Espey Mfg. & Electronics Corp. — Form 10-Q Summary
Business context and reporting period: Espey designs and manufactures power electronics and related equipment, primarily for military, rail, and other severe-environment applications. The filing covers the three months ended September 30, 2016—fiscal 2017 first quarter, despite the request metadata labeling it 2016 Q1. The financial statements are unaudited.
Financial performance
| Metric | Three months ended September 30, 2016 | Prior-year quarter | Change |
|---|---|---|---|
| Net sales | $6.07 million | $6.28 million | Down 3.4% |
| Gross profit / margin | $1.34 million / 22.1% | $1.97 million / 31.3% | Profit down 31.7%; margin down 9.2 percentage points |
| Operating income | $571,081 | $1,218,670 | Down 53.1% |
| Net income | $420,825 | $878,530 | Down 52.1% |
| Diluted EPS | $0.18 | $0.38 | Down $0.20 |
| Operating cash flow | $2.40 million | $2.95 million | Down $546,383 |
Management attributed weaker gross profit and earnings mainly to product mix and increased engineering investment in a military power-supply program; that investment reduced gross margin by approximately 3 percentage points. Lower power-supply and build-to-print sales were partly offset by higher magnetic shipments. SG&A rose by $23,017, primarily from increased compensation costs. Dividends were $0.25 per share in each comparable quarter.
Balance sheet, liquidity, and cash flow
- At September 30, 2016, cash and cash equivalents were $8.57 million and investment securities were $8.71 million, compared with $10.03 million and $5.58 million, respectively, at June 30, 2016.
- Current assets were $32.24 million and current liabilities $2.18 million, yielding working capital of approximately $30.1 million. Total liabilities were $2.38 million; the filing reports no borrowings and says no funds were borrowed in the prior two fiscal years.
- Operating cash flow was $2.40 million. Investing used $3.29 million, principally reflecting $4.39 million of investment-security purchases, partly offset by $1.26 million of proceeds from sales or maturities. Financing used $576,000, primarily for dividends. Cash declined $1.46 million during the quarter.
- Management reported access to a $3.0 million credit line and said it did not anticipate borrowing in the foreseeable future. Fiscal 2017 capital spending was budgeted at approximately $750,000; $155,730 was spent in the reported quarter.
Business outlook, risks, and other items
- Management expected fiscal 2017 revenue to be below fiscal 2016, chiefly because of weakness in the industrial sector. A significant rail customer reduced its purchase plan amid falling locomotive demand; shipments to that customer fell 41% year over year in the quarter.
- Backlog was approximately $34.2 million at September 30, 2016, versus $33.6 million a year earlier. Two significant customers accounted for $22.5 million of current backlog. Management expected at least $17 million of current backlog to ship in fiscal 2017, subject to change. New orders were approximately $1.2 million, compared with $3.4 million in the prior-year quarter.
- A military product in final design and qualification testing could begin shipments in fiscal 2017’s third quarter if testing is successful. Two other military power-supply designs had advanced to qualification testing, with multi-year production anticipated after qualification. These outcomes are not assured.
- Four customers represented 68.4% of quarterly sales, versus two customers representing 60.4% a year earlier. Management identified customer and program concentration, uncertain government appropriations, competition and price pressure, rail-market weakness, and successful development and customer acceptance of new products as risks.
- Outstanding quotations and opportunities exceeded $59.7 million as of November 9, 2016; the filing cautions that there is no assurance these opportunities will result in orders. Government audits and investigations of government contractors could result in contract termination, damages, sanctions, or loss of eligibility if requirements are not met. Standby letter-of-credit contingencies were zero; the filing reported no legal proceedings.
- Management said operating cash flow and available cash should meet foreseeable funding needs. It also cautioned that interim results are not necessarily indicative of full-year results. The company was evaluating the impact and adoption method for the new revenue-recognition standard; it had not yet determined the method.
Important facts for investors to verify
- Whether rail demand and the significant customer’s reduced purchases further affect sales, margins, and fiscal 2017 revenue.
- Progress and qualification results for the military programs, including the expected timing of production and shipments.
- Backlog conversion, order intake, and whether quoted opportunities become funded contracts.
- The sustainability of margins given engineering investment, product mix, price competition, and the high concentration of sales among a few customers.
- Cash and investment-security balances, planned capital spending, dividend policy, and any material changes in financing needs.