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EX-31.2 - EX-31.2 - TOROTEL INCttlo-20200430ex312be6b40.htm
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EX-21 - EX-21 - TOROTEL INCttlo-20200430ex21df1aecd.htm
EX-4.1 - EX-4.1 - TOROTEL INCttlo-20200430ex41f2b78be.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, 2020

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:

Title of each class

Trading Symbol(s)

Name of each exchange on which registered

None

N/A

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 every Interactive Data File required to be submitted 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 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 has filed a report on and attestation to its management’s assessment of the effectiveness of its internal control over financial reporting under Section 404(b) of the Sarbanes-Oxley Act (15 U.S.C. 7262(b)) by the registered public accounting firm that prepared or issued its audit report.  

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, 2019, was $3,597,450. As of July 28, 2020, there were 5,995,750 shares of Common Stock outstanding.

DOCUMENTS INCORPORATED BY REFERENCE

Portions of the registrant's definitive Proxy Statement for its 2020 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, 2020

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

8

Item 7.

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

9

Item 8.

Financial Statements and Supplementary Data

17

Item 9.

Changes In and Disagreements with Accountants on Accounting and Financial Disclosure

42

Item 9A.

Controls and Procedures

42

Item 9B.

Other Information

42

PART III

Item 10.

Directors, Executive Officers and Corporate Governance

42

Item 11.

Executive Compensation

43

Item 12.

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

43

Item 13.

Certain Relationships and Related Transactions, and Director Independence

43

Item 14.

Principal Accounting Fees and Services

43

PART IV

Item 15.

Exhibits, Financial Statement Schedules

44

Item 16.

Form 10-K Summary

46

SIGNATURES

47

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:

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 concentrated customer base;

risks in fulfilling military subcontracts;

our ability to finance operations;

our on-going analysis of the effect on our financial position and results of operations from 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 on-going ability to satisfy our debt covenant requirements and 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.

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 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.

Torotel provides end products to the defense industry and is considered part of the Defense Industrial Base (“DIB”).  The DIB is identified as a Critical Infrastructure Sector by the Department of Homeland Security and is defined as the worldwide industrial complex that enables research and development as well as design, production, delivery, and maintenance of military weapons systems/software systems, subsystems, and components or parts, as well as purchased services to meet U.S. Military requirements.  Based on this identification, and guidance from the “Memorandum for Defense Industrial Base” dated March 20, 2020, Torotel is considered an essential business by the Department of Defense during the COVID-19 pandemic.

The following discussion includes the business operations of Torotel as of and for the fiscal year ended April 30, 2020 (“fiscal year 2020”).

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 2020.

Marketing and Customers

Torotel’s sales do not represent a significant portion of any particular market in which it provides its products.  While approximately 42% of annual sales in fiscal year 2020 came from select commercial markets, such as commercial aerospace, and oil drilling, historically Torotel has primarily focused its activities on the defense industry.  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, in larger and higher voltage transformers, along with 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

4


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 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 10 customers that together provide 95% 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 this core group. During fiscal year 2020, sales to a single customer accounted for 31%, and sales to another customer accounted for 28% 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 MK Magnetics, Magnetic Metals-Western Division, EIS, Inc., Parkway Products, API Technologies Corporation, Krayden Inc., and Exxelia Dearborn, Inc. 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.  Torotel does not experience seasonal variations in its business.

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

5


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 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, 2029.  

Environmental Laws

In fiscal year 2020, Torotel incurred costs of approximately $42,000 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, 2020.

Employees

Torotel presently employs approximately 170 full-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 pursuant to Regulation S-K Item 101(h), but see “Forward Looking Information.”

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, 2020, the monthly base rate is $32,876, and subsequently through December 31, 2021, the monthly base rate is $35,289, escalating annually thereafter.

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. During fiscal year 2019, the lease was automatically extended, as stated within the original lease agreement, for an additional one year period to July 31, 2020. On June 17, 2020, Torotel entered into a new lease agreement adjusting the leased space to approximately 7,000 square feet and the monthly base rent to $4,241.

In general, we believe that our properties are suitable and adequate for us to operate at present levels, and the productive capacity and extent of utilization of the facilities are appropriate for our existing and reasonably anticipated manufacturing requirements.

6


Torotel owns a 24,000 square foot building located at 620 N. Lindenwood Drive in Olathe, Kansas. This facility was previously held for sale through February 2019.  A lease between Torotel and a tenant commenced on September 25, 2018, and continues through December 31, 2023.  The tenant began occupying the building in February 2019.  Through December 31, 2020, the monthly base rate is $12,500, and subsequently through December 31, 2021, the monthly base rate is $13,500, escalating annually thereafter.  

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 Open Market 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.

2020

2019

 

Fiscal Period

High

Low

High

Low

 

May to July

$

1.19

$

0.75

    

$

0.70

    

$

0.51

August to October

1.49

1.06

 

0.81

 

0.56

November to January

7.76

1.11

 

1.04

 

0.63

February to April

7.77

0.95

 

0.95

 

0.71

(b)

Approximate Number of Equity Security Holders

    

Number of

 

Record Holders as of

 

Title of Class 

June 28, 2019

 

Common stock, $0.01 par value

398

(c)

Dividends

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.

