TOROTEL, INC. Overview
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 includeTorotel 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: · aircraft navigational equipment; · digital control devices; · airport runway lighting devices; · medical equipment; · avionics systems; · radar systems; · down-hole drilling; · conventional missile guidance systems; and · other aerospace and defense applications.Torotel 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 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 the customers that accounted forTorotel's net sales for the first nine months of the fiscal year endingApril 30, 2020 ("fiscal year 2020") was 59% defense, 39% commercial aerospace, and 2% industrial compared to 47% defense, 48% commercial aerospace, and 5% industrial for the same period in the fiscal year endingApril 30, 2019 ("fiscal year 2019"). Approximately 97% ofTorotel's sales during the first nine months of fiscal year 2020 have been derived from domestic customers.Torotel is an approved source for magnetic components used in numerous military and commercial aerospace systems, which meansTorotel is automatically solicited for any procurement needs for such applications. The magnetic components manufactured byTorotel are sold primarily inthe United States , and most sales are awarded on a competitive bid basis. The markets in whichTorotel competes are highly competitive. A substantial number of companies sell components of the type manufactured and sold byTorotel . 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 byTorotel 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 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.
Business and Industry Considerations
Defense Markets
During the first nine months of fiscal years 2020 and 2019 the amount of
consolidated revenues derived from contracts with prime contractors of the
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respectively. As a result, our financial results in any period could be impacted
substantially by spending cuts or increases in the
Despite ongoing uncertainty associated with theDoD 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 ofJanuary 31, 2020 , our consolidated order backlog for the defense market was nearly$12.0 million , which included$6.7 million for the potted coil assembly.
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 domestic economic growth remains positive, the above demand drivers could be impacted by short-term changes in the economy such as spikes or declines in the price of oil, war, terrorism, or changes in 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 ofJanuary 31, 2020 , our consolidated order backlog for the aerospace and industrial markets was$4.8 million . However, a material portion of our business has been converted to long-term agreements. Business Outlook Our backlog as ofJanuary 31, 2020 as compared toJanuary 31, 2019 increased from$16.5 million to$16.9 million , a 2% increase. This was due primarily to an increase in the potted coil assembly orders. We anticipate that net sales for the full fiscal year 2020 will improve from net sales for fiscal year 2019. This is primarily due to the timing of newer program revenue that is projected to ship in fiscal year 2020. We anticipate that 41% of our$16.9 million backlog as ofJanuary 31, 2020 is expected to ship and be converted to sales in fiscal year 2020. Proposed Merger As previously reported, onNovember 26, 2019 we entered into the Merger Agreement with Standex. The Merger Agreement provides that, upon the terms and subject to the conditions set forth therein and in accordance with applicable law, the Company will merge with and into Merger Sub, with the Company continuing as the surviving entity. Pursuant to the terms and subject to the conditions set forth in the Merger Agreement, at the effective time of the Merger each issued and outstanding share of the Company's common stock will be cancelled and converted into the right to receive$7.77 per share in cash (the "Merger Consideration"). The Company will cause any shares of Company restricted common stock outstanding and subject to vesting conditions as of the effective time of the Merger (whether vested or unvested) to become fully vested and free of any restrictions immediately prior to the effective time, and such shares will be entitled to receive the Merger Consideration, subject to any applicable withholdings. OnFebruary 12, 2020 , the Company held a special meeting of its shareholders (the "Special Meeting") to adopt the previously disclosed Agreement and Plan of Merger (the "Merger Agreement"), by and among the Company, Standex International Corporation, aDelaware corporation ("Parent" or "Standex"), and ShockwaveAcquisition Corporation , aMissouri corporation and a wholly-owned subsidiary of Parent (the "Merger Sub"), datedNovember 26, 2019 . OnFebruary 12, 2020 , the Merger Agreement was approved by the requisite vote of the Company's shareholders at the Special Meeting, as disclosed on the Form 8-K filedFebruary 19, 2020 . The Company anticipates that the merger will be completed on or beforeMarch 31, 2020 .
The closing of the Merger is contingent upon the satisfaction of various conditions precedent set forth in the Merger Agreement and the parties expect that the Merger will be completed in the first calendar quarter of 2020.
