EnerSys (ENS) 2012 Q1 法說會逐字稿

Good day, ladies and gentlemen and welcome to the first-quarter 2012 EnerSys earnings conference call. My name is Alicia and I'll be your operator for today. At this time, all participants are in listen-only mode. Later, we will conduct a question-and-answer session.

(Operator Instructions)

This conference call is being recorded for replay purposes. I would now like to turn the conference over to your host for today, Mr. John Craig, Chairman, President, and CEO. Please proceed, sir.

Thank you, Alicia. Good morning and thank you for joining us for our conference call. During this call, we'll be discussing results of our first quarter for fiscal 2012 and will comment on the general state of our business. Joining me on the call is Mike Schmidtlein, our Chief Financial Officer and before we get started, I'll ask Mike 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. Our forward-looking statements are based on Management's current views regarding future events and operating performance and are applicable only as of the dates of such statements.

For a list of factors which could affect our future results, including our earnings estimates, see forward-looking statements included in Item 2, Management's Discussion and Analysis of Financial Condition and Results of Operations set forth in our quarterly report on Form 10-Q for the quarter ended July 3, 2011, which was filed with the US Securities and Exchange Commission.

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 information, please see our Company's Form 8-K, which includes our press release dated August 10, 2011, which is located on our web site at www.enersys.com.

I'm pleased we were able to report last evening another record in quarterly earnings. Once again, the earnings this quarter were a record for any first quarter in the Company's history. Our sales for the first quarter were $569 million and adjusted diluted earnings per share were $0.68.

Quarterly sales were up 31% year-over-year and 4% sequentially. The earnings matched the $0.68 mid-point guidance we gave during our last conference call.

Our adjusted operating earnings in operating earnings percentage for the quarter were $49.8 million at 8.8%. Year-over-year, all 3 geographic areas showed improved quarterly operating earnings, up over 30% from the first year or from first quarter of last year.

On a sequential basis, our operating percentages declined to 8.8% from 10.3%. As we discussed in our last conference call, we experienced a sequential increase in commodity cost, net of pricing, up $10 million or equivalent to $0.14 per share. We were able to partially offset these increased expenses with cost savings and increased manufacturing and efficiencies.

In a few minutes, Mike will provide further details explaining our performance by geographic region.

On the acquisition front, we made good progress on several opportunities and I'm confident we will close on a couple of these acquisitions in the next several months.

Last evening, we released our Company's estimated market share for calendar 2010 for the markets in which we participate. In calendar 2010, we increased our global market share from 25% to 27%, and again, this is only in the regions that we participate in. We experienced a 5% market share gain in the Americas to 37%, driven by gains in both reserve power and motive power; a 2% market share gain in Asia to 10%, and we remained flat in Europe at 32%.

We continue to maintain record backlog and the economic activity in our markets has been good. Motive power organic sales were up 18% year-over-year and up 1% sequentially.

The worldwide industrial fork truck for June was up 27% over June of last year and up over 9% versus the trailing 3-month average. This strong current order activity should bode well for the next several months, orders for electric fork truck batteries. Reserve power organic sales were up 14% year-over-year but lower sequentially by 3% due to a decline in Europe.

In the second fiscal quarter, we will be facing pressures from start-up of our new Chongqing China facility, the residual effects from the recent strike at one of our European manufacturing facilities, and slightly higher sequential commodity cost. In addition, the estimated level of future global economic growth is uncertain given the ongoing market events in the US and in Europe.

We have conservatively assumed that pricing will be challenging and volume will be flat or slightly lower in our second fiscal quarter. Therefore, as stated last evening, we expect adjusted diluted earnings per share to be in the range of $0.53 to $0.57 for the second quarter. It should be noted, if we hit even the low point of our earnings guidance for the second quarter, it would still be a record first half earnings performance for the Company.

Obviously, I am not pleased with our second-quarter guidance being lower than our first-quarter results. However, I am optimistic about the future of the Company. We have backlog at an all-time high, a strong motive power business, recently announced global market share gains, particularly in the reserve power area and a strong capital structure which will enable us to take advantage of acquisition opportunities and expand our advanced chemistries into new, higher-margin markets.

Now I'll ask Mike Schmidtlein to provide further information on the results and our guidance.

Our first-quarter net sales increased 31% over the prior year to $569 million, primarily from solid organic growth at 16%. Stronger foreign currencies and higher selling prices increased revenue 10% and 3% respectively while the impact of acquisitions added 2%.

On a regional basis, Europe's first quarter net sales increased 34% to $253 million compared to the prior year. Our sales in the Americas increased 26% to $259 million, while our Asian business increased 40% in the first quarter to $57 million.

On a product line basis, net sales for reserve power increased 28% to $266 million, while motive power continued in its solid recovery phase with an increase of 33% to $303 million. On a sequential quarterly basis, first-quarter net sales increased 4% over the fourth quarter with 2% from stronger foreign currencies and 1% each from pricing and acquisitions.

There were significant differences in the first-quarter sequential growth among our regions and our 2 product lines. Our Asia and Americas business grew by 27% and 6% respectively while Europe was down 2%. On a product line basis, our motive power business was up sequentially 6% as we continued to benefit from a worldwide economic recovery. Sales in our reserve power product line increased 1% sequentially.

Now a few comments about our adjusted consolidated operating 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 highlighted items. Please refer to our Company's Form 8-K, which our includes our press release dated August 10, 2011 for details concerning these highlighted items.

Our first-quarter adjusted consolidated operating earnings were $50 million or an increase of 30% in comparison with the prior year, with operating margin flat at 8.8%. Higher commodity cost stifled year-over-year first-quarter margins. Cost savings and incremental pricing essentially offset the higher commodity costs we experienced in the first quarter compared to the prior year.

Excluded from our adjusted operating earnings was approximately $0.4 million of restructuring costs from our European segment and $0.7 million of due diligence costs. On a sequential quarterly basis, adjusted consolidated operating earnings decreased $6 million, with the operating margin down 150 basis points from the net $10 million commodity cost versus pricing deficiency John referenced.

Our American business segment achieved an operating earnings percentage of 12.4% versus 12.6% in the first quarter of last year and 13.9% in the previous quarter. In addition to the impact of rising sequential commodity cost, our Americas business segment experienced a decline in their higher-margin aerospace and defense sales from a record fourth quarter.

