UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D. C. 20549

FORM 10-K

Annual Report Pursuant to Section 13 or 15 (d) of the Securities Exchange Act of 1934

For the fiscal year ended June 30, 20162018

Commission File Number I-4383

ESPEY MFG. & ELECTRONICS CORP.

(Exact name of registrant as specified in its charter)

233 Ballston Avenue, Saratoga Springs, New York 12866

(Address of principal executive offices)

518-584-4100

(Registrant's telephone number, including area code)

Securities registered pursuant to Section 12(b) of the Act

Securities registered pursuant to Section 12 (g) of the Act

None

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.

£ Yes          S No

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act.

£ Yes          S No

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15 (d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.

SYes           £No

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Date File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files.

S Yes          £ No

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.

£

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company:

£Large accelerated filer          £Accelerated filer           £Non-accelerated filer           SSmaller reporting company

Indicate by check mark whether the registrant is a shell company.

£ Yes           S No

The aggregate market value of the voting stock held by non-affiliates of the registrant was $42,825,456$40,076,299 based upon the closing sale price of $25.75$23.96 on the NYSE MKTAmerican on December 31, 2015.2017.

At September 12, 20164, 2018 there were 2,364,6842,388,224 shares outstanding of the registrant's Common stock, $.33-1/3 par value.

DOCUMENTS INCORPORATED BY REFERENCE

Portions of the registrant's definitive proxy statement relating to the 20162018 Annual Meeting of Shareholders, to be filed with the Securities and Exchange Commission, are incorporated by reference in Part III, Items 10 through 14 on Form 10-K as indicated herein.

Forward-Looking Statements

This Annual Report on Form 10-K contains forward-looking statements that are based on management’s expectations, estimates, projections and assumptions. Words such as “expects,” “anticipates,” “plans,” “believes,” “scheduled,” “estimates” and variations of these words and similar expressions are intended to identify forward-looking statements. Forward-looking statements are made pursuant to the safe harbor provisions of the Private Securities Litigation Reform Act of 1995, as amended. These statements are not guarantees of future performance and involve certain risks and uncertainties that are difficult to predict. Therefore, actual future results and trends may differ materially from what is forecast in forward-looking statements due to a variety of factors, including, without limitation:

All forward-looking statements speak only as of the date of this report or, in the case of any document incorporated by reference, the date of that document. All subsequent written and oral forward-looking statements attributable to the Company or any person acting on the Company’s behalf are qualified by the cautionary statements in this section. The Company does not undertake any obligation to update or publicly release any revisions to forward-looking statements to reflect events, circumstances or changes in expectations after the date of this report.

PART I

Item 1. Business

General

Espey Mfg. & Electronics Corp. (“Espey”) is a power electronics design and original equipment manufacturing (OEM) company with a long history of developing and delivering highly reliable products for use in military and severe industrial environment applications. Design, manufacturing, and testing is performed in our 150,000+ square foot facility located at 233 Ballston Ave, Saratoga Springs, New York. Espey is classified as a “smaller reporting company” for purposes of the reporting requirements under the Securities Exchange Act of 1934, as amended. Espey’s common stock is publicly-traded on the NYSE MKTAmerican under the symbol “ESP.”

Espey began operations after incorporation in New York in 1928. We strive to remain competitive as a leader in high power energy conversion and transformer solutions through the design and manufacture of new and improved products by using advanced and “cutting edge” electronics technologies.

Espey is ISO 9001:20082015 and AS9100:20092016 certified. Our primary products are power supplies, power converters, filters, power transformers, magnetic components, power distribution equipment, UPS systems, antennas and high power radar systems. The applications of these products include AC and DC locomotives, shipboard power, shipboard radar, airborne power, ground-based radar, and ground mobile power.

EspeyEspey’s services include design and development to specification, build to print, design services, design studies, environmental testing services, metal fabrication, painting services, and development of automatic testing equipment. Espey is vertically integrated, meaning that the Company produces individual components (including inductors), populates printed circuit boards, fabricates metalwork, paints, wires, qualifies, and fully tests items, mechanically, electrically and environmentally, in house. Portions of the manufacturing and testing process are subcontracted to vendors from time to time.

In fiscal years ended June 30, 20162018 and 2015,2017, the Company's totalsales were $32,517,883 and$27,471,365and$26,831,705,22,521,012, respectively. Sales totwodomestic customers accounted for 37%33% and 12%27% of total sales in 2016.2018. Sales tothreetwodomestic customers accounted for 36%, 15%29% and 10%16% of total sales in 2015.2017. This high concentration level with these customers presents significant risk. A loss of a significant customer would negativelyone of these customers or programs related to these customers could significantly impact the financial performance of the Company. One significant customer is experiencingHistorically, a significant declinesmall number of customers have accounted for a large percentage of the Company’s total sales in sales due to falling demand in its core locomotive business. This is discussed further in Item. 7 Management’s Discussion and Analysis of Financial Condition and Results of Operations.any given fiscal year.

Export sales in 2016fiscal years 2018 and 20152017 were approximately $2,125,000$3,112,000 and $2,384,000,$1,730,000, respectively. This decreaseincrease is primarily due to the reductionincrease in power supply and antenna shipments to specific customers.

Sources of Raw Materials

The Company has nevernot typically experienced any significant delaydelays or shortageshortages with respect to the purchase of raw materials and components used in the manufacture of its products and has at least two potential sources of supply for a majority of its raw materials. However, certain components used in its products are available from onlya single or a limited number of sources, and other components are only available from a single source.sources. Despite the risk associated with limitedsingle or singlelimited source suppliers, the benefits of higher quality goods and timely delivery minimize and often limit any potential risk and can eliminate problems with part failures during production. At times replacements are required to cover obsolete parts.

