UNITED STATES


SECURITIES AND EXCHANGE COMMISSION


Washington, DC 20549





FORM 10 – K





S
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE ACT OF 1934 for the fiscal year ended June 30, 2011


OR




£
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE ACT OF 1934 for the transition period from  to





Commission file number 1-4383





ESPEY MFG. & ELECTRONICS CORP.


(Exact name of registrant as specified in its charter)




NEW YORK
14-1387171(State or other jurisdiction of incorporation or organization)
(IRS Employer Identification No.)
 
 233 Ballston Avenue, Saratoga Springs, NY 12866
 (Address of principal executive offices including Zip Code)
 
 (Registrant's telephone number including area code) (518)245-4400




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




Title of each class

Name of each exchange on which registeredCommon Stock $.33-1/3 par value

NYSE - AmexCommon Stock Purchase Rights

NYSE - Amex


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 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 reportingcompany


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 $36,157,493 million based upon the closing sale price of $23.76 on the NYSE - Amex on December 31, 2010.





At September 8, 2011, there were 2,320,960 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 2011 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.




1




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:


·
Changing priorities or decreases in the U.S. government’s defense budget (including changes in priorities in response to terrorist threats,  improvement of homeland security and the overall financial health of the U.S. Government);


·
Termination of government contracts due to unilateral government action;


·
Differences in anticipated and actual program performance, including the ability to perform under long-term fixed-price contracts within estimated costs, and performance issues with key suppliers and subcontractors;


·
Potential of changing prices for energy and raw materials.





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.


2




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 environment applications. All 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-Amex 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 9001:2008 certified and 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 services include design and development to specification, build to print, design services, design studies, environmental testing services, metal fabrication, plating and painting services, and development of automatic testing equipment. Espey manufacturing is vertically integrated, meaning that the Company produces individual components (including inductors), populates printed circuit boards, fabricates metalwork, paints, plates, wires, qualifies, and fully tests items, mechanically, electrically and environmentally, in house.  Portions of the manufacturing process are subcontracted to vendors from time to time.





Espey is on the eligible list of contractors with the United States Department of Defense and generally is automatically solicited by Defense Department 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. and cage code 98675 as Espey Mfg. & Electronics Corp., Saratoga Industries Division.





In the fiscal years ended June 30, 2011 and 2010, the Company's total sales were $29,499,504and $28,900,013, respectively. Sales to two customers accounted for 31% and 31% of total sales in 2011.  Sales to three customers accounted for 22%, 13% and 13% of total sales in 2010.





Export sales in 2011 and 2010 were approximately $4,769,000 and $5,324,000, respectively.





Sources of Raw Materials





The Company has never experienced any significant delay or shortage 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 our products are available from only a limited number of sources, and other components are only available from a single source.  Despite the risk associated with limited or single 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.





Sales Backlog





At September 7, 2011, the Company's backlog was approximately $40.5million. The total backlog at June 30, 2011 was approximately $38.7 million compared to approximately $31 million at June 30, 2010. The Company’s total backlog represents the estimated remaining sales value of work to be performed under firm contracts.  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 6 below.





It is presently anticipated that a minimum of $30 million of orders comprising the June 30, 2011 backlog will be filled during the fiscal year ending June 30, 2012. The minimum of $30 million does not include any shipments, which may be made against orders subsequently received during the fiscal year ending June 30, 2012. The estimate


3




of the June 30, 2011 backlog to be shipped in fiscal 2012 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. 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 some cases external sales representatives help solicit and coordinate foreign contracts. The Company is also on the eligible list of contractors of agencies of the United States Department of Defense and generally is automatically solicited by such agencies for procurement 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 as a prime contractor.





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. The Company, as well as other companies engaged in supplying equipment for military use, is subject to various risks, including, without limitation, dependence on the United States and foreign government appropriations and program allocations, the competition for available military business, and government termination of orders for convenience.





The Company's business is not considered to be seasonal.  Also, management believes that due to the nature of the Company's business, the Company will not be adversely affected by recessionary factors in the U.S. economy generally.  Future cuts to the U.S.  Government’s defense budget could negatively impact the Company’s business. Although the anticipated partial disengagement of the United States military presence from both Iraq and Afghanistan as well as recent political discourse are indicative of a likely reduction in military and defense appropriations by Congress, the Company does not believe that these developments will adversely affect its business for several reasons:





·
Budget cuts will most likely come from expensive platforms and personnel (especially in overseas deployments) which are not the focus of our strategy.  Furthermore, cuts to big budget “marquis” programs tend to favor the legacy programs and upgrades which are Espey’s focus.


·
When it is judged that upgrade of a legacy system is more cost-effective than a brand-new development, functionality and therefore the electrical power requirement is almost always increased, resulting in more demand for Espey’s products.


·
It is unlikely that the U.S. will cede its leadership role in military affairs worldwide when political stability or sea lanes are at risk, and this fact is likely to mitigate any action leading to more than marginal cuts to defense spending.


·
As a hedge to expected cuts that do occur, Espey intends to maintain  20% -25% of its sales to non-defense applications.





Research and Development





The Company's expenditures for research and development were approximately $50,103 and $50,166 in fiscal 2011 and 2010, respectively.  Some of the Company's engineers and technicians spend varying degrees of time on either development of new products or improvements of existing products.  A majority of these expenditures 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.





Employees





The Company had 166 employees as of September 7, 2011.  Approximately 40% of these employees are represented by the International Brotherhood of Electrical Workers Local #1799. A collective bargaining agreement was approved in June 2008.  The four-year agreement expires on June 30, 2012.  The contract provided for pay increases of 4%, 3.75%, 3.75% and 4% for each year, respectively, of the four-year contract.  Relations with the Union are considered good. Union membership at September 7, 2011 was 70 people.


4





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 2011, and the Company believes will not in fiscal year 2012, 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.  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 currency.  Consequently, changes in exchange rates that strengthen the United States dollar 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.





Item 2.
Property





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





The Saratoga Springs plant, which the Company owns, consists of various adjoining one-story 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, plating, 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 plating, machine shop and environmental facilities are available to other companies on a contract basis.





