Sparton (SPA) 10-Q 2017 Q2 Quarterly report

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-Q

ý QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended January 1, 2017

Or

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

For the transition period from to

Commission File Number 1-1000

Sparton Corporation

(Exact name of registrant as specified in its charter)

Ohio	38-1054690
(State or other jurisdiction of incorporation or organization)	(I.R.S. Employer Identification No.)
425 N. Martingale Road, Suite 1000, Schaumburg, Illinois	60173-2213
(Address of principal executive offices)	(Zip code)

(847) 762-5800

(Registrant’s telephone number, including area code)

Indicate by check mark 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.    Yes  ý    No  ¨

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate website, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or such shorter period that the registrant was required to submit and post such files).    Yes  ý    No  ¨

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):

Large accelerated filer	¨	Accelerated filer	ý
Non-accelerated filer	¨ (Do not check if a smaller reporting company)	Smaller reporting company	¨

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes  ¨    No  ý

As of February 3, 2017, there were 9,835,635 shares of common stock, $1.25 par value per share, outstanding.

TABLE OF CONTENTS

PART I	FINANCIAL INFORMATION	3
ITEM 1.	FINANCIAL STATEMENTS	3
	CONSOLIDATED BALANCE SHEETS AS OF JANUARY 1, 2017 (UNAUDITED) AND JULY 3, 2016	3
	CONSOLIDATED STATEMENTS OF OPERATIONS FOR THE SECOND QUARTER AND FIRST TWO QUARTERS OF FISCAL YEARS 2017 AND 2016 (UNAUDITED)	4
	CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS) FOR THE SECOND QUARTER AND FIRST TWO QUARTERS OF FISCAL YEARS 2017 AND 2016 (UNAUDITED)	5
	CONSOLIDATED STATEMENTS OF CASH FLOWS FOR THE FIRST TWO QUARTERS OF FISCAL YEARS 2017 AND 2016 (UNAUDITED)	6
	NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS	7
ITEM 2.	MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS	14
ITEM 3.	QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK	20
ITEM 4.	CONTROLS AND PROCEDURES	20
PART II	OTHER INFORMATION	21
ITEM 1.	LEGAL PROCEEDINGS	21
ITEM 1A.	RISK FACTORS	21
ITEM 6.	EXHIBITS	22
SIGNATURES		23
CERTIFICATIONS

2

PART I. FINANCIAL INFORMATION

Item 1. Financial Statements.

SPARTON CORPORATION AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

(Dollars in thousands, except share data)

	January 1, 2017			July 3, 2016
Assets	(Unaudited)
Current Assets:
Cash and cash equivalents	$	589		$	132
Accounts receivable, net of allowance for doubtful accounts of $289 and $407, respectively	47,396			46,759
Inventories and cost of contracts in progress, net	59,871			77,871
Prepaid expenses and other current assets	5,615			5,844
Total current assets	113,471			130,606
Property, plant and equipment, net	32,901			33,320
Goodwill	12,663			12,663
Other intangible assets, net	32,533			36,933
Deferred income taxes	25,752			25,784
Other non-current assets	5,852			6,692
Total assets	$	223,172		$	245,998
Liabilities and Shareholders’ Equity
Current Liabilities:
Accounts payable	$	29,798		$	38,290
Accrued salaries and benefits	10,303			11,512
Current portion of capital lease obligations	267			217
Other accrued expenses	10,696			12,420
Total current liabilities	51,064			62,439
Credit facility	85,706			97,206
Capital lease obligations, less current portion	302			332
Environmental remediation	5,700			6,117
Pension liability	1,204			1,276
Total liabilities	143,976			167,370
Commitments and contingencies
Shareholders’ Equity:
Preferred stock, no par value; 200,000 shares authorized, none issued	—			—
Common stock, $1.25 par value; 15,000,000 shares authorized, 9,835,635 and 9,845,469 shares issued and outstanding, respectively	12,295			12,307
Capital in excess of par value	17,696			16,407
Retained earnings	50,851			51,650
Accumulated other comprehensive loss	(1,646		)	(1,736		)
Total shareholders’ equity	79,196			78,628
Total liabilities and shareholders’ equity	$	223,172		$	245,998

See Notes to unaudited consolidated financial statements.

3

SPARTON CORPORATION AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF OPERATIONS

(UNAUDITED)

(Dollars in thousands, except per share data)

	For the Second Quarter of Fiscal Years						For the First Two Quarters of Fiscal Years
	2017			2016			2017			2016
Net sales	$	97,399		$	103,529		$	197,766		$	210,220
Cost of goods sold	81,501			85,008			164,583			170,561
Gross profit	15,898			18,521			33,183			39,659
Operating Expense:
Selling and administrative expenses	12,953			14,340			26,336			27,964
Internal research and development expenses	533			438			884			951
Amortization of intangible assets	2,191			2,459			4,410			4,962
Restructuring charges	—			2,360			—			2,360
Reversal of accrued contingent consideration	—			(1,530		)	—			(1,530		)
Total operating expense	15,677			18,067			31,630			34,707
Operating income	221			454			1,553			4,952
Other income (expense)
Interest expense, net	(1,067		)	(900		)	(2,252		)	(1,783		)
Other, net	(11		)	34			9			102
Total other expense, net	(1,078		)	(866		)	(2,243		)	(1,681		)
Income (loss) before income taxes	(857		)	(412		)	(690		)	3,271
Income taxes	50			(680		)	109			609
Net income (loss)	$	(907	)	$	268		$	(799	)	$	2,662
Income (loss) per share of common stock:
Basic	$	(0.09	)	$	0.03		$	(0.08	)	$	0.27
Diluted	$	(0.09	)	$	0.03		$	(0.08	)	$	0.27
Weighted average shares of common stock outstanding:
Basic	9,802,664			9,783,237			9,793,046			9,781,884
Diluted	9,802,664			9,783,237			9,793,046			9,781,884

See Notes to unaudited consolidated financial statements.

4

SPARTON CORPORATION AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)

(UNAUDITED)

(Dollars in thousands)

	For the Second Quarter of Fiscal Years						For the First Two Quarters of Fiscal Years
	2017			2016			2017			2016
Net income (loss)	$	(907	)	$	268		$	(799	)	$	2,662
Other comprehensive income, net:
Pension amortization of unrecognized net actuarial loss, net of tax	55			40			90			47
Unrecognized loss on marketable equity securities, net of tax	—			(102		)	—			(173		)
Other comprehensive income (loss), net	55			(62		)	90			(126		)
Comprehensive income (loss)	$	(852	)	$	206		$	(709	)	$	2,536

See Notes to unaudited consolidated financial statements.

