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REV Group, Inc. (NYSE:REVG)
Q3 2019 Earnings Call
Sep 5, 2019, 11:00 a.m. ET

Contents:

  • Prepared Remarks
  • Questions and Answers
  • Call Participants

Prepared Remarks:

Operator

Greetings, and welcome to the REV Group, Inc. Third Quarter 2019 Earnings Conference Call. [Operator Instructions] A brief question-and-answer session will follow the formal presentation. [Operator Instructions]

It is now my pleasure to introduce your host Mr. Drew Konop, Vice President of Investor Relations. Thank you. You may begin.

Drew Konop -- Vice President, Investor Relations

Thanks, Michelle. Good morning, and thank you for joining us. Last night, we issued our third quarter 2019 results. A copy of the release is available on our website at investors.revgroup.com. Today's call is being webcast and is accompanied by a slide presentation, which includes reconciliation of non-GAAP to GAAP financial measures that we will use during this call. It is also available on our website.

Please refer now to Slide 2 of that presentation. Our remarks and answers will include forward-looking statements within the meaning of the Private Securities Litigation Reform Act. These forward-looking statements are subject to risks, that could cause actual results to be materially different from those expressed or implied by such forward-looking statements. These risks include among others, matters that we have described in our Form 8-K filed with the SEC last night and other filings we make with the SEC.

We disclaim any obligation to update these forward-looking statements, which may not be updated until our next quarterly earnings conference call, if at all. All references on this call to a quarter or a year are our fiscal quarter or fiscal year, unless otherwise stated. Joining me on the call today are our President and CEO, Tim Sullivan; and CFO, Dean Nolden. Please turn to Slide 3.

I'll now turn the call over to Tim.

Tim Sullivan -- Chief Executive Officer

Thanks, Drew. Good morning, everyone and thank you for joining us to discuss REV Group's third quarter results. So what happened in the past three months that caused us to fall short of our goals in the third quarter and reduce our full year earnings guidance by approximately 30%. A large portion of the change can be defined in one word, labor. Strategic decisions we made pertaining to labor during this fiscal year cannot be blamed entirely on our current situation with the tariffs, but they were a significant contributor.

I will provide some commentary on what has transpired and then Dean will follow with details on our Q3 financial performance, as well as a detailed financial analysis of our revised guidance. First and foremost, we believe the fundamentals that drive our business remained strong with the exception of softness in the RV market. Notwithstanding the overall strength of our markets and backlog, third quarter performance was well below our expectations and we now know that what occurred in the third quarter will flow into our fourth quarter.

Slide 3 identifies three primary drivers of underperformance, as well as some positives within the quarter, including the actions we are taking to improve our financial results and drive shareholder value. I'll walk you through the challenges we face in the quarter and order of the impact it had on our third quarter and full year guidance. Consolidated results were primarily driven by underperformance at our three largest businesses.

First, the production ramp in plant expansion, and one of our primary fire facilities has progressed slower than we anticipated. As a reminder, we had been ramping up this facility to expand capacity in order to service increasing customer demand. To fully understand our current situation, I must first offer some historical perspective. When this business was purchased out of bankruptcy in 2006, there was a major reduction in the physical footprint of the plant, as well as a reduction in the workforce of over 800 people. As our brand and market presence has recovered in recent years, we have been meeting our shipping requirements by engaging in an inordinate amount of overtime. This large amount of overtime was no longer sustainable at our current manufacturing labor market.

In other words, turn over became a major deterrent to continuing to rely on overtime to meet our production needs. Manufacturing labor is in high demand and people have many choices where they work. In Q1, we embarked on a 36% expansion of our manufacturing footprint, which constituted expanding into three new buildings in close proximity to our current plant. This expansion also required a 38% increase in labor. Those of you that appreciate manufacturing understand that this level of expansion is arduous in normal times, let alone in a very tight labor market. Our challenges have been overcoming bottlenecks as we balance our new plant flow and higher labor costs as we onboard and train new employees to fulfill our goal of doubling our plant capacity from 2017 levels. Basically, we are carrying excess labor as we expand and balance the expanded plant.

As we train and position this new labor, they are inefficient and unproductive, thus significantly deteriorating our earnings. We expect these conditions to alleviate in the fourth quarter, but we do not expect to hit our originally planned one rate until the first half of fiscal 2020. It is important to note that through these challenges, we have worked with our customers to continue to deliver quality fire trucks, we have not experienced any order cancellations. Additionally, as part of our expansion, we are implementing our proprietary REV Production Systems or RPS, which has added to the accountability, predictability and stability of our operations. RPS has already allowed us to reap additional operational benefits in our Commercial segment, which is performing at very high levels.

Second, we had two situations in our Ambulance business that created a slow start to our year. Similar to our Commercial division last year, we experienced delays in large orders from some of our normal municipal accounts; in particular, a delay in one large order reduced our normal booking levels early in the year by approximately 40%. We have now received that order and we will finish the year with a strong backlog for fiscal year 2020. Although none of this particular large order was shipped in fiscal 2019. Additionally, we experienced an unusual amount of remount activity in markets this year, although remounts have been an alternative solution to purchasing new units for some time they have become more popular recently delaying replacement of new units for two to three years.

Remounts are approximately half the margin opportunity of our new unit sale. Notwithstanding the initial lack of booking activity we decided to maintain a full workforce in anticipation of delivering against the delayed municipal orders. Quite frankly, this is a new normal in manufacturing in the era of tariffs unlike the past, if you have labor you retain it. Again, we made a strategic decision that during unusual times like this scarcity of manufacturing labor means you carry the labor you have during times of temporary booking shortfalls. We believe that we could carry the additional labor costs in the first two quarters and approach more normal levels of absorption in the last two quarters.

We have been unable to adequately absorb these costs in the back half of the year and they have negatively impacted our earnings guidance for year-end. We do believe that now with a well-defined backlog that this excessive labor costs will be absorbed by higher expected production rates as our new backlog begins production toward the end of Q4. On a positive note targeted inventory that was left over from the 2018 supply chain disruption has largely been liquidated and our new general manager at our largest Ambulance business is making strides with production process improvements and level loading the production line.

Third, the RV market in particular Class A and campers experienced a greater than anticipated slowdown of wholesale shipments within the quarter, although we entered the year expecting a 20% decline within the Class A market, certain product types experienced a more severe slowdown in dealer orders in wholesale shipments lagged our retail sales. As a result, we have taken measures to reduce costs at our Class A business by consolidating plants from two to one and shut down one extra week during the July 4th holiday. We have already reduced the share of Class A motor homes in this segment mix from roughly 60% to closer to 45% and we continue to shift our production mix to our stronger performing lines during the demand reduction in the Class A market. As we approached the September open house, we are excited about the 2021 line up of vehicles that we will be showcasing and we feel that dealer inventories for our products will respond quickly to any upturn in the overall market should it occur this year.

Finally, you'll recall that at the end of Q2 reported that we have begun to experience more normal material lead times as our suppliers continue to adjust to the tariffs, while this remains the case, we did experience some critical material supply issues during the quarter, which negatively impacted our ability to ship product. Until such time that the tariffs are removed, we expect to continue to manage through some inconsistencies in our material supply. Despite the underperformance, I'd like the highlight three key positives in the quarter that set REV up for our intermediate and long-term production of financial improvements. First, net cash provided by operating activities in the third quarter was $61 million compared to a $13 million use in the third quarter last year.

The significant year-over-year increase was a result of our focus on efficient management of net working capital and specifically the sale of targeted excess inventory. While we have reduced our full year cash flow guidance due to lower earnings, we anticipate paying down additional debt in the fourth quarter and we continue to target a normalized debt level of 2 times, which would allow REV to once again consider strategic capital allocation deployment within our key end markets.

Second, we also added key personnel within the Commercial segment in Ambulance division. Brian Perry joined us as President of the Commercial segment in July. Brian brings wide operational experience previously managing 21 facilities and his addition will continue upon the solid execution momentum we have built in our Commercial segment. Within the Ambulance division, we are pleased to announce the addition of Anoop Prakash as the new President, when we hired subsequent to the close of our fiscal third quarter. Anoop let the start-up of Harley Davidson's Commercial operations in India. Harley Davidson's direct selling initiatives in Canada and realignment of its US dealer network. We look forward to the positive contributions these gentlemen will bring to their respective positions.

Finally, we are formally introducing REV production systems. Our RPS team has leveraged sustainable processes to enhance operational efficiencies. This involves closely -- working closely with the individual businesses to enhance, install and measure processes, which have contributed to this year's stability and growth within our Commercial segment. The RPS team has now been dispatched to our Fire and Emergency segment to assist driving higher accountability, output and profitability improvements. We're optimistic that they can leverage the local teams and their experience to get our F&E segment headed in the right direction.

Let's shift to our outlook for the fourth quarter and fiscal 2020, as we begin our planning process for next year. Again, first and foremost, we believe fundamental demand across the majority of our end markets remain solid and we have continued to deliver high quality products against our roughly $1.3 billion backlog. Fire and Emergency backlog is up 28% year-over-year, which has been the result of an increase of orders across our fire truck and certain ambulance brand categories. We believe addressing the performance issues in the two Fire and Emergency businesses our two largest by far, we have mentioned is fully within our control as we leverage the key personnel additions, and continue to improve and measure the processes at these locations.

While the production cadence within fire has not increased as rapidly as anticipated and our unit sales are essentially flat sequentially. The primary cause of underperformance year-to-date has been lower absorption of increased labor. Our full year guidance now embed a slight increase to fire's third quarter production exit rate, along with a small amount of margin improvement as we begin to normalize operations from the disruption of training workers, reconfiguring the factory footprint and realigning sales in the production line. We fully expect that the new plant layout and staff return the fire divisions to its historical profitability and higher production rates over time. However, this guidance reset reflects the current situation within the business.

Our largest ambulance facility, we liquidated much of the targeted inventory that resulted from the chasse disruption late last year, albeit lower margins due to a higher labor content. We believe, for some time that they have become more popular recently. Ambulance remounts at dealers and contractors have increased throughout the year leading to irregular order timing within the industry and some near-term booking headwinds. As I mentioned, we retained current staffing levels relevant downsizing and flexing up to produce some of the large municipal orders that are now in our backlog.

Looking toward the end of the fiscal year and toward next fiscal year, we anticipate unit production at that plant to increase sequentially, which should alleviate the margin pressure we experienced within the business. Recreation end markets have continued to decline in our largest Class A category. Class A has been a primary driver of recent underperformance. Through this downturn, we have focused on what we can control. Within the quarter we took cost out by rationalizing facilities from two to one and reduced production at our Class A Decatur business. We have a solid line up of product that we will introduce at the September Open House and we remain confident that these will be well received.

This trade show serves as a significant venue for wholesale ordering. Dealer inventories or products are at a very low level as retail sales have outpaced replenishment orders. Our current factory footprint would support dealer restock should it occur. However, our current full year guidance does not rely on this happening. Outside of Class A, we have continued to deliver against a solid backlog in Class B and supersede products, but again our revised guidance takes a more cautious view of those markets as well on a reduced outlook for Towables.

In Commercial, the segment has benefited from improved mix to-date versus 2018 and I would like to reiterate that all businesses in this segment have met or beat expectations this quarter. This group is doing a great job of executing on their backlog and they've embraced the model of continuous improvement and the defined processes that we're deploying. Across these businesses we're seeing examples of improvement and throughput, lower cost of quality and higher overall profitability versus 2018. While we expect typical seasonality result and lower sales and EBITDA sequentially, the businesses are expected to continue on the path of improved year-over-year performance this quarter and into 2020.

I will now turn the call over to Dean to go through the financials.

Dean Nolden -- Chief Financial Officer

Thank you, Tim and good morning. I will start on Slide 4. As Tim discussed, the performance at our three largest businesses was lower than expected in the quarter, on a top line and bottom line basis. And the impact of those misses is evident on a consolidated adjusted EBITDA and adjusted EBITDA margin graphs on this page, as well as the update to fiscal 2019 guidance we have provided. While net sales have increased slightly for REV as a whole, the poor margin performance at these three specific business units make up nearly the entirety of our miss versus our expectations.

Total net sales for the third quarter were $617 million, up 3.2% compared to the third quarter of last year. The increase in consolidated net sales was primarily due to an increase in net sales in the Commercial and Fire and Emergency segments offset by a decrease in net sales in the Recreation segment. Net income for the quarter decreased by 69% to $5.6 million, or $0.09 per diluted share. Adjusted net income decreased by 45% to $13.6 million or $0.21 per diluted share. The decrease in the third quarter 2019 net income and adjusted net income was primarily the results of a decrease in gross profit in the Fire and Emergency and Recreation segments, partially offset by an increase in the Commercial segment. Adjusted EBITDA for the third quarter was $33.5 million versus $47.6 million in the year ago period. The decrease in third quarter was primarily due to lower gross margins at our largest fire, largest ambulance and largest recreation business units, partially offset by strong earnings in our commercial businesses, as well as continued strong performance in recreation by our Class B, Super C and towables businesses.

Please now turn to Slide 5 to discuss the performance of our segments individually. Fire and Emergency segment sales increased by 3.7% to $248 million for the third quarter 2019 versus the year ago period. The primary drivers of this result were improved pricing and mix of fire trucks and ambulances, slightly offset by a decrease in volume of ambulance shipments. F&E adjusted EBITDA for the quarter declined to 52% to $12.1 million, due primarily to two drivers that Tim referred to earlier. One, higher labor costs associated with the process to increase the output of fire trucks and our largest fire facility. This labor is currently less productive than needed to achieve our targeted line rates.

And second, maintaining staffing levels at one ambulance facility during a period of softness of incoming orders and buildable backlog. Total F&E backlog remains healthy and was up 28% year-over-year to $776 million to both the fire trucks and ambulances. As Tim mentioned, we now expect the production ramp at our largest fire facility to be delayed into the first half of fiscal 2020, while our operational excellence team continues to implement defined, measurable continuous improvement processes to assist the movement of chassis, cabs and trucks through production and final assembly.

In our largest ambulance business, incoming orders, production levels and staffing levels will start to come into balance at the end of the fourth quarter. These two factors give us confidence that profitability should improve from here, albeit at a slower rate than expected, because we won't start delivering on a recently awarded large municipal contract this year. But we believe this sets us up for better performance in fiscal 2020. In addition, our new General Manager of our largest ambulance business is hitting stride with improvements to operational efficiency, commercial strategies and adoption of the REV Production System.

We'll move next to the Commercial segment on Slide 6. Quarterly sales were up 29% compared to the prior year period, driven by an increase in the volume of transit and school bus shipments, improved pricing and increased sales of shuttle bus and terminal trucks. Commercial backlog at the end of the third quarter was down 6% to $395 million, compared to the third quarter 2018, resulting from the continued delivery of transit buses to a large municipal customer in the quarter.

Commercial adjusted EBITDA of $19.4 million was up 64% compared to the third quarter of last year. The increase -- This increase was due to increased sales of higher margin school and transit buses, terminal trucks and improved efficiencies driven by the implementation of our REV Production System, which started in late fiscal 2018. Adjusted EBITDA margin increased 200 basis points year-over-year to 9.5% in the third quarter. The result in this segment are evidence of the strength of our products and market positions. The capabilities of our production and management teams and the benefits of deployment of our RPS OpEx tools.

Turning to Slide 7. Quarterly sales in the Recreation segment declined 16% over the year ago period to $167 million. The decrease in net sales compared to the prior year period was primarily due to a decrease in the shipment volume of Class A motorhomes in higher discounting levels as dealers continue to reduce inventory in connection with soft RV end markets. Net sales of truck campers also decreased slightly, while net sales of our Class B and Super C's increased. Recreation adjusted EBITDA decreased 29% compared to the third quarter of last year to $12.8 million. The decrease in adjusted EBITDA compared to the prior year period was primarily due to the lower Class A volumes and competitive discounting. Tim mentioned actions we have taken to reduce Class A production volumes and costs. It is important to note that while we have downsized our footprint and cost structure within the current Class A environment. We have retained manufacturing floor space that could be ramped in the event that a more robust future dealer restock within this category should happen.

On Slide 8, we provided an update to our full year outlook, which reflects the lower year-to-date performance, as well as the expectation for continued slower pace of production within fire while we train and integrate the additional workforce. At ambulance, due to the timing of our recently awarded larger municipal contract. And in recreation, anticipation for continued softness in the Class A RV market, at least through this fall's Open House event. Well, both the fire production ramp and the trajectory of the RV market were identified during our last conference call as key challenges in the second half of fiscal 2019. We did not anticipate the magnitude of either outcome. At the time, we announced our second quarter results, we had seen progress in the planning for the production ramp up within fire and fully expected that the project plan to our target cadence by year end was under way.

Unfortunately, we reached limits within the fact that the facility footprint in the third quarter given the new labor and production volume that was introduced to the shop floor. This created bottlenecks which have been challenging to resolve. Considering the higher number of new employees who are currently under productive, our adjusted EBITDA margin dropped 120 basis points sequentially, on approximately flat sales. This was exacerbated within the F&E segment by retaining our staffing levels in the Ambulance business, despite the late award of that large municipal contract. We believe both decisions; first, to hire and train labor within fire; and two, to retain labor in ambulance will benefit our customers and investors over the long-term. Deploying our RPS teams to F&E has identified several opportunities to adjust our production plans and processes for improvement across the segment and will add to the stability of continuous improvement as we move into fiscal 2020.

For fiscal 2019, we now expect net sales to be in the range of $2.35 billion to $2.45 billion and adjusted EBITDA in the range of $100 million to $110 million. Net income is forecasted to be in the range of a loss of $8 million to positive income of $5 million. And adjusted net income is expected to be in the range of $28 million to $41 million. You will note the decrease in adjusted EBITDA is much greater than the reduction in sales, reflecting primarily the additional labor that we carried in the third quarter and no longer anticipate will be fully efficient in the fourth quarter. However, we believe the path to greater profitability is within our control and we will realize healthy incremental margins as we absorb this labor, implement RPS throughout the organization and further execute on our backlog within F&E.

Please turn to Slide 9. It is important at this point to provide a reconciliation of where we stood with regard to our full year outlook when we spoke to you last -- in early June for our second quarter results and our current guidance. After the end of the second quarter, we had line of sight to achieving the full -- to achieving the range of full year adjusted EBITDA guidance. As we disclosed in connection with our mid-year results, the biggest risks to achievement of our full year guidance were the successful execution of our ramp up in the Fire division and the progression of the RV markets during the seasonally strong summer months. As the third quarter progressed, our largest fire business unit progress stalled despite the investment in a large number of new production employees, support staff, additional factory space and related costs. We made the conscious effort to maintain employment and battle through the ramp up with the assistance of our op-ex teams and certain external expert resources.

In this tight labor market, we also made the decision to retain our complement of skilled manufacturing employees in one ambulance business unit despite the late award of the municipal contract. When these contracts are awarded, we don't include the opportunity in backlog or our production schedules until formal purchase orders are issued against the contract. In this case, PO is not -- PO is under this contract, we're not provided in time and we are now not physically capable of manufacturing and delivering on any of these trucks under this contract until fiscal 2020. Lastly, as the summer months progressed, the RV market remains softer than anticipated and further worsened as wholesale shipments slowed faster than retail sales.

Dealers remain cautious about the overall trajectory of demand and continued to manage their own balance sheets for minimum leverage and risk. Dealer inventories are now at low levels compared to history as result. All of these three items together resulted in approximately $26 million of EBITDA leakage during the third quarter from our previous forecast. The magnitude of this impact is consistent with the relative size and profitability of the businesses that we're impacted. As we look into the fourth quarter and toward updating our full year guidance, this $26 million shortfall primarily from three business units is not recoverable as it relates to period costs and at the end of -- and we are at the end of the summer peak season for RV and for our model year 2020 coaches.

Given the nature of these issues and our realistic look at the remainder of our fiscal year, we do not expect meaningful production output increases, and efficiencies in our fire businesses, nor delivery against the large and municipal ambulance contract order within this fiscal year. And it is not reasonable to anticipate a meaningful rebound in the RV end markets at this point in the RV season. Although, the fourth quarter impact of these items, on our full year outlook is not as significant as it was in the third quarter in proportion to the size of the quarter in our fiscal year. Due to some improvement in the benefit of certain cost reductions, the reasonable expectation for the impact in the fourth quarter is another approximately $26 million.

The combination of our third quarter adjusted EBITDA miss plus the anticipated miss from the same issues in the fourth quarter, totals approximately $50 million of second half impact, resulting in our updated guidance range of $100 million to $110 million. On the positive note, approximately two-thirds of this adjusted EBITDA debt reduction is unrelated to end market demand, and we believe our return to prior profitability levels for these F&E businesses is within our control.

Turning to the balance sheet and cash flow results for the quarter, which is a significant positive. Net cash provided by operating activities in the third quarter 2019 was positive $61 million compared to a use of cash of negative $13 million in the third quarter of 2018. This significant $74 million increase in cash from operating activities over the prior year quarter was due to the company's ongoing focus on efficient management of networking capital in addition to the sale of targeted excess inventory, which included completed inventory, some of which was left over from a supply chain disruptions in late 2018.

Our net increase of inventory within the third quarter includes an increase of working process against our backlog, and these -- in the large municipal orders. Net debt at July 31, 2019 was $399 million and our net leverage ratio was 3.3 times, reflecting over $50 million of net debt reduction within the quarter. We now expect $70 million to $80 million of cash from operations and over $25 million of cash flow for the full year from other initiatives. Due purely to the lower EBITDA forecast over the near term, not any liquidity or interest coverage issues, we now expect our year end net debt to EBITDA ratio to end in the low 3 times range, which is still below our covenant maximum. Having said that, we believe we have strong partnerships with our lender group. We will be proactive managing the situation as appropriate in our long term net debt to EBITDA target remains at 2 times or less and we plan to continue to pay down debt as we strive to improve EBITDA through the fourth quarter and into fiscal 2020.

With that, I'll turn the call back to Tim for some closing comments.

Tim Sullivan -- Chief Executive Officer

Thanks, Dean. Maybe to help with understanding the magnitude of the dollars involved, it's good to know that approximately 25% of our 8,000 employees work in these two facilities. So clearly, these are the two largest facilities in our entire portfolio and they happen to create these issues at the identical time. Once again, though, with the exception of RV, we believe we have strong tax base markets. The good news is that we are ramping our manufacturing capability to deal with record backlogs. Most people will say that, that is a good problem to have. True, however, we need to be better with our execution and meeting that demand. This has been particularly exasperate in our current markets and the challenges presented by the tariffs, but we still need to manage through it better than we have in the recent past.

We have mentioned many times that 10% EBITDA margins is the target for individual businesses and REV as a whole. It has been almost three years since our IPO and we are behind this goal on a consolidated basis. Many of our businesses are performing above that level and I would like to recognize them for the good work that they are doing. Nevertheless, it is time to take another look at those businesses where a near-term path of this target is not yet apparent.

With that operator, I'd like to open up the line to questions.

Questions and Answers:

Operator

Thank you. We'll now be conducting a question-and-answer session. [Operator Instructions] Our first question comes from the line of Jerry Revich with Goldman Sachs. Please proceed with your question.

Jerry Revich -- Goldman Sachs -- Analyst

Yes. Hi. Good morning, everyone.

Tim Sullivan -- Chief Executive Officer

Good morning, Jerry.

Jerry Revich -- Goldman Sachs -- Analyst

Tim, I'm wondering, could we just continue the discussion along that last comment that you made the areas that you folks are working hard on are seem to be core parts of the portfolio in terms of businesses that aren't performing well now. So how big is the part of the portfolio that you're evaluating whether it's a strategic fit, it doesn't sound like it's the businesses that we're working through now based on the fit within the business model. But I just want to get your comments on that to make sure we're thinking about it the right way and understand with magnitude of the portfolio that you are looking at, for potential divestiture.

Tim Sullivan -- Chief Executive Officer

It's really two areas. They are pretty clear. We have Type A RV that is not at the 10% level and with our other segments performing at that level and it is shuttle bus. Those are the two specific areas that right now are lagging to our goal.

Jerry Revich -- Goldman Sachs -- Analyst

Okay. And then on the fire truck side at KME, can you talk about as you're making that transition to the bigger manufacturing footprint? What are you finding as you make that transition on a product development side, I guess when we've seen plant consolidation and plant moves in this -- in the fire truck industry in the past, it's been tougher to get the institutional knowledge on the floor in terms of all of the custom made components and how they fit together. I'm wondering, if you can comment on how that part of the transition is playing out and whether that's impacting the cost structure that we're seeing this quarter and into next quarter?

Tim Sullivan -- Chief Executive Officer

You hit the nail on the head. We're really talking about the E-ONE facility in Ocala, Florida, which is by far our largest fire apparatus plant, that's exactly the issue, Jerry. Now we're trying to bring in a lot of new people, and it's very difficult to have them ramp to the expertise. The level of expertise, we need them to be productive. Having said that, we've been at this now for a few months and we're starting to see some light at the end of the tunnel. But you hit the nail on the head, that's exactly, what the issues are.

Dean Nolden -- Chief Financial Officer

And Jerry, maybe to put that in a bit of context, it's a couple 100 additional employees over previous levels on a base of approximately 700 truck labor employees in that facility. So it's a pretty large magnitude.

Jerry Revich -- Goldman Sachs -- Analyst

And the way we've seen this issue addressed in the past or most recently at a competitor of yours has been to really reduce the production rates, lock-in the process and then ramp back up. Is that part of the thinking here or are the customer delivery requirements making it tough to take that path to ride the ship here?

Tim Sullivan -- Chief Executive Officer

Yeah. The good news is the customers respect our product and they've been infinitely really patient with us. Obviously, it's not easy for them because when they get the money they need to spend it, but I think the other thing that they appreciate to a high level is the fact that we will not ship an inferior quality product. And I think they're willing to wait, I've met with a couple customers here just recently. We're not happy that we were late and in one instances we're two months late, but it complemented me on the level of quality that we're producing he says never been any better. So they've been patient, we got to pick it up though, I mean, our backlog is now approaching 16 months, which is way too long.

Jerry Revich -- Goldman Sachs -- Analyst

Okay. Thank you.

Operator

Thank you. Our next question comes from the line of Stephen Volkmann with Jefferies. Please proceed with your question.

Stephen Volkmann -- Analyst

Hi. Good morning, guys.

Tim Sullivan -- Chief Executive Officer

Good morning, Steve.

Stephen Volkmann -- Analyst

I guess, I want to just try to step back here a little bit and try to understand what's going on in the sense that, obviously companies have issues here and there, and they sort of address them and it sounds like you're doing that in some cases, but they just keep coming up. And Tim, it just feels like you don't have the reporting processes in place or maybe the people. How does this stuff just keep coming up? And I mean 90 days ago we had a very different message from you guys and obviously, things have really gone off the rails during the quarter. And I'm just -- I don't understand how that can change that quickly and that it seems like, you guys just don't have sort of the feedback loops that you need to stay on top of this stuff? I don't know if you can address that, but...

Tim Sullivan -- Chief Executive Officer

Steve, it's a fair comment, obviously, when we were sitting here in the first week in June we were laser focused on material demand and material lead time not believing that the ramping up at E-ONE and sustaining the labor at REV will would not write itself during the third quarter little in the fourth quarter. It's a fair comment, I mean, we got to get better, at execution, we got to get better at looking to see what's coming at us. I think in many respects, we thought we had some light at the end of the tunnel with E-ONE, we have been at it for six months and we were making progress. I don't think there's a person in this company that really fully appreciated the fact that we were not going to get to the production levels in the third and fourth quarter because we always got there before. The problem is that this was a massive increase in capacity.

And I mentioned in my remarks this is something that's difficult in normal times, let alone times that we're in right now. We're battling 30% labor turnover on average in our plants right now and that's not normal, and that really has to do with the fact that the labor market is incredibly tight. So every time you train somebody there for a couple weeks, they are gone and as you try to ramp your production you're bringing people that don't know anything about the work you're doing. So you're starting from scratch. It's just a tough situation, your point is well taken, I mean, you get to the point where you say when you guys going to get on your game. We've had two years in a row now. Last year, with the material side of the tariffs, this year the labor side and just other delays, we got to get on top of it. And we're dedicated to get that done.

Stephen Volkmann -- Analyst

So I guess, I mean, you talk about things may be starting to improve through the fourth quarter and then getting better in 2020, but how do you have any confidence in that?

Tim Sullivan -- Chief Executive Officer

Well, we talked about RPS. Right? And that's a fairly new phenomenon for us. It's started, Ian Walsh and his team attack the Commercial segment last year. Last year, about this time they started the process. And you can see how that has stabilized and done extremely well. We believe in the process, we think it's going to have a very positive effect on not only commercial going forward, but obviously for an emergency. And it starts to address your concerns or the things that you've raised. We need to know daily what's happening on their production floor. And these people have to have goals set and hit targets. And those disciplines have really not been in these businesses that we bought, especially vehicle businesses are not -- as we talked about are not very sophisticated, we got to get them a lot more sophisticated. And we are very encouraged by the results of RPS in commercial, it's done really well in a fairly short period of time.

Stephen Volkmann -- Analyst

Okay. And have you changed any of the incentive programs around, how people get paid or the other opportunity for job security, I guess, relative to hitting these targets?

Tim Sullivan -- Chief Executive Officer

Yeah. We actually broke it down into finer detail we used to have -- when we first started, three years ago, I guess will be four years in November as being REV. It was a pretty broad incentive plan where we had to hit certain global targets for the company. This thing is now being broken down. It's been broken down into quarters, months and weeks. These guys have weekly targets that they need to hit. We can see what's happening. The problem is it's very exasperating to attack and when it gets down to a labor situation, material as crazy as it was last year with chassis and material lead times, that sort of thing. You can kind of -- you can see that company can kind of muscle through it. Labor is like mercury, I mean, you've got -- they're here today, they're gone tomorrow, you got 10 under training as welders, and by the end of next week, you got two left. We will get that stabilized and we're looking at different ways to incent retention.

Just because of the market we're in right now, we've never had to do that before we had very experienced workforces and as we ramp and increase our production capability, we have to figure out how to retain some of these new employees. The good news is, the longer serving employees, the more experienced employees, they're sticking with us. Those aren't the people that we're having a problem with. The problem is, when you're increasing your labor in one plant by 38%, and you're fighting the 30% retention issue, that's a tall order. I will get there, I mean, we're absolutely convinced that we will get there, but we got to prove it. We haven't -- the last two years and I don't want to use the tariff as an excuse. But it's been hard enough to kind of grow this business and manage it as an operating company as REV without having that anchor around our neck as well trying to reach our goals. Not excuse. We will get there, I think with RPS. We will get there with some new incentive programs that we're going to introduce here in about six weeks for the new fiscal year. We have to demonstrate it.

Stephen Volkmann -- Analyst

All right. Thank you. I'll pass it on.

Operator

Thank you. Our next question comes from the line of Mig Dobre with Robert W. Baird and Company. Please proceed with your question.

Mig Dobre -- Robert W. Baird and Company -- Analyst

Good morning, guys. Just to sort of follow up on the questions already asked. I'm just trying to understand kind of what's going on in foreign emergency. I mean, if I look at your implied revenue guidance, you haven't adjusted that a whole lot. So the way I'm kind of interpreting it is, the shipments that are coming out of this segment don't seem to be kind of materially different than what you were thinking, but obviously, the costs are. So, I understand that you're talking about labor has been an issue. The part that I'm not quite clear on is, are you essentially seeing a lot of labor turnover? And if so, presuming that these newer employees are coming on board and they're not as efficient, shouldn't that result in lower production schedules as well or is it that, it simply takes more man hours just to get the product done? I'm not quite clear as to exactly what's happening here? And maybe to Jerry's or rather Steve's question, how do you gain the comfort that you can resolve this problem within, call it, the next three months or so?

Tim Sullivan -- Chief Executive Officer

Well, there are two different issues. They're both labor related. In the instance of the ambulance, we basically started the new year with a very meager small backlog. And we decided to hold that labor, retain it to the full extent possible, just for the fact that we had to retain we felt and more experienced workers because we felt, because we're in municipal tax based revenue, we would eventually get that backlog. We did get that backlog. And now, as we go into 2020, our Ambulance business in Orlando has got a nice backlog. We retain the labor and that will self heal itself, as we move into the new fiscal year. The orders that we got were just too late to really affect the fourth quarter, actually half the third quarter, the fourth quarter. So that was carrying a higher expense than we really thought we were going to when we gave the guidance back the first week in June.

E-ONE is a whole different situation. We're approaching a 16-month backlog. We're trying to significantly ramp the capability of that plant. And that is really the inefficiencies of the workforce. So it's not holding and retaining people waiting for new business to come, which was the situation in ambulance. This is a much more complicated problem. We're teaching people how to build fire trucks. And these are people that never done it before. They'll be good employees over time. We'll hit our marks over time. But if you ask me my confidence and give you a date when ambulance are going to turn round, I can tell you. We're going to start hitting stride immediately as we move into fiscal 2020. It's going to be a ramping up effect in Ocala just for the fact that we've got to retain these people, train them, and make them productive.

Dean Nolden -- Chief Financial Officer

And maybe I can also provide a little bit of context on the bridge that we provided on Slide 9, where we talk about $12 million of the third quarter being fire related, about half of that is volume and about half of that is labor. So even though we're producing and shipping units sequentially and year-over-year they're pretty consistent. We did have goals and targets at a higher level to start to bring our backlog into a shorter timeframe. And so we're short by about 15% or 40 units versus where we thought we'd be year-to-date or in the third quarter, sorry, third quarter in fire. And that provides about half of the miss from the standpoint of the EBITDA. The other piece, though, half is labor. And if you think about the couple of 100 employees that we had and they're not efficient and over $30 per hour kind of fully burdened rate. And then the remaining employees being almost 20% inefficient as they help to integrate and train the new employees. The numbers kind of climb pretty quickly and that's the other half of that $12 million.

Mig Dobre -- Robert W. Baird and Company -- Analyst

Okay. That's helpful, I appreciate that. And then, you mentioned Ian Walsh earlier Tim, I mean, he's been on a job now about a year as the Chief Operating Officer. And I guess, I'm wondering two things. One, what kind of work is he doing or what is his view as an operating officer of this feedback loop that has been described in a previous question and the improvements that you need to be potentially making there to have better control on a business? And then second, how are you approaching his deployment in terms of next things to tackle because clearly, your biggest businesses are the ones that are currently hurting and it seems to me like there's a lot of meat on this bone rather than commercial at this point? Thanks.

Tim Sullivan -- Chief Executive Officer

Well, he's sitting right next to me, so I'll let him answer for himself.

Ian Walsh -- Chief Operating Officer

So, good morning. I think it's the right question. And as Tim described, the focus of main effort started with commercial was our worst performing segment last year. There was a lot of opportunity that we went after. And we talked and architected, what Tim described is our new RPS. And I'm happy to talk a little bit about what the components are of that. But I think to your point, the focus right now is shifting pretty dramatically over to Fire and Emergency. We did anticipate, I think that the timing issues that are plaguing them today, my team, myself, I'm spending literally all of my time with those teams, and putting together the plans that we need to have execute against not just the remainder of the quarter, but more importantly setting themselves up for success in 2020.

Mig Dobre -- Robert W. Baird and Company -- Analyst

Thank you.

Operator

Thank you. Our next question comes from the line of Chad Dillard with Deutsche Bank. Please proceed with your question.

Chad Dillard -- Deutsche Bank -- Analyst

Hi. Good morning, guys.

Tim Sullivan -- Chief Executive Officer

Good morning, Chad.

Chad Dillard -- Deutsche Bank -- Analyst

So just trying to understand why the puts and takes on F&E side, most importantly, just I guess that your view on how the piece of margins improvement progresses over, let's say, the next three to nine months. I mean, it sounds like a lot of it has to do with E-ONE facility and labor issues. So I just want to understand, I guess, like in your -- from your perspective, how long does it take for labor to ramp up to the optimal productivity and how far away are we from that baseline?

Tim Sullivan -- Chief Executive Officer

Well, Dean is going to answer financially with some numbers here, but we clearly think that we will be hitting stride as we approach the second quarter of 2020.

Dean Nolden -- Chief Financial Officer

And I would say that, from the standpoint of Fire and Emergency and profitability and volumes implied in our guidance for the fourth quarter is kind of a sequential flat quarter in F&E, although we're going to strive to beat that. We don't want to assume that's going to happen at this point given where we are in the year. And so therefore from a margin, and a revenue perspective, you're going to probably see a pretty flat fourth quarter compared to the third quarter, with opportunity and goals to beat that. But we're at this point, not projecting that until early fiscal 2020.

And as Tim talked about, we've seen in the ambulance business, particularly larger unit that we talked about, we do have that contract. We are starting to see the purchase orders. Those will go in our backlog and they will start to help us absorb that labor in that ambulance business starting immediately next year as we deliver those products. So we'll see a ramp up in margins and ambulance much quicker than fire because of the proximity of that order. And if you remember, fire and ambulance are roughly 50-50 in terms of our total segment.

Chad Dillard -- Deutsche Bank -- Analyst

That's helpful. And then on the REV Production System opportunity, I know you've gotten some good improvement on the commercial side. So maybe you could perhaps just quantify how much that was? What sort of overlaps in terms of -- or commonalities in terms of problems are you seeing vis-a-vis, the Fire and Emergency group and how big of an opportunity you see for margin improvement and over what timeframe?

Dean Nolden -- Chief Financial Officer

Maybe I can start from the standpoint of what we've seen in commercial and let Tim or Ian follow-up on that and the benefits of RPS. I think first of all, we don't want to say that that is the be all end all of the results we've seen because obviously there's a lot of good product, people and processes currently in place and the mix has helped us. But the RPS has provided the stability and the predictability on the plans and the accountability that it takes or it took to increase the production at two of our largest facilities, our transit bus are more profitable as well, transit bus facility and our school bus facility that have approximately doubled or more than doubled their output since 2018.

Now, you can say that that was kind of a mix benefit, but in comparison to Fire who's also trying to increase their output, we had relatively fewer hiccups. There are a lot of things going on, a lot of things to manage, but you can see that the benefits of just that predictability and the tools and processes that were put in place to make sure that happened in the due course, as we expected. That was the benefit of RPS in commercial this year-to-date so far.

Operator

Thank you. Our next question comes from the line of Andrew Casey with Wells Fargo Securities. Please proceed with your question.

Andrew Casey -- Wells Fargo Securities -- Analyst

Thanks a lot. Good morning.

Tim Sullivan -- Chief Executive Officer

Good morning, Andy.

Andrew Casey -- Wells Fargo Securities -- Analyst

A few questions on the cash flow guide. First, do you expect all of that other $25 million, the cash generated from other sources outside of operating cash to occur in the fourth quarter? If so, it kind of looks like the Q4 debt reduction should be about $50 million to $60 million to get to that low 3x leverage range, are those correct assumptions?

Dean Nolden -- Chief Financial Officer

Yeah. You're correct. Year-to-date on our opportunities for cash reductions outside of regular cash flow, we're right on pace. We've got most of it into the third quarter. So there's a bit left to go and the fourth quarter that'll help us, but your estimates are pretty accurate.

Andrew Casey -- Wells Fargo Securities -- Analyst

Okay. Thanks, Dean. And then separately, the guide -- again, the cash flow guide, it seems to imply Q4 working capital benefit is going to be about half of the Q3 benefit. I'm just wondering, what's driving that and does it impact any of the normal seasonality as we look into next year?

Dean Nolden -- Chief Financial Officer

This would be -- you're correct in that and typically, at the end of the fourth quarter or in the past or has been a much bigger reduction in inventory and working capital. And given the status of our backlogs, especially in F&E the opportunities that are in front of us starting in fiscal 2020 to increase our throughput to the required levels and fire and to start delivering on those larger contracts in ambulances. We may have a little bit higher inventory at the end of this year than we would in a typical year end. So it wouldn't be something that's setting us up for continual year-over-year seasonality difference and change on a permanent basis. I think the circumstances today will have a little bit more in inventory at the end of the year. But still -- we're still projecting a positive cash from working capital in the fourth quarter.

Andrew Casey -- Wells Fargo Securities -- Analyst

Okay. Thanks. And then lastly, there has been a lot of discussion on F&E so I wanted to ask about the commercial margin, the improvement year-over-year was good. But I'm wondering how should we look at potential upside from the 9% that you did this quarter, because if I look at it little differently the incremental adjusted EBITDA margin seemed to moderate to 16% and change versus last quarter of about 43%, I'm just wondering, are we seeing the best that commercial can deliver at this point or was there something in the quarter that impacted that incremental margin?

Tim Sullivan -- Chief Executive Officer

We're not seeing the best that commercial can do because we've got two businesses that are dragging us down and that's the two shuttle bus businesses. Those are the ones that are on watch. The rest of them are all performing at very good levels above the 10% EBITDA levels. So more improvement in common commercial. We're just getting started.

Andrew Casey -- Wells Fargo Securities -- Analyst

Okay. Thank you very much.

Operator

Thank you. Our next question comes from the line of Courtney Yakavonis with Morgan Stanley. Please proceed with your question.

Courtney Yakavonis -- Morgan Stanley -- Analyst

Thanks for the question. Just wanted to understand, back on the F&E labor point. I thought that most of your hiring was done as of the second quarter, obviously reference of 30% churn rate. So is it fair to say you guys are continuing to hire -- this quarter and into the fourth quarter or is this all done and it is just about training? And then secondly, on the capacity side, you mentioned the new facilities. Are those ready to go right now and it's literally just training or is there still some are going there? And then, I think also you had referenced increase in production plant seven trucks a week to 14, I think the target was close to be 10 by the end of this year. So kind of how should we be thinking about that weekly production rate in the first half in 2020? Thanks.

Tim Sullivan -- Chief Executive Officer

Yeah. Let me take them one at a time here. I'll give you an example, in the third quarter, we hired 225 new people in Ocala, we get 95 and those 95 are fingers crossed that we are going to retain them. So the churn is really tough, it's a -- as you are going from a very stable workforce to 38% more bodies in that plant that have never touched a fire truck in their life, so it's a big challenge. As far as the footprint, we're in all three facilities and we're up and running. I think our biggest challenge right now besides the labor side is making sure we smooth out the flow. We are debottlenecking some areas in the flow, obviously we got new footprint to overcome that.

And having said all that it's sounds dire, but we actually really think there's some really good light of the end of the tunnel, I think Ian's team has been on the ground now for about three months, actually three and half months and we're really making good progress. I think the good news about that too is some of the new players that are come into play they are embracing some of the new RPS practices, they actually like them I think. And I think, people like to know the right way to do things. So as bad as it's been, and as bad as it's going to be as we move through the fourth quarter here and burn through more dollars, I think we're positioned well. I think, we will have some good positive news as we get into 2020.

Courtney Yakavonis -- Morgan Stanley -- Analyst

And then, on the recreational side, I think that's where you guys have actually decreased your outlook, not just for the As, but it sounds like also for some of the Towables and the Bs and the Cs. So is it fair to say that in that segment, you are adjusting your labor, or are we going to see the same thing that you guys mentioned in Ambulance kind of retaining the labor since it's been trained?

Tim Sullivan -- Chief Executive Officer

Yeah. No, I think that's a great question, because we have not in RV, just for the fact that we don't have good visibility into that market. It's one of the markets that's not as predictable as our other businesses, which are tax base, we can see the business it's in advance of us, we can see it coming. And we know which ones we're kind of going to get. We don't have that visibility in RV, so we have not retained labor to the extent that we have in our other businesses.

Courtney Yakavonis -- Morgan Stanley -- Analyst

Okay. So the view is that this will be a more kind of downturn on the Recreation side?

Tim Sullivan -- Chief Executive Officer

Well, we're prepared for it. I mean, it's been down all year and quite frankly, the predictions for 2020 from RVIA are not very encouraging. So we think we've got everything right sized right now. We can react, we haven't cut so deep that we can't react to good business that might come up this month at Open House. But we're low, we're quite a bit lower than what we were just even three months ago. So we're trying to find that rights spot that we don't cut so deep that we can't react, if this thing looks that it's going to be more protracted, we'll do some more trimming if we have to.

Courtney Yakavonis -- Morgan Stanley -- Analyst

Okay. And then, just lastly, on commercial, obviously, we saw some pretty decent sales growth there. But this was the first time that we had seen the backlog down year-over-year in a while. Just curious, if you have any comments on that?

Dean Nolden -- Chief Financial Officer

All right. On the backlog, we are aggressively and appropriately delivering on our larger LA County contract of buses through the end of this fiscal year and into the first quarter of next year. So that's a big focus for us and that's been a big benefit for us, and hopefully of our customer as well. But we have good line of sight on transit bus market, and projects and believe that, that's just something we'll be filling up again, fairly shortly with additional kind of base level business, larger municipal contracts that are multi-year. So that's not an issue.

Tim Sullivan -- Chief Executive Officer

Yeah. I think the -- again, stay tuned for news. We're at that point right now where we should be hearing on follow-on business from both Chicago and LA. And so it's just kind of a timing thing. We don't announce and we don't put in backlog until we got firm, uncancelable business. So stay tuned and watch that backlog number.

Courtney Yakavonis -- Morgan Stanley -- Analyst

Okay. Got you. And then just lastly, you mentioned you did have some critical supply issues during the quarter, I don't think, Dean that you called it out in the bridge. But just if you can quantify that, and which segments they impacted the most?

Dean Nolden -- Chief Financial Officer

Yeah. That is in the bridge it's kind of in that other. It's not huge, but it was enough to kind of move the needle slightly. It was in some areas in the shuttle bus business, some of them were in our control, some of them were not. But again, we don't want to overemphasize it, it's not huge, but it does -- did provide some disruption.

Tim Sullivan -- Chief Executive Officer

And a shot out to our sourcing people, they've been unbelievable, the last 12 months, and they mitigated that to the full extent they could in the quarter. And I think, we'll be better off here in the fourth quarter. I guess the point we just wanted to make is we're not over it. And just when you think it's good to come out from the bunker. There's more tariffs thrown out into the marketplace. And the new wave will affect us to some extent, probably not as much as last year. But our sourcing teams are staying on top, when I look at the US market and the fact that it only took the material suppliers 12 months to get their lead times back into line. That's pretty amazing. They're doing the best they can it's just -- it's challenging.

Courtney Yakavonis -- Morgan Stanley -- Analyst

Thanks.

Operator

Thank you. Our final question comes from the line of Joel Tiss with BMO Capital Markets. Please proceed with your question.

Joel Tiss -- BMO Capital Markets -- Analyst

Hey. How is it going?

Tim Sullivan -- Chief Executive Officer

Good morning Joel.

Joel Tiss -- BMO Capital Markets -- Analyst

So just, I mean, I think a lots been asked and answered. And can you update us on your parts initiative? I guess you got to put that on hold a little bit, while you've got all these other issues to work through.

Tim Sullivan -- Chief Executive Officer

No. We should put that as a positive Joe, we're up again year-over-year 10%. We're not setting the world on fire obviously, but we'll take it. And I think the team has done a really nice job. We have some really pockets of excellence there where it's above the 10%, but the average is 10%. We've hit as much as 18% in some of the segments. So the initiatives are not on hold, they're full speed ahead, and we're making good progress.

Operator

Thank you. There are no further questions at this time. I would like to turn the call back over to Mr. Sullivan for closing remarks.

Tim Sullivan -- Chief Executive Officer

Well, thanks again everyone for joining us today. Obviously, this is another year and another tough year for us. This is not usual for any of us. We're all experienced. We've been in this business of manufacturing things for a long-time. We really felt obviously with the comments I made at the second quarter that we were through a lot of the worst situations that we could face with the tariff situation. It's just -- you can't ramp easily in this environment right now. It's hard enough just to retain let alone ramp. And we -- the question earlier, why didn't we see it coming maybe we should have. We're dealing with it. It's something we just ask your patients, as we asked our customers to be patient. We'll get there. We know we can and we will. I think that a lot of the things that we're doing on the RPS side of the business are going to reap some tremendous benefits as we go into 2020. Again, thanks for joining us today. Keep the faith and we'll talk to you again in December.

Operator

[Operator Closing Remarks]

Duration: 69 minutes

Call participants:

Drew Konop -- Vice President, Investor Relations

Tim Sullivan -- Chief Executive Officer

Dean Nolden -- Chief Financial Officer

Stephen Volkmann -- Analyst

Ian Walsh -- Chief Operating Officer

Jerry Revich -- Goldman Sachs -- Analyst

Mig Dobre -- Robert W. Baird and Company -- Analyst

Chad Dillard -- Deutsche Bank -- Analyst

Andrew Casey -- Wells Fargo Securities -- Analyst

Courtney Yakavonis -- Morgan Stanley -- Analyst

Joel Tiss -- BMO Capital Markets -- Analyst

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