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Polypore International Inc. (NYSE:PPO)

Q2 2012 Earnings Call

July 31, 2012 05:00 pm ET

Executives

Kathy Brosco - Director, Corporate Communications

Bob Toth - President & CEO

Lynn Amos - CFO

Paul Clegg - Director, IR

Analysts

Michael Lew - Needham

Brain Drab - William Blair

Richard Eastman - Robert W. Baird

Craig Irwin - Wedbush Securities

Avinash Kant - D.A. Davidson & Company

Jeff Zekauskas - JPMorgan

Sanjay Shrestha - Lazard Capital Markets

Jinming Liu - Ardour Capital

Carter Driscoll - Capstone Investments

Operator

Good day everyone and welcome to the Polypore International second quarter 2012 conference call. Today's conference is being recorded. At this time I will turn the conference over to Ms. Kathy Brosco. Please go ahead, Ms. Brosco.

Kathy Brosco

Thank you, Kacie. Hello and thanks everyone for joining us today, and welcome to our conference call to discuss our second quarter 2012 financial results. As always, the results we discuss today can be found in our earnings announcement that was released today 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 net income, and adjusted earnings per share are non-GAAP financial measures discussed in this call. And I refer you to the reconciliation of these non-GAAP measures to the most directly comparable US GAAP financial measure included in the earnings release.

Before we begin today, I'd like to remind you of some important considerations. This conference call and webcast might contain forward-looking statements within the meaning of federal securities laws. We intend these 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're 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 Tuesday, July 31, 2012. 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 documents filed by us with the SEC, including those matters summarized under the captions Item 1A Risk Factors in our most recent 10-K filing with the SEC.

Today I'm joined by Bob Toth, President and Chief Executive Officer; Lynn Amos, Chief Financial Officer; and Rob Whitsett, Vice President of Finance. And also here with us today, we like to welcome to the team, Paul Clegg, Polypore’s Director of Investor Relations. At this point, I'll turn the call over to Bob for his opening remarks.

Bob Toth

Thank you, Kathy. Welcome everyone. As we described earlier this year, we experienced sequential revenue improvement across all of our businesses in the second quarter. Having said that, we're not satisfied with our current level of performance. While the good news is that we have new capacity, we're experiencing the incremental costs associated with that without yet having the meaningful sales to provide operating leverage.

Contrasting this to where we were virtually one year ago, recall that our businesses were operating at maximum capacity utilization with limited or no upside due to those capacity constraints. In fact, in some cases, we were turning away business. And at that point in time, we were accelerating and aggressively funding major capital investments and capacity expansions.

So we understand the cost of not having capacity especially in growth markets. Given the choice of where we are today compared to last year, we prefer to have capacity available. We're bearing some added costs as a result of that and while those costs are very transparent in our financial with the current level of sales, the value of having in our capacity will be very impactful when those incremental sales occur.

And it enables us to be highly responsive to an upturn in demand. Additionally, with the majority of our cash spent for these investments now behind us, we're positioned for substantial cash generation and substantial earnings growth potential going forward and we remain keenly focused on executing to meet the growing global demand for our products.

In the lead acid business, the future is in Asia which is the fastest growing region in the world. We've taken methodical and strategic actions over the past several years to be well positioned there. Today we serve the fastest growing customers in Asia. We have the largest facility and production capability in the region with more capacity beginning to ramp up in Thailand and China. And we have the most established infrastructure to service this region including manufacturing, sales, technical support and R&D as well as distribution capability.

In healthcare with the additional PUREMA capacity that was recently installed, we're well positioned to capitalize on current and future demand in hemodialysis membranes and we anticipate demand across our healthcare applications to remain solid.

We had three customers whose production schedules were unfortunately impacted by the earthquakes in Italy, the majority of that production is expected to resume by the end of the third quarter and obviously this does not change the long-term growth potential in healthcare which continues to be in the mid to high single-digits per year.

In filtration, be reminded that about half of this business is very stable, while the other half is sensitive to macroeconomic conditions. And nothing has changed on the long-term trend line where market growth is expected to be in the high single to low double-digit range.

We have leading edge technology here that allows us to participate at the highest end of filtration performance and we continue to see development of new applications.

In lithium and consumer electronics, consumers are demanding increased mobility and this trend will continue. In the core applications of consumer electronics and power tools, industry growth projections range from 8% to 20% per year plus additional growth in new applications like lawn and garden. We have made good progress to increase sales into consumer electronics now that we have available capacity and our separators are well positioned to see ongoing market penetration.

Finally in Electric Drive Vehicles, the automakers and the battery producers have moved closer to just in time inventories as they tie their production plants to the actual sales of specific vehicles. It’s clear that EDV is emerging. The near-term question is what will be the sales rate of certain high-content vehicles in the coming months. That being said, we have taken all the right strategic actions to establish an early leadership position in EDV.

We are at front end of the electrification of vehicles and EDV remains a tremendous step change growth opportunity. We continue to see investments throughout the global supply chain, we see aggressive program development worldwide and there is significant upside associated with EDV adoption and growth. Overtime as more vehicles get on the road, the impact of any one vehicle program will be diluted.

In summary, while we always prefer predictable straight-line growth quarter-to-quarter in emerging applications or in early stages of adoption, that’s not always realistic. However, the fundamental strengths of our company including global scale, our low-cost competitive position, our preferred technology, our relationships with the right customers and growing demand for our products and the continued application development, all of these ensure that we are well positioned to capitalize on the opportunities in our markets and as we grow, we will see substantial operating leverage and earnings growth. At this time point, I will turn it over to Lynn for the financial commentary.

Lynn Amos

Thanks, Bob. The second quarter revenues were impacted by foreign exchange and the earthquakes in Italy. Yet in the quarter we experienced sequential growth across our businesses. Turning to the second quarter results announced this afternoon, sales were $185.8 million. Adjusted EPS was $0.51 in the quarter. Segment operating income was $43.2 million and adjusted EBITDA was $57.3 million for the quarter. CapEx was approximately $50 million in the quarter.

