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spk01: Ladies and gentlemen, thank you for standing by, and welcome to the Q3 2022 InterSIS Earnings Conference Call. At this time, all participants are on a listen-only mode. After the speaker's presentation, there will be a question and answer session. To ask the question during this session, you will need to press star then 1 on your telephone. Please be advised that today's conference is being recorded. If you require any further assistance, please press star then 0. I would now like to send the conference over to your speaker for today. David Schaefer, President and CEO. You may begin.
spk04: Thanks, Tawanda. Good morning, and thank you for joining us for our third quarter fiscal 2022 earnings call. On the call with me this morning are Mike Schmidlein, our Chief Financial Officer, and Andrea Funk, who will be succeeding Mike when he retires next month. Last evening, we posted on our website that 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 Investors section of our website at www.annersys.com. I'm going to ask Mike to cover information regarding forward-looking statements.
spk03: 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, C, forward-looking statements included in Item 2, Management's Discussion and Analysis of Financial Condition Results of Operations, set forth in our quarterly report on Form 10Q for the fiscal quarter ended January 2, 2022, which was filed with the U.S. Securities and Exchange Commission. In addition, we will also be presenting certain non-GAAP financial measures, particularly concerning our adjusted consolidated operating earnings performance and our adjusted diluted earnings per share, which exclude certain highlighted items. 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 9, 2022, which is located on our website at www.enersys.com. Now let me turn it back to you, Dave. Thanks, Mike. Please turn to slide three.
spk04: Enersys delivered another quarter of strong year-over-year growth. with $844 million of revenue, the highest quarterly revenue in our company's history, increasing 12% over the third quarter, 21, driven mostly by volume as well as ongoing aggressive pricing actions. We saw record demand across all of our segments, with Q3 22 orders increasing 30% from the prior year and 33% compared to the same period of pre-COVID fiscal year 20. We also reported third-quarter adjusted earnings of $1.01 per diluted share, which was in line with our guidance. Our energy systems business performed better than expected due to strong product demand, improving price recapture, and excellent fulfillment execution. Motive Power successfully navigated the current environment to deliver impressive results, while strong demand in our specialty business, particularly in EMEA, drove another quarter of segment growth that was limited by our ability to supply. By leveraging our core product and service capabilities and technologies, we continue to develop a pipeline of short and long-term opportunities across the business. Helping to meet that demand, our global TPP output pace increased 10% sequentially with each TPPL factory improving over the prior quarter, while our Richmond, Kentucky, motive power facility continued to perform very well. Our quarter-end backlog increased an additional $160 million in Q3 to an all-time high of $1.2 billion, which is more than double historical levels. Based on positive customer feedback and ongoing industry analysis, we believe we are performing better than our competitors and continue to maintain and, in some cases, grow our market share. In addition, we utilized excess liquidity to buy back $116 million of stock since the beginning of the third quarter, bringing our full-year repurchases to $148 million while maintaining leverage below 2.5 times EBITDA. I'm proud of our employees for overcoming many of the headwinds we continue to face from mounting inflation, supply chain hurdles, and manning issues brought on by the recent surge in COVID variants. We incurred in excess of $30 million, or over 50 cents a share, of sequential incremental cost in the third quarter, the highest quarterly cost increase yet. Despite these challenges, Our teams aggressively offset most of these pressures with additional price increases, component resourcing, and engineering redesign work, which enabled us to achieve our guidance and set us up for the margin expansion in the quarters to come. While the supply chain issues remain, I'm very confident we will continue to adapt and make sequential progress in realizing the true profitability of our business and our financial results. Now I will provide a little more color on some of our key markets. Please turn to slide four. Let's start with our largest segment, energy systems, which continues to see robust demand, with Q3-22 order rates increasing over 54% compared to pre-COVID Q3-20. We saw strong 5G-related demand from several of our largest customers and were especially pleased with positive results in EMEA. Progress also continues with the California Public Utilities Commission grid shutdown extended network backup mandate with the ramp-up starting in Q3 and accelerating into Q4. This momentum should continue well into fiscal year 23, incorporating our lithium technology, and we are confident the solutions we develop for CPUC will be used for similar network resiliency programs. In addition, our strategic collaboration with Corning, which focuses on 5G deployments by simplifying the delivery of fiber and electrical power to small cell wireless sites, is gaining momentum with another large customer who communicated its intention to implement the system throughout its network of small cell sites by late fiscal year 23. We also had a booth at the Intersolar Institute. energy storage conference in January, where we showcased our new Mojave home energy storage system, including our lithium technology battery. It received strong customer interest, including our first tranche of orders that we expect to translate to revenue in fiscal year 23. In addition, I am pleased with our fast charge and storage initiative. We've hired 20 engineers dedicated to this effort, and we have made substantial progress on our software development and customer specification design. We continue to anticipate our first revenues will be booked near the end of fiscal year 23. Despite the positive product demand trends, energy systems' long and complicated supply chain continued to be hit hard by the macroeconomic environment of the third quarter, leading to further freight, lead, and other commodity inflation, as well as component and labor shortages. Although margins were again negatively impacted by MIX, With more project services revenue offsetting higher margin power systems backlog that could not be delivered due to chip shortages, we did see a modest improvement in energy systems margins and are optimistic this trend will continue. We have worked with our customers to reach fair accommodations to defray the explosive cost increases we have incurred. We are seeing the pace of inflation growth decelerate and certain supply chain headwinds ease, and we expect the positive impacts of our mitigating actions, including pricing, engineering redesign, and contract manufacturer onshoring, to be more broadly realized in Q4 and beyond. This expected cost improvement, combined