**UNITEDSTATESSECURITIES AND EXCHANGE COMMISSION**

Washington,D.C.  20549

**FORM10-QSB**
| x          |   | QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF THE  SECURITIES EXCHANGE ACT OF 1934  |
|------------|--------|-------------------------------------------------------------------------------------|
| ** ** |   | **For the quarter ended July 31, 2007**                                             |
| ** ** |   | ** **                                                                          |
| o          |   | TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF THE  SECURITIES EXCHANGE ACT OF 1934 |
|       |   | For  the transition 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   incorporation or organization) |   | (I.R.S. Employer  Identification No.) |

 

**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)

Check whether theissuer (1) filed all reports required to be filed by Section 13 or 15(d) of theExchange Act during the past 12 months and (2) has been subject to such filingrequirements for the past 90 days.

Yes x   No o

Check whether the issueris a shell company (as defined in Rule 12b-2 of the Exchange Act.)

Yes o   No x

As of September 12, 2007,there were 5,952,340 shares of Common Stock, $.01 par value, outstanding.

Transitional smallbusiness format:  Yes o   No x

 

 

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TOROTEL, INC. ANDSUBSIDIARIES

INDEX
| PART I.   FINANCIAL  INFORMATION                                               |   |   |   |
|------------------------------------------------------------------------------------------|--------|--------|--------|
|                                                                                     |   |   |   |
| Item  1.   Financial  Statements                                               |   |   |   |
|                                                                                     |   |   |   |
| Consolidated Balance Sheet as of July 31, 2007                                           |   | 1      |   |
|                                                                                     |   |   |   |
| Consolidated Statements of Operations for the three  months ended July 31, 2007 and 2006 |   | 2      |   |
|                                                                                     |   |   |   |
| Consolidated Statements of Cash Flows for the three  months ended July 31, 2007 and 2006 |   | 3      |   |
|                                                                                     |   |   |   |
| Notes to Consolidated Financial Statements                                               |   | 4      |   |
|                                                                                     |   |   |   |
| Item 2.   Management’s  Discussion and Analysis or Plan of Operation      |   | 12     |   |
|                                                                                     |   |   |   |
| Item 3.   Controls and  Procedures                                             |   | 18     |   |
|                                                                                     |   |   |   |
| PART  II.   OTHER  INFORMATION                                                 |   |   |   |
|                                                                                     |   |   |   |
| Item 6.   Exhibits and  Reports on Form 8-K                                    |   | 20     |   |
|                                                                                     |   |   |   |
| SIGNATURES                                                                               |   | 21     |   |

 

----

**PARTI.     FINANCIAL INFORMATION**

**Item1.       Financial Statements**

**CONSOLIDATEDBALANCE SHEET (Unaudited)**

As of July 31, 2007
| ASSETS                                     |   |      |      |
|--------------------------------------------|--------|-----------|-----------|
|                                       |   |      |      |
| Current assets:                            |   |      |      |
| Cash                                       |   | $         | 384,000   |   |
| Accounts  receivable, net                  |   | 595,000   |      |
| Inventories                                |   | 470,000   |      |
| Prepaid expenses  and other current assets |   | 71,000    |      |
|                                       |   | 1,520,000 |      |
|                                       |   |      |      |
| Property, plant and  equipment, net        |   | 1,008,000 |      |
|                                       |   |      |      |
| Other assets                               |   | 3,000     |      |
|                                       |   | $         | 2,531,000 |   |
|                                       |   |      |      |
| LIABILITIES AND  STOCKHOLDERS’ EQUITY |   |      |      |
|                                       |   |      |      |
| Current liabilities:                       |   |      |      |
| Current  maturities of long-term debt      |   | $         | 60,000    |   |
| Trade accounts  payable                    |   | 280,000   |      |
| Accrued  liabilities                       |   | 253,000   |      |
|                                       |   | 593,000   |      |
|                                       |   |      |      |
| Long-term debt, less  current maturities   |   | 695,000   |      |
|                                       |   |      |      |
| Stockholders’ equity                  |   | 1,243,000 |      |
|                                       |   | $         | 2,531,000 |   |

 

The accompanyingnotes are an integral part of this statement.

1

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**CONSOLIDATEDSTATEMENTS OF OPERATIONS (Unaudited)**

