**FORM 10-QSB**

 

**Quarterly Report Under Section 13 or 15(d) of the SecuritiesExchange Act of 1934**

 

**For thequarterly period ended January 31, 2004**

 

**CommissionFile No. 1-8125**

 

| **TOROTEL, INC.**                                                                   |
|-------------------------------------------------------------------------------------|
| (Exact name of small  business issuer as specified in its charter)                  |
|                                                                                |   |   |
| **MISSOURI**                                                                        |   | **44-0610086** |
| (State or other  jurisdiction of  incorporation or organization)                    |   | (I.R.S. Employer  Identification No.) |
|                                                                                |   |   |
| **13402  SOUTH 71 HIGHWAY, GRANDVIEW, MISSOURI   64030**                       |
| (Address of principal  executive offices)                                           |
|                                                                                |   |   |
| **(816)  761-6314**                                                                 |
| (Issuer’s telephone  number)                                                   |
|                                                                                |   |   |
| **NONE**                                                                            |
| (Former name, former  address and former fiscal year, if changed since last report) |

 

Check whether the issuer (1) filed all reports required to be filed bySection 13 or 15(d) of the Exchange Act during the past 12 months and (2) hasbeen subject to such filing requirements for the past 90 days.

 

Yes  ý   No  o

 

As of March 11, 2004, there were 5,111,590 shares of Common Stock, $.01Par Value, outstanding.

 

 

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TOROTEL, INC. ANDSUBSIDIARIES

 

INDEX

 
| PART I.  FINANCIAL INFORMATION |     |                                                                                        |
|-------------------------------------|----------|---------------------------------------------------------------------------------------------|
|                                |     |                                                                                        |
|                                | Item 1.  | Financial Statements                                                                        |   |
|                                |     |                                                                                        |   |
|                                |     | Consolidated  Balance Sheet as of January 31, 2004                                          |   |
|                                |     |                                                                                        |   |
|                                |     | Consolidated  Statements of Operations for the nine months ended January 31, 2004 and 2003  |   |
|                                |     |                                                                                        |   |
|                                |     | Consolidated  Statements of Operations for the three months ended January 31, 2004 and 2003 |   |
|                                |     |                                                                                        |   |
|                                |     | Consolidated  Statements of Cash Flows for the nine months ended January 31, 2004 and 2003  |   |
|                                |     |                                                                                        |   |
|                                |     | Notes to Consolidated  Financial Statements                                                 |   |
|                                |     |                                                                                        |   |
|                                | Item  2. | Management’s  Discussion and Analysis or Plan of Operation                             |   |
|                                |     |                                                                                        |   |
|                                | Item  3. | Controls  and Procedures                                                                    |   |
|                                |     |                                                                                        |   |
| PART  II.  OTHER INFORMATION   |     |
|                                |     |                                                                                        |   |
|                                | Item  4. | Submission  of Matters to a Vote of Security Holders                                        |   |
|                                |     |                                                                                        |   |
|                                | Item  6. | Exhibits  and Reports on Form 8-K                                                           |   |
|                                |     |                                                                                        |   |
| SIGNATURES                          |     |                                                                                        |
|                                     |          |                                                                                             |  |  |  |

 

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PART I.     FINANCIALINFORMATION

 

Item 1.             FinancialStatements

 

CONSOLIDATED BALANCE SHEET (Unaudited)

As of January 31, 2004

 
| ASSETS                                     |   |       |      |
|--------------------------------------------|--------|------------|-----------|
|                                       |   |       |      |
| Current assets                             |   |       |      |
| Cash                                       |   | $          | 625,000   |   |
| Accounts  receivable, net                  |   | 506,000    |      |
| Inventories                                |   | 286,000    |      |
| Prepaid expenses  and other current assets |   | 37,000     |      |
|                                       |   | 1,454,000  |      |
|                                       |   |       |      |
| Property, plant  and equipment, net        |   | 296,000    |      |
|                                       |   |       |      |
| Other assets                               |   | 17,000     |      |
| Intangible  assets, net                    |   | 1,099,000  |      |
| Equity  investment                         |   | 887,000    |      |
|                                       |   |       |      |
|                                       |   | $          | 3,753,000 |   |
|                                       |   |       |      |
| LIABILITIES AND  STOCKHOLDERS’ EQUITY |   |       |      |
|                                       |   |       |      |
| Current  liabilities                       |   |       |      |
| Current  maturities of long-term debt      |   | $          | 46,000    |   |
| Trade accounts  payable                    |   | 236,000    |      |
| Accrued  liabilities                       |   | 133,000    |      |
|                                       |   | 415,000    |      |
|                                       |   |       |      |
| Long-term debt,  less current maturities   |   | 298,000    |      |
|                                       |   |       |      |
| Note payable to  stockholders              |   | 750,000    |      |
|                                       |   |       |      |
| Stockholders’  equity                 |   |       |      |
| Common stock, at  par value                |   | 52,000     |      |
| Capital in  excess of par value            |   | 12,362,000 |      |
| Accumulated  deficit                       |   | (9,919,000 | )         |
|                                       |   | 2,495,000  |      |
| Less treasury  stock, at cost              |   | 205,000    |      |
|                                       |   | 2,290,000  |      |
|                                       |   |       |      |
|                                       |   | $          | 3,753,000 |   |

 

The accompanying notesare an integral part of this statement.

