<PAGE> 1
UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington D.C. 20549
FORM 10-Q
[X] QUARTERLY REPORT UNDER SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE ACT
OF 1934
For the quarterly period ended December 31, 1998
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)
<TABLE>
<S> <C>
Ohio 38-1054690
-------------------------------------------------------------- ------------------------------------
(State or other jurisdiction of incorporation or organization) (I.R.S. Employer Identification No.)
2400 East Ganson Street, Jackson, Michigan 49202
------------------------------------------ ---------
(Address of principal executive offices) (Zip Code)
</TABLE>
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
---- ----
Indicate the number of shares outstanding of each of the issuer's classes of
common stock, as of the latest practicable date. The number of shares of common
stock outstanding as of January 29, 1999 was 7,828,090.
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SPARTON CORPORATION
INDEX
<TABLE>
<CAPTION>
Financial Statements: Page No.
--------
<S> <C>
Condensed Consolidated Balance Sheet - December 31 and June 30, 1998 3
Condensed Consolidated Statement of Operations - Three-Month and Six-Month
Periods ended December 31, 1998 and 1997 4
Condensed Consolidated Statement of Cash Flows - Six-Month Periods ended
December 31, 1998 and 1997 5
Notes to Condensed Consolidated Financial Statements 6
Management's Discussion and Analysis of Financial Condition and Results of Operations 10
Other Information 16
Signatures 19
</TABLE>
2
<PAGE> 3
SPARTON CORPORATION AND SUBSIDIARIES
Condensed Consolidated Balance Sheet (Unaudited)
December 31 and June 30, 1998
<TABLE>
<CAPTION>
December 31 June 30
------------ ------------
(Note 5)
ASSETS
<S> <C> <C>
Current assets:
Cash and cash equivalents $ 3,792,958 $ 4,083,273
Investment securities 22,503,889 23,653,129
Accounts receivable 25,534,482 24,617,302
Inventories and costs on contracts in progress, less progress
payments of $3,993,053 at December 31 ($2,646,000 at June 30) 28,844,526 31,743,407
Prepaid expenses 4,253,498 4,340,455
Current assets of discontinued automotive operations 2,342,272 2,901,847
------------ ------------
Total current assets 87,271,625 91,339,413
Other assets 5,424,043 5,464,007
Property, plant and equipment - net 11,680,070 11,567,856
Noncurrent assets, principally property, plant and equipment, of
discontinued automotive operations - net (Note 5) 2,192,663 2,750,059
------------ ------------
Total assets $106,568,401 $111,121,335
============ ============
LIABILITIES AND SHAREOWNERS' EQUITY
Current liabilities:
Accounts payable $ 3,846,917 $ 11,390,801
Taxes on income 958,384 504,451
Accrued liabilities 9,519,382 8,325,766
------------ ------------
Total current liabilities 14,324,683 20,221,018
Deferred income taxes 2,531,500 2,531,500
Shareowners' equity:
Common stock - 7,828,090 shares outstanding at December 31,1998
and June 30, 1998 after deducting 106,622 shares in treasury 9,785,113 9,785,113
Capital in excess of par value 494,427 494,427
Retained earnings (Note 3) 79,432,678 78,089,277
------------ ------------
Total shareowners' equity 89,712,218 88,368,817
------------ ------------
Total liabilities and shareowners' equity $106,568,401 $111,121,335
============ ============
</TABLE>
See accompanying notes
3
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SPARTON CORPORATION AND SUBSIDIARIES
Condensed Consolidated Statement of Operations (Unaudited)
For the Three-Month and Six-Month Periods ended December 31, 1998 and 1997
<TABLE>
<CAPTION>
Three-Month Periods Six-Month Periods
1998 1997 1998 1997
------------ ------------ ------------ ------------
<S> <C> <C> <C> <C>
Net sales $ 38,974,458 $ 34,865,638 $ 71,423,886 $ 67,231,741
Costs and expenses 37,368,741 33,867,773 70,076,551 66,826,291
------------ ------------ ------------ ------------
1,605,717 997,865 1,347,335 405,450
Other income (expense):
Interest and investment income 320,446 403,107 755,205 933,551
Interest expense (416) -- (416) (720)
Other - net (3,835) (15,784) (6,723) 558,561
------------ ------------ ------------ ------------
Income before income taxes 1,921,912 1,385,188 2,095,401 1,896,842
Provision for income taxes 711,000 513,000 775,000 702,000
------------ ------------ ------------ ------------
Net income $ 1,210,912 $ 872,188 $ 1,320,401 $ 1,194,842
============ ============ ============ ============
Basic and diluted earnings per share $ 0.16 $ 0.11 $ 0.17 $ 0.15
============ ============ ============ ============
Dividends $ -0- $ -0- $ -0- $ -0-
============ ============ ============ ============
</TABLE>
See accompanying notes
4
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SPARTON CORPORATION AND SUBSIDIARIES
Condensed Consolidated Statement of Cash Flows (Unaudited)
For the Six-Month Periods ended December 31, 1998 and 1997
<TABLE>
<CAPTION>
1998 1997
------------ ------------
<S> <C> <C>
Cash flows (used) provided by operating activities:
Income from continuing operations $ 1,320,401 $ 1,194,842
Add non-cash items affecting continuing operations:
Depreciation 1,059,905 887,043
------------ ------------
2,380,306 2,081,885
Add (deduct) changes in operating assets and liabilities:
Inventories 2,898,881 3,312,715
Other 1,303,573 998,602
Taxes on income 453,933 (2,080,513)
Income taxes recoverable - (2,480,727)
Accounts receivable (917,180) 6,129,621
Accounts payable (7,543,884) (3,808,149)
