Business context and reporting period
Espey Mfg. & Electronics Corp. designs and manufactures power electronics and related equipment, principally for military and severe-environment applications. This 10-Q covers the fiscal third quarter and first nine months ended March 31, 2014; the supplied “2013 Q3” metadata does not match the filing period.
Financial results and liquidity
- Quarter: Net sales were $6.55 million, down 3.7% year over year. Gross profit was $1.68 million (25.6% margin versus 29.0%); operating income was $917,000; net income was $706,000, or $0.31 per basic and diluted share (versus $915,000, or $0.41 per share).
- Nine months: Net sales were $20.04 million, down 11.9%. Gross profit was $4.77 million (23.8% margin versus 29.0%); operating income was $2.45 million; net income was $1.87 million, or $0.83 basic and $0.82 diluted per share (versus $3.27 million, or $1.48 basic and $1.46 diluted).
- Cash flow: Nine-month operating cash flow was $3.42 million, compared with $1.81 million a year earlier. Investing used $1.41 million, including $660,000 of capital expenditures; financing used $3.63 million, primarily reflecting $3.92 million in dividends. Cash declined $1.63 million to $8.26 million.
- Balance sheet and liquidity: At March 31, cash and cash equivalents were $8.26 million and investment securities were $4.67 million. Working capital was approximately $27.7 million. Total liabilities were $3.11 million; the company reported no borrowings during the last two fiscal years. Total assets were $33.26 million.
- Dividends per share were $0.25 for the quarter and $1.75 for the nine-month period; management cautioned that future regular and special dividends are not assured.
Material changes and management commentary
- Lower sales, particularly of power supplies and transformers, and losses on engineering contracts reduced gross profit and earnings. SG&A increased, mainly due to salaries for new personnel, bonuses, and directors’ fees.
- Backlog was approximately $31.9 million at March 31, 2014, down from $47.9 million a year earlier. Net new orders for the first nine months were approximately $10.1 million versus $20.3 million. Two customers accounted for $23 million of backlog; customer concentration remains high.
- Management attributed backlog pressure to uncertainty in U.S. defense spending, procurement delays, aggressive competitor pricing, and setbacks on two programs. Production funding was cut for one vehicle program; another program encountered engineering problems, leading to a roughly $2 million backlog reduction. Management said that reduction did not negatively affect operating results.
- Management expected fiscal 2014 sales to be below fiscal 2013 and fiscal 2015 sales to be below fiscal 2014. It anticipated at least $8 million of March 31 backlog shipments in the final fiscal 2014 quarter, subject to execution and other events. Outstanding quotations and potential business totaled approximately $30.1 million, with no assurance of awards.
- Capital spending was budgeted at approximately $800,000 for fiscal 2014, primarily to expand transformer production capacity. Management expected operating cash flow and existing cash to support operations and funding needs.
Risks, contingencies, and other items
- Sales depend substantially on government appropriations, program funding, procurement timing, and a small number of customers. The filing warns that orders may be delayed, reduced, or canceled and that product mix and contract cost estimates can materially affect results.
- A pending U.S. government audit concerns government contracts. The company accrued its best estimate within a range of possible outcomes and did not believe any outcome would materially adversely affect financial position or results.
- Standby letter-of-credit contingent liabilities were zero at March 31, 2014. The company reported no legal proceedings and stated disclosure controls were effective, with no material change in internal control over financial reporting.
Important facts for investors to verify
- Whether backlog converts to shipments and new funded orders, particularly given the stated fiscal 2014 and fiscal 2015 sales outlook.
- Whether customer concentration, defense-budget uncertainty, and the two affected programs create further revenue or margin pressure.
- How engineering-contract cost estimates and potential losses develop, and whether gross margins stabilize.
- Whether operating cash generation supports planned capital expenditures and dividends; future special and regular dividends are not guaranteed.
- Developments or final financial effects, if any, from the pending government audit.