 

1

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CONSOLIDATED STATEMENTS OF OPERATIONS (Unaudited)

Nine Months Ended January 31,

 
|                                    |   | **2004**  |      | **2003**  |   |
|-----------------------------------------|--------|-----------|-----------|-----------|--------|
| Net sales                               |   | $         | 3,203,000 |      | $      | 3,214,000 |   |
| Cost of goods  sold                     |   | 2,005,000 |      | 1,955,000 |   |
|                                    |   |      |      |      |   |
| Gross profit                            |   | 1,198,000 |      | 1,259,000 |   |
|                                    |   |      |      |      |   |
| Operating  expenses                     |   |      |      |      |   |
| Engineering                             |   | 143,000   |      | 144,000   |   |
| Selling, general  and administrative    |   | 734,000   |      | 727,000   |   |
| Amortization of  intangible assets      |   | 115,000   |      | 250,000   |   |
|                                    |   | 992,000   |      | 1,121,000 |   |
|                                    |   |      |      |      |   |
| Earnings from  operations               |   | 206,000   |      | 138,000   |   |
|                                    |   |      |      |      |   |
| Other expense  (income)                 |   |      |      |      |   |
| Interest expense                        |   | 53,000    |      | 61,000    |   |
| Equity in loss  of investee             |   | 178,000   |      | 33,000    |   |
| Impairment of  intangible assets        |   | 610,000   |      | 219,000   |   |
| Interest income                         |   | —    |      | (7,000    | )      |
| Gain on  settlement of debt             |   | (440,000  | )         | —    |   |
| Other, net                              |   | 1,000     |      | (1,000    | )      |
|                                    |   | 402,000   |      | 305,000   |   |
|                                    |   |      |      |      |   |
| Loss before  provision for income taxes |   | (196,000  | )         | (167,000  | )      |
|                                    |   |      |      |      |   |
| Provision for  income taxes             |   | 7,000     |      | —    |   |
|                                    |   |      |      |      |   |
| Net loss                                |   | $         | (203,000  | )         | $      | (167,000 | ) |
|                                    |   |      |      |      |   |
| Basic and  diluted loss per share       |   | $         | (.04      | )         | $      | (.03 | ) |

 

The accompanying notes arean integral part of these statements.

 

2

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CONSOLIDATED STATEMENTS OF OPERATIONS (Unaudited)

Three Months Ended January 31,

 
|                                    |   | **2004** |      | **2003** |   |
|-----------------------------------------|--------|----------|-----------|----------|--------|
| Net sales                               |   | $        | 1,006,000 |     | $      | 786,000 |   |
| Cost of goods  sold                     |   | 624,000  |      | 573,000  |   |
|                                    |   |     |      |     |   |
| Gross profit                            |   | 382,000  |      | 213,000  |   |
|                                    |   |     |      |     |   |
| Operating  expenses                     |   |     |      |     |   |
| Engineering                             |   | 49,000   |      | 47,000   |   |
| Selling, general  and administrative    |   | 243,000  |      | 240,000  |   |
| Amortization of  intangible assets      |   | 38,000   |      | 84,000   |   |
|                                    |   | 330,000  |      | 371,000  |   |
|                                    |   |     |      |     |   |
| Earnings (loss)  from operations        |   | 52,000   |      | (158,000 | )      |
|                                    |   |     |      |     |   |
| Other expense  (income)                 |   |     |      |     |   |
| Interest expense                        |   | 18,000   |      | 20,000   |   |
| Equity in loss  of investee             |   | 110,000  |      | 34,000   |   |
| Impairment of  intangible assets        |   | 610,000  |      | 219,000  |   |
| Interest income                         |   | —   |      | (2,000   | )      |
| Gain on  settlement of debt             |   | (440,000 | )         | —   |   |
| Other, net                              |   | 1,000    |      | —   |   |
|                                    |   | 299,000  |      | 271,000  |   |
|                                    |   |     |      |     |   |
| Loss before  provision for income taxes |   | (247,000 | )         | (429,000 | )      |
|                                    |   |     |      |     |   |
| Provision for  income taxes             |   | 7,000    |      | —   |   |
|                                    |   |     |      |     |   |
| Net loss                                |   | $        | (254,000  | )        | $      | (429,000 | ) |
|                                    |   |     |      |     |   |
| Basic and  diluted loss per share       |   | $        | (.05      | )        | $      | (.08 | ) |

 

The accompanying notesare an integral part of these statements.

 

3

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CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited)

Nine Months Ended January 31,

 
|                                                                            |   | **2004** |       | **2003** |       |
|---------------------------------------------------------------------------------|--------|----------|------------|----------|------------|
| Cash flows from operating  activities                                           |   |     | ** ** |     | ** ** |
| Net loss                                                                        |   | $        | (203,000   | )        | $          | (167,000 | ) |
| Adjustments to  reconcile net loss to net cash provided by operating activities |   |     |       |     |       |
| Loss on equity  in loss of investee                                             |   | 178,000  |       | 33,000   |       |
| Impairment of  intangible assets                                                |   | 610,000  |       | 219,000  |       |
| Gain on  settlements of debt                                                    |   | (440,000 | )          | —   |       |
| Depreciation and  amortization                                                  |   | 132,000  |       | 276,000  |       |
| Increase  (decrease) in cash flows from operations resulting from changes in    |   |     |       |     |       |
| Accounts  receivable                                                            |   | (14,000  | )          | 170,000  |       |
| Inventories                                                                     |   | (99,000  | )          | (81,000  | )          |
| Prepaid expenses  and other assets                                              |   | (26,000  | )          | (25,000  | )          |
| Trade accounts  payable                                                         |   | (42,000  | )          | 25,000   |       |
| Accrued  liabilities                                                            |   | (15,000  | )          | (66,000  | )          |
| Income taxes  payable                                                           |   | —   |       | (8,000   | )          |
|                                                                            |   |     |       |     |       |
| Net cash  provided by operating activities                                      |   | 81,000   |       | 376,000  |       |
|                                                                            |   |     |       |     |       |
| Cash flows from  investing activities                                           |   |     |       |     |       |
| Capital  expenditures                                                           |   | (27,000  | )          | (24,000  | )          |
| Proceeds from  note receivable                                                  |   | —   |       | 119,000  |       |
| Electronika  acquisition costs                                                  |   | —   |       | (53,000  | )          |
| Apex acquisition  costs                                                         |   | (89,000  | )          | (35,000  | )          |
|                                                                            |   |     |       |     |       |
| Net cash  provided by (used in) investing activities                            |   | (116,000 | )          | 7,000    |       |
|                                                                            |   |     |       |     |       |
| Cash flows from  financing activities                                           |   |     |       |     |       |
| Principal  payments on long-term debt                                           |   | (41,000  | )          | (113,000 | )          |
|                                                                            |   |     |       |     |       |
| Net cash used in  financing activities                                          |   | (41,000  | )          | (113,000 | )          |
|                                                                            |   |     |       |     |       |
| Net increase  (decrease) in cash                                                |   | (76,000  | )          | 270,000  |       |
| Cash, beginning  of period                                                      |   | 701,000  |       | 338,000  |       |
|                                                                            |   |     |       |     |       |
| Cash, end of  period                                                            |   | $        | 625,000    |     | $          | 608,000 |   |
|                                                                            |   |     |       |     |       |
| Supplemental  disclosures of cash flow Information                              |   |     |       |     |       |
| Cash paid during  the period for                                                |   |     |       |     |       |
| Interest                                                                        |   | $        | 53,000     |     | $          | 61,000 |   |
| Income taxes                                                                    |   | $        | 7,000      |     | $          | 8,000 |   |