Item 3.
Legal Proceedings





None


5




PART II





Item 5.
Market for the Registrant's Common Equity and Related Stockholder Matters and Issuer Purchases of Equity Securities





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 - Amex (symbol "ESP"), the principal market for trading in the common stock, for each quarterly period for the last two fiscal years ended June 30:





2011
High
LowFirst Quarter
22.50
18.13Second Quarter
25.83
21.00Third Quarter
25.87
19.50Fourth Quarter
29.20
23.222010First Quarter
18.70
14.60Second Quarter
21.08
17.40Third Quarter
21.14
17.80Fourth Quarter
20.35
18.10





Holders





The approximate number of holders of record of the common stock was 99 on September 7, 2011according 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 $1.90 per share for the fiscal years ended June 30, 2011 and 2010, which included a special dividend of $1.00 per share during each such fiscal year.  The Board of Directors has authorized the payment of a fiscal 2012 first quarter dividend of $.225 payable September 30, 2011 to shareholders of record on September 9, 2011.  We anticipate that regular quarterly dividends will be paid for the foreseeable future.  There is no assurance that the Board of Directors will declare a special dividend during the fiscal year ending June 30, 2012.





During fiscal 2011, 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, 23,800 shares were sold at prices that ranged from $8.98 a share to $21.54 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 2011 fourth quarter.





The following table sets forth information as of June 30, 2011 with respect to compensation plans under which equity securities of the Company may be issued.





Equity Compensation Plan Information




Plan Category
Number of securities to

be issued upon exercise

of outstanding options,

warrants and rights
Weighted-average

exercise price of

outstanding options,

warrants and rights
Number of Securities remaining

available for future issuance under

equity compensation plan (excluding

securities reflected in column (a))(a)
(b)
(c)Equity compensationplans approved bysecurity holders
132,400
18.62
310,600Equity compensationplans not approvedby security holders
--

--Total
132,400

310,600




6




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





Business Outlook





Management expects revenues in fiscal 2012 to increase approximately 5% over fiscal year 2011.  Expectations are for product mix and margins to remain favorable for fiscal year 2012.  During fiscal 2011 new orders received by the Company were approximately $37.2 million.  The order backlog of approximately $38.7 million at June 30, 2011 gives the Company a solid base of future sales.  It is presently anticipated that a minimum of $30 million of orders comprising the June 30, 2011 backlog will be filled during the fiscal year ending June 30, 2012. The minimum of $30 million does not include any shipments, which may be made against orders subsequently received during the fiscal year ending June 30, 2012. See discussions below for further detail on the customer mix included in the backlog.





In addition to the backlog, the Company currently has outstanding quotations representing in excess of $43.9 million in the aggregate for both repeat and new programs.  Many potential orders are currently being discussed and negotiated with existing and potential new customers.  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 or all 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 military procurement generally.





Twosignificant customers in fiscal 2011 represented 62% of the Company's total sales and threesignificant customers in fiscal 2010 represented 48% of the Company's total sales.  These sales are in connection with multiyear programs in which the Company is a significant subcontractor.  The June 30, 2011 backlog of $38.7 million includes orders from two customers that represent 48% and 15%, respectively, of the total backlog.  A loss of one of these customers or programs related to these customers would 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.  Even though our business tends to be concentrated in several customers, the makeup of those customers often changes from year to year.  For several years, management has pursued 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.  Management continues to evaluate its business development functions and potential revised courses of action in order to diversify its customer base.  The defense industry itself tends to be concentrated with a few large tier one defense contractors which limits the amount of diversity the Company can achieve with its customer base.





Management, along with the Board of Directors, continues to evaluate the need and use of the Company’s working capital.  Capital expenditures are expected to be approximately $300,000 for fiscal 2012.  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, 2011 and 2010, were $29,499,504 and $28,900,013, respectively, a 2% increase.  This increase can be attributed to the contract specific nature of the Company’s business and the timing of deliveries on these contracts.  More specifically, shipments of power supplies increased by approximately $4.9 million offset by a decrease of $3 million in transformer and antenna shipments and a decrease of $1.1 million in engineering design related billings in fiscal 2011.





For the fiscal years ended June 30, 2011 and 2010 gross profits were $8,206,199 and $7,763,296, respectively.  Gross profit as a percentage of sales was 27.8% and 26.9%, for fiscal 2011 and 2010, respectively.  The primary factor in determining gross profit and net income is product mix.  The gross profits on mature products and build to print contracts are higher as compared to products that are still in the engineering development stage or in the early stages of production.  In any given accounting period the mix of product shipments between higher margin mature programs and less mature programs including loss contracts, has a significant impact on gross profit and net income.  The increased gross profit and gross profit percentage in fiscal 2011 as compared to fiscal 2010, was primarily the result of favorable product mix with only minor cost overruns related to certain products.


7





In addition to favorable product mix, management is implementing several “lean management” principles which have created efficiencies in the manufacturing process.  These efficiencies have allowed for greater production capacity and increased gross profit.  Employment of full time equivalents at June 30, 2011 was 165 compared to 169 people at June 30, 2010.





Selling, general and administrative expenses were $2,905,916 for the fiscal year ended June 30, 2011, a decrease of $100,601, or 3.3% as compared to the prior year.  The decrease for fiscal 2011 relates primarily to a decrease in salary expense.





Other income for the fiscal years ended June 30, 2011 and 2010 was $81,259 and $142,866, respectively.  The decrease is attributable to lower interest rates and related interest income on the Company’s cash and cash equivalents and short term investments.The Company does not believe that there is a significant risk associated with its investment policy.  At June 30, 2011 all of the investments were primarily represented by short-term liquid investments including certificates of deposit and money market funds.





The effective income tax rate was 28.3% in fiscal 2011 and 27.2% in fiscal 2010.  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 dividends paid on allocated ESOP shares.





Net income for fiscal 2011, was $3,857,537 or $1.79 and $1.77 per share, basic and diluted, compared to net income of $3,564,962 or $1.67 per share, both basic and diluted, respectively, for fiscal 2010. The increase in net income per share was primarily due to higher sales, higher gross profit on sales, and lower selling, general and administrative expenses.





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.





The Company's working capital as of June 30, 2011 and 2010 was $26,124,431 and $25,844,991, respectively. During the three months ended June 30, 2011 and 2010 the Company did not repurchase any shares of its common stock.  During the fiscal year ended June 30, 2011 and 2010 the Company repurchased 23,342 and 23,513 shares, respectively, of its common stock for a total purchase price of $575,246 and $452,155, respectively.  All shares were purchased from the Company's ESOP.  Under existing authorizations from the Company's Board of Directors, as of June 30, 2011, management is authorized to purchase an additional $2,000,000 million of Company stock.





