As disclosed in Note 3 to the Financial Statements, the Company is a former subsidiary of Mestek, Inc. On July 29, 2005, Mestek, Inc. effected a distribution of its 86% ownership of the Company’s common stock to the Mestek record shareholders. This distribution was preceded by the filing on July 22, 2005 of a definitive registration statement of the Company’s common stock on Form 10 with the Securities and Exchange Commission. The Company’s common shares began trading on the NASDAQ National Market under the trading symbol “OFLX” on August 1, 2005. Certain effects of the distribution are reflected in the changes of financial condition of the Company for the quarter ended September 30, 2005.
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 controlled 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 line, TracPipe® 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®, the TracPipe® flexible gas piping allows users to substantially cut the time required to install the gas piping, as compared to traditional methods. All of the Company’s annular hose products are manufactured at the Company’s Exton, Pennsylvania facility. 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.
Cash and cash equivalents increased from $280,000 in December 31, 2004 to $7,325,000 in September 30, 2005. This increase is the result of the Company maintaining its own cash balances subsequent to the “Spin Off” and the cash generated by the Company’s business operations since the “Spin Off”. The inter-company receivable from parent of $16,572,000 was eliminated, primarily as a result of the repayment by Mestek of its debt to the Company (from Mestek’s share of the dividends paid by the Company to its then current shareholders), and the remaining balance (approximately $3,250,000) of the Company’s intercompany receivables was fixed and documented in a written promissory note upon consummation of the “Spin Off”, and is now recorded as Note Receivable from
Mestek. The dividends declared prior to the “Spin-Off” were declared in October 2004, and paid in two installments in October 2004 in the amount of $9,000,000, and in January 2005 in the amount of $ 9,350,000, of which $8,041,000 was charged against retained earnings and $1,309,000 was charged against Common Stock Subject to Put Obligations. The payment of these dividends also reduced the Company’s retained earnings, although the Company’s continued earnings during the first nine months of 2005 dampened the overall impact of the dividend on retained earnings.
The balance of the liability for the Put Obligation ($2,693,000) was converted to Paid in Capital effective with the date of the “Spin Off.”
Other accrued liabilities decreased $2,039,000 from $5,060,000 at December 31, 2004 to $3,021,000 at September 30, primarily reflecting the payment of year-end customer rebates for the year 2004.
RESULTS OF OPERATIONS
| Three months ended September 30, 2005 vs. September 30, 2004 |
The Company reported comparative results from continuing operations for three-months period ended September 30, 2005 and 2004 as follows:
| Three-months ended September 30, |
| 2005 | 2005 | 2004 | 2004 |
| ($000) | % | ($000) | % |
| | | | |
Net Sales | $17,087 | 100.00% | $11,693 | 100.00% |
Gross Profit | $8,486 | 49.7% | $5,888 | 50.4% |
Operating Profits | $3,292 | 19.3% | $2,048 | 17.5% |
The Company’s sales increased $5,394,000 (46.1%) to $17,087,000 in the three-months period ended September 30, 2005, as compared against $11,693,000 in the three-months period ended September 30, 2004, due to continued strong sales of the Company’s flagship TracPipe® flexible gas piping product and its patented connection system. Sales of TracPipe( were sustained by relatively strong single family and multi-family residential construction activity. The $5,394,000 increase in sales from three-months period ended September 30, 2004 to three-months period ended September 30, 2005 reflects volume increases of $4,162,000 and net price increases of $1,232,000.
The Company’s gross profit margins were down slightly from 50.4% in the three-months period ended September 30, 2004 to 49.7% in the three-months period ended September 30, 2005 indicative of inflationary pressures affecting stainless steel and other commodities, softened somewhat by manufacturing efficiencies.
Reflecting the factors mentioned above, Operating Profit margins, increased by 1.8 percentage points from $2,048,000 in the three-months period ended September 30, 2004 to $3,292,000 in the three-months period ended September 30, 2005.
