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Executives

Robert B. Toth - Chairman of The Board, Chief Executive officer, President and Member of Executive Committee

Lynn K. Amos - Chief Financial Officer, Principal Accounting Officer, Secretary and Treasurer

Unknown Executive -

Analysts

Brian Drab - William Blair & Company L.L.C., Research Division

Craig E. Irwin - Wedbush Securities Inc., Research Division

Avinash Kant - D.A. Davidson & Co., Research Division

Michael Lew - Needham & Company, LLC, Research Division

Francesco Citro

Carter W. Driscoll - Capstone Investments, Research Division

Jeffrey J. Zekauskas - JP Morgan Chase & Co, Research Division

Dilip Warrier - Stifel, Nicolaus & Co., Inc., Research Division

Richard C. Eastman - Robert W. Baird & Co. Incorporated, Research Division

Polypore International (PPO) Q3 2011 Earnings Call November 3, 2011 9:00 AM ET

Operator

Good day, everyone, and welcome to the Polypore International Inc. Third Quarter 2011 Conference Call. Today's call is being recorded. At this time, I'm going to turn the call over to Kathy Brosco [ph]. Please go ahead.

Unknown Executive

Thank you, Jim, and hello, everyone, and welcome to our conference call to discuss our third quarter financial results.

And as always, the results we discuss today are in our earnings announcement that was released yesterday afternoon and furnished on Form 8-K with the SEC. And a copy of the release is also available on our website at polypore.net in the Investor Relations section. In conjunction with the release, we also issued supplemental financial information, which we filed as an 8-K and also posted on our Investor Relations website.

Adjusted EBITDA, adjusted operating income, adjusted net income and adjusted earnings per share are non-GAAP financial measures discussed in this call. We refer you to the reconciliation of these non-GAAP measures to the most directly comparable U.S. GAAP financial measure included in the earnings release.

Before we begin today, please remember these important considerations. This conference call and webcast might contain forward-looking statements within the meaning of federal securities laws. We intend these forward-looking 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 are made, which is Thursday, November 3, 2011.

Polypore undertakes no obligation to update or revise any forward-looking statements whether as a result of new information, future events or otherwise. You're also directed to consider the risks, uncertainties and other factors discussed in the documents filed by us with the SEC, including those matters summarized under the captions Item 1-A, Risk Factors in our most recent 10-K filing with the SEC and Risk Factors in Amendment #2 to the Form S4 filed on May 13, 2011.

Today, I'm joined by Bob Toth, President and Chief Executive Officer; Lynn Amos, Chief Financial Officer; and Rob Whitsett, Vice President of Finance. And at this point, I'll turn the call over to Lynn to start us off with the financial results.

Lynn K. Amos

Thanks, Kathy. As we reported yesterday, third quarter sales were $190.1 million, a 25% increase from the prior-year period. Adjusted EPS for the quarter was up 93% to $0.54 per diluted share. Our cash earnings, that is earnings net of the large noncash amortization expense, were $0.06 higher at $0.60 per share. Regarding other key financial measures for the quarter, adjusted operating income was $46.4 million, up 56% compared to the prior-year period. Adjusted EBITDA, which is a key financial measure in our credit agreement, was up 40% to $59.5 million. In the trailing 12 months, it was approximately $242 million. Interest expense was $3.6 million lower than the prior-year period, which reflects the refinancing and reduction of debt we achieved in the fourth quarter of 2010. CapEx was approximately $40 million in the quarter, and based on capital projects announced to date, the estimated CapEx for the full year 2011 is approximately $175 million, which is less than we projected last quarter solely due to the timing of expenditures. I would note that all of our projects remain on or ahead of schedule.

Let me be clear about something. On August 23, 2011, stock options were granted under our 2007 plan, resulting in an increase of noncash stock comp expense, which is included in SG&A. Going forward, we would expect noncash stock compensation expense to increase from what was historically below $1 million per quarter to be approximately $4.7 million for the full fourth quarter 2011.

I'd also like to highlight a slight change we made in the calculation of our non-GAAP measures in order for them to be consistent with how adjusted EBITDA is calculated as the bond in our credit agreement. We believe that calculating the non-GAAP measures consistently provides transparency on the impact of these adjustments and on the operating results and makes them comparable and easier to understand. The most significant impact of the change is to exclude noncash stock-based compensation expense from our adjusted numbers. For the quarter, primarily because of the recent stock option grant, the change increased adjusted operating income by $2.5 million, adjusted net income by $1.7 million and adjusted EPS by $0.04 per share.

Now moving on to the segment results for the quarter, beginning with Energy Storage. In the lead-acid separator business, the sales increase reflects strong performance in the Americas and Europe and the favorable effect of foreign exchange. Additionally, I'd like to comment on a couple of items in the lead-acid business in Asia. First, regarding China. Many of you have probably heard about the governmental mandate, and we commented on that last quarter. The mandate requires lead-acid battery producers to demonstrate the proper handling of lead, and in some cases, moves production outside of metropolitan areas. This is a short-term disruption, and in the long term, it is a positive and will lead to consolidation, which favors the larger battery producers we tend to serve. Second, regarding Thailand. There's been a lot of speculation about the impact of flooding. I'd like to be clear. This situation has not affected our facility or production to date, and obviously, if there was a material impact, we would have announced it. While we can't predict the weather, we believe potential issues, if any, would be mainly logistical and short term and minor in nature. And keep in mind, we have 8 lead-acid separator facilities around the world.

Continuing now with our summary of Energy Storage. On the lithium separator business, sales in the quarter reflect strong and growing demand in Electric Drive Vehicles, growth in consumer electronics and the benefit of new capacity, which I'll come back to in a moment. Segment operating income for the quarter increased to 26% of sales compared with 21% in the prior-year period, primarily as a result of operating leverage on higher sales volume.

In Separations Media, sales were up with solid demand in hemodialysis and blood oxygenation. Operating income was 18% of sales compared with 17% in the prior-year period. Recall that the typical seasonality impact we experienced in the third quarter shows up primarily in this segment due to lower production levels associated with the European holidays. We also experienced higher expenses in the quarter related to energy costs and our capacity investment in the healthcare business.

