SHYFT GROUP, INC. - Quarter Report: 2019 September (Form 10-Q)

 

 

Table of Contents

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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
_________________

 

FORM 10-Q

 

☒	QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the quarterly period ended September 30, 2019.
	OR
□	TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the transition period from ____________________ to ___________________

 

Commission File Number 001-33582

 

SPARTAN MOTORS, INC.
(Exact Name of Registrant as Specified in Its Charter)

 

Michigan (State or Other Jurisdiction of Incorporation or Organization)		38-2078923 (I.R.S. Employer Identification No.)
1541 Reynolds Road Charlotte, Michigan (Address of Principal Executive Offices)		48813 (Zip Code)

 

Registrant’s Telephone Number, Including Area Code:  (517) 543-6400

 

Securities registered pursuant to Section 12(b) of the Act:

 

Title of each class	Trading Symbol(s)	Name of each exchange on which registered
Common Stock, $.01 par value	SPAR	NASDAQ Global Select Market

 

Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.

Yes

X

No

 

Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files).          Yes   X        No         

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act.

 

Large accelerated filer	☐		Accelerated filer	☒
Non-accelerated filer	☐		Smaller Reporting Company	☐
Emerging Growth Company	☐

 

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act.    

 

Indicate by check mark whether the registrant is a shell company (as defined in Exchange Act Rule 12b-2 of the Exchange Act).           Yes             No   X      

 

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date.

 

Class	Outstanding at October 31, 2019
Common stock, $.01 par value	34,728,121 shares

 

 

 

SPARTAN MOTORS, INC.

 

INDEX
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			Page
FORWARD-LOOKING STATEMENTS			3
PART I.  FINANCIAL INFORMATION
	Item 1.	Financial Statements:
		Condensed Consolidated Balance Sheets – September 30, 2019 and December 31, 2018 (Unaudited)	4
		Condensed Consolidated Statements of Operations - Three and Nine Months Ended September 30, 2019 and 2018 (Unaudited)	5
		Condensed Consolidated Statements of Cash Flows - Nine Months Ended September 30, 2019 and 2018 (Unaudited)	6
		Condensed Consolidated Statement of Shareholders’ Equity – Nine Months Ended September 30, 2019 (Unaudited)	7
		Notes to Condensed Consolidated Financial Statements	9
	Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	30
	Item 3.	Quantitative and Qualitative Disclosures About Market Risk	47
	Item 4.	Controls and Procedures	48
PART II.  OTHER INFORMATION
	Item 1A.	Risk Factors	48
	Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	48
	Item 6.	Exhibits	49
SIGNATURES			50

 

 

 

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		September 30,				December 31,
		2019				2018
ASSETS
Current assets:
Cash and cash equivalents		$	15,019			$	27,439
Accounts receivable, less allowance of $384 and $133			112,455				106,801
Contract assets			49,043				36,027
Inventories			87,936				69,992
Other receivables – chassis pool agreements			16,975				-
Other current assets			6,247				5,070
Total current assets			287,675				245,329
Property, plant and equipment, net			62,189				56,567
Right of use assets-operating leases			37,110				-
Goodwill			60,333				33,823
Intangible assets, net			55,149				8,611
Other assets			2,693				2,313
Net deferred tax asset			7,463				7,141
TOTAL ASSETS		$	512,612			$	353,784
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Accounts payable		$	83,723			$	76,399
Accrued warranty			18,084				16,090
Accrued compensation and related taxes			17,362				10,520
Deposits from customers			11,369				22,632
Operating lease liability			5,133				-
Other current liabilities and accrued expenses			14,849				12,396
Short-term debt – chassis pool agreements			16,975				-
Current portion of long-term debt			0				60
Total current liabilities			167,495				138,097
Other non-current liabilities			4,376				4,058
Long-term operating lease liability			32,171				-
Long-term debt, less current portion			108,944				25,547
Total liabilities			312,986				167,702
Commitments and contingencies			-				-
Shareholders' equity:
Preferred stock, no par value: 2,000 shares authorized (none issued)			-				-
Common stock, $0.01 par value; 80,000 shares authorized; 35,333 and 35,321 outstanding			353				353
Additional paid in capital			83,565				82,816
Retained earnings			116,380				103,571
Total Spartan Motors, Inc. shareholders’ equity			200,298				186,740
Non-controlling interest			(672	)			(658	)
Total shareholders’ equity			199,626				186,082
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY		$	512,612			$	353,784

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		Three Months Ended September 30,								Nine Months Ended September 30,
		2019				2018				2019				2018
Sales		$	288,951			$	226,183			$	770,850			$	583,203
Cost of products sold			246,769				199,965				677,216				508,457
Restructuring charges			6				25				60				25
Gross profit			42,176				26,193				93,574				74,721
Operating expenses:
Research and development			1,869				2,117				6,507				5,323
Selling, general and administrative			26,673				17,251				68,198				54,163
Restructuring charges			131				476				259				1,292
Total operating expenses			28,673				19,844				74,964				60,778
Operating income			13,503				6,349				18,610				13,943
Other income (expense):
Interest expense			(144	)			(225	)			(831	)			(817	)
Interest and other income			480				156				1,963				2,581
Total other income (expense)			336				(69	)			1,132				1,764
Income before taxes			13,839				6,280				19,742				15,707
Taxes			3,424				1,037				4,499				2,527
Net income			10,415				5,243				15,243				13,180
Less: net income (loss) attributable to non-controlling interest			61				-				(14	)			-
Net income attributable to Spartan Motors Inc.		$	10,354			$	5,243			$	15,257			$	13,180
Basic net earnings per share		$	0.29			$	0.15			$	0.43			$	0.37
Diluted net earnings per share		$	0.29			$	0.15			$	0.43			$	0.37
Basic weighted average common shares outstanding			35,317				35,182				35,311				35,179
Diluted weighted average common shares outstanding			35,463				35,182				35,355				35,179

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		Nine Months Ended September 30,
		2019				2018
Cash flows from operating activities:
Net income		$	15,243			$	13,180
Adjustments to reconcile net income to net cash used in operating activities:
Depreciation and amortization			7,731				7,638
Gain on disposal of assets			(2	)			-
Accruals for warranty			10,173				6,068
Expense from changes in fair value of contingent consideration			-				(693	)
Deferred income taxes			(594	)			688
Expense on right of use assets			251				-
Stock based compensation related to stock awards			3,767				3,054
(Increase) decrease in operating assets:
Accounts receivable			(9	)			(26,799	)
Contract assets			(11,518	)			(13,017	)
Inventories			(10,934	)			(31,000	)
Other assets			(1,177	)			(403	)
Increase (decrease) in operating liabilities:
Accounts payable			4,393				51,955
Cash paid for warranty repairs			(8,277	)			(8,093	)
Accrued compensation and related taxes			6,211				(4,028	)
Deposits from customers			(11,517	)			(3,113	)
Other current liabilities and accrued expenses			2,147				955
Other long-term liabilities			406				(259	)
Other			(842	)			-
Taxes on income			781				(2,080	)
Total adjustments			(9,010	)			(19,127	)
Net cash provided by (used in) operating activities			6,233				(5,947	)
Cash flows from (used in) investing activities:
Purchases of property, plant and equipment			(7,515	)			(7,395	)
Proceeds from sale of property, plant and equipment			15				-
Acquisition of business, net of cash acquired			(89,650	)			-
Net cash used in investing activities			(97,150	)			(7,395	)
Cash flows from (used in) financing activities:
Proceeds from long-term debt			92,000				684
Payments on long-term debt			(10,102	)			(50	)
Payment of contingent consideration on acquisitions			-				(701	)
Payment of dividends			(1,777	)			(1,759	)
Purchase and retirement of common stock			(793	)			-
Net cash used in the exercise, vesting or cancellation of stock incentive awards			(832	)			(2,688	)
Net cash provided by (used in) financing activities			78,496				(4,514	)
Net decrease in cash and cash equivalents			(12,420	)			(17,856	)
Cash and cash equivalents at beginning of period			27,439				33,523
Cash and cash equivalents at end of period		$	15,019			$	15,667

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		Number of				Common				Additional Paid In				Retained				Non- Controlling				Total Shareholders'
		Shares				Stock				Capital				Earnings				Interest				Equity
Balance at December 31, 2018			35,321			$	353			$	82,816			$	103,571			$	(658	)		$	186,082
Issuance of common stock and the tax impact of stock incentive plan transactions			9				-				(922	)			-				-				(922	)
Issuance of restricted stock, net of cancellation			121				1				(1	)			-				-				-
Purchase and retirement of common stock			(101	)			(1	)			(236	)			(556	)			-				(793	)
Stock based compensation expense related to restricted stock			-				-				860				-				-				860
Transition adjustment for adoption of new lease standard			-				-				-				(113	)			-				(113	)
Net income			-				-				-				1,397				140				1,537
Balance at March 31, 2019			35,350				353				82,517				104,299				(518	)			186,651
Issuance of common stock and the tax impact of stock incentive plan transactions			8				-				28				-				-				28
Issuance of restricted stock, net of cancellation			(42	)			-				-				-				-				-
Issuance of common stock related to investment in subsidiary			(247	)			(2	)			(1,946	)			-				-				(1,948	)
Dividends declared ($0.05 per share)			-				-				-				(1,777	)			-				(1,777	)
Stock based compensation expense related to restricted stock			247				2				1,341				-				-				1,343
Net income			-				-				-				3,504				(215	)			3,289
Balance at June 30, 2019			35,316				353				81,940				106,026				(733	)			187,586
Issuance of common stock and the tax impact of stock incentive plan transactions			6				-				62				-				-				62
Issuance of restricted stock, net of cancellation			11				-				-				-				-				-
Stock based compensation expense related to restricted stock			-				-				1,563				-				-				1,563
Net income			-				-				-				10,354				61				10,415
Balance at September 30, 2019			35,333			$	353			$	83,565			$	116,380			$	(672	)		$	199,626

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		Number of				Common				Additional Paid In				Retained				Non- Controlling				Total Shareholders'
		Shares				Stock				Capital				Earnings				Interest				Equity
Balance at December 31, 2017			35,097			$	351			$	79,721			$	88,855			$	(658	)		$	168,269
Issuance of common stock and the tax impact of stock incentive plan transactions			3				-				(2,493	)			-				-				(2,493	)
Issuance of restricted stock, net of cancellation			191				2				(2	)			-				-				-
Stock based compensation expense related to restricted stock			-				-				819				-				-				819
Transition adjustment for adoption of new revenue recognition standard			-				-				-				3,668				-				3,668
Net income			-				-				-				4,194				-				4,194
Balance at March 31,2018			35,291				353				78,045				96,717				(658	)			174,457
Issuance of common stock and the tax impact of stock incentive plan transactions			2				-				(177	)			-				-				(177	)
Issuance of restricted stock, net of cancellation			(99	)			(1	)			1				-				-				-
Dividends declared ($0.05 per share)			-				-				-				(1,759	)			-				(1,759	)
Stock based compensation expense related to restricted stock			-				-				1,370				-				-				1,370
Net income			-				-				-				3,743				-				3,743
Balance at June 30, 2018			35,194				352				79,239				98,701				(658	)			177,634
Issuance of common stock and the tax impact of stock incentive plan transactions			4				-				(18	)			-				-				(18	)
Issuance of restricted stock, net of cancellation			(28	)			-				-				-				-				-
Stock based compensation expense related to restricted stock			-				-				865				-				-				865
Net income			-				-				-				5,243				-				5,243
Balance at September 30, 2018			35,170			$	352			$	80,086			$	103,944			$	(658	)		$	183,724

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NOTE 1 - GENERAL AND SUMMARY OF ACCOUNTING POLICIES

 

For a description of key accounting policies followed, refer to the notes to the Spartan Motors, Inc. (the “Company”, “we”, “our” or “us”) consolidated financial statements for the year ended December 31, 2018, included in our Annual Report on Form 10-K filed with the Securities and Exchange Commission on March 5, 2019. Refer to the Adoption of Lease Accounting Policy section below for the adoption of a new lease accounting standard in the first quarter of 2019.

 

We are a niche market leader in specialty vehicle manufacturing and assembly for the commercial vehicle (including last-mile delivery, specialty service and vocation-specific up-fit segments), emergency response and recreational vehicle industries. Our products include walk-in vans and truck bodies used in e-commerce/parcel delivery, up-fit equipment used in the mobile retail, and utility trades, fire trucks and fire truck chassis, luxury Class A diesel motor home chassis, military vehicles, and contract manufacturing and assembly services. We also supply replacement parts and offer repair, maintenance, field service and refurbishment services for the vehicles that we manufacture. Our operating activities are conducted through our wholly-owned operating subsidiary, Spartan Motors USA, Inc. (“Spartan USA”), with locations in Charlotte, Michigan; Brandon, South Dakota; Snyder and Neligh, Nebraska; Ephrata, Pennsylvania; Pompano Beach, Florida; Bristol, Indiana; North Charleston, South Carolina; Kansas City, Missouri; Montebello, Carson, Roseville and Union City, California; Mesa, Arizona; Dallas and Weatherford, Texas; and Saltillo, Mexico.

 

On September 9, 2019, the Company entered into a Unit Purchase Agreement with Fortress Resources, LLC D/B/A Royal Truck Body (“Royal”), pursuant to which the Company acquired all the outstanding equity interests of Royal. Royal is a leading California-based designer, manufacturer and installer of service truck bodies and accessories.  Royal manufactures and assembles truck body options for various trades, service truck bodies, stake body trucks, contractor trucks, and dump bed trucks. Royal is the largest service body company in the western United States with their principal facility in Carson, California.  Royal has additional manufacturing, assembly, and service space in branch locations in Union City and Roseville, California; Mesa, Arizona; and Dallas and Weatherford, Texas.  This acquisition allows us to quickly expand our footprint in the western United States supporting our strategy of coast-to-coast manufacturing and distribution.  Royal is part of our Specialty Chassis & Vehicle segment.

 

On June 12, 2019, the Company acquired certain assets and assumed certain liabilities of General Truck Body, Inc., located in Montebello, California, through the Company’s wholly-owned subsidiary, Spartan Motors GTB, LLC (“GTB”).  GTB is a provider of up-fit services for government and non-government vehicles.  The acquisition will enable the Company to increase its product offerings to fleet customers, while further expanding its manufacturing capabilities in the U.S. market.  Spartan Motors GTB, LLC is reported as part of the Fleet Vehicles and Services segment.

 

On December 17, 2018, the Company acquired all of the assets and assumed certain liabilities of Strobes-R-Us, Inc., located in Pompano Beach, Florida, through the Company’s majority-owned subsidiary, Spartan Upfit Services, Inc. dba Strobes-R-Us (“SRUS”).  SRUS is a premier provider of up-fit services for government and non-government vehicles.  The acquisition will enable the Company to increase its product offerings to both fleet and emergency response customers, while further expanding its manufacturing capabilities into the southeastern U.S. market.  As part of this acquisition, Spartan acquired Strobes-R-Us’ state-of-the-art up-fit facility and product showroom in Pompano Beach, Florida. Spartan Upfit Services, Inc. and the related noncontrolling interest is reported as part of the Fleet Vehicles and Services segment.

 

Our Bristol, Indiana location manufactures vehicles used in the parcel delivery, mobile retail and trades and construction industries, and supplies related aftermarket parts and services under the Utilimaster brand name. Our Kansas City, Missouri; Pompano Beach, Florida; North Charleston, South Carolina; Montebello California; and Saltillo, Mexico locations sell and install equipment used in commercial and fleet vehicles. Our Brandon, South Dakota; Snyder and Neligh, Nebraska; and Ephrata, Pennsylvania locations manufacture emergency response vehicles under the Spartan, Smeal, US Tanker and Ladder Tower Company brand names. Our Charlotte, Michigan location manufactures heavy-duty chassis and vehicles, and supplies aftermarket parts and accessories under the Spartan Chassis and Spartan brand names. Our Carson, Roseville and Union City, California; Mesa, Arizona; and Dallas and Weatherford, Texas locations manufacture service truck bodies and accessories under the Royal Truck Body brand name. Spartan USA was also a participant in Spartan-Gimaex Innovations, LLC (“Spartan-Gimaex”), a 50/50 joint venture with Gimaex Holding, Inc. that was formed to provide emergency response vehicles for the domestic and international markets. Spartan-Gimaex is reported as a consolidated subsidiary of Spartan Motors, Inc. In February 2015, Spartan USA and Gimaex Holding, Inc. mutually agreed to begin discussions regarding the dissolution of the joint venture. In June 2015, Spartan USA and Gimaex Holding, Inc. entered into court proceedings to determine the terms of the dissolution. In February 2017, by agreement of the parties, the court proceeding was dismissed with prejudice and the judge entered an order to this effect as the parties agreed to seek a dissolution plan on their own. The Company is continuing to work on this dissolution plan and no dissolution terms have been determined as of the date of this Form 10-Q.

 

 

SPARTAN MOTORS, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Dollar amounts in thousands, except per share data)

 

 

The accompanying unaudited interim condensed consolidated financial statements reflect all normal and recurring adjustments that are necessary for the fair presentation of our financial position as of September 30, 2019, the results of operations and cash flows for the three and nine-month periods ended September 30, 2019. These condensed consolidated financial statements should be read in conjunction with the audited consolidated financial statements and footnotes included in our Annual Report on Form 10-K for the year ended December 31, 2018.

 

The results of operations for the three and nine-months ended September 30, 2019 are not necessarily indicative of the results expected for the full year.

 

We are required to disclose the fair value of our financial instruments in accordance with Financial Accounting Standards Board (“FASB”) Codification relating to “Disclosures about Fair Values of Financial Instruments.” The carrying amounts of cash and cash equivalents, accounts receivable, accounts payable and our variable rate debt instruments approximate their fair value at September 30, 2019 and December 31, 2018.

 

New Accounting Standards

 

In June 2016, the FASB issued Accounting Standards Update 2016-13, Financial Instruments - Credit Losses: Measurement of Credit Losses on Financial Instruments (“ASU 2016-13”). ASU 2016-13 is intended to introduce a revised approach to the recognition and measurement of credit losses, emphasizing an updated model based on expected losses rather than incurred losses. The provisions of this standard are effective for reporting periods beginning after December 15, 2019 and early adoption is permitted. We believe that the adoption of the provisions of ASU 2016-13 will not have a material impact on our consolidated financial position, results of operations or cash flows.

 

In February 2016, the FASB issued Accounting Standards Update No. 2016-02, Leases (“ASU 2016-02”). The new standard establishes a right-of-use (“ROU”) model that requires a lessee to record a ROU asset and a lease liability on the balance sheet for all leases with terms longer than 12 months. Leases will be classified as either finance or operating, with classification affecting the pattern of expense recognition in the income statement. The new standard is effective for fiscal years beginning after December 15, 2018, including interim periods within those fiscal years. A modified retrospective transition approach is required for lessees with capital and operating leases existing at, or entered into after, the beginning of the earliest comparative period presented in the financial statements, with certain practical expedients available. We adopted ASU 2016-02 as of January 1, 2019 using the modified retrospective approach. See the “Adoption of Lease Accounting Policy” section below and Note 7 - Leases for a description of the impact of the adoption of the provisions of ASU 2016-02 on our consolidated financial position, results of operations and cash flows 

 

Except for the changes below, we have consistently applied the accounting policies to all periods presented in these condensed consolidated financial statements.

 

Adoption of Lease Accounting Policy

 

We applied ASU 2016-02 and all related amendments (“ASC 842”) using the modified retrospective method by recognizing the cumulative effect of adoption as an adjustment to the opening balance of retained earnings at January 1, 2019. Therefore, the comparative information has not been adjusted and continues to be reported under prior leasing guidance. In addition, we elected to apply the following package of practical expedients on a consistent basis permitting entities not to reassess: (i) whether any expired or existing contracts are or contain a lease; (ii) lease classification for any expired or existing leases and (iii) whether initial direct costs for any expired or existing leases qualify for capitalization under the amended guidance. As a result, as of January 1, 2019 we recorded ROU assets of $13,582 for operating leases and $675 for financing leases. We also recorded operating lease liabilities of $13,716 and finance lease liabilities of $696. The decrease to retained earnings was $113, net of the tax effect of $42 reflecting the cumulative impact of the accounting change. The standard did not have a material effect on consolidated net income or cash flows.

 

 

SPARTAN MOTORS, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Dollar amounts in thousands, except per share data)

 

 

We determine if an arrangement is a lease at inception. Operating leases are included in ROU assets - operating leases, Operating lease liability, and Long-term operating lease liability on our Condensed Consolidated Balance Sheets. Finance leases are included in Other assets, Other current liabilities and accrued expenses and Other non-current liabilities on our Condensed Consolidated Balance Sheets.

 

ROU assets represent our right to use an underlying asset for the lease term and lease liabilities represent our obligation to make lease payments arising from the lease. Operating lease ROU assets and liabilities are recognized at commencement date based on the present value of lease payments over the lease term. As most of our leases do not provide an implicit rate, we use our incremental borrowing rate based on the information available at commencement date in determining the present value of lease payments. The operating lease ROU asset also includes any lease payments made and excludes lease incentives and initial direct costs incurred. We include options to extend or terminate the lease in our lease term when it is reasonably certain that we will exercise that option. Lease expense for lease payments on operating leases is recognized on a straight-line basis over the lease term.

 

We do not record a ROU asset or lease liability for leases with an expected term of 12 months or less. Expenses for these leases are recognized on a straight-line basis over the lease term.

 

We have lease agreements with lease and non-lease components, which are accounted for separately for leases related to real property. For leases related to personal property we account for lease and non-lease components associated with a lease as a single lease component.

 

Revenue Recognition Accounting Policy

 

Essentially all of our revenue is generated through contracts with our customers. We may recognize revenue over time or at a point in time when or as obligations under the terms of a contract with our customer are satisfied, depending on the terms and features of the contract and the products supplied. Our contracts generally do not have any significant variable consideration. The collectability of consideration on the contract is reasonably assured before revenue is recognized. On certain vehicles, payment may be received in advance of us satisfying our performance obligations. Such payments are recorded in Customer deposits on the Condensed Consolidated Balance Sheets. The corresponding performance obligations are generally satisfied within one year of the contract inception. In such cases, we have elected to apply the practical expedient to not adjust the promised amount of consideration for the effects of a significant financing component. The financing impact on contracts that contain performance obligations that are not expected to be satisfied within one year are expected to be immaterial to our condensed consolidated financial statements.

 

We have elected to utilize the practical expedient to recognize the incremental costs of obtaining a contract as an expense when incurred because the amortization period for the prepaid costs that would have otherwise been deferred and amortized is one year or less. Revenue recognized in a current period from performance obligations satisfied in a prior period, if any, is immaterial to our condensed consolidated financial statements. We use an observable price to allocate the stand-alone selling price to separate performance obligations within a contract or a cost-plus margin approach when an observable price is not available. The estimated costs to fulfill our base warranties are recognized as expense when the products are sold (see “Note 8 - Commitments and Contingent Liabilities” for further information on warranties). Our contracts with customers do not contain a provision for product returns, except for contracts related to certain parts sales.

 

Revenue for parts sales for all segments is recognized at the time that control and risk of ownership has passed to the customer, which is generally when the ordered part is shipped to the customer. Historical return rates on parts sales have been immaterial. Accordingly, no return reserve has been recorded. Instead, returns are recognized as a reduction of revenue at the time that they are received.

 

 

SPARTAN MOTORS, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Dollar amounts in thousands, except per share data)

 

 

For certain of our vehicles and chassis, we sell separately priced service contracts that provide roadside assistance or extend certain warranty coverage beyond our base warranty agreements. These separately priced contracts range from 1 to 6 years from the date of the shipment of the related vehicle or chassis. We receive payment with the shipment of the related vehicle or at the inception of the extended service contract, if later, and recognize revenue over the coverage term of the agreement, generally on a straight-line basis, which approximates the pattern of costs expected to be incurred in satisfying the obligations under the contract.

 

Distinct revenue recognition policies for our segments are as follows:

 

Fleet Vehicles and Services

Our walk-in vans and truck bodies are generally built on a chassis that is owned and controlled by the customer. Due to the customer ownership of the chassis, the performance obligation for these walk-in vans and truck bodies is satisfied as the vehicles are built. Accordingly, the revenue and corresponding cost of products sold associated with these contracts are recognized over time based on the inputs completed for a given performance obligation during the reporting period. Certain contracts will specify that a walk-in van or truck body is to be built on a chassis that we purchase and subsequently sell to the customer. The revenue on these contracts is recognized at the time that the performance obligation is satisfied and control and risk of ownership has passed to the customer, which is generally upon shipment of the vehicle from our manufacturing facility to the customer or receipt of the vehicle by the customer, depending on contract terms. We have elected to treat shipping and handling costs subsequent to transfer of control as fulfillment activities and, accordingly, recognize these costs as the revenue is recognized.

 

Revenue for up-fit and field service contracts is recognized over time, as equipment is installed in the customer’s vehicle or as repairs and enhancements are made to the customer’s vehicles. Revenue and the corresponding cost of products sold is estimated based on the inputs completed for a given performance obligation. Our performance obligation for up-fit and field service contracts is satisfied when the equipment installation or repairs and enhancements of the customer’s vehicle has been completed. Our receivables will generally be collected in less than three months, in accordance with our underlying payment terms.

 

Emergency Response Vehicles 

Our emergency response chassis and apparatuses are generally manufactured to order based on customer-supplied specifications. Due to the custom nature of the products and the attributes of the contracts, we do not have a ready alternative use for our emergency response chassis and apparatuses, and we have an enforceable right to payment on the contracts. Accordingly, performance obligations for these custom ordered chassis and apparatuses are satisfied as the apparatuses and chassis are built. We recognize revenue and the corresponding cost of products sold on these contracts over time based on the inputs completed for a given performance obligation during the reporting period. We have elected to treat shipping and handling costs subsequent to transfer of control as fulfillment activities and, accordingly, recognize these costs as the revenue is recognized. Our receivables will generally be collected in less than six months, in accordance with our underlying payment terms.

 

Revenue on certain emergency response chassis and apparatuses that are sold from stock or utilized as demonstration units is recognized at the point in time that the contract is received. Revenue related to modifications made to trucks sold from stock or that were utilized as demonstration units is recognized over time as the modifications are completed. Our receivables will generally be collected in less than three months, in accordance with our underlying payment terms.

 

Specialty Chassis and Vehicles

We recognize revenue and the corresponding cost of products sold on the sale of motor home chassis when the performance obligation is completed and control and risk of ownership of the chassis has passed to our customer, which is generally upon shipment of the chassis to the customer.

 

Revenue and the corresponding cost of products sold associated with other specialty chassis is recognized over time based on the inputs completed for a given performance obligation during the reporting period. Other specialty chassis are generally built on a chassis that is owned and controlled by the customer. Due to the customer ownership of the chassis, the performance obligations for other specialty chassis contracts are satisfied as the products are assembled. Our receivables will generally be collected in less than three months, in accordance with our underlying payment terms.

 

 

SPARTAN MOTORS, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Dollar amounts in thousands, except per share data)

  

 

 

NOTE 2 – ACQUISITION ACTIVITIES

 

2019 Acquisition

 

On September 9, 2019, the Company completed the acquisition of Fortress Resources, LLC D/B/A Royal Truck Body (“Royal”) pursuant to which the Company acquired all the outstanding equity interests of Royal. The Company paid $90,081 in cash. The purchase price is subject to certain customary post-closing adjustments. The acquisition was financed using $90,081 borrowed from our existing $175,000 line of credit, as set forth in the Second Amended and Restated Credit Agreement, dated as of August 8, 2018. Included in our results since the September 9, 2019 acquisition are net sales of $3,871 and operating income of $801 for the quarter ended September 30, 2019.

 

Royal is a leading California-based designer, manufacturer and installer of service truck bodies and accessories.  Royal manufactures and assembles truck body options for various trades, service truck bodies, stake body trucks, contractor trucks, and dump bed trucks. Royal is the largest service body company in the western United States with their principal facility in Carson, California.  Royal has additional manufacturing, assembly, and service space in branch locations in Union City and Roseville, California; Mesa, Arizona; and Dallas and Weatherford, Texas.  This acquisition allows us to quickly expand our footprint in the western United States supporting our strategy of coast-to-coast manufacturing and distribution.  Royal is part of our Specialty Chassis & Vehicle segment.  

 

During the third quarter of 2019, we recorded pretax charges totaling $982 for legal expenses and other transaction costs related to the acquisition. These charges, which were expensed in accordance with the accounting guidance for business combinations, were recorded in “Selling, general and administrative” and reflected within the “Eliminations and Other” column in the business segment table in Note 11, Business Segments.

 

Purchase Price Allocation

This acquisition was accounted for using the acquisition method of accounting with the purchase price allocated to the assets purchased and liabilities assumed based upon their estimated fair values at the date of acquisition. Identifiable intangible assets include customer relationships, trade names & trademarks, patented technology and non-competition agreements. The preliminary excess of the purchase price over the estimated fair values of the net tangible and intangible assets acquired of $28,188 was recorded as goodwill, which is expected to be deductible for tax purposes. The preliminary goodwill recognized is subject to a final net working capital adjustment.

 

The fair value of the net assets acquired was based on a preliminary valuation and the estimates and assumptions are subject to change within the measurement period. The Company is continuing to evaluate the (i) inventory, (ii) intangible assets, (iii) deferred taxes and liabilities, and (iv) income tax and non-income tax accruals. The Company will finalize the purchase price allocation as soon as practicable within the measurement period, but in no event later than one year following the acquisition date.

 

 

SPARTAN MOTORS, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Dollar amounts in thousands, except per share data)

 

 

The preliminary allocation of purchase price to assets acquired and liabilities assumed is as follows:

 

 

Goodwill Assigned

Intangible assets totaling $47,150 have provisionally been assigned to customer relationships, trade names & trademarks, patented technology and non-competition agreements as a result of the acquisition and consist of the following (in thousands):

 

 

The Company plans to amortize the customer relationships utilizing an accelerated approach and plans to amortize patented technology and non-competition agreements assets utilizing a straight-line approach.  Amortization expense, including the intangible assets preliminarily recorded from the Royal acquisition, is estimated to be $666, $2,665, $2,665, $3,162, and $3,072 for the years 2019 through 2023, respectively.

 

Goodwill consists of operational synergies that are expected to be realized in both the short and long-term and the opportunity to enter into new markets which will enable us to increase value to our customers and shareholders. Key areas of expected cost savings include an expanded dealer network, complementary product portfolios and manufacturing and supply chain work process improvements.

 

 

SPARTAN MOTORS, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Dollar amounts in thousands, except per share data)

 

 

Pro Forma Results (Unaudited)

The following table provides unaudited pro forma net sales and results of operations for the three and nine months ended September 30, 2019 and 2018. The unaudited pro forma results reflect certain adjustments related to the acquisition, such as changes in the depreciation and amortization expense on the Royal assets acquired resulting from the fair valuation of assets acquired, expenses incurred to complete the acquisition and the impact of acquisition financing. The pro forma results do not include any anticipated cost synergies or other effects of the planned integration of Royal. Accordingly, such pro forma amounts are not necessarily indicative of the results that actually would have occurred nor are they indicative of the future operating results of the combined company.

 

 

 

The information presented above is for informational purposes only and is not necessarily indicative of the actual results that would have occurred had the acquisition been completed at the beginning of the respective periods, nor are they necessarily indicative of the future operating results of the combined companies.

 

2018 Acquisition

 

On December 17, 2018, the Company acquired the assets and assumed certain liabilities of Strobes-R-Us, Inc. through the Company’s majority-owned subsidiary, Spartan Upfit Services, Inc. dba Strobes-R-Us (“SRUS”). SRUS is a premier provider of up-fit services for government and non-government vehicles. The acquisition will enable the Company to increase its product offerings to both fleet and emergency response customers, while further expanding its manufacturing capabilities into the southeastern U.S. market. As part of this acquisition, Spartan acquired Strobes-R-Us’ state-of-the-art up-fit facility and product showroom in Pompano Beach, Florida.

 

Purchase Price Allocation

The total purchase price paid for our acquisition of SRUS was $8,032, subject to a net working capital adjustment. The consideration paid consisted of $5,200 in cash, plus a $2,832 contingency for performance-based earn-out payments. The price paid pursuant to the purchase agreement was the subject of negotiation between the sellers and us.

 

This acquisition was accounted for using the acquisition method of accounting, which requires the purchase price to be allocated to the assets purchased and liabilities assumed based upon their estimated fair values at the date of acquisition. The excess of the estimated purchase price over the preliminary estimated fair values of the net tangible and intangible assets acquired of $4,728 was recorded as preliminary estimated goodwill. During the third quarter of 2019, we made certain adjustments to our purchase price allocation related to the deferred tax asset, which resulted in a $272 increase in goodwill.

 

The fair value of the net assets acquired was based on a preliminary valuation and the estimates and assumptions are subject to change within the measurement period. The Company is continuing to evaluate the (i) inventory, (ii) intangible assets, (iii) deferred taxes and liabilities, (iv) income tax and non-income tax accruals and (v) the contingent consideration. The Company will finalize the purchase price allocation as soon as practicable within the measurement period, but in no event later than one year following the acquisition date.

 

The allocation of purchase price to assets acquired and liabilities assumed was as follows:

 

 

 

SPARTAN MOTORS, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Dollar amounts in thousands, except per share data)

 

 

Contingent Consideration

Pursuant to the purchase agreement, the former owners of the SRUS business may receive additional consideration through 2021 in the form of certain performance-based earn-out payments, up to an aggregate maximum of $3,250.  The purchase agreement specifies annual payments for each calendar year beginning in 2019 through and including 2021 as a percentage of and contingent upon EBITDA for that calendar year exceeding predetermined thresholds. In accordance with accounting guidance for business combinations, at the date of sale the Company recorded a contingent liability of $2,832 for the value of the future consideration based upon its best estimate of the likelihood of the payments, discounted to its present value using a discount rate of 4.7%.

 

The change in the carrying amount of goodwill for the nine months ended September 30, 2019 and 2018 were as follows (in thousands):

 

 

 

NOTE 3 – INVENTORIES

 

Inventories are summarized as follows:

 

 

We also have a number of demonstration units as part of our sales and training program. These demonstration units are included in the “Finished goods” line item above and amounted to $9,977 and $8,807 at September 30, 2019 and December 31, 2018. When the demonstration units are sold, the cost related to the demonstration unit is included in Cost of products sold on our Condensed Consolidated Statements of Operations.

 

 

NOTE 4 - DEBT

 

Short-term debt consists of the following:

 

 

Chassis Pool Agreements

The Company obtains certain vehicle chassis for its walk-in vans, truck bodies and specialty vehicles directly from the chassis manufacturers under converter pool agreements. Chassis are obtained from the manufacturers based on orders from customers, and in some cases, for unallocated orders. The agreements generally state that the manufacturer will provide a supply of chassis to be maintained at the Company’s facilities with the condition that we will store such chassis and will not move, sell, or otherwise dispose of such chassis except under the terms of the agreement. In addition, the manufacturer typically retains the sole authority to authorize commencement of work on the chassis and to make certain other decisions with respect to the chassis including the terms and pricing of sales of the chassis to the manufacturer’s dealers. The manufacturer also does not transfer the certificate of origin to the Company nor permit the Company to sell or transfer the chassis to anyone other than the manufacturer (for ultimate resale to a dealer). Although the Company is party to related finance agreements with manufacturers, the Company has not historically settled, nor expects to in the future settle, any related obligations in cash. Instead, the obligation is settled by the manufacturer upon reassignment of the chassis to an accepted dealer, and the dealer is invoiced for the chassis by the manufacturer. Accordingly, as of September 30, 2019, the Company’s outstanding chassis converter pool with manufacturers totaled $16,975 and the Company has included this financing agreement on the Company’s Condensed Consolidated Balance Sheets within Other receivables – chassis pool agreements and Short-term debt – chassis pool agreements. Typically, chassis are converted and delivered to customers within 90 days of the receipt of the chassis by the Company. The chassis converter pool is a non-cash arrangement and is offsetting between current assets and current liabilities on the Company's Condensed Consolidated Balance Sheets.

 

 

SPARTAN MOTORS, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Dollar amounts in thousands, except per share data)

 

 

Long-term debt consists of the following:

 

 

(1)   On August 8, 2018, we entered into a Credit Agreement (the "Credit Agreement") by and among us and certain of our subsidiaries as borrowers, Wells Fargo Bank, N.A., as administrative agent ("Wells Fargo"), and the lenders party thereto consisting of Wells Fargo, JPMorgan Chase Bank, N.A. and PNC Bank National Association (the "Lenders"). Under the Credit Agreement, we may borrow up to $150,000 (subsequently increased to $175,000) from the Lenders under a five-year secured revolving credit facility. The credit facility matures August 8, 2023. We may also request an increase in the facility of up to $75,000 (subsequently decreased to $50,000) in the aggregate, subject to customary conditions. The credit facility is also available for the issuance of letters of credit of up to $20,000 and swing line loans of up to $15,000 (subsequently increased to $30,000), subject to certain limitations and restrictions.  This line carries an interest rate of either (i) the highest of prime rate, the federal funds effective rate from time to time plus 0.5%, or the one month adjusted LIBOR plus 1.0%; or (ii) adjusted LIBOR plus margin based upon our ratio of debt to earnings from time to time. The applicable borrowing rate including margin was 3.3125% (or one-month LIBOR plus 1.25%) at September 30, 2019. The credit facility is secured by security interests in, and liens on, all assets of the borrowers, other than real property and certain other excluded assets.

 

On September 9, 2019, the Credit Agreement was amended by a Second Amendment to the Credit Agreement. The Second Amendment increased the revolving credit facility by $25,000, decreased future increases by $25,000, increased the availability of swing line loans by $5,000 and joined Royal as a borrower.  Under the Credit Agreement, as amended by the Second Amendment, the Company may borrow up to $175,000 and may also request an increase in the facility of up to $50,000 in the aggregate, subject to customary conditions. The credit facility is also available for the issuance of letters of credit of up to $20,000 and swing line loans of up to $20,000 (subsequently increased to $30,000), subject to certain limitations and restrictions.

 

On September 25, 2019, the Credit Agreement was amended by a Third Amendment to the Credit Agreement. The Third Amendment increased the availability of swing line loans by $10,000. Under the Credit Agreement, as amended by the Second Amendment and the Third Amendment, the Company may borrow up to $175,000 and may also request an increase in the facility of up to $50,000 in the aggregate, subject to customary conditions. The credit facility is also available for the issuance of letters of credit of up to $20,000 and swing line loans of up to $30,000, subject to certain limitations and restrictions.

 

 

SPARTAN MOTORS, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Dollar amounts in thousands, except per share data)

 

 

On December 1, 2017, we entered into a First Amendment to the Second Amended and Restated Credit Agreement (the "First Credit Agreement") by and among us and certain of our subsidiaries, as borrowers, Wells Fargo, National Association, as agent, and the lenders party thereto consisting of Wells Fargo, National Association, JPMorgan Chase Bank, N.A. and PNC Bank National Association.  Under the First Credit Agreement, we were able to borrow up to $100,000 under a three-year unsecured revolving credit facility.  The First Credit Agreement was paid off and terminated when the “Credit Agreement” described above was entered into on August 8, 2018.  This line carried an interest rate of the higher of either (i) the highest of prime rate, the federal funds effective rate plus 0.5%, or the one month adjusted LIBOR plus 1.00%; or (ii) adjusted LIBOR plus margin based upon our ratio of debt to earnings from time to time.

 

Under the terms of our Credit Agreement we are required to maintain certain financial ratios and other financial covenants, which limited our available borrowings (exclusive of outstanding borrowings) under our line of credit to a total of approximately $41,219 and $86,410 at September 30, 2019 and December 31, 2018, respectively.  The Credit Agreement also prohibits us from incurring additional indebtedness; limits certain acquisitions, investments, advances or loans; limits our ability to pay dividends in certain circumstances; and restricts substantial asset sales. At September 30, 2019 and December 31, 2018, we were in compliance with all covenants in the Credit Agreement.

 

 

NOTE 5 – REVENUE

 

Contract assets and liabilities 

The tables below disclose changes in contract assets and liabilities as of the periods indicated.

 

 

 

The aggregate amount of the transaction price allocated to remaining performance obligations in existing contracts that are yet to be completed are expected to be recognized as revenue in the following annual time-periods:

 

 

(1)

Revenue above includes amounts related to extended warranties and roadside assistance contracts of $245 and $34 for one to 12 months and $608 and $18 for 13 months and beyond, respectively.

 

 

SPARTAN MOTORS, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Dollar amounts in thousands, except per share data)

 

 

For performance obligations that are satisfied over time, revenue is expected to be recognized evenly over the time period to complete the contract due to the assembly line nature of the business operations. For performance obligations that are satisfied at a point in time, revenue is expected to be recognized when the customer obtains control of the product, which is generally upon shipment from our facility. No amounts have been excluded from the transaction prices above related to the guidance on constraining estimates of variable consideration.

 

In the following tables, revenue is disaggregated by primary geographical market and timing of revenue recognition for the three and nine months ended September 30, 2019. The tables also include a reconciliation of the disaggregated revenue with the reportable segments.

 

 

 

 

 

 

SPARTAN MOTORS, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Dollar amounts in thousands, except per share data)

 

 

 

 

 

 

 

 

NOTE 6 – SHARE-BASED COMPENSATION

 

Performance Units

During the nine months ended September 30, 2019, we granted 218,148 performance units ("PSUs") to certain employees, which are earned over a three-year service period.

 

After completion of the performance period, the number of performance units earned will be issued as shares of Common Stock. The aggregate number of shares of Common Stock that ultimately may be issued under performance units where the performance period has not been completed ranged from zero to 218,148 shares as of September 30, 2019. The awards will generally be forfeited if a participant leaves the Company for reasons other than retirement, disability or death.

 

 

SPARTAN MOTORS, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Dollar amounts in thousands, except per share data)

 

 

A dividend equivalent is calculated based on the actual number of units earned at the end of the performance period equal to the dividends that would have been payable on the earned units had they been held during the entire performance period as Common Stock. At the end of the performance period, the dividend equivalents are paid in the form of additional shares of Common Stock based on the then-current market value of the Common Stock.

 

87,260 of the performance units granted in 2019 are earned based on our three-year cumulative GAAP net income, subject to such adjustments as approved by the Company’s Human Resources and Compensation Committee in its sole discretion (Net Income PSUs), which is a performance condition. The number of shares that may be earned under the Net Income PSUs can range from 0% to 200% of the target amount. The Net Income PSUs are expensed and recorded in Additional paid-in capital on the Condensed Consolidated Balance Sheets over the performance period based on the probability that the performance condition will be met. The expense recorded will be adjusted as the estimate of the total number of Net Income PSUs that will ultimately be earned changes. The grant date fair value per share of Net Income PSUs granted was $8.99. The grant date fair value per unit is equal to the closing price of the Company’s stock on the date of grant.

 

130,888 of the performance units granted in 2019 are earned based on achievement of certain total shareholder return results relative to a comparison group of companies ("TSR PSUs"), which is a market condition. The number of shares that may be earned under the TSR PSUs can range from 0% to 200% of the target amount. The TSR PSUs are expensed and recorded in Additional paid-in capital on the Condensed Consolidated Balance Sheets over the performance period.

 

The fair value of the TSR PSUs was calculated using the Monte Carlo simulation model which resulted in the grant date fair value for these TSR PSUs of $13.71 per unit.

 

The Monte Carlo simulation was computed using the following assumptions:

 

 

1.

Based on the U.S. government bond benchmark on the grant date.

2.

Represents the historical price volatility of the Company’s common stock for the three-year period preceding the grant date.

 

The total PSU expense and associated tax benefit for all outstanding awards for the three and nine months ended September 30, 2019 and September 30, 2018 are as follows:

 

 

 

The PSU activity for the nine months ended September 30, 2019 is as follows:

 

 

 

SPARTAN MOTORS, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Dollar amounts in thousands, except per share data)

 

 

As of September 30, 2019, there was $1,651 of remaining unrecognized compensation cost related to nonvested PSUs, which is expected to be recognized over a remaining weighted-average period of 2.25 years.

 

Restricted Stock Units

During the nine months ended September 30, 2019, we awarded 182,333 restricted stock units ("RSUs") to certain employees and Board members. These RSUs vest ratably over three years after the date of grant for employees and vest one year after date of grant for Board members, at which time the units will be issued as unrestricted shares of Common Stock. RSUs are expensed and recorded in Additional paid-in capital on the Condensed Consolidated Balance Sheets over the requisite service period based on the value of the underlying shares on the date of grant.  At the time any RSUs vest and are settled through the issuance of Common Stock, the value of the dividends that would have been payable on the shares of Common Stock issued upon settlement of the vested RSUs had such shares been held during the entire vesting period will be paid to the employee or director in cash or, in the discretion of the Human Resources and Compensation Committee, in shares of Common Stock based on the then-current market value of the Common Stock.

 

The RSU expense and associated tax benefit for all outstanding awards for the three and nine months ended September 30, 2019 and September 30, 2018 are as follows:

 

 

 

As of September 30, 2019, there was $1,248 of remaining unrecognized compensation cost related to nonvested RSUs, which is expected to be recognized over a weighted-average period of 1.3 years.

 

The RSU activity for the nine months ended September 30, 2019 is as follows:

 

 

 

NOTE 7 – LEASES

 

We have operating and finance leases for land, buildings and certain equipment. Our leases have remaining lease terms of one year to 18 years, some of which include options to extend the leases for up to 10 years. Our leases do not contain residual value guarantees. As of September 30, 2019, assets recorded under finance leases were immaterial (See Note 4 - Debt).

 

Operating lease expenses are classified as cost of products sold and operating expenses on the Condensed Consolidated Statements of Operations. The components of lease expense were as follows:

 

 

1.

Includes expenses for month-to-month equipment leases, which are classified as short-term as the Company is not reasonably certain to renew the lease term beyond one month.

 

 

SPARTAN MOTORS, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Dollar amounts in thousands, except per share data)

 

 

The weighted average remaining lease term and weighted average discount rate were as follows:

 

 

Supplemental cash flow information related to leases was as follows:

 

 

Maturities of operating lease liabilities as of September 30, 2019 are as follows:

 

 

(1)	Excluding the nine months ended September 30, 2019.

 

 

SPARTAN MOTORS, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Dollar amounts in thousands, except per share data)

 

 

The aggregate amount of future minimum annual rental payments applicable to noncancelable leases as of December 31, 2018 were as follows:

 

 

 

NOTE 8 - COMMITMENTS AND CONTINGENT LIABILITIES

 

Under the terms of the Credit Agreement we have the ability to issue letters of credit totaling $20,000. At September 30, 2019 and December 31, 2018, we had outstanding letters of credit totaling $653 and $913 related to certain emergency response vehicle contracts and our workers compensation insurance.

 

At September 30, 2019, we and our subsidiaries were parties, both as plaintiff and defendant, to a number of lawsuits and claims arising out of the normal course of our businesses. In the opinion of management, our financial position, future operating results or cash flows will not be materially affected by the final outcome of these legal proceedings.

 

Warranty Related

 

We provide limited warranties against assembly/construction defects. These warranties generally provide for the replacement or repair of defective parts or workmanship for a specified period following the date of sale. The end users also may receive limited warranties from suppliers of components that are incorporated into our chassis and vehicles.

 

Certain warranty and other related claims involve matters of dispute that ultimately are resolved by negotiation, arbitration or litigation. Infrequently, a material warranty issue can arise which is beyond the scope of our historical experience. We provide for any such warranty issues as they become known and are estimable. It is reasonably possible that additional warranty and other related claims could arise from disputes or other matters beyond the scope of our historical experience.

 

Changes in our warranty liability during the nine months ended September 30, 2019 and 2018 were as follows:

 

 

 

SPARTAN MOTORS, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Dollar amounts in thousands, except per share data)

 

 

Spartan-Gimaex Joint Venture

 

In February 2015, Spartan USA and Gimaex Holding, Inc. mutually agreed to begin discussions regarding the dissolution of the Spartan-Gimaex joint venture. In June 2015, Spartan USA and Gimaex Holding, Inc. entered into court proceedings to determine the terms of the dissolution. In February 2017, by agreement of the parties, the court proceeding was dismissed with prejudice and the judge entered an order to this effect as the parties agreed to seek a dissolution plan on their own. No dissolution terms have been determined as of the date of this Form 10-Q. Costs associated with the wind-down will be impacted by the final dissolution terms. The costs we have accrued so far represent the low end of the range of the estimated total charges that we believe we may incur related to the wind-down. While we are unable to determine the final cost of the wind-down with certainty at this time, we may incur additional charges, depending on the final terms of the dissolution, and such charges are not expected to be material to our results. For the nine months ended September 30, 2019, we incurred charges totaling $216 to write down certain inventory items associated with this joint venture to their estimated fair values.

 

 

NOTE 9 – TAXES ON INCOME

 

Our effective income tax rate was 24.7% and 22.8% for the three and nine months ended September 30, 2019 compared to 16.5% and 16.1% for the three and nine months ended September 30, 2018. 

 

The effective tax rate for the three months ended September 30, 2019 reflects the impact of current statutory income tax rates on our Income before taxes. The effective tax rate for the nine months ended September 30, 2019 was primarily impacted by the recording of a discrete tax benefit recorded in the first quarter related to additional state tax credits from prior years becoming available for utilization in future tax returns, with a net reduction in income tax expense of $296. 

 

Our effective tax rate for the three months ended September 30, 2018 was impacted by two favorable adjustments, one related to a change in expected full year financial performance and the other to provisional tax amounts recorded at December 31, 2017 as a result of the 2017 Tax Act. During the third quarter of 2018 we recorded a reduction in income tax expense of $361 to decrease the balance of the tax expense recorded for the first nine months of 2018 to the Company’s current estimated full year effective tax rate of 25.0% before discrete items.

 

We also recorded a $373 favorable adjustment upon completion of our 2017 federal income tax return, from provisional amounts recorded in our 2017 Annual Report on Form 10-K, as a result of the provisions of the 2017 Tax Act enacted in December 2017. The 2017 Tax Act includes a number of changes to previous U.S. tax laws that impact us, most notably a reduction of the U.S. corporate income tax rate from 35 percent to 21 percent for tax years beginning after December 31, 2017. We recognized the income tax effects of the 2017 Tax Act in the financial statements included in our 2017 Annual Report on Form 10-K in accordance with Staff Accounting Bulletin No. 118, which provides SEC staff guidance for the application of ASC Topic 740, Income Taxes, in the reporting period in which the 2017 Tax Act was signed into law.

 

The effective tax rate for the nine months ended September 30, 2018 was primarily impacted by a $1,403 discrete tax benefit related to the difference in stock compensation expense recognized for book purposes and tax purposes upon vesting.

 

 

NOTE 10 - INTEREST AND OTHER INCOME

 

Interest and other income is as shown below:

 

 

1.

The net working capital settlement from the acquisition of Smeal was recorded to other income because the settlement occurred after the expiration of the measurement period on January 1, 2018.

2.

This gain represents the reduction of a contingent liability from the Smeal acquisition that was made after the expiration of the measurement period on January 1, 2018.

3.

This amount represents funds received from the Smeal escrow account for post-acquisition costs.

 

 

SPARTAN MOTORS, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Dollar amounts in thousands, except per share data)

 

 

 

NOTE 11 - BUSINESS SEGMENTS

 

We identify our reportable segments based on our management structure and the financial data utilized by our chief operating decision makers to assess segment performance and allocate resources among our operating units. We have three reportable segments: Fleet Vehicles and Services, Emergency Response Vehicles and Specialty Chassis and Vehicles.

 

We evaluate the performance of our reportable segments based on Adjusted EBITDA. Adjusted EBITDA is defined as earnings before interest, taxes, depreciation and amortization, and other adjustments made in order to present comparable results from period to period. For the periods covered by this Form 10-Q, these adjustments include: restructuring charges; accruals and adjustments to prior accruals for product recalls; various items related to business acquisition, litigation and strategic planning activities; certain stock compensation; and the impact of severe natural phenomena in areas surrounding our production facilities. We exclude these items from earnings because we believe they will be incurred infrequently and/or are otherwise not indicative of a segment's regular, ongoing operating performance. Adjusted EBITDA is also used as a performance metric for certain of our compensation programs, as discussed in our proxy statement for our 2019 annual meeting of shareholders, which proxy statement was filed with the SEC on April 19, 2019.

 

Our Fleet Vehicles and Services segment consists of our operations at our Bristol, Indiana location, and beginning in 2018 certain operations at our Ephrata, Pennsylvania location along with our operations at our up-fit centers in Kansas City, Missouri; North Charleston, South Carolina; Pompano Beach, Florida; Montebello, California and Saltillo, Mexico. The segment focuses on designing and manufacturing walk-in vans for parcel delivery, mobile retail, and trades and construction industries, the production of commercial truck bodies, and the distribution of related aftermarket parts and accessories.

 

Our Emergency Response Vehicles segment consists of the emergency response chassis operations at our Charlotte, Michigan location and our operations at our Brandon, South Dakota; Snyder and Neligh, Nebraska; and Ephrata, Pennsylvania locations. This segment engineers and manufactures emergency response chassis and apparatus and distributes related aftermarket parts and accessories.

 

Our Specialty Chassis and Vehicles segment consists of our Charlotte, Michigan operations that engineer and manufacture motor home chassis, defense vehicles, truck bodies and other specialty chassis, and distribute related aftermarket parts and assemblies. In addition, beginning in September 2019 with the acquisition of Royal, the Specialty Chassis and Vehicles segment includes operations in Carson and Union City, California; Mesa, Arizona; and Dallas and Weatherford, Texas. Royal is a leading California-based designer, manufacturer and installer of service truck bodies and accessories.

 

The accounting policies of the segments are the same as those described, or referred to, in Note 1 - General and Summary of Accounting Policies. Assets and related depreciation expense in the column labeled “Eliminations and Other” pertain to capital assets maintained at the corporate level. Eliminations for inter-segment sales are shown in the column labeled “Eliminations and Other”. Appropriate expense amounts are allocated to the three reportable segments and are included in their reported operating income or loss.  Segment loss from operations in the “Eliminations and Other” column contains corporate related expenses not allocable to the operating segments. Interest expense and Taxes on income are not included in the information utilized by the chief operating decision makers to assess segment performance and allocate resources, and accordingly, are excluded from the segment results presented below.

 

 

SPARTAN MOTORS, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Dollar amounts in thousands, except per share data)

 

 

Three Months Ended September 30, 2019

 

 

 

Three Months Ended September 30, 2018

 

 

 

SPARTAN MOTORS, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Dollar amounts in thousands, except per share data)

 

 

Nine Months Ended September 30, 2019

 

 

 

Nine Months Ended September 30, 2018

 

 

 

SPARTAN MOTORS, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Dollar amounts in thousands, except per share data)

 

 

The table below presents the reconciliation of our consolidated income before taxes to total segment Adjusted EBITDA. Adjusted EBITDA is not a measurement of our financial performance under GAAP and should not be considered as an alternative to net income. Adjusted EBITDA may have limitations as an analytical tool and should not be considered in isolation or as a substitute for analysis of our results as reported under GAAP. In addition, although we have excluded certain charges in calculating Adjusted EBITDA, we may in the future incur expenses similar to these adjustments, despite our assessment that such expenses are infrequent and/or not indicative of our regular, ongoing operating performance. Our presentation of Adjusted EBITDA should not be construed as an inference that our future results will be unaffected by unusual or infrequent items.