UNITED STATES SECURITIES AND EXCHANGE
COMMISSION
Washington, D.C. 20549
FORM 10-Q
⌧QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended July 31, 2020
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 No. 001-8125
TOROTEL, INC.
(Exact name of registrant as specified in its charter)
| | |
MISSOURI | | 44-0610086 |
(State or other jurisdiction of incorporation or organization) | | (I.R.S. Employer Identification No.) |
| | |
520 N. ROGERS ROAD, OLATHE, KANSAS | | 66062 |
(Address of principal executive offices) | | (Zip Code) |
(913) 747-6111
(Registrant’s telephone number, including area code)
Securities registered pursuant to Section 12(b) of the Act:
Title of each class | Trading Symbol | Name of each exchange on which registered |
None | N/A | N/A |
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. Yes ⌧ No ◻
Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files). Yes ⌧ No ◻
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer”, “accelerated filer”, “smaller reporting company”, and “emerging growth company” in Rule 12b-2 of the Exchange Act.
Large accelerated filer ◻ | Accelerated filer ◻ | Non-accelerated filer ◻ | Smaller Reporting Company ⌧ | Emerging growth company ◻ |
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ◻
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Securities Exchange Act of 1934). Yes ◻ No ⌧
As of September 11, 2020, there were 5,995,750 shares of Common Stock, $0.01 par value, outstanding.
TOROTEL, INC. AND SUBSIDIARIES
| 3 | | |||
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| | 3 | | ||
| | | 3 | | |
| | | 4 | | |
| | Consolidated Condensed Statements of Changes in Stockholders’ Equity | | 5 | |
| | | 6 | | |
| | | 7 | | |
| | | | | |
| 20 | | |||
| | | | ||
| Management's Discussion and Analysis of Financial Condition and Results of Operations | | 21 | | |
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| | 26 | | ||
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| | 26 | | ||
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| 27 | | |||
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| | 27 | | ||
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| 28 | | |||
2
CONSOLIDATED CONDENSED BALANCE SHEETS
| | | | | | |
|
| (Unaudited) | | | | |
| | July 31, 2020 | | April 30, 2020 | ||
ASSETS | | | | | | |
Current assets: | | | | | | |
Cash | | $ | 2,017,000 | | $ | 2,263,000 |
Trade receivables, net | | | 3,383,000 | |
| 2,104,000 |
Contract assets | | | 357,000 | |
| 960,000 |
Inventories | | | 3,921,000 | |
| 3,556,000 |
Prepaid expenses | | �� | 471,000 | |
| 285,000 |
| | | 10,149,000 | |
| 9,168,000 |
| | | | | | |
Land | | | 265,000 | | | 265,000 |
Buildings and improvements | | | 1,586,000 | |
| 1,586,000 |
Equipment | | | 4,561,000 | |
| 4,520,000 |
| | | 6,412,000 | |
| 6,371,000 |
Less accumulated depreciation | | | 4,484,000 | |
| 4,388,000 |
Property, plant and equipment, net | | | 1,928,000 | |
| 1,983,000 |
| | | | | | |
Operating right-of-use assets | | | 1,920,000 | | | 2,008,000 |
Deferred income taxes | | | 288,000 | |
| — |
Other assets | | | 156,000 | |
| 221,000 |
| | | | | | |
Total Assets | | $ | 14,441,000 | | $ | 13,380,000 |
| | | | | | |
LIABILITIES AND STOCKHOLDERS' EQUITY | | | | | | |
Current liabilities: | | | | | | |
Current maturities of long-term debt | | $ | 1,842,000 | | $ | 795,000 |
Current maturities of operating lease liabilities | | | 395,000 | | | 395,000 |
Current maturities of finance lease liabilities | | | 12,000 | | | 27,000 |
Trade accounts payable | | | 1,143,000 | |
| 1,933,000 |
Accrued liabilities | | | 1,128,000 | |
| 899,000 |
Customer deposits | | | 68,000 | | | 16,000 |
| |
| 4,588,000 | |
| 4,065,000 |
| | | | | | |
Long-term debt, less current maturities | | | 1,851,000 | |
| 2,008,000 |
Operating lease liabilities, less current maturities | | | 1,817,000 | | | 1,879,000 |
| | | 3,668,000 | | | 3,887,000 |
Stockholders' equity: | | | | | | |
Common stock; par value $0.01; 6,000,000 shares authorized; 5,995,750 shares issued and outstanding | | | 60,000 | |
| 60,000 |
Capital in excess of par value | | | 12,680,000 | |
| 12,653,000 |
Accumulated deficit | | | (6,555,000) | |
| (7,285,000) |
| | | 6,185,000 | | | 5,428,000 |
| | | | | | |
Total Liabilities and Stockholders' Equity | | $ | 14,441,000 | | $ | 13,380,000 |
The accompanying notes are an integral part of these statements.
3
CONSOLIDATED CONDENSED STATEMENTS OF OPERATIONS (Unaudited)
| | | | | | |
| | Three Months Ended | ||||
|
| July 31, 2020 |
| July 31, 2019 | ||
Net sales | | $ | 6,019,000 |
| $ | 6,346,000 |
Cost of goods sold | | | 3,680,000 |
| | 3,953,000 |
Gross profit |
| | 2,339,000 |
| | 2,393,000 |
Operating expenses: | | | | | | |
Engineering | | | 351,000 |
| | 388,000 |
Selling, general and administrative | | | 1,363,000 |
| | 1,423,000 |
| | | 1,714,000 |
| | 1,811,000 |
Income from operations |
| | 625,000 |
| | 582,000 |
Other expense: | | | | | | |
Interest expense, net | | | 23,000 |
| | 27,000 |
Income before income tax expense (benefit) |
| | 602,000 |
| | 555,000 |
Income tax expense (benefit) | | | (128,000) |
| | 111,000 |
Net income | | $ | 730,000 | | $ | 444,000 |
Basic earnings per share | | $ | 0.12 | | $ | 0.07 |
| | | | | | |
The accompanying notes are an integral part of these statements.
4
CONSOLIDATED CONDENSED STATEMENTS OF CHANGES IN STOCKHOLDERS’ EQUITY (Unaudited)
| | | | | | | | | | | | | | |
|
| |
| | |
| Capital In | | |
| Total | |||
| | | | Common | Excess of | Accumulated | Stockholders' | |||||||
| | Shares | Stock | Par Value | Deficit | Equity | ||||||||
For The Three Months Ended July 31, 2019: | | | | | | | | | | | | | | |
Balance, April 30, 2019 | | 5,995,750 | | $ | 60,000 | | $ | 12,545,000 | | $ | (7,999,000) | | $ | 4,606,000 |
Stock compensation earned |
| — | |
| — | |
| 27,000 | |
| — | |
| 27,000 |
Net income |
| — | |
| — | |
| — | |
| 444,000 | |
| 444,000 |
Balance, July 31, 2019 |
| 5,995,750 | |
| 60,000 | |
| 12,572,000 | |
| (7,555,000) | |
| 5,077,000 |
| | | | | | | | | | | | | | |
For The Three Months Ended July 31, 2020: | | | | | | | | | | | | | | |
Balance, April 30, 2020 | | 5,995,750 | | $ | 60,000 | | $ | 12,653,000 | | $ | (7,285,000) | | $ | 5,428,000 |
Stock compensation earned |
| — | |
| — | |
| 27,000 | |
| — | |
| 27,000 |
Net income |
| — | |
| — | |
| — | |
| 730,000 | |
| 730,000 |
Balance, July 31, 2020 |
| 5,995,750 | |
| 60,000 | |
| 12,680,000 | |
| (6,555,000) | |
| 6,185,000 |
| | | | | | | | | | | | | | |
The accompanying notes are an integral part of these statements.
