UNITED STATES SECURITIES AND EXCHANGE

COMMISSION

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Washington, D.C.  20549

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FORM 10-Q

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

For the quarterly period ended July 31, 2020

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or

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

For the transition period from _____ to _____

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Commission File No. 001-8125

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TOROTEL, INC.

(Exact name of registrant as specified in its charter)

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(913) 747-6111

(Registrant’s telephone number, including area code)

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

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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 ◻

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Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files).  Yes ⌧  No ◻

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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.

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If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act.   ◻

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Securities Exchange Act of 1934).  Yes ◻  No ⌧

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As of September 11, 2020, there were 5,995,750 shares of Common Stock, $0.01 par value, outstanding.

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Table of Contents
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TOROTEL, INC. AND SUBSIDIARIES

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INDEX

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PART I.   FINANCIAL INFORMATION

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Item 1.   Financial Statements

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CONSOLIDATED CONDENSED BALANCE SHEETS

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The accompanying notes are an integral part of these statements.

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CONSOLIDATED CONDENSED STATEMENTS OF OPERATIONS (Unaudited)

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The accompanying notes are an integral part of these statements.

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CONSOLIDATED CONDENSED STATEMENTS OF CHANGES IN STOCKHOLDERS’ EQUITY (Unaudited)

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The accompanying notes are an integral part of these statements.

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CONSOLIDATED CONDENSED STATEMENTS OF CASH FLOWS (Unaudited)

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The accompanying notes are an integral part of these statements.

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NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS

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NOTE 1 — BASIS OF PRESENTATION

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The consolidated condensed balance sheet as of April 30, 2020, which has been derived from the audited financial statements of Torotel, Inc. ("Torotel" or the “Company”), is accompanied by the unaudited interim consolidated condensed financial statements, which reflect the normal recurring adjustments that in the opinion of management are necessary to present fairly Torotel’s consolidated financial position at July 31, 2020, and the consolidated results of operations and cash flows for the three months ended July 31, 2020, and 2019, respectively. 

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The unaudited interim consolidated condensed financial statements have been prepared pursuant to the rules and regulations of the Securities and Exchange Commission ("SEC").  Certain information and note disclosures normally included in the annual financial statements prepared in accordance with generally accepted accounting principles have been condensed or omitted pursuant to those rules and regulations, although management believes the disclosures made are adequate to make the information not misleading. The financial statements contained herein should be read in conjunction with Torotel’s consolidated financial statements and related notes filed on Torotel's Form 10-K for the year ended April 30, 2020 as filed with the SEC on July 28, 2020.

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Accounting Pronouncements Issued, Not Yet Adopted

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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.

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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.

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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.

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NOTE 2 — NATURE OF OPERATIONS

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Torotel conducts business through its wholly owned subsidiary, Torotel Products, Inc. (“Torotel Products”). Torotel Products specializes in the custom design and manufacture of a wide variety of precision magnetic components, consisting of transformers, inductors, reactors, chokes, toroidal coils, high voltage transformers, dry-type transformers and electro-mechanical assemblies, for use in commercial, industrial and military electronics.

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NOTE 3—INVENTORIES

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The following table summarizes the components of inventories:

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NOTE 4—REVENUE

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We determine revenue recognition through the following steps:

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Performance Obligations Satisfied Over Time

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We recognize revenue on agreements for the sale of customized goods for use in commercial aerospace and military electronics on an over time basis.

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Commercial Aerospace and Defense Parts

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Performance obligations under long-term agreements are considered to be under contract at the time that authorization to ship has been obtained from the customer, except for one long-term agreement which provides a contract for two specific parts if the ship date is within 21 days. Performance obligations under standalone purchase orders are considered to be under contract at the time that the purchase order is received. Parts manufactured for customers in our aerospace and defense product revenue stream must be built to certain specifications that are then qualified by the customer. Due to the proprietary nature of our custom-built products designed for a specific use by our aerospace and defense customers, control is considered to be with the customer as the products are finalized and placed into finished goods. Goods within this revenue stream do not provide simultaneous receipt and benefit to the customer. The goods are controlled by our customers once the finished parts are created. The customers prevent any alternative use of the asset and an enforceable right to payment does exist. We provide for potential losses on any of these agreements when it is probable that we will incur the loss.

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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.

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Product fees and engineering and design services

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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.

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Performance Obligations Satisfied at a Point in Time

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We recognize revenue on agreements for the sale of customized goods for use in the industrial and commercial market on point in time basis.

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Industrial and Commercial Parts

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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.

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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.

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Taxes assessed by a governmental authority that are both imposed on and concurrent with a specific revenue-producing transaction, that are collected by the Company from a customer, are excluded from revenue.  Shipping and handling costs do not have a material impact to the financial statements.  No impairment losses were recognized in the three months ending July 31, 2020 and 2019, relating to receivables or contract assets arising from contracts with customers.

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Disaggregation of Revenue

The following tables summarize revenue from contracts with customers for the three months ended July 31, 2020 and 2019.

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Contract balances

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All contract asset balances relate to customer contracts entered into during the fiscal year ending April 30, 2021.  We have no contract liabilities other than customer deposits which represent prepaid consideration for contracts with customers.  There have been no significant adjustments to contract asset balances related to contract modifications.  We have certain customers totaling revenue of $337,000 with variable payment terms related to discounts in the amount of $3,000 in the fiscal year ending April 30, 2021.

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Remaining performance obligations

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As of July 31, 2020, the aggregate amount of the contracted revenues allocated to our unsatisfied (or partially unsatisfied) performance obligations was $10,992,000. The balance of unsatisfied performance obligations excludes contracts with original maturities of one year or less.  We expect to recognize revenue as we satisfy our remaining performance obligations.  Total remaining performance obligations to be recognized in the fiscal year ending April 30, 2021 is expected to be $4,779,000.  Total remaining performance obligations to be recognized in the fiscal year ending April 30, 2022 is expected to be $6,213,000.

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NOTE 5—LEASES

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The Company adopted ASC 842 on May 1, 2019 using the modified retrospective transition method. Upon transition to the new standard, the Company elected the package of practical expedients, which permitted the Company not to reassess under the new standard its prior conclusions about lease identification, lease classification and initial direct costs.

The Company leases buildings and equipment under operating and finance leases. The majority of the Company’s operations are conducted in premises occupied under lease agreements with initial base terms ranging from 5 to 15 years, with certain leases containing options to extend the leases for up to an additional 10 years. The Company typically does not believe that exercise of the renewal options is reasonably assured at the inception of the lease agreements and, therefore, considers the initial base term as the lease term. Lease terms vary but generally the leases provide for fixed and escalating rentals or contingent escalating rentals based on the Consumer Price Index.

Operating lease right-of-use (ROU) assets and lease liabilities were recognized at commencement date based on the present value of minimum lease payments over the remaining lease term. The minimum lease payments include base rent payments. The Company’s leases have remaining lease terms of approximately 1 year to 8 years, which may include the option to extend the lease when it is reasonably certain the Company will exercise that option. The present value of the lease payments is calculated using the incremental borrowing rate for operating leases, which was determined using a portfolio approach based on the rate of interest that the Company would have to pay to borrow an amount equal to the lease payments on a collateralized basis over a similar term. Operating lease expense is recognized on a straight-line basis over the lease term.

The Company’s lease agreements do not contain any material residual value guarantees. The Company elected the practical expedient to not separate lease and non-lease components and also elected the short-term practical expedient for all leases that qualify. As a result, the Company will not recognize ROU assets or liabilities for short-term leases that qualify for the short-term practical expedient, but instead will recognize the lease payments as lease cost on a straight-line basis over the lease term.

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

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The components of lease expense were as follows:

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The supplemental components of cash flows were as follows:

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The following table represents the weighted-average remaining lease term and discount rate as of July 31, 2020 and April 30, 2020:

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Future minimum lease payments on the amended operating lease and future minimum finance lease payments as of July 31, 2020 are as follows:

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NOTE 6—FINANCING AGREEMENTS

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On October 19, 2018, Torotel entered into three new business loan agreements (the “financing agreements”) with Cornerstone Bank (the “Bank”).  The financing agreements provide for an asset-backed revolving line of credit, a guidance line of credit, and a real estate term loan.  On October 19, 2019, Torotel renewed the asset-backed revolving line of credit.  A summary of the notes issued under the financing agreements is provided below:

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The asset-based revolving line of credit is intended to be used for working capital purposes and has a capacity of $2,000,000.  The asset-based revolving line of credit is renewable annually upon mutual agreement of Torotel and the Bank. The Company intends to renew the asset-based revolving line of credit.  The associated interest rate is equal to the greater of the floating Cornerstone Bank Corporate Base Rate (5.50%  as of July 31, 2020) or a floor of 5.0%.  Monthly repayments of interest only are required under the asset-based revolving line of credit promissory note with the principal due at maturity.  The borrowing base of the revolving line of credit is limited to 80% of eligible accounts receivable, plus 50% of eligible inventory, plus 80% of eligible equipment.  This asset-based revolving line of credit is cross collateralized and cross defaulted with all other financing agreements of Torotel with the Bank.  Pursuant to a Commercial Security Agreement dated October 19, 2018, between Torotel and the Bank (the “Commercial Security Agreement”), which was entered into in connection with the financing agreements, the asset-based revolving line of credit is secured by a first lien on all business assets of Torotel. Under the revolving line of credit, if the aggregate principal amount of the outstanding advances exceeds the applicable borrowing base, Torotel must pay the Bank an amount equal to the difference between the outstanding principal balance of the revolving line of credit and the borrowing base.

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The real estate term loan is in the principal amount of $815,000 and contains a 5-year term with a 20-year amortization period, with the balance at maturity on October 19, 2023.  The associated interest rate is fixed at 5.35%.  Monthly repayments of approximately $5,573, consisting of both interest and principal, are required.  The final payment of approximately $690,829 is due on the maturity date.  This real estate term loan is cross collateralized and cross defaulted with the other financing agreements.  The real estate term loan is secured by a first lien priority real estate mortgage on the property located at 620 North Lindenwood Drive in Olathe, Kansas pursuant to the Commercial Security Agreement.

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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.

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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

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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.

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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.

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Irrevocable Standby Letter of Credit

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Under the terms of a lease amendment for its manufacturing facility located in Olathe, Kansas, Torotel provided the landlord an irrevocable standby letter of credit in the original amount of $300,000 as additional security. On January 1, 2020, the letter of credit was reduced from $300,000 to $225,000.  The balance under the letter of credit will automatically reduce in accordance with the below schedule if not drawn upon:

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NOTE 7—INCOME TAXES

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The Company incurred an income tax benefit of $128,000 during the three months ended July 31, 2020 and incurred income tax expense of $111,000 during the three months ended July 31, 2019, with an effective tax rate of 26.5% and 19.9%, respectively.

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The income tax benefit was derived from a release of $288,000 from the valuation allowance offset by $160,000 of income tax expense during the three months ended July 31, 2020.  The valuation allowance was $301,000 and $589,000 as of July 31, 2020 and April 30, 2020, respectively.

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As of July 31, 2020, the federal tax returns for the fiscal years ended 2018 through 2020 are open to audit until the statute of limitations closes for the years in which our net operating losses are utilized. We would recognize interest and penalties accrued on unrecognized tax benefits as well as interest received from favorable tax settlements within income tax expense. As of July 31, 2020, we recorded no accrued interest or penalties related to uncertain tax positions. We expect no significant change in the amount of unrecognized tax benefit, accrued interest or penalties within the next twelve months.

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NOTE 8—RESTRICTED STOCK AGREEMENTS

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Restricted Stock Agreements, and stock awards thereunder, are authorized by the Compensation and Nominating Committee (the "Committee") and the Board of Directors of Torotel (the "Board"). The terms of the Restricted Stock Agreements afford the grantees all of the rights of a stockholder with respect to the award shares, including the right to vote such shares and to receive dividends and other distributions payable with respect to such shares since the date of award. Under the terms of each agreement, the non-vested shares are restricted as to disposition and subject to forfeiture under certain circumstances. The Restricted Stock Agreements further provide, subject to certain conditions, that if prior to all of the restricted shares having vested, we undergo a change in control, then all of the restricted shares will vest and no longer be subject to restrictions under the Restricted Stock Agreements. The restricted shares are treated as non-vested stock; accordingly, the fair value of the restricted stock at the date of award is offset against capital in excess of par value in the accompanying consolidated balance sheets under stockholders' equity.

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Restricted Stock Grants

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 On September 21, 2016, we entered into Restricted Stock Agreements (“2016 Agreements”) with three key employees for the grant of an aggregate total of 730,000 restricted shares of the Company's common stock (the “Shares”).  The Shares were granted, and the 2016 Agreements were entered into, pursuant to the Company’s Stock Award Plan (the “Plan”).  The award of the Shares was authorized by both the Committee and the Board as a whole on September 19, 2016.   Except for the number of shares granted to each recipient, the terms of each of the 2016 Agreements are identical.

