Espey Mfg. & Electronics Corp. — Q2 FY2018 Form 10-Q
Reporting period: Quarter and six months ended December 31, 2017; comparisons are with the corresponding periods ended December 31, 2016. Espey designs and manufactures power-electronics equipment, principally for military, rail, and industrial applications. The interim financial statements are unaudited.
Financial performance
| Metric | Three months ended Dec. 31, 2017 | Three months ended Dec. 31, 2016 | Six months ended Dec. 31, 2017 | Six months ended Dec. 31, 2016 |
|---|---|---|---|---|
| Net sales | $11.53 million | $5.67 million | $19.03 million | $11.74 million |
| Gross profit | $3.08 million | $1.08 million | $4.54 million | $2.42 million |
| Gross margin | 26.7% | 19.1% | 23.8% | 20.7% |
| Operating income | $2.09 million | $0.33 million | $2.68 million | $0.90 million |
| Net income | $1.61 million | $0.24 million | $2.06 million | $0.66 million |
| Diluted EPS | $0.69 | $0.11 | $0.88 | $0.29 |
For the six months, operating cash flow was $596,844, versus $3.49 million a year earlier. Investing activities used $2.18 million and financing activities used $1.27 million. Cash and cash equivalents were $7.20 million at December 31, 2017, down from $10.06 million at June 30, 2017; investment securities were $11.42 million, up from $9.43 million. Working capital was approximately $30.4 million. The company reported no borrowings in the prior two fiscal years, and had a $3 million line of credit available; management did not expect to need borrowing in the foreseeable future.
Total assets were $35.71 million and stockholders’ equity was $32.73 million at December 31, 2017. The company paid dividends of $0.50 per share during the six-month period. Capital expenditures were $185,190; approximately $2.5 million was budgeted for fiscal 2018 equipment and plant improvements, with $480,000 in purchase commitments outstanding.
Changes and management explanation
- Sales increased 103% in the quarter and 62% for the six months, primarily because shipments began on a significant new military power-supply contract. Lower magnetic-component shipments, reflecting contract timing and completion, partly offset the growth.
- Gross margin improved, which management attributed principally to product mix and lower engineering-design investment costs. SG&A increased by $231,989 for the quarter and $338,143 for the six months, largely due to employee compensation, professional services, outside selling costs, and freight.
- Six-month operating cash flow fell year over year, primarily reflecting the $2.16 million increase in trade receivables, partly offset by lower inventory and higher net income. Cash also declined as the company invested in securities, paid dividends, and repurchased shares.
- The effective tax rate for the six months was 25.5%, compared with 29.2%. The company recorded a provisional $35,200 tax expense in Q2 to remeasure deferred tax balances under the Tax Cuts and Jobs Act and said its analysis was ongoing.
Outlook, risks, and other notable items
- Management expected fiscal 2018 revenue to exceed fiscal 2017, citing backlog and shipments on the new military contract. It anticipated shipping at least $13.5 million of the December 31 backlog during fiscal 2018; this estimate excludes later orders and is subject to change.
- Backlog was approximately $38.4 million, including $33.4 million funded and $5.0 million unfunded, compared with $38.2 million a year earlier, which was fully funded. New orders in the first six months of FY2018 were approximately $14.3 million, versus $10.9 million.
- Outstanding quotations and opportunities exceeded $69 million as of January 30, 2018, but the company cautioned that there was no assurance they would result in orders. The company reported that three customers represented 63.2% of quarterly sales; two customers represented 61.0% of six-month sales. Management identified customer/program concentration as a significant risk.
- Other disclosed risks include uncertain U.S. and foreign government spending and appropriations, contract cancellations or termination, competition and price pressure, product-development and customer-acceptance risks, supply and manufacturing constraints, and reliance on rail and defense markets. Government audits and investigations of contractor compliance may result in contract, eligibility, or other sanctions.
- The company expected adoption of the new revenue-recognition standard on July 1, 2018 using the modified retrospective method and did not expect a material financial-statement impact. It reported no legal proceedings and no outstanding standby-letter-of-credit liabilities at December 31, 2017.
Important facts for investors to verify
- Whether military-contract shipments, backlog conversion, and expected FY2018 revenue develop as management anticipates, particularly given the unfunded backlog portion.
- Whether customer concentration remains high and how any loss, delay, or funding change at a major customer or program would affect sales and margins.
- Whether the receivables increase converts to cash and operating cash flow improves as sales grow.
- The final effects of Tax Act calculations and adoption of the revenue-recognition standard.
- Whether planned capital spending, dividend payments, and repurchases remain supportable from operating cash and investments.