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Spartan Motors, Inc. (SPAR)

Q2 2010 Earnings Call

July 23, 2010; 10:00 am ET

Executives

John Sztykiel - President and Chief Executive Officer

Joe Nowicki - Chief Financial Officer

Jeff Lambert - Investor Relations, Lambert, Edwards & Associates

Analysts

Ned Borland - Hudson Securities

Walt Liptak - Barrington Research

Joe Maxa - Dougherty & Company

Operator

Good morning, and welcome to the Spartan Motors second quarter 2010 earnings 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 now disconnect at this time.

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

Jeff Lambert

Thank you and good morning everyone. Welcome to Spartan Motors second quarter 2010 conference call. I’m Jeff Lambert with Lambert, Edwards and I have with me today a couple of members of Spartan’s management team, including John Sztykiel, President and CEO, and Joe Nowicki, Chief Financial Officer.

I assume all of you saw this morning’s earnings release on news wire and Internet; management would take a few minutes to discuss the results for the quarter. However, before we do it, it’s my responsibility to inform you that certain predictions and projections made on 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 prediction or projection, there are a number of factors that could cause Spartan’s results to differ materially. These risk factors are identified in our Form 10-K filed with the SEC.

A quick word about the format of today’s call, John Sztykiel will begin the call with a brief overview of the quarter to discuss the major initiatives undertaken during the quarter and then Joe Nowicki will then talk about financial and operating results for the period. That would then conclude the outlook for the future, and John and Joe both will be available for questions at the end.

With that, I’ll turn it over to John Sztykiel. John.

John Sztykiel

All right, Jeff. Thank you and good morning to all of you listening on today’s call and on the Internet as well. First, we’ll briefly discuss our progress in Q2 providing detail on the quarterly results, our markets, our operations and then followed by a Q-&-A session shortly thereafter.

In the second quarter, we focused our efforts on three key areas; exiting the Road Rescue business to focus on more profitable markets, ones with greater growth; aligning our cost structure with current and near-term sales volumes; and third, investing in promising and profitable growth opportunities.

While we have a lot of complexity in our financial reports this quarter, when you peel back the results, you will see that we made solid progress in key financial matrix and also continue to invest in our strategic growth initiatives. The foundation of our strategic and operating plans remain simple and straightforward, compelling products and services, growth and profitable market share, cost structure management and balance sheet management.

Now, let me address our core strategic initiatives from a Spartan wide perspective. First the balance sheet, once again we made great progress in the quarter in managing our balance sheet as we focused efforts to reduce our investments in receivables, inventory resulting in improved cash flow, reduction in debt.

At a cost structure perspective, we took a number of other action in the restructuring we announced a few weeks ago, which further reduced our cost structure to better match current levels of revenues and profit. The results are starting to become apparent as we saw sizeable improvements in our operating expenses down $4.2 million or 26%, compared to the same quarter in 2009, when one excludes restructuring charges and operating cost of Utilimaster, which were not present in the prior year.

Our third focus, compelling products and services represents our vision for growth and perhaps is best illustrated by the investment in our new 2010 emission compliance chassis and the new Next Generation Commercial Van or NGCV as we call it that we are developing with Isuzu. Combine, we invested $1.2 million in R&D on those two projects in the second quarter on top of the $1.8 million we invested in the first quarter. So, this year, we’ve invested over $3 million in some very, very major projects and all of us would like to see the growth happen overnight.

Now that’s both in the top line and the bottom line etc…, but that’s not reality. Sometimes no different than a farmer, you have to plant the seeds in order to harvest the fruit a little bit later on. We are excited by these new products and are looking forward to the market entry and the growth in profitable market share we expect to gain with them.

Perhaps most notably with long-range product planning is a new discipline for Spartan. I’ve been here since 1985 and it is a new discipline, and requires a level of strategic market insight, which we have today, but also the patience to see these programs’ yield return.

We are confident we are on the right path and we also encourage shareholders to join us in this long-term view. We’re on schedule with the NGCV. As this week or this past week the first two prototypes were produced. Consumer or fleet line rise will begin to take place in early October.

Again, as mentioned in the release, production or sale into the market place will be in the second half of 2011, but when you are delivering products in the delivery and service market place, they have to work. So, we are very disciplined as we work with Utilimaster, as we work Isuzu to make sure we go through the right methods, the right products that we not only have a very attractive product, but one that has great reliability and durability.

As I said earlier, we are pleased with our alliance with Isuzu and the opportunities we see for growth for both of our teams. Isuzu is the world’s largest commercial diesel engine manufacturer and has more than 300 dealers in North America and the Isuzu N-Series is the market and brand leader across its markets. The alliance with Isuzu for the assembly of the N-series gas chassis is another strategic growth path for us that will improve our capacity utilization, provide inroads into new markets and will broaden existing ones.

