ITEM 7. Management's Discussion and Analysis of Financial Condition and Results of Operations
Torotel conducts substantially all of its business through its wholly owned subsidiary, Torotel Products. Until February 2, 2016, Torotel also operated Electronika, which was another wholly-owned subsidiary. Electronika was dissolved and its affairs wound up as of February 8, 2016. Because Electronika conducted business during the fiscal year ended April 30, 2016, its results of operations, through the date of its dissolution, are included in Torotel’s consolidated statement of operations for the comparative year ended April 30, 2016. As a result of the dissolution of Electronika, Torotel no longer sells ballast transformers.
Overview
Introduction
Torotel Products 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 Products sells these magnetic components and electro-mechanical assemblies to original equipment manufacturers, which use them in products such as:
aircraft navigational equipment;
digital control devices;
medical equipment;
avionics systems;
radar equipment;
down-hole drilling;
conventional missile guidance systems; and
other aerospace and defense applications.
We believe the primary factors that drive our gross profit and net earnings are sales volume and product mix. The gross profits on mature products/programs and complex transformer devices tend to be higher than those that are still in the prototyping or early production stages and simpler inductor devices. As a result, in any given accounting period the mix of product shipments between higher and lower margin products has a significant impact on our gross profit and net earnings. Our operating plan continues to focus on expanding the product base beyond electronic components.
The industry mix of Torotel Products' net sales in fiscal year 2017 was 54% defense, 39% commercial aerospace and 7% industrial compared to 55% defense, 40% commercial aerospace and 5% industrial in the fiscal year ended April 30, 2016 (“fiscal year 2016”). We believe the mix in the fiscal year ended April 30, 2018 (“fiscal year 2018”) will remain weighted primarily towards defense.
Business and Industry Considerations
Defense Markets
During fiscal years 2017 and 2016, the amount of consolidated revenues derived from contracts with prime contractors of the U.S. Department of Defense (“DoD”) was approximately 54% and 55%, respectively. Our financial results in any period could be impacted substantially by spending cuts in the DoD budget and the funds appropriated for certain military programs.
Despite ongoing uncertainty and potential constraints associated with the DoD budget, we believe our overall defense business outlook remains favorable due to the present demand for the potted coil assembly and other existing orders from major defense contractors. As of April 30, 2017, our consolidated order backlog for the defense market was nearly $6.0 million, which included approximately $4.3 million for the potted coil assembly.
Gross profit as a percentage of net sales in fiscal year 2016 increased 1% as compared to fiscal year 2015. The gross profit percentage of Torotel Products for fiscal year 2016 increased primarily due to higher direct margins associated with the product mix.
For fiscal year 2016, the gross profit percentage of Electronika represented less than 1% of consolidated gross profit.
Operating Expenses
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|
|
|
|
|
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Fiscal years ended April 30,
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2017
|
|
2016
|
Engineering
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$
|
906,000
|
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$
|
811,000
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Selling, general and administrative
|
|
4,738,000
|
|
|
3,643,000
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Total
|
$
|
5,644,000
|
|
$
|
4,454,000
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Engineering expense increased 12%, or $95,000, in fiscal year 2017 as compared to fiscal year 2016. This increase primarily resulted from an increase in compensation costs due to the hiring of additional engineers to provide expanded technical capabilities.
Engineering expense increased 9%, or $66,000, in fiscal year 2016 as compared to fiscal year 2015.
This increase primarily resulted from an increase in engineering headcount and software to provide expanded technical capabilities.
Selling, general and administrative expenses increased 30%, or $1,095,000, in fiscal year 2017 as compared to fiscal year 2016. The increase resulted from an increase in salaries and recruiting due to an increase in headcount and higher personnel costs, an increase in professional and consulting fees, an increase in non-capitalizable costs associated with the transition to the new facility, stock compensation amortization expense and an increase in occupancy costs related to the new facility.
Selling, general and administrative expenses increased 13%, or $426,000, in fiscal year 2016 as compared to fiscal year 2015. The increase resulted primarily from an increase in salaries due to an increase in headcount and higher personnel costs, as well as an increase in occupancy costs, and an increase in consulting and professional fees.
