Categories Earnings Call Transcripts, Industrials

EnerSys Inc (NYSE: ENS) Q4 2020 Earnings Call Transcript

ENS Earnings Call - Final Transcript

EnerSys Inc (ENS) Q4 2020 earnings call dated June 02, 2020

Corporate Participants:

David M. Shaffer — Director, President and Chief Executive Officer

Michael J. Schmidtlein — Executive Vice President and Chief Financial Officer

Analysts:

Noah Kaye — Oppenheimer — Analyst

Brian Drab — William Blair & Company — Analyst

John Franzreb — Sidoti & Company — Analyst

Michael Webber — Webber Research — Analyst

Presentation:

Operator

Ladies and gentlemen, thank you for standing by, and welcome to the Fourth Quarter 2020 EnerSys Earnings Conference Call. [Operator Instructions] Please be advised that today’s conference is being recorded.

[Operator Instructions]. I would now like to hand the conference over to your speaker today, David Shaffer, President and CEO. Please go ahead.

David M. Shaffer — Director, President and Chief Executive Officer

Thanks, Sara. Good morning, and thank you for joining us for our fourth quarter and full year earnings call. On the call with me this morning is Mike Schmidtlein, our Chief Financial Officer.

Last evening, we posted slides on our website that we will be referencing during the call this morning. If you didn’t get a chance to see this information, you can go to the webcast tab in the Investors section of our website at www.enersys.com.

I’m going to ask Mike to cover information regarding forward-looking statements.

Michael J. Schmidtlein — Executive Vice President and Chief Financial Officer

Thank you, Dave, and good morning to everyone. As a reminder, we will be presenting certain forward-looking statements on this call that are based on management’s current expectations and views regarding future events and operating performance and are subject to uncertainties and changes in circumstances. Our actual results may differ materially from the forward-looking statements for a number of reasons. Our forward-looking statements are applicable only as of the date of this presentation.

For a list of factors which could affect our future results, including our earnings estimates, see forward-looking statements included in Item 7, Management’s Discussion and Analysis of financial condition and results of operations, set forth in our Annual Report on Form 10-K for the fiscal year ended March 31st, 2020, which was filed with the U.S. Securities and Exchange Commission.

In addition, we will also be presenting certain non-GAAP financial measures. For an explanation of the differences between the comparable GAAP financial information and the non-GAAP information, please see our Company’s Form 8-K, which includes our press release dated June 1st, 2020, which is located on our website at www.enersys.com.

Now let me turn it back to you, Dave.

David M. Shaffer — Director, President and Chief Executive Officer

Thanks, Mike. I would like to spend the first few minutes of this morning’s call providing an update on how COVID-19 is impacting our business and the things we are doing to confront this challenge.

Despite the many challenges this pandemic has brought with it, our focus has been on the health and safety of our employees worldwide. Wherever possible, our employees are working from home and every factory is operating in compliance with all applicable health and safety guidelines, rules and regulations.

I’m extremely proud of the responsiveness and adaptability of our employees in the face of this crisis. Morale has stayed high as the teams continue to pull together to get the job done for our customers. I’ll talk more about our go-forward strategy in this COVID environment later in the call.

I’d like to move on to Slide 3. The most significant COVID-related impact on EnerSys was the forced closure of our electric forklift and Class 8 over-the-road OEM truck customers in April, which had an immediate impact and significant effect on order rates. While these customer’s facilities have since reopened, many are not operating at full capacity due to market demand or their supply chain disruptions.

Though our May sales looks much stronger than April, given the uncertainty about the full size and shape of the truck OEM recovery, we are not in a position to provide forward-looking guidance at this time. While we have only seen minor supply chain disruptions, our largest factories around the world have continued to operate, given the vital nature of our products in many critical infrastructure markets including communications, information technology, defense, energy and transportation systems.

I’d like to move on to Slide 4. In light of the headwinds caused by the COVID outbreak during this quarter, we were pleased to report fourth quarter 2020 adjusted earnings of $1.11 per diluted share, which is largely in line with information contained in our April 21st press release. China’s economic activity was the hardest hit during our fourth quarter with our two plant shutdown for several weeks and our order demand slowed significantly.

In Europe and North America, the impact of the coronavirus was felt mainly toward the end of our fourth quarter. As previously noted, orders in EMEA had been softening from our traditional Motive Power OEM customers pre-COVID and we also saw the return to the market of a low priced competitor in EMEA in the third fiscal quarter. Despite these challenges, EMEA demand for high-margin, Motive Power TPPL products continues to be strong. Mike will provide more detail around the quarterly results in his portion of the call.

Please turn to Slide 5. I’d now like to update you on some of our key markets. Energy Systems Americas enjoyed a strong order intake in Q4, driven by a number of factors stemming from the nationwide build out of 5G.

T-Mobile closed the acquisition of Sprint which help move prior orders through as well as generating new ones as T-Mobile aggressively continues with its 5G ramp-up using the broader spectrum available to the combined companies. This benefits EnerSys batteries, Purcell cabinets and Alpha electronics. The regulatory approval also mandates that Dish is spun out and must create their own 5G network as the fourth nationwide provider, which we believe has positive implications for EnerSys down the road.

