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UNITED STATES SECURITIES AND EXCHANGE
COMMISSION
Washington, D.C.  20549
 
FORM 10-Q
 
x
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 
For the quarterly period ended July 31, 2011
 
or
 
o
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 
For the transition period from [     ] to [     ]
 
Commission File No. 1-8125
 
TOROTEL, INC.
(Exact name of registrant as specified in its charter) 
MISSOURI
 
44-0610086
(State or other jurisdiction of incorporation or
organization)
 
(I.R.S. Employer Identification No.)
 
 
 
620 NORTH LINDENWOOD DRIVE, OLATHE,
KANSAS
 
66062
(Address of principal executive offices)
 
(Zip Code)
 
(913) 747-6111
(Registrant’s telephone number, including area code)
 
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.  Yes x  No o
 
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).  Yes x  No o
 
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company.  See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.
 
Large accelerated filer o
 
Accelerated filer o
 
 
 
Non-accelerated filer o
(Do not check if a smaller reporting company)
 
Smaller reporting company x
 
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Securities Exchange Act of 1934).  Yes o  No x
 
As of September 12, 2011, there were 5,828,650 shares of Common Stock, $.01 par value, outstanding. 


TOROTEL, INC. AND SUBSIDIARIES

INDEX
 
 
 
 
 
 
 
 
 
 
 
 
Item 1
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Item 2
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Item 3
 
 
 
 
 
 
 
Item 4
 
 
 
 
 
 
 
 
 
 
 
 
 
Item 4
 
 
 
 
 
 
 
Item 6
 
 
 
 
 
 
 
 
 
 
 
 



PART I.         FINANCIAL INFORMATION
 
Item 1.           Financial Statements
 
CONSOLIDATED CONDENSED BALANCE SHEETS
 
 
(Unaudited)
As of
July 31,
2011
As of
April 30,
2011
ASSETS
 

 

 
 
 
Current assets:
 

 

Cash
$
638,000

$
490,000

Trade receivables, net
1,293,000

2,208,000

Inventories, net
1,333,000

1,401,000

Prepaid expenses and other current assets
87,000

55,000

Deferred income taxes
130,000

250,000

 
3,481,000

4,404,000

 
 
 
Property, plant and equipment, net
1,380,000

1,339,000

 
 
 
Deferred income taxes
478,000

358,000

Other assets
66,000

21,000

 
 
 
 
$
5,405,000

$
6,122,000

 
 
 
LIABILITIES AND STOCKHOLDERS’ EQUITY
 

 

 
 
 
Current liabilities:
 

 

Current maturities of long-term debt
$
139,000

$
125,000

Trade accounts payable
495,000

630,000

Accrued liabilities
244,000

336,000

Accrued income taxes

8,000

Customer deposits
593,000

826,000

 
1,471,000

1,925,000

 
 
 
Long-term debt, less current maturities
892,000

899,000

 
 
 
Stockholders’ equity
3,042,000

3,298,000

 
 
 
 
$
5,405,000

$
6,122,000

 
The accompanying notes are an integral part of these statements.

1


CONSOLIDATED STATEMENTS OF OPERATIONS (Unaudited)
 
 
Three Months Ended
 
July 31,
July 31,
 
2011
2010
Net sales
$
2,548,000

$
2,494,000

Cost of goods sold
1,908,000

1,597,000

 
 
 
Gross profit
640,000

897,000

 
 
 
Operating expenses:
 

 

Engineering
166,000

69,000

Selling, general and administrative
721,000

606,000

 
887,000

675,000

Earnings (loss) from operations
(247,000
)
222,000

 
 
 
Other expense (income):
 

 

Interest expense
12,000

10,000

Interest income

(3,000
)
 
12,000

7,000

 
 
 
Earnings (loss) before provision for income taxes
(259,000
)
215,000

 
 
 
Provision for income taxes


 
 
 
Net earnings (loss)
$
(259,000
)
$
215,000

 
 
 
Basic earnings (loss) per share
$
(0.05
)
$
0.04

 
The accompanying notes are an integral part of these statements.

2


CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited)
 
 
Three Months Ended
 
July 31,
July 31,
 
2011
2010
Cash flows from operating activities:
 

 

Net earnings (loss)
$
(259,000
)
$
215,000

Adjustments to reconcile net earnings (loss) to net cash used in operating activities:
 

 

Stock compensation earned
3,000

12,000

Depreciation
71,000

31,000

Change in value of stock appreciation rights
(11,000
)
7,000

Increase (decrease) in cash flows from operations resulting from changes in:
 

 

Trade receivables
915,000

(326,000
)
Inventories
68,000

(56,000
)
Prepaid expenses and other assets
(77,000
)
(66,000
)
Trade accounts payable
(135,000
)
294,000

Accrued liabilities
(81,000
)
(110,000
)
Customer deposits
(233,000
)
(255,000
)
Income taxes payable
(8,000
)

 
 
 
Net cash provided by (used in) operating activities
253,000

(254,000
)
 
 
 
Cash flows from investing activities:
 

 

Capital expenditures
(72,000
)
(47,000
)
 
 
 
Net cash used in investing activities
(72,000
)
(47,000
)
 
 
 
Cash flows from financing activities:
 

 

Principal payments on long-term debt
(25,000
)
(19,000
)
Payments on capital lease obligations
(8,000
)
(6,000
)
 
 
 
Net cash provided by (used in) financing activities
(33,000
)
(25,000
)
 
 
 
Net increase (decrease) in cash
148,000

(326,000
)
Cash, beginning of period
490,000

1,030,000

 
 
 
Cash, end of period
$
638,000

$
704,000

 
 
 
Supplemental Disclosures of Cash Flow Information:
 

 

 
 

 

Cash paid during the period for interest
$
12,000

$
10,000

Cash paid during the period for income taxes
$
8,000

$

 
 
 
Non-cash investing and financing activities:
 

 

Capital expenditure
$
(41,000
)
$
(13,000
)
Proceeds from capital lease
$
41,000

$
13,000

 
The accompanying notes are an integral part of these statements.

