ESPEY MFG & ELECTRONICS CORP 10-K

Item 8. Financial Statements and Supplementary Data REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM To the Board of Directors and Stockholders of Espey Mfg. & Electronics Corp. Opinion on the Financial Statements We have audited the accompanying balance sheets of Espey Mfg. & Electronics Corp (the Company) as of June 30, 2020 and 2019, the related statements of comprehensive income, changes in stockholders' equity and cash flows for the years then ended, and the related notes to the financial statements (collectively, the financial statements). In our opinion, the financial statements present fairly, in all material respects, the financial position of the Company as of June 30, 2020 and 2019, and the results of its operations and its cash flows for the years then ended, in conformity with accounting principles generally accepted in the United States of America. Basis for Opinion These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on the Company’s financial statements based on our audits. We are a public accounting firm registered with the Public Company Accounting Oversight Board (United States) ( PCAOB ) and are required to be independent with respect to the Company in accordance with U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB. We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement, whether due to error or fraud. The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. As part of our audits we are required to obtain an understanding of internal control over financial reporting but not for the purpose of expressing an opinion on the effectiveness of the Company's internal control over financial reporting. Accordingly, we express no such opinion. Our audits included performing procedures to assess the risks of material misstatement of the financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the financial statements. We believe that our audits provide a reasonable basis for our opinion. /s/ Freed Maxick CPAs, P.C. We have served as the Company's auditor since 2014. Buffalo, New York September 21, 2020 11 Espey Mfg. & Electronics Corp. Balance Sheets June 30, 2020 and 2019 2020 2019 ASSETS Cash and cash equivalents $ 5,402,122 $ 1,462,761 Investment securities 5,141,520 5,684,240 Trade accounts receivable, net of allowance of $3,000 9,013,405 10,995,783 Inventories: Raw materials 2,057,778 1,747,449 Work-in-process 614,521 408,130 Costs related to contracts in process 12,115,756 11,069,558 Total inventories 14,788,055 13,225,137 Prepaid expenses and other current assets 396,886 494,181 Total current assets 34,741,988 31,862,102 Property, plant and equipment, net 3,466,778 3,825,411 Total assets $ 38,208,766 $ 35,687,513 LIABILITIES AND STOCKHOLDERS' EQUITY Accounts payable $ 2,861,696 $ 2,160,433 Accrued expenses: Salaries and wages 469,201 329,890 Vacation 689,834 786,870 Other 318,322 109,755 Payroll and other taxes withheld 186,970 61,451 Contract liabilities 2,175,235 6,054 Income taxes payable 47,707 30,481 Total current liabilities 6,748,965 3,484,934 Deferred tax liabilities 232,953 277,075 Total liabilities 6,981,918 3,762,009 Commitments and Contingencies (See Note 14) Common stock, par value $.33-1/3 per share Authorized 10,000,000 shares; Issued 3,029,874 shares as of June 30, 2020 and 2019. Outstanding 2,402,633 and 2,401,213 as of June 30, 2020 and 2019, respectively (includes 0 and 14,166 Unearned ESOP Shares, respectively) 1,009,958 1,009,958 Capital in excess of par value 19,073,213 18,731,975 Accumulated other comprehensive loss (3,107 ) (1,299 ) Retained earnings 18,797,589 20,022,132 38,877,653 39,762,766 Less: Unearned ESOP shares — (204,706 ) Cost of 627,241 and 628,661 shares of common stock in treasury as of June 30, 2020 and 2019, respectively (7,650,805 ) (7,632,556 ) Total stockholders' equity 31,226,848 31,925,504 Total liabilities and stockholders' equity $ 38,208,766 $ 35,687,513 The accompanying notes are an integral part of the financial statements. 12 Espey Mfg. & Electronics Corp. Statements of Comprehensive Income Years Ended June 30, 2020 and 2019 2020 2019 Net sales $ 31,526,231 $ 36,477,851 Cost of sales 25,967,616 29,414,678 Gross profit 5,558,615 7,063,173 Selling, general and administrative expenses 4,386,307 4,410,234 Operating income 1,172,308 2,652,939 Other income Interest income 109,749 167,682 Other 27,132 61,012 Total other income 136,881 228,694 Income before provision for income taxes 1,309,189 2,881,633 Provision for income taxes 145,521 538,939 Net income $ 1,163,668 $ 2,342,694 Other comprehensive income, net of tax: Unrealized (loss) gain on investment securities (1,808 ) 5,050 Total comprehensive income $ 1,161,860 $ 2,347,744 Net income per share: Basic $ 0.49 $ 0.99 Diluted $ 0.49 $ 0.98 Weighted average number of shares outstanding: Basic 2,393,207 2,372,945 Diluted 2,396,618 2,389,228 The accompanying notes are an integral part of the financial statements. 13 Espey Mfg. & Electronics Corp. Statements of Changes in Stockholders' Equity Years Ended June 30, 2020 and 2019 Accumulated Capital in Other Unearned Total Outstanding Common Excess of Comprehensive Retained Treasury Stock ESOP Stockholders’ Shares Amount Par Value Income (Loss) Earnings Shares Amount Shares Equity Balance as of June 30, 2018 2,387,124 $ 1,009,958 $ 18,201,691 $ (6,349 ) $ 22,416,400 642,750 $ (7,718,835 ) $ (421,453 ) $ 33,481,412 Comprehensive income: Net income 2,342,694 2,342,694 Other comprehensive income, net of tax of $ 1,342 5,050 5,050 Total comprehensive income 2,347,744 Stock options exercised 15,899 184,514 (15,899 ) 131,167 315,681 Stock-based compensation 172,148 172,148 Dividends paid on common stock $2.00 per share (4,736,962 ) (4,736,962 ) Purchase of treasury stock (1,810 ) 1,810 (44,888 ) (44,888 ) Reduction of unearned ESOP shares 173,622 216,747 390,369 Balance as of June 30, 2019 2,401,213 $ 1,009,958 $ 18,731,975 $ (1,299 ) $ 20,022,132 628,661 $ (7,632,556 ) $ (204,706 ) $ 31,925,504 The accompanying notes are an integral part of the financial statements. 14 Espey Mfg. & Electronics Corp. Statements of Changes in Stockholders' Equity Years Ended June 30, 2020 and 2019 Accumulated Capital in Other Unearned Total Outstanding Common Excess of Comprehensive Retained Treasury Stock ESOP Stockholders’ Shares Amount Par Value Loss Earnings Shares Amount Shares Equity Balance as of June 30, 2019 2,401,213 $ 1,009,958 $ 18,731,975 $ (1,299 ) $ 20,022,132 628,661 $ (7,632,556 ) $ (204,706 ) $ 31,925,504 Comprehensive income: Net income 1,163,668 1,163,668 Other comprehensive loss, net of tax of $(481) (1,808 ) (1,808 ) Total comprehensive income 1,161,860 Stock options exercised 3,600 51,300 (3,600 ) 29,700 81,000 Stock-based compensation 189,639 189,639 Dividends paid on common stock $1.00 per share (2,388,211 ) (2,388,211 ) Purchase of treasury stock (2,180 ) 2,180 (47,949 ) (47,949 ) Reduction of unearned ESOP shares 100,299 204,706 305,005 Balance as of June 30, 2020 2,402,633 $ 1,009,958 $ 19,073,213 $ (3,107 ) $ 18,797,589 627,241 $ (7,650,805 ) $ — $ 31,226,848 The accompanying notes are an integral part of the financial statements. 