UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE
ACT OF 1934 FOR THE PERIOD ENDED September 30, 2002
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 (I.R.S. Employer Identification No.)
Incorporation or Organization)
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. Yes X No
--- ---
The aggregate market value of voting stock held by non-affiliates of the
registrant as of October 31, 2002, was $41,851,771.
Common Stock, $1.25 Par Value - 7,563,540 shares outstanding as of October 31,
2002.
-1-
SPARTON CORPORATION AND SUBSIDIARIES
INDEX
Part I. Financial Information
Item 1. Financial Statements (Unaudited)
Condensed Consolidated Balance Sheets
September 30 and June 30, 2002 .................................................................3
Condensed Consolidated Statements of Operations
Three-Month Periods ended September 30, 2002 and 2001...........................................4
Condensed Consolidated Statements of Cash Flows
Three-Month Periods ended September 30, 2002 and 2001 ..........................................5
Notes to Condensed Consolidated Financial Statements..............................................6
Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations..........10
Item 3. Quantitative and Qualitative Disclosures About Market Risk.....................................13
Item 4. Controls and Procedures .......................................................................13
Part II. Other Information
Item 1. Legal Proceedings..............................................................................13
Item 6. Exhibits and Reports on Form 8-K ..............................................................15
Signatures ............................................................................................15
Certifications ........................................................................................16
Amended Articles of Incorporation (exhibit 3.1)....................................................... 18
-2-
SPARTON CORPORATION AND SUBSIDIARIES
Condensed Consolidated Balance Sheets (Unaudited)
September 30 and June 30, 2002
ASSETS
September 30 June 30
------------ -------
Current assets:
Cash and cash equivalent $ 7,309,500 $ 8,687,873
Investment securities 14,376,665 11,530,374
Accounts receivable:
Trade 19,994,862 18,703,397
EPA settlement (Note 6) 5,850,000 -
Income taxes recoverable - 1,055,965
Inventories and costs on contracts in progress, less progress payments of
$7,777,000 at September 30 ($6,275,000 at June 30) 41,719,412 41,929,559
Prepaid expenses 2,081,961 2,214,845
------------ ------------
Total current assets 91,332,400 84,122,013
Pension asset 6,304,117 6,304,117
Other assets 2,724,286 2,940,918
Property, plant and equipment, net 9,045,004 9,034,200
------------ ------------
Total assets $109,405,807 $102,401,248
============ ============
LIABILITIES AND SHAREOWNERS' EQUITY
Current liabilities:
Account payable $ 8,078,256 $ 7,762,357
Salaries and wages 3,228,494 3,545,045
Accrued liabilities 3,348,024 2,104,170
Income taxes payable 1,836,718 -
------------ ------------
Total current liabilities 16,491,492 13,411,572
Environmental remediation 7,293,289 7,375,259
Shareowners' equity:
Common stock - 7,563,540 and 7,559,790 shares outstanding at September 30
and June 30 after deducting 371,172 and 374,922 shares in treasury 9,454,425 9,449,738
Capital in excess of par value 488,118 477,493
Accumulated other comprehensive income (loss) 241,462 (172,000)
Retained earnings 75,437,021 71,859,186
------------ ------------
Total shareowners' equity 85,621,026 81,614,417
------------ ------------
Total liabilities and shareowners' equity $109,405,807 $102,401,248
============ ============
See accompanying notes.
3
SPARTON CORPORATION AND SUBSIDIARIES
Condensed Consolidated Statements of Operations (Unaudited)
For the Three-Month Periods ended September 30, 2002 and 2001
September 30
----------------------------
2002 2001
---- ----
Net sales $ 36,767,907 $ 40,810,080
Costs of goods sold 33,003,645 36,082,165
------------ ------------
3,764,262 4,727,915
Selling and administrative income (expense):
Selling and administrative expenses (3,524,214) (3,279,106)
EPA related - net (Note 6) 5,347,000 (173,426)
------------ ------------
1,822,786 (3,452,532)
------------ ------------
Operating income 5,587,048 1,275,383
Other income (expense):
Interest and investment income 117,297 128,624
Equity loss in investment (39,000) (71,250)
Other - net 14,490 (41,947)
------------ ------------
92,787 15,427
Income before income taxes 5,679,835 1,290,810
Provision for income taxes 2,102,000 504,000
------------ ------------
Net income $3,577,835 $ 786,810
============ ============
Basic and diluted earnings per share $0.47 $0.10
============ ============
Dividends $-0- $-0-
============ ============
See accompanying notes.
4
SPARTON CORPORATION AND SUBSIDIARIES
Condensed Consolidated Statements of Cash Flows (Unaudited)
For the Three-Month Periods ended September 30, 2002 and 2001
September 30
--------------------------
2002 2001
----------- -----------
Cash flows provided (used) by Operating Activities:
Net income $ 3,577,835 $ 786,810
Add noncash items affecting operations:
Depreciation 363,426 426,304
EPA settlement (Note 6) (5,500,000) --
Add (deduct) changes in operating assets and liabilities:
Income taxes payable 1,836,718 453,589
Other 1,391,679 1,462,554
Income taxes recoverable 1,055,965 --
Accounts payable 315,899 (7,791,014)
Inventories 210,147 4,430,543
Accounts receivable (1,641,465) 1,649,697
----------- -----------
1,610,204 1,418,483
Cash flows provided (used) by Investing Activities:
Purchases of investment securities -net (2,846,291) (3,610,195)
Purchases of property, plant and equipment-net (,374,230) (101,053)
Noncurrent other assets 216,632 41,631
----------- -----------
(3,003,889) (3,669,617)
Cash flows provided by Financing Activities:
Stock options exercised 15,312 --
----------- -----------
Decrease in cash and cash equivalents (1,378,373) (2,251,134)
Cash and cash equivalents at beginning of period 8,687,873 13,034,790
----------- -----------
Cash and cash equivalents at end of period $ 7,309,500 $10,783,656
=========== ===========
Supplemental disclosures of cash paid (refunded) during the period:
Income taxes - net ($693,000) $ 89,000
=========== ===========
See accompanying notes.
5
SPARTON CORPORATION AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
1. 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 for interim financial information and
with the instructions to Form 10-Q and Article 10 of Regulations S-X.
Accordingly, they do not include all of the information and footnotes required
by accounting principles generally accepted in the United States for complete
financial statements. All significant intercompany transactions and accounts
have been eliminated. The condensed consolidated balance sheet at September 30,
2002, and the related condensed statements of operations and cash flows for the
three-month periods ended September 30, 2002 and 2001 are unaudited, but include
all adjustments (consisting of normal recurring accruals) which the Company
considers necessary for a fair presentation of such financial statements.
Operating results for the three-month period ended September 30, 2002, are not
necessarily indicative of the results that may be expected for the year ended
June 30, 2003.
The balance sheet at June 30, 2002, 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 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, 2002.
At June 30, 2002, the Company changed its method of accounting for its
investment in Cybernet Systems Corporation (Cybernet). The investment is now
accounted for under the equity method and included in other assets on the
balance sheets at September 30 and June 30, 2002. The condensed consolidated
statement of operations and cash flow for the three-month period ended September
30, 2001, have been changed to reflect the Company's share of Cybernet's losses
and accumulated other comprehensive income (loss), as required by Accounting
Principles Board Opinion No.18 "The Equity Method of Accounting for Investments
In Common Stock".
OPERATIONS - 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 for the telecommunications,
medical/scientific instrumentation, electronics, aerospace, and other
industries. The Company also develops and manufactures sonobuoys, anti-submarine
warfare (ASW) devices, used by the U.S. Navy and other free-world countries.
USE OF ESTIMATES - The preparation of financial statements in
conformity with accounting principles generally accepted in the United States
requires 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.
CREDIT PRACTICES - The Company sells products principally in the
commercial and governmental electronics manufacturing markets. Credit terms are
granted and periodically revised based on evaluations of the customers'
financial condition, with collateral generally not required. Receivables from
foreign customers are generally secured by letters of credit or cash advances.
NEW ACCOUNTING STANDARD - Effective July 1, 2002, the Company was
required to adopt Statement of Financial Accounting Standards (SFAS) No.144,
"Accounting for the Impairment of Long-Lived Assets" (SFAS No.144), which
supersedes SFAS No.121 "Accounting for the Impairment of Long-Lived Assets and
for Long-Lived Assets to be Disposed Of" and provides a single accounting model
for long-lived assets which are to be disposed of. The adoption of SFAS No.144
did not have any material effect on the Company's consolidated results of
operation or financial position.
DEPRECIATION - Depreciation is provided over estimated useful lives on
accelerated methods, except for certain buildings, machinery and equipment,
which are being depreciated on the straight-line method. Estimated useful lives
generally range from 5 to 50 years for buildings and improvements, 3 to 16 years
for machinery and equipment, and 3 to 5 years for test equipment.
6
TREASURY STOCK - The Company records treasury stock purchases at cost.
The excess of cost over par value is allocated to capital in excess of par value
based on the per share amount of capital in excess of par value for all shares,
with the difference charged to retained earnings.
2. The Company's net sales are comprised of product sales and revenues earned
from engineering and design services. 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.
Inventories are valued at the lower of cost (first-in, first-out basis)
or market and include costs related to long-term contracts. The following are
the major classifications of inventory, which are presented net of progress
payments.
September 30, 2002 June 30, 2002
------------------ -------------
Raw materials $25,030,000 $23,353,000
Work in process and finished goods 16,689,000 18,577,000
----------- -----------
Total $41,719,000 $41,930,000
=========== ===========
Work in progress and finished goods inventory includes $6.5 million and
$7.5 million of sonobuoys at September 30, 2002, and June 30, 2002,
respectively.
3. For the three months ended September 30, basic and diluted earnings per share
were computed based on the following:
Three Months Ended September 30
-------------------------------
2002 2001
---- ----
Basic - weighted average shares outstanding 7,563,105 7,570,090
Effect of dilutive stock options 75,260 39,079
---------- ----------
Weighted average diluted shares outstanding 7,638,365 7,609,169
========== ==========
For the three-month periods ended September 2002 and 2001, options to
purchase 94,000 and 98,500 shares of common stock were not included in the
computation of diluted earnings per share. Such option's exercise prices were
greater than the average market price of the Company's common stock and,
therefore, the effect would be antidilutive.
4. The reporting of comprehensive income requires disclosure of total
non-shareowner changes in equity in interim periods and additional disclosures
of the components of non-shareowner changes in equity on an annual basis. Total
non-shareowner changes in equity include all changes in equity during a period
except those resulting from investments by and distributions to shareowners.
Comprehensive income includes net income, as well as unrealized gains and losses
on investments, which are excluded from net income. Such gains and losses are
reflected as a direct charge or credit to shareowners' equity.
Comprehensive income for the three months ended September 30, 2002, and 2001 was
as follows:
Three Months Ended September 30
--------------------------------
2002 2001
Net income $3,578,000 $787,000
Other comprehensive income, net of tax:
Net unrealized gains (losses) - investment
securities owned 199,000 42,000
Net unrealized gains (losses) - investment
securities held by investee
accounted for by the equity method 214,000 (131,000)
---------- ---------
Comprehensive income $3,991,000 $698,000
========== =========
7
At September 30, 2002, shareowners' equity includes accumulated other
comprehensive income (loss) of $277,000 and ($36,000), which relates to
unrealized gains on investments securities owned and unrealized losses on
investment securities held by an investee accounted for by the equity method,
respectively. At June 30, 2002, these amounts were $78,000 and ($250,000),
respectively.
5. Cash and cash equivalents consist of demand deposits and other highly liquid
investments. The investment portfolio has various maturity dates up to 25 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. It is
the Company's intention to use these investment securities to provide working
capital and fund the expansion of its business and for other business purposes.
At September 30, 2002, the Company had net unrealized gains of
$441,000. At that date, the net after-tax effect of these gains was $277,000,
which amount is included in equity. Purchases of investments for the three-month
periods ended September 30, 2002 and 2001, totaled $3,033,000 and $3,610,000,
respectively. Sales of investment securities totaled $187,000 for the three
months ended September 30, 2002. There were no sales of investment securities
for the corresponding period ended September 30, 2001.
Sparton owns a 14% interest in Cybernet Systems Corporation (Cybernet),
which was purchased for $3,000,000 in June 1999. This investment is accounted
for under the equity method and is included in other assets on the condensed
consolidated balance sheet. Sparton'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 Sparton's
balance sheet.
6. One of Sparton's former manufacturing facilities, located in Albuquerque, New
Mexico (Coors Road), 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 1980s and involved
a review of onsite and offsite environmental impacts.
At September 30, 2002, Sparton has a remaining accrual of $7,823,000 as
its estimate of the minimum future undiscounted financial liability with respect
to this matter, of which $530,000 is classified as a current liability and
included on the balance sheet in accrued liabilities. The Company's minimum cost
estimate is based upon existing technology and excludes legal and related
consulting costs. The Company's estimate includes equipment and operating costs
for onsite and offsite pump and treat containment systems, a soil vapor
extraction program and continued onsite and offsite monitoring. Legal and
related consulting costs are expensed as incurred.
During the first quarter of fiscal 2003, Sparton reached an agreement
with the United States Department of Energy (DOE) and others to recover certain
remediation costs. Under the agreement, Sparton will be reimbursed for a portion
of the costs it has incurred in its investigation and site remediation efforts
at the Coors Road site. The settlement concludes a very lengthy negotiation
process and two court actions, one in the Federal Court of Claims and one in the
Federal District Court in Albuquerque. Under the settlement terms, Sparton will
receive $4,850,000 from the DOE and others in fiscal 2003, plus an additional
$1,000,000 in fiscal 2004. In addition, the DOE has agreed to reimburse Sparton
for 37.5% of certain future environmental expenses in excess of $8,400,000
incurred at the site.
With the settlement, Sparton received cash and gained some degree of
risk protection, with the DOE agreeing to reimburse future costs incurred above
an established level. The financial impact of the settlement was recorded in the
first quarter of fiscal 2003. Most of the settlement proceeds (approximately
$5,500,000) were recorded as income.
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.
8
Amounts charged to operations, principally legal and consulting, for
the three months ended September 30, 2002 and 2001 were $153,000 and $173,000,
respectively. These costs were generally incurred in pursuit of various claims
for reimbursement.
7. The Company follows Accounting Principles Board Opinion No. 25, "Accounting
for Stock Issued to Employees" (APB 25), and related Interpretations in
accounting for its employee stock options. Under APB 25, no compensation expense
is recognized as the exercise price of the Company's employee stock options
equals the market price of the underlying stock on the date of grant. The
Company follows the disclosure requirements of Statement of Financial Accounting
Standards (SFAS) No. 123, "Accounting for Stock-Based Compensation".
At September 30, 2002, the per share weighted-average exercise price of
options outstanding was $6.52. The weighted-average remaining contractual life
of those options was approximately 4 years. At September 30, 2002, there were
39,750 options exercisable at the per share price of $4.17. Remaining shares
available for grant under the plan were 266,000 at September 30, 2002.
During the three months ended September 30, 2002, stock options to
purchase 91,000 shares of common stock were granted. Had compensation cost for
all stock options outstanding been determined based on their estimated fair
values at the date of grant, consistent with the fair value method of SFAS 123
(using the Black Scholes method of valuation), the Company's net earnings for
the quarter would have been reduced by $38,250 ($0.01 per share).
9
SPARTON CORPORATION AND SUBSIDIARIES
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. The
Company's operations are in one line of business, electronic contract
manufacturing services (EMS). This includes the design, development and/or
manufacture of electronic parts and assemblies for both government and
commercial customers worldwide.
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. The following discussion
about the Company's results of operations and financial condition contains
forward-looking statements that involve risk and uncertainty. 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. The risks and uncertainties that may
affect the operations, performance, growth forecasts and results of the
Company's business include, but are not limited to, timing and fluctuations in
U.S. and/or world economies, customer demand for products, 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, changes in the
interpretation of environmental laws and the uncertainties of environmental
remediation. An additional 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, which have resulted in higher
prices and late deliveries. Finally, the timing of sonobuoy sales is dependent
upon access to, 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. 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.
RESULTS OF OPERATIONS
Sales for the three-month period ended September 30, 2002, totaled
$36,768,000, a decrease of $4,042,000 (10%) from last year. Government EMS sales
increased $1,008,000 (10%) to $10,829,000, while commercial EMS sales decreased
16% compared to last year. The uncertainty of customers' schedules in the
commercial market has resulted in Sparton taking additional measures to reduce
costs and expenses.
Reduced gross margin was attributable to several factors. The reduced
levels of sales did not allow for the absorption of fixed manufacturing overhead
as in the comparable periods. In addition, one facility was closed for two weeks
for regularly scheduled maintenance and vacations this quarter, which further
contributed to unabsorbed overhead. Also, disengagement issues with one
commercial customer, resulted in decreased margins in fiscal 2002. Included in
government EMS sales were $546,000 of shipments ($4,855,000 last year) with no
gross margin. As previously disclosed, several government programs are loss
contracts, which losses have been previously recognized. Finally, gross margin
in the prior year, fiscal 2002, was improved when several previously contested
customer issues were successfully completed, which resolution contributed
approximately $600,000 to operations through pricing adjustments. At September
30, 2002, the backlog of sales on loss contracts approximated $1.3 million.
Selling and administrative expenses were above last year. Actions continue to be
taken to control costs. Increased costs include additional bid and proposal
expenses related to the quest for new job opportunities. Sparton's bid activity
is now near record levels.
Operating income of $5,587,000 was reported for the three months ended
September 30, 2002, compared to $1,275,000 for the same period last year.
Included in operating income as of September 30, 2002, was $5,500,000 of income
related to the recovery of certain remediation costs. This income reflects
Sparton's settlement with the DOE and others regarding reimbursable costs
incurred at the Company's Sparton Technology, Inc. Coors Road site. Also
included are charges against income related to the Coors Road site remediation
effort , principally litigation, of $153,000 and $173,000 in 2002 and 2001,
respectively.
10
Interest and Investment Income decreased $11,000 to $117,000 in 2002,
due to lower interest rates. Equity loss in investment relates to Sparton's
investment in Cybernet Systems Corporation (Cybernet). Other Income-net was
$14,000 in 2002, compared to Other Expense-net of $42,000 for the corresponding
three-month period last year.
The Company reported net income of $3,578,000 ($0.47 per share) for the
three months ended September 30, 2002, compared to $787,000 ($0.10 per share)
for the corresponding period last year.
LIQUIDITY AND CAPITAL RESOURCE
For the three-month period ended September 30, 2002, Cash and Cash
Equivalents decreased $1,378,000 to $7,310,000. Overall, Cash and Investments
increased by $1,468,000 from June 30, 2002. Operating activities provided
$1,610,000 in net cash flows. Cash provided by operating activities was less
than net income because the $5.8 million related to the environmental settlement
with the DOE and others had not been received as of September 30, 2002. Cash
flows used by investing activities totaled $3,004,000, principally for the
purchase of investment securities. Cash flow provided by financing activities
totalled $15,000, from stock options exercised.
The Company's market risk exposure to foreign currency exchange and
interest rates are not considered to be material, principally due to short term
investments and minimal receivables and payables designated in foreign currency.
At September 30, 2002, and June 30, 2002, the aggregate government EMS
backlog was approximately $51 million and $60 million, respectively. A majority
of the September 30, 2002, backlog is expected to be realized in the next 8-10
months. Commercial EMS orders are not included in the backlog. The Company
does not believe the amount of commercial activity covered by firm purchase
orders is a meaningful measure of future sales, as such orders may be
rescheduled or cancelled without significant penalty.
No cash dividends were declared in either period presented. At
September 30, 2002, the Company had $85,621,000 in recorded shareowners' equity
($11.32 per share), $74,841,000 in working capital, and a 5.54:1.00 working
capital ratio.
CRITICAL ACCOUNTING POLICIES
The preparation of financial statements in conformity with accounting
principles generally accepted in the United States requires management to make
estimates and assumptions that affect the reported amounts of revenues and
expenses during the reporting periods. Actual results could differ from those
estimates. The Company believes that of its significant accounting policies, the
following may involve a higher degree of judgement 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). The investigation began in the early 1980s and involved a
review of onsite and offsite environmental impacts.
In December 1999, the Company increased its accrual for the estimated
cost of addressing the environmental impacts associated with its Coors Road
plant by $10,000,000 (pre-tax). This increase was reflective of revised cost
estimates in conjunction with the negotiated Consent Decree that settled
related lawsuits then outstanding, as well as a related administrative enforce-
ment action, and covered activities expected to be incurred over the next thirty
years.
As discussed in Note 6 to the condensed consolidated financial
statements, 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 and operating and monitoring costs for both onsite
and offsite remediation. Sparton recognizes legal and consulting services in the
periods incurred. Sparton reviews its EPA accrual activity quarterly.
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
11
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 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. The
Company formally reviews, on a quarterly basis, costs incurred-to-date and
estimated costs to complete on all significant contracts. These revised
estimated contract costs are reflected in the financial statements. Losses for
the entire amount of the 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 estimate can also occur when new designs are initially
placed into production. Depending upon the circumstances, it is possible that
the Company's financial position, results of operations and cash flows could be
materially affected by changes in estimated costs to complete on one or more
significant contracts.
COMMERCIAL INVENTORY VALUATION ALLOWANCES - Contracts with commercial
customers are 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 change, 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.
The establishment of inventory valuation allowances for commercial
customer inventories requires a significant degree of judgment and is 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. 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.
OTHER
LITIGATION - One of Sparton's 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 1980s and involved a
review of onsite and offsite environmental impacts.
