**FORM 10-QSB**

 

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

 

**For thequarterly period ended July 31, 2005**

 

**CommissionFile No. 1-8125**

 

**TOROTEL, INC.**

(Exact name of small businessissuer as specified in its charter)

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

 

**620 NORTHLINDENWOOD DRIVE, OLATHE, KANSAS  66062**

(Address of principal executiveoffices)

 

**(913) 747-6111**

(Issuer’s telephone number)

 

**NONE**

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

 

Check whether the issuer (1) filed all reports required to befiled by Section 13 or 15(d) of the Exchange Act during the past 12months and (2) has been subject to such filing requirements for the past90 days.

 

Yes  ý  No  o

 

Indicate by check mark whetherthe registrant is a shell company (as defined in Rule 12b-2 of the ExchangeAct.)

 

Yes  o  No  ý

 

As of September 8, 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, 2005 |   |
|                                      |    |   |   |
|                                      |    | Consolidated Statements of Operations for  the three months  ended July 31, 2005 and 2004 |   |
|                                      |    |   |   |
|                                      |    | Consolidated Statements of Cash Flows for  the three months  ended July 31, 2005 and 2004 |   |
|                                      |    |   |   |
|                                      |    | 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 BALANCE SHEET (Unaudited)

As of July 31, 2005

 
| ASSETS                                            |   |        |      |
|---------------------------------------------------|--------|-------------|-----------|
|                                              |   |        |      |
| Current assets:                                   |   |        |      |
| Cash                                              |   | $           | 341,000   |   |
| Accounts  receivable, net                         |   | 596,000     |      |
| Inventories                                       |   | 338,000     |      |
| Prepaid  expenses and other current assets        |   | 50,000      |      |
| Real estate  held for sale                        |   | 112,000     |      |
|                                              |   | 1,437,000   |      |
|                                              |   |        |      |
| Property, plant and equipment, net                |   | 1,054,000   |      |
|                                              |   |        |      |
| Other assets                                      |   | 30,000      |      |
| Equity investment                                 |   | —      |      |
| Intangible assets, net                            |   | 754,000     |      |
|                                              |   |        |      |
|                                              |   | $           | 3,275,000 |   |
|                                              |   |        |      |
| LIABILITIES AND STOCKHOLDERS’ EQUITY         |   |        |      |
|                                              |   |        |      |
| Current liabilities:                              |   |        |      |
| Current  maturities of long-term debt             |   | $           | 70,000    |   |
| Trade  accounts payable                           |   | 201,000     |      |
| Accrued  liabilities                              |   | 182,000     |      |
| Accrued  interest on note payable to shareholders |   | 5,000       |      |
|                                              |   | 458,000     |      |
|                                              |   |        |      |
| Long-term debt, less current maturities           |   | 928,000     |      |
|                                              |   |        |      |
| 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                              |   | (11,070,000 | )         |
|                                              |   | 1,344,000   |      |
| Less  treasury stock, at cost                     |   | 205,000     |      |
|                                              |   | 1,139,000   |      |
|                                              |   |        |      |
|                                              |   | $           | 3,275,000 |   |

 

The accompanying notes are anintegral part of this statement.

 

1

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CONSOLIDATED STATEMENTS OF OPERATIONS (Unaudited)

Three Months Ended July 31,

 
| ** **                                         | ** ** | **2005** | ** ** | **2004** | ** ** |
|----------------------------------------------------|------------|----------|------------|----------|------------|
| Net sales                                          |       | $        | 1,267,000  |     | $          | 1,004,000 |   |
| Cost of goods sold                                 |       | 718,000  |       | 679,000  |       |
|                                               |       |     |       |     |       |
| Gross profit                                       |       | 549,000  |       | 325,000  |       |
|                                               |       |     |       |     |       |
| Operating expenses:                                |       |     |       |     |       |
|                                               |       |     |       |     |       |
| Engineering                                        |       | 57,000   |       | 52,000   |       |
| Selling, general  and administrative               |       | 355,000  |       | 288,000  |       |
| Amortization  of intangible assets                 |       | 16,000   |       | 9,000    |       |
|                                               |       |     |       |     |       |
|                                               |       | 428,000  |       | 349,000  |       |
|                                               |       |     |       |     |       |
| Earnings  (loss) from operations                   |       | 121,000  |       | (24,000  | )          |
|                                               |       |     |       |     |       |
| Other expense (income):                            |       |     |       |     |       |
| Interest  expense                                  |       | 33,000   |       | 34,000   |       |
| Equity in  loss of investee                        |       | —   |       | 28,000   |       |
| Impairment  of real estate                         |       | 36,000   |       | —   |       |
| Gain on  settlement of debt                        |       | (35,000  | )          | —   |       |
| Gain on sale  of real estate                       |       | (105,000 | )          | —   |       |
|                                               |       | (71,000  | )          | 62,000   |       |
|                                               |       |     |       |     |       |
| Earnings  (loss) before provision for income taxes |       | 192,000  |       | (86,000  | )          |
|                                               |       |     |       |     |       |
| Provision for income taxes                         |       | —   |       | —   |       |
|                                               |       |     |       |     |       |
| Net earnings (loss)                                |       | $        | 192,000    |     | $          | (86,000 | ) |
|                                               |       |     |       |     |       |
| Basic and diluted earnings (loss) per share        |       | $        | .04        |     | $          | (.02 | ) |

 

The accompanying notes are anintegral part of these statements.

 

2

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CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited)

Three Months Ended July 31,

 
| ** **                                                                                             | ** ** | **2005** | ** ** | **2004** | ** ** |
|--------------------------------------------------------------------------------------------------------|------------|----------|------------|----------|------------|
| Cash flows from operating activities:                                                                  |       |     |       |     |       |
| Net earnings  (loss)                                                                                   |       | $        | 192,000    |     | $          | (86,000 | ) |
| Adjustments  to reconcile net earnings (loss) to net cash provided by (used in) operating  activities: |       |     |       |     |       |
| Gain on sale  of asset                                                                                 |       | (105,000 | )          | —   |       |
| Gain on  settlement of debt                                                                            |       | (35,000  | )          | —   |       |
| Impairment  of real estate                                                                             |       | 36,000   |       | —   |       |
| Equity in  loss of investee                                                                            |       | —   |       | 28,000   |       |
| Depreciation  and amortization                                                                         |       | 33,000   |       | 26,000   |       |
| Increase  (decrease) in cash flows from operations resulting from changes in:                          |       |     |       |     |       |
| Accounts  receivable                                                                                   |       | 81,000   |       | (274,000 | )          |
| Inventories                                                                                            |       | (66,000  | )          | (118000  | )          |
| Prepaid  expenses and other assets                                                                     |       | (47,000  | )          | (37,000  | )          |
| Trade  accounts payable                                                                                |       | 62,000   |       | (71,000  | )          |
| Accrued  liabilities                                                                                   |       | 27,000   |       | 69,000   |       |
|                                                                                                   |       |     |       |     |       |
| Net cash provided by (used in) operating  activities                                                   |       | 178,000  |       | (463,000 | )          |
|                                                                                                   |       |     |       |     |       |
| Cash flows  from investing activities:                                                                 |       |     |       |     |       |
| Capital  expenditures                                                                                  |       | (16,000  | )          | (16,000  | )          |
| Net proceeds  from sale of asset                                                                       |       | 205,000  |       | —   |       |
|                                                                                                   |       |     |       |     |       |
| Net cash provided by (used in) investing  activities                                                   |       | 189,000  |       | (16,000  | )          |
|                                                                                                   |       |     |       |     |       |
| Cash flows from financing activities:                                                                  |       |     |       |     |       |
| Principal  payments on long-term debt                                                                  |       | (219,000 | )          | (13,000  | )          |
|                                                                                                   |       |     |       |     |       |
| Net cash used in financing activities                                                                  |       | (219,000 | )          | (13,000  | )          |
|                                                                                                   |       |     |       |     |       |
| Net increase (decrease) in cash                                                                        |       | 148,000  |       | (492,000 | )          |
| Cash, beginning of period                                                                              |       | 193,000  |       | 532,000  |       |
|                                                                                                   |       |     |       |     |       |
| Cash, end of period                                                                                    |       | $        | 341,000    |     | $          | 40,000 |   |
|                                                                                                   |       |     |       |     |       |
| Supplemental Disclosures of Cash Flow  Information                                                     |       |     |       |     |       |
| Cash paid  during the period for:                                                                      |       |     |       |     |       |
| Interest                                                                                               |       | $        | 33,000     |     | $          | 34,000 |   |
| Income taxes  payable                                                                                  |       | $        | —     |     | $          | — |   |

 

The accompanying notes are anintegral part of these statements.

