C&D Technologies, Inc. F1Q09 (Qtr End 04/30/08) Earnings Call Transcript

| About: C&D Technologies (CHP)

C&D Technologies, Inc. (CHP) F1Q09 Earnings Call June 6, 2008 10:00 AM ET

Executives

Dr. Jeffrey Graves - President and Chief Executive Officer

Ian Harvie - Chief Financial Officer

Analysts

Michael Gallo – CLK

John Franzreb – Sidoti & Company

Richard Baxter – Ardour Capital

Craig Irwin – Merriman Curhan Ford & Co.

Johnny Brown – Stephens Inc.

Sean Boyd – Westcliff Capital

Joy Mukherjee – State of Wisconsin Investment Board

Bill Dezellem – Tieton Capital Management

Operator

Good Morning! My name is Carmen, and I will be your conference operator today. At this time, I would like to welcome everyone to the C&D Technologies’ First Quarter Fiscal Year 2009 Earnings Results Conference Call. (Operator Instructions) I’ll now turn the call over to Mr. Ian Harvie, Chief Financial Officer.

Ian Harvie

Good morning everybody, and thank you Carmen. Let me start by reminding you that this call is the property of C&D Technologies, Inc. Any redistribution, retransmission, or rebroadcast of this call in any form without the expressed written consent of C&D Technologies is strictly prohibited. Further, as this call is being webcast live and will be made available for a period of time on C&D’s website, this call contains time-sensitive information that is accurate only as of the date of the live webcast of this call on June 6, 2008.

This conference call may contain forward-looking statements within the meaning of Section of 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934. During this call, words and expressions reflecting something other than historical facts are intended to identify forward-looking statements, but are not the exact exclusive means of identifying such statements. Factors that appear within any forward-looking statement or in the company’s Securities and Exchange Commission filings including without limitation the company’s annual report on Form 10-K for the fiscal year ended January 31, 2008, and various 10-Q and 8-K filings could cause the company’s actual results to differ materially from those expressed in any forward-looking statements made herein.

Before I turn over the call to Dr. Jeffrey Graves, I wanted to remind shareholder of some important matters regarding the presentation of our financial results. First, results for the first quarter and all comparative financial data included herein reflect the presentation of the former motive power and power electronics divisions as discontinued operations. In addition, the financial presentation includes the retrospective application of a change in the company’s accounting for inventories from the last-in, first-out method to the first-in, first-out method. Our discussion of financial information today takes into account these changes.

Now, let me turn the call over to our President and Chief Executive Officer, Dr. Jeffrey Graves.

Dr. Jeffrey Graves

Thanks, Ian, and thanks everyone for joining us this morning. It gives me great pleasure to report to you that after several years of very hard work, C&D Technologies has returned to profitability. Last evening, we reported net income of $577,000 or $0.02 per fully diluted share for the first quarter of our fiscal 2009. Excluding any unusual or non-recurring items, this is the first quarter in which the company has reported consolidated net income solely from operation since the second quarter of fiscal 2006.

For much of the recent past, investor focus has understandably been on the influence of commodity prices and non-strategic businesses on our results. We’ve now concluded the actions needed to position C&D Technologies to capitalize on our competitive advantages in the markets that offer the greatest opportunity for our company, while simultaneously implementing a number of tactical changes that have and will continue to help mitigate the influence of volatile commodity prices on our results in the quarters and years ahead.

Beginning this quarter, C&D is now focused exclusively on the large and expanding power storage industry, an industry whose primary end markets, namely telecommunications, uninterrupted power supply systems, and utilities, remain resilient in the face of recent softness in the broader economy. As the largest provider of battery systems to these markets in North America, we continue to reinforce those factors for which our brand is associated. Those are innovative technology, reliability, and product quality leadership. While these factors have been our company’s hallmark for decades, our businesses had to adapt to a new set of challenging stemming from commodity cost volatility through the adoption of variable pricing mechanisms and a strong focus on cost reduction including importantly lead cost management. With these mechanisms now in place, our shareholders can anticipate less volatile performance that will enable them to better appreciate our operational progress in the quarters and years ahead.

From a strategic standpoint, with the lead market returning to surplus as reflected in the consistent LME inventory rise in recent months, there’s been a decline in lead prices from record levels of last year. While lead remains at an elevated price compared to its historic averages, even at these current levels, we now find ourselves competing on a much more level playing field from a cost standpoint with those companies that own and operate their own lead smelters. Without the capital burden and ongoing maintenance and environmental concerns associated with these smelters, we’re in an increasingly comfortable competitive arena and one in which product and service differentiation are the dominant factors in winning new business. These factors play to the strength to the C&D brand and our investment strategy.

Let me now open with a few highlights on the quarter, and then Ian will summarize the full financial results in some more details.

For the first quarter, we reported net income of $577,000, or $0.02 per diluted share. First quarter revenues were $93.8 million, up 21% from $77.5 million in the first quarter of last year and basically flat sequentially to the fourth quarter. Revenue growth continues to reflect both real unit growth and the impact of rising prices. For the first quarter, we estimate that about 20% of the year over year revenue increase was attributable to real unit growth, with the balance attributable to price increases.

On the demand side, we saw resiliency in our end markets, with quotation activity remaining strong. For the first quarter, our book to bill showed considerable improvement from preceding quarter, reflecting increased confidence on the part of our customers regarding their need for continued capital investments in their businesses in the year ahead.