ITEM 6.    Selected Financial Data

Information not required.

8


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;

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 Torotel’s net sales in fiscal year 2020 was 58% defense, 39% commercial aerospace and 3% industrial compared to 58% defense, 37% commercial aerospace and 5% industrial in the fiscal year ended April 30, 2019 (“fiscal year 2019”). We believe the mix in the fiscal year ended April 30, 2020 (“fiscal year 2020”) will remain weighted primarily towards defense.  Approximately 96% of Torotel’s sales during fiscal year 2020 were derived from domestic customers.

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

9


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 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 intend to use 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 fiscal year 2020 and fiscal year 2019, 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 58% for both periods. 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, 2020, our consolidated order backlog for the defense market was $19.4 million, which included approximately $13.4 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 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 in these markets include delays on the development and production of new commercial aircraft and competition from international suppliers.  As of April 30, 2020, our consolidated order backlog for the aerospace and industrial markets was $3.7 million.

Business Outlook

Our backlog as of April 30, 2020 as compared to April 30, 2019 increased to $23.0 million from $14.7 million, a 56% increase.  This increase was driven primarily by growth in new programs.  We anticipate that net sales for fiscal year 2021 will remain consistent with fiscal year 2020.  This is primarily due to an expectation that a reduction of net sales within the commercial aerospace industry, may be offset by growth within the defense industry orders for our products.  We anticipate that 22% and 47% of our $23.0 million backlog as of April 30, 2020 is expected to ship and be converted to sales in the first quarter of fiscal 2021, and in the ensuing nine months of fiscal 2021, respectively.  As noted previously, there are multiple uncertainties within our business associated with the COVID-19 pandemic; however, we believe that our large sales backlog and current defense industry opportunities will help maintain a positive 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 Financial Statements included pursuant to Item 8 of this Annual Report.

10


Net Sales

Years ended April 30,

    

2020

    

2019

Magnetic components

$

14,090,000

$

10,600,000

Potted coil assembly

5,655,000

5,751,000

Electro-mechanical assemblies

6,388,000

3,920,000

Large transformers

284,000

Total

$

26,133,000

$

20,555,000

Consolidated net sales in fiscal year 2020 increased $5,578,000, or 27%, as compared to fiscal year 2019, primarily due to higher demand for magnetic components and electro-mechanical assemblies.  The increase was expected as there were increases in new commercial aerospace products and advances in production automation of our magnetic components.

Consolidated net sales in fiscal year 2019 increased $2,159,000, or 12%, as compared to fiscal year 2018, primarily due to higher demand for magnetic components and electro-mechanical assemblies along with the change in revenue recognition policy (described in Note 1).  The change in revenue recognition policy caused and impact of $1,104,000 increase from fiscal year 2018 to fiscal year 2019.  The increase was expected as a number of products had an increase in demand from customers.

Gross Profit

Years ended April 30,

    

2020

    

2019

 

Gross profit

$

9,009,000

$

6,964,000

Gross profit % of net sales

 

34

%  

 

34

%  

Gross profit as a percentage of net sales in fiscal year 2020 remained consistent at 34% when compared to fiscal year 2019. The gross profit percentage for fiscal year 2020 increased primarily due to higher demand for magnetic components and electro-mechanical assemblies and lower manufacturing costs and scrap.

Gross profit as a percentage of net sales in fiscal year 2019 increased 8% as compared to fiscal year 2018.  The gross profit percentage for fiscal year 2019 increased primarily due to higher demand for magnetic components and electro-mechanical assemblies, lower manufacturing costs and scrap, and the change in revenue recognition policy (described in Note 1).  The change in the revenue recognition policy increased gross profit by $546,000 from fiscal year 2018 to fiscal year 2019.

Operating Expenses

Years ended April 30,

    

2020

    

2019

Engineering

$

1,462,000

$

1,316,000

Selling, general and administrative

6,662,000

 

4,881,000

Total

$

8,124,000

$

6,197,000

Engineering expense increased 11%, or $146,000, in fiscal year 2020 as compared to fiscal year 2019. This increase primarily resulted from the hiring of additional engineers to provide expanded technical capabilities.

Engineering expense increased 22%, or $234,000, in fiscal year 2019 as compared to fiscal year 2018. This increase primarily resulted from the hiring of additional engineers to provide expanded technical capabilities.

11


Selling, general and administrative expenses increased 36%, or $1,781,000, in fiscal year 2020 as compared to fiscal year 2019. The increase for administrative expenses in fiscal year 2020 primarily resulted from incurring transactional fees relating to the potential acquisition of Torotel in fiscal year 2020.  No transactional fees were incurred in fiscal year 2019.

Selling, general and administrative expenses decreased 2%, or $86,000, in fiscal year 2019 as compared to fiscal year 2018. The decrease resulted from a decrease in income tax expense.

Earnings (loss) from Operations

Years ended April 30,

    

2020

    

2019

Torotel Products

$

2,414,000

$

1,296,000

Torotel

 

(1,529,000)

 

(529,000)

Total

$

885,000

$

767,000

For the reasons discussed in the Net Sales, Gross Profit, and Operating Expenses above, consolidated earnings from operations increased by $118,000, in fiscal year 2020 as compared to fiscal year 2019, and increased by $2,035,000, in fiscal year 2019 as compared to fiscal year 2018.

Other Earnings Items

Years ended April 30,

    

2020

    

2019

Income from operations

$

885,000

$

767,000

Interest expense

96,000

 

112,000

Income before income taxes

 

789,000

 

655,000

Income tax expense

75,000

 

13,000

Net income

$

714,000

$

642,000

Interest expense decreased by 14%, or $16,000, in fiscal year 2020 as compared to fiscal year 2019, primarily due to lower levels of outstanding indebtedness for most of the year.  Income tax provision increased by $62,000 in fiscal year 2020 as compared to fiscal year 2019.

Interest expense increased by 51%, or $38,000, in fiscal year 2019 as compared to fiscal year 2018, primarily due to higher levels of outstanding indebtedness for most of the year.  Income tax provision decreased by $668,000 in fiscal year 2019 as compared to fiscal year 2018, with our income tax provision for fiscal year 2018 being related primarily to tax reform that became effective in January 2018 and an increase in deferred tax asset valuation allowance in fiscal year 2018, with no corresponding tax provisions for fiscal year 2019.

We evaluate the appropriateness of our deferred income tax asset valuation 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 determined we were 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.   Our evaluation in fiscal years 2020 and 2019 were consistent with our 2018 conclusions.  See Note 6 in the consolidated financial statements for further details.

12


Financial Condition and Liquidity

The following table highlights the funds available to us as of April 30, 2020 and 2019:

    

2020

    

2019

Cash

$

2,263,000

$

58,000

Amount available under our equipment loan

-

196,000

Amount available under our 5.00% asset-based revolving line of credit

2,000,000

275,000

Total funds available

$

4,263,000

$

529,000

Operating Activities

    

2020

    

2019

 

Net cash provided by (used in) operating activities

$

1,804,000

$

(453,000)

The increase of $2,257,000 of net cash provided by operating activities between fiscal year 2020 and fiscal year 2019 is primarily due to increases in operating ROU assets, inventories and trade accounts payable.  

Investing Activities

    

2020

    

2019

Net cash used in investing activities

$

(507,000)

$

(150,000)

The increase of $357,000 of net cash used in investing activities during fiscal year 2020 as compared to fiscal year 2019 was due to an increase in capital expenditures in fiscal year 2020 as compared to fiscal year 2019.  We expect capital expenditure spending will continue to increase during fiscal year 2021 as compared to fiscal year 2020.

Financing Activities

    

2020

    

2019

Net cash provided by financing activities

$

908,000

$

86,000

The increase of $822,000 in net cash used in financing activities between fiscal year 2020 and fiscal year 2019 is due to an increase in loan proceeds during fiscal year 2020.  

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 April 30, 2020, we had no funds drawn on the $2,000,000 asset-based revolving line of credit.  As of April 30, 2020 our total borrowing capacity is approximately $2,000,000, under our existing financing arrangements, plus $2,263,000 of cash on hand.

13


Off-Balance Sheet Arrangements

There are no off-balance sheet arrangements.

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.  As previously described in the “Information” section, there are several risks and uncertainties which could impact our estimates.  Management continues to monitor the pandemic and adjust estimates as deemed appropriate.

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

Leases

The Company adopted the guidance of ASU No. 2016-02, Leases, (“ASC 842”) as of May 1, 2019 using the modified retrospective transition approach with the cumulative effect recognized at the date of initial application. The comparative information in the prior year has not been adjusted and continues to be reported under ASC 840, Leases, which was the accounting standard in effect for that period. ASC 842 requires lessees to recognize leases on-balance sheet and disclose key information about leasing arrangements. The new standard establishes a right-of-use model (“ROU”) that requires a lessee to recognize a ROU asset and lease liability on the balance sheet for all leases with a term longer than 12 months. Leases are classified as finance or operating, with classification affecting the pattern and classification of expense recognition in the statement of operations and presentation of cash flows. See Note 4—Leases for the required disclosures of the nature, amount, timing, and uncertainty of cash flows arising from leases.

Revenue Recognition

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.

14


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 April 30, 2020 contained a significant financing component. Determining the transaction price requires significant judgment, which is discussed by revenue category in further detail below.

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 service to a customer.

Performance Obligations Satisfied Over Time

We recognize revenue on agreements for the sale of customized goods including magnetic components, consisting of transformers, inductors, reactors, chokes, toroidal coils, high voltage transformers, dry-type transformers and electro-mechanical assemblies 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

15


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.

Performance Obligations Satisfied at a Point in Time

We recognize revenue on agreements for the sale of customized goods including magnetic components, consisting of transformers, inductors, reactors, chokes, toroidal coils, high voltage transformers, dry-type transformers and electro-mechanical assemblies 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 fiscal years 2020 and 2019 relating to receivables or contract assets arising from contracts with customers.

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 normal credit terms. Interest is not charged on past due accounts. The allowance for doubtful accounts was $41,000 and $12,000 at the end of fiscal year 2020 and 2019, respectively.

16


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.

ITEM 8.    Financial Statements and Supplementary Data

INDEX TO CONSOLIDATED FINANCIAL STATEMENTS

17


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 April 30, 2020 and 2019, the related consolidated statements of operations, changes in stockholders’ equity, and cash flows, for each of the two years in the period ended April 30, 2020 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 April 30, 2020 and 2019, and the results of its operations and its cash flows for each of the two years in the period ended April 30, 2020, in conformity with accounting principles generally accepted in the United States of America.

