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ESPEY MFG & ELECTRONICS CORP - Annual Report: 2011 (Form 10-K)

form10k-117848_espey.htm


UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, DC 20549

FORM 10 – K

S
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE ACT OF 1934 for the fiscal year ended   June 30, 2011
OR
 
£
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 1-4383

ESPEY MFG. & ELECTRONICS CORP.
(Exact name of registrant as specified in its charter)
 
NEW YORK
14-1387171
(State or other jurisdiction of incorporation or organization)
(IRS Employer Identification No.)

233 Ballston Avenue, Saratoga Springs, NY 12866
(Address of principal executive offices including Zip Code)

(Registrant's telephone number including area code) (518)245-4400
 
Securities registered pursuant to Section 12(b) of the Act:
 
Title of each class
 
Name of each exchange on which registered
Common Stock $.33-1/3 par value
 
NYSE - Amex
Common Stock Purchase Rights
 
NYSE - Amex
     
Securities registered pursuant to Section 12 (g) of the Act: None

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.
£ Yes           S No
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act.
£ Yes           S No
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.
 S Yes           £ No
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.  £

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company:
£ Large accelerated filer
£ Accelerated filer
£ Non-accelerated filer
S Smaller reporting company
Indicate by check mark whether the registrant is a shell company.
£ Yes          S No
 
The aggregate market value of the voting stock held by non-affiliates of the registrant was $36,157,493 million based upon the closing sale price of $23.76 on the NYSE - Amex on December 31, 2010.

At September 8, 2011, there were 2,320,960 shares outstanding of the registrant's Common stock, $.33-1/3 par value.
DOCUMENTS INCORPORATED BY REFERENCE

Portions of the registrant's definitive proxy statement relating to the 2011 Annual Meeting of Shareholders, to be filed with the Securities and Exchange Commission, are incorporated by reference in Part III, Items 10 through 14 on Form 10-K as indicated herein.
 


 
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Forward-Looking Statements

This Annual Report on Form 10-K contains forward-looking statements that are based on management’s expectations, estimates, projections and assumptions.  Words such as “expects,” “anticipates,” “plans,” “believes,” “scheduled,” “estimates” and variations of these words and similar expressions are intended to identify forward-looking statements.  Forward-looking statements are made pursuant to the safe harbor provisions of the Private Securities Litigation Reform Act of 1995, as amended.  These statements are not guarantees of future performance and involve certain risks and uncertainties that are difficult to predict.  Therefore, actual future results and trends may differ materially from what is forecast in forward-looking statements due to a variety of factors, including, without limitation:
 
·
Changing priorities or decreases in the U.S. government’s defense budget (including changes in priorities in response to terrorist threats,  improvement of homeland security and the overall financial health of the U.S. Government);
 
·
Termination of government contracts due to unilateral government action;
 
·
Differences in anticipated and actual program performance, including the ability to perform under long-term fixed-price contracts within estimated costs, and performance issues with key suppliers and subcontractors;
 
·
Potential of changing prices for energy and raw materials.

All forward-looking statements speak only as of the date of this report or, in the case of any document incorporated by reference, the date of that document.  All subsequent written and oral forward-looking statements attributable to the Company or any person acting on the Company’s behalf are qualified by the cautionary statements in this section.  The Company does not undertake any obligation to update or publicly release any revisions to forward-looking statements to reflect events, circumstances or changes in expectations after the date of this report.

 
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PART I
Item 1.
Business

General

Espey Mfg. & Electronics Corp. (“Espey”) is a power electronics design and original equipment manufacturing (OEM) company with a long history of developing and delivering highly reliable products for use in military and severe environment applications. All design, manufacturing, and testing is performed in our 150,000+ square foot facility located at 233 Ballston Ave, Saratoga Springs, New York. Espey is classified as a “smaller reporting company” for purposes of the reporting requirements under the Securities Exchange Act of 1934, as amended.  Espey’s common stock is publicly-traded on the NYSE-Amex under the symbol “ESP.”

Espey began operations after incorporation in New York in 1928.  We strive to remain competitive as a leader in high power energy conversion and transformer solutions through the design and manufacture of new and improved products by using advanced and “cutting edge” electronics technologies.

Espey is ISO 9001:2008 certified and our primary products are power supplies, power converters, filters, power transformers, magnetic components, power distribution equipment, ups systems, antennas and high power radar systems. The applications of these products include AC and DC locomotives, shipboard power, shipboard radar, airborne power, ground-based radar, and ground mobile power.

Espey services include design and development to specification, build to print, design services, design studies, environmental testing services, metal fabrication, plating and painting services, and development of automatic testing equipment. Espey manufacturing is vertically integrated, meaning that the Company produces individual components (including inductors), populates printed circuit boards, fabricates metalwork, paints, plates, wires, qualifies, and fully tests items, mechanically, electrically and environmentally, in house.  Portions of the manufacturing process are subcontracted to vendors from time to time.

Espey is on the eligible list of contractors with the United States Department of Defense and generally is automatically solicited by Defense Department procurement agencies for their needs falling within the major classes of products produced by the Company. Espey contracts with the Federal Government under cage code 20950 as Espey Mfg. & Electronics Corp. and cage code 98675 as Espey Mfg. & Electronics Corp., Saratoga Industries Division.

In the fiscal years ended June 30, 2011 and 2010, the Company's total sales were $29,499,504 and $28,900,013, respectively. Sales to two customers accounted for 31% and 31% of total sales in 2011.  Sales to three customers accounted for 22%, 13% and 13% of total sales in 2010.

Export sales in 2011 and 2010 were approximately $4,769,000 and $5,324,000, respectively.

Sources of Raw Materials

The Company has never experienced any significant delay or shortage with respect to the purchase of raw materials and components used in the manufacture of its products, and has at least two potential sources of supply for a majority of its raw materials.  However, certain components used in our products are available from only a limited number of sources, and other components are only available from a single source.  Despite the risk associated with limited or single source suppliers, the benefits of higher quality goods and timely delivery minimize and often limit any potential risk and can eliminate problems with part failures during production.

Sales Backlog

At September 7, 2011, the Company's backlog was approximately $40.5 million. The total backlog at June 30, 2011 was approximately $38.7 million compared to approximately $31 million at June 30, 2010. The Company’s total backlog represents the estimated remaining sales value of work to be performed under firm contracts.  The Company's backlog and risks associated with government contracts is discussed in greater detail in Management's Discussion and Analysis of Financial Condition and Results of Operations, contained in Item 6 below.

It is presently anticipated that a minimum of $30 million of orders comprising the June 30, 2011 backlog will be filled during the fiscal year ending June 30, 2012. The minimum of $30 million does not include any shipments, which may be made against orders subsequently received during the fiscal year ending June 30, 2012. The estimate

 
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of the June 30, 2011 backlog to be shipped in fiscal 2012 is subject to future events, which may cause the amount of the backlog actually shipped to differ from such estimate.

Marketing and Competition

The Company markets its products primarily through its own direct sales organization. Business is solicited from large industrial manufacturers and defense companies, the government of the United States, foreign governments and major foreign electronic equipment companies.  In some cases external sales representatives help solicit and coordinate foreign contracts. The Company is also on the eligible list of contractors of agencies of the United States Department of Defense and generally is automatically solicited by such agencies for procurement needs falling within the major classes of products produced by the Company.  In addition, the Company directly pursues opportunities from the United States Department of Defense as a prime contractor.

There is competition in all classes of products manufactured by the Company, ranging from divisions of the largest electronic companies to many small companies. The Company's sales do not represent a significant share of the industry's market for any class of its products. The principal methods of competition for electronic products of both a military and industrial nature include, among other factors, price, product performance, the experience of the particular company and history of its dealings in such products. The Company, as well as other companies engaged in supplying equipment for military use, is subject to various risks, including, without limitation, dependence on the United States and foreign government appropriations and program allocations, the competition for available military business, and government termination of orders for convenience.

The Company's business is not considered to be seasonal.  Also, management believes that due to the nature of the Company's business, the Company will not be adversely affected by recessionary factors in the U.S. economy generally.  Future cuts to the U.S.  Government’s defense budget could negatively impact the Company’s business. Although the anticipated partial disengagement of the United States military presence from both Iraq and Afghanistan as well as recent political discourse are indicative of a likely reduction in military and defense appropriations by Congress, the Company does not believe that these developments will adversely affect its business for several reasons:

 
·
Budget cuts will most likely come from expensive platforms and personnel (especially in overseas deployments) which are not the focus of our strategy.  Furthermore, cuts to big budget “marquis” programs tend to favor the legacy programs and upgrades which are Espey’s focus.
 
·
When it is judged that upgrade of a legacy system is more cost-effective than a brand-new development, functionality and therefore the electrical power requirement is almost always increased, resulting in more demand for Espey’s products.
 
·
It is unlikely that the U.S. will cede its leadership role in military affairs worldwide when political stability or sea lanes are at risk, and this fact is likely to mitigate any action leading to more than marginal cuts to defense spending.
 