15 Espey Mfg. & Electronics Corp. Statements of Cash Flows Years Ended June 30, 2020 and 2019 2020 2019 Cash Flows from Operating Activities: Net income $ 1,163,668 $ 2,342,694 Adjustments to reconcile net income to net cash provided by (used in) operating activities: Bad debt expense — 69,010 Stock-based compensation 189,639 172,148 Depreciation 568,528 540,978 ESOP compensation expense 305,006 390,369 Loss on disposal of assets 4,525 566 Deferred income tax (benefit) expense (43,641 ) 258,040 Changes in assets and liabilities: Decrease (increase) in trade receivables 1,982,378 (6,687,067 ) Decrease in income tax receivable — 161,975 Increase in inventories (1,562,918 ) (1,816,211 ) Decrease in prepaid expenses and other current assets 97,295 798,394 Increase in accounts payable 701,263 337,836 Increase (decrease) in accrued salaries and wages 139,311 (199,115 ) (Decrease) increase in vacation accrual (97,036 ) 79,258 Increase in other accrued expenses 208,567 5,092 Increase in payroll and other taxes withheld 125,519 8,016 Increase (decrease) in contract liabilities 2,169,181 (96,870 ) Increase in income taxes payable 17,226 30,481 Net cash provided by (used in) operating activities $ 5,968,511 $ (3,604,406 ) Cash Flows from Investing Activities: Additions to property, plant and equipment (214,421 ) (608,318 ) Purchase of investment securities (9,338,100 ) (6,039,808 ) Proceeds from sale/maturity of investment securities 9,878,531 11,882,666 Net cash provided by investing activities 326,010 5,234,540 Cash Flows from Financing Activities: Dividends paid on common stock (2,388,211 ) (4,736,962 ) Purchase of treasury stock (47,949 ) (44,888 ) Proceeds from exercise of stock options 81,000 315,681 Net cash used in financing activities (2,355,160 ) (4,466,169 ) Increase (decrease) in cash and cash equivalents 3,939,361 (2,836,035 ) Cash and cash equivalents, beginning of the year 1,462,761 4,298,796 Cash and cash equivalents, end of the year $ 5,402,122 $ 1,462,761 Supplemental Schedule of Cash Flow Information: Income taxes paid $ 172,475 $ 87,200 The accompanying notes are an integral part of the financial statements. 16 Espey Mfg. & Electronics Corp. Notes to Financial Statements Note 1. Nature of Operations Espey Mfg. & Electronics Corp. (the Company) is a manufacturer of electronic equipment used primarily in military and industrial applications. The principal markets for the Company's products are companies that provide electronic support to both military and industrial applications across the United States and at some international locations. Note 2. Summary of Significant Accounting Policies Revenue The majority of our net sales is generated from contracts with industrial manufacturers and defense companies, the Department of Defense, other agencies of the government of the United States and foreign governments for the design, development and/or manufacture of products. Contracts may be long-term in nature. We provide our products and design and development services under fixed-price contracts. Under fixed-price contracts we agree to perform the specified work for a pre-determined price. To the extent our actual costs vary from the estimates upon which the price was negotiated, we will generate more or less profit or could incur a loss. We account for a contract after it has been approved by all parties to the arrangement, the rights of the parties are identified, payment terms are identified, the contract has commercial substance, and collectability of consideration is probable. We assess each contract at its inception to determine whether it should be combined with other contracts. When making this determination, we consider factors such as whether two or more contracts were negotiated and executed at or near the same time, or were negotiated with an overall profit objective. We evaluate the products or services promised in each contract at inception to determine whether the contract should be accounted for as having one or more performance obligations. Significant judgment is required in determining performance obligations. We determine the transaction price for each contract based on the consideration we expect to receive for the products or services being provided under the contract. The transaction price for each performance obligation is based on the estimated standalone selling price of the product or service underlying each performance obligation. Transaction prices on our contracts subject to the Federal Acquisition Regulations (FAR) are typically based on estimated costs plus a reasonable profit margin. We recognize revenue using the output method based on the appraisal of results achieved and milestones reached or units delivered based on contractual shipment terms, typically shipping point. Inventory Raw materials are valued at the lower of cost (average cost) or net realizable value. Balances for slow-moving and obsolete inventory are reviewed on a regular basis by analyzing estimated demand, inventory on hand, sales levels, market conditions, and other information and reduce inventory balances based on this analysis. Inventoried work relating to contracts in process and work in process is valued at actual production cost, including factory overhead incurred to date. Contract costs include material, subcontract costs, labor, and an allocation of overhead costs. Work in process represents spare units and parts and other inventory items acquired or produced to service units previously sold or to meet anticipated future orders. Provision for losses on contracts is made when the existence of such losses becomes probable and estimable. The provision for losses on contracts is included in other accrued expenses on the Company’s balance sheet. Contracts are subject to modification, change or cancellation, and the Company accounts for these changes as they are probable and estimable. The Company evaluates the impact of any scope modifications and will adjust reserves as information is known and estimable. Subsequent to year end, the Company received a request from a customer to temporarily stop work on a contract for a minimum of 120 days. The Company has determined that there is no immediate impact for the request, however the Company will continue to evaluate any impact on the financial statements. The costs attributed to units delivered under contracts are based on the estimated average cost of all units expected to be produced. Certain contracts are expected to extend beyond twelve months. The estimation of total cost at completion of a contract is subject to numerous variables involving contract costs and estimates as to the length of time to complete the contract. Given the significance of the estimation processes and judgments described above, it is possible that materially different amounts of expected sales and contract costs could be recorded if different assumptions were used, based on changes in circumstances, in the estimation process. When a change in expected sales value or estimated cost is determined, changes are reflected in current period earnings. 