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





2011


2010Net cash provided by operating activities

$
4,913,449


$
6,904,771Net cash provided by (used in) investing activities


4,515,760



(1,170,683
)Net cash used in financing activities


(4,208,464
)


(4,034,341
)





Net cash provided by operating activities fluctuates between periods primarily as a result of differences in net income, the timing of the collection of accounts receivable, purchase of inventory, level of sales and payments of accounts payable.  Net cash provided by investing activities increasedin fiscal 2011due to a decrease in purchases of short term investments.  The increase in cash used in financing activities is due primarily to an increase in the purchase of treasury stock.





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.





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 year 2011 and fiscal 2010, the Company expended $607,311 and $436,502, respectively, for plant improvements and new equipment. The Company has budgeted approximately $300,000 for new equipment and plant improvements in fiscal 2012. Management anticipates that the funds required will be available from current operations.


8




Critical Accounting Policies and Estimates





Our significant accounting policies are described in note 2 to the financial statements.  We believe our most critical accounting policies include revenue recognition and cost estimation on our contracts.





Revenue Recognition and Estimates





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.


9




Item 7.
Financial Statements and Supplementary Data





REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM






To the Board of Directors and Stockholders of


Espey Mfg. & Electronics Corp.


Saratoga Springs, New York






We have audited the accompanying balance sheets of Espey Mfg. & Electronics Corp. as of June 30, 2011 and 2010, and the related statements of income, stockholders’ equity, and cash flows for each of the years in the two-year period ended June 30, 2011. Espey Mfg. & Electronics Corp.’s management is responsible for these financial statements. Our responsibility is to express an opinion on these financial statements based on our audits.





We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. The company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. Our audit included consideration 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’s internal control over financial reporting. Accordingly, we express no such opinion. An audit also includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. 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, 2011 and 2010, and the results of its operations and its cash flows for each of the years in the two-year period ended June 30, 2011 in conformity with accounting principles generally accepted in the United States of America.






/s/EFP Rotenberg, LLP


Rochester, New York


September 8, 2011


10


Espey Mfg. & Electronics Corp.


Balance Sheet


June 30, 2011 and 2010





2011


2010ASSETSCash and cash equivalents

$
9,695,811


$
4,475,066Short term investments


1,946,214



7,111,182Trade accounts receivable, net


6,266,765



5,495,251Inventories:Raw materials


1,273,582



1,233,597Work-in-process


1,085,278



1,490,749Costs related to contracts in process, net of progresspayments of $126,361 in 2011 and $142,492 in 2010


8,220,200



8,217,040Total inventories


10,579,060



10,941,386Deferred tax asset


360,553



229,086Prepaid expenses and other current assets


208,904



185,832Total current assets


29,057,307



28,437,803Property, plant and equipment, net


2,703,014



2,717,330Loan receivable


108,303



11,546Total assets

$
31,868,624


$
31,166,679LIABILITIES AND STOCKHOLDERS' EQUITYAccounts payable

$
1,453,707


$
1,607,147Accrued expenses:Salaries, wages and commissions


412,555



203,435Vacation


623,757



544,021Other


121,026



177,086Payroll and other taxes withheld and accrued


44,085



46,330Income taxes payable


277,746



14,793Total current liabilities


2,932,876



2,592,812Deferred tax liability


270,729



127,148Total liabilities


3,203,605



2,719,960Common stock, par value $.33-1/3 per shareAuthorized 10,000,000 shares; Issued 3,029,874 shares in 2011and 2010. Outstanding 2,320,960 and 2,319,876 in 2011 and2010, respectively (includes 157, 500 and 179,166 UnearnedESOP Shares)


1,009,958



1,009,958Capital in excess of par value


14,674,189



14,172,284Retained earnings


22,780,026



23,002,98138,464,173



38,185,223Less:   Unearned ESOP shares


(2,275,872
)


(2,588,954
)Cost of 708,914 and 709,998 shares of common stockin treasury in 2011 and 2010, respectively


(7,523,282
)


(7,149,550
)Total stockholders' equity


28,665,019



28,446,719Total liabilities and stockholders' equity

$
31,868,624


$
31,166,679





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


11


Espey Mfg. & Electronics Corp.


Statements of Income


Years Ended June 30, 2011 and 2010





2011


2010Net sales

$
29,499,504


$
28,900,013Cost of sales


21,293,305



21,136,717Gross profit


8,206,199



7,763,296Selling, general and administrative expenses


2,905,916



3,006,517Operating income


5,300,283



4,756,779Other incomeInterest and dividend income


56,154



99,373Other


25,105



43,493Total other income


81,259



142,866Income before income taxes


5,381,542



4,899,645Provision for income taxes


1,524,005



1,334,683Net income

$
3,857,537


$
3,564,962Net income per share:Basic

$
1.79


$
1.67Diluted

$
1.77


$
1.67Weighted average number of shares outstanding:Basic


2,151,443



2,129,417Diluted


2,176,299



2,137,799





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





12


Espey Mfg. & Electronics Corp.


Statements of Changes in Stockholders' Equity


Years Ended June 30, 2011 and 2010





Outstanding





Capital in


UnearnedCommon





Excess of


ESOP


RetainedShares


Amount


Par Value


Shares


EarningsBalance as of June 30, 2009


2,314,803


$
1,009,958


$
13,755,808


$
(2,914,077
)

$
23,485,675Net income, 2010


















3,564,962Stock options exercised


8,100







68,755Stock option expense










94,423Dividends paid on common stock$1.90 per share


















(4,047,656
)Tax effect of stock options exercised










3,138Sale of treasury stock to ESOP


20,486







157,742Purchase of treasury stock


(23,513
)Reduction of unearned ESOP shares










92,418



325,123Balance as of June 30, 2010


2,319,876


$
1,009,958


$
14,172,284


$
(2,588,954
)

$
23,002,981Net income, 2011


















3,857,537Stock options exercised


23,800







227,904Stock option expense










66,237Dividends paid on common stock$1.90 per share


















(4,080,492
)Tax effect of stock options exercised










10,939Sale of treasury stock to ESOP


626







6,917Purchase of treasury stock


(23,342
)Reduction of unearned ESOP shares










189,908



313,082Balance as of June 30, 2011


2,320,960


$
1,009,958


$
14,674,189


$
(2,275,872
)

$
22,780,026





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





(Continued)


13





Espey Mfg. & Electronics Corp.


