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Spartan Motors Inc. (NASDAQ:SPAR)

Q2 2014 Earnings Conference Call

August 5, 2014 10:00 AM ET

Executives

Greg Salchow – Group Treasurer

John Sztykiel – CEO

Lori Wade – CFO

Analysts

Walter Liptak – Global Hunter

Robert Kosowsky – Sidoti

Rhem Wood – BB&T Capital Markets

Operator

Good morning and welcome to Spartan Motors second quarter 2014 conference call. All participants will be in listen-only mode until the question-and-answer session of the conference call. This call has been 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. Greg Salchow, Group Treasurer for Spartan Motors. Mr. Salchow, you may proceed, sir.

Greg Salchow

Thank you. Good morning, everyone. Welcome to Spartan Motors second quarter 2014 earnings call. I’m Greg Salchow and I’m joined on the call today by John Sztykiel, President and CEO of Spartan Motors, and Lori Wade, Chief Financial Officer.

Before we start today’s call, please be aware that certain statements made during today’s call, which may include management’s current outlook, viewpoint, predictions and projections regarding Spartan Motors and its operations may be considered forward-looking statements under the Private Securities Litigation Reform Act of 1995.

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

As always, we request that you ask only one question and one follow-up question during the Q&A portion of the call. That will allow everyone the opportunity to ask a question. After asking your question, you’re welcome to rejoin the queue for additional questions as time permits.

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

John Sztykiel

All right, thank you, Greg. Good morning, everyone, and, again, thank you for joining us on Spartan Motors second quarter 2014 conference call. Second quarter 2014 can be summarized simply by two words: good progress. We are pleased that Spartan posted net income of $0.01 per share or $0.2 million in the second quarter despite the challenges we faced.

We executed our drive strategy in a disciplined manner building on the progress we made in the previous quarters. From stronger brands to a higher gross margin versus the first quarter of 2014, we made good progress and expect the pace to accelerate. The deliver and service segment, Utilimaster, was the largest contributor to profitability for the quarter, reporting operating income of $1.7 million versus an operating loss of $1.6 million in the second quarter of 2013. It is clear the Bristol initiative continues to move in the right direction.

Next, the specialty chassis and vehicle segment was also profitable despite a drop in motor home chassis production. SCV, as we call it, posted an operating profit of $1.4 million compared to $3.9 million a year ago.

Switching over to emergency response, and while the emergency response segment was not profitable in the second quarter, its improvement from the first quarter of 2014 was substantial reducing the loss by $2.2 million or just over 60%.

When you look at ER, all things considered, the data server issues and their impact on emergency response, the second quarter of 2014 represents considerable progress in the right direction.

Before we move on to a more detailed review of each business unit/operating segment, I want to highlight the addition of two new members of our senior leadership team, Daryl Adams, Chief Operating Officer, and Tom Schultz, our new VP of HR. Both Daryl and Tom possess a core foundation of driving continuous improvement. Spartan has made considerable improvement in the second quarter of this year with more expected. Having Daryl and tom join our management team ensures we will accelerate the pace of change going forward. In addition, Daryl Adams will be joining us on future conference calls.

All right, now over to each business segment. Delivery and service, DSV as we call it, returning to the DSV segment, a few highlights included shipping 270 of the newly designed Reach Commercial Van. That is easier and less expensive to build. These newer units are significantly more profitable and made a positive contribution to DSV’s performance in the second quarter.

We also shipped the remaining 201 Reach vehicles that had been in inventory awaiting a component that had been in limited supply. At the end of Q2 we had approximately 400 Reach units remaining in our backlog.

In addition to the Reach, sales of walk-in vans were generally strong during the second quarter. Truck body sales were higher in the second quarter than 2013 although production was constrained by ongoing chassis availability issues. This shortage seems to be n issue affecting the industry as a whole, walk-in vans and truck bodies not just Utilimaster.

Also during the second quarter, within Utilimaster, the Delivery and Service group, the new Saltillo, Mexico outfit center began generating revenue. The Saltillo facility installs aftermarket parts and solutions such as shelving for Chrysler’s Ram Promaster commercial van and became profitable in June. We expect the Saltillo initiative to make a positive contribution to Delivery and Service in the months and quarters to come. My compliments to the group.

Despite the considerable progress DSV has made at increasing operating efficiency at Bristol versus Q2 of 2013, we still have room for improvement. We are approximately 50% of the way there to our stated target of $4 million in annual savings, which we are focused on attaining, which we will attain.

Now we’ll switch over to emergency response. The ER segment reported an operating loss of $1.5 million in the second quarter of 2014, a 60% reduction from the loss of $3.7 million in the first quarter of this year, indicating we are making very good progress in fixing the fire truck body portion of the business.

