Ladies and gentlemen, thank you for standing by. And welcome to the Q3 2021 EnerSys Earnings Conference Call. At this time, all participants are in listen-only mode. After the speakers’ presentation, there will be a question and answer session [Operator Instruction]. I would now like to hand the conference over to your speaker today, Mr. Dave Shaffer, President and CEO. Thank you and go ahead, sir.

Thanks, Don. Good morning, and thank you for joining us for our third quarter 2021 earnings call. On the call with me this morning is Mike Schmidtlein, our CFO. Last evening, we posted slides on our Web site 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 Web site at www enersys.com. I'm going to ask Mike to cover information regarding forward-looking statements.

Thank you, Dave, 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 views regarding future events and operating performance, and are subject to uncertainties and changes in circumstances. Our actual results may differ materially from the forward-looking statements for a number of reasons. Our forward-looking statements are applicable only as of the date of this presentation. For a list of factors which could affect our future results, including our earnings estimates, see forward-looking statements included in Item 2 Management 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 January 3, 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 February 10, 2021, which is located on our Web site at www.enersys.com. Now let me turn it back to you, Dave.

Thanks, Mike. Our third quarter reflected strong demand for our products and services, with order trends accelerating during the period. The strength of our business was even more impressive considering the ongoing headwinds created by the COVID-19 pandemic, which continued to disrupt economic activity around the world. We have been able to maintain cohesion throughout the EnerSys workforce despite a number of positive, symptomatic and close contact cases among our employee base. Those cases can lead to disruption and daily production schedules as workers are sent home in order to comply with COVID-19 protocols. EnerSys continues to emphasize social distancing, hygiene, the use of masks and reminding our employees to follow the same guidelines in their personal activities which has helped to mitigate the impact compared to many companies, but we have not been immune. Despite the ongoing challenges caused by COVID-19, the demand for EnerSys products was clear during the period as we reported strong third quarter fiscal 2021 adjusted earnings of $1.27 per diluted share, which included $0.10 benefit from the settlement of our claim related to the September 29th fire in our Richmond, Kentucky facility less $0.03 per share in foreign currency losses. Energy systems benefited from telecom driven 5G growth in the Americas and our motive power business saw marked revenue and earnings improvement over the second fiscal quarter. Our specialty segment continued its positive momentum in our third quarter, bolstered by our growing transportation backlog. Please turn to Slide 3. I'd now like to provide a little more color on some of our key markets. But before I begin, I would like to comment on how many of our customers across all of our lines of business have signaled increasing demand and alerted us to be ready. There seems to be pent up demand which…

Thanks, Dave. For those of you following along on our webcast, we have provided information on Slide 7 for your reference. I am starting with Slide 8. Our third quarter net sales decreased 2% over the prior year to $751 million due to 3% decrease from volume, net of 1% increase from currency. On a line of business basis, our third quarter net sales in the motive power were down 4% to $304 million, while Energy Systems net sales were down 2% at $337 million, while specialty increased 7% in the third quarter to $109 million. Motive power suffered 5% decline in volume due to the pandemic, net of the 1% increase in FX. Energy Systems had 4% decrease from volume, net of 2% improvement from currency. Specialty added 6% in volume improvements and 1% increase from currency. There were no notable changes in pricing and we had no impact from acquisitions. On a geographical basis, net sales for the Americas were down 1% year-over-year to $499 million, with 1% decrease from currency. EMEA was down 4% to $194 million and 9% volume decline, net of 5% improvement in currency, while Asia was flat at $58 million. Please now refer to Slide 9. On a sequential basis, third quarter net sales were up 6% compared to the second quarter, driven by volume improvements. On a line of business basis, specialty increased 5% with NorthStar continuing to contribute its capacity for transportation sales. And motive power was up 15% as it rebounds from the pandemic, while Energy Systems was down 1%. On a geographical basis, Americas was up 4%, EMEA was up 13% and Asia 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…

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

[Operator Instructions] Our first question is from the line of Mr. Noah Kaye from Oppenheimer.

