ENS

Enersys 10-Q Summary: Quarter Ended September 30, 2007

Business Context and Reporting Period

This filing is a Quarterly Report on Form 10-Q for Enersys, the world's largest manufacturer of industrial batteries, for the fiscal quarter ended September 30, 2007 (the second quarter of fiscal 2008). The company operates two primary segments: Reserve Power (backup power for telecommunications, UPS, and specialty applications) and Motive Power (power for material handling equipment and mining). The company operates globally with significant manufacturing capacity outside the U.S.

Key Financial Metrics

Material Changes vs. Prior Period

• Revenue Growth: Net sales increased 30.4% in the quarter and 25.0% year-to-date. Growth was driven by organic volume increases, price hikes to offset raw material costs, and acquisitions (contributing ~$7 million in the quarter). Foreign currency translation added approximately $24 million to quarterly sales due to a stronger Euro.
• Margin Compression: Gross profit margins declined 210 basis points in the quarter and 170 basis points year-to-date. This was primarily due to record-high lead prices, which increased costs by an estimated $40 million in the quarter and $67 million year-to-date. Price increases recovered approximately 75% of these commodity cost increases.
• Restructuring Charges: The company recorded $10.3 million in restructuring charges year-to-date, primarily related to a European restructuring initiative to integrate the Energia acquisition and reduce costs. This contrasts with $0 in restructuring charges for the same period in the prior year.
• Working Capital: Operating cash flow dropped significantly to $1.1 million (from $24.3 million prior year) due to a $26.7 million increase in cash used for primary working capital (receivables and inventory) to support sales growth and higher lead inventory costs.

Guidance, Outlook, and Risks

• Outlook: Management expects to incur approximately $7 million in additional restructuring charges related to the European initiative ($5 million in the remainder of fiscal 2008 and $2 million in fiscal 2009). The company continues to implement price increases to offset rising commodity costs, though full realization may be delayed.
• Commodity Risk: Lead prices remain a critical risk. Prices hit historic highs ($1.8053/lb post-period). The company estimates a 10% increase in lead costs would increase annual COGS by ~$35 million.
• Acquisitions: Recent acquisitions include Energia (Bulgaria) and Leclanché (Switzerland), expanding low-cost manufacturing and market presence in Eastern Europe and Switzerland.
• Debt Covenants: The company is in compliance with all debt covenants. It maintains a $455.9 million senior secured credit facility.

Investor Verification Checklist

• Lead Price Hedging: Verify the extent of lead price hedging contracts (currently covering ~9% of requirements at $1.11/lb) against the volatility of spot lead prices.
• Price Pass-Through: Monitor the effectiveness of selling price increases in offsetting raw material inflation in upcoming quarters.
• Restructuring Execution: Track the remaining $7 million in expected European restructuring charges and their impact on future operating earnings.
• Working Capital Trends: Assess if the high level of primary working capital (25.3% of annualized sales) stabilizes as sales growth moderates or inventory levels adjust.
• Foreign Currency Impact: Evaluate the sensitivity of future earnings to fluctuations in the Euro and other foreign currencies, given that nearly 60% of sales are generated outside North America.