3


NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS (Unaudited)
 
Note 1 — Basis of Presentation
 
The consolidated condensed balance sheet as of April 30, 2011, which has been derived from audited financial statements, is accompanied by the unaudited interim consolidated condensed financial statements, which reflect the normal recurring adjustments that in the opinion of management are necessary to present fairly Torotel’s consolidated financial position at July 31, 2011, and the consolidated results of operations for the three months ended July 31, 2011.
 
The unaudited interim consolidated condensed financial statements have been prepared pursuant to the rules and regulations of the Securities and Exchange Commission.  Certain information and note disclosures normally included in the annual financial statements prepared in accordance with generally accepted accounting principles have been condensed or omitted pursuant to those rules and regulations, although management believes the disclosures made are adequate to make the information not misleading.
 
The financial statements contained herein should be read in conjunction with Torotel’s consolidated financial statements and related notes filed on Form 10-K for the year ended April 30, 2011.
 
Note 2 — Nature of Operations
 
Torotel, Inc. (“Torotel”) conducts business primarily through three wholly owned subsidiaries, Torotel Products, Inc. (“Torotel Products”), Torotel Manufacturing Corp. (“TMC”), and Electronika, Inc. (“Electronika”).  TMC provides manufacturing services to Torotel Products.  Torotel specializes in the custom design and manufacture of a wide variety of precision magnetic components, consisting of transformers, inductors, reactors, chokes and toroidal coils, for use in commercial, industrial and military electronics.  Torotel also designs and distributes ballast transformers for the airline industry.  Approximately 98% of Torotel’s sales during the first three months of fiscal 2011 have been derived from domestic customers.
 
Note 3 — Inventories
 
The components of inventories are summarized as follows:
 
 
July 31,
2011
April 30,
2011
Raw materials
$
900,000

$
983,000

Work in process
324,000

300,000

Finished goods
109,000

118,000

 
$
1,333,000

$
1,401,000

 
Note 4 — Income Taxes
 
For the three months ended July 31, 2011 and July 31, 2010, the effective tax rate was 0% and 0%, respectively.  The effective tax rate for the three months ended July 31, 2011 and 2010 differs from our estimated statutory rate of 38% primarily due to income or loss from operations, depreciation and amortization differences, permanent tax adjustments, and a valuation allowance against the Company's deferred income tax assets. Torotel believes that the current net deferred income tax asset, as well as the allocation between current and non-current assets, remains appropriate as of July 31, 2011.

As of July 31, 2011, the federal tax returns for the fiscal years ended 2007 through 2011 will remain open to audit until the statute of limitations closes for the years in which the net operating losses are utilized.  Torotel would recognize interest and penalties accrued on unrecognized tax benefits as well as interest received from favorable tax settlements within income tax expense.  As of July 31, 2011, Torotel recorded no accrued interest or penalties related to uncertain tax positions.  Management expects no significant change in the amount of unrecognized tax benefit, accrued interest or penalties within the next twelve months.

Note 5 — Financing Agreements
 
The revolving line of credit, to be used for working capital purposes, has a capacity of $500,000 with a 12-month term that is renewable annually.  The borrowing base of this facility is limited to 75% of eligible receivables.  The associated interest rate is equal to the greater of the floating Commerce Bank Prime Rate (currently 3.25 percent) or a floor of 4 percent.  Monthly

4


repayments of interest only are required with the principal due at maturity.  This facility is cross collateralized and cross defaulted with all other facilities and is secured by a first lien on all business assets of Torotel Products.  As of July 31, 2011, the entire credit line was available and we anticipate renewal of the credit line on similar terms.

 
Note 6 — Restricted Stock Agreements
 
Restricted Stock Agreements are authorized by the Compensation and Nominating Committee ("Committee") and the Board of Directors of Torotel. The Committee and the Board have determined that the interests of Torotel and its stockholders will be promoted by hiring talented individuals and, to induce such individuals to accept employment with Torotel, the Committee and the Board believe a key component of such individuals' compensation should be granting equity ownership opportunities based upon the acceptance of employment and the continuing employment of such individual, subject to certain conditions and restrictions. The Restricted Stock Agreements afford the grantees all of the rights of a stockholder with respect to the award shares, including the right to vote such shares and to receive dividends and other distributions payable with respect to such shares since the Date of Award. Under the terms of each agreement, the non-vested shares are restricted as to disposition and subject to forfeiture under certain circumstances. The agreements further provide, subject to certain conditions, that if prior to all of the restricted shares having been released, Torotel undergoes a change in control, then all of the restricted shares shall be released and no longer subject to restrictions under the agreements. Upon issuance of the restricted stock, the aggregate number of shares issued is credited to common stock at $.01 par value per share and the excess of the market price of the common stock on the date of issuance over the par value is credited to capital in excess of par value. The restricted shares are treated as non-vested stock; accordingly, the fair value of the restricted stock at the date of award is offset against capital in excess of par value in the accompanying consolidated balance sheets under stockholders' equity.

The Restricted Stock Agreements with Benjamin E. Ames, Jr. were terminated in April 2009 and the unearned cost of $54,000 was recognized in fiscal 2009. These agreements, dated July 31, 2006 and August 7, 2007, represented 190,000 non-vested newly issued common shares of Torotel. These were newly issued shares from the number of authorized shares remaining to be issued. Pursuant to the terms of the agreement dated July 31, 2006, 40,000 shares were released from the restrictions on transfer on July 31, 2007 and 2008. Mr. Ames is now employed by Torotel Products under a new compensation arrangement and with different job responsibilities.

