EnerSys (NYSE:ENS) Q4 2023 Earnings Call Transcript

EnerSys (NYSE:ENS) Q4 2023 Earnings Call Transcript May 25, 2023

Operator: Ladies and gentlemen, thank you for standing by, and welcome to the Q4 Fiscal Year 2023 EnerSys Earnings Conference Call. At this time, all participants are in a listen-only mode. After the speakers’ presentation, there will be a question-and-answer session. Please be advised that today’s conference call is being recorded. I would now like to turn the conference over to Lisa Hartman, Vice President of Investor Relations. You may begin.

Lisa Hartman: Thank you and good morning, everyone. Thank you for joining us today to discuss EnerSys’ fourth quarter and full year fiscal year 2023 results. On the call with me this morning are David Shaffer, EnerSys’ President and Chief Executive Officer; Andrea Funk, EnerSys’ Executive Vice President and Chief Financial Officer. Last evening, we published our fourth quarter and fiscal year 2023 results and filed our 10-K with the SEC, which are currently available on our website. We also posted slides that we will be referencing during this call. The slides are available on the Presentations page within the Investor Relations section of our website. As a reminder, we will be presenting certain forward-looking statements on this call that are subject to uncertainties and changes in circumstances.

Our actual results may differ materially from these forward-looking statements for a number of reasons. Our forward-looking statements are made as of today. For a list of forward-looking statements and factors which could affect our future results, please refer to our recent 10-K filed with the SEC. In addition, we will also be presenting certain non-GAAP financial measures, particularly concerning our adjusted consolidated operating earnings performance, free cash flow, adjusted diluted earnings per share and adjusted EBITDA, which excludes certain items. For an explanation of the differences between the GAAP and non-GAAP financial metrics, please see our company’s Form 8-K, which includes our press release dated May 24, 2024. Now, I’ll turn the call over to EnerSys’ President and CEO, Dave Shaffer.

David Shaffer: Thanks, Lisa. Please turn to slide 4. We were pleased to have delivered an outstanding fourth quarter and full year fiscal ‘23. I’m proud of our team’s performance, achieving record revenue and operating earnings as demand remains steady across our markets. And we continue to build momentum on our strategic objectives. Before I walk through our results, there is some good news I want to report regarding the impact to EnerSys from the Inflation Reduction Act. EnerSys is a leader in driving the global energy transition and our eligibility for IRC 45X credits of the IRA reinforces the critical nature of the products and services we provide. Andy will provide background on these credits and discuss the financial implications for EnerSys in more detail, following the rest of my prepared remarks.

However, I want to be clear that we plan to use funds we receive from the IRA as intended by the law to make investments that accelerate our capacity and domestic sourcing of lithium-ion and other energy dense battery technologies. Now, to provide more color on our fourth quarter results. Record revenue in the fourth quarter was driven by organic growth and strong price mix realization. We maintained solid gross margins, offsetting continued but leveling pressure from inflation, representing significant year-over-year margin improvement even before the additional benefit of the 45X credits. Longer term, we’re well positioned to benefit from the IRA, growing demand for energy efficiency, electrification, 5G small cell build out the $1 trillion Infrastructure Law and defense spending.

These trends are driving demand for battery technologies and Energy Systems that we are uniquely positioned to supply. We’re staying on alert for signs of a slowdown, particularly in Motive Power, especially in EMEA. However, Motive Power orders overall remain in line with pre-COVID levels. Supply chain headwinds are finally beginning to ease. We were able to reduce inventory in Q4 after seven consecutive quarters of inventory builds from higher costs and strategic buffers against supply disruptions. We had a strong cash flow quarter with free cash flow of $113 million on improved earnings and primary operating capital transitioning to a net source of cash. This allowed us to reduce our leverage and further strengthen our balance sheet. We expect our cash flow to continue to improve with higher earnings and additional POC reductions from the leveling of inflation and ongoing targeted inventory reduction efforts, as well as the projected IRA cash benefits.

Please turn to slide 5. Backlog eased slightly from the prior quarter to just below $1.3 billion but remains healthy and currently sits roughly 2 times above pre-COVID levels, with healthy order rates. Orders were up 9% compared to Q3 ‘23 and down 11% versus the prior year. As a reminder, in 2022, we had received large program orders in Energy Systems and Motive Power’s order intake was elevated from supply chain disruptions and COVID-related lockdowns opening back up, which impacted customer order patterns and skews year-on-year comps. We view this as a positive, with loosening supply chains making it possible for us to satisfy customer demand. We continue to see stable demand across our lines of business and believe operational improvements will continue to direct backlog to normalize levels over the next few quarters.

