Shyft Group Inc (SHYF) 2013 Q3 法說會逐字稿

Good morning and welcome to the Spartan Motors Third Quarter 2013 Conference Call. All participants will be in listen-only mode until the question and answer session of the conference call. This call is being recorded at the request of Spartan Motors. If anyone has any objections, you may disconnect at this time. I would now like to introduce Greg Salchow, Director of Investor Relations and Treasury for Spartan Motors. Mr. Salchow, you may proceed.

Thank you. Morning everyone and welcome to the Spartan Motors third quarter 2013 earnings call. I'm Greg Salchow. I'm joined this morning by John Sztykiel, our President and CEO; Lori Wade, Interim Chief Financial Officer; and Tom Gorman, Chief Operating Officer. For this morning's call, we'll change the call format from past practice to devote some more time to the question and answer portion. We'll shorten our prepared remarks compared to previous quarters, so that we can address more of your questions.

Before we start today's call, please be aware that certain statements made during the call, which may include management's current outlook, viewpoint, predictions and projections regarding Spartan Motors and its operations may be considered forward-looking statements under the Securities Laws. I must caution you that as with any prediction or projection, there are a number of factors that could cause Spartan's results to differ materially. All known risks, our management believes, 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 that we face that we cannot anticipate. And as always, please remember that during the Q&A period, just ask one question and a follow-up and then after that please rejoin the queue, so that everyone has an opportunity to ask a question.

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

All right. Thank you, Greg. Good morning everyone and thank you for joining us on Spartan Motors third quarter 2012 conference call. We also have Tom Gorman, our Chief Operating Officer with us today as well for the Q&A portion of the call. Tom will be able to provide additional details on the operational initiatives we have underway throughout the organization.

As we start -- we continue to make progress in operating performance by executing our DRIVE strategy. As we stated during our second quarter conference call, we expected to make further improvement in operating performance in the third quarter and we delivered. We continue to execute DRIVE and expect to show additional progress in the fourth quarter of 2013 and into 2014 as well. There is one negative, though. For full year 2013, we expect to show a modest loss. Simply the hole we dug in Q1 of this year appears to be too great to overcome. Again, we expect Q4 to be profitable, improvement over Q3, and Lori Wade will get into the details of both Q3 and an outlook for Q4.

Today is really about two things. Operational improvement, results in Q3 up versus Q2 of 2013 and up substantially versus a year ago. The second item today is about -- it is about the future. Continued operational improvement with a strong backlog, up 37.8% versus a year ago and we're at our highest point since December of 2009. Include the recent Peru order, and today, we are at our highest backlog point in the last four years. The "I", Integrated Operational Improvement and the "D" Diversified Growth are both delivering results, simply DRIVE is working. Today is about operational improvement in the future. Operational improvement and strong backlog, giving us an opportunity for growth.

Now I'll turn to some of the quarterly highlights of our business segments. The delivery and service segment or DSV reported an operating profit of $1.3 million during the third quarter, as performance improved substantially from Q2 and the first half of the year, and this was great to see. To give you a little bit more color, walk-in van production has increased each quarter since the start of production in February of this year. Production in Q3 averaged 21 units per day, versus 14 units per day in the second quarter, a 50% increase. While we are not at plan yet, we have made great progress and expect further progress in the coming quarters.

Production of the Reach, let's switch product lines, [ramped] up early in the third quarter, followed by the addition of a second shift in August. During the third quarter, DSV produced 402 Reaches as part of the 1,900-unit order for FedEx. We expect to complete this order during the first half of 2014. During the last quarter's call, I also mentioned Utilimaster was Frito-Lay's 2012 Supplier of the Year and that we had just completed an order for 254 truck bodies that were built on the Reach production line. This marked another operational step forward for Spartan Motors, Inc., as we increased our flexible manufacturing capability. As we look over the next two to three years, I would expect very little CapEx, brick-and-mortar facility increases from us, from a dollar perspective. We are very focused on flexibility, double-shifting our operation to maximize the operating return.

We also recently received a follow-on order from Frito-Lay for several hundred more truck body units to be built in the first half of 2014. It's not surprising, when you execute, you do it quickly with high-quality product. Excellence always attracts , and it was great to see Frito acknowledge that with a substantial order as we look into 2014.

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

In addition, as we mentioned in our press release, during the third quarter, the delivery and service industry began to experience a slowdown in new truck body orders, compounded by a lack of availability of certain chassis. This had a fairly small impact on the third quarter, but is expected to have a more significant impact on the fourth quarter. At present, we believe this a seasonal softening for the next quarter too, rather than a long-term drop in demand. We say that because over the last couple of weeks, two of our largest fleet customers discussed their growth in both ground and e-commerce delivery. So long-term, small vehicles, small packages, small product, small services will look at Utilimaster delivery and service as a tremendous growth opportunity.

Now, let's spend a few moments on Reach, a very key strategic product for us. Today, we have absolute clarity about five items. First, Reach is a very exciting product in its current state on a diesel chassis, as demonstrated by the 1,900-unit order from FedEx. The current version of the Reach appeals to a segment of the overall market for commercial vehicles, a segment that we think totals 2,000 to 3,000 units per year for the Reach. Why diesel? Diesel, on average, is 20% to 30% more efficient than a gasoline engine. And as FedEx noted in their release earlier this week, fuel costs were their number one issue relative to margin erosion on their ground vehicles. So diesel chassis have a significant impact today and a significant impact and opportunity for tomorrow. Why? Because they are simply more fuel-efficient.

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

The third item relative to Reach is the commercial van market is growing rapidly, but it is also changing. Much of this market expansion stems from newer, smaller and more efficient commercial vans entering the marketplace over the next couple of years. These new entrants, along with growth in the market, are changing the competitive landscape, which in one respect is not surprising. If there is growth, then other people want to jump into it. This also creates an opportunity for us to add new variants of the Reach and to offer some of those variants at lower price points that compete more directly with some of these newer commercial vehicles.

We plan to increase the number of Reach body offerings to increase its flexibility and appeal to more segments of the marketplace. This is something we are actively working on today. Likewise, we are working on increasing its payload capacity by another 500 pounds, a project we are actively working on today. We're also currently analyzing the feasibility of offering more powertrain options. These options could include a gasoline engine, compressed natural gas or CNG and gasoline/electric hybrid solutions as well. We're at the beginning stages of this analysis, Reach product reset process, and it's something we will be very focused on over the next six to nine months. But as we look at the Reach, it's a market of great opportunity.

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

In summary, relative to the Reach, the overall expectations of the Reach's potential market size remain in the 7,000 to 10,000 [units per] year range. But the way we get there is different than it was a year ago. All markets evolve and the commercial van market is simply no different. Does it present us with challenges? Absolutely. But these challenges also present us with some very exciting growth opportunities.

Alright, now let's shift gears over to emergency response. The emergency response chassis business, or ERC, continued to make a strong contribution to the segment profitability, while the emergency response vehicle group, or ERV, made continued progress as well in improving its operating performance. Reports from the field indicate that pressure on fire departments is growing to replace aging fire trucks and apparatus, which is certainly good news for us and the industry. Again, to provide some color, a perfect example is the Southern Michigan dealer for Spartan ERV sold less than five units each year in 2011 and 2012. Already in 2013, this exact same dealer has booked 16 units. Obviously, the industry is rebounding, but we're also gaining share.

When we talk about new products, lower cost aerials, other things, we're very optimistic about next year as well. We're also seeing a higher take rate on our APS, full-cab airbag protection safety system, topping 70% in the third quarter of 2013 compared to a historical rate of 65%. Little bit more color, APS airbag safety system is a redefining technology and innovation relative to emergency response. It drives growth in sales. Through competitive market cannibalization, we're taking market share from other people. And next, it drives enhancement in the gross margin. This is the R part of DRIVE redefining technology and innovation working to perfection.

Our outlook for ERV remains positive, showing incremental improvement in each quarter of this year and we look forward to Q4 and 2014 as well. We've added engineering and operations management talent in recent months, which is all playing off. We have a lot more work to do in these areas and we're moving in the right direction. Probably the biggest challenge we have at ERV is we're working to improve the operational efficiencies, as we continue to grow the business in a very, very dramatic way. Another side note, as we look at the Peru order, which was noted in the release, 56 trucks, diversified global growth, the D in DRIVE, leveraging the capabilities, our relationships [ of GIMEX] to the benefit of a $17 million, very profitable order. This bodes extremely well for Spartan ER and Spartan ERV for 2014.

Alright, moving over to specialty vehicles, reported another outstanding quarter with both revenue and operating income increasing from the third quarter of 2012. Motorhome chassis sales rose more than 23%, as we continued to gain market share. Our focus, to be the most desired brand in the RV industry that there is simply nothing better than a Spartan, and that is what we are focused on. The good news is, we're gaining some traction. The RV industry also continues to recover, due to growth in disposable income, increased housing starts, pent-up demand, and easier financing. So as we look at the RV business, we're very, very excited, not just about today, but as we look at 2014 and beyond. The reality is, the RV industry is our largest growth industry and we're very focused on that.

Aftermarket parts and accessories, or APA, business performed well during the third quarter, but fell a bit short of year-ago levels, due to the slowing of defense-related parts. This was nearly offset by growth in revenue for Motorhome and fire truck part sales due to RV owners traveling extensively in the quarter and our efforts to expand sales in the emergency response arena.

During the third quarter, we also combined Utilimaster's aftermarket parts operations with the specialty vehicles parts operations in Charlotte, Michigan. The move went smoothly with no disruption to either group's operations. We expect this to generate modest cost savings for both segments in the short term. Over the longer term, we expect improved revenue growth, as the Charlotte-based APA group has exceeded their financial plan for 13 months in a row. That is great. A reduced cost structure, enhanced leadership, which means larger long-term opportunity, another example of DRIVE in action.

In summary, great news, each business posted higher incremental profit compared to the second quarter of 2013 and versus a year ago in 2012, as we successfully executed our DRIVE strategy, particularly the I in DRIVE. As well, the future, backlog up 38.7%, highest since the end of 2009. DRIVE works and we will continue to implement it, as we closed out 2013 and move into 2014. Also, as always, we face challenges, mentioned a few of them already, and as we execute our plans and run our business, we are more than meeting the challenges we are moving forward and our results illustrate this.

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

Thank you, John, and good morning to everyone listening this morning. During last quarter's call, we shared our expectations that the third quarter of 2013 would be more profitable than the second quarter. That proved to be the case, as Spartan posted operating income of $1.8 million versus $1.1 million. Operating income of $1.8 million also compares favorably to the loss of $0.3 million in the third quarter 2012, even if you include last year's restructuring charge of $1.6 million.

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

Income tax expense of $1.3 million was taken to adjust the income tax provision for 2013 to-date, in anticipation of a full-year rate of approximately 20%. Another way to look at it is that tax credits we booked on operating losses in previous period, such as the first quarter of 2013 were based upon projections of a 37% income tax rate for the year. Based upon our financial performance for the first nine months of this year and our outlook for the fourth quarter, we determine that a 20% tax rate was likely. This caused us to reduce the amount of tax credits from prior periods and resulted in income tax expenses well above statutory rates in the third quarter of 2013. We expect the tax rate for the fourth quarter of 2013 to be at or below 20%.

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

Inventories increased to $82.4 million at June 30, compared to $73.7 million at June 30, 2013. Most of the change was due to higher inventories at Utilimaster and in the motorhome chassis units. Much of the increase in Utilimaster's inventory was due to the ramping up of production of the Reach during the third quarter and extending into 2014. Inventory growth in the motorhome chassis unit was due to higher production and sales expected in the fourth quarter of 2013. Even with the ramp, I've discussed, we feel our inventories are too high for our business level and actions are being taken to right-size inventory levels at all locations.

Moving on to accounts receivable, grew to $52.3 million at the end of the third quarter, compared to $50.6 million at June 30, 2013, driven by higher sales during the third quarter. Accounts receivable stood at 35 [DSO] sales, meeting our target for the quarter. Higher receivables were more than offset by the growth in accounts payable to $32.9 million at September 30, 2013, versus a $24.2 million at June 30, 2013. Growth in payables closely tracked higher inventories, which should build up late in the third quarter to support fourth quarter production.

Growth in cash, a healthy balance sheet and improving profitability provided our Board of Directors with the confidence to declare a semi-annual dividend of $0.05 per share. The dividend will be paid December 19 to shareholders of record as of close of business on November 14, 2013.

Now moving on, as is stated in our press release, we expect the fourth quarter of 2013 to be profitable with operating income comparable to the third quarter of 2013. Our DSV business has experienced some slowing of orders for truck bodies, as has the rest of the industry. We believe this is a short-term issue reflecting a more pronounced seasonal demand trough, rather than a longer-term drop in demand. The DSV segment has also experienced some delays in receiving orders for the field service solutions from certain customers. These delays, along with sluggish truck body demand and some chassis availability issues are projected to reduce our fourth quarter profitability from our prior expectations. So we expect the fourth quarter 2013 to be profitable and anticipate a modest operating loss for the year as a whole, as John mentioned. This is due to the operating loss experienced during the first quarter of 2013, due to the move in launch of the walk-in van production at the Bristol, Indiana facility.

We expect to share our expectation for 2014 no later than our fourth quarter 2013 press call. Although we are not providing specific details regarding 2014 today, we know that we expect to wrap up 2013 on a profitable trend and expect improved financial and operating performance in 2014. I want to thank you all for your interest and will turn the call over to John Sztykiel for his closing remarks.

Alright, Lori, thanks so much and I'll keep it short. In summary, the third quarter of 2013 was about executing our DRIVE strategy. Integrated operational improvement, the "I" in DRIVE, as all three of our business segments were profitable during the quarter, with a positive outlook for further improvement in Q4 of this year.

Next is about the future. The future is simply the result of the order backlog and turning that order backlog into operating income. And our order backlog is strong, increasing in two of our three segments and the numbers today do not include the Peru order. And, finally, we are encouraged by our prospects and outlook. As we look at the future, as shown by the declaration of the $0.05 per share dividend, we've had a dividend for 20 years in a row. We always recognize that there are challenges ahead of us, some very, very significant, thus this always tempers our optimism. Okay. But the reality is every business has challenges. We've shown in our ability to overcome those challenges, to execute DRIVE, deliver results and move in the right direction. We look forward to ending 2013 on a positive note and carrying that momentum into 2014 and we've got some good wind at our back with a great backlog.

Thank you very much. Operator, we're now ready to take questions.

(Operator Instructions) Joe Maxa, Dougherty & Company.

My question -- first, I want to ask about the outlook for the rest of the year. Previously, you were expecting mid-single digits growth. Are we looking to see growth, given what you indicated on 4Q? And then also, did 3Q come in for expectations, just kind of curious what your internal goals were there?

Hey, Joe, this is Lori. I'll take the third quarter. I will tell you that we did see some softening in the truck body that we had not anticipated. I will say that our projections, they were down about 14%, versus what we had expected, and we believe in the fourth quarter to be about 48% reduction versus what we had expected. Our ERV segment was down slightly, just inability to get product out the door. The rest of our segments were pretty much right on task. We do believe that as mentioned, the motorhome, the RV business will be up in the fourth quarter versus third quarter, that we still -- going to the field service side, we still project that to be very soft compared to what we had anticipated early on in the year.

I see. Nice. Excuse me. So let me address gross margins. Gross margins down a little bit sequentially. I realize that would be year-over-year. Where do you think they can get to when you have -- when you're running on all cylinders, right, everything is working right. I mean there was talk of 17% a while back, maybe 15% is a better number. What should we be looking at for gross margin moving forward?

I would say that we have looked at that. And the 17%, we believe that in several years we'll have moments at being 17%. I don't believe that right now we believe that that is a sustainable full-year projection for a gross margin target. We're thinking more in the range of the 15% to 16% range. It's probably more of the segment, the market we could get with our base business as of today.

Joe, and this is John Sztykiel, one of the things we've brought it down a little bit is simply, as we looked at each one of our markets, and you see in the Reach, you see in the emergency response, you see it even the motorhome business, while there is very, very good growth, there is also an increased awareness or competitive pressure relative to price, okay? And so the reality is, we've got very good growth in our segments and our markets, but we've had to revise our outlook as we look over the next two or three years, and the reality is things are going to be a little bit more price-competitive in some of the lower or more entry-level markets, where I can't say we've got great products and we've got the right operational plan to execute from our perspective. So the reality is we're probably going to discount a little bit of our higher margin products to continue the growth. So the reality is, we've adjusted things down a little bit.

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

This is John Sztykiel, Joe, that will ship within the next 12 months, okay. So I mean it will ship within the next 12 months as of the end of October.

So that's going to be staggered to the year, it's not like one-quarter type shipment?

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

Understood. Thank you.

Robert Kosowsky, Sidoti.

Hello, good morning, how are you doing?

Good morning, Rob. How are you?

I'm doing alright. I was just wondering if you could maybe talk a little bit more about the progress you're making on the DSV side with the material handling, and kind of what you've seen there and kind of how the -- you know, the margins could also be trending on the Reach side as well, again, to gross margin-positive.

Yeah, Rob, this is Tom Gorman. Q3 was a real step forward on the material handling side for what we did. We did redo the racking that we had down there as well, lowered the group and the headcount by almost 25% and improved the time to line, if you will, on a daily basis that reduced our calls in for [ferrous] materials by about 80% over that particular period of time. So we're really -- really hitting pretty well. We've got a couple of cells that have given us some burps and headaches. But the material issue, by and large, has handled itself pretty decently, one section that we're working on pretty hard, but it's gotten away from some of the other stuff that we had experienced in Q2 certainly.

Okay. And was that because of lower build rates on the -- maybe the (multiple speakers)?

No, just -- actually it's just the opposite. The build rates on a daily basis have gone up on both lines. We're at about 18 a day in the high-volume line and 12, 13 a day in the low-volume line and pushing that through pretty decently. So we had pretty decent bill rates, -- about the same as it was for Q2, but in some days higher as we continued to ramp up that mixed modeling.

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

Yes sir.

Okay. And then otherwise, on the emergency response side, I don't know, product complexity was somewhat of an issue. It seemed like you -- it offered too much complexity to your customers and it was hard to build that. I'm wondering what progress you guys have made on that? And are you now resorting to maybe just offering a few different bundles that maybe reduce the complexity to make it easier to -- you know, to make, and then also if you can maybe touch upon the gross margin of the fire truck side of the business as well and the backlog -- the gross margin and the backlog?

All right, Rob, this is John Sztykiel. First, you know, the complexity is both positive and negative. The positive is the customers love it, the negative is it's difficult to build. So, the reality is we're working through very, very focused on the front end and what I would mean by that is defining a very clear order at the dealer, making sure that the contracts go through sales and engineering and purchasing in an expedited way. So that when it does come to the line, we're able to build the products effectively and efficiently. A key metric we're watching at the ERV group is, over time, we expect that to come down in Q4 versus Q3. And one I have no doubt we'll solve it, because we had the same issues at Spartan Chassis, five and six years ago and you work through mechanically, just one issue at a time or multiple issues in a very defined plan, but we will get there.

I will say this, though, it's interesting when you made the comment about the simpler trucks or we use the term program trucks, because it sounds like you were almost listening into our confrontation. One of the things we will be doing differently in 2014 from an emergency response perspective is we will be offering more programs or menu-driven trucks where there is less options available. And this really does a number of things. One, it creates an order, which improves overhead absorption, enables you to negotiate more efficiently at the supplier base, but what it doesn't do is have engineering be so involved in every order, okay? And so, we see this as a tremendous opportunity. The other [win for it], is short deliveries are becoming more and more of a priority within the emergency response industry and I think it's just society as a whole, where ones people want, they are [$250,000] to $1.3 million object, they just don't want to wait six, nine, 12 months. They want that fire truck and they want it right now.

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

The last thing is relative to the gross margin, the gross margin of the emergency response vehicle group is definitely better today than what it was six and 12 months ago. Part of that is the Peru order, part of that is some price increases, they are now starting to move into the queue, which will be built in 2014 and as we move on. So that is one of the reasons we're more optimistic about 2014 from an emergency response, especially a vehicle perspective, as we just know the help of the backlog is substantially better versus six and 12 months ago. Did I answer your questions?

Yes, you did. So it seems like the pricing is going to -- I guess, going to burn off some of the lower margin backlog within fourth quarter, but then as you enter next year you'll have a little bit more price increases and that's going to kind of carry you into better programming offering.

Exactly. I would expect both of our product groups, both emergency response chassis and emergency response vehicle to have another price increase going out -- in Q4 of this year and into 2014. But also we had some price increases earlier this year, especially in the vehicle group that we will start building in Q4 of this year and into 2014 as well. So this price increase in the emergency response vehicle, this didn't necessarily start in Q4 of this year. This started much earlier in 2013, as we knew we had to right-size ourself on the pricing side of life.

And it just gives the markets a little bit better market, because municipal finances might be a little better. So it's a little bit -- I'm not saying less competitive, but little more accommodative to pricing, is that kind of what's going on in the industry?