Torotel has Restricted Stock Agreements dated August 7, 2007, with eight key employees pursuant to the Stock Award Plan ("SAP"). The SAP provides key employees the opportunity to acquire newly issued common stock of Torotel pursuant to awards earned for accomplishing goals that promote the long-term financial performance of Torotel. Under the terms of the SAP, which was filed as Exhibit 10.9 of Form 10-KSB for the fiscal year ended April 30, 2007, the restricted stock awards have a 5-year restriction period, which shall lapse based on certain conditions as outlined in the SAP. As of July 31, 2011, the aggregate amount of the existing restricted stock awards was 312,900 shares. These were newly issued shares from the number of authorized shares remaining to be issued. Stock compensation cost of $8,000 for the existing restricted stock awards, net of an appropriate pre-vesting forfeiture rate, will be recorded per quarter during the remaining five-year vesting period provided the financial performance metrics as outlined in the Restricted Stock Agreement are likely to be attained. However, due to the uncertainty of the outcome of financial performance metrics as outlined in the Restricted Stock Agreement, Torotel has stopped amortizing the stock compensation cost associated with the restricted stock awarded on August 7, 2007 until more information becomes available. As of the date of this filing, Torotel anticipates that the likelihood of the vesting of the restricted stock issued under the August 7, 2007 Restricted Stock Agreement is more than remote but less than probable.

On September 2, 2009, Torotel entered into Restricted Stock Agreements with two key employees (Messrs. Sizemore and Serrone) pursuant to the SAP. The aggregate amount of the restricted stock awards was 250,000 shares of common stock, $.01 par value per share. These shares were transferred from treasury shares. Based on the market price of $0.27 for Torotel's common stock as of September 2, 2009, the fair value of the restricted stock at the date of award was $67,500. Stock compensation cost of $3,000, net of an appropriate pre-vesting forfeiture rate, will be recorded per quarter during the five-year vesting period provided the financial performance metrics as outlined in the Restricted Stock Agreement are likely to be attained.
 
Total stock compensation cost for all Restricted Stock Agreements for the three months ended July 31, 2011 and 2010 was $3,000 and $12,000, respectively. 

Restricted stock activity for the three month periods ended July 31 is summarized as follows:
 

5


 
2011
 
2010
 
Restricted
Shares
Under
Option
Weighted
Average
Grant
Price
 
Restricted
Shares
Under
Option
Weighted
Average
Grant
Price
Outstanding at May 1
562,900

$
0.398

 
607,350

$
0.405

Granted


 


Vested


 


Forfeited


 


Outstanding at July 31
562,900

$
0.398

 
607,350

$
0.405

 
Note 7 — Stockholders’ Equity
 
The components of stockholders’ equity are summarized as follows:
 
 
July 31,
2011
April 30,
2011
Common stock, at par value
$
60,000

$
60,000

Capital in excess of par value
12,709,000

12,623,000

Accumulated deficit
(9,708,000
)
(9,366,000
)
 
3,061,000

3,317,000

Less treasury stock, at cost
19,000

19,000

 
$
3,042,000

$
3,298,000

 
Torotel has 6,000,000 shares of common stock, $.01 par value, authorized and 5,828,650 shares issued and outstanding.  The changes in shares of common stock outstanding as of July 31 of each period are summarized as follows:

 
2011
2010
Balance, May 1
5,828,650

5,873,100

Restricted stock activity


Treasury stock activity


 
 
 
Balance, July 31
5,828,650

5,873,100

 
Note 8 — Earnings Per Share
 
Basic earnings per share is computed using the two-class method. The two-class method is an earnings allocation formula that determines net income per share for each class of common stock and participating security according to dividends declared and participation rights in undistributed earnings. Per share amounts are computed by dividing net income attributable to common shareholders by the weighted average shares outstanding during each period.
 
The basic earnings per common share were computed as follows:
 
Year-to-Date EPS Calculations


 
2011
2010
Net earnings (loss)
$
(259,000
)
$
215,000

Amounts allocated to participating securities (nonvested restricted shares)

(22,000
)
Net income (loss) attributable to common shareholders 
$
(259,000
)
$
193,000

Basic weighted average common shares
5,265,750

5,265,750

Earnings per share attributable to common shareholders:
 

 

Basic earnings (loss) per share
$
(0.05
)
$
0.04


6


 
ASC 260, Earnings per Share, provides that unvested share-based payment awards that contain non-forfeitable rights to dividends are considered to be participating securities and must be included in the computation of earnings per share pursuant to the two-class method.  Diluted earnings per share is not presented as Torotel does not have any shares considered incremental and dilutive. For the year-to-date 2011 earnings per share calculation, the participating securities identified above do not contain contractual obligations to participate in the losses of Torotel and are not classified using the two-class method.

Note 9 — Stock Appreciation Rights
 
The board of directors of Torotel approved the Directors Stock Appreciation Rights Plan (the “Plan”) for non-employee directors in September 2004.  Each stock appreciation right (“SAR”) is equal to one share of common stock of Torotel, and the aggregate number of SARs that may be granted under the Plan shall not exceed 500,000.  The effective date of the Plan is October 1, 2004, and the Plan has a term of 10 years.
 
Pursuant to the Plan, 20,000 SARs were granted on the effective date to each of the three current non-employee directors serving at that time.  The initial price at which each SAR was granted was $.35, which equaled the market price of Torotel’s common stock on the date of grant.  Accordingly, no compensation cost was recognized at the time of grant.
 
SARs shall automatically be granted in the future as follows: (1) each person who is elected as a director, who was not a director on the effective date of the Plan, shall be granted 10,000 SARs on the date such person is elected a director; and (2) on each May 1 following the effective date during the term of the Plan, each person serving as a director on such date shall be granted 10,000 SARs.  After the initial grant the price at which each SAR is granted shall be the average of the closing price of Torotel’s common stock for the 10 consecutive days immediately preceding the date of grant.  Upon exercise of a SAR, Torotel will pay the grantee an amount (the “Spread”) equal to the excess of the Exercise Price over the SAR grant price multiplied by the number of shares being exercised.  The Exercise Price shall be the average of the closing price of Torotel’s common stock for the 10 consecutive days immediately preceding the notice of exercise.  For any payments that exceed $10,000, Torotel has the option to make quarterly payments over 3 years with interest payable quarterly at the prime rate of Torotel’s primary bank.
 
Each SAR granted under the Plan may be exercised to the extent 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 Torotel director following
by a SAR in which
the Date of Grant
a Grantee is Vested
Under one
%
At least one but less than two
33
%
At least two but less than three
67
%
Three or more
100
%
 
A grantee shall become fully vested in all of his or her SARs under the following circumstances: (i) upon termination of the grantee’s service as a director of Torotel for reasons of death, disability or retirement; (ii) if the Compensation and Nominating Committee (the “Committee”), in its sole discretion, determines that acceleration of the SAR vesting schedule would be desirable for Torotel; or (iii) if Torotel shall, pursuant to action by its Board of Directors, at any time propose to merge into, consolidate with, or sell or otherwise transfer all or substantially all of its assets to another corporation, and provision is not made pursuant to the terms of such transaction for the assumption by the surviving, resulting or acquiring corporation of outstanding SARs or for substitution of new SARs therefor, the Committee shall cause written notice of the proposed transaction to be given to each grantee not less than 20 days prior to the anticipated effective date of the proposed transaction, and his or her SARs shall become fully vested and, prior to a date specified in such notice, which shall be not more than 10 days prior to the anticipated effective date of the proposed transaction, each grantee shall have the right to exercise all of his or her SARs.
 
Compensation expense is recognized over the vesting period based upon the estimated fair value of the SARs pursuant to the terms of the Plan using the Black-Scholes options-pricing model as of the end of each financial reporting period.  As of July 31, 2011, the fair value of the SARs was determined using the following assumptions: no dividend payments over the life of the SARs since Torotel has not issued any form of dividend since 1985; an expected volatility of 134.74% based on Torotel’s historical volatility using the weekly closing price over the past three years; a ten day average market price of $0.430; a risk-free interest rate of 1.54%; and an expected life of three years based on the length of service estimated to be served.  As of July 31, 2010, the fair value of the SARs was determined using the following assumptions: no dividend payments over the life of the SARs

7


since Torotel has not issued any form of dividend since 1985; an expected volatility of 103.11% based on Torotel’s historical volatility using the weekly closing price over the past three years; a ten day average market price of $0.280; a risk-free interest rate of 1.80%; and an expected life of three years based on the length of service estimated to be served.   Based on these assumptions, the fair value prices per share of the outstanding SARs as of July 31, 2011, are summarized as follows:
 
 
SARs
Under
Exercise
Fair Value
%
Aggregate
Vested
Aggregate
Intrinsic
Grant Date
Option
Price
Price
Vested
Fair Value
Value
October 1, 2004
60,000

$
0.350

$
0.336

100
%
$
20,000

$
13,000

May 1, 2005
30,000

$
0.302

$
0.343

100
%
$
10,000

$
8,000

May 1, 2006
30,000

$
0.695

$
0.298

100
%
$
9,000

$

May 1, 2007
30,000

$
0.500

$
0.318

100
%
$
10,000

$
2,000

May 1, 2008
30,000

$
0.550

$
0.313

100
%
$
10,000

$

May 1, 2009
30,000

$
0.208

$
0.358

67
%
$
7,000

$
11,000

May 1, 2010
30,000

$
0.300

$
0.343

33
%
$
3,000

$
8,000

May 1, 2011
30,000

$
0.560

$
0.312


$

$

June 3, 2011
10,000

$
0.550

$
0.313


$

$

 
The vested portion represents 210,000 SARs.  As of July 31, 2011, the total aggregate intrinsic value of these exercisable SARs was $42,000.
 
SARs transactions for the three month periods ended July 31, 2011 and 2010 are summarized as follows:
 
 
2011
 
2010
 
SARs
Under
Option
Weighted
Average
Grant
Price
 
SARs
Under
Option
Weighted
Average
Grant
Price
Outstanding at May 1
240,000

$
0.407

 
240,000

$
0.418

Granted
40,000

$
0.558

 
40,000

$
0.300

Exercised

$

 

$

Forfeited

$

 

$

Outstanding at July 31
280,000

$
0.428

 
280,000

$
0.401

 
 
 
 
 
 
SARs exercisable at end of period
210,000

$
0.426

 
200,000

$
0.438

Weighted average fair value of SARs granted during the period
 

$
0.313

 
 

$
0.191

 
The following information applies to SARs outstanding for each of the three month periods ended July 31, 2011 and 2010:
 
 
2011
2010
Number outstanding
280,000

280,000

Range of grant prices
$0.208 - $0.695

$0.208 - $0.695

Weighted average grant price
$
0.428

$
0.401

Weighted average remaining contractual life
6.04 yrs.

6.74 yrs.

 
Total compensation expense for the outstanding SARs for the three months ended July 31, 2011 and 2010 was a benefit of $11,000 and an expense of $7,000, respectively.  As of July 31, 2011, there was $23,000 of total unrecognized compensation expense related to non-vested SARs granted under the Plan.  That cost is expected to be recognized over a weighted average period of 2.23 years.  The liability for SARs on the consolidated condensed balance sheets as of July 31, 2011 and April 30, 2011 was $69,000 and $80,000, respectively.

8



Note 10 — Customer Deposits
 
Torotel currently has one contract for the potted coil assembly that provide for milestone payments by the customer prior to the commencement of product deliveries. These payments are used to procure raw materials and to maintain a 500-piece finished goods buffer as requested by the customer.  These milestone payments are applied as discounts to invoices ratably over the course of the contract as product is delivered. In accordance with our revenue recognition policy, Torotel recognizes revenue on this contract upon shipment of the product.  The remaining liability associated with the milestone payments as of dates shown  is summarized as follows:
 
 
July 31,
2011
April 30,
2011
2011 contract
$
593,000

$
826,000

 
$
593,000

$
826,000

 
This net amount is reflected as Customer Deposits under current liabilities in the accompanying consolidated condensed balance sheets.
 
Note 11 — Concentrations of Credit Risk
 
Financial instruments that potentially subject Torotel to concentrations of credit risk consist principally of cash and accounts receivable.  Torotel grants unsecured credit to most of its customers.  Management does not believe that it is exposed to any extraordinary credit risk as a result of this policy.  At various times, and at July 31, 2011, cash balances exceeded federally insured limits.  Torotel has not experienced any losses in the cash accounts and management does not believe Torotel is exposed to any significant credit risk with respect to its cash.
 

Note 12 — Out of Period Adjustment
 
During the first quarter of fiscal year 2012, we discovered errors in our restricted stock accounting that affect fiscal years 2008 to 2011. We incorrectly applied guidance contained in ASC 718 Compensation -Stock Compensation related to the reversal of previously amortized compensation expense at the time of forfeiture (due to employee termination). We also did not apply a pre-vesting forfeiture rate to our stock compensation amortization expense. These errors resulted in an understatement of our net income or overstatement of our net loss in fiscal years 2008, 2009, 2010, and 2011 for a total of $99,000 as detailed below.
We assessed the materiality of this error on our consolidated financial statements for the years ended April 30, 2008, 2009, 2010 and 2011 in accordance with SEC Staff Accounting Bulletin ("SAB") No. 99, Materiality and SAB No. 108, Considering the Effects of Prior Year Misstatements when Quantifying Misstatements in Current Year Financial Statements ("SAB 108"), using both the roll-over method and iron-curtain method as defined in SAB 108. Under SAB 108, prior-year misstatements which, if corrected in the current year would be material to the current year, must be corrected by adjusting prior year consolidated financial statements, even though such correction previously was and continues to be immaterial to the prior-year consolidated financial statements. Correcting prior-year consolidated financial statements for such “immaterial errors” does not require our previously filed reports to be amended, but rather these corrections will be made the next time we file the prior-year consolidated financial statements.
The following is a reconciliation between previously reported amounts for net earnings (or loss) and basic earnings (or loss) per share and restated amounts for the periods described above. We have debited paid in capital and credited stock compensation expense for the amounts detailed in the table below.

9


Fiscal Year Ended April 30,
2008
2009
2010
2011
 
 
 
 
 
Net earnings (loss)
 
 
 
 
As reported
$
165,000

$
303,000

$
(27,000
)
$
1,233,000

Adjustments
39,000

14,000

23,000

23,000

Restated
$
204,000

$
317,000

$
(4,000
)
$
1,256,000

 
 
 
 
 
 
 
 
 
 
Basic earnings (loss) per share
 
 
 
 
As reported
$
0.03

$
0.06

$
(0.01
)
$
0.21

Adjustments
0.01


0.01


Restated
$
0.04

$
0.06

$

$
0.21


Forward-Looking Information
 
This report, as well as our other reports filed with or furnished to the Securities and Exchange Commission ("SEC"), contains forward-looking statements made pursuant to the safe harbor provisions of The Private Securities Litigation Reform Act of 1995. The words "believe," "estimate," "anticipate," "project," "intend," "expect," "plan," "outlook," "forecast," "may," "will," "should," "continue," "predict" and similar expressions are intended to identify forward-looking statements. This report contains forward-looking statements regarding, among other topics, our expected financial position, results of operations, cash flows, strategy, budgets and management's plans and objectives. Accordingly, these forward-looking statements are based on assumptions about 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 to be different from what appear here. These risk factors include,without limitation:
economic and legislative factors that could impact defense spending;
our relatively concentrated customer base;
risks in fulfilling military subcontracts;
our ability to finance operations;
continued production of the Hellfire II missile system for which we supply parts;
the ability to adequately pass through to customers unanticipated future increases in raw material and labor costs;
decreased demand for products;
delays in developing new products;
markets for new products and the cost of developing new markets;
expected orders that do not occur;
loss of key customers;
our ability to satisfy our debt covenant requirements;
our ability to generate sufficient taxable income to realize the amount of our deferred tax assets;
the impact of competition and price erosion as well as supply and manufacturing constraints; and
other risks and uncertainties.

In light of these risks and uncertainties, there can be no assurance that the forward-looking information contained in this report will prove accurate. Accordingly, our actual results may differ materially from these forward-looking statements. We assume no obligation to update any forward-looking statements made herein.
 
Item 2.       Management’s Discussion and Analysis of Financial Condition and Results of Operations
 

Overview
 
Torotel, Inc. ("Torotel") conducts business primarily through its wholly owned subsidiary, Torotel Products, Inc. ("Torotel Products"), but it also operates another wholly owned subsidiary Electronika, Inc. ("Electronika"). Another subsidiary, Torotel Manufacturing Corporation ("TMC"), provides manufacturing services to Torotel Products.
 

10


Torotel Products specializes in the custom design and manufacture of a wide variety of precision magnetic components, injection molded transformers and electro-mechanical assemblies for use in military, aerospace and industrial electronic applications. These products are used to modify and control electrical voltages and currents in electronic devices. Torotel Products sells these products to original equipment manufacturers, which use them in applications such as:
aircraft navigational equipment;
digital control devices;
airport lighting devices;
medical equipment;
avionics systems;
down-hole drilling; and
conventional missile guidance systems.
 
Torotel Products markets its components primarily through an internal sales force and independent manufacturers’ representatives paid on a commission basis.  These commissions are earned when a product is sold and/or shipped to a customer within the representative’s assigned territory.  Torotel Products also utilizes its engineering department in its direct sales efforts for the purpose of expanding its reach into new markets and/or customers.
 
The industry mix of Torotel Products’ net sales for the first three months in fiscal 2012 was 55% defense, 25% industrial, and 20% aerospace compared to 62% defense, 18% industrial and 20% aerospace for the same period in fiscal year 2011.

Torotel Products is an approved source for magnetic components used in numerous military and aerospace systems, which means Torotel Products is automatically solicited for any procurement needs for such applications.  The magnetic components manufactured by Torotel Products are sold primarily in the United States, and most sales are awarded on a competitive bid basis.  The markets in which Torotel Products competes are highly competitive.  A substantial number of companies sell components of the type manufactured and sold by Torotel Products.  In addition, Torotel Products sells to a number of customers who have the capability of manufacturing their own electronic components.  The principal methods of competition for electronic products in the markets served by Torotel Products include, among other factors, price, on-time delivery performance, lead times, customized product engineering and technical support, marketing capabilities, quality assurance, manufacturing efficiency, and existing relationships with customers’ engineers.  While we believe magnetic components are not susceptible to rapid technological change, Torotel Products’ sales, which do not represent a significant share of the industry’s market, are susceptible to decline given the competitive nature of the market.

Electronika is a marketing and licensing company selling ballast transformers to the airline industry.  These transformers activate and control the lights in commercial airplane cockpits.  Electronika’s ballast 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 use in DC-8 and DC-9 aircraft.  As a result, the business of Electronika is subject to various risks including, without limitation, any decline in use of the referenced aircraft, and competition for the available spare parts business.  Electronika’s sales do not represent a significant portion of any particular market.
 
Electronika’s requirements for ballast transformers are outsourced pursuant to a Manufacturing Agreement with Magnetika, Inc. (“Magnetika”), a corporation owned by the Caloyeras family, which presently owns approximately 44% of the common shares of Torotel. Under the terms of the agreement, Magnetika provides all necessary raw material, labor, testing, packaging and related services required to complete the manufacture, delivery and sale of the ballast transformers, and Electronika is obligated to order all of its ballast transformer requirements exclusively from Magnetika. Electronika retains ownership of all designs, drawings, specifications and intellectual property rights associated with the ballast transformers. In exchange for the services provided to Electronika under the Manufacturing Agreement, Magnetika receives 40 percent of the net sales price of all ballast transformers sold by Electronika. The Manufacturing Agreement continues in effect until April 1, 2012. In the three months ended July 31, 2011, Electronika incurred costs of $1,000 for goods purchased on trade terms of net 20 days pursuant to the Manufacturing Agreement. Of the amount purchased, $1,000 was due and payable as of July 31, 2011.
 

Business and Industry Considerations

Defense Markets
 
During the first quarter of fiscal years 2012 and 2011, approximately 55% and 62%, respectively, of our consolidated revenues were derived from contracts with subcontractors of the U.S. Department of Defense ("DoD"). As a result, our financial results in any period could be impacted substantially by spending cuts in the DoD budget and the funds appropriated for certain military programs.

11


Notwithstanding the uncertainty associated with the DoD budget, we believe our overall defense business outlook remains favorable due to the present demand for the potted coil assembly for the Hellfire II missile system. In September 2010, Torotel was awarded a contract in excess of $5.4 million for the potted coil assembly. Most of the shipments for this contract will be made in fiscal year 2012. In addition, we anticipate another contract to be awarded later in calendar year 2011 (during fiscal year 2012) with deliveries scheduled to begin in late fiscal year 2012 or early fiscal year 2013.

Aerospace and Industrial Markets
We also provide magnetic components, injection molded products and electro-mechanical assemblies for a variety of applications in the aerospace and industrial markets. The significant growth factors for these markets include demand for Boeing commercial aircraft (including the Boeing 787), increases in airport modernization projects (for our runway lighting products), down-hole drilling applications, and general demand for electronic components.
We continue to believe that near-term demand for aerospace and industrial products will remain consistent with current demand. We also believe that the long-term outlook remains positive because of the nature of the customers' applications for these products; however, the fragile economic recovery and the inventory of Boeing 787's in partially completed stages will likely hinder any near-term increase in demand.
New Opportunities and Earnings Outlook
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 complex transformer devices tend to be higher than those that are still in the prototyping or early production stages and simpler inductor devices. As a result, in any given accounting period the mix of product shipments between higher and lower margin jobs has a significant impact on the gross profit and net earnings of Torotel Products.
During the second half of fiscal year 2011, we increased our investment in engineering, sales and marketing personnel to assist in our pursuit of new revenue opportunities in high voltage transformers, motor windings and other products associated with the defense, aerospace and industrial markets. While several new product opportunities are in the prototyping stage, our current revenue level is insufficient to generate earnings. With no significant change anticipated in our new order rate or in the shippable backlog in the second quarter, we implemented headcount reductions and other spending cuts late in the first quarter. While corporate related costs will be lower for the balance of the year, further reductions are being evaluated in the second quarter. As a result, we anticipate an improved earnings performance over the next few quarters.
As of July 31, 2011, the consolidated order backlog was nearly $6.0 million. This amount is comprised of $4.0 million for the potted coil assembly, $1.6 million in magnetic components, and $400,000 for electro-mechanical assemblies and injection molded products.

