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Executives

Jeff Lambert – IR, Lambert, Edwards & Associates, Inc.

John Sztykiel - President & CEO

Joe Nowicki - CFO

Analysts

Ned Borland - Hudson Securities

Jamie Wyland [ph] - Wyland Management [ph]

Walt Liptak - Barrington Research

Spartan Motors, Inc. (SPAR) Q4 2009 Earnings Call Transcript February 18, 2010 11:00 AM ET

Operator

Good morning, and welcome to the Spartan Motors fourth quarter and final year 2009 earnings conference call. All participants will be in a listen-only mode until the question-and-answer session of the conference call. This call is being recorded at the request of Spartan Motors. If anyone has any objections, you may disconnect at this time. I would now like to introduce Mr. Jeff Lambert on behalf of Spartan Motors. Mr. Lambert, you may proceed.

Jeff Lambert

Thank you, good morning, everyone, and welcome to Spartan Motors fourth quarter and full year 2009 conference call. I'm Jeff Lambert. I have with me today a couple of members of Spartan's management team, including John Sztykiel, President and CEO; Joe Nowicki, Chief Financial Officer.

I assume all of you saw this morning's earnings release on the news wire and Internet; management will take a few minutes to discuss the results for the quarter. However, before we do, it is my responsibility to inform you that certain predictions and projections made in today's conference call regarding Spartan Motors and its operations may be considered forward-looking statements under the Securities Laws.

As a result, I must caution you that, as with any projection or prediction, there are a number of factors that could cause Spartan's results to differ materially. These risk factors are identified in our Form 10-K filed with the SEC.

Quick word about the format of today's call, John Sztykiel will begin the call with a brief overview of the quarter. Joe Nowicki will discuss the financial results and go over the operational results for each business segment. And then John will conclude with an outlook for the future. And then both gentlemen will be available answer to questions following that. With that, I would like to turn the call over to John Sztykiel. John?

John Sztykiel

Jeff, thank you very much and good morning to those listening on today's call and on the Internet. First item, a quarterly loss is simply not part of our culture and something we do not take lightly. The moment one does, soon losses will define you, and the words, however and but will be the two most popular words in a release.

In Q4, we were focused on two priorities, reducing our cost structure and operational focus while investing for growth, a strategic focus. If not for the transaction cost in the inventory valuation associated with our purchase of Utilimaster, we would have remained profitable during the fourth quarter despite the significant fall in revenue, which we experienced.

In fact excluding these items, we would have reported an adjusted EPS of $0.01 on the positive side, instead of a loss of a penny a share. Quick summary of 2009, it was a year of operational accomplishment and strategic transformation. The operational accomplishment, annual profitability despite a 49% drop in sales. We did not reduce our dividend payment. We ended the year with moderate debt, and at the end of 2009, our backlog stood at $247 million, up 45% versus 2008. Not many companies can say that they accomplished all of that in 2009, especially in the light of the next statement, the strategic transformation.

We purchase Utilimaster, which will be at least 20% of our sales in 2010, an important diversification strategic initiative into the delivery and service market segment. A segment that not only represents great opportunities for bodies but also represents great opportunities for chassis and for integration to reduce our overall cost structure. Back to Q4 2009, the work we have done to make our cost structure leaner and strengthen our balance has enabled us to continue pursuing our growth strategy. Even as we have integrated the purchase of Utilimaster, we were able to maintain our cash, limit the amount of debt we added to fund this acquisition, still we must remain disciplined in managing our balance sheet by limiting debt and continuing to generate cash that will provide the foundation we need to fund future growth. Our CFO, Joe Nowicki, will go into further detail on that but really I would like to complement all the SMI associates for making great progress on this side of the fence in Q4 and all of 2009.

In a few minutes, I will talk about the progress in the area of transforming our markets from commercial to specialty, including the role of our recent acquisition in this process, Utilimaster, but first a quick recap of the financial results for the quarter, and again Joe will go into detail. As we saw in the third quarter, we continue to experience challenges in demand as we closed out the year. Sales in the quarter decreased 31% from last year's level driven by the conclusion of a large defense contract in 2008, combined with the decrease in service parts and assemblies and those associated revenues. Sequentially compared to the third quarter, our net sales increased 12% with the addition of one month of incremental revenues from Utilimaster. With the year-over-year decline in sales combined with a shift in revenue mix toward lower margin areas of our business, our gross margins fell to 14.9% of sales down 21.1% from last year.

In an effort to counter the falling gross margins, we also reduced our operating expenses by 37% from the prior year. Again my compliments to all SMI associates for reacting so fast. Speed and agility is something we take great pride in.

