EnerSys (ENS) 2008 Q3 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the third quarter 2008 earnings conference call. At this time, all participants are in listen-only mode. We will be facilitating a question-and-answer session towards the end of this conference. (OPERATOR INSTRUCTIONS).

As a reminder, this conference call is being recorded for replay purposes. I would now like to turn the presentation over to your host for today's call, Mr. John Craig, Chairman, President, and CEO. Please proceed, Sir.

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

Thank you, John, and good morning to everyone. As a reminder we will be presenting certain forward-looking statements on 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 Operation set forth in our quarterly report on Form 10-Q for the quarter ended December 30th, 2007, which was filed with the U.S. SEC.

In addition we will also be presenting certain non-GAAP financial measures. For an explanation of the differences between the comparable GAAP financial information and the non-GAAP financial information, please see our Company's Form 8-K which includes our press release dated February 6, 2008, which is located on our web site.

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

Thanks Mike.

I continue to be pleased with our strong performance this fiscal year. As compared to the third quarter of last year, revenue for this year's third quarter was up 46% and adjusted net earnings increased 89% as we benefited from solid growth, the improving pricing recovery and the continuation of our cost savings programs.

Adjusted earnings per diluted share for the third quarter were $0.35 which significantly exceeded the previous guidance that we provided in November of $0.25 to $0.29 per-share.

Each of our business segments in geographic locations had strong revenue growth and it was a major factor in the increasing in earnings. Although I am pleased with our success in achieving pricing recovery of over 80% of the incremental commodity costs through the first three quarters of this year, we still have a ways to go and we are committed to recovering all incremental commodity costs.

At the same time, we will remain highly focused on servicing our customers and providing new stored energy solutions to our market.

As an example, our proprietary thin plate pure lead technology has led to many new opportunities that are significantly expanding our business. In prior conference calls, I talked about our wide use of thin plate pure lead technology in tanks and other military vehicles, premium Reserve Power product solutions; the highly rated Sears platinum battery and the Battery Development project for the United States Navy to retrofit the nuclear submarine fleet.

Earlier this week, we issued a press release stating that we received our first contract award from the United States Navy to produce thin plate pure lead batteries for the nuclear submarine fleet. This is another major milestone for EnerSys in advancing our superior technologies and meeting or exceeding our customers' needs and expectations.

We are confident that we will continue to be successful in expanding the use of thin plate pure lead products around the world in many new and innovative applications. To a greater extent than ever, our customers are realizing the substantial benefits of this unique technology as we continue to work with them on new designs and applications.

As a result of the success, we are planning a major expansion of our manufacturing capacity for these products. This will result in approximately 20% increase in our total capital spending in fiscal 2009 to roughly $60 million and the future financial returns from this expansion will be very significant.

This is another good example of our ability to provide our customers with innovative and leading-edge products that they request and need, while creating new areas of growth for EnerSys.

I would like to focus now on the future of our business. We believe we will continue to experience growth in our markets and in our revenue. Energy stored requirements in the industrial area have grown faster than the global economy on average for many years. We remain highly confident that this growth will continue and that we will continue to increase our market share. Although the global economic outlook is certainly mixed at this time, we are not experiencing a downturn in our business. Demand for our products is at record high levels. Our backlog at quarter end was at a record high level and global spending for the telecom infrastructure, UPS systems and forklift usage continues to grow.

We are confident in the long-range growth prospectus for our markets and our business, and our ability to continue to extend our leadership in this industry and our conviction to this belief is reflected in our past expansion investments and our future investments in both expansions and acquisitions.

When Mike Philion and I joined the Company in 1994, our revenue was approximately $230 million versus our current run rate of approximately $2 billion. About two-thirds of our current revenue in earnings come from acquisitions that we've made since 2000. They are performing well and we remain very active in pursuing others.

We believe the strength of our balance sheet and earnings along with our solid management team gives us a clear advantage of pursuing acquisition opportunities in today's business environment. There are many exciting opportunities right now and we believe some of them may be concluded in the near future.

