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Executives

Jeff Lambert – IR, Lambert, Edwards & Associates

John Sztykiel – President & CEO

Joe Nowicki – CFO

Dave Reid – VP, Public Affairs, Brand & Strategic Management

Analysts

Ned Borland – Next Generation

Walt Liptak – Barrington Research

Joe Maxa – Dougherty & Company

Amy Norflus – Pilot

Brett Hendrickson – Nokomis Capital

Spartan Motors, Inc. (SPAR) Q2 2009 Earnings Call Transcript July 23, 2009 10:00 AM ET

Operator

Good day, and welcome to the Spartan Motors second quarter 2009 earnings conference call. All participants will be in a listen-only mode until the question-and-answer session of the conference call. This call is being recorded at the request of Spartan Motors. If anyone has any objections, you may disconnect at this time.

I would now like to introduce Mr. Jeff Lambert on behalf of Spartan Motors. Mr. Lambert, you may proceed.

Jeff Lambert

Thank you, and good morning, everyone, and welcome to the second quarter 2009 conference call. I'm Jeff Lambert with Lambert, Edwards. I have with me today several members of Spartan's management team, including John Sztykiel, President and CEO; our new CFO, Joe Nowicki; and, Dave Reid, Vice President of Public Affairs and Brand Management.

I assume all of you saw our release on the Newswire and Internet this morning. And I'm going take a few minutes to discuss the results for the quarter. However, before we do this, it is my responsibility to inform you that certain predictions and projections made in today's conference call regarding Spartan Motors and its operations maybe considered forward-looking statements under the Securities Laws. As a result, I must caution you that as with any projection or prediction, there are a number of factors that could cause Spartan's results to differ materially. These risk factors are identified in our Form 10-K filed with the SEC.

A quick word about the format of today's call, John Sztykiel will begin the call with a brief overview of the quarter, and then go over the operational results for each business segment, and conclude with an outlook for the future. Joe Nowicki will then discuss the financial results for the quarter. And Dave Reid will be available for questions towards the end. We'll conclude with the Q&A session, at which time the operator will instruct you on how to enter the queue.

With that, I'll turn it over to John.

John Sztykiel

All right, Jeff. Thanks so much. To all of you listening today on the call and on the Internet as well, thank you for taking your time. This was another good quarter, and our consistent performance through the first six months of the year is one that has demonstrated our diversification and the strength and the depth of our management. Challenging times, but in reality, Q2 and Q1 have really been very, very good in light of some very, very difficult times.

As we look at the second quarter and the financial results, and Jo's going to go over in greater detail, but we had net sales of $124 million; net earnings of $0.16 per share; gross margin of 20%, up 18% versus a year ago; and, actually the fifth straight quarter of year-over-year improvements in gross margin, consolidated backlog of $161 million, and return on invested capital of 12%.

Our EVTeam as an operating group was again, as a whole, profitable. Our fire truck or emergency-rescue markets, the sales and backlog continue to grow. And it's extremely positive and exciting as we look to the future because emergency-rescue is without a doubt one of our most stable markets with really very, very good growth potentials ahead of us. Beyond our financial results, we also undertook several other additions into the quarter that we expect to bear fruit later in '09, in 2010.

Operationally, we will continue to take steps to manage costs, improve efficiencies inside our business correctly with demand across all of our business units, product lines, and market segments. This includes adjustments to staffing as we continue to lien out our facilities, would it be from a profits (inaudible) perspective to ensure we are the right-sized company relative to the backlog in the business at hand. We have already seen the effectiveness of this effort in the first half of the year. However, there are still tremendous opportunities for improvement as we move ahead.

Another initiative, which we're moving forward on, which over time will reduce our cost base both short term and long term, is that of strategic fabrication. We're taking proactive steps to better control our supply chain through strategic fabrication. And this is simply in certain selected areas, both in metal cutting, assembly, weld, and fabrication. We will begin producing certain value added components in the third quarter this year, starting in our Michigan location. Over time, these parts will be utilized at our other assembly facilities outside of Michigan as well.

Why are we moving in this direction? Today, the marketplace values the complete vehicle and no longer separates the chassis and the body as it used to be. And we have tremendous opportunity to capture higher margins through enhancing the uniqueness of both the chassis and the vehicle, reacting with speed, but also reducing our cost base. If there's something, which is inherent within the custom business is when you order parts with short delivery time periods in small volumes, you pay an absolute premium from the supplier. That is a major initiative for us to reduce at this particular point in time.

Another major initiative, which was accomplished this past quarter, which I think will bear tremendous fruit as we move forward, was the addition of two experienced executives to our leadership team, Tom Gorman as our newly created Chief Operating Officer, and Joe Nowicki who is succeeding Jim Knapp as the Chief Financial Officer. While Tom is not here today, he will be on call in the future.

Tom's role as COO is to oversee the four current business units in addition to implementing strategic growth initiatives. We have been looking for an experienced person for quite some time, who has both the big picture view, a strategic view of both the operations and the opportunity, but at the same time has the demonstrated experience to ensure operational results each and everyday.

In addition to that, Joe Nowicki brings with us an experience on return on invested capital, and we would see a tremendous fit both within our culture, both from an operations perspective and a strategic perspective.

I also would like to thank Jim Knapp for his lasting contribution through seven years here, and what he's done to not only drive results, but position us for a very, very strong future. And we wish him well as he moves into retirement.

With the addition of both Tom and Joe, we bring global experience, we bring demonstrated excellence from a strategic perspective, and we also bring demonstrated excellence from an operational perspective. Both of these individuals, I think, will contribute significantly to SMI, both in the short term and the long term.

And before I get into the market segments, there are definitely going to be some challenges for us over the next few quarters. While Q1 and Q2 have demonstrated our ability to work through uncertain times, to work through difficult times, the next several quarters will be challenging as well. However, from an optimism perspective, ours is not diminished today. While there are challenges, one of the most exciting things about the times, which we're in today is that society continues to change at an ever increasing rate, and the opportunities for vehicles to change, and the opportunities in front of us are the largest I've seen in the past 20 years.

Now, I'd like to review our results by the end markets, which we serve. Looking at the defense markets, Spartan Motors was not part of winning the MATV bid, but we continue to supply components, vehicle integration under several contracts with our defense customers, primarily in the mine resistant vehicle area. We certainly have proven experience and production capacity to handle additional defense vehicle contracts. We're actively pursuing additional orders for variants, whether the ILAV, MRAP, et cetera.

Simply, while we were not successful in the MATV bid, but we potentially could be a supplier. And other than that I really could not comment any further as we make it a standard protocol not to comment on potential opportunities from a detailed perspective. We are in the defense business today. I see us being in the defense business tomorrow. I see us being in the defense business ten years from now.

We bring to the market customization. We bring to the market innovation. And we bring to the market agility. And those three things are attractive in almost any market segment for any product line in the global marketplace today.

Moving over to service parts and assemblies, sales are increased year-over-year by 110%. Along with strategic fabrication, SPA, or service, parts, and assembly, is a key part of value maximization strategy. Simply, there are over 65,000 Spartan related vehicles in service today. And each one of those represents a tremendous opportunity, not only when it leaves our facility, but also relative to maximizing opportunity to both provide value and increase sales and income as time goes on. SPA should also continue to be a revenue opportunity as we look to the future and other markets. As I mentioned earlier, we have over 65,000 vehicles out there. And as we move into the future, this is a very, very important initiative for us.

Let's move over to the RV business. Sales were again down in the quarter, reflecting the industry as a whole. And while the RV industry remains challenging and it will be a slow growth cycle up, we are finally starting to see some improvements, very, very slight, in May and June. What's interesting is if you look at the backlog sheet, the backlog promoter homes is actually up from a percentage perspective substantially. The number is still very, very small. But for the first time in quite some time, we have gone from order push backs, to forecast, to TOs. And so it appears that we have met the bottom, and the industry is now starting to come out of the depression-recession it has been in.

Again, it is going to take some time for the RV business to recover as a whole. However, as a company, we will be introducing four to six new product technology initiatives in our VIA. These will be some very, very, what I would call, forward-looking, some in line with today's opportunity in the marketplace. But the RV industry as a whole remains very, very important to us.

And what's interesting, as I pointed out as to why the RV industry is an important industry, more than half a million people per day enjoy an RV. That's a pretty outstanding number. And then when you look at the cost structures and some of the changes going on within society today in RV or a vacation to the outdoors, which involves either a motor home, a passenger car pulling a tow boat, et cetera, still remains one of the most cost effective vacations within North America today. So at you look at costs or value becoming more important in the future, and you look at the scenery, which we're blessed with within North America, and you look at the population opportunity getting back to the fact that half a million people each day are enjoying an RV somewhere, this is still a great market to be in. And we're very, very committed to it.

As we move ahead to emergency-rescue, first looking at the fire truck chassis business. We had another good quarter, compared to a year ago. Sales increased 51%, and the backlog increased 12%. Our sales and backlog reflected higher demand, some of which is from the 2010 emissions change, which will be coming up. We also believe, in the quarter, we're gaining in some areas from a competitive market share perspective as we continue to executive relative to competition.

The reality is we have a strong order backlog for the second half of '09. There is an emission standard change being implemented in January of 2010. Our operational performance is very responsive relative to adding new customers. And as a company, we will be bringing, or have brought, at least nine new products between 2008 and 2009 into the emergency-rescue marketplace. Now while we see very little results from those new products in 2009, and I doubt we'll see much momentum from those new products in the first half of 2010, we're very excited about the opportunities for those new products in the second half of 2010 and beyond.

And while in one respect that may seem like a long turning period, the reality is, within North America, being Canada and the US, there are over 30,000 fire departments, and it takes a significantly long time to introduce a product and develop that market. On average, it's 12 to 18 months because financially and physically, it is very, very difficult to create the exposure and the awareness with 30,000 plus fire departments. It's sort of an outstanding fact that a fire department typically makes a purchase after it has seen the vehicle 71% of the time. So you just have to do the Math. And when people say, "Why do this take so long for an emergency-rescue product to gain traction?" Think of the number 71%, they got to see the product, you do 30,000. It just doesn't happen overnight.

From an emergency vehicle team perspective, which made up about 22% of our total sales in the quarter, it was another solid quarter. And again, as a whole, it was a profitable quarter. This was largely to our streamline operations at all three companies within the emergency vehicle scene, Crimson Fire, Crimson Fire Aerials, and Road Rescue, and from the increased fire truck sales. Moreover, we expect the same factors to continue to gain momentum in Q3 and Q4. But there are challenges ahead of us, as there are in every market and every day. But we're very focused on ensuring the operational execution.

To wrap things up in the emergency-rescue market, it clearly remains our largest, most stable platform. We see very, very good opportunities for growth in the future. We hold a positive outlook for '09. And we're excited about 2010 and beyond.

In closing, as we look at the first six months of 2009, our diversified multiple market strategy/business models and our operational and strategic agility have reduced our downside risk while increasing our upside potential with really very good results in light of the circumstances, which we're in today. We have demonstrated Spartan's ability to transform markets and establish a portfolio of strong brands.

In addition, this current recession, as I mentioned earlier, is causing massive changes in our society. And as society changes, vehicles and markets will change. As a company, we are very focused on protecting our R&D costs. We're very focused on ensuring product development because to develop a market, to develop a vehicle is not a three to six months process. It definitely takes some time. You not only have to ensure that you're delivering a safe vehicle and ensuring a high quality vehicle, but you also have to ensure that the amount of invested capital you put into the project is going to have the right return on investment.

And to give you some idea relative to validating the opportunity for vehicles to change, attendance at the March 2009 National Truck and Equipment Association Show in Chicago – attendance was up 19% in the midst of the most difficult economy North America has been in quite some time. And the fact that attendance was up was really a validation that people as a whole are not satisfied, are unhappy with the vehicles they're using today. They expect costs to go up. They expect work to change or operations to change, so they're looking for something different. And that is where we fall in.

And so as we look to the future, as mentioned in the release, I have no doubt we will be in two to three new strategic markets within the next 9 to 12 months. And how can I say that taking a look at the number of initiatives, which we have going on internally, whether it be from an M&E perspective, whether it be from an organic perspective, whether it be from an opportunity perspective, as a company, we are moving forward from a strategic growth perspective.

And to reiterate, our expectations for the rest of the year, we believe the next few quarters will be challenging from an earnings perspective. I said that right at the beginning of the phone call. We expect that consolidated 2009 results to be less than 2008 because of macro market conditions as well as the year-over-year reduction, especially in vehicle sales for large scale defense contracts. Operationally, as mentioned earlier, we have taken the right steps to manage costs, improve efficiencies, and ensure our business is sized appropriately with demand relative to the market segments, which we're in.

However, as Spartan transforms from an opportunistic organization to one of balanced strategic growth, the long term opportunity is there. And what do mean by balanced strategic growth? First, you have opportunities, where you take advantage of opportunities that come to you with agility and demonstrated speed. You look at innovation and opportunities where we create, where we develop through an innovative process of product, we develop a new product or a new market niche.

The men on the mergers, acquisition, and partnerships side of life, while we have been very involved and we haven't brought the right partnership for acquisition yet and executed, we are very, very much within that field of place because there are opportunities out there. And Joe Nowicki will go further into that. But it has got to not only be the right strategic fit, it's got to be the right financial fit. Both have to be the right fit. Simply, we're being quite choosy.

And from a final note perspective relative to investor relations, we will be update – or I should say we have updated our Road Tests Virtual Management presentation in our Web site with second quarter information. And this really separates us from a lot of other public companies out there. So if you're not familiar with our Road Tests, please turn to it. You'll see the second quarter information up there, what will also be taking place in Q3 as well. Jim Knapp, our past CFO, is on our Road Tests. And in Q3 of this year, Joe Nowicki will now move on to the Road Tests as we update from a CFO perspective.

So in closing, I want to say thank you very, very much, appreciate your time. And we look forward to the days ahead. Joe?

Joe Nowicki

Thanks, John. Good morning, everyone. Before I talk about the highlights of the financials for the quarter, let me provide you with a little bit of information about my background. In my previous position, I've spent 17 years with the top office furniture manufacturer located here in Michigan, most recently as Treasurer and Vice President of Investor Relations, but also enrolled as the CFO over their international business as well as CFO of several operating units. I've also worked in financial roles in the automotive industry and the computer industry. In addition, I've worked in consulting, and began my career in public accounting.

My previous position was in an organization (inaudible) bit more culture than Spartan Motors. A culture based on innovation and focused execution. Further, Spartan's emphasis on return on invested capital because of my background with economic value added financial management.

Looking at my financial philosophy for Spartan, I plan to continue on the things that have been working here, including a conservative approach to financial matters, keeping a low breakeven point, and valuing decisions that improve SPAR or SPAR profit in return, which is the economic value added financial model we use.

I'm excited to join this excellent organization, and to speaking with all of you today and in the future.

Turning to our financials for the second quarter, we posted solid second quarter operating performance, driving a 6.6% operating income level despite difficult macroeconomic and market conditions, which caused a revenue decline of almost 37% from the prior year. The bulk of the revenue decline was in the motor home sector as well as defense sector, reflecting the completion of several large orders for defense customers in the second half of 2008. This was partially offset by increased volumes in the fire truck chassis business.

Gross margins improved for the quarter as result of the improved product mix, and also lowered commodity cost.

From a balance sheet perspective, we reported $16.8 million in cash and cash equivalents at the end of the quarter, compared to $13.7 million at December 31st, 2008. We ended the quarter with $16.3 million in long term debt. Depreciation for the quarter was $9.9 million. Our effective tax rate was 33%. Our return on invested capital for the quarter was 12.1% with Spartan Motors and its direct subsidiaries. We use ROIC as the key measure of our progress. As noted in the press release, we define ROIC as operating income less taxes on annual basis, divided by total shareholder equity. This was below our company ROIC target of 15% to 20%. With lower year-over-year sales, our ROIC was pressured despite our higher gross margins.

We also relate our bonus program for management and associates, which is based on an economic value added financial framework.

We forecast CapEx spending of almost $5 million to $6 million in 2009 to maintain our current operations. For operating cash flow, we used $5.1 million in cash to support current working capital needs.

Looking forward, we'll continue to structure the business to operate profitably at the current demand and (inaudible) levels. In addition to retaining our focus to further strengthen the balance sheet, all the while accelerating the development of new products and in new markets.

With that, I'll turn the call over now to the operator. We'll begin the Q&A session.

Question-and-Answer Session

Operator

(Operator instructions) And our first question comes from Ned Borland from Next Generation. Please go ahead with your question.

Ned Borland – Next Generation

Hi. Good morning, guys.

John Sztykiel

Good morning.

Ned Borland – Next Generation

Just looking at the backlog in other specialty, it's held pretty dramatically. I know that the spare parts and accessories are in there now. Now you said the install base of vehicles out there is 65,000. How is the install base going to trend going forward? Have you shipped already enough spare parts fits in order to – I mean to sustain this level of revenue that you've been seeing recently?

John Sztykiel

Well, first, Ned – and this is John Sztykiel, from the service, parts, and assemblies perspective, what's driven the business for the most, over the last 6 to 12 months, is obviously been the defense. And there are still tremendous opportunities out there to both grow – to both develop and grow that part of the business.

The interesting thing is about the turn cycle on service, parts, and assemblies is it has a very, very short turn cycle, in that when people want the parts, they place the orders. And part of our demonstrated excellence is that we turn the orders very, very quickly. So we see tremendous opportunities for us to grow the business.

On the other hand, though, the reality is that there are a fair amount of our vehicles, which are in Iraq. And the situation in Iraq today is not as violent as what it was 12 months ago at this time. So per a per use perspective, there is the potential for less service, parts, and assemblies relative to those vehicles overseas, in particular Iraq. However, there's also the opportunity for refurbishment. As the military take the vehicles out of service or reduces their service, they typically look to upgrade, refurbish, et cetera. So we're now starting to see those opportunities come to bid in the marketplace, so.

As we look at service, parts, and assemblies, we see still see it as one of our key business segments. Will we have the same demonstrated percentage growth over the six to nine months, which we've had over the six to nine months? Honestly, it's a bit too early for me to tell today. But the backlog is down in that particular area. And I think part of it is just the fact that the vehicles are not being used as much in a violent situation as what they were 12 months ago.

Ned Borland – Next Generation

Okay. Yes. It just seems like the installed base is sort of plateauing here. Absent any other military programs, significant ones to grow it, it would seem that you'd have a hard time matching what's already an impressive last 12 months of spare parts volume.

John Sztykiel

Now I would think, current with that, it's hard to be – it will be hard to match percentage growth, percentage growth, percentage growth. However, there is the potential for the ship to go, for example, from servicing what's operating to now refurbishing or updating what's not being used. And that's something, which we're actively involved with.

The other thing too, which to note is Spartan Chassis continues to receive numerous awards from the defense industry or the purchasers of these products relative to on-time delivery, really standards of excellence. And so, what's exciting for us internally, from a strategic team perspective and an operational team perspective, when we look at both vehicles and service, parts, and assemblies, we really do have a very, very strong team today. And they are very focused on growing the service, parts, and assemblies business outside of just MRAP related products.

So now, as we look to the future, and again it's too early to tell, but as we look to the future, we expect our opportunity, for a lack of a better term, to be a service parts provider on vehicles in the defense business, which are non-Spartan to grow, not become less.

Ned Borland – Next Generation

Okay. That's helpful. And then switching over to the fire or emergency-rescue side of the business, now you've described it as sort of stable at this level, and since we've all read about tight state municipal budgets, is perhaps the hangover effect after the emission deadline going to be a little less pronounced this time around than it was in '07?

John Sztykiel

Oh I would concur with that a 100%. I think one of the things with the industry, as a whole, is going through right now is the uncertainty in the economy and the reduction in state local budgets. It's definitely affecting some respects to the order intake. However, we saw that happening a year to a year and a half ago, which is why we accelerated a lot of product market development initiatives relative to emergency-rescue.

I don't believe you're going to see the drop off in orders in Q1, in Q2 of next year versus maybe Q3 and Q4 of this year to be as great as to what you saw in Q1 and Q2 of '07 versus Q3 and Q4 of '06. And Dave Reid's shaking his head, yes. And Dave Reid Crimson Fire, Crimson Fire Aerials – so David, I'm not sure if you've got any comments to that as well. But I'm pleased to see at least visually you're agreeing with what I'm stating.

Dave Reid

Yes, Ned, what we saw was the impact of huge amount of orders that we received at the end of '08 coming into '09. So '08, we received an inordinate amount of orders to – prior to the NFPA safety standards taking effect in January of '09. We are seeing our sales log right now also increasing, which is a good thing to see because that when you're trying to work a bubble through, I think Q1 and Q2 orders where a lot of them were pulled through last December. So we have seen an up tick in sales log as well. So we're keeping our fingers crossed.

Ned Borland – Next Generation

Okay. That's helpful. On EVTeam, it looks like operating margin came in at about 2% for the quarter. I mean, what has to happen in order for that to get to a 5% level or better? And how long would it take to accomplish that?

John Sztykiel

Well, a couple of things need to happen. One, we need to continue to reduce the labor hours, the assembly costs. I will say this, Crimson Fire's new Legend body is a huge step in that direction. The assembly hours of their new Legend body series is more than 35% less than what their previous or current body design is. And that needs to take place at Road Rescue.

Now that will not happen until probably Q2 or Q3 of next year, where they are working now and what they call their NGA or Next Generation Ambulance body, which, for lack of a better term, utilize a lot of the same methodologies that we utilize at Crimson's Next Generation body design. So first, the labor hours have to come down.

Second, you have to reduce the building material cost. For example, Crimson Fire's new Legend body weighs 15% less than what the current body design was. Obviously, that lower weight translates to a lower building material cost structure. And it's not just aluminum or steel. There's also a reduction in electrical, electronics, and other parts of the vehicle as well.

So from a Road Rescue perspective, while they are making progress, I don't think they are going to make, what I would call, the large incremental progress until probably Q2, Q3 of next year when they bring on their Next Generation ambulance design. And I feel confident that will happen because we've seen very, very good success, which is showing up in Crimson Fire's results relative to their Next Generation body design, which is now in production.

From an Aerials perspective, they continue to really need to do same thing. And that is to reduce the hours to assemble an Aerial product, and at the same time reduce the building material cost. And that organization is focused exactly the same methodology, re-engineering the product to reduce the hours to assemble, re-engineering the product to reduce the building material cost.

Ned Borland – Next Generation

Okay. Thank you.

John Sztykiel

Thanks, Ned.

Operator

Our next question comes from Walt Liptak from Barrington Research. Please go ahead with your question.

Walt Liptak – Barrington Research

Hi. Good morning, everyone.

John Sztykiel

Good morning.

Joe Nowicki

Good morning, Walt.

Walt Liptak – Barrington Research

This question is on the gross profit. And I wonder, you mentioned that the EVTeam is profitable. I wonder what kind of gross margin you're getting there. And I imagine that in motor home chassis that you're gross profit is negative observing overhead, and what kind of gross margin you might be getting with the other products?

John Sztykiel

Walt, this John Sztykiel. Normally, Joe would answer this, but (inaudible) on the job that long. But we really don't breakdown gross margins by market segment for the simple reason, a lot of our honorable competitors look into the exact same com. When we start to get into that kind of detail, you can really start to get into the numbers, drive down to the sales price. And to be quite blunt, we put ourselves at a disadvantage at a procurement process.

Walt Liptak – Barrington Research

Okay. I'm certainly not trying to get you in trouble with your customers. But with military parts –

John Sztykiel

You're already giving our competitors an advantage.

Walt Liptak – Barrington Research

Right, disadvantage, right. With the gross margin maybe being higher in the other products and the military business winding down, I just wonder about some of your comments in the press release about the next couple of quarters being tough. I'm just trying to get a read on how tough those might be.

John Sztykiel

Well I would think from a gross margin perspective, if you look at a percentage, I mean relative to where we are in Q2, I think we've got a reasonable opportunity to maintain to gross margins in Q3 and Q4. I'm not saying it's going to be easy. But as a company, we continue to get wiser. As I mentioned earlier, we've had some very good, what I would call, successive quarters in a row with gross margins have improved. And so it's not like all of a sudden, we're going to stop, okay?

On the positive side of the fence, we're not seeing large increases or really increases at all per se on a commodity or a building material pricing perspective. So that's very positive. I think relative to re-engineering our products to reduce our building material cost base, we're wiser and more efficient than where we were 12 months ago. And that's reflected in our improvement in gross margins. So if we look over the next couple of quarters, I think we've got a reasonable opportunity to maintain the gross margins, which we've seen in the second quarter of this year.

Walt Liptak – Barrington Research

Okay, good. Let me try and ask the question again in a different way. In some of the commentaries said that the gross margin improvement was product mix, some of it was lower commodity costs. So what percentage there or how would you break out the improvement, product mix versus the price cost relationship?

Joe Nowicki

Walt, this is Joe. When you take a look at those two pieces, Walt, it's really a pretty even split between both of those elements combined. It doesn't really lean towards one or the other. And to add on to John's earlier comments as we look forward to the third and fourth quarter. The challenge obviously is going to be the demand piece and its impact on the fixed overhead cost structure. So clearly, the commodity piece has been a benefit to us. The mix piece if it stays in that same order will help us as well too.

But the issue, which is going to be the challenge, will be offsetting the fixed cost associated with the overhead cost in manufacturing. So the demand the clients are aware, we're looking cautiously to how they'll impact the financials going forward.

Dave Reid

And Walt, as you look at the number of the trade press this month. You're going to see some very aggressive work that we're doing to increase demand. We bought stainless steel on the spot market when it was being dumped a couple of months ago. And we're offering stainless steel bodies at the same price as aluminum. Next month, you're going to see some add fittings with some very aggressive base prices. So along with the focus on right sizing the business and the commodities, we're being very aggressive on increasing sales activity and excitement on the products that we have. So we're continuing to invest in that area as well.

Walt Liptak – Barrington Research

Okay. Thanks. That's helpful.

John Sztykiel

Walt, and really for the group as a whole, sometimes they don't want to obviously jump in there. And I made this statement earlier. While we've got a reasonable opportunity to maintain those gross margins or what we had in the second quarter going forward, on the other hand too, it is a more competitive market, in that as you see earlier, the backlog's down.

In the RV business, while moving up is not great, you've got cities and budgets, which are tighter at the city looking forward. The defense business is not where it used to be, which typically means that from a pricing perspective, as you go out to try to attract and gain new business, we maybe making the operational decisions to take projects or orders, or to execute initiatives at a lower gross margin structure than maybe what we've done in the first six months of the year.

So I think we've got a lot of positives moving forward in the right direction. But at the same time, we're also trying to provide both with them in qualification that if we deem it to be the right fit, we probably would take orders at a lower gross margin over the next three to six months than maybe what we've done in the last three to six months just because this recovery, which people say we're talking about, is not going to be a dynamic recovery up. It's going to be a recovery that's representative – we tie in employment and slow growth, which typically means a little bit more aggressive pricing structure.

Walt Liptak – Barrington Research

Okay. I'll get back in queue, but after one last question. What are you doing to address the SG&A expenses? Are there any reductions that you can make there to help mitigate the slowing?

Joe Nowicki

This is Joe, and I'll take this – a quick answer for it. And as John mentioned earlier in my vast three days of experience with Fire, I'll give you all I do know. And between the new COO, Tom Gorman, and myself, we've just started to kind of dive into the cost structure across the organization looking for ways that we can try to improve things. And Tom and I have several ideas of actions that we could take to really look at getting the team working collectively and a little different ways than they do today, which will have a favorable impact on the SG&A piece. So we've got a lot of ideas. I don't have the specific number for you, but stay tuned on that. There will be a lot of good work going out in looking at it.

Walt Liptak – Barrington Research

Okay, Joe. Thank you.

John Sztykiel

But I'd say that's a very good question for the group. But one of the things Joe Nowicki brings to us is his previous employer had to go through a rather dramatic sizing in the early 2000s when the dot.com bubble sort of burst, or did burst for lack of a better term. And we had a descent recession. And they had to change the structure of their business. And maybe, Joe, you just want to – not so much expound on what Herman Miller did, but the lessons in which you learned and how that will be applied to Spartan because Joe has a demonstrated experience within this area.

Joe Nowicki

Unfortunately, the furniture industry is a cyclical environment and is a discretionary capital good. So that us to keep a very lean structure and place a highly variable structure in place from an SG&A perspective, and also for us to keep a very close eye on our balance sheet and capital structure as relative. So we were constantly looking across the board to not only keep our cost structure highly variable, but in addition to that looking for ways to make step functions from time to time as you need to as demand changed.

And that's the same type of philosophy I think we'll be looking at here. As one, how to create a variable cost structure as much as possible. And also, how to adjust when the demand requires you to make step functions in that cost structure as relative.

Walt Liptak – Barrington Research

All right. Thanks, Joe.

Operator

And our next question comes from Joe Maxa from Dougherty & Company. Please go ahead with your question.

Joe Maxa – Dougherty & Company

Thank you. John, I wanted to dive a little bit back into that SPA business, your backlog in the other line, is that $23 million down significantly. Are we at a level that you think is sustainable in your military parts over the coming quarters? Or do you think we'll see that drift lower given the lack of activity you talked about?

John Sztykiel

Well, I think – I tell you what, honestly, it's – in one respect, it's hard for me to forecast because there are such short turnaround cycles in the SPA side of the business. I think we've got a very good chance to maintain where we're at. However, I will say this, the need or the opportunities because the vehicles are not being utilized as much, we definitely saw that from a backlog perspective in Q2. So that will probably continue some as we move into Q3.

So realistically, what you may see is probably a lower revenue stream from a service, parts, and assemblies of business over the next couple of quarters. And then a ramp up as we increase some of our opportunities relative to other markets, whether the defense, emergency-rescue, RV, or refurbishment contracts. There is more quoting going on than what there was three months ago in the SPA side of life right now. And part of it is for other defense related markets, part of it is for emergency-rescue and RV, and other products as a whole. But part of it is what they call refurbishment or upgrade.

Joe Maxa – Dougherty & Company

So let me just see if I can understand the dynamics of the SPA. I mean it ranked up pretty strong over the last couple of quarters. Was this because of activity or were they were more stocky up to have to – in their warehouses ready to go and something happened and now they've basically fallen and don't need that – to have that product still coming in? You know what I mean? So is it looking like more – ?

John Sztykiel

Actually, it was quite a bit of both.

Joe Maxa – Dougherty & Company

Okay.

John Sztykiel

I mean when you have vehicles being used in a violent situation, stuff happens. And when you have a $700,000 plus object, which can't move, then that's an asset, which is undervalued, not being utilized. So what you had was parts being bought to ensure they were in operations; parts being bought to ensure if something happens, they were put in operation quickly, so. It was a period of both going on.

Joe Maxa – Dougherty & Company

I was just wondering if there was a potential to see a lumpy quarter as you get to see your big orders come in maybe a couple of quarters from now to re-supplement stuff that's been utilized? Or do you think it'll be more – ?

John Sztykiel

Now that I would say the opportunity is definitely there because when they go to refurbishment, re-set, upgrade, they're typically a large number with a large volume quote. And this is true not just on the MRAP product, but other defense related products as well. So I mean that opportunity's probably greater today than what it was nine months ago for a large potential upgrade, for lack of a better term. I don't think it's going to happen, honestly, within the next, probably, 90 days. There's an opportunity in Q4 as we look at some of the quoting activity going on. But I don't think you'd see something like that happen in Q3.

Joe Maxa – Dougherty & Company

So your inventory levels are pretty consistent with last quarter. And I think, if I remember right, a lot of that was due to the spare parts and being ready to ship them. What are we looking at inventories right now? Or should we be thinking about them? And how that may come down as the revenue start to ramp down?

John Sztykiel

Yes. I think, obviously, the demand will start to decline the revenues going forward or decline the inventories going forward, so. As you traditionally would see in any industry, utilities and inventory levels come down with the demand.

Joe Maxa – Dougherty & Company

Okay. And you talked about doing some more fabrication and welding in house. Is that going to lead to an increased CapEx in the near term?

John Sztykiel

No, not in the near term, no. That CapEx was really spent earlier. So not a discretionary –

Joe Maxa – Dougherty & Company

Can you talk about right sizing the business or keeping it at the right size? And you talked about staffing levels. Are you talking about any type of meaningful adjustments there?

John Sztykiel

I think what's stated earlier is probably as far as what we would like to go with that right now, Joe.

Joe Nowicki

To really give you a specific answer, we're really looking at a lot of things right now and what that might be. And as we get a better handle on it, well you're going to be the first to know.

Joe Maxa – Dougherty & Company

Okay. Talking about the challenging earnings, are you still expecting to be profitable in the back half?

John Sztykiel

The answer's yes.

Joe Maxa – Dougherty & Company

And one last thing, you talked more about, I think, delivering a more complete vehicle versus chassis. Can you expand on that a little bit on what you're looking at? Obviously, fire trucks and ambulances that are – I'm just looking for a little more background on what you're expecting out of this.

John Sztykiel

You mean out of new strategic markets?

Joe Maxa – Dougherty & Company

Yes.

John Sztykiel

And I mentioned this a little bit before, but if you just look at, for example, the delivery or due market, which we call them DoD, capital D, small O, big D, delivery or due. And if you look within large cities in particular, there are a lot of vehicles being utilized where they're not optimal for the work conditions being done. The frame nails can be too high. The vehicles could be too heavy. And now you've got excessive fuel consumption, et cetera.

And so, one of the things that you're seeing is there's a tremendous amount of activity as to how to change the vehicle to improve the optimization for entrance and egress from the vehicle. Now, the nice thing is when you create vehicles that have some of those character traits, then that takes you into other markets where potentially the product could be utilized, such as tow and recovery, such as waste management, have applications in emergency-rescue.

So as we look to the short term future over the next 9 to 12 months, the key area we are focusing on is the delivery or due marketplace, where the vehicles today, they primarily didn't purchase around a low price, but not optimization from a work perspective, and that provides opportunity for us from a vehicle perspective and a chassis perspective.

Another area of significant opportunity is in the alternative fuel area. Not so much from a public perspective or a commercial perspective, but more from a, what I would call, a state-municipality perspective. There have been over 800 mayors that have signed up for the Clean Cities Act. And there are opportunities and interests from cities/municipalities for vehicles, which are non-diesel and non-gasoline based, could be a hybrid, could be a pure electric. And part of that is being driven by increased Federal funding or support for products or projects where the vehicles have some kind of alternative fuel-based platform. So that is another key area of focus for us.

Another key are of focus would be in the aging population. The reality is 11,000 people turn 50 a day. There are over 146,000 taxi cabs in service today. But when you have an aging population, you have transport and you have medical needs. There are opportunities in what we would call the non-emergency ambulance transport arena. And so, that's a broad brush overview in my – as I mentioned earlier, would be one of the projects we expect to show at RVIA are rather exciting, combination class A, class C towable products. So we've got some very exciting initiatives ahead of us. But from a new market strategic perspective, I do think that's a pretty good overview.

Joe Maxa – Dougherty & Company

And then lastly – thanks, John. And lastly, you mentioned opportunities about the – in the MATV program. And I didn't want to expand too much, but are you talking with the potential supplier that – or someone that – or there's an order issue to a second supplier?

John Sztykiel

I really can't comment other than the fact that we're pursuing all opportunities that are available to us, which made both strategic and operational sense. And there is definite time and activity allocated relative to being a potential supplier in the MATV project. Other than that, I really can't provide any other comments.

Joe Maxa – Dougherty & Company

All right, John. Thank you.

Operator

(Operator instructions) And our next question comes from Amy Norflus from Pilot. Please go ahead with your question.

Amy Norflus – Pilot

Yes. Hi. Can you tell me when we're going to start to sell the cement mixers and how big can that be to the revenue stream, for the concrete mixers? Sorry.

John Sztykiel

Amy, this is John Sztykiel, and one – relative to cement mixers, I don't see that over the six to nine months. I do see a variety of other products. And I mentioned just a few moments ago, delivery or due markets, the non-emergency ambulance transport market, potentially in the tow and recovery market. But while concrete and waste management are two opportunities for us, the reality is the cement mixer business – and we have done them in the past, okay. We've actually built over 75 front discharge concrete mixers. That's probably a slow growth opportunity similar to the RV business because it's very, very related to housing.

And while we talk about strategic initiatives and we're excited about our opportunities, the reality is the RV is going to take some time to recover. And the energy, which we're spending is really towards markets – new strategic markets, whether recovery or opportunity is significantly faster with a higher ramp up than concrete and RV.

Amy Norflus – Pilot

And do any of these markets have to do with the infrastructure market or the stimulus packages?

John Sztykiel

Yes.

Amy Norflus – Pilot

How big can that be? And –

John Sztykiel

What's interesting is there are over 800,000 vehicles sold in 2006, which were basically dedicated towards what you would call infrastructure relative to society within North America. Now that's Class 3 through Class 8. But when people talk about the opportunity for, especially, vehicles in chassis, if you said, "What is the total market opportunity in one year?" It's about 800,000 vehicles. Now that's a 2006 number, and we use that number because that is, for lack of a better term, a more normal year than 2009. But that gives you an idea from a North America perspective just how large of the opportunity is for specialty vehicles, especially chassis.

Amy Norflus – Pilot

How long can we – I mean, how long will something like that take to get into the potential revenue stream?

John Sztykiel

Well, as mentioned earlier, we're not going to be – all those opportunities over the next 9 to 12 months. But we will in two to three new strategic markets within the next 9 to 12 months. So then you'll start to see that within the revenue stream.

Amy Norflus – Pilot

And the strategic market, will it be just the chassis or will you be making a complete vehicle?

John Sztykiel

Probably both, some cases the chassis, some cases the complete vehicle.

Amy Norflus – Pilot

All right, great. All right. Thank you.

Jeff Lambert

I just want to additionally comment, this is Jeff Lambert, that there was a news report on this cement mixer Spartan's opportunities in cement mixers. We have not indicated that as one of the strategic markets. And I know there's some discretion in the investment team to develop that. But that's not a market that we have said is a – is an opportunity or the opportunity. It's one of many we're looking at.

Operator

And we have an additional question and comments from Brett Hendrickson from Nokomis Capital.

Brett Hendrickson – Nokomis Capital

Hey, guys. Thanks for taking my question. I think it may have just been answered because you said you're looking at doing both chassis and completed project – product for both – any of these potential markets, whether it be the waste management or the concrete mixers, right?

John Sztykiel

Well, don't focus on concrete mixers.

Brett Hendrickson – Nokomis Capital

Because that market kind of sucks, (inaudible).

John Sztykiel

I'm not going to use that term, but it's going to be a slow growth market.

Brett Hendrickson – Nokomis Capital

Yes.

John Sztykiel

As we look at where we're investing our time and our capital, we are looking at markets, which have a significantly greater or faster ramp up opportunity relative to not just the economic recovery, but also what we bring in has value. Okay. And for example, if we brought in something of really great value into a market that was just going to add zero to tiny, tiny growth, then that would not work well within our Spartan invested capital structure. Basically, we'd be working for negative compensation, for lack of a better term.

Brett Hendrickson – Nokomis Capital

Yes. I was hoping (inaudible) – so you're not going to add capacity to this already capacity constrained markets unless you have something that's truly new and different for people who are afraid about –

John Sztykiel

That is exactly – that is exactly – well what's interesting is – because we’ve got a couple of markets. You see, the reality is if you look at the defense business, you look at the RV business, the RV business will probably have slow growth for the next two or three years. It probably will. Now percentage wise, it could go up rather substantially. But still, if you look at the number of units as a whole and if we all believe that we're probably going to be an economy of relatively high end employment with low GDP for the next couple of years, I mean RV business growth ramp up will be – will be slow or fairly – you're not going to see a rocket ship or what some people use a V-shape going up. Defense business is more of like a boom or bust kind of scenario.

So we've got a couple of markets, one would what I would call slow growth, the other one who would boom or bust. So, for us as we look at other strategic opportunities, we're very, very focused on those, which would have much faster, higher incremental growth. And it gets back to where we're going to spend our time, where are we going to spend our capital.

Joe Nowicki

I think another issue that we've discussed, John, is also the diversification of that revenue stream across those so that it's not as dependent on the highly volatile ones. But instead by having a portfolio of end markets and products you're serving, you're going to level up and create a more stable demand over the long term.

John Sztykiel

Joe brings up a good point if you asked yourself, "What goods or services or what transportation activities basically have to happen regardless of the economy?" And honestly, I don't want to give away too much competitively of where we're going, that would be a pretty good visualization.

Brett Hendrickson – Nokomis Capital

Good. And John, sorry it's been so long. It's been a while since I talked to you. So I just have a couple of other questions on RV while I got, real quick. Did I hear you say the new product RVIA is going to be some kind of combo product? Can you just clarify, add into that?

John Sztykiel

Yes. Basically, it will be a – actually it will be a rather exciting product, which will have applications in the towable business, in the Class C business, and in the Class A business. So instead of potentially making us a partner for just the motorized OEMs, which would be less than 30, I mean what's interesting is there are over 100 RV OEMs today, if you combine Class Cs, Class As, and towable, this product could actually have application to that group of 100. It's a rather exciting concept.

Brett Hendrickson – Nokomis Capital

So without making you say too much, John, are you saying that you're getting into towable chassis or is it something wholly different from chassis?

John Sztykiel

The RVIA. You have to see Reid. You'd have to come. But it truly is innovative, and what's interesting is some of the (inaudible) we've shown it to, the manufacturer, both towables and motorized has said, "Wow! Now this is neat."

Brett Hendrickson – Nokomis Capital

And I remember from last time is that RVIA – and this is my last question, John, that Fleetwood was a big customer for you. I know they're going through their, I guess, a bankruptcy re-org or something. Are you still able to ship to them through this?

John Sztykiel

Yes, we are. Honestly, Fleetwood was a first class customer for us prior to their reorganization. We look forward to a great partnership in the future. They have been a first-class company to do business with.

Brett Hendrickson – Nokomis Capital

Okay. Thanks. Well I will – I look forward to meeting the new people, and maybe I'll see you all at the RVIA or something.

John Sztykiel

We hope so.

Brett Hendrickson – Nokomis Capital

Thanks.

John Sztykiel

Thanks, Brett.

Operator

Thank you. At this time, we have no further questions. And I would like to turn the call over to Mr. Lambert. Mr. Lambert?

Jeff Lambert

Go ahead, John.

John Sztykiel

Well, one, I just want to give thanks to everybody for spending your time here. As I mentioned earlier, the next couple of quarters are definitely going to be challenging. But as the same time too, it's really nothing new than what we've been going through for the last several quarters. However, as a company, we're focused on execution, both strategically and operationally. We're focused on right sizing the business. But we're also focused on entering two to three new strategic markets, and making sure that whatever we do, we utilize our time wisely, we utilize our capital wisely. So thanks for the support. We thank you for your time. And we look forward to spending some time with you in the future as well. Thank you.

Operator

That concludes today's teleconference. You may now disconnect your telephone lines.

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Source: Spartan Motors, Inc. Q2 2009 Earnings Call Transcript
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