The power electronics industry is experiencing sustained growth and continuing demand from multiple manufacturing sectors. This growth has created volatility and unpredictability in the availability of certain electronic components and, in some cases, has created industry shortages. These shortages have a strong potential to impact our ability to support our customer’s schedule demands, as lead times for these components have, in some instances, increased from readily available to waiting times of nearly a year or more. We are working with our customers to mitigate adverse impact upon our ability to service their requirements resulting from the current industry-wide phenomenon.

In 2018, the President of the United States directed the imposition of tariffs on steel and aluminum imports from various countries. While currently we are not experiencing any significant financial or raw material sourcing issues resulting from the product tariffs, the Company cannot provide any assurance that the existing tariffs, the potential of additional tariffs, and the associated volatility arising from the Administration’s foreign trade policies, will not have a negative impact on our future earnings by increasing our raw material prices and augmenting the lead time for the availability of raw materials. From time to time the Company must identify parts to replace parts which are no longer produced.

Sales Backlog

The total backlog at June 30, 20162018 was approximately$39.1 $48.1 million compared to approximately $36.4$43.1 million at June 30, 2015.2017. The Company’s total backlog represents the estimated remaining sales value of work to be performed under firm contracts. The funded portion of this backlog was fully funded at June 30, 2016 and 2015. Funded backlog means2018 is approximately $45.0 million. This includes items that have been authorized and appropriated by Congress and/or funded by the customer. ThereThe unfunded backlog at June 30, 2018 is approximately $3.1 million and represents a firm multi-year order for which funding has not yet been appropriated by Congress or funded by our customer. While there is no guarantee that future budgets and appropriations will provide funding for follow-on orders forindividual programs, management has included in unfunded backlog only those programs that it believes are likely to receive funding based on discussions with customers and program status. The unfunded backlog at June 30, 2017 was $7.5 million. For both fiscal years ended 2018 and 2017, the unfunded backlog is comprised primarily of the same multi-year order from a given program.single customer. The Company's backlog and risks associated with government contracts is discussed in greater detail in Management's Discussion and Analysis of Financial Condition and Results of Operations, contained in Item 7 below.

It is presently anticipated that a minimum of$40.623million million of orders comprising the June 30, 20162018 backlog will be filled during the fiscal year ending June 30, 2017.2019. The minimumof $23$40.6 million does not include any shipments which may be made against orders received subsequently received duringto the fiscal year ending June 30, 2017.2018. The estimate of the June 30, 20162018 backlog to be shipped in fiscal 2017year 2019 is subject to future events, which may cause the amount of the backlog actually shipped to differ from such estimate.

Marketing and Competition

The Company markets its products primarily through its own direct sales organization and through outside sales representatives. Business is solicited from large industrial manufacturers and defense companies, the government of the United States, foreign governments and major foreign electronic equipment companies. In certain countries the Company has external sales representatives to help solicit and coordinate foreign contracts. Espey is also on the eligible list of contractors with the United States Department of Defense. We pursue opportunities for prime contracts directly with the Department of Defense and are generally is automatically solicited by Department of Defense Department procurement agencies for their needs falling within the major classes of products produced by the Company. In addition, the Company directly pursues opportunities from the United States Department of Defense for prime contracts. Espey contracts with the Federal Government under cage code 20950 as Espey Mfg. & Electronics Corp.

There is competition in all classes of products manufactured by the Company ranging from divisions of the largest electronic companies, as well asto many small companies. The Company's sales do not represent a significant share of the industry's market for any class of its products. The principal methods of competition for electronic products of both a military and industrial nature include, among other factors, price, product performance, the experience of the particular company and history of its dealings in such products.

Our business is not seasonal. However, the concentration of our business in the rail industry, and in equipment for military applications and industrial applications and our customer concentrations expose us to on-going associated risks. These risks including,include, without limitation, requirements for power supplies in the rail industry, dependence on appropriations from the United States Government and the governments of foreign nations, program allocations, and the potential of governmental termination of orders for convenience.

Uncertainty in federal defense spendingconvenience, and the current declinegeneral strength of the industry sectors in which our customers transact business.

Future procurement needs supporting the military and the rail industry continues to drive competition. ManyFor several years, many of our competitors have, beenand they continue to invest aggressively investing in upfront product design costs and loweringaccept lower profit margins as a strategic means of maintaining existing business and enhancing market share at the expense of short term profit.share. This change in the market place has put pressure on the pricing of our current products and will result in lowerhas lowered our profit margins on new business and some of our legacynew business. In order to compete effectively for new business, in some cases we investhave invested in upfront design costs, thereby reducing initial profitability as a means of procuring new long-term programs. Accordingly,As part of our strategy, we have adjustedadjust our pricing strategy in order to achieve a balance which enables us both to retain repeat programs while being more competitive in bidding on new programs. This trend will continue into fiscal 2017 andyear 2019.

In order to maintain a balanced business, we continueare continuing to invest in new programs and aggressively quote long-term programs inplace an emphasis on securing “build to print” opportunities, which will allow production work to go directly to the manufacturing floor, limiting the impact on our engineering staff. This effort will keep our manufacturing team busy while the products being developed transition to grow the business.production.

Moreover, to address current elements of competition and foster growth we have made targeted hires of experienced personnel to support enhanced sales, program fulfillment, engineering, quality control and supply chain management.

Research and Development

The Company's expenditures for research and development were approximately $49,236 and $234,812 in fiscal 2016 and 2015, respectively.

Some of the Company's engineers and technicians spend varying degreesamounts of time on either the development of new products or improvements ofto existing products. A majority of these expendituresthe resulting costs we incur relate to research that is required by Espey engineers to support a request for a quotation from a customer having a product-specific custom need usually associated with stringent size and weight requirements. We do very little pure research as our business primarily is driven by customer product needs as opposed to newand custom product development.development with some customer funding. The Company's expenditures for research and development were approximately $18,206 and $34,065 in fiscal year 2018 and 2017, respectively.

Employees

The Company had 145164 employees as ofSeptember 12, 2016August 31, 2018. During the year ended June 30, 2018, we increased the number of employees to support our business growth. Approximately 40%38% of these employees are represented by the International Brotherhood of Electrical Workers Local #1799. A new collective bargaining agreement was approved in July 2015.2018. The three-yearfour-year agreement expires onJune 30, 2018.2022. Relations with the Union are considered good.

Government Regulations

Compliance with federal, state and local laws regulating the discharge of materials into the environment, or otherwise relating to the protection of the environment, did not in fiscal year 2016,2018, and the Company believes will not in fiscal year 2017,2019, have a material effect upon the capital expenditures, net income, or competitive position of the Company.

The Company’s U.S. Government contract and subcontract orders are funded by government budgets, which operate on an October-to-September fiscal year. Normally, in February of each year, the President of the United States presents to Congress a proposed budget for the upcoming fiscal year. This budget includes recommended appropriations for every federal agency and is the result of months of policy and program reviews throughout the executive branch. From February through September of each year, the appropriations and authorization committees of Congress review the President’s budget proposals and establish the funding levels for the upcoming fiscal year in appropriations and authorization legislation. Once these levels are enacted into law, the Executive Office of the President administers the funds to the agencies.

There are two primary risks associated with this process. First, the process may be delayed or disrupted because of congressional schedules, negotiations over funding levels for programs or unforeseen world events, which could, in turn, alter the funding for a program or contract. Second, funding for multi-year contracts can be changed by future appropriations, which could affect the timing of funds, schedules and program content.

Also, our international sales are denominated in United States dollars. Consequently, changes in exchange rates that strengthena strengthening of the United States dollar against foreign currencies could increase the price in local currencies of our products in foreign markets and make our products relatively more expensive than competitors’ products.

U.S. Government Defense Contracts and Subcontracts

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.

Cyber or Other Security Threats or Other Disruptions

We routinely experience cybersecurity threats in the form of unauthorized attempts to gain access to our sensitive information. The threats we face vary from attacks common to most industries to more advanced attacks with the specific objective of accessing national security information. We believe our threat detection and mitigation processes and procedures are above adequate. The processes and procedures in place are designed to detect, manage and prevent current threats and respond quickly to detect and mitigate new threats. To ensure our systems remain protected, we continually assess and acquire, as appropriate, new available technology and provide employee training to utilize effectively our technological assets. Prior cyberattacks directed at us have not had a material impact on our financial results nor restricted us from being awarded contracts from other defense companies or directly from the United States Department of Defense. However, we can provide no assurance that the occurrence of any future event would not adversely affect our internal operations, our reputation and competitive advantage, and our future financial results.

The Company's entire operation, including administrative, manufacturing and engineering facilities, is located in Saratoga Springs, New York.

The Saratoga Springs plant, which the Company owns, consists of various adjoining buildings on a 22 acre site, approximately eight acres of which is unimproved. The property is not subject to mortgage indebtedness or any other material encumbrance. The plant has a sprinkler system throughout and contains approximately 151,000 square feet of floor space,of which 90,000 is used for manufacturing, 24,000 for engineering, 33,000 for shipping and climatically secured storage, and 4,000 for offices. The offices, engineering and some manufacturing areas are air-conditioned. In addition to assembly and wiring operations, the plant includes facilities for varnishing, potting, impregnation and spray-painting operations. The manufacturing operation also includes a complete machine shop, with welding and sheet metal fabrication facilities adequate for substantially all of the Company's current operations. Besides normal test equipment, the Company maintains a sophisticated on-site environmental test facility. In addition to meeting all of the Company's in-house needs, the machine shop and environmental facilities are available to other companies on a contract basis.

NoneWe 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.  

Not applicable

PART II

Price Range of Common Stock

The table below shows the range of high and low prices for the Company's common stock on the NYSE MKTAmerican (symbol "ESP"), the principal market for trading in the common stock, for each quarterly period for the last two fiscal years ended June 30:

Holders

The approximate number of holders of record of the common stock was 78on75 onSeptember 12, 20164, 2018according to records of the Company's transfer agent. Included in this number are shares held in "nominee" or "street" name and, therefore, the number of beneficial owners of the common stock is believed to be substantially in excess of the foregoing number.

Dividends

The Company paid cash dividends on common stock of $1.00 per share for each of the fiscal years ended June 30, 20162018 and 2015.2017. The Board of Directors has authorized the payment of a fiscal 2017year 2019 first quarter regular dividend of $0.25, and a special dividend of $1.00, payable September 29, 2016October 1, 2018 to shareholders of record on September 22, 2016.24, 2018. Our Board of Directors assesses the Company’s dividend policy periodically. ThereWhile there is no assurance that the Board of Directors will either maintain the amount of the regular cash dividend or declare a special dividend during any future years.years, we believe that the Company is in the position to continue to pay the regular cash dividends for the foreseeable future.

During fiscal 2016,year 2018, the Company sold common stock to certain employees and directors as they exercised existing stock options granted under a shareholder approved plan.During the year, 16,30020,601 shares were sold at prices that ranged from$17.09 a share to $21.54a$25.18 a share. The securities were sold for cash. Proceeds are used for general working capital purposes.

The Company did not make any open market purchases of equity securities in the fiscal 2016year 2018 fourth quarter.

The following table sets forth information as of June 30, 20162018 with respect to compensation plans under which equity securities of the Company may be issued.

Equity Compensation Plan Information

Item 7.  Management's Discussion and Analysis of Financial Condition and Results of Operations

Business Outlook

Management expects revenues in fiscal year 20172019 to be lesshigher than revenues during fiscal year 2016.2018 but expects the gross profit margin to be lower in fiscal year 2019 than the gross profit margin during fiscal year 2018. This expectation is driven primarily by recent communications with a significant customerorders already in the industrial sector who has advised us of a significantly scaled-back purchase plan resulting from falling demandour backlog that will be shipped in the rail industry. This negative development may be offset, in part, by a newfiscal year 2019. As market factors including competition and product for another customer which is currently in the final stages of design developmentcosts impact gross profit margins, management will continue to evaluate our sales strategy, employment levels, and qualification testing. If the testing is successful, shipments of the product are expected to begin in the third quarter of the fiscal year.facility costs.

During fiscal 2016year 2018 the Company received approximately $30.2$37.5 million in new orders. Our total backlog at June 30, 20162018 was approximately $39.1$48.1 million, as compared to $36.4$43.1 million at June 30, 2015.2017. Currently, we expect a minimum of $23$40.6 million of orders comprising the June 30, 20162018 backlog will be filled during the fiscal year ending June 30, 2017.2019. This $23$40.6 million will be supplemented by shipments which may be made against orders received during the fiscal year.

Successful conversion of engineering program backlog into sales is largely dependent on the execution and completion of our engineering design efforts.   It is not uncommon to experience technical or scheduling delays which arise from time to time as a result of, among other reasons, design complexity, the availability of personnel with the requisite expertise, and the requirements to obtain customer approval at various milestones.  Cost overruns which may arise from technical and schedule delays could negatively impact the timing of the conversion of backlog into sales, or the profitability of such sales.  While recently, we have been experiencing some technical and schedule delays with our major development programs, these delays have been resolved as they arise and we do not currently expect any negative impact on our customer order fulfillment projections for fiscal year 2019.  Engineering programs in both the funded and unfunded portions of the current backlog aggregate $8.8 million. 

In addition to the backlog, the Company currently has outstanding opportunities representing in excess of $50$69.6 million in the aggregate as of September 8, 2016,August 31, 2018, for both repeat and new programs. The outstanding quotations encompass various new and previously manufactured power supplies, transformers, and subassemblies. However, there can be no assurance that the Company will acquire any of the anticipated orders described above, many of which are subject to allocations of the United States defense spending and factors affecting the defense industry and industrial locomotive power supply procurement of a single customer.

industry. Two significant customers including the one which advised us of the intent to reduce orders during fiscal year 2017, represented 49%60% of the Company’s total sales in fiscal 2016year 2018 and threetwo significant customers represented 61%45% of the Company’s total sales in fiscal 2015.year 2017. These sales are in connection with multiyear programs in which the Company is a significant contractor. The June 30, 20162018 backlog of $39.1$48.1 million includesincluded orders from twothree customers that represent 35%23%, 16%, and 27%10%, respectively, of the total backlog. ThisThe June 30, 2017 backlog of $43.1 million includes orders from three customers that represent 23%, 20% and 18%, respectively, of the total backlog. Although improvement has been made in customer concentrations, this high customer concentration level presentscontinues to present significant risk. A loss of one of these customers or programs related to these customers, or customer requested deferrals of product delivery could significantly impact the Company.

Historically, a small number of customers have accounted for a large percentage of the Company’s total sales in any given fiscal year. Management continues to pursue opportunities with current and new customers with an overall objective of lowering the concentration of sales, mitigating excessive reliance upon a single major product of a particular program and minimizing the impact of the loss of a single significant customer. We continue to evaluate the Company’s business development functions and the implementation of potential alternative courses of action in order to diversitydiversify the Company’s customer base. The quotations for non-repeat programs referred to above include several new customers.

As market factors impact revenues, management will continue to evaluate our sales strategy, employment levels, and facility costs. Management is currently participating in a plant layout optimization review with an objective to improve capacity and maximum cost savings as product moves through the facility. Recommendations from the review are currently being implemented and expect to be completed in fiscal 2017 and 2018.

Management, along with the Board of Directors, continues to evaluate the need and use of the Company’s working capital. Capital expenditures, primarily for machinery and equipment, are expected to be approximately $750,000$500,000 for fiscal 2017.year 2019. A majority of these expenditures will be made to optimize the production flow as noted above and to upgrade existing equipment and add needed technology to stay competitive in the marketplace.marketplace and to meet the needs of current contracts. Expectations are that the working capital will be required to fund orders, dividend payments, and general operations of the business. From time to time, management along with the Mergers and Acquisitions Committee of the Board of Directors examine opportunities involving acquisitions or other strategic options, including buying certain products or product lines. The criteria for consideration are synergies with the Company’s existing product base and accretion to earnings.

Results of Operations

Net sales for fiscal years ended June 30, 20162018 and 2015,2017, were $27,471,365$32,517,883 and $26,831,705,$22,521,012, respectively, a 2.4%44% increase. The slight increase in sales can be attributed to the contract specific nature of the Company’s business and the timing of deliveries on these contracts. Specifically, the increase in net sales in the current fiscal year is primarily due to an increase in magneticpower supply sales resulting from the commencement of shipments of $1.1 million,on a significant military contract and the increase in shipments to several existing customers offset, in part, by a decrease in build-to-print sales.magnetic shipments due to timing and completion of specific contracts.

For the fiscal years ended June 30, 20162018 and 20152017 gross profits were $7,371,682$7,662,252 and $7,141,573,$4,714,568, respectively. Gross profit as a percentage of sales increased slightly to 26.8%23.6% for fiscal 2016,year 2018, up from 26.6%20.9% in fiscal 2015.year 2017. The primary factors in determining the change in gross profit and net income are overall sales levels and product mix. The gross profits on mature products and build to print contracts are typically higher as compared to products which are still in the engineering development stage or in early stages of production. In the case of the latter, the Company can incur what it refers to as “loss contracts,” meaning engineering design contracts in which the Company invests with the objective of developing future product sales. In any given accounting period the mix of product shipments between higher margin programs and less mature programs, and expenditures associated with loss contracts, has a significant impact on gross profit and net income. In total, theThe gross profit percentage remained consistent forincreased in the twelve months ended June 30, 2016,2018 as compared to the twelve months ended June 30, 2015. Fiscal 2016 profit margins on shipments were up slightlysame period in 2017 primarily due to product mix and less incidents of “loss contracts” as compared to the prior fiscal year. In addition, fiscal 2015 included a favorable one-time reduction to cost ofan increase in sales of $560,000 for a contract settlementwhile expenditures incurred related to a previously cancelled program.engineering design investments remained comparable to those incurred in the same period in 2017.

Selling, general and administrative expenses were $3,028,449$3,808,395 for the fiscal year ended June 30, 2016,2018, an increase of $316,642,$620,283, or 11.7%19.5% as compared to the prior year. The increase for fiscal 2016year 2018 relates primarily to anthe increase in employee compensation costs, professional services, outside selling expenses incurred for outside sales representatives, and freight due to an increase in the number of employees supporting sales and program management.shipments.

Employment of full time equivalents at June 30, 20162018 was 149153 people compared with 145136 people at June 30, 2015. Employees were hired2017. The increase in sales,headcount is primarily due to an increase in engineering quality control and program management both topersonnel in support of the Company’s current backlog and to build a team that can augment and diversify our business and effectively manage the Company.sales backlog.

Other income for the fiscal years ended June 30, 20162018 and 20152017 was $119,274$215,219 and $68,050,$124,949, respectively. The increase is primarily due to an increase in scrap sales offset by a slight decreaseinterest income resulting from the increase in interest income.investment securities and investment returns. Interest income is a function of the level of investments and investment strategies which generally tend to be conservative.

The Company’s effective income tax rate has remained consistent with the prior year and was 28.8%24.4% in fiscal 2016year 2018 and 29.2%31.2% in fiscal 2015.year 2017. The effective tax rate is less than the statutory tax rate mainly due to the benefit the Company receives on its “qualified production activities” under The American Jobs Creation Act of 2004 and the benefit derived from the ESOP dividends paid on allocated ESOP shares. The Company’s effective tax rate for the fiscal year ended June 30, 2018 uses a blended statutory tax rate which factors the reduction in the corporate statutory tax rate authorized under the Tax Cuts and Jobs Act (the “Tax Act”) effective on January 1, 2018. The Company re-measured certain U.S. deferred tax assets and liabilities based on the rates at which they are expected to reverse in the future, which is generally 21%, and provisionally recorded a net income tax expense of $35,200 related to the re-measurement in the second quarter of fiscal year 2018.

Net income for fiscal 2016,year 2018 was $3,175,801$3,075,797 or $1.39$1.32 and $1.38$1.31 per share, basic and diluted, respectively compared to net income of $3,183,127$1,135,736 or $1.40 and $1.39$0.49 per share, basic and diluted, respectively, for fiscal 2015.year 2017. The decreaseincrease in net income per share for the twelve months ended June 30, 2016,2018 was primarilymainly due to high gross profit resulting from higher selling, general and administrative expenses offset by an increase in sales and thehigher gross profit percentage resulting from product mix. Also, impactingmix with expenditures related to engineering design investments made by the comparison isCompany remaining comparable between periods. In addition, the Company received a prior year favorable one-time $560,000benefit in the current period from the reduction in the Company’s effective tax rate discussed above. The increase was offset, in part, by an increase in selling, general and administrative expenses primarily related to cost of sales referred to above.employee compensation costs resulting from an increase in headcount.

Liquidity and Capital Resources

The Company's working capital is an appropriate indicator of the liquidity of its business, and during the past two fiscal years, the Company, when possible, has funded all of its operations with cash flows resulting from operating activities and when necessary from its existing cash and investments. The Company did not borrow any funds during the last two fiscal years. Management has available a $3,000,000 line of credit to help fund further growth or working capital needs, if necessary, but does not anticipate the need for any borrowed funds in the foreseeable future. The line is reviewed annually in November for renewal on December 1^st.

The Company's working capital as of June 30, 20162018 and 20152017 was $30,242,950$29,740,468 and $28,656,762,$29,853,018, respectively. During the three and twelve months ended June 30, 20162018 the Company repurchased 0 and 14,3034,798 shares of its common stock, respectively, from the Company’s Employee Retirement Plan and Trust (“ESOP”) for a purchase price of $0 and $355,418,$109,694, respectively. During the three and twelve months ended June 30, 20152017 the Company repurchased 0 and 13,5531,633 shares of its common stock, respectively, from the Company’s ESOP for a purchase price of $0 and $320,504,$44,335, respectively. None of such purchases were made during the last three months of each fiscal year. Under existing authorizations from the Company's Board of Directors, as of June 30, 2016,2018, management is authorized to purchase an additional $1,030,326$876,297 of Company stock.

The table below presents the summary of cash flow information for the fiscal year indicated:

Net cash provided by operating activities fluctuates between periods primarily as a result of differences in sales and net income, provisionsprovision for income taxes, the timing of the collection of accounts receivable, purchase of inventory, and payment of accounts payable. The increasedecrease in net cash provided by operating activities compared to the prior year primarily relates to an increase in tradeaccounts receivable, collectionsinventories and prepaid expenses and other current assets as well as a declinereduction in inventory purchases due to the timing of production jobs,accounts payable. This was offset by an increase in cash paid for both federalnet income tax deposits and payments to vendors.resulting from higher sales in the current period. Net cash provided byused in investing activities decreased in the twelve months of fiscal 2016year 2018 as compared to the same period in fiscal year 2017 primarily due to an increase in maturing investments offset by an increase in the timingpurchase of investments and reinvestmentproperty, plant and equipment. Cash used in financing activities consists primarily of matured investment securities.dividend payments on common stock and the Company’s purchase and issuance of treasury stock. The increasedecrease in cash used in financing activities is due primarily to an increase in proceeds received from the dividend payable at June 30, 2015,exercise of stock options offset, in part, from the increase in cash expended on shares purchased from the Company’s ESOP and the increase in dividends paid in the twelve months ended June 30, 2016.fiscal year 2018 as compared to fiscal year 2017.

The Company currently believes that the cash flow generated from operations and when necessary, from cash and cash equivalents will be sufficient to meet its long-term funding requirements for the foreseeable future.

