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spk06: Ladies and gentlemen, thank you for standing by, and welcome to the Q3 of 2021 NRSA's earnings conference call. At this time, all participants are in a listen-only mode. After the speaker's presentation, there will be a question-and-answer session. To ask a question, you will need to press star 1 on your telephone. Please be advised that today's call is being recorded, and if you need any assistance during the call, press star 0. I would now like to hand the conference over to your speaker today, Mr. David Schaefer, President and CEO. Thank you, and go ahead, sir.
spk00: Thank you, Don. Good morning, and thank you for joining us for our third quarter 2021 earnings call. On the call with me this morning is Mike Schmidlein, our CFO. Last evening, we posted slides on our website that we will be referencing during the call this morning. If you didn't get a chance to see this information, you can go to the webcast tab in the investor section of our website at www.annersys.com. I'm going to ask Mike to cover information regarding forward-looking statements.
spk05: Thank you, Dave, and good morning to everyone. As a reminder, we will be presenting certain forward-looking statements on this call that are based on management's current expectations and views regarding future events and operating performance and are subject to uncertainties and changes in circumstances. Our actual results may differ materially from the forward-looking statements for a number of reasons. Our forward-looking statements are applicable only as of the date of this presentation. For a list of factors which could affect our future results, including our earnings estimates, see forward-looking statements included in Item 2, Management Discussion and Analysis of Financial Condition and Results of Operation, set forth in our quarterly report on Form 10-Q for the fiscal quarter ended January 3, 2021, which was filed with the U.S. Securities and Exchange Commission. In addition, we will also be presenting certain non-GAAP financial measures. For an explanation of the differences between the comparable GAAP financial information and the non-GAAP information, please see our company's Form 8K, which includes our press release dated February 10, 2021, which is located on our website at www.entersys.com. Now let me turn it back to you, Dave. Thanks, Mike.
spk00: Our third quarter reflected strong demand for our products and services, with order trends accelerating during the period. The strength of our business was even more impressive considering the ongoing headwinds created by the COVID-19 pandemic, which continued to disrupt economic activity around the world. We have been able to maintain cohesion throughout the NRCSIS workforce despite a number of positive, symptomatic, and close contact cases among our employee base. Those cases can lead to disruption in daily production schedules as workers are sent home in order to comply with COVID-19 protocols. NRCS continues to emphasize social distancing, hygiene, the use of masks, and reminding our employees to follow the same guidelines in their personal activities, which has helped to mitigate the impact compared to many companies, but we have not been immune. Despite the ongoing challenges caused by COVID-19, the demand for Anderson's products was clear during the period as we reported strong third quarter fiscal 2021 adjusted earnings of $1.27 per diluted share, which included a 10-cent benefit from the settlement of our claim related to the September 29 fire in our Richmond, Kentucky facility, less 3 cents per share in foreign currency losses. Energy systems benefited from telecom-driven 5G growth in the Americas, and our mode of power business saw marked revenue and earnings improvement over the second fiscal quarter. Our specialty segment continued its positive momentum in our third quarter, bolstered by our growing transportation backlog. Please turn to slide three. I'd now like to provide a little more color on some of our key markets, but before I begin, I would like to comment on how many of our customers across all of our lines of business have signaled increasing demand and alerted us to be ready. There seems to be pent-up demand, which should accelerate near-term growth. Our largest segment, energy systems, has struggled in recent quarters from slow broadband orders. the MSOs had focused on increasing node capacity for their work-from-home demand. Those MSOs have now resumed strong orders for our products, which increased their network's power capacity. Even more encouraging, MSO participation in recent wireless spectrum auctions and their enunciation of their intention to carry their 5G and 4G traffic on their own networks validates the broadband growth assumptions of our alpha acquisition strategy. Telecom 5G growth is also accelerating in the Americas, confirming their commitment to invest in their networks to increase capacity and reliability. Our 5G small cell powering project collaboration with Corning is progressing even better than we had hoped. In this quarter, we believe the network investment in 5G has, for the first time, surpassed the existing 4G network spend. It is also encouraging to see data center markets improving. In addition to our traditional businesses, renewable energy markets continue to expand with incredible opportunities for storage applications. The new administration has clearly focused on this emerging market. We plan to respond by updating our product offering using the same modular approach from our other lines of business. We will share more specifics with you on how we will participate in renewable energy storage and EV charging in coming calls. When you consider forklifts, we are currently the leader in charging electric vehicles globally, and this technology is easily transferred. Lastly, we are beginning to see the positive impact of the global alignment of the energy systems organization as we leverage regional expertise and key account development. Please turn to slide four. Our motive power business showed considerable improvement in the period compared to the second quarter, delivering higher sequential revenue and operating earnings. Our order rates have surpassed the pre-COVID levels of a