Torotel Inc (TTLO) SEC Quarterly Report (10-Q) for Q3 2015

Washington, D.C.  20549

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

For the quarterly period ended July 31 ,   2015

or

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

For the transition period from [     ] to [     ]

Commission File No. 1-8125

(Exact name of registrant as specified in its charter)

(913) 747-6111

(Registrant's telephone number, including area code)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.  Yes  ☒   No  ☐

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted 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 and post such files).  Yes  ☒  No  ☐

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company.  See the definitions of "large accelerated filer," "accelerated filer" and "smaller reporting company" in Rule 12b-2 of the Exchange Act.

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

As of September 1 1 , 2015, there were 5,615,750 shares of Common Stock, $.01 par value, outstanding.

TOROTEL, INC AND SUBSIDIARIES

INDEX

PA RT I . FINANCIAL INFORMATION

Item 1 . Financial Statements

CONSOLIDATED CONDENSED BALANCE SHEET S

The accompanying notes are an integral part of these statements.

CONSOLIDATED STATEMENTS OF OPERATION S (Unaudited)

The accompanying notes are an integral part of these statements.

CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited)

The accompanying notes are an integral part of these statements.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

NOTE 1 - BASIS OF PRESENTATION

The consolidated condensed balance sheet as of April 30, 2015 , which has been derived from the audited financial statements of Torotel, Inc. ("Torotel"), 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 ,   2015 , and the consolidated results of o perations for the three months ended July 31 ,   2015 , and 2014 , respectively. 

The unaudited interim consolidated condensed financial statements have been prepared pursuant to the rules and regulations of the Securities and Exchange Commission ("SEC").  Certain information and note disclosures normally included in the annual financial statements prepared in accordance with generally accepted accounting principles have been condensed or omitted pursuant to those rules and regulations, although management believes the disclosures made are adequate to make the information not misleading. The financial statements contained herein should be read in conjunction with Torotel's consolidated financial statements and related notes filed on Torotel's Form 10-K for the year ended April 30, 2015 as filed with the SEC on July 2 , 201 5 .

In May 2014, the Financial Accounting Standards Board ("FASB") issued Accounting Standards Update ("ASU") No. 2014-09, Revenue from Contracts with Customers (Topic 606). The standard is effective for reporting periods b eginning after December 15, 2017 and early adoption permitted for reporting periods beginning after December 15, 2016 . The standard will supersede existing revenue recognition guidance, including industry-specific guidance, and will provide companies with a single revenue recognition model for recognizing revenue from contrac ts with customers. The standard requires revenue to be recognized when promised goods or services are transferred to customers in amounts that reflect the consideration to which the company expects to be entitled in exchange for those goods or services. Adoption of the new r ules could affect the timing of revenue recognition for certain transactions. The two permitted transition methods under the new standard are the full retrospective method, in which case the standard would be applied to each prior reporting period presented, or the modified retrospective method, in which case the cumulative effect of applying the standard woul d be recognized at the date of initial application. The provisions of thi s new guidance are effective as of the beginning of Torote l's first fiscal quarter of 2018 . Torotel is currently evaluating the transition method to be used and the impact of adoption of this standard on its consolidated financial statements.

NOTE 2 - NATURE OF OPERATIONS

Torotel conducts business primarily through its wholly owned subsidiary, Torotel Products, Inc. ("Torotel Products"), but also operates another wholly owned subsidiary, Electronika, Inc. ("Electronika").  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 commercial, industrial and military electronics.  Torotel also distributes ballast transformers for the airline industry.

NOTE 3-INVENTORIES

The following table summarizes the components of inventories:

NOTE 4-FINANCING AGREEMENTS

Torotel Products has a financing agreement (the "financing agreement") with Commerce Bank, N.A (the "Bank").  The financing agreement provides for a revolving line of credit, a guidance line of credit, and a real estate term loan. Both Torotel and Electronika serve as additional guarantors to all notes described below. A summary of the notes withi n the financing agreement is provided below:

The revolving line of credit, to be used for working capital purposes, is renewable annually.  The associated interest rate is equal to the greater of the floating Commerce Bank Prime Rate (currently 3.25%) or a floor of 4% (as listed above).  Monthly repayments of interest only are required with the principal due at maturity.  The maximum borrowing of this line of credit is $500,000 .  This facility is cross collateralized and cross defaulted with all other facilities of Torotel Products and is secured by a first lien on all business assets of Torotel Products. 