 

The accompanying notesare an integral part of these statements.

 

4

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Unaudited)

 

Note 1 - Basis of Presentation

 

Torotel specializes in the custom design andmanufacture of a wide variety of precision magnetic components, consisting oftransformers, inductors, reactors, chokes and toroidal coils, for use incommercial, industrial and military electronics.  Torotel also designs and distributes ballast transformers for theairline industry.  Approximately 96% ofTorotel’s sales are derived from domestic customers.  The accompanying unaudited consolidated financial statementsreflect the normal recurring adjustments, which are, in the opinion ofmanagement, necessary to present fairly Torotel’s financial position at January31, 2004, and the results of operations for the nine months ended January 31,2004.

 

The financial statements contained herein should beread in conjunction with Torotel’s financial statements and related notes filedon Form 10-KSB for the year ended April 30, 2003.

 

Note 2 - Inventories

 

The components of inventories are summarized asfollows:

 
| Raw materials   |   | $       | 37,000  |   |
|-----------------|--------|---------|---------|--------|
| Work in process |   | 217,000 |    |
| Finished goods  |   | 32,000  |    |
|            |   | $       | 286,000 |   |

 

Note 3 - Income Taxes

 

Torotel has net operating loss carryforwards availableas benefits to reduce future income taxes, subject to applicablelimitations.  These operating losscarryforwards expire in various amounts in the years 2007 through 2014.

 

The difference between the financial and tax bases ofassets and liabilities is determined annually. Deferred income taxes and liabilities are computed for those differencesthat have future tax consequences using the currently enacted tax laws andrates that apply to the periods in which they are expected to affect taxableincome.  Valuation allowances areestablished, if necessary, to reduce the deferred tax asset to the amount thatwill, more likely than not, be realized. Income tax expense is the current tax payable or refundable for theperiod plus or minus the net change in the deferred tax assets orliabilities.  The following table summarizesthe components of the net deferred tax asset:

 
| Net operating loss  carryforwards |   | $         | 2,064,000 |   |
|-----------------------------------|--------|-----------|-----------|--------|
| Inventory valuation  reserve      |   | 189,000   |      |
| Depreciation and  amortization    |   | 151,000   |      |
| Disposal of ECH  liabilities      |   | 137,000   |      |
| Tax credit  carryforwards         |   | 19,000    |      |
| Other                             |   | 18,000    |      |
|                              |   | 2,578,000 |      |
| Less valuation  allowance         |   | 2,578,000 |      |
|                              |   | $         | —    |   |

 

5

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Note 4 - Earnings Per Share

 

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

 

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

 
|                                        |   | **2004**  |     | **2003**  |   |
|---------------------------------------------|--------|-----------|----------|-----------|--------|
| Net loss                                    |   | $         | (203,000 | )         | $      | (167,000 | ) |
| Weighted average  common shares outstanding |   | 5,111,590 |     | 5,111,590 |   |
| Incremental  shares                         |   | —    |     | —    |   |
|                                        |   |      |     |      |   |
| Basic and  diluted loss per share           |   | $         | (.04     | )         | $      | (.03 | ) |

 

**QuarterlyEPS Calculations**

** **
|                                        |   | **2004**  |     | **2003**  |   |
|---------------------------------------------|--------|-----------|----------|-----------|--------|
| Net loss                                    |   | $         | (254,000 | )         | $      | (429,000 | ) |
| Weighted average  common shares outstanding |   | 5,111,590 |     | 5,111,590 |   |
| Incremental  shares                         |   | —    |     | —    |   |
|                                        |   |      |     |      |   |
| Basic and  diluted loss per share           |   | $         | (.05     | )         | $      | (.08 | ) |

 

No incrementalshares are included in the Year-to-Date or Quarterly EPS calculations becauseof the net loss incurred in each of the periods.

