Spartan Motors' CEO Discusses Q3 2013 Results - Earnings Call Transcript

Oct.29.13 | About: Spartan Motors, (SPAR)

Spartan Motors, Inc. (NASDAQ:SPAR)

Q3 2013 Earnings Call

October 29, 2013 10:00 AM ET

Executives

Greg Salchow – Director, IR and Treasury

John Sztykiel – CEO

Lori Wade – CFO and Treasurer

Tom Gorman – COO

Analysts

Joe Maxa – Dougherty & Company LLC

Robert Kosowsky – Sidoti & Company

Shivangi Tipnis – Global Hunters Securities

Joe Maxa – Dougherty & Company

Robert Kosowsky – Sidoti

Operator

Good morning and welcome to Spartan Motor’s third quarter 2013 conference call. All participants will be in 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 Greg Salchow, Director of Investor Relations and Treasury for Spartan Motors. Mr. Salchow, you may proceed.

Greg Salchow

Thank you. Good morning everyone and welcome to the Spartan Motor’s third quarter 2013 earnings call. I’m Greg Salchow. I’m joined this morning by John Sztykiel our President and CEO. Lori Wade, Interim Chief Financial Officer and Tom Gorman, Chief Operating Officer.

For this morning’s call, we’ll change from – we’ll change the call format from past practice to devote some more time to the question-and-answer portion. We’ll shorten our prepared remarks compared to the previous quarters so that we can address more of your questions.

Before we start today’s call, please be aware that certain statements made during the 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 defer materially. All known risks our management believes could materially affect the results are identified in our Form’s 10-K and 10-Q filed with the SEC. However, there may be other risks that we face that we cannot anticipate.

And as always, please remember that during the Q&A period, just ask one question and a follow up and then after that please rejoin the queue so that everyone has an opportunity to ask a question.

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

John Sztykiel

All right, thank you Greg. Good morning everyone and thank you for joining us on Spartan Motor’s third quarter 2013 conference call. We also have Tom Gorman, our Chief Operating Officer with us today as well for the Q&A portion of the call. Tom will be able to provide additional details on the operational initiatives we have underway throughout the organization.

As we start, we continue to make progress in operating performance by executing our DRIVE strategy. As we stated during our second quarter conference call, we expected to make further improvement in operating performance in the third quarter and we delivered. We continued to execute DRIVE and expect to show additional progress in the fourth quarter of 2013 and into 2014 as well.

There is one negative though. For full year 2013, we expect to show a modest loss. Simply, the hole we dug in Q1 of this year appears to be too great to overcome. Again, we expect to be – Q4 to be profitable improvement over Q3 and Lori Wade will get into the details of both Q3 and an outlook for Q4.

Today is really about two things. Operational improvement results in Q3, up versus Q2 of 2013 and up substantially versus a year ago. The second item today is about – it is about the future. Continued operational improvement with a strong backlog of 37.8% versus a year ago. And we’re at our highest point since December of 2009. Include the recent Peru Award in today we are at our highest backlog point in the last four years.

The I, integrated operational improvement and the D, diversified growth are both delivering results, simply DRIVE is working. Today is about operational improvement in the future, operational improvement and strong backlog giving us an opportunity for growth.

Now, I’ll turn to some of the quarterly highlights of our business segments. The Delivery and Service Segment or DSV reported an operating profit of 1.3 million during the third quarter as performance improves substantially from Q2 in the first half of the year, and this was great to see.

To give a little bit more color, Walk-In Van production has increased each quarter since the start of production in February of this year. Production in Q3 average 21 units per day versus 14 units per day in the second quarter, a 50% increase. While we are not at plan yet, we have made great progress and expect further progress in the coming quarters.

Production of the Reach with switch product lines wrapped up early in the third quarter followed by the addition of a second shift in August. During the third quarter DSV produced 402 Reaches as part of the 1,900 unit order for FedEx. We expect to complete this order during the first half of 2014.

During the last quarter’s call I also mentioned Utilimaster was Frito Lay’s 212 supplier of the year. And that we have just completed an order for 254 truck bodies that were built on the Reach production line. This marked another operational step forward for Spartan Motors, Inc. as we increase our flexible manufacturing capability.

As we look over the next two to three years, I would expect very little CapEx brick and mortar facility increases from us, from a dollar perspective. We are very focused on flexibility, double shifting our operations to maximize the operating return. We also recently received a follow on order from Frito Lay for several hundred more truck body units to be built in the first half of 2014.

Now it’s not surprising when you execute, you do it quickly with high quality product, excellent always attracts, and it was great to see Frito acknowledge that with a substantial order as we look into 2014.

Another side note as you saw in the release this past quarter as we built our first mobile kitchen truck for a national restaurant change with promising test results. We believe this concept, as well as other mobile retail vehicles are a very attractive new growth segment with very strong potential. The reality as more and more brick and mortar establishments are looking to wheels as a business expansion opportunity to become more customer-centric with a very low CapEx cost.

