西式醫藥服務 (WST) 2006 Q4 法說會逐字稿

Welcome to the West Pharmaceutical Services fourth-quarter earnings conference call. (OPERATOR INSTRUCTIONS). Today's conference is being recorded. If you have any objections, you may disconnect at this time. Now I would like to turn the call over to Ms. Theresa Kelleher.

Thank you. Good morning, everyone, and welcome to the West Pharmaceutical Services fourth quarter 2006 results conference call. As you know, we issued our results this morning. The release has been posted on the Company's Web site, located at www.Westpharma.com. If you have not received a copy of this announcement, please call Financial Dynamics at 212-850-5600 and a copy will be sent to you immediately.

Before we begin I would like to remind you that certain statements that may be made by management of the Company may contain forward-looking statements as defined in the Private Securities Litigation Reform Act of 1995. These forward-looking statements set forth anticipated results based on management's plans and assumptions. Such statements give our current expectations or forecast of future events. They do not relate strictly to historical or current facts. In particular, these include statements concerning future actions, future performance or results of current and anticipated products, sales efforts, expenses, the outcome of (indiscernible) such as legal proceedings, and financial results. We have tried wherever possible to identify such statements by using words such as estimate, expect, intend, believe, plan, anticipate, and other words and terms of similar meaning, in connection with any discussion of future operating or financial performance or condition. We cannot guarantee that any forward-looking statement will be realized. If known or unknown risks or uncertainties materialize, or if underlying assumptions are inaccurate, actual results could differ materially from past results and those expressed or implied in any forward-looking statement. For a non-exclusive list of these factors which could cause actual results to differ from expectations, please refer to the factors listed in today's press release. Investors are advised, however, to consult any further disclosures the Company makes on related subjects in the Company's 10-K, 10-Q and 8-K reports. The Company undertakes no obligation to publicly update forward-looking statements, whether as a result of new information, future events or otherwise.

This call is being recorded on behalf of West Pharmaceutical Services and is copyrighted material. It cannot be re-recorded or rebroadcast without the Company's express permission. Your participation on this call implies your consent to our taping. Once management has concluded their remarks, we will open the floor for questions. At this time I would like to turn the call over to Don Morel, Chairman and CEO.

Thank you very much, Theresa. Good morning, everyone, and welcome to West's 2006 fourth-quarter and full-year conference call. Joining me on today's call are Bill Federici, our Chief Financial Officer, and Mike Anderson, West's Treasurer and primary investor relations contact.

I'd like to open today's call with a brief overview of 2006, after which Bill will provide more detailed commentary on the Company's financial performance for the fourth quarter and full year. We will then discuss our outlook and guidance for 2007.

2006 was a very strong operating year for the Company. Our steadily improving performance over the last few years is the direct result of management's decision to refocus on our injectable packaging components and delivery systems business, and our ability to introduce innovative new products, processes and services that satisfy our customers' evolving needs on a global basis.

For the year, consolidated sales rose to $913 million, a 30% increase over the prior year, with the timing impact of our acquisitions accounting for 13.4 percentage points of the increase. Operating profit rose to $101 million, an increase of 37.6%, and net income increased to 67.1 million, from 46.4 million, or 45%, resulting in earnings per fully diluted share, excluding several onetime items of $1.93, an approximately 37% increase over 2005.

Throughout 2006, West experienced significant broad-based demand for pharmaceutical packaging components and delivery systems, and more modest growth in several product lines within our disposable medical device business. More importantly, we recorded very strong sales growth from our key product offerings in our leading market segments, namely coated and --

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-- by consistently improving the value of our primary packaging components and delivery systems relative to market requirements.

The Company also accomplished a broad range of objectives in 2006, some of which contributed directly to our strong performance during the year, while others set the stage for future growth.

We completed the integration of our 2005 acquisitions. Our operations teams around the globe were able to meet unprecedented demand, especially in Europe. We launched the largest multi-year capital expansion program in the Company's history, focused on Europe and Asia, to meet forecasted demand in the years ahead.

The Tech Group team hit all delivery milestones for Exubera, ramping up production to three shifts, and hiring and training more than 400 new employees to meet new product launch goals.

We launched the China initiative to build and staff two facilities, one for plastic and one for rubber, in 2008 and 2010, respectively. We increased our R&D and innovation spending by 40% to $11.1 million, and the finance group reduced our pre-tax borrowing costs by $2.5 million a year by restructuring our debt portfolio.

Our significant improvement in operating performance over the last few years, and 2006 in particular, has set the stage for another good year. But before I comment on the outlook for 2007, I'd like to turn the call over to Bill Federici, who will provide more details on our fourth-quarter and our full-year operating performance for 2006. Bill?

Thank you, Don, and good morning, everyone. As indicated in this morning's press release, West reported fourth quarter 2006 income from continuing operations of $14.7 million, or $0.43 per diluted share, $0.02 higher than the 13.7 million, or $0.41 per diluted share, we reported in the fourth quarter of 2005.

Consolidated sales in the quarter were $231.9 million, an 18.5% increase over Q4 2005 sales, 3.7% of which related to currency. Sales growth in the Company's core Pharmaceutical Systems division remains strong at $164 million. Fourth-quarter sales were 20.2% higher, with 4.7% of the increase due to currency effects.

Growth in Pharm Systems' domestic markets was particularly strong this quarter at 18.1%, with the increase led by stronger demand for West's FluroTec and Teflon coated components, and those employing our Westar post-manufacturing processes in support of high-growth insulin, oncology and arthritis drugs. In addition, sales in the North America unit of the Company's Flip-Off seals, mostly relating to customer product launches and standard syringe components for disposable medical devices, were also significantly stronger.

Pharm Systems international sales grew by 21.6% in the quarter versus the prior year quarter, with 7.8% of the growth due to exchange effects. The largest portion of the international growth came from the European markets. Growth in Europe was driven by increased demand for pharmaceutical packaging components used in both pre-filled syringe systems and vials. Contributing to our European revenue growth was an increase in sales of components using West FluroTec advanced coating material and Westar process components.

The Tech Group segment achieved sales of $70.1 million in the quarter, 14.1% above sales in the prior year quarter, with 1.2% due to exchange. Most of the increase was from sales generated by the portion of the Tech Group we acquired in May 2005. Sales related to our production of Nektar's multi-component insulin inhalation device accounted for most of the growth.

Consolidated gross profit margins for the quarter were 28.3%, comparing favorably to the 27.1% margins we achieved in the fourth quarter of 2005. Gross margins in the Pharmaceutical Systems segment continued strong at 33.4%, a 0.4 percentage point margin improvement from last year's quarter, due to higher sales volumes generating improved overhead absorption, a favorable product mix, and efficiencies from our lean program.

In the Tech Group, margins increased over the prior year quarter by 2.3 margin points to 15.3%. Tech's margin improvement was primarily due to the impact of volume increases and a more favorable product mix that included significant sales of the Nektar insulin inhalation device.

Consolidated selling, general and administrative expenses increased by $11.6 million in the quarter versus the prior year quarter. The increase was primarily due to the impact of the Company's rising stock price on stock-based compensation, increased incentive compensation costs, increased outside service costs, most of which relate to the implementation of the Company's innovation program, the impact of foreign exchange, higher costs associated with the Company's U.S. pension plan, and increased compensation costs related to headcount additions and annual salary adjustments. As a percentage of sales, Q4 2006 SG&A expenses at 19% were 2.4 percentage points above fourth quarter 2005 levels. If you exclude the impact of the stock price increase on SG&A, the percentage of sales was virtually flat -- 17.4% versus 17.2%.

Net interest expense was $2 million in the quarter, with 1.5 million below the expense incurred in last year's fourth quarter. The decrease was primarily due to reduced interest rates brought about by the first-quarter refinancing of the Company's senior notes and the effect of lower average outstanding debt in the quarter.

Briefly turning to full-year results, we reported 2006 income from continuing operations of $61.5 million, or $1.83 per diluted share, versus income from continuing operations of $46 million, or $1.41 per diluted share recorded for the full year 2005. Full-year results include a net $0.10 per-share charge representing a pre-tax $5.9 million debt extinguishment charge, and the effect of a favorable resolution of a tax claim relating to a prior period. Full-year income from continuing operations excluding these two items was $1.93 per diluted share.