In summary, for the quarter, or any quarter, for that matter, there can always be some variability. That being said, for Q3, sales were up 25%. Adjusted EPS was up 93%. We're continuing to generate cash, and we're making the largest investments in our history to drive substantial growth, and these investments are being funded with cash from operations. To recap those investments, in the lithium separator business, demand continues to accelerate. We are doing all we can to ramp up our new capacity as quickly as possible for our core customers. While we don't disclose specifics, those of you who have been following us know that our EDV growth has been rapid and has become a material and growing component of our lithium battery sales. As you know, we have several expansions targeted at Electric Drive Vehicles. The first expansion at our Charlotte facility was at full capacity by the end of the second quarter, and we experienced the benefit of that capacity for the full third quarter. The second expansion in Charlotte will begin ramping up by the end of this year.

We're on schedule with our Concord facility, which has capacity coming online in 3 phases: the first phase will begin ramping up over the course of 2012; the second, later in 2012 and into 2013; and the third phase will ramp up in 2013 and be fully operational in 2014.

For consumer electronics demand in Asia, the expansion of our Korean facility, albeit more modest in size, and our EDV-related expansions is complete, and the initial orders are occurring.

In our lead-acid separator business, our capacity expansion in China, which is a majority-controlled joint venture with a customer, is scheduled to come online in mid-2012. And the additional equipment we're adding to our Thailand facility will also increase capacity later in 2012.

In Separations Media, in healthcare, our new capacity for PUREMA hemodialysis membranes began to come online late in the third quarter. Recall that expansion in healthcare typically take longer to ramp up than others due to a more stable growth rate and lengthy qualification periods for healthcare applications.

As a final point on these expansions, similar to prior expansions, keep in mind that we will have some incremental startup costs, things like utilities and employee hiring and training in advance of the capacity ramping up and the benefit of sales. At this point, I'll turn it over to Bob for closing remarks.

Robert B. Toth

Thank you, Lynn. We're pleased to report another strong quarter. We understand the importance of every quarter, and we're always focused on optimizing near-term performance while not compromising the large and long-term growth potential of our businesses. Be reminded that any quarter can have short-term variability, whether that be order patterns, seasonality or even a minor disruption like we saw in China. Having said that, any variables we experienced do not change our focus or effort, and we're focused on executing the $350-plus million of growth investments we have underway to drive growth in 2012 and substantial growth in 2013. We're fortunate to participate in a tremendous value space with positive long-term secular trends that drive growing and sustainable demand.

In the lithium separator business, we, as consumers, want to be more mobile, which means we'll continue to demand greater functionality and mobility in electronic devices. And we're at the beginning of the Electric Drive Vehicle opportunity, where the electrification of vehicles is being driven by broad and impactful global issues, including the need to reduce CO2 emissions throughout all regions of the world with a sharp emphasis in Europe, as well as the need to enhance mileage performance, which, of course, reduces fuel consumption and decreases the dependence on foreign oil.

In the lead-acid separator business, the market remains strong, and Asia remains the primary driver of growth, with the large and growing replacement market there, continued growth in OEM sales, greater application diversity and breadth and the ongoing conversion to higher-performance batteries which are enabled with our separators.

In healthcare, growth is being driven by worldwide population growth and Asian population, as well as the standard living improvement, which is resulting in increased access to healthcare treatments in developing economies.

And in filtration, we continue to see growing global demand for purity, whether that be ultrapure water for microelectronics or pharmaceutical applications, cleaning wastewater or purification of raw materials and feedstocks to drive production efficiencies. Purity enhances the quality of life in the environment and reduces production costs.

In summary, we serve exciting growth markets fueled by strong demand. We're on track with the strategic investments we're making to drive growth in 2012 and substantial growth in 2013 and beyond. And in the lithium separator business, where demand continues to accelerate, we're focused on increasing capacity as rapidly as possible. Make no mistake. We're at the front end of some remarkably impactful and attractive long-term secular trends that cut across our businesses. We're absolutely committed to making and executing on the investments that position us to capitalize on these trends, with the goal of growing our company, growing our company's value and rewarding long-term investors. Jim, at this point in time, I'd like to open up the call for questions.

Question-and-Answer Session

Operator

[Operator Instructions] And we'll take our first question from Brian Drab, William Blair.

Brian Drab - William Blair & Company L.L.C., Research Division

First question just on the CapEx guidance revision. Can you give a little more detail as to why -- I believe the previous guidance was for $200 million in 2011, and why we have come down to $175 million?

Robert B. Toth

It's just timing.

Lynn K. Amos

I think we were just optimistic we would spend the money before year-end. It's likely to come in January.

Robert B. Toth

Yes, in our highlight, keep in mind that we've got a keen focus on cash and cash management, so kudos to our organization for managing how they spend.

Brian Drab - William Blair & Company L.L.C., Research Division

Okay. And then I had previously been forecasting somewhere north of $150 million in CapEx for 2012. Should we expect some of this CapEx to move into the 2012 period?

Lynn K. Amos

The amount of CapEx dollars aren't going down. Based upon the capital we've announced today, we haven't given a 2012 number, but that's not crazy.

Brian Drab - William Blair & Company L.L.C., Research Division

Okay. And then on the stock compensation expense, just to confirm, you said $4.7 million to be expected in the fourth quarter of '11?

Lynn K. Amos

That's correct.

Brian Drab - William Blair & Company L.L.C., Research Division

And then what can we expect roughly throughout 2012 in terms of stock comp?

Lynn K. Amos

Well, given the stock options that have been granted, the number would be fairly consistent until other grants are fully vested and start dropping off. So some of the previous grants will start dropping off a little bit in 2012, but they weren't that impactful. In fact, the impact of stock option grants was a little larger -- not a little larger, was larger related to the most recent grants. And as you know, the calculation of stock option expense is a part of a theoretical accounting calculation that presumes future value of the stock based on historical stock appreciation. So the impact of new grants and the impact on stock expense of the last stock grant is going to be more impactful than what we had issued back in 2008 and 2009. So the short answer to your question, barring any new stock option grants, it would be at that $4.7 million level and start to decline a little bit over time.