Adoption of New Accounting Pronouncements

As discussed in Notes 1 and 4 to the consolidated financial statements, the Company changed its method of accounting for leases beginning on May 1, 2019 due to the adoption of ASC Topic 842, Leases.

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

July 28, 2020

18


TOROTEL, INC.

CONSOLIDATED BALANCE SHEETS

    

As of April 30,

2020

2019

ASSETS

Current assets:

Cash

$

2,263,000

$

58,000

Trade receivables, net

2,104,000

 

2,590,000

Contract assets

960,000

 

1,104,000

Inventories

3,556,000

 

3,054,000

Prepaid expenses

285,000

 

152,000

9,168,000

 

6,958,000

Land

265,000

265,000

Buildings and improvements

1,586,000

 

1,569,000

Equipment

4,520,000

 

4,045,000

6,371,000

 

5,879,000

Less accumulated depreciation

4,388,000

 

4,056,000

Property, plant and equipment, net

1,983,000

 

1,823,000

Operating lease right-of-use assets

2,008,000

Deferred income taxes

 

34,000

Other assets

221,000

 

186,000

Total Assets

$

13,380,000

$

9,001,000

LIABILITIES AND STOCKHOLDERS' EQUITY

Current liabilities:

Current maturities of long-term debt

$

795,000

$

1,121,000

Current maturities of operating lease liabilities

395,000

Current maturities of finance lease liabilities

27,000

Trade accounts payable

1,933,000

 

1,625,000

Accrued liabilities

899,000

 

824,000

Customer deposits

16,000

24,000

 

4,065,000

 

3,594,000

Long-term debt, less current maturities

2,008,000

 

801,000

Operating lease liabilities, less current maturities

1,879,000

3,887,000

801,000

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

12,653,000

 

12,545,000

Accumulated deficit

(7,285,000)

 

(7,999,000)

5,428,000

4,606,000

Total Liabilities and Stockholders' Equity

$

13,380,000

$

9,001,000

The accompanying notes are an integral part of these statements.

19


TOROTEL, INC.

CONSOLIDATED STATEMENTS OF OPERATIONS

Years ended April 30,

    

2020

    

2019

Net sales

$

26,133,000

 

$

20,555,000

Cost of goods sold

17,124,000

 

13,591,000

Gross profit

 

9,009,000

 

6,964,000

Operating expenses:

Engineering

1,462,000

 

1,316,000

Selling, general and administrative

6,662,000

 

4,881,000

8,124,000

 

6,197,000

Income from operations

 

885,000

 

767,000

Other expense:

Interest expense, net

96,000

 

112,000

Income before income tax expense

 

789,000

 

655,000

Income tax expense

75,000

 

13,000

Net income

$

714,000

$

642,000

Basic earnings per share

$

0.12

$

0.11

The accompanying notes are an integral part of these statements.

20


TOROTEL, INC.

CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY

    

    

    

Capital in

    

Total

 

Common

Excess of

Accumulated

Stockholders' 

 

Shares

Stock

Par Value

Deficit

Equity

 

Balance, May 1, 2018

5,995,750

$

60,000

$

12,437,000

$

(8,743,000)

$

3,754,000

Stock compensation earned

 

 

 

108,000

 

 

108,000

Net income

 

 

 

 

642,000

 

642,000

Cumulative effect of adoption of new accounting principle

102,000

102,000

Balance, April 30, 2019

 

5,995,750

 

60,000

 

12,545,000

 

(7,999,000)

 

4,606,000

Stock compensation earned

 

 

 

108,000

 

 

108,000

Net income

 

 

 

714,000

 

714,000

Balance, April 30, 2020

5,995,750

$

60,000

$

12,653,000

$

(7,285,000)

$

5,428,000

The accompanying notes are an integral part of these statements.

21


TOROTEL, INC.

CONSOLIDATED STATEMENTS OF CASHFLOWS

Years ended April 30,

    

2020

    

2019

Cash flows from operating activities:

Net income

$

714,000

$

642,000

Adjustments to reconcile net income to net cash provided by (used in) operating activities:

Stock compensation cost amortized

108,000

 

108,000

Depreciation

367,000

 

353,000

Deferred income taxes

 

34,000

Changes in operating assets and liabilities:

Trade receivables

486,000

 

(397,000)

Contract assets

144,000

(1,002,000)

Inventories

(502,000)

 

(692,000)

Prepaid expenses and other assets

(134,000)

 

109,000

Operating lease right-of-use assets

259,000

Trade accounts payable

288,000

 

580,000

Accrued liabilities

281,000

 

7,000

Current and long-term operating lease liabilities

(199,000)

Customer deposits

(8,000)

(195,000)

Net cash provided by (used in) operating activities

 

1,804,000

 

(453,000)

Cash flows from investing activities:

Capital expenditures

(508,000)

 

(152,000)

Proceeds from disposal of equipment

1,000

2,000

Net cash used in investing activities

 

(507,000)

 

(150,000)

Cash flows from financing activities:

Principal payments on long-term debt

(33,000)

 

(1,677,000)

Principal payments under capital and financing lease obligations

(71,000)

(71,000)

Payments on line of credit

(13,399,000)

(4,581,000)

Proceeds from line of credit

12,426,000

5,556,000

Proceeds from long-term debt

1,985,000

859,000

Net cash provided by financing activities

 

908,000

 

86,000

Net increase (decrease) in cash

 

2,205,000

 

(517,000)

Cash, beginning of period

 

58,000

575,000

Cash, end of period

$

2,263,000

$

58,000

SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION

Cash paid during the period for:

Interest

$

99,000

$

108,000

Income taxes

$

70,750

$

Non-cash investing and financing activities:

Tax credit reclassified from deferred tax asset to a receivable

$

34,000

$

Property held for sale reclassified as property, plant and equipment

694,000

Capital leases reclassified from long-term debt to finance lease liabilities

98,000

Deferred rent reclassified from accrued liabilities to operating lease right-of-use assets

206,000

Equipment financed through accounts payable

20,000

The accompanying notes are an integral part of these statements.

22


TOROTEL, INC.

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").  The terms “we,” “us,” “our,” and the “Company” as used in these notes 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 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. Cash balances did exceed federally insured limits at April 30, 2020.  At April 30, 2019, cash balances did not exceed 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

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, 2020 and 2019, 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.

Revenue Recognition

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

23


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 April 30, 2020 and 2019, contained a significant financing component. Determining the transaction price requires significant judgment, which is discussed by revenue category in further detail below.

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 service to a customer.

Performance Obligations Satisfied Over Time

We recognize revenue on agreements for the sale of customized goods including magnetic components, consisting of transformers, inductors, reactors, chokes, toroidal coils, high voltage transformers, dry-type transformers and electro-mechanical assemblies 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

24


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.

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 fiscal year 2020 relating to receivables or contract assets arising from contracts with customers.

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, 2020 and 2019 was $41,000 and $12,000, respectively.

25


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, 2020 and 2019 was $406,000 and $332,000, 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 ten 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 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 year ended April 30, 2020 advertising costs were $9,000.  For the year ended April 30, 2019 there were no advertising costs.

26


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 provides for awards of restricted stock, which is described more fully in Note 8 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.

Paycheck Protection Program

We received funding from the Small Business Administration relating to the Paycheck Protection Program in the amount of $1,985,000 through a promissory note.  The loan and the related interest are recorded as a financial liability.  As of April 30, 2020, we have not obtained sufficient reasonable assurance that forgiveness conditions have been satisfied.  For subsequent reporting periods, we will reevaluate if there is reasonable assurance that forgiveness conditions have been satisfied. Upon obtaining reasonable assurance that the forgiveness conditions have been satisfied, the earnings will be recorded on a systematic basis over the periods in which we recognize the expenses for which the funds are intended to compensate.  In April 2020, we incurred $440,000 of eligible Paycheck Protection Program expenses.  These expenses are classified as nondeductible for income tax purposes and are recorded as permanent differences.

Accounting Pronouncements Recently Adopted

The Company adopted the guidance of ASU No. 2016-02, Leases, (“ASC 842”) as of May 1, 2019 using the modified retrospective transition approach with the cumulative effect recognized at the date of initial application. The comparative information in the prior year has not been adjusted and continues to be reported under ASC 840, Leases, which was the accounting standard in effect for that period. ASC 842 requires lessees to recognize leases on-balance sheet and disclose key information about leasing arrangements. The new standard establishes a right-of-use model (“ROU”) that requires a lessee to recognize a ROU asset and lease liability on the balance sheet for all leases with a term longer than 12 months. Leases are classified as finance or operating, with classification affecting the pattern and classification of expense recognition in the statement of operations and presentation of cash flows. See Note 4—Leases for the required disclosures of the nature, amount, timing, and uncertainty of cash flows arising from leases.

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.

27


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.

NOTE 2—INVENTORIES

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

    

2020

    

2019

Raw materials

$

2,417,000

$

1,723,000

Work in process

961,000

1,052,000

Finished goods

178,000

279,000

$

3,556,000

$

3,054,000

NOTE 3—REVENUE

Disaggregation of Revenue

The following tables summarize revenue from contracts with customers for the fiscal years ended April 30 of each year:

2020

    

2019

Markets

Commercial Aerospace

$

10,208,000

$

7,690,000

Defense

15,140,000

11,849,000

Industrial

785,000

1,016,000

Total consolidated net sales

$

26,133,000

$

20,555,000

2020

    

2019

Product Line

Magnetic components

$

14,090,000

$

10,600,000

Potted coil assembly

5,655,000

5,751,000

Electro-mechanical assemblies

6,388,000

3,920,000

Large transformers

284,000

Total consolidated net sales

$

26,133,000

$

20,555,000

2020

    

2019

Geography

Domestic

$

25,082,000

$

18,472,000

Foreign

1,051,000

2,083,000

Total consolidated net sales

$

26,133,000

$

20,555,000

28


Torotel currently has a primary base of approximately 10 customers that historically provide nearly 95% of its annual sales volume.  Sales to two major customers as a percentage of consolidated net sales for the fiscal year ended April 30, 2020 was 31% and 28% respectively. Sales to two major customers as a percentage of consolidated net sales for the fiscal year ended April 30, 2019 was 30% and 21% respectively. Trade receivables from three major customers as a percentage of consolidated net trade receivables for the fiscal year ended April 30, 2020 was 48%. Trade receivables from one major customer as a percentage of consolidated net trade receivables for the fiscal year ended April 30, 2019 was 15%.

