BUTLER NATIONAL CORP - Quarter Report: 2005 October (Form 10-Q)

BUTLER NATIONAL CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED INCOME STATEMENT

SIX MONTHS ENDED

October 31,

2005

2004

(unaudited)

(unaudited)

REVENUES

Aircraft / Modifications

$

4,612,962

$

7,439,054

Avionics / Defense

1,426,342

1,432,623

Management / Professional Services

3,126,161

2,230,662

--------------

--------------

Net Revenues

9,165,465

11,102,339

COST OF SALES

Aircraft / Modifications

4,006,941

5,929,195

Avionics / Defense

752,146

978,428

Management / Professional Services

2,105,747

1,592,677

--------------

--------------

Total Cost of Sales

6,864,834

8,500,300

--------------

--------------

GROSS PROFIT

2,300,631

2,602,039

SELLING, GENERAL AND ADMINISTRATIVE EXPENSES

1,751,564

1,434,703

--------------

--------------

OPERATING INCOME

549,067

1,167,336

OTHER INCOME (EXPENSE)

Interest Expense

(216,396)

(135,360)

Other

-

3,644

--------------

--------------

Other expense

(216,396)

(131,716)

INCOME BEFORE PROVISION FOR INCOME TAXES

332,671

1,035,620

PROVISION FOR INCOME TAXES

(20,000)

(30,000)

--------------

--------------

NET INCOME

$

312,671

$

1,005,620

========

========

BASIC EARNINGS PER COMMON SHARE

$

.01

$

.03

========

========

Shares used in per share calculation

52,576,044

39,599,391

========

========

DILUTED EARNINGS PER COMMON SHARE

$

.01

$

.02

========

========

Shares used in per share calculation

52,722,056

48,423,140

========

========

The accompanying notes are an integral part of these financial statements.

BUTLER NATIONAL CORPORATION AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

1. The accompanying unaudited condensed consolidated financial statements have been prepared in accordance with the instructions to Form 10-Q of Regulation S-X and do not include all of the information and footnotes required by generally accepted accounting principles for complete financial statements. Therefore, these financial statements should be read in conjunction with the annual report on Form 10-K dated April 30, 2005. In our opinion, all adjustments (consisting of normal recurring accruals) necessary for a fair presentation have been included. Operating results for the three months ended October 31, 2005 are not indicative of the results of operations that may be expected for the year ending April 30, 2006.

Certain reclassifications within the condensed financial statement captions have been made to maintain consistency in presentation between years.

2. Advances for Indian Gaming Development: We are advancing funds for the establishment of Indian gaming. These funds have been capitalized in accordance with Statements of Financial Accounting Standards (SFAS) 67 "Accounting for Costs and Initial Rental Operations of Real Estate Projects." Such standard requires costs associated with the acquisition, development, and construction of real estate and real estate related projects to be capitalized as part of that project.

Our advances to the tribes for gaming developments are capitalized. These advances represent costs to be reimbursed upon approval of Indian gaming in several locations. We have agreements in place which require payments of advances to be made to us upon opening of Indian gaming facilities. Once gaming facilities have gained proper approvals, we will enter into a note receivable arrangement with the Tribe to secure reimbursement of advanced funds for that particular project. Reserves have been recorded for advances for the Indian gaming development costs when we are unable to determine whether reimbursement from the tribes will occur.

We have advanced and invested a total of $4,718,991 in Indian gaming developments. We have reserves of $2,912,440, at October 31, 2005 and $2,912,440 at April 30, 2005. Based on the information available to us we believe that our advances for Indian gaming developments will be totally reimbursed as casinos are opened. Due to the fact that all of the proposed casinos are involved in legal and governmental actions whose outcome is not certain nor is there any time frame for resolution we believe it is necessary to establish reserves against the advances. The reserve amount is an estimate of the value we would receive if a Tribal casino was not opened and we were forced to liquidate the assets that we have acquired with our advances. These assets were intended to be used with Tribal casinos and consist of the purchase of land, land improvements, professional design fees and other consulting and legal costs related to the development of Indian Gaming facilities. The land purchases are located adjacent to residential developments. We believe that these tracts could be developed and sold for residential and commercial use to recover advances if the gaming enterprises do not open.