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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.

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Stock Compensation Costs and Restricted Stock Activity

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Total stock compensation cost was $27,000 for each of the three months ended July 31, 2020 and 2019.

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Restricted stock activity for each three month period through July 31 is summarized as follows:

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NOTE 9—STOCKHOLDERS' EQUITY

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The shares of common stock outstanding as of each three month period ended as of July 31 are summarized as follows:

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NOTE 10—EARNINGS PER SHARE

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Basic and diluted earnings per share are computed using the two-class method. The two-class method is an earnings allocation formula that determines net income per share for each class of common stock and participating security according to dividends declared and participation rights in undistributed earnings. Per share amounts are computed by dividing net income attributable to common shareholders by the weighted average shares outstanding during each period.

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The basic earnings per common share were computed as follows:

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ASC 260, Earnings per Share, provides that unvested share-based payment awards that contain non-forfeitable rights to dividends are considered to be participating securities and must be considered in the computation of earnings per share pursuant to the two-class method.  Diluted earnings per share is not presented as we do not have any shares considered incremental and dilutive.

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NOTE 11—CONTRACT ASSETS

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For each of our contracts, the timing of revenue recognition, customer billings, and cash collections results in a net contract asset or liability at the end of each reporting period. Contract assets consist of unbilled receivables typically resulting from revenue recognition under contracts when either control has passed to the customer but the product has not yet shipped or the percentage-of-completion of revenue recognition is utilized when revenue recognized exceeds the amount billed to the customer for any project-related services, utilizing labor as the input method.

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Contract assets decreased $603,000 between July 31, 2020 and April 30, 2020 due to decreased satisfaction or partial satisfaction of customer contracts, and relates to the recognition of revenue related to the satisfaction or partial satisfaction of performance obligations for which we have not yet billed.

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NOTE 12 — CUSTOMER DEPOSITS

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For certain customers, we collect payment at the time the order is placed. These deposits are classified as a liability and will be recognized as revenue at the time performance obligations are satisfied in accordance with our revenue recognition policy. As of July 31, 2020 and April 30, 2020 we had $68,000 and $16,000, respectively in customer deposits related to this arrangement.

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NOTE 13 — CONCENTRATIONS OF CREDIT RISK

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Financial instruments that potentially subject us to concentrations of credit risk consist principally of cash and accounts receivable.  We grant unsecured credit to most of our customers.  We do not believe that we are exposed to any extraordinary credit risk as a result of this policy.  At various times cash balances exceeded federally insured limits. However, we have incurred no losses in the cash accounts and we do not believe we are exposed to any significant credit risk with respect to our cash.

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NOTE 14 – LEASED PROPERTY

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The Company adopted ASC 842 on May 1, 2019 using the modified retrospective transition method. Upon transition to the new standard, the Company elected the package of practical expedients, which permitted the Company not to reassess under the new standard its prior conclusions about lease identification, lease classification and initial direct costs.

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On February 15, 2019, a lease agreement became effective for tenant occupancy of the 23,924 square foot building owned by Torotel. Monthly installment payments of $11,500 began to be paid to us on March 1, 2019. The lease is for a sixty-two month term with monthly payments escalating periodically from $11,500 to $15,500. The tenant has the right to elect to purchase the building. The election to purchase must be made within the lease term or Torotel is not prohibited from placing the building up for public sale.

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Future minimum lease payments on the operating lease as of July 31, 2020 are as follows:

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Torotel’s leased property (where Torotel is the lessor) by asset category was as follows:

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Depreciation resulting from the leased property amounted to $23,000 and $13,000 during the three months ending July 31, 2020 and 2019, respectively.

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NOTE 15 – COVID-19 IMPACT

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The COVID-19 pandemic, first identified in Wuhan, Hubei Province, China, continues to spread worldwide, causing weakened international economic conditions. Torotel provides end products to the defense industry and is considered an essential business. We have been fully operating throughout the pandemic. Due to the concerns around the outbreak of COVID-19, we have implemented several new policies and procedures based on CDC recommendations. All of our employees who do not have critical functions requiring them to be on-site have been working remotely to lower the number of people within the facilities. For those employees required to work on-site, we have implemented new measures including increased distancing of workstations, closed access to common areas and meeting rooms, increased cleaning efforts, implemented face mask requirements, further restricted access to our premises by suppliers and customers, and other safety precautions. We expect to continue these changes for the foreseeable future. As a result of the pandemic, there is significant uncertainty around the U.S. and global economy, U.S. Department of Defense spending as a result of potential budget cuts, future customer demand, supply chain availability, oil price fluctuations, cash collections, and costs related to our changes to help ensure the safety and well-being of our employees. Late in the fourth quarter of fiscal 2020, we have experienced lower commercial aerospace sales as a result of COVID-19. Due to

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this change in sales and the significant uncertainties outlined above in April 2020, we applied for a loan under the Paycheck Protection Program (the “PPP”) of the 2020 Coronavirus Aid, Relief and Economic Security Act (the “CARES Act”) administered by the Small Business Association. On April 15, 2020, Torotel received $1.9 million in PPP funds. We believe we have used these funds from this loan only for the purposes included in the PPP, including payroll, employee benefits, rent, utilities and interest on certain finance agreements (See Note 6). The aerospace industry has seen large impacts from the pandemic and this has impacted some of our customers.  As identified in Note 4, our revenue from the commercial aerospace industry for the three month period ended July 31, 2020 and 2019 was $925,000 and $2,410,000, respectively.  The $1,485,000 decrease is primarily due to the pandemic impacts from lower commercial aerospace product demand. At the date of this filing, the full extent of which the COVID-19 pandemic may impact our financial condition or results of operations is uncertain.

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Forward-Looking Information

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This report, as well as our other reports filed with or furnished to the Securities and Exchange Commission (the “SEC”), contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended (the “Exchange Act”). The words “believe,” “estimate,” “anticipate,” “project,” “intend,” “expect,” “plan,” “outlook,” “forecast,” “may,” “should,” “predict,” and similar expressions are intended to identify forward-looking statements. Statements regarding expectations, including performance assumptions and estimates relating to capital requirements, as well as other statements that are not historical facts, are forward-looking statements. This report contains forward-looking statements regarding, among other topics, our expected financial position, results of operations, cash flows, strategy, budgets and management's plans and objectives. Accordingly, these forward-looking statements are based on management’s judgments based on currently available information and assumptions about a number of important factors. While we believe that our assumptions about such factors are reasonable, such factors involve risks and uncertainties that could cause actual results to differ materially from those in the forward-looking statements. These factors include,without limitation:

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In light of these risks and uncertainties, there can be no assurance that the forward-looking information contained in this report will prove accurate. Accordingly, our actual results may differ materially from these forward-looking statements. The reader should not place undue reliance on forward-looking statements, which speak only as of the date of this report. We assume no obligation to publicly update any forward-looking statements made herein to reflect events after the date of this report, including unforeseen events.

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Item 2.       Management’s Discussion and Analysis of Financial Condition and Results of Operations

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Overview

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Torotel, Inc. ("Torotel") conducts substantially all of its business primarily through its wholly owned subsidiary, Torotel Products, Inc. ("Torotel Products"). The terms “we,” “us,” “our,” and the “Company” as used herein include Torotel and all of its subsidiaries, including Torotel Products, unless the context otherwise requires. Torotel specializes in the custom design and manufacture of a wide variety of precision magnetic components consisting of transformers, inductors, reactors, chokes, toroidal coils, high voltage transformers, dry-type transformers and electro-mechanical assemblies for use in military, commercial aerospace and industrial electronic applications. These products are used to modify and control electrical voltages and currents in electronic devices. Torotel sells these products to original equipment manufacturers, which use them in applications such as:

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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.

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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.

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The industry mix of the customers that accounted for Torotel’s net sales for the first three months of the fiscal year ending April 30, 2021 (“fiscal year 2021”) was 81% defense, 15% commercial aerospace, and 4% industrial compared to 60% defense, 38% commercial aerospace, and 2% industrial for the same period in the fiscal year ending April 30, 2020 (“fiscal year 2020”).  Approximately 97% of Torotel’s sales during the first three months of fiscal year 2021 have been derived from domestic customers.

