Polypore International's (PPO) CEO Bob Toth on Q2 2014 Results - Earnings Call Transcript

| About: Polypore International, (PPO)

Polypore International, Inc (NYSE:PPO)

Q2 2014 Earnings Conference Call

August 6, 2014 16:45 ET

Executives

Kathy Brosco

Bob Toth - President & CEO

Lynn Amos - CFO

Rob Whitsett - VP, Finance

Paul Clegg - Director, IR

Analysts

Brian Drab - William Blair & Company

Chris Kapsch - Topeka Capital Markets

Rob Mason - Robert W. Baird

Brian Lee - Goldman Sachs

Craig Irwin - Wedbush

Operator

Welcome to the Polypore International Incorporated Second Quarter 2014 Earnings Conference Call. (Operator Instructions). I would now like to turn the conference to our host Ms. Kathy Brosco. Ma'am, you may now begin.

Kathy Brosco

Thank you, Eric and hello everyone and welcome to our call today to discuss our second quarter 2014 financial results. Joining me on the call today are Bob Toth, our President and Chief Executive Officer; Lynn Amos, our Chief Financial Officer; Rob Whitsett, our Vice President of Finance; and Paul Clegg, Director of Investor Relations

As always our earnings release and a presentation containing supplemental financial information are both available on our website at polypore.net in the Investor Relations section and this call is being webcast and a replay will be available on our website. I'd like to remind you that today's call may contain forward-looking statements under the meaning of Federal Securities Laws.

Please review our disclosures regarding forward-looking statements contained in our earnings release and in our quarterly financial supplement. Forward-looking statements are subject to risks and uncertainties that could cause future results to differ materially from those we discussed. Please review our SEC filings for a full discussion of risk factors related to the company's performance. Polypore undertakes no obligation to update or revise any forward-looking statements for any reason. When discussing financial performance, we often use non-GAAP measures such as adjusted EPS and adjusted EBITDA. A reconciliation of these items to U.S. GAAP measures is available in our earnings release and also in our presentation materials which can be found on our website in the Investor Relations section. With that said I'll turn the call over to Lynn to go over financial results.

Lynn Amos

Thanks Kathy. As we reported this afternoon in the second quarter sales were a $166.6 million, adjusted EPS was $0.35, segment operating income was $28.1 million and adjusted EBITDA was $42.2 million. On May 8, we completed our debt reduction and refinancing which substantially reduces interest expense going forward. For the purposes of our call today our discussion excludes non-recurring costs associated with these transactions. As scheduled reconciling our adjusted results to U.S. GAAP is included in the release. Regarding segment results, beginning with transportation and industrial. Sales in the quarter increased 3% from the prior year driven by higher sales in Asia and Europe partially offset by lower sales in the Americas. Segment operating income was 21% of sales similar to the prior year period. While ongoing performance remained solid operating income margin in the quarter reflects modest production and efficiencies including those related to labor negotiations at our facility in France which had successfully concluded by quarter end.

In the electronics and EDV segment sales were down 25% and segment operating income was 12% of sales compared with 27% in the second quarter of last year. The decrease in sales was primarily due to LG's large purchases of $14.2 million in the second quarter of last year prior to the end of our relationship. As well as the year-over-year declining in consumer electronics.

Sales to our current EDB customers grew meaningfully over the prior year period with higher volumes more than offsetting some pricing impact related to our recent long term agreements. We value customer commitments to volume and duration in this high growth application space and those willing to commit to long term partnerships with minimum purchase requirements have received a pricing benefit for that.

Moving on to the separation of the media segment, compared to the prior year healthcare sales were up 9% primarily due to growth in hemodialysis particularly in Asia as well as blood oxygenation and a positive effect of foreign currency translation. Filtration sales were up 20% over the prior year period due to growth across all major applications and the positive effect of foreign currency translation. In the quarter segment operating income margin modestly improved from the prior year period at 31% of sales. We call that our upcoming third quarter is typically our lowest quarter from an operating income margin perspective due to seasonal shutdowns in European holidays.

Operating income margin in the Separations Media segment over the last three years has been approximately 28% and we expect it to be similar this year. Moving on to CapEx, at this point we still expect to spend approximately $50 million for the year including the previously disclosed capital investments in our lead-acid separator joint venture in China and in our filtration business both of which allow us to participate in ongoing market growth.

Regarding the income tax rate in the quarter the debt reduction and refinancing cost had a onetime impact on U.S. GAAP income tax, however our adjusted tax rate should remain at approximately 30% for the year. Finally our business continues to generate a substantial amount of cash. During the quarter we used over a $150 million of cash on hand as part of our debt reduction and refinancing and another $9 million to repurchase 200,000 shares of stock and our liquidity position remained strong.

In summary our Separations Media and Transportation Industrial businesses continue to perform very well. We have more work to do in electronics and EDVs and we’re focused on that. We have a great capital structure in place and as we continue generate cash we will look to deploy it ways that generate the most shareholder value.

With that I will turn the call over to Bob.

Bob Toth

Thanks. As Lynn just described, our company is in good shape. Three of our four businesses are performing very well and we have a significant equity value creation opportunity in our fourth business, the lithium separator business. Given that I will spend more time in my remarks today on the dynamics of lithium which means I will be giving less time that deserved to the businesses that make up the majority of our company and are performing quite well.

First our transportation and industrial segment is on track for solid full year growth and we continue to make good progress in Asia, the fastest growing region in the world where we’re investing and expanding to further strengthen our leadership presence. In Separations Media we had robust growth in the quarter with strong sales in both healthcare and filtration. In healthcare we’re seeing good growth opportunities in Asia and in filtration we’re seeing demand across all key applications. As we look ahead given our technology and product portfolio as well as the broad application base, we believe the filtration space is an attractive area for future investment.

Now turning back to the lithium separator business in the electronics and the EDV segment. Improving performance is the most significantly lever we have to drive equity value and driving growth in this segment remains our number one priority. We believe we’re making good progress here in the businesses position for improved performance. Admittedly we’re not satisfied with where we’re in consumer electronics. We realize that our progress is too slow and we will continue to take the appropriate actions to rebuild this business using our technology leadership and our strong intellectual property position in the global OEM business or what I call Tier 1 market as well as using our significant available capacity and local cost competitive position to capitalize on the growing Tier 2 market composed of lower price less demanding applications primarily in China.

In Electric Drive Vehicles, new vehicle model introductions and feedback from customers suggest additional growth later in 2014 and 2015. And we are pleased with recent developments, we now have two long term agreements with Samsung and Panasonic, sophisticated customers and producers who have committed to minimum volume long term contracts. These are the first of this type in this industry. We believe this reflects the importance of high quality demonstrated capacity and proven supply capability to major manufacturers given their expectations for growth in EDVs.

We also have a licensing agreement with Sumitomo which includes an opportunity for a broader business partnership this too highlights the value of our intellectual property. Finally and meaningfully for the industry and for us there has been a favorable development related to protecting our intellectual property though I normally wouldn’t comment on ongoing litigation this development promptly questions, so I will briefly address it to be clear. Recently a U.S. Federal District Court found that LG was likely infringing on our patented ceramic coating technology and granted our motion for an injunction.

This order has been stayed which means the enforcement of this injunction is temporarily on hold. As anticipated LG has taken steps to appeal the injunction, however the ruling for us is a very significant development and it has the attention of separator and battery manufacturers as well as downstream users.

Should LG not get this injunction reversed ultimately they will not be able to sell batteries which contain ceramic coated lithium-ion battery separators in the United States and their customers will not be able to sell electric drive vehicles and consumer electronic devices which contain those batteries in the United States. Bottom line we’re very encouraged by this ruling as it relates to protecting our ceramic coating technology and we believe that this development together with our long term customer supply agreements and licensing agreement demonstrates the value of our intellectual property and technology leadership.

In summary our separations media businesses are performing well, transportation and industrial is performing well. In electronics and EDVs, we’re not satisfied with where we’re in regard to consumer electronics yet we’re making progress and related to EDVs we’re well positioned for growth. Looking at this segment as a whole we have established a solid foundation for upside.

With the strong capital structure, great liquidity position, solid cash generation capability, we will begin to explore investments to support growth and pursue opportunities that will continue to drive shareholder value in 2015 and beyond. At this point Eric I would like to open up the call for questions.

Question-and-Answer Session

Operator

(Operator Instructions). And our first question comes from Brian Drab from William Blair. Please go ahead.

