**FORM 10-QSB**

 

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

 

**For the quarterly period ended July 31, 2004**

 

**Commission File No. 1-8125**

 

**TOROTEL, INC.**

(Exact name of small business issuer as specified in its charter)

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

 

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

(Address of principal executive offices)

 

**(913) 747-6111**

(Issuer’s telephone number)

 

**NONE**

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

 

Check whether the issuer (1) filedall 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 suchfiling requirements for the past 90 days.

 

Yes  ý   No  o

 

As of March 30,2005, there were 5,111,590 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 July 31, 2004                                           |                                                            |
|          |                                                                                           |                                                            |
|          | Consolidated  Statements of Operations for the three months ended July 31, 2004 and  2003 |                                                            |
|          |                                                                                           |                                                            |
|          | Consolidated  Statements of Cash Flows for the three months ended July 31, 2004 and  2003 |                                                            |
|          |                                                                                           |                                                            |
|          | Notes  to Consolidated Financial Statements                                                    |                                                            |
|          |                                                                                           |
|          | Item  2.                                                                                       | Management’s  Discussion and Analysis or Plan of Operation |   |
|          |                                                                                           |
|          | Item 3.                                                                                        | Controls and Procedures                                         |   |
|          |                                                                                           |
| PART II. | OTHER INFORMATION                                                                              |                                                            |
|          |                                                                                           |
|          | Item 6.                                                                                        | Exhibits and  Reports on Form 8-K                          |   |
|          |                                                                                           |
| SIGNATURES    |                                                                                           |
|               |                                                                                                |                                                                 |  |  |  |  |

 

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PART I.     FINANCIALINFORMATION

 

Item 1.        FinancialStatements

 

CONSOLIDATED BALANCESHEET (Unaudited)

As of July 31, 2004

 
| ASSETS                                           |   |        |      |
|--------------------------------------------------|--------|-------------|-----------|
|                                             |   |        |      |
| Current assets:                                  |   |        |      |
| Cash                                             |   | $           | 40,000    |   |
| Accounts receivable, net                         |   | 587,000     |      |
| Inventories                                      |   | 445,000     |      |
| Prepaid expenses and other current assets        |   | 55,000      |      |
|                                             |   | 1,127,000   |      |
|                                             |   |        |      |
| Property, plant and equipment, net               |   | 1,079,000   |      |
|                                             |   |        |      |
| Real estate held for sale                        |   | 248,000     |      |
| Intangible assets, net                           |   | 852,000     |      |
| Equity investment                                |   | 122,000     |      |
| Other assets                                     |   | 27,000      |      |
|                                             |   |        |      |
|                                             |   | $           | 3,455,000 |   |
| LIABILITIES AND STOCKHOLDERS’ EQUITY        |   |        |      |
|                                             |   |        |      |
| Current liabilities:                             |   |        |      |
| Current maturities of long-term debt             |   | $           | 53,000    |   |
| Trade accounts payable                           |   | 288,000     |      |
| Accrued liabilities                              |   | 187,000     |      |
| Accrued interest on note payable to shareholders |   | 5,000       |      |
|                                             |   | 533,000     |      |
|                                             |   |        |      |
| Long-term debt, less current maturities          |   | 1,204,000   |      |
|                                             |   |        |      |
| Note payable to shareholders                     |   | 750,000     |      |
|                                             |   |        |      |
| Stockholders’ equity:                       |   |        |      |
| Common stock, at par value                       |   | 52,000      |      |
| Capital in excess of par value                   |   | 12,362,000  |      |
| Accumulated deficit                              |   | (11,241,000 | )         |
|                                             |   | 1,173,000   |      |
| Less treasury stock, at cost                     |   | 205,000     |      |
|                                             |   | 968,000     |      |
|                                             |   |        |      |
|                                             |   | $           | 3,455,000 |   |

 

The accompanying notes are an integral part of this statement.

 

1

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CONSOLIDATED STATEMENTSOF OPERATIONS (Unaudited)

Three Months Ended July 31,

 
| ** **                                        | ** ** | **2004** | ** ** | **2003** | ** ** |
|---------------------------------------------------|------------|----------|------------|----------|------------|
| Net sales                                         |       | $        | 1,004,000  |     | $          | 1,078,000 |   |
| Cost of goods sold                                |       | 679,000  |       | 675,000  |       |
|                                              |       |     |       |     |       |
| Gross profit                                      |       | 325,000  |       | 403,000  |       |
|                                              |       |     |       |     |       |
| Operating expenses:                               |       |     |       |     |       |
| Engineering                                       |       | 52,000   |       | 45,000   |       |
| Selling, general and administrative               |       | 288,000  |       | 244,000  |       |
| Amortization of intangible assets                 |       | 9,000    |       | 38,000   |       |
|                                              |       |     |       |     |       |
|                                              |       | 349,000  |       | 327,000  |       |
|                                              |       |     |       |     |       |
| Earnings (loss) from operations                   |       | (24,000  | )          | 76,000   |       |
|                                              |       |     |       |     |       |
| Other expense (income):                           |       |     |       |     |       |
| Interest expense                                  |       | 34,000   |       | 17,000   |       |
| Equity in loss of investee                        |       | 28,000   |       | 26,000   |       |
|                                              |       | 62,000   |       | 43,000   |       |
|                                              |       |     |       |     |       |
| Earnings (loss) before provision for income taxes |       | (86,000  | )          | 33,000   |       |
|                                              |       |     |       |     |       |
| Provision for income taxes                        |       | —   |       | —   |       |
|                                              |       |     |       |     |       |
| Net earnings (loss)                               |       | $        | (86,000    | )        | $          | 33,000 |   |
|                                              |       |     |       |     |       |
| Basic and diluted earnings (loss) per share       |       | $        | (.02       | )        | $          | .01 |   |

 

The accompanying notes are an integral part of these statements.

 

2

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CONSOLIDATED STATEMENTSOF CASH FLOWS (Unaudited)

Three Months Ended July 31,

 
| ** **                                                                                            | ** ** | **2004** | ** ** | **2003** | ** ** |
|-------------------------------------------------------------------------------------------------------|------------|----------|------------|----------|------------|
| Cash flows from  operating activities:                                                                |       |     |       |     |       |
| Net earnings (loss)                                                                                   |       | $        | (86,000    | )        | $          | 33,000 |   |
| Adjustments to reconcile net earnings (loss) to net  cash provided by (used in) operating activities: |       |     |       |     |       |
| Equity in loss of investee                                                                            |       | 28,000   |       | 26,000   |       |
| Depreciation and amortization                                                                         |       | 26,000   |       | 44,000   |       |
| Increase (decrease) in cash flows from operations resulting  from changes in:                         |       |     |       |     |       |
| Accounts receivable                                                                                   |       | (274,000 | )          | (70,000  | )          |
| Inventories                                                                                           |       | (118,000 | )          | (12,000  | )          |
| Prepaid expenses and other assets                                                                     |       | (37,000  | )          | (49,000  | )          |
| Trade accounts payable                                                                                |       | (71,000  | )          | (21,000  | )          |
| Accrued liabilities                                                                                   |       | 69,000   |       | (5,000   | )          |
|                                                                                                  |       |     |       |     |       |
| Net cash used in operating activities                                                                 |       | (463,000 | )          | (54,000  | )          |
|                                                                                                  |       |     |       |     |       |
| Cash flows from investing activities:                                                                 |       |     |       |     |       |
| Capital expenditures                                                                                  |       | (16,000  | )          | (10,000  | )          |
| Apex investment costs                                                                                 |       | —   |       | (89,000  | )          |
|                                                                                                  |       |     |       |     |       |
| Net cash used in investing activities                                                                 |       | (16,000  | )          | (99,000  | )          |
|                                                                                                  |       |     |       |     |       |
| Cash flows from financing activities:                                                                 |       |     |       |     |       |
| Principal payments on long-term debt                                                                  |       | (13,000  | )          | (14,000  | )          |
|                                                                                                  |       |     |       |     |       |
| Net cash used in financing activities                                                                 |       | (13,000  | )          | (14,000  | )          |
|                                                                                                  |       |     |       |     |       |
| Net decrease in cash                                                                                  |       | (492,000 | )          | (167,000 | )          |
| Cash, beginning of period                                                                             |       | 532,000  |       | 701,000  |       |
|                                                                                                  |       |     |       |     |       |
| Cash, end of period                                                                                   |       | $        | 40,000     |     | $          | 534,000 |   |
|                                                                                                  |       |     |       |     |       |
| Supplemental Disclosures of Cash Flow Information                                                     |       |     |       |     |       |
| Cash paid during the period for:                                                                      |       |     |       |     |       |
| Interest                                                                                              |       | $        | 34,000     |     | $          | 17,000 |   |
| Income taxes payable                                                                                  |       | $        | —     |     | $          | — |   |

 

The accompanying notes are an integral part of these statements.

 

3

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NOTES TO CONSOLIDATEDFINANCIAL STATEMENTS (Unaudited)

 

Note 1 - Basis ofPresentation

 

Torotelspecializes in the custom design and manufacture of a wide variety of precisionmagnetic components, consisting of transformers, inductors, reactors, chokesand toroidal coils, for use in commercial, industrial and militaryelectronics.  Torotel also designs anddistributes ballast transformers for the airline industry.  Approximately 97% of Torotel’s sales arederived from domestic customers.  Theaccompanying unaudited consolidated financial statements reflect the normalrecurring adjustments, which are, in the opinion of management, necessary topresent fairly Torotel’s financial position at July 31, 2004, and theresults of operations for the three months ended July 31, 2004.

 

Thefinancial statements contained herein should be read in conjunction withTorotel’s financial statements and related notes filed on Form 10-KSBfor the year ended April 30, 2004.

 

Note 2 - Inventories

 

Thecomponents of inventories are summarized as follows:

 
| Raw materials   |   | $       | 124,000 |   |
|-----------------|--------|---------|---------|--------|
| Work in process |   | 273,000 |    |
| Finished goods  |   | 48,000  |    |
|            |   | $       | 445,000 |   |

 

Note 3 - Income Taxes

 

Torotelhas net operating loss carryforwards available as benefits to reduce futureincome taxes, subject to applicable limitations.  These operating loss carryforwards expire invarious amounts in the years 2007 through 2014.

 

The difference betweenthe financial and tax bases of assets and liabilities is determinedquarterly.  Deferred income taxes andliabilities are computed for those differences that have future taxconsequences using the currently enacted tax laws and rates that apply to theperiods in which they are expected to affect taxable income.  Valuation allowances are established, ifnecessary, to reduce the deferred tax asset to the amount that will, morelikely than not, be realized.  Income taxexpense is the current tax payable or refundable for the period plus or minusthe net change in the deferred tax assets or liabilities.  The following table summarizes the componentsof the net deferred tax asset:

 
| Net operating loss carryforwards |   | $         | 1,768,000 |   |
|----------------------------------|--------|-----------|-----------|--------|
| Inventory valuation reserve      |   | 188,000   |      |
| Depreciation and amortization    |   | 313,000   |      |
| Disposal of ECH liabilities      |   | 137,000   |      |
| Tax credit carryforwards         |   | 19,000    |      |
| Other                            |   | 18,000    |      |
|                             |   | 2,443,000 |      |
| Less valuation allowance         |   | 2,443,000 |      |
|                             |   | $         | —    |   |

 

4

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Note 4 - Earnings Per Share

 

Statementof Financial Accounting Standards (SFAS) No. 128, *Earnings per Share*, requires dualpresentation of basic and diluted EPS on the face of the statement of earningsregardless of whether basic and diluted EPS are the same; and requires areconciliation 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 fullydiluted EPS pursuant to APB Opinion 15. Diluted EPS reflects the potential dilution that could occur ifsecurities or other contracts to issue common stock were exercised or convertedinto common stock or resulted in the issuance of common stock that then sharedin the earnings of the entity.  Pursuantto SFAS No. 128, the basic and diluted earnings per common share werecomputed as follows:

 
| ** **                                  | ** ** | **2004**  | ** ** | **2003**  | ** ** |
|---------------------------------------------|------------|-----------|------------|-----------|------------|
| Net earnings (loss)                         |       | $         | (86,000    | )         | $          | 33,000 |   |
| Weighted average common shares outstanding  |       | 5,111,590 |       | 5,111,590 |       |
| Incremental shares                          |       | —    |       | 428       |       |
|                                        |       |      |       |      |       |
| Basic and diluted earnings (loss) per share |       | $         | (.02       | )         | $          | .01 |   |

 

No incremental shares are included in the 2004 EPScalculations because of the net loss incurred in the period.

 

Note 5 - Employee StockOptions

 

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 and non-qualified stock options grantedprior to June 20, 2004.  The optionsare accounted for under APB Opinion 25, *Accountingfor Stock Issued to Employees*, and related interpretations.  The incentive stock options have a term offive years when issued and vest 50% per year at the end of each of the firsttwo years.  The non-qualified stockoptions have a term of ten years when issued and vest 25% per year at the endof each of the first four years.  Theexercise price of each option equals the market price of Torotel’s common stockon the date of grant.  Accordingly, nocompensation cost has been recognized for the Plan.  Had compensation cost for the Plan beendetermined based on the fair value of the options at the grant dates consistentwith the method of Statement of Financial Accounting Standards No. 123, *Accounting for Stock-Based Compensation,*Torotel’soperating results would have been reduced to the pro forma amounts indicatedbelow.

 
| ** **                                  | ** ** | ** **  | ** ** | **2004** | ** ** | **2003** | ** ** |
|---------------------------------------------|------------|-------------|------------|----------|------------|----------|------------|
| Net earnings (loss)                         |       | As Reported |       | $        | (86,000    | )        | $          | 33,000 |   |
|                                        |       | Pro Forma   |       | $        | (86,000    | )        | $          | 29,000 |   |
|                                        |       |        |       |     |       |     |       |
| Basic and diluted earnings (loss) per share |       | As Reported |       | $        | (.02       | )        | $          | .01 |   |
|                                        |       | Pro Forma   |       | $        | (.02       | )        | $          | .01 |   |

 

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

 

5

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Stockoption transactions under the 1994 Incentive Compensation Plan for each periodare summarized as follows:

 
| ** **                                                      | ** ** | **2004**     | ** ** | **2003**     | ** ** |
|-----------------------------------------------------------------|------------|--------------|------------|--------------|------------|
| ** **                                                      | ** ** | **Weighted** | ** ** | ** **   | ** ** | **Weighted** | ** ** | ** ** | ** ** |
| ** **                                                      | ** ** | **Shares**   | ** ** | **Average**  | ** ** | **Shares** | ** ** | **Average** | ** ** |
| ** **                                                      | ** ** | **Under**    | ** ** | **Exercise** | ** ** | **Under** | ** ** | **Exercise** | ** ** |
| ** **                                                      | ** ** | **Option**   | ** ** | **Price**    | ** ** | **Option** | ** ** | **Price** | ** ** |
| Outstanding at beginning of period                              |       | 40,000       |       | $            | .37        |   | 40,000 |   | $ | .37 |   |
| Granted                                                         |       | —       |       | —       |       | — |   | — |   |
| Exercised                                                       |       | —       |       | —       |       | — |   | — |   |
| Forfeited                                                       |       | —       |       | —       |       | — |   | — |   |
| Outstanding at end of period                                    |       | 40,000       |       | $            | .37        |   | 40,000 |   | $ | .37 |   |
|                                                            |       |         |       |         |       |   |   |   |   |
| Options exercisable at end of period                            |       | 40,000       |       | $            | .37        |   | 40,000 |   | $ | .37 |   |
| Weighted average fair value of options granted  during the year |       |         |       | —       |       |   |   | — |   |

 

The following informationapplies to options outstanding at July 31, 2004:

 
| Number outstanding                          |   | 40,000 |   |
|---------------------------------------------|--------|--------|--------|
| Range of exercise prices                    |   | $      | .37    |   |
| Weighted average exercise price             |   | $      | .37    |   |
| Weighted average remaining contractual life |   | 2.25   | yrs.   |

 

Note 6 - Stock Warrants

 

Awarrant certificate issued in May 1998 to purchase 100,000 shares ofTorotel, Inc. common stock at 75 cents per share expired on May 4,2003.  Stock warrant transactions foreach period are summarized as follows:

 
| ** **                                                       | ** ** | **2003**     | ** ** |
|------------------------------------------------------------------|------------|--------------|------------|
| ** **                                                       | ** ** | **Weighted** | ** ** | ** ** | ** ** |
| ** **                                                       | ** ** | **Shares**   | ** ** | **Average** | ** ** |
| ** **                                                       | ** ** | **Under**    | ** ** | **Exercise** | ** ** |
| ** **                                                       | ** ** | **Option**   | ** ** | **Price** | ** ** |
| Outstanding at beginning of period                               |       | 100,000      |       | $ | .75 |   |
| Granted                                                          |       | —       |       | — |   |
| Exercised                                                        |       | —       |       | — |   |
| Forfeited                                                        |       | (100,000     | )          | $ | .75 |   |
| Outstanding at end of period                                     |       | —       |       | — |   |
|                                                             |       |         |       |   |   |
| Warrants exercisable at end of period                            |       | —       |       | — |   |
| Weighted average fair value of warrants granted  during the year |       |         |       | — |   |

 

6

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Note 7 - Amortization ofIntangibles

 

The following tableprovides the gross carrying value and accumulated amortization for each majorclassof intangible asset based on Torotel’s reassessment of previously recognizedintangible assets and their remaining amortization lives in accordance with theadoption of Statement of Financial Accounting Standards No. 142, *Goodwill and Other Intangible Assets*:

 
| ** **          | ** ** | ** **      | ** ** | **2004**     | ** ** | **2003**         | ** ** |
|---------------------|------------|-----------------|------------|--------------|------------|------------------|------------|
| ** **          | ** ** | **Average**     | ** ** | **Gross**    | ** ** | ** **       | ** ** | **Gross** | ** ** | ** ** | ** ** |
| ** **          | ** ** | **Amortizable** | ** ** | **Carrying** | ** ** | **Accumulated**  | ** ** | **Carrying** | ** ** | **Accumulated** | ** ** |
| ** **          | ** ** | **Life**        | ** ** | **Amount**   | ** ** | **Amortization** | ** ** | **Amount** | ** ** | **Amortization** | ** ** |
| Order backlog       |       | 1               |       | $            | 205,000    |             | $          | 205,000 |   | $ | 205,000 |   | $ | 205,000 |   |
| Aircraft - ballasts |       | 3               |       | 1,148,000    |       | 296,000          |       | 2,177,000 |   | 172,000 |   |
|                |       |            |       |         |       |             |       |   |   |   |   |
|                |       |            |       | $            | 1,353,000  |             | $          | 501,000 |   | $ | 2,382,000 |   | $ | 377,000 |   |

 

The total intangibleamortization expense for the three months ended July 31, 2004, was $9,000.  The estimated aggregate amortization expensefor each of the next five years is as follows:

 

| **April 30,** | ** ** | **Amount** | ** ** |
|--------------------|------------|------------|------------|
| 2005               |       | $          | 33,000     |   |
| 2006               |       | —     |       |
| 2007               |       | —     |       |
| 2008               |       | —     |       |
| 2009               |       | —     |       |
|               |       |       |       |
|               |       | $          | 33,000     |   |

 

The carrying value of theintangible assets is supported by the estimated amount recoverable from theselling shareholders of Electronika (the Caloyeras Family Partnership).  The selling shareholders contractuallyguaranteed that the aggregate sales from Electronika’s existing ballast designsover the first five (5) full fiscal years, specifically fiscal years 2003-2007,would be at least $2,500,000, which based on the terms of the ManufacturingAgreement with Magnetika, Inc., would result in an aggregate gross profitof $1,500,000 before any operating expenses. Aggregate sales since fiscal 2003 have been $933,000.

 

Note 8 - EquityInvestment

 

Torotel owns 4,355,637common shares (16.47%) of Apex Innovations, Inc. (“Apex”).  These shares were purchased at a cost of 25cents per share.  This investment isaccounted for using the equity method. Because of Apex’s operating losses since inception, and the projectedlosses in the near term, Torotel reduced the carrying value of this investmentat the end of fiscal 2004.

 

The accompanyingconsolidated statements of operations include a loss of $28,000 and $26,000 forthe three months ended July 31, 2004 and 2003, respectively, which resultfrom Torotel’s proportionate share of Apex’s operating results for the threemonths ended May 31, 2004 and 2003. Condensed financial statements for Torotel’s investment in Apex are asfollows:

 

7

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Condensed Balance Sheet

 
| ** **                | ** ** | **May 31,** | ** ** |
|---------------------------|------------|------------------|------------|
| ** **                | ** ** | **2004**         | ** ** |
| Current assets            |       | $                | 599,000    |   |
| Other assets              |       | 6,593,000        |       |
|                      |       | $                | 7,192,000  |   |
|                      |       |             |       |
| Current liabilities       |       | $                | 945,000    |   |
| Other liabilities         |       | 3,537,000        |       |
| Stockholders’ equity |       | 2,710,000        |       |
|                      |       | $                | 7,192,000  |   |

 

Condensed Statements ofOperations

 
| ** **          | ** ** | **3-Mos. Ended** | ** ** | **3-Mos. Ended** | ** ** |
|---------------------|------------|------------------|------------|------------------|------------|
| ** **          | ** ** | **May 31,** | ** ** | **May 31,** | ** ** |
| ** **          | ** ** | **2004**         | ** ** | **2003**         | ** ** |
| Net sales           |       | $                | 831,000    |             | $          | 1,343,000 |   |
| Gross profit        |       | $                | 578,000    |             | $          | 563,000 |   |
| Net earnings (loss) |       | $                | (172,000   | )                | $          | (144,000 | ) |

 

8

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Item 2.        Management’sDiscussion and Analysis or Plan of Operation

 

Overview

 

Torotel, Inc. (“Torotel”)conducts business primarily through two wholly-owned subsidiaries, TorotelProducts, Inc. (“Torotel Products”) and Electronika, Inc. (“Electronika”).  In addition, Torotel has a 16.47% equityinterest in Apex Innovations, Inc. (“Apex”).

 

Torotel Products designsand manufactures a wide variety of magnetic components for use in military,aerospace and industrial electronic applications.  These magnetic components, which consist oftransformers, inductors, reactors, chokes, and toroidal coils, are used tomodify and control electrical voltages and currents in electronic devices.  For example, if equipment containing one ofthese components receives an electrical voltage or current which is too highfor proper operation of the equipment, the component would modify and controlthe electrical voltage or current to allow proper operation of theequipment.  While Torotel Productsprimarily manufactures the components in accordance with pre-developedmechanical and electrical requirements, in some cases it will be responsiblefor both the overall design and manufacture of the components.  The magnetic components are sold tomanufacturers who incorporate them into an end-product.  The major applications include aircraft navigationalequipment, voice and data secure communications, medical equipment, avionicsequipment, and conventional missile guidance systems.  Torotel Products markets its componentsprimarily through a direct sales force and one independent manufacturers’representative paid on a commission basis. In addition, Torotel Products is an approved source on numerousapplications, and generally is automatically solicited for any procurementneeds for such applications.  Themagnetic components manufactured by Torotel Products are sold primarily in theUnited States, and most 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 ability of Torotel Products to compete depends, among other things,upon its on-time delivery performance, customized product engineering andtechnical support, marketing capabilities, quality assurance and manufacturingefficiency.  While magnetic componentsare not susceptible to rapid technological change, Torotel Products’ marketshare is susceptible to decline given the highly competitive nature of themarket.

 

Electronika is amarketing and licensing company selling ballast transformers to the airlineindustry.  These transformers activateand control the lights in commercial airplane cockpits.  Electronika’s ballast transformers areapproved as spare and replacement parts in DC-8, DC-9, DC-10,MD-80, and MD-88 aircraft. However, sales of ballast transformers have been made primarily for usein DC-8 and DC-9 aircraft. As a result, the business of Electronika is subject to various risksincluding, without limitation, any decline in use of the referenced aircraft,and competition for the available spare parts business.  Electronika’s sales do not represent asignificant portion of any particular market. Electronika’s requirements for the ballast transformers are outsourcedpursuant to a Manufacturing Agreement with Magnetika, Inc. (“Magnetika”),a corporation owned by Peter B. Caloyeras and his family.  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.

 

Torotel’s management is not involved in the daily operations of Apex.  Dale H. Sizemore, Jr.,

 

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Torotel’s chairman and chief executive officer, served as a member of Apex’s board of directors from March 2002 until his resignation in October 2004.  ***i***-**INFO** is Apex’s umbrella term for a foundational system architecture of patented information management software products created by Apex primarily for government entities.  The success of Apex depends, among other things, its ability to market its products to government entities.  Because of Apex’s operating losses since inception, and the projected losses in the near term, Torotel reduced the carrying value of this investment at the end of fiscal 2004.

 

Business Outlook

 

The rate of new order bookings was up nearly 10% during the current quarter, and the order backlog was 49% higher than a year ago due to the major contract received last year for the potted coil assembly.  These increases are attributable to the high demand seen from Torotel’s military markets.  This trend is expected to continue.  Torotel’s aerospace markets, specifically the components used in retrofitting and upgrading instrumentation and communication systems in existing aircraft, remain soft but are expected to improve in the near future based on feedback from customers.  The primary factors that drive gross profit and net earnings for Torotel Products are sales volume and product mix.  The gross profits on mature products/programs and larger transformer devices tend to be higher than those which are still in the prototyping or early production stages and simpler inductor devices.  As a result, in any given accounting period the mix of product shipments between higher and lower margin jobs has a significant impact on the  gross profit and net earnings of Torotel Products.  Electronika’s net sales continue to be impacted by the soft conditions in the aerospace market and the decline in the number of active DC-8 and DC-9 aircraft.

 

Results of Operations

 

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

 

Thediscussion and analysis of the results of operations include the operations ofTorotel, Inc. and its subsidiaries, Torotel Products, Inc. andElectronika, Inc.  While eachcompany’s results are included in the following discussion, segment reportingis not applicable because the products offered are similar in form andfunction, and target similar markets.

 

ThreeMonths Ended July 31, 2004 Compared With Three Months Ended July 31,2003

 

Net sales decreased 7%.  The net sales of Torotel Products decreased 3% from $1,014,000 to $986,000.  This decrease is attributable to shipment delays, which resulted from manufacturing inefficiencies encountered with the training of new production personnel in the winding area.  The rate of new order bookings was up nearly 10% during the current quarter, and the order backlog was 49% higher than a year ago due to the major contract received last year for the potted coil assembly.  These increases are attributable to the high demand seen from Torotel’s military markets.  This trend is expected to continue.  Torotel’s aerospace markets, specifically the components used in retrofitting and upgrading instrumentation

 

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and communication systems in existing aircraft, remain soft but are expected to improve in the near future based on feedback from customers.  The net sales of Electronika decreased 72% from $64,000 to $18,000.  While Electronika’s sales have been impacted by the soft conditions in the aerospace market, the bigger impact going forward will be the decline in the number of active DC-8 and DC-9 aircraft.

 

Gross profit as apercentage of net sales decreased 5%. The gross profit percentage of Torotel Products decreased 8% because ofhigher labor costs associated with overtime and inefficiencies encountered withthe training of new production personnel in the winding area.  Electronika’s gross profit as a percentage ofnet sales increased 60% because of the labor and overhead savings associatedwith the discontinued assembly operation of Electronika-Kansas.

 

Engineering expenses,applicable only to Torotel Products, increased nearly 16% from $45,000 to$52,000 because of higher payroll costs associated with more hours worked bypart-time personnel and higher travel and training costs.  Management does anticipate an increase in thepresent level of engineering expenses as the plan is to hire an additionalengineer.

 

Selling, general andadministrative (SG&A) expenses increased 18%.  The SG&Aexpenses of Torotel, Inc. decreased 35% from $60,000 to $39,000 primarilybecause of transferring the CEO’s payroll costs of $26,000 to TorotelProducts.  This decrease was partiallyoffset by a $5,000 increase in directors fees associated with two additionaloutside board members.  The SG&Aexpenses of Torotel Products increased nearly 39% from $174,000 to $241,000primarily because of transferring the CEO’s payroll costs of $26,000 fromTorotel, Inc., an $18,000 increase in payroll costs for an inside salesassociate and clerical help, an $11,000 increase in training costs, a $9,000increase in depreciation, a $6,000 increase in property taxes, and $5,000increase in property and casualty insurance costs.  These increases were offset partially by an$8,000 decrease in professional fees. The SG&A expenses of Electronika decreased20% from $10,000 to $8,000 because of savings associated with the discontinuedassembly operation of Electronika-Kansas. Management does not anticipate any significant increase in the presentlevel of SG&A expenses.

 

Amortization costs,entirely attributable to Electronika, decreased 76% from $38,000 to $9,000 (seeNote 7 of Notes to Consolidated Financial Statements).

 

Interest expenseincreased 100%.  The interest expense ofTorotel, Inc. remained unchanged at $13,000.  The interest expense of Torotel Productsincreased from $4,000 to $21,000 because of a higher debt balance associatedwith the building purchase in March 2004.

 

Equity in loss ofinvestee was $26,000 compared with $28,000 in the prior year (see Note 8 ofNotes to Consolidated Financial Statements).

 

For the reasons discussedabove, the consolidated pretax earnings decreased from $33,000 to a loss of$86,000.  The pretax loss of Torotel, Inc.decreased from $99,000 to $80,000.  Thepretax earnings of Torotel Products decreased from $179,000 to breakeven.  The pretax earnings of Electronika increasedfrom a loss of $47,000 to a loss of $6,000.

 

Liquidity and CapitalResources

 

The table below presents the summary of cash flow for the three month periods indicated.

 
| ** **                            | ** ** | **2004** | ** ** | **2003** | ** ** |
|---------------------------------------|------------|----------|------------|----------|------------|
| Net cash used in operating activities |       | $        | (463,000   | )        | $          | (54,000 | ) |
| Net cash used in investing activities |       | $        | (16,000    | )        | $          | (99,000 | ) |
| Net cash used in financing activities |       | $        | (13,000    | )        | $          | (14,000 | ) |

 

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Netcash used in operating activities fluctuates between periods primarily as aresult of differences in operating earnings, the timing of shipments and thecollection of accounts receivable, changes in inventory, level of sales andpayment of accounts payable.  The decreasein net cash used in investing activities is primarily because of the additional$89,000 investment made in Apex in 2003. Capital expenditures were $16,000 during the first quarter of fiscal2005.  Management anticipatesapproximately $24,000 in capital expenditures during the balance of fiscal2005.  Net cash used in financingactivities is because of payments on long-term debt.  Management believes that the projected cashflow generated from operations, combined with its existing cash balances, willbe sufficient to meet its funding requirements for the foreseeable future.  Torotel does have a $200,000 bank line ofcredit available, which could be utilized, if required, to help fund growth.

 

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

 

Forward-LookingInformation

 

This report, as well asour other reports filed with the Securities and Exchange Commission (“SEC”),and in press releases and other public communications throughout the year, contains forward-looking statements made pursuant to thesafe harbor provisions of The Private Securities Litigation Reform Act of1995.  Forward-looking statements includeall information on our expected financial position, results of operations, cashflows, strategy, budgets and management’s plans and objectives.  These forward-looking statements are based onassumptions about a number of important factors and involve risks anduncertainties that could cause actual results to be different from what appearhere.  These risk factors include:impairment of intangible assets and other investments, decreased demand for products,delays in developing new products, expected orders that do not occur, loss ofkey customers, the impact of competition and price erosion as well as supplyand manufacturing constraints, issues involved in relocating manufacturingoperations, and other risks and uncertainties. In light of these risks and uncertainties, there can be no assurancethat the forward-looking information contained in this report will proveaccurate, and our actual results may differ materially from theseforward-looking statements.

 

Item 3.        Controlsand Procedures

 

Torotel’sChief Executive Officer and Chief Financial Officer (collectively, the “CertifyingOfficers”) are responsible for establishing and maintaining disclosure controlsand procedures.  Such officers have concluded(based upon their evaluation of these controls and procedures as of a datewithin 90 days of the filing of this report) that Torotel’s disclosure controlsand procedures are effective to ensure that information required to bedisclosed in this report is accumulated and communicated to Torotel’smanagement, including its principal executive officers as appropriate, to allowtimely decisions regarding required disclosure. The Certifying Officers also have indicated that there were nosignificant changes in Torotel’s internal controls or other factors that couldsignificantly affect such controls subsequent to the date of their evaluation,and there were no corrective actions with regard to significant deficienciesand material weaknesses.

 

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PART II.    OTHERINFORMATION

 

Item 6.   Exhibits and Reports on Form 8-K

 
| a)     | Exhibits                 |
|--------|--------------------------|
|   |                     |
|   | 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 |
|   |                     |   |
| b)     | Reports on Form 8-K | There were no  reports filed on Form 8-K during the three months ended July 31,  2004. |
|        |                          |  |  |

 

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SIGNATURES

 

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

 

 
| Torotel, Inc.              |
|---------------------------------|
| (Registrant)                    |
|                            |
|                            |
| /s/ Dale H.  Sizemore, Jr. |   |
| Dale H. Sizemore, Jr.      |
| Chief Executive  Officer        |
| Date:                           | March 30,  2005 |
|                            |
|                            |
| /s/ H. James  Serrone           |   |
| H. James Serrone                |
| Chief Financial  Officer        |
| Date:                           | March 30,  2005 |
|                                 |  |  |

 

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