Now, I’d like to share a quick recap of our quarter’s financial results and again, Joe will get into much more detail. Sales in the quarter fell 2.6% from last year’s level driven by reduced sales of specialty vehicles, aftermarket parts and assemblies and emergency response bodies. This was partially offset by the incremental revenues from Utilimaster as well as higher sales of motorhome chassis. Again, Joe will provide a more detailed review of the numbers.

In the outdoor rec/RV industry, we saw continued strength in our motorhome chassis revenues which increased by $18.5 million compared to a year ago. While backlogs have nearly doubled, and these increases were driven by stronger industry demand, the overall level of growth seems to have leveled off as the dealer or retail level suggesting that the recent inventory replenishment by RV dealers may have hit a plateau as noted by the drop in the Q2 backlog.

Our efforts in the outdoor recreational RV market continued to be based on regaining our market position where Spartan is noted for being the market leader in innovative concepts and products, supported by tremendous customer service.

Let’s switch over to defense and specialty vehicles. In the first quarter sales were down year-over-year by 23.9%, reflecting the conclusion of a number of significant defense contracts over the past year. The backlog in this area was up $11.5 million to $14.3 million which reflects, as we’ve mentioned in earlier releases or earlier conference calls, the small wins and a longer-range growth strategy that I’ve discussed.

The reality with more than 300 IED blasts per month outside of Afghanistan, the overall demand for mine resistant vehicles or some variation thereof will only grow over the long-term. In addition, we’re looking for new opportunities in defense and other specialty niches to grow as well where survivable vehicle is very, very important.

Emergency response posted very solid results in the second quarter, as ER body revenue was up 13.7% year-to-date compared to a year ago, very solid results for Crimson Fire and Crimson Fire Aerials. Although we are pleased with these results, we do remain conscious on the market as noted by the drop in the backlogs.

There is definitely pressure on state municipal governments around the country relative to the effects on economy and the tax base. From an ER emergency response chassis sales perspective, sales were up 7% year-over-date. However, the backlog was also down 6.5%, again representing concern.

As I mentioned earlier, we have high settled deficits, they are tied to state and local budgets, both are reason for concerns. On the positive side though, Spartan Chassis and Crimson Fire have introduced 12 major new products or technology innovations over the last 24 months.

We are now focused on market development and expect those backlog numbers to change and for those of you new to the industry, it takes on average 24 to 36 months to develop a market in the emergency response marketplace. And why does it take so long? The absolute reality, you’ve got 35,000 fire departments, 80% of those are volunteer, it just takes a long time to hit all those different departments, all those volunteer houses throughout North America and to get the job done.

But, I love it to be faster, absolutely. Are we working through a number of different methods to shorten up the market development timeframe? Absolutely, but right now, it just takes some time.

Aftermarket parts and assembly saw a year-over-year reduction of 76% to approximately $12 million in the second quarter. Although, this is still much lower than our historical rates, it was an improvement over the first quarter and was the second consecutive quarter-over-quarter improvement, and that’s important. We now have a trend in the right direction. We continue to work with our customers to grow this business. Our forecast for the rest of the year includes some additional growth as noted in the Q2 backlog increase of over 300%.

Over the long-term, we remain very optimistic about aftermarket parts and assemblies. More than 70,000 vehicles that Spartan has either produced or been a part of are still in service today. When we combine that with another 150,000 vehicles from Utilimaster, this gives us an installed base of more than 220,000 vehicles, providing a ready market for APA or Aftermarket Parts and Assemblies over the long run.

Let’s move over to delivery and service. Sales remained somewhat softer than anticipated. In Q2 at $22.5 million, however we saw continued improvement in backlog in Q2 versus Q1 up over 20%, suggesting improvements for Utilimaster in the second half 2010 as we move into 2011.

As mentioned earlier, the NGCV is a key strategic investment as this product’s numerous innovative, hard-to-replicate features will not only enhance Utilimaster’s sales, but will also enhance their gross margins as well, starting in the second half of 2011.

It’s also important to note that while Utilimaster generated a loss for the second quarter, those results included incremental cost for R&D, as well as some restructuring costs. In the past, we’ve mentioned that Utilimaster’s breakeven point was approximately $100 million in revenues, results for the second quarter we had a run rate that was $10 million below that level and we expect to make that up in the second half of the year.

Again, Joe is going to go into much more deal from a financial data metric perspective than I. Overall, we’re pleased with the progress of Utilimaster, since our acquisition closed last November.

We are slightly ahead of plan from an integration perspective. We’re excited about the market opportunities we see in the delivery and service segment, but in the near term, we will continue to invest in new products in markets which will affect our short-term results.

However, as we look forward to the second half, we are more upbeat and we have greater opportunities than what we did in the first half. Joe, I will turn it over to you.

Joe Nowicki

Thank you, John, and good morning, everyone. First, I’d like to cover a couple of housekeeping issues regarding the structure of the financials. As I’m sure, you’ve noticed that consistent with the accounting guidelines in the Road Rescue numbers, out of the details there are financials, instead they are all included within the one line called discontinued operations net of tax. From all the sales, cost of sales, operating expenses, other incoming expenses from Road Rescue has been pulled out and put into that one summary line.

