**UNITED STATES**

**SECURITIES AND EXCHANGECOMMISSION**

**Washington,D.C.  20549**

**FORM10-QSB**

**QuarterlyReport Under Section 13 or 15(d) of the Securities Exchange Act of 1934**

**For thequarterly period ended January 31, 2007**

**CommissionFile No. 1-8125**

**TOROTEL, INC.**

(Exact name ofsmall business issuer as specified in its charter)

| **MISSOURI**                     |   | **44-0610086**                        |
|----------------------------------|--------|---------------------------------------|
| (State or other  jurisdiction of |   | (I.R.S. Employer  Identification No.) |
| incorporation or  organization)  |   |                                  |

 

**620 NORTH LINDENWOOD DRIVE,OLATHE, KANSAS  66062**

(Address ofprincipal executive offices)

**(913) 747-6111**

(Issuer’stelephone number)

**NONE**

(Former name,former address and former fiscal year, if changed since last report)

Check whether theissuer (1) filed all reports required to be filed by Section 13 or 15(d) of theExchange Act during the past 12 months and (2) has been subject to such filingrequirements for the past 90 days.

Yes x   No o

Check whether the issueris a shell company (as defined in Rule 12b-2 of the Exchange Act.)

Yes o   No x

As of March 14, 2007, there were 5,376,590 shares of Common Stock, $.01par value, outstanding.

 

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TOROTEL, INC. ANDSUBSIDIARIES

INDEX
| PART  I.   FINANCIAL INFORMATION                                                 |   |   |
|-------------------------------------------------------------------------------------------------|--------|--------|
|                                                                                            |   |   |
| Item  1.    Financial Statements                                            |   |   |
|                                                                                            |   |   |
| Consolidated  Balance Sheet as of January 31, 2007                                              |   |   |
|                                                                                            |   |   |
| Consolidated  Statements of Operations for the nine months                                      |   |   |
| ended January  31, 2007 and 2006                                                                |   |   |
|                                                                                            |   |   |
| Consolidated  Statements of Operations for the three months                                     |   |   |
| ended January  31, 2007 and 2006                                                                |   |   |
|                                                                                            |   |   |
| Consolidated  Statements of Cash Flows for the nine months                                      |   |   |
| ended January  31, 2007 and 2006                                                                |   |   |
|                                                                                            |   |   |
| Notes to  Consolidated Financial Statements                                                     |   |   |
|                                                                                            |   |   |
| Item  2.    Management’s Discussion and Analysis or Plan of  Operation |   |   |
|                                                                                            |   |   |
| Item  3.    Controls and Procedures                                         |   |   |
|                                                                                            |   |   |
| PART  II.   OTHER INFORMATION                                                    |   |   |
|                                                                                            |   |   |
| Item  1.    Legal Proceedings                                               |   |   |
|                                                                                            |   |   |
| Item  6.    Exhibits                                                        |   |   |
|                                                                                            |   |   |
| SIGNATURES                                                                                      |   |   |

 

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PART I.               FINANCIALINFORMATION

Item 1.                       FinancialStatements

CONSOLIDATED BALANCESHEET (Unaudited)

As of January 31, 2007
| ASSETS                                            |   |       |    |
|---------------------------------------------------|--------|------------|---------|
|                                              |   |       |    |
| Current assets:                                   |   |       |    |
| Cash                                              |   | $          | 280,000 |   |
| Accounts  receivable, net                         |   | 714,000    |    |
| Inventories                                       |   | 396,000    |    |
| Prepaid expenses  and other current assets        |   | 31,000     |    |
|                                              |   | 1,421,000  |    |
|                                              |   |       |    |
| Property, plant and  equipment, net               |   | 1,032,000  |    |
|                                              |   |       |    |
| Intangible assets, net                            |   | 664,000    |    |
| Other assets                                      |   | 3,000      |    |
| Equity investment                                 |   | —     |    |
|                                              |   |       |    |
|                                              |   | $3,120,000 |    |
|                                              |   |       |    |
| LIABILITIES AND  STOCKHOLDERS’ EQUITY        |   |       |    |
|                                              |   |       |    |
| Current liabilities:                              |   |       |    |
| Current  maturities of long-term debt             |   | $          | 58,000  |   |
| Note payable to  shareholders                     |   | 750,000    |    |
| Trade accounts  payable                           |   | 282,000    |    |
| Accrued  liabilities                              |   | 221,000    |    |
| Accrued interest  on note payable to shareholders |   | 5,000      |    |
|                                              |   | 1,316,000  |    |
|                                              |   |       |    |
| Long-term debt, less  current maturities          |   | 726,000    |    |
|                                              |   |       |    |
| Stockholders’ equity                         |   | 1,078,000  |    |
|                                              |   |       |    |
|                                              |   | $3,120,000 |    |

 

The accompanyingnotes are an integral part of this statement.

1

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CONSOLIDATED STATEMENTSOF OPERATIONS (Unaudited)

Nine Months Ended January31,
| ** **                                                                                                 | ** ** | **2007**  | ** ** | **2006**  | ** ** |
|------------------------------------------------------------------------------------------------------------|------------|-----------|------------|-----------|------------|
| Net sales                                                                                                  |       | $         | 3,631,000  |      | $          | 4,090,000 |   |
| Cost of goods  sold                                                                                        |       | 2,278,000 |       | 2,337,000 |       |
|                                                                                                       |       |      |       |      |       |
| Gross profit                                                                                               |       | 1,353,000 |       | 1,753,000 |       |
|                                                                                                       |       |      |       |      |       |
| Operating  expenses:                                                                                       |       |      |       |      |       |
| Engineering                                                                                                |       | 193,000   |       | 191,000   |       |
| Selling, general and administrative                                                                        |       | 1,415,000 |       | 1,106,000 |       |
| Amortization of intangible assets                                                                          |       | 27,000    |       | 58,000    |       |
|                                                                                                       |       | 1,635,000 |       | 1,355,000 |       |
|                                                                                                       |       |      |       |      |       |
| Earnings (loss) from operations                                                                            |       | (282,000  | )          | 398,000   |       |
|                                                                                                       |       |      |       |      |       |
| Other expense  (income):                                                                                   |       |      |       |      |       |
| Interest expense                                                                                           |       | 86,000    |       | 89,000    |       |
| Interest income                                                                                            |       | (7,000    | )          | —    |       |
| Impairment of real estate                                                                                  |       | —    |       | 36,000    |       |
| Gain on settlement of debt                                                                                 |       | —    |       | (35,000   | )          |
| Gain on sale of real estate                                                                                |       | —    |       | (110,000  | )          |
|                                                                                                       |       | 79,000    |       | (20,000   | )          |
|                                                                                                       |       |      |       |      |       |
| Earnings (loss) before provision for income taxes  and cumulative effect of change in accounting principle |       | (361,000  | )          | 418,000   |       |
|                                                                                                       |       |      |       |      |       |
| Provision for  income taxes                                                                                |       | —    |       | —    |       |
|                                                                                                       |       |      |       |      |       |
| Earnings (loss)  before cumulative effect of change in accounting principle                                |       | (361,000  | )          | 418,000   |       |
|                                                                                                       |       |      |       |      |       |
| Cumulative  effect of change in accounting principle                                                       |       | 8,000     |       | —    |       |
|                                                                                                       |       |      |       |      |       |
| Net earnings  (loss)                                                                                       |       | $         | (353,000   | )         | $          | 418,000 |   |
|                                                                                                       |       |      |       |      |       |
| Basic earnings  (loss) per share:                                                                          |       |      |       |      |       |
| Before cumulative effect                                                                                   |       | $         | (.07       | )         | $          | .08 |   |
| Cumulative effect                                                                                          |       | —    |       | —    |       |
|                                                                                                       |       | $         | (.07       | )         | $          | .08 |   |
| Diluted earnings  (loss) per share:                                                                        |       |      |       |      |       |
| Before cumulative effect                                                                                   |       | $         | (.07       | )         | $          | .08 |   |
| Cumulative effect                                                                                          |       | —    |       | —    |       |
|                                                                                                       |       | $         | (.07       | )         | $          | .08 |   |

 

The accompanyingnotes are an integral part of these statements.

