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, 20182019

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.

S☒Yes     £☐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.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      S☒Smaller 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 $40,076,299$43,320,411 based upon the closing sale price of $23.96$24.92 on the NYSE American on December 31, 2017.2018.

At September 4, 201810, 2019 there were 2,388,2242,401,213 shares outstanding of the registrant's Common stock, $.33-1/3 par value.

PART I

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 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 American 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 9001:2015 and AS9100:2016 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.

Espey’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, 20182019 and 2017,2018, the Company's totalsales were $32,517,883$36,477,851 and$22,521,012,32,517,883, respectively. Sales to three domestic customers accounted for 34%, 10%, and 10%, respectively, of total sales in 2019. Sales totwodomestic customers accounted for 33% and 27% of total sales in 2018. Sales totwodomestic customers accounted for 29% and 16% of total sales in 2017. This high concentration level with these customers presents significant risk. A loss of one of these customers or programs related to these customers could significantly impact the financial performance of 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.

Export sales in fiscal years 20182019 and 20172018 were approximately $2,638,000 and $3,112,000, and $1,730,000, respectively. This increaseThe decrease is primarily due to the increasedecrease in power supply and antenna shipments to specific customers.shipments.

Sources of Raw Materials

The Company has not typically experienced any significant delays or shortages 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 a single or a limited number of sources. Despite the risk associated with single or limited 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, theThe President of the United States directedcontinued the imposition of tariffs on steel and aluminum imports from various countries.countries in 2019. 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 rawmaterials. 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, 20182019 was approximately $48.1$45.6 million compared to approximately $43.1$48.1 million at June 30, 2017.2018. 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 at June 30, 20182019 is approximately $45.0$42.9 million. This includes items that have been authorized and appropriated by Congress and/or funded by the customer. The unfunded backlog at June 30, 20182019 is approximately $3.1$2.7 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 individual 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, 20172018 was $7.5$3.1 million. For both fiscal years ended 20182019 and 2017,2018, the unfunded backlog is comprised primarily of the same multi-year order from a single customer. The Company's backlog and risks associated with government contracts is discussed in greater detail below.

It is presently anticipated that a minimum of$40.632.7 million of orders comprising the June 30, 20182019 backlog will be filled during the fiscal year ending June 30, 2019.2020. The minimumof $40.6$32.7 million does not include any shipments which may be made against orders received subsequently to the fiscal year ending June 30, 2018.2019. The estimate of the June 30, 20182019 backlog to be shipped in fiscal year 20192020 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. 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 automatically solicited by Department of Defense procurement agencies for their needs falling within the major classes of products produced by the Company. 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, to 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 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, the potential of governmental termination of orders for convenience, and the general 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. For several years, manyMany of our competitors have, and they continue to invest aggressively in upfront product design costs and accept lower profit margins as a strategic means of maintaining existing business and enhancing market share. This hascontinues to put pressure on the pricing of our current products and has lowered our profit margins on some of our new business. In order to compete effectively for new business, in some cases we have invested in upfront design costs, thereby reducing initial profitability as a means of procuring new long-term programs. As part of our strategy, we adjust our pricing 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 year 2019.

In order to maintain a balanced business, we are continuingWe continue to place an emphasis on securing “build to print” opportunities, which will allowallows production work to go directly to the manufacturing floor, limiting the impact on our engineering staff. This effort willallows us to keep our manufacturing team busy while the products being developed in-house transition to production.

Research and Development

Some of the Company's engineers and technicians spend varying amounts of time on either the development of new products or improvements to existing products. A majority of the resulting costs we incur relate to research that is required to support a request for quotation from a customer product-specific 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 and custom product development with some customer funding. The Company's expenditures for research and development were approximately $18,206$44,819 and $34,065$18,206 in fiscal year 20182019 and 2017,2018, respectively.

Employees

The Company had 164160 employees as ofAugust 31, 20182019. During the year ended June 30, 2018,2019, we increased the number of employees to support our business growth. Approximately 38%40% of thesethe employees are represented by the International Brotherhood of Electrical Workers Local #1799.Workers. A new collective bargaining agreement was approved in July 2018. The four-year agreement expires onJune 30, 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 2018,2019, and the Company believes will not in fiscal year 2019,2020, 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, a 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.

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.  

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 American (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 7572 onSeptember 4, 201810, 2019according 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 regular cash dividends on common stock of $1.00 per share and a special cash dividend of $1.00 per share for each of the fiscal yearsyear ended June 30, 20182019 and 2017.$1.00 per share for the fiscal year ended June 30, 2018. The Board of Directors has authorized the payment of a fiscal year 20192020 first quarter regular dividend of $0.25 and a special dividend of $1.00, payable October 1, 2018September 27, 2019 to shareholders of record on September 24, 2018.20, 2019. Our Board of Directors assesses the Company’s dividend policy periodically. While 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, we believe that the Company is in the position to continue to pay the regular cash dividends for the foreseeable future.

During fiscal year 2018,2019, 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, 20,60115,899 shares were sold at prices that ranged from$17.09 a share to $25.18$27.22 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 year 20182019 fourth quarter.

The following table sets forth information as of June 30, 20182019 with respect to compensation plans under which equity securities of the Company may be issued.

Equity Compensation Plan Information

Business Outlook

Management expects revenues in fiscal year 20192020 to be higher thanapproximate revenues during fiscal year 2018 but2019 and expects the gross profit margin to be lowerhigher in fiscal year 20192020 than the gross profit margin during fiscal year 2018.2019. This expectation is driven primarily by orders already in our backlog that will be shipped in fiscal year 2020 with lower anticipated aggregate production costs than with the product mix shipped during fiscal 2019. As market factors including competition and product costs impact gross profit margins, management will continue to evaluate our sales strategy, employment levels, and facility costs.

During fiscal year 20182019 the Company received approximately $37.5$33.9 million in new orders. Our total backlog at June 30, 20182019 was approximately $48.1$45.6 million, as compared to $43.1$48.1 million at June 30, 2017.2018. Currently, we expect a minimum of $40.6$32.7 million of orders comprising the June 30, 20182019 backlog will be filled during the fiscal year ending June 30, 2019.2020. This $40.6$32.7 million will be supplemented by shipments which may be made against orders received during the 2020 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,during the past two fiscal years we have been experiencingexperienced some technical and schedule delays with our major development programs, these delays have beenwere resolved as they arisearose and we do not currently expect any negative impact on our customer order fulfillment projections for fiscal year 2019.2020.  Engineering programs in both the funded and unfunded portions of the current backlog aggregate $8.8$5.4 million. 

In addition to the backlog, the Company currently has outstanding opportunities representing in excess of $69.6$52 million in the aggregate as of August 31, 2018,2019, 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. TwoThree significant customers represented 54% of the Company’s total sales in fiscal year 2019 and two significant customers represented 60% of the Company’s total sales in fiscal year 2018 and two significant customers represented 45% of the Company’s total sales in fiscal year 2017.2018. These sales are in connection with multiyear programs in which the Company is a significant contractor. The June 30, 20182019 backlog of $48.1$45.6 million included orders from threefive customers that represent 23%16%, 16%13%, 11%, 11% and 10%, respectively, of the total backlog. The June 30, 20172018 backlog of $43.1$48.1 million includes orders from three customers that represent 23%, 20%16% and 18%10%, respectively, of the total backlog. Although improvement has been made in customer concentrations, this high customer concentration level continues 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 diversify the Company’s customer base. The quotations for non-repeat programs referred to above include several new customers.

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 $500,000$300,000 for fiscal year 2019.2020. A majority of these expenditures will be made to stay competitive in the 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, managementManagement along with the Mergers and Acquisitions Committee of the Board of Directors will examine opportunities involving acquisitions or other strategic options, including buying certain products or product lines. The criteria for consideration arelines, provided that such opportunities demonstrate synergies with the Company’s existing product base and accretion to earnings.

Results of Operations

Net sales for fiscalthe years ended June 30, 2019 and 2018 were $36,477,851 and 2017, were $32,517,883, and $22,521,012, respectively, a 44%12% increase. The increase in net sales in the current fiscal year 2019 is primarily due to an increase in power supplybuild to print sales resulting fromfor product which had no shipments in the commencementprior fiscal year, an increase in magnetic sales consisting of certain engineering deliverables, and product shipments on a significant military contract and the increase in shipments to several existing customersone long-term program, offset, in part, by a decrease in magneticpower supply shipments. Although shipments supporting the rail industry increased and remain strong, the overall decline in power supply shipments in fiscal year 2019 relates primarily to the timing of shipments related to one military contract which had significant shipments in the prior fiscal year.

Our ability to ship product was constrained during fiscal years 2019 and 2018 by engineering design changes required to meet customer requirements, certain supplier product non-conformances and an increase in lead times for many parts including certain electronic components due to timingindustry shortages and completion of specific contracts.volatility within the power electronics industry. We expect these factors will continue to affect certain product shipments during fiscal year 2020.