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Torotel is an approved source for magnetic components used in numerous military and commercial aerospace systems, which means Torotel is automatically solicited for any procurement needs for such applications.  The magnetic components manufactured by Torotel are sold primarily in the United States, and most sales are awarded on a competitive bid basis.  The markets in which Torotel competes are highly competitive.  A substantial number of companies sell components of the type manufactured and sold by Torotel.  In addition, Torotel sells to a number of customers who have the capability of manufacturing their own electronic components.  The principal methods of competition for electronic products in the markets served by Torotel include, among other factors, price, on-time delivery performance, lead times, customized product engineering and technical support, marketing capabilities, quality assurance, manufacturing efficiency, and existing relationships with customers’ engineers.  While we believe magnetic components are generally not susceptible

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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.

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COVID-19 Impact

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The COVID-19 pandemic, first identified in Wuhan, Hubei Province, China, continues to spread worldwide, causing weakened international economic conditions. Torotel is identified as an essential business as previously discussed within the “Business” section and we have been fully operating throughout the pandemic. Due to the concerns around the outbreak of COVID-19, we have implemented several new policies and procedures based on CDC recommendations. All of our employees who do not have critical functions requiring them to be on-site have been working remotely to lower the number of people within the facilities. For those employees required to work on-site, we have implemented new measures including increased distancing of workstations, closed access to common areas and meeting rooms, increased cleaning efforts, implemented face mask requirements, further restricted access to our premises by suppliers and customers, and other safety precautions. We expect to continue these changes for the foreseeable future. As a result of the pandemic, there is significant uncertainty around the U.S. and global economy, U.S. Department of Defense spending as a result of potential budget cuts, future customer demand, supply chain availability, oil price fluctuations, cash collections, and costs related to our changes to help ensure the safety and well-being of our employees. Late in the fourth quarter of fiscal 2020, we have experienced lower commercial aerospace sales as a result of COVID-19. In April 2020, we applied for a loan under the Paycheck Protection Program (the “PPP”) of the 2020 Coronavirus Aid, Relief and Economic Security Act (the “CARES Act”) administered by the Small Business Association. On April 15, 2020, Torotel received $1.9 million in PPP funds. We believe we have used these funds from this loan only for the purposes included in the PPP, including payroll, employee benefits, rent, utilities and interest on certain finance agreements (See Liquidity and Capital Resources).

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Business and Industry Considerations

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Defense Markets

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During the first three months of fiscal years 2021 and 2020 the amount of consolidated revenues derived from contracts with prime contractors of the U.S. Department of Defense (“DoD”) was approximately 81% and 60% respectively. As a result, our financial results in any period could be impacted substantially by spending cuts or increases in the DoD budget and the funds appropriated for certain military programs.

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Despite ongoing uncertainty associated with the DoD budget, we believe our overall defense business outlook remains favorable due to the present demand for the potted coil assembly and other existing orders from major defense contractors. As of July 31, 2020, our consolidated order backlog for the defense market was nearly $17.2 million, which included $11.3 million for the potted coil assembly.

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Commercial Aerospace and Industrial Markets

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We provide magnetic components and electro-mechanical assemblies for a variety of applications in the commercial aerospace and industrial markets. The primary demand drivers for these markets include commercial aircraft production orders, oil and gas drilling exploration activity, and general economic growth.  Each of these could have an ongoing impact due to the effects of the pandemic on commercial aircraft production, oil prices and general economic turmoil and uncertainty.  Producers of commercial aircraft have announced a decrease in the production of multiple models of aircraft.  This reduction has adversely impacted our commercial aerospace backlog and is expected to further impact our commercial aerospace business throughout fiscal year 2021.  Other threats to our near-term and long-term market outlook include delays on the development and production of new commercial aircraft and competition from international suppliers.  As of July 31, 2020, our consolidated order backlog for the aerospace and industrial markets was $3.3 million.

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Business Outlook

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Our backlog as of July 31, 2020 as compared to July 31, 2019 increased from $12.9 million to $20.5 million, a 58% increase. This was due primarily to an increase in the potted coil assembly orders. We anticipate that net sales for

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fiscal year 2021 will remain consistent with fiscal year 2020 primarily due to an expectation that a reduction of net sales within the commercial aerospace industry; may be partially offset by sales growth within the defense industry.  We anticipate that 67% of our $20.5 million backlog as of July 31, 2020 is expected to ship and be converted to sales in fiscal year 2021.  As noted previously, there are multiple uncertainties within our business associated with the COVID-19 pandemic; however, we anticipate that our large sales backlog and current defense industry opportunities will help maintain our current business outlook.

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