Exide Technologies F1Q09 (Qtr End 06/30/08) Earnings Call Transcript

| About: Exide Technologies (XIDEQ)

Exide Technologies (XIDE) F1Q09 Earnings Call August 7, 2008 10:00 AM ET


Gordon A. Ulsh – President, Chief Executive Officer

Edward J. O’Leary – Executive Vice President, Chief Operating Officer

Phillip A. Damaska – Executive Vice President, Chief Financial Officer

Nicholas J. Iuanow – Vice President, Treasurer

Barbara Hatcher – Executive Vice President, General Counsel


Craig Irwin – Merriman Curhan Ford & Co.

Oliver [Corlet] – R.W. Press Bridge and Company


Welcome to the Exide Technologies first quarter 2009 fiscal year earnings conference call. (Operator Instructions) I would now like to introduce Gordon Ulsh, President and Chief Executive Officer of Exide Technologies.

Gordon A. Ulsh

With me today is Exide’s Executive Vice President and Chief Operating Officer, E. J. O’Leary; our Executive Vice President and Chief Financial Officer,

Phil Damaska; our Vice President and Treasurer, Nick Iuanow; and our Executive Vice President and General Counsel, Barbara Hatcher.

And Barbara will now review our Safe Harbor statement after which we’ll provide details of our first quarter results, followed by a question and answer period. Barbara.

Barbara Hatcher

Before discussing our fiscal 2009 first quarter results, we need to remind listeners that certain statements on this call may constitute forward-looking statements as defined by the Private Securities Litigation Reform Act of 1995. As such, they involve known and unknown risks, uncertainties and other factors that may cause the actual or expected results of the company to be materially different from any results expressed or implied by such forward-looking statements.

These factors are enumerated in further detail in the company’s most recent Form 10-K, filed on June 9, 2008 and on Form 10-Q, filed yesterday with United States Securities and Exchange Commission. In addition, any statements made during this call are made as of today and the company undertakes no obligation to update any of these statements in the future. Gordon, back to you.

Gordon A. Ulsh

While Phil Damaska will get into the numbers in more detail, I would summarize our first quarter of ’09 as a strong start to what looks to be another solid year of improvement. Although we are disappointed that we reported a net loss of $10.3 million, it’s important to note that an abnormally high tax provision and a $9.7 million increase in our warrants liability were the primary drivers that resulted in that net loss.

Operationally, our business has continued to improve in delivering results with consolidated adjusted EBITDA of $71.7 million, up from $39 million in the first quarter of ’08. We also generated positive free cash flow of $44.8 million, as compared with the free cash flow burn in the prior year period of $66.8 million.

Turning to page four, I’d now like to cover a few areas affecting our markets. Beginning with the automotive original equipment manufacturers for OEMs, it’s no secret that this industry is affected by the rising cost of fuel coupled with the slowing U.S. economy. Auto makers with sales both in the United States and Western Europe are experiencing a slow down in sales of their traditional product offerings.

The European Automobile Manufacturer’s Association reported a 2% decline in new car sales for the first half of ’08, compared to ’07, due to high fuel costs and a weak economy despite the strong demand for new autos in Eastern Europe. The Asian and South American markets has continued to have strong demand for autos and we know the North American declines have been more severe than those in Europe.

With many consumers making a conscious choice for more fuel efficient vehicles as opposed to large Sport Utility Vehicles and trucks, many auto makers are reconfiguring manufacturing facilities in order to boost production of smaller, fuel efficient vehicles.

In response to the current decline in the automotive OEM market it’s important to remember that Exide’s North American mix is approximately 12% of OEM. Additionally, our transportation segment participates in a variety of markets such as heavy duty both on and off road, agriculture, power sport, marine, golf cart and motorcycles.

This diversification helps to mitigate the significant downturn in the OEM market. We recognize that our Transportation Europe and rest of world segment is more exposed to the OEM channel and if the pace of economic slow down accelerates, this business would likely experience further volume decline. We’re watching this closely and we’re taking actions to mitigate the impact in the event it occurs.

The U. S. Department of Transportation recently reported that vehicle miles driven has declined for seven consecutive months. Some perceive this as a negative raft to market automotive suppliers, whose sales may be closely correlated to miles driven. In response to the DOT report of miles driven, this is not necessarily a negative for Exide.

While it may be a negative for some after market suppliers, it’s not necessarily true for battery manufacturers. Simply driving an auto fewer miles does not extend the life of a battery, and if in fact an auto is left parked for extended periods of time, this could shorten the life of the battery.

The life of a battery is also affected by age, maintenance, unusually hot summers, unusually cold winters, not just the numbers of miles driven.

The network power market, primarily the wireless segment, continues to be strong globally, particularly in the U.S. due in part to recent FCC regulations regarding back up power supply. The economies sea based in Europe and Asia are developing more telecom infrastructure to support growth in these areas and Exide offers many products to meet these needs.

The mode of power market tends to track the overall economy, which is slow in the U.S. and Western Europe as we previously mentioned. As fewer goods are sold, sales of lift trucks and lift truck batteries generally decline. We’ve seen this slowing in ordering patterns in our U.S. market and if we see further GDP contraction, slower order patterns could continue. Order activity in Europe continues to hold up quite well.

Turning to page five, rising commodity costs are affecting most manufacturers and in particular the automotive manufacturers. The prices of steel and other raw materials in addition to freight and utilities are having an impact and unfavorable affect on manufacturer’s earnings in the face of a weakening U.S. economy and higher fuel costs. Exide continues to face rising commodity costs which we will continue to effectively manage in our operations.

Lead, which was 49% of our cost goods sold in the first quarter of ’09 has increased 6% over the first quarter of ’08, but it’s still down significantly from the peak levels in the third quarter of last year. Much attention has been given to the price fluctuation of lead in the past 12 months, but it’s important to note that other costs have an increase and impact on our operations as well.

We’re experiencing rising costs for natural gas, diesel fuel, polypropylene, premium metals and sulphuric acid. Basically prices for all commodities used in the manufacture, recycling and distribution of batteries are on the rise. While we’ve been successful to date in recovering these costs, it’s a dynamic that requires constant monitoring and will continue to be a focus of our team.

Turn now to the next slide for an overview of our divisions first quarter. Transportation Americas enjoyed a good start to fiscal ’09 with higher net sales and improved margins as compared to the first quarter of ’08. New business developments include an agreement to supply Mercury Marines 6,000 dealers in the U.S. and Canada with a full line of marine batteries. We also began shipping to Pep Boys and Club Car during the first quarter.

Unit sales in the period were flat to the prior first quarter, with a decrease in OEM sales offset by an increase in units sold through the after market channels. Industrial Energy Americas experienced a strong first quarter driven by network power customers who are continuing to increase their back up power supplies to comply with FCC regulations.

Motor Power enjoyed a solid first quarter with strong sales to key accounts. The sales occurred despite the Industrial Truck Association’s recent report that OEM truck sales are down about 2.5%. We also successfully launched our new [Absolight] GP product line, which is environmentally friendly and provides a green Exide battery alternative for the network power market.

Transportation Europe and the rest of the world experienced higher net sales margins and EBITDA for the first quarter of ’09, and recently secured an agreement to ship approximately 100,000 Exide AGM batteries for Ikea Motors beginning in December of this year.

Industrial energy in the rest of the world increased net sales on somewhat lower volumes with improving margins, due to the lag between less cost decreases and price adjustments as well as our continued focus on our customer rationalization.

We’re experiencing growth in our network power business, particularly in Eastern Europe and Russia.

Turning to page seven, many of you are familiar with our strategy but I’d like to recap for any who are new to our story. We believe our Q1 results indicate what happens when a well thought out strategy is executed by an experienced management team and motivated employees throughout our business.

Our strategy has been to empower our employees to help us improve efficiency and productivity, primarily through Take Charge and Excell tools and programs; to establish a pricing structure that recognizes the value of our products and services in light of the escalating cost of commodity used in our manufacturing and distribution processes; to improve liquidity; to realign our operations and to continue to strengthen our management team. The execution of this strategy during ’07 and ’08 has built a foundation for an exciting fiscal 2009 year.

As I reported to you in June, we’re fortunate to bring Dr. Paul Cheeseman on board as Vice President Global Research, Development and Engineering. Paul spent his first 45 days working with our global teams to finalize an engineering and R&D structure to support our global business going forward. That framework is taking shape and will likely consist of first, a centralized group tasked with R&D of future advance technologies; and secondly, two centralized global design and engineering organizations, one for transportation, the second for industrial energy applications.

These groups will be tasked with product developments around existing products. As previously discussed there is efficiency and greater product commonality and greater opportunity to leverage our global footprint. The execution of this component of our strategy envisions the addition of some 60 engineering positions and we’ve begun the work to fill these. And we’ll provide periodic updates as this important initiative unfolds.

A moment about capital expenditures on page nine. As we communicated in June, we expect to invest approximately $100 million in our business during fiscal ’09. The level of capital expenditures in the first quarter of $12 million may not appear to have us on track to achieve this level of investment; however, about $32 million of projects have been approved.

These projects approved include approval to increase targeted capacity aggregating the approximately $14.5 million, approval of about $15.2 million for cost production programs and efficiency improvements. And lastly, a $2 million investment was approved for one of our recycling plants to further improve the efficiency of our furnaces, which also serves to be proactive with employee health and safety requirements.

These projects indicate our level of commitment to accelerating capital spending during fiscal 2009 as compared to the recent past.

In a bit about restructuring costs on page 10, while restructuring for the first quarter of fiscal ‘09 we’re only about $2 million and about flat for last year, we expect to accelerate our efforts to further streamline our businesses. These changes will result in further position eliminations including plant and back office employees, as well as operational and some sales management. Based on our relative levels of headcounts in relation to our size of businesses, the greatest opportunity for these changes continue to be in both European segments.

During the current quarter 41 positions have been eliminated as a result of these activities and we anticipate an acceleration in the elimination of positions as we move through the remainder of the year. For the full year we expect restructuring charges could exceed $20 million based on currently defined and approved initiatives. These initiatives should result in annual savings in excess of $12 million.

So we have a strong start to fiscal ’09 with increased sales and increased margins as we continue to focus on executing our business strategies. All of our divisions are contributing to our success, but we still have much to do.

Now our Executive Vice President and Chief Financial Officer, Phil Damaska, will provide you with some additional financial details of our quarter.

Phillip A. Damaska

Before I begin, I want to remind you that Exide uses adjusted EBITDA as the key measure of its operational and financial performance. We continue to believe it provides a more useful measure for Exide at the present time than designated income. We define adjusted EBITDA as earnings before interest, taxes, depreciation, amortization and restructuring charges.

Our adjusted EBITDA definition also adjusts reported earnings for the effect of non-cash currency remeasurement gains or losses, the non-cash gain or loss from revaluation of the company’s warrants liability as well as impairment charges, gains or losses on asset sales, and the one time debt extinguishment charge incurred in our fiscal 2008 first quarter.

We also provided a summary of our calculation of adjusted earnings per share in our press release to exclude the impact of certain special items impacting our financial statements with the intent of providing information more practical than that of some of our major competitors and peer group companies.

I would refer you to the press release and the tables at the end of the presentation for our reconciliation of adjusted EBITDA and EBIT to net loss under generally accepted accounting principles, for a breakdown of net sales and adjusted EBITDA by segment, for a summary of our adjusted EPS calculation and our definition of Free Cash Flow.

Moving on to page 13 and as Gordon indicated we completed a strong first quarter in which all of our business segments contributed to our quarter over quarter operating performance improvement. For our fiscal 2009 first quarter net sales increased $209 million to $971 million, a 27% increase. A weaker dollar against most foreign currencies accounted for $78 million of the increase and excluding the effect of foreign currency translation, net sales increased 17% due to effective pricing in all business segments.

Adjusted EBITDA for the current quarter improved 82% to $71 million from $39 million in the first quarter of 2008. EBIT increased to $32.4 million in the 2009 first quarter, compared to an EBIT loss of $14 million in the prior year period, driven in part by the $21.3 million quaff and early extinguishment of debt. And finally, we generated Free Cash Flow in the first quarter of $45 million compared to a Free Cash Flow burn in the prior year period of $67 million.

As we’ve described in the past, our results generally follow a definite seasonal trend as depicted on page 14 for the four quarters of fiscal 2008. This seasonality would generally result in our first quarter results being the weakest of the four quarters. The first quarter of fiscal 2009, however, benefited from the reduction of costs of lead as quoted on the LME, a dynamic that we have not seen for some time.

Given we still have a portion of our business in quarterly escalators, we enjoyed higher pricing relative to the lead costs in the first quarter for these customers. For the most part, pricing under these escalator arrangements re-set effective July 1, 2008, based on average lead costs in the first fiscal quarter.

Moving to page 15, this provides you with the reconciliation of our net loss to adjusted EBITDA for the first fiscal quarter with comparative data for the prior year first quarter. You will note an unusually high tax provision in the current year, which I will cover in more detail shortly.

Although we reported a net loss in the current quarter, we continue to be encouraged with improving operating performance as measured by adjusted EBITDA. The improvement in this metric is driven by an increase in gross profit to $169 million or 17.4% of sales as compared to $119 million or 15.6% of sales in the prior year period. The improvement in margin quarter over quarter continues to be driven by improved plant and distribution productivity, as well as effective pricing to offset higher input costs.

As was mentioned earlier, the first quarter also benefited to a degree from the lag in price escalators with some of our customers.

Talking now about the income tax effect on slide 16 and you’ll note that our quarterly tax provision was an unusually high 171%. There are three major factors contributing to this result. First we recorded $13.2 million of net non-cash valuational allowances in the quarter. This was principally the result of establishing a valuation allowance against net deferred tax assets in Australia.

Secondly, you will recall in the fourth quarter of fiscal 2008 we reversed a valuation allowance against our net deferred tax assets in the U.S. The result is our pre-tax earnings in the U.S. are now subject to the full statutory rate, plus or minus the impact of permit differences.

And finally our U.S. based pre-tax profits in the first quarter included a non-deductible, unrealized loss of $9.7 million associated with the mark-to-market of our warrants liability. And as you can see, this alone had a significant impact on our effective tax rate.

Given some of these factors, it is likely that our book based tax revision and resultant effective tax rate will continue to be higher than the statutory rate and will be volatile in the future. As a result, we believe cash taxes to be equally meaningful at this time. Such cash taxes are expected to aggregate in the range of $25 to $30 million for all of fiscal 2009.

Moving to page 17, we provide some information on our warrants and the related liability. This may be a refresher for some of you, but potentially new information for others. The warrants which gave rise to the referenced $9.7 million charge were issued as part of the May, 2004 bankruptcy exit plan. Certain relevant and [notably] facts about these securities include the current warrants outstanding permit the holders to purchase approximately 6.7 million shares of Exide common stock at a per share strike price of $29.84.

The warrants are quoted on the NASDAQ and the liability on the books is mark-to-market based on such quoted prices, which increased from $1.23 at March 31, 2008 to $2.67 at June 30, 2008.

And finally it’s important to note these warrants expire in May, 2011 with required payments to holders only in the event of a change in control prior to that time.

