insurance costs associated with product liability claims and coverage.
- Engineering expense increased 17.1% in Q3 and 12.6% for the nine-month period, reflecting product and process development activity.
- Other expense increased to $110,000 in Q3 and $288,000 for the nine-month period, primarily from foreign-currency losses related to the weakened British pound following the United Kingdom’s Brexit vote.
- Cash provided by operating activities was $7.325 million for the first nine months, compared with $7.050 million in 2015. Capital expenditures were $191,000, compared with $456,000 in the prior-year period.
- Cash and cash equivalents were $28.165 million at September 30, 2016, down from $30.152 million at December 31, 2015. The company had no borrowings under its unsecured $15.0 million revolving credit facility and was in compliance with debt covenants.
- Total assets were $64.399 million and total shareholders’ equity was $50.791 million at September 30, 2016. Current liabilities were $11.810 million, compared with $23.552 million at year-end, primarily because the $8.578 million special dividend payable at year-end was paid in January 2016.
Material changes versus the prior comparable periods
- Q3 revenue, operating profit, net income and EPS declined versus Q3 2015, while nine-month revenue increased but profitability and EPS declined.
- Nine-month gross margin improved modestly to 61.3% from 61.1%; Q3 gross margin decreased to 61.7% from 62.2%.
- Accounts receivable decreased 8.1% and inventory decreased 18.3% from December 31, 2015. Management attributed the inventory reduction to a program intended to lower carrying costs and increase cash, stating that inventory remained sufficient for demand.
- Other long-term assets increased $1.620 million, primarily because approximately $1.6 million was posted as security in connection with an appeal of a Pennsylvania product-liability matter.
- The company received $282,000 of restitution related to an insurance-premium fraud; $213,000 relieved a previously recorded asset and $69,000 reduced operating expenses.
- The company paid a $0.85-per-share special dividend totaling $8.578 million in January 2016. No share repurchases were made during 2016 through the filing date.
Guidance, outlook, risks and unusual items
No specific revenue, earnings or margin guidance was provided. Management stated that existing cash and cash equivalents should be sufficient to meet anticipated cash needs for at least the next twelve months and identified no known material capital-expenditure commitments.
- Pending product-liability and related litigation remains a significant contingency. Management believes the claims lack merit and is vigorously defending them, but cannot predict the ultimate liability. Aggregate maximum exposure within applicable insurance deductibles or retentions was estimated at approximately $4.1 million; recorded related liabilities were $277,000 at September 30, 2016.
- Legal and insurance spending increased during the first nine months and could remain elevated through the remainder of 2016 and future years. The company also paid $2.143 million for annual insurance premiums during Q3.
- A putative class action in the Western District of Missouri remains pending; the company filed a motion to dismiss.
- One significant customer represented more than 10% of sales and accounts receivable in both periods. The filing does not identify the customer or provide the precise percentage.
- Foreign-exchange movements, construction and general economic conditions, weather, regulatory changes, customer preferences, competition and litigation outcomes could materially affect results.
- The company is evaluating upcoming accounting standards covering revenue recognition, inventory measurement and leases; the expected impact of the revenue and lease standards had not been determined.
- Management reported effective disclosure controls and procedures and no material change in internal control over financial reporting during the quarter.
Most important facts for investors to verify
- Whether product-liability litigation costs, insurance premiums and potential claim exposures continue to pressure operating margins and liquidity.
- The identity and financial significance of the major customer concentration.
- Whether the Q3 volume decline is temporary or indicates weakening demand in construction and industrial markets.
- The recoverability and timing of the approximately $1.6 million litigation security deposit.
- The sustainability of operating cash flow after special dividends, working-capital changes and litigation-related cash requirements.
- The company’s eventual transition approach and financial impact for the new revenue-recognition and lease-accounting standards.