10-Q 1 form10-q.htm

 

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

FORM 10-Q

 

(Mark One)

 

[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the quarterly period ended June 30, 2019

 

[  ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the transition period from ________________________ to ______________________

 

Commission File Number 000-51372

 

Omega Flex, Inc.

(Exact name of registrant as specified in its charter)

 

Pennsylvania   23-1948942

(State or other jurisdiction of

incorporation or organization)

  

(I.R.S. Employer

Identification No.)

     
451 Creamery Way, Exton, PA   19341
(Address of principal executive offices)   (Zip Code)

 

(610) 524-7272

Registrant’s telephone number, including area code

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes [X] No [  ]

 

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes [X] No [  ]

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, non-accelerated filer, or a smaller reporting company filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange. (Check one):

 

Large accelerated filer [  ] Accelerated filer [X] Non-accelerated filer [  ] Smaller reporting Company [  ]

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of The Exchange Act). Yes [  ] No [X]

 

APPLICABLE ONLY TO ISSUERS INVOLVED IN BANKRUPTCY PROCEEDINGS

DURING THE PRECEDING FIVE YEARS.

 

Indicate by check mark whether the registrant has filed all documents and reports required to be filed by Sections 12, 12 or 15(d) of the Securities Exchange Act of 1934 subsequent to the distribution of securities under a plan confirmed by the courts.

 

The number of shares of the registrant’s common stock outstanding as of June 30, 2019 was 10,094,322.

 

 

 

  
 

 

OMEGA FLEX, INC.

QUARTERLY REPORT ON FORM 10-Q

FOR THE SIX MONTHS ENDED JUNE 30, 2019

 

INDEX

 

  Page No.
PART I - FINANCIAL INFORMATION  
   
Item 1 – Financial Statements  
   

Condensed consolidated balance sheets at June 30, 2019 (unaudited) and December 31, 2018

3

   

Condensed consolidated statements of income for the three-months and six-months ended June 30, 2019 and 2018 (unaudited)

4

   

Condensed consolidated statements of comprehensive income for the three-months and six-months ended June 30, 2019 and 2018 (unaudited)

5

   

Condensed consolidated statements of shareholder’s equity for the three-months and six-months ended June 30, 2019 and 2018 (unaudited)

6

   

Condensed consolidated statements of cash flows for the six-months ended June 30, 2019 and 2018 (unaudited)

8

   
Notes to the condensed consolidated financial statements (unaudited) 9
   
Item 2- Management’s Discussion and Analysis of Financial Condition and Results of Operations 25
   
Item 3 – Quantitative and Qualitative Information About Market Risks 39
   
Item 4 – Controls and Procedures 39
   
PART II - OTHER INFORMATION  
   
Item 1 – Legal Proceedings 40
   
Item 1A – Risk Factors 41
   
Item 2 – Unregistered Sales of Equity Securities and Use of Proceeds 41
   
Item 3 – Defaults Upon Senior Securities 41
   
Item 4 – Mine Safety Disclosures 41
   
Item 5 – Other Information 41
   
Item 6 - Exhibits 42
   
SIGNATURES 43

 

-2-
 

 

PART I - FINANCIAL INFORMATION

 

Item 1 - Financial Statements

OMEGA FLEX, INC.

CONDENSED CONSOLIDATED BALANCE SHEETS

(In Thousands, Except Share Amounts)

 

   June 30, 2019   December 31, 2018 
   (unaudited)     
ASSETS          
Current Assets:          
Cash and Cash Equivalents  $23,920   $32,392 
Accounts Receivable - less allowances of $946 and $985, respectively   16,665    16,451 
Investments   22,898    14,944 
Inventories-Net   9,387    7,976 
Other Current Assets   862    1,859 
           
Total Current Assets   73,732    73,622 
           
Right-Of-Use Assets   770    — 
Property and Equipment - Net   8,799    8,378 
Goodwill - Net   3,526    3,526 
Deferred Taxes   3    3 
Other Long Term Assets   1,385    1,307 
           
Total Assets  $88,215   $86,836 
           
LIABILITIES AND SHAREHOLDERS’ EQUITY          
Current Liabilities:          
Accounts Payable  $1,733   $2,775 
Accrued Compensation   2,273    5,295 
Accrued Commissions and Sales Incentives   3,402    4,246 
Dividends Payable   2,826    2,422 
Taxes Payable   738    58 
Lease Liability   317    — 
Other Liabilities   5,030    3,591 
           
Total Current Liabilities   16,319    18,405 
           
Lease Liability, net of current portion   472    — 
Deferred Taxes   211    566 
Other Long Term Liabilities   1,525    1,544 
           
Total Liabilities   18,527    20,515 
           
Commitments and Contingencies (Note 5)          
           
Shareholders’ Equity:          
Omega Flex, Inc. Shareholders’ Equity:          
Common Stock – par value $0.01 share: authorized 20,000,000 shares:
10,153,633 shares issued at June 30, 2019 and December 31, 2018,
respectively, and 10,094,322 and 10,091,822 shares outstanding at
June 30, 2019 and December 31, 2018, respectively		   102    102 
Treasury Stock   (1)   (1)
Paid-in Capital   11,025    10,808 
Retained Earnings   59,227    56,110 
Accumulated Other Comprehensive Loss   (1,002)   (950)
Total Omega Flex, Inc. Shareholders’ Equity   69,351    66,069 
Noncontrolling Interest   337    252 
           
Total Shareholders’ Equity   69,688    66,321 
           
Total Liabilities and Shareholders’ Equity  $88,215   $86,836 

 

See Accompanying Notes to Unaudited Condensed Consolidated Financial Statements.

 

-3-
 

 

OMEGA FLEX, INC.

CONDENSED CONSOLIDATED STATEMENTS OF INCOME

(In Thousands, Except per Share and Share Amounts)

 

   For the three-months ended   For the six-months ended 
   June 30,   June 30, 
   2019   2018   2019   2018 
   (Unaudited) 
Net Sales  $26,809   $26,847   $53,597   $52,244 
                     
Cost of Goods Sold   10,073    10,633    19,915    20,997 
                     
Gross Profit   16,736    16,214    33,682    31,247 
                     
Selling Expense   4,300    4,281    8,810    8,695 
General and Administrative Expense   6,140    4,465    11,644    8,554 
Engineering Expense   1,152    1,110    2,493    2,140 
                     
Operating Profit   5,144    6,358    10,735    11,858 
                     
Interest Income   236    94    456    145 
Other Income (Expense)   (33)   (76)   5    (40)
                     
Income Before Income Taxes   5,347    6,376    11,196    11,963 
                     
Income Tax Expense   1,325    1,564    2,743    2,948 
                     
Net Income   4,022    4,812    8,453    9,015 
Less: Net Income attributable to the
Noncontrolling Interest		   (39)   (36)   (88)   (76)
                     
Net Income attributable to Omega Flex, Inc.  $3,983   $4,776   $8,365   $8,939 
                     
Basic and Diluted Earnings per Common Share  $0.39   $0.47   $0.83   $0.89 
                     
Cash Dividends Declared per Common Share  $0.28   $0.46   $0.52   $0.46 
                     
Basic and Diluted Weighted-Average Shares Outstanding   10,091,832    10,091,822    10,091,827    10,091,822 

 

See Accompanying Notes to Unaudited Condensed Consolidated Financial Statements.

 

-4-
 

 

OMEGA FLEX, INC.

CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME

(In Thousands)

 

   For the three-months ended   For the six-months ended 
   June 30,   June 30, 
   2019   2018   2019   2018 
   (Unaudited) 
Net Income  $4,022   $4,812   $8,453   $9,015 
                     
Other Comprehensive Income (Loss):                    
Foreign Currency Translation Adjustment   (143)   (363)   (55)   67 
Other Comprehensive Income (Loss)   (143)   (363)   (55)   67 
                     
Comprehensive Income   3,879    4,449    8,398    9,082 
                     
Less: Comprehensive Income Attributable to the Noncontrolling Interest   (30)   (15)   (85)   (78)
                     
Total Comprehensive Income  $3,849   $4,434   $8,313   $9,004 

 

See Accompanying Notes to Unaudited Condensed Consolidated Financial Statements.

 

-5-
 

 

OMEGA FLEX, INC.

CONDENSED CONSOLIDATED STATEMENTS OF SHAREHOLDERS’ EQUITY

(In Thousands, Except Share Amounts)

 

For the three-months ended June 30, 2019

 

   Common Stock Outstanding  

Common

Stock

  

Treasury

Stock

   Paid In Capital   Retained Earnings  

Accumulated

Other

Comprehensive

Income (Loss)

  

Non

controlling

Interest

  

Shareholders’

Equity

 
                   (unaudited)             
April 1, 2019   10,091,822   $102   $(1)  $10,808   $60,492   $(868)  $307   $70,840 
                                         
Net Income                       3,983         39    4,022 
Cumulative Translation Adjustment                            (134)   (9)   (143)
Shares Reissued From Treasury Pursuant To Restricted Stock Unit Awards   2,500              217                   217 
Dividends Declared                       (5,248)             (5,248)
June 30, 2019   10,094,322   $102   $       (1)  $11,025   $59,227   $(1,002)  $337   $69,688 

 

For the three-months ended June 30, 2018

 

   Common Stock Outstanding  

Common

Stock

  

Treasury

Stock

   Paid In Capital   Retained Earnings  

Accumulated

Other

Comprehensive

Income (Loss)

  

Non

controlling

Interest

  

Shareholders’

Equity

 
                   (unaudited)             
April 1, 2018   10,091,822   $102   $(1)  $10,808   $49,620   $      (501)  $674   $60,702 
                                         
Net Income                       4,776         36    4,812 
Cumulative Translation Adjustment                            (342)   (21)   (363)
Dividends Declared
                       (4,642)        (491)   (5,133)
June 30, 2018   10,091,822   $102   $     (1)  $10,808   $49,754   $(843)  $198   $60,018 

 

See Accompanying Notes to Unaudited Condensed Consolidated Financial Statements.

 

-6-
 

 

OMEGA FLEX, INC.