with the many growth opportunities I mentioned, reinforce our positive long-term outlook for energy systems. Please turn to slide 5. Motive Power delivered another strong quarter with over $39 million of operating earnings, which is even more impressive when you consider the segment incurred $15 million of sequential cost increases. Price and mix improvements primarily offset these costs, aided by continued growth in our Nexus lithium ion and TPPL maintenance-free product offerings. We remain the only battery producer to offer both lithium and TPPL in maintenance-free, along with our traditional flooded products. In addition to generating strong financial results in the face of supply chain headwinds, we are continuing to invest in the transformation of our mode of power business. Initiatives include, one, flooded and legacy charger product consolidation as we transition to maintenance-free, two, robotic process automation for order entry, three, customer service self-help portals, And four, solution selling initiatives involving global collaboration on customer case studies supported by more user-friendly sales tools. Overall, we are seeing strong and steady growth in the motive power marketplace driven by several positive megatrends, including Toyota's commitment to full electrification as well as automation in material handling. Strong market dynamics combined with continued product differentiation in this segment are expected to drive additional growth opportunities going forward. In addition, as our OEM Motive Power customers have not fully recovered and continue to manufacture approximately 3% below their fiscal year 19 build rates, we believe there is even further runway for this LOB's volume growth to come. Please turn to slide 6. While energy systems and motive power exceeded expectations during the quarter, our specialty business results were mixed. Specialty revenue grew 18% sequentially to $119 million in Q3, despite being hindered by labor shortage pressures in our Missouri factories, along with component shortages impacting our ability to meet demand. In the face of these challenges, specialty still contributed nearly $12 million of operating earnings, And as the high-speed line and other productivity and capacity enhancements are installed in our TPPL factories, both incremental cost and capacity improvements should be evident in future results. We're also seeing strong demand signals for calendar year 22 as the U.S. economy recovers and the repressed Class A truck demand continues to be released. A&D performed well during the quarter as we continued to work on many exciting projects. We discussed one of these projects in a recent press release about our ABSL lithium-ion batteries being a critical component of the NASA James Webb Space Telescope that was launched into space on Christmas Day. It has been nearly 10 years since Andersys was awarded the contract for our batteries to power this telescope, and we are extremely excited to be part of such a historical mission. Our TPPL production capacity continues to grow, and we are at our planned run rate of 1.2 billion per annum. We also expect significant reductions in manufacturing variances next fiscal year as the supply chain issues subside. Improving manufacturing efficiencies, record backlog, and strong demand signals in transportation and A&D all point to good things to come in our specialty business. Please turn to slide 7. There is no doubt the recently passed infrastructure legislation holds many positives for Enersys. I want to take a minute to highlight the various areas of the law from which we expect Enersys to benefit. An overarching takeaway of the legislation is the opportunity to accelerate U.S. lithium ion cell manufacturing to support commercial and defense battery applications. While the details are still being finalized, certain inferences can be made as to how our business may benefit. More specifically, major funding allocations available by segment include the following. For energy systems, the infrastructure law supports public and private broadband communications network build-outs and upgrades, critical power and backup for industrial and utility systems operations, monitoring and equipment control, and providing rural digital opportunity funds for broadband coverage in underserved regions. In mode of power, more than $65 billion was allocated to improve the electrical grid, which should help our customers accelerate the electrification of fork trucks and material handling equipment. In specialty, the legislation should help drive advanced battery manufacturing, set up a recycling grant program, and support road infrastructure, which is expected to increase trucking profitability and investment in fleets. In addition, the U.S. government has recognized the lack of lithium-ion cell production in the U.S. has created a national security weakness. U.S. government plans to establish new domestic cell production capacity and is strongly considering solicitations that require U.S.-made cells for key programs, of which Enersys is actively working on. And lastly, we believe our fast charge and storage system will be buoyed by increased EV charging infrastructure as well as an interconnected network to facilitate data collection, access, and reliability. We will participate in various RFQs across all three of our lines of business in the coming years as part of the infrastructure legislation, as it is undeniable that the law aligns well with Enersys's core capabilities and technologies. Please turn to slide eight. Looking ahead, the global supply chain and its effect on rising commodity and labor costs, in addition to component shortages, will continue to be the major focus for the entire Enersys team. Fortunately, we have gotten better at identifying and mitigating these headwinds through incremental price increases, alternative sourcing, engineering redesigns, and aggressive hiring actions. As a result, we are optimistic that Q3 2022 represents the beginning of the recovery across the entire company, with the pace of cost increases starting to decelerate and multiple pricing actions beginning to catch up. We will remain laser focused on limiting the impact of these factors on our business. Even more importantly, we will work hard to keep our employees safe as the Omicron variant remains pervasive in various parts of the world. Despite all of the external headwinds impacting our business, one incredibly positive fact remains unchanged. that market demand across all segments of our business have reached all-time highs. Our technology, products, and services consistently and reliably meet the needs of our customers, and they've rewarded us by remaining loyal to Enersys. Our backlog has grown to unprecedented levels, and we are confident that we have maintained and in some cases grown our market share in this challenging environment. We continue to develop new products and technologies that are mission critical and linked to mega market trends for which both our customers and shareholders will benefit. While our bottom line does not yet reflect all the hard work and progress we have made, I am confident that we are on the right track to enter this, realizing our true potential in the quarters and years ahead. With that, I'll now ask Andy to provide further information on our third quarter results and go forward guidance.
spk02: Thanks, Dave. For those of you following along on our webcast, we've provided the information on slide nine for reference. I'm starting with slide 10. Our third quarter net sales increased 12% over the prior year to $844 million due to a 10% increase from volume and over 3% from price net of mix, partially offset by a 1% decline from foreign exchange. On a line of business basis compared to prior year, our third quarter net sales in energy systems were up 14% to $385 million. Specialty was up 9% to $119 million, and motive power revenues were up 12% to $340 million. Motive power's improvement was mostly driven by 9% growth in organic volume and 5% in price and favorable mix, offset by 2% impact from FX. our motive power volumes are now comparable to the pre-pandemic levels of two years ago, with 8% higher revenues from the favorable impact of price and mix. Energy systems had a 14% increase in revenues from volume, as well as a 1% improvement from price net of negative mix, partially offset by a 1% decrease from the impact of foreign exchange. Specialties revenues benefited from over 6% price mix improvement and 3% organic volume growth, with the volume growth tempered by delayed shipments. On a geographical basis, net sales for the Americas were up 16% year-over-year to $578 million, with 13% more volume and 3% higher price mix. EMEA's revenues were up 5% to $203 million from a 5% increase in volume and 5% improvement in price mix, offset by 5% impact from foreign exchange. Asia was up 8% at $63 million on 7% more volume and small gains from both price mix as well as currency. Please now refer to slide 11. On a sequential basis, Third quarter net sales were up 7% from the second quarter due to 5% organic volume growth and 3% price mix improvement, partially offset by 1% foreign exchange translation. On a line of business basis, specialty revenues increased 18% over 2Q, with 2% higher price mix and 17% higher volume from seasonality, as well as a pickup of second quarter order fulfillments that were pushed into the third quarter. While we are pleased with our results in specialty, it's important to note that this quarter does not fully reflect the revenue potential of the business due to continued supply chain constraints. We expect our specialty sales growth rates to increase as supply normalizes and our capacity increases. Sequential motive power revenues were up 6%, with 3% higher price and mix and over 4% volume growth, partially offset by nearly 1% currency translation. Motive power volume growth benefited from a return from the European holiday season in the second quarter. Energy systems sales were up 4%, with 3% sequential price mix improvement and 2% organic volume growth, partially offset by a 1% FX drag. On a geographical basis, America's revenues were up 5% over the second quarter from a combination of both net price mix and volume. EMEA was up 13% on 14% volume, buoyed by the second quarter European holiday season rebound, as previously mentioned, as well as a 2% improvement in price mix, partially offset by a 4% drag from currency. APAC revenues were up 3% from a combination of both volume and price mix. Please now turn to slide 12. On a year-over-year basis, adjusted consolidated operating earnings in the third quarter decreased to $60 million. As you may recall, in the third quarter of fiscal 21, we settled our insurance claim for the Richmond Fire, which resulted in a $6 million benefit to the quarter that skews the prior year comparison. On a sequential basis, our third quarter operating earnings dollars were relatively flat, as $30 million of higher costs from inflation and supply chain headwinds were offset by dramatic improvements in price mix and volume. Although gross margins eroded 80 basis points, our sequential gross margins would have been slightly higher if not for the cost recovery impact in the margin calculation. Mounting inflation and persistent supply chain headwinds negatively impacted mix and our ability to supply customer demand across all of our lines of businesses, as Dave has discussed. Operating expenses when excluding highlighted items were 14.7% of sales for the third quarter compared to 14.8% in the prior year and 16.4% in Q3-20, as we have maintained a more efficient operating leverage with our revenue growth continuing to exceed our OPEX spending growth. Excluding the previously mentioned Richmond fire recovery in the third quarter of 21, Prior year's operating expenses would have been 15.3% compared to this year's 14.7%. On a sequential basis, our operating expenses were $6 million higher as we have hired engineers and also incurred higher selling expenses to support the revenue growth and some resumption of travel, but we're still slightly lower as a percentage of revenue. Excluded from operating expenses recorded on a GAAP basis in Q3 were pre-tax charges of $9 million, primarily related to $6 million of Alpha and North Star amortization and $3 million of restructuring charges for the previously announced closure of our flooded Motive Power manufacturing site in Hagen, Germany. Excluding these charges, our Motive Power business generated operating earnings of $39 million or 11.5% of sales, which was 180 basis points lower than the 13.3% of sales for the third quarter of last year, but slightly better after adjusting for the $6 million benefit from the Richmond fire recovery received last year, as previously mentioned. Motive Power continues to capitalize on strong demand, favorable mix from our maintenance-free products growth, and ongoing OPEX restraints. OE dollars for Motive Power increased over $5 million from prior year, excluding the Richmond fire recovery, and up over $8 million from the same quarter two years ago. On a sequential basis, Motive Power's third quarter operating earnings percent of sales decreased 130 basis points from the second quarter due to escalating inflation and the margin math pressure from cost recovery pricing pass-through. Energy Systems operating earnings percentage of 2.6% was down from last year, but an improvement from the prior quarter's 2.3%. A $1 million investment in our fast charging initiative combined with higher freight, tariffs, and material costs, unfavorable mix from supply shortages, and lagging price improvement