Company Overview

Established in 1974 as a truck body manufacturer, Supreme Industries, Inc., through its wholly-owned subsidiary, Supreme Indiana Operations, Inc., is one of the nation's leading manufacturers of specialized vehicles. The Company engages principally in the production and sale of customized truck bodies, buses, and other specialty vehicles. Building on its expertise in providing both cargo and passenger transportation solutions, the Company's specialty vehicle offerings include products such as customized armored vehicles and homeland response vehicles.

The Company utilizes a nationwide direct sales and distribution network consisting of approximately 40 bus distributors, a limited number of truck equipment distributors, and approximately 1,000 commercial truck dealers. The Company's manufacturing and service facilities are located in seven states across the continental United States allowing us to meet the needs of customers across all of North America. Additionally, the Company's favorable customer relations, strong brand-name recognition, extensive product offerings, bailment chassis arrangements, and product innovation, competitively positions Supreme with a strategic footprint in the markets it serves.

The Company and its product offerings are affected by various factors which include, but are not limited to, economic conditions, interest rate fluctuations, volatility in the supply chain of vehicle chassis, and the availability of credit and financing to the Company, our vendors, dealers, or end users. The Company's business is also affected by the availability and costs of certain raw materials that serve as significant components of its product offerings. The Company's risk factors are disclosed in Item 1A "Risk Factors" in the Company's Annual Report on Form 10-K for the year ended December 31, 2011.

Results of Operations

The following discussion should be read in conjunction with the consolidated financial statements and related notes (See Note 1 "Basis of Presentation and Opinion of Management - Revised Financial Statements") thereto elsewhere in this document and pertains to continuing operations unless otherwise noted.

Overview

Net income from continuing operations for the second quarter of 2012 was $5.4 million, or $0.35 per diluted share, compared with a loss from continuing operations of $0.8 million, or ($0.05) per share, in the second quarter of 2011. Net income from continuing operations for the first half of 2012 was $7.9 million, or $0.51 per diluted share, compared with a loss from continuing operations of $1.9 million, or ($0.13) per share, in the first half of 2011. Despite lower net sales, gross margins improved significantly due to product price increases, stable raw material costs, favorable product mix, and manufacturing labor efficiency improvements. We experienced higher levels of general and administrative expenses due to severance costs and payroll-related costs and benefits and we expect these costs to decrease during the second half of 2012.

Our sales backlog at the end of the second quarter of 2012 totaled $89 million compared with $102 million a year ago. While 13% lower than the prior-year period, we believe our improved pricing discipline has resulted in a more profitable backlog.

During the fourth quarter of 2011, we began a major renovation project at our primary truck production facility in Goshen, Indiana. During the first half of 2012, we invested $2.6 million of an anticipated investment of approximately $7.2 million over the next three years and we were awarded $1.5 million of conditional tax credits, as well as property tax abatements, from state and local authorities as incentives for these investments. These capital investments are intended to substantially increase our efficiencies, improve our employee's work environment, and reduce operating costs.

As we move through 2012, and continue to position the Company for profitable growth, our key areas of focus include:

† Improving the buying experience for our customers by listening to their needs and exceeding their expectations throughout the order fulfillment cycle;

†          Improving our materials procurement sourcing nationwide;



†          Making strategic investments to ensure that our employees view the
Company as a great place to work and are proud to be members of the Supreme
team;

† Ongoing product development initiatives, involving both new and existing products;

† Continued refinement and monitoring of recently implemented pricing disciplines;

† Further product line rationalization efforts to improve our gross margins and remain focused on our core truck, bus, and armored products; and

† Investment in and implementation of perpetual inventory systems and processes at all locations.

We continue to aggressively review all aspects of our business to identify additional profit improvement opportunities.

Net Sales

Net sales for the three months ended June 30, 2012 decreased $10.1 million, or 10.7%, to $84.6 million as compared with $94.7 million for the three months ended July 2, 2011. Net sales for the six months ended June 30, 2012 decreased $5.4 million, or 3.3%, to $156.7 million as compared with $162.1 million for the six months ended July 2, 2011. The following table presents the components of net sales and the changes from period to period:

                                   Three Months Ended                            Six Months Ended
                        June 30,    July 2,                          June 30,     July 2,
($000's omitted)          2012        2011           Change            2012        2011           Change
Specialized vehicles:
Trucks                  $  67,587   $ 74,881   $  (7,294 )   (9.7 )% $ 116,767   $ 120,842   $ (4,075 )   (3.4 )%
Buses                      13,677     14,117        (440 )   (3.1 )     31,769      30,210      1,559      5.2
Armored vehicles            2,642      5,104      (2,462 )  (48.2 )      6,691       9,851     (3,160 )  (32.1 )
                           83,906     94,102     (10,196 )  (10.8 )    155,227     160,903     (5,676 )   (3.5 )
Fiberglass products           668        618          50      8.1        1,514       1,201        313     26.1
                        $  84,574   $ 94,720   $ (10,146 )  (10.7 )% $ 156,741   $ 162,104   $ (5,363 )   (3.3 )%

Truck division sales decreased by $7.3 million, or 9.7%, for the three months ended June 30, 2012, and decreased by $4.1 million, or 3.4%, for the six months ended June 30, 2012, primarily due to fewer orders from large national fleet customers. Although market demand remains below 2007 (pre-recession) levels, we expect retail truck market conditions to demonstrate improvement in the near-term.

Bus division sales decreased by $0.4 million, or 3.1%, for the three months ended June 30, 2012, primarily due to a reduction in the amount of hybrid chassis sold as compared with the corresponding quarter in 2011. Bus division sales increased by $1.6 million, or 5.2%, for the six months ended June 30, 2012, primarily due to product mix compared with the first half of 2011. The bus market remains very price-focused, due to a highly competitive state and municipal government contract bid process.

Armored division sales decreased by $2.5 million, or 48.2%, for the three months ended June 30, 2012, and decreased by $3.2 million, or 32.1%, for the six months ended June 30, 2012, primarily due to a reduction in orders from key customers and a slowdown of orders received from our contract with the U.S. Department of State to produce armored SUVs for embassies abroad.

Cost of sales and gross profit

Gross profit increased by $5.4 million, or 68%, to $13.5 million for the three months ended June 30, 2012, as compared with $8.1 million for the three months ended July 2, 2011. Gross profit increased by $9.9 million, or 68%, to $24.3 million for the six months ended June 30, 2012, as compared with $14.5 million for the six months ended July 2, 2011. The following table presents the components of cost of sales as a percentage of net sales and the changes from period to period:

                     Three Months Ended               Six Months Ended
                June 30,   July 2,   Percent    June 30,   July 2,   Percent
                  2012      2011     Change       2012      2011     Change
Material            57.6 %    64.1 %    (6.5 )%     57.2 %    62.6 %    (5.4 )%
Direct Labor        11.7      13.5      (1.8 )      11.9      13.6      (1.7 )
Overhead            12.6      11.9       0.7        13.2      12.8       0.4
Delivery             2.1       2.0       0.1         2.2       2.1       0.1
Cost of sales       84.0      91.5      (7.5 )      84.5      91.1      (6.6 )
Gross profit        16.0 %     8.5 %     7.5 %      15.5 %     8.9 %     6.6 %

Material - Material cost as a percentage of net sales decreased by 6.5% and 5.4% for the three and six months ended June 30, 2012, as compared with the corresponding periods in 2011. The decrease in the material percentage was due in part to favorable product mix and improved pricing disciplines. Although raw material commodity prices have stabilized, the potential for future raw material cost increases remains a concern for certain commodities (including but not limited to aluminum, steel, and wood). The Company closely monitors major commodities to identify raw material cost escalations and attempts to remain material-neutral by adjusting the price of its products as markets will allow and having material adjustment clauses in most key customer contracts.

Direct Labor - Direct labor as a percentage of net sales decreased by 1.8% and 1.7% for the three and six months ended June 30, 2012, as compared with the corresponding periods in 2011. The decrease in the direct labor percentage was due in part to efficiencies gained by producing increased quantities of similar fleet units. Fleet units typically are less customized than special-purpose retail trucks and require fewer direct labor hours to produce. Additionally, efficiencies were achieved at certain locations resulting from the use of real time metrics on labor utilization and product and plant redesign initiatives which resulted in more efficient operations.

