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OFLX > SEC Filings for OFLX > Form 10-Q on 13-Nov-2012All Recent SEC Filings

Show all filings for OMEGA FLEX, INC.

Form 10-Q for OMEGA FLEX, INC.


13-Nov-2012

Quarterly Report


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 and accessories. The Company's products are concentrated in residential and commercial construction, and general industrial markets. 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 with patented fittings distributed under the trademark AutoFlare®, TracPipe® and TracPipe® CounterStrike® flexible gas piping allows users to substantially cut the time required to install gas piping, as compared to traditional methods. Most of the Company's products are manufactured at the Company's Exton, Pennsylvania facility with a minor amount of manufacturing performed in the UK. 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.

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CHANGES IN FINANCIAL CONDITION

Cash and cash equivalents were $9,206,000 at September 30, 2012, compared to $3,476,000 at December 31, 2011, increasing $5,730,000 or 164.8% during the nine months ended September 30, 2012. As disclosed in previous SEC filings, in March of 2012 the Company received $4,700,000 as part of an Insurance Legal Recovery.
The Insurance Legal Recovery, less its by-product costs such as taxes, accounts for a majority of the change between periods. Earnings from the general business operation and its resulting cash account for the remainder of the change.

Accounts Receivable was $11,124,000 at September 30, 2012, compared to $9,052,000 at December 31, 2011, increasing $2,072,000, or 22.9%. The majority of this increase is the result of higher sales during third quarter of 2012 compared to the fourth quarter of 2011. The aging of the Company's receivables appears stable and consistent, and the Company is not aware of any deterioration in the viability of its customer base which is regularly monitored.

Other Current Assets have increased $422,000 or 34% from December 31, 2011, largely due to insurance premiums paid during September 2012, net of applicable amortization.

Other Long Term Assets have increased by $203,000 (11.6%), when comparing the September 30, 2012 balance to December 31, 2011. The increase is primarily attributed to the Company's purchase of long term insurance coverage, partially offset by the current year amortization of those policies.

Accounts Payable has increased $479,000 (47.0%), ending at $1,498,000 at September 30, 2012, from a balance of $1,019,000 at December 31, 2011. The Company acquired raw materials during the latter part of September 2012, and those obligations were still unpaid as of the end of the period, so the change was therefore largely timing related.

Accrued Compensation was $1,962,000 at September 30, 2012, increasing $492,000 or 33.5% from its balance of $1,470,000 at December 31, 2011. The majority of this relates to incentive compensation, which changes in correlation with profits.

Accrued Commissions and Sales Incentives were $2,634,000 and $2,098,000 at September 30, 2012 and December 31, 2011, respectively, increasing $536,000 or 25.5%. A larger portion of the customer base has achieved growth tiers, which increases the payments due to them related to accrued sales incentives.

Other Accrued Liabilities have increased $438,000 or 20.4% from December 31, 2011, primarily due to an increase in legal and product liability accruals.

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                             RESULTS OF OPERATIONS

          Three-months ended September 30, 2012 vs. September 30, 2011

The Company reported comparative results from operations for the three-month
period ended September 30, 2012 and 2011 as follows:

                    Three-months ended September 30,
                             (in thousands)

                    2012       2012      2011     2011
                   ($000)               ($000)
Net Sales        $            100.0%   $         100.0%
                  16,786               13,690
Gross Profit     $             51.8%   $          50.8%
                   8,690                6,956
Operating Profit $             15.2%   $          10.0%
                   2,553                1,364

Net Sales. The Company's 2012 third quarter sales increased $3,096,000 (22.6%) over the same period in 2011, ending at $16,786,000, compared to $13,690,000 for the same three months in 2011. Volume, or units sold, increased approximately 19% compared to the prior year quarter. Pricing related increases largely associated with the Company's transition to its TracPipe® CounterStrike® gas piping product accounted for the remainder of the sales increase, as that product commands premium pricing due to its highly engineered nature and superior material components.

During the third quarter of 2012, the Company recognized steady sales growth over the prior year with its core product, TracPipe® CounterStrike® , which has benefited from the uptick in the construction environment. Additionally, the Company experienced an increase in the sales of its double-containment piping products, such as DoubleTrac® and DEF-Trac®. The emergence of these products has also helped the Company to further diversify its product base.

