The following is management's discussion and analysis of certain significant events affecting the Company's earnings 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 Ethics, as well as various corporate charters. The Company operates in one line of business, electronic manufacturing services (EMS). Sparton's capabilities range from product design and development through aftermarket support, specializing in total business solutions for government, medical/scientific instrumentation, aerospace and industrial markets. This includes the design, development and/or manufacture of electronic parts and assemblies for both government and commercial customers worldwide. Governmental sales are mainly sonobuoys.
The Private Securities Litigation Reform Act of 1995 reflects Congress' determination that the disclosure of forward-looking information is desirable for investors and encourages such disclosure by providing a safe harbor for forward-looking statements by corporate management. This report on Form 10-K contains forward-looking statements within the scope of the Securities Act of 1933 and the Securities Exchange Act of 1934. The words "expects," "anticipates," "believes," "intends," "plans," "will," "shall," and similar expressions, and the negatives of such expressions, are intended to identify forward-looking statements. In addition, any statements which refer to expectations, projections or other characterizations of future events or circumstances are forward-looking statements. The Company undertakes no obligation to publicly disclose any revisions to these forward-looking statements to reflect events or circumstances occurring subsequent to filing this Form 10-K with the Securities and Exchange Commission (SEC). These forward-looking statements are subject to risks and uncertainties, including, without limitation, those discussed below. Accordingly, Sparton's future results may differ materially from historical results or from those discussed or implied by these forward-looking statements. The Company notes that a variety of factors could cause the actual results and experience to differ materially from anticipated results or other expectations expressed in the Company's forward-looking statements.
Sparton, as a high-mix, low to medium-volume supplier, provides rapid product turnaround for customers. High-mix describes customers needing multiple product types with generally low to medium-volume manufacturing runs. As a contract manufacturer with customers in a variety of markets, the Company has substantially less visibility of end user demand and, therefore, forecasting sales can be problematic. Customers may cancel their orders, change production quantities and/or reschedule production for a number of reasons. Depressed economic conditions may result in customers delaying delivery of product, or the placement of purchase orders for lower volumes than previously anticipated. Unplanned cancellations, reductions, or delays by customers may negatively impact the Company's results of operations. As many of the Company's costs and operating expenses are relatively fixed within given ranges of production, a reduction in customer demand can disproportionately affect the Company's gross margins and operating income. The majority of the Company's sales have historically come from a limited number of customers. Significant reductions in sales to, or a loss of, one of these customers could materially impact our operating results if the Company were not able to replace those sales with new business.
Other risks and uncertainties that may affect our operations, performance, growth forecasts and business results include, but are not limited to, timing and fluctuations in U.S. and/or world economies, sharp volatility of world financial markets over a short period of time, competition in the overall EMS business, availability of production labor and management services under terms acceptable to the Company, Congressional budget outlays for sonobuoy development and production, Congressional legislation, foreign currency exchange rate risk, uncertainties associated with the outcome of litigation, changes in the interpretation of environmental laws and the uncertainties of environmental remediation, customer labor and work strikes, and uncertainties related to defects discovered in certain of the Company's aerospace circuit boards. Further risk factors are the availability and cost of materials. A number of events can impact these risks and uncertainties, including potential escalating utility and other related costs due to natural disasters, as well as political uncertainties such as the conflict in Iraq. The Company has encountered availability and extended lead time issues on some electronic components due to strong market demand; this resulted in higher prices and/or late deliveries. In addition, some electronics components used in production are available from a limited number of suppliers, or a single supplier, which may affect availability and/or pricing. Additionally, the timing of sonobuoy sales to the U.S. Navy is dependent upon access to the test range and successful passage of product tests performed by the U.S. Navy. Reduced governmental budgets have made access to the test range less predictable and less frequent than in the past. Additional risk factors that have arisen more recently include risks associated with the increasingly tightened credit market, the Company's ability to maintain its credit facility on similar or more favorable terms, dependence on key personnel, recent volatility in the stock markets, and the impact on the Company's defined contribution plan, and the risk that the Company's stock might be delisted from the New York Stock Exchange (NYSE). Finally, the Sarbanes-Oxley Act of 2002 required changes in, and formalization of, some of the Company's corporate governance and compliance practices. The SEC and NYSE also passed rules and regulations requiring additional compliance activities. Compliance with these rules has increased administrative costs, and it is expected that certain of these costs will continue indefinitely. A further discussion of the Company's risk factors has been included in Part I, Item 1A, "Risk Factors", of this report. Management cautions readers not to place undue reliance on forward-looking statements, which are subject to influence by the enumerated risk factors as well as unanticipated future events.