ForGross profits for the fiscal years ended June 30, 2019 and 2018 were $7,063,173 and 2017 gross profits were $7,662,252, and $4,714,568, respectively. Gross profit as a percentage of sales increased towas 19.4% and 23.6%, for fiscal year 2018, up from 20.9% in fiscal year 2017.the same periods, respectively. 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,” meaningprimarily on 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. The gross profit percentage increaseddecreased in the twelve monthsfiscal year ended June 30, 20182019 as compared to the same period in 20172018 primarily due to the increase in cost resulting from the change in estimates on two separate contracts for the design and production of power transformers, offset in part, by an increase in sales while expenditures incurred relatedwhen compared to engineering design investments remained comparable to those incurred in the same period in 2017.2018. The gross profit percentage was further reduced by a slight overall decline in the gross profit percentage on product shipments. The decrease in gross profit related to the change in estimates on two specific contracts resulted from an increase in direct costs, material and labor, of approximately $1.1 million. The net increase in direct costs is attributable to in process design changes required to meet contract specifications, changes to the bill of materials and operations, and scrap and other costs incurred typically associated with first time builds.

Selling, general and administrative expenses were $3,808,395$4,410,234 for the fiscal year ended June 30, 2018,2019; an increase of $620,283, or 19.5%$601,839 compared to the fiscal year ended June 30, 2018. The increase for the fiscal year ended June 30, 2019 as compared to the prior year. The increase for fiscal yearsame period in 2018 relates primarily to thean increase in headcount and related employee compensation costs in support of our business growth, the incurrence of a bad debt expense related to a single customer, cost associated with the appointment of a new Class B Director effective June 1, 2018, professional services outside selling expenses incurred forconsisting primarily of commissions earned by outside sales representatives, and freight due to an increase in shipments.

Employment of full time equivalents at June 30, 2018 was 153 people compared with 136 people at June 30, 2017. The increase in headcount is primarily due to an increase in engineering and program management personnel in support of the Company’s sales backlog.freight costs resulting from higher sales.

Other income for the fiscal yearsyear ended June 30, 2019 and 2018 was $228,694 and 2017 was $215,219, and $124,949, respectively. The increase in the twelve months ended is primarily due to an increase in interest income resultingon investments and income received from the sale of scrap metal. The increase in interest income resulted from the gradual increase in current yield percentages earned on investment securities andoffset, in part, by a reduction in investment returns.securities. Interest income is a function of the level of investments and investment strategies which generally tend to be conservative. The increase in income from scrap metal sales is primarily due to an increase in saleable metal remnants resulting from the overall increase in material purchases during the current year when compared to the prior year.   

The Company’s effective income tax rate was 18.7% in the fiscal year 2019 and 24.4% in fiscal year 20182018. The statutory tax rate was reduced from 34% to 21% under the Tax Cuts and 31.2% in fiscal year 2017.Jobs Act (the “Tax Act’) effective on January 1, 2018. The effective tax rate in fiscal 2019 is less than the statutory tax rate mainly due to the benefit derived from the dividends paid on allocated shares in the Company’s Employee Retirement Plan and Trust (“ESOP”). The effective tax rate in fiscal 2018 is less than the statutory tax rate mainly due to the benefit the Company receivesreceived on its “qualified production activities” under The American Jobs Creation Act of 2004 which expired after the end of fiscal 2018 and the benefit derived from the ESOP dividends paid on allocated 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 year 20182019 was $2,342,694 or $0.99 and $0.98 per share, basic and diluted, respectively compared to $3,075,797 or $1.32 and $1.31 per share, basic and diluted, respectively compared to net income of $1,135,736 or $0.49 per share, basic and diluted, for fiscal year 2017.2018. The increasedecrease in net income per share for the twelve months ended June 30, 20182019 was mainly due to high gross profit resulting from higher sales and highera lower gross profit percentage resulting primarily from product mix withan increase in expenditures related to engineering design investments made by the Company remaining comparable between periods. In addition,company when compared to the Company receivedprior year and an increase in selling, general, and administrative expenses when compared to the same periods in 2018 as discussed above. These increases were offset, in part, by an increase in sales and a benefit 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 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. Contingent liabilities on outstanding standby letters of credit agreements aggregated to zero at June 30, 2019 and 2018. The line of credit is reviewed annually in November for renewal onby December 1^st.

The Company's working capital as of June 30, 2019 and 2018 was $28,377,168 and 2017 was $29,740,468, and $29,853,018, respectively. During the twelve months ended June 30, 2019, the Company repurchased 1,810 shares of its common stock from the ESOP for a purchase price of $44,888. During the twelve months ended June 30, 2018 the Company repurchased 4,798 shares of its common stock respectively, from the Company’s Employee Retirement Plan and Trust (“ESOP”) for a purchase price of $109,694, respectively. During the twelve months ended June 30, 2017 the Company repurchased 1,633 shares of its common stock, respectively, from the Company’s ESOP for a purchase price of $44,335, respectively. None of such purchases were made during the last three months of each fiscal year.$109,694. Under existing authorizations from the Company's Board of Directors, as of June 30, 2018,2019, management is authorized to purchase an additional $876,297$831,408 of Company stock.

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

Net cash provided byused in operating activities fluctuates between periods primarily as a result of differences in sales and net income, provision for income taxes, the timing of the collection of accounts receivable, purchase of inventory, and payment of accounts payable.payable. The decreaseincrease in net cash provided byused in operating activities compared to the prior year primarily relates to a decrease in net income, a decrease in accrued salaries and wages and an increase in inventories and accounts receivable offset, in part, by an increase in accounts receivable, inventories andpayable, a decrease in prepaid expenses and other current assets as well asand a reductiondecrease in accounts payable. This was offset by ancontract liabilities. The increase in net income resulting from higher salescash provided by investing activities in the current period. Net cash used in investing activities decreased in the twelve months of fiscal year 2018 as comparedis primarily related to a decrease in spending for the same period in fiscal year 2017purchase of property, plant and equipment and the reduction of investment security purchases. This reduction is primarily due to an increase in maturing investments offset by an increase in the purchaselate fiscal year shipment of investments and property, plant and equipment. Cash used in financing activities consists primarily of dividend payments on common stockproduct representing accounts receivable not yet converted into cash and the Company’s purchase and issuancepayment of treasury stock.a special dividend. The decreaseincrease in cash used in financing activities in the current fiscal year is dueprimarily related to an increasethe cash expended for the special dividend totaling $1.00 per share declared and paid in fiscal 2019 offset, in part, by proceeds received from the exercise of stock options offset, in part, fromduring the increase in cash expended on shares purchased from the Company’s ESOP and the increase in dividends paidcurrent fiscal year 2018 as compared to fiscal year 2017.year.

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 the fiscal years 2018ended June 30, 2019 and 2017,2018, the Company expended $1,923,220$608,318 and $352,132,$1,923,220, respectively, for plant improvements and new equipment. The Company has budgeted approximately $500,000$300,000 for new equipment and plant improvements in fiscal year 2019.2020. 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.

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 (the Company) as of June 30, 20182019 and 2017,2018, the related statements of comprehensive income, changes in stockholders' equity and cash flows for each of the years then 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, 20182019 and 2017,2018, 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 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 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.

Rochester, New York

September 12, 201816, 2019

Espey Mfg. & Electronics Corp.

Balance Sheets

June 30, 20182019 and 20172018

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

Espey Mfg. & Electronics Corp.

Statements of Comprehensive Income

Years Ended June 30, 20182019 and 20172018

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, 20182019 and 20172018

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, 20182019 and 20172018

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

Espey Mfg. & Electronics Corp.

Statements of Cash Flows

Years Ended June 30, 20182019 and 20172018

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

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 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 our net sales is generated from contracts with industrial manufacturers and defense companies, the Company’s revenue. The Company recognizes revenueDepartment 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 these product sales when persuasive evidencethe 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 an arrangement exists, transfer of title and risk of lossthe parties are identified, payment terms are identified, the contract has occurred, the sale price is fixed or determinable,commercial substance, and collectability of consideration is reasonably assured.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 Company sells its productstransaction price for each performance obligation is based on terms which transfer titlethe 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 risk of loss at a specified location,milestones reached or units delivered based on contractual shipment terms, 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

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;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.  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.

Contract Liabilities

Contract liabilities include advance payments and billings in excess of revenue recognized.

Espey Mfg. & Electronics Corp.

Notes to Financial Statements

Note 2. Summary of Significant Accounting Policies,Continued

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.

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, 20182019 and 20172018 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, 20182019 and 20172018 because of the immediate or short-term maturity of these financial instruments.

Espey Mfg. & Electronics Corp.

Notes to Financial Statements

Note 2. Summary of Significant Accounting Policies,Continued

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, 20182019 and 2017.2018.  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.

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, 20182019 and 20172018 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.