year ago, despite sporadic pandemic-related restrictions, particularly in EMEA. The Hagen Germany restructuring is ahead of schedule and forecasted to beat its budget. Although those restructuring benefits have not yet impacted our earnings, they will grow in magnitude throughout calendar year 2021, reaching nearly a $20 million annual run rate by the end of fiscal year 2022. Another exciting development is the launch of our Nexus ion lithium-motive power batteries. Several OEMs continue to accelerate their adoption of this chemistry, and our sales team is focusing efforts for Nexus ion products on the portions of the market with the most demanding duty cycles. Please turn to slide five. The third segment of our business, specialty, maintained its positive momentum with another strong quarter, which was slowed only by the ongoing impact of COVID on our capacity ramp, thereby delaying our ability to meet surging demand. Our transportation backlog continued to grow as we added a significant number of customers to the Odyssey channels. We currently are working with nearly every major player in the aftermarket distribution channel, along with many key truck OEMs and fleet operators. TPPL gained further traction in the quarter. The high-speed line is up and running, and we are adding a second shift to our Springfield plant and bringing on additional oxide and pasting capacity. We're also encouraged by several new awards in our aerospace and defense business. Before wrapping up, I'd like to take a minute to talk about some exciting advancements we've made on the technology front. We mentioned our lithium launch for Motive Power. Our customers have begun to order our new Nexus Ion products, and initial customer feedback is very positive. We have also achieved our first OEM approval and continue to work with other material handling manufacturers. The demand for fully integrated products has significantly increased for our energy systems group. To ensure necessary product development keeps up with the market's pace of change, we are aggressively hiring engineers. Our emphasis is on telecom, home, and industrial energy storage. Moreover, we are accelerating the development of high voltage electric vehicle fast charging stations using batteries to speed the process. A considerable number of the building blocks have already been developed for our material handling program, allowing extension into these new markets with substantial growth potential. Our ability to stay on the cutting edge of new technology development while continuing to leverage core lead acid products will further enhance our competitive edge in the quarters and years ahead. Please turn to slide six. In conclusion, I continue to be humbled by our employees' ability to deliver in the face of the ongoing global pandemic, quickly adapting to unforeseen challenges by remaining focused on delivering the products and services our customers have come to expect. Our overall strategy remains unchanged. One, to accelerate higher margin maintenance-free motive power sales with Nexus Ion and Nexus Pure. Two, to grow the portfolio of products in our energy systems business, particularly in telecom, with fully integrated DC power systems and small cell site powering solutions, which will accelerate our growth from 5G. Three, to increase transportation market share in our specialty business. And finally, to reduce waste through the continued rollout of our EnerSys operating system. As we continue to execute on each of these initiatives, the strength of the Enersys platform, and our position as the global leader in stored energy solutions will drive additional long-term value for our shareholders for years to come. With that, I'll now ask Mike to provide further information on our third quarter results and fourth quarter guidance.
spk05: Thanks, Dave. For those of you following along on our webcast, we've provided information on slide seven for your reference. I am starting with slide eight. Our third quarter net sales decreased 2% over the prior year to $751 million due to a 3% decrease from volume net of a 1% increase from currency. On a line of business basis, our third quarter net sales in the mode of power were down 4% to $304 million, while energy systems net sales were down 2% at $337 million, while specialty increased 7% in the third quarter to $109 million. Motive Power suffered a 5% decline in volume due to the pandemic, net of a 1% increase in FX. Energy Systems had a 4% decrease from volume, net of a 2% improvement from currency. Specialty had a 6% in volume improvements and 1% increase from currency. There were no notable changes in pricing, and we had no impact from acquisitions. On a geographical basis, net sales for the Americas were down 1% year-over-year to $499 million, with a 1% decrease from currency. EMEA was down 4% to $194 million on a 9% volume decline, net of a 5% improvement in currency, while Asia was flat at $58 million. Please now refer to slide 9. On a sequential basis, third quarter net sales were up 6% compared to the second quarter driven by volume improvements. On a line of business basis, specialty increased 5%, with Northstar continuing to contribute its capacity for transportation sales, and motive power was up 15% as it rebounds from the pandemic, while energy systems was down 1%. On a geographical basis, America's was up 4%, EMEA was up 13%, and Asia was up 4%. Now a few comments about our adjusted consolidated earnings performance. As you know, we utilize certain non-GAAP measures in analyzing our company's operating performance, specifically excluding highlighted items. Accordingly, my following comments concerning operating earnings and my later comments concerning diluted earnings per share exclude all highlighted items. Please refer to our company's Form 8K, which includes our press release dated February 10, 2021, for details concerning these highlighted items. Please now turn to Slide 10. On a year-over-year basis, adjusted consolidated operating earnings in the third quarter increased approximately $15 million to $78 million, with the operating margin up 210 basis points. On a sequential basis, our third quarter operating earnings improved 12 million or 110 basis points to 10.4%. We settled our claim for the Richmond Fire, which resulted in a $6 million benefit in the quarter. $4 million was a gain on the replacement of equipment reflected in operating expenses from the property policy while $2 million was a final recovery on the business interruption policy and is credited to cost of sales. Operating expenses when excluding highlighted items were at 14.8% of sales for the third quarter compared to $16.4 million in the prior year as we reduced our spending by $15 million year-over-year and by 100 basis points sequentially. Excluded from operating expenses recorded on a GAAP basis in Q3 our pre-tax charges of $22 million, primarily related to $6 million in alpha and north star amortization, and $12 million in restructuring charges for the previously announced closure of our flooded motive power manufacturing site in Hagen, Germany. Excluding those charges, our motive power business achieved operating earnings of 13.3%, or 330 basis points higher than the 10.0% in the third quarter of last year, due primarily to the insurance claim recovery of $6 million described earlier. On a sequential basis, Motor Power's third quarter OE also increased 420 basis points from the 9.2% posted in the second quarter, due primarily to sequential increases of nearly $5 million in recovery of the business interruption and other proceeds from the Richmond fire. OE dollars for motive power increased nearly $9 million from the prior year despite lower volume due to its lower operating expenses and $6 million in insurance recovery, while OE increased $16 million from the prior quarter on higher volume and $5 million or more in insurance recovery. The Richmond fire damage, which is since been repaired or replaced, and now a more capable, safer facility is in operation. Please see our 10Q for more specifics on cash received and related accounting. Meanwhile, energy systems operating earnings percentage of 7.4% was up from last year's 6.3%, but down from last quarter's 8.8%. OE dollars increased $3 million from the prior year, primarily from lower operating expenses. but decreased $5 million from the prior quarter on lower volume and higher operating expenses. Specialty operating earnings percentage of 11.9% was up from last year's 10.1% and up from last quarter's 11.4%. OE dollars increased nearly $3 million from the prior year on higher volume and lower operating expenses while increasing $1 million from the prior quarter on higher volume. Please move to slide 11. As previously reflected on slide 10, our third quarter adjusted consolidated operating earnings of $78 million was an increase of $15 million, or 23% from the prior year. Our adjusted consolidated net earnings of $55 million was nearly $11 million higher than the prior year. Improvements in the adjusted net earnings reflect the rise in operating earnings, net $3 million in foreign currency losses, primarily on unfavorable rate changes on intercompany borrowings. Our adjusted effective tax rate of 17% for the third quarter was slightly higher than the prior year's rate of 16%, but in line with the prior quarter's rate of 17%. Discrete tax items caused most of these variations. Fiscal 2019's full year rate was 17%, while our fiscal 2020 rate was which is consistent with our current expectations for fiscal 2021. EPS increased 22% to $1.27 on higher net earnings. We expect our final quarter of fiscal 2021 to increase slightly, the outstanding shares to increase slightly from the third quarter as higher share prices increase dilution from employee stock programs. As a reminder, we still have nearly $50 million of share buybacks authorized, but have no immediate plans to execute any repurchases, with perhaps the exception of the modest annual repurchase made to offset employee stock plan dilution. Our recently announced dividend remains unchanged. We have also included our year-to-date results on slides 12 and 13 for your information, but I do not intend to cover these in detail. Please now turn to slide 14. Our balance sheet remains strong, and we are well positioned for us to navigate the current economic environment. We now have nearly $489 million of cash on hand, and our credit agreement leverage ratio is below 2.0 times, which allows over $600 million in committed additional borrowing capacity. We expect our leverage ratio to remain below 2.0 times for the balance of fiscal 2021. We generated over $218 million in free cash flow through three-quarters of fiscal 2021. Our Q3 free cash flow generation was very strong at $41 million despite the drag of rising working capital from increased revenue. Capital expenditures year-to-date of $54 million were at our expectations. Expectation for fiscal 2021 of $75 million has expanded again slightly as the economic outlook improved. Our major investment programs, those being the lithium battery development, continued expansion of our TPPL capacity, including the Northstar integration. The integration of our high-speed line and the transition of Northstar products for European markets to our French factory are all progressing as planned. Our high-speed line has completed its commissioning and is expanding to its second shift this month. Even with these investments, we have also retained the agility to flex our manufacturing footprint as needed. Our closure announced last November of our Hagen, Germany facility has progressed better than our expectations in terms of speed and cost. We believe we will begin enjoying about half of the expected $20 million per year of savings next fiscal year with the full benefit thereafter. We anticipate our gross profit rate to remain near 25% in Q4 of fiscal 2021, as lower utilization in some of our factories over the holidays and from enhanced COVID restrictions will impact our P&L in Q4. We have initiated price increases in our fourth quarter to mitigate the rising costs of many of our non-lead inputs, which should maintain our margins. As Dave has described, we believe motor power markets are recovering while our energy systems and specialty markets continue to have bright prospects. With some of the uncertainty from our election and the pandemic behind us, we currently feel we have enough visibility to provide guidance in the range of $1.25 to $1.31 in our fourth fiscal quarter. Now let me turn the call back to Dave.
spk00: Thanks, Mike. Don, we can now open the line for questions.
spk06: Thank you. And as a reminder, to ask a question, you will need to press star 1 on your telephone. Again, there is star and the number 1 to ask a question. And please stand by while we compile the Q&A roster. Thank you. Our first question is from the line of Mr. Noah Kay from Oppenheimer. Your line is now open.
spk04: Good morning. Thanks for taking the questions. So, you know, getting back to being capacity constrained here following this rapid recovery in demand, Can we dimension the impact of those constraints on revenue currently? What was the revenue shortfall in the quarter? You know, what is kind of the shortfall that you envision in 4Q? And clearly, you know, you've mentioned transportation as one area, but can all of us understand where these constraints are really coming in?
spk00: Right. Hi, Noah. This is Dave. We've got a record backlog right now, and it should have been a record, or 4Q should definitely have been a record quarter, but we haven't gotten the train fully back going. A lot of it's upstream on the supply chain side. Some of it's and training and productivity related. You know, we've mentioned prior, we feel like we're about a quarter behind on our HSL ramp, so that is impacted. And so I think that I don't, you know, I guess, Mike, you can dimension for NOAA what you think the shortfalls were, but NOAA, it's absolutely... The other part of your question is it's mostly a TPPL issue, and as noted, all three businesses sell TPPL. And I think the largest portion of the backlog is probably the transportation sector. Right, Mike?
spk05: Yeah. So, you know, Noah, we expect to have a sequential improvement in our top line compared to the third quarter. of about $60 to $70 million. So that would be the step up. Now, that higher number for Q4 is still about that same amount as the amount by which we're missing our originally pre-COVID budgeted amount. So you can kind of see we're kind of making up half of the progress of where we wanted to be. In terms of the overall capacity, On TPPL, you know, we feel like we're somewhere in that $700 to $750 million with the high-speed line at its full operating, you know, 24-7. That should add about $150 to $200 million to our top line. So that would reset somewhere just $850 to $900 million. And then to the billion-two that we've spoken to in our analyst call, that's in CapEx expansions that will go on throughout our fleet of five factories that produce TPPL, so they will be all incremental bottleneck directed to try to expand each of those networks or factories over the next three years.
spk00: Yeah, and Noah, just as a reminder, those CapEx requirements have been communicated in that roughly $100 million a year of CapEx need we need going forward. That includes that TPPL expansion, further expansion.
spk04: Okay. Very helpful. And then on a related point, you mentioned in your prepared remarks, but just understanding the North Star integration progress, can you update us on where you're at in terms of having product qualified with all the relevant customers and how soon we can start to see really some of the logistics savings, the freight savings coming into the P&L as you kind of optimize your production to distribution footprint.
spk00: Yeah, well, we just had a great global ops review with Patrice and his whole team a week and a half ago, so we got a pretty good update on all the factories. We got a big certification in the French factory IETF, so that allows us to move some of the OEM volume that was being exported from the North Star Springfield factories, We're now in a position to start manufacturing that in France, which is a big piece part. We've qualified the alpha cell, which is a high-volume block that we were currently making in France. We've now qualified that on the high-speed line. So all those pieces we had talked about as part of the deal logic and the synergies are as you probably are insinuating, are behind the acquisition schedule largely because of COVID and the delays with the high-speed line. Most of that is on track. Mike mentioned we're hiring a second shift. Third quarter, I think the team was very frustrated. There was still trouble getting folks hired. We were still kind of wrestling with some of the COVID benefits and motivating people to come back to work. The ice seems to have broken a little bit, and we've been adding some folks now. So that situation is getting there, but obviously our inventories are way too low on the finished goods, and we're in a little bit of a hole right now. We're working very hard to get caught up. And, yeah, so I'd say I'm very pleased, you know, with the SOX, you know, getting that SOX qualified on the accounting side. I think we've hit most every mark on the North Star deal other than just being delayed because of COVID.
spk05: And I guess, no, I would just throw in, you know, the transition of the Daimler product, that was made in Springfield, Missouri to Arras, France, you know, depending on the volume we do with that customer, should benefit us $5 million to $10 million a year. And as Dave mentioned, the transfer of EnerSys product that was now being made in the Springfield factories of Northstar should help eliminate – we've had a $4 million to $5 million per quarter drag from those two factories – in their manufacturing variances. And as we put volume in there, TPPL demand in there, we would expect that, you know, those variances to eliminate it as utilization improves. So it's a big deal, and it should, you know, it's a big driver of what's going to enhance our margins over the next, you know, two fiscal years.
spk04: Perfect. Maybe I'll just sneak one last one in. You know, Dave, you mentioned in the prepared remarks that you're going to be working on some product development for EV fast charging. You know, we look at this as a significant market opportunity in the coming years, and we're looking at something close to $3 billion of EV hardware opportunity for DC fast charging in the U.S. and Western EU. And so I think it would be helpful, I know you don't want to say too much about it now, but just kind of give us the broad strokes of, you know, when we should think about the company, having a product in the marketplace, and maybe how you might go to market.
spk00: I think what's the most exciting piece of it is how similar the, so the first prototypes are being done this quarter over at the tech center in the building next door. And I've been very pleased with the amount of bill of material similarity that is with a motive power system, for example. There's, you know, the connectors. There's some things in the pedestals for the connecting to the electric vehicle that are a little bit different. But by and large, 100-kilowatt-hour batteries, 100-kilowatt-hour batteries, lithium pack like we're doing for Motive. So it's a natural step for us. And the channels to market are interesting. And there's been a lot of discussions with very large real estate companies, actually. So the interest for this and how these new charging infrastructures are going to roll out will be intriguing. And I think Part of it, Noah, is what we call application stacking, where one, let's call it appliance, can do multiple things. And I think that's what's exciting about these projects, is that same asset can be used for fast EV charging. It can be used for load leveling and demand shifting. It can be used for powering a 5G base station. It's really... It's really unbelievable, frankly, and it's interesting how a few of our real estate, big real estate companies have really locked onto this idea. So, like you said, more to come, but the key message for our shareholder base is that from a technology supply chain, I would say for the last four or five years, we've been building a lot of competency and building a lot of muscle memory and And it's about time we start to flex this. And we want to take, and I've said this since Investor Day and before, we want to take these core competencies of supply chain and engineering and start to push into new adjacent markets. And we're very excited about it.
spk04: Okay, great. We will look for more details on that. And now I'll drop back into the queue. Thanks.
spk01: Thank you.
spk06: And our next question is from the line of Greg Lewis from BDIJ. Your line is now open.
spk01: Yes, thank you and good morning. Hi, Greg. Hi, guys. Just realizing that it's early days and people like me on the finance side always want things to happen a lot quicker than they actually can happen in the real world. But you touched a little on the initial rollout of the lithium-ion battery in motive. And just as we think about that, you know, as you think about it gaining, you know, increasing in customer usage, is there any way to kind of think about how that plays out over the next two, three, four years? And as we think about that, You know, how should we be thinking how that maybe impacts margins on kind of like an annual basis? Is it just, yeah, any kind of color on that I think would be helpful.
spk00: Sure. Well, Greg, you know, what we laid out in our investor day model included a lot of the product migration and product rotation, a lot of the margin improvement. So a lot of that was baked into our investor day model and the assumptions at the time. I don't know that the assumptions have dramatically changed in terms of the rate of conversions or the rate of impact on the margins post-COVID. I think, if anything, just kind of that whole of demand has sort of delayed things from a COVID perspective. But in general, what we have to do, like, you know, the big one was the Hagen factory. You know, that certainly was an expensive endeavor, and it's part of that product rotation that a strong balance sheet allows us to make those right kind of moves. The adding of additional engineering talent with new skills. We've been doing this, you know, for years now, and, again, I think we're going to continue to see those lifts. We also should start to see additional lifts as we can. continue to drive waste out of the organization. One thing I've really pressed my three key line of business leaders on is operating expense. I think COVID really showed these work from home initiatives that we can do things a lot cheaper than we've done historically in terms of travel, entertainment, things in those areas. So there's certainly places to tighten up But in general, I would say most of the assumptions that we see about margin improvement, product rotations, restructuring costs is all reflected in the model. And I think as we communicated the last cycle, Mike, we feel like we're behind schedule as a result of COVID. Yeah.
spk05: And, Greg, I would say to your question on what it's going to do to overall margins, so You know, we would expect we ought to, in this upcoming fiscal year, sell 50 to 100 million in our mode of power products, lithium-based. And, you know, most of the product at current cost is, you know, you're using soft tooling. You have some fairly small purchase quantities. Your assembly teams are going through a learning curve. So as we expand, we would expect the first year, you know, those margins to be fairly modest, actually be a little dilutive to our overall margin profile. But as you expand, cost out in that first year the product. We would expect, obviously, that these are going to be among our higher margin models, but don't expect that in the upcoming year.
spk00: Yeah, I think Greg sort of asked in the long run, but certainly I agree with Mike's point. In the near term, there's going to be some growth pains in terms of margin impact, and that's reflected in our model.
spk01: Okay, perfect. And then you touched on it briefly in the prepared remarks. It seems like it's something that's really gaining momentum as we think about energy storage. You kind of laid out maybe opportunities in residential, telecom, energy. Is there any kind of, I guess two questions in there, is there any way to think about stacking those opportunities where where do we think Is telecom going to be the initial opportunity and maybe energy is the opportunity longer term? Is there any way to think about how each of those is going to perform over the next few years? And just on the back of that, as you think about that opportunity, clearly with the acquisition in 19, the deleveraging of the balance sheet, clearly you guys are an opportunity once again to bolt on you know, things that might be needed to kind of, you know, really plant the flag in these various sectors. Just kind of curious, you know, how you're thinking about, you know, the opportunity in energy storage.
spk00: Right now it's really a question of going after the right targets because it's such a target-rich environment. As Mike mentioned earlier, We think the change in administration is only going to improve the prospects for these opportunities. We think that the key, as I mentioned earlier to NOAA, is the ability to application stack these devices so there's multiple value streams that are created. And I feel very confident that the technology piece is well within our core competency. Now, as you expand into like Resi and you push into some of these kind of utility interconnects, there are some software elements where a tuck-in or something might make some sense. And we're working on those issues every day. So the software component of the business is increasing significantly. as part of the needs here. On the hardware side, I think we're really well positioned. We do need to add some expertise on software, but I really like this space. I think during the Obama administration, this same team in a lot of ways wanted to do some of these things. It just was too early. The technology wasn't ready. But all these years later, I think now, we're in a much better position to do things as the costs have come way down on battery energy storage in general.
spk01: Okay, and so when you mentioned earlier about the engineers, I guess it's safe to assume that a lot of those positions are potentially or probably for software.
spk00: Yeah, the software piece, the firmware piece, for sure. That's a big part of it, and as our needs, as we push deeper into these areas, that will be more and more of the mix of people we're hiring is on the software side.
spk01: Perfect. Hey, thank you very much for the time. Super helpful.
spk00: Thank you.
spk06: And our next question is from the line of Brian Drubb from William Blair. Your line is now open.
spk03: Hey, good morning. Hi, Dave. How am I?
spk04: Hi, Brian. Hi.
spk03: Just the first question, you know, there's a lot of moving parts here in terms of the capacity constraints and the need to push through some price. You're taking out costs, closing facilities. If I remember correctly, you know, we were at the analyst day about a year and a half ago talking about marching toward 28% to 30% gross margin, and we're at around 25% now. as you look to fiscal 22, you know, and you move past the capacity constraints, put through some of the price, you get the costs out, you know, what is a reasonable expectation? You know, can you get 200 basis points of gross margin in the next fiscal year? And also you have volume coming back, I guess, as well, or is it 100? You know, where do you think gross margin could be in fiscal 22?
spk05: Well, you know, we still feel like that margin expansion will happen. The pandemic and the restrictions from that is something of a wild card that I can't speak for, but to all the points you just mentioned of getting capacity up, that's, you know, the drag that the North Star factories have been on us. The overall capacity that will improve across all of those items, the benefits of $20 million not all recognized next year, but the rest of it, you know, we kind of estimated about $10 million of benefit from Hagen next year and $20 million thereafter. So all of those are the things that should drive it, including, you know, as we need to, you know, adjusting our pricing for any changes in freight or commodity inputs, et cetera. So, you know, I would say And there are, you know, you've got to caveat it with some of the uncertainty in this world. But that margin expansion should be, you know, it should be 100 to 200 basis points by the end of next fiscal year. So we ought to exit 2022 100 to 200 basis points higher than where we are today.
spk00: Yeah, I'd say the biggest – and Mike ticked off most of the, you know, the volume absorption – getting some of this COVID-related volume reductions, FIFO through the P&L hog. And I think the biggest headwind that the finance team has been flagging going into F-22 is the tariff and freight side. So freight rates are still a pressure point. Some of the tariffs have gone from 10% to 25%. That's a very time-consuming part of Our procurement team right now is moving things around and changing suppliers. And that's been a nightmare, frankly. But we just do what we have to do. But anyway, that's the biggest. But most everything, and like we are trying to get ahead, like we said, on the commodity pressure with some price increases. So... I think Mike's numbers are very reasonable. Okay.
spk03: I really appreciate that detail. And then, you know, one, one of the topics that, you know, I've been getting calls on for feels like 10 years now with respect to NRCIS is lithium. You know, the, the, the threat of new competitors, uh, producing lithium batteries for forklifts and, um, I just wanted to, again, kind of check in with you in a public way today on how that competitive landscape is looking to you. My understanding is that still today, less than 5% of forklifts are shipping with lithium batteries. Maybe it's a little more in Europe than it is in North America, but globally, somewhere around that 5% or less range is and you've got a lithium product now, you know, who are the competitors that you're seeing the most in the marketplace? And are you seeing some of the, you know, are you feeling increased pressure to have a lithium product because some of these forklift OEMs are partnering? You know, there's always been these partnerships that have been developing across the industry between the OEMs and some, you know, generally kind of startup lithium battery companies. suppliers?
spk00: Well, it's a great question. I think that Asia, especially the China market, is the furthest ahead on lithium. I think part of that is because BYD is both a battery company and a forklift company, and they use lithium iron phosphate technology. So I would say the percentages have moved higher than where you're at. It's... and our Nexus Ion product is well-positioned to participate. I think one of the things you have to think about is this whole make versus buy in terms of how easy it is for these forklift companies to get into the battery business. That's a real serious question, and the objective for me and my team is to, to make that decision real easy, that our products are going to be better, safer, cheaper, and readily available to try and protect our share, grow our share, grow our margins. And we're having success. And the other piece to it is... the maintenance-free is what a lot of these customers want, and our Nexus Pure, which is our TPPL variant, also fills a lot of those or checks a lot of those boxes as well. So we feel like between our new Nexus Pure and our Nexus Ion products, we have a very compelling option as people want to push their into more of these maintenance-free solutions. The percentage of lithium in the marketplace, I don't have a clean number like I do with lead because of industry associations and so forth. But it's pushed past that 5% number globally for sure. And we're going to participate. We're going to be there. And we're going to be the only supplier out there that carries traditional flooded lead. Nexus Ion and Nexus Pure maintenance-free products. Mike, do you want to add anything?
spk05: Yeah, I just think, Brian, when you think about market penetration, you have to think of the size of the vehicles, and they have a much higher penetration in the Class III vehicles where those vehicles that the operator walks alongside, so the counterbalance weight is a little bit different. They don't need to be heavy. So Even though those are Class III trucks are the most numerous, that's not, in terms of battery sales, it's not necessarily where the money is. So I would say you're higher in penetration, Class III, less so in I and II.
spk00: Yeah, but the market is moving to maintenance-free. We're moving with the market. And in terms of the competitive landscape you mentioned, there's really two sets of Principally, there's been a lot of small startup companies that have tried to compete, and that's not always easy in terms of costs and balance sheets. And then there are some of the big OEMs like Heinrich that have tried to do their own organic programs. And, again, it's incumbent on us to offer a better mousetrap and to do it more effectively, so it's easier for the OEMs to use our products integrated into their trucks, and that's what we're trying to do every day.
spk03: Okay, thanks. I'm just processing that and thinking, you know, you started, Dave, by talking about Asia. I mean, your share in Asia, if my memory is correct, is more around the mid-teens range, and in the Americas and motive, it's over 50%, I think, and You know, Europe is, you know, in the 40% range, I believe, or maybe mid-30s. And, you know, and then the large trucks is where the money is, as you just said. So, you know, overall, you know, if you just look at Americas and Europe, can you even ballpark, you know, what percentage of the market that's important to Enersys is now shipping with lithium versus lead acid?
spk00: You know, I can speak to the lead piece. So the lead markets and the demand are still robust and healthy in the U.S. market and in the European market. I would also say, you know, lithium is coming off of a very small base. So their growth potential or their growth rates are obviously super, double, triple, but coming off a small base. And so in terms of the loading, the margins, and all, we feel like a lot of that, as best as we could do, we baked into our Investor Day model. And that's the best answer I can give you. And I don't have, I really don't have good statistics like we do with lead for how many lithium batteries are out there. But in terms of our lead battery business, And the demand for our lead batteries, it's still very – it's normal. And I would think, based on a lot of the information we're seeing from our customers, that there's some pent-up demand from earlier in, let's say, the spring of 2020 when all the factories got shut down.
spk03: Okay. And then just the last question, probably for Mike. I just want to be clear on this. I think I heard you say that sequentially – revenue should improve in the fourth quarter, I think you said by $60 to $70 million. And then I'm wondering, as you go to the first quarter of fiscal 22, given that you have this dynamic of maybe capacity constraints lessening, would you expect typical seasonality in the fiscal first quarter where revenue steps down materially, or could it be a situation where actually revenue holds flat or is even up? as you move sequentially from the fourth quarter to first?
spk05: Yeah, I think it's going to be a flatter look than most years. But on the top line, I would expect Q1 won't look tremendously different from Q4.
spk03: And was I correct on the third to fourth you're expecting a sequential improvement? You said that, right?
spk05: Yeah.
spk03: Okay. Okay. Thank you.
spk06: And our next question is from the line of Greg Wasikowski from Weber Research. Your line is now open.
spk02: Hey, guys. Good morning. Thanks for taking our questions.
spk05: No problem.
spk02: I just wanted to revisit the comments on renewable storage. Is it explicitly talking about getting into the resi storage business, or is it something else, maybe like utility scale or something more unique?
spk00: Resi is part of it, and then the other one is commercial industrial, so CNI behind the meter. We've said previously we're looking at systems probably in the zip code of 500 kilowatt hours, plus or minus, and not utility scale. That's a piece that we have not identified in our product roadmap.
spk02: Got it. Okay. Thanks. And then Just kind of thinking about the EV charging and then the resi storage markets, you kind of touched on this earlier, but can you compare and contrast the competitive dynamics in those two markets and maybe just give the biggest hurdle for entering each one?
spk00: I think it's not a well-defined market yet. I think the Biden administration certainly recognizes the criticality of charging and charging infrastructure as part of reaching more carbon reduction targets and getting more vehicles electric. You have to be able to charge them. And we're looking at the portion of the market where folks that are interested in charging very quickly That's really the portion of the market we're most focused in. And we have forklift customers who want the same thing. They want to get the electricity back into the battery pack as fast as possible. So we want to leverage what we've done in the forklift area. and pursue it into the electric car market as well. So in terms of what the capabilities are, you have to have expertise in energy conversion. You have to have packaging, software, balance sheet. It's all the things that we feel like we already bring. In terms of the channels to market, you've seen some MOUs we've done before. with Blink, and certainly we've spoken to other people in this area. But it's still a very – I would say it's still fairly early days, and I don't know that there's a clear roadmap yet as to how this market's going to develop. I think what I said earlier, I think it was Noah, is it's very interesting how the real estate companies are thinking about taking a leadership role in a lot of this development. EV charging area.
spk02: Okay. And one more quick one, if I could. Jumping back to energy systems and 5G, last quarter you said you kind of expect like an accelerated ordering activity in the spring, late spring and into the summer. Just given how quickly things can change nowadays, it seems like that's still the case, but thought I'd check. Is that still the timeline that you're thinking?
spk00: Yeah, we're doing orders are good. And the Corning project is really exciting. They mentioned our collaboration in their call a couple weeks ago. And we're part of their Evolve program. And it's a whole concept of how to deploy fiber much easier for the customer. So it's prefabricated connectors. And our role in that is part of their big cable is embedded some power conductors. And we're using our new systems that allow through that Corning cable to transmit the energy to the base station or power supply like a mile away. And so it's a fantastic project. And Corning mentioned Verizon in their press release. Certainly Verizon is – and this is – tied really to the small cell site ultra-wideband rollouts. And so the timing of that is behind. The orders we're getting today are from customers mostly on the lower spectrum, and really the activity is good on building out 5G radios at more of a macro level. But the ultra-wideband and small cell site is coming probably a little bit later. But certainly we've hit some key milestones on this development. We're very excited about it. And the other thing I mentioned in my prepared remarks, which is not insignificant, is some communications by some of the big cable companies with their intention to go to a quad-play. So they're going to offer wireless communication. of their own, but they want to start to do it over their own networks. Instead of being a mobile virtual network operator, they want to put the data traffic, the radios, the powering right on their existing HFC networks. And that's really in a sweet spot for us. And it was one of the things that attracted us to the Alpha acquisition was the Gateway product family. that provided a DOCSIS-compliant high-speed modem for backhauling 5G traffic in addition to providing the 48-volt power. And the piece to the whole 5G rollout that I think it doesn't get well understood is how much the installation, getting licenses for electrical connections involved, That's a big, heavy part of this, and a lot of these programs we're working on is to try to make the rollout of 5G small cell site easier, faster, and cheaper.
spk02: Okay. Got it. Helpful. Thanks for your time, guys.
spk00: Thanks. Thanks, Greg.
spk06: Again, as a reminder, to ask a question, you will need to press star 1 on your telephone. Again, that is star and the number 1 to ask a question. And please stand by while we compile the Q&A roster. Thank you. And we have our last question from the line of John Franzer from Sidoti and Company. Your line is now open. Thank you.
spk03: Thank you, guys. My questions have been addressed.
spk00: Okay. Thanks, John. Thanks, John. Hey, Don, I don't think there's any more questions.
spk06: All right, there are no questions at this time, sir, and I'm turning it back to Mr. Schaefer. Thank you.
spk00: Well, again, we just want to thank everybody for attending the call today. We look forward to providing further updates on our progress on our fourth quarter and year-end 2021 call in May. Have a good day, everyone. Bye-bye.
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