CONDENSED CONSOLIDATED STATEMENTS OF SHAREHOLDERS’ EQUITY

(In Thousands, Except Share Amounts)

 

For the six-months ended June 30, 2019

 

   Common Stock Outstanding  

Common

Stock

  

Treasury

Stock

   Paid In Capital   Retained Earnings  

Accumulated

Other

Comprehensive

Income (Loss)

  

Non

controlling

Interest

  

Shareholders’

Equity

 
                   (unaudited)             
December 31, 2018   10,091,822   $102   $   (1)  $10,808   $56,110   $(950)  $252   $66,321 
                                         
Net Income                       8,365         88    8,453 
Cumulative Translation Adjustment                            (52)          (3)   (55)
Shares Reissued From Treasury Pursuant To Restricted Stock Unit Awards   2,500              217                   217 
Dividends Declared                       (5,248)             (5,248)
June 30, 2019   10,094,322   $102   $(1)  $11,025   $59,227   $(1,002)  $337   $69,688 

 

For the six-months ended June 30, 2018

 

   Common Stock Outstanding  

Common

Stock

  

Treasury

Stock

   Paid In Capital   Retained Earnings  

Accumulated

Other

Comprehensive

Income (Loss)

  

Non

controlling

Interest

  

Shareholders’

Equity

 
                   (unaudited)             
December 31, 2017   10,091,822   $102   $(1)  $10,808   $45,457   $(908)  $611   $56,069 
                                         
Net Income                       8,939         76    9,015 
Cumulative Translation Adjustment                            65    2    67 
Dividends Declared
                       (4,642)        (491)   (5,133)
June 30, 2018   10,091,822   $102   $     (1)  $10,808   $49,754   $     (843)  $198   $60,018 

 

See Accompanying Notes to Unaudited Condensed Consolidated Financial Statements.

 

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OMEGA FLEX, INC.

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(In Thousands)

 

   For the six-months ended 
   June 30, 
   2019   2018 
   (unaudited) 
Cash Flows from Operating Activities:          
Net Income  $8,453   $9,015 
Adjustments to Reconcile Net Income to          
Net Cash Provided by Operating Activities:          
Non-Cash Compensation   1,145    444 
Depreciation and Amortization   301    241 
Provision for Losses on Accounts Receivable, net of
write-offs and recoveries		   (42)   2 
Deferred Taxes   (355)   (172)
Provision for Inventory Reserves   (29)   (154)
Changes in Assets and Liabilities:          
Accounts Receivable   (199)   52 
Inventories   (1,388)   (142)
Other Assets   919    2,683 
Accounts Payable   (1,043)   (1,140)
Accrued Compensation   (3,019)   (2,380)
Accrued Commissions and Sales Incentives   (861)   (1,104)
Lease Liability, Net   18    — 
Other Liabilities   1,179    (1,258)
Net Cash Provided by Operating Activities   5,079    6,087 
           
Cash Flows from Investing Activities:          
Purchase of Investments   (22,954)   — 
Net Proceeds from Sale of Investments   15,000    — 
Capital Expenditures   (722)   (708)
Net Cash Used in Investing Activities   (8,676)   (708)
           
Cash Flows from Financing Activities:          
Dividend Paid   (4,844)   (4,931)
Net Cash Used in Financing Activities   (4,844)   (4,931)
           
Net (Decrease) Increase in Cash and Cash Equivalents   (8,441)   448 
Translation effect on cash   (31)   118 
Cash and Cash Equivalents – Beginning of Period   32,392    37,938 
Cash and Cash Equivalents – End of Period  $23,920   $38,504 
           
Supplemental Disclosure of Cash Flow Information:          
           
Cash paid for Income Taxes  $2,404   $3,517 
           
Cash paid for Interest  $—   $— 
           
Declared Dividends  $5,248   $5,133 

 

See Accompanying Notes to Unaudited Condensed Consolidated Financial Statements.

 

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OMEGA FLEX, INC.

 

NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

 

(Unaudited)

 

1. BASIS OF PRESENTATION AND DESCRIPTION OF BUSINESS

 

Basis of Presentation

 

The accompanying unaudited condensed consolidated financial statements include the accounts of Omega Flex, Inc. (Omega) and its subsidiaries (collectively the “Company”). The Company’s unaudited condensed consolidated financial statements for the quarter ended June 30, 2019 have been prepared in accordance with accounting principles generally accepted in the United States (GAAP), and with the instructions of Form 10-Q and Article 10 of Regulation S-X. Certain information and note disclosures normally included in annual financial statements prepared in accordance with GAAP have been condensed or omitted pursuant to those rules and regulations, although the Company believes that the disclosures made are adequate to make the information not misleading. It is suggested that these condensed consolidated financial statements be read in conjunction with the financial statements and the notes thereto included in the Company’s latest shareholders’ annual report (Form 10-K). All material inter-company accounts and transactions have been eliminated in consolidation. It is Management’s opinion that all adjustments necessary for a fair statement of the results for the interim periods have been made, and that all adjustments are of a normal recurring nature or a description is provided for any adjustments that are not of a normal recurring nature.

 

Description of Business

 

The Company’s business is controlled as a single operating segment that consists of the manufacture and sale of flexible metal hose (also described as corrugated tubing), as well as the sale of the Company’s related proprietary fittings and a vast array of accessories.

 

The Company is a leading manufacturer of flexible metal hose, which is used in a variety of ways to carry gases and liquids within their particular applications. Some of the more prominent uses include carrying fuel gases within residential and commercial buildings, the transfer of liquefied gases in certain processing applications, for use in medical or health care facilities to carry medical gases (oxygen, nitrogen, vacuum) or pure gases for pharmaceutical applications, vibration absorbers in high vibration applications, industrial applications where the customer requires the piping to have both a degree of flexibility and/or an ability to carry corrosive compounds or mixtures, or to carry at both very high and very low (cryogenic) temperatures, and the Company’s corrugated tubing can also be used in the healthcare industry to carry various medical related gases.

 

The Company manufactures flexible metal hose at its facilities in Exton, Pennsylvania, in the United States, and in Banbury, Oxfordshire in the United Kingdom, and primarily sells its products through distributors, wholesalers and to original equipment manufacturers (“OEMs”) throughout North America and Europe, and to a lesser extent other global markets.

 

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2. SIGNIFICANT ACCOUNTING POLICIES

 

Use of Estimates

 

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 and the disclosure of contingent assets and liabilities as of 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 allowances, investment valuations, inventory valuations, goodwill valuation, product liability reserve, stock-based compensation valuations and accounting for income taxes. Actual amounts could differ significantly from these estimates.

 

Revenue Recognition

 

Effective January 1, 2018, the Company adopted the requirements of Accounting Standards Update (“ASU”) 2014-09, Revenue from Contracts with Customers (Topic 606). The standard is a comprehensive new revenue recognition model that requires revenue to be recognized in a manner to depict the transfer of goods or services to a customer at an amount that reflects the consideration expected to be received in exchange for those goods or services.

 

The guidance permits two methods of adoption: retrospectively to each prior reporting period presented (full retrospective method), or retrospectively with the cumulative effect of initially applying the guidance recognized at the date of initial application (the modified retrospective approach). The Company selected the modified retrospective approach however there was no material impact which required a cumulative effect adjustment.

 

The principle of Topic 606 was achieved through applying the following five-step approach:

 

  ● Identification of the contract, or contracts, with a customer — a contract with a customer exists when the Company enters into an enforceable contract with a customer, typically a purchase order initiated by the customer, that defines each party’s rights regarding the goods to be transferred and identifies the payment terms related to these goods.
     
  ● Identification of the performance obligations in the contract — performance obligations promised in a contract are identified based on the goods that will be transferred to the customer that are distinct, whereby the customer can benefit from the goods on their own or together with other resources that are readily available from third parties or from us. Persuasive evidence of an arrangement for the sale of product must exist. The Company ships product in accordance with the purchase order and standard terms as reflected within the Company’s order acknowledgments and sales invoices.

 

-10-
 

 

  ● Determination of the transaction price —the transaction price is determined based on the consideration to which the Company will be entitled in exchange for transferring goods to the customer. This would be the agreed upon quantity and price per product type in accordance with the customer purchase order, which is aligned with the Company’s internally approved pricing guidelines.
     
  ● Allocation of the transaction price to the performance obligations in the contract — if the contract contains a single performance obligation, the entire transaction price is allocated to the single performance obligation. This applies to the Company as there is only one performance obligation to ship the goods.
     
  ● Recognition of revenue when, or as, the Company satisfies a performance obligation — the Company satisfies performance obligations at a point in time when control of the goods transfers to the customer. Determining the point in time when control transfers requires judgment. Indicators considered in determining whether the customer has obtained control of a good include:

 

  ■ The Company has a present right to payment
  ■ The customer has legal title to the goods
  ■ The Company has transferred physical possession of the goods
  ■ The customer has the significant risks and rewards of ownership of the goods
  ■ The customer has accepted the goods

 

It is important to note that the indicators are not a set of conditions that must be met before the Company can conclude that control of the goods has transferred to the customer. The indicators are a list of factors that are often present if a customer has control of the goods.

 

The Company has typical, unmodified FOB shipping point terms. As the seller, the Company can determine that the shipped goods meet the agreed-upon specifications in the contract or customer purchase order (e.g. items, quantities, and prices) with the buyer, so customer acceptance would be deemed a formality, as noted in Accounting Standards Codification (“ASC”) 606-10-55-86. As a result, the Company has a legal right to payment upon shipment of the goods.

 

Based upon the above, the Company has concluded that control substantively transfers to the customer upon shipment.

 

Other considerations of Topic 606 include the following:

 

  ● Contract Costs - costs to obtain a contract (e.g. customer purchase order) include sales commissions. Under Topic 606, these costs may be expensed as incurred for contracts with a duration of one year or less. The majority of the customer purchase orders are fulfilled (e.g. goods are shipped) within two days of receipt.
     
  ● Warranties - the Company does not offer customers to purchase a warranty separately. Therefore there is not a separate performance obligation. The Company does account for warranties as a cost accrual and the warranties do not include any additional distinct services other than the assurance that the goods comply with agreed-upon specifications. There is no impact of warranties under Topic 606 upon the financial reporting of the Company.

