** **

**UNITEDSTATESSECURITIES AND EXCHANGE COMMISSIONWashington, D.C.  20549**

**FORM10-QSB**

**Quarterly Report Under Section 13 or 15(d) ofthe Securities Exchange Act of 1934**

**Forthe quarterly period ended October 31, 2006**

**CommissionFile No. 1-8125**

**TOROTEL,INC.**(Exact name of small business issuer as specified in itscharter)
| **MISSOURI**                     | ** ** | **44-0610086**                        |
|----------------------------------|------------|---------------------------------------|
| (State or other  jurisdiction of | ** ** | (I.R.S. Employer  Identification No.) |
| incorporation or  organization)  | ** ** | ** **                            |
| ** **                       | ** ** | ** **                            |

 

**620 NORTHLINDENWOOD DRIVE, OLATHE, KANSAS  66062**(Address of principal executive offices)

**(913)747-6111**(Issuer’s telephone number)

**NONE**(Former name, former address and former fiscal year, ifchanged 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 December 8, 2006,there were 5,351,590 shares of Common Stock, $.01 par value, outstanding.

 

 

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**TOROTEL,INC. AND SUBSIDIARIES**

**INDEX**
| PART  I.   FINANCIAL  INFORMATION |                                                                                        |
|---------------------------------------------|---------------------------------------------------------------------------------------------|
|                                        |                                                                                        |   |
| Item 1.                                     | Financial Statements                                                                        |   |
|                                        |                                                                                        |   |
|                                        | Consolidated  Balance Sheet as of October 31, 2006                                          | 1 |
|                                        |                                                                                        |   |
|                                        | Consolidated  Statements of Operations for the six months ended October 31, 2006 and 2005   | 2 |
|                                        |                                                                                        |   |
|                                        | Consolidated Statements  of Operations for the three months ended October 31, 2006 and 2005 | 3 |
|                                        |                                                                                        |   |
|                                        | Consolidated  Statements of Cash Flows for the six months ended October 31, 2006 and 2005   | 4 |
|                                        |                                                                                        |   |
|                                        | Notes to  Consolidated Financial Statements                                                 | 5 |
|                                        |                                                                                        |   |
| Item 2.                                     | Management’s  Discussion and Analysis or Plan of Operation                             | 14 |
|                                        |                                                                                        |   |
| Item 3.                                     | Controls and  Procedures                                                                    | 20 |
|                                        |                                                                                        |   |
|                                        |                                                                                        |   |
| PART II.   OTHER  INFORMATION     |                                                                                        |
|                                        |                                                                                        |   |
| Item 1.                                     | Legal Proceedings                                                                           | 21 |
|                                        |                                                                                        |   |
| Item 4.                                     | Submission of  Matters to a Vote of Security Holders                                        | 21 |
|                                        |                                                                                        |   |
| Item 6.                                     | Exhibits                                                                                    | 22 |
|                                        |                                                                                        |   |
| SIGNATURES                                  | 23                                                                                          |

 

 

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**PART I. FINANCIALINFORMATION**

**Item 1.**                          FinancialStatements

**CONSOLIDATEDBALANCE SHEET (Unaudited)As of October 31, 2006**
| ASSETS                                            |   |      |      |
|---------------------------------------------------|--------|-----------|-----------|
|                                              |   |      |      |
| Current assets:                                   |   |      |      |
| Cash                                              |   | $         | 400,000   |   |
| Accounts  receivable, net                         |   | 680,000   |      |
| Inventories                                       |   | 305,000   |      |
| Prepaid expenses  and other current assets        |   | 44,000    |      |
|                                              |   | 1,429,000 |      |
|                                              |   |      |      |
| Property, plant and  equipment, net               |   | 1,048,000 |      |
|                                              |   |      |      |
| Intangible assets, net                            |   | 680,000   |      |
| Other assets                                      |   | 3,000     |      |
| Equity investment                                 |   | —    |      |
|                                              |   | $         | 3,160,000 |   |
|                                              |   |      |      |
| LIABILITIES AND  STOCKHOLDERS’ EQUITY        |   |      |      |
|                                              |   |      |      |
| Current liabilities:                              |   |      |      |
| Current  maturities of long-term debt             |   | $         | 56,000    |   |
| Note payable to  shareholders                     |   | 750,000   |      |
| Trade accounts  payable                           |   | 195,000   |      |
| Accrued  liabilities                              |   | 189,000   |      |
| Accrued interest  on note payable to shareholders |   | 5,000     |      |
|                                              |   | 1,195,000 |      |
|                                              |   |      |      |
| Long-term debt, less  current maturities          |   | 742,000   |      |
|                                              |   |      |      |
| Stockholders’ equity                         |   | 1,223,000 |      |
|                                              |   |      |      |
|                                              |   | $         | 3,160,000 |   |

 

 

The accompanyingnotes are an integral part of this statement.

 

1

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**CONSOLIDATEDSTATEMENTS OF OPERATIONS (Unaudited)Six Months Ended October 31,**
| ** **                                                                                                 | ** ** | **2006**  | ** ** | **2005**  | ** ** |
|------------------------------------------------------------------------------------------------------------|------------|-----------|------------|-----------|------------|
| Net sales                                                                                                  |       | $         | 2,486,000  |      | $          | 2,714,000 |   |
| Cost of goods  sold                                                                                        |       | 1,565,000 |       | 1,488,000 |       |
|                                                                                                       |       |      |       |      |       |
| Gross profit                                                                                               |       | 921,000   |       | 1,226,000 |       |
|                                                                                                       |       |      |       |      |       |
| Operating  expenses:                                                                                       |       |      |       |      |       |
| Engineering                                                                                                |       | 129,000   |       | 122,000   |       |
| Selling, general and administrative                                                                        |       | 942,000   |       | 758,000   |       |
| Amortization of intangible assets                                                                          |       | 11,000    |       | 37,000    |       |
|                                                                                                       |       | 1,082,000 |       | 917,000   |       |
|                                                                                                       |       |      |       |      |       |
| Earnings (loss) from operations                                                                            |       | (161,000  | )          | 309,000   |       |
|                                                                                                       |       |      |       |      |       |
| Other expense  (income):                                                                                   |       |      |       |      |       |
| Interest expense                                                                                           |       | 57,000    |       | 62,000    |       |
| Interest income                                                                                            |       | (5,000    | )          | —    |       |
| Impairment of real estate                                                                                  |       | —    |       | 36,000    |       |
| Gain on settlement of debt                                                                                 |       | —    |       | (35,000   | )          |
| Gain on sale of real estate                                                                                |       | —    |       | (110,000  | )          |
|                                                                                                       |       | 52,000    |       | (47,000   | )          |
|                                                                                                       |       |      |       |      |       |
| Earnings (loss) before provision for income taxes  and cumulative effect of change in accounting principle |       | (213,000  | )          | 356,000   |       |
|                                                                                                       |       |      |       |      |       |
| Provision for  income taxes                                                                                |       | —    |       | —    |       |
|                                                                                                       |       |      |       |      |       |
| Earnings (loss) before cumulative effect of change  in accounting principle                                |       | (213,000  | )          | 356,000   |       |
|                                                                                                       |       |      |       |      |       |
| Cumulative  effect of change in accounting principle                                                       |       | 8,000     |       | —    |       |
|                                                                                                       |       |      |       |      |       |
| Net earnings  (loss)                                                                                       |       | $         | (205,000   | )         | $          | 356,000 |   |
|                                                                                                       |       |      |       |      |       |
| Basic earnings  (loss) per share:                                                                          |       |      |       |      |       |
| Before cumulative effect                                                                                   |       | $         | (.04       | )         | $          | .07 |   |
| Cumulative effect                                                                                          |       | —    |       | —    |       |
|                                                                                                       |       | $         | (.04       | )         | $          | .07 |   |
|                                                                                                       |       |      |       |      |       |
| Diluted earnings  (loss) per share:                                                                        |       |      |       |      |       |
| Before cumulative effect                                                                                   |       | $         | (.04       | )         | $          | .07 |   |
| Cumulative effect                                                                                          |       | —    |       | —    |       |
|                                                                                                       |       | $         | (.04       | )         | $          | .07 |   |