Brian Drab - William Blair & Company

First question maybe just on the transportation industrial segment, I think you explained that you had again a quarter where you weren’t completely satisfied with the production efficiencies and the operation but what should we expect for the second half of the year? I know you had previously said something along the lines of you know that margin should trend upward from the 22.5% level that we saw in 2013. Is it too aggressive at this point to think that we’re going to be up from that 22.5% for full year ’14?

Bob Toth

Brian, I don’t think we’re going to get into China trying to lock in quarterly margin percentages. The take away is we have got a lot of things going on in that business, they are good, they are moving in the right direction. We’re investing capital in Asia and we will continue to enhance margin as time goes on as we produce more locally in that particular region. This quarter production wasn’t the efficiencies weren’t as robust as we would have liked and then in particular we called out the situation where we had labor negotiations in France which were concluded successfully at the end of the quarter but had a financial impact. So bottom line is you know even the quarter in and of itself would have been better had it not been for that but you got the right idea which is margin, we expect margin to expand especially as we get more on the ground capacity in Asia.

Brian Drab - William Blair & Company

So it's fair to expect expansion in the second half of the year over the first half of the year?

Bob Toth

I’m just not going to get into predicting it quarterly right? Because there is always an impact that can occur at any given quarter but directionally we expect margin to improve.

Lynn Amos

Yes I would say at the lower end of what we would expect.

Brian Drab - William Blair & Company

And then I will see how this line of questioning goes, same line of questioning on Separations Media. You talked about 28% margin on average over the last few years and expectation that you mentioned again today Lynn that we should see margins around that level in 2014 but first of all knowing that third quarter is seasonally soft. It still looks like 28% looks a little conservative for 2014 at this point, is that a fair assessment?

Bob Toth

Well I don’t think we’re in a position, I will let Lynn comment. I don’t think we’re in a position of predicting how much above 28 it could be either, right? I mean at the end of the day there is a lot of variables in that business like product mix and production mix, how our customers run campaigns and order timing and those kind of things. If what you’re asking if that business is focused on improving margin to questions absolutely yes but we have got three years now of 28% and at this point in time we’re not about to predict anything different, the business is doing a good job as we said, that business and transportation and industrial are performing very well but trying to peg a specific percentage and a quarter when you got that many big variables and the kind of margins our products it's just too hard to do.

Lynn Amos

I think they are comparable to last year, the way to think about it and obviously we’re trying to do everything we can to make it better but at this point I wouldn’t say it's going to be much better.

Brian Drab - William Blair & Company

Can you talk just a little bit about what’s driving the above trend margins in the first half of the year in Separations Media?

Bob Toth

Well I mean if you look at the operating income margins last year, the numbers are pretty comparable. So you tend, it tends to be more of production timing, we tend to produce more in the first half, we produce less in the third quarter and the fourth quarter sometimes we don’t produce quite as much as we do in the first and second but you can see it run into holidays at the end of the year.

Brian Drab - William Blair & Company

And then just one more question then for Lynn, on the lithium side you had relatively nice sequentially uptick about 5% in the electronics and EDV segment. Can you comment on whether that sequential move was driven more by EDV or CE?

Lynn Amos

Well we saw improvement in both but I wouldn’t write home about the improvement we saw in CE but it was nice to see an improvement there but fact of the matter that majority of the growth was electric drive vehicles.

Brian Drab - William Blair & Company

When you say that Bob, are you talking year-over-year or the majority of the sequential growth would be?

Bob Toth

Sequential.

Operator

Our next question comes from Chris Kapsch from Topeka Capital Markets. Please go ahead.

Chris Kapsch - Topeka Capital Markets

One thing that was notable about the IP litigation, both the complaint and the preliminary injunction that was granted, was that it covered separation materials that deployed the ceramic coating for both EDV as well as consumer electronics applications, and so in the context of your comments about really focusing on fixing your competitive position and taking advantage of the opportunity in consumer electronics you stress that in this Tier 1 market where you'd be focused on your technology advantages as well as your IP. I'm just wondering like in the context -- what you're sort of suggesting is that this coating technology is being used increasingly in consumer electronics and you're probably not getting paid for that. And so I’m wondering how widespread is this practice of using coded separators in consumer electronics become? What's the performance advantage that's conveyed? Or with in those applications and just what do you -- is there a way you can size up what the opportunity is over time in terms of leaning on your IP and your technology position in that Tier 1 market? Thank you.

Bob Toth

That’s a good question, so a couple of comments there. I mean first off with or without this intellectual property we believe we will be successful in both consumer electronics and EDV. People have as I said you know I think I very specifically said it's certainly has gotten the attention of separator producers, battery producers and end users this recent ruling and to your point ceramic coating as we said for kind of a couple of quarters has become much more popular recently because of the demands on the battery and in particular the need to protect oxidation resistance were you only have a polyethylene separator. And as you well know you get some of that benefit from our Trilayer since we can put polypropane on the outside and it doesn’t necessarily need as much of oxidation resistance as a pure polyethylene separator does.

But having said that the demand on batteries have gone up, ceramic coating is used to enhance cycle life in effect to protect that oxidation resistance. It comes at a cost but where people are using our technology we expect to have an appropriate business relationship which in effect allows us to get paid for it or we will take action as we have said, and we have seen very positive results from that in a pretty short period of time and as we have said we’re very confident of our position and we’re not going to simply allow people to steel our technology and ask us to ignore it.

So beyond that I don’t want to comment. I think this for anyone that knows the legal system getting an injunction has a very high hurdle rate and certainly shifts the burden of proof and we're very pleased with that ruling.

Chris Kapsch - Topeka Capital Markets

Bob if I could just follow-up, focusing on the tier one side of the consumer electronics, any way of framing out how pronounced or how widespread the use of the ceramic coating technology has become in consumer electronics? Just trying to get an order of magnitude what the opportunity might be in terms of how often that technology is being used in consumer electronics?

Bob Toth

I would say it's become -- I am not going to get any specifics here but I would say it has become very popular in primarily only the global OEM applications because that’s where the manufactures are willing to pay for that improved performance.

Operator

Our next question comes from Rob Mason of Robert W. Baird. Please go ahead.

Rob Mason - Robert W. Baird

I want to stay on consumer electronics real quickly. Bob previously if I rewind maybe last quarter a little ways, you had been hopeful that we would see more of a consumer electronics uptick later in 2014. You did mention a little bit of a sequential increase this quarter, but has anything changed around your view that -- by the time we get to the back half of ‘14 we can see consumer electronics improve more?

Bob Toth

You know I’m not going to get into predicting it. We’re taking a lot of actions and as we have said all along this is an industry that doesn’t move overnight and so we don’t get to control the timing in all cases. We have got a new business leader running that segment, very highly qualified business leader. We have got a new sales leader in China that’s very high potential and highly qualified who is also now quickly establishing action plans and account strategies and the organization to drive growth we have got a lot of work going on, on the coating front both from an IP perspective as well as where people have the need to have freedom to operate as well as from an investment perspective.

So we’re taking actions on a lot of fronts and we’re obviously looking at the Tier 2 market as we have talked about which is a big and growing market, a little less demanding which means a little lower cost product and lower price but still very attractive and it's a market that we have largely ignored to-date. So we’re taking actions on several fronts I really can’t tell you the precise timing of when they kick in like I couldn’t have been clear though and then the organization knows this as well. We’re not pleased with where we’re at, we’re not going fast enough and the organization is responding to that.

Rob Mason - Robert W. Baird

Just a follow-up on that, the thing in the lithium business, some of your supplier agreements relate to energy storage on the large format type batteries that don’t go in EDVs. Is there anything -- I mean as you separate that way from EDVs is there a bucket of large format that you could say is meaningful for you or that we would be speaking to another category in the next 6 to 12 months, another large format category besides EDVs?

Bob Toth

The distinction here is large format, we have got distinct advantages in the large format. We have got the capacity on the ground to demonstrate an improvement capacity and capability right? So if you’re going to make a large format battery there is not a shadow of doubt that our product has distinct advantages there.

Now today in energy storage systems, we talk about energy storage systems like it's in application. There is obviously myriad applications within energy storage systems and overtime there will be more and more especially as you get the linkage of the electric drive vehicle batteries coming off the cars and being put into their next highly valued use which is energy storage system. So it's in terms of applications today it's very fragmented there is a ton of development going on, a lot of projects going on but the distinction for us today is large format, where customers are making large format batteries, our product offers distinct advantages.

Operator

(Operator Instructions). And our next question comes from Brian Lee of Goldman Sachs. Please go ahead.

Brian Lee - Goldman Sachs

First on the recent injunction versus LNG, I know you don’t want to get into too much of the specifics but can you help us better understand Bob the time window for LG to appeal here and then when would a final decision or injunction be implemented by the court if they are unsuccessful in their appeal and then during the appeals process is there any limitation on what they can sell in the U.S.?

Bob Toth

Kind of tick through here, there needs to be a ruling or an understanding that in effect infringing on technology the injunction hurdle rate is higher so getting the injunction is very meaningful. They have taken the steps to appeal to that ruling, there is no rigid timeline here so I don’t want to mislead you, right, it can go on for weeks to months probably not years, right? And it's the burden of proof is on them to try to get this ruling reversed. So that’s the appeal process we’re kind of talking about. So certainly the stay is basically think about it in my non-legal terms it's kind of putting enforcement of it on hold and so that’s temporarily the case now but there is no rigid time line that I understand here on these kind of processes.

Brian Lee - Goldman Sachs

And then my second question switching gears here a bit on the EDV side, if I look at some of the recent EV sales data that’s available particularly in full EVs and plugin hybrids. There has been a nice upward trend in volume and actually some breath developing outside of the flagship Leeson [ph] and Volt models. So I just I’m wondering if that’s all together consistent with your view on better growth in EDV in late 2014 and to early 2015 or does it seem like the trajectory is moving at an even a faster clip than you might have been thinking earlier in the year. Thanks.

Bob Toth

You’re spot on, right. We’re seeing more and more vehicles come to the market and how they sell ultimately determines how much of an uptick there is but we’re seeing some name brands of course and brands that are very capable of marketing their vehicles and targeting the right consumer segments and those kind of things. So we’re delighted with that, we can really speak to any particular model specifically. We really don’t have that liberty but there is no doubt, we’re seeing more and more vehicles coming into the market and more and more in design that are addressing the consumer needs.

Operator

Our next question comes from Craig Irwin of Wedbush. Please go ahead.

Craig Irwin - Wedbush

Bob can you talk a little bit about the agreement with Panasonic and maybe frame out for us what the long term commitments are from Panasonic, really what we would like to know is how competitive you feel you’re versus the other suppliers already working with some on programs where vehicle is around the road and whether or not you feel this is a significant advantage to have this relationship versus a different bidding strategy maybe prior to this relationship?

Bob Toth

Craig, I guess I would clarify a few things, number one we will always respect the privacy in relationships we have with our customer so we can’t get too specific there. Needless to say all of our competitors would love for us to do that on the phone and we’re just not going to go there. Like most people we have worked with them for a long period of time and evolved into this long term relationship and partnership. So we view it as a win-win, right? We have said all along that we value volume and duration so where customers commit to growing volumes over a long period of time that’s valuable to us and they get some price in exchange for that and that’s a great value proposition for them. It's a great value proposition for us and for our shareholders. So we’re delighted with that.

I think what you’re seeing is an industry that you know either didn’t have contracts or very, very short contracts kind of an interesting development right? We have two long term agreements now that have guaranteed minimum supply and purchase commitments and the expectation overtime is that they grow considerably. So we can’t -- while we can’t get into the specifics I think these are pretty novel, I think they are pretty telling in terms of these companies are very sophisticated buyers, producers, and I think it gives you an indication of the need to have security of supply of high quality demonstrated products. So we’re really pleased with it or we wouldn’t have entered it obviously and very pleased with the agreement we have with Samsung as well.

Craig Irwin - Wedbush

My second question, there is a very important customer in the market that’s been actively discussing with investors how they would like to see future manufacturing done by a separator partner inside of their facility. How would you approach some sort of discussion like this? This is something where you could relocate underutilized capacity or maybe find capital to support a program like this or would you look to serve customers specifically from your existing footprint today?

Bob Toth

Well I don’t like addressing hypothetical situations because you could come up with any number of things. If what you’re referring to is a manufacturer that happens to be in the United States needing to have a lot of batteries in the United States, we’re well aware of that opportunity. We’re of course interested in it, we have got proven capacity, we have got sufficient capacity and we have got coating technology but ultimately that sourcing decision is for that producer and the battery supplier to make but no doubt we would be keenly interested in that.

Relocating equipment, now you're in hypothetical things of what needs to done where and what’s the most cost effective value chain and supply chain and infrastructure to do that. I’m highly confident we could have the most cost effective and efficient supply chain given our capacity and our technology and our cost position.

Craig Irwin - Wedbush

Agreed. And then last question if I may, Separations Media, it's always been a great little segment for the company, very stable, nice generator of profits and you’ve done some innovative things over the years to allow enhance growth. Can you maybe update us on the utilization in that segment and if there was anything specific that caused the sequential progression in operating margins there and how this is likely to trend versus historic given the typical seasonality work it out for the third quarter and then obviously the fourth quarter.

Bob Toth

Yes I mean Lynn said it, look this is a business that has performed at 28% operating income margin for each of the last three years and we always try to improve that but there is no reason to think there is a fundamental step change there right? It's going to be in that range. And you’re right the seasonality is, we tend to have more robust production in the first half of the year than in the back half of the year because of seasonality of -- and European holiday’s and things like that.

So that’s all true. The capacity utilization in this business is not that meaningful, right. We always run at a pretty high rate of capacity utilization and then add capacity as we need it just like we’re doing now. So the capacity in virtually all of our businesses with the exception for the need to get out in front of EDV because of the magnitude of the space, right. As we kind of invest as we need it to keep up with market growth and so we will continue to that in this business. There is no doubt we have got very highly functional, high value add marks. We see interest in this business all the time and we see interest from our customers and having closer partnerships and relationships there and as we look forward this is an interesting investment area for us as it relates to future investments so we will continue to take actions to grow this business.

It's a little unfair to frame it this way but if you think about where we have been with the investment opportunities we had and kind of had to make to get in front of EDV, we haven't really been on offense in that business but now is the time to start looking ahead to see what opportunities are out there for additional growth as we look to 2015 and beyond.

Lynn Amos

Yes, one thing I will add to that is our healthcare business continues to perform well. We highlighted that we’re seeing nice growth in Asia in that business. We have also got a lot of things that we have touched on over the past few years around new treatment methodologies that we can pursue so there is organic opportunities. The opportunities that we see in filtration, there is potentially opportunities that are strategic as well as just the organic opportunities and as we move into a period where we continue to generate more cash. We will be able to look at things like that, I mean nothing is eminent but we think the company is in great shape. The performance is excellent, the margins have been very strong and to your question on margin the front half is usually a little better than our back half but this business is one where the markets there, the demonstrated performance is there on the site and it's a pretty easy investment decision to pursue the opportunities they have.

Operator

We have time for one more question. Our final question comes from Brian Drab with William Blair. Please go ahead.

Brian Drab - William Blair & Company

Well this seemed obvious but just to be really clear, you did not have any sales to LG Chem in the second quarter is that correct?

Lynn Amos

That is correct.

Brian Drab - William Blair & Company

And then Lynn what can you tell us with regards to the interest expense run-rate quarterly third quarter, fourth quarter, roughly?

Lynn Amos

Well I mean we implemented the new structure in the middle of the second quarter. Our 10Q -- I guess it will be out tomorrow but what you will see the components of the debt are we have 500 million of term loans and we have about 19 million out on the revolver at the end of the quarter both of those are priced at plus 200. So depending on whether we enter into some hedging arrangements which we haven't yet but if we do that could potentially hedge the interest rate but limit it a little bit of the opportunity of capturing such low rate. Today we’re floating but you can look at the LIBOR and kind of do the math, it's pretty low rate today. So there is substantial interest savings and then of course revolver borrowings into the future could potentially affect that as well. But right now we continue to generate cash and as we have mentioned before we felt we would be in that 20ish million kind of interest savings number on an annual basis when it's fully in. It could be a little bit more than that if we don’t hedge and rate stay low.

Bob Toth

Thank you. We certainly appreciate your time, your interest in our company and we very much look forward to reporting our progress at the end of third quarter. Eric this concludes our call today.

Operator

Thank you. Ladies and gentlemen this does conclude the call. Thank you for your attendance. You may now disconnect. Everyone have a great day.

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