Ladies and gentlemen, thank you for standing by, and welcome to EnerSys Second Quarter Fiscal Year 2023 Earnings Call. [Operator Instructions]. I would now like to hand the call over to Lisa Hartman, Vice President of Investor Relations. Please go ahead.

Good morning, everybody. Welcome to the EnerSys Q2 Fiscal Year 2023 Earnings Conference Call. On the call with me today are David Shaffer, EnerSys's President and Chief Executive Officer; and Andrea Funk, EnerSys Executive Vice President and Chief Financial Officer. Last evening, we published our second quarter fiscal year 2023 results and filed our 10-Q with the SEC, which are available on our website. We also posted slides that will be referenced during this call. The slides are available on the Presentations page within the Investor Relations section of our website at www.enersys.com. As a reminder, we will be presenting certain forward-looking statements on this call that are subject to uncertainties and changes in circumstances. Our actual results may differ materially from those forward-looking statements for a number of reasons. Our forward-looking statements are applicable only as of today, November 10, 2022. For a list of forward-looking statements and factors which could affect our future results, please refer to our recent 10-K filed with the SEC. In addition, we will also be presenting certain non-GAAP financial measures, particularly concerning our adjusted consolidated operating earnings performance, adjusted diluted earnings per share and adjusted EBITDA, which excludes certain items. For an explanation of the difference between the GAAP and non-GAAP financial metrics, please see our company's Form 8-K, which includes our press release dated November 9, 2022. Now I'll turn the call over to our President and CEO, Dave Shaffer.

Thanks, Lisa, and good morning, everyone. Please turn to Slide 4. We delivered solid Q2 results with our second highest quarterly revenue in what is typically a slow quarter, significant gross margin expansion as prices catching up with costs and robust demand for our products across our diverse set of end markets. Second quarter net sales were $899 million, an increase of nearly 14% over Q2 '22 even after absorbing approximately $45 million of FX headwinds with strong volume growth in all lines of business. Despite ongoing supply chain and inflationary pressures, we reported second quarter adjusted earnings of $1.11 per diluted share, above the midpoint of our guidance and up $0.10 versus prior year. We were encouraged by our adjusted gross margin expansion of 120 basis points from last quarter, a sign that we have begun to turn the corner on the long anticipated catch-up on price/cost recapture. Margin improvement was driven by an impressive $30 million of favorable price/mix accomplished across all segments of our business, which was partially offset by an additional $11 million of volume-adjusted costs versus the first quarter. Let me put our price/cost recapture opportunity into perspective. Our Q2 '23 costs were in excess of $100 million higher than Q2 '21 before inflation began to rise. On an annualized basis, over $400 million of higher cost equates to nearly $8 per share of EPS pressure, even while ignoring the incremental impact on primary working capital and interest expense. Further closing of the gap between price and cost represents a significant earnings opportunity for EnerSys in the quarters ahead. Commodity prices remain elevated relative to historical averages and some supply chain shortages persist, both of which we are mitigating through alternative sourcing and increased stocking of critical raw materials. We are cautiously optimistic that we…

Thanks, Dave. I'll focus my discussion this morning on the key financial metrics and takeaways for the quarter. For more detailed information about our results, please refer to our second quarter 2023 10-Q, press release and supplemental slides that were posted to our website last night. For those of you following along on our PowerPoint slides, I will begin on Slide 12. Our second quarter fiscal '23 net sales increased nearly 14% over the prior year to $899 million, driven by 10% organic volume growth and 9% price/mix improvement, partially offset by a 5% decrease from foreign currency translation. Adjusted operating earnings were $65 million in the second quarter, up 7% from the second quarter of fiscal '22 and in line with Q1. Foreign exchange negatively impacted our year-on-year and sequential comparisons by $5 million and $2 million, respectively. In constant currency, Q2 '23 adjusted OE improved over 14% versus the second quarter of prior year. Adjusted EBITDA for the second quarter was $86 million and 9.5% of net sales compared to $79 million and 9.9% of net sales in the prior year second quarter. FX pressured the year-on-year comparison by $6 million. It is worth noting again that our margins are artificially deflated from the margin math impact of cost pass-through. A reconciliation of net earnings to adjusted EBITDA is presented in the appendix of our slides for your reference. Our adjusted EPS was $1.11 in the second quarter of fiscal '23 compared to $1.01 in prior year second quarter and $1.15 in the first quarter of fiscal '23. I will present a reconciliation of Q2 '23's sequential and year-on-year EPS shortly. Please turn to Slide 13. On a segment basis compared to the prior year, all lines of business posted significant revenue growth, driven by higher volumes and…

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

And nice to see a number of items inflecting positively here. I'd like to start with supply chain. You obviously mentioned a number of considerations during the prepared remarks. But can you talk about your visibility into supplier allocations and how we should think about the cadence of the backlog conversion this quarter and possibly in the fourth quarter as well?

Yes, Noah, I would say the key change quarter-to-quarter has been the semiconductor. That market has loosened up considerably. We've -- I've seen improved forecasts for certain product segments that, as noted, the electronics tend to be higher-margin products. So it's accretive to mix. And just as a reference point, it's -- one of the products was as low as 8,000 a quarter and forecasted going forward that could be as high as 25,000 a quarter. So it just -- it gives you a sense of how much loosening is occurring. And so that's going to help drag the backlog down. It's going to help drag some margin out of the backlog. And that's been the biggest change of late. In terms of the other supply chain issues, they've been a little quieter. Nothing -- I don't want to give the sense we're completely out of the woods. There's certainly still surprises that happen frequently, but it has improved. And -- so I think the biggest opportunity for me, I'm excited about the 2 things, commodities have come down. I don't say, I don't know, [indiscernible] if they're not all the way back, copper and steel and -- maybe steel, but all the way back, but certainly, they're on their way back to sort of these pre-inflationary periods. So that's helping. And certainly freight has come down considerably. So that's helping. And then semiconductors is the big pieces. And -- so yes, I think those are the major supply chain from an H2 versus H1 perspective are improving. But I don't want to -- certainly don't want to say we're completely out of the woods.

And do you think some of that improving allocation in any way related to the consumer electronics demand getting softer? Or are these really industrial chips, right, the analog and RF and mixed signal and you're just seeing improving flow on that side?

Well, I think the teams have done a lot of work on redesign. So a big part of this is we probably pulled 20% of our engineering and reassign them from new products on to redesigning products around or readily available chips. So that's been a huge part of it. I would -- most of the chipsets, Noah, that we use, especially on the microprocessor side, are the ones more automotive. So I think that the -- those are the types of chips that we use, these lower-cost micros. And it's just gotten better.

Okay. Very helpful. And then you mentioned capture some margin with that backlog conversion. I guess can you help us think about quantitatively, the margin uplift or the margin profile of what's in backlog? You talked earlier about that kind of price recapture opportunity. How much of that is just in the backlog conversion already?

Yes. Again, it will come down to execution in terms of how many of these units we [indiscernible] out the door. And what you should see as we go forward is a steady improvement in the performance, and this is principally going to be viewed in our Energy Systems business. So you should start to see a better mix coming out of that group. I'm a little hesitant to dimension too much. But I would tell you that the electronics mix tends to be very accretive. So it is a nice opportunity for us. And if you do look at the magnitude of the ES backlogs relative to historic norms, it came down a little bit. Backlog, it's still very, very high. And a lot of what's in that backlog is electronics. So we're optimistic as the allocations improve from our chip suppliers, things should steadily get better.

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

I'm curious what your thoughts are on the e-commerce market after a number of the larger players, Amazon and Walmart had decided to cancel the construction of some warehousing facilities. Have you seen any impact of that? Or do you expect to see that maybe in the Motive side of the business? Can you talk about what you're hearing there?

Yes. I would say Motive is where we're most tuned into recession monitoring and slowdown monitoring. In terms of a lot of -- if you remember, a lot of those big mega distribution centers were using fuel cells. So I don't know that we're seeing the direct impact of yet. Our order rates tend to be good. And then the other -- the key driver I ran into Chad out in the cafeteria a couple of days ago, and he runs the -- he runs Motive Power sales in North America. And he was very clear. The biggest issue that we're having in Motive is still -- it's just adapting to the very long lead times for the forklift trucks. And they're ordering the batteries much sooner than they did in the past. And that's been the biggest adaptation, but he didn't seem to have any concerns about a slowdown per se. I think more -- that's more for Vincent, and Vincent has got our European business. He seems a little more concerned about the macro situation, I think mostly around these energy and potential energy impacts on the European economy. But I would say that we aren't seeing or feeling any direct impact from these big e-commerce announcement. We have seen those for sure. And we're continuing to monitor. And what we're really -- what we're trying to do, John, is really make sure, and this is what I've asked the teams to do, is recognize that through this period of COVID shutdowns and then the snapbacks and the recoveries, there's a lot of noise from a volume perspective. And then in addition, the inflation and pricing recapture and then now the FX, there's just a tremendous amount of noise in the revenue. And what I try to get the team to focus on is isolation -- isolating the volume and comparing it to what sort of a normalized trajectory would be from a volume perspective kind of pre-COVID and to see how we're tracking relative to those historical norms. And I would say the best data I have for you right now is that things are really starting to normalize to -- from a volume perspective back to where they would have been. So think of a big drop and then a big spike and things seem to be coming back down to -- from a Motive Power. And we're watching very carefully, but I haven't seen any direct impacts on the e-commerce side yet over.

