Table of Contents

 

 

 

**UNITEDSTATES SECURITIES AND EXCHANGE COMMISSION**

**Washington,D.C.  20549**

 

**FORM 10-Q**

 

**x****     ****QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIESEXCHANGE ACT OF 1934**

** **

**Forthe quarterly period ended October 31, 2008**

** **

**o****        ****TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIESEXCHANGE ACT OF 1934**

** **

**For thetransition period from [    ] to [    ]**

** **

**CommissionFile No. 1-8125**

 

**TOROTEL,INC.**

(Exact name ofregistrant as specified in its charter)

 

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

 

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

(Address ofprincipal executive offices)

 

**(913)747-6111**

(Registrant’stelephone number)

 

**NONE**

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

 

Indicate by checkmark whether the registrant (1) has filed all reports required to be filedby Section 13 or 15(d) of the Securities Exchange Act of 1934 duringthe preceding 12 months, and (2) has been subject to such filingrequirements for the past 90 days.

 

Yes x   No o

 

Indicate by check markwhether the registrant is a large accelerated filer, an accelerated filer, anon-accelerated filer or a smaller reporting company.  See the definitions of “large acceleratedfiler,” “accelerated filer” and “smaller reporting company” in Rule 12b-2of the Exchange Act.

 

| Large accelerated filer  o                                             |   |                         |   | Accelerated filer o |
|------------------------------------------------------------------------|--------|------------------------------|--------|---------------------|
|                                                                   |   |                         |   |                |
| Non-accelerated filer o  (Do not check if a smaller reporting company) |   | Smaller reporting  company x |

 

Indicate by check markwhether the registrant is a shell company (as defined in Rule 12b-2 of theSecurities Exchange Act of 1934.)

 

Yes o   No x

 

As of December 10,2008, there were 5,878,340 shares of Common Stock, $.01 par value, outstanding.

 

 

 

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TOROTEL, INC. ANDSUBSIDIARIES

 

INDEX

 
| PART I.  | FINANCIAL INFORMATION                                                                             |   |   |
|---------------|---------------------------------------------------------------------------------------------------|--------|--------|
|          |                                                                                              |   |   |   |
| Item 1.       | Financial Statements                                                                              |   |   |
|          |                                                                                              |   |   |   |
|          | Consolidated  Condensed Balance Sheets as of October 31, 2008 and April 30, 2008        |   | 1      |
|          |                                                                                              |   |   |   |
|          | Consolidated  Statements of Operations for the six months ended October 31, 2008 and  2007   |   | 2      |
|          |                                                                                              |   |   |   |
|          | Consolidated  Statements of Operations for the three months ended October 31, 2008 and  2007 |   | 3      |
|          |                                                                                              |   |   |   |
|          | Consolidated  Statements of Cash Flows for the six months ended October 31, 2008 and  2007   |   | 4      |
|          |                                                                                              |   |   |   |
|          | Notes to Consolidated Condensed Financial Statements                                              |   | 5      |
|          |                                                                                              |   |   |   |
| Item 2.       | Management’s  Discussion and Analysis of Financial Condition and Results of Operations       |   | 12     |
|          |                                                                                              |   |   |   |
| Item 4T.      | Controls and  Procedures                                                                          |   | 19     |
|          |                                                                                              |   |   |   |
| PART II. | OTHER INFORMATION                                                                                 |   |   |
|          |                                                                                              |   |   |   |
| Item 4.       | Submission  of Matters to a Vote of Security Holders                                              |   | 20     |
|          |                                                                                              |   |   |   |
| Item 6.       | Exhibits                                                                                          |   | 21     |
|          |                                                                                              |   |   |   |
| SIGNATURES    |                                                                                              | 22     |

 

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**PART I.     FINANCIAL INFORMATION**

 

**Item1.       Financial Statements**

 

**CONSOLIDATEDCONDENSED BALANCE SHEETS**

 
| ** **                                 | ** ** | **(Unaudited)**      | ** ** | ** **         | ** ** |
|--------------------------------------------|------------|----------------------|------------|--------------------|------------|
| ** **                                 | ** ** | **As of**       | ** ** | **As of**     | ** ** |
| ** **                                 | ** ** | **October 31,** | ** ** | **April 30,** | ** ** |
| ** **                                 | ** ** | **2008**             | ** ** | **2008**           | ** ** |
| ASSETS                                     |       |                 |       |               |       |
|                                       |       |                 |       |               |       |
| Current assets:                            |       |                 |       |               |       |
| Cash                                       |       | $                    | 434,000    |               | $          | 410,000 |   |
| Trade  receivables, net                    |       | 745,000              |       | 775,000            |       |
| Inventories, net                           |       | 732,000              |       | 551,000            |       |
| Prepaid expenses  and other current assets |       | 53,000               |       | 23,000             |       |
|                                       |       | 1,964,000            |       | 1,759,000          |       |
|                                       |       |                 |       |               |       |
| Property, plant  and equipment, net        |       | 1,017,000            |       | 1,022,000          |       |
|                                       |       |                 |       |               |       |
| Other assets                               |       | 2,000                |       | 2,000              |       |
|                                       |       |                 |       |               |       |
|                                       |       | $                    | 2,983,000  |               | $          | 2,783,000 |   |
|                                       |       |                 |       |               |       |
| LIABILITIES AND  STOCKHOLDERS’ EQUITY |       |                 |       |               |       |
|                                       |       |                 |       |               |       |
| Current  liabilities:                      |       |                 |       |               |       |
| Current  maturities of long-term debt      |       | $                    | 75,000     |               | $          | 64,000 |   |
| Trade accounts  payable                    |       | 236,000              |       | 342,000            |       |
| Accrued  liabilities                       |       | 219,000              |       | 186,000            |       |
|                                       |       | 530,000              |       | 592,000            |       |
|                                       |       |                 |       |               |       |
| Long-term debt,  less current maturities   |       | 628,000              |       | 647,000            |       |
|                                       |       |                 |       |               |       |
| Stockholders’  equity                 |       | 1,825,000            |       | 1,544,000          |       |
|                                       |       |                 |       |               |       |
|                                       |       | $                    | 2,983,000  |               | $          | 2,783,000 |   |

 

The accompanyingnotes are an integral part of these statements.

 

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**CONSOLIDATEDSTATEMENTS OF OPERATIONS (Unaudited)**

 
| ** **                                         | ** ** | **Six Months Ended** | ** ** |
|----------------------------------------------------|------------|--------------------------------|------------|
| ** **                                         | ** ** | **October 31,**           | ** ** | **October 31,** | ** ** |
| ** **                                         | ** ** | **2008**                       | ** ** | **2007** | ** ** |
| Net sales                                          |       | $                              | 3,960,000  |   | $ | 3,049,000 |   |
| Cost of goods  sold                                |       | 2,512,000                      |       | 1,903,000 |   |
|                                               |       |                           |       |   |   |
| Gross profit                                       |       | 1,448,000                      |       | 1,146,000 |   |
|                                               |       |                           |       |   |   |
| Operating  expenses:                               |       |                           |       |   |   |
| Engineering                                        |       | 177,000                        |       | 131,000 |   |
| Selling, general  and administrative               |       | 993,000                        |       | 1,024,000 |   |
|                                               |       | 1,170,000                      |       | 1,155,000 |   |
|                                               |       |                           |       |   |   |
| Earnings (loss)  from operations                   |       | 278,000                        |       | (9,000 | ) |
|                                               |       |                           |       |   |   |
| Other expense:                                     |       |                           |       |   |   |
| Interest expense                                   |       | 29,000                         |       | 31,000 |   |
|                                               |       |                           |       |   |   |
| Earnings (loss)  before provision for income taxes |       | 249,000                        |       | (40,000 | ) |
|                                               |       |                           |       |   |   |
| Provision for  income taxes                        |       | —                         |       | — |   |
|                                               |       |                           |       |   |   |
| Net earnings  (loss)                               |       | $                              | 249,000    |   | $ | (40,000 | ) |
|                                               |       |                           |       |   |   |
| Basic earnings  (loss) per share                   |       | $                              | .05        |   | $ | (.01 | ) |
|                                               |       |                           |       |   |   |
| Diluted earnings  (loss) per share                 |       | $                              | .04        |   | $ | (.01 | ) |

 

The accompanyingnotes are an integral part of these statements.

 

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**CONSOLIDATEDSTATEMENTS OF OPERATIONS (Unaudited)**

 
| ** **                                  | ** ** | **Three Months Ended** | ** ** |
|---------------------------------------------|------------|----------------------------------|------------|
| ** **                                  | ** ** | **October 31,**             | ** ** | **October 31,** | ** ** |
| ** **                                  | ** ** | **2008**                         | ** ** | **2007** | ** ** |
| Net sales                                   |       | $                                | 1,989,000  |   | $ | 1,643,000 |   |
| Cost of goods  sold                         |       | 1,300,000                        |       | 1,029,000 |   |
|                                        |       |                             |       |   |   |
| Gross profit                                |       | 689,000                          |       | 614,000 |   |
|                                        |       |                             |       |   |   |
| Operating  expenses:                        |       |                             |       |   |   |
| Engineering                                 |       | 79,000                           |       | 66,000 |   |
| Selling, general  and administrative        |       | 488,000                          |       | 519,000 |   |
|                                        |       | 567,000                          |       | 585,000 |   |
|                                        |       |                             |       |   |   |
| Earnings from  operations                   |       | 122,000                          |       | 29,000 |   |
|                                        |       |                             |       |   |   |
| Other expense  (income):                    |       |                             |       |   |   |
| Interest expense                            |       | 15,000                           |       | 16,000 |   |
| Other, net                                  |       | (1,000                           | )          | — |   |
|                                        |       | 14,000                           |       | 16,000 |   |
|                                        |       |                             |       |   |   |
| Earnings before  provision for income taxes |       | 108,000                          |       | 13,000 |   |
|                                        |       |                             |       |   |   |
| Provision for  income taxes                 |       | —                           |       | — |   |
|                                        |       |                             |       |   |   |
| Net earnings                                |       | $                                | 108,000    |   | $ | 13,000 |   |
|                                        |       |                             |       |   |   |
| Basic earnings  per share                   |       | $                                | .02        |   | $ | .00 |   |
|                                        |       |                             |       |   |   |
| Diluted earnings  per share                 |       | $                                | .02        |   | $ | .00 |   |

 

The accompanyingnotes are an integral part of these statements.

 

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**CONSOLIDATEDSTATEMENTS OF CASH FLOWS (Unaudited)**

 
| ** **                                                                                  | ** ** | **Six Months Ended** | ** ** |
|---------------------------------------------------------------------------------------------|------------|--------------------------------|------------|
| ** **                                                                                  | ** ** | **October 31,**           | ** ** | **October 31,** | ** ** |
| ** **                                                                                  | ** ** | **2008**                       | ** ** | **2007** | ** ** |
| Cash flows from  operating activities:                                                      |       |                           |       |   |   |
| Net earnings  (loss)                                                                        |       | $                              | 249,000    |   | $ | (40,000 | ) |
| Adjustments to  reconcile net earnings (loss) to net cash provided by operating activities: |       |                           |       |   |   |
| Cost recognized  on cancellation of restricted stock                                        |       | —                         |       | 33,000 |   |
| Loss on disposal  of assets                                                                 |       | 1,000                          |       | — |   |
| Stock  compensation earned                                                                  |       | 32,000                         |       | 21,000 |   |
| Depreciation                                                                                |       | 52,000                         |       | 44,000 |   |
| Change in value  of stock appreciation rights                                               |       | (2,000                         | )          | 15,000 |   |
| Increase  (decrease) in cash flows from operations resulting from changes in:               |       |                           |       |   |   |
| Trade  receivables                                                                          |       | 30,000                         |       | (70,000 | ) |
| Inventories                                                                                 |       | (181,000                       | )          | (64,000 | ) |
| Prepaid expenses  and other assets                                                          |       | (30,000                        | )          | (46,000 | ) |
| Trade accounts  payable                                                                     |       | (106,000                       | )          | 87,000 |   |
| Accrued  liabilities                                                                        |       | 35,000                         |       | (17,000 | ) |
|                                                                                        |       |                           |       |   |   |
| Net cash  provided by (used in) operating activities                                        |       | 80,000                         |       | (37,000 | ) |
|                                                                                        |       |                           |       |   |   |
| Cash flows from  investing activities:                                                      |       |                           |       |   |   |
| Capital  expenditures                                                                       |       | (21,000                        | )          | (33,000 | ) |
|                                                                                        |       |                           |       |   |   |
| Net cash used in  investing activities                                                      |       | (21,000                        | )          | (33,000 | ) |
|                                                                                        |       |                           |       |   |   |
| Cash flows from  financing activities:                                                      |       |                           |       |   |   |
| Principal  payments on long-term debt                                                       |       | (31,000                        | )          | (28,000 | ) |
| Payments on  capital lease obligations                                                      |       | (4,000                         | )          | — |   |
|                                                                                        |       |                           |       |   |   |
| Net cash used in  financing activities                                                      |       | (35,000                        | )          | (28,000 | ) |
|                                                                                        |       |                           |       |   |   |
| Net increase  (decrease) in cash                                                            |       | 24,000                         |       | (98,000 | ) |
| Cash, beginning  of period                                                                  |       | 410,000                        |       | 247,000 |   |
|                                                                                        |       |                           |       |   |   |
| Cash, end of  period                                                                        |       | $                              | 434,000    |   | $ | 149,000 |   |
|                                                                                        |       |                           |       |   |   |
| Supplemental  Disclosures of Cash Flow Information                                          |       |                           |       |   |   |
| Cash paid during  the period for:                                                           |       |                           |       |   |   |
| Interest                                                                                    |       | $                              | 29,000     |   | $ | 31,000 |   |
| Income taxes  payable                                                                       |       | $                              | —     |   | $ | — |   |
|                                                                                        |       |                           |       |   |   |
| Non-cash  investing and financing activities:                                               |       |                           |       |   |   |
| Capital  expenditure                                                                        |       | $                              | (27,000    | ) | $ | — |   |
| Proceeds from  capital lease                                                                |       | $                              | 27,000     |   | $ | — |   |

 

The accompanyingnotes are an integral part of these statements.

 

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**NOTESTO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS (Unaudited)**

 

**Note 1 –Nature of Operations**

 

Torotel, Inc. (“Torotel”)specializes 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 duringthe first six months of fiscal 2009 have been derived from domestic customers.

 

**Note 2 –Basis of Presentation**

 

The condensedconsolidated balance sheet as of April 30, 2008, which has been derivedfrom audited financial statements, is accompanied by the unaudited interimcondensed consolidated financial statements, which reflect the normal recurringadjustments that in the opinion of management are necessary to present fairlyTorotel’s financial position at October 31, 2008, and the results ofoperations for the three and six months ended October 31, 2008.

 

The unaudited interimcondensed consolidated financial statements have been prepared pursuant to the rules andregulations of the Securities and Exchange Commission.  Certain information and note disclosuresnormally included in annual financial statements prepared in accordance withgenerally accepted accounting principles have been condensed or omittedpursuant to those rules and regulations, although management believes thedisclosures made are adequate to make the information not misleading.

 

The financial statementscontained herein should be read in conjunction with Torotel’s financialstatements and related notes filed on Form 10-KSB for the year ended April 30,2008.

 

**Note 3 – Reclassification**

 

Historically, certain costs associated with Torotel’s facility havebeen included with the selling, general and administrative expenses in theconsolidated statements of operations. These facilities costs are part of the overhead pool used to determinethe burden rate for calculating the amount of overhead applied to work inprocess inventories.  Management believesthese facilities costs should be presented as part of cost of goods sold in theconsolidated statements of operations. Accordingly, facilities costs of $56,000 and $106,000 are included incost of goods sold in the accompanying consolidated statement of operations forthe three and six months ended October 31, 2008, respectively, with acorresponding decrease in selling, general and administrative expenses.  In order to fairly present comparativeresults, management has reclassified selling, general and administrativeexpenses of $53,000 and $104,000 to cost of goods sold for the three and sixmonths ended October 31, 2007, respectively.

 

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**Note 4 –Inventories**

 

The components of inventoriesare summarized as follows:

 
| ** **                                         | ** ** | **October 31,** | ** ** | **April 30,** | ** ** |
|----------------------------------------------------|------------|----------------------|------------|--------------------|------------|
| ** **                                         | ** ** | **2008**             | ** ** | **2008**           | ** ** |
| Raw materials                                      |       | $                    | 868,000    |               | $          | 669,000 |   |
| Work in process                                    |       | 152,000              |       | 173,000            |       |
| Finished goods                                     |       | 90,000               |       | 84,000             |       |
|                                               |       | 1,110,000            |       | 926,000            |       |
| Less: reserve  for obsolete and excess inventories |       | 378,000              |       | 375,000            |       |
|                                               |       | $                    | 732,000    |               | $          | 551,000 |   |

 

**Note 5 –Income Taxes**

 

Torotel adopted theprovisions of Financial Accounting Standards Board Interpretation No. 48 (“FIN48”), *Accounting for Uncertainty in IncomeTaxes - an Interpretation of FASB No. 109,*effective May 1, 2007, which clarifiedthe accounting for uncertainty in tax positions*.*  FIN 48 prescribes a recognition threshold andmeasurement attribute for the financial statement recognition and measurementof a tax position taken or expected to be taken in a tax return.  It is management’s responsibility todetermine whether it is more likely than not that a tax position will besustained upon examination, including resolution of any related appeals orlitigation processes, based on the technical merits of the position.  Based on a third-party review of prior yearfederal and state tax returns, Torotel had no unrecognized tax benefits as ofthe date of adoption, the income tax positions taken or expected to be takenfor the open tax years are appropriately stated and supported for all openyears, and the adoption of FIN 48 did not have a material effect on Torotel’sconsolidated financial statements.  Opentax years are April 30, 2005, 2006, 2007 and 2008.  Torotel would recognize interest and penaltiesaccrued on unrecognized tax benefits as well as interest received fromfavorable tax settlements within income tax expense.  At the adoption date of May 1, 2007, andas of October 31, 2008, Torotel recorded no accrued interest or penaltiesrelated to uncertain tax positions. Management expects no significant change in the amount of unrecognizedtax benefit, accrued interest or penalties within the next twelve months.

 

**Note6 – Restricted Stock Agreements**

 

RestrictedStock Agreements are authorized by the Compensation and Nominating Committee (“Committee”)and the Board of Directors of Torotel. The Committee and the Board have determined that the interests ofTorotel and its stockholders will be promoted by hiring talented individualsand, to induce such individuals to accept employment with Torotel, theCommittee and the Board believe a key component of such individuals’compensation should be granting equity ownership opportunities based upon theacceptance of employment and the continuing employment of such individual,subject to certain conditions and restrictions.

 

ARestricted Stock Agreement was entered into between Torotel and Benjamin E.Ames, Jr. on July 31, 2006, as part of Mr. Ames’ employment asExecutive Vice President of Torotel Products, Inc. with primaryresponsibilities being new business development.  The amount of the restricted stock award was200,000 shares of common stock, $.01 par value per share.  Based upon Mr. Ames attaining mutuallyagreed upon written annual goals, the restricted shares shall be released fromthe restrictions on transfer and risk of forfeiture in the amount of 40,000shares per year for five years beginning July 31, 2007, and each

 

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anniversarythereof.  Based on the market price of$.30 for Torotel’s common stock as of July 31, 2006, the fair value of therestricted stock at the date of award was $60,000.  The restricted shares are treated asnon-vested stock pursuant to SFAS 123(R) and are classified as unearnedstock compensation in the accompanying consolidated balance sheet understockholders’ equity.  Stock compensationcost during the three and six months ended October 31, 2008 was $3,000 and$6,000, respectively.  Stock compensationcost of $3,000 per quarter will be recorded during the aggregate five-yearvesting period provided the mutually agreed upon goals are achieved.  As of October 31, 2008, a total of 80,000shares have been released from the restrictions on transfer.

 

Restricted Stock Agreements were entered into betweenTorotel and 12 key employees on August 7, 2007, pursuant to the StockAward Plan (“SAP”).  The SAP provides keyemployees the opportunity to acquire common stock of Torotel pursuant to awardsearned for accomplishing goals that promote the long-term financial performanceof Torotel.  Under the terms of the SAP,which was filed as Exhibit 10.9 on Form 10-KSB on July 30, 2007,the restricted stock awards have a five (5) year restriction period, whichshall lapse based on certain conditions as outlined in the SAP.  The Restricted Stock Agreements afford thegrantees all of the rights of a stockholder with respect to the award shares,including the right to vote such shares and to receive dividends and otherdistributions payable with respect to such shares since the date of award.  The aggregate amount of the restricted stockawards outstanding as of October 31, 2008, was 526,750 shares of commonstock, $.01 par value per share.  Basedon the market price of $.50 for Torotel’s common stock at the date of award,the fair value of the restricted stock outstanding was $263,375 as of October 31,2008.  The restricted shares are treatedas non-vested stock pursuant to SFAS 123(R) and are classified as unearnedstock compensation in the accompanying consolidated balance sheet understockholders’ equity.  Stock compensationcost during the three and six months ended October 31, 2008 was $13,169and $26,338, respectively.  Stockcompensation cost of $13,169 will be recorded per quarter during the remainingfive-year vesting period provided the financial performance metrics as outlinedin the SAP are likely to be attained.

 

Underthe terms of each agreement, the non-vested shares are restricted as todisposition and subject to forfeiture under certain circumstances.  The agreements provide the employee with allvoting rights with respect to the restricted shares.  The agreements further provide, subject tocertain conditions, that if prior to all of the restricted shares having beenreleased, Torotel undergoes a change in control, then all of the restrictedshares shall be released and no longer subject to restrictions under theagreements.

 

Restricted stock activityfor each six month period through October 31 is summarized as follows:

 
| ** **                          | ** ** | **2008**       | ** ** | **2007**     | ** ** |
|-------------------------------------|------------|----------------|------------|--------------|------------|
| ** **                          | ** ** | **Restricted** | ** ** | **Weighted** | ** ** | **Restricted** | ** ** | **Weighted** | ** ** |
| ** **                          | ** ** | **Shares**     | ** ** | **Average**  | ** ** | **Shares** | ** ** | **Average** | ** ** |
| ** **                          | ** ** | **Under**      | ** ** | **Grant**    | ** ** | **Under** | ** ** | **Grant** | ** ** |
| ** **                          | ** ** | **Option**     | ** ** | **Price**    | ** ** | **Option** | ** ** | **Price** | ** ** |
| Outstanding at  beginning of period |       | 686,750        |       | $            | .453       |   | 225,000 |   | $ | .317 |   |
| Granted                             |       | —         |       | —       |       | 575,750 |   | $ | .500 |   |
| Vested                              |       | (40,000        | )          | $            | .300       |   | (40,000 | ) | $ | .300 |   |
| Forfeited                           |       | —         |       | —       |       | (74,000 | ) | $ | .500 |   |
| Outstanding at  end of period       |       | 646,750        |       | $            | .463       |   | 686,750 |   | $ | .453 |   |

 

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**Note 7 –Stockholders’ Equity**

 

The components ofstockholders’ equity are summarized as follows:

 
| ** **                      | ** ** | **October 31,** | ** ** | **April 30,** | ** ** |
|---------------------------------|------------|----------------------|------------|--------------------|------------|
| ** **                      | ** ** | **2008**             | ** ** | **2008**           | ** ** |
| Common stock, at  par value     |       | $                    | 60,000     |               | $          | 60,000 |   |
| Capital in  excess of par value |       | 12,613,000           |       | 12,613,000         |       |
| Unearned stock  compensation    |       | (231,000             | )          | (263,000           | )          |
| Accumulated  deficit            |       | (10,527,000          | )          | (10,776,000        | )          |
|                            |       | 1,915,000            |       | 1,634,000          |       |
| Less treasury  stock, at cost   |       | 90,000               |       | 90,000             |       |
|                            |       | $                    | 1,825,000  |               | $          | 1,544,000 |   |

 

Torotelhas 6,000,000 shares of common stock, $.01 par value, authorized and 5,878,340shares issued and outstanding.  Thechanges in shares of common stock outstanding are summarized as follows:

 
| Balance,  May 1, 2008      |   | 5,878,340 |   |   |   |
|---------------------------------|--------|-----------|--------|--------|--------|
| Restricted stock  activity      |   | —    |   |   |   |
| Treasury stock  activity        |   | —    |   |   |   |
| Balance,  October 31, 2008 |   | 5,878,340 |   |   |   |

 

**Note8 – Earnings Per Share**

 

Statement of FinancialAccounting Standards (SFAS) No. 128, *Earningsper Share*, requires dual presentation of basic and diluted EPS onthe face of the statement of operations. Basic EPS excludes dilution and is computed by dividing earningsavailable to common stockholders by the weighted average number of commonshares outstanding for the period. 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.  The646,750 shares issued and outstanding pursuant to the Restricted StockAgreements (see Note 6 of Notes to Consolidated Financial Statements) meet thedefinition of contingently issuable shares as outlined in SFAS No. 128; asa result, these shares will not be included in the basic EPS calculation untilthe performance measurements have been satisfied.  The restricted shares are treated as a commonstock equivalent for the diluted EPS calculation.  Pursuant to SFAS No. 128, the basic anddiluted earnings per common share were computed as follows:

 

# **Year-to-Date EPS Calculations**

# ** **

| ** **                                                   | ** ** | **2008**  | ** ** | **2007**  | ** ** |
|--------------------------------------------------------------|------------|-----------|------------|-----------|------------|
| Net earnings  (loss)                                         |       | $         | 249,000    |      | $          | (40,000 | ) |
|                                                         |       |      |       |      |       |
| Weighted average  common shares outstanding for basic EPS    |       | 5,211,807 |       | 5,169,796 |       |
| Incremental  shares for the effect of restricted stock       |       | 666,533   |       | —    |       |
| Weighted average  common shares outstanding for dilutive EPS |       | 5,878,340 |       | 5,169,796 |       |
|                                                         |       |      |       |      |       |
| Basic earnings  (loss) per share                             |       | $         | .05        |      | $          | (.01 | ) |
| Diluted earnings  (loss) per share                           |       | $         | .04        |      | $          | (.01 | ) |

 

No incrementalshares are included in the 2007 EPS calculations for the 686,750 shares ofrestricted common stock since the effect would be anti-dilutive.

 

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# **Table of Contents**

 

# **Quarterly EPS Calculations**

# ** **

| ** **                                                   | ** ** | **2008**  | ** ** | **2007**  | ** ** |
|--------------------------------------------------------------|------------|-----------|------------|-----------|------------|
| Net earnings                                                 |       | $         | 108,000    |      | $          | 13,000 |   |
|                                                         |       |      |       |      |       |
| Weighted average  common shares outstanding for basic EPS    |       | 5,231,590 |       | 5,187,568 |       |
| Incremental  shares for effect of restricted stock           |       | 646,750   |       | 720,918   |       |
| Weighted average  common shares outstanding for dilutive EPS |       | 5,878,340 |       | 5,908,486 |       |
|                                                         |       |      |       |      |       |
| Basic earnings  per share                                    |       | $         | .02        |      | $          | .00 |   |
| Diluted earnings  per share                                  |       | $         | .02        |      | $          | .00 |   |

 

**Note9 – Stock Appreciation Rights**

 

On September 10, 2004, the board of directors of Torotel approvedthe Directors Stock Appreciation Rights Plan (the “Plan”) for non-employeedirectors.  Each SAR is equal to oneshare of common stock of Torotel, and the aggregate number of SARs that may begranted under the Plan shall not exceed 500,000. The effective date of the Planis October 1, 2004, and the Plan has a term of ten (10) years.  The SARs are now accounted for under SFAS No. 123(R),*Accounting for Stock-Based Compensation.*

 

Pursuant to the Plan,20,000 SARs were granted on the effective date to each of the three currentnon-employee directors serving at that time. The initial price at which each SAR was granted was $.35, which equaled themarket price of Torotel’s common stock on the date of grant.  Accordingly, no compensation cost wasrecognized at the time of grant in accordance with APB Opinion 25, prior to theadoption of SFAS No. 123(R) on May 1, 2006.

 

SARs shall automatically be granted in the future as follows: (1) eachperson who is elected as a director, who was not a director on the effectivedate of the Plan, shall be granted 10,000 SARs on the date such person iselected a director; and (2) on each May 1 following the effectivedate during the term of the Plan, each person serving as a director on suchdate shall be granted 10,000 SARs.  Afterthe initial grant, the price at which each SAR is granted shall be the averageof the closing price of Torotel’s common stock for the ten consecutive daysimmediately preceding the date of grant. Upon exercise of a SAR, Torotel will pay the grantee an amount (the “Spread”)equal to the excess of the Exercise Price over the SAR grant price multipliedby the number of shares being exercised. The Exercise Price shall be the average of the closing price of Torotel’scommon stock for the ten consecutive days immediately preceding the notice ofexercise.  For any payments that exceed$10,000, Torotel has the option to make quarterly payments over three yearswith interest payable quarterly at the prime rate of Torotel’s primary bank.

 

EachSAR granted hereunder may be exercised to the extent that the grantee is vestedin such SAR.  The SARs will vestaccording to the following schedule:

 
| **Number of Years the Grantee has remained** | ** ** | **Shares represented**               | ** ** |
|----------------------------------------------------------------------------|------------|-------------------------------------------|------------|
| **a director of the Company following**           | ** ** | **by a SAR in which** | ** ** |
| **the Date of Grant**                                       | ** ** | **a Grantee is Vested**    | ** ** |
| Under one                                                                  |       | 0                                         | %          |
| At least one but  less than two                                            |       | 33                                        | %          |
| At least two but  less than three                                          |       | 67                                        | %          |
| Three or more                                                              |       | 100                                       | %          |

## ** **

A grantee shallbecome fully (100%) vested in each of their SARs under the followingcircumstances:  (i) upon terminationof the grantee’s service as a director of Torotel for reasons of death,disability or retirement; (ii) if the Compensation and Nominating Committee(the “Committee”), in its sole discretion, determines that

 

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acceleration ofthe SAR vesting schedule would be desirable for Torotel; or (iii) ifTorotel shall, pursuant to action by its Board of Directors, at any timepropose to merge into, consolidate with, or sell or otherwise transfer all orsubstantially all of its assets to another corporation, and provision is notmade pursuant to the terms of such transaction for the assumption by thesurviving, resulting or acquiring corporation of outstanding SARs or forsubstitution of new SARs therefore, the Committee shall cause written notice ofthe proposed transaction to be given to each grantee not less than twenty daysprior to the anticipated effective date of the proposed transaction, and his orher SARs shall become fully (100%) vested and, prior to a date specified insuch notice, which shall be not more than ten days prior to the anticipatedeffective date of the proposed transaction, each grantee shall have the rightto exercise his or her SARs.

 

In accordance with SFAS 123(R), compensation expense is recognized overthe vesting period based upon the estimated fair value of the SARs pursuant tothe terms of the Plan using the Black-Scholes options-pricing model as of theend of each financial reporting period. As of October 31, 2008, the fair value of the SARs was determinedusing the following assumptions: no dividend payments over the life of the SARssince Torotel has not issued any form of dividend since 1985; an expectedvolatility of 166.2% based on Torotel’s historical volatility using the weeklyclosing price over the past 3.00 years; a risk-free interest rate of 3.00%; andan expected life of 3.00 years based on the length of service estimated to beserved.  Based on these assumptions, thefair value prices per share of the outstanding SARs are summarized as follows:

 
| ** **            | ** ** | **SARs**   | ** ** | ** **   | ** ** | ** **          | ** ** | ** ** | ** ** | **Aggregate**       | ** ** | **Aggregate** | ** ** |
|-----------------------|------------|------------|------------|--------------|------------|---------------------|------------|------------|------------|---------------------|------------|---------------|------------|
| ** **            | ** ** | **Under**  | ** ** | **Exercise** | ** ** | **Fair Value** | ** ** | **%**      | ** ** | **Vested**          | ** ** | **Intrinsic** | ** ** |
| **Grant Date**   | ** ** | **Option** | ** ** | **Price**    | ** ** | **Price**           | ** ** | **Vested** | ** ** | **Fair Value** | ** ** | **Value**     | ** ** |
| October 1,  2004 |       | 60,000     |       | $            | .350       |                | $          | .356       |       | 100                 | %          | $             | 21,000     |   | $ | 4,000 |   |
| May 1, 2005      |       | 30,000     |       | $            | .302       |                | $          | .360       |       | 100                 | %          | $             | 11,000     |   | $ | 3,000 |   |
| May 1, 2006      |       | 30,000     |       | $            | .695       |                | $          | .334       |       | 67                  | %          | $             | 7,000      |   | $ | — |   |
| May 1, 2007      |       | 30,000     |       | $            | .500       |                | $          | .345       |       | 33                  | %          | $             | 4,000      |   | $ | — |   |
| June 4,  2007    |       | 10,000     |       | $            | .412       |                | $          | .351       |       | 33                  | %          | $             | 1,000      |   | $ | — |   |
| May 1, 2008      |       | 40,000     |       | $            | .550       |                | $          | .342       |       | 0                   | %          | $             | —     |   | $ | — |   |

 

The vested portionrepresents 123,300 SARs.  As of October 31,2008, the total aggregate intrinsic value of these exercisable SARs was $7,000.

 

SARs transactions for each six month period through October 31 aresummarized as follows:

 
| ** **                                                     | ** ** | **2008**   | ** ** | **2007**     | ** ** |
|----------------------------------------------------------------|------------|------------|------------|--------------|------------|
| ** **                                                     | ** ** | ** ** | ** ** | **Weighted** | ** ** | ** ** | ** ** | **Weighted** | ** ** |
| ** **                                                     | ** ** | **SARs**   | ** ** | **Average**  | ** ** | **SARs** | ** ** | **Average** | ** ** |
| ** **                                                     | ** ** | **Under**  | ** ** | **Grant**    | ** ** | **Under** | ** ** | **Grant** | ** ** |
| ** **                                                     | ** ** | **Option** | ** ** | **Price**    | ** ** | **Option** | ** ** | **Price** | ** ** |
| Outstanding at  beginning of period                            |       | 160,000    |       | $            | .438       |   | 120,000 |   | $ | .424 |   |
| Granted                                                        |       | 40,000     |       | $            | .550       |   | 40,000 |   | $ | .478 |   |
| Exercised                                                      |       | —     |       | —       |       | — |   | — |   |
| Forfeited                                                      |       | —     |       | —       |       | — |   | — |   |
| Outstanding at  end of period                                  |       | 200,000    |       | $            | .460       |   | 160,000 |   | $ | .438 |   |
|                                                           |       |       |       |         |       |   |   |   |   |
| SARs exercisable  at end of period                             |       | 123,300    |       | $            | .408       |   | 90,000 |   | $ | .378 |   |
| Weighted average  fair value of SARs granted during the period |       |       |       | $            | .342       |   |   |   | $ | .422 |   |

 

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The following informationapplies to SARs outstanding for each six month period through October 31:

 
| ** **                                   | ** ** | **2008**      | ** ** | **2007**      | ** ** |
|----------------------------------------------|------------|---------------|------------|---------------|------------|
| Number  outstanding                          |       | 200,000       |       | 160,000       |       |
| Range of grant  prices                       |       | $.302 - $.695 |       | $.302 - $.695 |       |
| Weighted average  grant price                |       | $.460         |       | $.438         |       |
| Weighted average  remaining contractual life |       | 7.48 yrs.     |       | 7.97 yrs.     |       |

 

Total compensationexpense for the outstanding SARs for the six months ended October 31, 2008and 2007 was a credit of $2,000 and an expense of $15,000, respectively.  Total compensation expense for theoutstanding SARs for the three months ended October 31, 2008 and 2007, was$1,000 and $16,000, respectively.  As of October 31,2008, there was $26,000 of total unrecognized compensation expense related tonon-vested SARs granted under the Plan. That cost is expected to be recognized over a weighted average period of..88 years.  The liability for SARs on theconsolidated balance sheet as of October 31, 2008, was $44,000.

 

**Note 10 –****Concentrations of Credit Risk**

 

Financial instruments that potentially subject Torotel toconcentrations of credit risk consist principally of cash and accountsreceivable.  Torotel grants unsecuredcredit to substantially all of its customers. Management does not believe that it is exposed to any extraordinary creditrisk as a result of this policy.  Toroteldeposits all monies at the Bank of Blue Valley. These accounts are secured up to $250,000 by the Federal DepositInsurance Corporation through December 31, 2009.  At various times and at October 31,2008, these cash balances exceed federally insured limits.  Torotel has not experienced any losses insuch accounts.  Management does notbelieve Torotel is exposed to any significant credit risk with respect to itscash balances.

 

**Note 11 – Financing Agreement**

 

On September 30,2008, Torotel Products renewed its revolving credit agreement with Bank of BlueValley, increasing this line of credit to $500,000.  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 at1.00% over the bank’s corporate base rate with an interest rate floor of 6.00%and has a maturity date of September 30, 2009.  As of October 31, 2008, the effectiveborrowing rate was 6.00% and the entire credit line was available.

 

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**Item 2.****                     Management’sDiscussion and Analysis of Financial Condition and Results of Operation**

 

*Overview*

 

Torotel conducts business primarily through two whollyowned subsidiaries, Torotel Products, Inc. (“Torotel Products”) andElectronika, Inc. (“Electronika”). In addition, Torotel has a 12.88% equity interest in Apex Innovations, Inc.(“Apex”).

 

Torotel Products designs and manufactures a widevariety of magnetic components for use in military, aerospace and industrialelectronic applications.  These 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 tomanufacturers who incorporate them into an end-product.  The major applications include aircraftnavigational equipment, voice and data secure communications, medicalequipment, avionics equipment, and conventional missile guidance systems.  As part of its growth strategy, TorotelProducts has been actively pursuing opportunities in electro-mechanicalassemblies. These efforts are meeting with success as $534,000 in revenue hasbeen generated from these assemblies during the first six months of fiscal2009, with another $113,000 due to ship in December 2008.  In addition, management expects to receive anew order for approximately $400,000 in Torotel’s fourth fiscal quarter.

 

Torotel Products markets its components primarilythrough a 4-person internal sales force and four independent manufacturers’representatives paid on a commission basis. Torotel Products also utilizes its 4-person engineering department inits direct sales efforts for the purpose of expanding its reach into newmarkets and/or 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 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 ballasttransformers have been made primarily for use in DC-8 and DC-9 aircraft.

 

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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 ballasttransformers are outsourced pursuant to a Manufacturing Agreement withMagnetika, Inc. (“Magnetika”), a corporation owned by the Caloyerasfamily.  Under the terms of theagreement, Magnetika provides all necessary raw material, labor, testing,packaging and related services required to complete the manufacture, deliveryand sale of the ballast transformers. Electronika retains ownership of all designs, drawings, specificationsand intellectual property rights associated with the ballast transformers.  Magnetika is a manufacturing company that, inaddition to the aforementioned ballast transformers, manufactures various otherproducts similar to those of Torotel for other unrelated customers.  Magnetika’s annual sales are estimated to beabout two times the annual sales of Torotel. Total purchases of goods from Magnetika by Electronika amounted to$41,000 for the six months ended October 31, 2008.

 

*Business Outlook*

 

While the outlook for fiscal 2009 remains positivewhen compared to fiscal 2008, management’s goal of reaching $9 million inrevenue for fiscal 2009 will not be achieved due to various factors.  First, the recently ended labor strike atBoeing which lasted nearly two months, has caused many of Torotel’s aerospacecustomers to re-schedule the delivery of their orders to dates in early fiscal2010, which will result in lower revenues from Torotel’s magnetic components(this is in addition to the re-scheduling already incurred as a result ofBoeing’s ongoing production delays for the 787); second, by customer requestthe monthly delivery requirements for the potted coil assembly have beenreduced temporarily while the customer completes a re-tooling of theirproduction line to handle the higher quantities (management anticipates highermonthly shipments of the potted coil assembly to begin in the spring of 2009);and third, anticipated revenues from a follow-on contract for the new ballastassembly likely will not occur until early in fiscal 2010.  As a result, management is anticipatingfiscal 2009 revenues to increase approximately 15-20% instead of the nearly 50%originally anticipated.  As of October 31,2008, the order backlog is nearly $4.2 million. This amount is comprised of $2.5 million for the potted coil assembly,nearly $1.5 million in magnetic components and $200,000 in electro-mechanicalassemblies.  New order bookings havedeclined during the second fiscal quarter, which has the first half of fiscal2009 on equal terms with the same period last year.  Management believes new order bookings infiscal 2009 should still increase 10-15% because of an expected order for thepotted coil assembly.

 

The industry mix of Torotel Products’ net sales forthe first half of fiscal 2009 was 40% defense, 33% aerospace and 27% industrialcompared to 53% defense, 34% aerospace and 13% industrial for the same periodlast year.  Management still believes themix in fiscal 2009 should shift more toward industrial and defense primarilybecause of the new ballast assembly, higher demand for the potted coil assemblyfor the Hellfire II missile system and another electro-mechanical assembly fora new military application.  Torotel’smanagement will continue to focus its efforts in areas and solutions that offersignificant growth, which includes continued expansion of the product basebeyond electronic components.

 

The primary factors that drive gross profit and netearnings 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.

 

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Torotel’s operating plan continues to includeadditional sales and marketing costs in the form of personnel and/orcommissions, trade show exhibits, electronic newsletters and new printliterature.  The plan also continues theinvestment in workforce development as part of the ongoing efforts to improveTorotel’s processes and value streams. Management believes a well developed growth strategy is in place andthat going forward, some or all of these expenditures will be necessary on acontinuing basis in order to achieve the desired growth.  Future annual earnings will continue to beimpacted by increased auditing costs associated with complying with SECregulations, the standards of the Public Company Accounting Oversight Board(United States) and Section 404 of the Sarbanes-Oxley Act of 2002.

 

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.

 

*Resultsof Operations*

 

The following managementcomments regarding Torotel’s results of operations and outlook should be readin conjunction with the Consolidated Financial Statements included pursuant toItem 1 of this Quarterly Report.

 

The discussion andanalysis of the results of operations include the operations of Torotel and itssubsidiaries, Torotel Products and Electronika. 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.

 

**SixMonths Ended October 31, 2008 Compared With Six Months Ended October 31,2007**

 

Consolidated net sales increased 30%.  The net sales of Torotel Products increased 28% from $3,021,000 to $3,858,000.  This increase is primarily attributable to the new ballast assembly for a major industrial application, a new assembly for a military application and higher demand for molded coils used in down-hole drilling applications.  The net sales of Electronika increased 264% from $28,000 to $102,000.  This increase is the result of product shipments that were previously delayed awaiting Boeing’s approval of a replacement for an encapsulating material that had become obsolete.  Management expects Electronika’s sales to return to the lower levels seen in previous periods.

 

Consolidated gross profit as a percentage of net sales decreased1%.  The gross profit percentage ofTorotel Products decreased 1% because of higher material and labor costsassociated with the product mix and higher fixed production costs.  These higher costs were offset partially bythe effect of the higher sales volume. Electronika’s gross profit as a percentage of net sales remainedunchanged.

 

Engineering expenses, applicable only to Torotel Products, increased35% from $131,000 to $177,000 becauseof a $31,000 increase in payroll costs primarily associated with engineeringcollege interns employed this summer, an $8,000 increase in travel costs, a$5,000 increase in training costs and a $2,000 increase in consulting costs.  Management does not anticipate anysignificant increase in the present level of engineering expenses.

 

Consolidatedselling, general and administrative (“SG&A”) expenses decreased 3%.  The SG&A expenses of Torotel decreased31% from $277,000 to $190,000 primarily because of a $77,000 decrease inprofessional fees, a $17,000 decreasein the fair value of stock appreciation rights and a $7,000 decrease indirectors fees.  These decreases wereoffset partially by an $8,000 increase in auditing fees, a $3,000 increase forrenewal of Torotel’s two-year license and registration required under theInternational Traffic in

 

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Arms Regulations (“ITAR”)and the Arms Export Control Act (“AECA”), and a $3,000 increase in insurancecosts.  The SG&A expenses of TorotelProducts increased nearly 8% from $747,000 to $803,000 primarily because of a $72,000 increase in payrollcosts, a $33,000 increase in sales commissions, a $16,000 increase in IT costs,a $12,000 increase in consulting costs, a $10,000 increase in recruiting costsand a $7,000 increase in building supplies. These increases were offset partially by a $72,000 decrease in trainingcosts and a $22,000 decrease in stock compensation costs.  Electronika did not incur any SG&Aexpenses in either period.  Managementdoes not anticipate any significant increase in the present level of SG&Aexpenses.

 

Interest expense, entirely attributable to Torotel Products, decreasednearly 7% because of a lower debt level.

 

For the reasonsdiscussed above, the consolidated pretax earnings increased from a loss of$40,000 to a profit of $249,000.  Thepretax loss of Torotel decreased from $277,000 to $190,000.  The pretax earnings of Torotel Productsincreased from $220,000 to $378,000.  Thepretax earnings of Electronika increased from $17,000 to $61,000.

 

**ThreeMonths Ended October 31, 2008 Compared With Three Months Ended October 31,2007**

 

Consolidated net sales increased 21%. The net sales of Torotel Products increased 17% from $1,627,000 to$1,908,000.  This increase is primarilyattributable to the new ballast assembly for a major industrial application, anew assembly for a military application and higher demand for moldedcoils used in down-hole drilling applications. The net sales of Electronikaincreased 406% from $16,000 to $81,000.  Thisincrease is the result of product shipments that were previously delayedawaiting Boeing’s approval of a replacement for an encapsulating material thathad become obsolete.  Management expectsElectronika’s sales to return to the lower levels seen in previous periods.

 

Consolidated gross profit as a percentage of net sales decreased 3%.  The gross profit percentage of TorotelProducts decreased nearly 4% because of higher material and labor costsassociated with the product mix and higher fixed production costs.  These higher costs were offset partially bythe effect of the higher sales volume.  Electronika’s gross profit as a percentage ofnet sales remained unchanged.

 

Engineering expenses, applicable only to Torotel Products, increased 20%from $66,000 to $79,000 because of a $10,000 increase in payroll costsprimarily associated with engineering college interns employed the past fewmonths and a $3,000 increase in travel costs. Management anticipates the present level of engineering expenses toremain relatively the same during the next few quarters.

 

Consolidated selling, general and administrative (SG&A) expensesdecreased 6%.  The SG&A expenses ofTorotel decreased 41% from $123,000 to $72,000 primarily because of a $32,000decrease in professional fees, a $14,000 decrease in the fair value of stockappreciation rights and a $5,000 decrease in directors fees.  The SG&A expenses of Torotel Productsincreased 5% from $396,000 to $416,000 primarily because of a $44,000 increasein payroll costs, a $12,000 increase in consulting costs, a $9,000 increase inrecruiting costs, an $8,000 increase in sales commissions, $4,000 increase inbuilding supplies and a $3,000 increase in copier costs.  These increases were offset partially by a$35,000 decrease in stock compensation costs and a $25,000 decrease in trainingcosts.  Electronika did not incur anySG&A expenses in either period. Management does not anticipate any significant increase in the presentlevel of SG&A expenses.

 

Interest expense, entirely attributable to Torotel Products, decreased 6%because of a lower debt level.

 

For the reasons discussed above, the consolidated pretax earningsincreased from $13,000 to $108,000.  Thepretax loss of Torotel decreased from $123,000 to $72,000.  The pretax earnings of Torotel Productsincreased from $126,000 to $132,000.  Thepretax earnings of Electronika increased from $10,000 to $48,000.

 

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**Liquidityand Capital Resources**

** **

As of October 31,2008, Torotel had $434,000 in cash compared to $410,000 as of April 30,2008 and $149,000 as of October 31, 2007. Management anticipates a decline in cash flow from operations during thesecond half of fiscal 2009 given the anticipated increase in inventories due tothe re-scheduling of deliveries described under the *BusinessOutlook* section on page 13 of this Report.

 

The table below presents the summary of cash flow forthe six month periods indicated.

 
| ** **                                           | ** ** | **2008** | ** ** | **2007** | ** ** |
|------------------------------------------------------|------------|----------|------------|----------|------------|
| Net cash  provided by (used in) operating activities |       | $        | 80,000     |     | $          | (37,000 | ) |
| Net cash used in  investing activities               |       | $        | (21,000    | )        | $          | (33,000 | ) |
| Net cash used in  financing activities               |       | $        | (35,000    | )        | $          | (28,000 | ) |

 

Net cash provided byoperating activities fluctuates between periods primarily as a result ofdifferences in operating earnings, the timing of shipments and the collectionof accounts receivable, changes in inventory, level of sales and payment ofaccounts payable.  The $21,000 of cashused in investing activities was the result of capital expenditures.  Management anticipates approximately $35,000of capital expenditures during the remainder of fiscal 2009.  The $35,000 of cash used in financingactivities is because of long-term debt payments on the mortgage with the Bankof Blue Valley.  Management believes thatthe projected cash flow from operations, combined with its existing cashbalances, will be sufficient to meet its funding requirements for theforeseeable future.  Torotel does have a$500,000 bank line of credit available, which management anticipates could beutilized to help fund any working capital requirements.

 

Management believes thatinflation will have only a minimal effect on future operations since sucheffects will be offset by sales price increases, which are not expected to havea significant effect upon demand*.*

* *

Return on CapitalEmployed (“ROCE”) is the primary tool for managing Torotel’s business.  The performance of Torotel’s management andthe majority of its decisions will be measured by whether Torotel’s ROCEimproves.  ROCE measures output (EBIT)versus input (Net Operating Assets = Capital Employed).  For these purposes, net operating assets isdefined as “trade receivables plus inventories plus net fixed assets plusmiscellaneous operating assets less trade accounts payable less accruedliabilities”.  For the fiscal years endedApril 30, 2006, 2007 and 2008, Torotel’s ROCE was 19.04%, -.66% and12.25%, respectively.  Torotel’s ROCE forthe 12-month trailing period ended October 31, 2008 was 24.50%.

 

**Critical Accounting Policies**

** **

*Use of Estimates*

* *

The preparation of theconsolidated financial statements in conformity with accounting principles generallyaccepted in the United States of America requires management to make estimatesand assumptions that affect certain reported amounts and disclosures.  Significant estimates used in preparing theseconsolidated financial statements include those assumed in computing thecarrying value of equipment, allowance for doubtful accounts receivable,reserve for obsolete and excess inventory, the valuation allowance on deferredtax assets and the reserve for warranty costs. Accordingly, actual results could differ from those estimates.  Any changesin estimates are recorded in the period in which they become known.

 

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* *

*Credit Risk*

* *

Financial instruments that potentially subject Torotel toconcentrations of credit risk consist principally of cash and accountsreceivable.  Torotel grants unsecuredcredit to substantially all of its customers. Management does not believe that it is exposed to any extraordinarycredit risk as a result of this policy. Torotel deposits all monies at the Bank of Blue Valley.  These accounts are secured up to $250,000 bythe Federal Deposit Insurance Corporation through December 31, 2009.  At various times and at October 31,2008, these cash balances exceed federally insured limits.  Torotel has not experienced any losses insuch accounts.  Management does notbelieve Torotel is exposed to any significant credit risk with respect to itscash balances.

 

*Fair Value of Financial Instruments*

* *

Carrying amounts ofcertain financial instruments, including cash, trade receivables, prepaidexpenses and other current assets, trade accounts payable and accruedliabilities approximate fair value due to their short maturities.  As of October 31, 2008, the amount ofTorotel’s long-term debt approximates fair value based on the present value ofestimated future cash flows using a discount rate commensurate with a borrowingrate available to Torotel.

 

*Treasury Stock*

* *

Torotel utilizes theweighted average cost method in accounting for its treasury stock transactions.

 

*Revenue Recognition*

* *

Revenue is recognized oncontracts and orders on the date the product is shipped to the customer (unit-of-deliverymethod).  Torotel’s consolidated netsales arising from contracts having deliveries scheduled over a period of morethan one year for the six month periods ended October 31, 2008 and 2007,were approximately 20% and 26%, respectively, because of the contracts for thepotted coil assembly.

 

*Allowance for Doubtful Accounts*

* *

Gross trade accountsreceivable are offset with an allowance for doubtful accounts.  The allowance for doubtful accounts ismanagement’s best estimate of the amount of probable credit losses in Torotel’sexisting accounts receivable.  Managementreviews the allowance for doubtful accounts on a regular basis, and all pastdue balances are reviewed individually for collectibility.  Account balances are charged against theallowance when placed for collection. Recoveries of receivables previously written off are recorded whenreceived.  The majority of the customeraccounts are considered past due after the invoice becomes older than thecustomer’s credit terms.  Interest is notcharged on past due accounts.

 

*Inventories*

* *

Inventories are stated atthe lower of cost or market.  Cost isdetermined using a moving average cost method of valuation that approximatesthe first-in, first-out method.  Torotel’sindustry is characterized by short-term customer commitments and changes indemand, as well as other market considerations. Provisions for estimated obsolete and excess inventory are based onreviews of inventory usage, quantities

 

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on hand and latest product demand information fromcustomers.  Inventories are reviewedutilizing a 12-month time horizon. Individual part numbers that have not had any usage in a 12-month timeperiod are categorized as obsolete; individual part numbers having more than a12-month supply based on the current year’s usage are categorized asexcess.  The reserve balance is analyzedfor adequacy along with the inventory review each quarter.

 

*Property, Plant and Equipment*

* *

Property, plant andequipment are carried at cost. Depreciation and amortization are provided in amounts sufficient torelate the costs of depreciable assets to operations primarily using the straight-linemethod over estimated useful lives of three to five years for property andequipment, and ten to twenty years for buildings and improvements.

 

*Cash Flows*

* *

For purposes of thestatements of cash flows, Torotel considers all short-term investments purchasedwith original maturity dates of three months or less to be cash equivalents.

 

*Equity Investment in Apex*

* *

Torotel has a 12.88%interest in Apex.  The investment in Apexhas no carrying value on the consolidated balance sheets of Torotel, and in theopinion of Torotel management, it is not likely that any of the investment willbe recovered.  If Apex were to eventuallybe sold, any cash recovered would be recognized as a gain upon receipt of theproceeds.

 

*Warranty Costs*

* *

Torotel has a reserve forestimated warranty costs associated with products returned from customers.  A limited warranty is provided for a periodof one year which requires Torotel to repair or replace defective products atno cost to the customer.  The warrantyreserve is based on historical experience and reflects management’s bestestimate of probable liability under the product warranties.

 

*New Accounting Pronouncements*

* *

Effective May 1,2008, Torotel adopted Statement of Financial Accounting Standard No. 157 (“SFAS157”), *Fair Value Measurements*.  SFAS 157 defines fair value, establishes aframework for measuring fair value, and expands disclosures about fair valuemeasurements.  SFAS 157 applies to otheraccounting pronouncements that require or permit fair value measurements, butdoes not require any new fair value measurements.  The adoption of SFAS 157 did not have anyeffect on Torotel’s results of operations, financial condition and cash flows.

 

Effective May 1,2008, Torotel adopted Statement of Financial Accounting Standard No. 159 (“SFAS159”), *The FairValue Option for Financial Assets and Financial Liabilities - Including anamendment of FASB Statement No. 115*.  SFAS 159 permits entities to choose tomeasure many financial instruments and certain other items at fair value.  The objective is to improve financialreporting by providing entities with the opportunity to mitigate volatility inreported earnings caused by measuring related assets and liabilitiesdifferently without having to apply complex hedge accounting provisions.  SFAS 159 is expected to expand

 

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the use of fair value measurement, which is consistentwith the FASB’s long-term measurement objectives for accounting for financialinstruments.  Most of the provisions ofthis Statement apply only to entities that elect the fair value option.  However, the amendment to FASB Statement No. 115,*Accounting for Certain Investments in Debtand Equity Securities,* applies to all entities withavailable-for-sale and trading securities. The adoption of SFAS 159 did not have any effect on Torotel’s results ofoperations, financial condition and cash flows.

 

**Forward-LookingInformation**

** **

*This report, as well as our otherreports filed with the Securities and Exchange Commission (“SEC”), and in pressreleases and other public communications throughout the year, contains forwardlooking statements made pursuant to the safe harbor provisions of The PrivateSecurities Litigation Reform Act of 1995. The words “believe,” “estimate,” “anticipate,” “project,” “intend,” “expect,”“plan,” “outlook,” “forecast,” “may,” “will,” “should,” “continue,” “predict”and similar expressions are intended to identify forward lookingstatements.  This report containsforward-looking statements regarding, among other topics, our expectedfinancial position, results of operations, cash flows, strategy, budgets andmanagement’s plans and objectives. Accordingly, these forward-looking statements are based on assumptionsabout a number of important factors. While we believe that our assumptions about such factors are reasonable,such factors involve risks and uncertainties that could cause actual results tobe different from what appear here. These risk factors include: the ability to adequately pass through tocustomers unanticipated future increases in raw material costs, decreaseddemand for products, delays in developing new products, expected orders that donot occur, loss of key customers, the impact of competition and price erosionas well as supply and manufacturing constraints, general economic conditions inthe United States and specifically, economic conditions affecting the defenseand aerospace industries, the availability of credit, 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 4T.****             Controls andProcedures**

** **

*Evaluationof Disclosure Controls and Procedures*

* *

Torotel’s management,with the participation of the Chief Executive Officer and Chief FinancialOfficer, has evaluated the effectiveness of Torotel’s disclosure controls andprocedures, as such term is defined in Rules 13a-15(e) and 15d-15(e) underthe Securities Exchange Act of 1934, as amended (the “Exchange Act”), as of theend of the period covered by this report. Based on such evaluation, these officers have concluded that Torotel’sdisclosure controls and procedures are effective to provide reasonableassurance that information required to be disclosed in periodic filings underthe Exchange Act is accumulated and communicated to management, including thoseofficers, and to members of the Board of Directors, to allow timely decisionsregarding required disclosure.

 

*Changesin Internal Controls*There were no significant changes inTorotel’s internal controls over financial reporting or in other factors thatin management’s estimates are reasonably likely to materially affect Torotel’sinternal controls over financial reporting subsequent to the date of theevaluation.

 

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** **

**PART II.****          OTHER INFORMATION**

** **

**Item 4.****                     Submission ofMatters to a Vote of Security Holders**

** **

The annual meeting of shareholders was held in Kansas City, Missouri,on Monday, September 15, 2008, to vote on:

 

a.                    Thefollowing two management proposals:

 

(1)              To elect two membersto serve on the Board of Directors for a three-year term, with those nomineesreceiving the greatest number of votes being elected; and

 

(2)             To approve anamendment to Torotel’s Articles of Incorporation to increase the number ofauthorized shares of common stock, par value $.01 per share, from 6,000,000 to8,000,000 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.

 

b.                   Thefollowing three shareholder proposals:

 

(3)             To consider and voteupon a shareholder proposal that permits only shareholders to make, alter,amend, suspend or repeal the Corporation’s By-Laws;

 

(4)             To consider and voteupon a shareholder proposal to revoke a provision of the Corporation’s By-Lawsto remove advance notice requirements for shareholders to bring business beforea shareholder meeting; and

 

(5)             To consider and voteupon a shareholder proposal to reduce the number of members on the Board ofDirectors from seven to five.

 

A majority of the outstanding shares of common stock entitled to bevoted at the meeting, represented in person or by proxy, was necessary toconstitute a quorum to transact business at the meeting.  At the meeting, there were 5,640,205 sharesrepresented which was 95.95% of the shares outstanding and eligible tovote.  The voting results were asfollows:

 

***Proposal 1***.                        Shareholderselected the following individuals to three-year terms on the Board ofDirectors, with the number of shares voting “FOR” each nominee indicated.

 

| S. Kirk  Lambright, Jr. |   | 2,768,890 |   |
|------------------------------|--------|-----------|--------|
| H. James Serrone             |   | 2,931,119 |   |

 

In addition to thedirectors elected above, Anthony H. Lewis, Dale H. Sizemore, Jr., RichardA. Sizemore and Stephen K. Swinson also serve as directors.  The current three-year terms for Messrs. Sizemoreend in 2009, while the three-year terms for Messrs. Lewis and Swinson endin 2010.

 

***Proposal 2.******                       ***Shareholdersrejected the amendment to increase the number of authorized shares of commonstock, with the number of shares voting “FOR”, “AGAINST”, and “ABSTAIN”indicated below.

 

| FOR     |   | 2,724,278 |   |
|---------|--------|-----------|--------|
| AGAINST |   | 2,869,127 |   |
| ABSTAIN |   | 46,800    |   |

 

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*** ***

***Proposal 3.******                       ***Shareholdersnarrowly approved the shareholder proposal recommending that the Board ofDirectors submit to shareholders for a vote a proposed amendment to theCorporation’s Articles of Incorporation that would permit only shareholders tomake, alter, amend, suspend or repeal the Corporation’s By-Laws, with thenumber of shares voting “FOR” , “AGAINST”, and “ABSTAIN” indicated below.

 

| FOR              |   | 2,866,106 |   |
|------------------|--------|-----------|--------|
| AGAINST          |   | 2,043,618 |   |
| ABSTAIN          |   | 146,965   |   |
| BROKER NON VOTES |   | 583,516   |   |

 

***Proposal 4.******                       ***Shareholdersnarrowly approved the shareholder proposal recommending that the Board ofDirectors submit to shareholders for a vote a proposed amendment to theCorporation’s Articles of Incorporation that would revoke a provision of theCorporation’s By-Laws to remove advance notice requirements for shareholders tobring business before a shareholder meeting, with the number of shares voting “FOR”,“AGAINST”, and “ABSTAIN” indicated below.

 

| FOR              |   | 2,829,153 |   |
|------------------|--------|-----------|--------|
| AGAINST          |   | 2,079,741 |   |
| ABSTAIN          |   | 147,795   |   |
| BROKER NON VOTES |   | 583,516   |   |

 

***Proposal 5.******                       ***Shareholdersnarrowly approved the shareholder proposal recommending that the Board ofDirectors submit to shareholders for a vote a proposed amendment to theCorporation’s Articles of Incorporation that would reduce the number of memberson the Board of Directors from seven to five, with the number of shares voting “FOR”,“AGAINST”, and “ABSTAIN” indicated below.

 

| FOR              |   | 2,826,064 |   |
|------------------|--------|-----------|--------|
| AGAINST          |   | 2,082,475 |   |
| ABSTAIN          |   | 148,150   |   |
| BROKER NON VOTES |   | 583,516   |   |

 

The Board ofDirectors plans to consider the recommendations in Proposals 3, 4 and 5 at its December 2008Board meeting.

 

**Item 6.****                     Exhibits**

** **

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 |

 

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** **

**SIGNATURES**

** **

Pursuant to therequirements of the Securities Exchange Act of 1934, the registrant has dulycaused this report to be signed on its behalf by the undersigned, thereuntoduly authorized.

 

 

**Torotel, Inc.**

**(Registrant)**

** **

** **
| /s/  Dale H. Sizemore, Jr.     |   |
|------------------------------------------|--------|
| Dale H.  Sizemore, Jr.              |   |
| Chief Executive Officer                  |   |
| Date:   December 15, 2008 |   |
|                                     |   |
|                                     |   |
| /s/  H. James Serrone               |   |
| H. James Serrone                         |   |
| Chief Financial Officer                  |   |
| Date:   December 15, 2008 |   |

 

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