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Sparton Corporation (NYSE:SPA)

Q3 2014 Earnings Conference Call

May 7, 2014 11:00 ET

Executives

Cary Wood - President, CEO

Mark Schlei - CFO, SVP

Michael Osborne - SVP, Corporate Development

Analysts

Arnie Ursaner - CJS Securities

Tom Kerr - Singular Research

Rudy Hokanson - Barrington Research

Steve Shaw - Sidoti & Company

Ross Taylor - Somerset Capital

Sasha Kostadinov - Shaker Investments

Andrew Shapiro - Lawndale Capital Management

Question-and-Answer Session

Operator

Thank you. (Operator Instructions) And our first question comes from the line of Arnie Ursaner with CJS Securities. Please proceed.

Arnie Ursaner - CJS Securities

Hi. Good morning. I guess this press release raises a few questions and I wouldn't mind having to expand a little bit on. In the last call, you had talked about all three of your businesses expected to be up and two of them organically were down, so in both cases we have some reasons, but maybe you can expand on that?

Let's start with the easy one, on complex system, the (indiscernible) from one customer what is the – has that already been made up, or will it be made up in the course of the year, or is it shifting into next year?

Cary Wood

We expect that to be made up over the course of the coming quarters. It's not uncommon for us to experience either delays or engineering changes or volume shifts. But, we think the difference that we saw in Q3 on a year-over-year basis essentially negligible. But we do – we expect that impact to really come and go and be made up between now and the end of the year frankly.

Arnie Ursaner - CJS Securities

I'm sorry. In complex, your decline was a $1.4 million, was this single contract greater than a $1.4 million?

Cary Wood

It was close to that number. There are some other minor shifts, but generally one engagement, one shift accounted for the majority of that number, correct.

Arnie Ursaner - CJS Securities

Okay. Thank you. And then you are going to talk about medical?

Cary Wood

Hey, medical, is obviously a bit of a different conversation altogether. I mean there are other shifts there. And again, it's an ordinary course of our business. The shift that we didn't necessarily anticipate within Q3, but we knew that there was active conversation around was the reshifting and the rebalancing of our engagement with Fresenius. There are certain SKUs that we will increase our business and exposure, two, we are in the process of coding a new opportunities that will come with time but there are certain applications that we will see a reduction and over the course of the next several quarters.

Arnie Ursaner - CJS Securities

And what is the basis of the reduction, are they insourcing finding a different outsourcing company, what's the reason they are shifting if you would?

Cary Wood

They are insourcing. And it's a tricky conversation. We are a very close partner to Fresenius. We work closely with them helping solve some of their own challenges. Obviously, with Fresenius having acquired Fenwal, they are reevaluating their footprints. I don't want to get too far out of bounce with what we believe they are anticipating to do with that footprints. If I were an acquirer such as Fresenius, I would be looking at optimizing it. I would be looking to potential close consolidate move, expand where I should. And I think that's all the active discussions that they are having and frankly we are participating in.

So I think that again, it's a very complex issue. It's a highly technical and sophisticated device that they are looking to internalize again, very tricky to do. We are helping them with that as we speak. And we expect that the impact going in the next year as we have guided in the more recent Q is to be potentially as much as $19 million. And we are certainly seeing some of that in Q3 and we expect that we will see that in Q4 as well not entirely outside the bounce of ordinary course of business. It just happens to be a size of which we have to report otherwise you wouldn't hear a thing about these are the types of things that we deal with every single quarter with a good number if not the majority of our customers.

So again, it's a not inconsequential. We didn't necessarily expect to see this quick as what we have. I think generally speaking its probably being managed through adjustments in their current working capital, which is in my view a bit of a safety. But, I might not want to go to this quickly. But that said, their ambitions are essentially insource at least one SKU and we are going to help them do it.

Arnie Ursaner - CJS Securities

Okay. So just to clarify, you obviously have fixed cost, if you lose this much revenue roughly 13%, 14% of what we have modeled in medical, how is it possible you could maintain margin if you are using your facilities?

Cary Wood

Uncomfortable with the way we respond to changes in revenue. Not all costs are fixed obviously there is a portion that is. But we feel very, very comfortable with how we will adjust and respond as quickly as the tail end of our third quarter going into our fourth quarter. I think a lot of the analysts' outlook for the quarter is I believe very good. And while we may see revenue impact sooner than later we don't expect that we will see a dramatic cost impact. We will respond and already have to what we need to do. That's the very nature of our business is when we see these types of things we have to adjust quickly.

I think frankly, that's one of the differentiators of who are compared to a lot of our peers if not all of them. I think we adjust very, very quickly. We have a finger on the pulse of those types of changes. We adjust and I expect that's what we will do. So I'm not frankly concerned about how we will respond on the cost side.

Arnie Ursaner - CJS Securities

Thank you very much.

Cary Wood

Thanks Arnie.

Operator

And our next question comes from the line of Tom Kerr with Singular Research. Please proceed.

Tom Kerr - Singular Research

Hi, guys. Two quick questions, pretty minor. But back in the complex there been organic decline, does that imply there is large customer concentration in that segment, I know there is obviously you have two segments, but I didn't realize there was that much in the CS segment in terms of learning.

Cary Wood

Yes. Tom, there has always been a presence of a handful of customers that had sizeable not necessarily reportable but sizable engagements, Goodrich and Raytheon and all there – and those are all engagements that haven't necessarily been small engagement. And if we see a minor shift like what we just have talked a little bit about, its not small in its impact. I mean this is a little bit an exception to the norm. But, there is a handful of customers in there that represents a little more size than others.

Tom Kerr - Singular Research

Okay. And then one just minor, your income statement item is R&D line is – it declined over the quarter and I would think with all the acquisitions that would go the other way. So kind of all in or all of these acquisitions which good way to look at total R&D line maybe on an annual basis?

Cary Wood

Recorded over the course of the last several years that our R&D is half a point of point of revenue. And we have been large – the organization to the point where the dollar size that we spoke to in the previous years will remain relatively flat. But I would also add to that conversation that we went into our IR&D projections few years ago with the same kind of five year discounted cash flow we would in any kind of acquisition.

We are two and a half years into the development of the handful of products we launched a good number of them two or three in the last few years. But really optimistic about this upcoming year we were guiding internally some optimism with customer engagements.

I wouldn't rule out the guidance that we have given at IR&D as a percent of sales but also know that some times those quarters of activity have been slow. And I would maintain the guidance we have given in the past.

Tom Kerr - Singular Research

Okay. And that's all. And then just lastly just assuming general outlook on the M&A world up there, its – price are still high, still 15 deals or generally do you guys needed adjust all these acquisitions before you sort of moved forward, or how do you think?

Cary Wood

I think we are in a good place Tom. I mean the deal flow that I have been talking to for well over a year now has really started in large as a result of the activities the previous two or three years. Obviously these things don't come and get executed over night. So we have been in longstanding conversations some varying degree of diligence with a good number of them. We have increased our bandwidth internally to support it. We are approaching it a whole lot less as an event and more a normal due course of business. We have executed this year on roughly four of them.

And we are optimistic that there is more event to come. I don't feel like we are in digestion mode at all. Everyone of these more recent than is that – you are plugging them in. We are making quick adjustments. I think that the effort we put into our diligence is more than paying off because every bid of what we feel like needs to be addressed and how we might further optimize them as a matter of marriage, we will quickly address. And I think we are very careful about how we assess the culture. And we make sure that it fits who we are and what we are expecting out of them and everyone of them has delivered well and been integrated quickly. And where we have had any unexpected adjustments, we have to address them and we moved on and we have not seen a single glitch in the expectations of how they might perform.

Everyone of them has at least performed at the way we internally guided and evaluated them on a discounted cash flow basis. I'm very happy with our program and I expect that we will continue to move forward lots of optimism on that front.

Tom Kerr - Singular Research

Great. Good job. That's all I have. Thanks.

Michael Osborne

Thanks Tom.

Operator

And our next question comes from the line of Rudy Hokanson with Barrington Research. Please proceed.

Rudy Hokanson - Barrington Research

Again, thank you. Good morning, Cary. Good morning, Mark. I was wondering could you talk a little bit more about the Sonobuoy sales and DSS in the quarter. And I was wondering, is there anything in there related to the newer versions maybe for foreign sales or if you have been able to start anything with the U.S. Navy on those? Or would that just then maybe restocking inventory, if you could pull that apart a little bit and give an idea as to this is something that is becoming – could be viewed as sort of a normalized run rate right now or it was just a fortunate quarter in terms of what came together.

Cary Wood

It's a good question. And there is a lot there. See, if I can kind of peel back that question Rudy. We had a very solid third quarter. And if you look at last year's third quarter not as strong. We saw good foreign volumes. We saw obviously good domestic volume. We saw a good leverage of our cost down there and we saw good margins flow through as a result. But as you know you look over the course of the last several years on a q-over-q basis you can see that there is a little bit of – as much as I hate to use the word volatility in terms of how it performs. And has a little bit to do with timing of the demand, the availability of the testing and into some degree the navy's plans and inventory being one of them.

Yes. It was a good quarter. I wouldn't necessarily call it a fortunate quarter. I mean its very much inline over the course of an annual basis what we expect to see. We saw a very robust fourth quarter last year. I think we will finish strong. And I think that we will finish kind of inline with what we expected internally at cost. We will see a little bit of a softening on the medical side rev. But I think we will make up for that in other places but generally speaking it's a combination of good quarter both foreign and domestic up, was restocking in inventory component of it. Yes, was availability the range part of it, it typically is.

And I think I got to just about every bit of those questions. The only question you didn't ask perhaps was inferred, is this a portion of the new contract. I'm hard pressed to talk too much around that just yet. We are in active dialog. It's hard for me to say exactly where we are in this nine inning game, but it is much more active in the last several weeks than it has been in the prior weeks, so much so that I have even had my own engagements with the (indiscernible) platform.

So we are progressing, I'm confident, it will materialize, I'm as frustrated as anybody else is including the navy around the fact that we are not completed and consummated in moving forward. But it is a big deal. But I wouldn't suggest that what we are seeing in the third or even into the fourth has anything directly to do with this contract just yet.

Rudy Hokanson - Barrington Research

Okay. Thank you. With the product that you are developing for the P8, do you have any product you have talked about that India; I believe was looking at getting some of these planes and possibly becoming a customer. Do you have any type of product being offered to foreign customers yet, or is that still something that will be exclusively first like U.S. and then it will go to foreign customers?

Cary Wood

You are correct. India has involved themselves in the P8, and then one of the first to step forward and acquire some of those aircrafts. We have provided both domestically and foreign some degree of testing and prototyping. I'm not going to speculate just yet as to how we might see the high altitude being engaged with India and others that might acquire their way into the P8 that would be nothing but speculation at this point, so I don't want to get too far into that.

Keep in mind that this new contract is inclusive of high altitude and legacy product not just exclusively high altitude. And I think that's an important distinction. I do think that we have other involvement that's worth mentioning on the P8 that will include our Aydin ruggedized display. So whatever questions you are asking about the context of the Sonobuoy also have a little bit to do with the acquisition we made on the Aydin display side.

So broad question, I think generally we were optimistic around the contract, I wouldn't exclusively suggest that more recent volume has to do with the ramp up. But, we are continuing to make progress, is it going to go to foreign first versus domestic. Again, I would be speculating, I suggest that there will be versions and iterations to the device that we might provide to foreign over domestic. I certainly know the U.S. Navy is wanting to prioritize as soon or later. But again, keep in mind as I said for a very long time that this is no clean switch from low to high and just simply not going to be [teasing] (ph) time soon.

Rudy Hokanson - Barrington Research

Okay. Thank you very much.

Michael Osborne

Thanks Rudy.

Operator

Our next question comes from the line of Steve Shaw with Sidoti & Company. Please proceed.

Steve Shaw - Sidoti & Company

Hey, guys. I was wondering, is there anything out there whether its delivery of the P8 to Australia or search for the Malaysian flight that might make foreign Sonobuoy orders a little more transparent in the short-term? I know they are sometimes choppy and unpredictable.

Cary wood

If I interpret the question correctly Steve, I think you are asking are there – by the foreign dynamics that might generate some type of a change in volume, is that essentially the question?

Steve Shaw - Sidoti & Company

Yes, in a way.

Cary Wood

Those are very, very hard to predict. We have seen some years up, some years down. I think we have a handle on some of the expected norms. Obviously, when you see things going on that involve Russia, when you see things that are going on that involve China and the South China Sea, certainly it was – we were involved as a joint effort through ERAPSCO who are the search for the missing Malaysian aircraft, those are the ERAPSCO devices that were put to work. And there are certainly things that don't heard with some of the foreign demand if you will regardless of the fact of the circumstances.