 

-11-
 

 

  ● Returned Goods - from time to time, the Company provides authorization to customers to return goods. If deemed to be material, the Company would record a “right of return” asset for the cost of the returned goods which would reduce cost of sales. Upon implementation of Topic 606, the Company will monitor pending authorized returns of goods and, if deemed appropriate, record the right of return asset accordingly.
     
  ● Volume Rebates (Promotional Incentives) - volume rebates are variable (dependent upon the volume of goods purchased by our eligible customers) and, under Topic 606, must be estimated and recognized as a reduction of revenue as performance obligations are satisfied (e.g. upon shipment of goods). Also under Topic 606, to ensure that revenue recognized would not be probable of a significant reversal, the four following factors are considered:

 

  ■ The amount of consideration is highly susceptible to factors outside the company’s influence.
  ■ The uncertainty about the amount of consideration is not expected to be resolved for a long period of time.
  ■ The Company’s experience with similar types of contracts is limited.
  ■ The contract has a large number and broad range of possible consideration amounts.

 

If it was concluded that the above factors were in place for the Company, it would support the probability of a significant reversal of revenue. However, as none of the four factors apply to the Company, promotional incentives are recorded as a reduction of revenue based upon estimates of the products expected to be sold.

 

Regarding disaggregated revenue disclosures, as previously noted, the Company’s business is controlled as a single operating segment that consists of the manufacture and sale of flexible metal hose. Most of the Company’s transactions are very similar in nature, contract, terms, timing, and transfer of control of goods. As indicated within Note 2, under the caption “Significant Concentration”, the majority of the Company’s sales were geographically contained within North America, with the remainder scattered internationally. All performance assessments and resource allocations are generally based upon the review of the results of the Company as a whole.

 

Cash Equivalents

 

The Company considers all highly liquid investments with an original maturity of 90 days or less at the time of purchase to be cash equivalents. Cash equivalents include investments in an institutional money market fund, which invests in U.S. Treasury bills, notes and bonds, and/or repurchase agreements, backed by such obligations. Carrying value approximates fair value. Cash and cash equivalents are deposited at various area banks, which at times may exceed federally insured limits. The Company monitors the viability of the banking institutions carrying its assets on a regular basis, and has the ability to transfer cash to various institutions during times of risk. The Company has not experienced any losses related to these cash balances, and believes its credit risk to be minimal.

 

-12-
 

 

Accounts Receivable and Provision for Doubtful Accounts

 

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, additional allowances may be required.

 

The allowance for doubtful accounts reflects the Company’s best estimate of probable losses inherent in the accounts receivable balance. The Company determines the allowance based on any known collection issues, historical experience, and other currently available evidence. The reserve for future credits, discounts, and doubtful accounts was $946,000 and $985,000 as of June 30, 2019 and December 31, 2018, respectively. In regards to identifying uncollectible accounts, the Company reviews an aging report on a consistent basis to determine past due accounts, and utilizes a well-established credit rating agency. The Company charges off those accounts that are deemed uncollectible once all collection efforts have been exhausted.

 

Investments

 

The Company invests excess funds in liquid interest earning instruments including US Treasury bills and bank time deposits. These investments are stated at fair value, which approximates amortized cost, and are classified as available-for-sale in accordance with ASC 320, Investments – Debt and Equity Securities. Investments were $22,898,000 and $14,944,000 as of June 30, 2019 and December 31, 2018, respectively. Maturities, from the date of purchase, were six months or less.

 

Inventories

 

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

 

Property and Equipment

 

Property and equipment are initially recorded at cost. Depreciation and amortization are computed using the straight-line method over the estimated useful lives of the assets or, for leasehold improvements, the life of the lease, if shorter. When assets are retired or otherwise disposed of, the cost and related accumulated depreciation are removed from the accounts and any resulting gain or loss is reflected in other income or expense for the period. The cost of maintenance and repairs is expensed as incurred; significant improvements are capitalized.

 

Goodwill

 

In accordance with Financial Accounting Standards Board (“FASB”) ASC Topic 350, Intangibles – Goodwill and Other, the Company performed an annual impairment test in accordance with this guidance as of December 31, 2018. This analysis did not indicate any impairment of goodwill. There were no circumstances that indicate that goodwill might be impaired during the six months ended June 30, 2019.

 

-13-
 

 

Stock-Based Compensation Plans

 

In 2006, the Company adopted a Phantom Stock Plan (the “Plan”), which allows the Company to grant phantom stock units (“Units”) to certain key employees, officers or directors. The Units each represent a contractual right to payment of compensation in the future based upon the market value of the Company’s common stock. The Units follow a vesting schedule of three years from the grant date, and are then paid upon maturity. In accordance with FASB ASC Topic 718, Compensation - Stock Compensation, the Company uses the Black-Scholes option pricing model as its method for determining the fair value of the Units. Further details of the Plan are provided in Note 6.

 

Product Liability Reserves

 

Product liability reserves represent the estimated unpaid amounts under the Company’s insurance policies with respect to existing claims. The Company uses the most current available data to estimate claims. As explained more fully under Note 5, Commitments and Contingencies, for various product liability claims covered under the Company’s general liability insurance policies, the Company must pay certain defense and settlement costs within its deductible or self-insured retention limits, ranging primarily from $25,000 to $1,000,000 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.

 

Leases

 

Effective January 1, 2019, the Company adopted the requirements of FASB ASU 2016-02, Leases (Topic 842) which defines a lease as any contract that conveys the right to use a specific asset for a period of time in exchange for consideration. Leases are classified as a finance lease, formerly called a capital lease, if any of the following criteria are met:

 

  1. The lease transfers ownership of the underlying asset to the lessee by the end of the lease term.
  2. The lease grants the lessee an option to purchase the underlying asset that the lessee is reasonably certain to exercise.
  3. The lease term is for the major part of the remaining economic life of the underlying asset.
  4. The present value of the sum of lease payments and any residual value guaranteed by the lessee equals or exceeds substantially all of the fair value of the underlying asset.
  5. The underlying asset is of such a specialized nature that it is expected to have no alternative use to the lessor at the end of the lease term.

 

For any leases that do not meet the criteria identified above for finance leases, the Company treats such leases as operating leases. As of June 30, 2019, each of the Company’s leases are classified as operating leases.

 

-14-
 

 

Under the new guidance, both finance and operating leases are reflected on the balance sheet as lease or “right-of-use” assets and lease liabilities. It should be noted that under previous guidance operating leases (non-capital leases) were not required to be recorded as an asset on the balance sheet.

 

There are some exceptions, which the Company has elected in its accounting policies. For leases with terms of twelve months or less, or below the Company’s general capitalization policy threshold, the Company elects an accounting policy to not recognize lease assets and lease liabilities for all asset classes. The Company recognizes lease expense for such leases generally on a straight-line basis over the lease term.

 

The Company determines if a contract is a lease at the inception of the arrangement. The Company reviews all options to extend, terminate, or purchase its right-of-use assets at the inception of the lease and accounts for these options when they are reasonably certain to be exercised. Certain leases contain non-lease components, such as common area maintenance, which are generally accounted for separately. In general, the Company will assess if non-lease components are fixed and determinable, or variable, when determining if the component should be included in the lease liability. For purposes of calculating the present value of the lease obligations, the Company utilizes the implicit interest rate within the lease agreement when known and/or determinable, and otherwise utilizes its incremental borrowing rate at the time of the lease agreement.

 

As permitted under ASU 2018-11, the Company elected the optional transition method to adopt the new leases standard. Under this new transition method, the Company initially applied the new leases standard at the adoption date of January 1, 2019 and would have recognized a cumulative-effect adjustment, if appropriate, to the opening balance of retained earnings in the period of adoption. No cumulative-effect adjustment was recognized. The Company’s reporting for the comparative periods prior to 2019 in the financial statements are presented in accordance with existing GAAP in effect for 2018 and earlier (ASC Topic 840, Leases).

 

The impact of the adoption of this new standard resulted in an increase to the Company’s operating lease assets and liabilities on January 1, 2019 of approximately $800,000. The implementation did not have a material impact on the Company’s consolidated statements of income and statements of cash flows.

 

Fair Value of Financial and Nonfinancial Instruments

 

The Company measures financial instruments in accordance with 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 upon Level 1 inputs in determining the fair value of investments and the fair value of the Company’s reporting unit in its annual impairment test as described in the FASB ASC Topic 350, Intangibles - Goodwill and Other.

 

-15-
 

 

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 diluted earnings per share are the same.

 

Currency Translation

 

Assets and liabilities denominated in foreign currencies, most of which relate to the Company’s United Kingdom subsidiary whose functional currency is British pound sterling, 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 the statements of income (other expense) in the period in which they occur.

 

Income Taxes

 

The Company accounts for tax liabilities in accordance with the FASB ASC Topic 740, Income Taxes. Under this method the Company records tax expense, related deferred taxes and tax benefits, and uncertainties in tax positions.

 

Deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities from a change in tax rates is recognized in income in the period that includes the enactment date. A valuation allowance is provided for deferred tax assets if it is more likely than not that these items will either expire before the Company is able to realize the benefit, or that future deductibility is uncertain.

 

The FASB ASC Topic 740, Income Taxes, clarifies the criteria that an individual tax position must satisfy for some or all of the benefits of that position to be recognized in a company’s financial statements. This guidance prescribes a recognition threshold of more-likely than-not, and a measurement attribute for all tax positions taken or expected to be taken on a tax return, in order for those tax positions to be recognized in the financial statements.

 

-16-
 

 

The Company follows the provisions of ASC 740-10 relative to accounting for uncertainties in tax positions. These provisions provide guidance on the recognition, de-recognition and measurement of potential tax benefits associated with tax positions.

 

The Company reflected the effects of the Tax Cuts and Jobs Act (the “Act”) in its financial statements during the 2017 enactment period. This included the effects of the change in the US Corporate tax rate from 35% to 21% on deferred tax assets and liabilities, and a provision related to previously deferred taxes on earnings of the Company’s foreign subsidiary. The Company’s tax expense for the periods ended June 30, 2019 and 2018 included the continuing effect of the reduction in the U.S. federal tax rate from 35% to 21%, effective for those respective tax years. The Company’s tax provision also reflects other changes as a result of the Act, including the impact of the Global Intangible Low Taxed Income (“GILTI”) provisions, and changes effecting the deductibility of certain executive compensation.