 

Note 5 - Employee Stock Options

 

In accordance with the Incentive Compensation Planapproved by shareholders in 1994, Torotel reserved 400,000 common shares forissuance to key employees pursuant to the exercise of incentive andnon-qualified stock options granted prior to June 20, 2004.  The options are accounted for under APBOpinion 25, *Accounting for Stock Issued toEmployees*, and related interpretations.  The incentive stock options have a term of five years when issuedand vest 50% per year at the end of each of the first two years.  The non-qualified stock options have a termof ten years when issued and vest 25% per year at the end of each of the firstfour years.  The exercise price of eachoption equals the market price of Torotel’s common stock on the date ofgrant.  Accordingly, no compensationcost has been recognized for the Plan. Had compensation cost for the Plan been determined based on the fairvalue of the options at the grant dates consistent with the method of Statementof Financial Accounting Standards No. 123, *Accountingfor Stock-Based Compensation,*Torotel’s operating results would havebeen reduced to the pro forma amounts indicated below.

 

6

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# **Year-to-Date**

 
|                              |   |        |   | **2004** |     | **2003** |   |
|-----------------------------------|--------|-------------|--------|----------|----------|----------|--------|
| Net loss                          |   | As Reported |   | $        | (203,000 | )        | $      | (167,000 | ) |
|                              |   | Pro Forma   |   | $        | (207,000 | )        | $      | (174,000 | ) |
|                              |   |        |   |     |     |     |   |
| Basic and  diluted loss per share |   | As Reported |   | $        | (.04     | )        | $      | (.03 | ) |
|                              |   | Pro Forma   |   | $        | (.04     | )        | $      | (.03 | ) |

 

**Quarterly**

** **
|                              |   |        |   | **2004** |     | **2003** |   |
|-----------------------------------|--------|-------------|--------|----------|----------|----------|--------|
| Net loss                          |   | As Reported |   | $        | (254,000 | )        | $      | (429,000 | ) |
|                              |   | Pro Forma   |   | $        | (254,000 | )        | $      | (429,000 | ) |
|                              |   |        |   |     |     |     |   |
| Basic and  diluted loss per share |   | As Reported |   | $        | (.05     | )        | $      | (.08 | ) |
|                              |   | Pro Forma   |   | $        | (.05     | )        | $      | (.08 | ) |

 

The fair value of the incentive stock options grantedwas estimated on the date of grant using the Black-Scholes options-pricingmodel.  The fair value of the optionswas determined using the following weighted average assumptions: no dividendpayments over the life of the options; expected volatility of 551.0%; risk-freeinterest rate of 3.50%; and expected life of five years.

 

Stock option transactions under the 1994 IncentiveCompensation Plan for each period are summarized as follows:

 
|                                                            |   | **2004**                            |   | **2003**                     |   |
|-----------------------------------------------------------------|--------|-------------------------------------|--------|------------------------------|--------|
|                                                            |   | **Weighted  Shares  Under  Option** |   | **Average  Exercise  Price** |   | **Weighted  Shares  Under  Option** |   | **Average  Exercise  Price** |   |
| Outstanding at beginning  of period                             |   | 40,000                              |   | $                            | .37    |   | 40,000 |   | $ | .37 |   |
| Granted                                                         |   | —                              |   | —                       |   | — |   | — |   |
| Exercised                                                       |   | —                              |   | —                       |   | — |   | — |   |
| Forfeited                                                       |   | —                              |   | —                       |   | — |   | — |   |
| Outstanding at  end of period                                   |   | 40,000                              |   | $                            | .37    |   | 40,000 |   | $ | .37 |   |
|                                                            |   |                                |   |                         |   |   |   |   |   |
| Options  exercisable at end of period                           |   | 40,000                              |   | $                            | .37    |   | 20,000 |   | $ | .37 |   |
| Weighted average  fair value of options granted during the year |   |                                |   | —                       |   |   |   | — |   |

 

The following information applies to options outstanding at January 31,2004:

 
| Number outstanding                           |   | 40,000    |   |
|----------------------------------------------|--------|-----------|--------|
| Range of  exercise prices                    |   | $         | .37    |   |
| Weighted average  exercise price             |   | $         | .37    |   |
| Weighted average  remaining contractual life |   | 2.75 yrs. |   |

 

7

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Note 6 - Stock Warrants

 

A warrant certificate issued in May 1998 to purchase100,000 shares of Torotel, Inc. common stock at 75 cents per share expired onMay 4, 2003.  Stock warrant transactionsfor each period are summarized as follows:

 
|                                                             |   | **2004**                            |   | **2003**                     |   |
|------------------------------------------------------------------|--------|-------------------------------------|--------|------------------------------|--------|
|                                                             |   | **Weighted  Shares  Under  Option** |   | **Average  Exercise  Price** |   | **Weighted  Shares  Under  Option** |   | **Average  Exercise  Price** |   |
| Outstanding at  beginning of period                              |   | 100,000                             |   | $                            | .75    |   | 100,000 |   | $ | .75 |   |
| Granted                                                          |   | —                              |   | —                       |   | — |   | — |   |
| Exercised                                                        |   | —                              |   | —                       |   | — |   | — |   |
| Forfeited                                                        |   | (100,000                            | )      | $                            | .75    |   | — |   | —ss |   |
| Outstanding at  end of period                                    |   | —                              |   | —                       |   | 100,000 |   | $ | .75 |   |
|                                                             |   |                                |   |                         |   |   |   |   |   |
| Warrants  exercisable at end of period                           |   | —                              |   | —                       |   | — |   | — |   |
| Weighted average  fair value of warrants granted during the year |   |                                |   | —                       |   |   |   | — |   |

 

Note 7 – Impairment and Amortization of Intangibles

 