3. Earnings Per Share: Earnings per common share is based on the weighted average number of common shares outstanding during the year. Stock options have been considered in the dilutive earnings per share calculation.

4. Research and Development: We charge to operations research and development costs. The amount charged in the quarters ended October 31, 2005 and 2004 were approximately $377,786 and $303,191 respectively.

5. Lease Agreements: On October 17, 2005, Avcon leased additional space at its current location on the Newton City-County Airport in Newton, Kansas. The ten-year lease is for hangars C, D and M and requires a monthly use payment of approximately $8,000 per month for approximately 30,000 square feet of hangar and office space. Approximately one-half of the current space will be released to the Airport and will reduce the monthly use payment be approximately $3,000. The additional space is expected to provide for expansion of Avcon business resulting from new product development.

MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS

RESULTS OF OPERATIONS

Avionics: Sales from the Avionics business segment were $1,426,342 for the six months ended October 31, 2005 compared to $1,432,623 in the comparable period of the preceding year, a decrease of 0.4%. Operating profit for the six months ended October 31, 2005, was $368,107 compared to a profit of $233,167 for the six months ended October 31, 2004. Management expects this business segment to increase in future years due to the addition of new fuel system protection devices like the TSD and classic aviation defense products.

Services - SCADA Systems and Monitoring Services: Revenue from Monitoring Services increased from $596,999 for the six months ended October 31, 2004 to $693,499 for the six months ended October 31, 2005, an increase of 16.2%. During the six months ended October 31, 2005 we maintained a relatively level volume of long-term contracts with municipalities. We had increased revenue due to significant hurricane activity during the six months ended October 31, 2005. Revenue fluctuates due to the introduction of new products and services and the related installations of these products. Our contracts with our two largest customers have been renewed for fiscal 2006. An operating profit of $54,784 in Monitoring Services was recorded for the six months ended October 31, 2005, compared to a loss of $5,339 for the six months ended October 31, 2004.

Gaming: Revenues from management services related to gaming increased 0.7% from $541,236 for the six months ended October 31, 2004, to $545,063 for the six months ended October 31, 2005. This increase is related to the approval of Class III casino gaming in Oklahoma.

Corporate / Professional Services: These services include the architectural services of BCS Design, Inc., arrangements for financing, and on site contract management of establishments for Indian tribes and others. Flight and engineering services are also provided. Management consulting and professional fees were $1,887,599 for the six months ended October 31, 2005 and $1,092,426 for the six months ended October 31, 2004. BCS Construction completed two buildings during the 2^nd quarter. The revenue from these buildings was $1,552,297 and the related costs were $1,505,120.

Selling, General and Administrative (SG&A): Expenses were $1,751,564, or 19% of revenues for the six months ended October 31, 2005 and $1,434,703, or 13% of revenue for the six months ended October 31, 2004. Business insurance in the first six months of fiscal 2006 increased of over 22% to approximately $314,000. In fiscal 2006 an increase of 15 employees accounted for approximately $600,000 in additional wages. The sales per employee for the six months ended October 31, 2005 were $101,838 compared to $148,031 for the six months ended October 31, 2004. Additional rent and hangar space accounted for approximately $20,000 of the increase in general expenses. Fuel and aircraft maintenance increased by more than $58,000 during the first six months of this fiscal year. In an effort to increase our Avcon sales in Mexico and China additional travel and marketing expense accounted for approximately $21,000 during the first six months of fiscal 2006.

Other Income (Expense): Other expenses increased from $135,360 in the six months ended October 31, 2004 to $216,396 for the six months ended October 31, 2005. The additional interest expense was a result of financing activities related to inventory and asset purchases.

We employed 90 at October 31, 2005 and 75 at October 31, 2004.

