Shyft Group Inc (SHYF) 2010 Q1 法說會逐字稿

Good morning, and welcome to the Spartan Motors First Quarter 2010 Earnings Conference Call. (Operator Instructions.) At this time, I would like to introduce Mr. Jeff Lambert on behalf of Spartan Motors. Mr. Lambert, you may proceed.

Thank you, and good morning, everyone. Welcome to the First Quarter 2010 Conference Call. I'm Jeff Lambert with Lambert, Edwards and Associates, and I have with me today several members of Spartan's management team, including John Sztykiel, President and CEO, and Joe Nowicki, CFO.

I assume all of you saw our earnings release on the newswire and Internet this morning. I'm going to take a few minutes to discuss the results for the quarter. However, before we do, it is my responsibility to inform you that certain predictions and projections made in today's conference call regarding Spartan Motors and its operations may be considered forward-looking statements under the securities laws. As a result, I must caution you that as with any 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 with--the call with a brief overview of the quarter, and then go over the operational results for each business segment, and conclude with a bit of an outlook, followed by Joe Nowicki, who will discuss the financial results for the quarter and will conclude with a Q-and-A session at which time the operator will instruct you on how to enter the queue.

Now, I'd like to turn it over to John Sztykiel. John?

All right, Jeff. Good morning and thank you for all of you being here. The basis of our strategic and operational plans is really quite simple. Number one, compelling products and services; number two, growth and profitable market share; three, cost structure management; and number four, balance sheet management. And while we've made some significant progress, we continue to face some challenges relative to the current economic climate in our related markets. Granted, our profit line was small for the quarter, but it was a return to profitable results, especially in light of the investments we made in our future growth. And that we feel great about.

On the balance sheet management side of life, we also made some great strides in improving our operating cash flow, paying down all the incremental debt we incurred with the Utilimaster acquisition in the fourth quarter of last year. And Joe will get into that in detail. Cost structure management - we reduced our operating expenses to 13.8% of sales for the quarter from 14.5% in the prior year, same quarter, and from 15% in the fourth quarter of last year. We're not where we want to be yet, but we're on the right track and the plans are in place to continue to work our cost structure down, and that will happen.

Compelling products and services, the investment in our new 2010 emission compliance chassis is very, very complex; very, very large; and over time will drive business. The new next generation commercial vehicle that we are developing with Isuzu, an exciting product. Combined, we invested $1.8 million in R&D in those two products--in those two projects alone in the first quarter of this year. And all the--and although the elevated R&D had a short-term negative impact on our reported results, the investment yield--the investment yielded some exciting new opportunities for our future growth. And if one does not develop compelling products and services, the future growth and profitable market share will just not happen.

The next generation commercial vehicle that Utilimaster developed with Isuzu is the latest example of harnessing our R&D efforts to meet the demands of the marketplace, not just today, but tomorrow as well. The new vehicle offers the quality, durability, and optimization of space that Utilimaster is known for in a package that offers consumers a compelling total cost of ownership from both an acquisition and operating cost perspective. It is also a vehicle that offers weight rating and cargo capacity right in the sweet spot of currently unmet consumer demand, as well as lower floors to allow for drivers to get in and out of, a taller interior height for increased cargo area and easier work maneuverability in the back of the vehicle, and best in class fuel economy - all ideal features for the delivery and service marketplace.

And while the primary focus of this next generation product will be the delivery and service market, over time this vehicle platform can and will probably be utilized in numerous other markets. Powering this next generation commercial vehicle will be Isuzu's 4J engine, a turbo-charged, inner-cooled, three-liter, dual overhead [direct] ingestion, four-cylinder diesel engine that will generate approximately 150 horsepower and 282-foot pounds of torque. I know this is a lot of data, but this engine is a commercial truck engine that has a B10 life rating and approximately 310,000 miles of useful life before a major overhaul. This is a big ITC, or item important to the consumer, as other competitive products utilize a passenger car type engine, which typically do not have that high of a durability cycle.

It's also important to note that Isuzu is the world's largest commercial diesel engine manufacturer and has more than 300 dealers in North America. The Isuzu N-Series is the market and brand leader across its markets. Our assembly partnership with Isuzu for the N gas chassis is another strategic growth path for Spartan. This partnership will also improve capacity utilization and provide inroads into markets that will drive additional growth.

Something I just want to share with all of you - take some time to research Isuzu on the net and pencil down some of the strategic opportunities when one considers chassis, engines, components, distribution, global reach, this next generation vehicle.

When you combine those thoughts as you do your research with Spartan's market centric flexible business model, you'll start to gain some clarity as to how we see the future and why we are so excited about this partnership. Again, we're going to move along in a very methodical way. We're going to execute in such a manner to ensure we develop and grow the relationship with Isuzu, its partners and the consumers in the correct way. We will take it one step at a time. But we see tremendous growth and strategic opportunity.

And now, I'd like to share a quick recap of the financial results. Sales in the quarter increased 6.1% from last year's level, driven by the inclusion of a full quarter of revenue from Utilimaster not present in 2009. This more than offset a decline in revenues from the defense and aftermarket parts and assembly business. Again, Joe is going to get into the financials in much greater detail. With the shift in the revenue mix towards lower margin areas of our business, our gross margin fell to 14% of sales, down from 22.6% last year. Again, this also reflects that we do not have enough compelling products within our product portfolio as our gross margins went down.

Operating expenses increased by $140,000, which was primarily due to the higher R&D costs, which we incurred in the 2010 emissions changeover in the next generation vehicle I just spoke about. Without the incremental $1.8 million in R&D expense for these two projects, operating expenses would've fallen by 1.7 million this time period compared to last year. Our balance sheet management remains very strong, as we generated enough cash to pay down the incremental borrowing that resulted from the Utilimaster acquisition in Q4 of last year.

Now, let's get over to the market segment. In the outdoor recreation RV industry, we saw the strongest quarterly performance in quite some time. Total revenues from motor home chassis increased by more than 24 million from a year ago, and backlogs were up nearly four-fold. These increases were driven by stronger industry demand and specifically by the orders placed by dealers replenishing depleted inventories. Although we have seen some improvement in consumer activity in the outdoor rec RV marketplace, we remain guarded about future demand levels until we see a very strong continued follow-through on the consumer demand side.

Now, let's move over to defense and specialty vehicles. In the first quarter, sales were down year-over-year by 86%, reflecting the conclusion of a large defense contract in the prior year. Of all the backlog in this area, it is nearly double the level of a year ago, and that is a positive sign. The recent improvements reflect the small wins, as we have talked about in the past, and the longer range growth strategy of Spartan Motors, which both Joe Nowicki and I have discussed in the past. A data point, something to reiterate - today, on average, there are more than 300 IED blasts per month outside of Afghanistan. Mine-resistant vehicles or some variation thereof will continue to grow. We see a great opportunity in this niche. However, we also see that the strategy and the reality will be small wins over the next two to three years.

Over to emergency response - posted very solid results in the first quarter as the EV team revenue was up 22.9% for the quarter compared to a year ago. Plus, the EV team was profitable due to some great results at Crimson Fire and improvements at Road Rescue. Fire truck chassis sales were up 13.4% year-over-year. Crimson Fire sales were up approximately 7.6 million, or 55% year-over-year. On the negative side, Road Rescue sales were down 2.7 million, or 36%.

And again, while we have made some great progress at Road Rescue, it continues to have a negative impact on the EV team's performance and, simply, this is not acceptable. As mentioned before, we are looking at options to ensure we allocate our time and dollars wisely. However, let me also say we see tremendous strategic opportunities in the ambulance part of the emergency response marketplace from chassis to bodies to parts. And as one release indicated last week, another ambulance chassis entered into the marketplace, built by Spartan for Road Rescue, and this was a first.

And to reiterate or to share with those that are new to us for the first time, today in the ambulance marketplace 0% of the market rides on a custom chassis, a specific, purpose-built chassis for the ambulance marketplace, where in the fire truck side of the marketplace approximately 60% of the market rides on a custom chassis, specifically purpose-built for the fire truck marketplace. Spartan is focused on changing that statistic, just as we were instrumental in the fire truck market.

A quick recap. SMI had a great Fire District Instructors Conference this past week - FDIC, the largest emergency response show in North America. Several new products were introduced and something which is important to note - in total from 2008 to the end of 2010, Crimson Fire, Road Rescue, and Spartan Chassis will have introduced more than 15 new products or major technology innovations. We are developing a great group of independent, very strong leaders, who understand what it means to bring compelling products that will drive profitable market share as time goes on. As a result, Spartan is positioned well for long-term profitable market share growth.

Over to aftermarket parts and assemblies, there was a reduction in sales of 79%, approximately 11 million in the first quarter. Although this is much lower than our historical run rate, it was an improvement over the fourth quarter. And as we've mentioned in the past, we expect to see 2010 as the low point from an APA perspective. And as time moves on in the second half of '10 over into '11, APA should grow. We continue to work with our customers to grow this business and our forecast for the rest of the year includes some additional improvements. Over the long-term, we are very excited about this business as there are more than 70,000 vehicles that Spartan has either produced or been a part of that are still in service today.