Revenue did decline slightly year-over-year due to some production delays resulting from the Brandon server malfunction and a smaller number of chassis being shipped to external customers plus we had a few chassis remaining in inventory as part of the Peru order.

As you will recall from our first quarter conference call, our Brandon facility suffered a failure of data/server in the backup systems in late April. The failure of the server and its backups resulted in a loss of certain sale and engineering data that simply had to be recreated. This resulted in some production delays, labor and efficiencies and as we worked through the issues, some trucks will be pushed back into the third quarter and fourth quarter and it is questionable whether we will be able to make up the lost production by year-end. It is approximately seven to ten trucks.

Emergency response is our greatest operational issue. We know that. And also the source on the positive side, it was our greatest improvement in the second quarter versus the first quarter this year.

In the first quarter I stated we were focused on five areas relative to fixing ERV and part of that plan was to leverage the flexible manufacturing strength of Spartan, build the 70 Peru fire trucks here in Charlotte. One could also look at this, look at the Peru build as a test pilot relative to new methods of design and build as we have never built complete fire trucks in Charlotte, Michigan before.

The result has been very, very successful. With the Peru build on track, again, this is 70 trucks approximately $22 million to $25 million depending on the parts revenue that will come through, and we’re on track with that build to exceed our three-year corporate target of 6% operating income margin.

That’s great as it demonstrates we clearly know how to build complete fire trucks in an exciting manner from a financial perspective. Then the question is so now how do we apply these processes throughout Spartan ER to accelerate the pace of improvement even more? It comes down to focus, first, which we have.

Then you move over to the people side. Daryl Adams, our new Chief Operating Officer, has great operational experience. Tom Schultz, the new VP of HR, while HR is his core role, he has tremendous business acumen to ensure we have the right people aligned with the right strategy. It doesn’t stop there.

Next we’ve taken Ken Turner, VP of SMI Operations, and now his sole focus is emergency response operations. Last, we have a dedicated team where we have reprioritized some projects and moved people over to this team to accelerate even more the fix in transformation of Spartan ER.

What’s exciting is this is not being done out of desperation. It is being done because we have great momentum in many areas of opportunity. It is always easier to accelerate when one has momentum. We have that and we are focused on solving our last major operational issue fast.

While we have made very good progress, it is simply not enough. It is time to put this challenge behind us. Now we’ll shift gears over to specialty, chassis and vehicles. SCV is the acronym.

The specialty, chassis and vehicle segment, SCV as we call it, performed well in the second quarter and reported an operating profit of $1.4 million despite a sharp decline in revenue compared to the second quarter of 2013. Operating income remained positive due to a favorable mix, manufacturing efficiency and expense control, simply good business disciplines.

Included in the results for the most recent quarter was an additional reserve of approximately $200,000 or $0.2 million for the steering gear bracket recall announced in 2013. Again, we run a very conservative company in a number of areas.

Revenues were lower in the motor home chassis business as some RV manufacturers rebalanced their inventory levels. During the second quarter, we also added a new motor home manufacturer, something which we spoke about in Q1 of this year, Foretravel. Foretravel is an ultra high-end RV manufacturer and is doing some rather innovative things in the marketplace, obviously within the coach.

We recently learned last week that the first unit was sold to a well-known NASCAR driver. Honestly, this says a lot about the performance, not just of the motor home, of the chassis because we have no doubt we have the most dynamic ride and handling chassis on the marketplace.

We also have several other initiatives in place in the RV marketplace that will increase our RV retail market presence in 2015. Simply, we should be under three to five more RV platforms riding on a Spartan chassis this time next year. That’s exciting.

Also within SCV is defense and lower defense spending continued to negatively impact aftermarket parts and assemblies revenue, which declined nearly 47%. Sales of defense-related parts declined $3.7 million simply due to defense budget cuts. It’s not just us. It’s a variety of people within the defense wheel vehicle business.

When we look at other segments of the specialty vehicle business, one of those that also showed a decline was the complete vehicle. SCV did not produce any defense vehicles in the second quarter of 2014 compared to $3.1 million in the second quarter of 2013. And as we look to the future, this market will be very, very tough when it comes to complete vehicles, wheel vehicles for the defense industry.

In contrast, you look at our contract assembly work-free Isuzu, that is dynamic, increased more than 35% from Q2 of 2013 to today. What’s interesting is one comes to that facility within Spartan, we are now building over 30 units per day within 30,000 square feet with approximately 60 people from an assembly perspective.

Overall, we are pleased that the results from the second quarter exceeded expectations with a profit of $0.01 per share. Simply, we made very good progress. As we look to the second half, we will continue to face challenges, however, we have demonstrated our ability to meet and resolve the challenges as we look forward to the future. Now I will turn the call over to Lori where she will go into depth in a number of financial areas relative to the second quarter. Lori?

Lori Wade

Thank you, John, and good morning, everyone. Spartan Motors reported a net income of $0.2 million or $0.01 per share in the second quarter, better than the modest operating loss we had projected.