 

3

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)

 

Note 1 - Basis of Presentation

 

Torotel specializes in the custom design andmanufacture of a wide variety of precision magnetic components, consisting oftransformers, inductors, reactors, chokes and toroidal coils, for use incommercial, industrial and military electronics.  Torotel also designs and distributes ballasttransformers for the airline industry. Approximately 97% of Torotel’s sales are derived from domesticcustomers.  The accompanying unauditedconsolidated financial statements reflect the normal recurring adjustments, aswell as an adjustment to reflect real estate held for sale to the netrealizable value, which in the opinion of management are necessary to presentfairly Torotel’s financial position at July 31, 2005, and the results ofoperations for the three months ended July 31, 2005.

 

The financial statements contained hereinshould be read in conjunction with Torotel’s financial statements and relatednotes filed on Form 10-KSB for the year ended April 30, 2005.

 

Note 2 - Inventories

 

The components of inventories are summarizedas follows:

 
| Raw  materials  |   | $       | 66,000  |   |
|-----------------|--------|---------|---------|--------|
| Work in process |   | 208,000 |    |
| Finished goods  |   | 64,000  |    |
|            |   | $       | 338,000 |   |

 

Note 3 - Employee Stock Options

 

In accordance with the Incentive CompensationPlan approved by shareholders in 1994, Torotel reserved 400,000 common sharesfor issuance to key employees pursuant to the exercise of incentive andnon-qualified stock options granted prior to June 20, 2004.  The options are accounted for under APBOpinion 25, *Accounting for Stock Issued toEmployees*, 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.

 

The fair value of the incentive stock optionsgranted was estimated on the date of grant using the Black-Scholesoptions-pricing model.  The fair value ofthe options was determined using the following weighted average assumptions: nodividend payments over the life of the options; expected volatility of 551.0%;risk-free interest rate of 3.50%; and expected life of five years.

 

Stock option transactions under the 1994Incentive Compensation Plan for each period through July 31 are summarizedas follows:

 

4

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| ** **                                                      | ** ** | **2005**     | ** ** | **2004**     | ** ** |
|-----------------------------------------------------------------|------------|--------------|------------|--------------|------------|
| ** **                                                      | ** ** | **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 information applies to options outstanding for eachperiod through July 31:

 
| ** **                                  | ** ** | **2005**  | ** ** | **2004**  | ** ** |
|---------------------------------------------|------------|-----------|------------|-----------|------------|
| Number outstanding                          |       | 40,000    |       | 40,000    |       |
| Range of exercise prices                    |       | $         | .37        |      | $          | .37 |   |
| Weighted average exercise price             |       | $         | .37        |      | $          | .37 |   |
| Weighted average remaining contractual life |       | 1.25 yrs. |       | 2.25 yrs. |       |

 

Note 4 - Earnings Per Share

 

Statement of Financial Accounting Standards(SFAS) No. 128, *Earnings per Share*,requires dual presentation of basic and diluted EPS on the face of thestatement of earnings regardless of whether basic and diluted EPS are the same;and requires a reconciliation of the numerator and denominator used in computingbasic and diluted EPS.  Basic EPSexcludes dilution and is computed by dividing earnings available to commonstockholders by the weighted average number of common shares outstanding forthe period.  Diluted EPS is computedsimilarly to fully diluted EPS pursuant to APB Opinion 15.  Diluted EPS reflects the potential dilutionthat could occur if securities or other contracts to issue common stock wereexercised or converted into common stock or resulted in the issuance of commonstock that then shared in the earnings of the entity.  Pursuant to SFAS No. 128, the basic anddiluted earnings per common share were computed as follows:

 
| ** **                                  | ** ** | **2005**  | ** ** | **2004**  | ** ** |
|---------------------------------------------|------------|-----------|------------|-----------|------------|
| Net earnings (loss)                         |       | $         | 192,000    |      | $          | (86,000 | ) |
| Weighted average common shares outstanding  |       | 5,111,590 |       | 5,111,590 |       |
| Incremental shares                          |       | —    |       | —    |       |
|                                        |       |      |       |      |       |
| Basic and diluted earnings (loss) per share |       | $         | .04        |      | $          | (.02 | ) |

 

No incremental sharesare included in the 2004 or 2005 EPS calculations for the 40,000 shares underoption since the effect would be anti-dilutive for both periods presented.  There were no anti-dilutive incrementalshares in 2005 because the average market price of the common stock was lessthan the exercise price.

