Table of Contents

 

 

 

**UNITEDSTATES SECURITIES AND EXCHANGE COMMISSION**

**Washington,D.C.  20549**

 

**FORM 10-Q**

 

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

 

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

 

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

 

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

 

**CommissionFile No. 1-8125**

 

**TOROTEL,INC.**

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

 

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

 

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

(Address ofprincipal executive offices)

 

**(913)747-6111**

(Issuer’stelephone number)

 

**NONE**

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

 

Indicate by check markwhether the registrant (1) has filed all reports required to be filed by Section 13or 15(d) of the Securities Exchange Act of 1934 during the preceding 12months, and (2) has been subject to such filing requirements for the past90 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 September 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 Balance Sheets as of July 31, 2008  and April 30, 2008                  | 1                                                                                           |
|                                                                                           |                                                                                        |
| Consolidated  Statements of Operations for the three months ended July 31, 2008 and  2007 | 2                                                                                           |
|                                                                                           |                                                                                        |
| Consolidated  Statements of Cash Flows for the three months ended July 31, 2008 and  2007 | 3                                                                                           |
|                                                                                           |                                                                                        |
| Notes  to Consolidated Financial Statements                                                    | 4                                                                                           |
|                                                                                           |                                                                                        |   |
| Item 2.                                                                                        | Management’s  Discussion and Analysis of Financial Condition and Results of Operations | 10     |
|                                                                                           |                                                                                        |   |
| Item 4T.                                                                                       | Controls and  Procedures                                                                    | 16     |
|                                                                                           |                                                                                        |
| PART II.                                                                                  | OTHER INFORMATION                                                                           |   |
|                                                                                           |                                                                                        |
| Item 6.                                                                                        | Exhibits                                                                                    | 17     |
|                                                                                           |                                                                                        |
| SIGNATURES                                                                                     | 18                                                                                          |
|                                                                                                |                                                                                             |        |  |

 

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**PART I.     FINANCIAL INFORMATION**

 

**Item1.       Financial Statements**

 

**CONSOLIDATEDBALANCE SHEETS**

 
| ** **                                 | ** ** | **(Unaudited)**                   | ** ** | **(Audited)**                      | ** ** |
|--------------------------------------------|------------|-----------------------------------|------------|------------------------------------|------------|
| ** **                                 | ** ** | **As of July 31,** | ** ** | **As of April 30,** | ** ** |
| ** **                                 | ** ** | **2008**                          | ** ** | **2008**                           | ** ** |
| ASSETS                                     |       |                              |       |                               |       |
|                                       |       |                              |       |                               |       |
| Current assets:                            |       |                              |       |                               |       |
| Cash                                       |       | $                                 | 449,000    |                               | $          | 410,000 |   |
| Trade  receivables, net                    |       | 901,000                           |       | 775,000                            |       |
| Inventories                                |       | 758,000                           |       | 551,000                            |       |
| Prepaid expenses  and other current assets |       | 68,000                            |       | 23,000                             |       |
|                                       |       | 2,176,000                         |       | 1,759,000                          |       |
|                                       |       |                              |       |                               |       |
| Property, plant  and equipment, net        |       | 1,043,000                         |       | 1,022,000                          |       |
|                                       |       |                              |       |                               |       |
| Other assets                               |       | 2,000                             |       | 2,000                              |       |
|                                       |       |                              |       |                               |       |
|                                       |       | $                                 | 3,221,000  |                               | $          | 2,783,000 |   |
|                                       |       |                              |       |                               |       |
| LIABILITIES AND  STOCKHOLDERS’ EQUITY |       |                              |       |                               |       |
|                                       |       |                              |       |                               |       |
| Current  liabilities:                      |       |                              |       |                               |       |
| Current  maturities of long-term debt      |       | $                                 | 74,000     |                               | $          | 64,000 |   |
| Trade accounts  payable                    |       | 535,000                           |       | 342,000                            |       |
| Accrued  liabilities                       |       | 264,000                           |       | 186,000                            |       |
|                                       |       | 873,000                           |       | 592,000                            |       |
|                                       |       |                              |       |                               |       |
| Long-term debt,  less current maturities   |       | 647,000                           |       | 647,000                            |       |
|                                       |       |                              |       |                               |       |
| Stockholders’  equity                 |       | 1,701,000                         |       | 1,544,000                          |       |
|                                       |       |                              |       |                               |       |
|                                       |       | $                                 | 3,221,000  |                               | $          | 2,783,000 |   |

 

The accompanyingnotes are an integral part of these statements.