Earnings from Operations
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|
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|
|
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Fiscal years ended April 30,
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2017
|
|
2016
|
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Torotel Products
|
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$
|
303,000
|
|
$
|
1,223,000
|
|
Torotel
|
|
|
(692,000)
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|
|
(366,000)
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Total
|
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$
|
(389,000)
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$
|
857,000
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For the reasons discussed in the Net Sales, Gross Profit, and Operating Expenses found above, consolidated earnings from operations decreased by $1,246,000, in fiscal year 2017 as compared to fiscal year 2016, and increased by 174%, or $544,000, in fiscal year 2016 as compared to fiscal year 2015.
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"), and until early in the fourth quarter of the fiscal year ended April 30, 2016 also operated another wholly owned subsidiary, Electronika, Inc. ("Electronika") that licensed, marketed, and sold ballast transformers to the airline industry. Electronika was dissolved and its affairs wound up as of February 8, 2016. As a result of the dissolution of Electronika, Torotel no longer sells ballast transformers. 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, Inc. and its wholly owned subsidiaries, Torotel Products, Torotel Manufacturing Corporation, and Electronika (through Electronika’s date of dissolution). All significant inter-company accounts and transactions have been eliminated in consolidation.
Use of Estimates
The preparation of the consolidated financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect certain reported amounts and disclosures. Significant estimates used in preparing these consolidated financial statements include those assumed in computing the valuation allowance of inventory, the allowance for doubtful accounts receivable, the valuation allowance on deferred income tax assets, and the reserve for warranty costs. Accordingly, actual results could differ from those estimates. Any changes in estimates are recorded in the period in which they become known.
Credit Risk
Financial instruments that potentially subject us to concentrations of credit risk consist principally of cash and accounts receivable. We grant unsecured credit to most of our customers. We do not believe that we are exposed to any extraordinary credit risk as a result of this policy. At various times, and at April 30, 2017 and 2016, cash balances exceeded federally insured limits. We have not experienced any losses in the cash accounts and we do not believe we are exposed to any significant credit risk with respect to our cash.
Fair Value of Financial Instruments
We determine fair value by utilizing a fair value hierarchy that prioritizes observable and unobservable inputs used to measure fair value into three levels as follows:
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Level 1. Inputs to the valuation methodology are quoted prices (unadjusted) for identical assets or liabilities in active markets.
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Level 2. Inputs to the valuation methodology include quoted prices for similar assets and liabilities in active markets, and inputs that are observable for the asset or liability, either directly or indirectly, for substantially the full term of the financial instrument.
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Level 3. Inputs to the valuation methodology are unobservable and significant to the fair value measurement.
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The fair value hierarchy gives the highest priority to Level 1 inputs and the lowest priority to Level 3 inputs. In determining fair value, we utilize valuation techniques that maximize the use of observable inputs and minimize the use of unobservable inputs to the extent possible as well as consider counterparty credit risk in the assessment of fair value.
The carrying amounts of certain financial instruments, including cash, trade receivables and trade accounts payable approximate fair value due to their short maturities. As of April 30, 2017 and 2016, the amount of our long-term debt approximates fair value based on the present value of estimated future cash flows using a discount rate commensurate with a borrowing rate available to us. The inputs used to estimate the fair value of long-term debt are considered Level 2 inputs.
Treasury Stock
We utilize the weighted average cost method in accounting for treasury stock transactions.
Revenue Recognition
Revenue is recognized when a fixed price contract or purchase order exists; delivery has occurred; and collection is reasonably assured. Selling terms are generally FOB Shipping Point so we consider our products delivered once they have been shipped and title and risk of loss have been transferred.