5

SPARTON CORPORATION AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS

(UNAUDITED)

(Dollars in thousands)

	For the First Two Quarters of Fiscal Years
	2017			2016
Cash Flows from Operating Activities:
Net income (loss)	$	(799	)	$	2,662
Adjustments to reconcile net income (loss) to net cash provided by operating activities:
Depreciation	2,989			3,007
Amortization of intangible assets	4,410			4,962
Deferred income taxes	32			36
Stock-based compensation expense	1,277			869
Reversal of accrued contingent consideration	—			(1,530		)
Amortization of deferred financing costs	249			140
Excess tax benefit from stock-based compensation	—			(161		)
Changes in operating assets and liabilities (net of acquisitions):
Accounts receivable	(637		)	14,363
Inventories and cost of contracts in progress	18,000			(2,266		)
Prepaid expenses and other assets	599			(2,567		)
Performance based payments on customer contracts	127			111
Accounts payable and accrued expenses	(11,576		)	(6,517		)
Net cash provided by operating activities	14,671			13,109
Cash Flows from Investing Activity:
Acquisition of businesses, net of cash acquired	—			750
Purchases of property, plant and equipment	(2,570		)	(3,263		)
Net cash used in investing activity	(2,570		)	(2,513		)
Cash Flows from Financing Activities:
Borrowings from credit facility	59,644			46,300
Repayments against credit facility	(71,144		)	(67,000		)
Payments under capital lease agreements	(129		)	—
Payment of debt financing costs	(15		)	—
Repurchase of stock	—			(141		)
Excess tax benefit from stock-based compensation	—			161
Net cash used in financing activities	(11,644		)	(20,680		)
Net increase (decrease) in cash and cash equivalents	457			(10,084		)
Cash and cash equivalents at beginning of period	132			14,914
Cash and cash equivalents at end of period	$	589		$	4,830
Supplemental disclosure of cash flow information:
Cash paid for interest	$	1,972		$	1,508
Cash paid for income taxes	354			766
Supplemental disclosure of non-cash investing activities:
Machinery and equipment financed under capital leases	148			—
Adjustments to acquired companies' opening balance sheets	—			3,840

See Notes to unaudited consolidated financial statements.

6

SPARTON CORPORATION AND SUBSIDIARIES

NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

(Dollars in thousands, except per share data)

(1) Business and Basis of Presentation

The accompanying unaudited consolidated financial statements have been prepared in accordance with generally accepted accounting principles for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by generally accepted accounting principles for complete financial statements. In the opinion of management, all adjustments (consisting of normal recurring accruals) considered necessary for a fair presentation have been included. Certain reclassifications of prior year amounts have been made to conform to the current year presentation. Subsequent events have been evaluated through the date these financial statements were issued. Additionally, the consolidated financial statements should be read in conjunction with Item 2, Management’s Discussion and Analysis of Financial Condition and Results of Operations, included in this Quarterly Report on Form 10-Q. Operating results for the quarter and two quarters ended January 1, 2017 are not necessarily indicative of the results that may be expected for the year ending July 2, 2017. The consolidated balance sheet at July 3, 2016 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 ("GAAP") 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 fiscal year ended July 3, 2016.

The Company reports fiscal years on a 52-53 week year (5-4-4 basis) ending on the Sunday closest to June 30.

On April 27, 2016, Sparton announced that its Board of Directors had authorized a process to identify parties interested in acquiring the Company. This process is ongoing and there can be no assurance that this process will result in a consummation of any transaction. The Company cannot currently determine if the process will ultimately conclude in a sale of all or some of its assets. As such, no adjustments have been made to the Company’s carrying value of its assets or liabilities as a result of the contemplated sale.

(2) Inventories and Cost of Contracts in Progress, net

The following are the major classifications of inventory, net of interim billings:

	January 1, 2017			July 3, 2016
Raw materials	$	34,740		$	40,914
Work in process	18,990			23,626
Finished goods	17,497			22,294
Total inventory and cost of contracts in progress, gross	71,227			86,834
Inventory to which the U.S. government has title due to interim billings	(11,356		)	(8,963		)
Total inventory and cost of contracts in progress, net	$	59,871		$	77,871

(3) Property, Plant and Equipment, net

Property, plant and equipment, net consists of the following:

	January 1, 2017			July 3, 2016
Land and land improvements	$	1,429		$	1,429
Buildings and building improvements	27,693			27,660
Machinery and equipment	43,956			43,134
Construction in progress	3,042			1,372
Total property, plant and equipment	76,120			73,595
Less accumulated depreciation	(43,219		)	(40,275		)
Total property, plant and equipment, net	$	32,901		$	33,320

7

(4) Other Intangible Assets

The components of other intangible assets, net consist of the following: 

	Net Carrying Value at July 3, 2016		Additions		Amortization			Net Carrying Value at January 1, 2017
Non-compete agreements	$	2,193	$	—	$	(441	)	$	1,752
Customer relationships	32,625		—		(3,763		)	28,862
Trademarks/Tradenames	1,382		—		(81		)	1,301
Unpatented technology	733		—		(124		)	609
Patents	—		10		(1		)	9
Other intangible assets, net	$	36,933	$	10	$	(4,410	)	$	32,533

(5) Debt

On September 11, 2014, the Company entered into a revolving line-of-credit facility with a group of banks (the “Credit Facility”). The Company amended the Credit Facility on April 13, 2015 and again on June 27, 2016. As of the June 27, 2016 amendment, the Credit Agreement permits the Company to borrow up to $175,000, and the Company has the right to request an increase of the facility in an amount of up to $50,000, subject to restrictions. The facility is secured by substantially all assets of the Company and its subsidiaries and expires on September 11, 2019. As of January 1, 2017, the Company had $84,163 available under the facility, which included letters of credit of $4,562 and capital leases of $569. The letters of credit balance includes a $3,114 standby letter of credit issued during the second quarter of fiscal 2017 to support environmental remediation obligations. (See Note 8, Commitments and Contingencies, of the “Notes to Unaudited Consolidated Financial Statements” in this Quarterly Report on Form 10-Q for further information). All borrowings under the Facility are classified as long-term.