 

The accompanyingnotes are an integral part of these statements.

 

2

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**CONSOLIDATEDSTATEMENTS OF OPERATIONS (Unaudited)Three Months Ended October 31,**
| ** **                                        | ** ** | **2006** | ** ** | **2005** | ** ** |
|---------------------------------------------------|------------|----------|------------|----------|------------|
| Net sales                                         |       | $        | 1,287,000  |     | $          | 1,447,000 |   |
| Cost of goods  sold                               |       | 764,000  |       | 770,000  |       |
|                                              |       |     |       |     |       |
| Gross profit                                      |       | 523,000  |       | 677,000  |       |
|                                              |       |     |       |     |       |
| Operating  expenses:                              |       |     |       |     |       |
| Engineering                                       |       | 65,000   |       | 65,000   |       |
| Selling, general and administrative               |       | 496,000  |       | 403,000  |       |
| Amortization of intangible assets                 |       | 4,000    |       | 21,000   |       |
|                                              |       | 565,000  |       | 489,000  |       |
|                                              |       |     |       |     |       |
| Earnings (loss) from operations                   |       | (42,000  | )          | 188,000  |       |
|                                              |       |     |       |     |       |
| Other expense  (income):                          |       |     |       |     |       |
| Interest expense                                  |       | 30,000   |       | 29,000   |       |
| Interest income                                   |       | (3,000   | )          | —   |       |
| Gain on sale of real estate                       |       | —   |       | (5,000   | )          |
|                                              |       | 27,000   |       | 24,000   |       |
|                                              |       |     |       |     |       |
| Earnings (loss) before provision for income taxes |       | (69,000  | )          | 164,000  |       |
|                                              |       |     |       |     |       |
| Provision for  income taxes                       |       | —   |       | —   |       |
|                                              |       |     |       |     |       |
| Net earnings  (loss)                              |       | $        | (69,000    | )        | $          | 164,000 |   |
|                                              |       |     |       |     |       |
| Basic earnings  (loss) per share                  |       | $        | (.01       | )        | $          | .03 |   |
|                                              |       |     |       |     |       |
| Diluted earnings  (loss) per share                |       | $        | (.01       | )        | $          | .03 |   |

 

The accompanyingnotes are an integral part of these statements.

 

3

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**CONSOLIDATEDSTATEMENTS OF CASH FLOWS (Unaudited)Six Months Ended October 31,**
| ** **                                                                                              | ** ** | **2006** | ** ** | **2005** | ** ** |
|---------------------------------------------------------------------------------------------------------|------------|----------|------------|----------|------------|
| Cash flows from  operating activities:                                                                  |       |     |       |     |       |
| Net earnings (loss)                                                                                     |       | $        | (205,000   | )        | $          | 356,000 |   |
| 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                                                                               |       | 3,000    |       | —   |       |
| Depreciation and amortization                                                                           |       | 54,000   |       | 72,000   |       |
| Change in value of stock appreciation rights                                                            |       | 1,000    |       | 16,000   |       |
| Increase (decrease) in cash flows from operations  resulting from changes in:                           |       |     |       |     |       |
| Accounts receivable                                                                                     |       | 48,000   |       | 127,000  |       |
| Inventories                                                                                             |       | 22,000   |       | (174,000 | )          |
| Prepaid expenses and other assets                                                                       |       | (28,000  | )          | (32,000  | )          |
| Trade accounts payable                                                                                  |       | 47,000   |       | 116,000  |       |
| Accrued liabilities                                                                                     |       | (25,000  | )          | (7,000   | )          |
|                                                                                                    |       |     |       |     |       |
| Net cash  provided by (used in) operating activities                                                    |       | (83,000  | )          | 365,000  |       |
|                                                                                                    |       |     |       |     |       |
| Cash flows from investing  activities:                                                                  |       |     |       |     |       |
| Capital expenditures                                                                                    |       | (22,000  | )          | (41,000  | )          |
| Net proceeds from sale of asset                                                                         |       | —   |       | 317,000  |       |
|                                                                                                    |       |     |       |     |       |
| Net cash  provided by (used in) investing activities                                                    |       | (22,000  | )          | 276,000  |       |
|                                                                                                    |       |     |       |     |       |
| Cash flows from  financing activities:                                                                  |       |     |       |     |       |
| Proceeds from exercise of incentive stock options                                                       |       | 15,000   |       | —   |       |
| Principal payments on long-term debt                                                                    |       | (31,000  | )          | (349,000 | )          |
|                                                                                                    |       |     |       |     |       |
| Net cash used in  financing activities                                                                  |       | (16,000  | )          | (349,000 | )          |
|                                                                                                    |       |     |       |     |       |
| Net increase  (decrease) in cash                                                                        |       | (121,000 | )          | 292,000  |       |
| Cash, beginning  of period                                                                              |       | 521,000  |       | 193,000  |       |
|                                                                                                    |       |     |       |     |       |
| Cash, end of  period                                                                                    |       | $        | 400,000    |     | $          | 485,000 |   |
|                                                                                                    |       |     |       |     |       |
| Supplemental  Disclosures of Cash Flow Information                                                      |       |     |       |     |       |
| Cash paid during the period for:                                                                        |       |     |       |     |       |
| Interest                                                                                                |       | $        | 57,000     |     | $          | 62,000 |   |
| 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 of Presentation**

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 95% of Torotel’s sales duringthe first six 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 October 31, 2006, and the results of operations for thethree and six months ended October 31, 2006.

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   |   | $       | 49,000  |   |
|-----------------|--------|---------|---------|--------|
| Work in process |   | 194,000 |    |
| Finished goods  |   | 62,000  |    |
|            |   | $       | 305,000 |   |

 

**Note 3 — FinancingAgreement**

On June 25, 2006, Torotel Products refinanced itsmortgage debt with the  Bank of BlueValley.  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. and Electronika,Inc., has a maturity date of June 25, 2011 and is collateralized by a firstmortgage on the land and buildings in Olathe, Kansas.  As of October 31, 2006, the outstandingbalance was $798,000.

On September 30, 2006, Torotel Products renewed its$200,000 revolving credit agreement with Bank of Blue Valley.  Advances under the credit line are limited to75% of eligible billed receivables.  Therevolving line is collateralized by the land and buildings in Olathe,Kansas.  Under the terms of theagreement, the outstanding balance of the revolving line bears interest at1.25% over the bank’s corporate base rate and has a maturity date of September30, 2007.  As of October 31, 2006, theeffective borrowing rate was 9.50% and the entire credit line was available.

**Note 4 — Share-Based Compensation**

Effective May 1, 2006, Torotel adopted the fair valuerecognition provisions of Statement of Financial Accounting Standards No. 123(revised 2004), “Share-Based Payment” (SFAS 123(R)) using the modifiedprospective method of adoption under the provisions of SFAS No. 148, *Accounting for Stock-Based Compensation — Transitionand Disclosure*.  In accordancewith the modified prospective method, results for 

 

5

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prior periods have not been restated.  Prior to May 1, 2006, Torotel accounted forall stock option grants under the provisions of APB Opinion 25, *Accounting for Stock Issued to Employees*and related interpretations; and accounted for all grants involving stockappreciation rights (SARs) under the provisions of SFAS 123 using theintrinsic value measurement guidelines of APB Opinion 25.  The adoption of SFAS 123(R) on existingstock option grants did not have any impact on our financial condition or resultsof operations for the six months ended October 31, 2006; the adoption ofSFAS 123(R) for the SARs resulted in a cumulative effect reduction instock compensation costs of $8,000 for the same six-month period.

**Note 5 —Restricted Stock Agreement**

A Restricted Stock Agreement was entered into betweenTorotel and Benjamin E. Ames, Jr. effective July 31, 2006.  The agreement was authorized by theCompensation and Nominating Committee (Committee) and the Board of Directors ofTorotel, as part of Mr. Ames’ employment as Executive Vice President of TorotelProducts, Inc., with primary responsibilities being new businessdevelopment.  The Committee and the Boardhave determined that the interests of Torotel and its stockholders will be promotedby hiring talented individuals and, to induce such individuals to acceptemployment with Torotel, the Committee and the Board believe a key component ofsuch individuals’ compensation should be granting equity ownershipopportunities based upon the acceptance of employment and the continuingemployment of such individual, subject to certain conditions andrestrictions.  Mr. Ames is a recentlyhired key management employee.  Theamount of the restricted stock award was 200,000 shares of common stock, $.01par value per share.  Based upon Mr. Amesattaining mutually agreed upon written annual goals, the restricted sharesshall be released from the restrictions on transfer and risk of forfeiture inthe amount of 40,000 shares per year for five years beginning July 31, 2007,and each anniversary thereof.  Thenon-vested shares are restricted as to disposition and subject to forfeitureunder certain circumstances.  Theagreement provides Mr. Ames with all voting rights with respect to therestricted shares.  The agreement furtherprovides that if, prior to all of the restricted shares having been released,Torotel undergoes a change in control, then all of the restricted shares shallbe released and no longer subject to restrictions under the agreement.

Based on the market price of $.30 for Torotel’s commonstock as of July 31, 2006, the fair value of the restricted stock at the dateof award was $60,000.  Of this amount,$2,000 was credited to common stock at par value and the excess of $58,000 wascredited to additional paid-in capital. The restricted shares are treated as non-vested stock pursuant toSFAS 123(R).  Accordingly, an offsetamount, classified as unearned stock compensation, is included in theaccompanying consolidated balance sheet under stockholders’ equity.  Stock compensation cost of $3,000 per quarterwill be recorded during the aggregate five-year vesting period provided themutually agreed upon goals are achieved.

Restrictedstock activity for the six months ended October 31 is summarized as follows:

|                                     | ** ** | **2006**                            | ** ** |
|-------------------------------------|------------|-------------------------------------|------------|
| ** **                          | ** ** | **Weighted  Shares  Under  Option** | ** ** | **Weighted  Average  Grant Date  Value** | ** ** |
| Outstanding at  beginning of period |       | —                              |       | — |   |
| Granted                             |       | 200,000                             |       | $ | .30 |   |
| Vested                              |       | —                              |       |   |   |
| Fortified                           |       | —                              |       | — |   |
| Outstanding at end of period        |       | 200,000                             |       | $ | .30 |   |

 

6

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** **

**Note 6 —Employee Stock 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.

The fair value of the incentive stock options grantedwas estimated on the date of grant using the Black-Scholes options-pricingmodel.  The fair value of the options wasdetermined using the following weighted average assumptions: no dividendpayments over the life of the options; expected volatility of 551.0%; risk-freeinterest rate of 3.50%; and expected life of five years.

Stockoption transactions under the 1994 Incentive Compensation Plan for each periodthrough October 31 are summarized as follows:

|                                                                   | ** ** | **2006**                            | ** ** | **2005**                             | ** ** |
|-------------------------------------------------------------------|------------|-------------------------------------|------------|--------------------------------------|------------|
| ** **                                                        | ** ** | **Weighted  Shares  Under  Option** | ** ** | **   Average  Exercise  Price** | ** ** | **Weighted  Shares  Under  Option** | ** ** | **   Average  Exercise  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 |       |                                |       | —                               |       |   |   | — |   |
|                                                              |       |                                |       |                                 |       |   |   |   |   |

 

Thefollowing information applies to options outstanding for each period throughOctober 31:

|                                              | ** ** | **2006** | ** ** | **2005** | ** ** |
|----------------------------------------------|------------|----------|------------|----------|------------|
| Number outstanding                           |       | —   |       | 40,000   |       |
| Range of exercise  prices                    |       | —   |       | $        | .37        |   |
| Weighted average  exercise price             |       | —   |       | $        | .37        |   |
| Weighted average  remaining contractual life |       | —   |       | 1.00 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    |       | (57,000     | )          |
| Accumulated  deficit            |       | (11,004,000 | )          |
|                            |       | 1,313,000   |       |
| Less treasury  stock, at cost   |       | 90,000      |       |
|                            |       | $           | 1,223,000  |   |

 

 

7

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Thechanges in shares 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, October  31, 2006 |       | 5,351,590  |       |

 

**Note 8 —Earnings Per Share**

Statement of Financial Accounting Standards (SFAS) No.128, *Earnings per Share*, requiresdual presentation of basic and diluted EPS on the face of the statement ofearnings regardless of whether basic and diluted EPS are the same; and requiresa reconciliation of the numerator and denominator used in computing basic anddiluted EPS.  Basic EPS excludes dilutionand is computed by dividing earnings available to common stockholders by theweighted average number 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 6 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.

Pursuant to SFAS No. 128, the basic and dilutedearnings per common share were computed as follows:

# **Year-to-DateEPS Calculations**

|                                                                      | ** ** | **2006**  | ** ** | **2005**  | ** ** |
|----------------------------------------------------------------------|------------|-----------|------------|-----------|------------|
| Earnings (loss) before  cumulative effect                            |       | $         | (213,000   | )         | $          | 356,000 |   |
| Cumulative effect                                                    |       | 8,000     |       | —    |       |
| Net earnings (loss)                                                  |       | $         | (205,000   | )         | $          | 356,000 |   |
|                                                                 |       |      |       |      |       |
| Weighted average common  shares outstanding for basic EPS            |       | 5,116,373 |       | 5,111,590 |       |
| Incremental shares for  effect of stock options and restricted stock |       | —    |       | —    |       |
| Weighted average common  shares outstanding for dilutive EPS         |       | 5,116,373 |       | 5,111,590 |       |
|                                                                 |       |      |       |      |       |
| Basic and diluted  earnings (loss) per share:                        |       |      |       |      |       |
| Before  cumulative effect                                            |       | $         | (.04       | )         | $          | .07 |   |
| Cumulative  effect                                                   |       | —    |       | —    |       |
|                                                                 |       | $         | (.04       | )         | $          | .07 |   |

 

No incremental shares areincluded in the 2006 EPS calculations for the 40,000 shares under option or the200,000 shares of restricted common stock since the effect would beanti-dilutive.  There were noanti-dilutive incremental shares in 2005 because the average market price ofthe common stock was less than the exercise price.

 

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**QuarterlyEPS Calculations**
| ** **                                                           | ** ** | **2006**  | ** ** | **2005**  | ** ** |
|----------------------------------------------------------------------|------------|-----------|------------|-----------|------------|
| Net earnings (loss)                                                  |       | $         | (69,000    | )         | $          | 164,000 |   |
|                                                                 |       |      |       |      |       |
| Weighted average common  shares outstanding for basic EPS            |       | 5,121,155 |       | 5,111,590 |       |
| Incremental shares for  effect of stock options and restricted stock |       | —    |       | 2,626     |       |
| Weighted average common  shares outstanding for dilutive EPS         |       | 5,121,155 |       | 5,114,216 |       |
|                                                                 |       |      |       |      |       |
| Basic and diluted  earnings (loss) per share                         |       | $         | (.01       | )         | $          | .03 |   |

 

No incremental shares are included in the 2006 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 — Stock AppreciationRights**

On September 10, 2004, the board of directors ofTorotel approved the Directors Stock Appreciation Rights Plan (the “Plan”) fornon-employee directors.  Each SAR isequal to one share of common stock of Torotel, and the aggregate number of SARsthat may be granted under the Plan shall not exceed 500,000. The effective dateof the Plan is October 1, 2004.  The SARsare now accounted for under SFAS No. 123(R), *Accountingfor Stock-Based Compensation.*

Pursuant to the Plan, 20,000 SARs were granted on theeffective date to each of the three current non-employee directors.  The initial price at which each SAR wasgranted was $.35, which equaled the market price of Torotel’s common stock onthe date of grant.  Accordingly, nocompensation cost was recognized at the time of grant in accordance with APBOpinion 25, prior to the adoption of SFAS No. 123(R) on May 1, 2006, asdiscussed in Note 4 of Notes to Consolidated Financial Statements.

SARs shall automatically be granted in the future asfollows: (1) each person who is elected as a director, who was not a directoron the effective date of the Plan, shall be granted 10,000 SARs on the datesuch person is elected a director; and (2) on each May 1 following theeffective date during the term of the Plan, each person serving as a directoron such date shall be granted 10,000 SARs.   After the initial grant, the price at which each SAR is granted shall bethe average of the closing price of Torotel’s common stock for the tenconsecutive days immediately preceding the date of grant.  Upon exercise of a SAR, Torotel will pay thegrantee an amount (the “Spread”) equal to the excess of the Exercise Price overthe SAR grant price multiplied by the number of shares being exercised.  The Exercise Price shall be the average ofthe closing price of Torotel’s common stock for the ten consecutive daysimmediately preceding the notice of exercise. For any payments that exceed $10,000, Torotel has the option to makequarterly payments over three years with interest payable quarterly at theprime 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  a director of the Company following  the Date of Grant | ** ** | **Shares represented  by a SAR in which  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                                                                 | %          |   |
|                                                                                                                                |            |                                                                     |            |        |  |  |

 

 

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A Grantee shall become fully (100%) vested in each ofhis or her SARs under the following circumstances:  (i) upon termination of the Grantee’s serviceas a director of Torotel for reasons of death, disability or retirement; (ii)if the Compensation and Nominating Committee (the “Committee”), in its solediscretion, determines that acceleration of the SAR vesting schedule would bedesirable for Torotel; or (iii) if Torotel shall, pursuant to action by itsBoard of Directors, at any time propose to merge into, consolidate with, orsell or otherwise transfer all or substantially all of its assets to anothercorporation, and provision is not made pursuant to the terms of suchtransaction for the assumption by the surviving, resulting or acquiringcorporation of outstanding SARs or for substitution of new SARs therefore, theCommittee shall cause written notice of the proposed transaction to be given toeach Grantee not less than twenty days prior to the anticipated effective dateof the proposed transaction, and his or her SARs shall become fully (100%)vested and, prior to a date specified in such notice, which shall be not morethan ten days prior to the anticipated effective date of the proposedtransaction, each Grantee shall have the right to exercise his or her SARs.

