Omega Flex, Inc. — 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 Pennsylvania and the United Kingdom.
This report covers the three and six months ended June 30, 2017, compared with the corresponding 2016 periods. The financial statements are unaudited and prepared under U.S. GAAP.
Key Financial Metrics
| Metric | Three Months Ended June 30 | Six Months Ended June 30 |
|---|---|---|
| Net sales | $23.805 million; essentially flat versus $23.840 million | $49.412 million, up 11.1% from $44.466 million |
| Gross profit | $14.142 million; margin of 59.4% | $29.478 million; margin of 59.7% |
| Operating profit | $4.435 million; margin of 18.6% | $10.639 million; margin of 21.5% |
| Net income | $3.084 million | $7.267 million |
| Net income attributable to Omega Flex | $3.034 million; $0.30 diluted EPS | $7.172 million; $0.71 diluted EPS |
| Operating cash flow | Not separately provided for the quarter | $4.355 million versus $4.378 million |
At June 30, 2017, cash and cash equivalents were $28.568 million, compared with $35.318 million at December 31, 2016. The Company had no borrowings under its unsecured $15 million revolving credit facility, which matures December 31, 2019, and was in compliance with its debt covenants.
Total assets were $67.465 million and total liabilities were $15.932 million at June 30, 2017. Current assets were $53.554 million versus current liabilities of $14.459 million. Inventory increased to $8.474 million from $7.372 million at year-end, while accounts receivable were $15.128 million. Shareholders’ equity increased to $51.533 million from $46.061 million.
Cash Flow, Capital Allocation and Liquidity
- Operating activities generated $4.355 million during the first six months, approximately unchanged from the prior-year period.
- Investing activities used $2.862 million, primarily reflecting the approximately $2.5 million purchase of an Exton, Pennsylvania building previously leased by the Company.
- Financing activities used $8.578 million for payment of the special dividend declared in December 2016.
- The Board declared a regular quarterly dividend of $0.22 per share, or approximately $2.220 million, payable in July 2017. Management stated that existing cash should be sufficient for anticipated needs for at least the next twelve months.
Material Changes Versus the Prior Comparable Period
- Second-quarter sales were essentially unchanged, but higher customer promotional incentives reduced reported net sales.
- Second-quarter gross margin declined to 59.4% from 61.6%, primarily because of higher raw material costs.
- Second-quarter operating profit declined 22.1% to $4.435 million. Selling, general and administrative, and engineering expenses all increased; general and administrative expense also reflected higher phantom stock-related expense and insurance costs.
- Six-month sales increased 11.1%, primarily from higher unit volume. Six-month operating profit increased 9.5% to $10.639 million, despite gross margin declining to 59.7% from 61.1%.
- Six-month net income increased to $7.267 million from $6.444 million, while net income attributable to Omega Flex increased to $7.172 million from $6.356 million.
- Foreign-currency effects improved versus 2016: other income was $18,000 in the second quarter compared with a $132,000 loss, and the six-month loss narrowed to $22,000 from $178,000.
- Property and equipment increased 59.8% from year-end due largely to the building acquisition. Cash declined 19.1%, primarily because of the special dividend, capital spending and payments of year-end accrued compensation and other obligations.
Guidance, Outlook, Risks and Unusual Items
The filing does not provide quantitative revenue or earnings guidance. Management expects existing cash and available credit to meet anticipated needs for at least the next twelve months and identifies future capital requirements as dependent on revenue growth, expansion, acquisitions and facility needs. No material capital expenditure commitments were identified.
- The Company faces lawsuits, investigations and product-liability claims, primarily involving alleged lightning damage associated with flexible gas piping products. Management believes the claims lack merit and is defending them.
- Insurance coverage is subject to deductibles or self-insured retentions generally ranging from $25,000 to $1 million per claim. Aggregate maximum exposure for current open claims was estimated at approximately $4 million, although the ultimate liability cannot be predicted. Recorded liabilities for these matters were $337,000 at June 30, 2017.
- Approximately $1.6 million of collateral remains posted in connection with an appeal of a Pennsylvania product-liability matter and is included in other long-term assets.
- One customer represented more than 10% of sales and accounts receivable in both 2017 and 2016, creating customer-concentration risk.
- Phantom stock compensation expense was $468,000 in the first six months, up from $296,000, and the related liability was $1.664 million at June 30, 2017.
- The Company expects adoption of the new revenue-recognition standard in the first quarter of 2018 to have no significant impact, if any. The impact of the new lease standard, effective for the Company after December 15, 2018, had not yet been determined.
- Management reported effective disclosure controls and procedures and no material change in internal control over financial reporting.
Investor Verification Priorities
- Verify whether higher raw material costs and promotional incentives continue to pressure gross margins and quarterly profitability.
- Review the sustainability of the new $0.22 quarterly dividend relative to operating cash flow, capital spending and litigation needs.
- Assess customer concentration and the effect of construction and industrial-market demand on unit volumes.
- Monitor product-liability litigation, insurance retentions, the approximately $4 million estimated aggregate exposure and the $1.6 million appeal collateral.
- Confirm the cash impact and operating benefits of the Exton building acquisition.
- Track phantom stock expense and liability volatility, which are affected by the Company’s share price.