OMEGA FLEX, INC. – 10-K – MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Edgar Online, Inc.

This report contains forward-looking statements, which are subject to inherent uncertainties. These uncertainties include, but are not limited to, variations in weather, changes in the regulatory environment, customer preferences, general economic conditions, increased competition, the outcome of outstanding litigation, and future developments affecting environmental matters. All of these are difficult to predict, and many are beyond the ability of the Company to control.

Certain statements in this Annual Report on Form 10-K that are not historical facts, but rather reflect the Company's current expectations concerning future results and events, constitute forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. The words "believes", "expects", "intends", "plans", "anticipates", "hopes", "likely", "will", and similar expressions identify such forward-looking statements. Such forward-looking statements involve known and unknown risks, uncertainties and other important factors that could cause the actual results, performance or achievements of the Company, or industry results, to differ materially from future results, performance or achievements expressed or implied by such forward-looking statements.

Readers are cautioned not to place undue reliance on these forward-looking statements, which reflect management's view only as of the date of this Form 10-K. The Company undertakes no obligation to update the result of any revisions to these forward-looking statements which may be made to reflect events or circumstances after the date hereof or to reflect the occurrence of unanticipated events, conditions or circumstances.

                                         -11-                                        OVERVIEW  

The Company is a leading manufacturer of flexible metal hose, and is currently engaged in a number of different markets, including construction, manufacturing, transportation, petrochemical, pharmaceutical and other industries.

The Company's business is managed as a single operating segment that consists of the manufacture and sale of flexible metal hose and accessories. The Company's products are concentrated in residential and commercial construction, and general industrial markets. The Company's primary product, flexible gas piping, is used for gas piping within residential and commercial buildings. Through its flexibility and ease of use with patented fittings distributed under the trademark AutoFlare®, TracPipe® and TracPipe® CounterStrike® flexible gas piping allows users to substantially cut the time required to install gas piping, as compared to traditional methods. Most of the Company's products are manufactured at the Company's Exton, Pennsylvania facility with a minor amount of manufacturing performed in the United Kingdom. A majority of the Company's sales across all industries are generated through independent outside sales organizations such as sales representatives, wholesalers and distributors, or a combination of both. The Company has a broad distribution network in North America and to a lesser extent in other global markets.

                           CHANGES IN FINANCIAL CONDITION  

Cash and cash equivalents were $3,476,000 at December 31, 2011, rising $1,267,000 compared to the cash balance of $2,209,000 at December 31, 2010. The increase was mostly a factor of strong sales during the year, which produced $4,647,000 of net income and the residual cash. A reduction in cash was however felt in connection with insurance premium payments of $1,352,000 for long-term coverage. There was also an increase in accounts receivable of $1,738,000 from last year as noted below, which reflects amounts that are still to be collected and therefore not yet recognized in cash.

Accounts Receivable at December 31, 2011 was $9,052,000, and was $7,314,000 at December 31, 2010, which represents an increase of $1,738,000. The majority of this increase is consistent with sales growth in the latter half of the final quarter compared to the prior year. The Company is not aware of any significant collectability issues, and notes that accounts receivable aging over 90 days have diminished between those periods.

Other Current Assets and Other Long Term Assets have increased by $596,000 and $1,042,000, respectively. Regarding Current Assets, the Company has prepaid tax payments of $224,000 at December 31, 2011, versus a $215,000 liability that existed at December 31, 2010, which accounts for a majority of that change. For Other Long Term Assets, as noted above in the Cash discussion, the Company has pre-paid for long-term insurance coverage, which is a new strategy to reduce the overall expense to the Company.

Accrued Commissions and Sales Incentives decreased $312,000, starting at $2,410,000 at December 31, 2010, and decreasing to $2,098,000 at December 31, 2011. In general, the promotional incentive program obligations in 2011 have decreased in comparison to the prior year. The products with the most significant incentive programs have not recognized sales increases to the magnitude of those demonstrated by the Company in total, and therefore, customers are not hitting sales growth tiers equal to the level experienced in 2010.