·
As a hedge to expected cuts that do occur, Espey intends to maintain  20% -25% of its sales to non-defense applications.

Research and Development

The Company's expenditures for research and development were approximately $50,103 and $50,166 in fiscal 2011 and 2010, respectively.  Some of the Company's engineers and technicians spend varying degrees of time on either development of new products or improvements of existing products.  A majority of these expenditures relate to research that is required by Espey engineers to support a request for a quotation from a customer having a product-specific custom need usually associated with stringent size and weight requirements.

Employees

The Company had 166 employees as of September 7, 2011.  Approximately 40% of these employees are represented by the International Brotherhood of Electrical Workers Local #1799. A collective bargaining agreement was approved in June 2008.  The four-year agreement expires on June 30, 2012.  The contract provided for pay increases of 4%, 3.75%, 3.75% and 4% for each year, respectively, of the four-year contract.  Relations with the Union are considered good. Union membership at September 7, 2011 was 70 people.

 
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Government Regulations

Compliance with federal, state and local laws regulating the discharge of materials into the environment, or otherwise relating to the protection of the environment, did not in fiscal year 2011, and the Company believes will not in fiscal year 2012, have a material effect upon the capital expenditures, net income, or competitive position of the Company.

The Company’s U.S. government contract and subcontract orders are funded by government budgets, which operate on an October-to-September fiscal year.  In February of each year, the President of the United States presents to Congress a proposed budget for the upcoming fiscal year.  This budget includes recommended appropriations for every federal agency and is the result of months of policy and program reviews throughout the executive branch.  From February through September of each year, the appropriations and authorization committees of Congress review the President’s budget proposals and establish the funding levels for the upcoming fiscal year in appropriations and authorization legislation.  Once these levels are enacted into law, the Executive Office of the President administers the funds to the agencies.

There are two primary risks associated with this process.  First, the process may be delayed or disrupted because of congressional schedules, negotiations over funding levels for programs or unforeseen world events, which could, in turn, alter the funding for a program or contract.  Second, funding for multi-year contracts can be changed by future appropriations, which could affect the timing of funds, schedules and program content.

Also, our international sales are denominated in United States currency.  Consequently, changes in exchange rates that strengthen the United States dollar could increase the price in local currencies of our products in foreign markets and make our products relatively more expensive than competitors’ products.

U.S. Government Defense Contracts and Subcontracts

Generally, U.S. government contracts are subject to procurement laws and regulations.  Some of the Company’s contracts are governed by the Federal Acquisition Regulation (FAR), which lays out uniform policies and procedures for acquiring goods and services by the U.S. government, and agency-specific acquisition regulations that implement or supplement the FAR.  For example, the Department of Defense implements the FAR through the Defense Federal Acquisition Regulation (DFAR).

The FAR also contains guidelines and regulations for managing a contract after award, including conditions under which contracts may be terminated, in whole or in part, at the government’s convenience or for default.  If a contract is terminated for the convenience of the government, a contractor is entitled to receive payments for its allowable costs and, in general, the proportionate share of fees or earnings for the work done.  If a contract is terminated for default, the government generally pays for only the work it has accepted.  These regulations also subject the Company to financial audits and other reviews by the government of its costs, performance, accounting and general business practices relating to its contracts, which may result in adjustment of the Company’s contract-related costs and fees.

Item 2.
Property

The Company's entire operation, including manufacturing and engineering facilities, is located in Saratoga Springs, New York.

The Saratoga Springs plant, which the Company owns, consists of various adjoining one-story buildings on a 22 acre site, approximately eight acres of which is unimproved.  The property is not subject to mortgage indebtedness or any other material encumbrance. The plant has a sprinkler system throughout and contains approximately 151,000 square feet of floor space, of which 90,000 is used for manufacturing, 24,000 for engineering, 33,000 for shipping and climatically secured storage, and 4,000 for offices. The offices, engineering and some manufacturing areas are air-conditioned. In addition to assembly and wiring operations, the plant includes facilities for varnishing, potting, plating, impregnation and spray-painting operations. The manufacturing operation also includes a complete machine shop, with welding and sheet metal fabrication facilities adequate for substantially all of the Company's current operations. Besides normal test equipment, the Company maintains a sophisticated on-site environmental test facility. In addition to meeting all of the Company's in-house needs, the plating, machine shop and environmental facilities are available to other companies on a contract basis.

Item 3.
Legal Proceedings

None

 
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PART II

Item 5.
Market for the Registrant's Common Equity and Related Stockholder Matters and Issuer Purchases of Equity Securities

Price Range of Common Stock

The table below shows the range of high and low prices for the Company's common stock on the NYSE - Amex (symbol "ESP"), the principal market for trading in the common stock, for each quarterly period for the last two fiscal years ended June 30:

2011
High
Low
First Quarter
22.50
18.13
Second Quarter
25.83
21.00
Third Quarter
25.87
19.50
Fourth Quarter
29.20
23.22
     
2010
   
First Quarter
18.70
14.60
Second Quarter
21.08
17.40
Third Quarter
21.14
17.80
Fourth Quarter
20.35
18.10

Holders

The approximate number of holders of record of the common stock was 99 on September 7, 2011 according to records of the Company's transfer agent. Included in this number are shares held in "nominee" or "street" name and, therefore, the number of beneficial owners of the common stock is believed to be substantially in excess of the foregoing number.

Dividends

The Company paid cash dividends on common stock of $1.90 per share for the fiscal years ended June 30, 2011 and 2010, which included a special dividend of $1.00 per share during each such fiscal year.  The Board of Directors has authorized the payment of a fiscal 2012 first quarter dividend of $.225 payable September 30, 2011 to shareholders of record on September 9, 2011.  We anticipate that regular quarterly dividends will be paid for the foreseeable future.  There is no assurance that the Board of Directors will declare a special dividend during the fiscal year ending June 30, 2012.

During fiscal 2011, the Company sold common stock to certain employees and directors as they exercised existing stock options granted under a shareholder approved plan.  During the year, 23,800 shares were sold at prices that ranged from $8.98 a share to $21.54 a share.  The securities were sold for cash.   Proceeds are used for general working capital purposes.

The Company did not make any open market purchases of equity securities in the fiscal 2011 fourth quarter.

The following table sets forth information as of June 30, 2011 with respect to compensation plans under which equity securities of the Company may be issued.

Equity Compensation Plan Information
 
Plan Category
Number of securities to
be issued upon exercise
of outstanding options,
warrants and rights
Weighted-average
exercise price of
outstanding options,
warrants and rights
Number of Securities remaining
available for future issuance under
equity compensation plan (excluding
securities reflected in column (a))
 
(a)
(b)
(c)
Equity compensation
     
plans approved by
     
security holders
132,400
18.62
310,600
Equity compensation
     
plans not approved
     
by security holders
--
 
--
Total
132,400
 
310,600
 
 
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Item 7.
Management's Discussion and Analysis of Financial Condition and Results of Operations

Business Outlook

Management expects revenues in fiscal 2012 to increase approximately 5% over fiscal year 2011.  Expectations are for product mix and margins to remain favorable for fiscal year 2012.  During fiscal 2011 new orders received by the Company were approximately $37.2 million.  The order backlog of approximately $38.7 million at June 30, 2011 gives the Company a solid base of future sales.  It is presently anticipated that a minimum of $30 million of orders comprising the June 30, 2011 backlog will be filled during the fiscal year ending June 30, 2012. The minimum of $30 million does not include any shipments, which may be made against orders subsequently received during the fiscal year ending June 30, 2012. See discussions below for further detail on the customer mix included in the backlog.

In addition to the backlog, the Company currently has outstanding quotations representing in excess of $43.9 million in the aggregate for both repeat and new programs.  Many potential orders are currently being discussed and negotiated with existing and potential new customers.  The outstanding quotations encompass various new and previously manufactured power supplies, transformers, and subassemblies.  However, there can be no assurance that the Company will acquire any or all of the anticipated orders described above, many of which are subject to allocations of the United States defense spending and factors affecting the defense industry and military procurement generally.

Two significant customers in fiscal 2011 represented 62% of the Company's total sales and three significant customers in fiscal 2010 represented 48% of the Company's total sales.  These sales are in connection with multiyear programs in which the Company is a significant subcontractor.  The June 30, 2011 backlog of $38.7 million includes orders from two customers that represent 48% and 15%, respectively, of the total backlog.  A loss of one of these customers or programs related to these customers would significantly impact the Company.  Historically, a small number of customers have accounted for a large percentage of the Company’s total sales in any given fiscal year.  Even though our business tends to be concentrated in several customers, the makeup of those customers often changes from year to year.  For several years, management has pursued opportunities with current and new customers with an overall objective of lowering the concentration of sales, mitigating excessive reliance upon a single major product of a particular program and minimizing the impact of the loss of a single significant customer.  Management continues to evaluate its business development functions and potential revised courses of action in order to diversify its customer base.  The defense industry itself tends to be concentrated with a few large tier one defense contractors which limits the amount of diversity the Company can achieve with its customer base.

Management, along with the Board of Directors, continues to evaluate the need and use of the Company’s working capital.  Capital expenditures are expected to be approximately $300,000 for fiscal 2012.  Expectations are that the working capital will be required to fund orders, dividend payments, and general operations of the business.  From time to time, management along with the Mergers and Acquisitions Committee of the Board of Directors examine opportunities involving acquisitions or other strategic options, including buying certain products or product lines.  The criteria for consideration are synergies with the Company’s existing product base and accretion to earnings.

Results of Operations

Net Sales for fiscal years ended June 30, 2011 and 2010, were $29,499,504 and $28,900,013, respectively, a 2% increase.  This increase can be attributed to the contract specific nature of the Company’s business and the timing of deliveries on these contracts.  More specifically, shipments of power supplies increased by approximately $4.9 million offset by a decrease of $3 million in transformer and antenna shipments and a decrease of $1.1 million in engineering design related billings in fiscal 2011.

For the fiscal years ended June 30, 2011 and 2010 gross profits were $8,206,199 and $7,763,296, respectively.  Gross profit as a percentage of sales was 27.8% and 26.9%, for fiscal 2011 and 2010, respectively.  The primary factor in determining gross profit and net income is product mix.  The gross profits on mature products and build to print contracts are higher as compared to products that are still in the engineering development stage or in the early stages of production.  In any given accounting period the mix of product shipments between higher margin mature programs and less mature programs including loss contracts, has a significant impact on gross profit and net income.  The increased gross profit and gross profit percentage in fiscal 2011 as compared to fiscal 2010, was primarily the result of favorable product mix with only minor cost overruns related to certain products.

 
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In addition to favorable product mix, management is implementing several “lean management” principles which have created efficiencies in the manufacturing process.  These efficiencies have allowed for greater production capacity and increased gross profit.  Employment of full time equivalents at June 30, 2011 was 165 compared to 169 people at June 30, 2010.

Selling, general and administrative expenses were $2,905,916 for the fiscal year ended June 30, 2011, a decrease of $100,601, or 3.3% as compared to the prior year.  The decrease for fiscal 2011 relates primarily to a decrease in salary expense.

Other income for the fiscal years ended June 30, 2011 and 2010 was $81,259 and $142,866, respectively.  The decrease is attributable to lower interest rates and related interest income on the Company’s cash and cash equivalents and short term investments. The Company does not believe that there is a significant risk associated with its investment policy.  At June 30, 2011 all of the investments were primarily represented by short-term liquid investments including certificates of deposit and money market funds.

The effective income tax rate was 28.3% in fiscal 2011 and 27.2% in fiscal 2010.  The effective tax rate is less than the statutory tax rate mainly due to the benefit the Company receives on its “qualified production activities” under The American Jobs Creation Act of 2004 and the benefit derived from the dividends paid on allocated ESOP shares.

Net income for fiscal 2011, was $3,857,537 or $1.79 and $1.77 per share, basic and diluted, compared to net income of $3,564,962 or $1.67 per share, both basic and diluted, respectively, for fiscal 2010. The increase in net income per share was primarily due to higher sales, higher gross profit on sales, and lower selling, general and administrative expenses.

Liquidity and Capital Resources

The Company's working capital is an appropriate indicator of the liquidity of its business, and during the past two fiscal years, the Company, when possible, has funded all of its operations with cash flows resulting from operating activities and when necessary from its existing cash and investments. The Company did not borrow any funds during the last two fiscal years.

The Company's working capital as of June 30, 2011 and 2010 was $26,124,431 and $25,844,991, respectively.  During the three months ended June 30, 2011 and 2010 the Company did not repurchase any shares of its common stock.  During the fiscal year ended June 30, 2011 and 2010 the Company repurchased 23,342 and 23,513 shares, respectively, of its common stock for a total purchase price of $575,246 and $452,155, respectively.  All shares were purchased from the Company's ESOP.  Under existing authorizations from the Company's Board of Directors, as of June 30, 2011, management is authorized to purchase an additional $2,000,000 million of Company stock.

The table below presents the summary of cash flow information for the fiscal year indicated:

   
2011
   
2010
 
Net cash provided by operating activities
  $ 4,913,449     $ 6,904,771  
Net cash provided by (used in) investing activities
    4,515,760       (1,170,683 )
Net cash used in financing activities
    (4,208,464 )     (4,034,341 )

Net cash provided by operating activities fluctuates between periods primarily as a result of differences in net income, the timing of the collection of accounts receivable, purchase of inventory, level of sales and payments of accounts payable.  Net cash provided by investing activities increased in fiscal 2011 due to a decrease in purchases of short term investments.  The increase in cash used in financing activities is due primarily to an increase in the purchase of treasury stock.

The Company currently believes that the cash flow generated from operations and when necessary, from cash and cash equivalents, will be sufficient to meet its long-term funding requirements for the foreseeable future.

Management believes that the Company's reserve for bad debts of $3,000 is adequate given the customers with whom the Company does business. Historically, bad debt expense has been minimal.

During fiscal year 2011 and fiscal 2010, the Company expended $607,311 and $436,502, respectively, for plant improvements and new equipment. The Company has budgeted approximately $300,000 for new equipment and plant improvements in fiscal 2012. Management anticipates that the funds required will be available from current operations.

 
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Critical Accounting Policies and Estimates

Our significant accounting policies are described in note 2 to the financial statements.  We believe our most critical accounting policies include revenue recognition and cost estimation on our contracts.

Revenue Recognition and Estimates

A significant portion of our business is comprised of development and production contracts.  Generally revenues on long-term fixed-price contracts are recorded on a percentage of completion basis using units of delivery as the measurement basis for progress toward completion.

Percentage of completion accounting requires judgment relative to expected sales, estimating costs and making assumptions related to technical issues and delivery schedules.  Contract costs include material, subcontract costs, labor and an allocation of overhead costs.  The estimation of cost at completion of a contract is subject to numerous variables involving contract costs and estimates as to the length of time to complete the contract.  Given the significance of the estimation processes and judgments described above, it is possible that materially different amounts of expected sales and contract costs could be recorded if different assumptions were used, based on changes in circumstances, in the estimation process.  When a change in expected sales value or estimated cost is determined, changes are reflected in current period earnings.

 
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Item 7.
Financial Statements and Supplementary Data

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
 
 
To the Board of Directors and Stockholders of
Espey Mfg. & Electronics Corp.
Saratoga Springs, New York
 
 
We have audited the accompanying balance sheets of Espey Mfg. & Electronics Corp. as of June 30, 2011 and 2010, and the related statements of income, stockholders’ equity, and cash flows for each of the years in the two-year period ended June 30, 2011. Espey Mfg. & Electronics Corp.’s management is responsible for these financial statements. Our responsibility is to express an opinion on these financial statements based on our audits.

We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. The company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. Our audit included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the company’s internal control over financial reporting. Accordingly, we express no such opinion. An audit also includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of Espey Mfg. & Electronics Corp. as of June 30, 2011 and 2010, and the results of its operations and its cash flows for each of the years in the two-year period ended June 30, 2011 in conformity with accounting principles generally accepted in the United States of America.
 
 
/s/EFP Rotenberg, LLP
Rochester, New York
September 8, 2011

 
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Espey Mfg. & Electronics Corp.
Balance Sheet
June 30, 2011 and 2010

   
2011
   
2010
 
ASSETS
           
Cash and cash equivalents
  $ 9,695,811     $ 4,475,066  
Short term investments
    1,946,214       7,111,182  
Trade accounts receivable, net
    6,266,765       5,495,251  
                 
                 
Inventories:
               
Raw materials
    1,273,582       1,233,597  
Work-in-process
    1,085,278       1,490,749  
Costs related to contracts in process, net of progress
               
payments of $126,361 in 2011 and $142,492 in 2010     8,220,200       8,217,040  
Total inventories
    10,579,060       10,941,386  
                 
Deferred tax asset
    360,553       229,086  
Prepaid expenses and other current assets
    208,904       185,832  
Total current assets
    29,057,307       28,437,803  
Property, plant and equipment, net
    2,703,014       2,717,330  
Loan receivable
    108,303       11,546  
Total assets
  $ 31,868,624     $ 31,166,679  
                 
LIABILITIES AND STOCKHOLDERS' EQUITY
               
                 
Accounts payable
  $ 1,453,707     $ 1,607,147  
Accrued expenses:
               
Salaries, wages and commissions
    412,555       203,435  
Vacation
    623,757       544,021  
Other
    121,026       177,086  
Payroll and other taxes withheld and accrued
    44,085       46,330  
Income taxes payable
    277,746       14,793  
Total current liabilities
    2,932,876       2,592,812  
Deferred tax liability
    270,729       127,148  
Total liabilities
    3,203,605       2,719,960  
                 
Common stock, par value $.33-1/3 per share
               
Authorized 10,000,000 shares; Issued 3,029,874 shares in 2011
               
and 2010. Outstanding 2,320,960 and 2,319,876 in 2011 and                
2010, respectively (includes 157, 500 and 179,166 Unearned                
ESOP Shares)     1,009,958       1,009,958  
Capital in excess of par value
    14,674,189       14,172,284  
Retained earnings
    22,780,026       23,002,981  
      38,464,173       38,185,223  
                 
Less:   Unearned ESOP shares
    (2,275,872 )     (2,588,954 )
Cost of 708,914 and 709,998 shares of common stock
               
in treasury in 2011 and 2010, respectively     (7,523,282 )     (7,149,550 )
Total stockholders' equity
    28,665,019       28,446,719  
                 
Total liabilities and stockholders' equity
  $ 31,868,624     $ 31,166,679  

The accompanying notes are an integral part of the financial statements.

 
11

 

Espey Mfg. & Electronics Corp.
Statements of Income
Years Ended June 30, 2011 and 2010

   
2011
   
2010
 
Net sales
  $ 29,499,504     $ 28,900,013  
Cost of sales
    21,293,305       21,136,717  
Gross profit
    8,206,199       7,763,296  
                 
Selling, general and administrative expenses
    2,905,916       3,006,517  
Operating income
    5,300,283       4,756,779  
                 
Other income
               
Interest and dividend income
    56,154       99,373  
Other
    25,105       43,493  
Total other income
    81,259       142,866  
                 
Income before income taxes
    5,381,542       4,899,645  
                 
Provision for income taxes
    1,524,005       1,334,683  
                 
Net income
  $ 3,857,537     $ 3,564,962  
                 
Net income per share:
               
Basic
  $ 1.79     $ 1.67  
Diluted
  $ 1.77     $ 1.67  
                 
Weighted average number of shares outstanding:
               
Basic
    2,151,443       2,129,417  
Diluted
    2,176,299       2,137,799  

The accompanying notes are an integral part of the financial statements.

 
12

 

Espey Mfg. & Electronics Corp.
Statements of Changes in Stockholders' Equity
Years Ended June 30, 2011 and 2010

   
Outstanding
         
Capital in
   
Unearned
       
   
Common
         
Excess of
   
ESOP
   
Retained
 
   
Shares
   
Amount
   
Par Value
   
Shares
   
Earnings
 
                               
Balance as of June 30, 2009
    2,314,803     $ 1,009,958     $ 13,755,808     $ (2,914,077 )   $ 23,485,675  
                                         
Net income, 2010
                                    3,564,962  
                                         
Stock options exercised
    8,100               68,755                  
                                         
Stock option expense
                    94,423                  
                                         
Dividends paid on common stock
                                       
$1.90 per share
                                    (4,047,656 )
                                         
Tax effect of stock options exercised
                    3,138                  
                                         
Sale of treasury stock to ESOP
    20,486               157,742                  
                                         
Purchase of treasury stock
    (23,513 )                                
                                         
Reduction of unearned ESOP shares
                    92,418       325,123          
                                         
Balance as of June 30, 2010
    2,319,876     $ 1,009,958     $ 14,172,284     $ (2,588,954 )   $ 23,002,981  
                                         
Net income, 2011
                                    3,857,537  
                                         
Stock options exercised
    23,800               227,904                  
                                         
Stock option expense
                    66,237                  
                                         
Dividends paid on common stock
                                       
$1.90 per share
                                    (4,080,492 )
                                         
Tax effect of stock options exercised
                    10,939                  
                                         
Sale of treasury stock to ESOP
    626               6,917                  
                                         
Purchase of treasury stock
    (23,342 )                                
                                         
Reduction of unearned ESOP shares
                    189,908       313,082          
                                         
Balance as of June 30, 2011
    2,320,960     $ 1,009,958     $ 14,674,189     $ (2,275,872 )   $ 22,780,026  

The accompanying notes are an integral part of the financial statements.

(Continued)

 
13

 

Espey Mfg. & Electronics Corp.
Statements of Changes in Stockholders' Equity
Years Ended June 30, 2011 and 2010

                   
               
Total
 
   
Treasury Stock
   
Stockholders’
 
   
Shares
   
Amount
   
Equity
 
                   
Balance as of June 30, 2009
    715,071     $ (6,933,230 )   $ 28,404,134  
                         
Net income, 2010
                    3,564,962  
                         
Stock options exercised
    (8,100 )     66,825       135,580  
                         
Stock option expense
                    94,423  
                         
Dividends paid on common stock
                       
$1.90  per share
                    (4,047,656 )
                         
Tax effect of stock options exercised
                    3,138  
                         
Sale of treasury stock to ESOP
    (20,486 )     169,010       326,752  
                         
Purchase of treasury stock
    23,513       (452,155 )     (452,155 )
                         
Reduction of unearned ESOP shares
                    417,541  
                         
Balance as of June 30, 2010
    709,998     $ (7,149,550 )   $ 28,446,719  
                         
Net income, 2011
                    3,857,537  
                         
Stock options exercised
    (23,800 )     196,350       424,254  
                         
Stock option expense
                    66,237  
                         
Dividends paid on common stock
                       
$1.90  per share
                    (4,080,492 )
                         
Tax effect of stock options exercised
                    10,939  
                         
Sale of treasury stock to ESOP
    (626 )     5,164       12,081  
                         
Purchase of treasury stock
    23,342       (575,246 )     (575,246 )
                         
Reduction of unearned ESOP shares
                    502,990  
                         
Balance as of June 30, 2011
    708,914     $ (7,523,282 )   $ 28,665,019  

The accompanying notes are an integral part of the financial statements.
 
 
14

 
 
Espey Mfg. & Electronics Corp.
Statements of Cash Flows
Years Ended June 30, 2011 and 2010

   
2011
   
2010
 
Cash Flows From Operating Activities:
           
Net income
  $ 3,857,537     $ 3,564,962  
                 
Adjustments to reconcile net income to net cash provided by operating activities:
               
                 
Excess tax benefits from share-based compensation
    10,939       3,138  
                 
Stock-based compensation
    66,237       94,423  
                 
Depreciation
    467,296       455,592  
                 
ESOP compensation expense
    502,990       417,541  
                 
Loss on disposal of assets
    99,471       1,802  
                 
Deferred income tax benefit
    12,114       23,644  
                 
Changes in assets and liabilities:
               
                 
Increase in trade receivables, net
    (771,495 )     (361,459 )
                 
(Increase) decrease in other receivables
    (19 )     297  
                 
Decrease in ESOP receivable due to
               
dividends on unallocated shares
    --       71,053  
                 
Decrease in inventories, net
    362,326       2,087,819  
                 
(Increase) decrease in prepaid expenses and other current assets
    (23,072 )     47,240  
                 
(Decrease) increase in accounts payable
    (153,440 )     607,626  
                 
Increase (decrease) in accrued salaries, wages and commissions
    209,120       (16,098 )
                 
(Decrease) increase in other accrued expenses
    (56,060 )     134,223  
                 
Increase in vacation accrual
    79,736       23,949  
                 
(Decrease) increase in payroll and other taxes withheld and accrued
    (2,245 )     4,255  
                 
Increase (decrease) in income taxes payable
    252,014       (255,236 )
                 
Net cash provided by operating activities
  $ 4,913,449     $ 6,904,771  
 
The accompanying notes are an integral part of the financial statements.

(Continued)

 
15

 

Espey Mfg. & Electronics Corp.
Statements of Cash Flows
Years Ended June 30, 2011 and 2010

   
2011
   
2010
 
Cash Flows From Investing Activities:
           
             
Additions to property, plant and equipment
    (607,311 )     (436,502 )
                 
Proceeds on sale of assets
    54,860       --  
                 
Payment for loan receivable
    (125,000 )     --  
                 
Proceeds from loan receivable
    28,243       27,127  
                 
Purchase of short term investments
    (3,091,032 )     (8,410,871 )
                 
Proceeds from maturity of short term investments
    8,256,000       7,649,563  
                 
Net cash provided by (used in) investing activities
    4,515,760       (1,170,683 )
                 
Cash Flows From Financing Activities:
               
                 
Sale of treasury stock
    12,081       326,752  
                 
Dividends on common stock
    (4,080,492 )     (4,047,656 )
                 
Purchase of treasury stock
    (575,246 )     (452,155 )
                 
Proceeds from exercise of stock options
    424,254       135,580  
                 
Excess tax benefits from share-based compensation
    10,939       3,138  
                 
Net cash used in financing activities
    (4,208,464 )     (4,034,341 )
                 
Increase in cash and cash equivalents
    5,220,745       1,699,747  
                 
Cash and cash equivalents, beginning of the year
    4,475,066       2,775,319  
                 
Cash and cash equivalents, end of the year
  $ 9,695,811     $ 4,475,066  
                 
Supplemental Schedule of Cash Flow Information:
               
                 
Income taxes paid
  $ 1,238,000     $ 1,560,000  

The accompanying notes are an integral part of the financial statements.

 
16

 
 
Espey Mfg. & Electronics Corp.
Notes to Financial Statements

Note 1. Nature of operations

Espey Mfg. & Electronics Corp. (the Company) is a manufacturer of electronic equipment used primarily in military and industrial applications. The principal markets for the Company's products are companies that provide electronic support to both military and industrial applications.

Note 2. Summary of Significant Accounting Policies

Inventory Valuation, Cost Estimation and Revenue Recognition
Raw materials are valued at weighted average cost.

Inventoried work relating to contracts in process and work in process is valued at actual production cost, including factory overhead incurred to date. Work in process represents spare units; parts and other inventory items acquired or produced to service units previously sold or to meet anticipated future orders. The cost elements of contracts in process and work in process consist of production costs of goods and services currently in process and overhead. Provision for losses on contracts is made when the existence of such losses becomes probable and estimable. The costs attributed to units delivered under contracts are based on the estimated average cost of all units expected to be produced. Certain contracts are expected to extend beyond twelve months.

Revenue is recognized on contracts in the period in which the units are delivered and billed (units-of-delivery method).  A significant portion of our business is comprised of development and production contracts.  Generally, revenues on long-term fixed-price contracts are recorded on a percentage of completion basis using units of delivery as the measurement basis for progress toward completion.

Percentage of completion accounting requires judgment relative to expected sales, estimating costs and making assumptions related to technical issues and delivery schedules.  Contract costs include material, subcontract costs, labor and an allocation of overhead costs.  The estimation of cost at completion of a contract is subject to numerous variables involving contract costs and estimates as to the length of time to complete the contract.  Given the significance of the estimation processes and judgments described above, it is possible that materially different amounts of expected sales and contract costs could be recorded if different assumptions were used, based on changes in circumstances, in the estimation process.  When a change in expected sales value or estimated cost is determined, changes are reflected in current period earnings.

Depreciation
Depreciation of plant and equipment is computed on a straight-line basis over the estimated useful lives of the assets.

Estimated useful lives of depreciable assets are as follows:

Buildings and improvements
10 – 40 years
Machinery and equipment
3 - 20 years
Furniture and fixtures
7 – 10 years

Income Taxes
The Company follows the provisions of ASC Topic 740-10, "Accounting for Income Taxes."

Under the provisions of ASC 740-10, 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 taxes and liabilities of a change in tax rates is recognized in earnings in the period that includes the enactment date.  In addition, ASC 740-10 requires that the tax benefit of tax-deductible dividends on unallocated ESOP shares be recorded as a direct addition to retained earnings rather than as a reduction of income tax expense.

 
17

 
 
Espey Mfg. & Electronics Corp.
Notes to Financial Statements

Note 2.  Summary of Significant Accounting Policies, Continued

Cash and Cash Equivalents
Cash and cash equivalents consist of cash in banks, certificates of deposit, and money market funds.  The Company considers all highly liquid investments with original maturities of three months or less to be cash equivalents.

Short-term investments include certificates of deposit with maturities greater than three months to a year.

Accounts receivable and allowance for doubtful accounts
The Company extends credit to its customers in the normal course of business and collateral is generally not required for trade receivables. Exposure to credit risk is controlled through the use of credit approvals, credit limits and monitoring procedures. Accounts receivable are reported net of an allowance for doubtful accounts. The Company estimates the allowance based on its analysis of specific balances. An account is generally considered past due after thirty (30) days from the invoice date. Based on these factors, there was an allowance for doubtful accounts of $3,000 at June 30, 2011. Changes to the allowance for doubtful accounts are charged to expense and reduced by charge-offs, net of recoveries.

Per Share Amounts
ASC 260-10 “Earnings Per Share” requires the Company to calculate net income (loss) per share based on basic and diluted net income (loss) per share, as defined.  Basic EPS excludes dilution and is computed by dividing net income (loss) by the weighted average number of shares outstanding for the period.  Diluted EPS reflects the potential dilution that could occur if securities or other contracts to issue common stock were exercised or converted into common stock.  The dilutive effect of outstanding options issued by the Company are reflected in diluted EPS using the treasury stock method.  Under the treasury stock method, options will only have a dilutive effect when the average market price of common stock during the period exceeds the exercise price of the options.

Comprehensive Income
Comprehensive Income for the years ended June 30, 2011 and 2010 is equal to net income.

Use of Estimates
The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amount of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.

Investment Tax Credits
Investment tax credits are accounted for as a reduction of income tax expense in the year taxes payable are reduced.

Reclassifications
Certain reclassifications may have been made to the prior year financial statements to conform to the current year presentation.

Recently Issued Accounting Standards
In September 2009, the FASB issued ASC 605-25 for revenue recognition with multiple deliverables. These new standards impact the determination of when the individual deliverables included in a multiple-element arrangement may be treated as separate units of accounting. Additionally, these new standards modify the manner in which the transaction consideration is allocated across the separately identified deliverables by no longer permitting the residual method of allocating arrangement consideration. These new standards are effective in fiscal years beginning on or after June 15, 2010, however early adoption is permitted.  Adoption had will have no effect on the Company’s financial statements.

 
18

 
 
Espey Mfg. & Electronics Corp.
Notes to Financial Statements

Note 2.  Summary of Significant Accounting Policies, Continued

In May 2011, the FASB issued Accounting Standards Update No. 2011-04, topic 820, Fair Value Measurement, to improve the comparability of fair value measurements presented and disclosed in financial statements prepared in accordance with United States GAAP and International Financial Reporting Standards. Some of the amendments clarify the Board’s intent about the application of existing fair value measurement requirements. Other amendments change a particular principle or requirement for measuring fair value or for disclosing information about fair value measurements. Specifically, the guidance requires additional disclosures for fair value measurements that are based on significant unobservable inputs. The updated guidance is to be applied prospectively and is effective for the Company’s interim and annual periods beginning January 1, 2012. The adoption of this guidance is not expected to have a material impact on the Company’s consolidated financial statements.

FASB Accounting Standards Update 2011-05, "Presentation of Comprehensive Income," was issued in June 2011 to be effective for fiscal years beginning after December 15, 2011. Comprehensive income includes certain items that are recognized as "other comprehensive income" ("OCI") and are excluded from net income. Examples include unrealized gains/losses on certain investments and gains/losses on derivative instruments designated as hedges. Under provisions of the update, the components of OCI must be presented in one of two formats: either (i) together with net income in a continuous statement of comprehensive income or (ii) in a second statement of comprehensive income to immediately follow the income statement. An existing option to present the components of OCI as part of the statement of changes in shareholders' equity is being eliminated. The Company presently has no items classified as OCI and expects the update to have minimal effect on its financial statements.

Impairment of Long-Lived Assets
Long-lived assets, including property, plant, and equipment, are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable.  Recoverability of assets to be held and used is measured by a comparison of the carrying amount of an asset to estimated undiscounted future cash flows expected to be generated by the asset.  If the carrying amount of an asset exceeds its estimated future cash flows, an impairment charge is recognized by the amount by which the carrying amount of the asset exceeds the fair value of the asset.  Assets to be disposed of are separately presented in the balance sheet and reported at the lower of the carrying amount or fair value less costs to sell, and no longer depreciated.  The assets and liabilities of a disposed group classified as held for sale are presented separately in the appropriate asset and liability sections of the balance sheet.

Concentrations of Risk
The market for our defense electronics products is largely dependent on the availability of new contracts from the United States and foreign governments to prime contractors to which we provide components.  Any decline in expenditures by the United States or foreign governments may have an adverse effect on our financial performance.

Generally, U.S. government contracts are subject to procurement laws and regulations.  Some of the Company’s contracts are governed by the Federal Acquisition Regulation (FAR), which lays out uniform policies and procedures for acquiring goods and services by the U.S. government, and agency-specific acquisition regulations that implement or supplement the FAR.  For example, the Department of Defense implements the FAR through the Defense Federal Acquisition Regulation (DFAR).

The FAR also contains guidelines and regulations for managing a contract after award, including conditions under which contracts may be terminated, in whole or in part, at the government’s convenience or for default.  If a contract is terminated for the convenience of the government, a contractor is entitled to receive payments for its allowable costs and, in general, the proportionate share of fees or earnings for the work done.  If a contract is terminated for default, the government generally pays for only the work it has accepted.  These regulations also subject the Company to financial audits and other reviews by the government of its costs, performance, accounting and general business practices relating to its contracts, which may result in adjustment of the Company’s contract-related costs and fees.

 
19

 

Espey Mfg. & Electronics Corp.
Notes to Financial Statements

Note 3. Contracts in Process

Contracts in process at June 30, 2011 and 2010 are as follows:
 
   
2011
   
2010
 
Gross contract value
  $ 38,655,707     $ 30,995,710  
Costs related to contracts in process, net of progress payments
               
of $126,361 in fiscal 2011 $142,492  in fiscal 2010
  $ 8,220,200     $ 8,217,040  

Included in costs relating to contracts in process at June 30, 2011 and 2010 are costs of $779,568 and $1,806,212, respectively, relative to contracts that may not be completed within the ensuing year. Under the units-of-delivery method, the related sale and cost of sales will not be reflected in the statement of income until the units under contract are shipped.

Note 4. Property, Plant and Equipment

A summary of the original cost of property, plant and equipment at June 30, 2011 and 2010 is as follows:
 
   
2011
   
2010
 
Land
  $ 45,000     $ 45,000  
Building and improvements
    4,104,132       4,668,556  
Machinery and equipment
    7,352,055       6,994,505  
Furniture and fixtures
    160,867       161,825  
      11,662,054       11,869,886   
Accumulated depreciation
    (8,959,040 )     (9,152,556 )
Property, plant and equipment, net
  $ 2,703,014     $ 2,717,330  

Depreciation expense was $467,296 and $455,592, during the years ended June 30, 2011 and 2010, respectively.

Note 5. Pension Expense

Under terms of a negotiated union contract, the Company is obligated to make contributions to a union-sponsored defined benefit pension plan covering eligible employees. Such contributions and expenses are based upon hours worked at a specified rate and amounted to $102,281 in fiscal 2011 and $102,414 in fiscal 2010.

The Company sponsors a 401(k) plan with employee and employer matching contributions.  The employer match is 10% of the employee contribution and was $33,664 and $34,462, for fiscal years 2011 and 2010, respectively.

Note 6. Provision for Income Taxes

A summary of the components of the provision for income taxes for the years ended June 30, 2011 and 2010 is as follows:
 
   
2011
   
2010
 
Current tax expense - federal
  $ 1,480,465     $ 1,278,169  
Current tax expense - state
    31,425       32,871  
Deferred tax expense
    12,115       23,643  
    $ 1,524,005     $ 1,334,683  

Deferred income taxes reflect the impact of "temporary differences" between the amount of assets and liabilities for financial reporting purposes and such amounts measured by tax laws and regulations. These "temporary differences" are determined in accordance with ASC 740-10.

 
20

 
 
Espey Mfg. & Electronics Corp.
Notes to Financial Statements

Note 6. Provision for Income Taxes, Continued

The combined U.S. federal and state effective income tax rates of 28.3% and 27.2%, for 2011 and 2010 respectively, differed from the statutory U.S. federal income tax rate for the following reasons:
   
2011
   
2010
 
U.S. federal statutory income tax rate
    34.0 %     34.0 %
Increase (reduction) in rate resulting from:
               
State franchise tax, net of federal income tax benefit
    0.4       0.4  
ESOP cost versus Fair Market Value
    0.2       0.6  
Dividend on allocated ESOP shares
    (4.8 )     (6.8 )
Qualified production activities
    (2.7 )     (1.7 )
Stock-based compensation
    1.2       0.6  
Other
    --       0.1  
Effective tax rate
    28.3 %     27.2 %

For the years ended June 30, 2011 and 2010 deferred income tax expense of $12,115 and $23,643, respectively, result from the changes in temporary differences for each year.  The tax effects of temporary differences that give rise to deferred tax assets and deferred tax liabilities as of June 30, 2011 and 2010 are presented as follows:

   
2011
   
2010
 
Deferred tax assets:
           
Accrued expenses
  $ 306,963     $ 159,759  
ESOP
    116,981       108,316  
Stock-based compensation
    10,874       10,874  
Inventory - effect on uniform capitalization
    37,535       51,810  
Other
    5,180       6,644  
Total deferred tax assets
    477,533       337,403  
                 
Deferred tax liabilities:
               
Property, plant and equipment - principally due
               
to differences in depreciation methods
    387,709       235,462  
Total deferred tax liabilities
    387,709       235,462  
Net deferred tax asset
  $ 89,824     $ 101,941  

In assessing the realizability of deferred tax assets, management considers whether it is more likely than not that some portion or all of the deferred tax assets will be realized. The ultimate realization of deferred tax assets is dependent upon the generation of future taxable income during the periods in which those temporary differences become deductible. Management considers the scheduled reversal of deferred tax liabilities, projected future taxable income, and tax planning strategies in making this assessment. Based upon the level of historical taxable income and projection for future taxable income over the period in which the deferred tax assets are deductible, management believes it is more likely than not that the Company will realize the benefits of these temporary differences without consideration of a valuation allowance.

As the result of the implementation of the FASB interpretation ASC 740-10, Accounting for Uncertainty in Income Taxes – An Interpretation of ASC 740, the Company recognized no material adjustments to unrecognized tax benefits.  As of June 30, 2011 and 2010, the Company has no unrecognized tax benefits.

The Company recognizes interest and penalties related to uncertain tax positions, if any, in general and administrative expense.  As of June 30, 2011, the Company has not recorded any provision for accrued interest and penalties related to uncertain tax positions.

By statute, tax years ending June 30, 2011 and 2010 remain open to examination by the major taxing jurisdictions to which the Company is subject.

 
21

 
 
Espey Mfg. & Electronics Corp.
Notes to Financial Statements

Note 7. Significant Customers

A significant portion of the Company's business is the production of military and industrial electronic equipment for use by the U.S. and foreign governments and certain industrial customers. Sales to one domestic customer and one foreign customer accounted for 31% and 31%, respectively, of total sales in fiscal 2011.  Sales to two domestic customers and one foreign customer accounted for 22%, 13% and 13%, respectively of total sales in fiscal 2010.

Export sales in fiscal 2011 and fiscal 2010 were approximately $4,769,000 and $5,324,000, respectively.

Note 8. Stock Rights Plan

The Company has a Shareholder Rights Plan that expires on December 31, 2019. Under this plan, common stock purchase rights were distributed as a dividend at the rate of one right for each share of common stock outstanding as of or issued subsequent to April 14, 1989. Each right entitles the holder thereof to buy one-half share of common stock of the Company at an exercise price of $25 per share subject to adjustment. The rights are exercisable only if a person or group acquires beneficial ownership of 15% or more of the Company's common stock or commences a tender or exchange offer which, if consummated, would result in the offer or individually or, together with all affiliates and associates thereof, being the beneficial owner of 15% or more of the Company's common stock.

If a 15% or larger shareholder should engage in certain self-dealing transactions or a merger with the Company in which the Company is the surviving corporation and its shares of common stock are not changed or converted into equity securities of any other person, or if any person were to become the beneficial owner of 15% or more of the Company's common stock, then each right not owned by such shareholder or related parties of such shareholder (all of which will be void) will entitle its holder to purchase, at the right's then current exercise price, shares of the Company's common stock having a value of twice the right's exercise price. In addition, if the Company is involved in any other merger or consolidation with, or sells 50% or more of its assets or earning power to another person, each right will entitle its holder to purchase, at the right's then current exercise price, shares of common stock of such other person having a value of twice the right's exercise price.

The Company generally is entitled to redeem the rights at one cent per right at any time until the 15th day (or 25th day if extended by the Company's Board of Directors) following public announcement that a 15% position has been acquired or the commencement of a tender or exchange offer which, if consummated, would result in the offer or, together with all affiliates and associates thereof, being the beneficial owner of 15% or more of the Company's common stock.

Note 9. Employee Stock Ownership Plan

The Company sponsors a leveraged employee stock ownership plan (the "ESOP") that covers all nonunion employees who work 1,000 or more hours per year and are employed on June 30.  The Company makes annual contributions to the ESOP equal to the ESOP's debt service less dividends on unallocated shares received by the ESOP.  All dividends on unallocated shares received by the ESOP are used to pay debt service.  Dividends on allocated ESOP shares are recorded as a reduction of retained earnings.  As the debt is repaid, shares are released and allocated to active employees, based on the proportion of debt service paid in the year.  The Company accounts for its ESOP in accordance with Statement of Position 93-6.  Accordingly, the shares purchased by the ESOP are reported as Unearned ESOP Shares in the statement of financial position.  As shares are released or committed-to-be-released, the Company reports compensation expense equal to the current average market price of the shares, and the shares become outstanding for earnings-per-share (EPS) computations.  ESOP compensation expense was $502,990 for the year ended June 30, 2011 and $417,541 for the year ended June 30, 2010.  The ESOP shares as of June 30, 2011 and 2010 were as follows:

 
22

 
 
Espey Mfg. & Electronics Corp.
Notes to Financial Statements

Note 9. Employee Stock Ownership Plan, Continued

   
2011
   
2010
 
Allocated Shares
    443,939       453,561  
Committed-to-be-released shares
    --       --  
Unreleased shares
    157,500       179,166  
                 
Total shares held by the ESOP
    601,439       632,727  
                 
Fair value of unreleased shares
  $ 3,887,100     $ 3,379,071  

Note 10. Stock-based Compensation

The Company follows ASC 718 in establishing standards for the accounting for transactions in which an entity exchanges its equity instruments for goods or services, as well as transactions in which an entity incurs liabilities in exchange for goods or services that are based on the fair value of the entity’s equity instruments or that maybe settled by the issuance of those equity instruments. ASC 718 requires that the cost resulting from all share-based payment transactions be recognized in the financial statements based on the fair value of the share-based payment.  ASC 718 establishes fair value as the measurement objective in accounting for share-based payment transactions with employees, except for equity instruments held by employee share ownership plans.

Total stock-based compensation expense recognized in the Statement of Income for the fiscal years ended June 30, 2011 and 2010, was $66,237 and $94,423, respectively, before income taxes.  The related total deferred tax benefit was approximately $5,602 and $8,144, for the same periods.  ASC 718 requires the tax benefits resulting from tax deductions in excess of the compensation cost recognized for those options to be classified and reported as both an operating cash outflow and a financing cash inflow on a prospective basis upon adoption.

As of June 30, 2011, there was approximately $50,282 of unrecognized compensation cost related to stock option awards that is expected to be recognized as expense over the next 1.25 years.  The total deferred tax benefit related to these awards is approximately $4,556.

The Company has one employee stock option plan under which options may be granted, the 2007 Stock Option and Restricted Stock Plan (the "2007 Plan"). The Board of Directors may grant options to acquire shares of common stock to employees of the Company at the fair market value of the common stock on the date of grant.  Generally, options granted have a two-year vesting period based on two years of continuous service and have a ten-year contractual life.  Option grants provide for accelerated vesting if there is a change in control.  Shares issued upon the exercise of options are from those held in Treasury.  The 2007 Plan was approved by the Company's shareholders at the Company's Annual Meeting on November 30, 2007 and supercedes the Company's 2000 Stock Option Plan (the "2000 Plan").  Options covering 400,000 shares are authorized for issuance under the 2007 Plan, and 99,800 have been granted and 78,800 are outstanding as of June 30, 2011.  While no further grants of options may be made under the 2000 Plan, as of June 30, 2011, 53,600 options remain outstanding, vested and exercisable from the 2000 Plan.

ASC 718 requires the use of a valuation model to calculate the fair value of stock-based awards. The Company has elected to use the Black-Scholes option valuation model, which incorporates various assumptions including those for volatility, expected life and interest rates.

The table below outlines the weighted average assumptions that the Company used to calculate the fair value of each option award for the years ended June 30, 2011 and 2010, respectively:

   
2011
   
2010
 
Dividend yield
    4.69 %     5.30 %
Expected stock price volatility
    33.13 %     31.41 %
Risk-free interest rate
    1.08 %     1.79 %
Expected option life (in years)
 
4.1 years
   
4.3 years
 
Weighted average fair value per share
               
of options granted during the period
  $ 3.335     $ 2.767  
 
 
23

 

Espey Mfg. & Electronics Corp.
Notes to Financial Statements

Note 10. Stock-based Compensation, Continued

The Company pays dividends quarterly and anticipates that it will be able to continue to pay dividends in the foreseeable future.  While the Company has paid a special cash dividend of $1.00 per share in each of fiscal years 2010 and 2011, there is no assurance that the Board of Directors will declare a comparable special dividend in fiscal year 2012.  Expected stock price volatility is based on the historical volatility of the Company’s stock. The risk-free interest rate is based on the implied yield available on U.S. Treasury issues with an equivalent term approximating the expected life of the options. The expected option life (in years) represents the estimated period of time until exercise and is based on actual historical experience.

The following table summarizes stock option activity during the twelve months ended June 30, 2011:

   
Employee Stock Options Plan
 
               
Weighted
       
   
Number of
   
Weighted
   
Average
       
   
Shares
   
Average
   
Remaining
   
Aggregate
 
   
Subject
   
Exercise
   
Contractual
   
Intrinsic
 
   
To Option
   
Price
   
Term
   
Value
 
Balance at July 1, 2010
    127,600     $ 18.31       7.02        
Granted
    31,100     $ 19.20       9.13        
Exercised
    (23,800 )   $ 17.83       --        
Forfeited or expired
    (2,500 )   $ 17.54       --        
Outstanding at June 30, 2011
    132,400     $ 18.62       6.80     $ 802,813  
Vested or expected to vest at June 30, 2011
    127,537     $ 18.61       6.72     $ 774,748  
Exercisable at June 30, 2011
    99,300     $ 18.50       6.05     $ 613,300  

The aggregate intrinsic value in the table above represents the total pretax intrinsic value (the difference between the closing sale price of the Company’s common stock as reported on the NYSE-Amex on June 30, 2011 and the exercise price, multiplied by the number of in-the-money options) that would have been received by the option holders if all option holders had exercised their options on June 30, 2011.  This amount changes based on the fair market value of the Company’s common stock.  The total intrinsic values of the options exercised during the twelve months ended June 30, 2011 and 2010 was $152,855 and $23,046, respectively.

Note 11. Financial Instruments/Concentration of Credit Risk

The carrying amounts of financial instruments, including cash and cash equivalents, short term investments, accounts receivable, accounts payable and accrued expenses, approximated fair value as of June 30, 2011 and 2010 because of the relatively short maturities of these instruments.

Financial instruments that potentially subject the Company to concentrations of credit risk consist principally of cash and cash equivalents, short-term investments and accounts receivable. The Company maintains cash and cash equivalents with various financial institutions. At times such investments may be in excess of FDIC insurance limits. As disclosed in note 7, a significant portion of the Company's business is the production of military and industrial electronic equipment for use by the U.S. and foreign governments and certain industrial customers. The related accounts receivable balance, as a percentage of the Company's total trade accounts receivable balance, was 56% represented by two customers at June 30, 2011, and 55%, by three customers at June 30, 2010.

Although the Company's exposure to credit risk associated with nonpayment of these concentrated balances is affected by the conditions or occurrences within the U.S. and foreign governments, the Company believes that its trade accounts receivable credit risk exposure is limited. The Company performs ongoing credit evaluations of its customer's financial conditions and requires collateral, such as progress payments, in certain circumstances. The Company establishes an allowance for doubtful accounts based upon factors surrounding the credit risk of specific customers, historical trends and other information.

 
24

 
 
Espey Mfg. & Electronics Corp.
Notes to Financial Statements

Note 12. Related Parties

The administration of the shares of common stock held by the ESOP Trust is subject to the Second Amended and Restated Plan, effective as of July 1, 2002, creating the Trust, and a Trust Agreement dated July 15, 2005.  The Trustees’ rights with respect to the disposition of shares are governed by the terms of the Plan and the Trust Agreement.  As to shares that have been allocated to the accounts of participants in the ESOP Trust, the Plan provides that the Trustees are required to vote such shares in accordance with instructions received from the participants.  As to unallocated shares and allocated shares for which voting instructions have not been received from participants, the Plan provides that the Trustees are required to vote such shares in accordance with the direction of a Committee, appointed by the Board of Directors of the Company under the terms of the Plan and Trust Agreement.  See note 9 for additional information regarding the ESOP.

Note 13. Commitments and Contingencies

The Company at certain times enters into standby letters of credit agreements with financial institutions primarily relating to the guarantee of future performance on certain contracts.  Contingent liabilities on outstanding standby letters of credit agreements aggregated to zero at June 30, 2011 and 2010.  The Company, as a U.S. Government contractor, is subject to audits, reviews, and investigations by the U.S. government related to its negotiation and performance of government contracts and its accounting for such contracts. Failure to comply with applicable U.S. Government standards by a contractor may result in suspension from eligibility for award of any new government contract and a guilty plea or conviction may result in debarment from eligibility for awards. The government may, in certain cases, also terminate existing contracts, recover damages, and impose other sanctions and penalties. As a result of a pending U.S. government audit the Company has determined a range of possible outcomes none of which the Company believes would have a materially adverse effect on the Companys financial position or results of operations. In accordance with ASC 450 “Contingencies” the Company has accrued the amount within the range that appears to be its best estimate of a possible outcome.

Note 14. Stockholders' Equity

Reservation of Shares
The Company has reserved common shares for future issuance as follows as of June 30, 2011:

Stock options outstanding
    132,400  
Stock options available for issuance
    310,600  
Number of common shares reserved
    443,000  

The following table sets forth the reconciliation of the numerators and denominators of the basic and diluted per share computations for continuing operations for the years ended June 30:
 
   
2011
   
2010
 
Numerator:
           
Net Income
  $ 3,857,537     $ 3,564,962  
                 
Denominator:
               
Basic EPS:
               
Common shares outstanding, beginning of period
    2,319,876       2,314,803  
Unearned ESOP shares
    (179,166 )     (201,666 )
Weighted average common shares issued during the period
    9,550       20,124  
Weighted average common shares purchased during the period
    (6,964 )     (12,304 )
Weighted average ESOP shares earned during the period
    8,147       8,460  
Denominator for basic earnings per common shares –
               
Weighted average common shares
    2,151,443       2,129,417  

 
25

 
 
Espey Mfg. & Electronics Corp.
Notes to Financial Statements

Note 14. Stockholders' Equity, Continued

    2011      2010  
Diluted EPS:            
Common shares outstanding, beginning of period
    2,319,876       2,314,803  
Unearned ESOP shares
    (179,166 )     (201,666 )
Weighted average common shares issued during the period
    9,550       20,124  
Weighted average common shares purchased during the period
    (6,964 )     (12,304 )
Weighted average ESOP shares earned during the period
    8,147       8,460  
Weighted average dilutive effect of issued or forfeited shares
    24,856       8,382  
Denominator for diluted earnings per common shares –
               
Weighted average common shares
    2,176,299       2,137,799  

Not included in this computation of earnings per share for the year ended June 30, 2010 were options to purchase 29,700 of the Company's common stock.  These options were excluded because their inclusion would have been anti-dilutive due to the average strike price exceeding the average market price of those shares.  There were no anti-dilutive options for the year ended June 30, 2011.

Note 15. Quarterly Financial Information (Unaudited)
 
   
First
   
Second
   
Third
   
Fourth
 
2011
 
Quarter
   
Quarter
   
Quarter
   
Quarter
 
Net Sales
  $ 6,026,330     $ 6,581,342     $ 7,005,795     $ 9,886,037  
Gross profit
    1,650,532       1,624,799       2,047,156       2,883,712  
Net income
    753,539       649,747       1,012,031       1,442,220  
                                 
Net income per share -
                               
Basic
    .35       .30       .47       .67  
Diluted
    .35       .30       .46       .66  
                                 
2010
                               
Net Sales
  $ 6,874,940     $ 5,866,331     $ 6,955,827     $ 9,202,915  
Gross profit
    2,058,202       1,462,093       1,838,782       2,404,219  
Net income
    992,763       514,171       808,723       1,249,305  
                                 
Net income per share -
                               
Basic
    .47       .24       .38       .58  
Diluted
    .47       .24       .38       .58  

 
26

 
 
Item 9. 
Changes in and Disagreements With Accountants on Accounting and Financial Disclosure

None

Item 9A.
Controls and Procedures

Evaluation of Controls and Procedures

(a) The Company's management, with the participation of the Company's chief executive officer and chief financial officer, carried out an evaluation of the effectiveness of our disclosure controls and procedures (as defined in Rule 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934) as of the end of the period covered by this Annual Report on Form 10-K. Based on such evaluation, our chief executive officer and chief financial officer have concluded that our disclosure controls and procedures were effective as of the end of the period covered by this report.

(b) There have been no changes in our internal controls over financial reporting during the period covered by this report that have materially affected, or are reasonably likely to materially affect, our internal controls over financial reporting.

Management’s Report on Internal Control Over Financial Reporting

Management of our Company is responsible for establishing and maintaining adequate internal control over financial reporting, as that term is defined in Exchange Act Rules 13a-15(f) and 15d-15(f). Our internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles.

Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.

Under the supervision and with the participation of our management, including the principal executive officer and principal financial officer, we conducted an evaluation of the effectiveness of our internal control over financial reporting using the criteria set forth in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission. Based on our evaluation using the criteria set forth in Internal Control-Integrated Framework, management has concluded that our internal control over financial reporting was effective as of June 30, 2011.

This annual report does not include an attestation report of our registered public accounting firm regarding internal control over financial reporting. Our report was not subject to attestation by our registered public accounting firm pursuant to rules of the SEC that permit us to provide only management’s report in this annual report.

Item 9B. 
Other information

None

 
27

 
 
PART III

The information called for by "Item 10. Directors, Executive Officers, and Corporate Governance", "Item 11. Executive Compensation", "Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters", "Item 13. Certain Relationships and Related Transactions, and Director Independence" and "Item 14. Principal Accountant Fees and Services", is hereby incorporated by reference to the Company's Proxy Statement for its Annual Meeting of Shareholders, (scheduled to be held on November 17, 2011) to be filed with the SEC pursuant to Regulation 14A under the Securities Exchange Act of 1934, as amended.

PART IV

Item 15.
Exhibits, Financial Statement Schedules Signatures

3.1
 
Certificate of incorporation and all amendments thereto (incorporated by reference to Exhibit 3.1 to Espey’s Report on Form 10-K for the year ended June 30, 2004 and Report on Form 10-Q for the quarter ended December 31, 2004)
     
3.2
 
Amended and Restated By-Laws (incorporated by reference to Exhibit 3.2 to Espey’s Report on Form 8-K dated February 26, 2009)
     
4.1
 
Second Amended and Restated Rights Agreement, dated December 18, 2009, between Espey Mfg. & Electronics Corp. and Registrar and Transfer Company (incorporated by reference to Exhibit 4.01 to Espey’s Report on Form 8-K dated December 18, 2009)
     
4.2
 
Description of Capital Stock (incorporated by reference to Espey's Report on Form 8-K dated October 7, 2005)
     
10.1
 
2000 Stock Option Plan (incorporated by reference to Espey's Definitive Proxy Statement dated December 6, 1999 for the January 4, 2000 Annual Meeting)
     
10.2
 
Executive Officer contract with Howard Pinsley (incorporated by reference to Exhibit 10.2 to Espey's Report on Form 8-K dated July 27, 2009)
     
10.3
 
2007 Stock Option and Restricted Stock Plan (incorporated by reference to Espey’s Proxy Statement dated October 23, 2007 for the November 30, 2007 Annual Meeting)
     
10.4
 
Employment Agreement with David O’Neil (incorporated by reference to Exhibit 10.1 on Espey’s Report on Form 8-K dated August 17, 2009)
     
10.5
 
Retired Director Compensation Program and Mandatory Retirement Agreement (incorporated by reference to Exhibit 10.5 to Espey's Report on Form 10-Q dated May 12, 2011)
     
10.6
 
Retired Director Compensation Program and Mandatory Retirement Agreement – Paul Corr (incorporated by reference to Exhibit 10.6 to Espey's Report on Form 10-Q dated May 12, 2011)
     
10.7
 
Retired Director Compensation Program and Mandatory Retirement Agreement – Carl Helmetag (incorporated by reference to Exhibit 10.7 to Espey's Report on Form 10-Q dated May 12, 2011)
     
10.8
 
Retired Director Compensation Program and Mandatory Retirement Agreement – Barry Pinsley (incorporated by reference to Exhibit 10.8 to Espey's Report on Form 10-Q dated May 12, 2011)
     
10.9
 
Director Compensation Program and Mandatory Retirement Agreement – Howard Pinsley (incorporated by reference to Exhibit 10.9 to Espey's Report on Form 10-Q dated May 12, 2011)
     
10.10
 
Retired Director Compensation Program and Mandatory Retirement Agreement – Alvin Sabo (incorporated by reference to Exhibit 10.10 to Espey's Report on Form 10-Q dated May 12, 2011)
     
10.11
 
Retired Director Compensation Program and Mandatory Retirement Agreement – Michael Wool (incorporated by reference to Exhibit 10.11 to Espey's Report on Form 10-Q dated May 12, 2011)
     
 
Statement re: Computation of Per Share Net income (filed herewith)
 
 
28

 
 
14.1
 
Code of ethics (incorporated by reference to Espey’s website www.espey.com)
     
 
Consent of EFP Rotenberg, LLP (filed herewith)
     
 
Certification of the Chief Executive Officer pursuant to Rules 13a-14(a) and 15d-14(a) under the Securities Exchange Act of 1934, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 (filed herewith)
     
 
Certification of the Principal Financial Officer pursuant to Rules 13a-14(a) and 15d-14(a) under the Securities Exchange Act of 1934, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 (filed herewith)
     
 
Certification of the Chief Executive Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 (filed herewith)
     
 
Certification of the Principal Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 (filed herewith)

 
29

 

S I G N A T U R E S

Pursuant to the requirements of Section 13 and 15 (d) 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.
 
 
   
ESPEY MFG. & ELECTRONICS CORP.
       
       
   
/s/Mark St. Pierre
 
   
Mark St. Pierre
 
   
President and Chief Executive Officer
       
       
/s/Mark St. Pierre
 
President
 
Mark St. Pierre
 
(Chief Executive Officer)
   
September 8, 2011
 
       
/s/David O’Neil
 
Treasurer
 
David O'Neil
 
(Principal Financial Officer)
   
September 8, 2011
 
       
/s/Katrina Sparano
 
Assistant Treasurer
 
Katrina Sparano
 
(Principal Accounting Officer)
   
September 8, 2011
 
       
/s/Howard Pinsley
 
Chairman of the Board
 
Howard Pinsley
 
September 8, 2011
 
       
/s/Barry Pinsley
 
Director
 
Barry Pinsley
 
September 8, 2011
 
       
/s/Michael W. Wool
 
Director
 
Michael W. Wool
 
September 8, 2011
 
       
/s/Paul J. Corr
 
Director
 
Paul J. Corr
 
September 8, 2011
 
       
/s/Alvin O. Sabo
 
Director
 
Alvin O. Sabo
 
September 8, 2011
 
       
/s/Carl Helmetag
 
Director
 
Carl Helmetag
 
September 8, 2011
 
 
 
30