Earnings: Our net income for the prior six months period ended October 31, 2004 was $1,005,620. Our net income for the current six months ended October 31, 2005 was $312,671. Income derived from our RVSM business declined from 2005 to 2006 because of the passing of the initial RVSM required date of January 20, 2005. RVSM sales have continued as we continue to equip the Lear 20 series fleet and work toward approval of the Lear 30 series airplanes.

SECOND QUARTER FISCAL 2006 COMPARED TO SECOND QUARTER FISCAL 2005

Our sales for the three months ended October 31, 2005 were $5,053,299, a decrease of 14.8% from the three months ended October 31, 2004 with sales of $5,930,581. Our operating profit for the three months ended October 31, 2005 were $240,206, compared to $666,893 for the three months ended October 31, 2004.

Discussion of the specific changes by operation at each business segment follows:

Aircraft Modifications: Sales from the Aircraft Modifications business segment including modified aircraft decreased $2,341,921 (53.8%) from $4,350,090 in the second quarter of fiscal year 2005 to $2,008,169 in the current quarter of fiscal 2006. Revenues generated from other modification services increased 310%. The modifications segment had an operating loss of $48,908 for the three months ended October 31, 2005 compared to income of $489,374 for the three months ended October 31, 2004.

Aircraft Acquisitions and Sales: We acquired one aircraft during the three months ended October 31, 2005 and no aircraft for the three months ended at October 31, 2004.

Avionics: Sales from the Avionics business segment were $655,908 for the three months ended October 31, 2005 compared to $795,235 in the comparable period of the preceding year, a decrease of 17.5%. Operating profit for the three months ended October 31, 2005, was $148,477 compared to a profit of $181,203 for the three months ended October 31, 2004.

Services - SCADA Systems and Monitoring Services: Revenue from Monitoring Services increased from $312,255 for the three months ended October 31, 2004 to $355,388 for the three months ended October 31, 2005, an increase of 13.8%. An operating profit of $29,627 in Monitoring Services was recorded for the three months ended October 31, 2005, compared to a loss of $4,020 for the three months ended October 31, 2004.

Gaming: Revenues from management services related to gaming increased 14.9% from $250,259 for the three months ended October 31, 2004, to $287,558 for the three months ended October 31, 2005.

Corporate / Professional Services: These services include the architectural services of BCS Design, Inc., arrangements for financing, and on site contract management of establishments for Indian tribes and others. Flight and engineering services are also provided. Management consulting and professional fees were $1,746,277 for the three months ended October 31, 2005 and $222,743 for the three months ended October 31, 2004.

Other Income (Expense): Other expenses increased from $85,202 in the three months ended October 31, 2004 to $133,144 for the three months ended October 31, 2005.

Earnings: Our net income for the prior three months ended October 31, 2004 was $581,692. Our net income for the current three months ended October 31, 2005 was $107,062.


LIQUIDITY AND CAPITAL RESOURCES

Borrowed funds have been used primarily for working capital. Our first bank line of credit is $500,000. Our unused line of credit at October 31, 2005 was $175,506. Bank debt related to the Company's operating line was $324,494 at October 31, 2005, and $488,094 at October 31, 2004. The interest rate is prime plus two (with a floor of 7.0%). As of October 31, 2005, the interest rate was 8.9%. This note is collateralized by a first and second position on all assets of the Company.

We opened a second bank line of credit on February 10, 2004 of $1,500,000. This line of credit is used to support the additional inventory requirements of the RVSM product line. Debt relating to this line of credit at October 31, 2005 was $1,400,000. The interest rate is prime plus two (with a floor of 7.0%) As of October 31, 2005, the interest rate was 8.9%. This note is collateralized by a first and second position on all assets of the Company.

We believe both lines of credit will be extended when they are due and do not anticipate the repayment of these notes in fiscal 2006. Our first line of credit has been extended to September 2006 with no changes in the conditions of the terms. The second line of credit has been extended to September 2006. If the Bank were to demand repayment of all notes-payable we currently do not have enough cash to pay off the notes without materially adversely affecting the financial condition of the Company.

