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Sparton Corp. (NYSE:SPA)

F1Q12 (Qtr End 9/30/11) Earnings Call

November 9, 2011 12:00 am ET

Executives

Mike Osborne - SVP, Business Development

Cary Wood - President & CEO

Greg Slome - CFO

Analysts

Sarkis Sherbetchyan - B. Riley & Co

Andrew Shapiro - Lawndale Capital Management

Operator

[Operator comments]

Mike Osborne

Thank you, operator. Good morning and thank you for participating in Sparton’s fiscal 2012 first quarter financial results conference call.

Before we begin the discussion, I will take a few minutes to read the forward-looking statement. Certain statements in this conference call constitute forward-looking statements within the meaning of the Securities Act of 1933, as amended and the Securities Exchange Act of 1934, as amended. When used in this conference call, words such as “believe,” “expect,” “anticipate,” “project,” “plan,” “estimate,” “will” or “intend” and similar words or expressions as they relate to the Company or its management constitute forward-looking statements. These forward-looking statements reflect our current views with respect to future events and are based on currently available financial, economic and competitive data and our current business plans. The Company is under no obligation to, and expressly disclaims any obligation to, update or alter its forward-looking statements whether as a result of such changes, new information, subsequent events or otherwise. Actual results could vary materially depending on risks and uncertainties that may affect our operations, markets, prices and other factors. Important factors that could cause actual results to differ materially from those forward-looking statements include those contained under the heading of risk factors and in the management’s discussion and analysis contained from time-to-time in the Company’s filings with the Securities and Exchange Commission.

Adjusted operating income, adjusted net income and adjusted income per share – basic and diluted are non-GAAP financial measures that exclude or add the effect of certain gains and charges, including imputing taxes at a 36% effective rate. Sparton believes that the presentation of non-GAAP financial information provides useful supplemental information to management and investors regarding financial and business trends relating to the Company’s financial results. More detailed information, including period over period segment comparisons, non-GAAP reconciliation tables and the reasons management believes non-GAAP measures provide useful information to investors, is included in the Fiscal 2012 First Quarter Financial Results press release and Form 10-Q dated November 8, 2011.

Today, Cary Wood, our President and CEO, and Greg Slome, our CFO, will report our fiscal year 2012 first quarter financial results, provide an update on the status of our liquidity and capital resources, and provide a brief update on the outlook of fiscal 2012. At the end of the narrative, we will allow our investors and other interested parties to ask questions related to the Company’s financial performance and operations. In fairness to all participants, we will ask that one question be asked at a time with the call ending at approximately 11:00am CT.

I would now like to turn the call over to Cary.

Cary Wood

Thanks Mike. Good morning and welcome to our fiscal 2012 first quarter call. Today, we will begin by highlighting some of the key results and events that occurred in the first quarter.

The Company’s net sales were $51.8 million for the quarter, up 13% from the prior year and gross margins increased to 16% from 15% as compared to the same quarter last year. The adjusted net income for the first quarter, which is the same as our reported for fiscal 2012, was $1.5 million or $0.15 per share, up 36% from the prior year quarter adjusted income per share. In fiscal 2011, the new business development efforts started to take hold as 22 new customer programs were awarded to Sparton. This continued into the first quarter as nine new programs were awarded with a potential fiscal 2012 revenue impact in excess of $6.0 million. In August, the Navigation & Exploration group, a subset of the Defense & Security Systems business unit, successfully launched the GEDC-6, our new gyro-enhanced digital compass, and the PHOD-1, our newly commercialized hydrophone, at the AUVSI Unmanned Vehicle System trade show and symposium in Washington, D.C. In the few weeks since the launch, we have received more interest in these products than originally anticipated indicating to us that our products are very competitive and technically appealing to a broad range of customers. As of the end of the quarter, sales backlog across the entire Company grew for the seventh consecutive quarter to approximately $145 million, representing a 6% increase from the previous quarter and a 28% increase over a year ago. Lastly, over the last three years, we have been working towards divesting our interest in Cybernet Systems Corporation. In September, we reached an agreement to sell this non-performing investment for $1.75 million with the proceeds to be received in the second quarter of this fiscal year.

I would now like to review our first quarter consolidated performance.

We are pleased to report fiscal 2012 first quarter adjusted operating income of $2.4 million and adjusted net income of $1.5 million or $0.15 per share, versus an adjusted operating income of $1.8 million and adjusted net income of $1.1 million or $0.11 per share, for the first quarter of fiscal 2011. Included in the fiscal 2012 first quarter financials are the results of operations from the Delphi Medical Systems and Byers Peak acquisitions as compared to only having Delphi Medical Systems reporting from its acquisition date of August 6, 2011 onward in the first quarter of fiscal 2011.

Our consolidated first quarter revenue was $51.8 million, increasing 13% or $6.1 million from the same period in the prior year. The overall increase in revenue reflects additional sales in the current year quarter from the acquisitions of Delphi Medical and Byers Peak, increased foreign sonobuoy sales, and increased sales, primarily in our Medical segment, to existing and new customers. These increases were partially offset by the anticipated decrease in sales to Siemens Diagnostics as well as the expected decrease in U.S. Navy sonobuoy sales.

Our gross profit in the first quarter of fiscal 2012 was $8.3 million compared to $7.0 million in the first quarter of fiscal 2011. The gross profit percentage increased from 15% a year ago to 16% in the fiscal 2012 first quarter. The increased margin percentage reflects improved results from the Company’s Medical and Complex Systems segments.

Selling and administrative expenses as a percentage of sales decreased to 10.4% of sales from 10.6% in the prior year’s first quarter. The Company incurred $0.4 million and $0.1 million of internally funded research and development expenses in the quarters ended September 30, 2011 and 2010, respectively.

No restructuring or impairment charges were incurred in the first quarter of fiscal 2012; however, the Company recorded a gain on acquisition of $2.6 million and restructuring charges of $0.1 million in relation to its acquisition of Delphi Medical in the prior year’s first quarter.

Income tax expense of approximately $0.8 million was recognized in the first quarter compared to an income tax benefit of less than $0.1 million for the same period in the prior fiscal year. At June 30, 2011, the Company reinstated approximately $11.7 million of deferred tax assets as the Company now believes it is more likely than not that it will be able to utilize these tax benefits in future periods.

I would now like to turn over the next portion of today’s call to Greg so that he can update you on our individual segment results and our liquidity and capital resources.

Greg Slome

Thanks Cary.

Medical Device sales in the fiscal 2012 first quarter increased to $27.5 million, up $8.4 million or 44% from the same period a year ago. The sales increase reflects the $5.8 million impact of first quarter fiscal 2011 pre-acquisition sales from the Company’s fiscal 2011 acquisitions of Delphi Medical and Byers Peak, and $4.6 million of net increased sales to new and existing customers, offset by $2.0 million of decreased sales to Siemens Diagnostics, reflecting the beginning impact of its intended dual sourcing of certain of its programs with the Company.

The gross profit percentage on Medical sales in the fiscal 2012 first quarter increased to 13% from 10% for the prior quarter, reflecting increased capacity utilization at the Frederick, Colorado facility, cost management efforts at the Strongsville, Ohio facility, certain favorable product mix between the two periods and the Company’s continued implementation of Lean Enterprise.

Complex Systems sales for the three months ended September 30, 2011 increased $0.2 million as compared to the same quarter last year. The comparable sales reflect $1.8 million of increased sales to multiple new and existing customers, offset by reduced demand for two customers’ programs.

The gross profit percentage on Complex Systems sales increased to 9% for the quarter ended September 30, 2011 compared to 7% for the quarter ended September 30, 2010. The quarter over quarter comparison reflects favorable product mix, improved pricing, improved performance and an aggressive continuous improvement program.

DSS sales for the three months ended September 30, 2011 decreased by $2.3 million or 13% from the first quarter of last fiscal year, reflecting the anticipated decrease in U.S. Navy sonobuoy production and engineering sales in the current year quarter, partially offset by increased sonobuoy sales to foreign governments.

The gross profit percentage on DSS sales was 24% for each of the quarters ended September 30, 2011 and September 30, 2010. The comparable gross profit percentage reflects the positive effects of increased sonobuoy sales to foreign governments in the current year quarter as compared to the prior year period, offset by overall decreased margins related to U.S. Navy sonobuoy sales.

I would now like to review our current debt and liquidity positions as of the end of the quarter. The only remaining debt outstanding at September 30, 2011 is our Industrial Revenue Bonds with the State of Ohio of approximately $1.8 million. During the quarter ended September 30, 2011, the Company made total principal and interest payments of approximately $0.1 million. Our debt to equity ratio on September 30, 2011 was at .02 to one.

As of September 30, 2011, the Company had $27 million in cash and cash equivalents and no outstanding borrowings against available funds on its $20 million revolving credit facility provided in August 2009 by PNC Bank, National Association. The credit facility is subject to certain customary covenants with which the Company was in compliance at September 30, 2011.

Summarizing our cash flows for the three months ended September 30, 2011, operating activities provided $3.2 million of net cash flows. Excluding changes in working capital, operating activities provided $3.1 million in the first three months of fiscal 2012, reflecting the Company’s operating performance during the period. Working capital provided $0.1 million of net cash flows in the first three months of fiscal 2012, primarily reflecting the collection of advance billings related to U.S. Navy contracts during the quarter in excess of the funding of production under those contracts, partially offset by increased accounts receivable resulting from increased foreign sonobuoy sales near the end of the quarter, a planned temporary increase in inventory and reductions in accounts payable and accrued liabilities.

Cash flows used in investing activities in the three months ended September 30, 2011 totaled $0.7 million and related entirely of capital expenditures.

I would now like to turn the presentation back over to Cary.

Cary Wood

Thanks Greg.

Finally, I would like to close the presentation by providing a brief outlook on what to expect for the remainder of fiscal 2012.

Despite the declines in the Ohio Medical business in fiscal 2011, we believe we have positioned the Company to offset these reductions with incremental revenue from our Colorado acquisitions combined with increases in volume from across the Company as our business development efforts continue to result in new business awards. I am encouraged by some of the new opportunities that were awarded in fiscal 2011 as well as the most recent awards in the last quarter, the size of our still developing new business funnel, and the $145 million of backlog as of September 30, 2011.

We have started to see positive momentum around our newly commercialized navigation sensors and hydrophone products and will continue to selectively invest in internal research & development projects.

Additionally, we continue to remain acquisitive in our search for potential acquisitions that fit with our strategic growth plan.

As in the past, we will be presenting at various investor and trade show conferences, meeting with our existing investors, and calling on potential new investors throughout the year. In the near term, some of the events that will be occurring are:

meetings and a presentation at the SRA's 7th Annual Fall Growth Stock Conference in San Francisco from November 15th to the 16th,

the BioMEDevice trade show in San Jose from December 6th to the 7th,

a presentation at Sidoti’s Annual Investor Conference in New York on January 9th,

meetings and a presentation at Noble Financial Capital Markets' Eighth Annual Equity Conference in Fort Lauderdale from January 15th to the 16th,

the AFCEA West 2012 trade show for military related complex systems in San Diego from January 24th to the 26th, and

the MD&M West trade show in Anaheim from February 14th to the 16th.

As we continue to execute on our strategic growth plan, reflective in our recent new business wins, proprietary product launches and increasing backlog, I look forward to reporting on future organic growth successes. At the same time, we remain engaged in our search for and discussions with acquisition targets that can fit strategically into our business and remain committed to our vision of Sparton becoming a $500 million enterprise by fiscal 2015.

We thank you for your support.

Mike Osborne

Thank you, Cary and Greg. We will now open it up for questions. Operator, the first question please.

Question-and-Answer Session

Operator

(Operator Instructions). Our first question comes from the line of Jimmy Baker with B. Riley & Co. Please go ahead with your question.

Sarkis Sherbetchyan - B. Riley & Co

Hi, this is Sarkis stepping in for Jimmy.

Cary Wood

Hi, there. Good morning.

Sarkis Sherbetchyan - B. Riley & Co

Have you received anymore clarity from Siemens regarding the timing or the magnitude of the impact of their second sourcing initiatives?

Cary Wood

I think that there's a couple datapoints that we're able to interpolate, and I think that we've had ongoing conversations with them not just domestically here in the US but we've also met with them recently in Germany and that's their central point of sourcing. And I think we generally have some additional clarity. It's probably not to the extent that we would ultimately like. But our guidance as of this time last year or this time last quarter was that two programs that would ultimately impact us in the range of $12 million to $14 million, $16 million would ultimately come out of our revenue over the course of this current fiscal year. That’s 40% to 60% of two major programs.

We still feel at this point that we are on track for that. I think the one takeaway from our first quarter is that some of it had come about faster that we expected. It's in part the largest difference from what the Siemens backlog was in previous quarters, and so I think the takeaway is that our guidance continues to be somewhere between $12 million and $16 million. While it was expected to have occurred more substantially in the third and fourth quarter starting more in the second quarter, I'm actually pleased that its happened as quickly as it has in the first quarter, and on top of that we are certainly pleased that some of the opportunities in other business segments including medical have done as we gave guidance has more than offset that.

So the takeaway is that if there's anything different it has materialized in the fourth quarter where we didn’t expect it to really materialize until the second quarter but I think the guidance remains the same. And that really is the extent of our clarity and I think that’s exactly what's been given us and I think that’s pretty much what we expected other than timing.

Sarkis Sherbetchyan - B. Riley & Co

Okay, and following up on that, can you give us a little more color on the visibility in your new business funnel particularly in the medical segment?

Cary Wood

Well, there's really two data sets there that we use, first of which is backlog. And as we mentioned our backlog is up again for the seventh straight quarter. A good amount of that backlog has been and continues to be medical. If there is a difference on a quarter-over-quarter comparison in medical the largest majority of that is, as we would expect, a change in the Siemens forward-looking backlog.

The second set of data is our new business funnel. And that’s a little bit tricky to give any additional color around. It is not an inconsequential size of new opportunities. They just vary in some level of subjectivity as to how solid those opportunities are. We try and handicap them; we put a certain priority number around them based on where they are in the process. For instance, if it’s a new contact, a new prospect that we are in discussions with them about opportunities we certainly handicap that on the low end of our new business funnel. But if we've started some mock up designs, we've had conversations around drawings, we've entertained discussions around quotes and we're even in discussions around terms and conditions then we might give that a higher degree of probability on a new business win.

It's not a small funnel. It does substantially eclipse the $100 million mark, but it's hard for me to sit here and tell you that its $150 million to $200 million of forward-looking opportunities of which 75% of it will happen. There's a variety of moving parts there.

I think the real takeaway there is that its larger than it was a quarter ago, it was larger a quarter ago than it was the same time a year ago and that we've put far more sophisticated disciplines in place to handicap it, prioritize it and resource it.

Sarkis Sherbetchyan - B. Riley & Co

And on that note, can you please remind us of the average sales cycle length in that segment please?

Cary Wood

Sure. Each of the three segments are a bit different, the shortest of our three different reporting units starting with complex systems is a little bit shorter. There are opportunities or conquest opportunities in complex systems; the new opportunities can wallow in a little bit quicker. Generally, we've looked at that as being anywhere from a shortest six months on the prototyping side for sure and then it's starting ending up being 9, 12 and the upwards of 18 months. And then when you start looking at the further end of that scale our defense and security systems segments, given the complexity of anti-submarine devices and frankly, those are more around engineering developments and we have a clear cycle though that’s a much longer selling cycle those are highly technically highly engineered solutions for alternatives other than anti-submarine and that’s in the upwards of 18 to 24 months. And the medical piece can fall somewhere in the middle, and I think generally the way we handicapped that is 12 to 18 months selling cycle.

Sarkis Sherbetchyan - B. Riley & Co

Okay. And on the DSS side, what are you hearing from foreign governments? Are you on the cost of any significant new business there? It seems that the sales channel has been dormant for some time and that there ought to be some sense of demand coming back in the market. Can you give us your thoughts around that?

Cary Wood

Yeah. And it clearly was demonstrated in our fourth quarter sales. If you look at the mix between domestic and foreign sales, our foreign sonobuoy sales in the first quarter of fiscal’12 was an excessive, I think its $7.5 million or is it in $9.3 million. It was $9.3 million up $7.5 million from prior year. So, we saw substantial increase in foreign sales in our first quarter. And again, I don’t have to tell you that we are just one quarter into a year. So, we saw substantial gains in foreign sonobuoy sales already in the first three months of this year.

Sarkis Sherbetchyan - B. Riley & Co

Okay. And can you help us understand the inventory increase and may be provide some additional color on what that may be related to?

Cary Wood

Yeah. I think generally speaking there's a couple of things that contribute to that. Our ambitions are and we are quite comfortable that moving to an inventory turn methodology with an average turn of between 5 and 6 is something that is clearly in our line of sight. Our first quarter was about 3.5 turns and if you compare it to the same time last year, it was about 4 turns. There are a handful of driving issues there, the [Medtronic] and the [Covidien] transfer from Byers Peak to our location in Fredericks in Colorado is required a bit of build up. It is what we believe to be a temporary anomaly.

And if anything that is positive is that in our forward modeling of the combined state of Byers and Fredericks didn’t always include all the customers that were currently able to keep. And so we are providing good service we have done that in part by assuring them there will be no disruption in part of that has been through the creation of inventory. So, a good amount of what you have seen in that build up as come from the transition of customers and as a matter of that acquisition. So, that’s probably more the material explanation than anything.

Sarkis Sherbetchyan - B. Riley & Co

Okay. Thank you for that clarity. And do you anticipate any disruptions in the company supply chain as it relates to a component or part shortages from recent floods in Thailand?

Cary Wood

We have kept an eye on all of those issues over the last year to year and half, I mean there is seemingly no stop to circumstances that we have to pay attention to that have potential concerns or disruption on the supply chain. The tsunami on the Pacific Rim was probably more concerning to us than anything. But as it sits today, there is nothing about the Thailand circumstances it have us concerned about the supply chain. And so far, I think we have done just about all that we should to manage and to make the touchpoints with all of the critical supply chain aspects. No, at this point, there are no concerns.

Sarkis Sherbetchyan - B. Riley & Co

Okay. Thank you for that. And my last question, absent any further acquisitions, what is the expected tax rate and CapEx expectation for 2012?

Cary Wood

CapEx is going to be fairly consistent as it’s been expressed being about a point or point and a half of revenue, that is our general guidance. And it was slightly less than that last year compared to what our current run rate and revenue is. I think the only adder to that is that between now and next year we'll layer in fairly substantial investments in our enterprise system. So that will be a bit of a more near-term and normally on CapEx. But I think, generally our guidance looking back, looking ahead, and normalizing kind of the two to three year time horizon, its about a point or point and a half of our revenue. And, in terms of our tax rate, I would like Greg get into that.

Greg Slome

Yeah. We are forecasting at this point 36% effective tax rate, and you would see that in the first quarter results. Just to point out also that we still as of June 30 had a $6.5 million federal NOL that we still be utilizing as we get through fiscal 2012. So, clearly that has a cash impact favorable to us. But, overall from an expense standpoint, 36% is what we use as an effective rate.

Operator

(Operator Instructions).

And our next question comes from the line of Andrew Shapiro, President of Lawndale Capital Management. Please go ahead sir.

Andrew Shapiro - Lawndale Capital Management

To follow-up on a few of those questions that came in from B. Riley to get some clarity and I have a few individuals here. Can you, with your medical backlog, I know your overall backlog is up nicely, with your medical backlog down $2 million sequentially from prior quarter, can you help us determine by how much the non- Siemens backlog went up or down by sharing how much the Siemens backlog dropped sequentially?

Cary Wood

Yeah. Let me go back to say the March quarter end of 2011, that was the same level as what you are seeing today on backlog. And there was a lot of movement in our fourth quarter, we had a strong fourth quarter, if you remember, and that took us up, and now we are back down, as I say, to about the same as our third quarter of fiscal 2011. Now, when you just simply then bridge that, Siemens is a substantial portion of that. And then without getting into specific customers you see things ebb and flow. And we have got one customer that has probably seen some change in their external demand. It’s not an unusual thing to see them either come out of the backlog for a quarter’s time and then come back in another backlog when they get a better line of sight in the launch. But, generally speaking, it’s more materially speaking Siemens in that. There are a handful of other ups and downs. And then, there is one rather large engagement that is more about timing than anything else in my view.

Andrew Shapiro - Lawndale Capital Management

Right, but I would assume if Siemens is a potential decline of $12 million to $16 million, $2 million of that is now in the bag, is it right? That’s two of the $12 million to $16 million?

Cary Wood

I think that’s a way to look at, correct.

Andrew Shapiro - Lawndale Capital Management

Okay. So, if they have that much in the coming year that is expected to come out and that expectation occurred in the last quarter or so, it would have seemed to me that the medical backlog declines from Siemens would have been greater than $2 million and your non-Siemens backlog actually went up from last quarter.

Cary Wood

It wouldn’t be unusual for Siemens to ebb and flow over the course of -- in a lot sometimes its timing. And there are three different really moving data parts, there's the external demand, there is their own inventories, and then there is just dual sourcing initiative. I think the general takeaway is that we plan for something to be softer on our first quarter. We plan for that to have its effect on backlog, and what we are seeing is probably a stronger decline in first quarter than what was expected, and frankly that’s okay by us. The mix has, obviously been more favorable without it. And the new sales opportunities, as we expected in gave guidance, has more than offset it. And I think you should look ahead in the backlog; it’s clearly being affected at least in part by Siemens. And so, I think what we are seeing it’s probably, Andrew, just as we would expect, frankly.

Andrew Shapiro - Lawndale Capital Management

Okay. Now presumably, Siemens single source products with other parties not just Sparton and just other products and that might see your capabilities. Can you describe any opportunities if any might arise from this, and if you've identified products or competitors that have single sourcing with Siemens that you might target in order to be the second source for those products?

Cary Wood

We most recently were face-to-face with Siemens Central Purchasing in Europe. And one of the critical aspects of that meeting was to talk about out partnership, our capabilities, the breadth of our reach, and testing, and re-sourcing. And I think that that was generally speaking very well received. To the extent that I can see here today and say that there are five new opportunities that we are taking a look at, I am not at position to do that. I can’t say that I believe the meeting went well. I believe that it was longer overdue. I think that the sourcing that took place with us was in part initiated by the liquidity crisis of several years ago. But, I do know that it is an enterprise-wide endeavor to look at dual sourcing whenever that’s possible.

So, there are things where there might be sole-sourced, but to the extent that we know how wide their initiative is to look at alternatives, I can’t comment on that. But, I can tell you that we were there. I can tell you that it was a well invested in meeting, that it was well received, and to the extent that it transits into new opportunities, we look forward to those when we can.

Andrew Shapiro - Lawndale Capital Management

Okay. Regarding Frederick a facility which is now Delphi and Byers Peak first up, is all of Byers Peak now in Frederick as of the end of the September quarter, was it the end of the June quarter? What’s the timing for that integration at least everything to be in that facility and out of the Byers Peaks facility to be done?

Cary Wood

It is to be scheduled and always was to be schedule to come to a complete close as of the month end November. And, so that’s why at least, temporarily you are seeing some of the changes in inventory to help buffer that transition. So, to shorten the answer, simply put, by the end of November the transition will be complete.

Andrew Shapiro - Lawndale Capital Management

So that means in the current quarter or in the December quarter there will be still partial redundancies and partial integration savings, and then in the March quarter is when we will see the full integration savings?

Cary Wood

I think that’s a fair way to look at it. I think the other factor that you didn’t mention is that there are always some inherent inefficiencies that go with the ramp up. But we have been fortunate on that, in the past I think we are pretty good at that, but it’s always something to recall and to take into consideration then. To close and consolidate, move and ramp up, and integrate is we made look far easier than frankly it is. So, I think it’s true to say that it will be finish by November with the redundancies of an additional facility that will have every bit of it under one roof by December. And then, we will very quickly and efficiently start to work through inventory, and then, to full integrate it within the Frederick facility and we should start to see the benefits of that going into our third quarter.

Andrew Shapiro - Lawndale Capital Management

Okay. And, on the Strongsville facility, is there a measure or indicator of its organic revenue growth, but for the Siemens at all?

Cary Wood

It’s hard for us to comment on that right now. I can’t tell you that we segment out a bit of its backlog, but what we report is a combined backlog. And we are seeing just as we would expect it to have seen there given the influence of Siemens. It's going to become a little more complex, as we have mentioned in the past and given public guidance that we utilizes the totality of our footprint to its fullest extent. Meaning that if there is a geographical opportunity with a customer in the Mid-West that makes currently being Colorado, we will have conversations about shifting that to the proper footprint both for the economies of our own manufacturing, but to there own logistical benefit.

And, so we are -- it’s going to become a little bit tougher to say that Strongsville standalone won X number of newer revenue opportunities, because what we are simply doing is maximizing the totality of our selling efforts, selling into bulk footprints and shifting where appropriate certain customers, will they logistically benefit that frankly we wouldn’t be very excited about doing if it didn’t seemingly work for both parties. And so, all of those things are going on simultaneously and expeditiously.

Andrew Shapiro - Lawndale Capital Management

Okay. So, in the light of that and the fact that you have a goodwill on the balance sheet right, $7.5 million, and $6 million was said on the last call to be Ohio. To what Byers Peak assets, does the measurement of the other $1.5 million get applied to? And how does the future impairment measurements get made as things shift and move around with this business allocation?

Greg Slome

Andrew, you know that’s something that will evolve as we continue throughout the year. As you know, at the end of the year we looked at the two facilities on a standalone basis, and as we ultimately work through the year and the businesses are commingled and we look at medical as one segment, as we get to the end of the year we’ll then make a determination as to whether we would still review them individually or as a whole.

Andrew Shapiro - Lawndale Capital Management

Got it. All right. I have more questions on some of the other segments but I’ll back up in case you got some other people in the queue.

Cary Wood

Andrew, go ahead and keep your questions coming.

Andrew Shapiro - Lawndale Capital Management

Okay. One last thing on the medical, can you discuss the backlog you have in prior quarters but now Delphi is almost anniversaried. Can you discuss the backlog apples to apples, is it available with Delphi and Byers Peak on a prior year basis or not?

Cary Wood

It is. It’s always difficult to just try and break these things out and right now as we mentioned we report them on a combined basis and there’s been a lot of noise there as you are well aware. I think I’ll take a quick swag at, well, not a number but a general change and percentage of growth and to kind of grasp at it’s about up 80% from what it was the same time last year.

It’s continued to grow. Now, obviously Byers Peak as a part of that, you got to peel back out and then once you peel that back out it builds from say 80% to about 30%. So, there’s a lot of moving parts there but I think the takeaway is that Colorado’s backlog has grown every single quarter since we required it. It has been influenced, at least in part, by Byers Peak but no inconsequential way by our own internal resourcing taking advantage of the momentum it has grown as well.

Andrew Shapiro - Lawndale Capital Management

Okay. And while it was too soon to discuss in the last call but now after owning Byers Peak for I don’t know six months, nine months since March --

Cary Wood

Six, correct.

Andrew Shapiro - Lawndale Capital Management

Can you describe how the acquired field service refurbishment and installation capabilities which you didn’t have before, to what extent have they carried over to other Sparton customers besides those acquired?

Cary Wood

We’re just now folding that into a lot of our current sales literature and all of our prospecting. I think that is a capability well where we’re glad to have it; I think that we’ve now begun to tap the fullest extent of that. And at this point we do it on a one of a sporadic basis with a variety of devices. It is yet to be fully realized selling opportunity for us. So, I think generally speaking it’s in the infancy stages of what it might ultimately materialize to be for us.

Andrew Shapiro - Lawndale Capital Management

And this service and installation capability, is it higher margin or lower margin?

Cary Wood

Typically field service work has been more of the higher margin nature and it’s certainly not lost on us to exploit that opportunity. So, again it has typically been more higher margin than that.

Andrew Shapiro - Lawndale Capital Management

Okay. Regarding complex systems have there been any recent contract awards? This is a business that has the lifecycle span that’s kind of a shorter lifecycle is a shorter business development, you got to go through a lot of customers that come in and go out, how is that business funnel for that particular segment looking in what is your kind of metrics relative to the new initiatives you put in place in the last few quarters?

Cary Wood

We’re really pleased with the change I’ve seen on a year over year basis and even on quarterly basis when it comes to backlog. But the momentum there continues to improve. And the downside is that we work with a good number of sensitive customer engagements that don’t allow us to go out and brag about new customer wins. As I talked about our first quarter compared to the whole year of last year substantially different already, we've acquired 22 new engagements all of last year. In our first quarter, we required nine new engagements. You can do the math and annualize that and that’s a considerable improvement when you do an annualized comparison to a prior year full comparison. So we’re excited about that momentum.

A good number of those customers are coming up to do complex systems. I particularly like the idea that some of our current customers, some of which were acquired in the Colorado acquisition have shot out the breath of our capabilities and our geographic locations are looking to expand business with us, but in great many cases more times than not, they’re not anxious to make those announcements. They’re not anxious to allow us to talk about what it is we’re engaged with and in announcing their technology, where they’re located or what future volumes look like.

And so, we are little bit hamstrung when it comes to making those announcements, but I do think and I appreciate the opportunity of a call like this to announce that 9 nine new business wins in three months span compare to 22 over a twelve months span is no small win. And the momentum on that on the back log and complexes is substantial compared to the same time last year and even the previous quarter, even when you pull out the internal sales consequences, it certainly has shown good momentum. I am excited about the potential of that business. It’s still being held to a pretty rigid set of expectations, but on generally speaking I like where it’s heading.

Andrew Shapiro - Lawndale Capital Management

Okay. On DSSI, the DSS back log was sub sequentially actually to the highest low one at least two years, yet you discussed on the last call projected decline in US Navy shipments. So, can you clarify or reconcile your comment last quarter referring to sequential decline in revenues from last quarter’s peak DSS revenue levels with that increasing backlog number or was this guidance a short-term guidance for the quarter sequential segment revenue decline as you had record revenues?

Cary Wood

I think that it certainly was to clarify that our fourth quarter was an normally. And that is without question on the short term view. But I also hold still true the fact that there could and likely will be some level of domestic softening and we saw that. Now, the backlog is made up of several moving parts, you have got engineering revenue on high altitude, you've have got foreign sales which can sometimes come in out pretty quickly, you have got domestic sales and then to the degree that we have got forward-looking opportunities with the compass, you have got the compass. Our business is far more complex today than it was two or three years ago.

That said, I am certainly pleased with the increase in backlog, a lot of that was more about high altitude engineering than anything else. And with that be in the case, I still maintain my guidance that there should be concern and we certainly planned it accordingly for some level of domestic softening. But as I say that, and I have said this before, a good amount of that has been more than offset by a substantial increase in foreign demand. And you saw that in our first quarter which was up in no inconsequential way. I think foreign sales in our first quarter were $9.3 million. And we haven’t seen a quarter like that in foreign sales in a long time.

So, you take all of those together, I am still very cautious around what all the dynamics are on domestic demand. But, I am also very bullish on what I see either in the current quarter or as I look forward on other opportunities including foreign sales.

Andrew Shapiro - Lawndale Capital Management

Okay. And its fall, so what’s the timing of the next set of Navy contract towards to a ARAPSCO or Sparton?

Cary Wood

Well, the typical approach has been that we start having discussions around technical specs in terms and negotiate all of those types of details between now and the end of the year. And every single year, it’s the same conversation around the fact that they like to source it in the early part of the next calendar year January, February. But that never happens and so we typically expect that it will start to layer in and there will be more announcements in the, I'll call at the middle to end of third quarter, which is more typical than not, if you look over the previous few years. So, that is generally our expectation.

Andrew Shapiro - Lawndale Capital Management

Okay. The Cybernet investment monetization after legal expenses, what you expect Sparton’s net proceeds are to be and what is on the books for it, at September 30? Will this result in the gain or loss and above or below the line, the operating line?

Cary Wood

The book value on the offset, it had been impaired several times over the proceeding years and it’s registered currently at $1.6 million. The sale of $1.75 million on the peer comparative basis would give you the fact that it would be a gain, albeit small. There are some, as you pointed out, some administrative due expenses and legal related expenses and without getting into the details of what those professional service fees look like, it was certainly a well expended legal fee to get back what was an otherwise firmly locked up investment that was serving us no purpose. So at the end of the day, we are glad to be out of it. We will take our $1.7 million net of the various buybacks and that have taken place over the last couple of years, I wouldn’t suggest that it was single best investment as Sparton’s made in the past, but it’s a rear view mirror now.

Andrew Shapiro - Lawndale Capital Management

Okay. Your credit facility comes up to be renewed in August 2012, you really haven’t had to tap it, you cut the deal at a time the company was in deep financial stress. When do you plan to discuss renewal or I guess we'll call them more liberal termed credit facility?

Cary Wood

We’ve been in those discussions for a good number of months. And as you pointed out, our circumstances are certainly far different than they were at the time that I undertook that agreement. Times were tough, and it was tough to find a partner that was willing to bet on our plan, even given the results that we were showing. That said, we entered into an agreement with terms that I would not like to repeat.

Andrew Shapiro - Lawndale Capital Management

You don’t have to.

Cary Wood

I’d agree with that entirely.

Andrew Shapiro - Lawndale Capital Management

Its now $26 million net cash.

Cary Wood

That’s correct. So, we’re certainly negotiating as we go with options and we’d certainly like to tie that in with any ambitions to acquire opportunities in new businesses as well. So I mean, we’ve got a lot of moving parts there. We’re certainly mindful of what our date is and I think we’re more in the driver seat these days than not. I think we’re a proven entity when it comes to -- whereas I had no friends three years ago that were willing to lend, I’ve got a good number of options these days and I think we’ll certainly maximize those options when the time comes to renew.

Andrew Shapiro - Lawndale Capital Management

Right and with that of course, some of the talk is talking about this when it comes with respect to acquisitions. Can you give us an update on your M&A efforts and your M&A focus in terms of the -- you’ve given guidance already in you direction in market sectors and you do that in your road show presentations, but what are you most highly focused on or looking at and what are the parameters so we can get a little bit of sense around the size, the scope and the area where you would add an incremental business and the synergies or the strategic benefits of those additions?

Cary Wood

Yeah, we are on far more engaged in acquisition target discussions this quarter than I was in previous quarters. A lot of it has to do as you narrow down on opportunities that you looked at three and six months ago. And as I've said in the past, I think we’ve more than proven our capabilities with the two previous acquisitions as small as they were, that they weren’t so sizable that it was going to stress this business that was going to cause problems to maintain the progress of this company. I think we’ve more than established that. I think what we’re trying to look at these days are opportunities that are accretive, that are strategic, that fit well with our vision statements, not just of revenue but on enhancing our profitability.

We’re not interested in getting involved in dilutive opportunities albeit if there are certain aspects of it that are fixable, I’ll take a segment of a much larger piece that is somewhat sub-optimized that’s allows us to play to our strengths and maybe integrated with our business and improve upon it from where it sits today with the previous management and ownership.

There’s a lot there and I think if I was to characterize a perfect target for us. It’s a $50 million to $100 million acquisition. It’s in far more sophisticated and complex electronics than that. It has some presence in medical and complex industrials, and if the opportunity presents itself in our defense and security systems and advance security solutions, and it maybe has some sub-optimized components but that is not dilutive, that it is ideally profitable today so that we’re not betting the firm on a sick acquisition. I think that we’ve clearly flushed out a very specific set of filters and we’re out there looking for those types of things.

And while I’m reluctant to say we’ve narrowed in on a good number of them, I think it’s fair to say that we’re in detailed discussions with a handful that allows us to take a deeper dive. And I continue to be very confident that we will deploy the cash and whatever debt that we feel is appropriate to fund those types of opportunities. So I continue to be real bullish around what our vision statement has been.

Andrew Shapiro - Lawndale Capital Management

Have you found the prices now to be within that range because the pricing had gotten away from us?

Cary Wood

Yeah, they ebb and flow it seems with every single quarter. We’re not in it to compete against other company’s acquisition habits. We take that off the table immediately. And we look at every business compared to market multiples, compared to potential, what are the strategic implications it may have. What forward looking synergies maybe presented and then we’re certainly mindful of what multiples on a combined EBIDTA statement might be, what are projected debt to equity ratio -- mean we take every bit of all of those moving parts together and I think we then only start talking about what pricing its all over the board.

The defense and security segment piece still continues to be a little bit higher, probably more led than not by IP. I think that that could be coming down. But as I look as complex industrials, they continue to be in the wheelhouse of our interest, and when we look at complex medical devices short of IP, they continue to be optimistic for us as well. So we are clearly looking across at an array. But I think if you had to put it in the rank order the complex industrials and medical devices are still yet clearly on our radar given the pricing and given the opportunity that they sometimes present us.

Andrew Shapiro - Lawndale Capital Management

I have a few more questions but I wanted to just check with you is there someone in the queue that you want to get through to?

Cary Wood

No, you're good, Andrew.

Andrew Shapiro - Lawndale Capital Management

Okay. so, regarding some of that new business development and the marketing efforts as well as kind of your backlog, with respect to your medical and complex system backlog do you have a handle or an update because I think you provided it before and what percentage of the current backlog of these segments is from new customers and new business that was not at Sparton a year ago?

Cary Wood

It’s hard to give you that when it comes to backlog today as I sit here. We do track that. But I can’t say, as we mentioned in our script earlier, there’s about $6 million of incremental opportunities going into this current fiscal year that are coming in at least by part by nine new wins in business that we didn’t have as recent as a quarter ago. So one way to quickly look at it is that our currently reported complex systems is in excess of $30 million of our backlog, and when you take look at the $6 million of incremental opportunities you could argue that there’s about 20% of forward-looking backlog attributed to new customers.

Andrew Shapiro - Lawndale Capital Management

Can you give an update on your internal R&D efforts, like what are current examples that these efforts are bearing fruits, I guess given that some update maybe on the digital compass? And what are the current R&D expenditures that we just spent this quarter being focused on?

Cary Wood

We’ve had a long list of opportunities some of which are more sensitive than not to talk to at this point and time when it comes to forward R&D. We’re just now scratching the surface about opportunities to deploy anti-submarine warfare devices and alternative approaches. We’re trying to get creative in that space, and I’ll simply leave at that but I think we started to look at those opportunities, introduce them to the navy, introduce them to tier-1 OE defense contractors and we’ll continue to develop those relationships and peak that interest.

When I look back and I talk about some of the investment that went into the gyro-enhanced compass and our hydrophone, I was certainly very pleased with the traffic and interests that came as a result of the Unmanned Show in Washington in August. And as you’d expect there highly engineered solutions that become a part of a larger solution more times than not and that’s a time consuming endeavor. And right now, what we’re seeing in the way a revenue or the lack of revenue in our first quarter frankly was just as we’d expected. We’ve introduced a new product, we’ve peaked interest. We’ve been involved with engineering. But well, it’s anecdotal I can’t tell you that the interest and discussions are far larger than what they were a year ago on the traditional compass.

And so with that said, we’re pleased with the activity. The question becomes just how quickly does it materialize into the type revenue expectations we have. And you know the momentum as we talked about here before we’ve seen. It’s more than doubled just about every single year for the last two years and I don’t expect that that type of trajectory will continue this year.

I do appreciate the fact that it is a highly enriched margin product for us and that ideally we ought to expect to see the same level of volume and certainly that that’s we are going to be seeing some of our newly introduced products. So it gives you at least some broad strokes on the activity on the R&D, and the customer engagements.

Andrew Shapiro - Lawndale Capital Management

Okay, and you have this navigational exploration segment -- sub-segment that’s kind of has been announced and rolled out. Do you have breakouts at all about how that sub-segment is doing in terms of revenues and such or is it still too soon to do that?

Cary Wood

It’s too soon to do that. I think first, to just reiterate, it’s clearly a piece of our business in the DSS reporting segment. It has not reached the level of sophistication or math I mean, we should clearly put a marketing face around it because we think it’s got a distinct identity, but it does not report a segment. Now that said, we continue to sell that face to our customers, and it could be that at some point in time we have a discussion around it being a standalone reporting segment. At this point, it just doesn’t hold all the necessary characteristics for us to do that type of breakout. So, at this point the answer is no. But I think what we have said in the past is that that product line has shown a substantial increase in sales on a year-over-year basis from fiscal year '11 to '10 and '10 to '09.

Andrew Shapiro - Lawndale Capital Management

Okay. And Q1 this year versus Q1 last year?

Cary Wood

Q1 is down, and it was expected frankly. I mean each time we introduce a new product there’s a bit of a time lag when it comes to the type of momentum you would have expected to see. Our Q1 last year while it wasn’t real strong particularly compared to the next three quarters of fiscal year 2011. Our first quarter fiscal 2012 was less the net but as it was expected. Any time you roll out a new product and now you start having some initial discussions and how you integrate it, it’s a tough road to hold for a period of time. That’s clearly was within our cash flow expectation. So I guess we can report out momentum on that on the go forward basis but at this point it’s been a little bit softer than the first quarter of last year.

Andrew Shapiro - Lawndale Capital Management

Okay. Post Q1, so after September 30, as you kind of just started the process how many shares has your buyback -- you bought back and at what price, average price?

Greg Slome

Andrew, as at the end of October with just a little bit over 52,000 shares and the average price is right around $7.30. So, total cost through the end of October was just under $400,000.

Andrew Shapiro - Lawndale Capital Management

Okay. Well, there’s a lot of volume today so hopefully that will enable the company's pace of acquisition to expand because your daily volume limit should rise starting next week in addition to maybe there’s a block seller or two there you guys can hopefully find now that you’ve announced here in the market and you’ve actually executed on part of the buyback.

Cary Wood

Yeah, we’ve clearly been engaged as best we can and sought out block opportunities. You’ve mentioned it and I think most people are aware of it. There’s obviously a limitation on what this company can do when it comes to the buyback. There’s limitations on the start and the end of a buying period. There is an average volume that we can only exercise up against, and so there are certainly limitations that keep us from, as simple as it may sound, to go out and buy a full based volume. It’s just simply --

Andrew Shapiro - Lawndale Capital Management

Oh, no, strategically you’re limited to a small portion as the average daily volume so the average daily volume were to rise as today’s 105,000 share trading volume already would contribute to, then you’re in the market activities can be expanded each day. But there is a block trading exemption and I guess if someone has a block they want to blow out to someone sold that thing down today, for example, what should they do? They should contact the company? How do you want someone with a block stock they want to move out to approach you?

Greg Slome

Andrew, if anybody is interested I would recommend it they call me.

Andrew Shapiro - Lawndale Capital Management

Perfect. All right. Just wanted out there on the record so that you know you guys get a chance to, at these prices, acquire as much as you can.

Greg Slome

We appreciate that.

Mike Osborne

We like to thank all the participants in today’s call. Again today’s call including question-and-answer period has been recorded will be posted to our website on Investor Relations later on today. 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 line.

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