Brian Drab - William Blair & Company L.L.C., Research Division

Okay. So $4.7 million level per quarter but declining over time?

Lynn K. Amos

Exactly.

Brian Drab - William Blair & Company L.L.C., Research Division

Okay. And then one last question, and I'll get back in line. Are you now capacity-constrained in the lithium business for most of the fourth quarter?

Robert B. Toth

Yes. I mean, what we've said is we reached full capacity at the end of second quarter, so we benefited from the full third quarter timing of that expansion. And we've got new capacity coming online by year-end. So we're doing all we can to accelerate it. We're not going to get too granular in exactly what week or day or -- and certainly, we don't control all that. As we've talked numerous times, our customers need to qualify things, and we can't dictate when they do that exactly. So needless to say, we're doing all we can to ramp up capacity as quickly as possible. To date, our customers have worked with us because they wanted it as quickly as we could possibly give it to them, and we're very pleased with that dynamic.

Operator

Moving on, we'll take our next question from Michael Lew, Needham & Company.

Michael Lew - Needham & Company, LLC, Research Division

I've got a couple of questions. First, with regards to the 200 basis points of the sequential gross margin decline in Energy Storage, how much of that was related to expansion?

Robert B. Toth

I don't know if we broke it down that granularly. You've got seasonality in that. You've got increased expenses in that, and you've always got a product mix phenomena that takes place in that. So I'm not going to try to dissect that down. We've always suggested, and we do think of our operating income in a range, percentage in a range, and there's nothing there that surprised us at all.

Lynn K. Amos

Yes, I mean, I think it's fair to assume that the startup costs are increasing. So they are embedded in that, and that's part of your answer, Michael. I think you're right. I mean, certainly, our lithium business is our higher-margin business, and it's our faster-growing business. And given its higher proportional mix, I mean, generally, that drives margin expansion, but we're starting up a lot of facilities.

Robert B. Toth

Yes, year-on-year, obviously up.

Michael Lew - Needham & Company, LLC, Research Division

Also, could you elaborate a bit more on Asia? I guess it was flat year-on-year. Was it specific to China, or were there other areas where it slowed a bit? I mean, is there a regional impact in China right now because of the government intervention?

Robert B. Toth

Well, it's certainly up year-to-date. I always caution people to not read too much into a quarter because you always have timing phenomena, order patterns. On production, you had the disruption, in this particular case, in China. There's no sustainable change in demand, right? And in fact, if anything, it's even more positive because this will force -- the activity in China will force consolidation to occur more rapidly, which is a positive for us in terms of a demand driver going forward. Asia was a little bit softer. As I said before, and I mean, I think I said it for about 8 straight quarters, maybe less, but you can't expect 30% growth every quarter, right? Some quarters are going to be up more than others, and the only anomaly, if you want to kind of call it that, was China thus far.

Lynn K. Amos

I would just highlight that virtually, every battery-maker was impacted by this, and again, I mean, this is a short-term issue. And as we said earlier, that we think that the consolidation is actually going to benefit the capital of larger producers longer-term, and they're more likely to be our customers. So again, I think we're seeing some of that moderate a bit, but it was certainly an impact in the quarter.

Michael Lew - Needham & Company, LLC, Research Division

Okay. And also, you mentioned Euro-wide expansion was completed. Are you now producing commercial product as of today from this additional expansion?

Robert B. Toth

Yes, and Lynn highlighted that. Albeit, that's a more modest expansion. That's the other process which has slightly higher cost and targeted for consumer electronics in Asia, but yes.

Michael Lew - Needham & Company, LLC, Research Division

And also, Bob, you mentioned, obviously, EDV is coming on pretty strong. Could you characterize it a little more? Is it being driven more by battery-powered vehicles or hybrid electrics? Also, you're starting to experience some demand, let's say, for stationary-type applications.

Robert B. Toth

Yes, we are just scratching the surface. Well, we're just scratching the surface on penetration in automotive, and we're barely scratching the surface on penetration in the Energy Storage Systems. As I've always said, I kind of expect that to be the next wave of growth. And I think you've started to see some writing and projections on that that suggest it could be even bigger than Electric Drive Vehicles. And so I think we'll be talking a lot more about that in the future. In terms of Electric Drive Vehicles, it's everything. I mean, I keep saying, and I've said this for years, this isn't a binary will-it-or-won't-it-work or will-people-buy-them-or-won't-they. You see more and more hybrids out there around the world. People are either already buying hybrids or will be shortly. They don't really even know they're hybrids, right, because we'll just be designing vehicles for certain performance characteristics. And you'll have individuals walking into a dealership saying, "I have $30,000 or $35,000" or "I can afford this much of a monthly payment, and I need 35 miles to the gallon." And that's the only way you'll get to the CAFE standards that we're on track for here. In Europe, you have CO2 emissions driving it. You see, I might have even said this to you a few years ago, Michael. The debate 3 or 4 years ago was, well, we don't need hybrids because we have diesels. And my view always was they're complementary. It's not binary. It's not one or the other. It's not a tradeoff, and now you've seen some diesel announcements come out that will be hybrids. You've got battery electric vehicles selling as fast as they can make them. You've got plug-in electric vehicles selling as fast as they can make them. And you've got heavy vehicles in Asia, and you've got all kinds of novel Electric Drive Vehicle applications being developed from construction equipment, so they can perform construction during the day next to an office building or in a city with no noise, to recreational vehicles to you name it. So it's across the board, and I'll say again, we've seen nothing but an acceleration of development over the last 4 or 5 years in this.

Operator

Moving on, we'll take our next question from Richard Eastman from Robert W. Baird.

Richard C. Eastman - Robert W. Baird & Co. Incorporated, Research Division

Just a quick question. I wanted to circle back to lead-acid for a minute. And you've touched on and went through Asia, but I was actually a little bit curious as to the strong growth in Europe and the Americas. That's basically a lot of character, too, and is that something in the channel, or is there any shipments from there to Asia? Just curious where the strength came from in those 2 more mature markets.