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. Selling expense was $2,484,000 and $2,075,000 for the three months ended September 30, 2005 and 2004, respectively. The $409,000 increase in selling expenses is due to increased sales commissions and costs of additional personnel in the sales force. Sales expense as a percentage of sales declined from 17.7% for the three months ended September 30, 2004 to 14.5% for the three months ended September 30, 2005.
General and Administrative Expenses. General and administrative expenses consist primarily of employee salaries, benefits for administrative, executive and finance personnel, legal and accounting, and corporate general and administrative services. General and administrative expenses were $2,295,000 and $1,306,000 for the three months ended September 30, 2005 and 2004, respectively. The $989,000 increase in expenses is attributable to legal
expenses and to management compensation as well as expenses associated with operating as a public company. For the preceding reasons, general and administrative expense, as a percentage of sales, increased from 11.2% for the three months ended September 30, 2004 to 13.4% for the three months ended September 30, 2005.
Engineering Expense. Development expenses associated with the development of new products and enhancements to existing products, and manufacturing engineering costs. Engineering expenses were $415,000 and $459,000 for the three months ended September 30, 2005 and 2004 respectively. The $44,000 decrease in engineering expenses is due almost entirely from decreased expenditures associated with the certification and qualification of new products. Accordingly, engineering expenses as a percentage of sales decreased from 3.9% for the three months ended September 30, 2004 to 2.4% for the three months ended September 30, 2005.
Interest Income-Net. Interest income-net includes interest income on the note receivable from Mestek which bears interest at 5.03% per annum, interest income from the Company’s newly-enacted investment account for excess cash, and interest expense associated with the commercial bank borrowings in April 2004 related to the Company’s purchase of its manufacturing premises. The mortgage note bears interest at LIBOR plus 1.75%. Interest income was $57,000 in the three-months period ended September 30, 2005 and $153,000 for the three-months period ended September 30, 2004. The note receivable from Mestek decreased from $22,606,000 at September 30, 2004 to $3,250,000 at September 30, 2005. Interest Expense was $45,000 for the three-months ended September 30, 2005 and $46,000 for the 3 months ended September 30, 2004.
Other Income-Net. Other Income-net primarily consists of realized foreign currency exchange gains (losses) on Omega Flex Limited payments for accounts payable, interest and management fee to Omega Flex, Inc., its parent corporation.
Income Tax Expense. For three-months period ended September 30, 2005, the Company’s effective income tax rate varied slightly from the statutory rates for both federal and state income taxes due to limitations on deductions related to Incentive Stock Options.
Nine months ended September 30, 2005 vs. September 30, 2004
The Company reported comparative results from continuing operations for the nine-month period ended September 30, 2005 and nine-months ended September 30, 2004 as follows:
| Nine-months ended September 30, |
| 2005 | 2005 | 2004 | 2004 |
| ($000) | % | ($000) | % |
| | | | |
Net Sales | $45,579 | 100.00% | $33,820 | 100.00% |
Gross Profit | $22,789 | 50.0% | $16,934 | 50.1% |
Operating Profits | $8,530 | 18.7% | $5,898 | 17.4% |
The Company’s sales increased $ 11,759,000 (34.8%) to $45,579,000 in the nine-months period ended September 30, 2005, as compared to $33,820 in the nine-months period ended September 30, 2004, due to continued strong sales of the Company’s flagship TracPipe® flexible gas piping product and its patented connection system. Sales of TracPipe( were sustained by relatively strong single family and multi-family residential construction activity. The $11,759,000 increase in sales from the nine-month period ended September 30, 2004 to the nine-month period ended September 30, 2005 reflects volume increases of $7,811,000and net price increases of $3,948,000.
