UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D. C. 20549
FORM 10-Q
ý QUARTERLY Report Pursuant to Section 13 or 15 (d) of the Securities Exchange Act of 1934 for the quarterly period ended September 30, 2012
OR
o Transition Report Pursuant to Section 13 or 15 (d) of the Securities Exchange Act of 1934 for the transition period from _______ to _______
Commission File Number I-4383
ESPEY MFG. & ELECTRONICS CORP.
(Exact name of registrant as specified in its charter)
| NEW YORK | 14-1387171 |
| (State of incorporation) | (I.R.S. Employer's Identification No.) |
233 Ballston Avenue, Saratoga Springs, New York 12866
(Address of principal executive offices)
Registrant's telephone number, including area code 518-584-4100
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.
ý Yes o 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).
ý Yes o 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:
o Large accelerated filer
o Accelerated filer
o Non-accelerated filer
ý Smaller reporting company
Indicate by check mark whether the registrant is a shell company.
o Yes ý No
At November 13, 2012, there were 2,325,743 shares outstanding of the registrant's Common stock, $.33-1/3 par value.
ESPEY MFG. & ELECTRONICS CORP.
Quarterly Report on Form 10-Q
ESPEY MFG. & ELECTRONICS CORP.
September 30, 2012 and June 30, 2012
| September 30, | June 30, | |||||||
| 2012 | 2012 | |||||||
| ASSETS: | ||||||||
| Cash and cash equivalents | $ | 10,978,191 | $ | 11,523,424 | ||||
| Investment securities | 3,307,302 | 3,184,711 | ||||||
| Trade accounts receivable, net | 4,189,427 | 3,217,875 | ||||||
| Income tax receivable | 40,707 | — | ||||||
| Inventories: | ||||||||
| Raw materials | 1,446,928 | 1,364,019 | ||||||
| Work-in-process | 847,273 | 801,092 | ||||||
| Costs relating to contracts in process, net of advance | ||||||||
| payments of $514,151 at September 30, 2012 and | ||||||||
| $511,502 at June 30, 2012 | 9,618,948 | 9,480,595 | ||||||
| Total inventories | 11,913,149 | 11,645,706 | ||||||
| Deferred income taxes | 441,069 | 422,998 | ||||||
| Prepaid expenses and other current assets | 170,141 | 200,322 | ||||||
| Total current assets | 31,039,986 | 30,195,036 | ||||||
| Property, plant and equipment, net | 2,485,556 | 2,523,196 | ||||||
| Loan receivable | 56,945 | 67,371 | ||||||
| Total assets | $ | 33,582,487 | $ | 32,785,603 | ||||
| See accompanying notes to the financial statements. | (Continued) |
| 1 |
ESPEY MFG. & ELECTRONICS CORP.
Balance Sheets (Unaudited)
September 30, 2012 and June 30, 2012
| September 30, | June 30, | |||||||
| 2012 | 2012 | |||||||
| LIABILITIES AND STOCKHOLDERS' EQUITY: | ||||||||
| Accounts payable | $ | 1,401,289 | $ | 1,309,037 | ||||
| Accrued expenses: | ||||||||
| Salaries, wages and commissions | 482,423 | 417,677 | ||||||
| Vacation | 607,309 | 707,760 | ||||||
| ESOP payable | 108,951 | — | ||||||
| Other | 239,606 | 442,695 | ||||||
| Payroll and other taxes withheld and accrued | 50,628 | 44,886 | ||||||
| Income taxes payable | — | 73,596 | ||||||
| Total current liabilities | 2,890,206 | 2,995,651 | ||||||
| Deferred income taxes | 208,509 | 222,504 | ||||||
| Total liabilities | 3,098,715 | 3,218,155 | ||||||
| Common stock, par value $.33-1/3 per share. | ||||||||
| Authorized 10,000,000 shares; Issued 3,029,874 shares | ||||||||
| on September 30, 2012 and June 30, 2012. Outstanding | ||||||||
| 2,324,743 and 2,320,822 (includes 131,666 and 136,666 | ||||||||
| Unearned ESOP Shares) on September 30, 2012 and | ||||||||
| June 30, 2012, respectively | 1,009,958 | 1,009,958 | ||||||
| Capital in excess of par value | 15,222,798 | 15,093,512 | ||||||
| Accumulated other comprehensive income | 1,760 | 1,477 | ||||||
| Retained earnings | 23,842,235 | 23,053,762 | ||||||
| 40,076,751 | 39,158,709 | |||||||
| Less: Unearned ESOP shares | (1,974,829 | ) | (1,974,829 | ) | ||||
| Treasury shares, cost of 705,131 and 709,052 shares on | ||||||||
| September 30, 2012 and June 30, 2012, respectively | (7,618,150 | ) | (7,616,432 | ) | ||||
| Total stockholders’ equity | 30,483,772 | 29,567,448 | ||||||
| Total liabilities and stockholders' equity | $ | 33,582,487 | $ | 32,785,603 | ||||
See accompanying notes to the financial statements.