 

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**CONSOLIDATEDSTATEMENTS OF OPERATIONS (Unaudited)**

 
| ** **                                         | ** ** | **Three Months Ended** | ** ** |
|----------------------------------------------------|------------|----------------------------------|------------|
| ** **                                         | ** ** | **July 31,**                | ** ** | **July 31,** | ** ** |
| ** **                                         | ** ** | **2008**                         | ** ** | **2007** | ** ** |
| Net sales                                          |       | $                                | 1,971,000  |   | $ | 1,406,000 |   |
| Cost of goods  sold                                |       | 1,212,000                        |       | 874,000 |   |
|                                               |       |                             |       |   |   |
| Gross profit                                       |       | 759,000                          |       | 532,000 |   |
|                                               |       |                             |       |   |   |
| Operating  expenses:                               |       |                             |       |   |   |
| Engineering                                        |       | 98,000                           |       | 65,000 |   |
| Selling, general  and administrative               |       | 505,000                          |       | 505,000 |   |
|                                               |       | 603,000                          |       | 570,000 |   |
|                                               |       |                             |       |   |   |
| Earnings (loss)  from operations                   |       | 156,000                          |       | (38,000 | ) |
|                                               |       |                             |       |   |   |
| Other expense:                                     |       |                             |       |   |   |
| Interest expense                                   |       | 14,000                           |       | 15,000 |   |
| Other, net                                         |       | 1,000                            |       | — |   |
|                                               |       | 15,000                           |       | 15,000 |   |
|                                               |       |                             |       |   |   |
| Earnings (loss)  before provision for income taxes |       | 141,000                          |       | (53,000 | ) |
|                                               |       |                             |       |   |   |
| Provision for  income taxes                        |       | —                           |       | — |   |
|                                               |       |                             |       |   |   |
| Net earnings  (loss)                               |       | $                                | 141,000    |   | $ | (53,000 | ) |
|                                               |       |                             |       |   |   |
| Basic earnings  (loss) per share                   |       | $                                | .03        |   | $ | (.01 | ) |
|                                               |       |                             |       |   |   |
| Diluted earnings  (loss) per share                 |       | $                                | .02        |   | $ | (.01 | ) |

 

The accompanyingnotes are an integral part of these statements.

 

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**CONSOLIDATEDSTATEMENTS OF CASH FLOWS (Unaudited)**

