Omega Flex, Inc. 10-Q

Item 2 – Management’s Discussion and Analysis of Financial Condition and Results of Operations This report contains forward-looking statements, which are subject to inherent uncertainties. These uncertainties include, but are not limited to, variations in weather, changes in the regulatory environment, customer preferences, general economic conditions, increased competition, the outcome of outstanding litigation, and future developments affecting environmental matters. All of these are difficult to predict, and many are beyond the ability of the Company to control. Certain statements in this Quarterly Report on Form 10-Q that are not historical facts, but rather reflect the Company’s current expectations concerning future results and events, constitute forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. The words “believes”, “expects”, “intends”, “plans”, “anticipates”, “hopes”, “likely”, “will”, and similar expressions identify such forward-looking statements. Such forward-looking statements involve known and unknown risks, uncertainties and other important factors that could cause the actual results, performance or achievements of the Company, or industry results, to differ materially from future results, performance or achievements expressed or implied by such forward-looking statements. Readers are cautioned not to place undue reliance on these forward-looking statements, which reflect management’s view only as of the date of this Form 10-Q. The Company undertakes no obligation to update the result of any revisions to these forward-looking statements which may be made to reflect events or circumstances after the date hereof or to reflect the occurrence of unanticipated events, conditions or circumstances. OVERVIEW The Company is a leading manufacturer of flexible metal hose, and is currently engaged in a number of different markets, including construction, manufacturing, transportation, petrochemical, pharmaceutical and other industries. The Company’s business is managed as a single operating segment that consists of the manufacture and sale of flexible metal hose, fittings and accessories. The Company’s products are concentrated in residential and commercial construction, and general industrial markets, with a comprehensive portfolio of intellectual property and patents issued in various countries around the world. The Company’s primary product, flexible gas piping, is used for gas piping within residential and commercial buildings. Through its flexibility and ease of use, the Company’s TracPipe ® and TracPipe ® CounterStrike ® flexible gas piping, along with its fittings distributed under the trademarks AutoSnap ® and AutoFlare ® , allows users to substantially cut the time required to install gas piping, as compared to traditional methods. The Company’s newest product line MediTrac ® corrugated medical tubing is used for piping medical gases (oxygen, nitrogen, nitrous oxide, carbon dioxide, and medical vacuum) in health care facilities. Building on the recognized strengths and strategies employed in the flexible gas piping market, MediTrac ® can be used in place of rigid copper pipe, and due to its long continuous lengths and flexibility, it can be installed approximately five times faster than rigid copper pipe, saving on installation labor and construction schedules. The Company’s products are manufactured at its Exton, Pennsylvania and Houston, Texas facilities in the U.S., and in Banbury, Oxfordshire in the U.K. A majority of the Company’s sales across all industries are generated through independent outside sales organizations such as sales representatives, wholesalers and distributors, or a combination of both. The Company has a broad distribution network in North America and to a lesser extent in other global markets. - 26 - CHANGES IN FINANCIAL CONDITION For the period ended September 30, 2021 vs. December 31, 2020 The Company’s cash balance of $27,245,000 at September 30, 2021, increased $3,612,000 (15.3%) from the $23,633,000 balance at December 31, 2020 mainly the result of income generated from operations during 2021, less dividends of $8,809,000 paid during the first nine months of 2021. The condensed consolidated statement of cash flows is provided on page 8 which provides further details regarding changes in cash. Accounts Receivable was $22,115,000 and $20,077,000 as of September 30, 2021, and December 31, 2020, respectively, increasing $2,038,000 or 10.2%. This is mostly timing related, associated with higher sales during the current quarter compared to the fourth quarter of last year. RESULTS OF OPERATIONS Three months ended September 30, 2021 vs. September 30, 2020 The Company reported comparative results from continuing operations for the three months ended September 30, 2021 and 2020 as follows: Three months ended September 30, (in thousands) 2021 2021 2020 2020 ($000) % ($000) % Net Sales $ 31,725 100.0 % $ 27,087 100.0 % Gross Profit $ 20,039 63.2 % $ 17,266 63.7 % Operating Profit $ 8,326 26.2 % $ 6,379 23.6 % Net Sales. The Company’s 2021 third quarter sales of $31,725,000 increased $4,638,000 or 17.1% compared to the third quarter of 2020, which generated sales of $27,087,000. The increase in sales resulted primarily from an increase in pricing actions which the Company took to offset material cost pressure and to protect margins. Gross Profit. The Company’s gross profit margins were 63.2% and 63.7% for the three months ended September 30, 2021 and 2020, respectively. The Company experienced higher material prices which largely have been offset by the pricing actions noted above. - 27 - Selling Expenses . Selling expenses consist primarily of employee salaries and associated overhead costs, commissions, and the cost of marketing programs such as advertising, trade shows and related communication costs, and freight. Selling expense was $4,876,000 and $3,991,000 for the three months ended September 30, 2021 and 2020, respectively, representing an increase of $885,000 or 22.2%. The increase