**UNITEDSTATES SECURITIES AND EXCHANGE COMMISSION**

**Washington,D.C.  20549**

 

**FORM 10-QSB**

 

| **x**                                                                                        | **QUARTERLY REPORT UNDER SECTION 13 OR  15(d) OF THE SECURITIES EXCHANGE ACT OF 1934**  |
|----------------------------------------------------------------------------------------------|---------------------------------------------------------------------------------------------------|
| ** **                                                                                   | ** **                                                                                        |
| **For the quarter ended October 31, 2007**                                              |
|                                                                                         |
| **o**                                                                                        | **TRANSITION REPORT UNDER SECTION 13 OR  15(d) OF THE SECURITIES EXCHANGE ACT OF 1934** |
| ** **                                                                                   | ** **                                                                                        |
| **For the transition period from [    ]  to [    ]** |

 

**Commission File No. 1-8125**

 

**TOROTEL,INC.**

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

 

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

 

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

(Address of principal executive offices)

 

**(913) 747-6111**

(Issuer’s telephone number)

 

**NONE**

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

 

Check whether the issuer (1) 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 x   No o

 

Checkwhether the issuer is a shell company (as defined in Rule 12b-2 of theExchange Act.)

 

Yes o   No x

 

Asof December 12, 2007, there were 5,878,340 shares of Common Stock, $.01par value, outstanding.

 

Transitionalsmall business format:  Yes o   No x

 

 

----

 

TOROTEL, INC. AND SUBSIDIARIES

 

INDEX

 
| PART I.                                                                                      | FINANCIAL INFORMATION                                           |   |
|---------------------------------------------------------------------------------------------------|-----------------------------------------------------------------|--------|
|                                                                                              |                                                            |
| Item  1.                                                                                          | Financial Statements                                            |   |
|                                                                                              |                                                            |
| Consolidated Balance Sheet  as of October 31, 2007                                           | 1                                                               |
|                                                                                              |                                                            |
| Consolidated  Statements of Operations for the six months  ended October 31, 2007 and 2006   | 2                                                               |
|                                                                                              |                                                            |
| Consolidated  Statements of Operations for the three months  ended October 31, 2007 and 2006 | 3                                                               |
|                                                                                              |                                                            |
| Consolidated  Statements of Cash Flows for the six months  ended October 31, 2007 and 2006   | 4                                                               |
|                                                                                              |                                                            |
| Notes  to Consolidated Financial Statements                                                       | 5                                                               |
|                                                                                              |                                                            |
| Item  2.                                                                                          | Management’s Discussion and  Analysis or Plan of Operation | 13     |
|                                                                                              |                                                            |
| Item 3.                                                                                           | Controls and  Procedures                                        | 21     |
|                                                                                              |                                                            |
| PART II.                                                                                     | OTHER INFORMATION                                               |   |
|                                                                                              |                                                            |
| Item 4.                                                                                           | Submission of  Matters to a Vote of Security Holders            | 22     |
|                                                                                              |                                                            |
| Item  6.                                                                                          | Exhibits                                                        | 23     |
|                                                                                              |                                                            |
| SIGNATURES                                                                                        | 24                                                              |
|                                                                                                   |                                                                 |        |  |  |  |

 

----

 

**PART I.   FINANCIALINFORMATION**

 

**Item 1.    FinancialStatements**

 

**CONSOLIDATED BALANCE SHEET (Unaudited)**

Asof October 31, 2007

 
| ASSETS                                    |   |      |      |
|-------------------------------------------|--------|-----------|-----------|
|                                      |   |      |      |
| Current assets:                           |   |      |      |
| Cash                                      |   | $         | 149,000   |   |
| Accounts receivable, net                  |   | 823,000   |      |
| Inventories                               |   | 499,000   |      |
| Prepaid expenses and other current assets |   | 59,000    |      |
|                                      |   | 1,530,000 |      |
|                                      |   |      |      |
| Property, plant and equipment, net        |   | 1,008,000 |      |
|                                      |   |      |      |
| Other assets                              |   | 6,000     |      |
|                                      |   |      |      |
|                                      |   | $         | 2,544,000 |   |
|                                      |   |      |      |
| LIABILITIES AND STOCKHOLDERS’ EQUITY |   |      |      |
|                                      |   |      |      |
| Current liabilities:                      |   |      |      |
| Current maturities of long-term debt      |   | $         | 61,000    |   |
| Trade accounts payable                    |   | 296,000   |      |
| Accrued liabilities                       |   | 200,000   |      |
|                                      |   | 557,000   |      |
|                                      |   |      |      |
| Long-term debt, less current maturities   |   | 680,000   |      |
|                                      |   |      |      |
| Stockholders’ equity                 |   | 1,307,000 |      |
|                                      |   |      |      |
|                                      |   | $         | 2,544,000 |   |
|                                           |        |           |           |  |  |

 

The accompanying notes are an integral part of this statement.

 

1

----

 

**CONSOLIDATED STATEMENTS OF OPERATIONS (Unaudited)**

SixMonths Ended October 31,

 
|                                                                                            |   | **2007**  | ** ** | **2006**  |   |
|-------------------------------------------------------------------------------------------------|--------|-----------|------------|-----------|--------|
| Net sales                                                                                       |   | $         | 3,049,000  |      | $      | 2,486,000 |   |
| Cost of goods sold                                                                              |   | 1,799,000 |       | 1,565,000 |   |
|                                                                                            |   |      |       |      |   |
| Gross profit                                                                                    |   | 1,250,000 |       | 921,000   |   |
|                                                                                            |   |      |       |      |   |
| Operating expenses:                                                                             |   |      |       |      |   |
| Engineering                                                                                     |   | 131,000   |       | 129,000   |   |
| Selling, general and administrative                                                             |   | 1,128,000 |       | 942,000   |   |
| Amortization of intangible assets                                                               |   | —    |       | 11,000    |   |
|                                                                                            |   | 1,259,000 |       | 1,082,000 |   |
|                                                                                            |   |      |       |      |   |
| Loss from operations                                                                            |   | (9,000    | )          | (161,000  | )      |
|                                                                                            |   |      |       |      |   |
| Other expense (income):                                                                         |   |      |       |      |   |
| Interest expense                                                                                |   | 31,000    |       | 57,000    |   |
| Interest income                                                                                 |   | —    |       | (5,000    | )      |
|                                                                                            |   | 31,000    |       | 52,000    |   |
|                                                                                            |   |      |       |      |   |
| Loss before provision for income taxes and cumulative effect of  change in accounting principle |   | (40,000   | )          | (213,000  | )      |
|                                                                                            |   |      |       |      |   |
| Provision for income taxes                                                                      |   | —    |       | —    |   |
|                                                                                            |   |      |       |      |   |
| Loss before cumulative effect of change in accounting principle                                 |   | (40,000   | )          | (213,000  | )      |
|                                                                                            |   |      |       |      |   |
| Cumulative effect of change in accounting principle                                             |   | —    |       | 8,000     |   |
|                                                                                            |   |      |       |      |   |
| Net loss                                                                                        |   | $         | (40,000    | )         | $      | (205,000 | ) |
|                                                                                            |   |      |       |      |   |
| Basic loss per share:                                                                           |   |      |       |      |   |
| Before cumulative effect                                                                        |   | $         | (.01       | )         | $      | (.04 | ) |
| Cumulative effect                                                                               |   | —    |       | —    |   |
|                                                                                            |   | $         | (.01       | )         | $      | (.04 | ) |
| Diluted loss per share:                                                                         |   |      |       |      |   |
| Before cumulative effect                                                                        |   | $         | (.01       | )         | $      | (.04 | ) |
| Cumulative effect                                                                               |   | —    |       | —    |   |
|                                                                                            |   | $         | (.01       | )         | $      | (.04 | ) |

 

The accompanying notes are an integral part of these statements.

