EnerSys (ENS) Q3 2016 Earnings Report, Transcript and Summary

Good day, ladies and gentlemen, and welcome to the EnerSys Q3 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. [Operator Instructions] As a reminder, today’s call is being recorded. I would now like to introduce your host for this conference call, Mr. John Craig, CEO and Chairman. You may begin, sir.

Thank you, Kevin, and good morning, everyone. Thank you for joining us. On the call with me this morning is Dave Shaffer, our President and Chief Operating Officer; and Mike Schmidtlein, our Chief Financial Officer. On Thursday, we posted on our website slides that we’re going to be referencing during the call this morning. So if you do get a chance to see this information, you may want to go to our website and go to the webcast tab under www.enersys.com. As previously announced in March of this year, I will be stepping down as Chief Executive Officer of the company, but will remain on as Chairman of the Board. And with this move, Dave Shaffer will be replacing as CEO. I really enjoyed the last 21 years with the company and I believe we’ve accomplished a lot growing the company from approximately $200 million in revenue to over $2.4 billion. But now it’s time for Dave and the rest of EnerSys’ global team to take this company to new levels. In a minute, Dave will be taking over the call. But before we do that, I’m going to ask Mike Schmidtlein 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 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 the factors which could affect our future results, including our earnings estimates, see forward-looking statements included in Item 2, Management’s Discussion and Analysis of Financial Condition and Results of Operations, set forth in our Quarterly Report on Form 10-Q for the fiscal quarter ended December 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 January 28, 2016, which is located on our website at www.enersys.com. Now, let me turn it over to you, Dave.

Thanks, Mike. On Thursday, we reported third quarter results of $0.92 per share, which was in the middle of our guidance range of $0.90 to $0.94. You will notice on Slide 3, our year-over-year sales were lower in the third quarter, due mainly to the impact of foreign exchange rates and the continued pause in reserve power spending in the Americas and Middle East. This was the main reason our gross profit percentage declined 30 basis points to 25.4%. Our operating profit percentage declined 130 basis points to 10.4%, including the previously mentioned decline in gross profit coupled with 100 basis points increase in operating expenses, which Mike will address. Therefore, our year-over-year earnings per share were down $0.17 to $0.92 per share. I now want to focus on our current business activities and fourth quarter guidance. Our global motive power business continues to be good, as we experienced positive organic volume in all regions, as well as a positive global mix. We continue to believe that the motive power business will do well given our order activity and new electric fork truck orders. Moving to reserve power in the Americas, our enclosure business continues to experience a significant pause in spending. In addition, our UPS data center orders are lower. However, this reduction in volume will be partially offset by an increasing sales of our Odyssey batteries into trucking fleets, as this customer segment recognizes the benefits of our TPPL technology. Our fleet sales should begin to have a meaningful impact in revenue starting in the first quarter of fiscal year 2017. In our EMEA region, the telecommunications business is down slightly in Western Europe, as 4G investment is somewhat lower for us than last year. However, this Western Europe volume is more than offset with an increase in our Uninterruptible Power Systems business or UPS. We believe UPS is benefiting from the recent European Union decision on Safe Harbor personal data privacy and storage. This is leading the more data centers being built in Western Europe. We’re also experiencing moderate growth in our after-reserve power business. The key issue in our EMEA region remains the dramatic reduction in our Middle East and Russia telecommunications businesses. In our Asia region starting in late November, we began receiving significant telecommunications orders in China after the completion of the large tender we had mentioned on our last call. As a result, we anticipate double-digit telecom order increasing for the majority of calendar year 2016. In Australia, we continue to benefit from the Fiber To The Home multiyear project. However, India continues to be a challenge from a volume and profitability perspective. Also in China effective in January, there’s a 4% consumption tax imposed on all lead-acid battery sales. We’re in the process of recouping as much of this expense as possible through price increases. Based on the above trends and information, our earnings per share guidance for our fourth quarter is between $0.98 and $1.02 In our fourth quarter, we expect the higher sequential volumes in addition to lower commodity manufacturing operating costs will increase profitability. On Thursday, we also announced that our Board of the Directors approved a quarterly dividend of $0.175 per share payable on March 25. In August, we executed an accelerated share repurchase program of up to $180 million, and this program was completed in January 2016. We repurchased approximately 3 million shares at an average price of $56 per share. 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 positive with the performance of the majority of our businesses, while recognizing the need for constructive action to improve performance elsewhere. We’re committed to a disciplined approach of short-term cost cutting and long-term investment to sustained solid growth and net earnings. Our strong balance sheet continues to prove vital and assuring, we’re well positioned to take advantage of these opportunities for growth. And now I’ll ask Mike, to provide further information on our results and guidance.

Thanks, Dave. For those of you following along on our webcast, I’m starting with Slide 4. Our third quarter net sales decreased 6% over the prior year to $574 million despite the 2% increase in acquisitions, due to a 7% currency headwind and a 1% volume decline. On a regional basis, our third quarter net sales in the Americas were down 3% to $306 million, while Europe’s decreased 19% to $197 million, but Asia increased 28% in the third quarter to $71 million. In the Americas, the decline was from currency translation, while Europe had a 1% increase in price, but a 12% currency decline and an 8% volume decline. In Asia, the volume increased 23% and the new ICS acquisition added 19%, overcoming the 13% currency decline and a 1% decline in pricing. On a product line basis, net sales for motive power were down 1% to $302 million, while reserve power decreased 11% to $272 million. Despite the 8% currency headwind, motive power enjoyed a 6% volume gain and 1% from higher pricing, while reserve power incurred a 7% volume decrease and 7% of negative currency translation, while the new ICS acquisition added 3%. Please now refer to Slide 5. On a sequential quarterly basis, third quarter net sales were up 1% to the second quarter due to a 3% increase in volume plus 1% price and translation decline. The Americas region was down 5%, while Europe was up 23% all due to volume and Europe was up 4%. On a product line basis, motive power was up 2% and reserve power was down 1%. Now, few comments about our adjusted consolidated earnings performance. As you know, we utilized certain non-GAAP measures in analyzing our company’s performance specifically excluding highlighted items. Accordingly, my following comments concerning operating earnings, 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 January 28, 2016, for details concerning these highlighted items. Please now turn to Slide 6. On a year-over-year quarterly basis, adjusted consolidated operating earnings decreased approximately $12 million, while the operating margin declined a 130 basis points. On a sequential basis, our third quarter operating earnings dollars declined $7 million, while the operating margin also declined to 130 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 15.0% for the third quarter compared to 13.9% in the prior year. The third quarter’s operating expenses increased on higher selling expenses, stock and incentive compensation, and bad debt expenses. Now, we expect our operating expense dollars for the full-year to approximate that of fiscal 2015, it will be approximately 100 basis points higher as a percentage of sales, due to currency pressure on our top line and our inability to flex these costs as quickly. Our Americas business segment achieved an operating earnings percentage of 13.6% versus 13.3% in the third quarter of last year, primarily from the impact of lower commodity costs. On a sequential basis, Americas’ third quarter decreased to 170 basis points from the 15.3% margin posted in the second quarter, due to higher sequential commodity and other manufacturing costs. Europe’s operating earnings percentage of 8.4% was down 310 basis points on currency declines and lower volume from last year’s third quarter of a 11.5%, and lower than last quarter’s 9.0%. The operating earnings percentage in our Asia business remained down at 2.3% in the third quarter of this year from last year’s 4.4%, but improved from the break-even results with the prior quarter. Asia’s operating earnings for the third quarter reflects higher volume in Chinese telecom sales. Asia, due to its smaller size remains our most sensitive region to operating inputs. Please move to Slide 7. As previously noted on Slide 6, our third quarter adjusted consolidated operating earnings is $60 million was a decrease of 17% in comparison to the prior year, while the operating margin declined a 130 basis points. Excluded from our adjusted net earnings for the third quarter is approximately $3 million of highlighted net charges, largest being the $2 million net charge for costs associated with our restructuring efforts. Please see our press release issued January 28 for details of these items. Our adjusted consolidated net earnings of $41.5 million decreased 20% from the prior year to 7.2% of sales for a 120 basis point decrease, while our book tax rate was 23%. EPS decreased 16% to $0.92 on lower net earnings with 2.4 million fewer shares outstanding. The lower average diluted shares resulted primarily from the share buybacks, which exceeded the 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 has concluded and will results in an additional 961,444 shares delivered this month for a program total of 2.96 million shares at a cost of $166.4 million for an average costs of $56.19. Our adjusted effective income tax rate of 23% for the third quarter was slightly lower than the prior year. We believe, our tax rate for the next quarter of fiscal 2016 will be between 23% and 25% for a full-year rate of 24% on our as-adjusted net earnings. Please now turn to Slides 8 and 9. As usual, we have provided information on a year-to-date basis similar to that of our third quarter on prior pages. These two pages are for your reference and I don’t intent to cover the year-to-date results other than to point out that our year-to-date sales decline is primarily a currency decline followed by weakness in our reserve power business. 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 $346 million on hand in cash and short-term investments as of December 27, 2015, with nearly $447 million undrawn from our credit lines around the world. We generated $233 million in cash from operations year-to-date in fiscal 2016. Our leverage ratio was at 1.6 times, despite spending over $200 million in share buybacks and dividends in both fiscal 2016 and 2015. Capital expenditures were nearly $46 million year-to-date in fiscal 2016 and should reach up to $70 million for our full-year. We expect to generate adjusted diluted net earnings per share between $0.98 and $1.02 in our fourth quarter of fiscal 2016, which excludes an expected net charge of $0.04 per share for our restructuring programs and acquisition activities. We anticipate our gross profit rate in the fourth fiscal quarter to be between 25% and 27%, and our interest expense to be approximately $5.9 million, and our diluted shares outstanding to be approximately 44 million shares. In conclusion, we expect our fourth quarter to be our normal stronger finish to our fiscal year. Now, let me turn the call back to you, Dave.

Thanks, Mike. Kevin, let’s open up the line for questions.

[Operator Instructions] Our first question comes from Ben Hearnsberger with Stephens Inc.

Yes. Hi, guys, thanks for taking my question. This is Brandon in for Ben. Just real quick on the APAC region. I believe, it runs at a lower gross margin profile. Just curious what kind of revenue run rate we need to see this backup in the historical range?

There’s a lot of moving pieces and Brandon we appreciate the question. This is Dave. The Chinese piece, the telecom piece usually comes at a lower gross margin, where we can agree with that. There’s other parts for the region, where that’s not necessarily true. So the – it is a blend. I think the critical issues for us are not only the revenue piece, which is on the uptick and we’re going in the right direction. But we also have some challenges, as we alluded to in the script with regards to our EMEA operation. So, but given that, I think that we have a plan that puts us on the right trajectory to move towards what we consider healthy operating results. So, again, there’s still lots of work to do. I think key among that was the timing of this tender, which we’re seeing very positive results from, it came much later than we expected that we had spoken about earlier in the fiscal year. But that volume is upon us. The – all the changes we made with regards to the product designs and qualifications is all complete and the order is extremely strong. The plant loading has improved dramatically, which was a drain earlier in the year. So most of the things we spoke about earlier in the year happening a little later than we thought, but we are optimistic about the coming quarters.

Sounds great. That’s a great color. I appreciate it. Just a quick follow-up, on the motive side, what’s from a high level, what’s really causing us to buck the trend of kind of overall slowing industrial production on a global scale? Thanks.

We can talk about the different regions, I guess. In the United States, I don’t know that any of the markets that we serve are specifically at risk because of the strong U.S. dollar. So when you think of the market segments we’re in, not a lot of the use of our batteries are for export oriented manufacturing. So I think that’s protected us somewhat from some of the softness we’re seeing in the manufacturing sector. I think in the European region, this – the weaker euro is giving some manufacturing opportunities in Europe that probably have improved. So I think that the – there’s a lot of export oriented manufacturing in Europe, which we think we’re exposed to and, again, has had a moderating impact on what like you say the general softness. I think, as we go into the developing markets, those aren’t historically big motive power markets to start with. So that – the exposure there, even though on the telecom side, which you know, I know you didn’t ask about, but in the telecom side there’s certainly more exposure. On the motive power side, we don’t have a lot of exposure to the developing markets. And except for China, I guess, I don’t know if you want to consider that as a developing market. But let’s end with the discussion on China specifically. If you recall, we’ve been in a transition period from an older factory to a newer factory. So there has been a lot of noise in our comps from prior quarters, which again we’ve been making up for. So some of the the strength and at least relative to our comps is just getting back to what we consider normal operating ratios and so forth. In terms of the longer-term impact of the Chinese market motive, we’re yet to know what the real impact is going to be for us on the order book. So we’re still on the positive recovery mode, which has given us a reasonably good results. But again the China market for us in motive, it’s important, but it’s not going to really move the needle for us. Really – it’s really about the U.S. and about Western Europe, which both markets seem to be stable. Does that help?

Excellent. I appreciate it. Thanks so much.

You’re welcome.

Our next question comes from William Bremer with Maxim Group.

Good morning.

Hi, Bill.

Hey. John. First, the pleasure working with you since 2009, when EnerSys was sub $700 million in market cap, so I take my hat off to you and your team there.

Well, thanks, Bill, I appreciate the comment.

Okay. Hey, Dave. First, let’s touch base on overall volume in Europe and give me a sense of where you’re seeing that over the next quarter or so, I mean, we had a pullback of about 8% on the reserve side there. Are you still seeing that going forward? That’s number one. And, I guess, my second question goes right into capacity and utilization there, as you guys are consistently restructuring your entities there. Can you give us a sense of what you’re running at for both segments reserve and motive at this time?

Let’s take them in each piece. The motive power business is stable. And so the – when we look at our order rates, when we look at the worldwide Industrial Truck Association order statistics, we don’t see any major causes for concern on the motive power side in the European market. The reserve power side, as you noted, we’re coming up some tough comps. Last year, we had some very exciting wins in the telecommunications market, specifically. The telecom is a very cyclic business. It is – for us, it’s ups and downs. Last year, we were having great success. This year in the Western European market that we’re little softer than we were a year ago on the telecom side. But as we noted in the script, the data center has been a kind of a nice surprise for us. So when you look at reserve power in the Western European between the data center and a little bit of softness in telecom, it’s been a bit of a push. The real issue for us right now is the impact of the slowdown in telecommunications network deployment spending in the Middle East region. And this has a couple of complicating factors. It’s historically high margin business. It’s historically our premium TPPL products. And so that creates not only mixed issues, but it also creates loading issues in our European factories. So our telecom then is a very cyclic business. We know that region is going through some economic changes. And it’s just a question of when that spending turns back on. There – it’s very difficult to say. But in general I would say the exposure, we still feel is really mostly in the telecom spending arena, and that really applies globally frankly, and there’s puts and takes. One of the things I enjoy about this company is our regional diversification. So right now, we’re seeing exceptional telecom growth in the Asia region. So – but when we’re specifically talking and your question was about Europe.

Right.

It’s in the Middle East softness that continues to plague us. And, again, given the cyclic nature of telecom it’s hard for us to predict when that’s going to come back. And, Mike, you want to add anything?

But just build for your comment about the utilization. So Europe as a whole is running at factory utilization is in the low 70 rate, and the motive power business, as Dave has pointed out has been very stable. So that compared with it – and that at 70 – low 70 numbers combined motive power and reserve power. So given we have a very stable motive power platform, the utilization rates can be a little bit higher there higher than the low 70s and reserve power, because we’re looking at the EMEA’s impact primarily in Middle East and Russian reserve power. That utilization is slightly lower than the low 70 number.

And just one final thought on that. Historically, our Q2 is a little bit softer on manufacturing anyway. Last year was a bit of an anomaly given some of the big telecom wins we were scoring. And – but in normal that and given our FIFO, that has usually a bit of a drag on our third quarter in terms of gross profit, because we FIFO that slow period into our third quarter. So that’s certainly a meaningful contribution to our gross profit decline sequentially.

Gotcha. And my follow-up, John, would you happen to have the truck order numbers that you historically provide?

We got them here, Bill, for sure. Mike, you want to?

The – well, for the truck order information that we would have Bill was for December, and it has new truck orders worldwide are up 9%. And there is strength in the European performance in terms of new truck, although in that area, we’re looking at Class 1, 2 and 3, so you have to kind of standardize for these new truck orders. But I would say overall, you’re seeing growth in Europe and the Americas in new truck orders and you’re seeing at least for the month a softness in the Americas. But when you look at it from a trailing three-month trailing compared to the same period of a year ago, you are flat in the Americas. Europe strong and Europe that’s about 14%, and Asia has got 5% growth for worldwide growth of 8%. So that’s three months ended December compared to the same three-month period a year ago.

Okay, Mike. Thank you.

Our next question comes from Michael Gallo with C.L. King.

Hi, morning, and just want to echo. John, a great job we did over all the years.

Thank you. I appreciate the comment.

Yes, I had a couple of questions. First, obviously reserve has been soft. Volumes were slightly better, I think than they were in the first-half. I know you pointed to the opportunity that you have in truck fleet. So I was wondering how large an order of magnitude would you expect that to help reserve, that minus seven volume. Could it help make up half of it, or we talk in smaller order of magnitude than that?

Mike, the truck fleet opportunities, this is Dave. The truck fleet opportunities have significant upside, certainly from a plant loading perspective, we’re going to be in the right zip code. On the battery side of telecommunications, we’re actually in the U.S., we’re okay. That’s not really been an issue. On the enclosure side, that’s been a bit more of the drag. I think one of the things that’s different about this enclosure business is, there isn’t a replacement like there is in batteries. So we’re fully exposed to kind of in the normal deployment cycles of the telecommunications networks. So we don’t see so much initiative, but just in terms of replacing the revenue, there’s certainly significant upside in these truck fleet markets to replace anything we’ve lost recently on the telecom side.

Right. And then just a follow-up question, I know, you’ve said in the past that the goal was to get a 10% op margin in Asia in terms of run rate. You saw nice improvement in volume. But I think you were still only at in the low 2s. Is a 10% target by the end of the year, we ended the fiscal still realistic, or does that pushed out somewhat?

I think it’s going to be pushed out. I think what I spoke about earlier is what – when we made those comments, we correctly forecasted the positive impact of the Chinese telecom business, it just came much later than we had originally thought.

Right.

So it’s going to take some of the lift we get from the manufacturing side comes later with our FIFO methodology. So we still have that. We still have a lot of that ahead of us. We – our plant utilization in Asia has increased dramatically versus prior quarters. So we still have some good news there. The Australia business opportunities are very good. The consolidation of our new acquisition into our existing business is going slower than we had hoped. I think that’s part of the delays. So we’ve got some upside there. In India, we’ve got a lot of work to do in the India region. The – just the transition from our JV partner when we bottom out, we just continue to have negative surprises. But, again, the – with India, it hasn’t been a large contributor yet to our revenue profile. So from a risk, it’s not a big number. For Asia, it’s a – it’s is noticeable for – but for EnerSys worldwide, it’s not big enough to hurt too bad. But we certainly have opportunities, and the good news is that market continues to present significant opportunities for battery sales in the future.

All right. And then one quick follow-up to that, I know there’s a 4% consumption tax. Asia has always been a tough place to recover margin. You’re confident you can recover that through pricing. It seems like that’s always been a market, it’s been hard to get the pricing it is?

I would say that the domestic piece is going very well. So in the domestic Chinese market the price recovery is going as expected. I think what will take time is and you properly say is the inventory that’s in the channel across the world. So on our export piece, we’ve got to work very hard whether it’s Europe, or Australia, or the United States. Whenever we’ve exported out of our Chinese factories, local competitors with inventory there could be some delay there, but that’s no excuse. We’ve got the message out loud and clear to our guys that we have to get that back.

Okay, great. Thanks very much.

Welcome.

Our next question comes from Brian Drab with William Blair.

Good morning. Thanks. First, I want to start by saying and also congratulations to John. We’ve enjoyed following the company’s growth and your accomplishments over the year, so congratulations.

Thank you very much. Thank you. I appreciate it.

The first question I had is, you mentioned early in the call today the fleet opportunity, I believe those in the United States. I was wondering if you could talk a little bit more about that. but the timing and the significance of potential revenue from that opportunity?

Yes, as we alluded to earlier, and Brian, thanks for the question. This – there’s a significant opportunity. It’s going to start to ramp up from the first quarter of fiscal year 2017. So that’s when we should start to see the benefits of it. It is using our Thin Plate Pure Lead technology. What we’re finding is that, many of the trucking companies are seeing the benefit of this technology in that over-road application, and that’s a changing market from a regulatory standpoint. So the benefits of this battery and the efficiency of the battery is real. The longevity of the batteries and its vibration resistance are real, and we expect to see some significant impact for that in the coming quarters.

How is the regulatory environment generating demand for Thin Plate Pure Lead?

It’s just the fuel efficiency standards, the idling requirements for trucks when they’re at stops in terms of running either an APU or keeping the diesel engine running. There’s – it’s mostly related to the idling requirements. And so the more they can use battery or battery loads, they provide either the electrical load or the air-conditioning load of the cabin, or the guys who are waiting, or an idle, it’s an opportunity for the higher-quality batteries to deliver a lower total cost of ownership.

Great. Any idea in terms of, I mean, you’re clearly not saying how big this could be in terms of revenue?

We haven’t dimensioned that yet. And I think as we get into next quarter, we’ll have a little bit better visibility on that, and we’d dimension it better next quarter.

Okay, great. And then if I could just ask about gross margin, as you head into the fourth quarter your guidance was for 25 to 27. I’m wondering what factors would prevent gross margin from ticking up a little bit in the fourth quarter given increased volume, I would imagine that price of led has been favorable maybe the hedges won’t be as unfavorable as they were in the third quarter?

Yes. But so the, I guess I would say you should see a mild benefit on led. Keep in mind, because the euro is at a low point for several years. They don’t see the same benefit as U.S. currency-based operations do from a lower-priced pound of led. So that is somewhat muted. The higher volume will improve. The key is some of the operations that have been a drag, such as India to see performance improvements in those. But the mix of where we see our sales, if Europe and the Americas remain flat, or slightly down, and Asia increases, you will see the mix change and Asia does as a whole have a lower gross profit margin, which causes pressure. But I would say overall, I would anticipate you will see a normal pickup sequentially from Q3 to Q4.

Okay, thanks. And then one last quick one, this energy build that’s working its way through the Senate. I’m curious, I guess, it’s something longer-term. But what impact that could have on your business and I guess potentially the OptiGrid business, specifically?

Well, so far the OptiGrid opportunities have been fairly narrow and scope, as we talked about. And in terms of the broader opportunities, there’s certainly incentive plans out there for these grid scale storage opportunities, and we look forward to any benefits there. But as of today, we haven’t seen any meaningful change other than in California, I believe that there has been some significant legislation and opportunities created for large energy storage systems in the gigawatt hour kind of categories. But so far we haven’t seen any real meaningful shift in the demand. And our OptiGrid, as we have talked about in the past, it’s exciting, but it hasn’t been broad-based in terms of the demand.

And I would point out that it’s – that is largely behind the meter type operation for large commercial buildings, where some of the legislation is more at the other end of the meter, where there’s large utility scale and that’s not one that we see our future line.

Got it. Thanks for taking all my questions.

Great.

Our next question comes from John Franzreb with Sidoti.

Guys. Firstly, John, best of luck, it’s been fun working with you for the past decade, enjoy your retirement. Secondly…

Thank you, John. I appreciate it.

No problem. Secondly, I just want to go into the Americas and the sequential drop in the operating income. You kind of called out, it sounds like lead costs. But lead went from $0.77 to $0.80 roughly sequentially in the quarter. I wonder how much mix was an issue in the Americas, or if there’s something else I should be aware of?

Well, I – sequentially, you did see lower volume. You saw the fact that our manufacturing variances that are – that from the summer months when we have plant shutdowns, those FIFO out into the third quarter, so that becomes a negative impact. And the last thing is in the Americas, we were transitioning our chargers into a new modular arrangement. And that transition done successfully. We’re encouraging higher freight charges than we normally would have anticipated. But I would expect the Americas should see an improvement in Q4 at the GP level.

Okay. All right. You’ve called out the Middle East as a headwind. I don’t recall you ever saying the Middle East before. How big of a business is that? I know it’s a highly profitable business a little bit, in terms of revenue, what kind of size are we talking about -- the noise, and Russia, if you could also.

Yes, the – I think that region especially – this is Dave, represented some significant wins last year. I would say that region historically has delivered upwards of $40 million plus of revenue opportunities. And where we’ve got a lot of headwind there. I think the real challenge for us is the quality as you just alluded to, it’s the quality of that revenue, which is somewhat painful. But these telecom networks and it is principally a telecom play for us there. And these telecom networks the ebb and flow, and so we’re just waiting for the next peak to rise.

Okay, all right. And it looks like operating cash flow was up roughly $100 million year-over-year, I guess, that begs two questions. It looks like a lot of it’s because of low working capital. But can you just talk to that, A, and, B, your priorities for cash as cash rises? Could you discuss that a little bit?

You’re right. I mean working capital typically is that a benefit this quarter year-over-year and that’s a big chunk of why you were seeing the improvement. If you would look at it, I’m just, as you know the cash flows go on a year-to-date basis. But last year there was about $40 million, $37.5 million drag and primary working capital compared to March for the year before. This year is a benefit of $46 million. So that explains about $100 million of year-over-year change. So it’s – that would be the primary reason for it other than that as I scan or cash flow statement, that is the primary explanation, John.

And your priorities use for cash and while I’m at it, how much of the cash is domiciled here in the U.S.?

So, as you might expect, most of the cash is not domiciled here in the U.S., it’s in Europe and elsewhere. And that’s one of the reasons on our credit facility we get credit up to, I think $150 million of foreign-based currency. And as you know, we have about $347 million of total cash. And as I said most of it’s overseas. So there is that impact. But when we look at where we want to spend our cash, as you know, we say, we want to grow and whether that’s by organic growth, or by acquisition. So we still say that’s priority number one. But we also recognize the importance of, if we’re not using it in that activity growing organically or growing in acquisition then we’re focused on returning it to the investor. And that’s why you’ve seen in the last two fiscal years year-to-date, there will be $200 million plus return to the shareholders in share buybacks and dividends. And I think you would see, as we go forward, we think there are opportunities in the M&A landscape, and continue to be very active in that. But if that doesn’t occur, we will continue to look for opportunities in share buybacks as well.

Okay. And one last question, and this is really a clarification. Did you say that Asia-Pacific would grow at a double-digit rate in calendar 2016, or they just the China part of AP would grow at a double-digit rate?

The net effect will be Asia world.

All of Asia. Okay. Thank you very much, guys Thanks for taking my questions.

One moment for our next question. Our next question comes from Sven with Stifel.

Yes. Thanks for taking my questions. First, I wanted to just follow-up on some of the reserve power commentary. What were the trends for you in North America and Western European markets. Were those kind of year-over-year or sequentially flat, or did you see the variation there as well?

Sven, this is Dave. So in the U.S. specifically the – we can go through the different regions sectors. As we noted, the enclosure piece on the telecommunications part of our business in the United States is still a disappointment. On the battery side of the telecommunications business in the U.S., we’re okay. The data center market, the big UPS markets in the U.S. are slow. And the specialty side of our business, or the Odyssey has been an improving situation. So the net effect of the reserve power in the U.S. has been down a little bit right. So it’s, Mike, how much would you say?

Yes, I would say, it’s roughly about 5%.

5%. So and that’s really mostly the data center story is. And, again, similar to telecom, that that has ebbs and flows. So moving over to Europe, the enclosure piece of the business is actually good. We’ve got some great opportunities there. The battery side of the business on telecom is down single-digit. But the data center business in that theater is actually very favorable. We think that’s related some of these new Safe Harboring requirements. So that sector of the business is good in Europe. We talked about a lot about the Middle East, that’s a telecom story, and that’s been a very big disappointment for us. And then finally, we know the story in Asia. So does that give you the color that you’re looking for on those?

Yes, that’s very helpful. The second question is more on the housekeeping side. So if I look at the sequential gross margin performance down close to 200 basis points. How much of that, I understand there was some transportation cost, and there’s a FIFO impact. How much of that sequential decline was driven by Asia pricing?

That wasn’t the most meaningful impact. But I would say that the biggest sequential impact related to the manufacturing variances FIFO from Q2. So I would say to a much smaller effect so far the impact of the Asia has been much less meaningful. Now that could become as Asia volume increases, become a more meaningful impact in future quarters.

And I guess I would point out, Sven, that I know you’ve made your reference sequentially and your are coming off of our second quarter’s 27.2% gross profit, which was an all-time high. So dropping down to 25.4%, it looks like a big decline. But if we compare year-over-year to last year’s 25.7%, it’s a 30 basis point decline. So the comp year-over-year is slightly down. At that point when you look at Asia, the mix does become a little bit more relevant than you do have a substantial amount of currency that is kind of wreaking havoc. And in addition year-over-year, you did have a 1% organic volume decline in that period impacting gross profit.

And just as a reminder, Sven, last fiscal year, we were scoring some very big wins in the telecommunications market in EMEA, in the Middle East and some 4G in Europe. So the comps are also tough there, because typically in our summer months, we are slow. Last year was the anomaly in Europe especially, where we were extremely busy then. So hopefully, that answers your question.

Yes, that’s very helpful. One more here. In terms of, I think you mentioned bad debt expenses in your -- some of the cost commentary earlier. Could you just elaborate a little more? Is that Middle East region related, or and what was the magnitude of the charge in the quarter?

Well, let me start by saying our DSO as a company is at its normal point in the cycle. So the DSO itself is looks fine in comparison with where we normally would expect to see it. Now, when you break it down on a regional level and most of these bad debt calculations are mechanically driven and to be Sox compliant and they are triggered based on percentages, as to whether they are current or past 30 days, 60 days view etcetera. And so mechanically, what we saw was an increase year-over-year of about three quarters of a million dollars. When we look that at over about a five-year trend that reserve, which is a little over $10 million for us as a company, so just to put that in perspective…

Yes.

…of how the reserves are. But that number is well exactly where we would expect to see it based on our overall aging profile. So, I guess, I would say, these are sensitive to swings and depending on when a receivable breaks over from going into a 60-day to a 90- day category, et cetera, can have an impact. So while it is a hit year-over-year, and I will say last third quarter, there was actually no bad debt expense whatsoever. So we had a good – we’re going to get some very good comp of a year ago. However, we had a tough comp from the prior quarter. The prior quarter, we had a large mining company that went bankrupt and we had about $800,000 reserve we had to take for that bankruptcy. So this year in comparison with last year, bad debt is a significantly higher expense. But when we look at our DSO and we look at our overall profile, we feel like it’s within normal traditional ranges.

Got it. That’s helpful as well. And last question, on the M&A front, how is your activity pipeline and what are you focused on?

Sven, this is Dave, again. I would say the activity level is normal to a better than normal. So I think there’s some exciting opportunities. I wish I could talk more about those, but obviously, we can’t give much detail there. But certainly it’s average to above the average in terms of what’s – what would be – what we’re working on.

And it’s across all three regions.

Yes.

We would say we have transactions that we feel confident that we’ll probably consummate.

Great. Thanks very much.

Our next question comes from Rich Rosen with Columbia Management.

Yes. Hi, thanks a lot. First of all John, thanks for everything. As you know, we’ve been there since the beginning, and we can’t begin to say thanks enough for the job that you’ve done for us as investors.

Thanks you, Rich, I appreciate that.

Thanks. Second, on their earnings call, Verizon made some comments about 5G, starting to talk about rolling it out. My understanding is that this would be a very, very big business for you small-cell technology, more batteries, et cetera. Have you start to see any of that? Is that in the discussion stage at this point, or was Verizon more talking bigger picture?

Rich, this is Dave. We had a executive meeting with Verizon, I’m trying to think back now. It must be about four or five months ago that I personally attended. And at that point, they were very unsure as to what the timing of 5G would be and frankly, it was very unclear. And I’m not aware of anything so far that goes beyond thinking about it, testing it. And as far as we know most of it is still deep in the bowels of the big OEMs so…

Okay.

We’ve received no RFQs or tenders or anything significant. But as you alluded to, we do know that the transmission radius of those cell sites will be much shorter. I know that the lower frequency technologies and as such the sites will have less power, but will be more ubiquitous. And so we anticipate with our enclosures and our smaller battery technologies, it will be a different opportunity than it’s been in the past.

Great. And will there be a technological difference between having smaller cell technologies, or is it the same as the current cell tower power backup stuff?

We don’t know for sure, it’s still too early to say. But at least we feel fairly well positioned to offer a couple of different chemistries whatever their particular needs are. So if it’s a weight savings issue or space savings issue, or if it’s a cost driven issue, we’ve got a suite of products. We think we can help them with.

Okay. And then one final question. And that is about six months ago, there was speculation that Johnson Controls was about to acquire EnerSys. And since then they’ve made an acquisition or they have – they’re entering into make an acquisition elsewhere. Can you confirm or deny that such conversations may or may not have taken place or whether they approached you in the first place?

We can’t comment on any of that. So we’re just focused on net earnings and capital to shareholders. So our heads are down working hard here.

Yes, okay. All right. Thanks a lot. And John, best of luck to you.

Thanks, Rich.

The next question please.

The next question comes from Davis Paddock with Invesco.

Hey, good morning. Thanks for taking my call – my question. First question was just about CapEx. Is the China plant completed in terms of capital expenditures going forward?

Yes. I think there might be some extra equipment we have to layer in for additional capacity. But principally by and large, it’s done.

And just – are there any other sort of major CapEx projects planned for fiscal 2017? I’m just kind of – I’m not looking for a number, but just a directional look at what CapEx might look at – look like in 2017, given that this plan is largely complete.?

Well, I would say David that traditionally our CapEx is ranged from $50 million to $70 million and it kind of goes up, if you do have a plant addition. The only significant project that I could speak to that’s still ongoing is our implementation of the SAP ERP system, that’s about a $30 million CapEx program over two to three years. So I would expect price is slightly lower than it’s been in the last couple of years. But I think you should expect a minimum of $50 million just because of our normal replacement cycles investments in environmental health and safety issues, et cetera.

Got it. Thank you. And so, given – I’m guessing working capital might not be quite the tailwind next year that it is this year. But still – it looks like you will have some pretty healthy cash flow. And just curious, I know that the share repurchase was to repurchase the – sort of offset the convertible. But any thoughts on why you were – you haven’t considered sort of renewing another share repurchase authorization?

Well, when we look at that and we – and let’s assume that these were major repurchases, so $100 million to $200 million range. As we do that, we’re also looking at the M&A forefront in same what transactions do we think are actionable. How larger are those? Where do we need to deploy our capital. So that’s the put and take that we generally will look at, along with what is our share price, and what are our future prospects, right. So whenever the share price dips below what we think it’s intrinsic value is, then you would normally see us in the market buying, and the only time that might not occur if those conditions existed as if we were, we thought that there was a transaction that we thought was imminent.

Are there any opportunities in the pipeline that would be kind of larger than the norm – like a very meaningful size to bite for you guys?

Well there I guess I would say there are generally larger they are, the lower the probability of landing them, because they’re more difficult. But they do exist and we do pursue them. And sometimes that’s a multi-year effort.

Right. Okay. Well, I’m just looking – your stock price is kind of lower than it’s been in the couple of years now. And it seems like with the cash flow, lower CapEx and reasonably stable outlook in comparison to other industrials and the valuation it might be – it might make sense to consider another repurchase?

And we certainly agree with you and we’d likely be doing that unless we see other opportunities, that we think we will have a greater return.

Fair enough, thank you for your time.

Our next question comes from William Bremer with Maxim Group

Gentlemen, just a quick follow-up. Dave, can you give me an update on the product set for the China market that was needing a certification due to the revamp for the product line geared for telecom? Has that been completely completed, or you still have some that you are awaiting certifications on?

We are done with that and the tender results were great, so that’s behind us now and now it’s about execution more than anything else.

Okay, great. Thank you.

Big order shift.

Got it.

[Operator Instructions] Our next question comes from Howard Rosencrans with VA.

Hey, guys. I’ll just join the fray and to say John, thank you for the fabulous work and communications and everything you’ve done for the company and for shareholders and employees. Thank you.

Thank you. Thank you, Howard.

Dave, the last couple of questions pretty much fed into mine. You’ve largely addressed it, but I will regurgitate it. I just wanted to get a better understanding of what your posture is, since this is your show now in terms of return of capital and we know you’ll follow – or we suspect you will largely follow the same game plan. From an M&A standpoint, I know things may turn up. But, where do you stand in terms of your view of maybe a potential leverage ratio? That would be the focus of my question?

Howard at this point, our goal is to optimize the capital we return you guys and to the shareholders. So I don’t foresee any major departures, that we are going to remain acquisitive in terms of our dividend yields, in terms of the amount of buybacks those happen as Mike alluded to, as an evolving set of circumstances. So it depends on where were at on M&A potential. So it’s difficult to give you an answer, but at this point in terms of our capital structure the balance sheet is in great shape, I think Tom and Mike have done a super job with that, they have given me as you alluded to it’s my show now, they’ve given me a lot of opportunities and really job one largely is going to be staying on the M&A front. We also, there are some opportunities for us to invest in ourselves and this is something we spoken to the Board about, there are some you operational excellence initiatives, which might present great return to our shareholders that we are going to consider. But by and large, from a dividend, from a share buy back, and from an M&A perspectives and CapEx ratios, it should feel pretty comfortable. Mike you want to add any color.

Well, Howard, I would just say to your point about the leverage ratios, normally we would tell investors and we’ve told you over the years 2.5 times is typically our comfort range. We’re at 1.6 times at the moment. But as you look at targets the – generally the bigger the target, the more stable the cash flow generation is, which allows you to think a little higher maybe a three times, because you know you’re going to that cash generation to pay that debt down faster. So, in normal standard operating procedure we would say, we like to be below 2.5 times. If the opportunity comes along with the right opportunity, you could see it go a little higher.

Very good. Thank you so much.

And I’m not showing any further questions at this time. I’d like to turn the call back over to Dave Shaffer for closing remarks.

Thanks, Kevin. First of all, I would like to thank John for all he’s done with EnerSys. John had the vision that a $200 million North American industrial battery company to become the global leader in industrial batteries. John led the transformation of that company into the global leader that EnerSys is in annual sales, geographic coverage, profitability, breadth of product offerings, and always providing the best value. For that, we just want to say, thank you, John. I’m personally excited about the future for EnerSys, and I look forward to the challenges and opportunities that await us. Thank you all for taking your time today to attend our call. Everyone have a great day.

Ladies and gentlemen, this does conclude today’s presentation. You may now disconnect and have a wonderful day.