UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

   
[X]þ QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES
EXCHANGE ACT OF 1934

For the quarterly period endedDecemberMarch 31, 20042005

or

   
[   ]o TRANSITION REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES
EXCHANGE ACT OF 1934

For the transition period from tofrom______________to ______________

Commission File number1-1000

SPARTON CORPORATION

(Exact Name of Registrant as Specified in its Charter)

OhioOHIO
(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]þYes     [  ]o No

Indicate by checkmark whether the registrant is an accelerated filer (as defined by Rule 12b-2 of the Exchange Act).

[  ]

o Yes     [X]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 at
Class of Common Stock
 January 31,April 29, 2005
$1.25 Par Value
 8,788,3248,821,464

1


 

INDEX

INDEXPart I
Financial Information

Part I.
Financial Information
     
Item 1. Financial Statements
    
    
Condensed Consolidated Balance Sheets December
March 31, 20042005 and June 30, 2004
  3 
     
2004  4 
     
2004  5 
     
  6 
     
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations  11 
     
Item 3. Quantitative and Qualitative Disclosures About Market Risk17
Item 4. Controls and Procedures17

Part II
Other Information

Item 1. Legal Proceedings  18 
     
Item 4. Submission of Matters to a Vote of Security Holders  
Item 4. Controls and Procedures1819 
     
Item 6. Exhibits  
Part II.
Other Information
Item 1. Legal Proceedings1819 
     
Signatures  
Item 4. Submission of Matters to a Vote of Security Holders20
Item 6. Exhibits20
Signatures2019 

2


 

Item 1. Financial Statements

SPARTON CORPORATION AND SUBSIDIARIES
Condensed Consolidated Balance Sheets (Unaudited)
DecemberMarch 31, 20042005 and June 30, 200430,2004

        
       March 31 June 30 
 December 31 June 30 
      
Assets
      

Assets
Current assets:       
Cash and cash equivalents 12,043,410 10,820,461 $10,687,328 $10,820,461 
Investment securities  20,887,461  18,641,792 20,703,129 18,641,792 
Accounts receivable  17,052,849  21,267,459 20,547,356 21,267,459 
Income taxes recoverable    559,706  559,706 
Inventories and costs on contracts in progress  35,783,821  37,210,259 36,486,265 37,210,259 
Prepaid expenses  2,951,235  2,859,016 2,860,286 2,859,016 
     
Total current assets 91,284,364 91,358,693 
       
Total current assets  88,718,776  91,358,693
Pension asset  5,184,934  5,448,968 5,088,622 5,448,968 
Other assets  5,802,434  5,570,773 5,741,811 5,570,773 
Property, plant and equipment, net  14,756,676  12,041,062 15,923,578 12,041,062 
     
       
Total assets 114,462,820 114,419,496 $118,038,375 $114,419,496 
     
      
       
      
Liabilities and Shareowners’ Equity
      

Liabilities and Shareowners’ Equity
Current liabilities:       
Accounts payable 6,255,414 10,052,854 $9,939,297 10,052,854 
Salaries and wages  3,525,613  3,387,490 3,442,830 3,387,490 
Accrued health benefits  1,029,035  1,044,810 1,034,421 1,044,810 
Other accrued liabilities  4,660,638  4,526,234 4,539,530 4,526,234 
Income taxes payable  697,294   583,294  
     
      
Total current liabilities  16,167,994  19,011,388 19,539,372 19,011,388 
       
Environmental remediation — noncurrent portion  6,403,743  6,542,009 6,334,842 6,542,009 
       
Shareowners’ 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  10,439,423
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 10,439,423 
Capital in excess of par value  10,400,809  7,134,149 10,521,129 7,134,149 
Accumulated other comprehensive income  131,396  62,368
Accumulated other comprehensive income (loss)  (65,579) 62,368 
Retained earnings  70,373,473  71,230,159 70,681,781 71,230,159 
     
      
Total shareowners’ equity  91,891,083  88,866,099 92,164,161 88,866,099 
      
      
Total liabilities and shareowners’ equity 114,462,820 114,419,496 $118,038,375 $114,419,496 
     

See accompanying notes.

3


 

SPARTON CORPORATION AND SUBSIDIARIES
Condensed Consolidated Statements of Operations (Unaudited)
For the Three-Month and Six-MonthNine-Month Periods ended DecemberMarch 31, 20042005 and 20032004

                
                 Three-Month Periods Nine-Month Periods 
 Three-Month PeriodsSix-Month Periods  2005 2004 2005 2004 
 2004200320042003 
Net sales $34,526,907 $33,239,772 $79,715,222 $69,664,573  $41,561,001 $43,566,394 $121,276,223 $113,230,967 
Costs of goods sold 31,050,534 31,799,271 69,772,133 67,790,114  38,238,550 39,985,009 108,010,683 107,775,123 
         
Gross profit 3,476,373 1,440,501 9,943,089 1,874,459  3,322,451 3,581,385 13,265,540 5,455,844 
  
Selling and administrative expenses: 
Selling and administrative expenses 3,276,095 3,470,064 6,663,148 7,229,068  3,158,980 3,345,108 9,822,128 10,574,176 
EPA related - net environmental remediation 75,033 62,947 159,033 136,947 
          
EPA related — net environmental remediation 123,315 103,012 282,348 239,959 
 3,351,128 3,533,011 6,822,181 7,366,015  
Loss on sale of property, plant and equipment 42,342 266 42,342 266 
         
  
Operating income (loss) 125,245  (2,092,510) 3,120,908  (5,491,556)  (2,186) 132,999 3,118,722  (5,358,557)
  
Other income (expense):  
Interest and investment income 206,768 122,704 422,241 353,246  231,095 157,079 653,336 510,325 
Equity income (loss) in investment 15,000  (9,000) (5,000) 12,000   (5,000) 4,000  (10,000) 16,000 
Other - net 318,628  (250,440) 677,090  (309,425)
Other — net  (29,602)  (65,065) 647,488  (374,490)
         
 540,396  (136,736) 1,094,331 55,821  196,493 96,014 1,290,824 151,835 
         
  
Income (loss) before income taxes 665,641  (2,229,246) 4,215,239  (5,435,735) 194,307 229,013 4,409,546  (5,206,722)
Provision (credit) for income taxes 213,000  (713,000) 1,349,000  (1,739,000)  (114,000) 73,000 1,235,000  (1,666,000)
         
 
Net income (loss) $452,641 $(1,516,246) $2,866,239 $(3,696,735) $308,307 $156,013 $3,174,546 $(3,540,722)
         
  
Basic earnings (loss) per share(1)
 $0.05 $(0.17) $0.33 $(0.42) $0.04 $0.02 $0.36 $(0.40)
         
Diluted earnings (loss) per share(1)
 $0.05 $(0.17) $0.32 $(0.42) $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


 

SPARTON CORPORATION AND SUBSIDIARIES
Condensed Consolidated Statements of Cash Flows (Unaudited)
For the Six-MonthNine-Month Periods ended December 31,March 31,2005 and 2004 and 2003

        
 2005 2004 
        
 2004 2003  
Cash flows provided (used) by Operating Activities:  
Net income (loss) $2,866,239 $(3,696,735) $3,174,546 $(3,540,722)
Add (deduct) noncash items affecting operations:  
Depreciation, amortization and accretion 789,056 848,755  1,241,533 1,271,644 
Change in pension asset 264,034 64,016  360,346 545,338 
Loss on sale of property, plant & equipment 42,342 266 
Loss on sale of investment securities 14,510 70,254  34,510 51,284 
Equity (income) loss on investment 5,000  (12,000) 10,000  (16,000)
Add (deduct) changes in operating assets and liabilities:  
Accounts receivable 4,214,610 10,571,048  720,103 8,995,471 
Income taxes recoverable 559,706  (1,268,706) 559,706  (1,195,706)
Inventories and prepaid expenses 1,354,418  (5,324,813) 823,956  (6,671,942)
Accounts payable, salaries and wages, accrued liabilities and income taxes  (2,981,660)  (1,705,329) 320,818 96,345 
     
Net cash provided (used) by operating activities 7,085,913  (453,510) 7,287,860  (464,022)
 
Cash flows provided (used) by Investing Activities:  
Purchases of investment securities  (7,340,937)  (908,720)  (8,870,255)  (1,508,720)
Proceeds from sale of investment securities 5,026,145 5,845,761  6,500,722 7,352,848 
Purchases of property, plant and equipment, net  (3,504,648)  (5,044,814)  (5,166,303)  (5,410,649)
Other, principally noncurrent other assets  (133,241) 182,255   (136,618) 56,049 
     
Net cash provided (used) by investing activities  (5,952,681) 74,482   (7,672,454) 489,528 
 
Cash flows provided (used) by Financing Activities:  
Proceeds from exercise of stock options 92,655 18,857  254,399 23,451 
Stock dividends - cash in lieu of fractional shares  (2,938)  (3,687)
Stock dividends — cash in lieu of fractional shares  (2,938)  (3,687)
     
Net cash provided by financing activities 89,717 15,170  251,461 19,764 
     
 
Increase (decrease) in cash and cash equivalents 1,222,949  (363,858)  (133,133) 45,270 
Cash and cash equivalents at beginning of period 10,820,461 10,562,222  10,820,461 10,562,222 
     
Cash and cash equivalents at end of period $12,043,410 $10,198,364  $10,687,328 $10,607,492 
     
 
Supplemental disclosures of cash paid during the period:  
Income taxes - net $115,000 $244,000 
Income taxes — net $115,000 $247,000 
     

See accompanying notes.

5


 

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 DecemberMarch 31, 2004,2005, and the related Condensed Consolidated Statements of Operations and Cash Flows for the six-monthnine-month periods ended DecemberMarch 31, 20042005 and 2003,2004, 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 six-monthnine-month period ended DecemberMarch 31, 2004,2005, 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 aftermarketafter-market support. All facilities, with the exception of Vietnam which is currently under-going the evaluation process, are registeredcertified 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.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


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


New accounting standards- In December 2004, the Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting Standards (SFAS) No.123(R)No. 123(R), “Share-Based Payment”, which replaces SFAS No.123,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 BulletinsBulletin 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”.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)132(R). For the three months and sixnine months ended DecemberMarch 31, 2005 and 2004, $96,000 and 2003, $132,000$481,000 and $32,000$360,000 and $264,000 and $64,000$545,000 of expense has been recorded, respectively. Total net periodic benefit cost for fiscal 2005 is expected towill be $528,000,$480,000, compared to total net periodic benefit cost reported for fiscal 2004 of $727,000. For the sixthree months and nine months ended DecemberMarch 31, 2003, net period benefit cost was presented based upon the actuarial information received as of the period’s closing. The subsequent periods for fiscal2005 and 2004, reflected the adjustedrespectively, net periodic benefit cost which totaledincludes 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 $727,000.

plan assets. The components of net periodic pension expense for each of the periods presented were as follows:

                                
 Three Months Ended Six Months Ended  Three Months Ended Nine Months Ended 
 2004 2003 2004 2003  2005 2004 2005 2004 
          
Service cost $151,000 $119,000 $303,000 $238,000  $110,000 $358,000 $412,000 $406,000 
Interest cost 172,000 117,000 345,000 353,000  154,000 446,000 498,000 505,000 
Expected return on plan assets  (253,000)  (284,000)  (506,000)  (569,000)  (228,000)  (566,000)  (734,000)  (642,000)
Amortization of prior service cost 24,000 20,000 48,000 42,000  24,000 64,000 72,000 73,000 
Amortization of net loss 38,000 - 74,000 -  36,000 179,000 112,000 203,000 
         
Net periodic benefit cost $132,000 $32,000 $264,000 $64,000  $96,000 $481,000 $360,000 $545,000 
         

7


 

Stock options— Until- 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 DecemberMarch 31, 2004,2005, there were 569,476533,442 shares outstanding under option, with prices ranging from $3.24 to $8.90, a weighted average remaining contractual life of 2.42.2 years, and a weighted average exercise price of $5.83.$5.89. The following table summarizes information about stock options outstanding and exercisable at DecemberMarch 31, 2004:2005:

                              
Options Outstanding Options Exercisable 
 Options Outstanding Options Exercisable
Range of Wtd. Avg. Remaining Wtd. Avg. Wtd. Avg.  Wtd. Avg. Remaining Wtd. Avg. Wtd. Avg.
Exercise Prices Number Outstanding Contractual Life (years) Exercise Price Number Exercisable Exercise Price  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  384,489 $1.44 $5.34 317,126 $5.19
$6.26 to $8.90 155,321 4.37   7.32  65,526   7.29  148,953 $4.21 $7.33   63,051 $7.30

At DecemberUnder the plan at March 31, 2004,2005, exercisable options and the per share weighted average exercise price were 409,569380,177 and $5.46, respectively. At December 31, 2004,$5.54, respectively, with 159,561 remaining shares available for grant under the plan were 156,667.grant.

The following sets forth a reconciliation of net income (loss) and earnings (loss) per share information for the three months and sixnine months ended DecemberMarch 31, 20042005 and 2003,2004, 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 Ended 
 Three Months Ended Six Months Ended  2005 2004 2005 2004 
 2004 2003 2004 2003 
Net income (loss), as reported $453,000 $(1,516,000) $2,866,000 $(3,697,000) $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 83,000 93,000  42,000 47,000 125,000 140,000 
         
Pro forma net income (loss) $411,000 $(1,563,000) $2,783,000 $(3,790,000) $266,000 $109,000 $3,050,000 $(3,681,000)
         
Pro forma earnings (loss) per share - after stock dividend (Note 3): 
 
Pro forma earnings (loss) per share — after stock dividend (Note 3): 
Basic earnings (loss) per share $0.05 $(0.18) $0.32 $(0.43) $0.03 $0.01 $0.35 $(0.42)
         
Diluted earnings (loss) per share $0.05 $(0.18) $0.31 $(0.43) $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, 2004 
December 31, 2004 June 30, 2004 
Raw materials $25,334,000 $23,641,000  $26,845,000 $23,641,000 
Work in process and finished goods 10,450,000 13,569,000  9,641,000 13,569,000 
     
 $35,784,000 $37,210,000  $36,486,000 $37,210,000 
     

Work in process and finished goods inventories include $1.3$1.1 and $4.3 million of completed, but not yet accepted sonobuoys at DecemberMarch 31, 20042005 and June 30, 2004, respectively. Inventories are reduced by progress billings to the U.S. government of approximately $8,368,000$6,915,000 and $2,125,000 at DecemberMarch 31, 20042005 and June 30, 2004, respectively.

8


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


Due to the Company’s fiscal 2004 reported net loss 148,971 and 145,113for the nine months ended March 31, 2004, 146,163 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 based on the following:

                 
  Three Months Ended  Six Months Ended 
  2004  2003  2004  2003 
Basic-weighted average shares outstanding  8,774,241   8,762,243   8,771,915   8,761,626 
Effect of dilutive stock options  133,522      128,580    
             
Weighted average diluted shares outstanding  8,907,763   8,762,243   8,900,495   8,761,626 
             
Basic 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)
             
                 
  Three Months Ended  Nine Months Ended 
  2005  2004  2005  2004 
 
Basic — weighted average shares outstanding  8,792,440   8,763,076   8,778,657   8,762,106 
Effect of dilutive stock options  126,058   132,623   121,114    
 
Weighted average diluted shares outstanding  8,918,498   8,895,699   8,899,771   8,762,106 
 
                 
Basic 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 sixnine months ended DecemberMarch 31, 2005 and 2004, and 2003, respectively:

                
                 Three Months Ended Nine Months Ended 
 Three Months Ended Six Months Ended  2005 2004 2005 2004 
 2004 2003 2004 2003 
Net income (loss) $453,000 $(1,516,000) $2,866,000 $(3,697,000) $308,000 $156,000 $3,175,000 $(3,541,000)
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) 103,000 207,000 
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 44,000 281,000 
Net translation gains (losses) on Vietnam subsidiary         
         
Comprehensive income (loss) $455,000 $(1,638,000) $2,935,000 $(3,704,000) $111,000 $289,000 $3,047,000 $(3,416,000)
         

At DecemberMarch 31, 20042005 and June 30, 2004, shareowners’ equity includes accumulated other comprehensive income (loss) of $131,000$(66,000) 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 gainsThe components of $149,000 and $46,000 for investment securities held by an investee accounted for by the equity method,these amounts are as of December 31, 2004 and June 30, 2004, respectively.follows:

         
  March 31, 2005  June 30, 2004 
 
Accumulated other comprehensive income (loss), net of tax:        
Investment securities owned $(156,000) $16,000 
Investment securities held by investee accounted for by the equity method  90,000   46,000 
Translation 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 DecemberMarch 31, 2004,2005, which would represent other than temporary losses, and there are no unrealized losses with a duration of one year ofor 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.

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At DecemberMarch 31, 2004,2005, the Company had net unrealized losses of $28,000.$247,000. At that date, the net after-tax effect of these losses was $18,000,$156,000, which is included in accumulated other comprehensive income within shareowners’ equity. For the sixnine months ended DecemberMarch 31, 20042005 and 2003,2004, purchases of investment securities totaled $7,341,000$8,870,000 and $909,000,$1,509,000, and sales of investment securities totaled $5,026,000$6,501,000 and $5,846,000,$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 $1,821,000$1,727,000 and $1,677,000 at DecemberMarch 31, 2005 and June 30, 2004, respectively, represents the Company’s

9


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 DecemberMarch 31, 2004,2005, were as follows:

                    
                     Years
 Years  Within 1 1 to 5 5 to 10 Over 10 Total 
 Within 1 1 to 5 5 to 10 Over 10 Total 
Debt securities:  
Corporate-primarily U.S. $1,340,135 $4,027,888 $170,944 $ $5,538,967 
Corporate — primarily U.S. $1,182,682 $3,805,238 $158,298 $270,390 $5,416,608 
U.S. government and federal agency 711,753 2,798,852 1,432,307 1,726,152 6,669,064  601,565 2,544,979 1,742,742 1,810,853 6,700,139 
State and municipal 110,262 3,030,422 1,309,173  4,449,857  109,967 3,293,659 974,438  4,378,064 
           
Total debt securities 2,162,150 9,857,162 2,912,424 1,726,152 16,657,888  1,894,214 9,643,876 2,875,478 2,081,243 16,494,811 
Equity securities - primarily preferred stock 4,229,573    4,229,573 
Equity securities — primarily preferred stock 4,208,318    4,208,318 
           
Total investment securities $6,391,723 $9,857,162 $2,912,424 $1,726,152 $20,887,461  $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 DecemberMarch 31, 2004,2005, Sparton has accrued $7,040,000$6,962,000 as its estimate of the minimum future undiscounted financial liability, of which $636,000$627,000 is classified as a current liability and included in accrued liabilities. Amounts charged to operations, principally legal and consulting fees, for the sixnine months ended DecemberMarch 31, 2005 and 2004 were $282,000 and 2003 were $159,000 and $137,000,$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.

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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.

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RESULTS OF OPERATIONS

                    
 Three Months Ended March 31  
                     2005 2004  
 Three Months Ended December 31  % % %
 2004 2003    Sales of Total Sales of Total Change
   % of   % of % 
 Sales Total Sales Total Change 
Government $3,445,000  10.0% $6,385,000  19.2%  (46.0)% $10,143,000  24.4% $14,061,000  32.3%  (27.9)%
Industrial /Other 11,518,000 33.4 8,895,000 26.8 29.5 
Industrial/Other 11,641,000 28.0 11,169,000 25.6 4.2 
Aerospace 16,311,000 47.2 13,927,000 41.9 17.1  16,741,000 40.3 13,885,000 31.9 20.6 
Medical/Scientific Instrumentation 3,253,000 9.4 4,033,000 12.1  (19.3) 3,036,000 7.3 4,451,000 10.2  (31.8)
           
Totals $34,527,000  100.0% $33,240,000 100.0% 3.9  $41,561,000  100.0% $43,566,000  100.0%  (4.6)
         

Sales for the three-month period ended DecemberMarch 31, 2004,2005, totaled $34,527,000, an increase$41,561,000, a decrease of $1,287,000 (3.9%$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, 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 thisthrough the remainder of the fiscal year as some of these issues are now resolved. Industrial sales improved mainly due to increased sales to three existing customers, who appear to be experiencingcustomers. It is uncertain if this increased demand from their customers. This increased demand is expected towill 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.continue. Medical/Scientific Instrumentation was down from the prior year due to overall lower demand from existing customers in this market.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 DecemberMarch 31, 20042005 and 2003:2004:

        
         2005 2004
 2004 2003 
Net sales  100.0%  100.0%  100.0%  100.0%
Costs of goods sold 90.0 95.7  92.0 91.8 
     
 
Gross profit 10.0 4.3  8.0 8.2 
Selling and administrative expenses 9.7 10.6  7.6 7.7 
Other operating expenses 0.4 0.2 
     
 
Operating income (loss) 0.3  (6.3)  (0.0) 0.3 
Other income (expense) net 1.6  (0.4)
Other income — net 0.5 0.2 
     
 
Income (loss) before income taxes 1.9  (6.7)
Income before income taxes 0.5 0.5 
Provision (credit) for income taxes 0.6  (2.1)  (0.2) 0.1 
     
Net income  0.7%  0.4%
 
Net income (loss)  1.3%  (4.6)%
     

Operating incomeAn operating loss of $125,000$2,000 was reported for the three months ended DecemberMarch 31, 2004,2005, compared to an operating lossincome of $2,093,000$133,000 for the three months ended DecemberMarch 31, 2003.2004. Gross profit percentage for the three months ended DecemberMarch 31, 2004,2005, was 10%8.0%, updown from 4.3%8.2% 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 inclusionis reflective of a less favorable product mix and increased 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 sellingprogram start-ups. Selling and administrative expenses as a percentage of sales, was primarily due toare consistent with 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 lastprior year. These cost reductions are primarily the result of a one time sonobuoy engineering project which has been completed.

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Interest and investment income increased $84,000$74,000 to $207,000$231,000 in fiscal 2005. This increase was mainly due to increased funds available for investment.investment and improved interest rates. Other income-netexpense-net in fiscal 2005 was $319,000,$30,000, versus expense of $250,000$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 gainloss of $295,000$12,000 and $184,000$10,000 during the three months ended DecemberMarch 31, 2005 and 2004, and 2003, respectively. Other expense-net inDuring the prior year included a charge of $418,000 for workers’ compensation insurance charges relatedthird 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 Company’s previously owned automotive segment. These charges arecurrently 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 settlementthird quarter. Variables affecting the effective tax rate include, but are not limited to, extraterritorial tax credits, Canadian tax loss carryforwards, effect of a previously disputed claim.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.

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Due to the factors described above, the Company reported net income of $453,000$308,000 ($0.050.04 per share, basic, and $0.03 per share, diluted) for the three months ended DecemberMarch 31, 2004,2005, versus a loss of $1,516,000$156,000 ($(0.17)0.02 per share, basic and diluted) for the corresponding period last year.

                                        
    Nine Months Ended March 31  
 Six Months Ended December 31  2005 2004  
 2004 2003    % % %
   % of   % of %  Sales of Total Sales of Total Change
 Sales Total Sales Total Change 
           
Government $14,367,000  18.0% $16,685,000  24.0%  (13.9)% $24,510,000  20.2% $30,746,000  27.2%  (20.3)%
Industrial / Other 23,401,000 29.4 17,920,000 25.7 30.6 
Industrial/Other 35,042,000 28.9 29,089,000 25.7 20.5 
Aerospace 34,988,000 43.9 26,014,000 37.3 34.5  51,729,000 42.7 39,899,000 35.2 29.6 
Medical/Scientific Instrumentation 6,959,000 8.7 9,046,000 13.0  (23.1) 9,995,000 8.2 13,497,000 11.9  (25.9)
           
Totals $79,715,000  100.0% $69,665,000  100.0% 14.4  $121,276,000  100.0% $113,231,000  100.0%  7.1 
         

Sales for the six-monthnine-month period ended DecemberMarch 31, 2004,2005, totaled $79,715,000,$121,276,000, an increase of $10,050,000 (14.4%$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 later 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 threetwo existing customers, andit is expected touncertain if this demand will continue for the balance of this fiscal year. Sales to the aerospace markets continue to grow, increasing 34.5%29.6% over the prior year. In general, this reflects stronger demand in the commercial aerospace market. A large component of thismarket, primarily increased demand was due to higher sales offor products related to aircraft collision avoidance systems mandated for installation in all commercial aircraft. Approximately $7$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 year.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.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 31%28% and 25%24% of the sales through DecemberMarch 31, 20042005 and 2003,2004, respectively.

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The following table presents income statement data as a percentage of net sales for the sixnine months ended DecemberMarch 31, 20042005 and 2003:2004:

        
         2005 2004
 2004 2003 
Net sales  100.0%  100.0%  100.0%  100.0%
Costs of goods sold 87.5 97.3  89.1 95.2 
     
 
Gross profit 12.5 2.7  10.9 4.8 
 
Selling and administrative expenses 8.6 10.6  8.1 9.3 
Other operating expenses 0.2 0.2 
     
 
Operating income (loss) 3.9  (7.9)  2.6  (4.7)
 
Other income – net 1.4 0.1 
Other income — net 1.0 0.1 
     
 
Income (loss) before income taxes 5.3  (7.8)
Income before income taxes 3.6 (4.6)
Provision (credit) for income taxes 1.7  (2.5)  1.0  (1.5)
     
Net income  2.6%  (3.1)%
 
Net income (loss)  3.6%  (5.3)%
     

An operating profitOperating income of $3,121,000$3,119,000 was reported for the sixnine months ended DecemberMarch 31, 2004,2005, compared to an operatinga loss of $5,492,000$5,359,000 for the sixnine months ended DecemberMarch 31, 2003.2004. Gross profit percentage for the sixnine months ended DecemberMarch 31, 2004,2005, was 12.5%10.9%, up from 2.7%4.8% 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

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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 $455,000.$519,000. The lowered selling and administrative expenses as a percentageare primarily the result 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,decreased bid and proposal and research and development expenses for fiscal 2005, which were approximately $955,000$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 $69,000$143,000 to $422,000$653,000 in fiscal 2005. This increase was due to increased funds available for investment.investment and improving investment rates. Other income-net in fiscal 2005 was $677,000,$647,000, versus an expense of $309,000$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 $656,000$644,000 and $173,000$163,000 during the sixnine months ended DecemberMarch 31, 20042005 and 2003,2004, respectively. Other expense-net in the prior year included a charge of $478,000$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 $2,866,000$3,175,000 ($0.330.36 per share, basic $0.32 per shareand diluted) for the sixnine months ended DecemberMarch 31, 2004,2005, versus a loss of $3,697,000$3,541,000 ($(0.42)(0.40) per share, basic and diluted) for the corresponding period last year.

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LIQUIDITY AND CAPITAL RESOURCES

For the six-monthnine-month period ended DecemberMarch 31, 2004,2005, cash and cash equivalents increased $1,223,000decreased $133,000 to $12,043,000.$10,687,000. Operating activities provided $7,086,000$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, and a reduction in accounts receivable. The primary use of cash was a decline in accounts payable, primarily as a result of paymentwell as the adjustment for the earlier increased inventory purchases.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 DecemberMarch 31, 2004,2005, 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 six-monthnine-month period ended DecemberMarch 31, 2004,2005, totaled $5,953,000,$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. The net decreaseIn fiscal 2004 proceeds from the sale of $2.3 million wasinvestments were also used primarily for the purchaseto 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 DecemberMarch 31, 20042005 and June 30, 2004, the aggregate government EMS backlog was approximately $56$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 DecemberMarch 31, 2004,2005, 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;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 completesubstantially complete. Preliminary prototype product is currently being produced, with regular production beginning in early February, with some production accomplished by the end of that month.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 $1.4$2.0 million has been expended for the construction of the new facility.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.

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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 DecemberMarch 31, 2004,2005, the Company had $91,891,000$92,164,000 in shareowners’ equity ($10.4610.45 per share), $72,551,000$71,745,000 in working capital, and a 5.49:4.67:1.00 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.

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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.

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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.

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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$16,000 and $46,000 at DecemberMarch 31, 20042005 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 DecemberMarch 31, 2004.2005. 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.

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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 DecemberMarch 31, 2004,2005, Sparton has accrued $7,040,000$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.

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Item 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

The Company manufactures its products in the United States and Canada.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 controlscontrol 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.

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As of DecemberMarch 31, 2004,2005, 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 DecemberMarch 31, 2004.2005. 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 DecemberMarch 31, 2004,2005, Sparton has accrued $7,040,000$6,962,000 as its estimate of the minimum future undiscounted financial liability, of which $636,000$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.

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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. (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, Sparton Technology, Inc. (STI)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. 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 arewere included in Util-Link’s claim for damages and, as such, arewere duplicative. Sparton believes the counterclaim to be without merit and intends to vigorously defend against it. These claims are now in the pretrial stage.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.

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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:

None.
     
     Name Votes FOR Votes WITHHELD
 
     David P. Molfenter
 6,099,967 2,028,595
     W. Peter Slusser
 6,260,109 1,868,453
     Bradley 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

3.1Amended 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.
    
3.2Amended 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.
3.3The 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.
   
3.1Amended 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.
3.2Amended 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.
3.3The 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.
31.2Chief Financial Officer certification under Section 302 of the Sarbanes-Oxley Act of 2002.
32.1Chief 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.
   
31.2Chief Financial Officer certification under Section 302 of the Sarbanes-Oxley Act of 2002.
32.1Chief 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.
Date: May 13, 2005 /s/ DAVID W. HOCKENBROCHT   
 David W. Hockenbrocht, Chief Executive Officer 
Date: May 13, 2005 /s/ RICHARD L. LANGLEY  
Richard L. Langley, Chief Financial Officer  
   
 
                     Date: February 11, 2005 /s/ RICHARD L. LANGLEY.  
Richard L. Langley, Chief Financial Officer 

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