Allowance for Doubtful Accounts
Gross trade accounts receivable are offset with an allowance for doubtful accounts. The allowance for doubtful accounts is our best estimate of the amount of probable credit losses in our existing accounts receivable. We review the allowance for doubtful accounts on a regular basis, and all past due balances are reviewed individually for collectability. Account balances are charged against the allowance when placed for collection. Recoveries of receivables previously written off are recorded when received. The majority of the customer accounts are considered past due after the invoice becomes older than the customer's credit terms. Interest is not charged on past due accounts. The allowance for doubtful accounts as of April 30, 2017 and 2016 was $12,000 and $12,000, respectively.
Inventories
Inventories are stated at the lower of cost or market. 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, 2017 and 2016 was $261,000 and $379,000, respectively.
Property, Plant and Equipment
Property, plant and equipment are carried at cost. Depreciation and amortization are provided in amounts sufficient to relate the costs of depreciable assets to operations primarily using the straight-line method over estimated useful lives of three to five years for equipment and three and a half to twenty years for buildings and improvements.
Cash
For purposes of the consolidated statements of cash flows, we consider all short-term investments and demand deposits purchased with original maturity dates of three months or less to be cash.
Income Taxes
Our annual tax rate is based on our income, statutory tax rates and tax planning opportunities available to us in the various jurisdictions in which we operate. Significant judgment is required in determining our annual tax rate and in
evaluating our tax positions. An estimated effective tax rate for a year is applied to our quarterly operating results. In the event there is a significant or unusual item recognized in our quarterly operating results, the tax attributable to that item is separately calculated and recorded at the same time as that item. Tax law requires items to be included in our tax returns at different times than the items are reflected in our financial statements. As a result, our annual tax rate reflected in our financial statements is different than that reported in our tax returns (our cash tax rate). Some of these differences are permanent, such as expenses that are not deductible in our tax return, and some differences reverse over time, such as depreciation expense. These temporary differences create deferred tax assets and liabilities. Deferred tax assets generally represent items that can be used as a tax deduction or credit in our tax returns in future years for which we have already recorded the tax benefit in our statement of operations. We establish valuation allowances for our deferred tax assets if, based on the available evidence, it is more likely than not that some portion or all of the deferred tax assets will not be realized. Deferred tax liabilities generally represent tax expense recognized in our financial statements for which payment has been deferred, or expense for which we have already taken a deduction in our tax return but have not yet recognized as expense in our financial statements. The accounting for uncertainty in income taxes requires a more-likely-than-not threshold for financial statement recognition and measurement of tax positions taken or expected to be taken in a tax return. If necessary, we record a liability for the difference between the benefit recognized and measured for financial statement purposes and the tax position taken or expected to be taken on our tax return. To the extent that our assessment of such tax positions changes, the change in estimate is recorded in the period in which the determination is made. If applicable in a given year, tax-related interest and penalties are classified as a component of income tax expense.
Advertising Costs
Advertising costs are expensed as incurred. For the years ended April 30, 2017 and 2016 advertising costs were $6,000 and $1,000, respectively.
Warranty Costs
We maintain a reserve for estimated warranty costs associated with products returned from customers. A limited warranty is provided for a period of one year which requires us to repair or replace defective products at no cost to the customer. The warranty reserve is based on historical experience and reflects management's best estimate of probable liability under the product warranties.
Share-Based Compensation
We have a share-based compensation plan that includes restricted stock, which is described more fully in Note 7 of the Notes to the Consolidated Financial Statements. We account for the share-based compensation plan in accordance with authoritative guidance under which the estimated fair value of share-based awards granted under our share-based compensation plan is recognized as compensation expense over the vesting period of the award.
New Accounting Guidance
In May 2014, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) No. 2014-09, Revenue from Contracts with Customers (Topic 606). The standard is effective for reporting periods beginning 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 contracts 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 rules 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 would be recognized at the date of initial application. The provisions of this new guidance are effective as of the beginning of Torotel’s first quarter of 2019. Torotel is currently evaluating the transition method to be used and the impact of adoption of this standard on its consolidated financial statements. Torotel does not anticipate the impact to be material
to the consolidated financial statements. The status of the implementation effort is in the preliminary stage. No significant implementation matters have been identified as needing to be addressed.