Three Months Ended July31,
| ** **                                                                                      | ** ** | **2007** | ** ** | **2006** | ** ** |
|-------------------------------------------------------------------------------------------------|------------|----------|------------|----------|------------|
| Net sales                                                                                       |       | $        | 1,406,000  |     | $          | 1,199,000 |   |
| Cost of goods  sold                                                                             |       | 823,000  |       | 801,000  |       |
|                                                                                            |       |     |       |     |       |
| Gross profit                                                                                    |       | 583,000  |       | 398,000  |       |
|                                                                                            |       |     |       |     |       |
| Operating  expenses:                                                                            |       |     |       |     |       |
| Engineering                                                                                     |       | 65,000   |       | 64,000   |       |
| Selling, general and administrative                                                             |       | 556,000  |       | 446,000  |       |
| Amortization of intangible assets                                                               |       | —   |       | 7,000    |       |
|                                                                                            |       | 621,000  |       | 517,000  |       |
| Loss from operations                                                                            |       | (38,000  | )          | (119,000 | )          |
|                                                                                            |       |     |       |     |       |
| Other expense  (income):                                                                        |       |     |       |     |       |
| Interest expense                                                                                |       | 15,000   |       | 27,000   |       |
| Interest income                                                                                 |       | —   |       | (2,000   | )          |
|                                                                                            |       | 15,000   |       | 25,000   |       |
| Loss before provision for income taxes and  cumulative effect of change in accounting principle |       | (53,000  | )          | (144,000 | )          |
|                                                                                            |       |     |       |     |       |
| Provision for  income taxes                                                                     |       | —   |       | —   |       |
|                                                                                            |       |     |       |     |       |
| Loss before  cumulative effect of change in accounting principle                                |       | (53,000  | )          | (144,000 | )          |
|                                                                                            |       |     |       |     |       |
| Cumulative  effect of change in accounting principle                                            |       | —   |       | 8,000    |       |
|                                                                                            |       |     |       |     |       |
| Net loss                                                                                        |       | $        | (53,000    | )        | $          | (136,000 | ) |
|                                                                                            |       |     |       |     |       |
| Basic loss per  share:                                                                          |       |     |       |     |       |
| Before cumulative effect                                                                        |       | $        | (.01       | )        | $          | (.03 | ) |
| Cumulative effect                                                                               |       | —   |       | —   |       |
|                                                                                            |       | $        | (.01       | )        | $          | (.03 | ) |
| Diluted loss per  share:                                                                        |       |     |       |     |       |
| Before cumulative effect                                                                        |       | $        | (.01       | )        | $          | (.03 | ) |
| Cumulative effect                                                                               |       | —   |       | —   |       |
|                                                                                            |       | $        | (.01       | )        | $          | (.03 | ) |

 

The accompanyingnotes are an integral part of these statements.

2

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**CONSOLIDATEDSTATEMENTS OF CASH FLOWS (Unaudited)**

Three Months Ended July31,
| ** **                                                                       | ** ** | **2007** | ** ** | **2006** | ** ** |
|----------------------------------------------------------------------------------|------------|----------|------------|----------|------------|
| Cash flows from  operating activities:                                           |       |     |       |     |       |
| Net loss                                                                         |       | $        | (53,000    | )        | $          | (136,000 | ) |
| Adjustments to reconcile net loss to net cash  provided by operating activities: |       |     |       |     |       |
| Stock compensation earned                                                        |       | 3,000    |       | —   |       |
| Depreciation                                                                     |       | 23,000   |       | 21,000   |       |
| Amortization                                                                     |       | —   |       | 7,000    |       |
| Change in value of stock appreciation rights                                     |       | (1,000   | )          | (14,000  | )          |
| Increase (decrease) in cash flows from operations  resulting from changes in:    |       |     |       |     |       |
| Accounts receivable                                                              |       | 158,000  |       | 174,000  |       |
| Inventories                                                                      |       | (35,000  | )          | 14,000   |       |
| Prepaid expenses and other assets                                                |       | (55,000  | )          | (45,000  | )          |
| Trade accounts payable                                                           |       | 71,000   |       | 96,000   |       |
| Accrued liabilities                                                              |       | 52,000   |       | 10,000   |       |
|                                                                             |       |     |       |     |       |
| Net cash  provided by operating activities                                       |       | 163,000  |       | 127,000  |       |
|                                                                             |       |     |       |     |       |
| Cash flows from  investing activities:                                           |       |     |       |     |       |
| Capital expenditures                                                             |       | (12,000  | )          | (9,000   | )          |
|                                                                             |       |     |       |     |       |
| Net cash used in  investing activities                                           |       | (12,000  | )          | (9,000   | )          |
|                                                                             |       |     |       |     |       |
| Cash flows from  financing activities:                                           |       |     |       |     |       |
| Principal payments on long-term debt                                             |       | (14,000  | )          | (18,000  | )          |
|                                                                             |       |     |       |     |       |
| Net cash used in  financing activities                                           |       | (14,000  | )          | (18,000  | )          |
|                                                                             |       |     |       |     |       |
| Net increase in  cash                                                            |       | 137,000  |       | 100,000  |       |
| Cash, beginning  of period                                                       |       | 247,000  |       | 521,000  |       |
|                                                                             |       |     |       |     |       |
| Cash, end of  period                                                             |       | $        | 384,000    |     | $          | 621,000 |   |
|                                                                             |       |     |       |     |       |
| Supplemental  Disclosures of Cash Flow Information                               |       |     |       |     |       |
| Cash paid during the period for:                                                 |       |     |       |     |       |
| Interest                                                                         |       | $        | 15,000     |     | $          | 27,000 |   |
| Income taxes  payable                                                            |       | $        | —     |     | $          | — |   |

 

The accompanyingnotes are an integral part of these statements.

3

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**NOTESTO 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 98% of Torotel’s sales duringthe first three months of fiscal 2007 have been derived from domesticcustomers.

**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 July 31, 2007, and the resultsof operations for the three months ended July 31, 2007.

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

**Note3 — Inventories**

The components ofinventories are summarized as follows:

| Raw materials                                      |   | $       | 581,000 |   |
|----------------------------------------------------|--------|---------|---------|--------|
| Work in process                                    |   | 180,000 |    |
| Finished goods                                     |   | 91,000  |    |
|                                               |   | 852,000 |    |
| Less: reserve for  obsolete and excess inventories |   | 382,000 |    |
|                                               |   | $       | 470,000 |   |

 

**Note4 — Income Taxes**

** **

EffectiveMay 1, 2007, Torotel adopted the provisions of Financial Accounting StandardsBoard Interpretation No. 48 (“FIN 48”), Accounting for Uncertainty in IncomeTaxes - an Interpretation of FASB No. 109, which clarified the accounting foruncertainty in tax positions.  FIN 48 prescribesa recognition threshold and measurement attribute for the financial statementrecognition and measurement of a tax position taken or expected to be taken ina tax return.  It is management’sresponsibility to determine whether it is more likely than not that a taxposition will be sustained upon examination, including resolution of anyrelated appeals or litigation processes, based on the technical merits of theposition.  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; as of July31, 2007, the income tax positions taken or expected to be taken for the opentax years are appropriately stated and supported for all open years and thatthe adoption of FIN 48 did not have a material effect on Torotel’s consolidatedfinancial statements for the three months ended July 31, 2007.  Open tax years are April 30, 2003, 2004, 2005and 2006.  

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 July  31, 2007, Torotelrecorded no accrued interest or penalties related to uncertain taxpositions.  Management expects nosignificant change in the amount of unrecognized tax benefit, accrued interestor penalties within the next twelve months.

4

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**Note 5 — Share-Based Compensation**

Effective May 1,2006, Torotel adopted the fair value recognition provisions of Statement ofFinancial Accounting Standards No. 123 (revised 2004), “Share-BasedPayment” (SFAS 123(R)) using the modified prospective method of adoption underthe provisions of SFAS No. 148, *Accountingfor Stock-Based Compensation — Transition and Disclosure*.  Prior to May 1, 2006, Torotel accounted forall 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 not haveany impact on our financial condition or results of operations for the threemonths ended July 31, 2006; the adoption of SFAS 123(R) for the SARs resultedin a cumulative effect reduction in stock compensation costs of $8,000 for thesame three-month period.

**Note6 — 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 fully vestedin 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 July 31, 2007.  Stock option transactions for the periodended July 31, 2006,  are summarized asfollows:

5

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|                                                                | ** ** | **2006**     | ** ** |
|----------------------------------------------------------------|------------|--------------|------------|
| ** **                                                     | ** ** | **Weighted** | ** ** | ** ** | ** ** |
| ** **                                                     | ** ** | **Shares**   | ** ** | **Average** | ** ** |
| ** **                                                     | ** ** | **Under**    | ** ** | **Exercise** | ** ** |
| ** **                                                     | ** ** | **Option**   | ** ** | **Price** | ** ** |
| Outstanding at  beginning of period                            |       | 40,000       |       | $ | .37 |   |
| Granted                                                        |       | —       |       | — |   |
| Exercised                                                      |       | —       |       | — |   |
| Forfeited                                                      |       | —       |       | — |   |
| Outstanding at end of  period                                  |       | 40,000       |       | $ | .37 |   |
| Options exercisable at  end of period                          |       | 40,000       |       | $ | .37 |   |
| Weighted average fair value of options granted during the year |       | —       |       |   |   |

 

The followinginformation applies to options outstanding for the period ended July 31, 2006:

|                                             | ** ** | **2006** | ** ** |
|---------------------------------------------|------------|----------|------------|
| Number outstanding                          |       | 40,000   |       |
| Range of exercise  prices                   |       | $        | .37        |   |
| Weighted average  exercise price            |       | $        | .37        |   |
| Weighted average remaining contractual life |       | .25 yrs. |       |

 

**Note7 — 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 toaccept employment with Torotel, the Committee and the Board believe a keycomponent of such 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 Stock Agreementwas entered into between Torotel and Benjamin E. Ames, Jr., as part of Mr. Ames’employment as Executive Vice President of Torotel Products, Inc., with primaryresponsibilities being new business development.  The amount of the restricted stock award was200,000 shares of common stock, $.01 par value per share.  Based upon Mr. Ames attaining mutually agreedupon written annual goals, the restricted shares shall be released from therestrictions on transfer and risk of forfeiture in the amount of 40,000 sharesper year for five years beginning July 31, 2007, and each anniversary thereof.  Based on the market price of $.30 for Torotel’scommon stock as of July 31, 2006, the fair value of the restricted stock at thedate of award was $60,000.  Of thisamount, $2,000 was credited to common stock at par value and the excess of$58,000 was credited to additional paid-in capital.  The restricted shares are treated asnon-vested stock pursuant to SFAS 123(R). Accordingly, an offset amount, classified as unearned stockcompensation, is included in the accompanying consolidated balance sheet understockholders’ equity.  Stock compensationcost of $3,000 per quarter will be recorded during the aggregate five-yearvesting period provided the mutually agreed upon goals are achieved.  As of July 31, 2007, 40,000 shares have beenreleased from the restrictions on transfer.

A Restricted Stock Agreement having a measurement dateof February 12, 2007, was entered into between Torotel and E. Mark Flynn, aspart of Mr. Flynn’s employment as Vice President of Torotel Products, Inc.,with primary responsibilities being supply chain management anddevelopment.  The amount of therestricted stock award was 25,000 shares of common stock, $.01 par value pershare.  Based upon Mr.

