EnerSys (ENS) Q2 2016 Earnings Report, Transcript and Summary

Good day, ladies and gentlemen, and welcome to EnerSys Second Quarter Fiscal Year 2016 Earnings Conference Call. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session and instructions will follow at that time. As a reminder, this conference is being recorded. I would like to introduce your host for today's conference, Mr. John Craig, Chairman and CEO. Sir, you may begin. John D. Craig - Chairman & Chief Executive Officer: Thank you very much. I appreciate it. Good morning, everyone. And joining me on the call this morning is Dave Shaffer, our President and Chief Operating Officer; and Mike Schmidtlein. Now last evening, we posted information on our slides that we're going to be covering this morning on our website, which is www.enersys.com. Just as informed a few minutes ago that there is some technical problems, so you may not be able to see these things, even though we'll be referencing too, on this morning. But, before we get into the details on our second quarter results and what we're looking at for our third quarter, I'm going to ask Mike Schmidtlein to cover forward information, so Mike would your take it over from there please? Michael J. Schmidtlein - Chief Financial Officer & Senior Vice President: Thank you, John, and good morning to everyone. As a reminder, we will be presenting certain forward-looking statements on this call that are based on management's current expectations and are subject to uncertainties and changes in circumstances. Our actual results may differ materially from the forward-looking statements for a number of reasons. Our forward-looking statements are based on management's current views regarding future events and operating performance, and are applicable only as of the dates of such statements. For a list of factors which could affect our future results, including our earnings estimates, see forward-looking statements included in Item 2, Management's Discussion and Analysis of Financial Condition and Results of Operations, set forth in our Quarterly Report on Form 10-Q for the fiscal quarter ended September 27, 2015, 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 November 2, 2015, which is located on our website at www.enersys.com. Now, let me turn it back to you, John. John D. Craig - Chairman & Chief Executive Officer: Thanks, Mike. In September, we announced some organizational changes, which I'd like to discuss this morning. Effective April, 1, Dave Shaffer will become the new Chief Executive Officer of EnerSys. I will be retiring as CEO at the end of the fiscal year, but will stay on as Chairman of the board of the company. This is such a plan, has been in the works for quite a while and Dave has prepared himself for the CEO role by taking on excelling and leadership roles in the Americas, Europe and Asia. Dave knows our global business very well and I believe this transition will be seamless. The company is in great hands with Dave Shaffer. We also announced the retirement of Executive Vice President, Dick Zuidema. He joined the company in 1997 and has been instrumental in helping build EnerSys from a $200 million to the $2.5 billion company that it is today. I'd like to thank Dick for what he has done and all the hard work he has put into the company and wish him the best in his retirement. Also, we announced that effective January 1, Todd Sechrist, who is the President of our EMEA region and previously was President of Americas area, will be promoted to Executive Vice President and return to U.S. At the same time, Holger Aschke, who has run our reserve power business in EMEA will be promoted to President, Europe, Middle-East, and Africa. I'm highly confident in the succession management team that we've set up. As in average the individuals I just mentioned have about 20 years' experience in the battery business. Now, I'd like to turn the call over to Dave Shaffer. David M. Shaffer - President & Chief Operating Officer: Thanks, John. I appreciate your kind words. On Monday, we reported second quarter results of $0.97 per share, which exceeded our guidance range of $0.92 to $0.96. You will notice on slide three, our year-over-year sales and earnings were lower in the second quarter, due mainly to the impact of foreign exchange rates and a continued pause in reserve power spending. However, due to a positive motive power business and lower commodity costs, we experienced a record gross profit percentage of 27.2%, while our operating profit percentage remained strong at 11.7%. Our year-over-year earnings per share were down $0.09, mostly due to lower reserve power organic volume and the impact of exchange rates. I now want to focus on our current business activities and third quarter