EnerSys (ENS) 2013 Q3 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the third quarter 2013 EnerSys earnings conference call. My name is Carissa and I'll be your coordinator for today.

At this time all participants are in a listen-only mode. We will be facilitating a question-and-answer session towards the end of today's conference. (Operator Instructions). As a reminder, this conference is being recorded for replay purposes.

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

Thank you, Carissa. Good morning and thank you for joining us. Last night we posted on our website slides that we're going to be referencing during the call this morning. So if you didn't get a chance to see the information, you may want to go to the website at www.enersys.com and view the slides.

Before we get into the details of our third quarter results, I'm going to ask my Mike Schmidtlein, 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 are subject to urn certainties 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 event and operating performance and are applicable only as of the date 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 the 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 December 30, 2012, 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 information and the non-GAAP information, please see our Company's Form 8-K, which includes our press release dated February 6, 2013, which is located on our website at www.enersys.com.

Now let me turn it back to you, John.

Thanks, Mike.

I'd like to start by saying that we're very pleased with our accomplishments and financial results for our third quarter and first nine months. You'll notice on slide three we reported third quarter records for gross profit margins of 25.5%, operating profit margins of 11.4%, and earnings per share of $0.88.

Our sales for the third quarter of $557 million, were $17 million, or 3% lower, than last year's third quarter sales. However, year-over-year earnings per share were up $0.08 or 10%. During our last investor call, we cautioned that our recent order levels in October were lower than anticipated. However, in the remainder of the quarter, orders did pick up and stabilized at higher levels. The increase in orders drove our third quarter sales higher and this was the main reason we surpassed our EPS guidance.

On slide four, our first nine months fiscal highlights show similar records for any first nine months of the Company's history. Our earnings per share of $2.75 is 33% higher than last year's first nine months EPS of $2.06.

I now want to focus on our current business activities and fourth quarter guidance. Our current orders are holding at the higher levels we saw in the latter part of the third fiscal quarter. Our Americas and Asia segments continue to see solid orders, while Europe, Middle East, and Africa are holding steady. Our commodity costs in the fourth quarter will be rising sequentially, as the higher LME lead and other commodity costs work their way through our P&L. To offset the higher costs, we have recently announced price increases, which should recoup the majority of these increased costs, but will have little impact on our fourth quarter. Based on this information, last night we announced our fourth quarter guidance of $0.73 to $0.77 earnings per share.

Slide five provides with you with an update on two of our new products. We're receiving very positive customer feedback on our thin plate pure lead batteries for motive power applications. Also, our OptiGrid megawatt-scale energy management system is up and running and we have received several inquiries from large utility companies about this new product. With all new products, it will take time before they're fully implemented into the marketplace and contribute to enhancing our profit county.

I recently attended a ProMat show in Chicago. This is one of the world's largest material handling shows and our takeaway from discussions with distributors, OEMs, and end users was that the marketing is looking for continued growth in North American material handling business.

In closing, we've had a great first nine months of fiscal 2013. The fourth quarter will present some challenges due to rising commodity costs, however, the recent price increases will help offset these costs as we move be into fiscal 2014. Also, the recent increase that we've seen in orders, we're encouraged that things are picking up.

And now I'd like to turn it back to Mike Schmidtlein for more information on our results and our guidance. Mike?

Thank you again, John. For those of you following along on our webcast, I am starting with slide six.

Our third quarter net sales decreased 3% over the prior year to $557 million, primarily from volume declining 2% along with a 1% pricing decline from lower commodity costs and 1% decline in currency translation offset, by 1% from acquisitions.

On a regional basis, our sales in Asia increased 10% in the third quarter to $50 million, while Europe's third quarter decreased 7% to $231 million, and the Americas were down 2% to $276 million. In all regions, volume was the primary factor for the increase or decrease.

On a product line basis, net sales for motive power decreased 2% to $292 million on flat volume, while reserve power decreased 4% to $265 million, reflecting its unit volume decline. Both product lines absorbed 1% currency and pricing declines.

Please now refer to slide seven. On a sequential quarterly basis, third quarter net sales were up 1% to the second quarter due to higher exchange rates. Europe was up 7%, while Asia declined 19% and the Americas region was flat. The decline in Asia reflects the completion of a large order from a Japanese customer, which also caused the decline in the reserve power product line.

On a product line basis, our global reserve power business was down sequentially 7%, while sales in our motive power product line increased 9% sequentially. The improvements in motive power were from all geographic regions.

Now a few comments about our adjusted consolidated earnings performance. As you know, we utilized certain non-GAAP measures and analyze in 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 includes our press release dated February 6, 2013 for the details concerning these highlighted items.

Please now turn to slide eight. On a year-over-year quarterly basis, adjusted consolidated operating earnings increased over $7 million with the operating margin up 160 basis points. On a sequential basis, our third quarter earnings decreased nearly $1 million, with the sequential operating margin down 20 basis points. From a historical perspective operating earnings remained strong at 11.4% of sales.

Our Americas business segment achieved an operating percentage of 16.5%, versus 13.0% in the third quarter of last year, primarily from the impact of lower commodity costs. On a sequential basis the third quarter rose 70 basis points from the 15.8% margin posted in the second quarter.

Europe's operating earnings percentage of 6.5% was comparable to last year's third quarter of 6.6%, and the previous quarter's 6.5%. Europe's organic growth was down 4% from the prior year, but improved 3% from the prior quarter. Europe also benefited from lower commodity costs.

The operating earnings percentage in our Asia business segment decreased in the third quarter of this year to 6.6%, from 7.0% in the third quarter of last year, and 10.6% in the prior quarter. Asia's operating earnings were $3.3 million for the third quarter, reflecting 17% lower volume from the prior quarter as discussed earlier.

Please move to slide nine. Our third quarter adjusted consolidated operating earnings of $64 million was an increase of 13% in comparison to the prior year, with the operating margin of 160 basis points to 11.4%. Lower commodity costs were the primary factors. However, starting in our fourth fiscal quarter, we will see in our results the impact of rising lead costs, which began last September.

Excluded from our adjusted operating earnings for the third quarter was approximately $3.8 million of highlighted items. Our adjusted consolidated net earnings of nearly $43 million increased 11% from the prior year to 7.7% of sales for a 100 basis points improvement, with the book tax rate increasing to 27%.

EPS increased 10% to $0.88, a third quarter record, on higher net earnings despite higher shares outstanding. Our adjusted effective income tax rate of 27% for the third quarter decreased 100 basis points from the second quarter due to the mix of earnings by tax jurisdictions. We believe our tax rate for the fourth quarter of fiscal 2013 will be between 26% and 29%, and for the full year we expect a 28% rate. Our rate for full fiscal year 2012 was 25%.

I refer now to slides 10 and 11. We have provided information on a year-to-date basis, similar to that of our third quarter on the prior pages. These two pages are for your reference and I don't intend to cover the year-to-date results, other than to say with EPS of $0.95, $0.92, and $0.88, respectively for the first three quarters, all of these quarters were fairly similar in result, all of which were also records.

Please now turn to slide 12. Now some brief comments about our financial position and cash flow results. Our balance sheet remains very strong. We now have $229 million on hand in cash and short-term investments as of December 30, 2012, which over $400 million undrawn from our credit lines around the world. We generated over $135 million in cash from operations in our first nine months of fiscal 2013. Our leverage ratio, which must be maintained below 3.25 times, as calculated with our US credit agreement, was only 0.5 times. Our net debt to total capitalization ratio was under 10% as of December 30, 2012.

Capital expenditures were $38 million in the first nine months of fiscal 2013, compared to $35 million in fiscal 2012. In addition, during our third quarter we repurchased 683,000 shares of EnerSys stock at a cost of $22.6 million for an average cost per share of $33.

We expect to generate adjusted diluted net earnings per share between $0.73 and $0.77 in our fourth quarter fiscal 2013, which excludes expected charges of $0.06 per share from our restructuring program and acquisition activities.

Due to the increase in lead costs commencing in September, we anticipate a decline in our gross profit rate in our fourth fiscal quarter. The 25.8% recorded in our third fiscal quarter will likely drop 200 or more basis points in Q4 to the 23% to 24% range. On a longer term basis, we expect to return to our goal of 25%.

In conclusion, we continue to believe we are well-positioned to take advantage of future opportunities. Now let me turn the call back to John.

Thanks, Mike with that I'd like to open the line up for questions.

(Operator Instructions). And your first question comes from the line of Michael Gallo of CL King. Please proceed.

Hi, good morning.

Good morning, Michael.

Good results again. John, I was wondering if you can give us just an updated view on Europe. Obviously it's been difficult there for some time now. Are you starting to see signs of stabilizing? You look out six months, you think we maybe could start to see some pick-up? And then at some point I guess we should see LTE roll out over there, it seems like it's starting very slowly in a few countries. I was wondering if you could give your view on what you see going on in Europe and any signs that might start to flatten out or pick up here in the next six to 12 months.

Sure, Michael. I think I'm going to go a little further than that. I think I'll cover by each region. I'm sure during the call here, I'm going to be asked that question on each region and I'll come back to Europe and hit your questions specifically in a minute.