5
CONSOLIDATED CONDENSED STATEMENTS OF CASH FLOWS (Unaudited)
| | | | | | |
| | Three Months Ended | ||||
|
| July 31, 2020 |
| July 31, 2019 | ||
Cash flows from operating activities: | | | | | | |
Net income | | $ | 730,000 | | $ | 444,000 |
Adjustments to reconcile net income to net cash provided by (used in) operating activities: | | | | | | |
Stock compensation cost amortized | | | 27,000 | |
| 27,000 |
Depreciation | | | 96,000 | |
| 92,000 |
Deferred income taxes | | | (288,000) | |
| — |
Changes in operating assets and liabilities: | | | | | | |
Trade receivables | | | (1,279,000) | |
| 122,000 |
Contract assets | | | 603,000 | | | (69,000) |
Inventories | | | (365,000) | |
| (202,000) |
Prepaid expenses and other assets | | | (121,000) | |
| (199,000) |
Operating lease right-of-use assets | | | 88,000 | | | 53,000 |
Trade accounts payable | | | (790,000) | |
| 46,000 |
Accrued liabilities | | | 229,000 | |
| 511,000 |
Current and long-term operating lease liabilities | | | (62,000) | | | (53,000) |
Customer deposits | | | 52,000 | | | 2,000 |
Net cash provided by (used in) operating activities | |
| (1,080,000) | |
| 774,000 |
Cash flows from investing activities: | | | | | | |
Capital expenditures | | | (41,000) | |
| (116,000) |
Net cash used in investing activities | |
| (41,000) | |
| (116,000) |
Cash flows from financing activities: | | | | | | |
Principal payments on long-term debt | | | (9,000) | |
| (7,000) |
Principal payments under capital and financing lease obligations | | | (15,000) | | | (16,000) |
Payments on line of credit | | | (2,938,000) | | | (3,777,000) |
Proceeds from line of credit | | | 3,837,000 | | | 3,437,000 |
Net cash provided by (used in) financing activities | |
| 875,000 | |
| (363,000) |
Net increase (decrease) in cash | |
| (246,000) | |
| 295,000 |
Cash, beginning of period | |
| 2,263,000 | | | 58,000 |
Cash, end of period | | $ | 2,017,000 | | $ | 353,000 |
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION | | | | | | |
Cash paid during the period for: | | | | | | |
Interest | | $ | 23,000 | | $ | 27,000 |
Non-cash investing and financing activities: | | | | | | |
Capital leases reclassified from long-term debt to finance lease liabilities | | | — | | | 98,000 |
Deferred rent reclassified from accrued liabilities to operating right-of-use assets | | | — | | | 206,000 |
The accompanying notes are an integral part of these statements.
6
NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS
NOTE 1 — BASIS OF PRESENTATION
The consolidated condensed balance sheet as of April 30, 2020, which has been derived from the audited financial statements of Torotel, Inc. ("Torotel" or the “Company”), is accompanied by the unaudited interim consolidated condensed financial statements, which reflect the normal recurring adjustments that in the opinion of management are necessary to present fairly Torotel’s consolidated financial position at July 31, 2020, and the consolidated results of operations and cash flows for the three months ended July 31, 2020, and 2019, respectively.
The unaudited interim consolidated condensed financial statements have been prepared pursuant to the rules and regulations of the Securities and Exchange Commission ("SEC"). Certain information and note disclosures normally included in the annual financial statements prepared in accordance with generally accepted accounting principles have been condensed or omitted pursuant to those rules and regulations, although management believes the disclosures made are adequate to make the information not misleading. The financial statements contained herein should be read in conjunction with Torotel’s consolidated financial statements and related notes filed on Torotel's Form 10-K for the year ended April 30, 2020 as filed with the SEC on July 28, 2020.
Accounting Pronouncements Issued, Not Yet Adopted
In June 2016, the FASB issued ASU No. 2016-13 Measurement of Credit Losses on Financial Instruments. Under this guidance, a financial asset is required to be measured at amortized cost basis to be presented at the net amount expected to be collected. The allowance for credit losses is a valuation account that is deducted from the amortized cost basis of the financial asset to present the net carrying value at the amount expected to be collected on the financial asset. The measurement of expected credit losses will be based on current, historical, and forecasted information that impacts the collectability of the reported amount. Additional disclosures will be required to provide information regarding significant estimates and judgments used in estimating credit losses, as well as the credit quality and underwriting standards of an organization's portfolio. The original effective date for this guidance, including subsequently issued amendments, was for fiscal years beginning after December 15, 2020 and interim periods within those fiscal years. In November 2019, the FASB deferred the effective date of this guidance to fiscal years beginning after December 15, 2022, including interim periods within those fiscal years. We are currently evaluating this guidance.
In December 2019, the FASB issued ASU No. 2019-12, Income Taxes (Topic 740): Simplifying the Accounting for Income Taxes. This update removes certain exceptions and implements new requirements to help simplify the accounting for income taxes. This guidance is effective for fiscal years beginning after December 15, 2020. We are currently evaluating this guidance.
All other new accounting standards and updates of existing standards issued through the date of this filing were considered by management and did not relate to accounting policies and procedures pertinent to us at this time or were not expected to have a material impact to the consolidated financial statements.
Torotel conducts business through its wholly owned subsidiary, Torotel Products, Inc. (“Torotel Products”). Torotel Products specializes in the custom design and manufacture of a wide variety of precision magnetic components, consisting of transformers, inductors, reactors, chokes, toroidal coils, high voltage transformers, dry-type transformers and electro-mechanical assemblies, for use in commercial, industrial and military electronics.
7
The following table summarizes the components of inventories:
| | | | | | |
|
| | July 31, 2020 |
| | April 30, 2020 |
Raw materials | | $ | 2,669,000 | | $ | 2,417,000 |
Work in process | | | 928,000 | | | 961,000 |
Finished goods | | | 324,000 | | | 178,000 |
| | $ | 3,921,000 | | $ | 3,556,000 |
We determine revenue recognition through the following steps:
| |
1) | Identification of the contract, or contracts, with a customer A contract with a customer exists when (i) the Company enters into an enforceable contract with a customer that defines each party’s rights regarding the services to be transferred and identifies the payment terms related to these services, (ii) the contract has commercial substance and, (iii) the Company determines that collection of substantially all consideration for goods or services that are transferred is probable based on the customer’s intent and ability to pay the promised consideration. The Company applies judgment in determining the customer’s ability and intention to pay, which is based on a variety of factors including the customer’s historical payment experience or, in the case of a new customer, published credit and financial information pertaining to the customer. |
2) | Identification of the performance obligations in the contract Performance obligations promised in a contract are identified based on the goods or services that will be transferred to the customer that are both capable of being distinct, whereby the customer can benefit from the service either on its own or together with other resources that are readily available from third parties or from the Company, and are distinct in the context of the contract, whereby the transfer of the goods or services are separately identifiable from other promises in the contract. To the extent a contract includes multiple promised goods or services, the Company must apply judgment to determine whether promised goods or services are capable of being distinct and distinct in the context of the contract. If these criteria are not met the promised goods or services are accounted for as a combined performance obligation. |
3) | Determination of the transaction price The transaction price is determined based on the consideration to which the Company will be entitled in exchange for transferring goods or services to the customer. To the extent the transaction price includes variable consideration, the Company estimates the amount of variable consideration that should be included in the transaction price utilizing either the expected value method or the most likely amount method depending on the nature of the variable consideration. Variable consideration is included in the transaction price if, in the Company’s judgment, it is probable that a significant future reversal of cumulative revenue under the contract will not occur. None of the Company's contracts as of July 31, 2020 contained a significant financing component. Determining the transaction price requires significant judgment, which is discussed by revenue category in further detail below. |
8
4) | Allocation of the transaction price to the performance obligations in the contract If the contract contains a single performance obligation, the entire transaction price is allocated to the single performance obligation. However, if a series of distinct goods or services that are substantially the same qualifies as a single performance obligation in a contract with variable consideration, the Company must determine if the variable consideration is attributable to the entire contract or to a specific part of the contract. Contracts that contain multiple performance obligations require an allocation of the transaction price to each performance obligation based on a relative standalone selling price basis unless the transaction price is variable and meets the criteria to be allocated entirely to a performance obligation or to a distinct service that forms part of a single performance obligation. The Company determines standalone selling price based on the price at which the performance obligation is sold separately. If the standalone selling price is not observable through past transactions, the Company estimates the standalone selling price taking into account available information such as market conditions and internally approved pricing guidelines related to the performance obligations. |
5) | Recognition of revenue when, or as, we satisfy a performance obligation The Company satisfies performance obligations either over time or at a point in time as discussed in further detail below. Revenue is recognized at the time the related performance obligation is satisfied by transferring a promised good or service to a customer. |
Performance Obligations Satisfied Over Time
We recognize revenue on agreements for the sale of customized goods for use in commercial aerospace and military electronics on an over time basis.
