Attached files
| file | filename |
|---|---|
| EXCEL - IDEA: XBRL DOCUMENT - Polypore International, Inc. | Financial_Report.xls |
| EX-31.1 - EX-31.1 - Polypore International, Inc. | a2015q1ex311.htm |
| EX-32.1 - EX-32.1 - Polypore International, Inc. | a2015q1ex321.htm |
| EX-32.2 - EX-32.2 - Polypore International, Inc. | a2015q1ex322.htm |
| EX-31.2 - EX-31.2 - Polypore International, Inc. | a2015q1ex312.htm |
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549
FORM 10-Q
(Mark One)
ý Quarterly report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934
For the quarterly period ended April 4, 2015
Or
o Transition report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934
For the transition period from to
Commission file number: 1-32266
POLYPORE INTERNATIONAL, INC.
(Exact Name of Registrant as Specified in Its Charter)
Delaware | 43-2049334 | |
(State or Other Jurisdiction of Incorporation or Organization) | (IRS Employer Identification No.) | |
11430 North Community House Road, Suite 350 Charlotte, North Carolina | 28277 | |
(Address of Principal Executive Offices) | (Zip Code) | |
(704) 587-8409
(Registrant’s Telephone Number, Including Area Code)
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. ý Yes o No
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate website, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). ý Yes o No
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company. See the definitions of “large accelerated filer”, “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.
Large accelerated filer x | Accelerated filer o | |
Non-accelerated filer o | Smaller reporting company o | |
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). o Yes ý No
There were 45,008,249 shares of the registrant’s common stock outstanding as of April 30, 2015.
Polypore International, Inc.
Index to Quarterly Report on Form 10-Q
For the Quarterly Period Ended April 4, 2015
Page | ||
In this Quarterly Report on Form 10-Q, the words “Polypore International,” “Company,” “we,” “us” and “our” refer to Polypore International, Inc. together with its subsidiaries, unless the context indicates otherwise.
2
Forward-looking Statements
This Quarterly Report on Form 10-Q includes “forward-looking statements” within the meaning of Section 27A of the Securities Act of 1933, as amended (the “Securities Act”), Section 21E of the Securities Exchange Act of 1934, as amended (the “Exchange Act”), and the Private Securities Litigation Reform Act of 1995. All statements other than statements of historical facts included in this Quarterly Report on Form 10-Q that address activities, events or developments that we expect, believe or anticipate will or may occur in the future are forward-looking statements, including, in particular, the statements about Polypore International’s plans, objectives, strategies and prospects regarding, among other things, the financial condition, results of operations and business of Polypore International. We have identified some of these forward-looking statements with words like “believe,” “may,” “will,” “should,” “expect,” “intend,” “plan,” “predict,” “anticipate,” “estimate” or “continue” and other words and terms of similar meaning. These forward-looking statements may be contained under the captions entitled “Management’s Discussion and Analysis of Financial Condition and Results of Operations” or “Controls and Procedures,” the Company’s financial statements or the notes thereto or elsewhere in this Quarterly Report on Form 10-Q.
These forward-looking statements are based on current expectations about future events affecting us and are subject to uncertainties and factors relating to our operations and business environment, all of which are difficult to predict and many of which are beyond our control. Many factors mentioned in our discussion in this Quarterly Report on Form 10-Q, including the risks outlined under the caption entitled “Risk Factors” in our most recent Annual Report on Form 10-K and subsequent reports filed with the SEC, will be important in determining future results. Although we believe that the expectations reflected in our forward-looking statements are reasonable, we do not know whether our expectations will prove correct. They can be affected by inaccurate assumptions we might make or by known or unknown risks and uncertainties, including with respect to Polypore International, the following, among other things:
•the ability to consummate the proposed transactions with 3M Company ("3M") and Asahi Kasei Corporation
("Asahi Kasei");
•the highly competitive nature of the markets in which we sell our products;
•the failure to continue to develop innovative products;
•the loss of our customers;
•the vertical integration by our customers of the production of our products into their own manufacturing
processes;
•increases in prices for raw materials or the loss of key supplier contracts;
•our substantial indebtedness;
•interest rate risk related to our variable-rate indebtedness;
•our inability to generate cash;
•restrictions contained in our senior secured credit agreement;
•employee slowdowns, strikes or similar actions;
•product liability claims exposure;
•risks in connection with our operations outside the United States, including compliance with applicable anti-
corruption laws;
•the incurrence of substantial costs to comply with, or as a result of violations of, or liabilities under
environmental laws;
•the failure to protect our intellectual property;
•the loss of senior management;
•the incurrence of additional debt, contingent liabilities and expenses in connection with future acquisitions;
•the failure to effectively integrate newly acquired operations;
•lithium market demand not materializing as anticipated;
•the absence of expected returns from the intangible assets we have recorded;
•natural disasters, epidemics, terrorist acts and other events beyond our control; and
•cyber risk and failure to maintain the integrity of our information technology networks and systems.
Because our actual results, performance or achievements could differ materially from those expressed in, or implied by, the forward-looking statements, we cannot give any assurance that any of the events anticipated by the forward-looking statements will occur or, if any of them do, what impact they will have on Polypore International’s results of operations and financial condition. You are cautioned not to place undue reliance on these forward-looking statements, which speak only as of the date of this Quarterly Report on Form 10-Q. We do not undertake any obligation to update these forward-looking statements to reflect new information, future events or otherwise, except as may be required under federal securities laws.
3
PART I — FINANCIAL INFORMATION
Item 1. Financial Statements
Polypore International, Inc.
Condensed consolidated balance sheets
April 4, 2015 | ||||||||
(in thousands, except share data) | (unaudited) | January 3, 2015* | ||||||
Assets | ||||||||
Current assets: | ||||||||
Cash and cash equivalents | $ | 43,180 | $ | 44,458 | ||||
Accounts receivable, net | 112,222 | 121,755 | ||||||
Inventories | 104,756 | 101,176 | ||||||
Prepaid and other | 17,395 | 16,673 | ||||||
Total current assets | 277,553 | 284,062 | ||||||
Property, plant and equipment, net | 544,763 | 558,235 | ||||||
Goodwill | 444,512 | 444,512 | ||||||
Intangibles and loan acquisition costs, net | 74,463 | 78,303 | ||||||
Other | 10,014 | 10,180 | ||||||
Total assets | $ | 1,351,305 | $ | 1,375,292 | ||||
Liabilities and shareholders’ equity | ||||||||
Current liabilities: | ||||||||
Accounts payable | $ | 24,595 | $ | 24,358 | ||||
Accrued liabilities | 48,100 | 52,697 | ||||||
Income taxes payable | 5,388 | 2,310 | ||||||
Current portion of debt | 25,000 | 25,000 | ||||||
Total current liabilities | 103,083 | 104,365 | ||||||
Debt, less current portion | 456,250 | 462,500 | ||||||
Pension obligations, less current portion | 110,308 | 121,038 | ||||||
Deferred income taxes | 37,193 | 40,319 | ||||||
Other | 32,475 | 29,736 | ||||||
Commitments and contingencies | — | |||||||
Shareholders’ equity: | ||||||||
Preferred stock - 15,000,000 shares authorized, no shares issued and outstanding | — | — | ||||||
Common stock, $.01 par value - 200,000,000 shares authorized, 47,507,177 issued and 45,006,582 outstanding at April 4, 2015 and 47,330,740 issued and 44,859,492 outstanding at January 3, 2015 | 475 | 473 | ||||||
Paid-in capital | 603,215 | 600,418 | ||||||
Retained earnings | 185,672 | 171,287 | ||||||
Accumulated other comprehensive loss | (82,470 | ) | (61,308 | ) | ||||
Treasury stock, at cost - 2,500,595 shares at April 4, 2015 and 2,471,248 shares at January 3, 2015 | (102,728 | ) | (100,998 | ) | ||||
Total Polypore International, Inc. shareholders’ equity | 604,164 | 609,872 | ||||||
Noncontrolling interest | 7,832 | 7,462 | ||||||
Total shareholders’ equity | 611,996 | 617,334 | ||||||
Total liabilities and shareholders’ equity | $ | 1,351,305 | $ | 1,375,292 | ||||
* Derived from audited consolidated financial statements
See notes to condensed consolidated financial statements
4
Polypore International, Inc.
