Q2 2023 EnerSys Earnings Call
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The conference will begin shortly to raise your hand during Q&A you can dial star one one.
[music].
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Ladies and gentlemen, thank you for standing by and welcome to Interstates second quarter fiscal year 2023 earnings call. At this time all participants are in a listen only mode. After the speaker presentation. There will be a question and answer session to ask a question during the <unk>.
You will need to press star one one on your telephone please be advised that today's call is being recorded.
I would now like to hand, the call over to Lisa Hartman, Vice President of Investor Relations. Please go ahead.
Good morning, everybody welcome to the <unk> Q2 fiscal year 2023 earnings conference call on the call with me today are David Shaffer.
President and Chief Executive Officer, and Andrea Funk understood Executive Vice President and Chief Financial Officer, Steve.
Good evening, we published our second quarter fiscal year 2023 results and filed our 10-Q with the SEC, which are available on our website. We also posted slides that will be referenced during this call. The slides are available on the presentation page within the Investor Relations section of our website.
Ww Dot <unk> dot com.
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 those forward looking statements for a number of reasons are forward looking statements are applicable only as of today November 10th 2022 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 adjusted diluted earnings per share and adjusted EBITDA, which excludes certain items for an explanation of the difference between the GAAP and non-GAAP financial metrics. Please see.
Our company's form 8-K, which includes our press release dated November nine 2022.
Now I'll turn the call over to our President and CEO , Dave Schaeffer.
Thanks, Lisa and good morning, everyone. Please turn to slide four.
We delivered solid Q2 results with our second highest quarterly revenue in what is typically a slow quarter significant gross margin expansion as prices catching up with costs and robust demand for our products across our diverse set of end markets.
Second quarter net sales were $899 million, an increase of nearly 14% over Q2 'twenty two even after absorbing approximately $45 million of FX headwinds with strong volume growth in all lines of business.
Despite ongoing supply chain and inflationary pressures, we reported second quarter adjusted earnings of $1 11 per diluted share above the midpoint of our guidance and up 10 cents versus prior year.
We were encouraged by our adjusted gross margin expansion of 120 basis points from last quarter, a sign that we have begun to turn the quarter on the wall.
Long anticipated catch up on price cost recapture.
Margin improvement was driven by an impressive $30 million of favorable price mix accomplished across all segments of our business, which was partially offset by an additional $11 million of volume adjusted costs versus the first quarter.
Let me put our price cost recapture opportunity into perspective, our Q2 'twenty three costs were in excess of $100 million higher than Q2, 'twenty. One before inflation began to rise on an annualized basis over $400 million of higher cost equates to nearly $8.
For share of EPS pressure, even while ignoring the incremental impact on primary working capital and interest expense further closing of the gap between price and cost represents a significant earnings opportunity for enersys in the quarters ahead.
Commodity prices remained elevated relative to historical averages and some supply chain shortages persist both of which we are mitigating through alternative sourcing and increased stocking of critical raw materials. We're cautiously optimistic that we are approaching a supply chain inflection point with some note.
<unk> easing however, we continue to monitor how the supply chain environment is evolving including energy allocation in Europe and uncertainties in China.
Please turn to slide five.
Backlog was up 38% versus prior year and for the first time in several quarters declined slightly to $1 4 billion.
Due to an easing supply chain that enabled more products to be shipped primarily for energy systems in specialty.
Our backlog remains healthy and near all time highs with almost half attributable to program wins for energy systems projects and organic volume.
Demand continues to be strong across all lines of our business. Please.
Please turn to slide six.
Our strategy to invest in a diverse set of technology offerings and expanded the energy systems and markets is paying off as secular trends in U S. Government mandates and funding are driving markets to us while clarification from the U S government. Following the open comment period that closed last week.
Is still needed based on our initial assessment of the inflation reduction Act enersys could benefit from substantial direct taxpayer.
As well as market growth incentives for our transportation motive power and EV charging businesses.
Please turn to slide seven.
Our fast charging storage initiative continues to build momentum we are installing a significant upgrade to our current onsite demo with a near production grade system offering the highest energy density currently in its class with full artificial intelligence capabilities for optimized energy management and advanced cloud.
Services.
We are very pleased with our developments on this project. However, as previously mentioned the scope and scale of the project has increased throughout the design and development phase with our key customer. While this has led to a positive outcome. It is also added more time to the process than originally estimated.
The proof of concept phase is also being impacted by extended supply chain lead times as a result, we now expect our first revenue realization to be pushed out past this fiscal year.
That said, we remain incredibly excited about our fast charging storage initiatives and the significant opportunity that poses for us.
I'll now briefly walk through our business segment highlights the slides contain additional details about each line of business that I won't cover in my comments.
Please turn to slide eight.
Energy systems saw continued strong demand and volumes in the quarter, particularly in broadband and data center reporting revenue of $437 million or 18% increase compared to the same prior year period.
While we are realizing price and mix improvements across all end markets, resulting in sequential margin expansion and positive positive adjusted OE growth trajectory. We anticipate this topline growth to flow down to profitability as we continue to execute our price cost recapture strategy and.
To mitigate supply chain hurdles, which will yield a richer mix of sales for energy systems.
Demand continues for our mid spectrum <unk> architecture, DC power systems, and we are still in the early innings for small cell builds we expect this to be accretive to our business as we hold a large share of this market and we will ship a richer mix of products to support these projects deployment of <unk>.
<unk> <unk> small cells is forecast to reach $5 million in the U S and $13 million globally by 2027, According to Abi research.
Massive <unk> small cell deployments are expected around 2025 with network capacity on the seabed should run out without additional spectrum for small cell densification.
Sales related to the California public utility Commission CPUC public safety grid shutdown extended network powering program are ramping as expected with $40 million build in one H F 'twenty, three including $20 million in the second quarter and $95 million remaining in <unk>.
Backlog.
Since this mandate was announced we have booked over $170 million.
CPUC related orders to date significantly higher than our original expectations of $50 million to $100 million revenue opportunity a year and a half ago.
Motive power delivered another solid quarter, considering the typical seasonal slowdown in EMEA with <unk> 23 revenue of $338 million increase.
Increasing 5% compared to Q2 'twenty two we were pleased to realize significant sequential price recapture of $11 million in the quarter more than offsetting the $1 million of volume adjusted cost increases.
Our overall results reflect the strong customer demand for our proprietary <unk> <unk> and lithium ion maintenance free product offerings. We.
We expect the trend towards automation and electrification of material handling equipment, along with the value of our maintenance free technologies and advanced wireless charging solutions to continue to drive motive power going forward.
Strength of this business as evidenced by the successful launch of our recent Nexus customer day in our Ros, France plant, featuring <unk> and lithium ion line tours with 300 key customer decision makers across the globe, resulting in strong interest in orders for our proprietary maintenance free solution.
<unk>.
Our specialty segment delivered revenue of $124 million in the quarter up 23% year over year, primarily driven by strong volumes.
Demand remained robust throughout the business underscored by several customer wins during the quarter, including over 1000 store locations at a national retailer for our three new power sport batteries.
Although this line of business is challenged by <unk> capacity constraints Q2 price mix improvements more than offset sequential volume adjusted cost increases.
And transportation backlog was steady from the prior quarter and the outlook is bright as class eight truck OEM supply chains show signs of improvement.
September U S class eight truck orders hit an all time high in excess of 56000 more than two times those of a year earlier and above the previous record high in August of 2018.
We also remain very well positioned in our aerospace business and dominate the U S defense market with our premium <unk> and lithium technology.
Moving on to some developments and our production capacity and operational efficiencies.
The operations team experienced headwinds in Q2 due to unprecedented utility inflation, particularly in EMEA.
Along with a still unpredictable supply chain.
These headwinds coupled with a labor force in Missouri that has been difficult to build in a tight labor market.
In the ongoing productivity challenges and inventory increases in Q2.
However, we are pleased that our hiring targets have now been met across our <unk> factories and our focus for the second half of the fiscal year is to train and retain new hires which we expect to translate into productivity gains.
We exited the quarter better position in our Missouri plant than we were at the beginning of this calendar year. In addition, with signs of supply chain headwinds easing, we have shifted our inventory strategy and develop reduction goals by plant and line of business that our teams are now working on in lockstep to.
Against.
Due to a transition to Richmond has been seamless to date, which is a testament to our comprehensive planning process and culture of teamwork, especially given the scope of this cross functional project and the challenging global environment in which it was achieved we will begin to realize a portion of the $8 million of annual cost savings.
<unk> from this project in our Q4 'twenty three results.
Please turn to slide nine.
Sustainability is a core element of our growth strategy and we are working towards the many ESG goals, we announced this year. Our team has already identified additional ways to reduce waste energy consumption and costs as part of our initial planning phase we have allocated an average of $4 million of.
Annual capital spending over the next five years to execute these goals with expectations for accretive returns on these investments we look forward to sharing key milestones as we progress on our ESG journey.
Please turn to slide 10.
In closing, while we continue to monitor the supply chain environment and commodity markets. We are cautiously optimistic that our second quarter results represent a turning point with cost starting to plateau and signs of supply chain constraints easing.
Customer demand for our products remains strong with secular trends in our diverse set of end markets, providing support and a variety of economic environments scenarios.
Our top near term priorities are to increase productivity at our Missouri plants execute our inventory reduction initiatives and remain diligent and mitigating supply chain and inflationary pressures.
As we have firm last quarter, our long term strategic initiatives remain unchanged and we've made significant progress against them. Despite this highly disruptive period, we look forward to providing you details of our refreshed model and specific milestones, including our bottoms up analysis, reflecting current market.
Conditions at our next Investor Day, which will be held June 15th 2023 in New York.
I want to thank our employees for their continued focus and hard work.
<unk> quickly to changing environments.
Listening enersys for success, both in the near and long term. We're excited about the many opportunities ahead of us and look forward to updating our shareholders as we continue to execute.
With that I'll now ask Andy to provide further information on our second quarter results and go forward guidance.
Thanks, Steve.
I'll focus my discussion this morning on the key financial metrics and takeaways for the quarter.
For more detailed information about our results. Please refer to our second quarter 2023, 10-Q press release and supplemental slides that were posted to our website last night.
For those of you following along on our Powerpoint slides and will begin on slide 12.
Our second quarter fiscal 'twenty, three net sales increased nearly 14% over the prior year to $899 million.
Driven by 10% organic volume growth and 9% price mix improvement, partially offset by a 5% decrease from foreign currency translation.
Adjusted operating earnings were $65 million in the second quarter up 7% from the second quarter of fiscal 'twenty, two and in line with Q1.
Foreign exchange negatively impacted our year on year, and sequential comparisons by $5 million and $2 million respectively.
In constant currency Q2, 'twenty three adjusted OE improved over 14% versus the second quarter of prior year.
Adjusted EBITDA for the second quarter was $86 million and 95% of net sales compared to $79 million and nine 9% of net sales in the prior year second quarter.
FX pressured the year on year comparison by $6 million.
It is worth noting again that our margins are artificially deflated from the margin math impact of cost pass through.
Reconciliation of net earnings to adjusted EBITDA is presented in the appendix of our slides for your reference.
Our adjusted EPS was $1 11 in the second quarter of fiscal 2003 compared to $1. One in prior year second quarter and $1 15 in the first quarter of fiscal 'twenty three.
Present, a reconciliation of Q2, 'twenty threes sequential and year on year EPS shortly.
Please turn to slide 13.
On a segment basis compared to the prior year all lines of business posted significant revenue growth driven by higher volumes and substantial price mix improvement, which were partially offset by $45 million foreign exchange headwind.
However, the favorable impact of volume and price mix improvement on operating earnings was offset by higher costs and $5 million of unfavorable FX year on year.
As a result motive power and specialty posted slight OE declines however, energy systems almost doubled their quarterly operating earnings versus prior year with significant price mix catch up combined with higher volumes driving strong bottom line momentum.
More detailed sequential geographic results can be found in our press release and in the supplemental slides.
Please turn to slide 14.
On a sequential basis, we realized 60 per share of improvement in price mix in one quarter.
This easily dwarfed, the 23 per share or volume adjusted incremental costs incurred during the quarter, which while still significant where half of the sequential cost increases we incurred in the first quarter illustrating the long anticipated catch up on price cost recapture with our most substantial net quarterly price.
Recapture game by far.
Cost increases in the second quarter were driven by ongoing inflation in energy rates, particularly in Europe .
As well as some productivity challenges in our Missouri plant, while we train and develop our new team members.
It is important to remember that there is a delay in realizing product costs in our P&L until the related inventory is sold this accounting treatment coupled with lagging price cost adjustment should provide margin tailwind, if and when inflation turns to deflation and cost stabilize.
Expanding on Dave's comments about the extent of inflation, we've endured over the past two years, we have incurred aggregate cost increases in Q2, 'twenty three versus Q2, 'twenty one of over $2 per share or $8 per share on an annualized basis.
We have offset a $1 85 per share of these costs with price mix improvement, leaving approximately 15 cents per share of quarterly price cost recapture opportunity.
I would now like to highlight that this understates, our two margin expansion potential.
Price mix gains should not just catch up but rather should surpass cost increases over time due to the savings realization from our iOS accomplishments, including the Hagen and ultra what plant closures as well as mix improvements from supply chain loosening and the margin benefit of maintenance free conversions.
All of which should drop to our bottom line.
As Dave mentioned supply chains are starting to stabilize availability of key inputs, such as chip resin and other raw material is beginning to improve and become more reliable and indices indicate that inflation is beginning to level off giving is guarded optimism that our margins have reached an inflection point.
Indeed, after six consecutive quarters of gross margin erosion from steeply escalating costs, our gross margin improved by 120 basis points in Q2, 'twenty three as a regressive price mix improvements began to catch up with the unprecedented inflation, we've endured over the past year and a half.
However, we continue to keep a close eye on developments and global economies.
Particularly the energy situation in Europe , and its ensuing impact on our business.
Please turn to slide 15.
Looking at our quarterly sequential adjusted EPS Bridge.
As mentioned Q2 'twenty three adjusted EPS came in a penny higher than the midpoint of our guidance at $1 11 per diluted share.
Net sequential price cost recovery positively impacted earnings by <unk> 37 per share demonstrating our earnings growth opportunity as price catches up to costs.