Please turn to slide 6. We believe we’re at the forefront of technology for our industry and continue to make significant strides on our innovation roadmap. On our journey to deliver the most advanced power systems, safety is always a top priority. This is why many of our technologies, such as our advanced lithium systems and wireless charging, are among the first to pursue safety testing and certification from industry bodies such as Intertek and UL. For example, rigorous safety testing is underway for our touch-safe product, with customer field trials planned for early calendar 2024. We also shipped our first AMEA customer units of our NexSys Lithium-ion 80-volt, which received authorization to mark CE, certifying that we met EU health, safety, and environmental requirements, ensuring customer safety.

We were proud to receive the 2023 Power Project of the Year Award at the Electrical Review & Data Center Review Excellence Awards last week. This recognition is a testament to our commitment to excellence, innovation, and sustainability in data center energy storage and power management. Our fast charging storage initiatives are advancing with good progress on a production roadmap and supply chain initiatives, and our design for manufacturing now complete. Sourcing requirements related to EV tax credit qualification for our customers is top of mind as we qualify our domestic and global supply chain and production partners. And we’ve already secured all components with long lead times, which are being held in inventory at our contract manufacturer.

We’re excited about our progress and look forward to featuring our NexSys AIR wireless charger and fast-charging storage system, among other technologies, during our product showcase at Investor Day on June 15th. I’ll now briefly walk through our business segment highlights. Please turn to slide 7. Please note, I will discuss our segment adjusted operating earnings, excluding IRA benefit we recorded in cost of goods sold in the fourth quarter. We believe reviewing the results without this credit provides a better view and comparability into the operating performance of each line of business. Energy Systems had strong full-year sales of $1.7 billion, up 13%, and adjusted operating earnings were up over 80% versus fiscal year ‘22, driven primarily by growth in broadband, data center and telecom and our pricing actions catching up with the unprecedented cost increases we’ve endured the past two years.

In addition, while getting better, chip supply unpredictability continued to impact our production plants. Backlog is normalizing toward a run rate that we anticipate will settle to approximately one quarter of bookings, modestly higher than pre-COVID levels. Our CPUC lithium-ion installations, which account for a large portion of our $70 million of CPUC backlog are on track to begin deployments in the second quarter. While current demand trends are healthy, we’re monitoring our key customer CapEx spending plans closely. We remain excited about the long-term opportunity for Energy Systems, driven by the global megatrends for which our critical power solutions are a key enabler. Our Motive Power business had a strong year with revenue up 7% and adjusted operating earnings up 5% year-on-year.

Despite pressures in EAMEA and the potential of recession, this business remains healthy. Demand trends are stable and approximate normalized pre-COVID levels with backlog more than 2 times that of pre-COVID. EMEA lead times were stable and European on-time deliveries hit a record high, despite the softening order book. Maintenance-free was 19% of revenue mix at the end of fiscal year ‘23, up from 15% in fiscal year ‘21, driven by customer enthusiasm over our proprietary TPPL technology. Lithium order rates continue to climb and the CE rating for our new 80-volt variant has resulted in new customer trials in EMEA. Specialty full year sales were up an impressive 13% over the previous year, though adjusted operating earnings was down 14% over prior year, impacted by productivity headwinds in our Missouri factories and temporary cost pressures from our Sylmar facility, which are vacating at the end of the first quarter.

We continue to rationalize our footprint and are transitioning our Sylmar activities to other existing sites. Missouri TPPL output and costs are improving. Although it remains an area of focus and significant opportunity, as we see incredibly unmet demand for this technology with our transportation customers. As such, transportation revenue continues to be paced only by capacity. We saw strong U.S. transportation orders in Q4 with a book-to-bill ratio greater than 1 on top of achieving record deliveries in the quarter. Class 8 truck production is stable, up 12% year-on-year, and growth projections remain positive. Aerospace and defense demand strength continues. Our unique capability to combine commercial and defense production at scale has resulted in several exciting projects in our pipeline, which Mark will be talking about at Investor Day.

Please turn to slide 8. We achieved impressive milestones toward the ESG goals we announced last year and continue to ensure that our metrics are accurate and auditable. Last week, we published our 2022 sustainability update, which includes solid progress towards our long-term goals. On the leadership front, we announced Shannon Thomas as our new Chief Human Resources Officer. I’m delighted to have Shannon join our executive leadership team, where I believe her strategic vision and leadership will be instrumental as we continue to attract, develop and retain top talent from around the world, while fostering a culture that values diversity, equity, and inclusion and supports our ongoing goal of being the employer of choice for our valued employees.

