Omega Flex, Inc. 10-K

Item 7 - 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 consolidated financial statements and related notes included in this annual report. This discussion contains forward-looking statements based upon current expectations that involve risks and uncertainties. Our actual results may differ materially from those anticipated in these forward-looking statements as a result of various factors, including those set forth under the section titled “Risk Factors” or in other parts of this annual report. See “Cautionary Note Regarding Forward-Looking Statements” in this annual report. Our historical results are not necessarily indicative of the results that may be expected for any period in the future. 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 trademark 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 (“CMT”) 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 ® CMT 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. Changes in Financial Condition The Company’s cash balance of $46,356,000 as of December 31, 2023 increased $8,653,000 (23.0%) from a $37,703,000 balance at December 31, 2022. The primary reason for the increase in cash is due to income generated from operations during 2023. This was partially offset by dividend payments during 2023 totaling $13,124,000, as detailed in Note 12, Shareholders’ Equity, to the Consolidated Financial Statements included in this report. See the Company’s Consolidated Statements of Cash Flows for further details regarding the change in cash. Accounts Receivable were $15,361,000 and $17,503,000 as of December 31, 2023 and December 31, 2022, respectively, decreasing $2,142,000 or 12.2%. This is mostly timing related, associated with greater cash collections resulting from higher sales during the fourth quarter of the previous year versus the current quarter. Inventory was $15,597,000 and $17,764,000 as of December 31, 2023 and December 31, 2022, respectively, decreasing $2,167,000 or 12.2%. The decrease is mainly the result of lower inventory required to be on hand as the supply chain environment has recently stabilized and due to lower raw material costs. Other Liabilities were $4,390,000 and $7,530,000 as of December 31, 2023 and December 31, 2022, respectively. The decrease of $3,140,000 or 41.7% mainly relates to the payment of an accrual for legal and product liability matters associated with two cases provided for in the previous year, which were resolved through settlement. - 20 - Retained earnings were $68,493,000 and $60,954,000 as of December 31, 2023 and December 31, 2022, respectively, increasing $7,539,000 or 12.4%. The increase was primarily due to an increase from net income during the year, as provided on the Company’s Consolidated Statements of Operations, partially offset by dividends declared during 2023, as discussed in detail in Note 12, Shareholders’ Equity, to the Consolidated Financial Statements included in this report. Results of Operations Twelve months ended December 31, 2023 vs. twelve months ended December 31, 2022 The Company reported comparative results from operations for the twelve month periods ended December 31, 2023 and 2022 as follows: Twelve-months ended December 31, (dollars in thousands) 2023 % 2022 % Net Sales $ 111,465 100.0 % $ 125,487 100.0 % Gross Profit $ 68,365 61.3 % $ 78,305 62.4 % Operating Profit $ 25,799 23.1 % $ 31,016 24.7 % Net Sales . The Company’s sales for the full year of 2023 were $111,465,000, reflecting a decrease of $14,022,000, or 11.2%, compared to $125,487,000 in 2022. 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. Gross Profit . The Company’s gross profit margins were 61.3% and 62.4% for the years ended December 31, 2023, and 2022, respectively. The decline in gross profit margin is mainly due to an increase in the provision for excess inventories for MediTrac ® CMT products. Higher amounts of materials for MediTrac ® CMT products were initially purchased for cost considerations and because of longer required lead times. Also, lower production, which caused lower absorption of factory labor and overhead costs, contributed to the lower gross profit margin. Lower raw material costs, mainly for strip, partly offset the above referenced reasons for the decline in gross profit margin. 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 $20,993,000 and $21,931,000 for 2023 and 2022, respectively, representing a decrease of $938,000, or 4.3%. 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. As a percentage of net sales, selling expenses were 18.8% and 17.5% for the twelve months ended December 31, 2023 and 2022, 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 $17,705,000 and $20,625,000 for the years ended December 31, 2023 and 2022, respectively, decreasing $2,920,000, or 14.2% between periods. Product liability reserves and expenses were lower by $3,010,000, associated primarily with two cases, which were provided for in the previous year and subsequently resolved through settlement. There also was a decrease in the incentive compensation component which is aligned with profitability. These were partly offset by increases in staffing related costs, umbrella insurance premiums, and stock based compensation, which moves in relation to the Company’s stock price, as detailed in Note 8, Stock Based Compensation Plans. As a percentage of net sales, general and administrative expenses were 15.9% and 16.4% for the twelve months ended December 31, 2023 and 2022, respectively. - 21 - 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 $865,000 or 18.3% between periods, being $3,868,000 and $4,733,000 for the years ended December 31, 2023 and 2022, respectively, mainly associated with decreases in staffing related costs. As a percentage of net sales for the year, engineering expenses were 3.5% in 2023 and 3.8% in 2022. Operating Profit . Reflecting all the factors mentioned above, operating profits decreased $5,217,000, or 16.8%, between periods, reflecting a profit of $25,799,000 in 2023, as compared to $31,016,000 in 2022. 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 $1,700,000 for 2023, compared to $174,000 for 2022. The increase in interest income was mainly due to the increase in interest rates during 2023. There were no borrowings on its line of credit during 2023 or 2022. 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. and France subsidiaries. The Company recognized other income of $46,000 during 2023 and other expense of $211,000 during 2022. Income Tax Expense . Income tax expense was $6,825,000 for 2023, compared to $7,327,000 for 2022. The $502,000 or 6.9% decrease in tax expense was largely the result of the decrease in income before taxes. The effective tax rate for 2023 and 2022 was at approximately 25% and 24% of income before taxes, respectively. Twelve months ended December 31, 2022 vs. twelve months ended December 31, 2021 For a comparison of our results of operations for the twelve months ended December 31, 2022 vs. twelve months ended December 31, 2021, see “Part II, Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations” of our Annual Report on Form 10-K for the fiscal year ended December 31, 2022, filed with the SEC on March 10, 2023. Commitments and Contingencies See Note 7, to the Consolidated Financial Statements included in this report for a detailed description of commitments and contingencies. 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, 2023, the Company had a cash balance of $46,356,000. Additionally, the Company has a $15,000,000 line of credit available, as discussed in detail in Note 6, Line of Credit and Other Borrowings, which had no borrowings outstanding against it as of December 31, 2023. As of December 31, 2022 and December 31, 2021, the Company had cash balances of $37,703,000 and $32,913,000, respectively, 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 2023, the Company’s cash provided from operating activities was $23,422,000, compared to $15,246,000 of cash provided during 2022, and $25,149,000 of cash provided during 2021. This illustrates an increase of $8,176,000 during 2023, versus a decrease during 2022 of $9,903,000. For details of the operating cash flows refer to the Consolidated Statements of Cash Flows in the Company’s Consolidated Financial Statements. - 22 - 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 2023, 2022, and 2021 was $1,642,000, $942,000, and $971,000 respectively, all related to various capital expenditure projects. Financing Activities All financing activities relate to dividend payments, which are detailed in Note 12, Shareholders’ Equity, in the Consolidated Financial Statements included in this report. Dividend payments for 2023, 2022, and 2021 amounted to $13,124,000, $9,489,000, and $14,867,000, respectively. The Company had no borrowings or payments on its line of credit during 2023, 2022, or 2021 as described in Note 6, Line of Credit and Other Borrowings. 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. The Company’s primary contractual obligations as of December 31, 2023, 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 Total (in thousands) Operating Lease Obligations* $ 367 Purchase Obligations 12,316 Other Liabilities 212 Total Contractual Obligations $ 12,895 *Includes the estimated current portion of the West Chester, Pennsylvania lease, with a lease commencement date of January 1, 2024. See Note 14, Subsequent Events, in the Consolidated Financial Statements for additional details. As explained in Note 8, 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, 2023, which is anticipated to be paid within the next year, is $206,000. 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. - 23 - Critical Accounting Policies and Estimates Note 2, Significant Accounting Policies, to the Consolidated Financial Statements included in this report, includes a summary of the significant accounting policies and methods used in the preparation of our Consolidated Financial Statements. Our discussion and analysis of our financial condition and results of operations are based upon our Consolidated Financial Statements, which have been prepared in accordance with U.S. generally accepted accounting principles. The preparation of these financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses and related disclosure of contingent assets and liabilities. We evaluate our estimates on an on-going basis. Estimates are used for, but not limited to, revenue recognition and related sales incentives, provisions for credit losses, inventory reserves, valuation of goodwill, product liability reserves, valuation of phantom stock, and accounting for income taxes. We base our estimates on historical experience and on various other assumptions that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. We believe our judgments related to these accounting estimates are appropriate. Actual results may differ from these estimates under different assumptions or conditions. Revenue Recognition The Company’s accounting policy relating to revenue recognition reflects the impact of the adoption of Accounting Standards Codification (“ASC”) 606, Revenue from Contracts with Customers (“ASC 606”), which is discussed further in the Notes to the Consolidated Financial Statements. As a result of the adoption of ASC 606, the Company records revenue based upon a five-step approach. The Company sells goods on typical, unmodified free on board (FOB) shipping point terms. As the seller, it can be determined that the shipped goods meet the agreed-upon specifications in the contract or customer purchase order (e.g., items, quantities, and prices) with the buyer, so customer acceptance would be deemed a formality, as noted in ASC 606-10-55-86. As a result, the Company has a legal right to payment upon shipment of the goods. Based upon the above, the Company has concluded that transfer of control substantively transfers to the customer upon shipment. Other than standard product warranty provisions, the sales arrangements provide for no other post-shipment obligations. The Company offers rebates and other sales incentives, promotional allowances, or discounts to certain customers, typically related to purchase volume, and are classified as a reduction of revenue and recorded at the time of sale. The Company periodically evaluates whether an allowance for sales returns is necessary. Historically, the Company has experienced minimal sales returns. If it is believed there are to be material potential sales returns, the Company will provide the necessary provision against sales. Provision for Credit Losses The Company maintains allowances for credit losses, which represent an estimate of expected losses over the remaining contractual life of its receivables considering current market conditions and estimates for supportable forecasts when appropriate. The estimate is a result of the Company’s ongoing assessments and evaluations of collectability, historical loss experience, and future expectations in estimating credit losses in its receivable portfolio. For accounts receivable, the Company uses historical loss experience rates and applies them to a related aging analysis while also considering customer and/or economic risk where appropriate. Determination of the proper amount of allowances requires management to exercise judgment about the timing, frequency and severity of credit losses that could materially affect the provision for credit losses and, as a result, net earnings. The allowances consider numerous quantitative and qualitative factors that include receivable type, historical loss experience, delinquency trends, collection experience, current economic conditions, estimates for supportable forecasts, when appropriate, and credit risk characteristics. Changes in allowances may occur in the future as the above referenced quantitative and qualitative factors change. Inventories Inventories are valued at the lower of cost or net realizable value. The cost of inventories is determined by the first-in, first-out (FIFO) method. The Company generally considers inventory quantities beyond two years of usage, measured on a historical usage basis, to be excess inventory and reduces the carrying value of inventory accordingly. These reductions to the inventory carrying values are estimates, which could vary significantly, either favorably or unfavorably, from actual amounts if future economic conditions, sales levels, or competitive conditions change. - 24 - Goodwill In accordance with Financial Accounting Standards Board (“FASB”) ASC Topic 350, Intangibles – Goodwill and Other (ASU 2017-04) , using the simplified method as adopted, the Company performed an annual impairment test as of December 31, 2023. This test did not indicate any impairment of goodwill as the Company’s estimated fair value of the reporting unit exceeded carrying value. The test may be performed more frequently if we believe indicators of impairment might exist. These indicators may include changes in macroeconomic and industry conditions, overall financial performance, and other relevant entity-specific events. Product Liability Reserves Product liability reserves represent the estimated unpaid amounts under the Company’s insurance policies with respect to existing claims. The Company uses the most current available data to estimate claims. As explained more fully under Note 7, Commitments and Contingencies, to the Consolidated Financial Statements included in this report for various product liability claims covered under