 

2

----

 

**CONSOLIDATED STATEMENTS OF OPERATIONS (Unaudited)**

ThreeMonths Ended October 31,

 
|                                              |   | **2007** | ** ** | **2006** |   |
|---------------------------------------------------|--------|----------|------------|----------|--------|
| Net sales                                         |   | $        | 1,643,000  |     | $      | 1,287,000 |   |
| Cost of goods sold                                |   | 976,000  |       | 764,000  |   |
|                                              |   |     |       |     |   |
| Gross profit                                      |   | 667,000  |       | 523,000  |   |
|                                              |   |     |       |     |   |
| Operating expenses:                               |   |     |       |     |   |
| Engineering                                       |   | 66,000   |       | 65,000   |   |
| Selling, general and administrative               |   | 572,000  |       | 496,000  |   |
| Amortization of intangible assets                 |   | —   |       | 4,000    |   |
|                                              |   | 638,000  |       | 565,000  |   |
|                                              |   |     |       |     |   |
| Earnings (loss) from operations                   |   | 29,000   |       | (42,000  | )      |
|                                              |   |     |       |     |   |
| Other expense (income):                           |   |     |       |     |   |
| Interest expense                                  |   | 16,000   |       | 30,000   |   |
| Interest income                                   |   | —   |       | (3,000   | )      |
|                                              |   | 16,000   |       | 27,000   |   |
|                                              |   |     |       |     |   |
| Earnings (loss) before provision for income taxes |   | 13,000   |       | (69,000  | )      |
|                                              |   |     |       |     |   |
| Provision for income taxes                        |   | —   |       | —   |   |
|                                              |   |     |       |     |   |
| Net earnings (loss)                               |   | $        | 13,000     |     | $      | (69,000 | ) |
|                                              |   |     |       |     |   |
| Basic earnings (loss) per share                   |   | $        | .00        |     | $      | (.01 | ) |
|                                              |   |     |       |     |   |
| Diluted earnings (loss) per share                 |   | $        | .00        |     | $      | (.01 | ) |

 

The accompanying notes are an integral part of these statements.

 

3

----

 

**CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited)**

SixMonths Ended October 31,

 
|                                                                                       |   | **2007**   | ** ** | **2006**   |   |
|--------------------------------------------------------------------------------------------|--------|------------|------------|------------|--------|
| Cash flows from operating activities:                                                      |   | ** ** | ** ** | ** ** |   |
| Net loss                                                                                   |   | $          | (40,000    | )          | $      | (205,000 | ) |
| Adjustments to reconcile net loss to net cash provided by (used in)  operating activities: |   |       |       |       |   |
| Cost recognized on cancellation of restricted stock                                        |   | 33,000     |       | —     |   |
| Stock compensation earned                                                                  |   | 21,000     |       | 3,000      |   |
| Depreciation                                                                               |   | 44,000     |       | 43,000     |   |
| Amortization                                                                               |   | —     |       | 11,000     |   |
| Change in value of stock appreciation rights                                               |   | 15,000     |       | 1,000      |   |
| Increase (decrease) in cash flows from operations resulting from  changes in:              |   |       |       |       |   |
| Accounts receivable                                                                        |   | (70,000    | )          | 48,000     |   |
| Inventories                                                                                |   | (64,000    | )          | 22,000     |   |
| Prepaid expenses and other assets                                                          |   | (46,000    | )          | (28,000    | )      |
| Trade accounts payable                                                                     |   | 87,000     |       | 47,000     |   |
| Accrued liabilities                                                                        |   | (17,000    | )          | (25,000    | )      |
|                                                                                       |   |       |       |       |   |
| Net cash used in operating activities                                                      |   | (37,000    | )          | (83,000    | )      |
|                                                                                       |   |       |       |       |   |
| Cash flows from investing activities:                                                      |   |       |       |       |   |
| Capital expenditures                                                                       |   | (33,000    | )          | (22,000    | )      |
|                                                                                       |   |       |       |       |   |
| Net cash used in investing activities                                                      |   | (33,000    | )          | (22,000    | )      |
|                                                                                       |   |       |       |       |   |
| Cash flows from financing activities:                                                      |   |       |       |       |   |
| Proceeds from exercise of incentive stock options                                          |   | —     |       | 15,000     |   |
| Principal payments on long-term debt                                                       |   | (28,000    | )          | (31,000    | )      |
|                                                                                       |   |       |       |       |   |
| Net cash used in financing activities                                                      |   | (28,000    | )          | (16,000    | )      |
|                                                                                       |   |       |       |       |   |
| Net increase in cash                                                                       |   | (98,000    | )          | (121,000   | )      |
| Cash, beginning of period                                                                  |   | 247,000    |       | 521,000    |   |
|                                                                                       |   |       |       |       |   |
| Cash, end of period                                                                        |   | $          | 149,000    |       | $      | 400,000 |   |
|                                                                                       |   |       |       |       |   |
| Supplemental Disclosures of Cash Flow Information Cash paid during  the period for:        |   |       |       |       |   |
| Interest                                                                                   |   | $          | 31,000     |       | $      | 57,000 |   |
| Income taxes payable                                                                       |   | $          | —     |       | $      | — |   |

 

The accompanying notes are an integral part of these statements.

 

4

----

 

**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)**

 

**Note 1 – Nature of Operations**

 

Torotelspecializes in the custom design and manufacture of a wide variety of precisionmagnetic components, consisting of transformers, inductors, reactors, chokesand toroidal coils, for use in commercial, industrial and militaryelectronics.  Torotel also designs anddistributes ballast transformers for the airline industry.  Approximately 93% of Torotel’s sales duringthe first six months of fiscal 2008 have been derived from domestic customers.

 

**Note 2 – Basis of Presentation**

 

Theaccompanying unaudited consolidated financial statements reflect the normalrecurring adjustments which in the opinion of management are necessary topresent fairly Torotel’s financial position at October 31, 2007, and theresults of operations for the three and six months ended October 31, 2007.

 

Thefinancial statements contained herein should be read in conjunction withTorotel’s financial statements and related notes filed on Form 10-KSB forthe year ended April 30, 2007.

 

**Note 3 – Inventories**

 

Thecomponents of inventories are summarized as follows:

 
| Raw materials                                     |   | $       | 638,000 |   |
|---------------------------------------------------|--------|---------|---------|--------|
| Work in process                                   |   | 138,000 |    |
| Finished goods                                    |   | 95,000  |    |
|                                              |   | 871,000 |    |
| Less: reserve for obsolete and excess inventories |   | 372,000 |    |
|                                              |   | $       | 499,000 |   |

 

**Note 4 – Income Taxes**

 

EffectiveMay 1, 2007, Torotel adopted the provisions of Financial AccountingStandards Board Interpretation No. 48 (“FIN 48”), *Accounting for Uncertainty in Income Taxes - anInterpretation of FASB No. 109,*which clarified the accounting for uncertainty in tax positions*.* FIN 48 prescribes a recognition threshold and measurement attribute forthe financial statement recognition and measurement of a tax position taken orexpected to be taken in a tax return.  Itis management’s responsibility to determine whether it is more likely than notthat a tax position will be sustained upon examination, including resolution ofany related appeals or litigation processes, based on the technical merits ofthe position.  Any resulting cumulativeeffect of applying the provisions of FIN 48 upon adoption would be reported asan adjustment to the beginning balance of retained earnings and an adjustmentto tax liabilities in the period of adoption. Based on a third-party review of prior year federal and state taxreturns, Torotel had no unrecognized tax benefits as of May 1, 2007, the incometax positions taken or expected to be taken for the open tax years areappropriately stated and supported for all open years, and the adoption of FIN48 did not have a material effect on Torotel’s consolidated financialstatements for the six months ended October 31, 2007.  Open tax years are April 30, 2003, 2004,2005 and 2006.

 

5

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Torotelwould recognize interest and penalties accrued on unrecognized tax benefits aswell as interest received from favorable tax settlements within income taxexpense.  At the adoption date of May 1,2007, and as of October  31, 2007, Torotel recorded no accrued interest orpenalties related to uncertain tax positions. Management expects no significant change in the amount of unrecognizedtax benefit, accrued interest or penalties within the next twelve months.

 

**Note 5 –Share-Based Compensation**

 

Effective May 1, 2006, Toroteladopted the fair value recognition provisions of Statement of FinancialAccounting Standards No. 123 (revised 2004), “Share-Based Payment”(SFAS 123(R)) using the modified prospective method of adoption under theprovisions of SFAS No. 148, *Accountingfor Stock-Based Compensation – Transition and Disclosure*.  Prior to May 1, 2006, Torotel accountedfor all stock option grants under the provisions of APB Opinion 25, *Accounting for Stock Issued to Employees*and related interpretations; and accounted for all grants involving stockappreciation rights (SARs) under the provisions of SFAS 123 using the intrinsicvalue measurement guidelines of APB Opinion 25. The adoption of SFAS 123(R) on existing stock option grants did nothave any impact on Torotel’s financial condition or results of operations forthe six months ended October 31, 2006; the adoption of SFAS 123(R) forthe SARs resulted in a cumulative effect reduction in stock compensation costsof $8,000 for the same six-month period.

 

**Note 6 – Employee Stock Options**

 

Inaccordance with the Incentive Compensation Plan approved by shareholders in1994, Torotel reserved 400,000 common shares for issuance to key employeespursuant to the exercise of incentive stock options granted prior to June 20,2004.  The incentive stock options had aterm of five years when issued and vested 50% per year at the end of each ofthe first two years.  The exercise priceof each option equaled the market price of Torotel’s common stock on the dateof grant.  Accordingly, no compensationcost was recognized for the Plan at the time of grant, and no cost was incurredfrom the adoption of SFAS 123(R) as the outstanding options were fullyvested in 2004.

 

Thefair values of the options granted were estimated on the date of grant usingthe Black-Scholes options-pricing model. The fair value of the incentive stock options was determined using thefollowing weighted average assumptions: no dividend payments over the life ofthe options; expected volatility of 551.0%; risk-free interest rate of 3.50%;and expected life of five years.

 

Thereare no outstanding stock options as of October 31, 2007.  Stock option transactions for the periodended October 31, 2006,  aresummarized as follows:

 
| ** **                         | ** ** | **2006**     | ** ** |
|------------------------------------|------------|--------------|------------|
| ** **                         | ** ** | **Weighted** | ** ** | ** ** | ** ** |
| ** **                         | ** ** | **Shares**   | ** ** | **Average** | ** ** |
|                               |       | **Under**    | ** ** | **Exercise** |   |
|                               |       | **Option**   | ** ** | **Price** |   |
| Outstanding at beginning of period |       | 40,000       |       | $ | .37 |   |
| Granted                            |       | —       |       | — |   |
| Exercised                          |       | (40,000      | )          | $ | .37 |   |
| Forfeited                          |       | —       |       | — |   |
| Outstanding at end of period       |       | —       |       | — |   |

 

6

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**Note 7 – Restricted Stock Agreements**

 

Restricted Stock Agreements are authorized by theCompensation and Nominating Committee (“Committee”) and the Board of Directorsof Torotel.  The Committee and the Boardhave determined that the interests of Torotel and its stockholders will bepromoted by hiring talented individuals and, to induce such individuals to acceptemployment with Torotel, the Committee and the Board believe a key component ofsuch individuals’ compensation should be granting equity ownershipopportunities based upon the acceptance of employment and the continuingemployment of such individual, subject to certain conditions and restrictions.

 

Effective July 31, 2006, a Restricted StockAgreement was entered into between Torotel and Benjamin E. Ames, Jr., aspart of Mr. Ames’ employment as Executive Vice President of TorotelProducts, Inc., with primary responsibilities being new businessdevelopment.  The amount of therestricted stock award was 200,000 shares of common stock, $.01 par value pershare.  Based upon Mr. Amesattaining mutually agreed upon written annual goals, the restricted shares shallbe released from the restrictions on transfer and risk of forfeiture in theamount of 40,000 shares per year for five years beginning July 31, 2007,and each anniversary thereof.  Based onthe 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.  Of this amount, $2,000 was credited to commonstock at par value and the excess of $58,000 was credited to additionalpaid-in capital.  The restrictedshares are treated as non-vested stock pursuant to SFAS 123(R).  Accordingly, an offset amount, classified asunearned stock compensation, is included in the accompanying consolidatedbalance sheet under stockholders’ equity. Stock compensation cost of $3,000 per quarter will be recorded duringthe aggregate five-year vesting period provided the mutually agreed upon goalsare achieved.  As of October 31,2007, 40,000 shares have been released from the restrictions on transfer.

 

A Restricted Stock Agreement having a measurementdate of February 12, 2007, was entered into between Torotel and E. MarkFlynn, as part of Mr. Flynn’s employment as Vice President of Torotel Products, Inc.,with primary responsibilities being supply chain management anddevelopment.  The amount of the restrictedstock award was 25,000 shares of common stock, $.01 par value per share.  Based on the market price of $.45 for Torotel’scommon stock as of February 12, 2007, the fair value of the restrictedstock at the date of award was $11,250. Of this amount, $250 was credited to common stock at par value and theexcess of $11,000 was credited to additional paid-in capital.  Mr. Flynn’s employment was terminated onOctober 26, 2007.  Stockcompensation cost of $1,687.50 had been recognized during the employmentperiod; upon termination, the remaining unearned cost of $9,562.50 wasrecognized at the time of termination and the 25,000 shares were transferred totreasury stock.

 

On August 7, 2007,Restricted Stock Agreements were entered into between Torotel and 13 keyemployees pursuant to the Stock Award Plan (“SAP”).  The SAP provides key employees theopportunity to acquire common stock of Torotel pursuant to awards earned foraccomplishing goals that promote the long-term financial performance ofTorotel.  Under the terms of the SAP,which was filed as Exhibit 10.9 on Form 10-KSB on July 30, 2007,the restricted stock awards have a five (5) year restriction period, whichshall lapse based on certain conditions as outlined in the SAP.  The Restricted Stock Agreements afford thegrantees all of the rights of a stockholder with respect to the award shares,including the right to vote such shares and to receive dividends and otherdistributions payable with respect to such shares since the Date of Award.  The aggregate amount of the restricted stockawards was 575,750 shares of common stock, $.01 par value per share.  Based on the market price of $.50 for Torotel’scommon stock as of August 7, 2007, the fair value of the restricted stockat the date of award was $287,875.  Ofthis amount, $5,757.50 was

 

7

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credited to common stock at par value and the excessof $282,117.50 was credited to additional paid-in capital. The restrictedshares are treated as non-vested stock pursuant to SFAS 123(R).  Accordingly, an offset amount, classified asunearned stock compensation, is included in the accompanying consolidatedbalance sheet under stockholders’ equity. Stock compensation cost of $14,393.75 was recorded during the threemonths ended October 31, 2007.  Thisamount included $1,225 associated with the 49,000 restricted shares that wereissued to E. Mark Flynn as one of the 13 key employees.  Going forward, $13,168.75 of stockcompensation cost will be recorded per quarter during the remaining five-yearvesting period provided the financial performance metrics as outlined in theSAP are likely to be attained.  Theunearned cost of $23,275 for the 49,000 shares held by Mr. Flynn wasrecognized at the time of his termination and the 49,000 shares weretransferred to treasury stock.

 

Under the terms of each agreement, the non-vestedshares are restricted as to disposition and subject to forfeiture under certaincircumstances.  The agreements providethe employee with all voting 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.

 

Restrictedstock activity for each period through October 31 is summarized asfollows:

 
|                               |   | **2007**       | ** ** | **2006**     |       |
|------------------------------------|--------|----------------|------------|--------------|------------|
|                               |   | **Restricted** | ** ** | **Weighted** | ** ** | **Restricted** | ** ** | **Weighted** |   |
|                               |   | **Shares**     | ** ** | **Average**  | ** ** | **Shares** | ** ** | **Average** |   |
|                               |   | **Under**      | ** ** | **Grant**    | ** ** | **Under** | ** ** | **Grant** |   |
|                               |   | **Option**     | ** ** | **Price**    | ** ** | **Option** | ** ** | **Price** |   |
| Outstanding at beginning of period |   | 225,000        |       | $            | .317       |   | — |   | — |   |
| Granted                            |   | 575,750        |       | $            | .500       |   | 200,000 |   | $ | .300 |   |
| Vested                             |   | (40,000        | )          | $            | .300       |   | — |   | — |   |
| Forfeited                          |   | (74,000        | )          | $            | .483       |   | — |   | — |   |
| Outstanding at end of period       |   | 686,750        |       | $            | .453       |   | 200,000 |   | $ | .300 |   |

 

**Note 8 – Stockholders’ Equity**

 

Thecomponents of stockholders’ equity are summarized as follows:

 
| Common stock, at par value     |   | $           | 60,000    |   |
|--------------------------------|--------|-------------|-----------|--------|
| Capital in excess of par value |   | 12,613,000  |      |
| Unearned stock compensation    |   | (295,000    | )         |
| Accumulated deficit            |   | (10,981,000 | )         |
|                           |   | 1,397,000   |      |
| Less treasury stock, at cost   |   | 90,000      |      |
|                           |   | $           | 1,307,000 |   |

 

Torotel has 6,000,000 shares of common stock, $.01par value, authorized and 5,878,340 shares issued and outstanding.  The changes in shares of common stockoutstanding are summarized as follows:

 
| Balance, May 1, 2007      |   | 5,376,590 |   |
|--------------------------------|--------|-----------|--------|
| Restricted stock activity      |   | 575,750   |   |
| Treasury stock activity        |   | (74,000   | )      |
| Balance, October 31, 2007 |   | 5,878,340 |   |

 

8

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**Note 9 – Earnings Per Share**

 

Statementof Financial Accounting Standards (SFAS) No. 128, *Earnings per Share*, requires dualpresentation of basic and diluted EPS on the face of the statement ofoperations.  It also requires areconciliation of the numerator and denominator used in computing basic anddiluted EPS.  Basic EPS excludes dilutionand is computed by dividing earnings available to common stockholders by theweighted average number of common shares outstanding for the period.  Diluted EPS is computed similarly to fully dilutedEPS pursuant to APB Opinion 15.  DilutedEPS reflects the potential dilution that could occur if securities or othercontracts to issue common stock were exercised or converted into common stockor resulted in the issuance of common stock that then shared in the earnings ofthe entity.  The 686,750 shares issuedand outstanding pursuant to the Restricted Stock Agreements (see Note 7 ofNotes to Consolidated Financial Statements) meet the definition of contingentlyissuable shares as outlined in SFAS No. 128; as a result, these shareswill not be included in the basic EPS calculation until the performancemeasurements have been satisfied.  Therestricted shares are treated as a common stock equivalent for the diluted EPScalculation.  Pursuant to SFAS No. 128,the basic and diluted earnings per common share were computed as follows:

 

# **Year-to-DateEPS Calculations**

# ** **

| ** **                                                          | **2007**  | ** ** | **2006**  | ** ** |
|---------------------------------------------------------------------|-----------|------------|-----------|------------|
| Loss before cumulative effect                                       | $         | (40,000    | )         | $          | (213,000 | ) |
| Cumulative effect                                                   | —    |       | 8,000     |       |
| Net loss                                                            | $         | (40,000    | )         | $          | (205,000 | ) |
|                                                                |      |       |      |       |
| Weighted average common shares outstanding for basic EPS            | 5,169,796 |       | 5,116,373 |       |
| Incremental shares for effect of stock options and restricted stock | —    |       | —    |       |
| Weighted average common shares outstanding for dilutive EPS         | 5,169,796 |       | 5,116,373 |       |
|                                                                |      |       |      |       |
| Basic and diluted loss per share:                                   |      |       |      |       |
| Before cumulative effect                                            | $         | (.01       | )         | $          | (.04 | ) |
| Cumulative effect                                                   | —    |       | —    |       |
|                                                                | $         | (.01       | )         | $          | (.04 | ) |

 

Noincremental shares are included in the 2007 EPS calculations for the 686,750shares of restricted common stock since the effect would be anti-dilutive.  No incremental shares are included in the2006 EPS calculations for the 40,000 shares under option or the 200,000 sharesof restricted common stock since the effect would be anti-dilutive.

 

# **QuarterlyEPS Calculations**

 
|                                                                |   | **2007**  | ** ** | **2006**  |   |
|---------------------------------------------------------------------|--------|-----------|------------|-----------|--------|
| Net earnings (loss)                                                 |   | $         | 13,000     |      | $      | (69,000 | ) |
|                                                                |   |      |       |      |   |
| Weighted average common shares outstanding for basic EPS            |   | 5,187,568 |       | 5,121,155 |   |
| Incremental shares for effect of stock options and restricted stock |   | 720,918   |       | —    |   |
| Weighted average common shares outstanding for dilutive EPS         |   | 5,908,486 |       | 5,121,155 |   |
|                                                                |   |      |       |      |   |
| Basic earnings (loss) per share                                     |   | $         | .00        |      | $      | (.01 | ) |
|                                                                |   |      |       |      |   |
| Diluted earnings (loss) per share                                   |   | $         | .00        |      | $      | (.01 | ) |

 

9

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Noincremental shares are included in the 2006 EPS calculations for the 40,000shares under option or the 200,000 shares of restricted common stock since theeffect would be anti-dilutive.

 

**Note 10 – Stock Appreciation Rights**

 

On September 10, 2004, the board ofdirectors of Torotel approved the Directors Stock Appreciation Rights Plan (the“Plan”) for non-employee directors.  EachSAR is equal to one share of common stock of Torotel, and the aggregate numberof SARs that may be granted under the Plan shall not exceed 500,000. Theeffective date of the Plan is October 1, 2004.  The SARs are now accounted for under SFAS No. 123(R),*Accounting for Stock-Based Compensation.*

 

Pursuantto the Plan, 20,000 SARs were granted on the effective date to each of thethree current non-employee directors serving at that time.  The initial price at which each SAR wasgranted was $.35, which equaled the market price of Torotel’s common stock onthe date of grant.  Accordingly, nocompensation cost was recognized at the time of grant in accordance with APBOpinion 25, prior to the adoption of SFAS No. 123(R) on May 1,2006, as discussed in Note 5 of Notes to Consolidated Financial Statements.

 

SARs shall automatically be granted inthe future as follows: (1) each person who is elected as a director, whowas not a director on the effective date of the Plan, shall be granted 10,000SARs on the date such person is elected a director; and (2) on each May 1following the effective date during the term of the Plan, each person servingas 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 exercised to theextent that the Grantee is vested in such SAR. The SARs will vest according to the following schedule:

 
| **Number  of Years the Grantee has remained** | ** ** | **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 Torotel for reasons ofdeath, 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

 

10

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writtennotice of the proposed transaction to be given to each Grantee not less thantwenty days prior to the anticipated effective date of the proposedtransaction, and his or her SARs shall become fully (100%) vested and, prior toa date specified in such notice, which shall be not more than ten days prior tothe anticipated effective date of the proposed transaction, each Grantee shallhave the right to exercise his or her SARs.

 

In accordance with SFAS 123(R),compensation expense is recognized over the vesting period based upon theestimated fair value of the SARs pursuant to the terms of the Plan using theBlack-Scholes options-pricing model as of the end of each financial reportingperiod.  As of October 31,2007, thefair value of the SARs was determined using the following assumptions: nodividend payments over the life of the SARs since Torotel has not issued anyform of dividend since 1985; an expected volatility of 175.85% based on Torotel’shistorical volatility using the weekly closing price over the past 3.75 years;a risk-free interest rate of 4.00%; and an expected life of 3.75 years based onthe length of service estimated to be served. Based on these assumptions, the fair value prices per share of theoutstanding 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       |            | $          | .427       |       | 100             | %          | $             | 26,000     |   | $ | 7,000 |   |
| May 1, 2005     |       | 30,000     |       | $            | .302       |            | $          | .430       |       | 67              | %          | $             | 9,000      |   | $ | 5,000 |   |
| May 1, 2006     |       | 30,000     |       | $            | .695       |            | $          | .414       |       | 33              | %          | $             | 4,000      |   | $ | — |   |
| May 1, 2007     |       | 30,000     |       | $            | .500       |            | $          | .421       |       | 0               | %          | $             | —     |   | $ | — |   |
| June 4, 2007    |       | 10,000     |       | $            | .412       |            | $          | .424       |       | 0               | %          | $             | —     |   | $ | — |   |

 

Thevested portion represents 90,000 SARs. As of October 31, 2007, the total aggregate intrinsic value ofthese exercisable SARs was $12,000.

 

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

 
|                                                          |   | **2007**   | ** ** | **2006**     | ** ** |
|---------------------------------------------------------------|--------|------------|------------|--------------|------------|
|                                                          |   | ** ** | ** ** | **Weighted** | ** ** | ** ** | ** ** | **Weighted** | ** ** |
|                                                          |   | **SARs**   | ** ** | **Average**  | ** ** | **SARs** | ** ** | **Average** | ** ** |
|                                                          |   | **Under**  | ** ** | **Grant**    | ** ** | **Under** | ** ** | **Grant** | ** ** |
|                                                          |   | **Option** | ** ** | **Price**    | ** ** | **Option** | ** ** | **Price** | ** ** |
| Outstanding at beginning of period                            |   | 120,000    |       | $            | .424       |   | 90,000 |   | $ | .334 |   |
| Granted                                                       |   | 40,000     |       | $            | .478       |   | 30,000 |   | $ | .695 |   |
| Exercised                                                     |   | —     |       | —       |       | — |   | — |   |
| Forfeited                                                     |   | —     |       | —       |       | — |   | — |   |
| Outstanding at end of period                                  |   | 160,000    |       | $            | .438       |   | 120,000 |   | $ | .424 |   |
|                                                          |   |       |       |         |       |   |   |   |   |
| SARs exercisable at end of period                             |   | 90,000     |       | $            | .378       |   | 50,100 |   | $ | .334 |   |
| Weighted average fair value of SARs granted during the period |   |       |       | $            | .422       |   |   |   | $ | .642 |   |

 

Thefollowing information applies to SARs outstanding for each period through October 31:

 
|                                        |   | **2007**       | ** ** | **2006**       |   |
|---------------------------------------------|--------|----------------|------------|----------------|--------|
| Number outstanding                          |   | 160,000        |       | 120,000        |   |
| Range of grant prices                       |   | $.302  - $.695 |       | $.302  - $.695 |   |
| Weighted average grant price                |   | $.438          |       | $.424          |   |
| Weighted average remaining contractual life |   | 7.97  yrs.     |       | 8.46  yrs.     |   |

 

11

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Totalcompensation expense for the outstanding SARs for the six months ended October 31,2007 and 2006, was $15,000 and zero, respectively.  The amount for 2006 was net of an $8,000reduction for the cumulative effect of adopting SFAS No. 123(R).  Total compensation expense for the outstandingSARs for the three months ended October 31, 2007 and 2006, was $16,000 and$15,000, respectively.  As of October 31,2007, there was $29,000 of total unrecognized compensation expense related tonon-vested SARs granted under the Plan. That cost is expected to be recognized over a weighted average period of1.01 years.  The liability for SARs onthe consolidated balance sheet as of October 31, 2007, was $38,000.

 

**Note 11– Related Party Event**

 

The purchase option settlement agreementwith the Caloyeras Family Partnership, filed as Exhibit 10.1 on Form 8-Kon April 20, 2007, and incorporated herein by reference, expired on July 31,2007.  The litigation that was part ofthe settlement agreement can be re-filed as a result of the expiration.

 

**Note 12– Concentrations of Credit Risk**

 

Financial instruments that potentiallysubject Torotel to concentrations of credit risk consist principally of cashand accounts receivable.  Torotel grantsunsecured credit to substantially all of its customers.  Management does not believe that it isexposed 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 October 31,2007, 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.

 

**Note****13 –****Financing Agreement**

 

OnSeptember 30, 2007, Torotel Products renewed its $200,000 revolving creditagreement with Bank of Blue Valley. Advances under the credit line are limited to 75% of eligible billedreceivables.  The revolving line iscollateralized by the land and buildings in Olathe, Kansas.  Under the terms of the agreement, theoutstanding balance of the revolving line bears interest at 1.25% over the bank’scorporate base rate and has a maturity date of September 30, 2008.  As of October 31, 2007, the effectiveborrowing rate was 8.75% and the entire credit line was available.

 

12

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**Item 2.Management’s Discussionand Analysis or Plan of Operation**

 

*Overview*

 

Torotel conducts businessprimarily through two wholly owned subsidiaries, Torotel Products andElectronika.  In addition, Torotel has a12.88% equity interest in Apex.

 

Torotel Products designsand manufactures a wide variety of magnetic components for use in military,aerospace and industrial electronic applications.  These magnetic components, which consist oftransformers, inductors, reactors, chokes, and toroidal coils, are used tomodify and control electrical voltages and currents in electronic devices.  For example, if equipment containing one ofthese components receives an electrical voltage or current which is too highfor proper operation of the equipment, the component would modify and controlthe electrical voltage or current to allow proper operation of the equipment.  While Torotel Products primarily manufacturesthe components in accordance with pre-developed mechanical and electricalrequirements, in some cases it will be responsible for both the overall designand manufacture of the components.  Themagnetic components are sold to manufacturers who incorporate them into anend-product.  The major applicationsinclude aircraft navigational equipment, voice and data secure communications,medical equipment, avionics equipment, and conventional missile guidance systems.

 

Torotel Products marketsits components primarily through a 4-person internal sales force, whichincludes a Vice President of Business Development that was hired in July 2006,and five independent manufacturers’ representatives paid on a commissionbasis.  Torotel Products also utilizesits 4-person engineering department in its direct sales efforts for the purposeof expanding its reach into new markets and/or customers.

 

Torotel Products is anapproved source for magnetic components used in numerous military and aerospacesystems, which means Torotel Products is automatically solicited for anyprocurement needs for such applications. The magnetic components manufactured by Torotel Products are soldprimarily in the United States, and most sales are awarded on a competitive bidbasis.  The markets in which TorotelProducts competes are highly competitive. A substantial number of companies sell components of the type manufacturedand sold by Torotel Products.  Inaddition, Torotel Products sells to a number of customers who have thecapability of manufacturing their own electronic components.  The principal methods of competition forelectronic products in the markets served by Torotel Products include, among otherfactors, price, on-time delivery performance, lead times, customized productengineering and technical support, marketing capabilities, quality assurance,manufacturing efficiency, and existing relationships with customers’engineers.  While magnetic components arenot susceptible to rapid technological change, Torotel Products’ sales, whichdo not represent a significant share of the industry’s market, are susceptibleto decline given the competitive nature of the market.