You know, I think that's part of it, because the reality is the market has been off close to 50% for the last two or three years. So everybody would like to make a little bit more money or make some money, us included and our honorable competitors. So I'm sure that's part of it.

The other thing I will want to say, though, is our marketing group in emergency response, when I look at the industry, I would unequivocally say we are absolutely number one when it comes to marketing, go-to-market. When I look at our marketing and the investment which we've made and the execution of the team and you look at the growth of our backlog -- and that gets back -- if your brand or your aura is stronger, you can command more for the price. So when I look at our growth in backlog and I look at our growth in margin relative to 2014, I really want to compliment our marketing go-to-market group. We're doing a lot of things extremely well relative to our competition.

Okay, good. And what was the -- just last question, the Brandon, South Dakota facility, what's going on there, anymore clarity on that?

Now, we're still continuing to have some improvements there, looking to maximize our footprint on that. They've -- they juggled the schedule and with some of the continued -- we bolstered up the resources a lot, where we had some capacity issues, especially relative to -- in the engineering area for getting the engineering packets out to the floor. We've solved that problem and are getting the product out to the floor in a much more timely manner, Rob, and getting the trucks out the door. As Lori mentioned, we had a few things that we fell short on in Q3, but they're catching up pretty well.

You know, Rob, and as Tom said, the engineering packets -- and meanwhile, we are a very customer-centric company and that's our niche, is to serve the needs of many in a very broad way in very narrow markets, and is absolutely imperative that we have a clean order when it hits engineering. When it hits engineering, if it's a clean order, it is amazing how fast and efficient things operate. And just to use an example, as I'm sitting, looking out this window on the Charlotte campus, today on the Charlotte campus, where we've got a great set of 33 processes, which we call the Spartan operating system, today on this campus, we build fire truck chassis, RV chassis, we're building the Isuzu product at now approximately 29 units a day, with approximately 55 people. We're building the Reach product, we built Frito-Lay truck bodies, we're building almost anything within our repertoire of products, but it gets back -- when you have great people with great processes, it's amazing how efficient you can build something.

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

One more thing that's helping us on the Brandon facility is we're getting more multiple orders of trucks of more than one out -- singles, and that's allowing us to do a single engineering packet that would go through multiple trucks as well, and that's given us some pretty good help.

Okay. Thanks very much and good luck for everything.

Thanks.

(Operator Instructions) Shivangi Tipnis, Global Hunter Securities.

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

Shivangi, this is Tom Gorman. Our preference would be, if the orders keep coming in, our target would be to get above 35 if we can on one shift with the ability to move into a second, if needed be. But at that point, if we can hit into the mid 20s and close to 30 a day that's a good sweet spot for us and works well for our suppliers, but it really does depend on the supply and demand. And I believe, as you probably know, this is a walk-in van, because the large fleet orders can be pretty highly seasonal, where we're concentrated in late second quarter and third quarter with a little bit of a down in the fourth and first quarters.

Okay. And in terms of the margin improvement for the DSV, what is the expected improvement to the reengineering and the body structure, do we expect it to come in quarter four of 2013?

Shivangi, this is John Sztykiel. Relative to the specific dollar number, we really are reluctant to provide that because honestly, our competitors listen to these calls, it's a very competitive nature out there. That may be something Lori and Greg could work with you on. But relate to these cost reductions, as we look at Q4, most of the cost reductions will be through operational improvement, working through the issues on the line, where you'll start to see what I would call bill of material cost reductions through engineering-driven initiatives. That's actually going to be late Q1, early Q2 and they've got a very nice number identified. And I'd say what, very astute on your part to bring this up, because as we look long-term, we expect Bristol or this initiative, and it won't be in 2014, but to move past the $4 million savings, because one of the things we're now focused on is not just operational improvement, but also evolving the products. So it's easier to produce at a lower cost point, both from a bill of material and a labor perspective.

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

Okay. So all of these, like material cost and the engineering and all that would be for the entire DSV? So it would be for the Reach, as well as for the Bristol move, am I correct?

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

Okay, okay, that sounds good. I just had a last question. Do you have any new orders for Reach after this 1,900 that are expected to be done by -- in first half of 2014?

Well, this is John Sztykiel again, we're working very, very hard to secure those orders. The reality is, as Tom Gorman mentioned a few moments ago, we deliver a heck of a lot of product and there is a saying within the industry, sight unseen after Halloween. That's how they operate. So, the reality is, right now we're delivering product and they say we don't want to talk about ordering more products till we get past Halloween and then we get very focused on that. So do we expect more orders for the Reach? The answer is yes. Do I see us announcing anything over the next 30 to 60 days? Probably not, because that's just how the larger fleets operate.

Okay. That was helpful. Thank you guys.

Okay.

Joe Maxa, Dougherty & Company.

Just want to follow up on the tax rate, the 20% expected this year, do you expect that moving forward as well?

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

Right, the mid-30s or mid-to-upper 30s.

Exactly. Exactly.

Okay. And then there was also -- I saw a recall, is that on some motorhome chassis? Is that having -- do you expect to have any impact or is it just too minor?

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

Thank you. That's all I had.

Robert Kosowsky, Sidoti & Company.

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

I would say, so Joe -- or, sorry, Rob. So that business is made up of -- I think that we have motorhome chassis, we have Isuzu contract manufacturing, we have the defense build, we have APA which is made up of commercial and also the defense side. So, in Q2 of this year, we built out an ILAV order for 24 units. So that was a spike in Q2. As the sequester continues, we really truly are starting to see a lot of defense aftermarket parts drop down. And the motorhome is pretty consistent. We did have a low quarter in Q3, but we expect it to come right back up in Q4.

So, we have a lot of very diversified products in that whole segment that is causing that interesting anomaly. We've also taken our contract manufacturing for Isuzu up from 21 a day, up to 29 a day. So all those things coupled together makes it really difficult for me to give you a lot of guidance, because we never really know for sure when we are going to have those ILAVs. Those are one-time nice, nice increases, but we are growing the other aftermarket parts business, but we are expecting the defense side to continue to be down.

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

Rob, this is John Sztykiel. The defense business will be extremely spotty. And we do expect to get some ILAV orders next year, but they will be a very, very small number. The good news is when we get them, they are extremely profitable. We intend to stay in the defense business, both from a parts perspective and from a product perspective, because at some point in time the defense industry will get back to a more normalized cycle. Right now with sequester, we're seeing just a lot of defense cuts, it's not just us, but a variety of other people are actually being hurt much more than us on the wheeled-vehicle side of life. So, as we look at the defense business, when it comes in, it's great, it's going to be a tremendous boom to our margins et cetera, but it's not something we work into the forecast, because it's just extremely unpredictable right now.

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

That is our projection. We believe that -- as you know, we were behind -- we're a little behind in our Reach production. As we talked about, we are a little behind in our ERV projections. And also, when ERV changed their build rate downward, it was very difficult to slow that supply chain pipeline down for chassis, whether it be in customer, commercial. So we do have pause of excess inventory. So, we believe we can -- we are shooting for to reduce inventory between the 10% to 20% going into the end of the fourth quarter. We do know that as we continue then to ramp up businesses, when the truck body comes back, we'll take a little bit of cash. But think about inventory in -- probably full year, probably closer to a 10% reduction versus where we are at right now, going into next year.

And, Rob, this is John Sztykiel. That we should absolutely hit, no problem. To give you a little bit of color, at Spartan ERV, they've currently got 90 chassis on the ground, the reality is that their production rate, they should have maybe 35 to 40 chassis on the ground. So when you think of the value of those chassis, anywhere from $150,000 to maybe $300,000 in cost, that's a huge opportunity. So, I have no doubt that as we look through Q2 -- I should say Q1, Q2 and Q3, as we improve the efficiency of the operations rate at ERV, you'll see a substantial drop in our inventory number, in turn going into cash, reinforcing what Lori just said. And I have no doubt we'll get there, it's just a simple matter of operational mechanics making it happen.

Alright. Thank you very much.

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

Alright. Just want to say thank you very, very much to all. As we mentioned earlier, 2013, we look to close in a very solid positive way. We obviously have some significant challenges, but to be quite blunt, we've improved our operating results and it's not easy. I will tell you what, everything is a grind. But yet, when I look at the backlog and I look at where we stand today, and I know the gross margin in our backlog is more positive than what it was six months ago and what it was a year ago. That feels very, very good, as we look at 2014, and not a lot of organizations can say that today.

So we're thankful for the past, we're focusing on executing the DRIVE strategy and we're very, very focused as a group of team members to execute, not just into 2013, but 2014 and beyond, and deliver improved operational results for each and every shareholder. Thank you very much.