AT&T and Verizon both won recent 5G spectrum auctions and are expected to be strong bidders in the high-speed C-band spectrum auctions in the fall that will facilitate millimeter wave and the highest available 5G speeds. We continue to work closely on a next-generation line powering system with one of our larger customers in this space.

Telecom customers as a whole seem committed to their increased calendar year 2020 capital expenditure plans. Telecom batteries, power systems, enclosure and services should see the positive impact of this trend in fiscal 2021, particularly with 5G nationwide deployment initiation and fiscal ’22 acceleration.

The COVID related work from home initiatives have stressed all broadband networks with more than a million new broadband subscribers in the first quarter of this calendar year, encouraging broadband companies to continue investing in their networks to increase capacity. We believe outside plant powering products from Alpha will need to follow.

Finally, the outlook for wireless quad-play initiatives remains positive for EnerSys. We continue to develop broadband power electronics including our new DOCSIS 3.1 compliant outdoor UPS. Alpha’s gateway product allows a 5G small cell to be connected to over a million miles of existing hybrid fiber-coaxial networks installed by broadband providers, delivering immediate power, backup, and access to the MSOs backbone, fiber network for data backhaul.

Lastly, we have seen the data center battery replacement market slow somewhat recently due to COVID site access restrictions. However, demand for cloud computing services and capacity has increased as a result of COVID driven virtual workflows.

Please turn to Slide 6. Moving onto our Motive Power portion of the business. We are pleased to have fully recovered our capacity following the September fire at our Richmond, Kentucky plant. You may have read a large competitor declared bankruptcy for the third time. As a result of our quick recovery and return to full capacity, we have been able to respond to customers concerned about Exide’s ability to supply.

As noted prior, the key impact for our Motive Power OEM and charger business is from the closures and production ramps of our OEM customers. This has been offset partially by healthy battery demand from our national accounts retailers, especially in the e-commerce and home improvement sectors.

Thin Plate Pure Lead or TPPL; product demand continues to grow during the quarter. Our efforts to increase production including through the acquisition of NorthStar, will drive further growth in TPPL. In the Americas, legacy TPPL sales were up 14% compared to the prior year. Driving that growth was NexSys TPPL which doubled, approaching 10% of Motive Power Americas’ sales during the year. This is even more impressive considering that EnerSys was TPPL capacity constrained throughout fiscal 2020.

As a result of this growth, we have gained meaningful TPPL market share despite the overall lead-acid market staying largely flat and expect continued market share expansion in the years ahead.

Motive Power in Asia was slow in the fourth quarter, exacerbated due to the impact of the coronavirus, particularly in China. Conditions in Asia are now improving as the pandemic recedes. As we discussed during our October Investor Day, we have continued to increase EnerSys’ market share in the transportation sector by leveraging our technology platform of TPPL. We exited the fourth quarter with a healthy transportation backlog, largely due to our TPPL production constraints.

While our Class 8 OEM business is in a state of disruption due to COVID, we have opportunities to offset this lower volume by increased activity in the Class 8 replacement markets. We are also growing at premium battery automotive aftermarket distributors and retailers, including new accounts, such as AutoZone.

In addition to having a great product, our success has been fueled by the fact that we are reaching back out to ODYSSEY accounts that we weren’t able to go after on a large-scale in the past because of supply constraints. In EMEA transportation, the ODYSSEY brand continues to be a highly sought-after product due to its superior performance characteristics.

Moving onto another exciting part of our business, we are pleased with the continued momentum in the defense sector. Specifically, we are very excited about several recent contract wins as well as increased market share gains with ENSER [Phonetic] and thermal lithium batteries.

Since the Investor Day in late 2019, EnerSys has won over $50 million in funded munitions awards on multiple programs. The majority of these programs have capitalized on our industry-leading thermal battery technology that provides lighter weight and extended operating times for applications in air and missile defense, air to ground weapons, and hypersonics.

Highlighting these program wins are the PAC-3 MSE and the next generator interceptor with Lockheed Martin and the AIM-9X air-to-air missile with Raytheon. These programs all fall into U.S. Army’s Big 6 funding priorities and align EnerSys’ enabling technology with the challenging future requirements of the U.S. Department of Defense.

Please turn to Slide 7. I will now provide additional updates on the continued progress we are making on our strategic initiatives, which are more important and relevant than ever. As you know, in October we closed on the acquisition of NorthStar Battery which aligned perfectly with our strategy to increase sales of premium products by putting EnerSys in a position to accelerate our sales of higher margin TPPL.

The integration of NorthStar has gone extremely well, further supporting our rationale for the deal. In addition to its existing production capacity, a key reason for the NorthStar acquisition was that the newer of its two factories had additional floor space immediately available for our new TPPL high-speed production line, allowing us to avoid the cost and disruption associated with putting it into our Warrensburg facility. Installation of the new high-speed line was proceeding extremely well until technicians and engineers from our U.K. supplier were recalled home in April due to COVID concerns. We estimate this will delay commissioning by roughly two months to August of 2020.

During the quarter, we made significant progress toward lowering business costs through our initiatives. We reduced inventory by $27 million in March, improving in all categories, while continuing to maintain strong cash flow. The progress we are making in EOS or EnerSys Operating System also helped us mitigate the impact of COVID as our plants were able to flex most of their controllable variances in April. COVID has reinforced our ability to do more with less.

Finally, while COVID-19 has been a challenge in many areas of our business, we are pleased to say, it has not affected the scope and pace of our product development. As the pandemic spread, our product development teams quickly initiated a process to ensure consistent information flow between all global development units and previously developed hardware and modeling methodologies, allowing them to continue working on real hardware from remote locations.

We are planning to launch our lithium-ion solutions for the material handling market in Q2 with a variance of that system available for residential energy storage one quarter later. Lithium-ion for telecommunications, uninterruptable power supplies, and larger energy storage systems are lined up to launch sequentially.

In a year marked by a series of headwinds, including a broad-based telecom slow down, the lingering impact of our ERP implementation, a fire in our Richmond facility, and a worldwide pandemic, we continue to execute against our strategic plan of growing market share in Motive Power through our NexSys iON and PURE products; expanding in exciting high upside markets like transportation, defense and 5G; integrating two cornerstone acquisitions in Alpha and NorthStar; and making incredible progress on our product modernization roadmap.

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Looking ahead, the global spread of COVID-19 will create both challenges and opportunities for EnerSys, especially in the first half of fiscal year 2021. As stay-at-home orders are lifted throughout the world, many of our forklift and heavy truck OEM customers are just now ramping their factories in Europe and U.S. after week’s long shutdowns and our communications customers are re-prioritizing many of their investments on more immediate network streams, which often requires additional EnerSys power and backup technology.

While we expect important communications projects including 5G will experience some delays associated with the pandemic, the importance only grows as more people work, communicate, and order goods and services online. As an industry leader who has always emerged from economic downturn stronger and better positioned to compete, we look forward to the challenge and we’ll capitalize on the opportunities ahead of us.

Our strong balance sheet, strategic global footprint, and reputation for product excellence position us well to navigate the uncertainties ahead as we remain committed to our strategy of delivering highly integrated energy systems to serve the critical power needs of diversified industrial markets worldwide.

With that, I’ll now ask Mike to provide further information on our fourth quarter and full-year results. Now, let me call it — turn the call over to Mike.

Michael J. Schmidtlein — Executive Vice President and Chief Financial Officer

Thanks, Dave. For those of you following along on our webcast, I’m starting with Slide 8. Our fourth quarter net sales decreased 2% over the prior year to $782 million due to a 3% decrease from volume, a 2% decrease from currency, net of a 3% increase from acquisitions. On a regional basis, our fourth quarter net sales in the Americas were up 6% to $537 million while EMEA’s net sales were down 13% at $199 million and Asia decreased 25% in the fourth quarter to $46 million, driven by the COVID pandemic.

Americas enjoyed a 4% increase from volume and 3% from acquisitions, less a 1% decrease in currency. EMEA had a 4% increase from acquisitions but incurred a 14% volume decrease and 3% in negative currency. Asia had a 20% volume, 4% currency, and 1% price decline as COVID hit this region hardest in our fourth quarter.

On a product line basis, net sales for Motive Power were up 2% year-over-year at $353 million while Reserve Power was down 5% to $429 million. Reserve Power had an 8% volume, 1% price and 2% currency declines offset by 6% in acquisitions. Motive Power had a 1% increase in price, less a 2% foreign currency decline, while volume was up 3%.

Please now refer to Slide 9. On a sequential basis, fourth quarter net sales were up 2% compared to the third quarter of fiscal 2020 driven by a 2% volume and 1% price improvements offset by 1% currency decline. On a geographical basis, Americas was up 7% as Motive Power recovered from the fire in Richmond, Kentucky, while EMEA was down 2% and Asia was down 22% as the spread of the COVID virus particularly impacted our Asian region. On a product line basis, Reserve Power was down 4% while Motive Power was up 12%.

Now, let me make a few comments about our adjusted consolidated earnings performance. As you know, we utilize certain non-GAAP measures in analyzing our Company’s operating performance, specifically excluding highlighted items. Accordingly, my following comments concerning operating earnings and my later comments concerning diluted earnings per share exclude all highlighted items. Please refer to our Company’s Form 8-K, which includes our press release dated June 1st, 2020, for details concerning these highlighted items.

Please now turn to Slide 10. On a year-over-year basis, adjusted consolidated earnings in the fourth quarter decreased approximately $12 million to $71 million, with the operating margin down 130 basis points. Lower commodity costs were not enough to offset the volume declines in higher manufacturing and freight costs. On a sequential basis, our fourth quarter operating earnings improved 80 basis points to 9.1%.

Operating expenses, when excluding highlighted items, were at 16.4% of sales for the fourth quarter compared to 15.7% in the prior year. Excluded from operating expenses recorded on a GAAP basis in Q4, are pre-tax charges of $53 million primarily related to intangible asset impairments of $44 million, $2 million in restructuring, and $5 million in Alpha and NorthStar amortization charges.

Excluding those charges, our Americas business segment achieved an operating earnings percentage of 11.9%, which was 20 basis points lower than the 12.1% in the fourth quarter of last year, although on a positive front, gross profit dollars increased by $3 million. On a sequential basis, the Americas’ fourth quarter OE increased 200 basis points from the 9.9% margin posted in the third quarter, primarily due to the recovery of our Richmond — from our Richmond fire. Americas’ OE dollars were up $14 million from the prior quarter.

EMEA’s operating earnings percentage of 4% was down from last year’s 10.2% and down from last quarter’s 6.6%. OE dollars decreased $15 million from the prior year primarily from lower volume and decreased nearly $6 million from the prior quarter in EMEA. The decline from the prior year results was largely caused by the absence of a Motive Power competitor a year ago, while the decline sequentially reflects lower telecom revenue along with higher lead and manufacturing costs.

The operating earnings percentage in our Asia business improved 30 basis points in the fourth quarter of this year to 1.8% operating loss from the 2.1% loss in the fourth quarter of last year, but was down from last quarter’s 1.1% income. Asia’s OE dollars are comparable to the prior year, but down nearly $2 million from the prior quarter due to the virus.

Please move to Slide 11. As previously reflected on Slide 10, our fourth quarter adjusted operating earnings of $71 million was a decrease of 15% from the prior year. Our adjusted consolidated net earnings of $47.5 million was $15 million lower than the prior year. The decline in adjusted net earnings is primarily due from a high — higher tax rate along with the impacts of Asia and EMEA described above.

The recovery on our business interruption claim from the Richmond fire initially expected in the fourth quarter has been delayed in part by the remote work mandates for those involved in the claim. We had received $5 million [Technical Issues] this quarter for fiscal 2021. Those receipts reflect approximately 60% of our claim and we are diligently working on full recovery on our interruption loss.

Our adjusted effective income tax rate of 18% for the fourth quarter was higher than the prior year’s rate of 13% and higher than the prior quarter’s rate of 16%. Discrete tax items caused most of these variations. Fiscal 2019 full year tax rate was 17%, while our fiscal ’20 tax rate was just below 18%, but within the range of our expectations for fiscal 2020 [Technical Issues] decreased 22% to $1.11 on lower net earnings.

We expect our first fiscal quarter of 2021 to remain near 42.9 million shares outstanding and — that were outstanding in the fourth quarter. As a reminder, we still have nearly $50 million of share buybacks authorized, but have no immediate plans to execute any repurchases with perhaps the exception of the modest annual repurchases made to offset employee stock plan dilution. Our recently announced dividend remained unchanged.

We have included our year-to-date results on Slides 12 and 13 for your information, but I do not intend to cover these in detail. Please refer to Appendix 1 at the end of our webcast.

Alpha contributed to adjusted operating earnings of $6 million or 4.9% on revenue of $115 million during our fourth fiscal quarter. As Dave mentioned, our expectations for Alpha and our entire energy systems business including enclosures is quite strong, despite the lower revenue posted in Q4. Overall, after considering interest, taxes and dilution of shares issued to the seller, Alpha was 2% accretive after excluding $4 million in after-tax amortization on intangible assets recorded in purchase accounting.

NorthStar had an adjusted operating loss of $4 million on $29 million [Phonetic] in revenue, which resulted in a $0.11 drag on EPS in the quarter after interest and taxes.

Our legacy business was down slightly on lower volume. This reflects substantial headwinds from our enclosure business globally as it declined 25% in the quarter and 35% for the year. We think the decline in enclosures is short-lived as 5G should bring renewed demand. Without such drag from enclosures, our core energy storage business, in constant currency, remain stable and our margins improved 30 basis points.

The Alpha transaction continues to progress as planned with synergies realized as expected. The logic of our acquisition remains intact. However Alpha’s revenue was down year-over-year due to the current spend patterns of certain major broadband and telecom customers which will likely soon improve.

The NorthStar acquisition also remains on track, especially as we make the investments to unleash the value we foresaw in this acquisition. As noted in prior calls, as we integrate these acquisitions, the ability to isolate those acquired businesses from the legacy EnerSys business becomes harder. Consequently, this is the last period we plan to present this information on the call.

Please now turn back to Slide 14. Our balance sheet remains strong and well-positioned for us to navigate the current economic environment. We have nearly $327 million of cash on hand and our credit agreement leverage ratio is 2.25 times. We generated over $253 million in cash from operations in fiscal 2020. Capital expenditures were $101 million and were at our expectations for the year.

We now expect fiscal 2021 capex to be only half of fiscal 2020’s level, although we are committed to our major investment programs, those being the lithium battery development and the NorthStar integration, including the installation of our high speed line and the transition of NorthStar products for the European market to our French factory. Most of the spending on our high speed line has already been made. We expect our leverage ratio to remain at or below 2.5 times in fiscal 2021.

Our cash generation in April was positive, as expected, and our receivable collections remain strong with DSO remaining constant with that of March. We believe that the cost and cash conservation initiatives that we have already taken will save over $40 million in EBITDA and nearly $200 million in cash in fiscal 2021. We anticipate our gross profit rate to decline modestly in the first half of fiscal 2021 as lower revenue and lower utilization in some of our factories will likely outweigh the benefits of lower commodity and energy prices.

With regard to tariffs, we anticipate a cash and earnings claw back of up to $5 million from exemptions we have received some time in the first half of fiscal ’21. With regard to issuing guidance, we hope to be able to resume in the second half of the fiscal year.

As Dave has described, while we anticipate lower demand in Motive and transportation markets, other markets remain constant or may rise. We believe we have taken the necessary steps to position ourselves to not only withstand the challenge, but emerge stronger as was the case a decade ago. We believe potential marketing share enhancements may mitigate lower total market demand and we are encouraged by the fact that during the last recession we delevered and increased market share.

Now let me turn the call back to Dave.

David M. Shaffer — Director, President and Chief Executive Officer

Thanks, Mike. Sara, we can now open the line for questions.

Questions and Answers:

Operator

Thank you. [Operator Instructions] Our first question comes from the line of Noah Kaye with Oppenheimer. Your line is now open.

Noah Kaye — Oppenheimer — Analyst

Hey, good morning, and thanks for taking the questions. I guess to start, can we maybe unpack a bit the trends that you outlined on Slide 3. Really talking about the trends you observed in April and May. Can you kind of help us walk through, and if possible quantify, what the downturn looked like in Motive and how that start to recover in May, if you can?

And then it also sounds like on the — in some of the reserve markets, and telecom in particular, you’ve mentioned that it may be trending better than kind of rates exiting your fiscal fourth quarter. So again just anything you can do to kind of help us quantify the trough, you saw and how to think about kind of a revenue run rate?

David M. Shaffer — Director, President and Chief Executive Officer

Yeah, I would say the low point in orders hit around Easter. I would say that seem to be where things bottomed out and they’ve been improving fairly steadily and predictably every week since and that trend has continued obviously through May and into June, we expect that.

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Almost all I can say, maybe all of our big OEM customers have since reopened. Now they’ve opened — they’ve reopened at different levels of production. Some of them opened up at, I think the lowest I heard was 50%. I would say the majority of my heard opened up around 70% and with how they exit this month, we’ve heard a mixed — it’s a range, but I would say — I would expect, most of them will exit this month between like 70% and a 100%. So some of the big ones expect to be fully ramped back up to 100% by the end of this month.

So things are coming back to normal in that part of the business. It was a bit of a shock, obviously when the orders just slowed down so quickly around just — at the early part of April. But to Mike’s point, we’ve been scraping it out of other parts of the business, the — as I said in my prepared remarks, Noah, the orders coming in from the retailers directly has really held up and especially the home improvement sector, I think that’s been — that’s helped mitigate some of that depression.

I think the — we talked about, it’s really — there is three types of electric trucks; there’s Class 1, which are the big sit-down rider forklift trucks. Those are pretty good-sized batteries. Then there is Class 2, those are the narrow aisle trucks. Then the Class 3 or the walkie trucks. And then Class 8 as you know, are the over the road big rigs. Now those — that’s where we’re using ODYSSEY branded product.

So on the Class 1, that’s an important market. And again, I think we’re going to exit June getting back healthier, certainly better than where we’ve come from. I can’t tell you we’ll be 100% back across the board. Class 2 feels pretty good, Class 3, I really don’t have a good feel. Class 8, I’m a little bit worried about. The Class 8, as you know, those guys were a little overbuilt going into COVID.

So that was already a little bit slow. But the good news about those lines is we are rotating — we’re rotating out of that particular SKU that we typically send to like a big Daimler factory, for example, we’re rotating out of that SKU and moving it more to batteries for folks like AT&T or T-Mo. So that’s the nice thing about — it’s not we can’t flip a switch, you just can’t flip overnight, but the plants have done a good job. I’m very proud of the way they’ve been able to adapt and they’re really fighting through this situation.

Absenteeism is a bit of an issue for everybody. Folks are — they get a little nervous about coming to work, but I don’t think we are any different than anyone else and that situation has dramatically improved as well. So now it feels — it feels much better now than it did a few weeks ago. And I think by the end of June, it’s going to feel even better is the — seems to be the path we’re on.

And the bankruptcy of Exide is certainly going to have its issues as well. Some of their customers are going to be looking for some supply assurance. So there’s — there is, like we said, a lot of puts and takes, but we should leave June in a much better place and hopefully at that point. I think had this relative to our financial calendar, just been a few weeks sooner, we’d probably be in a position to give guidance, but we’re just — we’re just, Mike and I are pretty cautious guys and we just need a few more weeks to see how June unfolds.

Does that sort of summarize where we’re at?

Noah Kaye — Oppenheimer — Analyst

Yeah, it’s helpful, certainly and thanks. The other part of the question was on the reserve side and is it fair to say just based on your comment, it sounds like up double digits in the telecom business kind of now versus where you were at in the fourth quarter, does that feel like directionally the right way to think about it?

David M. Shaffer — Director, President and Chief Executive Officer

Yeah, it’s — I don’t want to say definitively where it’s going to finish in Q1, but certainly the battery piece is strong, as folks are out there hardening their networks. On the equipment side it’s still, I think we’ve got a couple of big projects going and the biggest projects we’re working on right now are related to 5G. As I noted in my prepared remarks, we think that some of the COVID stuff and I’m not trying to — it’s still super exciting and it’s, like I said, more important than ever. But there is — some of the schedules have shifted out a month or two.

So on the telecom equipment side it’s — we know it’s common, we get the forecast, we see it, feel it from the customers, but the battery side has definitely improved dramatically on the telco side. And we expect the equipment piece is going to follow shortly.

Noah Kaye — Oppenheimer — Analyst

Okay, great. And if I could ask one more before turning it over. You mentioned expectations around gross profit — gross margin rates and you mentioned some of the efforts. I think you said, Mike, in your remarks that you’re looking at conserving a couple of hundred million dollars in cash. I guess just one; how should we be thinking about the decremental EBIT margins in general here, where are you kind of managing to? And two, can you give us some more color on what you’re flexing besides capex to kind of get to that a couple of hundred million dollars of cash savings?

Michael J. Schmidtlein — Executive Vice President and Chief Financial Officer

Well, the — I’ll answer the latter part of your question, first. I think the two biggest pieces to your point was roughly $50 million of capex and the other one was — our expectation is that we can take up to $100 million of inventory out not only because of potentially slightly less volume but remember we’re not going to be shipping as much across the ocean as we were a year ago now that we have NorthStar and we’re making better progress there. So the inventory was the second part of that. There were other pieces that we’ve included. We did not issue a pay increase this year and there is some other smaller items that add up to that $200 million.

And with regard to the margins, my comment was referencing the gross profit margin, but obviously that should flow back through, but our gross profit margin, probably in comparison with the 25% to 26% rate is probably going to have 100 basis points to 200 basis points degradation and EBIT is probably going to be about 100 points down, I think from what your normal expectations were. So that’s about as good a color.

The bigger question becomes the top line and the top line becomes so much more of a question, I think just because of some of the virus mandates and factories that are not opening up, it’s just hard to predict when those are going to happen or whether any new additional restrictions might be incurred.

Noah Kaye — Oppenheimer — Analyst

Yeah, understood. That’s very helpful color. Thanks.

Operator

Thank you. Our next question comes from the line of Brian Drab with William Blair. Your line is now open.

Brian Drab — William Blair & Company — Analyst

Hi. It’s Brian Drab with William Blair. Thanks for taking my questions. I — just following up Mike on that last point, the gross margin down, I think you just said 100 basis points or 200 basis points. What time period are you talking about specifically?

Michael J. Schmidtlein — Executive Vice President and Chief Financial Officer

I was talking about, in the first half.

Brian Drab — William Blair & Company — Analyst

Yeah. So in the second half, how big a tailwind will you get from lead being down 18% to 20% here? I mean, I know that you hedge some there, but I mean that seems to me like that add up almost a third of your cost of goods. That should be a big deal six months from now, maybe even, I don’t know, if it’s $0.20, $0.25, $0.30 a quarter. And then the freight cutting — freight cost-cutting that you just mentioned. How big a deal is that for gross margin six months from now, combined?

Michael J. Schmidtlein — Executive Vice President and Chief Financial Officer

I think the lead costs themselves can have a 200 basis point to 300 basis point swing. So I would say, all things being equal, if today’s spot prices kind of remain for the next 60 days at least our third quarter is probably going to benefit by 200 basis points based on the lead itself. And to your point, we’re still hedging — although we’re hedging at lower rates than you might have seen us in the past.

So the freight costs, we should save a little bit more on overall freight just in terms of the amounts shipped. I think everyone is expecting the freight rates themselves to drop, not only because of lower demand, but because of the fuel prices being down. So hopefully that’s a double benefit for us and freight is a big number in our game. So that could have another 50 plus basis point improvement.

And the tariffs, I did mention that we received some exclusions, or let me make it clear what my comments were. We received some exclusion primarily on our Alpha-made products that we receive them last this — last fiscal year ended March 2020. We have not received the funds back from customs on that, and consequently, we are withholding recognition of that benefit or recovery until the cash is in, but that’s about a $5 million benefit that hopefully, we’ll see in the first half of this year.

Brian Drab — William Blair & Company — Analyst

Okay, thanks. And have you seen, related to NorthStar, the synergies associated with freight yet or is that — and synergies in general or is that still going to show up in the numbers later this year and can you put a finer point on when we see that?

David M. Shaffer — Director, President and Chief Executive Officer

Yeah, I would say, Brian, most of that is still ahead of us. There is a little bit of delay. For example, one of our big customers over there, Daimler there is certain ISO like approvals, we need to get at our French factory in order to ship it. Everyone wants it. They want a shorter supply chain, we want a shorter supply chain. It’s just a few of these hurdles that we have to jump through. That’s one of the things.

And then the biggest issue, as we mentioned, there has been a little bit of delay starting up and commissioning some of our new equipment because we had European suppliers, so that’s pushing some of those savings out because of tooling issues and where we have to tool up different SKUs in different factories. So I would say, in general, COVID has pushed a lot of those savings more towards the second half of the year for sure.

Brian Drab — William Blair & Company — Analyst

Okay. And then I’ll just ask one more for now, but if — and bear with me here, I think that this might be helpful for us to understand. But in May, the level of demand that you saw, how did that — forget April, but how did May compare with February and March. Can you give us any sense for it? I’m just trying to figure out where we are relative to — forget the worst of COVID, in May, are you back to levels that are somewhat normal or still far off from there?

David M. Shaffer — Director, President and Chief Executive Officer

No, I would say we’re getting back to normal. I wouldn’t say we’re there yet, but very much improved versus April for sure. And yeah, you’re right, April is just the month we’re all going to forget. But — yeah, it’s getting. I’m hoping to leave June at some semblance to normal. So where some of our OEM customers maybe aren’t back, we can hopefully recover those bits in other parts of the business.

Brian Drab — William Blair & Company — Analyst

Okay, thank you very much.

David M. Shaffer — Director, President and Chief Executive Officer

All right.

Operator

Thank you. [Operator Instructions] Our next question comes from the line of John Franzreb with Sidoti. Your line is now open.

John Franzreb — Sidoti & Company — Analyst

Good morning, guys.

Also Read:  Oak Street Health, Inc. (OSH) Q2 2020 Earnings Call Transcript

David M. Shaffer — Director, President and Chief Executive Officer

Hi, John.

John Franzreb — Sidoti & Company — Analyst

Regarding cost savings, how much do you expect to take out in 2021? And of that, how much is fixed versus variable?

David M. Shaffer — Director, President and Chief Executive Officer

Hold on, John, I got to reference. So the salary freeze that we talked about is somewhat across the board, but that’s — I’ll count most of it as the fixed piece. There’s been a number of other, you know, we have a tremendous amount of temporary labor throughout the fleet that we use to flex particularly in EMEA where adding permanent employees is such an expensive endeavor.

So as we’ve reduced those employees, we’ve been able to do that much more cost-effectively and that one certainly is a variable component. But if you think about just things like the travel restrictions that we’ve had, sales meetings, customer trips, there has been a fairly substantial amount of that, that would show up in the selling and other operating expenses, which we might normally think of as fixed expenses. But in this instance, they’d become more variable.

So I guess to answer your question, I would say it’s probably a 50-50 blend between what our fixed and variable cost that we’ve been able to reduce on that, call it $40 million number.

John Franzreb — Sidoti & Company — Analyst

Okay. All right. And in regards to Exide and any other competitor, can you talk a little bit about the pricing environment in Europe and maybe a little bit of a color also in North America. Exide has been in and out of bankruptcy a couple of times, it doesn’t seem like you’ve been interested in the assets before. I can’t imagine you’re interested in the assets now. But more on the pricing environment and how you expect that kind of to play out across the continents.

David M. Shaffer — Director, President and Chief Executive Officer

Yeah. What was interesting about this bankruptcy, John, was that they’ve bifurcated the Company between the U.S. and Europe. I would say in Europe, it’s going to be business as usual, I don’t foresee any changes or impacts. I think when it comes to the U.S. there — their position, I just don’t think that especially given the current demand environment, I think that it shouldn’t have a meaningful impact one way or the other, would be my best counsel at this point.

It’s very hard to say. I don’t want to say too much, obviously. It’s a sensitive issue right now given that they are in the midst of that process. So — but by and large, I would say, I don’t expect it to have too meaningful an impact on the pricing environment per se in either region.

John Franzreb — Sidoti & Company — Analyst

Okay. And just — I guess one last question and I’m sure I missed this. But how much is left outstanding in the insurance claims and do we expect that to be wrapped up by the June quarter?

Michael J. Schmidtlein — Executive Vice President and Chief Financial Officer

All right. So we had stated previously that our total amount of claims between the property and casualty and the business interruption was just under $50 million and so the — I believe that we’re probably, we were at — we collected in cash to date a total of about $26 million. So let’s say that we are somewhere over 50% on the claim now, obviously, the insurer has to review the claim, they may have different thoughts on the matter and to our point in our stated remarks, the fact that some of our employees are working remotely, not only at the location where we need to get supporting information, but in other locations and the consultants that are hired by us, the consultants hired by insurance carrier, the insurance carrier, everybody’s working remotely.

So the hope that we could have this thing wrapped up in the fourth quarter kind of went out of the window by the middle of March. But I’m still hopeful. It’s now June 2nd and the month ends in about 33 days, 34 days. So I know we’re going to make additional progress because we have made that progress, but how much further, can we say that — will be done, I think we accelerated our claim process versus apparently what other parties do when they have these type of losses.

So we’re probably trying to push the envelope a little faster than normal and we’re doing it in a time where that is kind of difficult, but we’ll certainly make progress in Q1. I can’t promise we’ll be wrapped up in Q1.

John Franzreb — Sidoti & Company — Analyst

One last question. Dave, if I may, when do you think you’re going to bring the team back to get together to Reading?

David M. Shaffer — Director, President and Chief Executive Officer

I mean, a lot depends on Governor Wolf. I would say probably starting around June 21st, maybe is sort of my goal. And then — you know then we run into the July 4th holiday. So certainly by the return of the July 4th holiday. John, I got to say, it really has not been — I think the Mike’s group has had the most stressed, they have been trying to close the year and the quarter and that’s very still paper-centric, unfortunately.

So that team, I’m really proud of them. They worked their tails off in the past several weeks, and — but other than that, and then [Indecipherable] kept the labs open. So other than some of the lab technicians and getting some of those engineers back in the labs, it’s — there is not, I don’t feel a gun to our head and we just want to do it gracefully and we want everyone to feel good about it.

And so — but I would say that starting late June probably coming out of July 4th, and of course we’re going to have to follow all of the distancing and protective equipment guidelines as outlined by the State of Pennsylvania. But it’s going to happen in the coming weeks.

Michael J. Schmidtlein — Executive Vice President and Chief Financial Officer

And John, just as a reminder, and I’ll say this because I am sitting in the Warrensburg factory, which is where I’ve been in the last two months. And here, life is fairly normal. There is a small component of our office staff that are working remotely. But by and large, the parking lot is full and life has been pretty normal, I think in a lot of our factories.

John Franzreb — Sidoti & Company — Analyst

Okay. Well don’t get too comfortable, Mike. Thanks for taking my questions.

Michael J. Schmidtlein — Executive Vice President and Chief Financial Officer

No worries. Thanks.

Operator

Thank you. Our next question comes from the line of Greg Wasikowski with Webber Research. Your line is now open.

Michael Webber — Webber Research — Analyst

Hey, good morning, guys. This is actually Mike on the line for Greg. How you’re doing?

David M. Shaffer — Director, President and Chief Executive Officer

Good.

Michael J. Schmidtlein — Executive Vice President and Chief Financial Officer

Hello, Mike.

Michael Webber — Webber Research — Analyst

Good. Thanks for making the time. A lot of my questions have already touched on, but I did want to loop back on some of your costs and I know someone asked earlier a bit on lead pricing and you kind of touched on your ability to hedge kind of generally there, but I was wondering if you get a bit more specific around maybe how aggressive, can you get down here to take advantage of softer pricing both I guess from a capacity perspective and then from a — from a — from a risk perspective where the — where kind of the goalposts that you would use to kind of think about being aggressive out here and locking in some more pricing and wider margin.

David M. Shaffer — Director, President and Chief Executive Officer

Well, the hedging — the hedges that you make is the spot rates declines is always probably more painful than when lead is going up and you don’t hedge. Because when the lead is going up and you don’t hedge, you can at least point to the spot price to support your price increases, but when lead is going down and you’re paying the lead from a forward contract you made 90 days earlier, that is harder to justify.

But let me just start, Mike, by saying, most of our European region have contractual obligations where they simply pass this through on a formula-driven basis. So for them, it’s just do the math and plug in the number. And so even though we never get the timing perfect in terms of when the cost hit our P&L versus the revenue and our customers can time their purchases to some extent to kind of on the margins, get a little bit of better deal, if they think the lead price is going up in the upcoming period, they will order more before the price goes up; and if they think lead is about the fall, they will order less.

In the Americas, it’s much more of a stated price list, and then it’s a discounts off that on the Motive Power side. And on the Reserve Power, it’s more of a contractual driven where the prices are probably a little stickier. And — but you have to — you have to be aware of what your competition is doing and you normally expect the rational [Technical Issues] find ourselves in and — but that’s the only caveat, I would give you is, if for some reason that the logic of the pricing throughout the competitive field were to breakdown, that’s the only thing that you’d have to be worried about.

Michael Webber — Webber Research — Analyst

Got you. So we shouldn’t view it as kind of a minor lever for you guys to pull at times like this when we get kind of a softer patch. It’s not something you have the framework really in place to play with all that much?

David M. Shaffer — Director, President and Chief Executive Officer

Like I said, pricing in the Americas tends to have less changes perhaps both on the upside and downside. In EMEA it goes with what the formula is based upon.

Michael Webber — Webber Research — Analyst

Got you. Okay, that’s helpful. You mentioned in on one of your earlier questions as well around kind of long-term margins and kind of some of the shifts you’re making in labor, particularly internationally and the headwinds associated on kind of bringing on permanent employees versus I guess presumably independent contractors. Is that — is that more EMEA focused versus Asia Pacific, just due to the kind of the higher taxation and regulatory hurdles there? And would be — should we view those changes as permanent or would we think maybe in Asia Pacific, that’s more of an intermediate-term shift, kind of measured in several quarters or a year or two versus something maybe more systemic in EMEA?

David M. Shaffer — Director, President and Chief Executive Officer

Yeah, I would say that it’s much more prevalent in EMEA to have contract employees and you have a permanent workforce that had been there for a decade or more. And then you have a temp force that works and turns over slightly higher and the price you pay for is perhaps higher turn at the lower seniority levels is you don’t have quite the severance costs if you need to flex your business.

So in Asia, you don’t see that concept of temp employees traditionally because the demand for or the ability for them to find other work has allowed — hasn’t allowed temp labor to kind of catch on, so to speak. Although the severance costs in Asia don’t underestimate those costs. They are fairly generous relative to what you pay the employee, severance costs can be fairly high there.

But right now, I would say our plants in Asia have already pretty much [Technical Issues] we dismiss the temporary labor. We largely felt like we’ve got the staffing levels where we need to be for the foreseeable future and most of that happened in late March and early April.

Michael Webber — Webber Research — Analyst

Makes sense. Okay, all right, guys. Appreciate the time. Thanks.

David M. Shaffer — Director, President and Chief Executive Officer

Thanks, Mike.

Operator

Thank you. This concludes today’s question-and-answer session. I would now like to turn the call back to David Shaffer for closing remarks.

David M. Shaffer — Director, President and Chief Executive Officer

Thanks, Sara, and I want to thank everyone for attending and taking your time to attend our call today. We look forward to providing further updates on our progress on our first quarter 2021 call in August. Have a great day. Bye-bye.

Operator

[Operator Closing Remarks]

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