Shyft Group Inc (SHYF) 2018 Q3 法說會逐字稿

Good morning, and welcome to Spartan Motors 2018 Third Quarter Conference Call. (Operator Instructions) This call is being recorded at the request of Spartan Motors. If anyone has any objections, you may disconnect at this time.

I'd now like to introduce Juris Pagrabs, Group Treasurer and Director of Investor Relations for Spartan Motors. Mr. Pagrabs, you may proceed.

Thank you, Keith. Good morning, everyone, and welcome to the Spartan Motors 2018 third quarter earnings call.

I'm Juris Pagrabs and joining me on the call today are Daryl Adams, our President and Chief Executive Officer; and Matt Long, our Interim Chief Financial Officer. For today's call, we've included a presentation deck, which will be filed with the SEC and will also be made available on our website at spartanmotors.com. You may download the deck from the Investor Relations section of our website and follow along with our presentation during the call.

Before we start today's call, please turn to Slide 2 of the presentation for our safe harbor statement. You should be aware that certain statements made during today's conference call, which may include management's current outlook, viewpoint, predictions and projections regarding Spartan Motors and its operations may be considered forward-looking statements under the Private Securities Litigation Reform Act of 1995. I caution you that as with any prediction or projection, there are a number of factors that could cause Spartan's actual results to differ materially from projections. All known risks that 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 cannot anticipate.

Please turn to Slide 3. As of January 1, 2018, the company adopted the new revenue recognition standard, ASC 606, using the modified retrospective transition method. The adoption had minimal impact to net income in Q3. As a result, reported consolidated sales and cost of products sold were lower by $4.9 million and $4.6 million, respectively. Consolidated net income, net of tax, was about $200,000 lower. The adoption reduced reported consolidated backlog by $32.2 million, reducing both FVS and ER reported backlog by $9.3 million and $22.8 million, respectively. For more details regarding ASC 606 and its impact on the company's financial results, see the company's quarterly report on Form 10-Q filed with the -- for the quarter ended September 30, 2018.

On the call today, Daryl will provide an overview of the third quarter alongside a business update, then Matt will provide a more detailed review of the third quarter results and our outlook for the remainder of the year before proceeding to the Q&A portion of the call.

At this time, I'm pleased to turn the call over to Daryl for his opening remarks.

Thank you, Juris. Good morning, everyone, and thank you for joining us on our third quarter conference call. The Spartan team's performance this past quarter was exceptional in the face of so many significant cross-energy challenges. I'm extremely proud of how they handled this adversity. The third quarter proved to be very challenging and difficult for Spartan Motors, as all three of our business segments faced increasing operating pressures, fueled by an incredibly robust, but volatile business environment.

Going into the quarter, we're optimistic that most of the headwinds encountered in Q2 were behind us, primarily commodity costs and chassis shortages, based on aluminum and steel pricing and what our OEMs were telling us. However, these headwinds continued in the third quarter and, in some cases, escalated, having a negative impact of approximately $6 million on our quarterly bottom line results. If not for the significant industry-wide headwinds and the operating issues we sustained as a result, we would have achieved results well ahead of our internal operating plan for the quarter.

I want to emphasize that despite the headwinds, the underlying business and operational fundamentals in each of our segments remain incredibly strong. Order activity remains robust in all segments, particularly at FVS and its related backlog, including a multiyear USPS truck body order is up 48% compared to a year ago. With that, let's review the quarter and the headwinds that negatively impacted the quarter.

Revenue for the third quarter rose 19.6% to $226.2 million from $189.2 million a year ago. The increase in sales was driven by strong growth in FVS and SCV, partially offset by a decline in ER. Our strong top line results benefited from increased volume relating to USPS truck bodies, Reach vehicles, improved production volume at our vehicle upfit centers, primarily relating to an e-commerce order and strong luxury motor coach chassis sales.

Gross profit margin decreased 350 basis points to 11.6% of sales from 15.1% of sales, which include significant material cost headwinds of approximately $3.5 million, fueled by tariff-driven increases in commodity and component costs. This is in addition to the $1 million headwinds we incurred during Q2. While we have taken pricing actions to offset these costs when available, we are seeing large purchase component pricing increases from major suppliers. We do expect some of these tariff-driven headwinds to continue into 2019 based on industry-wide conditions, and we've proactively announced a 4% price increase effective January 1 in our ER segment.

In addition to the tariff-driven increases in commodity and component costs, our third quarter bottom line was negatively impacted by production and labor inefficiencies and shipment delays due to the following headwinds. Chassis shortages and supply component delays during the quarter at our Bristol facility disrupted our workflow, causing a 10-day plant shutdown, creating labor inefficiencies and led to additional operating expenses for overtime that was required to meet customer demands. Normally during such plant shutdowns, we would have laid off workers, but with extremely tight skilled labor market that the entire industry is facing, we chose to keep them on our payroll to avoid longer-term disruptions.

On a positive note, after these delays were resolved late in the third quarter, our production efficiency rebounded quickly to over 90%, and in some weeks, over 100%, which reinforces the significant impact these headwinds had on our operations as well as our continued progress and operational fundamentals based on the Spartan Production System.

Driver shortages and freight logistics difficulties continue to have direct impact on getting components and chassis on time to meet production timetables and our ability to deliver finished vehicles to our customers in a timely manner. Freight disruptions also negatively impacted our launch at our Ladson, South Carolina facility in support of our new e-commerce upfit order. As a result, on average -- I'm sorry, as a result, on aggressive customer dictated launch plan, we incurred unplanned startup costs of approximately $350,000 related to expedited procurement and shipping costs.

Additionally, due to Hurricane Florence, we sustained a weeklong plant shut down, further disrupting operations in South Carolina. We also experienced labor shortages at multiple locations, particularly in Charlotte, Michigan contract manufacturing facility during the quarter, which impacted our Isuzu N-Gas production capabilities and shifted units into subsequent months. As you can see, the litany of increased operating pressures we faced during the quarter significantly impacted our profitability.

For the third quarter of 2018, net income decreased to $5.2 million or $0.15 per share compared to net income of $13.5 million or $0.38 per share last year. The prior year net income does include benefit from a $6.3 million or $0.18 per share tax valuation allowance adjustment due to the company's improved financial condition. Despite the tough operating environment, I am pleased with the underlying fundamentals of each of our business segments.

Now please turn to Slide 5 so I can provide an update of a few business highlights and developments, starting with FVS. [Last] mile delivery, including refrigeration, continues to expand and represents a significant growth opportunity for us. As we've indicated in the past, we've been working closely with some of the largest and most innovative parcel and grocery delivery companies to provide them with solution-based vehicles, upfit products, including new refrigeration capabilities [and electric-powered chassis.]

Last month, Amazon and Mercedes announced a 20,000 unit order for the Sprinter cargo van. We're currently operating in Mercedes ship-thru facility located in Ladson, South Carolina, north of Charleston, producing customer-specific upfit at a rate of 70 per day. As we indicated last quarter, we anticipated the customers -- customer order could be split across OEM platforms. We're happy to report that we have been awarded an 1,800 unit order on a Dodge ProMaster platform for the same e-commerce customer. We will produce the upfits in our ProMaster ship-thru facility located in Saltillo, Mexico. We continue to make good progress on a 2,141 unit truck body order for the USPS. According to plan, we're producing 7 to 8 units per day. And as of third quarter, about 2/3 of our $80 million revenue target for 2018 has been recognized.

Our work-driven design process, blending customer needs with vehicle and upfit-based solutions continues to drive sales across multiple product lines and locations. Most recently, both Frito Lay and UPS, [went with] the Spartan's Utilimaster go-to-market brand, designing them with innovative Class 3 truck bodies called small packs, some of which have refrigeration capabilities as well. As e-commerce grows and the overall parcel delivery landscape changes to more and smaller package deliveries, longtime customers such as UPS have responded in kind. Most recently, UPS has contracted Spartan Utilimaster to upfit a fleet of 100 Dodge ProMaster vans. Anticipating customer needs and responding to sustainability initiatives continues to be at the forefront. We are investing in electrification. EV chassis development and partnership with our customers and suppliers will continue to receive attention in 2019 and beyond. Anticipating this future growth, we will try to secure proven, well-established partners in EV space. New suppliers such as Zenith and Cummins Electrified Power joined Motiv to give Spartan first-to-market electric vehicle production capabilities across vehicles Class 1 through 6, including those that require refrigeration. Because we are the only one in the industry with this capability, Spartan Utilimaster now have access to a broader base of customers, who wish to supplement their fleet with electric-powered chassis.

Please turn to Slide 6, and I'll continue with Emergency Response. Our ER business saw another successful quarter of profitability despite the industry-wide headwinds impacting the quarter. The operational changes we've implemented have resulted in continued improvements in productivity, efficiency, quality and profitability in our facilities. At the end of the last quarter, we're working on a number of initiatives to improve our market position and enhance our margins. Our new order-to-ship process at Brandon is fully implemented and operational, and we recently started a manufacturing pilot of the same at our Snyder facility. This process improvement will take nearly 80 days out of the order-to-ship process and speed up the delivery time.

We successfully shut down and fully integrated the U.S. Tanker plant in Delavan, Wisconsin into the Brandon facility located in South Dakota. We also successfully relocated the production of the S180 Pumper to our Brandon facility to maximize both commodity and labor efficiencies. As we continue to focus on acquisition-related disruptions, like removing dealer territory conflicts, during the quarter, we streamlined several single dealerships in the key midwest markets, and we expect to complete the dealer rationalization by the end of Q1 2019.

We've also initiated expansion of distribution coverage in Georgia and Florida, fifth largest U.S. market, and we solidified a long-term distribution contract with a Canadian dealer. And finally, now that we've earned Professional Engineer Certification on LTC aerial product line, obtained with this new acquisition, we are reintroducing this very popular aerial products starting this quarter.

Please turn to Slide 7. And I'll continue with Specialty Chassis & Vehicles. In the SCV segment, our momentum continues to grow in both the over and under 400 horsepower segments, as we continue to gain market share with the current and new OEMs. I'm pleased to report we added NeXus RV to our growing list of premium Class A diesel RV manufacturers. Powering their custom Class A chassis model, the Bentley Diamond, is Spartan's K1 360 chassis, a new entry for them into the Class A diesel space. Spartan's ability to penetrate and win in this market segment grants us access to both younger buyers as well as RV owners, wishing to step down into a more nimble [top size] without sacrificing the quality, durability and innovation they've come to expect from Spartan.

Business with our long-term customer Isuzu World Truck North America continues to grow. Production demands required us to add a second shift on our Charlotte campus adding to our highly skilled and flexible workforce to support our contract manufacturing operations for Isuzu N-Gas and a new larger F-Series.

With that, I'll turn the call over to Matt to discuss Spartan's financial results for the third quarter as well as our outlook for 2018.

Thanks, Daryl. Please turn to Slide 9. As Daryl mentioned, the underlying fundamentals of the business remain strong and the operational and organizational improvements we've made over the past few years have provided a solid foundation that will continue to drive profitable long-term growth for Spartan Motors despite the significant industry-wide headwinds that continued in the third quarter.

We've responded as quickly as possible to these near-term challenges during the quarter and have implemented a number of proactive steps in cost-reduction actions to help mitigate the headwinds, including continued rationalization of our manufacturing footprint, shutting down our ER tanker facility in Delavan, Wisconsin and consolidating the manufacturing of the USP products in the existing Brandon, South Dakota campus. Moved production of all S180s from Charlotte to the Brandon campus, in so doing, all Spartan Pumper manufacturing operations will be under one roof, where we can leverage both commodity and labor efficiencies, and reductions at our Charlotte, Michigan corporate office, primarily in office and support functions.

Third quarter adjusted EBITDA decreased 17.8% to $10.6 million from $12.9 million. Adjusted EBITDA margin declined approximately 210 basis points to 4.7% of sales from 6.8% of sales a year ago.

Adjusted net income decreased 18.9% to $6 million [from $7.4 million in the third quarter of 2017. Adjusted EPS declined to $0.17 per share] from $0.21 per share, which excludes the $6.3 million or $0.18 per share tax valuation adjustments.

Our backlog at September 30, 2018, remained strong, and ended at $484.9 million compared to $537.7 million at September 30, 2017. We had $214 million of USPS truck body in backlog a year ago compared to $159 million remaining at the end of Q3. Excluding the USPS order, backlog on a consolidated basis is up slightly year-over-year, reflecting solid improvements in FVS and SCV. As Juris mentioned, the reported backlog was reduced by $32.2 million with the adoption of ASC 606.

Please turn to Slide 10, and I'll walk you through the adjusted EBITDA bridge from our initial expectations to our actual results for the quarter. Tariff-driven increases in commodity and component costs resulted in a negative impact to adjusted EBITDA of approximately 21% compared to our initial expectations. Chassis availability, freight and logistics issues combined negatively impacted our expectations by another 10%, while labor shortages and the impact of Hurricane Florence added another 6% or 7%. Partially offsetting these headwinds were the impact of positive pricing actions realized during the quarter, particularly in ER.

Now let's take a look at the results by operating segments, starting with FVS segment on Slide 11. FVS reported revenues of $118 million compared to $78.6 million last year, an increase of 50.6%. The revenue increase reflects increased volume related to USPS truck body, Reach vehicles and upfit. Adjusted EBITDA decreased $1.6 million to $7.2 million from $8.8 million a year ago, largely due to an unfavorable sales mix, higher commodity and component costs, increased freight and transportation costs and two plant shutdowns, one relating to Hurricane Florence and the other due to chassis shortages, resulting in production and labor inefficiencies as well as shipment delays. Adjusted EBITDA margin decreased 510 basis points to 6.1% of sales from 11.2% a year ago.

Backlog remained strong at $275.2 million compared to $292.5 million at September 30, 2017. Excluding the multiyear USPS truck body order, backlog totaled $116.2 million, up 48.6% compared to $78.2 million at a year ago. And if you exclude the $9.3 million impact for ASC 606, backlog was up 50.5%.

Moving on to Slide 12. In the ER segment, third quarter 2018 revenue decreased $5.6 million to $60.3 million from $65.9 million last year, primarily due to lower volume and unfavorable sales mix, partially offset by improved pricing. Adjusted EBITDA in the ER segment decreased $1.9 million to $600,000 or 1% of sales from $2.5 million or 3.8% of sales in the prior year. The decline in adjusted EBITDA reflects reduced volumes, higher commodity and component costs as well as supplier disruptions, resulting in production and labor inefficiencies.

Our ER backlog was $175.7 million compared to $213.3 million at September 30, 2017, which reflects the $22.8 million reduction from adopting ASC 606 that Juris mentioned previously. Excluding the impact of 606, backlog was down $15 million or 7%.

Let's move on to Slide 13. In the SCV segment, revenue was up 5.5% to $51.7 million from $49 million, due mainly to $1.9 million increase in luxury motor coach sales -- chassis sales as a result of increased volume driven by market share gains and continued strong industry demand. Adjusted EBITDA increased $800,000 to $5.9 million from adjusted EBITDA of $5.1 million a year ago, primarily resulting from the strong momentum in luxury motor coach chassis, and partially offset by operating inefficiencies due to labor and chassis component shortages and higher commodity and input costs. Adjusted EBITDA margin increased 90 basis points to 11.4% of sales from 10.5% of sales a year ago.

Backlog at the end of the quarter was up 6.6% to $34 million compared to $31.9 million a year ago, reflecting continued strong luxury motor coach sales and corresponding Spartan chassis orders.

Please turn to Slide 14, and I'll discuss the outlook for the remainder of 2018. It's been a challenging quarter, but we remain committed to doing everything we can to soften the impacts we have experienced to date. As we go forward, we are seeking additional ways to minimize our exposure to these headwinds as we believe they will persist through the balance of the year and beyond.

Based on our results year-to-date and these ongoing headwinds, we are adjusting our current outlook for 2018 as follows: revenue remains unchanged in the [range of $790 million to $815 million; net income is expected to be between $14.4 million and $16.4 million; adjusted EBITDA in the range of $29.3 million to $31.3 million; effective tax rate of approximately 24.5%.; earnings per share between $0.41 and $0.47, assuming approximately 35.3 million shares outstanding; and adjusted earnings per share of $0.42 to $0.48.

On Slide 15, you'll see a bridge we've put together explaining the revised adjusted EBITDA guidance at midpoint for 2018.] As you can see, we anticipate the tariff impact on commodity and the component costs to yield additional operational pressures, combined with the impact of chassis shortages, freight logistic issues and tight labor market to have a combined impact of approximately $10.2 million on full year EBITDA.