In November 2015, the FASB issued ASU No. 2015-17, Income Taxes (Topic 740): Balance Sheet Classification of Deferred Taxes. The standard requires that deferred tax assets and liabilities be classified as noncurrent on the balance sheet rather than being separated into current and noncurrent. The standard is effective for reporting periods beginning December 15, 2016. Early adoption is permitted and the standard may be applied either retrospectively or on a prospective basis to all deferred tax assets and liabilities. Torotel early adopted the standard during the third quarter of fiscal year 2016 on a retrospective basis.
In February 2016, the FASB issued ASU 2016-02,
Leases (Topic 842)
, in order to increase transparency and comparability among organizations by recognizing lease assets and lease liabilities on the balance sheet for those leases classified as operating leases under previous GAAP. ASU 2016-02 requires that a lessee should recognize a liability to make lease payments (the lease liability) and a right-of-use asset representing its right to use the underlying asset for the lease term on the balance sheet. ASU 2016-02 requires expanded disclosures about the nature and terms of lease agreements and is effective for annual reporting periods beginning after December 15, 2018, including interim periods within that reporting period. Early adoption is permitted. Torotel is currently evaluating the potential impact of this standard on its consolidated financial statements. Torotel anticipates the impact will be material to the consolidated financial statements for reporting periods beginning after December 15, 2018, due to the building lease amendment executed on October 31, 2016. The status of the implementation effort is in the preliminary stage. No significant implementation matters have been identified as needing to be addressed.
NOTE 2—INVENTORIES
The following table summarizes the components of inventories, as of April 30 of each year:
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2017
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|
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2016
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Raw materials
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$
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1,305,000
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$
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1,051,000
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Work in process
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|
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826,000
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|
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400,000
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Finished goods
|
|
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608,000
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|
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252,000
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|
|
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$
|
2,739,000
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$
|
1,703,000
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NOTE 3—FINANCING AGREEMENTS
On September 27, 2010, Torotel Products entered into a new financing agreement (the “agreement”) with Commerce Bank, N.A (the “Bank”). The agreement provides for a revolving line of credit, a guidance line of credit, and
a real estate term loan. Torotel serves as an additional guarantor to all notes described below. A summary of the notes issued under the agreement are provided below:
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2017
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|
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2016
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4.05% mortgage note payable in monthly installments of $4,873, including interest, with final payment of $349,000 due January 27, 2019
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$
|
415,000
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$
|
456,000
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4.00% line of credit with a maturity date of September 20, 2018
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465,000
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|
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-
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4.00% building line of credit with a maturity date of March 31, 2018
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-
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-
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Borrowings under an equipment financing line of credit:
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4.75% note payable in monthly installments of $2,269, including interest, with final payment due May 27, 2018
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28,000
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53,000
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3.75% note payable in monthly installments of $2,112, including interest, with final payment due April 10, 2018
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25,000
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49,000
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4.05% note payable in monthly installments of $3,680, including interest, with final payment due January 10, 2020
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115,000
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-
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Total long-term debt
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1,048,000
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558,000
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Less current installments
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603,000
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90,000
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Long-term debt, excluding current installments
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$
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445,000
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$
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468,000
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The working capital revolving line of credit, which is available for working capital purposes, is renewable annually. The associated interest rate is equal to the greater of the floating Commerce Bank Prime Rate (currently 4.00%) or a floor of 4% (as listed above). Monthly repayments of interest only are required with the principal due at maturity. The maximum borrowing of this line of credit is $500,000. This facility is cross collateralized and cross defaulted with all other facilities and is secured by a first lien on all business assets of Torotel Products.
On February 21, 2014, Torotel Products refinanced its mortgage note under the agreement with the Bank. No cash proceeds were received as a result of the refinancing. Prepayment of the new note up to $100,000 per year is allowed without penalty so long as these funds are generated through internal cash flow and not borrowed from a separate financial institution. The new note 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.
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.