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 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 Company is contractually obligated to provide to the customer. Among these considerations are: identifying the unit of account at which the entity should assess whether it is a principal or an 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 evaluated the impact of adopting of ASU No. 2014-09; this will not have a material impact on the Company’s financial statements aside from increased disclosures. The Company used the modified retrospective method when adopting the standard beginning 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 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 2015-17 during the first quarter of fiscal year 2018 on a prospective basis. Prior periods were not retrospectively adjusted. Accordingly, for 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 for June 30, 2017; a decrease in current assets of $317,559, a decrease in non-current liabilities of $220,571 and an increase in non-current assets of $96,988.

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 will 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. We adopted ASU 2016-09 during the first quarter of fiscal year 2018 on a prospective basis. We have elected to follow an accounting policy to estimate the number of awards that are expected to vest (consistent with ASU and prior GAAP). Adoption of ASU No. 2016-09 resulted 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 fiscal years beginning after December 15, 2018, including interim periods therein, and early adoption is permitted. The Company is evaluating the impact that ASU No. 2018-02 will have on the Company's financial statements.

Espey Mfg. & Electronics Corp.

Notes to Financial Statements

Note 2. Summary of Significant Accounting Policies,Continued

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 20182019 and 2017.2018.  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. 

Espey Mfg. & Electronics Corp.

Notes to Financial Statements

Note 3. Revenue,Continued

As a result of the adoption, we reclassified customer advance payments from inventory to contract liabilities. Contract liabilities were $6,054 and $102,924 as of June 30, 2019 and June 30, 2018, respectively.  The decrease in contract liabilities is due to the recognition of revenue related to certain amounts previously collected and included in contract liabilities. The company used the practical expedient to expense incremental costs incurred to obtain a contract when the contract term is less than one year.

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, 2019 based on units delivered totaled $30,677,077 compared to $29,762,111 for the same periods in 2018.  Total revenue recognized for the twelve months ended June 30, 2019 based on milestones achieved totaled $5,800,774 compared to $2,755,772 for the same periods in 2018.

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, 2019.  Our payment terms are generally 30-60 days. 

The company’s backlog at June 30, 2019 totaling $45.6 million is expected, based on contractual due dates, to be recognized in the following years: 72% in 2020; 16% in 2021; 11% in 2022, and 1% in 2023.  

Note 3.4. Investment Securities

Investment securities at June 30, 20182019 and 20172018 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, 20182019 and 20172018 are as follows:

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, 2018,2019, 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, 20182019 and 2017,2018, the remaining contractual maturities of available-for-sale securities were as follows:

Note 4.5. Contracts in Process

Contracts in process at June 30, 20182019 and 20172018 are as follows:

Included in costs relating to contracts in process at June 30, 20182019 and 20172018 are costs of$1,597,7392,740,804and $$11,635,661,602,827, 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.

Gross profit for the year ended June 30, 2019 was negatively impacted by the change in estimate on two separate contracts for the design and production of power transformers. The increase in direct costs, material and labor, approximated $1.1 million. The net increase in direct costs is attributable to in process design changes required to meet contract specifications, changes to the bill of materials and operations, and scrap and other costs incurred typically associated with first time builds.

Note 5.6. Property, Plant and Equipment

Property, plant and equipment at June 30, 20182019 and 20172018 is as follows:

Machinery and equipment includes $763,367$90,344 that was not placed in service as of June 30, 2018.2019. Depreciation expense was $429,679$540,978 and $435,557$429,679 for the years ended June 30, 20182019 and 2017,2018, respectively.

Note 6.7. 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 hoursworked at a specified rate and amounted to $129,095 in fiscal year 2019 and $99,031 in fiscal year 2018 and $89,023 in fiscal year 2017.2018. These contributions represent more than five percent of the total contributions made into the Plan. For the years beginning January 1, 20182019 and 2017,2018, 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.

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 $52,225$57,581 and $49,247,$52,225, for fiscal years 2019 and 2018, and 2017, respectively.

Espey Mfg. & Electronics Corp.

Notes to Financial Statements

Note 7.8. 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.

TheIn fiscal year 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 an increase to the provision for income taxes of $35,200 related to the re-measurement in the second quarter of fiscal year 2018.re-measurement. 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, 20182019 and 20172018 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 24.4%18.7% and 31.2%24.4%, for 20182019 and 20172018 respectively, differed from the statutory U.S. federal income tax rate for the following reasons:

For the years ended June 30, 20182019 and 20172018 deferred income tax expense (benefit) of $115,075$258,040 and ($46,488),$115,075, 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, 20182019 and 20172018 are presented as follows: