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EX-32.2 - EX-32.2 - TOROTEL INCttlo-20180430ex322d3a528.htm
EX-32.1 - EX-32.1 - TOROTEL INCttlo-20180430ex3215aeca2.htm
EX-31.2 - EX-31.2 - TOROTEL INCttlo-20180430ex3123d2dc2.htm
EX-31.1 - EX-31.1 - TOROTEL INCttlo-20180430ex311ce479a.htm
EX-21 - EX-21 - TOROTEL INCttlo-20180430ex21e02c03e.htm

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-K

 

 

 

ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the fiscal year ended April 30, 2018

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

(State or other jurisdiction of
incorporation or organization)

    

44-0610086

(I.R.S. Employer
Identification No.)

 

 

 

520 N. ROGERS ROAD, OLATHE, KANSAS
(Address of principal executive offices)

 

66062
(Zip Code)

 

Registrant's telephone number, including area code (913) 747-6111

Securities registered pursuant to Section 12(b) of the Act: None

 

 

 

 

    

 

 

 

 

 

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

Common Stock, $0.01 par value

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes ◻   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 ◻   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. Yes ☒No ◻

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Website, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§229.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes  ☒   No ◻

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (§229.405 of this chapter) 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, 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 ◻
(Do not check if a smaller reporting company)

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 Exchange Act). Yes ◻    No ☒

The aggregate market value of the voting stock held by non-affiliates of the registrant, computed based on the closing sale price reported on the OTC Market-Pink on October 30, 2017, was $3,597,450. As of June 29, 2018, there were 5,995,750 shares of Common Stock outstanding.

 

DOCUMENTS INCORPORATED BY REFERENCE

Portions of the registrant's definitive Proxy Statement for its 2018 Annual Meeting of Shareholders to be filed within 120 days after the end of the registrant’s fiscal year, are incorporated by reference into Part III of this Annual Report.

 

 

 


 

TOROTEL, INC. FORM 10-K

 

Fiscal Year Ended April 30, 2018

 

TABLE OF CONTENTS

 

 

    

    

    

    

 

PART I 

 

 

 

Item 1.

Business

 

4

 

Item 2.

Properties

 

6

 

Item 3.

Legal Proceedings

 

7

 

 

Item 4.

Mine Safety Disclosures

 

7

PART II 

 

 

 

 

Item 5.

Market for Registrant's Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities

 

8

 

 

Item 6.

Selected Financial Data

 

9

 

 

Item 7.

Management's Discussion and Analysis of Financial Condition and Results of Operations

 

10

 

 

Item 8.

Financial Statements and Supplementary Data

 

16

 

 

Item 9.

Changes In and Disagreements with Accountants on Accounting and Financial Disclosure

 

36

 

 

Item 9A.

Controls and Procedures

 

36

 

 

Item 9B.

Other Information

 

36

PART III 

 

 

 

 

Item 10.

Directors, Executive Officers and Corporate Governance

 

37

 

 

Item 11.

Executive Compensation

 

37

 

 

Item 12.

Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters

 

37

 

 

Item 13.

Certain Relationships and Related Transactions, and Director Independence

 

37

 

 

Item 14.

Principal Accounting Fees and Services

 

37

PART IV 

 

 

 

 

Item 15.

Exhibits, Financial Statement Schedules

 

38

 

 

Item 16.

Form 10-K Summary

 

40

SIGNATURES 

 

41

 

 

 

2


 

Forward-Looking Information

 

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 risk factors include, without limitation:

 

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 ongoing analysis of the effect on our financial position and results of operations from recently enacted and potential changes in tax law;

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 ability to satisfy our debt covenant requirements;

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.

3


 

PART I

ITEM 1.  Business

Torotel, Inc. ("Torotel") conducts substantially all of its business through its wholly owned subsidiary, Torotel Products, Inc. ("Torotel Products"). Torotel was incorporated under the laws of the State of Missouri in 1956. Torotel's offices are located at 520 North Rogers Road, Olathe, Kansas 66062. Torotel maintains a website at www.torotelinc.com. In addition, Torotel Products maintains a website at www.torotelproducts.com. Information contained on or accessible through either such website is not part of this annual report on Form 10-K. Our telephone number is (913) 747-6111. 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. Torotel sells these products to original equipment manufacturers, which use them in products such as aircraft navigational equipment, digital control devices, medical equipment, avionics equipment, down-hole drilling, conventional missile guidance systems, and other defense and commercial aerospace applications.

The following discussion includes the business operations of Torotel as of and for the fiscal year ended April 30, 2018 (“fiscal year 2018”).

Principal Products

Torotel specializes in the custom design and manufacture of a wide variety of precision magnetic components, 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. For example, if equipment containing one of these components receives an electrical voltage or current which is too high, the component would modify and control the electrical voltage or current to allow proper operation of the equipment. While Torotel primarily manufactures these products in accordance with pre-developed mechanical and electrical requirements, in some cases Torotel will be responsible for both the overall design and manufacturing. These products are sold to manufacturers who incorporate them into an end-product. The major applications include aircraft navigational equipment, digital control devices, medical equipment, avionics systems, down-hole drilling, conventional missile guidance systems, and other defense related applications. Torotel has a line of 400 Hz miniature power transformers listed on the Qualified Products List ("QPL") of the Department of Defense ("DoD"), which requires re-qualification with the DoD every five years.  Sales of the QPL products represented approximately 2% of the net sales of Torotel for fiscal year 2018.

Marketing and Customers

Torotel’s sales do not represent a significant portion of any particular market.  While approximately 43% of annual sales in fiscal year 2018 came from select commercial markets, such as commercial aerospace, and oil drilling, historically Torotel has primarily focused its activities toward the military market.  As a result, the business of Torotel is subject to various risks including, without limitation, dependence on government appropriations and program allocations, potential cutbacks in military spending, the requirement that some of our products be approved and qualified by the federal government before we can sell them, and the competition for available military business. Torotel pursues revenue opportunities in electro-mechanical assemblies, which we expect to continue as a major focus for Torotel.  Torotel also pursues revenue opportunities in larger and higher voltage transformers, plus products sourced from low-cost manufacturers in overseas markets who are compliant with aerospace standards.

Torotel markets its products primarily through an internal sales force and independent manufacturers' representatives paid on a commission basis. 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. Other sales methods may include visits to customers, lunch-and-learn presentations to customers' engineers, catalog brochures, trade show exhibits and speaker presentations at trade shows.

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

4


 

components manufactured by Torotel are sold primarily in the United States, and most sales are awarded on a competitive bid basis.

Torotel currently has a primary base of approximately 19 customers that together provide nearly 90% of its annual sales volume. This customer base includes many large prime defense and commercial aerospace companies. Torotel’s primary strategy focuses on providing superior service to this core group of customers, including engineering support and new product design. The objective is to achieve growth with these customers or other targeted companies that possess the potential for inclusion into the core group. During fiscal year 2018, sales to a single customer accounted for 34%, and sales to another customer accounted for 18% of the net sales of Torotel. A loss of or material reduction in orders from these customers could have a material adverse effect on sales.

Competition

The markets in which Torotel competes are highly competitive. A substantial number of companies utilizing similar resources sell components and assemblies 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 it is believed that magnetic components are not susceptible 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.

Manufacturing

Nearly all of Torotel’s sales consist of electronic products manufactured to customers' specifications. Aside from contractually required finished goods buffers, only a limited amount of finished goods is maintained in our inventory. Although special wire-winding machines and molding machines are used in the production process, the various electronic products are manually assembled, with numerous employees and some subcontractors contributing to the completion of the products.

