Omega Flex, Inc. 10-K

Item 7 - 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 Annual Report on Form 10-K 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-K. 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. - 21 - CHANGES IN FINANCIAL CONDITION The Company’s cash balance of $32,913,000 at December 31, 2021 increased $9,280,000 (39.3%) from a $23,633,000 balance at December 31, 2020. The primary reason for the increase in cash related to income generated from operations during 2021. This was partially offset by dividend payments during 2021 totaling $14,867,000, as detailed in Note 6, Shareholders’ Equity, to the Consolidated Financial Statements included in this report. See the Company’s Consolidated Cash Flow Statement for further details regarding the change in cash. Inventory was $15,565,000 and $11,510,000 as of December 31, 2021 and December 31, 2020, respectively, increasing $4,055,000 or 35.2%. The increase is mainly the result of the purchase of inventory in anticipation of stronger customer demand and to ensure enough materials on hand because of sporadic supply chain issues. Accrued Commissions and Sales Incentives were $7,183,000 and $4,348,000 as of December 31, 2021 and December 31, 2020, respectively, increasing $2,835,000 or 65.2%. The increase is the result of higher sales which allowed for many of our customers to achieve growth tiers as defined within their sales incentive agreements. Retained earnings were $50,053,000 and $35,769,000 as of December 31, 2021 and December 31, 2020, respectively, increasing $14,284,000 or 39.9%. The increase was primarily due to an increase in net income during the year, as provided on the Company’s Consolidated Statement of Operations, partially offset by dividends declared during 2021, as discussed in detail in Note 6, Shareholders’ Equity, to the Consolidated Financial Statements included in this report. RESULTS OF OPERATIONS Twelve-months ended December 31, 2021 vs. twelve months ended December 31, 2020 The Company reported comparative results from operations for the twelve-month periods ended December 31, 2021 and 2020 as follows: Twelve-months ended December 31, (dollars in thousands) 2021 2021 2020 2020 Net Sales $ 130,011 100.0 % $ 105,796 100.0 % Gross Profit $ 81,531 62.7 % $ 66,550 62.9 % Operating Profit $ 35,062 27.0 % $ 26,653 25.2 % Net Sales . The Company’s sales for the full year of 2021 were $130,011,000, reflecting an increase of $24,215,000, or 22.9%, compared to $105,796,000 in 2020. The increase in sales resulted mostly from an increase in unit volume, which was in some measure impacted by the COVID-19 pandemic in the previous year, as well as increases to selling prices that were necessary to help offset rising material commodity costs. Gross Profit . The Company’s gross profit margins were 62.7% and 62.9% for the years ended December 31, 2021, and 2020, respectively. The Company was able to maintain margins similar to prior year levels despite rising material commodity costs which were mainly offset by increases to selling prices. 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 $20,429,000 and $16,580,000 for 2021 and 2020, respectively, representing an increase of $3,849,000, or 23.2%. The most significant increases included commissions and freight, driven by the increase in sales. In addition, sales personnel were added in France and advertising, trade shows and travel returned to more expected levels as these were restricted in the previous year due to the COVID-19 pandemic. For the same annual periods, selling expense as a percentage of net sales was consistent at 15.7%. - 22 - General and Administrative Expenses . General and administrative expenses consist primarily of employee salaries, benefits for administrative, executive and finance personnel, legal and accounting, insurance, and corporate general and administrative services. General and administrative expenses were $21,430,000 and $19,117,000 for the years ended December 31, 2021 and 2020, respectively, increasing $2,313,000, or 12.1% between periods. Incentive compensation was derived from two notable yet partly offsetting components. There was an increase in the incentive compensation component which is aligned with profitability; however, this was partially offset by a reduction in expense pertaining to stock based compensation which moves in relation to the Company’s stock price, as detailed in Note 11, Stock Based Compensation Plans. Other items increasing from the previous year include legal and product liability expenses and director fees. As a percentage of net sales, general and administrative expenses were 16.5% and 18.1% for the twelve-months ended December 31, 2021 and 2020, respectively. Engineering Expenses . Engineering expenses consist of development expenses associated with the development of new products, and costs related to enhancements of existing products and manufacturing processes. Engineering expenses increased $410,000 or 9.8% between periods, being $4,610,000 and $4,200,000 for the years ended December 31, 2021 and 2020, respectively. The increase was primarily attributable to an increase in staffing, mainly in the U.K., and certification and qualification expenses. As a percentage of net sales for the year, engineering expenses were 3.6% in 2021 and 4.0% in 2020. Operating Profit . Reflecting all of the factors mentioned above, operating profits increased $8,409,000, or 31.6%, between periods, reflecting a profit of $35,062,000 in 2021, as compared to $26,653,000 in 2020. Interest Income. 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 interest income of $35,000 for 2021, compared to interest expense of $39,000 for 2020. The decrease in interest expense and increase in interest income was largely due to the interest expense incurred on the borrowings of $15,000,000 on its line of credit for a portion of the second quarter of 2020 to ensure liquidity during the COVID-19 pandemic. There were no borrowings on its line of credit during 2021. Other Income (Expense) . Other income (expense) primarily consists of foreign currency exchange gains (losses) on transactions within our foreign subsidiaries, and therefore tends to fluctuate with the strengthening and or weakening of the British Pound. The Company recognized other income of $21,000 during 2021 and other expense of $53,000 during 2020. Income Tax Expense . Income tax expense was $8,862,000 for 2021, compared to $6,594,000 for 2020. The $2,268,000 or 34.4% increase in tax expense was largely the result of the increase in income before taxes. The effective tax rate for both periods was similar at approximately 25% of income before taxes. Twelve-months ended December 31, 2020 vs. twelve months ended December 31, 2019 The Company reported comparative results from operations for the twelve-month periods ended December 31, 2020 and 2019 as follows: Twelve-months ended December 31, (dollars in thousands) 2020 2020 2019 2019 Net Sales $ 105,796 100.0 % $ 111,360 100.0 % Gross Profit $ 66,550 62.9 % $ 70,487 63.3 % Operating Profit $ 26,653 25.2 % $ 21,922 19.7 % - 23 - Net Sales . The Company’s sales for the full year of 2020 were $105,796,000, reflecting a decrease of $5,564,000, or 5.0%, compared to $111,360,000 in 2019. The decrease in sales resulted mostly from a decrease in unit volume, which was in some measure impacted by the COVID-19 pandemic, partially offset by a mild increase to selling prices that was necessary to help offset a rise in material commodity costs. Gross Profit . The Company’s gross profit margins were 62.9% and 63.3% for the twelve-months ended December 31, 2020 and 2019, respectively. The Company was able to maintain margins like prior year levels despite COVID-19 disruptions, such as increased costs to sanitize the factory and equipment, inefficiencies from staggered work shifts and overtime costs due to employees being quarantined, as well as unabsorbed overhead. 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 $16,580,000 and $19,032,000 for 2020 and 2019, respectively, representing a decrease of $2,452,000, or 12.9%. The most significant reduction relates to atypical consulting costs identified during 2019, attributable to the Company’s new product, MediTrac ® flexible medical gas piping. The Company also experienced decreases in travel and advertising during 2020, mostly related to restrictions stemming from the pandemic. Commissions were also down due to the decrease in sales. Conversely, the Company expanded its sales related staffing resources. For the same periods, selling expense as a percentage of net sales was 15.7% and 17.1%, respectively. General and Administrative Expenses . General and administrative expenses consist primarily of employee salaries, benefits for administrative, executive and finance personnel, legal and accounting, insurance, and corporate general and administrative services. General and administrative expenses were $19,117,000 and $24,818,000 for the years ended December 31, 2020 and 2019, respectively, decreasing $5,701,000, or 23% between periods. Legal and product liability defense costs decreased $5,158,000, associated primarily with one class action case which was dismissed during 2020, as explained in detail in Note 10, Commitments and Contingencies, of the Consolidated Financial Statements to this report. Professional fees and director related fees were also lower. Those items were softened by an increase to incentive compensation, which although not significant in total, was derived from two notable yet mostly offsetting components. There was an increase in the incentive compensation component which is aligned with profitability; however, there was a reduction in stock based compensation expense which moves in relation to the Company’s stock price, as detailed in Note 11, Stock Based Compensation Plans. As a percentage of net sales, general and administrative expenses were 18.1% and 22.3% for the twelve-months ended December 31, 2020 and 2019, respectively. Engineering Expenses . Engineering expenses consist of development expenses associated with the development of new products, and costs related to enhancements of existing products and manufacturing processes. Engineering expenses decreased $515,000 or 10.9% between periods, being $4,200,000 and $4,715,000 for the years ended December 31, 2020 and 2019, respectively. The decrease was primarily attributable to a reduction in experimental materials that diminished after the work was completed on various promising applications during 2019, and to a lesser extent travel. As a percentage of net sales for the year, engineering expenses were 4.0% in 2020 and 4.2% in 2019. Operating Profit . Reflecting all of the factors mentioned above, operating profits increased $4,731,000, or 21.6%, between periods, reflecting a profit of $26,653,000 in 2020, as compared to $21,922,000 in 2019. Interest Income. 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 interest expense of $39,000 for 2020, compared to interest income of $876,000 for 2019. The reduction in interest income was largely due to the lower cash balance and thus reduced investment, mostly resulting from the $35,330,000 special dividend paid in December 2019. Additionally, 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. Earning potential on short-term liquid investments has also diminished in comparison to this time last year. - 24 - Other Income (Expense) . Other income (expense) primarily consists of foreign currency exchange gains (losses) on transactions within our foreign subsidiaries, and therefore tends to fluctuate with the strengthening and or weakening of the British Pound. The Company recognized other expense of $53,000 during 2020 and other income of $56,000 during 2019. Income Tax Expense . Income tax expense was $6,594,000 for 2020, compared to $5,429,000 for 2019. The $1,165,000 or 21.5% increase in tax expense was largely the result of the increase in income before taxes. The effective tax rate for both periods was similar at approximately 24% to 25% of income before taxes. COMMITMENTS AND CONTINGENCIES See Note 10, to the Consolidated Financial Statements included in this report for a detailed description of commitments and contingencies. FUTURE IMPACT OF KNOWN TRENDS OR UNCERTAINTIES The Company’s operations are sensitive to a number of market and extrinsic factors, any one of which could materially adversely affect the Company’s business, competitive position, results of operations or financial condition in any given year. See Item 1A, Risk Factors, for a detailed description. 