ESPEY MFG & ELECTRONICS CORP - Quarter Report: 2020 December (Form 10-Q)

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D. C. 20549

FORM 10-Q

QUARTERLY Report Pursuant to Section 13 or 15 (d) of the Securities Exchange Act of 1934

For the quarterly period ended December 31, 2020

Commission File Number I-4383

ESPEY MFG. & ELECTRONICS CORP.

(Exact name of registrant as specified in its charter)

233 Ballston Avenue, Saratoga Springs, New York 12866

(Address of principal executive offices)

518-245-4400

(Registrant's telephone number, including area code)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15 (d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.

☒ Yes         ☐ No

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).

☒ Yes          ☐ No

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company:

Indicate by check mark whether the registrant is a shell company.

☐ Yes          ☒ No

At February 12, 2021, there were 2,702,633 shares outstanding of the registrant's Common stock, $.33-1/3 par value.

ESPEY MFG. & ELECTRONICS CORP.

Quarterly Report on Form 10-Q

I N D E X

PART I: FINANCIAL INFORMATION

ESPEY MFG. & ELECTRONICS CORP.

Balance Sheets

December 31, 2020 (Unaudited) and June 30, 2020

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

ESPEY MFG. & ELECTRONICS CORP.

Statements of Comprehensive Income (Loss) (Unaudited)

Three and Six Months Ended December 31, 2020 and 2019

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

Espey Mfg. & Electronics Corp.

Statements of Changes in Stockholders' Equity (Unaudited)

Three Months Ended December 31, 2020

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

Espey Mfg. & Electronics Corp.

Statements of Changes in Stockholders' Equity (Unaudited)

Six Months Ended December 31, 2020

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

Espey Mfg. & Electronics Corp.

Statements of Changes in Stockholders' Equity (Unaudited)

Three Months Ended December 31, 2019

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

Espey Mfg. & Electronics Corp.

Statements of Changes in Stockholders' Equity (Unaudited)

Six Months Ended December 31, 2019

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

ESPEY MFG. & ELECTRONICS CORP.

Statements of Cash Flows (Unaudited)

Six Months Ended December 31, 2020 and 2019

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

ESPEY MFG. & ELECTRONICS CORP.

Notes to Financial Statements (Unaudited)

Note 1. Basis of Presentation

In the opinion of management the accompanying unaudited financial statements contain all adjustments (consisting of normal recurring adjustments) necessary for a fair presentation of the results for such periods. The results for any interim period are not necessarily indicative of the results to be expected for the full fiscal year. Certain information and footnote disclosures normally included in financial statements prepared in accordance with United States generally accepted accounting principles have been condensed or omitted. The preparation of these financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosure of assets and liabilities. On an ongoing basis, we evaluate our estimates and judgments, including those related to revenue recognition, inventories, income taxes, and stock-based compensation. Specific to inventories, including work-in-process and contracts in process, management evaluates, quarterly, those estimates used in determining the cost to complete for each contract on Espey Mfg. & Electronics Corp. (the Company's) sales backlog. During the quarter ended December 31, 2020 the Company, related to the pandemic, received notice from a customer to cancel an in-process contract. The Company recorded a write-off of inventory to cost of sales to the net realizable value of the inventory based on the terms of the contract. The change in estimates may affect the reported amount of inventories and gross profit in the current or a future period. Management bases its estimates on historical experience and on various other factors that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying amounts of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions. These financial statements should be read in conjunction with the Company's most recent audited financial statements included in its report on Form 10-K for the year ended June 30, 2020. Certain reclassifications may have been made to the prior year financial statements to conform to the current year presentation.

Note 2. Investment Securities

Accounting Standards Codification (“ASC”) 820 establishes a fair value hierarchy which requires an entity to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value. The standard describes three levels of inputs that may be used to measure fair value:

The carrying amounts of financial instruments, including cash and cash equivalents, short term investment securities, accounts receivable, accounts payable and accrued expenses, approximated fair value as of December 31, 2020 and June 30, 2020 because of the immediate or short-term maturity of these financial instruments.