Torotel recognizedan impairment loss of $610,000 and $219,000 in the third quarter ended January31, 2004 and 2003, respectively.  Thiswrite-down pertained to certain technology-based intangible assets recognizedin the acquisition of Electronika in April 2002.  The impairment is a result of the economic condition of theairline industry and the lower than anticipated sales volume for ballasttransformers designed for certain aircraft. As a result, projected future cash flows from Electronika weredetermined to be less than the carrying value of these intangible assets. Therevised carrying value of the intangible assets was calculated using discountedestimated future cash flows.  Managementalso determined that the useful life of the technology-based intangible assetsshould be reduced.  As of January 31,2004, the residual balance of $1,099,000 for these intangible assets will beamortized over a weighted average period of seven years instead of twelve yearsas revised last year.  The followingtable provides the gross carrying value and accumulated amortization for eachmajor class of intangible asset based on Torotel’s reassessment of previouslyrecognized intangible assets and their remaining amortization lives inaccordance with the adoption of Statement of Financial Accounting Standards No.142, *Goodwill and Other Intangible Assets*:

 
|                |   |                           |   | **2004**                    |      | **2003**                      |   |
|---------------------|--------|--------------------------------|--------|-----------------------------|-----------|-------------------------------|--------|
|                |   | **Average  Amortizable  Life** |   | **Gross  Carrying  Amount** |      | **Accumulated  Amortization** |   | **Gross  Carrying  Amount** |   | **Accumulated  Amortization** |   |
| Order backlog       |   | 1                              |   | $                           | 205,000   |                          | $      | 205,000 |   | $ | 205,000 |   | $ | 154,000 |   |
| Aircraft - ballasts |   | 7                              |   | 1,348,000                   |      | 249,000                       |   | 1,958,000 |   | 96,000 |   |
|                |   |                           |   |                        |      |                          |   |   |   |   |   |
|                |   |                           |   | $                           | 1,553,000 |                          | $      | 454,000 |   | $ | 2,163,000 |   | $ | 250,000 |   |

 

The total intangible amortization expense for the nine months endedJanuary 31, 2004, was $115,000.  Theestimated aggregate amortization expense for each of the next five years is asfollows:

 

8

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| **Year  Ending****April 30,** |   | **Amount** |    |
|-------------------------------|--------|------------|---------|
| 2004                          |   | $          | 153,000 |   |
| 2005                          |   | 153,000    |    |
| 2006                          |   | 153,000    |    |
| 2007                          |   | 153,000    |    |
| 2008                          |   | 153,000    |    |
|                          |   |       |    |
|                          |   | $          | 765,000 |   |

 

Note 8 - Equity Investment

 

On May 23, 2003, Torotel purchased an additional355,637 common shares of Apex Innovations, Inc. (“Apex”) at 25 cents pershare.  Torotel now owns 4,355,637common shares of Apex.  Torotel’sownership position remains at 17.8%. The equity investment in Apex is accounted for using the equity methodof accounting.  As of January 31, 2004,there was a $408,000 difference between the $887,000 carrying value of theinvestment as reflected on the accompanying consolidated balance sheet and theunderlying equity in the net assets of Apex of $479,000.  This difference is treated as non-amortizinggoodwill.

 

The accompanyingconsolidated statements of operations include a loss of $178,000 and $33,000for the nine months ended January 31, 2004 and 2003, respectively, which resultfrom Torotel’s portion of Apex’s operating results for the nine months endedNovember 30, 2003 and 2002.  Condensedfinancial statements for Torotel’s investment in Apex are as follows:

** **

**Condensed Balance Sheet**

 
|                       |   | **November 30,  2003** |      |
|----------------------------|--------|------------------------|-----------|
| Current assets             |   | $                      | 1,012,000 |   |
| Other assets               |   | 7,240,000              |      |
|                       |   | $                      | 8,252,000 |   |
|                       |   |                   |      |
| Current  liabilities       |   | $                      | 1,193,000 |   |
| Other  liabilities         |   | 4,370,000              |      |
| Stockholders’  equity |   | 2,689,000              |      |
|                       |   | $                      | 8,252,000 |   |

 

**Condensed Statements of Operations**

 
|         |   | **9-Mos. Ended  November 30,  2003** |       | **9-Mos. Ended  November 30,  2002** |   | **3-Mos. Ended  November 30,  2003** |   | **3-Mos Ended  November 30,  2002** |     |
|--------------|--------|--------------------------------------|------------|--------------------------------------|--------|--------------------------------------|--------|-------------------------------------|----------|
| Net sales    |   | $                                    | 3,395,000  |                                 | $      | 4,161,000                            |   | $                                   | 910,000  |   | $ | 1,412,000 |   |
| Gross profit |   | $                                    | 1,257,000  |                                 | $      | 2,001,000                            |   | $                                   | 235,000  |   | $ | 587,000 |   |
| Net loss     |   | $                                    | (1,001,000 | )                                    | $      | (187,000                             | )      | $                                   | (618,000 | ) | $ | (190,000 | ) |

 

9

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Note 9 – Gain on Settlement of Debt

 

Other income as presented in the accompanyingconsolidated statements of operations for the three and nine months endedJanuary 31, 2004, includes a gain of $440,000 resulting from the dissolution ofEast Coast Holdings, Inc. (ECH), a wholly-owned subsidiary of Torotel, and itsremaining liabilities.  Several claimswere filed during fiscal years 2000-2002 by ECH vendors for collection ofamounts due, and more could be filed. However, ECH had no source of income to satisfy its trade debtobligations.  This trade debt remainedthe sole responsibility of ECH.  NeitherTorotel nor Torotel Products assumed these obligations.  While some of the claims by ECH vendorsresulted in judgments against ECH, neither Torotel or Torotel Products intendsto provide any funds to satisfy the judgments nor, in the opinion of legalcounsel, are they obligated to do so.

 

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Item 2.             Management’sDiscussion and Analysis or Plan of Operation

 

Overview

 

Torotel, Inc. (“Torotel”) conducts business primarilythrough two wholly-owned subsidiaries, Torotel Products, Inc. (“TorotelProducts”) and Electronika, Inc. (“Electronika”).  In addition, Torotel has a nearly 18% equity interest in ApexInnovations, Inc. (“Apex”).

 

Torotel Products designs and manufactures a widevariety of magnetic components for use in military, aerospace and industrialelectronic applications.  These magneticcomponents, which consist of transformers, inductors, reactors, chokes, andtoroidal coils, are used to modify and control electrical voltages and currentsin electronic devices.  For example, ifequipment containing one of these components receives an electrical voltage orcurrent which is too high for proper operation of the equipment, the componentwould modify and control the electrical voltage or current to allow properoperation of the equipment.  WhileTorotel Products primarily manufactures the components in accordance withpre-developed mechanical and electrical requirements, in some cases it will beresponsible for both the overall design and manufacture of the components.  The magnetic components are sold to manufacturerswho incorporate them into an end-product. The major applications include aircraft navigational equipment, voiceand data secure communications, medical equipment, avionics equipment, andconventional missile guidance systems. Torotel Products markets its components primarily through a direct salesforce and one independent manufacturers’ representative paid on a commissionbasis.  In addition, Torotel Products isan approved source on numerous applications, and generally is automaticallysolicited for any procurement needs for such applications.  The magnetic components manufactured byTorotel Products are sold primarily in the United States, and most sales areawarded on a competitive bid basis.  Themarkets in which Torotel Products competes are highly competitive.  A substantial number of companies sellcomponents of the type manufactured and sold by Torotel Products.  In addition, Torotel Products sells to anumber of customers who have the capability of manufacturing their ownelectronic components.  The ability ofTorotel Products to compete depends, among other things, upon its on-timedelivery performance, customized product engineering and technical support,marketing capabilities, quality assurance and manufacturing efficiency.  While magnetic components are notsusceptible to rapid technological change, Torotel Products’ market share issusceptible to decline given the highly competitive nature of the market.

 

Electronika is a marketing and licensing companyselling ballast transformers to the airline industry.  These transformers activate and control the lights in commercialairplane cockpits.  Electronika’sballast transformers are approved as spare and replacement parts in DC-8, DC-9,DC-10, MD-80, and MD-88 aircraft. However, sales of ballast transformers have been made primarily for usein DC-8 and DC-9 aircraft.  As a result,the business of Electronika is subject to various risks including, withoutlimitation, any decline in use of the referenced aircraft, and competition forthe available spare parts business. Electronika’s sales do not represent a significant portion of anyparticular market.  Electronika’srequirements for the ballast transformers are outsourced pursuant to aManufacturing Agreement with Magnetika, Inc. (“Magnetika”), a corporation ownedby Peter B. Caloyeras and his family. Under the terms of the agreement, Magnetika provides all necessary rawmaterial, labor, testing, packaging and related services required to completethe manufacture, delivery and sale of the ballast transformers.  Electronika retains ownership of alldesigns, drawings, specifications and intellectual property rights associatedwith the ballast transformers.

 

11

 

Torotel’s management is not involved in the daily operating activities of Apex; however, Dale H. Sizemore, Jr., Torotel’s chairman and chief executive officer, is a member of Apex’s board of directors.  ***i***-**INFO** is Apex’s umbrella term for a foundational system architecture of patented information management software products created by Apex primarily for government entities.

 

Business Outlook

 

Higher demand from military markets has contributed to increased sales at Torotel Products during the first nine months of fiscal year 2004.  This trend is expected to continue.  Torotel’s aerospace markets, specifically the components used in retrofitting and upgrading instrumentation and communication systems in existing aircraft, remain soft, but are expected to improve in the latter half of calendar 2004.  The rate of new order bookings at Torotel Products has increased 36% compared with last year because of the major contract received earlier this year for the potted coil assembly.  The primary factors that drive gross profit and net earnings for Torotel Products are sales volume and product mix.  The gross profits on mature products/programs and larger transformer devices tend to be higher than those which are still in the prototyping or early production stages and simpler inductor devices.  As a result, in any given accounting period the mix of product shipments between higher and lower margin jobs has a significant impact on the gross profit and net earnings of Torotel Products.  Electronika’s net sales continue to be impacted by the soft conditions in the aerospace market.  Because of the decline in Electronika’s sales, management is now targeting $4,200,000 in consolidated sales for fiscal 2004, down from $4,500,000 projected earlier in the year.

 

Torotel has entered into a real estate contract to purchase a 24,000square foot building in Olathe, Kansas, near its current operations.  Upon closing, which will take place no laterthan March 31, 2004, the operations of Torotel Products and Electronika-Kansaswill be consolidated into the new facility. Torotel Products will purchase the property, which will also serve asthe executive offices of Torotel, Inc. and Electronika, Inc.  The move will be completed in April, atwhich time the company intends to sell its Grandview, Missouri property.  The purchase price of the new building is$900,000.  This amount, along withimprovements of approximately $50,000, will be paid with funds from a newlending source.  Electronika-Kansas hasbeen leasing approximately 8,300 square feet in an office/industrial park inOlathe.  This lease will expire on March31, 2004.

 

Management believes the move will be beneficial inmatching near and long-term manufacturing requirements with the needs of majorcustomers, who are demanding more flexibility in production schedules andshorter lead times.  Rather thanconsolidating into the existing facility in Grandview, management selected theOlathe facility because it offers a better opportunity to organize themanufacturing processes in such a way to improve efficiencies and to differentiateTorotel in the market with shorter lead times. Additionally, the new facility will give Torotel the opportunity toincrease sales by expanding its product offerings to include larger units withhigher KVA and voltage ratings as well as sub-assemblies, which is the secondstep in our long-term strategy.

 

Since the new facility is only about 15 miles fromGrandview, management expects to retain most of the existing Grandviewemployees.  A 15-person workforce isalready in place in Olathe, initially doing work for our Electronikasubsidiary, plus the Olathe area has been identified as a good resource forrecruiting skilled electronics workers. Initially, management anticipates around 70 people being employed in thenew facility.  The State of Kansas hasoffered some relocation incentives that made this decision even moreattractive.

 

12

 

Results of 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.

 

NINE MONTHS ENDED JANUARY 31, 2004 VERSUS NINE MONTHS ENDED JANUARY 31,2003

 

Net sales decreased slightly.  The net sales of Torotel Products increasednearly 12% from $2,682,000 to $2,992,000. This increase was attributable to higher demand from Torotel’s militarymarkets.  The net sales of Electronikadecreased 60% from $532,000 to $211,000. This decrease is attributable to the soft conditions in the aerospacemarket.

 

Gross profit as apercentage of net sales decreased 2%. The gross profit percentage of Torotel Products increased 3% because ofhigher sales volume without a comparable increase in fixed productioncosts.  Electronika’s gross profit as apercentage of net sales decreased 48% because of labor and overhead costsincurred at the manufacturing facility in Olathe, Kansas.

 

Engineering expenses, applicable only to TorotelProducts, decreased nearly 1% from $144,000 to $143,000 because of lower travelcosts.  Management does anticipate anincrease in the present level of engineering expenses as the plan is to hire anadditional engineer.

 

Selling, general and administrative (SG&A)expenses increased 1%.  The SG&Aexpenses of Torotel, Inc. increased 4% from $199,000 to $207,000 primarilybecause of higher director fees associated with the addition of two new membersto the board of directors.  The SG&Aexpenses of Torotel Products decreased 2% from $505,000 to $494,000 primarilybecause of a decrease in incentive compensation awards.  The SG&A expenses of Electronikaincreased 43% from $23,000 to $33,000 because of administrative costsassociated with the Olathe manufacturing facility.  Management does anticipate an increase in the present level ofSG&A expenses because of higher depreciation costs associated with the newbuilding purchase (see Note 10 of Notes to Consolidated Financial Statements)and the plan to hire an additional sales representative.

 

Amortization costs, entirely attributable toElectronika, decreased 54% from $250,000 to $115,000 (see Note 7 of Notes toConsolidated Financial Statements).

 

Interest expense decreased 13%. The interest expense of Torotel, Inc. decreased 11% from $46,000 to$41,000 because of a lower debt balance. The interest expense of Torotel Products decreased 20% from $15,000 to$12,000 because of a lower debt balance and a lower annual interest rate on themortgage payable to United Trust Bank.

 

Equity in loss of investee was $178,000 compared to$33,000 in the prior year (see Note 8 of Notes to Consolidated FinancialStatements).

 

Impairment costs, entirely attributable to Electronika, increased 178%from $219,000 to $610,000(see Note 7 of Notes to Consolidated Financial Statements).

 

Interest income decreased $7,000 due to the payoff ofthe note receivable from SIGMA.

 

13

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Gain on settlement of debt of $440,000 resulted fromthe dissolution of East Coast Holdings, Inc., a wholly-owned subsidiary ofTorotel, and its remaining liabilities (see Note 9 of Notes to Consolidated FinancialStatements).

 

For the reasons discussed above, the consolidated pretax loss increasedfrom $167,000 to $196,000.  The pretaxearnings of Torotel, Inc. increased from a loss of $270,000 to a profit of$14,000.  The pretax earnings of TorotelProducts increased from $341,000 to $555,000. The pretax loss of Electronika increased from $238,000 to $765,000.

 

THREE MONTHS ENDED JANUARY 31, 2004 VERSUS THREE MONTHS ENDED JANUARY31, 2003

 

Net sales increased 28%.  The net sales of Torotel Products increased 37% from $678,000 to$930,000.  This increase wasattributable to higher demand from Torotel’s military markets.  The net sales of Electronika decreased 30%from $108,000 to $76,000.  This decreaseis attributable to the soft conditions in the aerospace market.

 

Gross profit as a percentage of net sales increased11%.  The gross profit percentage ofTorotel Products increased 10% because of higher sales volume without acomparable increase in fixed production costs. Electronika’s gross profit as a percentage of net sales was at breakevenbecause of the labor and overhead costs incurred at the manufacturing facilityin Olathe, Kansas.

 

Engineering expenses, applicable only to TorotelProducts, increased 4% from $47,000 to $49,000 because of higher payroll costs.  Management does anticipate an increase inthe present level of engineering expenses as the plan is to hire an additionalengineer.

 

Selling, general and administrative (SG&A)expenses increased 1%.  The SG&Aexpenses of Torotel, Inc. increased nearly 7% from $62,000 to $66,000 primarilybecause of higher director fees associated with the addition of two new membersto the board of directors.  The SG&Aexpenses of Torotel Products decreased nearly 4% from $171,000 to $165,000primarily because of lower professional fees. The SG&A expenses of Electronika increased slightly from $7,000 to$9,000 because of administrative costs associated with the Olathe manufacturingfacility.  Management does anticipate anincrease in the present level of SG&A expenses because of higherdepreciation costs associated with the new building purchase (see Note 10 ofNotes to Consolidated Financial Statements) and the plan to hire an additionalsales representative.

 

Amortization costs, entirely attributable toElectronika, decreased 55% from $84,000 to $38,000 (see Note 7 of Notes toConsolidated Financial Statements).

 

Interest expense decreased 10%.  The interest expense of Torotel, Inc.decreased 10% from $15,000 to $14,000 because of a lower debt balance.  The interest expense of Torotel Productsdecreased 20% from $5,000 to $4,000 because of a lower debt balance and a lowerannual interest rate on the mortgage payable to United Trust Bank.

 

Equity in loss of investee was $110,000 compared to $34,000 in theprior year (see Note 8 of Notes to Consolidated Financial Statements).

