UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-Q



ý	QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended ~~December 31, 2017~~September 30, 2018



¨	TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from to

Commission File Number 1-1000

Sparton Corporation

(Exact name of registrant as specified in its charter)



Ohio		38-1054690
(State or other jurisdiction of incorporation or organization)		(I.R.S. Employer Identification No.)
425 N. Martingale Road, Suite 1000, Schaumburg, Illinois		60173-2213
(Address of principal executive offices)		(Zip code)

(847) 762-5800

(Registrant’s telephone number, including area code)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes ý No ¨

Indicate by check mark whether the registrant has submitted electronically ~~and posted on its corporate website, if any,~~ every Interactive Data File required to be submitted ~~and posted~~ pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or such shorter period that the registrant was required to submit ~~and post~~ such files). Yes ý No ¨

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, smaller reporting company or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” and "emerging growth company" in Rule 12b-2 of the Exchange Act.



Large accelerated filer	¨	Accelerated filer	ý
Non-accelerated filer	¨~~(Do not check if a smaller reporting company)~~	Smaller reporting company	¨
		Emerging growth company	o

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. o

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ¨ No ý

As of ~~February~~November 2, 2018, there were 9,834,723 shares of common stock, $1.25 par value per share, outstanding.

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TABLE OF CONTENTS



PART I	FINANCIAL INFORMATION	4
ITEM 1.	FINANCIAL STATEMENTS	4
	CONSOLIDATED BALANCE SHEETS AS OF ~~DECEMBER 31, 2017~~SEPTEMBER 30, 2018 (UNAUDITED) AND JULY ~~2, 2017~~1, 2018	4
	CONSOLIDATED STATEMENTS OF OPERATIONS FOR THE ~~SECOND~~FIRST QUARTER ~~AND FIRST TWO QUARTERS~~ OF FISCAL YEARS ~~2018~~2019 AND ~~2017~~2018 (UNAUDITED)	5
	CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS) FOR THE ~~SECOND~~FIRST QUARTER ~~AND FIRST TWO QUARTERS~~ OF FISCAL YEARS ~~2018~~2019 AND ~~2017~~2018 (UNAUDITED)	6
	CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY FOR THE FIRST QUARTER OF FISCAL YEARS 2019 AND 2018 (UNAUDITED)	7
	CONSOLIDATED STATEMENTS OF CASH FLOWS FOR THE FIRST ~~TWO QUARTERS~~QUARTER OF FISCAL YEARS ~~2018~~2019 AND ~~2017~~2018 (UNAUDITED)	78
	NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS	89
ITEM 2.	MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS	1619
ITEM 3.	QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK	2224
ITEM 4.	CONTROLS AND PROCEDURES	2324
PART II	OTHER INFORMATION	2425
ITEM 1.	LEGAL PROCEEDINGS	2425
ITEM 1A.	RISK FACTORS	2425
ITEM 6.	EXHIBITS	2526
	SIGNATURES	2627
	CERTIFICATIONS

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FORWARD-LOOKING STATEMENTS

This Quarterly Report on Form 10-Q contains statements about future events and expectations that are “forward-looking statements.” We may also make forward-looking statements in our other reports filed with the SEC, in materials delivered to our shareholders and in press releases. These statements relate to future events or our future financial performance and involve known and unknown risks, uncertainties and other factors that may cause our actual results, levels of activity, performance or achievements to be materially different from any future results, levels of activity, performance or achievements expressed or implied by these forward-looking statements. Certain of these risks, uncertainties and other factors are described in Item 1A of Part II, “Risk Factors” of our most recent Annual Report on Form 10-K. In some cases, you can identify forward-looking statements by terminology such as “may,” “will,” “should,” “expects,” “intends,” “plans,” “anticipates,” “believes,” “estimates,” “predicts,” “potential,” or the negative use of these terms or other comparable terminology that convey the uncertainty of future events or outcomes. Although we believe these forward-looking statements are reasonable, they are based on a number of assumptions concerning future conditions, any or all of which may ultimately prove to be inaccurate. These forward-looking statements are based on management’s views and assumptions at the time originally made, and we undertake no obligation to update these statements whether as a result of new information or future events. There can be no assurance that our expectations, projections or views will materialize and you should not place undue reliance on these forward-looking statements. Any statement in this report that is not a statement of historical fact may be deemed to be a forward-looking statement and subject to the safe harbor created by the Private Securities Litigation Reform Act of 1995.

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PART I. FINANCIAL INFORMATION

Item 1. Financial Statements.

SPARTON CORPORATION AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

(Dollars in thousands, except share data)


	December 31, 2017			July 2, 2017			September 30, 2018			July 1, 2018
Assets	(Unaudited)						(Unaudited)
Current Assets:
Cash and cash equivalents	$	1,104		$	988		$	1,170		$	1,160
Accounts receivable, net of allowance for doubtful accounts of $374 and $429, respectively	54,466			45,347
Accounts receivable, net of allowance for doubtful accounts of $163 and $169, respectively							46,011			60,454
Inventories and cost of contracts in progress, net	62,767			60,248			91,230			72,406
Legal settlements - insurance receivable							4,500			4,500
Prepaid expenses and other current assets	4,177			3,851			6,823			3,944
Total current assets	122,514			110,434			149,734			142,464
Property, plant and equipment, net	34,484			34,455			32,024			32,790
Goodwill	12,663			12,663			12,663			12,663
Other intangible assets, net	24,629			28,445			19,438			21,108
Deferred income taxes	14,771			24,893			17,772			17,646
Other non-current assets	5,177			6,253			4,858			5,331
Total assets	$	214,238		$	217,143		$	236,489		$	232,002
Liabilities and Shareholders’ Equity
Current Liabilities:
Accounts payable	$	38,210		$	27,672		$	39,393		$	28,636
Accrued salaries	9,293			11,453			8,305			11,341
Accrued health benefits	1,124			1,150			1,177			947
Accrued legal settlements							5,500			5,500
Performance based payments on customer contracts	—			1,749			13,307			3,868
Advances from customers							6,418			5,949
Current portion of capital lease obligations	269			269			100			163
Other accrued expenses	10,121			11,959			10,438			10,718
Total current liabilities	59,017			54,252			84,638			67,122
Credit facility	78,900			74,500			73,000			84,500
Capital lease obligations, less current portion	32			167
Environmental remediation	5,208			5,468			4,705			4,866
Pension liability	820			888			657			690
Other non-current liabilities							—			1,220
Total liabilities	143,977			135,275			163,000			158,398
Commitments and contingencies
Shareholders’ Equity:
Preferred stock, no par value; 200,000 shares authorized, none issued	—			—			—			—
Common stock, $1.25 par value; 15,000,000 shares authorized, 9,834,723 and 9,860,635 shares issued and outstanding, respectively	12,293			12,326
Common stock, $1.25 par value; 15,000,000 shares authorized, 9,834,723 and 9,834,723 shares issued and outstanding, respectively							12,293			12,293
Capital in excess of par value	18,106			17,851			17,586			17,599
Retained earnings	41,081			52,967			44,580			44,713
Accumulated other comprehensive loss	(1,219		)	(1,276		)	(970		)	(1,001		)
Total shareholders’ equity	70,261			81,868			73,489			73,604
Total liabilities and shareholders’ equity	$	214,238		$	217,143		$	236,489		$	232,002

See Notes to unaudited consolidated financial statements.

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SPARTON CORPORATION AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF OPERATIONS

(UNAUDITED)

(Dollars in thousands, except per share data)


	For the Second Quarter of Fiscal Years						For the First Two Quarters of Fiscal Years						For the First Quarter of Fiscal Years
	2018			2017			2018			2017			2019			2018
Net sales	$	97,819		$	97,399		$	180,582		$	197,766		$	89,462		$	82,763
Cost of goods sold	77,390			81,501			145,565			164,583			71,823			66,839
Gross profit	20,429			15,898			35,017			33,183			17,639			15,924
Operating expense:
Operating expense
Selling and administrative expenses	14,074			12,953			29,279			26,336			12,370			15,205
Internal research and development expenses	669			533			1,241			884			1,349			572
Amortization of intangible assets	1,893			2,191			3,816			4,410			1,670			1,923
Total operating expense	16,636			15,677			34,336			31,630			15,389			17,700
Operating income	3,793			221			681			1,553
Other income (expense)
Operating income (loss)													2,250			(1,776		)
Other expense
Interest expense, net	(1,507		)	(1,067		)	(2,773		)	(2,252		)	(1,949		)	(1,266		)
Other, net	13			(11		)	3			9			(14		)	(10		)
Total other expense, net	(1,494		)	(1,078		)	(2,770		)	(2,243		)	(1,963		)	(1,276		)
Income (loss) before income taxes	2,299			(857		)	(2,089		)	(690		)	287			(3,052		)
Income taxes	11,333			50			9,797			109			75			(1,068		)
Net loss	$	(9,034	)	$	(907	)	$	(11,886	)	$	(799	)
Loss per share of common stock:
Net income (loss)													$	212		$	(1,984	)
Income (loss) per share of common stock:
Basic	$	(0.92	)	$	(0.09	)	$	(1.21	)	$	(0.08	)	$	0.02		$	(0.20	)
Diluted	$	(0.92	)	$	(0.09	)	$	(1.21	)	$	(0.08	)	0.02			(0.20		)
Weighted average shares of common stock outstanding:
Basic	9,834,723			9,802,664			9,845,686			9,793,046			9,834,723			9,856,649
Diluted	9,834,723			9,802,664			9,845,686			9,793,046			9,834,723			9,856,649

See Notes to unaudited consolidated financial statements.

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SPARTON CORPORATION AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)

(UNAUDITED)

(Dollars in thousands)


	For the Second Quarter of Fiscal Years						For the First Two Quarters of Fiscal Years						For the First Quarter of Fiscal Years
	2018			2017			2018			2017			2019		2018
Net Loss	$	(9,034	)	$	(907	)	$	(11,886	)	$	(799	)
Net income (loss)													$	212	$	(1,984	)
Other comprehensive income, net:
Pension amortization of unrecognized net actuarial loss, net of tax	22			55			57			90			31		35
Other comprehensive income, net	22			55			57			90			31		35
Comprehensive loss	$	(9,012	)	$	(852	)	$	(11,829	)	$	(709	)
Comprehensive income (loss)													$	243	$	(1,949	)

See Notes to unaudited consolidated financial statements.

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SPARTON CORPORATION AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF SHAREHOLDERS’ EQUITY

(UNAUDITED)

(Dollars in thousands)



	For the First Quarter of Fiscal 2019
	Common Stock			Capital In Excess of Par Value			Retained Earnings			Accumulated Other Comprehensive Loss			Total Shareholders' Equity
	Shares	Amount		Capital In Excess of Par Value			Retained Earnings			Accumulated Other Comprehensive Loss			Total Shareholders' Equity
Balance at July 1, 2018	9,834,723	$	12,293	$	17,599		$	44,713		$	(1,001	)	$	73,604
Stock-based compensation	—	—		(13		)	—			—			(13		)
Adjustment upon adoption of ASC 606	—	—		—			(345		)	—			(345		)
Net income							212						212
Comprehensive income, net	—	—		—			—			31			31
Balance at September 30, 2018	9,834,723	$	12,293	$	17,586		$	44,580		$	(970	)	$	73,489



	For the First Quarter of Fiscal 2018
	Common Stock					Capital In Excess of Par Value		Retained Earnings			Accumulated Other Comprehensive Loss			Total Shareholders' Equity
	Shares		Amount			Capital In Excess of Par Value		Retained Earnings			Accumulated Other Comprehensive Loss			Total Shareholders' Equity
Balance at July 2, 2017	9,860,635		$	12,326		$	17,851	$	52,967		$	(1,276	)	$	81,868
Forfeiture of restricted stock	(25,912	)	(33		)	33		—			—			—
Stock-based compensation	—		—			211		—			—			211
Net loss	—		—			—		(1,984		)	—			(1,984		)
Comprehensive income, net	—		—			—		—			35			35
Balance at October 1, 2017	9,834,723		$	12,293		$	18,095	$	50,983		$	(1,241	)	$	80,130

See Notes to unaudited consolidated financial statements.