Essential materials used by Torotel in the manufacturing process include magnetic materials, copper wire, plastic housings and epoxies. We believe these materials are available from many sources. Major suppliers include Magnetics Inc., Electrical Insulation Suppliers, Inc., Mod & Fab and Magnetic Metals-Western Division. Special contact plates purchased from Fotofab, LLC and polycarbonate materials purchased from Florida Custom Mold and Spectrum Plastics are used in manufacturing the potted coil assembly. Fotofab, Florida Custom Mold, and Spectrum Plastics are the only qualified approved sources for the materials they provide. As a result, Torotel maintains contingent business interruption insurance on these three suppliers' facilities, as well as the customers' production facility, to insure against loss of business income associated with a disruption in production by either supplier or at the customer as a result of a fire, tornado, explosion or other similar type loss.

Torotel has not experienced any significant curtailment of production because of material shortages, but any long lead times or high dollar minimum orders could have an adverse impact on sales bookings.

Engineering, Research and Development

Torotel does not intend to engage in research and development activities, but it does incur engineering expenses in designing products to meet customer specifications.

Governmental Regulations

A significant portion of Torotel’s business is derived from subcontracts with prime contractors of the U.S. government. As a U.S. subcontractor, Torotel is subject to federal contracting regulations. These subcontracts may be terminated at any time at the convenience of the U.S. government. Upon such termination, adequate financial compensation is usually provided in such instances to protect Torotel from suffering a loss on a subcontract. These subcontracts also may be terminated for default for failure to perform a material obligation. In the event of a termination for default, the customer may have the unilateral right at any time to require Torotel to pay the excess, if any, of the cost of purchasing a substitute

5


 

item from a third party. If the customer has suffered other ascertainable damages as a result of a sustained default, the customer could demand payment of such damages. Torotel has never experienced any terminations for default.

As a supplier of products for military applications, Torotel must comply with laws concerning the export of material used exclusively for military purposes. The export of those types of materials is covered under the International Traffic in Arms Regulations ("ITAR") and the Arms Export Control Act ("AECA"). Torotel is licensed with the U.S. Department of State making it eligible to provide defense-related components pursuant to ITAR and AECA. This license is renewed annually each October.

Intellectual Property

The products sold by Torotel are not protected by patents or licenses. Torotel relies on the expertise of its employees in both the design and manufacture of its products. Because of the highly competitive nature of the industry, it is possible that a competitor may also learn to design and produce products with similar performance characteristics. Torotel has been issued U.S. Trademark Registration #1,123,071 for "TOROTEL". This trademark registration expires July 24, 2019.

Environmental Laws

In fiscal year 2018, Torotel incurred costs of approximately $47,000 to ensure compliance with federal, state and local regulations on the proper handling, storage, disposal, and discharge of hazardous materials into the environment, or otherwise relating to the protection of employees, the community, and the environment. Torotel anticipates similar costs to be incurred in the fiscal year ending April 30, 2019.

Employees

Torotel presently employs approximately 143 full-time and 12 part-time employees. We believe an adequate supply of qualified personnel is available in our immediate vicinity. Torotel's employees are not affiliated with any union.

ITEM 1A.    Risk Factors

Not Applicable

ITEM 2.    Properties

Torotel leases approximately 72,000 square feet of space located at 520 N. Rogers Road in Olathe, Kansas. This facility serves as our corporate executive office and our primary manufacturing facility. The lease for this property continues through December 31, 2026. Through December 31, 2018, the monthly base rate is $26,844, and subsequently through December 31, 2019, the monthly base rate is $29,257, escalating annually thereafter, as previously disclosed in our other public filings.

Torotel leases approximately 5,000 square feet for manufacturing electro-mechanical assemblies and other transformers. This facility is located in Hatfield, Pennsylvania. The lease for this facility commenced on August 1, 2014 and continues through July 31, 2019.  The monthly base rent is $3,450.

Present utilization of these facilities is less than 50% of maximum capacity.

Torotel owns a 24,000 square foot building located at 620 N. Lindenwood Drive in Olathe, Kansas. This facility was previously occupied by Torotel through the end of March 2017 and, until such date, functioned as Torotel's corporate executive office and its largest manufacturing facility. This property is subject to a first deed of trust securing indebtedness with Commerce Bank in the amount of $533,000. The outstanding balance of such indebtedness bears interest at a fixed rate of 4.05% per annum and requires monthly principal and interest payments of $4,873. The note has a maturity date of January 27, 2019, may be prepaid without penalty up to $100,000 per year, and is collateralized by substantially all assets of Torotel.

6


 

As of April 30, 2018, the property owned by Torotel had a net carrying value of approximately $694,000, and is listed on the market for immediate sale. The property is currently accounted for as a capital asset and is valued at historical cost less depreciation.

ITEM 3.    Legal Proceedings

None.

ITEM 4.    Mine Safety Disclosures

None.

7


 

PART II

 

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

 

(a)Market Information

 

Trading in Torotel's common stock is conducted on the OTC Market Group’s OTC Pink platform under the symbol "TTLO."

 

Price Range of Common Stock

 

The following table sets forth the high and low sales prices of Torotel's common stock as obtained from the Yahoo Finance website at www.finance.yahoo.com. These prices reflect inter-dealer prices, without retail mark-up, markdown or commission and may not represent actual transactions.

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

2018

2017

 

Fiscal Period

 

High

Low

High

Low

 

May to July

$

0.86

$

0.60

    

$

0.92

    

$

0.70

 

August to October

 

0.70

 

0.43

 

 

0.90

 

 

0.72

 

November to January

 

0.74

 

0.46

 

 

1.23

 

 

0.72

 

February to April

 

0.72

 

0.52

 

 

1.35

 

 

0.69

 

 

(b)Approximate Number of Equity Security Holders

 

 

 

 

 

 

 

    

Number of

 

 

 

Record Holders as of

 

Title of Class 

 

June 29, 2018

 

Common stock, $0.01 par value

 

416

 

 

(c)Dividend History and Restrictions

 

Torotel has never paid a cash dividend on its common stock and has no present intention of paying cash dividends in the foreseeable future. Certain of Torotel's current borrowing agreements restrict the payment of cash dividends without the consent of the lender.

 

(d)Dividend Policy

 

Future dividends, if any, will be determined by our Board of Directors in light of the circumstances then existing, including Torotel's earnings, financial requirements, general business conditions and credit agreement restrictions.

 

8


 

(e)Securities Authorized for Issuance under Equity Compensation Plans

 

Torotel has certain long-term incentive plans, including a Stock Award Plan (see Note 6 of the Notes to Consolidated Financial Statements). The table below includes the number of shares authorized for the Stock Award Plan.

 

Equity Compensation Plan Information

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Number of

 

 

 

Number of

 

 

 

Securities

 

 

 

Securities to be

 

 

 

Remaining

 

 

 

Issued upon

 

Weighted Average

 

Available for

 

 

 

Exercise of

 

Exercise Price of

 

Future Issuance

 

 

 

Outstanding

 

Outstanding

 

under Equity

 

 

 

Options,

 

Options,

 

Compensation

 

 

 

Warrants, and

 

Warrants, and

 

Plans (excluding

 

 

 

Rights

 

Rights

 

securities reflected in Column A)

 

Plan Category

 

A

 

B

 

C

 

Equity Compensation Plans approved by shareholders

    

    

    

 

Equity Compensation Plans not approved by shareholders

 

 

 

4,250

 

Total

 

 

 

4,250

 

 

There were no unregistered sales of securities by Torotel, or any share repurchases by Torotel, during the fourth quarter of fiscal year 2018.

 

ITEM 6.    Selected Financial Data

 

Information not required.