In addition, as we mentioned in our press release. During the third quarter, the delivery and service industry began to experience a slowdown in new truck body orders compounded by a lack of availability of certain chassis. This had a fairly small impact on the third quarter but is expected to have a more significant impact on the fourth quarter.

At present, we believe this is seasonal, stopping for the next quarter or two rather than a long term drop in demand. We say that because over the last couple weeks, two of our largest customers discussed their growth in both ground and ecommerce delivery. So long term small vehicle, small packages, small product, small services, we look at Utilimaster delivery and service as a tremendous growth opportunity.

Now I’d spend a few moments on Reach, a very key strategic product for us. Today, we have absolute clarity about five items. First, Reach is a very exciting product in its current state, on a diesel chassis as demonstrated by the 1,900 unit order from FedEx. The current version of the Reach appeals to a segment of the overall market for commercial vehicles, a segment that we think totals 2,000 units to 3,000 units per year for the Reach.

Why diesel? Diesel on average is 20% to 30% more efficient than a gasoline engine. And as FedEx noted in their release earlier this week, fuel costs were their number one issue relative to margin erosion on their ground vehicles. So diesel chassis have a significant impact today and a significant impact in opportunity for tomorrow. Why? Because they’re simply fuel efficient.

The second item, we made considerable progress to reduce material and manufacturing costs of the Reach. But to achieve our profitability targets, we need to make further cost reductions. To-date, most of the cost reductions on the material side have been through negotiation of the building materials. As we look to the future, it will be more around reengineering and reducing the cost of the body structure.

The third item relative to Reach is the commercial van market is growing rapidly but it’s also changing. Much of this market expansion stems from newer, smaller and more efficient commercial vans entering the market place over the next couple of years. These new entrants along with growth in the market are changing the competitive landscape.

Pitching one respect is not surprising. If there’s growth, then other people want to jump into it. This also creates an opportunity for us to add new variance of the Reach and to offer some of those variance at lower price points that compete more directly with some of these newer commercial vehicles.

We plan to increase the number of Reach body offerings to increase its flexibility and appeal to more segments of the market place. This is something we are actively working on today. Likewise, we are working on increasing its payload capacity by another 500 pounds. A project we are actively working on today.

We’re also currently analyzing the feasibility of offering more Powertrain options. These could include a gasoline engine, compressed natural gas or CNG and gasoline/electric hybrid solutions as well.

We’re at the beginning stages of this analysis, Reach product reset process and it’s something we will be very focused on over six to nine months, but as we look at the Reach, it’s a market of great opportunity.

To give you some data points. According to R.L. Polk, the commercial van market was approximately 155,000 units in 2009. It is expected to grow to 365,000 units in 2016, more than double. This expansion and proliferation of the market challenges – offer us the opportunity to provide variance of the Reach that competed more segments that offer a much larger potential. We intend to remain a niche player. We’re only targeting 2% to 3% of the market. But when you do the math, that small share, 2% to 3% amounts to 7,000 to 10,000 units per year.

In summary, relative with the Reach, the overall expectations of the Reach’s potential market size remain in the 7,000 to 10,000 per unit year range. But the way we get there is different than it was a year ago.

All markets involved in the commercial van market is simply no different. They’ll present us with challenges, absolutely. But these challenges also present us with some very exciting growth opportunities.

All right, now let’s shift gears over to Emergency Response. The Emergency Response Chassis business or ERC continued to make a strong contribution to the segment profitability, while the Emergency Response Vehicle group or ERV, made continued progresses as well in improving its operating performance. Reports from the field indicate that pressure on fire departments is growing to replace aging fire trucks and apparatus which is certainly good news for us in the industry.

Again, to provide some color, a perfect example is the Southern Michigan dealer for Spartan ERV, sold less than 5 units each year in 2011 and 2012. Already in 2013, this exact same dealer has booked 16 units. Obviously, the industry is rebounding, but we’re also gaining share.

When we talk about new products, lower cost aerials, other things we’re optimistic about next year as well. We’re also seeing a higher take rate on our APS, Full Cab Airbag Protection Safety System, tapping 70% in the third quarter of 2013 compared to a historical rate of 65%.

Little bit more color, APS, Airbag Safety System, is a redefining technology in innovation relative to emergency response. It drives growth in sales through competitive market, cannibalization, we’re taking market share from other people and next it drives enhancement in the gross margin. This is the R part of DRIVE, redefining technology in innovation working to perfection.

Our outlook for ERV remains positive showing incremental improvement in each quarter of this year. And we look forward to Q4 in 2014 as well. We’ve added engineering and operation management talent in recent months which is all paying off. We have a lot more work to do in these areas and we’re moving in the right direction. Probably the biggest challenge we have at ERV is we’re working to improve the operational efficiencies as we continue to grow the business in a very, very dramatic way.

And another side note. As we look at the Peru [ph] order which was noted in the release, 56 trucks diversified global growth, the D, in Drive leveraging the capabilities, our relationships of Guaymex [ph] to the benefit of a $17 million very profitable order. This bodes extremely well for Spartan ER and Spartan ERV for 2014.

All right, moving over to specialty vehicles, reported another outstanding quarter with both revenue in operating income increasing from the third quarter of 2012. Motorhome chassis sale grows more than 23% and we continued to gain market share.

Our focus is to be the most desired brand in the RV industry, that there is simply nothing better than the Spartan. And that is what we are focused on. The good news is we’re gaining some traction. The RV industry also continues to recover due to growth in disposable income, increased housing starts pinned up demand and easier financing.

So as we look at the RV business, we’re very, very excited, not just about today, but as we look at 2014 and beyond. The reality is the RV industry is our largest growth industry, and we’re very focused on that.

Aftermarket parts and accessories, our APA business performed well during the third quarter, but fell a bit short of year-ago levels due in the slowing of defense-related parts.

This was nearly offset by growth in revenue from motorhome and fire truck part sales due to RV owners traveling extensively in the quarter in our efforts to expand sales in the emergency response arena.

During the third quarter, we also have combined Utilimaster’s aftermarket parts operations with the specialty vehicles parts operations in Charlotte, Michigan. The move went smoothly with no disruption to either group’s operations. We expect this to generate modest cost-savings for both segments in the short-term.

Over the longer-term, we expect improved revenue growth as the Charlotte-based APA group has exceeded their financial plan for 13 months in a row. That is great. A reduced cost structure, enhanced leadership, which means larger long-term opportunity, another example of DRIVE in action.

In summary, great news, each business posted higher incremental profit compared to the second quarter of ‘13 and versus a year ago in 2012, as we successfully executed our DRIVE strategy, particularly the I in DRIVE. As well, the future, backlog up 38.7%, highest since the end of 2009. DRIVE works and we will continue to implement it as we close out 2013 and moving to 2014.

Also, as always, we face challenges. I mentioned a few of them already. And as we execute our plans and run our business, we are more than meeting the challenges. We are moving forward. And our results illustrate this.

Now, I’ll turn it over to Lori Wade, our Chief Financial Officer for her comments on the third quarter. Lori?

Lori Wade

Thank you, John, and good morning to everyone listening this morning. During last quarter’s call, we shared our expectations that the third quarter of 2013 would be more profitable than the second quarter.

That proved to be the case as Spartan posted operating income of $1.8 million versus $1.1 million. Operating income of $1.8 million also compares favorably to the loss of $0.3 million in the third quarter 2012, even if you include last year’s restructuring charge of $1.6 million.

Pre-tax income tolled [ph] to $1.9 million in the third quarter. After tax expense of $1.3 million, Spartan reported net income of $0.6 million or $0.02 per diluted share. This compares to a loss of $0.3 million or $0.01 per diluted share in the third quarter of 2012.

Income tax expense of $1.3 million was taken to adjust the income tax provision for 2013 to date in anticipation of a full-year rate of approximately 20%. Another way to look at it is that tax credit rebooked on operating losses in previous periods such as the first quarter of 2013 are based upon projections of a 37% income tax rate for the year.

Based upon our financial performance for the first nine months of this year and our outlook for the fourth quarter, we determined that a 20% tax rate is likely. This causes to reduce the amount of tax credits from prior periods and resulted in income tax expenses well-above statutory rates in the third quarter of 2013. We expect the tax rate for the fourth quarter of 2013 to be at or below 20%.

Our cash balance has increased during the quarter, ended at nearly $20 million as of September 30th, up from $15.6 million at June 30, 2013. The increase was due to improved operating performance and profitability plus less capital spending during the quarter.

Inventory has increased to $82.4 million at June 30th compared to $73.7 million at June 30, 2013. Most of the change was due to higher inventories at Utilimaster and then the motorhome chassis unit. Much of the increase in Utilimaster’s inventory was due to the ramping up of production of the Reach during the third quarter and extending into 2014.

Inventory growth in our motorhome chassis unit was due to higher production and sales expected in the fourth quarter of 2013. Even with the ramp up discussed, we feel our inventories are too high for our business level and actions are being taken to right size inventory levels at all locations.

Moving on to accounts receivable, grew to $52.3 million at the end of the third quarter compared to $50.6 million at June 30, 2013 driven by higher sales during the third quarter, accounts receivables to 35 days in sales meet our target for the quarter. Higher [ph] receivables were more than upset by the growth in accounts payable to $32.9 million as of September 30, 2013 versus the $24.2 million at June 30, 2013.

Growth in payables closely track higher inventories which were pulled up late in the third quarter to support fourth quarter production. Growth in cash, a healthy balance sheet and improving profitability provided our board of directors with the confidence to declare a semi-annual dividend of $0.05 per share. The dividend will be paid December 19th to shareholders at record as of close of business on November 14, 2013.

Now moving on, as we stated in our press release, we expect the fourth quarter of 2013 to be profitable with operating income comparable to the third quarter of 2013. Our DSV business has experienced some slowing of orders for truck bodies as has the rest of the industry.

We believe this is a short-term issue reflecting a more pronounced seasonal demand trough rather than a longer-term drop in demand. The DSV segment has also experienced some delays in receiving orders for its field service solution from certain customers.

These delays along with sluggish truck body demand and some chassis availability issues are projected to reduce our fourth quarter profitability from our prior expectation. So we expect the fourth quarter of 2013 to be profitable, and anticipate a modest operating loss for the year as a whole as John mentioned.

This is due to the operating loss experienced during the first quarter 2013 due the move and launch of the walk-in van production at the Bristol, Indiana facility.

We expect to share our expectations for 2014 no later than our fourth quarter 2013 protocol. Although we are not providing specific details regarding 2014 today, we know that we expect to wrap up 2013 on a profitable trend and expect improved financial on operating performance in 2014.

I want to thank you all for your interest. And we’ll turn the call over to John Sztykiel for his closing remarks.

John Sztykiel

All right, Lori. Thanks so much, and I’ll keep it short. In summary the third quarter of 2013 was about executing our DRIVE strategy, Integrated Operational Improvement, the I in DRIVE, is all three of our business segments were profitable during the quarter with a positive outlook for further improvement in Q4 of this year.

Next, it’s about the future. The future is simply the result of the order backlog and turning that order backlog into operating income. Order backlog is strong, increasing in two of our three segments. And the numbers today do not include the Peru order.

And finally, we’re encouraged by our prospect and outlook as we look at the future as shown by the declaration of the $0.05 per share dividend. We’ve had a dividend for 20 years in a row.

We always recognize that there are challenges ahead of us, and some very, very significant, thus, this always tampers our optimism, okay. But the reality is every business has challenges. We’ve shown our ability to overcome those challenges, to execute DRIVE, deliver results and move in the right direction.

We look forward ending 2013 at a positive note and carrying that momentum into 2014. And we’ve got some good wind at our back with a great backlog. Thank you very much. Operator, we’re now ready to take questions.

Question-and-Answer Session

Operator

We will now begin the question-and-answer session. (Operator instructions). At this time, we will pause momentarily to assemble our roster. The first question comes from Joe Maxa from Dougherty & Company.

Joe Maxa – Dougherty & Company LLC

The question – first of all, I want to ask about the outlook for the rest of the year. Previously we’re talking mid-single digits growth. Are we looking to see growth given what you indicated on 4Q? And also did 3Q come in per expectations? Just kind of curious what you’re internal goals were there.

Lori Wade

Hey, Joe. This is Lori. I’ll take the third quarter. I will tell you that we did see some softening in the truck body that we had not anticipated. I will say that our projections, they were down about 14% versus what we had expected and we believe in the fourth quarter to be about 48% reduction versus what we had expected.

Our ERV segment was down slightly just in the ability to get product out the door. The rest of our segments were pretty much right on task. We do believe that as mentioned that the motorhome, the RV business will be up in the fourth quarter versus third quarter. But we are still going to the field service side. We still project that to be pretty – very soft compared to what we had anticipated early on in the year.

Joe Maxa – Dougherty & Company LLC

I see. I see. Excuse me. So let me address gross margins. Gross margin is down a little bit sequentially I realize that year-over-year. You know, where do you think they can get to when you have, you know, when you run out of cylinders, right? And it’s working, right? I mean there was talk of 17% a while back, you know, maybe 15% is a better number. What should we be looking at for gross margin moving forward?

Lori Wade

I would tell you that we have looked at that and the 17% we believe that in several years we’ll have moments of being 17%. I don’t believe that. Right now we believe that that is a sustainable full year projection for our gross margin target.

We’re thinking more in the range of this 15% to 16% range. It’s probably more of the segment, the mark that we could get with our basic business as of today.

John Sztykiel

You know, Joe, and this is John speaking. One of the things we brought down a little bit is simply as we look at each one of our markets and you’d see it in the Reach and you’d see it in the emergency response, you’d see it even in the Motorhome business. While there is very, very good growth, there’s also an increased awareness or competitive pressure relative to price. Okay. And so the reality is we’ve got very good growth in our segments in our markets, but we’ve then revised our outlook as we look over the next two or three years. And the reality is things are going to be a little bit more price competitive in some of the lower or more entry level markets where I can’t say we’ve got great products and we’ve got the right operational plan to execute from our perspectives.

So the reality is we’re probably just going to discount a little bit of our higher margin products to continue the growth. So the reality is we’ve adjusted things down a little bit.

Joe Maxa – Dougherty & Company LLC

Okay. Lastly for me if I may. When do you expect that order for, you know, for Peru to ship?

John Sztykiel

Oh, this is John Sztykiel, Joe. That will ship within the next 12 months. Okay. So I mean it will ship within the next 12 months as of the end of October.