At September 30, 2002, Sparton has an accrual of $7,823,000 as its
estimate of the future undiscounted minimum financial liability with respect to
this matter. The Company's cost estimate is based upon existing technology and
excludes legal and related consulting costs. The Company's estimate includes
equipment and operating costs for onsite and offsite pump and treat containment
systems, a soil vapor extraction program and continued onsite and offsite
monitoring. This estimate is based on existing methodology. Legal and related
consulting costs are expensed as incurred.
During the first quarter of fiscal 2003, Sparton reached an agreement
with the United States Department of Energy (DOE) and others to recover certain
remediation costs. Under the agreement, Sparton will be reimbursed for a portion
of the costs the
12
Company has incurred in its investigation and site remediation efforts at the
Coors Road site. The remediation efforts began in 1983. The settlement concludes
a very lengthy negotiation process and two court actions, one in the Federal
Court of Claims and one in the Federal District Court in Albuquerque.
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 ultimate resolution of this contingency.
Item 3. Qualitative and Quantitative Disclosures About Market Risk
The Company manufactures its products in the United States and Canada.
Sales of the Company's products are made 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 receipts from customers and payments to suppliers
in foreign currencies. 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 foreign markets in which the Company operates.
However, few receivables and payables are denominated in foreign currency. The
Company does not consider the market risk exposure relating to currency exchange
to be material.
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
believed to be material.
Item 4. Controls and Procedures
The Company maintains a system of internal accounting policies,
procedures, and controls intended to provide reasonable assurance, at
appropriate cost, that all material transactions are executed in accordance with
Company authorization and are properly recorded and reported in the financial
statements, and that assets are adequately safeguarded. The Company also
maintains a system of disclosure controls and procedures to ensure that
information required to be disclosed in Company reports, filed or submitted
under the Securities Exchange Act of 1934, is properly reported in the Company's
periodic and other reports.
As of September 30, 2002, 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 September 30, 2002. There have been no significant changes in the Company's
internal controls or in other factors that could significantly affect internal
controls subsequent to September 30, 2002.
Part II
OTHER INFORMATION
Item 1. Legal Proceedings
Various litigation is pending against the Company, in many cases
involving ordinary and routine claims incidental to the business of the Company
and in others presenting allegations that are non-routine. The Company and its
subsidiaries are also involved in certain compliance issues with the United
States Environmental Protection Agency (EPA) and various state agencies,
including being named as a potentially responsible party at several sites.
Potentially responsible parties (PRPs) can be held jointly and severally liable
for the clean-up costs at any specific site. The Company's past experience,
however, has indicated that when it has contributed only relatively small
amounts of materials or waste to a specific site relative to other PRPs, its
ultimate share of any clean-up costs has been minor. Based upon available
information, the Company believes it has contributed only small amounts to those
sites in which it is currently viewed as a potentially responsible party.
13
In February 1997, several lawsuits were filed against Sparton's wholly
owned subsidiary, Sparton Technology, Inc., alleging that Sparton Technology's
Coors Road facility presented an imminent and substantial threat to human health
or the environment. On March 3, 2000, a Consent Decree was entered, settling the
lawsuits as well as a related administrative enforcement action. The Consent
Decree represents a judicially enforceable settlement agreement under which
Sparton Technology paid $1,675,000 to resolve claims for damages, civil
penalties for alleged violations of state law, and for reimbursement of the
litigation costs of certain plaintiffs. The Consent Decree also contains work
plans describing remedial activity Sparton Technology agreed to undertake. The
remediation activities called for by the work plans have been installed and are
either completed, in the case of soil vapor extraction, or in operation, in the
case of offsite and onsite containment wells. It is anticipated that ongoing
remediation activities will operate for a period of time during which Sparton
Technology and the regulatory agencies will analyze their effectiveness. The
Company believes that it will take at least three to five years from the date of
the Consent Decree, dated March 3, 2000, before the effectiveness of the
groundwater containment wells can be established. If ineffective, additional
remedies may be imposed at a significantly increased cost. There is no assurance
that additional costs greater than the amount accrued will not be incurred or
that no adverse changes in environmental laws or their interpretation will
occur.
Upon entering into the Consent Decree, the Company reviewed its
estimates of the future costs expected to be incurred in connection with its
remediation of the environmental issues associated with its Coors Road Plant
over the next 30 years. The Company increased its accrual for the cost of
addressing environmental impacts associated with its Coors Road Plant by
$10,000,000 (pre-tax) in December 1999. At September 30, 2002, the remaining
undiscounted minimum accrual for EPA remediation approximates $7,823,000. The
Company's estimate is based upon existing technology and current costs which
have not been discounted. The estimate includes equipment and operating and
maintenance costs for the onsite and offsite pump and treat containment systems,
a soil vapor extraction program and continued onsite and offsite monitoring. It
also includes the required periodic reporting requirements. This estimate does
not include legal and related consulting costs which are expensed as in- curred.
The estimate does not reflect any offset or reduction for monies recovered from
various parties currently being pursued as described below.
In 1995, Sparton Corporation and Sparton Technology, Inc. filed a
Complaint in the Circuit Court of Cook County, Illinois, against Lumbermens
Mutual Casualty Company and American Manufacturers Mutual Insurance Company
demanding reimbursement of expenses incurred in connection with its
remediation efforts at the Coors Road facility based on various primary and
excess comprehensive general liability policies in effect between 1959 and 1975.
In 1999, the Complaint was amended to add various other excess insurers,
including certain London market insurers and Fireman's Fund Insurance Company.
The case is in the discovery stage.
In 1998, Sparton Technology, Inc. commenced litigation in two courts
seeking reimbursement of Sparton's costs incurred in complying with, and
defending against, Federal and state environmental requirements with respect to
its former Coors Road plant. Sparton also sought to recover future costs being
incurred by the Company on an ongoing basis as a result of continuing
remediation at the Coors Road facility. The first suit was commenced on February
11, 1998, in the United States Court of Federal Claims against the United States
Department of Energy (DOE), alleging that it is liable for reimbursement of
Sparton's environmental costs because the DOE prescribed certain mandatory
performance requirements which were then imposed on Sparton Technology.
In the second lawsuit, filed on September 21, 1998, Sparton Technology
also sought to recover environmental costs incurred in connection with the Coors
Road facility. This suit named the DOE, as well as other defendants, and sought
recovery of Sparton's costs under both contract and Federal environmental law
theories.
During the first quarter of fiscal 2003, Sparton reached an agreement
with the DOE and others to recover certain remediation costs. Under the
agreement, Sparton will be reimbursed for a portion of the costs the Company has
incurred in its investigation and site remediation efforts at the Coors Road
site.
Under the settlement terms, Sparton will receive $4,850,000 from the
DOE and others in fiscal 2003, plus an additional $1,000,000 in fiscal 2004. In
addition, the DOE has agreed to reimburse Sparton for 37.5% of certain future
environmental expenses in excess of $8,400,000 incurred at the site.
14
With the settlement, Sparton received cash and gained some degree of
risk protection, with the DOE sharing in costs incurred above an established
level. The financial impact of the settlement was recorded in the first quarter
of fiscal 2003, ending September 30, 2002. Most of the settlement proceeds
(approximately $5,500,000) were recorded as income.
In September 2002, Sparton Technology, Inc. (STI) filed an action in
the U.S. District Court for the Eastern District of Michigan to recover certain
unreimbursed costs incurred as a result of a manufacturing relationship with two
entities, Util-Link, LLC ("Util-Link") of Delaware and National Rural
Telecommunications Cooperative ("NRTC") of the District of Columbia. On or about
October 21, 2002, the defendants filed a counterclaim seeking money damages,
alleging that STI breached its duties in the manufacture of products for the
defendants. The defendant Util-Link has asked for damages in the amount of
$25,000,000 for lost profits. The defendant NRTC has asked for damages in the
amount $20,000,000 for the loss of its investment in and loans to Util-Link.
Sparton has not had an opportunity to fully assess the respective claims, but
believes that the damages sought by NRTC are included in Util-Link's claim for
damages and as such, are duplicative. Sparton believes the counterclaim to be
without merit and intends to vigorously defend against it.
Item 6. Exhibits and Reports on Form 10-K and 10-Q
(a) Exhibits
3.1 Instruments defining the rights of security holders are being
filed as follows:
Amended Articles of Incorporation of the Registrant, which
reflect the increase of authorized shares of Common Stock from
8,500,000 to 15,000,000, are filed herewith and attached.
3.2 Instruments defining the rights of security holders have been
previously filed as follows:
By-laws of the Registrant, as amended, were filed on Form 10-Q
for the three-month period ended December 31, 2000, and are
incorporated herein by reference.
(b) Reports on Form 8-K filed in the First Quarter of Fiscal 2003:
- On September 5, 2002, the Company reported on Form
8-K that it reached a settlement agreement with the
United States Department of Energy (DOE) and others
to recover past EPA remediation costs.
