EnerSys Fiscal 2016 Third-Quarter 10-Q Summary
Business Context and Reporting Period
EnerSys is a global manufacturer, marketer and distributor of industrial batteries, chargers, power equipment, accessories and related services. It operates through the Americas, EMEA and Asia segments and serves more than 10,000 customers in over 100 countries. The filing covers the 13-week quarter and nine months ended December 27, 2015, compared with periods ended December 28, 2014.
Financial Performance and Key Metrics
| Metric | Q3 FY2016 | Q3 FY2015 | Nine Months FY2016 | Nine Months FY2015 |
|---|---|---|---|---|
| Net sales | $573.6 million | $611.6 million | $1,704.8 million | $1,875.6 million |
| Gross profit | $145.9 million | $157.3 million | $451.2 million | $482.4 million |
| Gross margin | 25.4% | 25.7% | 26.5% | 25.7% |
| Operating earnings | $55.5 million | $68.7 million | $184.0 million | $220.4 million |
| Operating margin | 9.7% | 11.2% | 10.8% | 11.8% |
| Net earnings attributable to EnerSys | $38.5 million | $49.3 million | $126.9 million | $154.7 million |
| Diluted EPS | $0.86 | $1.04 | $2.76 | $3.19 |
| Effective tax rate | 22.0% | 23.6% | 23.6% | 26.0% |
Quarterly revenue declined 6.2%, while nine-month revenue declined 9.1%. Operating earnings fell 19.3% in the quarter and 16.5% year to date. The quarter’s lower operating margin reflected lower reserve-power volume, higher operating expenses, foreign-currency effects and relatively flat pricing, partly offset by lower commodity costs.
Reserve-power revenue decreased 11.4% in the quarter and 13.2% year to date. Motive-power revenue decreased 1.0% in the quarter and 5.0% year to date. EMEA was the weakest region, with revenue down 18.8% in both periods. Asia revenue increased 28.1% in the quarter but declined 2.0% year to date; the year-to-date decline reflected lower volume from a major Chinese telecommunications customer.
Operating cash flow was $232.7 million for the nine months, compared with $132.9 million in the prior-year period. Capital expenditures were $45.7 million, acquisition spending was $39.1 million and investing cash outflow was $74.7 million. Cash and cash equivalents increased to $346.1 million from $268.9 million at March 31, 2015.
Primary working capital was $590.1 million, equal to 25.7% of annualized quarterly sales, compared with $636.6 million and 25.3% at March 31, 2015. Management attributed the higher percentage primarily to lower sales volume.
Debt, Liquidity and Capital Allocation
At December 27, 2015, short-term debt was $23.5 million and long-term debt, net of issuance costs, was $626.7 million. Total principal debt included $300.0 million of 5.00% senior notes due 2023 and $333.25 million outstanding under the 2011 Credit Facility. The Convertible Notes were extinguished in July 2015 after a cash payment of approximately $172.3 million and issuance of 1,889,431 treasury shares.
The Company had approximately $447.4 million of available and undrawn credit lines, including $136.6 million of uncommitted lines. Management stated that liquidity was sufficient for short-term needs, anticipated growth, acquisitions, dividends and other capital requirements. The Company was in compliance with its debt covenants.
During the nine months, EnerSys paid $180.0 million under an accelerated share repurchase agreement and repurchased $120.6 million of treasury stock in total. The ASR was subsequently settled on January 19, 2016, resulting in total repurchases of 2,961,444 shares for $166.4 million, or an average price of $56.19. Quarterly dividends remained $0.175 per share.
Material Changes Versus the Prior Comparable Period
- Revenue, operating earnings, pretax earnings and diluted EPS declined, primarily because of foreign-currency translation, lower organic volume and weaker EMEA performance.
- Gross margin decreased 30 basis points in the quarter but increased 80 basis points for the nine months, primarily because of lower commodity costs.
- Operating expenses increased as a percentage of sales, reflecting acquisitions, payroll costs, bad debts and implementation costs for a new Americas ERP system.
- Interest expense increased to $16.7 million for the nine months from $14.2 million, principally because of higher average debt following the senior-notes issuance and share repurchase activity.
- Operating cash flow improved substantially because of lower working capital requirements and the absence of the prior-year cash effects related to the Altergy legal settlement.
- Foreign-currency translation losses were $20.8 million in other comprehensive income for the nine months, compared with $95.9 million in the prior-year period.
Guidance, Outlook, Risks and Unusual Items
The filing does not provide explicit quantitative revenue or earnings guidance. Management reported stable recent revenue and order-rate trends but described economic activity as mixed, with limited growth in North America and EMEA and slower-than-historical growth in Asia.
Restructuring charges were $3.2 million in the quarter and $7.1 million for the nine months. The Company expects additional restructuring charges related to EMEA and the Cleveland, Ohio facility, with programs extending into fiscal 2017. The filing estimates approximately 120 employee reductions from certain EMEA actions and approximately 100 reductions associated with the Cleveland facility closure.
Year-to-date unusual items included a $4.0 million reserve for European competition investigations, a $4.3 million gain on the sale of a Chinese facility and a $0.8 million reversal of a prior Americas legal accrual. The Company stated that the scope, timing and ultimate outcome of the Dutch competition investigation remain uncertain and that actual losses could differ from the current reserve.
Principal risks include foreign-currency and lead-price volatility, cyclical customer industries, pricing pressure, environmental and occupational-safety liabilities involving lead and acid, competition, product quality, litigation and regulatory investigations, restructuring and acquisition execution, goodwill impairment, variable-rate debt, customer credit risk and cybersecurity or operational disruptions. A 100-basis-point increase in variable interest rates would increase annualized interest expense by approximately $3.6 million. A 10% increase in lead costs was estimated to increase cost of goods sold by approximately $13 million for the quarter and $41 million for the nine months, absent offsetting actions.
EnerSys early adopted guidance requiring debt issuance costs to be presented as a direct reduction of debt. Management concluded that disclosure controls and procedures were effective as of December 27, 2015.
Important Facts for Investors to Verify
- Whether EMEA demand, reserve-power volumes and foreign-exchange conditions stabilize or continue to pressure revenue and margins.
- The final outcome and potential additional cost of the European competition investigations, particularly the Dutch proceeding.
- Progress, remaining costs and operational benefits of the EMEA, Cleveland and other restructuring programs.
- Debt reduction capacity, covenant compliance and exposure to variable interest rates following the refinancing and Convertible Notes extinguishment.
- Whether operating cash flow remains strong after considering acquisition spending, capital expenditures, dividends and share repurchases.
- The effect of lead prices, foreign-currency movements, pricing mechanisms and hedging positions on future gross margins.
- Integration and contribution from acquisitions, including the $39.1 million of year-to-date acquisition spending.