Omega Flex, Inc. (NASDAQ: OFLX)

Omega Flex, Inc. (NASDAQ: OFLX), referred to simply as Omega Flex for the remainder of this writeup, is a high return on capital manufacturer of flexible metal hoses. Per its Q3 2023 10-Q, these hoses are “used in a variety of applications to carry gases and liquids within their particular applications. The Company’s business is controlled as a single operating segment that consists of the manufacture and sale of flexible metal hose and accessories. These applications include carrying fuel gases within residential and commercial buildings; gasoline and diesel gasoline products (both above and below the ground) in a double containment piping to contain any possible leaks, which is used in automotive and marina refueling, and fueling for back-up generation; and medical gases in health care facilities. The Company’s flexible metal piping is also used to carry other types of gases and fluids in a number of 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.” The business is headquartered about an hour outside of Philadelphia in the mean streets of Exton, Pennsylvania. Omega Flex generated ~$125 million in sales in 2022 and ~$83 million in sales through the first three quarters of 2023.

History

Per p. 5 of its 2022 10-K, Omega Flex was “…incorporated in 1975 under the name of Tofle America, Inc., the Company was originally established as the subsidiary of a Japanese manufacturer of flexible metal hose. For a number of years, the Company was a manufacturer of flexible metal hose that was sold primarily to customers using the hose for incorporation into finished assemblies for industrial applications. The Company later changed its name to Omega Flex, Inc., and in 1996, the Company was acquired by Mestek, Inc. (Mestek).” Mestek announced a spinoff of the business in January 2005, and it went public in August of the same year.

CEO

Omega Flex brought in a new CEO on 1/1/2024 so I will mention both the outgoing and incoming CEO in this section. The 8-K detailing the change can be found here.

The outgoing CEO was Kevin Hoben. Per the 2023 Proxy Statement, “Mr. Hoben is currently Chairman and Chief Executive Officer of the Company, and previously served as President from 2005 to 2018. Mr. Hoben has served as our director since 1996, and as a director and chairman of our United Kingdom subsidiary, Omega Flex Limited, since 2001. Mr. Hoben is also a director of Taco Comfort Solutions, Inc., an HVAC manufacturer. Mr. Hoben has over 30 years of experience in the sale and distribution of flexible metal hose products in positions of increasing scope and responsibility.” Per TIKR, he owns 8.92% of the business.

Effective 1/1/2024, the new CEO of Omega Flex is Dean Rivest. Per the 2023 Proxy Statement again, “Mr. Rivest has served as our President since January 2022, providing leadership over operations of the Company. He previously served as Executive Vice President from 2020 to 2022 and was responsible for manufacturing and engineering for all products, as well as sales and marketing for the industrial and MediTrac® products. Prior to that, Mr. Rivest was the Vice President and General Manager of the industrial and MediTrac® products since 2005. Mr. Rivest is also a director of Omega Flex Limited, our United Kingdom subsidiary, and president of Omega Flex SAS, our French subsidiary. His credentials include an M.S. in Mechanical Engineering from Rensselaer Polytechnic Institute, a B.S. in Mechanical Engineering from Western New England College and an A.S. in Mechanical Engineering from Springfield Technical Community College. In addition to being a registered professional engineer, Mr. Rivest is the inventor of several patents directly related to the Company’s product lines.” Per TIKR, he owns <1% of the business.

CEO Compensation

Executive compensation at Omega Flex is composed of four elements: Base salary, an Incentive Bonus Plan, long-term compensation, and “other compensation”.

Mr. Hoben’s salary for 2023 was $510,648. It increased 3-4% per year like clockwork, and I would expect more of the same for Mr. Rivest.

The Incentive Bonus Plan is described as follows on p. 19 of the 2023 Proxy Statement: “Effective January 2012, the committee adopted a performance measurement for the plan based on earnings before interest and taxes (“EBIT”) because the committee determined that EBIT represented the true measure of management performance of the Company’s continuing operations. For fiscal year 2022, the bonus pool earned by management was approximately $3.5 million, which decreased from the prior year as a result of a reduction in the rate applied to EBIT to calculate the bonus pool from 16.2% to 10.2% due to Mr. Albino no longer participating in the pool because of his May 31, 2022 retirement from the Company, and also due to lower EBIT year to year.”

There are some additional points that I think should be mentioned regarding the Incentive Bonus pool.

First is the rate applied to it. It was 10.2% last year and 16.2% every year between 2017 and 2022. There was and still is no explanation that I’ve come across as to how the Compensation Committee came up with this percentage or why they made the figure public in the 2017 Proxy Statement. There was no mention of the bonus percentage rate between 2012 and 2016.

Second, there was a bit of a discrepancy between the stated target rate of 16.2% of EBIT and the actual bonus pool listed in the Proxy Statement. A screencap of the discrepancies is shown below.

I used Operating Income as EBIT in this calculation and the data were taken from TIKR. The “Theoretical EBIT Bonus Pool” cells are equal to the listed operating income on TIKR multiplied by 16.2% except for 2022 where it is multiplied by 10.2% due to the deduction in the rate applied to the bonus pool as described above. The “Actual EBIT Bonus Pool” cells are the bonus amounts listed in the Proxy Statements.  The total discrepancy adds up to ~$4.5 million dollars which isn’t a ton, but it’s enough to raise an eyebrow. For full transparency, I could be missing something here or miscalculating EBIT in some way or differently than the Compensation Committee does. However, the discrepancy was enough to warrant a red flag🚩.

Mr. Hoben was entitled to a sizable chunk of the Incentive Bonus Pool. The typical amount was between 30% - 40%, but it skyrocketed to 58.9% in 2023. The Incentive Bonus Pool often made up 75% or more of his total compensation.

One last thing to mention about the incentive bonus plan is that the metric used for performance hasn’t always been EBIT. Pre-2008, the metric used for performance was a hurdle rate of 20% on capital employed in the business. This was a better incentive for shareholders and the business generally, but the Compensation Committee has stuck with EBIT as the performance standard ever since, except for 2009 and 2010, where net income was the performance benchmark.

Long-term compensation is the third element of executive compensation at Omega Flex. The CEO does not receive these awards, so I’ll be as brief as I can with them. This form of compensation is issued in the form of phantom stock. It is described as follows on p. 25 of the 2023 Proxy Statement, “The phantom stock plan was instituted in 2006. It is designed to function as the long term component of our compensation program. Under the plan, select numbers of the management team may receive units of phantom stock. The value of the phantom stock is tied to the value of our common stock. Phantom stock units granted prior to January 1, 2023 have a three year vesting schedule, with approximately equal amounts vesting each year (1/3-1/3-1/3). Phantom stock units granted after January 1, 2023 also have a three year vesting schedule, but with “cliff vesting” on the third anniversary of the grant date. After the phantom stock units have vested, the executive would receive the value of the phantom stock which would be equal to the then current full value of the Company’s common stock on the maturity date of the phantom stock units, which for existing grants is a year following the final vesting date. If the executive voluntarily leaves the Company or is terminated, then any unvested awards of phantom stock units are forfeited, with limited exceptions in the case of retirement.” Quoting the same page, “Awards to employees are at the discretion of the compensation committee and upon recommendation by the CEO.” Lastly, there is no set plan on when or how much phantom stock will be issued to each recipient.

“Other compensation” is the final element of CEO Compensation. It includes medical and health benefits along with a profit-sharing 401k plan. Per p. 20 of the 2023 Proxy Statement, “For the fiscal year ended December 31, 2022, the committee recommended and the board of directors voted in favor of a Company contribution of three percent (3%) of annual base salary for all eligible employees up to the maximum of $147,000 and in favor of a Company contribution of six percent (6%) of annual base salary for all eligible employees for amounts in excess of the maximum of $147,000 (as limited in accordance with the Employee Retirement Income Security Act).”

The most recent Executive Compensation Table is shown below. It was taken from p. 28 of the 2023 Proxy Statement.

Insider Ownership

Per the 2023 Proxy Statement, 67.1% of Omega Flex’s stock was owned by insiders. That may be the highest amount of insider ownership I’ve seen at a publicly traded U.S. business.

5,677,678 shares (56.2% of all the outstanding stock) are owned or controlled by Stewart Reed who is the son of former CEO and Chairman John Reed. Per the same proxy statement, Mr. Reed’s stock ownership… “includes 905,559 shares of common stock owned by various family trusts, of which Mr. Reed is a trustee but for which he disclaims beneficial ownership, and includes 2,673,899 shares of common stock held by the Estate of John E. Reed for which Mr. Stewart Reed is acting as an executor but for which he disclaims beneficial ownership.” Mr. Reed is also the Vice Chairman of the Board of Directors.

11.3% of the stock is owned by Kayne Anderson Rudnick Investment Management, LLC and 5.7% of the stock is owned by Conestoga Capital Advisors LLC.

What Does Omega Flex Do?

Reading the introduction about a business that manufactures flexible metal hoses might make your eyes glaze over and I can’t blame you. It doesn’t exactly jump off the page, nor is it as exciting as reading about how NVIDIA will somehow take over the world, but learning about what Omega Flex does won’t take long.

I’ll start off by describing what a flexible metal hose is. They’re also known as corrugated stainless steel tubing (CSST). A picture of pieces of various kinds are shown below and a link to the General Product and Engineering Design Catalog where it was taken from can be found here.

There’s nothing fancy going on here. What you see is what you get. The business doesn’t call their products “solutions” and management doesn’t wax poetic about “changing the world” or using AI. The hoses and their attachments move liquids or gases under various conditions from Point A to Point B. Per p. 4 of the 2022 10-K, “The Company manufactures flexible metal hose at its facilities in Exton, Pennsylvania, and Houston, Texas in the United States (U.S.), and in Banbury, Oxfordshire in the United Kingdom (U.K.). The Company 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.” Per the 2022 10-K, Omega Flex sells its products through independent sales representatives, distributors, OEM, and direct sales. The business claims to have more than 10,000 customers on record.

What Is Unique About Omega Flex?

Advantages of Metal Hoses

A key differentiating factor of Omega Flex’s products is that they’re flexible. They are not rigid pieces of black iron pipe. Pp. 6 – 7 of the 2022 10-K provide further insight in to the advantages of flexible hoses where it states, “Within the residential construction industry, the flexible gas piping products that we offer, and similar products offered by our competitors have sought to overcome the use of black iron pipe that has traditionally been used by the construction industry in the U.S. and Canada for the piping of fuel gases within a building. Prior to the introduction of the first CSST system in 1989, nearly all construction in the U.S. and Canada used traditional black iron pipe for gas piping. However, the advantages of CSST in areas subject to high incidence and likelihood of seismic events had been first demonstrated in Japan. In seismic testing, the CSST was shown to withstand the stresses on a piping system created by the shifting and movement of an earthquake better than rigid pipe. The advantages of CSST over the traditional black iron pipe also include lower overall installation costs because it can be installed in long uninterrupted lines within the building.

The flexibility of the tube allows it to be bent by hand without any tools when a change in direction in the line is required. In contrast, black iron pipe requires that each bend in the pipe have a separate fitting attached. This requires the installer to thread the ends of the black iron pipe, apply an adhesive to the threads, and then screw on the fitting, all of which is labor intensive and costly, including testing and rework if the work is not done properly. As a result of these advantages, the Company estimates that CSST now commands over one-half of the market for fuel gas piping in new and remodeled residential construction in the U.S., and the use of rigid iron pipe, and to a lesser degree copper tubing, accounts for the remainder of the market. The Company plans to continue its growth trend by demonstrating its advantages against other technologies, in both the residential and commercial markets, in both the U.S. and overseas in geographic areas that have access to natural gas distribution systems.”

A second differentiating factor is that Omega Flex’s products can be installed in continuous runs of hundreds of feet. As mentioned on p. 7 of the 2022 10-K when discussing its DoubleTrac® product, “Similar to our flexible gas piping, DoubleTrac® provides advantages over older rigid pipe technologies. DoubleTrac® is made and can be installed in long continuous runs, eliminating the need for manually assembling rigid pipe junctions at the end of a pipe or at a turn in direction.” Do note that this feature applies to all of their metal hose products and not just DoubleTrac®.

If you’d like to learn more about the differences between black iron pipe and CSST then please watch the following video from the PEX Universe YouTube Channel:

Additional benefits are described on p. 9 of the 2022 10-K where it states, “Flexible metal hose is used in a wide variety of industrial and processing applications where the characteristics of the flexible hose in terms of its flexibility, and its ability to absorb vibration and thermal expansion and contraction, have substantial benefits over rigid piping. For example, in certain pharmaceutical processing applications, the process of developing the specific pharmaceutical may require rapid freezing of various compounds through the use of liquefied gases, such as liquefied nitrogen, helium or hydrofluorocarbons. The use of flexible metal tubing is particularly appropriate in these types of applications. Flexible metal hose can accommodate the thermal expansion caused by the liquefied gases carried through the hose, and the total length of the hose will not significantly vary. In contrast, fixed or rigid metal pipe would expand and contract along its length as the liquid gases passed through it, causing stresses on the pipe junctions that would over time cause fatigue and failure. Alternatively, within certain industrial or commercial applications using steam, either as a heat source or in the industrial process itself, the pumps used to transfer the liquid or steam within the system are subject to varying degrees of vibration. Additionally, flexible metal hoses can also be used as connections between the pump and the intake of the fluids being transferred to eliminate the vibration effects of the pumps on the piping transfer system. All of these areas provide opportunities for the flexible metal hose arena, and thus the Company continues to participate in these markets, as it seeks new innovative solutions which will generate additional revenue streams for the future.”

Unique Manufacturing Process

Management believes the business possesses a unique production method. Per p. 9 of the 2022 10-K again, “Through continuous improvement over the years, we have developed and fine-tuned the process so that we can manufacture annular flexible metal hose on a high speed, continuous process. We believe that our own rotary process for manufacturing annular corrugated metal hose is the most cost efficient method in the industry, and that our rotary process provides us with a significant advantage in many of the industries in which we participate. As a result, we can provide our product on a demand basis. Over the years, the Company has had great success in achieving on-time delivery performance to the scheduled ship date. The quick inventory turnover reduces our costs for in-process inventory, and further contributes to our gross profit levels. We have also improved our productivity on a historical basis.”

Differentiated Products

The business offers several different product lines which are described below.

TracPipe® - This was Omega Flex’s flagship product before the introduction of CounterStrike® which is described next. Per the TracPipe® literature linked here, this product is used to deliver natural gas and propane in residential houses and commercial buildings. In addition to the general advantages of metal hose listed above, this product is described as being “non-annealed” which leads to “superior crush resistance” combined with “single robust protective jacket” that is fitted over the hose.

CounterStrike® - Per the CounterStrike literature linked here, this is an upgraded version of TracPipe® and was developed in 2004. Per p. 7 of the 2022 10-K, “CounterStrike® is designed to be more resistant to damage from transient electrical arcing. In a lightning strike, the electrical energy of the lightning can energize all metal systems and components in a building. This electrical energy, in attempting to reach ground, may arc between metal systems that have different electrical resistance, and arcing can cause damage to the metal systems. In standard CSST systems, an electrical bond between the CSST and the building’s grounding electrode would address this issue, but lightning is an extremely powerful and unpredictable force. CounterStrike® CSST is designed to be electrically conductive and therefore disperse the energy of any electrical charge over the entire surface of the CounterStrike® line. In 2007, the Company introduced a new version of CounterStrike® CSST that was tested to be even more resistant to damage from electrical arcing than the original version, and substantially more effective than standard CSST products. As a result of its robust performance, the new version of CounterStrike® has been widely accepted in the market, and thus during 2011, the Company made the decision to sell exclusively CounterStrike® within the U.S.”

DoubleTrac® - Per the 2022 10-K, this is a double containment piping product that was introduced in 2008. It has earned several industry certifications for to “safely contain and convey liquid fuels”. It is one of the few piping products approved for both aboveground and belowground installations and is claimed to be an “essentially zero permeation system”. Its use has expanded from transferring fuel from the underground storage tank to the pump at gas stations to refueling at marinas, fuel lines for back-up generators, and moving corrosive liquids at waste treatment plants. Its product literature can be found here.

DEF-Trac® - Per p. 8 of the 2022 10-K, “DEF-Trac®, a complementary product which is very similar to DoubleTrac®, was brought to the marketplace in 2011. DEF-Trac® piping is specifically engineered to handle the demanding requirements for diesel emissions fluid (DEF). Federal regulations require all diesel engines to use DEF to reduce the particulate contaminants from the diesel combustion process. However, DEF is highly corrosive and cannot be pre-mixed with diesel fuel. This requires that new diesel trucks and automobiles must have separate tanks built into the vehicle so that the diesel emissions fluid can be injected into the catalytic converter after the point of combustion. Similarly, a large portion of fueling stations carrying diesel fuel are now also selling DEF through a separate dispenser. In addition to being highly corrosive, DEF also has a high freezing temperature, requiring a heat trace in the piping in applications in northern areas of the U.S. DEF-Trac® flexible piping is uniquely suited to handle all of these challenges, as the stainless steel inner core is corrosion resistant, and DEF-Trac® also comes with options for heat trace that is extruded directly into the wall of the product.”

AutoSnap® - This line of products are fittings specifically designed and engineered to be installed on TracPipe® and CounterStrike® hoses. Per the most recent product literature that I could find (linked here), these fittings are “…the only CSST fittings that do not require any disassembly or reassembly of the fitting to the TracPipe®CounterStrike® CSST. This greatly reduces installation difficulty and time as there are no small loose gaskets, O-rings, or retainer rings to contend with in a dark and/or cold work place environment!”

MediTrac® - This product line was brought to market in 2019 and is described as the “… world’s first corrugated medical gas tubing” product. The gases it delivers include oxygen, nitrogen, nitrous oxide, carbon dioxide, and medical vacuum. Per the 2022 10-K, it is made from a copper alloy with a fire-retardant jacket. The business cites a recent case study in the 2022 10-K that showed MediTrac® increases installation efficiency by a factor of five. Its product literature can be found here.

Market Position

Per pp. 9 – 10 of the 2022 10-K, “There are approximately 10 manufacturers of flexible metal hose in the U.S., and approximately that number in Europe and Asia. The U.S. manufacturers include Titeflex Corporation, Ward Manufacturing, Microflex Inc., Hose Master, Pennflex, and several smaller privately held companies. No one manufacturer, as a general rule, participates in more than two of the major market categories, automotive, aerospace, residential and commercial construction, and general industrial, with most concentrating on just one. We estimate that we are at or near the top position of the two major categories in which we participate regarding market share. In the flexible gas piping market, the U.S. market is currently concentrated in the residential housing market.” Just to clarify, the two major categories that Omega Flex participates in are the residential/commercial construction and general industrial markets.

Continued on the same pages, “As discussed elsewhere, black iron pipe or copper tubing was historically used by all builders of commercial and residential buildings until the advent of flexible gas piping and changes in the relevant building codes. Since that time, flexible gas piping has taken an increasing share of the total amount of fuel gas piping used in construction.

Due to the number of applications in which flexible metal hose may be used, and the number of companies engaged in the manufacture and sale of flexible metal hose, the general industrial market is very fragmented, and we estimate that no one company has a predominant market share of the business over other competitors. In the market for double containment piping, we compete primarily against rigid pipe systems that are more costly to install than DoubleTrac® double containment piping. For medical tubing applications, the main competitor is medical grade (Type K or Type L) rigid copper pipe. MediTrac® is the only corrugated medical tubing in the U.S. that is approved to the stringent requirements of UL 1365. The general industrial markets within Europe are very mature and tend to offer opportunities that are interesting to us in niche markets or during periods in which a weak dollar increases the demand for our products on a competitive basis. Such has been the case for several years and has created new relationships for us. Currently, we are not heavily engaged in the manufacture of flexible metal hose for the aerospace or automotive markets, but we continue to review opportunities in all markets for our products to determine appropriate applications that will provide growth potential and high margins.”

Valuation

******* All the data below were taken from TIKR. *******

Revenue

Omega Flex’s revenue growth is shown in the screencaps below.

The business has CAGR’d its revenue by 3.67% per year since going public which is underwhelming. The business trades at 5.58x 2022 sales given its current market cap of ~$700,000,000.

Revenues ticked down in 2022 due to what management claimed were a “decrease in unit volume”. Per p. 30 of the Q3 2023 10-Q, revenues were down 12% to $83,318,000 through the first three quarters of 2023 from $94,670,000 through the same period in 2022. Management claimed that, “The decrease in sales is mainly due to lower sales unit volumes as a result of the overall market being suppressed because of, among other factors, a decline in housing starts.” Not exactly encouraging stuff.

Management does not break down revenues by product category in public filings. It would’ve been nice to see how much each product line contributes to the overall revenue of the business.

Management does routinely mention that 90%+ of sales come from North America. The second biggest market is the U.K. with roughly 5% - 7% of revenues and the rest of the world makes up the remaining few percent of sales.

Capital Structure

Omega Flex’s balance sheet is shown in the screencaps below. I apologize for the small font size, but it’s the best I could do as far as getting all the data from 2005 – 2022.

The asset side of the balance sheet is pretty clean. The only thing I’ll mention is that the cash balance does not build up significantly due to the payment of dividends. Let’s move on to the liabilities and equity portions of the balance sheet.

Both the liabilities and equity portions of the balance sheet are clean too. The business has no debt outside of its capital lease obligations and minimal pension/retirement benefits. Retained earnings have fluctuated over the last several years, but, like the cash balance, this is affected by the payment of dividends.

One additional item to mention is that the business has a $15,000,000 line of credit with Santander Bank. It had no outstanding borrowings as of year-end 2022 or as of Q3 2023.

Free Cash Flow

The screencaps below display Omega Flex’s “real free cash flow” (RFCF) between 2005 – 2022.

Omega Flex’s growth in “real free cash flow” leaves a lot to be desired. It CAGR’d at a measly 2.31% per year between 2005 – 2022. The business currently trades at ~50x 2022 RFCF given its current market cap of ~$700,000,000. That is an eyewatering multiple for any business and especially so for one that is compounding its free cash flow by less than 3% a year.

Returns on Invested Capital (ROIC)

My calculations for Omega Flex’s returns on invested capital are shown in the screen caps below.

The business has achieved world class returns on capital since going public. A quick look at them will make any investor salivate.

NOPAT ROIC and Net Income ROIC differed materially in 2006 and 2012 due to lawsuits the business was dealing with at the time. It had to payout ~$10.5 million in legal settlements and costs in 2006 and was able to recover legal fees it had paid out via an insurer in 2012. I will come back to the lawsuits in the Risks section of this writeup.

Returns on Incremental Invested Capital (ROIIC)

My calculations for Omega Flex’s returns on incremental invested capital are shown in the screencap below.

Per my calculations, the business has been compounding its value between 6% – 7% per year since going public in 2005. Looking only at its ROIC would’ve fooled you as it did me. I would like to see a business compounding its value at a minimum of 10% – 15% per year and Omega Flex is a long way from that.

The image below shows Omega Flex’s stock price performance since it IPO’d in 2005.

Its stock price has CAGR’d at ~8% a year which isn’t too far off from my calculations. It does indicate a bit of overvaluation, but I don’t think it’s egregious. The market is roughly right at judging the performance of this business.

Risks

Omega Flex has dealt with a lot of litigation over the years. Most of the lawsuits were related to lightning damage of their metal hose products. Those that I came across in public filings are listed below:

2006 - ~$10.5 million settlement for a class action lawsuit. An additional $516k in costs were incurred for this settlement in 2007. A link to the 8-K regarding the settlement can be found here: https://www.sec.gov/Archives/edgar/data/1317945/000131794506000035/form8-k90606csa.htm

2013 – Paid £800,000 in March of 2013 to settle a lawsuit. Per the 2012 10-K, its UK subsidiary Omega Flex Limited was “sued regarding the installation of TracPipe product in an apartment complex in England, the performance of the product, and the involvement of OFL in subsequent remedial efforts to address perceived deficiencies in the system.”

2013 – Per the “Legal Proceedings” section of the 2013 10-K, “In 2013, the Company won two of the Claims at two separate trials, both of which were held in U.S. District Court; one in St. Louis, Missouri and the other in Bridgeport, Connecticut. In both cases, the jury unanimously found that the Company was not negligent in designing its TracPipe® product, and that the TracPipe® product was not defective or unreasonably dangerous.”

2014 – Per the Legal Proceedings” section again, “Finally, two putative class action cases have been filed against the Company; one in U.S. District Court for the Middle District of Florida titled Hall v. Omega Flex, Inc. and one in U.S. District Court for the Southern District of Ohio titled Schoelwer v. Omega Flex, Inc. In both cases, the lead plaintiffs claimed that they are exposed to an increased likelihood of harm if one of the plaintiffs’ houses that contain TracPipe CSST is struck by lightning, that could damage the CSST causing a release of fuel gas in the house and causing a fire. However, none of the lead plaintiffs have suffered any actual harm. In January 2014, the judge in the Hall case granted the Company’s motion to dismiss all of the plaintiff’s claims due primarily to a lack of jurisdiction because there is no actual case or controversy posed by these claims. The plaintiff in Schoelwer voluntarily dismissed her claims in January 2014.”

2014 – Per the “Legal Proceedings” section, “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 has 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.” This was a major case in Pennsylvania’s state product liability law. A summary of the case can be found here: https://campbelltriallawyers.com/result/tincher-v-omega-flex-inc/ . The article has a link to the full opinion of the Pennsylvania Supreme Court on the matter.

2016 – Per the “Legal Proceedings” section, “Finally, a putative class action case had been filed against the Company and other parties in U.S. District Court in the Western District of Missouri, titled George v. Powercet Corporation, et. al.; however, that case was dismissed by the court in December 2016.”

2017 – Per the “Legal Proceedings” section, “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. However, the trial court denied the company’s motion for a new trial and the company appealed the trial court decision. As a result of this new appeal, the Company was required during the second quarter of 2016 to post approximately $1,600,000 as security to proceed with the current appeal, and that collateral security is included in Other Long Term Assets as of December 31, 2017. After an extended appellate review, on February 16, 2018 the appeals court ruled in favor of the company, and the prior strict liability verdict for the plaintiff has been vacated and the case remanded for a new trial.” This case was closed and settled on August 7, 2018 per the 2018 10-K.

2017 – Per the “Legal Proceedings” section, “In March 2017, a putative class action case was re-filed against the Company and other parties in Missouri state court after a predecessor case was dismissed without prejudice by the federal court. The Company is currently vigorously defending the case.”

2019 – Per the “General and Administrative Expenses” subsection on p. 23 of the 2019 10-K, “Legal and product liability defense costs increased $4,659,000, associated primarily with one pending class action case, which the Company continues to vigorously defend itself against.”

2020 – Per the “Contingencies” subsection in Note 10 of the 2020 10-K, “In September 2017, a putative class action case was filed against the Company and other parties in Missouri state court. The Company successfully removed the case to federal court, and in August 2020, the court granted the defendants’ joint summary judgement motion, and dismissed the case. The parties have fully resolved the plaintiffs appeal of that decision, and the case has been dismissed by the plaintiffs, thus concluding the matter.” Per the G&A Expense subsection on p. 24, “Legal and product liability defense costs decreased $5,158,000, associated primarily with one class action case which was dismissed during 2020, as explained in detail in Note 10, Commitments and Contingencies, of the Consolidated Financial Statements to this report.”

2021 – Per the “Contingencies” subsection of Note 10 of 2021 10-K, “The Company was made aware of a potential legal liability regarding a legal dispute in the U.K., in which the Company’s subsidiary, Omega Flex Limited (“OFL”), was the claimant. After withdrawing the claim, the court determined that OFL was responsible for the defendant’s costs (including a portion of its attorneys’ fees). The Company reached an initial agreement during the fourth quarter of 2020 and made a payment of £320,000 accordingly. An additional payment of £110,000 was made on January 5, 2022, which was recorded as an accrued liability as of December 31, 2021, and represented the remaining amount of the liability as part of the final arrangement. This matter is now closed.”

