Spartan Motors' CEO Discusses Q2 2013 Results - Earnings Call Transcript

Aug. 1.13 | About: Spartan Motors, (SPAR)

Spartan Motors Inc. (NASDAQ:SPAR)

Q2 2013 Earnings Call

August 1, 2013 10:00 AM ET

Executives

Greg Salchow – IR

John Sztykiel – CEO

Lori Wade – CFO and Treasurer

Tom Gorman – COO

Analysts

Joe Maxa – Dougherty & Company

Walter Liptak – Global Hunter

Robert Kosowsky – Sidoti & Company

Operator

Good morning and welcome to Spartan Motors’ Second Quarter Earnings Results Conference Call. All participants will be in listen-only mode. (Operator instructions) After today’s presentation, there will be an opportunity to ask questions. (Operator instructions) Please note, this event is being recorded.

I would now like to turn the conference to Greg Salchow. Please go ahead.

Greg Salchow

Thank you, Catherine [ph]. Good morning everybody and welcome to the Spartan Motors second quarter 2013 earnings call. This is Greg Salchow and I’m joined today by John Sztykiel, our President and CEO; Lori Wade, our interim Chief Financial Officer. And calling in today for the Q&A period is Tom Gorman, Chief Operating Officer.

As always, before we start today’s call and to make you aware that certain statements made during today’s conference call which may include management’s current outlook, viewpoint, predictions, and projections regarding Spartan Motors and its operations may be considered forward-looking statements under the securities laws.

I must caution you that as with any prediction or projection, there are a number of factors that could cause Spartan’s results to differ materially. All known risk, our management believes could materially affect the results are identified in our forms 10-K and 10-Q filed with the SEC. However, there may be other risk we face that we cannot anticipate.

Also, please keep in mind that during the question-and-answer period, we request that you submit only one question and one follow-up question for analyst that’ll allow everyone the opportunity to ask a question. And after asking your question, you’re welcome to rejoin the queue for additional questions.

And I’m pleased to turn the call over to John Sztykiel for his opening remarks.

John Sztykiel

All right. Thank you, Greg, and good morning everyone and thank you for joining us on Spartan Motors’ second quarter 2013 conference call. First, I want to thank Lori and Greg for their efforts to add more information and clarity to our earnings release; something many of you have requested and honestly it’s something that we plan to continue. Another good point is clarity drives accountability, and we are accountable to every shareholder out there.

We also have Tom Gorman with us today for the Q&A portion of the call similar to last time. Tom will be able to provide additional details on the operational initiatives we have underway throughout the company.

During today’s call, we will talk about our results compared not only to the second quarter of 2012 but on a sequential basis as well from the first quarter of 2013. We are doing this because we want to illustrate that our businesses continue to improve on the operation side and on the revenue side as well.

In the second quarter, each of our business segments showed significant operational improvement. We expect this trend to continue throughout the second half of the year and into 2014. In addition, order backlog, an indicator of demand for Spartan products grew substantially. We are making progress at all fronts and that is great to see.

This morning, the three main points I wanted to make, we did what we’ve said we would do, be profitable in the second quarter of 2013, deliver operational improvements in every one of our business segments compared to the first. Next, the strength of the order backlog for Spartan products. Number three, we expect to be profitable for the remaining quarters of this year and for 2013 as a whole with operational momentum going into 2014.

Now, let’s get in to a little bit more detail. Some of our other accomplishments in the second quarter include sales and order growth in the specialty vehicle and emergency response segments. As our markets recover and we gain market share, revenue growth in these segments propelled Spartan as a whole with the higher revenue for the quarter in growth and order backlog.

Let me just talk about the ER backlog for a second, in today’s Wall Street Journal, front page, section B marketplace, there’s an article on Rural/Metro, ambulance provider bankruptcy. Part of also what’s taking place is fire departments are taking over more and more of patient transport emergency response service. We recognize this trend several years ago. It started the development of more multi-function big, red fire trucks.

So when you look at our backlog growth – our revenue growth today, it was because we recognized a strategic operational shift in the marketplace several years ago and now we’re benefiting from that. Another company is struggling with it but we’re benefiting from it.

There’s another reason why we sold Road Rescue, because we knew that core ambulance manufacturing business model as it as today or as it was several years ago was going to be severely challenged as the future unfolded.

And this is important because leadership is not just about impacting today but creating a better tomorrow as well.

As a whole, the order backlog increased to $233 million at June 30th, 2013 from $162 million, December 31st, 2012. And it was at $173 million a year ago, June 30th, 2012. This growth represents an increase in backlog of 34.5% from a year ago.

We are doing a great job, executing the D in DRIVE, Diversified Growth. As I mentioned earlier, all of our operating segments have reported improved results compared to the first quarter of 2013.

We are focused, executing with discipline as one team and the results are evident. There’s more work to be done; there’s also challenges that lay ahead. As I used to determine internally and externally, nothing is a walk in the park anymore. But substantial improvement and progress was made and honestly that feels good.

Spartan met the goal. We shared with you last quarter from modest profitability, posting a profit of $0.02 per diluted share for the second quarter of 2013. This was a substantial improvement from our first quarter results and marks an important step towards sustained profitability.

While this process often takes longer than expected fixing a business, it is a task we have successfully completed recently. A perfect example is our RV Chassis business; let’s roll the clock back to 2012.

The RV Chassis business lost nearly $5 million in 2012. We launched an intensive effort to fix that business. Today, the business has turned into a strong performer, making a sizeable contribution to our overall revenue growth and profitability with significant room for upward potential.

In reality, the RV business is our largest business segment to go after. And we play in just a small market share today or market niche that will grow over time. The reason I bring up the past is I’m sure you should be asking, as I am often asked – has this organization ever fixed the business before? Can I trust them when it comes to fixing current issues? The answer is yes.

But it should not surprise anyone that we have made substantial progress in Q2; as we have done it before, most recently in the RV business.

Now, I’ll turn to some of the quarterly highlight segments of our business segment. Delivery and service business reported improved results compared to the first quarter of 2013 but still reported an operating loss. It’s a loss; the good news is we made substantial progress.

Do we expect them to be profitable in the second half of the year? The answer is yes. The two main reasons for the second quarter loss was a decline in revenue especially in the aftermarket parts in field service solutions sales and Bristol launch to ramp up expenses.

You will recall that in the second quarter of 2012, we were finishing a large field service program, Pelus [ph] for UPS that ended in the third quarter of last year. That was a huge driver of income and revenue. The absence of those two thus impacted our year-over-year comparisons.

Next to add in, a large one time related expenses to the startup/launch and now into the ramp-up phase of Bristol, we’ve had a significant financial effect in the first half of 2013.

When viewing DSV’s performance, it’s important to remember that the Bristol facility remains in ramp-up mode; and has been producing walk-in vans for less than six months.

Compared to our original timetable, we’re achieving certain ongoing labor efficiency and other operational improvement targets. We believe we’re about 90 to 120 days from ending our ramp up period. That will result in incurring more expenses during the third quarter than we projected and we will not anticipate to realize the cost savings on a fully annualized basis to the fourth quarter of 2013.

Do we expect Utilimaster to be profitable in Q2? Or Q3, I should say, the answer is yes. So again, we expect continued operational improvement from Q2 to Q3. Do we expect them to improve that profitability in Q4? The answer is yes.

And as we look forward to 2013, the second half, we see substantial improvement in Utilimaster and we see substantial operational improvement going into 2014 on an annual basis.

To be very specific to give you some color, Utilimaster or Bristol produced 93 walk-in vans in the first quarter of this year. In Q2, we produced 914 walk-in vans in this year. So that’s a huge, huge change from an operational production rate.

We’re also very focused in meeting our customer delivery commitments. Thus, we are spending more overtime than what we initially anticipated. So while we’re behind 90 to 120 days from completing the ramp up schedule, we are meeting our customer commitments.

And the reason I highlight that or accentuate that, our honorable competitors typically listen to the webcast or these calls and I simply do not want anybody going out there saying Spartan is indicating that they are late on their customer commitments. We are not at Utilimaster. We are also moving forward on a variety of other areas to continue the improved profitability.

Now let’s talk about Reach. During the second quarter, we made a lot of progress on Reach as well. Our team continues their work to take out the material cost and make Reach an easier, less expensive product to build.

The good news is we are ahead of plan in this area. Something also very exciting is we also begin the production of the Reach for 1,900 unit order for FedEx early in the third quarter. We will be starting a second shift later this month.

Now remember that term, second shift. It is great to hear the term, second shift. Why? Because it’s a more effective use of your facilities, drives a better return on assets, on invested capital, over time, will improve financial results.

Production of this order should continue into early 2014. As of last Thursday, we were actually two units ahead of plan, we expect to meet or exceed FedEx’s delivery requirement with a high-quality product.

The latest units entering production already incorporate the changes we have validated so far, from a cost reduction perspective. In addition to these positive developments, we’re also working on a pilot program for a version of the Reach for another large customer.

The Reach is an exciting, strategic transformational product for Spartan. We expect it to move over to the positive side of gross margin late Q3, somewhere in Q4.

Another Q2 positive that illustrates our operational capabilities is Frito Lay PepsiCo named Utilimaster its Supplier of the Year for 2012. Now, we did make a mistake there. We probably should have done a release on that a few months ago but we did not. But that is a very, very great day from one of the world’s largest Pepsi [ph] brands and they own a lot of vehicles, their fleet is huge.

Shortly after receiving this award, we delivered 254 truck bodies to Frito Lay that were built in Charlotte on the same line as the Reach product line. Our team was able to transition to building a different product with high quality, ahead of schedule demonstrating what we are able to do from a flexibility perspective.

The good news is we expect more business from Frito Lay PepsiCo in 2014. This also illustrates, and let me focus on this for a second, an operational shift within Spartan which will drive improved financial results.

Revenue facilities, we are increasing our line flexibility as we strive to build more products in fewer facilities, moving to more and more second shifts within each facility. As this happens, our financial results will improve.

During Q2, – now we’re going to switch gears to the Specialty Vehicles Group who was also a strong performer. Specialty vehicle revenues increased 42.9% year-over-year in the second quarter or by $9.9 million to $32.9 million. The revenue increase was driven by growth in Motorhome, RV shipments from a chassis in building ILAV units during the second quarter of 2013. Although we do not have a follow order for additional ILAVs, we do believe there is a future for this product as ILAVs are probably the most cost-effective mine-resistant ambush protected vehicle out there. So again, we’re committed to the defense business. Again, it’s going to be very, very small as time goes on. However, we do have a role within that segment.

All of the business units within specialty vehicles posted revenue growth, but I wanted to mention specifically the RV chassis unit, which represents our largest growth opportunity today. Through May, Class-A Motorhome sales were up 28.1% compared to the same period of 2012, rising consumer confidence, housing value support future sales growth of this industry.

Spartan is continuing to evolve its products and develop the right strategic plans to create new growth opportunities within the RV market. We plan to combine these growth initiatives with strong products, great marketing and improved operational execution that deliver solid financial results.

Now, we’re going to switch gears, last business segment, Emergency Response. They posted slight revenue growth in the second quarter compared to last year and sales of our custom chassis group offsetting lower fire truck revenue at our ERV units. Revenue in the second quarter of 2013 was $43.8 million, up slightly from $43.6 million a year ago.

You will also recall from the first quarter call of this year that we made a decision to reduce the production rate at the ERV unit for Q2 to concentrate on improving assembly process and quality and removing production bottlenecks and to improve our operational efficiency. The good news was we delivered on all of those fronts as the Emergency Response, the ERV unit shows significant improvement in operational results compared to the first quarter.

Adding to that positive contribution of higher sales of custom chassis resulted in a profitable segment for the second quarter as a whole. We looked at the ER segment to continue with the path of better financing performance for the rest of the year. When we look at delivery and service, while they reported significantly improved second quarter results from the first quarter of this year, it also faced a difficult comparison to the second quarter of last year.

As I mentioned earlier, there was keyless both from a sales and an income perspective, so revenue declined to $44.2 million from $47.8 million in the second quarter of ‘12 due to the drop of aftermarket parts, the keyless, et cetera. The decline in aftermarket sales overshadowed the increase in vehicle sales to $38.6 million from $25 million a year ago. Vehicle sales increased in Q2 2013 from the prior due to the sale of 140 Reach vans and a 60% increase in traditional walk-in van sales despite the Bristol start launch ramp up.

And honestly, that’s quite amazing. We’re increasing vehicle sales, which is our core product versus a year ago, okay, and we’re starting up a new facility, and then we’re going through the ramp up phase. I mean, when you think about that, that’s a rather astounding set of data points, which honestly it excites not just us but a variety of people for the future.

In addition to higher vehicle sales in the second quarter, DSVs order backlog continue to increase reaching over $100 million in June 30, 2013, versus $75 million a year ago. This represents an increase of 33.7% year-over-year and shows long-term growth potentials of the delivery and service business.

An interesting quick closing on why backlog growth extended [ph] delivery and service, we use the term internally and externally that Utilimaster is the medium or the middleman between bricks and clicks. And so as we look at Utilimaster delivery and service truck bodies, walk-in vans, Reach, et cetera, it has an unbelievable future ahead of us.

In summary, we saw operational improvement across the board and strong growth and backlog. We expect to see more in the second half of the year, marking further improvement in each quarter. It will be incremental, but it will be positive.

Now, I will turn the call over to Lori Wade to provide more details of Spartan’s second quarter 2013 financial results. Lori?

Lori Wade

Thank you, John. I want to thank everyone for joining us today and for all the support I’ve received during these last several months. I’ve met a lot of great people and I’m very excited for the future.

I’m proud to say that Spartan met the commitment we made to you last quarter and posted a profit of $0.02 per diluted share for second quarter. This compares to net income of $0.07 per diluted share in second quarter of 2012. We will discuss the most recent results in comparison to results for the second quarter of 2012 that we think it is also helpful to discuss sequential quarterly results that is from the first quarter of 2013 to the second.

First, looking at revenue, sales grew to $120.9 million from a $114.4 million in the second quarter of 2012. Revenue for SV and ER segments increased year-over-year while DSV declined due to a significant drop in aftermarket and field service revenue.

Vehicle and chassis sales increased on all three segments in the second quarter of 2013 compared to last year, indicating our markets are improving and we are driving customer demand. As you recall DSV’s first quarter performance was negatively impacted by the impact [inaudible] walk-in van production to Bristol and its associated startup cost.

During the first quarter of 2013, we were heavily involved in the Bristol relocation project and didn’t began walk-in van production until the middle of the first quarter. While we have work remaining to do on the Bristol project, DSV’s performance improved dramatically on sequential basis with this operating loss declined from nearly $4 million in the first quarter 2013 to an operating loss of $1.6 million in the second quarter, thoroughly we’re not where we want – where we need to be at, but results are showing a definite improvement from first quarter to second quarter. Based upon our current outlook for the rest of the year, we expect that trend to continue and for DSV to be possible during the second half of 2013.

Now turning to Emergency Response or ER, that segment posted much better performance on both the sequential and a year-over-year basis, an operating profit of $0.4 million in the second quarter of 2013 compared to a loss of $2.6 million in the first quarter 2013 and a loss of nearly $1 million in the second quarter of 2012.

Sales of custom fire truck chassis increased compared to both periods and more than offset a temporary reduction in the build rate of fire trucks at the Spartan ERV. We expect ERV’s performance to improve throughout the second half of the year, making a positive contribution to the ER segment’s overall profitability.

Now, I onto discuss Specialty vehicle segments. This segment performs well during the second quarter of 2013 with both segment revenue and operating income higher in the second quarter of – than in the second quarter of 2012. Revenue increased by $9.9 million from the second quarter of 2012 with $4.2 million of the increase coming from higher production and sales of RV chassis.

During the quarter, we produced 18 ILAVs, the Isuzu in gas [ph] production increased and aftermarket parts increased compared to the year-ago second quarter. Revenue growth at each business unit combined with the success of operation improvement initiative implemented over the past year that John talked about drove operating income to $3.9 million compared to income of $0.6 million in a year ago second quarter. RV chassis orders continue to increase as more buyers in the high-end diesel market demand of Spartan.

Moving on to computer-wide performance. Our performance for the second quarter; gross margin came in at 12.9% versus 16.4% in second quarter of 2012. The decline in gross margin was due primarily to expenses related to the Bristol launch including the cost of extra support personnel and inefficient production, plus the impact of lower aftermarket parts and field service as mentioned earlier.

On the positive side, the second quarter’s gross margin of 12.9% with a substantial improvement from the first quarter 6.6%. Operating expense of a total $14.6 million in the second quarter of 2013, down $0.3 million from the $14.9 million in the second quarter of 2012. The SV and DSV operating segments recorded lower operating expenses for Q2 of 2013 while ER incurred higher expenses due to higher marketing expenditures. But as a percentage of sales, operating expenses totaled 12% in the second quarter of 2013 versus 13% in the year-ago second quarter.

Spartan posted an operating income of $1.1 million in the second quarter of 2013, down from operating income of $3.9 million in the second quarter of last year. On a per share basis Spartan earned $0.02 versus a $0.07 in the second quarter of 2012.

Now, turning for a moment to the balance sheet. We ended the second quarter of 2013 with the cash balance of $15.6 million, down $1 million from March 31 of 2013. The cash balance was adversely impacted by $1.7 million in sales made on extended terms that otherwise would have been collected prior to June 30th; plus $3.5 million that was received on July 1st. Also during the second quarter, Spartan paid a cash dividend $0.05 per share totaling $1.7 million.

Cash receivable rose by $10.3 million from March 31st, 2013 to $50.6 million while inventories declined sequentially to 73.7 million from 77.7 million at March. We believe inventories can be reduced further but note that level fell from the first quarter of this year despite a sales increase of nearly [ph] $24.8 million in Q2, and with further sales increase expected in Q3.

Capital investments totaled $1.1 million for Q2 of 2013, in addition to the $1.4 million invested in first quarter. We forecast capital investments of $4 million to $6 million for 2013 as a whole. This is down considerably from the $12.5 million we invested during 2012; the vast majority of which was the Bristol project.

Now, looking to the second half of 2013, we continued to expect Spartan to be profitable in both the third and fourth quarters of this year, as all of our operating segments continue to improve. Over the second half of this year, we currently expect both quarters to be profitable and for profitability to increase on a sequential basis. By that I mean we expect the third quarter to reflect earnings growth from the second quarter and for the fourth quarter’s earnings to grow compared to the third quarter of this year. We continue to expect revenue growth in the mid-single digit for 2013, with all of our segments generating growth for the rest of the year.

We expect operating expenses as a percentage of sales to be within the 11.5% to 12% range for 2013, while our operating income of 0.5% to 1.5% for the year. Now that this range is for the entire year and includes the first quarter 2013, during which Spartan reported a loss of $0.13 per share. Our forecast for operating income as a percentage of sales for the second half of the year is higher than the projected range for the entire year.

So to summarize all that, we expect Spartan to be profitable for 2013 as a whole and for the third and fourth quarters to show sequential earnings growth over the second quarter of this year. Now, I turn over to John Sztykiel for his closing remarks.

John Sztykiel

All right, Lori. Thank you very much. And the reality is we hope we have shown you how Spartan’s performance is improving and that we have improved significantly since the first quarter of this year. And understand this, while all of us seem enthusiastic on the call and we’re excited about the progress and no way are we satisfied, but there are also significant challenges.

As I indicate to others, it seems like it’s a lot easier to sell today but it’s a lot more difficult to make money than what it was 5, 10, 15 years ago. But we’re committed, we’re focused. We’ve got a great strategy in thrive and we’re disciplined in executing to keep our commitments to be profitable as time moves on on a consistent and a growing basis. And you saw that.

As mentioned, we’ll get there by executing our drive strategy in a disciplined way. We have demonstrated revenue growth that exceeds the growth rate of our markets by executing the D in DRIVE; diversified growth. Reality, this should surprise no one, and it is a key foundation as to why Spartan is such a compelling story; whether we’re public or private. As the world changes, its needs in vehicles change; meeting those changing need with specialty vehicles is where Spartan comes in. As I sit and look at our window today, I see a number of Reach FedEx vehicles and what’s exciting and I’m soon – I and others are going to start to see those on the street delivering packages, and that product didn’t even exist three years ago. That just shows you how fast we can not only develop, react, but deliver life-changing market transforming products.

Our success in meeting those changing needs comes from really five areas. One, product innovations introduced over the past 12 to 36 months, innovation or the redefining technology innovation, that’s the R in DRIVE is a core foundation of our strategy; creative, dynamic, go-to market, sales and marketing efforts. Number three, we are benefiting from economic cycle/recovery in delivery and service, emergency response and specialty vehicle markets. Four, enhanced distribution, both in North America and abroad; and number five, growth in global infrastructure, in particular, emergency response.

Reality, emergency response is a basic need to be provided by governments, and we are benefiting in particular in South America, in China, and look forward to continued growth not just in the second half of this year but potentially in a very way in 2014. The end result, the outcome, order backlog of 2% from Q1 of 2013 and up 34.5% from the second quarter of a year ago. Meeting changing needs is why we brought the Reach to market.

Now, I just wanted to talk specifically about that, because it is a core issue which we’re fixing in a positive way is a key strategic product for us. The Reach is a high-end, high-performance commercial van that delivers great operational results to the fleet operator. According to a recent R.L. Polk study, in 2009, the commercial van market was 155,000 units. And it’s expected to grow to 301,000 units in 2013. In 2014, the commercial van market is expected to increase further to 365,000 units.

With the Reach, and it is a high-end, high-performance commercial van that delivers great operational performance, all we want our strategic plans are set around is just 2% to 3% of that market, just 2% to 3%. Now, when you start to do the math, that 2% to 3% is 7,000 to 11,000 a year, a micro niche within the commercial van marketplace. Achieving this goal will not be easy. It will take time, but as you look emergency response, when you look at specialty vehicles, RB chassis, M-reps [ph], et cetera, we have already demonstrated that we can carve out micro niches within the markets we focus in on.

I also have two great articles covering the operational why of the FedEx Reach order; that’s one article. And the other detailing the commercial van marketplace at which I pulled the data from just right a few moments ago. If any of you would like a copy of those articles, please contact Greg Salchow. You know what’s closing and great is that Reach, as I mentioned earlier is a key strategic product, I talked – we’re in a disciplined way going down a path to execute a plan to carve out a micro niche which is 2% to 3%, and you know what’s nice is FedEx is a great place to start with a significant order. This is all wrapped up with an integration operational improvement or I in DRIVE. And it’s what brings it altogether delivering the results which we expect.

Q2 was a positive step in the right direction as all segments improved. Are we satisfied? No. Are we pleased with the progress? Yes. Are we committed to the future in improving the results? Absolutely.

In closing, backlog was up. Operational improvement was up. We are disciplined working together as a team, executing DRIVE in keeping commitment relative to increasing shareholder value. Thank you.

Operator, we’re now ready for questions.

Question-and-Answer Session

Operator

We will now begin the question-and-answer session. (Operator instructions) Our first question is from Joe Maxa with Dougherty & Co.

Joe Maxa – Dougherty & Company

Good morning.

John Sztykiel

Good morning, Joe.

Joe Maxa – Dougherty & Company

Yeah, so, looking at the second half, it appears to have some increase in production on Reach and Utilimaster picking up the way it sounded. Also, improvements in the cost, so what are we looking at sequentially, Q3 to Q4? I’m just trying to get a sense on top line, obviously Q4 looks stronger; and then bottom line, if it’s a pretty significant bump sequentially on the op margin side.

Lori Wade

Again, as we talked about, we said that the Utilimaster we expected to be profitable on both the Q3 and Q4 with each quarter sequentially getting better. We do expect volume to continue at a nice steady pace. Obviously, Q2 was significantly increased over prior Q2 but we do expect a nice steady trend for the year.

Joe Maxa – Dougherty & Company

So, okay, so you don’t want to give the specifics on how they might be tracking at this point. Let me ask on the ERV in particular, a very strong backlog, how should we think of the timing of those sales?

John Sztykiel

Well, Joe – this is John Sztykiel, and then I’ll switch it over to Greg; but the timing of the backlog in the emergency response business is typically anywhere from six months to a year depending upon the complexity of the product. Therefore, when you get in to very, very complex pumpers or aerials, you’re typically 9 to 12 months out. Simple pumpers or fire trucks, patient transport, et cetera, you could be anywhere from 4 to 5 out to 9 months, so – but on average a good rule of thumb is 6 to 9 months.

Joe Maxa – Dougherty & Company

Yeah, we’ve been seeing consistent increase in backlog each quarter, so I was expecting at some point you would turn it that into revenue instead of continuing to grow that, so that’s what I was looking for.

Greg Salchow

Right, yeah, Joe, you will see that backlog translating into revenue and that is occurring. The order patterns have been pretty strong so far this year. So we’ve been receiving more orders. And so, while the revenues increase we’re also seeing backlog come up somewhat.

And going back to your first question, Joe, I think what you’re going to see the second half of the year is as we make improvements at Bristol, you will see production there increasing and you’ll see the profitability improving. A lot of that is going to be the same issue with ERV and we are making some good progress there. Again, as we’ve said, we think that probably it becomes profitable during the fourth quarter of this year, but results improved sequentially from second quarter to third quarter and then third to fourth quarter. So I think if you look at the cadence of earnings, look for sequential improvement each quarter; so third quarter looks better than second and fourth looks better than third.

John Sztykiel

Joe, and this is John Sztykiel. One of the things – you talked specifically about emergency response as well, and one of things as I noted when I was talking earlier in the call is we made a disciplined decision to reduce the line rate in the fire truck body group ERV in the second quarter of this year in order to drive efficiency improvement and improve some of the processes in the office and so we could have greater efficiency within the shop. We’re seeing that; which is one of the reasons why you saw the operational improvement in the body group, so that was nice.

But in Q3, you are correct, you’ll see above growth from an emergency response perspective in Q3 versus Q2 which will also drive operational improvement because we’re very focused on turning backlog into income and the reality is, while I didn’t state, the reality is our backlog – I should say our order cycle is probably a little bit too long right now, anywhere from maybe 30 to 45 days in our emergency product and we’re conscious of that, so we’re very, very focused on reducing that order-to-build cycle.

Joe Maxa – Dougherty & Company

Just one more for me, if I could. Can you just discuss – you talked about the macro being favorable, what have you been seeing or how have orders trends down since the end of the quarter and what does the pipeline look? I’m just trying to get a sense for where you might expect backlog to be at the end of third quarter. Thanks.

John Sztykiel

Oh, interesting from a macroeconomic perspective, the RV business is doing really quite well versus where it was last year and the year before and it’s not just benefit us but a number of other companies that are public in the RV market. And the interesting thing is part of it is pent-up demand but the other part is when I look at the RVs today whether it be toggle [ph] or motorized, they are of much greater value; they absolutely are of much greater value.