Last evening we provided guidance, earnings guidance, for the fourth quarter with the estimate that our as-adjusted diluted EPS would be in the range of $0.31 to $0.35 as compared to $0.23 per share in the prior fourth quarter for our year fourth quarter.

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

Thank you again, John.

Certainly our solid fiscal 2008 results continues to demonstrate the strengths of our global business and industry-leading position. Our third quarter net sales increased 46% over the prior year to $553 million. On a business segment basis, net sales in the Reserve Power business increased 58% to $248 million while our Motive Power business increased 38% to $306 million.

The consolidated growth rate includes approximately 16% from base volume as demand for our products and services remains very strong. Also the third quarter growth rate includes approximately 18% due to our pricing recovery actions, 10% from foreign currency translation, and 2% from acquisitions.

Further, our fiscal 2008 third quarter sales growth was solid in all three regions with growth of 72% in Asia, 54% in Europe, and 32% in the Americas. We believe the combination of our outstanding products with superior customer service continues to drive our strong topline performance.

Net sales for our first nine months were also strong and increased 32% over the prior year to over $1.4 billion. On a business segment basis net sales in the Reserve Power business increased 33% to $631 million while our Motive Power business increased 32% to $814 million.

The total nine-month growth rate includes approximately 12% due to pricing actions, 11% from base volume, 7% from foreign currency translation and 2% from acquisitions. We believe our base volume growth of 11% is 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 February 6, 2008, for more details concerning these and other highlighted items.

Our third quarter as adjusted operating earnings were $33 million or an increase of 53% in comparison to the prior year with the operating margin increasing 30 basis points to 5.9%. This strong earnings performance was achieved in spite of higher commodity costs of approximately $85 million in the quarter. 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 increasing commodity cost, significant earnings pressure continued to be experienced in our third quarter as pricing recovery still lagged rising costs. We estimate the price increases totaled approximately $71 million were achieved in our third quarter were, roughly, an 18% increase in revenue. The earnings GAAP attributable to this cost, price, timing pressure was approximately $14 million in our third quarter or $0.20 of EPS.

We remain highly focused on this earning pressure and are steadfast in our results to eliminate this gap.

Our first nine months of fiscal 2008 as adjusted consolidated operating earnings were $94 million or an increase of 38% in comparison to the prior year with the operating margin increasing 30 basis points to 6.5%. Similar factors affected our nine-month results as described for our third quarter.

Our acquisitions remain on target and they have collectively added $0.05 per share to our third quarter EPS and $0.11 to our nine-month results. As expected, the May 2007 [Energia] acquisition was modestly accretive in the third quarter and remains an important initiative to further reduce our costs and expand our reach into new high-growth markets.

Our fiscal 2008 results have been significantly affected by the higher cost of lead, which is approximately 33% of our year-to-date cost of goods sold. We estimate that our third quarter lead costs have increased approximately $79 million or 106% compared to the third quarter of the prior year. Additionally we estimate that our nine-month lead costs have increased approximately $147 million or 70%. Further, we expect our fourth quarter of fiscal 2008 lead costs to increase by over $75 million or over 90% compared to the prior year.

These higher costs clearly illustrate why additional pricing recovery is necessary.

Now several comments concerning our diluted EPS. As-adjusted diluted earnings per share were $0.35 in the third quarter versus $0.19 in the prior year or an increase of 84%. Compared to the prior year's third quarter and expressed on an EPS equivalent basis, improved pricing recovery was equal to $1.01 per share while higher commodity costs negatively affected our earnings by $1.21 per share. This would have reduced our EPS by $0.20 were it not for the equivalent of $0.36 of additional earnings primarily from our sales growth and ongoing cost savings actions.

As-adjusted diluted net earnings per share were $1.00 in the first nine months of 2008, compared to $0.64 in the prior year, or an increase of 56%. Similar factors affected our nine-month EPS results as described for our third quarter.

Now, some brief comments about our financial position and cash flow results. In short, our performance continues to be good, very good with adequate liquidity to both operate and grow our business. Primary working capital increased $147 million since the beginning of fiscal 2008 to $523 million, principally due to our sales growth and the increasing cost of commodities. As a percentage of the annualized trailing three-month net sales, our primary working capital at 24.1% was down 110 basis points compared to the prior year.