The following discussion should be read in conjunction with the Consolidated Financial Statements and Notes thereto included in Item 8 of this report.

EXECUTIVE SUMMARY
In summary, the major elements affecting fiscal 2009 results compared to fiscal
2008 results were as follows (in millions):

Net loss fiscal 2008                                                            $ (13.1 )
Gain on Deming, NM plant sale in fiscal 2008                      $ (0.9 )
Litigation write-off in fiscal 2008                                  2.4

                                                                     1.5
2009 Items:
Increased margin resulting from disengagement terms with one
customer                                                             1.6
Increased restructuring/impairment charges                          (6.8 )
Improved margin on government programs                               2.0
Decreased income tax expense                                         3.4
Increased legal and consulting expense                              (1.1 )
Increased pension expense                                           (1.8 )
Increased translation/transaction exchange expense                  (1.4 )
Other                                                               (0.1 )

                                                                    (4.2 )
Net change                                                                         (2.7 )

Net loss fiscal 2009                                                            $ (15.8 )

Fiscal 2009 was impacted by:
- Consistent and successful sonobuoy drop tests contributing improved margins. Margins improved due to improved labor efficiencies and less rework cost. There were no minimal or zero margin contracts in sales in fiscal 2009.

- Higher sales in the Aerospace market of $22.0 million.

- Increased margin resulting from disengagement agreement with one aerospace customer.

- Increased administrative expenses primarily related to legal and consulting fees totaling $1.1 million above prior year.

- Increased pension expense, primarily related to lump-sum settlement and curtailment charges, of $1.8 million above prior year.

- Increased restructuring/impairment charges of approximately $6.8 million in fiscal 2009 over prior year.

- Income tax expense of $1.8 million in fiscal 2009, resulting principally from uncertainty in realization of future tax benefits.

During the last six months of fiscal 2009, Sparton announced several restructuring actions that were being taken as part of the Company's turnaround strategy. Included among these actions were Company-wide reductions in force, the closure of the Jackson, Michigan and London, Ontario facilities, changes in certain employee benefit plans and the disengagement from a significant customer. While the Company believes these actions will ultimately improve profitability, the implementation of these actions will take time to complete. A significant portion of the charges associated with these actions has been incurred in the fourth quarter of fiscal 2009. Future quarters, particularly the first two quarters of fiscal 2010, may be impacted depending on the timing of the completion of the respective actions.
These various factors, among others, are further discussed below. In this context, Sparton alerts readers that our President and Chief Executive Officer initiated during fiscal 2009 a full evaluation of our operations, including operating structure. This evaluation, which is ongoing, likely may result in changes to our analysis of how the components of Sparton's business contribute to consolidated operating results and the overall level of disaggregation of reported financial data, including the nature and number of operating segments, disclosure of segment information and the consistency of such information with internal management reports. The management discussion and analysis of operations disclosure in the Company's periodic report beginning in fiscal 2010 is expected to reflect the changes that arise due to this evaluation.

20

Fiscal 2009 Compared to Fiscal 2008

                                                       2009                                     2008
                                            Sales             % of Total             Sales             % of Total          % Change

Aerospace                               $  86,594,000                  39 %      $  64,558,000                  28 %           34 %
Medical/Scientific Instrumentation         67,710,000                  31           73,234,000                  32             (8 )
Government                                 42,310,000                  19           48,483,000                  21            (13 )
Industrial/Other                           25,257,000                  11           43,531,000                  19            (42 )


Totals                                  $ 221,871,000                 100 %      $ 229,806,000                 100 %           (3 )%

Sales for the year ended June 30, 2009 totaled $221,871,000, a decrease of $7,936,000 (or 3%) from fiscal 2008. Aerospace sales were significantly above prior year, increasing $22,036,000 (or 34%) primarily due to the increased volume of sales to four existing customers who, combined, contributed $21,515,000 to the increase. Included in this increase were $3,136,000 of sales related to Honeywell, with whom we are disengaging as further discussed below. Medical/Scientific Instrumentation sales decreased $5,526,000 (or 8%) from the prior year. This decrease was due to delayed new customer program starts and sales to the existing customer base. The majority of the decrease was due to two customers, whose combined volume contributed $5,238,000 to the overall decrease. Government sales in fiscal 2009 decreased $6,173,000 (or 13%), from the prior year primarily due to lower U.S. Navy and foreign awards received in fiscal 2008 for completion in fiscal 2009. While total government sales have decreased, the margins associated with these sales have significantly improved as rework and related costs have not been incurred as a result of successful sonobuoy drop tests during the current fiscal year. Industrial/Other sales also decreased by $18,274,000 (or 42%) from the same period last year. This decrease was primarily due to decreased sales to four customers, with whom we disengaged in fiscal 2009, which accounted for a combined decrease of $18,624,000 during the year ended June 30, 2009.
The majority of the Company's sales come from a small number of key strategic and large OEM customers. Sales to the six largest customers, including government sales, accounted for approximately 77% and 73% of net sales in fiscal 2009 and 2008, respectively. Five of the six largest customers, including government, were also included in the top six customers for the same period last year. Siemens Diagnostics, a medical customer, contributed 17% and 16% of total sales during fiscal 2009 and 2008, respectively. Honeywell, an aerospace customer with several facilities to which we supplied product, provided 19% and 17% of total sales for the years ended June 30, 2009 and 2008, respectively. On March 16, 2009, the Company announced the termination and winding down of our agreements with Honeywell, and disengagement procedures are currently underway, with completion anticipated by September 30, 2009. As part of this disengagement, the Company is receiving payment for production in addition to that specified in the original contracts. Margins for fiscal 2009 associated with this customer are approximately $1.6 million above those for the same period in the prior year. Almost all of this increase was experienced in the last six months of fiscal 2009 and resulted from this disengagement agreement. Sales to Honeywell totaled $41,615,000 and $38,479,000 in fiscal 2009 and 2008, respectively.
The following table presents consolidated income statement data as a percentage of net sales for the years ended June 30, 2009 and 2008, respectively.

                                                                        2009             2008
Net sales                                                               100.0 %          100.0 %
Costs of goods sold                                                      92.9             94.8

Gross profit                                                              7.1              5.2

Selling and administrative                                                8.8              8.6
Restructuring/impairment charges                                          3.2                -
EPA related (income) expense - net of environmental remediation             -                -
Net gain on sale of property, plant and equipment                           -             (0.4 )

Operating loss                                                           (4.9 )           (3.0 )

Interest expense                                                         (0.7 )           (0.5 )
Interest and investment income                                              -                -
Equity loss in investment                                                   -             (0.1 )
Other income (expense) - net                                             (0.7 )            0.1


Loss before income taxes                                                 (6.3 )           (3.5 )
Provision for income taxes                                                0.8              2.2

Net loss                                                                 (7.1 )%          (5.7 )%

An operating loss of $10,892,000 was reported for the year ended June 30, 2009, compared to an operating loss of $6,860,000 for the fiscal year ended June 30, 2008. The gross profit percentage for fiscal 2009, was 7.1%, an increase from 5.2% for the same period last year.