17 Espey Mfg. & Electronics Corp. Notes to Financial Statements Note 2. Summary of Significant Accounting Policies, Continued Contract Liabilities Contract liabilities include advance payments and billings in excess of revenue recognized. Depreciation Depreciation of plant and equipment is computed on a straight-line basis over the estimated useful lives of the assets. Estimated useful lives of depreciable assets are as follows: Buildings and improvements 10 – 50 years Machinery and equipment 3 – 20 years Furniture and fixtures 7 – 10 years Income Taxes The Company follows the provisions of Accounting Standards Codification (“ASC”) Topic 740-10, "Accounting for Income Taxes." Under the provisions of ASC 740-10, deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred taxes and liabilities of a change in tax rates is recognized in earnings in the period that includes the enactment date. Cash and Cash Equivalents Cash and cash equivalents consist of cash and money market funds. The Company considers all highly liquid investments with original maturities of three months or less to be cash equivalents. Investment Securities The Company accounts for its investment securities in accordance with ASC 320-10-25, “Accounting for Certain Investments in Debt and Equity Securities.” Investment securities at June 30, 2020 and 2019 consist of certificates of deposit and municipal bonds. The Company classifies investment securities as available-for-sale. Unrealized holding gains and losses, net of related tax effect, on available-for-sale securities are excluded from earnings and are reported as a separate component of stockholders’ equity until realized. Realized gains and losses for securities classified as available-for-sale are included in earnings and are determined using the specific identification method. Interest income is recognized when earned. Fair values are based on quoted market prices available as of the balance sheet date, and are therefore considered a Level 1 valuation. Fair Value of Financial Instruments ASC 820 establishes a fair value hierarchy which requires an entity to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value. The standard describes three levels of inputs that may be used to measure fair value: § Level 1: Quoted prices (unadjusted) for identical assets or liabilities in active markets that the entity has the ability to access as of the measurement date. § Level 2: Significant other observable inputs other than Level 1 prices such as quoted prices for similar assets or liabilities; quoted prices in markets that are not active; or other inputs that are observable or can be corroborated by observable market data. 18 Espey Mfg. & Electronics Corp. Notes to Financial Statements Note 2. Summary of Significant Accounting Policies, Continued § Level 3: Significant unobservable inputs that reflect a reporting entity’s own assumptions about the assumptions that market participants would use in pricing an asset or liability. The carrying amounts of financial instruments, including cash and cash equivalents, short term investments, accounts receivable, accounts payable, accrued expenses and contract liabilities, approximated fair value as of June 30, 2020 and 2019 because of the immediate or short-term maturity of these financial instruments. Accounts Receivable and Allowance for Doubtful Accounts The Company extends credit to its customers in the normal course of business and collateral is generally not required for trade receivables. Exposure to credit risk is controlled through the use of credit approvals, credit limits, and monitoring procedures. Accounts receivable are reported net of an allowance for doubtful accounts. The Company estimates the allowance based on its analysis of specific balances. Interest is not charged on past due balances. Based on these factors, there was an allowance for doubtful accounts of $3,000 at June 30, 2020 and 2019. Changes to the allowance for doubtful accounts are charged to expense and reduced by charge-offs, net of recoveries. Per Share Amounts ASC 260-10 “Earnings Per Share (EPS)” requires the Company to calculate net income (loss) per share based on basic and diluted net income (loss) per share, as defined. Basic EPS excludes dilution and is computed by dividing net income (loss) by the weighted average number of shares outstanding for the period. Diluted EPS reflects the potential dilution that could occur if securities or other contracts to issue common stock were exercised or converted into common stock. The dilutive effect of outstanding options issued by the Company are reflected in diluted EPS using the treasury stock method. Under the treasury stock method, options will only have a dilutive effect when the average market price of common stock during the period exceeds the exercise price of the options. Comprehensive Income Comprehensive income consists of net income and other comprehensive income. Other comprehensive income for fiscal years ended June 30, 2020 and 2019 consists of unrealized holding gains and losses on available-for-sale securities. Use of Estimates The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amount of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. Reclassifications Certain reclassifications may have been made to the prior year financial statements to conform to the current year presentation. Recently Issued Accounting Standards In February 2018, the FASB issued ASU No. 2018-02, “Income Statement—Reporting Comprehensive Income (Topic 220): Reclassification of Certain Tax Effects from Accumulated Other Comprehensive Income”. Under current accounting guidance, the income tax effects for changes in income tax rates and certain other transactions are recognized in income from continuing operations resulting in income tax effects recognized in Accumulated Other Comprehensive Income that do not reflect the current tax rate of the entity (“stranded tax effects”). The new guidance allows the Company the option to reclassify these stranded tax effects to retained earnings that relate to the change in the federal tax rate resulting from the passage of the Tax Cuts and Jobs Act (the “Tax Act”). This update is effective for fiscal years beginning after December 15, 2018, including interim periods therein, and early adoption is permitted. The adoption did not have a material effect on the Company’s financial statements. 