Other Liabilities were $2,143,000 at December 31, 2011, compared to $1,769,000 at December 31, 2010. The $374,000 increase is primarily associated with increases in general legal and product liability costs. The Company is vigorously defending numerous claims of which it is a defendant, and is also the plaintiff in a case to recover insurance damages. These cases are more fully disclosed in the Commitments and Contingencies Note 6, as well as in Part II, Item I, under the caption "Legal Proceedings".

                                               -12-                                 RESULTS OF OPERATIONS   

Three-months ended December 31, 2011 vs. December 31, 2010

The Company reported comparative results from continuing operations for the three-month period ended December 31, 2011 and 2010 as follows:

                       Three-months ended December 31,                             (in thousands)                      2011      2011      2010     2010                    ($000)              ($000) Net Sales        $           100.0%   $         100.0%                   15,618              12,821 Gross Profit     $            51.2%   $          51.7%                    7,990               6,623 Operating Profit $            14.6%   $          21.3%                    2,279               2,734   

The Company's sales increased $2,797,000 (21.8%) from $12,821,000 in the three-month period ended December 31, 2010 to $15,618,000 in the three-month period December 31, 2011.

The Company recently transitioned all of its standard CSST sales in the United States to TracPipe® CounterStrike®, an enhanced flexible gas piping product that provides an extra measure of safety against the unlikely event of lightning.

Sales of TracPipe® related products, especially TracPipe® CounterStrike®, have grown steadily over last year. Additionally, the Company has experienced an expansion of sales associated with its highly engineered assembled product capabilities, and more recent offerings such as DoubleTrac®. The Company has also seen improvements in revenue overseas mostly in the United Kingdom.

Altogether, revenues for the fourth quarter exemplify a growing appreciation for the benefits and unique features of the Company's products. Overall, unit volume for the quarter was up approximately 14% compared to the prior year quarter. Sales were further enhanced by increases to the selling prices of numerous products, which were required to combat the rising price of the Company's core raw materials. A reduction in marketing incentives during the quarter also helped to sustain a higher level of net sales.

The Company's gross profits have increased $1,367,000 from last year. Gross profits also held close as a percent of sales, being 51.7% for the three-month period ended December 31, 2010, and 51.2% for the same period in 2011. There was a rise in cost for numerous commodity type metals, such as nickel, which adversely impacts the price of stainless steel, a key raw material used in the manufacturing of many of the Company's flexible metal hoses, and copper, a key component of brass, which is used in the Company's patented fittings. However, these additional costs were largely offset by selling price increases initiated by the Company, and various manufacturing efficiencies.

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 $2,355,000 and $3,049,000 for the three months ended December 31, 2010 and 2011, respectively, increasing $694,000. The most significant increase was noted in advertising, which went up $230,000, largely focused on proprietary products such as TracPipe® CounterStike®. There was also an increase during the quarter in commissions and freight largely the result of higher sales. Sales expense as a percentage of sales increased from 18.4% to 19.5% for the three-months ended December 31, 2010 and 2011, respectively.

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 services.

General and administrative expenses were $918,000 and $2,048,000 for the three months ended December 31, 2010 and 2011, respectively. The $1,130,000 increase between quarters was primarily associated with two items. During the first three quarters of 2010, incentive compensation was being accrued at a higher rate than typical, and was then decreased in the fourth quarter of 2010 to bring it into alignment with historical payouts. Incentive compensation relative to the fourth quarter of 2011 was accrued at a more normal rate, and therefore did not require any realignment. The change between years relative to incentive compensation in the fourth quarter was $761,000. Additionally, the combination of legal and product liability costs also increased $335,000. As a percentage of sales, general and administrative expenses increased from 7.2% for the three months ended December 31, 2010 to 13.1% for the three months ended December 31, 2011.

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Engineering Expense. Engineering expenses consist of development expenses associated with the development of new products and enhancements to existing products, and manufacturing process improvements. Engineering expenses were almost identical to the prior year, being $616,000 and $614,000 for the three months ended December 31, 2010 and 2011, respectively. As a percent of sales, engineering expenses were 4.8% and 3.9% for the last three months of 2010 and 2011, respectively.

Operating Profits. Reflecting all of the factors mentioned above, Operating Profits decreased $455,000 (16.6%), from a profit of $2,734,000 in the three-month period ended December 31, 2010, to a profit of $2,279,000 in the three-month period ended December 31, 2011.

Interest (Expense) Income-Net. Interest income was nominal for the fourth quarter of 2010 and 2011, and there was also very little change between the two periods.

Other (Expense) Income-Net. This component primarily consists of foreign currency exchange gains (losses) on transactions.

Income Tax Expense. The Company's effective tax rate in 2011 is lower than the 2010 rate due to the expiration of the statute of limitations for assessment related to the Company's filings in earlier years, which lowered the tax expense by $178,000 for the three months ended December 31, 2011.

Twelve months ended December 31, 2011 vs. December 31, 2010

The Company reported comparative results from continuing operations for the twelve-month period ended December 31, 2011 and 2010 as follows:

                       Twelve-months ended December 31,                              (in thousands)                      2011       2011      2010     2010                    ($000)               ($000) Net Sales        $            100.0%   $         100.0%                   54,193               46,875 Gross Profit     $             51.1%   $          51.8%                   27,717               24,302 Operating Profit $             12.4%   $          14.4%                    6,709                6,748    

The Company's sales increased $7,318,000 (15.6%) from $46,875,000 in the twelve-month period ended December 31, 2010 to $54,193,000 in the twelve-month period December 31, 2011.

Revenue for the twelve-months ended December 31, 2011 reflects the market's support of the Company's proprietary products and conviction to innovation and safety, as indicated by the strong sales of TracPipe® CounterStrike® over the prior year. TracPipe® CounterStrike® is the only CSST product on the market that has been listed by independent evaluation agencies for resistance to damage from lightning, seismic events (earthquakes), and flame/smoke spread. Additionally, the Company has noticed improvements in its international revenues mostly associated with its United Kingdom subsidiary, and from its highly engineered assembled products. Positive strides were further recognized by some of the Company's fledgling products, such as DoubleTrac®, which gained momentum due to its superior performance and ease of use. For the Company as a whole, unit sales volume for the current year increased approximately 9% compared to the prior year. There were also increases to the selling prices of numerous products, which were required to overcome the rising price of the Company's core raw materials. A reduction in marketing incentives during the year also helped to increase net sales.

The Company's gross profits increased $3,415,000 (14.1%) over the prior year.

As a percent of sales, gross profits were 51.8% and 51.1% for the twelve-month periods ended December 31, 2010 and 2011, respectively. The slight deterioration in profits as a percent of sales is mostly due to cost increases in numerous commodity type metals including nickel and copper, which adversely impact the price of the Company's component material costs, such as stainless steel and brass fittings. Selling price increases were implemented as previously noted to help offset those additional materials costs, but were not sufficient enough to offset them in their entirety, due to the competiveness of the market place.

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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 expenses were $8,855,000 and $10,874,000 for the twelve-months ended December 31, 2010 and 2011, respectively, increasing $2,019,000. The Company increased its advertising spending by $591,000, with a focus on the many benefits of the Company's various proprietary products, such as TracPipe® CounterStrike®. Approximately $407,000 of the increase was attributable to staffing expenses, designed to expand sales markets and marketing expertise. To a lesser extent, expenses related to trade shows, travel, and consulting have also grown. Selling expenses as a percentage of sales increased from 18.9% to 20.1% between 2010 and 2011.

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 services. General and administrative expenses were $6,378,000 and $7,666,000 for the twelve-months ended December, 2010 and 2011, respectively, representing an increase of $1,288,000. The majority of the change was attributed to legal and product liability costs, which jointly experienced an increase of $1,032,000, with the details described in Note 10 of the financial statements. General and administrative expense costs, as a percentage of sales, have increased from 13.6% to 14.1%.

Engineering Expense. Engineering expenses consist of development expenses associated with the development of new products and enhancements to existing products, and manufacturing process improvements. Engineering expenses were $2,321,000 and $2,468,000 for the twelve months ended December 31, 2010 and 2011, respectively. The increase of $147,000 was largely related to an increase in developmental costs. Engineering expenses were 5.0% and 4.6% as a percent of sales for their respective years.