Overhead - Manufacturing overhead as a percentage of net sales increased by 0.7% and 0.4% for the three and six months ended June 30, 2012, as compared with the corresponding period in 2011. The overall overhead percentage increased primarily due to the fixed nature of certain overhead expenses that do not fluctuate with sales volume changes.

Delivery - Delivery as a percentage of net sales was relatively unchanged for the three and six months ended June 30, 2012, as compared with the corresponding periods in 2011. The Company continues to identify and utilize more cost-effective delivery methods to counteract the ongoing impact of high fuel costs.

Selling, general and administrative expenses

Selling, general and administrative ("G&A") expenses increased by $1.3 million, or 19.3%, to $8.2 million for the three months ended June 30, 2012, as compared with $6.9 million for the three months ended July 2, 2011. Selling and G&A expenses increased by $2.9 million, or 20.7%, to $16.8 million for the six months ended June 30, 2012, as compared with $13.9 million for the six months ended July 2, 2011. The following table presents selling and G&A expenses as a percentage of net sales and the changes from period to period:

                                Three Months Ended                                 Six Months Ended
                     June 30,         July 2,                         June 30,          July 2,
($000's omitted)       2012            2011           Change            2012              2011           Change
Selling expenses   $ 2,631   3.1 % $ 2,164   2.3 % $   467   0.8 % $  5,197    3.3 % $  4,602   2.8 % $   595   0.5 %
G&A expenses         5,608   6.6     4,745   5.0       863   1.6     11,591    7.4      9,305   5.8     2,286   1.6
Total              $ 8,239   9.7 % $ 6,909   7.3 % $ 1,330   2.4 % $ 16,788   10.7 % $ 13,907   8.6 % $ 2,881   2.1 %

Selling expenses - Selling expenses increased $0.5 and $0.6 million for the three and six months ended June 30, 2012, as compared to the corresponding periods in 2011. As a percentage of net sales, selling expenses increased 0.8% and 0.5% for the three and six months ended June 30, 2012, as compared with the corresponding periods in 2011. The increase as a percentage of sales resulted from a change in the sales commission structure.

G&A expenses - G&A expenses increased $0.9 million and $2.3 million for the three and six months ended June 30, 2012, as compared to the corresponding periods in 2011. As a percentage of net sales G&A expenses increased 1.6% for both the three and six months ended June 30, 2012, as compared with the corresponding periods in 2011. The increase was the result of several factors including additions to senior management, profit-based compensation plans, and severance costs related to certain senior management changes.

Other income

Other income was $0.1 million and $0.6 million for the three and six months ended June 30, 2012, compared with $0.4 million and $0.5 million for the three and six months ended July 2, 2011. Other income consisted of rental income, gain on the sale of assets, and other miscellaneous income received by the Company. During the first quarter of 2012, the Company realized a gain of approximately $0.3 million on the sale of real estate.

Legal settlement and related costs

The Company settled a lawsuit during the second quarter of 2011. The legal settlement and related costs were $1.9 million and $2.2 million for the three and six months ended July 2, 2011. No additional legal costs related to this lawsuit were incurred after settlement.

Interest expense

Interest expense was $0.3 million and $0.6 million for the three and six months ended June 30, 2012, compared with $0.5 million and $0.7 million for the three and six months ended July 2, 2011. The decline in interest expense resulted from a combination of lower borrowings and lower interest rates during the periods. The effective interest rate on bank borrowings was 3.1% at quarter end, and the Company was in compliance with all provisions of its Credit Agreement.

Income taxes

At December 31, 2011, the Company had a tax valuation allowance for net deferred tax assets of $4.6 million, the utilization of which was uncertain as of that date. In the second quarter of 2012, the Company determined it was likely the net deferred tax assets would be realized based upon sustained profitability and forecasted future operating results. As a result, the Company reversed $0.4 million of its $0.8 million valuation allowance, with the reversal recorded as a non-cash income tax benefit for the three and six months ended June 30, 2012. The Company expects that the remaining valuation allowance will be utilized during the second half of 2012 consistent with the Company's expected tax position. As the Company has generated taxable income and the release of a portion of the valuation allowance, the Company recorded a tax provision of $0.1 million (effective tax rate of 1.5%) for the three and six months ended June 30, 2012. Net income for the 2011 period excluded a tax provision due to the tax valuation allowance. The tax rate for 2013 and beyond could be significantly higher than 2012.

Net income (loss) from continuing operations

Net income from continuing operations increased by $6.2 million to $5.4 million (6.4% of net sales) for the three months ended June 30, 2012, from a net loss of $0.8 million (0.8% of net sales) for the three months ended July 2, 2011. Net income from continuing operations increased by $9.8 million to $7.9 million (5.0% of net sales) for the six months ended June 30, 2012, from a net loss of $1.9 million (1.2% of net sales) for the six months ended July 2, 2011. Despite lower net sales, net income improved significantly due to product price increases, stable commodity pricing, favorable product mix, and labor improvements.

Discontinued operations

The Company decided to discontinue its Oregon operations in December of 2010. Accordingly, the Company has classified the prior period results for Oregon as discontinued operations. The operations were ceased in the first quarter of 2011 due to the Company's decision to exit this unprofitable geographic region. The after-tax loss from the discontinued operations was $0.3 million and $0.7 million for the three and six months ended July 2, 2011.

Basic and diluted income (loss) per share

The following table presents basic and diluted income (loss) per share and the changes from period to period:

                                        Three Months Ended               Six Months Ended
                                      June 30,        July 2,        June 30,        July 2,
                                        2012           2011            2012            2011
Basic income (loss) per share:
Income (loss) from continuing
operations                          $       0.36    $     (0.05 )  $       0.52    $      (0.13 )
Loss from discontinued
operations                                     -          (0.02 )             -           (0.05 )
Net income (loss) per basic
share                               $       0.36    $     (0.07 )  $       0.52    $      (0.18 )

Diluted income (loss) per share:
Income (loss) from continuing
operations                          $       0.35    $     (0.05 )  $       0.51    $      (0.13 )
Loss from discontinued
operations                                     -          (0.02 )             -           (0.05 )
Net income (loss) per diluted
share                               $       0.35    $     (0.07 )  $       0.51    $      (0.18 )

Shares used in the computation
of income (loss) per share:
Basic                                 15,192,169     14,590,397      15,176,659      14,471,570
Diluted                               15,466,711     14,590,397      15,440,473      14,471,570

Liquidity and Capital Resources

Cash Flows

The Company's primary sources of liquidity have been cash flows from operating activities and borrowings under a credit facility entered into by the Company. Principal uses of cash have been to support working capital needs, meet debt service requirements, and fund capital expenditure needs.

Operating activities

Cash flows from operations represent the net income earned, or net loss sustained, in the reported periods adjusted for non-cash charges coupled with changes in operating assets and liabilities. Cash used in operating activities totaled $2.2 million for the six months ended June 30, 2012, as compared with $2.1 million for the six months ended July 2, 2011. Cash from operating activities was unfavorably impacted during the first half of 2012 by a $7.3 million increase in inventories and a $4.8 million increase in trade accounts receivable. The increase in inventories related to changes in the sales backlog product mix. The increase in trade accounts receivable reflected elevated levels of business activity resulting from the large fleet orders generally completed during the second quarter.

Investing activities

Cash used in investing activities was $3.2 million for the six months ended June 30, 2012 as compared with minimal cash used in investing activities for the six months ended July 2, 2011. During the first six months of 2012, the Company's capital expenditures totaled $4.0 million consisting primarily of the previously mentioned capital investments in our Indiana facilities. Additionally, we received $0.7 million from the sale of property, plant, and equipment, including $0.5 million from the sale of our Florida sales/service facility.

Financing activities

Financing activities provided $5.4 million of cash for the six months ended June 30, 2012 as compared with cash provided of $1.4 million for the six months ended July 2, 2011. The Company borrowed against its revolving line of credit in the amount of $5.3 million during the six months ended June 30, 2012. The additional borrowings were used to fund the elevated working capital needs typical for the first half of our year to support seasonal fleet orders.

Capital Resources

Revolving Line of Credit

On September 14, 2011, the Company entered into a Credit Agreement (the "Credit Agreement") with Wells Fargo Capital Finance, LLC (the "Lender"). As of June 30, 2012, the outstanding balance under the Credit Agreement was approximately $17.0 million, and the Company had unused credit capacity of approximately $18.1 million. Interest on outstanding borrowings under the Credit Agreement was based on the Lender's prime rate or LIBOR depending on the pricing option selected and the Company's leverage ratio, as defined in the Credit Agreement, resulting in an effective rate of 3.11% at June 30, 2012, and the Company was in compliance with all provisions of its Credit Agreement.

Other Long Term Debt

During 2011, the Company entered into a capital lease under a sale/leaseback transaction involving its California facility. The outstanding principal amount of the obligation as of June 30, 2012, was $3.5 million with an interest rate of 5.5%. Of this amount $0.1 million and $3.4 million were included in current maturities of long term debt and long term debt, respectively, in the accompanying balance sheet at June 30, 2012.

Summary of Liquidity and Capital Resources

The Company's primary capital needs are for working capital demands, to meet its debt service obligations, and to finance capital expenditure requirements. The Company has a substantial asset collateral base and a strong equity position which management believes adequately supports the outstanding revolving line of credit. Additionally, the Company is completing plans to sell certain idled assets which, if completed, will provide additional liquidity to reduce borrowings under the Company's revolving line of credit.

The Company's cash management system and revolving line of credit are designed to maintain zero cash balances and, accordingly, checks outstanding in excess of bank balances are classified as additional borrowings under the revolving line of credit.

Critical Accounting Policies and Estimates

Management's discussion and analysis of its financial position and results of operations are based upon the Company's consolidated condensed financial statements which have been prepared in accordance with accounting principles generally accepted in the United States of America. The preparation of these financial statements requires management to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosure of contingent assets and liabilities. The Company's significant accounting policies are discussed in Note 1 of the Notes to Consolidated Financial Statements included in the Annual Report on Form 10-K for the year ended December 31, 2011. In management's opinion, the Company's critical accounting policies include revenue recognition, allowance for doubtful accounts, excess and obsolete inventories, inventory relief, fair value of assets held for sale, accrued insurance, and accrued warranty.

Revenue Recognition - The Company generally recognizes revenue when products are shipped to the customer. Revenue on certain customer requested bill and hold transactions is recognized after the customer is notified that the products have been completed according to customer specifications, have passed all of the Company's quality control inspections, and are ready for delivery based on established delivery terms.

Allowance for Doubtful Accounts - The Company maintains an allowance for doubtful accounts for estimated losses resulting from the inability of our customers to make required payments. If the financial conditions of our customers were to deteriorate, resulting in an impairment of their ability to make payments, additional allowances may be required which would adversely affect our future operating results.

Excess and Obsolete Inventories - The Company must make estimates regarding the future use of raw materials, chassis, and finished products, and provide for obsolete or slow-moving inventories. If actual product life cycles, product demand, and/or market conditions are less favorable than those projected by management, additional inventory write-downs may be required which would adversely affect future operating results.

Inventory Relief - For monthly and quarterly financial reporting, cost of sales is recorded and inventories are relieved by the use of standard bills of material adjusted for scrap and other estimated factors affecting inventory relief. Because of our large and diverse product line and the customized nature of each order, it is difficult to place full reliance on the bills of material for accurate relief of inventories. Although the Company continues to refine the process of creating accurate bills of materials, manual adjustments (which are based on estimates) are necessary to assure correct relief of inventories for products sold. The calculations to estimate costs not captured in the bill of materials take into account the customized nature of products, historical inventory relief percentages, scrap variances, and other factors which could impact inventory relief.

The accuracy of the inventory relief is not fully known until physical inventories are conducted at each of the Company's locations. We conduct semi-annual physical inventories at a majority of our locations and schedule them in a manner that provides coverage in each of our calendar quarters. We have invested significant resources in our continuing effort to improve the physical inventory process and accuracy of our inventory accounting system.

Beginning in the second quarter of 2012, the Company began the process of implementing a perpetual inventory system. As a result of the ongoing implementation, the Company recently self-identified errors related to revenue recognition during certain past reporting periods (See Note 1). Although the errors were limited to one location and deemed immaterial, the Company believes that these findings underscore the importance of implementing a perpetual inventory system. The Company is in the process of implementing the perpetual . . .