Sparton Corporation (SPA)

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Sparton Corporation (SPA)

F2Q12 Earnings Call

February 8, 2012 11:00 AM ET

Executives

Mike Osborne – SVP, Business Development and Supply Chain

Cary Wood – President and CEO

Greg Slone – SVP and CFO

Analysts

Steve Shaw – Saccardi & Company

Jimmy Baker – B Riley & Company

Ross Taylor – Somerset Capital

Andrew Shapiro – Lawndale Capital Management

Kevin Casey – Casey Capital

Jack Gullaty – Safety Care

Presentation

[Presentation session will be updated shortly]

Question-and-Answer Session

Operator

Thank you. (Operator Instructions). And our first question comes from the line of Steve Shaw, Analyst with Saccardi & Company. Please go ahead.

Steve Shaw – Saccardi & Company

Hi guys, how are you doing?

Cary Wood

Good morning Steve, how are you doing?

Steve Shaw – Saccardi & Company

Question on the complex systems segment. I know a while back you guys said you would give it some time maybe, two or three years or so I believe and step back and reevaluate it. Now, in the sort of improving and getting to where you want to be, have you guys thought about what you’re going to do with that segment?

Greg Slone

We are, Steve as you well know, six of the eight quarters into our evaluation process. Our expectations, several years ago was that it would contribute positively on cash flow and that it would provide margins similar to some of the other business segments. And that it had to achieve a double digit sustainable performance and it is clearly gotten in that range. And it has shown I’ll call it shades of greatness with sustainability but we still got ways to go.

I think there are some performance enhancements there. There are, some revenue opportunities still yet there. And frankly, in the M&A space, there are lots of opportunities that could further augment the performance of this business if we were to choose to go that route and we’re certainly interested in those types of targets.

At this point, I’m not going to use today’s call to declare victory over our complex segment just yet. I prefer that the performance still gets improved and shows some sustainability. But I think that’s probably the best answer I can give for today Steve.

Steve Shaw – Saccardi & Company

Okay. And then, on the impact of the Sonobuoys testing to improve the quality for the Navy, is that still ongoing – do you guys have any idea of how exactly, how that impacted you guys for the quarter and how’s that acting going forward?

Cary Wood

Yeah, let me give you a little bit of history on that. When we ship our Sonobuoys, we ship in full lots, which is a significant sized revenue chunk. And they either pass or they fail in totality. We had several lot failures last year that were frankly frustrating. And the good news was that the failures were on older Sonobuoy applications that we hadn’t fully implemented some of our quality systems against.

When we came into this company several years ago, we concentrated on the 80/20 which was the more recent applications, the higher demanded Sonobuoy applications and we saw that mix shift a little bit last year and consequently we saw some failures on Sonobuoy applications that we weren’t fully attending. And frankly, we put in, in the near term, certain inline testing, destructive testing, outside re-sourcing. And it didn’t come without an impact financially to the quarter. But I think on a forward looking basis, while we’ll continue to put in rigorous quality impacts to the cogs, I don’t know that it will have the same effect on a go forward.

I’m not prepared as I sit here to give you a number as to what it was and what it will likely be. But we will improve on our yield, we’ll continue to interview certain inline processes including destructing testing and inspection. And all of which adds costs but yields out the backend, a more reliable and sustainable revenue stream because we shouldn’t see lot of failures to the degree that we’ve seen in the past.

So, that’s generally what we’ve accomplished there. And I’m hard pressed to give you a number. But I think, more importantly, if I looked at the DSS segment compared to historical performance, there is, really two or three things that are influencing. A, you just sit out one being the additional cost associated with or near term that not added cost on quality – destructive testing being the single biggest example of that.

Another big chunk of that includes the ramping up of Q125, high altitude related engineering resources. And that had certain impact on cogs. And then, lastly, we saw a downturn in certain planned revenue in our digital compass, our preexisting digital compass.

Its end user applications have been essentially called back from combat and we still believe that over time, there will be a demand to retro fit. But for now, the regular stream has been somewhat delayed. And those were very high margin products. And that has had an implication on our near term return. So, with that being the case, you’d sum those three, you essentially accounted for the difference between historical margin performance and this current quarter.

I would also say as we look forward, we’re very bullish on our third and fourth quarter’s performance. And we expect that it will be right back to historical performance of our DSS segment.

Steve Shaw – Saccardi & Company

Okay. And then, lastly, do you have a time-table on that – on the digital compass and when there might being some traction?

Cary Wood

We’re hard pressed to say that all the revenue that was lost in our first half of the year will be accounted for the second half. I’m still optimistic that the older version compass will continue to sell at our planned rates in the second and third quarter. And as I mentioned, we continue to be very optimistic about what those returns will look like.

And then, we expected and frankly are seeing and it’s actually a little stronger demand for the new revenue stream associated with the newer version of our compass. And those have very different end applications and end markets but we are starting – and the revenue is modest and it was always planned to be modest. And it was justified in our careful analysis, having been modest. But we do expect to continue to see that strengthen over the course of this year.

So, I’m hard pressed to tell you exactly what program it was, when it will come back, how big it will be. But I don’t believe that the revenue lost in its totality we would recover between now and yearend, I just think it will end up getting shifted.

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