2

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CONSOLIDATED STATEMENTSOF OPERATIONS (Unaudited)

Three Months EndedJanuary 31,
| ** **                                        | ** ** | **2007** | ** ** | **2006** | ** ** |
|---------------------------------------------------|------------|----------|------------|----------|------------|
| Net sales                                         |       | $        | 1,145,000  |     | $          | 1,376,000 |   |
| Cost of goods  sold                               |       | 713,000  |       | 849,000  |       |
|                                              |       |     |       |     |       |
| Gross profit                                      |       | 432,000  |       | 527,000  |       |
|                                              |       |     |       |     |       |
| Operating  expenses:                              |       |     |       |     |       |
| Engineering                                       |       | 64,000   |       | 69,000   |       |
| Selling, general and administrative               |       | 473,000  |       | 348,000  |       |
| Amortization of intangible assets                 |       | 16,000   |       | 21,000   |       |
|                                              |       | 553,000  |       | 438,000  |       |
|                                              |       |     |       |     |       |
| Earnings (loss) from operations                   |       | (121,000 | )          | 89,000   |       |
|                                              |       |     |       |     |       |
| Other expense  (income):                          |       |     |       |     |       |
| Interest expense                                  |       | 29,000   |       | 27,000   |       |
| Interest income                                   |       | (2,000   | )          | —   |       |
|                                              |       | 27,000   |       | 27,000   |       |
|                                              |       |     |       |     |       |
| Earnings (loss) before provision for income taxes |       | (148,000 | )          | 62,000   |       |
|                                              |       |     |       |     |       |
| Provision for  income taxes                       |       | —   |       | —   |       |
|                                              |       |     |       |     |       |
| Net earnings  (loss)                              |       | $        | (148,000   | )        | $          | 62,000 |   |
|                                              |       |     |       |     |       |
| Basic earnings  (loss) per share                  |       | $        | (.03       | )        | $          | .01 |   |
|                                              |       |     |       |     |       |
| Diluted earnings (loss)  per share                |       | $        | (.03       | )        | $          | .01 |   |

 

The accompanyingnotes are an integral part of these statements.

3

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CONSOLIDATED STATEMENTSOF CASH FLOWS (Unaudited)

Nine Months Ended January31,
| ** **                                                                                            | ** ** | **2007**   | ** ** | **2006**   | ** ** |
|-------------------------------------------------------------------------------------------------------|------------|------------|------------|------------|------------|
| Cash flows from  operating activities:                                                                | ** ** | ** ** | ** ** | ** ** | ** ** |
| Net earnings (loss)                                                                                   |       | $          | (353,000   | )          | $          | 418,000 |   |
| Adjustments to reconcile net earnings (loss) to net  cash provided by (used in) operating activities: |       |       |       |       |       |
| Gain on sale of real estate                                                                           |       | —     |       | (110,000   | )          |
| Gain on settlement of debt                                                                            |       | —     |       | (35,000    | )          |
| Impairment of real estate                                                                             |       | —     |       | 36,000     |       |
| Stock compensation earned                                                                             |       | 6,000      |       | —     |       |
| Depreciation and amortization                                                                         |       | 91,000     |       | 112,000    |       |
| Change in value of stock appreciation rights                                                          |       | (11,000    | )          | 30,000     |       |
| Increase (decrease) in cash flows from operations resulting  from changes in:                         |       |       |       |       |       |
| Accounts receivable                                                                                   |       | 14,000     |       | 206,000    |       |
| Inventories                                                                                           |       | (69,000    | )          | (124,000   | )          |
| Prepaid expenses and other assets                                                                     |       | (15,000    | )          | (6,000     | )          |
| Trade accounts payable                                                                                |       | 134,000    |       | 37,000     |       |
| Accrued liabilities                                                                                   |       | 19,000     |       | 40,000     |       |
|                                                                                                  |       |       |       |       |       |
| Net cash  provided by (used in) operating activities                                                  |       | (184,000   | )          | 604,000    |       |
|                                                                                                  |       |       |       |       |       |
| Cash flows from  investing activities:                                                                |       |       |       |       |       |
| Capital expenditures                                                                                  |       | (27,000    | )          | (72,000    | )          |
| Net proceeds from sale of asset                                                                       |       | —     |       | 317,000    |       |
|                                                                                                  |       |       |       |       |       |
| Net cash  provided by (used in) investing activities                                                  |       | (27,000    | )          | 245,000    |       |
|                                                                                                  |       |       |       |       |       |
| Cash flows from  financing activities:                                                                |       |       |       |       |       |
| Proceeds from exercise of incentive stock options                                                     |       | 15,000     |       | —     |       |
| Principal payments on long-term debt                                                                  |       | (45,000    | )          | (368,000   | )          |
|                                                                                                  |       |       |       |       |       |
| Net cash used in  financing activities                                                                |       | (30,000    | )          | (368,000   | )          |
|                                                                                                  |       |       |       |       |       |
| Net increase  (decrease) in cash                                                                      |       | (241,000   | )          | 481,000    |       |
| Cash, beginning  of period                                                                            |       | 521,000    |       | 193,000    |       |
|                                                                                                  |       |       |       |       |       |
| Cash, end of period                                                                                   |       | $          | 280,000    |       | $          | 674,000 |   |
|                                                                                                  |       |       |       |       |       |
| Supplemental  Disclosures of Cash Flow Information                                                    |       |       |       |       |       |
| Cash paid during  the period for:                                                                     |       |       |       |       |       |
| Interest                                                                                              |       | $          | 86,000     |       | $          | 89,000 |   |
| Income taxes  payable                                                                                 |       | $          | —     |       | $          | — |   |

 

The accompanyingnotes are an integral part of these statements.

4

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NOTES TOCONSOLIDATED FINANCIAL STATEMENTS (Unaudited)

Note 1 - Basis ofPresentation

Torotelspecializes in the custom design and manufacture of a wide variety of precisionmagnetic components, consisting of transformers, inductors, reactors, chokesand toroidal coils, for use in commercial, industrial and militaryelectronics.  Torotel also designs anddistributes ballast transformers for the airline industry.  Approximately 96% of Torotel’s sales duringthe first nine months of fiscal 2007 have been derived from domesticcustomers.  The accompanying unauditedconsolidated financial statements reflect the normal recurring adjustmentswhich in the opinion of management are necessary to present fairly Torotel’sfinancial position at January 31, 2007, and the results of operations for thethree and nine months ended January 31, 2007.

Thefinancial statements contained herein should be read in conjunction withTorotel’s financial statements and related notes filed on Form 10-KSB for theyear ended April 30, 2006.

Note 2 -Inventories

The components ofinventories are summarized as follows:
| Raw materials   |   | $       | 128,000 |   |
|-----------------|--------|---------|---------|--------|
| Work in process |   | 189,000 |    |
| Finished goods  |   | 79,000  |    |
|            |   | $       | 396,000 |   |

 

Note 3 - FinancingAgreement

OnJune 25, 2006, Torotel Products refinanced its mortgage debt with the Bank ofBlue Valley.  Under the terms of the newfinancing, the outstanding balance bears interest at a fixed rate of 8.0% perannum.  The note requires monthlyprincipal and interest payments of $9,947. The note, which continues to be guaranteed by Torotel, Inc. andElectronika, Inc., has a maturity date of June 25, 2011 and is collateralizedby a first mortgage on the land and buildings in Olathe, Kansas.  As of January 31, 2007, the outstandingbalance was $784,000.

OnSeptember 30, 2006, Torotel Products renewed its $200,000 revolving creditagreement with Bank of Blue Valley. Advances under the credit line are limited to 75% of eligible billedreceivables.  The revolving line iscollateralized by the land and buildings in Olathe, Kansas.  Under the terms of the agreement, theoutstanding balance of the revolving line bears interest at 1.25% over the bank’scorporate base rate and has a maturity date of September 30, 2007.  As of January 31, 2007, the effectiveborrowing rate was 9.50% and the entire credit line was available.

Note 4 - Share-Based Compensation

Effective May 1,2006, Torotel adopted the fair value recognition provisions of Statement ofFinancial Accounting Standards No. 123 (revised 2004), “Share-BasedPayment” (“SFAS 123(R)”) using the modified prospective method of adoptionunder the provisions of SFAS No. 148, *Accountingfor Stock-Based Compensation – Transition and Disclosure*.  In accordance with the modified prospectivemethod, results for prior periods have not been restated.  Prior to May 1, 2006, Torotel accounted forall stock option grants

5

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under the provisions ofAPB Opinion 25, *Accounting for Stock Issuedto Employees* and related interpretations; and accounted for allgrants involving stock appreciation rights (“SARs”) under the provisions ofSFAS 123 using the intrinsic value measurement guidelines of APB Opinion25.  The adoption of SFAS 123(R) onexisting stock option grants did not have any impact on our financial conditionor results of operations for the nine months ended January 31, 2007; theadoption of SFAS 123(R) for the SARs resulted in a cumulative effect reductionin stock compensation costs of $8,000 for the same nine-month period.

Note 5 -Restricted Stock Agreements

Restricted Stock Agreements are authorized by theCompensation and Nominating Committee (“Committee”) and the Board of Directorsof Torotel.  The Committee and the Boardhave determined that the interests of Torotel and its stockholders will bepromoted by hiring talented individuals and, to induce such individuals toaccept employment with Torotel, the Committee and the Board believe a keycomponent of such individuals’ compensation should be granting equity ownershipopportunities based upon the acceptance of employment and the continuingemployment of such individual, subject to certain conditions and restrictions.

