##### 



UNITED STATES
SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549
 FORM 10-Q þ
    
    QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE ACT OF 1934
 For the quarterly period ended March 31, 2005 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 number 1-1000 SPARTON CORPORATION  OHIO
(State or Other Jurisdiction of Incorporation or Organization) 38-1054690  2400 East Ganson Street, Jackson, Michigan 49202
(Address of Principal Executive Offices, Zip Code) (517) 787-8600  Indicate by checkmark 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.          þ Yes     o No Indicate by checkmark whether the registrant is an accelerated filer (as defined by Rule 12b-2 of
the Exchange Act). o Yes     þ No Indicate the number of shares outstanding of each of the issuers classes of common stock, as of
the latest practical date. Shares Outstanding atClass of Common Stock
    
    April 29, 2005$1.25 Par Value
    
    
    8,821,464
 1




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##### 



INDEX Part I 
Financial Information Item 1. Financial StatementsCondensed
Consolidated Balance Sheets 
March 31, 2005 and June 30, 2004
    
    
    3Condensed Consolidated Statements of Operations

Three-Month and Nine-Month Periods ended March 31, 2005 and 2004
    
    
    4Condensed Consolidated Statements of Cash Flows

Nine-Month Periods ended March 31, 2005 and 2004
    
    
    5Notes to Condensed Consolidated Financial Statements
    
    
    6Item 2. Managements Discussion and Analysis of Financial Condition and Results of
Operations
    
    
    11Item 3. Quantitative and Qualitative Disclosures About Market Risk
    
    
    17Item 4. Controls and Procedures
    
    
    17
 Part II
Other Information Item 1. Legal Proceedings
    
    
    18Item 4. Submission of Matters to a Vote of Security Holders
    
    
    19Item 6. Exhibits
    
    
    19Signatures
    
    
    19
 2




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##### 



Item 1. Financial Statements SPARTON CORPORATION AND SUBSIDIARIES
Condensed Consolidated Balance Sheets (Unaudited)
March 31, 2005 and June 30,2004 March 31
    
    
    June 30AssetsCurrent assets:Cash and cash equivalents
    
    $
    10,687,328
    
    
    $
    10,820,461Investment securities
    
    
    20,703,129
    
    
    
    18,641,792Accounts receivable
    
    
    20,547,356
    
    
    
    21,267,459Income taxes recoverable
    
    
    
    
    
    
    559,706Inventories and costs on contracts in progress
    
    
    36,486,265
    
    
    
    37,210,259Prepaid expenses
    
    
    2,860,286
    
    
    
    2,859,016Total current assets
    
    
    91,284,364
    
    
    
    91,358,693Pension asset
    
    
    5,088,622
    
    
    
    5,448,968Other assets
    
    
    5,741,811
    
    
    
    5,570,773Property, plant and equipment, net
    
    
    15,923,578
    
    
    
    12,041,062Total assets
    
    $
    118,038,375
    
    
    $
    114,419,496Liabilities and Shareowners EquityCurrent liabilities:Accounts payable
    
    $
    9,939,297
    
    
    
    10,052,854Salaries and wages
    
    
    3,442,830
    
    
    
    3,387,490Accrued health benefits
    
    
    1,034,421
    
    
    
    1,044,810Other accrued liabilities
    
    
    4,539,530
    
    
    
    4,526,234Income taxes payable
    
    
    583,294
    
    
    
    Total current liabilities
    
    
    19,539,372
    
    
    
    19,011,388Environmental remediation  noncurrent portion
    
    
    6,334,842
    
    
    
    6,542,009Shareowners equity:Preferred stock, no par value; 200,000 shares authorized, none
outstanding
    
    
    
    
    
    
    Common stock, $1.25 par value; 15,000,000 shares
authorized, 8,821,464 and 8,351,538 shares outstanding at March 31, 2005 and June 30,
2004, respectively
    
    
    11,026,830
    
    
    
    10,439,423Capital in excess of par value
    
    
    10,521,129
    
    
    
    7,134,149Accumulated other comprehensive income (loss)
    
    
    (65,579
    )
    
    
    62,368Retained earnings
    
    
    70,681,781
    
    
    
    71,230,159Total shareowners equity
    
    
    92,164,161
    
    
    
    88,866,099Total liabilities and shareowners equity
    
    $
    118,038,375
    
    
    $
    114,419,496
 See accompanying notes. 3




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##### 



SPARTON CORPORATION AND SUBSIDIARIES
Condensed Consolidated Statements of Operations (Unaudited)
For the Three-Month and Nine-Month Periods ended March 31, 2005 and 2004 Three-Month Periods
    
    
    Nine-Month Periods2005
    
    
    2004
    
    
    2005
    
    
    2004Net sales
    
    $
    41,561,001
    
    
    $
    43,566,394
    
    
    $
    121,276,223
    
    
    $
    113,230,967Costs of goods sold
    
    
    38,238,550
    
    
    
    39,985,009
    
    
    
    108,010,683
    
    
    
    107,775,123Gross profit
    
    
    3,322,451
    
    
    
    3,581,385
    
    
    
    13,265,540
    
    
    
    5,455,844Selling and administrative expenses
    
    
    3,158,980
    
    
    
    3,345,108
    
    
    
    9,822,128
    
    
    
    10,574,176EPA related  net environmental remediation
    
    
    123,315
    
    
    
    103,012
    
    
    
    282,348
    
    
    
    239,959Loss on sale of property, plant and equipment
    
    
    42,342
    
    
    
    266
    
    
    
    42,342
    
    
    
    266Operating income (loss)
    
    
    (2,186
    )
    
    
    132,999
    
    
    
    3,118,722
    
    
    
    (5,358,557
    )Other income (expense):Interest and investment income
    
    
    231,095
    
    
    
    157,079
    
    
    
    653,336
    
    
    
    510,325Equity income (loss) in investment
    
    
    (5,000
    )
    
    
    4,000
    
    
    
    (10,000
    )
    
    
    16,000Other  net
    
    
    (29,602
    )
    
    
    (65,065
    )
    
    
    647,488
    
    
    
    (374,490
    )196,493
    
    
    
    96,014
    
    
    
    1,290,824
    
    
    
    151,835Income (loss) before income taxes
    
    
    194,307
    
    
    
    229,013
    
    
    
    4,409,546
    
    
    
    (5,206,722
    )Provision (credit) for income taxes
    
    
    (114,000
    )
    
    
    73,000
    
    
    
    1,235,000
    
    
    
    (1,666,000
    )Net income (loss)
    
    $
    308,307
    
    
    $
    156,013
    
    
    $
    3,174,546
    
    
    $
    (3,540,722
    )Basic earnings (loss) per share (1)
    
    $
    0.04
    
    
    $
    0.02
    
    
    $
    0.36
    
    
    $
    (0.40
    )Diluted earnings (loss) per share (1)
    
    $
    0.03
    
    
    $
    0.02
    
    
    $
    0.36
    
    
    $
    (0.40
    )
 (1) All share and per share information have been adjusted to reflect the impact of the
5% stock dividend declared in November 2004. See accompanying notes. 4




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##### 



SPARTON CORPORATION AND SUBSIDIARIES
Condensed Consolidated Statements of Cash Flows (Unaudited)
 For the Nine-Month Periods ended March 31,2005 and 2004 2005
    
    
    2004Cash flows provided (used) by Operating Activities:Net income (loss)
    
    $
    3,174,546
    
    
    $
    (3,540,722
    )Add (deduct) noncash items affecting operations:Depreciation, amortization and accretion
    
    
    1,241,533
    
    
    
    1,271,644Change in pension asset
    
    
    360,346
    
    
    
    545,338Loss on sale of property, plant & equipment
    
    
    42,342
    
    
    
    266Loss on sale of investment securities
    
    
    34,510
    
    
    
    51,284Equity (income) loss on investment
    
    
    10,000
    
    
    
    (16,000
    )Add (deduct) changes in operating assets and liabilities:Accounts receivable
    
    
    720,103
    
    
    
    8,995,471Income taxes recoverable
    
    
    559,706
    
    
    
    (1,195,706
    )Inventories and prepaid expenses
    
    
    823,956
    
    
    
    (6,671,942
    )Accounts payable, salaries and wages, accrued liabilities and income taxes
    
    
    320,818
    
    
    
    96,345Net cash provided (used) by operating activities
    
    
    7,287,860
    
    
    
    (464,022
    )Cash flows provided (used) by Investing Activities:Purchases of investment securities
    
    
    (8,870,255
    )
    
    
    (1,508,720
    )Proceeds from sale of investment securities
    
    
    6,500,722
    
    
    
    7,352,848Purchases of property, plant and equipment, net
    
    
    (5,166,303
    )
    
    
    (5,410,649
    )Other, principally noncurrent other assets
    
    
    (136,618
    )
    
    
    56,049Net cash provided (used) by investing activities
    
    
    (7,672,454
    )
    
    
    489,528Cash flows provided (used) by Financing Activities:Proceeds from exercise of stock options
    
    
    254,399
    
    
    
    23,451Stock dividends  cash in lieu of fractional shares
    
    
    (2,938
    )
    
    
    (3,687
    )Net cash provided by financing activities
    
    
    251,461
    
    
    
    19,764Increase (decrease) in cash and cash equivalents
    
    
    (133,133
    )
    
    
    45,270Cash and cash equivalents at beginning of period
    
    
    10,820,461
    
    
    
    10,562,222Cash and cash equivalents at end of period
    
    $
    10,687,328
    
    
    $
    10,607,492Supplemental disclosures of cash paid during the period:Income taxes  net
    
    $
    115,000
    
    
    $
    247,000
 See accompanying notes. 5




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##### 



SPARTON CORPORATION & SUBSIDIARIES
Notes to Condensed Consolidated Financial Statements (Unaudited) 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES- The following is a summary of the Companys
accounting policies not discussed elsewhere within this report. Basis of presentation- The accompanying unaudited Condensed Consolidated Financial Statements of
Sparton Corporation and subsidiaries have been prepared in accordance with accounting principles
generally accepted in the United States of America for interim financial information and with the
instructions to Article 10 of Regulation S-X. Accordingly, they do not include all of the
information and footnotes required by accounting principles generally accepted in the United States
of America for complete financial statements. All significant intercompany transactions and
accounts have been eliminated. The Condensed Consolidated Balance Sheet at March 31, 2005, and the
related Condensed Consolidated Statements of Operations and Cash Flows for the nine-month periods
ended March 31, 2005 and 2004, are unaudited, but include all adjustments (consisting of normal
recurring accruals), which the Company considers necessary for a fair presentation of such
financial statements. Certain reclassifications of prior period amounts have been made to conform
to the current presentation. Operating results for the nine-month period ended March 31, 2005, are
not necessarily indicative of the results that may be expected for the fiscal year ended June 30,
2005. The balance sheet at June 30, 2004, has been derived from the audited financial statements at that
date but does not include all of the information and footnotes required by accounting principles
generally accepted in the United States of America for complete financial statements. For further
information, refer to the Consolidated Financial Statements and footnotes thereto included in the
Companys Annual Report on Form 10-K for the year ended June 30, 2004. Operations- The Company provides design and electronic manufacturing services, which include a
complete range of engineering, pre-manufacturing and post-manufacturing services. Capabilities
range from product design and development through after-market support. All facilities, with the
exception of Vietnam which is currently under-going the evaluation process, are certified to ISO
9001, with many having additional certifications. The Companys operations are in one line of
business, electronic contract manufacturing services (EMS). Products and services include complete
Box Build products for Original Equipment Manufacturers, microprocessor-based systems,
transducers, printed circuit boards and assemblies, sensors and electromechanical devices. Markets
served are in the medical/scientific instrumentation, aerospace, and industrial/other, with a
focus on regulated markets. The Company also develops and manufactures sonobuoys, anti-submarine
warfare (ASW) devices, used by the U.S. Navy and other free-world countries. Many of the physical
and technical attributes in the production of sonobuoys are the same as those required in the
production of the Companys other electrical and electromechanical products and assemblies. Use of estimates- Accounting principles generally accepted in the United States of America
require management to make estimates and assumptions that affect the disclosure of assets and
liabilities and the amounts reported in the financial statements and accompanying notes. Actual
results could differ from those estimates. Revenue recognition- The Companys net sales are comprised primarily of product sales, with
supplementary revenues earned from engineering and design services. Standard contract terms are FOB
shipping point. Revenue from product sales is generally recognized upon shipment of the goods;
service revenue is recognized as the service is performed or under the percentage of completion
method, depending on the nature of the arrangement. Long-term contracts relate principally to
government defense contracts. These contracts are accounted for based on completed units accepted
and their estimated average contract cost per unit. Development contracts are accounted for based
on percentage of completion. Costs and fees billed under cost-reimbursement-type contracts are
recorded as sales. A provision for the entire amount of a loss on a contract is charged to
operations as soon as the loss is determinable. Shipping and handling costs are included in costs
of goods sold. Market risk exposure- The Company manufactures its products in the United States and Canada, and
most recently in Vietnam. Sales of the Companys products are in the U.S. and Canada, as well as
other foreign markets. The Company is potentially subject to foreign currency exchange rate risk
relating to intercompany activity and balances, receipts from customers, and payments to suppliers
in foreign currencies. Also, adjustments related to the translation of the Companys Canadian
financial statements into U.S. dollars are included in current earnings. The Companys Vietnamese
translation gains and losses are carried in accumulated other comprehensive income (loss) within
the shareowners equity section of the Companys balance sheet. As a result, the Companys
financial results could be affected by factors such as changes in foreign currency exchange rates
or weak economic conditions in the domestic and foreign markets in which the Company operates.
However, minimal third party receivables and payables are denominated in foreign currency and the
related market risk exposure is considered to be immaterial. Historically, foreign currency gains
and losses related to intercompany activity and balances have not been significant. However,
recently due to the strengthening Canadian dollar the impact of transaction and translation gains
has increased. While a reversal of these recent gains is not anticipated, if the exchange rate
were to decline the Companys financial position could be significantly affected. 6




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##### 



The Company has financial instruments that are subject to interest rate risk, principally
short-term investments. Historically, the Company has not experienced material gains or losses due
to such interest rate changes. Based on the current holdings of short-term investments, the
interest rate risk is not considered to be material. New accounting standards- In December 2004, the Financial Accounting Standards Board (FASB)
issued Statement of Financial Accounting Standards (SFAS) No. 123(R), Share-Based Payment, which
replaces SFAS No. 123, Accounting for Stock-Based Compensation, and supersedes APB Opinion No.
25, Accounting for Stock Issued to Employees. The Statement requires that the cost resulting
from all share-based payment transactions be recognized in the financial statements. The Statement
also establishes fair value as the measurement objective in accounting for share-based payment
arrangements and requires all entities to apply a fair-value-based measurement method in
accounting for share-based payment transactions with employees, except for equity instruments held
by employee share ownership plans. The Statement is effective for the Company beginning July 1,
2005, and is required to be adopted using a modified prospective method. Under the modified
prospective method, the Statement applies to new awards and to awards modified, repurchased or
cancelled after the effective date. Additionally, compensation cost for the unvested portion of
awards as of the effective date is required to be recognized as the awards vest after the
effective date. The Company does not expect the requirements of this Statement will have a
significant impact on its results of operations or financial position. In November 2004, the FASB issued SFAS No. 151, Inventory Costs (SFAS No. 151), which amends the
guidance in Accounting Research Bulletin No. 43, Chapter 4, Inventory Pricing. The Statement
requires that the accounting for abnormal amounts of idle facility expense, freight handling costs,
and wasted material (spoilage) be recognized as current-period charges. In addition, the Statement
requires that the allocation of fixed production overhead to the costs of conversion be based on
the normal capacity of the production facilities. The Statement is effective for the Company for
inventory costs incurred beginning July 1, 2005. The Company does not expect the requirements of
this Statement will have any impact on its results of operations or financial position. In December 2004, the FASB issued SFAS No. 153, Exchange of Nonmonetary Assets, an amendment of
APB Opinion No. 29 (SFAS No. 153), which addresses the measurement of exchanges of nonmonetary
assets. The Statement eliminates the exception for nonmonetary exchanges of similar productive
assets and replaces it with a general exception for exchange of nonmonetary assets that do not
have commercial substance. It also specifies that a nonmonetary exchange has commercial substance
if the future cash flows of the entity are expected to change significantly as a result of the
exchange. The Statement is effective for the Company beginning July 1, 2005. The Company does not
expect the requirements of the Statement will have a significant impact on its results of
operations or financial position. During fiscal 2004, the Company purchased a manufacturing facility in Albuquerque, New Mexico,
that replaced an existing plant in Rio Rancho, New Mexico, which was subsequently sold. Because
these transactions were reported separately, at fair market value, there would have been no change
to how these transactions were recorded for financial reporting purposes had SFAS No. 153 been in
effect during fiscal 2004. The tax treatment for the sale and purchase of these facilities was as
a like-kind exchange. Recently there have been official discussions and clarifications of certain provisions of FASB
Statement No. 13, Accounting for Leases. The Company does not have any capital leases. All
leases are operating leases, mainly for the lease of machinery and equipment, with monthly
payments over a fixed term in equal, non-escalating amounts. The Company does not expect these
clarifications to have any impact on its results of operations or financial position. Periodic benefit cost- The Company follows the disclosure requirements of SFAS No. 132(R). For
the three months and nine months ended March 31, 2005 and 2004, $96,000 and $481,000 and $360,000
and $545,000 of expense has been recorded, respectively. Total net periodic benefit cost for
fiscal 2005 will be $480,000, compared to total net periodic benefit cost reported for fiscal 2004
of $727,000. For the three months and nine months ended March 31, 2005 and 2004, respectively, net
periodic benefit cost includes the effect of changes resulting from the actuarial valuations
performed as of the periods closing. Fiscal 2005 and 2004 anticipated and actual annual reported
expense amount to $480,000 and $727,000, respectively. The decrease from prior year is primarily
due to improved interest rates, and return on and valuation of plan assets. The components of net
periodic pension expense for each of the periods presented were as follows: Three Months Ended
    
    
    Nine Months Ended2005
    
    
    2004
    
    
    2005
    
    
    2004Service cost
    
    $
    110,000
    
    
    $
    358,000
    
    
    $
    412,000
    
    
    $
    406,000Interest cost
    
    
    154,000
    
    
    
    446,000
    
    
    
    498,000
    
    
    
    505,000Expected return on plan assets
    
    
    (228,000
    )
    
    
    (566,000
    )
    
    
    (734,000
    )
    
    
    (642,000
    )Amortization of prior service cost
    
    
    24,000
    
    
    
    64,000
    
    
    
    72,000
    
    
    
    73,000Amortization of net loss
    
    
    36,000
    
    
    
    179,000
    
    
    
    112,000
    
    
    
    203,000Net periodic benefit cost
    
    $
    96,000
    
    
    $
    481,000
    
    
    $
    360,000
    
    
    $
    545,000
 7




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##### 



Stock options- Pending the effective date of SFAS No. 123(R), the Company continues to
follow APB No. 25 and related Interpretations in accounting for its employee stock options. Under
APB No. 25, no compensation expense is recognized, as the exercise price of the Companys employee
stock options equals the market price of the underlying stock on the date of grant. The Company
follows the disclosure requirements of SFAS No. 123 as amended by SFAS No. 148. The Company has an incentive stock option plan under which 760,000 common shares were reserved for
option grants to key employees and directors at the fair market value of the stock at the date of
the grant. As of March 31, 2005, there were 533,442 shares outstanding under option, with prices
ranging from $3.24 to $8.90, a weighted average remaining contractual life of 2.2 years, and a
weighted average exercise price of $5.89. The following table summarizes information about stock
options outstanding and exercisable at March 31, 2005: Options Outstanding
    
    Options ExercisableRange of
    
    
    
    Wtd. Avg. Remaining
    
    Wtd. Avg.
    
    
    
    Wtd. Avg.Exercise Prices
    
    Number Outstanding
    
    Contractual Life (years)
    
    Exercise Price
    
    Number Exercisable
    
    Exercise Price$3.24 to $6.06
    
    384,489
    
    $1.44
    
    $5.34
    
    317,126
    
    $5.19$6.26 to $8.90
    
    148,953
    
    $4.21
    
    $7.33
    
    63,051
    
    $7.30
 Under the plan at March 31, 2005, exercisable options and the per share weighted
average exercise price were 380,177 and $5.54, respectively, with 159,561 remaining shares
available for grant. The following sets forth a reconciliation of net income (loss) and earnings (loss) per share
information for the three months and nine months ended March 31, 2005 and 2004, as if the Company
had recognized compensation expense based on the fair value at the grant date for awards under the
plan. For purposes of computing pro forma net income (loss), the fair value of each option grant
is estimated on the date of grant using the Black-Scholes option pricing model. Three Months Ended
    
    
    Nine Months Ended2005
    
    
    2004
    
    
    2005
    
    
    2004Net income (loss), as reported
    
    $
    308,000
    
    
    $
    156,000
    
    
    $
    3,175,000
    
    
    $
    (3,541,000
    )Deduct:Total stock-based compensation expense determined
under the fair-value-based method
for all awards, net of tax effects
    
    
    42,000
    
    
    
    47,000
    
    
    
    125,000
    
    
    
    140,000Pro forma net income (loss)
    
    $
    266,000
    
    
    $
    109,000
    
    
    $
    3,050,000
    
    
    $
    (3,681,000
    )Pro forma earnings (loss) per share  after stock dividend (Note 3):Basic earnings (loss) per share
    
    $
    0.03
    
    
    $
    0.01
    
    
    $
    0.35
    
    
    $
    (0.42
    )Diluted earnings (loss) per share
    
    $
    0.03
    
    
    $
    0.01
    
    
    $
    0.34
    
    
    $
    (0.42
    )
 2. INVENTORIES- Inventories are valued at the lower of cost (first-in, first-out basis) or
market and include costs related to long-term contracts. Inventories, other than contract costs,
are principally raw materials and supplies. The following are the major classifications of
inventory: March 31, 2005
    
    
    June 30, 2004Raw materials
    
    $
    26,845,000
    
    
    $
    23,641,000Work in process and finished goods
    
    
    9,641,000
    
    
    
    13,569,000$
    36,486,000
    
    
    $
    37,210,000
 Work in process and finished goods inventories include $1.1 and $4.3 million of completed,
but not yet accepted sonobuoys at March 31, 2005 and June 30, 2004, respectively. Inventories are
reduced by progress billings to the U.S. government of approximately $6,915,000 and $2,125,000 at
March 31, 2005 and June 30, 2004, respectively. 3. EARNINGS (LOSS) PER SHARE- On November 9, 2004, Spartons Board of Directors approved a 5%
stock dividend. Eligible shareowners of record on November 23, 2004, received the stock dividend on
December 15, 2004. To record the stock dividend, an amount equal to the fair market value of the
common stock issued was transferred from retained earnings ($3,723,000) to common stock ($522,000)
and capital in excess of par value ($3,198,000), with the balance ($3,000) paid in cash in lieu of
fractional shares of stock. Accordingly, all share and per share information for fiscal 2005 and
2004 has been adjusted to reflect the impact of all stock dividends declared for the periods shown. 8




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##### 



Due to the Companys reported net loss for the nine months ended March 31, 2004, 146,163 outstanding
stock option share equivalents were excluded from the computation of diluted earnings per share
because their inclusion would have been anti-dilutive. Basic and diluted earnings per share were
computed based on the following: Three Months Ended
    
    
    Nine Months Ended2005
    
    
    2004
    
    
    2005
    
    
    2004Basic  weighted average shares outstanding
    
    
    8,792,440
    
    
    
    8,763,076
    
    
    
    8,778,657
    
    
    
    8,762,106Effect of dilutive stock options
    
    
    126,058
    
    
    
    132,623
    
    
    
    121,114
    
    
    
    Weighted average diluted shares outstanding
    
    
    8,918,498
    
    
    
    8,895,699
    
    
    
    8,899,771
    
    
    
    8,762,106Basic earnings (loss) per share  after stock dividend
    
    $
    0.04
    
    
    $
    0.02
    
    
    $
    0.36
    
    
    $
    (0.40
    )Diluted earnings (loss) per share  after stock dividend
    
    $
    0.03
    
    
    $
    0.02
    
    
    $
    0.36
    
    
    $
    (0.40
    )
 4. COMPREHENSIVE INCOME (LOSS)- Comprehensive income (loss) includes net income (loss) as
well as unrealized gains and losses, net of tax, on investment securities owned and investment
securities held by an investee accounted for by the equity method, which are excluded from net
income. In addition, translation gains and losses on the Companys Vietnam subsidiary are included
in comprehensive income (loss). Unrealized gains and losses, net of tax, are reflected as a direct
charge or credit to shareowners equity. Total comprehensive income (loss) is as follows for the
three months and nine months ended March 31, 2005 and 2004, respectively: Three Months Ended
    
    
    Nine Months Ended2005
    
    
    2004
    
    
    2005
    
    
    2004Net income (loss)
    
    $
    308,000
    
    
    $
    156,000
    
    
    $
    3,175,000
    
    
    $
    (3,541,000
    )Other comprehensive income (loss), net of tax:Net unrealized gains (losses)  investment securities owned
    
    
    (138,000
    )
    
    
    59,000
    
    
    
    (172,000
    )
    
    
    (156,000
    )Net unrealized gains (losses)  investment securities held by investee
accounted for by the equity method
    
    
    (59,000
    )
    
    
    74,000
    
    
    
    44,000
    
    
    
    281,000Net translation gains (losses) on Vietnam subsidiary
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Comprehensive income (loss)
    
    $
    111,000
    
    
    $
    289,000
    
    
    $
    3,047,000
    
    
    $
    (3,416,000
    )
 At March 31, 2005 and June 30, 2004, shareowners equity includes accumulated other
comprehensive income (loss) of $(66,000) and $62,000, respectively, net of tax. The components of
these amounts are as follows: March 31, 2005
    
    
    June 30, 2004Accumulated other comprehensive income (loss), net of tax:Investment securities owned
    
    $
    (156,000
    )
    
    $
    16,000Investment securities held by investee accounted for by the equity method
    
    
    90,000
    
    
    
    46,000Translation gains (losses)  Vietnam subsidiary
    
    
    
    
    
    
    Accumulated other comprehensive income (loss)
    
    $
    (66,000
    )
    
    $
    62,000
 5. INVESTMENT SECURITIES- The fair value of cash and cash equivalents, accounts receivable,
and accounts payable approximate their carrying value. Cash and cash equivalents consist of demand
deposits and other highly liquid investments with an original term of three months or less. The
investment portfolio has various maturity dates up to 28 years. A daily market exists for all
investment securities. The Company believes that the impact of fluctuations in interest rates on
its investment portfolio should not have a material impact on financial position or results of
operations. Investments in debt securities that are not cash equivalents and marketable equity
securities have been designated as available-for-sale. Those securities are reported at fair
value, with net unrealized gains and losses included in accumulated other comprehensive income,
net of applicable taxes. Unrealized losses that are other than temporary are recognized in
earnings. The Company does not believe there are any significant individual unrealized losses as
of March 31, 2005, which would represent other than temporary losses, and there are no unrealized
losses with a duration of one year or more. Realized gains and losses on investments are
determined using the specific identification method. It is the Companys intention to use these
investment securities to provide working capital, fund the expansion of its business and for other
business purposes. At March 31, 2005, the Company had net unrealized losses of $247,000. At that date, the net
after-tax effect of these losses was $156,000, which is included in accumulated other
comprehensive income within shareowners equity. For the nine months ended March 31, 2005 and
2004, purchases of investment securities totaled $8,870,000 and $1,509,000, and sales of
investment securities totaled $6,501,000 and $7,353,000, respectively. The Company owns a 14% interest in Cybernet Systems Corporation (Cybernet), 12% on a fully diluted
basis. This investment, with a carrying value of $1,727,000 and $1,677,000 at March 31, 2005 and June 30, 2004,
respectively, represents the Companys 9




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##### 



equity interest in Cybernets net assets plus $770,000 of goodwill (no longer being amortized in
accordance with SFAS No. 142, Goodwill and Other Intangible Assets). The investment in Cybernet
is accounted for under the equity method, and is included in other assets on the condensed
consolidated balance sheet. The Company believes that the equity method is appropriate given
Spartons level of involvement in Cybernet. Prior to June 2002, Sparton accounted for its Cybernet
investment using the cost method, which reflected a more passive involvement with Cybernets
operations. Spartons current President and CEO is one of three Cybernet Board members, and as part
of that position is actively involved in Cybernets oversight and operations. In addition, he has a
strategic management relationship with the owners, who are also the other two board members,
resulting in his additional involvement in pursuing areas of common interest for both Cybernet and
Sparton. The Companys share of unrealized gains (losses) on available-for-sale securities held by
Cybernet is carried in accumulated other comprehensive income (loss) within the shareowners equity
section of the Companys balance sheet. The contractual maturities of debt securities, and total equity securities as of March 31, 2005,
were as follows: YearsWithin 1
    
    
    1 to 5
    
    
    5 to 10
    
    
    Over 10
    
    
    TotalDebt securities:Corporate  primarily U.S.
    
    $
    1,182,682
    
    
    $
    3,805,238
    
    
    $
    158,298
    
    
    $
    270,390
    
    
    $
    5,416,608U.S. government and federal agency
    
    
    601,565
    
    
    
    2,544,979
    
    
    
    1,742,742
    
    
    
    1,810,853
    
    
    
    6,700,139State and municipal
    
    
    109,967
    
    
    
    3,293,659
    
    
    
    974,438
    
    
    
    
    
    
    
    4,378,064Total debt securities
    
    
    1,894,214
    
    
    
    9,643,876
    
    
    
    2,875,478
    
    
    
    2,081,243
    
    
    
    16,494,811Equity securities  primarily preferred stock
    
    
    4,208,318
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    4,208,318Total investment securities
    
    $
    6,102,532
    
    
    $
    9,643,876
    
    
    $
    2,875,478
    
    
    $
    2,081,243
    
    
    $
    20,703,129
 6. COMMITMENTS AND CONTINGENCIES- One of Spartons former manufacturing facilities, located
in Albuquerque, New Mexico (Coors Road), has been involved with ongoing environmental remediation
since the early 1980s. At March 31, 2005, Sparton has accrued $6,962,000 as its estimate of the
minimum future undiscounted financial liability, of which $627,000 is classified as a current
liability and included in accrued liabilities. Amounts charged to operations, principally legal
and consulting fees, for the nine months ended March 31, 2005 and 2004 were $282,000 and $240,000,
respectively. These costs were generally incurred in pursuit of various claims for
reimbursement/recovery. The Companys minimum cost estimate is based upon existing technology and
excludes legal and related consulting costs, which are expensed as incurred. The Companys
estimate includes equipment, operating, and continued monitoring costs for onsite and offsite pump
and treat containment systems. In fiscal 2003, Sparton reached an agreement with the United States Department of Energy (DOE) and
others to recover certain remediation costs. Under the settlement terms, Sparton received cash and
the DOE agreed to reimburse Sparton for 37.5% of certain future environmental expenses in excess of
$8,400,000 incurred from the date of settlement. Uncertainties associated with environmental
remediation contingencies are pervasive and often result in wide ranges of reasonably possible
outcomes. Estimates developed in the early stages of remediation can vary significantly. Normally a
finite estimate of cost does not become fixed and determinable at a specific point in time. Rather,
the costs associated with environmental remediation become estimable over a continuum of events and
activities that help to frame and define a liability. Factors which cause uncertainties for the
Company include, but are not limited to, the effectiveness of the current work plans in achieving
targeted results and proposals of regulatory agencies for desired methods and outcomes. It is
possible that cash flows and results of operations could be significantly affected by the impact of
changes associated with the ultimate resolution of this contingency. Some of the printed circuit boards supplied to the Company for its Aerospace sales have been
discovered to have intermittent defects. The defect occurred during production at the board
manufacturers facility, prior to shipment to Sparton for further processing. All of the lots
involved have yet to be identified and Sparton, the board manufacturer, and the end customer who
received the defective boards are working to contain the defective boards. As of this date no
claims have been made or litigation commenced regarding this matter. The extent of Spartons
exposure, if any, is unknown at this time, thus nothing has been accrued related to this
contingency at March 31, 2005. 10




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##### 



Item 2. Managements Discussion and Analysis of Financial Condition and Results of Operations The following is managements discussion and analysis of certain significant events affecting the
Companys earnings and financial condition during the periods included in the accompanying
financial statements. Additional information regarding the Company can be accessed via Spartons
website at www.sparton.com. Information provided at the website includes, among other items, the
Annual Report on Form 10-K, Quarterly Reports on Form 10-Q, Quarterly Earnings Releases, News
Releases, and the Code of Business Conduct and Ethics, as well as the various committee charters of
the Board of Directors. These items are also available, free of charge, by contacting the Companys
Shareowners Relations department. The Companys operations are in one line of business, electronic
contract manufacturing services (EMS). Spartons capabilities range from product design and
development through aftermarket support, specializing in total business solutions for government,
medical/scientific instrumentation, aerospace and industrial/other markets. These include the
design, development and/or manufacture of electronic parts and assemblies for both government and
commercial customers worldwide. Governmental sales are mainly sonobuoys. The Private Securities Litigation Reform Act of 1995 reflects Congress determination that the
disclosures of forward-looking information is desirable for investors and encourages such
disclosure by providing a safe harbor for forward-looking statements by corporate management. This
report on Form 10-Q contains forward-looking statements within the scope of the Securities Act of
1933 and the Securities Exchange Act of 1934. The words expects, anticipates, believes,
intends, plans, and similar expressions, and the negatives of such expressions, are intended
to identify forward-looking statements. In addition, any statements which refer to expectations,
projections or other characterizations of future events or circumstances are forward-looking
statements. The Company undertakes no obligation to publicly disclose any revisions to these
forward-looking statements to reflect events or circumstances occurring subsequent to filing this
Form 10-Q with the Securities and Exchange Commission (SEC). These forward-looking statements are
subject to risks and uncertainties, including, without limitation, those discussed below.
Accordingly, Spartons future results may differ materially from historical results or from those
discussed or implied by these forward-looking statements. The Company notes that a variety of
factors could cause the actual results and experience to differ materially from anticipated
results or other expectations expressed in the Companys forward-looking statements. Sparton, as a high-mix, low to medium-volume supplier, provides rapid product turnaround for
customers. High-mix pertains to customers needing multiple product types with generally lower
volume manufacturing runs. As a contract manufacturer with customers in a variety of markets, the
Company has substantially less visibility to end user demand and, therefore, forecasting sales can
be problematic. Customers may cancel their orders, change production quantities and/or reschedule
production for a number of reasons. Depressed economic conditions may result in customers delaying
delivery of product, or the placement of purchase orders for lower volumes than previously
anticipated. Unplanned cancellations, reductions, or delays by customers negatively impact the
Companys results of operations. As many of the Companys costs and operating expenses are
relatively fixed within given ranges of production, a reduction in customer demand can
disproportionately affect the Companys gross margins and operating income. The majority of the
Companys sales have historically come from a limited number of customers. Significant reductions
in sales to, or a loss of, one of these customers could materially impact business if the Company
were not able to replace those lost sales with new business. Other risks and uncertainties that may affect operations, performance, growth forecasts and
business results include, but are not limited to, timing and fluctuations in U.S. and/or world
economies, competition in the overall EMS business, availability of production labor and management
services under terms acceptable to the Company, Congressional budget outlays for sonobuoy
development and production, Congressional legislation, foreign currency exchange rate risk,
uncertainties associated with the costs and benefits of new facilities, including the new plant in
Vietnam, and the closing of others, uncertainties associated with the outcome of litigation,
changes in the interpretation of environmental laws and the uncertainties of environmental
remediation. A further risk factor is the availability and cost of materials. The Company has
encountered availability and extended lead time issues on some electronic components in the past
when market demand has been strong, this resulted in higher prices and late deliveries.
Additionally, the timing of sonobuoy sales to the U.S. Navy is dependent upon access to the test
range and successful passage of product tests performed by the U.S. Navy. Reduced governmental
budgets have made access to the test range less predictable and less frequent than in the past.
Finally, the Sarbanes-Oxley Act of 2002 has required changes in, and formalization of, some of the
Companys corporate governance and compliance practices. The SEC and New York Stock Exchange have
also passed new rules and regulations requiring additional compliance activities. Compliance with
these rules has increased administrative costs, and it is expected that certain of these costs will
continue indefinitely. Management cautions readers not to place undue reliance on forward-looking
statements, which are subject to influence by the enumerated risk factors as well as unanticipated
future events. The following discussion should be read in conjunction with the Condensed Consolidated Financial
Statements and Notes thereto. 11




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##### 



RESULTS OF OPERATIONS Three Months Ended March 312005
    
    2004%
    
    
    
    
    
    %
    
    %Sales
    
    of Total
    
    Sales
    
    of Total
    
    ChangeGovernment
    
    $
    10,143,000
    
    
    
    24.4
    %
    
    $
    14,061,000
    
    
    
    32.3
    %
    
    
    (27.9
    )%Industrial/Other
    
    
    11,641,000
    
    
    
    28.0
    
    
    
    11,169,000
    
    
    
    25.6
    
    
    
    4.2Aerospace
    
    
    16,741,000
    
    
    
    40.3
    
    
    
    13,885,000
    
    
    
    31.9
    
    
    
    20.6Medical/Scientific Instrumentation
    
    
    3,036,000
    
    
    
    7.3
    
    
    
    4,451,000
    
    
    
    10.2
    
    
    
    (31.8
    )Totals
    
    $
    41,561,000
    
    
    
    100.0
    %
    
    $
    43,566,000
    
    
    
    100.0
    %
    
    
    (4.6
    )
 Sales for the three-month
period ended March 31, 2005, totaled $41,561,000, a decrease of $2,005,000 (4.6%) from the same quarter last year. Government sales were lower than expected due
to the rescheduling of engineering redesign work, sonobuoy drop test failures, and manufacturing
transitioning between sonobuoy contracts. Government sales are anticipated to improve through the
remainder of the fiscal year as some of these issues are now resolved. Industrial sales improved
mainly due to increased sales to existing customers. It is uncertain if this increased demand will
continue for the balance of this fiscal year. Aerospace sales were also above the prior year sales
due to increased sales to an existing customer in the commercial aerospace market. A large
component of this increased demand was due to higher sales of products related to aircraft
collision avoidance systems mandated for installation in all commercial aircraft. This increased
demand is not anticipated to continue. Medical/Scientific Instrumentation was down from the prior
year due to overall lower demand from existing customers in this market and new program delays.
While the Company has added several new customers, and/or products in the medical device area, the
volume of new business has not been as high as previously anticipated. The following table presents income statement data as a percentage of net sales for the
three-month periods ended March 31, 2005 and 2004: 2005
    
    2004Net sales
    
    
    100.0
    %
    
    
    100.0
    %Costs of goods sold
    
    
    92.0
    
    
    
    91.8Gross profit
    
    
    8.0
    
    
    
    8.2Selling and administrative expenses
    
    
    7.6
    
    
    
    7.7Other operating expenses
    
    
    0.4
    
    
    
    0.2Operating income (loss)
    
    
    (0.0
    )
    
    
    0.3Other income  net
    
    
    0.5
    
    
    
    0.2Income before income taxes
    
    
    0.5
    
    
    
    0.5Provision (credit) for income taxes
    
    
    (0.2
    )
    
    
    0.1Net income
    
    
    0.7
    %
    
    
    0.4
    %
 An operating loss of $2,000 was reported for the three months ended March 31, 2005, compared
to operating income of $133,000 for the three months ended March 31, 2004. Gross profit percentage
for the three months ended March 31, 2005, was 8.0%, down from 8.2% for the same period last year.
The depressed margin is reflective of a less favorable product mix and increased costs related to
several program start-ups. Selling and administrative expenses are consistent with the prior year. Interest and investment income increased $74,000 to $231,000 in fiscal 2005. This increase was
mainly due to increased funds available for investment and improved interest rates. Other
expense-net in fiscal 2005 was $30,000, versus $65,000 in fiscal 2004. Translation adjustments,
along with gains and losses from foreign currency transactions, are included in other income and,
in the aggregate, amounted to a loss of $12,000 and $10,000 during the three months ended March 31,
2005 and 2004, respectively. During the third quarter, the Companys annual effective tax rate was
estimated to be 28%, rather than the previously anticipated 32%. The Companys recorded adjustment
to the currently estimated rate resulted in a credit to third quarter income tax expense of
$168,000. This, combined with normal third quarter income tax expense of $54,000, resulted in a net
income tax credit of $114,000 for the third quarter. Variables affecting the effective tax rate
include, but are not limited to, extraterritorial tax credits, Canadian tax loss carryforwards,
effect of translation income and loss, and utilization of contribution carryforwards. This
estimated tax rate, while based on the Companys knowledge and expectations at this point in time,
may change based on actual fourth quarter activity and results of operations. 12




---



##### 



Due to the factors described above, the Company reported net income of $308,000 ($0.04 per
share, basic, and $0.03 per share, diluted) for the three months ended March 31, 2005, versus
$156,000 ($0.02 per share, basic and diluted) for the corresponding period last year. Nine Months Ended March 312005
    
    2004%
    
    
    
    
    
    %
    
    %Sales
    
    of Total
    
    Sales
    
    of Total
    
    ChangeGovernment
    
    $
    24,510,000
    
    
    
    20.2
    %
    
    $
    30,746,000
    
    
    
    27.2
    %
    
    
    (20.3
    )%Industrial/Other
    
    
    35,042,000
    
    
    
    28.9
    
    
    
    29,089,000
    
    
    
    25.7
    
    
    
    20.5Aerospace
    
    
    51,729,000
    
    
    
    42.7
    
    
    
    39,899,000
    
    
    
    35.2
    
    
    
    29.6Medical/Scientific Instrumentation
    
    
    9,995,000
    
    
    
    8.2
    
    
    
    13,497,000
    
    
    
    11.9
    
    
    
    (25.9
    )Totals
    
    $
    121,276,000
    
    
    
    100.0
    %
    
    $
    113,231,000
    
    
    
    100.0
    %
    
    
    7.1
 Sales for the nine-month period ended March 31, 2005, totaled $121,276,000, an increase of
$8,045,000 (7.1%) from the same period last year. Government sales decreased, and included $4.7
million of a delayed sonobuoy sale originally anticipated to ship in fiscal 2004. Government sales
were lower than anticipated due to production interruptions at the Companys Florida facilities,
as several tropical storms disrupted operations in the first quarter of fiscal 2005. In addition,
rescheduling of engineering redesign work, failed sonobuoy drop tests, and lack of access to the
U.S. Navys test site further depressed sales. Government sales are anticipated to improve in the
final quarter of this fiscal year. Industrial market sales increased from the same period last
year. This increase was attributed to increased demand from two existing customers, it is
uncertain if this demand will continue for the balance of this fiscal year. Sales to the aerospace
markets continue to grow, increasing 29.6% over the prior year. In general, this reflects stronger
demand in the commercial aerospace market, primarily increased demand for products related to
aircraft collision avoidance systems mandated for installation in all commercial aircraft.
Approximately $6.9 million of the aerospace increase was attributable to increased orders from one
customer, to which the Company supplies product to six manufacturing facilities. The increased
demand for the collision avoidance products is not anticipated to continue throughout the final
quarter. Medical/Scientific Instrumentation sales declined from the prior year. This decrease
resulted from overall lower demand from existing customers in this market area and new program
delays. While the Company has added several new customers, and/or products in the medical device
area, the volume of new business has not been as high as previously anticipated. The majority of the Companys sales come from a small number of customers. Sales to our six
largest customers, including government sales, accounted for approximately 76% and 72% of net
sales in fiscal 2005 and 2004, respectively. Five of the customers, including government, were the
same both years. One of these customers, with six separate facilities as discussed above, provided
28% and 24% of the sales through March 31, 2005 and 2004, respectively. The following table presents income statement data as a percentage of net sales for the nine
months ended March 31, 2005 and 2004: 2005
    
    2004Net sales
    
    
    100.0
    %
    
    
    100.0
    %Costs of goods sold
    
    
    89.1
    
    
    
    95.2Gross profit
    
    
    10.9
    
    
    
    4.8Selling and administrative expenses
    
    
    8.1
    
    
    
    9.3Other operating expenses
    
    
    0.2
    
    
    
    0.2Operating income (loss)
    
    
    2.6
    
    
    
    (4.7
    )Other income  net
    
    
    1.0
    
    
    
    0.1Income before income taxes
    
    
    3.6
    
    
    
    (4.6
    )Provision (credit) for income taxes
    
    
    1.0
    
    
    
    (1.5
    )Net income
    
    
    2.6
    %
    
    
    (3.1
    )%
 Operating income of $3,119,000 was reported for the nine months ended March 31, 2005,
compared to a loss of $5,359,000 for the nine months ended March 31, 2004. Gross profit percentage
for the nine months ended March 31, 2005, was 10.9%, up from 4.8% for the same period last year.
While the tropical storms largely bypassed the Companys two Florida facilities, extensive
preparations were undertaken for the storms. This unexpected activity, along with the minor damage
that was experienced and unproductive wages, resulted in costs of approximately $500,000 being
charged in the first quarter of fiscal 2005. Also included 13




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##### 



in the current years gross profit was a settlement in the second quarter of fiscal 2005 with
a customer, which resulted in the Companys recovery of $500,000 of prior period start-up expenses.
The prior years depressed margin reflects the inclusion of costs on the start-up phase of several
major programs, as well as final charges incurred at the completion of one sonobuoy contract that
had experienced technical problems. In addition, the prior years margin included a redesign effort
on an existing product line, which resulted in a charge to operations of $519,000. The lowered
selling and administrative expenses are primarily the result of decreased bid and proposal and
research and development expenses for fiscal 2005, which were approximately $1.7 million below the
same nine month period last year. These cost reductions are not indicative of reduced bid and
proposal activity, which is currently at an all time high, but primarily the result of a one time
sonobuoy engineering project which has been completed. Interest and investment income increased $143,000 to $653,000 in fiscal 2005. This increase was
due to increased funds available for investment and improving investment rates. Other income-net
in fiscal 2005 was $647,000, versus an expense of $374,000 in fiscal 2004. Translation
adjustments, along with gains and losses from foreign currency transactions, are included in other
income and, in the aggregate, amounted to a gain of $644,000 and $163,000 during the nine months
ended March 31, 2005 and 2004, respectively. Other expense-net in the prior year included a charge
of $538,000 for workers compensation insurance adjustments related to the Companys previously
owned automotive segment. Due to the factors described above, the Company reported net income of $3,175,000 ($0.36 per
share, basic and diluted) for the nine months ended March 31, 2005, versus a loss of $3,541,000
($(0.40) per share, basic and diluted) for the corresponding period last year.  LIQUIDITY AND CAPITAL RESOURCES For the nine-month period ended March 31, 2005, cash and cash equivalents decreased $133,000 to
$10,687,000. Operating activities provided $7,288,000 in net cash flows. The primary source of
cash was from operations, compared to a loss in fiscal 2004 resulting in a use of cash, as well as
the adjustment for depreciation. The primary source of cash in fiscal 2004 was a decrease in
accounts receivable. The decrease in accounts receivable in both fiscal 2005 and 2004 was
reflective of the receipt of payments for the large volume of sales recognized in June 2004 and
2003. The change in cash flow related to inventory and prepaid expenses from the prior year is
reflective of a large increase at June 30, 2004, of inventory due to delayed customer delivery
schedules, as well as increased inventory for new customer contracts. Inventory levels at March
31, 2005, reflect a decrease in inventory, as these customers schedules were no longer delayed,
as well as the start of several new customer contracts. Cash flows used by investing activities for the nine-month period ended March 31, 2005, totaled
$7,672,000, primarily for purchases of property, plant and equipment, which is discussed below.
The purchase of, and proceeds from the sale of, investment securities are generally reflective of
activity within the various investment options. In fiscal 2004 proceeds from the sale of
investments were also used to fund purchases of property, plant and equipment. Historically, the Companys market risk exposure to foreign currency exchange and interest rates
on third party receivables and payables has not been considered to be material, principally due to
their short term nature and minimal receivables and payables designated in foreign currency.
However, due to the recently strengthening Canadian dollar the impact of transaction and
translation gains on intercompany activity and balances has increased. While a reversal of these
recent gains is not anticipated, if the exchange rate were to materially decline the Companys
financial position could be significantly affected. The Company has had no short-term bank debt
since December 1996, and currently has an unused informal line of credit totaling $20 million. At March 31, 2005 and June 30, 2004, the aggregate government EMS backlog was approximately $52
million and $41 million, respectively. Current backlog includes the recent U.S. Navy sonobuoy
contract awards, which totaled $21.7 million. A majority of the March 31, 2005, backlog is
expected to be realized in the next 12-15 months. Commercial EMS orders are not included in the
backlog. The Company does not believe the amount of commercial activity covered by firm purchase
orders is a meaningful measure of future sales, as such orders may be rescheduled or cancelled
without significant penalty. Construction of the Companys new plant in Vietnam is substantially complete. Preliminary
prototype product is currently being produced, with regular production beginning in May. This new
facility is anticipated to provide increased growth opportunities for the Company, in current as
well as new markets. As the Company has not previously done business in this emerging market,
there are many uncertainties and risks inherent in this venture. It is estimated that the total
Company investment will approximate $5-$7 million, which includes land, building, and initial
operating expenses. To date, approximately $2.0 million has been expended for the construction of
the new facility, primarily in fiscal 2005. The new company operates under the name Spartronics.
The Company is also continuing a program of identifying and evaluating potential acquisition
candidates in both the defense and medical markets. 14




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The Company has purchased a manufacturing facility in Albuquerque, New Mexico. This facility
replaced an existing plant in Rio Rancho, New Mexico. The facility was purchased in December 2003
for approximately $4.5 million. The cost of additional remodeling and facility upgrades totaled
approximately $2.0 million and were incurred, primarily in 2005, as the Company transitioned
between facilities. The Rio Rancho plant was sold in June 2004 for approximately $1.7 million
($1.6 million after expenses related to the sale), resulting in a $844,000 gain. The Company
leased the Rio Rancho facility until the transition to the new facility was completed in December
2004. The new facility is expected to provide economic benefits to the Company, accommodating
customer products with higher technical requirements, as well as providing additional and more
efficient manufacturing space in the Southwest. No cash dividends were declared in either period presented. In November 2004, the Company approved
a 5% stock dividend. This dividend was distributed December 15, 2004, to shareowners of record on
November 23, 2004. At March 31, 2005, the Company had $92,164,000 in shareowners equity ($10.45
per share), $71,745,000 in working capital, and a 4.67:1.00 working capital ratio. For the
foreseeable future (12-18 months), the Company believes it has sufficient liquidity for its
anticipated needs, unless a significant business acquisition is identified and completed for cash. CONTRACTUAL OBLIGATIONS AND COMMITMENTS Information regarding the Companys environmental liability payments, operating lease payments,
and other commitments is provided in Item 7, Managements Discussion and Analysis of Financial
Condition and Results of Operation, of the Companys Annual Report on Form 10-K for the fiscal
year ended June 30, 2004. There have been no material changes in contractual obligations since
June 30, 2004. CRITICAL ACCOUNTING POLICIES AND ESTIMATES Managements discussion and analysis of financial condition and results of operations is based
upon the Companys consolidated financial statements, which have been prepared in accordance with
accounting principles generally accepted in the United States of America. Significant accounting
policies are summarized in Note 1 to the Consolidated Financial Statements included in our Annual
Report on Form 10-K for the fiscal year ended June 30, 2004. The preparation of these financial
statements requires management to make estimates and assumptions that affect the amounts reported
for assets, liabilities, revenues and expenses, and related disclosure of contingent assets and
liabilities. Estimates are regularly evaluated and are based on historical experience and on
various other assumptions believed to be reasonable under the circumstances. Actual results could
differ from these estimates. The Company believes that of its significant accounting policies, the
following involve a higher degree of judgment and complexity. Environmental Contingencies One of Spartons former manufacturing facilities, located in Albuquerque, New Mexico (Coors Road),
has been the subject of ongoing investigations and remediation efforts conducted with the
Environmental Protection Agency (EPA) under the Resource Conservation and Recovery Act (RCRA).
Sparton has accrued its estimate of the minimum future non-discounted financial liability. The
estimate was developed using existing technology and excludes legal and related consulting costs.
The minimum cost estimate includes equipment, operating and monitoring costs for both onsite and
offsite remediation. Sparton recognizes legal and consulting services in the periods incurred and
reviews its EPA accrual activity quarterly. Uncertainties associated with environmental remediation
contingencies are pervasive and often result in wide ranges of reasonably possible outcomes. It is
possible that cash flows and results of operations could be materially affected by the impact of
changes in these estimates. Government Contract Cost Estimates Government production contracts are accounted for based on completed units accepted with respect
to revenue recognition and their estimated average cost per unit regarding costs. Losses for the
entire amount of a contract are recognized in the period when such losses are determinable.
Significant judgment is exercised in determining estimated total contract costs including, but not
limited to, cost experience to date, estimated length of time to contract completion, costs for
materials, production labor and support services to be expended, and known issues on remaining
units to be completed. Estimated costs developed in the early stages of contracts can change
significantly as the contracts progress, and events and activities take place. Significant changes
in estimates can also occur when new designs are initially placed into production. The Company
formally reviews its costs incurred-to-date and estimated costs to complete on all significant
contracts on a quarterly basis and revised estimated total contract costs are reflected in the
financial statements. Depending upon the circumstances, it is possible that the Companys
financial position, results of operations, and cash flows could be materially affected by changes
in estimated costs to complete on one or more significant contracts. 15




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Commercial Inventory Valuation Allowances Inventory valuation allowances for commercial customer inventories require a significant degree of
judgment and are influenced by the Companys experience to date with both customers and other
markets, prevailing market conditions for raw materials, contractual terms and customers ability
to satisfy these obligations, environmental or technological materials obsolescence, changes in
demand for customer products, and other factors resulting in acquiring materials in excess of
customer product demand. Contracts with some commercial customers may be based upon estimated
quantities of product manufactured for shipment over estimated time periods. Raw material
inventories are purchased to fulfill these customer requirements. Within these arrangements,
customer demand for products frequently changes, sometimes creating excess and obsolete
inventories. The Company regularly reviews raw material inventories by customer for both excess and obsolete
quantities, with adjustments made accordingly. Wherever possible, the Company attempts to recover
its full cost of excess and obsolete inventories from customers or, in some cases, through other
markets. When it is determined that the Companys carrying cost of such excess and obsolete
inventories cannot be recovered in full, a charge is taken against income and a valuation allowance
is established for the difference between the carrying cost and the estimated realizable amount.
Conversely, should the disposition of adjusted excess and obsolete inventories result in recoveries
in excess of these reduced carrying values, the remaining portion of the valuation allowances are
reversed and taken into income when such determinations are made. It is possible that the Companys
financial position, results of operations and cash flows, could be materially affected by changes to
inventory valuation allowances for commercial customer excess and obsolete inventories. Allowance for Possible Losses on Receivables The accounts receivable balance is recorded net of allowances for amounts not expected to be
collected from customers. The allowance is estimated based on historical experience of write-offs,
the level of past due amounts, information known about specific customers with respect to their
ability to make payments, and future expectations of conditions that might impact the
collectibility of accounts. Accounts receivable are generally due under normal trade terms for the
industry. Credit is granted, and credit evaluations are periodically performed, based on a
customers financial condition and other factors. Although the Company does not generally require
collateral, cash in advance or letters of credit may be required from customers in certain
circumstances, including some foreign customers. When management determines that it is probable
that an account will not be collected, it is charged against the allowance for possible losses. The
Company reviews the adequacy of its allowance monthly. The allowance for doubtful accounts was
$16,000 and $46,000 at March 31, 2005 and June 30, 2004, respectively. If the financial condition
of customers were to deteriorate, resulting in an impairment of their ability to make payment, an
additional allowance may be required. Given the Companys significant balance of government
receivables and letters of credit from foreign customers, collection risk is considered minimal.
Historically, uncollectible accounts have been generally insignificant and the minimal allowance is
deemed adequate. Pension Obligations The Company calculates the cost of providing pension benefits under the provisions of SFAS No. 87.
The key assumptions required within the provisions of SFAS No. 87 are used in making these
calculations. The most significant of these assumptions are the discount rate used to value the
future obligations and the expected return on pension plan assets. The discount rate is consistent
with market interest rates on high-quality, fixed income investments. The expected return on assets
is based on long-term returns and assets held by the plan, which is influenced by historical
averages. If actual interest rates and returns on plan assets materially differ from the
assumptions, future adjustments to the financial statements would be required. While changes in
these assumptions can have a significant effect on the pension benefit obligations reported in the
Condensed Consolidated Balance Sheets and the unrecognized gain or loss accounts, the effect of
changes in these assumptions is not expected to have the same relative effect on net periodic
pension expense in the near term. While these assumptions may change in the future based on changes
in long-term interest rates and market conditions, there are no known expected changes in these
assumptions as of March 31, 2005. As indicated above, to the extent the assumptions differ from
actual results, there would be a future impact on the financial statements. The extent to which
this will result in future expense is not determinable at this time as it will depend upon a number
of variables, including trends in interest rates and the actual return on plan assets. For example,
an increase in the return on the plan assets due to improved market conditions would reduce the
unrecognized loss account and thus reduce future expense. While net periodic pension expense has
increased during the past two years, no cash payments are expected to be required for the next
several years due to the plans funded status. 16




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OTHER LITIGATION One of Spartons former manufacturing facilities, located in Albuquerque, New Mexico, has been the
subject of ongoing investigations conducted with the Environmental Protection Agency (EPA) under
the Resource Conservation and Recovery Act (RCRA). The investigation began in the early 1980s and
involved a review of onsite and offsite environmental impacts. At March 31, 2005, Sparton has accrued $6,962,000 as its estimate of the future undiscounted
minimum financial liability related to this site. The Companys cost estimate is based upon
existing technology and excludes legal and related consulting costs, which are expensed as
incurred. The Companys estimate includes equipment and operating costs for onsite and offsite
operations and is based on existing methodology. Uncertainties associated with environmental
remediation contingencies are pervasive and often result in wide ranges of reasonably possible
outcomes. Estimates developed in the early stages of remediation can vary significantly. Normally a
finite estimate of cost does not become fixed and determinable at a specific point in time. Rather,
the costs associated with environmental remediation become estimable over a continuum of events and
activities that help to frame and define a liability. It is possible that cash flows and results of
operations could be affected by the impact of the ultimate resolution of this contingency. Some of the printed circuit boards supplied to the Company for its Aerospace sales have been
discovered to have intermittent defects. The defect occurred during production at the board
manufacturers facility, prior to shipment to Sparton for further processing. All of the lots
involved have yet to be identified and Sparton, the board manufacturer, and the end customer who
received the defective boards are working to contain the defective boards. As of this date no
claims have been made or litigation commenced regarding this matter. The extent of Spartons
exposure, if any, is unknown at this time, thus nothing has been accrued related to this
contingency at March 31, 2005. Sparton is currently involved with two legal actions, which are disclosed in Part II  Other
Information, Item 1. Legal Proceedings of this report. At this time, the Company is unable to
predict the outcome of either of these claims. Item 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK The Company manufactures its products in the United States and Canada, and most recently in
Vietnam. Sales are to the U.S. and Canada, as well as other foreign markets. The Company is
potentially subject to foreign currency exchange rate risk relating to intercompany activity and
balances and to receipts from customers and payments to suppliers in foreign currencies. Also,
adjustments related to the translation of the Companys Canadian financial statements into U.S.
dollars are included in current earnings. The Companys Vietnamese translation gains and losses are
carried in accumulated other comprehensive income (loss) within the shareowners equity section of
the Companys balance sheet. As a result, the Companys financial results could be affected by
factors such as changes in foreign currency exchange rates or weak economic conditions in the
domestic and foreign markets in which the Company operates. However, minimal third party
receivables and payables are denominated in foreign currency and the related market risk exposure
is considered to be immaterial. Historically, foreign currency gains and losses related to
intercompany activity and balances have not been significant. However, recently due to the
strengthening Canadian dollar the impact of transaction and translation gains has increased. While
a reversal of these recent gains is not anticipated, if the exchange rate were to materially
decline the Companys financial position could be significantly affected. The Company has financial instruments that are subject to interest rate risk, principally
short-term investments. Historically, the Company has not experienced material gains or losses due
to such interest rate changes. Based on the current holdings of short-term investments, the
interest rate risk is not considered to be material. Item 4. CONTROLS AND PROCEDURES The Company maintains internal control over financial reporting intended to provide reasonable
assurance that all material transactions are executed in accordance with Company authorization,
are properly recorded and reported in the financial statements, and that assets are adequately
safeguarded. The Company also maintains a system of disclosure controls and procedures to ensure
that information required to be disclosed in Company reports, filed or submitted under the
Securities Exchange Act of 1934, is properly reported in the Companys periodic and other reports. 17




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As of March 31, 2005, an evaluation was updated by the Companys management, including the
CEO and CFO, on the effectiveness of the design and operation of the Companys disclosure controls
and procedures. Based on that evaluation, the Companys management, including the CEO and CFO,
concluded that the Companys disclosure controls and procedures continue to be effective as of
March 31, 2005. There have been no changes in the Companys internal controls over financial
reporting during the last fiscal quarter that have materially affected, or are reasonably likely
to materially affect, the Companys internal control over financial reporting. PART II
OTHER INFORMATION Item 1. Legal Proceedings One of Spartons former manufacturing facilities, located in Albuquerque, New Mexico (Coors Road),
has been involved with ongoing environmental remediation since the early 1980s. At March 31, 2005,
Sparton has accrued $6,962,000 as its estimate of the minimum future undiscounted financial
liability, of which $627,000 is classified as a current liability and included in accrued
liabilities. The Companys minimum cost estimate is based upon existing technology and excludes
legal and related consulting costs, which are expensed as incurred. The Companys estimate includes
equipment, operating, and continued monitoring costs for onsite and offsite pump and treat
containment systems. Factors, which cause uncertainties with respect to the Companys estimate, include, but are not
limited to, the effectiveness of the current work plans in achieving targeted results and proposals
of regulatory agencies for desired methods and outcomes. It is possible that cash flows and results
of operations could be significantly affected by the impact of changes associated with the ultimate
resolution of this contingency. Uncertainties associated with environmental remediation
contingencies are pervasive and often result in wide ranges of reasonably possible outcomes.
Estimates developed in the early stages of remediation can vary significantly. Normally a finite
estimate of cost does not become fixed and determinable at a specific point in time. Rather, the
costs associated with environmental remediation become estimable over a continuum of events and
activities that help to frame and define a liability. It is possible that cash flows and results of
operations could be materially affected by the impact of the ultimate resolution of this
contingency. In fiscal 2003, Sparton reached an agreement with the United States Department of Energy (DOE) and
others to recover certain remediation costs. Under the settlement terms, Sparton received cash and
the DOE agreed to reimburse Sparton for 37.5% of certain future environmental expenses in excess of
$8,400,000 incurred from the date of settlement. In 1995, Sparton Corporation and Sparton Technology, Inc. (STI) filed a Complaint in the Circuit
Court of Cook County, Illinois, against Lumbermens Mutual Casualty Company and American
Manufacturers Mutual Insurance Company demanding reimbursement of expenses incurred in connection
with its remediation efforts at the Coors Road facility based on various primary and excess
comprehensive general liability policies in effect between 1959 and 1975. In 1999, the Complaint
was amended to add various other excess insurers, including certain London market insurers and
Firemans Fund Insurance Company. The case remains in pretrial activity. In September 2002, STI filed an action in the U.S. District Court for the Eastern District of
Michigan to recover certain unreimbursed costs incurred as a result of a manufacturing
relationship with two entities, Util-Link, LLC (Util-Link) of Delaware and National Rural
Telecommunications Cooperative (NRTC) of the District of Columbia. On or about October 21, 2002,
the defendants filed a counterclaim seeking money damages, alleging that STI breached its duties
in the manufacture of products for the defendants. The defendant NRTC asked for damages in the
amount $20,000,000 for the loss of its investment in and loans to Util-Link. In addition, the
defendant Util-Link had previously asked for damages in the amount of $25,000,000 for lost
profits, which it no longer appears to be pursuing. Sparton has reviewed the respective claims and
believes that the damages sought by NRTC were included in Util-Links claim for damages and, as
such, were duplicative. Sparton believes the counterclaim to be without merit and intends to
vigorously defend against it. These claims are now in the pretrial stage, with jury trial
scheduled in Detroit, Michigan, in the September 2005 time-frame. At this time, the Company is unable to predict the outcome of either of these two claims. 18




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Item 4. Submission of Matters to a Vote of Security HoldersNone.Item 6. Exhibits3.1
    
    
    Amended Articles of Incorporation of the Registrant were filed on Form 10-Q for
the three-month period ended September 30, 2004, and are incorporated herein by reference.3.2
    
    
    Amended Code of Regulation of the Registrant were filed on Form 10-Q for the
three-month period ended September 30, 2004, and are incorporated herein by reference.3.3
    
    
    The amended By-Laws of the Registrant were filed on Form 10-Q for the nine-month
period ended March 31, 2004, and are incorporated herein by reference.31.1
    
    
    Chief Executive Officer certification under Section 302 of the Sarbanes-Oxley Act of
2002.31.2
    
    
    Chief Financial Officer certification under Section 302 of the Sarbanes-Oxley Act of
2002.32.1
    
    
    Chief Executive Officer and Chief Financial Officer certification pursuant to
18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
 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. Date: May 13, 2005
    /s/ DAVID W. HOCKENBROCHTDavid W. Hockenbrocht, Chief Executive OfficerDate: May 13, 2005
    /s/ RICHARD L. LANGLEYRichard L. Langley, Chief Financial Officer 19