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EnerSys (NYSE:ENS)

Q3 2009 Earnings Call

February 5, 2009 9:00 a.m. ET

Executives

John Craig – Chairman, President, and CEO

Michael Philion – Executive Vice President and Chief Financial Officer

Analysts

John Franzreb – Sidoti & Co.

Paul Clegg – Jefferies & Co.

Corey Tobin – William Blair

Todd Cooper – Stephens Inc.

Richard Baxter – Ardour Capital

Dan Whang – B. Riley

Michael Gallo – CL King

Dana Walker – Kalmar Investments

Chris Agnew – Goldman Sachs

Preetesh Manshi – Piper Jaffray

Operator

Good day, ladies and gentlemen, and welcome to the quarter three 2009 EnerSys earnings conference call. My name is Michelle and I will be your coordinator for today. (Operator instructions) I would now like to turn the presentation over to your host for today’s call, Mr. John Craig, Chairman, President, and CEO. Please proceed, sir.

John Craig

Thank you, Michelle. Good morning and thank you for joining us for our conference call. During this call, we will be discussing our results of our third quarter and first nine months of fiscal 2009 as well as commenting on the general state of our business. But before we start, I will ask Mike Philion, our Chief Financial Officer, to cover information regarding forward-looking statements. Mike?

Michael Philion

Thank you, John, and good morning to everyone. As a reminder, we will be presenting forward-looking statements on this call that are based on management's current expectations and assumptions which are subject to uncertainties and changes in circumstances. EnerSys 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 of management's discussion and analysis of financial condition and results of operations set forth in our quarterly report on form 10-Q for the quarter ended December 28, 2008, which was filed last evening with the United States SEC.

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 4, 2009, which is located on our website at www.enersys.com. Now, let me turn the call back to you, John.

John Craig

Thanks Mike. Last evening, we reported our third quarter results with adjusted diluted earnings per share of 80% to a record $0.63 compared to $0.35 in the prior year quarter. With global economic activity declining, our third quarter revenue declined 17% with organic volume down 10% versus the prior year third quarter. In spite of this, we achieved another sequential increase in our gross profit percentage from 20.7% in the second quarter to 22% in the third quarter. We continue to benefit from lower material cost in our ongoing cost reduction programs.

As I stated in previous calls, our goal is to achieve 25% gross profit, and I’m pleased with the improvement we made this quarter given the current economic environment. To help reach our 25% goal, we have further actions planned. Last night, we announced the closing of our manufacturing facility in Italy and then move this production to lower-cost locations. We’re in the process of implementing additional significant cost reduction actions around the world. We anticipate that the plant closing and the other recent actions, when fully implemented, will result in an annualized savings of approximately $13 million or $0.19 per share.

During this period of economic decline, we are in a very good position in several respects. First, we are enhancing our leadership position in the global industrial battery markets and we believe we will continue to increase our market share by staying focused on our customers. In this regard, we recently learned that several Chinese telecom companies plan to invest $41 billion in the next two years to operate their infrastructure. We estimate that this will result in at least $500 million in new battery purchases, and we are confident that we will receive a reasonable share of this business.

Second, as previously reported, we completed our refinancing last spring with favorable terms in pricing. Our all-in interest rate is approximately 5%. We do not have any significant term debt due in the next four years and we continue to have positive cash flow. We have $91 million in short-term investments at the end of our third quarter, a substantial increase from 55 million at the end of September. The $36-million increase was achieved even after the payment of approximately $20 million in October for the repurchase of EnerSys stock. We also have approximately $200 million in available credit lines. Our strong financial conditions allow us to pursue acquisitions and we anticipate that good opportunities will become available as a result of the difficult economic climate. We are continuing our major expansion project to increase capacity for thin plate pure lead products. This premium technology is used in a wide variety of applications. It remains the top performing technology in lead-acid batteries.

In addition, we are fortunate to have the financial strength to continue the necessary spending to restructure our operations and substantially reduce our future cost. Last night, we reported that we expect adjusted diluted earnings per share between $0.30 and $0.34 for the fourth quarter of 2009. This is a sequential decline in earnings but we believe still a very solid performance in the face of the current economic environment. We remain confident about our prospects for profitable operations even at the bottom of this economic cycle.

In summary, as stated in our conference call last August, we saw the beginning of market decline so we took immediate actions to enhance earnings. These actions helped us achieve our record $0.63 cents of earnings in the third quarter. As I mentioned earlier, we are closing our Italian plant; along with other actions, will result in an annualized savings of approximately $13 million or $0.19 a share when fully implemented. All the actions we are taking now will clearly put us in a very strong position when the global economy turns. Stated in other words, EnerSys’s plans to act (ph) at this global recession a stronger company than when we entered this recession.

I will now turn the discussion over to Mike Philion for further information about our results and our guidance. Mike?

Michael Philion

Thank you again, John. Our third quarter net sales decreased 17% over the prior year to 461 million. On the business segment basis, net sales in the reserve power business decreased 8% to 224 million, while our motor power business increased 24% to 234 million. The third quarter decrease includes approximately 10% due to lower volume; 8% from weaker foreign currency translation offset by a 1% increase due to pricing actions. The challenging global macroeconomic conditions had been most pronounced in our European operations as evidenced by the 28% decline in that region’s fiscal 2009 third quarter sales. Our Americas region’s third quarter sales declined a more modest 3% compared to the prior year, while our Asia business experienced 1% growth.

Net sales for our first nine months the fiscal of 2009 increased 9% over the prior year to over 1.5 billion. On a business segment basis, net sales in the reserve power business increased 16% to 732 million, while our motor power business increased 4% to 848 million. The 2009 nine-month growth rate includes approximately 9% due to pricing actions, 2% from stronger foreign currency translation, and a 2% decline from base volume. We believe our business has performed better than the market. Accordingly, we believe we continue to increase our global market share.

Now a few comments about our adjusted consolidated earnings performance. As you know, we utilize certain non-GAAP measures in analyzing our company’s operating performance, specifically excluding highlighted items. Accordingly, my following comments concerning operating earnings and my later comments concerning diluted earnings per share exclude all relevant highlighted items. Please refer to our company’s form 8-K, which includes our press release dated February 4, 2009, for details concerning these highlighted items.