Effective July 31, 2006, a Restricted Stock Agreementwas entered into between Torotel and Benjamin E. Ames, Jr., as part of Mr. Ames’employment as Executive Vice President of Torotel Products, Inc., with primaryresponsibilities being new business development.  The amount of the restricted stock award was200,000 shares of common stock, $.01 par value per share.  Based upon Mr. Ames attaining mutually agreedupon written annual goals, the restricted shares shall be released from therestrictions on transfer and risk of forfeiture in the amount of 40,000 sharesper year for five years beginning July 31, 2007, and each anniversary thereof.  Based on the market price of $.30 for Torotel’scommon stock as of July 31, 2006, the fair value of the restricted stock at thedate of award was $60,000.  Of thisamount, $2,000 was credited to common stock at par value and the excess of$58,000 was credited to additional paid-in capital. The restricted sharesare treated as non-vested stock pursuant to SFAS 123(R).  Accordingly, an offset amount, classified asunearned stock compensation, is included in the accompanying consolidatedbalance sheet under stockholders’ equity. Stock compensation cost of $3,000 per quarter will be recorded duringthe aggregate five-year vesting period provided the mutually agreed upon goalsare achieved.

A Restricted Stock Agreement having a measurement dateof February 12, 2007, was entered into between Torotel and E. Mark Flynn, aspart of Mr. Flynn’s employment as Vice President of Torotel Products, Inc.,with primary responsibilities being supply chain management anddevelopment.  The amount of therestricted stock award was 25,000 shares of common stock, $.01 par value pershare.  Based upon Mr. Flynn attainingmutually agreed upon written annual goals, the restricted shares shall bereleased from the restrictions on transfer and risk of forfeiture in the amountof 5,000 shares per year for five years beginning February 12, 2008, and eachanniversary thereof.  Based on the marketprice of $.45 for Torotel’s common stock as of February 12, 2007, the fairvalue of the restricted stock at the date of award was $11,250.  Of this amount, $250 will be credited tocommon stock at par value and the excess of $11,000 will be credited toadditional paid-in capital. The restricted shares are treated asnon-vested stock pursuant to SFAS 123(R). Accordingly, an offset amount, classified as unearned stock compensation,will be included in future consolidated balance sheets under stockholders’equity.  Stock compensation cost of $562.50per quarter will be recorded during the aggregate five-year vesting periodprovided the mutually agreed upon goals are achieved.

6

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Under the terms of both agreements, the non-vestedshares are restricted as to disposition and subject to forfeiture under certaincircumstances.  The agreements provideMessrs. Ames and Flynn with all voting rights with respect to the restricted shares.  The agreements further provide that if, priorto all of the restricted shares having been released, Torotel undergoes achange in control, then all of the restricted shares shall be released and nolonger subject to restrictions under the agreements.

Restrictedstock activity for the nine months ended January 31 is summarized as follows:
|                                     | ** ** | **2007**     | ** ** |
|-------------------------------------|------------|--------------|------------|
| ** **                          | ** ** | **Weighted** | ** ** | **Weighted** | ** ** |
| ** **                          | ** ** | **Shares**   | ** ** | **Average** | ** ** |
| ** **                          | ** ** | **Under**    | ** ** | **Grant Date** | ** ** |
| ** **                          | ** ** | **Option**   | ** ** | **Value** | ** ** |
| Outstanding at  beginning of period |       | —       |       | — |   |
| Granted                             |       | 200,000      |       | $ | .30 |   |
| Vested                              |       | —       |       | — |   |
| Forfeited                           |       | —       |       | — |   |
| Outstanding at end of period        |       | 200,000      |       | $ | .30 |   |

 

Note 6 - EmployeeStock Options

Inaccordance with the Incentive Compensation Plan approved by shareholders in1994, Torotel reserved 400,000 common shares for issuance to key employeespursuant to the exercise of incentive stock options granted prior to June 20,2004.  The incentive stock options have aterm of five years when issued and vest 50% per year at the end of each of thefirst two years.  The exercise price ofeach option equaled the market price of Torotel’s common stock on the date ofgrant.  Accordingly, no compensation costwas recognized for the Plan at the time of grant, and no cost was incurred fromthe adoption of SFAS 123(R) as the outstanding options were fully vested in2004.

Thefair value of the incentive stock options granted was estimated on the date ofgrant using the Black-Scholes options-pricing model.  The fair value of the options was determinedusing the following weighted average assumptions: no dividend payments over thelife of the options; expected volatility of 551.0%; risk-free interest rate of3.50%; and expected life of five years.

Stockoption transactions under the 1994 Incentive Compensation Plan for each periodthrough January 31 are summarized as follows:
|                                                                | ** ** | **2007**     | ** ** | **2006**     | ** ** |
|----------------------------------------------------------------|------------|--------------|------------|--------------|------------|
| ** **                                                     | ** ** | **Weighted** | ** ** | ** **   | ** ** | **Weighted** | ** ** | ** ** | ** ** |
| ** **                                                     | ** ** | **Shares**   | ** ** | **Average**  | ** ** | **Shares** | ** ** | **Average** | ** ** |
| ** **                                                     | ** ** | **Under**    | ** ** | **Exercise** | ** ** | **Under** | ** ** | **Exercise** | ** ** |
| ** **                                                     | ** ** | **Option**   | ** ** | **Price**    | ** ** | **Option** | ** ** | **Price** | ** ** |
| Outstanding at  beginning of period                            |       | 40,000       |       | $            | .37        |   | 40,000 |   | $ | .37 |   |
| Granted                                                        |       | —       |       | —       |       | — |   | — |   |
| Exercised                                                      |       | (40,000      | )          | $            | .37        |   | — |   | — |   |
| Forfeited                                                      |       | —       |       | —       |       | — |   | — |   |
| Outstanding at end of  period                                  |       | —       |       | —       |       | 40,000 |   | $ | .37 |   |
|                                                           |       |         |       |         |       |   |   |   |   |
| Options exercisable at  end of period                          |       | —       |       | —       |       | 40,000 |   | $ | .37 |   |
| Weighted average fair value of options granted during the year |       |         |       | —       |       |   |   | — |   |

 

7

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The following informationapplies to options outstanding for each period through January 31:
|                                             | ** ** | **2007** | ** ** | **2006** | ** ** |
|---------------------------------------------|------------|----------|------------|----------|------------|
| Number outstanding                          |       | —   |       | 40,000   |       |
| Range of exercise  prices                   |       | —   |       | $        | .37        |   |
| Weighted average  exercise price            |       | —   |       | $        | .37        |   |
| Weighted average remaining contractual life |       | —   |       | .75 yr.  |       |

 

Note 7 -Stockholders’ Equity

The components ofstockholders’ equity are summarized as follows:
| Common stock, at par value      |   | $           | 54,000    |   |
|---------------------------------|--------|-------------|-----------|--------|
| Capital in excess of  par value |   | 12,320,000  |      |
| Unearned stock  compensation    |   | (54,000     | )         |
| Accumulated deficit             |   | (11,152,000 | )         |
|                            |   | 1,168,000   |      |
| Less treasury stock, at  cost   |   | 90,000      |      |
|                            |   | $           | 1,078,000 |   |

 

The changes inshares of common stock outstanding are summarized as follows:
| Balance, May 1, 2006       |   | 5,111,590 |   |
|----------------------------|--------|-----------|--------|
| Restricted stock  activity |   | 200,000   |   |
| Treasury stock  activity   |   | 40,000    |   |
| Balance, January 31, 2007  |   | 5,351,590 |   |

 

Note 8 - EarningsPer Share

Statementof Financial Accounting Standards (SFAS) No. 128, *Earnings per Share*, requires dual presentation of basic anddiluted EPS on the face of the statement of earnings regardless of whetherbasic and diluted EPS are the same; and requires a reconciliation of thenumerator and denominator used in computing basic and diluted EPS.  Basic EPS excludes dilution and is computedby dividing earnings available to common stockholders by the weighted averagenumber of common shares outstanding for the  period. Diluted EPS is computed similarly to fully diluted EPS pursuant to APBOpinion 15.  Diluted EPS reflects thepotential dilution that could occur if securities or other contracts to issuecommon stock were exercised or converted into common stock or resulted in theissuance of common stock that then shared in the earnings of the entity.  The 200,000 shares issued pursuant to theRestricted Stock Agreement (see Note 5 of Notes to Consolidated FinancialStatements) meet the definition of contingently issuable shares as outlined inSFAS No. 128; as a result, these shares will not be included in the basic EPScalculation until the performance measurements have been satisfied.  The restricted shares will be treated as acommon stock equivalent for the diluted EPS calculation.