Gross profit varies from period to period and can be affected by a number of factors, including product mix, production efficiencies, capacity utilization, and costs associated with new program introduction, all of which impacted fiscal 2009's performance. During the year ended June 30, 2009, gross profit was favorably impacted by improved margins on several customers, a result of pricing increases, improved performance, and reductions in force. In addition, successful sonobuoy drop tests allowed for significantly improved margins associated with government sales due to labor efficiency and minimal rework costs, totaling an improved margin of $2.0 million above prior year. For the years ended June 30, 2009 and 2008, there were minimal cost to complete adjustments (totaling approximately $591,000 and $333,000 of income, respectively) related to the sonobuoy programs. Negatively impacting gross profit in fiscal 2008 was $19.4 million of government sonobuoy sales with no or minimal margin. The Company also experienced $1,557,000 of improved margin with one aerospace customer with whom we are disengaging, as previously discussed. Included in the years ended June 30, 2009 and 2008 were results from the Company's Vietnam facility, which has adversely impacted gross profit by $1,444,000 and $943,000, respectively. Translation adjustments related to inventory and costs of goods sold, in the aggregate, amounted to a gain of $128,000 and a loss of $202,000 for the years ended June 30, 2009 and 2008, respectively. Also included in costs of goods sold is approximately $2,061,000 of pension expense, an increase of $1,520,000 from the prior year, as further discussed below.
Included in costs of goods sold for fiscal 2008 was the write-off of inventory previously carried as a deferred asset. This write-off totaled approximately $1,643,000 and was the result of an adverse decision from the Sixth Circuit Court of Appeals where Sparton was defending the appeal of a decision of the lower court in Sparton's favor. A reserve of $800,000 was established in fiscal 2008 against other deferred assets relating to a different claim. For a further discussion of these legal claims see Note 10 to the Consolidated Financial Statements included in Item 8.
Pension expense totaled $2,451,000 and $639,000, of which approximately $2,061,000 and $541,000 was included in costs of goods sold, for the fiscal years 2009 and 2008, respectively. Based on the actuarial calculation, a $333,000 curtailment charge was recognized during the third quarter of fiscal 2009, related to the acceleration of all remaining prior service costs previously being amortized over future periods. In addition, lump-sum benefit distributions as of that date exceeded plan service and interest costs, resulting in a lump-sum settlement charge of $615,000 which was also recognized during the same period. Primarily due to reductions in force and the closure of the Jackson, Michigan facility, additional lump-sum distributions made during the remaining months of fiscal 2009 resulted in an additional settlement adjustment of $518,000 during the fourth quarter of fiscal 2009. A more complete discussion of the settlement adjustment and resulting increased pension expense is included in Note 6 to the Consolidated Financial Statements included in Item 8.
Selling and administrative expenses for the year ended June 30, 2009 decreased compared to the same period in the prior year. Included in this fiscal year were increased consulting fees related to increasing operational efficiencies and the hiring of personnel. These fees totaled $972,000 above the prior year, with the majority of these type of fees not incurred in fiscal 2008. In addition, legal costs incurred in connection with a recent trial were $127,000 above the same period last year. These increased expenses were offset by decreased expenses primarily at two facilities. The Company's Albuquerque, New Mexico facility was closed in October 2008, decreasing that location's selling and administrative expense. In addition, a second facility incurred increased costs in the prior fiscal year related to support and start up activity of new customers, which activity was not incurred to the same level this fiscal year.
Amortization expense, which totaled $492,000 and $481,000 for the years ended June 30, 2009 and 2008, respectively, was related to the purchase of SMS; for a further discussion see Note 13 of the Consolidated Financial Statements. Net gain on sale of property, plant and equipment in fiscal 2008 resulted from the sale of the property, plant and equipment of the Deming facility located in New Mexico. For a further discussion of this sale see Note 14 to the Consolidated Financial Statements included in Item 8.
During fiscal 2009 the Company initiated a restructuring plan, which activities resulted in charges of $7,008,000 primarily in the fourth quarter of the fiscal year. For a further discussion of the restructuring activities and expense components see Note 14 to the Consolidated Financial Statements included in Item 8.
Operating loss also includes charges related to the New Mexico environmental remediation effort. Net EPA charges and income are more fully discussed in Note 10 to the Consolidated Financial Statements included in Item 8.
Interest expense of $1,569,000 and $1,205,000 (net of capitalized interest of $2,000 and $11,000) in fiscal 2009 and 2008, respectively, is primarily a result of increased borrowings on the revolving credit facility. A complete discussion of debt is contained in Notes 9 and 15 to the Consolidated Financial Statements included in Item 8. Interest and investment income decreased $100,000 to $28,000 in fiscal 2009. This decrease was due to decreased funds available for investment. The Company's investment securities portfolio was substantially all liquidated in fiscal 2007. Investment securities are more fully described in Note 3 to the Consolidated Financial Statements included in Item 8. Other-net was $8,000 and $7,000 in fiscal 2009 and 2008, respectively. Fiscal 2009 and 2008 also included $(1,483,000) and $265,000, respectively, of net translation and transaction (losses) and gains.

Equity investment loss was $59,000 and $273,000 in fiscal 2009 and 2008, respectively. Included in the equity investment is the Company's investment in Cybernet Systems Corporation (Cybernet), representing a 14% ownership interest. The Company's investment in Cybernet is more fully discussed in Note 3 to the Consolidated Financial Statements included in Item 8.
The Company's effective tax rate (benefit) for fiscal 2009 was 12.8% compared to the statutory U.S. federal tax rate which is a benefit of (34%). The significant change in the effective tax rate was principally due to the additional valuation allowance of approximately $6.5 million recorded in fiscal 2009. This valuation allowance was established against the Company's deferred tax assets, whose realization at this time is uncertain. A complete discussion of the elements of the income tax provision is contained in Note 7 to the Consolidated Financial Statements included in Item 8.
After provision for applicable income taxes the Company reported a net loss of $15,753,000 ($(1.61) per share, basic and diluted) in fiscal 2009, compared to a net loss of $13,138,000 ($(1.34) per share, basic and diluted) in fiscal 2008. Fiscal 2008 Compared to Fiscal 2007
Fiscal 2008 results were favorably impacted by:
- Consistent and successful sonobuoy drop tests contributing to increased sales and improved margins, including $0.3 million of income in fiscal 2008 compared to $2.7 million of expense in fiscal 2007 resulting from cost to complete adjustments.

- Continued sales growth in the Medical/Scientific Instrumentation market and a number of significant new EMS program orders in start-up.

- Improved margins from a better product mix, improved performance, and repricing on some products.

- The completion of the sale of the Deming, New Mexico facility at a gain of approximately $0.9 million.

These factors, however, were offset by:
- Valuation allowance established against deferred tax assets of approximately $10 million.

- Sales of several lots of sonobuoys in the early part of fiscal 2008, which contracts carried minimal or no margin.

- Significant new program start-up costs related to hiring staff, training personnel and the costs of ordering material in advance of production, compounded by customer delays which lead to further unexpected cost growth.

- Increased selling and administrative expenses to support new program start-ups.

- Decreased sales and depressed margins in the Industrial/Other market, due primarily to reduced sales and pricing concessions to one customer.

- The write-off of a $1.6 million litigation claim (previously recorded as a deferred asset), due to an adverse court opinion.

- Increased outside service costs related to management's obligation to report for the first time on internal control over financial reporting at the end of fiscal 2008.

- Costs in advance of closing the Albuquerque, New Mexico facility related to severance benefits of $181,000 in the fourth quarter of fiscal 2008.

- Reserve established against previously deferred costs of $0.8 million.

These various factors, among others, are further discussed below.

                                                      2008                                     2007
                                            Sales             % of Total             Sales             % of Total          % Change

Medical/Scientific Instrumentation      $  73,234,000                  32 %      $  59,754,000                  30 %            23 %
Aerospace                                  64,558,000                  28           56,955,000                  28              13
Government                                 48,483,000                  21           29,677,000                  15              63
Industrial/Other                           43,531,000                  19           53,700,000                  27             (19 )


Totals                                  $ 229,806,000                 100 %      $ 200,086,000                 100 %            15 %

Sales for the year ended June 30, 2008 totaled $229,806,000, an increase of $29,720,000 (or 15%) from fiscal 2007. Medical/ Scientific Instrumentation sales increased $13,480,000 (or 23%), above sales from the prior year. This increase was partially due to new customer programs and expanded sales to the existing customer base. The majority of the increase was due to three existing customers, whose combined increased volume contributed $9,192,000 to the overall increase. In addition, one customer contributed $2,816,000. Medical/Scientific Instrumentation sales were expected to continue to expand. Aerospace sales were also up from prior year, $7,603,000 (or 13%) primarily due to the increased volume of sales to two existing customers who, combined, contributed $5,854,000 to the increase. Government sales in fiscal 2008 increased due to the results of successful

. . .