Sparton Corporation (

SPA

)

F1Q2011 Earnings Call Transcript

November 17, 2010 11:00 am ET

Executives

Mike Osborne – SVP, Business Development

Cary Wood – President and CEO

Greg Slome – CFO

Analysts

Andrew Shapiro – Lawndale Capital Management

Jonathan Haines [ph]

Presentation

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[Starts Abruptly] The gross profit percentage remains flat from 15.3% a year ago to 15.4% in the fiscal 2011 first quarter. Impacting the quarter-over-quarter gross margin was the favorable impact of increased sales in the company’s DSS segment, the impact of plant closure and consolidation within the EMS segment and the benefits of our continuous cost improvement programs across the Company. Offsetting these positive trends were unfavorable product mix, customer pricing adjustments and decreased capacity utilization within the medical segment.

Selling and Administrative expenses for the three months ended September 30, 2010, increased approximately 400,000 from the prior year’s quarter reflecting additional expense related to SMS Colorado facility, increased internal research and development expenses, increased informational technology expenses and increased expenses related to the company’s long term incentive plan, partially offset by reduced selling and administrative expenses resulting from the consolidation of our EMS facilities during fiscal 2010.

Restructuring and impairment charges were $100,000 and $900,000 for the three months ended September 30, 2010 and 2009 respectively. Interest expense was $200,000 for the fiscal 2011 first quarter compared to the $300,000 for the same quarter in fiscal 2010. The decrease in interest expense primarily reflects the payment of the company’s outstanding bank debt in August 2009.

We are extremely pleased to have closed on the Delphi Medical System acquisition during the first quarter and we substantially completed our integration plan well ahead of our schedule. The purchase price of $8 million is subject to certain adjustments based on the determination of final inventory value.

The cash consideration paid at closing of approximately $7.8 million including a $2 million escrowed holdback was reduced by $200,000 for the assumption of retained employee accruals and was financed entirely through the use of company’s cash.

The company has estimated that the additional cash consideration due to Delphi is subject to final agreement of the acquired inventory will be approximately 600,000 and has accrued for this amount on September 30, 2010.

Sparton has determined that the fair value of the assets acquired and the liabilities assumed related to this acquisition exceed the total purchase consideration and in compliance with recent acquisition accounting rules.

The company has recorded a gain on this acquisition of 2.4 million in the three months ended September 30, 2010. The acquired business which is reported in the company’s medical segment is expected to add $32 million in projected annual revenue from a new and diversified customer base and provides Sparton with a geographic presence in the western United States.

SMS Colorado primarily manufactures OEM medical devices, including blood separation equipment, spinal surgery products and 3D I-mapping devises. It also provides engineering and manufacturing support to market leading environmental sensor company whose markets include meteorology, weather critical operations and controlled environmental applications.

The operations of SMS Colorado are included in the consolidated operating results for fiscal 2011 first quarter from the August 6, 2010 date of acquisition. SMS Colorado reported first quarter net sales of $5.9 million, gross profit of 600,000 or 9% and operating income of $2.4 million. Excluding the $2.4 million gain on acquisition, the operations essentially had a neutral impact on the consolidated net income in our first quarter.

On a pro forma basis, the revenue for the current and prior comparable full quarters remained relatively flat at $9.4 million and $9.6 million for the quarters ended September 30, 2010 and 2009 respectively. The gross margin percent has increased from 1% for the fiscal 2010 first quarter to 7% for the current year first quarter.

To further enhance SMS Colorado's profitability, Sparton Management quickly initiated certain actions designed to reduce cost. The workforce at this location has been reduced by approximately 18% since acquisition and additionally the Company consolidated the Colorado operations from two facilities to one during the first quarter, terminating the lease for the exited buildings as of November 1, 2010.

Again, we are very pleased at the speed in which we have been able to execute on our cost savings initiatives as part of our 100-day plan having surpassed our internal timeline for the facility consolidation. Initial success in implementation of lien enterprise in Colorado is encouraging. For enhancing the profitability of this business further, as we anticipate this strategic addition to our medical business will be accretive to earnings no later than the third quarter of our fiscal 2011.

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

Greg Slome

Thank you, Cary. For the medical device business, sales decreased 500,000 or 3% in the three months ended September 30, 2010, as compared with same quarter last year, excluding the incremental first quarter sales from SMS Colorado, the quarter-over-quarter medical revenue decreased $6.5 million or 33%.

As previously mentioned, overall sales softening in the medical segment has continued with one customer right sizing their inventories, a second customer suspending production to make product enhancement modifications and a third customer elevating sales in the prior year relating to the initial channel fill for new product production.

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