 
| ** **                                                                                  | ** ** | **Three Months Ended** | ** ** |
|---------------------------------------------------------------------------------------------|------------|----------------------------------|------------|
| ** **                                                                                  | ** ** | **July 31,**                | ** ** | **July 31,** | ** ** |
| ** **                                                                                  | ** ** | **2008**                         | ** ** | **2007** | ** ** |
| Cash flows from  operating activities:                                                      |       |                             |       |   |   |
| Net earnings  (loss)                                                                        |       | $                                | 141,000    |   | $ | (53,000 | ) |
| Adjustments to  reconcile net earnings (loss) to net cash provided by operating activities: |       |                             |       |   |   |
| Loss on disposal  of assets                                                                 |       | 1,000                            |       | — |   |
| Stock  compensation earned                                                                  |       | 16,000                           |       | 3,000 |   |
| Depreciation                                                                                |       | 25,000                           |       | 23,000 |   |
| Change in value  of stock appreciation rights                                               |       | (3,000                           | )          | (1,000 | ) |
| Increase  (decrease) in cash flows from operations resulting from changes in:               |       |                             |       |   |   |
| Trade receivables                                                                           |       | (126,000                         | )          | 158,000 |   |
| Inventories                                                                                 |       | (207,000                         | )          | (35,000 | ) |
| Prepaid expenses  and other assets                                                          |       | (45,000                          | )          | (55,000 | ) |
| Trade accounts  payable                                                                     |       | 193,000                          |       | 71,000 |   |
| Accrued  liabilities                                                                        |       | 81,000                           |       | 52,000 |   |
|                                                                                        |       |                             |       |   |   |
| Net cash  provided by operating activities                                                  |       | 76,000                           |       | 163,000 |   |
|                                                                                        |       |                             |       |   |   |
| Cash flows from  investing activities:                                                      |       |                             |       |   |   |
| Capital  expenditures                                                                       |       | (20,000                          | )          | (12,000 | ) |
|                                                                                        |       |                             |       |   |   |
| Net cash used in  investing activities                                                      |       | (20,000                          | )          | (12,000 | ) |
|                                                                                        |       |                             |       |   |   |
| Cash flows from  financing activities:                                                      |       |                             |       |   |   |
| Principal  payments on long-term debt                                                       |       | (16,000                          | )          | (14,000 | ) |
| Payments on  capital lease obligations                                                      |       | (1,000                           | )          | — |   |
|                                                                                        |       |                             |       |   |   |
| Net cash used in  financing activities                                                      |       | (17,000                          | )          | (14,000 | ) |
|                                                                                        |       |                             |       |   |   |
| Net increase in  cash                                                                       |       | 39,000                           |       | 137,000 |   |
| Cash, beginning  of period                                                                  |       | 410,000                          |       | 247,000 |   |
|                                                                                        |       |                             |       |   |   |
| Cash, end of  period                                                                        |       | $                                | 449,000    |   | $ | 384,000 |   |
|                                                                                        |       |                             |       |   |   |
| Supplemental  Disclosures of Cash Flow Information                                          |       |                             |       |   |   |
| Cash paid during  the period for:                                                           |       |                             |       |   |   |
| Interest                                                                                    |       | $                                | 16,000     |   | $ | 15,000 |   |
| 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 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 98% of Torotel’s sales duringthe first three months of fiscal 2009 have been derived from domesticcustomers.

 

**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 July 31, 2008, and the results ofoperations for the three months ended July 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 $50,000 are included in cost of goodssold in the accompanying consolidated statement of operations for the threemonths ended July 31, 2008, with a corresponding decrease in selling,general and administrative expenses.  Inorder to fairly present the comparative results for the three months ended July 31,2007, management has reclassified $51,000 of selling, general andadministrative expenses to cost of goods sold.

 

**Note 4 –Inventories**

 

The components ofinventories are summarized as follows:

 
| ** **                                         | ** ** | **July 31,** | ** ** | **April 30,** | ** ** |
|----------------------------------------------------|------------|-------------------|------------|--------------------|------------|
| ** **                                         | ** ** | **2008**          | ** ** | **2008**           | ** ** |
| Raw materials                                      |       | $                 | 784,000    |               | $          | 669,000 |   |
| Work in process                                    |       | 259,000           |       | 173,000            |       |
| Finished goods                                     |       | 80,000            |       | 84,000             |       |
|                                               |       | 1,123,000         |       | 926,000            |       |
| Less: reserve  for obsolete and excess inventories |       | 365,000           |       | 375,000            |       |
|                                               |       | $                 | 758,000    |               | $          | 551,000 |   |

 

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**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 or litigationprocesses, 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 of thedate of adoption, the income tax positions taken or expected to be taken forthe open tax years are appropriately stated and supported for all open years,and the adoption of FIN 48 did not have a material effect on Torotel’sconsolidated financial statements.  Opentax years are April 30, 2004, 2005, 2006 and 2007.  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 July 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.

 

A RestrictedStock Agreement was entered into between Torotel and Benjamin E. Ames, Jr.on July 31, 2006, as part of Mr. Ames’ employment as Executive VicePresident of Torotel Products, Inc. with primary responsibilities beingnew business development.  The amount ofthe restricted stock award was 200,000 shares of common stock, $.01 par valueper share.  Based upon Mr. Amesattaining mutually agreed upon written annual goals, the restricted sharesshall be released from the restrictions on transfer and risk of forfeiture inthe amount of 40,000 shares per year for five years beginning July 31,2007, and each anniversary thereof. Based on the market price of $.30 for Torotel’s common stock as of July 31,2006, the fair value of the restricted stock at the date of award was$60,000.  The restricted shares aretreated as non-vested stock pursuant to SFAS 123(R) and are classified asunearned stock compensation in the accompanying consolidated balance sheetunder stockholders’ equity.  Stockcompensation cost during the three months ended July 31, 2008 was$3,000.  Stock compensation cost of$3,000 per quarter will be recorded during the aggregate five-year vestingperiod provided the mutually agreed upon goals are achieved.  As of July 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

 

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Form 10-KSBon July 30, 2007, the restricted stock awards have a five (5) yearrestriction period, which shall lapse based on certain conditions as outlinedin the SAP.  The Restricted StockAgreements afford the grantees all of the rights of a stockholder with respectto the award shares, including the right to vote such shares and to receivedividends and other distributions payable with respect to such shares since theDate of Award.  The aggregate amount ofthe restricted stock awards outstanding as of July 31, 2008, was 526,750shares of common stock, $.01 par value per share.  Based on the market price of $.50 for Torotel’scommon stock at the date of award, the fair value of the restricted stock outstandingwas $263,375 as of July 31, 2008. The restricted shares are treated as non-vested stock pursuant to SFAS123(R) and are classified as unearned stock compensation in theaccompanying consolidated balance sheet under stockholders’ equity.  Stock compensation cost during the threemonths ended July 31, 2008 was $13,168.75. Stock compensation cost of $13,168.75 will be recorded per quarterduring the remaining five-year vesting period provided the financialperformance metrics as outlined in 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 three month period through July 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                             |       | —         |       | —       |       | — |   | — |   |
| Vested                              |       | (40,000        | )          | $            | .300       |   | (40,000 | ) | $ | .300 |   |
| Forfeited                           |       | —         |       | —       |       | — |   | — |   |
| Outstanding at  end of period       |       | 646,750        |       | $            | .463       |   | 185,000 |   | $ | .320 |   |

 

**Note 7 –Stockholders’ Equity**

 

The components ofstockholders’ equity are summarized as follows:

 
| ** **                      | ** ** | **July 31,  2008** | ** ** | **April 30,  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    |       | (247,000           | )          | (263,000            | )          |
| Accumulated  deficit            |       | (10,635,000        | )          | (10,776,000         | )          |
|                            |       | 1,791,000          |       | 1,634,000           |       |
| Less treasury  stock, at cost   |       | 90,000             |       | 90,000              |       |
|                            |       | $                  | 1,701,000  |                | $          | 1,544,000 |   |

 

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

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

 

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**Note8 – Earnings Per Share**

 

Statement of FinancialAccounting Standards (SFAS) No. 128, *Earningsper Share*, requires dual presentation of basic and diluted EPS on theface 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 is computed similarly to fully diluted EPS pursuant to APBOpinion 15.  Diluted EPS reflects thepotential dilution that could occur if securities or other contracts to issuecommon stock were exercised or converted into common stock or resulted in theissuance of common stock that then shared in the earnings of the entity.  The 646,750 shares issued and outstanding pursuantto the Restricted Stock Agreements (see Note 6 of Notes to ConsolidatedFinancial Statements) meet the definition of contingently issuable shares asoutlined in SFAS No. 128; as a result, these shares will not be includedin the basic EPS calculation until the performance measurements have beensatisfied.  The restricted shares aretreated as a common stock 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)                                         |       | $         | 141,000    |      | $          | (53,000 | ) |
|                                                         |       |      |       |      |       |
| Weighted average  common shares outstanding for basic EPS    |       | 5,192,025 |       | 5,152,025 |       |
| Incremental  shares for the effect of restricted stock       |       | 686,315   |       | —    |       |
| Weighted average  common shares outstanding for dilutive EPS |       | 5,878,340 |       | 5,152,025 |       |
|                                                         |       |      |       |      |       |
| Basic earnings  (loss) per share                             |       | $         | .03        |      | $          | (.01 | ) |
|                                                         |       |      |       |      |       |
| Diluted earnings  (loss) per share                           |       | $         | .02        |      | $          | (.01 | ) |

 

No incrementalshares are included in the 2007 EPS calculations for the 160,000 shares ofrestricted common stock since the effect would be anti-dilutive.

