##### 



UNITED STATES
SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549
 FORM 10-Q [X]
    
    QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIESEXCHANGE ACT OF 1934
 For the quarterly period
ended December 31, 2004
or [   ]
    
    TRANSITION REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIESEXCHANGE 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
(I.R.S. Employer Identification No.) 2400 East Ganson Street, Jackson, Michigan 49202
(Address of Principal Executive Offices, Zip Code) (517)787-8600
(Registrants Telephone Number, Including Area Code) 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.                 
                          
                          
                          
                 [X]Yes [  ] No Indicate by checkmark whether the registrant is an accelerated filer (as defined by Rule 12b-2 of
the Exchange Act).  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
    
    January 31, 2005$1.25 Par Value
    
    8,788,324




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##### 



INDEX Part I.Financial InformationItem 1. Financial StatementsCondensed Consolidated Balance Sheets
December 31, 2004 and June 30, 2004
    
    
    3Condensed Consolidated Statements of Operations
Three-Month and Six-Month Periods ended December 31, 2004 and 2003
    
    
    4Condensed Consolidated Statements of Cash Flows
Six-Month Periods ended December 31, 2004 and 2003
    
    
    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
    
    
    18Item 4. Controls and Procedures
    
    
    18Part II.Other InformationItem 1. Legal Proceedings
    
    
    18Item 4. Submission of Matters to a Vote of Security Holders
    
    
    20Item 6. Exhibits
    
    
    20Signatures
    
    
    20
 2




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##### 



Item 1. Financial Statements SPARTON CORPORATION AND SUBSIDIARIES
Condensed Consolidated Balance Sheets (Unaudited)
December 31, 2004 and June 30, 2004 December
31
    

   June
30AssetsCurrent assets:Cash and cash equivalents
    
    $
    12,043,410
    
    $
    10,820,461Investment securities
    
    
    20,887,461
    
    
    18,641,792Accounts receivable
    
    
    17,052,849
    
    
    21,267,459Income taxes recoverable
    
    
    
    
    
    559,706Inventories and costs on contracts in progress
    
    
    35,783,821
    
    
    37,210,259Prepaid expenses
    
    
    2,951,235
    
    
    2,859,016Total current assets
    
    
    88,718,776
    
    
    91,358,693Pension asset
    
    
    5,184,934
    
    
    5,448,968Other assets
    
    
    5,802,434
    
    
    5,570,773Property, plant and equipment, net
    
    
    14,756,676
    
    
    12,041,062Total assets
    
    $
    114,462,820
    
    $
    114,419,496Liabilities and Shareowners EquityCurrent liabilities:Accounts payable
    
    $
    6,255,414
    
    $
    10,052,854Salaries and wages
    
    
    3,525,613
    
    
    3,387,490Accrued health benefits
    
    
    1,029,035
    
    
    1,044,810Other accrued liabilities
    
    
    4,660,638
    
    
    4,526,234Income taxes payable
    
    
    697,294
    
    
    Total current liabilities
    
    
    16,167,994
    
    
    19,011,388Environmental remediation  noncurrent portion
    
    
    6,403,743
    
    
    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, 8,788,324
and 8,351,538 shares outstanding at December 31 and June 30, respectively
    
    
    10,985,405
    
    
    10,439,423Capital in excess of par value
    
    
    10,400,809
    
    
    7,134,149Accumulated other comprehensive income
    
    
    131,396
    
    
    62,368Retained earnings
    
    
    70,373,473
    
    
    71,230,159Total shareowners equity
    
    
    91,891,083
    
    
    88,866,099Total liabilities and shareowners equity
    
    $
    114,462,820
    
    $
    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 Six-Month Periods ended December 31, 2004 and 2003 Three-Month Periods
    Six-Month Periods2004
    2003
    2004
    2003Net sales
    
    $
    34,526,907
    
    
    $
    33,239,772
    
    
    $
    79,715,222
    
    
    $
    69,664,573Costs of goods sold
    
    
    31,050,534
    
    
    
    31,799,271
    
    
    
    69,772,133
    
    
    
    67,790,114Gross profit
    
    
    3,476,373
    
    
    
    1,440,501
    
    
    
    9,943,089
    
    
    
    1,874,459Selling and administrative expenses:Selling and administrative expenses
    
    
    3,276,095
    
    
    
    3,470,064
    
    
    
    6,663,148
    
    
    
    7,229,068EPA related - net environmental remediation
    
    
    75,033
    
    
    
    62,947
    
    
    
    159,033
    
    
    
    136,9473,351,128
    
    
    
    3,533,011
    
    
    
    6,822,181
    
    
    
    7,366,015Operating income (loss)
    
    
    125,245
    
    
    
    (2,092,510
    )
    
    
    3,120,908
    
    
    
    (5,491,556
    )Other income (expense):Interest and investment income
    
    
    206,768
    
    
    
    122,704
    
    
    
    422,241
    
    
    
    353,246Equity income (loss) in investment
    
    
    15,000
    
    
    
    (9,000
    )
    
    
    (5,000
    )
    
    
    12,000Other - net
    
    
    318,628
    
    
    
    (250,440
    )
    
    
    677,090
    
    
    
    (309,425
    )540,396
    
    
    
    (136,736
    )
    
    
    1,094,331
    
    
    
    55,821Income (loss) before income taxes
    
    
    665,641
    
    
    
    (2,229,246
    )
    
    
    4,215,239
    
    
    
    (5,435,735
    )Provision (credit) for income taxes
    
    
    213,000
    
    
    
    (713,000
    )
    
    
    1,349,000
    
    
    
    (1,739,000
    )Net income (loss)
    
    $
    452,641
    
    
    $
    (1,516,246
    )
    
    $
    2,866,239
    
    
    $
    (3,696,735
    )Basic earnings (loss) per share (1)
    
    $
    0.05
    
    
    $
    (0.17
    )
    
    $
    0.33
    
    
    $
    (0.42
    )Diluted earnings (loss) per share (1)
    
    $
    0.05
    
    
    $
    (0.17
    )
    
    $
    0.32
    
    
    $
    (0.42
    )
 (1) All share and per share information have been adjusted to reflect the impact of
the 5% stock dividend declared in November 2004. 4




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##### 



SPARTON CORPORATION AND SUBSIDIARIES
Condensed Consolidated Statements of Cash Flows (Unaudited)
For the Six-Month Periods ended December 31, 2004 and 2003 2004
    
    
    2003Cash flows provided (used) by Operating Activities:Net income (loss)
    
    $
    2,866,239
    
    
    $
    (3,696,735
    )Add (deduct) noncash items affecting operations:Depreciation, amortization and accretion
    
    
    789,056
    
    
    
    848,755Change in pension asset
    
    
    264,034
    
    
    
    64,016Loss on sale of investment securities
    
    
    14,510
    
    
    
    70,254Equity (income) loss on investment
    
    
    5,000
    
    
    
    (12,000
    )Add (deduct) changes in operating assets and liabilities:Accounts receivable
    
    
    4,214,610
    
    
    
    10,571,048Income taxes recoverable
    
    
    559,706
    
    
    
    (1,268,706
    )Inventories and prepaid expenses
    
    
    1,354,418
    
    
    
    (5,324,813
    )Accounts payable, salaries and wages, accrued liabilities
and income taxes
    
    
    (2,981,660
    )
    
    
    (1,705,329
    )Net cash provided (used) by operating activities
    
    
    7,085,913
    
    
    
    (453,510
    )Cash flows provided (used) by Investing Activities:Purchases of investment securities
    
    
    (7,340,937
    )
    
    
    (908,720
    )Proceeds from sale of investment securities
    
    
    5,026,145
    
    
    
    5,845,761Purchases of property, plant and equipment, net
    
    
    (3,504,648
    )
    
    
    (5,044,814
    )Other, principally noncurrent other assets
    
    
    (133,241
    )
    
    
    182,255Net cash provided (used) by investing activities
    
    
    (5,952,681
    )
    
    
    74,482Cash flows provided (used) by Financing Activities:Proceeds from exercise of stock options
    
    
    92,655
    
    
    
    18,857Stock
dividends - cash in lieu of fractional shares
    
    
    (2,938
    )
    
    
    (3,687
    )Net cash provided by financing activities
    
    
    89,717
    
    
    
    15,170Increase (decrease) in cash and cash equivalents
    
    
    1,222,949
    
    
    
    (363,858
    )Cash and cash equivalents at beginning of period
    
    
    10,820,461
    
    
    
    10,562,222Cash and cash equivalents at end of period
    
    $
    12,043,410
    
    
    $
    10,198,364Supplemental disclosures of cash paid during the period:Income taxes - net
    
    $
    115,000
    
    
    $
    244,000
 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 all active 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 December 31, 2004, and
the related Condensed Consolidated Statements of Operations and Cash Flows for the six-month
periods ended December 31, 2004 and 2003, are unaudited, but include all adjustments (consisting
of normal recurring accruals), which the Company considers necessary for a fair presentation of
such financial statements. Operating results for the six-month period ended December 31, 2004, 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 aftermarket support. All facilities are
registered 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.
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. 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. 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. 6




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##### 



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 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 Bulletins 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 regardless of
whether they meet the criterion of abnormal. 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 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. Periodic benefit cost The Company follows the disclosure requirements of SFAS
No. 132 (R). For
the three months and six months ended December 31, 2004 and 2003, $132,000 and $32,000 and
$264,000 and $64,000 of expense has been recorded, respectively. Total net periodic benefit cost
for fiscal 2005 is expected to be $528,000, compared to total net periodic benefit cost reported
for fiscal 2004 of $727,000. For the six months ended December 31, 2003, net period benefit cost
was presented based upon the actuarial information received as of the periods closing. The
subsequent periods for fiscal 2004 reflected the adjusted net periodic benefit cost, which totaled
the annual reported expense of $727,000. The components of net periodic pension expense for each of the periods presented were as follows: Three Months Ended
    
    
    Six Months Ended2004
    
    
    2003
    
    
    2004
    
    
    2003Service cost
    
    $
    151,000
    
    
    $
    119,000
    
    
    $
    303,000
    
    
    $
    238,000Interest cost
    
    
    172,000
    
    
    
    117,000
    
    
    
    345,000
    
    
    
    353,000Expected return on plan assets
    
    
    (253,000
    )
    
    
    (284,000
    )
    
    
    (506,000
    )
    
    
    (569,000
    )Amortization of prior service cost
    
    
    24,000
    
    
    
    20,000
    
    
    
    48,000
    
    
    
    42,000Amortization of net loss
    
    
    38,000
    
    
    
    -
    
    
    
    74,000
    
    
    
    -Net periodic benefit cost
    
    $
    132,000
    
    
    $
    32,000
    
    
    $
    264,000
    
    
    $
    64,000
 7




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##### 



Stock options
Until the effective date of SFAS 123(R), the Company continues to
follow APB 25 and related Interpretations in accounting for its employee stock options. Under APB
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 December 31, 2004, there were 569,476 shares outstanding under option, with prices
ranging from $3.24 to $8.90, a weighted contractual life of 2.4 years, and a weighted average
exercise price of $5.83. The following table summarizes information about stock options outstanding
and exercisable at December 31, 2004: 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
    
    414,155
    
    
    1.66
    
    
    $5.28
    
    
    344,043
    
    
    $5.12$6.26 to $8.90
    
    155,321
    
    
    4.37
    
    
    7.32
    
    
    65,526
    
    
    7.29
 At December 31, 2004, exercisable options and the per share weighted average exercise price
were 409,569 and $5.46, respectively. At December 31, 2004, remaining shares available for grant
under the plan were 156,667. The following sets forth a reconciliation of net income (loss) and earnings (loss) per share
information for the three months and six months ended December 31, 2004 and 2003, 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
    
    
    Six Months Ended2004
    
    
    2003
    
    
    2004
    
    
    2003Net income (loss), as reported
    
    $
    453,000
    
    
    $
    (1,516,000
    )
    
    $
    2,866,000
    
    
    $
    (3,697,000
    )Deduct:Total stock-based compensation expense determined under
the
fair-value-based method for all awards, net of tax effects
    
    
    42,000
    
    
    
    47,000
    
    
    
    83,000
    
    
    
    93,000Pro forma net income (loss)
    
    $
    411,000
    
    
    $
    (1,563,000
    )
    
    $
    2,783,000
    
    
    $
    (3,790,000
    )Pro forma
earnings (loss) per share - after stock
dividend (Note 3):Basic earnings (loss) per share
    
    $
    0.05
    
    
    $
    (0.18
    )
    
    $
    0.32
    
    
    $
    (0.43
    )Diluted earnings (loss) per share
    
    $
    0.05
    
    
    $
    (0.18
    )
    
    $
    0.31
    
    
    $
    (0.43
    )
 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: December 31, 2004
    
    June 30, 2004Raw materials
    
    $
    25,334,000
    
    
    $
    23,641,000Work in process and finished goods
    
    
    10,450,000
    
    
    
    13,569,000$
    35,784,000
    
    
    $
    37,210,000
 Work in process and finished goods inventories include $1.3 and $4.3 million of completed, but
not yet accepted, sonobuoys at December 31, 2004 and June 30, 2004, respectively. Inventories are
reduced by progress billings to the U.S. government of approximately $8,368,000 and $2,125,000 at
December 31, 2004 and June 30, 2004, respectively. 8




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##### 



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. Due to the Companys fiscal 2004 reported net loss, 148,971 and 145,113 outstanding stock
option share equivalents were excluded from the computation of diluted earnings per share during
the three months and six months ended December 31, 2003, respectively, because their inclusion
would have been anti-dilutive. Basic and diluted earnings per share were computed on the following: Three Months Ended
    
    
    Six Months Ended2004
    
    
    2003
    
    
    2004
    
    
    2003Basic-weighted average shares outstanding
    
    
    8,774,241
    
    
    
    8,762,243
    
    
    
    8,771,915
    
    
    
    8,761,626Effect of dilutive stock options
    
    
    133,522
    
    
    
    
    
    
    
    128,580
    
    
    
    Weighted average diluted shares outstanding
    
    
    8,907,763
    
    
    
    8,762,243
    
    
    
    8,900,495
    
    
    
    8,761,626Basic
earnings (loss) per share - after stock dividend
    
    $
    0.05
    
    
    $
    (0.17
    )
    
    $
    0.33
    
    
    $
    (0.42
    )Diluted
earnings (loss) per share - after stock dividend
    
    $
    0.05
    
    
    $
    (0.17
    )
    
    $
    0.32
    
    
    $
    (0.42
    )
 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.
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 six months ended
December 31, 2004 and 2003, respectively: Three Months Ended
    
    
    Six Months Ended2004
    
    
    2003
    
    
    2004
    
    
    2003Net income (loss)
    
    $
    453,000
    
    
    $
    (1,516,000
    )
    
    $
    2,866,000
    
    
    $
    (3,697,000
    )Other comprehensive income (loss), net of tax:Net
unrealized losses - investment securities owned
    
    
    (81,000
    )
    
    
    (111,000
    )
    
    
    (34,000
    )
    
    
    (214,000
    )Net
unrealized gains (losses) - investment securities
held by investee accounted for by the equity method
    
    
    83,000
    
    
    
    (11,000
    )
    
    
    103,000
    
    
    
    207,000Comprehensive income (loss)
    
    $
    455,000
    
    
    $
    (1,638,000
    )
    
    $
    2,935,000
    
    
    $
    (3,704,000
    )
 At December 31, 2004 and June 30, 2004, shareowners equity includes accumulated other
comprehensive income of $131,000 and $62,000, respectively, net of tax. These balances include
$(18,000) and $16,000 for unrealized (losses) and gains on investment securities owned, and
unrealized gains of $149,000 and $46,000 for investment securities held by an investee accounted
for by the equity method, as of December 31, 2004 and June 30, 2004, respectively. 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 December 31,
2004, which would represent other than temporary losses, and there are no unrealized losses with a
duration of one year of 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. 9




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##### 



At December 31, 2004, the Company had net unrealized losses of $28,000. At that date, the net
after-tax effect of these losses was $18,000, which is included in accumulated other comprehensive
income within shareowners equity. For the six months ended December 31, 2004 and 2003, purchases
of investment securities totaled $7,341,000 and $909,000, and sales of investment securities
totaled $5,026,000 and $5,846,000, 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 $1,821,000 and $1,677,000 at December 31 and June
30, 2004, respectively, represents the Companys 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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 December 31, 2004,
were as follows: YearsWithin 1
    
    
    1 to 5
    
    
    5 to 10
    
    
    Over 10
    
    
    TotalDebt securities:Corporate-primarily U.S.
    
    $
    1,340,135
    
    
    $
    4,027,888
    
    
    $
    170,944
    
    
    $
    
    
    
    $
    5,538,967U.S. government and federal agency
    
    
    711,753
    
    
    
    2,798,852
    
    
    
    1,432,307
    
    
    
    1,726,152
    
    
    
    6,669,064State and municipal
    
    
    110,262
    
    
    
    3,030,422
    
    
    
    1,309,173
    
    
    
    
    
    
    
    4,449,857Total debt securities
    
    
    2,162,150
    
    
    
    9,857,162
    
    
    
    2,912,424
    
    
    
    1,726,152
    
    
    
    16,657,888Equity
securities - primarily
preferred stock
    
    
    4,229,573
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    4,229,573Total investment securities
    
    $
    6,391,723
    
    
    $
    9,857,162
    
    
    $
    2,912,424
    
    
    $
    1,726,152
    
    
    $
    20,887,461
 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 December 31, 2004, Sparton has accrued $7,040,000 as its estimate of the
minimum future undiscounted financial liability, of which $636,000 is classified as a current
liability and included in accrued liabilities. Amounts charged to operations, principally legal and
consulting fees, for the six months ended December 31, 2004 and 2003 were $159,000 and $137,000,
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. 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 Financial Statements and
Notes thereto. 11




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##### 



RESULTS OF OPERATIONS Three Months Ended December 312004
    
    

2003% of
    
    
    
    
    
    % of
    
    
    %Sales
    
    

Total
    
    

Sales
    
    

Total
    
    

ChangeGovernment
    
    $
    3,445,000
    
    
    
    10.0
    %
    
    $
    6,385,000
    
    
    
    19.2
    %
    
    
    (46.0
    )%Industrial /Other
    
    
    11,518,000
    
    
    
    33.4
    
    
    
    8,895,000
    
    
    
    26.8
    
    
    
    29.5Aerospace
    
    
    16,311,000
    
    
    
    47.2
    
    
    
    13,927,000
    
    
    
    41.9
    
    
    
    17.1Medical/Scientific Instrumentation
    
    
    3,253,000
    
    
    
    9.4
    
    
    
    4,033,000
    
    
    
    12.1
    
    
    
    (19.3
    )Totals
    
    $
    34,527,000
    
    
    
    100.0
    %
    
    $
    33,240,000
    
    
    
    100.0
    %
    
    
    3.9
 Sales for the three-month period ended December 31, 2004, totaled $34,527,000, an increase of
$1,287,000 (3.9%) from the same quarter last year. Government sales were lower than expected due to
the rescheduling of engineering redesign work, sonobuoy drop test failures, lack of access to the
U.S. Navys test range and manufacturing transitioning between sonobuoy contracts. Government sales
are anticipated to improve later in this fiscal year as these issues are resolved. Industrial sales
improved mainly due to increased sales to three existing customers, who appear to be experiencing
increased demand from their customers. This increased demand is expected to 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 throughout the year. Medical/Scientific Instrumentation was down from prior
year due to overall lower demand from existing customers in this market. 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 December 31, 2004 and 2003: 2004
    
    

2003Net sales
    
    
    100.0
    %
    
    
    100.0
    %Costs of goods sold
    
    
    90.0
    
    
    
    95.7Gross profit
    
    
    10.0
    
    
    
    4.3Selling and administrative expenses
    
    
    9.7
    
    
    
    10.6Operating income (loss)
    
    
    0.3
    
    
    
    (6.3
    )Other income (expense) net
    
    
    1.6
    
    
    
    (0.4
    )Income (loss) before income taxes
    
    
    1.9
    
    
    
    (6.7
    )Provision (credit) for income taxes
    
    
    0.6
    
    
    
    (2.1
    )Net income (loss)
    
    
    1.3
    %
    
    
    (4.6
    )%
 Operating income of $125,000 was reported for the three months ended December 31, 2004, compared to
an operating loss of $2,093,000 for the three months ended December 31, 2003. Gross profit
percentage for the three months ended December 31, 2004, was 10%, up from 4.3% for the same period
last year. Included in the current years gross profit was a settlement with a current 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 related to 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. The lower selling and administrative expenses, as a percentage
of sales, was primarily due to the increase in sales during fiscal 2005, compared to the same
period last year, without a related increase in these expenses. In addition, bid and proposal and
research and development expenses for fiscal 2005 were approximately $616,000 below the same period
last year. These cost reductions are primarily the result of a one time sonobuoy engineering
project which has been completed. 12




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##### 



Interest and investment income increased $84,000 to $207,000 in fiscal 2005. This increase was
mainly due to increased funds available for investment. Other income-net in fiscal 2005 was
$319,000, versus expense of $250,000 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 $295,000 and $184,000 during the three months ended December 31, 2004 and
2003, respectively. Other expense-net in the prior year included a charge of $418,000 for workers
compensation insurance charges related to the Companys previously owned automotive segment. These
charges are for the settlement of a previously disputed claim. Due to the factors described above, the Company reported net income of $453,000 ($0.05 per share,
basic and diluted) for the three months ended December 31, 2004, versus a loss of $1,516,000
($(0.17) per share, basic and diluted) for the corresponding period last year. Six Months Ended December 312004
    
    

2003% of
    
    
    
    
    
    % of
    
    
    %Sales
    
    
    Total
    
    
    Sales
    
    
    Total
    
    
    ChangeGovernment
    
    $
    14,367,000
    
    
    
    18.0
    %
    
    $
    16,685,000
    
    
    
    24.0
    %
    
    
    (13.9
    )%Industrial / Other
    
    
    23,401,000
    
    
    
    29.4
    
    
    
    17,920,000
    
    
    
    25.7
    
    
    
    30.6Aerospace
    
    
    34,988,000
    
    
    
    43.9
    
    
    
    26,014,000
    
    
    
    37.3
    
    
    
    34.5Medical/Scientific Instrumentation
    
    
    6,959,000
    
    
    
    8.7
    
    
    
    9,046,000
    
    
    
    13.0
    
    
    
    (23.1
    )Totals
    
    $
    79,715,000
    
    
    
    100.0
    %
    
    $
    69,665,000
    
    
    
    100.0
    %
    
    
    14.4
 Sales for the six-month period ended December 31, 2004, totaled $79,715,000, an increase of
$10,050,000 (14.4%) 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 later in
this fiscal year. Industrial market sales increased from the same period last year. This increase
was attributed to increased demand from three existing customers and is expected to continue for
the balance of this fiscal year. Sales to the aerospace markets continue to grow, increasing 34.5%
over the prior year. In general, this reflects stronger demand 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. Approximately $7
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 year. Medical/Scientific
Instrumentation sales declined from the prior year. This decrease resulted from overall lower
demand from existing customers in this market area. 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 31% and
25% of the sales through December 31, 2004 and 2003, respectively. 13




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##### 



The following table presents income statement data as a percentage of net sales for the six months
ended December 31, 2004 and 2003: 2004
    
    

2003Net sales
    
    
    100.0
    %
    
    
    100.0
    %Costs of goods sold
    
    
    87.5
    
    
    
    97.3Gross profit
    
    
    12.5
    
    
    
    2.7Selling and administrative expenses
    
    
    8.6
    
    
    
    10.6Operating income (loss)
    
    
    3.9
    
    
    
    (7.9
    )Other income
 net
    
    
    1.4
    
    
    
    0.1Income (loss) before income taxes
    
    
    5.3
    
    
    
    (7.8
    )Provision (credit) for income taxes
    
    
    1.7
    
    
    
    (2.5
    )Net income (loss)
    
    
    3.6
    %
    
    
    (5.3
    )%
 An operating profit of $3,121,000 was reported for the six months ended December 31, 2004,
compared to an operating loss of $5,492,000 for the six months ended December 31, 2003. Gross
profit percentage for the six months ended December 31, 2004, was 12.5%, up from 2.7% for the same
period last year. While the recent 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 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 $455,000. The lowered selling
and administrative expenses, as a percentage of sales, were primarily due to the increase in sales
during fiscal 2005, compared to the same period last year, without a related increase in these
expenses. In addition, bid and proposal and research and development expenses for fiscal 2005 were
approximately $955,000 below the same 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 $69,000 to $422,000 in fiscal 2005. This increase was due
to increased funds available for investment. Other income-net in fiscal 2005 was $677,000, versus
an expense of $309,000 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 $656,000 and $173,000 during the six months ended December 31, 2004 and 2003, respectively.
Other expense-net in the prior year included a charge of $478,000 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 $2,866,000 ($0.33 per share,
basic, $0.32 per share diluted) for the six months ended December 31, 2004, versus a loss of
$3,697,000 ($(0.42) per share, basic and diluted) for the corresponding period last year. 14




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##### 



LIQUIDITY AND CAPITAL RESOURCES For the six-month period ended December 31, 2004, cash and cash equivalents increased
$1,223,000 to $12,043,000. Operating activities provided $7,086,000 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,
and a reduction in accounts receivable. The primary use of cash was a decline in accounts payable,
primarily as a result of payment for the earlier increased inventory purchases. 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 December 31, 2004, 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 six-month period ended December 31, 2004, totaled
$5,953,000, 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. The net decrease of $2.3 million was used
primarily for the purchase 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 December 31, 2004 and June 30, 2004, the aggregate government EMS backlog was approximately $56
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 December 31, 2004, 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 expected to be complete in early February,
with some production accomplished by the end of that month. 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 $1.4 million has been expended for the construction of the new facility. 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. 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 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 December 31, 2004, the Company had $91,891,000 in shareowners equity
($10.46 per share), $72,551,000 in working capital, and a 5.49:1.00 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. 15




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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. 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. 16




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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
$176,000 and $46,000 at December 31, 2004 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 December 31, 2004. 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. 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 December 31, 2004, Sparton has accrued $7,040,000 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. 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. 17




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Item 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK The Company manufactures its products in the United States and Canada. 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. 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 controls 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. As of December 31, 2004, 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
December 31, 2004. 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
December 31, 2004, Sparton has accrued $7,040,000 as its estimate of the minimum future
undiscounted financial liability, of which $636,000 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. 18




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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. 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, Sparton Technology, Inc. (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 Util-Link has asked for
damages in the amount of $25,000,000 for lost profits. The defendant NRTC has asked for damages in
the amount $20,000,000 for the loss of its investment in and loans to Util-Link. Sparton has
reviewed the respective claims and believes that the damages sought by NRTC are included in
Util-Links claim for damages and, as such, are duplicative. Sparton believes the counterclaim to
be without merit and intends to vigorously defend against it. These claims are now in the pretrial
stage. At this time, the Company is unable to predict the outcome of either of these two claims. 19




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Item 4. Submission of Matters to a Vote of Security Holders At the November 10, 2004, Annual Meeting of Shareholders of Sparton Corporation, a total of
8,128,562 of the Companys shares were present or represented by proxy at the meeting. This
represented more than 97% of the Companys shares outstanding. Total shares outstanding and
eligible to vote were 8,352,352, of which 223,790 did not vote. All shares disclosed in this Item 4
are reflected prior to the 5% stock dividend approved on November 9, 2004. The individuals named below were re-elected to a three-year term as Directors: Name
    
    Votes FOR
    
    Votes WITHHELDDavid P. Molfenter
    
    6,099,967
    
    2,028,595W. Peter Slusser
    
    6,260,109
    
    1,868,453Bradley O. Smith
    
    6,260,419
    
    1,868,143
 Messrs. James D. Fast, James N. DeBoer, David W. Hockenbrocht, Richard J. Johns, M.D., Richard L.
Langley and William I. Noecker all continue as directors of the Company. 
 Item 6. Exhibits 3.1
    
    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: February 11, 2005
    /s/ DAVID W. HOCKENBROCHT.David W. Hockenbrocht, Chief Executive OfficerDate: February 11, 2005
    /s/ RICHARD L. LANGLEY.Richard L. Langley, Chief Financial Officer 20