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Polypore International, Inc. (NYSE:PPO)

Q1 2008 Earnings Call

May 1, 2008 9:00 am ET

Executives

Kathy Brosco – Director of Corporate Communications

Robert Toth – President, Chief Executive Officer

Lynn Amos – Chief Financial Officer

Analysts

Jeffrey Zekauskas – J.P. Morgan

Richard Eastman – Robert W. Baird

Brian Drab – William Blair

Michael [Lavine] – DB&T

Michael [Bone – Blue Bay]

Craig Erwin – Merriman Curhan Ford & Co.

Operator

Good day ladies and gentlemen. Welcome to this Polypore International first quarter 2008 earnings results conference call. Today’s conference is being recorded. At this time, I would like to turn things over to Ms. Kathy Brosco. Please go ahead maam.

Kathy Brosco

Thank you, and welcome everyone to our conference call today to discuss our first quarter financial results. The results we discuss today can be found in our earnings announcement we released yesterday afternoon and furnished on Form 8K with the SEC.

You can find a copy of the release also on our website at Polypore.net in the Investor Relations section, and in conjunction with the release as we’ve done in the past couple of quarters. We have also issued supplemental financial information, which we filed as an 8K yesterday and posted on our Investor Relations website.

Before we begin our presentation, of course, I’d like to remind you of some important considerations. As 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 involved estimates, assumptions, and uncertainties.

You are cautioned not to place undo reliance on these forward-looking statements, which speak as of the date on which they are made, which is Thursday, May 1, 2008. Polypore undertakes no obligation to update or revise any forward-looking statements, whether as a result of new information, future events, or otherwise.

You are also directed to consider the risks, uncertainties, and other factors discussed in the documents we filed with the SEC, including those matters summarized under the caption, “Item 1A Risks Factors” in our most recent 10K filing.

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

Bob Toth

I’ll begin by providing some general remarks about the quarter and, of course, Lynn will provide a more detailed look at the financials.

First, the quarter, we are off to a solid start this year. Our continued growth reflects the strength of our global presence, the breadth of applications and markets we serve, and the relatively high recurring revenue base of those markets.

We remain focused on strengthening our core businesses and our core capabilities in microporous membranes to meet the growing and sustainable demand for mobile power, and for curity as it relates to high-performance filtration.

Within energy storage in the lead-acid separator business, we’ve seen several quarters of well-above average growth, and in the first quarter, the more modest growth we see reflects the stability of this business. We are comparing first quarter ’08 to a strong first quarter in 2007.

In the industrial market, we’ve seen some impact as expected from the current economic environment. Over the long-term, we continue to view the lead-acid market as growing at a rate in excess of GDP.

During the quarter, we announced the acquisition of Microporous Holding Corporation as a strategic investment to strengthen our core business in the lead-acid space. Our integration is proceeding on schedule, and we’re pleased with the progress to date.

We’re glad to have the former Microporous employees as part of the Polypore team. The Federal Trade Commission has requested information from us about the acquisition. We’re cooperating to answer their questions, we anticipate that we’ll address all of their questions, and believe that the outcome will not have a material impact on the business.

Additionally, our capacity expansion in Thailand remains on track with start up expected in late ’08 and business benefits beginning in 2009.

On the lithium separator side, this market continues to be driven by worldwide growth associated with the increasing demand for mobile power as well as by application proliferation in electronic devices, and now in the large-cells, such as power tools.

Revenue growth in the quarter was solid, and our LTM performance continues to be aligned with the overall market growth.

We continue investing the strength and our capabilities in lithium battery separators, similar to the lead-acid business, we have a capacity expansion coming online in late ’08, with business benefits beginning in 2009.

We also continue placing resources behind hybrid electric vehicle development, and we remain involved in the major hybrid development programs. Moving on to separations media, healthcare had a strong quarter driven by the continued uptake of PUREMA in the marketplace, and the strength in the Euro-to-dollar exchange rate.

Filtration and specialty sales were up over last year, again positively impacted by the strength of the Euro, and we see ongoing development of high performance filtration applications.

In separations media, our sales and operating margin performance was substantially improved year-over-year. On our last earnings’ call I described the fourth quarter of ’07 as very strong, with robust sales and manufacturing performance. Comparatively, I described the first quarter as a good one, but our products are made to very exacting performance in quality standards, and our manufacturing performance wasn’t quite as positive.

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

Lynn Amos

We were pleased with our performance in the quarter, and sales were up in all businesses. We experienced a balance of growth and stability across our portfolio, especially given the current economic environment. As we reported yesterday, Polypore achieved 13% sales growth in the first quarter, up roughly $16 million over the same period in 2007.

Revenues included a positive FX impact of approximately $10 million. However, only a small portion of that currency impact, less than $1 million, flowed through to net income. Additionally, there were two events that occurred in the quarter and reflected in our financials. One, we acquired Microporous product from February 29, and we included the results of operations since that date, and two, in January, we divested a small, non-core synthetic paper business. We counted for this divesture in discontinued operations.

Excluding minor one-time items, adjusted net income was $10.9 million or $0.27 per diluted share, compared with $2.1 million or $0.08 per diluted share the prior year. As a reminder, our EPS includes $0.08 of non-cash, amortization expense on the quarterly basis. Excluding this, our cash EPS would have been $0.35 per share.

Our results highlight the strength and balance of our portfolio of businesses. To put some color around that, healthcare was strong, and we continue to see the impact of the transformation of this business, with growth in synthetics fully offsetting the impact of our exit of the sale of the hemodialysis membranes in 2007.

The lithium separator business is tracking 10% growth in both the quarter and on an LTM basis. The lead-acid separator business, excluding acquisition growth, and the filtration business both experienced modest growth, net of FX, and performed as expected given the current economy.

Looking more specifically at the performance drivers, segment operating income margins were up 167 basis points in the quarter compared with a year ago. While sales volumes provided operating leverage, that was partially offset by manufacturing performance and separations media, which as Bob mentioned, was not quite as positive compared to fourth quarter.

Adjusted EBITDA for the quarter, which is a key measure in our credit agreement, was $45.4 million compared with $37.7 million last year. For the 12 month ended March 29, 2008, adjusted EBITDA was $167.3, up from $146.5 million in the prior year.

To be clear, adjusted EBITDA as defined in our credit agreement provides for adjustment to reflect the pro forma impact of acquisitions, which are reflected in our 2008 and LTM numbers as well as other non-operating items. I refer you to our reconciliation of net income to adjusted EBITDA in the earnings release.

Turning to interest expense for the quarter, it was $15.9 million down almost $8 million compared last year. The reduced interest expense was due primarily to the actions we took upon completing the IPO to purchase and retire the 10.5% senior discount note, and to refinance our senior-secured credit facility.

Debt is up from year-end due to the acquisition of Microporous and to the effects of foreign currency exchange rates, however, our leverage ratio on a pro forma basis is, basically, unchanged from year-end.

As for our tax rate, excluding one-time items, it was 24.8%, which is generally in line with our longer-term guidance.

At this point, I’ll move onto the first quarter segment results. Beginning with energy storage, sales grew 12% over the same period last year, up 7% net of the Euro-to-dollar exchange rate, and segment operating income in the quarter was 23% of sales compared to 21% of sales in the prior year.

Specifically in lead-acid battery separator business, first quarter sales increased 12% over the prior year period. The sales increase was volume driven stemming from the acquisition of Microporous and also benefited from the continued strength in the Euro-to-dollar exchange rate.

In addition to our internal optimization efforts, we have also implemented price adjustments to help offset the impact of rising raw material and energy costs.

In the lithium battery separator business, sales grew 10% in the quarter, which is also consistent with our LTM growth rate. You’ll recall last quarter we talked about a buyer at a customer’s plant, that was unrelated to Polypore.

In the first quarter, we received a partial business interruption insurance recovery of $500,000. This was included as a separate component of gross profit and not included in revenue. We’re expecting an additional recovery, and hope to have that by the end of the second quarter. That customer did come back up to full operating levels during the quarter.

Moving on to separations media, for the first quarter, segment sales were up 15% from last year, up 4% net of Euro-to-dollar exchange rate, and segment operating income was 17% of sales compared with 13% of sales a year ago.

The healthcare side of separations media was particularly strong. Growth was driven by continued acceptance of our best-in-class, synthetic membrane PUREMA. Healthcare sales were up 18% compared with a year ago.

[I’m told] that we’re comping to 2007 results that included $18 million of cellulosic hemodialysis membrane sales on the full-year basis, and over $4 million alone in the first quarter of 2007. There will be virtually no cellulosic sales in 2008.

In the filtration and specialty business, first quarter sales grew 10%, largely due to FX and due to ongoing demand for our high-performance membranes, and a growing number of filtration applications.

Even with a softer economic environment, sales were solid, however, growth was more modest following ’07 growth that was well above market.

In summary, we’re off to a good start in 2008, and we’re pleased with the solid performance in the quarter. Now I’ll turn it back over to Bob for some brief comments before the Q&A.

Bob Toth

What you saw in the first quarter was the strength of our portfolio businesses. Our global presence, enabling technology, and the breadth of applications and markets provide a nice mix of growth and stability in today’s global economy.

Based on the first quarter results and our outlook for the balance of the year, we are maintaining the full-year guidance we provided on March 3, in conjunction with the Microporous acquisition.

On that note, I’d like to open the call up for questions.

Question-and-Answer Session

Operator

(Operator instructions) Your first question comes from Jeff Zekauskas – J.P. Morgan.

Jeffrey Zekauskas – J.P. Morgan

Did the Microporous acquisition benefit you by about $6 or 7 million in sales in the quarter?

Lynn Amos

No, no, Jeff. You know when we adjusted guidance relative to the Microporous acquisition, we increased guidance in the $35-40 million range. That was for ten months, so you can, kind of, do some math based on that for one month.

Jeffrey Zekauskas – J.P. Morgan

Can you talk about the low volume trends in lead-acid and lithium and in your various businesses, in that it’s a little bit difficult to disaggregate it from price and currency?

Bob Toth

Sure, sure, we’ll tick through all of them. I think in lithium, you see very nice volume growth offset a bit by price, largely as a function of large customers hitting, you know, price rebate gears and things like that.

In lead-acid, you see growth more modest in the quarter. I would describe it as kind of low single digits. The industrial portion of the market, which recall is about 20% of it, is probably the most economically sensitive portion of that market.

In the healthcare business, we of course, had very nice volume growth associated with the uptake of [inaudible] and offsetting cellulosics.

And in filtration, that’s probably the second most economically sensitive portion of the business, and you see just modest volume growth there as well in the quarter.

Jeffrey Zekauskas – J.P. Morgan

And then, lastly, can you just broadly describe some of the initiatives that are going on in lithium batteries in autos and whether the innovations are coming from the battery companies or the car companies, or from both of them in tandem.

Bob Toth

Yes, that’s a great question, Jeff. I think, you know, when you have a new transformational area like this, you have development going on in a lot of different areas, ranging from universities to companies like ours to the battery and the pack manufacturers as well as the automotive companies.

So you have a lot of people having a lot of interest in the space, because it’s potentially the biggest discontinuity this industry has ever faced, in a very positive sense, of course. You know, recall that just 10% of automotive production converts to hybrid, it in effect, more than doubles the market of the lithium separator volume.

So, you have a lot of development going on at car companies, certainly the leading, progressive companies you could guess. You have a lot of development going on at the major battery producers, and you of course, have electrolyte and separator producers like ourselves, non-electrolyte in our case, but electrolyte and separator producers like ourselves, all working on, you know, fine-tuning the product for that kind of a large format cell application.

Operator

Your next question comes from Richard Eastman – Robert W. Baird.

Richard Eastman – Robert W. Baird

Just a couple of things I wanted to bounce off you. Lynn, what’s the short-term debt at the end of the quarter? You just have all the current liabilities grouped together.

Bob, I also just wanted to ask you, you know, on the lithium side of the business, in early March there was a fire at an LG facility that I think took that one out of production. Would that be a customer of yours? Did that impact your quarter, or will it the second quarter?

Bob Toth

Well you could assume, yes, it’s a fairly small universe of high-quality battery producers in lithium, so we don’t get into too much customer detail, Rick, but you could assume that, you know, we call on and try to certainly participate at every major lithium battery producer.

The punch line now, I think, to your question is did we see any material impact in the quarter from that or expect to see any material impact? We haven’t, and at this point and time don’t expect to see any material impact.

Richard Eastman – Robert W. Baird

Then just a general question, on the healthcare side of the business, with PUREMA sales continuing to ramp up, is that a function of current growth? I’m a little bit confused as to the strength in that business. You know, when you look at the dialyzer market and you look at the pie chart, you know, a big piece of that business is AMBRO, [forcineas], as we ramp up with PUREMA, are we gaining, you know, share in that marketplace, or you know, is there a large existing customer that’s actually driving all that growth?

Bob Toth

No, it’s a… First of all, back up a step and say there’s really three drivers in the current growth, and two are what I would call temporary ones, very sustainable.

One driver is, of course, the market penetration we are just achieving with the best-in-class performance with PUREMA. One driver is the customer’s converting, in effect, from cellulosics, and that, as we’ve talked about, is not one-for-one, there’s a little bit of a time lag involved because they have to make some equipment modifications.

And then, of course, you have pretty robust fundamental market growth. I mean, this is a market that’s growing, as we’ve said, well in excess of 6% because of both patient population growth as well as the trend toward increased frequency-to-treatment, and of course, the continued trend of going to single use and opposed to reuse. Now, what we’ve said all along is we’ll continue to hang our hat on being able to grow with the market, but you’re right.

Now going to the next step of your question, you’ve got a number of integrated players, and in the past, of course, we had no reason to have a conversation with them, nor did they have a reason to have a conversation with us, because in the past, you know, we had kind of me-too synthetic products.

Today, we’ve got the world’s best synthetic product, and we’ve got a number of grades, so we can participate at places like that. And then, of course, you have a large portion of the market that is still a number of independent dialyzer producers, and the independent dialyzer producers are quite dependent on an independent membrane producer like us, since we’re not fully integrated as well.

So, as you look forward, you know, I would love to say this trajectory will continue, but fact of the matter is, you know, I think you need to think about it as just a very nice, continuing-to-grow marketplace for us.

Richard Eastman – Robert W. Baird

And the production problems that you mentioned in the quarter, may be just a lack of efficiencies, but is that something that was temporary?

Bob Toth

Yes, you know, I believe in, you know, complete disclosure, if you will, and I think I said fourth quarter, that the quarter was very robust with sales, and we had outstanding manufacturing performance, and you have a lot of variables there of yields, productivity, through-put, you know all kinds of things, and we make products to very exacting standards.

Sometimes you have great positive variances, and sometimes you don’t. So, I’d qualify it that way as opposed to an issue. It’s just that our performance wasn’t quite as good as it was in the fourth quarter.

Richard Eastman – Robert W. Baird

So we didn’t have a positive manufacturing variance in the first quarter, of significance?

Bob Toth

That’s one way to look at it, yes.

Lynn Amos

Back to your question on debt, yes, on debt, Rick, it’s $26 million for the current piece. As you recall, when we acquired Microporous, we borrowed under the revolver, and we’ve assumed some debt. We’ve been in the process of repaying the debt that we assumed, so that’s $26 million dollars of the current portion.

Richard Eastman – Robert W. Baird

So for the end of the quarter, about 862 or something. And then, just a final question I have, Lynn. On divesting this small paper business, there’s a gain from that divestiture? Is that in the P&L somewhere?

Lynn Amos

It’s in the line called discontinued operations on the P&L.

Richard Eastman – Robert W. Baird

So the gain is in there as well as the operating performance of last year… of the quarter.

Lynn Amos

Correct. It’s all lumped in there in the line item, income from discontinued operations net of tax. [inaudible] $3 million shown in the quarter, it’s the gain net of tax, along with the results of operations for that discontinued business in the quarter. But it’s a gain, it’s a net gain of 2.3.

Operator

Your next question comes from Brian Drab – William Blair.

Brian Drab – William Blair

In the lithium business, regarding the capacity addition coming on line later this year, can you tell us what percentage of your current capacity you’re adding?

Bob Toth

Well we don’t get into too much detail there, because frankly there’s a lot of confidential information wrapped up in, you know, effective capacity compared to announce capacity. This is an industry not unique to having some big announcements, so.

We are adding a… The way to think about it is, our current facility is, needless to say, approaching full-capacity utilization. We’re adding a completely new building with the ability to add multiple lines within that, and we’re adding a large line.

So, you know again, I’ll go back also to the point that this is a business… A highly technical term of mine is, this is a business that comes with pretty bite-sized capital. Buildings you don’t like building, because they don’t provide a great return, but you’ve got to have one to have the line, so we can add multiple lines within that building over the next several years at a lower capital cost. But bottom line is it’s a pretty substantial increase, but we don’t actually disclose the precise amounts.

Brian Drab – William Blair

Regarding gross margin, I know a couple of the primary drivers year-over-year, you know, solvent recovery system in healthcare, and drop off of cellulosic. What were some of the other key drivers, and maybe what were some of the items that have restrained gross margin? For example, were gross margins lower at Microporous from the company average?

Bob Toth

Well, you know, if you do the math on that one, I think we added, I said $35-40 million of revs to our guidance, and if you looked at the EBITDA, that got added 7-9, you could do some proportional math there, and say obviously that’s in the low 20’s and we’re in the high 20s to 30.

We certainly would expect over time those margins to approach ours as we enhance operational efficiency in their business and in their facilities that are now ours. And, you know, I think we talked about manufacturing performance not being exactly where we wanted it on the separations media side, that certainly could be considered a drag on margin. I can’t really think of anything else outside of that that was worth calling out, to be honest.

Lynn Amos

Yes, I think, you know, we are experiencing operating leverage in the business, so we’ll see the benefit of that in our gross margin.

You know, as we’ve mentioned now as you come to operating income in our business, we’ve continued to invest in things like our hybrid electric vehicle effort and new filtration applications.

I mean all in all, as we’ve talked about through the course of this year with our new capacity coming on line in the back half of the year. While we generally get operating leverage from sales growth, you can look at our guidance and see that we’re not expecting broad EBITDA margin expansions, and that’s because we will have some startup costs associated with those new capacity additions.

Brian Drab – William Blair

Just one last quick question, has your perception of how the second, third, and fourth quarters are going to turn out, has that changed at all since the beginning of the year?

Bob Toth

No no, I guess I answered for Lynn, but I don’t see any change. I think first quarter was on expectation, and we basically said that, you know, with the outlook for the balance of the year, we see things pretty much exactly similar to how we saw them at the end of last year.

Operator

Your next question comes from Michael [Lavine] – DB&T.

Michael [Lavine] – DB&T

Can I interpret from your previous comments in healthcare that maybe now you are selling some of your membranes into the big guys for [inaudible], and has that been part of your gross?

Bob Toth

Well, we won’t disclose specific customer comments on that, sorry about it, but what I will say is that we have the opportunity, certainly with the broader product portfolio, or performance range, than what we think anybody else has out there. So, you know, the way to think about it is two years ago, that was no opportunity, today, that’s an opportunity for us.

Michael [Lavine] – DB&T

So going forward, would you see your potential to grow at the market or maybe a little bit better than the market?

Bob Toth

You know, it’s tough to predict with exact precision, to be honest with you. You’ve got, you know, very good growth characteristics in this market around the world. You’ve got, you know, continued growth taking place in terms of quality of treatment for patient care in less-than developed economies or regions around the world.

So with what we know and see today, you know, I’m not going to get too far out over my skews on that and basically say, you know, we see ourselves growing in line with the market over the longer term.

Michael [Lavine] – DB&T

And then, you know, a couple years ago, when you came here, it seemed like all the segments had challenges, and the challenges were pretty obvious, and you’ve made a lot of progress addressing those. Going forward, what do you see at the two or three big challenges for the business, and do you have any initiative to address them going forward?

Bob Toth

Well, you know, I think when you look forward in the markets we serve, we’re fundamentally… this company’s fundamentally positioned in high-value space, right? We have an enabling technology for high-growth, high-value space, we have a lot of value. A lot of great growth characteristics, a lot of great stability characteristics of the market. The challenge continues to be very predictable on a quarterly basis.

I’ve talked a number of time to many of you, and you’ve heard me probably say it on these calls, that we don’t manage our business quarter-to-quarter. This is a business that you manage for the right long-term growing an sustainable trends, and you’ve got to make some investments out in front of those trends, which of course, I think we’ve done a pretty nice job of the last couple of years.

And so as I look forward, I think the biggest challenge is the predictability of growth, and when things will occur that we don’t have complete control over. ATV, you know, three years ago we’d have been sitting here debating whether or not consumers will buy hybrid electric vehicles, and today virtually every auto manufacturer has a development program going on.

We would have been debating three years ago about, will power tools convert from nickel to lithium, because, you know, it’s a pretty demanding application, people drop these things off the roof. Well, today, it’s a non-event. That’s happening, go look at a hardware store.

And that’s a great market where even though the market is, in fact, depressed, power tools, the lithium growth within that market is substantial. And so, really planning for the growth is the biggest challenge, especially from a perspective of where we’ve got the enabling technology in most cases, but [inaudible] in markets.

Michael [Lavine] – DB&T

So, just to follow up, can we assume then that you are happy with your technical capability and your ability to address these opportunities?

Bob Toth

The company has a remarkable portfolio of technology. I mean if you just go back to the very fundamental level of products and processes, I think the company’s a pretty scarce asset in having the broadest product portfolio, meaning things in which we put pores, and the broadest process technology portfolio, meaning how we put pores into things.

And, of course, we’ve got more than our fair share of application knowledge. Again, though, in the value chain we’re steps removed in many cases, and the value chain from the actual consumer. So, yes, I’m delighted with the company’s capability. We’ve got to continue to exploit how to share that across the company more assertively.

Operator

Your next question comes from Michael [Bone – Blue Bay].

Michael [Bone – Blue Bay]

Just really a quick question with respect to your guidance. I’m just looking at your LTM adjusted EBITDA for 167.3, through the end of March, and the guidance that you give. I mean, it doesn’t seem that you’re expecting a lot of growth, especially on the bottom line, through the remainder of this year.

Your revenue guidance, I think, means that you expect, you know, $30-40 million of revenue growth. Are you expecting margins to come down through the rest of the year, or is it just that this guidance is very conservative on the bottom line?

Bob Toth

No, I think you’ve got to compare apples to apples first on the EBITDA that you referenced.

Lynn Amos

That’s right, if you’re looking at the LTM EBITDA of 168.3, you’ve got to recognize in that number, because this is a number that’s used for a leverage calculation, it includes a pro forma adjustment of $6.9 million from Microporous. Obviously, that $6.9 million hasn’t been actually realized, and will be realized over the course of the year.

Bob Toth

You’re looking at guidance not pro forma, the other case you’re looking at an LTM pro forma.

Michael [Bone – Blue Bay]

So broadly, everything should move in line then? No, hang on, your EBITDA margins are roughly 31% through the first quarter. What are pro forma sales for 2007, including the Microporous acquisition?

Lynn Amos

As Bob mentioned, when we increased our guidance in March 3 for the acquisition of Microporous, we added $35-40 million of revenue for effectively ten months. See, we’ve had one month of results included in our actuals, gets you to the impact on full-year pro forma revs as defined in the bank agreement, LTM EBITDA.

Operator

Your next question comes from Craig Erwin – Merriman Curhan Ford & Co.

Craig Irwin – Merriman Curhan Ford & Co.

A quick question on the lead-acid market, I was hoping you could provide a little more color on the comments about the economic sensitivity on the industrial side, and maybe if there was sort of an abrupt transition you saw there or if it was more gradual, and possibly some geographic color as areas that are, you know, potentially more weak than others?

Bob Toth

Sure, you know first of all, when you look at our entire portfolio, Polypore businesses, we talk about the fact that probably in the 75% range is very stable, and something in the neighborhood of 25% is economically sensitive.

The industrial portion of the lead-acid market, transportation is about 80% of lead-acid, and of course, that’s a very high recurring revenue portion as well, because it’s over 80% replacement sales in transportation. The industrial segment continues to grow, meaning people are finding new applications, so you’ve got application proliferation taking place, but industrial is, of course, just more fundamentally, economically sensitive.

So you’ve got things like, you know, golf carts there, you’ve got things like forklifts there, you’ve got a variety of, you know, the floor scrubbers you’d see in restaurants, and in stores, you know, the large box chains, and those kinds of things. So, you could always hold off buying one of those for a quarter, or something, you can’t hold off forever, and you certainly can’t hold off once the battery dies and you need a replacement.

But that 20% of lead-acid is probably the more economically sensitive piece, and on top of that, you have unusually high lead costs right now, lead prices. So customers have, needless to say, no incentive whatsoever to store a bunch of inventory, produce and store inventory. And on top of that, just naturally, first quarter is typically the seasonally low period in lead-acid.

So, all said and done, that’s the side of the business that you’d see kind of economic sensitivity on first. And then, of course, industrial filtration would be the other piece, again, same kind of thing. Fundamentally in filtration, economic downturn is generally a good thing for it long term, because we’re adding efficiencies, productivity, yields, cost improvement, but in that particular quarter you might see people delaying spending for a quarter or something like that.

Craig Irwin – Merriman Curhan Ford & Co.

Can you, sort of, break out the sensitivity in that business to the seasonality versus, sort of, the economy just on the industrial side, if we could focus there.

Bob Toth

That’s actually at a level of granularity I probably don’t have. You know, the industrial side, we see continued growth. I think what you’re just seeing is, generally speaking, things are a little slow in the first quarter, as you saw in just global economic activity.

Craig Irwin – Merriman Curhan Ford & Co.

And then it’s fair to characterize the transportation market as, you know, consistent and stable and solid, right?

Bob Toth

Yes. In any one quarter, you might see builds change, but fact of the matter is there’s a correlation to replacement sales. If you don’t buy a new car, at some point in the not-to-distant future, you’re probably buying a battery for your old car, or you might have a small quarter-to-quarter phenomenon taking place, but it’s not a material impact in terms of… You can’t put it off for a year or two years.

Craig Irwin – Merriman Curhan Ford & Co.

And then are you still seeing Asian growth, you know, significantly higher than the rest of the market?

Bob Toth

Sure, I mean it’s all a fundamentally high GDP region, and you still have some conversion taking place in Asia, so we’re very pleased with the growth we see in Asia, and of course, that’s fundamental to the decision we made to expand our Prachinburi, Thailand facility.

Operator

Your final question comes from Richard Eastman – Robert W. Baird.

Richard Eastman – Robert W. Baird

Yes, Bob or Lynn, just I wanted to ask you, could you just kind of address raw material prices as they affect you, and also your ability to offset set those with pricing? Are we seeing any decrement in the gross margin from material prices?

Bob Toth

We’re absolutely feeling it. I mean, needless to say, you know even though raw materials and energy are a smaller component of our costs than what you’d consider in industrial businesses we’re, you know, we’re way on the low end of that continuum.

Having said that, we still use them, and we still feel the costs associated with escalating energy and oil, and how that translates into shipping.

The two primary raw materials we have in the company are silica and ultra high-molecular weight polyethylene. Those are the two biggest, and those are both in the lead-acid space, and so we’ve, you know, we’ve seen some pressure associated with those, so, like of course, it’s associated with natural gas.

What we’ve done between our internal optimization efforts, I mean we have a keen focus on cost management internally. We have to, and we’ll continue to. Between that, and what we can pass along, we think we’ve kind of held our own ground.

Richard Eastman – Robert W. Baird

And then just a last question, Bob, when you look at the lithium marketplace, you know, we tend to talk almost exclusively about consumer electronics, the HEB opportunity, obviously power tools. But you know, there’s the lithium-ion battery applications are expanding to utility power storage, you know, electric bikes, you know, there’s a host of other things that seem to be, or technologies that seem to be adopting lithium-ion batteries.

I’m curious if you’re seeing that influence in your business or if you’re involved in any development programs that could rival the size of the power tool business, for instance?

Bob Toth

You’ve got it, Rick, I mean, you’re spot on with your assessment of that. Now the difficulty is pegging it precisely. You know E-bikes, how big will they be? Will they be high-end for… You know, there’s high-end electric bikes that are dirt bikes in the U.S. and European markets today that are very attractive, high performance, but those are, you know small niches.

But the key point you hit on is the continued application proliferation, right? And so, you’ve got electronics, in and of themselves, continuing to grow, not just the things we know, but, you know, there’s continuing to be new applications there. Five year’s ago, who would’ve thought the GPS devices are the size they are today, or the Bluetooth devices or MP3 players, right?

So you have continued growth within the core electronics business. You’ve got power tools, as we pretty well know it and define it around, you know drills and saws and those kinds of things. The question is, how much does power tools go beyond power tools into what we’ll call lawn and garden.

Because if you walk through a Home Depot or a Lowe’s, you know, you’ve got weed whackers, you’ve got leaf blowers, you’ve got, you name it out there that’s got a nickel type battery in it, and as those things transform and as they update those models, I’m pretty confident that they’ll probably start to think hard about lithium. You’ve got lawnmowers as a potential in the future. You just have a whole series of things. It’s just tough, it’s just very tough to exactly peg the consumer acceptance of those things, right?

You know, I wish I could tell you that lithium was going to take over the universe for lawnmower, because it’s a great concept. Whether or not that flies, I really don’t know. And then, of course, you’ve got, you know, very visible, the HEV front that’s starting to get to be visible to the average consumer, because the car companies are making more announcements about it today.

Richard Eastman – Robert W. Baird

One application that we stumble across that looks particularly interesting is just the utilities, perhaps looking to adopt lithium-ion batteries for, you know, intermediate-term storage of power, and there seems to be a couple that are trialing that application now, but that would seem to be fairly larger-format batteries as well.

Bob Toth

He just hit the key on the head with that last comment, right? As manufacturing scales up for the large-format cells, this will go through a re-typical industrial curve of people look for a home for large format cells.

So today, they’re being designed very uniquely for the new applications that are, you know, hitting us in the forehead right now, like power tools and things like that. The next wave will be, okay, so now we’ve got large-format cell capability, where else can these things be sold, let’s go get some application development going. But that’s exactly what you see taking place in the industry.

Operator

At this time, we have no further questions. I’ll turn the conference back over to our presenters for any closing or additional remarks.

Bob Toth

I’d just like to take the opportunity again to thank everyone. Great questions, we appreciate the support, and we look forward to continuing to report our progress to you. Thanks.

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Source: Polypore International, Inc. Q1 2008 Earnings Call Transcript
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