19 Espey Mfg. & Electronics Corp. Notes to Financial Statements Note 2. Summary of Significant Accounting Policies, Continued Recent Accounting Pronouncements Not Yet Adopted In December 2019, the FASB issued guidance (ASU 2019-12) intended to simplify the accounting for income taxes. The amendments in this guidance are effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2020 (the Company’s fiscal 2021), with early adoption permitted. The Company is currently evaluating the potential impact of this guidance on the Company’s disclosures. In August 2018, the FASB issued ASU No. 2018-13, “Fair Value Measurement (Topic 820): Disclosure Framework – Changes to the Disclosure Requirements for Fair Value Measurement.” This ASU is part of the FASB’s larger disclosure framework project intended to improve the effectiveness of financial statement footnote disclosure. ASU 2018-13 modifies required fair value disclosures related primarily to level 3 investments. This ASU is effective for annual periods beginning after December 15, 2019 and interim periods within those annual periods. The adoption of ASU 2018-13 is not expected to have a material effect on the Company’s financial position, results of operations, and cash flows. Impairment of Long-Lived Assets Long-lived assets, including property, plant, and equipment, are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. Recoverability of assets to be held and used is measured by a comparison of the carrying amount of an asset to estimated undiscounted future cash flows expected to be generated by the asset. If the carrying amount of an asset exceeds its estimated future cash flows, an impairment charge is recognized by the amount by which the carrying amount of the asset exceeds the fair value of the asset. There were no impairments of long-lived assets in fiscal years 2020 and 2019. Assets to be disposed of are separately presented in the balance sheet and reported at the lower of the carrying amount or fair value less costs to sell, and no longer depreciated. The assets and liabilities of a disposed group classified as held for sale are presented separately in the appropriate asset and liability sections of the balance sheet, if applicable. Concentrations of Risk The market for our defense electronics products is largely dependent on the availability of new contracts from the United States and foreign governments to prime contractors to which we provide components. Any decline in expenditures by the United States or foreign governments may have an adverse effect on our financial performance. Generally, U.S. Government contracts are subject to procurement laws and regulations. Some of the Company’s contracts are governed by the Federal Acquisition Regulation (FAR), which lays out uniform policies and procedures for acquiring goods and services by the U.S. Government, and agency-specific acquisition regulations that implement or supplement the FAR. For example, the Department of Defense implements the FAR through the Defense Federal Acquisition Regulation (DFAR). The FAR also contains guidelines and regulations for managing a contract after award, including conditions under which contracts may be terminated, in whole or in part, at the government’s convenience or for default. If a contract is terminated for the convenience of the government, a contractor is entitled to receive payments for its allowable costs and, in general, the proportionate share of fees or earnings for the work done. If a contract is terminated for default, the government generally pays for only the work it has accepted. These regulations also subject the Company to financial audits and other reviews by the government of its costs, performance, accounting and general business practices relating to its contracts, which may result in adjustment of the Company’s contract-related costs and fees. Note 3. Revenue Effective July 1, 2018, we adopted Financial Accounting Standards Board (“FASB”) Accounting Standards Codification (“ASC) 606 “Revenue from Contracts with Customers”, which requires entities to assess the products or services promised in contracts with customers at contract inception to determine the appropriate unit at which to record revenues. Revenue is recognized when control of the promised products or services is transferred to customers at an amount that reflects the consideration to which the entity expects to be entitled to in exchange for those products or services. We adopted ASC 606 using the modified retrospective method, which means, using the allowed practical expedient, we applied the new standard to open contracts at June 30, 2018. We reviewed remaining obligations as of the effective date and determined no adjustment was required to the opening balance of retained earnings. Under the modified retrospective method, prior period revenue is not restated for comparative periods. As a result of the adoption, we reclassified customer advance payments from inventory to contract liabilities. Contract liabilities were $2,175,235 and $6,054 as of June 30, 2020 and June 30, 2019, respectively. The increase in contract liabilities is primarily due to cash collected from progress payments related to specific contracts. The company used the practical expedient to expense incremental costs incurred to obtain a contract when the contract term is less than one year. 20 Espey Mfg. & Electronics Corp. Notes to Financial Statements Note 3. Revenue, Continued Significant judgment is required in determining the satisfaction of performance obligations. Revenues from our performance obligations are satisfied over time using the output method which considers the appraisal of results achieved and milestones reached or units delivered based on contractual shipment terms, typically shipping point. Revenue is recognized when the customer takes control of the product or services. The output method best depicts the transfer of control to the customer as the output method represents work completed. Control is typically transferred to the customer at shipping point as the Company has a present right to payment, the customer has legal title to the asset, the customer has the significant risks and rewards of ownership of the asset, and in most instances the customer