------------ ------------
Net cash (used) provided by continuing operations (1,424,371) 4,153,434
Cash flow provided by discontinued operations 823,175 189,124
------------ ------------
(601,196) 4,342,558
Cash flows (used) provided by investing activities:
Sales of investment securities-net 1,149,240 741,801
Noncurrent other assets 39,964 62,722
Purchases of property, plant and equipment-net (1,172,119) (2,137,805)
Discontinued operations 293,796 (221,473)
------------ ------------
310,881 (1,554,755)
Cash flows (used) provided by financing activities:
Common stock transactions from exercise of stock options - 66,249
Discontinued operations, decrease in long-term obligations - (50,279)
------------ ------------
- 15,970
------------ ------------
(Decrease) increase in cash and cash equivalents (290,315) 2,803,773
Cash and cash equivalents at beginning of period 4,083,273 8,021,620
------------ ------------
Cash and cash equivalents at end of period $ 3,792,958 $ 10,825,393
============ ============
Supplemental disclosures of cash flows information:
Cash paid during the period for:
Interest expense $ 400 $ 1,000
============ ============
Income taxes $ 296,000 $ 6,175,000
============ ============
</TABLE>
See accompanying notes
5
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SPARTON CORPORATION AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
1. The accompanying condensed consolidated balance sheet at December
31, 1998, and the related condensed consolidated statements of operations for
the three-month and six-month periods ended December 31, 1998 and 1997 and cash
flows for the six-month periods ended December 31, 1998 and 1997 are unaudited,
but include all adjustments (consisting only of normal recurring accruals) which
the Company considers necessary for a fair presentation of such financial
statements. The results of operations for the periods ended December 31, 1998
are not necessarily indicative of the results that may be expected for the full
fiscal year.
2. Basic earnings per share were computed using the weighted average
number of shares outstanding. For the three-month periods, average shares
outstanding were 7,828,090 in both 1998 and 1997; for the six-month periods,
7,828,090 in 1998 and 7,825,590 in 1997. Differences in the weighted average
number of shares outstanding for purposes of computing diluted earnings per
share were due to the inclusion of the dilutive effect of employee incentive
stock options previously granted of 144,528 for the three months ended December
31, 1997, and 31,510 and 140,682 for the six months ended December 31, 1998 and
1997, respectively. These differences in the weighted average number of shares
outstanding for the calculation of basic and diluted earnings per share were not
material and resulted in no differences between basic and diluted earnings per
share. Options to purchase 189,000 shares of common stock at $8.375 per share
were outstanding for the three months and six months ended December 31, 1998,
and 32,000 shares at $6.625 for the three months ended December 31, 1998. These
options were not included in computation of diluted earnings per share because
their exercise price was greater than the average market price of the common
shares and therefore their effect would be anti-dilutive.
3. The Company has adopted Statement of Financial Accounting
Standards (SFAS) No. 130, "Reporting Comprehensive Income." SFAS No. 130
requires disclosure of total non-stockholder changes in equity in interim
periods and additional disclosures of the components of non-stockholder changes
in equity on an annual basis. Total non-stockholder changes in equity includes
all changes in equity during a period except those resulting from investments by
and distributions to stockholders. Total comprehensive income for the
three-month and six-month periods December 31, 1998 and 1997 are as follows:
<TABLE>
<CAPTION>
Three Months Ended Six Months Ended
------------------ ----------------
1998 1997 1998 1997
---- ---- ---- ----
<S> <C> <C> <C> <C>
Net Income $ 1,211,000 $ 872,000 $ 1,320,000 $ 1,195,000
Other Comprehensive Income:
Unrealized gains (losses) on
investment securities (19,000) 20,000 23,000 68,000
----------- ----------- ----------- -----------
Comprehensive income $ 1,192,000 $ 892,000 $ 1,343,000 $ 1,263,000
=========== =========== =========== ===========
</TABLE>
Retained earnings includes accumulated other comprehensive income of $38,000
and $15,000 at December 31 and June 30, 1998, respectively, which is unrealized
gains on investments.
4. Cash and cash equivalents consist of demand deposits and other
highly liquid investments with an original maturity date of less than three
months. The Company has had investment securities since January 1997. A large
majority of the investment portfolio has an original maturity date of less than
two years and a daily market exists for all the 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
6
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Company's intention to use these investment securities to provide working
capital and to fund equipment additions.
At December 31, 1998, the Company had net unrealized gains of $61,000. At that
date the net after tax effect of these gains was $38,000 and included with
equity. For the six months ended December 31, the Company had gross purchases
and sales of investment securities totaling $4,932,000 and $6,081,000 for 1998,
and $3,760,000 and $4,329,000 for 1997, respectively.