Condensed consolidated statements of income
(unaudited)
Three Months Ended | ||||||||
(in thousands, except per share data) | April 4, 2015 | March 29, 2014 | ||||||
Net sales | $ | 137,908 | $ | 161,002 | ||||
Cost of goods sold | 88,652 | 102,486 | ||||||
Gross profit | 49,256 | 58,516 | ||||||
Selling, general and administrative expenses | 33,341 | 36,156 | ||||||
Operating income | 15,915 | 22,360 | ||||||
Other (income) expense: | ||||||||
Interest expense, net | 3,171 | 9,620 | ||||||
Foreign currency and other | (10,440 | ) | 598 | |||||
Integrated sale transactions expenses | 2,954 | — | ||||||
(4,315 | ) | 10,218 | ||||||
Income before income taxes | 20,230 | 12,142 | ||||||
Income taxes | 5,530 | 3,400 | ||||||
Net income | 14,700 | 8,742 | ||||||
Net income attributable to noncontrolling interest | 315 | 345 | ||||||
Net income attributable to Polypore International, Inc. | $ | 14,385 | $ | 8,397 | ||||
Net income attributable to Polypore International, Inc. per share: | ||||||||
Basic | $ | 0.32 | $ | 0.19 | ||||
Diluted | $ | 0.32 | $ | 0.18 | ||||
Weighted average shares outstanding: | ||||||||
Basic | 44,719,614 | 44,884,728 | ||||||
Diluted | 45,377,615 | 45,423,573 | ||||||
See notes to condensed consolidated financial statements
5
Polypore International, Inc.
Condensed consolidated statements of comprehensive income (loss)
(unaudited)
Three Months Ended | ||||||||
(in thousands) | April 4, 2015 | March 29, 2014 | ||||||
Net income | $ | 14,700 | $ | 8,742 | ||||
Other comprehensive income (loss): | ||||||||
Foreign currency translation adjustment | (18,864 | ) | 660 | |||||
Change in net actuarial loss and prior service credit | 567 | 22 | ||||||
Unrealized loss on interest rate swap | (4,134 | ) | — | |||||
Income taxes related to other comprehensive income (loss) | 1,324 | 172 | ||||||
Other comprehensive income (loss) | (21,107 | ) | 854 | |||||
Comprehensive income (loss) | (6,407 | ) | 9,596 | |||||
Comprehensive income attributable to noncontrolling interest | 370 | 277 | ||||||
Comprehensive income (loss) attributable to Polypore International, Inc. | $ | (6,777 | ) | $ | 9,319 | |||
See notes to condensed consolidated financial statements
6
Polypore International, Inc.
Condensed consolidated statements of cash flows
(unaudited)
Three Months Ended | ||||||||
(in thousands) | April 4, 2015 | March 29, 2014 | ||||||
Operating activities: | ||||||||
Net income | $ | 14,700 | $ | 8,742 | ||||
Adjustments to reconcile net income to net cash provided by operating activities: | ||||||||
Depreciation expense | 10,397 | 10,941 | ||||||
Amortization expense | 2,797 | 2,786 | ||||||
Amortization of loan acquisition costs | 349 | 618 | ||||||
Stock-based compensation | 2,799 | 5,377 | ||||||
Deferred income taxes | (1,867 | ) | (1,728 | ) | ||||
Foreign currency (gain) loss | (7,109 | ) | 896 | |||||
Changes in operating assets and liabilities: | ||||||||
Accounts receivable | 5,850 | 364 | ||||||
Inventories | (7,295 | ) | 399 | |||||
Prepaid and other current assets | (784 | ) | 1,868 | |||||
Accounts payable and accrued liabilities | (3,134 | ) | (7,741 | ) | ||||
Income taxes payable | 2,860 | 1,187 | ||||||
Other, net | 1,205 | 574 | ||||||
Net cash provided by operating activities | 20,768 | 24,283 | ||||||
Investing activities: | ||||||||
Purchases of property, plant and equipment, net | (10,279 | ) | (3,748 | ) | ||||
Net cash used in investing activities | (10,279 | ) | (3,748 | ) | ||||
Financing activities: | ||||||||
Principal payments on debt | (6,250 | ) | (7,500 | ) | ||||
Proceeds from revolving credit facility | 30,000 | — | ||||||
Payments on revolving credit facility | (30,000 | ) | — | |||||
Repurchases of common stock | (1,730 | ) | (282 | ) | ||||
Proceeds from stock option exercises | — | 619 | ||||||
Net cash used in financing activities | (7,980 | ) | (7,163 | ) | ||||
Effect of exchange rate changes on cash and cash equivalents | (3,787 | ) | 646 | |||||
Net increase (decrease) in cash and cash equivalents | (1,278 | ) | 14,018 | |||||
Cash and cash equivalents at beginning of period | 44,458 | 163,423 | ||||||
Cash and cash equivalents at end of period | $ | 43,180 | $ | 177,441 | ||||
See notes to condensed consolidated financial statements
7
Polypore International, Inc.
Notes to condensed consolidated financial statements
(unaudited)
1. Description of Business and Basis of Presentation
Description of Business
Polypore International, Inc. (the “Company”) is a leading global high-technology filtration company that develops, manufactures and markets specialized microporous membranes used in separation and filtration processes. The Company has a global presence in the major geographic markets of North America, South America, Europe and Asia.
Basis of Presentation
The accompanying unaudited condensed consolidated financial statements include the accounts of the Company and all majority-owned subsidiaries after elimination of intercompany accounts and transactions. The unaudited condensed consolidated financial statements are prepared in accordance with U.S. generally accepted accounting principles (“U.S. GAAP”) for interim financial information. Accordingly, the unaudited condensed consolidated financial statements and notes do not contain certain information included in the Company’s annual financial statements. In the opinion of management, all normal and recurring adjustments that are necessary for a fair presentation have been made. The unaudited condensed consolidated financial statements should be read in conjunction with the consolidated financial statements in the Company’s Annual Report on Form 10-K for the fiscal year ended January 3, 2015. Operating results for the three months ended April 4, 2015 are not necessarily indicative of the results that may be expected for the fiscal year ending January 2, 2016.
2. Integrated Sale Transactions
On February 23, 2015, the Company entered into integrated transactions with 3M Company (“3M”), Asahi Kasei Corporation (“Asahi Kasei”) and ESM Holdings Corporation (“ESM”), an affiliate of Asahi Kasei, pursuant to which the Company will sell its separations media business to 3M and, immediately thereafter, will be merged with ESM. In connection with the integrated transactions, at the time of the merger, each share of the Company’s common stock issued and outstanding immediately prior to the effective time of the merger will be converted into the right to receive $60.50 in cash without interest (the “Merger Consideration”), payable to the holder of such share. Each option to purchase shares of the Company’s common stock and each restricted share of the Company's common stock that is outstanding immediately prior to the effective time of the merger will immediately accelerate and vest and be cancelled and converted into the right to receive a payment in cash. The integrated transactions are subject to customary closing conditions, including regulatory and stockholder approval. There are no assurances that the proposed integrated transactions will be consummated on any given timetable, or at all.
3. Recent Accounting Pronouncements
In May 2014, the FASB issued ASU No. 2014-09, Revenue from Contracts with Customers, which requires an entity to recognize the amount of revenue to which it expects to be entitled for the transfer of promised goods or services to customers. The ASU will replace most existing revenue recognition guidance in U.S. GAAP when it becomes effective. The new standard is effective for the Company on January 1, 2017. Early application is not permitted. The standard permits the use of either the retrospective or cumulative effect transition method. The Company is evaluating the effect that this standard will have on its consolidated financial statements and related disclosures.
In April 2015, the FASB issued ASU No. 2015-04, Compensation - Retirement Benefits, which provides a practical expedient for employers with fiscal year-ends that do not fall on a calendar month-end by permitting those employers to measure defined benefit plan assets and obligations as of the month-end that is closest to the entity's fiscal year-end. The new standard is effective for the Company on January 3, 2016; however, early adoption is permitted. Adoption of the standard is not expected to have an impact on the Company's consolidated financial statements.
8
Polypore International, Inc.
Notes to condensed consolidated financial statements
(unaudited)
4. Inventories
Inventories are carried at the lower of cost or market using the first-in, first-out method of accounting and consist of:
(in thousands) | April 4, 2015 | January 3, 2015 | ||||||
Raw materials | $ | 33,344 | $ | 35,700 | ||||
Work-in-process | 13,280 | 11,846 | ||||||
Finished goods | 58,132 | 53,630 | ||||||
$ | 104,756 | $ | 101,176 | |||||
5. Debt
Debt consists of:
(in thousands) | April 4, 2015 | January 3, 2015 | ||||||
Senior credit agreement: | ||||||||
Revolving credit facility | $ | — | $ | — | ||||
Term loan facility | 481,250 | 487,500 | ||||||
481,250 | 487,500 | |||||||
Less current portion | 25,000 | 25,000 | ||||||
Long-term debt | $ | 456,250 | $ | 462,500 | ||||
On April 8, 2014, the Company entered into a new senior secured credit agreement that provides for a $150,000,000 revolving credit facility and a $500,000,000 term loan facility. At that date, the Company used cash on hand, proceeds from the initial draw of $100,000,000 under the new term loan facility and borrowings of $33,000,000 under the new revolving credit facility to pay all outstanding principal and interest under the previous senior secured credit agreement and loan acquisition costs. The Company incurred loan acquisition costs of approximately $4,080,000, of which $3,944,000 was capitalized and will be amortized over the life of the new credit agreement. During the three months ended June 28, 2014, the Company wrote off unamortized loan acquisition costs of $1,012,000 associated with the previous credit agreement.
On May 8, 2014, the Company borrowed the remaining $400,000,000 available under the new term loan facility and used the proceeds to purchase and retire all of the previously outstanding 7.5% senior notes. The total purchase price for the notes was $385,542,000, consisting of principal of $365,000,000, redemption premiums of $20,531,000 and other expenses associated with the transaction. During the three months ended June 28, 2014, the Company incurred a $24,937,000 charge to income during the second quarter of 2014, comprised of the redemption premiums, write-off of unamortized loan acquisition costs of $4,395,000 and other expenses associated with the purchase.
The Company's domestic subsidiaries guarantee indebtedness under the credit agreement. Substantially all assets of the Company and its domestic subsidiaries and a first priority pledge of 65% of the voting capital stock of its foreign subsidiaries secure indebtedness under the credit agreement. Interest rates under the credit agreement are equal to, at the Company’s option, either an alternate base rate or the Eurodollar base rate, plus a specified margin. The Company’s ability to pay dividends on its common stock is limited under the terms of the credit agreement. The Company is also subject to certain financial covenants, including a maximum leverage ratio and a minimum interest coverage ratio, all of which the Company was in compliance with as of April 4, 2015. The revolving credit facility and term loan facility mature in April 2019.
At April 4, 2015, the Company had no amounts outstanding and $150,000,000 available for borrowing under the revolving credit facility.
9
Polypore International, Inc.
Notes to condensed consolidated financial statements
(unaudited)
6. Fair Value of Financial Instruments
The Company’s financial instruments include cash and cash equivalents, accounts receivable, accounts payable, accrued liabilities, long-term debt and an interest rate swap. The carrying value of cash and cash equivalents, accounts receivable, accounts payable and accrued liabilities approximates the fair value due to the short-term maturities of these assets and liabilities. The carrying value of borrowings under the senior credit agreement approximates fair value because the interest rates adjust to market interest rates. See Note 7 for the fair value of the interest rate swap.
7. Derivative Instruments and Hedging Activities
In August 2014, the Company entered into a forward-starting interest rate swap to pay a fixed interest rate of 1.9% and receive one-month LIBOR on a notional amount of $250,000,000 from its effective date of July 31, 2015 through its expiration on April 8, 2019. The Company’s principal objective is to reduce significant, unanticipated earnings fluctuations and cash flow variability that may arise from volatility in interest rates. The interest rate swap economically converts a portion of the Company’s LIBOR-based, variable rate debt into fixed rate debt. Under the contract, the Company agrees with a counterparty to exchange, at specified intervals, the difference between floating and fixed rate interest payments on the notional amount. The Company’s interest rate swap is governed by a standard International Swaps and Derivatives Association master agreement.
The interest rate swap has been designated as a cash flow hedge and is recorded at fair value in the consolidated balance sheet with changes in fair value, net of income taxes, recorded to shareholders’ equity in “Accumulated other comprehensive loss.” The fair value of the interest rate swap is derived from a discounted cash flow analysis based on the terms of the contract and the observable market interest rate curve (level two inputs in the fair value hierarchy), taking into consideration the risk of nonperformance, including counterparty credit risk. The interest rate swap is recorded in the condensed consolidated balance sheets as follows:
(in thousands) | Balance Sheet Location | April 4, 2015 | January 3, 2015 | |||||||
Interest rate swap (current portion) | Accrued liabilities | $ | 2,489 | $ | 1,414 | |||||
Interest rate swap (non-current portion) | Other liabilities | 3,910 | 851 | |||||||
Total fair value of interest rate swap | $ | 6,399 | $ | 2,265 | ||||||
For the three months ended April 4, 2015, cash flow hedge activity, net of income taxes, was included in "Accumulated other comprehensive loss" as follows:
(in thousands) | ||||
Beginning balance | $ | (1,439 | ) | |
Hedging loss before reclassifications | (2,628 | ) | ||
Amount reclassified into earnings | — | |||
Other comprehensive loss | (2,628 | ) | ||
Ending balance | $ | (4,067 | ) | |
No derivative gains or losses, including those related to either ineffectiveness or to amounts excluded from effectiveness testing, were recognized in earnings during the periods presented. The estimated loss, net of income taxes, expected to be reclassified out of “Accumulated other comprehensive loss” into earnings during the next twelve months is approximately $1,582,000.
8. Income Taxes
The income tax provision for the interim periods presented is computed at the effective rate expected to be applicable in each respective full year using the statutory rates on a country-by-country basis. Income taxes recorded in the financial statements differ from the federal statutory income tax rate due to a variety of factors, including state income taxes, the mix of income between U.S. and foreign jurisdictions taxed at varying rates and changes in estimates of permanent differences and valuation allowances.
10
Polypore International, Inc.
Notes to condensed consolidated financial statements
(unaudited)
9. Pension Plans
The Company and its subsidiaries sponsor multiple defined benefit pension plans based in subsidiaries located outside of the United States. The following table provides the components of net periodic benefit cost:
Three Months Ended | ||||||||
(in thousands) | April 4, 2015 | March 29, 2014 | ||||||
Service cost | $ | 620 | $ | 524 | ||||
Interest cost | 659 | 1,080 | ||||||
Expected return on plan assets | (82 | ) | (109 | ) | ||||
Amortization of prior service credit | (26 | ) | (32 | ) | ||||
Recognized net actuarial loss | 591 | 269 | ||||||
Net periodic benefit cost | $ | 1,762 | $ | 1,732 | ||||
10. Environmental Matters
Environmental obligations are accrued when such expenditures are probable and reasonably estimable. The amount of liability recorded is based on currently available information, including the progress of remedial investigations, current status of discussions with regulatory authorities regarding the method and extent of remediation, presently enacted laws and existing technology. Accruals for estimated losses from environmental obligations are adjusted as further information develops or circumstances change. Costs of future expenditures for environmental obligations are not discounted to their present value. The Company does not currently anticipate any material loss in excess of the amounts accrued. However, the Company’s future remediation expenses may be affected by a number of uncertainties including, but not limited to, the difficulty in estimating the extent and method of remediation, the evolving nature of environmental regulations and the availability and application of technology. The Company does not expect the resolution of such uncertainties to have a material adverse effect on its consolidated financial position or liquidity. Recoveries of environmental costs from other parties are recognized as assets when receipt is deemed probable.
In connection with the acquisition of Membrana GmbH (“Membrana”) in 2002, the Company recorded a reserve for environmental obligations. The reserve provides for costs to remediate known environmental issues and operational upgrades which are required in order for the Company to remain in compliance with local regulations. The initial estimate and subsequent finalization of the reserve were included in the allocation of purchase price at the date of acquisition. The environmental reserve for the Membrana facility, which is denominated in euros, was $828,000 and $917,000 at April 4, 2015 and January 3, 2015, respectively. The Company anticipates the expenditures associated with the reserve will be made in the next twelve months. The reserve is included in “Accrued liabilities” in the accompanying condensed consolidated balance sheets.
11. Related Party Transactions
The Company’s German subsidiary has a 33% equity investment in a patent and trademark service provider and a 25% equity investment in a research company. The investments are accounted for under the equity method of accounting and were $669,000 and $593,000 at April 4, 2015 and January 3, 2015, respectively. Charges from the affiliates for work performed were $395,000 and $357,000 for the three months ended April 4, 2015 and March 29, 2014, respectively. Amounts due to the affiliates were $211,000 and $223,000 at April 4, 2015 and January 3, 2015, respectively.
12. Noncontrolling Interest
In 2010, the Company formed a joint venture with Camel Group Co., Ltd. (“Camel”), a leading battery manufacturer in China, to produce lead-acid battery separators primarily for Camel’s use. The joint venture, Daramic Xiangyang Battery Separator Co., Ltd. (“Daramic Xiangyang”), is located at Camel’s facility and owned 65% by the Company and 35% by Camel.
Daramic Xiangyang has notes payable to Camel and the Company for the purchase of certain assets. The notes payable and related interest will be paid by Daramic Xiangyang using available free cash flow, as defined in the joint venture agreement. The note payable to Camel had a principal balance of $10,348,000 at April 4, 2015 and January 3, 2015 and is included in
11
Polypore International, Inc.
Notes to condensed consolidated financial statements
(unaudited)
“Other” non-current liabilities in the accompanying condensed consolidated balance sheets. The note payable to the Company eliminates in consolidation.
13. Stock-Based Compensation Plans
The Company offers stock-based compensation plans to attract, retain, motivate and reward key officers, non-employee directors and employees. Stock-based compensation expense was $2,799,000 and $5,377,000 for the three months ended April 4, 2015 and March 29, 2014, respectively. The income tax benefit related to stock-based compensation expense was $1,000,000 and $1,920,000 for the three months ended April 4, 2015 and March 29, 2014, respectively. Stock-based compensation expense includes costs associated with stock options and restricted stock and is classified as “Selling, general and administrative expenses” in the accompanying condensed consolidated statements of income.
The 2007 Stock Incentive Plan (“2007 Plan”) allows for the grant of stock options, restricted stock and other instruments for up to a total of 6,251,963 shares of common stock. On March 10, 2015, the Company granted 176,437 shares of restricted stock under the 2007 Plan with an aggregate grant-date fair value of $10,447,000, to be recognized over a three-year vesting period.
The Company repurchased shares of common stock to satisfy certain employees' statutory withholding tax liabilities for $1,730,000 and $282,000 during the three months ended April 4, 2015 and March 29, 2014, respectively.
14. Segment Information
The Company’s operations are principally managed on a products basis and are comprised of three reportable segments for financial reporting purposes. The Company’s three reportable segments are presented in the context of its two primary businesses — energy storage and separations media.
The energy storage business produces and markets membranes that provide the critical function of separating the cathode and anode in a variety of battery markets and is comprised of the following reportable segments:
•Electronics and EDVs — produces and markets membranes for lithium batteries that are used in portable
electronic devices, cordless power tools, electric drive vehicles (“EDVs”) and energy storage systems
(“ESS”).
•Transportation and industrial — produces and markets membranes for lead-acid batteries that are used in
automobiles, other motor vehicles, forklifts and uninterruptible power supply systems.
The separations media business is a reportable segment and produces and markets membranes and membrane modules used as the high-technology filtration element in various medical and industrial applications.
The Company evaluates the performance of segments and allocates resources to segments based on operating income before depreciation and amortization. In addition, it evaluates business segment performance before stock-based compensation and certain non-recurring and other costs.
Financial information relating to the reportable segments is presented below:
12
Polypore International, Inc.
Notes to condensed consolidated financial statements
(unaudited)
Three Months Ended | ||||||||
(in thousands) | April 4, 2015 | March 29, 2014 | ||||||
Net sales to external customers (by major product group): | ||||||||
Electronics and EDVs | $ | 20,657 | $ | 30,072 | ||||
Transportation and industrial | 69,312 | 79,101 | ||||||
Energy storage | 89,969 | 109,173 | ||||||
Healthcare | 28,550 | 32,157 | ||||||
Filtration and specialty | 19,389 | 19,672 | ||||||
Separations media | 47,939 | 51,829 | ||||||
Net sales | $ | 137,908 | $ | 161,002 | ||||
Segment operating income: | ||||||||
Electronics and EDVs | $ | (1,938 | ) | $ | 3,061 | |||
Transportation and industrial | 14,605 | 16,966 | ||||||
Energy storage | 12,667 | 20,027 | ||||||
Separations media | 16,479 | 17,757 | ||||||
Corporate and other | (8,989 | ) | (8,434 | ) | ||||
Segment operating income | 20,157 | 29,350 | ||||||
Stock-based compensation | 2,799 | 5,377 | ||||||
Non-recurring and other costs | 1,443 | 1,613 | ||||||
Total operating income | 15,915 | 22,360 | ||||||
Reconciling items: | ||||||||
Interest expense, net | 3,171 | 9,620 | ||||||
Foreign currency and other | (10,440 | ) | 598 | |||||
Integrated sale transactions expenses | 2,954 | — | ||||||
Income before income taxes | $ | 20,230 | $ | 12,142 | ||||
Depreciation and amortization: | ||||||||
Electronics and EDVs | $ | 4,277 | $ | 4,324 | ||||
Transportation and industrial | 2,913 | 2,850 | ||||||
Energy storage | 7,190 | 7,174 | ||||||
Separations media | 3,166 | 3,716 | ||||||
Corporate and other | 2,838 | 2,837 | ||||||
$ | 13,194 | $ | 13,727 | |||||
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Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
The following discussion of our financial condition and results of operations should be read together with our unaudited condensed consolidated financial statements and the related notes included elsewhere in this Quarterly Report on Form 10-Q and our audited consolidated financial statements and the related notes included in our Annual Report on Form 10-K for the fiscal year ended January 3, 2015.
The following discussion includes financial information prepared in accordance with U.S. generally accepted accounting principles (“U.S. GAAP”), as well as segment operating income, which is considered a non-GAAP financial measure. Generally, a non-GAAP financial measure is a numerical measure of financial performance that excludes amounts that are included in the most directly comparable measure calculated and presented in accordance with U.S. GAAP. The presentation of segment operating income is intended to supplement investors’ understanding of our operating performance and is not intended to replace net income as determined in accordance with U.S. GAAP. Segment operating income is defined as operating income before stock-based compensation and certain non-recurring and other costs and is used by management to evaluate business segment performance and allocate resources. See Note 14, “Segment Information,” in the accompanying condensed consolidated financial statements for a reconciliation of segment operating income to income before income taxes.
Overview
We are a leading global high-technology filtration company that develops, manufactures and markets specialized microporous membranes used in separation and filtration processes. In fiscal 2014, we generated total net sales of $658.4 million. We operate in two primary businesses: energy storage, which includes the transportation and industrial segment and the electronics and EDVs segment, and separations media. The transportation and industrial and separations media segments represent approximately 80% of our total net sales and operate in stable, growing markets, have high recurring revenue bases and generate strong cash flows. In the electronics and EDVs segment, we have a presence in the more established consumer electronics market, but our most significant growth opportunity is the potentially larger and developing electric drive vehicle (“EDV”) and energy storage systems (“ESS”) markets where lithium is the disruptive technology. As described in more detail below, the long-term growth drivers for lithium batteries are positive, but we have experienced and may continue to experience variability in the short term as these markets emerge.
On February 23, 2015, we entered into integrated transactions with 3M Company (“3M”), Asahi Kasei Corporation (“Asahi Kasei”) and ESM Holdings Corporation (“ESM”), an affiliate of Asahi Kasei, pursuant to which we will sell our separations media business to 3M and, immediately thereafter, will be merged with ESM. In connection with the integrated transactions, at the time of the merger, each share of our common stock issued and outstanding immediately prior to the effective time of the merger will be converted into the right to receive $60.50 in cash without interest (the “Merger Consideration”), payable to the holder of such share. Each option to purchase shares of our common stock that is outstanding immediately prior to the effective time of the merger will immediately accelerate and vest and be cancelled and converted into the right to receive a payment in cash of an amount, subject to the amount of any required tax withholding, equal to the product of the total number of shares of our common stock subject to such cancelled option and the excess, if any, of the Merger Consideration over the applicable exercise price of the option; provided that any such option with respect to which the exercise price per share subject to the option is equal to or greater than the Merger Consideration shall be cancelled in exchange for no consideration. Each restricted share of our common stock that is outstanding immediately prior to the effective time of the merger will immediately accelerate and vest and be cancelled and converted into the right to receive a payment in cash of an amount, subject to the amount of any tax withholding, equal to the Merger Consideration, without interest, treating such restricted share in the same manner as the other shares of our common stock. The integrated transactions are subject to customary closing conditions, including regulatory and stockholder approval. The Company's stockholders will vote on adoption of the merger agreement at a special meeting to be held on May 12, 2015. There are no assurances that the proposed integrated transactions will be consummated on any given timetable, or at all.
Energy Storage
In the energy storage business, our membrane separators are a critical functional component in lithium batteries, which are primarily used in consumer electronics and EDV applications, and lead-acid batteries, which are used globally in transportation and numerous industrial applications. We believe that the long-term growth drivers for the energy storage business — growth in Asia, demand for consumer electronics, and growing demand for EDVs — are positive. The energy storage business is comprised of two reportable segments.
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Electronics and EDVs. Lithium batteries are the power source in a wide variety of applications, including consumer electronics applications such as notebook computers, tablets, mobile phones and cordless power tools; EDVs; and emerging applications such as ESS. Demand for lithium batteries in consumer electronics is driven by the need for increased mobility. In EDV applications, demand is driven by the need to increase fuel efficiency to meet mileage standards in many countries such as the U.S. and China, the need to reduce carbon dioxide (“CO2”) emissions around the world but especially in Europe due to regulations, conversion from nickel metal hydride to lithium battery technology in hybrid vehicles due to greater energy and power density, concern in developed countries and emerging markets over future access to petroleum at stable prices, smog and pollution control, and the need to address increasing transportation needs in developing economies. Since late 2009, we have expanded capacity at our existing Charlotte, North Carolina and Ochang, South Korea facilities and built a new facility in Concord, North Carolina. Production started for portions of the Concord facility in 2012, and the remaining capacity will be completed, qualified and ramped up over time as the nascent market for EDVs develops.
In 2014, we entered into long-term supply agreements with Samsung SDI Co., Ltd. (“Samsung”) and Panasonic Automotive and Industrial Division (“Panasonic”), respectively, that include guaranteed purchase and supply volume requirements and volume-based price incentives. The Samsung agreement has an initial four-year term with a two-year extension provision and the Panasonic agreement has a five-year term. We believe that these agreements highlight the value of our capacity investments and proven industry-leading products and technology.
Interest in and usage of our patent-protected ceramic coating technology is growing in both EDV and consumer electronics applications. We believe that this technology has value for current and future customers, and we have enforced and intend to continue to enforce our intellectual property rights around this and other patent-protected technology. In December 2013, we signed a technology licensing agreement with Sumitomo Chemical Co., Ltd. (“Sumitomo”), which provides for an annual technology licensing fee. In January 2014, we filed a complaint against LG Chem. Ltd. (“LG”) alleging infringement of our patent covering ceramic coating technology. In July 2014, the United States District Court for the Western District of North Carolina granted a motion for a preliminary injunction against LG relating to patent infringement of our ceramic coating technology, although the court has stayed enforcement of the injunction pending appeal. We believe that the long-term supply agreements, the licensing agreement with Sumitomo and the preliminary injunction against LG confirm our ability to provide certainty of supply for high-growth applications like EDVs and ESS and the value of our technology and intellectual property.
We believe the long-term demand drivers for our products—consumer demand for mobility, regulations for better fuel efficiency and lower CO2 emissions, conversion from nickel metal hydride to lithium battery technology in hybrids, concerns about access to petroleum, efforts to reduce pollution, and increasing transportation needs in developing countries—remain intact. While consumer electronics applications have attractive long-term market growth trends, EDV and ESS applications represent our most significant growth opportunity and the long-term outlook continues to be positive. Based on industry forecasts and industry studies, the use of lithium technology in these applications is expected to grow at a compound annual growth rate in excess of 30% through 2020 on an energy capacity basis. Many factors influence membrane separator usage in lithium batteries, but because many new applications are incorporating large-format lithium batteries that require much greater membrane separator volume per battery, we believe that membrane separator growth will exceed battery unit sales growth and, although not perfectly correlated, will more closely approximate the growth rate in energy capacity. We believe the electrification of the worldwide fleet of vehicles is just beginning, from hybrids to plug-ins to full battery electric vehicles, including automobiles, buses, taxis and commercial fleet vehicles. We believe our dry process products continue to be the preferred product in large-format lithium batteries for EDVs and ESS. We are currently working with existing and new customers on next-generation batteries, which is important considering the long lead times required to become qualified for EDV applications. EDV and ESS are emerging market applications and are being adopted around the world in many forms. We are qualified on more than seventy-five EDV models and have field-proven products, significant production capacity already in place, technical advantages, low-cost manufacturing capabilities and intellectual property around ceramic coatings for lithium battery separators. We believe the factors that influenced our decision to expand capacity remain valid, and we continue to expect significant sales growth and utilization of our current production capacity as the EDV market develops and as ESS experiences more meaningful adoption. Although the long-term growth drivers are positive for these applications, short-term fluctuations in demand can be expected in the early stages of adoption while initial penetration rates are low. Given the high separator content for these applications and the potential size of these markets, small changes in end-market demand can have a significant impact on our business.
Transportation and industrial. In the lead-acid battery market, the high proportion of aftermarket replacement sales and the steady growth of the worldwide fleet of motor vehicles provide us with a growing recurring revenue base in lead-acid battery separators. Worldwide demand for lead-acid battery separators is expected to continue to grow at slightly more than annual economic growth. The Asia-Pacific region is the fastest growing market for lead-acid battery separators. Growth in this region is driven by the increasing penetration of automobile ownership, growth in industrial and manufacturing sectors, export incentives and ongoing conversion to the polyethylene-based membrane separators we produce.
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Separations Media
In the separations media business, our filtration membranes and modules are used in healthcare and high-performance filtration and specialty applications. We believe that the separations media business will continue to benefit from continued growth in demand for higher levels of purity in a growing number of applications. The separations media business is a reportable segment.
For healthcare applications, we produce membranes used in blood filtration for hemodialysis, blood oxygenation and plasmapheresis. Growth in demand for hemodialysis membranes is driven by the increasing worldwide population of end-stage renal disease patients. We believe that conversion to single-use dialyzers and increasing treatment frequency will result in additional dialyzer market growth.
For filtration and specialty applications, we produce a wide range of membranes and membrane-based elements used in the microfiltration, ultrafiltration and gasification/degasification of liquids. Microfiltration and ultrafiltration membrane element market growth is being driven by several factors, including end-market growth in applications such as water treatment and pharmaceutical processing, displacement of conventional filtration media by membrane filtration due to membranes’ superior cost and performance attributes, and increasing purity requirements in industrial and other applications.
Critical accounting policies
Critical accounting policies are those accounting policies that can have a significant impact on the presentation of our financial condition and results of operations, and that require the use of complex and subjective estimates based on past experience and management’s judgment. Because of the uncertainty inherent in such estimates, actual results may differ from these estimates. These policies are critical to the understanding of our operating results and financial condition and include policies related to the impairment of goodwill, pension benefits, repairs and maintenance and stock-based compensation. For a discussion of each of these policies, please see the discussion entitled “Critical accounting policies” in the “Management’s Discussion and Analysis of Financial Condition and Results of Operations” section of our Annual Report on Form 10-K for the year ended January 3, 2015.
Results of operations
The following table sets forth, for the periods indicated, certain operating data in amount and as a percentage of net sales:
Three Months Ended | Percentage of Net Sales Three Months Ended | |||||||||||||
($’s in millions) | April 4, 2015 | March 29, 2014 | April 4, 2015 | March 29, 2014 | ||||||||||
Net sales | $ | 137.9 | $ | 161.0 | 100.0 | % | 100.0 | % | ||||||
Gross profit | 49.3 | 58.5 | 35.7 | 36.3 | ||||||||||
Selling, general and administrative expenses | 33.4 | 36.1 | 24.2 | 22.4 | ||||||||||
Operating income | 15.9 | 22.4 | 11.5 | 13.9 | ||||||||||
Interest expense, net | 3.2 | 9.6 | 2.3 | 6.0 | ||||||||||
Integrated sale transactions expenses | 3.0 | — | 2.2 | — | ||||||||||
Foreign currency and other | (10.5 | ) | 0.7 | (7.6 | ) | 0.4 | ||||||||
Income before income taxes | 20.2 | 12.1 | 14.6 | 7.5 | ||||||||||
Income taxes | 5.5 | 3.4 | 3.9 | 2.1 | ||||||||||
Net income | $ | 14.7 | $ | 8.7 | 10.7 | % | 5.4 | % | ||||||
Comparison of the three months ended April 4, 2015 with the three months ended March 29, 2014
Net sales. Net sales for the three months ended April 4, 2015 were $137.9 million, a decrease of $23.1 million, or 14.3%, from the same period in the prior year. The decrease was due to lower sales in the electronics and EDVs and transportation and industrial segments, as well as the negative impact of foreign currency translation of $12.2 million. See “Financial reporting segments” below for more information.
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Gross profit. Gross profit for the three months ended April 4, 2015 was $49.3 million, a decrease of $9.2 million from the same period in the prior year due to lower sales in the electronics and EDVs and transportation and industrial segments. Gross profit as a percent of net sales was 35.7%, as compared to 36.3% in the same period of the prior year. See “Financial reporting segments” below for more information.
Selling, general and administrative expenses. Selling, general and administrative expenses for the three months ended April 4, 2015 were $33.4 million, a decrease of $2.7 million from the same period in the prior year primarily due to a $2.6 million decrease in stock-based compensation expense. Selling, general and administrative expenses were 24.2% of net sales, as compared to 22.4% for the same period in the prior year.
Segment operating income. Segment operating income, which excludes stock-based compensation and certain non-recurring and other costs, was $20.2 million, a decrease of $9.2 million from the same period in the prior year. Segment operating income as a percent of net sales was 14.6%, as compared to 18.3% for the same period in the prior year. The decrease in segment operating income and segment operating income as a percent of net sales was due to lower sales in the electronics and EDVs and transportation and industrial segments. See “Financial reporting segments” below for more information.
Interest expense. Interest expense for the three months ended April 4, 2015 was $3.2 million, a decrease of $6.4 million from the same period in the prior year. The decrease was the result of the debt reduction and refinancing transactions that were completed during the second quarter of 2014.
Integrated sale transactions expenses. Integrated sale transactions expenses, consisting of incremental costs directly attributable to the sale transactions, were $3.0 million for the three months ended April 4, 2015.
Foreign currency and other. Foreign currency and other of $10.5 million for the three months ended April 4, 2015 primarily consists of unrealized foreign currency gains related to euro-denominated intercompany notes.
Income taxes. The income tax provision for the interim periods presented is computed at the effective rate expected to be applicable in each respective full year using the statutory rates on a country-by-country basis. Income taxes recorded in the financial statements differ from the federal statutory income tax rate and fluctuate between years due to a variety of factors, including the mix of income between U.S. and foreign jurisdictions taxed at varying rates and changes in estimates of permanent differences and valuation allowances. The applicable statutory income tax rates in the jurisdictions in which we operate range from 0% to 39%.
The effect of these items on our effective tax rate is quantified as follows:
Three Months Ended | ||||||
April 4, 2015 | March 29, 2014 | |||||
U.S. federal statutory rate | 35.0 | % | 35.0 | % | ||
Mix of income in taxing jurisdictions | (7.5 | ) | (8.1 | ) | ||
Other | (0.2 | ) | 1.1 | |||
Total effective tax rate | 27.3 | % | 28.0 | % | ||
Financial reporting segments
Electronics and EDVs
Comparison of the three months ended April 4, 2015 with the three months ended March 29, 2014
Net sales. Net sales for the three months ended April 4, 2015 were $20.7 million, a decrease of $9.4 million, or 31.2%, from the same period in the prior year due primarily to lower sales volumes into EDV applications. Sales volumes into EDV applications decreased due to order timing, including customer inventory adjustments around their fiscal year-ends, and weak demand for certain EDV models. In addition, one large EDV customer placed fewer orders and took lower volume than it had previously forecast in, what we believe was, an attempt to renegotiate better terms. However, this customer is under a long-term supply agreement with guaranteed purchase requirements, and we expect sales to this customer to increase during the remainder of the year in accordance with the customer's contractual obligations. EDV applications represent our most significant growth opportunity, and the long-term outlook continues to be positive, given that we are qualified on more than seventy-five EDV
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models and have field-proven products, significant production capacity already in place, technical advantages, low-cost manufacturing capabilities and intellectual property around ceramic coatings for lithium battery separators.
Segment operating income. Segment operating loss was $1.9 million, compared to segment operating income of $3.1 million for the same period in the prior year. The segment operating loss was due to lower sales volumes. The key drivers of segment operating income and segment operating income as a percent of net sales are sales and the amount of fixed costs relative to sales. Because of the decrease in sales with no significant change in fixed costs, segment operating income and segment operating income as a percent of net sales decreased.
Transportation and Industrial
Comparison of the three months ended April 4, 2015 with the three months ended March 29, 2014
Net sales. Net sales for the three months ended April 4, 2015 were $69.3 million, a decrease of $9.8 million, or 12.4%, from the same period in the prior year, due to lower sales in all regions, particularly in Asia where sales were impacted by mild weather in India, which temporarily delayed inverter battery production and demand; an increase in lead prices in China, which resulted in a short-term reduction in lead-acid battery production; and the negative impact of foreign currency translation of $4.6 million.
Segment operating income. Segment operating income was $14.6 million, a decrease of $2.4 million from the same period in the prior year. The decrease in segment operating income was due to lower sales volumes. Segment operating income as a percent of net sales was 21.1%, consistent with the same period in the prior year.
Separations Media
Comparison of the three months ended April 4, 2015 with the three months ended March 29, 2014
Net sales. Net sales for the three months ended April 4, 2015 were $47.9 million, a decrease of $3.9 million, or 7.5%, from the same period in the prior year, with higher sales in both healthcare and filtration and specialty products more than offset by the negative impact of foreign currency translation of $7.6 million.
Segment operating income. Segment operating income was $16.5 million, a decrease of $1.2 million from the same period in the prior year due to lower sales. Segment operating income as a percent of net sales was 34.4%, consistent with the same period in the prior year. Segment operating income margins can fluctuate between quarters due to production timing and mix, but are expected to be relatively consistent to the prior year on an annual basis.
Corporate and other costs
Corporate and other costs include costs associated with the corporate office and other costs that are not allocated to the reportable segments for segment reporting purposes, including amortization of identified intangible assets and performance-based incentive compensation.
Comparison of the three months ended April 4, 2015 with the three months ended March 29, 2014
Corporate and other costs for the three months ended April 4, 2015 were $9.0 million, an increase of $0.6 million from the same period in the prior year.
Foreign operations
As of April 4, 2015, we manufactured our products at 15 strategically located facilities in the U.S., Europe and Asia. Net sales from foreign locations were $87.8 million (63.7% of consolidated sales) and $103.5 million (64.3% of consolidated sales) for the three months ended April 4, 2015 and March 29, 2014, respectively. In the electronics and EDVs segment, we primarily produce in the U.S. for customers located in Asia. The majority of sales from foreign production facilities are attributable to the transportation and industrial and separations media segments. In the transportation and industrial segment, we have production facilities in the U.S., Europe and Asia and generally produce in the same geographic region that we sell, though we do export
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some production from U.S. and European facilities to meet growing demand in Asia. In the separations media segment, the majority of production is at our manufacturing facility in Germany and sales are made to customers worldwide. Operating results generated by production facilities within business segments were not significantly impacted by differences in economic, regulatory, geographic or other competitive factors.
Typically, we sell our products in the currency of the country where the manufacturing facility that produces the product is located. Sales to foreign customers are subject to numerous additional risks, including the impact of foreign government regulations, currency fluctuations, political uncertainties and differences in business practices. There can be no assurance that foreign governments will not adopt regulations or take other actions that would have a direct or indirect adverse impact on our business or market opportunities within such governments’ countries. Furthermore, there can be no assurance that the political, cultural and economic climate outside the U.S. will be favorable to our operations and growth strategy.
Liquidity and capital resources
Cash and cash equivalents decreased by $1.3 million during the three months ended April 4, 2015, as we used cash on hand and cash generated from operations to fund capital expenditures and make scheduled principal payments under our senior credit agreement.
Operating activities. Net cash provided by operating activities was $20.8 million in the three months ended April 4, 2015, driven by cash generated from operations of $22.1 million, partially offset by changes in operating assets and liabilities. Accounts receivable decreased from fiscal 2014 year-end due to lower sales, while days sales outstanding increased due to the timing of sales and cash receipts. We have not experienced significant changes in accounts receivable aging or customer payment terms and believe that we have adequately provided for potential bad debts. Inventory increased from prior year-end, and days in ending inventory increased by approximately 24%, as compared to the fourth quarter of 2014. Inventory levels are impacted by production schedules and expected future customer demand, which is based on a number of factors, including discussions with customers, customer forecasts and industry and economic trends. Inventory is generally not subject to obsolescence and does not have a shelf life, and we do not believe there is a significant risk of inventory impairment. Accounts payable and accrued liabilities together decreased primarily due to lower accrued interest as a result of our debt reduction and refinancing transactions that were completed during the second quarter of 2014, as well as the timing of payments.
Investing activities. Capital expenditures were $10.3 million and $3.7 million in the three months ended April 4, 2015 and March 29, 2014, respectively. We currently estimate capital expenditures for fiscal 2015 to be approximately $85.0 million. As of April 4, 2015, we had $151.6 million of construction in progress, primarily related to capacity expansions in the electronics and EDVs segment, portions of which will be completed, qualified and ramped up over time as market demand develops.
Financing activities. During the three months ended April 4, 2015, financing activities primarily consisted of scheduled principal payments of $6.3 million under our new term loan facility.
During the second quarter of 2014, we completed a debt reduction and refinancing, using cash on hand and borrowings under the new senior credit agreement to repay all outstanding obligations under our previous senior credit agreement, redeem and retire our previously outstanding 7.5% senior notes, and pay loan acquisition costs. The total purchase price for the notes was $385.5 million, consisting of principal of $365.0 million and redemption premiums of $20.5 million.
We intend to fund our ongoing operations with cash on hand, cash generated by operations and borrowings under our senior credit agreement. As of April 4, 2015, approximately 75.8% of our cash and cash equivalents were held by foreign subsidiaries. There were no significant restrictions on our ability to transfer funds with and among subsidiaries. Taxes have been provided on earnings distributed and expected to be distributed by the Company's foreign subsidiaries. All other foreign earnings are undistributed and considered to be indefinitely reinvested and, accordingly, no provision for U.S. federal and state taxes have been provided thereon. Our current operating plans do not demonstrate a need to repatriate additional foreign earnings to fund our U.S. operations. However, if we decided to repatriate additional cash held by our foreign subsidiaries, we would be required to accrue and pay any applicable U.S. and local taxes to repatriate these funds.
Our senior credit agreement provides for a $150.0 million revolving credit facility and a $500.0 million term loan facility and matures in April 2019. At April 4, 2015, we had no amounts outstanding and $150.0 million available for borrowing under the revolving credit facility. Interest rates under the new senior credit agreement are equal to, at our option, either an alternate base rate or the Eurodollar base rate, plus a specified margin. At April 4, 2015, the interest rate on borrowings under the new senior credit agreement was 2.18%.
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Under the senior credit agreement, we are subject to a maximum ratio of indebtedness to adjusted EBITDA and a minimum ratio of adjusted EBITDA to cash interest expense. Adjusted EBITDA, as defined under our senior credit agreement, was as follows:
(in millions) | Twelve months ended April 4, 2015 | ||
Income from continuing operations attributable to Polypore International, Inc. | $ | 40.6 | |
Add/Subtract: | |||
Depreciation and amortization expense | 54.7 | ||
Interest expense, net | 15.6 | ||
Income taxes | 11.8 | ||
Stock-based compensation | 19.2 | ||
Integrated sale transactions expenses | 3.0 | ||
Costs related to purchase of 7.5% senior notes | 24.9 | ||
Write-off of loan acquisition costs and other expenses associated with refinancing of senior credit agreement | 1.1 | ||
Foreign currency gain | (19.8 | ) | |
Litigation costs associated with patent enforcement | 8.3 | ||
Loss on disposal of property, plant and equipment | 0.3 | ||
Other non-cash or non-recurring items | (1.9 | ) | |
Adjusted EBITDA | $ | 157.8 | |
As of April 4, 2015, the calculation of the leverage ratio, as defined under the senior credit agreement, was as follows:
(in millions) | Twelve months ended April 4, 2015 | ||
Indebtedness (1) | $ | 438.1 | |
Adjusted EBITDA | $ | 157.8 | |
Actual leverage ratio | 2.78x | ||
Required maximum leverage ratio | 4.25x | ||
(1) Calculated as the sum of outstanding borrowings under the senior credit agreement, less cash on hand (not to exceed
$50.0 million).
As of April 4, 2015, the calculation of the interest coverage ratio, as defined under the senior credit agreement, was as follows:
(in millions) | Twelve months ended April 4, 2015 | ||
Adjusted EBITDA | $ | 157.8 | |
Interest expense, net (1) | $ | 11.8 | |
Actual interest coverage ratio | 13.33x | ||
Required minimum interest coverage ratio | 3.00x | ||
(1) Calculated as cash interest expense, as defined under the senior credit agreement, for the twelve months ended April 4,
2015.
Our senior credit agreement contains certain restrictive covenants which, among other things, limit the incurrence of additional indebtedness, investments, dividends, transactions with affiliates, asset sales, acquisitions, mergers and consolidations, prepayments of other indebtedness, liens and encumbrances, and other matters customarily restricted in such agreements. The agreement also contains certain customary events of default, subject to grace periods, as appropriate. As of April 4, 2015, we were in compliance with the covenants contained in the senior credit agreement.
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In August 2014, we entered into a forward-starting interest rate swap to pay a fixed interest rate of 1.9% and receive one-month LIBOR on a notional amount of $250.0 million. The interest rate swap economically converts a portion of the Company’s LIBOR-based, variable rate debt into fixed rate debt from its effective date of July 31, 2015 through its expiration on April 8, 2019.
Future debt service payments are expected to be paid out of cash flows from operations, borrowings on our revolving credit facility and future refinancing of our debt. Our cash interest requirements for the next twelve months are estimated to be $14.0 million, including the impact of the interest rate swap.
We believe we have sufficient liquidity to meet our cash requirements over both the short (next twelve months) and long term (in relation to our debt service requirements). In evaluating the sufficiency of our liquidity, we considered cash on hand, expected cash flow to be generated from operations and available borrowings under our senior credit agreement compared to our anticipated cash requirements for debt service, working capital, cash taxes, capital expenditures and funding requirements for long-term liabilities. We anticipate that our cash on hand and operating cash flow, together with borrowings under the revolving credit facility, will be sufficient to meet our anticipated future operating expenses, capital expenditures and debt service obligations as they become due for at least the next twelve months. However, our ability to make scheduled payments of principal, to pay interest on or to refinance our indebtedness and to satisfy our other debt obligations will depend upon our future operating performance, which will be affected by general economic, financial, competitive, legislative, regulatory, business and other factors beyond our control. See the “Risk Factors” section in our most recent Annual Report on Form 10-K.
From time to time, we may explore additional financing methods and other means to lower our cost of capital, which could include equity or debt financings and the application of the proceeds therefrom to the repayment of bank debt or other indebtedness. In addition, in connection with any future acquisitions, we may require additional funding which may be provided in the form of additional debt or equity financing or a combination thereof. There can be no assurance that any additional financing will be available to us on acceptable terms or at all.
Environmental matters
Environmental obligations are accrued when such expenditures are probable and reasonably estimable. The amount of liability recorded is based on currently available information, including the progress of remedial investigations, current status of discussions with regulatory authorities regarding the method and extent of remediation, presently enacted laws and existing technology. Accruals for estimated losses from environmental obligations are adjusted as further information develops or circumstances change. Costs of future expenditures for environmental obligations are not discounted to their present value. We do not currently anticipate any material loss in excess of the amounts accrued. However, future remediation expenses may be affected by a number of uncertainties including, but not limited to, the difficulty in estimating the extent and method of remediation, the evolving nature of environmental regulations and the availability and application of technology. We do not expect the resolution of such uncertainties to have a material adverse effect on our consolidated financial position or liquidity. Recoveries of environmental costs from other parties are recognized as assets when their receipt is deemed probable.
In connection with the acquisition of Membrana GmbH (“Membrana”) in 2002, we recorded a reserve for environmental obligations. The reserve provides for costs to remediate known environmental issues and operational upgrades which are required in order for us to remain in compliance with local regulations. The initial estimate and subsequent finalization of the reserve was included in the allocation of purchase price at the date of acquisition. The environmental reserve for the Membrana facility, which is denominated in euros, was $0.8 million at April 4, 2015. We anticipate the expenditures associated with the reserve will be made in the next twelve months.
Off-Balance Sheet Arrangements
We are not a party to any off-balance sheet arrangements that have, or are reasonably likely to have, a material current or future effect on our financial condition, revenues or expenses, results of operations, liquidity, capital expenditures or capital resources.
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Item 3. Quantitative and Qualitative Disclosures About Market Risk
We are exposed to various market risks, which are potential losses arising from adverse changes in market rates and prices, such as interest rates and foreign exchange fluctuations. We do not enter into derivatives or other financial instruments for trading or speculative purposes.
Interest rate risk
At April 4, 2015, we had variable rate debt of $481.3 million. To reduce the interest rate risk inherent in our variable-rate debt, in August 2014 we entered into a forward-starting interest rate swap to pay a fixed interest rate of 1.9% and receive one-month LIBOR on a notional amount of $250.0 million. The interest rate swap economically converts a portion of the Company’s LIBOR-based, variable rate debt into fixed rate debt from its effective date of July 31, 2015 through its expiration on April 8, 2019. The pre-tax earnings and cash flow impact resulting from a 100 basis point increase in interest rates on our variable rate debt, including the impact of the interest rate swap, is estimated to be $3.1 million per year.
Currency risk
Outside of the United States, we maintain assets and operations in Europe and Asia. The results of operations and financial position of our foreign operations are principally measured in their respective currency and translated into U.S. dollars. As a result, exposure to foreign currency fluctuations exists. The reported income of these subsidiaries will be higher or lower depending on a weakening or strengthening of the U.S. dollar against the respective foreign currency. Our subsidiaries and affiliates also purchase and sell products and services in various currencies. As a result, we may be exposed to cost increases relative to the local currencies in the markets in which we sell. Because the percentage of our sales in foreign currencies differs from the percentage of our costs in foreign currencies, a change in the relative value of the U.S. dollar could have a disproportionate impact on our sales compared to our costs, which could impact our margins. A portion of our assets are based in our foreign locations and are translated into U.S. dollars at foreign currency exchange rates in effect as of the end of each period, with the effect of such translation reflected in "Accumulated other comprehensive loss." Accordingly, our consolidated shareholders’ equity will fluctuate depending upon the weakening or strengthening of the U.S. dollar against the respective foreign currency, primarily the euro.
The dollar/euro exchange rates used in our financial statements for the periods ended as set forth below were as follows:
April 4, 2015 | March 29, 2014 | |||||
Period end rate | 1.0915 | 1.3744 | ||||
Period average rate for the three months ended | 1.1271 | 1.3711 | ||||
Our strategy for management of currency risk relies primarily on conducting our operations in a country’s respective currency and may, from time to time, involve foreign currency derivatives. As of April 4, 2015, we did not have any foreign currency derivatives outstanding.
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Item 4. Controls and Procedures
An evaluation of the effectiveness of our disclosure controls and procedures (as defined in Rule 13a-15(e) or 15d-15(e) promulgated under the Exchange Act) was performed under the supervision, and with the participation of, our management, including our Chief Executive Officer and Chief Financial Officer. Our disclosure controls are designed to ensure that information required to be disclosed in reports that we file or submit under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the rules and forms of the Securities and Exchange Commission. Based upon our evaluation, our Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures were effective as of April 4, 2015 to ensure that information required to be disclosed in the reports that we file under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission’s rules and forms, and is accumulated and communicated to management, including our Chief Executive Officer and Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosure.
During the three months ended April 4, 2015, there has been no change in our internal control over financial reporting (as defined in Rules 13a-15(f) or 15d-15(f) promulgated under the Exchange Act) that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.
In May 2013, the Committee of Sponsoring Organizations of the Treadway Commission ("COSO") released its Internal Control-Integrated Framework (the “2013 Framework”). The 2013 Framework updates the COSO's original Internal Control-Integrated Framework (1992), formalizes the principles embedded in the original framework, incorporates business and operating environment changes since the original framework's issuance, broadens the application of internal control in addressing operations and reporting objectives, and clarifies the requirements for determining what constitutes effective internal control. We expect to complete our transition to the 2013 Framework during the year ending January 2, 2016. We do not expect that the transition will have a significant impact on our underlying compliance with the applicable provisions of the Sarbanes-Oxley Act of 2002, including internal control over financial reporting and disclosure controls and procedures.
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PART II — OTHER INFORMATION
Item 1. Legal Proceedings
On January 30, 2014, we filed a complaint against LG Chem. Ltd. (“LG”) alleging infringement of our patent covering ceramic coating technology. On July 21, 2014, the United States District Court for the Western District of North Carolina granted a motion for a preliminary injunction against LG relating to patent infringement of our ceramic coating technology, although the court has stayed enforcement of the injunction pending appeal.
In early 2014, separate Inter Partes Review petitions were filed by Mitsubishi Plastics, Inc., LG and SK Innovations Co. seeking to invalidate our patent covering our ceramic coating technology. The Patent Trial and Appeal Board instituted proceedings for each, but not on all asserted grounds.
On March 3, 2015, a putative class action lawsuit captioned Lax v. Toth, et al., Civil Action No. 10741-VCN (the “Lax Action”) was filed in the Delaware Court of Chancery against Polypore, its directors, Asahi Kasei and ESM. Subsequently, five additional putative class action lawsuits, captioned Pirollo v. Polypore Int’l, Inc., et al., Civil Action No. 10746-VCN, Kott v. Graff, et al., Civil Action No. 10752-VCN, Zaborny v. Polypore Int’l, Inc., et al., Civil Action No. 10762-VCN, Scardina v. Graff, et al., Civil Action No. 10777-VCN (the “Scardina Action”) and Police Retirement System of St. Louis v. Toth, et. al., Civil Action No. 10832-VCN (the “St. Louis Action” and, collectively with the preceding putative class action lawsuits and the Lax Action, the “Stockholder Litigation”), were filed in the Delaware Court of Chancery against the defendants named in the Lax Action (except that Polypore is not a defendant in the Scardina Action or the St. Louis Action) and, in certain cases, 3M. Collectively, the complaints in the Stockholder Litigation, filed by purported holders of shares of Polypore common stock, challenge the contemplated integrated transactions with 3M, Asahi Kasei and ESM and allege, among other things, that Polypore’s directors breached their fiduciary duties to Polypore stockholders by engaging in a flawed sales process, agreeing to a transaction price that does not adequately compensate Polypore and agreeing to certain unfair deal protection terms. On April 13, 2015, an amended complaint was filed in the St. Louis Action, which complaint also alleges that the directors of Polypore breached their fiduciary duties by making materially misleading and incomplete disclosures in the definitive proxy statement filed with the SEC on April 8, 2015 in connection with the integrated transactions. The complaints in the Stockholder Litigation also allege that Asahi Kasei, ESM and, in certain cases, 3M, aided and abetted breaches of fiduciary duties. The complaints in the Stockholder Litigation seek various remedies, including declaratory and injunctive relief, as well as damages and costs. On April 29, 2015, the Court entered an order consolidating lawsuits. A consolidated amended complaint has not yet been filed. Polypore and its directors believe that the allegations against them lack merit and intend to defend the lawsuits vigorously.
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
Issuer Purchases of Equity Securities
The following table provides detail about our share repurchase activity during the three months ended April 4, 2015:
Fiscal Month | Total Number of Shares Purchased | Average Price Paid per Share | Total Number of Shares Purchased as Part of Publicly Announced Program | Maximum Number of Shares that May Yet Be Purchased Under the Program (1) | |||||||||
January 4, 2015 — January 31, 2015 | — | $ | — | — | 4,050,000 | ||||||||
February 1, 2015 — February 28, 2015 (2) | 17,922 | 59.39 | — | 4,050,000 | |||||||||
March 1, 2015 — April 4, 2015 (2) | 11,425 | 58.30 | — | 4,050,000 | |||||||||
Total | 29,347 | $ | 58.96 | — | 4,050,000 | ||||||||
(1) In May 2014, the Company announced that its Board of Directors authorized the repurchase of up to 4,500,000 shares
of the Company’s common stock. The share repurchase program has no expiration date. As of April 4, 2015, the
Company had repurchased 450,000 shares of common stock under the May 2014 repurchase program.
(2) The Company withheld and repurchased 17,922 and 11,425 shares of common stock in February and March 2015,
respectively, to satisfy certain employees’ withholding tax liabilities related to restricted stock grants.
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Item 6. Exhibits
Exhibit No. | Exhibit Description | |
2.1 | Agreement and Plan of Merger, dated as of February 23, 2015, by and among Polypore International, Inc., Asahi Kasei Corporate and ESM Holdings Corporation (incorporated by reference to Exhibit 2.1 to the Company's Current Report on Form 8-K filed on February 24, 2015) | |
2.2 | Asset Purchase Agreement, dated as of February 23, 2015, by and among Polypore International, Inc. and 3M Company (incorporated by reference to Exhibit 2.2 to the Company's Current Report on Form 8-K filed on February 24, 2015) | |
3.2 | Third Amended and Restated Bylaws of Polypore International Inc., adopted on February 22, 2015 (incorporated by reference to Exhibit 3.1 to the Company's Current Report on Form 8-K filed on February 24, 2015) | |
31.1 | Certification of Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 | |
31.2 | Certification of Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 | |
32.1 | Certification of Chief Executive Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 | |
32.2 | Certification of Chief Financial Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 | |
101 | Interactive Data Files | |
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SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
Date: May 8, 2015 | POLYPORE INTERNATIONAL, INC. | |
By: | /s/ Robert B. Toth | |
Robert B. Toth | ||
President and Chief Executive Officer | ||
(principal executive officer) | ||
By: | /s/ Lynn Amos | |
Lynn Amos | ||
Chief Financial Officer | ||
(principal financial officer and principal accounting officer) | ||
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