the Company’s general liability insurance policies, the Company must pay certain defense and settlement costs within its deductible or self-insured retention limits, ranging primarily from $250,000 to $3,000,000 per claim, depending on the terms of the policy and the applicable policy year, up to an aggregate amount. The Company is vigorously defending against all known claims. It is possible that the Company may incur increased litigation costs in the future due to a variety of factors, including a higher number of claims, higher legal costs, and higher insurance deductibles or retentions. Litigation is subject to many uncertainties and management is unable to predict the outcome of the pending suits and claims. From time to time, depending upon the nature of a particular case, the Company may decide to spend more than a deductible or retention to enable more discretion regarding the defense, although this is not common. It is possible that the results of operations or liquidity of the Company, as well as the Company’s ability to procure reasonably priced insurance, could be adversely affected by the pending litigation, potentially materially. The Company is currently unable to estimate the ultimate liability, if any, that may result from the pending litigation, or potential litigation from future claims or claims that have not yet come to our attention, and accordingly, the liability in the Consolidated Financial Statements primarily represents an accrual for legal costs for services previously rendered, settlements for Claims not yet paid, and anticipated settlements for claims within the Company’s remaining retention under its insurance policies. Stock Based Compensation Plans In 2006, the Company adopted a Phantom Stock Plan (the “Plan”), which allows the Company to grant phantom stock units (“Units”) to certain key employees, officers, or directors. The Units each represent a contractual right to payment of compensation in the future based upon the market value of the Company’s common stock and are accordingly recorded as liabilities. The Units follow a vesting schedule over three years from the grant date and are then paid upon maturity. In accordance with FASB ASC Topic 718, Compensation - Stock Compensation (“Topic 718”), the Company uses the Black-Scholes option pricing model as its method for determining the fair value of the Units. The liabilities for the Units are adjusted to market value over time from the grant dates to the related maturity dates. The Company recognizes the reversal of any previously recognized compensation expense on forfeited nonvested Units in the period the Units are forfeited. The Plan has been amended and restated, for all grants made starting January 1, 2023, to set the vesting method to three-year cliff vesting following the grant date, with full value paid upon maturity. Additionally, for grants made starting January 1, 2023, upon retirement at age 67 or greater, and with one year of continuous service prior to retirement, vesting of the issued grant(s) would accelerate on a pro-rata basis, 1/3 per year from the grant date. The Company does not believe the amended and restated plan will have a material impact upon compensation expense. Further details of the Plan are provided in Note 8, Stock Based Compensation Plans, to the Consolidated Financial Statements included in this report. Any significant changes in the Company’s stock price may have a material impact upon the valuation of the Units. - 25 - Income Taxes The Company accounts for tax liabilities in accordance with the FASB ASC Topic 740, Income Taxes . Under this method the Company recorded tax expense and related deferred taxes and tax benefits. Deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities from a change in tax rates is recognized in income in the period that includes the enactment date. A valuation allowance is provided for deferred tax assets if it is more likely than not that these items will either expire before the Company is able to realize the benefit, or that future deductibility is uncertain. The Company’s accounting for deferred tax consequences represents the best estimate of those future events. Changes in estimates, due to unanticipated events or otherwise, could have a material effect on the financial condition and results of operations of the Company. The Company continually evaluates its deferred tax assets to determine if a valuation allowance is required. Recent Accounting Pronouncements In March 2020, the FASB issued Accounting Standards Update (“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 Consolidated Financial Statements. In December 2023, the FASB issued ASU No. 2023-09, Income Taxes (Topic 740): Improvements to Income Tax Disclosures . The ASU expands public entities tax disclosures including improving disclosures surrounding the company’s rate reconciliation, cash taxes paid, and disaggregation of income tax expense (or benefit) from continuing operations. The amendment is effective for annual periods beginning after December 15, 2024. The Company is in the process of evaluating the impact of ASU No. 2023-09 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 -