 

Electronika is amarketing and licensing company selling ballast transformers to the airlineindustry.  These transformers activateand control the lights in commercial airplane cockpits.  Electronika’s ballast transformers areapproved as spare and replacement parts in DC-8, DC-9, DC-10, MD-80 and MD-88aircraft; however, sales of ballast transformers have been made primarily foruse in DC-8 and DC-9 aircraft.  As aresult, the business of Electronika is subject to various risks including,without limitation, any decline in use of the referenced aircraft, andcompetition for the available spare parts business.  Electronika’s sales do not represent asignificant portion of any particular market.

 

13

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Electronika’s requirements for theballast transformers are outsourced pursuant to a Manufacturing Agreement withMagnetika, a corporation owned by the Caloyeras 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.  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$11,000 for the six months ended October 31, 2007.

 

*BusinessOutlook*

 

The sales mix for thefirst half of fiscal 2008 was 53% defense, 34% aerospace and 13%commercial/industrial.  Managementbelieves that the mix in fiscal 2008 should shift more toward defense as higherdemand for the potted coil assembly for the Hellfire II missile system isprojected.  In addition, managementbelieves expanded selling and marketing efforts within our existing majorcustomer base should yield a number of opportunities in new militaryprograms.  Management also believes theaerospace segment should continue to be a strong market, especially with themajor suppliers of the Boeing 787 Dreamliner and the 737 series.  New order bookings in the first half offiscal 2008 increased 32% over the prior year period, exclusive of the $2.1million contract for the potted coil assembly awarded in last year’s firsthalf.  Management does anticipate anothercontract for the potted coil assembly to be awarded within the next few weeks,and continues to project an overall increase in new order bookings of 13% forfiscal 2008.  The primary factors thatdrive gross profit and net earnings for Torotel Products are sales volume andproduct mix.  The gross profits on matureproducts/programs and larger transformer devices tend to be higher than thosethat are still in the prototyping or early production stages and simplerinductor devices.  As a result, in anygiven accounting period the mix of product shipments between higher and lowermargin jobs has a significant impact on the gross profit and net earnings ofTorotel Products.

 

Torotel’s operating plancalled for additional sales and marketing costs in the form of personnel and/orcommissions and trade show exhibits. Management has also invested more training dollars toward workforcedevelopment as part of the ongoing efforts to improve Torotel’s processes andvalue streams.  Management believes awell developed growth strategy is in place and that going forward, some or allof these expenditures will be necessary on a continuing basis in order toachieve the desired growth.  Futureannual earnings will continue to be impacted by increased auditing costsassociated with complying with SEC regulations and the standards of the PublicCompany Accounting Oversight Board (United States) and Sarbanes-Oxley Section 404compliance.  Torotel’s management willcontinue to focus its efforts in areas and solutions that they believe offersignificant growth, which includes expanding the product base beyond electroniccomponents.  The aircraft manufacturerscontinue to book orders at a record pace with substantial backlog through atleast the end of the decade; Torotel will continue to expand its sales andmarketing efforts in this area.  Management’s goal continues to be “9-by-9”, which is to reach a revenuelevel of $9 million by fiscal year 2009.

 

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

 

14

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* *

*Results of Operations*

 

The following management comments regarding Torotel’s results ofoperations and outlook should be read in conjunction with the ConsolidatedFinancial Statements included pursuant to Item 1 of this Quarterly Report.

 

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

 

**Six Months Ended October 31, 2007 Compared With SixMonths Ended October 31, 2006**

 

Net sales increased 23%.  The net sales of Torotel Products increased 24% from $2,443,000 to $3,021,000.  This increase is attributable to higher demand for components used in certain aerospace and military applications, and higher shipments of the potted coil assembly for the Hellfire II missile system.  The net sales of Electronika decreased 35% from $43,000 to $28,000, which is representative of the downward trend in Electronika’s sales.

 

Gross profit as a percentage of net salesincreased 4%.  The gross profitpercentage of Torotel Products increased 4% primarily because of higher salesvolume.  Electronika’s gross profit as apercentage of net sales remained unchanged.

 

Engineering expenses, applicable only toTorotel Products, increased slightly from $129,000 to $131,000.  Management does anticipate an increase in thepresent level of engineering expenses during the next few quarters asadditional engineering technical support is planned.

 

Selling, general and administrative(SG&A) expenses increased 20%.  TheSG&A expenses of Torotel, Inc. increased 10% from $251,000 to $277,000primarily because of a $22,000 increase in professional fees associated with opposition to certain shareholderproposals submitted by the Caloyeras Family Partnership, a $10,000 increase inauditing fees, a $7,000 increase in the costs recognized for the fair value ofstock appreciation rights and a $6,000 increase in directors fees.  These increases were offset partially by a$13,000 decrease in consulting costs incurred in the prior year for short andlong-term compensation planning, a $3,000 decrease in travel costs and a $3,000decrease in insurance costs.  TheSG&A expenses of Torotel Products increased 26% from $676,000 to $851,000primarily because of a $65,000 increase in training costs, a $51,000 increase inpayroll costs, a $51,000 increase in stock compensation costs, a $14,000increase in travel costs, a $9,000 increase in fast pay-discounts to majorcustomers and an $8,000 increase in sales commissions.  These increases were offset partially by an$8,000 decrease in employee recruiting costs, an $8,000 decrease in bankcharges associated with the write-off in the prior year of capitalized loanfees on the original mortgage loan for the Olathe facility and a $7,000decrease in computer network maintenance costs. The SG&A expenses of Electronika decreased $15,000 because of theexpiration of the monthly management fee pursuant to the terms of themanufacturing agreement with Magnetika. Management does anticipate a decrease in the present level of SG&Aexpenses for the balance of fiscal 2008.

 

Amortization costs, entirely attributableto Electronika, decreased $11,000 as the intangible assets are fully amortized.

 

15

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Interest expense decreased 46%.  The interest expense of Torotel, Inc.decreased $26,000 because of the retirement of the note payable toshareholder.  The interest expense ofTorotel Products remained unchanged at $31,000.

 

Interest incomedecreased $5,000 because of less funds set aside in a money management account.

 

Forthe reasons discussed above, the consolidated pretax loss decreased from$213,000 to $40,000.  The pretax loss ofTorotel, Inc. remained unchanged at $277,000.  The pretax earnings of Torotel Productsincreased from $62,000 to $220,000.  Thepretax earnings of Electronika increased from $2,000 to $17,000.

 

**Three Months Ended October 31, 2007 Compared With ThreeMonths Ended October 31, 2006**

 

Net sales increased 28%.  The net sales of Torotel Products increased 28% from $1,268,000 to $1,627,000.  This increase is attributable to higher demand for components used in certain military applications and higher shipments of the potted coil assembly for the Hellfire II missile system.  The net sales of Electronika decreased 16% from $19,000 to $16,000, which is representative of the downward trend in Electronika’s sales.

 

Gross profit as a percentage of net salesremained unchanged.  The gross profitpercentage of Torotel Products remained unchanged with the higher sales volumebecause of lower direct margins associated with the product mix and a higherabsorption of labor and overhead costs due to a decrease in the level of workin process inventory.  Electronika’sgross profit as a percentage of net sales remained unchanged.

 

Engineering expenses, applicable only toTorotel Products, increased slightly from $65,000 to $66,000.  Management does anticipate an increase in thepresent level of engineering expenses during the next few quarters asadditional engineering technical support is planned.

 

Selling, general and administrative(SG&A) expenses increased 15%.  TheSG&A expenses of Torotel, Inc. decreased nearly 12% from $139,000 to$123,000 primarily because of a $13,000 decrease in consulting costs incurredin the prior year for short and long-term compensation planning, a $3,000decrease in travel costs,  a $2,000decrease in insurance costs, a $2,000 decrease in  professional fees and a $2,000 decrease inauditing fees.  These decreases wereoffset partially by a $6,000 increase in directors fees.  The SG&A expenses of Torotel Productsincreased 28% from $350,000 to $449,000 primarily because of a $48,000 increasein stock compensation costs, a $27,000 increase in training costs, a $22,000increase in payroll costs, a $9,000 increase in travel costs, a $6,000 increasein fast pay-discounts to major customers and a $3,000 increase in salescommissions.  These increases were offsetpartially by a $9,000 decrease in employee recruiting costs, a $4,000 decreasein printing costs and a $3,000 decrease in computer network maintenance costs.  The SG&A expenses of Electronikadecreased $7,000 because of the expiration of the monthly management feepursuant to the terms of the manufacturing agreement with Magnetika.  Management does anticipate a decrease in thepresent level of SG&A expenses for the balance of fiscal 2008.

 

Amortization costs, entirely attributableto Electronika, decreased $4,000 as the intangible assets are fully amortized.

 

Interest expense decreased 47%.  The interest expense of Torotel, Inc.decreased $13,000 because of the retirement of the note payable toshareholder.  The interest expense ofTorotel Products decreased from $17,000 to $16,000 because of a lower debtlevel.

 

Interest incomedecreased $3,000 because of less funds set aside in a money management account.

 

16

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For the reasons discussed above, theconsolidated pretax earnings increased from a loss of $69,000 to a profit of$13,000.  The pretax loss of Torotel, Inc.decreased from $152,000 to $123,000.  Thepretax earnings of Torotel Products increased from $82,000 to $126,000.  The pretax earnings of Electronika increasedfrom $1,000 to $10,000.

 

**Liquidity and Capital Resources**

 

Asof October 31, 2007, Torotel had $149,000 in cash and cash equivalentscompared to $400,000 as of October 31, 2006.  Management expects cash flow from operationsto improve during the balance of fiscal 2008 because of the current shippablebacklog position, the implementation of a payment service offered by certainmajor customers which should help reduce the number of days that Torotel’saccounts receivable are outstanding and lower corporate expenses in the secondhalf of fiscal 2008.

 

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

 
|                                  |   | **2007** | ** ** | **2006** |   |
|---------------------------------------|--------|----------|------------|----------|--------|
| Net cash used in operating activities |   | $        | (37,000    | )        | $      | (83,000 | ) |
| Net cash used in investing activities |   | $        | (33,000    | )        | $      | (22,000 | ) |
| Net cash used in financing activities |   | $        | (28,000    | )        | $      | (16,000 | ) |

 

Net cash provided by or used in operating activities fluctuates betweenperiods primarily as a result of differences in operating earnings, the timingof shipments and the collection of accounts receivable, changes in inventory,level of sales and payment of accounts payable. The $33,000 of cash used in investing activities was the result ofcapital expenditures.  Managementanticipates approximately $60,000 in total capital expenditures during fiscal2008.  Net cash used in financing activitiesis because of payments on long-term debt. Management believes that the projected cash flow from operations,combined with its existing cash balances, will be sufficient to meet itsfunding requirements for the foreseeable future.  Torotel does have a $200,000 bank line ofcredit available, which could be utilized to help fund any working capitalrequirements.

 

Return on Capital Employed (“ROCE”) is the primary tool for managingTorotel’s business.  ROCE is measured bythe following formula:

 
| **Earnings  before interest and taxes (EBIT)**        | **X**      | ** **                                                        | **Net Sales**                  |   | **=** | **ROCE** |
|-------------------------------------------------------|------------|-------------------------------------------------------------------|--------------------------------|--------|-------|----------|
| **Net Sales**                                         | ** ** | ** **                                                        | **Net Operating Assets (NOA)** |   |
| ** **                                            | ** ** | ** **                                                        | ** **                     |   |
| **Measures profit and loss management**               | ** ** | **Measures balance sheet management**                             |
| ** **                                            | ** ** | ** **                                                        |
| **Profitability%**                                    | ** ** | **Activity rating**                                               |
| ** **                                            | ** ** | ** **                                                        |
| **Measures how much profit in each dollar of  sales** | ** ** | **Measures how much sales is generated from  each dollar of NOA** |
| ** **                                            | ** ** | ** **                                                        |
| **Quality of Revenue**                                | ** ** | **Quantity of Revenue**                                           |

 

ROCE measures what you get out (EBIT) versus what you put in (NOA =Capital Employed).  For these purposes,NOA is defined as “accounts receivable + inventory + net fixed assets +miscellaneous operating assets – accounts payable – miscellaneous operatingliabilities”.  The performance of Torotel’smanagement

 

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and the majority of its decisions going forward will be measured bywhether Torotel’s ROCE improves.  In fiscal2005, 2006 and 2007, Torotel’s ROCE was 5.84%, 19.04% and -.66%,respectively.  Torotel’s ROCE for the12-month trailing period ended October 31, 2007 was 6.69%.

 

**Critical Accounting Policies**

 

*Use of Estimates*

 

The preparation of the consolidated financial statements in conformitywith accounting principles generally accepted in the United States of Americarequires management to make estimates and assumptions that affect certainreported amounts and disclosures. Significant estimates used in preparing these consolidated financialstatements include those assumed in computing the carrying value of equipment,allowance for doubtful accounts receivable, reserve for obsolete and excessinventory, the valuation allowance on deferred tax assets and the reserve forwarranty costs.  Accordingly, actualresults could differ from those estimates. Any changes in estimates are recorded in the period in which they becomeknown.

 

*Credit Risk*

 

Financial instruments that potentially subject Torotel to concentrationsof credit risk consist principally of cash and accounts receivable.  Torotel grants unsecured credit tosubstantially 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 October 31, 2007, these cash balancesexceed federally insured limits.  Torotelhas not experienced any losses in such accounts.  Management does not believe Torotel isexposed to any significant credit risk with respect to its cash and cashequivalents.

 

*Fair Value of Financial Instruments*

 

Cost approximates market for all financial instruments as of October 31,2007 and 2006.

 

*Treasury Stock*

 

Torotel utilizes the weighted average cost method in accounting for itstreasury stock transactions.

 

*Revenue Recognition*

 

Revenue is recognized on contracts and orders on the date the productis shipped to the customer (unit-of-delivery method).  Torotel’s annual consolidated sales arisingfrom contracts having deliveries scheduled over a period of more than one yearfor fiscal years 2007 and 2006 were approximately 23% and 20%, respectively,because of the contracts for the potted coil assembly.

 

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*Allowance for Doubtful Accounts*

 

Gross trade accounts receivable are offset with an allowance fordoubtful accounts.  The allowance fordoubtful accounts is management’s best estimate of the amount of probablecredit losses in Torotel’s existing accounts receivable.  Management reviews the allowance for doubtfulaccounts on a regular basis, and all past due balances are reviewedindividually for collectibility.  Accountbalances are charged against the allowance when placed for collection.  Recoveries of receivables previously writtenoff are recorded when received.  Themajority of the customer accounts are considered past due after the invoicebecomes older than the customer’s credit terms. Interest is not charged on past due accounts.

 

*Inventories*

 

Inventories are stated at the lower of cost or market.  Cost is determined using a moving averagecost method of valuation that currently and historically approximates thefirst-in, first-out method.  Torotel’sindustry is characterized by short-term customer commitments and changes indemand, as well as other market considerations. Provisions for estimated obsolete and excess inventory are based onreviews of inventory usage, quantities on hand and latest product demandinformation from customers.  Inventoriesare reviewed in detail utilizing a 12-month time horizon.  Individual part numbers that have not had anyusage in a 12-month time period are categorized as obsolete; individual partnumbers having more than a 12-month supply based on the current year’s usageare categorized as excess.  The reservebalance is analyzed for adequacy along with the inventory review each quarter.

 

*Property, Plant and Equipment*

 

Property, plant and equipment are carried at cost.  Depreciation and amortization are provided inamounts sufficient to relate the costs of depreciable assets to operationsprimarily using the straight-line method over estimated useful lives of threeto five years for property and equipment, and ten to twenty years for buildingsand improvements.

 

*Cash Flows*

 

For purposes of the statements of cash flows, Torotel considers allshort-term investments purchased with original maturity dates of three monthsor less to be cash equivalents.

 

*Equity Investment in Apex*

 

Torotel has a 12.88% interest in Apex. The investment in Apex has no carrying value on the consolidated balancesheet of Torotel, and in the opinion of Torotel management, it is not likelythat any of the investment will be recovered because of Apex’s continuedfinancial losses.  If Apex were toeventually be sold, any cash recovered would be recognized as a gain uponreceipt of the proceeds.

 

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*Warranty Costs*

 

Torotel has a reserve for estimated warranty costs associated withproducts returned from customers.  Alimited warranty is provided for a period of one year which requires Torotel torepair or replace defective products at no cost to the customer.  The warranty reserve is based on historicalexperience and reflects management’s best estimate of probable liability underthe product warranties.

 

*Share-Based Compensation*

 

Effective May 1, 2006, Toroteladopted the fair value recognition provisions of Statement of FinancialAccounting Standards No. 123 (revised 2004), “Share-Based Payment”(SFAS 123(R)) using the modified prospective method of adoption under theprovisions of SFAS No. 148, *Accountingfor Stock-Based Compensation – Transition and Disclosure*.  Prior to May 1, 2006, Torotel accountedfor all stock option grants under the provisions of APB Opinion 25, *Accounting for Stock Issued to Employees*and related interpretations; and accounted for all grants involving stockappreciation rights (SARs) under the provisions of SFAS 123 using the intrinsicvalue measurement guidelines of APB Opinion 25. The adoption of SFAS 123(R) on existing stock option grants did nothave any impact on our financial condition or results of operations for the sixmonths ended October 31, 2006; the adoption of SFAS 123(R) for theSARs resulted in a cumulative effect reduction in stock compensation costs of$8,000 for the same six-month period.

 

**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 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 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. 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-lookinginformation contained in this report will prove accurate, and our actualresults may differ materially from these forward looking statements.  We assume no obligation to update anyforward-looking statements made herein.*

 

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Item 3.    Controls and Procedures

 

Torotel’s Chief Executive Officer andChief Financial Officer (collectively, the “Certifying Officers”) areresponsible for establishing and maintaining disclosure controls and procedures(as defined in Exchange Act Rule 13a-15(e)) for Torotel.  Such officers have concluded (based upontheir evaluation of these controls and procedures as of the end of the periodcovered by this report) that Torotel’s disclosure controls and procedures areadequate and effective for purposes of Rule 13a-15(e) in timelyalerting 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**

 

**Item 4.    Submissionof Matters to a Vote of Security Holders**

 

The annual meeting of shareholders washeld in Kansas City, Missouri, on Monday, October 15, 2007, to vote on:

 

a.      The following two management proposals:

 

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

 

(2)             To approvean amendment to the Torotel’s Articles of Incorporation to increase the numberof authorized shares of common stock, par value $.01 per share, from 6,000,000to 20,000,000 shares, with the affirmative vote of a majority of the shares ofcommon stock present, in person or by proxy, and entitled to vote required toapprove this proposed amendment.

 

b.      The following three shareholderproposals:

 

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

 

(4)             To considerand vote upon a shareholder proposal to revoke a provision of the Corporation’sBy-Laws to remove advance notice requirements for shareholders to bringbusiness before a shareholder meeting; and

 

(5)             To considerand vote upon a shareholder proposal to reduce the number of members on theBoard of Directors from seven to five.

 

A majority of the outstanding shares ofcommon stock entitled to be voted at the meeting, represented in person or byProxy, was necessary to constitute a quorum to transact business at themeeting.  At the meeting, there were4,208,413 shares represented which was 70.70% of the shares outstanding andeligible to vote.  The voting resultswere as follows:

 

***Proposal1***.       Shareholderselected the following individuals to a three-year term on the Board ofDirectors, with the number of shares voting “FOR” each nominee indicated.

 
| Anthony H. Lewis   |   | 3,049,329 |
|--------------------|--------|-----------|
| Stephen K. Swinson |   | 3,048,972 |

 

In addition to the directors elected above, S. Kirk Lambright, Jr.,H. James Serrone, Dale H. Sizemore, Jr. and Richard A. Sizemore also serveas directors.  The current three-yearterm for Messrs. Lambright and Serrone ends in 2008, while the three-yearterm for Messrs. Sizemore ends in 2009.

 

***Proposal2.      ***Shareholdersrejected the amendment to increase the number of authorized shares of commonstock, with the number of shares voting “FOR” , “AGAINST”, and “ABSTAIN”indicated below.

 
| FOR     |   | 2,747,437 |
|---------|--------|-----------|
| AGAINST |   | 1,399,101 |
| ABSTAIN |   | 61,875    |

 

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***Proposal3.      ***Shareholdersrejected the shareholder proposal that permits only shareholders to make,alter, amend, suspend or repeal the Corporation’s By-Laws, with the number ofshares voting “FOR” , “AGAINST”, and “ABSTAIN” indicated below.

 
| FOR     |   | 1,079,338 |
|---------|--------|-----------|
| AGAINST |   | 2,197,953 |
| ABSTAIN |   | 60,489    |

 

***Proposal4.      ***Shareholdersrejected the shareholder proposal to revoke a provision of the Corporation’sBy-Laws to remove advance notice requirements for shareholders to bringbusiness before a shareholder meeting, with the number of shares voting “FOR” ,“AGAINST”, and “ABSTAIN” indicated below.

 
| FOR     |   | 1,074,583 |
|---------|--------|-----------|
| AGAINST |   | 2,202,708 |
| ABSTAIN |   | 60,489    |

 

***Proposal5.      ***Shareholdersrejected the shareholder proposal to reduce the number of members on the Boardof Directors from seven to five, with the number of shares voting “FOR” , “AGAINST”,and “ABSTAIN” indicated below.

 
| FOR     |   | 1,060,489 |
|---------|--------|-----------|
| AGAINST |   | 2,218,397 |
| ABSTAIN |   | 58,894    |

 

**Item 6. Exhibits**

 

a)                Exhibits

 
| Exhibit 31.1 |   | Officer Certification                                                                                                              |
|-------------------|--------|------------------------------------------------------------------------------------------------------------------------------------|
| Exhibit 31.2 |   | Officer Certification                                                                                                              |
| Exhibit 32.1 |   | Certification Pursuant to 18 U.S.C.  Section 1350, as Adopted Pursuant to Section 906 of the  Sarbanes-Oxley Act of 2002 |
| Exhibit 32.2 |   | Certification Pursuant to 18 U.S.C.  Section 1350, as Adopted Pursuant to Section 906 of the  Sarbanes-Oxley Act of 2002 |

 

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**SIGNATURES**

 

In accordance with the requirements of the Securities Exchange Act of1934, the Registrant has duly caused this report to be signed on its behalf bythe undersigned, thereunto duly authorized.

 

 

**Torotel, Inc.**

**(Registrant)**

 

 
| /s/ Dale H. Sizemore, Jr. |   |   |
|--------------------------------|--------|--------|
| Dale H. Sizemore, Jr.     |   |
| Chief Executive Officer        |   |
| Date: December 17, 2007   |   |

 

 
| /s/ H. James Serrone          |   |   |
|-------------------------------|--------|--------|
| H. James Serrone              |   |
| Chief Financial Officer       |   |
| Date:  December 17, 2007 |   |

 

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