 

Other Comprehensive Income

 

For the three and six months ended June 30, 2019 and 2018, respectively, the components of other comprehensive income consisted solely of foreign currency translation adjustments.

 

Significant Concentration

 

The Company has one significant customer which represented more than 10% of the Company’s Accounts Receivable at June 30, 2019 and December 31, 2018. That same customer represented more than 10% of the Company’s total Net Sales for the six months ended June 30, 2019 and 2018. Geographically, the Company has a significant amount of sales in the United States versus internationally. These concentrations are consistent with those discussed in detail in the Company’s December 31, 2018 Form 10-K.

 

Subsequent Events

 

The Company evaluates all events or transactions through the date of the related filing that may have a material impact on its condensed consolidated financial statements. Refer to Note 10 of the condensed consolidated financial statements.

 

Recent Accounting Pronouncements

 

In January 2017, the FASB amended ASC Topic 350, Intangibles – Goodwill and Other (issued under ASU 2017-04, “Simplifying the Test for Goodwill Impairment”). This amendment simplifies the test for goodwill impairment by only requiring an entity to perform an annual or interim goodwill impairment test by comparing the fair value of a reporting unit with its carrying amount and recognize an impairment charge for the amount that the carrying amount exceeds the reporting unit’s fair value. Any loss recognized should not exceed the total amount of goodwill allocated to that reporting unit. The amendment requires adoption on January 1, 2020. The Company does not expect that the adoption of ASU 2017-04 will have a material impact on its consolidated financial statements.

 

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3. INVENTORIES

 

Inventories, net of reserves of $333,000 and $363,000 at June 30, 2019 and December 31, 2018, respectively, consisted of the following:

 

   June 30, 2019   December 31, 2018 
   (dollars in thousands) 
Finished Goods  $5,340   $4,756 
Raw Materials   4,047    3,220 
           
Inventories - Net  $9,387   $7,976 

 

4. LINE OF CREDIT

 

On December 1, 2017, the Company agreed to a new Amended and Restated Revolving Line of Credit Note and Third Amendment to the Loan Agreement with Santander Bank, N.A. (the “Bank”). The Company established a line of credit facility in the maximum amount of $15,000,000, maturing on December 1, 2022, with funds available for working capital purposes and other cash needs. The loan is unsecured. The loan agreement provides for the payment of any borrowings under the agreement at an interest rate range of either LIBOR plus 0.75% to plus 1.75% (for borrowings with a fixed term of 30, 60, or 90 days), or, Prime Rate up to Prime Rate plus 0.50% (for borrowings with no fixed term other than the December 1, 2022 maturity date), depending upon the Company’s then existing financial ratios. Currently, the Company’s ratio would allow for the most favorable rate under the agreement’s range, which would be a rate of 3.07%. The Company is also required to pay on a quarterly basis an unused facility fee of 10 basis points of the average unused balance of the note. The Company may terminate the line at any time during the five year term, as long as there are no amounts outstanding.

 

As of June 30, 2019 and December 31, 2018, the Company had no outstanding borrowings on its line of credit, and was in compliance with all debt covenants.

 

5. COMMITMENTS AND CONTINGENCIES

 

Commitments:

 

Under a number of indemnity agreements between the Company and each of its officers and directors, the Company has agreed to indemnify each of its officers and directors against any liability asserted against them in their capacity as an officer or director, or both. The Company’s indemnity obligations under the indemnity agreements are subject to certain conditions and limitations set forth in each of the agreements. Under the terms of the Agreement, the Company is contingently liable for costs which may be incurred by the officers and directors in connection with claims arising by reason of these individuals’ roles as officers and directors. The Company has obtained directors’ and officers’ insurance policies to fund certain obligations under the indemnity agreements.

 

-18-
 

 

The Company has salary continuation agreements with one current employee, and one former employee who retired at the end of 2010. These agreements provide for monthly payments to each of the employees or their designated beneficiary upon the employee’s retirement or death. The payment benefits range from $1,000 per month to $3,000 per month with the term of such payments limited to 15 years after the employee’s retirement. The agreements also provide for survivorship benefits if the employee dies before attaining age 65, and severance payments if the employee is terminated without cause; the amount of which is dependent on the length of company service at the date of termination. The net present value of the retirement payments associated with these agreements is $475,000 at June 30, 2019, of which $463,000 is included in Other Long Term Liabilities, and the remaining current portion of $12,000 is included in Other Liabilities, associated with the retired employee previously noted who is now receiving benefit payments. The December 31, 2018 liability of $462,000 had $450,000 reported in Other Long Term Liabilities, and a current portion of $12,000 in Other Liabilities.

 

The Company has obtained and is the beneficiary of three life insurance policies with respect to the two employees discussed above, and one other employee policy. The cash surrender value of such policies (included in Other Long Term Assets) amounts to $1,376,000 at June 30, 2019 and $1,296,000 at December 31, 2018.

 

As disclosed in detail in Note 7 and in the Company’s December 31, 2018 Form 10-K, Note 8, under the caption “Leases”, the Company has several lease obligations in place that will be paid out over time. Most notably, the Company leases a facility in Banbury, England that serves the manufacturing, warehousing and distribution functions.

 

Contingencies:

 

In the ordinary and normal conduct of the Company’s business, it is subject to periodic lawsuits, investigations and claims (collectively, the “Claims”). Most of the Claims, including a putative class-action claim, relate to potential lightning damage to the Company’s flexible gas piping products, which impact legal and product liability related expenses. The Company does not believe the Claims have legal merit, and therefore has commenced a vigorous defense in response to the Claims. It is possible that the Company may incur increased litigation costs in the future due to a variety of factors, including a higher number of Claims, higher legal costs, and higher insurance deductibles or retentions.

 

In 2010, the Company took its first Claim to trial in Pennsylvania, and the jury returned a verdict that the Company was not negligent in designing and selling the TracPipe® product, but also returned a verdict for plaintiff on strict liability. The Company appealed that portion of the verdict, and in December 2014, the Supreme Court of Pennsylvania ruled in favor of the Company, and returned the case to the trial court for further hearings. The cash bond of $1,600,000, which was previously included in Other Long Term Assets and posted as security for a subsequent appeal, was returned to the Company in May 2018. This case was finally settled and closed on August 7, 2018.

 

-19-
 

 

In March 2017, a putative class action case was re-filed against the Company and other parties in Missouri state court after the predecessor case was dismissed without prejudice by the federal court. The Company successfully removed the case to federal court and is currently vigorously defending the case.

 

The Company has in place commercial general liability insurance policies that cover most Claims, which are subject to deductibles or retentions, ranging primarily from $25,000 to $1,000,000 per claim (depending on the terms of the policy and the applicable policy year), up to an aggregate amount. Litigation is subject to many uncertainties and management is unable to predict the outcome of the pending suits and claims. The potential liability for a given claim could range from zero to a maximum of $1,000,000, depending upon the circumstances, and insurance deductible or retention in place for the respective claim year. The aggregate maximum exposure for all current open Claims, excluding the putative class action case, as of June 30, 2019 is estimated to not exceed approximately $3,200,000, which represents the potential costs that may be incurred over time for the Claims within the applicable insurance policy deductibles or retentions. From time to time, depending upon the nature of a particular case, the Company may decide to spend in excess of a deductible or retention to enable more discretion regarding the defense, although this is not common. It is possible that the results of operations or liquidity of the Company, as well as the Company’s ability to procure reasonably priced insurance, could be adversely affected by the pending litigation, potentially materially. The Company is currently unable to estimate the ultimate liability, if any, that may result from the pending litigation, or potential litigation from future claims or claims that have not yet come to our attention, and accordingly, the liability in the consolidated financial statements primarily represents an accrual for legal costs for services previously rendered, and outstanding or anticipated settlements for Claims. The liabilities recorded on the Company’s books at June 30, 2019 and December 31, 2018 were $228,000 and $150,000, respectively, and are included in Other Liabilities.

 

6. STOCK BASED PLANS

 

Phantom Stock Plan

 

Plan Description. On April 1, 2006, the Company adopted the Omega Flex, Inc. 2006 Phantom Stock Plan (the “Plan”). The Plan authorizes the grant of up to one million units of phantom stock to employees, officers or directors of the Company. The phantom stock units (“Units”) each represent a contractual right to payment of compensation in the future based on the market value of the Company’s common stock. The Units are not shares of the Company’s common stock, and a recipient of the Units does not receive any of the following:

 

  ■ ownership interest in the Company
  ■ shareholder voting rights
  ■ other incidents of ownership to the Company’s common stock

 

-20-
 

 

The Units are granted to participants upon the recommendation of the Company’s CEO, and the approval of the Compensation Committee. Each of the Units that are granted to a participant will be initially valued by the Compensation Committee, at an amount equal to the closing price of the Company’s common stock on the grant date, but are recorded at fair value using the Black-Sholes method as described below. The Units follow a vesting schedule, with a maximum vesting of three years after the grant date. Upon vesting, the Units represent a contractual right of payment for the value of the Unit. The Units will be paid on their maturity date, one year after all of the Units granted in a particular award have fully vested, unless an acceptable event occurs under the terms of the Plan prior to one year, which would allow for earlier payment. The amount to be paid to the participant on the maturity date is dependent on the type of Unit granted to the participant.

 

The Units may be Full Value, in which the value of each Unit at the maturity date, will equal the closing price of the Company’s common stock as of the maturity date; or Appreciation Only, in which the value of each Unit at the maturity date will be equal to the closing price of the Company’s common stock at the maturity date minus the closing price of the Company’s common stock at the grant date.

 

On December 9, 2009, the Board of Directors authorized an amendment to the Plan to pay an amount equal to the value of any cash or stock dividend declared by the Company on its common stock to be accrued to the phantom stock units outstanding as of the record date of the common stock dividend. The dividend equivalent will be paid at the same time the underlying phantom stock units are paid to the participant.

 

In certain circumstances, the Units may be immediately vested upon the participant’s death or disability. All Units granted to a participant are forfeited if the participant is terminated from their relationship with the Company or its subsidiary for “cause,” which is defined under the Plan. If a participant’s employment or relationship with the Company is terminated for reasons other than for “cause,” then any vested Units will be paid to the participant upon termination. However, Units granted to certain “specified employees” as defined in Section 409A of the Internal Revenue Code will be paid approximately 181 days after termination.

 

Grants of Phantom Stock Units. As of December 31, 2018, the Company had 17,805 unvested units outstanding, all of which were granted at Full Value. On February 15, 2019, the Company granted an additional 6,050 Full Value Units with a fair value of $65.40 per unit on grant date, using historical volatility. In February 2019, the Company paid $746,000 for the 10,460 fully vested and matured units that were granted during 2015, including their respective earned dividend values. As of June 30, 2019, the Company had 15,635 unvested units outstanding.

 

The Company uses the Black-Scholes option pricing model as its method for determining fair value of the Units. The Company uses the straight-line method of attributing the value of the stock-based compensation expense relating to the Units. The compensation expense (including adjustment of the liability to its fair value) from the Units is recognized over the vesting period of each grant or award.

 

The FASB ASC Topic 718, Compensation - Stock Compensation, requires forfeitures to be estimated at the time of grant and revised, if necessary, in subsequent periods if actual forfeitures differ from those estimates in order to derive the Company’s best estimate of awards ultimately to vest.

 

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Forfeitures represent only the unvested portion of a surrendered Unit and are typically estimated based on historical experience. Based on an analysis of the Company’s historical data, which has limited experience related to any stock-based plan forfeitures, the Company applied a 0% forfeiture rate to Plan Units outstanding in determining its Plan Unit compensation expense as of June 30, 2019.

 

The total Phantom Stock related liability as of June 30, 2019 was $1,892,000 of which $830,000 is included in Other Liabilities, as it is expected to be paid in February 2020, and the balance of $1,062,000 is included in Other Long Term Liabilities. At December 31, 2018, the total Phantom Stock liability was $1,692,000, with $599,000 in Other Liabilities, and $1,093,000 included in Other Long Term Liabilities.

 

Related to the Phantom Stock Plan, in accordance with FASB ASC Topic 718, Compensation - Stock Compensation, the Company recorded compensation expense of approximately $928,000 and $444,000 for the six months ended June 30, 2019 and 2018, respectively. Compensation expense for a given period largely depends upon fluctuations in the Company’s stock price.

 

The following table summarizes information about the Company’s nonvested phantom stock Units at June 30, 2019:

 

   Units   Weighted Average Grant Date Fair Value 
Number of Phantom Stock Unit Awards:          
Nonvested at December 31, 2018   17,805   $46.08 
Granted   6,050   $65.40 
Vested   (8,220)  $39.94 
Forfeited   —    — 
Canceled   —    — 
Nonvested at June 30, 2019   15,635   $56.79 
Phantom Stock Unit Awards Expected to Vest   15,635   $56.79 

 

The total unrecognized compensation costs calculated at June 30, 2019 are $872,000 which will be recognized through February of 2022. The Company will recognize the related expense over the weighted average period of 1.35 years.

 

7. LEASES

 

In the United States, the Company owns its two main operating facilities located in Exton, PA. In addition to the owned facilities, the Company also has operations in other locations that are leased, as well as other leased assets. In conjunction with the new guidance for leases, as defined by the FASB with ASU 2016-02, Leases (Topic 842), the Company has described the existing leases, which are all classified as operating leases, pursuant to the below.

 

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Facility leases within the United States include a warehousing and distribution center in Houston, Texas, which currently provides manufacturing, stocking and sales operations, with the original lease term running through October 2019. In April 2019, the Company entered into a new operating lease agreement extending the lease term through October 2024. Additionally, the Company leases its corporate office space in Middletown, CT, with the lease term expiring in 2022.

 

In the United Kingdom, the Company leases a facility in Banbury, England, which serves sales, warehousing and operational functions with the lease term ending in March 2021.

 

In addition to the above property leases, the Company also has lease agreements in place for various fleet vehicles and equipment with various lease terms.

 

In the June 30, 2019 condensed consolidated balance sheet, the Company has recorded right-of-use assets of $770,000, and a lease liability of $789,000, of which $317,000 is reported as a current liability. The respective weighted average remaining lease term and discount rate are approximately 3.11 years and 3.73%.

 

As of June 30, 2019, payment of the lease liability over the next five years, which includes the related interest, is as follows:

Twelve Months

Ending June 30,

 

Lease

Liability

Payments

 
   (in thousands) 
2020  $317 
2021   262 
2022   108 
2023   42 
2024   44 
Thereafter   16 
      
Total Lease Payments  $789 

 

A similar description of the lease obligations for the previous year is disclosed in the Company’s December 31, 2018 Form 10-K.

 

Lease expense for the operating leases was approximately $75,000 and $150,000 for the three and six months ended June 30, 2019, respectively. Lease expense is allocated to each portion of the business generally based upon use, with the majority absorbed by manufacturing (cost of goods sold), and the remainder apportioned to selling, administrative and engineering.

 

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8. SHAREHOLDERS’ EQUITY

 

As of June 30, 2019 and December 31, 2018, the Company had authorized 20,000,000 common stock shares with par value of $0.01 per share. At these same dates, the total number of outstanding shares was 10,094,322 and 10,091,822, shares held in Treasury was 59,311 and 61,811, and total shares issued was 10,153,633 for both periods.

 

During 2019 and 2018, upon approval of the Board of Directors (the “Board”) the Company has made regular quarterly dividend payments, as set forth in the following table:

 

Dividend Declared  Dividend Paid on or Before
Date  Price Per Share   Date  Amount 
June 12, 2019  $0.28   July 3, 2019*  $2,826,000 
December 13, 2018  $0.24   January 3, 2019**  $2,422,000 
September 11, 2018  $0.24   October 2, 2018**  $2,422,000 
June 6, 2018  $0.24   July 3, 2018**  $2,422,000 
April 10, 2018  $0.22   April 30, 2018**  $2,220,000 
December 13, 2017  $0.22   January 3, 2018**  $2,220,000 

 

The number of shares outstanding during the related dividend period was *10,094,322 and **10,091,822.

 

In addition to the above dividend amounts, there were dividends approved by the Company’s foreign subsidiary during April 2018, which amounted to an outlay of cash of $491,000 to the foreign subsidiary’s noncontrolling interest, and again in July 2019, with the cash distribution to the noncontrolling interest of $137,000 paid during July 2019.

 

It should be noted that from time to time, the Board may elect to pay special dividends, in addition to or in lieu of the regular quarterly dividends, depending upon the financial condition of the Company.

 

The Board approved and granted a total of 2,500 restricted stock unit awards (the “Awards”) to be allocated to the existing non-employee directors of the Company. The Awards were approved by the shareholders’ of the Company at the annual meeting on June 11, 2019, and distributed on June 20, 2019. A Form S-8 registration statement, and the restricted stock unit award agreements, were filed with the SEC on December 13, 2018 (2,000 units) and May 24, 2019 (500 units). The related director compensation cost of approximately $217,000 was recognized during June 2019.

 

On April 4, 2014, the Company’s Board of Directors authorized an extension of its stock repurchase program without expiration, up to a maximum amount of $1,000,000. The original program established in December 2007 authorized the purchase of up to $5,000,000 of its common stock. The purchases may be made from time-to-time in the open market or in privately negotiated transactions, depending on market and business conditions. The Board retained the right to cancel, extend, or expand the share buyback program, at any time and from time-to-time. Since inception, the Company has purchased a total of 61,811 shares for approximately $932,000, or approximately $15 per share, which were held as treasury shares. The Company has not made any stock repurchases since 2014; however, as stated above, there were 2,500 shares distributed from treasury to non-employee directors during June 2019.

 

9. RELATED PARTY TRANSACTIONS

 

From time to time the Company may have related party transactions (“RPTs”). In short, RPTs represent any transaction between the Company and any Company employee, director or officer, or any related entity, or relative, etc. The Company performs a review of transactions each year to determine if any RPTs exist. Through this investigation, the Company is currently not aware of any RPTs between the Company and any of its current directors or officers outside the scope of their normal business functions or expected contractual duties. The Company does on occasion share a small amount of services with its former parent Mestek, Inc., mostly related to board meeting expenses. Additionally, the Company is aware of transactions between a few service providers which employ individuals indirectly associated to Omega Flex employees, but these have been determined to be independent transactions with no indication that they are influenced by the related relationships. The Company had note agreement assets with related parties amounting to approximately $5,000 at December 31, 2018, which were contractually secured by the Company. In February 2019, the amounts due from related parties were collected.

 

10. SUBSEQUENT EVENTS

 

The Company evaluated all events or transactions that occurred through the date of this filing. During this period, the Company did not have any material subsequent events that impacted its condensed consolidated financial statements.

 

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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 (also described as corrugated tubing), and is currently engaged in a number of different markets, including construction, medical, healthcare and pharmaceutical industries, manufacturing, transportation, petrochemical, pharmaceutical, healthcare 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, as well as the sale of the Company’s related proprietary fittings and a vast array of accessories. The Company’s products are concentrated in residential and commercial construction, and general industrial markets, with a comprehensive portfolio of intellectual property and patents issued in various countries around the world. The Company’s primary product, flexible gas piping, is used for gas piping within residential and commercial buildings. Through its flexibility and ease of use, the Company’s TracPipe® and TracPipe® CounterStrike® flexible gas piping, along with its fittings distributed under the trademarks AutoSnap® and AutoFlare®, allows users to substantially cut the time required to install gas piping, as compared to traditional methods. Developed for the healthcare industry, the Company’s newest product MediTrac® has received robust interest during its launch, and is generating high expectations. MediTrac® is used in hospitals, ambulatory care centers, dental, physician and veterinary clinics, laboratories, pharmaceutical installations, and any facility that uses medical or pure gas. Similar to TracPipe® CounterStrike®, the same flexibility of the corrugated medical tubing sold in long continuous lengths allows the product to be installed in health care facilities much more easily and safely than traditional medical grade rigid copper pipe. The Company’s products are manufactured at its Exton, Pennsylvania facilities in the United States, and in Banbury, Oxfordshire in the United Kingdom. Through the use of its broad network of independent outside sales organizations, such as sales representatives, the Company primarily sells its products to distributors, wholesalers and OEM’s, mostly throughout North America, and to a lesser extent in other global markets.

 

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CHANGES IN FINANCIAL CONDITION

 

For the period ended June 30, 2019 vs. December 31, 2018

 

The Company’s cash balance of $23,920,000 at June 30, 2019, decreased $8,472,000 (26.2%) from the $32,392,000 balance at December 31, 2018. The Company made a net purchase of investments of $7,954,000 and paid regular quarterly dividends of $2,422,000 in April and January 2019. Additionally, consistent with prior years, the Company paid a significant amount of cash during the first quarter for obligations that were accrued as of the end of the preceding year, such as sales promotional incentive programs and various incentive related compensation. Those cash outflows were partially offset by income generated from operations during 2019. The condensed consolidated statement of cash flows is provided on page 7 which provides further details regarding changes in cash.

 

Investments were $22,898,000 and $14,944,000 as of June 30, 2019 and December 31, 2018, respectively, increasing $7,954,000 or 53.2%. During 2019, the Company invested excess funds in various liquid interest earning instruments including U.S. Treasury bills. These investments are stated at fair value, which approximates amortized cost, and are classified as available-for-sale in accordance with Accounting Standards Codification 320, Investments – Debt and Equity Securities (or “ASC 320”). Maturities, from the date of purchase, were six months or less.

 

Accrued Compensation was $2,273,000 at June 30, 2019, compared to $5,295,000 at December 31, 2018, decreasing $3,022,000 (57.1%). A significant portion of the liability that existed at year end related to incentive compensation earned in 2018. As is customary, the liability was then paid during the first quarter of the following year, or 2019, thus diminishing the balance. The liability now represents amounts earned during the current year.

 

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RESULTS OF OPERATIONS

 

Three-months ended June 30, 2019 vs. June 30, 2018

 

The Company reported comparative results from continuing operations for the three-month periods ended June 30, 2019 and 2018 as follows:

 

  

Three-months ended June 30,

 
   (in thousands) 
   2019   2019   2018   2018 
Net Sales  $26,809    100.0%  $26,847    100.0%
Gross Profit  $16,736    62.4%  $16,214    60.4%
Operating Profit  $5,144    19.2%  $6,358    23.7%

 

Net Sales. The Company’s 2019 second quarter sales of $26,809,000 were essentially flat with the second quarter of 2018, which generated sales of $26,847,000. The Company continues to see sustained demand for our products and maintain a dominant position in our core market.

 

Gross Profit. The Company’s gross profit margins were 62.4% and 60.4% for the three-months ended June 30, 2019 and 2018, 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 very similar for the three-months ended June 30, 2019 and 2018, being $4,300,000 and $4,281,000, respectively. Selling expenses as a percent of net sales were also 16.0% for both periods.

 

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 $6,140,000 and $4,465,000 for the three-months ended June 30, 2019 and 2018, respectively, thus increasing by $1,675,000 or 37.5%. Legal and product liability defense costs increased $1,892,000, associated primarily with one pending class action case, which the Company continues to vigorously defend itself against. There was also an increase in director compensation connected to the shares awarded to the non-employee directors upon approval by the shareholders in June 2019. The impact of these items was however partially offset by a decrease in incentive compensation of $517,000 primarily resulting from a softening in the stock price from the surge experienced during the first quarter of 2019, which decreased the phantom stock expense. As a percentage of sales, general and administrative expenses increased to 22.9% for the three-months ended June 30, 2019 from 16.6% for the three-months ended June 30, 2018.

 

Engineering Expense. Engineering expenses consist of development expenses associated with the development of new products and enhancements to existing products, and manufacturing engineering costs. Engineering expenses were $1,152,000 and $1,110,000 for the three-months ended June 30, 2019 and 2018, respectively, increasing by $42,000 or 3.8%, partially associated with the progression of the Company’s new MediTrac® corrugated medical tubing product, as well as other promising applications such as the DoubleTrac® offerings. Engineering expenses increased as a percentage of sales, being 4.3% for the three-months ended June 30, 2019, and 4.1% for the same period in 2018.

 

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Operating Profits. Reflecting all of the factors mentioned above, operating profits were $5,144,000 and $6,358,000 for the quarters ended June 30, 2019 and 2018, respectively, decreasing by $1,214,000 or 19.1%.

 

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 Company recorded $236,000 and $94,000 of interest income during the second quarters of 2019 and 2018, respectively.

 

Other Income (Expense)-Net. Other Income (Expense)-net primarily consists of foreign currency exchange gains (losses) on transactions with Omega Flex Limited, our UK subsidiary. There was expense of $33,000 and $76,000 recorded during the second quarter 2019 and 2018, respectively.

 

Income Tax Expense. Income Tax Expense was $1,325,000 for the second quarter of 2019, compared to $1,564,000 for the same period in 2018. The $239,000 or 15.3% decrease in tax expense was largely the result of the decrease in income before taxes. A lower rate was in effect during the second quarter of both 2019 and 2018 attributable to the Tax Cuts and Jobs Act enacted at the end of 2017. The Act reduced the U.S. federal tax rate from 35% to 21%, effective for the Company’s 2018 tax year. The Company’s tax provision also reflects other changes as a result of the Act, including the impact of the Global Intangible Low Taxed Income provisions, and changes effecting the deductibility of certain executive compensation.

 

Six-months ended June 30, 2019 vs. June 30, 2018

 

The Company reported comparative results from continuing operations for the six-month periods ended June 30, 2019 and 2018 as follows:

 

  

Six-months ended June 30,

 
   (in thousands) 
   2019   2019   2018   2018 
   ($000)   %   ($000)   % 
Net Sales  $53,597    100.0%  $52,244    100.0%
Gross Profit  $33,682    62.8%  $31,247    59.8%
Operating Profit  $10,735    20.0%  $11,858    22.7%

 

Net Sales. The Company’s sales for the first six months 2019 of $53,597,000 increased $1,353,000 or 2.6% over the first six months of 2018, which generated sales of $52,244,000.

 

Gross Profit. The Company’s gross profit margins were 62.8% and 59.8% for the six-months ended June 30, 2019 and 2018, respectively. The Company has experienced strong expansion in gross profit due to robust pricing actions, and a focus on costs and operating leverage.

 

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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 $8,810,000 and $8,695,000 for the six-months ended June 30, 2019 and 2018, respectively, representing an increase of $115,000 or 1.3%. Selling expenses as a percent of net sales compared to last year, were 16.4% for the six-months ended June 30, 2019, and 16.6% for the six-months ended June 30, 2018, decreasing slightly.

 

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 $11,644,000 and $8,554,000 for the six-months ended June 30, 2019 and 2018, respectively, thus increasing by $3,090,000 or 36.1%. Legal and product liability defense costs increased $2,487,000, associated primarily with one pending class action case, which the Company continues to vigorously defend itself against. The Company also experienced an increase in the phantom stock portion of incentive compensation expense between years, and an increase in director compensation due to the distribution of shares awarded to the non-employee directors upon approval by the shareholders in June 2019. As a percentage of sales, general and administrative expenses increased to 21.7% for the six-months ended June 30, 2019 from 16.4% for the six-months ended June 30, 2018.

 

Engineering Expense. Engineering expenses consist of development expenses associated with the development of new products and enhancements to existing products, and manufacturing engineering costs. Engineering expenses were $2,493,000 and $2,140,000 for the six-months ended June 30, 2019 and 2018, respectively, increasing by $353,000 or 16.5%, partially associated with the progression of the Company’s new MediTrac® corrugated medical tubing product, as well as other promising applications such as the DoubleTrac® offerings. Engineering expenses increased as a percentage of sales, being 4.7% for the six-months ended June 30, 2019, and 4.1% for the same period in 2018.

 

Operating Profits. Reflecting all of the factors mentioned above, operating profits were $10,735,000 and $11,858,000 for the quarters ended June 30, 2019 and 2018, respectively, decreasing by $1,123,000 or 9.5%.

 

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 Company recorded $456,000 and $145,000 of interest income during the first six months of 2019 and 2018, respectively.

 

Other Income (Expense)-Net. Other Income (Expense)-net primarily consists of foreign currency exchange gains (losses) on transactions with Omega Flex Limited, our UK subsidiary. There was income of $5,000 recorded during the first six months of 2019, and expense of $40,000 for the same period in 2018.

 

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Income Tax Expense. Income Tax Expense was $2,743,000 for the first six months of 2019, compared to $2,948,000 for the same period in 2018. The $205,000 or 7.0% decrease in the tax expense was largely the result of the decrease in income before taxes. A lower rate was in effect during the first six months of both 2019 and 2018 attributable to the Tax Cuts and Jobs Act enacted at the end of 2017. The Act reduced the U.S. federal tax rate from 35% to 21%, effective for the Company’s 2018 tax year. The Company’s tax provision also reflects other changes as a result of the Act, including the impact of the Global Intangible Low Taxed Income provisions, and changes effecting the deductibility of certain executive compensation.

 

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 include a summary of the significant accounting policies and methods used in the preparation of our condensed consolidated financial statements. The following is a discussion of the Company’s significant accounting policies.

 

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 as of 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, investment valuations, inventory valuations, goodwill valuation, product liability reserve, stock-based compensation valuations 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

 

Effective January 1, 2018, the Company adopted the requirements of Accounting Standards Update (“ASU”) 2014-09, Revenue from Contracts with Customers (Topic 606). The standard is a comprehensive new revenue recognition model that requires revenue to be recognized in a manner to depict the transfer of goods or services to a customer at an amount that reflects the consideration expected to be received in exchange for those goods or services.

 

The guidance permits two methods of adoption: retrospectively to each prior reporting period presented (full retrospective method), or retrospectively with the cumulative effect of initially applying the guidance recognized at the date of initial application (the modified retrospective approach). The Company selected the modified retrospective approach however there was no material impact which required a cumulative effect adjustment.

 

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The principle of Topic 606 was achieved through applying the following five-step approach:

 

  ● Identification of the contract, or contracts, with a customer — a contract with a customer exists when the Company enters into an enforceable contract with a customer, typically a purchase order initiated by the customer, that defines each party’s rights regarding the goods to be transferred and identifies the payment terms related to these goods.
     