Contract balances

All receivable balances relate to customer contracts entered into during the fiscal year 2020.  We have no contract liabilities other than customer deposits which represent prepaid consideration for contracts with customers (see Note 13).  There have been no significant adjustments to contract asset balances related to contract modifications.  In fiscal year 2020 and 2019, we had certain customers totaling revenue of $7,973,000 and $4,301,000, respectively, with variable payment terms related to discounts in the amount of $59,000 and $32,000, respectively.

Remaining performance obligation

As of April 30, 2020, the aggregate amount of the contracted revenues allocated to our unsatisfied (or partially unsatisfied) performance obligations was $10,726,000. 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 obligation to be recognized in fiscal year 2021 is expected to be $4,659,000.  Total remaining performance obligation to be recognized in fiscal year 2022 is expected to be $6,067,000.

As of April 30, 2019, the aggregate amount of the contracted revenues allocated to our unsatisfied (or partially unsatisfied) performance obligations was $4,591,000. 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 obligation to be recognized in fiscal year 2020 is expected to be $4,571,000.  Total remaining performance obligation to be recognized in fiscal year 2021 is expected to be $20,000.

NOTE 4—LEASES

The Company adopted ASC 842 on May 1, 2019 using the modified retrospective transition method; and therefore, the comparative information has not been adjusted for the year ended April 30, 2019. 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 ROU assets and lease liabilities were recognized at commencement date based on the present value of minimum lease payments over the remaining lease term less the balance of our ASC 840 deferred rent liability. The minimum lease payments include base rent payments. The Company’s leases have remaining lease terms of approximately 1 year to 7 years, with an option to extend the lease. 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.

 

29


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.

As a result of adopting ASC 842, the Company’s consolidated balance sheet includes additional operating ROU lease assets and total operating lease liabilities of $2,008,000 and $2,274,000, respectively, at April 30, 2020. The initial measurement occurring on May 1, 2019, resulted in operating lease ROU assets of $2,267,000, finance lease ROU assets of $98,000, current operating lease liabilities of $380,000, current finance lease liabilities of $73,000, noncurrent operating lease liabilities of $2,093,000, and noncurrent finance lease liabilities of $25,000. The difference of $206,000 between the ROU assets and the lease liabilities results from a reclassification of deferred rent to the operating lease ROU asset of $206,000.

The following table provides the operating and finance ROU assets and lease liabilities at April 30:

Balance Sheet Classification

    

2020

Assets

Operating lease right-of-use assets

Operating right-of-use assets

$

2,008,000

Finance lease right-of-use assets

Property, plant and equipment, net

27,000

Total leased assets

$

2,035,000

Liabilities

Current

Operating lease liabilities

Current maturities of operating lease liabilities

$

395,000

Finance lease liabilities

Current maturities of finance lease liabilities

27,000

Noncurrent

Operating lease liabilities

Operating lease liabilities, less current maturities

1,879,000

Total lease liabilities

$

2,301,000

30


The components of lease expense were as follows at April 30:

2020

Operating lease expense

$

532,000

Finance lease expense

Amortization of right-of-use assets

71,000

Interest on lease liabilities

7,000

Total finance lease expense

78,000

Total lease expense

$

610,000

The supplemental components of cash flows were as follows at April 30:

2020

Cash paid for amounts included in the measurement of lease liabilities

Operating cash flows from operating leases

$

472,000

Financing cash flows from finance leases

71,000

Total cash paid for amounts included in the measurement of lease liabilities

$

543,000

The following table represents the weighted-average remaining lease term and discount rate as of April 30, 2020:

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 April 30, 2020 are as follows:

Finance Lease

Operating Lease

Fiscal Years Ending April 30,

Payments

Payments

2021

$

27,000

$

436,000

2022

448,000

2023

452,000

2024

452,000

2025

456,000

2026

467,000

2027

350,000

$

27,000

$

3,061,000

31


NOTE 5—FINANCING AGREEMENTS

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:

2020

2019

5.00% asset-based revolving line of credit with a maturity date of October 19, 2020

 

$

-

$

975,000

6.25% guidance line of credit with a maturity date of October 19, 2019

-

54,000

5.35% mortgage note payable in monthly installments of $5,573, including interest, with final payment of $690,829 due October 19, 2023

773,000

795,000

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

45,000

-

1.00% Paycheck Protection Program loan note payable in monthly installments of $111,712 starting after the six month payment deferment period on October 30, 2020, with a final payment of $111,712 due April 29, 2022. Interest will accrue during the deferment period.

1,985,000

-

Capital lease obligations (see Note 4)

-

98,000

Total long-term debt

2,803,000

1,922,000

Less current installments

795,000

1,121,000

Long-term debt, excluding current installments

$

2,008,000

$

801,000

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 associated interest rate is equal to the greater of the floating Cornerstone Bank Corporate Base Rate (5.00% as of April 30, 2020) or a floor of 5%.  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 has 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.

32


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 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.

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

Year Ending April 30,

    

Amount

 

2021

$

795,000

2022

 

1,251,000

2023

38,000

2024

 

719,000

$

2,803,000

Irrevocable Standby Letter of Credit

Under the terms of a lease amendment for its manufacturing facility located in Olathe, Kansas (see Note 7), 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

-

33


NOTE 6—INCOME TAXES

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

    

2020

    

2019

 

Current tax expense (benefit)

Federal

$

$

(34,000)

State

75,000

 

13,000

 

75,000

 

(21,000)

Deferred tax expense

Federal

 

34,000

State

 

 

 

34,000

Total income tax provision

$

75,000

$

13,000

The effective tax rate as of April 30, 2020 and 2019 is 9.5% and 2.0%, respectively.

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:

    

2020

    

2019

 

Computed tax expense at statutory rates

$

166,000

$

137,000

Permanent differences

98,000

 

6,000

State tax and credits

59,000

 

56,000

Adjustments required by change in method of accounting as a result of adopting ASC 606

(24,000)

 

31,000

Other

(4,000)

Use of net operating loss carryforward

(220,000)

 

(217,000)

$

75,000

$

13,000

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

 

2038

$

92,000

34


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

    

2020

    

2019

 

Net operating loss carryforwards

$

19,000

$

226,000

Inventory valuation reserve

109,000

 

89,000

Loss on equity and impairment in investee

301,000

 

301,000

Tax credit carryforward

 

34,000

Adjustments required by change in method of accounting as a result of adopting ASC 606

(31,000)

Cost of sales adjustment from ASC 606

15,000

163,000

Depreciation expense

(171,000)

(111,000)

Uniform capitalization

19,000

Right-of-use asset

(538,000)

Lease liability

609,000

Bad debt reserve

11,000

3,000

Warranty reserve

5,000

9,000

Accrued vacation

35,000

7,000

Accrued bonuses

65,000

42,000

Accrued commissions

15,000

16,000

Claims reserve

7,000

7,000

Stock compensation

105,000

76,000

Deferred rent

55,000

Other

2,000

 

 

589,000

905,000

Less: valuation allowance

(589,000)

 

(871,000)

$

$

34,000

As of April 30, 2018, the Company had federal minimum tax credit carryforwards of $68,000. In 2019, 50% of the federal minimum tax credit carryforwards were refunded. In 2020, the remaining 50% of the federal minimum tax credit carryforwards were eligible for refund and applied towards future period tax due.

We record deferred income tax assets to the extent we believe these assets will more likely than not be realized. In making such determination, we consider all available positive and negative evidence. Positive evidence includes, but is not limited to the following: cumulative earnings in recent years, earnings expected in future years, excess appreciated asset value over the tax basis and positive industry trends. Negative evidence includes, but is not limited to the following: cumulative losses in recent years, earnings expected in future years, a history of operating losses or tax credit carryforwards expiring, and adverse industry trends. Cumulative losses in recent years are significant negative evidence when determining the need for a valuation allowance. During the fourth quarter of the fiscal year ending April 30, 2018 the Company determined that is was no longer in a positive cumulative earnings position for the three-year period ended April 30, 2018.

The net change in the valuation allowance for the year ended April 30, 2020 and 2019, was a decrease of $282,000 and $217,000, respectively.  Valuation allowances are reviewed on a quarterly basis and adjustments made as appropriate.  The decrease in the valuation allowance in 2020 and 2019 resulted primarily from utilization of NOLs and credits.

The Company's determination of the realizable deferred tax assets requires the exercise of significant judgment, based in part on business plans and expectations about future outcomes. In the event the actual results differ from these estimates in future periods, the Company may need to adjust the valuation allowance, which could materially impact our financial position and results of operations. The Company will continue to assess the need for a valuation allowance in future periods. As of April 30, 2020 and 2019, the Company maintained a valuation allowance of $589,000 and $871,000, respectively, for its deferred tax assets.

35


As of April 30, 2020, the federal tax returns for the fiscal years ended 2017 through 2019 remain subject to examination and assessment. Fiscal years ending before 2017 remain open solely for purposes of examination of our loss and credit carryforwards. As of April 30, 2020, the Company has no federal or state examinations ongoing.

We recognize accrued interest and penalties related to unrecognized tax benefits, as well as interest received from favorable tax settlements, within income tax expense. As of April 30, 2020 and 2019, 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 7—COMMITMENTS AND CONTINGENCIES

As part of our ongoing operations, we enter into arrangements that obligate us to make future payments to various parties. Some of these contractual obligations are not reflected on the accompanying consolidated balance sheets due to the nature of the obligations. Such obligations include operating leases for production space and for equipment.

On July 10, 2014, we entered into a real estate lease agreement in Hatfield, Pennsylvania to lease approximately 5,000 square feet for manufacturing electromechanical assemblies and other transformers.  This agreement commenced on August 1, 2014 and continues through July 31, 2019.  During fiscal year 2019, the lease was automatically extended, as stated within the original lease agreement, for an additional one year period to July 31, 2020.  On June 17, 2020, Torotel entered into a new lease agreement adjusting the leased space to approximately 7,000 square feet and the monthly base rent to $4,241.

On October 31, 2016, Torotel entered into the Second Amendment (“Second Amendment”) to the lease for its Rogers Road facility located in Olathe, Kansas. The Second Amendment became effective as of April 1, 2017, and served to extend the lease term through December 31, 2026 and expand the leased space from approximately 14,137 square feet to approximately 72,388 square feet. The Second Amendment provides that through December 31, 2018, the monthly base rate is $26,844, and subsequently through December 31, 2019 and 2020, the monthly base rate is $29,257 and $32,876, respectively, escalating annually thereafter as previously disclosed in our other public filings. The Second Amendment required Torotel to increase its security deposit from $12,750 to $55,000 and provide a letter of credit as additional security. Additionally, the Second Amendment addressed other terms and conditions by which Torotel is leasing the facility or may terminate the lease, and provided Torotel two separate options to extend the lease term for additional five year periods.

The gross amount of assets recorded under capital leases amounted to $225,000 of equipment.

Minimum rent payments under operating leases are recognized on a straight-line basis over the term of the lease including any periods free of rent. Total rent expense for all operating leases for the fiscal years ended April 30, 2020 and 2019 was $532,000 and $650,000, respectively.

Torotel is subject to legal proceedings and claims that arise in the normal course of business.  It is the opinion of management that the disposition or ultimate resolution of such claims and lawsuits will not have a material adverse effect on the financial position or results of operations of Torotel.

NOTE 8—EMPLOYEE INCENTIVE PLANS

Short-term Cash Incentive Plan

The Short-term Cash Incentive Plan ("STIP") became effective for fiscal year 2008. The purpose of the STIP is to promote the long-term financial performance of Torotel by providing key employees with the opportunity to earn cash awards for accomplishing annual goals for Return on Capital Employed ("ROCE") as defined in the STIP. For the years ended April 30, 2020 and 2019 there were no short-term cash incentive plan expenses.

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Long-term Incentive Plans

The Long-term Incentive Plans ("LTIPs"), which consist of a Stock Award Plan and a Long-term Cash Incentive Plan, also became effective for fiscal year 2008. The purpose of the LTIPs is to provide incentives that will attract and retain highly competent persons as key employees to promote the long-term financial performance of Torotel by providing key employees an opportunity to earn stock and cash awards for accomplishing long-range goals for sales growth, earnings growth, ROCE and debt to equity, as defined and measured in each of the Stock Award Plan and the Long-term Cash Incentive Plan.

Stock Award Plan

The Stock Award Plan ("SAP"), which did not require shareholder approval, provides key employees the opportunity to acquire common stock of Torotel pursuant to awards earned for accomplishing goals that promote the long-term financial performance of Torotel. Under the terms of the SAP, stock awards are in the form of restricted stock having a 5-year restriction period, which shall lapse, based on certain conditions as outlined in the SAP. All stock awards are represented by a Restricted Stock Agreement, which 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.

Long-term Cash Incentive Plan

The Long-term Cash Incentive Plan ("LTCIP") provides key employees with the opportunity to earn cash awards for accomplishing plan goals based on predetermined targets for average annual sales and earnings growth, ROCE and debt to equity. Under the terms of the LTCIP, awards will not be paid if Torotel's performance on any LTCIP metric is less than the threshold level of performance defined for that LTCIP metric. For the years ended April 30, 2020 and 2020, there were no long-term cash incentive plan expenses for both years.

Performance Bonus

We provided discretionary performance bonuses for employees.  Total expense for these bonuses was $226,000 and $209,000 for the years ended April 30, 2020 and 2019.

401(k) Retirement Plan

We have a 401(k) Retirement Plan for Torotel’s employees. Employer contributions to that plan are at the discretion of the Board of Directors. Employer contributions to the plan for the years ended April 30, 2020 and 2019 were  $169,000 and $148,000, respectively.

NOTE 9—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 shall be vested and no longer 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.

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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 SAP.  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.  In fiscal year 2017, 350,000 shares of restricted common stock granted under the SAP in 2013 were reverted to treasury shares because it was determined that it was unlikely that the requisite financial performance metrics for the restrictions on such shares to lapse would be achieved.

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.  For the years ended April 30, 2020 and 2019, there were no stock award plan expenses.

Stock Compensation Costs and Restricted Stock Activity

Total stock compensation cost for both years ended April 30, 2020 and 2019, was $108,000.

.

Restricted stock activity for each year ended through April 30 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 April 30

 

730,000

$

0.740

 

730,000

$

0.740

NOTE 10—STOCKHOLDERS' EQUITY

The changes in shares of common stock outstanding as of April 30 of each year 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, April 30

5,995,750

5,995,750

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NOTE 11—EARNINGS PER SHARE

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.

The basic earnings per common share were computed as follows for the year ended April 30:

    

2020

   

2019

Net income

$

714,000

$

642,000

Amounts allocated to participating securities (nonvested restricted shares)

(87,000)

 

(78,000)

Net income attributable to common shareholders

$

627,000

$

564,000

Basic weighted average common shares

5,265,750

 

5,265,750

Earnings per share attributable to common shareholders:

Basic earnings per share

$

0.12

$

0.11

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 included 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.

NOTE 12—ACCRUED LIABILITIES

Accrued liabilities as of April 30 of each year consist of the following: