EnerSys (ENS) 2022 Q1 法說會逐字稿

Good day, and thank you for standing by. Welcome to the EnerSys First Quarter 2022 Earnings Conference Call. (Operator Instructions) Please be advised that today's conference is being recorded. (Operator Instructions) I would now like to hand the conference over to your speaker today, David Shaffer, President, and CEO. Please go ahead.

Thanks, Victor. Good morning, and thank you for joining us for our first quarter 2022 earnings call. On the call with me this morning is Mike Schmidtlein, our CFO. Last evening, we posted slides on our website that we will be referencing during the call this morning. If you didn't get a chance to see this information, you can go to the webcast tab in the Investors section of our website at www.enersys.com.

I'm going to ask Mike to cover information regarding forward-looking statements.

Thank you, Dave, and good morning

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Current expectations and views regarding future events and operating performance 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 applicable only as of the date of this presentation. 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 fiscal quarter ended July 4, 2021, which was filed with the U.S. 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 11, 2021, which is located on our website at www.enersys.com.

Now let me turn it back to you, Dave.

Thanks, Mike. Please turn to Slide three. We delivered solid first quarter results due to robust demand for our products and services in each of our business segments. Orders over the last three weeks -- or 12 weeks, excuse me, are 25% higher than the same period FY '20 pre COVID. We reported first quarter fiscal 2021 adjusted earnings of $1.25 per diluted share, a 36% increase over the first quarter of last year. Our Motive Power business generated strong revenue and earnings growth, while our Specialty business continued its positive momentum, fueled by accelerating demand for our transportation products.

Despite challenges in the supply chain, Energy Systems began its rebound from a challenging fourth quarter, driven by growing demand in a variety of end markets, including mid spectrum 5G, broadband, and utility markets. Similar to other industrial companies, we are facing some challenges in the wake of the world's steepest economic recovery as businesses reopen and competition for labor, materials, and transportations remains fierce.

While we are seeing unprecedented demand growth, we have experienced constraints in our ability to bring on new employees necessary to keep up with demand. Freight and tariffs continues to be a source of cost pressure, along with a variety of other components, including resins and semiconductors. Our team has responded well to these short-term challenges, and we expect to see steady improvements in the supply chain as we work to mitigate its impact by identifying alternative sourcing methods and further leveraging our global footprint to align supply with demand. As these temporary issues unwind, we will benefit from the strong market momentum.

I'd now like to provide a little more color on some of our key markets. Please turn to Slide four. Let's start with our largest segment, Energy Systems, which saw modest improvement from the prior quarter, growing revenue by more than $22 million and generating a nearly $4 million gain in operating income versus Q4. Demand for our energy systems products remained strong with order intake from one of our larger telecom customers picking up after a slow Q4 that was driven by 5G radio availability, labor, and permitting challenges.

Broadband orders continue to improve and are expected to accelerate dramatically as the California Public Utilities Commission public safety grid shutdown extended network backward -- backup programs roll forward. While the market is displaying positive momentum, energy systems continues to experience drags in three primary areas. First, we have seen higher tariffs and freight costs as our efforts to move contract manufacturing out of China, closer to home is slowed by COVID versus our plan. Also, container shipping rates are at an unprecedented fourfold from historical rates and expedited fees are common. Delayed sales due to supply chain challenges, including semiconductors, continue to constrain our top line and gross margins due to lack of capacity for higher-margin cable power supplies, DC power plants, and Thin Plate Pure Lead products.

Second, we have incurred additional engineering costs to support our touch safe collaboration with Corning as well as advancing our lithium offerings and other NPIs supporting 5G and renewables from which revenue will begin to accelerate in the second half of this fiscal year. Our investment in R&D will also accelerate during the calendar year to advance the DC fast charge initiative that will benefit our next fiscal year. These investments will position us to be a significant participant in these new mega market trends.

Third, the ES group has been more heavily burdened with the ramp-up of the integration inefficiencies of the NorthStar acquisition. As noted prior, this integration and expansion is roughly nine months behind schedule due to COVID. Despite the short-term cost pressures, we remain committed to TPPL expansion and cost improvements to handle the rapidly expanding TPPL demand in all lines of business. Driven by sound underlying demand, we expect the Energy Systems business to continue its upward trajectory with the full opportunity set to be unleashed as these COVID related supply chain headwinds subside.

Please turn to Slide five. Our Motive Power business was a bright spot during the quarter. Despite some lingering supply chain constraints, we returned to the historically higher end of our return on sales for this business. Our backlog is now at historic levels, and our NexSys TPPL, along with recently released lithium variants, continues to gain market acceptance. We anticipate normal seasonality over the summer holiday months. While lift truck industry order statistics remain exceptionally high, we are being mindful of OEM supply limitations. We are confident that we are well-positioned to benefit from a steady recovery throughout the balance of the fiscal year.

