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PPO > SEC Filings for PPO > Form 10-Q on 7-Aug-2014All Recent SEC Filings

Show all filings for POLYPORE INTERNATIONAL, INC.

Form 10-Q for POLYPORE INTERNATIONAL, INC.


7-Aug-2014

Quarterly Report


Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations

The following discussion of our financial condition and results of operations should be read together with our unaudited condensed consolidated financial statements and the related notes included elsewhere in this Quarterly Report on Form 10-Q and our audited consolidated financial statements and the related notes included in our Annual Report on Form 10-K for the fiscal year ended December 28, 2013.

The following discussion includes financial information prepared in accordance with U.S. generally accepted accounting principles ("U.S. GAAP"), as well as segment operating income, which is considered a non-GAAP financial measure. Generally, a non-GAAP financial measure is a numerical measure of a financial performance that excludes amounts that are included in the most directly comparable measure calculated and presented in accordance with U.S. GAAP. The presentation of segment operating income is intended to supplement investors' understanding of our operating performance and is not intended to replace net income as determined in accordance with U.S. GAAP. Segment operating income is defined as operating income before stock-based compensation and certain non-recurring and other costs and is used by management to evaluate business segment performance and allocate resources. See Note 13, "Segment Information," in the accompanying condensed consolidated financial statements for a reconciliation of segment operating income to income (loss) from continuing operations before income taxes.

All disclosures and amounts in the "Management's Discussion and Analysis of Financial Condition and Results of Operations" section relate to our continuing operations, unless otherwise indicated.

Overview

We are a leading global high-technology filtration company that develops, manufactures and markets specialized microporous membranes used in separation and filtration processes. In fiscal 2013, we generated total net sales of $636.3 million. We operate in two primary businesses: energy storage, which includes the transportation and industrial segment and the electronics and EDVs segment, and separations media. The transportation and industrial and separations media segments represent approximately 75% of our total net sales and operate in stable, growing markets, have high recurring revenue bases and generate strong cash flows. In the electronics and EDVs segment, we have a presence in the more established consumer electronics market, but our most significant growth opportunity is the potentially larger and developing electric drive vehicle ("EDV") and energy storage systems ("ESS") markets where lithium is the disruptive technology. As described in more detail below, the long-term growth drivers for lithium batteries are positive, but we have experienced and may continue to experience variability in the short term as these markets emerge.

In the second quarter of 2014, we refinanced our existing senior secured credit agreement. We used cash on hand and borrowings under the new senior secured credit agreement to retire our previously outstanding 7.5% senior notes and pay redemption premiums and other transaction-related expenses. The debt reduction and refinancing will provide substantial interest savings and flexibility to pursue growth and value-creation opportunities as we continue to generate cash. We will continue to evaluate alternatives for cash, including returning value to shareholders through share repurchases.

Energy Storage

In the energy storage business, our membrane separators are a critical functional component in lithium batteries, which are primarily used in consumer electronics and EDV applications, and lead-acid batteries, which are used globally in transportation and numerous industrial applications. We believe that the long-term growth drivers for the energy storage business - growth in Asia, demand for consumer electronics and growing demand for EDVs - are positive. The energy storage business is comprised of two reportable segments.

Electronics and EDVs. Lithium batteries are the power source in a wide variety of applications, including consumer electronics applications such as notebook computers, tablets, mobile phones and cordless power tools; EDVs; and emerging applications such as ESS. Demand for lithium batteries in consumer electronics is driven by the need for increased mobility. In EDV applications, demand is driven by the need to increase fuel efficiency to meet mileage standards in many countries such as the U.S. and China, the need to reduce carbon dioxide ("CO2") emissions around the world but especially in Europe due to regulations, conversion from nickel metal hydride to lithium battery technology in hybrid vehicles due to greater energy and power density, concern in developed countries and emerging markets over future access to petroleum at stable prices, smog and pollution control, and the need to address increasing transportation needs in developing economies. Since late 2009, we have expanded capacity at our existing Charlotte, North Carolina and Ochang, South Korea facilities and built a new facility in Concord, North Carolina. Production started for portions of the Concord facility in 2012 and the remaining capacity will ramp up over time as the nascent market for EDVs develops.


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In January and May 2014, we entered into long-term supply agreements with Samsung SDI Co., Ltd. ("Samsung") and Panasonic Automotive and Industrial Division ("Panasonic"), respectively, that include guaranteed purchase and supply volume requirements and volume-based price incentives. The Samsung agreement has an initial four-year term with a two-year extension provision and the Panasonic agreement has a five-year term. We believe that these agreements highlight the value of our capacity investments and proven industry-leading products and technology.

We have patent-protected ceramic coating technology in which interest and usage is growing in both EDV and consumer electronics applications. We believe that this technology has value for current and future customers, and we have enforced and intend to continue to enforce our intellectual property rights around this and other patent-protected technology. In December 2013, we signed a technology licensing agreement with Sumitomo Chemical Co., Ltd. ("Sumitomo"). In January 2014, we filed a complaint against LG Chem. Ltd. ("LG") alleging infringement of our patent covering ceramic coating technology. In July 2014, the United States District Court for the Western District of North Carolina granted a motion for a preliminary injunction against LG relating to patent infringement of our ceramic coating technology, although the court has stayed enforcement of the injunction pending appeal. We believe that the recently signed long-term supply agreements, licensing agreement with Sumitomo and the preliminary injunction against LG confirm our ability to provide certainty of supply for high-growth applications like EDVs and ESS and the value of our technology and intellectual property.

We believe the long-term demand drivers for our products-consumer demand for mobility, regulations for better fuel efficiency and lower CO2 emissions, conversion from nickel metal hydride to lithium battery technology in hybrids, concerns about access to petroleum, efforts to reduce pollution, and increasing transportation needs in developing countries-remain intact. While consumer electronics applications have attractive long-term market growth trends, EDV and ESS applications represent our most significant growth opportunity and the long-term outlook continues to be positive. Based on industry forecasts and industry studies, the use of lithium technology in EDV applications is expected to grow at a compound annual growth rate in excess of 40% through 2020 on an energy capacity basis. Many factors influence membrane separator usage in lithium-ion batteries, but because many new applications are incorporating large-format lithium batteries that require much greater membrane separator volume per battery, we believe that membrane separator growth will exceed battery unit sales growth and, although not perfectly correlated, will more closely approximate the growth rate in energy capacity. We believe the electrification of the worldwide fleet of vehicles is just beginning, from hybrids to plug-ins to full battery electric vehicles, including automobiles, buses, taxis and commercial fleet vehicles. We believe our dry process products continue to be the preferred product in large format lithium-ion batteries for EDVs and ESS. We are currently working with existing and new customers on next-generation batteries, which is important considering the long lead times required to become qualified for EDV applications. EDV and ESS are emerging market applications and are being adopted around the world in many forms. We are qualified on more than fifty EDV models and have field-proven products, significant production capacity already in place, technical advantages, low-cost manufacturing capabilities and intellectual property around ceramic coatings for lithium battery separators. We believe the factors that influenced our decision to expand capacity remain valid, and we continue to expect significant sales growth and expect to utilize our current production capacity as the EDV market develops and as ESS experiences more meaningful adoption. Although the long-term growth drivers are positive for these applications, short-term fluctuations in demand can be expected in the early stages of adoption while initial penetration rates are low. Given the high-separator content for these applications and the potential size of these markets, small changes in end-market demand can have a significant impact on our business.

Transportation and industrial. In the lead-acid battery market, the high proportion of aftermarket replacement sales and the steady growth of the worldwide fleet of motor vehicles provide us with a growing recurring revenue base in lead-acid battery separators. Worldwide demand for lead-acid battery separators is expected to continue to grow at slightly more than annual economic growth. The Asia-Pacific region is the fastest growing market for lead-acid battery separators. Growth in this region is driven by the increasing penetration of automobile ownership, growth in industrial and manufacturing sectors, export incentives and ongoing conversion to the polyethylene-based membrane separators we produce.

Separations Media

In the separations media business, our filtration membranes and modules are used in healthcare and high-performance filtration and specialty applications. We believe that the separations media business will continue to benefit from continued growth in demand for higher levels of purity in a growing number of applications. The separations media business is a reportable segment.

For healthcare applications, we produce membranes used in blood filtration applications for hemodialysis, blood oxygenation and plasmapheresis. Growth in demand for hemodialysis membranes is driven by the increasing worldwide population of end-stage renal disease patients. We believe that conversion to single-use dialyzers and increasing treatment frequency will result in additional dialyzer market growth.


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For filtration and specialty applications, we produce a wide range of membranes and membrane-based elements for micro-, ultra- and nanofiltration and gasification/degasification of liquids. Micro-, ultra- and nanofiltration membrane element market growth is being driven by several factors, including end-market growth in applications such as water treatment and pharmaceutical processing, displacement of conventional filtration media by membrane filtration due to membranes' superior cost and performance attributes, and increasing purity requirements in industrial and other applications.

Critical accounting policies

Critical accounting policies are those accounting policies that can have a significant impact on the presentation of our financial condition and results of operations, and that require the use of complex and subjective estimates based on past experience and management's judgment. Because of the uncertainty inherent in such estimates, actual results may differ from these estimates. These policies are critical to the understanding of our operating results and financial condition and include policies related to the impairment of goodwill, pension benefits, repairs and maintenance and stock-based compensation. For a discussion of each of these policies, please see the discussion entitled "Critical accounting policies" in the "Management's Discussion and Analysis of Financial Condition and Results of Operations" section of our Annual Report on Form 10-K for the year ended December 28, 2013.

Results of operations

The following table sets forth, for the periods indicated, certain operating data in amount and as a percentage of net sales:

                                                                                 Percentage of Net Sales
                                                Three Months Ended                  Three Months Ended
($'s in millions)                        June 28, 2014      June 29, 2013     June 28, 2014    June 29, 2013
Net sales                               $         166.6    $         168.9            100.0 %          100.0 %

Gross profit                                       58.6               60.4             35.2             35.8
Selling, general and administrative
expenses                                           38.2               32.4             22.9             19.2
Operating income                                   20.4               28.0             12.3             16.6
Interest expense, net                               5.6                9.9              3.4              5.9
Costs related to purchase of 7.5%
senior notes                                       24.9                  -             14.9                -
Write-off of loan acquisition costs
and other expenses associated with
refinancing of senior credit
agreement                                           1.1                  -              0.7                -
Other                                              (1.7 )             (0.3 )           (1.0 )           (0.2 )
Income (loss) from continuing
operations before income taxes                     (9.5 )             18.4             (5.7 )           10.9
Income taxes                                       (5.1 )              5.7             (3.1 )            3.4
Income (loss) from continuing
operations                              $          (4.4 )  $          12.7             (2.6 )%           7.5 %




                                                                                 Percentage of Net Sales
                                                 Six Months Ended                    Six Months Ended
($'s in millions)                        June 28, 2014      June 29, 2013     June 28, 2014    June 29, 2013
Net sales                               $         327.6    $         314.8            100.0 %          100.0 %

Gross profit                                      117.2              109.6             35.8             34.8
Selling, general and administrative
expenses                                           74.4               63.1             22.7             20.0
Operating income                                   42.8               46.5             13.1             14.8
Interest expense, net                              15.2               19.7              4.7              6.3
Costs related to purchase of 7.5%
senior notes                                       24.9                  -              7.6                -
Write-off of loan acquisition costs
and other expenses associated with
refinancing of senior credit
agreement                                           1.1                  -              0.3                -
Other                                              (1.0 )              0.3             (0.3 )            0.1
Income from continuing operations
before income taxes                                 2.6               26.5              0.8              8.4
Income taxes                                       (1.8 )              7.9             (0.5 )            2.5
Income from continuing operations       $           4.4    $          18.6              1.3 %            5.9 %

Comparison of the three months ended June 28, 2014 with the three months ended June 29, 2013

Net sales. Net sales for the three months ended June 28, 2014 were $166.6 million, a decrease of $2.3 million, or 1.4%, from the same period in the prior year, as higher sales in the transportation and industrial and separations media segments and the positive impact of


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foreign currency translation of $2.0 million were offset by lower sales in the electronics and EDVs segment, due to a $14.2 million decline in sales attributable to LG. See "Financial reporting segments" below for more information.

Gross profit. Gross profit for the three months ended June 28, 2014, was $58.6 million, a decrease of $1.8 million from the same period in the prior year. Gross profit margin was 35.2%, which is comparable to the same period in the prior year, as an increase in gross profit margin in the separations media segment due to higher sales and favorable product mix and production timing was offset by a decrease in the electronics and EDVs segment due to lower sales. Gross profit margin was comparable to the same period in the prior year in the transportation and industrial segment. See "Financial reporting segments" below for more information.

Selling, general and administrative expenses. Selling, general and administrative expenses for the three months ended June 28, 2014 were $38.2 million, an increase of $5.8 million from the same period in the prior year, primarily due to a $2.1 million increase in litigation costs associated with patent enforcement and a $1.3 million increase in stock-based compensation expense. Selling, general and administrative expenses were 22.9% of consolidated net sales as compared to 19.2% for the same period in the prior year.

Segment operating income. Segment operating income, which excludes stock-based compensation and certain non-recurring and other costs, was $29.1 million, a decrease of $5.1 million from the same period in the prior year. Segment operating income margin was 17.5% as compared to 20.2% for the same period in the prior year. The decrease in segment operating income margin was primarily due to a decrease in the electronics and EDVs segment offset to some extent by an increase in the separations media segment. Segment operating income margin was consistent with the same period in the prior year in the transportation and industrial segment. See "Financial reporting segments" below for more information.

Interest expense. Interest expense for the three months ended June 28, 2014 was $5.6 million, a decrease of $4.3 million from the same period in the prior year. The decrease was the result of the debt reduction and refinancing transactions that were completed during the second quarter of 2014.

Income taxes. Income tax expense for the interim periods presented is computed at the effective rate expected to be applicable in each respective full year using the statutory rates on a country-by-country basis. The mix of earnings between the tax jurisdictions has a significant impact on the effective tax rate. Each tax jurisdiction has its own set of tax laws and tax rates, and income earned by our subsidiaries is taxed independently by these various jurisdictions. Currently, the applicable statutory income tax rates in the jurisdictions in which we operate range from 0% to 42%. In the second quarter of 2014, our effective tax rate was also impacted by the $9.6 million tax benefit related to costs incurred in connection with the refinancing of our senior secured credit agreement and purchase of our 7.5% senior notes, which were considered discrete events for interim income tax provision purposes.

The components of our effective tax rate are as follows:

                                                              Three Months Ended
                                                        June 28, 2014    June 29, 2013
U.S. federal statutory rate                                      35.0 %           35.0 %
State income taxes                                                0.1              0.5
Mix of income in taxing jurisdictions                            (8.3 )           (3.0 )
Costs associated with debt reduction and refinancing             27.7                -
Other                                                            (0.2 )           (1.5 )
Total effective tax rate                                         54.3 %           31.0 %

Comparison of the six months ended June 28, 2014 with the six months ended June 29, 2013

Net sales. Net sales for the six months ended June 28, 2014 were $327.6 million, an increase of $12.8 million, or 4.1%, from the same period in the prior year, as higher sales in the transportation and industrial and separations media segments and the positive impact of foreign currency translation of $2.8 million were offset to some extent by lower sales in the electronics and EDVs segment, due to a $19.7 million decline in sales attributable to LG. See "Financial reporting segments" below for more information.

Gross profit. Gross profit for the six months ended June 28, 2014 was $117.2 million, an increase of $7.6 million from the same period in the prior year. Gross profit margin was 35.8% as compared to 34.8% for the six months ended June 29, 2013. The increase in gross profit margin was due to higher sales and favorable product mix and production timing in the separations media segment, offset to some extent by the impact of lower sales in the electronics and EDVs segment. Gross profit margin was comparable to the prior year in the transportation and industrial segment. See "Financial reporting segments" below for more information.


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Selling, general and administrative expenses. Selling, general and administrative expenses for the six months ended June 28, 2014 were $74.4 million, an increase of $11.3 million from the same period in the prior year, primarily due to a $3.2 million increase in litigation costs associated with patent enforcement, a $2.3 million increase in performance-based incentive compensation expense and a $2.2 million increase in stock-based compensation expense. Selling, general and administrative expenses were 22.7% of consolidated net sales as compared to 20.0% for the same period in the prior year.

Segment operating income. Segment operating income, which excludes stock-based compensation and certain non-recurring and other costs, was $58.5 million, an increase of $0.4 million from the same period in the prior year. Segment operating income margin was 17.9% for the six months ended June 28, 2014 compared to 18.5% for the six months ended June 29, 2013. See "Financial reporting segments" below for more information.

Interest expense. Interest expense for the six months ended June 28, 2014 was $15.2 million, a decrease of $4.5 million from the same period in the prior year. The decrease was the result of the debt reduction and refinancing transactions that were completed during the second quarter of 2014.

Income taxes. Income tax expense for the interim periods presented is computed at the effective rate expected to be applicable in each respective full year using the statutory rates on a country-by-country basis. The mix of earnings between the tax jurisdictions has a significant impact on the effective tax rate. Each tax jurisdiction has its own set of tax laws and tax rates, and income earned by our subsidiaries is taxed independently by these various jurisdictions. Currently, the applicable statutory income tax rates in the jurisdictions in which we operate range from 0% to 42%. In the second quarter of 2014, our effective tax rate was also impacted by the $9.6 million tax benefit related to costs incurred in connection with the refinancing of our senior secured credit agreement and purchase of our 7.5% senior notes, which were considered discrete events for interim income tax provision purposes.

The components of our effective tax rate are as follows:

                                                               Six Months Ended
                                                        June 28, 2014    June 29, 2013
U.S. federal statutory rate                                      35.0 %           35.0 %
State income taxes                                                0.1             (0.2 )
Mix of income in taxing jurisdictions                            (8.3 )           (3.4 )
Costs associated with debt reduction and refinancing            (93.9 )              -
Other                                                             0.4             (1.5 )
Total effective tax rate                                        (66.7 )%          29.9 %

Discontinued operations

On December 19, 2013, we completed the sale of our Microporous business, which consisted of the production facilities in Piney Flats, Tennessee, and Feistritz, Austria, for $120.0 million. We recognized a gain on sale of $35.5 million, net of direct transaction costs and income taxes, of which $35.8 million was recognized in the fourth quarter of 2013 and subsequently reduced in the second quarter of 2014 by $0.3 million as a result of the finalization of the working capital adjustment. Microporous was previously included in the transportation and industrial segment. The results of operations from this business are classified as discontinued operations and are excluded from continuing operations and segment results for the three and six months ended June 28, 2014 and June 29, 2013.

Financial reporting segments

Electronics and EDVs

Comparison of the three months ended June 28, 2014 with the three months ended June 29, 2013

Net sales. Net sales for the three months ended June 28, 2014 were $31.7 million, a decrease of $10.5 million, or 24.9%, from the same period in the prior year. Net sales decreased by 17.5% due primarily to lower sales volumes for consumer electronics applications. We are working on new projects and development opportunities for consumer electronics applications, but it may take several quarters to see the results of these efforts. As a result, we cannot currently predict when or if sales volumes into consumer electronics applications will improve. Although we expect over time to regain some or all of our supply position in consumer electronics, sales into EDV applications represent our most significant growth opportunity and the long-term outlook continues to be positive, especially considering that we are qualified on more than fifty EDV models and have field-proven products, significant production capacity already in place, technical advantages, low-cost manufacturing capabilities and intellectual property around ceramic coatings for lithium battery separators. Sales volumes into EDV applications were comparable to the prior year, as growth in EDV applications offset most of the $14.2 million decline in sales attributable to LG. We believe that


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LG purchased in excess of their supply needs in the second quarter of 2013 as a result of the ongoing supply discussions at that time. We have had no sales to . . .

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