Turning to our balance sheet on Slide 16. Spartan's balance sheet remained strong. Total liquidity at the end of the quarter was $132 million, reflecting $15.7 million in cash and $116 million in borrowing capacity, which is more than adequate to support our working capital requirements and acquisition opportunities as they present themselves. The borrowing capacity reflects a new $150 million secured credit facility that we upsized during the quarter from the previous $100 million facility. The new facility has a 5-year term, with more favorable financial covenants, providing increased liquidity to fund our working capital needs as well as our M&A growth strategy.

In accordance with ASC 606, we have $43.6 million of contract assets on the balance sheet, representing revenue with corresponding profit recognized on products in process, but not yet invoiced to the customer.

I'd like now to turn it back over to Daryl for his closing remarks.

Thanks, Matt. Please turn to Slide 17. In summary, I want to emphasize that the underlying fundamentals of our three business segments remain strong. The hard work we've done over the past 3 years on implementing operational and organizational improvements to drive profitable growth is not lost. We'll continue to work hard to deliver on our commitments.

Based on this new revised guidance for 2018 and the headwinds still in front of us, including changing realities around low-cost [country] sourcing, many of you are likely questioning whether our 2020 targets of $100 million in revenue and 10% adjusted EBITDA margins are still achievable. We do believe our financial objectives remain obtainable, but not within the original timetable we outlined at our Analyst Day a year ago. Due to these recent supply disruptions and industry-wide headwinds, those financial objectives will now include our M&A growth strategy as well.

We'll anticipate -- while we anticipate these unfavorable industry-wide conditions to persist, our long-term expectations have not changed as we see opportunities for continued margin expansion through 2020 and beyond, and we remain committed to our strategic plan. We will remain focused on executing our overall strategic plan, including our capital allocation strategy, which reflects funding our growth initiative, including acquisitions and creating shareholder value.

Operator, we're now ready to take questions.

(Operator Instructions) And the first question comes from Matt Koranda with Roth Capital.

I just wanted to see if we could look at Slide 15, it's a helpful bridge to your 2018 guide. But wondered if you could kind of cover each of those individual headwinds or buckets that you kind of bracketed out as it pertains to 2019? I know you said that there are certain headwinds that persist into the early part of 2019. So is there a way to sort of build that bridge for us or help us understand which of those are stronger headwinds than others as we head into next year?

This is Matt Long. Matt, we're still in the process of really getting our arms around 2019 as it stands right now. A large portion of material is still probably questionable, depending on what happens with tariffs and so on. But from our perspective, many of these were certainly not anticipated on our part, so I don't know that we're -- yet we're ready to talk about '19.

Got it. Do the industry challenges change your view on your acquisition pipeline in any way or change your capital deployment strategy going forward? Just curious to get your take on that? And maybe, I don't know, does it make certain potential acquisitions soften up on price a bit, if you're still willing to go that route?

Matt, this is Daryl. No, it has not. We view this, as I mentioned, our business fundamentals are strong, the efficiencies came right back up once we have the chassis. So we're trying to keep the team focused on things that we can control, even though some of these are uncontrollable to us. So our M&A strategy remains, the pipeline is strong, we're still focused on the acquisition opportunities that we laid out in our strategic plan and our plan to build out our locations around the country. I'm not sure if we've seen any softening in the multiples yet of the acquisition targets. But obviously, we're trying to keep the lowest costs we can when we're negotiating on the valuation.

Okay, that's helpful. I wanted to drill down into the fleet vehicle segment, if we could. Is there a way to sort of help us understand, which of those buckets in the headwinds that you guys have eliminated were sort of the greatest headwinds in fleet vehicles, specifically? I would assume, it's probably the tariff material impact, but -- and maybe the chassis shortage, but what else should we sort of understand as sort of the headwinds that you faced in the quarter?

In FVS, this is Matt, again. In FVS, it is the tariff-driven commodity costs is a huge portion. We also had product mix with USPS, which is a lower-margin business from what our normal is. That's probably the biggest piece to your point or FVS is commodity costs, component costs.

And I think, if I can add one, Matt, we -- the logistics of getting these trucks -- these trucks can't be put on a trailer similar to some of our F-Series and N-Series trucks from Isuzu. These need to have drivers. And driver shortage left a bunch of these products [that are now] in a shipping lot out in Pennsylvania for us. We're working [now] to work through those, and should have that cleaned up by the end of the year, but that impacted Q3 as well.

Okay. Does that impact from a revenue standpoint, then? So you're saying that you weren't able to [look out] for the quarter?

Yes, both revenue and EBITDA.

Is there a way to quantify the impact that you guys felt from that specific issue?

I'm not sure, Matt, that we go into that depth of detail.

Okay. How about this, from the Bristol shutdown you mentioned, any way to sort of dimension that impact or the headwinds for the quarter from that issue, in particular?

Well, from the script, and I think Daryl talked about it, the chassis shortages impacted the Bristol plant to the point that we had a 10-day shutdown. So while we did our best to get us much cost out of there as we could, that's a very tight labor market, and so we had to be prudent with layoffs and to be able to still have the skilled labor to come back when the chassis did arrive.

Okay, so if I put that into the 5% headwind in the chassis shortage bucket in Slide 10, would that be fair?

Yes.

Yes. And you also had a little bit of the labor inefficiencies built in too, right. As I mentioned, and Matt just reminded everyone that, we made the decision not to lay people off because we knew chassis were coming. It wasn't an industry or backlog issue, it was more we didn't have the products to build on. So we were doing some Spartan production system activities to work on lean and [continuous] improvement, but we missed over 200 chassis at Bristol in the quarter.

Okay, all right. So I'm trying to just make sure I understand where that falls in the EBITDA bridge that you guys provided. So it sounds like it's chassis, components and logistics delays as well as labor shortages. So essentially that whole middle portion of the waterfall chart that you've got is largely Bristol shutdown related?

Correct.

Yes.

Okay. All right. Got it. That's helpful. Okay, so let's just talk segment backlog really quickly on fleet vehicles, up pretty strongly. Is that -- is the majority of that e-commerce related? Could you just comment on the mix in backlog and sort of the growth there and the delivery time line for the non-USPS products?

I'll take the broad picture, Matt. I mentioned that it was USPS, right, so that could fall under e-commerce and traditional parcel delivery as well as Frito Lay, right. And we have the Amazon in the quarter, right. So it falls in both last mile and more granular, it'd be e-commerce and parcel delivery.

Okay. That's helpful. And then upfit capacity, it sounds like or at least your build rate was 70 units per day at Ladson. What does that equate to in terms of sort of capacity utilization? Do you have the ability to go higher on that front? Just some help there would be great?

Sure. We did have to ramp it up a little bit, more to try to catch up and get the units through the process to the customer. Still I think we did hit 90 on a -- for a period of time. But it all relates back to how many chassis can we get from Daimler, how many Sprinter chassis we can get. And -- then right now the contract that we have to meet is 70 per day. We are on target. We can flex up and flex down as needed. So the capacity is not a issue there or down at Saltillo.

Okay, got it. And then I guess, lastly, just in the Emergency Response business, to the backlog, is a bit down, even if we kind of strip out the impact of ASC 606. How do you think about market share? And sort of the competitive environment there? What are your latest thoughts just in terms of how that's tracking relatively?

I think we talked about it a little bit last quarter, and we did some more processing of what's going on in ER. I think we call it acquisition disruption this quarter, and I explained a little bit. In 2017, because of the long build time and cycle time of these units that -- let's call it a year. In 2017, when we did the acquisition, the first 4 or 5 months we had -- dealers were confused on what was going to happen and some of the salespeople were confused if they were going to stay. And then we had some dealer rationalization. So you take all of that and fast forward it, it comes into this period we're seeing right now, call it 18 months, because we're working on the orders before the build time starts, which is a year, so maybe you put 6 months in front of that. So it fell into this second quarter and third quarter. I will tell you though that we're seeing some really nice opportunities, and we feel comfortable that will land a number of these before the end of the year. I think on our press releases, as we mentioned, Calgary, we've a couple other large cities that we're -- we know they have the funding, and we're right in there and feel confident that we're going to win those as well. So it's -- to me, the orders that are good, the opportunities are out there, and we're starting to win those. So you'll see them as we win them we'll have press releases that talk about it because we feel it's important for the shareholders to understand that.

Okay. And just to be clear, you haven't necessarily pulled back on quotations because even with the economics of certain orders or anything, I think we have that discussion last call, but just wanted to clarify that?

No. We're seeing everyone's taking pricing as we are. We took 3% as a reminder, January 1, '18, and we're taking another 4% January 1, '19, and we're seeing our -- the market react and basically do the same. So we're all seeing the same trends in pricing across the industry.

And the next question comes from Steven Dyer with Craig-Hallum Capital Group.

It's Ryan Sigdahl on for Steve. You guys mentioned a 4% price increase in ER effective January 1, and you took 3% last year. Is that enough to offset the cost pressures? I mean, can you maybe bifurcate that out of how much you're pushing through versus absorbing [out by] Spartan?

I can't give you that, all that detail, but what I can tell you is, we're taking that pricing on the full price of the truck, right. So material is not the full price of the truck. We're not seeing that significant increase in our labor, but we're seeing it in the component parts, right, Cummins, Allison Transmissions, some of our pump manufacturers because these things coming in from China. So there's some impact, and we believe the 4% will cover it and give us a little room to the bottom line as well. But I think it's important to remind everyone that the pricing we took January of '18 this year of 3%, we won't do that until January of '19. And the 4% we're taking at the end of this year, we won't see sort of falling because it is a -- about a 1-year pipeline to get the product through the system. And that's what we started taking pricing, I think we go back since I joined Spartan, we're taking some smaller ones and now that the commodities continue to increase, we're continuing to price that in. And we do -- we feel we're ahead of it. And it will take care [of the actions we see.] Again, we thought that too coming at the end of this year, but we have a commodities pricing change like this year, I'm not sure we'll cover all that, but we have some in there.

Great. And then I don't think you mentioned pricing on the other segment, FVS specifically, but any thoughts on taking price increases there to offset the cost pressures? And what do you think your ability to do that is with your key customers?

Yes. So if we talk about FVS, I think if we mentioned it previously, we have some orders that were in the backlog. I think, we say it's 4- to 6-month backlog approximately. So those are already priced. So when the material impact start to hitting us, it affected those units, but the new quotes that we were submitting, we did put in current material costs, and we continue to do that. So we believe that, that will work itself out. I think the other thing that Matt mentioned, is that we did commit, I know we mentioned in the last quarter, we went out and committed aluminum pricing on volume. So we didn't hedge, we committed to take in volume because the price was going up so fast, we thought it was the right decision to do at that time. Unfortunately, a few weeks after we made that commitment, the pricing started to come back down. So we do have to work through some of that still. And that should be cleaned up by the end of the year and then will be -- everything will be at current market price. We also put in place a policy that on larger orders, I think it was 20 or more, something around, and this don't hold me to that exact number. We are going out and committing to price to volume, which would set the price and fix the price after the lesson learned from this year. So continuous improvement on how we manage pricing at FVS. And anything that's over 20 units or so on out, [we're going to go out and commit the material] so that we don't hit the fluctuation going forward.

So just a follow-up on that. I know you're pretty tight-lipped on what 2019 will entail, but if you're pricing the current quotes, which will flow through kind of early part of next year, is that enough that, at least the materials and tariff headwinds will lessen? Or is that headwind accelerating faster than you guys can keep up with it, basically with your current pricing?

It depends really on segments. So to get back to what Daryl was saying, so the ER obviously, we've got a long lead time, so we're assuming that our pricing will compensate for the majority of that. The segments that was impacted the most, as it stands now, is FVS. And FVS will be quoting that next round of orders -- fleet orders, and we will adjust pricing accordingly. So we -- as we do POs, we're able to adjust. So we anticipate to offset a good portion of that. If our exposures goes up beyond what we've priced in. We'll have a little bit of a miss there, but otherwise, we have that covered. And in the SCV segment, it's the PO basis, and we adjust before we hit that PO. So for the most part, we're covered. It's just the intervening time between when we [quote] and when we take the order. Did that answer your question?

Yes, that's helpful. And then lastly for me, you mentioned margin expansion through 2020, not necessarily commenting on 2019 in that statement. But with the increased headwinds, it sounds like limited visibility, but you guys are taking pricing, working on some productivity improvements. Do you think it is enough, broadly speaking next year to at least hold the gross margins or potentially even expand them?

Yes, it was -- like I said earlier, we thought that coming into this year -- so my answer would be, if we don't see the type of tariffs and material impacts and items that we saw this year -- yes, we believe we will. Right now I will say yes without any unforeseen-type issues like we had this year, we should be okay.

And the next question comes from Steve O'Hara with Sidoti.

I was just wondering if you could, I get confused about the materials and commodity cost pressures that you saw. I mean, I guess, I'm curious about why the pressures are still impactful now versus -- I mean, commodities have risen pretty significantly in the past. And I'm just wondering why the impact is now or is it more on the material side, where you guys are buying materials and those costs have gone up maybe with the lag from commodity cost pressures and those prices being [tacked] on to you?

Steve, we're talking tariffs, material impacts, we're talking the 10% tariff that was put on aluminum and then the 25% that was put on steel. And now that's starting to work through the supply base, right. And Cummins and Allison and some of the bigger suppliers are passing that on. And we have the -- we mentioned, we went out and committed to material when the price was going up on aluminum. And the other thing we're starting to see now too is that the processors where we had them locked in are ignoring that and increasing their processing costs. So it's not only the ingot price you're seeing go up, it's also the processing or the conversion rate on the aluminum go up as well. So it's not so much -- [if you want to put aluminum in your commodity, yes, aluminum and steel is a commodity, yes, but we're seeing that,] mostly the tariffs on those.

Okay. And then just relative to the price increases that you're putting in, I just -- it seems like they would roughly meet the pressures that you've seen on the commodity side within different business segments, I guess. Is that not the case? Correct me there. But -- and then, what about the USPS order? How is that kind of indexed? Or is it indexed for any changes in pricing that you're seeing -- cost pressures that you're seeing?

Yes. So on your first question, right, the pricing we're taking is on the entire unit, not just on the material costs, so it's on a total cost of the unit. I'll remind you that we still operate in a competitive environment. And we have -- [we saw it] to be competitive on our pricing. And I'll also remind you that we still have operational improvements at each location. We're not done with those yet, right, that will offset what we believe or add to the gross margin and adjusted EBITDA as we move forward. Those have not stopped. We continue, right, to stick with the Spartan Production System, the operational improvement fundamentals that we're working on, and we still have those projects in works. And then on the USPS, that was a fixed unit pricing across the -- with all the suppliers. We all signed agreements. And -- so that pricing is not affected by what we've seen.

Okay. Just -- and maybe just a follow-up on the comments about competitive environment. I mean, are there competitors? Are your competitors, maybe -- I mean, obviously, maybe [they] have a better, more efficient manufacturing system in operations, et cetera? But I mean, are competitors being logical in terms of the -- their willingness to eat the cost increases? Or are they -- are you seeing them kind of raise prices as well? I mean, I would think that -- I mean with commodity cost pressures, I would think that everybody is kind of seeing the same impact and that would kind of lead me to believe market would act rationally and increase prices. You mean is there a reason not to think that's the case?

I'll answer to each one. So FVS, I think, very competitive market. The competitor for the most part is not a public company. But when our backlog increases -- normalized backlog increases 60% quarter over a year quarter, right, Q3 last year to Q3 this year. That's telling us that we're gaining market share, our pricing is competitive, and we feel comfortable with the pricing we're taking. If you go to especially chassis, again, gaining market share, taking some pricing in, and -- so we feel good on all the pricing. And with FVS, we can reprice every opportunity -- put current material price in every opportunity. So it's not a long-term contract with fixed material. Every PO we can adjust the pricing. The problem was, we'd that backlog and we didn't have that policy of anything over 20%, we're going to go out and commit to volume on aluminum. So we've taken a bunch of actions that we feel comfortable with going forward to be competitive in the market and still gain market share and grow the business.

Okay. And maybe just last follow-up. I mean, you're talking about taking market share and taking pricing up. I mean, do you think you're gaining -- do you think there is a gain in the market share because maybe you're not being as aggressive on pricing? Or do you not think that's the case?

I don't think that's the case. I think people announce taking pricing, but then they may discount. I mean, we're not doing that on the ER side, especially.

And as there are no more questions at the present time, we'd like to return the floor to management for any closing comments.

Okay. There is no more additional questions. Okay. Thanks, Keith. Thanks, everyone, for joining us today on our call. Please, if you have any additional questions, just follow up with us and we'd be happy to set up a call with you. Just a heads up, we'll be in Chicago next week at the Baird conference. So if you want any opportunity to do a one-on-one, please -- I think our schedule is out and have some slots open, so hope you'll reach out. Thanks and have a great day.

Thank you. The conference has now concluded. Thank you for attending today's presentation. You may now disconnect your lines.