Statements of Changes in Stockholders' Equity


Years Ended June 30, 2011 and 2010





TotalTreasury Stock


Stockholders’Shares


Amount


EquityBalance as of June 30, 2009


715,071


$
(6,933,230
)

$
28,404,134Net income, 2010










3,564,962Stock options exercised


(8,100
)


66,825



135,580Stock option expense










94,423Dividends paid on common stock$1.90  per share










(4,047,656
)Tax effect of stock options exercised










3,138Sale of treasury stock to ESOP


(20,486
)


169,010



326,752Purchase of treasury stock


23,513



(452,155
)


(452,155
)Reduction of unearned ESOP shares










417,541Balance as of June 30, 2010


709,998


$
(7,149,550
)

$
28,446,719Net income, 2011










3,857,537Stock options exercised


(23,800
)


196,350



424,254Stock option expense










66,237Dividends paid on common stock$1.90  per share










(4,080,492
)Tax effect of stock options exercised










10,939Sale of treasury stock to ESOP


(626
)


5,164



12,081Purchase of treasury stock


23,342



(575,246
)


(575,246
)Reduction of unearned ESOP shares










502,990Balance as of June 30, 2011


708,914


$
(7,523,282
)

$
28,665,019





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




14




Espey Mfg. & Electronics Corp.


Statements of Cash Flows


Years Ended June 30, 2011 and 2010





2011


2010Cash Flows From Operating Activities:Net income

$
3,857,537


$
3,564,962Adjustments to reconcile net income to net cash provided by operating activities:Excess tax benefits from share-based compensation


10,939



3,138Stock-based compensation


66,237



94,423Depreciation


467,296



455,592ESOP compensation expense


502,990



417,541Loss on disposal of assets


99,471



1,802Deferred income tax benefit


12,114



23,644Changes in assets and liabilities:Increase in trade receivables, net


(771,495
)


(361,459
)(Increase) decrease in other receivables


(19
)


297Decrease in ESOP receivable due todividends on unallocated shares


--



71,053Decrease in inventories, net


362,326



2,087,819(Increase) decrease in prepaid expenses and other current assets


(23,072
)


47,240(Decrease) increase in accounts payable


(153,440
)


607,626Increase (decrease) in accrued salaries, wages and commissions


209,120



(16,098
)(Decrease) increase in other accrued expenses


(56,060
)


134,223Increase in vacation accrual


79,736



23,949(Decrease) increase in payroll and other taxes withheld and accrued


(2,245
)


4,255Increase (decrease) in income taxes payable


252,014



(255,236
)Net cash provided by operating activities

$
4,913,449


$
6,904,771




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





(Continued)


15





Espey Mfg. & Electronics Corp.


Statements of Cash Flows


Years Ended June 30, 2011 and 2010





2011


2010Cash Flows From Investing Activities:Additions to property, plant and equipment


(607,311
)


(436,502
)Proceeds on sale of assets


54,860



--Payment for loan receivable


(125,000
)


--Proceeds from loan receivable


28,243



27,127Purchase of short term investments


(3,091,032
)


(8,410,871
)Proceeds from maturity of short term investments


8,256,000



7,649,563Net cash provided by (used in) investing activities


4,515,760



(1,170,683
)Cash Flows From Financing Activities:Sale of treasury stock


12,081



326,752Dividends on common stock


(4,080,492
)


(4,047,656
)Purchase of treasury stock


(575,246
)


(452,155
)Proceeds from exercise of stock options


424,254



135,580Excess tax benefits from share-based compensation


10,939



3,138Net cash used in financing activities


(4,208,464
)


(4,034,341
)Increase in cash and cash equivalents


5,220,745



1,699,747Cash and cash equivalents, beginning of the year


4,475,066



2,775,319Cash and cash equivalents, end of the year

$
9,695,811


$
4,475,066Supplemental Schedule of Cash Flow Information:Income taxes paid

$
1,238,000


$
1,560,000





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


16




Espey Mfg. & Electronics Corp.


Notes to Financial Statements





Note 1. Nature of operations





Espey Mfg. & Electronics Corp. (the Company) is a manufacturer of electronic equipment used primarily in military and industrial applications. The principal markets for the Company's products are companies that provide electronic support to both military and industrial applications.





Note 2. Summary of Significant Accounting Policies





Inventory Valuation, Cost Estimation and Revenue Recognition


Raw materials are valued at weighted average cost.





Inventoried work relating to contracts in process and work in process is valued at actual production cost, including factory overhead incurred to date. 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 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:





Buildings and improvements
10 – 40 yearsMachinery and equipment
3 - 20 yearsFurniture and fixtures
7 – 10 years





Income Taxes


The Company follows the provisions of 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.


17




Espey Mfg. & Electronics Corp.


Notes to Financial Statements





Note 2.  Summary of Significant Accounting Policies, Continued





Cash and Cash Equivalents


Cash and cash equivalents consist of cash in banks, certificates of deposit, and money market funds.  The Company considers all highly liquid investments with original maturities of three months or less to be cash equivalents.





Short-term investments include certificates of deposit with maturities greater than three months to a year.





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. An account is generally considered past due after thirty (30) days from the invoice date. Based on these factors, there was an allowance for doubtful accounts of $3,000 at June 30, 2011. 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” requires the Company to calculate net income (loss) per share based on basic and diluted net income (loss) per share, as defined.  Basic EPS excludes dilution and is computed by dividing net income (loss) by the weighted average number of shares outstanding for the period.  Diluted EPS reflects the potential dilution that could occur if securities or other contracts to issue common stock were exercised or converted into common stock.  The dilutive effect of outstanding options issued by the Company are reflected in diluted EPS using the treasury stock method.  Under the treasury stock method, options will only have a dilutive effect when the average market price of common stock during the period exceeds the exercise price of the options.





Comprehensive Income


Comprehensive Income for the years ended June 30, 2011 and 2010 is equal to net income.





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.





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 September 2009, the FASB issued ASC 605-25 for revenue recognition with multiple deliverables. These new standards impact the determination of when the individual deliverables included in a multiple-element arrangement may be treated as separate units of accounting. Additionally, these new standards modify the manner in which the transaction consideration is allocated across the separately identified deliverables by no longer permitting the residual method of allocating arrangement consideration. These new standards are effective in fiscal years beginning on or after June 15, 2010, however early adoption is permitted.  Adoption had will have no effect on the Company’s financial statements.


18




Espey Mfg. & Electronics Corp.


Notes to Financial Statements





Note 2.  Summary of Significant Accounting Policies, Continued





In May 2011, the FASB issued Accounting Standards Update No. 2011-04, topic 820, Fair Value Measurement, to improve the comparability of fair value measurements presented and disclosed in financial statements prepared in accordance with United States GAAP and International Financial Reporting Standards. Some of the amendments clarify the Board’s intent about the application of existing fair value measurement requirements. Other amendments change a particular principle or requirement for measuring fair value or for disclosing information about fair value measurements. Specifically, the guidance requires additional disclosures for fair value measurements that are based on significant unobservable inputs. The updated guidance is to be applied prospectively and is effective for the Company’s interim and annual periods beginning January 1, 2012. The adoption of this guidance is not expected to have a material impact on the Company’s consolidated financial statements.





