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Polypore International, Inc. (PPO)

Q3 2008 Earnings Call Transcript

October 30, 2008, 9:00 am ET

Executives

Kathy Brosco – Director of Corporate Communications

Bob Toth – President and CEO

Lynn Amos – CFO, Treasurer and Secretary

Analysts

Jeff Zekauskas – JP Morgan

Kevin Maczka – BB&T Capital Markets

Brian Drab – William Blair

Richard Eastman – Robert W. Baird

Craig Irwin – Merriman

Michael Levene [ph] – BB&T Capital Markets

Christopher Butler – Sidoti & Company

Operator

Good day and welcome to the Polypore International Third Quarter 2008 Earnings Results conference call. Today’s conference is being recorded. At this time, I would like to turn the conference over to Ms. Kathy Brosco [ph]. Please go ahead Ma’am.

Kathy Brosco

Thank you, Rochelle. Hello everyone and thank you for joining us today and welcome to our conference call to discuss our third quarter financial result. The results we discuss today are found in our earnings announcement that was released yesterday afternoon and furnished on Form 8-K with the SEC. A copy of the release is also available on our website at www.polypore.net in the Investor Relations section. And in conjunction with the release, we also issued the supplemental financial information which we filed as an 8-K and also posted on our Investor Relations website.

Before we begin, as always, I’d like to remind you of some important considerations. This conference call and webcast might contain forward-looking statements within the meaning of Federal Securities Laws. We intend these statements to be covered by the Safe Harbor Provisions for forward-looking statements contained in the Private Securities Litigation Reform Act of 1995. These forward-looking statements are subject to risks, uncertainties and assumptions made by management about Polypore and the industry and environment in which we operate. These forward-looking statements are not guarantees of future performance and may differ materially from actual events or results because they involve estimates, assumptions and uncertainties.

You are cautioned not to place undue reliance on these forward-looking statements which speak only as of the date on which they’re made, which is Thursday, October 30, 2008. Polypore undertakes no obligation to update or revise any forward-looking statements whether as a result of new information, future events or otherwise. You are also directed to consider the risks, uncertainties and other factors discussed in documents filed by us with the SEC, including those matters summarized under the caption Item 1A Risk Factors in our most recent 10-K filing with the SEC.

Today, I’m joined by Bob Toth, President and Chief Executive Officer; Lynn Amos, Chief Financial Officer; and Rob Witzit [ph], Vice President of Finance. At this point, I’ll turn the call over to Bob who will start things off today by sharing Polypore’s business highlights for the third quarter.

Bob Toth

Thanks, Kathy. Good morning and good afternoon everyone. I’ll begin with some general remarks about performance in the quarter, as well as the restructuring plan we announced for our lead-acid separator business, and Lynn will follow with a more detail look at the financials.

As we previously disclosed, we dealt with some unusual items in our lead-acid battery separator business in the third quarter, namely a work stoppage at one of our largest facilities in the FTC matter. Outside of those items, which I’ll come back to and address later, our businesses performed very well particularly in today’s economic environment. I’d like to point out that the long term demand drivers for our business, the increasing need for mobile power and high-performance filtration remain quite favorable.

During the quarter, revenue increased at or above market growth rates in our lithium battery separator, healthcare and high-performance filtration businesses. Our products remain in high demand and our team is executing on our growth plans. More specifically, within our lithium battery separator business, we continue to experience solid growth due to the increasing global demand for mobile power and the penetration of lithium ion batteries, and an increasing number of electronic devices and into new applications with large format cells.

We call that the third quarter of ’07 was a very strong quarter for us. An 18% sales growth year-over-year speaks to the strength we’ve seen in this market, the penetration at our customers and our presence in China. The continued penetration of lithium into new applications and a continued development of hybrid electric vehicles and electric vehicle applications provide the strong base for growth.

We remain on track with the development of our new membrane process technology at our lithium separator facility in Korea. As we stated, we expect this acquisition to be accretive beginning in late 2009. During the quarter, we opened our new lithium separator facility here in Charlotte as planned and it is beginning to scale up.

In our separation’s media segment, we experienced strong performance in both healthcare and filtration. This segment is well-positioned for continued long term growth due to recurring revenue nature of our healthcare business, as well as the functionality and cost efficiencies provided by our membranes and filtration applications.

Specific to healthcare, we are very pleased with the strong growth in sales of PUREMA synthetic membranes and with the complete transformation of our dialysis business from cellulosics to the industry-leading PUREMA technology.

And now, I'd like to come back to the specific items I mentioned in our lead-acid battery separator business as well as the restructuring or implementing in the fourth quarter. First, at our Owensboro, Kentucky facility, this was our first major work stoppage in more than 25 years and it was concluded on October 1, with the current labor contract being extended through March of 2010. Throughout the stoppage, we made every effort to satisfy the needs of our customers, including shifting production between facilities, calling on employees from around the world to operate Owensboro and absorbing substantial additional cost to do so. While the strike was unfortunate, the fact that we’re able to shift production to other global facilities and fulfill orders during this time highlights our unique capability to serve customers around the world in an event of an extended production outage.

Second, regarding the FTC matter, the hearing originally scheduled for December has been moved to April of '09. As previously stated, we continue to believe in and will defend our position.

Finally, regarding the restructuring, this is directly related to the upcoming expiration of the contract between our Daramic business unit and Johnson Controls to supply automotive lead-acid battery separators. Johnson Controls or JCI is a large company with many resources at its disposal. It’s worth noting that our primary competitor has had the major share of the automotive lead-acid business with JCI for many years. It is important to point out that our product quality, our service and our technical support had nothing to do with this change.

In addition to their direct investment in Asia, we believe JCI has made a strategic decision to align with their primary supplier and create a virtual vertically integrated supply position. While the news about JCI is unfortunate, this event is linked to one specific customer and we’re proactively addressing this issue.

The related restructuring plan positions us for growth and is consistent with our long term strategy in which we remain focused on maintaining our world-class cost competitive position and strategically placing assets in the high-growth region such as Asia.

I’d also like to highlight that Johnson Controls remains a valued customer and we’ll continue to supply them with separators for specialty lead-acid applications and JCI-Saft venture for lithium batteries.

At this point, I’ll turn it over to Lynn to share more detail around the financial results.

Lynn Amos

Thanks, Bob. As we reported yesterday, Polypore achieved 19% sales growth in the third quarter, up roughly $25 million over the same period in 2007. This reflects strong growth in lithium battery separators, healthcare and high-performance filtration. Net of approximately $7 million of FX impact, sales were up 14%. Adjusted net income was $9 million or $0.20 per diluted share, compared with adjusted net income in the prior year of $5.2 million or $0.13 per diluted share. As a reminder, our earnings include approximately $0.08 of non-cash amortization expense on a quarterly basis.

Looking more specifically at the performance drivers. As reported, operating income margins on an adjusted basis were down due to the $6.3 million of incremental strike-related and FTC costs incurred in our lead-acid battery separator business. Adjusting for these costs, our operating income margin was comparable to the prior year.

Additionally, and as expected, the 2008 acquisitions in the energy storage segment of Microporous and Yurie-Wide also impacted the operating income margins and mapped the operating leverage we would have otherwise seen from our sales growth.

Adjusted EBITDA for the quarter, which is a key financial measure on our credit agreement, was up 20% or $7 million compared to the same period last year. For the 12 months ending September 27, 2008, adjusted EBITDA was up 20% to $179.3 million from $148.2 million in the prior year. I’ll refer you to the reconciliation of net income to adjusted EBITDA in the earnings release.

Turning to interest expense, it was $14.6 million net of interest income, down approximately $2 million compared to last year. Our tax rate remains consistent with our longer term view in the mid 20% range.

At this point, I’ll move on to the third quarter segment results, beginning with energy storage. Sales grew 23% over the same period last year. This was up 19% net of the Euro to dollar exchange rate and segment operating income was 13% of sales compared to 21% in the prior year, which reflects the impact from the acquisition, the FTC costs, and the strike-related expenses at our lead-acid battery separator facility in Owensboro, Kentucky.

Specifically in the lead-acid battery separator business, third quarter sales increased 25% over the prior year. The sales increase was due primarily to the Microporous acquisition as well as continued strength in the Euro to dollar exchange rate and the 2008 price adjustments to help offset the ongoing escalation of raw materials and energy costs.

During the quarter, we incurred approximately $6 million in strike-related expenses from the duration of the work stoppage, reduced production levels, and legal and security costs. We expect another $0.01 to $0.03 of costs extending into the fourth quarter associated with ramping up to full production.

Regarding the FTC matter, we incurred approximately $300,000 or $0.01 per share of legal expenses in the quarter. Recall that in the second quarter, we incurred approximately $1.5 million of these costs. However, we did not exclude them from our operating results. Subsequent to the FTC's filing of an administrative complaint in the third quarter, we will now highlight and exclude these legal costs in our adjusted numbers.

In the lithium battery separator business, sales grew 18% in the quarter and 16% on an LTM basis. This quarter compares favorably to a strong quarter in the third quarter of 2007.

Moving on to Separations Media, for the third quarter, segment sales were up 9% from the prior year. Excluding the sales of cellulosics, which were discontinued in 2007 and the effect of Euro to dollar exchange rate, sales increased by the same 9%. Segment operating income increased nearly 75% to 15% of sales compared to the prior year. Within the healthcare side of Separations Media, third quarter sales grew 7%. Backing out the cellulosics sale in 2007, sales increased 21% primarily driven by continued growth in PUREMA, our synthetic membrane with best in class performance, and a positive Euro to dollar exchange rate.

Within the filtration and specialty business, third quarter sales grew 14% driven by ongoing demand for our high-performance membranes and a growing number of filtration applications and a positive Euro to dollar exchange rate. The impact of foreign exchange on both Separations Media businesses generally was split proportional to sales within the segment.

I would now like to address the financial impact of the restructuring we’re implementing in our lead-acid battery separator business in the fourth quarter. As we’ve said, the restructuring is related to a supply contract between Polypore’s Daramic lead-acid battery separator business and JCI that expires on December 31, 2008. We anticipate that we will not have a material supply position with this customer for automotive lead-acid battery separators in 2009.

While we don’t disclose specific sales information for customers representing less than 10% of our total company net sales, sales of automotive lead-acid battery separators covered by this expiring contract represent a high single-digit percentage of Polypore’s consolidated net sales.

The restructuring plan includes closing the company’s facility in Potenza, Italy and streamlining production at the company’s facility in Owensboro, Kentucky. We estimate the cost of the plan to be between $54 million and $63 million. This includes cash charges in the range of $24 million to $30 million for site clean-up and remediation and other costs including severance as well as a non-cash impairment charge of $30 million to $33 million primarily for building and equipment that will no longer be used in Potenza, Italy.

We are implementing the plan in the fourth quarter and we expect to record the estimated $54 million to $63 million restructuring charge in that quarter. This translates to approximately $52 million to $61 million net of income tax or an estimated $1.16 to $1.36 per fully diluted share. We expect cash payments associated with this plan to be paid over the next five years with the majority of those payments occurring in the first three years. Naturally, the timing, scope, and costs of these restructuring measures including income tax considerations are subject to change as we implement the plan and continue to evaluate our business needs and costs.

Now, left me shift gears for a minute. Given today’s credit markets, I get a number of investor calls with questions regarding our capital structure and liquidity. What may not be obvious is the significance of the capital structure actions we have taken over the last few years.

In 2007, we de-levered with the IPO and in parallel, we refinanced our bank debt on favorable terms. In 2008, we completed a follow-on offering to fund growth and we fixed the interest rate on a large portion of our floating-rate debt.

We have a comfortable liquidity position today and we are being prudent in our actions to maintain that into the future. We currently have a $170 million in liquidity with approximately $80 million in cash on the balance sheet at the end of Q3, and an undrawn revolver with approximately $90 million of availability. Of course, we continue to generate positive cash flow from operations which enables us to fund growth even at historically high CapEx levels, as well as the cash restructuring expenses we discussed earlier.

Recall that the three financing of our credit agreement in early July 2007 was a covenant like deal with covenants substantially similar to those of our 8.75% bonds. We have a net senior leverage covenant that determines our ability to borrow under the revolver. That covenant is at 3 times. We are well under it at 1.8 times as of Q3.

With the filing of our third quarter results and commensurate improvement in our net leverage, we will achieve a 25 basis point step down in pricing to L plus 200 on both the $370 million of outstanding term loans and on our revolver if drawn upon. We have no material near term maturities of debt until 2012.

Finally, in January 2008, we locked in the LIBOR rate on $200 million of our term loans with interest rate swaps through 2009 and on an additional $50 million through mid 2009. With these swaps, we currently have 85% of our total debt under low fixed interest rates. As we said, we will continue to evaluate the best use of our cash.

Today, in the absence of a return to orderly credit markets, we believe it is prudent to maintain our cash to fund organic growth opportunities while preserving a meaningful liquidity position. The takeaway here is that we have plenty of liquidity to run our business.

Now, I’ll turn it back over to Bob for some brief comments before the Q&A.

Bob Toth

Thanks, Lynn. As we share the issues we are addressing on our lead-acid separator business including the specific customer issue, I don’t want to lose sight of the fact that we had strong performance in the quarter especially in our higher growth businesses. The trends that drive growth, namely the demand for mobile power, portable energy, and high-performance filtration are both favorable and sustainable. Our markets are strong, we have a solid cash-generating business and we’ll continue to invest where we believe we have the best growth opportunities going forward.

On that note, Rochelle, I would like to open up the call for Q&A.

Question-and-Answer Session

Operator

(Operator instructions) Our first question we’ll hear from Jeff Zekauskas with JP Morgan.

Jeff Zekauskas – JP Morgan

Hi, good morning.

Bob Toth

Hi, Jeff.

Jeff Zekauskas – JP Morgan

A few questions. In your relationship with JCI, it sounds like NPEC [ph] was a primary supplier and you’re a secondary supplier. What about in the JCI-Saft joint venture? Is it the same situation where they are the primary supplier and you’re a secondary supplier?

Bob Toth

First step on the automotive lead-acid batteries separators, you’re exactly correct. NPEC was the major supplier; we’re the minor supplier for a long history. Well, we don’t get into a lot of customer specific detail obviously with our businesses, but we can say that that is a different relationship with JCI Saft. We work very, very closely with them. Lithium is different needless to say than lead-acid and I wouldn’t necessarily extrapolate anything there.

Jeff Zekauskas – JP Morgan

So, are you the primary supplier or the secondary supplier, or you’re equal? And if they’re vertically integrating into lead-acid, why wouldn’t they vertically integrate into lithium?

Bob Toth

Well, let me address that part of the question first, the vertical integration. You know, people have attempted vertically – or to produce lithium separators for a number of years. There is a degree of – a big degree of process technology and difficulty that’s very different with lithium separators than what they’re dealing with lead-acid, especially the automotive grade of lead-acid separators.

So they’re very, very different process technologies while they’re both separator membranes for batteries, very different, products look dramatically different. Thicknesses are different. Performance characteristics are different. Other design in is different, of course. In lithium, you have to work hand in hand with the electrolyte and things like that.

We’re not going to comment specifically on our relationships, in terms of relative shares at accounts. I can just tell you that we’re very confident of our position, especially as it relates to HEV and working very, very closely with all of the customers who would be in development on that, including JCI and Saft.

Jeff Zekauskas – JP Morgan

Secondly, can you remind me when your contract with Exide expires?

Bob Toth

Sure, it’s the end of ’09.

Jeff Zekauskas – JP Morgan

The end of ’09, right. And then lastly, in listening to Lynn’s explanation of the effects of the termination or the ending of the lead-acid relationship with JCI, just doing like a rough calculation where it looks like – if this is 8% of your sales, that’s about $53 million or $55 million for next year. Maybe the gross margins are 35%, and so that’s $18.6 million; if you tax effected it 25%, you get something like $14 million after tax or about $0.32 a share, which I guess you’ll offset with cost cuts. Is that the rough order of magnitude of the financial impact of the lost business for next year?

Bob Toth

I think that’s a very reasonable way to think about it, Jeff. I think your analysis is pretty rational and appropriate. The last part of it, of course, we’re taking very aggressive action to reduce both fixed costs and other operational costs like SG&A and things like that, so we’re not sitting back idly on this. We’re taking the opportunity to try to address capacity in the regions and try to address our internal cost structure to ensure that we’ve got a world-class cost competitive position going forward. Lynn, anything to add?

Lynn Amos

Yes, I would just comment that the mid-20% tax rate that we have, which I think is what you used.

Jeff Zekauskas – JP Morgan

Yes.

Lynn Amos

You need to recognize that the bulk of the business that we have done here is also where we’ve taken our restructuring action in Italy and in the U.S., they are higher tax rate jurisdictions, so the tax impact would be different from our blended enterprise tax rate; so you’d be talking something closer to mid 30s.

Jeff Zekauskas – JP Morgan

Okay, thank you very much.

Bob Toth

Yes, good point.

Operator

And next we will move to Kevin Maczka with BB&T Capital Markets.

Kevin Maczka – BB&T Capital Markets

Bob, Lynn, good morning.

Bob Toth

Hey, Kevin.

Lynn Amos

Good morning, Kevin.

Kevin Maczka – BB&T Capital Markets

Another question on the restructuring. I guess the decision to close the plant in Italy, that implies that you don’t think there’s a chance of back-filling that capacity with business from other customers anytime soon; so I guess in that context, can you just talk about your view into ’09 and beyond for lead-acid growth in general?

Bob Toth

Yes, I think – let me qualify that. We're still working the details and trying to understand all the opportunities and implications in the market that this can create, so we’re being very proactive here. The fact of the matter is Europe and North America are the slower growth regions in lead-acid. They both have had some excess capacities, so I think you could conclude, I guess, by the fact that we’re closing a facility out that we don’t expect to fully offset that volume; but having said that, there could be some market opportunities as a result of the relationship between our competitor in them. Lynn, do you have any other build on that? I think the –

Lynn Amos

I would just comment that as you recall, we have been putting additional capacity into Asia, which is a lower cost region for us.

Bob Toth

Yes, we have a plant there [ph].

Lynn Amos

We’ve got a new facility starting up in Thailand and as you know, we acquired a new facility in Austria with the Microporous acquisition as well, so we do have incremental new capacity that’s come online as well.

Bob Toth

Right, right.

Kevin Maczka – BB&T Capital Markets

Okay. And then with the elimination of that plant, how much of your lead-acid capacity does that remove and what position are you in now and post that, in terms of capacity utilization?

Bob Toth

Well, we don’t disclose those precise numbers, Kevin. Sorry. I can tell you that we’re very comfortable with our capacity in our regions, recognizing that we’re taking capacity out of both Europe and North America. And as Lynn said, we’re in the midst of scaling up Thailand as we speak from that investment, and Asia continues to be the highest growth region in lead-acid.

Kevin Maczka – BB&T Capital Markets

Okay. And then, Bob, I think you mentioned that of the things that were not sort of a culprit here for this lost business, you mentioned quality, service, technical support. You did not mention price though. Was that a factor in this at all and how long are these contracts typically? Are these multi-year contracts, 10 years maybe?

Bob Toth

I think contracts – no, I wouldn’t conclude anything on duration of contracts. It's all over the map, Kevin. Some people want to buy spot, some people want long-term contracts; so you end up having a pretty wide disparity of customer interest there. Was it price? I don’t think so. Anything could’ve factored in. I think this was more a case of a strategic decision made with their major supplier, as well as a direct investment they’ve made in Asia; and so that’s the way we’re viewing it. I think we made every reasonable attempt to keep the business, certainly viewed them as a valuable customer and would’ve preferred to have been a major supplier of theirs.

Kevin Maczka – BB&T Capital Markets

Okay, and just finally on the strike. Can you quantify how much revenue was lost in Q3 because of the strike? And will that revenue just be pushed out into Q4 or is that lost market share to someone else?

Bob Toth

No, I think – I wouldn’t conclude that any material amount was lost. I think one of the benefits that we have as a company, I think it’s a huge benefit for this industry, we recognize we’re providing a lot of functionality to a battery, and we’re a very low percentage of cost, being under 5% of the cost of a lead-acid battery. One of the strengths we have as a supplier to the industry is we have plants around the world, and we have the ability to shift production; and we did that aggressively with the strike. Not only did we operate Owensboro at reduced rates, we were able to move production to other facilities in the United States, to other facilities in Europe, and certainly had to eat some freight cost but we were able to keep people producing batteries. At the end of the day, I wouldn’t conclude that there was a material shift or loss of any revenue there.

Kevin Maczka – BB&T Capital Markets

Okay, thank you.

Bob Toth

Thank you.

Operator

And next, we’ll move on to Brian Drab with William Blair.

Brian Drab – William Blair

Good morning.

Bob Toth

Good morning, Brian.

Brian Drab – William Blair

I just want to make sure I’m clear on the percentage of revenue or at least as clear as we can be that JCI is responsible for it. You said high single digits, but you’re only losing the automotive lead-acid battery separator business to them. Can you give us a rough idea for the breakdown between the automotive separators that you’ve been supplying them versus the specialty and lithium?

Bob Toth

Well, I think you could say – you could conclude it was the majority of it. The automotive separator business represented the high single digits, just to be clear. That’s what Lynn was stating. What we expect to not have was that.

Brian Drab – William Blair

Okay, I understand. And then could you talk a little bit more in detail on the lithium separator side? I mean, 18% growth was, I think, above everyone’s expectations. Are you starting to see benefits from the hybrid vehicle opportunity? Could you talk more specifically about the factors driving that growth?

Bob Toth

Well, we were very pleased with our lithium performance, and I think we’ve taken a number of actions to strategically strengthen our lithium business. Recall, with the acquisition in Korea, we’re now the only supplier in the world that has the full range of product types and preferences. I think we’ve been very focused on HEV, but recognize HEV is still largely in development. While the press is picking it up a lot and while Mercedes has announced the launch of their vehicle, we’re still in that phase of nickel converting over to lithium; so I wouldn’t conclude that in our current revenue base, there is any substantial amount of HEV sales beyond development.

Brian Drab – William Blair

Okay, thank you very much.

Bob Toth

Well, let me just highlight.

Brian Drab – William Blair

Sure.

Bob Toth

What you see there is, you see in consumer electronics while in the US or in a developed economy, we may not feel real good about things, the fact of the matter is there are more and more mobile devices and laptops being sold around the world. And from our perspective, whether it’s a very high end or a very low end, it doesn’t really matter, it’s still lithium-ion battery and virtually has the same content, the same design profile and things like that, from our point of view. And you still have, of course, application growth and you’ve had the large format cells moving through power tools and hopefully next to lawn and garden. So the fundamental growth characteristics of mobile power hasn’t changed at all.

Brian Drab – William Blair

Okay, thank you.

Bob Toth

Thank you.

Operator

And we’ll move on to Richard Eastman with Robert Baird.

Richard Eastman – Robert W. Baird

Yes, just a couple of follow-up questions on the Johnson Controls lead-acid side again. How comfortable are you with the amount of restructuring charges that you’ve identified, not exposing a significant amount of unabsorbed overhead in next year’s number?

Bob Toth

I think, Rick, the way I think about it and I’ll ask Lynn to build on it; I’ll approach it from a qualitative perspective. I’m a big believer that everything we do has to create value, so we will aggressively address the fixed cost structure that was attached to this business. We’ll also aggressively address the variable costs that might have gone along, theoretically, with that business. So when you walk through the numbers, as Jeff did to get to a gross profit impact earlier, we’d expect to take a number of actions to materially offset that. Lynn, do you want to address Rick’s question?

Lynn Amos

I would agree. I think we have aggressively gone at the cost structure here with closing facility and scaling back a line. In addition, we’ve addressed the SG&A structure as well within that business. So we believe this was a very aggressive action on the cost side to help us offset the impact of this.

Richard Eastman – Robert W. Baird

With your new facility in Thailand, then you have some – presumably some unabsorbed overhead there as well? I mean, I wouldn’t think that capacity is all spoken for.

Bob Toth

Well, the capacity’s ramping up as we speak. Recall the expansion there in Thailand, and that’s at the existing facility.

Lynn Amos

And I would also highlight that our growth in Asia has been very strong over the last few years, and we have been exporting product to Asia; so continuing to shift our production there is going to lower our costs as well.

Richard Eastman – Robert W. Baird

Okay. And then, when I look at the lead-acid battery segment of the business for this quarter, I pull out an FX assumption. I’m going to assume maybe Microporous did $10.5 million or $11 million of revenue, and it looks like the core growth there was maybe around 4% in local currency. Does that sound about right?

Bob Toth

Yes, low single-digits is probably about right.

Lynn Amos

Are you talking about the enterprise or lead-acid?

Richard Eastman – Robert W. Baird

Lead acid.

Bob Toth

Lead acid, yes.

Lynn Amos

Yes. Yes, that’s right.

Richard Eastman – Robert W. Baird

Now, is there any volume gain there, or was volume positive or negative in the quarter? As you mentioned –

Bob Toth

I think it was – I don’t think volume was up materially. Lynn, do you have any comment on that?

Lynn Amos

No, I think there’s probably an immaterial amount shifted because of the strike, but they’ve been pretty flat, I think.

Bob Toth

Yes.

Richard Eastman – Robert W. Baird

Okay. And then just a last question. As you look out into ’09, I guess we’re not going to talk to ’09, I guess, at this point in this quarter call. But when you look out to ’09, you see the JCI piece of business disappear. We obviously have some currency issues to deal with, maybe some slowing in our end markets. Lynn, how comfortable are you with your coverage ratios because you tend to look on a trailing 12-month basis, which is how those are structured, but at the end of ’09, how comfortable are you that those ratios remain quite firmly in the middle of the range?

Bob Toth

Rick, while Lynn is formulating his answer, let me jump in and clarify something I said. The volume was generally flat, I said, in lead acid. And the point I should’ve made, which I know, just didn’t explicitly state is, it’s getting really tough to discern what’s our core business and what we’ve shifted to production facilities that came with the acquisition, so it’s getting tougher to carve out Microporous per se. The fact of the matter is when I said volume was flat, I generally looked at it under the old lead-acid separator business pre the acquisitions, but some of the volume that would be in the plants that were acquired with Microporous, we’ve seen shift, especially associated with the strike. Just to clarify that comment.

Richard Eastman – Robert W. Baird

Okay.

Lynn Amos

Then on the covenant question, I guess I’m going to speak to that first a little qualitatively. We don’t have a financial maintenance covenant. What we have is a covenant that limits our access to the revolver, and that covenant is a three times net senior leverage. So if we have $370 million outstanding on the term loans today and our covenant structure says that we can reduce that number by cash on the balance sheet of up to $50 million, that would bring you to a debt number of $320 million. Even a fully drawn revolver would be $410 million, and divided by three gets you a number of about $136 million at a fully drawn revolver. So I’m pretty comfortable at the 1.8 times net leverage that we’re at today.

Richard Eastman – Robert W. Baird

Okay. Okay, very good. Thank you.

Lynn Amos

Thanks, Rick.

Operator

And next, we’ll hear from Craig Irwin with Merriman.

Craig Irwin – Merriman

Good morning, gentlemen.

Bob Toth

Hey, Craig.

Craig Irwin – Merriman

I was hoping for a little more color around your restructuring actions. I understand closing Potenza, but were there any major customers other than Johnson Controls that were surfed out of this facility?

Bob Toth

Sure, sure. I mean, the fact of the matter is as Lynn mentioned, we’ve exported from Europe to Asia and we have a number of other customers. Keep in mind that we’ve got a very large facility in Selestat, France and we’ve got a new set of assets that we’ve scaled up in Feistritz, Austria.

Craig Irwin – Merriman

Okay. And then since you’re writing down the land, buildings and equipment, can you tell us, is this equipment that you can potentially move to one of those other plants you mentioned or is this something that’ll be probably sold to the scrap dealers in the region?

Bob Toth

No, this is equipment. As we’ve done in the past, we can relocate this equipment to Asia in particular. That’s how some of the assets have gotten to Thailand, so we could certainly consider that in the future.

Craig Irwin – Merriman

Okay, excellent. And then just a little more color around Owensboro if you could. I mean, can you give us some specific actions that you’re going to be taking to offset the lower coverage of fixed expenses in that facility? It’s obviously a very important facility in North America.

Bob Toth

Well, I think the action that we’re taking is consistent on both sides of the water here, right? It just so happens that Potenza was a smaller plant, so unfortunately we’ll close the whole site. In the case of Owensboro, we’ll be scaling it back, reducing headcount, reducing fixed as well as hourly, and we’ll be taking capacity out the same way.

Craig Irwin – Merriman

Okay. Excellent. And then if we could just go back to Microporous. It sounds like from your comments about organic growth that Microporous is probably growing quite nicely. Are you seeing uptake into the industrial market really drive that? Or can you give us a little more color around that?

Lynn Amos

One point I’d like to qualify here is that it’s getting tougher and tougher to carve out acquisition growth from organic, particularly in the third quarter when we shifted production out of Owensboro to all of our other sites, including the Microporous sites to subsidize the capacity we needed to cover the strike.

Bob Toth

(inaudible) is getting tough to discern here, right? We’ve scaled up Feistritz and we’ve moved production there, so is that them or us? Well, at the end of the day, it’s us, right? And that’s the point I tried to make earlier. The industrial market, if you’re asking a broader question there, that’s the one we said that certainly could be impacted to some extent by macroeconomic conditions. But generally speaking, it has a very high replacement rate of sales, so while the market may not be growing double digits, the fact of the matter is it’s got a high-recurring revenue nature of the business and there is still some growth.

Craig Irwin – Merriman

Excellent. Thank you very much.

Bob Toth

Thank you.

Operator

(Operator instructions) Next, we move on to Michael Levene [ph] with BB&T Capital Markets,

Michael Levene – BB&T Capital Markets

Good morning.

Bob Toth

Good morning.

Michael Levene – BB&T Capital Markets

You mentioned you’re going to take the restructuring charge in the fourth quarter. Will all your actions be pretty much done by the end of the quarter? Is there going to be some carryover into next year?

Bob Toth

I think the intent is to address the vast majority of the actions by the end of the fiscal year here.

Michael Levene – BB&T Capital Markets

Okay.

Bob Toth

The carryover would be pretty modest.

Michael Levene – BB&T Capital Markets

Okay.

Bob Toth

Having said that, the cash comes a little differently. The actions and the cash are not necessarily locked up.

Michael Levene – BB&T Capital Markets

Okay. So you’re saying cash may carryover into next year?

Bob Toth

I’ll let Lynn make a comment.

Lynn Amos

Yes, cash is going to go out over about a five-year period. The majority of it’ll go out over the three years. Obviously, some of these actions, particularly as it relates to dealing with the local authorities within Italy and designing the severance packages that’ll be involved, that’ll all come out of the action that has been announced. But based upon what we’ve seen, it is our view that it’s probably most of the cash over the first three years.

Michael Levene – BB&T Capital Markets

Okay, all right. Maybe I should know this, but can you give us – on the Johnson revenues, can you just give us an idea geographically where those were on a percentage basis or something?

Bob Toth

I think it would be fair to conclude it was largely Europe and North America.

Michael Levene – BB&T Capital Markets

Okay. You don’t want to give me any a breakdown?

Bob Toth

Slightly more in Europe than North America.

Michael Levene – BB&T Capital Markets

The FTC investigation, is that limited to just precisely the acquisition of Microporous with negative resulting backing out what you bought?

Lynn Amos

I don’t know how you speculate on what a potential outcome would be. Fact of the matter is, their purview, their jurisdiction is over the competitive environment in the U.S., and obviously this is a very global business and as we’ve said and obviously the JCI situation has demonstrated it is a very competitive market.

Michael Levene – BB&T Capital Markets

Okay. So they’re actually investigating the whole U.S. business as a whole versus just Microporous?

Lynn Amos

I’m not sure how you’re defining whole. It’s the lead-acid separator business, right?

Michael Levene – BB&T Capital Markets

Okay. That’s what I mean.

Lynn Amos

Yes, that’s it.

Michael Levene – BB&T Capital Markets

Okay. All right. I saw an announcement that BYD is going to start building electric cars. Is that a pretty significant development for Polypore?

Lynn Amos

Again, we have to be a little bit careful about specific customer discussion. At the end of the day, we have a very significant presence in China and we’re pleased with the development we see there in the electric vehicles and hybrid electric vehicles as well and we’re closely and – virtually every development program around the world.

Michael Levene – BB&T Capital Markets

Okay. Thanks. That’s it for me this morning. Thank you very much.

Lynn Amos

Thank you.

Operator

And Christopher Butler with Sidoti & Company will have our next question.

Christopher Butler – Sidoti & Company

Hi. Good morning guys.

Bob Toth

Good morning.

Christopher Butler – Sidoti & Company

I was hoping you might talk to the economic sensitivity of some of your businesses. I think we’re all probably fairly familiar with the fact that lead-acid batteries is largely replacement that would be at least partially resistant. How would that apply to lithium batteries? Is there a replacement component there that can be drawn upon at time of weakness or even filtration and specialty, those filters need to be replaced periodically?

Bob Toth

Great question. First of all, you said it well. In lead-acid, you’ve got a very high percentage of replacement sales and transportation, it’s 80% or north and in industrial, it’s probably 50% or north. And obviously recalibrating for the JCI loss, we’d expect that this business would continue to grow and has the same exact growth characteristics for the market that we’ve described all along.

In lithium, while I wouldn’t describe it as a big replacement market, what I would describe it as is a growing market, right? We’re certainly on a global basis not just from our perspectives of the U.S. or developed economy prospective. This is a market where you’ve got a growing number of applications. Many developing economies have just skipped landlines completely and are going to mobile devices. You’ve got a proliferation of mobile devices continuing to happen. You’ve got the large format cell portion of the industry developing and growing and moving through power tools, and then moving on through lawn and garden. And in fact, I think power tools is a great microcosm for the macroeconomic environment. Power tools are down year-on-year but the penetration of lithium is up and accelerating. And so, we look forward to the day that if that continues to happen, but then you get the wave of growth from the market as well.

And then last but not the least of course, you’ve got tremendous development with HEV. And while oil prices are down a bit, the volatility of oil prices certainly is continuing to drive development of hybrid electric vehicles and full electric vehicles. So that’s the lithium case. And in fact, third quarter here, we lived with a pretty – how would you define it, not so good macroeconomic environment and you saw our performance within that in lithium.

In healthcare, very high recurring revenue nature of business. It’s not very sensitive to the macroeconomic environment. And in industrial and specialty filtration, it’s a little bit like the industrial portion of lead-acid in that, in any given quarter, you may see an impact. Yes, I can try to delay spending for a quarter, but at the end of the day, basically that is driven by the functionality and the cost efficiencies of our membranes. So arguably a poor economy drives a greater future growth because it will cause people to look more consciously and more seriously at their cost structures and that’s where membranes provide functionality.

Christopher Butler – Sidoti & Company

I’m sorry if I missed it. Could you give us the foreign currency top and bottom line for the quarter and what have you have baked into the guidance at this point for the fourth quarter?

Lynn Amos

Well, in terms of the quarter, revenue we benefited just under $7 million by exchange, the FX rate in the third quarter and net income was a few hundred thousand dollars. In terms of FX for the quarter, we haven’t given specific guidance in the quarter except that we said that we are still comfortable excluding the one-time items with our full-year forecast.

Christopher Butler – Sidoti & Company

Thank you for your time.

Bob Toth

Thanks.

Operator

And we’ll take a follow-up question from Kevin Maczka with BB&T Capital Markets.

Kevin Maczka – BB&T Capital Markets

Lynn, just a quick one on the guidance. Your comments about guidance for the full year implies that revenues will be down sequentially in Q4, whereas they were up pretty significantly last year and also implies that EPS will be down on a year-over-year basis pretty significantly. So I guess JCI aside, I’m just wondering if that’s indicative of some macro slowing that’s finally starting to show up in your business or is there something else unusual going on there?

Lynn Amos

What we’ve said is we’re comfortable at the higher end of the guidance. We didn’t revise our guidance, (inaudible) we are comfortable at the higher end. I would also highlight that in our Separations Media business last year, we highlighted that it was an extraordinarily strong quarter, with the start-up of our new lines. We had fantastic operating results in the fourth quarter of last year, so that’s going to be a tough comparison for us in the fourth quarter but that’s not indicative of a trend.

Bob Toth

And there was a slug of cellulosics around [ph] and that’s causing some (inaudible).

Lynn Amos

Yes, that’s right. We had the final sale out of a large quantity of a cellulosics in the fourth quarter of last year.

Kevin Maczka – BB&T Capital Markets

Okay. That’s all I have. Thank you.

Operator

Then we’ll take a follow-up from Craig Irwin with Merriman.

Craig Irwin – Merriman

Thank you. I was hoping you might be able to give us a little more color around some of the drivers in the background of your lithium-ion business. Has your early experience with the lithium-ion iron phosphate technology really helped you get on with some of the productions runs that are starting with a dozen or so suppliers making that type of product now?

Bob Toth

Let me answer that. I think that when we talk about lithium-ion, we’re talking about the breadth of the chemistries in that marketplace. And as we’ve talked, this is what I mean by the separator and the electrolyte working hand in hand in a system, and this is I think where the value of our very technical field sales force and our technical resources that back them up and the fact that we have a battery lab here and we’re the only supplier in the world with a battery lab. I think the fact that we can get involved in those kinds of developments early on and help our customers make batteries with the electrolyte and the separator going hand in hand and that does give us an advantage. But I’m not going to necessarily speak to any particular chemistry. I mean we’re front and center we think on all of those developments and those evolutions with lithium-ion and chemistry.

Craig Irwin – Merriman

Okay, okay. Excellent, and then could you give us a little more color around the major customers in China that you do business with in the lithium-ion business?

Bob Toth

Well, we definitely do a lot of business in China and I don’t know how you – how you put a lot of color to it. You’ve got a handful of major players that over the years have emerged as very high-quality battery producers. China continues to be one of the rapidly growing markets in lithium ion. We’ve had a strategic focus there with resources on the ground. Recall back two or three years ago, we made the change from the indirect agents to the direct technical sales and service organization and we deal with all of the major customers there we believe. In fact the business leader, Mitch and I, are heading over there shortly to visit with customers. So I think we’ve got a very good strategic position in China.

Craig Irwin – Merriman

Agreed, agreed. I mean, I remember you were one of the early companies to commit to BYD when they started contract manufacturing batteries, but are there any other top customers that you can mention by name in China?

Bob Toth

Well, we listed in our public filings a number of producers that would be in China, right? You’ve got ATL [ph], you’ve got BYD, you’ve got Lee Shen [ph]. I could go on, but I mean there’s just several major battery producers there.

Craig Irwin – Merriman

Okay, okay. Excellent. Thank you very much.

Bob Toth

Thank you.

Operator

There are no further questions at this time. I would like to turn the call back over to Mr. Bob Toth for any additional or closing remarks.

Bob Toth

I would like to thank everyone. We’re obviously very focused on value creation, very focused on controlling the things we can control and aggressively continuing to grow our business, so I’d like to thank everyone for their support. Goodbye.

Operator

And that will conclude today’s call. We thank you for your participation.

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Source: Polypore International, Inc. Q3 2008 Earnings Call Transcript
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