Gross Profit. The Company's gross profit margins increased between the two periods, being 51.8% and 50.8% for the three-months ended September 30, 2012 and 2011, 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 $3,035,000 and $2,777,000 for the three-months ended September 30, 2012 and 2011, respectively, representing an increase of $258,000.
Commissions were the largest contributing factor, as they were $239,000 higher, primarily a result of the increase in sales. Sales expense as a percent of net sales is lower, being 18.1% for the three-months ended September 30, 2012, and 20.3% for the three-months ended September 30, 2011.

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

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administrative expenses were $2,402,000 and $2,197,000 for the three-months ended September 30, 2012 and 2011, respectively, increasing $205,000 between periods. Staffing related expenses account for the bulk of the change, as they increased $180,000, largely associated with incentive compensation which increased in conjunction with higher profits. As a percentage of sales, general and administrative expenses decreased to 14.3% for the three months ended September 30, 2012 from 16.0% for the three months ended September 30, 2011.

Engineering Expense. 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 $82,000. They were $700,000 and $618,000 for the three months ended September 30, 2012 and 2011, respectively. However, engineering expenses as a percentage of sales were lower, at 4.2% for the three months ended September 30, 2012 and 4.5% for the three months ended September 30, 2011.

Operating Profits. Reflecting all of the factors mentioned above, Operating Profits increased by $1,189,000 or 87.2%. The Company had a profit of $2,553,000 in the three-month period ended September 30, 2012, versus a profit of $1,364,000 in the three-months ended September 30, 2011.

Interest Income (Expense)-Net. 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 interest income was nominal for the third quarter of 2012 and 2011, and both periods had reasonably similar amounts of income.

Other Income (Expense)-Net. Other Income (Expense)-net primarily consists of foreign currency exchange gains (losses) on transactions with Omega Flex Limited, our U.K. subsidiary.

Income Tax Expense. Income Tax Expense was $900,000 for the third quarter of 2012, compared to $399,000 for the same period in 2011. The increase was related to higher profits. The Company's effective tax rate in 2012 does however approximate the 2011 rate and does not differ materially from expected statutory rates.

          Nine-months ended September 30, 2012 vs. September 30, 2011

The Company reported comparative results from operations for the nine-month
period ended September 30, 2012 and 2011 as follows:

                    Nine-months ended September 30,
                            (in thousands)

                    2012      2012      2011     2011
                   ($000)              ($000)
Net Sales        $           100.0%   $         100.0%
                  45,590              38,575
Gross Profit     $            51.0%   $          51.1%
                  23,232              19,727
Operating Profit $            20.4%   $          11.5%
                   9,286               4,430

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Net Sales. The Company's sales for the first nine months of 2012 increased $7,015,000 (18.2%) over the same period in 2011, ending at $45,590,000 and $38,575,000 in 2012 and 2011, respectively. Volume, or units sold, increased approximately 15% compared to the prior year quarter, and price increases were also recognized largely related to the sales of the Company's highly advanced TracPipe® CounterStrike®, which sells at a premium compared to its predecessor product.

The success over the prior year is primarily driven by the appeal in the gas market of the Company's flagship product, TracPipe® CounterStrike® , along with a surge in the sales of its emerging products, such as DoubleTrac® and DEF-Trac® double-containment flexible piping systems. The increase in sales has been most notable in the domestic operations, as the construction environment in the United States has shown signs of economic recovery during 2012.

Gross Margins. The Company's gross profit margins are very similar for the two periods, being 51.0% and 51.1% for the nine-months ended September 30, 2012 and 2011, 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 $9,049,000 and $7,825,000 for the nine-months ended September 30, 2012 and 2011, respectively, representing an increase of $1,224,000. Commissions and Freight increased largely in unison with the increase in sales volume, accounting for $840,000, or close to 70% of the variance from last year. The Company also had more costs in advertising relating to various initiatives, and additional sales staff and travel related expenses compared to last year. Sales expense was however lower than the prior year when compared as a percent of net sales, being 19.8% for the nine-months ended September 30, 2012, and 20.3% for the nine-months ended September 30, 2011.

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 $7,667,000 and $5,618,000 for the nine-months ended September 30, 2012 and 2011, respectively, increasing $2,049,000 between periods. Compared to last year, the Company incurred $1,195,000 of additional legal and insurance related expenses primarily associated with product liability claims and coverage. Furthermore, the Company absorbed $942,000 additional administrative staffing expenses in 2012, which includes an increase in incentive compensation related to increased profits from this year's general business activities, as well as the additional earnings derived from the Insurance Legal Recovery discussed below. Those increases were slightly offset by efficiencies found in various other items. As a percentage of sales, general and administrative expenses increased to 16.8% for the nine-months ended September 30, 2012 from 14.6% for the nine months ended September 30, 2011.

Insurance Legal Recovery - As previously disclosed in the Form 8-K/A filed with the Securities and Exchange Commission on March 15, 2012, the Company agreed to settle a legal dispute relating to insurance coverage and received $4,700,000 as part of the settlement during

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the same month. This receipt was all recorded as income during the first quarter of 2012. There was no comparable event during the previous year, and thus the change between periods is $4,700,000. This event also impacted incentive compensation, which is included in the General and Administrative Expenses, and Income Tax Expense, increasing both significantly compared to last year.

Engineering Expense. 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 $76,000 between periods, due to various insignificant items, as ended at $1,930,000 and $1,854,000 for the nine months ended September 30, 2012 and 2011, respectively. Engineering expenses as a percentage of sales improved, being 4.2% for the nine months ended September 30, 2012, compared to 4.8% for the nine months ended September 30, 2011.

Operating Profits. Reflecting all of the factors mentioned above, Operating Profits were up 109.6%, increasing by $4,856,000 to a profit of $9,286,000 in the nine-months ended September 30, 2012, from a profit of $4,430,000 in the nine-months ended September 30, 2011. Excluding the Insurance Legal Recovery less its applicable auxiliary costs, operating profits were still up $917,000 or approximately 21% compared to the prior year.

Interest Income (Expense)-Net. 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 interest income was nominal for the first quarter of 2012 and 2011, and both periods had similar amounts of income.

Other Income (Expense)-Net. Other Income (Expense)-net primarily consists of foreign currency exchange gains (losses) on transactions with Omega Flex Limited, our U.K. subsidiary.

Income Tax Expense. Income Tax Expense was $3,292,000 for the first nine months of 2012, compared to $1,552,000 for the same period in 2011. Of the $1,740,000 increase in tax expense, approximately $1,400,000 was the result of the receipt of the Insurance Legal Recovery, with the remaining increased associated with higher profits from general operations. The Company's effective tax rate in 2012 does however approximate the 2011 rate and does not differ materially from expected statutory rates.

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 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 following is a brief discussion of the Company's more significant accounting policies.

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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 at the dates of the financial statements, and the reported amounts of revenues and expenses during the reporting periods. The most significant estimates and assumptions relate to revenue recognition and related sales incentives, accounts receivable valuations, inventory valuations, goodwill valuation, product liability reserve and accounting for income taxes. Actual amounts could differ significantly from these estimates.

Our critical accounting policies and significant estimates and assumptions are described in more detail as follows:

Revenue Recognition

The Company's revenue recognition activities relate almost entirely to the manufacture and sale of flexible metal hose and pipe. Under GAAP, revenues are considered to have been earned when the Company has substantially accomplished what it must do to be entitled to the benefits represented by the revenues. The following criteria represent preconditions to the recognition of revenue:

·

Persuasive evidence of an arrangement for the sale of product or services must exist.

·

Delivery has occurred or services rendered.

·

The sales price to the customer is fixed or determinable.

·

Collection is reasonably assured.

The Company recognizes revenue upon shipment in accordance with the above principles.

Gross sales are reduced for all consideration paid to customers for which no identifiable benefit is received by the Company. This includes promotional incentives, which includes various programs including year-end rebates and discounts. The amounts of certain incentives are known with reasonable certainty at the time of sale, while others are projected based upon the most reliable information available at the reporting date.

Commissions, for which the Company receives an identifiable benefit, are accounted for as a sales expense.

Accounts Receivable

Accounts receivable are reduced by an allowance for amounts that may become uncollectible in the future. The estimated allowance for uncollectible amounts is based primarily on specific analysis of accounts in the receivable portfolio and historical write-off experience. While management believes the allowance to be adequate, if the financial condition of the Company's customers were to deteriorate, resulting in their inability to make payments,

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additional allowances may be required.

Inventory

Inventories are valued at the lower of cost or market. Cost of inventories is determined by the first-in, first-out (FIFO) method. The Company generally considers inventory quantities beyond two-years usage, measured on a historical usage basis, to be excess inventory and reduces the gross carrying value of inventory accordingly.

Goodwill and Intangible Assets

In accordance with FASB ASC Topic 350 Intangibles - Goodwill, the Company performs an annual impairment test in accordance with this guidance at the end of each year, or when a triggering event is noted that may create impairment.
This was last tested at December 31, 2011, and the analysis did not indicate any impairment of goodwill. There are no circumstances that indicate that Goodwill might be impaired at September 30, 2012.

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 Contingencies, for various product liability claims covered under the Company's general liability insurance policies, the Company must pay certain defense costs within its deductible or self-insured retention limits, ranging from $25,000 to $250,000 per claim, depending on the terms of the policy in the applicable policy year, up to an aggregate amount. The Company is vigorously defending against all known claims.

Fair Value of Financial and Nonfinancial Instruments

The Company measures financial instruments in accordance with Financial Accounting Standards Board (FASB) ASC Topic 820, Fair Value Measurements and Disclosures. The accounting standard defines fair value, establishes a framework for measuring fair value under GAAP, and enhances disclosures about fair value measurements. Fair value is defined as the exchange price that would be received for an asset or paid to transfer a liability (an exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date. Valuation techniques used to measure fair value must maximize the use of observable inputs and minimize the use of unobservable inputs. The standard creates a fair value hierarchy which prioritizes the inputs to valuation techniques used to measure fair value into three broad levels as follows: Level 1 inputs are quoted prices (unadjusted) in active markets for identical assets or liabilities; Level 2 inputs are inputs other than quoted prices included within Level 1 that are observable for the asset or liability, either directly or indirectly; and Level 3 inputs are unobservable inputs that reflect the Company's own assumptions about the assumptions market participants would use in pricing the asset or liability. The Company relies on its actively traded share value - a level 1 input - in determining the fair value of the reporting unit in its annual impairment test as described in the

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FASB ASC Topic 350 Goodwill and Intangibles.

Earnings per Common Share

Basic earnings per share have been computed using the weighted-average number of common shares outstanding. For the periods presented, there are no dilutive securities. Consequently, basic and dilutive earnings per share are the same.

Currency Translation

Assets and liabilities denominated in foreign currencies are translated into U.S. dollars at exchange rates prevailing on the balance sheet dates. The Statements of Income are translated into U.S. dollars at average exchange rates for the period. Adjustments resulting from the translation of financial statements are excluded from the determination of income and are accumulated in a separate component of shareholders' equity. Exchange gains and losses resulting from foreign currency transactions are included in operations (other income (expense)) in the period in which they occur.

Accounting for Income Taxes

The Company accounts for federal tax liabilities in accordance with 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. No valuation allowance was deemed necessary at September 30, 2012 or at December 31, 2011. Also, in accordance with FASB ASC Topic 740, the Company had reserves on the books for uncertainties in tax positions of $118,000 at September 30, 2012, and $135,000 at December 31, 2011.
These reserves are reviewed each quarter.

Other Comprehensive Income (Loss)

For the quarter ended September 30, 2012 and 2011, respectively, the sole component of Other Comprehensive Income (Loss) was a foreign currency translation adjustment.

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LIQUIDITY AND CAPITAL RESOURCES

Historically, the Company's primary cash needs have been working capital (including capital used for inventory purchases), which the Company has largely funded through cash generated from operations.

As of September 30, 2012, the Company had a cash balance of $9,206,000.
Additionally, the Company has a $10,000,000 line of credit available with Sovereign Bank, as discussed in detail in Note 4, which currently has no borrowings outstanding upon it. At December 31, 2011, The Company had cash of $3,476,000, and therefore has experienced an increase in cash of $5,730,000 during 2012.

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 . . .

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