Espey Mfg. & Electronics Corp. — Form 10-Q Summary
Business context and period: The filing covers the three months ended September 30, 2017, the first quarter of fiscal 2018. Espey designs and manufactures power-electronics equipment, principally for military, rail, and other severe-environment applications. The interim financial statements are unaudited.
Financial performance and position
| Metric | Q1 FY2018 | Q1 FY2017 |
|---|---|---|
| Net sales | $7.50 million | $6.07 million |
| Gross profit / gross margin | $1.46 million / 19.5% | $1.34 million / 22.1% |
| Operating income | $582,334 | $571,081 |
| Net income | $442,764 | $420,825 |
| Diluted EPS | $0.19 | $0.18 |
| Operating cash flow | $(198,211) | $2.40 million |
Revenue increased approximately 23.5% year over year, while gross profit rose about 8.7% and net income about 5.2%. The gross margin fell 2.6 percentage points, reflecting product mix. SG&A increased $106,153 to $878,820, primarily due to professional services, training, and travel. Interest income increased to $31,224 from $12,021.
Cash and cash equivalents were $7.39 million at September 30, 2017, down from $10.06 million at June 30; investment securities were $11.29 million, up from $9.43 million. Total current assets were $33.00 million and current liabilities $3.51 million; management reported working capital of approximately $29.5 million. Total liabilities were $3.51 million, with no debt reported. The company has a $3 million credit line, which it did not expect to need in the foreseeable future. Cash dividends were $0.25 per share, totaling $581,580.
Material changes and cash flow
Higher power-supply shipments following the start of a significant military contract drove sales growth; this was partly offset by lower magnetic shipments after certain contracts were completed. Operating cash flow swung from positive $2.40 million to negative $198,211, mainly because of increased receivables and inventory purchases, compared with receivables collection and lower inventory purchases in the prior-year quarter. Investing cash outflow was $1.89 million, principally reflecting net investment-security purchases; financing cash outflow was $581,580 for dividends.
At September 30, backlog was approximately $42.6 million, versus $34.2 million a year earlier. It included $35.1 million funded and $7.5 million unfunded; the prior-year backlog was fully funded. Two customers accounted for 73.9% of quarterly sales, compared with four customers accounting for 68.4% in the prior-year quarter.
Outlook, risks, and other disclosures
Management expected fiscal 2018 revenue to exceed fiscal 2017 revenue, primarily on existing backlog and shipments under the new military contract. It anticipated shipping at least $20.2 million of the September backlog during fiscal 2018, excluding orders received later. New orders in the quarter were approximately $6.9 million, compared with $1.2 million a year earlier. Outstanding quotations exceeded $72 million as of November 6, 2017, but the company cautioned that opportunities may not become orders. It budgeted approximately $2.5 million for fiscal 2018 equipment and facility improvements, expecting to fund them from operations.
Risks include dependence on a small number of customers and programs, uncertainty in government defense appropriations and rail-industry procurement, potential contract termination, competition and price pressure, and execution, supply, and manufacturing constraints. Government contract audits and investigations could lead to sanctions or loss of eligibility if requirements are not met. The company reported no legal proceedings and no contingent standby-letter-of-credit liabilities at quarter-end. Management stated disclosure controls were effective and reported no material change in internal control over financial reporting.
The company adopted the deferred-tax balance-sheet classification standard prospectively in the quarter, reclassifying deferred taxes without a stated material effect on total assets or equity. It was evaluating the impact and transition method for the new revenue-recognition standard, expected to be adopted beginning July 1, 2018. The 2007 stock plan expired in August 2017; a proposed 2017 plan covering up to 400,000 shares was subject to shareholder approval at the December 1, 2017 annual meeting. Management cautioned that interim results may not indicate full-year performance.
Important facts for investors to verify
- Whether the military contract ramps as expected and supports the fiscal 2018 revenue outlook and planned backlog shipments.
- How customer concentration, including 73.9% of quarterly sales from two customers, affects future results and program risk.
- Whether gross margins recover as product mix changes, given the decline to 19.5% from 22.1%.
- Whether receivables and inventory convert to cash after the quarter’s negative operating cash flow.
- Funding and shipment timing for the $7.5 million of unfunded backlog, and the realization of quoted opportunities.
- Shareholder approval and eventual terms of the proposed 2017 stock plan, and the board’s future dividend decisions.