In the delivery and service market, sales were off a little from expectations. However, we expect the strengthening of the economy will bode well for Utilimaster in late Q3 and Q4 and as we move into 2011. The next generation commercial vehicle is a key strategic investment. This product has numerous innovative, hard to replicate, compelling benefits that will enhance Utilimaster's gross margins. But we will not see that until the second half of 2011. What you'll start to see in the second half of this year will be units delivered to consumers in the marketplace for test ride and evaluations. Then you go into pre-product production ramp-up, et cetera, to ensure you deliver a high quality product that excites people to not only want to buy it, but to share the good news with others.

And something else I want to share with you - and it relates to aftermarket parts and assemblies, but it relates to delivery and service and Utilimaster - is that currently Utilimaster has over 150,000 vehicles in operation. In addition to the normal wear and tear parts replacement, there are several initiatives in place where existing vehicles for fleet can be upfitted with newer customer desired enhancements. These initiatives should begin to bear fruit in late Q4 as testing is currently in process. What's interesting - and this is something which we will stay accountable to - is the total Spartan Motors, Inc. aftermarket parts and assembly opportunity on an installed consumer base is over 220,000 vehicles as I sit here today. That is extremely large.

From a market strategy perspective, we have accomplished a lot. We have a lot more work to do against all of our 10 strategic directives. I will talk more about these initiatives in my closing comments. But now, let me turn it over to Joe, as he'll get into a deep dive in some of the quarterly financials and the operational results. Joe?

Thank you, John, and good morning, everyone. Although we faced a number of significant challenges in the quarter, we're pleased to present a breakeven result when considering the substantial R&D investments we had in the quarter. In addition, our balance sheet remains solid as we paid down $23 million in debt, including all the incremental borrowing for the Utilimaster acquisition.

From a revenue perspective, first quarter net sales were 122.5 million, up 6.1% from the prior year. The majority of the increase was due to the incremental Utilimaster sales, but we also saw higher sales of outdoor recreational vehicles and fire trucks. Specifically, our EV team sales were up 22.9% from the previous year, and sales of fire truck chassis increased 13.4% in the quarter. Same store sales, excluding Utilimaster, were down almost 15% year-over-year, primarily as a result of the lower APA and defense contract business. The purchase of Utilimaster provides further diversification of our revenue stream, expanding the breadth of our market reach, and thus improving our ability to limit cyclical swings more common in individual markets.

On a sequential basis, compared to quarter four sales were up 22%, again due mainly to the strength of the motor home chassis sales, improvements of the EV team, and the addition of a full quarter of Utilimaster sales. Despite the sequential sales increases in motor home and EV team markets for the quarter, our defense and APA markets remained flat quarter-over-quarter and our outlook remains guarded over the near term in these same markets.

Our consolidated backlog was 218.9 million as of March 31, 2010, compared with 217.5 million a year earlier. The backlog for 2009 does not include backlog from Utilimaster. Excluding Utilimaster, backlogs were down 15.5% for the prior year, driven by the decrease in aftermarket parts orders. The backlogs did increase for fire truck and motor home chassis by a combined 16.1 million, and the specialty vehicles backlog, which increased by 7.3 million. These improvements were more than offset by a $16.8 million decline in the EV team backlog as the pre-emission orders are filled, and a $39.9 million decline in the APA backlog.

Sequentially, our consolidated backlog declined by 28.7 million, but this was anticipated due to the significant increase in the backlog in Q4 as the transitional chassis orders were pulled ahead of the new emissions related requirements slated for 2010.

As John mentioned, the gross margin percentage in the quarter was 14%, down from 22.6 last year, due mainly to a shift in product mix from defense and APA to motor homes and service and delivery vehicles. While this is a little lower than we anticipated going forward--than we do anticipate going forward, due to some one-time warranty charges in the current quarter, lower gross margins will be a reality in the short-term given the new mix of sales within the markets we operate.

For the first quarter, operating expenses increased slightly to 16.9 million. There were a few offsetting factors within the quarter that got us here. We had incremental operating expenses of 3.5 million related to the addition of Utilimaster, and one-time R&D expenses of 1.8 million associated with the recently announced next generation commercial vehicle and the development expenses related to the new 2010 emissions standards.

These were offset by approximately $2 to $3 million of cost reductions that were implemented as part of our previously announced restructuring. As a percentage of sales, operating expense improved to 13.8% from 14.5 last year and 14.9 in the prior quarter. We do expect that R&D costs will remain high in the next quarter as we incur the expense of prototyping and testing some of the new products within the R&D area. Given the reduced gross profit levels and increased operating expenses, operating income fell to 0.2 million in the quarter. Interest and other expenses increased slightly, resulting in a small net income or breakeven EPI.

Although we're encouraged with the return to our breakeven point this quarter, some of our major accomplishments occurred in the management of our balance sheet. We continued to work down receivables and control our working capital investment, which resulted in 10.2 million in operating cash flow in the quarter. Although we made progress on our balance sheet, we still see additional opportunities for improvement, particularly with our inventory level. Our cash flow, combined with our existing cash balance, was enough to pay down $23 million on our revolver, eliminating all the incremental debt we took on when we completed the Utilimaster acquisition in November, well ahead of our anticipated schedule.

Despite the progress we made in the quarter, we realize that in the current economic environment we must continually improve our operational structure to ensure our future. We see additional potential to enhance efficiency and lower our operating costs. Over the next several months we'll continue to execute on the cost reduction initiatives we put in place last year and seek out opportunities for additional improvement. We'll look to implement processes that will enhance our manufacturing efficiencies and better flex our cost in operations within our current level and mix of revenue.

I will now turn the call back to John, who will share some closing comments and thoughts and our outlook as we continue into 2010.

Thanks, Joe. While we had a small but positive start to 2010 with our first quarter results, we will continue working to implement and execute the momentum throughout the year. Even so, again, let me reiterate, we remain cautious in that Spartan still faces significant headwind. While we are doing a lot to position Spartan for strategic growth over the long-term, some of our current markets and economic conditions present some short-term challenges. However, in spite of these challenges we are energized as we see tremendous opportunity. I talked a lot about the Isuzu Utilimaster announcements of last week, and there are numerous opportunities to leverage the strength of Spartan in Utilimaster across all our markets and into other markets.

We also see opportunities to expand our presence within our core markets today. As we develop new, innovative products and processes to meet the needs of delivery and service, emergency response, outdoor recreation RV, and defense markets, we will become known as a next practices company.

In closing, this was a great quarter from a strategic perspective relative to compelling products and a great quarter from a balance sheet management perspective. We still have more work to do on the profitable growth and market share and the cost structure. 2009 was a year of transformation. 2010 will be a year of implementation. This will be a slow process to start as the market conditions are tough. But as we stay focused on compelling products and services, growth and profitable market share, improved cost structure, and improved balance sheet management, in line with our 10 strategic directives - customer centric, innovation, RAM leadership, Lean, speed and agility, financial stewardship, value maximization, green, global, and social responsibility - initiatives will translate into results.

Again, I want to thank you for your time. And Jeff, let's open it up for questions.

Operator?

(Operator Instructions.) And our first question comes from [Mike Rigorella] from Barrington Research.

Good morning, guys.

Good morning, Mike.

Just a few questions for you.

Sure.

Am I correct to understand that the [ILAB] contract that you guys won a little bit--a little while back here, you're making those and shipping them now?

Yes, we are. We began the production this quarter, so in the second quarter right now. You didn't see any in the first quarter results.

Okay.

But I was over there through that plant just last--two weeks ago and they're building them and they're shipping them. Yes.

So that's going to be all in your second quarter or mostly in the second quarter, sometime--some part in third quarter?

Second and third quarter.

Okay.

But what's interesting, Mike - and, again, for the new listeners - but as time goes on and all you read about the tightening of the federal operating budgets, et cetera--.

--Yes--.

--You're probably going to see greater product variations in much smaller numbers. And what's interesting, that's in line with our business model. We really are not a high volume, commodity-type production company. We're a very customer centric company, very focused on small wins or small order volumes and differentiating ourself in the marketplace.

And you're saying this specific contract fits right in there.

Absolutely.

Okay.

Absolutely.

What was the total number on that contract or did you guys give it?

I don't know if we disclosed it.

Yes, I don't think we disclosed it.

The last I heard of the number is somewhere in the 60 to 80 range.

Okay.

And that's over that couple quarter period of time.

And then, so if I'm to understand correctly, the gross margin was lower this quarter because of the mix. Would that be assuming--would I be correct in assuming then next quarter it would be a little bit higher because of these military contracts?

Yes, we should see a little bit of improvement in the gross margin next quarter as a result. Not a lot, but--because we'll still see some of the other issues. It will still be a lot of motor home sales going through.

Yes.

And again, with the addition of Utilimaster, the delivery and service vehicles. But it should step up and improve a little bit from the current quarter. Yes.

Okay, makes sense. Just a few cash flow questions, then. You guys mentioned--it looks like you've done a good job on lowering accounts receivable. Is this a reasonable level or should we expect more? What's your guys' target level?

Yes, I think we should be able to get even a little bit more improvement from it. The AR team has just done a phenomenal job in focusing on cash collections and getting both the DSO number way down and also getting the percentage over 90 days way down as well, too.

Okay.

It's really been good. I think there's still a little bit more for--improvement for them as well too, Mike. So you'll see us gain some ground there. The bigger opportunity for us really becomes in the inventory part. As you guys saw, the inventory is still way up there.

Yes.

It came down slightly, but it's still $100 million of inventory. We've got room for improvement there. From a turns perspective, looking at the aging of the materials, that will help us on the cash flow part as we look at the second and third quarter by really focusing on the inventory. That's the big improvement.

And so, it looks like there was a jump in the fourth quarter, about 20 million, and we are to assume those are somewhat related to the transition engines?

Yes.

What's the status of that?

We began working down some of the transition engines during the current quarter. I think the total we had was $22 million as of the fourth quarter. At the first quarter end, the number was closer around 18 million-ish that we had. So we've started to work some down. You'll see them work down as we go through all of 2010.

I guess--and then the same question with the accounts receivable. Is there somewhat of a target inventory level or is that a moving target?

We're--we've got some pretty aggressive goals and targets out for the inventory. So if it's at 100 million--and besides the $20 million that we, in essence, from these transitional engines, which will work itself out. But there's--we've got various kind of goals. But there's--Mike, there's probably another $20 million in inventory that we're targeting to try to take that level down even further.

However, though, at the same time, too, what we also discuss internally--and that's why we use the term compelling products and services--in a number of our market segments we're known for delivering products much faster than our competition. And to do that, we do have to carry a little bit more inventory.

Yes.

And so--and that's an area where I think Spartan chassis really excels that. So while we are very focused on balance sheet management, reducing the inventory, we also understand that the word compel also applies to services and that means we do want to have shorter delivery time. So it's something I think we're very focused on. We're moving in the right direction. Do we have work to do? Absolutely. But we also want to differentiate ourselves as we don't want to compete on price.

Okay, sounds good, guys. That's all my questions. Thank you.

Thanks, Mike.

Our next question comes from Ned Borland from Hudson Securities.

Good morning, guys. I've got a couple of Utilimaster questions here. First, you mentioned there was going to be some additional R&D. I was just wondering magnitude-wise what we might be seeing in subsequent quarters in relation to this Isuzu opportunity.

Sure, we can talk about that for a moment. In the current--first, if you look historically, Utilimaster does not historically spend a lot of money in R&D. So a program like this is a big deal for them and as you saw from the press releases we've got some pretty high expectations. In the first quarter we spent around $900,000--$800,000 on R&D costs associated with the new product at Utilimaster. In the second quarter, you'll probably see us spend another close to $1 million on R&D related activities at Utilimaster related to the new product. It will taper off then somewhat in the third and fourth quarter. We will have some launch costs that will start to ramp up as well, too. But the big bulk of it will be another roughly $1 million in the second quarter.

Okay. And then, in your parts and accessories business, was there anything in there associated with Utilimaster?

Yes. They--Utilimaster does have some parts business, but that's in the Utilimaster numbers. It wouldn't be in that other category.

Okay.

But they do have some. I think the proportion--I don't know for the quarter, but traditionally they run somewhere around 20% of their revenue is in aftermarket parts and assemblies. I'm not sure specifically in the first quarter, but I assume it's probably in that range, maybe a little bit less.

Are there any indications by looking at spare parts for Utilimaster vehicles that would lead you to indicate that there is sort of demand recovery here? I mean, in the sense that you basically would repair an old vehicle first, and then maybe you would replace it later.

Well, Ned, again, they are just now moving down what I would call a defined strategic path to maximize the value relative to their installed user base in excess of over 150,000 units. At our Board meeting last week in Utilimaster, they showed us a couple of very, very innovative, what we would call, retrofit for large fleets. And they are, for lack of a better term, difficult to replicate from a competitive perspective. But for the past I would say six to 12 months--and, again, we found this out in the due diligence process, but Utilimaster has established a strategic focus to maximize the value of their installed user base.

So while I think their past history has been just to take orders and replace parts that have worn out, now they're looking at being proactive with the installed user base saying, we recognize a lot of you keep these products very, very long. These are some of the enhancements where even though you're not going to buy a vehicle you can still put it on the vehicle to maximize the value, which is exactly what they should be. If somebody is going to keep a vehicle five, 10 to 15 years, that vehicle can and probably should change because work life cycle operating costs, et cetera, change. And so, Utilimaster has, I think, a very, very good team and they are defining a very effective strategic path to take advantage of that.

Hey, Ned, the other thing that this does for Utilimaster is, as we've talked about, that's a very relationship driven business with a few big customers that they have business with. Right? What this work does around creating some upsets or new enhancements to their existing products is this really helps to create a culture of a partnership with those customers and really solidifies that partner in a long-term relationship with them because they know we're always working to help them on what else can they do to improve the current fleet of vehicles they have. So it's also a benefit to solidify the long-term customer relationships as well.

Okay. And then, I'm trying to understand the dynamics with this Isuzu opportunity. I mean, if you launch a product in the second quarter of next year, is there some risk that some of the existing Utilimaster customers may hold off on replacing their fleet until that comes out?

Ned, there is some risk. But what's interesting is because within this business, and it's representative of a large installed user base, the people keep their products very, very long. And so, one thing which is nice is they've got a fairly disciplined process relative to replacing fleets. Not the whole fleet, but they do a certain portion each year at a time. And then, there is absolutely some risk. But we really don't see that as a large risk. I think the most positive news is--relative to delivery and service is that the economic growth is starting to become a little bit more stable where people are now starting to feel that there's a stronger foundation from an economic perspective as we look at the rest of 2010 and into '11. So I think that positive more than outweighs some of the risks you just talked about.

Okay. And then, maybe some commentary on what some of your fire customers are saying, I mean, given where municipal budgets are right now. You've got kind of the hangover effect from the emission change. I'm just wondering when--are we looking at this kind of just sort of flat-lined with the first quarter level over the course of the year in fire chassis? Is there--do you expect some pickup at the back half of the year?

Well, one, I mean, budgets are very, very tight and that's reality. The important thing to note though is about 80% of the business is very volunteer-based. And fire, ambulance, emergency response is very high profile within a community. There's a call for help every 1.25 seconds, so that need's not going to go away. And that's why we brought up the note of 15 innovations over the last three years. We started this product innovation cycle about two, 2.5 years ago because we knew there was going to be an emissions pre-buy angle, which we are experiencing some today.

You've got 35,000 fire departments, 1.2 million firefighters, EMS, 80% is volunteer. And the reality is in emergency response it takes 18 to 24 months to develop the market once you introduce the product. So are there challenges? Absolutely. But we had, I think, one of our best shows ever from an innovation excitement perspective at FDIC. So I think we've got a lot of compelling products out in the marketplace or will be coming out into the marketplace, which will make it probably easier for us to overcome some of the challenges that drive profitable growth.

Again, I'm not saying it's easy. But we are in a very, very good spot. Rather than hoping, now we've got a very, very disciplined process over the last two to 2.5 years. Because, again, we've gone through these emission hangovers before. And how you get through it is deliver compelling products to drive profitable growth that excites the customer. And so, again, we've got challenges, but we feel confident that we will be able to gain profitable market share.

I think it's also [an issue], as you know. And when you have 70 or 80 or 90% market share, you're going to move with the market. Our market share is not there. There's a lot of opportunity for us to grow and gain market share. And how do you do that even during difficult times? Through innovation, as John described.

Okay. And then, last question. You've built up--or you've generated some pretty impressive cash, paid off 23 million in debt or so. What are your priorities for cash flow going forward? Are acquisitions still a consideration or are you going to look at share repurchase?

At this point, we're going to continue to manage the balance sheet through the [inaudible] from the inventory management, and then we'll look at ways to continue to invest and grow the business. But a lot of what we've already described - the new R&D programs, the 2010 emissions program, it's the R&D programs for the CV--or the new product commercial van launch as well, too. It's really investing and growing the business and that's where you'll see us. And you probably will see our cash balance tend to grow a bit through the course of the year then as we look at what's the next investment.

But I don't think you'll see us realistically looking at the M&A market again until we get into next year. We want to work through this year, continue through some of the implementation of the changes we described, continue to strengthen our balance sheet, and to get us into position like we did last time with the Utilimaster folks. Right? We got in a healthy position where we had a strong cash balance. We were able to make that acquisition and also finance some of it and quickly pay it back. So I think you'll see that same logic apply to us going forward. Let's continue to strengthen our balance sheet before we take the next step.

Ned, as John's detailed, that's why as I started off, I said the four basic, simple foundation points - compelling products, profitable market share growth, cost structure management, balance sheet management. I mean, we've done a lot and did a lot in 2009 from a transformation perspective. Now it's about implementation to drive over time double-digit growth in both sales and income. So--and sometimes people can spread themselves too thin. We've done that in the past. I'm not going to go down that path again. Now it's about improving our focus to improve the implementation and execution.

Okay, thank you.

Thanks, Ned.

Our next question comes from Jamie Wilen from Wilen Management.

Fellows, a couple questions on the business segment chart that you put out there. One thing I don't understand is when I look at interest expense, the EV team has about $0.5 million a year or $0.5 million a quarter, yet Utilimaster that you just paid $50 million for only has a $50,000 interest expense. Could you explain that?