Pursuantto SFAS No. 128, the basic and diluted earnings per common share were computedas follows:

8

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# Year-to-DateEPS Calculations

|                                                                      | ** ** | **2007**  | ** ** | **2006**  | ** ** |
|----------------------------------------------------------------------|------------|-----------|------------|-----------|------------|
| Earnings (loss)  before cumulative effect                            |       | $         | (361,000   | )         | $          | 418,000 |   |
| Cumulative  effect                                                   |       | 8,000     |       | —    |       |
| Net earnings (loss)                                                  |       | $         | (353,000   | )         | $          | 418,000 |   |
|                                                                 |       |      |       |      |       |
| Weighted average  common shares outstanding for basic EPS            |       | 5,128,112 |       | 5,111,590 |       |
| Incremental  shares for effect of stock options and restricted stock |       | —    |       | 4,790     |       |
| Weighted average  common shares outstanding for dilutive EPS         |       | 5,128,112 |       | 5,116,380 |       |
|                                                                 |       |      |       |      |       |
| Basic and  diluted earnings (loss) per share:                        |       |      |       |      |       |
| Before cumulative effect                                             |       | $         | (.07       | )         | $          | .08 |   |
| Cumulative  effect                                                   |       | —    |       | —    |       |
|                                                                 |       | $         | (.07       | )         | $          | .08 |   |

 

No incremental shares areincluded in the 2007 EPS calculations for the 40,000 shares under option or the200,000 shares of restricted common stock since the effect would beanti-dilutive.

# QuarterlyEPS Calculations

|                                                                      | ** ** | **2007**  | ** ** | **2006**  | ** ** |
|----------------------------------------------------------------------|------------|-----------|------------|-----------|------------|
| Net earnings  (loss)                                                 |       | $         | (148,000   | )         | $          | 62,000 |   |
|                                                                 |       |      |       |      |       |
| Weighted average  common shares outstanding for basic EPS            |       | 5,151,590 |       | 5,111,590 |       |
| Incremental  shares for effect of stock options and restricted stock |       | —    |       | 14,658    |       |
| Weighted average  common shares outstanding for dilutive EPS         |       | 5,151,590 |       | 5,126,248 |       |
|                                                                 |       |      |       |      |       |
| Basic and diluted  earnings (loss) per share                         |       | $         | (.03       | )         | $          | .01 |   |

 

No incremental shares are included in the 2007 EPScalculations for the 40,000 shares under option or the 200,000 shares ofrestricted common stock since the effect would be anti-dilutive.

Note 9 - StockAppreciation Rights

On September 10,2004, the board of directors of Torotel approved the Directors StockAppreciation Rights Plan (the “Plan”) for non-employee directors.  Each SAR is equal to one share of commonstock of Torotel, and the aggregate number of SARs that may be granted underthe Plan shall not exceed 500,000. The effective date of the Plan is October 1,2004.  The SARs are now accounted forunder SFAS No. 123(R), *Accounting forStock-Based Compensation.*

Pursuantto the Plan, 20,000 SARs were granted on the effective date to each of thethree current non-employee directors. The initial price at which each SAR was granted was $.35, which equaledthe market price of Torotel’s common stock on the date of grant.  Accordingly, no compensation cost wasrecognized at the time of grant in accordance with APB Opinion 25, prior to theadoption of SFAS No. 123(R) on May 1, 2006, as discussed in Note 4 of Notes toConsolidated Financial Statements.

SARs shall automatically be granted in the future as follows: (1) eachperson who is elected as a director, who was not a director on the effectivedate of the Plan, shall be granted 10,000 SARs on the date such person iselected a director; and (2) on each May 1 following the effective date duringthe term of the Plan, each person serving as a director on such date shall begranted 10,000 SARs.    After the initialgrant, the price at which each SAR is granted shall be the average of theclosing price of Torotel’s common stock for the ten consecutive daysimmediately preceding the date of grant. Upon exercise of a SAR, Torotel will

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pay the grantee an amount (the “Spread”) equal to the excess of theExercise Price over the SAR grant price multiplied by the number of sharesbeing exercised.  The Exercise Priceshall be the average of the closing price of Torotel’s common stock for the tenconsecutive days immediately preceding the notice of exercise.  For any payments that exceed $10,000, Torotelhas the option to make quarterly payments over three years with interest payablequarterly at the prime rate of Torotel’s primary bank.

Each SAR granted hereunder may be exercised to theextent that the Grantee is vested in such SAR. The SARs will vest according to the following schedule:
| Number of Years the Grantee has remained | ** ** | **Shares represented**               | ** ** |
|------------------------------------------------------------------------|------------|-------------------------------------------|------------|
| **a director of the Company following**       | ** ** | **by a SAR in which** | ** ** |
| **the Date of Grant**                                   | ** ** | **a Grantee is Vested**    | ** ** |
| Under one                                                              |       |                                      | 0          | % |   |
| At least one but less than two                                         |       |                                      | 33         | % |   |
| At least two but less than three                                       |       |                                      | 67         | % |   |
| Three or more                                                          |       |                                      | 100        | % |   |

 

A Grantee shall become fully (100%) vested in each of his or her SARsunder the following circumstances:  (i)upon termination of the Grantee’s service as a director of Torotel for reasonsof death, disability or retirement; (ii) if the Compensation and NominatingCommittee (the “Committee”), in its sole discretion, determines thatacceleration of the SAR vesting schedule would be desirable for Torotel; or(iii) if Torotel shall, pursuant to action by its Board of Directors, at anytime propose to merge into, consolidate with, or sell or otherwise transfer allor substantially all of its assets to another corporation, and provision is notmade pursuant to the terms of such transaction for the assumption by thesurviving, resulting or acquiring corporation of outstanding SARs or forsubstitution of new SARs therefore, the Committee shall cause written notice ofthe proposed transaction to be given to each Grantee not less than twenty daysprior to the anticipated effective date of the proposed transaction, and his orher SARs shall become fully (100%) vested and, prior to a date specified insuch notice, which shall be not more than ten days prior to the anticipatedeffective date of the proposed transaction, each Grantee shall have the rightto exercise his or her SARs.

Inaccordance with SFAS 123(R), compensation expense is recognized over thevesting period based upon the estimated fair value of the SARs pursuant to theterms of the Plan using the Black-Scholes options-pricing model as of the endof each financial reporting period.  Asof January 31, 2007, the fair value of the SARs was determined using thefollowing assumptions: no dividend payments over the life of the SARs sinceTorotel has not issued any form of dividend since 1985; an expected volatilityof 175.9% based on Torotel’s historical volatility using the weekly closingprice over the past 4.50 years; a risk-free interest rate of 4.50%; and anexpected life of 4.50 years based on the length of service estimated to beserved.  Based on these assumptions, thefair value prices per share of the outstanding SARs are summarized as follows:
|                     | ** ** | **SARs**   | ** ** | ** **   | ** ** | ** **          | ** ** | ** ** | ** ** | **Aggregate**       | ** ** | **Aggregate** | ** ** |
|---------------------|------------|------------|------------|--------------|------------|---------------------|------------|------------|------------|---------------------|------------|---------------|------------|
| ** **          | ** ** | **Under**  | ** ** | **Exercise** | ** ** | **Fair Value** | ** ** | **%**      | ** ** | **Vested**          | ** ** | **Intrinsic** | ** ** |
| **Grant Date** | ** ** | **Option** | ** ** | **Price**    | ** ** | **Price**           | ** ** | **Vested** | ** ** | **Fair Value** | ** ** | **Value**     | ** ** |
| October 1, 2004     |       | 60,000     |       | $            | .350       |                | $          | .428       |       | 67                  | %          | $             | 17,000     |   | $ | 6,000 |   |
| May 1, 2005         |       | 30,000     |       | $            | .302       |                | $          | .429       |       | 33                  | %          | $             | 4,000      |   | $ | 4,000 |   |
| May 1, 2006         |       | 30,000     |       | $            | .695       |                | $          | .419       |       | 0                   | %          | $             | —     |   | $ | — |   |

 

The vested portionrepresents 50,100 SARs.  As of January31, 2007, the total aggregate intrinsic value of these exercisable SARs was$5,000.