Robert B. Toth

Yes, I don't think it's anything anomalous. So I think Asia -- or I'm sorry, Americas and Europe had been a little weaker in the prior quarter, so I think it's just a function of the same thing I kind of said about Asia as you always get some natural variability quarter-to-quarter, product mix, those kinds of things. But yes, they were up a bit. I don't think there's any meaningful shipments. Or I should say it differently. I don't think there are any meaningful changes in shipments to Asia as a result of the disruption in China at this point. Certainly, if that disruption goes on, people will compromise and make some changes in what they ship and where because at the end of the day, obviously, managing lead more carefully in China has nothing to do with demand for batteries. People aren't going to walk because they're making battery producers handle lead more responsibly there. But as we've said, that's probably a short-term disruption, and the battery producers there are responding and starting back up and those kind of things. So I don't think we'd see any major changes going on. It's just kind of quarter-to-quarter variability. Lynn, anything from your perspective?

Lynn K. Amos

No, that's it.

Richard C. Eastman - Robert W. Baird & Co. Incorporated, Research Division

And then just in terms of China and this disruption on the battery shipment side, I understand the long-term positives are favorable or certainly remain favorable in China in the lead-acid side. But just in the short-term here, do you think that that business, the Asian lead-acid business, does it just stay kind of flat here, or is there some risk that we -- the channel gets drawn down? And I'm trying to figure out just sequentially how that business looks in Asia, the lead-acid business, as we roll through the next few quarters because clearly, the Chinese government's actions on the shutdowns, I mean, it's temporary, but that can be in place for a while. I mean, how do you manage the volumes?

Robert B. Toth

I could only really kind of speak to the facts, and we don't see it as a lasting impact in any way, shape or form. Whether it's a quarter or 2, I don't know. At the end of the day, kind of what's been done, right, is they've gone in every battery producer, and my understanding is they have said basically, you're shut down until you prove you can handle this responsibly or you're not in an area and contaminating things or whatever, right? So that has had different lengths of shutdown for battery producers. In some cases, it may be a few days, and in some cases, as Lynn mentioned, battery producers have had to relocate outside of metropolitan areas. And so you have all of that noise kind of taking place at a time when the market's still growing. It's very robust replacement market there now. You've got good OEM sales there now. All the demand drivers are still in place there. And mind you, China is one country within a very broad region, so it's not -- I would not ever correlate China solely with driving all of Asia. And you've got some inventory buffer always, right? But as we talked about, the lead-acid inventory, it's not ever like you pilot way up and just hope it sells. You've got kind of a 5-, 6-month inventory window there, where if you have more than that, you've got to rehandle the inventory, which is very costly for producers. So you've got a little bit of production being down. I'm sure you've got a little bit of inventory drawdown and yet no fundamental change in demand. So if it lasts beyond a quarter or 2, people, to the earlier question, will probably just ship batteries in there from other places.

Richard C. Eastman - Robert W. Baird & Co. Incorporated, Research Division

Okay. And then, Bob, on the lithium side of the business, can you just give us a tone maybe to the channel, in lithium battery channel for consumer electronics? There's been a lot of noise mid- to late summer, early fall just about, maybe the consumer device market backing up a bit. Maybe just kind of year-end outlook for the consumer side of the lithium business.

Robert B. Toth

Well, I'm not going to get too specific on our forecast for the quarter, obviously. We don't go forward like that. But in consumer electronics, you can almost take probably any sound bite I said for the last 3 years and apply it to this quarter. We're continuing to see significant application proliferation. We're continuing to see new device categories growing nicely. And every quarter, you have some typical noise around -- whether it's cell phones or whether its laptops, you always have some noise around that. But the fact of the matter is the market is still growing at a very high percent. Whether it's 8% or 20%, everybody debates every quarter, but that's kind of the range of volatility there.

Lynn K. Amos

I would just highlight that our capacity is totally fungible between consumer electronics or EDV or any lithium application, and we don't have a demand problem.

Richard C. Eastman - Robert W. Baird & Co. Incorporated, Research Division

Okay. And then I'm sorry, one last question there. On the filtration separations piece of the business, again, we saw -- core LC growth there maybe was a slight negative number. Are we starting to see any cyclical downturn from the electronics market, from the semi market show up in that business?

Robert B. Toth

Well, first of all, in our filtration business, we've never described it precisely, but we've always said about half is very stable associated with pharma and food and those kind of things, and about half is kind of tied to microelectronics. And certainly, you get some cyclicality in microelectronics. It doesn't fundamentally alter the long-term growth, but at any point in time, it can be up or down a little. And we saw a little softness in microelectronics. I mean, you know what happens, right? We're more tied to investment on facilities more so than anything else in terms of our participation in microelectronics. And so what happens when the world gets a little jitterish people hold off for a quarter until they see higher capacity utilization rates or something like that. But it doesn't stop the world demand growth for all those things over the long-term. It's really kind of a short-term disruption.

Operator

Moving on, we'll take our next question from Avinash Kant from D. A. Davidson & Co.

Avinash Kant - D.A. Davidson & Co., Research Division

Quick question on seasonality. Typically, you've had a seasonally weak Q3. And given that we are past that and based on your visibility, do you think that the seasonal pattern will hold going forward despite the economic headwind that people have been worried about?

Robert B. Toth

Well, I don't know that seasonality has anything to do with the economy. I mean, typically, Europeans take shutdowns and holidays in the third quarter. We schedule our maintenance around that. Our customers do maintenance around that. And that's really the driver. Fundamental demand, we don't see any change going forward in terms of the trajectory and demand drivers on our business.

Lynn K. Amos

The only thing I would say is the question is really getting that macroeconomics, right? I'd refer you back to 2008, right, when the world ended. 70% of our business is high recurring revenue in nature, and 30% was what has some cyclicality in there. But I'll also remind you that in that 30% calculation that we mentioned, we put our whole lithium business in. So that's right now, I wouldn't call it very seasonal or cyclical.