In North America, shipments for uninterrupted power supply, or UPS systems, and utility applications were once again strong as our largest end markets continue to sidestep any major domestic economy-oriented weakness. Telecommunication markets were also stable, as these companies continue to focus on wireless infrastructure needs and fiber to home expansion. Our value technology and reputation for quality have enabled us to sustain and in some cases grow market share through this recent period of record commodity prices, despite cost disadvantages relative to competitors that manufacture their own lead requirements. These competitive dynamics are swinging more in our favor, and we’re excited about the future.

With key customer relationships that in many cases have spanned decades, we’re proud to serve the most successful companies in each of our end markets. They look to us for technology and quality leadership which are the key elements of our brand and ones in which we continue to invest in and focus on as an organization. To accelerate the introduction of new products, we continue to invest both capital and personnel in new product development activities. These efforts have begun to bear fruit. We’ve already talked about the first wave of new standby power products, most notably the msEndur II, our new green battery system, which is being very well received by our customers in both telecom and UPS applications due to its ability to reduce electricity costs while offering the longest product life in the industry for this type of product.

Looking to the course ahead, equally exciting new products will be launched over the next year and a half until each of our major product families have been refreshed with the newest, most innovative designs and materials technology in the industry. Gone are the days when battery innovations occurred over decades. With recent advances in material science and process technology, we now have the capability to accelerate the introduction of new generations of batteries, and we plan to be the leader in doing so. I believe the results will be exciting for our customers and our shareholders, as our business continues to sustain vibrant growth in the years ahead.

While we’re excited about the real growth we’re seeing in our business, most importantly this quarter, we reported a significant improvement in our gross margins, up from approximately 8% in Q4 fiscal ’08 to 15% in this quarter. During this first quarter, the impact of lead was effectively normalized as pricing changes we had implemented in the prior quarter finally caught up with the inflated lead costs through our P&L, and our cost reductions continue to flow through to the bottom line. As a results, we look at Q1 results as a base from which future profitability or run rate of the company can now be more effectively measured by our stakeholders.

As we move forward, we expect to see continued improvement in our gross margin performance as we benefit from the cost-reduction programs initiated now more than a year ago. After delivering slightly more than $15 million in direct savings last year, we estimate these initiatives have contributed an incremental $2.5 million in the first quarter of this year. Looking forward, we remain on pace to achieve our total of $15 million in cost reductions again this fiscal year, primarily from savings arising from our new product designs, improved plant efficiencies, and from our strategic sourcing initiatives. We should see cost reductions increase sequentially each quarter as we move through the year and a larger ramp up in the second half.

Let me now comment on lead and its impact on C&D Technologies this quarter and as we move forward. The intention of variable pricing strategy that we’ve been adding to our contracts and other pricing mechanisms has been to ultimately neutralize the influence of the changes in the cost of lead on our financial results over time. Q1 of fiscal 2009 was a catchup quarter with lead costs and pricing now for the first time in over two years substantially balanced.

As we move forward, while the lag between timing of lead costs and customer price changes may positively or negative influence results in the short term, eventually price fluctuations will tend to even out. The impact on earnings should be viewed as somewhat transient. With that said, it’s important to understand that the recent rundown in lead back to levels around $0.90 a pound has not and will not present any windfall gains for us. However, it’s not to say that the drop in price of lead is not a welcome relief. It provides a number of benefits. It will help reduce our investment in working capital, freeing cash for investment, and it also narrows the difference between the cost of lead for those who do and those who do not manufacture their own lead requirements as discussed earlier. Both are very definite positives for C&D. While the drop in price of lead is improving our competitive position, we’re approaching the market in a very disciplined manner. Keep in mind that the cost of many of our inputs such as plastics, steel, chemicals, and energy are all up significantly, so we are still in an environment of rising costs. Consequently, we continue to manage and look to hold the line on pricing, and we’re communicating these factors to our customers regularly.

We’re certainly pleased by our results this quarter, especially how they validate our strategy and represent significant progress towards our goals and objectives. The difficult decisions and actions are now behind us, and we’ve focused the business on the standby power market, and importantly through a combination of our pricing mechanisms, lead procurement strategy and hedging programs have come a long way in managing the impact of lead volatility and the influence it may have on future financial performance.

Now that we have established solid operational performance, we are focusing our efforts on growing our business and improving our bottomline. Our strategy is to grow market share through the introduction of new and exciting products that will effectively leverage our strong brand, which for decades has been associated with technology and quality leadership, our leading North American market share, and our outstanding customer base who represent industry leaders in each of their markets. Bottomline improvement over the balance of this fiscal year will principally come from our ongoing cost reduction activities which remain on track for the year.

We appreciate the support and encouragement of our shareholders and employees throughout this transitional year, which was difficult but necessary in the transformation of C&D. We can now look to the future with positive expectations for all our stakeholders.

Now let me turn the call over to Ian to discuss the financial results in more detail.

Ian Harvie

Thank you Jeff. Net sales for the first quarter were $93.8 million, up 21% from $77.5 million in the first quarter of last year and basically flat sequentially compared to the fourth quarter. We estimate approximately 20% of the year over year increase was attributable for volume growth with the balance coming from higher pricing. Importantly, we see resiliency in our end markets despite general economic uncertainty and turmoil in global credit markets. As Jeff mentioned, we are seeing continued strength in the data center UPS business, growing demand in telecom, and robustness throughout the utility industry, which is yet to evidence any signs of weakness.

For the quarter, the company reported net income of $577,000, or $0.02 for diluted share, compared to net income of $4.1 million or $0.13 per fully diluted share in last year’s first quarter. Last year’s first quarter included a $15.2 million gain on the sale of our Shanghai China plant, approximately $10.2 million net of minority interest, and $5.2 million charge and cost for losses from discontinued operations. There were no corresponding unusual items or discontinued operations in the first quarter of this year. Excluding these non-recurring and unusual items, net loss from continuing operations was approximately $800,000 or $0.03 per fully diluted share in the first quarter last year.

To eliminate some noise and get a better appreciation of the comparative improvement represented by this first quarter, in the fourth quarter of fiscal 2008, which also did not have any non-recurring gain or other distortions, we reported a net loss from continuing operations of $6.2 million or $0.24 per diluted share. On a sequential basis, since net income and income from continuing operations were the same in the first quarter of this year, financial performance improved by a little under $7 million or $0.26 per diluted share in just the last 3 months.

Gross profit in absolute dollar terms for the quarter was $13.7 million versus $10.4 million last year. Margins were 14.6% in the first quarter versus 13.5% last year. Sequentially, first quarter margins are up 7.8% from our fourth quarter. Q1 margins reflect essentially a normalizing impact from lead as pricing has caught up with lead cost. In the past, the volatility in the cost of lead has also somewhat obscured the progress being achieved in our cost reduction initiatives. However, with the impact of lead cost essentially normalized, margins will now more directly reflect these improvements. Our goal and expectation is to exit the year with a gross margin near 20% and on an upward trend, consistent with the prior directional guidance we provided on these calls.

Interest expense was $2.3 million for the quarter, up from $2.2 million in last year’s first quarter and from $2.1 million in the fourth quarter. The increase is attributable to slightly higher levels of outstanding debt in our Chinese subsidiary during the year. Due to tax loss carried forward, there was little income tax expense this quarter.

Our liquidity position continues to be stable, if not improving. For the quarter, cash flow from operating activities was $614,000 positive compared to a use of $7.2 million in the same quarter last year. We are beginning to see a reduction in inventories, a key management objective in fiscal 2009, down $6.5 million from year end, and we should see further benefit from lowering our investment and working capital should the recent rundown in lead costs hold. During the quarter, trade accounts payable and other liability balances were also down.

Capital spending for the quarter was $3.6 million, up from $1.5 million last year. We are continuing to forecast total CapEx for fiscal 2009 of approximately $18 to $20 million, primarily to support new growth and ongoing cost reduction initiatives. Debt net of unamortized finance costs at the end of the quarter was $130 million, about the same as at the end of last year. Cash at $6.3 million was also basically flat from year end despite an approximately $10 million reduction in current liabilities. In addition, we had restricted cash balances of $71.1 million. As of today, our cash balances remain around these levels, and we have a little under $40 million of undrawn revolver availability.

With that, we will now open up the call for questions. Operator, if you could please compile the Q&A.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from the line of Michael Gallo with CLK.

Michael Gallo – CLK

Congratulations on the return to profitability. A couple of questions. I wanted to ask first on the G&A side, G&A, as I recall, when you sold Motive you had indicated at that time that there was some G&A cost reduction potential that you saw there, but G&A has kind of stayed at that level. Should we assume that this is the new level going forward, or are there still some overhead that was residually left over from Motive that we should expect to be reduced as we go through the year?

Ian Harvie

I think on the first point, Mike, what we talked about is that we’ve taken some additional cost actions to offset any stranded overhead, so I’d say otherwise that additional overhead would have come across to standby and increase the G&A costs, so it was really an offset of those stranded costs that we talked about in terms of those cost reduction programs. If you look, for this quarter SG&A is about 10.3% of sales. In absolute dollar terms, it was up principally because of some higher incentive compensation accruals and some slightly higher warranty expense, sort of tracking the higher sales line, but it was down on a percentage basis from the prior period. I think clearly, going forward, the percentage could look to come down, if we drive volume, but I don’t think there’s any sort of large bucket of cost there that we see as opportunity other than better overhead recovery with, I’ll call it, a stronger top line.

Michael Gallo – CLK

The second question I have is I have you had some hedges on lead still in the first quarter. What was the impact of those in the first quarter, and two, do you have any hedges remaining as you enter the second quarter?

Ian Harvie

Yes. Clearly with the strategy that we’ve employed with hedging out up to 3 months and not going any longer than that at this point in time other than large contracts or projects where we take specific hedge positions on those, we do have some open hedge positions as we exited the quarter. With the recent rundown in lead, they’re somewhat out of the money, so that cost, if you like, will roll through in the future, but frankly with the way our pricing mechanisms work, our intent with that strategy was to get a better matching between the selling price that we are getting and taking orders out with the cost of lead, so I would say the impact this quarter we would expect a similar impact next quarter in terms of what impact there is of hedge positions in the P&L, and by the time we get to the third quarter, we’ll see what’s happened to lead.

Michael Gallo – CLK

How many million pounds did have hedged? I guess it was 12 million in the first quarter?

Ian Harvie

Yes, and it’s not a dissimilar number today, because it’s really a three-month program activity, so clearly on a mark-to-market basis, clearly a number of those hedges are apparently out of the money.

Operator

Your next question comes from the line of John Franzreb with Sidoti & Company.

John Franzreb Sidoti & Company

Congrats for finally getting results in black. It must feel good. My first question is about the core volume. It’s up only 4% in the quarter. Could you talk a little bit about what were the pluses and minuses in the quarter, and is it just the vagrancies and dynamics of the telecommunications market? Can you just give us some color on what are you seeing out there?

Dr. Jeffrey Graves

Yes, John. I would tell you as we exited last year, our book to bill was down a little bit. We still felt the market was strong. We were doing and have done quarter over quarter for quite some time increased quoting activity. Particularly to go back before the big Bear Stearns announcement and all of that, there was a lot of nervousness out there in the market, so a lot of projects ongoing, a lot of quoting activity, a lot of interest, but if you look at the order flow rate, it was probably down slightly as reflected in our book to bill as we came out of last year. Now, a lot of that was recovered in Q1 in terms of bookings. We ended the quarter very close to 1 in terms of book to bill, so after the financial markets settled down a bit, there seemed to be renewed confidence from our customers, actually placing orders, and the order book is certainly filling nicely right now, so I wouldn’t say there was any softening in the markets in reality. There was certainly nervousness as we exited last year and entered Q1, and a lot of that nervousness dissipated very early in the quarter, and we saw increased bookings throughout the quarter, and so I would tell you that all three of our big markets, telecom, utilities, and UPS, UPS end markets, the word we are using right now is resilient. All of them are basically strong. It’s a very strong and weathering this economic storm quite nicely. So feel good about that. We would expect our volumes to continue to grow over time, and pricing eventually will reflect volatility in lead cost, but we would volume growth. We have held or grown share in every one of our major markets.

John Franzreb Sidoti & Company

So, Jeff, am I reading you correctly in saying that your book to bill trend is now above 1? Is that what you’re implying?

Dr. Jeffrey Graves

Yes. It strengthened throughout the quarter. We entered the quarter well below that, and we recovered month by month throughout the quarter, exiting for the entire quarter at 1 or very near 1, so yes, I would tell you month over month we’ve been very pleased with the increased bookings and we exited definitely on a strong foot, John.

John Franzreb Sidoti & Company

And the gross margin, you kind of implied that you reached a catch-up scenario. Are you saying that 15% is the targeted gross margin for the business and then everything north of that has to be done internally, or maybe is it by the end of the quarter you hit a higher number and the blended 15% isn’t truly reflective of what your targeted recapture on the gross margin?

Dr. Jeffrey Graves

It’s real simple, John. We swung from 8% gross margin in Q4 of last year to 15% in Q1 of this year, and we would expect by the time we get to the end of the year to be at that 20% kind of number. So, we expect quarter over quarter margin improvements attributable primarily to our cost reduction activities, which are well on tract as we said. So those should roll through. We should get back to approaching normalcy in terms of our overall gross margins of 20%, and then we look to further improve that next year.

John Franzreb Sidoti & Company

If I look a little bit further back, the company was able to track gross margins in the mid 20s level. Is that something that’s not achievable, or what do you think there?

Dr. Jeffrey Graves

We believe it is perfectly achievable. We wanted to lay out realistic goals for the year and be as transparent as we could on what our objectives are. We feel very confident in delivering our $15 million of cost reductions. We’ll be at that 20% kind of gross margin level at the end of the year, and we think it can further improve going into next. There’s no reason in the world that we can’t get back to historical or better margin performance over the long term in this company.

John Franzreb Sidoti & Company

Excellent! And one last question, and they kind of tie in with each other. You talked a little bit about renewed growth opportunities and you are refreshing each product line. Could you just spell out a little bit more of what the timeline is of refreshing those product lines and what your expectations on new product contribution to the overall revenue mix going forward?

Dr. Jeffrey Graves

What we said for the last couple of quarters, John, is that the products we launch today should lead to an incremental $50 million in revenue. Every time we launch a new product family or refresh a new product family going forward, we’ll try to give some kind of expectations in terms of revenue growth. It’s a balance between products that cannibalize current technology. Obviously, there’s a displacement of some technology, and then there’s true growth in the end markets, and growth in share for our company, so it will be pure estimates on our part, but we’ll try to give you guidance as we launch new products. In terms of timing expectation, I would say quarter by quarter, you can expect new products to be announced from our company throughout the course of the next 18 months. I won’t share with you the details of the plan and detailed timeline, but expect quarter by quarter to hear some exciting announcements from us.

Operator

Your next question comes from the line of Richard Baxter with Ardour Capital.

Richard Baxter Ardour Capital

Question on your US and international sales break-out. How are you international sales going?

Ian Harvie

We only break out the absolute numbers in our filings on an annual basis, but I’d say the growth that we’re seeing internationally is running at or above the levels in our domestic business, and the international business last year standalone was in the sort of $45 million range or about 15% of our total revenues.

Dr. Jeffrey Graves

Richard, we face two nice opportunities right now. North America is strong in our end markets. They are going through a refresh cycle certainly in a lot of the end markets that are driven by electronic systems like UPS systems clearly going through refresh in the technology and a build-out of technology again. Telecom is much the same. Utilities as a general expansion, so in North America, we have some nice growth opportunities there. Again, we are holding or growing share in those markets. If you look internationally, historically we’ve been at that 15% kind of number in terms of percentage of revenue, and we’re seeing very nice growth there, and we are holding very high margin standards for that business. So you can kind of walk around the world, and if you look at where you would expect markets to be hot, certainly the oil-rich regions of the world are investing in their own infrastructure which consumes our type of products, so we’re accessing those. We’re growing our sales team there and accessing those. We’re looking to the emerging markets like China, and again to leverage our existing infrastructure with our new plant in China, we try to participate in that exciting growth as well. So we’ve got tremendous upside in terms of share gains worldwide even with holding our margin expectations quite high.

Richard Baxter Ardour Capital

One followup is the expectation of the rollout of the FCC requirements for the additional backup. Your views on how that’s going to be coming out?

Dr. Jeffrey Graves

Well, it seems to definitely be the trend, Richard, and the direction things are going. As you would expect I would guess there are a lot of discussions and negotiation on timing between our customers and the federal government, and we see that reflected in their aggressiveness, if you will, about how quickly they’re moving in that direction, but certainly it is a trend, it is a mandate, and we expect that expansion from the wireless side from a 4- to an 8-hour nominal backup time requirement to be realized, and it’s just a matter of timing when they all capitalize to do it.

Operator

Your next question comes from the line of Craig Irwin with Merriman Curhan Ford & Co.

Craig Irwin Merriman Curhan Ford & Co.

A couple of quick questions, really starting with one-time items. The $238,000 for severance on Conyers, that flows through the P&L in the quarter, didn’t it?

Ian Harvie

In terms of the bridge, Craig, is that what you’re referring to?

Craig Irwin Merriman Curhan Ford & Co.

Yes.

Ian Harvie

Those costs were actually in there last year, so it’s a positive as we bridge from Q1 last year to Q1 of this year.

Craig Irwin Merriman Curhan Ford & Co.

But this quarter, did you have any residual severance payments there?

Dr. Jeffrey Graves

No.

Craig Irwin Merriman Curhan Ford & Co.

No residual payments for Conyers in the quarter?

Dr. Jeffrey Graves

Right.

Craig Irwin Merriman Curhan Ford & Co.

Excellent! And then the roughly $1.3 million for the assets you sold to Crown, the Motive assets, the warranty expense, does that flow through you P&L even though it’s a discontinued sold asset?

Ian Harvie

You’re looking at the table in the 10-Q, Craig, in terms of …

Craig Irwin Merriman Curhan Ford & Co.

The Q and the footnote below in detail.

Ian Harvie

Basically, the charges have already been taken through the P&L in prior periods, so that’s a utilization of the reserve we have on our balance sheet as claims are paid or settled.

Craig Irwin Merriman Curhan Ford & Co.

Okay, so you’ve already built the reserves, so you’re not anticipating any further warranty expense to flow through your P&L for the Motive assets?

Ian Harvie

Clearly at this point in time, Craig, we’re comfortable with the reserves for warranty that we have on our balance sheet in terms of supporting that, I’ll call it, warranty process over the next year or two.

Craig Irwin Merriman Curhan Ford & Co.

Excellent! That’s good news! Just one thing I was hoping maybe you could clarify for me. When I look at Excide, they have 16% operating margin in their directly competitive division, but you have something around 2%, and you said that you’re basically competitive with your other competitors out there that are vertically integrated with smelting. Can you help me understand that or reconcile the differences in profitability?

Dr. Jeffrey Graves

Craig, from a lead cost standpoint, what you should’ve taken away from there is that we’re more competitive. Obviously when lead has been at the levels it is and continues to be, there is a built-in cost advantage to smelt your own lead. There are also a lot of requirements with that in terms of maintenance, environmental costs, and all the rest, and ongoing capital investments. So when lead was at its peak last year, obviously there’s a big advantage there to being vertically integrated. As lead rolls down, that advantage falls off and at some point becomes a negative to them and helps us, so what I had intended to way was that the pendulum swinging back the other way as the lead rolls off works to our advantage.

Craig Irwin Merriman Curhan Ford & Co.

Yes, lower lead is good for everybody. Definitely agreed. And then what do you see driving gross margin improvement over the course of the year?

Dr. Jeffrey Graves

Internal cost reductions primarily. There may be transient effects due to pricing of lead, but if you assume over the long term that it’s a wash, it’s our cost reductions that get us back to the historical gross margins for this business. That’s what our focus is on. That’s what our intention is. If we get any short-term benefits from lead rolling down, great. We’ll certainly take them. We are actively managing price out there because working against us in this entire industry is there has been a run-up in other commodity cost, significant run-ups in plastics, in the acid that we use in batteries. There’s a lot of upward pressure which has been overshadowed by the huge run-up in lead, so as lead rolls on, again, we’re trying to be very transparent about it. There are other costs that remain high and going higher that we have to continue to manage our selling price for. That’s why we are out there working that very hard. So, we may get some transient benefits from pricing in lead. As lead falls, that obviously helps us. When lead goes up rapidly like last year, it hurt us, but it’s a transient effect. The gross margin improvement that we cited is driven primarily by our internal cost reductions. That’s the way it should be viewed. Any short-term benefits from lead coming down are viewed as short term.

Operator

Your next question comes from the line of Johnny Brown with Stephens Inc.

Johnny Brown Stephens Inc.

My question has to do with the last caller. Can you give a little bit more color on your relative competitiveness with your products? In terms of lead costs, specifically, what price in lead do you see as kind of pivotal to where you’re competitive with companies with their own smelting operations and not?

Dr. Jeffrey Graves

Well, we’re very comfortable, Johnny, in either scenario whether lead is rolling up or down. We’ve got variable pricing mechanisms. We’re able to pass that on to customers if it’s rising. Obviously not a fun conversation, but we’re able to pass that on contractually, and we give them some of the benefit of it as it rolls down, with the exception for other commodity costs going up. So, in terms of overall competitiveness, we’re very comfortable with that. Obviously, when you look at the cost of lead inherently to the company, there are periods of time when lead is very high that it’s more economical to smelt your own lead. It’s not a decision to be taken lightly because there’s a lot of baggage that goes with that, and when lead rolls back down, as it has in recent months, that advantage lessens until it’s an advantage not to own your own smelter. So that pivot point is probably different for everybody in the industry. In terms of lead consumption in our batteries, as we roll out new designs quarter by quarter, we’re looking obviously at driving performance up. Every product we’re launching has higher performance from an energy standpoint, energy density, and from a life standpoint, so all of that. Increasingly, we are adding to those benefits the environmental benefit of lower electricity consumption. So on those basis, we can offer more value to our customers. Along with that, we’re often able to take the lead content down in the product, so through more advances in metallurgy and process technology, we’re able to actually take lead out of the product while we offer performance improvements to our customers, so it’s a win all the way around. We’re consuming less lead, we’re consuming more recycled lead, and that tradeoff point between nonvertically and vertically integrated companies drives down every day. So, I hope in there you found the answer to your question.

Johnny Brown Stephens Inc.

I think that’s helpful, and my other questions have been asked and answered, so thanks a lot. Good job guys!

Operator

Your next question comes from the line of Bill Dezellem with Tieton Capital Management.

Bill Dezellem Tieton Capital Management

We had a couple of question, and you touched on both of these, so if you’ve already answered them to the extent that you would like to, I apologize for doubling up. The book to bill, you had mentioned, it improved each quarter or each month within the quarter, and we’re presuming that actually continued into the month, I guess the first month of the next quarter. Is that an accurate statement, number one, and then number two, you had mentioned that things started to improve really after the Bear Stearns issue got cleaned up, or with JP Morgan announcing that they were taking them over. Why was it that we saw that improvement, or what it just from your perspective?

Dr. Jeffrey Graves

Yes, Bill. I can’t tell you there was any cause and effect with the Bear Stearns transaction. It just seemed to us that that as a benchmark in time, and we started seeing a nice translation from quoting activity which had remained very strong to actually orders being placed, and I connect the dots and say everybody became more confident that the world wasn’t collapsing, that things were going to be okay, and orders were flowing through. The level was quoting activity was enormous, and it reflect continued need by our customers for this infrastructure refresh or expansion, so that was always very encouraging to us. To see the actual order flow improve month by month really confirmed that, and we were pleased in how we exited the quarter in terms of our sales plan from a volume standpoint. So, I liked the trajectory we were on. We still see a lot of quoting activity in all of our major end markets, and we remain very comfortable for the year at this point that the current economic turmoil out there is not having a big effect on our end customer base.

Bill Dezellem Tieton Capital Management

In the month of May, did the book to bill improve sequentially again?

Dr. Jeffrey Graves

We just exited that month, Bill. I am not really in a position to say that. Again, I would tell you about the end-market demand and quoting activity. We left the quarter with momentum in Q1, and we’re confident in the plan that we had laid out the beginning of the year for our sales budget, so we wouldn’t back off on that at all.

Bill Dezellem Tieton Capital Management

That is helpful, and then I would like to switch to the international markets, and you discussed the oil-rich regions and China as a couple of areas specifically that you’re looking to focus some efforts. Are there other areas of the globe that you’re also wanting to focus efforts, and if so, where are they, and what is your strategy to break into those markets or improve share?

Dr. Jeffrey Graves

Well, the first two markets I mentioned carve out big pieces of the world, so I wouldn’t underestimate the size of those. The remainder, Europe, we have been growing our sales in Europe, and obviously the strength of our brand carries worldwide, so that’s a good backdrop to have when you go in, but what’s really helped us a lot there, Bill, is our customers particularly on the UPS side of the business who are truly global players. It’s a fairly consolidated industry of UPS companies out there. Some new companies have come in and some very good blue chip companies have entered the market. Every one of those, Bill, is a very global player. We are a very big supplier to them in North America, and we are now working to leverage that relationship into other parts of the world, which are going through the same kind of refresh cycle on data centers. So if you look at for example Western European, you don’t often think of Western Europe as a real growth economy these days. Much like the US, it’s a mature economy growing at modest GDP levels, but in terms of UPS technology or data center technology, that stuff that they built out just like in North America back in the early 2000s or year 2000 for Y2K, it’s ancient equipment now. It’s grossly outdated and has to be refreshed, and we have been benefitting from that for the last year, certainly in North America. That trend continues, and we’re leveraging that now because our customers are global customers. We are leveraging that relationship to participate more fully worldwide.

Bill Dezellem Tieton Capital Management

And do you have more that you would like to add relative to your strategy to break into the oil-rich regions and further penetrate China?

Dr. Jeffrey Graves

Many of the oil-rich regions are use US-type specifications for their products, and obviously with oil at $125 a barrel, there’s a lot of revenue they’re generating for themselves. They are using that revenue to build infrastructure, Bill. They are building new cities. They’re building all the types of facilities that use our type of product, so you’ve got data centers, you’ve got hospitals, you’ve got utilities and power plants. Telecommunications is expanding rapidly in those parts of the world. They’re using that revenue stream to build their infrastructure out, and that’s our bread and butter. That’s what we do. Those are the backup power batteries that we provide, and where there are western specifications, which there are in many of those countries, we’re able to leverage that for sales growth nicely, and still deliver nice margins for our shareholders, so it’s great business for us, and we’re investing in that direction.

Operator

Your next question comes from the line of Joy Mukherjee with the State of Wisconsin Investment Board.

Joy Mukherjee – State of Wisconsin Investment Board

Congratulations! It’s good to be returning to profitability. The question I had is, do you see many opportunities in alternative energy with your UPS product, whether it be solar or wind?

Dr. Jeffrey Graves

Yes. Certainly I would say as a general comment, Joy, our customers are extremely sensitive these days, and I think it’s a good very thing, energy conservation itself. Whether it’s a data center, a UPS customer, it’s energy saving, so our new product like the msEndur II where we can go out and say look, it’s a got a much longer life than any product in the market in its category. It’s got better power density, and we can save you electricity cost, which are again reflected in lower C02 emissions. That’s a great thing. In terms of utilities, we are the largest provider to the utility industry in North America for backup power. Those utilities are showing increasing interest in renewable energies, photovoltaic and wind energy. Those types of systems often require significant battery backup, so it is a real opportunity for us. We are certainly looking at it. We’ve got products we sell today, and in terms of our refresh plan for the next year and a half, that certainly features as a prominent product.

Operator

Your next question comes from the line of Sean Boyd with Westcliff Capital.

Sean Boyd – Westcliff Capital

I want to go back to the variable pricing strategy that you mentioned earlier in the call that you are working into the contract. Can you give us a little bit more color on that in terms of does that completely rip out the exposure to the change in the lead price and how much of your current order book would feature such those contracts?

Dr. Jeffrey Graves

All our pricing mechanisms are now variable. As we said in the last couple of calls, Sean, when lead ran from a $1 to $1.80, we and I think virtually everybody in the industry were forced to go back and have those discussions with customers about moving to variable pricing. Historically for many many years, lead was very inexpensive and very flat in price, and you really could wait for the end of a contract to renegotiate your new pricing. The whole world changed there, and it did for many industries exposed to oil and all basically commodity metals and chemicals. Everybody had to go to much more variable pricing, so we did that. We were either the leader or among the leaders in doing that with our customers, and after painful discussions, it was all implemented. Now, the word ‘completely,’ does it completely insulate us from lead? There are still time lags. Obviously, you don’t readjust pricing daily. In most cases, it’s a month or three months or six months in cases, but it’s all variable, so the way lead volatility should be looked at now, it’s a stimulus to the business, either good or bad, and then our adjusts and offset, so by moving to FIFO accounting and by our hedging strategy going forward, we’re now much better aligned in our actual pricing with our lead costs through the P&L, so that we can normally offset those fluctuations. That’s our strategy, because it’s unfair for shareholders to expose them to just unpredictable volatility and your performance driven strictly by a large commodity purchase, so we can be more predictable to shareholders and customers in doing this.

Sean Boyd – Westcliff Capital

On that hedge strategy, that’s only on the larger jobs? What percentage of your business would you say you end up hedging?

Dr. Jeffrey Graves

We hedge forward for a very limited amount of time as Ian mentioned. We hedge forward for a few months, a fair percentage of our needs, and basically that combined with our FIFO counting and the flow-through of lead through our inventory aligns our pricing changes with the cost of lead. Now, it took some time to get that balance, and what we said in this was this was the first quarter where we had relatively close balance between pricing and cost flowing through the P&L, because as lead was spiking up so quickly last year, even variable pricing took time to adjust and flow through, so Q4 was particularly painful before all the pricing hit. Q1 was better as lead stabilized, and then pricing caught up with it so, now we have had lead movement downward, so obviously there are some transient effects there that may help, but what we wanted to be clear with our shareholders and folks on the call was we view lead fluctuations as transient. There may be some transient benefits or penalties, but with lead coming down, there are some benefits. Any hedges you haven’t placed when lead is coming down hurts you obviously because you’ve locked in your cost basically, but again our objective is to align those costs with our pricing.

Sean Boyd – Westcliff Capital

So, those hedges are certainly taken into consideration as you guide gross margins from 15% today to an exit rate at 20% at the end of the year?

Ian Harvie

Correct, and that’s reflective of the nature of what our backlog is priced at.

Sean Boyd – Westcliff Capital

So business in that backlog goes out how far on average?

Ian Harvie

The majority of the backlog is over the course of the next quarter, but clearly there is there is project business that can go out up to a year.

Dr. Jeffrey Graves

Yes. We put some large projects out a year. A large data center for example maybe under construction for a long time, Sean, but the bulk of our backlog is 3- to 4-month kind of backlog.

Sean Boyd – Westcliff Capital

Just for some of us who might be a little bit newer to the company. The volume growth of 4% every year in the quarter, how does that stack up? What were the last couple of years just historically and what are you guys targeting going forward?

Dr. Jeffrey Graves

Our volume growth every quarter has increased. I would have to go back and look at the numbers Sean, but our volume growth has increased quarter of a quarter probably for the last year to two years. The end markets have been strong, Sean. Now, as the nervousness got high at the end of last year, I think it was a deep breath taken on the part of our customers. Continued interest, as I mentioned, in quoting, but in terms of order placement…, but in retrospect, it’s a minor glitch. In reality, our end markets across all three of our end markets, the big ones, are strong, and they continue to be very resilient in the face of this economy, so we’ve had volume growth. We continue to be pleased with it. Our estimates of market share, we’ve held or grown in each one of our major end markets and each one of our major product categories over the last year to year and a half.

Sean Boyd – Westcliff Capital

So that sales budget that you’ve got for fiscal ‘09 here, what are you targeting in volume growth?

Ian Harvie

We haven’t given any specific guidance in terms of sales growth number for the year.

Dr. Jeffrey Graves

And again, Sean, it will be volume and pricing. They will be the two factors, so we haven’t given any guidance on an actual number.

Sean Boyd – Westcliff Capital

Last question if I may. The utilities, in your answer to one of the questions earlier, Jeff, you mentioned that North American revenue is very strong, specifically in utility. Well, you mentioned all the areas were strong, but you talked about general expansion in utilities. Can you give us just a little bit more color on that specifically what is it?

Dr. Jeffrey Graves

Sure, Sean. There are two pieces of the utility market that we participate in. One is electricity generation. It’s backup for nuclear power plants and fossil fuel plants, and there is the transmission piece of electricity in all of North America, US and Canada, and the transmission infrastructure as it’s been widely published has been under-invested in for many many years now, and we’re starting to see a renewal of that, so folks don’t respond well in North America to power outages. I think that the power companies and the transmission companies are sensitive to that and they are investing in their infrastructure, so we’re very pleased with their capital investment and their use of our batteries. We continue to have a very strong market presence in utilities, and it’s growing, not in absolute dollars and volume but in share, and I would tell you it’s probably equal, I don’t have the numbers in from me, but it’s probably equal on the transmission and the generation side. The interesting thing now, and it’s to a prior question, is this move toward renewable energy is really exciting. A lot of the batteries historically that you use in very hot climates for photovoltaic systems, for example, haven’t historically lasted very long, so there’s a frequent replacement cycle. When photovoltaic generation in the US is very low percentage as it has been, that’s not such a big deal to people. When you now look at expanding solar arrays, especially in the sunny hot climates, to build big fields of these things and to put them on buildings and homes and all, the need for batteries is not only going up, but the need for long-life batteries is increasing a lot, and technologically, our company has generally delivered the longest life batteries in the industry. That’s always our objective. So, we like that trend. It’s a good fundamental demand trend. It’s a good technology trend for us, and we’re excited about it.

Sean Boyd – Westcliff Capital

That’s really exciting. What percentage of your business is utilities overall?

Dr. Jeffrey Graves

Probably 15%. Again, I don’t have the numbers in front of me, but it’s probably, say, 15% to 20%, Sean.

Operator

Your next question comes from the line of John Franzreb with Sidoti & Company.

John Franzreb - Sidoti & Company

A couple of followups guys. Could you talk a little bit about competitive technologies, and what you’re seeing out there?

Dr. Jeffrey Graves

John, I tell you, there are a lot of exciting developments in material science and processing. I would tell you, today, it’s equally exciting on the lead acid side as it is any ether of the advanced chemistries. I mean you look at, we’re working on lithium now. We’re involved in lithium from both a cell and a system standpoint, and we continue to be excited about these emerging technologies, but I would tell you John, I’ve been so pleasantly surprised with the advances that we’ve been able to identify in lead acid technology. Lead acid technology continues to be the lowest cost solution out there for most applications, and at the end of the day, if you can meet a customer need for performance and provide it at a lower overall price because it’s a lead acid solution versus a more exotic solution, they’ll do it every time. Unless there’s a specific need for low weight or something that’s unique to the other chemistries, lead acid continues to be a very very vital product, and with the new materials and process technology we have available to us now, we continue seeing that to be the dominant case. We revisit that assumption, I can tell you, every day, every week with our R&D activities. We’re working hard on lithium and competing technologies. We’re excited about them for some niche applications, and we want to be there if they are ready to take over more lead acid. We want to be there for that. Today we’re working on all of it. We want to make sure we’re there if our customers want it from us, but I’m very pleased still with the future of lead acid. I think it’s a great product.

John Franzreb - Sidoti & Company

Now, I just want to clarify, did Ian say that 85% of sales are US sales. Is that the number?

Dr. Jeffrey Graves

John, they have been. Yes. That’s going to change with the international markets. As we gain traction there and grow, it may be a growing percentage. There is a lot of opportunity for us. Historically, it’s been 15% of revenue.

John Franzreb - Sidoti & Company

Okay. Now if I also heard correctly that the foreign sales orders were trending better than US, so implies that US sales were down slightly in the order trend book during the quarter? Is that a fair assessment?

Dr. Jeffrey Graves

No, I don’t think we’d say that, John. In terms of order trends, North America remains a very vibrant market for us. Obviously, there are regions of the world that are growing faster. China, India, and the oil-rich states, they’re all investing in infrastructure faster than North America, but our end markets in North America remain strong. So, there may be a relative change in growth rates between the two sectors, but both sectors will grow, so it wouldn’t imply weakness in one and strength in the other.

John Franzreb - Sidoti & Company

Great! That helps. Jeff, are you satisfied with the personnel level that you have, or do you think additional staffing might be needed to address some of these foreign opportunities?

Dr. Jeffrey Graves

We continue to staff up for international opportunities, absolutely, but we’re very selective about it. We want to make sure there’s a cost-benefit obligation that’s met there, so we look at what regions do we need to have a presence in and who are the best sales folks out there to have. So, we do continue to add resources to that area, John, but we have very specific criteria to be met to add them. So, we don’t take any headcount additions lightly.

John Franzreb - Sidoti & Company

And one last question, given the variable pricing mechanism you have in place, should we expect that the industry will be facing or that you will be leading actually the industry in lower pricing in the latter half of the year if lead stays at the current level?

Dr. Jeffrey Graves

We, John, I think are the most vocal on pricing for two years now, and we are going to continue to be very vocal about all the cost prices. We have a lot of other commodity cost pressures other than lead which impact the cost of our product which we have to see reflected in our pricing. So, we are reluctant comers to party on any price reductions. The reality is with our contracts now, they are variable pricing contracts, and I think John, the industry has migrated there. That's a good question for you to ask other people, but by and large, the days of long-term fixed price contracts in an industry like ours that consumes such a large amount on a percentage basis are gone. It’s moved to variable pricing where you can accommodate those fluctuations, John.

Operator

You have no further question at this time.

Dr. Jeffrey Graves

Thank you very much Carmen. I have a quick closing comment, if you would. Let me wrap up with just a couple of final thoughts. We’ve traveled a long path to achieve the success evident in today’s results. I want to thank all the dedicated C&D employees, our suppliers, and others who contributed to this outstanding accomplishment. The wide power storage markets on which we’re focused offer great growth opportunities as a result of the tremendous demand arising from a number of a macro trends that we discussed in this call. They’re certain only to accelerate from here. By concentrating exclusively on this industry, where we have a long heritage of innovation and leadership, we believe can increase our share of the global market. We’re embarking on this exciting journey from one of our strongest financial positions in many years. We hope you, our shareholders, share with us our enthusiasm about the year ahead and our opportunity to build value over the long term. We continue to look forward to speaking with all of you again in the near future.

Operator

This concludes today’s conference. You may now disconnect.

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