Commercial Aerospace and Defense Parts
Performance obligations under long-term agreements are considered to be under contract at the time that authorization to ship has been obtained from the customer, except for one long-term agreement which provides a contract for two specific parts if the ship date is within 21 days. Performance obligations under standalone purchase orders are considered to be under contract at the time that the purchase order is received. Parts manufactured for customers in our aerospace and defense product revenue stream must be built to certain specifications that are then qualified by the customer. Due to the proprietary nature of our custom-built products designed for a specific use by our aerospace and defense customers, control is considered to be with the customer as the products are finalized and placed into finished goods. Goods within this revenue stream do not provide simultaneous receipt and benefit to the customer. The goods are controlled by our customers once the finished parts are created. The customers prevent any alternative use of the asset and an enforceable right to payment does exist. We provide for potential losses on any of these agreements when it is probable that we will incur the loss.
Our billing terms for these over-time contracts vary, but are generally based on ship date. Control is transferred as products are completed and closed to finished goods.
Product fees and engineering and design services
For product fees along with engineering and design services, transfer of control is determined by the revenue stream of the associated product. Percentage-of-completion revenue recognition is utilized when revenue recognized exceeds the amount billed to the customer for any project-related services, utilizing labor as the input method.
9
Performance Obligations Satisfied at a Point in Time
We recognize revenue on agreements for the sale of customized goods for use in the industrial and commercial market on point in time basis.
Industrial and Commercial Parts
Performance obligations under long-term agreements are considered to be under contract at the time that authorization to ship has been obtained from the customer. Performance obligations under standalone purchase orders are considered to be under contract at the time that the purchase order is received. For our commercial customers, control of the underlying product design is retained by Torotel, therefore the products are considered in our control until the moment of shipment. Also, upon shipment the customers have an obligation to pay for the asset and we have an enforceable right to payment. We provide for potential losses on any of these agreements when it is probable that we will incur the loss.
Our billing terms for these point in time sales are generally based on ship date. Control is transferred as products are shipped to the customers.
Taxes assessed by a governmental authority that are both imposed on and concurrent with a specific revenue-producing transaction, that are collected by the Company from a customer, are excluded from revenue. Shipping and handling costs do not have a material impact to the financial statements. No impairment losses were recognized in the three months ending July 31, 2020 and 2019, relating to receivables or contract assets arising from contracts with customers.
Disaggregation of Revenue
The following tables summarize revenue from contracts with customers for the three months ended July 31, 2020 and 2019.
| | | | | |
| Three Months Ended | ||||
| July 31, 2020 |
| July 31, 2019 | ||
Markets | | | | | |
Commercial Aerospace | $ | 925,000 | | $ | 2,410,000 |
Defense | | 4,869,000 | | | 3,823,000 |
Industrial | | 225,000 | | | 113,000 |
Total consolidated net sales | $ | 6,019,000 | | $ | 6,346,000 |
| | | | | |
| | | | | |
| Three Months Ended | ||||
| July 31, 2020 |
| July 31, 2019 | ||
Product Line | | | | | |
Magnetic components | $ | 3,963,000 | | $ | 3,254,000 |
Potted coil assembly | | 1,735,000 | | | 1,519,000 |
Electro-mechanical assemblies | | 321,000 | | | 1,573,000 |
Total consolidated net sales | $ | 6,019,000 | | $ | 6,346,000 |
| | | | | |
| | | | | |
| Three Months Ended | ||||
| July 31, 2020 |
| July 31, 2019 | ||
Geography | | | | | |
Domestic | $ | 5,898,000 | | $ | 6,098,000 |
Foreign | | 121,000 | | | 248,000 |
Total consolidated net sales | $ | 6,019,000 | | $ | 6,346,000 |
| | | | | |
10
Contract balances
All contract asset balances relate to customer contracts entered into during the fiscal year ending April 30, 2021. We have no contract liabilities other than customer deposits which represent prepaid consideration for contracts with customers. There have been no significant adjustments to contract asset balances related to contract modifications. We have certain customers totaling revenue of $337,000 with variable payment terms related to discounts in the amount of $3,000 in the fiscal year ending April 30, 2021.
Remaining performance obligations
As of July 31, 2020, the aggregate amount of the contracted revenues allocated to our unsatisfied (or partially unsatisfied) performance obligations was $10,992,000. The balance of unsatisfied performance obligations excludes contracts with original maturities of one year or less. We expect to recognize revenue as we satisfy our remaining performance obligations. Total remaining performance obligations to be recognized in the fiscal year ending April 30, 2021 is expected to be $4,779,000. Total remaining performance obligations to be recognized in the fiscal year ending April 30, 2022 is expected to be $6,213,000.
The Company adopted ASC 842 on May 1, 2019 using the modified retrospective transition method. Upon transition to the new standard, the Company elected the package of practical expedients, which permitted the Company not to reassess under the new standard its prior conclusions about lease identification, lease classification and initial direct costs.
The Company leases buildings and equipment under operating and finance leases. The majority of the Company’s operations are conducted in premises occupied under lease agreements with initial base terms ranging from 5 to 15 years, with certain leases containing options to extend the leases for up to an additional 10 years. The Company typically does not believe that exercise of the renewal options is reasonably assured at the inception of the lease agreements and, therefore, considers the initial base term as the lease term. Lease terms vary but generally the leases provide for fixed and escalating rentals or contingent escalating rentals based on the Consumer Price Index.
Operating lease right-of-use (ROU) assets and lease liabilities were recognized at commencement date based on the present value of minimum lease payments over the remaining lease term. The minimum lease payments include base rent payments. The Company’s leases have remaining lease terms of approximately 1 year to 8 years, which may include the option to extend the lease when it is reasonably certain the Company will exercise that option. The present value of the lease payments is calculated using the incremental borrowing rate for operating leases, which was determined using a portfolio approach based on the rate of interest that the Company would have to pay to borrow an amount equal to the lease payments on a collateralized basis over a similar term. Operating lease expense is recognized on a straight-line basis over the lease term.
The Company’s lease agreements do not contain any material residual value guarantees. The Company elected the practical expedient to not separate lease and non-lease components and also elected the short-term practical expedient for all leases that qualify. As a result, the Company will not recognize ROU assets or liabilities for short-term leases that qualify for the short-term practical expedient, but instead will recognize the lease payments as lease cost on a straight-line basis over the lease term.
11
The following table provides the operating and finance ROU assets and lease liabilities:
| | | | | | | | | |
| | | Balance Sheet Classification |
| | July 31, 2020 |
| | April 30, 2020 |
Assets | | | | | | | | | |
Operating lease right-of-use assets | | | Operating right-of-use assets | | $ | 1,920,000 | | $ | 2,008,000 |
Finance lease right-of-use assets | | | Property, plant and equipment, net | | | 12,000 | | | 27,000 |
Total leased assets | | | | | $ | 1,932,000 | | $ | 2,035,000 |
| | | | | | | | | |
Liabilities | | | | | | | | | |
Current | | | | | | | | | |
Operating lease liabilities | | | Current maturities of operating lease liabilities | | $ | 395,000 | | $ | 395,000 |
Finance lease liabilities | | | Current maturities of finance lease liabilities | | | 12,000 | | | 27,000 |
Noncurrent | | | | | | | | | |
Operating lease liabilities | | | Operating lease liabilities, less current maturities | | | 1,817,000 | | | 1,879,000 |
Total lease liabilities | | | | | $ | 2,224,000 | | $ | 2,301,000 |
| | | | | | | | | |
The components of lease expense were as follows:
| | | | | | | | | |
| | | | | Three Months Ended | ||||
| | | | | | July 31, 2020 | | | July 31, 2019 |
| | | | | | | | | |
Operating lease expense | | | | | $ | 135,000 | | $ | 112,000 |
Finance lease expense | | | | | | | | | |
Amortization of right-of-use assets | | | | | | 11,000 | | | 10,000 |
Interest on lease liabilities | | | | | | - | | | 3,000 |
Total finance lease expense | | | | | | 11,000 | | | 13,000 |
Total lease expense | | | | | $ | 146,000 | | $ | 125,000 |
| | | | | | | | | |
The supplemental components of cash flows were as follows:
| | | | | | | | | |
| | | | | Three Months Ended | ||||
| | | | | | July 31, 2020 | | | July 31, 2019 |
Cash paid for amounts included in the measurement of lease liabilities | | | | | | | | | |
Operating cash flows from operating leases | | | | | $ | 109,000 | | $ | 112,000 |
Financing cash flows from finance leases | | | | | | 15,000 | | | 16,000 |
Total cash paid for amounts included in the measurement of lease liabilities | | | | | $ | 124,000 | | $ | 128,000 |
| | | | | | | | | |
12
The following table represents the weighted-average remaining lease term and discount rate as of July 31, 2020 and April 30, 2020:
| | | | | | |
| | | July 31, 2020 | |||
| | | Weighted Average | | | Weighted Average |
| | | Remaining | | | Discount |
Lease Term and Discount Rate | | | Lease Term (years) | | | Rate |
Operating leases | | | 6.17 | | | 4.52% |
Finance leases | | | 0.25 | | | 5.44% |
| | | | | | |
| | | | | | |
| | | April 30, 2020 | |||
| | | Weighted Average | | | Weighted Average |
| | | Remaining | | | Discount |
Lease Term and Discount Rate | | | Lease Term (years) | | | Rate |
Operating leases | | | 6.60 | | | 4.52% |
Finance leases | | | 0.42 | | | 5.43% |
| | | | | | |
Future minimum lease payments on the amended operating lease and future minimum finance lease payments as of July 31, 2020 are as follows:
| | | | |
| Finance Lease | Operating Lease | ||
Fiscal Years Ending April 30, | Payments | Payments | ||
2021 | $ | 12,000 | $ | 371,000 |
2022 | | — | | 512,000 |
2023 | | — | | 505,000 |
2024 | | — | | 452,000 |
2025 | | — | | 456,000 |
2026 | | — | | 467,000 |
2027 | | — | | 350,000 |
| $ | 12,000 | $ | 3,113,000 |
On October 19, 2018, Torotel entered into three new business loan agreements (the “financing agreements”) with Cornerstone Bank (the “Bank”). The financing agreements provide for an asset-backed revolving line of credit, a guidance line of credit, and a real estate term loan. On October 19, 2019, Torotel renewed the asset-backed revolving line of credit. A summary of the notes issued under the financing agreements is provided below:
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| | | | | | |
| | | July 31, 2020 | | | April 30, 2020 |
5.00% asset-based revolving line of credit with a maturity date of October 19, 2020 |
| $ | 899,000 | | $ | - |
5.35% mortgage note payable in monthly installments of $5,573, including interest, with final payment of $690,829 due October 19, 2023 | | | 766,000 | | | 773,000 |
5.50% equipment term loan note payable in monthly installments of $1,034, including interest, with final payment of $1,034 due on May 13, 2024 | | | 43,000 | | | 45,000 |
1.00% Paycheck Protection Program loan note payable in monthly installments | | | 1,985,000 | | | 1,985,000 |
Total long-term debt | | | 3,693,000 | | | 2,803,000 |
Less current installments | | | 1,842,000 | | | 795,000 |
Long-term debt, excluding current installments | | $ | 1,851,000 | | $ | 2,008,000 |
The asset-based revolving line of credit is intended to be used for working capital purposes and has a capacity of $2,000,000. The asset-based revolving line of credit is renewable annually upon mutual agreement of Torotel and the Bank. The Company intends to renew the asset-based revolving line of credit. The associated interest rate is equal to the greater of the floating Cornerstone Bank Corporate Base Rate (5.50% as of July 31, 2020) or a floor of 5.0%. Monthly repayments of interest only are required under the asset-based revolving line of credit promissory note with the principal due at maturity. The borrowing base of the revolving line of credit is limited to 80% of eligible accounts receivable, plus 50% of eligible inventory, plus 80% of eligible equipment. This asset-based revolving line of credit is cross collateralized and cross defaulted with all other financing agreements of Torotel with the Bank. Pursuant to a Commercial Security Agreement dated October 19, 2018, between Torotel and the Bank (the “Commercial Security Agreement”), which was entered into in connection with the financing agreements, the asset-based revolving line of credit is secured by a first lien on all business assets of Torotel. Under the revolving line of credit, if the aggregate principal amount of the outstanding advances exceeds the applicable borrowing base, Torotel must pay the Bank an amount equal to the difference between the outstanding principal balance of the revolving line of credit and the borrowing base.
The real estate term loan is in the principal amount of $815,000 and contains a 5-year term with a 20-year amortization period, with the balance at maturity on October 19, 2023. The associated interest rate is fixed at 5.35%. Monthly repayments of approximately $5,573, consisting of both interest and principal, are required. The final payment of approximately $690,829 is due on the maturity date. This real estate term loan is cross collateralized and cross defaulted with the other financing agreements. The real estate term loan is secured by a first lien priority real estate mortgage on the property located at 620 North Lindenwood Drive in Olathe, Kansas pursuant to the Commercial Security Agreement.
The equipment note was a guidance line of credit to be used for equipment purchases and had a capacity of $250,000. On May 13, 2019, Torotel converted the guidance line of credit relating to the equipment note into an equipment term loan. The equipment term loan is in the principal amount of $54,000 and contains a 5-year term with a 5-year amortization period, with the balance at maturity on May 13, 2024. The associated interest rate is fixed at 5.50%. Monthly repayments of approximately $1,034, consisting of both interest and principal, are required. This final payment of approximately $1,034 is due on the maturity date. This equipment term loan is cross collateralized and cross defaulted with the other financing agreements of Torotel and is secured by a purchase money security interest in the assets purchased as well as a first lien on all business assets of Torotel.
On April 15, 2020, Torotel entered into a promissory note with the Bank, which provides for a loan in the amount of $1,984,688 (the “PPP Loan”) pursuant to the Paycheck Protection Program under the Coronavirus Aid, Relief, and Economic Security Act (the “CARES Act”). The PPP Loan has a two-year term and bears interest at a rate of 1.0% per annum. Monthly principal and interest payments are deferred for six months after the date of disbursement. The PPP Loan may be prepaid at any time prior to maturity with no prepayment penalties. The Promissory Note contains events of default and other provisions customary for a loan of this type. The Paycheck Protection Program provides that the PPP Loan may be partially or wholly forgiven if the funds are used for certain qualifying expenses as described in the CARES Act. Torotel Products intends to use the proceeds from the PPP Loan for qualifying expenses and to apply for forgiveness of the PPP
14
Loan in accordance with the terms of the CARES Act. However, neither the Company nor Torotel Products can completely assure at this time that such forgiveness of the PPP Loan will occur.
The financing agreements contain customary representations, warranties, and covenants of Torotel for the benefit of the Bank, as well as customary default provisions. Other than the borrowing base limitations under the asset-based revolving line of credit, none of the financing agreements requires Torotel to comply with any financial covenants. Prepayments are allowed without penalty under all of the financing agreements.
Irrevocable Standby Letter of Credit
Under the terms of a lease amendment for its manufacturing facility located in Olathe, Kansas, Torotel provided the landlord an irrevocable standby letter of credit in the original amount of $300,000 as additional security. On January 1, 2020, the letter of credit was reduced from $300,000 to $225,000. The balance under the letter of credit will automatically reduce in accordance with the below schedule if not drawn upon:
| | | | |
Date of Reduction | | Amount of Reduction | | Balance of Letter of Credit |
January 1, 2021 | $ | 75,000 | $ | 150,000 |
January 1, 2022 | | 75,000 | | 75,000 |
January 1, 2023 | | 75,000 | | - |
The Company incurred an income tax benefit of $128,000 during the three months ended July 31, 2020 and incurred income tax expense of $111,000 during the three months ended July 31, 2019, with an effective tax rate of 26.5% and 19.9%, respectively.
The income tax benefit was derived from a release of $288,000 from the valuation allowance offset by $160,000 of income tax expense during the three months ended July 31, 2020. The valuation allowance was $301,000 and $589,000 as of July 31, 2020 and April 30, 2020, respectively.
As of July 31, 2020, the federal tax returns for the fiscal years ended 2018 through 2020 are open to audit until the statute of limitations closes for the years in which our net operating losses are utilized. We would recognize interest and penalties accrued on unrecognized tax benefits as well as interest received from favorable tax settlements within income tax expense. As of July 31, 2020, we recorded no accrued interest or penalties related to uncertain tax positions. We expect no significant change in the amount of unrecognized tax benefit, accrued interest or penalties within the next twelve months.
NOTE 8—RESTRICTED STOCK AGREEMENTS
Restricted Stock Agreements, and stock awards thereunder, are authorized by the Compensation and Nominating Committee (the "Committee") and the Board of Directors of Torotel (the "Board"). The terms of the Restricted Stock Agreements afford the grantees all of the rights of a stockholder with respect to the award shares, including the right to vote such shares and to receive dividends and other distributions payable with respect to such shares since the date of award. Under the terms of each agreement, the non-vested shares are restricted as to disposition and subject to forfeiture under certain circumstances. The Restricted Stock Agreements further provide, subject to certain conditions, that if prior to all of the restricted shares having vested, we undergo a change in control, then all of the restricted shares will vest and no longer be subject to restrictions under the Restricted Stock Agreements. The restricted shares are treated as non-vested stock; accordingly, the fair value of the restricted stock at the date of award is offset against capital in excess of par value in the accompanying consolidated balance sheets under stockholders' equity.
15
Restricted Stock Grants
On September 21, 2016, we entered into Restricted Stock Agreements (“2016 Agreements”) with three key employees for the grant of an aggregate total of 730,000 restricted shares of the Company's common stock (the “Shares”). The Shares were granted, and the 2016 Agreements were entered into, pursuant to the Company’s Stock Award Plan (the “Plan”). The award of the Shares was authorized by both the Committee and the Board as a whole on September 19, 2016. Except for the number of shares granted to each recipient, the terms of each of the 2016 Agreements are identical.
The Shares were granted subject to restrictions that prohibit them from being sold, assigned, pledged or otherwise disposed of until the restrictions lapse. The restrictions will lapse on the fifth anniversary of the date of grant if during the five year restriction period, (1) the Company's cumulative annual growth in revenue is at least 10%, and (2) the average economic value added as a percentage of revenue is at least 2%. The economic value added, which attempts to capture the true economic profit, will be calculated as the operating profit less the cost of capital with adjustments made for taxes. The restrictions will also lapse, if prior to the fifth anniversary of the date of grant, (1) the grantee's employment with the Company is terminated by reason of disability, (2) the grantee dies, or (3) the Committee, in its sole discretion, terminates the restrictions. If the restrictions on the Shares have not lapsed by the fifth anniversary of the date of grant, the Shares will be forfeited to the Company.
Stock Compensation Costs and Restricted Stock Activity
Total stock compensation cost was $27,000 for each of the three months ended July 31, 2020 and 2019.
Restricted stock activity for each three month period through July 31 is summarized as follows:
| | | | | | | | | | | |
| | 2020 | | 2019 |
| ||||||
|
| Restricted |
| Weighted |
| Restricted |
| Weighted |
| ||
| | Shares | | Average | | Shares | | Average |
| ||
| | Under | | Grant | | Under | | Grant |
| ||
| | Option | | Price | | Option | | Price |
| ||
Outstanding at May 1 |
| 730,000 |
| $ | 0.740 |
| 730,000 |
| $ | 0.740 | |
Granted | | — | | | — |
| — | | | — | |
Forfeited | | — | | | — |
| — | | | — | |
Outstanding at July 31 |
| 730,000 | | $ | 0.740 |
| 730,000 | | $ | 0.740 | |
The shares of common stock outstanding as of each three month period ended as of July 31 are summarized as follows:
| | | | | |
|
| 2020 | | 2019 |
|
Balance, May 1 | | 5,995,750 | | 5,995,750 | |
Shares released from treasury for restricted stock grants | | — | | — | |
Newly issued shares for restricted stock grants | | — | | — | |
Shares reverted to treasury for restricted stock forfeitures | | — | | — | |
Balance, July 31 | | 5,995,750 | | 5,995,750 | |
Basic and diluted earnings per share are computed using the two-class method. The two-class method is an earnings allocation formula that determines net income per share for each class of common stock and participating security according to dividends declared and participation rights in undistributed earnings. Per share amounts are computed by dividing net income attributable to common shareholders by the weighted average shares outstanding during each period.
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The basic earnings per common share were computed as follows:
| | | | | | |
| | Three Months Ended | ||||
|
| July 31, 2020 |
| July 31, 2019 | ||
Net income | | $ | 730,000 | | $ | 444,000 |
Amounts allocated to participating securities (nonvested restricted shares) | | | (89,000) | |
| (54,000) |
Net income attributable to common shareholders | | $ | 641,000 | | $ | 390,000 |
Basic weighted average common shares | | | 5,265,750 | |
| 5,265,750 |
Earnings per share attributable to common shareholders: | | | | | | |
Basic earnings per share | | $ | 0.12 | | $ | 0.07 |
| | | | | | |
ASC 260, Earnings per Share, provides that unvested share-based payment awards that contain non-forfeitable rights to dividends are considered to be participating securities and must be considered in the computation of earnings per share pursuant to the two-class method. Diluted earnings per share is not presented as we do not have any shares considered incremental and dilutive.
For each of our contracts, the timing of revenue recognition, customer billings, and cash collections results in a net contract asset or liability at the end of each reporting period. Contract assets consist of unbilled receivables typically resulting from revenue recognition under contracts when either control has passed to the customer but the product has not yet shipped or the percentage-of-completion of revenue recognition is utilized when revenue recognized exceeds the amount billed to the customer for any project-related services, utilizing labor as the input method.
| | | | | | |
|
| July 31, 2020 |
| April 30, 2020 | ||
Contract assets | | $ | 357,000 | | $ | 960,000 |
Contract assets decreased $603,000 between July 31, 2020 and April 30, 2020 due to decreased satisfaction or partial satisfaction of customer contracts, and relates to the recognition of revenue related to the satisfaction or partial satisfaction of performance obligations for which we have not yet billed.
For certain customers, we collect payment at the time the order is placed. These deposits are classified as a liability and will be recognized as revenue at the time performance obligations are satisfied in accordance with our revenue recognition policy. As of July 31, 2020 and April 30, 2020 we had $68,000 and $16,000, respectively in customer deposits related to this arrangement.
NOTE 13 — CONCENTRATIONS OF CREDIT RISK
Financial instruments that potentially subject us to concentrations of credit risk consist principally of cash and accounts receivable. We grant unsecured credit to most of our customers. We do not believe that we are exposed to any extraordinary credit risk as a result of this policy. At various times cash balances exceeded federally insured limits. However, we have incurred no losses in the cash accounts and we do not believe we are exposed to any significant credit risk with respect to our cash.
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The Company adopted ASC 842 on May 1, 2019 using the modified retrospective transition method. Upon transition to the new standard, the Company elected the package of practical expedients, which permitted the Company not to reassess under the new standard its prior conclusions about lease identification, lease classification and initial direct costs.
On February 15, 2019, a lease agreement became effective for tenant occupancy of the 23,924 square foot building owned by Torotel. Monthly installment payments of $11,500 began to be paid to us on March 1, 2019. The lease is for a sixty-two month term with monthly payments escalating periodically from $11,500 to $15,500. The tenant has the right to elect to purchase the building. The election to purchase must be made within the lease term or Torotel is not prohibited from placing the building up for public sale.
Future minimum lease payments on the operating lease as of July 31, 2020 are as follows:
| | |
| Operating Lease | |
Fiscal Years Ending April 30, | Payments | |
2021 | $ | 117,000 |
2022 | | 166,000 |
2023 | | 178,000 |
2024 | | 124,000 |
Total | $ | 585,000 |
| | |
Torotel’s leased property (where Torotel is the lessor) by asset category was as follows:
| | | | | | |
|
| July 31, 2020 |
| April 30, 2020 | ||
Land | | $ | 265,000 | | $ | 265,000 |
Buildings and improvements | | | 1,000,000 | | | 1,000,000 |
| | | 1,265,000 | | | 1,265,000 |
Less accumulated depreciation | | | (730,000) | | | (707,000) |
Net leased property | | $ | 535,000 | | $ | 558,000 |
| | | | | | |
Depreciation resulting from the leased property amounted to $23,000 and $13,000 during the three months ending July 31, 2020 and 2019, respectively.
NOTE 15 – COVID-19 IMPACT
The COVID-19 pandemic, first identified in Wuhan, Hubei Province, China, continues to spread worldwide, causing weakened international economic conditions. Torotel provides end products to the defense industry and is considered an essential business. We have been fully operating throughout the pandemic. Due to the concerns around the outbreak of COVID-19, we have implemented several new policies and procedures based on CDC recommendations. All of our employees who do not have critical functions requiring them to be on-site have been working remotely to lower the number of people within the facilities. For those employees required to work on-site, we have implemented new measures including increased distancing of workstations, closed access to common areas and meeting rooms, increased cleaning efforts, implemented face mask requirements, further restricted access to our premises by suppliers and customers, and other safety precautions. We expect to continue these changes for the foreseeable future. As a result of the pandemic, there is significant uncertainty around the U.S. and global economy, U.S. Department of Defense spending as a result of potential budget cuts, future customer demand, supply chain availability, oil price fluctuations, cash collections, and costs related to our changes to help ensure the safety and well-being of our employees. Late in the fourth quarter of fiscal 2020, we have experienced lower commercial aerospace sales as a result of COVID-19. Due to
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this change in sales and the significant uncertainties outlined above in April 2020, we applied for a loan under the Paycheck Protection Program (the “PPP”) of the 2020 Coronavirus Aid, Relief and Economic Security Act (the “CARES Act”) administered by the Small Business Association. On April 15, 2020, Torotel received $1.9 million in PPP funds. We believe we have used these funds from this loan only for the purposes included in the PPP, including payroll, employee benefits, rent, utilities and interest on certain finance agreements (See Note 6). The aerospace industry has seen large impacts from the pandemic and this has impacted some of our customers. As identified in Note 4, our revenue from the commercial aerospace industry for the three month period ended July 31, 2020 and 2019 was $925,000 and $2,410,000, respectively. The $1,485,000 decrease is primarily due to the pandemic impacts from lower commercial aerospace product demand. At the date of this filing, the full extent of which the COVID-19 pandemic may impact our financial condition or results of operations is uncertain.
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This report, as well as our other reports filed with or furnished to the Securities and Exchange Commission (the “SEC”), contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended (the “Exchange Act”). The words “believe,” “estimate,” “anticipate,” “project,” “intend,” “expect,” “plan,” “outlook,” “forecast,” “may,” “should,” “predict,” and similar expressions are intended to identify forward-looking statements. Statements regarding expectations, including performance assumptions and estimates relating to capital requirements, as well as other statements that are not historical facts, are forward-looking statements. This report contains forward-looking statements regarding, among other topics, our expected financial position, results of operations, cash flows, strategy, budgets and management's plans and objectives. Accordingly, these forward-looking statements are based on management’s judgments based on currently available information and assumptions about a number of important factors. While we believe that our assumptions about such factors are reasonable, such factors involve risks and uncertainties that could cause actual results to differ materially from those in the forward-looking statements. These factors include,without limitation:
| ● | disruption in our business, customers and suppliers in connection with COVID-19; |
| ● | economic, political and legislative factors that could impact defense spending; |
| ● | continued production of the Hellfire II missile system for which we supply parts; |
| ● | loss of key customers and our relatively concentrated customer base; |
| ● | risks in fulfilling military subcontracts; |
| ● | our ability to finance operations; |
| ● | our ability to adequately pass through to customers unanticipated future increases in raw material and labor costs; |
| ● | delays in developing new products; |
| ● | markets for new products and the cost of developing new markets; |
| ● | expected orders that do not occur; |
| ● | our ability to adequately protect and safeguard our network infrastructure from cyber security vulnerabilities; |
| ● | our on-going ability to satisfy our debt repayment obligations; |
| ● | fluctuations in oil prices; |
| ● | our ability to generate sufficient taxable income to realize the amount of our deferred tax assets; and |
| ● | the impact of competition and price erosion as well as supply and manufacturing constraints. |
In light of these risks and uncertainties, there can be no assurance that the forward-looking information contained in this report will prove accurate. Accordingly, our actual results may differ materially from these forward-looking statements. The reader should not place undue reliance on forward-looking statements, which speak only as of the date of this report. We assume no obligation to publicly update any forward-looking statements made herein to reflect events after the date of this report, including unforeseen events.
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Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
Torotel, Inc. ("Torotel") conducts substantially all of its business primarily through its wholly owned subsidiary, Torotel Products, Inc. ("Torotel Products"). The terms “we,” “us,” “our,” and the “Company” as used herein include Torotel and all of its subsidiaries, including Torotel Products, unless the context otherwise requires. Torotel specializes in the custom design and manufacture of a wide variety of precision magnetic components consisting of transformers, inductors, reactors, chokes, toroidal coils, high voltage transformers, dry-type transformers and electro-mechanical assemblies for use in military, commercial aerospace and industrial electronic applications. These products are used to modify and control electrical voltages and currents in electronic devices. Torotel sells these products to original equipment manufacturers, which use them in applications such as:
| ● | aircraft navigational equipment; |
| ● | digital control devices; |
| ● | airport runway lighting devices; |
| ● | medical equipment; |
| ● | avionics systems; |
| ● | radar systems; |
| ● | down-hole drilling; |
| ● | conventional missile guidance systems; and |
| ● | other aerospace and defense applications. |
We believe the primary factors that drive our gross profit and net earnings are sales volume and product mix. The gross profits on mature products/programs and complex transformer devices tend to be higher than those that are still in the prototyping or early production stages and simpler inductor devices. As a result, in any given accounting period the mix of product shipments between higher and lower margin products has a significant impact on our gross profit and net earnings. Our operating plan continues to focus on expanding the product base beyond electronic components.