has accepted the asset. Total revenue recognized for the twelve months ended June 30, 2020 based on units delivered totaled $25,739,709 compared to $30,677,077 for the same periods in 2019. Total revenue recognized for the twelve months ended June 30, 2020 based on milestones achieved totaled $5,786,522 compared to $5,800,774 for the same periods in 2019. The Company offers a standard one-year product warranty. Product warranties offered by the Company are classified as assurance-type warranties, which means, the warranty only guarantees that the good or service functions as promised. Based on this, the provided warranty is not considered to be a distinct performance obligation. The impact of variable consideration has been considered but none identified which would be required to be allocated to the transaction price as of June 30, 2020. Our payment terms are generally 30-60 days. The Company’s backlog at June 30, 2020 totaling $54.9 million is expected, based on contractual due dates, to be recognized in the following fiscal years: 66% in 2021; 24% in 2022; 7 % in 2023, and 3% thereafter. Note 4. Investment Securities Investment securities at June 30, 2020 and 2019 consist of certificates of deposit and municipal bonds which are classified as available-for-sale securities and have been determined to be level 1 assets. The cost, gross unrealized gains, gross unrealized losses and fair value of available-for-sale securities by major security type at June 30, 2020 and 2019 are as follows: Gross Gross Amortized Unrealized Unrealized Fair Cost Gains Losses Value 2020 Certificates of deposit $ 4,679,847 $ — $ — $ 4,679,847 Municipal bonds 462,618 1,243 (2,188 ) 461,673 2020 Total investment securities $ 5,142,465 $ 1,243 $ (2,188 ) $ 5,141,520 2019 Certificates of deposit $ 5,046,627 $ — $ — $ 5,046,627 Municipal bonds 636,269 1,576 (232 ) 637,613 2019 Total investment securities $ 5,682,896 $ 1,576 $ (232 ) $ 5,684,240 21 Espey Mfg. & Electronics Corp. Notes to Financial Statements Note 4. Investment Securities, Continued The portfolio is diversified and highly liquid and primarily consists of investment grade fixed income instruments. At June 30, 2020, the Company did not have any investments in individual securities that have been in a continuous loss position considered to be other than temporary. As of June 30, 2020 and 2019, the remaining contractual maturities of available-for-sale securities were as follows: Years to Maturity Less than One to One Year Five Years Total 2020 Available-for-sale $ 5,141,520 $ — $ 5,141,520 2019 Available-for-sale $ 5,549,460 $ 134,780 $ 5,684,240 Note 5. Contracts in Process Contracts in process at June 30, 2020 and 2019 are as follows: 2020 2019 Unrecognized gross contract value $ 54,929,249 $ 45,552,562 Costs related to contracts in process $ 12,115,756 $ 11,069,558 Included in costs relating to contracts in process at June 30, 2020 and 2019 are costs of $1,716,176 and $ 2,740,804 , respectively, relative to contracts that may not be completed within the ensuing year. Under the units-of-delivery method, the related sale and cost of sales will not be reflected in the statements of comprehensive income until the units under contract are shipped. Note 6. Property, Plant and Equipment Property, plant and equipment at June 30, 2020 and 2019 is as follows: 2020 2019 Land $ 45,000 $ 45,000 Building and improvements 4,387,113 4,591,429 Machinery and equipment 11,118,670 11,156,006 Furniture and fixtures 164,200 170,120 15,714,983 15,962,555 Accumulated depreciation (12,248,205 ) (12,137,144 ) Property, plant and equipment, net $ 3,466,778 $ 3,825,411 Machinery and equipment includes $39,496 that was not placed in service as of June 30, 2020. Depreciation expense was $568,528 and $540,978 for the years ended June 30, 2020 and 2019, respectively. Note 7. Pension Expense Under terms of a negotiated union contract which expires on June 30, 2022, the Company is obligated to make contributions to a union-sponsored International Brotherhood of Electrical Workers Local 1799 defined benefit pension plan (Plan identifying number is 14-6065199) covering eligible employees. Such contributions and expenses are based upon hours worked at a specified rate and amounted to $121,273 in fiscal year 2020 and $129,095 in fiscal year 2019. These contributions represent more than five percent of the total contributions made into the Plan. For the years beginning January 1, 2020 and 2019, the Plan was in the “green zone” which means it is neither endangered nor critical status. A Funding Improvement Plan, entered into by Plan Trustees in fiscal year 2013, when the Plan was in “critical status,” calls for an increase in contributions starting January 1, 2016 of $0.04 per hour for each year for five years thereafter. The increase did not and will not have a material impact on the Company’s financial statements. 22 Espey Mfg. & Electronics Corp. Notes to Financial Statements Note 7. Pension Expense, Continued The Company sponsors a 401(k) plan for non-union workers with employee and employer matching contributions. The employer match is 10% of the employee contribution and was $58,389 and $57,581, for fiscal years 2020 and 2019, respectively. Note 8. Provision for Income Taxes A summary of the components of the provision for income taxes for the years ended June 30, 2020 and 2019 is as follows: 2020 2019 Current tax expense - federal $ 190,801 $ 274,889 Current tax (benefit) expense - state (1,158 ) 6,010 Deferred tax (benefit) expense (44,122 ) 258,040 Provision for income taxes $ 145,521 $ 538,939 Deferred income taxes reflect the impact of "temporary differences" between the amount of assets and liabilities for financial reporting purposes and such amounts measured by tax laws and regulations. These "temporary differences" are determined in accordance with ASC 740-10. The combined U.S. federal and state effective income tax rates of 11.1% and 18.7%, for 2020 and 2019 respectively, differed from the statutory U.S. federal income tax rate for the following reasons: 2020 2019 U.S. federal statutory income tax rate 21.0 % 21.0 % Increase (reduction) in rate resulting from: State franchise tax, net of federal income tax benefit (0.1 ) 0.2 ESOP cost versus Fair Market Value 1.6 1.3 Dividend on allocated ESOP shares (14.5 ) (3.0 ) Stock-based compensation 3.0 0.2 Foreign Derived Intangible Income Deduction (0.2 ) (0.3 ) Other 0.3 (0.7 ) Effective tax rate 11.1 % 18.7 % For the years ended June 30, 2020 and 2019 deferred income tax benefit and expense of $44,122 and $258,040, respectively, results from the changes in temporary differences for each year. The tax effects of temporary differences that give rise to deferred tax assets and deferred tax liabilities as of June 30, 2020 and 2019 are presented as follows: 2020 2019 Deferred tax assets: Accrued expenses $ 171,880 $ 164,388 ESOP — 17,702 Stock-based compensation 56,280 56,382 Inventory - effect of uniform capitalization 74,352 64,148 Other 1,437 1,437 Total deferred tax assets $ 303,949 $ 304,057 Deferred tax liability: Property, plant and equipment - principally due to differences in depreciation methods $ 503,009 $ 541,150 Prepaid expenses 33,893 39,982 Total deferred tax liability $ 536,902 $ 581,132 Net deferred tax liability $ (232,953 ) $ (277,075 ) 23 Espey Mfg. & Electronics Corp. Notes to Financial Statements Note 8. Provision for Income Taxes, Continued In assessing the realization of deferred tax assets, management considers whether it is more likely than not that some portion or all of the deferred tax assets will be realized. The ultimate realization of deferred tax assets is dependent upon the generation of future taxable income during the periods in which those temporary differences become deductible. Management considers the scheduled reversal of deferred tax liabilities, projected future taxable income, and tax planning strategies in making this assessment. Based upon the level of historical taxable income and projection for future taxable income over the period in which the deferred tax assets are deductible, management believes it is more likely than not that the Company will realize the benefits of these temporary differences without consideration of a valuation allowance. As the result of the implementation of the FASB interpretation No. 48 (“FIN 48”), Accounting for Uncertainty in Income Taxes – An Interpretation of FASB Statement No. 109, the Company recognized no material adjustments to unrecognized tax benefits. As of June 30, 2020 and 2019, the Company has no unrecognized tax benefits. The Company recognizes interest and penalties in general and administrative expense. As of June 30, 2020 and 2019, the Company has not recorded any provision for accrued interest and penalties. The Company is subject to taxation in the United States and various state jurisdictions. By Federal statute tax returns are subject to audit for three years from date of filing unless the return was audited within that period. In general the majority of state statues follow similar guidelines. As such, the Company’s tax returns for tax years ending June 30, 2020, 2019, 2018, and 2017 remain open to examination by the respective taxing authorities. Note 9. Significant Customers A significant portion of the Company's business is the production of military and industrial electronic equipment for use by the U.S. and foreign governments and certain industrial customers. Sales to two domestic customers, accounted for approximately 38% of total sales in 2020. Sales to three domestic customers accounted for 54% of total sales in 2019. The related accounts receivable balance, as a percentage of the Company's total trade accounts receivable balance, was 54% represented by two customers at June 30, 2020 and 51% represented by two customers at June 30, 2019. Export sales in fiscal years 2020 and 2019 were approximately $2,077,000 and $2,638,000, respectively. Note 10. Employee Stock Ownership Plan The Company sponsors a leveraged employee stock ownership plan (the "ESOP") that covers all nonunion employees who work 1,000 or more hours per year and are employed on June 30. The Company makes annual contributions to the ESOP equal to the ESOP's debt service less dividends on unallocated shares received by the ESOP. All dividends on unallocated shares received by the ESOP are used to pay debt service. Dividends on allocated ESOP shares are recorded as a reduction of retained earnings. As the debt is repaid, shares are released and allocated to active employees, based on the proportion of debt service paid in the year. The Company accounts for its ESOP in accordance with FASB ASC 718-40. Accordingly, the shares purchased by the ESOP are reported as Unearned ESOP Shares in the statement of financial position. As shares are released or committed-to-be-released, the Company reports compensation expense equal to the current average market price of the shares, and the shares become outstanding for earnings-per-share (EPS) computations. ESOP compensation expense was $305,006 and $390,369 for the years ended June 30, 2020 and 2019, respectively. The ESOP shares as of June 30, 2020 and 2019 were as follows: 2020 2019 Allocated shares 466,929 454,943 Unreleased shares — 14,166 Total shares held by the ESOP 466,929 469,109 Fair value of unreleased shares $ — $ 350,609 The Company may at times be required to repurchase shares at the ESOP participants’ request at the fair market value. During the twelve months ended June 30, 2020, the Company repurchased 2,180 shares previously held in the ESOP for $47,949. During the twelve months ended June 30, 2019 the Company repurchased 1,810 shares previously held by the ESOP for $44,888. 24 Espey Mfg. & Electronics Corp. Notes to Financial Statements Note 10. Employee Stock Ownership Plan, Continued The ESOP allows for eligible participants to take whole share distributions from the plan on specific dates in accordance with the provision of the plan. Share distributions from the ESOP during the twelve months ended June 30, 2020 and 2019 totaled 2,180 shares and 17,279 shares, respectively. It is the Company’s intention to continue the program with an additional purchase of shares by the ESOP from the Company in fiscal 2021. Note 11. Stock-based Compensation The Company follows ASC 718 in establishing standards for the accounting for transactions in which an entity exchanges its equity instruments for goods or services, as well as transactions in which an entity incurs liabilities in exchange for goods or services that are based on the fair value of the entity’s equity instruments or that may be settled by the issuance of those equity instruments. ASC 718 requires that the cost resulting from all share-based payment transactions be recognized in the financial statements based on the fair value of the share-based payment. ASC 718 establishes fair value as the measurement objective in accounting for share-based payment transactions with employees, except for equity instruments held by employee share ownership plans. Total stock-based compensation expense recognized in the statements of comprehensive income for the fiscal years ended June 30, 2020 and 2019, was $189,639 and $172,148, respectively, before income taxes. The amount of this stock-based compensation expense related to non-qualified stock options (“NQSO”) for the fiscal years ended June 30, 2020 and 2019, was $50,075 and $44,780, respectively. The deferred tax benefit related to the NQSO’s as of June 30, 2020 and 2019 was approximately $10,516 and $9,404, respectively. The remaining stock option expense in each year related to incentive stock options (“ISO”) which are not deductible by the corporation when exercised, assuming a qualifying disposition and as such no deferred tax benefit was established related to these amounts. As of June 30, 2020, there was approximately $147,324 of unrecognized compensation cost related to stock option awards that is expected to be recognized as expense over the next 1.5 years, of which $40,970 relates to NQSO’s and $106,354 relates to ISO’s. The total deferred tax benefit related the NQSO’s in future years will be approximately $8,604. The Company has one employee stock option plan under which options or stock awards may be granted, the 2017 Stock Option and Restricted Stock Plan (the "2017 Plan"), approved by the Company's shareholders at the Company's Annual Meeting on December 1, 2017. The Board of Directors may grant options to acquire shares of common stock to employees and non-employee directors of the Company at the fair market value of the common stock on the date of grant. The maximum aggregate number of shares of common stock subject to options or awards to non-employee directors is 133,000 and the maximum aggregate number of shares of common stock subject to options or awards granted to non-employee directors during any single fiscal year is the lesser of 13,300 and 33 1/3% of the total number of shares subject to options or awards granted in such fiscal year. The maximum number of shares subject to options or awards granted to any individual employee may not exceed 15,000 in a fiscal year. Generally, options granted have a two-year vesting period based on two years of continuous service and have a ten-year contractual life. Option grants provide for accelerated vesting if there is a change in control. Shares issued upon the exercise of options are from those held in Treasury. Options covering 400,000 shares are authorized for issuance under the 2017 plan, of which 164,329 have been granted as of June 30, 2020. While no further grants of options may be made under the Company’s 2007 Stock Option and Restricted Stock Plan, as of June 30, 2020, 136,150 options were outstanding under such plan of which all are vested and exercisable. ASC 718 requires the use of a valuation model to calculate the fair value of stock-based awards. The Company has elected to use the Black-Scholes option valuation model, which incorporates various assumptions including those for volatility, expected life, and interest rates. The table below outlines the weighted average assumptions that the Company used to calculate the fair value of each option award for the year ended June 30, 2020 and 2019. 25 Espey Mfg. & Electronics Corp. Notes to Financial Statements Note 11. Stock-based Compensation, Continued 2020 2019 Dividend yield 4.88% 3.68% Expected stock price volatility 27.81% 27.63% Risk-free interest rate 1.67% 2.70% Expected option life (in years) 5.3 yrs 5.2 yrs Weighted average fair value per share of options granted during the period $ 3.03 $ 5.13 The Company declares regular dividends quarterly and declared and paid a regular cash dividends of $1.00 per share for the twelve months ended June 30, 2020. The Company declared regular cash dividends of $1.00 per share and a special cash dividend of $1.00 per share for the twelve months ended June 30, 2019. Expected stock price volatility is based on the historical volatility of the Company’s stock. The risk-free interest rate is based on the implied yield available on U.S. Treasury issues with an equivalent term approximating the expected life of the options. The expected option life (in years) represents the estimated period of time until exercise and is based on actual historical experience. The following table summarizes stock option activity during the twelve months ended June 30, 2020: Employee Stock Options Plan Weighted Number of Weighted Average Shares Average Remaining Aggregate Subject Exercise Contractual Intrinsic to Option Price Term Value Balance at July 1, 2019 259,164 $ 25.16 6.37 Granted 54,025 $ 20.50 9.44 Exercised (3,600 ) $ 22.50 — Forfeited or expired (32,877 ) $ 25.05 — Outstanding at June 30, 2020 276,712 $ 24.30 6.10 $ 0 Vested or expected to vest at June 30, 2020 261,573 $ 24.34 5.93 $ 0 Exercisable at June 30, 2020 179,520 $ 24.63 4.54 $ 0 The aggregate intrinsic value in the table above represents the total pretax intrinsic value (the difference between the closing sale price of the Company’s common stock as reported on the NYSE American on June 30, 2020 and the exercise price, multiplied by the number of in-the-money options) that would have been received by the option holders if all option holders had exercised their options on June 30, 2020. This amount changes based on the fair market value of the Company’s common stock. The total intrinsic values of the options exercised during the twelve months ended June 30, 2020 and 2019 was $263 and $67,328, respectively. The following table summarizes changes in non-vested stock options during the twelve months ended June 30, 2020: Weighted Number of Average Shares Grant Date Subject Fair Value to Option (per Option) Non-Vested at July 1, 2019 104,214 $ 4.08 Granted 54,025 3.03 Vested (45,920 ) 2.93 Forfeited or expired (15,127 ) 4.11 Non-Vested at June 30, 2020 97,192 $ 4.03 26 Espey Mfg. & Electronics Corp. Notes to Financial Statements Note 12. Concentration of Credit Risk Financial instruments that potentially subject the Company to concentrations of credit risk consist principally of cash and cash equivalents, short-term investments and accounts receivable. The Company maintains cash and cash equivalents with various financial institutions. At times such investments may be in excess of FDIC insurance limits. As disclosed in Note 9, a significant portion of the Company's business is the production of military and industrial electronic equipment for use by the U.S. and foreign governments and certain industrial customers. The related accounts receivable balance, as a percentage of the Company's total trade accounts receivable balance, was 53.9% represented by two customers at June 30, 2020 and 46.2% represented by one customer at June 30, 2019. Although the Company's exposure to credit risk associated with nonpayment of these concentrated balances is affected by the conditions or occurrences within the U.S. and foreign governments, the Company believes that its trade accounts receivable credit risk exposure is limited. The Company performs ongoing credit evaluations of its customer's financial conditions and requires collateral, such as progress payments, in certain circumstances. The Company establishes an allowance for doubtful accounts based upon factors surrounding the credit risk of specific customers, historical trends and other information. Note 13. Related Parties The administration of the shares of common stock held by the ESOP Trust is subject to the Amended and Restated Plan and a Trust Agreement, each effective as of July 1, 2016. The Trustees’ rights with respect to the disposition of shares are governed by the terms of the Plan and the Trust Agreement. As to shares that have been allocated to the accounts of participants in the ESOP Trust, the Plan provides that the Trustees are required to vote such shares in accordance with instructions received from the participants. As to unallocated shares and allocated shares for which voting instructions have not been received from participants, the Plan provides that the Trustees are required to vote such shares in accordance with the direction of the Board of Directors of the Company under the terms of the Plan and Trust Agreement. See Note 10 for additional information regarding the ESOP. Note 14. Commitments and Contingencies The Company at certain times enters into standby letters of credit agreements with financial institutions primarily relating to the guarantee of future performance on certain contracts. Contingent liabilities on outstanding standby letters of credit agreements aggregated to zero at June 30, 2020 and 2019. The Company, as a U.S. Government contractor, is subject to audits, reviews, and investigations by the U.S. Government related to its negotiation and performance of government contracts and its accounting for such contracts. Failure to comply with applicable U.S. Government standards by a contractor may result in suspension from eligibility for award of any new government contract and a guilty plea or conviction may result in debarment from eligibility for awards. The government may, in certain cases, also terminate existing contracts, recover damages, and impose other sanctions and penalties. As a result of contract audits the Company will determine a range of possible outcomes and in accordance with ASC 450 “Contingencies” the Company will accrue amounts within a range that appears to be its best estimate of a possible outcome. Adjustments are made to accruals, if any, periodically based on current information. We are party to various litigation matters and claims arising from time to time in the ordinary course of business. While the results of such matters cannot be predicted with certainty, we believe that the final outcome of such matters will not have a material adverse effect on our business, financial condition, results of operations or cash flows. Currently, there are no matters pending. Note 15. Stockholders' Equity Reservation of Shares The Company has reserved common shares for future issuance as follows as of June 30, 2020: Stock options outstanding 276,712 Stock options available for issuance 253,348 Number of common shares reserved 530,060 27 Espey Mfg. & Electronics Corp. Notes to Financial Statements Note 15. Stockholders’ Equity, Continued The following table sets forth the reconciliation of the numerators and denominators of the basic and diluted earnings per share computations for continuing operations for the years ended June 30: 2020 2019 Numerator: Net income $ 1,163,668 $ 2,342,694 Denominator: Basic EPS: Common shares outstanding, beginning of period 2,401,213 2,387,124 Unearned ESOP shares (14,166 ) (29,166 ) Weighted average common shares issued during the period 2,161 9,708 Weighted average common shares purchased during the period (1,332 ) (362 ) Weighted average ESOP shares earned during the period 5,331 5,641 Denominator for basic earnings per common shares – Weighted average common shares 2,393,207 2,372,945 Diluted EPS: Common shares outstanding, beginning of period 2,401,213 2,387,124 Unearned ESOP shares (14,166 ) (29,166 ) Weighted average common shares issued during the period 2,161 9,708 Weighted average common shares purchased during the period (1,332 ) (362 ) Weighted average ESOP shares earned during the period 5,331 5,641 Weighted average dilutive effect of stock options 3,411 16,283 Denominator for diluted earnings per common shares – Weighted average common shares 2,396,618 2,389,228 Not included in this computation of earnings per share for the year ended June 30, 2020 and 2019 were options to purchase 276,712 and 196,039 shares, respectively, of the Company’s common stock. These options were excluded because their inclusion would have been anti-dilutive due to the average strike price exceeding the average market price of those shares. The Company paid regular cash dividends on common stock of $1.00 per share for the fiscal year ended June 30, 2020 and paid regular cash dividends on common stock of $1.00 per share and a special cash dividend of $1.00 per share for the fiscal year ended June 30, 2019. The Board of Directors has authorized the payment of a fiscal year 2021 first quarter regular dividend of $0.25 payable October 14, 2020 to shareholders of record on October 5, 2020. Our Board of Directors assesses the Company’s dividend policy periodically. There is no assurance that the Board of Directors will maintain the amount of the regular cash dividend or declare a special dividend during any future years. Note 16. Line of Credit At June 30, 2020, the Company has an uncommitted and unused Line of Credit with a financial institution. The agreement provides that the Company may borrow up to $3,000,000. The line provides for interest payments equal to the LIBOR Daily Floating Rate plus 2.00%. Any borrowing under the line of credit will be collateralized by accounts receivable. The line will be reviewed annually in November for renewal on December 1st. All outstanding balances are payable no later than the expiration date of the agreement, unless other terms are agreed to by the lender. 28 Espey Mfg. & Electronics Corp. Notes to Financial Statements Note 17. Quarterly Financial Information (Unaudited) First Second Third Fourth 2020 Quarter Quarter Quarter Quarter Net sales $ 5,923,819 $ 7,286,674 $ 6,191,300 $ 12,124,438 Gross profit 1,136,348 1,480,148 910,933 2,031,186 Net income (loss) 81,776 228,964 (103,765 ) 956,693 Net income (loss) per share - Basic 0.03 0.10 (0.04 ) 0.40 Diluted 0.03 0.10 (0.04 ) 0.40 2019 Net sales $ 8,337,399 $ 7,303,109 $ 9,218,141 $ 11,619,202 Gross profit 992,934 1,516,235 2,150,439 2,403,565 Net income 61,671 217,758 922,456 1,140,809 Net income per share - Basic 0.03 0.09 0.39 0.48 Diluted 0.03 0.09 0.39 0.47 29 Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure None