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 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.
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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 for
production.
The total backlog at December 31, 2022 was approximately $78.3 million, which
included approximately $64.2 million from six significant customers, compared to
$70.1 million at December 31, 2021, which included $45.8 million from four
significant customers. The Company's total backlog represents the estimated
remaining sales value of work to be performed under firm contracts. The backlog
at December 31, 2022 is fully funded except for $32 thousand, representing one
firm multi-year order from a single customer for which funding has not yet been
appropriated by Congress and/or the customer has not funded the program. 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
program status and discussions with customers. The unfunded backlog at December
31, 2021 was approximately $0.4 million and represented two firm multi-year
orders from a single customer for which funding had not yet been appropriated by
Congress and/or funded by our 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 and increased raw material costs 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 certain major development programs. The issues causing the delays
are being resolved as soon as possible and we continue to work with our
customers on newly arising delays. Engineering programs in both the funded and
unfunded portions of the current backlog aggregate $7.5 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 2023 to be higher than revenues
during fiscal year 2022 and expects net income per share to be higher in fiscal
2023 as compared to the net income per share realized during fiscal year 2022.
These expectations are driven by orders already in our sales backlog. Consistent
quarter to quarter financial performance will remain a challenge as we navigate
a current difficult environment of inflation and parts shortages.
Effects from global events and the resulting supply chain disruptions continue
to place pressure on the cost of raw materials, freight, utility, labor and
other production and administrative costs. These inflationary cost challenges
are expected to continue to have a negative impact on operating income in fiscal
year 2023. Volatile raw material indexes and shortages have led to wide-spread
vendor price increases. For our executed fixed-price contracts, we will either
singularly or in combination, continue to 1) be required to absorb the increased
costs 2) mitigate cost increases through the identification of additional supply
chain buying strategies or 3) submit for price remediation assistance from our
customers. To minimize exposure on future fixed-price contracts, we continue to
incorporate inflationary increases to product quotations provided to our
customers, some of which have resulted in significant price increases. As
additional mitigation steps, we have, in many instances, reduced the time in
which certain product quotations remain valid and have also extended lead times
for product deliveries. We continue to work with our customers to mitigate any
adverse impact upon our ability to service their requirements.
The Company currently expects new orders in fiscal 2023 to approximate the $43.2
million in new orders received in fiscal year 2022. 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.
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New orders received in the first six months of fiscal year 2023 were
approximately $19 million as compared to approximately $19.5 million new orders
received in the first six months of fiscal 2022. It is presently anticipated
that a minimum of $18.6 million of orders comprising the December 31, 2022
backlog will be filled during the fiscal year ending June 30, 2023 subject,
however, to the impact of the factors identified above. The minimum of $18.6
million does not include any shipments, which may be made against orders
subsequently received during the fiscal year ending June 30, 2023.
In addition to the backlog, the Company currently has outstanding opportunities
representing approximately $105 million in the aggregate as of February 6, 2023
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 69% of the Company's total sales for the three-month period ended
December 31, 2022. 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 five significant customers represented 83% of the Company's total
sales for the six-month period ended December 31, 2022. Net sales to five
significant customers represented 67% of the Company's total sales for the
six-month period ended December 31, 2021. 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 with a customer 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 collection of
substantially all of the amount to which the entity will be entitled in exchange
for the goods or services that will be transferred to the customer 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.
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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 for the three months ended December 31, 2022 and 2021 were $8,804,109
and $7,458,050, respectively, an 18.0% increase. Net sales for the six months
ended December 31, 2022 and 2021 were $17,439,904 and $15,003,482, respectively,
a 16.2% increase. 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. In general, the Company continues to
experience long lead times and supply chain delays which have a direct impact on
the timing of shipments for certain programs and may result in sales
fluctuations recorded between periods.
For the three months ended December 31, 2022, sales increased primarily due to
an increase in shipments on specific contracts related to a family of power
distribution transformers for a single customer when compared to sales
recognized in the prior year. In addition, sales increased in the current
quarter on several new and repeat contracts which had no comparable sales in the
same period last year. These increases were offset, in part, by a decrease in
sales on several power supply programs, two of which had no sales in the current
year when compared to the same period last year and the other which had lower
sales in the current period, a result of ongoing supply chain material delays
and long component lead times. Sales increased in the six months ended December
31, 2022, primarily due to an increase in shipments on specific contracts
related to a family of power distribution transformers for a single customer
when compared to sales recognized in the prior year. In addition, sales
increased in the current quarter on multiple new and repeat contracts which had
no or significantly fewer comparable sales in the same period last year. One
such contract was for a new engineering and production program. These increases
were offset, in part, by a decrease in sales on several power supply programs,
two of which had no or minimal sales in the current year when compared to the
same period last year and the other which had lower sales in the current period,
a result of ongoing supply chain material delays and long component lead times.
Sales in the six month period also declined on a large magnetic engineering and
production contract and several build to print contracts due to timing of orders
and customer delivery dates.
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Gross profits for the three months ended December 31, 2022 and 2021 were
$2,260,722 and $1,206,817, respectively. Gross profit as a percentage of sales
was approximately 25.7% and 16.2%, for the same periods, respectively. Gross
profits for the six months ended December 31, 2022 and 2021 were $4,072,864 and
$2,559,915, respectively. Gross profit as a percentage of sales was
approximately 23.4% and 17.1% 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.
The increase in gross profit for the three months ended December 31, 2022 when
compared to the same period last year resulted from an increase in sales and a
higher overall gross profit percentage comprising those shipments which was
influenced by product mix. In the current period, gross profit was favorably
impacted from higher sales and improved margins on a specific magnetics contract
and a build to print contract, resulting from manufacturing improvements. The
prior year's gross profit was negatively impacted by certain programs which had
higher sales in the prior year and contributed less to gross profit as the
result of cost overruns when compared to the same period this year. These costs
overruns included labor from both production and engineering efforts made and
the impact of inflationary pricing on materials for certain fixed-price
contracts. In addition, specific to the prior year, gross profit was negatively
impacted by the expensing of remaining development costs formerly capitalized in
inventory on a specific engineering design program in which our customer had
delayed unit qualification testing and for which production units were not
expected to be manufactured in the near term. The increase in gross profit for
the six months ended December 31, 2022 when compared to the same period last
year resulted from an increase in sales and a higher overall gross profit
percentage comprising those shipments which was influenced by product mix. In
the current period, gross profit was favorably impacted from higher sales and
improved margins on a specific magnetics contract and a build to print contract,
resulting from manufacturing improvements. Conversely, current year gross
profit was negatively impacted by cost overruns on a specific engineering design
contract for a power supply due to the unforeseen complexity of the design. In
addition, sales on a certain build to print contract did not contribute to gross
profit due to production overruns caused by test failures. The prior year gross
profit was negatively impacted by certain programs which had higher sales in the
prior year and contributed less to gross profit as the result of cost overruns
when compared to the same period this year. These cost overruns included labor
from both production and engineering efforts made and the impact of inflationary
pricing on materials for certain fixed-price contracts. In addition, to a
lesser extent, specific to the prior year, gross profit was negatively impacted
by the expensing of remaining development costs formerly capitalized in
inventory on a specific engineering design program in which our customer had
delayed unit qualification testing and for which production units were not
expected to be manufactured in the near term.
Selling, general and administrative expenses were $874,931 for the three months
ended December 31, 2022, a decrease of $311,237, compared to the three months
ended December 31, 2021. Selling, general and administrative expenses were
$1,713,961 for the six months ended December 31, 2022, a decrease of $467,029
compared to the six months ended December 31, 2021. The higher costs for the
three and six months ended December 31, 2021 related primarily to one-time
expenses attributed to a change in senior management. In addition, fewer costs
were incurred in the current period when compared to the prior period resulting
from a decrease in board of directors fees resulting from a reduction of two
non-employee directors, a decrease in outside selling costs related to outside
sales representatives, and lower professional recruiting costs incurred.
Other income for the three months ended December 31, 2022 and 2021 was $73,542
and $11,821, respectively. Other income for the six months ended December 31,
2022 and 2021 was $86,116 and $31,388, respectively. The increase for the three
and six months ended is primarily due to the increase in interest income
resulting from an increase in investment securities and an increase in interest
rates, offset, in part by a decrease in other income primarily 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,
2022 was approximately 21.5% and 21.7% respectively, compared to 34.7% and 20.2%
for the three and six months ended December 31, 2021. The effective tax rate in
fiscal 2023 is greater than the statutory tax rate mainly due to the permanent
difference for incentive stock option expense recorded for book purposes which
is not deductible for tax purposes. In the current period, there was no benefit
received from ESOP dividends paid on allocated shares due to the suspension of
the company dividend. The effective tax rate in fiscal 2022 was less than the
statutory tax rate mainly from the benefit derived from the ESOP dividends paid
on allocated shares. The effective tax rate was lower for the three month
periods ended December 31, 2022 when compared to the same period in 2021. The
prior year rate was unfavorably impacted from non-qualified stock forfeitures.
The effective tax rate was higher for the six months ended December 31, 2022
when compared to the same period in 2021 primarily due to no benefit received
from ESOP dividends paid due to the suspension of the company dividend.
Net income for the three months ended December 31, 2022, was $1,146,042 or $0.47
per share, basic and diluted, compared to net income of $21,201 or $0.01 per
share, basic and diluted, for the three months ended December 31, 2021. Net
income for the six months ended December 31, 2022 was $1,914,308 or $0.78 per
share, basic and diluted, compared to $327,262 or $0.14 per share, basic and
diluted, for the six months ended December 31, 2021. The increase in net income
in the three and six months ended resulted primarily from the increase in gross
profit, a decrease in selling, general and administrative expenses, an increase
in interest income, offset in part, by an increase in the provision for income
taxes, all discussed above.
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Index
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, 2022 and 2021.
The existing line of credit expires February 28, 2023. It is our expectation the
line will be renewed.
The Company's working capital as of December 31, 2022 and 2021 was approximately
$31.6 million and $28.1 million, respectively. The Company may at times be
required to repurchase shares at the ESOP participants' request at fair market
value. During the three and six months ended December 31, 2022 and 2021, 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, 2022,
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,
2022 2021
Net cash provided by operating activities $ 4,683,450 $ 277,858
Net cash used in investing activities
(6,459,068 ) (62,288 )
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 increase in cash provided by operating
activities compared to the prior year primarily relates to an increase in net
income, an increase in cash collected from trade receivables, an increase in
cash collected from customer advances, and an increase in accounts payable when
compared to the comparable period last year offset, in part, by an increase in
prepaid expenses and other current assets between comparable periods. Net cash
used in investing activities increased in the six months ended December 31, 2022
as compared to the same period in 2021 primarily due to an increase in
investment securities when compared to the same period last year. The Company
currently believes that the cash flow generated from operations and when
necessary, from cash and cash equivalents will be sufficient to meet its
long-term funding requirements for the foreseeable future.
During the six months ended December 31, 2022 and 2021, the Company expended
$103,885 and $97,288, respectively, for plant improvements and new equipment.
The Company has budgeted approximately $500,000 for new equipment and plant
improvements in fiscal year 2023. The Company expects additional cash outlay in
fiscal 2023 associated with the facility and capital equipment upgrades
discussed in Note 9. Subsequent Events. Management anticipates that the funds
required will be available from current operations.
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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.
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