Joe Maxa – Dougherty & Company LLC

So it’s going to be staggered through the year? It’s not like one quarter type shipment?

John Sztykiel

No, no, no. It will be throughout the first three quarters of next year. It’s a very large order. It’s on a Spartan chassis and the ERV body, very nice trucks. However, it’s not like we’re going to run 52 in a row because we’ve got a variety of other customers we’ve got to serve in the emergency response marketplace.

Joe Maxa – Dougherty & Company LLC

Understood. Thank you.

Operator

Next question comes from Robert Kosowsky from Sidoti.

Robert Kosowsky – Sidoti & Company

Hello. Good morning. How are you doing?

Greg Salchow

Good morning, Rob. How are you?

Robert Kosowsky – Sidoti & Company

I’m doing all right. I was just wondering if you can maybe talk a little bit more about the progress you’re making on the DSV side with the material handling and kind of what you’ve seen there? Kind of how the margins could also be turning on the Reach side as well, again the gross margin positive.

Tom Gorman

Yeah, Rob. This is Tom Gorman. Q3 was a real step forward on the material handling side for what we did. We did redo the racking that we had down there as well, lowered the group and the headcount by almost 25% and improved the time to line if you will on a daily basis that reduced our cost in for fast material by about 80% over that particular period of time.

So we’re really hitting pretty well. We’ve got a couple of sales that have given us some burps and headaches but the material issue by in large has handled itself pretty decently. One section that we’re working on pretty hard but it’s gotten in the way from some of the stop that we had experienced in Q2 certainly.

Robert Kosowsky – Sidoti & Company

Okay. And was that because of lower builder rates on the, maybe the [indiscernible] side or just the –

Tom Gorman

Actually, just the opposite. The build rates on a daily basis have gone up. On both lines we’re at about 18 a day in the high volume line and 12, 13 a day on the low volume line and pushing that through pretty decently. So we had pretty decent build rates over – well, they’re approximately as it was for Q2 but in some days higher as we continue to ramp up that mix modeling.

Robert Kosowsky – Sidoti & Company

Okay. So does that play on the trajectory to get the same cost that we had talked about before kind of entering into 2014 is you got another quarter under your belt, I imagine?

Tom Gorman

Yes, sir.

Robert Kosowsky – Sidoti & Company

Okay. And then otherwise on the emergency response, I don’t know the product complexity was somewhat of an issue with a team like you [ph]. We had offered too much complexity to your customers and it’s hard to build that. I’m wondering what progress do you guys have made on that and are you now resorting to maybe just offering a few different bundles that maybe reduce the complexity to make it easier to make and then also if you can maybe touch on the gross margin of the fire trucks out of the business as well – on the back log, the gross margin – the back log.

John Sztykiel

All right. Rob, this is John Sztykiel. First, the complexity is both a positive and negative. The positive is the customers love it. The negative is it’s difficult to build. So the reality is we’re working through very, very focused on the front end. And what I would mean by that is defining a very clear order at the dealer making sure that the contracts go through sales and engineering and purchasing in an expedited way. So that when it does come to the line, we’re able to build the products effectively and efficiently.

Key metric we’re watching at the ERV group is overtime. We expect that to come down in Q4 versus Q3. And one, I have no doubt we’ll solve it because we have the same issues at Spartan Chassis five and six years ago and you went through mechanically, just one issue at a time or multiple issues, you know, at a very defined plan but we will get there.

I will say this was interesting when you made the comment about the simpler trucks or we use the term program trucks. One of the –because it sounds like you were almost listening in to our conversations. One of the things we will be doing differently in 2014 from an emergency response perspective is we will be offering more program or menu driven trucks where there’s less options available. The news will be a dozen number of things one, it creates an order which improves overhead absorption, enables you to negotiate more efficiently at the supply base. But what it doesn’t do is have engineering be so involve in every order. Okay?

And so we see this is a tremendous opportunity. The other wind for it is short deliveries are becoming more and more of a priority within the emergency response industry. And I think it’s just society as a whole where once people want, there are 250 then $1.3 million object they just don’t want to wait six, nine, 12 months. They want that fire truck and they want it right now.

So as we look at the future, we’re very, very focused on shortening up the delivery cycles of our emergency response products especially the bodies. And one of the things we will be doing differently in 2014 is offering more and more of these program or menu driven trucks.

The last thing is relative to the gross margin, the gross margin of the emergency response vehicle group is definitely better today than what it was six and 12 months ago. Part of that is the Peru order, part of that is some price increases are now starting to move in to the queue which will be built in 2014 and as we move on.

So that is one of the reasons we’re more optimistic about 2014 from an emergency response specially the vehicle perspective is we just know the help of the backlog is substantially better versus six and 12 months ago. Did that answer your questions?

Robert Kosowsky – Sidoti & Company

Yeah, it did. So it seems like the pricing is going to – I guess you’re going to burn up some of the lower margin backlogs within fourth quarter but then as you get in to next year you’ll have a little bit more price increases and that’s going to kind of carry you into better program and offering.

John Sztykiel

Exactly. I would expect both of our product groups, both emergency response chassis and the emergency response vehicle, they have another price increase going out in Q4 of this year in the 2014. But also, we had some price increases earlier this especially in the vehicle group that we will start rebuilding in Q4 of this year and into 2014 as well.

So this price increase in the emergency response vehicle group [indiscernible] Q2 this year. This started much earlier in 2013 as we knew we had to right size our self on the pricing satellite.

Robert Kosowsky – Sidoti & Company

Is this because the market’s a little bit better market because municipal finances might be a little better so it’s a little bit – I’m not saying less competitive, but a little bit more accommodative to pricing? Is that kind of what’s going on in the industry?

John Sztykiel

You know, I think that’s part of it because the reality is the market’s been up close to 50% for the last two or three years, so everybody would like to make a little bit more money or make some money, you know, what’s included in our honorable competitor, so I’m sure that’s part of it.

The other thing I will want to say though is our marketing group and emergency response – when I look at the industry, I would unequivocally say we are absolutely number one when it comes to marketing go-to market. When I look at our marketing and the investment which we’ve made and the execution of the team when you look at the growth of our backlog, and that gets back if your brand or your aura is stronger, you can come in more for the price.

So when I look at our growth in backlog and I look at our growth in margin relative to 2014, I really want to complement our marketing go-to market group. We’re doing a lot of things extremely well relative to our competition.

Robert Kosowsky – Sidoti & Company

Okay. Good. And what was the – just last question. The brand in South Dakota facility, what’s going on there? Any more clarity on that?

Tom Gorman

Right now we’re still continuing to have some improvements. We’re looking to maximize our footprint on that. They’ve juggled the schedule and with some of the – continue to – we bolstered up the resources a lot where we had some capacity issues especially relative in the engineering area if we get the engineering packets out of the floor. We solved that problem and are getting the products out to the floor in a much more timely manner up and get the trunks out the doors.

Lori mentioned we had a few things that we fell short on in Q3 but they’re catching up pretty well.

John Sztykiel

Robert, it’s time to say the engineering packets – and meanwhile, we are a very customer-centric company, and that’s our niche is to serve the needs of many in a very broad way and very narrow market. It is absolutely imperative that we have a clean order when it gets to engineering.

When it gets to engineering, if it’s a clean order, it is amazing how fast and efficient things operate. And just to use an example as I’m sitting and looking out this window on the Charlotte campus, today on the Charlotte campus where we’ve got a great set of 33 profits in which we call the Spartan operating system, today in this campus we build fire truck chassis, RV chassis, we’re building the Isuzu product and now approximately 29 units a day with approximately 55 people. We’ve built – we’re building the Reach product, we’ve built Frito Lay truck bodies. We’re building almost anything within our repertoire of products but it gets back when you have great people with great processes. It’s amazing how efficient you can build something.

So Tom is absolutely right. Our whole focus is on the frontend getting a clean order. So it absolutely flies through engineering and purchasing.

Tom Gorman

One more thing that’s helping us on that branded facility as we’re getting more multiple orders of trucks of more than one out or singles and that’s allowing us to do a single engineering packet that would go for multiple trucks as well, and that’s given us some pretty good help.

Robert Kosowsky – Sidoti & Company

Okay. Thanks very much and good luck with everything.

Lori Wade

Thanks.

Operator

(Operator Instructions) Our next question comes from Shivangi Tipnis from Global Hunter Securities.

Shivangi Tipnis – Global Hunters Securities

Hello, guys. Thanks for taking my call. I have this question about the Bristol move, so with respect to the walk-in van production, it increased to 21 from 14. So what is the targeted production run rate and what is the roadmap for it? Can you comment on that?

Tom Gorman

Shivangi, this is Tom Gorman. Our preference would be if the orders keep coming in, our target would be to get about 35, if we can, on one shift with the ability to move into a second if needed be. But at that point, if we can hit in to the mid-20s and in close to 30 a day, that’s a good sweet spot for us and it works well for our suppliers. But it really does depend on the supply and demand.

And I believe, as you probably know, this is the walk-in van because of the large fleet orders can be petty highly seasonal where we’re concentrated in the late second quarter and third quarter with a little bit of a down in the fourth and the first quarter.

Shivangi Tipnis – Global Hunters Securities

Okay. Okay. And in terms of the modern improvement for the DSV, what is the expected improvement of the engineering and the body structure, and do we expect it to come in quarter four of ‘13?

John Sztykiel

Shivangi, this is John Sztykiel. Relative to the specific dollar number, we really are reluctant to provide that because honestly, our competitors listen to these calls.

Shivangi Tipnis – Global Hunters Securities

Okay.

John Sztykiel

It’s a very competitive nature out there. That may be something Lori and Greg can work with you on. But relative to these cost reductions as we look at Q4, most of the cost reductions will be through operation improvement, working through the issues on the line.