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SPARTON CORPORATION AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS

(UNAUDITED)

(Dollars in thousands)


	For the First Two Quarters of Fiscal Years						For the First Quarter of Fiscal Years
	2018			2017			2019			2018
Cash Flows from Operating Activities:
Net loss	$	(11,886	)	$	(799	)
Adjustments to reconcile net loss to net cash provided by (used in) operating activities:
Net income (loss)							$	212		$	(1,984	)
Adjustments to reconcile net income (loss) to net cash provided by (used in) operating activities:
Depreciation	2,990			2,989			1,410			1,536
Amortization of intangible assets	3,816			4,410			1,670			1,923
Deferred income taxes	10,122			32			8			19
Stock-based compensation expense	221			1,277			(13		)	211
Amortization of deferred financing costs	597			249			374			212
Loss on sale of property, plant and equipment, net	31			—
Changes in operating assets and liabilities:
Accounts receivable	(9,119		)	(637		)	6,666			(8,586		)
Inventories and cost of contracts in progress	(2,519		)	18,000			(9,023		)	(9,734		)
Prepaid expenses and other assets	341			599			4,589			(204		)
Advance billings on customer contracts							469			—
Performance based payments on customer contracts	(1,749		)	127			(454		)	(1,749		)
Accounts payable and accrued expenses	6,281			(11,576		)	6,321			(4,873		)
Net cash provided by (used in) operating activities	(874		)	14,671			12,229			(23,229		)
Cash Flows from Investing Activities:
Purchases of property, plant and equipment	(3,099		)	(2,570		)	(651		)	(455		)
Proceeds from sale of property, plant and equipment	14			—
Net cash used in investing activity	(3,085		)	(2,570		)	(651		)	(455		)
Cash Flows from Financing Activities:
Borrowings under credit facility	104,800			59,644			48,100			71,700
Repayments under credit facility	(100,400		)	(71,144		)	(59,600		)	(48,600		)
Payments under capital lease agreements	(136		)	(129		)	(68		)	(68		)
Payment of debt financing costs	(189		)	(15		)	—			(17		)
Net cash provided by (used in) financing activities	4,075			(11,644		)	(11,568		)	23,015
Net increase in cash and cash equivalents	116			457
Net increase (decrease) in cash and cash equivalents							10			(669		)
Cash and cash equivalents at beginning of period	988			132			1,160			988
Cash and cash equivalents at end of period	$	1,104		$	589		$	1,170		$	319
Supplemental disclosure of cash flow information:
Cash paid for interest	$	1,880		$	1,972		$	1,505		$	950
Cash paid for income taxes	603			354			22			509
Supplemental disclosure of non-cash investing activities:
Machinery and equipment financed under capital leases	—			148

See Notes to unaudited consolidated financial statements.

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SPARTON CORPORATION AND SUBSIDIARIES

NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

(Dollars in thousands, except per share data)

(1) Business and Basis of Presentation

The accompanying unaudited consolidated financial statements have been prepared in accordance with generally accepted accounting principles for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by generally accepted accounting principles for complete financial statements. In the opinion of management, all adjustments (consisting of normal recurring accruals) considered necessary for a fair presentation have been included. Certain reclassifications of prior year amounts have been made to conform to the current year presentation. Subsequent events have been evaluated through the date these financial statements were issued. Additionally, the consolidated financial statements should be read in conjunction with Item 2, Management’s Discussion and Analysis of Financial Condition and Results of Operations, included in this Quarterly Report on Form 10-Q. Operating results for the quarter ~~and two quarters~~ ended ~~December 31, 2017~~September 30, 2018 are not necessarily indicative of the results that may be expected for the year ending ~~July 1, 2018.~~June 30, 2019. The consolidated balance sheet at July ~~2, 2017~~1, 2018 has been derived from the audited financial statements at that date but does not include all of the information and footnotes required by accounting principles generally accepted in the United States ("GAAP") for complete financial statements. For further information, refer to the consolidated financial statements and footnotes thereto included in the Company’s Annual Report on Form 10-K for the fiscal year ended July ~~2, 2017.~~1, 2018.

The Company reports fiscal years on a 52-53 week year (5-4-4 basis) ending on the Sunday closest to June 30.

Potential Sale of the Company

On July 7, 2017, Sparton Corporation (the "Company" or "Sparton"), Ultra Electronics Holdings plc, ~~("Parent" or “Ultra”~~(“Ultra”), and Ultra Electronics Aneira Inc., (“Merger Sub”) entered into an Agreement and Plan of Merger (the "Merger Agreement") that ~~provides~~provided for Ultra to acquire the Company by merging Merger Sub into the Company (such transaction referred to as the "Merger"), subject to the terms and conditions set forth in the Merger Agreement.

At the effective time of the Merger, each issued and outstanding share of common stock, par value $1.25 per share, of the Company (each, a “Share”) (other than (i) Shares that immediately prior to the effective time of the Merger are owned by Parent, Merger Sub or any other wholly owned subsidiary of Parent or owned by the Company or any wholly owned subsidiary of the Company (including as treasury stock) and (ii) Shares that are held by any record holder who is entitled to demand and properly demands payment of the fair cash value of such Shares as a dissenting shareholder pursuant to, and who complies in all respects with, the provisions of Section 1701.85 of the Ohio General Corporation Law (the “OGCL”)) will be cancelled and converted into the right to receive $23.50 per Share in cash, without interest.

The Merger Agreement provides for certain other termination rights for both the Company and Ultra, and further provides that, upon termination of the Merger Agreement under certain specified circumstances, the Company will be required to pay Ultra a termination fee of $7.5 million or Ultra will be required to pay the Company a termination fee of $7.5 million.

On October 5, 2017, at a special meeting of holders of shares of common stock of the Company, shareholders voted to adopt the Merger Agreement. Although the Merger Agreement ~~has~~had been adopted by the Company's shareholders, consummation of the Merger ~~remains~~remained subject to other closing conditions, including the expiration or termination of the applicable waiting period (or any extension thereof) under the Hart-Scott-Rodino Antitrust Improvements Act (the “HSR Act”).

On ~~September 22, 2017,~~March 5, 2018, Sparton announced the ~~Company~~termination by Sparton and Ultra ~~each received~~of the Merger Agreement as a ~~request for additional information (the “second requests”) from~~result of the staff of the United States Department of Justice (the “DOJ”) informing the parties that it intended to recommend that the DOJ block the Merger. Under a Merger Termination Agreement entered into by Sparton, Ultra and Merger Sub, the parties agreed to release each other from certain claims and liabilities arising out of or related to the Merger Agreement or the transactions contemplated therein or thereby, including any termination fees. The parties also agreed that certain agreements with confidentiality obligations will continue in ~~connection~~full force and effect.

Also on March 5, 2018, Sparton announced that, during the DOJ’s review of Sparton’s proposed Merger with Ultra, the United States Navy (the “Navy”) expressed the view that instead of the parties proceeding with the ~~pending merger. The second requests were issued under~~Merger, each of Sparton and Ultra should enhance its ability to independently develop, produce and sell sonobuoys and over time work toward the ~~Hart-Scott-Rodino Antitrust Improvements Act~~elimination of ~~1976, as amended. On October 23, 2017,~~their use of Sparton’s and Ultra’s joint venture for such activities. Since that time, Sparton has been in communication with the Navy to better understand its expectations with respect to the timing, funding and terms of current and future sonobuoy indefinite delivery / indefinite quantity ("IDIQ") production contracts.

As a result of the termination of the Merger Agreement, the Company ~~Ultra~~announced that it would seek to re-engage with parties that previously expressed an interest in acquiring all or a part of Sparton and that are in a position to expeditiously proceed to effect such a transaction. There can be no assurance that any such process will result in the ~~DOJ entered into~~execution of a ~~timing~~definitive agreement ~~pursuant to which, among other things,~~or the ~~Company and Ultra agreed not to consummate the pending merger until 90 days following the date on which both~~completion of them shall have certified compliance with the second requests, unless the DOJ’s investigation shall have been closed sooner, subject to certain exceptions. The Company and Ultra have been cooperating fully with the DOJ as it conducts its review of the pending merger and will continue to do so in connection with the second requests. a transaction.

Q-125A Sonobuoy Bid Process

On ~~January 31,~~July 9, 2018, the Company ~~and Ultra agreed to extend~~announced the ~~outside date for completing the pending merger from January 31, 2018 to March 31, 2018, pursuant to the Merger Agreement. The Merger Agreement provides Ultra~~filing of a bid protest by ERAPSCO with the ~~right to further extend~~United States Government Accountability Office ("GAO") challenging the ~~outside date for completing the pending merger until July 31, 2018 if certain regulatory approvals, including clearance~~competitive range exclusion of ERAPSCO under the ~~HSR Act, remain pending as~~United States Navy ("Navy") Solicitation No. N00019-19-R-0002 for the GFY 19-23 AN/SSQ-125A (the “Q-125A”) production sonobuoy. The protest challenged on a number of ~~March 31, 2018. The pending merger also remains subject~~bases the Navy's decision to ~~other governmental approvals, as well as other customary closing conditions.~~

exclude ERAPSCO from the solicitation process and requested that GAO restore ERAPSCO's ability to participate in the process. On August 30, 2018, the Navy issued a notice that it had

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taken corrective action to reopen the competitive range regarding the Q-125A production sonobuoy and include ERAPSCO in that competitive range. This allows ERAPSCO to again participate in the bid process. As a result of the Navy’s decision to restore ERAPSCO’s ability to participate in the bid process, the GAO dismissed the protest on September 4, 2018.

(2) Revenue Recognition

Effective July 2, 2018, we adopted Accounting Standards Codification 606, “Revenue from Contracts with Customers” (“ASC 606”) using the modified retrospective method. As a result, the cumulative effect of adopting ASC 606 on contracts that were open on the date of adoption was recognized as an adjustment to the opening balance sheet at July 2, 2018. We did not restate prior period information in our Balance Sheet, Statement of Operations or Statement of Cash Flows.

Our customers typically engage us to provide distinct products and services. In our Manufacturing and Design Segment, we perform services that include contract design, manufacturing, and aftermarket repair. In our Engineered Components & Products Segment, we provide products and services including design, development and production of proprietary products for domestic and foreign defense markets as well as for commercial needs. We consider contracts to exist once (i) the parties have approved the contract and have committed to perform their respective rights and obligations under the contract, (ii) the commitment of goods or services to be transferred has been established, (iii) the payment terms have been established, (iv) we have determined the contract has commercial substance, and (v) we have determined collectability of substantially all due consideration. We treat contracts with similar characteristics as a portfolio when the results are not materially different from treating contracts individually. The contract price is allocated to each distinct performance obligation and recognized as revenue when, or as, the performance obligation is satisfied.

Performance Obligations

Performance obligations are typically satisfied when or as products are shipped to customers. In certain contracts, transfer of control is recognized prior to shipment if it meets the requirements of a bill-and-hold arrangement or if the contract restricts Sparton’s use of the products, thereby eliminating the ability to obtain a benefit from them outside the customer contract. Service based performance obligations are considered satisfied as services are rendered based on costs incurred. The amount of consideration we expect to receive is allocated on the basis of each performance obligation’s selling price, including the effect variable consideration to the extent that revenue would likely not be reversed. The primary method used to estimate the standalone selling price is the contracted or list price. Typical payment terms are 30 days from invoicing and, in certain agreements, we receive progress based payments and deposits in advance of our satisfaction of performance obligations. Our warranties are assurance type which are not considered performance obligations and refund or return obligations are not material. The amount of the transaction price allocated to wholly unsatisfied (or partially unsatisfied) performance obligations is represented by our backlog. Of the $336 million of backlog at September 30, 2018, $50 million is expected to be recognized as revenue outside the next 12 months.