Second, we’ve also taken the opportunity to change our reportable segments given the exit from Road Rescue, the recent acquisition of Utilimaster and also the realignment of our operational structure.

Our reporting will now be based on two segments. The first is specialty vehicle which includes fire truck chassis, motor home chassis, other vehicle chassis for the defense market, aftermarket parts and assemblies and fire truck bodies. And the second segment is delivery and service vehicles, which consist of Utilimaster progress.

Although, we’ve faced a number of challenges in the quarter, we continue to post solid results in terms of improving the strength of our balance sheet and we are shaping our cost structure to reflect the current realities of our markets. We’re making tough restructuring decisions to align our cost structure to the current and near-term demand, focusing on the profitable core competencies. Our operating results excluding one-time charges are already showing positive results, and we expect this trend to continue into the future.

From a revenue perspective, second quarter net sales were $115.7 million, up 2.6% from the prior year. The majority of the sale decreased from the prior year was due to specialty vehicle segment, partially offset by $22.5 million in incremental Utilimaster sales.

On a sequential basis compared to Q1, sales were down 1.7% due to softness across both segments, specialty vehicle revenue fell $0.7 million or 0.7% from last quarter while delivery and service vehicles posted a sequential decrease of 1.3 million or 5.4%.

Our consolidated backlog was $205.7 million as of June 30, 2010, compared with a $150 million in year earlier. Now the backlog for 2009 did not include the backlog from Utilimaster. However, excluding Utilimaster the backlogs were still up $12.4 million or 8.2% from the prior year, driven by increases in defense vehicles, motor homes and aftermarket parts orders.

The backlog decreased for the fire truck chassis and fire truck bodies by $5.5 million and $12 million, respectively. This decrease was driven by the fall in orders for the 2010 emission change. Sequentially, our consolidated backlog was essentially flat for the first quarter as we continue to work with the fire truck industry orders offset by increasing orders in our Utilimaster and APA businesses.

It’s worth pausing here to note the benefits we are seeing in our sales and backlogs from our purposeful moves to diversify our revenue string. It has clearly allowed us to maintain a more stable overall top line even as the parts underneath are shifting away.

As announced, we incurred $1.8 million in the structuring charges net of tax in this quarter related to our decision to exit our Road Rescue operation. In addition, there is another $1.1 million of restructuring charges net of tax in the quarter and other parts of our business.

Although these changes were significant, they will provide savings over the long term as we size our infrastructure to match our current level and mix of business and we’ll position us long term for the future period.

As I will discuss the many items in the quarter here, I refer to our reported numbers and those line items, excluding restructuring charges or our non-GAAP number. I’d refer you to the table and reconciliation of GAAP to non-GAAP numbers that appears in our press release regarding these items.

Gross margin percentage in the quarter was 14.3% or 15.1% without the million dollars restructuring charges, down from the 20.7% last year due to mainly a shift in product mix from defense and APA to motor homes and delivery and service vehicles.

As I’ve mentioned in previous conference calls, lower gross margins will be a reality given the new mix of our sales within the markets we operate, though we have recognized there is clearly room for improvement.

For the second quarter, operating expenses decreased by $700,000 to $15.5 million, excluding the restructuring charges, in addition operating expenses in the prior did not include the incremental cost from our Utilimaster acquisition, which was $3.5 million in the second quarter 2010. So, if we exclude the restructuring charges and the recently acquired expenses of Utilimaster, our operating expenses in the quarter were really reduced by $4.2 million or 26% compared to the same period in 2009.

Also included in those operating expenses in the current quarter were $1.2 million in one-time R&D cost associated with our recently announced next generation commercial van and also the expenses related to the development of our new 2010 emission standards.

As the percentage of sales adjusted operating expense decreased to 13.4% from 13.6% last year and 13.6% in the first quarter. We mentioned last quarter, we expected R&D cost will remain elevated to incur the expense of prototyping and testing of new product, but we should begin to display it over the second half of 2010.

Given the reduced gross profit levels and increased operating expenses, reflecting the restructuring and heightened R&D expense, operating income fell to near breakeven in the quarter, operating income included $1.8 million and pre-tax restructuring charges in the second quarter.

On the bottom-line, we reported a net loss from continuing operations of a $172,000. Excluding the restructuring charges from that number, we would have reported income from continuing operations of $900,000 or approximately $0.03 per diluted share.

Although we made significant progress in many fronts in the second quarter scaling the business and controlling cost, all our major accomplishments occurred in the balance sheet. We continue to work down receivables and inventory to control our working capital investment, which resulted in a $22 million operating cash flow in the first six months of 2010.

We made some great progress in inventories this quarter, although we still see additional opportunities for improvement. With regard to receivables, our DSO were 32.7 days in the second quarter, which is well within our internal target. Inventory 6:43 turned were 4.5 days or 81.3, which are heading in the right direction, but as we close the area for great potential.

Our solid cash flow enabled us to continue paying down debt in the quarter, the debt stood at $20.3 million at June 30, down from 46.4 million at the end of 2009. We did some great progress there.

With regard to Road Rescue, as we mentioned in our press release a few weeks ago, we intend to exit this business while seeking opportunities for sale. Since that announcement, we’ve been encouraged by the level of interest from potential strategic and financial buyers. With the high level of interest we’ve also established a timeframe for submission of bids and completion of the due diligence process. We are hopeful that we may complete the exit from Road Rescue business earlier than we had initially anticipated.

Now, I am going to turn back the call back to John, who will share some closing thoughts on our outlook as we continue into 2010.

John Sztykiel

As mentioned earlier, the second quarter market turning point for Spartan, as we decided to exit the Road Rescue Ambulance business and while this entailed significant cost short term, we believe it was the right action for the long-term health of Spartan Motors. And again this decision while it’s behind us, we must conclude the exit from this business and also continue our focus on growing the business in our other profitable market segments.

Clearly we have a number of challenges ahead of us, from the restructuring activities to the continued challenging conditions in a number of our market. Something I do want to point out though as I look at the release, is if you look at the backlog from March or Q1 and Q2, the nice thing is its basically flat, not a lot of companies can say that today. Combine that also with what Joe mentioned and got into detail a few moments earlier, increased cash, less debt, another very, very positive. Third, we do have a lower breakeven point versus 90 days ago.

Financially, as I go through the major points, we are sound, generating cash, reducing debt and developing plans to use it wisely. Number two, we are beginning to achieve very good market diversification.

As one looks at the sales breakdown for Q2 in the release, you’ll see a company no longer dependent on one or two markets or business segments to drive the revenue to drive the income. Are we perfect, no, but we made tremendous product in market diversification. Now, we’re focused on enhancing growth and improving the operating income within each market.

Number three; catalyst within each market. It is a difficult economy out there, but we have some great catalysts as we look going forward. NGCV, a major catalyst for increased profitable growth in delivery and service. The project is on track, wide and bright, starting in Q4 production in the second half of 2011.

The Isuzu line, assembly agreement, Isuzu N-Series Cab and Chassis, that will be a new multi-market opportunity which I have no doubt will take us in the other market because the Isuzu N-Series today can be in a number of specialty vehicle markets of which there is at least 58 plus within North America.

Crimson Fire, Spartan ER chassis, numerous product technology, now it’s on to market development. As time goes on though, more major catalysts will be unveiled as innovation, effective innovation, disciplined innovation will be unveiled from Spartan Motors in the business units within our groups.

Number four, data, demographic trends that are in our favor. Emergency response, there is a call for help every 1.25 seconds. In defense, GSA Commercial Survival Vehicles, we have over a 100,000 kidnappings per year, over 300 IED blasts per month outside of Afghanistan.

As mentioned earlier, we’ve got an install user base of over 220,000 vehicles. We have a great team now developing opportunity in aftermarket parts and assembly, as noted in the growth and the backlog.

Outdoor rec/RV 11,000 people of [age turned 50] that also benefit emergency response as more get older most of us are going to make a call for help in an emergency response product whether we need it or not. Delivery and service, economy moving in the right direction, against referenced by the backlog slowly, but we are a consumer nation and that was a key part of our acquisition decision for Utilimaster.

Number five; the team, there is a reality that sometimes you will not score a touchdown every time you have the football. Sometimes you play for field position and you have to improve that field position and we are doing exactly that, as demonstrated by the results once you peel back the restructuring charges.

In addition, this quarter is the one-year anniversary of our Chief Operating Officer, Tom Gorman, and Chief Financial Officer, Joe Nowicki. We are unequivocally much stronger because of them. We are more disciplined. To others as well, I really want to compliment the people within the Spartan Motors team. A lot of hard work, a lot of great things done, you all are improving the field position of us as we go forward. As mentioned earlier, the integration of Utilimaster is ahead of plan. Difficult decisions have been made with a lot of hard work and again thanks to all.

In summary, as I mentioned last quarter division of SMI is transforming the world through specialty vehicles. Our mission, our plan is simple, compiling products and growth in profitable market share. And the reality is great companies accomplish this in all three areas, and again I’m not saying we’re great, but a huge difference versus two years ago. The three areas accomplish growth is organic. Well, you can look at CB-23, this is a market-changing product. You saw it last week, it looks better in reality than what it does in pictures and that doesn’t happen very often.

The acquisition of Utilimaster, been with the company since 1985, this is the first integration where we are head of plan, where we’ve got disciplined processes for due diligence and disciplined processes for integration, again my compliments to Joe, Tom and the team.

Third, alliances. When you look at what we’ve been able to accomplished so far with Isuzu, some of the things which we’ve got going forward again, starting to come out in 2011 when you look at organic, acquisition and alliances, we’ve now got three fronts, great companies do this, again are we perfect, no, but you know what, we’ve got a lot of going in the right direction.

Last, relative to cost management, balance sheet management. Joe covered a lot of those. Everything revolves around our 10 strategic directives, and as we implement we are becoming a more professional, i.e., effective and efficient organization.

We’re making progress the data and financials support that, especially when you peel back the restructuring charges and something else to consider. Isuzu is one of the world’s leaders in truck sales and is the world’s leader in commercial diesel engines. It’s selling over a 120 companies and yet they make a decision to partner with us in North America, that in and of itself says a lot how we have evolved over the past 12 to 24 months.

In closing, in Q2 there was progress. The future is brighter, but it’s also very, very challenging. We are excited, we’re focused and we are working together as a team. Thank you very much.

Now, I would like to turn over to question and answers. Operator.

Question-and-Answer Session

Operator

(Operator Instructions) Our first question is from Ned Borland of Hudson Securities. Please go ahead.

Ned Borland - Hudson Securities

Hi. Good Morning. I apologize, I joined the call a little bit late, an overlapping previous call, but did I hear a run rate for Utilimaster. I think you said you are below plan for this quarter, but you expect to make that up in the back half for the year? I mean, where do you think you stand now for the full year in terms of sales in Utilimaster?

Joe Nowicki

Sure. Good morning, Ned. How are you doing? This is Joe.

Ned Borland - Hudson Securities

Good.

Joe Nowicki

I am giving you a quick update on the Utilimaster part of our business. Yes, we run a little bit high behind and we’re slightly soft during the first half of the year, but you know as you can always tell from their backlog that is up substantially from the first or second quarter.

You are going to see the pacing of their business kind of wrap up quite a lot in the second quarter, the second and the third quarter and the fourth quarter in the second half of the year. We don’t get specific numbers, given a forecast by entity or total as you know. But directionally the improvement in their backlog that you are seeing, that’s going to give you a good idea of where that business is going.

Ned Borland - Hudson Securities

Okay. But I think the previous targets when you guys announced the acquisition was $105 million. I mean, can we at least acknowledge that, it could be the north of that?

Joe Nowicki

Yes, I think the $105 million numbers was what their prior numbers were and for this year, we said it was about the same and yes, our expectation is they will be higher than that number because of the strength we are seeing in the back half of the year.

If you think about it, Ned that was really our objective in buying Utilimaster, was trying to get another business that would diversify our revenue stream, right that had different variables and different timings to it.

So, on one half of the business, we all know that fire truck industry is slowing down a bit as a result of the industrial budgets and funding. But on the good side is, we have a company like Utilimaster that’s more of an early cycle business, but they are going to start to see their business to ramp up which is really what the backlog is depicting and what we are describing for them in the second half of this year. So, it’s working well.

John Sztykiel

And again, Ned and to the other, what’s nice is you are also seeing growth in the backlogs when you look at other heavy truck manufacturers etc... So, while the recovery we all would like to see at much greater and probably a greater ramp up, at least the good news is it’s moving in the right direction. So, what’s nice is our backlog data is also we are seeing the same thing in others as well. It’s not just us, we are not the exception but as a whole thing are moving in the right direction.

Joe Nowicki

Yes, Ned the good news on the Utilimaster part is the backlog is up 23%, we should exceed the initial numbers we had thought off and when we put the acquisition together. So, everything is actually ahead of all our estimates when we initially did the acquisition, not only in their physical self, but also the progress on CV-23 and our successful releases. So, we are feeling really good about that acquisition.

Ned Borland - Hudson Securities

Okay. And then, sticking with Utilimaster and again, this is due to me joining late, but did I hear that delivery of the new vehicle would start in second half of 2011?

Joe Nowicki

Well, Ned you are absolutely right. The first couple of prototypes rolled off the line a week ago. We are not going to testing in validation and fleet ride and drives will start in Q4. Again a very, very disciplined process from an investor relations perspective, people like yourself are actually going to start to see pictures of it somewhere mid to late August.

We’ll also start to set up some visual demonstrations of the product in Q4 of this year, but relative to production on the product we are on track for it to be at second half of 2011. Again, it’s not just the sales increase, but also will enhance the margins of Road Rescue, I should say of Utilimaster.

Third, this is a very, very difficult product to replicate. We should have at least a two to maybe five-year competitive advantage over our honorable competition. This is a difficult product to replicate, but it is exciting.

John Sztykiel

Hey Ned, it’s also probably important to note in clarity, since we talked about it last quarter but just to refresh everybody’s mind, we’ve got two great initiatives going on at Isuzu, currently and the CV-23 program is one of them and just to be clear on that and is that great relationship we have with Isuzu on CV23 and the launch of this product from Utilimaster as John just mentioned in mid 2011.

The other half of it though, our relationship we have with Isuzu is on the N-Series, the vehicle that we talked about as well too. And that N-Series vehicle again is separate product, another relationship with Isuzu and that is expected to also occur in middle of 2011 around that second quarter.

Now, the N-Series vehicle, that will start kind of earlier in the second quarter. That NGCV vehicle, which is a Utilimaster product that will really start more towards the latter half of the second quarter.

John Sztykiel

And I think, one of the things within the group as Joe talked about, the N-series, from a numbers perspective you are going to see improved capacity utilization for both the NGCV, but also the assembly of the N-series gap. So from an overhead absorption in light of other things, honestly we’ve got some very, very good things going on with Isuzu, which will improve our financial metrics in the second half of next year.

Ned Borland - Hudson Securities

Okay, and then restructuring cost, what do you expect in the third quarter. I think you guys called out when you would announce the Road Rescue potential sale; you were talking $6 million to $7 million of restructuring costs. I think you put like what 1.8 this quarter. So does that imply that the balance of that falls in the third quarter?

Joe Nowicki

Well, there is the after tax thing…

Ned Borland - Hudson Securities

Okay.

Joe Nowicki

We described that $6 million to $7 million in total that we would see in the second through fourth quarters. We are still on track with that same network. In the second quarter we booked approximately $5 million. There is the pre-tax number of the structure that we’ve recorded; it’s about $5 million in this quarter. So there is another couple of million dollars coming in the third and fourth quarter. Does that help?

Ned Borland - Hudson Securities

That helps. Thank you.

Joe Nowicki

Yeah, that’s good clarity, because you are right, we have taken the bulk of it right now. I don’t want folks to believe the expectation that there is a lot more coming. It’s just the remainder of what we previously announced and we are on target towards that same $6 million to $7 million range.

Ned Borland - Hudson Securities

Okay, that’s all I had. Thanks.

Joe Nowicki

Thanks Ned.

Operator

Our next question is from Walt Liptak of Barrington Research. Please go ahead.

Walt Liptak - Barrington Research

Hi, thanks. Good morning everyone and good job on the heavy lifting with the restructuring and Road Rescue. I want to ask about the payback from the work that you are doing and specifically what SG&A is going to look like in the third and fourth quarter.

Joe Nowicki

I’ve alluded about what’s in the restructuring charges. So if you take that, we just described roughly $5 million that’s in this quarter. The bulk of it is in the Road Rescue part of our business. That’s a little over $3 million of it is there. That’s our discussion around payback on that obviously.

If you take the rest of the structuring charges, which amount to somewhere around $1.1 million before tax, $1.2 million, that number is primarily related with the severance and people related costs. So if you are thinking about a payback on that, it’s tough to say, but usually the traditional severance, I’d say you start to get a return on that in six to nine month. Does that help?

Walt Liptak - Barrington Research

Yeah, so does that mean on a quarterly basis, we could see lower SG&A by about $0.25 million?

Joe Nowicki

By the time you start getting out to 2011, you will start to see a much lower run rate, but if I look at the 2010 numbers, keep in mind we’ve been doing this much restructuring for the last couple of quarters.

You continue to see our SG&A cost come down in the first quarter and the second quarter. You will see them come down a little bit further in the third quarter as well and then even further in the fourth quarter, because that only isn’t the restructuring cost, but we are also going to getting some benefits of some lower R&D cost. As you know, we did kind of a front end loaded on our R&D cost related to some of these new programs we had.

Walt Liptak - Barrington Research

Okay. So you are saying R&D in the third quarter is going to be below the second quarter number.

Joe Nowicki

Yeah, absolutely.

Walt Liptak - Barrington Research

And the fourth quarter will trail down again?

Joe Nowicki

The fourth quarter will trail down in R&D a little bit further yet as well too.

Walt Liptak - Barrington Research

What do you think your annual run rate is going to be on a normalized basis for R&D?

Joe Nowicki

I don’t know of R&D, but what we have described is, what we are moving to is trying to get to a operating income number that’s in that mid-single digit’s range. So in the mid-term here, so in kind of interim where we are trying to get at, obviously longer-term we’d like to improve that even more from an operating income prospective in that mid-single digits as we try to get into next year, actually as we get into the last half of this year and into next year as well too.

Walt Liptak - Barrington Research

So as we are modeling 2011, we could use like a 5% operating margin.

Joe Nowicki

In mid-single digits, yeah.

John Sztykiel

One other thing Walt, and this is John Sztykiel, from a pure R&D prospective, the NGCV is by far the most expensive product technology initiative and most of those costs are being in the first half of this year and as Joe mentioned, you are going to get less as Q3 and Q4 go on.

And while we have a number of other, what I would call exciting and major projects going forward in R&D, which will start to flow out as we move over the next 6 to 12 to 18 months, none of them are as expensive as what we are going through within NGCV.

Walt Liptak - Barrington Research

Okay. Joe, I want to go back to a comment that you just made about the charges. It’s a little bit confusing before tax and after tax, but I think you just mentioned that the charge excluding Road Rescue before tax is $1.1 million, is that right?

Joe Nowicki

Yes, that’s in the current quarter. Excluding the Road Rescue part of it, our restructuring charges in the quarter were roughly around $1.1 million, $1.2 million.

Walt Liptak - Barrington Research

Before tax?

Joe Nowicki

Yes.

Walt Liptak -- Barrington Research

Okay. But in that first chart that you got in the press release, you got gross margin related of almost $1 million of restructuring charge and then 841 of operating restructuring charge.

Joe Nowicki

I apologize. I was also confusing about that before/after tax numbers.

Walt Liptak - Barrington Research

Okay. Its 1.8 before tax, 1.1 after tax

Joe Nowicki

Yes, it’s correct. It’s $1.8 million in a before tax prospective, so...

Walt Liptak - Barrington Research

Okay, got it. So anything related to Road Rescue charges adjustments to the valuation or whatever went through that discontinued op?

Joe Nowicki

Yes, that’s correct.

John Sztykiel

A bit of a confusion there Walt.

Walt Liptak - Barrington Research

Okay. Good.

Joe Nowicki

And Walt, to the group, if you go to the non-GAAP financial summary, which is on page 3 of the release, I think there is a real good breakdown in clarity, which this time is very healthy for all of us.

Walt Liptak - Barrington Research

Okay, and I want to ask about the Utilimaster backlog. When I was out visiting, the Utilimaster business had just taken in a big order from a customer and you were hiring people, and so I was a little bit surprised that the backlog wasn’t higher given the visibility that you seemed to have.

I guess I am wondering about what you can talk about publicly with the order, who was it from? How large the order is? The number of trucks when it’s shipped? And just provide a little bit more detail about the improvement that’s going on in that early cycle business.

John Sztykiel

Walt, this is John Sztykiel. Related to your first or just say your second question, to be able to talk about the size of the order, the customer, etc, I mean that honestly is a challenge Joe and I are working through with the Utilimaster team. What’s interesting is in the delivery and service market. They get very large orders, but their customers really don’t want any public announcements going out there.

So we are working through that. We don’t have an handy answer, because all of us, even the associates who were within SMI would like to know as well, okay. So we don’t have the answer what you are looking for today, other than the fact that we’re sizeable, it’s reflected in the backlog, but in addition, we are also seeing some nice fleet orders from smaller fleet. It’s not just driven by one customer.

So we are seeing some orders coming from a variety of different areas, which is inline with the economy starting to move slowly in the right direction. In regards to the number being higher, we have a 20% increase in backlog from one quarter to the next, that’s the pretty sizeable increase. So we are pleased with that.

Joe Nowicki

Walt, the other part that I would add is, unlike the rest of Spartan’s business, Utilimaster, they have much shorter lead times as well. So you won’t see a nine-month or three quarter backlog sitting out there. They in terms do it a lot quicker. So you’ll see additional orders and we expect a much stronger kind of third and fourth quarter.

The back log gives you a good indication of that, but again with the shorter lead times of their business, you’ll see even more orders start to pop in, which could drive even higher than what the backlog is.

John Sztykiel

Actually, what Joe says is true and what’s amazing is within their business and some of their models, they can take in an order and ship it before the end of the quarter where they cycle their products less than 90 days.

Walt Liptak - Barrington Research

Okay, well maybe the way they ask the question is, you’ve got two big express package companies out there right, that when they place an order do they give you an indication or do they give you like other truck orders usually like a five year contract or a one year contract? What do they, do they give you an indication and then give you monthly orders or something?

John Sztykiel

Well, I think the term Joe has used in the past is, the business it’s sort of lumpy, but now they have to find buying patterns and they may place orders ones, two or three times a year, but they give you a firm order, but they do give you -- most of them don’t give you three or five year agreement.

Walt Liptak -- Barrington Research

Okay. Alright thanks. I’ll get back in queue.

Joe Nowicki

Thanks Walt.

Operator

(Operator Instructions) Our next question comes from Joe Maxa of Dougherty & Company. Please go ahead.

Joe Maxa – Dougherty & Company

Thank you. Joe, on the restructuring, how much of that $2 million left is going to run through to continue in ops?

Joe Nowicki

All of it. The remainder of it is primarily all of it. There’s a little bit of stuff that won’t be, but most of its going to run through the Road Rescue, that discontinued ops.

Joe Maxa – Dougherty & Company

Oh, discontinue ops, okay.

John Sztykiel

He asked continued ops.

Joe Nowicki

Oh! I apologize, yeah, discontinued operations. So the remaining of it is all related to the Road Rescue discontinued operations, so it will run through that line.

Joe Maxa – Dougherty & Company

Okay. Alright, thank you. Just wanted to clarify that. I want to talk a little bit on the fire truck chassis side. I mean, a tough market of course, orders have been down last couple of quarters, backlogs down. What we are looking at for run rates in the next couple of quarters given the lower backlog? Are you going to have to pull that down from recent levels and significantly?