Investment securities at December 31, 2020 and June 30, 2020 consist of certificates of deposit and municipal bonds which are classified as available-for-sale securities and have been determined to be level 1 assets. The cost, gross unrealized gains, gross unrealized losses and fair value of available-for-sale securities by major security type at December 31, 2020 and June 30, 2020 are as follows:

The portfolio is diversified and highly liquid. At December 31, 2020, the Company did not have any investments in individual securities that have been in a continuous loss position considered to be other than temporary.

As of December 31, 2020 and June 30, 2020, the remaining contractual maturities of available-for-sale securities were as follows:

Note 3. Net (Loss) Income per Share

Basic net (loss) income per share excludes dilution and is computed by dividing net income available to common stockholders by the weighted average number of common shares outstanding for the period. Diluted net income per share reflects the potential dilution that could occur if securities or other contracts to issue common stock were exercised or converted into common stock or resulted in the issuance of common stock that then shared in the income of the Company. The computation of diluted net (loss) income per share, excluded options to purchase 315,337 and 253,312 shares for the three and six months ended December 31, 2020 and 184,342 shares of our common stock for the three and six months ended December 31, 2019, as the effect of including them would be anti-dilutive. As unearned ESOP shares are released or committed-to-be-released the shares become outstanding for earnings-per-share computations.

Note 4. 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 may be 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 statements of comprehensive income (loss) for the three-month periods ended December 31, 2020 and 2019 was $33,707 and $45,271, respectively, before income taxes. The related total deferred tax benefits were $1,080 and $2,483 for the same periods. Total stock-based compensation expense recognized in the statements of comprehensive income (loss) for the six-month periods ended December 31, 2020 and 2019, was $80,874 and $92,447, respectively, before income taxes. The related total deferred tax benefits were $3,808 and $5,061 for the same periods.

As of December 31, 2020, there was $139,818 of unrecognized compensation cost related to stock option awards that is expected to be recognized as expense over the next 2 years. The total deferred tax benefit related to these awards is expected to be $ 7,712.

The Company has one employee stock option plan under which options or stock awards may be granted, the 2017 Stock Option and Restricted Stock Plan (the "2017 Plan"). The Board of Directors may grant options to acquire shares of common stock to employees and non-employee directors of the Company at the fair market value of the common stock on the date of grant. The maximum aggregate number of shares of Common Stock subject to options or awards to non-employee directors is 133,000 and the maximum aggregate number of shares of Common Stock subject to options or awards granted to non-employee directors during any single fiscal year is the lesser of 13,300 and 33 1/3% of the total number of shares subject to options or awards granted in such fiscal year. The maximum number of shares subject to options or awards granted to any individual employee may not exceed 15,000 in a fiscal year. 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. Options covering 400,000 shares are authorized for issuance under the 2017 Plan, of which 226,354 have been granted as of December 31, 2020. While no further grants of options may be made under the Company’s 2007 Stock Option and Restricted Stock Plan, as of December 31, 2020, 119,750 options were outstanding under such plan of which all are vested and exercisable.

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 dividend yield, 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 six months ended December 31, 2020 and 2019.

The Company declares regular dividends quarterly and declared and paid regular cash dividends of $0.50 per share for the six months ended December 31, 2020. The Company declared regular cash dividends of $0.50 per share for the six months ended December 31, 2019. 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 term (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 six months ended December 31, 2020:

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 American on December 31, 2020 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 December 31, 2020. 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 six months ended December 31, 2020 and 2019 were $0 and $263, respectively.

The following table summarizes changes in non-vested stock options during the six months ended December 31, 2020:

Note 5. Commitments and Contingencies

The Company from time to time, 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 December 31, 2020 and June 30, 2020. 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 contract audits the Company will determine a range of possible outcomes and in accordance with ASC 450 “Contingencies” the Company will accrue amounts within a range that appears to be its best estimate of a possible outcome. Adjustments are made to accruals, if any, periodically based on current information.

We are party to various litigation matters and claims arising from time to time in the ordinary course of business. While the results of such matters cannot be predicted with certainty, we believe that the final outcome of such matters will not have a material adverse effect on our business, financial condition, results of operations or cash flows. Currently, there are no matters pending.

Note 6. Revenue

The company follows ASC 606 “Revenue from Contracts with Customers” to determine the recognition of revenue. This standard requires entities to assess the products or services promised in contracts with customers at contract inception to determine the appropriate unit at which to record revenues.  Revenue is recognized when control of the promised products or services is transferred to customers at an amount that reflects the consideration to which the entity expects to be entitled to in exchange for those products or services.

Significant judgment is required in determining the satisfaction of performance obligations.  Revenues from our performance obligations are satisfied over time using the output method which considers the appraisal of results achieved and milestones reached or units delivered based on contractual shipment terms, typically shipping point.  Revenue is recognized when the customer takes control of the product or services.  The output method best depicts the transfer of control to the customer as the output method represents work completed. Control is typically transferred to the customer at the shipping point as the company has a present right to payment, the customer has legal title to the asset, the customer has the significant risks and rewards of ownership of the asset, and in most instances the customer has accepted the asset.

Total revenue recognized for the three and six months ended December 31, 2020 based on units delivered totaled $5,865,878 and $11,724,584, respectively, compared to $5,702,565 and $10,820,879 for the same periods in fiscal year 2020.  Total revenue recognized for the three and six months ended December 31, 2020 based on milestones achieved totaled $1,096,187 and $2,502,996, respectively, compared to $1,584,109 and $2,389,614 for the same periods in fiscal year 2020.

The Company offers a standard one-year product warranty. Product warranties offered by the Company are classified as assurance-type warranties, which means, the warranty only guarantees that the good or service functions as promised. Based on this, the provided warranty is not considered to be a distinct performance obligation.  The impact of variable consideration has been considered but none identified which would be required to be allocated to the transaction price as of December 31, 2020.  Our payment terms are generally 30-60 days. 

Contract liabilities were $1,650,288 and $2,175,235 as of December 31, 2020 and June 30, 2020, respectively.  The decrease in contract liabilities is primarily due to revenue recognized, offset, in part, by the advance collection of cash on specific contracts. The company used the practical expedient to expense incremental costs incurred to obtain a contract when the contract term is less than one year.

The Company’s backlog at December 31, 2020 totaling $60.1 million is expected, based on expected due dates, to be recognized in the following fiscal years: 27% in 2021; 51% in 2022; 12% in 2023, and 10% thereafter.   

Note 7. Recently Issued Accounting Standards

Recent Accounting Pronouncements Adopted

In August 2018, the FASB issued ASU No. 2018-13, “Fair Value Measurement (Topic 820): Disclosure Framework – Changes to the Disclosure Requirements for Fair Value Measurement.”  This ASU is part of the FASB’s larger disclosure framework project intended to improve the effectiveness of financial statement footnote disclosure.  ASU 2018-13 modifies required fair value disclosures related primarily to level 3 investments.  This ASU is effective for annual periods beginning after December 15, 2019 and interim periods within those annual periods.  The adoption of ASU 2018-13 does not have a material effect on the Company’s financial position, results of operations, and cash flows as our investments are currently Level 1. We will, however, continue to evaluate going forward should we obtain any Level 3 investments.

Recent Accounting Pronouncements Not Yet Adopted

In December 2019, the FASB issued guidance (ASU 2019-12) intended to simplify the accounting for income taxes. The amendments in this guidance are effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2020 (the Company’s fiscal 2021), with early adoption permitted. The Company is currently evaluating the potential impact of this guidance on the Company’s disclosures.

Note 8. 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.  Prior to December 1, 2020, the ESOP owned 469,119 shares, all of which were allocated to employees.  On December 1, 2020, pursuant to a Stock Purchase Agreement dated as of such date, the Company, by selling 300,000 shares of its common stock, par value $0.33 1/3 per share, to the Espey Mfg. & Electronics Corp. Employee Stock Ownership Plan Trust, provided more shares to be allocated to employees for services rendered over the next 15 years.  The ESOP paid $18.29 per share, for an aggregate purchase price of $5,487,000.  The determination of the purchase price was based on a fairness opinion obtained by an independent valuation firm.  The ESOP borrowed from the Corporation an amount equal to the purchase price.  The loan will be repaid in fifteen (15) equal annual installments of principal.  The Board of Directors has fixed the interest rate and the unpaid balance will bear interest at a fixed rate of 3.00% per annum.

The Board of Directors of the Company had approved a purchase price per share equal to the lesser of the trading value on the day of closing or the lowest price listed in the valuation established by the independent valuation firm plus $0.25. The valuation identified a range of $18.04 - $19.43 per share.   

In making the sale, the Company relied on the exemption from registration under Section 4(2) of the Securities Act of 1933, as amended, because the shares sold were offered only to the ESOP.

After giving effect to the transaction, the ESOP owned 769,119 shares of the Company's 2,702,633 outstanding shares of common stock as of December 1, 2020.

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 FASB ASC 718-40. Accordingly, the shares purchased by the ESOP are reported as Unearned ESOP shares in the balance sheets and the statements of changes in stockholders’ equity. 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 $56,274 and $77,987 for the three-month periods ended December 31, 2020 and 2019, respectively. ESOP compensation expense was $56,274 and $165,820 for the six-month periods ended December 31, 2020 and 2019, respectively.

The ESOP shares as of December 31, 2020 and 2019 were as follows:

The Company may at times be required to repurchase shares at the ESOP participants’ request at the fair market value. During the three and six months ended December 31, 2020 the Company did not repurchase shares previously held by the ESOP. During the three and six months ended December 31, 2019 the Company repurchased 1,847 and 2,180 shares previously held by the ESOP for $39,658 and $47,949, respectively.

The ESOP allows for eligible participants to take whole share distributions from the Plan on specific dates in accordance with the provision of the Plan.  Share distributions from the ESOP during the six months ended December 31, 2020 and 2019 totaled 456 and 2,180, respectively.

Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations

Overview

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. 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 American 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 9001:2015 and AS9100:2016 certified. 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, painting services, and development of automatic testing equipment. Espey is vertically integrated, meaning that the Company produces individual components (including inductors), populates printed circuit boards, fabricates metalwork, paints, wires, qualifies, and fully tests items, mechanically, electrically and environmentally, in house. Portions of the manufacturing and testing process are subcontracted to vendors from time to time.

The Company markets its products primarily through its own direct sales organization and through outside sales representatives. Business is solicited from large industrial manufacturers and defense companies, the government of the United States, foreign governments and major foreign electronic equipment companies. Espey is also on the eligible list of contractors with the United States Department of Defense. We pursue opportunities for prime contracts directly with the Department of Defense and are generally automatically solicited by Department of Defense 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.

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.

Our business is not seasonal. However, the concentration of our business in the rail industry, and in equipment for military applications and industrial applications, and our customer concentrations expose us to on-going associated risks. These risks include, without limitation, fluctuating requirements for power supplies in the rail industry, dependence on appropriations from the United States Government and the governments of foreign nations, program allocations, the potential of governmental termination of orders for convenience, and the general strength of the industry sectors in which our customers transact business.

In order to compete effectively for new business, in some cases we have invested in upfront design costs, thereby reducing initial profitability as a means of procuring new long-term programs. As part of our strategy, we adjust our pricing in order to achieve a balance which enables us both to retain repeat programs while being more competitive in bidding on new programs.

We continue to place an emphasis on securing “build to print” opportunities, which will allow production work to go directly to the manufacturing floor, limiting the impact on our engineering staff. This allows us to keep our manufacturing team busy while the products are being developed in-house to production.

The total backlog at December 31, 2020 was approximately $60.1 million, which included $26.5 million from three significant customers, compared to $58.4 million at December 31, 2019, which included $30 million from four significant customers. The Company’s total backlog represents the estimated remaining sales value of work to be performed under firm contracts. The funded portion of this backlog at December 31, 2020 is approximately $57.7 million. This includes items that have been authorized and appropriated by Congress and/or funded by the customer. The unfunded backlog at December 31, 2020 is approximately $2.4 million and represents two firm multi-year orders from a single customer for which funding has not yet been appropriated by Congress or funded by our customer. While there is no guarantee that future budgets and appropriations will provide funding for individual programs, management has included in unfunded backlog only those programs that it believes are likely to receive funding based on discussions with customers and program status. The unfunded backlog at December 31, 2019 was $2.7 million, comprised of one of the same multi-year orders from a single customer. Contracts are subject to modification, change or cancellation, and the Company accounts for these changes as they are probable and estimable. The Company evaluates the impact of any scope modifications and will adjust reserves as information is known and estimable.

Successful conversion of engineering program backlog into sales is largely dependent on the execution and completion of our engineering design efforts.   It is not uncommon to experience technical or scheduling delays which arise from time to time as a result of, among other reasons, design complexity, the availability of personnel with the requisite expertise, and the requirements to obtain customer approval at various milestones.  Cost overruns which may arise from technical and schedule delays could negatively impact the timing of the conversion of backlog into sales, or the profitability of such sales.  We continue to experience technical and schedule delays with our major development programs. However, these delays are being resolved as they arise and we do not expect any negative impact on our customer order fulfillment projections for fiscal year 2021. Engineering programs in both the funded and unfunded portions of the current backlog aggregate $5.7 million. 

The global outbreak of the novel strain of coronavirus COVID-19 disease was declared a pandemic by The World Health Organization (WHO) during March 2020. This resulted in initial country and state-wide mandated closures of non-essential businesses lasting various durations as determined by local jurisdictions. In most instances, businesses have since re-opened, some with limited or reduced capacity due to adherence and compliance with reopening and mitigation guidelines set in place to help prevent workplace exposures. Deemed an essential business, authorized by the Department of Homeland Security, we remained open and continue to be fully operational. Global supply chain disruptions from closures has had an impact on our ability to ship product during the first half of fiscal year 2021. As the effects of the pandemic continue world-wide, we believe it is likely we will continue to experience some trickle-down effects to our direct supply base which may impact our ability to ship some scheduled deliveries for the foreseeable future. Presently, we expect these disruptions to be minimal in nature and could result in our suppliers extending lead times for materials or, in some rare instances, require us to procure materials from an alternate supplier in order to meet contractual dates which could impact our anticipated material costs.

The pandemic has had a direct effect on at least one key customer of the Company with resulting significant impact on the Company. Subsequent to fiscal year ended June 30, 2020, the Company received a request from a customer to stop work temporarily on a design and production contract for a product to be used in the airline industry for a minimum of 120 days. As of December 31, 2020, the contract was cancelled by the customer and as a result the Company has reduced the contract value from $1.7 million to approximately $0.4 million to cover the carrying value of inventory and selling, general and administrative expenses. The current impact to the financial statements for this reduction is discussed in Results of Operations, below. The Company is reviewing legal options and will continue to evaluate the financial statement impact.

Management expects revenues in fiscal year 2021 to approximate revenues during fiscal year 2020 but expects the net income per share to be lower in fiscal year 2021 than the net income per share during fiscal year 2020. These expectations are driven by orders already in our sales backlog. Net income per share has been lowered due to a lower sales expectation and an adjustment made to gross profit in the current quarter related to an inventory write-off discussed in greater detail in Results of Operations.

The Company currently expects new orders in fiscal 2021 to approximate the $40.9 million in new orders received in fiscal year 2020. As market factors including competition and product costs impact gross profit margins, management will continue to evaluate our sales strategy, employment levels, and facility costs.

New orders received in the first six months of fiscal year 2021 were $19.4 million as compared to $26 million new orders received in the first six months of fiscal 2020. It is presently anticipated that a minimum of $16.3 million of orders comprising the December 31, 2020 backlog will be filled during the fiscal year ending June 30, 2021. The minimum of $16.3 million does not include any shipments, which may be made against orders subsequently received during the fiscal year ending June 30, 2021. The estimate of the December 31, 2020 backlog to be shipped in fiscal year 2021 is subject to future events, which may cause the amount of the backlog actually shipped to differ from such estimate.

In addition to the backlog, the Company currently has outstanding opportunities representing approximately $80.8 million in the aggregate as of February 5, 2021 for both repeat and new programs. 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 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.

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. Net sales to three significant customers represented 47% of the Company’s total sales for the three-month period ended December 31, 2020. Net sales to three significant customers represented 42% of the Company’s total sales for the three-month period ended December 31, 2019. Net sales to four significant customer represented 58% of the Company’s total sales for the six-month period ended December 31, 2020. Net sales to one significant customer represented 25.2% of the Company’s total sales for the six-month period ended December 31, 2019. This high concentration level with these customers presents significant risk. A loss of one of these customers or programs related to these customers could 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.

Critical Accounting Policies and Estimates

Management believes our most critical accounting policies include revenue recognition and cost estimation on our contracts.

Revenue

The majority of our net sales is generated from contracts with industrial manufacturers and defense companies, the Department of Defense, other agencies of the government of the United States and foreign governments for the design, development and/or manufacture of products. We provide our products and design and development services under fixed-price contracts. Under fixed-price contracts we agree to perform the specified work for a pre-determined price. To the extent our actual costs vary from the estimates upon which the price was negotiated, we will generate more or less profit or could incur a loss.

We account for a contract after it has been approved by all parties to the arrangement, the rights of the parties are identified, payment terms are identified, the contract has commercial substance, and collectability of consideration is probable. We assess each contract at its inception to determine whether it should be combined with other contracts. When making this determination, we consider factors such as whether two or more contracts were negotiated and executed at or near the same time, or were negotiated with an overall profit objective.

We evaluate the products or services promised in each contract at inception to determine whether the contract should be accounted for as having one or more performance obligations. Significant judgment is required in determining performance obligations. We determine the transaction price for each contract based on the consideration we expect to receive for the products or services being provided under the contract. The transaction price for each performance obligation is based on the estimated standalone selling price of the product or service underlying each performance obligation. Transaction prices on our contracts subject to the Federal Acquisition Regulations (FAR) are typically based on estimated costs plus a reasonable profit margin.

We recognize revenue using the output method based on the appraisal of results achieved and milestones reached or units delivered based on contractual shipment terms, typically shipping point.

Inventory

Raw materials are valued at the lower of cost (average cost) or net realizable value. Balances for slow-moving and obsolete inventory are reviewed on a regular basis by analyzing estimated demand, inventory on hand, sales levels, market conditions, and other information and reduce inventory balances based on this analysis.

Inventoried work relating to contracts in process and work in process is valued at actual production cost, including factory overhead incurred to date. Contract costs include material, subcontract costs, labor, and an allocation of overhead costs. Work in process represents spare units and parts and other inventory items acquired or produced to service units previously sold or to meet anticipated future orders. Provision for losses on contracts is made when the existence of such losses becomes probable and estimable.  The provision for losses on contracts is included in other accrued expenses on the Company’s balance sheet.  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.

The estimation of total 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, the change is reflected in current period earnings.

Contract Liabilities

Contract liabilities include advance payments and billings in excess of revenue recognized.

Results of Operations

Net sales decreased for the three months ended December 31, 2020 to $6,962,065 as compared to $7,286,674 for the same period in 2019. Net sales for the six months ended December 31, 2020 increased to $14,227,580 as compared to $13,210,493 for the same period in 2019. For the three months ended December 31, 2020, sales decreased due to a decline in magnetic and power supply sales offset, in part, by an increase in build to print shipments. For the six months ended December 31, 2020, the increase in net sales is primarily due to an increase in build to print sales, offset in part, by a decline in power supply shipments. Magnetic sales decreased in the current three month period primarily from product mix. Several programs which had reached completion, provided little or no sales in the current period when compared to the same period last year offset, in part, by shipments in the current period on one existing significant design and production contract in which there were no sales in the same period last year. Magnetic sales were also negatively impacted in the current three month period from fewer sales on one specific contract due to the timing of contractual delivery dates. Power supply sales decreased modestly in the three month period and decreased more significantly in the six month period when compared to the same periods last year. The decline in sales in both periods resulted primarily from two specific programs which had reached completion, providing little or no sales in the current periods when compared to the same periods last year. These decreases were offset, in part, by shipments on a larger contract which had minimal sales in the comparative periods last year. Build to print sales increased in both the three and six month periods from multiple contracts of varying size, scope and duration with the largest concentration of sales in both periods related to one significant contract.

We continued to be constrained by engineering design changes required to meet customer requirements, certain supplier product non-conformances, obtaining timely resolutions on issues encompassing build to print customer-owned drawings and an increase in lead times for many parts, including certain electronic components due to industry shortages and volatility within the power electronics industry. We are also experiencing an increase in delays with certain supplier deliveries resulting from COVID. Engineering, program management, and supply chain personnel are working closely with our customers and suppliers to execute on our past due deliveries and we do not expect this situation to affect future business opportunities. We anticipate that many of these issues will be resolved during fiscal 2021. However, COVID has had a direct impact on the airline industry and, as noted above, a resulting impact on the Company contract which has been cancelled by the customer.

Gross profits for the three months ended December 31, 2020 and 2019 were $713,461 and $1,480,148, respectively. Gross profit as a percentage of sales was 10.2% and 20.3%, for the same periods, respectively. For the six months ended December 31, 2020 and 2019, gross profits were $1,840,835 and $2,616,496, respectively. Gross profit as a percentage of sales was 12.9% and 19.8%, for the same periods, respectively. The primary factors in determining the change in gross profit and net income are overall sales levels and product mix. The gross profits on mature products and build to print contracts are typically higher as compared to products which are still in the engineering development stage or in early stages of production. In the case of the latter, the Company can incur what it refers to as “loss contracts,” primarily on engineering design contracts in which the Company invests with the objective of developing future product sales. In any given accounting period the mix of product shipments between higher margin programs and less mature programs, and expenditures associated with loss contracts, has a significant impact on gross profit and net income.

Several factors contributed to a decrease in the gross profit percentage in the three months ended December 31, 2020 as compared to the same period in 2019.  First, the Company wrote down the value of inventory by $335,000, equivalent to approximately fifty percent of the inventory balance, pertaining to a certain design and production contract serving the airline industry which was cancelled by the customer during the fiscal quarter.   We made the adjustment to the cost of sales after the customer rejected our initial proposal for a contract settlement.  Discussions with this customer continue and the Company is reviewing its legal options.  Collections in respect of this contract which may be received in the future will be recognized in income, if and when received.  Second, build to print shipments, including on one contract which yielded no gross profit, in the aggregate yielded lower margins on a higher sales base when compared to the same period last year.  There had been no sales on the specific contract during the prior year.  Third, the gross profit percentage was negatively impacted by a reduction of shipments during the fiscal quarter of magnetic products which had represented robust sales and margins during the same quarter last year. The gross profit percentage decreased in the six months ended December 31, 2020 as compared to the same period in 2019 primarily from product mix, specifically on build to print shipments which yielded lower margins on a higher sales base when compared to the same period last year.  This is largely attributed to a specific contract which had no comparable sales in the prior period.  In addition, the gross profit percentage was negatively impacted by the inventory adjustment made to a specific contract discussed above. 

Selling, general and administrative expenses were $945,478 for the three months ended December 31, 2020, a decrease of $304,264, compared to the three months ended December 31, 2019. Selling, general and administrative expenses were $1,860,104 for the six months ended December 31, 2020, a decrease of $473,850 compared to the six months ended December 31, 2019. The decrease for the three months ended December 31, 2020 as compared to the same period in 2019 relates primarily to the decrease in employee compensation, travel, and board of director’s fees resulting from a reduction of one director. The decrease for the six months ended December 31, 2020 as compared to the same period in 2019 relates primarily to the decrease in employee compensation, travel, conference and training expenditures, audit fees due to the timing of progress billings, reduction in outside services supporting sales leads, and a decrease in board of director’s fees due to a reduction of one director. For both periods, employee compensation decreased due to a reduction in workforce and cost reduction measures implemented that included forgoing cost of living increases and the payment of bonuses during the current fiscal year.

Other income for the three months ended December 31, 2020 and 2019 was $15,487 and $38,764, respectively. Other income for the six months ended December 31, 2020 and 2019 was $33,831 and $86,253, respectively. The decrease for the three and six months ended is primarily due to the reduction in investment securities and interest rate reductions. Interest income is a function of the level of investments and investment strategies which generally tend to be conservative.   

The Company’s effective tax rates for the three and six months ended December 31, 2020, were 16.4% and 39.5%, respectively, compared to 14.9% and 15.7% for the three and six months ended December 30, 2019, respectively. The effective tax rate in fiscal 2021 and 2020 is less than the statutory tax rate mainly due to the benefit derived from the ESOP dividends paid on allocated shares. The increase in the effective tax rate between periods resulted from discreet tax adjustments relative to income before taxes.    

Net loss for the three months ended December 31, 2020, was $(181,006) or $(0.08) per share, basic and diluted, compared to net income of $228,964 or $0.10 per share, basic and diluted, for the three months ended December 31, 2019. Net income for the six months ended December 31, 2020, was $8,817 or $0.00 per share, basic and diluted, compared to $310,740 or $0.13 per share, basic and diluted, for the six months ended December 31, 2019. The decrease in net income in the three and six months ended resulted from the decrease in gross profit and lower other income offset, in part, by the decrease in selling, general and administrative, all discussed above.

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. Management has available a $3,000,000 line of credit to help fund further growth or working capital needs, if necessary, but does not anticipate the need for any borrowed funds in the foreseeable future. Contingent liabilities on outstanding standby letters of credit agreements aggregated to zero at December 31, 2020 and 2019. The line of credit is reviewed annually in November for renewal by December 1^st.

The Company's working capital as of December 31, 2020 and 2019 was approximately $27.1 million and $27.7 million, respectively. The Company may at times be required to repurchase shares at the ESOP participants’ request at the fair market value. During the three and six months ended December 31, 2020 the Company did not repurchase any shares held by the ESOP. During the three and six months ended December 31, 2019 the Company repurchased 1,847 and 2,180 shares previously held by the ESOP for $39,658 and $47,949, respectively. Under existing authorizations from the Company's Board of Directors, as of December 31, 2020, management is authorized to purchase an additional $783,460 of Company stock.

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

Net cash provided by operating activities fluctuates between periods primarily as a result of differences in sales and net income, provision for income taxes, the timing of the collection of accounts receivable, purchase of inventory, and payment of accounts payable. The decrease in cash provided by operating activities compared to the prior year primarily relates to the decrease in cash collected from customers as advances in contract liabilities, a decrease in trade accounts receivables collected, and the decrease in net income, offset, in part, by a decrease in spending on accounts payable, inventory purchases and prepaid expenses. Net cash provided by investing activities increased in the six months ended December 31, 2020 as compared to the same period in 2019 primarily due to maturing investments that were not reinvested during this period when compared to the same period last year. Cash used in financing activities increased minimally during the current period. The increase is primarily due to the decrease in cash proceeds collected from the exercise of stock options offset by the decrease in the purchase of treasury stock as compared to the same period last year.

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.

During the six months ended December 31, 2020 and 2019, the Company expended $29,173 and $177,826, respectively, for plant improvements and new equipment. The Company has budgeted approximately $200,000 for new equipment and plant improvements in fiscal year 2021. Management anticipates that the funds required will be available from current operations.

CAUTIONARY STATEMENT FOR PURPOSES OF THE "SAFE HARBOR" PROVISIONS OF THE PRIVATE

SECURITIES LITIGATION REFORM ACT OF 1995

This report contains "forward-looking statements" within the meaning of the Private Securities Litigation Reform Act of 1995. The terms "believe," "anticipate," "intend," "goal," "expect," and similar expressions may identify forward-looking statements. These forward-looking statements represent the Company's current expectations or beliefs concerning future events. The matters covered by these statements are subject to certain risks and uncertainties that could cause actual results to differ materially from those set forth in the forward-looking statements, including the Company's dependence on timely development, introduction and customer acceptance of new products, the impact of competition and price erosion, supply and manufacturing constraints, potential new orders from customers, the impact of cyber or other security threats or other disruptions to our business, the impact of the COVID-19 pandemic on the United States economy and our operations and other risks and uncertainties. The foregoing list should not be construed as exhaustive, and the Company disclaims any obligation subsequently to revise any forward-looking statements to reflect events or circumstances after the date of such statements or to reflect the occurrence of anticipated or unanticipated events. The Company wishes to caution readers not to place undue reliance on any such forward-looking statements, which speak only as of the date made.

Item 3. Quantitative and Qualitative Disclosures About Market Risk

The Company is a smaller reporting company as defined under Securities and Exchange Commission Rule 12b-2. Pursuant to the exemption available to smaller reporting company issuers under Item 305 of Regulation S-K, quantitative and qualitative disclosures about market risk, the Company is not required to provide the information for this item.

Item 4. 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 Quarterly Report on Form 10-Q. 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.

PART II: Other Information and Signatures

We are party to various litigation matters and claims arising from time to time in the ordinary course of business.  While the results of such matters cannot be predicted with certainty, we believe that the final outcome of such matters will not have a material adverse effect on our business, financial condition, results of operations or cash flows.  

None

Not applicable

None

S I G N A T U R E S

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

Date: February 16, 2021