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 December 31, 2021, the Company had a cash balance of $32,913,000. Additionally, the Company has a $15,000,000 line of credit available, as discussed in detail in Note 5, which had no borrowings outstanding against it as of December 31, 2021. On 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 2021, the Company’s cash provided from operating activities was $25,149,000, compared to $19,310,000 of cash provided during 2020, and $16,041,000 of cash provided during 2019. This illustrates an increase of $5,839,000 during 2021, versus an increase during 2020 of $3,269,000. For details of the operating cash flows refer to the consolidated statements of cash flows in Item 8. Financial Statements and Supplementary Data on page 37. 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. However, as previously disclosed, during December 2019, the Company liquidated its investments to support the payment of a special dividend to shareholders totaling $35,330,000. Investing Activities Cash used in investing activities during 2021 and 2020 was $971,000 and $564,000 respectively, all related to various capital expenditure projects. - 25 - Cash provided by investing activities during 2019 was $13,719,000, with most of the transactions related to the purchase and/or sale of short-term investments. During December 2019, the Company liquidated all its existing short-term investments to support the payment of a special dividend to shareholders. In total, cash proceeds from the sale of short-term investments during 2019 was $70,882,000. Inversely, cash used for the purchase of the short-term investments during 2019 was $55,938,000. Cash was also used to purchase capital expenditures of $1,225,000, mostly related to the new MediTrac ® products. Financing Activities All financing activities relate to dividend payments, which are detailed in Note 6, Shareholders’ Equity. Dividend payments for 2021, 2020, and 2019 amounted to $14,867,000, $11,306,000, and $46,028,000, respectively. 2019 included the payment of a special dividend, which is primarily why the cash outflow in that year is higher. Dividend payments are outlined in Note 6, Shareholders’ Equity, to the Consolidated Financial Statements included in this report. Also, see Note 5, Line of Credit and Other Borrowings, for a description of borrowings and repayments during the second quarter of 2020. The Company had no borrowings or payments on its line of credit during 2021 or 2019. 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. The Company’s primary contractual obligations as of December 31, 2021, which are due over the next twelve months are summarized in the following table and are more fully explained in Notes to the Consolidated Financial Statements. Contractual Obligations (in thousands) Total Operating Lease Obligations $ 383 Purchase Obligations 31,292 Other Long-Term Liabilities 171 Total Contractual Cash Obligations $ 31,846 As explained in Note 11, Stock Based Compensation Plans, to the Consolidated Financial Statements included in this report, the Company is obligated to make payments to plan participants. Due to the uncertain nature of the payments, due to numerous variables, including the potential change in stock price, and employment status of participants and any applicable forfeitures, the amounts are not disclosed in the above table. The liability associated with this plan as of December 31, 2021, which is anticipated to be paid within the next year is $1,156,000. RECENT ACCOUNTING PRONOUNCEMENTS In March 2020, the FASB issued ASU No. 2020-04, Reference Rate Reform (Topic 848): Facilitation of the Effects of Reference Rate Reform on Financial Reporting . The ASU applies to all entities that have contracts, hedging relationships, and other transactions that reference LIBOR or another reference rate expected to be discontinued because of reference rate reform. The ASU provides optional expedients and exceptions for applying GAAP to contracts, hedging relationships, and other transactions affected by reference rate reform if certain criteria are met. The expedients and exceptions provided by the ASU do not apply to contract modifications made and hedging relationships entered into or evaluated after December 31, 2022, except for hedging relationships existing as of December 31, 2022, that an entity has elected certain optional expedients for and that are retained through the end of the hedging relationship. The ASU is effective for all entities as of March 12, 2020 through December 31, 2022. The impact of the adoption of ASU 2020-04 did not have a material impact on the Company’s Consolidated Financial Statements. In December 2019, the FASB issued ASU 2019-12, Income Taxes (Topic 740): Simplifying the Accounting for Income Taxes. The guidance removes certain exceptions for recognizing deferred taxes for equity method investments, performing intraperiod allocation, and calculating income taxes in interim periods. The ASU also adds guidance to reduce complexity in certain areas, including recognizing deferred taxes for goodwill and allocating taxes to members of a consolidated group, among others. The amendments in ASU 2019-12 are effective for public business entities for fiscal years beginning after December 15, 2020, including interim periods therein. Early adoption of the standard is permitted, including adoption in interim or annual periods for which financial statements have not yet been issued. The Company adopted this new guidance, and it did not have a material impact on its Consolidated Financial Statements. Item 7A - QUANTITATATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISKS The Company does not engage in the purchase or trading of market risk sensitive instruments. The Company does not presently have any positions with respect to hedge transactions such as forward contracts relating to currency fluctuations. No market risk sensitive instruments are held for speculative or trading purposes. - 26 -