Our capital expenditures were $27 million for the nine-month periods of both fiscal 2008 and 2007. We expect capital spending for all of fiscal 2008 will approximate $50 million. And as John mentioned earlier, we expect capital expenditures will approximate $60 million in fiscal 2009 as we continue to believe in the future growth prospects for our business.

Net debt as defined in our senior credit agreement was $422 million at the end of our third quarter with a leverage ratio of 2.7 times. Our average interest rate was 6.5% in the first six months of fiscal 2008 and 2007. We remain in full compliance with our credit agreements and have over $100 million of available but unused credit under existing facilities at December 30th, 2007.

As John mentioned earlier, we expect to generate diluted net earnings per share of between $0.31 and $0.35 in our fourth quarter, which excludes the expected $0.02 per share charge from our ongoing European restructuring program which is largely attributable to the Energia acquisition.

The two primary factors that will impact our fourth quarter earnings are, first, continued progress in further increasing our selling prices and reducing our costs and, second, the anticipated sequential quarterly increase in our lead cost of approximately $16 million.

In closing, I remain highly confident in our Company's future. We have consistently demonstrated our global organization's ability to adapt quickly to rapidly changing market conditions and successfully grow both revenue and earnings.

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

Thanks, Mike. With that, I would like to open the lines for questions that you may have about our business.

John Franzreb. Sidoti & Company.

Impressive numbers. There's no two ways about it. I guess my first question is can you talk a little bit about the sensitivity of your business to maybe an economic downturn? Especially what your thoughts are about the Motive business, given all the concerns we have about a recessionary environment going forward?

Yes, John, as we talked through the -- earlier this morning on -- we are not seeing the impact of a downturn taking place. I know all of us are reading about credit prices and everything. We are not seeing it in our business. We believe that the telecom industry is going to continue to rebuild the infrastructure or invest in the infrastructure. Same thing with the UPS industry.

We have seen some mild downturns in certain segments in the Motive Power area. However it's more than offset by other areas that we have. As an example, in the Americas, the ITA data, or Industrial Truck Association data, when you look at it, it is down year-to-year. But we are more than offset in that in Europe and in our Asia business.

So that's one of the advantages of being a global company. When one market is down, the others are up and it's offset quite nicely.

Actually that led into another one of my questions. The growth in Europe on a percentage basis, 54% was stellar. How much of that was acquisitions and how much of that is organic? And could you just talk a little bit about the drivers, what's going on in Europe?

I'm going to reference base volume growth, John, because obviously there's translation. But the simple answer is Europe continues to be very strong. Year-to-date, nine months, the base volume of Europe is up 11%. In the third quarter, up 17. In order of magnitude, maybe 2% of that has some acquisitions in it.

So everywhere we see the volume growth in Europe, it's very, very strong.

And is that motive or is that in the Reserve Power business? What's driving that?

It's in both. Although certainly the Motive continues to be a bit stronger, but it's good growth in both sides.

And there's really not much of the currency price benefits, because you produce over there. Correct?

That's correct. You're correct. The weakening dollar has very minimal effect because we are naturally hedged around the world where we operate.

One last question, and then I'll go back into queue. Can you talk a little bit about the timing of your price increases, what you expect to do this year and when do you expect to reach equilibrium as far as price and cost? Especially given the -- the significant pullback we've had in lead cost over the past couple of months.

Normally what takes place is we are looking at three to six months before we can -- once we announce a price increase before it works through the system that we finally realize that particular price increase to our P&L. The reason for that is backlog. We normally give advance notice to customers, but as far as when we reach an equilibrium on it, I think that all depends on what happens to the lead market.

If we were to stick at today's price at $1.26 and it it stayed there for the next year, three to six months from now we would be 100% caught up, but more than likely what will happen is lead will either go up or go down. If it goes down we will catch up faster. If it goes up it will take longer.

John, do your customers buy in advance of a price increase?

Some do but it's a relatively small portion of the business. When you are putting an installation in place in, say, the telecommunications infrastructure or UPS, and the battery is going to run between 5 to 15% and usually they have it ordered ahead of time and the lead time on it is such that they are not trying to tie into market. Motive Power area, some will go ahead and if they know a price increase is coming, yes they will go ahead and buy it ahead of time.

Corey Tobin. William Blair.

Great quarter, guys. Let me just follow up on that last question if I could then I have a different line I wanted to take, thanks.

You gave the breakout rather in Europe year-to-date for base volume and also in Q3. Can you provide the same number for the Americas?

Sure. The year-to-date Americas is identical. It is 11%. And in Q3 it is 13%.

So you actually saw acceleration in volume for both geographic regions in Q3?

Yes, we did. Meaningful as you've noticed.

Changing gears for just a second, how much of the CapEx do you have slated for next year will be for just sort of general plant expansion versus plant expansion specifically for that thin plate technology?

Well, it's the thin plate pure lead technology investment that we are looking at -- I'm going to talk over a three-year period because as I mentioned earlier it's a significant investment. Over a three-year period order of magnitude, we are looking at $50 million. As I mentioned earlier the returns on it are significant.

I guess what's giving you the confidence that -- is it just such a unique product line in the marketplace or is it the demand that you are hearing from a customer base for this type of product? Or what exactly is giving you the confidence to put that sort of investment in play?

We have many customers right now that are in product allocations. We can't keep up. We are running the plant seven -- two plants that we have currently, we are running them seven days a week around the clock and we are turning away business. Our marketing and sales guys are not really going out and looking too heavily for new business right now because of lack of capacity.

We've shown the product to a number of different applications which we haven't talked about. They are very excited about it; but we are not in a position to go forward with them. It's one that demand is way in excess of the capacity we currently have.

Great to year. Finally, final questions on this front, how much of the thin plate technology I guess is going through the (inaudible) today? What do you expect that to contribute as we look out to next year?

When we talk about -- and I will give you the broad answer and then come to thin plate. We have other proprietary technology, as you know, our square tube Motive Power. In total, that plus thin plate pure lead is a little over 20% of our worldwide revenue and it's relatively evenly balanced with certainly both performing very well.

So 20% of revenue here in the third quarter?

No. These are -- I don't know the specific number, but it's averaged roughly 20% of our year-to-date revenue. About 10 of it is thin plate, 10% is thin plate and 10% of it is our unique square tube and Motive Power. So in summary we generally view 20% of our revenue from our very unique proprietary technologies.

And looking at next year that would -- I'm assuming we could think of that as growing as a percentage of revenue?

Absolutely. That will go off, in fact, our third quarter is a little higher than 20. Mike's number is right on the year-to-date, but I suspect it's a little higher in the third quarter. We are going to -- as we add the capacity, I'm not worried about getting the sales out because as I said the demand is there for the product. As we put the capacity on line the product will be sold and I think we are looking at almost doubling the capacity in that business.

Great to hear. Congrats again.

Craig [Horwin]. Merriman.

Solid quarter. Congratulations on that. Just wanted to ask a couple of sort of general questions around your acquisition strategy. You've really gained the reputation out there in the market as the most aggressive acquirer of the energy storage assets which I think is probably a badge you wear with pride, but I was just hoping you could discuss a little bit around your valuation disciplines. What you look for, where you like to buy things and what sort of rates you look to earn on the assets you acquire?

We look at a number of different things so there's quite a number. I mean at any given time in a year's period to 20 to 30 different assets so potentially we would go after just to back up what we are looking for. We are looking for companies that would be vertical integrations like the ones that we've done in trade manufacturing.

We are looking for what I call bolt-on companies in the lead assets areas where there would be highly synergy plays where they make the same product that we essentially do and we can work the synergies with them.

We are looking at alternate technologies. Lithium ion as our modular energy is an example. We bought a company in (inaudible) Germany, GAZ is the name of it, that has helped us. And the other one is geographic expansion like Bulgaria, where we are entering the Russian market.

So those are the ones that we are really are focused on highly and the screening process is really simply this. That I want to take a look first off at the entity and what would we be willing to play on a 25% IRR. That's a starting point. Looking at a five-year period.

Second thing, you show me a model with synergies on it. Third, who are we competing against and buying it? That's a screening process that we go through. Then we get into the due diligence and really see how well it fits and where would we want to go with it.

Excellent, excellent. So then on a -- in the lead acid market I understand there's a few of the smaller sort of tertiary guys that are speaking to a variety of people right now. Would you prefer to have an asset like that or something close to asset value where it is more of a turnaround story or would you prefer to go after one of the high-quality providers in the market?

I care about the return on investment to be honest with you. That's what it really comes down to.

I've said many times that I really don't necessarily care to buy companies that are accretive right out of the chute. PM was a good example of it when we bought the company; we said it would be dilutive $0.02 a share first year. It would be accretive a minimum of $0.04 a share the second year. It was breakeven first year, it was way north of $0.04 the second year. The return on it was very solid for us.

The ones that are accretive, they tend to want a higher price. So the metric we are looking for is that return on investment and how fast we can execute and the risk associated with it.

Excellent, excellent. Thanks for that commentary and congratulations again on the quarter.

Dan Whang with Lehman Brothers.

First question was a little bit more details on the pricing and actually it sounds like both Reserve and Motive are on parity in terms of pricing. I guess historically reserve market has been a little bit more challenging, but so is it essentially saying that both of those product segments saw [a 10]% price increase?

That's fair to say and as I said earlier our objective is 100% commodity recovery in all aspects of our business.

I know it's been historically a little bit more challenging to get pricing on reserve. I mean, what's enabled you to sort of reach parity in those different markets? What's changed in the marketplaces that some of the excess capacity is going away on the reserve side?

I don't think it's as much -- you may be right. It may be part of that but I think more importantly is things like pure lead which tends to be higher margin products and the change that we're seeing customers going to that.

The capacity with certain areas and certain customers, I do know it's an issue where we've been able to get pricing on it. That is an issue on some of the other products, but I think part of it is the change in mix.

You mentioned the other thin plate pure lead opportunity that I think historically, as you mentioned, the applications have been more focused on the military side. So is this the growing opportunity in the thin plate area? Is it just expanding into commercial applications and outside the normal sort of sphere?

You're right, Dan. Couple years ago or sometime in the past it was highly focused on the military applications where it was military tanks. We then put thin plate pure lead into military aircraft like the F-16, F-18s, C-130 transports, Black Hawk helicopters. We then expanded it into commercial aircraft.

We've also expanded into high-end starting applications for diesel starting trucks -- diesel starting engines. We have expanded into Sears as the platinum battery. It has gone very heavily into the telecommunications area and it was started in telecommunications also. But we've done a major expansion in the telecom industry where they are looking for less space to store the battery. Or put place the battery and more power output.

That is where the thin plate pure lead really has its advantage. There's more power per square foot.

Right. And I know the -- because of the intricacies in the manufacturing process with thin plate, you've held a competitive advantage. I mean are you seeing other potential players? Any signs of that in the marketplace?

Nothing that has really changed in the last several years on it.

That's great. We will look for the good news on that.

And finally I think one of the other battery manufacturers reported results and it's obvious that you continue to gain share. And in that regard are you doing anything different out there in the marketplace that is allowing you to outperform or is it just the same old, maybe not old but the same EnerSys blocking and tackling?

I think what it gets back to is best value in the industry and I think what that is is servicing the customer, taking care of the customer, looking at what the customer wants. Sometimes they don't know exactly what it is they want so we come up with new ideas. We try to study their applications. We look at how we can help them improve their business.

It is like one of our major customers told us recently, a large OEM, "you're not only the best battery supplier that we have, you are the best supplier, period." And that's the kind of things that we really look for.

Taking care of the customers is what service is about. It's service. It's service, service, service. I don't how else to put it.

Thank you very much and it's a great quarter.

Paul Clegg from Jefferies.

Congrats on the quarter. I will add my congratulations to everyone else's.

When do we see those $1.75 per pound LME lead costs that we reached late last year moving through your P&L? Is that more in the March quarter or the June quarter?

You will see it starting in this next quarter and if you notice sequentially that $0.35 going down to $0.33. And as Mike Philion alluded to earlier that the step up quarter to quarter is $16 million. Which on a share basis is what? $0.22, $0.23 headwind?

Right, okay. And so you'll see some of that in the March quarter, but you also see it carry through to the June?

Very little. Some, but very little.

Okay. Very good. Any update on competitor behavior? Are you still seeing pretty [rational] behavior on pricing?

I think many of our competitors are hurting and they are in worse shape than we are. They are following, in some cases actually leading in going after pricing. And it's nice to be following a competitor and going after pricing in some cases because it says the market has some discipline to it.

So I think it's been very rational recently. I think most of the competitors out there -- my perception on it -- they have the same situations that we do and the same focus and that is that, unfortunately, commodity costs have gone up. And unfortunately in the lead acid battery business, lead has a big impact on us. And unfortunately the end user ultimately is going to have to pay for what's happened to things that we can't control. And I think our industry has recognized that.

And are you seeing that across the board geographically or is it different in some different markets? Are you seeing more?

In Asia -- the exception would be in China. China is a tough market on pricing. It's a very tough market on pricing. I think ultimately we are going to see changes there. China is about 5% of our total business, but if I had to pick one market that's the toughest, it would be China.

Russ Campbell. Evergreen.

Great quarter. Just wanted to ask you a question about the new FCC ruling with the whole UPS changeover and if you could sort of fill out some color about the quantification of how big that is or when that should go into effect or any headways that are sort of going in that direction for you guys?

I assume you are referring to the requirement of eight hour backup on cellphone, 24 hour backup on wireline?

Exactly.

Yes. That was driven by Homeland Security stating that -- it's been around for a long time. It's nothing new, but Homeland Security, I think at this point, is insisting that that is put in place.

It's still being contested. I've heard numbers that it'd be north of a $100 million impact. In fact no one really knows what the impact is going to be on it.

I will say though that would a number of large telecoms we currently are out doing surveys on their equipment and what the demand or what the needs would be. They've hired us to do that on the front end. And certain telecoms have already decided to move forward with it and we are doing business with them right now.

It will have a positive impact. I believe that. To what extent it's hard to tell.

(OPERATOR INSTRUCTIONS). Mike Marberg from Ramsey.

In the last couple of quarters, the gains from your hedging activities have become more material for obvious reasons associated with the lead situation. I'm just trying to understand the policy as it relates to hedging activities.

Some companies effectively use hedging as a zero sum situation over time. They hedge the exact amount of whatever they're hedging, regardless of their specific judgment as to how things may or may not evolve. Other companies use their judgment and they might hedge 30% in this quarter and 50% in another quarter. And it's not easy (inaudible) gain. They are actually trying to make a little bit of profit over time.

Which kind of bucket do you guys fit into?

Let me describe I think what we've done historically and the way we view that.

We carry about the next quarter -- most of the next quarter of our projected sales is currently in backlog. So when we are looking at hedging, we are going to look out in the short window there, that if lead were to jump way up or go way down we are at risk.

So we want to hedge out a portion of the next quarter, a fairly substantial portion. Because if lead were to drop down we wouldn't get caught short on it because we would have already had the price fixed on that or taken the [order at] that.

The concern that we've had is that we are not going to go long on the market because it is so volatile. We have demonstrated or proved from lead going from $0.20 many years ago up to a high of $1.82 and I will remind everybody one cent in lead is worth $0.07 EPS to us. It is a big impact. The condition that we feared has been that if we hedge at a high price and we are out long on it and lead drops way down like it has recently from $1.82 in mid-October, January down to $1.12 that big drop -- if we are locked in at that high price and it stays down, we could be in a world of hurt.

So we are not going to go long on it.

On the other side, as lead creeps up or continues to go up, we have demonstrated we are able to pass most of that through. We are at 80% right now. We've made up the difference with volume and cost savings.

So ultimately, we are not looking to betting on the market. We are not trying to take and say that we are going to take and make it a profit center to hedge lead. That's not our business.

Our business is in lead acid battery business we want to be sure that we can remove volatility and remove or mitigate some of the risks associated with our business.

Good. So that would fit into sort of the first bucket. And I think the that's what people would -- well, I guess I can't speak for other people. That's what I was hoping for.

Then, the next question is, what in this current quarter what were the realized gains from the hedging activity that that flowed through the income statement? How many millions of dollars?

We don't give a prescriptive number, but you'll see it in our public filing. I think the nine-month number was $44 million. And certainly there are some meaningful benefits, as John referenced.

So John said it perfectly. We hedge for volatility protection. We recognize the link between backlog and pricing dynamics.

So we don't believe in the philosophy with our business model of going long or to do anything that we would characterize as knee-jerk or reckless.

Let me pick it up a little further. If you look through the nine-month period in total commodity costs increase, we've seen over a $200 million headwind against us. $200 million.

As Mike just alluded to we've offset $44 million of that in hedging. Where we have lost additional money is we haven't got the pricing to offset it yet. If the commodity cost, if we could raise the prices in sync with the increase of commodity costs, everything would offset.

What I'm trying to say is here that our total business is down $157 million. Our total costs I should say is up $157 million year on year and we have not recognized or realized all the pricing to offset that yet. We've only got a portion of it.

So yes. The lead hedging has helped us during the first nine months, but we haven't got the price increases that we would really like to have either. So going forward, if we lose the hedging -- hypothetically -- we will offset it with the pricing.

I understand. That makes sense. So the real impact of this $1.80 to $1.12 drop on the hedging activities is probably not in this coming quarter but in the following one. By that time you're saying most of the pricing pass-through increases should be realized and it should offset what would be some loss associated with hedging activity.

It will be in future quarters. You're right. It won't be in this next but it will be in future quarters.

Dana Walker from Kalmar Investments.

From an interest rate standpoint, Mike, how will your debt balance and your debt burden and the cost of that be affected by the reduction in LIBOR?

Obviously near-term we have roughly half of our debt that floats and half is with interest rate swap. So in the near-term, certainly, we will get some modest benefit from lower interest rates.

One way to look at that might be roughly $200 million that is sensitive to the reduction rates?

Yes. $200 million is the ballpark number that is -- that floats. That's correct.

And with LIBOR having come down 200 basis points or so I suppose there might be $4 million per annum roughly pretax benefit?

Yes in the isolated examples you used, that is absolutely correct.

Okay. When lead spiked in the late summer, would you say that you were less active in pursuing it and had the ability to be less active? Or would you say that your purchasing patterns were just as active, given the volume strength that you're having to serve?

I would say that we were fairly consistent through that period of time where we were looking at the orders coming in and what we were going out at pricing. And we were looking at the next three months out and seeing what we want to do.

Any reason to think that your competitors would have taken a different tack and that you would be disadvantaged by the steps that you took versus what they may have done?

I really have no idea what they have done. I have no idea.

The submarine contract that you announced, should that be considered a long-term engagement with the Navy or is that going to be done year by year?

The first pass on it is for two years, the contract that we have. But our expectations are that it will be a long-term. And to go further with that, this is a start. We do business with approximately 20 different countries in the military area around the globe. We -- this is the first that we've used thin plate pure lead with the United States Navy but we do plan on offering that to other countries.

Of the 70 some odd nuclear subs, how many of them would be retrofit in that two-year timeframe?

I don't know the exact number on that. And it is one of the things that I am not sure if we did know that, that the Navy would want us to talk about.

With the strength in your Reserve business, you describe how some of the -- they really aren't RBOCs anymore, but some of the telephone companies have been active in pursuing this FCC mandate.

What are some of the other themes that you are alert to that appear to be responsible for the pickup in business?

I would say that, in part, it is speed on the Internet and new technologies coming out. The competitive situation set up between the telecoms and cable I think are probably the big ones. I think that the telecom industry is one that it seems like it has to reinvent itself every few years because of the competition that's there. And there's a lot of capital that needs to be spent to keep the earnings and cash flow going with those companies. So I think the growth from our standpoint is going to be substantial going forward.

I think the other thing is -- now this is talking mainly to the United States and I think the same thing applies in Europe, but the other side to it is with many of the OEMs, the equipment manufacturers, it's the deployment or the expansion of cellphones around the globe. Places like China as an example or different countries where the infrastructure is just being developed and they're putting wireless in.

Your relative involvement with cable companies as they build that infrastructure, would you say it is modest or less or more than modest?

Less than modest.

Two last questions.

That's in the U.S., I should say. In the US. We are not a strong player in that market.

Overseas?

We're stronger there.

Two last questions. Where would you describe -- you've talked about thin plate pure lead -- but how would you describe your utilization broadly of your productive capacity of double-digit volume growth? You must be taxing that?

If I understand your question correctly I wish there were 10 days in the week because we just can't keep up. We're working as I said earlier seven days a week 24 hours a day. And we are not heavily marketing the product right now until -- to new customers, I should say -- and that we think that there's a very, very large opportunity going forward.

Let me phrase the question.

(multiple speakers)

I think your question might have been broader. Were you reverencing the total business or any one particular element?

It was a poorly phrased question but I was trying to reference the total business.

Well, certainly, you're right, with the growth as strong as it is. Clearly we are at high capacity utilization throughout the world and in both segments.

Are you in a position to deal with volume growth of a reasonable level over the next couple of years based on the pacing of your productive capacity yet?

Yes we are. I think and I understand your question, I think the thing that we take a look at -- just to make it clear -- on the manufacturing plants [24] around the globe. Obviously these things are not inexpensive to keep operating. We want to be sure that we are running very high capacity utilization. High 80s to 90s. (inaudible) but not a lot.

Whenever an appropriation comes in to me to add or expand the first thing I say is, "Geez, guys, let's take a look at the pricing, what you're getting. Look at the low margin business and if you were to raise your prices that business goes away, you've got the capacity."

Thin plate pure lead we've done that with it and it says we still are way short and it's a good solid investment for us to add.

Now if you take a look at the other end of business, where we are looking at the high double-digit growth 11, 12%, we can add that fairly easily in the rest of our factories. And it is not going to require the same amount of capital that we are talking about on thin plate pure lead either.

That was very helpful. Final question relates to thin plate pure lead. As you take additional -- as you more broadly address Reserve needs that are outside of Aerospace and Defense, to what degree will you be -- will you be stepping on your own toes with products that you already have that address some of that need. Or would you be incrementally serving market that you wouldn't be able to serve otherwise?

I think it's a little of both. It's more than -- I think it is going to be new business for us, and new applications. But certainly the other products are the calcium batteries.

Yes, we could expect that we would see some reduction there. However the growth that's taking place in the markets what it would mean is, we would more likely not add additional capacity.

In other words what I'm trying to say is that growth is going to come in thin plate pure lead and if a customer switches away from a calcium product, to thin plate pure lead, we will use that capacity for something else. (multiple speakers) demand for that product because the price difference between thin plate pure lead and calcium.

So there will be some cannibalization but you think part of it is incremental and it would appear given the premium product status that this would be positive for the profit profile and return profile of the Company?

Absolutely.

John, you might -- I mean, clearly, the reference of thin plate in Reserve is principally telecom, but the UPS growth prospects which is calcium product, continues to be very promising, so -- .

Mike's right on the mark with it. That's where I was going with it. Because if we were to see the calcium product go down because of the telecoms switching to thin plate pure lead, it will be more than offset with the UPS business. Because UPS is growing rapidly too and they tend not to use the thin plate pure lead.

There are no further questions. Back to you, Mr. John Craig, for final remarks.

Thank you for joining us this morning on our conference call. We do appreciate your interest in our Company and I wish everybody a good day. Thank you.

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