On March 31, 2017, we entered into a $500,000 building revolving line of credit, which is available for working capital purposes and is renewable annually. The associated interest rate is equal to the greater of the floating Commerce Bank Prime Rate (currently 4.00%) or a floor of 4% (as listed above). Monthly repayments of interest only are required with the principal due at maturity. The maximum borrowing of this line of credit is $500,000. This facility is cross collateralized and cross defaulted with all other facilities and is secured by a first lien on the building located at 620 North Lindenwood Drive in Olathe, Kansas.
Torotel Products is also required to comply with specified financial covenants and as of April 30, 2017, Torotel Products was in compliance with these covenants.
The amount of long-term debt maturities by year is as follows:
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Year Ending April 30,
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Amount
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2018
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$
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603,000
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2019
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415,000
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2020
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30,000
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|
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$
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1,048,000
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Irrevocable Standby Letter of Credit
Under the terms of a lease amendment for its building located at 520 N. Rogers Road in Olathe, Kansas (see Note 5), Torotel provided the landlord an irrevocable standby letter of credit in the amount of $350,000 as additional security. The balance under the letter of credit will automatically reduce in accordance with the below schedule if not drawn upon:
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Date of Reduction
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Amount of Reduction
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Balance of Letter of Credit
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January 1, 2020
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$
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75,000
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$
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275,000
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January 1, 2021
|
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75,000
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200,000
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January 1, 2022
|
|
75,000
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|
125,000
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January 1, 2023
|
|
75,000
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|
50,000
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January 1, 2024
|
|
50,000
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-
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NOTE 4—INCOME TAXES
The components of the provision (benefit) for income taxes are as follows:
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2017
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2016
|
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Current tax expense (benefit)
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|
|
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Federal
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$
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2,000
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$
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9,000
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State
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|
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1,000
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|
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75,000
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|
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3,000
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|
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84,000
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Deferred tax expense (benefit)
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|
|
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Federal
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(137,000)
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254,000
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State
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(18,000)
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(10,000)
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|
|
|
(155,000)
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|
|
244,000
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Total income tax provision
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|
$
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(152,000)
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$
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328,000
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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:
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2017
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2016
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Computed tax expense at statutory rates
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$
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(144,000)
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$
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283,000
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Permanent differences
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6,000
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8,000
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State tax and credits
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(18,000)
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37,000
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Provision to Return Adjustment
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4,000
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(2,000)
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Increase in valuation allowance
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—
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2,000
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|
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$
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(152,000)
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$
|
328,000
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We have available as benefits to reduce future income taxes, subject to applicable limitations, estimated federal net operating loss carryforward amounts as described below. In addition, we have available to us federal and state tax credits that carry forward indefinitely.
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NOL
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Year of Expiration
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Carryforwards
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2027
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$
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82,000
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2030
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|
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28,000
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2032
|
|
|
298,000
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2037
|
|
|
726,000
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|
|
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$
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1,134,000
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The following table summarizes the components of the net deferred income tax asset:
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2017
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2016
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Net operating loss carryforwards
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$
|
420,000
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|
$
|
139,000
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Inventory valuation reserve
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101,000
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147,000
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Loss on equity and impairment in investee
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437,000
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|
437,000
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Tax credit carryforward
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68,000
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68,000
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Other
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|
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158,000
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|
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238,000
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|
|
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1,184,000
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|
|
1,029,000
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Less: valuation allowance
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(437,000)
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(437,000)
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$
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747,000
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$
|
592,000
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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, including future reversals of existing taxable temporary differences, projected future taxable income, tax planning strategies and recent financial operations. As of April 30, 2017, we do not anticipate the realization of a portion of our deferred income tax assets. The valuation allowance is specifically related to impairment on an investment that would result in a capital loss for tax purposes that we do not anticipate realizing due to the absence of offsetting capital gain income.
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 could affect our determination. We believe that our current valuation allowance is appropriate due to anticipated demand over the next few fiscal years related to continuing business in the aerospace and defense markets. We also believe that this demand should generate sufficient taxable earnings to enable us to realize our net deferred tax assets except as discussed above, thus outweighing any negative evidence concerning the cyclical and competitive nature of our industry. Also, we have achieved consistent taxable earnings in recent fiscal years, we have established a recent history of utilizing our net deferred tax asset, our available carryforward
periods of our net operating losses are of sufficient length and are at minimum risk of expiring unused, and our products are included in applications that generally have a longer lifecycle.
