UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

FORM 10-Q

For the quarterly period ended December 31, 2004

or

For the transition period from                      to                     

Commission File number 1-1000

SPARTON CORPORATION

Ohio
(State or Other Jurisdiction of Incorporation or Organization)

38-1054690
(I.R.S. Employer Identification No.)

2400 East Ganson Street, Jackson, Michigan 49202
(Address of Principal Executive Offices, Zip Code)

(517)787-8600
(Registrant’s Telephone Number, Including Area Code)

Indicate by checkmark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.                                                                                                                    [X]Yes [  ] No

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

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practical date.

INDEX

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Item 1. Financial Statements

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

See accompanying notes.

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SPARTON CORPORATION AND SUBSIDIARIES
Condensed Consolidated Statements of Operations (Unaudited)
For the Three-Month and Six-Month Periods ended December 31, 2004 and 2003

⁽¹⁾ All share and per share information have been adjusted to reflect the impact of the 5% stock dividend declared in November 2004.

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

See accompanying notes.

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SPARTON CORPORATION & SUBSIDIARIES
Notes to Condensed Consolidated Financial Statements (Unaudited)

1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES —The following is a summary of the Company’s accounting policies not discussed elsewhere within this report.

Basis of presentation — The accompanying unaudited Condensed Consolidated Financial Statements of Sparton Corporation and all active subsidiaries have been prepared in accordance with accounting principles generally accepted in the United States of America for interim financial information and with the instructions to Article 10 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by accounting principles generally accepted in the United States of America for complete financial statements. All significant intercompany transactions and accounts have been eliminated. The Condensed Consolidated Balance Sheet at December 31, 2004, and the related Condensed Consolidated Statements of Operations and Cash Flows for the six-month periods ended December 31, 2004 and 2003, 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, 2004, are not necessarily indicative of the results that may be expected for the fiscal year ended June 30, 2005.

The balance sheet at June 30, 2004, has been derived from the audited financial statements at that date but does not include all of the information and footnotes required by accounting principles generally accepted in the United States of America for complete financial statements. For further information, refer to the Consolidated Financial Statements and footnotes thereto included in the Company’s Annual Report on Form 10-K for the year ended June 30, 2004.

Operations — The Company provides design and electronic manufacturing services, which include a complete range of engineering, pre-manufacturing and post-manufacturing services. Capabilities range from product design and development through aftermarket support. All facilities are registered to ISO 9001, with many having additional certifications. The Company’s operations are in one line of business, electronic contract manufacturing services (EMS). Products and services include complete “Box Build” products for Original Equipment Manufacturers, microprocessor-based systems, transducers, printed circuit boards and assemblies, sensors and electromechanical devices. Markets served are in the medical/scientific instrumentation, aerospace, and industrial/other, with a focus on regulated markets. The Company also develops and manufactures sonobuoys, anti-submarine warfare (ASW) devices, used by the U.S. Navy and other free-world countries. Many of the physical and technical attributes in the production of sonobuoys are the same as those required in the production of the Company’s other electrical and electromechanical products and assemblies.

Use of estimates — Accounting principles generally accepted in the United States of America require management to make estimates and assumptions that affect the disclosure of assets and liabilities and the amounts reported in the financial statements and accompanying notes. Actual results could differ from those estimates.

Revenue recognition — The Company’s net sales are comprised primarily of product sales, with supplementary revenues earned from engineering and design services. Standard contract terms are FOB shipping point. Revenue from product sales is generally recognized upon shipment of the goods; service revenue is recognized as the service is performed or under the percentage of completion method, depending on the nature of the arrangement. Long-term contracts relate principally to government defense contracts. These contracts are accounted for based on completed units accepted and their estimated average contract cost per unit. Development contracts are accounted for based on percentage of completion. Costs and fees billed under cost-reimbursement-type contracts are recorded as sales. A provision for the entire amount of a loss on a contract is charged to operations as soon as the loss is determinable. Shipping and handling costs are included in costs of goods sold.

Market risk exposure — The Company manufactures its products in the United States and Canada. Sales of the Company’s products are in the U.S. and Canada, as well as other foreign markets. The Company is potentially subject to foreign currency exchange rate risk relating to intercompany activity and balances, receipts from customers, and payments to suppliers in foreign currencies. Also, adjustments related to the translation of the Company’s Canadian financial statements into U.S. dollars are included in current earnings. As a result, the Company’s financial results could be affected by factors such as changes in foreign currency exchange rates or weak economic conditions in the domestic and foreign markets in which the Company operates. However, minimal third party receivables and payables are denominated in foreign currency and the related market risk exposure is considered to be immaterial. Historically, foreign currency gains and losses related to intercompany activity and balances have not been significant. However, recently due to the strengthening Canadian dollar the impact of transaction and translation gains has increased. While a reversal of these recent gains is not anticipated, if the exchange rate were to decline the Company’s financial position could be significantly affected.

The Company has financial instruments that are subject to interest rate risk, principally short-term investments. Historically, the Company has not experienced material gains or losses due to such interest rate changes. Based on the current holdings of short-term investments, the interest rate risk is not considered to be material.

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New accounting standards—In December 2004, the Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting Standards (SFAS) No.123(R) “Share-Based Payment”, which replaces SFAS No.123, “Accounting for Stock-Based Compensation”, and supersedes APB Opinion No. 25, “Accounting for Stock Issued to Employees”. The Statement requires that the cost resulting from all share-based payment transactions be recognized in the financial statements. The Statement also establishes fair value as the measurement objective in accounting for share-based payment arrangements and requires all entities to apply a fair-value-based measurement method in accounting for share-based payment transactions with employees, except for equity instruments held by employee share ownership plans. The Statement is effective for the Company beginning July 1, 2005, and is required to be adopted using a “modified prospective” method. Under the modified prospective method, the Statement applies to new awards and to awards modified, repurchased or cancelled after the effective date. Additionally, compensation cost for the unvested portion of awards as of the effective date is required to be recognized as the awards vest after the effective date. The Company does not expect the requirements of this Statement will have a significant impact on results of operations or financial position.

In November 2004, the FASB issued SFAS No. 151, “Inventory Costs” (SFAS No. 151), which amends the guidance in Accounting Research Bulletins No. 43, Chapter 4, “Inventory Pricing”. The Statement requires that the accounting for abnormal amounts of idle facility expense, freight handling costs, and wasted material (spoilage) be recognized as current-period charges regardless of whether they meet the criterion of “abnormal”. In addition, the Statement requires that the allocation of fixed production overhead to the costs of conversion be based on the normal capacity of the production facilities. The Statement is effective for the Company for inventory costs incurred beginning July 1, 2005. The Company does not expect the requirements of this Statement will have any impact on its results of operations or financial position.

In December 2004, the FASB issued SFAS No. 153, “Exchange of Nonmonetary Assets, an amendment of APB Opinion No. 29” (SFAS No. 153), which addresses the measurement of exchanges of nonmonetary assets. The Statement eliminates the exception for nonmonetary exchanges of similar productive assets and replaces it with a general exception for exchange of nonmonetary assets that do not have commercial substance. It also specifies that a nonmonetary exchange has commercial substance if the future cash flows of the entity are expected to change significantly as a result of the exchange. The Statement is effective for the Company beginning July 1, 2005. The Company does not expect the requirements of the Statement will have a significant impact on results of operations or financial position.

During fiscal 2004, the Company purchased a manufacturing facility in Albuquerque, New Mexico, that replaced an existing plant in Rio Rancho, New Mexico, which was subsequently sold. Because these transactions were reported separately, at fair market value, there would have been no change to how these transactions were recorded for financial reporting purposes had SFAS No. 153 been in effect during fiscal 2004. The tax treatment for the sale and purchase of these facilities was as a like-kind exchange.

Periodic benefit cost — The Company follows the disclosure requirements of SFAS No. 132 (R). For the three months and six months ended December 31, 2004 and 2003, $132,000 and $32,000 and $264,000 and $64,000 of expense has been recorded, respectively. Total net periodic benefit cost for fiscal 2005 is expected to be $528,000, compared to total net periodic benefit cost reported for fiscal 2004 of $727,000. For the six months ended December 31, 2003, net period benefit cost was presented based upon the actuarial information received as of the period’s closing. The subsequent periods for fiscal 2004 reflected the adjusted net periodic benefit cost, which totaled the annual reported expense of $727,000.

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

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Stock options — Until the effective date of SFAS 123(R), the Company continues to follow 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 as amended by SFAS No. 148.

The Company has an incentive stock option plan under which 760,000 common shares were reserved for option grants to key employees and directors at the fair market value of the stock at the date of the grant. As of December 31, 2004, there were 569,476 shares outstanding under option, with prices ranging from $3.24 to $8.90, a weighted contractual life of 2.4 years, and a weighted average exercise price of $5.83. The following table summarizes information about stock options outstanding and exercisable at December 31, 2004:

At December 31, 2004, exercisable options and the per share weighted average exercise price were 409,569 and $5.46, respectively. At December 31, 2004, remaining shares available for grant under the plan were 156,667.

The following sets forth a reconciliation of net income (loss) and earnings (loss) per share information for the three months and six months ended December 31, 2004 and 2003, as if the Company had recognized compensation expense based on the fair value at the grant date for awards under the plan. For purposes of computing pro forma net income (loss), the fair value of each option grant is estimated on the date of grant using the Black-Scholes option pricing model.

2. INVENTORIES — Inventories are valued at the lower of cost (first-in, first-out basis) or market and include costs related to long-term contracts. Inventories, other than contract costs, are principally raw materials and supplies. The following are the major classifications of inventory:

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

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3. EARNINGS (LOSS) PER SHARE — On November 9, 2004, Sparton’s Board of Directors approved a 5% stock dividend. Eligible shareowners of record on November 23, 2004, received the stock dividend on December 15, 2004. To record the stock dividend, an amount equal to the fair market value of the common stock issued was transferred from retained earnings ($3,723,000) to common stock ($522,000) and capital in excess of par value ($3,198,000), with the balance ($3,000) paid in cash in lieu of fractional shares of stock. Accordingly, all share and per share information for fiscal 2005 and 2004 has been adjusted to reflect the impact of all stock dividends declared for the periods shown.

Due to the Company’s fiscal 2004 reported net loss, 148,971 and 145,113 outstanding stock option share equivalents were excluded from the computation of diluted earnings per share during the three months and six months ended December 31, 2003, respectively, because their inclusion would have been anti-dilutive.

Basic and diluted earnings per share were computed on the following:

4. COMPREHENSIVE INCOME (LOSS) — Comprehensive income (loss) includes net income (loss) as well as unrealized gains and losses, net of tax, on investment securities owned and investment securities held by an investee accounted for by the equity method, which are excluded from net income. Unrealized gains and losses, net of tax, are reflected as a direct charge or credit to shareowners’ equity. Total comprehensive income (loss) is as follows for the three months and six months ended December 31, 2004 and 2003, respectively:

At December 31, 2004 and June 30, 2004, shareowners’ equity includes accumulated other comprehensive income of $131,000 and $62,000, respectively, net of tax. These balances include $(18,000) and $16,000 for unrealized (losses) and gains on investment securities owned, and unrealized gains of $149,000 and $46,000 for investment securities held by an investee accounted for by the equity method, as of December 31, 2004 and June 30, 2004, respectively.

5. INVESTMENT SECURITIES — The fair value of cash and cash equivalents, accounts receivable, and accounts payable approximate their carrying value. Cash and cash equivalents consist of demand deposits and other highly liquid investments with an original term of three months or less. The investment portfolio has various maturity dates up to 28 years. A daily market exists for all investment securities. The Company believes that the impact of fluctuations in interest rates on its investment portfolio should not have a material impact on financial position or results of operations. Investments in debt securities that are not cash equivalents and marketable equity securities have been designated as available-for-sale. Those securities are reported at fair value, with net unrealized gains and losses included in accumulated other comprehensive income, net of applicable taxes. Unrealized losses that are other than temporary are recognized in earnings. The Company does not believe there are any significant individual unrealized losses as of December 31, 2004, which would represent other than temporary losses, and there are no unrealized losses with a duration of one year of more. Realized gains and losses on investments are determined using the specific identification method. It is the Company’s intention to use these investment securities to provide working capital, fund the expansion of its business and for other business purposes.

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At December 31, 2004, the Company had net unrealized losses of $28,000. At that date, the net after-tax effect of these losses was $18,000, which is included in accumulated other comprehensive income within shareowners’ equity. For the six months ended December 31, 2004 and 2003, purchases of investment securities totaled $7,341,000 and $909,000, and sales of investment securities totaled $5,026,000 and $5,846,000, respectively.

The Company owns a 14% interest in Cybernet Systems Corporation (Cybernet), 12% on a fully diluted basis. This investment, with a carrying value of $1,821,000 and $1,677,000 at December 31 and June 30, 2004, respectively, represents the Company’s equity interest in Cybernet’s net assets plus $770,000 of goodwill (no longer being amortized in accordance with SFAS No. 142, “Goodwill and Other Intangible Assets”). The investment in Cybernet is accounted for under the equity method, and is included in other assets on the condensed consolidated balance sheet. The Company’s share of unrealized gains (losses) on available-for-sale securities held by Cybernet is carried in accumulated other comprehensive income (loss) within the shareowners’ equity section of the Company’s balance sheet.

The contractual maturities of debt securities, and total equity securities as of December 31, 2004, were as follows: