EnerSys Q1 FY2022 Earnings Call

Good day, and thank you for being here. Welcome to the EnerSys First Quarter 2022 Earnings Conference call. All participants are currently in listen-only mode. After the presentation, we will have a question-and-answer session. I would now like to turn the call over to your speaker today, David Shaffer, President and CEO. Please proceed.

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 Michael 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, David and good morning. The forward-looking statements made in this presentation reflect management’s 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 only applicable as of the date of this presentation. For a list of factors that could affect our future results, including our earnings estimates, see the forward-looking statements included in item two 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 US Securities and Exchange Commission. In addition, we will also be presenting certain non-GAAP financial measures. For an explanation of the differences between the comparable GAAP financial information and the non-GAAP information, please see our company's Form 8-K, which includes our press release dated August 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 3. 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 12 weeks are 25% higher than the same period in fiscal year 2020 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 to rebound from a challenging fourth quarter, driven by growing demand in various 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 reopened, and competition for labor, materials, and transportation remains fierce. While we are seeing unprecedented demand growth, we've experienced constraints in our ability to bring on new employees necessary to keep up with demand. Freight and tariffs continue 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 4. 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 nearly a $4 million gain in operating income versus Q4. Demand for our Energy Systems products remains 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's Public Safety grid shutdown extended network 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 have slowed due to 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 a lack of capacity for higher margin cables, 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 NPI 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 significant participants in these new mega market trends. Third, the ES group has been more heavily burdened with the ramp-up of the integration and 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 5. 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 continue to gain market acceptance. We anticipate normal seasonality over the summer holiday months. While lift truck industry order statistics remain exceptionally high, we're being mindful of OEM supply limitations. We're confident 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 terms of 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 6. 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 increased capacity in our second-half results. Demand in our transportation business remains exceptional, buoyed by significant incremental revenue that we're positioned to win as additional Springfield capacity comes online. US 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 US 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 than thermal batteries. We will have doubled this business since the acquisition in just five years. Positive recent conversations with several large customers combined with the US source lithium initiative that 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 7. 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 charge 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 installation 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 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 8. 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 the electric grid, EV charging, and the rural build-out of high-speed broadband. Please turn to Slide 9. 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 site powering solutions, which will accelerate our growth in 5G, as well as the addition of our battery energy storage system plus DC fast charging initiatives. 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 forward guidance.

Thank you, Dave. For those following along on our webcast, the information on Slide 10 is available for your reference. I will start with Slide 11. In the first quarter, our net sales increased 16% year-over-year to $815 million, driven by a 12% increase in volume and a 4% gain from currency. By line of business, net sales in Energy Systems rose 5% to $371 million, Specialty increased 21% to $108 million, and Motive Power revenues grew 28% to $336 million. The growth in Motive Power was primarily due to a 22% increase in organic volume and a 5% improvement from currency gains. Last year's first quarter revenues for Motive Power were notably affected by the pandemic, resulting in a 24% decline. Our current Motive Power revenues for Q1 are now comparable to the first quarter from two years ago. Energy Systems experienced a 3% gain from volume and currency improvements offsetting a 1% decrease in pricing. Specialty saw an 18% increase in volume, a 2% positive currency adjustment, and a 1% decrease in pricing. There were no impacts from acquisitions during the quarter. Geographically, net sales in the Americas rose 13% year-over-year to $557 million, driven by 12% increased volume and a 1% contribution from currency. EMEA increased 27% to $201 million, with 18% volume growth, a 10% improvement in currency, and a 1% drop in pricing. Asia was up 3%, reaching $57 million due to 9% currency improvements, despite a 6% decline in volume. Please move to Slide 12. On a sequential basis, first quarter net sales were flat compared to the fourth quarter. By line of business, Specialty decreased 19% from a robust Q4 due to resin shortages, which are now mostly resolved. Motive Power increased 1% as it continues to bounce back from the pandemic, while Energy Systems grew 6% from organic volume. By region, both the Americas and EMEA remained relatively flat, while Asia experienced a 5% increase. Now, I’ll provide some insights on our adjusted consolidated earnings performance. We use certain non-GAAP measures in assessing our company's performance, specifically excluding highlighted items. My upcoming comments about operating earnings and my later comments regarding diluted earnings per share will exclude these highlighted items. Please refer to our company's Form 8-K for detailed information about these items. Now, let's turn to Slide 13. Year-over-year, adjusted consolidated operating earnings for the first quarter increased by about $14 million to $75 million, with the operating margin up 50 basis points. Sequentially, our operating earnings for Q1 decreased by $3 million from $78 million, with the operating margin falling 40 basis points to 9.2%, mainly due to Energy Systems' results. Excluding highlighted items, operating expenses were 14.5% of sales for the first quarter, compared to 16.1% last year, as our revenue growth outpaced our spending. Sequentially, operating expenses dropped by $1 million and 10 basis points. Excluded from GAAP operating expenses in Q1 are pre-tax charges of $14 million, mainly related to $6 million in Alpha and NorthStar intangible asset amortization and $8 million in restructuring charges from the previously announced closure of our flooded Motive Power manufacturing site in Hagen, Germany. Excluding these charges, our Motive Power business generated operating earnings of 15.1%, which is 470 basis points higher than the 10.4% in last year's first quarter, thanks to the easing of pandemic-related restrictions and persistent operational expense restraint. Operating earnings dollars for Motive Power grew over $23 million year-over-year. Sequentially, Motive Power's first quarter operating earnings decreased by 50 basis points from the 15.6% margin achieved in the fourth quarter due to rising 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%. Operating earnings dollars for Energy Systems decreased by $15 million compared to the prior year but rose by $4 million from the previous quarter because of increased volume. Higher tariffs, trade materials, and manufacturing costs continue to present challenges. Specialty's operating earnings percentage of 10.6% improved from last year’s 6.5% due to higher volume, yet declined from last quarter’s 13.2%. Operating earnings dollars recorded an increase of $6 million from last year but fell $6 million from a strong fourth quarter due to reduced revenue. Please proceed to Slide 14. As highlighted in Slide 13, our adjusted consolidated operating earnings for the first quarter of $75 million represents a $14 million increase or 23% from the previous year. Our adjusted consolidated net earnings of $54.4 million exceeded the prior year by $15 million. This improvement in adjusted net earnings is primarily due to the rise in operating earnings alongside lower interest expenses and a slight currency gain. Our adjusted effective income tax rate for the first quarter was 18%, slightly below the previous year's rate of 21% and lower than the prior quarter's 19%, largely influenced by discrete tax items. We have not adjusted for any recently announced proposed tax changes. First quarter EPS climbed 36% to $1.25, which falls at the upper end of our guidance range. We expect our average shares for the second quarter of fiscal '22 to remain relatively stable at around 43.5 million. Additionally, we have over $55 million in authorized share buybacks, having repurchased nearly $32 million recently. This recent buyback aligns with our normal strategy to mitigate the dilutive effects of our stock compensation programs. Last week, we announced our quarterly dividend, which remains at the previous year's levels. Please move to Slide 16. Our balance sheet is strong, positioning us well to handle the current economic landscape. We have $406 million in cash on hand, and our credit agreement leverage ratio stands at 1.95 times, permitting over $600 million in additional borrowing capacity. Last month, we extended and amended our credit facility on favorable terms, valid through 2026. We anticipate our leverage to remain close to 2.0 times in fiscal 2022. We spent $26 million on restructuring related to Hagen and $46 million on inventory growth to support higher backlogs, leading to a negative cash flow from operations of $48 million in the first quarter, as anticipated. The advantages from the Hagen restructuring began in Q1, and we project ending the year with a $20 million annual run rate. Our capital expenditures totaled $16 million, consistent with our earlier guidance, and we expect them to reach $100 million for fiscal 2022, reflecting significant investments in lithium battery development and expansion of our TPPL capacity, including the NorthStar integration. We expect our gross profit rate to remain around 24% in Q2 of fiscal 2022. As Dave mentioned, we believe all three lines of business have high demand for their products. However, short-term supply challenges are limiting our ability to capitalize fully on these opportunities. Our guidance range for the second fiscal quarter of FY '22 is $1.03 to $1.13, factoring in the impact of these challenges, typical Q2 seasonality, and additional investments in product development and personnel. Now, I’ll turn the call back to Dave.

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

Our first question will come from Noah Kaye from Oppenheimer.

To put it mildly, this is a very dynamic production environment across the industrial space. And we've seen many 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 will be greatly appreciated.

In terms of the supply chain pressures, there are really four areas impacting the first half of our year so far. Firstly, freight. The base freight situation is stabilizing. So relative to where we were 90 days ago, the base freight rate is higher, and the lead times are longer than historic norms, but it seems like that situation is stabilizing. Our supply chain folks are adapting. However, it’s more on the expedited freight where things are still crazy. Unfortunately, we’ve had to expedite things too often, especially in Q1, and those costs are still exorbitant, so we’re trying to minimize the amount of expedited freight we use as it continues to put pressure on the organization. Another issue is that we've been experiencing inflation on other non-lead items. We’ve executed three price increases across our three lines of business since April, and we will continue to push these costs through to our customers. The energy systems business has a longer tail because, due to the nature of the business, getting pricing is a little harder than the other two. That said, we are committed to protecting our gross profit dollars. Resin shortages were a real acute problem 90 days ago, limiting our ability to ship TPPL in both our specialty transportation and reserve power battery businesses. We absorbed a lot of variances, but we should exit this quarter with enough resin to cover the rest of the year. The semiconductor issue has equated to about 40 basis points of gross profit pressure so far in the first half. This is mostly an issue of mix since higher margin products are on allocation for some of these chips. We have a significant backlog and could be doing much more, but these shortages have constrained our capacity on the higher end of our mix. We need to adapt to these issues while trying to offer some stability to our customers. Regarding sequential outlook, yes, we expect some pressure in Q2 from the DC fast charge initiative. The annual wage increase has been timed differently this year, meaning it’s been a 3% adjustment for a long time, but we plan to stick with this timing going forward. The seasonality in Q2 is significantly influenced by our OEM customers in Europe who are taking their normal holidays. We anticipated that seasonality will be there, with about two cents worth of impact from FX and other elements. So these are the main pressures we are seeing, and operationally, Q1 and Q2 feel similar, with unique challenges ahead in Q2.

You mentioned the stickiness of pricing. Given all the costs you're discussing, it seems like the pricing was flat in the quarter and looks like you're getting maybe a couple million dollars of pricing benefit year-over-year. It doesn't seem enough to offset some of these increased cost pressures. The company talks about 5% to 10% price increases. When do we start to see more of that price flow and when could potentially we get into a more favorable price cost dynamic?

There's always a lag between when these things are executed. The situation with commodity categories has been stabilizing, which provides hope for some pricing stability. Most recently, a price increase was implemented last week, but as you know, it takes time to get prices through the system. Our Energy Systems business might lag due to its contractual agreements. But Mike, would you like to add anything?

We expect price improvements in the upcoming quarter totaling around $10 million. As I mentioned, some of that is absorbed by ongoing costs; however, we have experienced about $0.20 of headwinds over the last two quarters. Some of these may abate in the upcoming quarter. We have been doing well managing substitutes for chip shortages, so these haven't impacted us as severely as anticipated. However, the investment for the fast charge initiative will cause a little drag, but the seasonality and higher tax rates that add to pressure will disappear, and we do expect an improvement in sequential top lines.

Our next question will come from the line of John Franzreb from Sidoti.

Can you talk about the state of the EV market and the expected investment? What are the changes in the outlook for the EV initiative?

It's really exciting. Initially, there was an expectation of about $100 million in the EV opportunity. We're focusing on securing an order for the first 100 systems, which could yield between $50 million and $100 million depending on the specifics of those orders. We are excited about combining the battery energy storage system with DC fast charge initiatives to provide efficient charging solutions, and those systems are starting to become economical with decreasing lithium battery costs. The demand landscape is evolving, particularly for commercial real estate partners that value energy storage systems and EV charging as part of their service offerings. We are confident in our strategic focus and want to maintain a position at the forefront of this growing market. Furthermore, the upcoming stimulus bill may provide significant funding for EV infrastructure, and we have a portfolio that matches the requirements for those projects.

In addition to our EV initiative, we’re also excited about the California Public Utility Commission's backup, which represents a significant $50 million opportunity. This is focusing on keeping their networks operational in emergency conditions. It’s exciting to see many projects aligning with our business strengths, including 5G advancements and rural broadband initiatives that optimize our product offerings.

The demand for our products across every line is unprecedented. We have concerns about resin shortages which have plagued us but overcoming this with improved production at our Springfield plant should drive benefits. Although supply challenges remain, we’re optimistic about execution and anticipate a strong demand environment.

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

Thanks, Victor. 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.