EnerSys (ENS) 2009 Q2 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the second quarter 2009 EnerSys earnings conference call. My name is Marcia and I will be your coordinator for today's call. At this time, all participants are in listen-only mode. We will conduct a question-and-answer session toward the end of this conference. (Operator Instructions). As a reminder, this conference is being recorded for replay purposes.

I would now like to turn the call over to Mr. John Craig, Chairman, President and CEO. Please proceed, sir.

Thank you, Marcia. Good morning, and thank you for joining us for our conference call. During this call, we will be discussing our second quarter and first half of fiscal 2009 results, as well as commenting on the general state of our business.

But before we start, I will ask Mike Philion, our Chief Financial Officer, to cover information regarding forward-looking statements. Mike?

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 assumptions, which are subject to uncertainties and changes in circumstances.

EnerSys actual results may differ materially from the forward-looking statements for a number of reasons. Our forward-looking statements are based on management's current view regarding future events and operating performance, and are applicable only as of the dates of such statements.

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 September 28, 2008, which was filed last evening with the US Securities and Exchange Commission.

In addition, we will be also presenting certain non-GAAP financial measures. For an explanation of the differences between the comparable GAAP financial information and the non-GAAP information, please see our Company's Form 8-K, which includes our press release dated November 5, 2008, which is located on our website at www.EnerSys.com.

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

Thanks, Mike. We're certainly pleased with our second quarter record earnings that we reported last night. Our adjusted earnings of $25.9 million were up 51% compared to the second quarter of the prior year. Since we continue to experience higher commodity costs in the quarter, we are particularly pleased that we achieved pricing recovery, which allowed us to more than offset those higher costs. Beyond recovered costs, during the last four years, have put continued pressure on our gross margins. In an effort to improve these margins, we have continued to stay focused on our pricing management.

As part of that effort, we have recently reduced a portion of our revenue that is tied to automatic lead pass-through mechanisms, which now accounts for approximately 35% of our revenue. As I stated in our last quarterly call, we are firmly committed to achieving our 25% gross margin target.

Since the low point of 17.6% in the third quarter of fiscal 2008, we have steadily increased our margins and we are now at 20.7%. We will continue our strong focus on this target, which we plan to achieve through combinations of improving pricing related to commodity costs, additional cost savings measurements, and a shift in certain segments of our business towards higher margin products.

Net sales for the quarter increased 14%, which included approximately 10% in increased selling price and 5% due to translation of stronger foreign currencies. Slower global economic activity resulted in a unit volume decrease of about 1% in the quarter compared to last year's second quarter.

As you know, the global economic outlook has deteriorated significantly since our last quarterly call in August. I'd like to discuss in broad terms our outlook and plans at this time.

We are now assuming that we will experience a period of slower global economics. Our recent order flow has slowed, and we recognize that we cannot predict future demand with great certainty. Economic activity around the world has slowed, and most businesses, along with many economists, are struggling to predict the depths and length of this economic downturn.

As we enter this slower period, we have developed plans for a variety of circumstances. Clearly, the potential of reduced volume will not be the same in all regions and in all product lines. Therefore, these plans are tailored specifically to regions and product lines that will vary based on our outlook for each of these areas.

Our plans already include reductions in our temporary labor force and in other costs and expense areas. We will continue to adjust our staffing expending based on our future order patterns. For obvious reasons, we are not going to discuss any of the details of these plans; but you can rest assure that we intend to react quickly in order to minimize the near-term pressure on earnings.

Last night, we stated our guidance for the third fiscal quarter of 2009 with forecasted adjusted diluted earnings per share between $0.40 and $0.44. Using the $0.42 midpoint of this guidance, it would be a 20% increase over the comparable quarterly earnings per share in the prior year of $0.35. Given the global economic environment, I'm quite pleased with these anticipated earnings.

We are fortunate to have completed our refinancing earlier this year and currently have significant liquidity, with approximately $55 million in short-term investments at the end of our second quarter, and over $200 million in available lines of credit. Our current all-in interest expense on debt is a favorable 5%. If revenue growth does slow, we will experience an increasing cash flow, generated from the reduction of primary working capital.

During the last four months, we have generated over $45 million in total cash flow, of which we used $19.8 million for the stock buyback program we completed on October 30. As you know, we acquired 1.8 million shares at $11 per share, and we believe that will prove to be a very sound financial decision.

In summary, we know we cannot avoid some unfavorable impact from the current economic environment. However, we see this as an opportunity to strengthen our business in a number of ways -- some of which would be more difficult in a stronger economic environment.

During this period, we will cut costs, accelerate both automations in our factories and the shift of production to lower cost sites, and potentially consolidate certain production operations. Most important, we will continue taking care of our customers with a high level of service, product quality, and innovation that they've come to expect from us.

We are continuing, for example, our capacity expansion for thin plate pure lead products, which remain in high demand from our customers. We will also continue to introduce new products to better serve our customers, such as our recently announced EcoSafe product line for wind, solar, and other renewable energy applications. These actions will ensure that we come out of this period a stronger company with lower costs and the best possible customer relations.

In addition, we believe this environment may result in good acquisition opportunities for us, and we intend to accelerate our activities in seeking businesses that will fit well with ours. And we have the liquidity and solid capital structure necessary in today's environment to finance sound acquisitions.

Last fiscal year, our net sales were over $2 billion. And $1.5 million of that was provided from the 13 acquisitions that we've completed since 2002. One of the good things that could come from this economic slowdown is valuation from target companies are likely to come down. Our strong financial position puts us in a very good position to be more acquisitive.

I would now like to turn the call back to Mike Philion for further information on our results and our guidance. Mike?

Well, thank you again, John. Our record second quarter and first six months of fiscal 2009 earnings continue to demonstrate the strengths of our global business and industry-leading position. Our second quarter net sales increased 14% over the prior year to $527 million. On a business segment basis, net sales in the Reserve Power business increased 24% to $246 million, while our Motive Power business increased 7% to $281 million.

The second quarter growth rate includes approximately 10% due to our pricing recovery actions; 5% from foreign currency translation; and a 1% decrease in volume, as the challenging global macroeconomic conditions have impacted our business.

Further, our second quarter, we also achieved sales growth in all three regions, with growth of 25% in Asia; 22% in the Americas; and 7% in Europe.

Net sales for our first six months of fiscal 2009 were solid, and increased 26% over the prior year to over $1.1 billion.

On a business segment basis, net sales in the Reserve Power business increased 32% to $505 million, while our Motive Power business increased 21% to $614 million. The 2009 six-month growth rate includes approximately 14% due to pricing actions; 8% from foreign currency translation; and 4% from base volume.

We believe our base volume growth of 4% 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. 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 5, 2008 for more details concerning these items.

Our second quarter as-adjusted consolidated operating earnings were $45 million or an increase of 40% in comparison to the prior year, with the operating margin increasing 160 basis points to 8.5%. This strong earnings performance was achieved in spite of higher commodity costs of approximately $40 million in the quarter. Clearly, our commodity costs pressure was more than offset by the favorable impact of selling price increases and cost savings.

The single most important factor, combating higher commodity costs in the second quarter, was the continued progress made in our pricing recovery. We estimate that pricing actions increased second quarter revenue by approximately 10% or $47 million when compared to the prior year. Further, our second quarter pricing recovery improved in both business segments and in all three regions.

Our first six months of fiscal 2009 as-adjusted consolidated operating earnings were $88 million or an increase of 44% in comparison to the prior year, with the operating margin increasing 100 basis points to 7.8%. Similar factors affected our six-month results as described for our second quarter.

Our fiscal 2009 results have been significantly affected by the higher cost of lead, which is approximately 35% of our second quarter cost of goods sold. We estimate that our second quarter lead costs have increased approximately $35 million, or over 30%, compared to the second quarter of the prior year. Further, we estimate that our first half lead costs have increased approximately $100 million or 50%. And finally, on a sequential quarterly basis, our lead costs have decreased approximately $35 million or 20% when compared to the first quarter of fiscal 2009.

Now several comments concerning our diluted earnings per share. As adjusted, diluted net earnings per share were a record $0.51 in the second quarter versus $0.35 in the prior year or an increase of 46%. For the first half of fiscal 2009, as-adjusted diluted net earnings per share were a record $0.99 versus $0.65 in the prior year or an increase of 52%.

As mentioned earlier, our improving pricing recovery was the main contributor to our strong earnings growth. While we are pleased with our consistent earnings growth over the last seven quarters, our 25% gross profit target remains our unwavering goal.

Our pricing recovery, commodity costs timing gap has steadily improved, but the unrecovered cumulative price cost pressure since the beginning of fiscal 2005 is approximately $100 million or roughly $1.40 per share of cumulative earnings pressure, which is approximately 150 basis points of cumulative gross profit margin pressure. We remain confident in our ability to significantly improve earnings margins in the future.

Now some brief comments about our financial position in cash flow results. In short, our performance continues to be good with adequate liquidity and a strong capital position as illustrated by the following points.

First, cash flow for the first half of fiscal 2009 was $64 million. Second, $55 million is on hand in short-term US treasury securities as of September 2008. Third, over $200 million is currently available in unused revolving credit lines. Fourth, our leverage ratio was at two times and our debt to total capitalization ratio was at 35% as of the end of September, 2008. And fifth, we expect our cash flow for the second half of fiscal 2009 to exceed $50 million.

Primary working capital decreased $15 million since the beginning of fiscal 2009 to $563 million, principally due to weakening foreign currencies. As a percentage of annualized trailing three-month net sales, our primary working capital ratio at September 28, 2008 was 26.7% compared to 25.3% at September of 2007. This increase in our primary working capital ratio was primarily caused by a modest slowing in inventory turns and customer payments. We expect further reductions in primary working capital for the balance of fiscal 2009.

Our capital expenditures for the first six months of fiscal 2009 were $27 million compared to $17 million in fiscal 2008. We expect capital expenditures will approximate $15 million in fiscal 2009, as we continue to believe in the long-term growth prospects for our business.

Net debt as defined in our credit agreements was $402 million at the end of September, with a leverage ratio of two times. Our average interest rate was 5.2% for the first six months and 5% in the second quarter of fiscal 2009, compared to 6.5% in the (technical difficulty) [two] periods of fiscal 2008.

As John mentioned earlier, we expect to generate diluted net earnings per share of between $0.40 and $0.44 in our third quarter of fiscal 2009, which excludes the expected $0.03 per share charge from our ongoing European restructuring program. Our anticipated third quarter earnings will be driven by three key factors.

First, a sequential quarterly reduction in third quarter revenue. Second, a sequential quarterly decrease in total commodity costs. And third, the ongoing benefits realized from cost reduction activities and improving pricing recovery.

The global economy remains uncertain and extremely volatile. We believe that these unprecedented challenges also present us with extraordinary opportunities to improve our future business. Whether the current economic slowdown is short and shallow or long and deep, we are fully prepared for either and see many unique opportunities that we will aggressively pursue. We are convinced that whenever economic growth resumes, EnerSys will be even stronger and better positioned.

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. Even with the challenges we experience from this economic downturn, our fundamental markets continue to have a solid potential for growth. The long-term global expansion of manufacturing activities and product movement through supply chains will certainly drive an increase in our Motive Power segment. Additionally, our Reserve Power segment will be driven by the world's strong demand for more telecommunications infrastructure along with more intensive and powerful computer capabilities.

These applications all require substantial backup power due to the continued concern about power quality. Newer requirements for solar and wind power applications will grow even faster in the future than our base business. So even though we may face a temporary slowdown, we are highly confident in our long-term potential prospects. This confidence is driving our actions to improve our productivity and continue our expansion -- fast expansion, as we know we're going to need that in the not-too-distant future.

Now with that, I'd like to open the lines up for questions.

(Operator Instructions) Paul Clegg, Jefferies.

Thanks for taking my question. Can you comment on the visibility and the demand for Reserve Power in your sales channel? Motive, obviously, has been weak but typically, your reserve moves in kind of an unrelated manner. Were you still seeing that in the month of October?

In the month of October, since the credit crisis has taken place, we have seen a slow-off. I think it's been a pause, if you will, and it's been a slight pause. And we think it's going to come back very strong.

What we're hearing from customers and what we've heard from a major customer just yesterday in a conference call, they're still projecting their business to be very strong in both telecom and the UPS area. And it's really hard to tell on a few week basis, but if you look at their Reserve Power business in the quarter, the volume was up 5%. And we may see a quarter here that's going to slump a little bit, but I think it's going to, in the next three, four to six months, I think it's going to pop right back to where it was.

Okay. Can you comment at all on the type of volume declines associated with your December quarter forecast?

Well, Paul, as you know, we go out on guidance on earnings per share only. And we come out with a midpoint of $0.42. And that does have included in it, I think, the uncertainty with the economic environment that we're seeing today. We're comfortable with the $0.42. We think that there may be some upside even to that number; but we're going to be conservative and we're going to keep a close eye on things. There's a lot of certain uncertainty, as you well know, taking place I think in the global economy today.

Most definitely. I just -- maybe if you could comment then on just kind of the -- I'm assuming that it involves both sequential declines in volumes for both Motive and Reserve, and I was wondering if you could just talk about them relative to each other, the relative strength of the two in December quarter.

Well, you're right, that both of the segments we're projecting are going to be down as reflected in our $0.42. I really think what we're seeing right now is a wait-and-see attitude by a lot of companies today. And within our $0.42, we have taken it down. We think we have it well-covered, but we anticipate that once the credit crisis gets a little bit further behind us, that we're going to see things pop back very strong.

Okay, thanks, guys.

Chris Agnew, Goldman Sachs.

Just I guess a little bit of a follow-up talking about the slowdown order patterns through October. Can you give us any color on what you were seeing geographically? Any differentiation?

Well, I think the big one actually was Europe more so than in the United States. And I think that Europe kind of went into a little bit of a freeze there. We've seen slow-up in the United States but not the same level that we have in Europe.

And is there any way you can differentiate -- is it end customers that are reigning in spending and they were preferring to sit on cash and almost delaying patterns? Or are dealers and distributors running tighter inventory?

And maybe as a follow-up to that, I think you touched slightly you'd had slightly extended payment -- not payment terms, but getting the money back in. Have you had any problems with suppliers or dealers? Anyone having liquidity issues?

No, not to any great extent. We've been very concerned about it, but we went through risk management and looked at every aspect of our business. That's one that we'd really heightened awareness in our credit department. We've kept a very close eye on it and we're not seeing -- I think the general feeling is that it's like what we did -- you don't know what's going to happen; we took all of our cash and put in US treasuries. We've taken very conservative positions on things. We've held back on certain spending. We're keeping a very close eye on it because it is so volatile -- the markets are so volatile, you just don't know where it's going to go.

So what we're doing, if you will, is we're hunkering down and really holding on this thing as much as we can to see what's going to break out.

Now to your question, do we think it's people holding back? The answer is yes. We think it's a pent-up demand that's there. We think people are being very cautious right now and they're going to watch and see what happens.

So, could that create two things? I mean, obviously global industrial production is slowing down and likely for 12, 18 months, but there could be a sort of short-term bounce as people come back from a little bit of pent-up demand.

What we have found over the years is exactly that. If you take a look at the Motive Power segment as an example, when it's down, it comes back double digits for a two to three-year period.

Batteries are wearing out. There's a shelf life on them, if you will. These batteries are wearing out and there's going to be a pent-up demand that's there. We're ready for it. We're going to be ready for it. This is a good opportunity for us right now. There's a lot of things that we can do during this slow-up as far as rationalizing our production, reducing our costs. And we're going to take advantage of this opportunity. And we'll come out much stronger.

We've been through similar situations, not quite the same as this one, with the telecom bust that took place; with lead going up very high. There's always these bad things that happen, but every time, we have found a way to actually improve our base business and come out stronger. And I see this to be the same thing. I think it's a great opportunity for us.

Great. And one final question. FX moved quite sharply during September. I know it historically has had a very limited impact on the bottom line but more the revenue line. Can you help us think about the next couple of quarters and maybe can you just confirm that you still believe it will have a limited impact on earnings?

Well, you're right, Chris, that it's unprecedented, the strengthening of the dollar and the weakening of all the foreign currencies. The obvious impact on translation everyone can get their arms around, just for reference, in our second quarter, the dollar/euro averaged about 1.5. And obviously we're 1.25, 1.30. So we know the translation effect will be felt.

The long-term, we also are relatively naturally business hedged. So we know over long time periods, these things tend to net out and they don't have an appreciable effect. But clearly, Q2 was a quarter that, at the tail end of it, had some measured influence. Our best guess would be it hurt earnings per share in the range of $0.05. Certainly we are very focused on it and the influences of currency are very appropriately evaluated in our guidance.

So in short, over long time periods, not a particularly big deal. But when there's any sudden huge movement, whether it's up or down, you'll feel a little bit of effect until things stabilize again.

Great. Thank you. Good luck.

John Franzreb, Sidoti & Co.

I was pretty impressed to see that you had pulled the number down of lead pass-through contracts down to 35%. Could you talk to that? And was it more on the Motive or the Reserve side? Just a little color on what you're doing there.

It's really on our Reserve side. And with large Reserve Power customers with contracts that have pass-throughs in place, we have not touched those at all. These are more of pricing that is set at point of sale type things. So it's in the Reserve Power segments.

Okay. And given the numbers you put through for the third quarter guidance, two things. One, sequentially revenues are down, the cost-savings in lead inputs, does that imply that you're looking for sequential improvements in gross margin? Should I infer that from those reference points you gave us before?

That's a fair assumption.

Okay. And Mike, you said that $0.05 impact on currency hurt you. Was that in the quarter or is that forecasted for the December quarter? I didn't quite understand that.

That was, John, in Q2. And we certainly factored in our guidance what I would characterize as relatively unusual movement in currency. So, roughly $0.05 in Q2 pressure. And we fully factored currencies into our Q3 guidance.

Okay. And currency would be a headwinds, right?

Currency will continue to be a translation headwind, you're correct. And we don't think it will quite have the same negative influence on the bottom line, but yes, it will pressure the bottom line in Q3 as well, modestly.

Okay. And Mike, [I got you -- ATD of 14.1] -- I had referenced it in the 10-Q. It looks like it's a $0.02 per share impact. Could you just walk us through what's going on there?

That is the pronouncement that will affect us in fiscal '10, John. And that's dealing with the convertible debt, as you well know. So the accounting profession will in fact require everybody with convertible debt to restate and go to the new standard. It will increase our fiscal '09 interest expense in the ballpark of $5 million. You restate fiscal '08, so there's an apple to an apple comparison.

Okay. And one last question. You did significant stock repurchases lately. How much is left in your authorization? And can you walk us through your appetite for share repurchases, maybe versus what you're seeing as an opportunity to be a consolidator in a weak marketplace to kind of balance those two positions, please?

Well, obviously what we're looking for is the best return for our shareholders. Liquidity today is very, very important, I think to any company. And since we have a very strong balance sheet, which we've covered, we felt that $20 million wasn't a lot of money to buy back. We thought it was a very good investment for our shareholders.

We will continue to evaluate and weigh the balance between the need for liquidity versus where we can invest in money, whether it's in acquisitions or buying stock back. We will assess it at that time and make decisions that we think will be in the best interest of our shareholders.

Okay. Just -- how much do you have cash on the books right now? Did you use cash as your borrowed to buy back the stock?

We have approximately $55 million, cash.

Right now?

Right now.

Okay, great. Thanks a lot, guys.

Corey Tobin, William Blair & Co.

I wanted just a couple of things. But first, let me clarify -- or if you could clarify, I should say, your comments on demand, specifically. Are we to take from your comments that you see an additional slowdown in October post the September period?

And I guess the follow-up question to that would be -- has that changed dramatically to the positive or the negative in the last week or so?

Well, actually, if you take a look at our last analyst call, I brought up that we saw a slowdown take place and we were concerned about it; we didn't know if it was the summer months or holidays in Europe, or exactly what it was.

When you take a look at our orders today compared to what they were back then, our orders are actually higher today than they were back then. But they didn't come out at the same strength that we saw in prior years. So, I don't think that it's anything in the last week or month. It's been fairly consistent. It just did not go up, jump up as high as what we have seen in prior years during this period of time.

And I think a lot of it right now is we are being very cautious, very cautious -- from the standpoint of, as I mentioned earlier, we moved everything -- all of our cash into US treasuries. We've checked with our banks repeatedly that our ability to tap that $200 million and it's solid, it's there. We have just looked at this from a risk management standpoint and we think that we're being very prudent and conservative with our numbers. And we're very confident in the guidance we give.

Okay. Great. Then shifting gears for a second to look at the cost side of things, we're very pleased, obviously, to hear you reiterate your targets for the gross margin improvement. If my notes are correct, a large portion of that gross margin improvement was expected to come through in the next 12 to 18 months. And the question is, is there any change to the timing of that improvement, given the volume slowdown in the last month or so?

I think it's going to be tougher to hit with the volumes that we are currently looking at, but I'm still optimistic that we've got a lot of things that are going very good.

Let's break it down by segment. When you take a look at the volume portion of it, I'm not as confident in it today as I was three months ago. When you look at the pricing of our products versus cost of commodities, I'm still very confident that we will pick that up.

And by the way, each of these three items I'm covering are roughly 200 basis points. So the volume -- the pricing side of it was 200 basis points that we're looking to bring up. The cost-savings initiatives that we have going on, I'm very confident in those; our move to -- from Western Europe facilities into our facility into Bulgaria is well on target. It's moving very well. In fact, the return on investment for that particular project is significantly better than what we thought it would be, even with lower volumes.

So I am very confident in that particular portion of it. In our thin plate pure lead products, I mentioned earlier. We're keeping that $50 million investment on track. We are moving forward with it because the demand for that product continues to be high.

This is a situation today that we're going to see a slow-up we believe because people are afraid today -- to go out and spend money. There's too much uncertainty. But I strongly believe that when this credit market frees up and all of a sudden we see businesses start to get back to normal, you're going to see the telecoms continue to spend and expand. You're going to see the UPS providers because of poor quality in power, they're going to continue to invest.

In the Motive Power market, when it comes back -- and I can't tell you when that is; I don't know -- but when it comes back, my prediction is you will see double digit growth in that particular segment. Whether that's six weeks or six months or a year or two, I don't know the timing on it. But during this period of time, we're very comfortable of where our businesses are.

We will continue to generate positive earnings. We will continue to invest. We will continue to cost reduce our operations. And when we come out in the end, I'm very convinced that we will be a better and stronger company than we are today.

Great. Very good. And last one if I could -- I guess just to that final comment, given there's a lot of volatility on the volume side, but looking at earnings over the next 12 months or so, I guess the question would be -- your confidence level that it will be -- that earnings will be positive, as again, as you look out over the next four quarters.

Yes, I'm fairly confident. Again, the uncertainty -- how bad could things get? If we headed into a world depression, would I feel that way? No, I wouldn't, it could be possible we could see something be very negative here. But I don't believe that we're headed into a global depression, either. I think we're going to see some significant slow-ups in the market globally. I think GDP globally is going to be down. And I think our business is going to be somewhat impacted by it.

But I don't believe our business is going to feel the full brunt of what we're seeing in the credit market or the downturns that the global economy is seeing. We're stronger than -- we're going to perform better, I think, than the general economy, because of the nature of our business.

Very good. Thank you.

Dan Whang, B. Riley.

Just had a question -- I mean this may not be an easy exercise, but I think something we're all trying to get our hands around. But I was wondering if you could perhaps compare and contrast what you're hearing and seeing from your customers and kind of compare that to the '01 downturn.

Obviously, back then, you had the whole telecom build-up and the dot-com build-up. But to the extent that you can, and some of the actions that you're taking and costs and so forth, could you perhaps discuss that?

Sure. I think if you go back and look at the '01 and compare it to today, and let's talk about telecommunications. At that point in time, roughly 30% of our business was in telecom and it's closer to 21%, I believe it is.

What took place in telecom was, frankly, the industry was out of control. They were buying products, putting in warehouses, and storing them. And I don't even think the management, the upper management, even knew it. It was out of control. They were spending money like crazy. At the time, Worldcom, as I recall, was spending something like 51% of their revenue in CapEx. That goes back to December of 2001, I believe it was.

But you've got an industry today that's much more rational. They're monitoring things a lot closer. We're not seeing a major slow-up take place in telcom; it's a little slower but it's rational.

UPS, from the large UPS providers that we've talked to, they're not really seeing a big slow-up take place. They're saying -- they're projecting things are going to -- that they're moving along pretty well with things.

The fork truck side, though, is a different story. In industrial fork truck side, if you look at ITA, which is Industrial Truck Association, if you look at the data on new fork trucks coming out right now, it's down in double digits; it's down 15% roughly globally. And that is where you're going to see some pent-up demand take place with it -- come through with it.

Now, our business in Motive Power is not down to the same level. We have a replacement market there. So new trucks being down, we're not feeling the full 15% down. As I mentioned earlier, our Motive Power segment was down in unit volume by 5% this last quarter, not 15% or 20%, where you see -- like in Europe, it was down closer to 20% today.

So and we didn't see that slowdown take place in Motive Power back in the 2000 timeframe. The big slow-up back in 2000/2001 was clearly the burst of the bubble in the telecom and the dot-coms. So it's a different situation. I think today, though, that it's people are -- they're scared, I think is the best way of putting it. They're fearful of where this thing is going. There's a lot uncertainty. And I think people are just pausing right now on some of the investments.

Okay. Your comment about UPS not really seeing the big slow-up. Is that because of the longer-term project nature of the demand there? Or is there -- what's really driving that?

Peter, I'm kind of surprised that it hasn't slowed up, given that a lot of it is for data center, for banks and stuff. And that portion clearly has slowed up in the UPS area. But there are other projects that are going on right now, that many of the large UPS providers are working on. And our order flow coming in from them is fair. It's decent.

Right. And how about demand for your thin plate pure lead, I mean I know you are moving ahead with the capacity expansion there. I mean how is the relative demand for thin plate pure lead held out versus the non-products?

I think the best way to answer that question is we are still running seven days a week in our Lawrenceburg, Missouri plant today. We're running all out on the capacity.

Great. In terms of the environment out there, obviously this is an industry-wide slowdown that we are seeing. How are some of your competitors behaving in terms of pricing attraction? And in that regard, how should a third quarter develop in terms of the pricing? I guess that you still have some catch-up that we will see on the benefit side?

Yes. You know, I recently was in Europe and we had a sales meeting for approximately 150 -- 200 salespeople. And I gave a speech to the group there and I did the same thing in the Americas. And I said this, we are the world's largest industrial battery company; we're the most profitable. Many of our competitors are losing money. We are the 800 pound gorilla in this segment of the business. And we have been leaders and we need to continue to act as leaders in the pricing arena. And we are highly committed to holding the pricing.

Our salespeople are incentivized on earnings, so pricing is extremely important to them personally. We are going to do everything that we possibly can to hold pricing.

Now that being said, many of our competitors are in a weaker position than we are. We don't know what our competitors are going to do, but I would think it would be in their best interest to try to keep pricing also, that will keep them out of the red, so to speak.

Today we are seeing very little on pricing reduction take place. Our industry has been pretty good at holding. And I think the reason for that is, what I say earlier, that many of our competitors are in a different financial situation than we are in.

Okay. My final question was obviously, you have strong liquidity, expect $50 million in free cash in the second half, and you talked about perhaps different ways you can allocate that -- buybacks, acquisitions. I think historically, you've made some good purchases on the acquisition front, Energy [Fion] and so forth. I mean, are there certain geographies or product segments that you may focus on in terms of acquisitions or --?

Yes. If you notice, in our acquisitions, there were a lot of them that took place, and recently we haven't had many large acquisitions take place. And the big reason for that has been valuations, then price. And we think that -- we've looked at a number of things and we've walked away from them. And the reason for it is because we couldn't negotiate a price that we thought was where we wanted to be. We want to take advantage of the opportunities that are out there.

Today, with this environment, it's my prediction -- maybe it's my hope -- that we're going to see valuations come down. And we're going to have other opportunities. I have always said, it's real simple, our philosophy -- we are a stored energy solutions that make money; whether it's a lithium ion battery or lead asset battery, or nickel cadmium batteries, we're in the stored energy solutions that make money.

Now specifically to your question, there are regions in the world that we're not strong in today -- India being one of them; Eastern Europe -- we've made some improvements there, but I still think we have a ways to go. Africa -- we just started a joint venture in Africa. I think we need to expand further there.

We're going to look for regions of the world where we think that we can invest money in giving good return to our shareholders. And we think right now is the time to really keep our eyes open with it because valuations are going to come down.

I guess in that regard, back in early '02, probably made one of the most pivotal moves that with ESG, so I guess we'll have to see what this market provides.

Yes. And just to take it and talk about that particular one for a second, it was a situation at that time that the credit markets dried up. And we -- there was really -- there was no credit available. Fortunately, we had a financial sponsor that had the ability to write a very, very large equity check. We did not finance that deal with banks. Now we did a recap I think about 18 months later, so that our equity-holder could pull out. The point is we took advantage of the opportunity that presented itself at the time, and we had the ability to do that.

I see today to be the same situation. That we have the capital to do it, we have the resources to do it, and we have the people on the ground in different regions of the world that know how to do acquisitions and acquire properties and put them into -- integrate them into EnerSys. So I think it's an exciting time from the M&A standpoint for us.

Great. Thank you very much. That was very helpful.

Dana Walker, Kalmar Investments.

Could you talk about where you stand with your European restructuring?

Sure. The big restructuring project that we had this year is the move from manufacturing operations in Western Europe to our Bulgaria operations. And as I mentioned earlier, our return on investment in that particular project has come out significantly better than we anticipated.

And part of the reason for that is that we had a plant in Manchester, the UK, and we exited that facility, that was part of the plant. But what we didn't contemplate, or didn't think would happen or didn't know what happened, was we could actually sell that building. And I think it was something like $8 million that we sold that property for. So that did help quite a bit.

Our Bulgarian operation -- it was a struggle to get it running. It was a bigger challenge than we thought. But it is working along very well right now. Quality coming out of that plant is excellent. The productivity has improved; it's still not exactly where we want it to be, but it's improved considerably. And we still have additional moves in product lines that we will be moving further into Bulgaria, the lower cost operations. So it is on track with it.

Mike, do you want to pick up on it too?

Yes. Just to add to John, as you recall, this was a two-year program where our spending was going to be roughly $18 million -- $15 million last year and a little over $3 million this year. And that's all on schedule, as John said. But the savings are downstream. The majority of the savings -- sure, we've felt some them, but the big savings are coming. So, on schedule, very excited about it but that's the key point I wanted to amplify.

Yes, Mike brings up an excellent point there. From an operating end, we are getting things in line with it. But really when you look at this next fiscal year, that is when we are really going to see the kick-in take place with this.

We should therefore be focused on next summer for the more visible savings to start to stream?

Start, yes, to start. I think if you look from next summer to beyond, you're going to have two major events that is going to kick in place. We are going to see the start of the capacity expansion on thin plate pure lead. We are going to see Bulgaria kick in and I can't go into any details, but we have a couple of other major projects that will be coming up here that we think is going to have further savings opportunities for us.

In Europe, as an example, eight, ten years ago, we were one of the high cost producers in motive power batteries. Today we believe we are the low cost producer. And the reason for that is we bought a plant in Bielsko-Biala, Poland that came with the Hawker Group. And that was really a very -- it was almost a start-up, if you will. It was a very small company. Today, that's our largest Motive Power plant. And we've made substantial investments in that operation. And it's really put us in a low cost position.

Now we didn't do that with the Reserve Power business; we focused on the Motive Power business back then. Today, the focus is more on the Reserve Power business to take the cost down even further.

I think you've described where there is about $100 million of revenue production opportunity in Bulgaria as you sketched it out -- is that an accurate recollection? And where would you be in filling that location now?

I don't recall the number of $100 million, exactly. It's in the ballpark. But today we are running roughly $45 million under that operation. And when we bought it, I think it was $19 million. And you're right, as I recall, it was $90 million to $100 [million] -- that is a correct number. So we're probably about halfway there.

How about a discussion about Asia? I believe a year or so ago, you were -- maybe it was earlier this calendar year, you were less than keen on how your profit margins in Asia, which seems to have picked up nicely.

They have. They picked up very nicely. We've made some changes over there. And we are pleased with the results. I think there's a lot more opportunity. I'm going to be over there next week. They're excited about meeting with the management team over -- actually in Singapore. I think that the group has done a great job over there and they're moving it forward.

They have some other projects that are going on, further cost reduction activities that we're looking at. I won't get too technical, but there is a two-volt cell that we have, that the demand for that particular product is very high right now. And we are going to have to add some added capacity in China at one of our factories to meet the demand for that product. Good margins, selling to telcoms.

Final thought from me -- Mike, you mentioned how currency you thought would be minor and we've had a discussion about that in the past. If the effect was $0.05 in the quarter just reported, and the euro/dollar relationship went much more in favor of the dollar, at least to date in this quarter, as will likely percolate through your numbers -- why wouldn't the effect be larger than that $0.05 in the December quarter, everything else being equal?

It's certainly a good question. It was essentially the dollar strength and even though the average is a little misleading, it really strengthened meaningfully in September. And so it's more of a spot rate influence than it is an average when you sort of work through the mechanics.

So I mean, believe me, we're not currency prognosticators, but we believe that the majority of that unusual dislocation happened at September. And as I referenced, we think it was about $0.05 give or take. And assuming that the dollar stays relative to the euro, but all the relationships are about the same. In a 1.25 to 1.30, we don't expect to see another major influence. So in short, that's why. Most of it was felt in September. There will be a little noise in Q3, but it is of a lesser degree.

One last thought about the price pass-through proportionate change that you've talked about. How will that affect you presently? And what are the implications for that over a longer period of time?

Well, I think what's going to happen with it, it's going to allow us to -- with lead coming down -- obviously, if you have the automatic pass-throughs in place, with lead coming down, your pricings going to come down. But on this portion of the business I referred to earlier, that we've taken the automatic pass-through away, that what we're going to attempt to do is we're going to attempt to hold the price up as commodity costs come down, which should improve margins.

So this would not be a -- it sounds like an obtuse question, but this isn't after the horse has left the barn? The price cost spread continues to be attractive and you're going to try to defend its attractiveness?

That's correct. And stated a different way, with an automatic pass-through in place, the price is going to come down. With that automatic pass-through eliminated, we're going to do everything we can to try to hold the price as the commodity comes down, thus increasing our margins. But a lot of that depends on what our competitors do.

As I stated earlier, competitors are being rational today, they're holding. And if they continue to hold and commodities go down, we think it's going to improve our margins. That's what the game plan is.

Are some of the initiatives that your customers are undertaking that would involve a thin plate pure lead product, are they waiting for that product before they go forward? Or are they using something else presently?

They're using something else.

You would expect to have incremental volumes of TTPL in what timeframe?

Well, the project is next summer that we'll get -- start to see -- early next summer we'll start to see the capacity kick in. And hopefully, if the demand for the product stays where it is, we will see the revenue of thin plate pure lead pick up.

Weren't there -- once again, this is a recollection thing, but wasn't there a couple of waves of this project where you were expecting to see some incremental volume late this fall?

You're correct. There was a little bit that we picked up on it and we've used that capacity. And you are correct in that.

Very well. Thank you. Keep up the good work.

Arthur Friedman, Friedman Asset Management.

I wanted -- the first question I wanted to ask is -- do you feel you've -- in terms of your foreign income, revenue income, do you feel you've limited the exposure of your net income and currency fluctuations? This is for income outside the US?

Well, I think, Arthur, that the simple answer is yes, because absent extreme movements of currency, which happened in Q2, we are fundamentally naturally business hedged. So in short, we think of the model as very effective. As I mentioned earlier, over any longer time period, these ups and downs have a tendency to net out.

So when you have extraordinarily volatile currencies and heck, we aren't smart enough to predict where currencies are going to be in 12 months. So you could still have some waves of pluses or minuses if you see extreme movements in very short time periods.

Right. Okay. And the same question I have -- I'm just trying to get some color going forward. For the two areas, Reserve Power and Motive Power, would you say over the next six months what percentage of your existing contracts will continue for each category in the next six months? In other words, your business that you have today will -- what percentage would be -- do you have, like, booked through the next six months?

Well, the way the contracts work, it's a general contract that lays out the conditions and terms. And I don't think we're going to see anything that is going to expire at all. But the fact is that under most of those contracts, the OEM is not required to buy any minimum volume; it's not a take or pay type contract.

So, I don't see any fundamental changes taking place. The only exception to that I think there's a couple of contracts with new customers we're working on right now, and hopefully we'll pick them up. So, if anything, I think that we'll probably see some increase -- hopefully see some increasing contracts. But I don't think it's really -- going to see any fundamental change here.

Right. That's actually not -- what I was trying to get at -- it seems the strength of your business, the way I'm looking at it, is quite strong. And even though there's a slowdown, it's more of a hiccup as opposed to a trend, is what I'm getting at.

I can't predict that, but I happen to believe that. And I want to be careful not to say I happen -- and I'll go back again -- I don't believe that the world is going to all of a sudden walk away from telecommunications and cell phones. I happened to believe we're going to continue to see expansion there.

I also happen to believe that the need for power quality and UPS systems is not going to go away. It's a hiccup. It's a slow up. I happen to believe that manufacturing and distribution in the world is going to continue. And there is a pent-up demand taking place.

I agree with your point. I think it's more of a hiccup. There is not another technology that is going to displace us here. And I think that you that we're in a cycle. And it's not a surprise. I said -- a year ago, I was asked a question -- it's not will we see a slowdown, it's when will we see a slowdown.

And I'll say the same thing right now. We will see a pickup. I just don't know when.

All right. That's great. The last question I have is -- I was on a bit late on the call, so I might have missed this -- where do you see the lead costs? Because that's a key factor. Where do you see this going, let's say, the next three months? About the same or a little lower or higher?

You know, it's hard to project and it's hard to predict, but let me just give you the fundamentals on it. There is not a supply shortage of lead in the world. We have 23 plants across the globe. I've never once in 15 years in this business ever seen a shortage of lead.

So what drove lead from $0.20 to a high a year ago right now at a $1.80? It was speculation. It was investors. And the same thing happened with copper. Same thing happened with oil. And you saw investors into it.

Now where are investors going to go? I think is really the -- the real answer there, there's a real question here. I don't know the answer to that question. Now where do I think the fair market price of lead is on a fair return? In the $0.50 to $0.60 range. Today, it's in the $0.60 range. Say that $0.60 to $0.70 range.

I'm hoping it stays there but we can't predict it. But we have had the ability, as lead goes up, to pass that price along. We have demonstrated that. And today our recovery on lead is over 100%. Meaning that if lead prices go up in the quarter, we are recovering it.

Mike, you want to add to it?

Yes. As I commented, Arthur, you might not have been on -- clearly, we see Q3 lead costs going down. As John indicated, that if market stay, let's call it -- and I'll give you a broad bandwidth here -- $0.60 to $0.80. As you may recall and I know Lenny, we forward by -- we have a certain amount of lead in inventory. So I'm just going to use the hypothetical lead is around $0.70 today. If it would maintain at that level for, let's say, three-plus months, we'd finally start to feel that in approximately three to six months.

So in short, absent lead exploding higher -- and it may; don't expect it, but it may -- we would continue to see, for several quarters, meaningful sequential reductions in lead costs.

Okay, yes. That's what I was looking for. And the last question I have is, is there any news in terms of the batteries in the wind area -- wind business?

Well, as you are aware, probably aware, that we introduced a new product line, the EcoSafe product lines here about a month or so ago. We are working with a couple of very large OEMs in the wind portion of the business. And it's looking pretty good as far as picking up some contracts. We're not quite there yet.

But this last year in renewable energy, wind and solar, we did approximately $30 million in business. And if that industry takes off, we're ready for it. We have the product lines and the service and everything in place.

Right. Great. Thank you very much.

Todd Cooper, Stephens, Inc.

In the part of your business where you do have lead price surcharge mechanisms, what's the average lag that you see as it works through your financials when lead prices are dropping?

We'd say it's generally a quarter. I mean, you have a few outliers, but keeping it sort of simple, it's generally about one quarter mechanism, Todd.

And those mechanisms are primarily in your Reserve segment?

If you look at it globally, it's a little bit more in Reserve than Motive, that is correct.

Okay.

In Motive Power in Europe, though, it is a much bigger portion.

I'm just -- speaking globally. Yes, you're absolutely right, John. When you look at the regions, just to finish John's thought, Europe and Asia have a marginally higher percentage and Americas has the lowest. When, again, when you look at the total region.

Okay. And then what percentage of revenue in the Reserve segment do you consider to be replacement sales that really can't be delayed?

You know, it's tough for us to really tell -- that's how we go to market with it. If we sell a battery to an OEM, as an example, that has -- and most all of them have -- a service group, they're buying the battery. And whether they're putting in a new application or a replacement application, it's hard for us to tell. Historically, what we believed it to be is about 50/50.

Okay, and one last, if I may. Was there anything unusual in first quarter operating expenses that caused them to jump like they did?

First quarter operating expenses -- well, now, that's where, Todd, you have to parse through some of the highlighted items. And I'll come back to you; I've just got to get my notes. I don't have them handy, but --

Well, I guess my main question or the gist of that question is, as you talk about pulling in your horns during this downturn, is that primarily where we will see a reduction on the line item in the income statement?

No, you're biggest cost reduction as always going to be in cost of sales. I mean, certainly we're focused on all the line items, but there's no question -- the vast majority of the cost-savings activities are always going to be up there.

When you look at our SG&A expenses, the biggest portion of that is the selling expenses. And one of the things that we're not going to do is make major reductions in taking care of our customers. We're going to keep the high quality and high standards of service that we've had. That's why we're not the low price provider in the industry. We are higher price. And we get a higher price -- but we think we're best value. We're the best value because of our service and taking care of the customers. And that's an area that we're going to continue to stay highly focused on.

Okay. That's all for me. Thank you.

Richard Baxter, Ardour Capital.

I guess, can you talk a little bit about your replacement versus new build-out sales? Just -- not counting any of the new technology replacement sales, such as maybe your thin plate pure lead for one of your existing products, but the replacement versus new infrastructure sales that you have for your customers in both the Motive and Reserve Power segments.

Yes, I mentioned earlier -- we believe, it's hard for us to tell exactly, because of how we go to market and whether it's Motive Power or Reserve Power, it's the same thing on it. Our best estimate is about 50/50.

Oh, for both?

That number does change, however. When you see a downturn like this, if -- like new truck sales, as an example, being down, I mentioned earlier, 15%. And we're not down near that. The percentage of batteries going into replacement market today is greater on a percentage basis than it was, let's say, a year ago.

All right. Great. Well, thank you very much.

John Franzreb, Sidoti Capital.

Yes, John, you had talked about I'd say your relative enthusiasm for the Reserve Power business. Does that change on a geographic basis? Are some geographies in better reserve than others? Can you talk to us about that?

Yes, right now, the Asia market is strong for us; the Americas have been very strong for us. And I think -- in the Americas, frankly, our sales team has just done an outstanding job of driving that business.

In Europe, it's done a great job also, but I think if you had to pick the one that's really performed, that's had the biggest impact this last year -- or last few months, has been the Reserve Power business in the Americas. And that's picking up new customers. And again, it's back to the things I've referred to about being best value and then really taking care of the customers.

And is that at expense of competitors or is it just new development going on out there? Can you just fill in that blank?

It's a little of both.

Really, okay. And you've always been very prudent about expanding capacity. You know, you've always kind of run extra shifts and didn't want to put much brick and mortar in place. Any thoughts now that -- I know you're expanding the thin plate products, but that -- maybe what your position is as far as capacity right now versus what your expectations are for the sell-through in the year ahead?

I'm not sure I understand your question.

Well, I'm just wondering what, you know, what you think -- as far as realignment of capacity based on current environments, where do you stand right now?

Yes, I think that there's two things. When you take a look at the product line like the thin plate pure lead, obviously we're expanding in that area. We are going to expand, as I mentioned earlier, in China in our two volt cells. Demand is there because we don't have the capacity.

The other side of the fence, where we are seeing slow-ups taking place, we're looking how we can consolidate operations and actually take some capacity out. And by taking that capacity out, what we're really looking at -- if you have, let's say, one area that's a very, very high cost, another area that's a low cost, can you combine those together, increase volume and even automate them further to get your cost structure even lower? And those are some areas that are under review right now.

Excellent, excellent. Thanks a lot. Keep up the good work.

And we have no further questions at this time. I would now like to turn the call back over to Mr. John Craig. Please proceed.

Okay. Well, thank you very much, Marcia. And everyone, thank you very much for joining us today and have a great day. Thanks again.

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