  ● Identification of the performance obligations in the contract — performance obligations promised in a contract are identified based on the goods that will be transferred to the customer that are distinct, whereby the customer can benefit from the goods on their own or together with other resources that are readily available from third parties or from us. Persuasive evidence of an arrangement for the sale of product must exist. The Company ships product in accordance with the purchase order and standard terms as reflected within the Company’s order acknowledgments and sales invoices.
     
  ● Determination of the transaction price —the transaction price is determined based on the consideration to which the Company will be entitled in exchange for transferring goods to the customer. This would be the agreed upon quantity and price per product type in accordance with the customer purchase order, which is aligned with the Company’s internally approved pricing guidelines.
     
  ● Allocation of the transaction price to the performance obligations in the contract — if the contract contains a single performance obligation, the entire transaction price is allocated to the single performance obligation. This applies to the Company as there is only one performance obligation to ship the goods.
     
  ● Recognition of revenue when, or as, the Company satisfies a performance obligation — the Company satisfies performance obligations at a point in time when control of the goods transfers to the customer. Determining the point in time when control transfers requires judgment. Indicators considered in determining whether the customer has obtained control of a good include:

 

  ■ The Company has a present right to payment
  ■ The customer has legal title to the goods
  ■ The Company has transferred physical possession of the goods
  ■ The customer has the significant risks and rewards of ownership of the goods
  ■ The customer has accepted the goods

 

    It is important to note that the indicators are not a set of conditions that must be met before the Company can conclude that control of the goods has transferred to the customer. The indicators are a list of factors that are often present if a customer has control of the goods.

 

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    The Company has typical, unmodified FOB shipping point terms. As the seller, the Company can determine that the shipped goods meet the agreed-upon specifications in the contract or customer purchase order (e.g. items, quantities, and prices) with the buyer, so customer acceptance would be deemed a formality, as noted in Accounting Standards Codification (“ASC”) 606-10-55-86. As a result, the Company has a legal right to payment upon shipment of the goods.
     
    Based upon the above, the Company has concluded that control substantively transfers to the customer upon shipment.
     
  Other considerations of Topic 606 include the following:

 

  ● Contract Costs - costs to obtain a contract (e.g. customer purchase order) include sales commissions. Under Topic 606, these costs may be expensed as incurred for contracts with a duration of one year or less. The majority of the customer purchase orders are fulfilled (e.g. goods are shipped) within two days of receipt.
     
  ● Warranties - the Company does not offer customers to purchase a warranty separately. Therefore there is not a separate performance obligation. The Company does account for warranties as a cost accrual and the warranties do not include any additional distinct services other than the assurance that the goods comply with agreed-upon specifications. There is no impact of warranties under Topic 606 upon the financial reporting of the Company.
     
  ● Returned Goods - from time to time, the Company provides authorization to customers to return goods. If deemed to be material, the Company would record a “right of return” asset for the cost of the returned goods which would reduce cost of sales. Upon implementation of Topic 606, the Company will monitor pending authorized returns of goods and, if deemed appropriate, record the right of return asset accordingly.
     
  ● Volume Rebates (Promotional Incentives) - volume rebates are variable (dependent upon the volume of goods purchased by our eligible customers) and, under Topic 606, must be estimated and recognized as a reduction of revenue as performance obligations are satisfied (e.g. upon shipment of goods). Also under Topic 606, to ensure that revenue recognized would not be probable of a significant reversal, the four following factors are considered:

 

  ■ The amount of consideration is highly susceptible to factors outside the company’s influence.
  ■ The uncertainty about the amount of consideration is not expected to be resolved for a long period of time.
  ■ The Company’s experience with similar types of contracts is limited.
  ■ The contract has a large number and broad range of possible consideration amounts.

 

  If it was concluded that the above factors were in place for the Company, it would support the probability of a significant reversal of revenue. However, as none of the four factors apply to the Company, promotional incentives are recorded as a reduction of revenue based upon estimates of the products expected to be sold.

 

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Regarding disaggregated revenue disclosures, as previously noted, the Company’s business is controlled as a single operating segment that consists of the manufacture and sale of flexible metal hose. Most of the Company’s transactions are very similar in nature, contract, terms, timing, and transfer of control of goods. As indicated within Note 2, under the caption “Significant Concentration”, the majority of the Company’s sales were geographically contained within North America, with the remainder scattered internationally. All performance assessments and resource allocations are generally based upon the review of the results of the Company as a whole.

 

Cash Equivalents

 

The Company considers all highly liquid investments with an original maturity of 90 days or less at the time of purchase to be cash equivalents. Cash equivalents include investments in an institutional money market fund, which invests in U.S. Treasury bills, notes and bonds, and/or repurchase agreements, backed by such obligations. Carrying value approximates fair value. Cash and cash equivalents are deposited at various area banks, which at times may exceed federally insured limits. The Company monitors the viability of the banking institutions carrying its assets on a regular basis, and has the ability to transfer cash to various institutions during times of risk. The Company has not experienced any losses related to these cash balances, and believes its credit risk to be minimal.

 

Accounts Receivable and Provision for Doubtful Accounts

 

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, additional allowances may be required.

 

The allowance for doubtful accounts reflects the Company’s best estimate of probable losses inherent in the accounts receivable balance. The Company determines the allowance based on any known collection issues, historical experience, and other currently available evidence. The reserve for future credits, discounts, and doubtful accounts was $946,000 and $985,000 as of June 30, 2019 and December 31, 2018, respectively. In regards to identifying uncollectible accounts, the Company reviews an aging report on a consistent basis to determine past due accounts, and utilizes a well-established credit rating agency. The Company charges off those accounts that are deemed uncollectible once all collection efforts have been exhausted.

 

Investments

 

The Company invests excess funds in liquid interest earning instruments including US Treasury bills and bank time deposits. These investments are stated at fair value, which approximates amortized cost, and are classified as available-for-sale in accordance with ASC 320, Investments – Debt and Equity Securities. Investments were $22,898,000 and $14,944,000 as of June 30, 2019 and December 31, 2018, respectively. Maturities, from the date of purchase, were six months or less.

 

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Inventories

 

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

 

Property and Equipment

 

Property and equipment are initially recorded at cost. Depreciation and amortization are computed using the straight-line method over the estimated useful lives of the assets or, for leasehold improvements, the life of the lease, if shorter. When assets are retired or otherwise disposed of, the cost and related accumulated depreciation are removed from the accounts and any resulting gain or loss is reflected in other income or expense for the period. The cost of maintenance and repairs is expensed as incurred; significant improvements are capitalized.

 

Goodwill

 

In accordance with Financial Accounting Standards Board (“FASB”) ASC Topic 350, Intangibles – Goodwill and Other, the Company performed an annual impairment test in accordance with this guidance as of December 31, 2018. This analysis did not indicate any impairment of goodwill. There were no circumstances that indicate that goodwill might be impaired during the six months ended June 30, 2019.

 

Stock-Based Compensation Plans

 

In 2006, the Company adopted a Phantom Stock Plan (the “Plan”), which allows the Company to grant phantom stock units (“Units”) to certain key employees, officers or directors. The Units each represent a contractual right to payment of compensation in the future based upon the market value of the Company’s common stock. The Units follow a vesting schedule of three years from the grant date, and are then paid upon maturity. In accordance with FASB ASC Topic 718, Compensation - Stock Compensation, the Company uses the Black-Scholes option pricing model as its method for determining the fair value of the Units. Further details of the Plan are provided in Note 6.

 

Product Liability Reserves

 

Product liability reserves represent the estimated unpaid amounts under the Company’s insurance policies with respect to existing claims. The Company uses the most current available data to estimate claims. As explained more fully under Note 5, Commitments and Contingencies, for various product liability claims covered under the Company’s general liability insurance policies, the Company must pay certain defense and settlement costs within its deductible or self-insured retention limits, ranging primarily from $25,000 to $1,000,000 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.

 

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Leases

 

Effective January 1, 2019, the Company adopted the requirements of FASB ASU 2016-02, Leases (Topic 842) which defines a lease as any contract that conveys the right to use a specific asset for a period of time in exchange for consideration. Leases are classified as a finance lease, formerly called a capital lease, if any of the following criteria are met:

 

  1. The lease transfers ownership of the underlying asset to the lessee by the end of the lease term.
  2. The lease grants the lessee an option to purchase the underlying asset that the lessee is reasonably certain to exercise.
  3. The lease term is for the major part of the remaining economic life of the underlying asset.
  4. The present value of the sum of lease payments and any residual value guaranteed by the lessee equals or exceeds substantially all of the fair value of the underlying asset.
  5. The underlying asset is of such a specialized nature that it is expected to have no alternative use to the lessor at the end of the lease term.

 

For any leases that do not meet the criteria identified above for finance leases, the Company treats such leases as operating leases. As of June 30, 2019, each of the Company’s leases are classified as operating leases.

 

Under the new guidance, both finance and operating leases are reflected on the balance sheet as lease or “right-of-use” assets and lease liabilities. It should be noted that under previous guidance operating leases (non-capital leases) were not required to be recorded as an asset on the balance sheet.

 

There are some exceptions, which the Company has elected in its accounting policies. For leases with terms of twelve months or less, or below the Company’s general capitalization policy threshold, the Company elects an accounting policy to not recognize lease assets and lease liabilities for all asset classes. The Company recognizes lease expense for such leases generally on a straight-line basis over the lease term.

 

The Company determines if a contract is a lease at the inception of the arrangement. The Company reviews all options to extend, terminate, or purchase its right-of-use assets at the inception of the lease and accounts for these options when they are reasonably certain to be exercised. Certain leases contain non-lease components, such as common area maintenance, which are generally accounted for separately. In general, the Company will assess if non-lease components are fixed and determinable, or variable, when determining if the component should be included in the lease liability. For purposes of calculating the present value of the lease obligations, the Company utilizes the implicit interest rate within the lease agreement when known and/or determinable, and otherwise utilizes its incremental borrowing rate at the time of the lease agreement.

 

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As permitted under ASU 2018-11, the Company elected the optional transition method to adopt the new leases standard. Under this new transition method, the Company initially applied the new leases standard at the adoption date of January 1, 2019 and would have recognized a cumulative-effect adjustment, if appropriate, to the opening balance of retained earnings in the period of adoption. No cumulative-effect adjustment was recognized. The Company’s reporting for the comparative periods prior to 2019 in the financial statements are presented in accordance with existing GAAP in effect for 2018 and earlier (ASC Topic 840, Leases).

 

The impact of the adoption of this new standard resulted in an increase to the Company’s operating lease assets and liabilities on January 1, 2019 of approximately $800,000. The implementation did not have a material impact on the Company’s consolidated statements of income and statements of cash flows.

 

Fair Value of Financial and Nonfinancial Instruments

 

The Company measures financial instruments in accordance with 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 upon Level 1 inputs in determining the fair value of investments and the fair value of the Company’s reporting unit in its annual impairment test as described in the FASB ASC Topic 350, Intangibles - Goodwill and Other.

 

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 diluted earnings per share are the same.

 

Currency Translation

 

Assets and liabilities denominated in foreign currencies, most of which relate to the Company’s United Kingdom subsidiary whose functional currency is British pound sterling, 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 the statements of income (other expense) in the period in which they occur.

 

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Income Taxes

 

The Company accounts for tax liabilities in accordance with the FASB ASC Topic 740, Income Taxes. Under this method the Company records tax expense, related deferred taxes and tax benefits, and uncertainties in tax positions.

 

Deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities from a change in tax rates is recognized in income in the period that includes the enactment date. A valuation allowance is provided for deferred tax assets if it is more likely than not that these items will either expire before the Company is able to realize the benefit, or that future deductibility is uncertain.

 

The FASB ASC Topic 740, Income Taxes, clarifies the criteria that an individual tax position must satisfy for some or all of the benefits of that position to be recognized in a company’s financial statements. This guidance prescribes a recognition threshold of more-likely than-not, and a measurement attribute for all tax positions taken or expected to be taken on a tax return, in order for those tax positions to be recognized in the financial statements.

 

The Company follows the provisions of ASC 740-10 relative to accounting for uncertainties in tax positions. These provisions provide guidance on the recognition, de-recognition and measurement of potential tax benefits associated with tax positions.

 

The Company reflected the effects of the Tax Cuts and Jobs Act (the “Act”) in its financial statements during the 2017 enactment period. This included the effects of the change in the US Corporate tax rate from 35% to 21% on deferred tax assets and liabilities, and a provision related to previously deferred taxes on earnings of the Company’s foreign subsidiary. The Company’s tax expense for the periods ended June 30, 2019 and 2018 included the continuing effect of the reduction in the U.S. federal tax rate from 35% to 21%, effective for those respective tax years. The Company’s tax provision also reflects other changes as a result of the Act, including the impact of the Global Intangible Low Taxed Income (“GILTI”) provisions, and changes effecting the deductibility of certain executive compensation.

 

Other Comprehensive Income

 

For the three and six months ended June 30, 2019 and 2018, respectively, the components of other comprehensive income consisted solely of foreign currency translation adjustments.

 

Significant Concentration

 

The Company has one significant customer which represented more than 10% of the Company’s Accounts Receivable at June 30, 2019 and December 31, 2018. That same customer represented more than 10% of the Company’s total Net Sales for the six months ended June 30, 2019 and 2018. Geographically, the Company has a significant amount of sales in the United States versus internationally. These concentrations are consistent with those discussed in detail in the Company’s December 31, 2018 Form 10-K.

 

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Subsequent Events

 

The Company evaluates all events or transactions through the date of the related filing that may have a material impact on its condensed consolidated financial statements. Refer to Note 10 of the condensed consolidated financial statements.

 

Recent Accounting Pronouncements

 

In January 2017, the FASB amended ASC Topic 350, Intangibles – Goodwill and Other (issued under ASU 2017-04, “Simplifying the Test for Goodwill Impairment”). This amendment simplifies the test for goodwill impairment by only requiring an entity to perform an annual or interim goodwill impairment test by comparing the fair value of a reporting unit with its carrying amount and recognize an impairment charge for the amount that the carrying amount exceeds the reporting unit’s fair value. Any loss recognized should not exceed the total amount of goodwill allocated to that reporting unit. The amendment requires adoption on January 1, 2020. The Company does not expect that the adoption of ASU 2017-04 will have a material impact on its consolidated financial statements.

 

LIQUIDITY AND CAPITAL RESOURCES

 

Historically, the Company’s primary cash needs have been related to working capital items, which the Company has largely funded through cash generated from operations.

 

As of June 30, 2019, the Company had a cash balance of $23,920,000. Additionally, the Company has a $15,000,000 line of credit available, as discussed in detail in Note 4, which had no borrowings outstanding upon it at June 30, 2019. At December 31, 2018, the Company had a cash balance of $32,392,000, with no borrowings against the line of credit.

 

We believe our existing cash and cash equivalents will be sufficient to meet our anticipated cash needs for at least the next twelve months. Our future capital requirements will depend upon many factors including our rate of revenue growth, the timing and extent of any expansion efforts, and the potential for investments in, or the acquisition of any complementary products, businesses or supplementary facilities for additional capacity. The details of our operating, investing and financing activities are provided below.

 

Operating Activities

 

Cash used in operating activities is net income adjusted for certain non-cash items and changes in certain assets and liabilities, such as those included in working capital.

 

For the first six months of 2019, the Company’s operating activities provided cash of $5,079,000, compared to the first six months of 2018 which provided cash of $6,087,000, a difference of $1,008,000. For details of the operating cash flows refer to the condensed consolidated statements of cash flows in Part I – Financial Information on page seven.

 

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Investing Activities

 

Cash used in investing activities during the first six months of 2019 and 2018 was $8,676,000 and $708,000, respectively. During 2019, cash was used to purchase short-term investments of $22,954,000, which was partially offset by cash received from net proceeds from the sale of short-term investments of $15,000,000. There were also capital expenditures during 2019 amounting to $722,000. All of the investing activities during the first six months of 2018 were capital in nature. The capital spending during both 2019 and 2018 related to various projects, with prominent spending designated for the new MediTrac products.

 

Financing Activities

 

All financing activities relate to dividend payments, which are detailed in Note 8, Shareholders’ Equity. Dividend payments through the first six months of 2019 and 2018, amounted to $4,844,000 and $4,931,000 respectively.

 

CONTINGENT LIABILITIES AND GUARANTEES

 

See Note 5 to the Company’s condensed consolidated financial statements.

 

OFF-BALANCE SHEET ARRANGEMENTS

 

None

 

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.

 

Item 4 – Controls and Procedures

 

(a) Evaluation of Disclosure Controls and Procedures.

 

At the end of the fiscal second quarter of 2019, 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 this report, 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.

 

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(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 six-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

 

In the ordinary and normal conduct of the Company’s business, it is subject to periodic lawsuits, investigations and claims (collectively, the “Claims”). Most of the Claims, including a putative class-action claim, relate to potential lightning damage to our flexible gas piping products, which impact legal and product liability related expenses. The Company does not believe the Claims have legal merit, and therefore has commenced a vigorous defense in response to the Claims. It is possible that the Company may incur increased litigation costs in the future due to a variety of factors, including a higher number of Claims, higher legal costs, and higher insurance deductibles or retentions.

 

In 2010, the Company took its first Claim to trial in Pennsylvania, and the jury returned a verdict that the Company was not negligent in designing and selling the TracPipe® product, but also returned a verdict for plaintiff on strict liability. The Company appealed that portion of the verdict, and in December 2014, the Supreme Court of Pennsylvania ruled in favor of the Company, and returned the case to the trial court for further hearings. The cash bond of $1,600,000, which was previously included in Other Long Term Assets and posted as security for a subsequent appeal, was returned to the Company in May 2018. This case was finally settled and closed on August 7, 2018.

 

In March 2017, a putative class action case was re-filed against the Company and other parties in Missouri state court after the predecessor case was dismissed without prejudice by the federal court. The Company successfully removed the case to federal court and is currently vigorously defending the case.

 

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The Company has in place commercial general liability insurance policies that cover most Claims, which are subject to deductibles or retentions, ranging primarily from $25,000 to $1,000,000 per claim (depending on the terms of the policy and the applicable policy year), up to an aggregate amount. Litigation is subject to many uncertainties and management is unable to predict the outcome of the pending suits and claims. The potential liability for a given claim could range from zero to a maximum of $1,000,000, depending upon the circumstances, and insurance deductible or retention in place for the respective claim year. The aggregate maximum exposure for all current open Claims, excluding the putative class action case, as of June 30, 2019 is estimated to not exceed approximately $3,200,000, which represents the potential costs that may be incurred over time for the Claims within the applicable insurance policy deductibles or retentions. From time to time, depending upon the nature of a particular case, the Company may decide to spend in excess of a deductible or retention to enable more discretion regarding the defense, although this is not common. It is possible that the results of operations or liquidity of the Company, as well as the Company’s ability to procure reasonably priced insurance, could be adversely affected by the pending litigation, potentially materially. The Company is currently unable to estimate the ultimate liability, if any, that may result from the pending litigation, or potential litigation from future claims or claims that have not yet come to our attention, and accordingly, the liability in the consolidated financial statements primarily represents an accrual for legal costs for services previously rendered, and outstanding or anticipated settlements for Claims. The liabilities recorded on the Company’s books at June 30, 2019 and December 31, 2018 were $228,000 and $150,000, respectively, and are included in Other Liabilities.

 

Item 1A – Risk Factors

 

Risk factors are discussed in detail in the Company’s December 31, 2018 Form 10-K. There are no additional risks attributable to the quarter.

 

Item 2 – Unregistered Sales of Equity Securities and Use of Proceeds

 

None.

 

Item 3 – Defaults Upon Senior Securities

 

None.

 

Item 4 – Mine Safety Disclosures

 

Not Applicable.

 

Item 5 – Other Information

 

None.

 

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Item 6 - Exhibits

 

Exhibit

No.

   Description
     
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 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.

 

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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: August 5, 2019 By: /S/ Paul J. Kane
    Paul J. Kane
    Vice President – Finance
    and Chief Financial Officer

 

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