 

**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 Plan is 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 equaledthe market price of Torotel’s common stock on the date of grant.  Accordingly, no compensation cost wasrecognized at the time of grant in accordance with APB Opinion 25, prior to theadoption of SFAS No. 123(R) on May 1, 2006.

 

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

 

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Plan, each person serving as a director on such dateshall be granted 10,000 SARs.  After the initialgrant, the price at which each SAR is granted shall be the average of theclosing price of Torotel’s common stock for the ten consecutive daysimmediately preceding the date of grant. Upon exercise of a SAR, Torotel will 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 NominatingCommittee (the “Committee”), in its sole discretion, determines thatacceleration of the 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 July 31,2008, the fair value of the SARs was determined usingthe following assumptions: no dividend payments over the life of the SARs sinceTorotel has not issued any form of dividend since 1985; an expected volatilityof 175.3% based on Torotel’s historical volatility using the weekly closingprice over the past 3.00 years; a risk-free interest rate of 3.50%; and anexpected 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       |                | $          | .350       |       | 100                 | %          | $             | 21,000     |   | $ | 3,000 |   |
| May 1, 2005      |       | 30,000     |       | $            | .302       |                | $          | .354       |       | 100                 | %          | $             | 11,000     |   | $ | 3,000 |   |
| May 1, 2006      |       | 30,000     |       | $            | .695       |                | $          | .332       |       | 67                  | %          | $             | 7,000      |   | $ | — |   |
| May 1, 2007      |       | 30,000     |       | $            | .500       |                | $          | .342       |       | 33                  | %          | $             | 3,000      |   | $ | — |   |
| June 4,  2007    |       | 10,000     |       | $            | .412       |                | $          | .347       |       | 33                  | %          | $             | 1,000      |   | $ | — |   |
| May 1, 2008      |       | 40,000     |       | $            | .550       |                | $          | .339       |       | 0                   | %          | $             | —     |   | $ | — |   |

 

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The vested portionrepresents 123,300 SARs.  As of July 31,2008, the total aggregate intrinsic value of these exercisable SARs was $6,000.

 

SARs transactions for each three month period through July 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       |   | 70,200 |   | $ | .385 |   |
| Weighted average  fair value of SARs granted during the period |       |       |       | $            | .339       |   |   |   | $ | .324 |   |

 

The following informationapplies to SARs outstanding for each three month period through July 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 |       | 7.73 yrs.     |       | 8.22 yrs.     |       |

 

Total compensationexpense for the outstanding SARs for the three months ended July 31, 2008 and2007 was a credit of $3,000 and $1,000, respectively.  As of July 31, 2008, there was $26,000of total unrecognized compensation expense related to non-vested SARs grantedunder the Plan.  That cost is expected tobe recognized over a weighted average period of 1.02 years.  The liability for SARs on the consolidatedbalance sheet as of July 31, 2008, was $43,000.

 

**Note 10 –****Concentrations ofCredit 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 $100,000 bythe Federal Deposit Insurance Corporation. At various times and at July 31, 2008, these cash balances exceedfederally insured limits.  Torotel hasnot experienced any losses in such accounts. Management does not believe Torotel is exposed to any significant creditrisk with respect to its cash and cash equivalents.

 

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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 nearly $650,000 in neworders have been received.  These orders,as well as follow-on orders for the same assemblies, should contribute tohigher revenue levels in fiscal 2009.

 

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.  As a result, the business of Electronika issubject to various risks including, without limitation, any decline in

 

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use of the referenced aircraft, and competition for the available spareparts business.  Electronika’s sales donot represent a significant portion of any particular market.

 

Electronika’s requirements for the ballasttransformers are outsourced pursuant to a Manufacturing Agreement withMagnetika, Inc. (“Magnetika”), a corporation owned by the 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$8,000 for the three months ended July 31, 2008.