This was offset by <unk> <unk> per share of pressure from our seasonally lower volumes 24 per share of incremental opex from higher personnel and travel costs.
<unk> per share of net pressure from FX and interest rates.
Similar to last quarter, we have been increasingly impacted by significant foreign exchange movement.
In Q2, 'twenty three versus prior year operating earnings were reduced by approximately <unk> 10 per share from the weak euro.
This was partially offset by <unk> <unk> per share favorable other income and expense change largely due to FX revaluation from the declining euro.
We anticipate that we will continue to experience operating earnings pressure from the strong dollar, but the favorable FX revaluation and other income and expense will not repeat in future quarters. If the euro dollar exchange remains at current levels.
Sequentially FX created <unk> <unk> of incremental drag on both OE and EPS in the second quarter of fiscal 'twenty three versus the first quarter.
Please turn to slide 16.
Our balance sheet remains strong and positions us well to navigate both the current economic environment as well as the potential downturn.
At the end of Q2, 'twenty, three we had almost $300 million of cash on hand.
Our credit agreement leverage ratio was at two nine times EBITDA, which was at the high end of our target range, but slightly lower than the first quarter of fiscal 'twenty three.
In Q2, we invested an additional $41 million in primary working capital to support our strong revenue growth.
We have increased inventory over $170 million in the past fiscal year 34 million of which came in in the second quarter due to our higher revenue, but even more so as a result of our intentional decision to create targeted inventory buffers against potential supply chain disruptions.
As well as the impact on inventory from longer lead times, and higher raw material manufacturing and freight costs.
That said as Dave mentioned, we have now shifted our focus to reducing inventory, we're prudent with teams in place to execute on inventory reduction targets that we expect to begin to generate positive free cash flow by the end of fiscal 'twenty, three and minimize the potential risk of obsolescence, if demand softens and more.
Both areas of our business.
We anticipate our leverage ratio will improve and trend towards the midpoint of our target range of two to three times EBITDA in the second half of fiscal 'twenty three from this shift in focus to more efficient working capital levels combined with the numerator and denominator benefit from improved earnings as our prices continue.
To catch up with costs, and we realized a richer mix of sales from an improving supply chain.
Capital expenditures were roughly $17 million in fiscal Q2, 'twenty three we remain confident in our multiyear plan to TPP L capacity targets building off our capacity expansion success in fiscal 'twenty two.
Our capital allocation strategy is unchanged with their focus on three key priorities in this order investing in organic growth.
Strategic M&A.
Returning excess cash to shareholders through consistent dividends and opportunistic share buybacks.
In Q2, 'twenty three we did not repurchase any shares in order to maintain our liquidity position and an uncertain macro environment.
We are committed to our capital allocation strategy and expect to buy back shares once our leverage returns to the midpoint of our target range we.
We currently have $185 million authorized in our share buyback program.
Please turn to slide 17.
While we have not seen signs of a slowdown in our business.
Factors, such as the fed tightening and the ongoing war in Ukraine are raising increased concerns of a global recession.
As a reminder, we have a strong balance sheet conservative capital structure and a number of structural advantages that have mitigated the financial impact to us in past economic downturns and position us even better at this time.
These include.
Over 60% of our business follows GDP independent cycles that are fueled by large mega trends, including five that.
That are expected to continue regardless of the macro environment.
We have a near record backlog and strong orders in all of our lines of business.
Stable costs should drive further price recovery catch up improvement with potentially lower cost, creating tailwind from lagging price cost dynamics.
The continued easing easing of supply chain disruptions should help drive profit through volume and mix benefits and.
And finally, because primary working capital historically has been a significant cash generator and slow down it should serve as a very effective natural hedge on our balance sheet and even more so now to our due to our current elevated levels.
Please turn to slide 18.
Our fiscal third quarter 2023 guidance range is $1 20 to $1 30, adjusted EPS a significant increase to the dollar one share we reported in Q3 22.
Our guidance reflects our expectation of continued sequential volume and price mix improvement, partially offset by ongoing FX headwinds and higher interest rates.
We expect our gross margin to be in the range of 21% to 23%.
Our capex expectation for the full fiscal 'twenty three remains at approximately $100 million.
Reflecting investments in new products, including lithium production lines continued expansion of our <unk> capacity and cost improvement and automation initiatives.
We are cautiously optimistic that the true profitability of our business and the advancements we have made against our strategic plan are beginning to be visible in the trajectory of our earnings even in the face of ongoing macroeconomic challenges.
We look forward to providing you an overview of our refreshed five year model at our Investor Day in June .
This concludes our prepared remarks, operator, you may now open the call for questions.
As a reminder to ask a question you will need to press star one one on your telephone again Thats Star one one on your telephone to ask a question. Please standby, while we compile the Q&A roster.
Our first question comes from the line of Noah Kaye of Oppenheimer. Please go ahead.
Good morning, Thanks for taking the questions.
Nice to see the number of items impacting positively here.
I'd like to start with supply chain, you, obviously mentioned a number of.
Our considerations during the prepared remarks, but can you talk about your visibility into supplier allocations.
How we should think about the cadence of the backlog conversion.
This quarter and possibly.
The fourth quarter as well.
No I.
I would say the key.
Change.
Quarter to quarter has been the semi conductor.
That market has loosened up considerably.
<unk> seen improved forecasts for certain product segments.
That is noted.
The electronics tend to be higher margin products. So it's accretive to mix and just as a reference point is one of the.
Products was as low as 8000 a quarter.
And <unk>.
Forecasted going forward is that could be as high as 25000 a quarter.
So it just it gives you a sense of.
How much loosening is occurring.
And so.
That's going to help.
Drags in the shack logged out that's going to help drag.
Some margin out of the backlog.
And that's been the biggest change of late in terms of the other supply chain issues, they've been a little quieter nothing.
I don't want to give the sense, we're completely out of the woods are certainly still.
Surprises that happen frequently.
But it has improved.
So.
So I think the biggest opportunity for me I'm excited about the two things.
<unk> have come down I don't say.
I don't know Andy there, if they're not all the way back copper and steel and maybe steel but.
Things aren't all the way back, but certainly they're on their way back to.
Sort of these pre inflationary periods, so that's helping.
And certainly the freight has come down considerably.
So that's helping and then semiconductors is the big pieces.
And.
So yes, I think those are the major supply chain.
From a H two versus H, one perspective are.
Our improving but I don't want to certainly don't want to say, we're completely out of the woods.
Do you think.
Some of that improving the allocation.
Related to the consumer electronics.
Demand is getting softer or are these really industrial chips, right analog and RF and mixed signal and Youre, just seeing improving flow.
On that side.
Well I think the.
Teams have done a lot of work on redesign so a big part of this is we probably pulled 20% of our engineering.
And re reassign them from new products onto redesigning products around or readily available chips. So that's been a huge part of it.
Most of the chipsets Noah that we use.
Especially on the microprocessor side are the ones more automotive so I think that the.
Those are the types of chips that we use these these lower costs micros.
And it's just it's just gotten better.
Okay.
Very helpful. And then you mentioned.
Capture some margin with that backlog conversion I guess can you help us think about quantitatively.
The margin uplift in the margin profile of what's in backlog or you talked earlier about that kind of price recapture opportunity how much of that is just in the backlog conversion already.
Yes, again, it will come down too.
Execution.
In terms of how many of these units we had at the door and what you should see as we go forward is a steady improvement in the performance and this is principally going to be viewed in our energy systems business. So.
You should start to see a better mix coming out of that group I'm, a little hesitant to dimension too much but I would tell you that the electronics mix tends to be very accretive.
So.
It is a nice opportunity for us and if you do look at the magnitude of the Es backlogs relative to historic norms.
Yeah.
Came down a little bit of backlog, it's still very very high.
A lot of what's in that backlog is electronics. So we're.
We're optimistic as the as the allocations improve from our chips.
Chip suppliers things things should steadily get better.
I'll take the rest of my questions offline, but nice quarter. Thank.
Thank you. Thank you.
<unk>.
Yes.
Thank you. Our next question comes from the line of John <unk> of <unk>.
Adobe. Please go ahead.
Good morning, everyone and thanks for taking the questions.
I'm curious what your thoughts are on the e-commerce market.
Number of the larger players Amazon.
Walmart has decided to cancel two construction of some warehousing facilities.
Have you seen any impact of that or.
Or you expect to see that maybe in the motive side of the business can you talk about what you're hearing now.
Yes, I would say motive is where we're most tuned into.
Recession monitoring a slowdown monitoring.
In terms of a lot of if you remember.
A lot of those big Mega distribution centers, where.
Using fuel cells. So.
I don't know that we're seeing the direct impact of yet our order rates tend to be good and then the other the key driver.
I ran into Chad the cafeteria couple of days ago, and he runs that.
He runs motive power sales in North America.
And he.
He was very clear the biggest issue that we're having in motive is still its just adapting to the very long lead times for the forklift trucks.
They're ordering the batteries much sooner than they did in the past and thats been the biggest adaptation, but he didn't seem to have any concerns about.
A slowdown per se.
Think more that's more for Vincent Vincent Scott, our European business, He seems a little more.
Concerned about the macro situation I think mostly around these energy and.
And potential energy impacts on the European economy, but I would say that we are seeing or feeling any direct impact from these big E. Commerce announcement, we have seen those.
For sure.
And we're continuing to monitor.
And.
What we're really what we're trying to do.
John is really make sure and this is what I've asked.
Teams to do.
Is recognize that through this period.
Covid shutdowns and then the and then the snap backs in the recoveries. There's a lot of noise from a volume perspective, and then an additional the inflation and pricing recapture and then now the FX you shipped a tremendous amount of noise in the revenue and what I tried to get the team to focus on this.
Ice halation isolating the volume.
And comparing it to what sort of a <unk>.
Normalized trajectory would be from a volume perspective kind of <unk>.
Pre COVID-19 and to see how we're tracking relative to those historical norms and I would say the best data I have for you right now.
Is that things are really starting to normalize to from a volume perspective back to where they would've been so think of a big drop and then a big spike in <unk>.
And things seem to be coming back down to.
From a motive power.
We're watching very carefully but haven't seen any direct impacts on the ecommerce side yet over.
Yeah.
Thank you thanks, David Thats helpful.
And just on the backlog historically wasn't something we haven't talked about but Scott so large that we can't ignore it.
I'm just kind of curious.
How firm is the backlog.
What is the cancellation risks is it different between each segment.
Maybe some context there what your thoughts about you seem to be buying in advance or others.
I have to take delivery.
That was helpful.
Let's go through the different business segments, and then Andy can certainly dimension for US I would say the biggest backlog growth has been related to some big program wins in our energy systems business. So backlog growth has been a function of a lot of these mid spectrum DC power cabinets, we've been set.
<unk> four <unk>.
So that's been a big part of it and then another big part of our backlog growth has come from the CPUC project, We had mentioned and we're shifting we're shipping against that.
We haven't but we havent of the $170 million in orders, we have we've shipped less than half of that so far.
So the.
That's been a big so there's been some big program wins in our defense business. There's some program wins, so some big ones and those are the pieces of the business that.
That we feel good about nothing's recession proof, but.
These businesses Es and defense.
They have their own rhythm.
In terms of motive I would say principally the backlog growth today is related to what I had mentioned earlier, which has a lot to do with the truck lead time, So I think that.
The the truck lead times are getting people to order sooner.
And and we're still coming off a strong period of motive power demand for new trucks. So.
Yes.
I would say that.
And we've challenged the teams.
Lee said and Youre sitting with me and we challenged the teams regularly to look at cancellation rates too.
And Andy is there anything you've seen in the testing.
And I can give a little bit of simonton to the data that will be helpful. For you John .
G systems in our backlog is up $600 million.
Versus two years ago, very healthy no COVID-19.
Covid related risk of cancellations a lot of it is as David launching program related <unk> CPUC.
Strong market and just give me an idea at $600 million at higher margins with a lot more electronics less service.
He assumed the 25% drop through over $100 million of OE trapped in that backlog, so big numbers minimal risk Theyre transportation's up $30 million versus two years ago. There's a lot of pent up demand from 18 trucks minimal risk of cancellations I think you've seen we just had a record.
Class eight order a lot.
So very strong there as is down slightly but that's really choppy because of projects.
S government replacement spend for Ukraine support isn't flowing through yet, but we expect that's going to start coming in strong which leaves us a quote of power probably the area you're focused on the most.
It's up 200 million dollar backlog versus two years ago, and $100 million from a year ago.
We would look at that is most exposed so as Dave mentioned, we're constantly plotting at it but we arent seeing any cracks yet.
If you look at the data in our backlog there $380 million our quarterly backlog cover just over 111 in Q2 of 'twenty. One to give you an idea that was <unk> six a book to ship ratio with just around 100%.
So.
While we have seen a softening of orders. So we look at a five year trajectory rate and we're right in line with where we were pre COVID-19. So we're seeing a softening because we don't have this huge catch up from the one we had the COVID-19 decline, but we're keeping our eye on it but it still look pretty healthy we're not we're not concerned yet but.
I assure you, we're not taking our eye off that.
And then just on this topic.
You said, there's some concerns in Europe as the order.
That could change at all in Europe , We just discussed.
Monitoring.
Because of the conditions.
Say more monitoring.
Excuse me, yes, I would say it's more just we're just nervous as everybody as we're all watching CNN and.
Thank you.
Lot of a lot of risk.
We're doing a lot of.
We're taking a lot of proactive actions.
For any kind of mitigation. If there is curtailment that would be outside of our control. Each of our plants has provided a letter to be handed out to authorities highlighting the importance of our activity.
If there is any kind of curtailment.
We split our EMEA countries into three risks from low to high raw switches are our large <unk> plant in France is at least at risk because of the excess capacity of nuclear energy in France, we have planned scenarios in place at each one of our plants in case of restriction, including priority to single source products.
Perhaps some contractual agreements.
Looking at different ways, we can look at a bottleneck saturation, reducing consumption on the supply side alternative sources for suppliers in any high risk countries, so not only our own exposure with exposure ever.
Our suppliers and finally longer run we've developed the plan to reduce the energy consumption by about 15% per kilowatt hour over the next 12 months.
They're looking at processes, reducing usage consumption and waste in house production and fully aligning that with our sustainability goals as Dave mentioned, we've allocated about $4 million per year for the next five years to achieve our sustainability goals and we're prioritizing.
That region because of the exposure.
And John back on your first question.
And again staying focused on motive.
We've been through some downturns together over the years and if I look at if we do get a downturn what system that will look like compared to the ones in the past.
We have two less big factories than we did before in terms of.
Hagen.
That's going to help the motive.
<unk> got a leadership team in there that is 100% wholly committed to.
Opex productivity.
Automation.
In doing doing more with less I'm really proud of that team and a lot of their efforts.
And then we've expanded our product range dramatically with higher margin products, including our Nexus pure <unk> on Nexus I on lithium.
And our wireless charging which is just getting kicked off so I think theres a lot of reason.
And then as Andy always notes that in these recessionary periods commodities tend to fall off which takes a little pressure off the P&L and we tend to generate a lot of free cash flow, our working capital needs to go down so.
I think that relative to prior downturns, we're in better shape than we've ever been.
The new product mix and the smaller factory footprint in the higher level of productivity out of our.
Out of our other factories so.
We're doing what we can do to be ready.
Great Thanks, David and Andy I appreciate the detail.
Okay.
Sure.
Thank you. Our next question comes from the line of Greg Watson Koski of Webber Research. Please go ahead.
Hey, good morning, guys. Thanks for taking the question.
First one just on.
And then on the IRA and slide six I know everybody needs. Some more further details before really.
Figuring out your full strategy, but.
The potential there kind of change how you think about your strategy for some of your products and end markets and I'm just thinking.
Outback for an example, like maybe making that less of a niche product and trying to make it more mainstream in.
Ready or commercial solar.
Or any of the other products that are listed on that slide.
Yes, I would say.
On Iras.
There is the tax piece, which is interesting.
And I would say the biggest issues there and the common period, just closed I think last Friday right Lisa.
And.
And most of the comments or questions were around defining.
So the target was a battery that was 100 watt hours per liter. So we wanted a clarification on what see rate to determine the watt hours.
And then on the leaders we needed some clarification on.
Being.
Which dimensions to use interior cell dimensions of the exterior module dimensions, and so forth so but that's a.
I was really.
This is my product engineering background.
All of our lithium products will hit that what a 100 watt hours per liter target and.
And then.
A pretty nice chunk, depending on how things shake out with the with the comment period. In these definitions are pretty good chunk of our <unk> business because it is the.
We have always targeted volumetric energy density that's what we've always pushed is not so much gravimetric our weight.
But that's not been our our focus is always on volumetric energy density. So we've got quite a few products that are should hit that 100 watt hours per liter metric and as such could qualify for some.
Material.
Savings.
Have to see how those definitions work out so well I don't want to dimension anything for you but.
It could be a real interesting and then in terms of your question on the on the demand or market side.
We just feel really good about.
Yes.
Nervy and some of the things in the original inflation or excuse me infrastructure, a law that came out.
Theres just a lot of positive.
Activities within each all of this recent legislation.
That is right in our wheelhouse so.
Specifically on Outback I would.
Yes.
I had noted earlier, we pulled about 20% of our engineers off of.
<unk>.
New products to focus on Redesigns.
To make sure that we could ship, our Chargers and ship, our rectifiers and UBS systems the biggest.
Hit.
For engineering resource allocation was our residential energy and some of those out back programs, so and Thats kind of unfortunate so I take your point.
In terms of.
And as we get through some of the supply chain redesign issues, we do.
I take your point loud and clear we should let.
Some of those opportunities.
From from these new laws shape, how we prioritize and re prioritize where those engineers are allocated so it's a good suggestion.
Got it okay. Thank you.
Next one is on the EV charging product and this is it.
Tough for us from the outside looking in but.
It seems like the product is maybe maybe been commercially ready for some time.
I know you guys had done some upgrades.
But maybe maybe we could think about them as more more akin to like typical annual generation updates but.
At the same time it seems like things are pretty cooperative between you and your.
I am declaring an anchor customer which is good.
Speed to market is really important right now in EV charging so just.
Have you thought about.
Going out into the market with other customers who are doing other pilot programs.
Did your agreement maybe preclude you from doing so I'm, just trying to understand the relative sense of urgency and.
Desire for land grab felt around the industry versus.
The speed with which.
This product is moving just I'm just trying to get your thoughts there.
Yes, I would say that.
Engineers have gone and this may be the first time that the engineers are ahead of the salespeople.
The engineers have done extremely well.
And.
We've got the new I would call a production system getting installed near.
Near production system I think there's a couple a couple of things that need to be tweaked, but the new system is getting installed right now.
Next door.
And just to your point beyond our original target customer who has a use case, which is really interesting and we really like.
But we've also decided that we're going to go after some of these nervy.
Charging station projects that the RF queues are just starting to come out I think we should see.
The first RF queues, maybe December but probably January .
I know theres about seven states and they are building out these fast EV charging along major arterial routes. This is if you remember this is about $5 billion worth of monies that were.
Allocated in the.
Infrastructure law, so and the states are I think it's in the 80%.
Funding and the states have to kick in 20% as they build out these charging stations. So we are participating in those RF queues just person dimensions, we gave some rough targets for us $50 million to $100 million to get started.
50 $50 million is 1%.
That Navy program, so given given what we've assessed so far in terms of.
The specifications.
We feel good we feel good that there is a good overlap between what the what the states are looking for and what we've got ready. So in terms of your comment earlier about commercial readiness, we really arent commercial ready wear.
We're just now getting the design, where we want it with the DC to DC.
Higher efficiency conversion architecture, but that said the engineers are doing a fantastic job.
And we will just continue to report progress and hopefully by the next time, we speak we will have seen some of these RF queues and we can give you a sense as to how.
From the cost targets and the specifications how optimistic we can probably give you some at least a level of optimism as to.
What we think once we started to see the RF queues.
Okay.
Great context very helpful. Thanks, Dave I'll pass it on.
Okay.
Thank you again to ask a question. Please press star one one on your telephone again star one one on your telephone.
Question.
Our next question comes from Greg Lewis of <unk>. Please go ahead.
Hey, Thanks, and good morning, everybody I'm, Dave I did want to touch a little bit on the comments you made around inventory run off.
Realizing we're not probably going to get too granular on or around that but is there any way to kind of walk through.
The different business lines, and maybe how youre thinking about.
Whether it's energy systems or mode over specialty.
We're thinking about rolling off that inventory and as part of that was that an overbuilding inventory.
Inventory build given supply chain issues that you have that the industry was facing over the last 18 months or is some of that also related to conversations we're having with.
With some customers.
A big chunk of it a big chunk is stockpiling lithium.
For our <unk>, making sure given the choppiness in the tight lithium cell market is extremely tight so a big chunk of the inventory build is related to lithium and the other part of the build.
Is just the.
We werent trusting our Asian supply chain, given all the choppiness with the freight and the longer lead times and the Covid shutdown. So we were way overstocking relative to historic norms, a lot of the DC power systems.
We're putting together that have an Asia content.
I would say most of it there hasnt been a ton in motive per se.
Strategic other than the Chargers, because the electronics supply chain I think we did stuff a lot more chargers in inventory than we historically do.
And then on the specialty side.
It's really just been about the.
Having enough whip and.
Raw materials like led.
Just making sure we had enough.
To give us a higher sense of comfort things are improving and I think that the.
The ops teams are.
Under.
Severe pressure from Andy frankly.
Pushing hard to get back to more historical norms and we.
We're coming through this kind of traumatic period of supply chain disruption in security.
Andy is there did I Miss anything on that go around.
Can't give you a little more color, Greg if it would be helpful.
And put a little bit of data behind it so I think Dave Neal.
Points, but since Q2 of 'twenty, two we've grown inventory by about $170 million.
And if you look where that comes from about $65 million of strategic investments about $35 million as volumes about 55 million inflation and $15 million supply chain, but if I look at typically where I am on Q2 on an inventory turns I usually between four three or four eight so call. It four.
<unk> four and a half as an average if I pull out my strategic build so much supply chain headwinds around four two right now so.
There is some opportunity to be more efficient, but the.
Other thing we'd like to look at where interest rates are where they are and also with any potential exposure of a downturn. We wanted to be actually better than we were before even after taking into consideration strategic builds in supply chain headwinds. So we've passed there's a weekly meetings that we have all of our lines of businesses represented all of our heads if Oliver.
Our different manufacturing areas representative Dave identified $150 million of reduction opportunities, they're tracking them on a weekly basis. There is actions in line.
I haven't felt all of that into my sensitivity analysis from a working capital standpoint, because I recognize there's going to continue to be headwinds and I will say until supply chain issues subside. We will continue to use inventory buffer exposure. So we're not we're not turning the corner on being Penny wise and dollar foolish and.
We're fortunate enough that we don't we have the borrowing capacity that we don't have to make decisions that are not in the best interest of our shareholders. We recognize its going to be a cash flow opportunity when macro environment normalize but.
And all of our review meetings every week, Dave would be same price price price price now it's price inventory.
So there is definitely a change in focus there isn't accountability, we are measuring it and we do believe there's opportunity to make improvements here.
Okay Super helpful. Thank you very much.
Thank you.
Thank you at this time I would like to turn the call back over to David Shaffer for any closing remarks, Sir.
Thanks, Latif and thank you everyone for joining us today, and we look forward to providing further updates on our progress on our third quarter fiscal 2023 call in February .
Good day everyone.
Yes.
This concludes today's conference call. Thank you for participating you may now disconnect.
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