- On September 27, 2002, under section 906 of the
Sarbanes-Oxley Act of 2002, certifications for the
Chief Executive Officer, and Chief Financial Officer,
were furnished on Form 8-K for the year ended June
30, 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.
SPARTON CORPORATION
Registrant
Date: November 14, 2002 /s/ DAVID W. HOCKENBROCHT
----------------------------------------
David W. Hockenbrocht, CEO and President
Date: November 14, 2002 /s/ RICHARD L. LANGLEY
----------------------------------------
Richard L. Langley, Chief Financial Officer
15
CERTIFICATION UNDER SECTION 302 OF THE SARBANES-OXLEY ACT OF 2002
I, DAVID W. HOCKENBROCHT, certify that:
1. I have reviewed this quarterly report on Form 10-Q of Sparton
Corporation;
2. Based on my knowledge, this quarterly report does not contain any
untrue statement of a material fact or omit to state a material fact
necessary to make the statement made, in light of the circumstances
under which such statements were made, not misleading with respect to
the period covered by this quarterly report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all
material respects the financial condition, results of operations and
cash flows of the registrant as of, and for, the periods presented in
this quarterly report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as
defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and
we have:
a) designed such disclosure controls and procedures to ensure
that material information relating to the registrant,
including its consolidated subsidiaries, is made known to us
by others within those entities, particularly during the
period in which this quarterly report is being prepared;
b) evaluated the effectiveness of the registrant's disclosure
controls and procedures as of a date within 90 days prior to
the filing date of this quarterly report (the "Evaluation
Date"); and
c) presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based
on our evaluation as of the Evaluation Date;
5. The registrant's other certifying officers and I have disclosed, based
on our most recent evaluation, to the registrant's auditors and the
audit committee of registrant's board of directors (or persons
performing the equivalent function):
a) all significant deficiencies in the design or operation of
internal controls which could adversely affect the
registrant's ability to record, process, summarize and report
financial data and have identified for the registrant's
auditors any material weaknesses in internal controls; and
b) any fraud, whether or not material, that involves management
or other employees who have a significant role in the
registrant's internal controls; and
6. The registrant's other certifying officers and I have indicated in this
quarterly report whether there were significant changes in internal
controls or in other factors that could significantly affect internal
controls subsequent to the date of our most recent evaluation,
including any corrective actions with regard to significant
deficiencies and material weakness.
Date: November 14, 2002 /s/ DAVID W. HOCKENBROCHT
-------------------------------
David W. Hockenbrocht, CEO
16
CERTIFICATION UNDER SECTION 302 OF THE SARBANES-OXLEY ACT OF 2002
I, RICHARD L. LANGLEY, certify that:
1. I have reviewed this quarterly report on Form 10-Q of Sparton
Corporation;
2. Based on my knowledge, this quarterly report does not contain any
untrue statement of a material fact or omit to state a material fact
necessary to make the statement made, in light of the circumstances
under which such statements were made, not misleading with respect to
the period covered by this quarterly report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all
material respects the financial condition, results of operations and
cash flows of the registrant as of, and for, the periods presented in
this quarterly report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as
defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and
we have:
a) designed such disclosure controls and procedures to ensure
that material information relating to the registrant,
including its consolidated subsidiaries, is made known to us
by others within those entities, particularly during the
period in which this quarterly report is being prepared;
b) evaluated the effectiveness of the registrant's disclosure
controls and procedures as of a date within 90 days prior to
the filing date of this quarterly report (the "Evaluation
Date"); and
c) presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based
on our evaluation as of the Evaluation Date;
5. The registrant's other certifying officers and I have disclosed, based
on our most recent evaluation, to the registrant's auditors and the
audit committee of registrant's board of directors (or persons
performing the equivalent function):
a) all significant deficiencies in the design or operation of
internal controls which could adversely affect the
registrant's ability to record, process, summarize and report
financial data and have identified for the registrant's
auditors any material weaknesses in internal controls; and
b) any fraud, whether or not material, that involves management
or other employees who have a significant role in the
registrant's internal controls; and
6. The registrant's other certifying officers and I have indicated in this
quarterly report whether there were significant changes in internal
controls or in other factors that could significantly affect internal
controls subsequent to the date of our most recent evaluation,
including any corrective actions with regard to significant
deficiencies and material weakness.
Date: November 14, 2002 /s/ RICHARD L. LANGLEY
--------------------------
Richard L. Langley, CFO
17