ESPEY MFG & ELECTRONICS CORP - Quarter Report: 2021 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, 2021

OR

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

 

Commission File Number 1-4383

 

 

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:

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Securities Exchange Act. ☐

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

At February 11, 2022, 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, 2021 (Unaudited) and June 30, 2021

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, 2021 and 2020

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

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

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

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

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, 2021 and 2020

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”) sales backlog. 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, 2021. 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 investments, accounts receivable, accounts payable and accrued expenses, approximated fair value as of December 31, 2021 and June 30, 2021 because of the immediate or short-term maturity of these financial instruments.

Investment securities at December 31, 2021 and June 30, 2021 consist of certificates of deposit 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, 2021 and June 30, 2021 are as follows:

The portfolio is diversified and highly liquid and primarily consists of investment grade fixed income instruments. At December 31, 2021, 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, 2021 and June 30, 2021, the remaining contractual maturities of available-for-sale securities were as follows:

Note 3. Net Income per Share

Basic net 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 income per share, excluded options to purchase 316,912 shares of our common stock for the three and six months ended December 31, 2021 and 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, as the effect of including them would be anti-dilutive. As unearned shares owned by the Company’s sponsored leveraged employee stock ownership plan (the “ESOP”) 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 for the three-month periods ended December 31, 2021 and 2020 was $41,791 and $33,707, respectively, before income taxes. The amount of this stock-based compensation expense related to non-qualified stock options (“NQSO”) for the three-month periods ended December 31, 2021 and 2020, was $8,757 and $5,143, respectively. The deferred tax benefit related to the NQSO’s as of December 31, 2021 and 2020 was approximately $1,839 and $1,080, respectively. Total stock-based compensation expense recognized in the statements of comprehensive income for the six-month periods ended December 31, 2021 and 2020, was $94,567 and $80,874, respectively, before income taxes. The amount of this stock-based compensation expense related to non-qualified stock options (“NQSO”) for the six-month periods ended December 31, 2021 and 2020, was $16,123 and $18,131, respectively. The deferred tax benefit related to the NQSO’s as of December 31, 2021 and 2020 was approximately $3,386 and $3,808, respectively. The remaining stock option expense in each year related to incentive stock options (“ISO”) which are not deductible by the corporation when exercised, assuming a qualifying disposition and as such no deferred tax benefit was established related to these amounts.

As of December 31, 2021, there was approximately $219,311 of unrecognized compensation cost related to stock option awards that is expected to be recognized as expense over the next 2 years, of which $179,408 relates to ISO’s and $39,903 relates to NQSO’s. The total deferred tax benefit related to these awards is expected to be $8,380.

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. The plan allows for cancelled or expired options to be re-granted to participants at a later date. 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. As of December 31, 2021, 303,904 shares have been granted, of which 228,062 are outstanding, and 171,938 remain available for grant. While no further grants of options may be made under the Company’s 2007 Stock Option and Restricted Stock Plan, as of December 31, 2021, 98,050 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, 2021 and 2020.

Effective March 9, 2021, the Company suspended the payment of its regular quarterly dividend. For the six months ended December 31, 2020, the Company declared and paid regular cash dividends of $0.50 per share, and for the six months ended December 31, 2021 the Company paid no cash dividends. 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, 2021:

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, 2021 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, 2021. This amount changes based on the fair market value of the Company’s common stock. The intrinsic value of options exercised during the six months ended December 31, 2021 and 2020 was $0, resulting from no option exercise activity during those periods.

The following table summarizes changes in non-vested stock options during the six months ended December 31, 2021:

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, 2021 and June 30, 2021. 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, or as, 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, 2021 based on units delivered was $6,100,228 and $12,592,464, respectively, compared to $5,865,878 and $11,724,584 for the same periods in fiscal year 2021. Total revenue recognized for the three and six months ended December 31, 2021 based on milestones achieved was $1,357,822 and $2,411,018, respectively, compared to $1,096,187 and $2,502,996 for the same periods in fiscal year 2021.

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, 2021. Our payment terms are generally 30-60 days.

Contract liabilities were $2,904,746 and $3,077,605 as of December 31, 2021 and June 30, 2021, 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, 2021 totaling approximately $70.1 million is projected, based on expected due dates, to be recognized in the following fiscal years: 30% in 2022; 43% in 2023; 21% in 2024, and 6% thereafter.

Note 7. Recently Issued Accounting Standards

Recent Accounting Pronouncements Adopted

In December 2019, the FASB issued ASU 2019-12, “Income Taxes (Topic 740): Simplifying the Accounting for Income Taxes.” ASU 2019-12 amends ASC 740 to simplify the accounting for income taxes by removing certain exceptions for investments, intraperiod allocations and interim calculations, and adding guidance to reduce complexity in the accounting standard under the FASB’s simplification initiative. ASU 2019-12 is effective for public entities for fiscal years beginning after December 15, 2020. Upon adoption, the amendments in ASU 2019-12 should be applied on a prospective basis to all periods presented. The Company adopted the new guidance under ASU 2019-12 in the first quarter of fiscal year 2021 and removed the exception for intraperiod allocations from its interim period tax provision calculation, accordingly. The removal of the exception for intraperiod allocations did not have a material impact on the Company.

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. Any dividends on unallocated shares received by the ESOP are used to pay debt service. Any 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 $83,812 and $56,274 for the three-month periods ended December 31, 2021 and 2020, respectively. ESOP compensation expense was $168,318 and $56,274 for the six-month periods ended December 31, 2021 and 2020, respectively.

The ESOP shares as of December 31, 2021 and 2020 were as follows:

The Company may at times be required to repurchase shares at the ESOP participants’ request at the shares’ fair market value. During the three and six months ended December 31, 2021 and 2020, the Company did not repurchase shares previously held by the ESOP.

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, 2021 and 2020 totaled 8,285 and 456 shares, respectively.

 

Index 

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.

 

Future procurement needs supporting the military and the rail industry continue to drive competition. Many of our competitors have invested, and they continue to invest aggressively in upfront product design costs and accept lower profit margins as a strategic means of maintaining existing business and enhancing market share. This continues to put pressure on the pricing of our current products and has lowered our profit margins on some of our new 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, 2021 was approximately $70.1 million, which included $45.8 million from four significant customers, compared to approximately $60.1 million at December 31, 2020, which included $26.5 million from three 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, 2021 is approximately $69.7 million. This includes items that have been authorized and appropriated by Congress and/or funded by the customer. The unfunded backlog at December 31, 2021 is approximately $0.4 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, 2020 was approximately $2.4 million, comprised 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. The issues causing the delays are being resolved as soon as possible. Engineering programs in both the funded and unfunded portions of the current backlog aggregate $7.2 million.

 

The growth and continuing demand in the power electronics industry across multiple manufacturing sectors has created volatility and unpredictability in the availability of certain electronic components and, in some cases, continues to create industry shortages. These shortages have and will likely continue to impact our ability to support our customer’s schedule demands, as lead times for these components have, in some instances, increased from readily available to waiting times of nearly a year or more. In addition, we continue to incur delays in material deliveries from some company suppliers due to the COVID-19 pandemic. We continue to work with our customers to mitigate any adverse impact upon our ability to service their requirements. These issues, if they persist, may cause us to miss projected delivery dates.

 

Management expects revenues in fiscal year 2022 to be higher than revenues during fiscal year 2021 and expects to generate net income per share as compared to the net loss per share realized during fiscal year 2021. These expectations are driven by orders already in our sales backlog.

 

Management continues to closely monitor the impact of evolving workforce and supplier constraints, primarily from the effects from the pandemic, to our planned delivery schedules. We continue to experience disruptions from workforce absences due to COVID-19 illnesses and direct contact exposures, resulting in self-isolating protocols to be followed to ensure the safety of company personnel. In addition, we are experiencing disruptions from workforce turnover, as local businesses emerging from the pandemic compete for personnel. Many of our positions require certain skillsets resulting in longer than average time to fill position vacancies. Some company suppliers continue to incur similar disruptions, in addition to incurring longer lead times on certain raw materials.

 

The Company currently expects new orders in fiscal 2022 to approximate the $38.5 million in new orders received in fiscal year 2021. 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 2022 were approximately $19.5 million as compared to $19.4 million new orders received in the first six months of fiscal 2021. It is presently anticipated that a minimum of $21 million of orders comprising the December 31, 2021 backlog will be filled during the fiscal year ending June 30, 2022 subject, however, to the impact of the factors identified above. The minimum of $21 million does not include any shipments, which may be made against orders subsequently received during the fiscal year ending June 30, 2022.

 

In addition to the backlog, the Company currently has outstanding opportunities representing approximately $63 million in the aggregate as of February 1, 2022 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 four significant customers represented 59% of the Company’s total sales for the three-month period ended December 31, 2021. 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 five significant customer represented 67% of the Company’s total sales for the six-month period ended December 31, 2021. Net sales to four significant customers represented 58% of the Company’s total sales for the six-month period ended December 31, 2020. Improvement has been made in customer concentrations recently. However, this high customer concentration level continues to present significant risk. A loss of one of these customers or programs related to these customers, or customer requested deferrals of product delivery 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. Management continues to pursue 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. Given the nature of our business, we believe our existing sales order backlog is fairly diversified in terms of customers and the category of products on order.

 

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 increased for the three months ended December 31, 2021 to $7,458,050 as compared to $6,962,065 for the same period in 2020. Net sales for the six months ended December 31, 2021 increased to $15,003,482 as compared to $14,227,580 for the same period in 2020. For the three months ended December 31, 2021, sales increased primarily from an increase in magnetic sales. For the six months ended December 31, 2021, the increase in sales is primarily due to an increase in build to print and magnetic sales, offset in part, by a decline in power supply, repair and antenna shipments. In general, sales fluctuations within product categories will occur during a comparable fiscal period as the direct result of product mix, influenced by the duration of specific programs and the contractual terms of firm orders placed for product and services under those programs including contract value, scope of work and duration. Deliverables within firm contracts are often subject to delivery schedules which also contributes to sales fluctuations between comparable periods. Internal and external constraints, at times, impact our ability to ship. The impact of the COVID-19 pandemic continues to impact raw material delivery schedules with longer lead times on certain raw materials and lends to unplanned employee absences due to sickness and self-isolating protocols in place. In addition, we are experiencing disruptions from workforce turnover, as local businesses emerging from the pandemic compete for personnel. These disruptions have a direct impact on our ability to optimally build, test, inspect and ship product. Specific to the current three and six month periods discussed above, the fluctuations when compared to the same periods last year were primarily the result of contractual timing offset, in part, by internal and external constraints, all discussed above.

 

In addition, we continued to be constrained by (i) engineering design changes required to meet customer requirements, (ii) certain supplier product non-conformances, (iii) delays in obtaining timely resolutions on issues encompassing build to print customer-owned drawings, and (iv) an increase in lead times for many parts, including certain electronic components due to industry shortages and volatility within the power electronics industry. 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.

 

Gross profits for the three months ended December 31, 2021 and 2020 were $1,206,817 and $713,461, respectively. Gross profit as a percentage of sales was approximately 16.2% and 10.2%, for the same periods, respectively. For the six months ended December 31, 2021 and 2020, gross profits were $2,559,915 and $1,840,835, respectively. Gross profit as a percentage of sales was 17.1% and 12.9%, 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 an increase in gross profit and the gross profit percentage in the three months ended December 31, 2021 as compared to the same period in 2020. First, there was an increase in sales on magnetic shipments and the product mix comprising those shipments. This improvement resulted mostly from higher sales and improved margins on a select production contract when compared to sales for the same period last year. Second, the current quarter profit on build to print shipments improved on fairly comparable sales, in aggregate, between periods, resulting from product mix, and is primarily attributable to a specific program in which there were no comparable sales in the prior year. Finally, specific to the prior year, gross profit was negatively impacted by an inventory write-down pertaining to a certain design and production contract serving the airline industry which was cancelled by the customer. These improvements during the current quarter were offset, to a lesser extent, by the expensing of remaining development costs formerly capitalized in inventory on an engineering design program in which our customer has delayed unit qualification testing and for which production units are not expected to be manufactured in the near term.

 

The improvement in gross profit and the gross profit percentage in the six months ended December 31, 2021 as compared to the same period in 2020 resulted primarily from an increase in sales and the gross profit percentage on magnetic and build to print shipments resulting primarily from product mix. The increase in gross profits on magnetic shipments was primarily driven by the increase in sales on certain mature product when compared to the same period last year. The increase in gross profits on build to print shipments was primarily driven by the increase in sales on certain mature product when compared to the same period last year, as well as, sales and higher margins on a specific program in which there were no comparable sales in the prior year. This improvement in build to print shipments was offset, in part, by increased spending on as specific build to print contract when compared to the same period last year. Comparatively, and specific to the prior year, gross profit was negatively impacted by an inventory write-down pertaining to a certain design and production contract serving the airline industry which was cancelled by the customer. Gross profit in the current year was reduced, in part, by an increase in spending incurred on several power supply design contracts when compared to the same period last year. In addition, gross profit was reduced, to a lesser extent, by the expensing of remaining development costs formerly capitalized in inventory on an engineering power supply design contract in which our customer has delayed unit qualification testing and for which production units are not expected to be manufactured in the near term.

 

Selling, general and administrative expenses were $1,186,168 for the three months ended December 31, 2021, an increase of $240,690, compared to the three months ended December 31, 2020. Selling, general and administrative expenses were $2,180,990 for the six months ended December 31, 2021, an increase of $320,886 compared to the six months ended December 31, 2020. The increase for the three months ended December 31, 2021 as compared to the same period in 2020 relates primarily to the costs incurred resulting from the change in senior management announced at the end of the quarter. The increase for the six months ended December 31, 2021 as compared to the same period in 2020 resulted primarily from the costs recorded in the current quarter as the result of a change in senior management, the increase in costs incurred to recruit and fill company-wide position vacancies, the increase in costs associated with the stock option grant awarded to employees in the first quarter of the current fiscal year, the increase in costs associated with the current year allocation of shares from the leveraged ESOP transaction dated December 1, 2020 which did not have comparable expense in the six month period last year as the prior leveraged ESOP transaction was fully allocated as of June 30, 2020, an increase in professional services due to timing of progress billings, and an increase in travel. These increases were offset, in part, by a decrease in direct payroll expense primarily from the department restructuring of program management personnel and the timing of those changes.

 

Other income for the three months ended December 31, 2021 and 2020 was $11,821 and $15,487, respectively. Other income for the six months ended December 31, 2021 and 2020 was $31,388 and $33,831, respectively. The decrease for the three months ended December 31, 2021 as compared to the same period in 2020 is primarily due to the decrease in other income primarily comprised of income from the sale of fixed assets. The decrease for the six months ended December 31, 2021 as compared to the same period in 2020 is primarily due to a decrease in interest income, resulting from updated investment strategies which yield lower interest while maintaining higher liquidity, offset, in part, by an increase in other income primarily comprised of income from scrap sales. Interest income is a function of the level of investments and investment strategies that generally tend to be conservative.   

 

The Company’s effective tax rate for the three and six months ended December 31, 2021 was approximately 34.7% and 20.2%, respectively, compared to 16.4% and 39.5% for the three and six months ended December 31, 2020. 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 effective tax rate in the three month period ended December 31, 2021 was higher than the prior year as the direct result of a decreased benefit derived from ESOP dividends paid on allocated shares in the current period and from a discreet tax adjustment in the current quarter related to the expiration of non-qualified stock options. The effective tax rate in the six month period ended December 31, 2021 was lower than the prior year as the direct result of decreased benefit derived from ESOP dividends paid on allocated shares in the current period, offset in part, by higher income in the current period when compared to last year.

 

 

Net income for the three months ended December 31, 2021, was $21,201 or $0.01 per share, basic and diluted, compared to net loss of $(181,006) or $(0.08) per share, basic and diluted, for the three months ended December 31, 2020. Net income for the six months ended December 31, 2021 was $327,262 or $0.14 per share, basic and diluted, compared to $8,817 or $0.00 per share, basic and diluted, for the six months ended December 31, 2020. The increase in net income in the three and six months ended resulted from the increase in gross profit offset, in part, by an increase in selling, general and administrative expenses and an increase in the provision for income taxes, 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, 2021 and 2020. The current line of credit expires February 28, 2022. It is our expectation the line will be renewed.

The Company's working capital as of December 31, 2021 and 2020 was approximately $28.1 million and $27.1 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, 2021 and 2020, the Company did not repurchase any shares held by the ESOP. Under existing authorizations from the Company's Board of Directors, as of December 31, 2021, 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:

 

		Six Months Ended December 31,
		2021				2020
Net cash provided by operating activities		$	277,858			$	2,929,039
Net cash (used in) provided by investing activities			(62,288	)			1,910,548
Net cash used in financing activities			—				(1,201,316	)

 

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 trade receivables offset, in part, by an increase in net income and the decrease in inventory purchases. Net cash used in investing activities increased in the six months ended December 31, 2021 as compared to the same period in 2020 primarily due to the reinvestment of matured securities when compared to the same period last year. During the six months ended December 31 2021, there was no cash used for financing activities primarily resulting from the suspension of the regular dividend. In the prior year, cash used in financing activities resulted from the payment of regular dividends.

 

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, 2021 and 2020, the Company expended $97,288 and $29,173, respectively, for plant improvements and new equipment. The Company has budgeted approximately $200,000 for new equipment and plant improvements in fiscal year 2022. 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

 

Item 1.

Legal Proceedings

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.

 

Item 2.

Unregistered Sales of Equity Securities and Use of Proceeds

(a)

Securities Sold

(c)

Securities Repurchased

As of December 31, 2021 the Company can repurchase up to $783,460 of its common stock pursuant to an ongoing plan authorized by the Board of Directors. During the quarter ended December 31, 2021 no shares were repurchased.

Item 3.

Defaults Upon Senior Securities

None

Item 4.

Mine Safety Disclosures

Not applicable

Item 5.

Other Information

Effective January 1, 2022, the Company entered an Employment Agreement with Peggy A. Murphy, the Company’s Corporate Secretary, Director of Human Resources and Facility Security Officer, which supersedes the Executive Employment Agreement dated as of March 1, 2013. The Agreement has a term of one year which automatically renews for additional one year periods unless either party gives notice of intention not to renew at least 60 days prior to the end of the current term. Ms. Murphy is entitled to a base salary of $140,400, subject to annual review (but with no decrease) by the Board.

In addition, Ms. Murphy is eligible to receive an annual cash bonus at the discretion of the Board.

If Ms. Murphy’s employment is terminated without cause, she is entitled to severance pay equal to nine months of her base salary.

Item 6.

Exhibits

	10.14	Employment Agreement dated as of January 1, 2022 with Peggy A. Murphy
	31.1	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
	31.2	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
	32.1	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
	32.2	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

 

 

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.

 

	ESPEY MFG. & ELECTRONICS CORP.
	/s/ David O’Neil
	David O’Neil
	President and Chief Executive Officer
	/s/Katrina Sparano
	Katrina Sparano
	Principal Financial Officer

 

 

Date: February 14, 2022