That's helpful. And just on the backlog, historically, it wasn't something we ever talked about, but it's gotten so large that we can't ignore it. I'm just kind of curious how firm is the backlog? What's the cancellation risks? Is it different between each segment? Just maybe some context to what your thoughts about -- you seem to be buying in advance or others that have to take delivery that would be helpful?

I would -- let's go through the different business segments. And then Andi can certainly dimension things for us. I would say the biggest backlog growth has been related to some big program wins in our Energy Systems business. So backlog growth has been a function of a lot of these mid-spectrum DC power cabinets we've been selling for 5G. So that's been a big part of it. And then another big part of our backlog growth has come from the CPUC project we had mentioned. And we are shipping against that. We haven't -- but we haven't -- of the $170 million in orders, we have -- we've shipped less than half of that so far. So that's been a big -- so there's been some big program wins in our defense business, there's some program wins, some big ones. And those are the pieces of the business that we feel good about it. Nothing's recession-proof, but these businesses, ES and defense, have their own rhythm. In terms of Motive, I would say principally, the backlog growth today is related to what I mentioned earlier, which has a lot to do with the truck lead times. So I think that the truck lead times are getting people to order sooner. And we're still coming off a strong period of Motive Power demand for new trucks. So I would say that -- and we've challenged the teams -- Lisa and Andi are sitting with me, and we challenge the teams regularly to look at cancellation rates to -- and Andi, has there been anything you've seen in the testing?

No. And I can give a little bit of dimension to the data, if it would be helpful for you, John. Energy Systems, our backlog is up $600 million versus 2 years ago. Very healthy. There's no COVID-related risk of cancellations. A lot of it is, as Dave has mentioned, program-related, 5G, CPUC, strong market. And to give you an idea, at $600 million at higher margins with a lot more electronics, less service. If you assumed a 25% drop through, you'd have -- you have over $100 million of OE trapped in that backlog. So big numbers and minimal risk there. Transportation is up $30 million versus 2 years ago. There's a lot of pent-up demand from [indiscernible] trucks, minimal risk of cancellations. I think you've seen we just had a record Class 8 order . So very strong there. EAS is down slightly, but that's really choppy because of projects. U.S. government replacement spend for Ukraine support isn't flowing through yet, but we expect that's going to start coming in strong, which leaves us with Motive Power, probably the area you're focused on the most, $200 million backlog versus 2 years ago and $100 million from a year ago. We would look at that as most exposed. So as Dave mentioned, we're constantly getting at it, but we aren't seeing any cracks yet. If you look at the data, our backlog there, $380 million. Our quarterly backlog coverage is over $1 million, $1.1 million. In Q2 of '21, to give you an idea, that was $0.6 million. Our book-to-ship ratio was just around 100%. So while we have seen a softening of orders, we look at a 5-year trajectory rate and we're right in line with where we were pre-COVID. So we're seeing a softening because we don't have this huge catch-up from when we had the COVID decline. But we're keeping our eye on it, but it still looks pretty healthy. We're not concerned yet, but I assure you we're not taking our eye off that.

And just on this topic, you said there's some concerns in Europe. Has the order trajectory changed at all at Europe? Or you just monitoring it closely because of conditions?

I would say more monitoring. Yes, I would say it's more just -- we're just nervous as everybody is, we're all watching CNN and just a lot of risk.

Yes. And I think we're doing a lot of -- we're taking a lot of proactive actions for any kind of mitigation. If there is curtailment that would be outside of our control. Each of our plants has provided a letter to be handed out to authorities, highlighting the importance of our activity if there is any kind of curtailment. We split our EMEA countries into 3 risks from low to high. Arass, which is our large TPPL plant in France is least at risk because of the excess capacity of nuclear energy in France. We have planned scenarios in place at each one of our plants in case of restriction, including priority to single sourced products, customer contractual agreements, looking at different ways we can look at bottleneck saturation, reducing consumption on the supply side, the alternative sources for suppliers in any high-risk countries. So not only our own exposure but exposure of our suppliers. And finally, longer run, we've developed a plan to reduce the energy consumption by about 15% per kilowatt hour over the next 12 months by looking at processes, reducing usage, consumption and waste, in-house production and fully aligning that with our sustainability goals. As Dave mentioned, we've allocated about $4 million per year for the next 5 years to achieve our sustainability goals, and we're prioritizing that region because of exposure.

I think -- and John, back on your first question, and again, staying focused on Motive. We've been through some downturns together over the years. And if I look at -- if we do get a downturn, what this were going to look like compared to ones in the past? We have 2 less big factories than we did before in terms of Ooltewah and Hagen. So that's going to help the Motive. I've got a leadership team in there that is 100% wholly committed to OpEx productivity, automation, and doing more with less. I'm really proud of that team and a lot of their efforts. And then our -- we've expanded our product range dramatically with higher-margin products, including our NexSys Pure TPPL, our NexSys iON, lithium and our wireless charging, which is just getting kicked off. So I think there's a lot of reason. And then as Andi always notes that in these recessionary periods, commodities tend to fall off which takes a little pressure off the P&L, and we tend to generate a lot of free cash flow. Our working capital needs go down. So I think that relative to prior downturns, we're in better shape than we've ever been with the new product mix and the smaller factory footprint and the higher level of productivity out of our other factories. So we're doing what we can do to be ready.

Our next question comes from the line of Greg Wasikowski of Webber Research.

First one, just on the IRA in Slide 6. I know everybody needs some more further details before really figuring out your full strategy. But does the potential there kind of change how you think about your strategy for some of your products and end markets? I'm just thinking Outback for an example, like maybe making that less of a niche product and trying to make it more mainstream in resi or commercial, solar or any of the other products that are listed on that slide?

Yes. I'd say on IRA, there's the tax piece, which is interesting. And I would say the biggest issues there and the comment period just closed, I think, last Friday, right, Lisa. And most of the comments or questions were around defining -- so the target was a battery that was 100-watt hours per liter. So we want a clarification on what to determine the watt hours. And then on the liters, we needed some clarification on being which dimensions to use, interior cell dimensions or the exterior module dimensions and so forth. So -- but that's -- I was really -- and this is my product engineering background, but all of our lithium products will hit that watt hour, 100-watt hour per liter target. And then a pretty nice chunk depending on how things shake out with the comment period and these definitions, a pretty good chunk of our TPPL business because it is the -- we have always targeted volumetric energy density. That's what we've always pushed is not so much grab metric or weight. But that's not been our -- our focus is always on volumetric energy density. So we've got quite a few products that are -- should hit that 100-watt hours per liter metric and as such, could qualify for some material savings. We'll just have to see how those definitions work out. So I don't want to dimension anything for you, but it could be really interesting. And then in terms of your question on the demand or market side, we just feel really good about this. NEVI and some of the things in the original inflation -- or excuse me, infrastructure, the law that came out. There's just a lot of positive activities within each -- all of this recent legislation that is right in our wheelhouse. So specifically on Outback, I would -- I noted earlier, we pulled about 20% of our engineers off of new products to focus on redesigns to make sure that we could ship our chargers and ship our rectifiers and UPS systems. The biggest hit for engineering resource allocation was our residential energy in some of those Outback programs. So that's kind of unfortunate. So I take your point in terms of -- and as we get through some of these supply chain redesign issues, we do -- and I take your point loud and clear, we should let some of those opportunities from these new laws shape how we prioritize and reprioritize where those engineers are allocated. So it's a good suggestion.

Got it. Okay. Next one is on the EV charging product. And this is -- it's tough for us from the outside looking in, but it seems like the product has maybe been commercially ready for some time. And I know you guys have done some upgrades, but maybe we could think about them as more akin to like typical annual generation updates. But -- at the same time, it seems like things are pretty cooperative between you and your -- I'm declaring it an anchor customer, which is good. But speed to market is really important right now in EV charging. So I'm just -- have you thought about getting out into the market with other customers or doing other pilot programs? Does your agreement maybe you from doing so? I'm just trying to understand the relative sense of urgency and desire for land grab felt around the industry versus the speed with which this product is moving, just trying to get your thoughts there?

Yes. I would say that the engineers have gone -- and this may be the first time that the engineers are ahead of the salespeople, the engineers have done extremely well. And we've got the new, I would call, it production system, getting installed, near production system. I think there's a couple of things that need to be tweaked. But the new system is getting installed right now next door. And just to your point, beyond our original target customer who has a use case, which is really interesting and we really like. But we've also decided that we're going to go after some of these NEVI charging station projects that are -- the RFQs are just starting to come out. I think we should see the first RFQs maybe December, but probably January. I know there's about 7 states, and they're building out these fast EV charging along major arterial routes. This is -- if you remember, this is about $5 billion worth of monies that were allocated in the Infrastructure Law. So -- and the states are -- I think it's an 80% funding and the states have to kick in 20% as they build out these charging stations. So we are participating in those RFQs. Just for some dimensioning, we gave some rough targets for us, $50 million to $100 million to get started. $50 million is 1% of that NEVI Program. So given what we've assessed so far in terms of the specifications, we're -- we feel good. We feel good that there's a good overlap between what the states are looking for and what we've got ready. So in terms of your comment earlier about commercial readiness, we really aren't commercial ready. We're just now getting the design where we want it with the DC-to-DC higher efficiency conversion architecture. But that said, the engineers are doing a fantastic job. And we'll just continue to report progress. And hopefully, by the next time we speak, we will have seen some of these RFQs, and we can give you a sense as to how from the cost targets and the specifications, how optimistic we can probably give you some at least a level of optimism as to what we think once we started to see the RFQs.

[Operator Instructions]. Our next question comes from Greg Lewis of BTIG.

And Dave, I did want to touch a little bit on the comments you made around inventory runoff. Realizing we're not probably going to get too granular around that. But is there any way to kind of walk through on the different business lines and maybe how you're thinking about -- whether Energy Systems or Motive or Specialty, how we're thinking about rolling off that inventory? And as part of that, was that an overbuilding or just an inventory build, given supply chain issues that the industry was facing over the last, what, 18 months? Or is some of that also related to conversations we're having with some customers?

A big chunk of it -- a big chunk is stockpiling lithium for our -- making sure, given the choppiness in the tight -- the lithium cell market is extremely tight. So a big chunk of the inventory build is related to lithium. Another part of the build is just the -- we weren't trusting our Asian supply chain given all the choppiness with the freight and the longer lead times and the COVID shutdown. So we were way overstocking relative to historic norms. A lot of the power systems that we're putting together that have content. I would say most of it -- there hasn't been a in Motive per se of strategic other than the chargers because the electronic supply chain, I think, we did stuff a lot more chargers in the inventory than we historically do. And then on the Specialty side, it's really just been about the -- having enough and raw materials like lead, just making sure we had enough to give us a higher sense of comfort. Things are improving. And I think that the ops teams are under severe pressure from Andi, frankly, pushing hard to get back to more historical norms and we're coming through this kind of traumatic period of supply chain disruption and insecurity. Andi, is there -- did I miss anything on that go around?

Yes. I can give you a little more color, Greg, if it would be helpful and put a little bit of data behind it. So I think Dave nailed all the points, but since Q2 of '22, we've grown inventory by about $170 million. And if you look where that comes from, about $65 million is strategic investments, about $35 million is volume, about $55 million inflation and $15 million supply chain. But if I look at typically where I am on Q2 on an inventory , I usually am between . If I pull out my strategic builds and in headwinds, I'm around right now. So there's some opportunity to be more efficient. But the other thing we'd like to look at where interest rates are where they are and also with any potential exposure of a downturn want to be actually better than we were before, even after taking into consideration strategic builds and supply chain headwinds. So we've cast -- there's a weekly meeting that we have all of our lines of businesses represented, all of our heads of all of our different manufacturing areas represented. They've identified $150 million of reduction opportunities. They're tracking them on a weekly basis. There's actions . I haven't built all that into my sensitivity and sit from a working capital standpoint because I recognize there's going to continue to be headwinds. And I will say until supply chain issues subside, we will continue to use inventory to buffer exposure. So we're not turning the corner being penny-wise and dollar-foolish. And we're fortunate that we don't -- we have the borrowing capacity that we don't have to make decisions that are not in the best interest of our shareholders. We recognize it's going to be a cash flow opportunity when macro environments normalize. But at all of our review meetings every week, Dave would be saying price, price, price, price. Now it's price, inventory, price, inventory. So there's definitely a change in focus. There is an accountability. We are measuring it, and we do believe there's opportunity to make improvements here.

At this time, I'd like to turn the call back over to David Shaffer for any closing remarks. Sir?

Thanks, Latif, and thank you, everyone, for joining us today, and we look forward to providing further updates on our progress on our third quarter fiscal 2023 call in February. Have a good day, everyone.

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