 

*Business Outlook*

 

Management believes the business outlook for fiscal2009 remains very positive.  As of July 31,2008, the order backlog is nearly $5.0 million. This amount is comprised of nearly $3.0 million for the potted coilassembly, $1.5 million in magnetic components and $500,000 inelectro-mechanical assemblies.  New orderbookings during the first three months of fiscal 2009 increased 15% compared tothe same period last year.  Managementbelieves new order bookings in fiscal 2009 should increase 10-15%.

 

The industry mix of Torotel Products’ net sales forthe first three months of fiscal 2009 was 37% industrial, 33% military and 30% aerospacecompared to 45% defense, 40% aerospace and 15% industrial for the same periodlast year.   This shift toward industrialfollows the trend expected for fiscal 2009. Management believes the mix in fiscal 2009 should shift more towardindustrial and defense primarily because of an electro-mechanical assembly fora new customer application, higher demand for the potted coil assembly for theHellfire II missile system and another electro-mechanical assembly for a newmilitary application.  Management alsobelieves the aerospace segment will continue to be a strong market for current productsalthough production delays for Boeing’s new 787 will push more deliveries ofmagnetic components to Torotel’s fiscal 2010. Torotel’s management will continue to focus its efforts in areas andsolutions that offer significant growth, which includes continued expansion ofthe product base beyond 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.

 

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.

 

Management believes Torotel is well-positioned toachieve its goal of $9 million in sales revenue for fiscal 2009.  The order backlog remains solid and othersignificant contract awards for magnetic components, 

 

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the potted coil assembly and electro-mechanical assemblies areanticipated during the year.  Whether $9million is actually shipped depends upon (i) Torotel’s receipt of anticipatedcontract awards in a timely fashion, and (ii) minimal changes in customers’expected quantity and delivery requirements.

 

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

 

*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.

 

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

 

Consolidated net sales increased 40%. The net sales of Torotel Products increased 40% from $1,394,000 to $1,950,000.  This increase is primarily attributable to thenew ballast assembly contract for a major industrial application and higher demand for molded coils used indown-hole drilling applications and other magnetic components.  Thenet sales of Electronika increased 75% from $12,000 to $21,000, which is consistentwith the sales volume expected from Electronika.

 

Consolidated gross profit as a percentage of net sales increased nearly 1%.  The gross profit percentage of TorotelProducts increased nearly 1% because of higher sales volume.  The effect of the higher volume was offsetpartially by a higher material content associated with the product mix.  Electronika’s gross profit as a percentage ofnet sales remained unchanged.

 

Engineering expenses, applicable only to Torotel Products, increased 51% from$65,000 to $98,000  because of a $22,000increase in payroll costs primarily associated with engineering college internsemployed this summer, a $5,000 increase in travel costs and a $5,000 increasein training costs.  Management anticipatesa decrease in the present level of engineering expenses during the next fewquarters as nearly all of the interns have returned to school.

 

Consolidated selling, general and administrative (SG&A) expenses remainedunchanged.  The SG&A expenses ofTorotel decreased 23% from $154,000 to $118,000 primarily because of a $45,000 decreasein  professional fees, a $2,000 decreasein directors fees and a $2,000 decrease in the value of stock appreciationrights.  These decreases were offsetpartially by a $13,000 increase in auditing fees.  The SG&A expenses of Torotel Productsincreased 10% from $351,000 to $387,000 primarily because of a $27,000 increasein payroll costs, a $26,000 increase in sales commissions, a $14,000 increasein IT costs, a $13,000 increase in stock compensation costs and a $3,000increase in costs of supplies.  These increaseswere offset partially by a $47,000 decrease in training 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, decreased 7%because of a lower debt level.

 

For the reasons discussed above, the consolidated pretax earningsincreased from a loss of $53,000 to a profit of $141,000.  The pretax loss of Torotel decreased from $154,000to $118,000.  The pretax earnings 

 

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ofTorotel Products increased from $94,000 to $246,000.  The pretax earnings of Electronika increasedfrom $7,000 to $13,000.

 

**Liquidityand Capital Resources**

 

As of July 31, 2008,Torotel had $449,000 in cash and cash equivalents compared to $410,000 as of April 30,2008 and $384,000 as of July 31, 2007.  Management expects cash flow from operationsto improve during fiscal 2009 given the current shippable backlog position andthe higher sales volume expected throughout fiscal 2009.

 

The table below presentsthe summary of cash flow for the fiscal periods indicated.

 
| ** **                                 | ** ** | **2008** | ** ** | **2007** | ** ** |
|--------------------------------------------|------------|----------|------------|----------|------------|
| Net cash  provided by operating activities |       | $        | 76,000     |     | $          | 163,000 |   |
| Net cash used in  investing activities     |       | $        | (20,000    | )        | $          | (12,000 | ) |
| Net cash used in  financing activities     |       | $        | (17,000    | )        | $          | (14,000 | ) |

 

 

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 $20,000 of cash usedin investing activities was the result of capital expenditures.  Management anticipates approximately $50,000 ofcapital expenditures during the remainder of fiscal 2009.  The $17,000 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$200,000 bank line of credit available, which could be utilized to help fundany 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.  For the fiscal years ended April 30,2006,  2007 and 2008, Torotel’s ROCE was19.04%, -.66% and 12.25%, respectively. Torotel’s ROCE for the 12-month trailing period ended July 31, 2008was 21.24%.

 

**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 instrumentsthat potentially subject Torotel to concentrations of credit risk consistprincipally of cash and accounts receivable. Torotel grants unsecured credit to substantially all of itscustomers.  Management does not believethat it is exposed to any extraordinary credit risk as a result of this policy.  Torotel deposits all monies at the Bank ofBlue Valley.  These accounts are securedup to $100,000 by the Federal Deposit Insurance Corporation.  At various times and at July 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 and cash equivalents.

 

*Fair Value of Financial Instruments*

 

Cost approximates marketfor all financial instruments as of July 31, 2008 and 2007.

 

*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-delivery method).  Torotel’sconsolidated net sales arising from contracts having deliveries scheduled overa period of more than one year for the three month periods ended July 31,2008 and 2007, were approximately 17% and 25%, respectively, because of thecontracts for the potted 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 currently andhistorically approximates the first-in, first-out method.  Torotel’s industry is characterized by short-termcustomer commitments and changes in demand, as well as other marketconsiderations.  Provisions for estimatedobsolete and excess inventory are based on reviews of inventory usage,quantities on hand and latest product demand information from customers.  Inventories are reviewed utilizing a 12-monthtime horizon.  Individual part numbersthat have not had any usage in a 12-month time period are categorized asobsolete; individual part numbers having more than a 12-month supply based onthe current year’s usage are categorized as excess.  The reserve balance is analyzed for adequacyalong with the inventory review each quarter.

 

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*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 thestraight-line method over estimated useful lives of three to five years forproperty and equipment, 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 the use of fairvalue measurement, which is consistent with the FASB’s long-term measurementobjectives for accounting for financial instruments.  Most of the provisions of this Statementapply 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.

 

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

 

**Item 4T.    Controls and Procedures**

 

*Evaluationof Disclosure Controls and Procedures*

 

Torotel’smanagement, with the participation of the Chief Executive Officer and ChiefFinancial Officer, has evaluated the effectiveness of Torotel’s disclosurecontrols and procedures, as such term is defined in Rules 13a-15(e) and15d-15(e) under the Securities Exchange Act of 1934, as amended (the “ExchangeAct”), as of the end of the period covered by this report.  Based on such evaluation, these officers haveconcluded that Torotel’s disclosure controls and procedures are effective toprovide reasonable assurance that information required to be disclosed inperiodic filings under the Exchange Act is accumulated and communicated tomanagement, including those officers, and to members of the Board of Directors,to allow timely decisions regarding required disclosure.

 

*Changesin Internal Controls*

 

Therewere no significant changes in Torotel’s internal controls over financialreporting or in other factors that in management’s estimates are reasonablylikely to materially affect Torotel’s internal controls over financialreporting subsequent to the date of the evaluation.

 

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**PART II.   OTHER INFORMATION**

 

**Item6.   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:   September 15, 2008 |   |
|                                      |   |
|                                      |   |
| /s/ H. James Serrone                      |   |
| H. James Serrone                          |   |
| Chief Financial Officer                   |   |
| Date:   September 15, 2008 |   |

 

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