FASB Accounting Standards Update 2011-05, "Presentation of Comprehensive Income," was issued in June 2011 to be effective for fiscal years beginning after December 15, 2011. Comprehensive income includes certain items that are recognized as "other comprehensive income" ("OCI") and are excluded from net income. Examples include unrealized gains/losses on certain investments and gains/losses on derivative instruments designated as hedges. Under provisions of the update, the components of OCI must be presented in one of two formats: either (i) together with net income in a continuous statement of comprehensive income or (ii) in a second statement of comprehensive income to immediately follow the income statement. An existing option to present the components of OCI as part of the statement of changes in shareholders' equity is being eliminated. The Company presently has no items classified as OCI and expects the update to have minimal effect on its financial statements.





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.  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.





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.


19


Espey Mfg. & Electronics Corp.


Notes to Financial Statements





Note 3. Contracts in Process





Contracts in process at June 30, 2011 and 2010 are as follows:




2011


2010Gross contract value

$
38,655,707


$
30,995,710Costs related to contracts in process, net of progress paymentsof $126,361 in fiscal 2011 $142,492  in fiscal 2010

$
8,220,200


$
8,217,040





Included in costs relating to contracts in process at June 30, 2011 and 2010 are costs of $779,568 and $1,806,212, 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 statement of income until the units under contract are shipped.





Note 4. Property, Plant and Equipment





A summary of the original cost of property, plant and equipment at June 30, 2011 and 2010 is as follows:




2011


2010Land

$
45,000


$
45,000Building and improvements


4,104,132



4,668,556Machinery and equipment


7,352,055



6,994,505Furniture and fixtures


160,867



161,82511,662,054



11,869,886Accumulated depreciation


(8,959,040
)


(9,152,556
)Property, plant and equipment, net

$
2,703,014


$
2,717,330





Depreciation expense was $467,296 and $455,592, during the years ended June 30, 2011 and 2010, respectively.





Note 5. Pension Expense





Under terms of a negotiated union contract, the Company is obligated to make contributions to a union-sponsored defined benefit pension plan covering eligible employees. Such contributions and expenses are based upon hours worked at a specified rate and amounted to $102,281 in fiscal 2011 and $102,414 in fiscal 2010.





The Company sponsors a 401(k) plan with employee and employer matching contributions.  The employer match is 10% of the employee contribution and was $33,664 and $34,462, for fiscal years 2011 and 2010, respectively.





Note 6. Provision for Income Taxes





A summary of the components of the provision for income taxes for the years ended June 30, 2011 and 2010 is as follows:




2011


2010Current tax expense - federal

$
1,480,465


$
1,278,169Current tax expense - state


31,425



32,871Deferred tax expense


12,115



23,643$
1,524,005


$
1,334,683





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.


20




Espey Mfg. & Electronics Corp.


Notes to Financial Statements





Note 6. Provision for Income Taxes, Continued





The combined U.S. federal and state effective income tax rates of 28.3% and 27.2%, for 2011 and 2010 respectively, differed from the statutory U.S. federal income tax rate for the following reasons:


2011


2010U.S. federal statutory income tax rate


34.0
%


34.0
%Increase (reduction) in rate resulting from:State franchise tax, net of federal income tax benefit


0.4



0.4ESOP cost versus Fair Market Value


0.2



0.6Dividend on allocated ESOP shares


(4.8
)


(6.8
)Qualified production activities


(2.7
)


(1.7
)Stock-based compensation


1.2



0.6Other


--



0.1Effective tax rate


28.3
%


27.2
%





For the years ended June 30, 2011 and 2010 deferred income tax expense of $12,115 and $23,643, respectively, result 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, 2011 and 2010 are presented as follows:





2011


2010Deferred tax assets:Accrued expenses

$
306,963


$
159,759ESOP


116,981



108,316Stock-based compensation


10,874



10,874Inventory - effect on uniform capitalization


37,535



51,810Other


5,180



6,644Total deferred tax assets


477,533



337,403Deferred tax liabilities:Property, plant and equipment - principally dueto differences in depreciation methods


387,709



235,462Total deferred tax liabilities


387,709



235,462Net deferred tax asset

$
89,824


$
101,941





In assessing the realizability of deferred tax assets, management considers whether it is more likely than not that some portion or all of the deferred tax assets will be realized. The ultimate realization of deferred tax assets is dependent upon the generation of future taxable income during the periods in which those temporary differences become deductible. Management considers the scheduled reversal of deferred tax liabilities, projected future taxable income, and tax planning strategies in making this assessment. Based upon the level of historical taxable income and projection for future taxable income over the period in which the deferred tax assets are deductible, management believes it is more likely than not that the Company will realize the benefits of these temporary differences without consideration of a valuation allowance.





As the result of the implementation of the FASB interpretation ASC 740-10, Accounting for Uncertainty in Income Taxes – An Interpretation of ASC 740, the Company recognized no material adjustments to unrecognized tax benefits.  As of June 30, 2011 and 2010, the Company has no unrecognized tax benefits.





The Company recognizes interest and penalties related to uncertain tax positions, if any, in general and administrative expense.  As of June 30, 2011, the Company has not recorded any provision for accrued interest and penalties related to uncertain tax positions.





By statute, tax years ending June 30, 2011 and 2010 remain open to examination by the major taxing jurisdictions to which the Company is subject.


21




Espey Mfg. & Electronics Corp.


Notes to Financial Statements





Note 7. Significant Customers





A significant portion of the Company's business is the production of military and industrial electronic equipment for use by the U.S. and foreign governments and certain industrial customers. Sales to one domestic customer and one foreign customer accounted for 31% and 31%, respectively, of total sales in fiscal 2011.  Sales to two domestic customers and one foreign customer accounted for 22%, 13% and 13%, respectively of total sales in fiscal 2010.





Export sales in fiscal 2011 and fiscal 2010 were approximately $4,769,000 and $5,324,000, respectively.





Note 8. Stock Rights Plan





The Company has a Shareholder Rights Plan that expires on December 31, 2019. Under this plan, common stock purchase rights were distributed as a dividend at the rate of one right for each share of common stock outstanding as of or issued subsequent to April 14, 1989. Each right entitles the holder thereof to buy one-half share of common stock of the Company at an exercise price of $25 per share subject to adjustment. The rights are exercisable only if a person or group acquires beneficial ownership of 15% or more of the Company's common stock or commences a tender or exchange offer which, if consummated, would result in the offer or individually or, together with all affiliates and associates thereof, being the beneficial owner of 15% or more of the Company's common stock.





If a 15% or larger shareholder should engage in certain self-dealing transactions or a merger with the Company in which the Company is the surviving corporation and its shares of common stock are not changed or converted into equity securities of any other person, or if any person were to become the beneficial owner of 15% or more of the Company's common stock, then each right not owned by such shareholder or related parties of such shareholder (all of which will be void) will entitle its holder to purchase, at the right's then current exercise price, shares of the Company's common stock having a value of twice the right's exercise price. In addition, if the Company is involved in any other merger or consolidation with, or sells 50% or more of its assets or earning power to another person, each right will entitle its holder to purchase, at the right's then current exercise price, shares of common stock of such other person having a value of twice the right's exercise price.





The Company generally is entitled to redeem the rights at one cent per right at any time until the 15th day (or 25th day if extended by the Company's Board of Directors) following public announcement that a 15% position has been acquired or the commencement of a tender or exchange offer which, if consummated, would result in the offer or, together with all affiliates and associates thereof, being the beneficial owner of 15% or more of the Company's common stock.





Note 9. Employee Stock Ownership Plan





The Company sponsors a leveraged employee stock ownership plan (the "ESOP") that covers all nonunion employees who work 1,000 or more hours per year and are employed on June 30.  The Company makes annual contributions to the ESOP equal to the ESOP's debt service less dividends on unallocated shares received by the ESOP.  All dividends on unallocated shares received by the ESOP are used to pay debt service.  Dividends on allocated ESOP shares are recorded as a reduction of retained earnings.  As the debt is repaid, shares are released and allocated to active employees, based on the proportion of debt service paid in the year.  The Company accounts for its ESOP in accordance with Statement of Position 93-6.  Accordingly, the shares purchased by the ESOP are reported as Unearned ESOP Shares in the statement of financial position.  As shares are released or committed-to-be-released, the Company reports compensation expense equal to the current average market price of the shares, and the shares become outstanding for earnings-per-share (EPS) computations.  ESOP compensation expense was $502,990 for the year ended June 30, 2011 and $417,541 for the year ended June 30, 2010.  The ESOP shares as of June 30, 2011 and 2010 were as follows:


22




Espey Mfg. & Electronics Corp.


Notes to Financial Statements





Note 9. Employee Stock Ownership Plan, Continued





2011


2010Allocated Shares


443,939



453,561Committed-to-be-released shares


--



--Unreleased shares


157,500



179,166Total shares held by the ESOP


601,439



632,727Fair value of unreleased shares

$
3,887,100


$
3,379,071





Note 10. Stock-based Compensation





The Company follows ASC 718 in establishing standards for the accounting for transactions in which an entity exchanges its equity instruments for goods or services, as well as transactions in which an entity incurs liabilities in exchange for goods or services that are based on the fair value of the entity’s equity instruments or that maybe settled by the issuance of those equity instruments. ASC 718 requires that the cost resulting from all share-based payment transactions be recognized in the financial statements based on the fair value of the share-based payment.  ASC 718 establishes fair value as the measurement objective in accounting for share-based payment transactions with employees, except for equity instruments held by employee share ownership plans.





Total stock-based compensation expense recognized in the Statement of Income for the fiscal years ended June 30, 2011 and 2010, was $66,237 and $94,423, respectively, before income taxes.  The related total deferred tax benefit was approximately $5,602 and $8,144, for the same periods.  ASC 718 requires the tax benefits resulting from tax deductions in excess of the compensation cost recognized for those options to be classified and reported as both an operating cash outflow and a financing cash inflow on a prospective basis upon adoption.





As of June 30, 2011, there was approximately $50,282 of unrecognized compensation cost related to stock option awards that is expected to be recognized as expense over the next 1.25 years.  The total deferred tax benefit related to these awards is approximately $4,556.





The Company has one employee stock option plan under which options may be granted, the 2007 Stock Option and Restricted Stock Plan (the "2007 Plan"). The Board of Directors may grant options to acquire shares of common stock to employees of the Company at the fair market value of the common stock on the date of grant.  Generally, options granted have a two-year vesting period based on two years of continuous service and have a ten-year contractual life.  Option grants provide for accelerated vesting if there is a change in control.  Shares issued upon the exercise of options are from those held in Treasury.  The 2007 Plan was approved by the Company's shareholders at the Company's Annual Meeting on November 30, 2007 and supercedes the Company's 2000 Stock Option Plan (the "2000 Plan").  Options covering 400,000 shares are authorized for issuance under the 2007 Plan, and 99,800 have been granted and 78,800 are outstanding as of June 30, 2011.  While no further grants of options may be made under the 2000 Plan, as of June 30, 2011, 53,600 options remain outstanding, vested and exercisable from the 2000 Plan.





ASC 718 requires the use of a valuation model to calculate the fair value of stock-based awards. The Company has elected to use the Black-Scholes option valuation model, which incorporates various assumptions including those for volatility, expected life and interest rates.





The table below outlines the weighted average assumptions that the Company used to calculate the fair value of each option award for the years ended June 30, 2011 and 2010, respectively:





2011


2010Dividend yield


4.69
%


5.30
%Expected stock price volatility


33.13
%


31.41
%Risk-free interest rate


1.08
%


1.79
%Expected option life (in years)

4.1 years


4.3 yearsWeighted average fair value per shareof options granted during the period

$
3.335


$
2.767




23





Espey Mfg. & Electronics Corp.


Notes to Financial Statements





Note 10. Stock-based Compensation, Continued





The Company pays dividends quarterly and anticipates that it will be able to continue to pay dividends in the foreseeable future.  While the Company has paid a special cash dividend of $1.00 per share in each of fiscal years 2010 and 2011, there is no assurance that the Board of Directors will declare a comparable special dividend in fiscal year 2012.  Expected stock price volatility is based on the historical volatility of the Company’s stock. The risk-free interest rate is based on the implied yield available on U.S. Treasury issues with an equivalent term approximating the expected life of the options. The expected option life (in years) represents the estimated period of time until exercise and is based on actual historical experience.





The following table summarizes stock option activity during the twelve months ended June 30, 2011:





Employee Stock Options PlanWeightedNumber of


Weighted


AverageShares


Average


Remaining


AggregateSubject


Exercise


Contractual


IntrinsicTo Option


Price


Term


ValueBalance at July 1, 2010


127,600


$
18.31



7.02Granted


31,100


$
19.20



9.13Exercised


(23,800
)

$
17.83



--Forfeited or expired


(2,500
)

$
17.54



--Outstanding at June 30, 2011


132,400


$
18.62



6.80


$
802,813Vested or expected to vest at June 30, 2011


127,537


$
18.61



6.72


$
774,748Exercisable at June 30, 2011


99,300


$
18.50



6.05


$
613,300





The aggregate intrinsic value in the table above represents the total pretax intrinsic value (the difference between the closing sale price of the Company’s common stock as reported on the NYSE-Amex on June 30, 2011 and the exercise price, multiplied by the number of in-the-money options) that would have been received by the option holders if all option holders had exercised their options on June 30, 2011.  This amount changes based on the fair market value of the Company’s common stock.  The total intrinsic values of the options exercised during the twelve months ended June 30, 2011 and 2010 was $152,855 and $23,046, respectively.





Note 11. Financial Instruments/Concentration of Credit Risk





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, 2011 and 2010 because of the relatively short maturities of these instruments.





Financial instruments that potentially subject the Company to concentrations of credit risk consist principally of cash and cash equivalents, short-term investments and accounts receivable. The Company maintains cash and cash equivalents with various financial institutions. At times such investments may be in excess of FDIC insurance limits. As disclosed in note 7, a significant portion of the Company's business is the production of military and industrial electronic equipment for use by the U.S. and foreign governments and certain industrial customers. The related accounts receivable balance, as a percentage of the Company's total trade accounts receivable balance, was 56% represented by two customers at June 30, 2011, and 55%, by three customers at June 30, 2010.





Although the Company's exposure to credit risk associated with nonpayment of these concentrated balances is affected by the conditions or occurrences within the U.S. and foreign governments, the Company believes that its trade accounts receivable credit risk exposure is limited. The Company performs ongoing credit evaluations of its customer's financial conditions and requires collateral, such as progress payments, in certain circumstances. The Company establishes an allowance for doubtful accounts based upon factors surrounding the credit risk of specific customers, historical trends and other information.


24




Espey Mfg. & Electronics Corp.


Notes to Financial Statements





Note 12. Related Parties





The administration of the shares of common stock held by the ESOP Trust is subject to the Second Amended and Restated Plan, effective as of July 1, 2002, creating the Trust, and a Trust Agreement dated July 15, 2005.  The Trustees’ rights with respect to the disposition of shares are governed by the terms of the Plan and the Trust Agreement.  As to shares that have been allocated to the accounts of participants in the ESOP Trust, the Plan provides that the Trustees are required to vote such shares in accordance with instructions received from the participants.  As to unallocated shares and allocated shares for which voting instructions have not been received from participants, the Plan provides that the Trustees are required to vote such shares in accordance with the direction of a Committee, appointed by the Board of Directors of the Company under the terms of the Plan and Trust Agreement.  See note 9 for additional information regarding the ESOP.





Note 13. Commitments and Contingencies





The Company at certain times enters into standby letters of credit agreements with financial institutions primarily relating to the guarantee of future performance on certain contracts.  Contingent liabilities on outstanding standby letters of credit agreements aggregated to zero at June 30, 2011 and 2010.  The Company, as a U.S. Government contractor, is subject to audits, reviews, and investigations by the U.S. government related to its negotiation and performance of government contracts and its accounting for such contracts. Failure to comply with applicable U.S. Government standards by a contractor may result in suspension from eligibility for award of any new government contract and a guilty plea or conviction may result in debarment from eligibility for awards. The government may, in certain cases, also terminate existing contracts, recover damages, and impose other sanctions and penalties. As a result of a pending U.S. government audit the Company has determined a range of possible outcomes none of which the Company believes would have a materially adverse effect on the Company’s financial position or results of operations. In accordance with ASC 450 “Contingencies” the Company has accrued the amount within the range that appears to be its best estimate of a possible outcome.





Note 14. Stockholders' Equity





Reservation of Shares


The Company has reserved common shares for future issuance as follows as of June 30, 2011:





Stock options outstanding


132,400Stock options available for issuance


310,600Number of common shares reserved


443,000





The following table sets forth the reconciliation of the numerators and denominators of the basic and diluted per share computations for continuing operations for the years ended June 30:




2011


2010Numerator:Net Income

$
3,857,537


$
3,564,962Denominator:Basic EPS:Common shares outstanding, beginning of period


2,319,876



2,314,803Unearned ESOP shares


(179,166
)


(201,666
)Weighted average common shares issued during the period


9,550



20,124Weighted average common shares purchased during the period


(6,964
)


(12,304
)Weighted average ESOP shares earned during the period


8,147



8,460Denominator for basic earnings per common shares –Weighted average common shares


2,151,443



2,129,417





25




Espey Mfg. & Electronics Corp.


Notes to Financial Statements





Note 14. Stockholders' Equity, Continued





2011


2010Diluted EPS:Common shares outstanding, beginning of period


2,319,876



2,314,803Unearned ESOP shares


(179,166
)


(201,666
)Weighted average common shares issued during the period


9,550



20,124Weighted average common shares purchased during the period


(6,964
)


(12,304
)Weighted average ESOP shares earned during the period


8,147



8,460Weighted average dilutive effect of issued or forfeited shares


24,856



8,382Denominator for diluted earnings per common shares –Weighted average common shares


2,176,299



2,137,799





Not included in this computation of earnings per share for the year ended June 30, 2010 were options to purchase 29,700 of the Company's common stock.  These options were excluded because their inclusion would have been anti-dilutive due to the average strike price exceeding the average market price of those shares.  There were no anti-dilutive options for the year ended June 30, 2011.





Note 15. Quarterly Financial Information (Unaudited)




First


Second


Third


Fourth2011

Quarter


Quarter


Quarter


QuarterNet Sales

$
6,026,330


$
6,581,342


$
7,005,795


$
9,886,037Gross profit


1,650,532



1,624,799



2,047,156



2,883,712Net income


753,539



649,747



1,012,031



1,442,220Net income per share -Basic


.35



.30



.47



.67Diluted


.35



.30



.46



.662010Net Sales

$
6,874,940


$
5,866,331


$
6,955,827


$
9,202,915Gross profit


2,058,202



1,462,093



1,838,782



2,404,219Net income


992,763



514,171



808,723



1,249,305Net income per share -Basic


.47



.24



.38



.58Diluted


.47



.24



.38



.58


26




Item 9.
Changes in and Disagreements With Accountants on Accounting and Financial Disclosure





None





Item 9A.
Controls and Procedures





Evaluation of Controls and Procedures





(a) The Company's management, with the participation of the Company's chief executive officer and chief financial officer, carried out an evaluation of the effectiveness of our disclosure controls and procedures (as defined in Rule 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934) as of the end of the period covered by this Annual Report on Form 10-K. Based on such evaluation, our chief executive officer and chief financial officer have concluded that our disclosure controls and procedures were effective as of the end of the period covered by this report.