The mortgage note requires monthly payments consisting of both interest and principal.  This facility is cross collateralized and cross defaulted with all other facilities of Torotel Products and is secured by a first real estate mortgage on the property located at 620 North Lindenwood Drive in Olathe, Kansas. This loan was refinanced on February 21, 2014 with a principal amount of $5 42,000 .  

The equipment note is a guidance line of credit to be used for equipment purchases. Monthly repayments consisting of both interest and principal are required. This facility is cross collateralized and cross defaulted with all other facilities of Torotel Products and is secured by a purchase money security interest in the assets purchased as well as a first lien on all business assets of Torotel Products.  The maximum borrowing of this line of credit is $500,000 .

Torotel is also required to comply with specified financial covenants in its guaranty of the financing agreement. As of July 31 ,   2015 , Torotel was in compliance with these covenants.

NOTE 5-INCOME TAXES

As of July 31 ,   2015 , the federal tax returns for the fiscal years ended 201 1 through 201 5 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 ,   2015 , 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 6-RESTRICTED STOCK AGREEMENTS

Restricted Stock Agreements are authorized by the Compensation and Nominating Committee (the "Committee") and the Board of Directors of Torotel (the "Board"). The Committee and the Board have determined that the interests of Torotel and its stockholders will be promoted by hiring talented individuals and, to induce such individuals to accept employment with Torotel, the Committee and the Board believe a key component of such individuals' compensation should be granting equity ownership opportunities based upon the acceptance of employment and the continuing employment of such individuals, subject to certain conditions and restrictions. 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.

On June 17, 2013, we entered into Restricted Stock Agreements with three  key employees pursuant to the SAP ("Stock Appreciation Plan"). The aggregate amount of the restricted stock awards was 400,000 shares of common stock, 0.01 par value per share. These shares were transferred from treasury shares. Based on the market price of $0.50 for our common stock as of June 17, 2013, the fair value of the restricted stock at the date of award was $200,000 . The shares issued pursuant to the Restricted Stock Agreements on June 17, 2013 are restricted and may not be 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 (5) year restriction period, (1) Torotel's cumulative annual growth in earnings before interest and taxes ("EBIT") is at least 10% and (2) Torotel's average return on capital employed ("ROCE") is at least 25% . The restrictions will also lapse, if prior to the fifth anniversary of the date of grant, (1) the grantee's employment with Torotel 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 such shares have not lapsed by the fifth anniversary of the date of grant, such shares will be forfeited to Torotel.  Stock compensation cost net of an appropriate pre-vesting forfeiture rate is recorded per quarter for the remainder of the vesting period provided the financial performance metrics as outlined in the SAP are likely to be attained.

Total stock compen sation cost for the three months ended July 31 ,   2015  and  2014  was $8 ,000 and $4 ,000, respectively.

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

NOTE 7-STOCKHOLDERS' EQUITY

The changes in shares of common stock outstanding as of July 31 of each year are summarized as follows:

NOTE 8-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:

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 9 -CUSTOMER DEPOSITS

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 of shipment in accordance with our revenue recognition policy.  As of July 31 ,   2015 we had approximately $86 ,000 in customer deposits related to these arrangements.

NOTE 1 0 - CONCENTRATIONS OF CREDIT RISK

Financial instruments that potentially subject us to concentrations of credit risk consist principally of cash and accounts receivable.  We grant unsecured credit to most of our customers.  We do not believe that we are exposed to any extraordinary credit risk as a result of this policy.  At various times, and at  July 31 ,   2015 , 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.

Forward-Looking Information

This report, as well as our other reports filed with or furnished to the Securities and Exchange Commission ("SEC"), contains forward-looking statements made pursuant to the safe harbor provisions of The Private Securities Litigation Reform Act of 1995. The words "believe," "estimate," "anticipate," "project," "intend," "expect," "plan," "outlook," "forecast," "may," "will," "should," "continue," "predict" and similar expressions are intended to identify 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 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 be different from what appear here. These risk factors include,without limitation:

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. We assume no obligation to update any forward-looking statements made herein.

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

Overview

Torotel, Inc. ("Torotel") conducts business primarily through its wholly owned subsidiary, Torotel Products, Inc. ("Torotel Products"), but it also operates another wholly owned subsidiary, Electronika, Inc. ("Electronika").

Torotel Products is engaged 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 Products sells these products to original equipment manufacturers, which use them in applications such as:

Torotel Products markets its components primarily through an internal sales force and independent manufacturers' representatives paid on a commission basis.  These commissions are earned when a product is sold and/or shipped to a customer within the representative's assigned territory.  Torotel Products 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 Products' net sa les for the first three months of fiscal year 2016 was 54 % defense, 4 1 % commercial aerosp ace, and 5 % industrial compared to 58% defense, 30% commercial aerospace, 12 % industrial for the same period in fiscal year 2015 .  Also, approximately 93 % of Torotel Produ cts' sales during the first three months of fiscal year 2016 have been derived from domestic customers.