Electronika’s net sales continue to be impacted by the decline in the number of active DC-8 and DC-9 aircraft. We expect these sales to continue to decline and eventually phase out with the expiration of the Manufacturing Agreement with Magnetika.
 
Results of Operations
 
The following management comments regarding Torotel’s results of operations and outlook should be read in conjunction with the Consolidated Condensed Financial Statements and Notes to the Consolidated Condensed Financial Statements included in Part I, Item 1 of this Quarterly Report.
 
This discussion and analysis of the results of operations include the operations of Torotel, Inc. and its subsidiaries, Torotel Products, Inc., Torotel Manufacturing Corp., and Electronika, Inc.  While each company’s results are included separately in the following discussion, segment reporting is not applicable because the products offered are similar in form and function, and target similar markets.

Three Months Ended July 31, 2011 Compared With Three Months Ended July 31, 2010
 
Net Sales


12


Three months ended July 31,
2011
2010
Torotel Products:
 
 
Magnetic components
$
1,122,000

$
1,378,000

Potted coil assembly
1,239,000

1,050,000

Electro-mechanical assemblies
125,000

57,000

Injection molded products
59,000


Total Torotel Products
2,545,000

2,485,000

Electronika
3,000

9,000

Total consolidated net sales
$
2,548,000

$
2,494,000



Consolidated net sales increased nearly 2%. The net sales of Torotel Products increased 2% due to higher demand for the potted coil assembly and electro-mechanical assemblies. Additional sales were generated from the injection molded products for airport lighting which went into production in the third quarter of fiscal year 2011. These increases were offset by lower demand for magnetic components due to lower sales for components of a missile system as well as the conclusion of a long-term commercial contract. The net sales of Electronika decreased from $9,000 to $3,000, which is consistent with the sales volume we expect from Electronika until the expiration of the Manufacturing Agreement.

Gross Profit

Three months ended July 31,
2011
2010
Torotel Products:
 
 
Gross profit
$
638,000

$
892,000

Gross profit % of net sales
25
%
36
%
Electronika:
 
 
Gross profit
$
2,000

$
5,000

Gross profit % of net sales
60
%
60
%
Consolidated:
 
 
Gross profit
$
640,000

$
897,000

Gross profit % of net sales
25
%
36
%

Consolidated gross profit as a percentage of net sales decreased by 11%. The gross profit percentage of Torotel Products decreased 11% due to higher material costs associated with the product mix, higher fixed costs due to the leased facility for manufacturing the injection molded products and the electro-mechanical assemblies, and higher costs for fringe benefits such as group health insurance. These higher costs as a percentage of sales were offset partially by a lower direct labor content associated with the product mix. The gross profit percentage of Electronika remained unchanged as it is fixed by the Manufacturing Agreement with Magnetika, Inc.

Operating Expenses

Three months ended July 31,
2011
2010
Engineering
$
166,000

$
69,000

Selling, general and administrative
721,000

606,000

Total
$
887,000

$
675,000


Engineering expenses increased nearly 140%, or $97,000. This increase was primarily due to a $100,000 increase in payroll costs, as well as higher costs for fringe benefits such as group health insurance.

Selling, general and administrative expenses increased 19%, or $115,000. This increase primarily resulted from a $125,000 increase in payroll costs as well as higher costs for fringe benefits such as group health insurance, a $31,000 increase in accounting fees, a $25,000 increase in depreciation expenses, a $24,000 increase in customer discounts, a $19,000 increase in travel costs,

13


and a $16,000 increase in computer services expense. This increase was partially offset by a $31,000 decrease in training costs, a $31,000 decrease in recruiting fees, a $30,000 decrease in professional fees, a $17,000 decrease in stock appreciation rights expense, a $9,000 decrease in stock compensation amortization expense, and a $7,000 decrease in operating supplies.
    
Earnings (Loss) from Operations

Three months ended July 31,
2011
2010
Torotel Products
$
(133,000
)
$
358,000

Electronika
2,000

5,000

Torotel
(116,000
)
(141,000
)
Total
$
(247,000
)
$
222,000


For the reasons discussed above, consolidated earnings from operations decreased by $469,000.

Other Earnings Items

Three months ended July 31,
2011
2010
Earnings (Loss) from operations
$
(247,000
)
$
222,000

Interest expense
12,000

10,000

Interest income

(3,000
)
Earnings (Loss) before income taxes
$
(259,000
)
$
215,000

Provision (Benefit) for income taxes


Net earnings (loss)
$
(259,000
)
$
215,000


Net interest expense increased by $5,000 due to a higher debt level and the interest income earned in 2010. No provision or benefit for income taxes was recognized in either period presented above.

Return on Capital Employed

Return on Capital Employed ("ROCE") is the primary benchmark used by management to evaluate Torotel's performance. ROCE measures how effectively and efficiently net operating assets ("NOA") are used to generate income before interest and taxes (EBIT). For these purposes, NOA, or Capital Employed, is defined as "accounts receivable + inventory + net fixed assets + miscellaneous operating assets - accounts payable - miscellaneous operating liabilities". The performance of Torotel's management and the majority of its decisions will be measured by whether Torotel's ROCE improves. For the fiscal years ended April 30, 2011 and 2010, Torotel's ROCE was 17.59% and 1.13%, respectively. The ROCE for the 12-month trailing period ended July 31, 2011 was 5.44%. This decrease in ROCE is primarily attributed to lower operating income generated in the first quarter of fiscal year 2012 as result of lower sales and higher fixed costs.


