Omega Flex, Inc. — 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. The company operates as one segment, with manufacturing facilities in Exton, Pennsylvania and Banbury, United Kingdom. This report covers the three and six months ended June 30, 2016; the financial statements are unaudited.
Financial Results and Liquidity
| Metric | Three Months Ended June 30 | Six Months Ended June 30 |
|---|---|---|
| Net sales | $23.840 million vs. $21.636 million | $44.466 million vs. $42.609 million |
| Gross profit | $14.689 million vs. $13.338 million | $27.181 million vs. $25.728 million |
| Gross margin | 61.6% vs. 61.7% | 61.1% vs. 60.4% |
| Operating profit | $5.693 million vs. $5.384 million | $9.714 million vs. $10.091 million |
| Operating margin | 23.9% vs. 24.9% | 21.9% vs. 23.7% |
| Net income attributable to Omega Flex | $3.713 million vs. $3.670 million | $6.356 million vs. $6.812 million |
| Basic and diluted EPS | $0.37 vs. $0.36 | $0.63 vs. $0.68 |
Six-month operating cash flow was $4.378 million, compared with $3.121 million in the prior-year period. Capital expenditures were $91,000 versus $384,000, producing net cash used in investing activities of $91,000. Financing cash outflow was $8.578 million, reflecting payment of the $0.85-per-share special dividend declared in December 2015.
Cash and cash equivalents were $25.423 million at June 30, 2016, down from $30.152 million at December 31, 2015. The company had no borrowings under its unsecured $15 million 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 needs for at least the next twelve months.
Total assets were $59.436 million and total liabilities were $12.452 million at June 30, 2016. Accounts receivable were $14.505 million, inventories were $7.208 million and shareholders’ equity was $46.984 million.
Material Changes Versus Prior Comparable Period
- Second-quarter sales increased 10.2%, primarily from higher unit volume. Six-month sales increased 4.4%.
- Second-quarter gross margin was broadly stable, while six-month gross margin improved by 70 basis points because of stable manufacturing costs and modest strip-metal savings.
- Six-month operating profit declined 3.7% despite higher sales, primarily because general and administrative expense increased 22.8%, including a $989,000 increase in legal and insurance costs related to product liability claims and coverage.
- Second-quarter general and administrative expense increased 26.3%, including $574,000 of additional legal and insurance costs and higher staffing-related incentive compensation.
- Foreign-currency losses increased following the weakening of the British pound after the United Kingdom’s vote to exit the European Union. Other expense was $178,000 for the first six months of 2016 versus $1,000 of other income in the prior-year period.
- Cash from operations increased $1.257 million year over year, supported by stronger collections and lower inventory purchases.
- Other long-term assets increased $1.587 million to $2.892 million, primarily because the company posted $1.600 million of security in connection with an appeal involving a product-liability claim.
Outlook, Risks, Contingencies and Unusual Items
The filing does not provide quantitative revenue or earnings guidance. Management expects cash resources to cover anticipated requirements for at least the next twelve months, but future capital needs may depend on revenue growth, expansion, acquisitions and capacity investments. No material capital expenditure commitments were identified.
- The company faces product-liability and lightning-subrogation claims. It estimates aggregate maximum exposure for current open claims at approximately $4.0 million within applicable insurance deductibles or retentions, but cannot estimate ultimate liability. Recorded related liabilities were $371,000 at June 30, 2016.
- The company posted $1.600 million of collateral for an appeal related to a 2010 Pennsylvania claim. Litigation outcomes could adversely affect operations, liquidity and insurance costs.
- The company received $282,000 of restitution related to an insurance-premium fraud; $213,000 reduced the related asset balance and $69,000 reduced operating expenses.
- One customer represented more than 10% of sales and accounts receivable in the reported periods. Sales are concentrated geographically in the United States.
- Key estimates include revenue recognition and sales incentives, receivable allowances, inventory valuation, goodwill impairment, product-liability reserves, phantom-stock compensation and income taxes.
- The company had no material subsequent events through the filing date. Management concluded that disclosure controls and procedures were effective and reported no material change in internal control over financial reporting.
Facts Investors Should Verify
- Whether product-liability litigation costs and potential claims remain elevated beyond the $4.0 million estimated aggregate exposure.
- The status and ultimate resolution of the Pennsylvania appeal and release of the $1.600 million security deposit.
- The sustainability of sales-volume growth and the effect of customer concentration.
- Whether higher legal, insurance, incentive-compensation and engineering costs continue to pressure operating margins.
- The effect of British-pound volatility on other income, comprehensive income and shareholders’ equity.
- The company’s future dividend policy and ability to fund dividends while maintaining cash reserves and no revolver borrowings.
- The eventual impact of pending accounting standards for revenue recognition, inventory measurement and leases.