It is important to highlight of the $370 million of capital investments we have announced since late 2009, we have less than $50 million remaining to be spend and as Bob said that positions us for substantial cash generation and earnings growth potential going forward. During the quarter we also closed on a new $450 million senior secured credit agreement. This included a $300 million term loan facility and a $150 million revolving credit facility. Proceeds from the refinancing were used to repay the old senior debts and related refinancing expenses.

Now moving on to the segment discussion. Beginning with transportation and industrial segment. While foreign exchange worked against us, we had a good quarter and return to the $90 million to $95 million revenue range. Excluding the effect of foreign exchange, sales would have been above that range and comparable to the prior year.

Our new lines in China and Thailand are beginning to ramp up and will help us meet growing demand in Asia particularly in 2013. Segment operating income declined due to the geographical mix of sales, the cost of exporting from the US and European facilities to meet the growing demand in Asia and the cost associated with our capacity investments in China and Thailand. In electronics and EDV segment, we noted on the last call that sales of lithium separators this quarter would be similar with the first quarter.

We were actually up sequentially due to increased sales from consumer electronics applications. With that consumer electronic sales for the first six months of 2012 were a little more than half of the total lithium separator sales. Segment operating income was 31% of sales compared with 47% a year ago.

We are not satisfied with that and we don't expect that to be the long-term operating income margin. I would like to take a step back and explain the factors currently impacting us here.

First, we have been aggressively putting in place production capacity to meet anticipated customer demand. While EDV is emerging, the sales level of a few high currents in EDVs has not been what was originally projected. Therefore, we haven't had the operating leverage that would come with the sales volume to fill that capacity.

So the start up and operating costs of a completely new manufacturing facility are more exposed and transparent. Second, the startup costs of our new facility were higher than anticipated due to some challenges with bringing the equipment online. Plus we had some added depreciation. It's important to note that what we experienced is not out of the ordinary for a plant startup. If anything that highlights the complexity of ramping up capacity in this industry.

At the end of the day, our ability to be responsive to a demand upturn is a function of having equipment qualified and capable. Finally, because we have some available capacity or line time we are running some process and product trials which in the near term obviously represent added costs but over the long-term this will provide us with step change cost advantages as well as throughput and performance advantages allowing us to remain in our strategically advantaged leadership position.

Bottom line, even without EDV lithium separators represents a growth industry and we believe this capacity will be needed in both EDV and consumer electronics. In 2011, we demonstrated the kind of operating leverage in margins that are achievable in the lithium business.

Now with the added capacity in place and the majority of our investment costs behind us, we anticipate substantial operating leverage going forward at sales growth. Moving on now for the separations media segment, adjusting for foreign exchange sales were above the second quarter of 2011 growing at 4%. Yet in the quarter, sales were impacted by limited production at three customers in Italy who were affected by the recent earthquakes there, as well as continued softness in the economically sensitive microelectronics portion of our filtration business.

With regard to our healthcare customers who are unfortunately affected by the earthquakes, our current information suggests that we will see a near term sales disruption spread across Q2 and Q3 abruptly $5 million in total.

Most, if not all of which we would expect to make up over a reasonable period of time and we will pace our production accordingly. Segment operating income and separations media was 28% of sales compared with 32% in the prior year quarter. The decline was primarily due to production timing, product mix and the cost associated with increased capacity for hemodialysis membranes.

Turning now to our second half outlook, we anticipate our typical seasonality in the third quarter associated with the European holidays which historically has had more of an impact on margins and a minor impact on revenue. Even with the Q3 seasonality and some continuing start up costs in the lithium separator business, we expect sales and earnings to improve in the second half of 2012 compared to the first half of the year, which obviously suggest the stronger Q4.

The degree of improvement will largely be determined by the sales of certain EDV models. The point I'll leave with you today is that we have strong businesses and we've been bringing online the largest investments in the history of the company, and while the sales haven’t been to the levels we or our customers had anticipated, we serve growth markets and we will need the capacity.

Additionally, we know we have the products and technologies that are in demand and that we are well positioned with the leading battery makers. We also know the operating leverage we have in our business and today, unlike last year, we have the ability and the capacity to capitalize on growth.

Before we go to Q&A, I want to introduce our new Director of Investor Relations, Paul Clegg. Paul joined us two weeks ago and comes to us with more than 20 years of experience as a banker and self side analyst with firms such as Mizuho, Jefferies, and Credit Lyonnais. Paul?

Paul Clegg

Thanks, Lynn. I am very excited to be joining Polypore. Already many of you on the line and I am looking forward to getting some rest of you over the coming quarters.

Bob Toth

Thanks Paul and with that, Kathy will open up the line for questions.

Question-and-Answer Session

Operator

(Operator Instructions) We will hear from Michael Lew with Needham.

Michael Lew - Needham

A quarter ago, with regard to lead-acid a quarter ago, there was a negative impact of a mild winter. I was just curious, have you started experiencing some acceleration due to the extreme summer heat in the US, as inventories start to get replenish?

Bob Toth

Well the way to think about that is, we like heat in lead-acid business and we like cold right because the heat degrade the battery faster and when it’s cold you need the cold crank power that’s not there when the heat degrades the battery. So while it’s hot I don’t do that puts batteries into the failure mode right it’s certainly I mean your spot on with kind of the thinking, right. But these batteries that didn’t fail last winter probably won’t make it through another winter, but having said that it’s a little tough to predict.

Michael Lew - Needham

Okay. On the consumer electronics side, do you had previously mentioned reengaging with potential customers with regard to utilization I mean how far longer you are on that process like how many customers you are looking to engage with?

Bob Toth

Well yeah, absolutely we are I wouldn’t say we have ever not been engaged with them we didn’t have supply for them last year, recall we talked for several quarters about running it maximum, capacity utilization and having to make basically allocation decisions in that business and when you do that you basically work with your customers to move business away from you and now we have been working with customers since we have capacity to move business back to us. So we have got a preferred product, we have got tremendous products and technology and you saw on the quarter we saw a pretty nice upturn in consumer electronics now that we have got available capacity.

Michael Lew - Needham

Okay. The question I was asking with regard to these customers reengaging are you liking the third inning of the process or more like seventh inning to help drive or fill up the addition on the excess capacity you have?

Bob Toth

Well I don’t know how you think about that. You got to have capacity first and then you have got to get approvals, second and get qualified in products and we are seeing that transpire, so we are in an inning I don’t know that there is ever a ninth inning when it stops because there is constant cycle and churn here and we think we have got preferred products and preferred technology and before we had to walk away from business we were growing share and grew shares for several years. So I wouldn't necessarily not anticipate that going forward.

Michael Lew - Needham

And finally on the EDV side just curious with regards to outlook for EDV while your opposite is tied to some larger platform vehicles but is your internal projections are they been driven by large format or prismatic batteries or more the traditional cylindrical types?

Bob Toth

In EDV no, I mean the mass majority of the development is for the large format sales. There is only a particular company that is using the small traditional cylindrical format style you are representing or talking about. The vast majority of the world wide development are large format cells both prismatic and cylindrical although prismatic has the strength advantages from the design you know cooling etcetera capability. So you know when you look at the world today really there is only a few niche vehicles that are going smaller battery if that’s your question.

Operator

We will now hear from Brain Drab with William Blair.

Brain Drab - William Blair

So I think the big question this quarter is, it was addressed by Lynn in the prepared remarks but it is around the margins in lithium and it looks like the incremental operating expense from first to second quarter is about $7 million in that business and I understand revenue is up $5 million and variable costs associated with that in terms of energy and materials and may be that is a $1 million lets call it just for the sake of conversation here. So you know $6 million in incremental cost and Lynn mentioned some buckets of startup cost higher than expected, number one, added depreciation. Number two, running the process and product trials for this, it sounds like for the new technology that would be implemented in the Phase 5 expansion in the Concord facility as a third bucket. So am I thinking about this correctly and could you talk about the incremental $6 million or so in operating expenses in terms of those buckets and maybe help us break it down? And then secondly, help us understand if some of those expenses were specific to the second quarter?

Bob Toth

Oh yeah, well, I think they are, first of let me just kind of qualify that and I don't know if it will change how you think about it. But there are several buckets of the cost, right, number one and we are starting a new facility and it just didn't ramp up as smoothly as we had anticipated. So when you run equipment at a different scale and you run it slower on start-up, you don't have big expense with that in the first quarter. You actually might make some pretty good stuff with that.

And then as you fire it up you get it running at full scale, you know we ran into some challenges, nothing major, just very simple things like for instance the scale of this facility is very large, so we've got a very large scale raw material handling capability; one that we hadn't proven out. And so with that there were a few bumps in the road in terms of where you need filters, how you need to handle raw materials and those kind of things, not a big issue, but costly when you are trying to run the plant at a much higher rate of capacity.

And I should preface all that with keep in mind, we have no responsiveness unless we have the equipment planned out, the equipment qualified and the product proven and probably even the application qualified. So just having equipment or having steel in the ground doesn't do you any good and while you don't want to absorb those costs especially not in an unbelievably transparent sort of way at a time when you don't have operating leverage taking that on is the right strategic action, because the position should be much more responsive going forward. But there is cost associated with that.

Also the good news and the bad news is we have capacity available and as we mentioned, we believe we’ve got fundamentally the best technology in the world. We certainly have proprietary technology as well on top of that. We've got a low cost position in the world and we’ve got technology which needs to be proven out in production which can allow step changes on both cost, potentially even quality and certainly in throughput, and since we're already in a strategically advantage position, you know, distancing ourselves from the pack even further we think is pretty substantial.

So we did make the decision to actually run some of those trials in the quarter, which were pure cost, because you're proving out new process technology and we're delighted with what we see there, not going to get out of SKUs and talk about when it might be in place, but we're delighted with what we see there.

And then lastly, you had added depreciation because you're continuing to accelerate bringing on equipment. I think Lynn year-on-year it was what…

Lynn Amos

Year-on-year it’s about $2 million in the lithium business, from first quarter to second quarter it's about $1 million incremental.

Bob Toth

So we did a little bit of a pile-on all in a very transparent way because the operating leverage really wasn’t there from a sales perspective.

Brain Drab - William Blair

Okay, so the depreciations there clearly going forward, does the depreciation go up then sequentially in the third and fourth quarter it’s what as you are turning on some additional lines?

Bob Toth

I think we saw most of the uptick in depreciation moving into first quarter and then the second quarter. I think you are going to see a relatively modest increase from here.

Brain Drab - William Blair

And then some of the challenges that you saw in terms of – that resulted in additional startup costs. Does that bucket of cost increase or decrease going into the third quarter?

Bob Toth

I think Lynn described better though carrying some into the third quarter. I mean we're not, I mean look our goal is to have a world class plant that nobody can touch in terms of cost and quality and capability. So carrying a little cost from second quarter into third quarter, to demonstrate that out and to put in place the responsiveness to an upturn in demand with a business like this in terms of operating leverage, is the cost I'll take. And so we’ll carry a little bit of that from second quarter to third quarter. I don’t have a reason to believe it going up, I mean at this point. And then you know we may or may not elect to still spend some in terms of the technology trials.

Brain Drab - William Blair

Okay, so do you have to, you're running at 40% plus operating margin in this business, all through last year and even in the first quarter, you were on less revenue. What do you need to do to get back to that? What kind of revenue do you need to see to get back to that 40% plus operating margin?

Lynn Amos

Well, clearly the biggest thing is sales, right. Incremental sales is probably built of plant and that’s why we added the additional infrastructure cost and operating cost, is to sport a higher level of business than we currently have. And you know we talked some about the sales that we had anticipated that frankly where we or our customers thought they’d be here in the second quarter.

As you go forward, we don’t see any reason to change the investment cost or the operating cost that we have in the business today. If we believe the long-term trend rate in sales were changing, then we deal with the cost side. There is really two solutions, right, either sales go up and you get the operating leverage or you address the cost side. And right now we don’t see a reason to address the cost side.

Of course there are some unusual costs in the second quarter as Bob mentioned relative to some incremental startup cost, troubles we had starting up large scale equipments as well as some R&D and product trials, but a chunk of this is cost associated with bringing new facility up and new people and new operators.

Bob Toth

And we haven’t, we are not going to get into providing kind of guidance by quarter in terms of margin, but a lot of people did a lot of analysis last year on what our contribution margin must have been to drive those operating income margins up. And I don’t know what all promises everyone made, but I don’t know that any of those -- all of those would hold true today, right; except for the fact that we’ve got more sales capability now.