In the second quarter of 2013, we reported net income of $0.7 million or $0.02 per share. From a management perspective, even more important than the fact that we reported profit in the second quarter, is the fact that performance was sequentially better compared to the first quarter of 2014 when we reported a loss of $2.1 million or $0.06 per share.

This is especially true in the ER segment, which demonstrated substantially better performance in the second quarter than the first quarter of 2014. Revenue declined slightly in the second quarter of 2014 to $115.8 million from the $120.9 million a year ago. The drop in revenue was primarily due to the specialty, chassis and vehicle segment, which reported a decline of nearly $9 million from the second quarter of 2013.

Our product mix and manufactured efficiency was generally favorable in the second quarter resulting in a gross margin that approached that of last year’s second quarter despite our lower revenue.

Spartan reported a second quarter 2014 gross margin of 12.7% compared to 12.9% in the second quarter of 2013. When you look at Spartan’s gross margin in the second quarter in light of the extra cost resulting from the Brandon server malfunction and significantly lower revenue in SCV, it highlights the impact of our efforts to improve operating performance and manufacturing efficiency throughout the company.

As John mentioned, we have many opportunities to improve our performance further but this shows we are definitely making progress and moving in the right direction. We held operating expenses essentially unchanged year over year at $14.6 million. We kept a close watch on expenses during the quarter, although we continued to invest in the business to fund future growth.

Net income for the second quarter 2014 was higher than operating income due to an adjustment in our tax provision to record the impact of the change in our full-year financial projection. Also, our 2014 projected full-year tax rate is negatively impacted by roughly 5% to 6% due to the expiration of the research and development tax credit on December 31, 2013.

Our balance sheet and cash position remain solid. In second quarter, Spartan paid a dividend of $0.05 per share of common stock, totally approximately $1.7 million. We also repurchased $1 million of common stock and made capital investments of $1.9 million.

Inventory at the end of the second quarter was $84.4 million, up from the $75.4 million at the end of March 31, 2014 mainly due to the addition of $8 million of inventory for the Peru fire truck program. Despite these expenditures in inventory growth, Spartan’s cash balance at June 30, 2014 was $29.7 million compared to $15.6 million a year ago and $30.7 million at the end of 2013.

While our cash position remains strong and the increase in inventory can be explained by the Peru units, we believe that inventory is still too high and actions are being taken to improve our performance (inaudible) considerably to enhance our cash position.

Now looking ahead for a moment, we are reducing our 2014 revenue forecast slightly to the range of $500 million to $520 million, down only $5 million from the higher end of the range we shared with you last quarter.

The change in our forecast is predominantly due to production delays by the data loss in the ER segment and lower motor home chassis shipments.

As I stated in last quarter’s call, we expect both DSV and SCV to be profitable during 2014 with ER expected to continue to have sequential profitability improvements each quarter.

We expect Spartan to report an operating profit in both the third and fourth quarters of 2014 and be profitable for the year as a whole.

We have added resources to accelerate the pace of improvement in the ER business which will increases expenses during the second half of the year. To some extent, we expect lower production volume in the SCV segment to have a negative impact on operating margins as well.

In light of this, we are lowering our projected operating margin for 2014 to the range of 0.5% to 1%. Again, we expect to be profitable in the second half of 2014 and for the year as whole but we are somewhat more conservative in our assumptions for revenue and operating margins for the year.

I would now like to turn the call back over to John Sztykiel for his closing remarks.

John Sztykiel

All right, Lori, thank you very much. To summarize, it was a quarter of good progress, profitable, very encouraged by our disciplined execution of drive. The focus on operational performance is simply paying off.

Operational discipline is a major reason we are seeing positive results. A couple other examples, earlier in the year we closed our internal metal fabrication operations, which lost or cost us approximately $770,000 in 2013. Second, the startup cost of our new Saltillo, Mexico outfit center was approximately $600,000 incurred in the third and fourth quarter of 2014 in early Q1 and Q2 of 2014. Saltillo is now up and running making a profit.

When you look at these two items alone, that’s a $1.3 million operational swing in the positive direction now going forward.

Quick recap, in delivery and service, we have a good backlog, some new products coming and we’re 50% of the way towards realizing the $4 million in annual cost savings relative to the Bristol initiative. We will get there.

In emergency response, we have a solid backlog of 43% versus one year ago. The Peru build is an indication that we have the capability to build fire trucks at an attractive operating margin.

While we have made very good operational progress, we have enhanced the team to accelerate the pace of improvement. Specialty, chassis and vehicles remains profitable as a higher backlog compared to the second quarter of 2013 despite some softening in the market indicating we are gaining market strength, plus we have a new motor home chassis customer in Foretravel and expect to have new platforms in the marketplace next year anywhere from three to five which is really all very exciting when you try to extrapolate where we could be mid-2015.

Last, everything revolves around the right people. Daryl and Tom Schultz both have demonstrated operational excellence and it is their mandate to accelerate the rate of improvement.

And a little bit of clarity relative to the Chief Operating Officer, as an organization, from 2010 to 2013, we moved to become a highly matrixed organization. To be quite blunt, we probably moved too far as demonstrated by some of our operational results going in the wrong direction.

Henceforth in 2014, we moved away from a highly matrixed organization. We now have, I believe, the right blend of matrix or leverage within Spartan Motors and we’re very focused on our number one issue of operational excellence, Daryl Adams, the Chief Operating Officer. He is the driver.

However, we are also a hot products company, one of redefining innovation because when you have an attractive product in the marketplace, as demonstrated by our airbag safety system, or you look at (Keyless) a few years ago, where it’s in demand and people will pay a nice premium for it that obviously drives margins in the right direction, that is a core focus of me, John Sztykiel.

What’s interesting is in years past, this was the structure we had. So we’re now getting back to a structure which we had to a certain extent with the right blend of both matrix and what I would call autonomy within the business units which is one reason why you’ve seen very nice progress over the last two to three quarters.

We also had a negative in Q2 and that is our balance sheet. While it is strong, it will become stronger as we worked on inventory. As Lori talked about, our inventories are simply too high and that is not an effective utilization of cash and we understand that. That will be addressed in the second half of this year. We will get it resolved.

In closing, we are one team centered around one plan drive. And while we are pleased with the progress in the second quarter, understand this. We are not satisfied from a shareholder perspective, absolutely not satisfied. Thus, we are focused on accelerating the rate of progress, making some changes in the people, slight adjustments in the plan. We look forward to a profitable second half of 2014 and profitable growth beyond that.

Thank you for your time today. We look forward to the future, John Sztykiel. Greg?

Greg Salchow

All right, thank you, John. And at this time, we’re ready to take questions. So we’ll open the queue for the Q&A portion.

Question-and-Answer Session

Operator

Thank you, sir. We will now begin the question-and-answer session. (Operator Instructions) The first question we have comes from Walter Liptak of Global Hunter. Please go ahead.

Walter Liptak – Global Hunter

Hi, thanks. Good morning, guys, and congratulations. Sounds like you’re making some good progress.

John Sztykiel

Thank you, Walt. We are.

Walter Liptak – Global Hunter

Wanted to ask about the emergency response vehicles. And with the backlog high, what’s the timing of the shipments or are your production rates going to be higher in the third quarter and then higher in the fourth quarter or are they spaced out a little bit more into 2015?

John Sztykiel

Well, this is John Sztykiel. The production rates will be higher in Q3 and Q4. The backlog being up is both good and bad. The good news is the backlog’s up. We’ve got opportunities to grow our revenues and income and accelerate the progress. The bad news is it’s too long for the marketplace, which is why we’re accelerating production. We recognize our delivery times are probably anywhere from one to three months depending upon product model, too long out there. So that is something we’re focused on rectifying very fast.

Walter Liptak – Global Hunter

Okay. I guess when I think of fourth quarter, you’ve got the holidays in there. Do you try to get more of the production done in the third compared to the fourth?

Lori Wade

Hey, Walt. This is Lori. If we look, Q3 is going to be a bit artificially high because we have the majority of the Peru units going to be shipped in Q3. We have the first 10 units shipped in Q2 and the remainder will be shipped in Q3. But we do expect to see progressive, steady improvement in our manufacturing schedule every month here on out at all the other locations.

As we had talked about in the past, we are in the process of ramping up our Ocala, Florida location as well and we’re going to continue to drive and enhance using the leveraging up on Spartan’s manufacturing locations. We will continue to drive more easy products (after) Peru built here in the Charlotte. We’ll continue to utilize this campus to help relieve the pressure at Brandon. And so you will definitely see in Q4 a rate increase from what you had been seeing in Q2.

John Sztykiel

And Walt, this is John Sztykiel (in the group). The other reason, it’s clear when I discussed just quickly the Peru build and where it looks like our financially… from a financial perspective we’re doing extremely well there. So obviously we are going to try to leverage the discipline, the strength in what we’re doing here in Charlotte relative to more fire trucks, building more fire trucks here in Charlotte as time goes on.

Walter Liptak – Global Hunter

Okay. Okay, that sounds good. What kind of capacity do you have in Charlotte at this point? Is it possible to look at those operations and relocate and consolidate your cost out that way?

John Sztykiel

First from here in Charlotte, we’re maybe at I’d say 60% capacity on a single shift, 50% to 60%. As a company, we are moving more and more to try to have less facilities and to go more and more to a double shift type of operation. We did that with the Reach product line.

So as we look not just at emergency response but when you look at delivery and service in all of our business units, one of the things we’re very, very focused on is how can we reduce our manufacturing footprint which accelerates our ability to deliver high-quality product in a very efficient way at a very low cost, a metric we measure internally to, Walt, in the group. That’s a key part of our year-end compensation value add per square foot and that is sales minus build material costs divided by total square feet.

So grow the sales at the right margins, focus on reducing our build material costs with less square feet, more double shifts and our value add per square foot will go up. Ironically, that’s very, very much like a retail space kind of term and it’s a key metric for us. So I know I spoke a little bit but the answer is, to your question, are we analyzing and looking in… do we have opportunities to reduce and improve our manufacturing efficiency by having a smaller footprint? The answer is yes.

Walter Liptak – Global Hunter

Okay, all right. Sounds good, thanks. I’ll get back in queue.

Operator

Next we have Robert Kosowsky of Sidoti.

Robert Kosowsky – Sidoti

Good morning, guys and Lori. How are you doing?

John Sztykiel

Hey, Robert.

Greg Salchow

Good morning.

Robert Kosowsky – Sidoti

I was wondering on the service or specialty vehicle side of the business, can you maybe explain why the sequential margin expansion occurred?

Lori Wade

If you want to look… are you talking just from Q1 to Q2?

Robert Kosowsky – Sidoti

Yeah, specialty vehicles looks like it went from 2.5% to 6% operating margin on lower revenue and I’m wondering what the source of the margin expansion was.

Lori Wade

If we look… hang on. We did have… I’m just looking here just to answer some of those questions. So the one thing, Q1 was extremely, extremely low in our aftermarket parts and assembly sale of this year but we definitely… we went up… or that segment of the business went up about 30% from Q1 to Q2, the aftermarket parts, which is extremely profitable segment of our business.

And our Isuzu, our contract manufacturing, that business also we are on a steady ramp to take those up to… John mentioned we’re going to 30 units a day and in Q1 we were in the mid teens or high teens probably. So a lot of it is just product mix and we also, in that segment, our fabrication business falls into there. And, again, as John mentioned, we closed that in the early part of Q1 or Q2, excuse me, so we didn’t have that drain on the margins and so between Isuzu going up, fabrication going away internally and then the APA volume going up, those are really the three key drivers of that going up.

John Sztykiel

Robert, that’s a really good question. Lori, I appreciate, gave a very good answer but simply as we look at our organization and we’re focused on driving the right path towards our gross margin target 17%. We’re looking at every area within the organization, what can we do to improve or raise the price or accelerate the revenue as well an area where we have absolute control over our cost base relative to facilities, build material cost, et cetera.

So I think this is something we’re really now starting to exhibit some very good operating discipline is in the cost base side of our model and how do we effect that or drive that in the right direction? And as Lori talked about, eliminating the (inaudible) operation will save us to the positive side approximately $770,000 as we look at the second half of 2014 on into 2015.

Robert Kosowsky – Sidoti

Okay, that’s awesome. So would you expect this mid-single digit operating margin to be sustainable because I know that you were ramping up some operating growth spending within this business as well?

Lori Wade

I believe that that is definitely the trend for heading to what you saw in Q2, probably more of the norm. But, again, we will have moments of expenses for the new products as John talked about, those three to five new platforms we’re going to be on. There will be some investment to get under those platforms.

Robert Kosowsky – Sidoti

Okay. Then how close are we to getting better motor home volumes with the one customer that’s working on inventory? Is it going to be fourth quarter this year we might get return for revenue growth within the motor home chassis business or do we have to wait until 2015 to rectify the inventory issue?

John Sztykiel

No, this is John Sztykiel. I think you’ll start to see some of that in Q4. As Lori talked about, the backlog’s up a little bit on the RV side of life. I will say this. You’re probably going to start to see I think what I would call a nice double digit increase in the RV side, probably in Q2 of 2015.

And the reason I say that, what’s interesting is when we produce, excuse me, a new product or innovation which we consider to be redefining, we are no different than a software or a tech company in that we start small, which minimized our investment to a certain extent. We try to disrupt the marketplace and work the growth from that.

So as I mentioned earlier on the call, when I look at next year, the prototypes which we have flowing to the OEMs, et cetera, we will be on three to five new platforms from a retail shelf perspective next year at this time versus where we’re at today. So I don’t think you’re going to see the bump in that from a revenue perspective until probably Q2 of 2015.

Robert Kosowsky – Sidoti

Okay, that’s helpful.

John Sztykiel

It’ll be small but I don’t think you’ll see double digit growth until probably Q2 of 2015.

Robert Kosowsky – Sidoti

Okay. Now are these higher volume platforms you’re looking to get on or are they more premium like you did with the other one that you just gained back this year?

John Sztykiel

The most recent one was premium, very high end. But the other ones, yes, are… yeah, are definitely higher in volume platforms.

Robert Kosowsky – Sidoti

Okay. And then finally, given that Peru’s going to largely ship in this quarter and it seems like it’s pretty profitable slice of business (inaudible) what the rest of the RV does, do you expect Q3 earnings to be higher than Q4 because of this mix?

Lori Wade

I would say yes. We are expecting that… are you talking for the ER segment or…

Robert Kosowsky – Sidoti

No, for the company as a whole. Would you expect earnings to be higher in 3Q just because of the Peru order?

Lori Wade

We’re really not projecting it to be significantly higher. We really think there will be sequential improvement. We don’t think that Q3 will be the high point for the year.

Robert Kosowsky – Sidoti

Okay. Thank you very much and good luck.

John Sztykiel

Thanks, Robert.

Operator

Next we have Rhem Wood with BB&T Capital Markets.

Rhem Wood – BB&T Capital Markets

Hi, good morning.

John Sztykiel

Hi, good morning, Rhem.

Rhem Wood – BB&T Capital Markets

Can you give us a little bit of color on just the server malfunction? What was the impact in the quarter, some guidance, some clue, any impact going forward, whether you guys received any insurance money to maybe offset this? What would be the impact in the back half of the year?

Greg Salchow

Rhem, this is Greg. We found that it was really difficult to quantify this. As John mentioned, there are about seven to ten units that have been pushed out from second quarter and into the second half of the year. With the lead times involved and the requirements to engineer each one of these units, it’s questionable whether we can make up those units.

As part of the server malfunction, we did have some extra costs sending some people up there and we slowed down the production line so that there was some impact in the second quarter. But as we make progress throughout that segment as a whole, I think that will be alleviated.

We’ve been looking at the possibility of an insurance claim and at this stage I don’t know that we’ve really been able to quantify it. It’s something that we’re still looking at as I understand the situation.

Rhem Wood – BB&T Capital Markets

Okay.

Greg Salchow

As far as the impact on the guidance, yes, those impacts are all included in our assumptions for the second half of the year.

Rhem Wood – BB&T Capital Markets

Okay. All right. And then with Bristol, do you guys still expect the $4 million cost savings by the fourth quarter? And then on DSV you mentioned I think you said some new products were coming out in the back half of the year. Could you talk a little bit about those and give us a little color?

Lori Wade

So Rhem, I’ll take the first part of that question. So we are definitely on a good pace for our efficiencies for the $4 million but we do not believe at the moment we’re on the right trajectory to get to that annualized $4 million. So what we’re doing is we’re actually going to bring in… we’ll call it we’ve sort of plateaued. We’ve come to a point that we need that little boost to get us to that next level.

So we’re going to be looking at some resources to come in and help take us to that next level. So I think that we’re probably two to three quarters out before we’ll really start to see the pace of the generation of that annualized efficiency of getting up that $4 million pace.

Rhem Wood – BB&T Capital Markets

Okay.

John Sztykiel

And Rhem, and this is John Sztykiel. I’ll talk a little bit about the products. So really what Lori’s saying while we’ve got the targets identified in the areas where we know, simply we just don’t have enough of the right people. So this is what Lori’s talking about is we’re bringing in… and it’s not like it’s 10 or 20. It’s really just two or three to work to get the industrial engineering the right operating disciplines to build the walk-in vans with a greater efficiency rate, et cetera.

Relative to new products, there will be very little impact in 2014 and, again the reality is in the delivery and service market it’s no different than emergency response, in some respects no different than RVs. While we’ll be bringing some new products to marketplace in Q4 of this year I would not expect to see much of an impact until probably second half of 2015 because, again, you’ve got to start small and then the people in the delivery and service business want to validate the operating efficiencies, et cetera, of the product and then as they go through that six to nine month process then they in turn say, okay, we either like it, dislike it, et cetera and then they make their decisions to move forward at accelerated rates from a growth perspective.

I think if there’s one thing for all to note in that is that if you look over the last two or three years, while we’ve done a lot of things and focused on the operations and we’re now starting to get some progress going forward, we really only had two what I would call really redefining our hot products in the marketplace. One was Reach and that is now a positive product for us and we’re working on trying to grow the volume on that. The other one was the Spartan Airbag Safety System for fire trucks.

The good news is we’ve got enough for a project in all three markets, the first one which you saw recently on Foretravel, okay, where those projects will start to come out into the market in Q4 of this year, first half of 2015, second half of 2016. We’ll be announcing some… a couple of ER innovations in a couple weeks at the International Fire Truck Show in Dallas.

So what I like about us going forward, while we’re making improvement on the operational side, we’ve got some nice innovations in the pipeline, which we believe will not just accelerate the top line revenue as we move through 2014 but also make it easier to improve our gross margin as well as we will command a higher selling price.

Rhem Wood – BB&T Capital Markets

Okay. Thanks. And then just one more… one quick one. Lori, what tax rate should we use in third and fourth quarter?

Lori Wade

Right now assuming that the government is going to review the (R&D) tax credit, right now we’re using about a 45% internal tax rate for the year.

Rhem Wood – BB&T Capital Markets

Okay. Thanks. And then one last… just so I understand, the backlog, it’s looking overall down slightly from first quarter level. I mean, just is that really a result of… you guys talked about kind of focusing on profitability over market share as I look back at quarter, so was that some of it or is it more just an impact from the server issue, a timing thing? Just a little bit more color on what happened and where the backlog’s kind of going.

Lori Wade

So if we look at backlog, so if we look at backlog in total, we know that the ER has gone down slightly. Part of that is due to shipping some of the Peru units. We’re not really seeing… we are seeing a little bit of pent up demand on the chassis side of the business. There are orders there. They’re ready to come to us but they just haven’t quite made it through that final, final gate to come to us, so we do believe that we’re going to see a bit of a surge in the next quarter for chassis orders from the outside world.

The delivery and service, the reason why that’s continued to go down, we’re seeing that’s much shorter cycle of when we get the order to fulfillment. What you’re seeing in the reduction there is the fulfillment of the Reach order that has been sitting in our backlog now for several quarters. And our specialty, vehicle is holding very strong and actually going up slightly quarter over quarter.

John Sztykiel

And I think, Rhem… this is John Sztykiel… while we will see some small number of Reach orders coming through the Isuzu distribution group, the reality is from a large fleet perspective, those orders probably won’t be allocated or decided upon from a large fleet perspective until probably early Q1 of next year. So just certain cycles of the market plays with capital appropriations, et cetera.

So as Lori said, part of it in delivery and service, some of the backlog softening is just shipping the lot of Reach’s and we’re about a four to six month away from the cycle of the larger fleets buying that product. Emergency response, some of the data and server issues. The nice thing is the specialty, chassis and vehicle backlog, in particular, the RVs is up. I think while that will grow a little bit, I wouldn’t expect much growth in that from a double digit perspective until probably 2015 to next year.

So the backlog, we’re always focused on it. It’s still up year over year. Would we like it higher? Yes. Would we like it at a higher price within the backlog? Yes, and those two things we’re focused on.

Rhem Wood – BB&T Capital Markets

Okay, great. Thanks for the time. Keep up the good work.

John Sztykiel

Thanks, Rhem.

Lori Wade

Thanks, Rhem.

Operator

(Operator Instructions) Next we have Walter Liptak – Global Hunter.

Walter Liptak – Global Hunter

Hi, thanks. I think you kind of alluded to some of the fleet ordering in the delivery and service. My question is medium duties are not as strong as heavy duty trucks year to date. But what are you hearing from your fleet customers in terms of spending for this year and how’s order trending?

John Sztykiel

For the most part, Walt, everything which we’re hearing is that people, in 2014, and that’s almost behind us, but as they look at 2015, they feel positive about the economy. We don’t see cutbacks or major concerns.

When we look at our customers, those are public for the most part. Some are exceeding earnings estimates and expectations in the marketplace and that’s good. So overall, I think the US economy has weathered extremely well some of the global influences out there and we are benefitting from that. So we see growth in delivery and service and right now the fleets, their comment to us is, okay, they see 2015 in a positive way and that’s good.

Walter Liptak – Global Hunter

Okay, should we see orders and backlog sort of trending at the same level until we get into 2015?

John Sztykiel

Oh, I think that would be a safe statement. Typically you’re not going to see a whole lot from an order backlog perspective and delivery and service in late Q3 or Q4 because it typically cycles down some and then it starts to pick up in Q1 of next year. So you’ll probably see a lightning of the backlog in delivery and service. You’ll probably see a growth in backlog in some of the emergency response as people, honestly, they work to spend their money before the year-end budgets, those that are on an end-of-December cycle. Then I think you’ll probably see some growth on the RV side from a backlog perspective because typically late Q3 and Q4 are pretty good months as people try to buy the product and make sure that they get the right product on the lots for the spring selling season in the RV business.

Walter Liptak – Global Hunter

Okay, got it. And then you mentioned the Reach vehicles, there were some orders that were out four to six months. Is that because of truck testing or do you already know that there’s timing of orders that are out there?

John Sztykiel

It’s really timing of orders. Again, while it’s not guaranteed, when we look at past large fleet orders of Reach, they’re typically placed in the Q1 timeframe, so place them in Q1, deliver the product in Q2 and Q3, early Q4 and then move on. So that’s where that comes from. Again, it’s not guaranteed and while we would sell small numbers through the Isuzu distribution group, the larger fleets, it’s really very similar to walk-in vans. Their larger orders are typically a Q1, early Q2 scenario.