During fiscal years 2018 and 2017, the Company expended $1,923,220 and $352,132, respectively, for plant improvements and new equipment. The Company has budgeted approximately $500,000 for new equipment and plant improvements in fiscal year 2019. Management anticipates that the funds required will be available from current operations.

Management believes that the Company's reserve for bad debts of $3,000 is adequate given the customers with whom the Company does business. Historically, bad debt expense has been minimal.

During fiscal years 2016 and 2015, the Company expended $284,210 and $266,029, respectively, for plant improvements and new equipment. The Company has budgeted approximately $750,000 for new equipment and plant improvements in fiscal 2017. Management anticipates that the funds required will be available from current operations.

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 ofEspey Mfg. & Electronics Corp.Corp (the Company) as of June 30, 20162018 and 2015, and2017, the related statements of comprehensive income, changes in stockholders’stockholders' equity and cash flows for each of the years ended June 30, 2018 and 2017, 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, 2018 and 2017, and the results of its operations and its cash flows for the years then ended. 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 thesethe Company’s financial statements based on our audits. We are a public accounting firm registered with thePublic 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 Public Company Accounting Oversight Board (United States).PCAOB. Those standards require that we plan and perform the auditsaudit to obtain reasonable assurance about whether the financial statements are free of material misstatement.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. OurAs part of our audits included considerationwe are required to obtain an understanding of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the company’sCompany's internal control over financial reporting. Accordingly, we express no such opinion. An audit also includes

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 supportingregarding the amounts and disclosures in the financial statements, assessingstatements. 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 statement presentation.statements. We believe that our audits provide a reasonable basis for our opinion.

In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of Espey Mfg. & Electronics Corp. as of June 30, 2016 and 2015, and the results of its operations and its cash flows for the years then ended, in conformity with U.S. generally accepted accounting principles.

/s/ Freed Maxick CPAs, P.C.

Freed Maxick CPAs, P.C.

We have served as the Company's auditor since 2014.

Rochester, New York

September 12, 2016

2018

Espey Mfg. & Electronics Corp.

Balance Sheets

June 30, 20162018 and 20152017

The accompanying notes are an integral part of the financial statements.

Espey Mfg. & Electronics Corp.

Statements of Comprehensive Income

Years endedEnded June 30, 20162018 and 20152017

The accompanying notes are an integral part of the financial statements.

Espey Mfg. & Electronics Corp.

Statements of Changes in Stockholders' Equity

Years Ended June 30, 20162018 and 20152017

(Continued)

The accompanying notes are an integral part of the financial statements.

Espey Mfg. & Electronics Corp.

Statements of Changes in Stockholders' Equity

Years Ended June 30, 20162018 and 20152017

The accompanying notes are an integral part of the financial statements.

Espey Mfg. & Electronics Corp.

Statements of Cash Flows

Years Ended June 30, 20162018 and 20152017

(Continued)

The accompanying notes are an integral part of the financial statements.

Espey Mfg. & Electronics Corp.

Statements of Cash Flows

Years Ended June 30, 2016 and 2015

The accompanying notes are an integral part of the financial statements.

Espey Mfg. & Electronics Corp.

Notes to Financial Statements

Note 1. Nature of operationsOperations

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 Recognition

The Company recognizes revenue in accordance with Financial Accounting Standards Board (“FASB”) Accounting Standards Codification (“ASC”) Topic 605 “Revenue Recognition”. Product sales represent the majority of the Company’s revenue. The Company recognizes revenue from these product sales when persuasive evidence of an arrangement exists, transfer of title and risk of loss has occurred, the sale price is fixed or determinable, and collectability is reasonably assured. The Company sells its products on terms which transfer title and risk of loss at a specified location, typically shipping point. Accordingly, revenue recognition from product sales occurs when all factors are met. If these conditions are not met, the Company will defer revenue recognition until such time as these conditions have been satisfied. The Company collects and remits sales taxes in certain jurisdictions and reports revenue net of any associated sales taxes. The provision for product returns and price adjustments is assessed for adequacy at each quarter end and is based on recent historical experience and known customer claims and was not material as of June 30, 2018 or 2017.

A portion of our revenue, primarily for development contracts, is recognized using the milestone method of accounting. Each milestone for which revenue is recognized is considered substantive. In determining this the Company considered whether the consideration associated with the milestone was commensurate with the performance to achieve the milestone, relates solely to past performance, and reasonable relative to the other deliverables and payment terms within the agreement.

Inventory Valuation and Cost Estimation and Revenue Recognition

Raw materials are valued at the lower of weighted average cost (average cost) or market.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; parts and other inventory items acquired or produced to service units previously sold or to meet anticipated future orders.  The cost elements of contracts in process and work in process consist of production costs of goods and services currently in process and overhead. 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.  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.

Revenue is recognized on contracts in the period in which the units are delivered and billed (units-of-delivery method).  A significant portion of our business is comprised of development and production contracts.  Generally, revenues on long-term fixed-price contracts are recorded on a percentage of completion basis using units of delivery as the measurement basis for progress toward completion. 

Percentage of completion accounting requires judgment relative to expected sales, estimating costs and making assumptions related to technical issues and delivery schedules.  Contract costs include material, subcontract costs, labor, and an allocation of overhead costs.  The estimation of 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.

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:

Espey Mfg. & Electronics Corp.

Notes to Financial Statements

Note 2. Summary of Significant Accounting Policies,Continued

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.  In addition, ASC 740-10 requires that the tax benefit of tax-deductible dividends on unallocated ESOP shares be recorded as a direct addition to retained earnings rather than as a reduction of income tax expense.

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. 

Espey Mfg. & Electronics Corp.

Notes to Financial Statements

Note 2. Summary of Significant Accounting Policies,Continued

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, 20162018 and June 30, 20152017 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.

§          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 and accrued expenses, approximated fair value as of June 30, 20162018 and 20152017 because of the immediate or short-term maturity of these financial instruments. 

Accounts receivableReceivable and allowanceAllowance for doubtful accountsDoubtful 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. An account is generally considered past due after thirty (30) days from the invoice date.  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, 20162018 and 2015.2017.  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”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.

Espey Mfg. & Electronics Corp.

Notes to Financial Statements

Note 2. Summary of Significant Accounting Policies,Continued

Comprehensive Income

Comprehensive income consists of net income and other comprehensive income.  Other comprehensive income for fiscal years ended June 30, 20162018 and 20152017 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.

Espey Mfg. & Electronics Corp.

Notes to Financial Statements

Note 2. Summary of Significant Accounting Policies,Continued

Investment Tax Credits

Investment tax credits are accounted for as a reduction of income tax expense in the year taxes payable are reduced. Unused credits are reflected as a deferred tax asset.

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 July 2015, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) No. 2015-11, “Inventory (Topic 330): Simplifying the Measurement of Inventory.”  ASU No. 2015-11 requires inventory measured using any method other than last-in, first out or the retail inventory method to be subsequently measured at the lower of cost and net realizable value, rather than at the lower of cost or market.  Net realizable value is defined as the estimated selling price, less the estimated costs to complete, dispose, and transport such inventory.  ASU No. 2015-11 will be effective for fiscal years and interim periods beginning after December 15, 2016.  ASU No. 2015-11 is required to be applied prospectively and early adoption is permitted.  The Company’s adoption of ASU No. 2015-11 is not expected to have a material impact on the Company’s financial position or results of operations.

In May 2014, the FASB issued ASU No. 2014-09, “Revenue from Contracts with Customers,” which supersedes nearly all existing revenue recognition guidance under U.S. GAAP.  The core principle of ASU No. 2014-09 is to recognize revenues when promised goods or services are transferred to customers in an amount that reflects the consideration to which an entity expects to be entitled for those goods or services.  ASU No. 2014-09 defines a five step process to achieve this core principle and, in doing so, more judgment and estimates may be required within the revenue recognition process than are required under existing U.S. GAAP.

In subsequent periods, the FASB issued additional ASUs intended to clarify specific aspects related to the interpretation and implementation of ASU No. 2014-09. In March 2016, the FASB issued ASU No. 2016-08, “Revenue from Contracts with Customers – Principal versus Agent Considerations (Reporting Revenue Gross versus Net)” to provide guidance on principal versus agent considerations by an entity as discussed in ASU No. 2014-09. ASU No. 2016-08 provides criteria to be assessed by an entity when determining whether it is the principal or agent in relation to the goods or services which the companyCompany is contractually obligated to provide to the customer. Among these considerations are;are: identifying the unit of account at which the entity should assess whether it is a principal or an agent,agent; identifying the nature of the good or service provided to the customer; applying the control principle to certain types of transactions; and, interaction of the control principle with the indicators provided to assist in the principle versus agent evaluation. In April 2016, the FASB issued ASU No. 2016-10, “Revenue from Contracts with Customers – (Topic 606): Identifying Performance Obligations and Licensing” to provide implementation guidance related to the necessary judgements required in identifying performance obligations of a contract and guidance related to recognition of licensing revenues. In May 2016, the FASB issued ASU No. 2016-12, “Revenue from Contracts with Customers – (Topic 606): Narrow-Scope Improvements and Practical Expedients” to provide guidance related to the implementation of ASU No. 2014-09 in the following areas; assessing collectability for contracts that do not meet Step 1 of revenue recognition, presentation of sales taxes, noncash consideration, contract modifications at transition, and completed contracts at transition.

These standards are effective for annual periods beginning after December 15, 2017, and interim periods therein, using either of the following transition methods: (i) a full retrospective approach reflecting the application of the standard in each prior reporting period with the option to elect certain practical expedients, or (ii) a retrospective approach with the cumulative effect of initially adopting ASU No. 2014-09 recognized at the date of adoption (which includes additional footnote disclosures).  Early adoption is permitted for annual periods beginning after December 15, 2016 and interim periods therein. We are currently evaluatingevaluated the impact of our pending adoptionadopting of ASU No. 2014-092014-09; this will not have a material impact on ourthe Company’s financial statements and have not yet determinedaside from increased disclosures. The Company used the modified retrospective method by which we will adoptwhen adopting the standard inbeginning July 1, 2018.

Espey Mfg. & Electronics Corp.

Notes to Financial Statements

Note 2. Summary of Significant Accounting Policies,Continued

In July 2015, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) No. 2015-11, “Inventory (Topic 330): Simplifying the Measurement of Inventory.”  ASU No. 2015-11 requires inventory measured using any method other than last-in, first out or the retail inventory method to be subsequently measured at the lower of cost and net realizable value, rather than at the lower of cost or market.  Net realizable value is defined as the estimated selling price, less the estimated costs to complete, dispose, and transport such inventory.  ASU No. 2015-11 was effective for fiscal 2019.years and interim periods beginning after December 15, 2016.  ASU No. 2015-11 was required to be applied prospectively and early adoption was permitted.  The Company adopted ASU No. 2015-11 and it did not have a material impact on the Company’s financial position or results of operations.

In November 2015, the FASB issued ASU No. 2015-17, “Income Taxes (Topic 740): Balance Sheet Classification of Deferred Taxes”. The guidance requires the classification of deferred tax assets and liabilities as non-current in a classified balance sheet. The current requirement that deferred tax assets and liabilities of a tax-paying component of an entity be offset and presented as a single amount is not affected by this update. We adopted ASU No. 2015-17 will be effectiveduring the first quarter of fiscal year 2018 on a prospective basis. Prior periods were not retrospectively adjusted. Accordingly, for annual periods beginning after December 15, 2016, and interim periods within those annual periods. ASU No. 2015-17 may be applied prospectively or retrospectively, and early adoption is permitted.the twelve-month period ended June 30, 2018 we decreased current deferred tax assets by $310,650 netted against noncurrent deferred tax liabilities of $328,343; resulting in a noncurrent deferred tax liability balance of $17,693. Adoption of ASU No. 2015-17 for the prior period presented would have the following impact on the Company’s financial statements atfor June 30, 2016;2017; a decrease in current assets of $252,558,$317,559, a decrease in non-current liabilities of $203,237$220,571 and an increase in non-current assets of $49,321.

$96,988.

Espey Mfg. & Electronics Corp.

Notes to Financial Statements

Note 2. Summary of Significant Accounting Policies,Continued

In January 2016, the FASB issued ASU No. 2016-01, “Financial Instruments – Overall (Subtopic 825-10): Recognition and Measurement of Financial Assets and Financial Liabilities”. The amendments in this Update address certain aspects of recognition, measurement, presentation and disclosure of financial instruments (primarily equity securities) in order to enhance the reporting model for financial instruments to provide users of financial statements with more decision-useful information. ASU No. 2016-01 will be effective for annual periods beginning after December 15, 2017, and interim periods within those annual periods. The Company is evaluating the impact thatwill be adopting ASU No. 2016-01 and it will not have a material impact on the Company's financial statements.

In March 2016, the FASB issued ASU No. 2016-09, “Compensation – Stock Compensation (Topic 718): Improvements to Employee Share-Based Payment Accounting”. The areas for simplification in this update involve several aspects of the accounting for share-based payment transactions, including the income tax consequences, classification of awards as either equity or liabilities, and classification on the statement of cash flows. Additionally, thisWe adopted ASU allows an entity2016-09 during the first quarter of fiscal year 2018 on a prospective basis. We have elected to makefollow an accounting policy election to either estimate the number of awards that are expected to vest (current(consistent with ASU and prior GAAP) or account for forfeitures as they occur.. Adoption of ASU No. 2016-09 will beresulted in certain tax benefits of equity transactions being shown in the tax provision rather than in equity. The adoption of the ASU did not have a material impact on the Company’s financial statements.

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 annual periodsfiscal years beginning after December 15, 2016, and2018, including interim periods within those annual periods. ASU No. 2016-09 may be applied prospectively or retrospectively,therein, and early adoption is permitted. The Company is evaluating the impact that ASU No. 2016-092018-02 will have on the Company's financial statements.

Espey Mfg. & Electronics Corp.

Notes to Financial Statements

Note 2. Summary of Significant Accounting Policies,Continued

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 2016years 2018 and 2015.2017.  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. Investment Securities

Investment securities at June 30, 20162018 and June 30, 20152017 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, 20162018 and June 30, 20152017 are as follows:

Espey Mfg. & Electronics Corp.

Notes to Financial Statements

Note 3. Investments Securities,Continued

The portfolio is diversified and highly liquid and primarily consists of investment grade fixed income instruments. At June 30, 2016,2018, the Company did not have any investments in individual securities that have been in a continuous loss position considered to be other than temporary.

Espey Mfg. & Electronics Corp.

Notes to Financial Statements

Note 3. Investment Securities,Continued

As of June 30, 20162018 and June 30, 2015,2017, the remaining contractual maturities of available-for-sale securities were as follows:

Note 4. Contracts in Process

Contracts in process at June 30, 20162018 and 20152017 are as follows:

Included in costs relating to contracts in process at June 30, 20162018 and 20152017 are costs of$3,944,0351,597,739and $3,515,0081,635,661, 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 statementstatements of comprehensive income until the units under contract are shipped.

Note 5. Property, Plant and Equipment

Property, plant and equipment at June 30, 20162018 and 20152017 is as follows:

Machinery and equipment includes $763,367 that was not placed in service as of June 30, 2018. Depreciation expense was $434,401$429,679 and $445,687 during$435,557 for the years ended June 30, 20162018 and 2015,2017, respectively.

Espey Mfg. & Electronics Corp.

Notes to Financial Statements

Note 6. Pension Expense

Under terms of a negotiated union contract which expires on June 30, 2018,2022, 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 hoursworked at a specified rate and amounted to $97,336$99,031 in fiscal 2016year 2018 and $89,198$89,023 in fiscal 2015.year 2017. These contributions represent more than five percent of the total plan contributions.contributions made into the Plan. For the years beginning January 1, 20162018 and 2015,2017, 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 planPlan 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.

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 $47,175$52,225 and $37,703,$49,247, for fiscal years 20162018 and 2015,2017, respectively.

Espey Mfg. & Electronics Corp.

Notes to Financial Statements

Note 7. Provision for Income Taxes

The Tax Cuts and Jobs Act (“Tax Act”) was enacted on December 22, 2017. The legislation significantly changes U.S. tax law by, among other things, lowering the U.S. federal corporate tax rate, bonus depreciation that allows for full expensing of qualified property, and limiting the deductibility of interest expense and executive compensation. The Tax Act permanently reduces the U.S. corporate income tax rate to a flat 21% rate, effective January 1, 2018. Pursuant to Section 15 of the Internal Revenue Code, the Company applied a blended corporate tax rate of 28.1 percent for fiscal year 2018, which was based on the applicable tax rates before and after the Tax Reform Act and the number of days in the year.

The Company re-measured certain U.S. deferred tax assets and liabilities based on the rates at which they are expected to reverse in the future, which is generally 21%, and provisionally recorded an increase to the provision for income taxes of $35,200 related to the re-measurement in the second quarter of fiscal year 2018. However, as of June 30, 2018 the impact from the Tax Act related to the re-measurement of the company’s deferred tax assets and liabilities was a $4,553 increase to the provision for income taxes. The year-end amount differed from the provisional amount booked in the second quarter due to variances in timing adjustments from those forecasted, mainly the accelerated expensing of property, plant and equipment placed in service in the third and fourth quarter.

A summary of the components of the provision for income taxes for the years ended June 30, 20162018 and 20152017 is as follows:

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 28.8%24.4% and 29.2%31.2%, for 20162018 and 20152017 respectively, differed from the statutory U.S. federal income tax rate for the following reasons: