Back to GetFilings.com
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 - December 31, 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 (I.R.S. Employer
of Incorporation or Organization) Identification No.)
2400 EAST GANSON STREET, JACKSON, MICHIGAN 49202
(Address of Principal Executive Offices, Zip Code)
(517) 787-8600
(Registrant's Telephone Number, Including Area Code)
Indicate by 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 [X] No [ ]
Indicate by check mark whether the registrant is an accelerated filer (as
defined by Rule 12b-2 of the Exchange Act). Yes [ ] No [X]
The aggregate market value of voting stock held by non-affiliates of the
registrant as of January 31, 2003, was $38,700,705.
Common Stock, $1.25 Par Value - 7,563,540 shares outstanding as of January 31,
2003.
1
SPARTON CORPORATION AND SUBSIDIARIES
INDEX
Part I. Financial Information
Item 1. Financial Statements (Unaudited)
Condensed Consolidated Balance Sheets December 31 and
June 30, 2002 .................................................... 3
Condensed Consolidated Statements of Operations Three-Month
and Six-Month Periods ended December 31, 2002 and 2001 ........... 4
Condensed Consolidated Statements of Cash Flows Six-Month
Periods ended December 31, 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 ............................................... 14
Item 4. Controls and Procedures ................................... 14
Part II.Other Information
Item 1. Legal Proceedings ......................................... 14
Item 6. Exhibits and Reports on Form 8-K .......................... 16
Signatures ................................................................ 16
Certifications ............................................................ 17
2
SPARTON CORPORATION AND SUBSIDIARIES
Condensed Consolidated Balance Sheets (Unaudited)
December 31 and June 30, 2002
ASSETS
December 31 June 30
------------- -------------
Current assets:
Cash and cash equivalents $ 15,697,092 $ 8,687,873
Investment securities 14,672,817 11,530,374
Accounts receivable:
Trade 19,944,423 18,703,397
EPA settlement (Note 6) 1,000,000 --
Income taxes recoverable -- 1,055,965
Inventories and costs on contracts in progress, less progress payments of
$8,582,000 at December 31($6,275,000 at June 30) (Note 2) 37,686,556 41,929,559
Prepaid expenses 2,714,711 2,214,845
------------- -------------
Total current assets 91,715,599 84,122,013
Pension asset 6,240,101 6,304,117
Other assets 2,692,494 2,940,918
Property, plant and equipment, net 8,908,176 9,034,200
------------- -------------
Total assets $ 109,556,370 $ 102,401,248
============= =============
LIABILITIES AND SHAREOWNERS' EQUITY
Current liabilities:
Accounts payable $ 7,827,233 $ 7,762,357
Salaries and wages 2,620,615 3,545,045
Accrued liabilities (Note 6) 3,586,562 2,104,170
Income taxes payable 638,896 --
------------- -------------
Total current liabilities 14,673,306 13,411,572
Environmental remediation (Note 6) 7,192,841 7,375,259
Shareowners' equity:
Common stock - 7,941,717 and 7,559,790 shares outstanding at December 31 and
June 30 after deducting zero shares in treasury at December 31 and
374,922 shares in treasury at June 30 (Note 3) 9,927,146 9,449,738
Capital in excess of par value (Note 3) 3,002,995 477,493
Accumulated other comprehensive income (loss) (Notes 4 and 5) 132,226 (172,000)
Retained earnings 74,627,856 71,859,186
------------- -------------
Total shareowners' equity 87,690,223 81,614,417
------------- -------------
Total liabilities and shareowners' equity $ 109,556,370 $ 102,401,248
============= =============
See accompanying notes.
3
SPARTON CORPORATION AND SUBSIDIARIES
Condensed Consolidated Statements of Operations (Unaudited)
For the Three-Month and Six-Month Periods ended December 31, 2002 and 2001
Three-Month Periods Six-Month Periods
---------------------------------- ----------------------------------
2002 2001 2002 2001
------------ ------------ ------------ ------------
Net sales $ 43,279,295 $ 41,065,819 $ 80,047,202 $ 81,875,899
Costs of goods sold 37,514,228 37,248,947 70,517,873 73,331,112
------------ ------------ ------------ ------------
5,765,067 3,816,872 9,529,329 8,544,787
Selling and administrative income (expense):
Selling and administrative expenses (3,209,415) (3,086,312) (6,733,629) (6,365,418)
EPA related - net (Note 6) (117,438) (127,047) 5,229,562 (300,473)
------------ ------------ ------------ ------------
(3,326,853) (3,213,359) (1,504,067) (6,665,891)
------------ ------------ ------------ ------------
Operating income 2,438,214 603,513 8,025,262 1,878,896
Other income (expense):
Interest and investment income 184,360 114,344 301,657 242,968
Equity loss in investment (18,000) (71,250) (57,000) (142,500)
Other - net (61,141) 268,207 (46,651) 226,260
------------ ------------ ------------ ------------
105,219 311,301 198,006 326,728
------------ ------------ ------------ ------------
Income before income taxes 2,543,433 914,814 8,223,268 2,205,624
Provision for income taxes 365,000 365,000 2,467,000 869,000
------------ ------------ ------------ ------------
Net income $ 2,178,433 $ 549,814 $ 5,756,268 $ 1,336,624
============ ============ ============ ============
Basic and diluted earnings per share (Note 3) $ 0.27 $ 0.07 $ 0.72 $ 0.17
============ ============ ============ ============
Dividends $ -0- $ -0- $ -0- $ -0-
============ ============ ============ ============
See accompanying notes.
4
SPARTON CORPORATION AND SUBSIDIARIES
Condensed Consolidated Statements of Cash Flows (Unaudited)
For the Six-Month Periods ended December 31, 2002 and 2001
December 31
----------------------------------
2002 2001
------------ ------------
Cash flows provided (used) by Operating Activities:
Net income $ 5,756,268 $ 1,336,624
Add noncash items affecting operations:
Depreciation 725,937 854,271
EPA settlement (Note 6) (1,000,000) --
Add (deduct) changes in operating assets and liabilities:
Accounts receivable (1,241,026) 3,895,436
Income taxes recoverable 1,055,965 --
Inventories 4,243,003 3,528,731
Pension asset 64,016 --
Accounts payable 64,876 (5,834,973)
Income taxes payable 638,896 618,589
Equity loss in investment 57,000 142,500
Other 179,904 (303,249)
------------ ------------
10,544,839 4,237,929
Cash flows provided (used) by Investing Activities:
Purchases of investment securities-net (3,142,443) (3,543,709)
Purchases of property, plant and equipment-net (599,913) (149,791)
Noncurrent other assets 191,424 (158,369)
------------ ------------
(3,550,932) (3,851,869)
Cash flows provided (used) by Financing Activities:
Stock options exercised 15,312 --
Purchase of common stock for treasury -- (66,639)
------------ ------------
15,312 (66,639)
------------ ------------
Increase in cash and cash equivalents 7,009,219 319,421
Cash and cash equivalents at beginning of period 8,687,873 13,034,790
------------ ------------
Cash and cash equivalents at end of period $ 15,697,092 $ 13,354,211
============ ============
Supplemental disclosures of cash paid (received) during the period:
Income taxes paid $ 1,723,000 $ 799,000
============ ============
Income taxes refunded $ (852,000) $ (485,000)
============ ============
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
Article 10 of Regulation S-X. Accordingly, they do not include all of the
information and footnotes required by accounting principles generally accepted
in the United States for complete financial statements. All significant
intercompany transactions and accounts have been eliminated. The condensed
consolidated balance sheet at December 31, 2002, and the related condensed
statements of operations for the three-month and six-month periods ended
December 31, 2002 and 2001, and cash flows for the six-month periods ended
December 31, 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
six-month period ended December 31, 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 December 31 and June 30, 2002. The condensed consolidated
statement of operations and cash flows for the periods ending December 31, 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. In the governmental market, 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.
Revenue recognition - The Company's net sales are comprised primarily of
product sales, with supplementary revenues earned from engineering and design
services. Standard contract terms are FOB shipping point. Revenue from product
sales is generally recognized upon shipment of the goods; service revenue is
recognized as the service is performed or under the percentage of completion
method, depending on the nature of the arrangement. Long-term contracts relate
principally to government defense contracts. These contracts are accounted for
based on completed units accepted and their estimated average contract cost per
unit. Development contracts are accounted for based on percentage of completion.
Costs and fees billed under cost-reimbursement-type contracts are recorded as
sales. A provision for the entire amount of a loss on a contract is charged to
operations as soon as the loss is determinable. Shipping and handling costs are
included in costs of goods sold.
Credit practices - Products are sold principally in 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.
6
New accounting standards - 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 impaired long-lived assets and for long-lived assets which are to be
disposed of. The adoption of SFAS No. 144 did not have a material effect on the
Company's consolidated results of operations or financial position.
In December 2002, the Financial Accounting Standards Board (FASB) issued
SFAS No. 148. "Accounting for Stock-Based Compensation-Transition and
Disclosure" (SFAS No. 148), which amends SFAS No. 123, "Accounting for
Stock-Based Compensation". The amendment permits two additional transition
methods for a voluntary change to the fair value based method of accounting for
stock-based compensation. In addition, SFAS No. 148 amends the disclosure
requirements of SFAS No. 123 to require more prominent and frequent disclosures
about the effects of stock-based compensation. SFAS No. 148 is effective for
Sparton's fiscal year end June 30, 2003. The Company is still evaluating whether
it will adopt SFAS No. 148 and, if it does, which transition method it will
follow. However, should the Company decide to change to the fair value method of
accounting for its stock-based compensation, it is not expected to have a
material effect on the Company's consolidated results of operations 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.
Treasury stock - The Company records treasury stock purchases at cost. In
recording the Company's treasury stock purchases, 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. 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.
DECEMBER 31, 2002 JUNE 30, 2002
----------------- -------------
Raw materials $20,638,000 $23,353,000
Work in process and finished goods 17,049,000 18,577,000
----------- -----------
Total $37,687,000 $41,930,000
=========== ===========
Work in progress and finished goods inventories include $6.1 million and
$7.5 million of sonobuoys at December 31, 2002, and June 30, 2002, respectively.
3. On January 10, 2003, Sparton's Board of Directors approved a 5% common
stock dividend. Eligible shareowners of record as of January 21, 2003, will
receive the stock dividend on February 18, 2003. Cash will be paid in lieu of
fractional shares. For purposes of recording the stock dividend, the full 5%
stock dividend was assumed on total shares outstanding; no assumption was made
with respect to fractional shares nor the related cash distribution. Shares will
be issued from treasury stock. For the purpose of this calculation, it is
assumed this will result in zero remaining treasury shares. An amount equal to
the fair market value of the common shares issued was transferred from retained
earnings ($2,988,000) to common stock ($473,000) and capital in excess of par
value ($2,515,000) to record the stock dividend. This transfer has been
reflected in the consolidated financial statements at December 31, 2002. Shares
outstanding and earnings per share for the three months and the six months ended
December 31, 2002, have therefore been adjusted accordingly and are as follows.
For the three months and six months ended December 31, basic and diluted
earnings per share were computed based on the following:
THREE MONTHS ENDED SIX MONTHS ENDED
--------------------------- ---------------------------
2002 2001 2002 2001
--------- --------- --------- ---------
Basic - weighted average shares outstanding 7,563,540 7,566,560 7,563,323 7,568,325
Estimated additional shares to be issued with respect to the
5% common stock dividend declared January 10, 2003 378,177 377,990 378,177 377,990
--------- --------- --------- ---------
7,941,717 7,944,550 7,941,500 7,946,315
Effect of dilutive stock options 70,202 37,765 74,776 38,467
--------- --------- --------- ---------
Weighted average diluted shares outstanding 8,011,919 7,982,315 8,016,276 7,894,782
========= ========= ========= =========
Basic & diluted earnings per share - after stock dividend $ 0.27 $ 0.07 $ 0.72 $ 0.17
========= ========= ========= =========
7
For the three-month and six-month periods ended December 2002, options to
purchase 94,000 shares of common stock were not included in the computation of
diluted earnings per share. For the three-month and six-month periods ended
December 2001, options to purchase 267,000 and 2,500 shares, respectively, of
common stock were not included in the computation of diluted earnings per share.
Such options' exercise prices were greater than the average market price of the
Company's common stock and, therefore, 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 and six months ended December
31 was as follows:
THREE MONTHS ENDED SIX MONTHS ENDED
-------------------------------- -------------------------------
2002 2001 2002 2001
----------- ----------- ----------- -----------
Net income $ 2,178,000 $ 550,000 $ 5,756,000 $ 1,337,000
Other comprehensive income (loss), net of tax:
Net unrealized gains (losses)
Investment securities owned 10,000 (42,000) 209,000 --
Investment securities held by investee
accounted for by the equity method (119,000) (131,000) 95,000 (262,000)
----------- ----------- ----------- -----------
Comprehensive income $ 2,069,000 $ 377,000 $ 6,060,000 $ 1,075,000
=========== =========== =========== ===========
At December 31, 2002, shareowners' equity includes accumulated other
comprehensive income (loss) of $287,000 and ($155,000), 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 December 31, 2002, the Company had net unrealized gains of $456,000. At
that date, the net after-tax effect of these gains was $287,000, which amount is
included in accumulated comprehensive income within shareowners' equity. For the
six months ended December 31, 2002 and 2001, purchases of investments totaled
$3,361,000 and $3,564,000, and sales of investment securities totaled $219,000
and $20,000, respectively.
Sparton owns a 14% interest in 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 December 31, 2002, Sparton has a remaining accrual of $7,763,000 as its
estimate of the minimum future undiscounted financial liability with respect to
this matter, of which $570,000 is classified as a current liability and included
on the balance sheet
8
in accrued liabilities. The Company's minimum cost estimate is based upon
existing technology and excludes legal and related consulting costs, which are
expensed as incurred. The Company's estimate includes equipment and operating
costs for onsite and offsite pump and treat containment systems, a soil vapor
extraction program and continued onsite and offsite monitoring.
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 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. 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, New Mexico.
With the settlement, Sparton received cash and gained some degree of risk
protection, with the DOE agreeing to reimburse future costs incurred above the
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.
Amounts charged to operations, principally legal and consulting, for the
six months ended December 31, 2002 and 2001 were $270,000 and $301,000,
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 SFAS No. 123, "Accounting for
Stock-Based Compensation".
At December 31, 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 December 31, 2002, there were
134,906 options exercisable at the weighted-average per share price of $5.56.
Remaining shares available for grant under the plan were 266,000 at December 31,
2002.
At December 31, 2002, 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 No. 123 (using the Black
Scholes method of valuation), the Company's net earnings for the quarter and
year to date would have been reduced by $38,250 (less than $0.01 per share) and
$76,500 ($0.01 per share), respectively.
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 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 price
and delivery issues. 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
Three-Month Periods
Sales for the three-month period ended December 31, 2002, totaled
$43,279,000, an increase of $2,213,000 (5%) from last year. The increase in
sales reflects strong sales in homeland defense related products, avionics, and
medical markets. Sales in other markets, which other than government were
immaterial, declined. The majority of the sales increase has been due to the
addition of new customers. Among these customers are several in the area of
avionics, including those producing products in demand due to the increased
requirements for homeland security. The increased demand in airport security
products has favorably impacted the current quarter's sales; additional sales
are expected in the remaining periods of this year. Governmental sales decreased
32% ($5,745,000) to $12,047,000 compared to last year. The decrease in
governmental sales is a result of fewer drop tests of sonobuoys, due to more
limited range access. In addition, several lots tested earlier are in rework,
but are expected to ship by June 30, 2003.
Several factors contributed to the improved gross margin this quarter. In
general, the higher margins received this period reflect a more favorable
product mix. Also, cost reduction measures put in place in prior quarters have
allowed for improved job margins. In addition, a government job which was
experiencing rework was completed. The rework reserve associated with this job
was no longer required, resulting in a reversal to income of $308,000 in
December. Selling and administrative expenses, as a percentage of sales, are
consistent with last year. Actions to control costs continue to be taken.
Operating income of $2,438,000 was reported for the three months ended
December 31, 2002, compared to $604,000 for the same period last year. Included
in operating income are charges against income related to the Coors Road site
remediation effort, principally litigation, of $117,000 and $127,000 in 2002 and
2001, respectively.
10
Interest and Investment Income increased $70,000 to $184,000 in 2002, due
to higher average investments. Equity loss in investment relates to Sparton's
investment in Cybernet. Other Expense-net was $61,000 in 2002, compared to Other
Income-net of $268,000 for the corresponding three-month period last year.
Included in Other Income-net in 2001 is $200,000 of a one time recovery from a
former insurer as part of that company's conversion to a stock company (formerly
a mutual company). Other Expense-net in 2002 contains no individually
significant items.
During the three months ended December 31, 2002, the Company reduced its
estimate of its annual effective tax rate based on anticipated usage of the
existing Canadian loss and contribution carry-forwards. This change in estimated
annual effective tax rate resulted in a $398,000 reduction of second quarter tax
expense that was previously recorded in the first quarter. The change resulted
in second quarter and year to date effective tax rates of 14% and 30%,
respectively, for fiscal 2003.
The Company reported net income of $2,178,000 ($0.27 per share) for the
three months ended December 31, 2002, versus $550,000 ($0.07 per share) for the
corresponding period last year.
Six-Month Periods
Sales for the six-month period ended December 31, 2002, totaled
$80,047,000, a decrease of $1,829,000 (2%) from last year. Governmental sales
decreased $4,738,000 (17%) to $22,876,000 compared to last year, while sales in
other markets increased $2,909,000 (5%) to $57,171,000. The uncertainty of
customers' schedules in selected markets has resulted in Sparton continuing to
implement additional measures to reduce costs and expenses. Sparton has
experienced an increase in sales related to homeland security products as a
result of the overall increase in spending for homeland defense. The decrease in
governmental sales is the result of less frequent access to the sonobuoy testing
range, as well as product rework still in process on several sonobuoy lots.
Governmental sales are anticipated to increase over the remaining six months of
Sparton's fiscal year ending June 30, 2003.
The improved gross margin was attributable to several factors. Margins on
many jobs have been running favorable due to the impact of cost reduction
measures put in place in prior quarters. In addition, Sparton has new product
introduction programs at all facilities. These programs have resulted in more
efficient new job start ups, and fewer jobs with negatively impacted margins.
Finally, disengagement issues with one customer resulted in decreased margins in
fiscal 2002. Selling and administrative expenses, as a percentage of sales,
are consistent with last year. Actions continue to be taken to control costs.
Costs include bid and proposal expenses related to new job opportunities.
Sparton's bid activity remains at near record levels.
Operating income of $8,025,000 was reported for the six months ended
December 31, 2002, compared to $1,879,000 for the same period last year.
Included in operating income as of December 31, 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 $270,000 and $301,000 in 2002 and 2001,
respectively.
Interest and Investment Income increased $59,000 to $302,000 in 2002, due
to increased funds available for investment. Equity loss in investment relates
to Sparton's investment in Cybernet. Other Expense-net was $47,000 in 2002,
compared to Other Income-net of $226,000 for the corresponding six-month period
last year. Other Income-net in 2001 includes a one time recovery of $200,000
from a former insurer as part of that company's conversion to a stock company
(formerly a mutual company). Other Expense-net in 2002 contains no individually
significant items.
As previously discussed, the Company's lower effective tax rate
contributed to improved performance for the six month period, as well as the
three month period.
The Company reported net income of $5,756,000 ($0.72 per share) for the
six months ended December 31, 2002, versus $1,337,000 ($0.17 per share) for the
corresponding period last year.
11
LIQUIDITY AND CAPITAL RESOURCE
For the six-month period ended December 31, 2002, Cash and Cash
Equivalents increased $7,009,000 to $15,697,000. Overall, Cash and Investments
increased by $10,152,000 from June 30, 2002. Operating activities provided
$10,545,000 in net cash flows. Cash provided by operating activities was mainly
attributable to the EPA settlement and a decline in inventory. $4.85 million of
the EPA settlement negotiated with the DOE has been received. The remaining $1
million of the settlement will be received next year. Cash flows used by
investing activities totaled $3,551,000, principally for the purchase of
investment securities. Cash flow provided by financing activities was from stock
options exercised. The Company continues to operate with no bank debt.
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 December 31 and June 30, 2002, the aggregate government EMS backlog was
approximately $45 million and $60 million, respectively. A majority of the
December 31, 2002, backlog is expected to be realized in the next 8-10 months.
The Company has submitted proposals to the U.S. Government for the upcoming
contract year. Government awards of sonobuoy contracts are expected to be
announced over the next couple of months. Sparton's share of these awards will
be reflected in the backlog number at that time. The Company does not believe
other 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 December
31, 2002, the Company had $87,690,000 in recorded shareowners' equity ($11.04
per share), $77,042,000 in working capital, and a 6.25:1.00 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 enforcement 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 undiscounted financial
liability. The estimate was developed using existing technology and excludes
legal and related consulting costs, which are expensed as incurred. The minimum
cost estimate includes equipment and operating and monitoring costs for both
onsite and offsite remediation. 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 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.
12
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 estimates 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 December 31, 2002, Sparton has an accrual of $7,763,000 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, which are expensed as incurred. The
Company's estimate includes equipment and operating costs for onsite and offsite
operations and is based on existing methodology.
Uncertainties associated with environmental remediation contingencies are
pervasive and often result in wide ranges of reasonably possible outcomes.
Estimates developed in the early stages of remediation can vary significantly.
Normally a finite estimate of cost does not become fixed and determinable at a
specific point in time. Rather, the costs associated with environmental
remediation become estimable over a continuum of events and activities that help
to frame and define a liability. It is possible that cash flows and results of
operations could be affected by the ultimate resolution of this contingency.
13
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 December 31, 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 December 31, 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 December 31, 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.
In February 1997, several lawsuits were filed against Sparton's wholly
owned subsidiary, Sparton Technology, Inc. (STI), 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. The Consent Decree represents a judicially enforceable
settlement and 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 or are currently in
operation. 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.
14
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 December 31, 2002, the remaining undiscounted
minimum accrual for EPA remediation approximates $7,763,000. 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 incurred. The estimate
does not reflect any offset or reduction for monies recovered from various
parties currently being pursued as described below.
In 1998, Sparton Technology, Inc. commenced litigation in two courts
against the United States Department of Energy (DOE) and others 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.
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 received $4,850,000 from the DOE and others in
fiscal 2003, plus an additional $1,000,000 to be received 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 sharing in costs incurred above the 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 1995, Sparton Corporation and Sparton Technology, Inc. filed a
Complaint in the Circuit Court of Cook County, Illinois, against Lumbermens
Mutual Casualty Company and American Manufacturers Mutual Insurance Company
demanding reimbursement of expenses incurred in connection with its remediation
efforts at the Coors Road facility based on various primary and excess
comprehensive general liability policies in effect between 1959 and 1975. In
1999, the Complaint was amended to add various other excess insurers, including
certain London market insurers and Fireman's Fund Insurance Company. The case
remains in pretrial activity.
In September 2002, Sparton Technology, Inc. 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. This case is in the
initial stages of discovery.
At this time, the Company is unable to predict the amount of recovery, if
any, that may result from the pursuit of these two before-mentioned claims.
15
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits
3.1 Amended Articles of Incorporation of the Registrant, were
filed on Form 10-Q for the three-month period ended September
30, 2002, and are incorporated herein by reference.
3.2 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 second quarter of fiscal 2003:
o On November 14, 2002, the Company filed on Form 8-K, Item 9.
Regulation FD Disclosure, Officer's Certification, under
Section 906 of the Sarbanes-Oxley Act of 2002, relating to the
Registrant's Quarterly Report on Form 10-Q for the three-month
period ended September 30, 2002.
o On November 21, 2002, the Company filed on Form 8-K, Item 4.
Changes in Registrant's Certifying Accountant, reporting the
resignation of its certifying accountant Ernst & Young, LLP.
o On December 20, 2002, the Company filed on Form 8-K, Item 4.
Changes in Registrant's Certifying Accountant, reporting the
selection of its new certifying accountant BDO Seidman, LLP.
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: February 14, 2003 /s/ DAVID W. HOCKENBROCHT
--------------------------
David W. Hockenbrocht,
CEO and President
Date: February 14, 2003 /s/ RICHARD L. LANGLEY
--------------------------
Richard L. Langley,
Chief Financial Officer
16
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 officer 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 officer 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 officer 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: February 14, 2003 /s/ DAVID W. HOCKENBROCHT
------------------------------
David W. Hockenbrocht, CEO
17
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 officer 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 officer 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 officer 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: February 14, 2003 /s/ RICHARD L. LANGLEY
------------------------------
Richard L. Langley, CFO
18