I would now like to focus on the results of our reportable segments beginning with Transportation Americas on slide 18. This business’s net sales for the 2009 first quarter increased 22% to $306 million, as compared with $251 million in the same period last year. The increase reflects favorable pricing actions on about the same volume as the prior year. After market unit volume was higher in the prior year, however, this increase was offset by a decline in OE volume.

Gross margin for the first quarter of fiscal 2009 was 19.4% versus 19% in the same period last year, and resulted in an increased adjusted EBITDA to $34 million versus $26 million for the 2008 first quarter.

On page 19, net sales for Transportation Europe and rest of the world were $276 million in the first quarter versus $213 million in the comparable period last year. Net sales excluding the feral impact of foreign currency translation of $37 million increased by 12% over the prior year period. The increase was entirely the result of favorable pricing, partially offset by softer volumes in both the OE and after market channels.

Adjusted EBITDA in the fiscal 2009 first quarter rose 41% to just over $7 million versus $5 million in 2008 first quarter in the face of higher manufacturing input costs. Industrial Energy Americas, which is discussed on slide 20, had a strong first quarter driven by their network power customers who are continuing to increase their back up capabilities. Motor Power enjoyed a solid first quarter with strong sales to key accounts, although order patterns are showing signs of some weakness tied to slowing economic growth.

Net sales for Industrial Energy Americas increased almost [31.7%] to $89 million in our 2009 first quarter versus $65 million in the prior year quarter. Increase in sales over the prior year is due to strong network power sales as well as favorable pricing actions in both network and motor power markets.

Gross margin was a strong 27% for the current year’s first quarter compared to 25% in the same period last year, and adjusted EBITDA rose 62% to $16 million in the 2009 first quarter from $10 million in the comparable quarter of the prior year.

Turning to the next slide, fiscal 2009 first quarter net sales for Industrial Energy Europe and rest of the world grew 28% to $300 million compared with $233 million for the comparable period last year. Pricing and favorable foreign exchange were the primary contributors to the increase.

Network power sales continued strong in the quarter but were partially offset by reduced volumes in motor power. Gross margin in 2009 first quarter was 19% versus 14% in the same period of 2008 as the business benefited from a price de-escalation coupled with lower lead costs and continued productivity improvements. The improvement in gross margin drove adjusted EBITDA for the quarter to over $20 million as compared with $7 million in the first quarter of 2008.

Couple comments on some corporate items on page 22, unallocated corporate expenses for the first quarter of fiscal 2009 were $6.5 million, a decrease from $9.2 million in the comparable 2008 period. The decrease was primarily due to lower professional fees. Net interest expense was $19 million in the fiscal 2009 first quarter compared with $21 million in the fiscal 2008 period. This $2 plus million decrease reflects lower borrowing costs and lower average debt balances outstanding.

Finally on page 23, a few comments on our liquidity and debt [inaudible]. At June 30, 2008 the company had cash and cash equivalents of $131.5 million and availability under the bank revolving loan facility of just over $134 million. Net debt at June 30, 2008 was $584.5 million, $45 million less than at March 31, 2008 reflecting our Free Cash Flow generation during the first quarter.

Also of note is the rating upgrades received from both Standard and Poor’s and Moodys, reflecting our improved credit profile. Although positive in and of itself, these upgrades also allowed us to reduce our [libre] spread on our term loans by 25 basis points, which will reduce interest costs going forward.

Now Gordon will make a few closing comments before we open the call to your questions. Gordon.

Gordon A. Ulsh

We’re certainly pleased but certainly not fully satisfied with our first quarter results. With our Take Charge Program and Excell rolled out at the majority of our manufacturing facilities worldwide, tools that have a strong success rate we expect continued savings and productivity improvements in the future. Additionally our strong book of business and our success with pricing adjustments and customer rationalization, we feel competent that our business will continue to improve as we go forward.

We continue to focus on improving margins in all of our business segments and we recognize that we have the opportunity to do so. Another effective tool at Exide is our economic profit and set up compensation program. And I remind you that all employees, except those covered by collective bargaining agreements, participate in this plan which functions very much like an economic value added plan. Employees are incented for profit oriented decisions and actions.

I’d like to close by stating that we’re very focused on improving our financial results and executing our strategies each and every day. I thank you for participating in today’s call and now we’d be happy to entertain any questions that you might have. Brandy.

Question-and-Answer Session


(Operator Instructions) Your first question comes from Craig Irwin – Merriman Curhan Ford & Co.

Craig Irwin – Merriman Curhan Ford & Co.

I was surprised by the sequential strength in gross margins given that this is typically a seasonally weak quarter. Can you talk a little bit about what’s going on in the individual segments that’s driving the improvement? And really why maybe industrial Europe, sorry Transportation Europe with the one out [liner] as far as sequential improvement?

Gordon A. Ulsh

A couple of points, first thanks for recognizing that continued improvement in margin. As I said it’s a very important goal of ours as we go forward. A couple of points, one, we continue to gain improvement in productivity and scrap and all the operational measurements throughout our manufacturing facilities. And that continues to help on the cost side of margin.

Secondly, we’ve pointed out that in some cases, margin gets a little bit of a help. You’ll recall that in prior calls we’ve talked about the lag effect of pricing catching up with lead. And clearly in this case we get a little bit of help as lead comes down, and those lags work in our favor. Particularly in the case of Transportation Europe I would mention that there is clear evidence that we have some decline in volume as some of the customers waited for those escalators to bring offer pricing down in the market.

And the fact that that’s a bit of a time shift if you will, Craig, is borne out by the extremely strong order activity and shipping activity that we had in the month of July. And I would point out that as you have seen us act in North American Transportation and as you’ve seen us act in our Industrial segments as we rationalize our customers and pick the best partners with whom to do business, you’ve seen that the margin improves and we get a little bit of volume erosion as we go along.

Also lastly I’d point out you’ve seen that we took some provisions in Australia from a tax standpoint. It continues to be a very aggressive market. This was led by much of this sort of slide in margin compression was led by some unscheduled maintenance requirements that we had in our New Zealand smelter, which caused us some down time. Secondarily required us to go out and buy some cores on the open market, driving up the cost of raw material into the Asian Transportation business.

So those are the major factors that have had both positive and negative impacts in the margin, an area that we work on nonstop.

Craig Irwin – Merriman Curhan Ford & Co.

If we could move on to the Free Cash Flow, $44 million of Free Cash Flow again is very strong, tremendous share of your improvement there. But a couple things I noticed were inventory was up $34 million quarter over quarter and the payables were down $47 million quarter over quarter. My understanding is that the next quarter’s typically also a seasonally weak quarter. Is there anything going on on the inventory side that would necessitate a build there? Or was this just opportunistic purchases?

And then on payables, I mean I know you’ve got to be earning a low rate on your cash but was there a benefit to you in paying down your payables at this time?

Phillip A. Damaska

Let me try to address that. Going from an inventory perspective we have seen a unit build, which is consistent with our seasonal nature of our business as we build product in advance of the selling season. I think it’s safe to say that in Transportation Europe rest of world in particular as we saw some volume drop, we didn’t react as quickly as we might, maybe should have in bringing those units down.

We think we’re certainly very well positioned from a unit perspective in both of our Transportation businesses as we enter the second quarter, which should allow us to keep fill rates at very good levels and therefore potentially provide some opportunities. As it relates to payables a big part of it, and it’s in excess of $20 million, was really the result of the timing of Spanish payments under what’s termed [Pogris].

It’s an electronic means of paying vendors on a schedule basis and at the end of fiscal ’08, the March 31, ’08 period that scheduled Pogris payment of in excess of $20 million was actually made on April 2 as scheduled, and in the current quarter that normal scheduled payment actually hit in the quarter. So we’re certainly not troubled by what we saw. We’re obviously very pleased with our Free Cash Flow results and with the comments that I’ve made in respect to inventory and payables, we certainly are fairly bullish with what might present itself for the second quarter as well.

Craig Irwin – Merriman Curhan Ford & Co.

Just touching on your comments about the capacity addition, would you be able to give us a little more color as far as maybe what geography or business line you’re adding capacity in? And really the rationale for adding capacity there at this time?

Gordon A. Ulsh

Well, a couple of points; one, I don’t want to give a lot of detail on geography on products specifically, but there are certainly newer technology batteries that go in some micro hybrids especially you would read about some of the new applications with called Start Stop Technology in Europe, our AGM of stored plasmat battery is particularly suited for that application as we see more and more car makers growing.

So that’s one area of growth in our product line. We also see some particular chemistry increase in North America. So it’s very targeted. It’s in the markets where we see growth, both in product demand and in margin opportunity.

Craig Irwin – Merriman Curhan Ford & Co.

I noticed you mentioned $2 million you’re going to invest in one of your recycling plants related to a furnace upgrade. Is this one of the facilities that’s either out or has been out recently? Or is this something that’s going to happen in a turnaround in the quarter?

Phillip A. Damaska

It’s actually in another facility that wasn’t affected by that impact. But let me point out that we don’t have any facilities that are out today. I think the facilities or the point that you make as I talked to you before, we had a facility down in New Zealand having to do with a stack replacement.

We also as you might have seen on the wire services had some reduced output in our facility in Vernon, California. That kind of grew out of some disagreements between the Air Quality Board and ourselves. We received some notification of violation, which we don’t think we did. We worked on some other improvements and have them back to full capacity for well over a month. But these are improvements in both feed of stock and the handling of the feed stock through the furnaces.


Your next question comes from Oliver [Corlet] – R.W. Press Bridge and Company.

Oliver [Corlet] – R.W. Press Bridge and Company

I wonder are you going to tell us this quarter what your open market sales and tolling proportions were?

Gordon A. Ulsh

No we typically don’t do that. I would tell you just sort of in broad terms we have used the call it roughly 6 and 8% ranges of tolling and open market sales. As I mentioned previously, we had some down time in our California smelter and during that period, I’ll be candid, we had some lowered sales in the market where we consumed internally a greater percentage of our share. But it’s not certainly outside of that band.

It would be little bit lower. I just don’t have the actual numbers in front of me. But it would be below both in third party sales and maybe more traditionally around the tolling number. That’s really where we have any sort of watch in revenues in the outside sales, Oliver.

Oliver [Corlet] – R.W. Press Bridge and Company

I suppose the network FCC back up regulations, my understanding was that that was going to be challenged; it wasn’t a slam dunk that it was going to go through. Do you have kind of any color that you could give us on that?

Gordon A. Ulsh

Well we know there is still a challenge – a legal challenge to the specifics of that number, whether it’s a seven or an eight hour type, but there clearly a drive on the part of the wireless customer to preserve and increase both the reliability of that back up and the term of the agreement.

So while we can’t say that there’s any specific number of hours that are going to be required to bring that back up up, there’s a noticeable trend of both improving the technology of the battery in the cabinet and increasing the hours. But you’re right there’s still some of a challenge going onto that.

Oliver [Corlet] – R.W. Press Bridge and Company

Do you have any idea what kind of market opportunity that is in terms of total market if there’s some reasonable compromise reached on that deal?

Gordon A. Ulsh

No. We’ve tried to do some back of envelope things about which manufacturer moved, but it’s still kind of open enough in terms of what the number would be and what the chosen approach, and whether that’s another battery sort of in parallel with it, or it’s an upgraded new chemistry. So it’s premature. We sort of have said in the past that until that gets warmed up it’s not a huge definable opportunity for us.

Oliver [Corlet] – R.W. Press Bridge and Company

And could you give us some idea of what the proportion is in your industrials sector between network and other uses or motive in North America and Europe?

Gordon A. Ulsh

We’ve not really broken out the industrial and the automotive piece in terms of shared, traditionally have not done that. As I’ve said to you on both sides of the shore we’re seeing less growth on the motive than on the back up but we’ve not broken out those segment shares.

Oliver [Corlet] – R.W. Press Bridge and Company

You used to break it out a few years ago. Has it changed substantially since say three or four years ago?

Edward J. O’Leary

I don’t think so from a volume standpoint. But you know as you look at a percentage we’ve seen a lot of growth to Gordon’s point on the network side, both with telecom as well as for back up power with data. That is a growth segment for us, is on the network power side.

Oliver [Corlet] – R.W. Press Bridge and Company

You talked a little bit about your R&D, can you give us some idea of what the magnitude of your R&D is? And how much the expansion is going to add to your expense lines in the next few quarters?

Gordon A. Ulsh

Well we’ve not broken out the percentage of what R&D is. I think what we have said is we intend to double it and we said that from a headcount standpoint we will nearly double the headcount with the addition of the 60 people. And our focus is clearly on one, leverage in the long way there is to run with lead acid chemistries and you will see that there are new and discreet additions on other technologies and combination technologies. Think about lead acid batteries and capacitors, think about other chemistries in lead acid. But I would go back to what we said before. We’re on track to double this.

Oliver [Corlet] – R.W. Press Bridge and Company

You noted that the lag is helping you on your pricing right now. How long is that lag on average and do you anticipate that’s going to continue for the next quarter or two? Or what’s the dynamic there?

Gordon A. Ulsh

Well as we’ve said in other public calls, in North America we have the OE’s on escalators, so we would see some of that business that trends down. Not a threat to margin, by the way, but it would trend down in terms of revenue. In Europe we have both a sizeable portion of the automotive business and industrial business on escalators. Most of our OEM industrial business is on quarterly escalators. And very much of our significant after market business is on monthly escalators.

So while we’ll see some decline, most of those quarterly escalators are on calendar quarters so they tend to be rolling off, and as we said there’s less lag and less sort of carry over, positive or negative, on the transportation. We don’t see that as a threat in terms of continuing to improve the business going forward.

Oliver [Corlet] – R.W. Press Bridge and Company

How much of your business as a percentage is on escalators roughly? And on the other hand is that an entirely negotiated process or how does that work?

Gordon A. Ulsh

Well on most customers, and I don’t think we’ve ever said exactly what the total is, we’ve probably been more direct in terms of the industrial business in Europe. Virtually all of our OE business around the world is on formal escalators and yes they are negotiated, on a customer by customer basis.

Oliver [Corlet] – R.W. Press Bridge and Company

But they’re negotiated when, Gordon? They’re not negotiated every time you have a price increase?

Gordon A. Ulsh

No, no, no, you don’t. You negotiate the escalator and then you have an automatic adjustment of that pricing based on the escalator. But you do – you can’t really legislate it by the market segment. You need to get concurrence. And there is sort of a trend in the industry that ourselves and other manufacturers are sort of embedded in right now. The transportation business is more based on monthly kind of pricing adjustments. We have less formality in escalators. That’s true both in North America and Europe.

But I would say in general well over half the business is in some sort of formal structure. And the other is less formal called escalator but well understood in terms of our need to modify pricing for both lead and other commodities.


At this time there are no further questions.

Gordon A. Ulsh

Well thank you Brandy and thanks to all participants in our call. We’re certainly pleased with our continued improvement in the business. As you know we have a long way to run in terms of continued opportunity to improve on the business and we think we’re working on the right things. And I think with that Brandy you can disconnect the call. Thank you again.

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