The Company’s gross profit margins were decreased slightly from 50.1% in the nine-month period ended September 30, 2004 to 50.0% in the nine months period ended September 30, 2005 indicative of our abilities to effectively price our products, despite inflationary pressures affecting stainless steel and other commodities
Selling Expenses. Selling expense was $7,269,000 and $6,127,000 for the nine-month period ended September 30, 2005 and 2004, respectively. The $1,142,000 increase in selling expenses is due to increased sales commissions and freight costs on incremental sales, and costs of additional personnel in the sales force at our
foreign subsidiary. Sales expense as a percentage of sales declined from 18.1% for the nine-month period ended September 30, 2005 to 15.9% for the nine-month period ended September 30, 2004.
General and Administrative Expenses. General and administrative expenses were $5,943,000 and $3,544,000 for the nine months ended September 30, 2005 and 2004, respectively. The $2,399,000 increase in expenses is attributable to legal, management compensation, and costs associated with the “spin-off” from Mestek, Inc. For the preceding reasons, general and administrative expense, as a percentage of sales, increased from 10.5% for the nine months ended September 30, 2004 to 13.0% for the nine months ended September 30, 2005.
Engineering Expense. Engineering expenses were $1,047,000 and $1,364,000 for the nine months ended September 30, 2005 and 2004 respectively. The $317,000 decrease in engineering expenses is due mostly to decreased expenditures associated with the certification and qualification of new products. Accordingly, engineering expenses as a percentage of sales decreased from 4.0% for the nine months ended September 30, 2004 to 2.3% for the nine months ended September 30, 2005.
Interest Income-Net. Interest income-net includes interest income on the note receivable from Mestek which bears interest at 5.03% per annum, interest income from the Company’s newly-enacted investment account for excess cash, and interest expense associated with the commercial bank borrowings in April 2004 related to the Company’s purchase of its manufacturing premises. The mortgage note bears interest at LIBOR plus 1.75%. Interest income was $227,000 in the nine-months period ended September 30, 2005 and $304,000 for the nine-months period ended September 30, 2004. The note receivable from Mestek decreased from $22,606,000 at September 30, 2004 to $3,250,000 at September 30, 2005. Interest Expense was $128,000 for the nine-months ended September 30, 2005 and $51,000 for the nine months ended September 30, 2004.
Other Income-Net. Other Income-net primarily consists of realized foreign currency exchange gains (losses) on Omega Flex, Ltd. payments for accounts payable, interest and management fee to Omega Flex, Inc., the Parent.
Income Tax Expense. For nine-month period ended September 30, 2005, the Company’s effective income tax rate varied slightly from the statutory rates for both federal and state income tax due to limitations on deductions related to Incentive Stock Options.
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 1 of the Notes to the Consolidated Financial Statements includes 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 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, accounts receivable valuations, inventory valuations, goodwill valuation, intangible asset valuations, product liability costs, workers compensation claims reserves, health care claims reserves, 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 generally accepted accounting principles, 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.
Accounting for Income Taxes
The Company has elected in 2004 and prior years to file its federal income tax return as part of the consolidated tax return of Mestek, Inc. its former parent company. Mestek and Omega account for Omega’s federal tax liabilities on the “separate company basis” method in accordance with FAS 109, Accounting for Income Taxes. Under this method Omega recorded tax expense and related deferred taxes and tax benefits in a manner comparable to that which it would have recorded if it were not affiliated during those periods with Mestek.
The preparation of the Company’s Consolidated Financial Statements requires it to estimate its income taxes in each of the jurisdictions in which it operates, including those outside the United States which may be subject to certain risks that ordinarily would not be expected in the United States. The income tax accounting process involves estimating its actual current exposure together with assessing temporary differences resulting from differing treatment of items, such as depreciation and stock based compensation, for tax and accounting purposes. These differences result in the recognition of deferred tax assets and liabilities. The Company must then record a valuation allowance to reduce its deferred tax assets to the amount that is more likely than not to be realized. Significant management judgment is required in determining the Company’s provision for income taxes, its deferred tax assets and liabilities and any valuation allowance recorded against deferred tax assets. In the event that actual results differ from these estimates or the Company adjusts these estimates in future periods, it may need to adjust its valuation allowance which could materially impact its financial position and results of operations.