| 2 |
ESPEY MFG. & ELECTRONICS CORP.
Statements of Comprehensive Income (Unaudited)
Three Months Ended September 30, 2012 and 2011
| Three Months Ended | ||||||||
| September 30, | ||||||||
| 2012 | 2011 | |||||||
| Net sales | $ | 7,891,877 | $ | 7,993,927 | ||||
| Cost of sales | 5,409,684 | 5,992,119 | ||||||
| Gross profit | 2,482,193 | 2,001,808 | ||||||
| Selling, general and administrative expenses | 722,589 | 742,867 | ||||||
| Operating income | 1,759,604 | 1,258,941 | ||||||
| Other income | ||||||||
| Interest and dividend income | 10,905 | 10,167 | ||||||
| Other | 4,849 | 26,883 | ||||||
| 15,754 | 37,050 | |||||||
| Income before income taxes | 1,775,358 | 1,295,991 | ||||||
| Provision for income taxes | 494,640 | 369,087 | ||||||
| Net income | $ | 1,280,718 | $ | 926,904 | ||||
| Other comprehensive income, net of tax: | ||||||||
| Unrealized gain (loss) on investment securities | 283 | (1,692 | ) | |||||
| Total other comprehensive income | $ | 283 | $ | (1,692 | ) | |||
| Net income per share: | ||||||||
| Basic | $ | .59 | $ | 0.43 | ||||
| Diluted | $ | .57 | $ | 0.42 | ||||
| Weighted average number of shares outstanding: | ||||||||
| Basic | 2,186,424 | 2,164,202 | ||||||
| Diluted | 2,234,361 | 2,196,104 | ||||||
| Dividends per share: | $ | 0.2250 | $ | 0.2250 | ||||
See accompanying notes to the financial statements.
| 3 |
ESPEY MFG. & ELECTRONICS CORP.