On our balance sheet, we increased our cash position by 34.5% and added only $18.6 million to our long term debt, even with the $43 million net cost of acquisition of Utilimaster completed during the past quarter. In addition, we have continued to invest in internal R&D as we will set the stage for future growth. We have significant efforts underway in preparing new chassis and body products to meet the coming emissions change in 2010 as well as a major new product line at Utilimaster.

It is this incremental R&D spend that will cause Utilimaster to not be immediately accretive in 2010. While the fourth quarter was operationally tough on our financial results, not up to past expectations and performance levels, we are pleased with the efforts of our team in accomplishments we made in the quarter from a strategic perspective. And again, in a few minutes, Joe will provide more detail and review the numbers, the financials, and what it means to us both short term and long term.

Before that I'd like to share with you some insights into the operating conditions of the markets where we operate. In the outdoor recreation RV industry, we are starting to see an increase in the volume from motorhome chassis as well as improved order flow in backlogs. In fact, our total motorhome sales increased a 172% in the quarter and our backlogs have increased nearly four folds over a year ago levels, suggesting that demand is heading in the right direction.

However, I also wish to temper that statement with a caution as well, if there are no negative trends and the order backlog is up, there is still a lot of global uncertainty. In addition, in late 2010, we will move from 2009 engines to 2010 engines and there will be a chassis/cost increase. I've been in the RV outdoor recreation business since 1984 and have only seen an emissions change once affect the market price. In the mid 90s, there have been several emission changes, thus we are aware and cautious.

We had a very positive RVIA show in December. In this segment, there are several R&D initiative innovative projects in the pipeline, the Spartan aura is starting to grow. Switching to our other segment, which includes defense and specialty vehicles, sales were down in Q4 year-over-year by 85% and down in 2009 year-over-year by 71%. Backlog in this area is down as well, down by approximately 235%. As I mentioned on the last call, over the next two to three years, small wins growing as time goes by will define us in the defense part of life.

There are some large opportunities in the defense arena, which may be decided over the next two to three months from a business perspective. Long term the reality is that IEDs will be around for quite sometime, there are over 100,000 kidnappings per year. Over time the demand for mine resistant, survivable vehicles will evolve and it will continue to grow. Let's move over to emergency response which continues to be a very strong market for us. But there was also a low light, however, first the highlights. Fire truck chassis were up 15%, the EV Team comprised of Crimson Fire and Road Rescue were up 13.3%; and emergency response, that market segment again should be strong for us in 2010.

Spartan Chassis just concluded their dealer OEM partnership meeting with record attendance, again a positive sign. In regards to 2011, there is some concern due to the macro uncertainty; however, every 1.25 seconds there is a call for help. Plus we have introduced over 10 new products/technologies over the last 2.5 years and we are focused on gaining market share in 2011, even if the market is smaller.

From a low light prospective, road rescue, while there was significant progress and this may seen like a strange statement to say, it's still not acceptable. We are focused on looking at strategic and operational options, those that are out there to ensure we allocate our time and our dollars wisely. However, let me reiterate, there is tremendous strategic opportunity in the ambulance market from a chassis, body and parts prospective.

Last from an emissions perspective, as you look at the emergency response market, that could have some effect on 2011 business model; however, as I mentioned earlier, we have introduced over 10 new products/technologies over last 2.5 years and again we are focused on gaining market share even if the market is smaller. It is important to note for those that are new to the Spartan business model, in emergency response it takes about 18 to 36 months to develop that market from when you introduce the product simply because there are about 35,000 fire departments in north America, and it takes a long time to get past the awareness stage, the spec writing stage, the order to bid stage.

Moving over to delivery and service, obviously the inclusion of Utilimaster has helped to raise our backlog. This business, and I like Joe Nowicki's term is lumpy, here orders come in bunches. However, we expect 2010 to be slightly ahead of 2009. A big positive is Internet commerce continues to grow helping to drive demand. Our data point there is from 2002 to 2007, Internet retail commerce grew 182%. Plus, we are in the initial stages of developing a Spartan Chassis for Utilimaster but again that won't be the 24 to 36 month initiative.

It takes a significant amount of time and we talked about that on the conference call when we announced the acquisition of Utilimaster, develop chassis for very, very new market segments. Last, Utilimaster can be a significant player in the emergency response market. We recently delivered a walk-in rescue body to Prescott, Arizona, a strategy is now being developed as to how we leverage the brand name of Spartan to grow Utilimaster sales in this market in a large way.