As of April 30, 2017, the federal tax returns for the fiscal years ended 2012 through 2016 are open to audit until the statute of limitations closes for the years in which the net operating losses are utilized. We recognize interest and penalties accrued on unrecognized tax benefits as well as interest received from favorable tax settlements within income tax expense. As of April 30, 2017, 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 5—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.
On October 31, 2016, Torotel entered into a Second Amendment (“Amendment”) to the lease for its Rogers Road facility located in Olathe, Kansas. The 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 Amendment provides that the monthly base rate in the first two years of the extended term is $26,844, escalating thereafter. The 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 Amendment addresses other terms and conditions by which Torotel may continue to lease the facility or terminate the lease, and provides Torotel two separate options to extend the lease term for additional five year periods.
Future minimum lease payments on operating leases are as follows:
|
|
|
Years Ending April 30,
|
|
|
|
|
|
2018
|
$
|
413,000
|
2019
|
|
413,000
|
2020
|
|
407,000
|
2021
|
|
402,000
|
2022
|
|
427,000
|
2023
|
|
442,000
|
2024
|
|
452,000
|
2025
|
|
456,000
|
2026
|
|
467,000
|
2027
|
|
350,000
|
Total
|
$
|
4,229,000
|
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 years ended April 30, 2017 and 2016 was $246,000 and $193,000, respectively.
As of April 30, 2017, the property owned by Torotel at 620 N. Lindenwood in Olathe, Kansas had a net carrying value of approximately $688,000, and is listed on the market for immediate sale. The property is currently accounted for as a capital asset at historical cost less depreciation.
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 6—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, 2017 and 2016, total short-term cash incentive plan expense was $0 and $0, respectively.
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, 2017 and 2016, total long-term cash incentive plan expense was $0 for both years.
Performance Bonus
We provided discretionary performance bonuses for employees not participating in the above incentive plans. Total expense for these bonuses was $0 and $176,000 for the years ended April 30, 2017 and 2016.
401(k) Retirement Plan
We have a 401(k) Retirement Plan for Torotel Products' 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, 2017 and 2016 were $86,000 and $35,000, respectively.
NOTE 7—RESTRICTED STOCK AGREEMENTS
Restricted Stock Agreements, and stock awards thereunder, are authorized by the Compensation and Nominating Committee ("Committee") and the Board of Directors of Torotel. 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 agreements further provide, subject to certain conditions, that if prior to all of the restricted shares having been released, we undergo a change in control, then all of the restricted shares shall be released and no longer subject to restrictions under the 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.
2013 Restricted Stock Grants
On June 17, 2013, we entered into Restricted Stock Agreements with three key employees pursuant to the SAP. The aggregate amount of the restricted stock awards was 400,000 shares of common stock. 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 aggregate 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 (or a subsidiary thereof) 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. However, due to updated projections developed in the third quarter of fiscal year 2016, the likelihood of achieving the financial performance metrics as outlined in each Restricted Stock Agreement was classified as not probable. As a result, we stopped amortizing the stock compensation cost associated with the restricted stock awarded on July 17, 2013 and recovered the previously amortized stock compensation cost of $88,000 in the third quarter ended January 31, 2016. The 350,000 shares associated with the Restricted Stock Agreements dated June 17, 2013 were reverted to treasury shares during the fiscal year 2017.
2016 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 Plan. The award of the Shares was authorized by both the Committee and the Board as a whole on September 19, 2016. Except for the number of shares granted to each recipient, the terms of each of the 2016 Agreements are identical.
The Shares were granted subject to restrictions that prohibit them from being sold, assigned, pledged or otherwise disposed of until the restrictions lapse. The restrictions will lapse on the fifth anniversary of the date of grant if during the five year restriction period, (1) the Company’s cumulative annual growth in revenue is at least 10%, and (2) the average economic value added as a percentage of revenue is at least 2%. The economic value added, which attempts to capture the true economic profit, will be calculated as the operating profit less the cost of capital with adjustments made for taxes. The restrictions will also lapse, if prior to the fifth anniversary of the date of grant, (1) the grantee’s employment with the Company is terminated by reason of disability, (2) the grantee dies, or (3) the Committee, in its sole discretion, terminates the restrictions. If the restrictions on the Shares have not lapsed by the fifth anniversary of the date of grant, the Shares will be forfeited to the Company.
Total stock compensation cost for the years ended April 30, 2017 and 2016 was an expense of $61,000 and a credit of $65,000, respectively. Restricted stock activity for each period through April 30, 2017 and 2016 is summarized as follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
2017
|
2016
|
|
|
|
Restricted
|
|
Weighted
|
|
Restricted
|
|
Weighted
|
|
|
|
Shares
|
|
Average
|
|
Shares
|
|
Average
|
|
|
|
Under
|
|
Grant
|
|
Under
|
|
Grant
|
|
|
|
Option
|
|
Price
|
|
Option
|
|
Price
|
|
Outstanding at May 1
|
|
350,000
|
|
$
|
0.500
|
|
350,000
|
|
$
|
0.500
|
|
Granted
|
|
730,000
|
|
|
0.740
|
|
—
|
|
|
—
|
|
Vested
|
|
—
|
|
|
—
|
|
—
|
|
|
—
|
|
Forfeited
|
|
(350,000)
|
|
|
0.500
|
|
—
|
|
|
—
|
|
Outstanding at April 30
|
|
730,000
|
|
$
|
0.740
|
|
350,000
|
|
$
|
0.500
|
|
NOTE 8—STOCKHOLDERS' EQUITY
The changes in shares of common stock outstanding as of April 30 of each year are summarized as follows:
|
|
|
|
|
|
|
|
2017
|
|
2016
|
|
Balance, May 1
|
$
|
5,615,750
|
$
|
5,615,750
|
|
Shares released from treasury for restricted stock grants
|
|
717,795
|
|
—
|
|
Newly issued shares for restricted stock grants
|
|
12,205
|
|
—
|
|
Shares reverted to treasury for restricted stock forfeitures
|
|
(350,000)
|
|
—
|
|
Balance, April 30
|
$
|
5,995,750
|
$
|
5,615,750
|
|
NOTE 9—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:
|
|
|
|
|
|
|
|
|
|
Year Ended
|
|
|
|
2017
|
|
2016
|
|
Net earnings (loss)
|
|
$
|
(261,000)
|
|
$
|
504,000
|
|
Amounts allocated to participating securities (nonvested restricted shares)
|
|
|
—
|
|
|
(2,000)
|
|
Net income attributable to common shareholders
|
|
$
|
(261,000)
|
|
$
|
502,000
|
|
Basic weighted average common shares
|
|
|
5,123,000
|
|
|
5,266,000
|
|
Earnings per share attributable to common shareholders:
|
|
|
|
|
|
|
|
Basic earnings per share
|
|
$
|
(0.05)
|
|
$
|
0.10
|
|
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 10—ACCRUED LIABILITIES
Accrued liabilities as of April 30 of each year consist of the following:
|
|
|
|
|
|
|
|
|
|
2017
|
|
2016
|
|
Employee related expenses:
|
|
|
|
|
|
|
|
Accrued payroll
|
|
$
|
68,000
|
|
$
|
236,000
|
|
Accrued payroll taxes
|
|
|
5,000
|
|
|
19,000
|
|
Accrued employee benefits
|
|
|
136,000
|
|
|
115,000
|
|
|
|
$
|
209,000
|
|
$
|
370,000
|
|
Other, including interest:
|
|
|
|
|
|
|
|
Warranty reserve
|
|
$
|
24,000
|
|
$
|
67,000
|
|
Property taxes
|
|
|
20,000
|
|
|
31,000
|
|
Other
|
|
|
66,000
|
|
|
—
|
|
|
|
$
|
110,000
|
|
$
|
98,000
|
|
|
|
$
|
319,000
|
|
$
|
468,000
|
|
The changes in warranty reserve as of April 30 of each year are summarized as follows:
|
|
|
|
|
|
|
|
|
|
2017
|
|
2016
|
|
Balance, May 1
|
|
$
|
67,000
|
|
$
|
75,000
|
|
Credit memos issued
|
|
|
(161,000)
|
|
|
(165,000)
|
|
Provision for warranty accrual
|
|
|
118,000
|
|
|
157,000
|
|
Balance, April 30
|
|
$
|
24,000
|
|
$
|
67,000
|
|
NOTE 11—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 April 30, 2017 and April 30, 2016 we had approximately $33,000 and $29,000, respectively in customer deposits related to this arrangement.