In our application of practical expedients, under ASC 606, we (i) treat contracts with similar characteristics as a portfolio, (ii) exclude implied financing costs from variable consideration, (iii) record service revenue based on our right to invoice, (iv) expense the incremental cost of obtaining a contract for contracts less than twelve months, (v) exclude taxes collected on behalf of a government authority related to our revenue generating transactions from our calculation of transaction price, and (vi) accrue for expected shipping and handling expenses that are expected to be incurred after control is transferred to customers.

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The net impact of adoption of ASC 606 on the opening balance sheet for the quarter ended September 30, 2018 was as follows:



	Before Adoption of ASC 606		Effect of adoption			After adoption of ASC 606
Assets:
Accounts receivable, net of allowance for doubtful accounts	$	60,454	$	(7,777	)	$	52,677
Inventories and cost of contracts in progress, net	72,406		9,801			82,207
Prepaid expenses and other current assets	3,944		7,390			11,334
Deferred income taxes	17,646		134			17,780
Liabilities:
Performance based payments on customer contracts	3,868		9,893			13,761
Shareholders' equity:
Retained earnings	44,713		(345		)	44,368

Progress payments from customers related to inventory purchases are reflected as a liability rather than as a reduction of inventory and unbilled accounts receivable are reflected as prepaid and other current assets rather than as accounts receivable. The net impact to retained earnings as a result of adopting ASC 606 was a decrease of $345.

Contract Assets and Contract Liabilities

Contract assets consist of our right to consideration for work performed or performance obligations completed which have not yet billed. Contract assets are invoiced and considered accounts receivable when the right to consideration no longer has any further contractual conditions. Contract liabilities consist of customer advances or progress payments for which we have not transferred goods or services to our customers. We expect to transfer all underlying goods and services to our customers within 12 months of establishing a contract liability.

Contract assets and contract liabilities from revenue contracts with customers consists of the following as of:



	For the First Quarter of Fiscal Year 2019
	Beginning of quarter		End of quarter
Contracts assets:
Prepaid expenses and current assets	$	6,891	$	2,202
Contracts liabilities:
Performance based payments on customer contracts	13,761		13,307
Advance from customers	5,899		6,368

Revenue of $13.5 million that was included in the contract liabilities at the beginning of the period was recognized in the quarter ended September 30, 2018. Changes in the contract asset and contract liability account balances were attributed to regular business activity.

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The following tables summarize the impact of adopting ASC 606 on our unaudited condensed consolidated financial statements for the first quarter of fiscal year 2019:



Condensed Consolidated Balance Sheet	September 30, 2018
	As reported		Net effect of adoption of ASC 606			Balances without adoption of ASC 606
Assets:
Current Assets:
Inventories and cost of contracts in progress, net	$	91,230	$	(1,591	)	$	89,639
Total current assets	149,734		(1,591		)	148,143
Deferred income taxes	17,772		(134		)	17,638
Total assets	$	236,489	$	(1,725	)	$	234,764
Liabilities and Shareholders’ Equity:
Performance based payments on customer contracts	$	13,307	$	(3,149	)	$	10,158
Other accrued expenses	10,438		227			10,665
Total current liabilities	84,638		(2,922		)	81,716
Total liabilities	163,000		(2,922		)	160,078
Retained earnings	44,580		1,197			45,777
Total shareholders’ equity	73,489		1,197			74,686
Total liabilities and shareholders’ equity	$	236,489	$	(1,725	)	$	234,764



Condensed Consolidated Statement of Operations	For the First Quarter of Fiscal Year 2019
	As reported		Net effect of adoption of ASC 606		Balances without adoption of ASC 606
Net sales	$	89,462	$	1,473	$	90,935
Cost of goods sold	71,823		394		72,217
Gross profit	17,639		1,079		18,718
Operating income	2,250		1,079		3,329
Income before income taxes	287		1,079		1,366
Income taxes	75		227		302
Net income	$	212	$	852	$	1,064

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Revenue by Category

The following table reflects our revenue disaggregated by major end-use market for the periods ended:



	For the First Quarter of Fiscal Years
	2019		2018
ECP Segment
U.S. sonobuoy	$	20,843	$	16,967
Foreign sonobuoy	3,124		5,608
Engineering services	2,188		549
Rugged electronics	7,157		7,268
Total ECP Segment	33,312		30,392
MDS Segment
Manufacturing	$	51,907	$	47,692
Engineering services	3,605		4,269
Other	638		410
Total MDS Segment	56,150		52,371
Total net sales	$	89,462	$	82,763

(3) Inventories and Cost of Contracts in Progress, net

The following are the major classifications of inventory, net of interim billings:


	December 31, 2017			July 2, 2017			September 30, 2018		July 1, 2018
Raw materials	$	48,316		$	31,353		$	59,482	$	56,088
Work in process	19,711			19,098			20,482		16,138
Finished goods	4,946			18,338			11,266		8,784
Total inventory and cost of contracts in progress, gross	72,973			68,789			91,230		81,010
Inventory to which the U.S. government has title due to interim billings	(10,206		)	(8,541		)	—		(8,604		)
Total inventory and cost of contracts in progress, net	$	62,767		$	60,248		$	91,230	$	72,406

In accordance with the application of ASC 606, progress payments from customers related to inventory purchases are reflected as liabilities rather than as a reduction of net inventories as presented on July 1, 2018.

~~(3)~~(4) Property, Plant and Equipment, net

Property, plant and equipment, net consists of the following:


	December 31, 2017			July 2, 2017			September 30, 2018			July 1, 2018
Land and land improvements	$	1,439		$	1,439		$	1,439		$	1,439
Buildings and building improvements	28,104			28,121			28,204			28,160
Machinery and equipment	50,472			46,502			53,390			53,250
Construction in progress	3,330			4,463			1,851			1,391
Total property, plant and equipment	83,345			80,525			84,884			84,240
Less accumulated depreciation	(48,861		)	(46,070		)	(52,860		)	(51,450		)
Total property, plant and equipment, net	$	34,484		$	34,455
Property, plant and equipment, net							$	32,024		$	32,790

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~~(4)~~

(5) Other Intangible Assets

The components of other intangible assets, net consist of the following:


	Net Carrying Value at July 2, 2017		Amortization			Net Carrying Value at December 31, 2017		Net Carrying Value at July 1, 2018		Amortization			Net Carrying Value at September 30, 2018
Non-compete agreements	$	1,345	$	(337	)	$	1,008	$	680	$	(161	)	$	519
Customer relationships	25,377		(3,296		)	22,081		19,061		(1,428		)	17,633
Trademarks/Tradenames	1,221		(81		)	1,140		1,059		(40		)	1,019
Unpatented technology and patents	502		(102		)	400		308		(41		)	267
	$	28,445	$	(3,816	)	$	24,629
Other intangible assets, net								$	21,108	$	(1,670	)	$	19,438

~~(5)~~(6) Debt

On September 11, 2014, the Company entered into a revolving line-of-credit facility with a group of banks (the “Credit Facility”)~~. The~~ which expires on September 11, 2019. On May 3, 2018, the Company ~~amended~~entered into Amendment No.5 ("Amendment 5") to the Credit ~~Facility on April 13, 2015, June 27, 2016 and again on June 30, 2017.~~Facility. As a result of ~~the June 30, 2017 amendment, the Credit Agreement permits~~Amendment 5, the Company reduced the revolving credit facility from $125,000 to ~~borrow up~~$120,000, increased the permitted total funded debt to ~~$125,000.~~ EBITDA ratio for fiscal quarters ending April 1, 2018 and July 1, 2018 and increased the interest rates to either LIBOR, plus 3.50% to 4.50%, or the bank’s base rate, as defined, plus 2.50% to 3.50%.

The facility is secured by substantially all assets of the Company and its ~~subsidiaries and expires on September 11, 2019.~~subsidiaries. As of ~~December 31, 2017,~~September 30, 2018, the Company had ~~$41,974~~$43,194 available under the facility, reflecting borrowings under the facility of ~~$78,900, which included~~$73,000, outstanding letters of credit of ~~$3,825~~$3,706 and capital leases of ~~$301.~~$100.

~~Outstanding~~As of September 30, 2018, outstanding borrowings under the Credit Facility will bear interest, at the Company’s option, at either LIBOR, fixed for

interest periods of one, two, three or six month periods, plus 1.00% to 3.75%, or at the bank’s base rate, as defined, plus 0.00%

to 2.75%, based upon the Company’s Total Funded Debt/EBITDA Ratio, as defined. The Company is also required to pay

commitment fees on unused portions of the Credit Facility ranging from 0.20% to 0.50%, based on the Company’s Total

Funded Debt/EBITDA Ratio, as defined. The Credit Facility includes representations, covenants and events of default that are

customary for financing transactions of this nature. The effective interest rate on outstanding borrowings under the Credit

Facility was ~~5.50%~~6.90% at ~~December 31, 2017.~~September 30, 2018.

As a condition of the Credit Facility, the Company is subject to certain customary covenants. The Company was compliant with all such covenants ~~which had been met~~ at ~~December 31, 2017.~~September 30, 2018.

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~~(6)~~(7) Income Taxes

~~The new tax rate is effective January 1, 2018.~~ For corporations that report on a fiscal year basis, the Tax Act ~~requires~~required the use of a full-year blended income tax rate based on the new and old rates. ~~Based on a federal rate of 35% for~~For the first ~~two quarters~~quarter of fiscal year 2018, ~~and 21% for~~we used an effective income tax rate of 35% as the ~~second two quarters of fiscal year 2018, as well as other factors discussed below,~~Tax Act had not yet been enacted. Subsequent to the ~~Conmpany estimated its~~Tax Act, the Company used an annual effective income tax rate of 28% for fiscal year 2018, ~~will be approximately 28%,~~ exclusive of any discrete tax events. ~~During~~In the second quarter of fiscal year 2018, ~~as a result~~the Company recognized the impact of the Tax Act the Company recorded income tax expense of $10,100 for a provisional reduction in its net deferred tax assets, $400 for a provisional liability related to unrepatriated earnings and profits of foreign subsidiaries and $307 to adjust the tax benefit recorded inon the first quarter of fiscal year 2018. The Company's estimated annual effective income tax rate for the fiscal year 2019 was determined to be 21%. Income tax expense for the quarter ended September 30, 2018 included a $15 discrete tax item. The Company's effective income tax rate for interim periods was determined based on the Company's estimated annual effective tax rate for the applicable year using the federal statutory income tax rate, permanent tax differences, foreign income taxes and state income taxes, as well as the impact of federal, foreign and state tax deductions and credits.

In December 2017, the Securities and Exchange Commission issued Staff Accounting Bulletin No. 118 which addresses how a company recognizes provisional amounts when a company does not have the necessary information available, prepared or analyzed (including computations) in reasonable detail to complete the accounting for certain tax effects of the Tax Act and provides for a one-year measurement period. The ultimate impact of the Tax Act may differ from the provisional amounts the Company has recorded due to additional analysis, changes in interpretations and assumptions the Company has made and additional regulatory guidance that may be issued. The accounting is expected to be completed ~~near~~at or before the end of ~~calendar year 2018, as~~ the ~~tax return for fiscal year 2018 is being finalized.~~measurement period on December 22, 2018.

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During the second quarter of fiscal year 2018, the Company recognized the impacts of the Tax Act as discrete income tax events. Additionally, the Company recognized a discrete income tax benefit of $118 during the second quarter of fiscal 2018 as a result of the filing of the fiscal year 2017 tax return as well as amending certain tax returns from earlier tax years. During the second quarter of fiscal year 2017, the Company recognized a discrete income tax expense of $350 related to its Vietnam subsidiary.

The Company's effective income tax rate for interim periods was determined based on the Company's estimated annual effective tax rate for the applicable year using the federal statutory income tax rate, permanent tax differences, foreign income taxes and state income taxes, as well as the impact of federal, foreign and state tax deductions and credits. Excluding the discrete tax events described above, the Company's estimated annual effective rate for the fiscal years 2018 and 2017 was determined to be approximately 28% and 35%, respectively.

~~(7)~~(8) Defined Benefit Pension Plan

The Company has a frozen defined benefit pension plan. The Company recorded net periodic pension ~~income of $6 and pension~~ expense of ~~$24~~$2 and $18 for the ~~second~~first quarter of fiscal years ~~2018~~2019 and ~~2017, respectively. Net periodic pension expense was $13 and $37 for the first two quarters of fiscal years~~ 2018, ~~and 2017,~~ respectively. No contributions were made to the pension plan during either of the first ~~two quarters~~quarter of fiscal years ~~2018~~2019 and ~~2017.~~2018.

~~(8)~~(9) Commitments and Contingencies

The Company is a party to an environmental remediation matter in Albuquerque, New Mexico ("Coors Road"). As of ~~December 31, 2017~~September 30, 2018 and July ~~2, 2017,~~1, 2018, Sparton had accrued ~~$5,775~~$5,347 and ~~$6,036~~$5,508 respectively, as its estimate of the remaining minimum future discounted financial liability regarding this matter, of which ~~$567~~$642 and ~~$568,~~$642, respectively, was classified as a current liability and included on the balance sheets in other accrued expenses. As of ~~December 31, 2017~~September 30, 2018 and July ~~2, 2017,~~1, 2018, the Company had accrued $1,606, in relation to expected reimbursements from the Department of Energy, which are included in other non-current assets on the balance sheets and are considered collectible.

OnAt the end of each fiscal year, the Company is required to certify compliance with Environmental Protection Agency (“EPA”) financial assurance requirements. If the Company is not in compliance, funds for environmental remediation costs must be set aside. As a result of the $9,197 of income tax expense related to the tax law changes from the Tax Act that the Company recorded in fiscal year 2018, the Company was not in compliance with such financial assurance requirements at the end of fiscal year 2018. In October ~~3, 2016,~~2018, the Company established the Sparton Corporation Standby Financial Assurance Trust and issued a standby letter of credit in the amount of ~~$3,114~~$2,512 related to the Coors ~~Road~~Rd environmental remediation liability. The trust was established to alternately meet the United States Environmental Protection Agency’s financial assurance requirements. As a result of the goodwill write-off of $64,174 in fiscal year 2016, the Company was not in compliance with these requirements as of the end of fiscal year 2016. As of the end of fiscal year 2017, the Company was again in compliance with these requirements and during the second quarter of fiscal year 2018, the Company dissolved the trust and canceled the letters of credit.

See the Company’s Annual Report on Form 10-K for the fiscal year ended July ~~2, 2017~~1, 2018 for further information regarding the Company's environmental matters.

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In addition to the foregoing, from time to time, the Company is involved in various legal proceedings relating to claims arising in the ordinary course of business.

The Company and the members of our board of directors were named as defendants in four federal securities class actions purportedly brought on behalf of all holders of the Company’s common stock challenging the ~~pending merger transaction~~now terminated proposed Merger with Ultra. The lawsuits generally sought, among other things, to enjoin the defendants from proceeding with the shareholder vote on the ~~merger~~Merger Agreement at the special meeting or consummating the ~~merger transaction~~Merger unless and until the Company disclosed the allegedly omitted information. The complaints also sought damages allegedly suffered by the plaintiffs as a result of the asserted omissions, as well as related attorneys’ fees and expenses.

After discussions with counsel for the plaintiffs, the Company included certain additional disclosures in the proxy statement soliciting shareholder approval of the ~~Merger.~~Merger Agreement. The Company believes the demands and complaints were without merit, there were substantial legal and factual defenses to the claims asserted, and the proxy statement disclosed all material information prior to the inclusion of the additional disclosures. The Company made the additional disclosures to avoid the expense and burden of litigation. On September 1, 2017, the court dismissed the lawsuits with prejudice with respect to lead plaintiffs in the lawsuits and without prejudice as to all other shareholders. During the second quarter of fiscal year 2018, the Company and plaintiffs agreed onto settle the ~~amount of attorneys’ fees, and $200 was paid to plaintiffs’ counsel.~~claim for $200.

~~In addition, the~~The members of our board of directors were named as defendants in another class action suit filed in the

United States District Court for the Northern District of Ohio on October 24, 2017, purportedly brought on behalf of all holders of the Company's common stock. This lawsuit ~~seeks~~sought damages allegedly suffered by plaintiffs as a result of violations by the members of the board of directors of their fiduciary duties. As a result of the termination of the Merger Agreement, on March 16, 2018, the parties to the lawsuit stipulated to a dismissal of the lawsuit without prejudice.

The Company ~~believes~~is party to a dispute regarding a health claim by a former employee and her children of one of the ~~allegations~~Company’s former businesses. The plaintiffs sought monetary damages related to their medical care and treatment, pain and suffering, and lost earnings. In fiscal year 2018, the Company accrued $635 for potential insurance deductibles and legal fees associated with this claim. In August 2018, a $5,500 settlement was reached between the plaintiffs, the Company, and the Company’s insurer, where the Company will pay $500 in settlement costs in excess of its $5,000 insurance coverage and $500 in insurance deductibles. The Company recorded this settlement in fiscal year 2018, and also recorded $594 of legal fees related to this dispute. The Company expects to pay the settlement in November 2018.

The Company was the plaintiff in a lawsuit against the previous owner and other shareholders of Hunter Technology Corporation (“Hunter”), a business acquired by the Company, for breaches of the acquisition agreement and fraud. In June 2018, the Court ruled against the Company, and the Company was required to reimburse the defendant’s legal fees of $484. The Company also incurred $115 of legal fees related to this matter. The Company recorded the liability in the ~~complaint are without merit.~~fourth quarter of

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fiscal year 2018, and expensed its related legal fees during 2018. The Company is also involved in a dispute between a predecessor company of Hunter and the California State Board of Equalization (“SBOE”) regarding unpaid taxes for which the Company is liable. In the fourth quarter of fiscal year 2018, the Company accrued $500 as an estimated settlement of this liability. This dispute remains in negotiations with the SBOE and the Company.

The Company is involved in a matter with Goodrich Corporation (“Goodrich”) in which Goodrich has alleged the Company owes indemnification to Goodrich under an agreement as a result of damages suffered by Goodrich in a lawsuit that Goodrich settled. The Company has disputed the indemnification claim and Goodrich has requested the parties mediate the dispute or move to trial. This dispute is covered by insurance, subject to normal reservation of rights by the insurance company, and the Company believes that a settlement, if any, would likely be within the Company’s coverage. No amounts have been accrued as it is not probable a loss has been incurred.

The Company is not currently a party to any other ~~such~~ legal proceedings, the adverse outcome of which, individually or in the aggregate, is expected to have a material adverse effect on our business, financial condition or results of operations. ~~However, Goodrich Corporation (“Goodrich”) has alleged the Company owes indemnification under an agreement as a result~~

~~of damages suffered by Goodrich in a lawsuit that Goodrich settled. The Company has disputed the indemnification claim to~~

~~date and Goodrich has requested the parties mediate the dispute.~~

The Company is subject to audits by certain federal government agencies, including the Defense Contract Audit Agency and the Defense Contract Management Agency. The agencies audit and evaluate government contracts and government contractors’ administrative processes and systems. These agencies review the Company’s performance on contracts, pricing practices, cost structure, financial capability and compliance with applicable laws, regulations and standards. They also review the adequacy of the Company’s internal control systems and policies, including the Company’s purchasing, accounting, estimating, compensation and management information processes and systems. The Company works closely with these agencies to ensure compliance. From time to time, the Company is notified of claims related to noncompliance arising from the audits performed by agencies. Such claims have historically been subject to actions of remediation and/or financial claims that are typically subject to negotiated settlements. The Company believes that it has appropriate reserves established for outstanding issues and is not aware of any ~~other~~ issues of noncompliance that would have a material effect on the Company’s financial position or results of operations.

~~(9)~~(10) Stock-Based Compensation

The Company has a long-term incentive plan to offer incentive and non-qualified stock options, stock appreciation rights, restricted stock or restricted stock units, performance awards and other stock-based awards, including grants of shares under the Sparton Corporation 2010 Long-Term Incentive Plan (the “2010 Plan”).

The following table shows stock-based compensation expense by type of share-based award included in the consolidated statements of income:

For the Second Quarter of Fiscal Years For the First Two Quarters of Fiscal Years
2018 2017 2018 2017
Fair value expense of stock option awards $ 4
$ 49
$ 43
$ 97
Restricted stock units 7
525
178
804
Restricted and unrestricted stock —
394
—
376
Total stock-based compensation expense $ 11
$ 968
$ 221
$ 1,277

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	For the First Quarter of Fiscal Years
	2019			2018
Fair value expense of stock option awards	$	1		$	40
Restricted stock units	(14		)	171
Restricted and unrestricted stock	—			—
Total stock-based compensation expense	$	(13	)	$	211

The following is a summary of activity for the first ~~two quarters~~quarter of fiscal year ~~2018~~2019 related to the 2010 Plan:


	Stock Options		Restricted stock units		Restricted shares		Stock Options		Restricted stock units		Restricted shares
Outstanding at July 2, 2017	100,022		128,134		25,912
Outstanding at July 1, 2018							78,249		95,686		—
Granted	—		—		—		—		—		—
Forfeited	(5,532	)	(10,380	)	(25,912	)	(7,130	)	(21,093	)	—
Outstanding at December 31, 2017	94,490		117,754		—
Outstanding at September 30, 2018							71,119		74,593		—

As of ~~December 31, 2017, 55,883~~September 30, 2018, 58,367 stock options were exercisable, of which ~~22,227 and 911~~16,207 vested in the first ~~and second quarters~~quarter of fiscal year ~~2018, respectively.~~2019.

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~~(10)~~

(11) Earnings Per Share Data

The following table sets forth the computation of basic and diluted net loss per share:


	For the Second Quarter of Fiscal Years						For the First Two Quarters of Fiscal Years						For the First Quarter of Fiscal Years
	2018			2017			2018			2017			2019		2018
Numerator:
Net loss	$	(9,034	)	$	(907	)	$	(11,886	)	$	(799	)
Net income (loss)													$	212	$	(1,984	)
Less net income allocated to contingently issuable participating securities	—			—			—			—			—		—
Net loss available to common shareholders	$	(9,034	)	$	(907	)	$	(11,886	)	$	(799	)
Net income (loss) available to common shareholders													$	212	$	(1,984	)

Weighted average shares outstanding – Basic	9,834,723			9,802,664			9,845,686			9,793,046			9,834,723		9,856,649
Dilutive effect of stock options	—			—			—			—			—		—
Weighted average shares outstanding – Diluted	9,834,723			9,802,664			9,845,686			9,793,046			9,834,723		9,856,649

Net loss available to common shareholders per share:
Net income (loss) available to common shareholders per share:
Basic	$	(0.92	)	$	(0.09	)	$	(1.21	)	$	(0.08	)	$	0.02	$	(0.20	)
Diluted	$	(0.92	)	$	(0.09	)	$	(1.21	)	$	(0.08	)	0.02		(0.20		)

Net income available to common shareholders was not reduced by allocated earnings associated with unvested restricted shares of ~~10,963, 34,141 and 25,912~~ 21,926for the first ~~two quarters of fiscal years 2018 and 2017 and the second~~ quarter of fiscal year ~~2017, respectively,~~2018, as the unvested restricted shares did not participate in the net ~~losses~~loss for ~~these periods. There were no restricted shares outstanding during~~ the ~~second~~first quarter of fiscal year 2018.

There were ~~563, 3,213, 436 and 1,596~~no unvested restricted stock in first quarter of fiscal year 2019.

The computations of diluted income or loss per share excluded potential shares of common stock issuable upon exercise of stock options ~~which were excluded from diluted income or loss per share computations,~~totaling 74,803 and 97,640 for the ~~second quarters~~first quarter of fiscal years ~~2018~~2019 and ~~2017 and the first two quarters of fiscal years~~ 2018, ~~and 2017,~~ respectively, as they were anti-dilutive due to option exercise prices in excess of the ~~net losses~~average share prices for ~~these periods.~~the first quarter of fiscal years 2019 and for 2018, respectively. The computations of diluted income or loss per share also excluded potential shares of common stock issuable upon exercise of restricted stock units totaling 88,539 and 128,134 for the first quarter of fiscal years 2019 and 2018, respectively.

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~~(11)~~(12) Business Segments

The Company has identified two reportable segments; Manufacturing & Design Services ("MDS") and Engineered Components & Products ("ECP"). The Company uses an internal management reporting system, which provides important financial data to evaluate performance and allocate the Company's resources on a segment basis. The Company’s Chief Operating Decision Maker assesses segment performance and allocates resources to each segment individually.

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Operating results and certain other financial information about the Company’s two reportable segments for the ~~second~~first quarter ~~and first two quarters~~ of fiscal years ~~2018~~2019 and ~~2017~~2018 were as follows:


	For the Second Quarter of Fiscal Year 2018													For the First Quarter of Fiscal Year 2019
	MDS			ECP		Unallocated			Eliminations			Total		MDS			ECP		Unallocated			Eliminations			Total
Net sales	$	58,353		$	42,468	$	—		$	(3,002	)	$	97,819
Gross sales														$	59,294		$	33,312	$	—		$	(3,144	)	$	89,462
Gross profit														7,209			10,430		—			—			17,639
Selling and administrative expenses (incl. depreciation)														5,544			3,683		3,143			—			12,370
Internal research and development expenses														—			1,349		—			—			1,349
Depreciation and amortization														2,013			478		589			—			3,080
Operating income														290			5,103		(3,143		)	—			2,250
Capital expenditures														92			284		275			—			651
Total assets at September 30, 2018														$	150,719		$	66,048	$	19,722		$	—		$	236,489

														For the First Quarter of Fiscal Year 2018
														MDS			ECP		Unallocated			Eliminations			Total
Gross sales														$	55,308		$	30,399	$	—		$	(2,944	)	$	82,763
Gross profit	6,960			13,469		—			—			20,429		5,993			9,931		—			—			15,924
Selling and administrative expenses (incl. depreciation)	5,614			3,570		4,890			—			14,074		5,900			3,580		5,725			—			15,205
Internal research and development expenses	—			669		—			—			669		—			572		—			—			572
Depreciation and amortization	2,247			535		567			—			3,349		2,327			561		571			—			3,459
Operating income (loss)	(208		)	8,891		(4,890		)	—			3,793		(1,485		)	5,434		(5,725		)	—			(1,776		)
Capital expenditures	2,210			208		226			—			2,644		105			187		163			—			455
Total assets at December 31, 2017	$	145,929		$	68,754	$	(445	)	$	—		$	214,238
Total assets at July 1, 2018														$	147,860		$	71,558	$	12,584		$	—		$	232,002

	For the Second Quarter of Fiscal Year 2017
	MDS			ECP		Unallocated			Eliminations			Total
Net sales	$	67,382		$	32,350	$	—		$	(2,333	)	$	97,399
Gross profit	8,357			7,541		—			—			15,898
Selling and administrative expenses (incl. depreciation)	5,561			3,545		3,847			—			12,953
Internal research and development expenses	—			533		—			—			533
Depreciation and amortization	2,649			585		445			—			3,679
Operating income (loss)	986			3,082		(3,847		)	—			221
Capital expenditures	464			423		564			—			1,451
Total assets at July 2, 2017	$	142,513		$	64,694	$	9,936		$	—		$	217,143

	For the First Two Quarters of Fiscal Year 2018
	MDS			ECP		Unallocated			Eliminations			Total
Net sales	$	113,661		$	72,867	$	—		$	(5,946	)	$	180,582
Gross profit	12,953			22,064		—			—			35,017
Selling and administrative expenses (incl. depreciation)	11,514			7,150		10,615			—			29,279
Internal research and development expenses	—			1,241		—			—			1,241
Depreciation and amortization	4,575			1,096		1,135			—			6,806
Operating income (loss)	(1,693		)	12,989		(10,615		)	—			681
Capital expenditures	$	2,315		$	395	$	389		$	—		$	3,099

	For the First Two Quarters of Fiscal Year 2017
	MDS			ECP		Unallocated			Eliminations			Total
Net sales	$	132,384		$	69,942	$	—		$	(4,560	)	$	197,766
Gross profit	15,651			17,532		—			—			33,183
Selling and administrative expenses (incl. depreciation)	11,537			7,369		7,430			—			26,336
Internal research and development expenses	—			884		—			—			884
Depreciation and amortization	5,325			1,191		883			—			7,399
Operating income (loss)	472			8,511		(7,430		)	—			1,553
Capital expenditures	$	670		$	758	$	1,142		$	—		$	2,570

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~~(12)~~(13) New Accounting Standards

~~In May 2014, the Financial Accounting Standards ("FASB") issued Accounting Standards Update ("ASU") No. 2014-09 ("ASU 2014-09"),~~ ~~Revenue from Contracts with Customers~~, which amends guidance for revenue recognition. Under the new standard, revenue will be recognized when control of the promised goods or services is transferred to customers in an amount that reflects the consideration to which the Company expects to be entitled in exchange for those goods and services. The standard creates a five-step model that will generally require companies to use more judgment and make more estimates than under current guidance when considering the terms of contracts along with all relevant facts and circumstances. These include the identification of customer contracts and separating performance obligations, the determination of transaction price that potentially includes an estimate of variable consideration, allocating the transaction price to each separate performance obligation, and recognizing revenue in line with the pattern of transfer. In August 2015, the FASB issued an amendment to defer the effective date for all entities by one year. The new standard will become effective for annual reporting periods beginning after December 15, 2017, including interim periods within that reporting period. Early adoption is permitted as of annual reporting periods beginning after December 15, 2016. Companies have the option of using either a full or modified retrospective approach in applying this standard. During fiscal years 2016 and 2017, the FASB issued four additional updates which further clarify the guidance provided in ASU 2014-09. The Company has identified key personnel to evaluate the guidance and approve a transition method, while also formulating a time line to review the potential impact of the new standard on its existing revenue recognition policies and procedures.

~~In July 2015, the FASB issued ASU No. 2015-11 ("ASU 2015-11"),~~ ~~Simplifying the Measurement of Inventory.~~ ASU 2015-11 clarifies that inventory should be held at the lower of cost or net realizable value. Net realizable value is defined as the estimated selling price, less the estimated costs to complete, dispose and transport such inventory. ASU 2015-11 will be effective for fiscal years and interim periods beginning after December 15, 2016. ASU 2015-11 is required to be applied prospectively and early adoption is permitted. There was no significant impact on the Company's financial statements as a result of the adoption in the first quarter of fiscal year 2018.

In February 2016, the FASB issued ASU No. 2016-02 (“ASU 2016-02”), Leases (Topic 842). ASU 2016-02 establishes a right-of-use (ROU) model that requires a lessee to record a ROU asset and a lease liability on the balance sheet for all leases with terms longer than 12 months. Leases will be classified as either finance or operating, with classification affecting the pattern of expense recognition in the income statement. ASU 2016-02 is effective for fiscal years beginning after December 15, 2018, including interim periods within those fiscal years. A modified retrospective transition approach is required for capital leases and operating leases existing at, or entered into after, the beginning of the earliest comparative period presented in the financial statements, with certain practical expedients available. The Company is currently in the process of evaluating the impact of adoption on its consolidated financial statements.

In June 2016, the FASB issued ASU No. 2016-13 ("ASU 2016-13"), Financial Instruments—Credit Losses (Topic 326). ASU 2016-13 requires the measurement of all expected credit losses for financial assets held at the reporting date based on historical experience, current conditions, and reasonable and supportable forecasts. ASU 2016-13 is effective for fiscal years beginning after December 15, 2019 and early adoption is permitted. The Company is currently in the process of evaluating the impact of adoption on its consolidated financial statements.

In ~~August 2016, the FASB issued ASU No. 2016-15 ("ASU 2016-15"),~~ ~~Statement of Cash Flows(Topic 230): Classification of Certain Cash Receipts and Cash Payments~~. ASU 2016-15 will make eight targeted changes to how cash receipts and cash payments are presented and classified in the statement of cash flows. ASU 2016-15 is effective for fiscal years beginning after December 15, 2017. The new standard will require adoption on a retrospective basis unless it is impracticable to apply, in which case it would be required to apply the amendments prospectively as of the earliest date practicable. The Company is currently in the process of evaluating the impact of adoption on its consolidated financial statements.

~~In October 2016, the FASB issued ASU 2016-16 ("ASU 2016-16"),~~ ~~Income Taxes - Intra-Entity Transfers of Assets Other Than Inventory~~, which requires entities to recognize the income tax consequences of an intra-entity transfer of an asset other than inventory when the transfer occurs. ASU 2016-16 is effective for fiscal years beginning after December 15, 2017, including interim periods within those fiscal years. Early adoption is permitted as of the beginning of a fiscal year. ASU 2016-16 must be adopted using a modified retrospective transition method which is a cumulative-effective adjustment to retained earnings as of the beginning of the first effective reporting period. The Company is currently in the process of evaluating the impact of adoption on its consolidated financial statements.

~~In November 2016, the FASB issued ASU No. 2016-18 ("ASU 2016-18"),~~ ~~Restricted Cash~~, which addresses classification and presentation of changes in restricted cash on the statement of cash flows. ASU 2016-18 requires an entity’s reconciliation of the beginning-of-period and end-of-period total amounts shown on the statement of cash flows to include in cash and cash equivalents amounts generally described as restricted cash and restricted cash equivalents. ASU 2016-18 does not define restricted cash or restricted cash equivalents, but an entity will need to disclose the nature of the restrictions. ASU

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2016-18 is effective for public business entities for annual and interim periods in fiscal years beginning after December 15, 2017. Early adoption is permitted, including adoption in an interim period. If an entity early adopts the amendments in an interim period, adjustments should be reflected at the beginning of the fiscal year that includes that interim period. Entities should apply this ASU using a retrospective transition method to each period presented. The Company is currently in the process of evaluating the impact of adoption on its consolidated financial statements.

In January 2017, the FASB issued ASU No. 2017-04 (“ASU 2017-04”), Simplifying the Test for Goodwill Impairment. ASU 2017-04 eliminates step 2 from the goodwill impairment test. As amended, the goodwill impairment test will consist of one step comparing the fair value of a reporting unit with its carrying amount. An entity should recognize a goodwill impairment charge for the amount by which the carrying amount exceeds the reporting unit’s fair value. An entity may still perform the optional qualitative assessment for a reporting unit to determine if it is more likely than not that goodwill is impaired. ASU 2017-04 will be effective for fiscal years and interim periods beginning after December 15, 2019. ASU 2017-04 is required to be applied prospectively and early adoption is permitted for interim or annual goodwill impairment tests performed on testing dates after January 1, 2017. The Company is currently in the process of evaluating the impact of adoption on its consolidated financial statements.

In ~~March 2017,~~February 2018, the FASB issued ASU ~~No. 2017-07,~~2018-02 (“ASU ~~2017-07”~~2018-02”), ~~Improving~~Reclassification of Certain Tax Effects from Accumulated Other Comprehensive Income. ASU 2018-02 permits the ~~Presentation~~reclassification of ~~Net Periodic Pension Cost and Net Periodic Postretirement Benefit Cost. ASU 2017-07 requires that the service cost component be disaggregated~~certain “stranded tax effects” resulting from the recent U.S. tax reform from accumulated other ~~components of net benefit cost and provides guidance for separate presentation in the~~comprehensive income ~~statement.~~to retained earnings. ASU ~~2017-07 also changes the rules for capitalization of costs such that only the service cost component of net benefit cost may be capitalized rather than total net benefit cost. ASU 2017-07 will be~~2018-02 is effective for fiscal years and interim periods beginning after December 15, 2017. ASU 2017-07 is required to be applied retrospectively for the income statement presentation and prospectively for the capitalization of the service cost component of net periodic pension cost. The Company is currently in the process of evaluating the impact of adoption on its consolidated financial statements.

~~In May 2017, the FASB issued Accounting Standards Update No. 2017-09 (“ASU 2017-09”),~~ ~~Scope~~

Table of ~~ModificationAccounting.~~ ASU 2017-09 clarifies when to account for a change to the terms or conditions of a share-based payment award as a modification. Under the new guidance, modification accounting is required only if the fair value, the vesting conditions, or the classification of the award (as equity or liability) changes as a result of the change in terms or conditions. ASU 2017-09 is effective Contents

for all entities for fiscal years beginning after December 15, ~~2017,~~2018, including interim periods within those years. Entities have the option to record the reclassification either retrospectively to each period in which the income tax effects of tax reform are recognized, or at the beginning of the annual or interim period in which the amendments are adopted. Early adoption is permitted, including adoption in an interim period. The Company is currently in the process of evaluating the impact of adoption on its consolidated financial statements.

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Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations.

The following is management’s discussion and analysis of certain significant events affecting Sparton Corporation’s (the “Company” or “Sparton”) results of operations and financial condition during the periods included in the accompanying financial statements. Additional information regarding the Company can be accessed via Sparton’s website at www.sparton.com. Information provided at the website includes, among other items, the Annual Report on Form 10-K, Quarterly Reports on Form 10-Q, Quarterly Earnings Releases, News Releases and the Code of Business Conduct and Ethics, as well as various corporate charters and documents.

Consolidated Results of Operations

Presented below is comparative data and discussions regarding our consolidated results of operations for the ~~second~~first quarter ~~and first two quarters~~ of fiscal year ~~2018~~2019 compared to the ~~second~~first quarter ~~and first two quarters~~ of fiscal year ~~2017.~~2018. Results of operations for any period less than one year are not necessarily indicative of results of operations that may be expected for a full year. The following discussion should be read in conjunction with the Unaudited Consolidated Financial Statements and Notes thereto included in Item 1 of this Quarterly Report on Form 10-Q.

For the ~~Second~~First Quarter of Fiscal Year ~~2018~~2019 compared to the ~~Second~~First Quarter of Fiscal Year ~~2017~~2018

The following table presents selected consolidated statements of operations data (dollars in thousands):

CONSOLIDATED


	For the Second Quarter of Fiscal Years										For the First Quarter of Fiscal Years
	2018			% of Sales		2017			% of Sales		2019			% of Sales		2018			% of Sales
Net sales	$	97,819		100.0	%	$	97,399		100.0	%	$	89,462		100.0	%	$	82,763		100.0	%
Cost of goods sold	77,390			79.1		81,501			83.7		71,823			80.3		66,839			80.8
Gross profit	20,429			20.9		15,898			16.3		17,639			19.7		15,924			19.2
Selling and administrative expenses	14,074			14.4		12,953			13.3		12,370			13.8		15,205			18.4
Internal research and development expenses	669			0.7		533			0.5		1,349			1.5		572			0.7
Amortization of intangible assets	1,893			1.9		2,191			2.3		1,670			1.9		1,923			2.3
Operating income	3,793			3.9		221			0.2		2,250			2.5		(1,776		)	(2.2	)
Other expense, net	(1,494		)	(1.5	)	(1,078		)	(1.1	)	(1,963		)	(2.2	)	(1,276		)	(1.5	)
Income (loss) before income taxes	2,299			2.4		(857		)	(0.9	)	287			0.3		(3,052		)	(3.7	)
Income taxes	11,333			11.6		50			—
Net loss	$	(9,034	)	(9.2	)%	$	(907	)	(0.9	)%
Income taxes (benefit)											75			0.1		(1,068		)	(1.3	)
Net income (loss)											$	212		0.2	%	$	(1,984	)	(2.4	)%

The increase in net sales was the result of a ~~$10.1~~$3.8 million sales increase in our MDS segment due to increasing net volume with existing customers, and a $2.9 million sales increase in our ECP segment ~~which was partially offset by a $9.7 million sales decline in our MDS segment.~~due to increasing revenue for engineering and rugged electronics. The increase in our gross margin was primarily due to ~~a sales mix shift from~~improved MDS margins related to lower ~~gross margin MDS sales~~direct labor and direct service spending and improved margins in rugged electronics due to ~~higher gross margin ECP sales and an improvement in ECP gross margin.~~mix. Selling and administrative expense was ~~higher due to costs associated with the proposed merger, which were partially mitigated by the continued focused effort on cost containment and expense reduction.~~

On December 22, 2017, the Tax Cuts and Jobs Act of 2017 (“Tax Act”) was signed into law. The Tax Act made significant changes to U.S. tax laws including, but not limited to, lowering the federal income tax rate for U.S. corporations from a maximum of 35% to a fixed 21%, revising certain corporate income tax deductions, implementing a territorial tax system and imposing a repatriation tax on unrepatriated earnings of foreign subsidiaries. The new tax rate is effective January 1, 2018. For corporations that report on a fiscal year basis, the Tax Act requires the use of a full-year blended income tax rate based on the new and old rates. Based on a federal rate of 35% for the first two quarters of fiscal year 2018 and 21% for the second two quarters of fiscal year 2018, as well as other factors discussed below, the Company estimated its annual effective income tax rate for fiscal year 2018 will be approximately 28%, exclusive of any discrete tax events. During the second quarter of fiscal year 2018, as a result of the Tax Act, the Company recorded income tax expense of $10.1 million for a provisional reduction in its net deferred tax assets, $0.4 million for a provisional liability related to unrepatriated earnings and profits of foreign subsidiaries and $0.3 million to adjust the tax benefit recordedsignificantly reduced in the first quarter of fiscal year ~~2018.~~

~~During the second~~2019, as compared to first quarter of fiscal year 2018, due to lower advisory and legal expenses of $1,670 related to the ~~Company recognized the impacts~~potential sale of the ~~Tax Act as discrete income tax events. Additionally, the~~ Company ~~recognized a discrete income tax benefit of $0.1 million during the second quarter of fiscal 2018 as a result of the filing of the fiscal year 2017 tax return~~ as well as ~~amending certain tax returns from earlier tax years.~~ other expense reductions of $1,159. Internal research and development costs increased over the prior year quarter due to investment in technologies for use in undersea warfare.

During the ~~second~~first quarter of fiscal year ~~2017,~~2019, the Company recognized a discrete income tax expense of ~~$0.3 million~~$15 related to

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its Vietnam subsidiary. The Company's effective income tax rate for interim periods was determined based on the Company's estimated annual effective tax rate for the applicable year using the federal statutory income tax rate, permanent tax differences, foreign income taxes and state income taxes, as well as the impact of federal, foreign and an ongoing state tax ~~deductions and credits.~~audit. Excluding the discrete tax ~~events~~event described above, the Company's estimated annual effective income tax rate for the fiscal years ~~2018~~2019 and ~~2017~~2018 was determined to be approximately ~~28%~~21% and ~~35%~~28%, respectively. The Company used a 35% effective income tax rate for the first quarter of fiscal year 2018 as it was before the Tax Act was enacted. The difference in rates is due to the impact of the Tax Act.

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Due to the factors described above, the Company reported a net earnings of $0.2 million, or $0.02 earnings per share, basic and diluted, for the first quarter of fiscal year 2019, compared to net loss of ~~$9.0~~$2.0 million, or ~~$0.92~~$0.20 loss per share, basic and diluted, for the ~~second~~first quarter of fiscal year ~~2018, compared to a net loss of $0.9 million, or $0.09 loss per share, basic and diluted, for the second quarter of fiscal year 2017.~~2018.

Segment Information

The Company has two reportable segments - Manufacturing and Design Services ("MDS") and Engineered Components and Products ("ECP").

MDS

MDS segment operations are comprised of contract design, manufacturing and aftermarket repair and refurbishment of sophisticated printed circuit card assemblies, sub-assemblies, full product assemblies and cable/ wire harnesses for customers seeking to bring their intellectual property to market. Additionally, Sparton is a developer of embedded software and software quality assurance services in connection with medical devices and diagnostic equipment. Customers include OEM and ET customers serving the Medical & Biotechnology, Military & Aerospace and Industrial & Commercial markets. In engineering and manufacturing for its customers, this segment adheres to very strict military and aerospace specifications, Food and Drug Administration guidelines and approvals, in addition to product and process certifications.

ECP

ECP segment operations are comprised of design, development and production of proprietary products for both domestic and foreign defense as well as commercial needs. Sparton designs and manufactures anti-submarine warfare ("ASW") devices known as sonobuoys for the U.S. Navy and foreign governments that meet Department of State licensing requirements. This segment also performs an engineering development function for the United States military and prime defense contractors for advanced technologies, ultimately leading to future defense products, as well as replacements for existing products. The sonobuoy product line is built to stringent military specifications. These products are restricted by International Tariff and Arms Regulations and qualified by the U.S. Navy, which limits opportunities for competition. This segment is also a provider of rugged flat panel display systems for military panel PC workstations, air traffic control and industrial and commercial marine applications, as well as high performance industrial grade computer systems and peripherals. Rugged displays are manufactured for prime contractors, in some cases to specific military grade specifications. Additionally, this segment internally develops and markets commercial products for underwater acoustics and microelectromechanical (“MEMS”)-based inertial measurement.

MDS

The following table presents selected segment data (dollars in thousands):


	For the Second Quarter of Fiscal Years													For the First Quarter of Fiscal Years
	2018			% of Sales		2017			% of Sales		$ Chg			2019			% of Sales		2018			% of Sales		$ Chg
Gross sales	$	58,353		100.0	%	$	67,382		100.0	%	$	(9,029	)	$	59,294		100.0	%	$	55,308		100.0	%	$	3,986
Intercompany sales	(2,970		)	(5.1	)	(2,333		)	(3.5	)	(637		)	(3,144		)	(5.3	)	(2,937		)	(5.3	)	(207		)
Net sales	55,383			94.9		65,049			96.5		(9,666		)	56,150			94.7		52,371			94.7		3,779
Gross profit	6,960			11.9		8,357			12.4		(1,397		)	7,209			12.2		5,993			10.8		1,216
Selling and administrative expenses	5,614			9.7		5,561			8.2		53			5,544			9.4		5,900			10.7		(356		)
Amortization of intangible assets	1,554			2.6		1,810			2.7		(256		)	1,375			2.3		1,578			2.8		(203		)
Operating income (loss)	$	(208	)	(0.4	)%	$	986		1.5	%	$	(1,194	)	$	290		0.5	%	$	(1,485	)	(2.7	)%	$	1,775

The ~~$9.7~~$3.8 million ~~decrease~~increase in net sales was due to ~~(i) prior year insourcing in our medical end-market and the loss of a customer in our industrial end-market reducing sales by $10.7 million and (ii) program delays and~~net volume ~~reductions of $15.8 million. These losses were partially offset by revenues from new program wins and increased volumes~~increases with ~~other customers of $16.8 million.~~existing customers. MDS backlog was ~~$142.1~~$156.3 million at the end of the ~~second~~first quarter of fiscal year ~~2018~~2019 compared to ~~$123.3~~$130.5 million at the end of the ~~second~~first quarter of fiscal year ~~2017.~~2018. Commercial orders, in general, may be rescheduled or canceled

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without significant penalty, and as a result, may not be a meaningful measure of future sales. A majority of the ~~December 31, 2017~~September 30, 2018 MDS backlog is currently expected to be realized in the next 12 months.

Gross margin ~~decreased slightly as a result of lower fixed overhead absorption~~increased primarily due to ~~the~~lower labor and direct service spending. The decrease ~~in revenue. The increase~~ in selling and administrative expense was due to ~~higher medical benefit claims costs, mostly offset by~~cost mitigation and lower corporate ~~allocations and site spending controls.~~allocations.

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ECP

The following table presents selected segment data (dollars in thousands):


	For the Second Quarter of Fiscal Years												For the First Quarter of Fiscal Years
	2018			% of Sales		2017		% of Sales		$ Chg			2019		% of Sales		2018			% of Sales		$ Chg
Gross sales	$	42,468		100.0	%	$	32,350	100.0	%	$	10,118		$	33,312	100.0	%	$	30,399		100.0	%	$	2,913
Intercompany sales	(32		)	(0.1	)	—		—		(32		)	—		—		(7		)	—		7
Net sales	42,436			99.9		32,350		100.0		10,086			33,312		100.0		30,392			100.0		2,920
Gross profit	13,469			31.7		7,541		23.3		5,928			10,430		31.3		9,931			32.7		499
Selling and administrative expenses	3,570			8.4		3,545		11.0		25			3,683		11.1		3,580			11.8		103
Internal research and development expenses	669			1.6		533		1.6		136			1,349		4.0		572			1.9		777
Amortization of intangible assets	339			0.8		381		1.2		(42		)	295		0.9		345			1.1		(50		)
Operating income	$	8,891		20.9	%	$	3,082	9.5	%	$	5,809		$	5,103	15.3	%	$	5,434		17.9	%	$	(331	)

The ~~$10.1~~$2.9 million increase in net sales was due to ~~an $8.1~~(i) a $3.9 million increase in domestic sonobuoy sales, (ii) increased engineering sales of $1.6 million, offset by (i) a ~~$1.8~~$2.5 million ~~increase~~decrease in foreign sonobuoy sales and ~~a $0.3 million increase in rugged electronics sales. These increases were slightly offset by~~(ii) a $0.1 million decrease in ~~the combined engineering~~rugged electronics sales and other revenue streams. Total sales to the U.S. Navy in the ~~second~~first quarter of fiscal years 2019 and 2018 ~~and 2017~~ were ~~$30.1~~$23.0 million and ~~$22.1~~$17.5 million, respectively. For the ~~second~~first quarter of fiscal years ~~2018~~2019 and ~~2017,~~2018, sales to the U.S. Navy accounted for ~~31%~~26% and ~~23%~~21%, respectively, of consolidated Company net sales and ~~71%~~69% and ~~68%~~58%, respectively, of ECP segment net sales. ECP backlog was ~~$130.2~~$180.2 million at the end of the ~~second~~first quarter of fiscal year ~~2018~~2019 compared to ~~$113.1~~$141.9 million at the end of the ~~second~~first quarter of fiscal year ~~2017.~~2018. Substantially all of the ~~December 31, 2017~~September 30, 2018 ECP backlog is currently expected to be realized in the next 18 months.

Gross margin ~~increased~~percentage declined from prior year due to ~~higher fixed overhead absorption resulting~~mix. Gross margin increased from ~~the increase in sales, as well as slightly lower overhead costs. There was a slight increase in selling~~prior year due to volume. Selling and administrative expense ~~due to slightly higher corporate allocations mostly offset by site spending controls.~~remained consistent.

Internal research and development expenses reflect costs incurred for the internal development of technologies for use in undersea warfare, navigation, ~~hand held~~hand-held targeting applications as well as rugged electronics and display devices. These costs include salaries and related expenses, contract labor and consulting costs, materials and the cost of certain research and development specific equipment. In the ~~second~~first quarter of fiscal year ~~2018,~~2019, ECP increased internal research and development spending, ~~$0.1~~primarily toward technologies in undersea warfare, by $0.8 million as compared to the same period in fiscal year ~~2017.~~2018.

Eliminations and Corporate Unallocated

The following table presents selected data (dollars in thousands):


	For the Second Quarter of Fiscal Years									For the First Quarter of Fiscal Years
	2018			2017			$ Chg			2019			2018			$ Chg
Intercompany sales elimination	$	(3,002	)	$	(2,333	)	$	(669	)	$	(3,144	)	$	(2,944	)	$	(200	)
Selling and administrative expenses unallocated	4,890			3,847			1,043			3,143			5,725			(2,582		)

Total corporate selling and administrative expenses before allocation to operating segments were ~~$8.0~~$6.4 million and ~~$7.0~~$9.2 million for the ~~second~~first quarter of fiscal year ~~2018~~2019 and fiscal year ~~2017,~~2018, respectively, or ~~8.2%~~7.2% and ~~7.2%~~11.1% of consolidated sales, respectively. Of these costs, ~~$3.1~~$3.3 million and ~~$3.2~~$3.4 million, respectively, were allocated to segment operations in each of these periods. The ~~increase~~decrease in corporate selling and administrative expenses was due ~~primarily~~ to lower advisory and legal ~~costs associated with the proposed merger.~~

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~~For the First Two Quarters of Fiscal Year 2018 compared~~expenses related to the ~~First Two Quarters of Fiscal Year 2017~~

~~The following table presents selected consolidated statement of operations data (dollars in thousands):~~

~~CONSOLIDATED~~

For the First Two Quarters of Fiscal Years
2018 % of Sales 2017 % of Sales
Net sales $ 180,582
100.0 % $ 197,766
100.0 %
Cost of goods sold 145,565
80.6
164,583
83.2
Gross profit 35,017
19.4
33,183
16.8
Selling and administrative expenses 29,279
16.2
26,336
13.3
Internal research and development expenses 1,241
0.7
884
0.5
Amortization of intangible assets 3,816
2.1
4,410
2.2
Operating income 681
0.4
1,553
0.8
Other expense, net (2,770 ) (1.5 ) (2,243 ) (1.1 )
Loss before income taxes (2,089 ) (1.1 ) (690 ) (0.3 )
Income taxes 9,797
5.4
109
0.1
Net loss $ (11,886 ) (6.5 )% $ (799 ) (0.4 )%

~~The decrease in net sales was the result of a $20.1 million sales reduction in our MDS segment, which was partially offset by a $2.9 million sales increase in our ECP segment.~~

The increase in gross margin was due to a sales mix shift from lower gross margin MDS sales to higher margin ECP sales and improvements in ECP gross margin, partially offset by decreased MDS gross margin. The increase in selling and administrative expense was higher due to costs associated with the proposed merger, which were partially offset by the continued focused effort on cost containment and expense reduction.

~~Excluding the discrete tax events and the adjustment~~potential sale of the income tax benefit recorded in the first quarter of fiscal year 2018, described above, the Company's estimated annual effective income tax rate for the first two quarters of fiscal years 2018 and 2017 was determined to be approximately 28% and 35%, respectively.

~~Due to the factors described above, the~~ Company reported a net loss of $11.9 million, or $1.21 loss per share for the first two quarters of fiscal year 2018, compared to a net loss of $0.8 million, or $0.08 per share for the first two quarters of fiscal year 2017

~~MDS~~

~~The following table presents selected segment data (dollars in thousands):~~

For the First Two Quarters of Fiscal Years
2018 % of Sales 2017 % of Sales $ Chg
Gross sales $ 113,661
100.0 % $ 132,384
100.0 % $ (18,723 )
Intercompany sales (5,907 ) (5.2 ) (4,533 ) (3.4 ) (1,374 )
Net sales 107,754
94.8
127,851
96.6
(20,097 )
Gross profit 12,953
11.4
15,651
11.8
(2,698 )
Selling and administrative expenses 11,514
10.2
11,537
8.7
(23 )
Amortization of intangible assets 3,132
2.7
3,642
2.7
(510 )
Operating income (loss) $ (1,693 ) (1.5 )% $ 472
0.4 % $ (2,165 )

The $20.1 million decrease in net sales was due to (i) the prior year insourcing in our medical end-market and the loss of a customer in our industrial end-market reducing sales by $21.7 million and (ii) program delays and volume reductions of $27.9 million. These losses were offset by revenues from new programs wins and increased volumes withas well as other customers of $29.5 million. Gross margin decreased slightly as the impact of lower absorption of fixed overhead costs due to lower sales was partially offset by a more favorable sales mix. The selling and administrative expense ~~was essentially flat.~~

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~~ECP~~

~~The following table presents selected segment data (dollars in thousands):~~

For the First Two Quarters of Fiscal Years
2018 % of Sales 2017 % of Sales $ Chg
Gross sales $ 72,867
100.0 % $ 69,942
100.0 % $ 2,925
Intercompany sales (39 ) (0.1 ) (27 ) —
(12 )
Net sales 72,828
99.9
69,915
100.0
2,913
Gross profit 22,064
30.3
17,532
25.1
4,532
Selling and administrative expenses 7,150
9.8
7,369
10.5
(219 )
Internal research and development expenses 1,241
1.7
884
1.3
357
Amortization of intangible assets 684
1.0
768
1.1
(84 )
Operating income $ 12,989
17.8 % $ 8,511
12.2 % $ 4,478

The increase in net sales of $2.9 million is due to a $7.3 million increase in domestic sonobuoy sales, partially offset by decreased revenue of (i) $1.6 million in engineering and other combined, (ii) $1.3 million in foreign sonobuoy sales, and (iii) $1.5 million in rugged electronics. Total sales to the U.S. Navy in the first two quarters of fiscal years 2018 and 2017 were approximately $47.7 million and $42.1 million, respectively. For the first two quarters of fiscal years 2018 and 2017, sales to the U.S. Navy accounted for 26% and 21%, respectively, of consolidated Company net sales and 65% and 60%, respectively, of ECP segment net sales.

Gross margin was positively impacted in the current year by favorable sales mix and lower overhead as the prior year was negatively impacted by unabsorbed fixed overhead costs due to new program launch activity. The selling and administrative expenses were slightly favorable when compared to the prior year, due to slightly lower corporate allocations and site spending controls.

Internal research and development expenses reflect costs incurred for the internal development of technologies for use in navigation, oil and gas exploration and flat panel display technology. These costs include salaries and related expenses, contract labor and consulting costs, materials and the cost of certain research and development specific equipment. In the first two quarters of fiscal year 2018, ECP increased internal research and development spending $0.4 million as compared to the same period in fiscal year 2017.

~~Eliminations and Corporate Unallocated~~

~~The following table presents selected consolidated statement of income data (dollars in thousands):~~

For the First Two Quarters of Fiscal Years
2018 2017 $ Chg
Intercompany sales elimination $ (5,946 ) $ (4,560 ) $ (1,386 )
Selling and administrative expenses unallocated 10,615
7,430
3,185

Total corporate selling and administrative expenses before allocation to operating segments were $17.2 million and $14.3 million for the first two quarters of fiscal year 2018 and fiscal year 2017, respectively, or 9.5% and 7.2% of consolidated sales, respectively. Of these costs, $6.6 million and $6.9 million, respectively, were allocated to segment operations in each of these periods. The increase in corporate selling and administrative expenses was due primarily to legal and advisory costs associated with the proposed merger.reductions.

Liquidity and Capital Resources

As of ~~December 31, 2017,~~September 30, 2018, the Company had ~~$42.0~~$43.2 million available under its ~~$125.0~~$120.0 million credit facility, reflecting borrowings under the facility of ~~$78.9~~$73.0 million, outstanding letters of credit of ~~$3.8~~$3.7 million and capital leases of ~~$0.3~~$0.1 million.

On May 3, 2018, the Company entered into Amendment No.5 ("Amendment 5") to the Credit Facility. As a ~~condition~~result of ~~the Credit Facility,~~Amendment 5, the Company ~~is subject~~reduced the revolving credit facility from $125.0 million to ~~certain customary covenants, which had been met at December 31, 2017.~~$120.0 million, increased the permitted total funded debt to EBITDA ratio for fiscal quarters ending April 1, 2018 and July 1, 2018 and increased the interest rates to either LIBOR, plus 3.50% to 4.50%, or the bank’s base rate, as defined, plus 2.50% to 3.50%.