Our third quarter as adjusted consolidated operating earnings were 39 million, or an increase of 19% in comparison to the prior year, with the operating margin increasing 250 basis points to 8.4%. This strong earnings performance was achieved in spite of lower sales of approximately 93 million in the quarter. Clearly, the reduced sales volume impact on our earnings was more than offset by the favorable impact of lower commodity cost and cost savings. Our first nine months in fiscal 2009 as adjusted consolidated operating earnings were 126 million, or an increase of 35% in comparison to the prior year, with the operating margin increasing 150 basis points to 8%. The increase in year-to-date earnings was primarily due to pricing and cost saving actions offset by higher commodity cost.

Now, several comments concerning our diluted EPS. As adjusted, diluted net earnings per share were a record $0.63 in the third quarter versus 35% in the prior year or an increase of 80%. During our third quarter of fiscal 2009, we experienced unprecedented volatility in currency rates. When considering all the impacts from foreign currency on our third quarter earnings, which are primarily from translation, transaction exchange, currency hedging, and purchases of dollar-denominated lead, all currency impacts were approximately $0.04 of our total $0.63 VPS. Additionally, when considering these total third quarter currency impacts, they are approximately $0.10 per share better than we expected when we provided our third quarter earnings guidance.

For the first nine months of fiscal 2009, as adjusted diluted net earnings per share were a record $1.62 versus $1.0 in the prior year, or an increase of 62%. The key influences on our earnings for the first nine months of 2009 were sequentially declining sales volumes, volatile lead cost coupled with pricing recovery actions, and our ongoing cost reduction initiatives.

Now, some brief comments about our financial position and cash flow results, but in short, our performance continues to be very strong with growing liquidity, secure and favorable debt facilities, and a strong capital position as illustrated by the following five points. First, cash flow for the nine months of fiscal 2009 was 85 million, and for the third quarter, 20 million. Second, 91 million on hand in short-term investments primarily in U.S. treasury securities as of December 2008 compared to 55 million at the beginning of this quarter. Third, over 200 million remains available from unused revolving credit lines. Fourth, our leverage ratio was at 1.5 times, and our debt-to-total capitalization ratio was 34% as of December 2008. And fifth, we expect our cash flow for the fourth quarter of fiscal 2009 to remain strong.

As John mentioned earlier, we expect to generate diluted net earnings per share between $0.30 and $0.34 in our fourth quarter of fiscal 2009, which excludes the expected $0.25-per-share charge from all our existing and recently announced restructuring programs. Our anticipated fourth quarter earnings will be driven by four primary factors: First, a sequential quarterly reduction in fourth quarter revenue primarily from declining unit volumes and lead-based pricing. Second, a sequential quarterly reduction in commodity cost. Third, a sequential quarterly reduction in the net earnings benefit from foreign currency experienced in our third quarter. And fourth, the ongoing benefits from cost reduction activities.

In closing, we believe that the unprecedented macroeconomic challenges of today also present us with tremendous opportunities to improve our business in the future. We have consistently demonstrated our global organization’s ability to anticipate and adapt quickly to rapidly changing market conditions while delivering solid financial results. We are convinced that whenever economic growth resumes, EnerSys will be in even stronger and better position. I remain highly confident in our company’s future. John, let me turn the call back to you.

John Craig

Thank you, Mike. And with that I’d like to open the lines for questions.

Question–and–Answer Session

Operator

(Operator instructions) Your first question comes from the line of John Franzreb with Sidoti. Please proceed.

John Franzreb – Sidoti and Co.

Good morning, guys.

Michael Philion

Hi, John.

John Craig

Good morning, John.

John Franzreb – Sidoti and Co.

I was kind of impressed by the 1% price realization (ph) in the December quarter. Certainly, it seems to me to be a close concern about that, to maintain price in the current environment. Can you, A, just give us a little background color around how you were able to achieve 1% in the quarter; and, B, can you talk a little bit about how the pricing environment currently stands right now.

John Craig

Well, John, obviously the market is going to set what the pricing is. And we are finding right now that the industry seems to be reasonably disciplined on maintaining pricing. The way we view it is the relationship between commodity cost and the price of our products. And all-in-all, if you look over our two-year period here that we have actually lost money; in other words, our pricing has been less than the commodity cost. There are some quarters where the commodity costs are a little lower than the pricing that we’re getting and vice versa. All-in-all, I think that the pricing has come down because commodity has come down, but I think the ratio between our pricing and the commodity cost has stayed reasonably consistent.

Now, going forward, how it is going to go, again it goes back to what our competitors do. We’re the world’s largest industrial battery company. We are going to continue to provide the best service and best value to our customers. And we think our pricing is set in line with that philosophy.

John Franzreb – Sidoti and Co.

Okay. Regarding the cost of restructuring measures, John, if you have said this, I apologize. But what is timing of you realizing those benefits, and have you set a timeline for hitting that 25%? What are the margins (ph) that you want to hit?

John Craig

Yeah. The first part of the question, the $13-million savings, the $0.19 per share, we expect that to be fully implemented by the first part of fiscal 2010. I think we are probably looking at May or June for 100% implementation, if not sooner. And I think we are on course with that. So I think we are in good shape there.

The second part of your question was

John Franzreb – Sidoti and Co.

Gross profit target.

John Craig

Oh, the gross profit, the 25%. That is a tough one on the timing with it. If the volume stays up, we would probably be very close to the 25% right now. We are going to continue to stay focused on that particular objective. If volume goes down, obviously it is going to be harder to hit the 25%. But I view this as almost like two steps forward, one step backwards. We will get to the 25%. When we get there, in part, is going to be determined by where the volume goes. If you look at our guidance for the fourth quarter, obviously we’re projecting that the volume more than likely will come down some.

John Franzreb – Sidoti and Co.

Okay. I guess in a related question, you know, the restructuring actually taken, embedded in that, what is your thinking about the outlook in the near-term? Are you looking for a significant degradation in the top line in volume? Or do you think we are pretty much troughing (ph)? What is embedded in your outlook as far as you customer base?

John Craig

Yeah. I am going to go back to August when we first said that we thought we would see a downturn take place. And I think the way we described it then was we’re going to plan for the worst and hope for the best. It did not come out quite as bad. In fact, it came out very good for us. I describe today the global manufacturing environment to be this: It is frozen. People just basically seem to be in a freeze mode. They are not spending a lot. We have actually seen systems where people did not invest in replacement batteries and they have actually had their UPS systems go down. And of course we get quick orders on that thing and they have kind of changed in their philosophy and they are coming back. It is hard to predict what is going on in this economy right now. But as I said, we’re planning on setting (ph) to go down some, and as reflected in our midpoint $0.32 guidance, but there will be coming a time where this thing will the freeze state unfold. How fast will it unfold and when, I cannot project that.

John Franzreb – Sidoti and Co.

Okay, John. Thanks a lot. I’ll get back with you.

Operator

Your next question comes from Paul Clegg with Jefferies. Please proceed.

Paul Clegg – Jefferies & Co.

Hi, guys. Thanks for taking the call and congratulations on the strong performance this quarter. You obviously blew away expectations this quarter and yet your guidance is down sequentially by a fairly significant amount. I guess my question is, why do you have better visibility now into volumes being done next quarter relative to the visibility that you have when you first gave guidance for the December quarter?

John Craig

Well, obviously, our guidance for the last quarter, we were off on it. We did better than we performed. And as I said earlier, we plan for the worst, hope for the best, and we have some things that came very well. Our implementation of cost reductions were significantly better than what we thought they would be in this quarter. Our ability to maintain that ratio between pricing and lead cost, we did better than what we put in our guidance with it. And to answer your question, it is very difficult for us right now to project. This is the most volatile period that we have ever seen and what we are going to do with it, as I said, we’re going to plan for low numbers and try to beat them.

Paul Clegg – Jefferies & Co.

Okay. So there’s, I mean, a certain amount of conservatism being built in. And I guess your beat was primarily though really on volumes, it sounds like.

John Craig

I would say that our beat was not really on volumes. It was more on our ability to hold that pricing to commodity cost and our cost reduction activities, the execution there.

Paul Clegg – Jefferies & Co.

And can you say for the coming quarter whether or not currency is a tailwind or headwind for you and when you give that guidance range, are you expecting it to be very significant factor at all?

John Craig

Mike, do you want to pick up on that?

Michael Philion

Sure. To answer your question, we think that clearly FX will be a bit of a headwind sequentially. But let me frame it because I know that there was a lot of moving parts in Q3’s currency fall. And let me just go back to the obvious. We exceeded our guidance’s. I’m sure everyone saw in Q3, $0.10 of the beat was because of currency. Now, clearly the currencies are extraordinarily volatile but the trick here is in total. Only $0.04 of the $0.63 cents was because of all the currency movements. Now, let me be specific. In other income, everyone can see that we had a $14-million currency gain in Q3. What is not visible is the huge headwind which brought that big gain literally down to a modest $0.04 favorable. The other factors are translation, FX hedges, and the FX impact of dollar-denominated lead. So in short, Paul, you can see the big transaction gain in that one-line item, but what is not visible is all those other headwind’s that are embedded essentially in cost of sales and the other line items. So in summary, Paul, sequentially, we do believe currency will be a modest in an aggregate sense EPS headwind. But it's the old problem with everyone today, it's volatility and while we think we understand the general shape of currency influences, we just can't be certain whether we're going to have it exactly correct.

Paul Clegg – Jefferies & Co.

Okay.

John Craig

To pick up on that, just to summarize what Mike is saying, at $0.63 a share, we had $0.04 favorable because of FX in total or in other words, without that FX we would have been at $0.59. However, relative to the guidance we gave, we thought we would be unfavorable $0.06 in FX, but we were really favorable $0.04, the total being $0.10 favorable to our forecast. Further what Mike is saying in the next quarter, we don't expect it to be favorable, we expect it to be unfavorable. So hypothetically, if we were unfavorable in the next quarter $0.01, $0.04 plus 1, we would be unfavorable $0.05 on a sequential basis.

Paul Clegg – Jefferies & Co.

Got you. Now that's very clear and that's very helpful and I appreciate that. And if I could one final one, the Italian restructuring, you're going to record a 23 million charge, 17.5 (inaudible) so that comes in the March quarter. The remainder, is that spread out over a number of quarters or is it in the June quarter all at once?

Michael Philion

Paul, it'll be spread, but it'll be probably more heavily weighted to the first half and just one additional clarifying point if I may on Italy, as John referenced, most of those initiatives are clearly underway and more will gain traction in Q4 an our first quarter. The $0.19 earning benefit that John referenced, believe me it doesn't all just kick in in Q1. It will come into the quarter over time, but we certainly expect as we get into the latter half of fiscal '10, we will see a majority of that benefit starting to be realized in our operating results.

Paul Clegg – Jefferies & Co.

Okay, thanks very much guys. I'll jump back in the queue.

Operator

Your next question comes from the line of Corey Tobin with William Blair. Please proceed.

Corey Tobin – William Blair

Hi. Good morning. Nice quarter, guys.

John Craig

Thank you, Corey.

Corey Tobin – William Blair

Let me start with two housekeeping questions and then some bigger picture stuff. First, it seems like accounts payable was a big use of cash this quarter. Is that correct and was there anything in particular going on there?

Michael Philion

Corey, you're right and no, nothing in particular, but let's put again the obvious into perspective. We are certainly seeing a decrease in volume. So we have ratcheted back very quickly purchasing to essentially get into alignment with production levels. So in its simplest form, accounts payable dollars are falling quicker on a relative basis than the corresponding reductions in receivables and inventory. So clearly you have it right. Do we expect that trend to continue indefinitely? It depends where volume goes. So I think the ratio of primary working capital which got skewed a bit in the current quarter because of that phenomenon will probably settle out a bit as these forces get in more alignment.

John Craig

Total primary working capital is down I believe about 60 million, Mike?

Michael Philion

It was down 60 million from the beginning of the year, that's correct, John.

John Craig

Yes.

Michael Philion

So the dollars in primary working capital, Corey, we continue to expect we'll see further benefits, hence why we're so confident that our fourth quarter cash flow will continue to be very, very strong.

Corey Tobin – William Blair

Right and the dollars in primary working capital ticked up a little bit as a percentage of revenue, can I infer from your comments that should tick back down on your expectations over the next couple of quarters?

Michael Philion

I don't know. I think the primary working capital dollars clearly are heading down meaningfully. The ratios are trickier. So I don't think we have enough visibility, Corey, to give you an accurate read, but to me right now, the dollars are very important, and clearly they are coming down appropriately and we continue to manage it dynamically.

John Craig

But to Mike's point earlier on the payable side, just the phenomena has taken place by cutting purchasing back quickly. You're not going to work down the receivables in the inventory as fast as you're going to work the payables and the payables coming down so fast has driven that percentage up. And that will flow through. That will go down, just if everything else stayed constant, the percentage would come down.

Corey Tobin – William Blair

Understood. Shifting gears for a second, can you give us a feeling for the annual volume or what percentage of revenue currently goes through the Italian operations?

Michael Philion

That's a tough one because we tend not to mix. We view our plants as cost centers, not as profit centers, so it's less than 5%, we know that, but I don't have an exact number on what that would be because we don't look at plants as revenue generators.

Corey Tobin – William Blair

Understood, but in terms of order of magnitude, less than 5% (inaudible).

Michael Philion

That's correct.

Corey Tobin – William Blair

Okay. Shifting gears a bit, the thin plate business, I know there was a lot of CapEx invested this year and the Q calls for an additional 50 million or so next year to go back into capacity expansion there, any change in terms of the demand in the thin plate business and do you still expect or I guess what's the degree of variability that might come through in that 50 million budgeted CapEx for the thin plate expansion next year?

John Craig

Well, it's more than budgeted. We're in the process of suspending it right now. We're going to tone it back slightly, but not that much and the reason for that is we're mostly through the project right now, but the demand for the product is off slightly than where it was, but the applications that we have available for that, we are convinced that we will be using that capacity in still a very sound investment. As I said earlier, we're going to come out of this stronger, a stronger company than when we went into this recession and the last thing we want to do is cut back on our long-term strategies. The thin plate purelet (ph) product, we have never had the capacity to meet the demand on it. Right now, we have the capacity 'cause there is some slowing up that's taking place in telecom industry, but we fully expect that we'll be utilizing that capacity in the next year or two. Mike, you want to add to that?

Michael Philion

Corey, just a clarifying point, the 50 million that you reference is the total multi-year expected spend for the Warrensburg thin plate expansion. Now, that is being toned down, but that 50 million is a multi-year investment.

Corey Tobin – William Blair

Understood. While we're on this point, just CapEx expectations for next year in total?

John Craig

The CapEx expectations this next year when we look, this year we're looking between $45 and $50 million, I expect that'll be down slightly but again we've got some longer term initiatives here that we're not going to see the pay offs in the next year or a year and a half, but we're going to continue to stay the course on a longer term thinking. We're not in a cash crunch or anything like that. We're not in the situation where we have to pull way back on CapEx spending. We're longer view investing into the company.

Corey Tobin – William Blair

Great. Last one if I could, I know you only guide to revenue, but since Mike you already sort of mentioned that you anticipate I think it was some volume slowdown next quarter, can you just give us a feeling for order magnitude as to what you're thinking about at this point based on January order flow and what not? Are we speaking of a sort of 10% decline similar to what we saw last quarter or is there a good chance that accelerates more toward 20% level? Thanks.

Michael Philion

Just to pick a number on it I think it's going to be less than 10%.

Corey Tobin – William Blair

Great. Thank you.

Operator

Your next question comes from the line of Todd Cooper with Stephens Inc. Please proceed.

Todd Cooper – Stephens Inc.

Yes, ma'am, my first one, for Mike. I'm sorry I'm still a little confused but on the other income of $13 million depending on how that's taxed, it seems to account for more than $0.10 of the FX that you talked about. What else is in there?

Michael Philion

Todd, again, the $14 million, 13.8 currency gain, which is visible in other income as you referenced is offset by those three other huge headwinds that I referenced, translation which is about $6 million headwind, hedging and the impact of dollar-denominated lead which is also a headwind in dollars of that order of magnitude and those are embedded in the various line items above operating earnings. So net-net when you add those, you're looking at that net $0.04, let's call it $3 million, a little under $3 million. So that's just the housekeeping and the absolute numbers of that $0.04, again to be repetitive, $0.63 of earnings, the net of all those FX items was $0.04 positive.

Todd Cooper – Stephens Inc.

Okay, and Motive Power revenues declined on a sequential basis, yet your operating income was up for Motive Power. What was behind that?

John Craig

You're right. The MotivePower revenue was down, but again when you look at the ability of the pricing to the commodity ration, we did slightly better than that and we also had some very nice cost savings that came through.

Todd Cooper – Stephens Inc.

Okay, and john, given the opportunities that you outlined or highlighted in China, I'm curious, what is the mix between reserve and Motive Power manufacturing in China.

John Craig

Well, that's an interesting question because what we're doing right now, we're in the process of looking how we add additional capacity in China to meet this demand that we are anticipating is going to come after us. And the point of it is that this is going to be very heavily reserved power business, this telecommunication business and what we're doing is we’re actually going to be shipping some of our Motive Power business, manufacturing, outside of China into Europe to help load the plants up there and when we start shipping product say to Australia as an example, that product could be coming out of Poland going to Australia and we'll use that capacity in China for the demand that we're looking at in the telecom business.

Todd Cooper – Stephens Inc.

Okay. And after you close the plant in Italy, will that leave you still with 21 manufacturing facilities worldwide?

John Craig

No, we'll go down one facility.

Todd Cooper – Stephens Inc.

Okay, so 20, counting Italy, didn’t you have 22 manufacturing facilities?

John Craig

No actually it was 23, and we're down one.

Todd Cooper – Stephens Inc.

Okay. And how many employees in Italy will be laid off?

John Craig

It's going to be under 200 in total.

Todd Cooper – Stephens Inc.

Is it roughly a cost to you of about 30,000 per employee?

John Craig

I don't have that number here, it's a little higher than that and I'm not sure what it is right off, again, when we're looking at the total project, the total plants that we have in place as we mentioned earlier, it's the $0.19 savings. I'm going to guess it's probably about double that, the 30,000 that you mentioned.

Todd Cooper – Stephens Inc.

Okay. Okay, congratulations on a good quarter. Thanks.

John Craig

Thank you.

Operator

Your next question comes from Richard Baxter with Ardour Capital.. Please proceed.

Richard Baxter – Ardour Capital

Thank you. I guess I will follow-up on the China telecom opportunities, I guess can you explain a little the drivers that you're seeing from that and do you expect maybe some other countries to be following on? Is this sort of like the I guess the impetus for like the SEC following the Katrina year or something else?

John Craig

Well, what we've seen on it and it's been in the press that it's our belief that the Chinese government has opened up certain frequencies for the telecommunications industry there and part of it is a stimulation package in China and that's actually hit the press. We've had the telecoms approach us to look at our capacity, how much capacity do we have to meet the potential demand that's going to be coming at us, but there's been several articles that's been out about the $41 billion. In fact, one I read the other day it says on the $41 billion, $25 billion is anticipated to be spent first year.

Richard Baxter – Ardour Capital

Okay, thank you.

Operator

Your next question comes from the line of Dan Whang with B. Riley. Please proceed.

Dan Whang – B. Riley

Yes, good morning. First question was you had commented, John, about the market sort of freezing up and I know you're fairly short cycle business. Could you comment about the level of inventories out there and the supply chain and I know everyone is tightening up, but do you think that it's a possibility that the tightening up could be going too far and creating some potential pent-p demand near-to mid-term?

John Craig

Well, there is going to be pent up demand and I totally agree with that, it's just when does it unfreeze as I said earlier. The thing about the batteries is they do wear out and they're going to need to be replaced whether it's a telecommunications system or UPS system or an industrial fork truck. The fact of the matter is they're going to have to be replaced and it's just when does that take place and how do they replace them. Do they do it in a standard maintenance or do they wait until it fails? It's expensive to wait until they fail. So I think we're going to see it open up, I just don't know when it’s going to be.

Now as far as the inventory out there, there tends not to be a lot of inventory in the pipeline on this 'cause normally if someone buys a battery, they buy it 'cause they need it right away and there's very little that end users would buy and put it in inventory. In fact, that's kind of unheard of in our industry now. The only time that really happened was back in the telecom boom when we had telecom companies who were buying ahead on batteries.

Dan Whang – B. Riley

Okay. Now it seems like obviously the monthly trends sort of slowed down in the latter couple of months of the quarter, maybe continuing into January, could you kind of give us a little bit of a flavor for how the monthly trends look?

John Craig

I'm sorry, I didn't understand. Could you ask it again, please?

Dan Whang – B. Riley

It seems like the monthly demand probably slowed down in the in the last couple of months of third quarter, but I was just wondering if you could just give us a feel for how the monthly trends looked?

John Craig

Yes, they have definitely slowed down as I said earlier and I describe it as things are going into a freeze. I mean the orders are not coming through as strong as they were six months ago. And whether it's down 10% or 12% this next quarter, I think it's probably going to be as I said earlier slightly under 10, it may be a little higher than that, we just don't know at this point in time. But I think what we're going to see is in future quarters, whether it’s the first quarter of next year or second quarter, we'll see that pent-up demand start to come through. But I don't believe it's going to happen in our fourth quarter.

Dan Whang – B. Riley and Company

Okay. In terms of the devised restructuring move and consolidation moves, where are you currently on capacity utilization and where do you think the consolidation moves would take that utilization?

John Craig

I don't have an exact number right here, but I can give you order of magnitude that we were running on the north of 90% about a year ago and as I've mentioned many times in the past with being a roll-up (ph) vehicle in the industrial battery business if you will, in other words we bought 23 companies over the last 15 years, we've never really had the time to go back and take certain higher cost operations out of commission and put the production in lower cost areas. We knew all along that we were going to see a slow up, just how big it would be, obviously this is bigger than we anticipated, but we knew we were going to see a slow up. It's always been our plan to take and reduce those high cost plants and move to lower cost manufacturing. I've said in other calls that I see this as a great opportunity for us. It's a good opportunity for us to back up, take out some of the high cost factors that we have, continue to stay focused on the new product development and I'm convinced that we will come out of this being a much stronger company in the future and this has given us the opportunity to clean a lot of those issues up. I would guess today we're probably running in the 70% range of capacity utilization and with this move, I don't know what it's going to be. It's probably going to take us up to 75.

Dan Whang – B. Riley

Okay. And I guess the other benefit to these moves is that I know in the past you talked about probably a global manufacturing footprint and maybe again in about (inaudible) or so coming from low-cost countries and longer term wanting to take that to about (inaudible), so I'm sure this will accelerate that process.

John Craig

That's exactly right and you're exactly on the mark with it. Today, when we first started looking at this thing, we set the target to get the 50%. At that time we were running about 20% in low cost areas. Today, we're way over 30%, probably 34, 35% and this is a move that's going to take us to the next level. Will they actually ever get to the 50%? I don't know because I'll tell you, some of our other what I would call higher cost operations have done a tremendous job in automating processes and reducing cost out. The objective isn't to have 8% (ph) in low cost. The objective is to have the lowest cost platform in the industry and that's what we're moving towards.

Dan Whang – B. Riley

Okay, that's great. Congrats on a great quarter.

John Craig

Yes, let me clarify one thing. Well, I believe today we are the low cost. We're going to move to a new level.

Dan Whang – B. Riley

Great. Thank you.

Operator

And your next question comes from Michael Gallo with CL King. Please proceed.

Michael Gallo – CL King

Hi. Good morning. Congratulations on a good quarter.

John Craig

Thank you.

Michael Philion

Thank you, Mike.

Michael Gallo – CL King

The question I have, just when you look at your cost, I mean obviously just a follow-up on you mentioned obviously you are the low-cost provider, talk about some other areas where you see opportunities to move those gross margins up from say 22% to 25% or just other cost areas where we might expect you to be able to take cost out over the next year or so?

John Craig

Well, I don't want to go too far in details with that 'cause I'm sure we've got competitors listening on the phone today, but just to give you some ideas on some things that there are some products design changes that we could make that will take lead out of the product, but not impact, negatively impact the performance of the product. I'll give you a hint on that where we have products that are thicker plate. We've talked about thin-plate products and you've got that grid in there that has a certain weight to it. If we can take out 25% of the lead on the grid in the battery and not impact on performance, we will do that. In other words, putting a thin plate, one of the plates in the battery, a negative plate as an example, making a thin plate, that will be substantial cost reduction.

The second thing is as a number of automation projects that we have going on right now that have substantial savings coming with it.

Third thing is with consolidation of customers within the industry, really we are reassessing our total sales organization. Are we properly aligned to have the right structure in place or do we need some of the overhead that we have? We are not going to take away from servicing the customer, that's one thing that we've been very good at. We do take a close look at our SG&A and we are higher than probably most of our competitors, but we're going to continue to provide top service.

Michael Gallo – CL King

Okay, that's very helpful. Thank you.

Operator

Your next question comes from the line of Dana Walker with Kalmar Investments. Please proceed.

Dana Walker – Kalmar Investments

Good morning, everybody.

John Craig

Good morning, Dana.

Michael Philion

Good morning, Dana.

Dana Walker – Kalmar Investments

John and Mike, when you talk about volumes potentially being down 10% in Q4, I presumed you're talking about in relation to Q3, not to year-over-year?

John Craig

That's correct.

Dana Walker – Kalmar Investments

So the year-over-year volumes, in that seasonally you're business tends to mount through your fiscal year will quite likely be off 15 to 20?

John Craig

On a fiscal year basis?

Dana Walker – Kalmar Investments

Well, comparing March to March. If you were down 10 in

John Craig

Well, we'll have to do the math. We finished last year at, what was it, $2.063 (ph) million, I think it was.

Michael Philion

Well, the math would be down lower because we were exiting and having sequential growth at the end of last year. As John said, we've not done the math, but I think on a year-over-year Q4 basis, it's certainly down in the near 10% zip code. Didn't do (ph) the precise math, Dana.

Dana Walker – Kalmar Investments

Okay.

Michael Philion

I mean the point is that John's amplified is we're continuing to see the pressures from the global economy. Candidly we just don't know where they're going right now. The trends that John's I think laid out very well, we wish we had better visibility, but we just don't at this stage of this recession cycle.

Dana Walker – Kalmar Investments

Can you speak to the difference performances that we've seen in your geographies where Europe was very soft, units down mid teens, whereas in the Americas, as a for instance, you're only down 5? Can you provide some color?

John Craig

Yes, I think the best way of viewing that is Europe from a manufacturing standpoint is in worse shape than the United States from our viewpoint.

Dana Walker – Kalmar Investments

Can you provide some more detailed color on Motive? What are you seeing to the degree that you have visibility on new versus replacement battery requirements? How does that look?

John Craig

It appears to us that the OEMs on the industrial fork trucks are looking at cutbacks that they are projecting that the volume on new trucks will be down.

Dana Walker – Kalmar Investments

Are your dealers and are you hearing directly though from customers that the replacement demands behavior is meaningfully different than you ordinarily expect it to be in a soft market?

John Craig

I can't say. Interesting question, Dana, because I recently was with a group of customers, dealers in the completely across the United States and some regions of the United States, they're not even seeing a slow up right now, they're doing well on the replacement business. Others are saying that they're seeing real problems. It's a mixed bag of out there. But I think all in all that my takeaway from it is that you got a number of customers that are looking at it and saying, look, I'm not going to spend until that battery absolutely dies. I'm going to get away from the preventative maintenance program of replacing things and I'm going to wait till it dies. I think there's some of that out there today.

Dana Walker – Kalmar Investments

When you talk about your Q4 guidance at the EPS level, given the trend or given the progress you've made on gross margin, would you expect your gross margin to be sequentially lower?

Michael Philion

Dana, again, it's hard to say, but at this writing the answer is we don’t think so. We think the gross margin will hold up relatively well. I mean clearly the top line is going to be down sequentially, but we think gross margin broadly will be about the same.

Dana Walker – Kalmar Investments

Will Bulgaria be the beneficiary of a fair amount of the volume that once was made in Italy?

John Craig

It's going to be split between Bulgaria, Poland, France and Germany and what we have to look at is the capacity utilization of all those plants. By taking the fixed cost out, let's take a higher cost plant which would be the France plant and it would seem like, geez, why would you put production in there? Well, if the other plants are running at maximum capacity and you take a look at and you run the analysis on putting it in France on a variable basis 'cause we already have the fixed asset there, it's still a savings for us, even if we put it in the France plant. So what we’re going to do is we're obviously we're going to run it in the lowest cost plants we can, but there will be some benefit that Bulgaria should see from this move.

Dana Walker – Kalmar Investments

How would you describe your Bulgaria experiment thus far? Is it going the way you would like it to go?

John Craig

I would describe it this way that it was rougher than we thought it was going to be to start up and right now, we are on target to where we want to be, but if you had asked me that six months ago I would've said it's running rougher. But fortunately what's happened is that we got in there, we found out there was a bigger challenge than we thought, we put additional resources in there, in people, in engineers, they did an outstanding job of getting their arms around it, turning it around and now it's back running on target.

Dana Walker – Kalmar Investments

A question on currency for a moment, you've made a case in the past that you have natural hedges within your income statement that would mean that translation ought not to hurt you badly. As you look at currency or at least from a guidance standpoint where currency would be sequentially negative, as one looks on the income statement, is the difference going to be that you won't have the natural hedges that we'll see in other income and yet you'll still have the embedded stuff that's going on above the operating line? Or should we look at it differently?

Michael Philion

Let me give you the macro again and then I think that your answer will be more evident. There is no question our business still is fundamentally naturally business hedged and it’s the volatility within a short time period that can skew that.

Let me go back to fiscal '08 and some of you may recall I indicated, which is still the case, that when you look at total earnings from fiscal '08 which was $1.42 a share on an as adjusted basis, we had about a $0.05 favorable impact from all those four elements of currency that I explained earlier, translation, transaction, etc. and clearly the third quarter of this year was an aberration (ph). We had a much different currency profile than you would ever see.

Now we have adjusted on the margin some of our hedging strategies to mitigate some of that, but in short, Dana, I still believe that we are fundamentally still naturally business hedged and it all comes down to volatility in short time periods. We have adapted. If it changes again on us a little, we will adapt again. But it still is the macro view and it is the fact that we have a huge currency advantage. Most of our business is other than dollar-denominated lead and some of these wild swings is naturally hedged.

Dana Walker – Kalmar Investments

The fact that the euro went from $1.55 to the euro to $1.30, you're describing that volatility as having prompted the type of unusual currency behavior that we saw under Q3?

Michael Philion

That's correct, but what is not as visible is cross rate volatility, euro to (inaudible), euro to pound, etc., and again, not to complicate it, we understand those very well and we've managed to tweak some of our currency thinking to take some of what I'll say shorter term volatility out. So we still believe we are naturally hedged and we'll modify accordingly when we see world and market conditions throw a bit of a curve ball. Long term, we're naturally hedged and I'm very confident of that.

Dana Walker – Kalmar Investments

I've a final question and it relates to competition, you've described what you're doing to your cost structure, you've described what you would hope to not do on a customer facing fronts. How would you compare what you believe you're doing to what your competitors are doing to have greater conviction that you come out the other end of this with advantage?

John Craig

Well, I think that I kind of view it a little differently. We're looking at our customers, what our customers want, what our customers need and we spend a lot of our time really going at it from that vantage point. It's tough for me at this stage to really take and say much about our competitors. They haven't come out with much. Recently I did see that one of our competitors had some positive earnings last evening. Another one is cutting back considerably in the manufacturing area I believe and are having layoffs and stuff, so I really don't have a good answer for you there.

Dana Walker – Kalmar Investments

Keep up the good work.

John Craig

Thank you.

Operator

Your next question comes from the line of Chris Agnew with Goldman Sachs. Please proceed.

Chris Agnew – Goldman Sachs

Thank you. Good morning. First question, just follow-up on China, have you any sense of what your market share in the reserve business is in China? Sort of follow-up to that, what is your confidence in the $41 billion in spending that you talked about? And also, when could you see the first orders on this spending coming through? Thanks.

John Craig

Okay, first part of the question is our market share, we are lower in China than we are globally and it's very difficult to get market share in China, so it's a guess on my part because there is not hard data out there like there is in the Western world. My guess is it's probably in the 10% range.

Now, my confidence and the second part of your question, what's my confidence in that, again, I don't know on that other than what we've read, what's come out, what's hit the press on it. Secondly, we have had customers call us and ask us availability of product and to be sure that we can support it, so they seem to be serious about it. But until you get hard orders on it, I tend to view it, wait and see attitude. I guess to show me from Missouri state (ph). You have to show me the order before I really believe it. But I think there's enough there for us to take and plan our production accordingly and I think it's going to hit.

Chris Agnew – Goldman Sachs

Okay, thanks, John. And outside of Asia in the reserve business, can you just comment. It had been holding up better than most have, but comment on what you’re seeing in terms of volume orders there.

John Craig

It's still very good growth that we're seeing in the Asian market. The problem with the Asian market it tends to be much tougher on pricing. If we wanted to go after market share over there, we would reduce our pricing way down which we haven't, we're not going to do that. We would have to make investments in capacity. In other words, what I'm saying we’re running our three factories there all out. I mean we're running the production. To go to the next step would take a major capacity in Asia in the manufacturing areas and we just can't justify making that investment based on the pricing that we see today. Now that being said, with this volume that's kicking in, it may open the door up to say that we need to go to the next level on investment over manufacturing.

Chris Agnew – Goldman Sachs

And outside of Asia?

John Craig

Outside of Asia, mainly we're in Australia, Southeast Asia, Japan and again, we're single digits in that area, about 10% market share in that area.

Michael Philion

Europe and Americas.

John Craig

Oh, I'm sorry, your question was outside of Asia.

Chris Agnew – Goldman Sachs

Yes, sorry, I meant the Americas and Europe, I know demand had been holding up better in those markets, but what are you seeing in terms of volume trends in Europe and Americas in reserves?

John Craig

Okay, I'm sorry, I misunderstood your question. As I said earlier, it is slowing down in those regions and we're in what I'm going to call a freeze mode right now and we are seeing reductions. I said earlier that our fourth quarter, order of magnitude, I don't know the percentage is going to be down on revenue, but my guess would be probably in the 10% range.

Chris Agnew – Goldman Sachs

Great. Thank you.

Operator

Your next question comes from the line of Paul Clegg with Jefferies. Please proceed.

Paul Clegg – Jefferies & Co.

Hi, guys. Thanks for taking the follow-up, just a quick one on M&A opportunities. Are sellers getting any more rational about valuations yet? And then a quick one on tax rate, it was a little higher this quarter. What was the driver there?

John Craig

Well, sellers are never rational with valuations, we like the low ones. So I think right now we’re very active in that area. We continue to look at things. I think that if this freeze mode as I quoted stays in place that certain areas and certain competitors are going to struggle with it and hopefully the valuations will come down and we're going to look for the right opportunities. We've not overpaid for companies in the past and we don't plan on doing it now.

Paul Clegg – Jefferies & Co.

Okay.

Michael Philion

Tax rate.

John Craig

Tax rate, go ahead, Mike.

Michael Philion

Paul, clearly what you saw in the third quarter was a spike up and it's simple as a higher proportion of our earnings came from the North American platform. I still expect for the full year, we're going to be in the 31% book range give or take, but certainly that dynamic is driven by just the relative profitability in all the tax regions as we all know, some don't, but the U.S. has a tendency to be one of the higher tax rate jurisdictions that we operate.

Paul Clegg – Jefferies & Co.

Right. Okay, understood. Thanks.

Operator

Your next question comes from the line of John Franzreb with Sidoti. Please proceed.

John Franzreb – Sidoti & Co.

Guys, you've shown a willingness to back off on hedging positions when lead spiked north of 1.50 or so. With it currently down in the $0.50 range, can you, A, review what your average lead cost was in the December quarter, what your expectations are for March and what your thoughts about lead hedging at the current price level?

John Craig

Well, our lead hedging philosophy has been to go short on it, all three to four months as we said in the past and we're not changing that fundamental belief because of the volatility that's associated with it. We have roughly 11% of our total requirements, annual requirements hedged today at about $0.63 which is higher than the market.

John Franzreb – Sidoti & Co.

Right.

John Craig

So, fortunately, the little bit we've got out there, the 11% which is going to hurt us, no question about it, but it's a small percentage and that's part of the reason why we haven't gone long on it. The thing we really manage and keep a very close eye on is that pricing ratio to the lead ratio. That's the way we view it is how well are we doing in that ratio, in that thing there, because if lead goes way up and we can get the pricing with it, that's fine. What I'm really concerned about is if we were to lock in let's say at a $1.25 and lead was at 1.50, we would be heroes. But if were to lock in a $1.25 and lead is at $0.50 that ratio would be very, very bad and we wouldn't have done $0.63 in this quarter. So we manage it from that perspective.

John Franzreb – Sidoti & Co.

Did the $0.63 you're referencing, John, is that the March quarter, is that what it was in December?

John Craig

That's what we just finished at the $0.63 a share in this quarter.

John Franzreb – Sidoti & Co.

Okay. And what's your blunted (ph) expectation going to be in March?

Michael Philion

Well, John, I'll go back.

John Franzreb – Sidoti & Co.

Okay.

Michael Philion

Clearly we know the obvious, lead costs on a sequential basis are coming down for everybody as market prices come down. And we're not going to get into what it is cost per pound because as John said that's not particularly relevant. It’s how we're managing the dynamic of commodity cost and pricing which has to be viewed in unison. So there's no doubt that our cost will ultimately travel with market and lead is coming down as you know. So as I said earlier we expect Q4 to sequentially be less than Q3 and you tell us, John, where LME (ph) is moving in the subsequent quarters and I'll be able to give you a better gauge when we get beyond that, but the good news is I think the obvious with the recessionary economies that are plaguing all of us, it's unlikely that we're going to see commodity costs taking off on us, can't, no doubt with certainty, but we think that is one of the things that will give us some less volatility, more stable commodity costs as we look out over the next six plus months.

John Craig

Yes, you probably heard me say before, John, I didn't care if lead was $0.20 or $2 a pound because that's not really the objective here. The objective here is to manage your pricing to the commodity cost and that's what we've been very successful in doing. I say successful, we're still less than 1 on that ratio, but we're doing much better on it now than we were a while back.

John Franzreb – Sidoti & Co.

To be fair, guys, I have an atrocious record in forecasting lead. Thanks a lot.

John Craig

Okay.

Operator

Your next question comes from Preetesh Manshi, Piper Jaffray.

Preetesh Manshi – Piper Jaffray

Hi. Good morning, guys. Thanks for taking my question. And congratulations on a good quarter.

John Craig

Thank you.

Preetesh Manshi – Piper Jaffray

A lot of my questions have been answered, but we're hearing a lot of buzz at least at the moment on energy storage solutions for utilities, utilities scale (ph) solutions and I know you guys have been doing some work in that area. Can you tell us a little more, what do you see there in terms of opportunities and anything that we can expect to hear in the near term?

John Craig

Well, first off, we’ve been a big player in utility business for a lot of years whether it's a backup to a nuclear power plant or any type of utility, there's going to be batteries associated with it. I think maybe what you're referring to

Preetesh Manshi – Piper Jaffray

Oh, no, renewables is what I was referring to, I'm sorry, yes, renewables, sorry, yes.

John Craig

Yes, renewables, okay. That's what I was about to say I think what you may be referring to is the renewable side. We have a complete product line, our EcoSafe (ph) batteries and we could produce anything to meet the demands of where we think that industry is going. Now where is that industry going? When fuel costs were extremely high, there was a lot of attention put to it, a lot of questions asked about it. A lot of people were looking at investing. Gas coming down, gasoline coming down, or fuel costs coming down, it's a different story. We don't see the same emphasis being placed on it. I think what it is, is that we're kind of the tail on the dog on this. We got to wait for the dog to get going here. When that industry picks up and it goes and you guys can read as much about it as we can that we're ready, ready, willing and able. We've got the batteries. We can produce them today. We've got the designs in place for everything with it, but it's one that I don't know when the renewable is going to pick up.

Now with what the current administration is talking about and making investments in it, we may see a pickup in that area will take place. We hope we do.

Preetesh Manshi – Piper Jaffray

Yes, because we're hearing there's some sodium sulfur guys were actually getting some traction there so just wondering if you were, would that involve a change in strategy on your part in terms of when scale ups are required and you think lead will also have some role when you work with renewables?

John Craig

I think lead's going to have a very, very big role in it because even when you look at lead, if I go back I say $2 a pound of lead is cheap compared to the other commodities. When we look at all different types of stored energy solutions, whether it's lithium or sodium, it doesn't matter what the technology is, we spend a lot of time looking at them. One of the things that we find when you get down to the bottom line, the other technologies work, but you have to look at the cost of those solutions compared to lead acid and in many cases, it's very difficult to justify the premium. We have a complete battery line of nickel cadmium batteries as an example and we sell nickel cadmium batteries and lithium ion batteries, but when you look at the cost or the price of those products versus the price of a lead acid battery, you're looking four to five to six times as much. So I think lead acid is definitely going to have a place if we get to the point that the energy is going to be stored.

Now in many cases what happens with solar and with wind power, they're selling directly to the grid, so there isn't really a battery that's a backup storage. It's only going to be the remote locations that we're going to see the need for that. That being said, and wind is an example, there are batteries in it, but they're not used for storage of the energy to give to the grid later to use for safety precautions or in other words, the windmill itself could take off or the generator could take off and self destruct if there wasn't some battery back up there to protect it.

Preetesh Manshi – Piper Jaffray

Great. Fair enough. And thanks a lot for taking my question. Again, we look forward to hosting you at our conference on February 19th.

John Craig

Okay. Thank you.

Operator

At this time, there are no additional questions in the queue. I will now turn the call back to Mr. John Craig for any closing remarks.

John Craig

Well, thank you very much and we appreciate your joining us today for the conference call and everyone, have a good day.

Operator

Ladies and gentlemen, thank you for your participation in today's conference. This concludes the presentation. You may now disconnect and have a wonderful day.

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