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SARs transactions for each period though January 31 are summarized asfollows:
|                                     | ** ** | **2007**   | ** ** | **2006**     | ** ** |
|-------------------------------------|------------|------------|------------|--------------|------------|
| ** **                          | ** ** | ** ** | ** ** | **Weighted** | ** ** | ** ** | ** ** | **Weighted** | ** ** |
| ** **                          | ** ** | **SARs**   | ** ** | **Average**  | ** ** | **SARs** | ** ** | **Average** | ** ** |
| ** **                          | ** ** | **Under**  | ** ** | **Grant**    | ** ** | **Under** | ** ** | **Grant** | ** ** |
| ** **                          | ** ** | **Option** | ** ** | **Price**    | ** ** | **Option** | ** ** | **Price** | ** ** |
| Outstanding at  beginning of period |       | 90,000     |       | $            | .334       |   | 60,000 |   | $ | .350 |   |
| Granted                             |       | 30,000     |       | $            | .695       |   | 30,000 |   | $ | .302 |   |
| Exercised                           |       | —     |       | —       |       | — |   | — |   |
| Forfeited                           |       | —     |       | —       |       | — |   | — |   |
| Outstanding  at end of period       |       | 120,000    |       | $            | .424       |   | 90,000 |   | $ | .334 |   |
|                                |       |       |       |         |       |   |   |   |   |
| SARs exercisable at end  of period  |       | 50,100     |       | $            | .341       |   | 20,000 |   | $ | .350 |   |
| Weighted average fair  value of     |       |       |       |         |       |   |   |   |   |
| SARs granted during the  period     |       |       |       | $            | .419       |   |   |   | $ | .705 |   |

 

The followinginformation applies to SARs outstanding for each period through January 31:
|                                             | ** ** | **2007**      | ** ** | **2006**      | ** ** |
|---------------------------------------------|------------|---------------|------------|---------------|------------|
| Number outstanding                          |       | 120,000       |       | 90,000        |       |
| Range of grant prices                       |       | $.302 - $.695 |       | $.302 - $.350 |       |
| Weighted average grant  price               |       | $             | .424       |          | $          | .334 |   |
| Weighted average remaining contractual life |       | 8.21 yrs.     |       | 8.86 yrs.     |       |
|                                             |            |               |            |               |            |  |  |

 

Total compensationexpense for the outstanding SARs for the nine months ended January 31, 2007 wasa reduction of $11,000, which included an $8,000 reduction for the cumulativeeffect of adopting SFAS No. 123(R).  Totalcompensation expense for the outstanding SARs for the nine months ended January31, 2006 was $30,000.  Total compensationexpense for the outstanding SARs for the three months ended January 31, 2007was a reduction of $12,000.  Totalcompensation expense for the outstanding SARs for the three months endedJanuary 31, 2006 was $14,000.  As ofJanuary 31, 2007, there was $30,000 of total unrecognized compensation expenserelated to non-vested SARs granted under the Plan.  That cost is expected to be recognized over aweighted average period of 1.21 years. The liability for SARs on the consolidated balance sheet as of January31, 2007, was $21,000.

Thefollowing table summarizes the pro forma effect if compensation cost for thePlan had been determined applying the fair value based method to alloutstanding SARs in the period presented:

# Year-to-DatePro Forma EPS Calculations

|                                                                                    | ** ** | **2006** | ** ** |
|------------------------------------------------------------------------------------|------------|----------|------------|
| Net earnings (loss)                                                                |       | $        | 418,000    |   |
|                                                                               |       |     |       |
| Add: Stock-based  compensation expense included in reported net earnings (loss)    |       | 30,000   |       |
|                                                                               |       |     |       |
| Deduct: Stock-based  compensation expense determined under fair value based method |       | 12,000   |       |
| Pro forma net earnings  (loss)                                                     |       | $        | 436,000    |   |
|                                                                               |       |     |       |
| Basic and diluted  earnings (loss) per share:                                      |       |     |       |
| as reported                                                                        |       | $        | .08        |   |
| pro forma                                                                          |       | $        | .09        |   |

 

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Quarterly Pro Forma EPS Calculations
|                                                                                    | ** ** | **2006** | ** ** |
|------------------------------------------------------------------------------------|------------|----------|------------|
| Net earnings (loss)                                                                |       | $        | 62,000     |   |
|                                                                               |       |     |       |
| Add: Stock-based  compensation expense included in reported net earnings (loss)    |       | 14,000   |       |
|                                                                               |       |     |       |
| Deduct: Stock-based  compensation expense determined under fair value based method |       | 1,000    |       |
| Pro forma net earnings  (loss)                                                     |       | $        | 75,000     |   |
|                                                                               |       |     |       |
| Basic and diluted  earnings (loss) per share:                                      |       |     |       |
| as reported                                                                        |       | $        | .01        |   |
| pro forma                                                                          |       | $        | .02        |   |

 

Note 10 - Amortization of Intangibles

Since the acquisition of Electronika primarily involved the purchase ofcertain technology-based intangible assets, annual reviews have been performedto determine the amount of any impairment. The remaining carrying value of these intangible assets is estimated at$664,000 and is supported by the projected amount recoverable from the sellingshareholders of Electronika (the Caloyeras Family Partnership).  The selling shareholders contractuallyguaranteed that the aggregate sales from Electronika’s existing ballast designsover the first five (5) full fiscal years, specifically fiscal years 2003-2007,would be at least $2,500,000, which based on the terms of the ManufacturingAgreement with Magnetika, Inc., would result in an aggregate gross profit of$1,500,000 before any operating expenses. Aggregate sales since fiscal 2003 have been $1,366,000, whichcontractually results in an amount due from the Caloyeras Family Partnership of$681,000 as of January 31, 2007.

The following table provides the adjusted gross carrying value andaccumulated amortization for each major class of intangible asset based onTorotel’s reassessment of previously recognized intangible assets in accordancewith the adoption of Statement of Financial Accounting Standards No. 142, *Goodwill and Other Intangible Assets*:
|                     | ** ** | ** **      | ** ** | **2007**     | ** ** | **2006**         | ** ** |
|---------------------|------------|-----------------|------------|--------------|------------|------------------|------------|
| ** **          | ** ** | **Average**     | ** ** | **Gross**    | ** ** | ** **       | ** ** | **Gross** | ** ** | ** ** | ** ** |
| ** **          | ** ** | **Amortizable** | ** ** | **Carrying** | ** ** | **Accumulated**  | ** ** | **Carrying** | ** ** | **Accumulated** | ** ** |
| ** **          | ** ** | **Life**        | ** ** | **Amount**   | ** ** | **Amortization** | ** ** | **Amount** | ** ** | **Amortization** | ** ** |
| Aircraft - ballasts |       | 3               |       | $            | 1,148,000  |             | $          | 484,000 |   | $ | 1,148,000 |   | $ | 436,000 |   |
|                     |            |                 |            |              |            |                  |            |  |  |  |  |  |  |  |  |

 

Thetotal intangible amortization expense for the nine months ended January 31,2007 and 2006 was $27,000 and $58,000, respectively.  The estimated aggregate amortization expensefor fiscal 2007 is as follows:
| April 30, | ** ** | **Amount** | ** ** |
|----------------|------------|------------|------------|
| 2007           |       | $          | 45,000     |   |
|                |            |            |            |  |

 

The remaining book value of approximately $646,000 at April 30, 2007,represents the projected amount recoverable from the former shareholders, andis based on the estimated sales from the aforementioned

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ballast designs.  The recoverableamount will reduce the $750,000 note payable to shareholders, who are also theowners of Magnetika.

Note 11 - Concentrations of Credit Risk

At various times and at January 31, 2007, Torotel maintained cash inbank balances that exceed the federally insured limits.

Note 12 - New AccountingPronouncements

In July 2006, the FASB issued Interpretation No. 48 (“FIN 48”), *Accounting for Uncertainty in Income Taxes–An Interpretation of FASBStatement No. 109,* which prescribes a recognition threshold andmeasurement attribute for the financial statement recognition and measurementof a tax position taken or expected to be taken in a tax return.  In particular, this interpretation requiresuncertain tax positions to be recognized only if they are, more likely thannot, to be upheld based on their technical merits.  Additionally, the measurement of the taxposition will be based on the largest amount that is determined to have greaterthan a 50% likelihood of realization upon ultimate settlement.  Any resulting cumulative effect of applyingthe provisions of FIN 48 upon adoption would be reported as an adjustment tothe beginning balance of retained earnings and an adjustment to tax liabilitiesin the period of adoption.  FIN 48 willbe effective beginning July 1, 2007. Torotel does not believe the adoption of FIN 48 will have a materialeffect on its results of operations, financial condition and cash flows.

InSeptember 2006, the FASB issued Statement of Financial Accounting Standard No.157 (“SFAS 157”), *Fair Value Measurements*.  SFAS 157 defines fair value, establishes aframework for measuring fair value, and expands disclosures about fair valuemeasurements.  SFAS 157 applies to otheraccounting pronouncements that require or permit fair value measurements, butdoes not require any new fair value measurements.  SFAS 157 is effective for financialstatements issued for fiscal years beginning after November 15, 2007, andinterim periods within those years. Torotel is currently evaluating the effect of the guidance contained inSFAS 157 and does not expect the implementation to have a material effect onits results of operations, financial condition and cash flows.