Outstanding borrowings under the Credit Facility will bear interest, at the Company’s option, at either LIBOR, fixed for

interest periods of one, two, three or six month periods, plus 1.00% to 3.00%, or at the bank’s base rate, as defined, plus 0.00%

to 2.00%, based upon the Company’s Total Funded Debt/EBITDA Ratio, as defined. The Company is also required to pay

commitment fees on unused portions of the Credit Facility ranging from 0.20% to 0.50%, based on the Company’s Total

Funded Debt/EBITDA Ratio, as defined. The Credit Facility includes representations, covenants and events of default that are

customary for financing transactions of this nature. The effective interest rate on outstanding borrowings under the Credit

Facility was 3.36% at January 1, 2017. As a condition of the Credit Facility, the Company is subject to certain customary covenants, with which it was in compliance at January 1, 2017.

(6) Income Taxes

The Company recognized a discrete income tax expense of $350 in the second quarter of fiscal year 2017 for a tax event at its Vietnam subsidiary and a discrete income tax benefit of $536 in the second quarter of fiscal year 2016 as a result of the reversal of previously accrued contingent purchase price consideration liability. The Company's effective income tax rate for interim periods was determined based on the Company's estimated annual effective tax rate for the applicable year using the federal statutory income tax rate, permanent tax differences, foreign income taxes and state income taxes. Excluding the discrete tax events described above, the Company's estimated annual effective rate for the second quarters and first two quarters of fiscal year 2017 and 2016 was determined to be approximately 35%.

(7) Defined Benefit Pension Plan

The Company has a frozen defined benefit pension plan. The Company recorded net periodic pension expense of $24 and $12 for the second quarter of fiscal year 2017 and 2016, respectively. Net periodic pension expense was $37 for the first two quarters of fiscal year 2017 and net periodic pension income was $23 for the first two quarters of 2016, respectively. No contributions were made to the pension plan during the first two quarters of fiscal years 2017 and 2016, respectively.

(8) Commitments and Contingencies

From time to time, the Company is involved in various legal proceedings relating to claims arising in the ordinary course of business. The Company is not currently a party to any such legal proceedings, the adverse outcome of which, individually or in the aggregate, is expected to have a material adverse effect on the Company's financial condition or results of operations. Additionally, the Company believes it has sufficient insurance coverage to effectively mitigate any litigation exposure.

The Company is a party to an environmental remediation matter in Albuquerque, New Mexico ("Coors Road"). As of January 1, 2017 and July 3, 2016, Sparton had accrued $6,192 and $6,701, respectively, as its estimate of the remaining

8

minimum future discounted financial liability regarding this matter, of which $492 and $584, respectively, was classified as a current liability and included on the balance sheets in other accrued expenses. As of January 1, 2017 and July 3, 2016, the Company had accrued $1,379 and $1,606, respectively, in relation to expected reimbursements from the Department of Energy, which are included in other non-current assets on the balance sheets and are considered collectible.

On October 3, 2016, the Company established the Sparton Corporation Standby Financial Assurance Trust and issued a standby letter of credit in the amount of $3,114 related to the Coors Road environmental remediation liability. The trust was established to meet the United States Environmental Protection Agency’s financial assurance requirements. As a result of the goodwill write-off of $64,174 in the prior fiscal year, the Company was not in compliance with these requirements. The release of such funds would only occur should the Company not meet its financial remediation requirements. The trust will remain in place until the Company is in compliance with the financial requirements. Upon successful compliance with the financial requirements, the trust will be dissolved and the letter of credit canceled. See the Company’s Annual Report on Form 10-K for the fiscal year ended July 3, 2016 for further information.

The Company is subject to audits by certain federal government agencies, including the Defense Contract Audit Agency and the Defense Contract Management Agency. The agencies audit and evaluate government contracts and government contractors’ administrative processes and systems. These agencies review the Company’s performance on contracts, pricing practices, cost structure, financial capability and compliance with applicable laws, regulations and standards. They also review the adequacy of the Company’s internal control systems and policies, including the Company’s purchasing, accounting, estimating, compensation and management information processes and systems. The Company works closely with these agencies to ensure compliance. From time to time, the Company is notified of claims related to noncompliance arising from the audits performed by agencies. Such claims have historically been subject to actions of remediation and/or financial claims that are typically subject to negotiated settlements. The Company believes that it has appropriate reserves established for outstanding issues and is not aware of any other issues of noncompliance that would have a material effect on the Company’s financial position or results of operations.

(9) Stock-Based Compensation

The Company has a long-term incentive plan to offer incentive and non-qualified stock options, stock appreciation rights, restricted stock or restricted stock units, performance awards and other stock-based awards, including grants of shares under the Sparton Corporation 2010 Long-Term Incentive Plan (the “2010 Plan”).

The following table shows stock-based compensation expense by type of share-based award included in the consolidated statements of income:

	For the Second Quarter of Fiscal Years					For the First Two Quarters of Fiscal Years
	2017		2016			2017		2016
Fair value expense of stock option awards	$	49	$	195		$	97	$	317
Restricted stock units	525		349			804		567
Restricted and unrestricted stock	394		(107		)	376		(15		)
Total stock-based compensation expense	$	968	$	437		$	1,277	$	869

No stock options were granted during the first or second quarters of fiscal year 2017. During the first and second quarters of fiscal year 2016, the Company awarded an aggregate of 129,798 stock options to certain members of management with an average exercise price of $23.02, of which 5,076 stock options were granted during the second quarter of fiscal year 2016. Unrestricted shares of 16,905 and 14,234 were granted to the Company's board of directors in the second quarters of fiscal year 2017 and 2016, respectively, as part of their annual compensation.

The following is a summary of activity for the first two quarters of fiscal year 2017 related to the 2010 Plan: 

	Stock Options		Restricted stock units		Restricted shares
Outstanding at July 3, 2016	115,415		79,274		52,651
Granted	—		79,889		—
Forfeited	(10,630	)	(6,029	)	(26,739	)
Outstanding at January 1, 2017	104,785		153,134		25,912

As of January 1, 2017, 33,829 stock options were exercisable, of which 356 and 20,011 vested in the second quarter and first two quarters of fiscal year 2017, respectively.

9

(10) Earnings Per Share Data

The following table sets forth the computation of basic and diluted net income (loss) per share:

	For the Second Quarter of Fiscal Years						For the First Two Quarters of Fiscal Years
	2017			2016			2017			2016
Numerator:
Net income (loss)	$	(907	)	$	268		$	(799	)	$	2,662
Less net income allocated to contingently issuable participating securities	—			(3		)	—			(28		)
Net income (loss) available to common shareholders	$	(907	)	$	265		$	(799	)	$	2,634
Weighted average shares outstanding – Basic	9,802,664			9,783,237			9,793,046			9,781,884
Dilutive effect of stock options	—			—			—			—
Weighted average shares outstanding – Diluted	9,802,664			9,783,237			9,793,046			9,781,884
Net income (loss) available to common shareholders per share:
Basic	$	(0.09	)	$	0.03		$	(0.08	)	$	0.27
Diluted	$	(0.09	)	$	0.03		$	(0.08	)	$	0.27

The number of shares excluded from the calculation of diluted net income (loss) per share because the shares were either contingently issuable or their inclusion would be anti-dilutive was 283,831 and 463,031 for the second quarter and first two quarters of fiscal years 2017 and 2016, respectively.

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(11) Business Segments

The Company has identified two reportable segments; Manufacturing & Design Services ("MDS") and Engineered Components & Products ("ECP"). The Company uses an internal management reporting system, which provides important financial data to evaluate performance and allocate the Company's resources on a segment basis. The Company’s Chief Operating Decision Maker assesses segment performance and allocates resources to each segment individually.

Operating results and certain other financial information about the Company’s two reportable segments for the second quarters and first two quarters of fiscal years 2017 and 2016 were as follows:

	For the Second Quarter of Fiscal Year 2017
	MDS			ECP		Unallocated			Eliminations			Total
Net sales	$	67,382		$	32,350	$	—		$	(2,333	)	$	97,399
Gross profit	8,357			7,541		—			—			15,898
Selling and administrative expenses (incl. depreciation)	5,561			3,545		3,847			—			12,953
Internal research and development expenses	—			533		—			—			533
Operating income	986			3,082		(3,847		)	—			221
Capital expenditures	464			423		564			—			1,451
Total assets at January 1, 2017	$	151,020		$	63,143	$	9,009		$	—		$	223,172
	For the Second Quarter of Fiscal Year 2016
	MDS			ECP		Unallocated			Eliminations			Total
Net sales	$	67,586		$	40,642	$	—		$	(4,699	)	$	103,529
Gross profit	6,989			11,532		—			—			18,521
Selling and administrative expenses (incl. depreciation)	6,646			3,715		3,979			—			14,340
Internal research and development expenses	—			438		—			—			438
Restructuring charges	2,360			—		—			—			2,360
Reversal of accrued contingent consideration	(1,530		)	—		—			—			(1,530		)
Operating income (loss)	(2,524		)	6,957		(3,979		)	—			454
Capital expenditures	427			228		1,128			—			1,783
Total assets at July 3, 2016	$	167,277		$	69,627	$	9,094		$	—		$	245,998
	For the First Two Quarters of Fiscal Year 2017
	MDS			ECP		Unallocated			Eliminations			Total
Net sales	$	132,384		$	69,942	$	—		$	(4,560	)	$	197,766
Gross profit	15,651			17,532		—			—			33,183
Selling and administrative expenses (incl. depreciation)	11,537			7,369		7,430			—			26,336
Internal research and development expenses	—			884		—			—			884
Operating income	472			8,511		(7,430		)	—			1,553
Capital expenditures	$	670		$	758	$	1,142		$	—		$	2,570
	For the First Two Quarters of Fiscal Year 2016
	MDS			ECP		Unallocated			Eliminations			Total
Net sales	$	141,543		$	78,731	$	—		$	(10,054	)	$	210,220
Gross profit	17,285			22,374		—			—			39,659
Selling and administrative expenses (incl. depreciation)	12,527			7,312		8,125			—			27,964
Internal research and development expenses	—			951		—			—			951
Restructuring charges	2,360			—		—			—			2,360
Reversal of accrued contingent consideration	(1,530		)	—		—			—			(1,530		)
Operating income (loss)	(183		)	13,260		(8,125		)	—			4,952
Capital expenditures	$	1,433		$	273	$	1,557		$	—		$	3,263

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(12) New Accounting Standards

In May 2014, the FASB issued Accounting Standards Update No. 2014-09 ("ASU 2014-09"), Revenue from Contracts with Customers, which amends guidance for revenue recognition. Under the new standard, revenue will be recognized when control of the promised goods or services is transferred to customers in an amount that reflects the consideration to which the Company expects to be entitled in exchange for those goods and services. The standard creates a five-step model that will generally require companies to use more judgment and make more estimates than under current guidance when considering the terms of contracts along with all relevant facts and circumstances. These include the identification of customer contracts and separating performance obligations, the determination of transaction price that potentially includes an estimate of variable consideration, allocating the transaction price to each separate performance obligation, and recognizing revenue in line with the pattern of transfer. In August 2015, the FASB issued an amendment to defer the effective date for all entities by one year. The new standard will become effective for annual reporting periods beginning after December 15, 2017, including interim periods within that reporting period. Early adoption is permitted as of annual reporting periods beginning after December 15, 2016. Companies have the option of using either a full or modified retrospective approach in applying this standard. During fiscal 2016, the FASB issued three additional updates which further clarify the guidance provided in ASU 2014-09. The Company is currently in the process of evaluating the impact of adoption on its consolidated financial statements.

In July 2015, the FASB issued Accounting Standards Update No. 2015-11 ("ASU 2015-11"), Simplifying the Measurement of Inventory. ASU 2015-11 clarifies that inventory should be held at the lower of cost or net realizable value. Net realizable value is defined as the estimated selling price, less the estimated costs to complete, dispose and transport such inventory. ASU 2015-11 will be effective for fiscal years and interim periods beginning after December 15, 2016. ASU 2015-11 is required to be applied prospectively and early adoption is permitted. The Company is currently in the process of evaluating the impact of adoption on its consolidated financial statements.

In February 2016, the FASB issued Accounting Standards Update No. 2016-02 (“ASU 2016-02”), Leases (Topic 842). ASU 2016-02 establishes a right-of-use (ROU) model that requires a lessee to record a ROU asset and a lease liability on the balance sheet for all leases with terms longer than 12 months. Leases will be classified as either finance or operating, with classification affecting the pattern of expense recognition in the income statement. ASU 2016-02 is effective for fiscal years beginning after December 15, 2018, including interim periods within those fiscal years. A modified retrospective transition approach is required for capital leases and operating leases existing at, or entered into after, the beginning of the earliest comparative period presented in the financial statements, with certain practical expedients available. The Company is currently in the process of evaluating the impact of adoption on its consolidated financial statements.

In March 2016, the FASB issued Accounting Standards Update No. 2016-09 ("ASU 2016-09"), Compensation - Stock Compensation (Topic 718): Improvements to Employee Share-Based Payment Accounting. ASU 2016-09 will directly impact the tax administration of equity plans. ASU 2016-09 is effective for fiscal years beginning after December 15, 2016, including interim periods within those fiscal years. Early adoption is permitted and any adjustments should be reflected as of the beginning of the fiscal year that includes that interim period. The Company has elected to early adopt ASU 2016-09 as of July 4, 2016 on a prospective basis. There was no impact on the Company's financial statements as a result of early adoption in the first quarter of fiscal year 2017.

In June 2016, the FASB issued Accounting Standards Update No. 2016-13 ("ASU 2016-13"), Financial Instruments—Credit Losses (Topic 326). ASU 2016-13 requires the measurement of all expected credit losses for financial assets held at the reporting date based on historical experience, current conditions, and reasonable and supportable forecasts. ASU 2016-13 is effective for fiscal years beginning after December 15, 2019 and early adoption is permitted. The Company is currently in the process of evaluating the impact of adoption on its consolidated financial statements.

In August 2016, the FASB issued Accounting Standards Update No. 2016-15 ("ASU 2016-15"), Statement of Cash Flows (Topic 230): Classification of Certain Cash Receipts and Cash Payments. ASU 2016-15 will make eight targeted changes to how cash receipts and cash payments are presented and classified in the statement of cash flows. ASU 2016-15 is effective for fiscal years beginning after December 15, 2017. The new standard will require adoption on a retrospective basis unless it is impracticable to apply, in which case it would be required to apply the amendments prospectively as of the earliest date practicable. The Company is currently in the process of evaluating the impact of adoption on its consolidated financial statements.

In October 2016, the FASB issued ASU 2016-16 ("ASU 2016-16"), Income Taxes - Intra-Entity Transfers of Assets Other Than Inventory, which requires entities to recognize the income tax consequences of an intra-entity transfer of an asset other than inventory when the transfer occurs. ASU 2016-16 is effective for fiscal years beginning after December 15, 2017, including interim periods within those fiscal years. Early adoption is permitted as of the beginning of a fiscal year. ASU 2016-16 must be adopted using a modified retrospective transition method which is a cumulative-effective adjustment to

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retained earnings as of the beginning of the first effective reporting period. The Company is currently in the process of evaluating the impact of adoption on its consolidated financial statements.

In November 2016, The FASB issued ASU No. 2016-18 ("ASU 2016-18"), Restricted Cash, which addresses classification and presentation of changes in restricted cash on the statement of cash flows. ASU 2016-18 requires an entity’s reconciliation of the beginning-of-period and end-of-period total amounts shown on the statement of cash flows to include in cash and cash equivalents amounts generally described as restricted cash and restricted cash equivalents. ASU 2016-18 does not define restricted cash or restricted cash equivalents, but an entity will need to disclose the nature of the restrictions. ASU 2016-18 is effective for public business entities for annual and interim periods in fiscal years beginning after December 15, 2017. Early adoption is permitted, including adoption in an interim period. If an entity early adopts the amendments in an interim period, adjustments should be reflected at the beginning of the fiscal year that includes that interim period. Entities should apply this ASU using a retrospective transition method to each period presented. The Company is currently in the process of evaluating the impact of adoption on its consolidated financial statements.

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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 Sparton Corporation’s (the “Company” or “Sparton”) results of operations 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 various corporate charters and documents.

Consolidated Results of Operations

Presented below is comparative data and discussions regarding our consolidated results of operations for the second quarter and first two quarters of fiscal year 2017 compared to the second and first two quarters of fiscal year 2016. Results of operations for any period less than one year are not necessarily indicative of results of operations that may be expected for a full year. The following discussion should be read in conjunction with the Unaudited Consolidated Financial Statements and Notes thereto included in Item 1 of this Quarterly Report on Form 10-Q.

For the Second Quarter of Fiscal Year 2017 compared to the Second Quarter of Fiscal Year 2016

The following table presents selected consolidated statements of operations data (dollars in thousands):

CONSOLIDATED

	For the Second Quarter of Fiscal Years
	2017			% of Sales		2016			% of Sales
Net sales	$	97,399		100.0	%	$	103,529		100.0	%
Cost of goods sold	81,501			83.7		85,008			82.1
Gross profit	15,898			16.3		18,521			17.9
Selling and administrative expenses	12,953			13.3		14,340			13.9
Internal research and development expenses	533			0.5		438			0.4
Amortization of intangible assets	2,191			2.3		2,459			2.4
Restructuring charges	—			—		2,360			2.3
Reversal of accrued contingent consideration	—			—		(1,530		)	(1.5	)
Operating income	221			0.2		454			0.4
Other expense, net	(1,078		)	(1.1	)	(866		)	(0.8	)
Income (loss) before income taxes	(857		)	(0.9	)	(412		)	(0.4	)
Income taxes	50			—		(680		)	(0.7	)
Net income (loss)	$	(907	)	(0.9	)%	$	268		0.3	%

The decrease in sales is primarily from lower foreign sonobuoy sales of $7.1 million and reduced engineering sales to the U.S. Navy of $3.4 million, partially offset by increased domestic sonobuoy sales of $3.5 million and increases in MDS segment revenues of $2.1 million principally as a result of strong demand from several customers.

Gross margin was negatively impacted in the second quarter of fiscal year 2017 as compared to the second quarter of last year primarily due to lower sales volume in the ECP segment. The MDS segment partially offset the lower ECP gross margin through lower overhead costs. The selling and administrative expense dollars were lower when compared to the prior year due to the continued focused effort on cost containment.

The Company recognized a discrete income tax expense of $0.4 million in the second quarter of fiscal year 2017 for a tax event at its Vietnam subsidiary and a discrete income tax benefit of $0.5 million in the second quarter of fiscal year 2016 as a result of the reversal of previously accrued contingent purchase price consideration liability. Excluding these discrete tax events, the Company's estimated annual effective rate for the second quarter of fiscal 2017 and 2016 was determined to be approximately 35%.

Due to the factors described above, the Company reported net loss of $0.9 million, or $0.09 loss per share, basic and diluted, for the second quarter of fiscal year 2017, compared to net income of $0.3 million, or $0.03 earnings per share, basic and diluted, for the second quarter of fiscal year 2016.

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Segment Information

The Company has two reportable segments - Manufacturing and Design Services ("MDS") and Engineered Components and Products ("ECP").

Manufacturing and Design Services Segment

Manufacturing and Design Services segment operations are comprised of contract design, manufacturing and aftermarket repair and refurbishment of sophisticated printed circuit card assemblies, sub-assemblies, full product assemblies and cable/ wire harnesses for customers seeking to bring their intellectual property to market. Additionally, Sparton is a developer of embedded software and software quality assurance services in connection with medical devices and diagnostic equipment. Customers include OEM and ET customers serving the Medical & Biotechnology, Military & Aerospace and Industrial & Commercial markets. In engineering and manufacturing for its customers, this segment adheres to very strict military and aerospace specifications, Food and Drug Administration guidelines and approvals, in addition to product and process certifications.

Engineered Components and Products Segment

Engineered Components and Products segment operations are comprised of design, development and production of proprietary products for both domestic and foreign defense as well as commercial needs. Sparton designs and manufactures ASW devices known as sonobuoys for the U.S. Navy and foreign governments that meet Department of State licensing requirements. This segment also performs an engineering development function for the United States military and prime defense contractors for advanced technologies, ultimately leading to future defense products, as well as replacements for existing products. The sonobuoy product line is built to stringent military specifications. These products are restricted by International Tariff and Arms Regulations and qualified by the U.S. Navy, which limits opportunities for competition. This segment is also a provider of rugged flat panel display systems for military panel PC workstations, air traffic control and industrial and commercial marine applications, as well as high performance industrial grade computer systems and peripherals. Rugged displays are manufactured for prime contractors, in some cases to specific military grade specifications. Additionally, this segment internally develops and markets commercial products for underwater acoustics and microelectromechanical (“MEMS”)-based inertial measurement.

MDS

The following table presents selected segment data (dollars in thousands): 

	For the Second Quarter of Fiscal Years
	2017			% of Sales		2016			% of Sales		$ Chg
Gross sales	$	67,382		100.0	%	$	67,586		100.0	%	$	(204	)
Intercompany sales	(2,333		)	(3.5	)	(4,640		)	(6.9	)	2,307
Net sales	65,049			96.5		62,946			93.1		2,103
Gross profit	8,357			12.4		6,989			10.3		1,368
Selling and administrative expenses	5,561			8.2		6,646			9.8		(1,085		)
Amortization of intangible assets	1,810			2.7		2,037			3.0		(227		)
Restructuring charges	—			—		2,360			3.5		(2,360		)
Reversal of accrued contingent consideration	—			—		(1,530		)	(2.3	)	1,530
Operating income (loss)	$	986		1.5	%	$	(2,524	)	(3.7	)%	$	3,510

The increase in sales was due to increased demand from several customers. MDS backlog was $123.3 million at January 1, 2017 compared to $144.4 million at December 27, 2015. Commercial orders, in general, may be rescheduled or canceled without significant penalty, and, as a result, may not be a meaningful measure of future sales. A majority of the January 1, 2017 MDS backlog is currently expected to be realized in the next 12 months.

The increase in gross margin percentage on MDS sales is primarily due to higher absorption of fixed overhead costs as a result of the higher sales volumes. The decrease in selling and administrative expense is due to lower professional fees and corporate allocated costs.

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ECP

The following table presents selected segment data (dollars in thousands):

	For the Second Quarter of Fiscal Years
	2017		% of Sales		2016			% of Sales		$ Chg
Gross sales	$	32,350	100.0	%	$	40,642		100.0	%	$	(8,292	)
Intercompany sales	—		—		(59		)	(0.2	)	59
Net sales	32,350		100.0		40,583			99.8		(8,233		)
Gross profit	7,541		23.3		11,532			28.4		(3,991		)
Selling and administrative expenses	3,545		11.0		3,715			9.1		(170		)
Internal research and development expenses	533		1.6		438			1.1		95
Amortization of intangible assets	381		1.2		422			1.0		(41		)
Operating income	$	3,082	9.5	%	$	6,957		17.1	%	$	(3,875	)

The segment had a decrease of $7.1 million in foreign sonobuoy sales and a $3.4 million decrease in engineering sales partially offset by a $3.5 million increase in domestic sonobuoys to the U.S. Navy. Total sales to the U.S. Navy in the second quarter of fiscal years 2017 and 2016 were both $22.1 million. For the second quarter of fiscal years 2017 and 2016, sales to the U.S. Navy accounted for 23% and 21%, respectively, of consolidated Company net sales and 68% and 54%, respectively, of ECP segment net sales. ECP backlog was $113.1 million at January 1, 2017 compared to $119.1 million at December 27, 2015. A majority of the January 1, 2017 ECP backlog is currently expected to be realized in the next 18 months.

Gross margin on ECP sales was negatively impacted in the current year quarter due to the lower sales volumes and an unfavorable shift in product mix. The decrease in selling and administrative expense is due to lower professional fees and corporate allocated costs.

Internal research and development expenses reflect costs incurred for the internal development of technologies for use in undersea warfare, navigation, hand held targeting applications as well as rugged computer and display devices. These costs include salaries and related expenses, contract labor and consulting costs, materials and the cost of certain research and development specific equipment.

Eliminations and Corporate Unallocated

The following table presents selected data (dollars in thousands):

	For the Second Quarter of Fiscal Years
	2017			2016			$ Chg
Intercompany sales elimination	$	(2,333	)	$	(4,699	)	$	2,366
Selling and administrative expenses unallocated	3,847			3,979			(132		)

Total corporate selling and administrative expenses before allocation to operating segments were $7.0 million and $7.5 million for the second quarter of fiscal year 2017 and fiscal year 2016, respectively, or 7.2% and 7.3% of consolidated sales, respectively. Of these costs, $3.2 million and $3.5 million, respectively, were allocated to segment operations in each of these periods.

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For the First Two Quarters of Fiscal Year 2017 compared to the First Two Quarters of Fiscal Year 2016

The following table presents selected consolidated statement of operations data (dollars in thousands):

CONSOLIDATED

	For the First Two Quarters of Fiscal Years
	2017			% of Sales		2016			% of Sales
Net sales	$	197,766		100.0	%	$	210,220		100.0	%
Cost of goods sold	164,583			83.2		170,561			81.1
Gross profit	33,183			16.8		39,659			18.9
Selling and administrative expenses	26,336			13.3		27,964			13.3
Internal research and development expenses	884			0.5		951			0.5
Amortization of intangible assets	4,410			2.2		4,962			2.3
Restructuring charges	—			—		2,360			1.1
Reversal of accrued contingent consideration	—			—		(1,530		)	(0.7	)
Operating income	1,553			0.8		4,952			2.4
Other expense, net	(2,243		)	(1.1	)	(1,681		)	(0.8	)
Income (loss) before income taxes	(690		)	(0.3	)	3,271			1.6
Income taxes	109			0.1		609			0.3
Net (loss) income	$	(799	)	(0.4	)%	$	2,662		1.3	%

The decrease in sales is primarily from reduced engineering sales to the U.S. Navy and lower foreign sonobuoy sales in the ECP segment and customer attrition, fluctuations in customer demand and product insourcing in the MDS segment, partially offset by increased sales in domestic sonobuoys.

Gross profit percentage was negatively impacted in the current year by lower sales volumes in both the ECP and MDS segments as well as an unfavorable shift in product mix which lead to higher material content in the MDS segment and unabsorbed fixed overhead costs due to new program launch activity in the ECP segment. The decrease in selling and administrative expense is due to the continued focused effort on cost containment in both segments and the corporate office.

Excluding the discrete income tax events described above, the Company's estimated annual effective rate for the first two quarters of fiscal 2017 and 2016 was determined to be approximately 35%.

Due to the factors described above, the Company reported net loss of $0.8 million, or $0.08 loss per share for the first two quarters of fiscal year 2017, compared to net income of $2.7 million, or $0.27 per share for the first two quarters of fiscal year 2016.

MDS

The following table presents selected segment data (dollars in thousands): 

	For the First Two Quarters of Fiscal Years
	2017			% of Sales		2016			% of Sales		$ Chg
Gross sales	$	132,384		100.0	%	$	141,543		100.0	%	$	(9,159	)
Intercompany sales	(4,533		)	(3.4	)	(9,869		)	(7.0	)	5,336
Net sales	127,851			96.6		131,674			93.0		(3,823		)
Gross profit	15,651			11.8		17,285			12.2		(1,634		)
Selling and administrative expenses	11,537			8.7		12,527			8.9		(990		)
Amortization of intangible assets	3,642			2.7		4,111			2.9		(469		)
Restructuring charges	—			—		2,360			1.6		(2,360		)
Reversal of accrued contingent consideration	—			—		(1,530		)	(1.1	)	1,530
Operating income (loss)	$	472		0.4	%	$	(183	)	(0.1	)%	$	655

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The decrease in sales was due to customer attrition, fluctuations in customer demand and product insourcing in the MDS segment. Gross profit percentage on MDS sales was negatively affected in the first two quarters of fiscal year 2017 by lower sales volumes and an unfavorable shift in product mix which lead to higher material content as compared to the same period of the prior year. The selling and administrative expense decrease is primarily due to lower professional fees and compensation costs.

ECP

The following table presents selected segment data (dollars in thousands):

	For the First Two Quarters of Fiscal Years
	2017			% of Sales		2016			% of Sales		$ Chg
Gross sales	$	69,942		100.0	%	$	78,731		100.0	%	$	(8,789	)
Intercompany sales	(27		)	—		(185		)	(0.2	)	158
Net sales	69,915			100.0		78,546			99.8		(8,631		)
Gross profit	17,532			25.1		22,374			28.4		(4,842		)
Selling and administrative expenses	7,369			10.5		7,312			9.3		57
Internal research and development expenses	884			1.3		951			1.2		(67		)
Amortization of intangible assets	768			1.1		851			1.1		(83		)
Operating income	$	8,511		12.2	%	$	13,260		16.8	%	$	(4,749	)

The decrease in sales is primarily from reduced engineering sales to the U.S. Navy and lower foreign sonobuoy sales, partially offset by increased domestic sonobuoy sales. Total sales to the U.S. Navy in the first two quarters of fiscal years 2017 and 2016 were approximately $42.1 million and $46.5 million, respectively. For the first two quarters of fiscal years 2017 and 2016, sales to the U.S. Navy accounted for 21% and 22%, respectively, of consolidated Company net sales and 60% and 59%, respectively, of ECP segment net sales.

Gross profit percentage on ECP sales was negatively impacted in the current year by lower sales volumes and unabsorbed fixed overhead costs due to new program launch activity compared to the same period last year. The selling and administrative expenses were flat when compared to prior year.

Internal research and development expenses reflect costs incurred for the internal development of technologies for use in navigation, oil and gas exploration and flat panel display technology. These costs include salaries and related expenses, contract labor and consulting costs, materials and the cost of certain research and development specific equipment.

Eliminations and Corporate Unallocated

The following table presents selected consolidated statement of income data (dollars in thousands):

	For the First Two Quarters of Fiscal Years
	2017			2016			$ Chg
Intercompany sales elimination	$	(4,560	)	$	(10,054	)	$	5,494
Selling and administrative expenses unallocated	7,430			8,125			(695		)

Liquidity and Capital Resources

As of January 1, 2017, the Company had $84.2 million available under its $175.0 million credit facility, reflecting borrowings under the facility of $85.7 million, letters of credit of $4.5 million and capital leases of $0.6 million. The letters of credit balance includes a $3.1 million standby letter of credit issued during the second quarter of fiscal year 2017 to support environmental remediation obligations. (See Note 8, Commitments and Contingencies, of the “Notes to Unaudited Consolidated Financial Statements” in this Quarterly Report on Form 10-Q for further information)

As a condition of the Credit Facility, the Company is subject to certain customary covenants, with which it was in compliance at January 1, 2017.

The Company currently expects to meet its liquidity needs through a combination of sources including, but not limited to, operations and its revolving line-of-credit. With the above sources providing the expected cash flows, the Company currently

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believes that it will have sufficient liquidity for its anticipated needs over the next 12 months, but no assurances regarding liquidity can be made.

	For the First Two Quarters of Fiscal Years
CASH FLOWS	2017			2016
Operating activities, excluding net changes in working capital	$	8,158		$	9,985
Net changes in working capital	6,513			3,124
Operating activities	14,671			13,109
Investing activity	(2,570		)	(2,513		)
Financing activities	(11,644		)	(20,680		)

Net changes in working capital related cash flows in the first two quarters of fiscal year 2017 primarily reflect decreased inventories partially offset by decreased accounts payable and accrued expenses. Working capital related cash flows in the first two quarters of fiscal year 2016 primarily reflect collections of accounts receivables partially offset by decreased accounts payable and accrued expenses.

Net cash flows from investing activity for the first two quarters of fiscal year 2017 and 2016 reflect net capital expenditures of $2.6 million and $3.3 million, respectively.