Europe's operating earnings percentage of 5.6% was higher than last year's first quarter of 5.3%, but lower than the previous quarter's 8.2%. Results were negatively impacted by lower sequential organic volume, higher commodity costs, and a 3-week strike at one of our European manufacturing facilities in June. The impact of the strike is estimated to be $3 million over the first half of fiscal 2012, with the majority felt in Q2.

The reported operating earnings percentage in our Asia business segment increased in the first quarter of this year to 5.9% from 5.7% in the first quarter of last year and 2.6% in the prior quarter. Sales in the quarter were up sharply to $57 million, which is a record for the Asian region.

If you exclude the business development costs for our new Chongqing facility and the India expansion opportunities, the operating earnings percentage in the Asia region would have been approximately 8.2%. Our new Central China facility in Chongqing is scheduled for start-up at the beginning of October.

Our adjusted effective income tax rate of 24.2% for the first quarter benefited from certain discrete items that provided an additional benefit of approximately 200 basis points. We believe our tax rate for the remainder of fiscal 2012 will be modestly higher than that of the first quarter.

Our improved operating earnings led directly to the increase in our adjusted diluted net and earnings per share, which were $0.68 in the first quarter, an increase of 42% from the $0.48 from the prior year. The main drivers to the increase in the EPS, similar to our operating earnings, were the higher volume and cost reduction initiatives partially offset by higher commodity costs net of pricing.

The first-quarter results also reflect the tax benefit of a lower tax rate resulting from a change in mix of earnings among our various legal entities of multiple jurisdictions.

Now some brief comments about our financial position and cash flow results. Our balance sheet remains very strong, with substantial liquidity, secure and favorable debt facilities, and a strong capital position. We refinanced our credit facility on March 29, 2011 and have $100 million drawn on our $350 million revolver. We have $117 million on hand in cash and short-term investments as of July 3, 2011, with over $350 million undrawn from our credit lines around the world.

Our leverage ratio, which must be maintained below 3.25 times as calculated in our US credit agreement was 0.9 times and our net debt to total capitalization ratio was 17% as of July 3, 2011. Our plans for acquisitions, investments and added capacity and premium products can all be met with our existing cash and credit facilities. As we execute these plans, we will assess our capital structure for strength and efficiency.

Capital expenditures were $12 million in the first quarter of fiscal 2012, compared to $11 million in the first quarter of fiscal 2011. Our capital spending focused on our new facility in Chongqing, China.

We remain very active in pursuing potential acquisitions around the world and are currently in advanced negotiations with multiple companies. As noted earlier, our strong capital position and significant liquidity gives us confidence in our ability to finance the transactions we are pursuing. We expect to generate adjusted diluted net earnings per share of between $0.53 and $0.57 in our second quarter fiscal 2012, which excludes expected charges of $0.04 from our restructuring programs and acquisition activities.

Our anticipated second-quarter earnings will decline due to a modest increase in commodity costs and operating earnings. In addition, the second quarter will be negatively impacted by the residual effects of the 3-week strike in June in one of our European manufacturing plants, as well as the start-up expenses in our new Chongqing facility.

We also anticipate greater pressure in our pricing recovery and potentially lower organic volumes. We are confident we will recover from this dip in earnings. We look forward to additional opportunities we will have through acquisitions, and we believe market volatility is beneficial to our Company in the longer term due to the strength of our balance sheet.

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

(Operator Instructions) Questions will be taken in the order received. (Operator Instructions)Your first question comes from the line of John Franzreb from Sidoti and Company. Please proceed.

Good morning, John and Mike.

Hello, John, how are you doing?

You listed four items that will hurt profits in the coming quarter relative to the first quarter but you only quantified one, that was the strike impact. I was wondering if you could kind of just walk us through what the other numbers are behind the impact in the sequential drop in profitability?

Well, John, some of the other items that are out there obviously Poland, which we talked about, the $2 million impact, most of which will be in Q2. Another one that wasn't specifically mentioned at the end when we talked about guidance, but we did talk about it earlier was the impact of, call it our tax rate, going back up from the first quarter up to about 200 basis points. So we would anticipate our tax rate for the balance of this year being somewhere in the 26% to 27% effective tax rate. That's another item. That's probably $0.02 of pressure. The Chongqing facility, as you know, we're starting this plant up at the very end of the second quarter. We have employees being trained right now that are going through prototype runs and pilot runs so the spending is ramping up in this quarter on that facility. So that's, you know, another $0.01. So that gets you, if you were looking sequentially at our first quarter results versus guidance, that probably gets you about half the way there. The remainder of that balance, the two items that we talked about in terms of potentially flat or lower organic sales volume and price recovery pressure, we didn't quantify. That metric, we kind of have taken on a collective basis and said that we think that, that is probably $0.03 to $0.05 of additional pressure that we will be facing in the quarter.

Okay. And I guess sticking to this theme, Mike, I would assume that some of these items would be gone by the time we reach the December quarter. Is that fair or should we look for spillage in say the start-up costs or something of that nature?

John, most of these items we think were going to be gone in second quarter. Second quarter, historically, is our lowest quarter also on volume. So it usually is our worst quarter during the year. And that's mainly because of summer shutdowns that take place. But there are a number of things that are one-time events that are taking place, we believe in this quarter, but we also have factored in a number because of the current economic environment and the pessimism that exist out there. Whether it actually turns as bad as some are predicting, we don't know but I think the best way to describing it is we're going to prepare for the worst and hope for the best on this. We went through a recession a couple years ago. As you know, we took a very similar approach and we weathered through it quite well. And we anticipate doing the same thing this particular, if there is a downturn, during this particular period of time.

Well, John, on that topic over the past few years you've been taking numerous restructuring charges. Assuming that you've kind of reset the profitability profile of the Company, would it be fair to assume that you would have a lower low if we did go into a similar recession? Can you kind of quantify where you probably stand on a relative basis today versus two or three years ago?

You say a lower low, I want to be sure I understand your question.

Assuming we had another downturn, another recession.

Yes.

I would assume the profit profile wouldn't diminish to the same extent as we did last time just based on the restructuring charges that you've done since then. Is that a fair assessment?

Yes, John, I think it's a fair assessment. We've spent over $40 million in the last five years in cash on restructuring and we believe it's provided incrementally about a $40 million benefit to us year-over-year. Now, the savings that have occurred since the last recession, you know that may be another $0.20 to $0.25. So as you recall, our low point was, what $0.23 in the first quarter of two years ago?

Right.

I think, post-recession? So, yes, I would not expect to us go nearly to the lows that you saw in early 2009.

Yes, I would totally agree with that. I think the thing to take a look at in the $40 million that was spent, and a lot of that was spent in closing some factories down. In those cases, that overhead's gone completely. We've moved production from a high-cost factory to a low-cost factory. Now given the situation we are in today, let's take one product type that we manufacture in three different facilities. One's in Germany, one's in France and one's in Poland. The low-cost plant is in Poland. If all of a sudden we saw a major downturn, we would keep the Polish plant more likely, we'd keep that loaded. And we would take the production down in the higher cost factories.

But there's still fixed costs associated with it that would be there. But when you go back and compare prior to having the other plants that I mentioned earlier that we have shut down, if we had those in place, our numbers would be significantly worse than they will be because we have those plants down now. Mike, you want to add to it?

Yes, one follow-up on that, John, is that the one thing that did occur in the recession that occurred, you know in the fall of 2008 and early 2009 was our commodity costs, more specifically, lead dropped fairly precipitously during that time frame and by the low point of our revenue lines, we had average lead costs in the low to mid-$0.50 per pound range. So, that's the one caveat I would give you is yes, I do believe we will benefit from $0.20 to $0.30 from the restructuring charges annualized, but the bigger question is whether commodities take a similar dip if there was a dip in, let's say, our top line revenue because of demand declines.

And one last question. I'll get back into queue. You'll soon have a balance sheet that would allow you to be more aggressive in re-purchasing stock. Could you talk a little bit about your appetite to do so relative to M&A? I would think you'd get a better return out of any of that stock than you would on an acquisition?

Well it's not that we've considered, in fact that we've had a lot of conversations about that in recent weeks here. As you know, we're a growth Company and we're going to continue to invest and buy companies that grow the business. And we think, in the long term that's the right move. Right now, until the markets shake out and we understand really where the economies are going globally, I think it behooves us to sit on that cash, to hold it, in case there is a really, really bad recession that takes place. We would weather through it very well because of our strong balance sheet. So today, at this writing, I think we wait for a while and see what happens here. Now, as we mentioned earlier, we have a number of things going on right now on the acquisition front. And as we start spending money buying those companies, I want to be sure that even under the most draconian situation, you know, spending the money, buying new companies and a major downturn, that we still will be in a good situation balance sheet-wise.

Thanks a lot for the color, John.

Thanks.

Your next question comes from the line of Steve Sanders from EnerSys. Please proceed.

Hello, good morning guys, Steve Sanders from Stephens.

Yes, Steve.

I was going to say, I didn't think you were employed by EnerSys there, Steve. But--

Maybe just a follow-up, John, on your use of cash as it relates to M&A. Are you also going to be a little bit more patient there and see if valuations come down or revisit some of those in light of what's going on?

Well, you know, I think we said last quarter that we were anticipating closing on some pretty soon. We are very patient. And one thing that we are not going to do is be overpaying. And as the economic conditions deteriorate, we're going to do whatever we can on pricing to get the best value for our shareholders. So some of these processes, they take a long, long time to go through. You think you get close to it and then something else comes up. But we're very patient, and I think that's in part why in buying 30 companies over the years, we've been very successful in integrating those and creating value.

You know, Steve, yesterday, I was busy on a particular deal and we're looking more at introducing contingent earn-out schemes so that if those companies do not have the ability or don't meet the projections that we were basing it on, that we'd have the ability to change the valuation accordingly.

Okay, okay good. Thanks for that. And then as it relates to Asia, I think you indicated that most of the one-timers will be out by the December quarter, but a couple other questions there. Very strong sales growth. Was there anything unusual in this quarter or are we close to establishing a higher run rate in Asia?

Well, our goal is to establish a much higher run rate in Asia. I mean, there's no question about that. We're growing that business and we're going to continue to grow it. That's why we're investing in a new factory. That's why in the short run, we're taking these fairly substantial hits in our earnings because we're investing in that factory. You know, I said in the past, I hate building new factories because there comes a prolonged period of time where your earnings are impacted because of start-up costs associated with them. We would have bought companies in China but we weren't going to pay multiples on EBITDA of 10, 12, 14, 15. So we decided to build a factory but the downside to that is the things I just referred to on earnings.

You take our motive power business in Europe or in Asia, I mean. You look at that business and we've got a run rate today that's about $70 million is what we're looking at. If you go back to 2004, that was the first year we started that business. It was $4 million the first year. So we're going to continue to look at growing the motive power business. When you look at reserve power business, again, we're putting in the new factory, getting lower cost products going through that operation. So I expect that we're going to see growth in the future, and that's not going to be every quarter of course, there's going to be quarters where it's going to be up, it's going to be down. But ultimately, the longer term direction is to take that business up considerably. We're not the largest player. We're only 10% in the Asia market. And we need to be more in the 20% to 30% region market share wise in that market and we're going to make the investments to grow it. Now, in the last quarter, our earnings were much better than they've been in the prior quarter and the main reason for that was mix coming through. We had a strong mix of product that went through to select customer or certain customers that really benefited us.

Okay. Okay. Thanks for that. And then two more. May first, Mike, just generally how do you feel about inventory levels and are you planning now to take any production days out in the quarter? And then second, maybe for you, John, it sounds like the motive business, in terms of the order book, is still strong. I understand you had a tough sequential comp in A&D but it sounds like maybe reserve is a little softer in recent orders than maybe you expected. So, you could just expand on that a little bit?

Go ahead, Mike.

Well, Steve, with regard to the inventory, currently we feel like the inventory's positioned properly. As you know, this time of year particularly in Europe, most of our factories are down as they're going on their summer holidays. But we'll take this opportunity to see what order patterns develop in the next two to three weeks to conclude on what measures we're going to need to take to address inventory. Based on where we are with our order book, currently at record levels, we feel pretty good about it but we're going to see what order intake looks like in the next three to six weeks.

Yes and that's a critical part. If we do see a downturn, we need to be reacting very quickly and taking the production down. I will say that we had some production plans that we were going to take things up, and those have been delayed until we look at the next few weeks here to see what the order pattern is.

Okay. And then the order patterns in reserve, just recently, what are you seeing?

They're down. They're not as strong as they were. And the reserve power business, as you know, is a very -- you could get large orders one month, the next orders, they're slow. They are project related. So what we're hearing from customers right now, and this is prior to last Friday, that things were moving along still pretty good. We have been approved by another source or customer just recently, which we anticipate in the future will pick up additional business with this particular customer. So right now if you look at the numbers, it says it's down modestly, and we hope it stays there or picks up. But again, we've got to wait and see what happens with the current economic environment.

Okay. Thanks very much.

All right. Thanks, Steve.

Operator. Your next question comes from the line of Jesse Patel from Jefferies.

Hello, John and Mike, this is Elaine for Jesse.

Hello, Elaine.

Hello. I'm sorry if you covered this earlier, but with the items that were impacting Q2, including the residual strike effects, the commodity and the start-up costs, what's the relative magnitude of each factor? Is it something that's sort of evenly a third, a third, a third or is one more impacted than another?

Well you know, the largest impact of the ones listed were, I guess, in order of descent, would probably have been the Polish strike, which was about $0.03 per share. After that, I would say that the impact of the tax rate going up 200 plus basis points is probably a couple pennies and lastly of the ones we identified specifically, the start up of the facility in Chongqing is going to be another $0.01 or so.

Yes and the other thing is the, Steve asked prior, is about the reserve power business and we're being conservative on this and thinking that it's not going to come back as strong and the A&D business, also the mix on that was, we're not anticipating as strong. We look at our A&D business. We had a very strong fourth quarter. If you take the fourth quarter out of the numbers last year and if you look at a year ago in our A&D business, we're actually running much better, much higher numbers in A&D this quarter and in the next quarter than we did a year ago. But the comp, looking sequentially, that fourth quarter was just a very, very good quarter for us. The other thing I would add to it is, if you go back last Friday, we had a higher forecast than we have today. We have taken it down because of this economic environment that we're in. Whereas I said earlier, we're going to plan for the worst and hope for the best on this thing. But I don't want to go out with a high number and put our head in the sand and saying that what's happening in the world is not going to impact our Company. It could impact our Company and we've just got to wait and see what happens here.

Right. And just, I don't know if you can speak to sort of what was the dispute behind the strike and if that's something that's been completely resolved or if that's something that could also kind of rear its head again either in Poland or at another plant?

Well there's always a possibility that things could pop up. But right now, I think we're right back -- we have signed a contract, and the problems that impacted this last quarter and this next quarter, they're behind us. And we took a position that what was being requested, we thought, was way out of bounds. And we said in, you know, a short run, you can settle a problem like this and walk away from it, but in the long run, it's not the right thing to do and if it impacts a quarter, so be it. But we have to do what's right.

Okay. Great. And just going back to the commodity cost, it sounded like from your earlier comments that it wasn't a relatively large factor. I just wanted to understand that a little bit better because looking at the price of lead, it's, you know there's been some changes but it doesn't look like anything that's more significant than what you guys have managed through in the past. I was wondering if you could just add a little more color there just in terms of the trends you're seeing and what specifically led to the impact from commodities this time?

Yes. I'll address it then I'll ask Mike to pick up on it, also but if you go back to my prepared remarks, what I said was that we had approximately a $0.14 hit sequentially. When you take a look at the increase of commodity cost and offset that with the increase in pricing, it nets out to about $10 million, to about $0.14 a share, or in other words, to $0.68 you could add $0.14 on top of it if we were to get 100% recovery on lead. Mike, you want to pick up on it, also?

Yes. And then if you move forward to the second quarter, you're right, Elaine, that lead itself was slightly positive, but it was overshadowed by much higher commodity costs in the other area --, plastics, copper, steel. Those costs kind of overwhelmed and so when we looked at it -- call it about $0.02 to $0.03 of pressure that came from that aspect of it.

Great. Thanks so much for the extra color there.

Okay.

Your next question comes from the line of Michael Gallo from DL King, please proceed.

Hello, CL King. Good morning.

Good morning.

Good morning.

Question for John. I mean, John, obviously you came through the last cycle, you took out significant costs. You consolidated some facilities. I was wondering, as you start to obviously see or get somewhat concerned about what you're seeing out there, if there is a significant number of additional costs you think you can take out, obviously, the second rung's always harder than the first. But I was wondering, as you look around, whether you see meaningful opportunities, and then I would guess that you starting to look at those potential areas now. Thank you.

Yes, your question's right on the mark. So I mentioned earlier, we had a meeting with the top executives, 30 executives around the world yesterday, to lay out the whole picture of what we have, about an hour and a half meeting. And each of the divisions are going back and looking at the what-if scenario to take out additional costs. How we would consolidate operations further. There are opportunities. I'll leave it at that. There are opportunities. Some of this would mean cutting back in capacity. And I hope some of these opportunities we don't have to take advantage of because I'm hoping that the markets won't get that bad, that we won't go into a double-dip recession. And then what we'd do is take off modest costs but if it got really bad, we'd have to consider going to the next phase and potentially shutting down additional operations.

When you look across the regions, is it Europe that's the most concerning? Do you still see a lot of bifurcation within different European countries or is this Europe, just with everything that's gone on there obviously in the last few weeks, the area you'd be most concerned about?

Yes, Europe is the one I'm most concerned about right now. As you know, we were trying to get to 10% operating earnings in Europe. We were hoping to get improvement. We finished this quarter at 5.6%. It's better than last year, but it's still, it's not up where it needs to be. And when you get behind the numbers in Europe and you look at the revenue, it's down modestly, and this is looking at Q1 versus Q4. In Q4, Europe was at $258 million and we're in Q1 at $253 million. So you got about a $5 million reduction there. But when you get behind the numbers and you look at the unit volume, the unit volume was down $23 million. $23 million and the impact on operating earnings is about $6 million. Bit when you look at the offset, we had primarily FX that's gone up and of course you get no gain in operating earnings in the FX change with it. So the unit volume is down at that $23 million, you've got an offset of $16 million, which is FX and acquisitions. Net-net, the operating earnings have dropped off considerably, but it looks like the revenue on an average actual is much higher.

Right. Okay. Very helpful content. Thank you.

Your next question comes from the line of William Bremer from Maxim Group. Please proceed.

Good morning, John. Good morning, Mike.

Hello, Bill.

Hello, Bill.

All right. Good color on Europe. Maybe just to refresh us, 35% to 40% of your business is on automatic pass-through's. Can you talk about that lag effect on pricing there first?

Well, typically that lag effect, we would think, is about three to six months out. I mean, a typical example would be that for pricing that commenced effective April 1, it was for the average of lead from the December through February time frame. And that April 1 price effect would stay through pricing through the end of June 30. So you think about it, you could have pricing set in June that was based on lead costs starting last December. So you can see where the lag effect occurs. So when we look at lead that's on pass-through, we know we will get that recovery but we won't get it on a -- it'll take some time to come back. What was a little more troubling for us in the most recent quarter is since it wasn't lead itself that was going up, it was commodity costs, and some of those pass-through's are not as effective at tracking those as lead. So we'll reexamine those contracts as they come up throughout the course of this upcoming year to see if we can get better coverage on those areas as well.

Okay. And could we get an update on India?

I today got a discussion. We are in discussions with a company there in India and we had a continued dialogue with them on the prospects of acquiring a controlling stake in that company but in the meantime, we continue with our efforts to seed that market with our product, albeit at low or no margins because of the tariffs that it costs to bring in product from outside but that is a market that we wish to participate in. It's too big of a market to ignore. So we are continuing with our investment in that area.

Okay and then a product update on thin plate pure lead. Is that still operating close to full capacity given these times?

It's not at full capacity but it wasn't -- the facility that we put in place and the investments that we've made were to have excess capacity for future growth. So we're running about where we anticipate it would be running on the capacity side with it. So I'm real pleased with what's coming on and how the guys have operated it with us.

Okay and then just my final question is on the aerospace and defense arena there. Can you give us some color on what you're seeing currently and how you potentially could be affected going out?

Well, first off, and with all the talk that's going on about defense cuts, I don't anticipate that we are going to see major cuts in batteries and spending. When you think about it, defense spending, depending on who you read, is somewhere between $600 billion and $700 billion. And you look at if, just to pick a round number, if we did $100 million, percentage-wise that is so small, it's a peanut. When you take a $10 million army tank and you look at a couple hundred bucks for the batteries, I don't think they're going to park that army tank in the parking lot because the battery is not working. So I think we will see the replacement business to be good.

On the OEM side, potentially there could be a cut back and we could see reductions there, but as a percent of the total business, it's relatively small on OEM. The big cuts, I think we're going to see in defense spending, are going to be major projects that are in the billions of dollars, not the replacement and the maintenance business. So I don't think we're going to see big cuts there. Second point is that is somewhat of a -- very similar to reserve power where you can get very large orders come in, and they're very profitable and they're very good and then the next week or next month, the order take is very small on it. So it's a hit or miss type situation with it.

Good. And Mike, just a little color on SG&A going forward. We did have, I think, some one-time charges hit this first quarter. What type of run rates should we be using for SG&A going forward given the pullback in the second quarter and throughout the second half of the year?

Well, you know, on a perspective basis, I think every analyst is going to have to kind of look at their models to assume what rates and what top line to expect, but I would tell you, some of the costs that we have that influence our first quarter and it's continuing to impact on our second quarter, are our annual stock compensation for employees tends to hit our second, third, and fourth quarters harder than the first quarter because that grant is issued about mid-way through the first quarter. So you would see and we alluded to high are operating expenses in the second quarter compared to the first quarter. You know, if we finished with operating expenses once you pull out the acquisition-related charges, we were at about 12.7% of sales and we've traditionally been in the 12% to 14% range, depending on the quarter and the top line. You know, I would still anticipate -- we still believe our second quarter if it's flat and assuming FX rates were still going to be somewhere near the same top line that we were in this quarter, so I would not anticipate seeing a dramatic change as the percentage of sales in Q2.

Yes, one thing you said was the second half of the year. And let me just clarify one point here. We have a number of events that are taking place in the second quarter that has brought our guidance down. If we do not see a downturn in the economy, if things level out here, we fully anticipate the second half to be much stronger than our first half. But we're going to have to see what happens with this economy. That's the wild card. As one of our major customers said in their analyst call just recently, there is no visibility right now. And this is a major customer of ours a very large publicly traded company. And the visibility is, it's just not good right now. So, as I said earlier, we're going to plan for the worst but hope for the best with this thing and if it doesn't turn down, we're going to have a good second half.

Thank you, gentlemen. I appreciate the time.

All right. Thanks, Bill.

Next question comes from the line of Paul Clegg from Mizuho. Please proceed.

Thanks for taking my question, guys. John, could you talk about what economic metrics you look at to see what might be coming down the pipe on your order book? Which ones do you think do a good job of predicting what you eventually saw in past recessions and is it really the same metrics that work well in looking at downturns as well as recoveries?

Well there's a number of things, Paul. First off, one that is a quick read is the Industrial Truck Association data, as I mentioned earlier. And that's a good leading indicator. And the data has been very positive on the ITA data. Second thing is that we have a process in place that every month we go through a sales forecast and there's a lot of conversations about what we're hearing from our customers and what we're hearing at each margin or each market, I mean. So that factors into it a lot. Third is what we read daily in the newspaper and see in the business channels and just a general sentiment or feel of what's happening in the marketplace. Reading different economists, different reports, just trying to put the whole thing together. You know, we're not economists but what we are is we try to look ahead and project how we position this Company so that we can do the best on any given market. And by that, what I mean is if you go back again when the last recession was in place, we used the same process, we looked ahead, and we did the same thing -- plan for the worst, hope for the best. And it got very ugly, as we all know. And but for our Company, we weathered through it very well and we plan on doing the same thing this time if it gets ugly.

Okay and a follow-up, I know you guys, you talked about being willing to do diluted acquisitions in the past. And I think your logic on that is rock solid, but can you kind of comment whether or not the acquisitions you're looking at would be dilutive and then, what's kind of the magnitude? Are these bite-sized or are these larger acquisitions that would require larger scale integration plans?

All of the above. If you take a look at everything that we're in conversations with right now, there's some that are large, there's some that are small, some that are mid-size.

Okay. Okay. And then just one follow-up on A&D, I think was already covered but do you have any sense on whether or not the government will get more aggressive on pricing given that this seems to be higher margin stuff that they're buying from you?

Well, I think they've been aggressive in the past, and I think that it's potentially we could see that. I think we've gone through a lot of conversations and a lot of negotiations back and forth and I think that we've come to an agreement with our customers at what's the right price and so I think it's going to just continue to be very similar to what it's been in the past.

The other point, some of the A&D or a good deal of it. Batteries are often treated as the COTS designation is commercial-off-the-shelf and they're competitively bid with other vendors. So you don't have the same cost plus type pressure of auditors coming in after the fact to review your costs because it was competitively bid on the front end.

I see. So I see. And then maybe just one final one. I was a little bit confused on the discussion between motive and reserve when it comes to the September quarter and maybe beyond. It sounds like reserve is more the issue in Europe near-term and that makes sense. But as you look out and you build in a factor for potential economic weakness into the guidance, it seems like motive is the segment that's more susceptible to economic downturns. So am I looking at that the right way or is it still reserve that you're more worried about?

Well right now I'm more worried about reserve. But you're right if there's a big downturn, would we see the motive power be hit by it? And the answer is yes it would be.

Okay. Thanks very much.

All right. Thanks, Paul.

Your next question comes from the line of Walter Nasdeo from Ardour Capital. Please proceed.

Thank you. Good morning, guys.

Hello, Walter.

Hello. Most of my questions have already been bandied about, but I would like to just touch back on the motive again, if we could. And what are you seeing as far as the materials handling on a global basis as far as development goes? Are you seeing any new products and what are you seeing as far as competition goes out there? And the reason I say that is because recently a fuel cell company has been talking about a huge set of orders that they've been taking to kind of fulfill over the course of the rest of the year and was wondering if you're banging into anybody that you haven't seen in the past out there?

Not really. We're really not seeing much that's changing there. There are some fork truck operators in Europe that are working more with lithium-ion batteries. We do have lithium-ion batteries that we could sell, we have fuel cells that we can sell today. But we don't see -- just the price difference in the fuel cell or a lithium-ion battery for a fork truck versus a lead-acid battery -- the spread is very, very large. A typical lead-acid battery, an installation, you going to look at, they say $6,000. With a fuel cell or a lithium-ion battery, our price point would be more like $50,000. It's a big spread. And so we're not seeing a lot of activity in it. There's some there but it's not -- I don't consider that a major threat at this point.

Okay, good. And then I know we've talked about acquisitions quite a bit both on this cal and in the past. But are you seeing, as far as valuations go, kind of over the course of last six months, are you seeing any kind of moderation in valuation, are guys getting not as proud of their companies as they've been in the past? And are you seeing any greater opportunities because of that?

Well I think we saw valuations go down over the course of the last recession. I would say over the last six months, we haven't seen much difference at least with the companies that we've been dealing with in terms of their expectations. It's simply a matter of making sure that their performance matches the valuations that were ascribing to them, so.

Yes, I agree with Mike and I think the thing of it is, what happens in this next cycle here, in the next few months? It'll be interesting to see.

Yes.

It may present some really nice opportunities for us.

Okay. Understood. Thank you very much, guys. Appreciate it.

Thanks, Walter.

Operator. Your next question comes from the line of Bill Dezellem from Tieton Capital Management. Please proceed.

Thank you. We had a couple of questions. First of all, just to make sure that we are clear relative to your view of the economic situation. If you were only looking at EnerSys' business and not reading the newspapers or watching TV, you would have a much more favorable view of the economy and would not even be discussing potential for recession. Is that a correct assessment on our part?

That is a correct assessment.

And then shifting to next question. The Chinese lead rules and regulations, and some of the competitors being shut down and more stringent nets being cast upon those competitors, what's the update there and to what degree are you anticipating this will or will not have a material impact on your business over the next couple of years?

When you look at the number of factories that have been closed in China, it is a staggering number, and there's many of them that are never going to open up again. And you could talk yourself into believing it was going to have a major impact on our Company going forward. However, that being said, a lot of these manufacturers are very small manufacturers and they don't sell to the same type of customers that we sell. In other words, they're making batteries for electric bicycles. And those companies that are closed down, it will have no impact on us whatsoever other than they're not going to be assuming lead and maybe it'll have an impact on lead pricing. But I think it will have a positive impact on us. I think we're seeing a little bit of it right now. And I think as it goes forward, that if nothing else, it's going to require even the factories that are not to the same standards that we're at, that they're going to have to make the investment, so they're cost is going to go up, so I think it's going to make it more of a level playing field for us.

Our costs in Asia or in the China market has been higher than many of our competitors because right on the front end, we made the investments to put in bag-houses and the equipment and the showers and things that are required to really have a safe work environment. So we've been at a disadvantage because of the investments we've had to make there. And I think what's going to happen is that this is going to make a level playing field even for those competitors that do make it.

And from what you have seen, how much longer do you anticipate that the shutdowns will continue? Is this a process that will be going on for several more quarters or, I suppose years for that matter or is it more anticipated to be the washout process completed here reasonably soon?

Well, this whole thing started at the top of the Chinese government in Beijing and it's been forced down to the regions, is my understanding on it. And it's one they're very, very serious on it. And the reason for it is because there were a lot of people that were sick because of lead poison. And my understanding on it, the government was concerned, very concerned about the people and they put very stringent rules in place and their approach was, as I've described it is it's ready, shoot, aim. They walk into a factory. They say, you shut it down now. They did that to one of our factories. They walked in, they said shut it down. We did. We closed it for a day or two.

They evaluated our plant and said you're fine, go ahead and start back up. We're one of the few plants that were able to do that. There were others. But we were definitely of the minority of plants that were able to get started back up again. It's projected there will be hundreds of plants that will never start up again.

And what perspective do you have on how far along they are in their evaluation of the facilities they wanted to? 10% of the way, 90%?

I think they've hit three provinces, the three larger provinces right now. And how much more there is to go on it, I don't really know. But I do know, I'm the president of Battery Council International, also and Battery Council International, we are sending people over at the request of the Chinese government to educate Chinese manufacturers and show them that it can be done right, that you can have a lead-acid battery company right next door to an elementary school or a hospital, that environmentally, you can control it. We do it in the United States, we do it in Europe. And Asia is finally -- China is finally coming up to the same standards of other parts of the world.

Great. Thank you.

Your next question comes from the line of Matthew Crews from Noble Financial. Please proceed.

Excuse me. Good morning, everyone. I would like to spend just and it's a long call here, characterize where the economic activity was forklift sales in 2008 we had the disruption. Where would you characterize rebound from those 2009 lows when you -- that would be my first question is -- what inning might you call it that we were exiting out at that 2009 low activity level?

Well, I think some of the data John has alluded to was the year-over-year improvement, which have been in the 30% to [40%] new truck sales higher than the previous period. So if you want to take that, and that's already not at, the prior year was already coming off the bottom. So certainly we're much higher on sales of new trucks than we were at the very depth of the last recession.

So would you say that's like a seventh inning -- I guess another way of asking simpler is when do you think you would -- barring Friday's event and then this week's event -- when you would have expected to be to a more normalized run rate?

Well, I think we've been on an uptick. We're still on an uptick. There's no hard data at this moment that says that we're going to see a downturn other than what you're reading in the newspaper. Our data coming in, our orders, our backlog says it's very strong. But we've got to believe, or we believe, that with everything that's happening in the world, there's a potential that it could go down. And we're reflecting that potential in our forecast. Hope I'm wrong, by the way. I'm hope I'm wrong in that.

I think that's understood. What I was trying to get at is, when you have a rebound off of a pretty devastating low back in the downturn of late '08, early '09, what level of downturn could you see again based on the fact that it's been generically speaking a pretty slow recovery in most economies since that time frame? So I'm just trying to get a sense for if we do get a slowdown, the magnitude relative to what you saw slowdown in the '08 time frame?

Yes, I don't know the answer to that question. The visibility is so unclear right that our customers -- I think everyone's just scared right now -- I think we're in a panic -- not the Company but the global economy is in a panicked situation. And what our job is to take and assess that and position the Company going forward, and I feel very comfortable where we are with it.

Okay. All right. Thank you very much.

Your question comes from the line of Howard Rosencrans from VA. Please proceed.

Hello. My questions have been asked and answered. Thank you.

Thank you.

Your next question comes from the line of Jeff Bencik from Kaufman. Please proceed.

Okay. Thank you. Just have a couple questions. My understanding is that in Asia, particularly China, you are fully utilized. So I would like to know where the incremental revenue came from this quarter versus last quarter? Did you ship that in from other facilities and how much did that impact the margins in that segment?

We had a lot of thin plate pure lead product that went in that is manufactured in Europe and the Americas.

Okay.

It went into the Japanese market primarily.

Okay. And if we look at some of the public lithium-ion companies, they've seen their market values decline by a factor of 4 or 5 so they're 0.2 or even in some cases 0.1 the market cap they were just as recently as three to six months ago. So in terms of the acquisition pricing that you're looking at, I know most of it is likely private companies. But so far, it seems like you are not seeing that revaluation yet. Does it make sense from your perspective to wait a little bit and show these figures to your potential acquisitions and ask for a lower price and can you do that at this point?

Well, I think you have to look at the markets that some of these companies are in that you're referring to and it's been companies that has been associated with the auto industry. And, Jeff, you've heard me over the years saying that I think that there's a lot of hype over there. I think it's way overpriced and it's not the one that we've been participating in. The companies that we are looking in, in the lithium space, I'll take ABSL that we just acquired in March, is a company that builds batteries for satellites. It builds batteries for military applications, and so it's kind of an apple and the orange. We're not looking at buying these companies that are building batteries for the auto industry. That's not our think because we don't think we can make a good return on it. And when the valuations were way up at the time on those companies and I know you and I have had conversations about, I thought they were over-valued then. I didn't think you could make money in those areas. That's an area that we've stayed away from.

Yes. Okay. Fair enough. And in terms of the thin plate pure lead, obviously, you just recently completed an expansion in that space. You indicated at the time that I think that was going to take from you 100% utilization down to the 80% range. Where are you at in terms of your capacity utilization for a thin plate?

In the same zip code that you just quoted. We're right on target to where we thought we would be.

Okay, and--

So we have upside. We do have upside. And we have plans if the markets demand more product that we would do further expansions in capacity.

Okay. Very good. And then just in terms of your comments today it just seems like you're taking a more conservative view on your pricing recovery as well. Obviously, your record backlogs and strong orders for fork-lifts continue and you haven't seen any impact on your business, but imbedded in your guidance, it appears that you are not assuming that you'll be able to get full commodity cost pricing recovery. Is that the case? And if so, why?

That is the case. We are looking at a scenario that potentially, as I said earlier, that if you take if that the revenue drops down because of a bad economy, I think what happened and you've taken market share the way we've picked up market share, that I think what we would see was certain competitors that are not making money today and if the markets get really bad, they are going to be very competitive. They're going to have to do something. So we've looked at it from the standpoint and said again, we're going to try to get higher pricing and everything else but let's be realistic about it. If the markets drop off that bad, it's go to be tougher to get pricing. So we want to be very realistic and very transparent and upfront about it.

Understood. But in that scenario, would it be safe to say that historically you've had, if your volumes are dropping down and your commodity pricing or commodity costs are also going to drop? Is that what you would expect or do you think this time it's different?

That's what I'd hope for. But one thing feared that comes out, you look at gold yesterday crossed over $1,800. Will people be sticking money in other commodities to go out of equities? And you raise a good point. We may be overly conservative on the way we're viewing this next quarter.

Okay. That's all I had, John. Thank you.

Operator. Your next question comes from the line of Dana Walker from Kalmar Investments. Please proceed.

Good morning.

Good morning, Dana.

As you look at opening your new site in China, can you talk about the thresholds that you'll need to achieve so that you go from an operating drag to operating contribution?

Yes. The first thing that we are going to be adding extra cost to is that we do have -- when we manufacture the product in our new factory in Chongqing, we will be sending it to another factory to have further and additional testing done on it. The number one priority coming out of that factory is quality by far and away. We want to be sure that the product that we build there, since it is a start-up, since it's new employees, many of them never worked in a battery factory before. There's going to be a lot of training. There's going to be a lot of control and there's going to be a lot of testing on that product to be sure the quality's there. It's going to take several quarters to work through and really get the cost refined down on it. So I think that you're probably looking at three to four quarters before we would get things running at the level we want to get it at.

In the past, you've talked about the revenue capacity that you would have there. Would you update those numbers for us?

The revenue capacity I've quoted in the past is the same. It's about $150 million in revenue. Obviously that's not going to produce at day one. That is the size of the plant. That's the capability of the plant of producing $150 million. It's obviously going to start up at a very low number and it's going to increase as time goes on.

Aside from the [tenth] of quality control testing that you'll undergo, one presumes that as you make strides towards that $150 million that you don't need to get close to that $150 million for that to be a profit contributor?

Absolutely. It's significantly less than that, the $150 million.

The mix of business that you would expect to make in that plant would look like what?

It'll be capable of building batteries for nuclear power plants, for our telecommunications business or UPS business and some for motive power.

Okay. Looking at the market share numbers that you talked about before, would you expand on your comments on share gained in motive and in reserve by market and then talk a little bit about the fact that you didn't seem to gain share in Europe? I presume that makes sense because that appears to be the lowest return on revenue market but expand on why you chose to not gain share or why you did not gain share in Europe and whether there's benefits to gaining share in Europe?

Yes, as we've said in the past, that there's been some pricing situations. Europe has been much tougher pricing than it has been in other regions. And as I said in the past that we will walk away from low margin business and let the competitors have it. If we can't make a good return on it, we're not going to do it. So we've been basically walking away from lower margin business and we've picked up some better margin business. And it goes back to the earlier question about pricing. If the markets were to drop way off, and you hit the nail on the head, do we need to lower pricing to be competitive?

If the volumes were cut -- you go back a couple years ago, we were running just shy of $2 billion and went down to $1.579 billion to be exact, a $448 million cut in revenue over a year or two period of time. If we were to see a situation like that again, would we be able to hold pricing? Now, the other thing on it though is, to the other question, if lead cost came down, it might be okay. There's a lot of moving parts on this thing and we've just got to be prepared that as we move forward that we're in a position to optimize our position.

To what degree, though, are you making an argument that is succeeding that price is not the only equation to buying a product in Europe?

That's something we daily -- that we go in it's about added value. We continue to present ourselves of being best value in the industry, and with certain customers, they want to buy a battery at the lowest price. It doesn't matter what the value equation is, it's low price. And others, they do understand the value chain.

Your thoughts behind why you gained share in Asia and particularly in North America?

I think that it goes back to what we've talked about on best value, and when you have customers that they look at initial price and if we are higher and they look at the total value equation that they have seen that they're further ahead to do business with us than others.

John, one thing you've talked about in the past that may not apply in this cycle, but you have believed that when wireless infrastructure has been updated for a new generation and in this instance, which would apply, would be 4G and LTE, that quite often, they swap out the batteries as they update most everything else. Do you expect that to take place now and if so, given the greater spend on LTE, do you believe that we're looking at a cycle within the reserve family that ought to be a secular driver for you?

Yes, I would agree with that. I think that if you go back and you look at Europe specifically, Europe is not been spending the capital. It's not been growing in the telecommunications area. They haven't really deployed the 4G and other technologies that we have in the United States. The US market has been very good for us in reserve power. Asia, the volume is there. Some of the pricing is not as good as we'd like to see it. But Europe has been a tough, tough market from the standpoint that they haven't been making the capital investment. I don't think that will last a whole lot longer. There's going to come a point in time and I can't tell you when that additional CapEx spending will take place in the European telecommunications community and when that does take place, we fully expect that we will get our fair share of that market.

Final question is this -- you've long talked about a goal of a 10% margin in Europe. You didn't get there presuming that this cycle is getting close to peaking but we'll cross our fingers on that. Do you believe that your team and you have a high confidence strategy to get there under what comes next?

Yes, I do. I think that if you, again, you go back to what I mentioned earlier about looking at Europe and the $22 million I talked about and dropping off $5.6 million in earnings because of the unit volume being down. That's one thing -- as we talked six months or nine months ago, that I didn't anticipate that we would see a slow-up in reserve power to the level that we have. We will get to the 10%. The only thing I can't tell you right now is when because of this lack of visibility of what's going currently in the markets. I hope that what we have done here is that we have gone out too conservatively. I hope that we don't see the downturns. But I know you guys listen to the same things that we do, and it seems that we are either going to talk ourselves into a recession or we're going to go into some bad times. We need to be prepared for that. And by the way, I hope I'm wrong on it. Because I hope that we don't see a downturn. But I can assure you if we do, we're going to do the same thing we did last time. We're going to weather through it and we'll weather through it better than our competitors.

Mike, John, thank you for your thoughts.

Thanks, Dana.

(Operator Instructions)Your next question is a follow-up question from the line of William Bremer from Maxim group. Please proceed.

Yes, gentlemen. Just a brief question on Asia. You called out the thin plate pure lead sales particularly from Japan. Were there any one-time large orders or should we look at this first quarter and say hey, maybe there's some new lines that they're on, new contracts that they've won during it and we can sort of use this as a base line going forward?

Well. We had some sales that we hope might be continuing and we hope a further introduction. We've been selling thin plate pure lead into Japan for over 15 years but it has been on a fairly isolated business and not in bigger UPS applications and we're hopeful that we can get some traction there but for the time being, we're assuming that this is a one-time situation.

The tsunami drove a lot of this. I mean, there was a lack of battery supply in Japan. They needed it and needed it quickly. And so I would agree with Mike. But hopefully what'll happen is when they see the quality of the product coming in and they like the product, that we'll get additional orders in the future.

Thank you, gentlemen.

All right. Thanks, Bill.

We have no more questions in the queue. This does conclude the question and answer portion of the call. I would like to turn the call back over to John Craig for closing remarks. Please proceed, sir.

Well, I appreciate everyone's interest in the Company. And I thank you for calling in today. Hopefully we won't see a big downturn take place. But I think you can see, we've positioned and we're prepared for it. And I'll just end it by saying that we plan for the worst and hope for the best this thing. Either way, the Company's in very, very good shape going forward. I mean it's one with very strong balance sheet, I'm very confident we're going to continue to have good earnings or have earnings and eventually this thing is going to turn around and is going to go the other way. I still anticipate that second half of this year will be stronger than our first half of this year. So with that, everyone have a good day. Thank you.

Ladies and gentlemen, that concludes today's conference. Thank you for your participation. You may now disconnect. Have a great day.