InSeptember 2006, the SEC staff issued Staff Accounting Bulletin No. 108, *“Financial Statements – Considering the Effects ofPrior Year Misstatements when Quantifying Misstatements in Current YearFinancial Statements”* (“SAB 108”). This Bulletin provides guidance on how prior year misstatements shouldbe taken into consideration when quantifying misstatements in current yearfinancial statements for purposes of determining whether the current year’sfinancial statements are materially misstated and should be restated.  SAB 108 is effective for fiscal years endingafter November 15, 2006.  Torotel iscurrently evaluating whether SAB 108 will have a material impact upon adoption.

InOctober 2006, the FASB issued FSP No. FAS 123(R)-6, “*Technical Corrections of FASB Statement No. 123(R)*”,which amends various provisions of SFAS No. 123(R). FSP No. FAS123(R)-6 (1) exempts nonpublic entities from disclosing the aggregateintrinsic value of outstanding fully vested share options (or share units) andshare options expected to vest, (2) revises the computation of the minimumcompensation cost that must be recognized to comply with paragraph 42 of SFASNo. 123(R), (3) amends paragraph A170 of Illustration 13(e) toindicate that at the date that the illustrative awards were no longer probableof vesting, any previously recognized compensation cost should have beenreversed, and (4) amends the definition of

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“short-terminducement” to exclude an offer to settle an award.  The provisions of FSP No. FAS 123(R)-6are required to be applied in the first reporting period beginning afterOctober 20, 2006.  Retrospectiveapplication is required if an entity had been applying Statement 123(R)inconsistent with the guidance in FSP No. FAS 123(R)-6.  Torotel does not expect the adoption of FSPNo. FAS 123(R)-6 to have a material impact on its results of operations,financial condition and cash flows.

Note 13 – LegalProceedings

OnNovember 7, 2006, Basil P. Caloyeras, the beneficial owner of 998,066 shares ofTorotel common stock, filed suit in the United States District Court for theDistrict of Kansas, against Torotel and each of the members of its board ofdirectors,  seeking to preliminarily andpermanently enjoin the defendants from taking any further action which would inany way adversely effect plaintiff’s present interest or rights as ashareholder, including, but not limited to, amending Torotel’s Articles ofIncorporation or By-Laws, issuing additional shares of Torotel common stock, orentering into contractual agreements with members of the board of directors,until a meeting of Torotel’s shareholders has been properly convened at whichplaintiff’s nominations to Torotel’s board of directors and proposed amendmentsto Torotel’s Articles of Incorporation as set out by plaintiff are presentedand voted on.

Torotelmanagement and the Board intend to vigorously oppose Mr. Caloyeras’ motion foran injunction.  The Board believes itacted in accordance with Securities and Exchange Commission rules, Missourilaw, Torotel’s Articles of Incorporation, Amended and Restated By-Laws andCompensation and Nominating Committee Charter in declining to present Mr.Caloyeras’ proposals at the 2006 annual meeting.  The Board believes that the injunction soughtby Mr. Caloyeras would harm Torotel by prohibiting the Board from taking manyactions necessary to manage the business and operations of Torotel.

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Item 2.                       Management’s Discussion andAnalysis or Plan of Operation

Overview

Torotel, Inc. (“Torotel”) conducts business primarilythrough two wholly owned subsidiaries, Torotel Products, Inc. (“TorotelProducts”) and Electronika, Inc. (“Electronika”).  In addition, Torotel has a 12.88% equityinterest in Apex Innovations, Inc. (“Apex”).

Torotel Products designs and manufactures a widevariety of magnetic components for use in military, aerospace and industrialelectronic applications.  The magneticcomponents, which consist of transformers, inductors, reactors, chokes, andtoroidal coils, are used to modify and control electrical voltages and currentsin electronic devices.  For example, ifequipment containing one of these components receives an electrical voltage orcurrent which is too high for proper operation of the equipment, the componentwould modify and control the electrical voltage or current to allow properoperation of the equipment.  WhileTorotel Products primarily manufactures the components in accordance withpre-developed mechanical and electrical requirements, in some cases it will beresponsible for both the overall design and manufacture of the components.  The magnetic components are sold to manufacturerswho incorporate them into an end product. The major applications include aircraft navigational equipment, voiceand data secure communications, medical equipment, avionics equipment, andconventional missile guidance systems. As part of its long-term strategy, Torotel Products has started toinclude value-added, electro-mechanical sub-assemblies as part of its productbase.

Torotel Products markets its components primarilythrough a 4-person internal sales force, which includes a recently hiredExecutive Vice President in charge of new business development, and fiveindependent manufacturers’ representatives paid on a commission basis.  Torotel Products also has a 4-personengineering department that is active in the sales and marketing efforts.  An incentive program has been developed in thisregard for all engineering personnel to earn a commission on new product salesto existing, as well as new customers.

Torotel Products is an approved source for magneticcomponents used in numerous military and aerospace systems, which means TorotelProducts is automatically solicited for any procurement needs for suchapplications.  The magnetic componentsmanufactured by Torotel Products are sold primarily in the United States, andmost sales are awarded on a competitive bid basis.  The markets in which Torotel Productscompetes are highly competitive.  Asubstantial number of companies sell components of the type manufactured andsold by Torotel Products.  In addition,Torotel Products sells to a number of customers who have the capability ofmanufacturing their own electronic components. The principal methods of competition for electronic products in themarkets served by Torotel Products include, among other factors, price, on-timedelivery performance, lead times, customized product engineering and technicalsupport, marketing capabilities, quality assurance, manufacturing efficiency,and existing relationships with customers’ engineers.  While magnetic components are not susceptibleto rapid technological change, Torotel Products’ sales, which do not representa significant share of the industry’s market, are susceptible to decline giventhe highly competitive nature of the market.

Electronika is a marketing and licensing companyselling ballast transformers to the airline industry.  These transformers activate and control thelights in commercial airplane cockpits. Electronika’s ballast transformers are approved as spare and replacementparts in DC-8, DC-9, DC-10, MD-80, and MD-88 aircraft.  However, sales of ballast transformers havebeen made primarily for use in DC-8 and DC-9

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aircraft.  As a result, thebusiness of Electronika is subject to various risks including, withoutlimitation, any decline in use of the referenced aircraft, and competition forthe available spare parts business. Electronika’s sales do not represent a significant portion of anyparticular market.  Electronika’srequirements for the ballast transformers are outsourced pursuant to aManufacturing Agreement with Magnetika, Inc. (“Magnetika”), a corporation ownedby the family of Peter B. Caloyeras, who passed away on December 5, 2006.  Basil P. Caloyeras is a director andpresident of Electronika.  Under theterms of the agreement, Magnetika provides all necessary raw material, labor,testing, packaging and related services required to complete the manufacture,delivery and sale of the ballast transformers. Electronika retains ownership of all designs, drawings, specificationsand intellectual property rights associated with the ballast transformers.  Due to lower than anticipated sales forElectronika, the carrying value of the intangible assets of Electronika is now$664,000.  These intangible assets arebeing partially amortized in fiscal 2007. At April 30, 2007, the remaining value of the intangible assets isexpected to be approximately $646,000, which will represent the projectedamount recoverable pursuant to the sales guarantee provided by the sellingshareholders of Electronika.  Therecoverable amount will reduce the $750,000 note payable to shareholders, whoare also the owners of Magnetika. Magnetika is a manufacturing company that, in addition to theaforementioned ballast transformers, manufacturers various other productssimilar to those of Torotel for other unrelated customers.  Magnetika’s annual sales are estimated to beapproximately two to three times the annual sales of Torotel.  Total purchases from Magnetika by Electronikaamounted to $33,000 for the nine months ended January 31, 2007.

Business Outlook

Torotel Products’ industry mix for fiscal 2006 net sales was 52% defense, 32% aerospace and 16% commercial/industrial.  The mix for the first half of fiscal 2007 was 42% defense, 37% aerospace and 21% commercial/industrial.  This shift toward aerospace and commercial/industrial follows the trend expected for fiscal 2007.  New order bookings for fiscal 2007 were projected to increase 12% primarily due to new opportunities in the aerospace market, higher order rates of the new capacitor assemblies in the second half of fiscal 2007, and a major commercial contract award that was expected near the end of the first quarter of fiscal 2007.  New order bookings for the first nine months of fiscal 2007 increased 13%, which included a $2.1 million contract for the potted coil assembly for the Hellfire II missile system.  The major commercial contract award that was originally expected in July 2006 has been delayed and most likely will not be awarded until the latter half of FY2008.  In addition, the new capacitor assemblies were designed out of the OEM’s application so no further production is anticipated for this product.  The order backlog at January 31, 2007 is $3,361,000, a 61% increase from a year ago.  The primary factors that drive gross profit and net earnings for Torotel Products are sales volume and product mix.  The gross profits on mature products/programs and larger 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 jobs has a significant impact on the gross profit and net earnings of Torotel Products.