Walter Liptak – Global Hunter

Okay. Thank you.

John Sztykiel

Thank you.

Operator

Next we have Robert Kosowsky of Sidoti.

Robert Kosowsky – Sidoti

Yeah, just two other questions. One was on the Reach. Do you have any indications of interest from I guess new fleet buyers opposed to just the ones you’ve been servicing over the past two years?

John Sztykiel

Robert, this is John Sztykiel. We have interest. On the positive side, the Reach has a very durable, very dynamic body with a lot of cargo capacity. On the negative side of the Reach, okay, is a diesel power. And if there’s one huge change that has really affected the transportation marketplace is the price of gas going down and the growth of compressed natural gas.

So as we look at the Reach, the market opportunity is not where it was three years ago just because change is going on from a fuel source perspective. So while we’re having products and shipping products, other fleets being smaller fleets, et cetera, and we believe the Reach is still a viable product and we’re pleased it’s profitable now, we also have to develop a different chassis with a different fuel platform on that product but, honestly, that’s a 12 to 18 month initiative. It’s something we’re looking at, analyzing, et cetera.

But as we look at the Reach, versus where we were three years ago, I think the opportunity is there but its ability to be a dramatic success in the marketplace is limited today versus three years ago just because the price in gasoline and compressed natural gas.

Robert Kosowsky – Sidoti

Okay. And a 12 to 18 month timer, how far along are you in that? Are you just starting to look at C&G or kind of where are you in that?

John Sztykiel

No, we have done a fair amount of work. We’re now down to looking at what would be the right chassis platform, how to be configured into the body to create the least amount of engineering work, et cetera, so I would probably say, in a fair amount I’d say we’re between 15% and 20% of the way there but that’s something which we’ll be working to decide upon on or before the end of October when we conclude our three-year strategic planning process.

Robert Kosowsky – Sidoti

Okay. And then I noticed you started to buy back some stock. Could you may be shed some lights on your thoughts about how regular, how, I guess, methodical you’re going to be in terms of buying back stock, so you’d be expecting $1 million a quarter or may ramp up as you get a bigger cash inflow from inventory? Just any thoughts on that.

Greg Salchow

It’ll depend on a few factors. One is how much cash we have available. We want to keep about $20 million in cash for working capital purposes. Once we get above that level our first priority is for acquisitions and if we’re not particularly active on that front then our second priority is share buyback.

Going forward, we think we’ll have sufficient cash to continue this program. We have about 800,000 shares remaining in our existing authority to repurchase shares. So we’ll definitely be taking a look at that the rest of this year and going forward.

I don’t know that it’s something that we would say yes we’re committed to doing it each quarter but it’s certainly on our agenda.

Robert Kosowsky – Sidoti

Okay, thanks very much.

Operator

Next we have Rhem Wood with BB&T Capital Markets.

Rhem Wood – BB&T Capital Markets

Hi, just one follow-up. I just wanted to clarify one thing. From an earnings perspective, Q3 is typically the best for you guys but what you’re seeing this year is that you expect margins to increase sequentially. You think fourth quarter earnings will be better than third quarter? Is that correct?

Lori Wade

Based on our current… I wouldn’t say better. It could be slightly better. This is that top line. Based on our current projections and what we’re seeing in the marketplace, we’re seeing that they could be slightly better than Q3 but, again, Q3 and Q4 will probably be pretty similar to each other but not having Q3 be that big inflexion like normal. John, you want to add something?

John Sztykiel

You know what I think, Rhem? You ask a very good question. Dependent upon the mix, while we expect to see some operational improvement, that’s positive but we also do have a few less working days. I will say this. Hopefully we will not be cursed with the kind of winter we had last year. We started early, went way too long. But to be blunt, it’s a little bit too close to call. It could be slightly ahead, slightly down a little bit. But the good news is we’re moving in the right direction.

Rhem Wood – BB&T Capital Markets

Okay, great. Thank you.

Operator

At this time, I’m showing no further questions. We will go ahead and conclude the question-and-answer session. I would now like to turn the conference back over to management for any closing remarks. Ms. Wade, gentlemen?

John Sztykiel

All right, to the group, just want to say thank you very, very much to all the Spartan associates for delivering improved results. I’ll be blunt, it’s nice to see a (beep) in front of where the analyst estimates are and our own internal estimates. And that’s always a good day.

So it was a quarter of good progress, back to two words. But the reality is we know we have a long ways to go and both internally and externally we are very, very focused on accelerating the rate of improvement.

Again, while we’re pleased with the results, we are not satisfied from a shareholder perspective and we are very focused on accelerating the rate of improvement. Thank you very much.

Operator

And we thank you, sir, to the rest of the management team for your time. The conference call is now concluded. We thank you all for attending today’s presentation. At this time, you may disconnect your lines. Thank you and have a great day, everyone.

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