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Amendment 5 increased the permitted total funded debt to EBITDA ratio to 4.5x for fiscal quarters ending April 1, 2018 and July 1, 2018. Beginning with the fiscal quarter ended September 30, 2018 and thereafter, the funded debt to EBITDA ratio covenant was 3.0x. The Company ~~currently expects to meet its liquidity needs through a combination of sources including, but not limited to, operations~~was in compliance with all covenants at September 30, 2018. The credit facility expires September 11, 2019 and ~~its revolving line-of-credit. With the above sources providing the expected cash flows,~~ the Company ~~currently~~ believes that it will ~~have~~be able to restructure its long-term debt in order to provide for sufficient liquidity for its anticipated needs ~~over~~for the next 12 ~~months, but no assurances regarding liquidity can be made.~~months.


	For the First Two Quarters of Fiscal Years						For the First Quarter of Fiscal Years
CASH FLOWS	2018			2017			2019			2018
Operating activities, excluding net changes in working capital	$	5,891		$	8,158		$	3,661		$	1,917
Net changes in working capital	(6,765		)	6,513			8,568			(25,146		)
Operating activities	(874		)	14,671			12,229			(23,229		)
Investing activities	(3,085		)	(2,570		)	(651		)	(455		)
Financing activities	4,075			(11,644		)	(11,568		)	23,015

Net changes in working capital related cash flows in the first ~~two quarters~~quarter of fiscal year 2019 primarily reflect decreased accounts receivables, increased performance based payments on customer contracts and accounts payable and accrued expenses, which were partially offset by increased inventories and prepaid expenses and other assets. Working capital related cash flows in the first quarter of fiscal year 2018 primarily reflect increased accounts receivables and inventories, ~~as well as reduced performance based payments, which were partially offset by increased~~and decreased accounts ~~payable. Working capital related cash flows in the first two quarters of fiscal year 2017 primarily reflect reduced inventories, partially offset by reduced accounts payable.~~payable and accrued expenses.

Net cash used in investing activity for the first ~~two quarters~~quarter of fiscal year ~~2018~~2019 and ~~2017~~2018 reflect net capital expenditures of ~~$3.1~~$0.7 million and ~~$2.6~~$0.5 million, respectively.

Net cash provided by financing activities in the first ~~two quarters~~quarter of fiscal year ~~2018~~2019 reflects ~~$4.4~~$11.5 million of net ~~borrowings~~repayments under the Company's Credit Facility as compared to ~~$11.5~~$23.1 million in net ~~payments~~borrowings for the first ~~two quarters~~quarter of fiscal year ~~2017.~~2018.

Commitments and Contingencies

See Note 8,9, Commitments and Contingencies, of the “Notes to Unaudited Consolidated Financial Statements” in this Quarterly Report on Form 10-Q for a discussion of the Company's commitments and contingencies.

Contractual Obligations

Information regarding the Company’s long-term debt obligations, environmental liability payments, operating lease payments and other commitments is provided in Part II, Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” of the Company’s Annual Report on Form 10-K for fiscal year ended July ~~2, 2017.~~1, 2018. As of July ~~2, 2017,~~1, 2018, there were ~~$45.6~~$51.0 million of non-cancelable purchase orders outstanding, ~~$74.5~~$84.5 million of debt, ~~$13.6~~$12.3 million of operating lease payments and a liability related to performance based billings was ~~$1.7~~$3.9 million. As of ~~December 31, 2017,~~September 30, 2018, compared to July ~~2, 2017,~~1, 2018, the non-cancelable purchase orders outstanding increased to ~~$53.6~~$64.2 million, debt ~~increased~~decreased to ~~$78.9~~$73.0 million, operating lease payments, net of subleases, ~~decreased to $12.8~~remained at $12.3 million and ~~there was no~~a liability related to performance based ~~billings.~~billings increased to $13.3 million. Other than as noted above, there have been no material changes in the nature or amount of the Company’s contractual obligations since the end of fiscal year ~~2017.~~2018.

Off-Balance Sheet Arrangements

The Company has standby letters of credit outstanding of ~~$3.8~~$3.7 million at ~~December 31, 2017,~~September 30, 2018, principally to support foreign sonobuoy sales and insurance arrangements. Other than these standby letters of credit and the operating lease commitments referenced above, we have no off-balance sheet arrangements that would have a current or future material effect on our financial condition, changes in financial condition, revenue, expense, results of operations, liquidity, capital expenditures or capital resources.

Critical Accounting Policies

Our financial statements are prepared in conformity with GAAP and require us to select appropriate accounting policies. The assumptions and judgments we use in applying our accounting policies have a significant impact on our reported amounts of assets, liabilities, revenue and expenses. While we believe that the assumptions and judgments used in our estimates are reasonable, actual results may differ from these estimates under different assumptions or conditions.

We have identified the most critical accounting policies upon which our financial status depends. The critical policies were determined by considering accounting policies that involve the most complex or subjective decisions or assessments. We

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also have other policies considered key accounting policies; however, these policies do not meet the definition of critical accounting policies because they do not generally require us to make estimates or judgments that are complex or subjective.

Our critical accounting policies include the following:

•Revenue recognition

•Goodwill and other intangible assets

•~~Percentage-of-completion accounting~~

•Environmental contingencies

•Income taxes

•Commercial inventory valuation

•Stock-based compensation

~~There~~Aside from changes previously disclosed in Note 13, New Accounting Standards, of the “Notes to Unaudited Consolidated Financial Statements," there have been no significant changes to our critical accounting policies ~~that are~~ described in Part II, Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations” section of our Annual Report on Form 10-K for the fiscal year ended July ~~2, 2017.~~1, 2018.

New Accounting Pronouncements

See Note ~~12,~~13, New Accounting Standards, of the “Notes to Unaudited Consolidated Financial Statements” in this Quarterly Report on Form 10-Q for a discussion of new accounting pronouncements.

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Item 3. Quantitative and Qualitative Disclosures About Market Risk.

The Company manufactures its products in the United States, Canada and Vietnam. Sales of the Company’s products are in the U.S. and foreign markets. The Company is subject to foreign currency exchange rate risk relating to intercompany activity and balances and to receipts from customers and payments to suppliers in foreign currencies. Adjustments related to the remeasurement of the Company's Canadian and Vietnamese financial statements into U.S. dollars are included in current earnings. As a result, the Company's financial results could be affected by factors such as changes in foreign currency exchange rates or economic conditions in the domestic and foreign markets in which the Company operates. However, minimal third party receivables and payables are denominated in foreign currencies and the related market risk exposure is considered to be immaterial.

The Company’s revolving credit line, when drawn upon, is subject to future interest rate fluctuations which could potentially have a negative impact on cash flows of the Company. The Company had ~~$78.9~~$73.0 million outstanding under its Credit Facility at ~~December 31, 2017.~~September 30, 2018. A prospective increase of 100 basis points in the interest rate applicable to the Company’s outstanding borrowings under its Credit Facility would result in an increase of ~~$0.8~~$0.7 million in our annual interest expense. The Company is not party to any currency exchange or interest rate protection agreements as of ~~December 31, 2017.~~September 30, 2018.

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Item 4. Controls and Procedures.

Our Interim Chief Executive Officer and our Chief Financial Officer each has evaluated the effectiveness of our disclosure controls and procedures (as such term is defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934) as of the end of the period covered by this quarterly report. Based on such evaluation, such officers have concluded that, as of the end of the period covered by this quarterly report, our disclosure controls and procedures are effective.

~~There have been no changes~~Remediation of prior year material weaknesses

We previously identified and disclosed in our Form 10-K for the year ended July 1, 2018, a material weaknesses in our internal ~~controls~~control over financial reporting ~~(as such term is defined~~as we did not maintain effective controls related to the use of our consolidation and financial reporting tool in ~~Rules 13a-15(f) and 15d-15(f) under~~our interim reporting periods within the ~~Exchange Act) during the second quarter~~above year.

As part of our financial statement close process for fiscal year 2018 ~~ended December 31, 2017, that have materially affected, or are reasonably likely~~and for the first three months of fiscal 2019, we implemented changes to ~~materially affect,~~ our ~~internal~~processes to improve our controls over financial reporting. Among the changes implemented as a result of the identified material weakness, we no longer allow adjustments to be made in our consolidation and financial reporting tool (other than reclassification entries for reporting purposes) that are not also reflected in the ERP systems of the operating entities and we have increased our oversight of the consolidation and reporting tool. Based on the remediation performed by us, we have concluded that the material weakness described above and first disclosed in our Annual Report on Form 10-K for the year ended July 1, 2018 has been remediated as of September 30, 2018.

Changes in Internal Control over Financial Reporting

23In addition to the changes described above to remediate the previously identified material weakness, we adopted ASC 606, “Revenue from Contracts with Customers” (“ASC 606”), as of July 2, 2018, and as a result, there was an impact to our internal control over financial reporting. The majority of our ECP revenue changed from being recognized on a percentage of completion based on units shipped methodology to a point in time upon shipment methodology. We implemented changes to our processes related to revenue recognition and control activities within them. These changes included the development of new and revised processes based on the five-step model provided in ASC 606, and the revision of processes for ongoing contract review requirements, development and monitoring of contract estimates, and gathering of disclosure information.

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PART II. OTHER INFORMATION

Item 1. Legal Proceedings.

See Note 8,9, Commitments and Contingencies, of the “Notes to Unaudited Consolidated Financial Statements” in this Quarterly Report on Form 10-Q for a discussion of legal proceedings and other commitments and contingencies.

Item 1A. Risk Factors.

You should carefully consider the risks and uncertainties described in Part I, Item 1A., "Risk Factors," in our Annual Report on Form 10-K for the year ended July ~~2, 2017~~1, 2018 and the other information in our subsequent filings with the SEC, including this Quarterly Report on Form 10-Q. Our business, financial condition, results of operations and stock price could be materially and adversely affected by any of these risks. The risks described in our Annual Report on Form 10-K are not the only ones we face. Additional risks and uncertainties that are currently unknown to us or that we currently consider to be immaterial may also impair our business or adversely affect our financial condition, results of operations and stock price.

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Item 6. Exhibits.



Exhibit Number			Description

3.1			Second Amended Articles of Incorporation of the Registrant, incorporated herein by reference from the Registrant’s Proxy Statement on Form DEF 14A filed with the SEC on September 21, 2010.
3.2			Amended and Restated Code of Regulations of the Registrant, incorporated herein by reference from Exhibit 3.2 to the Registrant’s Current Report on Form 8-K filed with the SEC on May 5, 2015.
3.3			Amendment to Amended and Restated Code of Regulations of the Registrant, incorporated by reference from Exhibit 99.1 to the Registrant’s Current Report on Form 8-K filed with the SEC on June 15, 2017.
10.1			Merger Termination Agreement dated as of March 4, 2018 by and among Sparton Corporation, Ultra Electronics Holdings plc, and Ultra Electronics Aneira Inc., incorporated herein by reference from Exhibit 10.1 to the Registrant’s Current Report on Form 8-K filed with the SEC on March 5, 2018.
31.1*			Interim Chief Executive Officer certification under Section 302 of the Sarbanes-Oxley Act of 2002.
31.2*			Chief Financial Officer certification under Section 302 of the Sarbanes-Oxley Act of 2002.
32.1*			Interim Chief Executive Officer and Chief Financial Officer certification pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
101.INS*			XBRL Instance Document
101.SCH*			XBRL Taxonomy Extension Schema Document
101.CAL*			XBRL Taxonomy Calculation Linkbase Document
101.DEF*			XBRL Taxonomy Extension Definition Linkbase Document
101.LAB*			XBRL Taxonomy Extension Label Linkbase Document
101.PRE*			XBRL Taxonomy Extension Presentation Linkbase Document



*	Filed herewith.

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SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.



	Sparton Corporation

Date: ~~February 6,~~November 8, 2018	By:	/s/ JOSEPH J. HARTNETT
		Joseph J. Hartnett
		Interim President and Chief Executive Officer
		(Principal Executive Officer)

Date: ~~February 6,~~November 8, 2018	By:	/s/ JOSEPH G. MCCORMACK
		Joseph G. McCormack
		Senior Vice President and Chief Financial Officer
		(Principal Financial Officer)

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