Torotel markets its components primarily through an internal sales force and independent manufacturers’ representatives paid on a commission basis. As a result of the coronavirus (COVID-19) pandemic, we have implemented restrictions on travel, a reduction in sales conferences being attended and limitations on in-person meetings which is expected to decrease expenses relating to sales and may have an adverse effect on customer demand. These commissions are earned when a product is sold and/or shipped to a customer within the representative’s assigned territory. Torotel also utilizes its engineering department in its direct sales efforts for the purpose of expanding its reach into new markets and/or customers.
The industry mix of the customers that accounted for Torotel’s net sales for the first three months of the fiscal year ending April 30, 2021 (“fiscal year 2021”) was 81% defense, 15% commercial aerospace, and 4% industrial compared to 60% defense, 38% commercial aerospace, and 2% industrial for the same period in the fiscal year ending April 30, 2020 (“fiscal year 2020”). Approximately 97% of Torotel’s sales during the first three months of fiscal year 2021 have been derived from domestic customers.
Torotel is an approved source for magnetic components used in numerous military and commercial aerospace systems, which means Torotel is automatically solicited for any procurement needs for such applications. The magnetic components manufactured by Torotel are sold primarily in the United States, and most sales are awarded on a competitive bid basis. The markets in which Torotel competes are highly competitive. A substantial number of companies sell components of the type manufactured and sold by Torotel. In addition, Torotel sells to a number of customers who have the capability of manufacturing their own electronic components. The principal methods of competition for electronic products in the markets served by Torotel include, among other factors, price, on-time delivery performance, lead times, customized product engineering and technical support, marketing capabilities, quality assurance, manufacturing efficiency, and existing relationships with customers’ engineers. While we believe magnetic components are generally not susceptible
21
to rapid technological change, Torotel’s sales, which do not represent a significant share of the industry’s market, are susceptible to decline given the competitive nature of the market.
COVID-19 Impact
The COVID-19 pandemic, first identified in Wuhan, Hubei Province, China, continues to spread worldwide, causing weakened international economic conditions. Torotel is identified as an essential business as previously discussed within the “Business” section and we have been fully operating throughout the pandemic. Due to the concerns around the outbreak of COVID-19, we have implemented several new policies and procedures based on CDC recommendations. All of our employees who do not have critical functions requiring them to be on-site have been working remotely to lower the number of people within the facilities. For those employees required to work on-site, we have implemented new measures including increased distancing of workstations, closed access to common areas and meeting rooms, increased cleaning efforts, implemented face mask requirements, further restricted access to our premises by suppliers and customers, and other safety precautions. We expect to continue these changes for the foreseeable future. As a result of the pandemic, there is significant uncertainty around the U.S. and global economy, U.S. Department of Defense spending as a result of potential budget cuts, future customer demand, supply chain availability, oil price fluctuations, cash collections, and costs related to our changes to help ensure the safety and well-being of our employees. Late in the fourth quarter of fiscal 2020, we have experienced lower commercial aerospace sales as a result of COVID-19. In April 2020, we applied for a loan under the Paycheck Protection Program (the “PPP”) of the 2020 Coronavirus Aid, Relief and Economic Security Act (the “CARES Act”) administered by the Small Business Association. On April 15, 2020, Torotel received $1.9 million in PPP funds. We believe we have used these funds from this loan only for the purposes included in the PPP, including payroll, employee benefits, rent, utilities and interest on certain finance agreements (See Liquidity and Capital Resources).
Business and Industry Considerations
Defense Markets
During the first three months of fiscal years 2021 and 2020 the amount of consolidated revenues derived from contracts with prime contractors of the U.S. Department of Defense (“DoD”) was approximately 81% and 60% respectively. As a result, our financial results in any period could be impacted substantially by spending cuts or increases in the DoD budget and the funds appropriated for certain military programs.
Despite ongoing uncertainty associated with the DoD budget, we believe our overall defense business outlook remains favorable due to the present demand for the potted coil assembly and other existing orders from major defense contractors. As of July 31, 2020, our consolidated order backlog for the defense market was nearly $17.2 million, which included $11.3 million for the potted coil assembly.
Commercial Aerospace and Industrial Markets
We provide magnetic components and electro-mechanical assemblies for a variety of applications in the commercial aerospace and industrial markets. The primary demand drivers for these markets include commercial aircraft production orders, oil and gas drilling exploration activity, and general economic growth. Each of these could have an ongoing impact due to the effects of the pandemic on commercial aircraft production, oil prices and general economic turmoil and uncertainty. Producers of commercial aircraft have announced a decrease in the production of multiple models of aircraft. This reduction has adversely impacted our commercial aerospace backlog and is expected to further impact our commercial aerospace business throughout fiscal year 2021. Other threats to our near-term and long-term market outlook include delays on the development and production of new commercial aircraft and competition from international suppliers. As of July 31, 2020, our consolidated order backlog for the aerospace and industrial markets was $3.3 million.
Business Outlook
Our backlog as of July 31, 2020 as compared to July 31, 2019 increased from $12.9 million to $20.5 million, a 58% increase. This was due primarily to an increase in the potted coil assembly orders. We anticipate that net sales for
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fiscal year 2021 will remain consistent with fiscal year 2020 primarily due to an expectation that a reduction of net sales within the commercial aerospace industry; may be partially offset by sales growth within the defense industry. We anticipate that 67% of our $20.5 million backlog as of July 31, 2020 is expected to ship and be converted to sales in fiscal year 2021. As noted previously, there are multiple uncertainties within our business associated with the COVID-19 pandemic; however, we anticipate that our large sales backlog and current defense industry opportunities will help maintain our current business outlook.
Consolidated Results of Operations
The following management comments regarding Torotel’s results of operations and outlook should be read in conjunction with the Consolidated Condensed Financial Statements and Notes to the Consolidated Condensed Financial Statements included in Part I, Item 1 of this Quarterly Report.
This discussion and analysis of the results of operations include the operations of Torotel and its subsidiary Torotel Products as of July 31, 2020.
Net Sales
| | | | | | |
| | Three Months Ended | ||||
|
| July 31, 2020 |
| July 31, 2019 | ||
Magnetic components | | $ | 3,963,000 | | $ | 3,254,000 |
Potted coil assembly | | | 1,735,000 | | | 1,519,000 |
Electro-mechanical assemblies | | | 321,000 | | | 1,573,000 |
Total | | $ | 6,019,000 | | $ | 6,346,000 |
Consolidated net sales in the three months ended July 31, 2020 decreased 5%, or $327,000, compared to the three months ended July 31, 2019. Consolidated net sales decreased primarily because of decreased demand in electro-mechanical assemblies due largely to the impacts of the pandemic on the aerospace industry.
Gross Profit
| | | | | | | |
| | Three Months Ended | | ||||
| |
| July 31, 2020 |
| July 31, 2019 |
| |
Gross profit | | $ | 2,339,000 | | $ | 2,393,000 | |
Gross profit % of net sales | |
| 39 | % |
| 38 | % |
Consolidated gross profit decreased by 2%, or $54,000, in the three ended July 31, 2020 compared to the three months ended July 31, 2019. Consolidated gross profit decreased primarily due to decreased demand in electro-mechanical assemblies due largely to the impacts of the pandemic on the aerospace industry.