Avinash Kant - D.A. Davidson & Co., Research Division

Okay. And just trying to get a handle on the impact from China, if you could maybe give us some idea about what the percentage of your lead-acid business comes from China or how much was the impact from China, so we could model you going forward.

Lynn K. Amos

Well, no, we don't disclose countries. What we've said is Asia is our largest and fastest-growing region, and we expect that to continue. And obviously, we said that Asia was kind of flattish this quarter, so...

Avinash Kant - D.A. Davidson & Co., Research Division

Okay. And the mix is very similar in lead-acid and lithium-ion, right?

Robert B. Toth

Lynn?

Lynn K. Amos

No, no, in lead-acid -- the disruption in China was lead-acid. It had nothing to do with lithium.

Avinash Kant - D.A. Davidson & Co., Research Division

What I'm saying is that you gave the broad mix of the overall revenues, but I'm trying to understand, does that mix change or lead-acid and lithium-ion is the same?

Lynn K. Amos

Bob said -- what Bob said was our largest region for lead-acid is Asia.

Robert B. Toth

Lithium-ion, obviously, Asia is the largest region, but we sell that all over the world, and we clearly don't break out countries on that.

Avinash Kant - D.A. Davidson & Co., Research Division

Okay. And final question, going forward, would you be breaking out the impact from the stock-based comp every quarter now on?

Robert B. Toth

Well, we always have broken it out for adjusted EBITDA. The reason for highlighting it this particular quarter is because on August 23, there was a grant. On August 25, there were public disclosures of that. And some people consider it, and some people don't. And it's noncash and nonoperational, so we just wanted to highlight that change.

Lynn K. Amos

Yes, I would just point out that there were Form 4s that were issued in August, and I didn't really see any estimates revised because of all those Form 4s. And it's going to have a bigger impact from stock comp going forward than it has in the past, and we felt it very important to make it transparent for you. We put it -- it doesn't really reflect the operations of the business. Again, it's driven by the accounting methodology largely based on historical stock price appreciation. And we wanted to put it out there, so you could understand what the impact of this noncash item was.

Operator

Moving on, we'll take our next question from Dilip Warrier, Stifel, Nicholas.

Dilip Warrier - Stifel, Nicolaus & Co., Inc., Research Division

I was just wondering if you could talk a little bit more again on China. I understand the situation is pretty fluid, but directionally, at least, do you have a sense of the current quarter, whether it's going to be any better or any worse or just the bottom line with the third quarter in terms of production disruption?

Robert B. Toth

Well, let me kind of get this at the right level of thinking here, and I'd welcome kind of talking about this from a fundamental demand perspective. But there isn't anyone in China at all or Asia or wherever those batteries go that say, if our battery dies, I'm going to walk because the government in China is going to make us handle lead responsibly and our battery producers, right? So all we're talking about here is kind of a supply chain production disruption in one country, which is one part of a very big region. So whether or not -- I'm actually not going to kind of split hairs and even predict whether China will be flat, up, down or sideways in the next quarter or the next 2 quarters. It's not a long-term, lasting impact. Asia is the fastest-growing region, hands down, for all of the very explicit demand drivers. And all we're kind of talking about here is the sway that occurs in the supply chain and where the batteries get produced at. And that's only going to be short-lived. Again, I can't really predict whether that's a quarter or 2 quarters. I think we mentioned it even a couple of quarters ago, and it kind of didn't happen until third quarter. But it's not at all a lasting impact, so whether or not it impacts our revs $1 million or $2 million in the quarter, up or down, we actually -- that's not a metric and a driver of our success. So I can tell you we're just not that keenly focused on it.

Lynn K. Amos

We're also expanding in China with our joint venture partner. We're expanding aggressively there. We're expanding in Thailand. Our confidence and belief that this business is headed to Asia hasn't changed at all.

Robert B. Toth

Not a bit, yes.

Dilip Warrier - Stifel, Nicolaus & Co., Inc., Research Division

All right. And on the expense line, so stock-based compensation actually went up this quarter, and I see that your SG&A line actually went down sequentially this quarter. And I was wondering if this was just in line with normal seasonality or they were, perhaps, less startup expenses this quarter than last quarter?

Robert B. Toth

No. Every quarter, there's been variability in SG&A. I can't recall the exact sequence, but I think first quarter was down a little, second quarter was up a little, third quarter was down a little, but we had the stock comp expense. That's just normal variability and timing of spend and things like that. So I wouldn't read anything into that. The stock comp was the clear distinction, and that's why that was called out.

Lynn K. Amos

And I would also highlight that most of the startup costs are showing up in the SG&A line anyway. They're showing up in the cost of goods sold line as a variance in the production plan.

Operator

Moving on, we'll take your next question from Carter Driscoll, Capstone Investments.

Carter W. Driscoll - Capstone Investments, Research Division

I was hoping you could compare and contrast maybe the qualification periods between, obviously, the segments, but maybe drill down a little bit into maybe EDVs. Is there really a differential in terms of timing or the commitment based on whether it's battery-based or plug-in or a hybrid vehicle? If you can you give a little color. Obviously, the healthcare segment takes a little bit longer, but maybe a little bit more color on how that qualification process works between the segments and maybe by application or choose an application and discuss it.

Robert B. Toth

Well, it depends on what level you're talking about. If we're qualified and selling to a particular battery for Electric Drive Vehicles -- and I wouldn't differentiate whether it's a -- well, that's going on a hybrid or a plug-in or a battery electric vehicle, right? They all are subject to the same rigorous scrutiny in automotive. So the front end development and approval can take 3 or 4 years, right? Now once you're in, qualifying a new piece of equipment in your product from that new piece of equipment could take weeks to a few months, right, based on your reliability and how much effort and testing you do and can demonstrate the confidence level in that testing. So if you try to replace the product completely with a new product, you're talking about multiple years. And I think Lynn quoted that even in the conference call or 2 ago, we saw a presentation where one of the battery producers said, "Look, to change a screw on a battery pack takes about 4 years." But if you're talking about just having new capacity online, when people really want that capacity, they tend to put the right resources to it and work very closely with you to get it qualified as quickly as possible, and it can be weeks to months, but we don't predict that.

Lynn K. Amos

[indiscernible] a different piece of equipment.

Robert B. Toth

Or control that, yes. On the medical, it's just a longer version of that, as you'd expect when you're dealing with blood membrane interaction. A little more study, a little more in terms of potential impact on the patient. And so it just takes a little longer, but it's not years. It's just a little longer.

Dilip Warrier - Stifel, Nicolaus & Co., Inc., Research Division

But if, let's say, one of the battery OEMs changed the chemistry, that would be a multiyear process, most likely?

Robert B. Toth

Well, then you're fundamentally changing the cell, right? You have to have been working on that for a while. You couldn't wake up today and say -- and you couldn't do it even on a -- and I'm not familiar with automotive, but on virtually any functional component, you can't kind of just walk in and say, "Hey, I've got a better idea for how this shock absorber should work," right? They're going to want to test it out. They want to put it in Arizona. They want to put it in cold climates, hot boxes, aging testing, all those kind of things. That's very different than just saying I'm using product A, and there's new capacity of product A, and we want to make sure product A is the same from either line that it comes from. And we've got a pretty good history of demonstrating our capability on reproducibility of assets.

Dilip Warrier - Stifel, Nicolaus & Co., Inc., Research Division

And have you had any notable qualification issues? I know you're saying currently, you haven't had any. In the past that have you had them, how quickly can you rectify them? And typically, what type of investment would it take on your behalf versus the vendor?

Robert B. Toth

Well, I can't really -- I mean, I can't really comment on that too specifically, right? That's a qualification issue. It takes a couple days longer to get that an extruder planed out or get the temperature zones under control or -- I mean, those things are all just normal startup experiences. We're not introducing novel, new, non-proven technology. We've been at this for as long as anybody in the world, which is part of the value we bring to people. And we've got a battery lab which we can test this stuff. In a battery -- I mean, not only can we test the product, we can test this stuff on a battery before we walk through the door with the confidence level that this is identical to what we're giving you off of the other machine. So I don't know how else to answer that, but these are pretty incremental stuff in terms of starting up and proving out equipment.

Operator

Moving on, we'll take our next question from Jeff Zekauskas from JPMorgan.

Jeffrey J. Zekauskas - JP Morgan Chase & Co, Research Division

Many of the chemical companies that have reported earnings this quarter have talked about a slowing in consumer electronics demand. So whether it's Dell or Du Pont or [indiscernible], and your business seems to be proving much more resilient in the way that it addresses the consumer electronics market. So what is it about the dynamics that Polypore is experiencing that makes its consumer electronics end market so much stronger than the end markets that many other companies are facing right now?

Robert B. Toth

Well, I'd give it to you on multiple dimensions. One, we're not a chemical company, right? We're not selling large -- low-margin, large-volume, little-margin products and applications. We're selling small amounts of very high-functionality, high-value items in the specialty applications that all have found fundamental demand growth curves. Our products continue to go into more and more new applications, and we continue to deliver and capture value from those new applications. And at the end of the day, we've got very high-recurring revenue products in nature, right? So if you pick consumer electronics, you go and say, okay, you've got lithium separators that go into that, and you've got some of our filtration products that go into microelectronics, but where we sell, the products are still fundamentally in-demand, right? I can decide I'm not going to buy a mobile phone or a laptop for a quarter, but consumers in the space in which we participate don't ever say, "You know what? The economy is weak. I am never buying a laptop. I will never buy a smartphone." Or they'll trade down. And that doesn't matter to us. And whether it's the best, latest and greatest smartphone or a product that's been out there for a year and doesn't have as many features, that doesn't really impact us.

Really a lot of different dimensions to this. At the end of the day, the products we go into are typically newer, highly demanded products. And if there is any tradeoff, it's kind of short term in nature. Consumers can put things off for a quarter or wait, but they don't just say, "Well, I'll never buy another one of those devices."

Jeffrey J. Zekauskas - JP Morgan Chase & Co, Research Division

Okay. So many companies that have been manufacturing in Thailand really have had difficulties, though it sounds like you haven't. And your reports from Thailand have been extraordinary, that is water in the roads that are meters or 1 meter high. So how is it that your manufacturing operation coped with such a difficult operating environment in the third quarter and going into the fourth? Or what steps or what logistics have you put in place in order to maintain a very good production level and adequacy of shipment?

Robert B. Toth

Well, that's a great question, Jeff. And first of all, I'd say that we're obviously very sympathetic to and very sorry for the people that have been affected there. That's a given. Including some of our employees, mind you, right? Because they live in all kind of different communities around that area. But the bottom line is our facility, we have -- the team has done a terrific job of not only planning for it but planning through this. We used multiple ports. The location we selected is well above sea level intentionally. We have contingency plans for of all these things, all the way to how rigorously our people manage the businesses from a raw material perspective. And at the end of the day, even though it wasn't affected, we have 8 facilities, so we can alternately source and things like that. So bottom line is the flooding just didn't affect us. Certainly, we might reroute some things or use some different ports. But I give tremendous credit to the people there for having done that planning in advance, and I give tremendous credit to the people in our business. So that's just part of our ordinary business planning process.

Jeffrey J. Zekauskas - JP Morgan Chase & Co, Research Division

So lastly, if I understand you correctly, your utilization rate in Thailand was really essentially unaffected by the weather conditions both in the third quarter and now beginning in the fourth?

Lynn K. Amos

No effect.

Robert B. Toth

Yes, I think Lynn said no effect on the facility or production.

Lynn K. Amos

That's correct.

Operator

Moving on, we'll take your next question from JinMing Liu from Ardour Capital.

Francesco Citro

Good morning. This is Francesco Citro filling in for JinMing. I just have a follow-up on Thailand. Although your production has not been affected by the flood, have you experienced any change in demand coming from your customer base or due to any trouble that complementary goods manufacturers might have experienced because of the flood?

Robert B. Toth

I would say if there is any, I haven't seen it in a measurable way.

Lynn K. Amos

No, I mean, we call, right? I've seen some press about auto producers impacted. The vast majority of the market is replacement, it's not new cars. And the producer in Thailand is making a car that's going to a different country. Just because the purchaser of the car can't get the one that was produced in Thailand, if there's a car on the lot, you're still going to buy a car.

Robert B. Toth

Yes, we haven't seen any measurable impact at all.

Francesco Citro

All right. And moving on, on the lithium-ion segment, recently, there was a headline from the Chinese government that they want to favor expansion of domestic production of lithium-ion separators. What is your comment on that? I mean, if this is the new scenario, can you stay ahead of your competitors in terms of capacity, cost, prices?

Robert B. Toth

Well, let me be clear about that. It's not a new announcement. I think they said 5 or 6 years ago, at least, probably, that this was a strategic industry, and they wanted to have some capability of having that supply chain within the country. So it's been a strategic initiative of theirs for multiple years. That's not new at all. In fact, I believe there have even been a number of local investments there in China from 3, 4 or 5 years ago. And as we've talked about, we're a major supplier into China. So there's nothing at all new about that statement.

Francesco Citro

Okay. And last, if I can. Sequentially, your lead-acid segment has had a pretty strong decline. I think you had something comparable going back to the third quarter of '08. If you could comment and give us any color why you experienced this kind of decline and what we can expect for next quarter.

Robert B. Toth

Are you referring to the seasonality in third quarter, or are you referring to a different quarter?

Francesco Citro

Again, it's the decline quarter-over-quarter. I'm trying to understand if it was just seasonality, if it was pricing, I mean, whatever color you can give us on that. What will be going on next quarter?

Robert B. Toth

Well, third quarter is the seasonally slow quarter in that business, right, primarily because of the European holidays and the European shutdowns and the maintenance and things like that. And then in this last particular quarter, we said there was a little bit of a disruption in China. But third quarter is not -- that's not unusual to have seasonality. That's typical.

Francesco Citro

I'm also talking about the amount. This kind of strong decline, I think going back from Q2 to Q3, you only had this kind of decline in 2008.

Robert B. Toth

In lead-acid, you're talking about from Q2 to Q3. Is that what you're referring to?

Francesco Citro

Right.

Robert B. Toth

There's just normal variability there. I'm not sure what you're referring to.

Lynn K. Amos

Yes, I'm not sure your math is right there. I mean, we talked about having capacity to produce somewhere between $90 million and $97 million worth of revenue in the business. And there's always some variability depending on product mix, order timing, what have you. And we talked about in the second quarter, when we did $97 million, that that was at the high end of our capacity given the available capacity. That's why we're expanding in Thailand and China. We mentioned that there was some impact from the Chinese short-term disruption. There's really not that much movement in terms of revenue impact from one quarter to the next. That's kind of -- the level of business that we can do with our existing capacity is in the $90 million to $97 million range until we get new capacity on.

Operator

Moving on, we'll take our next question from Craig Irwin, Wedbush Securities.

Craig E. Irwin - Wedbush Securities Inc., Research Division

Lynn, Bob, looking at the PUREMA side of the business, obviously the capacity addition is a vote of confidence from your customers and you working together to serve that market. But can you maybe discuss how we can potentially see that capacity come online and what sort of commitments you have from customers already to take that product and if there are any unique factors that'll affect profitability there over the next few quarters?

Robert B. Toth

Well, first of all, the product is the best-in-class performance within the hemodialysis market, treatment of end-stage renal disease, which means our product has the functionality that most resembles the functionality of the human kidney. So we've obviously had very good success with that. The team there has done just a terrific job of focusing on asset effectiveness to drive yields and mind speeds and all those kinds of things to kind of keep up with the market. I think the real punch line is we're delighted with our product. It continues to have the best-in-class performance, as demonstrated clinically, in the marketplace. We see nice continued growth in the market, 6% kind of plus patient population growth, continued growth in terms of increased frequency of treatment. Obviously, what little left that's multiple-use will go to single-use, and so there'll be some additive growth factors there. You see emerging economies having access to healthcare, so they can keep people alive with this disease. So we see all of the right fundamental growth characteristics here. I think the point -- there's really 2 points. One is because it's a medical application, it takes a little longer in terms of people feeling comfortable that it's identical to the other lines, right? And the second is just because we have new capacity, we don't create a bunch of new patients with end-stage renal disease, right? So our customers are kind of growing with the market as you'd expect, and we'd anticipate we have a normal variability around that the same kind of thing.

Craig E. Irwin - Wedbush Securities Inc., Research Division

Okay. So looking back, I guess, about 5 years ago, there was a customer in the dialysis market that transitioned away. Is it a possibility for you to maybe serve that customer in a more meaningful way going forward, or is it simply your customers, your existing customers taking share in new applications that's allowing the growth that's going to take out that capacity?

Robert B. Toth

No, Craig, that's actually apples to oranges. If you recall, when we went public and we talked about it, when I joined the company we had -- our largest presence was in the cellulosics membrane, which was the oldest kind of technology in the market and, we believed, was going away. If you go back at history, we had about $80 million of revenue associated with cellulosics membrane, and the new PUREMA synthetic product, the best-in-class performance product, hasn't really started up. And what you're kind of referring to is the transition from the old technology to the new technology, and that occurred primarily over 2, 3, 4 year time period back in that time period. Today, we've got the best-in-class performance product in the marketplace, and we're just continuing to stay focused on the key customers that are growing in the regions that we're kind of focusing on strategically and servicing them. Nothing unusual about kind of step change stuff at this point in time.

Lynn K. Amos

And the ancient history customer you're talking about there is one who went from being a producer of dialyzers to outsourcing the dialyzers. And I wouldn't necessarily conclude that we didn't serve them and don't serve them through their outsource partner.

Craig E. Irwin - Wedbush Securities Inc., Research Division

Okay. Lynn answered my question. So the next question that I had was in the lithium-ion separator market, would you characterize your competitive position as gaining share in that market fairly significantly over the last several quarters? And do you expect to continue to gain share, or do you think that there's a little bit of trading back and forth going on?

