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Executives

Cary Wood - President and Chief Executive Officer

Gregory Slome - Chief Financial Officer

Michael Osborne - Senior Vice President of Business Development

Analysts

Jimmy Baker - B Riley & Company

Ross Taylor - Somerset Capital

Steve Shaw - Saccardi & Company

Andrew Shapiro - Lawndale Capital Management

Sparton Corporation (SPA) F3Q2012 Earnings Call May 8, 2012 11:00 AM ET

Mike Osborne

Thank you operator. Good morning and thank you for participating in Sparton's fiscal 2012 third 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 gross profit, adjusted operating income, adjusted net income and adjusted income per share - basic and diluted and adjusted earnings before interest, taxes, depreciation and amortization ("adjusted EBITDA") 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 Third Quarter Financial Results press release and Form 10-Q dated May 8, 2012.

Today, Cary Wood, our President and CEO, and Greg Slome, our CFO, will report our fiscal year 2012 third quarter financial results, provide an update on the status of our liquidity and capital resources, summarize the momentum of the Company's new business development activities, and provide a brief update on the remainder 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 12:00pm ET.

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

Cary Wood

Thanks Mike. Good morning and welcome to our fiscal 2012 third quarter call.

Today, we will begin by reviewing our third quarter performance highlights:

* Net sales of $55.0 million, a 6% increase from the same quarter last year, after the net effect of the Company's prior year acquisition of Byers Peak

* Adjusted net income increase of 20% to $1.9 million, or $0.19 per share, versus adjusted net income of $1.6 million, or $0.16 per share in the prior year quarter.

* Twelve new business programs were awarded, of which seven were with new customers, during the third quarter of fiscal 2012 with estimated future annualized revenue of $7.6 million.

* Quarter end sales backlog increased 20% from a year ago to approximately $146.6 million.

* An adjusted EBITDA increase of 19% to $3.6 million versus adjusted EBITDA of $3.1 million in the prior year quarter, and

* Repurchases of common shares for the third quarter totaled $1.5 million or approximately 180,000 shares.

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

We are pleased to report fiscal 2012 third quarter adjusted operating income of $3.1 million and adjusted net income of $1.9 million or $0.19 per share, versus an adjusted operating income of $2.6 million and adjusted net income of $1.6 million or $0.16 per share, for the third quarter of fiscal 2011. The fiscal 2011 third quarter financials include the results of operations from the Byers Peak acquisition beginning on March 4, 2011.

Our consolidated third quarter revenue was $55.0 million, increasing 9% or $4.7 million from the same period in the prior year or up 6% after adjusting for the effect of the Company's prior year acquisition of Byers Peak Incorporated. All three segments contributed to the overall increase in revenue which is reflective of our increased investment in business development over the past year. Medical and Complex Systems segments have been outpacing the impact of Siemens dual sourcing and various customer disengagements and program delays with growth in new and existing programs. Within DSS, the increase of foreign sonobuoy shipments also contributed to the increase in sales.

Our adjusted gross profit in the third quarter of fiscal 2012 was $9.1 million compared to $8.2 million in the third quarter of fiscal 2011. The adjusted gross profit percentage remained consistent at 16% in both the fiscal 2012 and fiscal 2011 third quarter, reflecting decreases in the Company's Complex Systems segment, offset by a 4% increase from the DSS segment.

Selling and administrative expenses as a percentage of sales decreased to 10.0% of sales in the fiscal 2012 third quarter from 10.2% in the prior year third quarter. The Company incurred an additional $0.1 million of internally funded research and development expenses as compared to the prior year quarter.

During the fiscal year 2011 third quarter, the Company recorded a $0.1 million gain on the $4.2 million sale of the Company's Albuquerque, New Mexico property.

Income tax expense of approximately $1.1 million was recognized in the current year third quarter compared to $0.1 million for the same period in the prior fiscal year. In conjunction with the June 30, 2011 reinstatement of approximately $11.7 million of deferred tax assets, the Company began to recognize income tax expense in fiscal year 2012 using an estimated 36% effective tax rate.

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 sales increased approximately $1.7 million in the three months ended March 31, 2012 as compared with the same quarter last year. Excluding the impact of $4.8 million of decreased sales to Siemens due to its dual sourcing decision, and excluding $1.8 million of fiscal 2011 third quarter pre-acquisition sales related to Byers Peak, Medical sales increased approximately $4.7 million as compared with the same quarter last year.

The adjusted gross profit percentage on Medical sales remained relatively consistent at 13% for the three months ended March 31, 2012 compared to 14% in the prior year quarter. This comparable margin on Medical sales reflects decreased capacity utilization at the Strongsville, Ohio facility and certain unfavorable product mix between the two periods, partially offset by increased capacity utilization at the Frederick, Colorado facility and cost management efforts at the Strongsville, Ohio facility.

Complex Systems sales increased approximately $0.5 million in the three months ended March 31, 2012 reflecting increased intercompany sales as compared to the same quarter last year. Consistent sales to external customers as compared with the same quarter last year reflect $1.0 million of increased sales to multiple new and existing customers, offset by $1.0 million reduced demand for one customer's program.

The gross profit percentage on CS sales decreased to 7% for the three months ended March 31, 2012 compared to 11% for the three months ended March 31, 2011. The quarter over quarter comparison primarily reflects unfavorable product mix and, to a lesser extent, certain new program start-up costs in the current year quarter.

DSS sales increased approximately $3.0 million in the three months ended March 31, 2012 as compared with the same quarter last year, reflecting increased sonobuoy sales to foreign governments and, to a lesser extent, increased engineering sales revenue, partially offset by decreased U.S. Navy sonobuoy production and legacy digital compass sales in the current year quarter.

The DSS gross profit percentage of 24% was positively affected in the current year quarter by a significant increase in foreign sonobuoy sales, which typically carry higher margins, partially offset by the adverse impact from decreased digital compass sales, which also typically carry higher margins, and by slightly increased costs resulting from continuing sonobuoy quality improvement activities in the current year quarter.

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 March 31, 2012 is our Industrial Revenue Bonds with the State of Ohio of approximately $1.7 million. During the quarter ended March 31, 2012, the Company made total principal and interest payments of $0.1 million. Our debt to equity ratio on March 31, 2012 was at .02 to one.

As of March 31, 2012, 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 which were met at March 31, 2012.

Summarizing our cash flows for the nine months ended March 31, 2012, operating activities provided $6.4 million of net cash flows. Excluding changes in working capital, operating activities provided $10.6 million in the first nine months of fiscal 2012, reflecting the Company's positive operating performance during the period. Working capital used $4.2 million of net cash flows in the first nine months of fiscal 2012, primarily reflecting increased accounts receivable due to increased sonobuoy sales to foreign governments, partially offset by the collection of advance billings related to U.S. Navy contracts during the nine month period in excess of the funding of production under those contracts.

Cash flows used in investing activities in the nine months ended March 31, 2012 totaled $1.4 million, reflecting proceeds from the Company's sale of its investment in Cybernet Systems Corporation for approximately $1.8 million, offset by capital expenditures totaling $3.4 million. Included within the fiscal 2012 capital expenditures is approximately $1.2 million of capital expenditures related to the implementation of a new enterprise resource planning system currently expected to be put into service in calendar 2012.

Cash flows used in financing activities in the nine months ended March 31, 2012 totaled $2.9 million and included $3.0 million used to repurchase the Company's common stock. Through the end of March 2012, the Company purchased 366,808 shares of its common stock under its stock repurchase plan at an average price of $8.14 per share for approximately $3.0 million. Shares purchased were retired upon repurchase. As of March 31, 2012, all authorized funds under the stock repurchase program have been expended.

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

Cary Wood

Thanks Greg.

As we continue to implement the growth phase of the Company's turnaround, we see further momentum in our business development and marketing efforts.

As a snapshot of our business development success, in the third quarter of fiscal 2012, each business segment has contributed to the awarding of twelve new business opportunities with seven of those coming from new customers to Sparton.

* DSS was awarded 2 foreign sonobuoy awards and one engineering developmental project with the U.S. Navy;

* Between Strongsville and Frederick, Medical had 6 wins split equally between engineering and manufacturing with 5 being with new customers; and,

* Complex Systems had 3 new awards of which 2 were with new customers.

In the third quarter of fiscal 2012, we completed the seamless implementation of salesforce.com, a customer relationship management software tool. This tool is used Company-wide to track progress to our new business development objectives and to monitor the programs at various stages within the new business opportunity funnel.

We have seen a significant increase in the funnel for opportunities within the Medical business segment through the implementation of marketing driven lead generation programs that feed the business development function with solid opportunities while strengthening our brand within our target audience. As we move into fiscal 2013, we will be evaluating all of our marketing initiatives to ensure that we are properly targeting and reaching the intended audience at the most cost effective method possible. Additionally, we will leverage the success we have seen in Medical by disseminating those best practices across the rest of the Company to further enhance the entire sales and marketing effort.

As we continue to refine and implement new marketing tools, add additional business development resources, maintain leading customer performance indicators in the areas of communication, on-time delivery, and quality, we not only anticipate the new business opportunity funnel will grow, but the quality of the programs being pursued will result in an even higher new business award hit rate in the future.

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

From a day-to-day operational perspective, we continue to see success with the deployment of the Sparton Production System in a number of areas.

* We continue to work on improving the gross margins within the Complex Systems segment.

* New business awards and increased order volume from existing customers within Medical have more than offset the impact from the Siemens dual sourcing initiative and end-of-life product ramp-down.

* And, we have a number of foreign sonobuoy orders that are offsetting reduced U.S. Navy sonobuoy contracts.

We are also focused on implementing the strategic growth plan by concentrating on the three growth initiatives of targeted business development, internal research and development, and strategic mergers and acquisitions. As previously discussed, our business development efforts continue to generate new business leads through the various marketing methods and by increased new opportunities with existing customers as they realize our high-ranking performance levels and extended service offerings in a low volume/high mix regulated environment are among the best. We continue to prudently invest in internal research & development opportunities that will provide profitable revenue streams and anticipate the launch of our next generation digital compass to occur within this calendar year. At the same time, we remain acquisitive and will continue to be prudent in our identification and evaluation of further opportunities. I look forward to reporting on each of these initiatives in future quarters.

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:

* MD&M East Medical trade show in Philadelphia from May 22nd to May 24th,

* B Riley Annual Investor Conference in Santa Monica from May 22nd to May 23rd,

* 3 Parts Advisors Ideas Conference in Boston from June 5th to June 6th,

* Sidoti's Technology Investor Conference in New York from June 14th to 15th, and

* Investor road shows with new and existing shareholders in San Francisco and Los Angeles.

As we prepare to close out fiscal 2012, I am very encouraged that we will finish the year strong. We have continued to see solid momentum on the implementation of our strategic growth plan with additional new business awards which were converted from our robust opportunity funnel and anticipate that success to carry forward as we enter fiscal 2013.

We thank you for your continued 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

Thanks you. (Operator instructions) Our first question from the line of Jimmy Baker with B Riley & Company. Please go ahead.

Jimmy Baker - B Riley & Company

Hey, good morning, guys, and congratulations on the traction in your new business initiatives.

Cary Wood

Good morning, Jimmy, thank you.

Jimmy Baker - B Riley & Company

Cary or Greg could you remind us what portion of your revenue eliminations are comprised of CS sales intercompany to your DSS segment?

Gregory Slome

Yeah, pretty much 100% of the eliminated sales relate to intercompany shipments from Complex Systems to DSS related into the buoys.

Jimmy Baker - B Riley & Company

Okay, so, I believe you disclosed on the last conference call that those intercompany sales offer the CS segment similar gross margins to that of your DSS segment. You can check my math here, but if I simplistically take that $4.2 million in eliminations and in the quarter and run it through at DSS-like gross margins, that equates to the lion’s share of CS’s gross profit, if not the entirety of it’s gross profit. So, am I correct in that in excluding intercompany transactions? Is CS’s businesses just break even at the gross margin line?

Cary Wood

I think that’s a fair statement minus any variance discussion that might come with the internal sales revenue. I think, generally speaking, you’re correct.

Jimmy Baker - B Riley & Company

Okay, so, I think it was this time a year ago that you commented you wanted another six to eight quarters to evaluate that CS business in an effort to determine whether or not you want to pursue some strategic alternatives. I mean this business continues to be challenged and, while it poked it’s head into profitability for a few quarters, it’s seems the intercompany sales were a large driver of that.

This is not to criticize you or your team, but it just seems like this has been a tough, highly competitive, low margin business that has not generally earned it’s cost to capital. Has the scale tipped in favor of you pursuing alternatives or should we interpret the commentary regarding new business ramp-ups to suggest that you’ve committed to retaining and turning around that asset?

Cary Wood

It’s a great question. I certainly don’t take it as a criticism. It’s reviewed very rigorously and regularly here. I think first and foremost your observations are spot on and I think if we were a business that was wholly made up of low margin EMS type business, we may view it differently, but I think in contrast to the balance of our business, it is frustrating, to say the least. I think we’ve made, obviously, good progress, not just strengthening the performance of internal sales, but further growing and proliferating the business with new customers, albeit smaller in revenue size and I think we’re slowly but surely chipping away.

But at some point, and your observation is spot on and we’ve certainly given it a good amount of time to evaluate it, obviously, improving from no gross margin, even then having internal sales, to doubling that twice in two years, I’m pleased with that. I’m pleased that it is a cash neutral type of business, to say the least, but it does have us in a spot in time where you start evaluating an array of alternatives.

First and foremost I would say we’re committed to the customers that we’ve engaged with. We’re committed to the business. As I sit here on this call today, I don’t think any customer, who might be evaluating that business with us, should be in the least amount concerned about us being an ongoing concern in that segment. I think we’re fully committed to that.

But I do think that there is a time and place and I think we’re quickly getting there. We started evaluating options and it’s a footprint that potentially could be further consolidated from within and you could certainly that potentially with the internal sales portion of it, further strengthening it and then further segmenting it away from the, otherwise, CS standalone business. We could certainly explore alternatives with the remainder of that business, up to and including, as you hinted, divestiture. That’s not news. That’s something we’ve said before now.

So, I don’t want to sit here and announce anything. I certainly don’t want to tip the scales to investors that we’ve made a decision about anything. I think we’ve done exactly as we said we were going to do. We’re going to be patient, methodical and we’re going to evolve with that business. We continue to be committed to its momentum and progress, but I certainly think that we’ve demonstrated more than that. This management team and its board are committed to maximizing shareholder value and return on capital and this has certainly one in contrast to the other two businesses that’s not ideal. And, so, we’ve got to assess the options all the time.

So, I’m not going to sit here and give you a specific answer to your question. I think I’m going to reaffirm your observations and say the things I think best need to be heard that suggest that this management team is no different in the way that we observe the business.

Jimmy Baker - B Riley & Company

Okay. Fair enough. That’s helpful. And I just have a couple more and I’ll back out and then let somebody else ask questions. I know you’re not issuing guidance for fiscal ’13 here, but can you maybe comment on any just preliminary changes and expectations for the margin profiles of your segments and, specifically, I’d be interested to know what kind of savings you might be expecting from the implementation of your new ERP system or if we should be baking any one-time OpEx items related to that launch in the near term?

Cary Wood

Yeah, those are all great questions. There’s about three things in there. First, I would say that on a year-to-date basis the ERP planning and ramp-up in this current fiscal year has consumed the lion’s share of our CapEx. So, I would say that, generally speaking, I don’t expect CapEx next year to be as significant and certainly not as consumed by IT as it has been in the past. We still have some trailing expenditure there, but as a percentage of OpEx not nearly the same magnitude.

Second, I would say that our interest in primary goal over the course of the next several quarters is to go live with a phase one implementation and that is to outright replace, as best we can, business as usual without it being remotely disruptive. Phase two and three is where you’ll start to enhance the system and ultimately see some level of economy to scale. I don’t want to go too far into that, but I think, generally speaking, with enhanced systems, the elimination of redundancies, the elimination of manual inputs and dependency starts to translate into speed and accuracy of information, but also some cost efficiency.

So, certainly we anticipate that over time, but I don’t know that I feel comfortable suggesting that that should be seen in the first several quarters of next year. Now that said, and, again, you’re right, we don’t typically give guidance other than to talk a little bit about gross margins. I’m going to maintain the guidance on the three different segments that we report today. We are in the planning stages right now. I would say, as I’ve hinted before, that we anticipate a very robust fourth quarter.

We’ve started to conclude that while it may not be typical seasonality, we do see some trending on buyer seasonality. Saw it last year. Saw it to a lesser degree the year before that in our fourth quarter and with that in mind we expect that we have a strong finish to this year. And going forward into next year I think that that level of seasonality will probably continue and I think that also suggests, as we saw, the impact strengthening of our fourth quarter, we saw a bit of an anemic first and second quarter last year. I think that we’ll see that same trending going into the fiscal ’13. So, until I’m finished and buttoned up a budget, I think its premature for me to give too much in the way of guidance.

I will tell you this, we don’t expect to take steps backwards. We’re very pleased with the momentum of organic growth and we expect to see that again next year. I’m very bullish on that front. I continue to be bullish on how we’re evolving on our lean deployment and cost savings. I think we’ve got some things to consider that could bring about opportunities, specifically in the context of your question around Complex Systems and I don’t think that it should be expected that any significant synergies or economies will realize from the ERP, in and of itself, in the early part of next year, to say the least. We’ll just have to see how things play out with some of our new business awards and just how incremental they might be. But I think the sum of it is that our momentum, I think, continues more positively on the overall score as opposed to anything negative.

Jimmy Baker - B Riley & Company

Okay. And, lastly, with regard to the buyback, obviously nicely accretive for you with the stock up over, I guess, 20% higher than the average purchase price. Understanding that you want to keep, you have plenty of dry powder for M&A, have you and the Board given some consideration to renewing that program? Or, kind of, just what are your general thoughts there?

Cary Wood

We have, as you'd expect, with every Board Meeting assess our liquidity. We talk about our anticipated cash flow and needs. We talk about opportunities to maximize shareholder value. That can be done, obviously, in a good number of ways. Certainly, we'd like to keep that cash as anticipated for strength of an acquisition but at the same time, if we're not staring down the barrel of one in the next 30 days, it's obviously a conversation... I would say today, we've not authorized any additional buyback but I will tell you it has been a topic of discussion in our more recent board meetings to the extent that any shareholder or interested investor might expect this to be.

But as I sit here today, not prepared to announce any enhanced or additional buyback and we'll maintain our cash position as we have. We expect that between now and the balance of the year, particularly with a strong collections fourth quarter from receivables in our third, as well as anticipated revenue and the timing on prepayment from the Navy. I think we expect there to be a strong cash flow quarter. And that will have us reflecting again at year's end as how to maximize the return on that capital.

Jimmy Baker - B Riley & Company

All right. Thanks a lot for the time. I really appreciate it and look forward to seeing you out here soon in Santa Monica.

Cary Wood

See you in a few weeks, Jimmy. Thank you.

Operator

(Operator instructions) Our next question comes from the line of Ross Taylor with Somerset. Please go ahead.

Ross Taylor - Somerset Capital

Congratulations on a great quarter. And I'd like you to just give me a little bit of thought on what you're going to be doing with Strongsville, to bring those margins more in line with what we are seeing elsewhere in the company?

Cary Wood

Great question. We report, now, medical on a consolidated basis. And I think what you're concluding which is a fair extrapolation, is that we are seeing strength out of what was otherwise reported as a standalone segment a year ago. So you can only assume that we are seeing of margins in Frederick and those are probably being, if at all, slightly offset by not necessarily erosion but a suppression of margin in Strongsville if for not other reason, a change in seaman's revenue.

I think that's a fair thing to expect or have interpolated and so I'll talk about the consolidated. It's really not a year-over-year change but given what I describe, you're generally suggesting that you're seeing under-absorbed assets in Strongsville and how are we combating it? I appreciate the question.

I think a year ago, to see new business activity was an anomaly in Strongsville. It suggested that we didn't have the leadership and/or the momentum there to support it, and we've obviously addressed that and made a strong change that we brought on a good additional resource, a good number of resources, in Strongsville.

As we looked at just the third quarter alone, our year-to-date basis, a lot of our new winds, as I look at them, are shared between both Frederick and Strongsville. We're going to move some business, a very small amount of business, from Colorado to Strongsville. We're not in the business of doing that, but we do maximize the footprints. But I think our investment thesis of having a geography like Strongsville as well as Frederick is played out, and we've seen new customer opportunities come our way.

The new business winds in fiscal year '13, in the third quarter, there were a total of six of them and they were split evenly between manufacturing and engineering and a good a number of those will end up in Strongsville. I do expect Strongsville to finish the year from a revenue perspective stronger than we had planned for, and that's net of any Siemens’ activity. It's not as strong as it needs to be, at a very robust run rate as recent as two years ago.

So, looking ahead, I think more the same from new business development activity, maximizing the shared footprint between the two geographies. I think all of that is going to further enhance and strengthen Strongsville's growth margin.

Ross Taylor - Somerset Capital

Okay. Great. Can you comment on your thoughts on M&A and what you're looking at. Are you looking at a new leg to the stool. Would you be looking at building up one of the specific areas. Your thoughts on kind of strategically how you see that being implemented.

Cary Wood

Yeah. There's a good number of targets that we've been involved with. We've gone a considerable length with a few. I think than more than not we've targeted substantially larger targets then what we've traditionally acquired. Our range of acquisitions before now have been a low of 10, a high of 32. There certainly are targets out there that are tremendously larger.

Obviously, those things can bring some level of risk. But I can tell you, a $75 million acquisition brings no large level of integration work and due diligence work than the small ones do. I think generally speaking we're targeting much larger revenue based opportunity's them that. Our filters are frankly very specific, but they're not really targeted toward any one segment, but there's a good number of complex industrial opportunities out there. There's been a handful of medical.

I would further put color around our acquisitions strategy discussed to include that we like the idea of vertically Integrating into areas that we're not. A couple good examples of that might be, to get into the embedded systems which is generally the brains or the logic component of an electronic device. Just about every electronic device from consumer goods all the way to medical devices have been in there. It is basically an embedded software chip that drives the mechanics of an electronic device. We like that. We like the idea of those as an expansion of our capabilities and the value proposition that we offer.

So I think it's a couple of things. One, we're focused across each of the three segments, I think we're focused more on, sequentially, more impactful opportunities. We certainly haven't ruled out opportunities that are suboptimized or undermanaged in a way that gives us something to maximize. I would say that we're interested in vertically extending our capabilities in embedded systems. Example is one of those types of targets. I think that's the broad strokes of initiative of today.

Ross Taylor - Somerset Capital

Okay, and I would like to put another vote in for the idea of renewing the buyback for your stock with as much cash as you have on the balance sheet. Honestly, I know you want to add another leg and I know your growth stretch and I support it but at the same time I don't see them as exclusionary sets, and when you find something three times EBIT or EBITDA you don't actually have to run it, you don't have an integration risk. It seems like it might be one of the best things around.

Cary Wood

Yeah, it's certainly been a topic of discussion with the board and we just exited a board meeting midweek last week and I can tell you that it's always considered and we certainly appreciate the guidance.

Ross Taylor - Somerset Capital

Take care. Good luck.

Cary Wood

Thanks, Ross, I appreciate it.

Operator

Our next question comes from the line of Steve Shaw with Saccardi & Company. Please go ahead.

Steve Shaw - Saccardi & Company

Hey, guys. How are you doing?

Cary Wood

Good, Steve. How are you?

Steve Shaw - Saccardi & Company

Good. Do you guys have any identity of the impact you'll take on of Siemens in the fourth quarter of this year?

Cary Wood

I think I'm going to back into that. We gave guidance last year on the dual sourced impact being somewhere between 12 and 14 and we expect for that to materialize probably right squarely in the middle of that, so about 13. So, you take that impact from last year's annualized revenue from Siemens at 36 and I think we'll be right in line with that. Some of that was heavier in the first half and was materializing in the back half, no new news. That was as expected as the dual sourcing was starting to take hold.

And I think it's fair to say that the dual sourcing initiative will hit an annualized run rate of $2 million to $2.5 million. And then I think it's an open question of some of the sunsetting product, Versant [SP] specifically, that was anticipated. And then some of the annualized effect of some of the other external effect dynamics and all of that. We're in the process of working through budgets now.

So I can't necessarily give guidance because it's not completely clear, but I wouldn't expect that it would be any higher and if it was I'd be extremely surprised from what we saw in the way of the current perspective, annualized impact of Siemens, which, by the time you flush out 36 less 13, it ends up being roughly in the 23 range, and that was as expected. It's just a matter of planning out next year as to how different that looks.

Steve Shaw - Saccardi & Company

And then for the CS segment, you mentioned that there was reduced demand for one program, I may have missed it, can you provide any color on what happened there?

Cary Wood

Yeah, generally speaking we've had one of our larger customers delay the ramp up of a program that's now since been approved and they've announced to us with internal demand and forward looking forecast that that will start to ramp up. We expect it in the third quarter and it will start to ramp up in the fourth quarter. I don't believe that we'll be able to reconcile that for the balance of this year and recover from it.

We've got a number of other places where that revenue has been stronger and will offset the whole. Disappointing to all of us, certainly. When you compare CS on a year-over-year basis. Year to date it's fine in gross margin, but the third quarter gross margin was not as ideal as was expected given the one customer. The one customer's revenue impact was far in excess of a million bucks just in the third quarter, and much needed frankly. So we'll see it in the third quarter, it'll be pushed out, we probably won't recover from it. The balance of it will ramp up in fiscal year '13, the one customer has to remain nameless. The program I can't get in to but I would generally say that it was a DoD program that has now since been ramped up.

Steve Shaw - Saccardi & Company

All right. Thanks, Cary.

Cary Wood

Sure. Thanks, Steve.

Operator

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

Andrew Shapiro - Lawndale Capital Management

Yeah. Hi, I have a few questions and then I'll back out and then come back to us. But an immediate follow up to what you just answered Cary, you mentioned that this was a DoD program, but within Complex Systems?

Cary Wood

Correct.

Andrew Shapiro - Lawndale Capital Management

OK. Just wanted to make sure it wasn't in process. But, Complex Systems, you mention about a million dollars of increases in sales due to multiple new and existing customers that offset this reduced demand from the delayed bottleneck in the program. Might you give us some insight into who or what type of new customers these are?

Cary Wood

I anticipated the question. Unfortunately I cannot. There are within the quarter, three. And I would generally say that of those three, two were industrial, one was military, so another DoD contract. I would say that just by example, one I can talk a little bit about is a laser sight detection and electronic system that we're involved with and we expect those types of things to ramp up and other than that I can't get into the specifics of the main customers. We contractually give up that opportunity.

Andrew Shapiro - Lawndale Capital Management

Okay. And you said another DoD. Is there a lot of DoD activity that's in Complex Systems historically, is that an area where you're ramping a bit and, so DSS is more specific to the componentry of sonobuoys, like the digital components of sonobuoys itself?

Cary Wood

About a quarter of that revenue has been on a trailing basis involved with DoD work. That has been the profile. I would say that our commercial activity and business development activity really hasn't changed from that. I think we're just as involved in those opportunities today as we once were.

Andrew Shapiro - Lawndale Capital Management

Okay, and is the assumption that the million in new sales is lower margin than the million in sales reduction. Is that a correct assumption? And if so, is it start-up expenses implying a non-recurring margin hindrance in that the margins will ramp up on this new business?

Cary Wood

Raytheon was a very strong program and the others that are ramping up, I think, are in ramp up mode. And I think it's by the net effect of that, one customer where they were delayed was a strong program offset by the ramp up of not as strong a program.

Andrew Shapiro - Lawndale Capital Management

Okay. And can the non-recurring start-up expenses be quantified or a range given or not?

Cary Wood

No. I can't. I think generally speaking, the gross margins on the one delayed customer engagement are not inconsequential. And we generally give guidance within that segment of being roughly in the double digit plus 10 up to the 15% market-based range. So it's hard for me to sit here and tell you, because there is a lot of working parts. There's the gross margins of the customer engagement that slowed a ramp up, there's some costs associated with MPI, there's a standard gross margin that's expected that hasn't been truly tested. It could be better or worse, so it's hard for me to give you that number Andrew.

Andrew Shapiro - Lawndale Capital Management

All right. Last question, complex systems, the Vietnam facility has primarily been focused on or included within the complex systems. When you have and if you do, I doubt it'll be much DSS, but medical program work that is done within Vietnam, does that flow through complex systems or does that stay within medical?

Cary Wood

It does. It flows through complex systems. We're starting to ramp up in that business with a level of medical opportunities. As you'd expect we've been able to maximize the new business funnel particularly from the acquisition and some of the customers that came with those acquisitions and we've been able to provide them opportunities that they weren't able to have before. They will ultimately be flushed through inter-company sales. But generally speaking, right now, we don't have a whole lot of medical to speak to in Vietnam. We anticipate that we will with time. It's certainly an opportunity for us. But for now, there's not anything material to discuss there.

Andrew Shapiro - Lawndale Capital Management

Okay. And that's why Greg said all inter-company was DSS. I'll ask a question or two on DSS and back out. But I have more, so please come back to us here. But in particular, on DSS, we saw that the gross profit was up by $1 million on only $1 million of higher sales. So can you provide some greater clarity on this sizable margin bump to understand kind of how sustainable it is.

And if I can clarify in particular, while the exact pace of higher margin foreign sales is unpredictable, on your last call, we discussed that overall foreign sonobuoy use should trend up as the USP3 Orion prop plane fleet gets migrated to U.S. allies and replaced in the U.S. Navy by the jet-based P8 Poseidon. So taking into account your knowledge of the traction of your new digital compass products that they're getting or not getting? When do you feel that this higher margin in DSS from an overlay of these three kind of programs becomes more recurring in the new norm?

Cary Wood

Now there's a good number of questions there. I'll start with first saying as opposed to highlighting the strength of the performance in the quarter in terms of gross margin on incremental sales, I'd first say that frankly I'm a bit disappointed in its third quarter performance if for no other reason the softness on Legacy compass sales. Historically, we've seen good momentum there in the last several years. It's a strong margin contributor. We expected stronger contribution. We understand why there's not. Clearly with the changes in Afghanistan and other conflict theaters, it generally has brought to a halt some of the applications and end use of that device for now.

I don't think that it's going away. I just think that it's going to slow it down and we certainly saw the impact of that. Net of that, we still saw a very strong third quarter on a gross margin basis but it could have been incrementally better. So I would suggest to you that as good as it is, it could have been better.

That opens up then the discussion around our R&D, our new compass, our Legacy. And I think I've talked a little bit about the Legacy. I can't give you an outlook as to when I expect that to ramp up. I think we're going to be a little bit more prudent as to how we plan that going into next year. But I would also say that the cash flow analysis, obviously the revenue aspect of that, has been outperformed on the new compass within the current fiscal year.

It was not a real strong guidance or expectation that starts to increase going into next year, but I wouldn't say that it is significant or at the magnitude of what we've seen with the Legacy compass, not even in year two. So I expect it to start to increase. I don't necessarily expect it to contribute as quantitatively as the old compass line has.

That said, we're planning now for next year's revenue mix and impact. I think that we have seen more than not a cyclicality on foreign sonobuoys. So we're having a very strong year on foreign sonobuoy sales up to this point. I think generally we're probably not going to see it as strong going into next year, but we also expect that there will be some strengthening comeback from domestic demand. I think by the time we get it all flushed out, it's hard for me to sit here and give too much guidance.

Now you've hit on a very strong investment thesis as to why there should be some expected momentum on DSS looking ahead. The P8 is going to ramp up. I think we've tried to be a little bit more careful given the DoD's guidance. They've expected strong ramp up on the 125 as soon as the fiscal year '14 and '15 and that will be upon us before you know it. I don't know that I'm as bullish as they are. Now I think the grow will still be there for us, but I'm not as confident, nor am I careless enough to build their guidance in. So we'll discount a bit.

But I do think the premise that there are going to be P3 aircraft available, they'll ultimately will be outright replaced by the P8s. I think it's fair to say that for a good number of quarters, maybe even years, they'll fly simultaneously and both be in service but I also think that it's fair to say there are other form friendlies that might find interest in acquiring those aircraft and you reference the Taiwan's acquisition of a number of aircraft, that's certainly been the case. And I would say that they've shown interest in their own standalone anti-submarine warfare platform and, obviously, we would want to participate in that.

So a good number of questions. My hope is I gave you enough to triangulate, but I didn't give you the specifics of what I think next year's guidance will be. I just gave out what I believe will to be a lot of the underpinnings of which we're planning to.

Andrew Shapiro - Lawndale Capital Management

Right. I have more questions on DSS, but asked a bunch in Complex. I'll back out, but please come back to me.

Cary Wood

Sure.

Operator

(Operator instructions) Our next question is a follow-up question from the line of Andrew Shapiro with Lawndale Capital Management. Please go ahead.

Andrew Shapiro - Lawndale Capital Management

Okay. Continuing on DSS, on the backlog, are all the announced contract wins that were announced by Sparton including your April announcements reflected in your Q3 backlog?

Cary Wood

There was a foreign announcement in the more recent weeks that is currently not in the backlog.

Andrew Shapiro - Lawndale Capital Management

That's the (inaudible) $13 million?

Cary Wood

Correct. Our share was much smaller on that particular award. Those things tend to normalize over time, but in that case the announcement's been made. But it is not currently in our backlog as that materialized in the April time frame.

Andrew Shapiro - Lawndale Capital Management

Okay, but the Japan one is?

Cary Wood

Correct.

Andrew Shapiro - Lawndale Capital Management

Okay. And I think Taiwan. I can't remember what other ones there were that you've announced. And of the DoD announcements that have not yet gotten Navy clearance from you to formally press release out, are any of those in your Q3 backlog?

Cary Wood

There is a public announcement out there. We can neither confirm or deny at this point, but it is a DoD announcement on Q53s that they have exercised an option of $4 million.. And I would suggest had that come to the company and materialized as the announcement suggests, that would be an addition to our backlog currently that we're not in a position to announce until we're approved.

Andrew Shapiro - Lawndale Capital Management

Right. Understand. And to what extent are foreign sales? In other words, can you quantify the amount of foreign sales that are in your Q3 backlog versus last year's backlog and versus last quarters' defense backlog? And the reason I ask is because the foreign sales have the higher margin profile.

Cary Wood

Yeah. A couple of things there. The Q3 backlog of fiscal year '12 on foreign alone is 5.6 million.

Andrew Shapiro - Lawndale Capital Management

Okay.

Cary Wood

And if I compare that to Q3 '11 where it was only 4, and if I go back to Q2 of '11, I think generally speaking it was even smaller than that.

Andrew Shapiro - Lawndale Capital Management

No, it would be Q2 of this year.

Cary Wood

Q2 '12 was 7.3 million.

Andrew Shapiro - Lawndale Capital Management

Okay. So it's lower than Q2, Q3 now and it was only 4. So either way it's all pretty negligible relative to the big backlog that you've built up now?

Cary Wood

Yeah. I think that's the actual observation, yes.

Andrew Shapiro - Lawndale Capital Management

Okay. What's the status of your RFP bids on the SSQ-101s and the SSQ-125s, which I believe you guys have been on but the Navy has not yet on their end even announced anything. When are they expected to announce those contracts?

Cary Wood

You never know when those announcements are coming. Obviously, you're aware that seasonally speaking this is about the time we engage, or have before now engaged in conversations, contracts, RFP, back and forth detail work. And normally around this time you start seeing the announcement of the 8R and Q-125 awards. So I anticipate that that could happen soon than later.

Andrew Shapiro - Lawndale Capital Management

Okay. And then regarding your new sonobuoy testing programs and costs that had said had peaked last quarter but the programs themselves would be continuing and they would obviously there are costs that were in DSS this quarter, albeit with net of all your higher margins. You said these would continue forward and they would lead to payback via improved quality and lower rework costs.

Cary Wood

Right.

Andrew Shapiro - Lawndale Capital Management

Have you seen visibility for those program expenditures with improved quality and lower rework costs already?

Cary Wood

Yeah. Yes, absolutely. First I would tell you that the expense continued into Q3 and that is net obviously of the gross margin performance that we did see. I would say that as we look forward, we anticipate to build some of those costs into our standard because I don't expect that they are going to go away. That standard allows us to obviously have some discussions around how much of that might be included in future contract awards at a standard cost. But a demonstrated performance and while I don't have the exact historical year-over-year performance, first I'll tell you the mandate was we need to get away from having lot failures, period.

They are disruptive to your anticipated revenue, they are disruptive from forecasted costs, and those are the least of mentions when you think about the disruption it causes and frustration it causes our end customer the U.S. Navy. So, generally speaking, what we've seen so far, through the first three-quarters of this year is one lot failure. And, historically speaking, that has just simply not been the case. So we've seen a negligible number of lot failures this year.

Andrew Shapiro - Lawndale Capital Management

It was one of my main problems with your predecessors. Okay. On the cost of goods sold, last quarter you mentioned the engineering costs for the SS Q-125s. Added to cost of good sold and effective margin, was this an ongoing issue in Q3 again as an offset against your very favorable margins this quarter or is that all done in Q2?

Cary Wood

That was all finished in Q2.

Andrew Shapiro - Lawndale Capital Management

Okay. Let me back out again in case you have someone else, but I do have more questions.

Cary Wood

Why don't you wrap up Andrew, why don't you go ahead and wrap up.

Andrew Shapiro - Lawndale Capital Management

You guys had, this quarter versus last quarter, a sizable ramp in receivables. Are these receivables a function of one of the segments and if it is DSS, is it a function of the higher foreign sales, and are these U.S. government guaranteed receivables or are these U.S. Navy receivables where we have no concerns on payoff?

Cary Wood

We're not concerned with payoff and they are, in fact, within that segment, and they are highly dependent upon foreign sales and a good amount of that, to put things to rest, have been since collected, so we feel very, very comfortable with what the cash outlook will be and what the receivables state will be in the Q4.

Andrew Shapiro - Lawndale Capital Management

Can you discuss the nature and the program focus of the most recently referred to U.S. Navy Engineering development projects. Is that SS Q-125s, other high-altitude sonobuoy work or other disclosable items?

Cary Wood

Those are some of the disclosable items. We are always working with the Navy on a handful of special projects. I try not to spend a lot of time talking about them, nor do I want to hint that they are a silver lining of some future development that will be an incremental breakthrough. There is just no way of knowing how those things are going to play out.

But I do know that we are pretty involved with providing engineering solutions and generating ideas and trying to expand creative uses of anti-submarine warfare. I think, generally speaking, more of what we're involved with is the enhancements and the ramp-up of 125 in particular.

Andrew Shapiro - Lawndale Capital Management

You touched on it, but didn't really detail it. Have you had meaningful progress on your new digital compass in the navigation and oil and gas areas.

Cary Wood

Yeah, we have. There's really one barometer of success at this point. In contrast to the legacy compass, there were but a handful of engagements, and highly dependent upon but a small number of end markets, customers, and applications.

In contrast to that, the new launch of our compass last year was intended to open up the versatility and ultimately end markets. We've displayed at a good number of shows, we've done a good number of technical symposiums, and I think it's fair to say that we have seen an exponential number of engaged conversations, samples. It does have a bit of a long lead time to it, if for no other reason, it ultimately gets specked into end devices.

I would say that we've seen, on the scores, an excess of a couple dozen of different discussions, engagements, and samples provided. When you go back and look at our ultimate activity in the context of cash flow and revenue, it is right on target within the current fiscal year. As you'd expect, that will start to increase into next year and it will ultimately ramp up into year three, four, and five in a way that will play out and more than pay for what we expended at the front end.

Andrew Shapiro - Lawndale Capital Management

Right. Now, when does this tax rate equalize out because obviously when your bottom line figures show year-over-year while you've put on some very substantial and nice growth on the table. The bottom line figures of course don't show that because one year is taxed and the prior year is not taxed. When does that anniversary?

Gregory Slome

That would be in Q1 of next year, Andrew. If you remember through the first three quarters of fiscal 11, we still had the evaluation allowance against the (inaudible) assets and then that was restated at June 30. That's what we've taken into account when we calculate the adjusted EPS. That's will start getting apples to apples as we get into Q1.

Andrew Shapiro - Lawndale Capital Management

Q1 will be the first quarter that we'll then see if things stay the same substantial year-over-year growth.

Cary Wood

Right.

Andrew Shapiro - Lawndale Capital Management

On the bottom line number we're seeing the revenues. I appreciate you breaking out what the growth is or the organic growth is, and that of the acquisition, so that's helpful too. On medical, can you describe and discuss the products that you make for your new largest customer, Finwell.

Cary Wood

We have limited ability to do that by contract. I will say this, we've been very pleased with the momentum there. We've grown on a year-over-year basis almost 50% with that particular customer. Some of it attributed to pent up and aged backlog given our service levels, but I would also say that we've helped them by providing selling solutions, specifically in the service segment of that has only strengthened their own revenue, which has certainly strengthened our demands. That's kind of a limit of what I think the broad strokes are of that engagement.

Andrew Shapiro - Lawndale Capital Management

Well since they're not public, can you at least discuss what line of business is, what kind of products they sell.

Cary Wood

They are blood separation devices.

Andrew Shapiro - Lawndale Capital Management

Okay. And is your experience then, I think you just mentioned it, but I want to clarify. Is your experience with the relationship after acquiring the business, which I think was Delphi had it more than Byers Peak, but after acquiring Delphi has your experience been a strengthening of that relationship, status quo, or, you know, some touchy feelings going on just like there might have been with some of the former Sparton customers?

Cary Wood

Well, absolutely, it has strengthened. And it's not limited to Finwell. There are a good number of customers that we engaged there that were assessing their options. Service levels were horrible. Attention to detail, the list goes on an on. As you'd expect, it's a business that was non-core, so legacy owners, and it was treated as much.

And so, with some of our key customers, you've named one that had no manufacturing assets. They were extremely vulnerable. And I think they have been more than pleased with our service levels as have been a couple of other anchor customers there that at one point were considering disengagement that are now asking us to quote on new opportunities. I think that's a great barometer.

I would also suggest to you that we've had some of our key customers on the ground in Asia examining some other assets to understand just how much further vertically they can go with us given our capabilities. Those are all good signs to me.

And that doesn't happen unless you are performing at least at the level they'd expect, if not better. You are talking about things like service quality, fill rate, and ramp up of new opportunities, prototyping, all of that. I think every bit of what we've expected from that acquisition, but probably not just isolated to that acquisition.

We've brought on a whole slew of new business development resources, and they are regionalized, they are on the ground; they're engaged. And I think probably better than they've ever done before. They are not just selling our acquisition assets, they are selling the full array of our capabilities. Everything on the business development fronts with the exception of more organic growth has been seen up to date.

Andrew Shapiro - Lawndale Capital Management

And with Siemens is there any update on any evidence of a continuation of their relationship in terms of new program opportunities, increased orders on your existing programs?

Cary Wood

The relationship remains probably status quo. Saying that it was not a bad relationship in the past. I think that we continue to be engaged with them. We were on the ground in Europe with their key purchasing people last year. That's a first for this company. That's not something the legacy management, and frankly, even the local and the new management team had been doing.

So we've gotten on the ground with them in Germany. We've had discussions around the current account, as well as expanding it. None of that has materialized at this point. But look, I think that it's also true to say that Siemens has some of their own issues, and those are out there in public disclosure. And I think they are working through some of those things, and we are mindful of those, not knowing how they could ultimately impact us positively and/or negatively.

Our sell to them, no differently than a lot of the primary OEs, is that you're in the business of generating ideas and bringing them to market. What we do is help make the contract manufacturing side of things easier and cheaper. And so more outsourcing is good for you and it's a better deployment of your cash. Obviously, that's the thesis that we continue to sell with Siemens and others. Our hope is that it's eventually going to evolve but as I sit here today, I'm not prepared and I don't expect that I'm going to be giving you an announcement on any new Siemens wins.

I think frankly a lot of what we do today is ultimately to sunset. It was a customer that was among that accounted for darn near 80% of our revenue three years ago and that's just simply not the case today. The number of customers that account for 80% of our revenue has more than doubled over the course of the last few years. So we've taken away the leverage, we've taken away the impact that would have been just disastrous in fiscal year '10 or '09, but I think that's generally the state of our relationship with Siemens today.

Andrew Shapiro - Lawndale Capital Management

Okay, a few more here. Can you update on your internal R&D efforts? I've seen the expenditures are at the levels you project and all that. Your new digital company was born out of some of that. But what are current examples or new examples of tat your R&D expenditures are bearing additional fruit and what are the current R&D expenditures being focused on?

Cary Wood

We rolled as you're aware last year. The GD6 Compass, to name one. And it was a land focus with enhanced gyro. Obviously, it had specific end use and application targets. it was expanding on what was a narrowly focused legacy compass to have more versatile applications but more oriented towards land applications. As we move in the future years and launches, we start to expand that into air usage. We certainly feel like we're the smallest and the least power consuming in the industry, which I think presents a bit of niche for us. And as we move forward, we'll expand that to land, or land and air, and we'll just evolve on a year-over-year basis and expand the versatility. And we like the idea that the end markets in the unmanned space for the DOD in particular presents an opportunity for us and a good number of our activity are targeted at that end market.

Andrew Shapiro - Lawndale Capital Management

So the bulk of the R&D then is focused on the digital compass, the UAV area and all?

Cary Wood

It has been up till now. Now that's not to say that we haven't examined some of our other business segments but we have not authorized anything on an IRD basis and we won't. We won't until the business case makes sense. But that's not out primarily focus. It just happens to be one of the multi-legged approach to our growth and it's one that I think to bring good rich margins but I think it's the one that probably takes the longest, incubates the longest. It's certainly has its uncertainties. It's market based independent, but we continue to invest in it. And until we find that what we projected, the investment thesis to produce doesn't do that, right now we're going to continue to invest in that way.

Andrew Shapiro - Lawndale Capital Management

Okay. This is probably a question for Greg. Did the March quarter contain any restructuring charges? And where on the income statement and in which segment info ought they be backed out if we were to do recurring analysis? Because I saw a reference in footnote two in your 10-Q to a small inventory write down and I wasn't sure if that was a recurring testing nature or of an acquisition related one-time.

Gregory Slome

No. There was nothing restructuring related that went through the third quarter. The one thing we did push through that got inputted into the adjusted calculation was we had a gain on the finalization of the Delphi excess inventory issue related to the acquisition agreement. That resulted in a $106,000 gain in the quarter that went through gross margin.

Andrew Shapiro - Lawndale Capital Management

Okay. And then footnote two referring to the small inventory write down is just a recurring testing nature?

Cary Wood

Right.

Andrew Shapiro - Lawndale Capital Management

Okay. And not acquisition related so we will leave that as recurring. You have about a million and a half during the quarter added to building machinery construction. While the ERP accounted for some of this, what else is primarily accounting for this CapEx Spend for the quarter?

Cary Wood

Yeah. You're right. The ERP accounted for the lion's share and for the small balance that was still there, we invested in some productivity based equipment, specifically, in DSS. And it was further intended to help with our end testing in a way that accelerates and improves our quality. So I think the balance of it was focused in DSS and it was focused in productivity, but it was marginal, to say the least.

Andrew Shapiro - Lawndale Capital Management

Okay. And with your continued cash flow generation, sustained profitability, presumably a newly negotiated line of credit and all and obviously ability to probably negotiate an acquisition financing particular to any particular target, and you've got your R&D and all that, I think I'd also want to toss my two cents in for your buyback or, frankly, maybe the potential of the establishment of a small, but recurring dividend stream now.

Whether it's $0.02 a share every quarter or not, it opens up the attractiveness of the Sparton stock to income-limited investment funds and investment communities. It rewards your continuing investors with a small income stream while they wait for your acquisitions, while still being a good use of company capital.

So I do want to toss in the concept of, I know you don't want to make it too big because dividend is not a good thing to be, dropping and cutting, but I think you may be at a point where you could have as a recurring nature just a small but ongoing dividend stream that makes you now an income-generating kind of entity. So a security. Just something for you guys to consider alongside stock buyback.

Cary Wood

Appreciated. As you'd expect, it received a amount of hearty discussion and debate in a more recent board meeting.

Andrew Shapiro - Lawndale Capital Management

Great. Thank you.

Cary Wood

Okay, Andrew.

Michael Osborne

Well, we'd like to thank all the participants in today's call. Again, today's call, including the question-and-answer period, has been recorded and will be posted to our website under the Investor Relations tab later today. Thank you.

Operator

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

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