So getting back to being capacity constrained here following this rapid recovery in demand. Can we dimension the impact of those constraints on revenue currently? What was the revenue shortfall in the quarter? What is kind of the shortfall that you envision in 4Q? And clearly, you've mentioned transportation as one area, but if you can help us understand where these constraints are really coming in.

We've got a record backlog right now, and it should have been a record -- or 4Q should definitely have been a record quarter, but we haven't gotten the train fully back going. A lot of it's upstream on the supply chain side and some of it's hiring and training and productivity related. We've mentioned prior. We feel like we're about a quarter behind on our HSL ramp, so that is impacted. And so I guess, Mike, you can dimension for Noah what you think the shortfalls were, but Noah, it's absolutely -- the other part of your question is it's mostly a TPPL issue. And as noted, all three businesses sell TPPL. And I think the largest portion of the backlog is probably the transportation sector, right Mike?

So Noah, we expect to have a sequential improvement in our top line contribute to third quarter of about $60 million to $70 million, so that would be the step up. Now that higher number for Q4 is still about that same amount as the amount by which we're missing our originally pre-COVID budgeted amount. So you can kind of see we're kind of making up half of the progress of where we wanted to be. In terms of the overall capacity on TPPL, we feel like we're somewhere in that $700 million to $750 million, with the high speed line at its full, operating 24/7. That should add about $150 million to $200 million to our top line, so that would reset somewhere just $850 million to $900 million. And then to the $1.2 billion that we've spoken to in our analyst call, that's in CapEx expansions that would go on throughout our fleet of five factories that produce TPPL. So they will be all incremental bottleneck directed to try to expand each of those networks over the factories over the next three years.

And Noah, just as a reminder, those CapEx requirements have been communicated in that roughly $100 million a year of CapEx need, we need going forward. That includes that TPPL expansion -- further expansion.

And then on a related point, you mentioned in your prepared remarks, but just understanding the NorthStar integration progress. Can you update us on where you're at in terms of having product qualified with all the relevant customers? And how soon we can start to see really some of the logistics savings, the freight savings, coming into the P&L as you kind of optimize your production to distribution footprint?

Well, we just had a great global half review with Patrice and his whole team a week and half ago, so we got a pretty good update on all the factories. We got a big certification in the French factory IATF, so that allows us to move some of the OEM volume that was being exported from the NorthStar Springfield factories. We're now in a position to start manufacture that in France, which is a big piece part. We've qualified the Alpha sale, which is a high volume block that we were currently making in France. We've now qualified that on the high speed line. So all those pieces we had talked about as part of the deal logic and the synergies as you probably are insinuating are behind the acquisition schedule largely because of COVID and the delays for the high speed line, most of that is on track. Mike mentioned, we're hiring a second shift. Third quarter, I think the team was very frustrated that there were still trouble getting folks hired. We're still kind of wrestling with some of the COVID benefits and motivating people to come back to work. That seems -- the eye seems to have broken a little bit and we've been adding some folks now. So that situation is getting there, but obviously, our inventories are way too low on the finished goods. And we're in a little bit of a hole. We're working very hard to get caught up. And yes, so I'd say I'm very pleased with the SOx, getting that SOx qualified on the accounting side. I think we've hit most every mark on the NorthStar deal other than just being delayed because of COVID.

And I guess, Noah, I would just throw in. The transition of the Daimler product that was made in Springfield, Missouri to Arras, France, depending on the volume we do with that customer, should benefit us $5 million to $10 million a year. And as Dave mentioned, the transfer of EnerSys product that was now being made in the Springfield factories of NorthStar should help eliminate -- we've had $4 million to $5 million per quarter drag from those two factories in their manufacturing variances. And as we put volume in their TPPL demand in there, we would expect that those variances to eliminate as utilization improves. So it's a big deal and it's a big driver of what's going to enhance our margins over the next two fiscal years.

Maybe I could just sneak one last one in. Dave, again, you mentioned in the prepared remarks that you're going to be working on some product development for EV fast charging. We look at this as a significant market opportunity in the coming years, and we're looking at something close to $3 billion of EV hardware opportunity for DC fast charging in the US and Western EU. And so I think it would be helpful, I know you don't want to say too much about it now. But just can you give us the broad strokes of when we should think about the company having a product in the marketplace and maybe how you might go to market?

I think what's the most exciting piece of it is how similar the -- so the first prototypes are being done this quarter over the tech center in the building next door, and I've been very pleased with the amount of bill of material similarity that is with a motive power system, for example. There's the connectors, there's some things in the pedestals for connecting to the electric vehicle that are a little bit different. But by enlarge, 100 kilowatt hour batteries, 100 kilowatt hour battery lithium pack, like we're doing for motive. So it's a natural step for us. And the channels to market are interesting and there's been a lot of discussions with very large real estate companies, actually. So for the interest for this and how it's going to, how these new charging infrastructures are going to roll out will be intrigued. And I think part of it, Noah, is it's what we call application stacking, where one, let's call it, appliance, can do multiple things. And I think that's what's exciting about these projects is that same asset can be used for fast EV charging, it can be used for load leveling and demand shifting, it can be used for powering a 5G base station. It's really unbelievable, frankly. And it is interesting how a few of our real estate, big real estate companies, have really locked on to this idea. So like you said, more to come. But the key message for our shareholder base is that from a technology supply chain, I would say for the last four or five years, we've been building a lot of competency and building a lot of muscle memory. And it's about time we start to flex this. And we want to take, and I've said this since Investor Day and before, we want to take these core competencies of supply chain and engineering and start to push into new adjacent markets and we're very excited about it.

And our next question is from the line of Greg Lewis from BTIG.

Just realizing that it's early days and people like me on the finance side always want things to happen a lot quicker than they actually can happen in the real world, but you touched a little on the initial rollout of the lithium ion battery in mode of and just as we think about that, as you think about it gaining increasing in customer usage. And is there any way to kind of think about how that plays out over the next two, three, four years? And as we think about that, how should we be thinking how that maybe impacts margins on kind of like an annual basis? Any kind of color around that, I think, would be helpful.

Well, Greg, what we laid out at our Investor Day model included a lot of the product migration and product rotation, a lot of the margin improvement. So a lot of that was baked into our Investor Day model and the assumptions at the time. I don't know that the assumptions have dramatically changed in terms of the rate of conversions or the rate of impact on the margins post COVID. I think if anything, just the kind of that whole of demand has sort of delayed things from a COVID perspective. But in general, what we have to do, like the big one was the Hagen factory that certainly was an expensive endeavor and it’s part of that product rotation that a strong balance sheet allows us to make those right kind of move. The adding of additional engineering talent with new skills, we’ve been doing this for years now. And I think we’re going to continue to see those lifts. We also should start to see additional lifts as we can continue to drive waste out of the organization. One thing I’ve really pressed my three key line of business leaders on is operating expense. I think COVID really showed these work from home initiatives that we can do things a lot cheaper than we’ve done historically in terms of travel, entertainment, things in those areas. So there’s certainly places to tighten up there. But in general I would say most of the assumption that we say about margin improvement, product rotations, restructuring costs is all reflected in the model. And I think as we communicated the last cycle, Mike, we feel like we’re behind schedule as a results of COVID.

And Greg, I would say to your question on what it’s going to do to overall margin. So we would expect we ought to in this upcoming fiscal year sell $50 million to $100 million in our motive power products lithium base. And most of the product with current costs is you're using soft tooling, you have some fairly small purchase quantities. Your assembly teams are going through a learning curve. So as we expand, we would expect the first year, those margins to be fairly modest, actually be a little dilutive to our overall margin profile. But as you cost out in that first year the product, we would expect, obviously, that these are going to be among our higher margin models. But don't expect that in the upcoming year…

Yes, I think Greg sort of asked in the long run. But certainly, I agree with Mike's point. In the near term, there's going to be some growth pains in terms of margin impact, and that's reflected in our model.

And then you touched on it briefly in the prepared remarks, it seems like it's something that's really gaining momentum or as we think about Energy Storage, you kind of laid out maybe opportunities in residential, telecom, energy. I guess two questions in there. Is there any way to think about stacking those opportunities where, where do we think -- I mean is telecom going to be the initial opportunity and maybe energy is the opportunity longer term? Is there any way to think about how each of those is going to perform over the next few years? And just on the back of that, as you think about that opportunity, clearly, with the acquisition in '19, the deleveraging of the balance sheet, clearly, you guys are at an opportunity that, once again, to bolt on things that might be needed to kind of really plant the flag in these various sectors. Just kind of curious how you're thinking about the opportunity in energy storage.

Right now, it's really a question of going after the right targets because it’s such a target rich environment. As Mike mentioned, we think the change in administration is only going to improve the prospects for these opportunities. We think that the key, as I mentioned earlier to Noah, is the ability to application stack these devices so there's multiple value streams that are created. And I feel very confident that the technology piece is well within our core competency. Now as you expand into like resi and you push into some of these kind of utility interconnects, there are some software elements where a tuck-in or something might make some sense. And we're working on those issues every day. So the software component of the business is increasing as part of the needs here. On the hardware side, I think we're really well positioned. We do need to add some expertise on software, but I really like this space. I think during the Obama administration, this same team in a lot of ways, wanted to do some of these things. It just was too early. The technology wasn't ready. But all these years later, I think now we're in a much better position to do things as the costs have come way down on battery energy storage in general.

And so when you mentioned earlier about the [Technical Difficulty] of engineers. I guess it's safe to assume that a lot of those positions are potentially or probably for software?

Yes. The software piece, the firmware piece, for sure, that's a big part of it. And as we push deeper into these areas, that will be more and more of the mix of people we're hiring is on the software side.

And our next question is from the line of Brian Drab from William Blair.

Just a first question, there's a lot of moving parts here in terms of the capacity constraints and the need to push through some price, you're taking out cost, closing facilities. If I remember correctly, we were at the Analyst Day about year and half ago talking about marching toward 28% to 30% gross margin and we're at around 25% now. As you look to fiscal '22 and you move past the capacity constraints, put through some of the price, you get the costs out. What is a reasonable expectation can you get? 200 basis points of gross margin in the next fiscal year, and also you have volume coming back, I guess, as well, or is it 100? Where do you think gross margin could be in fiscal '22?

Well, we still feel like that margin expansion will happen. The pandemic and the restrictions from that is something of a wildcard that I can't speak for, but to all the points you just mentioned of getting capacity up, that's the drag that the NorthStar factories have been on us. The overall capacity that will improve across all of those items, the benefits of $20 million, not all recognized next year, but the rest of it we kind of estimated about $10 million of benefit from Hagen next year and $20 million thereafter. So all of those are the things that should drive it, including as we need to adjusting our pricing for any changes in freight or commodity inputs, et cetera. So I would say -- and you got to caveat it with some of this uncertainty in this world, but that margin expansion should be, it should be 100 to 200 basis points by the end of next fiscal year. So we ought to exit 2022, 100 to 200 basis points higher than where we are today.

Yes. I'd say that the biggest -- and Mike ticked off most of the volume absorption, getting some of this COVID related volume reductions FIFO through the P&L, Hagen. I think the biggest headwind that the finance team has been flagging going into F '22 is the tariff and freight side. So freight rates are still a pressure point. Some of the tariffs have gone from 10% to 25%. That's a very time consuming part of our procurement team right now is moving things around and changing suppliers, and that's been a nightmare, frankly. But we just do what we have to do. But anyway, that's the biggest. But most everything, and like we are trying to get ahead like we said on the commodity pressure with some price increases. So I think Mike's number is very reasonable.

And then one of the topics that I've been getting calls on for, it feels like 10 years now with respect to EnerSys is lithium, the threat of new competitors producing lithium batteries for forklifts. And I just wanted to, again, kind of check in with you in a public way, today, on how that competitive landscape is looking to you. My understanding is that, still, today, less than 5% of forklifts are shipping with lithium batteries, maybe it's a little more in Europe than it is in North America, but globally, somewhere around that 5% or less range. And you've got a lithium product now. Who are the competitors that you're seeing the most in the marketplace? And are you seeing some of the -- are you feeling increased pressure to have a lithium product because some of these forklift OEMs are partnering? There's always been these partnerships that have been developing across the industry between the OEMs and some generally kind of start up lithium battery suppliers.

Well, it's a great question. I think that Asia, especially the China market, is the furthest ahead on lithium. I think part of that is because BYD is both a battery company and a forklift company, and they use lithium ion phosphate technology. So I would say the percentages have moved higher than where you're at. Our NexSys iON product is well positioned to participate. I think one of the things you have to think about is this whole make versus buy in terms of how easy it is for these forklift companies to get into the battery business. That's a real serious question. And the objective for me and my team is to make that decision really easy that our products are going to be better, safer, cheaper and readily available to try and protect our share, grow our share, grow our margins, and we're having success. And the other piece to it is the maintenance-free is what a lot of these customers want. And our NexSys Pure, which is our TPPL variant, also fills a lot of those, or checks a lot of those boxes as well. So we feel like between our new NexSys Pure and our NexSys iON products, we have a very compelling option as people want to push into more of these maintenance-free solutions. The percentage of lithium in the marketplace, I don't have a clean number like I do with lead because of industry associations and so forth, but it's pushed past that 5% number globally for sure. And we're going to participate. We're going to be there. And we're going to be the only supplier out there that carries traditional flooded lead, NexSys iON and NexSys Pure maintenance free products. Mike, do you want to add anything?

I just think, Brian, when you think about market penetration, you have to think of the size of the vehicles, and they have a much higher penetration in Class III vehicles where those vehicles, the operator walks alongside, so the counterbalance weight is a little bit different. They don't need to be heavy. So even though those are Class III trucks are the most numerous, that's not in terms of battery sales, it's not necessarily where the money is. So I would say you're higher in penetration Class III less so in I and II.

Yes, the market is moving to maintenance free. We're moving with the market. And in terms of the competitive landscape you mentioned, there's really two sets. Principally, there's been a lot of small start up companies that have tried to compete and that's not always easy in terms of costs and balance sheets. And then there are some of the big OEMs like Heidrick that have tried to do their own organic programs. And again, it's incumbent on us to offer a better mousetrap and to do it more effectively. So it's easier for the OEMs to use our products integrated into their trucks and that's what we're trying to do every day.

I'm just processing that and thinking, you started, Dave, by talking about Asia. I mean your share in Asia, if my memory is correct, is more around the mid teens range. And in the Americas and motive, it's over 50%, I think. And Europe is in the 40% range, I believe, or maybe mid-30s. And then the large trucks is where the money is, as you just said. So overall, if you just look at Americas and Europe, can you even ballpark what percentage of the market that's important to EnerSys is now shipping with lithium versus lead acid?

I can speak to the lead piece. So the lead markets and the demand are still robust and healthy in the US market and in the European market. I would also say, lithium is coming off of a very small base, so their growth potential or their growth rates are obviously super, double, triple, but coming off a small base. And so in terms of the loading, the margins, we feel like a lot of that as best as we could do, we baked into our Investor Day model. And that's the best answer I can give you. And I really don't have good statistics like we do with lead for how many lithium batteries are out there. But in terms of our lead battery business and the demand for our lead batteries, it's still vary. It's normal. And I would think, based on a lot of the information we're seeing from our customers, that there's some pent up demand from earlier in, let's say, the spring of 2020 when all the factories got shut down.

And then just a last question, probably for Mike. I just want to be clear on this. I think I heard you say that sequentially, revenue should improve in the fourth quarter. I think you said by $60 million to $70 million. And then I'm wondering, as you go to the first quarter of fiscal '22, given that you have this dynamic of maybe capacity constraints lessening, would you expect typical seasonality in the fiscal first quarter where revenue steps down materially, or could it be a situation where actually revenue holds flat or is even up as you move sequentially from the fourth quarter to first?

Yes. I think it's going to be a flatter look than most years. But on the top line, I would expect Q1 won't look tremendously different from Q4.

And was I correct on the third and to fourth, you're expecting a sequential improvement? You said that, right?

Yes.

And our next question is from the line of Greg Wasikowski from Webber Research.

I just wanted to revisit the comments on renewable storage. Is that explicitly talking about getting into the resi storage business, or is it something else, maybe like utility scale or something more unique?

Resi is part of it. And then the other one is commercial, industrial. So C&I behind the meter. We've said previously, we're looking at systems probably in the ZIP code of 500 kilowatt hours, plus or minus, and not utility scale. That's a piece that we have not identified in our product roadmap.

And then just kind of thinking about the EV charging and then the resi storage market, you kind of touched on this earlier. But can you compare and contrast the competitive dynamics in those two markets, and maybe just give like the biggest hurdle for entering each one?

I think it's not a well defined market yet. I think the Biden administration is certainly recognizes the criticality of charging and charging infrastructure as part of reaching more carbon reduction targets and getting more vehicles electric, you have to be able to charge them. And we're looking at the portion of the market where folks that are interested in charging very quickly, that's really the portion of the market we're most focused in. And we have forklift customers who want the same thing. They want to get the electricity back into the battery pack as fast as possible. So we want to leverage what we've done in the forklift area and pursue it into the electric car market as well. So in terms of what the capabilities are, you have to have expertise in energy conversion. You have to have packaging, software, balance sheet, and it's all the things that we feel like we already bring. In terms of the channels to market, you've seen some MOUs we've done before with Blink. And then we certainly we've spoken to other people in this area. But it's still a very, I would say, it's still fairly early days. And I don't know that there's a clear road map yet as to how this market is going to develop. I think what I said earlier, I think it was Noah, is it's very interesting how the real estate companies are thinking about taking a leadership role in a lot of this EV charging area.

And then one more quick one, if I could. Jumping back to Energy Systems and 5G. Last quarter, you said you kind of expect like an accelerated ordering activity in the spring, late spring and into the summer. Just given how quickly things can change nowadays, it seems like that's still the case, but I'd thought I check, is that still a timeline that you're thinking?

Yes, orders are good. And the Corning project is really exciting. They mentioned our collaboration in their call a couple of weeks ago, and we're part of their eVolve program, and it's a whole concept of how to deploy fiber much easier for the customer, so it's prefabricated connectors. And our role in that is part of their big cable is embedded some power conductors, and we're using our new systems that allow through that Corning cable to transmit the energy to the base station or power supply like a mile away. And so it's a fantastic project. And Corning mentioned Verizon in their press release. Certainly, Verizon is -- and this is tied really to the small cell site ultrawide band rollouts. And so the timing of that is behind. The orders we're getting today are from customers mostly on the lower spectrum, and really activity is good on building out 5G radios at more of a macro level. But the ultrawide band and small cell site is coming probably a little bit later. But certainly, we've hit some key milestones on this development. We're very excited about it. And the other thing I mentioned in my prepared remarks, which is not insignificant, is some communications by some of the big cable companies with their attention to go to a quad play. So they're going to offer wireless of their own, but they want to start to do it over their own networks instead of being a mobile virtual network operator. They want to put the data traffic, the radios, the powering, right on their existing HFC networks. And that's really in a sweet spot for us. And it was one of the things that - attracted us to the Alpha acquisition was the gateway product family provided a DOCSIS compliant, high speed modem for backhauling 5G traffic in addition to providing the 48 volt power. And the piece to the whole 5G rollout that I think it doesn't get well understood is how much the installation, getting licenses for electrical connections, that's a big, heavy part of this. And a lot of these programs we're working on is to try to make the rollout of 5G small cell site easier, faster and cheaper.

[Operator Instructions] And we have our last question from the line of John Franzreb from Sidoti & Company.

My questions have been addressed.

Don, I don't think there's any more questions.

All right. There are no questions at this time, sir. And I'm turning it you back, Mr. Shaffer. Thank you.

Well, again, we just want to thank everybody for attending the call today. We look forward to providing further updates on our progress on our fourth quarter and year end 2021 call in May. Have a good day, everyone. Bye bye.

And this concludes today's conference. Thank you for participating. You may now disconnect.