As disclosed in Torotel’s Form 10-KSB for the fiscal year ended April 30, 2006, Torotel’s operating plan called for additional sales and marketing costs in the form of personnel, advertising, trade show exhibits and new print literature.  Management believes a well developed growth strategy is in place and that these expenditures are critical for achieving that growth; as a result, near-term earnings will be impacted.

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Torotel’s management will continue to focus its efforts in areas and solutions that offer significant growth, which includes expanding the product base beyond electronic components.  The aircraft manufacturers continue to book orders at a record pace with substantial backlog through at least the end of the decade; Torotel will continue to expand its sales and marketing efforts in this area.  Fiscal 2006 brought some success in the assembly of value-added electro-mechanical solutions and cables; Torotel management sees this as a strong growth area in the future.  Management’s goal, “9-by-9”, is to reach a revenue level of $9 million by fiscal year 2009.

Electronika’s net sales continue to be impacted by the decline in the number of active DC-8 and DC-9 aircraft.  Management expects these sales to continue to decline and eventually bottom out.

Results ofOperations

Thefollowing management comments regarding Torotel’s results of operations andoutlook should be read in conjunction with the Consolidated FinancialStatements included pursuant to Item 1 of this Quarterly Report.

Thediscussion and analysis of the results of operations include the operations ofTorotel, Inc. and its subsidiaries, Torotel Products, Inc. and Electronika,Inc.  While each company’s results areincluded in the following discussion, segment reporting is not applicablebecause the products offered are similar in form and function, and targetsimilar markets.

Nine Months Ended January31, 2007 Compared With Nine Months Ended January 31, 2006

Net sales decreased 11%.  The net sales of Torotel Products decreased 10% from $3,938,000 to $3,549,000.  This decrease is attributable primarily to lower sales of components used on the AMRAAM, Hellfire II and Maverick missile systems.  This decrease was offset partially by higher shipments of the potted coil assembly for the Hellfire II missile system, higher demand for components used in aerospace applications and higher demand for molded coils used in down-hole drilling applications.  The net sales of Electronika decreased 46% from $152,000 to $82,000, which is representative of the downward trend in Electronika’s sales.

Gross profit as a percentage of net sales decreased nearly 6%.  The gross profit percentage of TorotelProducts decreased nearly 6% because of lower sales volume, higher fixedproduction costs due to the hiring of a production and quality assurancetechnician, higher material costs associated with product mix, and lessabsorption of labor and overhead costs due to a decrease in the level of workin process inventory as part of the ongoing efforts to reduce averageproduction cycle times by implementing lean manufacturing concepts and DemandFlow Technology®.  Electronika’s grossprofit as a percentage of net sales remained unchanged.

Engineeringexpenses, applicable only to Torotel Products, increased 1% from $191,000 to$193,000 because of higher payroll costs associated with two college internsutilized during the summer months and additional travel costs; these highercosts were offset partially by lower training costs.  Management does anticipate an increase in thepresent level of engineering expenses as additional engineering technicalsupport is planned.

Selling, generaland administrative (“SG&A”) expenses increased 28%.  The SG&A expenses of Torotel, Inc.increased 47% from $230,000 to $338,000 primarily because of a $108,000increase in

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professional feesassociated with change in control tactics, non-compliant shareholder proposals andrecently filed litigation initiated by Basil P. Caloyeras (see Note 13 of Noteto Consolidated Financial Statements). The SG&A expenses of Torotel Products increased nearly 24% from$854,000 to $1,055,000 primarily because of higher payroll costs of $137,000, a$37,000 increase in travel costs, an $18,000 increase in marketing andadvertising costs, an $8,000 increase in printing costs and a $6,000 increasein equipment maintenance costs.  Theseincreases were offset partially by a $5,000 decrease in utilities costs.  The SG&A expenses of Electronika remainedunchanged at $22,000.  Management doesanticipate an increase in the present level of SG&A expenses as the plancalls for additional sales and marketing costs in the form of personnel and/orcommissions, advertising, trade show exhibits and new print literature.

Amortizationcosts, entirely attributable to Electronika, decreased from $58,000 to $27,000(see Note 10 of Notes to Consolidated Financial Statements).

Interest expensedecreased 3%.  The interest expense ofTorotel, Inc. remained unchanged at $39,000. The interest expense of Torotel Products decreased from $50,000 to$47,000 because of a lower debt balance. This decrease was offset partially by the effect of a higher borrowingrate resulting from the refinancing the mortgage debt as discussed in Note 3 ofNotes to Consolidated Financial Statements.

Interest income increased $7,000 because of funds setaside in a money management account.

There was no earnings impact in the current year from an impairment ofreal estate.  A charge of $36,000 wasrecorded in the prior year.

There was no earnings impact in the current year from a gain on thesettlement of debt.  A gain of $35,000was recorded in the prior year.

There was no earnings impact in the current year from a gain on thesale of real estate.  A gain of $110,000was recorded in the prior year.

For the reasons discussed above, the consolidated pretax earningsdecreased from a profit of $418,000 to a loss of $361,000.  The pretax loss of Torotel, Inc. increasedfrom $234,000 to $377,000.  The pretaxearnings of Torotel Products decreased from $641,000 to $13,000.  The pretax earnings of Electronika decreasedfrom $11,000 to $3,000.

Three Months EndedJanuary 31, 2007 Compared With Three Months Ended January 31, 2006

Net sales decreased 17%.  The net sales of Torotel Products decreased 16% from $1,315,000 to $1,106,000.  This decrease is primarily attributable to the same reasons as outlined above in the year-to-date net sales comparison.  The net sales of Electronika decreased 36% from $61,000 to $39,000.

Gross profit as a percentage of net sales decreased slightly.  The gross profit percentage of TorotelProducts decreased slightly because of lower sales volume.  The effect of the lower sales volume wasoffset partially by a higher margin on the product mix in the current year’squarter.  Electronika’s gross profit as apercentage of net sales remained unchanged.

Engineeringexpenses, applicable only to Torotel Products, decreased 7% from $69,000 to$64,000 because of a decrease in outsourced services for certain print packagerevisions.

Selling, generaland administrative (“SG&A”) expenses increased 36%.  The SG&A expenses of Torotel, Inc.increased 58% from $55,000 to $87,000 primarily because of a $68,000 increasein professional fees associated with recently filed litigation initiated byBasil P. Caloyeras (see Note 13 of Note to Consolidated FinancialStatements).  This increase was offsetpartially by a $25,000 decrease in the value of the stock appreciation rightsdiscussed in Note 9 of Notes to the Consolidated Financial Statements

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and a $12,000 decrease inaccounting fees.  The SG&A expensesof Torotel Products increased 33% from $285,000 to $379,000 primarily becauseof higher payroll costs of $65,000, a $23,000 increase in travel costs, and a$14,000 increase in training costs. These increases were offset partially by an $8,000 decrease inrecruiting fees.  The SG&A expensesof Electronika decreased slightly from $8,000 to $7,000.

Amortizationcosts, entirely attributable to Electronika, decreased 24% from $21,000 to$16,000 (see Note 10 of Notes to Consolidated Financial Statements).

Interest expenseincreased 7%.  The interest expense ofTorotel, Inc. remained unchanged at $13,000. The interest expense of Torotel Products increased from $14,000 to$16,000 because of a higher borrowing rate associated with refinancing themortgage debt as discussed in Note 3 of Notes to Consolidated FinancialStatements.

Interest income increased $2,000 because of funds setaside in a money management account.

For the reasons discussed above, the consolidated pretax earningsdecreased from a profit of $62,000 to a loss of $148,000.  The pretax loss of Torotel, Inc. increasedfrom $68,000 to $100,000.  The pretaxearnings of Torotel Products decreased from a profit of $123,000 to a loss of$49,000.  The pretax earnings ofElectronika decreased from $7,000 to $1,000.

Liquidity andCapital Resources

As of January 31, 2007,Torotel had $280,000 in cash and cash equivalents compared to $674,000 as ofJanuary 31, 2006.  Cash flow fromoperations is expected to improve during the fourth quarter given the currentshippable backlog position and the implementation of a payment service offeredby certain major customers which should help reduce Torotel’s days salesoutstanding metric.  On June 25, 2006,Torotel refinanced its mortgage debt with the Bank of Blue Valley with a newmaturity date of June 25, 2011; on September 30, 2006, Torotel renewed its$200,000 credit line with the Bank of Blue Valley with a new maturity date ofSeptember 30, 2007 (see Note 3 of Notes to Consolidated FinancialStatements).  The $750,000 note payableto shareholders matures in March 2007 (see Note 10 of Notes to ConsolidatedFinancial Statements).  Torotel intendsto offset this debt by the amount recoverable pursuant to the sales guaranteeprovided by the selling shareholders of Electronika.  At April 30, 2007, the projected amountrecoverable is $664,000.  The projecteddifference of $86,000 after the offset will be paid from existing cashresources.