Consolidated annual sales grew by 29.9%, excluding exchange effects, to $913.3 million. Excluding both the timing impact of our 2005 acquisitions and exchange effects, annual sales grew by 16.5% over 2005 sales. We improved full-year gross margins in our core Pharmaceutical Systems business by 2.7 margin points to 34.4%, driven by increased sales of our advanced coating products, increased customer conversions to Westar processing of our products, and increased plant efficiencies, including our lean manufacturing focus.

Full-year margins in the Tech Group segment improved by 0.9 percentage points as a result of a more favorable product mix. Selling, general and administrative expenses of $155.9 million increased by $35.6 million versus the prior year, with $8.6 million of the increase related to the effect of including our 2005 acquired companies for all of 2006, and another 7.5 million due to the increased value of our stock price on stock-based compensation. Increased compensation costs, higher pension expenses, and increased outside service costs accounted for most of the remaining increase. As a percentage of sales, 2006 full-year SG&A expenses were 17.1% versus 17.2% in 2005. Full-year interest costs of $10.6 million were $1.4 million below 2005 interest expense due to our Q1 refinancing.

Turning to the balance sheet and liquidity, the Company's cash balance at December 31st was $47.1 million and working capital totaled $124.8 million. Debt at December 31st was $236.3 million, down from $281 million at the prior year end due to our repayment of borrowings primarily in Europe. Our debt to total invested capital ratio at the year end was 36%, a significant decrease from the prior year end.

Operating cash flows were approximately $47 million for the quarter, and capital expenditures were $43.1 million, with roughly half of the quarter's capital focused on our new product and expansion activities. For the full year, operating cash flows were approximately $140 million, and we spent 90.3 million in capital, with much of the increased spending due to our accelerated capacity expansion in Europe and Asia, brought on by increased customer demand.

As we've stated before, we expect capital spending to approximate $130 million per year for the next several years. We can fund our expansion through existing debt arrangements and with expected operating cash flows. We are working with our board looking at alternatives for raising capital to take advantage of favorable capital markets and provide additional liquidity.

Our order backlog at December 31st remains strong at $250 million, compared to our 2005 year-end backlog of $183 million. The increased backlog is primarily due to strengthening demand for key products and blanket full-year orders placed by certain customers.

In summary, we experienced another very strong operating quarter, capping off a very successful 2006. Don?

I would now like to turn our commentary to our outlook for 2007. West begins the year following one of the strongest operating years in the Company's 90-year history. Even with this backdrop, we have many opportunities for continued growth over the next three to four years. Our goal this year is to continue to deliver improving performance while adding new capacity in key product lines to continue to develop and launch innovative new products and maintain customer service levels around the globe.

West continues to be well positioned to expand our leading role in components and systems for the injectable administration of therapeutics, vaccines and diagnostics to generate sustained growth in the years ahead.

In terms of market dynamics, we see a number of trends that support the opportunity for continued sustained growth. First is the increase in chronic diseases such as cancer, rheumatoid arthritis, multiple sclerosis and diabetes, that are the inevitable result of an aging Western population. To more effectively treat these diseases, pharmaceutical companies are increasingly turning to therapeutics of a biologic origin. These new protein-based therapeutics will require the cleanest, most advanced packaging systems available, and thus, in many cases, come to market with West's most advanced packaging systems in both vial and pre-filled syringe format.

Second, new vaccines are emerging and research into prophylactic vaccines is increasing. Like biologics, many vaccines are delivered by injection.

Third, as more compounds come off patent, novel devices and packaging systems offer the innovator companies a new way to differentiate their products. Growth in combination products such as Exubera are expected to drive improved safety profiles and patient use profiles in the future. Tech is well positioned to serve this market.

Fourth, a shift is occurring in the point of administration as hospitals and insurers try to drive down costs. In many cases, drug administration is moving away from the hospital and doctor's office to specialty clinics and the patient's home. Systems such as the Medimop MIX2VIAL and others have the opportunity to simplify the reconstitution procedure and make it easier for the patient to prepare and deliver their dose in an accurate manner.

Finally, many preparations continue to migrate into pre-filled syringes, especially in Europe. We believe this process will pick up momentum in the United States as well over the next few years.

For West to benefit from these trends, we must stay focused on the operating priorities within our growth strategy. First, we need to deliver maximum value from our key growth drivers -- Westar, FluroTec, pre-filled syringe components and reconstitution devices for the biologics market and for treating other chronic diseases. We need to continue to focus on our operations and run them as efficiently as possible. We need to remain focused on executing our capacity expansion plans and geographic expansion plans around the globe. We need to work on shifting the Tech business model from a pure contract manufacturing operation to producing more proprietary products such as the Medimop systems. We need to push our innovation programs to commercialization, and we need to continue to look strategically at technology acquisitions for products or systems that can complement our core packaging and delivery business.

In terms of new product opportunities, we plan to launch a range of new products and product line extensions throughout 2007. These include Spectra ID and radio frequency ID seals for anti-counterfeiting and track-and-trace applications. We have a range of desiccating closures called [Wyotech] that can be utilized on lyophilized drugs. We're launching steam sterilized Westar closures and certified clean seals to meet the increasing cleanliness demands of the market. We will be launching [Ensacap] for IV applications in countries outside the United States and Europe. We will launch [VIAL2BAG], a new system from Medimop. We will expand our lab services and our contract services laboratory, and we expect two proprietary customer products to come to launch for Tech during the year. We also expect spending on research and product development to further increase another 30% in 2007 versus the prior year to over $14 million per year.

Turning to China. With regard to our China initiative, we are waiting only for final approval of our land use certificate from the Chinese government. All other licenses and permits have been received for the plastics facility. We have signed the construction agreements with our contractor and are ready to break ground sometime in March once we do receive the land use certificate. Work is expected to commence on the rubber facility sometime in late 2008 or 2009, once the plastics facility is up and running.

In terms of risks and challenges ahead, there are many risk factors that could impact our ability to deliver on our business goals for the year. We expect demand in the first half of '07 to remain at record levels. The management team continues to monitor our plant loading and utilization very carefully, especially in Europe and North America, where demand for pharmaceutical packaging components remains very, very strong. We continue to watch energy prices and transportation costs very closely, as we do the cost and availability of key raw materials. Also, since we are a predominantly make-to-order business, we continue to work closely with our customers to understand their inventory and risk mitigation strategies as they apply to West products.

There is also the ongoing uncertainty of new product approval timing by the regulatory authorities in the country in which we and our customers operate. The launch of new products by West often also mirrors the drug development process, which can be lengthy, due to testing and validation requirements by both our customers and the regulatory agencies.

Overall, as we begin the year, I like the position we are in very much from both a market trend and a demand standpoint. The stage has been set for another very good year.

I would now like to turn the call back to Bill, who will provide our guidance and financial expectations for 2007.

Thanks, don. We have detailed our earnings guidance for 2007 in this morning's release. We expect 2007 earnings to be between $2.20 and $2.35 per diluted share, based on expected sales of approximately $1 billion, and expect consolidated gross margin in the range of 28.8%.

We expect that Pharm Systems will have sales of approximately $710 million and will achieve gross margins in the range of 34.2% for the year, slightly below 2006 margins of 34.4%. It's expected that cost increases in our Europe/Asia region, incurred in connection with our accelerated capacity expansions and for increased labor, materials, utility and depreciation, will exceed our ability to recover these costs through sales price increases and lean savings.

Tech Group gross margins are expected to improve by about 1 percentage point to the range of 15.2% on sales of approximately $300 million, including $25 million to $35 million of tooling revenues, with the gross margin improvement due to lean savings and a further improved product mix.

Selling, general and administrative expenses are expected to increase in 2007, with the bulk of the increase coming from the impact of headcount increases, mostly in the Pharmaceutical Systems business units, to support growth plans and new programs, a substantial increase in funding to support the global innovation program, and increases related to annual merit salary adjustments, the revised savings plan program for U.S. employees, and additional sales commission expense to support sales growth. As a percentage of sales, we expect full year 2007 SG&A expenses to be marginally less than the full year 2006 SG&A expenses.

Our 2007 earnings guidance does not include the effects of any significant additional increase in raw material or energy costs, or the effects of currency valuation changes, particularly the euro, which is reflected in our 2007 estimates at $1.27 per euro.

As you know, we do not provide guidance for any interim periods. However, historically our business has been stronger in the first half of the year, and we expect that trend to continue in 2007.

This concludes our commentary for this morning. Don and I would now be pleased to answer any questions you have. Operator?

(OPERATOR INSTRUCTIONS). Arnie Ursaner, CJS Securities.

A couple of real quick questions if I can. Focusing on Tech Group for a moment, ex Exubera, you had relatively minimal growth in the year. And wanted to -- in the quarter; I'm sorry. Wanted to follow up a little bit on that a little more specifically. Can you comment on what the growth was in Medimop? And you also have highlighted that you have had declines in sales of consumer electronics, industrial products and tools. How much of that is desired eliminations, if you will?

Let me kind of go from the back to the front. Bill is going to dig out the number for Medimop for you. Part of it's desired and part of it is a fallout from the construction of the Grand Rapids facility. As we talked about in the middle of last year, we'd outgrown the old facility. We had acquired a new site and were in the process of fitting out the building there over the last six months of the year. So part of it has been fallout from the transition from the old facility to the new facility. That also impacted the sales for the quarter; that's why they were down flat -- down a little bit outside of Nektar. And as you said, we also did see some decline due to order pattern shifts in the consumer and the consumer electronics areas.

Medimop sales last year in Q4 were $7 million -- I'm sorry -- in 2006 Q4 were $7 million, and 2005 Q4 were $3 million. And the operating profit on those sales was 1.5 in '06 Q4, and it was flat in Q4 '05.

Got it. You've also talked about two projects that have been experiencing delays -- regulatory delays. Can you attempt to quantify the revenue that you might have lost from those two projects together?

No; it's really difficult to project. The good news is that we believe those regulatory hurdles have been overcome, and we expect those products to launch in the first quarter of this year.

Two more quick questions if I can. In looking at your guidance for Exubera in the upcoming year, you basically are implying either a slowdown or negative trend in the upcoming year.

We had $29 million of sales in all of '06, and we expect that number to be in the 32 to 36 million range in '07.

I was just looking at your fourth quarter, where you had 8.9 million [in sales].

The run rate is running fairly flat, and we expect it to continue that way. That's at least what we have in our budgets.

Right. But as I say, if I just take the run rate in Q4, that would be 35.6 million. So at least in terms of your guidance, some of it is lower than what you've had.

Yes, technically. It's roughly flat.

Except that that Q4 number, remember, is running balls out in that facility with three shifts.

It's running -- in Q4 we were running at the way we expect to run during 2007.

You had seen a pretty lengthy extension in the delivery times on various orders. Can you update us on where we stand now on delivery schedules, if you will?

They're still for certain products running in the 10 to 12 to 14-week leadtime range, especially for the higher-margin Westar FluroTec items, as we go through the first half of the year. We also see those kinds of leadtimes for certain products within the seal range, because, obviously, they're used to finish out the package on the biologicals. We're expecting them to come down slightly in the second half of the year. But the good news is demand continues to be very strong in those product categories, and we expect that to continue through the first half of the year for sure.

Final question for me at this stage. Your fastest-growing line item is SG&A, which, obviously, is being impacted by stock-based comp. What stock-based comp have you embedded in your 2007 guidance?

We have embedded roughly $0.05 per share.

Do you have it in millions of dollars? You were (multiple speakers)

It's roughly $2.5 million.

So dramatically lower than what we (multiple speakers)

Dramatically lower.

Thank you very much. I'll jump back in queue.

Steven Postal, Lehman Brothers.

Congratulations on a great year. Could you maybe talk about the pharmaceutical packaging business, and elaborate on some of your commentary? It seemed like, obviously, very strong growth in '07. What's driving that business, and what do you think of in terms of the market growth rate? And since you seem to be taking some share there, what are the drivers to that?

I think our growth is really coming from the value-added attributes in a lot of products that we're selling. Growth in biologics has been mid double-digits and will continue to be there. Growth in diabetes has been in mid double-digits and will continue to grow there.

We're seeing healthy growth in unit volume versus what we've seen maybe five years ago. But when you overlay FluroTec, Westar and specialized ways of packaging that and shipping it to the customer, each one of those items tends to drive up the value of what you're selling. So a lot of the growth is in the value-added attributes of our product line.

On a positive side, although the new product pipeline has been somewhat thin the last couple of years, we are seeing fairly broad expansion in indications for many of the biologics that we sell the packaging components for. So collectively, you've got an aging population, as we noted; you've got a greater demand for the higher-value drugs that go in there to treat rheumatoid arthritis, diabetes, other chronic illnesses, cancer -- all of those are very, very good growth drivers for our business. So, it really is a collection of things. But the good news is we expect those positive trends to continue for the foreseeable future.

Can you remind us on how you guys are feeling about raw material costs? How was that trending in Q4, and how do you anticipate that trending (multiple speakers)

We expect to have a slightly positive variance versus our budget on raw materials through the first half of the year. As you know, oil prices are declining. Right now the environment is favorable. As far as we can see, that should remain relatively stable through the first half or three-quarters of the year. Beyond that, we'll just have to keep an eye on things. But right now it's running positive for us.

Don, can you remind us how those automatic adjusters work in the business?

As you know, in the consumer contracts, we either mark to spot pricing in the market and adjust immediately, or we have a three-month lag where we adjust up or down outside of a band within the agreement. Because of the long-term nature of the rubber business and our contracts with our pharmaceutical customers, those are typically adjusted to a PPI or a CPI on an annual basis.

On the supply side, Steven, we do have contracts. And those contracts -- as you remember, on the way up they had break points within there so that they slowed the progression of the growth up. Well, on the way down, it also slows it on the way down. So we actually expect, while Don is right that there is a -- in the marketplace the costs seem to be coming down, it will take some time before we see those reduced costs in our P&L.

Because there's some kind of a lag there?

There is a lag. What happens is is that -- and it worked for us as the prices were going up. We have a -- there are price points built in -- and I don't want to bore you with all the details. But basically, as long as you're winning a price band of the barrel of oil, you don't get a price increase. Once you step outside of that band you'll get a price increase, but it's delayed. Similarly, on the way down there's a -- and it works every quarter -- there's the pricing mechanism. So you've got a natural built-in hedge on the way up, but you also have a natural built-in inhibitor on the way down.

That's helpful. And in terms of inventory levels at your customers, I know that's been -- that has been an issue over the years. Can you give any perspective on how you feel about inventory levels of customers?

We're going to see adjustments throughout the year as we always do. Right now, given the leadtimes that we're looking at in the key product lines, clearly, they're working through their inventories quickly, and they're keeping them at a level that they're comfortable with. Assuredly, as we get towards the end of the year we are going to see some adjustments, however.

Just to confirm that, any adjustments that you're anticipating I presume are included in that range of guidance.

Yes. We look at historical patterns, and what we've done is account for it with our historical average.

Final question for me. In terms of capital structure, the debt levels have obviously declined. It seemed like the focus in '06 was removing some of the leverage. Now that you have removed some of that leverage, would you be more open in '07 to acquisitions?

We always have an active slate. And as I've said in the past, what we're focusing on more are the smaller bolt-on technology acquisitions that can really complement the product line. That's really where our emphasis is, especially as it regards Tech. Working on shifting their business model from being a pure contract manufacturer to a manufacturer that's focused on West proprietary products with higher margins is one of the top four priorities for the management team. So the acquisition strategy is to focus in that area.

Don, what kind of timeframe would you anticipate in executing on that planned transition?

It's going to be over the next couple of years. It's not something that's going to happen overnight. As the earlier questioner had indicated, we are in the process of evaluating the whole product portfolio with Tech. There are some things that make sense for us to produce. There are some things with our cost structure, given our engineering overhead and our technical overhead, that aren't going to make sense for us. We're going to look at it, and what we're going to do is work through it over the next 12 to 24 months.

Thanks. Congratulations again.

(OPERATOR INSTRUCTIONS). Arnie Ursaner, CJS Securities.

Can you give us your D&A guidance for '07 please?

Depreciation and amortization we do not give guidance for. I will give you -- the 2006 number was $52.7 million for the full year. It was up from 47.4 the year before. So, we expect it to increase as we have added a significant amount of capital this year. We've added $90 million, as I mentioned in the comments. But we are not going out with a specific guidance number there.

You have three major contracts with some very key customers that expired or are expiring. Have they been renewed? And if so, can you give us any feel for sort of the general trends you're dealing with on your major contracts?

Our most significant contract has been re-signed up. It's been signed up for five years. The other two are currently in the final stages. We're down to the nits and nats on a couple of items. We expect those to be finished by, conservatively, the middle of the year, to give ourselves a little bit of breathing room. So, it will be nice to get those behind us.

And focusing on the gross margin, a lot of people are concerned about startup expenses on new facilities and how that would impact your gross margin. A couple questions related to that. One is, were there any in Q4 that are noteworthy? And if so, what sort of startup expenses are embedded in your gross margin guidance for the upcoming year?

If you're referring to China, we did have some cost in China of $1.5 million for all of 2006. So it was very -- it was muted. In terms of our expectations for 2007, we haven't guided there. But as you saw in my commentary about the -- and in the press release, actually, the commentary about the gross margins and how they're being impacted in Pharm Systems slightly down, one of the reasons for that is the increased spending in China, and also the fact that we think that raw material, energy overhead, etcetera, increases are going to slightly outstrip our ability to pass them on through price increases in lean.

I'm a little confused by some of those remarks. Because one of the things that's been happening is you're moving up the value-add chain quite consistently, which is much higher-margin. I'm hearing that as a trend in looking at '07.

Yes.

And yet you're offsetting that. You've told us you've gotten full price relief generally for raw material costs.

In the past, yes.

In parts of '06 you were operating inefficiently as you were trying to meet client demand. I guess when I put all of that together, it would seem to me very logical that your gross margin would be trending higher, not lower, unless there are some sizable startup expenses.

In the long-term, Arnie, what you said is absolutely correct. The problem is that what we're seeing is as we start to -- remember, in '06 we were running at very, very high utilization of our plants, very high. And as we're starting to add the costs associated with these new programs -- not only the ones in China, but for the European expansion programs as well -- we're adding people, processes, etcetera, in advance of when we'll get the commercial revenue out of those. So you're naturally going to see a dip in the utilization of those plants, and therefore, you'll see -- with the additional cost and the dip you'll see a lessening of the margin in the short-term. Longer-term, you're absolutely right; your expectation that we believe we can drive margins higher is correct.

The other thing to remember there, Arnie, is that specifically as it applies to Europe, we're actually expanding plants within plants. So we've got to be careful to continue to run our operations as best we can to meet the demand while we're trying to put new systems and production lines into those existing walls at the same time.

Focusing on the 130 million or so for CapEx in the upcoming year, can you give us a little better breakdown of where some of that might be spent?

I have it. You have about -- almost half of it is going into Europe and Asia-Pacific, so say in that $75 million a year kind of range. A good chunk of it will go into North America, say, in that $25 million to $30 million range. And the rest of it will be for Tech.

And when you think about the total expenditure, how much of it would you view as maintenance CapEx and how much as growth CapEx?

In that number, in the 130 million -- let me back up a little bit. If you have -- if you think about our normal CapEx before we started this expansion phase, we were running in that $60 million to $70 million of total capital expenditures. And roughly half of that number was in the Pharm Systems space, so roughly a third to a half was maintenance, was pure maintenance. So if you're trying to translate that to the 130, I suggest that somewhere around probably a third would be a good number for what that amount would be maintenance.

Great. One more final question if I can on Tech Group. When you bought Tech Group, it had been growing in the low double-digits generally. And I know you embedded your prior plastics business into Tech Group. In trying to look at your 7% growth guidance for the upcoming year, if I were to think of what I would call the acquired Tech Group, what sort of rate of growth is that growing at at this stage?

It's going to be in the high single-digits.

About the same. In that same range.

You originally had talked about the industry growing 12 to 15, and you thought you had opportunities to gain share. What is causing the slowdown?

Really I think it's our focus on what makes sense to keep in the product portfolio. We've got a little bit of extra capacity in the lower-cost manufacturing areas. We're trying to be as selective as we can with the programs that we put in there. The other thing is that some of the longer-term projects that are coming out of our innovation group are going to require plastics cleanroom capacity for assembly, and we're reserving some of that capacity for West proprietary products.

Final wrap-up question on Exubera. I know you have been and may still be highly constrained in what you can say, but a lot of people are concerned about Exubera launching late. Can you just remind us of how your deal is structured with Exubera, and how much of your demand is tied to -- directly to their final sales? And if for some reason they have a dramatic slowdown, for whatever the reason, how would that impact you?

The contract, of course, is the cost-plus contract. It allocates half of the volume to us and half of the volume to the European producer here, regardless of the final point of sale. From the Nektar folks we get a detailed quarterly forecast and a rolling 12-month forecast, and there's been no changes there. They haven't modified the forecast at all. The next meeting will be in the middle of the year with regard to the project teams between the companies. And at that point we'll probably have a little bit clearer indication of what's happening in the market.

One thing, Arnie, I forgot to mention on the contract front. I believe we did a release on this. It wasn't a customer contract. The other significant contract executed, of course, was early this year, and that was our distributorship and technology exchange agreements with our partner Daikyo in Japan.

Steven Postal, Lehman Brothers.

I just had a couple of quick follow-up questions. One, you talked a lot about the capacity expansion. And I heard a lot of your comments, but I guess what I'm trying to build down to is how should we think about maybe the variability from quarter-to-quarter in '07 related to the capacity expansion? I guess what I mean by that is couldn't -- given there could be some timing -- there would be some issues in terms of timing of completion of capacity expansion, couldn't that impact the margin and profitability?

I think the answer is that we don't comment quarter-to-quarter. We like our full year, and we're a lot more comfortable there. I think what you're going to see this year is very similar to what we've seen the last three to four years. You're going to see a very strong first half. The third quarter has a little less visibility because of the planned shutdowns that we go through, as well as our customers. And the fourth quarter, of course, is when you've got not only shutdowns for the vacation holidays in Europe, and we shut down at the end of the year for preventive maintenance and other things -- also has a little bit less visibility.

What we do know is that we feel pretty good about the year, and we're going to have a good year in '07. There are some timing issues. Those timing issues relate not only to the timing of the CapEx, but when the actual systems come online. So up to the point where you begin -- you don't have any depreciation up to the point where you actually begin commercial operation of the equipment, and that depends on the timing of having your customer complete their validation runs on their own systems, and West complete our validation runs on the machinery itself.

But of course, Steven, from a cash flow perspective, we'll be going out cash first.

Understood. That's very helpful, actually. On the tax rate, I just noticed it looks like the last couple of years you've been running at about 29%. I guess it's not a significant variance, but you're guiding to 30%. Can you just maybe go through how you're thinking about that (multiple speakers)

Sure. An easy way to look at it is take a look at that 29% from 2006. That included about 1.4 percentage points of tax refunds and closeouts from earlier audit years that closed with the IRS and various other taxing authorities. So, if you try to look at it from an apples-to-apples basis, it's actually -- the 30% that we're estimating for '07 on a pure basis is a little less than what we had in 2006.

At this time there are no further questions.

Thank you very much, operator. Overall the senior management team and I are very pleased with the position West finds itself in to begin the 2007 year. Demand remains very strong in our key product lines and the major therapeutic segments that we serve. And by keeping our focus on the priorities we have outlined above, West expects to deliver another year of solid performance for our shareholders. At the current time we see continued sales growth -- strong sales growth for the first half of the year, which should yield full-year sales growth in the range of 10 to 12%. Revenues should exceed $1 billion for the first time in the Company's history, resulting in earnings per share of $2.20 to $2.35 per fully diluted share. Thank you very much for your time today.

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