 

Impairment costs, entirely attributable to Electronika, increased 178%from $219,000 to $610,000 (see Note 7 of Notes to Consolidated FinancialStatements).

 

Gain on settlement of debt of $440,000 resulted from the dissolution ofEast Coast Holdings, Inc., a wholly-owned subsidiary of Torotel, and itsremaining liabilities (see Note 9 of Notes to Consolidated FinancialStatements).

 

Interest income decreased $2,000 due to the payoff ofthe note receivable from SIGMA.

 

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For the reasons discussed above, the consolidated pretax loss decreasedfrom $429,000 to $247,000.  The pretaxearnings of Torotel, Inc. increased from a loss of $109,000 to profit of$250,000.  The pretax earnings ofTorotel Products increased from a loss of $9,000 to a profit of $164,000.  The pretax loss of Electronika increasedfrom $311,000 to $661,000.

Liquidity and Capital Resources

 

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

 
|                                                 |   | **2004** |     | **2003** |   |
|------------------------------------------------------|--------|----------|----------|----------|--------|
| Net cash  provided by operating activities           |   | $        | 81,000   |     | $      | 376,000 |   |
| Net cash  provided by (used in) investing activities |   | $        | (116,000 | )        | $      | 7,000 |   |
| Net cash used in  financing activities               |   | $        | (41,000  | )        | $      | (113,000 | ) |

 

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 ininventory, level of sales and payment of accounts payable.  The increase in net cash used in investingactivities is because of the additional $89,000 investment in Apex (see Note 8of Notes to Consolidated Financial Statements) and capital expenditures of$27,000.  Aside from the building purchasediscussed in the Business Outlook section above, management anticipatesapproximately $20,000 in capital expenditures during the balance of fiscal2004.  The decrease in net cash used infinancing activities is because of lower debt balances during the currentyear.  Management believes that the cashflow generated from operations and when necessary, from existing cash balances,will be sufficient to meet its funding requirements for the foreseeable future.  As part of the financing package for the buildingpurchase, Torotel is establishing a $200,000 bank line of credit, which couldbe utilized, if required, to help fund growth.

 

Management believes that inflation will have only aminimal effect on future operations since such effects will be offset by salesprice increases, which are not expected to have a significant effect upondemand*.*

 

Forward-Looking Information

 

This report, as well as our other reports filed withthe Securities and Exchange Commission (“SEC”), and in press releases and otherpublic communications throughout the year, contains forward-looking statementsmade pursuant to the safe harbor provisions of The Private SecuritiesLitigation Reform Act of 1995. Forward-looking statements include all information on our expectedfinancial position, results of operations, cash flows, strategy, budgets andmanagement’s plans and objectives. These forward-looking statements are based on assumptions about a numberof important factors and involve risks and uncertainties that could cause actualresults to be different from what appear here. These risk factors include: impairment of intangible assets, 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, issues involved in relocatingmanufacturing operations, and other risks and uncertainties.  In light of these risks and uncertainties,there can be no assurance that the forward-looking information contained inthis report will prove accurate, and our actual results may differ materiallyfrom these forward-looking statements.

 

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Item 3.             Controls andProcedures

 

Torotel’s Chief Executive Officer and Chief FinancialOfficer (collectively, the “Certifying Officers”) are responsible forestablishing and maintaining disclosure controls and procedures.  Such officers have concluded (based upontheir evaluation of these controls and procedures as of a date within 90 daysof the filing of this report) that Torotel’s disclosure controls and proceduresare effective to ensure that information required to be disclosed in thisreport is accumulated and communicated to Torotel’s management, including itsprincipal executive officers as appropriate, to allow timely decisionsregarding required disclosure.  TheCertifying Officers also have indicated that there were no significant changesin Torotel’s internal controls or other factors that could significantly affectsuch controls subsequent to the date of their evaluation, and there were nocorrective actions with regard to significant deficiencies and materialweaknesses.

 

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PART II.                                                 OTHERINFORMATION

 

Item 4.             Submission of Mattersto a Vote of Security Holders

 

                                                Theannual meeting of stockholders was held in Grandview, Missouri, on Monday,September 15, 2003, to elect a Board of Directors.  At the meeting, there were 3,178,489 shares voting, with nomineesneeding 1,589,246 shares to be elected. Stockholders elected the following individuals to a one-year term on theBoard of Directors, with the number of shares voting “FOR” each nomineeindicated.

 

| Anthony H. Lewis      |   | 3,148,346 |
|-----------------------|--------|-----------|
| H. James Serrone      |   | 3,148,346 |
| Dale H. Sizemore, Jr. |   | 3,178,087 |
| Richard A. Sizemore   |   | 3,178,086 |
| Stephen K. Swinson    |   | 3,148,345 |

 

Item 6.             Exhibits and Reportson 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 Form8-K                      There weretwo reports filed on Form 8-K during the three months ended January 31, 2004.

 

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SIGNATURES

 

In accordance with the requirements of the SecuritiesExchange Act of 1934, the Registrant has duly caused this report to be signedon its behalf by the undersigned, thereunto duly authorized.

 

 
| Torotel, Inc.                    |           |
|----------------------------------|----------------|
| (Registrant)                     |           |
|                             |           |
|                             |           |
| /s/  Dale H.  Sizemore, Jr. |           |   |
| Dale H. Sizemore, Jr.            |           |   |
| Chief Executive Officer          |           |   |
| Date:                            | March 11, 2004 |   |   |
|                             |           |
|                             |           |
| /s/  H. James  Serrone      |           |   |
| H. James Serrone                 |           |   |
| Chief Financial Officer          |           |   |
| Date:                            | March 11, 2004 |   |   |
|                                  |                |  |  |  |  |

 

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