realization caused the OE erosion versus prior year. As Dave mentioned, The contract nature of this business causes delays in matching price and costs that negatively impact us in inflationary periods, but will benefit us when costs stabilize and decline. We were encouraged by Energy Systems' sequential price improvement in the third quarter and believe the price actions are beginning to catch up with the cost increases, and we will continue to see ongoing, sequentially improving margins in the quarters to come. Specialties operating earnings, 9.6% of sales, was down from last quarter's 11.8% and last year's 11.9%. OE dollars were largely flat sequentially and down $1.6 million year-on-year, with margin erosion coming from inflation and input cost increases being only partially offset by price mix and higher volumes and supply headwinds delaying additional order fulfillments. Please move to slide 13. As reflected on slide 12, our third quarter adjusted consolidated operating earnings were $60 million. Our adjusted consolidated net earnings were $43 million. Our adjusted net earnings reflect the change in operating earnings previously discussed, along with $2 million of currency gains in the third quarter of 22 versus a $2 million currency loss in Q3 21, and a lower share count, partially offset by a slightly higher adjusted tax rate. Our adjusted effective income tax rate of 17.5% for the third quarter of fiscal 22 was higher than the prior year's rate of 16.8%, and also the prior quarter's rate of 15.6%. Discrete tax items caused most of these variations. At $1.01 per share, third quarter EPS was at the midpoint of our guidance range despite dramatic and rapid cost increases, aggressive pricing actions, volatile supply chain conditions, and extremely robust demand throughout the period. Our EPS was flat sequentially and down 26 cents from prior year after absorbing over $60 million in or $1 per share of year-on-year cost increases, as delayed pricing realization and supply chain headwinds temporarily muted and offset our strong demand, and the impact of the Richmond fire insurance recovery in Q321 exaggerated the prior year comparison. As announced in our subsequent events footnote and last night's press release, We acquired nearly 1.5 million NRSA shares for $116 million since the beginning of the third quarter, bringing our year-to-date repurchases to almost 1.9 million shares for $148 million this fiscal year and leaving $42 million remaining on our Board of Directors share buyback authorization. As a result of our share buyback activity, we expect a lower weighted average share count for our fourth fiscal quarter of 2022 to be approximately 42 million shares versus 42.5 million shares in the third quarter. Our leverage at Q3 2022 remained below 2.5 times EBITDA, which has historically been the high end of our comfort range to enable untapped liquidity for both growth and investments. As demand for our lithium technology mounts, we are intentionally preserving some capacity for lithium sourcing strategies to buffer against supply chain exposures. Last night we also announced our quarterly dividend, which remained unchanged from prior levels. Slides 14 and 15 reflect year-to-date results and are provided for your reference, but I don't intend to cover them at this time. Please now turn to slide 16. Our balance sheet remains strong and positions us well to navigate the current economic environment. We have $397 million of cash on hand, and as previously mentioned, our credit agreement leverage ratio is now at 2.4 times EBITDA, which allows $385 million in additional borrowing capacity for growth and investments. We expect our leverage to remain below 2.5 times EBITDA for the fourth fiscal quarter of 2022. Our year-to-date cash flow from operations was a negative $78 million. This was primarily due to our inventory expanding $164 million year-to-date to meet the requirements of rising revenues, as well as from higher input costs and transit times, along with intentional inventory builds to mitigate supply chain disruptions. Capital expenditures of $52 million were in line with our prior guidance. Our CapEx expectation for fiscal 2022 remains at or below $100 million. and reflects major investment programs in lithium battery technology development and continued expansion of our TPPL capacity. Also included in our operating cash flows was $34 million in cash spending on highlighted items, primarily related to the previously announced restructuring of our Hagen Germany motive power plant, which delivered almost $5 million of savings in the third quarter, in line with the projected annual savings of $20 million, as previously communicated. We anticipate our gross margin to remain near 22% in the fourth quarter of fiscal 2022, with continued but decelerating inflation being offset by accelerating and aggressive price actions and mixed improvements. In addition, as Dave has described, demand across all three of our lines of businesses is robust and continues to grow. While temporary supply chain challenges are suppressing our ability to fully capitalize on these opportunities, our mitigating actions, including onshoring of contract manufacturing, strategic inventory builds, and product redesign are beginning to take hold. We therefore anticipate ongoing sequential margin improvements in the upcoming quarters as the true underlying profitability of our business emerges. As a result, Our guidance range of $1.11 to $1.21 per share in our fourth fiscal quarter of 2022 reflects our volume growth combined with aggressive price actions and other mitigated activities more than offsetting the sequential impact of continued inflation and supply chain challenges as we make progress on our return to the true underlying profitability levels for our growing business. Now let me turn the call back to Dave.
spk04: Thanks, Andy. Tawanda, we can now open the line for questions.
spk01: Thank you. Ladies and gentlemen, as a reminder to ask a question, you will need to press star then one on your telephone. To withdraw your question, press the pound key. Again, that's star one to ask the question. Please stand by while we compile the Q&A roster. Our first question comes from the line of Moira Kay with Oppenheimer. Your line is open.
spk09: Hi, good morning, and thanks for taking the questions. Appreciate all the color around the sequential improvements here. I was just wondering if it would be possible to mention for us how much price benefit you're sequentially expecting in 4Q, and if possible, to give us some color on how much of that is really, you know, coming in energy systems just based off of the lag in these contracts starting to catch up, and if possible, What are you thinking about price runway in terms of further improvement as we get into 2023?
spk04: Noah, as Andy's looking up the numbers here real quick, I just want to tell you that the issue really in energy systems right now, is the constraint we have on releasing backlog and also the mix impact because the products that we can't ship are the ones that have the highest margin. So there still is a nagging mix constraint on that business as well as unleashing some backlog. but there's been a lot of good work done on the price. So, Andy, do you have those numbers for NOAA?
spk02: Yeah, I do, NOAA. It's a good question. It's obviously what we spend a lot of our time and focus on. As we mentioned, Q3 was the highest cost increases, but it was also the first quarter where our price kept pace with those cost increases. So that gives us a lot of confidence. In Q4, we expect our cost increases to, again, be very high in the range of $20 million, but we expect our pricing to keep pace with that, again, and actually be slightly higher. In energy systems... They have probably about a third of that cost increase, and we think their pricing is going to be almost twice what the cost increases are in the quarter. So that will be part of what contributes to the ongoing margin improvement in the business. And with more to come once, as Dave mentioned, the mix begins to improve.
spk04: And, Noah, remember that most of our costs are FIFOed, so we do have a fairly good line of sight. on the cost side and are optimistic, as Andy noted, that the pricing is starting to keep pace. So the deceleration is welcome, but by no means are we out of the woods in terms of these inflationary pressures. But we did see a $9 million drop sequentially in terms of the sequential rate of inflation increase. So fingers crossed it's going to start to continue to slow down.
spk09: That's super helpful, guys. I guess to follow up on that, you mentioned that there's some easing of bottlenecks, but then you just pointed to, you know, ongoing shortages still presenting some issues. So I guess, you know, really where are kind of still the primary bottlenecks? Is it really the chips and energy systems? And I guess what are your expectations for when we start to see some easing there and your mix can really improve?
spk04: Yeah, I think we're kind of whittling it down to the chip issue. I think the redesigns are helping. Jern and his team have unfortunately had to reallocate a lot of our focus on some chip redesigns in products to chips that are more readily available. That's helping. I think that we haven't seen any benefit, but we've actually made tremendous progress on our onshoring initiatives. So we have quite a few products now that are not being made in China anymore, which will start to have future impacts. So we've made great progress on all the initiatives we laid out last quarter, and I'm really happy with the team. But, again, I would say the biggest constraints right now beyond the chip issues, the second biggest issue I think we fought in this quarter that we're talking about, this prior quarter, were the labor issues that we had in Missouri. I think we're getting our arms around that one. Ted, he heads up our HR group, and he's over there. He's in Missouri today, and he called me last night. So I feel like that one we're getting our arms around, but certainly the chip issues, they're pervasive, and we'll just continue to adapt. The customers in the beginning were very resistant. We had a lot of contractual obligations. We didn't have the necessary protections for some of these explosive costs. But everybody's reaching a new level of fairness, and there's been a lot of positive cooperation with everybody to come up with mutually beneficial solutions. So I would say, yeah, it's coming down to mostly a CHIP concern as we go into fiscal year 23.
spk09: That's super helpful. And I guess one more related question before I turn it over, really around working capital and inventory management. You know, it's no surprise you're going to have working capital build when you've got record broad-based demand and the supply constraints. But I guess when do you think working capital starts to, you know, ease up a little bit in particular, you know, when do inventory levels start to, you know, plateau back down? Because Obviously, it's a super dynamic environment. You don't want to carry too high inventory balances, particularly if that's relatively high-cost inventory.
spk04: I think Andy did a good job in her script of detailing out why the inventory numbers are good. I think DSO, DPO are largely in check. I don't think there's any issues there to discuss. It's all in the inventory line. and so much of it's just related to the extended lead times out of Asia, the longer times on the boats. It's just mathematical. We did do, we are sort of pigeonholing or stockpiling some of the critical components. That's been a part of the number. Andy certainly has all the breakdowns on that. But in terms of when does that situation stabilize more, It's just when our confidence builds on the supply chain, we get back to some, as you noted, it's just a very dynamic environment. So I would say, you know, next year at some point things should get better. but in the meantime, we're just going to continue to make what we think are the right allocations. So, Andy, is there any other color on the inventory you want to talk about?
spk02: Yeah, Dave, I think you nailed it. Until supply chain issues subside, we're going to continue to use inventory as a buffer, and we're very fortunate to have the borrowing capacity to do so. It will be a cash flow opportunity when the macro environment normalizes, but As you mentioned, we had $153 million of increase in inventory year-to-date, with $30 million of that being in the third quarter. A lot of that is the cost increases. It's intentional strategic builds to mitigate against some of these supply chain headwinds. And then as our growth continues, I mean, you've seen our backlog numbers, but just to give you an idea, our Q3 22 order rate is 40% higher than our sales rate. So, you know, we're seeing an impressive growth. Last year that was about a one-to-one, you know, ratio. So, you know, we need to make sure we've got ample working capital to satisfy our customer demand.
spk09: Yeah. Yeah, you put all these points together. It seems like you're setting up 2023 for, you know, a very strong free cash flow generating year. I'll turn it over here.
spk08: Thanks, Noah.
spk01: Thank you. Our next question comes from the line of John French-Rabe with Sedoti. Your line is open.
spk05: Good morning, everybody, and thanks for taking the questions. I just want to go back to the previous point about the higher mixed products and when you expect to realize shipping those products because if you're maintaining the gross margin profiles flat, it doesn't sound like you expect to have made any headway into the fourth quarter. Is that a fair assessment or am I missing something?
spk04: I think, John, the on-shoring and the mix issues are definitely going to get better, and we're expecting just continued steady progress, but it's just a question of the rate of progress. So, Andy, do you have any dimensions you want to add?
spk02: Yeah, you know, obviously we've got – significant price improvement that we continue to expect to see. But on top of that, I think it's worth at least noting the mass impact of margins. When we've got the price recapture of the cost increases, it's zero margin sales. Now, when that's not a big number, it's not that noticeable. But it hurts our margin when the percentages are going up, but it helps us when it's coming down. To give you an idea, in Q3-22, the gross margin impact of this margin math was 100 basis points. So, you know, we typically see ourselves as a 25%, 10% to 15% OE business, which obviously isn't where we are right now. If you were to add $250 million of pricing at zero margin, you'd get a 200 basis point erosion in gross margin, 100 basis point erosion in operating earnings. So part of what we're seeing is the lag in the pricing catch-up as well as these mix impacts that, you know, we're starting to see improvement with our mitigating activities, but we're not yet where the business can get to. And part of it is just the math of this cost increase.
spk05: Do you have a sense of when you'll be able to reach equilibrium as far as the pricing and the mix balancing out?
spk02: Yeah, when we look at next year, we expect the second half of the year is probably when we'll get back to normalized levels. Obviously, there's some things outside of control with supply chain, but as we have become more aggressive and effective with our mitigating activities and our pricing is catching up, we expect continuous sequential improvement in the second half of next year to really be at record levels.
spk05: Great, great. And then just switching to some of your lithium comments, Dave, I guess a couple of things. Could you talk about how much lithium sales are across three segments in total of the total company maybe and where you see that going in two years in light of the slide that had all those opportunities you were pointing out?
spk04: Yeah, I would say in terms of the backlog here, It's still below $100 million in terms of the backlog for lithium, but a lot of positive projects that we're working on involve lithium, and that's really in all three of our business lines. So my job is to focus on the future. There is quite a bit that we know is within reach. I think the fast charge and storage project, the California Public Utility Commission's project, there's a lot of lithium in there. Lithium motive power, we've got quite a bit in the budget that we just went through with the board last week. So the team is very focused and optimistic there, and that's why we made some comments in here about from a capital structure standpoint, we're trying to make sure that we keep some portion of dry powder available for securing that supply chain because it's really, I would say, exceeding expectations versus where my head was at five years ago in terms of the rate at which lithium opportunities would avail themselves. I think things are accelerating quickly. I think as we noted the legislation that the infrastructure law is part of that. Customer feedback and acceptance of our solutions has been a big part of it. So everything is picking up pace and as such we need to make sure that we have a viable supply chain and that's one of our key focuses with our with our cap structure.
spk05: Okay, and just one last question, just because I never heard this before. On the motor side, you talked about the electrical grid offers opportunity for higher forklift sales. Could you just talk to me about that comment or that slide and what that means?
spk04: What the group is talking about is that there is a big push right now, I think similar in the transportation world, with electric vehicles, I think there's a major push right now for electrification of material handling equipment. Well, you can't do that if you don't have available power and grid capacity. So I think there's just some general optimism that as the grid investments are put into place, it's not only going to facilitate electrifying the transportation fleets, but there's also some large customers that are committed to electrifying material handling. I think we've been stuck with a ratio in the US, for example, in the 60s for the percentage of material handling equipment that was electric versus gas. We think there's going to be a breakthrough in that number, and part of breaking through that number is going to be the availability of electricity to charge these forklifts and so forth. And then we're working on a couple of projects longer term, which tie together Similarly, our fast charge and storage solution with solar and then putting that in a DC warehouse, a distribution center warehouse environment. So we just feel very positive and optimistic that what's laid out in this bipartisan legislature is just, we're well aligned, our investors are well aligned with these future investments.
spk05: Got it. Thanks for taking my questions. I got back at the queue.
spk04: Thank you.
spk01: Thank you. Our next question comes from the line of Greg Wyskowski with Weber Research. Your line is open.
spk06: Hey, good morning, everyone. How are you doing?
spk01: Good.
spk02: Good morning.
spk06: First question is on the backlog. And, Andy, those are really interesting data points that you brought up on that plus 40% of the order rate. So just curious, How long do you think the backlog continues to build here? And then, you know, as supply chain starts to ease, do you think that eventually the backlog returns to more normalized levels or you kind of see that coinciding with, you know, this rise in demand that you're seeing and maybe the backlog kind of stays at this historically elevated level?
spk02: Yeah, thanks, Greg. You know, as long as our order-to-sale ratio is, you know, 30%, 40% above 130%, obviously our backlog will continue to grow because we're getting more orders in than we're shipping. So we do see the demand continuing. But if you look at what makes up some of the backlog growth, I'd say about $70 million or so of that is supply chain delaying deliveries. So that should normalize as supply chains begin to get back to stabilized levels and we're able to ship that product out. We probably have about $50 million, which is price. So as we have higher-priced orders, our backlog will be reflective of that. And then we do have some advance ordering where the order book is increasing at longer than normal phasing because of truck lead times and electronic lead times. That might be in the range of $150 to $200 million. And, again, as supply chains normalize, that should start to be realized into revenue and not on a backlog book.
spk03: Yeah, Mike, do you have anything to add? Greg, one other thing to think about. In motive power and specialty, the battery is probably not going to get ordered you know, with a longer lead time than the truck itself. But when you get to energy systems and the scope and complexity of some of these builds, whether it's for 5G or the CPUC mandate, you know, you can still be taking orders that might go out 18 to 24 months. So I think in that line of business, you could see continuing growth in the order book beyond, you know, well beyond the revenue number that Andy referenced. Yeah.
spk04: I think, Greg, what's important to me is that we have and all the LOBs have extremely good line of sight on what's driving the backlog. And it's all in the energy systems, for example. As Mike noted, it's tied to very specific network construction initiatives, our transportation business, It's really tied to our market penetration with our thin plate pure lead into a very enormous transportation sector. We've had tremendous success in the class eight over the road market, reaching the end users, showing the total cost of ownership benefits. So I think that there's a high degree of strategic alignment of our backlog with our strategic initiatives that we laid out in our analyst day some time ago. We feel like we're lined up well. And then in motive power, for example, as Mike noted, most of the customers wait until just the trucks, you know, maybe 8, 12 weeks before the truck is supposed to arrive at the dealer. That's when they order the battery. So I would say, Andy, most of our backlog in motive is less than 90 days old. So I think in general we feel extremely good about the quality of our backlog. And to your question about getting more of it released, it's just going to come down to contract manufacturing. So I don't have that breakdown. Andy, I don't think we talked about that yesterday. But some portion of that backlog obviously is going to be out of our battery factories, and then some portion is going to be out of contract manufacturing companies. And so the contract manufacturing, I think we have probably a little bit better ability to flex up as soon as the chips become available. So that's really a lot of the constraint on the electronics and the contract manufacturing piece. And then on the battery piece, as you know, there's really – there's only so much we can do out of those big fixed asset type of businesses. So – but we feel extremely – optimistic about that. And just like you, we look forward to just, if anything, and I said this to Andy yesterday and Mike, we just need stability. That's what we, you know, if we have to readapt to a new level of lead times or cost price, we can do that. It's just, it's this crazy dynamic. I mean, just the sequential impact of really more than 50 cents a share of cost pressure sequentially. It's just these are unprecedented times, but it too shall pass.
spk06: Okay, that's a really helpful color. Thanks. The follow-up is on the EV charging product. I just have a couple there. Can you give us any specific details or updates around those initial expected orders or initial two customers in that $100 million order that's kind of dangling out there? And then as you kind of continue to think about this product and commercializing it, is the focus still on the commercial REITs, thinking about office parks, shopping centers, apartment buildings, et cetera? Or have you – you kind of spoke about this a little bit in the material handling. Have you thought about different applications, like, highway corridors or, you know, fleet applications, kind of combining that material handling seems like, you know, something that would really make sense for that system. Just your thoughts there as you kind of move forward with commercializing it would be great.
spk04: Yeah, it's a great question. And our sales funnel, even in the last 90 days, has sort of exploded in terms of the breadth of opportunity. So it's not as narrow a play as I thought maybe initially was. that I think especially fleet charging, corridor charging, the ability to rapid charge. We had one customer, Class 8 fleet customer, that was looking at Class 8 electric trucks, and they had kind of a charge drive profile where they wanted the charge to be done in 45 minutes. Well, in this particular application... that was over 700 kilowatts of electrical load. And just to dimension that, that's like adding 100 homes to the grid every time you plug in one of these trucks to charge it. So, I mean, just the scale of that. So I think most people are starting to recognize in these high-charge environments how limiting the grid connectivity is going to be And so that people are certainly coming to the realization that they're probably going to have to buffer that with available energy so that the impact of that surge or that charge is not so heavily felt on the grid directly. So I think all the things you mentioned, the distribution center, the corridor, And then fleet charging, I think we've gotten a lot. Now for us, what I'm trying to do from an execution standpoint and the way we roll it out is keep the spec narrow so we don't get too crazy in terms of rolling this out. And I've been pushing the team hard to hunt with a rifle, not a shotgun. So as we go forward, our focus is still on these commercial REIT-type customers. I would say the spec is done. There's been a lot of arm-wrestling over the last 90 days about the size of the container, the number of how much storage energy, but that's all nailed down now, and I really hope by the end of this coming up fiscal year 23, we're going to start the revenue. But This same concept, and one of the things I just have to remind you, I want to take this opportunity, is that the technology we're using is highly, highly, highly aligned with the modules that we're doing for motive power for our energy systems business. I think these Baukhausen principles that our CTO has driven into the business are are really starting to show the benefits. So it's amazing to me how quickly we've been able to put this system together simply because of the hard work we've done over the last five years putting together our whole lithium infrastructure and DNA software, BMSs. So it's a very exciting project. We've made a tremendous amount of progress in the last 90 days.
spk06: Okay, that's great. Thanks, David and Andy, and congrats again, Mike. Best of luck to you.
spk01: Thank you. Our next question comes from the line of Greg Lourdes with BTIG. Your line is open.
spk08: Yeah, hey, thank you, and good morning. And, yeah, Mike, thanks for the help over the last couple years, and good luck. You know, Dave, I guess I wanted to talk a little bit about your comments around the ability to kind of aggressively push price, but at the same time gain market share. Any kind of color around the business lines where that's happening, or is that being driven by any, or should I say, are there any differences by region of where that is happening?
spk04: I don't think it's a regional issue. It's pretty much the toughest place on the price recapture was on our energy systems with our large contracts with big wireless carriers, broadband carriers. And it's just the nature of the agreements that we've had with them. So it just took longer. So you saw that in terms of our mode of business and our specialty. Now, in the specialty side, we have similar issues with the – some of our large OEM customers on the Class 8 side. But in general, it's really not the issue anymore. But there was absolutely a delay in our ES business just due to the nature and the customer concentricity issues. We have much fewer customers and much bigger customers in ES than we do in the others just by the nature of the business. But I think the pricing and the fair accommodation has gotten a lot better, will continue to improve, and really it's the mix from the electronics drag that I'm still really cautious about. And then from a margin perspective, and then obviously as Andy pointed out, the margin math, We're not getting a margin on the cost-price recapture, so that obviously has a dilutive effect on the way up. But to Andy's point, we'll be more of a benefit on the way down.
spk08: Okay. I realize we're on the hour, so thank you very much.
spk04: Thank you.
spk01: Thank you. As a reminder, ladies and gentlemen, that's star one to ask the question. Our next question comes from the line of Brian Drab with William Blair. Your line is open.
spk07: All right, good morning. This is Blake Keating on for Brian. Hi, Blake. Hey, Blake. So we're just looking to get an update on the alpha business, how that's been growing, kind of how you expect it to grow, you know, over the next year or two. And then also within that business, you know, how you're seeing the opportunities in 5G and if there are upgrade opportunities in the cable network.
spk04: Right. I would say it's hard for me anymore to talk about the Alpha business because it's so integrated in with our whole energy systems business today. But I will tell you that Alpha's greatest market share as a brand was in the North American cable television companies like Comcast and Charter, for example. They've always just done extremely well there. I think the business is doing fantastically. The California Public Utilities Commission business is coming through those kind of legacy channels. But the products we're putting together for CPUC are absolutely an amalgam of what was Alpha and what is Enersys. So whether it's TPPL batteries, lithium batteries, enclosures from our Enersys legacy Purcell factory, or XM3 UPS systems out of Alpha, But I would say the business is extremely healthy, doing extremely well. Those customers continue to invest heavily in their hybrid fiber coaxial networks. There's still a lot of potential in the rural broadband. I think the RDOF projects, we've started to capture revenues for the RDOF funding already. So plenty of runway left in that business. It's just the electronics piece, as noted, has been frustrating, first with tariffs, you know, bringing that, you know, those tariffs became extremely burdensome. And so I would say when we talk about alpha, I'd say a lot of what we're talking about the pressures are on the electronics piece of our business. And as noted, we've made significant progress on onshoring for tariff relief. And the CHIP issues are – they are what they are. We're doing what we can with redesigns and so forth.
spk07: All right. And then just the last quick one. Do you guys still expect revenue in the fourth quarter to be up about $50 million sequentially? And then any directional guidance on 23 – 23 revenue would be great. Thanks.
spk03: Well, Blake, traditionally we don't guide for the upcoming year's revenue at this point. I would say in terms of sequentially that you would expect our fourth quarter is historically our strongest quarter. I think in terms of we had a very good third quarter in terms of top line, too. So it's probably not as big of a sequential volume growth, but you will see pricing moving the needle up as more of our pricing initiatives come in. So the $50 million is probably not all that unreasonable, but it's not all volume growth.
spk04: Yeah, it's different. It's a little different right now with all the constraints we have on delivery.
spk07: I'll pass it along. Thank you.
spk01: Thank you. I'm sure no further questions in the queue. I would now like to turn the call back over to David Schaffer for closing remarks.
spk04: David Schaffer All right. Well, Mike, I went back and counted. You've participated in 50 of these. This is your 50th analyst call. You've done three investor days for us. You were on the stage twice to ring the bell for the New York Stock Exchange. 18 acquisitions, a billion dollars of debt offerings, and I don't know how many calls with investors. That's got to be a countless number. Let me speak on behalf of all Enersys stakeholders in thanking you for 26 years of invaluable service to the company, thanking you for recruiting and preparing Andy, and for me personally, thank you for your wisdom and loyalty to the company. I will miss you and always consider you a friend.
spk03: Well, thank you very much. It's been a most enjoyable ride. I'm working through the 31st, but Andy's taking over most of the day-to-day stuff. I've got some bucket list items, the strategic initiatives I want to try to run down, so I'll still be around. I'll miss all of you, but if anybody needs to talk to me in the next Seventy-five days, I'm still here. Great. Thanks, Mike.
spk04: So thanks to you, everyone, and we look forward to providing further updates on our progress on our fourth quarter and year-end 22 call in May. Have a good day, everyone.
spk01: Ladies and gentlemen, this concludes today's conference call. Thank you for your participation.
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