There is a definite need for what they produce adapted to emergency response. Last market segment, service parts and assembles, which in the future we will be talking about is after market parts and assembles, or the acronym APA, did see a sales reduction of 77% in Q4 to just over $10 million. This was much lower than anticipated as some orders were delayed; however, we expect this to be the bottom.

Versus 2009, SPA, Service Parts and Assemblies will continue to be or have an unfavorable impact in 2010 versus 2009. However long term, there are over 10,000 vehicles that Spartan has either produced or been a part of, thus the opportunity is great. Tom Gorman, our Chief Operating Officer has recently appointed a new lead in this market segment, Ms. Vicky Black, she has demonstrated experience and success in this area and we look forward to grow as time moves on.

In the past, service parts and assemblies has been an operational or opportunistic focus for SMI. However, with Vicky on board, the strategy and the structure are being developed. We are now focused on this group, service parts and assemblies, or APA as it will be called in the future becoming or developing into a strategic impact to SMI. Last we are continuing to position ourselves for strategic growth in the 2010 and beyond. And as we move into the future we are committed. Now I would like to turn it over to Joe to get into some detail from a financial and operations perspective and then we will have a quick wrap up before we get into Q&A. Joe?

Joe Nowicki

Thank you, John, and good morning, everyone. Despite the disappointing bottom line, we had some significant accomplishments during the quarter, most notably coming to an agreement on the $43 million purchase of Utilimaster and then quickly completing the acquisition and beginning the integration. We also remained focused on controlling cost and retaining agility in our operations; in fact, if it were not for the acquisition cost, we would have remained profitable in the quarter.

Fourth quarter net sales were $100 million down 31% from the prior year, down 40% excluding Utilimaster. The majority of the decrease from the prior year was really in our other product sales category due to the conclusion of a large defense contract in 2008 as well as the decrease in related SPA sales.

On a positive side, our motorhome chassis sales more than doubled, sales of fire truck chassis increased 15% in the quarter and total emergency vehicle team sales increased by 13%. On a sequential basis compared to Q3, sales were up 12% with addition of one month's revenue from Utilimaster; excluding Utilimaster, sales sequentially were down roughly 3%.

While we did experience sequential increases in our motor home and EV team sales for the quarter, these were offset by continued declines in our defense and SPA business.

Orders and backlog were definitely a highlight for the quarter. Excluding Utilimaster, orders for the fourth quarter were up 66% from the prior year driven by improved demand for motorhomes and fire trucks. The significant improvement in order intake translated into improvements in backlogs as well. Spartan's consolidated backlog was $247.6 million at December 31, 2009 compared with a $169.9 million a year earlier.

The number for 2009 does include $34 million in backlog from Utilimaster but even excluding the increase from the acquisition back log still showed a healthy 25.7% increase. The growth in backlog was primarily the result of increased orders of transitional chassis ahead of the new emissions requirements slated for 2010. Within the total, fire truck chassis back log increased 68.5% and motorhome chassis backlog increased over 260% which is certainly an encouraging sign. EV Team backlog fell 25% from the year earlier due to a large order they had in Q4 of 2008 but it’s remained mostly unchanged over the last three quarters.

Moving onto gross margin, our percentage in this quarter was 14.9% down from 21.1% last year, due mainly to lower volumes and also a shift in product mix, from defense in SPA to motorhomes and fire trucks as well as a one time charge of approximately $500,000 related to the inventory valuation associated with Utilimaster acquisition.

Moving on to operating expenses, we reduced our operating expenses by $8.8 million to $15 million in Q4, an improvement of approximately 37%. The majority of the improvement in operating expenses was mostly due to the $6 million in one time settlement cost that occurred in the fourth quarter of 2008, accompanied by the favorable impact of the cost reduction efforts that we began in Q3. Excluding the impact of the one time settlement cost, operating expenses improved by $2.8 million or 15.7%.

As a percentage of sales, operating expenses were held constant at 15% proved that we have been working hard to re-align our cost structure to the current sales levels.

During the first quarter, we faced a number of costs as we integrated Utilimaster into our operations. These costs include legal and accounting costs that are typical at closing and they amounted to approximately to $700,000. In addition, we saw a number of accounting adjustments that impacted Utilimaster's results for the first month of operations as part of Spartan, most notably the $500,000 inventory evaluation adjustment.

In addition, we incurred higher than anticipated R&D expenses as John described with some new products we have under development. We expect these costs to remain elevated in the first half of 2010 as we continue to invest in our future. Our effective tax rate was 34.8% for the full year. Fourth quarter was impacted by some non-deductible costs related to the acquisition of Utilimaster.