John Sztykiel

Joe, this is John Sztykiel. You are going to see a comparable run rate in Q3, a slightly lower run rate in Q4. We anticipate that as we look at Q1 and Q2 of next year, the run rate will stay flat relative to Q4, possibly go up, really that’s what we are focused on market development for right now.

On the positive side though, we still have a very good order book and emergency response chassis. We have a number of new products out there. So while the market developing is very, very challenging, been in the business since 1985 and have never seen the emergency response market this challenging, but we’ve never seen this kind of high single digit unemployment, double digit unemployment at some state and then a difficult economy.

On the other hand, I really want to credit the Spartan team, the Crimson team at a number of new product innovations and technology innovations they brought in the market one and two years ago, because they’ve got some very, very good opportunity to gain competitive market share.

Joe Maxa – Dougherty & Company

So based on your comment it sounds like even though its tough, you are starting to see a pick up in order or at least in RFPs of some sort to get you up to that 35 million to 40 million order rate per quarter, is that fair?

John Sztykiel

One is just a transformer loan, which is truly a unique product which Crimson showed on the Spartan Chassis, this table at FDIC. The one mistake Crimson did make was they did not build enough demos. The demand for that product has been so great from the distribution group, they don’t have enough of them to go around the company and they are working through that.

But getting back, I guess answering your question; we’ve got some major products, technology innovations out there. We are going through the market development and talking to the teams over the past couple of weeks. The bid activity has been better over the last four to five weeks than what it was in the previous first half of the quarter. So that’s a positive sign.

Joe Maxa – Dougherty & Company

Okay, okay. The comments of expecting growth in the second half of the year, are you talking sequentially or second half over first half or you are just talking more year-over-year?

Joe Nowicki

Second half over first half sequentially, Joe.

Joe Maxa – Dougherty & Company

Okay great, that’s helpful. And the drivers of that clearly are Utilimaster and mostly military?

Joe Nowicki

And the parts business is well too. So our parts business and good defense vehicle business that we’ve talked about with ILABs, the NMPV kits and a few others as well too that’s driving from defense, parts business and Utilimaster, yes.

John Sztykiel

Joe, and this is John Sztykiel. I think that if there is an area where people may have over reacted, was they thought that okay, when the large military contracts disappeared that we were going to disappear altogether. And Joe as we’ve said over a number of calls, we see the business model being one of small wins now, while we are just executing and delivering on those statements.

So the backlog is up a little bit, with hedge reflecting in the Q3, Q4 comments as we look going forward, but there is still very good opportunity in the small win area and defense. We are a company that’s agile, delivering a very customer-centric product in a very, very short time, and that’s our niche.

Joe Maxa – Dougherty & Company

Right. The last question from me, on the mid single digit operate income, are you talking on a quarterly basis and you are expecting to see that in Q3 and Q4?

Joe Nowicki

Yes, that’s correct. We are talking a quarterly number and based on the work that we’ve done and where we’ve been targeting to get to for the back half of this year, and into 2011 as well too, we should be able to get into that range.

Joe Maxa – Dougherty & Company

Great. Alright. Thanks guys.

Joe Nowicki

Yeah.

Operator

We have a follow-up question from Walt Liptak of Barrington Research. Please go ahead.

Walt Liptak – Barrington Research

Okay. I guess my last question is on the motor home business and the sequential decline in backlog. What can you tell us about the market trends and your customer base?

John Sztykiel

Well, this is John Sztykiel. I think what you are seeing in the reduction in the backlog, it’s similar what you’ve seen at other manufactures in the class-A area that some of the bump ups in the retail and dealer replenishment is now starting to flatten out.

I think part of what you’ve also seen and some of the consumer confidence numbers sort of flattening out for lack of a better term, especially in the large ticket items is affecting the industry and that’s just reflected in the backlog.

If there is an area where we do not have enough catalysts or major product technology innovations right now, that is the market segment. We have a great leader in that group and over time we will deliver some catalyst major innovations in the market place, it’s not going to happen overnight. So for lack of the better term, we are sort of riding the consumer confidence index in the macro part of the economy from a big ticket, large purchase item perspective.

Walt Liptak – Barrington Research

Okay. Thanks guys.

John Sztykiel

You bet Walt.

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

Well first, again I’d really like to say a special thanks to a lot of you and to all of the SMI associates. We’ve made a lot of progress in Q2, made some very difficult decisions. The future is bright, but it’s also very challenging.

To the investment community and our other stakeholders, we are extremely excited, we are focused and we are working together as a team. It’s not going to be easy, but we are more confident about the second half of the year than we were about the first half of the year and we are focused on delivering results in the right direction. Thank you very much.

Operator

Thank you. The conference has concluded. You may now disconnect your lines.

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Source: Spartan Motors, Inc. Q2 2010 Earnings Call Transcript
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