NOTE 12—SELF-INSURANCE CAPTIVE
We are a member of a limited liability company formed as an insurance association captive (the "captive") in order to provide partially self-insured health benefits to our employees that elect coverage under the plan. Our membership percentage in this captive is approximately 0.5% and represents an investment of $87,000. Therefore, our investment is accounted for utilizing the cost method of accounting. Our risk of loss is limited to our investment in the captive and we are not required to fund additional capital to the captive in the event of negative capital accounts. Our share of net income from the captive is based on our ratio of contribution to the captive. No income has been allocated in either fiscal year 2016 or 2017.
We maintain a reserve for incurred but not reported medical claims and claim development. Our reserve is an estimate based on historical experience and other assumptions, some of which are subjective. We adjust our self-insured medical benefits reserve as we experience changes due to medical inflation, changes in the number of plan participants and changes to specific cases. Our total reserve for these claims for the fiscal years ended April 30, 2017 and 2016 was $28,000 and $32,000 respectively.
NOTE 13—SEGMENT INFORMATION
Torotel reports the manufacturing, marketing, selling and distribution of precision magnetic components, consisting of transformers, inductors, reactors, chokes, toroidal coils, high voltage transformers, dry-type transformers,
and electro-mechanical assemblies as one operating and one reportable segment. Torotel's chief operating decision maker is its Chief Executive Officer, who reviews financial information on a consolidated basis for purposes of making operating decisions and assessing financial performance.
Torotel’s net sales by product line and geography for the periods presented were as follows:
|
|
|
|
|
|
|
|
|
|
|
|
Years ended April 30
|
|
2017
|
|
2016
|
|
Torotel Products:
|
|
|
|
|
|
|
|
Magnetic components
|
|
$
|
7,924,000
|
|
$
|
8,339,000
|
|
Potted coil assembly
|
|
|
5,268,000
|
|
|
4,989,000
|
|
Electro-mechanical assemblies
|
|
|
3,098,000
|
|
|
2,716,000
|
|
Large Transformers
|
|
|
12,000
|
|
|
150,000
|
|
Total Torotel Products
|
|
$
|
16,302,000
|
|
$
|
16,194,000
|
|
|
|
|
|
|
|
|
Years ended April 30,
|
|
2017
|
|
2016
|
Domestic
|
|
$
|
14,755,000
|
|
$
|
15,022,000
|
Foreign
|
|
|
1,547,000
|
|
|
1,172,000
|
Total consolidated net sales
|
|
$
|
16,302,000
|
|
$
|
16,194,000
|
Torotel Products currently has a primary base of approximately 18 customers that provide nearly 90% of its annual sales volume. Sales to two major customers as a percentage of consolidated net sales for the year ended April 30, 2017 was 34% and 23% respectively. Sales to two major customers as a percentage of consolidated net sales for the year ended April 30, 2016 was 35% and 28% respectively.
NOTE 14—RELOCATION AND NEW FACILITY COSTS
Torotel incurred $609,000 in costs related to the move to the new facility over the last six months of fiscal 2017. $401,000 of the costs were capitalized as leasehold improvements and equipment related to the new space, including reconfiguration of support rooms, electrical, ventilation, and exhaust work. $208,000 of the costs were expensed as a period cost, including furniture, IT and office equipment below the company capitalization rate and payments to the moving company.