BUTLER NATIONAL CORP - Quarter Report: 2006 October (Form 10-Q)

5. Borrowings: A line of credit in the amount of $1,224,285 was entered into on July 7, 2006. An additional line of credit in the amount of $1,508,000 was entered into on October 25, 2006. Both lines of credit are to be used for the BCS Design, Inc. developments. As of October 31, 2006 we have borrowed $411,732 and $219,591 respectively.

YEAR TO DATE OCTOBER 31, 2006 COMPARED TO YEAR TO DATE OCTOBER 31, 2005

Our sales for the six months ended October 31, 2006 were $7,431,169, a decrease of 18.9% from the six months ended October 31, 2005 with sales of $9,165,465. Our operating profit for the six months ended October 31, 2006 was $596,478, compared to $549,067 for the six months ended October 31, 2005.

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

Aircraft Modifications: Sales from Aircraft Modifications including modified aircraft decreased $468,148 (10.1%) from $4,612,962 in the first six months of fiscal year 2006 to $4,144,814 in the current six months of fiscal 2007. Revenues from non RVSM modification services increased $259,352 or 9.2% in the first six months of fiscal 2007. RVSM revenues decreased by 41% in the second quarter of fiscal 2007, compared to the second quarter of fiscal 2006.

We believe we will sell and install approximately 50 to 100 Lear 20 & 30 series RVSM kits during the next few years. In addition to the RVSM sales, we expect to experience some increase in our base modification sales. As the economy grows aircraft owners may elect to update, modify, and purchase business aircraft. A shift to business aircraft ownership positively impacts our aircraft modification revenues. Although we cannot anticipate the future we must always consider the negative impact of items such as the 9-11 event, increases in fuel prices and general economic downturns.

Considerable time was spent on additions to the RVSM STC and certification of special mission STC's for our modification customers. These events reallocated used capacity and reduced RVSM completions. The modifications segment had an operating profit of $224,170 for the six months ended October 31, 2006 compared to operating profit of $20,803 for the three months ended October 31, 2005.

Aircraft Acquisitions and Sales: There was no activity for the six months ended October 31, 2006 compared to the acquisition of three aircraft during the six months ended October 31, 2005. FAA required modifications to the business aircraft fleet may increase customer demand for company owned aircraft.

Avionics: Sales were $1,375,655 for the six months ended October 31, 2006 compared to $1,426,342 in the comparable period of the preceding year, a decrease of 3.6%. Operating losses for the six months ended October 31, 2006 were $21,646 compared to an operating profit of $368,107 for the six months ended October 31, 2005. We expect this business segment to significantly increase in future years due to the addition of new fuel system protection devices like the TSD, GFI and other classic aviation defense products. During the second quarter of 2007 we continued to focus our efforts on the build up of product for several customers.

Services - SCADA Systems and Monitoring Services: Revenue increased from $693,499 for the six months ended October 31, 2005 to $1,060,728 for the six months ended October 31, 2006, an increase of 53.0%. During the six months ended October 31, 2006 we maintained a relatively level volume of long-term contracts with municipalities. Revenue fluctuates due to the introduction of new products and services and the related installations of these products. Our contract with one of our largest customers has been renewed through fiscal 2008. We had an operating profit of $112,550 in Monitoring Services for the six months ended October 31, 2006, compared to $54,784 for the six months ended October 31, 2005.

Gaming: Revenues from management services related to gaming increased for the six months ended October 31, 2006. 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 gaming establishments and engineering services. Flight and engineering services are also provided. Management consulting and professional fees were $165,378 for the six months ended October 31, 2006 and $1,887,599 for the six months ended October 31, 2005, a decrease of 91.2%. We completed construction projects in fiscal 2005 that accounted for approximately $1,552,000 of this decrease.

Selling, General and Administrative (SG&A): Expenses were $1,868,285 or 25% of revenues for the six months ended October 31, 2006. Business overhead expenses were maintained at relatively the same level as last year.

Other Income (Expense): Other expenses increased from $216,396 in the six months ended October 31, 2005 to $226,721 for the six months ended October 31, 2006. The additional interest expenses of $45,108 were a result of increases in interest rates.

Earnings: Our net income for the prior six months period ended October 31, 2005 was $312,671. Our net income for the current six months ended October 31, 2006 was $309,933.

Employees: We employed 95 at October 31, 2006 and 90 at October 31, 2005.

SECOND QUARTER FISCAL 2007 COMPARED TO SECOND QUARTER FISCAL 2006

Our sales for the three months ended October 31, 2006 were $4,355,107, a decrease of 13.8% from the three months ended October 31, 2005 with sales of $5,053,299. Our operating profit for the three months ended October 31, 2006 was $432,573, compared to $240,206 for the three months ended October 31, 2005.

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

Aircraft Modifications: Sales from Aircraft Modifications including modified aircraft increased $95,199 (4.7%) from $2,008,169 in the second quarter of fiscal year 2006 to $2,103,368 in the current quarter of fiscal 2007. Revenues from non RVSM modification services decreased $76,956 or 5% in the second quarter of fiscal 2007. RVSM revenues increased by 36.7% in the second quarter of fiscal 2007, compared to the second quarter of fiscal 2006.

We believe we will sell and install approximately 50 to 100 Lear 20 & 30 series RVSM kits during the next few years. In addition to the RVSM sales, we expect to experience some increase in our base modification sales. As the economy grows aircraft owners may elect to update, modify, and purchase business aircraft. A shift to business aircraft ownership positively impacts our aircraft modification revenues. Although we cannot anticipate the future we must always consider the negative impact of items such as the 9-11 event, increases in fuel prices and general economic downturns.

Considerable time was spent on additions to the RVSM STC and certification of special mission STC's for our modification customers. These events reallocated used capacity and reduced RVSM completions. The modifications segment had an operating profit of $94,587 for the three months ended October 31, 2006 compared to operating loss of $48,908 for the three months ended October 31, 2005.

Aircraft Acquisitions and Sales: There was no activity for the three months ended October 31, 2006. We acquired one aircraft during the three months ended October 31, 2005. FAA required modifications to the business aircraft fleet may increase customer demand for company owned aircraft.

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 off the shelf items and aircraft sales is recognized on the date of the sale.

Revenue from Avionics are recognized when shipped and payment for materials are due within thirty days of invoicing. Revenue for SCADA services, Gaming Management, and other Corporate/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

Bad Debts: Bad debts are calculated on the historical write-off of bad debts of the individual subsidiaries. Invoices are considered a bad debt if no payment has been made in the past 90 days. We review these policies on quarterly basis, and based on these reviews we believe we maintain adequate reserves. We do not anticipate substantial changes to these estimates in the future.

Use of 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 October 31, 2006, 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. We believe we have enough future sales to fully amortize our STC development costs.

Advances for Indian Gaming Developments: 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 represent costs to be reimbursed upon approval of Indian gaming in several locations. We have agreements in place which require payments to be made to us for the respective projects upon opening of Indian gaming facilities. Once gaming facilities have gained proper approvals, we plan to enter into a note receivable arrangement with the Tribe to secure reimbursement of advanced funds for that particular project.

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, 2006 and October 31, 2005. We believe that our advances for Indian gaming developments will be totally reimbursed as casinos are opened. We believe it is necessary to establish reserves against the advances 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. 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 and land improvements related to the development of Indian Gaming facilities. We believe that these tracts could be developed and sold for residential and commercial use to recover our advances if the gaming enterprises do not open.

Changing Prices and Inflation

We did experience some pressure from inflation in fiscal 2007. These include increases in airplane travel and transportation costs. This additional cost may not be transferable to our customers resulting in lower income. We anticipate long-term fuel costs and interest rates to continue to rise.