Omega Flex, Inc. — Q1 2018 Form 10-Q Summary
Business Context and Reporting Period
Omega Flex manufactures and sells flexible metal hose, corrugated tubing, proprietary fittings and accessories for construction, industrial, healthcare, petrochemical and other applications. Products are manufactured in Exton, Pennsylvania and Banbury, United Kingdom, and sold primarily through distributors, wholesalers and OEMs in North America and Europe. The filing covers the unaudited three months ended March 31, 2018, compared with the three months ended March 31, 2017.
Key Financial Metrics
| Metric | Q1 2018 | Q1 2017 | Change |
|---|---|---|---|
| Net sales | $25.397 million | $25.607 million | (0.8%) |
| Gross profit | $15.033 million | $15.336 million | (2.0%) |
| Gross margin | 59.2% | 59.9% | (70 bps) |
| Operating profit | $5.500 million | $6.204 million | (11.4%) |
| Operating margin | 21.7% | 24.2% | (250 bps) |
| Net income attributable to Omega Flex | $4.163 million | $4.138 million | 0.6% |
| Basic and diluted EPS | $0.41 | $0.41 | Flat |
| Net cash used in operating activities | $0.107 million | $0.176 million | Improved by $0.069 million |
| Capital expenditures | $0.397 million | $2.675 million | Down $2.278 million |
Income before taxes was $5.587 million versus $6.188 million. Income tax expense declined to $1.384 million from $2.005 million, reflecting the lower U.S. federal tax rate under the Tax Cuts and Jobs Act and other tax-law effects. Other comprehensive income was $0.430 million, primarily from foreign-currency translation.
At March 31, 2018, cash and cash equivalents were $35.579 million, compared with $37.938 million at December 31, 2017. The company had a $15.0 million unsecured revolving credit facility maturing December 1, 2022, with no borrowings outstanding and compliance with all debt covenants. Management stated that existing cash and cash equivalents should meet anticipated needs for at least the next twelve months.
Material Changes Versus the Prior Comparable Period
- Sales were essentially flat, which management attributed partly to a 4% decline in seasonally adjusted housing starts and possible customer purchases ahead of a 2017 price increase.
- Gross margin declined modestly because of slightly higher manufacturing expenses.
- Selling expense increased 2.5%, general and administrative expense increased 1.8%, and engineering expense increased 27.5% to $1.030 million, partly due to development of the MediTrac medical tubing product.
- Operating profit declined 11.4% despite relatively stable sales, reflecting higher operating expenses and slightly lower gross margin.
- Net income attributable to Omega Flex increased modestly because the lower tax expense substantially offset the decline in operating profit.
- Operating cash usage improved modestly. Investing cash usage declined primarily because the company purchased its Exton facility for approximately $2.5 million in February 2017.
- The company paid a regular quarterly dividend of $2.220 million, or $0.22 per share, in January 2018. No dividend payable remained at March 31, 2018.
Guidance, Outlook, Risks and Unusual Items
The filing does not provide quantified revenue, earnings or margin guidance. Management cited housing activity, general economic conditions, customer preferences, competition, regulatory developments, weather and litigation outcomes as factors that could affect future results.
- Product-liability and putative class-action litigation remains outstanding, primarily involving alleged lightning damage to flexible gas piping products. Management believes the claims lack merit and is vigorously defending them.
- A February 2018 appellate ruling vacated a prior strict-liability verdict and remanded the case for a new trial. The company expects the related $1.6 million cash bond to be returned.
- Aggregate potential exposure for current open claims within insurance deductibles or retentions was estimated at approximately $4.0 million, but the ultimate liability cannot currently be estimated. Recorded related liabilities were $0.215 million at March 31, 2018.
- One customer represented more than 10% of both quarterly sales and accounts receivable, creating customer-concentration risk.
- The company adopted ASC Topic 606 using the modified retrospective approach effective January 1, 2018. The adoption had no material financial statement impact.
- The company plans to adopt the new lease standard, ASC Topic 842, effective January 1, 2019. It expects additional assets and liabilities, primarily for real-estate operating leases, but had not quantified the impact.
- In April 2018, a foreign subsidiary paid an approximately $10.0 million dividend, most of which was received by the parent; management stated that consolidated net cash was largely unchanged.
- Disclosure controls and procedures were evaluated as effective, with no material changes to internal control over financial reporting.
Facts Investors Should Verify
- Whether sales growth improves as housing and construction conditions change, and whether the 2017 customer buy-ahead effect distorts comparisons.
- Whether engineering and other operating expenses, particularly MediTrac-related spending, produce corresponding revenue growth.
- The sustainability of the approximately 59% gross margin and 22% operating margin profile.
- Future cash generation after regular dividends, capital expenditures and any litigation-related payments.
- The status and ultimate cost of product-liability and class-action matters, including recovery of the $1.6 million bond.
- The effect of ASC 842 on reported assets, liabilities and leverage after adoption in 2019.
- The company’s dependence on its significant customer and North American sales concentration.