We’re also seeing the benefits of easier financing or financing flexibility. But the other thing which I think a lot of people underestimated is the market was so soft [ph] for two or three years in the RV business that people kept their Motorhomes or two boats [ph] for another three or four years. So now when they go in to do a trade-in they’re not as upside down as what they were three or four years ago.

So you have, in essence, pent-up demand with easier or more credible financing. When you look at the emergency response satellite, that activity is good not just for us but a variety of other companies. Those that have an innovative product, I think that they’ve been more multifunction oriented. So as the economy continues at a slow growth, the nice thing is an emergency response. The rate of calls continues to grow up, and people look at emergency response as just as a simple basic need, no different than they look at education road. So there’s good recovery there from that perspective. When we look at delivery and service, there’s growth in truck bodies, walk-in vans that’s really dependent upon the recovery per se.

The Reach is really what I would call a market transforming cannibalization kind of product where we’re going in to a large market and we’re literally carving out a unique micro niche where people say, “You know what, this is worth the extra money to buy this Reach product. The value we get out of it, it is absolutely dynamic.”

So, from a macro perspective, feel good what’s going on with North America; all three markets are boding well for us. I’d probably say RV is growing the fastest, delivery and service second, emergency response third. And the Reach is truly a market cannibalization transforming product.

Did I answer your question, Joe?

Operator

Our next question is from Walter Liptak with Global Hunter.

Walter Liptak – Global Hunter

Hi, thanks. Good morning guys, and good quarter.

Greg Salchow

Thanks, good morning, Walt.

John Sztykiel

Hey, Walt.

Walter Liptak – Global Hunter

Hi. Okay, I wanted to ask kind of along the lines of the last question. In the mix conversation that you were talking about with higher volume versus lower volume in the mix, when do we start to see that switch? And when you’re talking about lower volume, higher margin, I presume you’re talking about ERV.

John Sztykiel

Well, actually, and, Walt, this is John Sztykiel; the lower volume we went through in Q2 where we reduced the production rates in the emergency vehicle body group now we’re actually increasing production rates in Q3 and into Q4. So as we look to the second half of the year you’re going to see increased production in the specialty vehicle side which includes RV business, the Isuzu product lines. You’ll see increased production rates in the Reach product line. You’ll see increased production rates in emergency response, being chassis, in bodies. You’ll see increased production rates on walk-in vans. Then in Q4 you’ll start to see some reduction in the walk-in van side alike [ph] from a business perspective just because of the cyclicality where a lot of their fleets want their product typically by the end of September or October.

Walter Liptak – Global Hunter

Okay. All right. Got it. Yeah, so it sounds like a pretty good second half. I wonder if we could talk about the Bristol inefficiencies a little bit and if you could quantify how much cost you absorb either in material or time and how much comes out or has already come out that you’ll benefit from in the third quarter.

John Sztykiel

Well, and what I’d do – I’ll let Lori talk a little bit about the macro from a cost perspective and then, Tom Gorman, why don’t you talk a little bit about some of the operational improvements we’ve done or accomplished in the Bristol ramp/launch phase, okay, because we’re pass the significant cost portion. Now, everything is on decline thoughts [ph] relative to moving forward in the ramp up. Lori?

Lori Wade

Yeah, well, so, we roughly, I would say, have in the range of a couple of million dollars, rough numbers of inefficiencies, some material costs and things like that that happened in Q2 that we expect to be reduced in Q3 dramatically. We are, as John mentioned, we believe that we are going to meet our customer demands and to have for customer satisfaction, we’re going to have to spend a little bit of money in Q3 for over time to do that. But for the most part, we still expect it to be profitable, that DSE [ph] will be profitable in Q3 as compared to both Q1 and Q2.

Walter Liptak – Global Hunter

Okay, good. That’s good color. And the move – I’m sorry.

Greg Salchow

Walter.

Walter Liptak – Global Hunter

Oh, okay, I’m sorry, Tom. Go ahead.

Greg Salchow

No, this is Greg. I was just saying that this is probably a good time for Tom Gorman to talk about some of the initiatives we have underway at Bristol that might give you some more color on what’s going on and some of the progress we expect to make in the third and fourth quarter.

Walter Liptak – Global Hunter

Okay, good idea. That’s perfect.

John Sztykiel

Tom?

Greg Salchow

Tom, are you there?

Tom Gorman

Yeah, yeah. Thanks, Greg. Hi, Walt. Let me talk about a couple of areas. One is on the direct labor side, we’re continuing to drive up the daily rate that we have in the plant. As John mentioned, we had 90 some in the first quarter and 900 vehicles came out in Q2. Currently, we’re at above 20 [inaudible] to 25 to 35. Our real pacing that we want to hit is 35 vehicles a day and we’re manning to be able to ship that particular number.

On the direct labor side, we’ve had some pretty good control while Lori mentioned we’ll be looking at over time to meet customer commitments.

The area that’s receiving a lot of concentration for us here for like Q2 and Q3 has been in materials management inside the plant, as you know we went for a fairly large campus to a small area with all the material inside the plant and being able to deliver that in a timely fashion to the production lines has been one of the challenges that we’re meeting. And to that end, we’ve got a – not only a daily walk around but a daily measurement that we do how many time did somebody from the line have to call in to materials to be able to do that.

And we’ve gone from well north of 10 calls a day on the 45 different stations we got, Walt, down to fewer than five at this point. So we’re seeing some pretty rapid improvements. The third area I will do is that while we’ve got a fair amount of stability in the Charlotte campus, we’re continuing to take some of our better resources that we have in Charlotte and plugging into Bristol so that we can accelerate those improvements. And that’s both in manufacturing and engineering, materials management and purchasing and supply side.

Walter Liptak – Global Hunter

Okay, good. They sound like all pretty normal production ramp issues that you have to work through. I wonder if you can give a timeframe on when you think this operation will be, operating at sort of the level that you’d like to see in terms of capacity utilization and then efficiency.

Tom Gorman

I think we’re certainly going to see it when we’re getting into the third quarter. We’ve got a couple of risk that may take a little longer but nothing that I think is going to impact some fairly significantly improved performances. We brought in some more automotive experienced people on the consultant side that are giving us a hand in terms of understanding the type of serial production that those of us had been in automotive are used to in being able to drive that cultural change down there. But I think the strides we’re seeing into August and September are going to make the third quarter pretty strong, improving quarter for us.

Walter Liptak – Global Hunter

Okay, good. And if I can ask another one on, just generally on material cost, that would include the Utilimaster businesses. What we’re seeing from some companies as material prices are coming down and they’re able to maintain some pricing and getting the margin benefit from that, how would you characterize your material at this point?

Tom Gorman

Agreed, we’re coming down. We had some – the materials group, our supply chain group will hit their cost reduction targets this year that we set for them which were fairly aggressive at the beginning of the year and it’s not only been because of commodity shifts but some real cost reductions that are both real and sustainable. I think our next case that we’re really looking forward to, and John has been – has really led a lot of the strategy, and John Sztykiel led the strategy is that we do more common parts while maintaining the flexibility and picking down the number of final part numbers that we have so we can enjoy more.

And we’ve been part of a consortium down in Bristol in particular that has really yielded us some good opportunities on the supply side as we’re working with other companies in the area for some combined purchases that’s helped us in aluminum and wheels and some other areas.

Walter Liptak – Global Hunter

Okay, good. All right. Thanks very much. And if I could switch back to the ERV for a second, over the last couple of quarters and including this quarter that’s very pronounced is the lower backlog in fire truck chassis versus fire truck bodies. I wonder if you could just address, as you increase production rates, just what that means in terms of profitability on the third and fourth quarter. It may be why [inaudible] pronounced.

John Sztykiel

Walt, this is John Sztykiel. Actually, that’s a positive. What’s interesting is in the fire truck chassis side alike our backlog – I should say our order to production is probably 3 to 5 months versus 6 to 9 months when I mentioned on the complete [ph] vehicle. So while the backlog is down or flat, what we’ve done is actually we reduced our cycle time in that area. So, the interesting thing is we’re doing extremely well on the ERC side alike from a chassis backlog perspective and on order intake perspective. I’m not saying everything is easy from that perspective, okay. We’ve seen a mix shift to slightly lower priced products on the emergency response chassis side alike. But what’s nice is in Q2, we saw gross margin improvement on the fire truck chassis side alike which was a key contributor to the profitable view or I should say the overall profitability of the emergency response group. So we’re very, very focused on reducing the cycle time or throughput of our vehicles but on a chassis backlog side alike, right now, really don’t have any concerns that I was very, very pleased with their gross margin improvement.

Walter Liptak – Global Hunter

Okay. All right, good. And why is it that the cycle times are so stretched in the fire truck body side?

John Sztykiel

One, we underestimated the growth, okay. We simply underestimated the growth from a backlog perspective. And in this business, because everything is specialty vehicle more so than what it is in delivery and service or even RVs or even the ILVs or Isuzu. We underestimated the growth. It takes a while to get the sale, the engineering the purchasing, all of that to be done effectively and efficiently.

And to be quite blunt, we thought we could accelerate the front end of the business being those three disciplines I mentioned earlier much faster than what we were able to. So in late Q1, early Q2 we made a decision to reduce the line rate because while in Q1 we were producing product on the body side, the emergency vehicle side, we were not doing it efficiently with high quality. So that’s why you saw the slowdown from a rate perspective in Q2 versus Q3. Now, we’re actually increasing the rate of production again. We’ve done some very, very good work on the front-end side and sales and engineering and purchasing and we expect to increase production in Q3 and Q4.

The interesting thing is we know we can grow our business in very, very good margins by reducing our cycle time from when we get an order to deliver the product and you saw that in the chassis side.

Walter Liptak – Global Hunter

Okay, but that doesn’t mean that as you ship the product and increase production in the third and fourth quarter that there are some margin impact from this longer cycle time, does it? Or you can still get the margin out of it, right?

Lori Wade

No, no. No, we’ll still get the expected type of margins on those products.

Walter Liptak – Global Hunter

Okay, good. Okay. Thank you very much.

Operator

Our next question comes from Robert Kosowsky with Sidoti.

Robert Kosowsky – Sidoti & Company

Hello, good morning guys and Lori, how are you doing?

Lori Wade

Good morning.

John Sztykiel

Good morning, Robert.

Greg Salchow

Hi.

Robert Kosowsky – Sidoti & Company

Yeah, just to build on the ERV side of the business, so the improvement that we saw in segment earnings, was that largely on the fire truck chassis side gross margin increasing and have you seen gross profit increasing on the fire truck body and what are the new orders, like your front [ph] backlog look like from a margin standpoint?

Lori Wade

I’ll pick that one, Rob. Actually, the improvement from first quarter to second quarter, I will say it’s pretty close to being 50-50 between the chassis and the body side. Both sides did a nice improvement. Sales were up for both segments and so we had some fix absorption. We had some nice margin on the ERC side that John told you about. And the margins for the ERV side are definitely trending upward and very positive for Q2. So I’d say it’s probably about a 50-50 split between the two for that growth.