Operating Expenses
| | | | | | |
| | Three Months Ended | ||||
|
| July 31, 2020 |
| July 31, 2019 | ||
Engineering | | $ | 351,000 | | $ | 388,000 |
Selling, general and administrative | | | 1,363,000 | |
| 1,423,000 |
Total | | $ | 1,714,000 | | $ | 1,811,000 |
Engineering expenses decreased 10%, or $37,000, in the three months ended July 31, 2020 compared to the three months ended July 31, 2019. The decrease in the three month period primarily resulted from a decrease in headcount and a decrease in travel expenses.
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Selling, general and administrative expenses decreased 4%, or $60,000, in the three months ended July 31, 2020 compared to the three months ended July 31, 2019. The decrease primarily resulted from a decrease in headcount.
Earnings (loss) from Operations
| | | | | | |
| | Three Months Ended | ||||
|
| July 31, 2020 |
| July 31, 2019 | ||
Torotel Products | | $ | 790,000 | | $ | 765,000 |
Torotel | |
| (165,000) | |
| (183,000) |
Total | | $ | 625,000 | | $ | 582,000 |
For the reasons discussed under each of the Gross Profit and Operating Expenses headings above, consolidated earnings from operations increased by $43,000, for the three months ended July 31, 2020 when compared to the three months ended July 31, 2019.
Other Earnings Items
| | | | | | |
| | Three Months Ended | ||||
|
| July 31, 2020 |
| July 31, 2019 | ||
Income from operations | | $ | 625,000 | | $ | 582,000 |
Interest expense | | | 23,000 | |
| 27,000 |
Income before income taxes | |
| 602,000 | |
| 555,000 |
Income tax expense (benefit) | | | (128,000) | |
| 111,000 |
Net income | | $ | 730,000 | | $ | 444,000 |
We anticipate that our effective income tax rate for fiscal year ending April 30, 2021 will be 26.5%. For additional discussion related to Income Taxes, see Note 7 of Notes to the Consolidated Financial Statements.
Financial Condition and Liquidity
Cash generated by operations together with the borrowing under our lines of credit are our primary sources of liquidity. The following table highlights the sources of liquidity available to us as of July 31, 2020 compared to July 31, 2019.
| | | | | |
| July 31, | ||||
|
| 2020 |
| | 2019 |
Cash | $ | 2,017,000 | | $ | 353,000 |
Amount available under our 5.00% asset-based revolving line of credit | | 1,101,000 | | | 864,000 |
Total funds available | $ | 3,118,000 | | $ | 1,217,000 |
Operating Activities
The following table compares net cash provided by (used in) operating activities during the three months ended July 31, 2020 compared to the three months ended July 31, 2019.
| | | | | | |
| | Three Months Ended | ||||
|
| July 31, 2020 |
| July 31, 2019 | ||
Net cash provided by (used in) operating activities | | $ | (1,080,000) | | $ | 774,000 |
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Net cash provided by operating activities decreased by $1,854,000 during the three months ended July 31, 2020 versus the comparable period of the 2020 fiscal year primarily due to an increase in trade receivables and a decrease in trade accounts payable.
Investing Activities
| | | | | | |
| | Three Months Ended | ||||
|
| July 31, 2020 |
| July 31, 2019 | ||
Net cash used in investing activities | | $ | (41,000) | | $ | (116,000) |
The decrease of $75,000 in net cash used in investing activities during the three months ended July 31, 2020 compared to the comparable period of fiscal year 2020 was due to lower capital expenditures. We expect capital expenditure spending to rise moderately during the remainder of fiscal year 2021 which is consistent with the anticipated needs of our business.
Financing Activities
| | | | | | |
| | Three Months Ended | ||||
|
| July 31, 2020 |
| July 31, 2019 | ||
Net cash provided by (used in) financing activities | | $ | 875,000 | | $ | (363,000) |
The increase of $1,238,000 in net cash provided by financing activities during the three months ended July 31, 2020 from the comparable period in fiscal year 2020 is due primarily to proceeds from the asset-based revolving line of credit in fiscal year 2021.
Liquidity and Capital Resources
Due to the above-mentioned pandemic-related challenges, we are proactively managing costs and finding new sources of revenue to offset the impact of the anticipated commercial aerospace downturn. We believe that maintaining our skilled workforce of production employees and engineers is vital to our continued success. Without the combination of the PPP loan and the expansion of our line of credit, we would have had to make significant cost structure changes to our operations beginning near the end of fiscal year 2020. We believe that the projected cash flow from operations, additional proceeds from PPP funding and available borrowings under existing financing arrangements that supplement our working capital needs, will enable us to meet our anticipated funding requirements for the foreseeable future, based on historical levels. Our asset-based revolving line of credit and guidance line of credit are scheduled to mature on October 19, 2020. We expect to renew each of the financing agreements, if deemed necessary. The increase in our cash position from the prior fiscal year is due to the $1,985,000 PPP funding. As of July 31, 2020, we had $899,000 funds drawn on the $2,000,000 asset-based revolving line of credit. As of July 31, 2020 our total borrowing capacity is approximately $1,101,000, under our existing financing arrangements, plus $2,017,000 of cash on hand.
Off-Balance Sheet Arrangements
There are no off-balance sheet arrangements.
We discuss our critical accounting policies and estimates in Item 7, “Management's Discussion and Analysis of Financial Condition and Results of Operations,” in our Annual Report on Form 10-K for the year ended April 30, 2020 filed with the SEC on July 28, 2020. We have made no significant change in our critical accounting policies since April 30, 2020.
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Item 3. Quantitative and Qualitative Disclosures About Market Risk
Not Applicable
Item 4. Controls and Procedures
Evaluation of Disclosure Controls and Procedures
Torotel’s management, with the participation of its Chief Executive Officer and Chief Financial Officer, has evaluated the effectiveness of Torotel’s disclosure controls and procedures, as such term is defined in Rule 13a-15(e) under the Securities Exchange Act of 1934, as amended, as of the end of the period covered by this report. Based on such evaluation, the Chief Executive Officer and the Chief Financial Officer have concluded that Torotel’s disclosure controls and procedures are effective as of the end of the period covered by this report.
Changes in Internal Control
There were no significant changes in Torotel’s internal control over financial reporting or in other factors that in management’s estimates have materially affected, or are reasonably likely to materially affect, Torotel’s internal control over financial reporting during the fiscal quarter covered by this Quarterly Report on Form 10-Q.
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| | | |
Exhibit 3.1 |
|
| |
Exhibit 3.2 | | | |
Exhibit 10.1† | | | |
Exhibit 31.1* | | | |
Exhibit 31.2* | | | |
Exhibit 32.1** | | | |
Exhibit 32.2** | | | |
Exhibit 101.INS | | XBRL Instance Document | |
Exhibit 101.SCH | | XBRL Taxonomy Extension Schema Document | |
Exhibit 101.CAL | | XBRL Taxonomy Extension Calculation Linkbase Document | |
Exhibit 101.DEF | | XBRL Taxonomy Extension Definition Linkbase Document | |
Exhibit 101.LAB | | XBRL Taxonomy Extension Label Linkbase Document | |
Exhibit 101.PRE | | XBRL Taxonomy Extension Presentation Linkbase Document | |
* Filed herewith.
** The Certifications attached as Exhibits 32.1 and 32.2 that accompany this Quarterly Report on Form 10-Q are not deemed filed with the Securities and Exchange Commission and are not to be incorporated by reference into any filing of Torotel, Inc., irrespective of any general incorporation language contained in such filing.
† Indicates management contract or compensatory plan.
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Pursuant to the requirements 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.
| |
| Torotel, Inc. |
Date: September 11, 2020 | /s/ Heath C. Hancock |
| Heath C. Hancock |
| Chief Financial Officer |
| Principal Financial Officer |
| |
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