One of the things I look at are the orders that are coming in currently. And to see what the daily average order take will be. Or is. We look at a four-week average, an eight-week average, a 12-week average, and a 16-week average. When you look at the four-week average, in the total business compared to prior year, we're up 14%. When you look at the four-week average and compare it to the 16-week average, we're up over 8%. So orders are -- as I said earlier, are coming back strong.

Now to break that data down a little further. In the Americas, looking at the four-week average compared to a year ago four-week average, we're at 20%. Looking at the four-week average in the Americas, compared to the 16-week average in the Americas, we're up over 11%. Same numbers with Asia, up over 50% the prior year. Compared to 16-week average, we're up 20%.

Now Michael, specifically to your question. Europe is up about 2%, looking at the four-week average compared to the four-week average a year ago. When you look at the four-week average compared to 16-week average in Europe, it's up 2.5%. Specifically to answer your question, I think we've hit bottom in Europe, and I think it's going to be a gradual climb up is the position I would take on it right now, based on the orders that we're seeing.

Thanks very much.

Your next question comes from the line of Zach Larkin of Stephens. Please proceed.

Hey, good morning, Jeff. Thanks for take my call.

Thank you.

Mike, first off. I wondered if we could talk more about the margins, appreciate the color on the range, but with all of the restructuring and everything that you guys have done recently, even with the move up in lead, is this kind of a new floor that we should maybe think about that we're looking for, the margin range you talked about in Q4? I mean, structurally I'm assuming we've improved kind of what the deck might be on the margin profile for the Company as a whole.

Well, you know, we have experienced in the last five years margins as low as 19% range and as high as now almost 26%. But I would say it is dependent on commodities. We do know that those commodities come through our P&L about three months after the actual incurred dates. So for our third fiscal quarter, we're really experiencing the costs that we saw in the July, August, September timeframe. And now that the costs that occurred in the fall are showing up in our Q4, in our pricing typically lags a couple of months, which is why we saw expansion in margins in Q3, we're going to see a contraction in margins in Q4.

So to your earlier point, you're right. We are always trying to improve on a cost improvement. The money we spend on restructuring, the new programs that we introduce to try to promote products like our thin plate pure lead into new markets -- all of which are there to drive a longer term improvement in our gross profits.

So I would tell you we can't control what lead is going to do. And we know where we can achieve pricing. And knowing that it typically lags, I think you could expect -- I think that 19% floor is probably now 22%. But the -- what you're going to see over the course of the next year or two I think will obviously be dependent on lead. As I said, we think 25% is a goal for us, which we ought to be able to achieve on a longer term basis. And that's what we strive for.

Thanks. That's very helpful, that color. And then John, I wondered if you talk a little bit about your thoughts on potential acquisitions, leverages as low as it's been a really long time. You're generating a ton of cash. How itchy are you to look for companies, and how much has the kind of current mid-cycle pause increased your opportunities on this front?

Well, I would say we're always busy. We continue to be busy looking at the acquisitions. We're very highly disciplined on the acquisitions. And if we find the right deal, we're going to go for it. We don't plan on overpaying. We haven't historically. We've done, since 1994, I think it's 34 acquisitions. We've been successful at it. But we're active and if the price the price is right, we're there. I'll leave it at that.

But the pipeline is the pipeline. I mean, a good kind of flow of pipeline assuming you can get your prices, you guys have had a great track record on discipline on that side.

There are opportunities out there we're looking at currently. Obviously I cannot go into any details on those because of nondisclosure agreements and other reasons. But I can say that we're active.

All right. Thank you very much. Congrats on the quarter.

Thanks Zach.

Your next question comes from the line of Brian Drab of William Blair. Please proceed.

Good morning. Congratulations on a great quarter.

Thank you, Brian.

A few questions. First, can you comment at all on what the ultimate impact of Hurricane Sandy was and if you're still seeing the impact of that?

As I said in that last call, we expect little impact on that. It's relative to the $2.3 billion, $2.4 billion we are in size, it's going to be a very small impact. We've had some orders come through, some things that had to take place very quickly. We responded to it very quickly. Dollar wise, small. But I think there's something that really came out of this that's been very good for us. And that is that the customers that did call and the response that we gave, there within a few hours, and having the product and installing it -- the goodwill that we build up with those customers was very, very good. So the dollar impact on it, small. Goodwill impact on with the customers, I think was outstanding.

Okay. Thanks. And then, John, thanks for that great detail on the latest trends in orders. And I'm wondering, you know, as I'm looking at the forecast, because my forecast, consensus forecast, looks like analysts were forecasting revenue to be down in the fourth quarter, relative to the fourth quarter 2012. But with this outstanding momentum, it sounds like you have in most regions in orders, shouldn't we expect revenue to be up year-over-year in the fourth quarter?

As you're aware, we do not give out the guidance on the revenue side. So I'm not going to comment on that. But I also will add that when orders are coming in, you have to take into account that some of these orders, if -- let's say in the telecommunications system or a military application, these orders can run out three, four, five months. In fact, some of them can run out in years. So I'm not going to comment on the impact on fourth quarter. It's factored into the guidance that we've given, the volume is. But I'll say what we're seeing out there is more encouraging today than it was on November 6, which was the date of our last analyst call.

Okay. And one follow-up on that point. Can you -- I know that there's such a wide range, as you pointed out, in order to sale timing. But what is the typical average, if you can put an average number on it?

Again that depends on the mix of the products and the orders coming in. I would be -- it's speculation on my part. But generally speaking I'm going to guess two to four months would be a range.

Okay. Thank you very much.

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

Good morning, John.

Good morning.

Okay. Great quarter.

Thanks, Bill.

I want to go right into your operating margins on the Americas. Stellar. You're over 16.4% there. It's always been a target to hold 15%. Is there a new target here? And then I want to take that also to Europe, and you did a very splendid job in our opinion, in holding your margins there at about 6.5%, given the 6.5% pullback top line. And now I'm assuming based upon your commentary, Europe that just ought to have a nice little ramp-up as we go into the fall, your strongest quarter and then 2014. Can you give us some color on where you anticipate your operating margins going here from this point on?

Well, obviously with the guidance that we've given, the operating margins we would anticipate them going down in the fourth quarter. And that's primarily because of the lead situation. As you know, when lead goes up and we go after price increases, there's a time delay there. And when you look at the cycle, and you look and see that our -- the LME costs of lead back a quarter ago was in the $0.98 range and now more at $1.03 -- those are LME prices, by the way, that's not exactly what we're paying for it. But it's up is the point that we're going to be playing catch-up on the pricing. It's going to take some time to catch that.

Now the other side of the fence when the LME goes down or lead prices go down, what happens is if we can hold the pricing, we can neutralize that thing. The long-term effect of lead costs or commodity costs versus pricing historically we've been able to get back 100% of it. But in the cycle that we're in right now, we're going to see a downside here. So beyond that we're going to continue to do everything we can to improve our productivity, to reduce our costs, to introduce new products. Our target on new product designs going out right now, Rod Evans, who is our global engineering Vice President -- Rod knows and he manages it well.

On all of our products, we want to look at gross profit margins of 30% or greater. That's not to say that there won't be some products in there that we have to come out at a lower margins, but generally speaking we want to be working on the higher margin products. So I hope that answers your question.

No, it does. That's good to hear going forward. The quarter, in terms of the split between reserve and motive -- we thought that the reserve would be a little bit stronger then where it came in versus motive. Can you give us some color on what you saw during the quarter and do you expect now for them to flip-flop a little bit going forward?

I'll ask Mike to cover the details on this. I'll say this, the motive power orders and the reserve power orders, it's funny over the years how it's changed. One day the reserve power looks great, the motive is down, and the next month the motive is up and reserve is down. It flips back and forth. So it's nothing unusual there. But, Mike, why don't you get the specific numbers on it?

As I mentioned in my script, Bill, that in our Asian market we had a large order in Japan with a customer and happened to be a reserve power order that completed itself in the prior quarter. That's why you saw Asia's step down of about $12 million of sales sequentially or I think 17%, which was a big impact.

And by region it was a little bit mixed. The reserve was down in Asia and Europe, it was up in the Americas. So I would say it was probably a little bit skewed by one specific order. Some of the comments made earlier I think Mike Gallo mentioned the LTE drive in Europe. And we hope that that has some longer term positive impacts on us. We certainly think our reserve power business is one that is growing with the normal expansion and the transmission and storage of data. So we're very positive and bullish on reserve power market. But in terms of the timing of when the large orders start and stop, it had a little bit of a negative impact this quarter.

Okay. My final question is on the restructuring charges. What could we look for? I know that you voiced last call the tightening potentially on the lithium side of the business. What can we see fourth quarter and going out into 2014 in terms of more restructuring across the board?

Well, in our guidance we said that we would expect or you should expect about $0.06 of charges related to our restructuring program for the fourth quarter. So, you know, in broad numbers we're at about $5.5 million year-to-date in restructuring charges. We're going to finish probably some place in $9 million to $10 million range on restructuring.

One of the programs that we mentioned in the MD&A this quarter was a realignment of our manufacturing footprint in China. And those charges will continue in the fourth quarter and that would be one of the larger ones. And we also have some programs going on in Europe, which are intended to continue to drive the costs out of that structure. So you should expect -- let's call it $4 million of restructuring charges in our Q4.

And, Mike, finally, I apologize. Here's one more. Saw the stock buyback affect this quarter. I know it's still active. Can you give us some color on what has been since the end of the third, what has also occurred coming into the fourth?

Well, we did a repurchase that we referenced, 683,000 shares I think, $22.6 million. That program essentially is completed. We do have authorization with our Board for another buyback program of about $50 million. That has some pricing levels at which it would be put into place. They're lower than where our share price is at the moment.

So as we've said in the past, we will when the opportunity presents itself, and that's when we think the market price of our shares is below what we view is the intrinsic value of shares -- we plan to be in the market to repurchase shares. So, I would say we have programs out there. I can't promise you they're going to hit in Q4. But if the opportunity presents itself, we have the balance sheet to do it.

Okay. Gentlemen, thank you for the color.

And your next question comes from the line of Elaine Kwei of Jefferies. Please proceed.

Hi, John and Michael. Thanks so much for all of the details. It's really helpful.

I just have a question related to the convertibles. The stocks had quite a run here. And I think we're above the conversion price. But could you give us just A little bit of an update in terms of where we stand with that.

Sure, Elaine. So the convertible has a conversion threshold of about $40.60. So, currently you're right. We are above. And that convertible becomes dilutive at prices above $40.60. And just to kind of give you some metrics for sensitivities, if you will, if our share price moved to $45 per share, that would add approximately 415,000 shares to our share calculation as you computed for diluted earnings per share. At current earning levels, that's a little bit less than $0.01 per quarter of pressure. And you can kind of use that metric and say with every $5 increment in price, I'm going to add 400,000 to 500,000 shares. And you can do your own math on where you think our net earnings might be in future quarters. But let's say for practice purposes, it's $0.01 per quarter.

Okay. Great. That's really helpful.

And just one last one on the restructuring -- just sort of from a big picture standpoint. I know you guys have a lot of ongoing programs taking out costs and rightsizing the organization. When do you think you'd be at a point where you'd have more of that substantially done? I mean, beyond Q4? Would that be essentially by the end of this calendar year, or do you see more going into next year as well?

My answer may surprise you. It's probably a long, long ways off. The reason I say that, when you look at the restructuring programs, what we're doing is we're reducing costs and becoming more productive in driving our earnings up by them. And these are very solid investments that we're making. We have a lot of cash and I look at the best way to use that cash and I call it investing in ourselves. And what that really means is, ladies and gentlemen, within EnerSys, we have to find a better way of providing better products at lower, lower cost.

And the other thing is when you look at the M&A work that we've done recently and what we're anticipating in the future, that's going to require restructuring costs to take and make us more profitable. That whole philosophy and concept that we've covered here is what's taken us from a smaller company to a little bit larger, and what's going to take from us where we currently are to even being larger yet and even more profitable.

Great. Thanks so much. And congrats on the great results again.

Thank you.

And your next question comes from the line of Bill Dezellem of Tieton Capital Management. Please proceed.

Thank you. A couple of questions. First of all, would you please go into some detail on the China footprint realignment that you're doing? I have not yet had an opportunity to read the MD&A. And if it's totally laid out in there, then just tell me I'm wasting your time.

Well, you're not wasting our time. We'd be happy to cover it for you.

About two years ago, we made a decision that we were going to build a new factory in China. And the primary reason for that was that when we analyzed our China business, we were really not competitive from a cost standpoint, and the product designs that we had over there were more western European designs, and we needed to get more in line with the China market. We built a state-of-the-art 450,000 square foot factory in Chongqing, China.

With doing that, we had some smaller operations that we evaluated those and said, "jeez, we can actually integrate those smaller factories into our new factory, thus, reducing overhead, thus saving money. And having a better quality product that fits the market at a lower cost."

So China's no different than anywhere else in the world. We're going to continue to look at how we can restructure or business. And take costs out and that's, in fact, what we're doing in China today.

Which facilities are you now exiting?

The facility is in Chaoan, which is in Chaozhou district. It's a facility that was part of the Huada Battery Company when we acquired it, our predecessors acquired it in the mid-1990s. It had then been sold off. We repurchased it in 2005. It's a smaller facility -- in light of that footprint, in light of other considerations, we felt that it was appropriate at this time to take it out of our footprint. I will say, and by no means a promise, but we're taking the charges right now as we close that property. At some point, we believe in the next year or so, we will be able to sell that property and we may be able to realize a gain off the appreciation and value that the property has had in the 10 to 15 years that we've owned it.

That is helpful. Let me shift to the management changes, if we could please in Europe and Asia. And share with us what you can about that and what you're trying to accomplish here.

Well, I'm not going to go back and talk about the changes per se that we have made and any reasons why. But I will say we have an outstanding management team in both Asia and we have an outstanding management team globally. I'll start with that.

Specifically in the European market, a new set of eyes looking at it. We're not at 10%. We're at 6.5%. I've committed to our shareholders, I've committed to our Board, and I've even committed to myself that we're going to get Europe to 10%. Europe has gone through a lot of problems. We all know that. We've held at the 6.5%, 6.4% to 6.6% range in operating earnings. But we're still not at the target, and I think with the new set of eyes and the team being very open and energized about looking at how we take it to the next level, I'm encouraged that we can get there.

Thank you. And then finally, I do want to beat the lead price increase horse here a little bit further, if we could please. Lead prices have been going up since the fall, and since the last conference call. But you did reference the pricing action that you've taken. And so what degree does that pricing action take into account the $1.10 or so lead where we're now at, versus taking into account only the lower prices that were in place last fall? What can you do to help us understand how much you're getting there, please?

It's tough question. Because we don't know the answer to it at this stage. What we do is we analyze by region. We look at where we are price wise, compared to our competitors. We try to come up with what we think is a fair value to the market in each region. We analyze that. And we announce the price increase.

Historically, as I said earlier, we were able to get enough of the price increase to ultimately offset the costs of the commodity costs going up. But part of it was offset because the commodity costs were going back down again. So right now it's tough for us to analyze -- or to assess it. We have announced the price increase. We hope to get 100% of the price increase. And we'll see what happens.

I guess I would add that because of the timing lag effect of when our pricing is in place, compared to when our costs hit, that's typically a quarter later. So, to your point, Bill, lead has been going up, I'll call it $0.15 moving from Q3 basis to Q4. It's going up another $0.10 or more going out into Q1. And obviously we think our pricing will recapture that. But it will always be lagging at least a quarter.

So I would say right now, I cannot predict where lead is going to go after February 7. But using February 7 prices, I would say that the margins that we projected, the 23% to 24% range for Q4, you know, it will probably stay in that range. At least one quarter beyond that. And then we'll to see where lead prices go.

But as we said, we expect to get and maybe the second half of next year. But our target is 25%. And we continue to take actions to reduce costs, improve our product mix, so that we can drive that in a longer-term basis.

Great. I think that was very clear. But I do want to just make sure that I'm understanding correctly, that if lead prices were to stay at this level, and not change, you would not in a quarter from now feel the need to raise prices again to account for again that -- the increase that's recently taken place. Did I get that?

I would say keep in mind that 35%, 40% of our business is on automatic pass- through. So those are always going to be moving up and down as whatever metrics they use to calculate that pass-through occurs. So I would say in other parts of our businesses that are not in a pass-through mode, that those are set on a more periodic basis. I would say that at the moment we think that they reflect the current market situation, the prices do.

Very helpful. Thank you both.

Your next question comes from the line of Jeff Osborne of Stifel Nicolaus. Please proceed.

Good morning. Congratulations on the strong results this quarter. Just a couple questions that haven't been answered.

On the recent quarter, obviously gross margins were quite strong. I'm trying to get a sense of how much was that due to non-material, non-raw material conversion costs improvement and lower overhead from the initiatives you've had over the past couple of quarters. And is that flowing through? Is that anything you can help us quantity?

Well, we said in the MD&A section on the Q that it's primarily driven in the shorter term by the commodity costs decline that ran through our P&L in Q3. On a more longer term, as I referenced earlier, looking back five years, I would tell you it is -- there is a definite improvement that occurs in the longer term from the cost improvement and the improvement in mix and pushing our thin plate pure lead and other premium products.

I think when you look at the business in total, and I'm not talking about one quarter to the next, I'm talking over a longer term period of time -- the investments that we've made in restructuring have paid off, very, very well. The investments that we've made in new products have paid off very, very well. In each of the areas with service to customers, by giving best value, has taken our margins up. But the variation that we see quarter-to-quarter, a lot of that comes because of this whole thing with where commodities go, and where our pricing goes with it. So it's tough one to answer, because it's constantly changing, because commodity cost are constantly changing. But the base business is improving every quarter with cost reductions and better products, and better service.

I understand. A few other quick ones here. On the tax rate for the upcoming fiscal year, any reason to believe that it wouldn't be in the 28% range, similar to this fiscal year?

The biggest impact that occurs outside of discrete items coming in and out of our tax calculation, and our reserves, is the mix of where we are earning our money. And we have talked about Europe has been relatively stable in its earnings. The Americas have been up. That puts pressure, upward pressure on our tax rate. Because the Americas has the highest tabs rate, corporate rate in the world. And Asia has been declining a little bit sequentially. That also puts pressure on our tax rate, because Asia is lower than the US. So as I look out to 2014, I would say it's mostly dependent on the mix of earnings and where we earn it, which is why when John says he's determined to get Europe up to 10%, that would have the biggest long-term effect on reducing our tax rate.

Yes. Mike, just to pick up on that, our goal is to see that tax rate go down and the reason for it to go down, take everything else and push it aside, is because of mix. We need to get Europe to 10%. The growth in the Asia market is big. If we could hold steady in the Americas and increase the percentage in the other areas, our rate should come down with everything else being equal.

No, the move to 10% in Europe, how much of that is your footprint and realignment there, versus just competitive dynamics that are bit out of your control?

Well, it's -- competitive dynamics is always going to enter on that. And that's something that hopefully that the moves -- hopefully we get better service than we have in Europe in the past, and hopefully we can have customers recognize that the value that we give is paying a little bit more in the front end. Ultimately the customer will end up paying less over the life of the product, because of better performance of products and better service.

Understand. The last quick one here. I had a chance to see the OptiGrid product at the recent trade show in San Diego. It was very exciting. I just had a question on how you think about pricing that product going forward?

At this stage I really don't want to comment on, that because we are still working with a number of customers on this. And we haven't really finalized that.

I understand. Thanks much.

Okay.

And your next question comes from the line of Richard Rosen of Columbia management. Please proceed.

Hi. Thanks a lot for taking my question.

So as an investor and we think about growth going forward, you guys have laid out your target of 25% gross margins and 10% operating margins. And give or take the movement in the price of lead, we're effectively there. You've spent a lot of the call talking about investing, reinvesting in yourself, which presumably means better margins, in the new projects that you have outstanding, et cetera. And other than -- but that at these prices you're not really buying back a lot of stocks. So in a long-winded way, how should we think about when it is that you'll be comfortable perhaps increasing your secular target for where it is that the profitability of the business should be?

Well, Rich, at this point we haven't set that internally. We are obviously very pleased with what's happening in the Americas. Europe, we've got work to do. Asia, we have work to do. So we obviously want to continue to grow our top line and our bottom line, and continue to improve. So at this stage, I'm going to leave that, as you put it, to 25% and 10%. In time we're going to adjust those accordingly.

So if the industry demand grows, 6% a year and we're roughly at where your targets are , maybe even a little higher, that's -- from the standpoint of expectations, that's really what we ought to be expecting out of EnerSys, is that fair?

Well, I think if, you know, we can sustain that 6% growth and those targets are definitely achievable. It's the decreases and increase, the puts and takes in our demands in the world's economy that kind of throw that.

A steady 6%. Yes, I think 10% would quickly become 12%.

Yes. Let's be sure we understand each other on those targets. The 25% and the 10% are minimum targets.

Yes.

Those are minimum targets. They're not, "We're happy at 10%."

Okay.

They're minimum targets. And when you look at this right now, and, yes we're hitting those targets. And we have hit them for a couple of quarters here. But are we on real solid ground to have 10% and 25% every quarter going forward? Mike mentioned earlier that the bottom could be 22%. Whether it's 22% or 23%, it's still not 25%.

Okay.

We've got to have a system in place and company in place, even under the bad times, that we can take and get that 25% and that 10% as minimum.

Okay. I guess I was thinking more of where is it that you think is possible within the organization, not as a year in and year out -- because obviously there is a lot of -- or certainly a degree of cyclicality caused by the economy and lead costs.

That cyclicality, that's the reality. That's real. I think a good management team has to understand that that's real, and we have to look at how we contend with it and manage around those things.

Okay. You highlighted a couple of new products and obviously thin plate pure lead is -- has been a great success for you. At what point do you anticipate some of these other projects becoming more significant to your business mix?

That's hard to tell because you take the OptiGrid as an example. Some have said that that market could be $100 billion, $200 billion. There's all kinds of numbers out there. It really doesn't matter. If it's $10 billion, it's a market we want to participate in. It's one that we're kind of the tail on the dog, so to speak. The market has to develop. And the end user has to want it. All I know is that the investment for our us to get into it is a modest investment at this stage. And the -- so the risk is low. The potential rewards could be significant.

Okay. But this is years away? This is years away, not 2014?

I think that one could be -- you know, I don't know. It depends how fast grid storage really takes off. And all I know is that we have a product that's ready and proven and tested and ready to go. And that market takes off. We're going to be there with that market.

Okay. Fine. One final question and this is even outside of what you currently do. The issues that Boeing has been having, obviously they still don't know what the problems are. From the standpoint of EnerSys, how does this change what you do? What is your observation, not necessarily from a Boeing standpoint, but from the standpoint of solutions and development of lith-ion battery solutions.

Rich, as you know, our investments in lithium have been modest. They've been small.

I know.

Part of the reason for that is because you've heard me say it in the past, when you look at the economics associated with lithium, not just the sale, the sale goes for $270 per kilowatt hour. The total battery cost, in my opinion, has been high, and it's going to get higher. And the reason I think it's going to get higher is because those applications, you're going to find that added protection is needed.

I'll give you an example of one. With the lithium-ion batteries, probably 12 or 13 different types of lithium-ion batteries. So when you look at the particular one that we used in Boeing, that one is one that does have conditions that can cause problems. I think what you're going to see in the future, that from our end on, those designs, you need to assume they're going to catch fire. When they do, they need to be in a container not to allow it to cause damage to other areas.

Okay.

I mean, that's lithium technology. It does have a condition called thermal run away. That's nothing new. The computer industry, the cell phone industry, has experienced in the past. The auto industry, to a lesser extent, has seen some problems with it, too. You have to be very careful from a design standpoint on it. The other side of the fence, I think it's a great technology for certain applications at the premium associated with it that people are willing to pay.

Okay.

And should pay. As an example, your cell phone or on a satellite. And our area of expertise in this is really into satellites, it's putting them into proton rockets, and it's putting into select military applications, and into select telecommunications applications. But it's a technology that's different, and needs to be treated differently than the traditional lead acid.

All right. Thanks. And great quarter.

Thank you.

Thanks, rich.

Again, ladies and gentlemen, that is star one for audio questions. And your next question comes from the line of Dana Walker of Kalmar Investments. Please proceed.

Good morning. Well done.

Thank you, Dana. How are you?

Doing great. Thank you. Nice to hear your voice. And, John, when you prefaced an earlier response as to you might be surprised by my answer, I wasn't surprise by your answer at all. You folks are indefatigable in finding ways to add to your structural advantages.

Question is this -- with the pick-up that you're seeing in orders, do you think that that's being shared by the market, or do you think that's unique to you?

Yes, Dana, it's an excellent question. One of our competitors has information out this morning. I haven't read all of it. But I think the indications in there were that they were seeing an increase also. So that piece of data right there would indicate that the market is up. I think in the Asia market it is up. I think the Americas is up. It's good question and I don't have a really good answer for you just yet. I think we have to further analysis on that.

I would say that we have picked up some market share, modest market share. Not a lot, by design, we're not going out giving pricings. The market share that we picked up is better service, better performance. So I would guess that it's both market and in a little bit with picking up market share, Dana.

Do you see anything in the mix of your business or the premium mix of your business that is different than the average number you described with your order pacing?

The premium business has picked up modestly.

Modestly better than the number you cited, or?

Modestly better than -- if you look at the percentage of the premium products to the other product lines, the premium products have picked up a little bit more than the other products.

Okay. You have described how you have felt that Asia has been difficult on European-manufactured demands in the past. And you thought that with some of the reduction outside of you in China that there might be a return of more demand sourced from Europe in Europe. If you were to update how you feel that interplay is working today, how does that look?

Well, if you go back when I made the statement, and the reason I made that statement, you had to look at where the Euro was to the RMB. Currency was one issue. The second issue, and the bigger issue was where the Shanghai exchange was to the LME. The Shanghai exchange to the LME, the LME was $0.22 per pound for lead less than the Shanghai exchange. Today that has changed. We're at parity. In fact, in a given day the SMN is actually less than the LME. So the bottom line to it is that perceived competitive advantage that we had because of the reasons stated has now gone away.

Now that's not bad from us. Because you got to keep in mind, we're also a Chinese manufacturer. So where we source the products from, we could take it to China and compete head-on in that end. So to your point, that has changed. That dynamic has changed.

Which may argue for a little less level loading in Europe than would have been the case when the LME was at a discount?

That is possible, yes.

Final question. As you look at your reserve business, can you talk about the different markets that you're addressing in reserve and the tone of them today?

Sure. Telecommunications market in the United States I think is continuing to expand. Data system in the US continue to expand. China telecommunications, they've basically stopped buying for a while. They're back buying strong right now, although those margins are lower than many other areas. Europe is mainly a replacement business today, on telecommunications. 4G really hasn't taken off. Data systems in Europe, on the UPS side, is doing fairly well. Middle East and Africa, a lot of good activity taken -- although small for us at this stage, we continue to invest in that area to pick up additional market share.

Good stuff. Thank you.

And there are no further questions at this time. I'd like to turn the call back over to Mr. John Craig for closing remarks.

Thank you very much.

I appreciate everybody joining us this morning. And to continue your interest in our Company. Thanks and have a great day.

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