(b) There have been no changes in our internal controls over financial reporting during the period covered by this report that have materially affected, or are reasonably likely to materially affect, our internal controls over financial reporting.





Management’s Report on Internal Control Over Financial Reporting





Management of our Company is responsible for establishing and maintaining adequate internal control over financial reporting, as that term is defined in Exchange Act Rules 13a-15(f) and 15d-15(f). Our internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles.





Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.





Under the supervision and with the participation of our management, including the principal executive officer and principal financial officer, we conducted an evaluation of the effectiveness of our internal control over financial reporting using the criteria set forth in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission. Based on our evaluation using the criteria set forth in Internal Control-Integrated Framework, management has concluded that our internal control over financial reporting was effective as of June 30, 2011.





This annual report does not include an attestation report of our registered public accounting firm regarding internal control over financial reporting. Our report was not subject to attestation by our registered public accounting firm pursuant to rules of the SEC that permit us to provide only management’s report in this annual report.





Item 9B.
Other information





None


27




PART III





The information called for by "Item 10. Directors, Executive Officers, and Corporate Governance", "Item 11. Executive Compensation", "Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters", "Item 13. Certain Relationships and Related Transactions, and Director Independence" and "Item 14. Principal Accountant Fees and Services", is hereby incorporated by reference to the Company's Proxy Statement for its Annual Meeting of Shareholders, (scheduled to be held on November 17, 2011) to be filed with the SEC pursuant to Regulation 14A under the Securities Exchange Act of 1934, as amended.





PART IV





Item 15.
Exhibits, Financial Statement Schedules Signatures





3.1

Certificate of incorporation and all amendments thereto (incorporated by reference to Exhibit 3.1 to Espey’s Report on Form 10-K for the year ended June 30, 2004 and Report on Form 10-Q for the quarter ended December 31, 2004)3.2

Amended and Restated By-Laws (incorporated by reference to Exhibit 3.2 to Espey’s Report on Form 8-K dated February 26, 2009)4.1

Second Amended and Restated Rights Agreement, dated December 18, 2009, between Espey Mfg. & Electronics Corp. and Registrar and Transfer Company (incorporated by reference to Exhibit 4.01 to Espey’s Report on Form 8-K dated December 18, 2009)4.2

Description of Capital Stock (incorporated by reference to Espey's Report on Form 8-K dated October 7, 2005)10.1

2000 Stock Option Plan (incorporated by reference to Espey's Definitive Proxy Statement dated December 6, 1999 for the January 4, 2000 Annual Meeting)10.2

Executive Officer contract with Howard Pinsley (incorporated by reference to Exhibit 10.2 to Espey's Report on Form 8-K dated July 27, 2009)10.3

2007 Stock Option and Restricted Stock Plan (incorporated by reference to Espey’s Proxy Statement dated October 23, 2007 for the November 30, 2007 Annual Meeting)10.4

Employment Agreement with David O’Neil (incorporated by reference to Exhibit 10.1 on Espey’s Report on Form 8-K dated August 17, 2009)10.5

Retired Director Compensation Program and Mandatory Retirement Agreement (incorporated by reference to Exhibit 10.5 to Espey's Report on Form 10-Q dated May 12, 2011)10.6

Retired Director Compensation Program and Mandatory Retirement Agreement – Paul Corr (incorporated by reference to Exhibit 10.6 to Espey's Report on Form 10-Q dated May 12, 2011)10.7

Retired Director Compensation Program and Mandatory Retirement Agreement – Carl Helmetag (incorporated by reference to Exhibit 10.7 to Espey's Report on Form 10-Q dated May 12, 2011)10.8

Retired Director Compensation Program and Mandatory Retirement Agreement – Barry Pinsley (incorporated by reference to Exhibit 10.8 to Espey's Report on Form 10-Q dated May 12, 2011)10.9

Director Compensation Program and Mandatory Retirement Agreement – Howard Pinsley (incorporated by reference to Exhibit 10.9 to Espey's Report on Form 10-Q dated May 12, 2011)10.10

Retired Director Compensation Program and Mandatory Retirement Agreement – Alvin Sabo (incorporated by reference to Exhibit 10.10 to Espey's Report on Form 10-Q dated May 12, 2011)10.11

Retired Director Compensation Program and Mandatory Retirement Agreement – Michael Wool (incorporated by reference to Exhibit 10.11 to Espey's Report on Form 10-Q dated May 12, 2011)11.1

Statement re: Computation of Per Share Net income (filed herewith)




28




14.1

Code of ethics (incorporated by reference to Espey’s website www.espey.com)23.1

Consent of EFP Rotenberg, LLP (filed herewith)31.1

Certification of the Chief Executive Officer pursuant to Rules 13a-14(a) and 15d-14(a) under the Securities Exchange Act of 1934, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 (filed herewith)31.2

Certification of the Principal Financial Officer pursuant to Rules 13a-14(a) and 15d-14(a) under the Securities Exchange Act of 1934, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 (filed herewith)32.1

Certification of the Chief Executive Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 (filed herewith)32.2

Certification of the Principal Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 (filed herewith)


29


S I G N A T U R E S





Pursuant to the requirements of Section 13 and 15 (d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.






ESPEY MFG. & ELECTRONICS CORP./s/Mark St. PierreMark St. PierrePresident and Chief Executive Officer/s/Mark St. Pierre

PresidentMark St. Pierre

(Chief Executive Officer)September 8, 2011/s/David O’Neil

TreasurerDavid O'Neil

(Principal Financial Officer)September 8, 2011/s/Katrina Sparano

Assistant TreasurerKatrina Sparano

(Principal Accounting Officer)September 8, 2011/s/Howard Pinsley

Chairman of the BoardHoward Pinsley

September 8, 2011/s/Barry Pinsley

DirectorBarry Pinsley

September 8, 2011/s/Michael W. Wool

DirectorMichael W. Wool

September 8, 2011/s/Paul J. Corr

DirectorPaul J. Corr

September 8, 2011/s/Alvin O. Sabo

DirectorAlvin O. Sabo

September 8, 2011/s/Carl Helmetag

DirectorCarl Helmetag

September 8, 2011




30