But, we try not to make too bigger deal of our engagement in that. But otherwise, it's hard to suggest to you that what's going on in the Ukraine and Russia is going to generate more demand. I can't suggest to you that like everybody else I would expect that when those dynamics pop up, we ought to be wondering around what the navy is doing or not doing. And we have seen those trends.

So we go back to last summer when there is a Syrian issue, we are being engaged. You ask about what's going on in China, and what's going on in South China Sea when you have circumstances there. We tend to be dragged in – at the very least through conversation. So it's hard for me to speculate. It's hard for me to tell you that those dynamics aren't going to generate more volume. So right now it would be pure speculation on it Steve.

Steve Shaw - Sidoti & Company

Right. And then one more, is there any update on the NavEx development?

Cary Wood

Yes. That's what I was referencing a little bit too earlier when Rudy asked the question. I believe was Rudy. We have been involved in a good number of years in IR&D investment. We approached it like we would on acquisition and said what's the intermediate to long-term benefit with this type of an investment and bringing forth a product that is adaptable to other end markets.

And we have done that. And we speculate it and I think we have made a good bet. We have involved ourselves with an exponentially higher number of OEs and the defense primes. We are starting to see very material types of conversations and we expect that sales going into next year going to be better. It's hard for me to go ahead and guide. But I would suggest to you that the levels we have seen in the trailing 12 months are much more robust than I have seen in year’s prior, years prior. And I expect going into next year, the increase will not be inconsequential. So I'm very pleased with the progress we are making there. And we are moving into kind of year three almost year four of the investment IR&D pieces. And I'm anxious to see how well it's going to prove out.

I have always said that business segment would never be a material standalone kind of business segment. If it ever got to the $3 million, $5 million up to $10 million revenue producer particularly at the times of margins you would expect with IP like of ours. It's a good strong contributor.

And it's a part of our three legged store. So I have absolutely no concerns around how it looks in the coming months. It doesn't mean that two years ago, I didn't have my concerns just generally because of my impatient for it. But it looks to me like it's starting to materialize. But again, I want to be cautious around the expectations there. It will never be in my view a material revenue. It will be – we believe it will be at a fairly healthy margins if you will.

Steve Shaw - Sidoti & Company

Okay. Thanks.

Cary Wood

Thanks Steve.

Operator

Our next question comes from the line of Ross Taylor with Somerset Capital. Please proceed.

Ross Taylor - Somerset Capital

Great quarter, gentlemen. And most of the questions I have had been addressed, but I want to touch on a couple of things real quick. One is Fenwal somewhat analogous to what happened with Roche several years ago.

Cary Wood

It's hard to say how the Fresenius Fenwal relationship will play out over the course of the next year. When I think back to one of the more analogous types of engagements more importantly something like a Siemens, I would say that they are somewhat different. Siemens was uncomfortable with our liquidity crisis if you will albeit we had come through it. And think most of our ratios were better than Siemens as an entire corporation. They were already well down the road towards having made that decision of moving that product. Probably for all the wrong reasons of my bet that the total cost of that move far exceeded any kind of service and type of margins that they were getting with us.

That said, I see this as a slightly different. First, we have a very strong relationship with Fresenius. We are deeply engaged with providing them engineering redirection of the products, ease of service, ease of manufacturability, we are giving the product design ideas material substitutions. We have been a very solid partner to them.

And like that if I speculate it, that has a lot of reasons, lot to do with why they lean on us for new business volume increases aren't new SKUs. And even as far as hey, look we are thinking about utilizing some assets of our own. It's not something we have done before, like that as you can understand why and we want to understand if you can help us get there from here. And that's the bit of the conversation.

Again, I don't want to go too far so as to put myself on an uncomfortable spot with a good partner. So I only suggest to you that it's a tricky transition. It is a highly technical product. It's not something that they have been involved with before. We are going to make sure that goes as well as it can for them and that's really how I would differentiate, our experience with them currently from some of the ones that we have seen in the past.

Ross Taylor - Somerset Capital

Okay. And in that same vein, do you see anything about this developing situation that causes you to feel that you can't achieve the roughly $500 million 10% EBITDA margin targets that you have been talking about for the end of fiscal 2015?

Cary Wood

I’m still very bullish around the guidance I gave three plus years ago on our fiscal 2015 plan. Now, I have always qualified it Ross, with look I will apologize if I finish a $445 million or $450 million on a run rate basis, I'm experiencing solid sustainable repetitive 10% types of EBITDA margins because we have probably steered away from some bad engagements or bad deals that's the component of this that I can't control. But I'm pleased with their business development effort and the new business that we won.

I'm pleased with what we have done in the acquisition front and I like the fact that we have significantly dialed up our infrastructure and we have proved it over the course of last three or four that we can move quickly get things integrated and integrated effectively and very much inline with our thesis.

And then lastly, as I mentioned earlier in the call, our R&D efforts are starting to bring some good results. So I don't feel comprised as I sit here today against the fiscal 2015 outlook. And again, it's a run rate type of perspective. It's at the end of 2015, so we are about a year and a quarter away. I know what the M&A pipeline looks like. I know what our new business pipeline looks like, I know what our organic efforts are. I'm still very, very comfortable with that type of guidance and I stuck to it, don't expect to change. I'm still fairly confident of that.

Ross Taylor - Somerset Capital

Okay. Great. Also J&J had a product pulled or effectively pulled out of the market by the FDA, does that have any impact on you either negligibly or potentially positively?

Cary Wood

First of all, it has no direct effects given that we are not involved with that product. As you might expect, there is competing technology that is often out there waiting in the wings and in this case we being who we are both having engineering capabilities certainly with the acquisition of Aubrey. But also the manufacturing assets and being as problem solvers as we are, as quick as we respond, you might bet and speculate that we are involved in some competing technology that we might want to help some folks out with.

So again, I don't want to go too far into that. We serve a lot of medical customers. But generally speaking it does not affect us directly. The answer is definitely no. Are there competing technologies that were involved with certainly we were open to those types of conversations and we have been.

Ross Taylor - Somerset Capital

Okay. And lastly, with Sonobuoy potential contract, what level of capacity is your facility currently operating at?

Cary Wood

I quoted it, roughly 50% to 60% utilization. But, I also want to qualify that. And that is that there is currently no physical impediments. There is no variable cost related impediments. There is no headcount restriction. There is no readiness restriction. There is no capital acquisition that we are looking to make all be very small that is pitching us. There is nothing that gets in the way of the expected volume of the high side of what the navy has projected over the course of the next several years.

So 50%, 60% utilization and more importantly I think your broader question is around readiness, and we are ready.

Ross Taylor - Somerset Capital

Well, I actually want to try and get at is, generally in an operating standard manufacturing company, if you are running it 50% of capacity and you are looking at roughly doubling sales, not necessarily doubling units let's say having a substantial growth in units. One would expect to see significant operating margin improvement as a result.

Cary Wood

Yes. And I have said before that there isn't a lot from an infrastructure related expense, capital expense that's going to need to be executed. This is a lot of variable related scale off. So I understand what you are asking and I think generally I would agree that this is probably driven more by variable adds which are linear not fixed cost adds. So you are correct there is – so part of this that is about fortune for sure.

Ross Taylor - Somerset Capital

Okay. Great. Thank you very much. And keep up the good work and look forward to seeing how you guys put the Fenwal situation in the agreement.

Michael Osborne

Thanks Ross.

Operator

Our next question comes from the line of Sasha Kostadinov of Shaker Investments. Please proceed.

Sasha Kostadinov - Shaker Investments

Yes. Hello. Thank you for taking my questions. How much or if any was there an impact to your medical business in the quarter that you just reported from this insourcing by federal?

Cary Wood

I was just balloting real quick. It was a couple of million dollars in the quarter.

Sasha Kostadinov - Shaker Investments

Okay. And do you expect that you will be able to maybe not next quarter but following quarters after that show organic growth or will your organic growth be negative in the next couple of quarters?

Cary Wood

We expect that they are going to continue to be good organic momentum as we look between now and the end of fiscal 2015. If you are asking about that on a segment basis, medical compared to a consolidated uncomfortable with consolidated, obviously we have done some good things in other pockets of medical just by example, the efforts that we are undergoing up in our Watertown facility. We compensate in the immediate term, the softening that we expect to see as a result of the Fresenius shift, no.

Do we have a guidance internally as to when we think that will come right back around we do? I think generally to get to the point we will see a softening in Q4 that we won't compensate in medical along with and we won't see that probably until we get to the close of the first half of next year.

But, I do think the organic momentum will compensate for that as we go into full fiscal next year. So I'm not concerned about the consolidated. We just got a bit of a headwind issue to deal with over the course of the next two and a half to three quarters in medical alone.

Sasha Kostadinov - Shaker Investments

Okay. So just to make sure that I'm clear, so on a consolidated basis you expect your organic growth rate to be positive going forward?

Cary Wood

We do. We do. Very much in line with the guidance I have been giving for many years. And we have been guiding 3% to 5% band and I expect that to be the case.

Sasha Kostadinov - Shaker Investments

That's very impressive. All right. Thank you very much.

Cary Wood

Thank you.

Operator

Our next question comes from the line of Andrew Shapiro with Lawndale Capital Management. Please proceed.

Andrew Shapiro - Lawndale Capital Management

Hi. It's Lawndale.

Cary Wood

Hi, Andrew.

Andrew Shapiro - Lawndale Capital Management

I have a lot of questions on topics of interest have been asked and my questions are a little more detailed or fill around the few of them since you could help out on a few items. Regarding the – we call it the Big Kahuna, the big Sonobuoy five year RFP that you applied for. Based on past conversations, I think we are all of view that we would have expected that things would have worked out and have been negotiated by now. But, covenant budget impasse et cetera. Do you feel like this wall come to head, they will be ideal. Do you announce at least by the end of your fiscal year end of June or this may drag on beyond the current fiscal quarter?

Cary Wood

I certainly hope so Andrew. I'm as frustrated as anyone else. And I haven't typically said many things particularly in the public venue that I haven't delivered on over the course of the last many years. This is a case where we haven't been quick to agreeable for the sake of timing and we are managing through a very large RFP highly technical, lots of hands involved in this. Nobody is taking this lightly. Obviously, the magnitude for both us ERAPSCO is all of a navy or not small, the stakes are high.

So we are scrutinizing every bit of this new contract as you would hope us to do and that has had at least hand in delaying things. Do I expect this sooner than later, I really do. I do know that the last several weeks have been fast and furious. As I mentioned, I had been in direct conversation with the (indiscernible) platform. I know they want to get moved along and there had been exchanges a point of clarification and we're making good progress. I'm optimistic. It's just a matter of timing and we don't necessarily control the ball all the time.

Andrew Shapiro - Lawndale Capital Management

So why I'm asking or some of the additional color on this is that. I had a long history with the company. These are two-year contract historically, this is a five year and the RFP at least, you had two-year historical contracts, we follow and watch your backlog. If I'm correct, your backlog has dropped, the round of this particular RSP as you've mentioned contains legacy Sonobuoy is not just high altitude, we call it foreign conflict risk has escalated and the backlog dropping we're not giving our – we'll call it annual round of two year contracts. Do you have visibility into, are you seeing or is there some issues whereby legacy Sonobuoy inventory at the navy could be more eaten up and consumed whereby – they're going to need those legacy Sonobuoy regardless of when you cut the deal on the high altitudes.

Cary Wood

Well, keep in mind just for clarification, the new deal is inclusive of not just high altitude, but in mix of all constructions including the altitude as well so…

Andrew Shapiro - Lawndale Capital Management

Exactly. That's why I raised the question because your backlog is down, they haven't ordered in a while, you're working off of the last round of again does an annual contract each year, but do you worked off of the one, two years ago, long ago and you're working on really the last round of contracts and they are throwing Sonobuoy out in front of the carrier task forces everyday as more and more Russian subs are hitting seas.

Cary Wood

Right. Yes, I mean your observations are fairly accurate. I think the most material of your statement is that backlog has been affected in no small way in the more recent quarters by delay and by otherwise been a DSS Sonobuoy order before now, which is typically been the case. So I have sensitized our backlog to have a better sense of what I should have been seen before now.

I’m also looking at on a segment basis, it's essentially flat in one and up in other, up in medical and flat in CS, and we know why CS is what it is. I'm comfortable with how that's going to look moving forward. The real mover of the needle is DSS. So I think if I hear you correctly, you're right. The external kinds of market demands are driving consumption. The inventory assuming it is, what it is, is got to be affected by that and we're seeing no contract having been necessarily execute. I think all your observations are reasonably fair. We'll get this contract executed.

I don't think it's going to change when the navy wants Sonobuoy. They're going to come looking for Sonobuoy. So contract or not, they will come to us when they want them.

Andrew Shapiro - Lawndale Capital Management

So when and if that happens in historical military contracting activity, they have their arms like negotiations in your – there is [Ross] (ph) product up, you got this potential overhead absorption that would get swallowed away and we normally may be resolved a lot of bottom-line margin, but that is also arm-length negotiating to get negotiated away. But when military comes to a manufacturing like you were anyone else. On the short notice, it's okay. I need a ton of Sonobuoy and I need them yesterday. Usually that kind of expedited production results in a much higher margin negotiation.

Is that something that the possibility that the navy ought to consider and are a possibility for us as shareholders in this company to see if they – the situation piddles around for too long?

Cary Wood

Every bit of that is speculation; I understand where you are coming from. I don't think that for a moment we don't use those very arguments in conversations with the seller group as well as the buying group and point out the fact that wanting everything yesterday will make it very difficult terms in the immediate term. But it look every bit of the speculation I certainly don't, I mean, the business of managing under promising over delivering is what I've executed against. So I want to maintain that kind of role here and that is – until the contract executed, it would be pure speculations how we see quarters play out.

Andrew Shapiro - Lawndale Capital Management

Okay. Understand. Regarding the advance payments from the navy, they are down to levels not seen in the long time as well, I just want to confirm, this is a function of the reduced backlog and sizeable RFP or has there been any change in the purchase in funding terms of the navy?

Cary Wood

You are correct in your first point. It is a function of the backlog change or the failure to execute a new contract and it being in the backlog. So you are absolutely correct. That's the change.

Andrew Shapiro - Lawndale Capital Management

Are you allowed to more fully describe the 14 military projects that Spartan sensors are going into test phases with – then you referred in your press release?

Cary Wood

I want to stay away from the specifics. I'm going to maintain kind of what we said before now and in other investor conferences, FD environment is that we are involved in a good number of unmanned vehicle applications. They could be air, land and/or sea. As you would expect a lot of different primes are quoting on very similar if not exactly the same program. So I would be hard pressed to go into too many of those specifics and find ourselves at odds with people that we're engaged with.

So generally speaking – I'm pleased with the progress. And we have more than good number of them.

Andrew Shapiro - Lawndale Capital Management

One or two strategic questions. Just regarding your past and current acquisition strategy, what's the backward in Aubrey acquisitions they ended you into geographic markets you have previously discussed with all of us. You were seeking to get into it. What remains strategically now that you seek or all your future acquisitions albeit potentially larger, all your future acquisitions tuck-ins to what the template you now put on the math?

Cary Wood

There is a couple of different components to it. They are vey much the same. There are still some regional pockets that we would like to fulfill some capabilities in. We like the idea of the Northwest. We like the idea of the biotech corner of Northern California. Yes, we have got an engineering site presence in Southern California, but I still think it's important that we find some capabilities on the manufacturing side in Southern California.

While we are still – while we were in the Northeast, I still think that we are going to be looking to fill some pockets of engineering capability. There is some regional pockets. I just gave you a handful of them. I like and certainly really like the idea of tuck-ins, close consolidates lead behinds like we have executed a number of times before now. And we will continue to seek those out. And those are on our pipeline.

There are some products that we have discussed that we would like to probably take a look at particularly given that we have now find our way into the ruggedized display piece. It's a fairly fermented space there are some smaller players out there that we are in conversations with. Ideally to the extent that we can do close, consolidate better utilize assets but extend our product reach with ruggedized display beyond the end markets that we are primarily involved with certainly a part of our thesis.

All of this is important to say, we are going to go through with some level of detail in the October timeframe where we highlight our progress against the 2015 and then we talked a little bit about the 2020 vision and that certainly a part of that discussion. So two or three different kind of legs to that stool within the M&A and I just talked about them. I think I gave you a good enough color there Andrew.

Andrew Shapiro - Lawndale Capital Management

Yes. Thank you very much. Nice quarter.

Cary Wood

Thanks Andrew.

Michael Osborne

Well, that will be all the questions today. I would like to thank all the participants in today's call. Again, the call including the question-and-answer period has been recorded and will be posted to our Web site at our Investor Relations later this week. Thank you.

Operator

Ladies and gentlemen, that does conclude the conference call for today. We thank you for your participation and ask that you please disconnect your lines.

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Source: Sparton's (SPA) CEO Cary Wood on Q3 2014 Results (Q&A Session) - Earnings Call Transcript
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