Statements of Cash Flows (Unaudited)
Three Months Ended September 30, 2012 and 2011
| Three Months Ended | ||||||||
| September 30, | ||||||||
| 2012 | 2011 | |||||||
| Cash Flows From Operating Activities: | ||||||||
| Net income | $ | 1,280,718 | $ | 926,904 | ||||
| Adjustments to reconcile net income to net cash provided by operating activities: | ||||||||
| Excess tax benefits from share-based compensation | (11,163 | ) | (39,028 | ) | ||||
| Stock-based compensation | 32,965 | 16,316 | ||||||
| Depreciation | 104,539 | 108,248 | ||||||
| ESOP compensation expense | 139,701 | 127,761 | ||||||
| Loss on disposal of assets | 5,288 | 79 | ||||||
| Deferred income tax | (32,219 | ) | (26,320 | ) | ||||
| Changes in assets and liabilities: | ||||||||
| (Increase) decrease in trade receivable, net | (971,552 | ) | 967,899 | |||||
| Increase in income taxes receivables | (40,707 | ) | (75,875 | ) | ||||
| Increase in inventories | (267,443 | ) | (284,141 | ) | ||||
| Decrease in prepaid expenses and other current assets | 30,181 | 60,543 | ||||||
| Increase in accounts payable | 92,252 | 159,583 | ||||||
| Increase in accrued salaries, wages and commissions | 64,746 | 51,829 | ||||||
| Decrease in vacation accrual | (100,451 | ) | (37,203 | ) | ||||
| Decrease in ESOP payable | (30,750 | ) | (35,438 | ) | ||||
| Decrease in other accrued expenses | (203,089 | ) | (50,305 | ) | ||||
| Increase in payroll and other taxes withheld and accrued | 5,742 | 2,639 | ||||||
| Decrease in income taxes payable | (62,433 | ) | (238,718 | ) | ||||
| Net cash provided by operating activities | 36,325 | 1,634,773 | ||||||
| Cash Flows From Investing Activities: | ||||||||
| Additions to property, plant and equipment | (72,187 | ) | (40,370 | ) | ||||
| Proceeds from loan receivable | 10,426 | 10,118 | ||||||
| Purchase of investment securities | (1,621,921 | ) | (1,611,980 | ) | ||||
| Proceeds from maturity of investment securities | 1,499,766 | 1,010,000 | ||||||
| Net cash used in investing activities | (183,916 | ) | (632,232 | ) | ||||
| Cash Flows From Financing Activities: | ||||||||
| Sale of treasury stock | 66,102 | 58,974 | ||||||
| Dividends on common stock | (492,245 | ) | (487,303 | ) | ||||
| Purchase of treasury stock | (50,566 | ) | — | |||||
| Proceeds from exercise of stock options | 67,904 | 27,344 | ||||||
| Excess tax benefits from share-based compensation | 11,163 | 39,028 | ||||||
| Net cash used in financing activities | (397,642 | ) | (361,957 | ) | ||||
| (Decrease) increase in cash and cash equivalents | (545,233 | ) | 640,584 | |||||
| Cash and cash equivalents, beginning of period | 11,523,424 | 9,695,811 | ||||||
| Cash and cash equivalents, end of period | $ | 10,978,191 | $ | 10,336,395 | ||||
| Supplemental Schedule of Cash Flow Information: | ||||||||
| Income taxes paid | $ | 630,000 | $ | 710,000 | ||||
See accompanying notes to the financial statements.
| 4 |
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 only 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. 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 values 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, 2012. Certain reclassifications may have been made to the prior year financial statements to conform to the current year presentation.
Note 2. 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. As Unearned ESOP shares are released or committed-to-be-released the shares become outstanding for earnings-per-share computations.
Note 3. 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 period ended September 30, 2012 and 2011, was $32,965 and $16,316, respectively, before income taxes. The related total deferred tax benefit was approximately $3,620 and $1,489 for the same periods. ASC 718 requires the tax benefits resulting from tax deductions in excess of the compensation cost recognized for those options to be classified and reported as both an operating cash outflow and a financing cash inflow on a prospective basis upon adoption.
As of September 30, 2012, there was approximately $137,838 of unrecognized compensation cost related to stock option awards that is expected to be recognized as expense over the next 1.75 years. The total deferred tax benefit related to these awards is approximately $15,640.
The Company has one employee stock option plan under which options may be granted, the 2007 Stock Option and Restricted Stock Plan (the "2007 Plan"). The Board of Directors may grant options to acquire shares of common stock to employees of the Company at the fair market value of the common stock on the date of grant. Generally, options granted have a two-year vesting period based on two years of continuous service and have a ten-year contractual life. Option grants provide for accelerated vesting if there is a change in control. Shares issued upon the exercise of options are from those held in Treasury. The 2007 Plan was approved by the Company's shareholders at the Company's Annual Meeting on November 30, 2007 and supercedes the Company's 2000 Stock Option Plan (the "2000 Plan"). Options covering 400,000 shares are authorized for issuance under the 2007 Plan, of which 158,500 have been granted and 131,250 are outstanding as of September 30, 2012. While no further grants of options may be made under the 2000 Plan, as of September 30, 2012, 52,200 options remain outstanding, vested and exercisable from the 2000 Plan.
| 5 |
ASC 718 requires the use of a valuation model to calculate the fair value of stock-based awards. The Company has elected to use the Black-Scholes option valuation model, which incorporates various assumptions including those for volatility, expected life and interest rates.
There were no options awarded for the three months ended September 30, 2012. The table below outlines the weighted average assumptions that the Company used to calculate the fair value of the option award for the three months ended September 30, 2011:
| September 30, 2011 | ||||
| Dividend yield | 3.59% | |||
| Expected stock price volatility | 33.82% | |||
| Risk-free interest rate | 0.64% | |||
| Expected option life (in years) | 3.6 yrs | |||
| Weighted average fair value per share of options granted during the period | $ | 4.757 | ||
The Company pays dividends quarterly. Our Board of Directors assesses the Company’s dividend policy periodically and we anticipate that regular quarterly dividends will be paid for the foreseeable future. There is no assurance, however, that the Board of Directors will either increase the amount of the regular cash dividend or declare a special dividend during the fiscal year ending June 30, 2013 or any future years. Expected stock price volatility is based on the historical volatility of the Company’s stock. The risk-free interest rate is based on the implied yield available on U.S. Treasury issues with an equivalent term approximating the expected life of the options. The expected option life (in years) represents the estimated period of time until exercise and is based on actual historical experience.
The following table summarizes stock option activity during the three months ended September 30, 2012:
| Employee Stock Options Plan | ||||||||||||||||
| Weighted | ||||||||||||||||
| Number of | Weighted | Average | ||||||||||||||
| Shares | Average | Remaining | Aggregate | |||||||||||||
| Subject | Exercise | Contractual | Intrinsic | |||||||||||||
| To Options | Price | Term | Value | |||||||||||||
| Balance at July 1, 2012 | 187,050 | $ | 20.69 | 6.96 | ||||||||||||
| Granted | — | — | — | |||||||||||||
| Exercised | (3,600 | ) | $ | 18.86 | — | |||||||||||
| Forfeited or expired | — | — | — | |||||||||||||
| Outstanding at September 30, 2012 | 183,450 | $ | 20.72 | 6.72 | $ | 1,027,076 | ||||||||||
| Vested or expected to vest at September 30, 2012 | 175,509 | $ | 20.52 | 6.61 | $ | 1,017,710 | ||||||||||
| Exercisable at September 30, 2012 | 125,000 | $ | 18.65 | 5.52 | $ | 958,135 | ||||||||||
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-MKT on September 30, 2012 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 September 30, 2012. 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 three months ended September 30, 2012 and 2011 was $34,441 and $9,360, respectively.
Note 4. Commitments and Contingencies
The Company at certain times enters into standby letters of credit agreements with financial institutions primarily relating to the guarantee of future performance on certain contracts. Contingent liabilities on outstanding standby letters of credit agreements aggregated to zero at September 30, 2012 and 2011. The Company, as a U.S. Government contractor, is subject to audits, reviews, and investigations by the U.S. Government related to its negotiation and performance of government contracts and its accounting for such contracts. Failure to comply with applicable U.S. Government standards by a contractor may result in suspension from eligibility for award of any new government contract and a guilty plea or conviction may result in debarment from eligibility for awards. The government may, in certain cases, also terminate existing contracts, recover damages, and impose other sanctions and penalties. As a result of a pending U.S. government audit the Company has determined a range of possible outcomes none of which the Company believes would have a materially adverse effect on the Company's financial position or results of operations. In accordance with ASC 450 “Contingencies” the Company has accrued the amount within the range that appears to be its best estimate of a possible outcome.
| 6 |
Note 5. Recently Issued Accounting Standards
In May 2011, the FASB issued Accounting Standards Update No. 2011-04, topic 820, “Fair Value Measurement,” to improve the comparability of fair value measurements presented and disclosed in financial statements prepared in accordance with United States GAAP and International Financial Reporting Standards. Some of the amendments clarify the Board’s intent about the application of existing fair value measurement requirements. Other amendments change a particular principle or requirement for measuring fair value or for disclosing information about fair value measurements. Specifically, the guidance requires additional disclosures for fair value measurements that are based on significant unobservable inputs. The updated guidance is to be applied prospectively and is effective for the Company’s interim and annual periods beginning January 1, 2012. The adoption of this guidance did not have a material impact on the Company’s financial statements.
FASB Accounting Standards Update 2011-05, "Presentation of Comprehensive Income," was issued in June 2011 to be effective for fiscal years beginning after December 15, 2011. Comprehensive income includes certain items that are recognized as "other comprehensive income" ("OCI") and are excluded from net income. Examples include unrealized gains/losses on certain investments and gains/losses on derivative instruments designated as hedges. Under provisions of the update, the components of OCI must be presented in one of two formats: either (i) together with net income in a continuous statement of comprehensive income or (ii) in a second statement of comprehensive income to immediately follow the income statement. An existing option to present the components of OCI as part of the statement of changes in shareholders' equity is being eliminated. The Company expects the update to have minimal effect on its financial statements. The FASB recently issued Accounting Standards Update (ASU 2011-12) that defers the effective date of the requirement to present separate line items on the income statement for reclassification adjustments of items out of accumulated other comprehensive income into net income. The deferral is temporary until the Board reconsiders the operational concerns and needs of financial statement users. The Board has not yet established a timetable for its reconsideration.
Note 6. Employee Stock Ownership Plan
The Company sponsors a leveraged employee stock ownership plan (the "ESOP") that covers all nonunion employees who work 1,000 or more hours per year and are employed on June 30. The Company makes annual contributions to the ESOP equal to the ESOP's debt service less dividends on unallocated shares received by the ESOP. All dividends on unallocated shares received by the ESOP are used to pay debt service. Dividends on allocated ESOP shares are recorded as a reduction of retained earnings. As the debt is repaid, shares are released and allocated to active employees, based on the proportion of debt service paid in the year. The Company accounts for its ESOP in accordance with FASB ASC 718-40. Accordingly, the shares purchased by the ESOP are reported as Unearned ESOP Shares in the statement of financial position. As shares are released or committed-to-be-released, the Company reports compensation expense equal to the current average market price of the shares, and the shares become outstanding for earnings-per-share (EPS) computations. ESOP compensation expense was $139,701 for the three-month period ended September 30, 2012 and $127,761 for the three-month period ended September 30, 2011. The ESOP shares as of September 30, 2012 and 2011 were as follows:
| September 30, | September 30, | |||||||
| 2012 | 2011 | |||||||
| Allocated shares | 456,909 | 440,023 | ||||||
| Committed-to-be-released shares | 5,000 | 5,208 | ||||||
| Unreleased shares | 131,666 | 152,292 | ||||||
| Total shares held by the ESOP | 593,575 | 597,523 | ||||||
| Fair value of unreleased shares | $ | 3,465,449 | $ | 3,531,651 | ||||
| 7 |
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. All design, manufacturing, and testing is performed in our 150,000+ square foot facility located at 233 Ballston Ave, Saratoga Springs, New York. Espey is classified as a “smaller reporting company” for purposes of the reporting requirements under the Securities Exchange Act of 1934, as amended. Espey’s common stock is publicly-traded on the NYSE-MKT under the symbol “ESP.”
Espey began operations after incorporation in New York in 1928. We strive to remain competitive as a leader in high power energy conversion and transformer solutions through the design and manufacture of new and improved products by using advanced and “cutting edge” electronics technologies.
Espey is ISO 9001:2008 certified and our primary products are power supplies, power converters, filters, power transformers, magnetic components, power distribution equipment, ups systems, antennas and high power radar systems. The applications of these products include AC and DC locomotives, shipboard power, shipboard radar, airborne power, ground-based radar, and ground mobile power.
Espey services include design and development to specification, build to print, design services, design studies, environmental testing services, metal fabrication, painting services, and development of automatic testing equipment. Espey manufacturing is vertically integrated, meaning that the Company produces individual components (including inductors), populates printed circuit boards, fabricates metalwork, paints, wires, qualifies, and fully tests items, mechanically, electrically and environmentally, in house. Portions of the manufacturing process are subcontracted to vendors from time to time.
Business is solicited from large industrial manufacturers and defense companies, the government of the United States, foreign governments and major foreign electronic equipment companies. In certain countries the Company has external sales representatives to help solicit and coordinate foreign contracts. Espey is on the eligible list of contractors with the United States Department of Defense and generally is automatically solicited by Defense Department procurement agencies for their needs falling within the major classes of products produced by the Company. Espey contracts with the Federal Government under cage code 20950 as Espey Mfg. & Electronics Corp. and cage code 98675 as Espey Mfg. & Electronics Corp., Saratoga Industries Division.
There is competition in all classes of products manufactured by the Company from divisions of the largest electronic companies, as well as many small companies. The Company's sales do not represent a significant share of the industry's market for any class of its products. The principal methods of competition for electronic products of both a military and industrial nature include, among other factors, price, product performance, the experience of the particular company and history of its dealings in such products. The Company, as well as other companies engaged in supplying equipment for military use, is subject to various risks, including, without limitation, dependence on United States and foreign government appropriations and program allocations, the competition for available military business, and government termination of orders for convenience.
New orders received in the first three months of fiscal 2013 were approximately $7.2 million, representing a 23.6% decrease from the amount of new orders received in the first three months of fiscal 2012. Due to the uncertain timing of receipt of new orders, particularly large orders, period to period comparisons are not necessarily indicative of business trends.
The new orders were predominantly in line with our strategy of getting involved in products incidental to long-term, high quantity military and industrial products and represented follow-on production of mature products. We are able to be more price-competitive in responding to repeat orders for long-term projects because our early stage design costs have already been absorbed. Conversely, we believe that a principal impediment to our receipt of awards of products in connection with new programs has been our pricing reflecting the inclusion of up-front design costs. Accordingly, we have re-examined our pricing strategy in order to achieve a balance which enables us both to retain repeat programs while being more competitive in bidding on new programs.
| 8 |
The expected decrease in defense spending has also enhanced the competitive environment and pricing pressures. Substantially all of our business is attributable to component manufacturing for large military and industrial programs. As the prime contractors incur greater competition for fewer defense programs, we expect corollary pricing pressure at the sub-contractor level.
Our competitive edge in pricing for repeat programs has two associated risks: (i) customer concentration and (ii) customer strategies of diffusing reliance on single-sourcing for component products. The latter also presents opportunities for the Company with prime contractors with whom we do not currently have significant business relationships.
The Company's backlog was approximately $50.1 million at September 30, 2012 which includes $33.4 million from two significant customers compared to $40.1 million at September 30, 2011 which included $27.2 million from two significant customers. The backlog for the Company represents the estimated remaining sales value of work to be performed under firm contracts. The funded portion of this backlog at September 30, 2012 is approximately $47.8 million. This includes items that have been authorized and appropriated by Congress and/or funded by the customer. The unfunded backlog is approximately $2.3 million and represents firm multi-year orders 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 a given program, 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 September 30, 2011 was zero.
The sales backlog gives the Company a solid base of future sales. Based upon the backlog and our anticipated schedule for the fulfillment of orders, management expects net sales revenues in fiscal year 2013 to exceed net sales revenues in fiscal year 2012.
In addition to the backlog, the Company currently has outstanding quotations and potential business representing approximately $30 million in the aggregate for both repeat and new programs. However, there can be no assurance that the Company will acquire any or all of the anticipated orders described above, many of which are subject to allocations of the United States Department of Defense spending and factors affecting the defense industry and military procurement generally.