9


 

 

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

 

Overview

 

Introduction

 

Torotel conducts substantially all of its business through its wholly owned subsidiary, Torotel Products.

 

Torotel specializes in the custom design and manufacture of a wide variety of precision magnetic components 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 magnetic components and electro-mechanical assemblies to original equipment manufacturers, which use them in products such as:

 

aircraft navigational equipment;

digital control devices;

medical equipment;

avionics systems;

radar equipment;

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.

 

The industry mix of Torotel’s net sales in fiscal year 2018 was 52% defense, 43% commercial aerospace and 5% industrial compared to 54% defense, 39% commercial aerospace and 7% industrial in the fiscal year ended April 30, 2017 (“fiscal year 2017”). We believe the mix in the fiscal year ended April 30, 2019 (“fiscal year 2019”) will remain weighted primarily towards defense.

 

Business and Industry Considerations

 

Defense Markets

 

During fiscal years 2018 and 2017, the amount of consolidated revenues derived from contracts with prime contractors of the U.S. Department of Defense (as previously defined, the “DoD”) was approximately 52% and 54%, respectively. Our financial results in any period could be impacted substantially by spending cuts in the DoD budget and the funds appropriated for certain military programs.   

 

Despite ongoing uncertainty and potential constraints 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 April 30, 2018, our consolidated order backlog for the defense market was $6.3 million, which included approximately $3.9 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 orders, oil and gas drilling exploration activity, and general economic growth.  The above demand drivers could be impacted by short-term changes in the economy such as spikes or declines in the price of oil, war, terrorism, or changes in

10


 

regulation. Other threats to our anticipated positive 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 April 30, 2018, our consolidated order backlog for the aerospace and industrial markets was $2.8 million.

 

Business Outlook

 

Our non-headcoil backlog as of April 30, 2018 as compared to April 30, 2017 increased to $5.2 million from $3.0 million, a 73% increase.  This was due primarily to an increase in customer order volume.  We anticipate that net sales for fiscal year 2019 will improve from fiscal year 2018.  This is primarily due to the timing of newer program revenue that is projected to positively impact fiscal year 2019.

 

Consolidated Results of Operations

 

The following management comments regarding Torotel's results of operations and outlook should be read in conjunction with the Consolidated Financial Statements included pursuant to Item 8 of this Annual Report.

 

Net Sales

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Years ended April 30,

    

2018

    

2017

 

Magnetic components

 

$

9,251,000

 

$

7,924,000

 

Potted coil assembly

 

 

5,962,000

 

 

5,268,000

 

Electro-mechanical assemblies

 

 

3,060,000

 

 

3,098,000

 

Large transformers

 

 

123,000

 

 

12,000

 

Total

 

$

18,396,000

 

$

16,302,000

 

Consolidated net sales in fiscal year 2018 increased $2,094,000, or 13%, as compared to fiscal year 2017, primarily due to higher demand for potted coil and magnetic components.  The increase was expected as a number of products had an increase in demand from customers.

 

Consolidated net sales in fiscal year 2017 increased 1%, or $108,000, as compared to fiscal year 2016, primarily due to higher demand for potted coil and electro-mechanical assemblies.

 

Gross Profit

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Years ended April 30,

 

    

2018

    

2017

 

Gross profit

 

$

4,781,000

 

$

5,255,000

 

Gross profit % of net sales

 

 

26

%  

 

32

%  

 

Gross profit as a percentage of net sales in fiscal year 2018 decreased 9% as compared to fiscal year 2017.  The gross profit percentage for fiscal year 2018 decreased primarily due to higher manufacturing costs, changing product mix, higher scrap, and an increase in inventory obsolescence.

Gross profit as a percentage of net sales in fiscal year 2017 decreased 1% as compared to fiscal year 2016. The gross profit percentage for fiscal year 2017 decreased primarily due to higher manufacturing costs and scrap.

11


 

Operating Expenses

 

 

 

 

 

 

 

 

 

 

Years ended April 30,

2018

    

2017

Engineering

$

1,082,000

 

$

   906,000

Selling, general and administrative

 

4,967,000

 

 

4,738,000

Total

$

6,049,000

 

$

5,644,000

 

Engineering expense increased 19%, or $176,000, in fiscal year 2018 as compared to fiscal year 2017. This increase primarily resulted from the hiring of additional engineers to provide expanded technical capabilities.

Engineering expense increased 12%, or $95,000, in fiscal year 2017 as compared to fiscal year 2016. This increase also primarily resulted from the hiring of additional engineers to provide expanded technical capabilities.

Selling, general and administrative expenses increased 5%, or $230,000, in fiscal year 2018 as compared to fiscal year 2017. The increase resulted from an increase in headcount and an increase in occupancy costs related to the new facility.  These additional costs were incurred as part of our overall growth strategy, as evidenced by our stronger backlog year-over-year.

Selling, general and administrative expenses increased 30%, or $1,095,000, in fiscal year 2017 as compared to fiscal year 2016. The increase resulted from an increase in salaries and recruiting due to an increase in headcount and higher personnel costs, an increase in professional and consulting fees, an increase in non-capitalizable costs associated with the transition to the facility located at 520 N. Rogers Road in Olathe, Kansas, and stock compensation amortization expense.

Earnings (loss) from Operations

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Years ended April 30,

    

2018

    

2017

 

Torotel Products

 

$

(701,000)

 

$

303,000

 

Torotel

 

 

(567,000)

 

 

(692,000)

 

Total

 

$

(1,268,000)

 

$

(389,000)

 

 

For the reasons discussed in the Net Sales, Gross Profit, and Operating Expenses found above, consolidated earnings from operations decreased by $880,000, in fiscal year 2018 as compared to fiscal year 2017, and increased by $1,246,000, in fiscal year 2017 as compared to fiscal year 2016.

Other Earnings Items

 

 

 

 

 

 

 

 

 

 

Years ended April 30,

2018

    

2017

Loss from operations

$

(1,268,000)

 

$

(389,000)

Interest expense

 

74,000

 

 

24,000

Gain on asset disposal

 

(8,000)

 

 

 —

Loss before income taxes

 

(1,334,000)

 

 

(413,000)

Provision (credit) for income taxes

 

681,000

 

 

(152,000)

Net Loss

$

(2,015,000)

 

$

(261,000)

 

Interest expense increased by 160%, or $50,000, in fiscal year 2018 as compared to fiscal year 2017, primarily due to higher levels of capital leases and outstanding indebtedness for most of the year.  Income tax provision increased by $833,000 in fiscal year 2018 as compared to fiscal year 2017, which was related primarily to tax reform, and an increase in deferred tax asset valuation allowance.

12


 

Interest expense decreased by 4%, or $1,000, in fiscal year 2017 as compared to fiscal year 2016, primarily due to lower levels of capital leases and outstanding indebtedness. Income tax provision decreased by $446,000 in fiscal year 2017 as compared to fiscal year 2016. 

We evaluate the appropriateness of our deferred income tax asset valuations allowance on a quarterly basis and continue to consider positive and negative trends in our industry that affect our determination.  During the fourth quarter of fiscal year 2018, we are no longer in a positive cumulative earnings position which is significant negative evidence indicating the need for a valuation allowance. As a result, we concluded it unlikely the full benefit of our deferred tax assets will more-likely-than-not be fully realized and our valuation allowance has been increased accordingly.   See Note 4 in the consolidated financial statements for further details.

 

Financial Condition and Liquidity

 

The following table highlights the funds available to us as of April 30, 2018 and 2017:

 

 

 

 

 

 

 

 

 

    

2018

    

 

2017

 

Cash

$

575,000

 

$

298,000

 

Amount available under our building line of credit

 

35,000

 

 

35,000

 

Amount available under our equipment loan

 

423,000

 

 

332,000

 

Amount available under our working capital line of credit

 

100,000

 

 

500,000

 

Total funds available

$

1,133,000

 

$

1,165,000

 

Operating Activities

 

 

 

 

 

 

 

 

 

 

 

    

2018

    

2017

 

Net cash used in operating activities

 

$

(186,000)

 

$

(1,092,000)

 

 

The decrease of $906,000 of net cash used in operating activities between fiscal year 2018 and fiscal year 2017 is primarily due to a decrease in inventory and an increase in accrued liabilities in fiscal year 2018.  This decrease in inventory was due to the shipment of accumulated assembly inventory that had been scheduled for shipment in fiscal year 2018, and a decrease in safety stock on long-term agreements. The increase in accrued liabilities was due to an increase in the warranty provision.

Investing Activities

 

 

 

 

 

 

 

 

 

 

 

    

2018

    

2017

 

Net cash used in investing activities

 

$

(100,000)

 

$

(946,000)

 

 

The decrease of $846,000 of net cash used in investing activities was due to lower capital expenditures in fiscal year 2018 as compared to fiscal year 2017.  Capital expenditures during fiscal year 2017 were primarily related to leasehold improvements incurred related to the relocation of our primary manufacturing facility and corporate office, as referenced in Item 2 above and Note 5 of the financial statement footnotes.  We expect capital expenditure spending will maintain current levels during fiscal year 2019 as compared to fiscal year 2018.

Financing Activities

 

 

 

 

 

 

 

 

 

 

 

    

2018

    

2017

 

Net cash provided by financing activities

 

$

563,000

 

$

490,000

 

The change of $73,000 in net cash provided by financing activities between fiscal year 2018 and fiscal year 2017 is due to an increase in debt obligations utilized to finance the remaining leasehold improvements during the first quarter of fiscal year 2018. 

13


 

 

Liquidity and Capital Resources

 

We believe that the projected cash flow from operations, combined with existing cash balances and available borrowings under our existing financing arrangements to supplement our working capital needs, will be sufficient to meet our anticipated funding requirements for the foreseeable future, based on historical levels. As of April 30, 2018, we had $751,000 drawn on our working capital line of credit. During fiscal year 2017, we entered into a $500,000 building revolving line of credit with $465,000 drawn down as of April 30, 2018. As of April 30, 2018 our total borrowing capacity is approximately $558,000 under our existing financing arrangements, plus $575,000 of cash on hand. Torotel Products is required to comply with specified financial covenants of the financing agreement with Commerce Bank.  As of April 30, 2018, Torotel Products was not in compliance with the covenants in such financing agreement that require a ratio of EBITDA (as defined in the financing agreement) to fixed charge coverage (as defined in the financing agreement) in excess of 1.100 to 1.000 and that Torotel maintain a minimum Tangible Net Worth (as defined in the financing agreement) of not less than $4,500,000.  A waiver for non-compliance with these covenants was received from Commerce Bank for the period ending April 30, 2018.

 

Our building revolving line of credit and the promissory note upon which we have borrowed funds under our working capital line of credit described in Note 3 of the Consolidated Financial Statements are scheduled to mature on October 20, 2018.  If our property located at 620 N. Lindenwood Drive in Olathe, Kansas is not sold prior to the maturity date of our building revolving line of credit, we expect to refinance this line of credit prior to the maturity date. Additionally, we expect to refinance our second working capital line of credit, if deemed necessary, prior to the maturity date. Torotel serves as an additional guarantor to all notes and Commerce Bank financing arrangements under which Torotel Products is the borrower.

 

We believe that inflation will have only a minimal effect on future operations since such effects are expected to be offset by sales price increases, which are not expected to have a significant effect upon demand.

 

Critical Accounting Policies

 

The preparation of the consolidated financial statements in conformity with accounting principles generally accepted in the United States of America requires us to make estimates and assumptions that affect certain reported amounts and disclosures. Such judgments affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosure of contingent assets and liabilities. We continuously evaluate our estimates and assumptions including those related to computing the carrying value of equipment, allowance for doubtful accounts receivable, the valuation allowance on deferred tax assets and the reserve for warranty costs. Accordingly, actual results could differ from those estimates, and such differences may be material. Any changes in estimates are recorded in the period in which they become known.

 

The following is a summary of the most critical accounting policies used in the preparation of our consolidated financial statements.

 

Revenue Recognition

 

Revenue is recognized when a fixed price contract or purchase order exists; delivery has occurred; and collection is reasonably assured. Selling terms are generally FOB Shipping Point so we consider products delivered once they have been shipped and title and risk of loss have been transferred.

 

Allowance for Doubtful Accounts

 

Gross trade accounts receivable are offset with an allowance for doubtful accounts. The allowance for doubtful accounts is our best estimate of the amount of probable credit losses in our existing accounts receivable. We review the allowance for doubtful accounts on a regular basis, and all past due balances are reviewed individually for collectability. Account balances are charged against the allowance when placed for collection. Recoveries of receivables previously written off are recorded when received. The majority of the customer accounts are considered past due after the invoice

14


 

becomes older than the customer's normal credit terms. Interest is not charged on past due accounts. The allowance for doubtful accounts was $12,000 at the end of each of fiscal years 2018 and 2017.

 

Inventories

 

Inventories are stated at the lower of cost or net realizable value. Cost is determined using a FIFO approximated weighted average costing method of valuation. Our industry is characterized by short-term customer commitments and changes in demand, as well as other market considerations. Provisions for obsolete and excess inventory are based on reviews of inventory usage, quantities on hand and latest product demand information from customers. Inventories are reviewed in detail utilizing a 12-month time horizon. Individual part numbers that have not had any usage or purchases in a 12-month time period and do not have any known usage requirements are categorized as obsolete; individual part numbers having more than a 12-month supply based on the current year's usage are categorized as excess. Once specific inventory has been identified as excess or obsolete, the cost of the identified inventory is fully reserved and the cost of the inventory is not recovered until it is sold. The reserve balance is analyzed for adequacy as part of the inventory review each quarter.

 

Income Taxes

 

Our annual tax rate is based on our income, statutory tax rates and tax planning opportunities available to us in the various jurisdictions in which we operate. Significant judgment is required in determining our annual tax rate and in evaluating our tax positions. An estimated effective tax rate for a year is applied to our quarterly operating results. In the event there is a significant or unusual item recognized in our quarterly operating results, the tax attributable to that item is separately calculated and recorded at the same time as that item. Tax law requires items to be included in our tax returns at different times than the items are reflected in our financial statements. As a result, our annual tax rate reflected in our financial statements is different than that reported in our tax returns (our cash tax rate). Some of these differences are permanent, such as expenses that are not deductible in our tax return, and some differences reverse over time, such as depreciation expense. These temporary differences create deferred tax assets and liabilities. Deferred tax assets generally represent items that can be used as a tax deduction or credit in our tax returns in future years for which we have already recorded the tax benefit in our income statement. We establish valuation allowances for our deferred tax assets if, based on the available evidence, it is more likely than not that some portion or all of the deferred tax assets will not be realized. Deferred tax liabilities generally represent tax expense recognized in our financial statements for which payment has been deferred, or expense for which we have already taken a deduction in our tax return but have not yet recognized as expense in our financial statements. The accounting for uncertainty in income taxes requires a more-likely-than-not threshold for financial statement recognition and measurement of tax positions taken or expected to be taken in a tax return. If necessary, we record a liability for the difference between the benefit recognized and measured for financial statement purposes and the tax position taken or expected to be taken on our tax return. To the extent that our assessment of such tax positions changes, the change in estimate is recorded in the period in which the determination is made. If applicable in a given year, tax-related interest and penalties are classified as a component of income tax expense.

 

ITEM 7A.    Quantitative and Qualitative Disclosures About Market Risk

 

Information not required.

15


 

16


 

Report Of Independent

Registered Public Accounting Firm

 

 

Shareholders and Board of Directors

Torotel, Inc.

 

 

Opinion On The Financial Statements

 

We have audited the accompanying consolidated balance sheets of Torotel, Inc. and subsidiary (collectively, the Company) as of and , the related consolidated statements of operations, changes in stockholders’ equity, and cash flows, for the years then ended and the related notes (collectively referred to as the financial statements). In our opinion, the financial statements present fairly, in all material respects, the financial position of the Company as of and , and the results of its operations and its cash flows for the years then ended, in conformity with accounting principles generally accepted in the United States of America.

 

Basis For Opinion

 

These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on the Company's financial statements based on our audits. We are a public accounting firm registered with the Public Company Accounting Oversight Board (United States) (PCAOB) and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.

 

We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement, whether due to error or fraud. Our audits included performing procedures to assess the risks of material misstatement of the financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the financial statements. We believe that our audits provide a reasonable basis for our opinion.

 

/s/ RubinBrown LLP

 

We have served as the Company's auditor since 2012.

 

Kansas City, Missouri

June 29, 2018

17


 

CONSOLIDATED BALANCE SHEETS

 

 

 

 

 

 

 

 

 

 

    

As of April 30,

 

 

 

2018

 

2017

 

ASSETS

 

 

 

 

 

 

 

Current assets:

 

 

 

 

 

 

 

Cash

 

$

575,000

 

$

298,000

 

Trade receivables, net

 

 

2,193,000

 

 

2,007,000

 

Inventories

 

 

2,362,000

 

 

2,739,000

 

Prepaid expenses and other current assets

 

 

238,000

 

 

217,000

 

Property held for sale

 

 

694,000

 

 

688,000

 

 

 

 

6,062,000

 

 

5,949,000

 

 

 

 

 

 

 

 

 

Leasehold improvements

 

 

616,000

 

 

532,000

 

Equipment

 

 

3,951,000

 

 

3,718,000

 

 

 

 

4,567,000

 

 

4,250,000

 

Less accumulated depreciation

 

 

3,235,000

 

 

2,937,000

 

Property, plant and equipment, net

 

 

1,332,000

 

 

1,313,000

 

 

 

 

 

 

 

 

 

Deferred income taxes

 

 

68,000

 

 

747,000

 

Other assets

 

 

209,000

 

 

256,000

 

 

 

 

 

 

 

 

 

Total Assets

 

$

7,671,000

 

$

8,265,000

 

 

 

 

 

 

 

 

 

LIABILITIES AND STOCKHOLDERS' EQUITY

 

 

 

 

 

 

 

Current liabilities:

 

 

 

 

 

 

 

Current maturities of long-term debt

 

$

1,706,000

 

$

603,000

 

Trade accounts payable

 

 

1,045,000

 

 

1,204,000

 

Accrued liabilities

 

 

817,000

 

 

319,000

 

Customer deposits

 

 

219,000

 

 

33,000

 

 

 

 

3,787,000

 

 

2,159,000

 

Long-term debt, less current maturities

 

 

130,000

 

 

445,000

 

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

 

 

12,437,000

 

 

12,329,000

 

Accumulated deficit

 

 

(8,743,000)

 

 

(6,728,000)

 

 

 

 

3,754,000

 

 

5,661,000

 

 

 

 

 

 

 

 

 

Total Liabilities and Stockholders' Equity

 

$

7,671,000

 

$

8,265,000

 

The accompanying notes are an integral part of these statements.

18


 

CONSOLIDATED STATEMENTS OF OPERATIONS

Years ended April 30,

 

 

 

 

 

 

 

 

 

 

 

 

 

 

    

2018

    

2017

 

Net sales

 

$

18,396,000

 

$

16,302,000

 

Cost of goods sold

 

 

13,615,000

 

 

11,047,000

 

Gross profit

 

 

4,781,000

 

 

5,255,000

 

Operating expenses:

 

 

 

 

 

 

 

Engineering

 

 

1,082,000

 

 

906,000

 

Selling, general and administrative

 

 

4,967,000

 

 

4,738,000

 

 

 

 

6,049,000

 

 

5,644,000

 

Loss from operations

 

 

(1,268,000)

 

 

(389,000)

 

Other expense:

 

 

 

 

 

 

 

Interest expense, net

 

 

74,000

 

 

24,000

 

Gain on asset disposal

 

 

(8,000)

 

 

 —

 

Loss before provision (credit) for income taxes

 

 

(1,334,000)

 

 

(413,000)

 

Provision (benefit) for income taxes

 

 

681,000

 

 

(152,000)

 

Net loss

 

$

(2,015,000)

 

$

(261,000)

 

Basic loss per share

 

$

(0.38)

 

$

(0.05)

 

 

The accompanying notes are an integral part of these statements.

19


 

CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

    

 

    

 

 

    

 

 

    

 

 

    

Treasury

    

Total

 

 

 

 

 

Common

Excess of

Accumulated

Stock, 

 

Stockholders' 

 

 

 

Shares

Stock

Par Value

Deficit

at cost

 

Equity

 

Balance, April 30, 2016

 

5,983,545

 

$

60,000

 

$

12,277,000

 

$

(6,467,000)

 

$

(9,000)

 

$

5,861,000

 

Stock compensation earned

 

 —

 

 

 —

 

 

61,000

 

 

 —

 

 

 —

 

 

61,000

 

Shares reverted

 

(350,000)

 

 

 —

 

 

 —

 

 

 —

 

 

 —

 

 

 —

 

Shares released and issued

 

362,205

 

 

 —

 

 

(9,000)

 

 

 —

 

 

9,000

 

 

 —

 

Net loss

 

 —

 

 

 —

 

 

 —

 

 

(261,000)

 

 

 —

 

 

(261,000)

 

Balance, April 30, 2017

 

5,995,750

 

 

60,000

 

 

12,329,000

 

 

(6,728,000)

 

 

 —

 

 

5,661,000

 

Stock compensation earned

 

 —

 

 

 —

 

 

108,000

 

 

 —

 

 

 —

 

 

108,000

 

Net loss

 

 —

 

 

 —

 

 

 —

 

 

(2,015,000)

 

 

 —

 

 

(2,015,000)

 

Balance, April 30, 2018

 

5,995,750

 

$

60,000

 

$

12,437,000

 

$

(8,743,000)

 

$

 —

 

$

3,754,000

 

 

The accompanying notes are an integral part of these statements.

20


 

CONSOLIDATED STATEMENTS OF CASHFLOWS

Years ended April 30,

 

 

 

 

 

 

 

 

 

 

 

 

 

 

    

2018

    

2017

 

Cash flows from operating activities:

 

 

 

 

 

 

 

Net loss

 

$

(2,015,000)

 

$

(261,000)

 

Adjustments to reconcile net loss to net cash used in operating activities:

 

 

 

 

 

 

 

Stock compensation cost amortized

 

 

108,000

 

 

61,000

 

Depreciation

 

 

314,000

 

 

265,000

 

Gain on disposal of equipment

 

 

(8,000)

 

 

 —

 

Deferred income taxes

 

 

679,000

 

 

(155,000)

 

Increase (decrease) in cash flows from operations resulting from changes in:

 

 

 

 

 

 

 

Trade receivables

 

 

(186,000)

 

 

(105,000)

 

Inventories

 

 

377,000

 

 

(1,036,000)

 

Prepaid expenses and other assets

 

 

20,000

 

 

(156,000)

 

Trade accounts payable

 

 

(159,000)

 

 

440,000

 

Accrued liabilities

 

 

498,000

 

 

(149,000)

 

Customer deposits

 

 

186,000

 

 

4,000

 

Net cash used in operating activities

 

 

(186,000)

 

 

(1,092,000)

 

Cash flows from investing activities:

 

 

 

 

 

 

 

Capital expenditures

 

 

(122,000)

 

 

(946,000)

 

Proceeds from disposal of equipment

 

 

22,000

 

 

 —

 

Net cash used in investing activities

 

 

(100,000)

 

 

(946,000)

 

Cash flows from financing activities:

 

 

 

 

 

 

 

Principal payments on long-term debt

 

 

(132,000)

 

 

(99,000)

 

Payments on capital lease obligations

 

 

(55,000)

 

 

 —

 

Proceeds from long-term debt

 

 

 —

 

 

124,000

 

Proceeds from line of credit

 

 

750,000

 

 

465,000

 

Net cash provided by financing activities

 

 

563,000

 

 

490,000

 

Net increase (decrease) in cash

 

 

277,000

 

 

(1,548,000)

 

Cash, beginning of period

 

 

298,000

 

 

1,846,000

 

Cash, end of period

 

$

575,000

 

$

298,000

 

SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION

 

 

 

 

 

 

 

Cash paid during the year for:

 

 

 

 

 

 

 

Interest

 

$

74,000

 

$

24,000

 

Income taxes

 

$

 —

 

$

101,000

 

Non-cash investing and financing activities:

 

 

 

 

 

 

 

Property, plant and equipment reclassified as held for sale

 

$

6,000

 

$

688,000

 

Equipment financed with proceeds from capital lease

 

$

225,000

 

$

 —

 

 

The accompanying notes are an integral part of these statements.

 

 

21


 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

NOTE 1—SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

 

Torotel, Inc. ("Torotel") conducts business primarily through its wholly owned subsidiary, Torotel Products, Inc. ("Torotel Products").  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 aerospace, industrial and military electronics.

 

Principles of Consolidation

 

The consolidated financial statements include the accounts of Torotel and its wholly owned subsidiary, Torotel Products. All significant inter-company accounts and transactions have been eliminated in consolidation.

 

Use of Estimates

 

               The preparation of the consolidated financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect certain reported amounts and disclosures. Significant estimates used in preparing these consolidated financial statements include those assumed in computing the valuation allowance of inventory, the allowance for doubtful accounts receivable, the valuation allowance on deferred income tax assets, and the reserve for warranty costs. Accordingly, actual results could differ from those estimates. Any changes in estimates are recorded in the period in which they become known.

 

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, and at April 30, 2018 and 2017, cash balances exceeded federally insured limits. We have not experienced any losses in the cash accounts and we do not believe we are exposed to any significant credit risk with respect to our cash.

 

Fair Value of Financial Instruments

 

We determine fair value by utilizing a fair value hierarchy that prioritizes observable and unobservable inputs used to measure fair value into three levels as follows:

 

Level 1.    Inputs to the valuation methodology are quoted prices (unadjusted) for identical assets or liabilities in active markets.

Level 2.    Inputs to the valuation methodology include quoted prices for similar assets and liabilities in active markets, and inputs that are observable for the asset or liability, either directly or indirectly, for substantially the full term of the financial instrument.

Level 3.    Inputs to the valuation methodology are unobservable and significant to the fair value measurement.

 

The fair value hierarchy gives the highest priority to Level 1 inputs and the lowest priority to Level 3 inputs. In determining fair value, we utilize valuation techniques that maximize the use of observable inputs and minimize the use of unobservable inputs to the extent possible as well as consider counterparty credit risk in the assessment of fair value.

 

The carrying amounts of certain financial instruments, including cash, trade receivables and trade accounts payable approximate fair value due to their short maturities. As of April 30, 2018 and 2017, the amount of our long-term debt approximates fair value based on the present value of estimated future cash flows using a discount rate commensurate with a borrowing rate available to us. The inputs used to estimate the fair value of long-term debt are considered Level 2 inputs.

22


 

 

Treasury Stock

 

               We utilize the weighted average cost method in accounting for treasury stock transactions.

 

Revenue Recognition

 

Revenue is recognized when a fixed price contract or purchase order exists; delivery has occurred; and collection is reasonably assured. Selling terms are generally FOB Shipping Point so we consider our products delivered once they have been shipped and title and risk of loss have been transferred.

 

Allowance for Doubtful Accounts

 

Gross trade accounts receivable are offset with an allowance for doubtful accounts. The allowance for doubtful accounts is our best estimate of the amount of probable credit losses in our existing accounts receivable. We review the allowance for doubtful accounts on a regular basis, and all past due balances are reviewed individually for collectability. Account balances are charged against the allowance when placed for collection. Recoveries of receivables previously written off are recorded when received. The majority of the customer accounts are considered past due after the invoice becomes older than the customer's credit terms. Interest is not charged on past due accounts. The allowance for doubtful accounts as of April 30, 2018 and 2017 was $12,000 and $12,000, respectively.

 

Inventories

 

Inventories are stated at the lower of cost or net realizable value. Cost is determined using a FIFO approximated weighted average cost method of valuation. Our industry is characterized by short-term customer commitments and changes in demand, as well as other market considerations. Provisions for obsolete and excess inventory are based on reviews of inventory usage, quantities on hand and latest product demand information from customers. Inventories are reviewed in detail utilizing a 12-month time horizon. Individual part numbers that have not had any usage or purchases in a 12-month time period and do not have any known usage requirements are categorized as obsolete; individual part numbers having more than a 12-month supply based on the current year's usage are categorized as excess. Once specific inventory has been identified as excess or obsolete, the cost of the identified inventory is fully reserved and the cost of the inventory is not recovered until it is sold. The reserve balance is analyzed for adequacy as part of the inventory review each quarter.  The reserve for inventory as of April 30, 2018 and 2017 was $364,000 and $261,000, respectively.

 

Property, Plant and Equipment

 

               Property, plant and equipment are carried at cost. Depreciation and amortization are provided in amounts sufficient to relate the costs of depreciable assets to operations primarily using the straight-line method over estimated useful lives of three to five years for equipment and three and a half to twenty years for buildings and improvements.

 

Cash

 

For purposes of the consolidated statements of cash flows, we consider all short-term investments and demand deposits purchased with original maturity dates of three months or less to be cash.

 

Income Taxes

 

Our annual tax rate is based on our income, statutory tax rates and tax planning opportunities available to us in the various jurisdictions in which we operate. Significant judgment is required in determining our annual tax rate and in evaluating our tax positions. An estimated effective tax rate for a year is applied to our quarterly operating results. In the event there is a significant or unusual item recognized in our quarterly operating results, the tax attributable to that item is separately calculated and recorded at the same time as that item. Tax law requires items to be included in our tax returns at different times than the items are reflected in our financial statements. As a result, our annual tax rate reflected in our financial statements is different than that reported in our tax returns (our cash tax rate). Some of these differences are

23


 

permanent, such as expenses that are not deductible in our tax return, and some differences reverse over time, such as depreciation expense. These temporary differences create deferred tax assets and liabilities. Deferred tax assets generally represent items that can be used as a tax deduction or credit in our tax returns in future years for which we have already recorded the tax benefit in our statement of operations. We establish valuation allowances for our deferred tax assets if, based on the available evidence, it is more likely than not that some portion or all of the deferred tax assets will not be realized. Deferred tax liabilities generally represent tax expense recognized in our financial statements for which payment has been deferred, or expense for which we have already taken a deduction in our tax return but have not yet recognized as expense in our financial statements. The accounting for uncertainty in income taxes requires a more-likely-than-not threshold for financial statement recognition and measurement of tax positions taken or expected to be taken in a tax return. If necessary, we record a liability for the difference between the benefit recognized and measured for financial statement purposes and the tax position taken or expected to be taken on our tax return. To the extent that our assessment of such tax positions changes, the change in estimate is recorded in the period in which the determination is made. If applicable in a given year, tax-related interest and penalties are classified as a component of income tax expense.

 

Advertising Costs

 

Advertising costs are expensed as incurred. For the years ended April 30, 2018 and 2017 advertising costs were $22,000 and $6,000, respectively.

 

Warranty Costs

 

We maintain a reserve for estimated warranty costs associated with products returned from customers. A limited warranty is provided for a period of one year which requires us to repair or replace defective products at no cost to the customer. The warranty reserve is based on historical experience and reflects management's best estimate of probable liability under the product warranties.

 

Share-Based Compensation

 

We have a share-based compensation plan that includes restricted stock, which is described more fully in Note 7 of the Notes to the Consolidated Financial Statements. We account for the share-based compensation plan in accordance with authoritative guidance under which the estimated fair value of share-based awards granted under our share-based compensation plan is recognized as compensation expense over the vesting period of the award.

 

New Accounting Guidance

 

In May 2014, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) No. 2014-09, Revenue from Contracts with Customers, Topic 606 (“ASC 606”). The standard is effective for reporting periods beginning after December 15, 2017. Torotel has evaluated the transition method to be used and the impact of adoption of this standard on its consolidated financial statements. As part of the evaluation and transition process, no significant implementation matters have been identified as needing to be addressed. 

 

In applying ASC 606, revenue is recognized when control of promised goods or services transfers to a customer and is recognized in an amount that reflects the consideration which the entity expects to receive in exchange for those goods or services. The major provisions of the new standard include: the determination of enforceable rights and obligations between parties; the identification of performance obligations including those related to material right obligations; the allocation of consideration based upon relative standalone selling price; accounting for variable consideration; the determination of whether performance obligations are satisfied over time or at a point in time; and enhanced disclosure requirements.

 

ASC 606 will be effective for Torotel beginning May 1, 2018 and permits two methods of adoption: retrospectively to each prior reporting period presented (“full retrospective method”) or retrospectively with the cumulative effect of the initial application recognized at the date of initial application (“modified retrospective method”). Torotel will adopt the standard using the full retrospective method and will record an adjustment to Retained Earnings for the effect of

24


 

the initial application on April 30, 2017 for the cumulative portion earned through the end of fiscal year 2017, and will record a second adjustment on April 30, 2018 for the portion earned during fiscal year 2018 (the “Transition Adjustments”).

 

Torotel has reviewed all of its contracts with customers and has implemented the required process, data, and system changes to comply with the requirements of ASC 606.

 

Prior to adoption, revenue has historically been recognized when a fixed price contract or purchase order exists; delivery has occurred; and collection was reasonably assured.  Upon adoption, ASC 606 will be applied by analyzing each contract, or a combination of contracts, to determine if revenue is recognized over time or at a point in time. Torotel has determined that some of its contracts will have performance obligations that are satisfied over time and some at a point in time based on when performance obligations have been satisfied by the transfer of control of the goods and services to the customer.

 

For performance obligations that are satisfied over time, Torotel will use an input method as the basis for recognizing revenue. Input methods recognize revenue on the basis of an entity’s efforts or inputs toward satisfying a performance obligation (for example, resources consumed, labor hours expended, costs incurred, time lapsed, or machine hours used) relative to the total expected inputs to satisfy the performance obligation. Torotel will generally use costs incurred as the measure of performance; and therefore will generally not defer any production costs. Performance obligations that are not recognized over time will be recognized at the point in time when performance obligations have been satisfied by the transfer of control to the customer.

 

ASC 606 requires Torotel to allocate contract consideration to performance obligations on the basis of their relative standalone selling price. Torotel has determined that certain contracts require a deferral of revenues due to the requirement to allocate revenue based upon relative standalone selling price. Accordingly, contract liabilities will be established at the Transition Date to defer revenue that was previously recognized under ASC 605 (“legacy GAAP”).

 

We have completed our preliminary assessment of adopting ASC 606 on our 2018 and 2017 operating results, and have presented selected recast, unaudited financial data in the following table.  The impact of adopting ASC 606 on our 2018 and 2017 operating results may not be indicative of the adoption impacts in future periods or of our operating performance.

 

 

 

 

 

 

 

 

 

    

Unaudited

 

 

 

2018

    

2017

 

Net sales

 

$

18,469,000

 

$

17,395,000

 

Earnings (loss) from operations

 

 

(1,280,000)

 

 

147,000

 

 

ASC 340-40 was added by ASC 606, and becomes effective for reporting periods beginning after December 15, 2017.  ACC 340-40 provides guidance on contract costs that are not within the scope of other authoritative literature, and is applied to costs to obtain or fulfill a contract if existing guidance is not applicable. Torotel’s accounting for preproduction, tooling, and certain other costs is expected to continue under existing guidance, since the costs generally do not fall within the scope of ASC 340-40.

 

Torotel anticipates that in fiscal year 2019, revenue and gross margin for certain contracts that would not have been recognized under legacy GAAP will be accelerated because of the allocation of revenue to performance obligations based upon relative standalone selling price.

 

The enhanced disclosure requirements of ASC 606 include discussions on the nature, amount, timing, and uncertainty of revenue and cash flows arising from contracts with customers. Torotel expects the disclosures to include qualitative and quantitative information about its contracts with customers; information about contract assets and liabilities; information about the performance obligation for customer contracts; and, the significant judgments made in applying the guidance in ASC 606. This will result in changes to Torotel’s existing disclosures, as well as new disclosures, which will impact the information reported in Torotel’s financial statements.

 

25


 

In February 2016, the FASB issued ASU 2016-02, Leases (Topic 842), in order to increase transparency and comparability among organizations by recognizing lease assets and lease liabilities on the balance sheet for those leases classified as operating leases under previous GAAP. ASU 2016-02 requires that a lessee should recognize a liability to make lease payments (the lease liability) and a right-of-use asset representing its right to use the underlying asset for the lease term on the balance sheet. ASU 2016-02 requires expanded disclosures about the nature and terms of lease agreements and is effective for annual reporting periods beginning after December 15, 2018, including interim periods within that reporting period. Early adoption is permitted. Torotel is currently evaluating the potential impact of this standard on its consolidated financial statements. Torotel anticipates the impact will be material to the consolidated financial statements for reporting periods beginning after December 15, 2018, due to the building lease amendment executed on October 31, 2016. The status of the implementation effort is in the preliminary stage.  No significant implementation matters have been identified as needing to be addressed.

 

 

 

NOTE 2—INVENTORIES

 

The following table summarizes the components of inventories, as of April 30 of each year:

 

 

 

 

 

 

 

 

 

 

    

 

2018

    

 

2017

 

Raw materials

 

$

1,278,000

 

$

1,305,000

 

Work in process

 

 

635,000

 

 

826,000

 

Finished goods

 

 

449,000

 

 

608,000

 

 

 

$

2,362,000

 

$

2,739,000

 

 

 

 

NOTE 3—FINANCING AGREEMENTS

 

On September 27, 2010, Torotel Products entered into a financing agreement (the “agreement”) with Commerce Bank, N.A (the “Bank”).  The agreement provides for a revolving line of credit, a guidance line of credit, and a real estate term loan. Torotel serves as an additional guarantor to all notes described below. A summary of the notes issued under the agreement are provided below:

 

 

 

 

 

 

 

 

 

 

 

2018

 

 

2017

4.05% mortgage note payable in monthly installments of $4,873, including interest, with final payment of $349,000 due January 27, 2019

 

$

373,000

 

$

415,000

4.00% working capital line of credit with a maturity date of October 20, 2018

 

 

751,000

 

 

465,000

4.00% building line of credit with a maturity date of October  20, 2018

 

 

465,000

 

 

 -

Capital lease obligations (see Note 5)

 

 

170,000

 

 

 -

Borrowings under an equipment financing line of credit:

 

 

 

 

 

 

4.75% note payable in monthly installments of $2,269, including interest, with final payment made on May 27, 2018

 

 

2,000

 

 

28,000

3.75% note payable in monthly installments of $2,112, including interest, with final payment made on April 10, 2018

 

 

 -

 

 

25,000

4.05% note payable in monthly installments of $3,680, including interest, with final payment due January 10, 2020

 

 

75,000

 

 

115,000

Total long-term debt

 

 

1,836,000

 

 

1,048,000

Less current installments

 

 

1,706,000

 

 

603,000

Long-term debt, excluding current installments

 

$

130,000

 

$

445,000

 

Under the financing agreement with the Bank, prepayment of the mortgage note up to $100,000 per year is allowed without penalty so long as these funds are generated through internal cash flow and not borrowed from a separate financial institution. The mortgage note is cross collateralized and cross defaulted with all other credit facilities of Torotel Products and is secured by a first real estate mortgage on the property located at 620 North Lindenwood Drive in Olathe, Kansas.

 

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Two separate promissory notes have been delivered by Torotel Products under the working capital line of credit, and amounts under this working capital revolving line of credit are available for working capital purposes. As of April 30, 2018, Torotel Products has only drawn upon the promissory note that matures on October 20, 2018 and no amounts were outstanding under the promissory note that matured on April 30, 2018. The working capital revolving line of credit is renewable annually. The associated interest rate of both promissory notes is equal to the greater of the floating Commerce Bank Prime Rate (4.75% as of April 30, 2018) or a floor of 4% (as listed above).  Monthly repayments of interest only are required under both promissory notes with the principal due at maturity.  The maximum borrowing of this line of credit is $1,250,000.  This revolving line of credit is cross collateralized and cross defaulted with all other credit facilities and arrangements of Torotel Products with the Bank and is secured by a first lien on all business assets of Torotel Products. This working capital line of credit is scheduled to mature on October 20, 2018, and Torotel Products expects to negotiate an extension of that maturity date on similar terms.

 

On March 31, 2017, Torotel Products entered into a $500,000 building revolving line of credit, which is available for working capital purposes and is renewable annually. The associated interest rate is equal to the greater of the floating Commerce Bank Prime Rate (4.75% as of April 30, 2018) or a floor of 4% (as listed above). Monthly repayments of interest only are required with the principal due at maturity. The maximum borrowing of this line of credit is $500,000. This facility is cross collateralized and cross defaulted with all other facilities and is secured by a first lien on the building located at 620 North Lindenwood Drive in Olathe, Kansas. This revolving line of credit is scheduled to mature on October 20, 2018, and Torotel Products expects to negotiate an extension of that maturity date on similar terms.

 

The equipment note is a guidance line of credit to be used for equipment purchases. Monthly repayments consisting of both interest and principal are required. This note is cross collateralized and cross defaulted with all other facilities of Torotel Products 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 Products.  The maximum borrowing of this line of credit is $500,000.

 

Torotel Products is required to comply with specified financial covenants of the financing agreement with Commerce Bank. As of April 30, 2018, Torotel Products was not in compliance with the covenants in such financing agreement that require a ratio of EBITDA (as defined in the financing agreement) to fixed charge coverage (as defined in the financing agreement) in excess of 1.100 to 1.000, and that Torotel maintain a minimum Tangible Net Worth (as defined in the financing agreement) of $4,500,000.  A waiver for non-compliance with these covenants was received from Commerce Bank for the period ending April 30, 2018.

 

The amount of long-term debt maturities by year is as follows:

 

 

 

 

 

 

Year Ending April 30,

    

Amount

 

2019

 

$

1,706,000

 

2020

 

 

100,000

 

2021

 

 

30,000

 

 

 

$

1,836,000

 

 

Irrevocable Standby Letter of Credit

 

Under the terms of a lease amendment for its building located at 520 N. Rogers Road  in Olathe, Kansas (see Note 5), Torotel initially provided the landlord an irrevocable standby letter of credit in the amount of $350,000 as additional security, with the letter of credit requirement being reduced to $300,000 in accordance with the third amendment to the lease entered into on August 30, 2017 (the “Third Amendment”), 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, 2020

$

75,000

$

225,000

January 1, 2021

 

75,000

 

150,000

January 1, 2022

 

75,000

 

75,000

January 1, 2023

 

75,000

 

 -

 

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NOTE 4—INCOME TAXES

The components of the provision (benefit) for income taxes are as follows:

 

 

 

 

 

 

 

 

 

 

    

2018

    

2017

 

Current tax expense

 

 

 

 

 

 

 

Federal

 

$

 —

 

$

2,000

 

State

 

 

2,000

 

 

1,000

 

 

 

 

2,000

 

 

3,000

 

Deferred tax expense (benefit)

 

 

 

 

 

 

 

Federal

 

 

612,000

 

 

(137,000)

 

State

 

 

67,000

 

 

(18,000)

 

 

 

 

679,000

 

 

(155,000)

 

Total income tax provision (benefit)

 

$

681,000

 

$

(152,000)

 

 

The provision for income taxes reflected in the consolidated statements of operations differs from the amounts computed at the federal statutory tax rates.

 

The principal differences between our statutory income tax expense and the effective provision for income taxes are summarized as follows:

 

 

 

 

 

 

 

 

 

 

 

    

2018

    

2017

 

Computed tax expense at statutory rates

 

$

(405,000)

 

$

(144,000)

 

Permanent differences

 

 

11,000

 

 

6,000

 

State tax and credits

 

 

(49,000)

 

 

(18,000)

 

Provision to return adjustment

 

 

6,000

 

 

4,000

 

Impact of federal rate change

 

 

467,000

 

 

 —

 

Increase in valuation allowance

 

 

651,000

 

 

 —

 

 

 

$

681,000

 

$

(152,000)

 

 

We have available as benefits to reduce future income taxes, subject to applicable limitations, estimated federal net operating loss carryforward amounts as described below.

 

 

 

 

 

 

 

 

    

Net Operating Loss

 

Year of Expiration

 

Carryforwards

 

2027

 

$

94,000

 

2030

 

 

28,000

 

2032

 

 

298,000

 

2037

 

 

960,000

 

2038

 

 

909,000

 

 

 

$

2,289,000

 

 

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The following table summarizes the components of the net deferred income tax asset:

 

 

 

 

 

 

 

 

 

 

    

2018

    

2017

 

Net operating loss carryforwards

 

$

574,000

 

$

420,000

 

Inventory valuation reserve

 

 

98,000

 

 

101,000

 

Loss on equity and impairment in investee

 

 

301,000

 

 

437,000

 

Tax credit carryforward

 

 

68,000

 

 

68,000

 

Other

 

 

115,000

 

 

158,000

 

 

 

 

1,156,000

 

 

1,184,000

 

Less: valuation allowance