6

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Flynnattaining mutually agreed upon written annual goals, the restricted sharesshall be released from the restrictions on transfer and risk of forfeiture inthe amount of 5,000 shares per year for five years beginning February 12, 2008,and each anniversary thereof.  Based onthe market price of $.45 for Torotel’s common stock as of February 12, 2007,the fair value of the restricted stock at the date of award was $11,250.  Of this amount, $250 was credited to commonstock at par value and the excess of $11,000 was credited to additional paid-incapital.  The restricted shares aretreated as non-vested stock pursuant to SFAS 123(R).  Accordingly, an offset amount, classified asunearned stock compensation, is included in the consolidated balance sheet understockholders’ equity.  Stock compensationcost of $562.50 per quarter will be recorded during the aggregate five-yearvesting period provided the mutually agreed upon goals are achieved.

Under the terms of both agreements, the non-vestedshares are restricted as to disposition and subject to forfeiture under certaincircumstances.  The agreements provideMessrs. Ames and Flynn with all voting rights with respect to the restrictedshares.  The agreements further providethat if, prior to all of the restricted shares having been released, Torotelundergoes a change in control, then all of the restricted shares shall bereleased and no longer subject to restrictions under the agreements.

Restrictedstock activity for each period through July 31 is summarized as follows:

|                                    | ** ** | **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                            |       | —         |       | —       |       | 200,000 |   | $.300 |   |
| Vested                             |       | (40,000        | )          | $.300        |       | — |   | — |   |
| Forfeited                          |       | —         |       | —       |       | — |   | — |   |
| Outstanding at end of period       |       | 185,000        |       | $.320        |       | 200,000 |   | $.300 |   |

 

On August 7, 2007, Restricted Stock Agreements wereentered into between Torotel and 13 key employees pursuant to the Stock AwardPlan (“SAP”).  The SAP provides keyemployees the opportunity to acquire common stock of Torotel pursuant to awardsearned for accomplishing goals that promote the long-term financial performanceof Torotel.  Under the terms of the SAP,which was filed as Exhibit 10.9 on Form 10-KSB on July 30, 2007, the restrictedstock awards have a five (5) year restriction period, which shall lapse basedon certain conditions as outlined in the SAP. The Restricted Stock Agreements afford the grantees all of the rights ofa stockholder with respect to the award shares, including the right to votesuch shares and to receive dividends and other distributions payable withrespect to such shares since the Date of Award. The aggregate amount of the restricted stock awards was 575,750 sharesof common stock, $.01 par value per share. Based on the market price of $.50 for Torotel’s common stock as ofAugust 7, 2007, the fair value of the restricted stock at the date of award was$287,875.  Of this amount, $5,757 will becredited to common stock at par value and the excess of $282,118 will becredited to additional paid-in capital. The restricted shares are treatedas non-vested stock pursuant to SFAS 123(R). Accordingly, an offset amount, classified as unearned stockcompensation, will be included in future consolidated balance sheets understockholders’ equity.  Stock compensationcost of $14,393.75 per quarter will be recorded during the five-year vestingperiod provided the financial performance metrics as outlined in the SAP arelikely to be attained.

7

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**Note8 — Stockholders’ Equity**

The components ofstockholders’ equity are summarized as follows:

| Common stock, at par value      |   | $           | 54,000    |   |
|---------------------------------|--------|-------------|-----------|--------|
| Capital in  excess of par value |   | 12,331,000  |      |
| Unearned stock  compensation    |   | (58,000     | )         |
| Accumulated  deficit            |   | (10,994,000 | )         |
|                            |   | 1,333,000   |      |
| Less treasury  stock, at cost   |   | 90,000      |      |
|                            |   | $           | 1,243,000 |   |

 

Torotelhas 6,000,000 shares of common stock, $.01 par value, authorized and 5,376,590shares issued and outstanding.  Thechanges in shares of common stock outstanding are summarized as follows:

| Balance, May 1, 2007      |   | 5,376,590 |   |
|---------------------------|--------|-----------|--------|
| Restricted stock activity |   | —    |   |
| Treasury stock activity   |   | —    |   |
| Balance, July 31, 2007    |   | 5,376,590 |   |

 

**Note9 — Earnings Per Share**

Statementof Financial Accounting Standards (SFAS) No. 128, *Earnings per Share*, requires dual presentation of basic anddiluted EPS on the face of the statement of operations.  It also requires a reconciliation of thenumerator and denominator used in computing basic and diluted EPS.  Basic EPS excludes dilution and is computedby dividing earnings available to common stockholders by the weighted averagenumber 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 185,000 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 shares will notbe included in the basic EPS calculation until the performance measurementshave been satisfied.  The restrictedshares will be 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:

8

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|                                                                      | ** ** | **2007**  | ** ** | **2006**  | ** ** |
|----------------------------------------------------------------------|------------|-----------|------------|-----------|------------|
| Loss before  cumulative effect                                       |       | $         | (53,000    | )         | $          | (144,000 | ) |
| Cumulative  effect                                                   |       | —    |       | 8,000     |       |
| Net loss                                                             |       | $         | (53,000    | )         | $          | (136,000 | ) |
|                                                                 |       |      |       |      |       |
| Weighted average  common shares outstanding for basic EPS            |       | 5,152,025 |       | 5,111,590 |       |
| Incremental  shares for effect of stock options and restricted stock |       | —    |       | —    |       |
| Weighted average  common shares outstanding for dilutive EPS         |       | 5,152,025 |       | 5,111,590 |       |
|                                                                 |       |      |       |      |       |
| Basic loss per  share:                                               |       |      |       |      |       |
| Before cumulative effect                                             |       | $         | (.01       | )         | $          | (.03 | ) |
| Cumulative effect                                                    |       | —    |       | —    |       |
|                                                                 |       | $         | (.01       | )         | $          | (.03 | ) |
|                                                                 |       |      |       |      |       |
| Diluted loss per  share:                                             |       |      |       |      |       |
| Before cumulative effect                                             |       | $         | (.01       | )         | $          | (.03 | ) |
| Cumulative effect                                                    |       | —    |       | —    |       |
|                                                                 |       | $         | (.01       | )         | $          | (.03 | ) |

 

No incremental shares areincluded in the 2007 EPS calculations for the 185,000 shares of restrictedcommon 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.

**Note 10 —Stock Appreciation Rights**

On September 10,2004, the board of directors of Torotel approved the Directors StockAppreciation Rights Plan (the “Plan”) for non-employee directors.  Each SAR is equal to one share of commonstock of Torotel, and the aggregate number of SARs that may be granted underthe Plan shall not exceed 500,000. The effective date of the Plan is October 1,2004.  The SARs are now accounted forunder SFAS No. 123(R), *Accounting forStock-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, asdiscussed in Note 5 of Notes to Consolidated Financial Statements.

SARs shallautomatically be granted in the future as follows: (1) each person who iselected as a director, who was not a director on the effective date of thePlan, shall be granted 10,000 SARs on the date such person is elected adirector; and (2) on each May 1 following the effective date during the term ofthe Plan, each person serving as a director on such date shall be granted10,000 SARs.  After the initial grant,the price at which each SAR is granted shall be the average of the closingprice of Torotel’s common stock for the ten consecutive days immediatelypreceding the date of grant.  Uponexercise of a SAR, Torotel will pay the grantee an amount (the “Spread”) equalto the excess of the Exercise Price over the SAR grant price multiplied by thenumber of shares being exercised.  TheExercise Price shall be the average of the closing price of Torotel’s commonstock 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.

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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%                                      |       |

 

A Grantee shall becomefully (100%) vested in each of his or her SARs under the followingcircumstances:  (i) upon termination ofthe Grantee’s service as a director of Torotel for reasons of death, disabilityor retirement; (ii) if the Compensation and Nominating Committee (the “Committee”),in its sole discretion, determines that acceleration of the SAR vestingschedule would be desirable for Torotel; or (iii) if Torotel shall, pursuant toaction by its Board of Directors, at any time propose to merge into,consolidate with, or sell or otherwise transfer all or substantially all of itsassets to another corporation, and provision is not made pursuant to the termsof such transaction for the assumption by the surviving, resulting or acquiringcorporation of outstanding SARs or for substitution of new SARs therefore, theCommittee shall cause written notice of the proposed transaction to be given toeach Grantee not less than twenty days prior to the anticipated effective dateof the proposed transaction, and his or her SARs shall become fully (100%) vestedand, prior to a date specified in such notice, which shall be not more than tendays prior to the anticipated effective date of the proposed transaction, eachGrantee shall have the right to exercise his or her SARs.

In accordance withSFAS 123(R), compensation expense is recognized over the vesting period basedupon the estimated fair value of the SARs pursuant to the terms of the Planusing the Black-Scholes options-pricing model as of the end of each financialreporting period.  As of July 31,2007,the fair 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 176.49% based on Torotel’shistorical volatility using the weekly closing price over the past 4.00 years;a risk-free interest rate of 4.50%; and an expected life of 4.00 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       |           | $          | .328       |       | 67%                 |       | $             | 13,000     |   | $ | — |   |
| May 1, 2005     |       | 30,000     |       | $            | .302       |           | $          | .330       |       | 67%                 |       | $             | 7,000      |   | $ | 2,000 |   |
| May 1, 2006     |       | 30,000     |       | $            | .695       |           | $          | .318       |       | 33%                 |       | $             | 3,000      |   | $ | — |   |
| May 1, 2007     |       | 30,000     |       | $            | .500       |           | $          | .323       |       | 0%                  |       | $             | —     |   | $ | — |   |
| June 4, 2007    |       | 10,000     |       | $            | .412       |           | $          | .326       |       | 0%                  |       | $             | —     |   | $ | — |   |

 

The vested portionrepresents 70,200 SARs.  As of July 31,2007, the total aggregate intrinsic value of these exercisable SARs was $1,000.

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SARs transactions for each period though July 31 aresummarized 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                            |       | 70,200     |       | $            | .385       |   | 29,700 |   | $ | .334 |   |
| Weighted average fair value of SARs granted during the period |       |       |       | $       | .324       |   |   |   | $  | .590 |   |

 

The following informationapplies to SARs outstanding for each period through July 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 |       | 8.22 yrs. |         | 8.71 yrs. |       |

 

Total compensationexpense for the outstanding SARs for the three months ended July 31, 2007 and2006, was a reduction of $1,000 and $15,000, respectively.  The reduction of $15,000 in 2006 included$8,000 for the cumulative effect of adopting SFAS No. 123(R).  As of July 31, 2007, there was $29,000 oftotal unrecognized compensation expense related to non-vested SARs grantedunder the Plan.  That cost is expected tobe recognized over a weighted average period of 1.22 years.  The liability for SARs on the consolidatedbalance sheet as of July 31, 2007, was $23,000.

**Note 11 — Related Party Event**

The purchaseoption settlement agreement with the Caloyeras Family Partnership, filed asExhibit 10.1 on Form 8-K on April 20, 2007, and incorporated herein byreference, expired on July 31, 2007.  Thelitigation that was part of the settlement agreement can be re-filed as aresult of the expiration.

**Note 12 — Concentrations of CreditRisk**

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, 2007, 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 or Plan of Operation

*Overview*

Torotel conducts business primarily through two whollyowned subsidiaries, Torotel Products and Electronika.  In addition, Torotel has a 12.88% equityinterest in 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.

Torotel Products markets its components primarilythrough a 4-person internal sales force, which includes a Vice President ofBusiness Development that was hired in July 2006, and six independentmanufacturers’ representatives paid on a commission basis.  Torotel Products also utilizes its 4-personengineering department in its direct sales efforts for the purpose of expandingits reach into new markets 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 components manufacturedby Torotel Products are sold primarily in the United States, and most sales areawarded on a competitive bid basis.  Themarkets in which Torotel Products competes are highly competitive.  A substantial number of companies sellcomponents of the type manufactured and sold by Torotel Products.  In addition, Torotel Products sells to anumber of customers who have the capability of manufacturing their ownelectronic components.  The principalmethods of competition for electronic products in the markets served by TorotelProducts include, among other factors, price, on-time delivery performance,lead times, customized product engineering and technical support, marketingcapabilities, quality assurance, manufacturing efficiency, and existing relationshipswith customers’ engineers.  Whilemagnetic components are not susceptible to rapid technological change, TorotelProducts’ sales, which do not represent a significant share of the industry’smarket, are susceptible to decline given the 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 andMD-88 aircraft; however, sales of ballast transformers have been made primarilyfor use 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, and competitionfor the available spare parts business. Electronika’s sales do not represent a significant portion of anyparticular market.

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Electronika’s requirements for the ballast transformers are outsourcedpursuant to a Manufacturing Agreement with Magnetika, a corporation owned bythe Caloyeras family.  Under the terms ofthe agreement, 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$5,000 for the three months ended July 31, 2007.

*Business Outlook*

The mix for the first quarter sales of fiscal 2008 was45% defense, 40% aerospace and 15% commercial/industrial.  Management believes that the mix in fiscal2008 should shift more toward defense as higher demand for the potted coilassembly for the Hellfire II missile system is projected.  In addition, management believes expandedselling and marketing efforts within our existing major customer base willyield a number of opportunities in new military programs.  Management also believes the aerospacesegment will continue to be a strong market for new opportunities, especially withthe major suppliers of the Boeing 787 Dreamliner.  New order bookings in the first quarter offiscal 2008 increased 14% over the prior year quarter, exclusive of the $2.1million contract for the potted coil assembly awarded in last year’s firstquarter.  Management does anticipateanother contract for the potted coil assembly to be awarded within the next fewmonths, and continues to project an overall increase in new order bookings of13% for fiscal 2008.  The primary factorsthat drive gross profit and net earnings for Torotel Products are sales volumeand product mix.  The gross profits onmature products/programs and larger transformer devices tend to be higher thanthose that 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 plan called for additional salesand marketing costs in the form of personnel and/or commissions and trade showexhibits.  Management is also committedto workforce development training as part of the ongoing efforts to improveTorotel’s processes and value streams. Management believes a well developed growth strategy is in place andthat these expenditures will continue to be necessary for achieving thatgrowth.  As a result, near-term earningswill continue to be impacted by these costs, as well as increased auditingcosts associated with complying with SEC regulations and the standards of thePublic Company Accounting Oversight Board (United States), Sarbanes-OxleySection 404 compliance, and legal costs that may be necessary in the event thatlitigation is re-filed by the Caloyeras family. Torotel’s management will continue to focus its efforts in areas andsolutions that they believe offer significant growth, which includes expandingthe product base beyond electronic components. The aircraft manufacturers continue to book orders at a record pace withsubstantial backlog through at least the end of the decade; Torotel willcontinue to expand its sales and marketing efforts in this area.   Management’s goal continues to be “9-by-9”,which is to reach a revenue level of $9 million by fiscal year 2009.

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.

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*Resultsof Operations*

The following management comments regarding Torotel’sresults of operations and outlook should be read in conjunction with theConsolidated Financial Statements included pursuant to Item 1 of this QuarterlyReport.

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

**Three Months EndedJuly 31, 2007 Compared With Three Months Ended July 31, 2006**

Net sales increased 17%.  The net sales of Torotel Products increasednearly 19% from $1,175,000 to $1,394,000. This increase is attributable to higher demand for components used inaerospace applications and higher shipments of the potted coil assembly for theHellfire II missile system.  The netsales of Electronika decreased 50% from $24,000 to $12,000, which isrepresentative of the downward trend in Electronika’s sales.

Gross profit as a percentage of net sales increased8%.  The gross profit percentage ofTorotel Products increased 9% because of higher sales volume, higher directmargins associated with the product mix, and lower absorption of labor andoverhead costs due to an increase in the level of work in process inventory forthe potted coil assembly as part of the efforts to meet increasing demand.  Electronika’s gross profit as a percentage ofnet sales remained unchanged.

Engineering expenses, applicable only to TorotelProducts, increased slightly from $64,000 to $65,000.  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 25%.  The SG&Aexpenses of Torotel, Inc. increased nearly 38% from $112,000 to $154,000primarily because of a $24,000 increase in professional fees associated with opposition to certain shareholderproposals submitted by the Caloyeras Family Partnership, a $12,000 increase inauditing fees and a $6,000 change in the value of stock appreciation rights dueto a $7,000 reduction recorded in the prior year quarter.  The SG&A expenses of Torotel Productsincreased nearly 23% from $326,000 to $402,000 primarily because of a $38,000increase in training costs, a $33,000 increase in payroll costs and a $5,000increase in travel costs.  The SG&Aexpenses of Electronika decreased $8,000 because of the expiration of the monthlymanagement fee pursuant to the terms of the manufacturing agreement withMagnetika.  Management does anticipate anincrease in the present level of SG&A expenses as the plan calls foradditional sales and marketing costs in the form of personnel and/or commissions,trade show exhibits, additional training costs for workforce development,increased auditing costs associated with complying with SEC regulations and thestandards of the Public Company Accounting Oversight Board (United States), aswell as increased costs for compliance with the provisions of Sarbanes-OxleySection 404, and legal costs that may be necessary in the event that litigationis re-filed by the Caloyeras family.

Amortization costs, entirely attributable toElectronika, decreased $7,000 as the intangible assets are fully amortized.

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Interest expense decreased 44%.  The interest expense of Torotel, Inc.decreased $13,000 because of the retirement of the note payable toshareholder.  The interest expense of TorotelProducts increased from $14,000 to $15,000 because of a higher borrowing rateassociated with the debt refinancing in the prior year quarter.

Interest income decreased $2,000 because of less fundsset aside in a money management account.

For the reasons discussed above, the consolidatedpretax loss decreased from $144,000 to $53,000. The pretax loss of Torotel, Inc. increased from $125,000 to$154,000.  The pretax earnings of TorotelProducts increased from a loss of $20,000 to a profit of $94,000.  The pretax earnings of Electronika increasedfrom $1,000 to $7,000.

**Liquidityand Capital Resources**

As of July 31, 2007, Torotel had $384,000 in cash andcash equivalents compared to $621,000 as of July 31, 2006.  Management expects cash flow from operationsto improve during fiscal 2008 given the current shippable backlog position andthe implementation of a payment service offered by certain major customerswhich should help reduce the number of days that Torotel’s accounts receivableare outstanding.

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

|                                            | ** ** | **2007** | ** ** | **2006** | ** ** |
|--------------------------------------------|------------|----------|------------|----------|------------|
| Net cash  provided by operating activities |       | $        | 163,000    |     | $          | 127,000 |   |
| Net cash used in  investing activities     |       | $        | (12,000    | )        | $          | (9,000 | ) |
| Net cash used in  financing activities     |       | $        | (14,000    | )        | $          | (18,000 | ) |

 

Net cash provided by operating activities fluctuatesbetween periods primarily as a result of differences in operating earnings, thetiming of shipments and the collection of accounts receivable, changes in inventory,level of sales and payment of accounts payable. The $12,000 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 financingactivities is because of payments on long-term debt.  Management believes that the projected cashflow from operations, combined with its existing cash balances, will besufficient to meet its funding 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 primarytool for managing Torotel’s business. ROCE is measured by the 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**  | ** **                                 | **Measures how much sales is  generated** | ** ** | ** **                         |
| **of  sales**                                 | ** **                                 | **from each dollar of NOA**               | ** ** | ** **                         |
| **Quality  of Revenue**                       | ** **                                 | **Quantity of Revenue**                   | ** ** | ** **                         |

 

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

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and the majorityof its decisions going forward will be measured by whether Torotel’s ROCEimproves.  In fiscal 2005, 2006 and 2007,Torotel’s ROCE was 5.84%, 19.04% and -.66%, respectively.  Torotel’s ROCE for the 12-month trailingperiod ended July 31, 2007 was 3.66%.

**CriticalAccounting Policies**

*Useof Estimates*

The preparation of the consolidated financialstatements in conformity with accounting principles generally accepted in theUnited States of America requires management to make estimates and assumptionsthat 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, reservefor obsolete and excess inventory, the valuation allowance on deferred taxassets and the reserve for warranty costs. Accordingly, actual results could differ from those estimates.  Any changes in estimates are recorded in theperiod in which they become known.

*CreditRisk*

Financial instruments that potentially subject Torotelto concentrations 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.  Toroteldeposits all monies at the Bank of Blue Valley. These accounts are secured up to $100,000 by the Federal DepositInsurance Corporation.  At various timesand at July 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.

*FairValue of Financial Instruments*

Cost approximates market for all financial instrumentsas of July 31, 2007 and 2006.

*TreasuryStock*

Torotel utilizes the weighted average cost method inaccounting for its treasury stock transactions.

*RevenueRecognition*

Revenue is recognized on contracts and orders on thedate the product is 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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*Allowancefor Doubtful Accounts*

Grosstrade accounts receivable are offset with an allowance for doubtfulaccounts.  The allowance for doubtfulaccounts is management’s best estimate of the amount of probable credit lossesin Torotel’s existing accounts receivable. Management reviews the allowance for doubtful accounts on a regularbasis, and all past due balances are reviewed individually forcollectibility.  Account balances arecharged 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*

Inventoriesare stated at the lower of cost or market. Cost is determined using a moving average cost method of valuation thatcurrently and historically approximates the first-in, first-out method.  Torotel’s industry is characterized byshort-term customer 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 in detail utilizinga 12-month time horizon.  Individual partnumbers that have not had any usage in a 12-month time period are categorizedas obsolete; individual part numbers having more than a 12-month supply basedon the current year’s usage are categorized as excess.  The reserve balance is analyzed for adequacyalong 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-linemethod over estimated useful lives of three to five years for property andequipment, and ten to twenty years for buildings and improvements.

*CashFlows*

Forpurposes of the statements of cash flows, Torotel considers all short-terminvestments purchased with original maturity dates of three months or less tobe cash equivalents.

*EquityInvestment in Apex*

Torotelhas a 12.88% interest in Apex.  Theinvestment in Apex has no carrying value on the consolidated balance sheet ofTorotel, and in the opinion of Torotel management, it is not likely that any ofthe investment will be recovered because of Apex’s continued financiallosses.  If Apex were to eventually besold, any cash recovered would be recognized as a gain upon receipt of theproceeds.

*WarrantyCosts*

Torotelhas a reserve for estimated warranty costs associated with products returnedfrom customers.  A limited warranty isprovided for a period of one year which requires Torotel to repair or replacedefective 

 

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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-BasedCompensation*

Effective May 1,2006, Torotel adopted the fair value recognition provisions of Statement ofFinancial Accounting Standards No. 123 (revised 2004), “Share-BasedPayment” (SFAS 123(R)) using the modified prospective method of adoption underthe provisions of SFAS No. 148, *Accountingfor Stock-Based Compensation — Transition and Disclosure*.  Prior to May 1, 2006, Torotel accounted forall 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 thethree months ended July 31, 2006; the adoption of SFAS 123(R) for the SARsresulted in a cumulative effect reduction in stock compensation costs of $8,000for the same three-month period.

**Forward-LookingInformation**

*Thisreport, as well as our other reports filed with the Securities and ExchangeCommission (“SEC”), and in press releases and other public communicationsthroughout the year, contains forward looking statements made pursuant to thesafe harbor provisions of The Private Securities Litigation Reform Act of1995.  The words “believe,” “estimate,” “anticipate,”“project,” “intend,” “expect,” “plan,” “outlook,” “forecast,” “may,” “will,” “should,”“continue,” “predict” and similar expressions are intended to identify forwardlooking statements.  This report containsforward-looking statements regarding, among other topics, our expectedfinancial position, results of operations, cash flows, strategy, budgets andmanagement’s plans and objectives. Accordingly, these forward-looking statements are based on assumptionsabout a number of important factors. While we believe that our assumptions about such factors are reasonable,such factors involve risks and uncertainties that could cause actual results tobe different from what appear here. 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.*

**Item 3.**                          Controlsand Procedures

Torotel’s ChiefExecutive Officer and Chief Financial Officer (collectively, the “CertifyingOfficers”) are responsible for establishing and maintaining disclosure controlsand procedures (as defined in Exchange Act Rule 13a-15(e)) forTorotel.  Such officers have concluded(based upon their evaluation of these controls 

 

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and procedures as of a date within 90 days of thefiling of this report) that Torotel’s disclosure controls and procedures areadequate and effective for purposes of Rule 13a-14(c) in timely alerting themto material information relating to Torotel required to be included in Torotel’sfilings with the SEC under the Securities Exchange Act of 1934.  The Certifying Officers also have indicatedthat there were no changes during the period covered by this report in Torotel’sinternal controls over financial reporting or other factors that havematerially 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 6.   Exhibitsand Reports on Form 8-K**
|        | a)     | Exhibits            |                                                                                                                                                |   |
|--------|--------|---------------------|-----------------------------------------------------------------------------------------------------------------------------------------------------|--------|
|   |   |                |                                                                                                                                                |   |
|   |   | Exhibit 31.1        | Officer Certification                                                                                                                               |   |
|   |   | Exhibit 31.2        | Officer Certification                                                                                                                               |   |
|   |   | Exhibit 32.1        | Certification Pursuant to 18 U.S.C. Section 1350, as  Adopted Pursuant to         Section 906 of the Sarbanes-Oxley Act of 2002 |   |
|   |   | Exhibit 32.2        | Certification Pursuant to 18 U.S.C. Section 1350, as  Adopted Pursuant to        Section 906 of the Sarbanes-Oxley Act of 2002  |   |
|   |   |                |                                                                                                                                                |   |
|   | b)     | Reports on Form 8-K | There was one report filed on Form 8-K during the  three months ended  July 31, 2007.                                                               |   |
|        |        |                     |                                                                                                                                                     |        |  |

 

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**SIGNATURES**

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

**Torotel,Inc.(Registrant)**
| /s/ Dale H. Sizemore, Jr.       |   |   |
|--------------------------------------|--------|--------|
| Dale H. Sizemore, Jr.                |   |   |
| Chief Executive Officer              |   |   |
| Date:   September 14, 2007 |   |   |
|                                 |   |   |
|                                 |   |   |
|                                 |   |   |
| /s/ H. James Serrone            |   |   |
| H. James Serrone                     |   |   |
| Chief Financial Officer              |   |   |
| Date:   September 14, 2007 |   |   |

 

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