was primarily related to higher staffing costs, as resources were added, and freight expenses, which move in relation to sales. Selling expenses as a percent of net sales were 15.4% and 14.7% for the three months ended September 30, 2021 and 2020, respectively. General and Administrative Expenses . General and administrative expenses consist primarily of employee salaries, benefits for administrative, executive and finance personnel, legal and accounting, and corporate general and administrative services. General and administrative expenses were $5,724,000 and $5,951,000 for the three months ended September 30, 2021 and 2020, respectively, thus decreasing by $227,000 or 3.8%. The most notable decrease related to a decrease in phantom stock expense of $1,162,000, driven by the change in the Company’s stock price between periods, as discussed in detail in Note 6, Stock Based Plans, to the condensed consolidated financial statements included in this report, partially offset by an increase in incentive compensation associated with higher profitability and by higher legal and product liability related defense costs. As a percentage of sales, general and administrative expenses decreased to 18.0% for the three months ended September 30, 2021 from 22.0% for the three months ended September 30, 2020. Engineering Expense . Engineering expenses consist of development expenses associated with the development of new products and enhancements to existing products, and manufacturing engineering costs. Engineering expenses were $1,113,000 and $945,000 for the three months ended September 30, 2021 and 2020, respectively, increasing by $168,000 or 17.8%, partially associated with an increase in staffing and development and certification related costs required for the progression of various promising applications. Engineering expenses as a percentage of sales, were essentially the same at 3.5% for the three months ended September 30, 2021, and 2020. Operating Profits . Reflecting all of the factors mentioned above, operating profits were $8,326,000 and $6,379,000 for the quarters ended September 30, 2021 and 2020, respectively, increasing by $1,947,000 or 30.5%. As a percentage of sales, operating profits increased, being 26.2% and 23.6% for the three months ended September 30, 2021 and 2020, respectively. Interest Income (Expense). Interest income is recorded on cash investments, and interest expense is recorded at times when the Company has debt amounts outstanding on its line of credit. The Company recorded $10,000 and $6,000 of interest income for the quarters ended September 30, 2021 and 2020, respectively. Other Income (Expense). Other Income (Expense) primarily consists of foreign currency exchange gains (losses) on transactions settled in currencies other than the Company’s local currency, typically related to the Company’s foreign U.K. subsidiaries. There was expense of $19,000 and income of $19,000 recorded for the quarters ended September 30, 2021 and 2020, respectively. Income Tax Expense . Income Tax Expense was $2,160,000 for the third quarter of 2021, compared to $1,576,000 for the same period in 2020, increasing $584,000 or 37.1%, mostly the result of the increase in income before taxes. - 28 - Nine months ended September 30, 2021 vs. September 30, 2020 The Company reported comparative results from operations for the nine month periods ended September 30, 2021 and 2020 as follows: Nine months ended September 30, (in thousands) 2021 2021 2020 2020 ($000) % ($000) % Net Sales $ 94,554 100.0 % $ 74,171 100.0 % Gross Profit $ 59,296 62.7 % $ 46,297 62.4 % Operating Profit $ 25,064 26.5 % $ 17,110 23.1 % Net Sales. The Company’s 2021 sales for the first nine months of 2021 of $94,554,000 increased $20,383,000 or 27.5% compared to the first nine months of 2020, which generated sales of $74,171,000. The increase in sales was two-fold, resulting primarily from an increase in unit volume, and to a lesser extent by pricing actions which the Company took to offset material cost pressure and to protect margins. Sales during the first nine months of 2020 were partially impeded by the COVID-19 pandemic. Gross Profit. The Company’s gross profit margins were 62.7% and 62.4% for the nine months ended September 30, 2021 and 2020, respectively. Selling Expenses . Selling expenses consist primarily of employee salaries and associated overhead costs, commissions, and the cost of marketing programs such as advertising, trade shows and related communication costs, and freight. Selling expense was $14,625,000 and $12,045,000 for the nine months ended September 30, 2021 and 2020, respectively, representing an increase of $2,580,000 or 21.4%. The increases primarily related to freight and commissions, which are variable costs and thus increased in relation to sales volume. Other less significant increases were noted in staffing, as resources were added. Selling expenses decreased as a percent of net sales compared to last year, being 15.5% for the nine months ended September 30, 2021, and 16.2% for the nine months ended September 30, 2020. General and Administrative Expenses . General and administrative expenses consist primarily of employee salaries, benefits for administrative, executive and finance personnel, legal and accounting, and corporate general and administrative services. General and administrative expenses were $16,281,000 and $14,056,000 for the nine months ended September 30, 2021 and 2020, respectively, thus increasing by $2,225,000 or 15.8%. Incentive compensation increased $1,561,000 over last year due to higher operating profits. Additional higher items include legal and product liability related defense costs and director fees due to a revised arrangement resulting from an independent study performed to align board compensation with comparable peers. These higher items were partially offset by a decrease in phantom stock expense between years, driven by the change in the Company’s stock price between periods, as discussed in detail in Note 6, Stock