5. In August 1996, the Company formalized its decision to offer for
sale its automotive operations. Accordingly, these operating results have been
reported as discontinued operations. In December 1996, the Company sold
substantially all of the net assets and operations of the Sparton Engineered
Products, Inc.-KPI Group (KPI) which comprised approximately 80% of the
automotive operations of the Company. This sale did not include the net assets
and operations of the remaining automotive unit, Sparton Engineered Products,
Inc.-Flora Group (Flora). The Company has pursued the sale of the Flora
operations since the August 1996 decision was made. During this protracted
period, a number of events occurred that negatively impacted the potential value
of the Flora Group including continued unplanned operating losses, loss of
personnel, tornado damage to the plant on April 15, 1998 and loss of a major
customer. In April 1998, the Company abandoned attempts to finalize a
sale/purchase agreement with a party with whom negotiations had been ongoing for
some 16 months.
At its meeting on August 28, 1998, the Board of Directors approved the closing
of the Flora operation and an orderly liquidation of its assets. In December
1998, all production ceased. An auction of inventory and equipment was held in
January 1999, with an auction of remaining real property scheduled for February
1999. At December 31, 1998, approximately $1,938,000 in accruals and reserves
are available to cover the costs associated with this closing and the sale of
the assets.
For purposes of balance sheet presentation, the assets and liabilities of
discontinued operations have been netted. The presentation at June 30, 1998 has
been reclassified to conform to the December 31, 1998 amounts. The detail of the
discontinued operations balances are as follows:
<TABLE>
<CAPTION>
December 31 June 30
----------- -------
<S> <C> <C>
Current assets $4,770,000 $7,036,000
Current liabilities 2,428,000 4,135,000
---------- ----------
NET $2,342,000 $2,901,000
========== ==========
Noncurrent assets $2,193,000 $2,808,000
Noncurrent liabilities -- 58,000
---------- ----------
NET $2,193,000 $2,750,000
========== ==========
</TABLE>
6. One of Sparton's facilities, located in New Mexico, has been the
subject of ongoing investigations conducted with the EPA under the Resource
Conservation and Recovery Act ("RCRA"). This EPA compliance issue is related to
continuing operations, but involves a largely idled facility. In June 1996, the
EPA issued its final decision selecting a corrective action at the site,
different from what Sparton had proposed. The EPA estimated that the present
value cost of its remedies would range from between $15,000,000 and $26,400,000
based on a thirty (30) year time frame. In Sparton's judgment, the remedies
proposed by the EPA were either unnecessary or technically impracticable and
Sparton vigorously challenged the EPA's remedy selection.
Since June of 1996 the parties have been in negotiations regarding workplans and
the resulting final remedies to be selected. Sparton has been proceeding on the
workplan originally presented. At the current time, all litigation has been
stayed until March 1999 to allow the parties to continue settlement discussions
on remaining workplans. The
7
<PAGE> 8
parties have reached tentative agreement on what initial corrective action will
be required to further address on-site impacts to the environment. Those
agreements are described in four workplans that are in a form that should be
acceptable to all parties by February 1999. As a result of these developments
the Company believes the EPA's estimate of $15,000,000 to $26,400,000 is now
outdated. The Company is currently updating its cost estimates. It is believed
that the initial cost of the corrective measures called for in these plans is
not expected to be materially different from the cost estimates the Company has
previously accrued. There is no assurance that additional corrective measures,
involving increased expenditures, may not be required.
The proposed workplans provide for the installation of an off-site containment
well (already completed and operating), an on-site containment well and an
on-site soil vapor extraction system (operating). The purpose of the containment
wells is to restrict further migration of impacted groundwater. The soil vapor
extraction system removes solvents in the on-site soil above the groundwater.
The installation and operation of these wells and system are dependent upon
various permits, licenses and approvals from regulatory agencies and third
parties. It's anticipated that these remediation activities will operate for a
period of time during which the Company and the regulatory agencies will analyze
their effectiveness. The Company believes that it will take at least three to
five years before the effectiveness of the groundwater extraction wells can be
established. Until then, no definitive conclusion can be reached on whether
additional remediation activities may be required.
At December 31, 1998, Sparton has accrued $1,499,000 as its estimate of the
future undiscounted minimum obligation with respect to this matter. This
reflects the minimum range of the amount Sparton expects to incur over the next
five years. This amount includes equipment and operating and maintenance costs.
In many cases, new technologies become available over time, which result in
modified costs for environmental remediation. The Company's estimate of cost is
based on the existing methodology and excludes legal and related consulting
costs. For further discussion of legal activities, see page 16 regarding
litigation.
Uncertainties associated with environmental remediation contingencies are
pervasive and often result in wide ranges of reasonably possible estimates.
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. Amounts charged to operations, principally
legal and consulting, for the six months ended December 31, 1998 and 1997 were
$300,000 and $500,000, respectively. It is reasonably possible that Sparton's
recorded estimate of this liability may change. If a remedy is imposed on
Sparton, other than in the anticipated workplans described above, the ultimate
cleanup costs could increase significantly. There is no assurance that
additional costs greater than the amount accrued will not be incurred or that
changes in environmental laws or their interpretation will not require that
additional amounts be spent.