Robert Kosowsky – Sidoti & Company

Okay, how does the new orders look from a margin standpoint? I’m sorry to interrupt.

Lori Wade

They look very positive. Obviously, we talked about last quarter that we had a few that were priced at a lower level but we’re being able to offset some of that with efficiencies in on the shop floor. So we do believe, we feel the backlog is still very profitable backlog and that it will only continue as more of the units flow through with the higher selling price.

Greg Salchow

Right, and we mentioned that we took some pricing actions earlier in the year and the closer we get to year-end, the more we start to see that. We started to see some of the – some very small positive impact from that in the quarter. But as we go through the year, we expect to see more favorable impact. And –

John Sztykiel

Rob, this is John Sztykiel. One of the things – I just want to jump in quickly, okay? Dennis Schneider, who runs our emergency growth, okay, came from Bobcat, where he was a Chief Operating Officer. And he came on board in January, I think, it was of last year. The gentleman comes on board. We eliminate a brand, Crimson Fire, we combine everything into Spartan under one brand. And so you’ve seen a lot of growth because of that.

The reality is from one individual for probably our org structure was too much, okay, for Dennis, so we’ve added some very, very key people in there. And what’s nice which makes me feel good with some of those key people but also Dennis’s operational excellence, we did a great job on growing the sales. We were a little bit behind on improving the operational process and the gross margin, now, wonderfully [ph] starting to get some acceleration there.

In hindsight, when Dennis came in, we probably should have had one or two other key operational people underneath him because we knew a lot of this time was going to be very focused on the combination of the brand, eliminating Crimson Fire, and working through all of that and the consumer and the dealer part of the marketplace.

Robert Kosowsky – Sidoti & Company

Okay, that’s helpful. And then otherwise on the Specialty Vehicle side, some other question kind of just bridge the sequential increase and operating profit, how much was due to just, I guess, the ILAV sell that you had but it looks like Motorhome chassis were pretty steady and how sustainable is this higher margin profile?

Greg Salchow

Lori?

Lori Wade

Yes, I’ll take that one. So I would say that of the growth in the whole SV from first quarter to second quarter, I’d say probably around, I’ll say, between a quarter and a third of that came from the growth and the defense business. But we also grew as we talked about the Isuzu and the N-Gas business that grew dramatically. The EPA continues to be strong. We still have some nice dispense part sales there that grew nicely.

And in the SV business, again, remember in Q1, we took the $1 million reserve on the recall for the Motorhome process. So obviously, that was an indicator, so that shows some of that significant improvement as well.

Robert Kosowsky – Sidoti & Company

Okay. So there’s nothing majorly, I guess, want be in a positive way in this quarter and if you get similar revenue, you should have [inaudible].

John Sztykiel

Rob, you’re right. But also Tom Gorman, I’d like for you to just jump in quickly and give Rob and the group some quick color is that some of the operational improvements we’ve made like on the Specialty Vehicles side of our business.

Tom Gorman

Sure, John. We’re continuing to drive the labor out of the product and taken away a lot of waste elimination. And this thing at this point is – has really had that big turnaround that John talked about earlier where we’re hitting some – there at the highest inventory turns that we have in the company, as well as some of the best quality metrics, which is allowing us to really take out any of the waste in there and hitting our customers on time.

So there’s real innovative products that we’re bringing in pretty quickly that are enhancing our brand image out there. And really look some into the customers with some new technologies that we’re looking to plug in there as well. So it’s been on the material side, it’s been on the indirect labor side, certainly good on the direct labor side and continue to roll into the third quarter on Specialty Vehicle side.

John Sztykiel

And Rob, this is John Sztykiel. For all of you, if you look at the very last page of the release, which gets into the backlog, you look at the delivery cycle time, the Motorhome chassis, two months. Yes, this is for available [ph] material that’s anywhere from $60,000 to $120,000 less than 60 days, I mean, that is unbelievable.

So you’re part of [inaudible] the group is doing as we’re improving the operational performance, we’re reducing the cycle of times which is enabling us to gain a little bit more market share and a better margin.

Robert Kosowsky – Sidoti & Company

All right, thank you very much and good luck.

Greg Salchow

Thanks, Rob.

Operator

(Operator instructions) This concludes our question-and-answer session. I would like to turn the conference back over to John Sztykiel for any closing remarks.

John Sztykiel

All right, I want to say thank you very, very much for being here today. In closing, I’m often asked the question recently. How does one deliver or execute drive the strategy? And to give you an idea how we have evolved over the last 12 to 18 months, well, we have a very defined operational strategic plan which actually we’ve got the most important objectives now in just one sheet of paper each side, and we manage a number of metrics on a daily basis.

What’s interesting as I sit here today, each week we get a sheet, we get an update on 48 metrics key performance indicators within our business, 16 of them are SMI [ph] and they’re broken down between delivery and service, the Reach, Emergency Response Vehicle, Emergency Response chassis and Specialty Vehicle, and how we deliver. And execute drive the strategy is we manage the state of the business in a timely manner against our objective on a key performance indicators, we worked as one team in a discipline way, committed to delivering growth in shareholder value.

We’re satisfied, I should say, we’re not satisfied, we’re pleased with the improvement, we have challenges and we’re committed to delivering and improve Q3 on top of that and improve Q4 in delivering a profitable 2013. Thank you very much.

Operator

The conference is now concluded. Thank you for attending today’s presentation. You may now disconnect.

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