Based Plans, to the condensed consolidated financial statements included in this report. As a percentage of sales, general and administrative expenses decreased to 17.2% for the nine months ended September 30, 2021 from 19.0% for the nine months ended September 30, 2020. - 29 - Engineering Expense . Engineering expenses consist of development expenses associated with the development of new products and enhancements to existing products, and manufacturing engineering costs. Engineering expenses were $3,326,000 and $3,086,000 for the nine months ended September 30, 2021 and 2020, respectively, increasing by $240,000 or 7.8%. Engineering expenses decreased as a percentage of sales, being 3.5% for the nine months ended September 30, 2021, and 4.2% for the same period in 2020. Operating Profits . Reflecting all of the factors mentioned above, operating profits were $25,064,000 and $17,110,000 for the nine months ended September 30, 2021 and 2020, respectively, increasing by $7,954,000 or 46.5%. Interest Income (Expense). Interest income is recorded on cash investments, and interest expense is recorded at times when the Company has debt amounts outstanding on its line of credit. The Company recorded $27,000 of interest income and $46,000 of interest expense during the first nine months of 2021 and 2020, respectively. The Company had borrowed $15,000,000 on its line of credit for a portion of the second quarter of 2020 to ensure liquidity during the COVID-19 crisis, which created the interest expense during that period. Other Income (Expense) . Other Income (Expense) primarily consists of foreign currency exchange gains (losses) on transactions settled in currencies other than the Company’s local currency, typically related to the Company’s foreign U.K. subsidiaries. There was income of $6,000 recorded during the first nine months of 2021, but expense of $112,000 during the first nine months of 2020. The British Pound had weakened in 2020 as a result of the pandemic impacting the economy. Income Tax Expense . Income Tax Expense was $6,441,000 for the first nine months of 2021, compared to $4,188,000 for the same period in 2020, increasing $2,253,000 or 53.8%, mostly the result of the increase in income before taxes. CRITICAL ACCOUNTING POLICIES AND USE OF ESTIMATES Financial Reporting Release No. 60, released by the Securities and Exchange Commission, requires all companies to include a discussion of critical accounting policies or methods and use of estimates used in the preparation of financial statements. Note 2 of the Notes to the condensed consolidated financial statements includes a summary of the significant accounting policies and methods used in the preparation of our condensed consolidated financial statements. The Company considers all of its significant accounting policies and estimates to be critical. - 30 - The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, disclosure of contingent assets and liabilities as of the dates of the financial statements, and the reported amounts of revenues and expenses during the reporting periods. Management develops, and changes periodically, these estimates and assumptions based on historical experience and on various other factors that are believed to be reasonable under the circumstances. Actual amounts could differ significantly from these estimates. LIQUIDITY AND CAPITAL RESOURCES Historically, the Company’s primary cash needs have been related to working capital items, which the Company has largely funded through cash generated from operations. As of September 30, 2021, the Company had a cash balance of $27,245,000. Additionally, the Company has a $15,000,000 line of credit available, as discussed in detail in Note 4, which had no borrowings outstanding upon it as of September 30, 2021. At December 31, 2020, the Company had a cash balance of $23,633,000, with no borrowings against the line of credit. Operating Activities Cash provided by operating activities is net income adjusted for certain non-cash items and changes in certain assets and liabilities, such as those included in working capital. For the nine months ended September 30, 2021, the Company’s operating activities provided cash of $13,164,000, compared to the nine months ended September 30, 2020 which provided cash of $11,341,000, a difference of $1,823,000. For details of the operating cash flows refer to the unaudited condensed consolidated statements of cash flows in Part I – Financial Information on page eight. As a general trend, the Company tends to deplete or generate lower amounts of cash early in the year, as significant payments are typically made for accrued promotional incentives, incentive compensation, and taxes. Cash has then historically shown a tendency to be restored and accumulated during the latter portion of the year. Investing Activities Cash used in investing activities during the nine months ended September 30, 2021 and 2020 was $720,000 and $381,000, respectively for capital expenditures. Financing Activities All financing activities relate to dividend payments, which are detailed in Note 8, Shareholders’ Equity. Dividend payments through the first nine months of 2021 and 2020, amounted to $8,809,000 and $8,479,000, respectively. See Note 4, Line of Credit and Other Borrowings, for a description of borrowings and repayments during the second quarter of 2020. - 31 - Liquidity We believe our existing cash and cash equivalents, along with our borrowing capacity, will be sufficient to meet our anticipated cash needs for at least the next twelve months. Our future capital requirements will depend upon many factors including our rate of revenue growth, the timing and extent of any expansion efforts, the potential for investments in, or the acquisition of any complementary products, businesses or supplementary facilities for additional capacity, and the COVID-19 pandemic. CONTINGENT LIABILITIES AND GUARANTEES See Note 5 to the Company’s condensed consolidated financial statements. OFF-BALANCE SHEET ARRANGEMENTS None