Omega Flex, Inc. 10-Q

Item 2 – Management’s Discussion and Analysis of Financial Condition and Results of Operations You should read the following discussion and analysis of our financial condition and results of operations together with our condensed consolidated financial statements and related notes thereto included in Part I, Item 1 of this Form 10-Q. This discussion and other parts of this report contain forward-looking statements that involve risks and uncertainties, such as statements of our plans, objectives, expectations, and intentions that are based on the beliefs of our management, as well as assumptions made by, and information currently available to, our management. Our actual results could differ materially from those discussed in these forward-looking statements. See “Cautionary Note Regarding Forward-Looking Statements” in this Form 10-Q. 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, 2023 vs. December 31, 2022 The Company’s cash balance of $35,480,000 on March 31, 2023 decreased $2,223,000 (5.9%) from a $37,703,000 balance at December 31, 2022. 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 incentive related compensation. The Company also paid an accrual for a legal and product liability matter associated with one case, which was resolved through settlement in the previous year, and made a dividend payment during 2023 totaling $3,232,000, as detailed in Note 9, Shareholders’ Equity, to the Condensed Consolidated Financial Statements included in this report. These cash outflows were partially offset by income generated from operations. See the Company’s Condensed Consolidated Cash Flow Statements for further details regarding the change in cash. Accrued Compensation was $1,136,000 on March 31, 2023, compared to $3,782,000 on December 31, 2022, decreasing $2,646,000 or 70.0%. A significant portion of the liability that existed at the previous year end related to incentive compensation earned in 2022. As is customary, the liability was then paid during the first quarter of the following year, or 2023, thus diminishing the balance. The liability now represents amounts mainly earned during the current year. Other Liabilities were $5,192,000 and $7,530,000 as of March 31, 2023 and December 31, 2022, respectively. The decrease of $2,338,000 or 31.0% mainly relates to the payment of an accrual for a legal and product liability matter associated with one case, which was resolved through settlement in the previous year. Retained earnings were $63,467,000 and $60,954,000 as of March 31, 2023 and December 31, 2022, respectively, increasing $2,513,000 or 4.1%. 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 2023, as discussed in detail in Note 9, Shareholders’ Equity, to the Condensed Consolidated Financial Statements included in this report. RESULTS OF OPERATIONS Three months ended March 31, 2023 compared to three months ended March 31, 2022 The Company reported comparative results from operations for the three month periods ended March 31, 2023 and 2022 as follows: Three months ended March 31, (in thousands) 2023 2023 2022 2022 ($000) % ($000) % Net Sales $ 29,987 100.0 % $ 31,293 100.0 % Gross Profit $ 18,628 62.1 % $ 19,115 61.1 % Operating Profit $ 7,306 24.4 % $ 7,366 23.5 % Net Sales. The Company’s 2023 first quarter sales of $29,987,000 decreased $1,306,000 or 4.2% compared to the first quarter of 2022, which generated sales of $31,293,000. The decrease in sales is mainly due to lower sales unit volumes as a result of the overall market being suppressed because of, among other factors, a decline in housing starts. - 26 - Gross Profit. The Company’s gross profit margins were 62.1% and 61.1% for the quarters ended March 31, 2023 and 2022, respectively. Gross profit for the first quarter of 2023 improved mainly due to the lower cost of certain raw materials. 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 expenses were $5,573,000 and $5,783,000 for the quarters ended March 31, 2023 and 2022, respectively, representing a decrease of $210,000 or 3.6%. The decreases are mostly related to commissions and freight. In the previous year, commissions increased partly because of a shift of more 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 decreased because of lower sales volumes and lower carrier rates. These decreases were partially offset by higher staffing related costs and travel. Selling expenses increased as a percent of net sales compared to last year, being 18.6% for the quarter ended March 31, 2023, and 18.5% for the quarter ended March 31, 2022. 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 $4,794,000 and $4,750,000 for the quarters ended March 31, 2023 and 2022, respectively, increasing by $44,000 or 0.9%. Higher items include staffing related costs and stock based compensation which moves in relation to the Company’s stock price, as detailed in Note 7, Stock Based Compensation Plans. These were mainly offset by a decrease in the incentive compensation component, which is aligned with profitability, mainly because of the changes in the executive management team in the previous year. As a percentage of sales, general and administrative expenses increased to 16.0% for the quarter ended March 31, 2023 from 15.2% for the quarter ended March 31, 2022. 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 $955,000 and $1,216,000 for the quarters ended March 31, 2023 and 2022, respectively, decreasing by $261,000 or 21.5%, mainly associated with decreases in staffing related costs and experimental materials. Engineering expenses decreased as a percentage of sales, being 3.2% for the quarter ended March 31, 2023, and 3.9% for the same quarter in 2022. Operating Profits . Reflecting all of the factors mentioned above, operating profits were $7,306,000 and $7,366,000 for the quarters ended March 31, 2023 and 2022, respectively, decreasing by $60,000 or 0.8%. 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 $281,000 of interest income for the first quarter of 2023 and $9,000 for the first quarter of 2022. Higher interest rates are mainly responsible for the higher interest income. - 27 - 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 a gain of $31,000 during the first quarter of 2023 compared to a loss of $26,000 during the first quarter of 2022. The British Pound had strengthened during the first quarter of 2023 and weakened during the first quarter of 2022. Income Tax Expense . Income tax expense was $1,877,000 for the first quarter of 2023, compared to $1,879,000 for the first quarter in 2022, decreasing $2,000 or 0.1%, mostly the result of the reduction of non-deductible incentive compensation to align with the changes in the executive management team in the previous year mainly offset by higher current quarter income before income taxes. 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, 2023, the Company had a cash balance of $35,480,000. Additionally, the Company has a $15,000,000 line of credit available, as discussed in detail in Note 5, which had no borrowings outstanding upon it as of March 31, 2023. As of December 31, 2022, the Company had a cash balance of $37,703,000, with no borrowings against the line of credit. 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. See Notes 6 and 8 to the Company’s Condensed Consolidated Financial Statements included in this Form 10-Q for a description of the Company’s commitments and contingencies. CASH FLOWS 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 quarter ended March 31, 2023, the Company’s operating activities provided cash of $1,470,000, compared to the quarter ended March 31, 2022 which used cash of $3,876,000, a difference of $5,346,000. 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 incentive compensation and accrued promotional incentives. Cash has then historically shown a tendency to be restored and accumulated during the latter portion of the year. - 28 - Investing Activities Cash used in investing activities during the quarters ended March 31, 2023 and 2022 was $453,000 and $79,000, respectively, as a result of payments for mainly manufacturing equipment capital expenditures. Financing Activities All financing activities relate to dividend payments, which are detailed in Note 9, Shareholders’ Equity. A dividend was declared in December 2022 of $3,232,000 which was paid in January 2023. CRITICAL ACCOUNTING POLICIES AND ESTIMATES See our Annual Report on Form 10-K for the year ended December 31, 2022 for a discussion of our critical accounting policies and estimates. There have been no material changes to our critical accounting policies and estimates discussed in such report. 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, updated in December 2022 by ASU No. 2022-06, Deferral of Sunset Date of Topic 848 . The ASUs apply 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 ASUs provide 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 ASUs do not apply to contract modifications made and hedging relationships entered into or evaluated after December 31, 2024, except for hedging relationships existing as of December 31, 2024, that an entity has elected certain optional expedients for and that are retained through the end of the hedging relationship. ASU 2020-04, as updated by ASU 2022-06, is effective for all entities as of March 12, 2020, through December 31, 2024. The impact of the adoption did not have a material impact on the Company’s Condensed Consolidated Financial Statements.