 

5

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Note5 - Amortization of Intangibles

 

Since the acquisition ofElectronika primarily involved the purchase of certain technology-basedintangible assets, annual reviews have been performed to determine the amountof any impairment.  The remaining carryingvalue of these intangible assets is estimated at $754,000 and is supported bythe projected amount recoverable from the selling shareholders of Electronika(the Caloyeras Family Partnership).  Theselling shareholders contractually guaranteed that the aggregate sales fromElectronika’s existing ballast designs over the first five (5) full fiscalyears, specifically fiscal years 2003-2007, would be at least $2,500,000, whichbased on the terms of the Manufacturing Agreement with Magnetika, Inc.,would result in an aggregate gross profit of $1,500,000 before any operatingexpenses.  Aggregate sales since fiscal2003 have been $1,165,000.

 

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

 
| ** **          | ** ** | ** **      | ** ** | **2005**     | ** ** | **2004**         | ** ** |
|---------------------|------------|-----------------|------------|--------------|------------|------------------|------------|
| ** **          | ** ** | **Average**     | ** ** | **Gross**    | ** ** | **Gross**        | ** ** | ** ** | ** ** | ** ** | ** ** |
| ** **          | ** ** | **Amortizable** | ** ** | **Carrying** | ** ** | **Accumulated**  | ** ** | **Carrying** | ** ** | **Accumulated** | ** ** |
| ** **          | ** ** | **Life**        | ** ** | **Amount**   | ** ** | **Amortization** | ** ** | **Amount** | ** ** | **Amortization** | ** ** |
| Aircraft - ballasts |       | 3               |       | $            | 1,148,000  |             | $          | 394,000 |   | $ | 1,148,000 |   | $ | 296,000 |   |
|                     |            |                 |            |              |            |                  |            |  |  |  |  |  |  |  |  |

 

The total intangible amortization expense forthe three months ended July 31, 2005 and 2004 was $16,000 and $9,000,respectively.  The estimated aggregateamortization expense for each of the next two years is as follows:

 
| **April 30,** | ** ** | **Amount** | ** ** |
|--------------------|------------|------------|------------|
| 2006               |       | $          | 63,000     |   |
| 2007               |       | 42,000     |       |
|               |       |       |       |
|               |       | $          | 105,000    |   |

 

Theremaining book value of approximately $665,000 at April 30, 2007,represents the amount recoverable from the former shareholders, and is based onthe estimated sales from the aforementioned ballast designs.

 

Note6 – Stock Appreciation Rights (SARs)

 

OnSeptember 10, 2004, the board of directors of Torotel approved theDirectors 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.  The SARs areaccounted for under Statement of Financial Accounting Standards No. 123, *Accounting for Stock-Based Compensation.*

 

Pursuant to the Plan, 20,000 SARs were grantedon the effective date to each of the three current non-employee directors.  The initial price at which each SAR wasgranted was $.35, which equals the market price of Torotel’s common stock onthe date of grant.  Accordingly, nocompensation cost was recognized at the time of grant, but compensation costswill be recognized in future periods in which the market price of Torotel’scommon stock increases above the grant price.

 

6

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SARs shall automaticallybe granted in the future as follows: (1) each person who is elected as adirector, who was not a director on the effective date of the Plan, shall begranted 10,000 SARs on the date such person is elected a director; and (2) oneach May 1 following the effective date during the term of the Plan, eachperson serving as a director on such date shall be granted 10,000 SARs.    After the initial grant, the price at whicheach SAR is granted shall be the average of the closing price of Torotel’scommon stock for the ten consecutive days immediately preceding the date ofgrant.  Upon exercise of a SAR, Torotelwill pay the grantee an amount (the “Spread”) equal to the excess of theExercise Price over the SAR grant price multiplied by the number of sharesbeing exercised.  The Exercise Priceshall be the average of the closing price of Torotel’s common stock for the tenconsecutive days immediately preceding the notice of exercise.  For any payments that exceed $10,000, Torotelhas the option to make quarterly payments over three years with interestpayable quarterly at the prime rate of Torotel’s primary bank.

 

Each SAR granted hereunder may be exercisedto the extent that the Grantee is vested in such SAR.  The SARs will vest according to the followingschedule:

 
| **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                     | %          |

 

AGrantee shall become fully (100%) vested in each of his or her SARs under thefollowing circumstances:  (i) upontermination of the Grantee’s service as a director of the Company for reasonsof death, disability or retirement; (ii) if the Compensation andNominating Committee (the “Committee”), in its sole discretion, determines thatacceleration of the SAR vesting schedule would be desirable for theCompany; or (iii) if the Company shall, pursuant to action by its Board ofDirectors, at any time propose to merge into, consolidate with, or sell orotherwise transfer all or substantially all of its assets to anothercorporation, and provision is not made pursuant to the terms of suchtransaction for the assumption by the surviving, resulting or acquiringcorporation of outstanding SARs or for substitution of new SARs therefore, theCommittee shall cause written notice of the proposed transaction to be given toeach Grantee not less than twenty days prior to the anticipated effective date ofthe proposed transaction, and his or her SARs shall become fully (100%) vestedand, prior to a date specified in such notice, which shall be not more than tendays prior to the anticipated effective date of the proposed transaction, eachGrantee shall have the right to exercise his or her SARs.

 

Pursuant to the Plan,10,000 SARs were granted on May 1, 2005, at a price of $.302, to each ofthe three current non-employee directors. SARs transactions for each period though July 31 are summarized asfollows:

 

7

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| ** **                                                     | ** ** | **2005**     | ** ** | **2004**    | ** ** |
|----------------------------------------------------------------|------------|--------------|------------|-------------|------------|
| ** **                                                     | ** ** | **Weighted** | ** ** | ** **  | ** ** | **Weighted** | ** ** | ** ** | ** ** |
| ** **                                                     | ** ** | **SARs**     | ** ** | **Average** | ** ** | **SARs** | ** ** | **Average** | ** ** |
| ** **                                                     | ** ** | **Under**    | ** ** | **Grant**   | ** ** | **Under** | ** ** | **Grant** | ** ** |
| ** **                                                     | ** ** | **Option**   | ** ** | **Price**   | ** ** | **Option** | ** ** | **Price** | ** ** |
| Outstanding at beginning of period                             |       | 60,000       |       | $           | .350       |   | — |   | — |   |
| Granted                                                        |       | 30,000       |       | $           | .302       |   | — |   | — |   |
| Exercised                                                      |       | —       |       | —      |       | — |   | — |   |
| Forfeited                                                      |       | —       |       | —      |       | — |   | — |   |
| Outstanding at end of period                                   |       | 90,000       |       | $           | .334       |   | — |   | — |   |
|                                                           |       |         |       |        |       |   |   |   |   |
| SARs exercisable at end of period                              |       | —       |       | —      |       | — |   | — |   |
| Weighted  average fair value of SARs granted during the period |       |         |       | —      |       |   |   | — |   |

 

The following information applies to SARs outstanding for each periodthrough July 31:

 
| ** **                                  | ** ** | **2005**       | ** ** | **2004** | ** ** |
|---------------------------------------------|------------|----------------|------------|----------|------------|
| Number outstanding                          |       | 90,000         |       | —   |       |
| Range of grant prices                       |       | $.302 -  $.350 |       | —   |       |
| Weighted average grant price                |       | $.334          |       | —   |       |
| Weighted average remaining contractual life |       | 9.36 yrs.      |       | —   |       |

 

Note 7 – Gain on Settlement of Debt

 

Otherincome as presented in the accompanying consolidated statements of operationsfor the three months ended July 31, 2005, includes a net gain of $35,000resulting from the settlement of an old liability at an amount lower thanoriginally recorded.

 

Note 8 – Grandview, Missouri Real Estate

 

Priorto moving to Olathe, Kansas in March 2004, Torotel previously occupied atwo-building complex with approximately 29,000 square feet located inGrandview, Missouri.  This property wassplit into two parcels, one consisting of a 24,000 square foot building on a1.72-acre lot (“Lot No. 1”), and the other consisting of a 5,000 squarefoot building on an .88-acre lot (“Lot No. 2”).  On July 20, 2005, Torotel closed on thesale of Lot No. 2 at a contract price of $225,000.  The sale resulted in net proceeds of $205,000and a net gain of $105,000, which is presented in other income in theaccompanying consolidated statements of operations for the three months ended July 31,2005.

 

Torotelhad entered into a real estate contract to sell Lot No. 1 at a grossselling price of $175,000, with closing scheduled for no later than September 1,2005.  Upon completion of the 50-dayinspection period, the buyer rescinded his original offer of $175,000 andcountered at a price of $125,000, which Torotel has accepted in order toeliminate the costs for real estate taxes, property and casualty insurance, andutilities.  Torotel will receive netproceeds from the sale of approximately $112,000, which is below the property’sbook value of $148,000.  As a result,Torotel has recorded an impairment charge of $36,000, which is presented inother expense in the accompanying consolidated statements of operations for thethree months ended July 31, 2005. Closing on the sale is now scheduled for September 16, 2005.

 

Note9 – Concentrations of Credit Risk

 

Atvarious times and at July 31, 2005, Torotel maintained cash in bankbalances that exceed the federally insured limits.

 

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Item2.             Management’sDiscussion and Analysis or Plan of Operation

 

Overview

 

Torotel, Inc.(“Torotel”) conducts business primarily through two wholly owned subsidiaries,Torotel Products, Inc. (“Torotel Products”) and Electronika, Inc. (“Electronika”).  In addition, Torotel has a 15.27% equityinterest in Apex Innovations, Inc. (“Apex”).

 

TorotelProducts designs and manufactures a wide variety of magnetic components for usein 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 aircraftnavigational equipment, voice and data secure communications, medicalequipment, avionics equipment, and conventional missile guidance systems.

 

TorotelProducts markets its components primarily through a 3-person internal salesforce and three independent manufacturers’ representatives paid on a commissionbasis.  In June 2005, TorotelProducts added a design engineer with sales experience (formerly with StandexElectronics) for the purpose of expanding its reach into new markets and/orcustomers.    The plan is to have theengineering department become more active in the sales and marketingefforts.  An incentive program has beendeveloped in this regard for all inside sales and engineering personnel to earna commission on new product sales to existing, as well as new customers.

 

TorotelProducts is an approved source for magnetic components used in numerous militaryand aerospace systems, which means Torotel Products is automatically solicitedfor any procurement needs for such applications.  The magnetic components manufactured byTorotel Products are sold primarily in the United States, and most sales areawarded on a competitive bid basis.  Themarkets in which Torotel Products competes are highly competitive.  A substantial number of companies sellcomponents of the type manufactured and sold by Torotel Products.  In addition, Torotel Products sells to anumber of customers who have the capability of manufacturing their ownelectronic components.  The principalmethods of competition for electronic products in the markets served by TorotelProducts include, among other factors, price, on-time delivery performance,lead times, customized product engineering and technical support, marketingcapabilities, quality assurance, manufacturing efficiency, and existingrelationships with customers’ engineers. While magnetic components are not susceptible to rapid technologicalchange, Torotel Products’ sales, which do not represent a significant share ofthe industry’s market, are susceptible to decline given the highly competitivenature of the market.

 

Electronikais a marketing and licensing company selling ballast transformers to theairline industry.  These transformersactivate and 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-88aircraft.  However, sales of ballasttransformers have been made primarily for use in DC-8 and DC-9 aircraft.  As a result, the business of Electronika issubject to various risks including, without limitation, any decline in use ofthe referenced aircraft, and competition for the available spare

 

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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.  Due to lower than anticipated sales forElectronika, the carrying value of the intangible assets of Electronika is now$754,000.  These intangible assets arebeing partially amortized over the next three fiscal years.  At April 30, 2007, the remaining valueof the intangible assets are expected to be approximately $665,000, which willrepresent the projected amount recoverable pursuant to the sales guaranteeprovided by the selling shareholders of Electronika.  The recoverable amount will reduce the$750,000 note payable to shareholders, who are also the owners ofMagnetika.  Magnetika is a manufacturingcompany that, in addition to the aforementioned ballast transformers,manufacturers various other products similar to those of Torotel for otherunrelated customers.  Magnetika’s annualsales are estimated to be approximately two to three times the annual sales ofTorotel.  Total purchases from Magnetikaby Electronika amounted to $19,000 for the three months ended July 31,2005.

 

Torotel’s management is not involved in thedaily operations of Apex.  Dale H.Sizemore, Jr., Torotel’s chairman and chief executive officer, served as amember of Apex’s board of directors from March 2002 until his resignationin October 2004.  ***i***-**INFO** is Apex’s umbrella term for afoundational system architecture of patented information management softwareproducts created by Apex primarily for government entities.  The success of Apex depends, among otherthings, on its ability to market its products to government entities.  The investment in Apex has no carrying valueon the consolidated balance sheet of Torotel, and in the opinion of Torotelmanagement, it is not likely that any of the investment will be recoveredbecause of Apex’s continued financial losses. If Apex were to become profitable and eventually be sold, any cashrecovered would be recognized as a gain upon receipt of the proceeds.

 

Business Outlook

 

Torotel Products projected an overall increase in new order bookings of 28% for fiscal year 2006.  The rate of new order bookings during the first quarter was up 178%.  The rate for magnetics was up 32%, with the balance of the bookings increase represented by the $1,395,000 contract received for the potted coil assembly in May 2005.  As a result, the order backlog was 42% higher than a year ago.  The primary factors that drive gross profit and net earnings for Torotel Products are sales volume and product mix.  The gross profits on mature products/programs and larger transformer devices tend to be higher than those that are still in the prototyping or early production stages and simpler inductor devices.  As a result, in any given accounting period the mix of product shipments between higher and lower margin jobs has a significant impact on the gross profit and net earnings of Torotel Products.

 

Electronika’s overall sales will continue to be impacted by the decline in the number of active DC-8 and DC-9 aircraft.

 

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Results of Operations

 

The following management comments regardingTorotel’s results of operations and outlook should be read in conjunction withthe Consolidated Financial Statements included pursuant to Item 1 of thisQuarterly Report.

 

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

 

Three Months Ended July 31, 2005 ComparedWith Three Months Ended July 31, 2004

 

Net sales increased 26%.  The net sales of Torotel Products increased nearly 24% from $986,000 to $1,219,000.  This increase is attributable to higher demand for molded coils used in down-hole drilling applications, higher shipments of the potted coil assembly for the Hellfire II missile system, and higher demand from Torotel’s aerospace markets.  The net sales of Electronika increased nearly 167% from $18,000 to $48,000; however, the current quarter’s sales volume is slightly lower than the previous three quarters, which is representative of the downward trend in Electronika’ sales.

 

Grossprofit as a percentage of net sales increased 11%.  The gross profit percentage of TorotelProducts increased 11% because of higher sales volume without a comparableincrease in fixed production costs, and lower labor costs due to higher levelsof overtime and inefficiencies encountered with the training of new productionpersonnel in last year’s quarter, which was in conjunction with the move toOlathe.  Electronika’s gross profit as apercentage of net sales remained unchanged.

 

Engineeringexpenses, applicable only to Torotel Products, increased nearly 10% from$52,000 to $57,000 because of higher payroll costs associated with the hiringof an additional engineer and higher training costs.  Management does anticipate an increase in thepresent level of engineering expenses as additional training costs are planned.

 

Selling,general and administrative (SG&A) expenses increased 23%.  The SG&A expenses of Torotel, Inc.increased 87% from $39,000 to $73,000 primarily because of auditing feesabsorbed in the quarter.  The SG&Aexpenses of Torotel Products increased 14% from $241,000 to $275,000 primarilybecause of higher payroll costs of $10,000, a $5,000 relocation bonus for a newemployee, a $4,000 increase in fast-pay discounts taken by certain majorcustomers, a $4,000 increase in travel costs, a $4,000 increase computersoftware costs, a $4,000 increase in repairs and maintenance costs, and a$3,000 increase in advertising costs. The SG&A expenses of Electronika decreased slightly from $8,000 to$7,000.  Management does anticipate anincrease in the present level of SG&A expenses as additional training costsare planned.

 

Amortizationcosts, entirely attributable to Electronika, increased 78% from $9,000 to$16,000 (see Note 5 of Notes to Consolidated Financial Statements).

 

Interestexpense decreased slightly.  The interestexpense of Torotel, Inc. remained unchanged at $13,000.  The interest expense of Torotel Productsdecreased from $21,000 to $20,000 because of a lower debt balance.

 

Therewas no earnings impact in the current quarter from the investment in Apex.  Equity in loss of investee was $28,000 in theprior year.

 

Impairmentof real estate increased $36,000 due to reducing the book value of the realestate held for sale in Grandview, Missouri to its contracted price, lessestimated selling and closing cost (see Note 8 of Note to ConsolidatedFinancial Statements).

 

Gainon settlement of debt increased because of the $35,000 gain that resulted fromthe settlement of an old liability at an amount lower than originally recorded.

 

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Gainon sale of real estate increased because of the $105,000 net gain that resultedfrom the sale of a portion of the real estate located in Grandview, Missouri(see Note 8 of Notes to Consolidated Financial Statements).

 

Forthe reasons discussed above, the consolidated pretax earnings increased from aloss of $86,000 to a profit of $192,000. The pretax loss of Torotel, Inc. decreased from $80,000 to$51,000.  The pretax earnings of TorotelProducts increased from breakeven to $237,000. The pretax earnings of Electronika increased from a loss of $6,000 to aprofit of $6,000.

 

Liquidity and Capital Resources

 

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

 
| ** **                                           | ** ** | **2005** | ** ** | **2004** | ** ** |
|------------------------------------------------------|------------|----------|------------|----------|------------|
| Net cash provided by (used in) operating  activities |       | $        | 178,000    |     | $          | (463,000 | ) |
| Net cash provided by (used in) investing  activities |       | $        | 189,000    |     | $          | (16,000 | ) |
| Net cash used in financing activities                |       | $        | (219,000   | )        | $          | (13,000 | ) |

 

Net cash used in operating activitiesfluctuates between periods primarily as a result of differences in operatingearnings, the timing of shipments and the collection of accounts receivable,changes in inventory, level of sales and payment of accounts payable.  The increase in net cash provided byinvesting activities is because of the net proceeds of $205,000 from the saleof part of the real estate located in Grandview, Missouri.  Capital expenditures were $16,000 during thefirst quarter of fiscal 2006.  Managementanticipates approximately $50,000 in total capital expenditures for fiscal2006.  Net cash used in financingactivities is because of payments on long-term debt, most of which came fromthe proceeds from the building sale. Management believes that the projected cash flow generated fromoperations, combined with its existing cash balances, will be sufficient tomeet its funding requirements for the foreseeable future.  Torotel does have a $200,000 bank line ofcredit available, which could be utilized to help fund growth, if required.

 

Management believes that inflation will haveonly a minimal effect on future operations since such effects will be offset bysales price increases, which are not expected to have a significant effect upondemand*.*

 

Forward-Looking Information

 

Thisreport, as well as our other reports filed with the Securities and ExchangeCommission (“SEC”), and in press releases and other public communicationsthroughout the year, contains forward looking statements made pursuant to thesafe harbor provisions of The Private Securities Litigation Reform Act of1995.  The words “believe,” “estimate,” “anticipate,”“project,” “intend,” “expect,” “plan,” “outlook,” “forecast,” “may,” “will,” “should,”“continue,” “predict” and similar expressions are intended to identify forwardlooking statements.  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.

 

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These risk factorsinclude: the ability to adequately pass through to customers unanticipatedfuture increases in raw material costs, impairment of intangible assets andinvestments, decreased demand for products, delays in developing new products,expected orders that do not occur, loss of key customers, the impact ofcompetition and price erosion as well as supply and manufacturing constraints,and other risks and uncertainties.  In lightof these risks and uncertainties, there can be no assurance that theforward-looking information contained in this report will prove accurate, andour actual results may differ materially from these forward lookingstatements.  We assume no obligation toupdate any forward-looking statements made herein.

 

Item 3.             Controlsand Procedures

 

Torotel’sChief Executive Officer and Chief Financial Officer (collectively, the “CertifyingOfficers”) are responsible for establishing and maintaining disclosure controlsand procedures (as defined in Exchange Act Rule 13a-15(e)) forTorotel.  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 adequate and effective for purposes of Rule 13a-14(c) intimely alerting them to material information relating to Torotel required to beincluded in Torotel’s filings with the SEC under the Securities Exchange Act of1934.  The Certifying Officers also haveindicated that there were no changes during the period covered by this reportin Torotel’s internal controls over financial reporting or other factors thathave materially affected, or are reasonably likely to materially affect suchcontrols, and there were no corrective actions with regard to significantdeficiencies and material weaknesses.

 

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PART II.                         OTHERINFORMATION

 

Item6.   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)                                Reportson Form 8-K                                       Therewas one report filed on Form 8-K during the three months ended July 31,2005.

 

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SIGNATURES

 

In accordance with the requirements of theSecurities Exchange Act of 1934, the Registrant has duly caused this report tobe signed on its behalf by the undersigned, thereunto duly authorized.

 

 

Torotel, Inc.

(Registrant)

 

 
| /s/ Dale H. Sizemore, Jr. |                   |   |
|--------------------------------|------------------------|--------|
| Dale H. Sizemore, Jr.     |                   |
| Chief Executive Officer        |                   |
| Date:                          | September 9, 2005 |   |
|                           |                   |
|                           |                   |
| /s/ H. James Serrone           |                   |   |
| H. James Serrone               |                   |
| Chief Financial Officer        |                   |
| Date:                          | September 9, 2005 |   |
|                                |                        |        |  |  |

 

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