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OFLX > SEC Filings for OFLX > Form 10-K on 14-Mar-2014All Recent SEC Filings

Show all filings for OMEGA FLEX, INC.

Form 10-K for OMEGA FLEX, INC.


14-Mar-2014

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.

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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 facilities 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

The Cash balance was $8,257,000 at December 31, 2013, compared to $939,000 at December 31, 2012, increasing $7,318,000 (779.3%) during the year. Net Income attributable to Omega Flex, Inc. for 2013 was $10,037,000, which helped to replenish cash throughout the year. The income for 2013 includes an accrual for incentive compensation of approximately $2,800,000 which will not be paid until the first quarter of 2014, and therefore adds to cash as of December 31, 2013. The Company did however have a couple of significant outflows during 2013. On December 31, 2013 the Company funded a dividend amounting to $4,289,000, which is described in detail in Note 6, under Shareholders' Equity. In addition, the Company also paid the UK Settlement of approximately $1,300,000, which is detailed in Note 11, Commitments and Contingencies.

Accounts Payable has decreased $944,000 (34.5%), ending at $1,793,000 at December 31, 2013, from a balance of $2,737,000 at December 31, 2012. The majority of the change is timing related, with less payments due to vendors outstanding at December 31, 2013 than experienced at December 31, 2012.

The Company's Line of Credit, discussed in detail within Note 5, had an outstanding balance of $324,000 at December 31, 2012, but was paid off in its entirety during the first quarter of 2013.

Accrued Compensation was $3,114,000 at December 31, 2013, compared with $349,000 at December 31, 2012, thus increasing $2,765,000 (792.3%). A majority of the incentive compensation that was earned in 2012 was paid during the fourth quarter of 2012. The accrual at December 31, 2013 represents the accumulation of the current year's accrual for a full twelve months, as earned in correlation with profits. Typically, incentive compensation is paid during the first quarter of the following year, but in 2012 it was largely earned and paid in the same year, thus diminishing the accrual at the end of that year.

Other Liabilities were $3,575,000 at December 31, 2013, compared to $4,214,000 at December 31, 2012. As disclosed in Note 11, Commitments and Contingencies, the Company's subsidiary, OFL, had been sued regarding the installation of TracPipe product in an apartment complex in England. The Company had reached a settlement of approximately $1,300,000 regarding this issue in March of 2013, and recorded the amount in Other Liabilities as of December 31, 2012. OFL then paid $1,300,000 during March of 2013 and thus diminished the balance of the liability accordingly, which accounts for a majority of the change between periods. This event along with various other partially offsetting items accounts for the 15.2% change in years of $639,000.

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RESULTS OF OPERATIONS

Three-months ended December 31, 2013 vs. December 31, 2012


The Company reported comparative results from continuing operations for the
three-month period ended December 31, 2013 and 2012 as follows:


                    Three-months ended December 31,
                            (in thousands)

                    2013      2013      2012     2012
                   ($000)              ($000)
Net Sales        $           100.0%   $         100.0%
                  21,860              18,426
Gross Profit     $            55.3%   $          52.6%
                  12,093               9,698
Operating Profit $            21.1%   $           7.9%
                   4,602               1,461

Net Sales. The Company's 2013 fourth quarter Net Sales increased $3,434,000 (18.6%) over the same period in 2012, ending at $21,860,000 for the three-months ended December 31, 2013, compared to $18,426,000 for the same three months in 2012.

Net Sales have expanded over the prior year partially due to improvements in the residential construction industry. The sales results also appear to demonstrate a preference for the Company's products and performance, as they are statistically exceeding the growth experienced in the CSST market place for the fourth quarter. An increase in volume, or units sold, accounts for the majority of the change compared to the prior year, and there was also a slight rise in pricing.

Gross Profit. The Company's gross profit margins have increased between the two periods, being 55.3% and 52.6% for the three-months ended December 31, 2013 and 2012, respectively. The favorable change resulted from a combination of items, including the pricing action noted above, and the Company's ability to find various efficiencies in procurement and manufacturing processes, and increased production volume also helped to better absorb certain fixed manufacturing overhead costs.

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 $3,525,000 and $3,207,000 for the three-months ended December 31, 2013 and 2012, respectively, representing an increase of $318,000.
Commissions and Freight together accounted for the majority of the change, increasing $233,000, largely associated with the increase in sales volume.
Sales expense as a percent of net sales has however decreased, being 16.1% for the three-months ended December 31, 2013, compared to 17.4% for the three-months ended December 31, 2012.

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 $3,225,000 and $4,363,000 for the three-months ended December 31, 2013 and 2012, respectively, decreasing $1,138,000 between periods. Legal related costs decreased $1,756,000. 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. Inversely, the Company recognized a $651,000 increase in administrative staffing expenses, mostly related to incentive compensation in conjunction with higher profits. As a percentage of sales, general and administrative expenses decreased to 14.8% for the three months ended December 31, 2013 from 23.7% for the three months ended December 31, 2012.

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 $74,000 for the quarter. They were $741,000 and $667,000 for the three months ended December 31, 2013 and 2012, respectively. Engineering expenses as a percentage of sales were 3.4% for the three months ended December 31, 2013, and 3.6% for the three months ended December 31, 2012.

Operating Profit. Reflecting all of the factors mentioned above, Operating Profits increased by $3,141,000, rising 215% over last year. The Company had a profit of $4,602,000 in the three-month period ended December 31, 2013, versus a profit of

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$1,461,000 in the three-months ended December 31, 2012. Excluding the UK settlement discussed above, less its applicable auxiliary costs, operating profits were actually higher by 80.5% versus the prior year.

Interest Income (Expense). 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 (expense) was nominal for the fourth quarter of 2013 and 2012, and both periods had similar amounts of income.

Other Income (Expense). Other Income (Expense) 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 $1,373,000 for the fourth quarter of 2013, compared to $754,000 for the same period in 2012. The $619,000 increase was primarily due to higher income before taxes. The Company's effective tax rate in 2013 was 29.9% of pretax income compared to 51.2% in 2012. The significant change was largely the result of the significant loss in the UK during the fourth quarter of 2012, which has a much lower tax rate than in the US. UK operations were however profitable during the same period in 2013. The rates for both periods do not differ materially from expected statutory rates.

Twelve months ended December 31, 2013 vs. December 31, 2012

The Company reported comparative results from continuing operations for the twelve-month period ended December 31, 2013 and 2012 as follows:

Twelve-months ended December 31,

(in thousands)

                    2013       2013      2012     2012
                   ($000)               ($000)
Net Sales        $            100.0%   $         100.0%
                  77,122               64,016
Gross Profit     $             54.3%   $          51.4%
                  41,893               32,930
Operating Profit $             19.5%   $          16.8%
                  15,048               10,747

Net Sales. The Company's Net Sales for 2013 increased $13,106,000 (20.5%) over the same period in 2012, ending at $77,122,000 and $64,016,000 in 2013 and 2012, respectively.

Net Sales have received a boost over the prior year partially due to improvements in the residential construction industry. The sales have also gained market share over competitor products, such as black iron pipe, as they are statistically exceeding the growth experienced in the housing market during the year. An increase in volume, or units sold, accounts for the majority of the change compared to the prior year, and there was also a slight rise in pricing.

Gross Profit. The Company's gross profit margins have increased between the two periods, being 54.3% and 51.4% for the twelve-months ended December 31, 2013 and 2012, respectively. The improvement resulted from a combination of items, including the pricing action noted above, and the Company's ability to find various efficiencies in procurement and manufacturing processes. Increased production volume also allowed for better absorption of certain fixed manufacturing overhead costs.

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 $12,954,000 and $12,256,000 for 2013 and 2012, respectively, representing an increase of $698,000. Commissions and Freight increased by $1,019,000 compared to last year, largely attributable to the increase in sales volume. The increases in Commissions and Freight were however softened by a decrease in advertising relating expenses. Sales expense is however lower than the prior year when compared as a percent of net sales, being 16.8% for 2013, and 19.1% for 2012.

General and Administrative Expenses. General and administrative expenses consist primarily of employee salaries including incentive compensation, benefits for administrative, executive and finance personnel, legal and accounting, insurance, and corporate general and administrative services.
General and administrative expenses were $11,133,000 and $12,030,000 for the twelve-months ended December 31, 2013 and 2012, respectively, decreasing $897,000 between periods. Legal expenses have decreased by $1,944,000, mostly due to the previously mentioned UK settlement recorded in 2012 of approximately $1,300,000.

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The decrease in legal was however partially offset by a $942,000 increase in administrative staffing expenses during 2013, mostly related to incentive compensation earned in association with higher profits, and various other insignificant items. As a percentage of sales, general and administrative expenses were 14.4% and 18.8% for 2013 and 2012, respectively.

Insurance Legal Recovery. As previously disclosed in a 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 that same month. This receipt was all recorded as income during the first quarter of 2012. There was no comparable event during 2013, 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 Expenses, increasing both significantly compared to this 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 have increased $161,000 between periods, as they were $2,758,000 during 2013, and $2,597,000 in 2012. Engineering expenses as a percentage of sales were 3.6% for the year ended December 31, 2013, and were 4.1% for the full year of 2012.

Operating Profit. Reflecting all of the factors mentioned above, Operating Profits increased $4,301,000 or 40%, ending with a profit of $15,048,000 for 2013, compared to $10,747,000 in 2012. Excluding the Insurance Legal Recovery and the UK settlement discussed above, less their applicable auxiliary costs, operating profits were actually higher by 90.6% versus the prior year.

Interest Income (Expense). 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 net interest income was nominal during 2013 and 2012, and both periods had similar amounts of income.

Other Income (Expense). Other Income (Expense) 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 $4,891,000 in 2013, compared to $4,046,000 for the same period in 2012, increasing by $845,000, largely in correlation with the change in income before taxes. The Company's effective tax rate in 2013 was 33% of pretax income compared to 37% in 2012. The rates in both years do not differ materially from expected statutory rates, based upon the jurisdictions in which the income was earned.

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. The construction industry can be cyclical, shifting upwards and downwards depending on a variety of factors. After a few years of significant building, the United States construction industry appeared to hit a peak in 2006. Low interest rates and easy availability of credit, contributed to a high level of construction activity. However, following that period, the industry experienced a significant 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 had increased the inventory of available residential housing, thereby decreasing the demand for new construction, and

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·

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

During 2012 and 2013, the construction activity appeared to reflect a recovery, and has shown upward mobility. Statistics provided by the National Association of Home Builders suggests housing starts will continue to 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 if one of the Company's key vendors experiences any catastrophic event, such as bankruptcy.

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 in 2013 was successful in obtaining a couple favorable outcomes. 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, and could potentially inhibit the Company from obtaining insurance in the future through mainstream markets at an affordable price.

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 sometimes 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.

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 Santander Bank, formerly Sovereign Bank, NA (Sovereign), and as of December 31, 2013, has no outstanding amounts due 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, 2013, the actual rate to borrow was at approximately 2.00%. 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

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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.

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 generally 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 selling expense.

Accounts Receivable

Accounts receivable are reduced by an allowance for amounts that may become . . .

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