On June 17, 1998, Sparton Corporation and Sparton Technology, Inc. filed a
complaint in the Circuit Court of Cook County, Illinois, against Lumbermens
Mutual Casualty company and American Manufactures 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. On
February 11, 1998, Sparton Technology, Inc. commenced litigation in the United
States Court of Federal Claims alleging that the Department of Energy (DOE),
acting through its contractors, Sandia Corporation and Allied Signal Aerospace
Company, is liable for reimbursement of Sparton's costs incurred in defending
against and complying with Federal and state regulatory requirements. DOE
proscribed certain mandatory performance requirements that were then imposed
upon Sparton through its agreements with Sandia and Allied Signal. At this time,
the Company is unable to predict the amount of recovery, if any, that may result
in the pursuit of these claims.
8
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7. In June 1997 SFAS No. 131, "Disclosures about Segments of an Enterprise and
Related Information", was issued. SFAS No. 131 establishes standards for the way
that a public enterprise reports information about operating segments in annual
financial statements and requires that those enterprises report selected
information about operating segments in interim financial reports issued to
stockholders, but not for interim periods in the initial year of adoption. SFAS
No. 131 is effective for fiscal years beginning after December 15, 1997. Since
SFAS No. 131 is not required for interim reporting in the year of adoption, the
Company plans to address this standard in the preparation of its annual
financial statements for the year ended June 30, 1999.
9
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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
continuing operations are in one line of business, namely the design,
development and/or manufacture of electronic parts and assemblies for both
government and commercial customers worldwide. In August 1996, the Company
formalized its plan to offer for sale its automotive operations. Accordingly,
these operations, formerly classified as the Automotive and Industrial Products
segment, were reclassified and reported as discontinued operations.
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 Company's financial
statements, SEC filings and shareholder's reports contain forward-looking
statements that involve risk and uncertainty. The Company notes that a variety
of factors could cause the actual results 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 include, but are not limited to,
fluctuations in U. S. and/or world economies, competition in the overall
electronic contract manufacturing (ECM) business, Congressional budget outlays
for sonobuoy development and production, Congressional legislation, changes in
the interpretation of environmental laws, the uncertainties of environmental
litigation and the availability of materials, production labor and management
services under terms acceptable to the Company.
RESULTS OF OPERATIONS
- ---------------------
Six-Month Periods
- -----------------
Sales for the six-month period ended December 31, 1998 were $71,424,000, an
increase of $4,192,000 (6%) from the corresponding six-month period last year.
While revenues increased from the prior period, they were below expectations as
unanticipated delays were encountered in the start-up of several programs,
principally ECM. Government sales increased $2,364,000 and ECM sales increased
$2,187,000. All other sales declined $359,000. Sales increased $2,401,000 (4%)
to $59,892,000 at Sparton Electronics. Revenues increased at Sparton Technology
by $1,641,000 (18%) to $10,764,000. This was primarily due to the start-up of a
new program as well as additional business with several existing customers
including a contract with the U.S. Department of Immigration and Naturalization
Services. This sales level, however, was below management's expectations.
Revenues at Sparton of Canada totaled $981,000, down $238,000 from the same
period last year and below expectations, primarily due to customer design issues
on a major program.
An operating profit of $1,347,000 was reported for the six-month period ended
December 31, 1998 compared to $405,000 for the same period last year. These
results were slightly below management's expectations. Included in these
operating results were adverse capacity variances of $1,974,000 caused by
underutilized capacity at various production facilities. Sparton Electronics
reported an operating profit of $2,166,000 for the current period compared to
$2,093,000 for the same period last year. These operating results reflect a more
favorable product mix and improved cost control. Sparton Technology reported an
operating profit of $736,000 compared to an operating loss of $30,000 last year.
Included within these results were charges, principally legal and consulting,
totaling $300,000 in the current period and $500,000 last year related to the
environmental claim previously discussed on pages 7 and 8. Without consideration
of the effects of environmental costs, operating results were below
expectations, primarily due to continued delays in key programs. The Canadian
unit incurred an operating loss of $716,000 compared to a loss of $528,000 last
year. These results were below management's expectations as low sales volume
continues to impact
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<PAGE> 11
operations. Underutilized manufacturing capacity resulted in a current charge of
$226,000 to the Canadian operations.
Interest and Investment Income decreased $179,000 to $755,000 for the six-month
period ended December 31, 1998 due to lower average investments and a decline in
interest rates. In December 1996, the Company used a portion of the proceeds
from the sale of its automotive operations to eliminate short-term borrowings.
Since then, the Company has incurred minimal interest expense. Other Expense-Net
was $7,000 for the current six-month period compared to Other Income-Net of
$559,000 last year. Included within last years Other Income-Net was a gain of
$511,000 from the sale of equipment and other assets at the Canadian operating
unit. After provision for applicable income taxes, the Company reported income
from continuing operations of $1,320,000 ($0.17 per share) for the six-month
period ended December 31, 1998 compared to $1,195,000 ($0.15 per share) for the
same period last year.
Three-Month Periods
- -------------------
Sales for the three-month period ended December 31, 1998 were $38,974,000, an
increase of $4,109,000 (12%) compared to the same quarter last year. Overall,
government sales increased $4,092,000, ECM sales increased $279,000, while all
other sales decreased $262,000 from the same quarter last year. Revenues at
Sparton Electronics were $32,078,000, an increase of $2,745,000 (9%) from the
same period last year but below forecast. Revenues at Sparton Technology were
$6,281,000, up $1,141,000 (22%) when compared to the previous year. These
revenues included the completion of the aforementioned U.S. Department of
Immigration and Naturalization Services contract. At the Canadian unit, revenues
were $733,000 compared to $614,000 for the same period last year. This unit
continues to be challenged in replacing government defense sales with ECM
opportunities.
Operating income of $1,606,000 was reported for the three months ended December
31, 1998 compared to $998,000 for the same period last year. These current
operating results were below management's expectations. Included within these
current three-month results were adverse capacity variances of $313,000 caused
by underutilized capacity at various production facilities. Sparton Electronics
reported an operating profit of $1,556,000 for the current three-month period,
which was essentially unchanged from the same quarter last year. These results
were primarily due to the previously mentioned factors of a more favorable
product mix and improved cost control. Sparton Technology had an operating
profit of $751,000 for the current three-month period compared to $220,000 last
year. Sparton of Canada incurred an operating loss of $387,000. Continued low
revenue levels at the Canadian unit was responsible for the operating loss.
Interest and Investment Income decreased to $320,000 for the three-month period
ended December 31, 1998 compared to $403,000 last year due to the previously
discussed amount of investments and interest rates. As previously stated in
December 1996 the Company used a portion of the proceeds from the sale of its
automotive operations to eliminate short-term borrowings. After provision for
applicable income taxes, the Company reported income from continuing operations
of $1,211,000 ($0.16 per share) for the three-month period ended December 31,
1998, compared to $872,000 ($0.11 per share) for the corresponding period last
year.
Discontinued Operations
- -----------------------
In August 1996, the Company formalized its plans to sell its automotive
operations and accordingly reclassified and reported operating results as
discontinued operations. As more fully described in Note 5 to the financial
statements, in December 1996, the Company sold substantially all of the net
assets and operations of the Sparton Engineered Products, Inc.-KPI Group (KPI)
which comprised approximately 80% of its automotive operations. This sale did
not include the net assets and operations of the remaining automotive unit,
Sparton Engineered Products, Inc.-Flora Group (Flora). After extensive efforts
to sell the Flora operations proved unsuccessful, the Board of Directors
approved the closing of the facility in August 1998. In December 1998, Flora
production
11
<PAGE> 12
ceased. An auction of inventory and equipment was held on January 28th 1999,
with the land and building auction to occur in late February. At December 31,
1998, a reserve of approximately $1,938,000 was available to cover the costs
associated with this closing and the sale of its assets. The amount that the
Company ultimately realizes, however, could differ materially based upon its
ability to sell or otherwise liquidate the Flora assets.
FINANCIAL POSITION
- ------------------
For the six-month period ended December 31, 1998, Cash and Cash Equivalents
decreased $290,000 to $3,793,000. Operating activities used $601,000 in net cash
flows. Principal sources of cash flows from operating activities included
decreases in inventories, changes in income tax assets and liabilities, and
income from continuing operations. Principal uses were a decrease in accounts
payable and an increase in accounts receivable. The decrease in accounts payable
was due to a decline in inventory levels and higher than normal payables at
year-end. Cash flows provided by investing activities were $311,000, principally
from the sale of equipment and investments. The Company will continue to
strategically invest in additional property, plant, and equipment to accommodate
growth in the ECM business. Two additional production lines were acquired
through a five-year operating lease of approximately $5 million.
Investments will continue to be made in high quality marketable securities. The
resulting interest and investment income, combined with a lack of interest
expense, should favorably impact the Company's operations. It is uncertain,
however, how long and to what extent this favorable non-operating income trend
will continue. This trend is dependent upon how quickly the Company's ECM
business develops as well as the emergence of alternate uses for these proceeds.
The Company's market risk exposure to foreign currency exchange and interest
rates are not considered to be material due to principally short term
investments and minimal foreign currency designated receivables and payables.
At December 31, 1998 and June 30, 1998, the aggregate backlog from continuing
operations was approximately $80 million and $103 million, respectively.
No dividends were declared in either period presented. At December 31, 1998, the
Company had $89,712,000 in recorded shareowners' equity ($11.46 per share),
$72,947,000 in working capital, and a 6.09:1.00 working capital ratio.
OTHER
- -----
One of Sparton's facilities, located in New Mexico, has been the subject of
ongoing investigations conducted with the EPA under the Resource Conservation
and Recovery Act ("RCRA"). This EPA compliance issue is related to continuing
operations, but involves a largely idled facility. In June 1996, the EPA issued
its final decision selecting a corrective action at the site, different from
what Sparton had proposed. The EPA estimated that the present value cost of its
remedies would range from between $15,000,000 and $26,400,000 based on a thirty
(30) year time frame. In Sparton's judgment, the remedies proposed by the EPA
were either unnecessary or technically impracticable and Sparton vigorously
challenged the EPA's remedy selection.
Since June of 1996 the parties have been in negotiations regarding workplans and
the resulting final remedies to be selected. Sparton has been proceeding on the
workplan originally presented. At the current time, all litigation has been
stayed until March 1999 to allow the parties to continue settlement discussions
on remaining workplans. The parties have reached tentative agreement on what
initial corrective action will be required to further address on-site impacts to
the environment. Those agreements are described in four workplans that are in a
form that should be acceptable to all parties by February 1999. As a result of
these developments the Company believes the EPA's estimate of $15,000,000 to
$26,400,000 is now outdated. The Company is currently updating its cost
estimates. It is believed that the initial cost of the corrective measures
called for in these plans is not expected to be
12
<PAGE> 13
materially different from the cost estimate the Company has previously accrued.
There is no assurance that additional corrective measures, involving increased
expenditures, may not be required.
The proposed workplans provide for the installation of an off-site containment
well (already completed and operating), an on-site containment well and an
on-site soil vapor extraction system (operating). The purpose of the containment
wells is to restrict further migration of impacted groundwater. The soil vapor
extraction system removes solvents in the on-site soil above the groundwater.
The installation and operation of these wells and system are dependent upon
various permits, licenses and approvals from regulatory agencies and third
parties. It's anticipated that these remediation activities will operate for a
period of time during which the Company and the regulatory agencies will analyze
their effectiveness. The Company believes that it will take at least three to
five years before the effectiveness of the groundwater extraction wells can be
established. Until then, no definitive conclusion can be reached on whether
additional remediation activities may be required.
At December 31, 1998, Sparton has accrued $1,499,000 as its estimate of the
future undiscounted minimum obligation with respect to this matter. This
reflects the minimum range of the amount Sparton expects to incur over the next
five years. This amount includes equipment and operating and maintenance costs.
In many cases, new technologies become available over time, which result in
modified costs for environmental remediation. The Company's estimate of cost is
based on the existing methodology and excludes legal and related consulting
costs. For further discussion of legal activities, see page 16 regarding
litigation.
Uncertainties associated with environmental remediation contingencies are
pervasive and often result in wide ranges of reasonably possible estimates.
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. Amounts charged to operations, principally
legal and consulting, for the six months ended December 31, 1998 and 1997 were
$300,000 and $500,000, respectively. It is reasonably possible that Sparton's
recorded estimate of this liability may change. If a remedy is imposed on
Sparton, other than in the anticipated workplans described above, the ultimate
cleanup costs could increase significantly. There is no assurance that
additional costs greater than the amount accrued will not be incurred or that
changes in environmental laws or their interpretation will not require that
additional amounts be spent.
On June 17, 1998, Sparton Corporation and Sparton Technology, Inc. filed a
complaint in the Circuit Court of Cook County, Illinois, against Lumbermens
Mutual Casualty company and American Manufactures 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. On
February 11, 1998, Sparton Technology, Inc. commenced litigation in the United
States Court of Federal Claims alleging that the Department of Energy (DOE),
acting through its contractors, Sandia Corporation and Allied Signal Aerospace
Company, is liable for reimbursement of Sparton's costs incurred in defending
against and complying with Federal and state regulatory requirements. DOE
proscribed certain mandatory performance requirements that were then imposed
upon Sparton through its agreements with Sandia and Allied Signal. At this time,
the Company is unable to predict the amount of recovery, if any, that may result
in the pursuit of these claims.
13
<PAGE> 14
New Accounting Standards
- ------------------------
As more fully described in notes to the financial statements the Company has
adopted SFAS No.130 "Reporting Comprehensive Income". SFAS No.131 "Disclosures
About Segments Of An Enterprise and Related Information" appears in footnote 7.
Impact of Year 2000
- -------------------
The Year 2000 problem results from the fact that many older computer programs
were written using two digits rather than four to define the applicable year. A
computer program that has time-sensitive software may recognize a date using
"00" as the year 1900 rather than the year 2000. This could result in a system
failure or miscalculations causing disruptions of operations, including, among
other things, a temporary inability to process transactions, send invoices, or
engage in normal business activities.
Sparton Electronics implemented a new business information system in the summer
of 1997, to further enhance the Company's competitive position. This system,
called Manufacturing Total Management System (MTMS), will enable information to
be shared between all of Sparton's manufacturing locations. The information
system is presently being implemented throughout the remainder of the Company's
management units with full implementation scheduled for completion in fiscal
1999. The timing of the decision to purchase and implement MTMS was independent
of the Year 2000 issue. Based upon representation from the manufacturer the
Company believes that implementation of MTMS will render all of its significant
internal information systems Year 2000 compliant, with no disruptions in
operations. The Company has initiated a plan to discuss and monitor Year 2000
compliance issues with its major suppliers and customers. With respect to
suppliers and customers software being Year 2000 compliant, the Company does not
believe that there is sufficient integration and/or dependency upon such
software to potentially have any material impact on the Company's business
operating systems or processes. Substantially all the locations have completed
their assessments of information technology (IT) system's, other than MTMS which
was discussed earlier, and have begun the modification and upgrading process of
these systems which are expected to be completed by the end of fiscal 1999.
Certain of the Company's ECM revenues involve products built to contract
specifications dictated by the customer using a customer-owned design. As these
products are non-proprietary in nature, the Company believes that potential Year
2000 problems, if any, associated with these products are the customer's
responsibility. Regarding proprietary products, the Company has completed an
assessment of both current and past products. Corrective measures for current
products have been completed where applicable. Corrective measures for past
products have been identified, where applicable, and affected customers
notified. The Company does not anticipate that internal Year 2000 conversion
issues will materially affect operations or operating results. However, if all
Year 2000 issues are not properly identified, assessed and corrected as required
in a timely manner, there can be no assurance that the Year 2000 issue will not
materially adversely impact the Company's results of operation or adversely
affect the Company's relationships with customers, suppliers and others.