Net cash used in financing activities in the first two quarters of fiscal year 2017 reflects $11.5 million of net payments under the Company's Credit Facility as compared to $20.7 million in net payments for the first two quarters of fiscal year 2016.

Commitments and Contingencies

See Note 8, Commitments and Contingencies, of the “Notes to Unaudited Consolidated Financial Statements” in this Quarterly Report on Form 10-Q for a discussion of the Company's commitments and contingencies.

Contractual Obligations

Information regarding the Company’s long-term debt obligations, environmental liability payments, operating lease payments and other commitments is provided in Part II, Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” of the Company’s Annual Report on Form 10-K for fiscal year ended July 3, 2016. As of July 3, 2016, there were $49.0 million of non-cancelable purchase orders outstanding, $97.2 million of debt, $9.8 million of operating lease payments and a liability related to performance based billings was eliminated. As of January 1, 2017, compared to July 3, 2016, the non-cancelable purchase orders outstanding decreased to $45.9 million, debt decreased to $85.7 million, operating lease payments, net of subleases, increased to $10.5 million and the liability related to performance based billings increased to $0.1 million. Other than as noted above, there have been no material changes in the nature or amount of the Company’s contractual obligations since fiscal year end 2016.

Off-Balance Sheet Arrangements

The Company has standby letters of credit outstanding of $4.5 million at January 1, 2017, principally to support environmental remediation obligations and insurance arrangements. Other than these standby letters of credit and the operating lease commitments referenced above, we have no off-balance sheet arrangements that would have a current or future material effect on our financial condition, changes in financial condition, revenue, expense, results of operations, liquidity, capital expenditures or capital resources.

Critical Accounting Policies

Our financial statements are prepared in conformity with GAAP and require us to select appropriate accounting policies. The assumptions and judgments we use in applying our accounting policies have a significant impact on our reported amounts of assets, liabilities, revenue and expenses. While we believe that the assumptions and judgments used in our estimates are reasonable, actual results may differ from these estimates under different assumptions or conditions.

We have identified the most critical accounting policies upon which our financial status depends. The critical policies were determined by considering accounting policies that involve the most complex or subjective decisions or assessments. We also have other policies considered key accounting policies; however, these policies do not meet the definition of critical accounting policies because they do not generally require us to make estimates or judgments that are complex or subjective.

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Our critical accounting policies include the following:

Revenue recognition

•Goodwill and other intangible assets

•Percentage-of-completion accounting

•Environmental contingencies

•Income taxes

•Commercial inventory valuation

•Stock-based compensation

There have been no significant changes to our critical accounting policies that are described in Part II, Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations” section of our Annual Report on Form 10-K for the fiscal year ended July 3, 2016.

New Accounting Pronouncements

See Note 12, New Accounting Standards, of the “Notes to Unaudited Consolidated Financial Statements” in this Quarterly Report on Form 10-Q for a discussion of new accounting pronouncements.

Item 3. Quantitative and Qualitative Disclosures About Market Risk.

The Company manufactures its products in the United States, Canada and Vietnam. Sales of the Company’s products are in the U.S. and foreign markets. The Company is 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. Adjustments related to the remeasurement of the Company's Canadian and Vietnamese 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 economic conditions in the domestic and foreign markets in which the Company operates. However, minimal third party receivables and payables are denominated in foreign currencies and the related market risk exposure is considered to be immaterial.

The Company’s revolving credit line, when drawn upon, is subject to future interest rate fluctuations which could potentially have a negative impact on cash flows of the Company. The Company had $85.7 million outstanding under its Credit Facility at January 1, 2017. A prospective increase of 100 basis points in the interest rate applicable to the Company’s outstanding borrowings under its Credit Facility would result in an increase of $0.9 million in our annual interest expense. The Company is not party to any currency exchange or interest rate protection agreements as of January 1, 2017.

Item 4. Controls and Procedures.

Our Interim Chief Executive Officer and our Chief Financial Officer each has evaluated the effectiveness of our disclosure controls and procedures (as such term is defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934) as of the end of the period covered by this quarterly report. Based on such evaluation, such officers have concluded that, as of the end of the period covered by this quarterly report, our disclosure controls and procedures are effective.

There have been no changes in our internal controls over financial reporting (as such term is defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act) during the second quarter of fiscal year 2017 ended January 1, 2017, that have materially affected, or are reasonably likely to materially affect, our internal controls over financial reporting.

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PART II. OTHER INFORMATION

Item 1. Legal Proceedings.

See Note 8, Commitments and Contingencies, of the “Notes to Unaudited Consolidated Financial Statements” in this Quarterly Report on Form 10-Q for a discussion of legal proceedings and other commitments and contingencies.

Item 1A. Risk Factors.

You should carefully consider the risks and uncertainties described in Part I, Item 1A., "Risk Factors," in our Annual Report on Form 10-K for the year ended July 3, 2016 and the other information in our subsequent filings with the SEC, including this Quarterly Report on Form 10-Q. Our business, financial condition, results of operations and stock price could be materially and adversely affected by any of these risks. The risks described in our Annual Report on Form 10-K are not the only ones we face. Additional risks and uncertainties that are currently unknown to us or that we currently consider to be immaterial may also impair our business or adversely affect our financial condition, results of operations and stock price.

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Item 6. Exhibits.

Exhibit Number	Description
3.1	Second Amended Articles of Incorporation of the Registrant, incorporated herein by reference from the Registrant’s Proxy Statement on Form DEF 14A filed with the SEC on September 21, 2010.
3.2	Amended and Restated Code of Regulations of the Registrant, incorporated herein by reference from Exhibit 3.2 to the Registrant’s Current Report on Form 8-K filed with the SEC on May 5, 2015.
31.1*	Interim 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*	Interim 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.
101.INS*	XBRL Instance Document
101.SCH*	XBRL Taxonomy Extension Schema Document
101.CAL*	XBRL Taxonomy Calculation Linkbase Document
101.DEF*	XBRL Taxonomy Extension Definition Linkbase Document
101.LAB*	XBRL Taxonomy Extension Label Linkbase Document
101.PRE*	XBRL Taxonomy Extension Presentation Linkbase Document

* Filed herewith.

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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.

	Sparton Corporation
Date: February 7, 2017	By:	/s/ JOSEPH J. HARTNETT
		Joseph J. Hartnett
		Interim President and Chief Executive Officer
		(Principal Executive Officer)
Date: February 7, 2017	By:	/s/ JOSEPH G. MCCORMACK
		Joseph G. McCormack
		Senior Vice President and Chief Financial Officer
		(Principal Financial Officer)

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