Net sales to three significant customers represented 66.1% of the Company's total sales for the three month period ended September 30, 2012 and net sales to three significant customers represented 76.3% of the Company's total sales for the first three month period ended September 30, 2011. Historically, a small number of customers have accounted for a large percentage of the Company’s total sales in any given fiscal year. Even though our business tends to be concentrated in a few customers, the makeup of those customers sometimes changes from year to year.
Our strategic objective, associated with our pricing review noted above, is to broaden our customer base and thereby lower the concentration of sales, mitigate excessive reliance upon a single major product of a particular program and minimize the impact of the loss of a single significant customer. However, the defense industry itself tends to be concentrated with a few large tier one defense contractors which limits the amount of diversity the Company can achieve with our military customer base.
Management, along with the Board of Directors, continues to evaluate the need and use of the Company’s working capital. Capital expenditures are expected to be approximately $200,000 for fiscal 2013, of which $72,187 was expended through September 30, 2012. We believe that our working capital will be adequate to fund orders, general operations of the business, and regular dividend payments, consistent with past practice.
Critical Accounting Policies and Estimates
Management believes our most critical accounting policies include revenue recognition and estimates to completion.
A significant portion of our business is comprised of development and production contracts. Generally, revenues on long-term fixed-price contracts are recorded on a percentage of completion basis using units of delivery as the measurement basis for progress toward completion.
| 9 |
Percentage of completion accounting requires judgment relative to expected sales, estimating costs and making assumptions related to technical issues and delivery schedule. Contract costs include material, subcontract costs, labor and an allocation of overhead costs. The estimation of cost at completion of a contract is subject to numerous variables involving contract costs and estimates as to the length of time to complete the contract. Given the significance of the estimation processes and judgments described above, it is possible that materially different amounts of expected sales and contract costs could be recorded if different assumptions were used, based on changes in circumstances, in the estimation process. When a change in expected sales value or estimated cost is determined, changes are reflected in current period earnings.
Results of Operations
Net sales remained relatively flat for the three months ended September 30, 2012 at $7,891,877 as compared to $7,993,927 for the same period in 2011. The product mix of net sales changed slightly with a lower amount of power supply sales offset by an increase in magnetic and transformer sales, for the three months ended September 30, 2012 as compared to the same period ended September 30, 2011.
For the three months ended September 30, 2012 and 2011 gross profits were $2,482,193 and $2,001,808, respectively. Gross profit as a percentage of sales was 31.5% and 25.0%, for the three months ended September 30, 2012 and 2011, respectively. The primary factors in determining gross profit and net income are overall sales levels and product mix. The gross profits on mature products and build to print contracts are higher as compared to products which are still in the engineering development stage or in the early stages of production. In any given accounting period the mix of products being produced between higher margin mature programs and less mature programs, including loss contracts, has a significant impact on gross profit and net income. The gross profit percentage increase in the three months ended September 30, 2012 as compared to September 30, 2011 was primarily the result of increased sales backlog for both engineering and production with a favorable product mix, and the absence of any significant loss contracts.
Selling, general and administrative expenses were $722,589 for the three months ended September 30, 2012; a decrease of $20,278, compared to the three months ended September 30, 2011. The decrease for the three months ended September 30, 2012 relates primarily to a decrease in salary expense.
Interest and dividend income for the three months ended September 30, 2012 as compared to the three months ended September 30, 2011 remained relatively unchanged.
The effective income tax rate at September 30, 2012 and 2011 was 27.9% and 28.5%, respectively. The effective tax rate is less than the statutory tax rate mainly due to the benefit the Company receives on its “qualified production activities” under The American Jobs Creation Act of 2004 and the benefit derived from the ESOP dividends paid on allocated shares.
Net income for the three months ended September 30, 2012, was $1,280,718 or $.59 and $.57 per share, basic and diluted, respectively, compared to $926,904 or $.43 and $.42 per share, basic and diluted, respectively for the three months ended September 30, 2011. The increase in net income per share was mainly due to higher gross profit offset created by an improved product mix.
Liquidity and Capital Resources
The Company's working capital is an appropriate indicator of the liquidity of its business, and during the past two fiscal years, the Company, when possible, has funded all of its operations with cash flows resulting from operating activities and when necessary from its existing cash and investments. The Company did not borrow any funds during the last two fiscal years.
The Company's working capital as of September 30, 2012 was approximately $28.1 million. During the three month period ended September 30, 2012 the Company repurchased 2000 shares of common stock for $50,566 and for the three month period ended September 30, 2011 the Company did not repurchase any shares of its common stock. Under existing authorizations from the Company's Board of Directors, as of September 30, 2012, management is authorized to purchase an additional $1,805,702 of Company stock.
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| Three Months Ended September 30, | ||||||||
| 2012 | 2011 | |||||||
| Net cash provided by operating activities | $ | 36,325 | $ | 1,634,773 | ||||
| Net cash used in investing activities | (183,916 | ) | (632,232 | ) | ||||
| Net cash used in financing activities | (397,642 | ) | (361,957 | ) | ||||
Net cash provided by operating activities fluctuates between periods primarily as a result of differences in net income, the timing of the collection of accounts receivable, purchase of inventory, level of sales and payment of accounts payable. Net cash used in investing activities decreased in the first three months of fiscal 2012 due to the increase in investment securities that matured during the current period. The slight increase in cash used in financing activities is due primarily to dividends on common stock and the purchase of treasury stock.
The Company currently believes that the cash flow generated from operations and when necessary, from cash and cash equivalents will be sufficient to meet its long-term funding requirements for the foreseeable future.
During the three months ended September 30, 2012 and 2011, the Company expended $72,187 and $40,370, respectively, for plant improvements and new equipment. The Company has budgeted approximately $200,000 for new equipment and plant improvements in fiscal 2013. Management anticipates that the funds required will be available from current operations.
The Company at certain times enters into standby letters of credit agreements with financial institutions primarily relating to the guarantee of future performance on certain contracts. Contingent liabilities on outstanding standby letters of credit agreements aggregated to zero at September 30, 2012 and 2011.
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 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.
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PART II: Other Information and Signatures
| Item 1. | Legal Proceedings |
None
| Item 2. | Unregistered Sales of Equity Securities and Use of Proceeds |
| (a) | Securities Sold - | For the three-month period ended September 30, 2012, the Company sold 2,321 shares to the ESOP in connection with participants of the ESOP electing to reinvest dividends paid on ESOP shares. The aggregate gross proceeds from the shares of common stock sold were $66,102. The securities were sold for cash and the sales were made without registration under the Securities Act in reliance upon the exemption from registration afforded under Section 4(2) of the Securities Act of 1933. Proceeds were used for general working capital purposes. |
| (c) | Securities Repurchased - |
Purchases of Equity Securities
| Total Number | Maximum Number | ||||||||||||||||
| of Shares | (or Approximate | ||||||||||||||||
| Purchased | Dollar Value) | ||||||||||||||||
| as Part of | of Shares | ||||||||||||||||
| Total | Average | Publicly | that May Yet | ||||||||||||||
| Number | Price | Announced | Be Purchased | ||||||||||||||
| of Shares | Paid | Plan or | Under the Plan | ||||||||||||||
| Period | Purchased | per Share | Program | or Program (1) | |||||||||||||
| September 1 to | |||||||||||||||||
| September 30, 2012 | 2,000 | $ | 25.28 | 2,000 | $ | 1,805,702 | |||||||||||
| (1) | Pursuant to a prior Board of Directors authorization, as of September 30, 2012 the Company can repurchase up to $1,805,702 of its common stock pursuant to an ongoing plan. |
| Item 3. | Defaults Upon Senior Securities |
None
| Item 4. | Mine Safety Disclosures |
Not applicable
| Item 5. | Other Information |
None
| Item 6. | Exhibits |
| 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 |
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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/ Mark St. Pierre | |
| Mark St. Pierre | |
| President and Chief Executive Officer | |
| /s/ David O'Neil | |
| David O'Neil | |
| Treasurer and Principal Financial Officer |
November 13, 2012
Date
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