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. - 25 - CHANGES IN FINANCIAL CONDITION For the period ended March 31, 2022 vs. December 31, 2021 The Company’s cash balance of $28,971,000 on March 31, 2022 decreased $3,942,000 (12.0%) from a $32,913,000 balance at December 31, 2021. Consistent with prior years, the Company paid a significant amount of cash during the first quarter for obligations that were accrued as of the end of the preceding year, such as various incentive related compensation and sales promotional incentive programs. The Company also purchased additional raw materials because of the challenging supply chain environment. Those cash outflows were partially offset by income generated from operations, net cash collections from accounts receivables, and an increase in taxes payable. See the Company’s Condensed Consolidated Cash Flow Statements for further details regarding the change in cash. Accounts Receivable was $18,760,000 and $20,726,000 as of March 31, 2022 and December 31, 2021, respectively, decreasing $1,966,000 or 9.5%. This is mostly timing related, associated with greater cash collections resulting from higher sales during the fourth quarter of the year versus the first quarter. Inventory was $17,820,000 and $15,565,000 as of March 31, 2022 and December 31, 2021, respectively, increasing $2,255,000 or 14.5%. The increase is mainly the result of the purchase of inventory to ensure enough materials on hand because of the challenging supply chain environment. Accrued Compensation was $1,791,000 on March 31, 2022, compared to $7,008,000 on December 31, 2021, decreasing $5,217,000 or 74.4%. A significant portion of the liability that existed at the previous year end related to incentive compensation earned in 2021. As is customary, the liability was then paid during the first quarter of the following year, or 2022, thus diminishing the balance. The liability now represents amounts earned during the current year. Accrued Commissions and Sales Incentives were $3,589,000 and $7,183,000 as of March 31, 2022 and December 31, 2021, respectively, decreasing $3,594,000 or 50.0%. A portion of the decrease relates to a customary trend of a lower level of sales during first quarter of the year in comparison to the fourth quarter, and the resulting commissions and sales incentives that are earned. Additionally, a portion of the sales incentives have an annual component which accumulates during the year and are then paid during the first quarter of the following year. Taxes Payable were $1,873,000 on March 31, 2022, compared to $1,000 on December 31, 2021, increasing $1,872,000. The increase is mainly the result of the timing of the payment of taxes in April 2022 for taxable income recognized for the quarter ending March 31, 2022. Retained earnings were $52,476,000 and $50,053,000 as of March 31, 2022 and December 31, 2021, respectively, increasing $2,423,000 or 4.8%. The increase was primarily due to net income during the quarter, as provided on the Company’s Condensed Consolidated Statements of Income, partially offset by dividends declared during 2022, as discussed in detail in Note 8, Shareholders’ Equity, to the condensed consolidated financial statements included in this report. - 26 - RESULTS OF OPERATIONS Three months ended March 31, 2022 vs. March 31, 2021 The Company reported comparative results from operations for the three-month periods ended March 31, 2022 and 2021 as follows: Three-months ended March 31, (in thousands) 2022 2022 2021 2021 ($000) % ($000) % Net Sales $ 31,293 100.0 % $ 30,863 100.0 % Gross Profit $ 19,115 61.1 % $ 19,559 63.4 % Operating Profit $ 7,366 23.5 % $ 8,319 27.0 % Net Sales. The Company’s 2022 first quarter sales of $31,293,000 increased $430,000 or 1.4% compared to the first quarter of 2021, which generated sales of $30,863,000. 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 61.1% and 63.4% for the three-months ended March 31, 2022 and 2021, respectively. The Company experienced higher material prices which largely have been offset by the pricing actions noted above. 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 $5,783,000 and $4,821,000 for the three-months ended March 31, 2022 and 2021, respectively, representing an increase of $962,000 or 20.0%. The increases mostly related to commissions, freight, travel, trade shows, and sales meeting expenses. Commissions increased partly because of a shift of shipments from third party warehouses, whose shipments are subject to commission, compared to those directly from the manufacturing facilities, whose shipments are not subject to commission. Freight costs increased because of higher fuel costs and constrained availability. Travel, trade shows, and sales meeting expenses were much lower in the previous year because of COVID-19 pandemic restrictions. Selling expenses increased as a percent of net sales compared to last year, being 18.5% for the three-months ended March 31, 2022, and 15.6% for the three-months ended March 31, 2021. - 27 - 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 $4,750,000 and $5,418,000 for the three-months ended March 31, 2022 and 2021, respectively, thus decreasing by $668,000 or 12.3%. Lower items include legal and product liability related defense costs, incentive compensation, and director fees. Incentive compensation is derived from two notable components. There was a decrease in the incentive compensation component which is aligned with profitability; and there was a reduction in stock based compensation expense which moves in relation to the Company’s stock price, as detailed in Note 6, Stock Based Compensation Plans, to the condensed consolidated financial statements included in this report. Director fees were also lower due to a revised arrangement resulting from an independent study performed to align board compensation with comparable peers in the previous year. As a percentage of sales, general and administrative expenses decreased to 15.2% for the three months ended March 31, 2022 from 17.6% for the three-months ended March 31, 2021. 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 $1,216,000 and $1,001,000 for the three-months ended March 31, 2022 and 2021, respectively, increasing by $215,000 or 21.5%, mainly associated with increases in experimental materials, travel, and staffing related costs. Engineering expenses increased as a percentage of sales, being 3.9% for the three-months ended March 31, 2022, and 3.2% for the same period in 2021. Operating Profits . Reflecting all of the factors mentioned above, operating profits were $7,366,000 and $8,319,000 for the quarters ending March 31, 2022 and 2021, respectively, decreasing by $953,000 or 11.5%. 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 $9,000 of interest income each during the first quarters of 2022 and 2021. Other (Loss) Income . Other (loss) income 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 a loss of $26,000 recorded during the first quarter 2022, but income of $18,000 during the first quarter of 2021. The British Pound had weakened during the first quarter of 2022. Income Tax Expense . Income tax expense was $1,879,000 for the first three months of 2022, compared to $2,049,000 for the same period in 2021, decreasing $170,000 or 8.3%, mostly the result of the decrease in income before taxes. - 28 - 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. 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 March 31, 2022, the Company had a cash balance of $28,971,000. 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 on March 31, 2022. On December 31, 2021, the Company had a cash balance of $32,913,000, with no borrowings against the line of credit. Operating Activities Cash provided or used 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 three months ended March 31, 2022, the Company’s operating activities used cash of $3,876,000, compared to the three months ended March 31, 2021 which provided cash of $2,207,000, a difference of $6,083,000. For details of the operating cash flows refer to the Condensed Consolidated Statements of Cash Flows in Part I – Financial Information on page seven. 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 and incentive compensation. 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 three months ended March 31, 2022 and 2021 was $79,000 and $362,000, respectively for capital expenditures. - 29 - Financing Activities All financing activities relate to dividend payments, which are detailed in Note 8, Shareholders’ Equity. A dividend was declared in both December of 2021 and 2020, amounting to $3,029,000 and $2,826,000 each, with payment due and paid during December 2021 and January 2021, respectively. There were no dividend payments during the quarter ending March 31, 2022. 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, and the potential for investments in, or the acquisition of any complementary products, businesses, or supplementary facilities for additional capacity. CONTINGENT LIABILITIES AND GUARANTEES See Note 5 to the Company’s condensed consolidated financial statements. OFF-BALANCE SHEET ARRANGEMENTS None.