guidance. Our global motive power business continues to experience good order levels and a positive mix. In the last 12 weeks to 16 weeks, motive power orders have averaged year-over-year an increase of close to mid-single-digits. We continue to believe that these positive order levels are sustainable due to the ongoing strength of new electric fork truck orders. The three-month electric fork truck orders for July through September are up 7% globally compared to prior-year. Moving to reserve power, most markets are experiencing relatively stable volume with the exception of telecommunications, which continues to be soft, especially in EMEA. As we have said in the past, telecommunications is an up and down business, although we continue to have normal quote activity in both enclosures and batteries. Due to the reduced telecommunications' volumes, we have taken measures to reduce our manufacturing and SG&A costs. In Asia, we are experiencing double-digit order growth, mainly due to the fiber-to-the-home project in Australia, which we previously announced. Also, we now have visibility to the major telecom tender results in China and the results are encouraging, though the tender is approximately three months behind the original schedule. Our fourth fiscal quarter should benefit from increased volume from this tender. Based on the above trends and information, our earnings per share guidance for our third quarter is between $0.90 and $0.94. In our third quarter, we expect that higher manufacturing variances generated in the summer months will flow through cost of goods sold and impact gross margin. In addition, our lead cost will be impacted as lead hedges that were locked in when the spot rate was higher, worked through the third quarter financials. On Monday, we also announced that our board of directors approved a quarterly dividend of $0.175 per share payable on December 24. In August, we executed an accelerated share repurchase program of up to $180 million, which has a final settlement date in February 2016. These repurchase shares will primarily replenish the company's treasury shares, which were issued in July to pay off the premium amount due on the convertible notes. In closing, we are still on track to have our global fiscal 2016 business deliver improved financial results in the second half of the year versus our first half. Even if the pause in reserve power orders were to continue in the Americas and EMEA, our fourth quarter will benefit from lower lead costs, more days in the fiscal quarter, and higher volume in Asia. I remain optimistic about the future opportunities available to EnerSys. And now I'll ask Mike Schmidtlein to provide further information on our results and guidance. Michael J. Schmidtlein - Chief Financial Officer & Senior Vice President: Thanks, Dave. And for those of you that follow along on our webcast, which I understand should be up in a few moments. I'm starting with slide four. Our second quarter net sales decreased 10% over the prior-year to $569 million, despite 1% increases in both price and acquisitions due to a 9% currency headwind and 3% volume decline. On a regional basis, our second quarter net sales in the Americas were down 3% to $323 million, while Europe's decreased 19% to $189 million, and Asia decreased 10% in the second quarter to $57 million. In the Americas, a 1% organic volume decline was further reduced by a 2% currency decline. Europe had a 2% increase in price, but 16% currency decline and a 5% volume decline. In Asia, volume decreased 9% along with the 13% currency translation and a 1% decline in pricing, while the new ICS acquisition added 13%. On a product line basis, net sales from motive power were down 6% to $295 million, while reserve power decreased 13% to $274 million. Despite the 9% currency headwind, motive power enjoyed a 1% volume gain and 2% from higher pricing, while reserve power incurred an 8% volume decrease and 8% of negative currency translation net of a 3% price increase. Please now refer to slide five. On a sequential quarterly basis, second quarter net sales were up 1% from the first quarter, due to 1% increases in pricing and acquisitions, less a 1% currency decline. The Americas region was up 2%, and Asia was up 18%, all due to their recent acquisition, while Europe was down 4%. On a product line basis, motive power was down 1% and reserve power was up 4%. 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 November 2, 2015, for details concerning these highlighted items. Please now turn to slide six. On a year-over-year quarterly basis, adjusted consolidated operating earnings decreased approximately $7 million, while the operating margin remained flat. On a sequential basis, our second quarter operating earnings dollars were similar, while the operating margin declined 20 basis points. The decrease in operating earnings from the prior-year reflects primarily lower organic volume and currency headwinds. Operating expenses, when excluding restructuring and due diligence costs were at 15.2% for the second quarter compared to 13.8% in the prior-year. The rates of the second quarter's operating expenses increased on higher stock compensation, bad debt expenses and foreign exchange rates. Our Americas business segment achieved an operating earnings percentage of 15.3% versus 12.9% in the second quarter of last year, primarily from the impact of lower commodity and manufacturing costs. On a sequential basis, Americas' second quarter increased 70 basis points from the 14.6% margin posted in the first quarter also due to lower commodity and other manufacturing costs. Europe's operating earnings percentage of 9.0% was down 220 basis points on currency declines and lower volume from last year's second quarter of 11.2%, and lower than last quarter's rate of 10.5%. The operating earnings percentage in our Asia business declined in the second quarter of this year to breakeven from 7.2% in the second quarter of last year, but remained consistent with the prior quarter. Asia's operating earnings for the second quarter reflect lower volume in Chinese telecom sales as well as the impact on earnings of plant startups in Q2 versus the prior-year. Asia, due to its smaller size, remains our most sensitive region to operating inputs. Please move to slide seven. As previously noted on slide six, our second quarter adjusted consolidated operating earnings of $67 million was a decrease of 10% in comparison to the prior-year, while the operating margin remained consistent at 11.7%. Excluded from our adjusted net earnings for the second quarter was approximately $5 million of highlighted net charges, the largest being the $3 million net charges for costs associated with an investigation of the industry, competition matters in Europe. Please see our press release issued November 2 for details of these items. Our adjusted consolidated net earnings of $44.7 million decreased 14% from the prior-year to 7.9% of sales for a 30 basis point decrease, while our book tax rate was 27%. EPS decreased 8% to $0.97 on lower net earnings with 2.5 million fewer shares outstanding. The lower average diluted shares resulted primarily from share buybacks, which exceeded the final 1.9 million share dilution from our convertible debt, which was extinguished in July. To offset this dilution, the company entered into an accelerated share repurchase program with an investment bank to acquire between $120 million to $180 million of our shares by the end of our fiscal year. This program should result in an average diluted shares outstanding of approximately 45.0 million shares in our third quarter and 43.75 million shares in fourth fiscal quarter. Our adjusted effective income tax rate of 27% for the second quarter was comparable to the prior-year. We believe our tax rate for the next quarter of fiscal 2016 will be between 25% and 27%; but for the full-year, we expect a 25% rate on our as-adjusted earnings. Please now turn to slides eight and nine. As usual, we have provided information on a year-to-date basis similar to that of our second quarter on the prior pages. These two pages are for your reference and I don't intent to cover the year-to-date results. Please now turn to slide 10. Now for some brief comments about our financial position and cash flow results. Our balance sheet remains very strong. We now have $321 million on hand in cash and short-term investments as of September 27, 2015, with nearly $443 million undrawn from our credit lines around the world. We generated $175 million in cash from operations in our first half of fiscal 2016. Our leverage ratio was at 1.5 times, despite spending over $200 million in share buybacks and dividends in fiscal 2015. Capital expenditures were nearly $34 million in the first half of fiscal 2016 and we should reach up to $75 million for our full-year. We expect to generate adjusted diluted net earnings per share between $0.90 and $0.94 in our third quarter of fiscal 2016, which excludes an expected net charge of $0.06 per share from our restructuring programs and acquisition activities. We anticipate our gross profit rate in our third fiscal quarter will be between 25% and 27% and our interest expense will be approximately $5.5 million. In conclusion, we expect our third quarter to be followed by our normal stronger finish to our fiscal year. Now, let me turn the call back to you, John. John D. Craig - Chairman & Chief Executive Officer: Thank you, Mike. And with that, I'd like to open up the lines for questions.

And our first question comes from the line of Ben Hearnsberger of Stephens. Your line is now open.

Hey, thanks for taking my question. First question on pricing, it looks like it held up really well in the quarter, despite some negative macro trends we've seen. Can you give us a sense for how you expect pricing to play out in the back half of the year and what you've seen so far in 3Q? David M. Shaffer - President & Chief Operating Officer: Ben, hi. This is Dave. The pricing largely reflects a very positive mix. We've introduced some new products and we always try to focus on the value our products provide. So we don't expect any major changes in that throughout the second half of the year.

Okay. And then kind of along that vein, if we see a more pronounced industrial downturn, would the expectation be that your customers start to trade down from premium products to more of the standard products? David M. Shaffer - President & Chief Operating Officer: I think it's a very mature market, Ben. And those kind of decisions – they see the value and it's a total cost of ownership play. So, it's possible, but we don't anticipate a major change in the mix.

Okay. And then last question on China telco, it sounds like you expect some volumes in 4Q. Will that be enough to get the segment to 10% operating margin by the end of the year? David M. Shaffer - President & Chief Operating Officer: We stated prior that's always our goal for every business unit to maintain that minimum. We think we're going to make a significant move in that direction and that is always our goal.

Okay. Michael J. Schmidtlein - Chief Financial Officer & Senior Vice President: I'd like to add to that is, keep in mind that with business in Asia running at $200 million to $250 million. And as I've said on prior calls, that's just unacceptable for us. We have to look at doubling the size of that business over there. And the actions that we've taken, even though they hurt the P&L in the short run, in the long run they're the right decisions. We need to see this business go to $400 million to $500 million. That's why you see expansions that we've done or an acquisition in Australia, what we're doing in India, the new plants in China. We're investing for the future. If we wanted to keep that at 10% or near 10% in the short run, we wouldn't have made those investments. But whenever you start doing the things that we're talking about, thinking about long term, there's some pain you go through with that. So we'll look back on this in time and we'll be happy with what we're doing.

So, I guess the question is, are we going to go through more pain in the near term on the margin line or would the expectation be that we do get to that 10% sometime and I guess near the intermediate term? David M. Shaffer - President & Chief Operating Officer: Ben, we feel like many of the major changes are behind us and we're in the recovery phase, so we're on the way up. And specifically on exactly when the timing will be there, I can just say we're optimistic about the direction.

Okay. Thank you very much.

Thank you. Our next question comes from Sven Eenmaa of Stifel. Your line is now open. Sven Eenmaa - Stifel, Nicolaus & Co., Inc.: Great. Thanks for taking my question. First, I wanted to ask in terms of telecom and reserve power market and regional dynamics you saw there. Was the North American telecom revenue stream for you guys stable quarter-over-quarter or did it still decline? David M. Shaffer - President & Chief Operating Officer: Sven, this is Dave again. I would say that specifically in the United States, we see that the telecommunications volume has stabilized. We've noted in the prior calls that we had seen some historically high numbers as two of the major carriers were doing their 4G rollouts. I don't anticipate we'll necessarily go back to those volumes in the short term. There are other businesses and other carriers that are trying to close that gap, so we will see some improvements, but the business in the U.S. has stabilized. The biggest issues we're seeing right now in telecommunications are stemming from the Middle East and Western Europe as the choppy rollout of the 4G continues. Sven Eenmaa - Stifel, Nicolaus & Co., Inc.: Got it. And so just moving to the EMEA region, you mentioned that the quoting activity remains normal; but obviously, revenues were sequentially lower here. What is your expectation in terms of quoting activity or how much visibility you have in that quoting activity converting into orders? David M. Shaffer - President & Chief Operating Officer: That's been a mix bag. It's usually a question of timing, when those quotes turn in, and that's always the dynamic that's hard to control. I think that, unlike the U.S. the rollout in 4G is continuous. It's not just one country and one set of legislation they're dealing with there. They're trying to do it across many different government bodies. It's made for a choppier rollout and so it's difficult to say. And then the Middle East region was also a significant growth for us last year and that region has slowed way down. Sven Eenmaa - Stifel, Nicolaus & Co., Inc.: That's very helpful. And the final question is, you reported organic growth in motive power around 1%. Your order growth rates are around, you mentioned around mid-single-digits and the WITS data has been showing, kind of the electric lift truck markets up in 7% to 10% year-over-year level in recent quarters. How do you see that the order, kind of rates you're seeing currently translating into your actual organic growth in motive power? Should we expect continued kind of 1% to 2% level of growth here or do you see an uptick here in coming quarters? Michael J. Schmidtlein - Chief Financial Officer & Senior Vice President: Yeah, I think, the thing you have to take a look at, if you look at the ITA data, to your point that the Americas are up about 5%. But keep this in mind that whenever we see an increase in new fork truck orders, we're going to pick up about half that amount or in another words, if the Americas are up 5%, we're going to look at about 2.5% on batteries. The same thing takes place on the downside; if also in the market we're to drop by 10%, we're going down about 5% and that's because of the aftermarket batteries in place. But motive power continues to be running along at a very good rate for us, and we don't see, based on the data that we're looking at and the averages, I don't see the thing going down. Then in another words, when I'm basing on, if you look at the three month average, right now, compared to three month average a year ago, worldwide it's up 7% on new fork truck orders. So, we're seeing the correlation on our battery sales, as I mentioned earlier, come through based on the ITA data. Sven Eenmaa - Stifel, Nicolaus & Co., Inc.: Got it. Thanks so much.

Thank you. Our next question comes from William Bremer of Maxim Group. Your line is now open.

Good morning, gentlemen. This is Travis DiGiacomo on behalf of William Bremer. My first question comes in China. And if you could elaborate more on the certifications that you guys are trying to achieve there? David M. Shaffer - President & Chief Operating Officer: Yes, this is Dave. So, there is several different types of certifications. There is product certifications and factory certifications. We're active on all. Let's talk about the factory certifications, first. As you know, China went through a major upgrade of its battery factory regulations a couple of years ago as a result of some bad, I guess, performance by some of our competitors in terms of pollution. So the Chinese have implemented a new standard for what it takes to manufacture batteries in China. I can tell you, it's very rigorous. It has cost significant dollars of investment for the industry. Thankfully, we were closer to the standard than many of our competitors, so the impact on us was slightly less. In terms of the product qualifications, we had noted that we had walked away in the past from large China telecom business, because the margins were just too unattractive. We've since gone back, and redesigned our products, re-qualified the products. And as I noted earlier, we've had very good feedback about the tender results as a result of some of this testing qualification for redesign. And so, we're optimistic that the volume is going to increase as we exit fiscal year and our fourth quarter.

Okay. Great. Thank you. And can you touch on the Thin Plate Pure Lead? John D. Craig - Chairman & Chief Executive Officer: Yeah. Sure. David M. Shaffer - President & Chief Operating Officer: The Thin Plate Pure Lead continues to be one of our key profit drivers for the company. It experienced very good performance and it qualified in most telecommunications carriers around the world.

Okay. Great. And my last question is, do you guys achieve any revenue sources from DirecTV at all? David M. Shaffer - President & Chief Operating Officer: There's nothing direct that we know of, with regards to revenue from them and it's very difficult for us to anticipate, how – what's going on with AT&T and DirecTV, would impact our revenue directly.

Okay. Great. Thanks guys. I'll hop back in.

Thank you. Our next question comes from John Franzreb of Sidoti. Your line is now open. John E. Franzreb - Sidoti & Co. LLC: Good morning, everyone. In your prepared remarks, you mentioned some sort of manufacturing variances or some sort of variances that will flow through into the third quarter. What exactly were they and how they impact the margin profile? Michael J. Schmidtlein - Chief Financial Officer & Senior Vice President: Hey, John. It's Mike. So, yes, Dave did comment in his prepared remarks about the fact that in our third fiscal quarter it is normal that the manufacturing variances that we incurred during our summer slowdown, where we're often times shutting down factories to allow the staff there to go on vacation or holiday and to do maintenance repair. So, those variances typically, because we have about a three-month delay or a five-full rollout, those manufacturing variances hit our third fiscal quarter, even though they were incurred in our second fiscal quarter. So that puts a significant amount of pressure on the third quarter that you don't normally see. So we did have the impact of that. We also, as you probably saw in the Q, that we do still have about 85 million pounds of lead that's hedged in the mid to low $0.80 range, which is higher than the spot rate. So between the facts that sequentially our lead costs are not declining and our manufacturing costs are increasing, that's the primary reason you're seeing our guidance, which might surprise you that we were guiding down, because we don't necessarily anticipate the volume decline sequentially. We'd probably expect a slight increase, but those two are the primary factors that are leading us to expect. And as I've commented in my remarks, that I would expect that 27.2% gross profit to decline slightly sequentially in our third quarter. John E. Franzreb - Sidoti & Co. LLC: Okay. Well, taking that thought a step further then, Mike. Two things, one would you expect, based on your telecom order trends that you mentioned earlier to have Q4 be seasonally strongest in telecom? Two, would you expect those variances coupled with lower lead costs results in a bounce back on the gross margin profile in Q4 versus Q3, all things being equal? Michael J. Schmidtlein - Chief Financial Officer & Senior Vice President: Well, I guess, John to comment on what we might anticipate in Q4 I've got very little visibility, particularly on the telecom side. So I'm not going to venture to guess on that. And the only thing I can say about Q4 is typically that is our strongest earnings performance. And, if we're talking specifically to manufacturing variances, yes, normally, all other things being equal, you would see a better P&L impact from manufacturing variances in Q4 versus Q3. John E. Franzreb - Sidoti & Co. LLC: Okay. And the orders profile that you're hearing from the European telco customers doesn't give you confidence one way or the other that telco will be sequentially better? John D. Craig - Chairman & Chief Executive Officer: Yeah, John, I think if you take a look at our Q1 to Q2, actually sales revenue went up in Q2 versus Q1. John E. Franzreb - Sidoti & Co. LLC: Right. John D. Craig - Chairman & Chief Executive Officer: And I will tell you, in Q3 guidance that we have in place that we're looking at a step up. The whole story is this, we've seen year-on-year, because primarily the telecommunications volume has come down, we believe that it's hit the bottom and it's on its way up. Now relative to Q4, our practice has been, we don't go out, we don't talk anything beyond the next quarter and it's on an EPS basis. So I really don't want our guys getting into what we're going to do in Q4, because that's just things that we have not done historically. John E. Franzreb - Sidoti & Co. LLC: I'm just trying to make sure that the normal seasonality is in place to play out that's kind of what I'm looking for John. John D. Craig - Chairman & Chief Executive Officer: (30:06). John E. Franzreb - Sidoti & Co. LLC: Okay. And I guess one final question, when you think about, in the past, you've been willing to comment about what inning you thought we are, as far as rolling out the 3G to 4G in Europe. And, I guess, I'm staying with this theme a little bit. Would you be willing to update your thoughts on that? Is it still the early innings or are we thinking maybe where they are in the process based on just the tempo of the rollout? John D. Craig - Chairman & Chief Executive Officer: The comments I made some while back that we were in the early innings of 4G, and I really believed that at the time, and I was basing that on the patterns of what we saw in the U.S. and the way Verizon, AT&T, or I should say the telecom industry in total, were spending money and how fast they were doing it. I assumed at that time, we're going to see the same thing take place in Europe. I'm really surprised that we've seen this pause, and I believe it's a pause and I'm not sure why. You look at the percentage of people that are actually on 4G in Europe, it is still a relatively small percentage. Now the question is, and I don't know the answer to it, if you believe that Europe is not going to go to 4G in the long run, we're in the late innings, if that's the case. If you believe that Europe is going to ultimately go to 4G, we're in the early-to-middle innings. I don't know exactly where it is, but it would be early-to-middle innings. So I'm surprised by the pause that we're seeing take place on it. And I don't have a good answer for it, to be honest with you. John E. Franzreb - Sidoti & Co. LLC: Okay. All right. Good enough. Thanks for taking my questions.

Thank you. And we have a follow-up question from William Bremer of Maxim Group. Your line is now open.

Hi, guys, just one more question. The pause in reserve power, can you elaborate a little bit more on that? What's impacting this? Is it hospitals? Data centers, what have it? David M. Shaffer - President & Chief Operating Officer: Yeah, that's a good question, this is Dave again. So, the pause principally we've discussed so far has been surrounding our telecommunications business. And you bring up the point about data centers, that's hit or miss depending on the region, and we don't break out reserve power by regions specifically. But, I can make a broad comment that the data center business is stronger in some regions than others, but it's not a particular strength right now as it may have been a few years ago, but most of what we've talked about today and most of what we're feeling sequentially or versus prior-year is related to telecommunications.

Okay. Great. Thanks, guys.

Thank you. And at this time, I'm showing no further participants in the queue. I would like to turn the call over to John Craig. John D. Craig - Chairman & Chief Executive Officer: Okay. Well, everybody thank you for calling in this morning. We certainly appreciate your interest in our company and we wish everybody as best of day today. Thank you.

Ladies and gentlemen, thank you for your participation on today's conference. This concludes your program. You may now disconnect. Everyone, have a great day.