EnerSys (ENS) 2008 Q2 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the second quarter 2008 EnerSys earnings conference call. At this time, all participants are in a listen-only mode. We will be facilitating a question-and-answer session towards the end of today's conference. (OPERATOR INSTRUCTIONS). As a reminder, this conference is being recorded for replay purposes.

I would now like to turn the presentation over to your host for today's conference, Mr. John Craig, Chairman, President and CEO. Sir, please proceed.

Thank you. Good morning, and thank you for joining us for our second quarter conference call. On this call, we will be discussing our financial results for our second quarter, guidance for our third quarter, and commenting on the general state of our business. But before we get started this morning, I would like to ask Mike Philion, our Chief Financial Officer, to cover information regarding forward-looking statements. Mike?

Yes. Thank you, John, and good morning to everyone. As a reminder, we will be presenting certain forward-looking statements in this call that are based on management's current expectations and are subject to uncertainties and changes in circumstances. Our actual results may differ materially from the forward-looking statements for a number of reasons. For a list of the factors which could affect our future results including our earnings estimates, see forward-looking statements included in Item 2, Management's Discussion and Analysis of Financial Condition and Results of Operations set forth in our quarterly report on Form 10-Q for the quarter ended September 30, 2007, which was recently filed with the SEC.

In addition, we will also be presenting certain non-GAAP financial measures. For an explanation of the differences between comparable GAAP financial information and the non-GAAP information, please see our Company's Form 8-K which includes our press release dated November 7, 2007, which is located on our website at www.enersys.com.

Now let me turn the call back to you, John.

Thanks, Mike. I'm pleased with the continuation of our strong performance this fiscal year. In the second quarter, revenue was up 30% and adjusted net earnings increased 51% over last year's second quarter. Adjusted earnings per diluted share for the second quarter were $0.35, which significantly exceeded the previous guidance that we provided in August of $0.22 to $0.26 per share.

Each of our business segments and geographic regions contributed to our revenue growth, which was a major factor in the increase in earnings. We continue to experience strong overall growth in our markets. Telecom capital spending for our products is strong globally, as account telecom companies continue to expand our networks and upgrade their technology for better service. At the same time, we are [experiencing] rapid growth in UPS demand. Aerospace and Defense segment of our business of Reserve Power has continued to perform very well through successful acceptance of our advanced technology products.

Global economic growth has resulted in solid increases in the Motive Power market. In addition, we believe we are continuing to increase our share of the market. First half, Motive Power revenue, excluding the positive effects of stronger foreign currencies, acquisitions, and pricing, increased 12% over the first half of the prior year. Our ability to grow adjusted earnings at a faster rate than sales is in large part due to our continued success in our cost savings programs. We have been successfully moving production to our low cost manufacturing plants while continuing to further automate operations in our higher cost plants.

We now have approximately 30% of our production in low cost facilities, and our target remains to be over 50% in the next few years. The May acquisition of Energia in Bulgaria will significantly help us in achieving this objective. We also continued, through many cost-saving programs, to reduce our operating expenses as a percentage of sales. In the first half of fiscal 2008, our operating expenses as a percentage of net sales decreased from 15.2% last year to 13.2% this year.

Although our earnings have benefited nicely from our cost saving programs as well as from the very strong sales growth, we have not yet experienced appropriate pricing recovery to offset the large increase in commodities we are seeing. While the pricing environment is improving, the cost of lead, in particular, has accelerated its increase. As recently as January of this year, the average price of lead on the LME was $0.76 a pound. It has since increased every month to an average of $0.87 a pound in March; $1.09 in June; and now $1.68 per pound in October. We are continuing to implement price increases to recover these high commodity costs. However, we will not totally recover these costs until the cost of lead either stabilizes or decreases.

We believe that we are increasing our global market share which gives us the confidence that our customers recognize the overall value they receive from our high quality products and services; even in the face of higher prices. Last evening, we provided guidance for the third quarter in which we estimated that our as-adjusted, diluted earnings per share would be in the range of $0.25 to $0.29 compared to $0.19 per share in the prior year. Considering the recent rapid rise in lead cost, I am pleased that we're expected to increase our earnings over the prior year.

I would now like to turn the meeting over to Mike Philion to give further information on our results and our guidance. Mike?

John, thank you again. Our fiscal 2008 results continued to demonstrate the strengths of our global business and industry-leading position. Our second quarter net sales increased 30% over the prior year to $461 million. On a business segment basis, net sales in the Reserve Power business increased 25% to $199 million while our Motive Power business increased 35% to $263 million. Our second quarter 30% growth rate includes approximately 10% due to our pricing recovery actions; 6% from foreign currency translation; and 2% from acquisitions.

Further, our fiscal 2008 second quarter sales growth was solid in all three regions with growth over the prior year of 49% in Asia; 38% in Europe; and 19% in the Americas. We believe the combination of our outstanding products with superior customer service continues to drive our strong top line performance. Net sales for our first half were also strong and increased 25% over the prior year to $891 million.

On a business segment basis, net sales in the Reserve Power business increased 21% to $383 million, while our Motive Power business increased 28% to $508 million. Our first half 25% growth rate includes roughly 8% due to pricing actions, 5% from foreign currency translation, and 2% from acquisitions. We believe our base volume growth of 10% during the first half is indeed higher than the market. Accordingly, we believe we continue to increase our global market share.

Now a few comments about our as-adjusted consolidated earnings performance. As you know, we utilize certain non-GAAP measures in analyzing our Company's operating performance, specifically excluding highlighted items which are primarily litigation settlement income in fiscal 2007, and the European restructuring charges in fiscal 2008. Accordingly, my following comments concerning operating earnings and my later comments concerning diluted earnings per share exclude all relevant highlighted items. Please refer to our Company's Form 8-K, which includes our press release dated November 7 for more details concerning these and other highlighted items.

Our second quarter as-adjusted consolidated operating earnings were $32 million, or an increase of 35% in comparison to the prior year with the operating margin increasing 20 basis points to 6.9%. This strong earnings performance was achieved in spite of higher commodity costs of approximately $44 million in the quarter when compared to the prior year. Clearly, our commodity cost headwind was more than offset by the favorable impact of higher revenue, selling price increases, and cost savings.

While progress is ongoing in raising our selling prices due to ever increasing commodity cost, significant earnings pressure continues to be experienced in our second quarter as pricing recovery still lags rising costs. We estimate that a price increase of approximately $34 million was achieved in our second quarter compared to the prior year were roughly a 10% increase in revenue. The earnings gap attributable to this cost/price/timing pressure was approximately $10 million in our second quarter or $0.14 of earnings per share.

Our first half of fiscal 2008 as-adjusted consolidated operating earnings were $61 million, or an increase of 31% in comparison to the prior year, with the operating margin increasing 40 basis points to 6.9%. Similar factors affected our first half results as previously noted for our second quarter.

Our acquisitions remain on target and they have collectively added $0.02 per share to our second quarter EPS and $0.06 to our first half results. The May, 2007 Energia acquisition was dilutive by less than $0.02 per share in the second quarter as we expected, and remains an important initiative to further reduce our costs and expand our reach into fast growth new markets. We anticipate Energia will be modestly accretive in the third quarter of this year.

As John has already discussed, our second quarter and first half of fiscal 2008 results have been significantly affected by the higher cost of lead, which is approximately 30% of our cost of goods sold. We estimate that our second quarter lead costs have increased approximately $40 million or 60% compared to the second quarter of the prior year. Additionally, we estimate that our first half lead costs have increased approximately $67 million or 50% versus the comparable prior year period. Further, we expect our third quarter of fiscal 2008 lead costs to increase by over $75 million or over 100% compared to the prior year.

Now, several comments concerning our diluted earnings per share. As adjusted, diluted net earnings per share were $0.35 in the second quarter versus $0.24 in the prior year, or an increase of $0.11 per share or 46% compared to the prior year second quarter and expressed on a EPS equivalent basis. Improved pricing recovery was equal to $0.49 per share, while higher cost negatively affected our earnings by $0.63 per share. This would have reduced our second quarter EPS by $0.14 were it not for the equivalent of $0.25 of additional earnings, primarily from our strong sales growth and ongoing cost savings actions.

As adjusted, diluted net earnings per share were $0.65 in the first half of fiscal 2008 compared to $0.45 in the prior year or an increase of 44%. Similar factors impacted our first half results as previously covered for our second quarter.

Now, some brief comments about our financial position and cash flow results. In short, our performance continues to be good with adequate liquidity to both operate and continue to grow our business. Primary working capital increased $81 million since the beginning of fiscal 2008 to $467 million, principally due to our sales growth and the increasing cost of commodities. As a percentage of annualized trailing three month net sales, our primary working capital ratio at 25.3% was down 100 basis points compared to the prior year.

Our first half capital expenditures were $17 million compared to $19 million in the prior year. We expect capital spending for all of fiscal 2008 will approximate $52 million. The $7 million increase in expected fiscal 2008 capital spending since our last quarterly call is primarily due to the planned expansion of selected manufacturing capacity.

Net debt as defined in our credit agreements, was $410 million at the end of our second quarter with a leverage ratio of 2.8 times. Our average interest rate was 6.5% in the first half of fiscal 2008 compared to 6.4% in the comparable period last year. We remain in full compliance with all our credit agreements and have over $100 million of available but unused credit under existing facilities at September 30, 2007.

As John mentioned earlier, we expect to generate diluted net earnings per share of between $0.25 and $0.29 in our third quarter, which excludes an expected $0.03 per share charge from our ongoing European restructuring program, which is largely attributable to the Energia acquisition.

The three primary factors that will impact our third quarter earnings are first, an anticipated sequential quarterly increase in our third quarter sales volume as demand for our products and services remains robust; second, continued progress in further increasing our selling prices and reducing our costs; and third, the anticipated sequential quarterly increase in our lead cost of approximately $40 million or 40%.

The expected sequential quarterly reduction in our third quarter earnings is primarily attributable to the time lag in fully realizing recent price increases. Simply put, pricing actions taken to offset the expected 40% jump in our third quarter lead cost will take longer than three months to be fully realized in our operating results.

In closing, I remain very confident in our Company's future. We have consistently demonstrated our global organization's ability to successfully grow both revenue and earnings.

Now let me take the call back to you, John.

Thank you, Mike. In closing, I want to emphasize that although we are pleased with our sales and earnings results, we remain highly focused on improving the Company's operating margins. We have not been able to fully recover the higher commodity cost we have experienced and are continuing to implement appropriate price increases. At the same time, we continue to provide our customers what we believe to be the best value products and services in our industry.

And with that, I'd like to open the meeting up for questions.

(OPERATOR INSTRUCTIONS). John Franzreb, Sidoti.

First, I'd like to address the telecom business. It seems like it's been kind of lumpy as of late. They had seller numbers in this quarter. Can you kind of walk us through what's happening in that market and what are you seeing there going forward?

Yes. We're seeing that there is a requirement put on some companies that they need to increase their storage capacity to have greater time if the lines go down, if electricity goes out. So we're seeing demand take place in that area.

We're seeing -- I would summarize it by saying in the Western world, we're seeing probably somewhere between a 7% to 9% market pickup or growth. But we are also picking up market share. We're finding a number of our customers are coming to us because of some of the specialty products that we have that our competitors do not have.

Is that market share in North America, John?

I would say the market share pick up is much stronger in North America than what it is in Europe, although we do believe that we're getting modest market share pickup in Europe also.

Great. And would you characterize the way the business flows -- just kind of help me out -- the way the business flows? Is it a lumpy business all the time? Or is it just that we just had maybe a period of softness and then maybe now we should expect more of that steady-state kind of 7% to 9% number you just threw out there?

That's an excellent question. I wish I had a good answer to it. I think it really goes back to the consolidation that takes place in the industry. What you'll find is that when telecoms are consolidating at the top level, it's going to trigger down to the supplier level. And we're seeing that chain take place. When a number of telecom companies get together, they merge together, their purchasing function has to sort out where they're going to do and what they're going to do. So there's a lot of volatility in the telecom business globally with the M&A side. So I think when we see stability in that, we'll see a more even flow.

Great. Now, given the volatility in the price of lead, can you just give us a sense of what kind of price increases, frequency of the price increases that you've been having to do to kind of almost try to catch up. Now, how often do you have to go back to your customers? And it seems that it's being received, but just can you give us a sense of how often you're going back to the market and increasing prices?

Yes. Over the last 18 months, we've taken around eight major price increases, which -- some that we led, some that our competitors led. The resistance to those price increases is significantly less now than what it was at the start of lead jumping up. In other words, our competitors and ourselves are doing the same thing. We recognize that when lead is going from years ago at $0.20 a pound and today at $1.60 a pound, it's a significant increase. And the market is accepting the price increases from the battery manufacturers.

And then one final question maybe about the capacity. You mentioned the jump in the CapEx to $52 million. You also suggested that, you know, you've kind of maintained that you're going to increase your production to low cost increases from 30% to 50%. Two questions -- one, what is the current capacity utilization rate of the firm? And two, do you need to add more brick and mortar, absent Energia, to get to that 50% threshold?

As far as getting to the 50% threshold on today's volume, we would have to add some brick and mortar. It would be minor in nature. But we would have to add some. And it would just be some small facilities or small buildings that would be in addition to our current plans. So, it wouldn't be anything significant.

As far as our capacity utilization today, we are running at a very high percent; high 80s, low 90s. Some areas we are working seven days a week in. We've been resistant to adding extra capacity unless we're getting very good margins in that business area. Or in other words, the first thing if we run against, tight against a capacity, we will increase our prices. What we found in increasing our prices, we expected to lose some market share, and we didn't. We, in fact, gained market share because of our service to our customers. That opens the door up when you're getting the pricing and you've exceeded the capacity, then you consider adding the capital investments. And that's kind of where we are at this point.

Great. Great quarter. Thanks, John.

Paul Clegg, Jefferies.

Just wanted -- can you talk about the ability to push through price increases in reserve relative to Motive Power? Are you seeing pretty good receptivity on both sides?

I would say that on the Reserve Power it is tougher to pass through the cost increases that we are experiencing. And the primary reason for that, Paul, is what I mentioned earlier about consolidation. You have larger customers and they have much better leverage.

In the Motive Power area, it's more diversified -- the customer base. So it is rougher to get the -- or tougher to get the price increases in Reserve Power side.

And I guess you have somewhat different capacity utilization on those two sides of the business, actually? Sort of industry-wide?

Well, I would say on our capacity utilization that we're running high ends on both product lines.

Okay. And can you maybe also give a little bit of color on how you see orders shaping up regionally throughout the world for the next couple of quarters? And could there be any foreign exchange issue affecting that? In other words, could you see some boost in demand due to customers benefiting from favorable exchange rates?

Well, to start off with on where we see orders, I will just say that our backlog is at a historic high right now. Our order intake is at a historic high. Two weeks ago, we had an order intake that was an all-time record. Things are very, very strong. Demand is very strong for our products at this point.

Mike, I can't think of anything on the foreign exchange at all that I've heard where someone is buying. I don't know if you (multiple speakers) --?

Certainly I agree, Paul. We really aren't seeing any measured impact from the weak dollar/stronger foreign currencies in the near-term influencing order patterns demand. As you also know, we're generally naturally hedged. So at this writing, we don't see anything near term that's influencing order patterns.

Okay. And thanks for the guidance on the upcoming quarter. I was wondering if you could also just maybe add a little color there on how you see margins shaping up directionally for the remainder of the year?

Well, as Mike stated, we've seen a $67 million increase in commodity costs in the first half. And we're anticipating another $40 million to take place in the third quarter. That is a major step-up taking place. Lead can go up overnight, for the [LOME] price. Our cost side can go up overnight. Our ability to pass that normally takes anywhere from three to six months. So what we have is a time lag there. We're experiencing this very high lead cost at $1.68 a pound in October. And remember what I said earlier, January at $0.70. Major ramp-up on the cost side. Our ability to pass that on is not instantaneous. It takes time; three to six months.

So when you look at our earnings in second quarter, we're going to see a drop relative to second quarter in our third quarter because of that rapid increase.

Okay. All right, thanks very much, guys. Congratulations on the nice quarter.

(OPERATOR INSTRUCTIONS). Dan Whang, Lehman Brothers.

That's an impressive quarter. My first question was I think when you said that $0.22, $0.26 guidance originally back in early August, I think that was obviously your best forecast based on what you saw in the month of July. But I'm assuming that obviously the momentum picked up beyond your expectations August/September. But was there -- maybe you could just go through a little bit more detail on how the quarter kind of played out.

Sure, Dan. As you will recall that in the last conference call when we gave the guidance at $0.22 to $0.26, we emphasized that we were going to go after pricing. That our industry and our Company, we felt that we needed to take and pass these extraordinarily high commodity costs on to the end-user. When we put our forecast together, there are two assumptions that I think we missed. Number one, the global growth and demand for Reserve Power products, therefore stored energy solutions, was stronger than what we thought it would be. Number two, I fully expected that we would lose some market share because of the pricing actions. We did not lose market share; we gained market share.

And I think that really speaks highly of the service and value that we provide to our customers. We believe that we needed to push the cost on, we expected to lose market share, and we didn't; we gained it.

Okay, that's helpful. Now, the other thing I noticed in the quarter was that the volume growth picked up, 12% rate from like the 6% rate in the first quarter. And obviously you're gaining market share. But do you think the market growth rate also picked up sequentially in the second quarter? And if so, what do you think is driving that?

Well, again, and I think that was part of the question I answered earlier. We do believe it has picked up -- the market has. It's really two things -- the market has grown and we've taken market share.

And as I mentioned earlier, in the telecom industry there are some expansions taking place. It's my belief that on the reading I've done, it's high single digits. And the Motive Power area has been very strong for us, globally speaking. And we're seeing very high demands. As I mentioned earlier, the backlogs are at record high, our orders are at record highs.

Moving over to Asia, I mean I noticed that strength there was quite noticeable, particularly versus first quarter and a nice pickup in margins as well sequentially as well as on a year-over-year basis. Could you go into a little bit more detail as to what's driving that?

Yes, I think the management team in Asia has done a great job in this last quarter of really assessing their business and saying, these are products that we've been selling that were not making the kind of returns we should be making on. We are either going to discontinue shipping those products or we are going to get price increases.

Second thing, they have gone after some cost reductions in the operations sides, which they have implemented both their product design and in other areas, which has helped. We were obviously not happy with our results in prior quarters in the Asia area. There's been a lot of emphasis put on that. And the management team there has done a pretty good job of getting things headed in the right direction.

Okay. And kind of an off question here but with moving the lead prices out there in the marketplace, I mean, I know you really haven't had your own internal smelting operation, but is that something that you would consider either acquiring or sort of building?

Well, Dan, I think two things on it. You know we do not comment on future other businesses we would get into or acquisitions and things. So it would be not fair for me to take and really comment on that portion. But that being said, anything that will help improve our costs, our service to our customers, our earnings for our shareholders, obviously we have an eye on it.

Thank you very much and congrats again.

John Franzreb, Sidoti.

I was wondering about the Motive business. Could you give us a sense what the demand was by region?

Well, John, we typically do not give that information out by region because of the competitive sensitivity to it. But I would just say globally we are seeing pretty good growth in each of the areas -- or fair growth in each of the areas.

All right. Well, could you rank which one is the best? Europe, Americas, or Asia? Would that be possible?

Yes, I think I could do that. I think that -- I mentioned earlier about the improvement in China. You may recall that a number of years ago we were not building Motive Power product for the Asian markets. Today we manufacture there. So, we've seen growth there by just getting in the business. Europe has been very, very strong for us. So I would say on a percentage basis, Asia, 1%; Europe, 2%.

Okay. And can you talk about your appetite for hedging at the current levels? I know you've kind of gone back and forth based on the escalating lead prices. What are your thoughts right now about hedging at the current levels?

If we have a long-term contract, something goes out at two years and we put a price on the product, it's a fixed price, we'll lock the lead in to assure those margins longer-term to take the volatility out. Otherwise what we're looking at is three to six months going out. We're very nervous about going out further than that with where lead is today. Primary reason, and I think we've demonstrated that over the last two years or so, over the last three years, we've seen major increases in lead costs and we will manage through those increases.

My biggest fear is that I believe there's a high probability that lead will go down back in the $0.70, $0.60 range. If we're locked in current prices today, let's say at a $1.60, it drops down. If the competitors start to reduce their prices and we're holding those long-term hedges at $1.60, it would negatively impact us.

The other side of the fence, if lead were to go up to $2.00 or $2.50, we'll keep doing what we're doing, and that is offsetting that through cost savings, through volume, through taking care of our customers and the things that we've been doing.

I'll add to that, over the last three years we have seen commodity cost pressures affecting our earnings per share by $3.79 -- a negative $3.79. We've been able to offset that with a positive $4.08 in selling price, cost recovery, and top line volume growth. So we'll stay the course with that to try to avoid the situation that lead would drop way down and we're holding expensive paper.

Now, do you -- I know that Australia had a disruption in lead supply, some environmental that's caused a shutdown. Do you know the update on that? Or if there's any new capacity expansions, or notable capacity expansions, that are coming online in the coming six months or so?

Well, you're referring to the [Emerson mine] in Australia, which is roughly 3% of the global capacity. As far as looking at global capacity on lead, if you look on a global basis, there really is not an issue with it. The problem we're experiencing today, in my opinion, is looking at what's taking place with China. If you look at the concentrates that are going into China, they are up over 50% year-on-year. If you look at what's being exported out of China, it's down significantly. So you're seeing a lot of lead going into China that normally would be in the Western world, it's being used in China.

There are some expansions taking place in a number of different regions. There are right now, the supply/demand we are in a deficit, meaning there's less supply than demand for lead. It's anticipated, though, it's going to swing the other way in the next year.

Okay. Thanks a lot, John.

This concludes today's question-and-answer session. Mr. Craig, please proceed to closing remarks.

Well, I'd like to thank you for joining us for our call this morning. And we look forward to seeing each of you in the future. Thank you very much.

Thank you for your participation in today's conference. This concludes the presentation. You may now disconnect. Good day.