Additionally, there can be no assurance that the Year 2000 issues may not in
other respects have a material adverse impact on the Company's systems or
results of operations.
The Company has not yet developed a comprehensive contingency plan to address
situations that may result if the Company, or any of the third parties upon
which the Company is dependent, are unable to achieve Year 2000 readiness.
However, the Company's Year 2000 compliance program is ongoing and will continue
to be reevaluated.
14
<PAGE> 15
Year 2000 Forward-Looking Statements
- ------------------------------------
The foregoing Year 2000 discussion contains "forward-looking statements" within
the meaning of the Private Securities Litigation Reform Act of 1995. Such
statements, including without limitation, expected financial impact and the
dates by which the Company expects to complete certain actions, are based on
management's best estimates at this time, which were derived utilizing numerous
assumptions about future events, including the continued availability of certain
resources, representations received from third parties and other factors.
However, there can be no guarantee that these estimates will be achieved, and
actual results could differ materially from those anticipated. Specific factors
that might cause such material differences include, but are not limited to, the
ability to identify and remediate all relevant IT and non-IT systems, results of
Year 2000 testing, adequate resolution of Year 2000 Issues by businesses and
other third parties who are service providers, suppliers or customers of the
Company, unanticipated system costs, the adequacy of and ability to develop and
implement contingency plans and similar uncertainties. The "forward-looking
statements" made in the foregoing Year 2000 discussion are only as of the date
on which such statements are made, and the Company undertakes no obligation to
update on less than a quarterly basis.
15
<PAGE> 16
OTHER INFORMATION
Part II - Other Information
- ---------------------------
Item 1 - Legal Proceedings
- --------------------------
Litigation
- ----------
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 (PRP's) can be held jointly and severally liable
for the cleanup 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 PRP's, its
ultimate share of any cleanup 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 a potentially responsible party.
Environmental compliance issues involving either the discontinued oil and gas
operations, which were sold in fiscal 1991, or the discontinued automotive
operations, are not material.
One of Sparton's facilities, located in New Mexico, has been the subject of
ongoing investigations conducted with the Environmental Protection Agency
("EPA") under the Resource Conservation and Recovery Act ("RCRA"). This EPA
compliance issue is related to continuing operations, but involves a largely
idled facility. The investigation began in the early 1980's and involved a
review of on-site and off-site environmental impacts. In 1988, an administrative
order on consent ("AOC") was executed with EPA related to further investigation
and proposing a means of dealing with quantified impacts.
The remedial investigation called for in the AOC has been completed and
approved. In May 1996, Sparton submitted to the EPA a final corrective measure
study, based on the results of its investigations, as required in the AOC. In
June 1996, the EPA issued its final decision selecting a corrective action at
the site, different from what Sparton had proposed. The EPA estimated that the
present value cost of its remedies would range from between $15,000,000 and
$26,400,000 based on a thirty (30) year time frame. In Sparton's judgment, the
remedies proposed by the EPA are either unnecessary or technically
impracticable. Sparton vigorously challenged the EPA's remedy selection and
filed suit in Federal District Court in Dallas asserting that the EPA's decision
on remedy selection violated the AOC.
In September 1996, the EPA issued an initial administrative order under RCRA
ordering Sparton to undertake additional testing to justify the implementation
of the remedy selected by the agency in June 1996, and then implementing that
remedy. Sparton vigorously contested that order administratively, but on
February 10, 1998, EPA issued a Final Administrative Order that in all material
respects followed the initial administrative order issued in September 1996.
Sparton has refused to implement those portions of that order that it believes
are unjustified.
In February 1997, three lawsuits were filed against Sparton in Federal District
Court in Albuquerque, one by the United States on behalf of the EPA, the second
by the State of New Mexico and the third by the City of Albuquerque and the
County of Bernalillo. All three actions allege that the impacts to soil and
groundwater associated with Sparton's Coors Road facility present an imminent
and substantial threat to human health or the environment. Through these
lawsuits, the plaintiffs seek to compel Sparton to undertake additional testing
and to implement the same remedy selected by the EPA in June of 1996 now
incorporated in the Final Administrative Order, and referred to in the preceding
paragraph. In March 1997, the plaintiffs in these three lawsuits filed a
16
<PAGE> 17
motion for preliminary injunction and in July of 1997, the action in Dallas was
transferred to Federal District Court in Albuquerque and consolidated with the
three lawsuits filed in February 1997.
A pretrial schedule has been established for the consolidated actions, but no
trial date set. Limited discovery, involving interrogatories and requests for
production, has been undertaken by the plaintiffs. The plaintiffs have sought to
amend their lawsuit to compel Sparton to implement the Final Administrative
Order, and seeking civil penalties for alleged noncompliance. Sparton has
opposed this request and no decision has been made by the court on the
plaintiffs' request to amend.
In March 1998, a hearing was held on the plaintiffs' request for a preliminary
injunction. After two days of testimony, the federal district judge indicated he
had tentatively concluded he might issue a preliminary injunction. The parties
subsequently entered into settlement discussions that culminated in an agreed
workplan for the installation of certain off-site monitoring, observation, and
containment wells, in exchange for plaintiffs withdrawing their request for a
preliminary injunction. An order withdrawing that request and approving this
off-site workplan was signed on July 7, 1998.
At the current time, all litigation has been stayed to allow the parties to
continue settlement discussions. The most recent stay will expire in March 1999.
The parties have reached tentative agreement on what initial corrective action
will be required to further address on-site and off-site impacts to the
environment. Those agreements are described in four work plans that should be in
a form acceptable to all parties by February 5, 1999. It is anticipated that
implementation of these workplans will relieve the Company of its obligations
under the February 10, 1998 Final Administrative Order. As a result of these
developments the company is currently updating its cost estimates. It is
believed the initial cost of the corrective measures called for in these plans
is not expected to be materially different from the cost estimates the Company
has previously accrued. There is no assurance that additional corrective
measures, involving increased expenditures, may not be required.
The proposed workplans provide for the installation of an off-site containment
well (already completed and operating), an on-site containment well and an
on-site soil vapor extraction system (operating). The purpose of the containment
wells is to restrict further migration of impacted groundwater. The soil vapor
extraction system removes solvents in the on-site soil above the groundwater.
The installation and operation of these wells and system are dependent upon
various permits, licenses and approvals from regulatory agencies and third
parties. It's anticipated that these remediation activities will operate for a
period of time during which the Company and the regulatory agencies will analyze
their effectiveness. The Company believes that it will take at least three to
five years before the effectiveness of the groundwater extraction wells can be
established. Until then, no definitive conclusion can be reached on whether
additional remediation activities may be required.
At December 31, 1998, Sparton has accrued $1,499,000 as its estimate of the
future undiscounted minimum obligation with respect to this matter. This
reflects the minimum range of the amount Sparton expects to incur over the next
five years. This amount includes equipment and operating and maintenance costs.
In many cases, new technologies become available over time, which result in
modified costs for environmental remediation. The Company's estimate of cost is
based on the existing methodology and excludes legal and related consulting
costs. The estimate includes the minimum range of activity expected to occur in
the next five years including on-site and off-site pump and treat containment
systems, a soil vapor extraction program and continued on-site/off-site
monitoring. Beyond five years, while additional expenditures are probable,
Sparton does not believe such expenditures are reasonably estimable based on
available information. Factors causing the uncertainty include, but are not
limited to, effectiveness of the currently proposed programs to achieve targeted
results and decisions made by regulating agencies regarding future proposals and
reports of Sparton. Sparton routinely refines and revises the estimate of its
environmental efforts as additional information becomes available.
Uncertainties associated with environmental remediation contingencies are
pervasive and often result in wide ranges of reasonably possible estimates.
Estimates developed in the early stages of remediation can vary
17
<PAGE> 18
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. Amounts charged to
operations, principally legal and consulting, for the six months ended December
31, 1998 and 1997 were $300,000 and $500,000, respectively. It is reasonably
possible that Sparton's recorded estimate of this liability may change. If a
remedy is imposed on Sparton, other than the one it has proposed, the ultimate
cleanup costs could increase significantly. There is no assurance that
additional costs greater than the amount accrued will not be incurred or that
changes in environmental laws or their interpretation will not require that
additional amounts be spent. At this time, it is not possible to estimate the
ultimate cost to resolve this matter.
On June 17, 1996, 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. On
February 11, 1998, Sparton Technology, Inc. commenced litigation in the United
States Court of Federal Claims alleging that the Department of Energy (DOE),
acting through its contractors, Sandia Corporation and Allied Signal Aerospace
Company, is liable for reimbursement of Sparton's costs incurred in defending
against and complying with Federal and state regulatory requirements. DOE
proscribed certain mandatory performance requirements that were then imposed
upon Sparton through its agreements with Sandia and Allied Signal. At this time
the Company is unable to predict the amount of recovery, if any, that may result
in the pursuit of these claims.
18
<PAGE> 19
OTHER INFORMATION
PART II - Other Information
- ---------------------------
Item 6 - Exhibits and Reports on Form 10-K and 10-Q
- ---------------------------------------------------
(a) Exhibits
3 & 4 Instruments defining the rights of security holders have been
previously filed as follows:
Articles of Incorporation of the Registrant were filed on form
10-K for the year ended June 30, 1981 and an amendment thereto
was filed on Form 10-Q for the three-month period ended
December 31, 1983 and are incorporated herein by reference.
By-laws of the Registrant were filed on Form 10-K for the year
ended June 30, 1981 and are incorporated herein by reference.
Code of Regulation of the Registrant was filed on Form 10-K
for the year ended June 30, 1981 and an amendment thereto was
filed on Form 10-Q for the three-month period ended September
30, 1982 and are incorporated herein by reference.
27 Submitted to the Securities and Exchange Commission for its
information.
(b) Reports on Form 8-K filed in the Second Quarter of Fiscal 1999: None
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.
<TABLE>
<S> <C>
SPARTON CORPORATION
-------------------
Registrant
Date: February 12, 1999 /s/ David W. Hockenbrocht
------------------ ---------------------------------------------------
David W. Hockenbrocht, President
Date: February 12, 1999 /s/ Richard Langley
------------------ ---------------------------------------------------
Richard Langley, Vice President/Treasurer and
Principal Financial Officer
</TABLE>
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<FISCAL-YEAR-END> JUN-30-1999
<PERIOD-START> JUL-01-1998
<PERIOD-END> DEC-31-1998
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<SECURITIES> 22,503,889
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