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For further information about the Merger Agreement and the proposed Merger, please see the Current Reports on Form 8-K filed by us onDecember 3, 2019 andFebruary 12, 2020 . The Merger is subject to risks and uncertainties, and we cannot assure you that we will be able to complete the Merger on the expected timeline or at all.
COVID-19 Outbreak and Risks to the Company
We are closely monitoring the coronavirus (COVID-19) pandemic and its potential impact on our business. The recent outbreak of COVID-19, first identified inWuhan ,Hubei Province ,China , continues to spread worldwide, causing weakened international economic conditions. It could cause disruptions to our business, as well as impact our suppliers or their manufacturers, because of worker absenteeism, quarantines, or other travel or health-related restrictions as a result of COVID-19 outbreaks or concerns, and may also increase costs associated with ensuring the safety and health of personnel. If our suppliers or their manufacturers are so affected, our supply chain could be disrupted, our product shipments could be delayed, our costs could be increased and our business could be adversely affected. While we do not expect that COVID-19 will have a material adverse effect on our business or financial results at this time, because of the unpredictability of COVID-19, management will continue to monitor the areas being impacted by COVID-19 and continuously assess the risks to the business. We are currently reviewing our business continuity plans.
Consolidated Results of Operations
The following management comments regardingTorotel'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
Net Sales Three Months Ended Nine Months Ended January 31, 2020 January 31, 2019 January 31, 2020 January 31, 2019 Magnetic components$ 3,230,000 $ 2,440,000 $ 10,394,000 $ 6,983,000 Potted coil assembly 1,299,000 1,321,000 4,226,000 4,186,000
Electro-mechanical assemblies 1,565,000 972,000
4,612,000 2,631,000
Large transformers - 17,000 - 297,000
Total $ 6,094,000 $ 4,750,000 $ 19,232,000 $ 14,097,000 Consolidated net sales in the three and nine months ended
2020 increased 28%, or$1,344,000 and 36%, or$5,135,000 , compared to the three and nine months ended January 31, 2019. Consolidated net sales increased in both periods primarily because of increased demand in magnetic components and electro-mechanical assemblies. Gross Profit Three Months Ended Nine Months Ended January 31, 2020 January 31, 2019 January 31, 2020 January 31, 2019 Gross profit $ 1,634,000$ 1,070,000 $ 6,706,000$ 4,223,000 Gross profit % of net sales 27 % 23 % 35 % 30 % Consolidated gross profit increased by 53%, or$564,000 and 59%, or$2,483,000 , in the three and nine months endedJanuary 31, 2020 compared to the three and nine months endedJanuary 31, 2019 . Consolidated gross profit increased in both periods primarily due to increased direct labor efficiencies during the first quarter of fiscal year 2020, as well as overall increases in overhead efficiencies, reduction of expenses associated with non-direct operational labor and changes in product mix during both the three and nine month periods. The gross profit percentage decreased by 8% for 23
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the three months endedJanuary 31, 2020 when compared to the nine months endedJanuary 31, 2020 . This reduction in gross profit percentage is primarily due to product mix within sales, temporary inefficiencies related to the introduction of several new products, and an increase in fringe benefits during the third quarter. Operating Expenses Three Months Ended Nine Months Ended January 31, 2020 January 31, 2019 January 31, 2020 January 31, 2019 Engineering $ 334,000
$ 351,000
1,834,000 1,089,000 5,138,000 3,590,000
Total $ 2,168,000 $ 1,440,000 $ 6,254,000 $ 4,556,000
Engineering expenses decreased 5%, or $17,000 and increased 16%, or $150,000 , in
the three and nine months ended January 31, 2020 compared to the three and
nine months ended January 31, 2019 . The decrease in the three month period
primarily resulted from a decrease in headcount during the third quarter of
fiscal year 2020. The increase in the nine month period primarily resulted from
an increase in headcount during the first quarter of fiscal year 2020.
Selling, general and administrative expenses increased 68%, or $745,000 and 43%,
or $1,548,000 , in the three and nine months ended January 31, 2020 compared to
the three and nine months ended January 31, 2019 . The increase primarily
resulted from an increase in headcount during the first quarter of fiscal year
2020 and increased expenses relating to the proposed merger during the second
and third quarters of fiscal year 2020. For further information about the
Merger Agreement and the proposed Merger, please see the Current Report on Form
8-K filed by us on December 3, 2019 .
Earnings (loss) from Operations
Three Months Ended Nine Months Ended
January 31, 2020 January 31, 2019 January 31, 2020 January 31, 2019
Torotel Products $ 105,000 $ (294,000) $ 1,820,000 $ 69,000
Torotel (639,000) (76,000) (1,368,000) (402,000)
Total $ (534,000) $ (370,000) $ 452,000 $ (333,000)
For the reasons discussed under each of the Gross Profit and Operating Expenses
headings above, consolidated earnings from operations decreased by $164,000 and
increased by $785,000 , for the three and nine months ended January 31, 2020 when
compared to the three and nine months ended January 31, 2019 .
Other Earnings Items
Three Months Ended Nine Months Ended
January 31, 2020 $ (534,000) $ (370,000) $ 452,000$ (333,000) Interest expense 27,000 36,000 77,000 84,000 Income (loss) before income taxes (561,000) (406,000) 375,000 (417,000) Income tax expense (benefit) (125,000)
- 61,000 -
Net income (loss) $ (436,000) $ (406,000) $ 314,000 $ (417,000)
We anticipate that our effective income tax rate for fiscal year ending April
30, 2020 will be 16.3%. For additional discussion related to Income Taxes, see
Note 7 of Notes to the Consolidated Financial Statements.
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Financial Condition and Liquidity
Cash generated by operations together with the borrowing under our lines of credit are our primary sources of liquidity. The following table highlights the sources of liquidity available to us as ofJanuary 31, 2020 compared toJanuary 31, 2019 . January 31, 2020 2019 Cash$ 415,000 $ 40,000
Amount available under our equipment loan -
196,000
Amount available under our 6.25% asset-based revolving line of credit 864,000 222,000 Total funds available$ 1,279,000 $ 458,000 Operating Activities The following table compares net cash provided by (used in) operating activities during the nine months endedJanuary 31, 2020 compared to the nine months endedJanuary 31, 2019 . Nine Months Ended January 31, 2020 January 31, 2019
Net cash provided by (used in) operating activities$ 1,141,000
$ (590,000) Net cash provided by operating activities increased$1,731,000 during the nine months endedJanuary 31, 2020 versus the comparable period of the 2019 fiscal year primarily due to increases in operating income and contract assets. Investing Activities Nine Months EndedJanuary 31, 2020 January 31, 2019
Net cash used in investing activities
The increase of$261,000 in net cash used in investing activities during the nine months endedJanuary 31, 2020 compared to the comparable period of fiscal year 2019 was due to higher capital expenditures. Capital expenditures during the nine months endedJanuary 31, 2020 were primarily related to the purchase of system upgrades and automation equipment. We expect capital expenditure spending to rise moderately during the remainder of fiscal year 2020 which is consistent with the anticipated needs of our business. Financing Activities Nine Months EndedJanuary 31, 2020 January 31, 2019
Net cash provided by (used in) financing activities$ (415,000)
$ 163,000 The decrease of$578,000 in net cash provided by financing activities during the nine months endedJanuary 31, 2020 from the comparable period in fiscal year 2019 is due primarily to payments made on the asset-based revolving line of credit in fiscal year 2020. Capital Resources We believe that the projected cash flow from operations, and available borrowings under our existing financing arrangements to supplement our working capital needs, will be sufficient to meet our anticipated funding requirements for the foreseeable future, based on historical levels. As ofJanuary 31, 2020 , our total borrowing capacity is$1,500,000 , of 25
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which approximately
We believe that inflation will have only a minimal effect on future operations since such effects are expected to be offset by sales price increases, which are not expected to have a significant effect upon demand. Critical Accounting Policies 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 endedApril 30, 2019 filed with theSEC onJuly 23, 2019 . We have made no significant change in our critical accounting policies sinceApril 30, 2019 .
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