2022 – Per p. 24 of the 2022 10-K,” Other Liabilities were $7,530,000 and $4,864,000 as of December 31, 2022 and December 31, 2021, respectively. The increase of $2,666,000 or 54.8% mainly relates to accruals for legal and product liability matters associated mainly with two cases, one which was resolved through settlement and the other is pending which the Company continues to vigorously defend.” There was no further information provided about these cases.

2023 – Per p. 28 of the Q3 2023 10-Q, “Other Liabilities were $3,910,000 and $7,530,000 as of September 30, 2023 and December 31, 2022, respectively. The decrease of $3,620,000 or 48.1% mainly relates to the payment of an accrual for legal and product liability matters associated with two cases provided for in the previous year, which were resolved through settlement.”

Almost every business will face a lawsuit of some kind, but the amount that Omega Flex has had to deal with just feels like a lot. With that being said, I don’t know what the base rates are for lawsuits against businesses that manufacture and install exposed metal products above ground in lightning prone areas of the country.  On the other hand, public filings state that the pace of claims has decreased over the last several years.

I mentioned that management does not break out the revenue streams from each product line and that’s due to its reliance on the sale of TracPipe® and CounterStrike® and the associated fittings for those products. Per p. 13 in the “Risk Factors” section of the 2022 10-K, “Most of the Company’s sales are derived from the sale of TracPipe® and CounterStrike® flexible gas piping systems, including Autoflare® and AutoSnap® fittings and a variety of accessories. Sales of our flexible metal hose for other applications represent a small portion of our overall sales and income. Any event or circumstance that adversely affects our TracPipe® or CounterStrike® flexible gas piping could have a greater impact on our business and financial results than if our business were more evenly distributed across several different product lines. The effects of such an adverse event or circumstance would be magnified in terms of our Company as a whole as compared to one or more competitors whose product lines may be more diversified, or who are not as reliant on the sales generated by their respective flexible gas piping products.”

Another risk mentioned is the movement away from the use of fossil fuels. Given Omega Flex’s reliance on TracPipe® and CounterStrike®, which transfer both natural gas and propane, a sudden move to renewables would be terrible for its long-term prospects.

The final risk that I’ll mention goes back to the Market Position subsection above. In the section it states that there are approximately ten manufacturers of CSST in the U.S. and approximately that many in Europe and Asia. It also mentions some of Omega Flex’s competitors. The potential issue here is that these statistics have been given since the business went public in 2005. This tells me that the industry is at or approaching its limit in terms of size and doesn’t grow by much every year, or that there isn’t a lot of competition between CSST manufacturers. It could possibly be a combination of both. One could make the case that this industry is primed for a roll-up or some kind of acquisition strategy.

Tailwinds

There continues to be an undersupply of millions of houses in the United States. I know that management referenced a downturn in housing starts as the reason for the decrease in revenues through Q3 2023, but they must be built over the next several years. This bodes well for continued increases in sales of its flagship CounterStrike® product line.

There was a limited, but positive update about MediTrac®. Per the Chairman’s Letter that is included in the 2022 10-K filing, “In the United States and internationally, we continue to make gains in sales of MediTrac® flexible medical gas piping, our newest product. With medical facility installations in 46 states and 5 countries, we believe we have moved beyond the proof of concept phase with this cutting-edge technology. We continue to expect sales to grow steadily over time as the obvious benefits of the MediTrac® system are realized by a critical mass of customers. Well protected by issued and pending patents, proprietary design features, and unique Omega Flex® technology, we continue to expand our MediTrac® salesforce.”

Conclusion

Is Omega Flex a great business? I think it’s a pretty good one as evidenced by its consistent high returns on capital and its robust balance sheet. Do I think it’s a compounder? Nope. The incremental returns on capital haven’t been nearly as good as one would think by looking at the year-by-year returns on capital. The business just doesn’t grow revenues by much either. This lack of growth combined with the almost constant litigation, reliance on one product line, and lack of dynamism in the form of growth and competition in the CSST market indicates that I should pass on this one. I do think Omega Flex has a lot of potential, but it just does not meet my standards at this time.

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*** Remember that this isn’t investing advice. Consult a trusted financial or investment advisor before making any kind of investment decision. ***

Disclosure: I do not own shares of Omega Flex.