Liquidity and Capital Resources
 
As of July 31, 2011, Torotel had $638,000 in cash compared to $490,000 as of April 30, 2011 and $704,000 as of July 31, 2010. The factors contributing to the differences from period to period are discussed below.
 
The table below presents the summary of cash flow for the three month periods indicated through July 31.
 
 
2011
2010
Net cash provided by (used in) operating activities
$
253,000

$
(254,000
)
Net cash used in investing activities
$
(72,000
)
$
(47,000
)
Net cash used in financing activities
$
(33,000
)
$
(25,000
)
 
Operating Activities


14


Net cash provided by (used in) operating activities fluctuates between periods primarily as a result of differences in operating earnings, the timing of shipments and the collection of accounts receivable, changes in inventory, level of sales and payment of accounts payable.  We do not anticipate any significant changes in the amount of cash flow from operations in the near-term. 

Investing Activities

The $72,000 of cash used in investing activities in the first three months of fiscal 2012 was the result of capital expenditures.  This amount included approximately $30,000 related to building improvements for the parking lot at Torotel's principal office.  We anticipate approximately $300,000 in additional capital expenditures during the remainder of fiscal 2012 primarily related to our investment in high voltage production equipment and a new enterprise resource planning system. 

Financing Activities

The $33,000 of cash used in financing activities in the first three months of fiscal 2012 is the result of payments on long-term debt and capital lease obligations. 

Capital Resources

We believe the projected cash flow from operations, combined with existing cash balances, will be sufficient to meet funding requirements for the foreseeable future.  Torotel has a $500,000 bank line of credit available, which we anticipate could be utilized to help fund any working capital requirements. 

We believe that inflation will have only a minimal effect on future operations since such effects should be offset by sales price increases, which are not expected to have a significant effect upon demand.

 
Critical Accounting Policies
 
We discuss our critical accounting policies and estimates in Item 7, “Management's Discussion and Analysis of Financial Condition and Results of Operations,” in our Annual Report on Form 10-K for the year ended April 30, 2011. We have made no significant change in our critical accounting policies since April 30, 2011.


Item 3.            Quantitative and Qualitative Disclosures About Market Risk
 
Not Applicable
 
Item 4.            Controls and Procedures
 
Evaluation of Disclosure Controls and Procedures
 
Torotel’s management, with the participation of the Chief Executive Officer and Chief Financial Officer, has evaluated the effectiveness of Torotel’s disclosure controls and procedures, as such term is defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended (the “Exchange Act”), as of the end of the period covered by this report.  Based on such evaluation, the Chief Executive Officer and the Chief Financial Officer have concluded that Torotel’s disclosure controls and procedures are ineffective.
 
Changes in Internal Control
 
Our enterprise resource planning system, which was implemented on November 1, 2010, processes all financial information for our business. Late in the fourth quarter of fiscal year 2011, we encountered irregularities related to the calculation of inventory costs. In an effort to identify the magnitude and scope of these irregularities, we undertook an extensive review of our inventory transactions as well as other transactional areas, including revenue and accounts payable. Based on our review, we believe that these errors were systematic in nature and not caused by our implementation or usage of the system. As a result of these errors, we filed an amended quarterly report on Form 10-Q/A for the period ended January 31, 2011 with the restated financial statements on August 15, 2011. 

Since identifying the material weakness as described above, we have implemented measures to remediate the material

15


weakness, including:

Performing extensive detailed price testing on our raw material inventory balance; and
Expanding reviews of certain functional areas including revenue and accounts payable transactions.

We believe that the remediation measures described above will strengthen our internal control over financial reporting and will remediate the identified material weakness. As we continue to evaluate and work to enhance internal control over financial reporting, we may determine that additional measures must be taken to address this control deficiency or may determine that we need to modify or otherwise adjust the remediation measures described above.

Because the reliability of the internal control process requires repeatable execution, the successful remediation of this material weakness will require review and evidence of effectiveness prior to us concluding that the controls are now effective. Some of the mitigating controls that have been implemented have not been in place for a sufficient period of time to demonstrate that their effectiveness is sustainable. Also, we believe that this material weakness will be fully remediated via the transition to a new ERP system. We have initiated a search for a new ERP system and will implement this new system as soon as reasonably practicable. Therefore, additional time is required to validate that the material weakness is fully remediated.

Other than measures implemented to remediate the material weakness, as described above, there have been no changes in our internal control over financial reporting or in other factors that have materially affected, or in our estimates are reasonably likely to materially affect our internal control over financial reporting during the period covered by this report.




16


PART II.   OTHER INFORMATION
 
Item 4.   [Removed and Reserved]
 
Item 6.   Exhibits
 
a)                                                        Exhibits
 
Exhibit 31.1
 
Officer Certification
Exhibit 31.2
 
Officer Certification
Exhibit 32.1
 
Certification Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
Exhibit 32.2
 
Certification Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
Exhibit 101.INS
 
XBRL Instance Document
Exhibit 101.SCH
 
XBRL Taxonomy Extension Schema Document
Exhibit 101.CAL
 
XBRL Taxonomy Extension Calculation Linkbase Document
Exhibit 101.DEF
 
XBRL Taxonomy Extension Definition Linkbase Document
Exhibit 101.LAB
 
XBRL Taxonomy Extension Label Linkbase Document
Exhibit 101.PRE
 
XBRL Taxonomy Extension Presentation Linkbase Document


17


SIGNATURES
 
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
 
 
 
 
Torotel, Inc.
 
 
(Registrant)
 
 
 
 
 
 
September 14, 2011
 
/s/ Dale H. Sizemore, Jr.
Date
 
Dale H. Sizemore, Jr.
 
 
Chief Executive Officer
 
 
 
September 14, 2011
 
/s/ H. James Serrone
Date
 
H. James Serrone.
 
 
Chief Financial Officer

18