We will continue to update you on these important objectives. Please turn to slide 9. In closing, I’m pleased that our excellent Q4 and full year 2023 results demonstrate continued progress towards achieving our long-term financial and operational goals. We believe the steps we have taken over the past three years better position our business to benefit from global megatrends such as 5G, data center growth, material handling electrification and automation, grid stabilization and electric vehicle fast charging, all of which provide us both near and long-term growth opportunities that are materializing in our financial results and outlook. In addition to these trends, we’re excited about our opportunities to benefit from U.S. government mandates and funding that are driving markets to us because of the criticality of the goods and services we provide, such as broadband expansion to the Rural Digital Operating (sic) Fund and the IRA.

I am proud of everything our team achieved in fiscal year 2023, despite lingering uncertainties from geopolitical tensions and potential recession, as well as ongoing headwinds from supply chains, inflation, interest rates, and FX. I want to thank our employees for their dedication and hard work, consistently capitalizing on opportunities and confronting challenges head-on. I look forward to seeing you in the next few weeks at our Investor Day on June 15th in New York City. I’ll now ask Andy to provide further information on our fourth quarter and fiscal ‘23 results and go-forward guidance.

Andrea Funk: Thanks, Dave. Please turn to slide 11. Our fourth quarter net sales increased 9% over the prior year to $990 million due to a 7% price and mix improvement and 4% growth from volume, partially offset by a 2% erosion from foreign exchange. Full year net sales increased 10% over the prior year to $3.7 billion due to an 8% increase in price mix and 7% increase in volume, partially offset by a 4% FX headwind. Adjusted operating earnings were $107 million in the fourth quarter, up $22 million sequentially, and $322 million for the full fiscal year, up $59 million versus prior year, inclusive of the $17 million IRA benefit booked in Q4. Even excluding the IRA impact, this marks three consecutive quarters of sequential adjusted operating earnings improvement, enabling the Company to achieve another record quarter with our price recapture offsetting inflation and our mix improvements and EnerSys Operating System cost savings beginning to be visible on our bottom line.

Adjusted EBITDA for the fourth quarter was $118 million and 11.9% of net sales, compared to $88 million and 9.7% of net sales in the prior year fourth quarter. For the full fiscal 2023, adjusted EBITDA was $388 million and 10.5% of net sales, compared to $340 million and 10.1% of net sales in the prior year. Our adjusted EPS was $1.82 per share in the fourth quarter of fiscal ‘23, up from $1.27 in the third quarter, due to the adjusted operating earnings improvements previously mentioned, as well as the favorable impact of the IRA, which contributed $0.42 per share. Full year adjusted EPS of $5.34 represents an increase of approximately 20% over fiscal ‘22. Note that our full year adjusted EPS before the IRA benefit was $4.93 per share, matching the previous annual EPS record level achieved in fiscal year ‘19, despite approximately $1.20 per share of FX and interest rate pressure.

Please turn to slide 12. I will now provide additional details on the benefits we expect to receive through the Inflation Reduction Act. Section 45X of the IRA introduced advanced manufacturing production tax credits for batteries and battery cells produced in the United States with a specified energy density. Credits will be determined based on third-party sales of qualifying products produced in the U.S. over the 10-year period from January 1, 2023 through December 31, 2032. Based on the current information available on the tax credit qualifications, we expect the material portion of our U.S. produced batteries and battery cells, including much of our proprietary Thin Plate Pure Lead batteries, and a portion of our flooded lead acid batteries will qualify for these tax credits.

While we are still awaiting further clarification from the IRS on some specifics of this law, based on our sales of U.S. produced batteries and battery cells in the quarter, we have calculated that we qualify for credits of $17 million, which we reported as a reduction to cost of goods sold. As Dave mentioned, consistent with the intent of the law, we plan to use the credits received to accelerate our investment in U.S. capacity of qualifying batteries, including lithium and Thin Plate Pure Lead products. We will continue to evaluate the potential benefits of the IRA as the Treasury and IRS provide specific implementation guidance, and we’ll provide further updates to you as appropriate. Please turn to slide 13. On a segment basis, compared to the prior year, all lines of business posted strong revenue growth in the quarter driven by substantial price mix improvements and higher volumes in Energy Systems and Specialty, which were partially offset by foreign exchange headwinds.

The favorable impact of price mix improvements on adjusted operating earnings more than offset the higher costs for the quarter year-on-year. Please note, like Dave, the figures I will present on segment adjusted operating earnings, also exclude the benefit of the IRA for better comparability purposes and insight into operating performance. As Dave has mentioned, Energy Systems delivered significant improvement to adjusted operating earnings as a result of price mix cost recapture taking hold for the second consecutive quarter with almost 90% adjusted OE improvement versus prior year and over 12% improvement sequentially. We are pleased the recapture lag in Energy Systems has reversed as we had anticipated, when we advised that price mix cost recapture would be slower to manifest in Energy Systems versus our other segments due to the contractual nature and historically Asian based supply chains inherent in this business.

On another positive note, Motive Power adjusted operating earnings improved 26% over the prior year fourth quarter and 7% sequentially, driven by very strong TPPL mix improvements in the Americas as well as ongoing positive price cost recapture. And finally, adjusted op earnings in our Specialty segment was down $1 million versus prior year on 12% higher revenue, as a result of performance issues in our Missouri plant incurred in the third quarter and higher costs in our Sylmar plant, which we are closing and transferring production out to other factories this quarter. These elevated costs were approximately $5 million in the fourth quarter. We expect the consolidation of the Sylmar factory to provide annual cost savings of approximately $4 million.

Accomplishments across all of our lines of business, coupled with healthy market dynamics, resulted in solid improvement in our quarterly adjusted OE results and increasing momentum going forward. More detailed sequential and geographic results can be found in our press release and in the supplemental slides. Please turn to slide 14. On a sequential basis, in the fourth quarter of fiscal ‘23, we realized $15 million or $0.29 per share of improvements in price mix, adding on to an exceptional Q3, in which we had realized over $30 million of sequential price mix improvement over Q2, Q4 ‘23. Sequential price mix improvements more than offset the $12 million or $0.24 per share of volume-adjusted incremental costs incurred during the quarter.

While we are still incurring significant cost increases, Q4’s $0.05 per share, a positive price mix cost recapture, is our third consecutive quarter of favorable net price mix cost recapture, closing the gap on the unprecedented cost increases we’ve endured over the past two years. Cost increases in the fourth quarter were driven by continued but leveling inflation, including commodity and energy rates, particularly in Europe, as well as productivity challenges in our Missouri plants. While we are beginning to see cost stabilize, it is important to remember that there is a delay in realizing product costs in our P&L until the related inventory is sold. Fortunately, this accounting treatment, coupled with lagging price-cost adjustments, should provide very nice margin tailwinds if and when inflation turns to deflation and costs normalize.

And we are more optimistic now that inflation is near an inflection point, as we’ve seen three consecutive quarters of solid gross margin improvement. Our adjusted gross margin expanded 320 bps in Q4 ‘23 over prior year inclusive of the IRA benefits and 150 bps before the IRA impact. Excluding the IRA benefit, we maintained margins sequentially. Going forward, price mix gains should continue to surpass cost increases due to ongoing price-cost pass-through mix improvements from supply chains loosening, especially for our higher-margin electronics products, and the margin benefit of maintenance-free conversions, as well as savings realization from our EOS accomplishments, such as footprint rationalization cost reductions and other lean initiatives, all of which should drop to our bottom line.

Please turn to slide 15. Looking at our quarterly sequential adjusted EPS bridge. Q4 ‘23 adjusted EPS came in at $0.02 per share higher than the midpoint of our guidance at $1.40 per diluted share, before the additional $0.42 per share benefit from the IRA. Our sequential results were driven by higher volumes and the $0.05 per share of net price mix cost impact previously discussed. Year-over-year, Q4 ‘23 adjusted EPS endured over $1.20 per share of pressure from higher costs in the quarter, which were more than recovered by an impressive nearly $2 per share of quarterly price mix improvements. Please turn to slide 16. Our balance sheet remains strong and positions us well to invest in growth and navigate the current economic environment.

As of March 31, 2023, we had over $340 million of cash on hand, and our credit agreement leverage ratio was at 1.8 times EBITDA, below the low-end of her target range. For the full year, we generated cash flow of $191 million, aided by a reduction in inventory this quarter. It is important to note that primary operating capital has historically been a significant cash generator during recessionary periods, providing a very effective natural hedge against the risk of a downturn on our balance sheet. Capital expenditures of $89 million in fiscal 2023 were below our original full year guidance due to the impact of supply chain headwinds on our capital projects. We remain on track for continued expansion of our TPPL capacity for fiscal ‘24 and incremental $150 million to $200 million per annum increases through fiscal year ‘25.

Our capital allocation strategy remains focused on three key priorities, investing in organic growth, complemented by strategic M&A and then returning excess cash to shareholders through competitive dividends and opportunistic share buybacks. We have adjusted our target to the lower end of or 2 to 3 times EBITDA leverage ratio range, in an effort to mitigate the impact of higher interest rates and provide dry powder for investment opportunities. I should note that in the first quarter, we completed a small bolt-on acquisition of a UK motive power distributor IBCS for under $10 million. Our fiscal ‘23 capital allocation demonstrates our flexibility to thoughtfully invest in organic growth and return cash to shareholders during a period of little to no M&A activity.

We repurchased approximately $23 million of shares and paid $28 million in dividends in fiscal 2023. We are entering fiscal 2024 with ample room on our balance sheet to remain flexible to meet our business needs. And we will continue to allocate capital with the goal of delivering the best long term returns to our shareholders. Please turn to slide 17. While we enter a new fiscal year 2024 with stable demand trends and a healthy backlog, we expect to continue to operate in a dynamic macro environment and anticipate the headwinds including FX, geopolitical tensions, supply chain challenges and inflation to persist for some time. Our fiscal first quarter 2024 guidance range is $1.77 to $1.87, adjusted diluted earnings per share, inclusive of $0.40 to $0.50 per share from IRA benefits.

Excluding the IRA credits, this represents an increase of approximately 20% over the prior year. We anticipate realizing gross margins of 24.5% to 26.5%, including 150 to 250 bps from the IRA, reflecting our expectations that our continuing mix improvements and EOS savings will drive margin expansion. This is especially impressive when you consider that we have absorbed approximately $500 million of zero margin pass-through price cost recaptured drag over the past two years on an annualized basis. Our CapEx expectation for the full year fiscal 2024 is approximately $120 million, reflecting investments in new products, including lithium production lines, and continued expansion of our TPPL capacity and will increase over time as we deploy additional investment from the IRA credits.

Please turn to slide 18. A reminder here that we look forward to presenting our strategic plans, growth drivers, and long-term outlook during our Investor Day in three weeks on June 15th, at the New York Stock Exchange, and we hope you will join us in person or virtually. This concludes our prepared remarks. Operator, you may now open the call for questions.

Q&A Session

Operator: Thank you. Our first question comes from the line of Olivia Young with Oppenheimer.

Noah Kaye: Yes. Good morning. This is Noah. Can you hear me?

David Shaffer: Hi, Noah. This is Dave.

Noah Kaye: All right. Yes, just to make sure, this is Noah Kaye from Oppenheimer. Thank you. So, a quick question on the tax credit, to start, the range of $0.40 to $0.50 benefit for the next quarter. I guess, just what factors would drive that to the higher or lower end of the range? Is it really just production of batteries or selling of those batteries? Are there other tax-related variables? Just help us understand the factors in the calculation.

David Shaffer: It’s mostly going to be mix, you know, just — and if there’s any production issues or unforeseen, so, the go-forward, obviously, for the rest of the year is going to be more like our forward look. In Q4, to qualify, you had to build in the quarter and ship in the quarter. But we shipped in Q4, some of that was from inventory. So that’s why we didn’t get a full benefit in Q4. But I think the go-forward should be fairly predictable and consistent with product mix. And certainly, we have to work, Noah, towards this new reality in terms of energy density. The market is clearly going to move and we have to move with it. Thankfully, energy — volumetric energy density has always been one of the key things our engineers have strived for since the beginning.

Our customers want the most available energy in the smallest available space. So, we’ve always driven for high volumetric energy density. And so — but the market is going to continue to move that way. And my team — and we’ve allocated dedicated resources to make sure that we keep pace with the market. But I think it’s largely a fairly predictable number.

Noah Kaye: That’s very helpful. And if we can sort of carry that forward, I guess, what would drive it up from here is really just your capacity and manufacturing expansion, right? If it really is just a function of how much you produce, and you’re already kind of capacity-limited as you add, TPPL and lithium-ion capacity. Theoretically, that number can grow from here. Is that fair?

David Shaffer: Absolutely. This is mostly a TPPL story right now. But to your point, lithium is certainly going to far exceed those volumetric energy density criterion. So, I think you summed it up really well. As we can execute to higher levels of kilowatt hour production output out of our TPPL factories, we should see more of this benefit. And again, there will be some level of optimization required in terms of balancing our factories deciding what we make where. So, there’s some — certainly some opportunities around the edges. But, I think you summed it up well.

Noah Kaye: Thanks. Can I double click on the commentary around how you see the timing of backlog normalization playing out? I think you had said maybe it would be a couple of quarters. Obviously, it’s still pretty elevated versus historical. Talk to us about how you see that playing out and any directional view you have on actual order rates versus just improving conversion of orders?

David Shaffer: Yes. I would say, largely orders are getting back to what I consider they feel more normal, even though to your point, they’re still elevated. I think a lot of that is going to depend on our customers in their ability to clear through their supply chain challenges and how much they’re going to be able to get their staffing necessary to work down their backlogs as well. So, we’re not entirely in control of the rate at which that backlog gets absorbed. We certainly have our own challenges that we have to wrestle with every day, but — so do our customers. And so a lot of that backlog release will come down to their ability to clear things out. But in terms of the go-forward, the order rates are getting back in check.

So, I’ve always, Noah, since the beginning of all this craziness, tried to keep the team focused on what an extrapolated projection of order activity would be from a pre-COVID standpoint, because everything that’s so disrupted. And I would say we’re largely on track. Europe, we certainly have our ion. They’ve got some very unique challenges over in that part of the world related to energy and the Eastern bloc countries, certainly a lot of that demand has evaporated. But I would say things largely in the EF space, it’s always lumpy. There’s always big project wins. And I know we have our ion, one of the big — one of our big customers in the telco space in the U.S. has announced a CapEx slowdown. So certainly, we’ve got our eyes on that impact.

I think so far, Andy, I don’t know if you see, that seems to be isolated to that one customer. I don’t think Drew or John or Paul or anybody has said anything different.

Andrea Funk: Yes. I think, right now, it’s the one customer. But actually, Noah, I’m real happy with what happened to our backlog in the quarter. What we’d like to see is a very soft landing to more normalized levels. And we’re still seeing strong orders in line with pre-COVID levels where we’d expect them to be and we don’t expect it to be some big drop-off of backlog. We think it’s going to be kind of normalized as customer order patterns return to pre-COVID levels.

David Shaffer: It’s going to take a little while to burn that through.

Noah Kaye: Okay. I guess, just the last question related to that is, within motive, the volume is kind of going slightly negative. Was that more related to production issues or kind of end markets? Can you just give us some color on the volume dynamics there?

David Shaffer: I would say mostly Europe, it’s mostly Europe story. So, that’s where most of the if any of the pressure is.

Andrea Funk: Yes. But Motive Power had an incredible maintenance-free mix pickup in the Americas. We — it’s a little bit of softening in EMEA. America has remained strong. We’re not yet seeing really anything that we’re concerned with, but we’re keeping a close eye on it because we read the same things in the newspapers you guys do.

David Shaffer: No, that team’s doing a great job. That’s really a fantastic group effort. I love what they’re doing in their forward look, and the product roadmap is — I’m really, really proud of that group.

Noah Kaye: Okay. Well, look, nice job on the margins. And great to see the IRA benefits come through. We’ll see you at Investor Day.

Andrea Funk: Thanks Noah.

Operator: Our next question comes from the line of Greg Wasikowski with Weber Research and Advisory. Your line is open.

Greg Wasikowski: Hey. Thanks for taking our questions. First one is on the tax credits and material portion being qualified. So, can you just — a two-parter with it. Can you remind us what portion of your product is produced within the U.S.? And then, within that, what is currently on plan regarding that portion of U.S. product that you expect to qualify for the credits? And I’m thinking, in other words, — yes, I just kind of want to establish a benchmark, I guess maybe, when we get to the other side of treasury guidance in the second half of this year. And we know that X percent will ultimately qualify, how does that ultimately compare to what you guys are putting in plan right now?

David Shaffer: Yes. This is just batteries for 45X. So, I would say, U.S. batteries as a percentage of revenue, is probably a little north of 50%. It’s in that ZIP code. I don’t have that exactly. I apologize. But I think in terms of the way to model it and think of it is, as I said to Noah, is it shouldn’t be reasonably stable from that Q1 projection to extrapolate that. And then, as we are able to increase our TPPL production capacity, that should drag along additional IRA benefit as well.

Greg Wasikowski: Okay. That makes sense. And then, along those lines, just on the facility closures. Just curious now at this point, is this still purely related to cost savings, or is there any sort of correlation to draw here between the products that you expect to qualify for tax credits and the facilities that you’ve closed or should be thinking about closing in the future?

David Shaffer: One case, we got evicted. So the developer, that industrial park wanted to redevelop it. So, we had to scramble frankly. We didn’t — that was out in California. So luckily, we were able to. The team has been really supportive. I just had a great call. And we had some success on our first product we made for some medical batteries in a new facility. So, the team out there has been great and we’re really happy with that. But in that instance, thankfully, we were able to pick up that equipment and physically move some of the team members into other locations. And I’m really happy with the folks that moved. And then, that’s one of the cases. And then, Andy is there…?

Andrea Funk: Yes. I’d add two things. First, just to comment on the Sylmar closure, even though we are evicted, it’s going to cost us a little shy of $6 million, of which $1 million is non cash, but we’ll save $4 million a year. So it’s a net positive. But these plant closures, while cost savings is always something we look at when we optimize our strategic plan, Greg, I think it’s really interesting to us to just show how the Inflation Reduction Act really aligned with what our long term strategic objectives are, closing Hagen, closing Ooltewah with closing some of our flooded footprint, as we migrate to more of our energy dense products, like Thin Plate Pure Lead and lithium. So, it’s really consistent with the strategic initiatives we had in place already.

David Shaffer: Yes. And the maintenance-free element of that as well is critical for where we intended. So, volumetric energy density and maintenance-free are exactly what we’ve been focused on all along. Andy’s exactly right. So, that is the go-forward plan.

Greg Wasikowski: Got it. Okay. That makes sense. One more if I could just on slide 14, the price mix charts, which are always very helpful for us. Just wondering if you could break that down for a segment at a high level, remind us, which segments are contributing most to that price mix catch-up and which are lagging at the moment?

David Shaffer: I’m going to start and let Andy go to her magic computer here. But I would say all groups in the prior Q4 had a good price mix catch-up. And I have to say that our customers have been reasonable. And we’ve tried to be reasonable as well recouping these costs. It’s just been — it’s been an unprecedented period and there certainly were some lags. Our EOS got — it took much longer due to the nature of that business to get started. But I think all three groups had pretty good performance in the quarter. Andy, do you have those numbers in front of you?

Andrea Funk: Yes. I mean, there’s a couple of things that I think are worth commenting. Number one is we had talked about before in Energy Systems, there really was a lag. So, they were a little slower getting out of the gate. And a lot of that, as we had talked about previously, was really due to the fact that they sourced a lot of their products from China. So, there was a longer lead time between the quote to ship. And so it really just took a long time…

David Shaffer: More contracts as well.

Andrea Funk: Yes. So, it took a little while to begin to manifest, and we’re very pleased to see it coming through. So that — we continue to get positive price cost recapture. The other thing that happened this quarter is our Motive Power, as we mentioned, this quarter and last quarter, just had an outstanding mix improvement with migration toward maintenance-free. So, that’s very positive as well. I think when you look at the trend of the price-cost, as we mentioned, the last three quarters being positive price mix, it’s — we’ve caught up. And I think our narrative now will probably pivot from being a price-cost recapture — we’ll certainly continue to go after pricing of inflation, and move more towards a mix improvement and cost reduction.

David Shaffer: Yes. But in terms of the balance between the three LoBs, it was fairly consistent, right? All three groups contributed meaningfully to the results.

Andrea Funk: Yes. Especially, we had a little bit of struggle from the Missouri plant. But otherwise, yes, all right, Dave.

Greg Wasikowski: All right. Thanks, Dave and Andy. I’ll see you in June.

David Shaffer: Thank you.

Operator: Thank you. Our next question comes from a line of Sherif Elmaghrabi with BTIG. Your line is open.

Sherif Elmaghrabi: I want to focus on Specialty. How do you see margins trending past Q1? Are they just a function of Missouri production and working through those TPPL capacity constraints?

David Shaffer: Yes, and the Sylmar facility move we just talked about. So, it was a combination of — we had a pretty tough Q3 in Missouri, and those costs disproportionately hurt the specialty P&L because it’s smaller. So, as a percentage of revenue, those costs are more problematic for the return on sales, and then the Sylmar facility. So yes, in terms of the price mix, the revenue growth, the product roadmap, I would say that that business is moving along nicely. I think there’s a lot of defense momentum building for us. So, it’s really exactly as you said, it’s these plant issues that we think are temporary and should improve as we move forward.

Andrea Funk: Yes. But, I could definitely see us returning back to double-digit in Specialty over the course of the next fiscal year. It’ll be a gradual pickup as we get Sylmar behind us. That might take a quarter or two, and then continuous improvement in our Missouri plants, as we’ve mentioned, both on a cost standpoint as well as an output standpoint.

David Shaffer: You have it right. Yes.

Sherif Elmaghrabi: That leads perfectly into my follow-up. The backlog increased sequentially for Specialty. So, I’m wondering, what are you hearing from your Class 8 customers more broadly? Obviously, you just said growth is limited by capacity. But, I’m just curious about the demand side.

David Shaffer: A lot of our Class 8 business today is with the OEM. So, we’re selling into the OEM portion of the business. And that sort of dominates the narrative with us. And that’s where a lot of our focus is. And the most of the discussion we have with the OEMs is still related to the tremendous amount of backlog there is for new trucks. So, that’s one of the industries that sort of really had trouble releasing a lot of pent-up demand for new trucks. And folks want new trucks for better fuel efficiency, just modernizing the fleet. So that — we still see a lot of opportunity as that backlog works its way through. And in terms of the miles driven or the overall economic activity, I would say that we haven’t been given any strong signals that are negative in any way.

But one of the big opportunities we have to remind you of is, as our production capacity improves, we want to expand our focus on beyond just the factory-fit OEM business. But there’s still three, maybe four times as much business in the service elements of these OEMs that do the service for these fleets. So, there’s still so much upside in this business. But in general, the team’s very optimistic. The backlog is still very, very strong in that — just in that transportation sector. Andy, is there anything I missed?

Andrea Funk: Yes. The only other comment that I’d make, and hopefully you’ll get this message from Mark Investor Day, what’s really exciting, as Dave mentioned, is the side that we’ve really been holding the reins on. We have a new transportation DC already to go as soon as we have the capacity available to start getting out of the gate. And Mark will provide a lot more color on that at Investor Day. It’s higher margin. The other piece when you look at Specialty backlog in the aggregate is to keep in mind that our aerospace and defense is pretty much made to order, so backlog isn’t really a good indicator in that business.

Operator: Our next question comes from the line of Blake Keating with William Blair.

Blake Keating: Hi, guys. Good morning. This is Blake on for Brian.

Andrea Funk: Good morning, Blake.

Blake Keating: I just wanted to ask about the maintenance-free. You guys have touched on it a little bit. It was up almost 20%, year-over-year for the full year. Can you talk — dive a little bit more into the demand drivers you’ve seen this year, and how we should think about growth moving forward? And then, what kind of margin tailwind should we see from growth in maintenance-free?

David Shaffer: I think, the demand driver mainly for maintenance is it’s just related to the lack of availability of human capital to do this task. So, these — there’s just not available people anymore to maintain batteries. So, that’s the key driver. So, it’s — in a sense, it’s a form of automation, but it’s — or technology advancement. So, that’s just been the key driver all along, and it will continue to be. So the other element of our products beyond being maintenance-free is we tend to operate at the high-performance end. And the duty cycle on batteries tends to just increasingly every year get more tough. In the old days, the battery sort of had one job, which was to crank an engine or just to emergency backup one time.

The amount of service that the battery was called to do was not very frequent. But today, the electrical demands, the batteries just get really abused. So customers need higher quality, more advanced products to stand up to the abuses of today’s application. So, that’s the other — the other driver is just a more electronic content in anything from a Class 8 big rig or forklift truck, there’s just more electronic content. And as such, the batteries are having to work much, much harder than they did in the years past. So, these are the main drivers for these. And this is things we identified from the beginning is the need for us to have these high-performance maintenance-free products. And as Andy noted, I don’t think it’s a coincidence that this lines up so well with what the IRA is all about.

So, we’ve been on the right path, and we’re going to stay on that path.

Blake Keating: Got it. Understood. Thank you. And then, just lastly, we’re hearing companies are beginning to see quoting activity pick up for projects related to the Infrastructure Bill. Can you talk about what you’re seeing with project activity and the expansion of broadband access? Are you seeing like the level of activity you are expecting or how should we think about potential growth tailwinds there?

David Shaffer: I think, specifically for us the one that gets most attention on my radar screen is the Rural Digital Opportunity Fund, the RDOF, the RDOF bill, which I think some of the funding came through that law. And one of our, I guess, broadband cable television customers has really taken a strong lead in that area. And we’ve seen and identified a pretty good chunk of their order book has been associated directly with these RDOF bill. So, that’s encouraging. We expect more of our customers — they’re certainly out front. We expect more of our customers in the ILAC world and other cable television type customers will also see opportunities to push fiber deeper into these rural areas. So, that’s the one that’s the most prominent for me. And we’re off to a very good start.

Operator: Thank you. I’m showing no further questions in the queue. I would now like to turn the call back over to David Shaffer, President and CEO, for closing remarks.

David Shaffer: I just want to thank everybody for your time today, and most importantly, I’m really excited to go into a higher level of detail and really demonstrate the product roadmap and the strategic initiatives we have going at our Investor Day, June 15th at the New York Stock Exchange. I hope you can make it, or certainly at least I hope you can dial in. Thank you so much for your time today. Take care.

Operator: Ladies and gentlemen, this concludes today’s conference call. Thank you for your participation. You may now disconnect.