Operating Profits. Reflecting all of the factors mentioned above, Operating Profits were largely in line with the prior year, being $6,748,000 in the twelve-month period ended December 31, 2010, and $6,709,000 in the twelve-month period ended December 31, 2011. Operating profit as a percent of sales lost two points, at 14.4% and 12.4% in 2010 and 2011, respectively.

Interest (Expense) Income-Net. Interest income includes interest earned at 6% on the note receivable from Mestek, the Company's former parent, which was issued in June 2009, and paid back in October of 2010. Interest expense was recorded at 4% on the Sovereign line of credit loan balance outstanding, which was established in December 2010, and paid in full by the end of November 2011.

The net increase in income from last year was $33,000.

Other (Expense) Income-Net. Other Income-net primarily consists of foreign currency exchange gains (losses) on transactions. There was an increase to income from last year of $29,000.

Income Tax Expense. The Company's effective tax rate in 2011 is essentially the same as in 2010. The rate in 2011 does not differ materially from expected statutory rates.

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 of the Company's obligations under the indemnity agreements.

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 at age 65. 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

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associated with these agreements is $468,000 at December 31, 2011, of which $456,000 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, 2010 liability of $407,000, had $395,000 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 whole life insurance policies with respect to the two employees discussed above, and one other policy. The cash surrender value of such policies (included in Other Long Term Assets) amounts to $756,000 at December 31, 2011 and $706,000 at December 31, 2010.

Contingencies:

The Company's general liability insurance policies are subject to deductibles or retentions, ranging from $25,000 to $250,000 per claim, (depending on the terms of the policy and the applicable policy year) up to an aggregate amount. The Company is insured on a 'first dollar' basis for workers' compensation subject to statutory limits.

In the ordinary and normal conduct of our business, the Company is subject to periodic lawsuits, investigations and claims (collectively, the "Claims").

There has been an increase in the frequency of those Claims over the past two years relating to product liability. The Company does not believe that the Claims have legal merit, and is therefore vigorously defending against those Claims. The Company has in place commercial general liability insurance policies that cover the Claims, as noted above, including those alleging damages as a result of product defects. Litigation is subject to many uncertainties and management is unable to predict the outcome of the pending suits and claims. It is possible that the results of operations or liquidity and capital resources of the Company could be adversely affected by the ultimate outcome of the pending litigation or as a result of the costs of contesting such lawsuits, potentially materially. The Company is currently unable to estimate the ultimate liability, if any, that may result from the pending litigation and, accordingly, no provision for any liability (except for accrued legal costs for services and claim settlements previously rendered) has been made in the consolidated financial statements. Those liabilities were estimated to be $414,000 and $309,000, at December 31, 2011 and December 31, 2010, respectively, and are included in Other Liabilities.

Warranty Commitments:

Gas transmission products such as those made by the Company carry potentially serious personal injury risks in the event of failures in the field. As a result, the Company performs extensive internal testing and other quality control procedures. Historically, due to the extensive nature of these quality controls the Company has not had a meaningful warranty claim rate, and the warranty expense is de minimis. Accordingly, the Company does not maintain a warranty reserve beyond a nominal amount.

FUTURE IMPACT OF KNOWN TRENDS OR UNCERTAINTIES

The Company's operations are sensitive to a number of market and extrinsic factors, any one of which could materially adversely affect its results of operations in any given year:

Construction Activity-The Company is directly impacted by the level of single family and multi-family residential housing starts and, to a lesser extent, commercial construction starts. Historically low interest rates and easy availability of credit, contributed to construction activity in recent years.

There are a number of factors in the current economy that are reducing the demand for residential, commercial and institutional construction. These factors include:

·

the fairly recent crisis in the financial markets has reduced the availability of financing for new construction,

·

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

·

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

Recent initiatives by the federal government to assist individuals with their mortgages, may provide a lift to the housing industry; however, it is possible that once these programs are exhausted that a drop off in housing sector may occur. Additionally, recent news has portrayed a flawed foreclosure system, which may indicate that more foreclosures exist than previously predicted. This could potentially hinder the speed of new home construction. A significant reduction in residential construction activity may materially adversely affect the Company's revenues.

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

Weather Conditions-The Company's flagship TracPipe® and CounterStrike ®products are used in residential and commercial heating applications. As such, the demand for its products is impacted by weather as it affects the level of construction.

Furthermore, severe climatic changes, such as those suggested by the "global climate change" phenomenon, could over time adversely affect the demand for fossil fuel heating products and adversely affect the Company's results of operations and financial position.

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

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

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

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

Interest Rate Sensitivity - The Company currently has access to a $10,000,000 line of credit (LOC) with Sovereign Bank, NA (Sovereign), but has no draws on the line outstanding at December 31, 2011, and therefore has no related interest rate risk. However, if the Company borrows against the LOC, all amounts must be paid back with interest, using an interest rate range of LIBOR plus 1.75% to LIBOR plus 2.75% or Prime less 0.50% to Prime plus 0.50%, depending upon the Company's then existing financial ratios. The Company may elect to use either the LIBOR or PRIME rates. As of December 31, 2011, the actual rate to borrow was at 2.05%. Interest rates are also significant to the Company as a participant in the residential construction industry, since interest rates can be a determinant factor on whether or not borrowing funds for building will be affordable to our customers. (See Construction Activity, above). Currently, interest rates are at historic lows, but any dramatic change to interest rates could have a detrimental effect on the business.

Retention of Qualified Personnel - The Company does not operate with multiple levels of management. It is relatively "flat" organizationally, which does subject the Company to the risks associated with the loss of critical managers.

From time to time, there may be a shortage of skilled labor, which may make it more difficult and expensive for the Company to attract and retain qualified employees. The Company is dependent upon the relatively unique talents and managerial skills of a small number of key executives.

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CRITICAL ACCOUNTING POLICIES AND USE OF ESTIMATES

Financial Reporting Release No. 60, released by the Securities and Exchange Commission, requires all companies to include a discussion of critical accounting policies or methods used in the preparation of financial statements. Note 2 in the Notes to the Consolidated Financial Statements includes a summary of the significant accounting policies and methods used in the preparation of our Consolidated Financial Statements. The following is a brief discussion of the Company's more significant accounting policies.

The preparation of financial statements in conformity with generally accepted accounting principles (GAAP) requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities at the dates of the financial statements and the reported amounts of revenues and expenses during the reporting periods. The most significant estimates and assumptions relate to revenue recognition, inventory valuations, goodwill and intangible asset valuations, product liability costs, phantom stock and accounting for income taxes. Actual amounts could differ significantly from these estimates.

Our critical accounting policies and significant estimates and assumptions are described in more detail as follows:

Revenue Recognition

The Company's revenue recognition activities relate almost entirely to the manufacture and sale of flexible metal hose and pipe. Under GAAP, revenues are considered to have been earned when the Company has substantially accomplished what it must do to be entitled to the benefits represented by the revenues. The following criteria represent preconditions to the recognition of revenue:

·

Persuasive evidence of an arrangement for the sale of product or services must exist.

·

Delivery has occurred or services rendered.·

The sales price to the customer is fixed or determinable.

·

Collection is reasonably assured.

The Company generally recognizes revenue upon shipment in accordance with the above principles.

Gross sales are reduced for all consideration paid to customers for which no identifiable benefit is received by the Company. This includes promotional incentives, which includes various programs including year-end rebates and discounts. The amounts of certain incentives are known with reasonable certainty at the time of sale, while others are projected based upon the most reliable information available at the reporting date.

Commissions, for which the Company receives an identifiable benefit, are accounted for as a selling expense.

Accounts Receivable

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

Inventory

Inventories are valued at the lower of cost or market. Cost of inventories are 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 gross carrying value of inventory accordingly.

Goodwill and Intangible Assets

In accordance with Financial Accounting Standards Board (FASB) ASC Topic 350, with respect to Goodwill and Intangibles, the Company performs annual impairment tests using the market capitalization on the last day of the year to determine

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the fair value of the reporting unit and then compares that value to the carrying value. As of December 31, 2011 and December 31, 2010, the fair value of the reporting unit exceeded the carrying value, and therefore the Company concluded that goodwill was not impaired.

Product Liability Reserves

Product liability reserves represent the unpaid amounts under the Company's insurance policies with respect to Claims that have been resolved. The Company uses the most current available data to estimate claims. As explained more fully under Contingencies, for various product liability claims covered under the Company's general liability insurance policies, the Company must pay certain defense costs within its deductible or self-insured retention limits, ranging from $25,000 to $250,000 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.

Phantom Stock

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 requisite service period of each grant or award.

The FASB ASC Topic 718 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.

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 for December 31, 2011.

Accounting for Income Taxes

The Company accounts for federal tax liabilities in accordance with ASC Topic 740, Income Taxes. Under this method the Company recorded 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. No valuation allowance was deemed necessary at December 31, 2010 or at December 31, 2011.

Also, in accordance with FASB ASC Topic 740, the Company reserved for uncertainties in tax positions of $135,000 at December 31, 2011, and $276,000 at December 31, 2010. These reserves are reviewed each quarter.

LIQUIDITY AND CAPITAL RESOURCES

Twelve Months ended December 31, 2011

The Company's cash balance at December 31, 2011 was $3,476,000 compared to $2,209,000 at December 31, 2010, which represents an increase of $1,267,000 between the periods. The change is attributable to various components, as described below.

  Operating Activities  

Cash provided by operating activities was $3,338,000 lower in 2011 than in 2010, being $1,422,000 and $4,760,000, respectively.

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Cash related to accounts receivable is unfavorable by $962,000 compared to last year. Sales for the final two months of 2011 were substantially stronger than in the same period of 2010. The collection of a majority of that cash however had yet to be realized. The overall disparity in cash is considered to be timing related and is expected to flow through in the coming months.

There has been no discernible deterioration to the Company's customer base or customer liquidity, as it is tracked on a regular basis. Also, accounts over 90 days old have diminished from 4% of the accounts receivable balance at December 31, 2010, to only 2.4% at the end of 2011.

Inventory purchases have increased $579,000 from last year. The Company has expanded its warehousing through the use of its sales agencies in various strategic locations to allow for the expansion of business and superior delivery time. The Company has also decided to stock certain additional merchandise where demand is growing and a quick turnaround is required to fulfill sales.

Cash has also been used at a higher level in Other Assets. A change of $1,123,000 compared to last year is primarily related to prepaying for a 5-Year product liability insurance coverage during 2011. In the past the Company typically only had premiums related to a twelve or thirteen month period.

Accrued commissions and sales incentives required $1,042,000 more cash. Sales incentive payouts were higher in 2011 because the increase in sales was more significant between 2010 and 2009 then it was between 2011 and 2010. Therefore, more customers were able to reach higher growth tier rebates in 2010, which were then paid out during of 2011.

Investing Activities

Cash used in investing activities in 2011 was $131,000, compared with $3,106,000 provided in 2010. During the fourth quarter of 2010, the Company received payment of the $3,250,000 outstanding note from Mestek, described in Note 12, offset partially by $144,000 of capital spending. All of the outflows in 2011 related to capital spending.

Financing

There was only cash used in financing activities relative to 2010 in the amount of $7,500,000, which was the result of available cash being applied to the outstanding line of credit.

RECENT ACCOUNTING PRONOUNCEMENTS

ASU 2011-06, Fair Value Measurements and Disclosures (Topic 820) - Improving Disclosures about Fair Value Measurements This ASU affects all entities that are required to make disclosures about recurring and nonrecurring fair value measurements under FASB ASC Topic 820, originally issued as FASB Statement No. 157, Fair Value Measurements. The ASU requires certain new disclosures and clarifies two existing disclosure requirements. The new disclosures and clarifications of existing disclosures are effective for interim and annual reporting periods beginning after December 15, 2010, except for the disclosures about purchases, sales, issuances, and settlements in the roll forward of activity in Level 3 fair value measurements. Those disclosures are effective for fiscal years beginning after December 15, 2011, and for interim periods within those fiscal years. The Company does not believe that these new fair value measurement requirements will have a significant impact on the Company's financial position, results or operation, or cash flows.

Off-Balance Sheet Obligations or Arrangements

The Company has off-balance sheet obligations or arrangements at December 31, 2011 that relate to purchase commitments for the following year, and also operating lease obligations, which total equal $12,989,000. The total amount of these obligations at December 31, 2010 was $10,088,000.

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