Brain Drab - William Blair

Have you seen any pressure on price in that business?

Lynn Amos

Our pricing was consistent; our average pricing was consistent in the second quarter to the first quarter to last year frankly. It’s strictly we have added operating costs into the business. If you think about the magnitude of the capacity we have added across our company, we have made an investment to support a much larger business than we have today. We have made investments in the healthcare business and brain and hemodialysis membrane. We made investments in China and in Thailand in the lead-acid business and we made big investments in the lithium business. And frankly we are glad we did and we think it’s the right choice for us to have that business; I mean are we bearing the costs of that right now, yes we are.

Lynn Amos

We wouldn’t have needed a lot of sales and we’ll not be having in this conversation in the quarter, but the fact of the matter is the costs were there and the operating leverage wasn’t.

Operator

Moving on to Richard Eastman with Robert W. Baird.

Richard Eastman - Robert W. Baird

Hi just as a follow-up on the lithium business. Bob have you lost any visibility on this incremental 25 year goals that you intend to be on by year-end or is that much intact?

Bob Toth

No; I mean fact of the matter Rick, this is one to the polar extremes right; you have to delineate what’s kind of going on at the macro level here from what’s going on the in the near term, short term associated with the fuel hike content vehicles.

So the dilemma we have right now, if you want to call it that, is there are handful of vehicles that for all different reasons and people could put whatever spent on it if they want, but for all different reasons are not selling at the originally projected rates and those are pretty impactful today. Those get diluted overtime and frankly we’re seeing nothing but more vehicles being added and so we see nothing on the long term trend line that would suggest for a minute there is a problem.

In fact, we could point to things that it’s funny that people have this kind of -- look at the China mandate that came out in the last week or two, right; they are going to add 500,000 plug-in or battery electric vehicles on the road by 2015. And if you don’t believe that, they are still going to have 5 million by 2020 and if you don’t believe that I think it’s worth a 100,000 buses a year by 2015. Just do a math on that.

Now that is one country that seems to have a government employee that can get things done; that proven that time and time again, but discount that France has just put in place some additional incentives; you’ve got a wave of new vehicles coming out each year and more and more being piled on each year.

But fundamentally, we know a couple of vehicles that are visible in the US that we talked about in the past and a couple of vehicle launches in Europe got the way. So how they sell going forward will determine the upside as Lynn said, right. You see it even in our customers recently cite their forecast being associated with the uncertain sales levels of those. So people have stopped kind of getting out over their skis on the projections and just said we are going to build it when it comes in terms of those vehicles selling and we are not going to build it in anticipation of that coming.

Richard Eastman - Robert W. Baird

And if I think about where you are from a capacity standpoint and again sticking with the lithium business. Again everybody has got their own estimates here in terms of how much capacity we will have available because you have two minds here. One coming on as we speak and another one I believe in the fourth quarter. And that maybe provides 20% more capacity than what you had available in the first half. But I'm just trying to get a sense of how you think demand will shake out second half versus first half.

Bob Toth

Well, we always talk in phases, not lines, right we've got multiple phases of expansion, some of which we've accelerated, right. And the way to think about it, the easy way to think about it is with all that we've said except for the last phase which we've always said we could kind of time appropriately is we will have a $400 million run rate capability in the lithium business in 2013, not for the full year. But in 2013 so you can kind of -- we are not going to try to nail it too precisely because of the qualification timing and the grades and all those kind of things and mix that you can have. But in 2013 we will have an annual run rate capability during the year of occurring of $400 million revenue on this business. We got $200 million today. We see nothing to cause us to want to change that at this point in time.

Lynn Amos

And if you look at the capital we spent right, the capital has been spent already to support that $400 million revenue run rate. That steel is in the ground, those lines are what are being qualified, ramped up and planned out and planned out and we are working through the bugs of the start up on and that's what we are bearing now.

Richard Eastman - Robert W. Baird

Yes I understand that, but again when I think of your lithium business in 2H, second half versus the first half, we clearly will get some growth out of consumer electronics because we seem to have rebuilt our opportunity there, but I presume you are still expecting measurable growth on the EDV side relative to model introductions and now your capacity availability. Is that fair?

Bob Toth

I guess I will reframe it for you a bit because we are not going to get into being too granular on this, but we are continuing to focus on consumer electronics now that we've got capacity available. When it comes online is a little tough to predict, right, it's when you get awards and when that business starts up and how well those devices sell. We are delighted with what we saw in the second quarter, right. So the good news is we've got capacity available. The bad news is we walked away from business a year ago plus that we are having to earn back and we are seeing what we had hoped for which is we've got good products and the right technology and we are earning that back.

So we fully expect that to continue, I am not about to try to predict that quarter-to-quarter because it’s a function of so many things but we like what we see there. You saw it in our second quarter results. In EDV, first half wasn’t the most robust, right. You had the few high content vehicles not selling as well for a variety of different reasons, we've cited those. People can believe whatever they want or say what they want about that, but the facts are the facts. There were investments going in, in the General Motors plant. Nissan is building two new plants that haven't started up yet.

In Europe Renault delayed the launch of a couple of vehicles into the back half of the year, not much we can do about that. It's unfortunate, not much we can do about that. People can try to paint that as that's a proxy for EDV or not, we don't see that, but that's everyone’s right to kind of guess. And during the second quarter, you had customers going, okay, I’m not relying on projections, I am going to build as I get the orders and as the cars sell.

Right so you had inventory kind of to please. So you know what's changed going into the back half of the year. Right, several things have changed. One is the [Volt] now has HOV lane compliance. People have suggested that the sales rate has stabilized. People have suggested that the sales rate will go up. Everybody has the right to believe what they want there, but I think even some customers have indicated that that, that sales rates stabilized. You've got some new vehicles launching in particular in Europe in the back half of the year.

How well they sell, you know, I am not going to speculate on that, but they’re new vehicles that are launching. You've got two new facilities at Nissan starting up. One for sure, probably this year and one for sure probably around the end of the year, they have been a little more vague on that as to whether it's at the end of this year or the beginning of next year. And you've got customers going into the back half of the year with relatively low to no inventory levels.

So what's changed going into the back half of the year. Now how high is up? You know, we’re not going to get into kind of speculating on that.

Richard Eastman - Robert W. Baird

Okay, and then just a quick question. I’ll get back in queue for Lynn. Lynn, the corporate expense number at 6 million, why did that, what caused that to drop sequentially?

Lynn Amos

Well there is two big things. The biggest item in there is incentive pay. We’re not happy with the performance, then we’re not accruing incentive pay. That’s a big chunk of it and the other thing is amortization expense is starting to roll off on some of our intangible assets. That’s about just under a $1 million.

Richard Eastman - Robert W. Baird

So there is no reason that shouldn’t stay you know, more or less that level for a quarter or hopefully not two because the incentive pay will bump back up.

Bob Toth

Well it's right, that will change relative to performance, that’s right.

Operator

Your next question will come from Craig Irwin with Wedbush Securities.

Craig Irwin - Wedbush Securities

So previously on the healthcare side, you discussed how some of your customers have had take or pay contracts, can you update us on the relative portion of your overall mix on the healthcare side and when these volume commitments anniversary if we are looking at maybe a December flush there or if there is potential for cash payments in December or if this is something that may be has a longer contract duration as far as when you see the volume commitment?

Bob Toth

Yeah we can’t get too specific because of the confidentiality reasons, but the point on the take or pay was the running virtually all of our healthcare customers run their production and campaigns because they make multiple different products, right. And so the point we were making earlier in the year was and I can’t even recall the exact number. It wasn’t a big number, but it was a few million dollars out of first quarter made up kind of over the balance of the year and the point we wanted to make was just because it was out of first quarter, it’s going to come back based on their production schedules and the balance of the year because A, they told us and B, we have contracts.

And that’s transpiring, some of that probably started to get made up a little bit in the second quarter and third quarter and over fourth quarter. If I were to actually measure because we just in the spirit of complete disclosure we talked about it because first quarter was down a little bit, but the fact of the matter is it’s only a few million dollars spread over multiple quarters. So there is no big unusual event kind of taking place here.

Lynn Amos

And then there was the earthquake which is about $5 million over a couple of quarters, it hit second quarter and will carry into third quarter a bit. Virtually all that we expect to be made up. The question is, is it all made up and fourth quarter or first quarter or some balance of those two, it is little hard to say right now.

Craig Irwin - Wedbush Securities

Great my next question was about consumer. So in your prepared remarks you discussed the consumer market as a growth market. I don’t think there is anyone out there that would disagree with you. Can you may be update us on your -- where this stands as a priority for Polypore as far as capturing new business and what do you think about some of the larger programs out there whether or not you have potential to serve them in the back half of the year or if there is potential for consumer to contribute a greater portion of mix in 2013?

Bob Toth

Well I mean it is unfortunate when you are sold out, but you have to make choices, right and we make all those same choices today if given that exact set of dynamics again. Now having said that, we also knew that we were building a lot of capacity with the expectation of continuing the work with our consumer electronics business and continuing to grow. And hopefully continuing to grow share like we had been for years kind of in advance to that. So that’s where we are back. I mean we built the capacity as you know and we are focused on working with them again. So there is certainly capacity available for them and hopefully we don’t see a need to have to make that kind of decision again. I mean the intent was to put in place capacity to grow. In consumer electronics we see it as being very important and those customers as being very important to us.

Craig Irwin - Wedbush Securities

Then my final question is about the guidance. So you mentioned seasonality in the guidance and in the past when we used to talk about seasonality. That was typically sort of inferring sequentially down earnings and revenue in the third quarter versus the second quarter. It wasn’t always the case over the last several years, but can you update us on whether or not you expect third quarter EPS to be lower sequentially than the second quarter and how we should look at the relative hockey stick on earnings into the fourth quarter?

Bob Toth

Well Lincoln built on this. You are absolutely spot on in your assessment right. If you look at a typical historical seasonality event in the third quarter its impacted, reims are little in margin a little more right, but in a couple of quarters with the growth we've had we've kind of plowed right through that and so it massed or muted when otherwise had been a better quarter, right the growth pushed the numbers up so you kind of didn't see that compression.

So we are not going to get that granular that kind of do quarter-to-quarter guidance here, especially in our kind of business, you got mix every quarter, you've got customers quarters that could move a day and mean a quarter in terms of how you report externally. The point is and I think Lynn said it and if I didn't know well, we expect the back half to be stronger, our business is strengthening, we saw sequential improvement in second quarter even more so perhaps than lithium than we anticipated as mentioned because of the recovery in consumer electronics, and the level of improvement is going to largely to the [length] to how well certain high content vehicle sell in the back half of the year.

There's a lot of things that change going into the back half of the year as we mentioned on EDVs on our available capacity, on our ability to manage costs but we are going to continue to do the right thing for this business to put it out of reach from a competitive dynamic point of view for a long point in time so we've got some costs in the short-term.

Operator

Our next question will come from Avinash Kant with D.A. Davidson & Company.

Avinash Kant - D.A. Davidson & Company

The first question was about the year-over-year changes you've seen in your combined lithium ion business, you gave us some idea about sequentially it seems the strength was coming from the electronic side. Could you give us some idea of the year-over-year change, you know, are you up on both, are you down both on electronics and EDVs or are you up on one and down on one?

Bob Roth

Year-over-year, with the decrease is primarily in EDV from I think we’re down about $3 million in the quarter year-over-year.

Avinash Kant - D.A. Davidson & Company

On EDV right?

Bob Roth

In total and the decrease is due to EDV.

Avinash Kant - D.A. Davidson & Company

So basically the electronics side of the business kind of remained flat?

Bob Roth

We’re not going to get into splitting this out exactly. We've seen some growth in consumer electronics and the decrease year-over-year is EDV.

Avinash Kant - D.A. Davidson & Company

Okay, and again, historically you talked about kind of 300 basis points decline in Q3 given your maintenance shutdown and everything. Is that what we should be thinking about for this year also based on ---

Bob Roth

As I kind of mentioned, it's going to be a function of growth in the quarter and we’re not going to kind of get in to that granular level of predicting it. In a typical year, we’ll see the compression on margin because of shutdowns and just you know, the lack of production, the cost associated with that and a little bit of an impact on revenue because you got some customers particular in Europe it is a same thing.

Lynn Amos

And the most significant impact is on our separations media business, largely because we have you our largest facility for separations media business in Germany in the month of August in Germany it’s a holiday month. So that’s our plan to shutdown every year in August.

Avinash Kant - D.A. Davidson & Company

And in the past you've given some idea about two key vehicles like the Nissan Leaf, Chevy Volt combined being I think the last time you talked about did you say roughly one-third of your EDV sales is that ratio still valid or it has gone up or down meaningfully?

Bob Roth

No, I don't think we ever said. I think people have speculated that’s what it is but we haven't disclosed what the vehicles are. We just said certain high content vehicles disproportionately impact the short-term.

Operator

We’ll now hear from Jeff Zekauskas with JPMorgan.

Jeff Zekauskas - JPMorgan

You’ve been very kind as to point this all toward various pieces of consultancy literature on separator market and when I look over the consultancy literature, especially the consultancy literature concerning China, what's interesting is that in the literature, gains a lot of market share at some accounts and it loses a lot of market share in some Chinese accounts. What is it that really accounts for the gain and loss of market share with some of the primary Chinese battery manufacturers? And this is over, you know, a period of time from 2009 to the present?

Bob Roth

Well, I can’t really speak to that because I am not sure exactly what you're referring to but generically or at least using the word generally, I can say we walked away from business. So, it's easy to lose market share when you walk away from business. Its unfortunate we had to but that gets back to the allocation mode we’re in. I mean we plan out, didn’t have capacity for what 18 months we’re running in a month or more. And you would have loved to have not walked away from business because we wouldn’t have had the self-inflicted pain we had first quarter and even second quarter still in terms of recovery. But we didn’t have any choice, we didn’t have capacity. We couldn't get on the ground fast enough. So that’s a big reason.

Jeff Zekauskas - JPMorgan

So you are always careful not to talk about particular customers as best you can. So may be if you would you could talk about particular geographies that is in your EDV revenues. Can you talk about sort of the general proportion that might be China or US or Europe and when you speak about a possible turn up in the fourth quarter, do you have a particular geography in mind is that more China, the US or Europe if you can say?

Bob Toth

No, we can’t really say. I think what you have to do on that is look more broadly at what the dynamics are and then kind of make the estimation of which side of that equation do you want to be on. And you have got let’s kind of talk about this at a specific level. We can’t say if we are on these vehicles unfortunately but you guys can do a lot of guesses. So you got the (inaudible). So what’s going on with the (inaudible) I read headlines, I read this, I read that, I see television commercials, I see political commercials but what’s going on with the (inaudible) is very fact based what are the facts, the facts are last year they had about 15,000 unit capability may be give or take a little more.

They invested in that facility it got disrupted a bit by the additional NHTSA testing in December but that all proved out just fine, they had to make a modification to the battery pack, they didn’t make the vehicle originally the exhaust system HOV lane compliant in California so that it takes some time to do that, but they did all that and they increased capacity so the estimate is no less than 60,000 to as much as a 100,000.

So people go why are they only making them, when they are selling them now and the answer is really because they can, they have got a much higher level of capability today than they had last year. But they need to make sure they can make the cars that people want whether that’s HOV lane compliant or the mix and expand them geographically and know by the way since they have a batched it and changed the name and start selling it Europe as the [Impera] etcetera.

They have also announced that they are moving into China. There has been some speculation and talk of them upgrading the combustion side of that engine out next year and which means they must plan to keep this vehicle around if they are going to doing that, they have added some options on the vehicle this year and they have changed it over recently to the 2013 model year. I laugh because I recently read someone writing a big report of about them taking a shutdown which was a planned shutdown for model year change over but that was a big deal, and so it's just funny how people pick up these bits of news. So that’s all been announced out there. The [leap] is that situation has been crystal clear right they had a plant in Zama Japan and still do. They are selling those in Japan the yen is appreciated, so it is pretty costly to fill the pipeline anywhere else. They've said they are just not going to do that. They haven’t been doing it, but they took two plants that were originally intended to start up both some time next year and one later than the other and accelerated both of those one into this year which is in Tennessee you can drive by, fly over whatever you want to do to see it. It's big and in Sunderland UK and Sunderland is like I said, they have been a less clear about whether that starts up fourth quarter or starts up first quarter but they have accelerated it because that was originally going to be last year and you got some Renault vehicles that are starting up in Europe in the back half of the year.

We don’t know how they'll sell but the pretty high content vehicles and then you have more and more hybrids coming out, you got the BMW 3 series hybrid which will be introduced in the fall of this year in the United States and Europe. You have got Volkswagen introducing some things you can go on and on. And by the way, the customers have depleted their inventories. So lot of change from the front half to the back half and then you throw in, you've got a lot going on in Asia, you've got buses going on in Asia, you've got cars going on in Asia, but as we've said along I think the cars I think will be bigger in Asia overtime and the buses will be bigger kind of now, the big vehicles will be bigger; earlier, the cars will be bigger overtime.

Jeff Zekauskas - JPMorgan

That's very helpful. Just as a last question, so with Nissan or General Motors contracting to buy batteries, using your battery separator, regardless of the particular model and you commit to selling a certain amount of separator over, I don't know the course of the quarter or year. Are price terms that quarterly or annually or longer than that or what is the structure under which price terms are set; if they are something that's common about the way that they are set?

Bob Toth

Well, I mean I can speak for common in terms of what we've kind of always said, as you know when we got involved in this programs four and five years ago customers think they are going to use certain volumes out into the future and they built demand curves and we build the price curve consistent with that. And if they get the volumes which gives us the operating leverage, they get the price, if they don't get the volumes, they don't get the price. And so that's kind of how it work, you know I mean any good buyer always asks for price everyday, but really, really these prices were kind of negotiated in the past and you are just living to a price curve that's associated with volume, largely like it is in consumer electronics.

Operator

Moving onto Sanjay Shrestha with Lazard Capital Markets.

Sanjay Shrestha - Lazard Capital Markets

A couple of quick questions, Bob you talked about sort of you know on the electric vehicle side there is some uncertainty as to what the exact demand on those quite look like given a lot of guys interest in a lot of the vehicles. So from the allocation standpoint right with the consumer business picking-up how are you guys thinking about sort of your capacity matching to demand as we look at the second half of this year and also through 2013?

Bob Toth

Well, when you have a $200 million run rate and you've got approaching a $400 million capacity, capability I am not that worried about it…

Lynn Amos

Because we can make either consumer or EDV on the same assets…..

Bob Toth

Yeah, I mean that's completely tangible, you know the assets that way. So I am not sure if that was your question. But we've built capacity and we need the capacity. The industry needs the capacity. It’s just a short term phenomena that we are kind of dealing with on a few high content vehicles.

Sanjay Shrestha - Lazard Capital Markets

Okay, so basically then for you guys to my question was more about if the electric drive trains, are the high content vehicle sales continue to sort of remain relatively weak like it has been in the first half of this year, it sort of becomes a capacity utilization issue for you guys unless you go and aggressively qualify a lot more consumer electronics customers, right so how are you thinking about that?

Bob Toth

Well, I am not sure I am following your question. We've been doing that, that's in fact what we ate a bunch cost on in the second quarter. If you think about this, our products are highly technical, right, customers generally have to approve the site and handle doesn't have the air quality, doesn't have the clean room environment, they have to approve the equipment and how formally they all do this is very different, right; some will just see the site and go yes, pretty robust, some will go through a full audit, so you get all the above.

You have to approve the equipment, you have to actually demonstrate the equipment can make something, then you have to demonstrate something that it makes and then you have to put it into the product, the application and demonstrate that the application works, right; so that all takes time. We can shut a lot of that off pretty fast, with a stroke of a pen, we can shut a lot of that cost off, but you don’t get it back instantly, the quality of our workforce is pretty remarkable, right. You got to have well trained high quality workforce that specializes in particular steps of a multiple step process that no one else in the world has the capability of.

So if you want to grow long-term, what do you do, you just wait for that to happen or do you put that infrastructure in place and as Lynn said, then if the anticipated demand curve changes, you respond to that. We’ve got a history of being pretty responsive to changes. Today, we don’t see any need to do that. We’re building capacity for a high growth industry and again let’s go back in time and just kind of talk about the industry here.

In the absence of EDV, you know, you could go well, I am going to make something up and say EDV isn’t going to happen. I am going to say these cars are proxy free for EDV and I am trying to scare people with that. Well, that’s not going to happen, right, but lets say it does. We’re not going to what it does. You’ve got 500 million square meter market today that’s grown at 8% to 20% a year. Now do that math and you go, we’ve been growing share, we’ve got the products that’s most desirable and I am talking product like it’s singular, the grades that are most desirable, so you are layering in anywhere from 50 million to 100 million square meters of growth a year with zero growth in kind of EDV and ESS, Energy Storage Systems both of which have huge potential with minor penetration.

So you go, well, if you're adding a $200 million of run rate capability, you're obviously not adding 200 million square meters, you're adding a lot less square meters when you do the math and divide by what people think the average price is. So we're not adding some unusual amount of capacity; we're adding in a very condensed period of time, which just furthers our competitive advantage here.

As I said before, in the past scale was less important than in the future and that’s absolutely going to be true now and especially if we tease out some of these new technology things where we can maybe even get additional throughput with not much additional capital or step change cost or throughput we become a real moving target and we will distance ourselves from anybody even thinking about trying to playing this game.

Sanjay Shrestha - Lazard Capital Markets

Absolutely, complete for you operate even you have to happen it’s a part of capital standard, but that’s there, its long term, no question about that. What I was sort of more referring to is, so this is more of near term issue versus the long term opportunity and balancing that right. So when you talk about the second half growth and growth into 2013 with the OEM moving from hard target to soft targets so what’s embedded in your assumption as it relates to that; have you gone back qualified more consumer guides in an event that electric vehicle was exploited and have you got full levy and still remaining slow in second half of this year and also into 2013?

Bob Toth

Well it’s not mutually exclusive; we are going after consumer business and re-earning all of our customer’s trust there and pursuing that as aggressively as we can and we are continuing to get pulled into more and more new EDV development programs. So it’s both it’s not mutually exclusive by any means.

Sanjay Shrestha - Lazard Capital Markets

Okay.

Lynn Amos

I think your question is a confidence question around that commentary; I mean what we saw in the first half of the year is we saw the supply chain being worked down after building up some inventory in the back half of ’11. I think we are looking at the sales rate of the few of those high content vehicle stabilizing and even improving and the level of improvement that’s ultimately what nobody really knows the answer to. And certainly the level of improvement those will have will have an impact on how much stronger our back half is than our front half. But and I think people had pointed correctly, this is as some new vehicles coming as well, so I think Bob said it earlier on the call it looks like our businesses are getting stronger really across the platform.

Operator

Moving on to Jinming Liu with Ardour Capital.

Jinming Liu - Ardour Capital

Thanks for taking my question. First of all your guidance; during the last earnings call you said you expect year-over-year earnings growth with the first half numbers already available and the higher cost; do you continue to expect your year-over-year growth in earnings and potential to (inaudible)?

Bob Toth

Well, that’s a good question Jinming I am sure if I said it again that people would believe me anymore this time. So what we are saying clearly though that we see our businesses improving; we see the second half better than the first half. We have FX that’s worked against us since the last time we talked. But fact of the matter is the sales rate of a few high content vehicles is going to determine the upside, so people can put whatever you know premise they like those vehicles, but I must say solid and significantly improved pace in the second half while we still would see a second half stronger it would be difficult to assume we could assume we could exceed last year’s performance.

Jinming Liu - Ardour Capital

Switching to your lead-acid segment; I believe you have both your pace and expansion off of the joint venture on-track to contribute in the second half of this year; should we expect higher than normal quarterly run rate for your lead-acid segment?

Bob Toth

Well, as it comes on, I think when I said it’s going to be more of a 2013 event that equipment just started…

Lynn Amos

Yeah, that equipment is ramping up; yes we are getting some sales out of it. But it’s going to ramp up in terms of throughput off those facilities over the course of the back half of this year and so I mean I think…

Bob Toth

It would more impact the 2013. You get a difficult seasonality in that business in the third quarter, fourth quarter is typically an improved quarter. We don't know how good it will be this year, it depends on how quickly the replacement market comes back to the weather factors we talked about earlier.

Lynn Amos

Yeah, and then I mean relative to last year the euros in quite a bit of different place kind of was at this time last year as well from an FX rate perspective.

Jinming Liu - Ardour Capital

And also regarding your inventory level, it's high and the increased inventory I wonder whether it came mainly from your healthcare segment or (inaudible) segment.

Lynn Amos

Well, let's talk about our inventory level. I believe on the last call, a peak question was asked about the inventory level and I mentioned you know we've been short on inventory for about two years due to all being sold out that bog had talked about and at the end of the first quarter I mentioned that our inventory levels were at a level we are very comfortable with. I think if you look today at the inventory we have on hand and the customers forecast, we are not uncomfortable with what we have, but it's probably a few million dollars higher than normal, but certainly not at an uncomfortable level that would cause us any real concern. The $5 million or $6 million growth that we saw really was more in the lead assets and the lithium business than it was in the healthcare business.

Jinming Liu - Ardour Capital

Lastly regarding the emerging energy storage potential for your lithium segment, is there any parameter you can share with us like should we expect similar amount of revenue from kilowatt-hour or megawatt-hour any agreed level of energy storage capacity, that’s comparable to same power off for electric vehicles?

Bob Roth

First thing I would say is you know, in the purist sense, I wouldn’t equate separator usage to kilowatt hours always because there is a lot of ways to design a battery. So you can’t as a rule of thumb but I just always caution you to not rely on that being precise. But to your point, largely, yes so the same batteries, they are large format cells where we have a distinct advantage in energy storage system. The large format cells, we've talked about our product advantages, I think even some of our customers have acknowledged that pretty publicly and so the energy storage system sales are being designed to be very consistent with EDV sales because in fact that’s one of the, you know, one of the growth dynamics. When the car is done after eight or 10 years, the battery will have 80% of its useful life left. So it can go in to an energy storage applications. So those will all be large format cells.

Operator

And we will now hear from Carter Driscoll with Capstone Investments.

Carter Driscoll - Capstone Investments

I would say lithium iron (inaudible) the doubt. So I was wondering if you could comment on the recent Circuit Court of Appeals ruling on Microporous and your timeframe, your expected timeframe of a response and potential impact, obviously we know what percentage of sales you've estimated but and what decrease is going forward but maybe you could just provide some additional color, it'll be helpful?

Bob Roth

Yeah, I think we're disappointed in that. I would like to think this is a fact based progress and we think the facts process and we think the facts are on our side. So, having said that, we're going to continue to the appeal process and continue to defend our position. I think to your timing question, you know, there is not precise timing on these things. There is not precise month-to-month calendar but I think the easy way to think about it is if you look at the procedural steps in an appeal process, it's probably at least six to nine months if you assume a lose case. Right, so if you kind of go through and then you have six months to sell. So if you kind of go through the lose scenario, you are out of here, that’s kind of the easy way to think about it.

Carter Driscoll - Capstone Investments

If you just remind us what the two main issues that you’re contending, one I guess the horizontal aspect of the merger and definition of the market just to remind us what the central issues are?

Bob Roth

Central issues are, we didn’t view as a competitive dynamic, right? They make rubber, they are the only rubber producing assets in the world in Piney Flats, Tennessee, of the business we bought, the vast majority of it was a rubber separator for deep cycle that our customers claimed we had no product to compete with for years and years and years, probably trying for 10 years.

So that’s pretty easy call monopoly for the rubber asset separator business, that was the only rubber producing asset in the world they didn’t think that was a problem buying a rubber monopoly. And then secondarily, they operated without a plant in Europe for 30 years but now need a plant in Europe to be able to operate. That doesn’t make a lot of logical sense to us in Europe why that wasn’t built. So I mean obviously we think the fact stand by our side but you know, again the process is as process and I am just going to stick to the timeline that I gave you, if we lose that’s kind of the timeline you're on. You got six to nine months of procedural issues and then six month divestiture time; if we win along the way that timeline changes.

Carter Driscoll - Capstone Investments

And then it is as you, I think put in your K, approximately 10% of last year’s sales, correct and about 5% assets?

Bob Toth

I think that’s right, yeah I mean it’s in there.

Carter Driscoll - Capstone Investments

Obviously, a bit difficult to try to gauge in a type of public comparables if you were forced to sell it, and they are really on the transaction?

Bob Toth

Yeah, but make no mistake we have had a lot of interest. There has been no lack of interest along the way in this business; it’s not often you get to buy the only rubber producing asset in the world and we’ve had interest from pretty wide universe. So we have always said, we think we will get fair value; I don’t know how you define exactly what fair value is, but we think we will get fair value for it; we have improved it and it’s a pretty good business.

Operator

Ladies and gentlemen we have time for one more question which will come from Brian Drab with William Blair.

Brian Drab - William Blair

Yeah you mentioned that inventories, I guess the supply chain being much leaner at this point, I am looking at LG’s results and if I am looking at this correctly, they were up 60% in their EV battery sales from first quarter to second quarter and just surprised that maybe we didn’t see more of that in your results. Can you comment on that; has there been inventory of separator in the supply chain when you are talking about less inventory at this point are you talking about a drawdown of separator inventory or are you talking about auto manufacturers holding less inventory?

Bob Toth

Well, I am not going to get too granular on it; I think it’s all the above and you really should ask them that. If their sales were up people think we supplied them (inaudible)

Lynn Amos

We have of many customers.

Bob Toth

Yeah so, I mean you can kind of box down to that whether or not it was purely in cells or in battery packs or in separator or in cars; I can’t really break it down that fine, but you are right. Their sales were up and ours weren’t materially and therefore you can conclude inventory came down.

Brian Drab - William Blair

Okay, alright thanks guys.

Bob Toth

Okay. Thanks everyone for your time, interest and support. I would also like to say that the Polypore management team as Lynn mentioned earlier, has compensated in an unbelievably close correlation to shareholder value creation as we should be and we are very committed to growing the value of our company. We certainly look forward to reporting second half progress to you at the end of third quarter if we don’t speak to you sooner. Thank you very much.

Operator

Well again, ladies and gentlemen that does concludes our conference for today. We thank you all for your participation.

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