Yes, sure. It's really just a method of how we utilize the intercompany interest expense and how we charge it between the companies. It's all based on their intercompany purchases and their intercompany balances. So, in essence, Utilimaster started with a clean slate through the acquisition, didn't have any of the intercompany balances kind of with it. On the other hand, the Crimson business and Road Rescue business had some higher intercompany balances from the prior years. So that's what we use as the basis from an intercompany perspective on the interest. So--.

--Is it fair to really look at the segment--when you look at the segment earnings and you put all your interest expense against the EV team and nothing against anything else?

Great question. When we look at and evaluate the business internally, that's an element which obviously we consider. But we look above the line at the operational performance above that. And we look at how the companies are doing from more of that operating income perspective before you get to some of those other charges below the line. So that's a very fair comment, Jamie.

Okay. But nothing that you're going to address? You're just going to keep it that way.

No, well, I mean, I think you're challenging us to look at it. You brought up a good point and we will look at it. I mean, you've got some very good merit to it. I mean--.

--Yes.

Joe and I are sort of smiling. I'm just a little bit surprised we haven't heard some comments from some of the people at Crimson or Road Rescue about this. But you've got a good point.

In the EV team this quarter you made money. You had stated that you were going to lose money for the year in the EV business. Could you explain that disparity?

Well, I think, the clarity is here. Both groups made - I should say they improved their business model and execution substantially relative to what the plan or the expectation was. Again, the first quarter is not a guarantee of what the second quarter is going to be. But as I commented earlier, we made progress both at Crimson Fire and Road Rescue. So, again, celebrate and enjoy the improvement. However, are where we--are we at where we want to be, especially at Road Rescue? The answer is no.

You saw, Jamie, a lot of improvements in the quarter in the EV team, specifically from the Crimson Fire business unit, and a lot of it was high demand, great orders. You saw that in the revenue numbers as well, too. That was some of the buy--the--in essence, the transition engine buy ahead orders that took place in the fourth quarter. So they had great demand in the third and the fourth quarter as a result of people trying to buy ahead on these transition engines. That rolled into some first quarter pretty strong performance.

Now, are we going to try to continue to maximize that and drive as much profitability through that segment through future quarters? Absolutely. But we're just cautious as well, too, watching the demand as we've brought up before around municipal markets going forward and what that might look like as you get to the later quarters in the year, especially for somebody like Crimson.

Okay. And lastly, as far as Utilimaster, again, you paid $50 million. You expect a very decent return understanding this year is a transition year. But what would your objective be to--on the $50 million investment? What type of return type of earnings would you look to achieve in 2011 and beyond on an annual basis?

Yes, how we looked at the decision when we made it, Jamie, is we evaluate everything here now under an [EVA] framework to it. So we looked at it again. We looked over a long timeframe. So we made the acquisition. We looked over a 10-year period of time. What's the benefit, the results going to be? And we also went beyond an income statement, looked at the balance sheet implications, and looked at the full, what's the EVA impact to it. The EVA cost of capital we use for evaluation purposes is an 11% number. So that's our hurdle rate that we use. This is more than past that.

We're really excited about the potential, especially in light of one of the reasons for the acquisition was the new product launch with Isuzu that we described. That put them in a great market position to further increase and enhance their market share, plus, it's also--because it's an innovative product, it also improved some of their profitability as well, too.

So, if I can translate that back to income statement-wise, when you say an EVA of 11% as a hurdle rate, how does that--is that translating somewhat to the purchase price of we should have pre-tax earnings from this segment of a certain level?

It's really a cash flow tool. So from an EVA perspective, similar to doing a net present value analysis. A return on our $50 million investment gains us over our threshold, which is 11% return. So either return on invested capital or if you want to look at it as a net present value discounted cash flow, what's that hurdle rate. It's that number, which is the 11%. Does that help?

And a lot of that is taking to the account working capital improvements such as reducing inventory and receivables as opposed to income-related things.

Well, some of it will be that but more of it is based from the income side. When we did the acquisition analysis we didn't anticipate a ton of improvement from the balance sheet part. We didn't know that much about it going into it. More of our improvement was based on the operating income perspective on it. Plus, of course, there was a lot baked into it from the synergies of our--the combined organizations pulling them together between Spartan Motors and Utilimaster, getting some synergies by leveraging some activities across the organization. And we're clearly seeing some of those as well, too.

Okay. And lastly, as you talk about the improvement in Utilimaster, their profit outlook in the third and fourth quarters, is that--is there any seasonal basis to that or once you round into 2011 the first and second quarter should be kind of firing as they were in the third and fourth of 2010?

The profitability is really due from two things. One is lower cost. A lot of the R&D is in the first half of the year. Right? So the R&D is in the first half of the year, so you won't have as much spending and R&D in the second half of the year. So that's part of how you'll get additional profitability in the second half of the year. And the second element, as you described, is from a revenue perspective. Again, this is more of a--not as much their particular seasonality, but more of where they're at in the cycle and the general economy, and our confidence and theirs that as you get towards the back half of 2010, given what we're seeing in the economy today, you'll see that pickup in their business start to flow through, which will carry into 2011. Yes.

Okay. Thanks, fellows.

Yes, you bet, Jamie.

Thank you, Jamie.

(Operator Instructions.) Our next question comes from Joe Maxa from Dougherty and Company.

Thank you. Sorry if a couple of these questions have been asked. I was jumping from another call. But can you just give us your thoughts on the overall top line revenue trend for this year when you blend it all together? Should we be near similar levels to Q1? Do you see some pickup? What should we be thinking about?

Yes, we don't--as you know, we don't do a forecast going forward, so we don't kind of give that level of detail. We can describe here, just from a general perspective. I don't think anything in our view of the business going forward would suggest anything different on a quarterly basis than what we're seeing in the first quarter. No, there isn't anything dramatically different.

Now, we'll see some shifts in our business. We do--because of the ILAB and some of the government business, we'll see a little bit more of the government business as we get into the second and third and even fourth quarter. And we'll probably see a little bit less of the fire truck business as we get into the end of the year, the fourth quarter as well, too, as we're working through some of the transition engine orders right now. And we'll probably start to see the mix shift to a little bit more of the business from Utilimaster in the back half of the year as well, too. But when you put all of that together, Joe, I don't know if I see a dramatically different picture through the year than the type of demand estimates in total that we saw in the current quarter. John, your thoughts?

I think, I mean, on the positive side, the economy is moving in the right direction. So--and that especially relates to two markets - outdoor rec RV and delivery and service. When you look at consumer confidence numbers, they're starting now to ratchet up a little bit more again. And that's a positive. I think, Joe, as we look forward, there's probably more pressure on the positive side from a market perspective than there was maybe two or three months ago. I think two or three months ago people were talking about maybe a U-shaped kind of recovery. There was a recovery, then a dip, then another recovery. You don't see that much being talked about anymore nor do you see that in the data quite so much anymore.

So, again, we don't do guidance. But I think as you look at the macro data, stay focused on consumer confidence, especially as it relates to delivery and service and outdoor rec RV, and right now we're a little bit more optimistic today than what we were two or three months ago. I know you'd like something very, very specific, but that's something we're just not going to do.

No, that's a helpful look at the systems and ideas of what you're thinking. Obviously, all your businesses have different trends. Let me ask on the gross margin side, I mean, we were looking for it to start to pick up and we saw some softness sequentially. Are we beyond that where we should start to see a blended gross margin start to pick up maybe a percentage point or so?

Yes. A good portion of it is driven by the mix issue. The decline from fourth to first quarter was really the shift in business mix. I think that's the major change. If you think about--we talk about demand being reasonably stable, so that means you're not going to get a lot of fixed overhead cost changes or absorption changes. It's all going to be the mix of the issue, which will drive a different gross margin. As we were talking about through an earlier question, with a little more defense business in the second and third quarter that'll help our gross margins a bit in those quarters most certainly.

Okay. And do you have a target margin you're trying to achieve?

Yes, as we've described before, our long-term gross margin is targeting a high teens gross margin number.

I meant operating margin. What are you trying to get for the year or maybe next year?

Again, long-term perspective we are targeting that mid-single digits. Our financial structure has been getting to a high-teens gross margin, low-teens operating expense, and really targeting an operating income at the mid-single digit range.

All right.

And I think, Joe, again, this was a discipline which started to come about mid-2008. We're looking at each one of our key financial metrics from a range perspective because we're in today four different markets. And in different markets you've got different areas where you have to or where you should be operating in relative to flexibility, et cetera. So that's why I don't think you see--it's hard for us to put like a single point out there. You have to look at it in a range because each market is different.

Right. That's helpful. Thank you, guys.

Thanks, Joe.

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

First, I want to thank all of you for being on the call. I also want to thank all the SMI associates for really doing a lot--or really accomplishing a lot, especially from a strategic perspective and a balance sheet management perspective. A lot of progress was made. Second, we are very focused on compelling products and services, growth and profitable market share, cost structure management, balance sheet management. As we implement, ultimately we will transform the world through specialty vehicles. That's our mission. That's our vision. And over time that will become more of a reality.

Thank you very much. Have a great day.

This concludes today's conference call. You may now disconnect your telephone lines.