IMPACT OF INFLATION
Stainless steel and other related commodities represent a significant portion of the Company’s prime costs. As such, the Company’s margins are vulnerable to inflationary pressures which affect the commodity markets from time to time. Gross profit margins were down slightly in the three-month period ended September 30, 2005 from the comparable period in 2004, which is indicative of inflationary pressures affecting stainless steel and other commodities, mitigated somewhat by manufacturing efficiencies. However, in the nine month period ended September 30, 2005, gross profit margins were essentially unchanged from the comparable period in 2004 due to the timely implementation of price increases to our customers and to increased manufacturing efficiencies.
LIQUIDITY AND CAPITAL RESOURCES
As of September 30, 2005 and December 31, 2004, the Company had no commercial bank line of credit for working capital purposes. The Company had historically relied upon its former corporate parent, Mestek, Inc. (Mestek), to provide working capital and other credit as needed through an intercompany account relationship; however, the Company consistently transferred more cash to Mestek than it has borrowed resulting in a cumulative intercompany receivable from Mestek. The Company discontinued the coordination of its bank accounts with Mestek on or about July 5, 2005, so that the Company continued to receive all of the proceeds from the payment of its accounts receivable, and Mestek continued to pay the Company’s account payables until on or about July 21, 2005, at which time the Company began paying its own accounts payable. The Company’s intercompany receivable from Mestek was fixed and documented in a written promissory note upon the consummation of the Spin-off (as described in Note 3 to the consolidated financial statements), in the principal amount of $3,249,615 . The Mestek promissory note bears interest at a rate equal to 5.03%, which is equal to the three year U.S. Treasury note yield plus 100 basis points prevailing on the date the note was executed, and is payable in full after three years from the effective date of the Spin-off. The Company has accumulated approximately $7,325,000 in cash and cash equivalents which are invested in a short-term investment facility.
The Company believes its liquidity position as of September 30, 2005 and December 31, 2004 is fully adequate to meet foreseeable future needs. The Company also believes that it will possess adequate cash reserves and will be able to obtain sufficient working capital lines of credit to meet its day-to-day needs including any acquisitions or capital expenditures it can reasonably foresee at this time.
CONTINGENT LIABILITIES AND GUARANTEES
See Note 5 to the Company’s financial statements.
The Company is obligated as a guarantor for the debt incurred by its wholly-owned subsidiary, Exton Ranch, Inc., for the purchase of the facility at 451 Creamery Way, Exton, Pennsylvania, as disclosed in Note 8 to the financial statements.
OFF-BALANCE SHEET ARRANGEMENTS
The Company has no off-balance sheet arrangements.
Item 3. Quantitative And Qualitative Information 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. For a discussion of the risk factors facing the Company, and the shareholders’ investment in the Company, please refer to the Risk Factors set forth in the Company’s final registration statement on Form 10-12G/A, filed with the Securities and Exchange Commission on July 22, 2005.
Item 4 – Controls And Procedures
| (a) | Evaluation of Disclosure Controls and Procedures. |
At the end of the fiscal third quarter of 2005, the Company evaluated the effectiveness of the design and operation of its disclosure controls and procedures. The Company’s disclosure controls and procedures are designed to ensure that the Company records, processes, summarizes and reports in a timely manner the information required to be disclosed in the periodic reports filed by the Company with the Securities and Exchange Commission. The Company’s management, including the chief executive officer and chief financial officer, have conducted an evaluation of the effectiveness of the design and operation of the Company’s Disclosure Controls and Procedures as defined in the Rule 13a-15(e) of Securities Exchange Act of 1934. Based on that evaluation, the chief executive officer and chief financial officer have concluded that, as of the date of their evaluation, the Company’s disclosure controls and procedures are effective to provide reasonable assurance of achieving the purposes described in Rule 13a-15(e), and no changes are required at this time. However, the Company’s management has disclosed to its audit committee and to its independent auditors a control deficiency regarding two non-material contractual commitments that were not previously recorded in the Company’s financial records. As of September 30, 2005, the Company has recorded these non-material contractual commitments without any material impact on the current or prior period financial results.
| (b) | Changes in Internal Controls. |
There was no change in the Company’s “internal control over financial reporting” (as defined in rule 13a-15(f) of the Securities Exchange Act of 1934) identified in connection with the evaluation required by Rule 13a-15(d) of the Securities Exchange Act of 1934 that occurred during the three-month period covered by this Report on Form 10-Q that has materially affected or is reasonably likely to materially affect the Company’s internal control over financial reporting subsequent to the date the chief executive officer and chief financial officer completed their evaluation.
PART II - OTHER INFORMATION
Item 1 – Legal Proceedings
The Company is subject to several legal actions and proceedings in which various monetary claims are asserted. Management, after consultation with its corporate legal department and outside counsel, does not anticipate that any ultimate liability arising out of all such litigation and proceedings will have a material adverse effect on the financial condition of the Company, except as set forth below.
Berry, et al. v. Titeflex Corp., et al.
Case No. CV-2004-211, Circuit Court of Clark County, Arkansas, filed November 15, 2004.
Four individual residents of Arkansas and an individual Texas resident have sued the top four manufacturers of corrugated stainless steel tubing (“CSST”), including Omega Flex, Inc. as the manufacturer of TracPipe® brand CSST. The complaint proposes a national class action on behalf of all owners of installed CSST. Installed CSST is alleged to be defective because it is alleged to be more susceptible to failure from near-lightning strikes than traditional black iron pipe and because the manufacturers allegedly failed to warn of CSST’s allegedly heightened susceptibility to such damage.
The Company has filed motions to dismiss the amended complaint and the cross-complaint of the individual Arkansas plumber defendant, who likewise proposed a class action cross-claim on behalf of installers of CSST. Full discovery is proceeding and disposition of the class certification issue is expected in the second half of 2006. The Company will oppose both class certification and any request for a national class. The Company believes it has valid defenses to the issues of both class certification and product liability and the Company will contest these claims vigorously. At this time, the Company believes that no estimation of potential liability in the matter can be reasonably made. It is the nature of class action litigation in general and this matter in particular, that if there should be an adverse decision on the issue of certification of a national class of CSST owners and an adverse decision on the issue of product liability, the financial position and results of operation of the Company could be materially adversely affected.
Item 3 - Defaults Upon Senior Securities
Certain inter-company dividends paid by the Company to Mestek in 2004 and 2005, prior to the “spin-off” transaction described in more detail in Note 5, caused the Company to be in technical breach of two loan covenants relating to the mortgage note for certain periods. The Company paid all amounts due under the mortgage note during the periods of the above technical breaches. On September 6, 2005, the Company received a waiver of the technical breach and revised Loan Covenants which are more conducive to the Company’s operations as a public company. The Company believes that it is in compliance with all required covenants as of September 30, 2005.
Exhibit
31.1 | Certification of Chief Executive Officer of Omega Flex, Inc. pursuant to Rule 15d-14(a) promulgated under the Securities Exchange Act of 1934, as amended. |
31.2 | Certification of Chief Financial Officer of Omega Flex, Inc. pursuant to Rule 15d-14(a) promulgated under the Securities Exchange Act of 1934, as amended. |
32.1 | Certification of Chief Executive Officer and Chief Financial Officer of Omega Flex, Inc., pursuant to 18 U.S.C. Section 1350 as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. |
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
OMEGA FLEX, INC.
(Registrant)
Date: November 14, 2005 | By: /S/ E. Lynn Wilkinson_________________________ |
E. Lynn Wilkinson
Vice President – Finance
and Chief Financial Officer