The restructuring of our Hagen, Germany facility remains ahead of schedule in regards to cost and timing, with most of the cost savings yet to be realized. We will further evaluate our global footprint to ensure we can meet strong current order patterns and continue to extract savings with further standardization of our legacy product offerings and other business transformation initiatives.

Please turn to Slide six. Our Specialty business contributed another strong quarter to our overall results, despite the NorthStar related cost drag mentioned earlier. As the high-speed line and other productivity capacity enhancements are installed in our TPPL factories, we will enjoy lower costs and increase capacity in our second half results. Demand in our transportation business remains exceptional, buoyed by significant incremental revenue that we are positioned to win as additional Springfield capacity comes online.

U.S. transportation grew rapidly from the year ago quarter, and our backlog remains at record levels. We expect continued strong demand for the remainder of the calendar year from the U.S. economic recovery. We delivered exceptional results in aerospace and defense, as all of our markets were strong, including tactical vehicles and munitions. Munitions recorded several key wins based on our industry-leading technology that provides 40% extended life in thermal batteries. We will have doubled this business since the acquisition in just five years. Positive recent conversations with several of our customers, combined with the U.S.-sourced lithium initiative the Biden administration is highlighting in their infrastructure legislation gives us great confidence in the future growth opportunities in many of our businesses.

Please turn to Slide seven. As you know, we announced our battery energy storage system, plus DC fast charge initiative in the fourth fiscal quarter which remains on track regarding product development and performance, all while this tremendous market opportunity continues to grow. Our goal is to deliver an EV charger that charges any electric passenger car as fast as the car can handle, reducing the process from hours to minutes. By using a large stationary battery to quickly charge the EVs, we can dramatically reduce system insulation costs at many sites, including the size of the AC transformer and high-voltage cabling from the utility interconnect as well as the opportunity to provide optimized energy usage and emergency backup power. Feedback from our potential launch customer has been very positive, both on the speed of the development and level of software maturity, and we will continue to provide updates on this exciting initiative as we move forward.

Please turn to Slide eight. Although we expect to continue to face some supply chain disruptions in the near term, the fundamentals of our business are stronger than ever, with global demand for our products and services growing by the day. The massive 5G build-out is getting underway and will provide a strong multi-year tailwind for EnerSys. Thin Plate Pure Lead demand is growing rapidly in all lines of business and the launch of best-in-class modular lithium systems in motive power and energy systems further enhances our market-leading positions.

Lastly, a large bipartisan infrastructure bill is moving through Congress with additional bills being discussed, which could provide another catalyst for EnerSys in areas such as the electric grid, EV charging, and the rural build-out of high-speed broadband.

Please turn to Slide nine. I'd like to close by recapping our strategic initiatives, which remain unchanged: one, to accelerate higher-margin maintenance-free motive power sales with NexSys iON and NexSys PURE. Two, to grow the portfolio of products in our Energy Systems business, particularly in telecom, with fully integrated DC power systems and small cell side powering solutions, which will accelerate our growth in 5G as well as the addition of our battery energy storage system plus DC fast charge initiative. Three, to increase Thin Plate Pure Lead capacity, particularly for transportation market share in our specialty business. And finally, four, to reduce waste through the continued rollout of our EnerSys operating system. We will continue to execute on each of these initiatives and look forward to providing you updates on our progress in the quarters ahead.

With that, I'll now ask Mike to provide further information on our first quarter results and go forward guidance.

Thanks, Dave. For those of you following along on our webcast, we have provided the information on Slide 10 for your reference. I am starting with Slide 11.

Our first quarter net sales increased 16% over the prior year to $815 million due to a 12% increase from volume and 4% from currency gains. On a line of business basis, our first quarter net sales and energy systems were up 5% to $371 million. Specialty was up 21% to $108 million and motive power revenues were up 28% to $336 million. Motive Power's growth was mostly from 22% in organic volume and 5% in currency improvements. The prior year motive power first quarter revenues were impacted significantly by the pandemic with a 24% decrease in revenue. Our motive power revenues for Q1 are now comparable to the first quarter of two years ago.

Energy systems had a 3% increase from volume and a 3% improvement from currency, net of a 1% decrease in pricing. Specialty at 18% in volume improvements, along with 2% positive currency and 1% in pricing. We had no impact from acquisitions in the quarter.

On a geographical basis, net sales for the Americas were up 13% year-over-year to $557 million with a 12% more volume and 1% in currency. EMEA was up 27% to $201 million from 18% volume, 10% improvement in currency, less 1% in pricing. Asia was up 3% at $57 million and 9% currency improvement, less 6% volume declines.

Please now turn to Slide 12. On a sequential basis, first quarter net sales were flat to the fourth quarter. On a line of business basis, specialty decreased 19% from a very strong Q4 due to resin shortages, which are largely behind us. Motive Power was up 1% as it rebounds from the pandemic, and Energy systems was up 6% from organic volume. On a geographical basis, Americas and EMEA were relatively flat, while Asia was up 5%.

Now a few comments about our adjusted consolidated earnings performance. As you know, we utilize certain non-GAAP measures in analyzing our company's operating performance, specifically excluding highlighted items. Accordingly, my following comments concerning operating earnings and my later comments concerning diluted earnings per share exclude all highlighted items. Please refer to our company's Form 8-K, which includes our press release dated August 11, for details concerning these highlighted items.

Please now turn to Slide 13. On a year-over-year basis, adjusted consolidated operating earnings in the first quarter increased approximately $14 million to $75 million, with the operating margin up 50 basis points. On a sequential basis, our first quarter operating earnings dollars declined $3 million from $78 million, while the OE margin dropped 40 basis points to 9.2%, primarily due to Energy Systems results, which Dave has addressed.

Operating expenses, when excluding highlighted items, were at 14.5% of sales for the first quarter compared to 16.1% in the prior year as our revenue growth exceeded our spending. On a sequential basis, our operating expenses declined 1 and 10 basis points. Excluded from operating expenses recorded on a GAAP basis in Q1 are pretax charges of $14 million, primarily related to $6 million in Alpha and NorthStar amortization of intangibles and $8 million in restructuring charges for the previously announced closure of our flooded motive power manufacturing site in Hagen, Germany.

Excluding those charges, our Motive Power business generated operating earnings of 15.1% or 470 basis points higher than the 10.4% in the first quarter of last year due to easing of pandemic related restrictions and demand, coupled with ongoing OpEx restraint. The OE dollars from motive power decreased over -- excuse me, increased over $23 million from the prior year. On a sequential basis, motive power's first quarter OE decreased 50 basis points from the 15.6% margin posted in the fourth quarter due to higher lead and other input costs.

Energy Systems operating performance percentage of 3.5% was down from last year's 8.0%, although it improved from last quarter's 2.6%. The OE dollars decreased $15 million from the prior year. However, it increased $4 million from the prior quarter on higher volume. The cost of higher tariffs, freight, materials, and manufacturing costs continues to create headwinds. Specialty operating earnings percentage of 10.6% was up from last year's 6.5% on higher volume, but down from last quarter's 13.2%. OE dollars increased $6 million from the prior year but declined $6 million from a strong fourth quarter on lower revenue.

Please move to Slide 14. As previously reflected on Slide 13, our first quarter adjusted consolidated operating earnings of $75 million was an increase of $14 million or 23% from the prior year. Our adjusted consolidated net earnings of $54.4 million was $15 million higher than the prior year. The improvement in adjusted net earnings reflects primarily the rise in operating earnings, along with lower interest expense and a small currency gain.

Our adjusted effective income tax rate of 18% for the first quarter was slightly lower than the prior year's rate of 21% and lower than the prior quarter's rate of 19%. Discrete tax items caused most of these variations. We have made no adjustments for any proposed changes in taxation announced recently.

First quarter EPS increased 36% to $1.25, which was the top of our guidance range. We expect our weighted average shares for the first quarter -- or excuse me, second quarter of fiscal '22 to remain relatively constant with approximately $43.5 million outstanding. As a reminder, we now have over $55 million in share buybacks authorized, and we repurchased nearly $32 million recently. This recent buyback reflects the return to our normal pattern of removing the dilutive impact of our stock comp programs. Last week, we also announced our quarterly dividend, which remained unchanged from prior levels.

Please now turn to Slide 16. Our balance sheet remains strong and positions us well to navigate the current economic environment. We have $406 million of cash on hand and our credit agreement leverage ratio is 1.95x levered, which allows over $600 million in additional borrowing capacity. Last month, we extended and amended our credit facility on favorable terms, which is now in place through 2026. We expect our leverage to remain near 2.0x in fiscal 2022. We spent $26 million on our Hagen restructuring along with $46 million in inventory growth to support higher backlog. And as a result, our cash flow from operations was negative $48 million in the first quarter as we expected. The benefits from the Hagen Germany restructuring started in Q1, and we should exit the year with a $20 million annual run rate.

Capital expenditures of $16 million were in line with our prior guidance. Our CapEx expectation for fiscal 2022 is $100 million and reflects major investment programs in lithium battery development and continued expansion of our TPPL capacity, including the NorthStar integration. We anticipate our gross profit rate to remain near 24% in Q2 of fiscal 2022.

As Dave has described, we believe all three of our lines of business find their products in high demand. Near-term supply challenges are restricting our ability to execute fully on these opportunities. Our guidance range of $1.03 to $1.13 for our second fiscal quarter of FY '22, reflects the impact of these challenges, along with the normal seasonality of Q2 and the added investments in product development and personnel.

Now let me turn the call back to Dave.

Thanks, Mike. Victor, we can now open up the line for questions.

(Operator Instructions) Our first question comes from the line of Noah Kaye from Oppenheimer.

To put it mildly, this is a very dynamic production environment across the industrial space, and we've seen many number of companies talk about the impacts on supply chain from chip shortages and the like. So I was wondering if you can help us maybe dimension out a little bit some of these moving parts, what you saw in the quarter and what you expect in the upcoming quarter from tariffs to higher freight costs, components cost increases. You mentioned the pull forward of the wage increases in the next quarter and the EV investment. So if you can give us any granularity on some of those moving parts, it would be greatly appreciated.

In terms of the supply chain pressures, there's really four areas that are impacting, I'd say, the first half of our year so far. So what we posted in Q1 and what we're forecasting in these Q2 numbers, I would say the first one, and we talked about this last quarter, was freight. The base freight situation, I think, is stabilizing. So relative to where we were 90 days ago, the -- unfortunately, the base freight rate is higher, and the lead times are longer than historic norms. But I think that situation is stabilizing. So our supply chain folks are just having to adapt, but it seems like that situation is okay. It's more on the expedited freight, where things are still crazy. And so you can imagine in this era of all these supply chain surprises that more often than not and too often, especially in Q1, we've had to expedite things. And that -- those costs right now are exorbitant. So we're trying very hard to minimize the amount of expedited freight we use because that continues to be a major pressure on the organization.

Obviously, another one is just -- lead, we've talked about for years, and that's something that we have to deal with. But what we've seen this year is, obviously, just like everyone else is inflation on other things, non-led. And I think we've done three price increases already in our three lines of business so far since April. And we'll continue to push these costs through. It's just no one likes -- our suppliers don't like giving us price increases, and we certainly don't like giving them to our customers. It's just -- it's the world we live in right now. And I think we're all hoping for a little bit of stability. But in general, I would say the price stickiness is good. I think our Energy Systems business has a longer tail because of the nature of the businesses. So getting pricing from that piece of the business is a little harder than the other two.

But that said, all of our sales leaders are committed to protecting our gross profit dollars. The resin shortages was a real acute problem 90 days ago when we spoke. And it really has limited our ability to ship TPPL, both in our specialty transportation business as well as our reserve power -- legacy reserve power, Energy systems battery business and that really put one of our factories, especially in Q1 and Q4 on their tail because they just couldn't get enough product. And so we absorbed a lot of variances. I'm happy to report that we should exit this quarter with enough resin for the rest of the year. So that situation has dramatically improved versus 90 days ago. And when you combine that with the improvements we've made in terms of our ramp in Springfield, we're much more optimistic about our production levels on tin plate pure led in the second half.

And then finally, the semiconductor issue, this is, like many companies -- now again, the amount of semiconductors we have in our revenue stream is different than other companies. So I would say, in the first half, Mike, I would say semiconductors has equated to about 40 bps of gross profit pressure so far in H1. And it's really an issue, Noah, of mix because a lot of our higher-margin products -- we're on allocation right now on some of these chips. So we could be doing a lot more. We certainly have the backlog. And a lot of the shortages we've had at resins included, have been for products that are on the higher end of our mix. So the mix has been dragged.

And the chip situation, I think our allocations are going up a little bit as we go forward per quarter, but that one is just something we have to adapt to. I know that everyone in the engineering group have been feverishly trying to redesign things and our supply chain folks are jumping through hoops. And obviously, we're having to do some spot buys that we don't normally do to secure some of these. I mean, one of the things we've talked about is we have to protect the customers throughout all this craziness. And I was laughing to myself this morning, I think our ops team has probably had more sleepless nights post COVID than during COVID. It's just been that sort of crazy environment right now.

But that said, we're hanging in there, and we're still extremely optimistic about our end markets. And in terms of the sequential, Noah, you mentioned, I would say, yes, we're definitely seeing some pressure in the second quarter sequentially from the DC fast charge. We -- again, because of COVID, we retimed our normal annual wage increase, I'd say it's been 3% forever. It's just been re-timed, and I wanted to make sure that we adjusted -- I think we're going to stick with this timing going forward, Noah. So we just wanted to call that up to make sure we have that.

We've got our normal seasonality in the second quarter, has a lot to do with the -- a lot of the OEM customers in Europe. They've told us they're going to take their normal holidays. No one's working through the holidays. We thought maybe they would, but everybody has taken their normal holidays. And so seasonality is certainly part of their -- and then I think there's probably about two pennies by below the line, FX and so forth. So that's sort of -- I think the supply chain pressure we're feeling and then some of the sequential -- I would say, really right now, H1 and H2 operationally feel pretty similar. There's just these other pieces to Q2 versus -- excuse me, Q1 and Q2, feel operationally, very similar. It's just that there's these other pieces we just called out for the second quarter versus the first.

That's very helpful, Dave. You mentioned the stickiness of pricing. Just given all the costs that you're talking about incurring, I guess it's a little bit hard to see in the quarterly results and price was basically flat and even in motive and specialty, it looks like you're getting maybe a couple of million dollars of pricing benefit year-over-year. It doesn't seem enough to offset some of these increased cost pressures you're talking about. So help us understand because the company talked about 5% to 10% type price increases. When do we start to see more of that price flow? And when could potentially you be getting into a more favorable price cost dynamic?

It's -- there's always a lag, always between when these things are executed. We've -- it's been a worsening situation in some of the commodity categories. It's been a stabilizing situation in others. None of them have really receded. So we're just executing prices, but the most recent price increase just went out last week. So it's just -- there's just delays in how long it takes to get these through the system. And I think it's a longer tail as noted on the Energy Systems business relative to the other two businesses. Mike, you want to add anything?

No, we expect price improvements in the upcoming quarter as much as $10 million. The -- some of that is absorbed on some of the costs that continue to increase. But by and large, we have been running at about $0.20 of headwinds for the last two quarters as we looked at. And some of those will be abating in the upcoming quarter. And we've done a great job on things like resin shortages and chip shortages of doing workarounds and substitutions. So we haven't -- it hasn't had as big of an impact. But moving into Q2 from Q1, the investment in the fast charge engineering cost, the raise, at least temporarily, I would say it would have a little bit of drag. The seasonality will disappear and a higher tax rate and a little bit higher interest in FX headwinds will go away. So we don't necessarily see those as permanent. And we do expect sequentially improving top lines, particularly once we move into H2.

Our next question comes from the line of John Franzreb from Sidoti.

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All right. Our next question is from the line of Brian Drab from William Blair.

Can you, maybe Mike, quantify a little more specifically the sequential impact of these temporary issues from first quarter to second quarter, like the EV investment, the wage increase in terms of EPS impact as first quarter relative to second quarter?

Yes. No, as Dave said, we -- the investment in additional engineering resources in the second quarter is about $0.03 of headwind. The annual increase in raises for that quarter is about $0.06. Our normal seasonality. And I will say that our second quarter is more often than not less because of the -- primarily because of the European holiday situation. It doesn't always work that way because there's other dynamics that could impact the Q2. But one thing that is always constant is that seasonality is a drag. It just may be offset by other items as we report Q2 results. But that we expect to be about $0.05 to $0.06 worth of a drag. And then as Dave mentioned, there's $0.02 to $0.03 on the FX interest and tax rate below the op earnings line.

Is it fair to say that when we talked to, I think, last -- in May, end of May, probably, that you felt like maybe other factors would overshadow these -- kind of offset some of these headwinds and that the second quarter is shaping up below where you would have expected previously? Or is this kind of -- has this kind of guidance been contemplated, you think? Have things gotten worse in terms of your outlook for the second quarter since May?

Yes, Brian. This is Dave. I'll start. I tried to make the point that, I think, operationally, really, H1 has been one set of circumstances. So there's no major changes there in terms of the seasonality and these things we've pointed out, yes, I guess that they've been there. As often is the case, as Mike said, in the case of seasonality, the engineering, certainly, that's an investment we've signaled that we're really excited about this opportunity. So yes, it's really -- the first half has been sailing into some fairly strong headwinds. I personally have a lot of optimism about the second half versus the first half. I would say we're going to have more TPPL, which is going to help margins. It's going to help revenue. We should have less manufacturing variances. Some of this COVID stuff gets out of the way. I think even though we're adding in this engineering, I think OpEx as a percentage to sales should stay in check in the second half. I think we're going to come into the second half this year with the strongest backlog we've ever had going into the second half.

So that certainly can't be a bad thing. I think as Noah and I were discussing earlier, some of the pricing should start to catch up. And I think that Hagen, we haven't really realized much of those savings, and we're going to start to feel that more acutely in the second half. So those are sort of my key reasons for optimism. Of course, the supply situation, as we noted in the press release, is fluid. And you just don't know what's going to further happen. But most of the signal -- we've gotten some signals from our OEMs. I think the -- like for the example, the semiconductor issue has been probably more of a downstream issue for EnerSys than an upstream issue because a lot of our OEM customers aren't building vehicles at the rate they would like to simply because they can't get enough chips. And we've had a few of them signal to us and give us advanced warning that they're going to ramp back their production rates higher in our fiscal second half than where they've been running in our first half.

So these are sort of the reasons for optimism. By no means are we discounting the pressures that we're seeing on the supply chain side. But you worry about what you can control, and we're just -- we're trying to get pricing as often as we can. So that's my best sense of the situation. Mike, did I miss anything there?

No, I think you covered all the relevant items.

Yes. I guess this is -- it's such a challenging situation that we're in the middle of a global pandemic. I mean, Mike, Dave, you mentioned -- you used the term post COVID. I don't know if everyone's feeling that way at the moment, like cases in Illinois doubled again last night. So I know it's a tough situation, but it's just as a stock analyst looking at this and trying to model the second half of the year -- and right now, the consensus estimate, like the average EPS for the third quarter and fourth quarter is $1.48. And when we see the guidance for the second quarter, just wondering, can you make any comment as to whether I mean the $1.48 is feeling like a stretch to me at the moment. And I just wonder if you could comment on that since you obviously have much better visibility than I do.

Well, Brian, I think we've done a pretty good job of navigating COVID for the last 18 months. I'm not saying that it's behind as clearly, it isn't. But I think that is okay. The inflationary pressure is somewhat of a guess. We really just do not know how much more headwind we have. There is always a drag between some of what we incur versus what we can do in pricing, particularly in our order book or some of that pricing, not all of it, but some of it's set. Others are indexed to things like lead adjustments, et cetera.

So there are plenty of things that you could say could make the second half not as good as the analysts' expectations for H2. But the demand for our product across every line of business is been unprecedented. And just, for example, the drag we've had on resins that we've really just kind of gotten behind, to be able to unleash the TPPL capacity up to a $300 million per quarter run rate and get our Springfield Plant 2 and its high-speed lineup to full operational speed, we'll have great benefits, which we haven't really enjoyed to date. So there are plenty of reasons for optimism.

The Hagen factory, which, as I said, only just started to deliver benefits, it's going to start showing up on our bottom line in ever-increasing amounts per quarter for the rest of this year. So there's a lot of things that we're excited about it. And there are some things that are going to be a detriment. There's some unknowns we just can't comment on. But I don't know that -- I don't think anyone here is ready to throw out H2 and say it's not going to be the step-up that you expect, that we expect.

Right. Brian, -- and you're right, it's poor choice of words on my part. There's certainly -- we're living with the pressures every day. I meant -- that was really about the shutdowns that we saw last year. And we're -- so yes, we were very concerned about the Delta variant and the transmissibility. And I think I'm more optimistic than I was a year ago. I think we've got protocols in place. We've got a fair number of vaccinated folks. We've got a lot of folks that have had the virus already. And I haven't seen any signaling from really anyone about the draconian type of shutdowns we saw or the precipitous type of shutdowns we saw. So -- but I agree with you 100%. We are by no means out of the woods. And our EH&S folks, we still meet on a very regular basis and review all the data. So that was a poor choice of words on my part.

Yes. Sorry, I wasn't meaning to emphasize that. I was just -- obviously still a tough situation. And good luck to you guys.

Thank you.

Our next question is coming from the line of John Franzreb from Sidoti.

Can you hear me now, guys?

Yes.

Yes, we can.

Thanks to the operator. Dave, I want to go back to your commentary about the EV market and calling it an immense opportunity. From my understanding, I think the original expectations was something around $100 million. Has that changed? And can you talk about the investment that's involved in the EV opportunity?

Yes. It's really exciting. We've slated. And again, it was about $0.03 of pressure in Q2 for additional engineering support we need on the systems integration side. We've got a launch customer that we're focused on and the forecasts are so big, I don't even want to talk about it because it's just unbelievably exciting. But that said, our initial focus in the next 12 months or less is to secure an order for the first 100 systems. And that 100 systems could be between 50 and $100 million depending on what variation of the systems, the launch customer wants to look at. And we're particularly excited about this system because there's a lot of intrinsic benefits of combining this battery energy storage system with this DC fast charge.

So these BES systems are just now starting to pencil because the cost of the lithium batteries has come down so much. So the systems are just starting to pencil. But then when you layer on the ability to really rapidly or hyper-fast charging electric car, it really pushes the math over the top, and we've just seen tremendous -- and our focus, I know that the EV market is the wild west right now. And we're really trying to hunt with a rifle, not a shotgun. And we've really zeroed in on these commercial real estate partners that have big portfolios where they can benefit from the battery energy storage system, the energy systems, the demand charge mitigation, the emergency backup power, but then they also, for their tenants or their clients want to offer fast EV charging as part of their services that they provide.

So it's -- we're locked in. We've got a great software partner. We've -- and I'm just really proud of my engineering team and how fast and how far we've come already. And then I think a lot of what we're going to see, hopefully, this gets past this stimulus bill. But as you see, there's an astronomical amount of funds that are going to be allocated towards EV charging. And the space where we're trying to compete, which is the above 50 kilowatts. So fast charging is 50 kilowatt. We're trying to -- our chargers are more like in the 160 kilowatt range. So these are hyper-fast chargers. That's a much less crowded space.

So it's -- and we think the macros are lined up. In the end -- and we just had this discussion at the Board meeting last week, it's really, in the end, the system we're putting together, it's batteries and chargers. And this is what we do as EnerSys, we do batteries and we do chargers. And the systems integration piece, we've come a long way over the last four years, five years. So we're a different company in a lot of ways. And it sets us up perfectly for market opportunities like this.

I think the other part of the stimulus bill too that we mentioned we're excited about is this rural broadband initiative. That's really big for us. We're so well positioned with the Lex, like Windstream, Century, Frontier. We're well-positioned with the MSOs, Comcast, Charter, Cox, folks like that. And these are going to be the big winners in this rural broadband initiative. And then the -- I don't know if you've read the bill yet, but a lot of the -- it's fairly prescriptive on what equipment is going to attract subsidy. It has to be part of the core.

And all the products that we make even really the new Corning project we've been working so hard on that fits right in the sweet spot of what this rural broadband build-out is going to be like. So the demand side of things, the strategic plan we've laid out, the product portfolio, we're really in tremendous shape. It just comes down to getting through this period. And I can spend the whole call complaining about it, but there's no use in complaining about it. We're just going to continue to fight through it.

Mike, you want to add anything?

Yes. And the other program that we mentioned that we're really excited about and it's probably the most immediate of all of them is the California Public Utility Commission's back up for that, which for us is just starting out as a $50 million opportunity. It's providing turnkey operations in both -- with both lithium cells and our TPPL cells. And that's -- this is for the cable MSOs and to keep their networks up and running in case of fires, high winds, et cetera. So it's -- that is something we're working on and finalizing some of the details right now. And so there are a number of things. And the last one, I think most people know the 5G build out right now is kind of that mid- spectrum, which we are participating in, but the one that we're really excited about is the small cell at the ultra-wideband. That's where we think things like the Touch Safe program is really going to shine. So there are probably five different projects, including the RDOF or rural digitization program that Dave mentioned. There's a lot of great things in energy systems coming down the road in the next three years.

Okay. And I guess, more immediately, when we think about how the resin shortage has hit your TPPL line that you put in price increases that semiconductors have impacted your higher-margin products by 40 bps. When you think about the second half of the year and that stuff is presumably behind you, what kind of gross margin benefit would you anticipate from a normalization of those sales of those products?

I don't have that number in front of me. Mike, do you have a good estimate for that?

We talked about the fact that just the drag we've been experiencing thus far from some of the lost sales of those products was about a 40 to 50 basis points improvement. We probably incurred nearly 100 points basis -- 100 basis points drag from expediting fees and higher freight. Now I can't promise that that's going to normalize or I don't know when it's going to normalize, but I don't see it staying at this sustained rate.

So there are -- and as we said, the other things that we expect to see improving, the manufacturing variances, which were kind of dragging back as these plants come out of lower capacities and they step up their operating efficiencies, Springfield gets better. You're going to see sequentially better manufacturing variances coming through on the P&L. OpEx should stay the same and even drive a little bit lower, allowing us to make some of these investments in engineering costs. And the pricing will stick. It does take a quarter or two, but we will start recovering on pricing. And the Hagen savings are going to be there.

So I can't promise when it's going to happen, but there certainly is enough opportunities to get over 200 basis points of improvement in margin.

(Operator Instructions) Our next question comes from the line of Greg Lewis from BTIG.

Just following on, Mike, on the energy systems. I realize it's kind of been picked over throughout the call. But is really that lag time on pricing? It sounds like that's a quarter or two before -- is that the right way to think about energy systems? Or is it kind of longer lead times just as we've been thinking about inflation in the market for the last couple of quarters? And just trying to understand, if you can provide a little more color there.

Yes, right, Greg. I think that the energy systems business has a much different supply chain than our other two businesses. And whether it's our old Purcell asset that we own before the acquisition, and certainly, the Alpha pace has -- it's really more of an integrator business where we have a lot of the components and subcomponents and subassemblies made in Asia with a very long supply chain. And relative to our other businesses, it has more semiconductor content, just a far more complex supply chain. And there's -- and as we've talked about, those long supply chains right now are getting brutalized.

So the longer the supply chain, the tougher it's been. So whether it's freight, expedited freight, we couldn't even get C containers for a while. We had products sitting in warehouses in China that we just couldn't get. So it's the length of that supply chain and tariffs obviously has been a major headache for us. And we've been pushing really hard to bring that stuff closer to home and shorten up these freight lines and supply chains. But you can imagine during COVID, it's just been -- it's been the wild west, trying to get anything done, and with these contract manufacturers with all the supply shortages and so forth.

So it's just a much different business. But that said, the outlook is fantastic, and we just have to get through this period. Mike, is there anything you want to add?

Well, I would say that the pricing in energy systems and in some cases, in our aerospace and defense tend to be fixed for a period of time, a contractual period, maybe a year. And there's little or limited ability to move pricing. Some of those agreements may have some escalators. But there are somewhere you're limited in time for a certain amount of time to do any pricing. Motive power tends to be more adapt to changing quicker in the market. But -- so we will come to a point where those prices will be renegotiated, those costs can then be recovered. And that's just things that we're working through on a case-by-case basis.

I guess the other piece of that and along that line is the Energy Systems business is dominated by some very big customers, Comcast, Charter, T&T, and T-Mo Sprint. That -- so it's just -- it's a very different business in that sense. But the -- we just need to manage through this. And the upside potential, in the long run, is tremendous. But Mike's point is right. The price tail is much different than it is in the other businesses.

Yes. Okay. I appreciate that. And then, Mike, inventories went up sequentially. Was that largely on the back of those, I guess, prepurchases or inventory building of resin? Is that maybe the right way to think about that?

Well, I would say that -- a couple of things. Number one, given the size of our backlog and when our production planners look at the order book, they start ordering product and assume that the production plan can be executed. So whenever your backlog goes up, your inventory order process goes up. In some cases where you've seen some spot shortages, you can find that they will try to cover with a little bit more safety stock. So some of that defense is trying to just be -- have enough on hand because sometimes just getting containers becomes a hit or miss thing. So some of that is just being prudent in some of it.

So -- and I will say that typically, our fourth quarter tends to be the low point on inventory, and then it kind of starts growing throughout the fiscal year. But -- so it wasn't unexpected. I would say that the two things we've probably done this quarter, we've made sure we paid our suppliers on time because we don't want to cause ourselves to drop in anybody's priority list because we weren't paying on terms. And we, in some cases, order a little more than we need for a safety factor.

Yes. And then just if I think about this, I mean, obviously, the supply chain issues globally are a mess. I mean, I guess, today, this morning, China announced that like they're closing -- shutting temporarily one of their Boards down. Is there any way, like as we think about your different segments, maybe which ones are more exposed to the Asian supply chain than others?

Well, as Dave just mentioned, energy systems has the most exposure with the contract manufacturing. Other than that, we try to build in the regions that we sell in. So we're typically insulated for the most part, on a battery side. But when it comes to the electronics and the people that manufacture --

It's a question about with some charges and stuff, but it's manageable where the sales teams are doing a tremendous job and substitution. So it's for us, it's an ES problem.

Okay. Perfect. Great. And then just one final one for me. Dave, just because it is -- I mean, it's good, hopefully, largely good, but as I think about that backlog, and it's kind of hitting that record level, is there any kind of way to parcel out how much of that backlog is there because of the supply chain issues, i.e., would it be maybe 5% or 10% lower if you weren't having these issues and that revenue maybe last quarter would have been higher? Is there any kind of way to think about that -- way like that?

Yes. It's a good question. I would say that when I pressed during our monthly business reviews with my leaders, they pretty much tie most of this to particular jobs. And so whether it's a T-Mo cabinet that's going out or whether it's a motive power battery that's tied to a truck, it's mostly accounted for. So I haven't been able to -- I try to pressure test that. But that's -- and Mike can certainly add some color here.

But so far, we just haven't been able to look for any real kind of softness in the backlog number. And the -- one of the things -- and we tried to point out is in the worldwide industrial truck data, we see these unbelievable 80 kind of percent growth rates on orders, but then the forklift market continues to -- the revenue. So their orders are just like a Mount Everest, but their actual sales -- so our sales are really linked to their sales, not to their orders. We're not going to -- the truck lead time is so much longer than the battery lead time.

So that again gives me some comfort that we're just in a great demand environment right now. EnerSys is well in some great macro markets. And we just need to execute through the supply chain issues and keep our chins up and not get too dejected about it and stay optimistic, and that's what we're trying to do. Mike, do you want to add anything?

Yes. Our backlog is probably $200 million higher than it might be on a typical quarter historically. And we've already said that there's probably $10 million to $20 million that we leave on the table any quarter from missed revenue because of these shortages we've been describing. So you could probably take that off of backlog if you execute it. There is probably some people ordering from us and other suppliers just to get in the queue, but I think that's fairly limited. That might be $20 million, $30 million. So collectively, I think what's left is at least $150 million, which, to Dave's point, reflects core demand that is real, and that is a reflection of what the markets for our products are doing.

And I'm not showing any further questions in the queue. I'd like to turn the call back over to David Shaffer for closing remarks.

Thanks, Victor. And I want to thank everyone else for taking the time to join our call today. We look forward to providing further updates on our progress and on our second quarter 2022 call in November. Have a great day.

This concludes today's conference call. Thank you for participating. You may now disconnect.