In accordance withSFAS 123(R), compensation expense is recognized over the vesting period basedupon the estimated fair value of the SARs pursuant to the terms of the Planusing the Black-Scholes options-pricing model as of the end of each financialreporting period.  As of October 31,2006, the fair value of the SARs was determined using the followingassumptions: no dividend payments over the life of the SARs since Torotel hasnot issued any form of dividend since 1985; an expected volatility of 183.7%based on Torotel’s historical volatility using the weekly closing price overthe past five years; a risk-free interest rate of 4.50%; and an expected lifeof 4.75 years based on the length of service estimated to be served.  Based on these assumptions, the fair valueprice per share of the outstanding SARs are summarized as follows:
| **Grant Date** | ** ** | **SARs  Under  Option** | ** ** | **Exercise  Price** | ** ** | **Fair Value  Price** | ** ** | **%  Vested** | ** ** | **Aggregate  Vested  Fair Value** | ** ** | **Aggregate  Intrinsic  Value** | ** ** |
|---------------------|------------|-------------------------|------------|---------------------|------------|----------------------------|------------|---------------|------------|----------------------------------------|------------|---------------------------------|------------|
| October 1, 2004     |       | 60,000                  |       | $                   | .350       |                       | $          | .651          |       | 67                                     | %          | $                               | 26,000     |   | $ | 19,000 |   |
| May 1, 2005         |       | 30,000                  |       | $                   | .302       |                       | $          | .652          |       | 33                                     | %          | $                               | 7,000      |   | $ | 11,000 |   |
| May 1, 2006         |       | 30,000                  |       | $                   | .695       |                       | $          | .642          |       | 0                                      | %          | $                               | —     |   | $ | — |   |

 

The vested portionrepresents 50,100 SARs.  As of October31, 2006, the total aggregate intrinsic value of these exercisable SARs was$16,000.

SARs transactions for each period though October 31are summarized as follows:

|                                                                  | ** ** | **2006**                | ** ** | **2005**                            | ** ** |
|------------------------------------------------------------------|------------|-------------------------|------------|-------------------------------------|------------|
| ** **                                                       | ** ** | **SARs  Under  Option** | ** ** | **Weighted  Average  Grant  Price** | ** ** | **SARs  Under  Option** | ** ** | **Weighted  Average  Grant  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                  |       | $                                   | .334       |   | — |   | — |   |
| Weighted average  fair value of SARs   granted during the period |       |                    |       | $                                   | .642       |   |   |   | — |   |

 

 

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The followinginformation applies to SARs outstanding for each period through October 31:

|                                              | ** ** | **2006**  | ** **   | **2005**  | ** ** |
|----------------------------------------------|------------|-----------|--------------|-----------|------------|
| 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 |       | 8.46 yrs. |         | 9.11 yrs. |       |

 

Total compensation expense for the outstanding SARsfor the six months ended October 31, 2006 and 2005, was zero and $16,000,respectively.  The amount for 2006 wasnet of an $8,000 reduction for the cumulative effect of adopting SFAS No. 123(R).  Total compensation expense for theoutstanding SARs for the three months ended October 31, 2006 and 2005, was$15,000 and $19,000, respectively.  As ofOctober 31, 2006, there was $45,000 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 1.46 years. The liability for SARs on the consolidated balance sheet as of October31, 2006, was $33,000.

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 each period presented:

# **Year-to-DatePro Forma EPS Calculations**

|                                                                                                                                         | ** ** | **2006** | ** ** | **2005** | ** ** |
|-----------------------------------------------------------------------------------------------------------------------------------------|------------|----------|------------|----------|------------|
| Net earnings  (loss)                                                                                                                    |       | $        | (205,000)  |     | $          | 356,000 |   |
|                                                                                                                                    |       |     |       |     |       |
| Add:   Stock-based  compensation expense included in         reported net earnings (loss)                 |       | —   |       | 16,000   |       |
|                                                                                                                                    |       |     |       |     |       |
| Deduct:   Stock-based  compensation expense determined            under fair value based method |       | —   |       | 11,000   |       |
| Pro forma net  earnings (loss)                                                                                                          |       | $        | (205,000)  |     | $          | 361,000 |   |
|                                                                                                                                    |       |     |       |     |       |
| Basic and  diluted earnings (loss) per share:                                                                                           |       |     |       |     |       |
| as reported                                                                                                                             |       | $        | (.04)      |     | $          | .07 |   |
| pro forma                                                                                                                               |       | $        | (.04)      |     | $          | .07 |   |

 

# **QuarterlyPro Forma EPS Calculations**

|                                                                                                                                        | ** ** | **2006** | ** ** | **2005** | ** ** |
|----------------------------------------------------------------------------------------------------------------------------------------|------------|----------|------------|----------|------------|
| Net earnings  (loss)                                                                                                                   |       | $        | (69,000)   |     | $          | 164,000 |   |
|                                                                                                                                   |       |     |       |     |       |
| Add:   Stock-based  compensation expense included in         reported net earnings (loss)                |       | 15,000   |       | 19,000   |       |
|                                                                                                                                   |       |     |       |     |       |
| Deduct:   Stock-based  compensation expense determined           under fair value based method |       | 15,000   |       | 11,000   |       |
| Pro forma net  earnings (loss)                                                                                                         |       | $        | (69,000)   |     | $          | 172,000 |   |
|                                                                                                                                   |       |     |       |     |       |
| Basic and  diluted earnings (loss) per share:                                                                                          |       |     |       |     |       |
| as reported                                                                                                                            |       | $        | (.01)      |     | $          | .03 |   |
| pro forma                                                                                                                              |       | $        | (.01)      |     | $          | .03 |   |

 

** **

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** **

**Note**  10 — Amortization of Intangibles

Since the acquisition of Electronika primarilyinvolved the purchase of certain technology-based intangible assets, annualreviews have been performed to determine the amount of any impairment.  The remaining carrying value of theseintangible assets is estimated at $680,000 and is supported by the projectedamount recoverable from the selling shareholders of Electronika (the CaloyerasFamily Partnership).  The sellingshareholders contractually guaranteed that the aggregate sales from Electronika’sexisting ballast designs over the first five (5) full fiscal years,specifically fiscal years 2003-2007, would be at least $2,500,000, which basedon the terms of the Manufacturing Agreement with Magnetika, Inc., would resultin an aggregate gross profit of $1,500,000 before any operating expenses.  Aggregate sales since fiscal 2003 have been$1,327,000, which contractually results in an amount due from the CaloyerasFamily Partnership of $704,000 as of October 31, 2006.

The followingtable provides the adjusted gross carrying value and accumulated amortizationfor each major class of intangible asset based on Torotel’s reassessment ofpreviously recognized intangible assets in accordance with the adoption ofStatement of Financial Accounting Standards No. 142, *Goodwill and Other Intangible Assets*:

|                      | ** ** | ** **                     | ** ** | **2006**                    | ** ** | **2005**                      | ** ** |
|----------------------|------------|--------------------------------|------------|-----------------------------|------------|-------------------------------|------------|
| ** **           | ** ** | **Average  Amortizable  Life** | ** ** | **Gross  Carrying  Amount** | ** ** | **Accumulated  Amortization** | ** ** | **Gross  Carrying  Amount** | ** ** | **Accumulated  Amortization** | ** ** |
| Aircraft -  ballasts |       | 3                              |       | $                           | 1,148,000  |                          | $          | 468,000 |   | $ | 1,148,000 |   | $ | 415,000 |   |
|                      |            |                                |            |                             |            |                               |            |  |  |  |  |  |  |  |  |

 

The total intangible amortization expense for the sixmonths ended October 31, 2006 and 2005 was $11,000 and $37,000,respectively.  The estimated aggregateamortization expense for fiscal 2007 is as follows:

|      | **April 30,** | ** ** | ** ** | **Amount** | ** ** |
|------|--------------------|------------|------------|------------|------------|
| 2007 |               | $          | 22,000     |       |
|      |                    |            |            |            |            |  |

 

The remaining book value of approximately $669,000 atApril 30, 2007, represents the projected amount recoverable from the formershareholders, and is based on the estimated sales from the aforementionedballast designs.  The recoverable amountwill reduce the $750,000 note payable to shareholders, who are also the ownersof Magnetika.

**Note 11 — Concentrations of Credit Risk**

At various times and at October 31, 2006, Torotelmaintained cash in bank balances that exceed the federally insured limits.

**Note 12 — New AccountingPronouncements**

In September 2006, the SEC staff issue StaffAccounting Bulletin (SAB) Topic 1N, *“Financial Statements —Considering the Effects of Prior Year Misstatements when QuantifyingMisstatements in Current Year Financial Statements”* (SAB 108).  This Bulletin provides guidance on how prioryear

 

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misstatementsshould be taken into consideration when quantifying misstatements in currentyear financial 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.  The companydoes not believe SAB 108 will have a material impact on its results ofoperations, financial condition and cash flows.

**Note 13 —Legal Proceedings**

On November 7, 2006, Basil P. Caloyeras, thebeneficial owner of 998,066 shares of Torotel common stock, filed suit in theUnited States District Court for the District of Kansas, against Torotel andeach of the members of its board of directors, seeking to preliminarily and permanently enjoin the defendants fromtaking any further action which would in any way adversely effect plaintiff’spresent interest or rights as a shareholder, including, but not limited to,amending Torotel’s Articles of Incorporation or By-Laws, issuing additionalshares of Torotel common stock, or entering into contractual agreements withmembers of the board of directors, until a meeting of Torotel’s shareholdershas been properly convened at which plaintiff’s nominations to Torotel’s boardof directors and proposed amendments to Torotel’s Articles of Incorporation asset out by plaintiff are presented and voted on.

Torotel management and the Board intend to vigorouslyoppose Mr. Caloyeras’ motion for an injunction and to file their opposition tothe motion on or about December 8, 2006. The Board believes it acted in accordance with Securities and ExchangeCommission rules, Missouri law, Torotel’s Articles of Incorporation, Amendedand Restated By-Laws and Compensation and Nominating Committee Charter indeclining 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’sDiscussion and Analysis 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 fourindependent 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 inthis regard for all engineering personnel to earn a commission on new productsales to 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’ssales do not represent a significant portion of any particular market.  Electronika’s requirements for the ballasttransformers are outsourced pursuant to a Manufacturing Agreement withMagnetika, Inc. (“Magnetika”), a corporation owned by the family of Peter B.Caloyeras, who passed away on December 5, 2006. Basil P. Caloyeras is a director and president of Electronika.  Under the terms of the agreement, Magnetikaprovides all necessary raw material, labor, testing, packaging and relatedservices required to complete the manufacture, delivery and sale of the ballasttransformers.  Electronika retainsownership of all designs, drawings, specifications and intellectual propertyrights associated with the ballast transformers.  Due to lower than anticipated sales forElectronika, the carrying value of the intangible assets of Electronika is now$680,000.  These intangible assets arebeing partially amortized in fiscal 2007. At April 30, 2007, the remaining value of the intangible assets isexpected to be approximately $669,000, 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 $17,000 for the six months ended October 31, 2006.

**Business Outlook**

Torotel Products’ industry mix for fiscal 2006 net saleswas 52% defense, 32% aerospace and 16% commercial/industrial.  The mix for the first half of fiscal 2007 was42% defense, 37% aerospace and 21% commercial/industrial.  This shift toward aerospace and commercial/industrialfollows 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 ratesof the new capacitor assemblies in the second half of fiscal 2007, and a majorcommercial contract award that was expected near the end of the first quarterof fiscal 2007.  New order bookings forthe first half of fiscal 2007 increased 10%, which included a $2.1 millioncontract for the potted coil assembly for the Hellfire II missile system.  The major commercial contract award that wasoriginally expected in July 2006 has now been delayed indefinitely.  In addition, the new capacitor assemblies arebeing designed out of the OEM’s application so no further orders areanticipated for this product.  The orderbacklog at October 31, 2006 is $3,289,000, a 35% increase from a year ago.  The primary factors that drive gross profitand net earnings for Torotel Products are sales volume and product mix.  The gross profits on mature products/programsand larger transformer devices tend to be higher than those that are still inthe prototyping or early production stages and simpler inductor devices.  As a result, in any given accounting periodthe mix of product shipments between higher and lower margin jobs has asignificant impact on the gross profit and net earnings of Torotel Products.

As disclosed in Torotel’s Form 10-KSB for the fiscalyear ended April 30, 2006, Torotel’s operating plan calls for additional salesand marketing costs in the form of personnel, advertising, trade show exhibitsand new print literature.  Managementbelieves a well developed growth strategy is in place and that theseexpenditures are critical for achieving that growth; as a result, near-termearnings may be impacted. Torotel’s management will continue to focus itsefforts in areas and solutions that offer significant growth,

 

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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 thedecline in the number of active DC-8 and DC-9 aircraft.  Management expects these sales to continue todecline and eventually bottom out.

**Resultsof Operations**

The following management comments regarding Torotel’sresults of operations and outlook should be read in conjunction with theConsolidated Financial Statements included pursuant to Item 1 of this QuarterlyReport.

The discussion and analysis of the results ofoperations include the operations of Torotel, Inc. and its subsidiaries,Torotel Products, Inc. and Electronika, Inc. While each company’s results are included in the following discussion,segment reporting is not applicable because the products offered are similar inform and function, and target similar markets.

**Six Months Ended October 31, 2006 Compared WithSix Months Ended October 31, 2005**

Net sales decreased 8%.  The net sales of Torotel Products decreased7% from $2,623,000 to $2,443,000.  Thisdecrease is attributable primarily to lower sales of components used on theAMRAAM, Hellfire II and Maverick missile systems.  This decrease was offset partially by highershipments of the potted coil assembly for the Hellfire II missile system,higher demand for components used in aerospace applications and higher demandfor molded coils used in down-hole drilling applications.  The net sales of Electronika decreased 53%from $91,000 to $43,000, which is representative of the downward trend inElectronika’ sales.

Gross profit as a percentage of net sales decreased8%.  The gross profit percentage ofTorotel Products decreased 8% 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 implement Demand FlowTechnology® and reduce average production cycle times.  Electronika’s gross profit as a percentage ofnet sales remained unchanged.

Engineering expenses, applicable only to TorotelProducts, increased 6% from $122,000 to $129,000 because of higher payrollcosts associated with two college interns utilized during the summer months andadditional travel costs.  Management doesanticipate an increase in the present level of engineering expenses as additionalengineering technical support is planned.

Selling, general and administrative (SG&A)expenses increased 24%.  The SG&Aexpenses of Torotel, Inc. increased 43% from $175,000 to $251,000 primarilybecause of a $40,000 increase in professional fees associated with change incontrol tactics and non-compliant shareholder proposals initiated by certainshareholders, including Basil P. Caloyeras and the Caloyeras FamilyPartnership, higher auditing and tax fees of $24,000 and a consulting charge of$13,000 associated with short and long-term compensation

 

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planning.  The SG&A expenses of Torotel Productsincreased 19% from $569,000 to $676,000 primarily because of higher payrollcosts of $67,000, a $15,000 increase in travel costs, a $12,000 increase in marketingand advertising costs, a $10,000 increase in equipment maintenance costs, a$9,000 increase in recruiting fees, a $7,000 increase in printing costs and a$4,000 increase in bank charges associated with the write-off of capitalizedloan fees on the original mortgage loan for the Olathe facility (see Note 3 ofNotes to Consolidated Financial Statements). These increases were offset partially by a $12,000 decrease in trainingcosts and a $5,000 decrease in utilities costs. The SG&A expenses of Electronika increased slightly from $14,000 to$15,000.  Management does anticipate anincrease in the present level of SG&A expenses as the plan calls foradditional sales and marketing costs in the form of personnel, advertising,trade show exhibits and new print literature.

Amortization costs, entirely attributable toElectronika, decreased from $37,000 to $11,000 (see Note 10 of Notes toConsolidated Financial Statements).

Interest expense decreased 8%.  The interest expense of Torotel, Inc.remained unchanged at $26,000.  Theinterest expense of Torotel Products decreased from $36,000 to $31,000 becauseof a lower debt balance.

Interest income increased $5,000 because of funds setaside in a money management account.

There was no earnings impact in the current year froman impairment of real estate.  A chargeof $36,000 was recorded in the prior year.

There was no earnings impact in the current year froma gain on the settlement of debt.  A gainof $35,000 was recorded in the prior year.

There was no earnings impact in the current year froma gain on the sale of real estate.  Again of $110,000 was recorded in the prior year.

For the reasons discussed above, the consolidatedpretax earnings decreased from a profit of $356,000 to a loss of $213,000.  The pretax loss of Torotel, Inc. increasedfrom $166,000 to $277,000.  The pretaxearnings of Torotel Products decreased from $518,000 to $62,000.  The pretax earnings of Electronika decreasedfrom $4,000 to $2,000.

**Three Months Ended October 31, 2006 Compared With ThreeMonths Ended October 31, 2005**

Net sales decreased 11%.  The net sales of Torotel Products decreased10% from $1,404,000 to $1,268,000.  Thisincrease is attributable to the same reasons as outlined above in theyear-to-date net sales comparison.  Thenet sales of Electronika decreased 56% from $43,000 to $19,000.

Gross profit as a percentage of net sales decreased6%.  The gross profit percentage ofTorotel Products decreased 6% because of lower sales volume, higher fixedproduction costs due to the hiring of a production and quality assurancetechnician and less absorption of labor costs due to a decrease in the level ofwork in process inventory as part of the ongoing efforts to implement DemandFlow Technology® and reduce average production cycle times.  Electronika’s gross profit as a percentage ofnet sales remained unchanged.

Engineering expenses, applicable only to TorotelProducts, remained unchanged at $65,000.     Selling, general andadministrative (SG&A) expenses increased 23%.  The SG&A expenses of Torotel, Inc.increased 36% from $102,000 to $139,000 primarily because of a $16,000 increasein professional fees associated with change in control tactics andnon-compliant shareholder proposals initiated by Peter B. and Basil P.Caloyeras and the Caloyeras Family Partnership, a consulting charge of $13,000associated with

 

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short and long-term compensation planning and higherauditing and tax fees of $8,000.  TheSG&A expenses of Torotel Products increased 19% from $294,000 to $350,000primarily because of higher payroll costs of $52,000, a $9,000 increase inrecruiting fees, a $7,000 increase in travel costs, a $5,000 increase inmarketing and advertising costs and a $3,000 increase in equipment maintenancecosts.  These increases were offset partiallyby a $20,000 decrease in training costs. The SG&A expenses of Electronika remained unchanged at $7,000.

Amortization costs, entirely attributable toElectronika, decreased 81% from $21,000 to $4,000 (see Note 10 of Notes toConsolidated Financial Statements).

Interest expense increased 3%.  The interest expense of Torotel, Inc.remained unchanged at $13,000.  Theinterest expense of Torotel Products increased from $16,000 to $17,000 becauseof a higher borrowing rate associated with refinancing the mortgage debt (seeNote 3 of Notes to Consolidated Financial Statements).

Interest income increased $3,000 because of funds setaside in a money management account.

There was no earnings impact in the current quarterfrom a gain on the sale of real estate. A gain of $5,000 was recorded in the prior year.

For the reasons discussed above, the consolidatedpretax earnings decreased from a profit of $164,000 to a loss of $69,000. The pretax loss of Torotel, Inc. increased from $115,000 to$152,000.  The pretax earnings of TorotelProducts decreased from $281,000 to $82,000. The pretax earnings of Electronika increased from a loss of $2,000 to aprofit of $1,000.

**Liquidityand Capital Resources**

As of October 31, 2006, Torotel had $400,000 in cashand cash equivalents, compared to $485,000 as of October 31, 2005.  On June 25, 2006, Torotel refinanced itsmortgage debt with the Bank of Blue Valley with a new maturity date of June 25,2011; on September 30, 2006, Torotel renewed its $200,000 credit line with the Bankof Blue Valley with a new maturity date of September 30, 2007 (see Note 3 ofNotes to Consolidated Financial Statements). The $750,000 note payable to shareholders matures in March 2007 (seeNote 10 of Notes to Consolidated Financial Statements).  Torotel intends to offset this debt by theamount recoverable pursuant to the sales guarantee provided by the sellingshareholders of Electronika.  At April30, 2007, the projected amount recoverable is $669,000.  The projected difference of $81,000 after theoffset will be paid from existing cash resources.

The table belowpresents the summary of cash flow for the six-month periods indicated.

|                                                      | ** ** | **2006** | ** ** | **2005** | ** ** |
|------------------------------------------------------|------------|----------|------------|----------|------------|
| Net cash  provided by (used in) operating activities |       | $        | (83,000    | )        | $          | 365,000 |   |
| Net cash  provided by (used in) investing activities |       | $        | (22,000    | )        | $          | 276,000 |   |
| Net cash used in  financing activities               |       | $        | (16,000    | )        | $          | (349,000 | ) |

 

Net cash provided by operating activities fluctuatesbetween periods primarily as a result of differences in operating earnings, thetiming of shipments and the collection of accounts receivable, changes in inventory,level of sales and payment of accounts payable. The decrease in net cash provided by investing activities is because ofthe net proceeds of $317,000 from the sale of the real estate parcels in 2005.* *Capital expenditures were $22,000 during the firsthalf of fiscal 2007.  Managementanticipates approximately $60,000 in total capital expenditures for fiscal2007.  Net cash used in financingactivities is

 

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because long-termdebt payments of $31,000 less proceeds of $15,000 received from the exercise ofan incentive stock option.  Managementbelieves that the projected cash flow from operations, combined with its existingcash balances, will be sufficient to meet its funding requirements for theforeseeable future.  Torotel does have a$200,000 bank line of credit available, which could be utilized, if required,to help fund growth.

Management believes that inflation will have only aminimal effect on future operations since such effects will be offset by salesprice increases, which are not expected to have a significant effect upondemand*.*

Torotel’s board of directors has determined thatReturn on Capital Employed (“ROCE”) will be the primary tool for managingTorotel’s business.  ROCE is measured bythe 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 youput in (NOA = Capital Employed).  Forthese purposes, NOA is defined as “accounts receivable + inventory + net fixedassets + miscellaneous operating assets — accounts payable — miscellaneousoperating liabilities”.  The performanceof Torotel’s management and the majority of its decisions going forward will bemeasured by whether Torotel’s ROCE improves. In fiscal 2004, 2005 and 2006, Torotel’s ROCE was 1.46%, 5.84% and19.04%, respectively.  Torotel’s ROCE forthe 12-month trailing period ended October 31, 2006 is .55%, which is notindicative of the expectations for the balance of fiscal 2007.

**Forward-LookingInformation**

This report, as well as our other reports filed withthe Securities and Exchange Commission (“SEC”), and in press releases and otherpublic communications throughout the year, contains 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

 

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developing new products, expected orders that do notoccur, loss of key customers, the impact of competition and price erosion aswell as supply and manufacturing constraints, and other risks anduncertainties.  In light of these risksand uncertainties, there can be no assurance that the forward-lookinginformation contained in this report will prove accurate, and our actualresults may differ materially from these forward looking statements.  We assume no obligation to update anyforward-looking statements made herein.

**Item 3.**                          Controlsand Procedures

Torotel’s Chief Executive Officer and Chief FinancialOfficer (collectively, the “Certifying Officers”) are responsible forestablishing and maintaining disclosure controls and procedures (as defined inExchange Act Rule 13a-15(e)) for Torotel. Such officers have concluded (based upon their evaluation of thesecontrols and procedures as of a date within 90 days of the filing of thisreport) that Torotel’s disclosure controls and procedures are adequate andeffective for purposes of Rule 13a-14(c) in timely alerting them to materialinformation relating to Torotel required to be included in Torotel’s filingswith 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.**                Legal Proceedings

On November 7, 2006, Basil P. Caloyeras, thebeneficial owner of 998,066 shares of Torotel common stock, filed suit in theUnited States District Court for the District of Kansas, against Torotel and eachof the members of its board of directors, seeking to preliminarily and permanently enjoin the defendants fromtaking any further action which would in any way adversely effect plaintiff’spresent interest or rights as a shareholder, including, but not limited to,amending Torotel’s Articles of Incorporation or By-Laws, issuing additionalshares of Torotel common stock, or entering into contractual agreements withmembers of the board of directors, until a meeting of Torotel’s shareholdershas been properly convened at which plaintiff’s nominations to Torotel’s boardof directors and proposed amendments to Torotel’s Articles of Incorporation asset out by plaintiff are presented and voted on.

Torotel management and the Board intend to vigorouslyoppose Mr. Caloyeras’ motion for an injunction and to file their opposition tothe motion on or about December 8, 2006. The Board believes it acted in accordance with Securities and ExchangeCommission rules, Missouri law, Torotel’s Articles of Incorporation, Amendedand Restated By-Laws and Compensation and Nominating Committee Charter indeclining 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 4.**                Submission of Matters to a Vote ofSecurity Holders

The annual meeting of stockholders was held in KansasCity, Missouri, on Tuesday, October 17, 2006, to vote on the following twoproposals:

(1)                    To elect twomembers to serve on the Board of Directors for a three-year term, with thosenominees receiving the greatest number of votes being elected; and

(2)                    To approve anamendment to the Torotel’s Articles of Incorporation to increase the number ofauthorized shares of common stock, par value $.01 per share, from 6,000,000 to20,000,000 shares, with the affirmative vote of a majority of the shares ofcommon stock present, in person or by proxy, and entitled to vote required toapprove this proposed amendment.

A majority of the outstanding shares of common stockentitled to be voted at the meeting, represented in person or by Proxy, wasnecessary to constitute a quorum to transact business at the meeting.  At the meeting, there were 5,095,629 sharesrepresented which was 95.93% of the shares outstanding and eligible to vote.

Stockholders elected the following individuals to athree-year term on the Board of Directors, with the number of shares voting “FOR”each nominee indicated.

|        | Dale H.  Sizemore, Jr. | 2,507,818 |
|--------|------------------------|-----------|
|   | Richard A.  Sizemore   | 2,506,986 |

 

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In addition to thedirectors elected above, Anthony H. Lewis, H. James Serrone and Stephen K.Swinson also serve as directors.  Thecurrent three-year term for Messrs. Lewis and Swinson ends in 2007, while thethree-year term for Mr. Serrone ends in 2008.

Stockholders rejected the amendment to increase thenumber of authorized shares of common stock, with the number of shares voting “FOR”, “AGAINST”, and “ABSTAINED” indicated below.
|        | FOR     |   | 2,465,197 |   |
|--------|---------|--------|-----------|--------|
|   | AGAINST |   | 2,627,949 |   |
|   | ABSTAIN |   | 2,483     |   |

 

**Item 6.**                Exhibits
|        | Exhibit 10.2 | Form of Director Non-Compete/Non-Disclosure  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**

In accordance with the requirements of the SecuritiesExchange Act of 1934, the Registrant has duly caused this report to be signedon its behalf by the undersigned, thereunto duly authorized.

Torotel, Inc.(Registrant)
| /s/ Dale H. Sizemore,  Jr.      |   |
|--------------------------------------|--------|
| Dale H.  Sizemore, Jr.               |   |
| Chief Executive  Officer             |   |
| Date:   December  10, 2006 |   |
|                                 |   |
|                                 |   |
| /s/ H.  James Serrone           |   |
| H. James Serrone                     |   |
| Chief Financial  Officer             |   |
| Date:   December  10, 2006 |   |

 

 

 

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