The net loss for the quarter was $413,000 or $0.01 per diluted share, although when you exclude the impacts of the acquisition, our adjusted diluted earnings per share would have been a positive penny. Please review the accompanying tables and explanatory notes in our press release, reconciling our non-GAAP disclosures to EPS reported in accordance with GAAP.

Despite the fall off in earnings, we had positive operating cash flow of $7.5 million in the fourth quarter and $38 million for the full year triggered by our improved working capital position, primarily the result of our continuous focus on our (inaudible) collections.

We ended the year with $18.5 million in cash and cash equivalents as well as $35.2 million in long term debt, mainly due to the financing of the purchase of Utilimaster. We made progress in strengthening our balance sheet again this quarter and throughout the year, we have more work to do as we remained focused on managing inventory and receivables for our combined company.

Depreciation and amortization for the quarter was $2.3 million and $7.8 million for the full year. The full year ROIC was 6.8%, Spartan Motors and each of our subsidiaries uses ROIC as a key measure of our progress. It's also related to our bonus program for management associates which is based upon an economic value added financial model.

As noted in the press release, we define ROIC as operating income less taxes on an annualized basis divided by total shareholders equity. CapEx was $5.8 million for the full year of 2009 and we are now forecasting CapEx spending of around $6 million to $8 million in 2010 due to the addition of Utilimaster and in addition we have some increased R&D efforts in the current year.

With that I will now turn the call back to John who will share some final thoughts on our outlook as we move into 2010.

John Sztykiel

Thanks, Joe. As I mentioned earlier, 2009 was a year of strategic growth and operational accomplishment. We made significant progress in positioning ourselves with a lean cost structure and a strong balance sheet to support our long term strategy. And although we are pleased with the increase in our efficiency and improved results, companies do not succeed over the long term by just cutting cost alone. You have to grow the business. Simply as leaders, as individuals each day, we must act operationally and focus the organization on short term results. In addition each day, all of us must act strategically positioning the organization for future growth. What's interesting is a lot of companies don't do that. First they don't perceive it, then they don't do it or execute it.

One of the things I think I take great pride in is we have been pretty consistent on that since our inception in 1975. The acquisition into the delivery and service market Utilimaster was a major step in executing our strategic plan to grow into two to three new markets over the next couple of years. We believe diversification beyond our current outdoor rec-RV, emergency response in defense market is critically important to our long term growth but it also represents a reduction in risk.

As we enter 2010, our new combined company will also face challenges as well as significant opportunities. But it’s interesting as Utilimaster's core delivery in service market reminds me of a number of our other core markets over the past 30 years. Whether in RVs, fire trucks, emergency rescue, we had successfully transformed these markets from commercial commodity markets into specialty vehicle markets. 30 years ago, 95% of the fire truck market rolled on a commercial chassis. Today 55% of the fire truck market rides on a specialty or a custom chassis. We played a significant role in this evolution. We are very, very market centric, customer centric company and we see the same transformational opportunities with Utilimaster and that truly excites us.

As Joe also noted, we have made some significant investments in R&D over the past year and that will continue into 2010. As I have said many times in the past, we are a market and customer centric driven company and our efforts to develop new products to meet the evolving demands of society absolutely must continue. If you don't plan and execute for the future, there will not be a future, and as society changes, vehicles and services become more customer centric and Spartan is there to take advantage of this evolution.

From a capacity perspective, today we have capacity. Thus as Joe noted, CapEx should be small, we have room to grow, EVA or ROIC should improve as should our balance sheet, executing against this opportunity will provide operational results in strategic growth as time moves on.

In closing, in 2010, at least the first half will definitely be more challenging than 2009 from an operational perspective. From a strategic perspective, we are absolutely transforming in the right direction with some great opportunities for strategic growth.

Over the last 10 years, the compound annual growth rate of Spartan stock has been 13.69%. Since 1984, the year we went public or just over 25 years, it has been 10.5%. Anytime you are in the double digit range, you are doing more right than wrong. However, we will not rest on the past, we are focused on the future. What we have done in 09 and the strategy we will execute against in 2010 should enable those trends to continue. I'm excited about the future, I take pride in the past; however, the past is the past, and today and tomorrow is what both, you and all of us at SMI care about. Now operator, let’s start the Q&A.

Question-and-Answer Session

Operator

(Operators instructions). Our first question comes from Ned Borland of Hudson Securities.

Ned Borland - Hudson Securities

Good. Couple of questions here with regard to Utilimaster, you know, obviously one month of sales, $13 million, I mean if you annualize that, that'd be about a $150 million. I don't think it's probably the right move to annualize it, but I mean was there something in the month in that business, was there a big order, is there a seasonality factor that we should be thinking about with the Utilimaster?

Joe Nowicki

Actually, Ned, I will take that one. This is Joe. And really what you saw for the December sales was tied a lot into the inventory, the market adjustment that I described that we made. They had a lot of sales at closing that didn't get into product closing so they ended up in the inventory in WIP and finished goods, or just about finished goods. So you saw higher amount of sales go through in December, things that really weren't done during the month of November. So that's really what drove was kind of carryover of prior month's business that really got moved into the December result.

And the impact that had on us then was on the inventory market valuation that I described. Because what you really do, is you have to take all that higher inventory and mark it to whatever the market value is at that point in time. And that's increasing it's kind of to the selling price. Then that increased market value flows through to cost of goods the next month which is really why in December I mentioned we had this $500,000 inventory valuation adjustment really as a result of that. So all those pieces tied together.

Ned Borland - Hudson Securities

That is helpful. And then the backlog of $35 million roughly what -- I mean how quickly does that backlog turn? I mean I saw on the release, we know your core businesses and how they turned, but what about Utilimaster?

Joe Nowicki

It's a much quicker business than our markets and our turn in the backlog. For Utilimaster, it can be somewhere between a 30 to 60 day kind of turn that will start to roll through, their backlogs tend to be a lot quicker than ours.

Although the piece I would add though, that is what John described, the business is more lumpy, so what you will get is a large order that will come in to their backlog and it may stretch over a longer period of time to kind of turn it through. It really depends on whether it's a big lumpy project that came through or a bunch of the smaller orders.

Ned Borland - Hudson Securities

Okay, and then on the -- switching over to the sort of core chassis businesses, obviously you guys and Tom Gorman have been making operational improvements, I was wondering if there's a way to compare the margin in prior RV, even the military businesses with the exit from this emission standard period to say 2007 when you exited the last one?

John Sztykiel

Joe, let me jump into that. Typically what happens into the group is short term, you typically have a little bit of gross margin reduction, because what you do is you bring new products into market, the supply base is not set-up, you have got some product design changes as you move through production. And that may be a 1 to 2 quarter mix kind of scenario; however, on the very positive side, I use the term very, what we have seen is typically an emissions change enabled the vehicle in the market to structurally change, which enables the margins to go up over time. What's interesting is our margins have gone up substantially since 2000 and I think we have had two different emissions, two to three different emissions changes in the last 10 years. So you have a short term hit, may be two or three quarters, and it is not large but I would expect some gross margin reduction, but then long term you start to see gross margin enhancement or improvement, whatever you want to call it.

Ned Borland - Hudson Securities

Okay. And then I guess with respect to RV, obviously that looks like it's the most rapidly growing, although there is warning flags with regard to the economy and so forth. But given that seems to be a lowest margin chassis business, I mean, what can you guys do to sort of improve the margins there and keep it from being exerting too much downward pressure on your growth gross margin?

John Sztykiel

First, let me talk about the innovative side, and then I think we got some opportunists to reduce our cost base and we look at some of the synergies, you know with Utilimaster and just the operational improvements. And Joe, why don't you jump in there. But one of the things that I feel very excited about in 2010 versus where we were in 2008 is, and I use the term the Spartan aura is starting to grow.

The reality is, for the past two or three years, 05 to 08, there were not a lot of innovative platforms, product technology developments brought into the RV arena. So we enabled our chassis, our product base to become commoditized for lack of a better term. You know extremely excited about Tom Gorman's focus, the group's focus, we displayed a concept, the NGP [ph] at RVIA. They're working on turning that into a product that will not so much have life in 2010 from a sales perspective but hopefully 2011, but the focus on innovation which compels the market i.e. the consumer to buy our product is definitely back within the outdoor rec-RV group.

So, again, we've got caution relative to the backlog but you know there's two ways to enhance the gross margin, one is to get a little bit more for your product on the consumer side, and I think Tom Gorman's got a great focus there. Second, is on the operational side, to reduce your cost base and Joe, I'll let you jump in there.

Joe Nowicki

The only things I would add to what John said is, obviously, one of the ways to help improve that margin net is with the additional volume to offset some of the fixed cost that we have, the buildings, etc., where we get extra capacity on the motorhome side. Clearly the new agreement that we have with one of our clients, Fleetwood, is working out great to our advantage in those regards. They have been driving a lot of additional volumes through. And top of that, we are also looking at other ways, other products from really other what I call market areas to utilize some of that fixed cost and capacity as well. The last piece that I will put in there is being an EVA company, we also look at that whole cash collection time as well too.

So we have been spending time also on how do you increase the overall speed of the cash collection by looking at the back half on the receivable part as well too. So, we spend a lot of time in the working with some of those vendors on terms in order to increase the speed of the cash collection, the receivables down, improve our balance, sheet that way also driving value from the business. And that's just from a gross margin, but looking at it from a total profitability.

Operator

Thank you. Our next question comes from Jamie Wyland [ph] of Wyland Management [ph].

Jamie Wyland - Wyland Management

I just want to go back and ask some question about the MRAP business and what we are going to be doing moving forward. When you look back at it, the reason that the people we work with did not get the Afghanistan business was a function of the suspension systems I believe, and how could we have altered that and is our product just as good as the competition? And how are we going to evolve moving forward into what businesses in the military specialty vehicle business?

John Sztykiel

All right, Jamie. This is John Sztykiel. One, relative to why the military chose a firm other than our current partners, there were a number of criteria ranging from price to product performance, et cetera, so really wasn't just one i.e. being the suspension system and the performance of the product. Relative to the future, and as I mentioned earlier, as we look at defense government services, the opportunity in defense is really no different than in our other market. We have innovative product technology platforms that compel the consumer i.e. the market to come to us.

There are a number of R&D initiatives underway in that arena, led by Roy Bierwirth. A year and half-ago, Roy not leading that team from a strategic and operational prospective, today he is. Another opportunity when you look at defense in government services is, how do you leverage the brands of Crimson, Road rescue, Utilimaster into that arena as well.

Our federal government buys a large number of emergency response products as does the defense group. They buy a large number of delivery service type vehicles as does the defense group. So what's exciting again under Tom's leadership is he works to develop these market and leverage teams. Our core focus over the last 3 to 4 years has been very opportunistic from a Spartan chassis perspective, now we are moving towards strategic perspective where a corner stone of that is innovation that compels the market to buy, but another corner stone of it is how do we take advantage of some of the great brands we have got as defense and government services buy a large number of those products.

And what's interesting is we see also and I noted it, I use the term survivable vehicle. There is tremendous opportunity in products of the government buys which are not so much defense oriented but they do need to be survivable, they do need to be special and therefore a variety of markets, whether it be for border patrol, etc., could be export because the reality is that the world is a pretty dangerous place in a lot of areas today, even within North America.

Jamie Wyland - Wyland Management

And secondly on the fire engine chassis, congratulations on the order in China and apologize if you mentioned this, I missed the earlier part of the call. But how much is the opportunity not just in China but throughout the world for selling our chassis, and can we make the same margin selling them abroad that we do domestically? And if that does evolve into a real business for us of major proportions, is it worth while to actually produce the products somewhere outside the United States?

John Sztykiel

Well, first, from a global perspective, our past performance has not been very good, which is one of the reasons why Joe is here, which is why one of the reasons why Tom's here, because they both got demonstrated success overseas. While I don't know the exact number in 2009, 2008 export sales were I think 2% to 3% of our total sales. so we have tremendous opportunity to grow especially when you look at the currency rate.

First relative to China, one, we're pleased with the order. What's exciting is China as a country likes big box fire trucks. You know these products are going to Beijing, their capital, you know China likes big box North American fire trucks, that is great for us, for our competitors, but it's a great opportunity.

We've heard a data point, that over the next 10 years, the country of China will be building 3,500 fire departments. Now that may seem like a lot but if you think about it long term, we have 35,000 North American and we don't have as many people as China.

There is tremendous strategic opportunity within China and it is a global focus for us. Tom Gorman has been over there just recently, I expect he will be going back over again within the next two to three months, that is a core focus for us from a global perspective. We had a nice small win, I see our export or global business being (inaudible).

Relative to your last question, the opportunities for all of our brands really is very good overseas in certain areas, okay, by product. For example, in Europe do not see a lot of opportunity, very, very hard to compete; South America, Africa, certain parts of Asia, Australia, very, very good opportunities, the Caribbean. So, there are opportunities from an export perspective which is the first path we are going to take. We will be focused on leveraging our opportunities with partners who we have today either from a body perspective or a component perspective, et cetera.

Longer term relative to our products being assembled in other countries, while we talked about it, we have just talked about it. I can't see that on our horizon over the next two or three years that could maybe on the horizon in the three to five year timeframe but over the next two to three years, we see a significant amount of opportunity addressing a similar path or utilizing a similar path to what we did in China.

