Omega Flex, Inc. — Fiscal 2016 Form 10-K Summary
Business context and reporting period
Omega Flex manufactures and sells flexible metal hose and accessories through a single operating segment. Its principal products are TracPipe and CounterStrike flexible gas piping systems, AutoFlare and AutoSnap fittings, and specialty industrial piping. Products are manufactured in Exton, Pennsylvania, and Banbury, United Kingdom, and sold primarily through distributors, wholesalers, independent sales organizations and OEMs.
The filing covers the fiscal year ended December 31, 2016, with quarterly information for the fourth quarter ended December 31, 2016. The Form 10-K was filed March 13, 2017.
Financial performance and position
| Metric | 2016 | 2015 | Change |
|---|---|---|---|
| Net sales | $94.051 million | $93.278 million | Up 0.8% |
| Gross profit | $57.884 million | $57.146 million | Up 1.3% |
| Gross margin | 61.5% | 61.3% | Up 0.2 percentage points |
| Operating profit | $21.897 million | $23.503 million | Down 6.8% |
| Operating margin | 23.3% | 25.2% | Down 1.9 percentage points |
| Net income attributable to Omega Flex | $14.377 million | $15.788 million | Down 8.9% |
| Basic and diluted EPS | $1.42 | $1.56 | Down 9.0% |
| Cash flow from operations | $14.758 million | $13.250 million | Up 11.4% |
Net income was $14.546 million including noncontrolling interests. Estimated net margin attributable to Omega Flex was approximately 15.3%; total net income margin was approximately 15.5%.
- Fourth-quarter sales were $25.643 million, gross profit was $15.926 million, net income attributable to Omega Flex was $4.133 million, and EPS was $0.41.
- Cash and cash equivalents were $35.318 million at year-end, versus $30.152 million in 2015. Working capital was $36.941 million, versus $33.139 million.
- Total assets were $70.562 million and shareholders’ equity was $46.061 million at December 31, 2016.
- Capital expenditures were $233,000. Cash used in financing activities was $8.578 million, primarily reflecting the special dividend paid in January 2016.
- The company had no borrowings under its unsecured $15.0 million revolving credit facility and was in compliance with its debt covenants. The filing states that cash and the available facility are expected to meet anticipated needs for at least the next twelve months.
Material changes versus the prior comparable period
- Sales reached a company record but grew only modestly, partly because certain customers purchased ahead in the fourth quarter of 2015, reducing first-quarter 2016 sales.
- Gross margin improved slightly through stable component pricing and manufacturing performance.
- Operating profit declined because selling expense increased 2.9%, general and administrative expense increased 8.9%, and engineering expense increased 18.7%. Higher legal and insurance costs related to product-liability claims were the primary driver of the general and administrative increase.
- Foreign exchange losses increased to $474,000 from $12,000, primarily due to weakness in the British pound following the United Kingdom’s Brexit vote. Foreign currency translation adjustments reduced other comprehensive income by $1.061 million.
- Accounts receivable decreased to $15.005 million from $16.605 million, while net inventory decreased to $7.372 million from $8.287 million.
- The company posted approximately $1.6 million of security related to an appeal of a Pennsylvania product-liability matter; this amount was included in other long-term assets.
- Research and development expense decreased to $788,000 from $876,000, although total engineering expense increased because of additional project staffing.
Guidance, outlook, risks and unusual items
The filing provides no formal numerical revenue or earnings guidance. Management expects growth opportunities from flexible gas piping, product innovation, broader construction and industrial applications, and international markets, but cautions that results are sensitive to construction activity, weather, interest rates, competition, commodity prices, regulations, currency movements and litigation.
- One customer represented approximately 13% of 2016 sales and 20% of year-end accounts receivable. North America represented approximately 88% of sales.
- The business is concentrated in TracPipe and CounterStrike flexible gas piping, making the company sensitive to distributor relationships, building codes, product liability claims and changes in residential construction.
- Manufacturing capacity is concentrated in Exton, Pennsylvania, and Banbury, United Kingdom. A significant facility disruption could interrupt operations and sales.
- Stainless steel, polyethylene, brass fittings, nickel and copper costs may be volatile, and the company relies on one or two suppliers for certain major components.
- Open product-liability claims, primarily related to lightning subrogation, had an estimated aggregate maximum exposure of approximately $4.3 million within applicable insurance deductibles and retentions. Recorded liabilities for these matters were $273,000 at December 31, 2016.
- The company received $282,000 of restitution related to an insurance-premium fraud and settled a related advisor lawsuit for $132,500. Of the restitution, $69,000 reduced operating expenses.
- In early 2017, the company purchased its previously leased 30,000-square-foot Exton facility for approximately $2.5 million in cash to support capacity and growth.
- Total contractual cash obligations were $21.591 million, including $19.720 million of purchase obligations and $1.763 million of operating lease obligations. Phantom stock liabilities totaled $1.624 million.
- The company declared a special dividend of $0.85 per share, or $8.578 million, in December 2016, paid in January 2017. Future dividends remain subject to Board discretion.
Most important facts for investors to verify
- Whether sales growth accelerates after the temporary 2015 customer pre-buying effect and how housing and commercial construction trends affect demand.
- Whether elevated legal, insurance, engineering and selling expenses normalize and allow operating margins to recover.
- The ultimate cost, timing and liquidity impact of pending product-liability claims and the Pennsylvania appeal.
- Exposure to commodity prices, supplier concentration, Brexit-related currency volatility and customer or distributor concentration.
- Execution and returns from the approximately $2.5 million 2017 facility purchase and related capacity expansion.
- Future dividend policy and the extent to which cash generation is retained for investment, acquisitions or returned to shareholders.
- The filing’s stated accounting adoption expectations for revenue recognition, inventory measurement and leases, including the currently undetermined impact of the new lease standard.