Two notes payable to the same bank in the amount of $1,110,000 and $550,000 were entered into on July 11, 2005 at a fixed rate of 7.75%. The loan is in five (5) quarterly payments beginning October 11, 2005 and ending January 11, 2007. The note is secured by an Aircraft and Engine security agreement.

A note payable to a bank in the amount of $850,000 was entered into in December 2003, with interest of prime plus 2% (with a floor of 6 %). At October 31, 2005 and October 31, 2004 the balance was $810,000 and $850,000 respectively. The note is collateralized by an Aircraft and Engine Security Agreement. Until June 2005, we had made interest payments only. Thereafter the note was extended for one year with monthly principal payments of $10,000 plus interest.

A note payable to a bank in the amount of $650,000 was entered into in December 2003, with interest at prime. At October 31, 2005 and 2004 we had borrowed $552,500 and $650,000 respectively on this note. The note is collateralized by an Aircraft and Engine Security Agreement.

We have unsecured demand notes to individuals totaling $108,500. Interest ranges from 12% to 14% on these notes.

We are not in default of any of our notes as of October 31, 2005.

We believe that our current banks will provide the necessary capital for our business operations. However, we continue to maintain contact with other banks that have an interest in funding our working capital needs to continue our growth in operations in 2006 and beyond.

We do not, as of October 31, 2005 have any material commitments for other capital expenditures other than the terms of the Indian gaming Management Agreements. Depending upon the development schedules, we will need additional funds to complete its currently planned Indian gaming opportunities. We will use current cash available as well as additional funds, for the start up and construction of gaming facilities. We anticipate initially obtaining these funds from internally generated working capital and borrowings. After a few gaming facilities become operational, gaming operations will generate additional working capital for the start up and construction of other gaming facilities. We expect that our start up and construction financing of gaming facilities will be replaced by other financial lenders, long term financing through debt issue, or equity issues.


Analysis and Discussion of Cash Flow

During the quarter our cash position increased by $83,158. The increase in the cash flow was attributed to an increase in operating activities of $1,311,679. Aircraft inventory increased by $1,581,996 while all other inventory decreased by $248,891. Additional borrowings in the first six months were $1,619,105 while re-payments of loans were slightly over $204,268.

The increase in inventory is expected to cover less than four months of aircraft modifications. We believe all our inventory will be realized in the normal course of business. Lead-time for the components is dictated by the market place resulting in a build up of inventory to support sales and to avoid halting production because of material shortages.

Revenue Recognition: We perform aircraft modifications under fixed-price contracts. Revenues from fixed-price contracts are recognized on the percentage-of-completion method, measured by the direct labor costs incurred compared to total estimated direct labor costs.

Revenue for SCADA services, Gaming Management, and other Professional Services are recognized on a monthly basis as services are rendered. Payments for these services are received within 30 days of invoicing.

In regard to warranties and returns our products are special order and are not suitable for return. Our products are unique upon installation and tested prior to their release and have been accepted by the customers. In the rare event of a warranty claim, the claim is processed through the normal course of business; this may include additional charges to the customer. In our opinion any future warranty work would not be material to the financial statements.

Critical Accounting Policies

Our accounting estimates include bad debt of the accounts receivable and amortization of the Supplemental Type Certificates (STC). Bad debt is calculated on the historical write-off of bad debt of the individual subsidiaries. In addition to the historical value, invoices are considered a bad debt if no payment has been made in the past 90 days. Based on these estimates we believe we maintain adequate reserves. Although we review these policies on quarterly basis, we do not anticipate substantial changes to these estimates in the future. Over 99% of the aircraft modifications are sold based on cash on delivery terms, and the remaining subsidiaries customer base is stable business and repeat sales. These factors are presented in the financial statements.

Estimates: The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.

Long-lived assets: Long-lived assets and identifiable intangibles to be held and used are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount may not be recoverable. Impairment is measured by comparing the carrying value of the long-lived asset to the estimated undiscounted future cash flows expected to result from use of the assets and their eventual disposition. We determined that as of July 31, 2005, there had been no impairment in the carrying value of long-lived assets.

Supplemental Type Certificates: Supplemental Type Certificates (STCs) are authorizations granted by the Federal Aviation Administration (FAA) for specific modification of a certain aircraft. The STC authorizes us to perform modifications, installations and assemblies on applicable customer-owned aircraft. Costs incurred to obtain STCs are capitalized and subsequently amortized against revenues being generated from aircraft modifications associated with the STC. The costs are expensed as services are rendered on each aircraft through costs of sales using the units of production method. The legal life of an STC is indefinite.

Changing Prices and Inflation

From fiscal year 2004 to fiscal year 2005 we have experienced an increase in airplane and truck operating costs of approximately 100%. This is mainly related to increases in fuel costs. We anticipate long-term fuel costs to continue to rise in fiscal years 2006 and 2007.

Off-Balance Sheet Arrangements

We do not have any off-balance sheet arrangements.


FORWARD LOOKING INFORMATION

The information set forth below includes "forward-looking" information as outlined in the Private Securities Litigation Reform Act of 1995. The Cautionary Statements, filed by us as Exhibit 99 to its Form 10-K, are incorporated herein by reference and you are specifically referred to such Cautionary Statements for a discussion of factors which could affect our operations and forward-looking statements contained herein.

Part I Item 3:

Quantitative and Qualitative Disclosures about Market Risk.
None

Part I Item 4

Controls and Procedures
We maintain a set of disclosure controls and procedures and internal controls designed to ensure that information required to be disclosed in our filings under the Securities Exchange Act of 1934 is recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission's rules and forms. Our principal executive and financial officers have evaluated our disclosure controls and procedures within 90 days prior to the filing of this Quarterly Report on Form 10-Q and have determined that such disclosure controls and procedures are effective.

PART II.
OTHER INFORMATION

Item 1

Legal Proceedings
None

Item 1A.

Risk Factors
None

Item 2

Unregistered Shares of Equity Securities and Use of Proceeds
None

Item 3

Defaults Upon Senior Securities
None

Item 4

Submission of Matters to Vote of Security Holders
None

Item 5

Other Information
None

Item 6

Exhibits and reports on Form 8-K.
(A) Exhibits.

Articles of Incorporation, as amended and restated are incorporated by reference to Exhibit 3.1 of our Form DEF 14A filed on December 26, 2001.

Bylaws, as amended, are incorporated by reference to Exhibit 3.2 of our Form DEF 14A filed on December 15, 2003.

31.1

Certificate of Chief Executive Officer

31.2

Certificate of Chief Financial Officer

Certifications of Chief Executive Officer pursuant to 18 U.S.C. Section 1350, as adopted to Section 906 of the Sarbanes-Oxley Act of 2002

32.2

Certifications of Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted to
Section 906 of the Sarbanes-Oxley Act of 2002

99

Exhibit Number 99
Cautionary Statements for Purposes of the "Safe Harbor" Provisions of the Private Securities Litigation Reform Act of 1995, are incorporated by reference to Exhibit 99 of the Form 10-K for the fiscal year ended April 30, 2005

27.1

Financial Data Schedule (EDGAR version only). Filed herewith.
We agree to file with the Commission any agreement or instrument not filed as an exhibit upon the request of the Commission.

(B)

Reports on Form 8-K.

We reported on September 14, 2005 on Form 8-K under Item 8.01 and Item 9.01 that we issued a press release regarding the filing of our quarterly report on Form 10-Q with the Securities and Exchange Commission for the period ending July 31, 2005.

We reported on October 19, 2005 on Form 8-K under Item 8.01 and Item 9.01 that we issued a press release announcing that we were invited to join Kansas delegation exploring business opportunities in China.