Joe Nowicki

Okay, Jamie, as I look at our intents overseas as well too, a lot of your questions are great around kind of sourcing and most of those are in the what I call the to be determined bucket. As we are kind of working through right now, our sourcing strategy internationally as well as our go to market strategy as well too, we are convinced there is a ton of opportunity there that we are not touching on yet. And now it's just Tom and John and I getting arms around how best to get at that opportunity.

John Sztykiel

For the first time ever, we will be at the world's largest emergency response show in Germany in June. Over a 135,000 people attend this five day show, it’s called in Interschutz. It only happens once every five years. We have been in business since 1974, but from a strategic prospective, we have a made a decision to go to this exposition, it gets great world exposure, and you know so that's one part of developing, as Joe said, the go to market executing against the strategic plan.

Jamie Wyland - Wyland Management

When you go to the show, are you bringing your entire emergency vehicle product line or just the chassis or?

John Sztykiel

We will bring a selective number of products/visuals because it is an expensive show but we will not bring the entire everything because it is just simply too expensive.

Jamie Wyland - Wyland Management

Now I mean you'll be showing Road Rescue, you'll showing Crimson or not?

John Sztykiel

Either visually or through a product, the answer is yes.

Operator

(Operator instructions) Your next question comes from Walt Liptak of Barrington Research

Walt Liptak - Barrington Research

So just to follow on the military discussion, your backlog, it looks like it grew from about $13 million to $28 million if you include the SPA and specialty vehicles, is that related to the BAE ILAV award?

Joe Nowicki

Yes it is, that's correct.

Walt Liptak - Barrington Research

Okay. And then Navistar and Oshkosh recently got orders because of the troop build in Afghanistan, is there a potential there for other BAE related business?

John Sztykiel

You know as I noted in the earlier statements, there's activity going on, thus there's potential. It is way too early to qualify that potential.

Walt Liptak - Barrington Research

Okay, we'll leave it at. Does the $28 million shift next quarter or what's the time frame for that?

Joe Nowicki

No, a lot of the ILAVs go within the second and third quarter mostly.

Walt Liptak - Barrington Research

Okay. And then if I could switch over to Utilimaster, you filed that 8-K with their financial statements through the third quarter 09?

Joe Nowicki

Yup, that's correct, that short reading document?

Walt Liptak - Barrington Research

Yeah and it’s pretty impressive that the gross margins held up with a big revenue decline at 13%, and maybe even more impressive is that the company even before you bought them, took a lot of cost out, overhead costs out, to maintain a nice operating margin, right?

Joe Nowicki

Correct.

Walt Liptak - Barrington Research

So I guess my question is on the neutral accretion assumption that you've laid out because of R&D spending, you know if volume's going up, it seems that there would be a lot of leverage in this business. How much are you spending on R&D, you know I guess during 2010?

Joe Nowicki

First to your question -- this is Joe -- first, your question with regards to the leveraged piece, absolutely. As their business grows because of the great changes that they've made in their cost structure, they are positioned really well to take advantage of the opportunity, also some incremental profitability as volume grows. As we said looking at the 2010 numbers, they will be pretty comparable for them in 2010 as 9, a slight increase in volume but nothing too dramatic, right now that we see in the works. So we won't see that leverage yet in the 2010 numbers.

Second, on your question to R&D, really I prefer not to get into the specifics of the R&D details with you. As a lot of it are some great products that they have got in the queue specifically going after that delivery in service marketplace. When you look that combined amount of R&D from an expense in capital expenditures, it is several million dollars that we will spending investing in that business to get at some of these new product offerings.

John Sztykiel

This is John Sztykiel of the group. I just would make a couple of quick comments, we appreciate the positive comment on the Utilimaster but really what a couple of items you had said was one of the things that attracted us very much to them. You mentioned the gross margins, and within their industry they are known to be innovative, very customer centric.

They are the brand leader in the walk in industry, so they are very similar to our thought process methodology there. And then you mentioned the operating margins again, they are in line with our main operational philosophy, so I just take pride, feel very, very good that you were able to pick that up as you got into the detail, and those were one of that strong attraction points of moving forward with Utilimaster.

Walt Liptak - Barrington Research

Okay. So the products that they are developing, they were developing prior to Spartan acquiring them?

Joe Nowicki

Yes, that's correct.

John Sztykiel

Again some are moving mid-stream right now in that product development. As we noted earlier, they are on track for a new product line introduction in 2011.

