Espey Mfg. & Electronics Corp. — Q2 FY2017 Form 10-Q
Reporting period: Quarter and six months ended December 31, 2016. Espey designs and manufactures power electronics and related equipment, with substantial exposure to defense and rail customers. Financial statements are unaudited.
Financial performance
| Metric | Three months ended Dec. 31, 2016 | Prior year | Six months ended Dec. 31, 2016 | Prior year |
|---|---|---|---|---|
| Net sales | $5.67 million | $7.24 million | $11.74 million | $13.52 million |
| Gross profit / margin | $1.08 million / 19.1% | $1.59 million / 21.9% | $2.42 million / 20.7% | $3.56 million / 26.3% |
| Operating income | $0.33 million | $0.83 million | $0.90 million | $2.05 million |
| Net income | $0.24 million | $0.61 million | $0.66 million | $1.49 million |
| Diluted EPS | $0.11 | $0.27 | $0.29 | $0.65 |
- Quarterly sales declined about 22%; six-month sales declined about 13%. Management attributed the decline mainly to reduced power-supply shipments for a rail customer, partly offset by higher magnetic shipments.
- Gross margin fell 2.8 percentage points for the quarter and 5.6 points for the six months. Management cited product mix and engineering investment in military power-supply designs; that investment reduced gross margin by 4.1 points and 3.6 points, respectively.
- Six-month operating cash flow was $3.49 million, versus $3.82 million. Investing used $3.61 million, including $6.23 million of investment-security purchases and $0.22 million of capital expenditures. Financing used $1.05 million, including $1.15 million of dividends.
- At December 31, cash was $8.86 million and investment securities were $8.97 million, compared with $10.03 million and $5.58 million at June 30. Working capital was approximately $29.9 million. Total liabilities were $1.84 million; the filing reports no borrowings and says a $3 million credit line is available. Management did not expect to need borrowing in the foreseeable future.
- Quarterly dividends were $0.25 per share; six-month dividends totaled $0.50 per share, unchanged from the prior-year period.
Business changes, outlook, and risks
- Backlog was approximately $38.2 million at December 31, 2016, down from $43.0 million a year earlier; $21.8 million was attributable to two significant customers. Management estimated at least $11 million of year-end backlog would ship in FY2017, subject to change.
- Management expects FY2017 revenue to be below FY2016, primarily because of weakness in the industrial/rail sector. Six-month shipments to a significant rail customer fell 49% year over year, and new orders from that customer fell 87%.
- Six-month new orders were approximately $10.9 million, versus $20.2 million a year earlier; the prior-year period included a $10.1 million initial delivery order on a federal contract. The next installment under that contract was not expected until full-rate production, then scheduled for Q4 FY2017; future procurements require federal funding approval and are not guaranteed.
- A new military product was in final design and qualification testing, with shipments expected to begin in Q4 FY2017 if testing succeeds. Two other military power-supply designs were in qualification; testing delays on one could delay production orders. A new-customer design-and-build contract worth about $3 million could lead to future sales, but the potential volume was not quantified.
- Outstanding quotations exceeded $54 million as of January 31, 2017, but Espey cautioned that there is no assurance they will become orders. Customer concentration remained material: two customers represented 42.6% of six-month sales, versus 54.7% a year earlier.
- Key risks include uncertain defense appropriations and program funding, rail-market weakness, customer and program concentration, competitive pricing and margin pressure, product-development and qualification delays, and government contract audits or sanctions. The company disclosed no legal proceedings and no outstanding standby-letter-of-credit contingencies.
Important facts for investors to verify
- Whether rail demand and the concentrated customer’s procurement continue to weaken, and the effect on revenue and margins.
- Progress and timing of military-product qualification, full-rate production, and any follow-on federal orders.
- How much of the $38.2 million backlog ships in FY2017 and whether quoted opportunities convert to funded orders.
- Whether engineering investment, product mix, and customer concentration continue to pressure profitability and cash generation.
- The board’s future dividend policy; the filing states there is no assurance the regular dividend will be maintained.