Where you’ll start to see what I would call bill of [ph] material cost reductions through engineering driven initiatives, that’s actually going to be late Q1, early Q2 and they’ve got a very nice number identified.

And I tell you what, very astute on your part to bring this up because as we look long term, we expect Bristol or this initiative and it won’t be in 2014 but to move past the $4 million savings because one of the things we’re now focused on is not just operational improvement but also evolving the products so it’s easier to produce at a lower cost point both from a bill of material and a labor perspective.

So right now we’re very focused on the operational efficiency improvements, material process flow, et cetera. Late Q1, Q2 of next year is where you’ll start to see some bill of material savings through engineered cost reductions move into the walk-in van product line. But that’s a very astute question.

Shivangi Tipnis – Global Hunters Securities

Okay. So all of these like material cost and the engineering and all, that would be for the entire DSV, so before the Reach and the last for the – of Bristol move, am I correct?

John Sztykiel

Yes. Each one of the product of truck body, Reach, and walk-in van have some very disciplined engineered bill of material cost reductions where you’ll start to see that move in, in Q1 and Q2 of next year.

Shivangi Tipnis – Global Hunters Securities

Okay. Okay. So then on the [indiscernible] I just had a last question. Do you have any new models for Reach after this 1900 that are expected to be done by in first half of 2014?

John Sztykiel

Well, this is John Sztykiel again. We’re working very, very hard to secure those orders. The reality is, as Tom Gorman mentioned a few moments ago, we deliver a heck of a lot of product. And there’s a saying within the industry sight on scene [ph] after Halloween, and that’s how they operate. So the reality is, right now we’re delivering product and they say we don’t want to talk about ordering more products until we get past Halloween and then we get very focused on that.

So do we expect more orders for the Reach? The answer is yes. Do I see us announcing anything over the next 30 to 60 days? Probably not because that’s just how the larger fleets operate.

Shivangi Tipnis – Global Hunters Securities

Okay. Okay. So that was helpful. Thank you, guys.

John Sztykiel

Okay.

Operator

Next question comes from Joe Maxa from Dougherty & Company.

Joe Maxa – Dougherty & Company LLC

Yeah. I just want to follow up on the tax rate, the 20% expected this year. Do you expect that moving forward as well?

Lori Wade

Hey, Joe. This is Lori. As we know – as we go – as you hover around that breakeven mark, that barely profitable, barely marginally negative, percentage has really start to mean nothing and that’s really where we’re at. I don’t expect the 20% rate to continue on because I believe our operative income will improve next year. And so, it’s sort of that anomaly with those fixed elements of your tax rate that’s causing these really what I would call non-standard rates to mathematically occur – will become more normalized in 2014.

Joe Maxa – Dougherty & Company LLC

Right. The mid 30s or mid upper 30s.

Lori Wade

Exactly. Exactly.

Joe Maxa – Dougherty & Company LLC

Okay. And there was also – I saw a recall. Is that at [ph] some Motorhome chassis? Does that have an – expect of any impact or is it – it’s just too minor?

Lori Wade

We had on that recall if it’s the one I’m understanding, we had taken a reserve at the end of Q1 for a steering gear bracket. And as we’ll say, we have no further – we took $1 million reserve at the end of Q1. We have no further information to believe – we still believe the range is between $1 million to $2.5 million, but we have no reason to believe at the moment that it will go to that higher side. But that’s still open. We hope to have that closed out and fully analyzed by the end of the year.

Joe Maxa – Dougherty & Company

Thank you. That’s all I had.

Operator

Next question comes from Robert Kosowsky from Sidoti.

Robert Kosowsky – Sidoti

Hi, just two quick follow up questions. One is on the specialty vehicle side. It’s like the operating margin has bounced around a lot this year at 8% quarter mile model on the first quarter 12% and 6%. And I’m just wondering how to think about modeling that into next year because it’s been pretty volatile in trying to figure out how to be more accurate.

Lori Wade

I would tell you. So Joe or sorry, Rob. So that business is made up of, let’s think about, we have motorhome chassis, we have Isuzu contract manufacturing, we have the defense build. We have APA which is made up of commercial and also the defense side.

So in Q2 of this year, we built out some – an ILAV order for 24 units. So that was a spike in Q2. As the sequester continues, we really, truly are starting to see a lot of defense aftermarket parts drop down. And the motorhome is pretty consistent, we did have a low quarter in Q3, but we expect it to come right back up in Q4. So we have a lot of very diversified products in that whole segment that is causing that intricate anomaly.

We’ve also taken our contract manufacturing for Isuzu up from 21 a day up to 29 a day which – so all those things coupled together makes it really difficult for me to give you a lot of guidance, because we never really know for sure when we’re going to have those ILAVs, those are one time nice, nice increases, but we are growing the other aftermarket parts business. But we are expecting that – the defense side to continue to be down.

Robert Kosowsky – Sidoti

Okay. Do you see further downside from what it was in the third quarter or is third quarter just kind of as we could see on the defense and the motorhome side?

John Sztykiel

Rob, this is John Sztykiel. The defense business will be extremely spotty and we do expect to get some ILAV orders next year, but they will be a very, very small number.

The good news is, when we get them, they’re extremely profitable. We intend to stay in the defense business both from a parts perspective and from a product perspective because at some point in time, the defense industry will get back to a more normalized cycle. Right now with sequester, honestly just a lot of defenses cut, it’s not just us, but a variety of other people are actually being hurt much for the nuts [ph] on the wheeled vehicle side of life.

So as we look at the defense business, when it comes in it’s great. It’s going to be a tremendous boom to our margins, et cetera. But it’s something we work into the forecast because it’s just extremely unpredictable right now.

Robert Kosowsky – Sidoti

Okay, that’s awesome. And finally, how much cash do you think you could generate from inventory. I mean, I guess, how far down could you work inventory and what’s the cadence for how that happens, is it based with the operations or strong enough now that you can then see 2014 being a very nice inventory source of cash year?

Lori Wade

That is our projection. We believe that as you know, we were behind. We’re a little behind in our Reach production. We’re as we said, we talked a about, we’re a little behind on our ERV projections and also when ERV changed their build rate downward, it was very difficult to slow that supply chain pipeline down for chassis, whether it be in customer or commercial.

So we have – we do have pods of excess inventory. So we believe we can – we’re shooting for to reduce inventory between the 10% to 20% going into the end of the fourth quarter. We do know that as we continued then to ramp up business when the truck body comes back, we’ll take a little bit of cash. But think about inventory in probably full year, probably closer to a 10% reduction versus where we are at right now and it’s going into next year.

John Sztykiel

And Rob, this is John Sztykiel, you know we should absolutely hit no problem. To give you a little bit of color, at Spartan ERV, they’ve currently got 90 chassis on the ground, the reality is that their production rate, they should maybe 35 to 40 chassis on the ground. So when you think of the value of those chassis anywhere from $150,000 to maybe $300,000 in cost, that’s a huge opportunity.

So I have no doubt that as we look through Q2, I should say Q1, Q2 and Q3, as we improve the efficiency of the operations rate at ERV, you will see a substantial drop in our inventory number and in turn, going into cash reinforcing what Lori just said. And I have no doubt we’ll get there. It’s just a simple matter of operational mechanics making it happen.

Robert Kosowsky – Sidoti

All right. Thank you very much.

Operator

Thank you. At this time, we have no further questions. I would now like to turn the call over to Mr. Sztykiel for closing comments.

John Sztykiel

All right. Just want to say thank you very, very much to all. As we mentioned earlier, 2013 as we like to close in a very solid, positive way. We obviously have some significant challenges, but you know, to be quite blunt, we’ve improved our operating results and it’s not easy.

I will tell you what, everything is a grind. But, yes, when I look at the backlogs and I look at where we stand today and I know the gross margin in our backlog is more positive than what it was six months ago and what it was a year ago. That feels very, very good as we look at 2014. And not a lot of organizations can say that today.

So we’re thankful for the past. We’re focusing at executing the DRIVE strategy and we’re very, very focused as a group of team members to execute not just in the 2013, but 2014 and beyond and deliver improved operational results for each and every shareholder.

Thank you very much.

Copyright policy: All transcripts on this site are the copyright of Seeking Alpha. However, we view them as an important resource for bloggers and journalists, and are excited to contribute to the democratization of financial information on the Internet. (Until now investors have had to pay thousands of dollars in subscription fees for transcripts.) So our reproduction policy is as follows: You may quote up to 400 words of any transcript on the condition that you attribute the transcript to Seeking Alpha and either link to the original transcript or to www.SeekingAlpha.com. All other use is prohibited.

THE INFORMATION CONTAINED HERE IS A TEXTUAL REPRESENTATION OF THE APPLICABLE COMPANY'S CONFERENCE CALL, CONFERENCE PRESENTATION OR OTHER AUDIO PRESENTATION, AND WHILE EFFORTS ARE MADE TO PROVIDE AN ACCURATE TRANSCRIPTION, THERE MAY BE MATERIAL ERRORS, OMISSIONS, OR INACCURACIES IN THE REPORTING OF THE SUBSTANCE OF THE AUDIO PRESENTATIONS. IN NO WAY DOES SEEKING ALPHA ASSUME ANY RESPONSIBILITY FOR ANY INVESTMENT OR OTHER DECISIONS MADE BASED UPON THE INFORMATION PROVIDED ON THIS WEB SITE OR IN ANY TRANSCRIPT. USERS ARE ADVISED TO REVIEW THE APPLICABLE COMPANY'S AUDIO PRESENTATION ITSELF AND THE APPLICABLE COMPANY'S SEC FILINGS BEFORE MAKING ANY INVESTMENT OR OTHER DECISIONS.

If you have any additional questions about our online transcripts, please contact us at: transcripts@seekingalpha.com. Thank you!