Walt Liptak - Barrington Research

And did you make a comment that Spartan’s going to make a chassis for Utilimaster, is that where some of the R&D spending is coming from?

John Sztykiel

Well, there is development starting in a chassis for Utilimaster; however, I noted it will be 24 to 36 months before you start to see significant top-line revenue from that happening because it takes a long time in the R&D, the product development process, the evaluation and testing, then moving into the market development process, in this particular business model because the fleets keep the vehicles for a long time.

Joe Nowicki

Yeah, the R&D expenditures that we described in the first half of the year are partially related to the Utilimaster new product and the other big half of it is really related to the 2010 engine and cap design work that is going on right now. That's a significant amount of effort, it’s not just a light change that’s going on as a result of the change in the emission standard, this is a pretty significant change to our chassis and to our cap design.

Walt Liptak - Barrington Research

And then since you mentioned the 2010 engine change, how many months or units of transition engines do you have, can you go through the first half of 2010, with 09 engines?

Joe Nowicki

Yes, we can. I think, right now we have approximately $20 million of inventory on hand, of engines on hand as we ended 2009, about $20 million of engines on hand to help us move into pretty much the first half of 2010 and a little bit further. It kind of varies a bit depending on the type of engine and the timing of when those transition orders will be filled.

John Sztykiel

And that also applies to the outdoor rec-RV market segment as well. The other thing, our sound financial position has enabled us to pick up engines when available to serve our customer base. So really in one respect, when the opportunity is right, we are into the market picking up the right engines to serve our OEM and our customers.

Walt Liptak - Barrington Research

Okay, so working capital ought to be pretty good, especially in the first half of the year as you work down that inventory?

Joe Nowicki

We've got -- I've got a big focus on working capital. As you've seen, we've done some great things with the, on the AR side of it. Our receivables teams across the company have done a tremendous job of driving cash flow to help us to pay down that debt sooner, which is our intention. But, secondarily as well too, we're going to keep the focus on as well, not only on receivables but also on the inventory part.

We'll see the cash flow from the transition engines certainly as we sell those. But even if you take that out of the equation, our $100 million in inventory, take out the 28 engines, still have $80 million of inventory. It's still a high number and we're going to have to try to reduce that as well. That's going to continue to provide the balance sheet strength and that's what allows us to do things like we also announced today, the continuation of the dividend, which we plan to do.

Walt Liptak - Barrington Research

Can you give us an expectation on where total debt could be at the end of 2010? I mean you went through a couple of items already that we can subtract from the total debt.

Joe Nowicki

Yes, if you look at our total debt number that we have out there, roughly that $46 million, about $30 million of it is on the revolver, so that's on our line of credit. And $15 million of it is long term. The $15 million is long term, that'll still be there, $16 million, that will still be there when we end the year. The opportunity is for us to take down that $30 million on the revolver as soon as possible. And you will see us make some improvements to get it back. And by the end of the year, should we have that taken care of, I would say absolutely.

Walt Liptak - Barrington Research

Nice, that would be a good goal. What is D&A expectation for 2010?

Joe Nowicki

Total CapEx, D&A was running around $2 million a quarter, now currently I think around $2.3 million of D&A in the fourth quarter, that's probably a good estimate going forward because our CapEx numbers for next year aren't going to be too different from this year, a little bit more, but not too different. So I'd say $2.3 million per quarter.

Walt Liptak - Barrington Research

Okay. And then let me just ask a couple more, interest expense what kind of run rate should we be at for 2010?

Joe Nowicki

From an interest expense perspective?

Walt Liptak - Barrington Research

Yes.

Joe Nowicki

Again, that number is going to start to come down as we pay down the debt quicker. So you will see that work itself off. I think our weighted average cost to debt right now, if you include the long term debt and the part from the revolver is running somewhere around 5%. And then whatever assumptions you want to work in, Walt, regarding the timing of how we work it down, use that accordingly.

Operator

Thank you, at this time we have no further questions. I would now like to turn the call back over to Mr. John Sztykiel. Mr. Sztykiel, you may proceed.

John Sztykiel

All right. In closing first just, wish to say thank you for those of you that are on the call, for those of you who will be listening to the call later on the Internet, or some other device, thank you for time. As mentioned earlier the past is the past and while we are thankful and appreciative of some of our accomplishments, we are paid to execute for today and tomorrow as well and we look forward to doing that. Thank you very much and have a great day.

Operator

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

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Source: Spartan Motors, Inc. Q4 2009 Earnings Call Transcript
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