The table below presents the summary of cash flow for the nine-month periods indicated.
|                                                      | ** ** | **2007** | ** ** | **2006** | ** ** |
|------------------------------------------------------|------------|----------|------------|----------|------------|
| Net cash  provided by (used in) operating activities |       | $        | (184,000   | )        | $          | 604,000 |   |
| Net cash  provided by (used in) investing activities |       | $        | (27,000    | )        | $          | 245,000 |   |
| Net cash used in  financing activities               |       | $        | (30,000    | )        | $          | (368,000 | ) |

 

Net cash providedby operating activities fluctuates between periods primarily as a result of differencesin operating earnings, the timing of shipments and the collection of accountsreceivable, changes in inventory, level of sales and payment of accountspayable.  The decrease in net cashprovided by investing activities is because of the net proceeds of $317,000from the sale of the real estate parcels in fiscal 2006.  Capital expenditures were $27,000 during thefirst nine months of fiscal 2007. Management anticipates approximately $40,000 in total capitalexpenditures for fiscal 2007.  Net cashused in financing activities is the result of long-term debt payments of$45,000 less proceeds of $15,000 received from the exercise of an

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incentive stockoption.  Management believes that theprojected cash flow from operations, combined with its existing cash balances,will be sufficient to meet its funding requirements for the foreseeablefuture.  Torotel does have a $200,000bank line of credit available, which could be utilized to help fund any workingcapital requirements.

Managementbelieves that inflation will have only a minimal effect on future operationssince such effects will be offset by sales price increases, which are notexpected to have a significant effect upon demand*.*

Torotel’s board of directors has determined that Return on Capital Employed(“ROCE”) will be the primary tool for managing Torotel’s business.  ROCE is measured by the following formula:
| **Earnings before interest and taxes (EBIT)** | ** ** | **X**      | ** ** | **Net  Sales**                           | ** ** | ** ** | **=** | ** ** | **ROCE** |
|-----------------------------------------------|------------|------------|------------|------------------------------------------|------------|------------|-------|------------|----------|
| **Net Sales**                                 | ** ** | ** ** | ** ** | **Net Operating Assets (NOA)**           |
| ** **                                    | ** ** | ** ** | ** ** | ** **                               |
| **Measures  profit and loss management**      | ** ** | ** ** | ** ** | **Measures balance sheet management**    |
| ** **                                    | ** ** | ** ** | ** ** | ** **                               |
| **Profitability%**                            | ** ** | ** ** | ** ** | **Activity rating**                      |
| ** **                                    | ** ** | ** ** | ** ** | ** **                               |
| **Measures  how much profit in each dollar**  | ** ** | ** ** | ** ** | **Measures how much sales is generated** |
| **of  sales**                                 | ** ** | ** ** | ** ** | **from each dollar of NOA**              |
| ** **                                    | ** ** | ** ** | ** ** | ** **                               |
| **Quality  of Revenue**                       | ** ** | ** ** | ** ** | **Quantity of Revenue**                  |

 

ROCE measures what you get out (EBIT) versus what you put in (NOA =Capital Employed).  For these purposes,NOA is defined as “accounts receivable + inventory + net fixed assets +miscellaneous operating assets – accounts payable – miscellaneous operatingliabilities”.  The performance of Torotel’smanagement and the majority of its decisions going forward will be measured bywhether Torotel’s ROCE improves.  Infiscal 2004, 2005 and 2006, Torotel’s ROCE was 1.46%, 5.84% and 19.04%,respectively.  Torotel’s ROCE for the12-month trailing period ended January 31, 2007 is -8.36%.  An improvement in this metric is anticipatedin the fourth quarter as well as for fiscal 2008.

Forward-LookingInformation

This report, aswell as our other reports filed with the Securities and Exchange Commission  (“SEC”), and in press releases and otherpublic communications throughout the year, contain forward looking statementsmade pursuant to the safe harbor provisions of The Private SecuritiesLitigation Reform Act of 1995.  The words“believe,” “estimate,” “anticipate,” “project,” “intend,” “expect,” “plan,” “outlook,”“forecast,” “may,” “will,” “should,” “continue,” “predict” and similarexpressions are intended to identify forward looking statements.  This report contains forward lookingstatements regarding, among other topics, our expected financial position,results of operations, cash flows, strategy, budgets and management’s plans andobjectives.  Accordingly, theseforward-looking statements are based on assumptions about a number of importantfactors.  While we believe that ourassumptions about such factors are reasonable, such factors involve risks anduncertainties that could cause actual results to be different from what appearhere.  These risk factors include: theability to adequately pass through to customers unanticipated future increasesin raw material costs, decreased demand for products, delays in developing newproducts, expected orders that do not occur, loss of key customers, the impactof

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competition and priceerosion as well as supply and manufacturing constraints, and other risks anduncertainties.  In light of these risksand uncertainties, there can be no assurance that the forward-looking informationcontained in this report will prove accurate, and our actual results may differmaterially from these forward looking statements.  We assume no obligation to update anyforward-looking statements made herein.

Item 3.                       Controlsand Procedures

Torotel’s ChiefExecutive Officer and Chief Financial Officer (collectively, the “CertifyingOfficers”) are responsible for establishing and maintaining disclosure controlsand procedures (as defined in Exchange Act Rule 13a-15(e)) for Torotel.  Such officers have concluded (based upontheir evaluation of these controls and procedures as of a date within 90 daysof the filing of this report) that Torotel’s disclosure controls and proceduresare adequate and effective for purposes of Rule 13a-14(c) in timely alertingthem to material information relating to Torotel required to be included inTorotel’s filings with the SEC under the Securities Exchange Act of 1934.  The Certifying Officers also have indicatedthat there were no changes during the period covered by this report in Torotel’sinternal controls over financial reporting or other factors that havematerially affected, or are reasonably likely to materially affect suchcontrols, and there were no corrective actions with regard to significantdeficiencies and material weaknesses.

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PART II.           OTHERINFORMATION

Item 1.                       LegalProceedings

OnNovember 7, 2006, Basil P. Caloyeras, the beneficial owner of 998,066 shares ofTorotel common stock, filed suit in the United States District Court for theDistrict of Kansas, against Torotel and each of the members of its board ofdirectors,  seeking to preliminarily andpermanently enjoin the defendants from taking any further action which would inany way adversely effect plaintiff’s present interest or rights as a shareholder,including, but not limited to, amending Torotel’s Articles of Incorporation orBy-Laws, issuing additional shares of Torotel common stock, or entering intocontractual agreements with members of the board of directors, until a meetingof Torotel’s shareholders has been properly convened at which plaintiff’snominations to Torotel’s board of directors and proposed amendments to Torotel’sArticles of Incorporation as set out by plaintiff are presented and voted on.

Torotelmanagement and the Board intend to vigorously oppose Mr. Caloyeras’ motion foran injunction.  The Board believes itacted in accordance with Securities and Exchange Commission rules, Missourilaw, Torotel’s Articles of Incorporation, Amended and Restated By-Laws andCompensation and Nominating Committee Charter in declining to present Mr.Caloyeras’ proposals at the 2006 annual meeting.  The Board believes that the injunction soughtby Mr. Caloyeras would harm Torotel by prohibiting the Board from taking manyactions necessary to manage the business and operations of Torotel.

Item 6.                       Exhibits
| Exhibit 10.1 |   | Restricted Stock Agreement                                                                                                     |
|--------------|--------|--------------------------------------------------------------------------------------------------------------------------------|
| Exhibit 31.1 |   | Officer Certification                                                                                                          |
| Exhibit 31.2 |   | Officer Certification                                                                                                          |
| Exhibit 32.1 |   | Certification  Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant  to Section 906 of the Sarbanes-Oxley Act of  2002 |
| Exhibit 32.2 |   | Certification  Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the  Sarbanes-Oxley Act of 2002       |

 

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SIGNATURES

Inaccordance with the requirements of the Securities Exchange Act of 1934, theRegistrant has duly caused this report to be signed on its behalf by theundersigned, thereunto duly authorized.

Torotel, Inc.

(Registrant)
| /s/ Dale H. Sizemore, Jr.             |   |
|---------------------------------------|--------|
| Dale H. Sizemore, Jr.                 |
| Chief Executive Officer               |
| Date:   March 15, 2007 |
|                                  |
|                                  |
| /s/ H. James Serrone                  |   |
| H. James Serrone                      |
| Chief Financial Officer               |
| Date:   March 15, 2007 |

 

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