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OFLX > SEC Filings for OFLX > Form 10-K on 27-Mar-2013All Recent SEC Filings

Show all filings for OMEGA FLEX, INC. | Request a Trial to NEW EDGAR Online Pro

Form 10-K for OMEGA FLEX, INC.


27-Mar-2013

Annual Report


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 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 United Kingdom. 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

Cash and cash equivalents were $939,000 at December 31, 2012, compared to $3,476,000 at December 31, 2011. The change is essentially a function of solid earnings from operations, plus insurance legal recovery funds, less a dividend payment. As stated in the Company's Statement of Operations, the Company had net income during 2012 of $6,876,000, which resulted in higher cash. A good portion of the Company's income was generated from ongoing operations. As disclosed in March 2012, the Company also received a $4,700,000 Insurance Legal Recovery, which after considering its auxiliary costs such as taxes, served to increase the year's income and cash by approximately $2,530,000. As a result of the strong cash position of the Company as of September 2012, which had a balance of $9,206,000, as well as other factors, the board elected to pay a cash dividend to shareholders during December 2012, which amounted to $10,092,000.
It should also be mentioned that the board elected to allow the Company to pay the bulk of the year's earned incentive compensation during December 2012.

Accounts Receivable was $12,134,000 at December 31, 2012, compared to $9,052,000 at December 31, 2011, increasing $3,082,000, or 34.0%. The majority of this increase is the result of higher sales during fourth quarter of 2012, particularly in December, compared to the fourth quarter and December 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.

Inventory has increased $663,000 or 10.3% from December 31, 2011. This was largely due to a ramp up in emerging product inventory, such as DoubleTrac®, to meet the increasing market demand in a timely manner.

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Accounts Payable has increased $1,718,000 (168.6%), ending at $2,737,000 at December 31, 2012, from a balance of $1,019,000 at December 31, 2011. The Company acquired a sizable amount of raw materials during the latter part of December 2012, and those obligations, as well as a few other large invoices were still unpaid as of the end of the period, but all were still within normal payments terms. The change was therefore largely timing related, as the Company typically pays all vendors within discount terms to ensure priority relationships.

The Line of Credit had a balance of $324,000 at the end of December 2012, but had no borrowings against it at the same point in 2011. As noted above, the Company paid a significant dividend payment and also incentive compensation at the end of 2012, which reduced cash and required the Company to draw against the line.

Accrued Compensation was $349,000 at December 31, 2012, decreasing $1,121,000 or 76.3% from its balance of $1,470,000 at December 31, 2011. The majority of this change relates to the incentive compensation payment discussed above, which was made during December 2012, and was higher than the prior year in general as it changes in correlation with profits.

Accrued Commissions and Sales Incentives were $3,671,000 and $2,098,000 at December 31, 2012 and 2011, respectively, increasing $1,573,000 or 75.0%. 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 $2,071,000 or 96.6% from December 31, 2011, primarily due to an increase in the legal accrual in relation to the legal settlement discussed in Note 13, "Subsequent Events", also due to an increase in legal and product liability accruals, which is described in detail in Note 11, "Commitments and Contingencies".

RESULTS OF OPERATIONS

Three-months ended December 31, 2012 vs. December 31, 2011


The Company reported comparative results from continuing operations for the
three-month period ended December 31, 2012 and 2011 as follows:


                    Three-months ended December 31,
                            (in thousands)

                    2012      2012      2011     2011
                   ($000)              ($000)
Net Sales        $           100.0%   $         100.0%
                  18,426              15,618
Gross Profit     $            52.6%   $          51.2%
                   9,698               7,990
Operating Profit $             7.9%   $          14.6%
                   1,461               2,279

Net Sales. The Company's 2012 fourth quarter sales dollars increased $2,808,000 (18.0%) over the same period in 2011, ending at $18,426,000, compared to $15,618,000 for the same three months in 2011. Volume, or units sold, increased approximately 24% compared to the prior year quarter. Pricing related decreases were however required due to the competitive nature of the market place, which lessened the impact of the surge in volume.

During the fourth quarter of 2012, the Company had experienced sales growth simultaneously from various product lines. Domestically, the Company's gas piping product, TracPipe® CounterStrike®, had benefited from the improving construction environment, as everything from single homes to high-rises and hospitals look to install gas piping to keep energy costs down. Additionally, the Company's emerging DoubleTrac® and DEF-Trac® double-containment piping systems have thrived, as the world moves towards more environmentally friendly solutions. Internationally, despite the soft economy, the Company's long standing gas piping product TracPipe® also showed signs of growth.

Gross Profit. The Company's gross profit margins increased between the two periods, being 52.6% and 51.2% for the three-months ended December 31, 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

-13-


expense was $3,207,000 and $3,049,000 for the three-months ended December 31, 2012 and 2011, respectively, representing an increase of $158,000. Commissions were the largest contributing factor, as they went up primarily as a result of the increase in sales. Sales expense for the quarter was 17.4% compared to 19.5% last year, which was an improvement.

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 $4,363,000 and $2,048,000 for the three-months ended December 31, 2012 and 2011, respectively, increasing $2,315,000 between periods. Legal related costs increased $2,451,000. As announced on March 20, 2013, the Company's English subsidiary, Omega Flex Limited, had reached an agreement to settle litigation related to a construction project in Milton Keynes, England, to avoid any potentially prolonged and costly legal conflict. The amount of the settlement equated to approximately $1,300,000. The Company has also seen an increase of $1,151,000 in legal costs related to product liability cases, as discussed in detail in Note 11 of the financial statements, "Commitments and Contingencies".
Fortunately, the Company has been able to find small savings in other various areas to mildly offset the increase in legal. As a percentage of sales, general and administrative expenses increased to 23.7% for the three months ended December 31, 2012 from 13.1% for the three months ended December 31, 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 $53,000. They were $667,000 and $614,000 for the three months ended December 31, 2012 and 2011, respectively. However, engineering expenses as a percentage of sales were lower, at 3.6% for the three months ended December 31, 2012 and 3.9% for the three months ended December 31, 2011.

Operating Profits. Reflecting all of the factors mentioned above, Operating Profits decreased by $818,000 or 35.9%. The Company had a profit of $1,461,000 in the three-month period ended December 31, 2012, versus a profit of $2,279,000 in the three-months ended December 31, 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 fourth 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 $754,000 for the fourth quarter of 2012, compared to $555,000 for the same period in 2011. Although the Company had a decrease in Income before Income Taxes compared to last quarter, the income tax expense for the same period increased due to the significant loss generated from our United Kingdom subsidiary, OFL, which has a much lower tax rate. Additionally, there was a release of a tax reserve for uncertainties during the fourth quarter of 2011 for amounts beyond the statutory audit period.

Twelve months ended December 31, 2012 vs. December 31, 2011

The Company reported comparative results from continuing operations for the twelve-month period ended December 31, 2012 and 2011 as follows:

Twelve-months ended December 31,

(in thousands)

                    2012       2012      2011     2011
                   ($000)               ($000)
Net Sales        $            100.0%   $         100.0%
                  64,016               54,193
Gross Profit     $             51.4%   $          51.1%
                  32,930               27,717
Operating Profit $             16.8%   $          12.4%
                  10,747                6,709

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Net Sales. The Company's sales for the twelve-months of 2012 increased $9,823,000 (18.1%) over the same period in 2011, ending at $64,016,000 and $54,193,000 in 2012 and 2011, respectively. Volume, or units sold, increased approximately 17% compared to the prior year quarter, and modest price increases were also recognized primarily related to the sales of the Company's highly advanced TracPipe® CounterStrike®, which sells at a premium compared to its predecessor product.

During 2012, the Company had experienced sales growth simultaneously from various directions during the year. Domestically, the Company's gas piping product, TracPipe® CounterStrike®, had benefited from the improving construction environment, as everything from single homes to high-rises and hospitals look to install gas piping to keep energy costs down. Additionally, the Company's emerging DoubleTrac® and DEF-Trac® double-containment piping systems have thrived, as the world moves towards more environmentally friendly solutions.
Internationally, despite the soft economy, the Company's long standing gas piping product TracPipe® also showed signs of growth.

Gross Margins. The Company's gross profit margins increased slightly, being 51.4% and 51.1% for the twelve-month period ended December 31, 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 $12,256,000 and $10,874,000 for 2012 and 2011, respectively, representing an increase of $1,382,000. Commissions and Freight increased largely in unison with the increase in sales volume, accounting for $1,069,000, or approximately 77% of the variance from last year. The Company also had 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 19.1% for the twelve-months ended December 31, 2012, and 20.1% for the twelve-months ended December 31, 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 $12,030,000 and $7,666,000 for the twelve-months ended December 31, 2012 and 2011, respectively, increasing $4,364,000 between periods. Compared to last year, the Company incurred $2,322,000 of additional legal and insurance related expenses primarily associated with product liability claims and coverage.
Additionally, as announced on March 20, 2013, the Company's English subsidiary, Omega Flex Limited, had reached an agreement to settle litigation related to a construction project in Milton Keynes, England, to avoid any potentially prolonged and costly legal conflict. The amount of the settlement equated to approximately $1,300,000. Furthermore, the Company absorbed $818,000 of 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 18.8% for 2012 from 14.1% in 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 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. These expenses were $2,597,000 and $2,468,000 for the twelve-months ended December 31, 2012 and 2011, respectively, thus increasing $129,000 between periods. There was an increase in staffing during the year of $223,000, which was then partially offset by various other insignificant favorable items. Engineering expenses as a percentage of sales improved, being 4.1% for the twelve-months ended December 31, 2012, compared to 4.6% for the twelve-months ended December 31, 2011.

Operating Profits. Reflecting all of the factors mentioned above, Operating Profits were up 60.2%, increasing by $4,038,000 to a profit of $10,747,000 in the twelve-months ended December 31, 2012, from a profit of $6,709,000 in the twelve-months ended December 31, 2011.

-15-


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 years ended 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 $4,046,000 for 2012, compared to $2,107,000 in 2011. Of the $1,939,000 increase in tax expense, approximately $1,400,000 was the result of the receipt of the Insurance Legal Recovery, with the remaining increase associated with higher profits from general operations, and the release of a tax reserve for uncertainties during the fourth quarter of 2011, as they were beyond the statutory audit period. The Company's effective tax rate in 2012 does however approximate the 2011 rate and does not differ materially from expected statutory rates.

COMMITMENTS AND CONTINGENCIES

See Note 11 to the Company's financial statements 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 its results of operations in any given year:

Construction Activity-The Company is directly impacted by the level of single family and multi-family residential housing starts and, to a lesser extent, commercial construction starts. A few years ago, low interest rates and easy availability of credit, contributed to a high level of construction activity.
However, the past couple of years have seen deterioration in demand for residential, commercial and institutional construction.

Some of the factors that influenced the decline include:

·

the crisis in the financial markets reduced the availability of financing for new construction, especially large projects

·

foreclosures have increased the inventory of available residential housing, thereby decreasing the demand for new construction, and

·

consumer demand and confidence has declined as a result of reduced economic activity and increased unemployment.

Recently construction activity has shown upward mobility, and statistics provided by the National Association of Home builders suggests housing starts will increase during the coming year. However, any significant decrease in residential construction activity may materially adversely affect the Company's financial condition.

Technological Changes-Although the HVAC industry has historically been impacted by technology changes in a relatively incremental manner, it cannot be discounted that radical changes-such as might be suggested by fuel cell technology, burner technology and/or other developing technologies which might impact the use of natural gas-could materially adversely affect the Company's results of operations and/or financial position in the future.

Weather Conditions-The Company's flagship TracPipe® and CounterStrike ®products are used in residential and commercial heating applications. As such, the demand for its products is impacted by weather as it affects the level of construction.
Furthermore, severe climatic changes, such as those suggested by the "global climate change" phenomenon, could over time adversely affect the demand for fossil fuel heating products and adversely affect the Company's results of operations and financial position.

Purchasing Practices-It has been the Company's policy in recent years to aggregate purchase volumes for high value commodities with fewer vendors to achieve maximum cost reductions while maintaining quality and service. This policy has been effective in reducing costs, but has introduced additional risk which could potentially result in short-term supply disruptions or cost increases from time to time in the future.

-16-


Legal Costs -The Company is subject to lawsuits mostly relating to claims of product liability. The company has in place insurance policies to cover the defense of most of these cases, and any amounts payable with respect thereto, are typically subject to deductibles or self-insured retention amounts that vary depending on the policy year. The company is vigorously defending these cases and is confident of prevailing in one or more lawsuits in the near term.
However, continued litigation and the defense costs associated therewith, in addition to any other payments made, could affect the company's results of operations, perhaps materially.

Supply Disruptions and Commodity Risks-The Company uses a variety of materials in the manufacture of its products, including stainless steel, polyethylene and brass for its AutoFlare® connectors. In connection with the purchase of commodities, principally stainless steel for manufacturing requirements, the Company occasionally enters into one-year purchase commitments which include a designated fixed price or range of prices. These agreements typically require the Company to accept delivery of the commodity in the quantities committed, at the agreed upon prices. Transactions required for these commodities in excess of the one year commitments are conducted at current market prices at the Company's discretion. Currently, the Company does not have any fixed purchase commitment contracts, but may enter into such transactions in the future.

In addition to the raw material cost strategy described above, the Company enters into fixed pricing agreements for the fabrication charges necessary to convert these commodities into useable product. It is possible that prices may decrease below the fixed prices agreed upon and therefore require the Company to pay more than market price, potentially materially. Management believes at present that it has adequate sources of supply for its raw materials and components (subject to the risks described above under Purchasing Practices) and has historically not had significant difficulty in obtaining the raw materials, component parts or finished goods from its suppliers. The Company is not dependent for any commodity on a single supplier, the loss of which would have a material adverse effect on its business.

Interest Rate Sensitivity - The Company currently has access to a $10,000,000 line of credit (LOC) with Sovereign Bank, NA (Sovereign), and as of December 31, 2012, has drawn $324,000 on the line. When the Company borrows against the LOC, all amounts must be paid back with interest, using an interest rate range of LIBOR plus 1.75% to LIBOR plus 2.75% or Prime less 0.50% to Prime plus 0.50%, depending upon the Company's then existing financial ratios. The Company may elect to use either the LIBOR or PRIME rates. As of December 31, 2012, the actual rate to borrow was at 2.75%. Interest rates are also significant to the Company as a participant in the residential construction industry, since interest rates can be a determinant factor on whether or not borrowing funds for building will be affordable to our customers. (See Construction Activity, above). Currently, interest rates are at historic lows, but any dramatic change to interest rates could have a detrimental effect on the business.

Retention of Qualified Personnel - The Company does not operate with multiple levels of management. It is relatively "flat" organizationally, which does subject the Company to the risks associated with the loss of critical managers.
From time to time, there may be a shortage of skilled labor, which may make it more difficult and expensive for the Company to attract and retain qualified employees. The Company is dependent upon the relatively unique talents and managerial skills of a small number of key executives.

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 in the Notes to the Consolidated Financial Statements include a summary of the significant accounting policies and methods used in the preparation of our Consolidated Financial Statements. The following is a brief discussion of the Company's more significant accounting policies.

The preparation of financial statements in conformity with generally accepted accounting principles (GAAP) requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and the 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, inventory valuations, goodwill and intangible asset valuations, product liability costs, phantom stock and accounting for income taxes. Actual amounts could differ significantly from these estimates.

. . .

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