Torotel Products is an approved source for magnetic components used in numerous military and commercial aerospace systems, which means Torotel Products is automatically solicited for any procurement needs for such applications.  The magnetic components manufactured by Torotel Products are sold primarily in the United States, and most sales are awarded on a competitive bid basis.  The markets in which Torotel Products competes are highly competitive.  A substantial number of companies sell components of the type manufactured and sold by Torotel Products.  In addition, Torotel Products 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 Products 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 not susceptible to rapid technological change, Torotel Products' sales, which do not represent a significant share of the industry's market, are susceptible to decline given the competitive nature of the market.

Business and Industry Considerations

Defense Markets

During the first three months of fiscal years 2016 and 2015 , the amount of consolidated revenues derived from contracts with prime contractors of the U.S. Department of Defense ("DoD") was approxi mately 54 % and 58 % respectively.   While we attempt to diversify the military programs and customers that we pursue, our financial results in

any period could be impacted substantially by both future changes in DoD funding priorities and the diversity of our portfolio of military programs containing Torotel manufactured components. At this time, we believe our overall defense business outlook remains favorable due to the present demand for the potted coil assembly for the Hellfire II missile system and other existing orders from major defense contractors. As of July 31, 2015, our consolidated order backlog for the defense market was nearly $3.0  million, which included $1.8 million for the potted coil assembly.

Commercial Aerospace and Industrial Markets

We provide magnetic components and electro-mechanical assemblies for a variety of applications in the commercial aerospace and industrial markets. The primary demand drivers for these markets include commercial aircraft orders, oil and gas drilling exploration activity, and general economic growth. While global economic growth remains positive, the above demand drivers could be impacted by short-term changes in the economy such as spikes in the price of oil, war, terrorism, or changes in regulation. Other threats to our anticipated positive near-term and long-term market outlook include delays on the development and production of new commercial aircraft and competition from international suppliers. As of July 31 ,   2015 , our consolidated order backlog for the aerospace and industrial markets was $4.0 million.

Business Outlook

Our orde r activity during the first three months of fiscal year 2016 increased nearly 14% to $7 .0 million compared to the same period last year.  This order rate included $1 . 8 million for the potted coil assembly used on the Hellfire II missile system, $2.2 million for electro-mechanical assemblies and $3.0 million for magnetic components.  We do anticipate an additional contract award for the potted coil assembly in fiscal year 2016 .  Our backlog of orders scheduled to ship during fiscal year 2016 should enable us to excee d last year's net sales of $13.6 million.  We anticipate profits to improve as we focus on gaining efficiencies from our fixed production costs related to establishing the manufacturing and quality support structure needed to produce at a higher sales volume .

Consolidated Results of Operations

The following management comments regarding Torotel's results of operations and outlook should be read in conjunction with the Consolidated Condensed Financial Statements and Notes to the Consolidated Condensed Financial Statements included in Part I, Item 1 of this Quarterly Report.

This discussion and analysis of the results of operations include the operations of Torotel and its subsidiaries, Torotel Products and Electronika.  While each company's results are included separately in the following discussion, segment reporting is not applicable because the products offered are similar in form and function, and target similar markets.

Net Sales

Consolidated net sal es in the three months ended July 31 ,   2015 increased 50%, or $1,359 ,000.  Torotel Products' net sale s increased during the three months primarily because of higher volume in magnetics and assemblies in the three months ended July 31 ,   2015 The increase in magnetics was expected as a number of new products were in the qualification

process until the first quarter of the 2016 fiscal year. Electro-mechanical assemblies increased due to a large order placed in the quarter .   We anticipate that overall shipments will increase during the remainder of fiscal year 2016 .  Electronika's sales continue to fluctuate within a small range as overall demand for the ballast transformers is very limited.

Gross Profit

Consolidated gross profit in creased by 54 %, or $4 52 ,000, in the three months ended July 31 ,   2015 . The gross profit of Torotel Produ cts in creased in the three months ended because of an increase in magnetics and assemblies net sales as well as a more favorable product mix .

Operating Expenses

Engineering expen ses increased nearly 7%, or $12 ,000, in the three months ended July 31 ,   2015 .  These increases were primarily due to an increase in engineering headcount related to an expansion of our engineering design capabilities and consulting . These were offset slightly by a decrease in travel.

Selling, general and administrative expenses increased 18%, or $154 ,000 in the three months ended July 31 ,   2015 .   The in crease in the three month period resulted from a $61,000 increase in consulting expense; a $56,000 increase in salaries and wages due to an increase in headcount; a $48,000 increase in inform ation technology related to compliance with new security standards ; a $3 0,000 increase in training and a $20,0 00 increase in commissions due to a change in mix of assembly sales .  These in crease s were partially offset by  a $53 ,000 de crease related to recruiting costs and an $8,000 decrease in employee relations .

Earnings from Operations

For the reasons discussed above, consolidated earnings from operations increased by 164 %, or $29 6 ,000 for the three months ended July 31 ,   2015 and 2014, respectively.

Other Earnings Items

We anticipate that our effective income tax rate for fiscal year 2015 will be  38.5 %.  The ef fective income tax rate was 38.5 % for the same period in the prior year. For additional discussion related to Income Taxes, see Note 5 of Notes to Consolidated Financial Statements.

Return on Capital Employed

Return on capital employed ("ROCE") is the primary benchmark used by management to evaluate Torotel's performance. ROCE measures how effectively and efficiently net operating assets ("NOA") are used to generate earnings before interest and taxes. For these purposes, NOA, or capital employed, is defined as "accounts receivable + inventory + net fixed assets + miscellaneous operating assets - accounts payable - miscellaneous operating liabilities." The performance of Torotel's management and the majority of its decisions will be measured by whether Torotel's ROCE improves. For the fiscal years ended April 30, 2015  and 2014 , Torotel's ROCE was 7.66 % and 20.70 %, respectively. The ROCE for the 12-month trailing period ended July 31 ,   2015 was 13.16 %. This change in ROCE is attributable to high er sales as well as an operating loss in the first three months of fiscal year 2015 .  

Financial Condition and Liquidity

Cash generated by operations is our primary source of liquidity. The following table highlights the funds available to us as of  July 31 ,   2015  and  2014 :

Operating Activities

The increase of $356 ,000 between fiscal years 2016 and 2015 is primarily due to a n in crease in earnings from operations, a   decrease in accrued liabilities, an increase in inventories, an increase in deferred income taxes, and a n increase in customer deposits.

Investing Activities

The change of  $19 ,000 in n et cash in investing activities was due to higher capital expenditures in fiscal year  2016  as compared to fiscal year  2015 . Capital expenditures during fiscal year  2016  and 2015 were primarily related to purchases of new production equipment and machinery. We expect capital expenditure s pending to continue during fiscal year 2016 which is consistent with the anticipated needs of our business .

Financing Activities

We have used cash generated by operating activities as the primary source for the repayment of our debt. The change of  $108 ,000  between fiscal year  2016  an d fiscal year  2015  is due to proceeds received of $100,000 from additional borrowing on our existing equipment loan to purchase additional machinery and equipment in fiscal year 2015 and repayment of our debt in fiscal year 2016 .

Capital Resources

We believe the projected cash flow from operations, combined with existing cash balances, will be sufficient to meet funding requirements for the foreseeable future.  Torotel has a $500,000 bank line of credit available, which we anticipate could be utilized to help fund any working capital requirements. As of July 31 ,   2015 , the entire credit line was available and we have not utilized this credit line in fiscal year 2016 .

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

Critical Accounting Policies

We discuss our critical accounting policies and estimates in Item 7, "Management's Discussion and Analysis of Financial Condition and Results of Operations," in our Annual Report on Form 10-K for the year ended April 30, 2015 filed with the SEC on July 2, 2015 . We have made no significant change in our critical accounting policies since April 30, 2015 .

Item 3.            Quantitative and Qualitative Disclosures About Market Risk

Not Applicable

Item 4.             Controls and Procedures

Evaluation of Disclosure Controls and Procedures

Torotel's management, with the participation of its Chief Executive Officer and Chief Financial Officer, has evaluated the effectiveness of Torotel's disclosure controls and procedures, as such term is defined in Rule 13a-15(e) under the Securities Exchange Act of 1934, as amended as of the end of the period covered by this report.  Based on such evaluation, the Chief Executive Officer and the Chief Financial Officer have concluded that Torotel's disclosure controls and procedures are effective as of the end of the period covered by this report.

Changes in Internal Control

There were no significant changes in Torotel's internal control over financial reporting or in other factors that in management's estimates have materially affected, or are reasonably likely to materially affect, Torotel's internal control over financial reporting during the fiscal quarter covered by this quarterly report on Form 10-Q.

PART II .   OTHER INFORMATION

Item 6 .   Exhibits

a)  Exhibits

SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.