Robert B. Toth

Well, we're not in the business of kind of predicting quarter-to-quarter share, but we'll say what we've said, which is obviously, we've grown share in consumer electronics, and we have an early leadership position in Electric Drive Vehicles, and you can kind of see the impact that that's had on our sales. So you can conclude from all that, our shares are going up. But this isn't a business like a commodity Polypore or something like that where people are betting on in each quarter, right? You get this business, you win this business through a very keen focus on application development, and you win at the time of the battery working before the device is even introduced.

Lynn K. Amos

I would just comment that given our -- as we said, the rapid growth we're seeing in EDV, that we're experiencing and the investments that we've got going in there, I think they are probably the largest investments in the industry. So I think that says something for where we think we're going with this business.

Craig E. Irwin - Wedbush Securities Inc., Research Division

Great. And then last question, if I may. Obviously, Asia's a very important market in the lead-acid battery business, really, probably one of the last great growth markets for lead-acid over the next decade. Your investments there make sense, and the overall dynamics in that market are that, yes, I agree, we're going to see consolidation around the top 10 players, maybe the top 5 players in the market. Can you share with us your competitive positioning with the top domestic Chinese manufacturers of lead-acid batteries and maybe identify who your major customers are there?

Robert B. Toth

Well, a couple of things. No, we won't go into detail on customers, but what I would say also is keep in mind, I don't see Asia nor do I see China consolidating to the top 5 or 10 producers, right? You're dealing in Asia with thousands of producers, and a consolidation might look like to several hundred. The U.S. is unbelievably anomalous in the world, having 4 or 5 producers control 95% of the market. Even in Europe, acquisitions have been stopped and consolidation has been stopped. We probably have 30, 40, or whatever, 50 producers controlling 95% of the market. And Asia is exponentially more fragmented than that today. So the projections are to go, even in China alone, from thousands, hopefully, down to several hundred to 1,000, right? And that's just a country within Asia, and Asia has an element of fragmentation to it because, as you know, Malaysia is different than Indonesia, than Thailand, than Vietnam, et cetera. So obviously, we're the only major producer with the kind of on-the-ground presence we have in Asia, largest facility of its kind in Asia and in Thailand. We are obviously expanding with one customer that people know because they're public. Camel, in China, they're one of the largest producers in China, and obviously, we're keenly focused on serving the battery producers there and the large battery producers there. And we think we've got the -- we know we have the broadest array of product grades, as well as the highest-quality product in the marketplace, in addition to having the broadest coverage for the region and a battery lab in Thailand and things like that. So we're focused on all the major producers there.

Craig E. Irwin - Wedbush Securities Inc., Research Division

Just another way to ask that question maybe that would help a little bit, if you look at the top 10 producers in China, there's obviously one that's not on the list for you. But how well-represented would you say you are with the other remaining 9 top 10 producers in China?

Robert B. Toth

I think we're well represented, and I wouldn't draw a lot of conclusions. We'd like to serve all them.

Operator

And moving on, we'll take our next question from Brian Drab, William Blair.

Brian Drab - William Blair & Company L.L.C., Research Division

Just one more quick one, and I'm sorry if I've missed this in all the discussion, but in terms of startup costs in the back half of 2011, originally, you had said that, of course, a step-up in startup costs but more in the fourth quarter than in the third quarter. Given that Korea's online already, I'm wondering if maybe that happened a little faster than expected. Does that comment that fourth quarter startup is more material than third quarter still apply?

Lynn K. Amos

I think it does, but we're talking incremental, not that much.

Brian Drab - William Blair & Company L.L.C., Research Division

Did anything change in terms of the balance in that between today and the previous time we spoke, the last time we talked?

Lynn K. Amos

No, [indiscernible] incrementally higher in the fourth quarter.

Robert B. Toth

I mean, I think Lynn said in his remarks it's utilities, it's people hiring, it's training, it's things like that. And so that all starts up, and then basically, as sales occur and you get the benefit of sales, that's just a natural part of the COGS. But until you have sales, it's just anomalous cost, and so it's incremental in nature. It doesn't go away. It just converts into COGS, and obviously, you get revenue when sales occur.

Lynn K. Amos

It's not going to make or break us.

Operator

And we'll take our final question from Richard Eastman, Robert W. Baird.

Richard C. Eastman - Robert W. Baird & Co. Incorporated, Research Division

I mean, just so I kind of clarify this, I mean, going forward now, from an EPS perspective, you guys are going to report an adjusted EPS number, which, again, continues to exclude the about $0.28 of intangibles and will exclude about $0.26 of stock comp.

Lynn K. Amos

Well, adjusted EPS doesn't exclude the intangibles.

Richard C. Eastman - Robert W. Baird & Co. Incorporated, Research Division

Okay. All right. So I guess goodwill, right?

Lynn K. Amos

Well, goodwill, you don't amortize goodwill. There is no expense. There's no intangibles amortization excluded from EPS. Obviously, in EBITDA, it's excluded, but not in EPS. The only adjustment that change here, right, that's of any size is the impacts of stock comp, the noncash stock comp.

Richard C. Eastman - Robert W. Baird & Co. Incorporated, Research Division

And that'll be about $0.26. And then does that share count looks like what then at the end of the -- say, for the fourth quarter, is it like a 47 7 number, fully diluted?

Lynn K. Amos

I don't know if I have that number. I think it's probably just a little bit lower than that. Obviously, there's a treasury stock method calculation of -- and a portion of exercise of options and things like that, but it's in that zone 47 2, something like that.

Operator

And at this time, I'd turn the conference back over to Bob Toth for any closing or additional remarks.

Robert B. Toth

Well, certainly, I appreciate everybody's time. I appreciate your support and interest in our company. We're obviously very pleased to be one quarter closer to our substantial new capacity starting up, and we look forward to reporting progress with you next quarter. Thank you very much, and goodbye.

Operator

Thank you. That will conclude today's conference. Thank you for your participation.

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