西式醫藥服務 (WST) 2007 Q1 法說會逐字稿

Welcome and thank you for standing by. [Operator Instructions] I would now like to turn the meeting over to Ms. Theresa Kelleher. Ma'am, please go ahead.

Thank you. Good morning, everyone, and welcome to the West Pharmaceutical Services' First Quarter 2007 Results Conference Call. As you know, we issued our results this morning. The release has been posted on the Company's website located at www.westpharma.com. If you have not received a copy of this announcement, please call FD 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 forecasts 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 contingencies 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 conditions.

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 statements. For a nonexclusive list of those 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 now like to turn the call over to Dr. Don Morel, Chairman and CEO.

Thank you, Theresa, and good morning, everyone. Welcome to West's first quarter 2007 investor call. I'm joined for this morning's call by Bill Federici, our Chief Financial Officer, and Mike Anderson, West's Treasurer and primary investor relations contact.

Earlier this morning we released earnings and I'm pleased to report that the first three months of the year exhibited a continuation of the robust performance we experienced throughout 2006. Sales grew 15.6% before currency to $257.6 million versus $222.8 million in the first quarter of 2006.

Operating profit grew to $39.6 million, compared to $28.2 million, resulting in net income of $26.5 million or $0.77 per fully diluted share. In addition to the positive impact of currency, earnings also benefited from a lower share price, which lowered the cost of stock-based incentive programs for directors and managers. Bill will provide more in-depth commentary on our financial performance in a few moments.

The primary growth drivers that contributed to our outstanding performance in '06 remain in place. In the Pharmaceutical Systems segment, sales increased 19.6% before the impact of currency, driven by high demand for standard bioclosures and seals, I.V. fitments, and disposable medical devices. Overall unit growth in this segment was on the order of 5.0% and price contributed roughly 2.0% to the sales gain.

Our sales mix was also positive, as high demand for the Biotechnology Packaging segment continued, resulting increased sales of coated and Westar processed closures. Westar and Teflon-coated product sales were particularly strong in North America.

Sales of prefilled syringe components continued their positive trend, especially in Europe, and sales of insulin packaging components also delivered nice growth. We also experienced more moderate increases in demand for standard products used in vaccine packaging and components used for blood collection and other diagnostic applications.

Sales in the Tech Group segment grew at a more moderate pace of approximately 5.0% versus 2006 and were impacted by lower demand for engineering and tooling services, softer than forecasted juice closure sales due to a low crop harvest and soft demand for two consumer product lines, compared with the first quarter of '06. Results during the quarter were also impacted by the build out of the new Grand Rapids facility and subsequent transition of production to that facility.

We continue to evaluate all of our products in the portfolio as we focus on margin improvement for this business. In the business development side, we've been successful in winning a range of new programs and we continue to look for new technology and product acquisitions to shift the product mix to more proprietary programs at this business unit.

Overall, a very good start to the year and I'd now like to turn the call over to Bill Federici. Bill?

Thank you, Don, and good morning everyone. As indicated in this morning's press release, West reported first quarter 2007 income from continuing operations of $26.5 million or $0.77 per diluted share, $0.34 higher than the $14.3 million or $0.43 per diluted share we reported in the first quarter of 2006.

Last year's results included a $5.9 million charge associated with the refinancing of a portion of our fixed rate debt and a positive tax benefit from a prior year tax position. As the non-GAAP measures table in the morning's release indicates, excluding the effect of those two items, first quarter 2006 earnings from continuing operations were $0.54 per diluted share.

While there were no similar nonrecurring items in this year's quarter, results benefited significantly from the impact on stock-based compensation of the first quarter decline in the Company's stock price and the favorable first quarter impact of currency translation rates on our European operating profits. These items combined to increase operating profit over last year's quarter by $6.5 million or $0.13 per diluted share.

The Company's consolidated sales in the quarter were $257.6 million, a 15.6% increase over Q1 2006 sales, 4.7 percentage points of which related to currency. Sales growth in the core Pharm Systems segment continued to strengthen.

At $191.3 million, first quarter sales were 19.6% above 2006 first quarter sales, with 6.0 percentage points of the increase due to currency effects. Growth in Pharmaceutical Systems' domestic markets was particularly strong this quarter, accounting for nearly two-thirds of the segment's growth, with sales growing 23.2% over Q1 2006 sales.

The increase was, once again, led by increased demand for West's advanced coated components and Westar post-manufacturing processing of those components in support of customers' biotechnology, oncology and diabetes products. Some of the growth in the quarter relates to customer inventory builds to address peak demand and customer-requested order deferrals from 2006.

In addition, sales in the North America unit of the Company's Flip-Off Seals and I.V. fitments for disposable medical devices were also significantly higher. Pharmaceutical Systems' international sales grew by 17.4% in the quarter, versus the prior year quarter, with 9.7 percentage points of the growth due to exchange effects.

In dollar terms, the largest portion of the international growth came from Europe, where increased demand continued for pharmaceutical packaging components used in both prefilled syringe systems and vials for various drugs in the vaccine and biotech markets. Sales of components using West's advanced coated components and Westar post-manufacturing processing of those components were also contributors to our European revenue growth.

On a percentage basis, Europe's growth at 6.0% slowed somewhat versus prior quarters. Most European plants are now operating at or near peak capacity in critical areas and while we see no decline in customer demand, our ability to continue to grow sales is becoming very much capacity driven. New capacity is being added in all critical capacity-constrained production areas.

The Tech Group segment generated sales of $69 million in the quarter, 5.0% above sales in the prior year quarter, with 1.2 percentage points due to exchange. Sales to Nektar of the multicomponent insulin inhalation device increased by $6.6 million over the prior year quarter to a total of $9.9 million in Q1 2007.

In addition, two new products that had experienced delays - one a new product launch, the other a product transfer - produced sales in the quarter which contributed significantly to the growth over prior year. Partially offsetting these sales increases were volume declines with several customers, some associated with transfers of business and a slowdown in demand for or timing of tooling projects.

Turning to margins, consolidated gross profit margins for the quarter were 31.2%, comparing favorably to the 30.4% margins we achieved in the first quarter of 2006. Gross margins in the Pharm Systems segment strengthened to 37.6%, a 1.7 percentage point margin improvement from last year's quarter due to a favorable product mix, higher sales volumes generating improved overhead absorption and efficiencies from our lean program.

In the Tech group, margins decreased over the prior year quarter by 3.5 margin points to 12.2%. Tech's margin decline was primarily due to the impact of higher plant overhead costs, increased costs and inefficiencies associated with the Grand Rapids plant relocation and expansion, and a slowdown in activity in its tooling unit resulting in less absorption of costs in that unit.

Consolidated SG&A expenses increased by $700,000 in the quarter versus the prior year quarter. The increase was primarily due to increased compensation costs, mostly related to headcount additions, annual salary adjustments and incentive comp increases, the impact of foreign exchange and increased outside service costs.

These cost increases were significantly offset by the previously mentioned impact of the quarter-over-quarter decline of the Company's stock price on stock-based compensation of approximately $4.0 million and lower costs associated with the Company's U.S. pension plan.

As a percent of sales, Q1 2007 SG&A expenses at 14.4% were 1.9 percentage points below first quarter 2006 levels. Excluding the stock-based comp effect, SG&A as a percentage of sales was 14.9% in Q1 2007 versus 15.1% in Q1 2006.

Net interest expense was $2.3 million in the quarter, $700,000 below the expense incurred in last year's first quarter. The decrease was largely due to reduced interest rates on the Company's senior notes and lower average borrowing levels on our revolving debt agreement.

We also had a couple of other special items occur in the quarter that I wanted to expand on briefly.

As most of you know, we completed a public offering of $150 million of Convertible Junior Subordinated Notes. An additional $11.5 million over allotment was issued in April. The four-year notes pay interest at 4.0% annually and after paying off some higher-cost revolver debt, approximately $110 million of the proceeds has been invested in short-term liquid investments currently earning just over 5.0% interest. The proceeds will be used to support our capital expansion plans and to fund possible technology acquisitions.

We are also pleased to report that we finalized a closing agreement with the IRS on a claim we filed in 2006. The claim is for U.S. ordinary deductions for losses related to our drug delivery business and our closed UK plastics plant.

The settlement creates a permanent cash flow benefit of $23 million over 2007 and 2008. The financial impact of the settlement was included as an increase in retained earnings associated with the Company's first quarter adoption of FIN 48 on Accounting for Uncertainty in Income Taxes.

I wanted to also mention that commencing this quarter, we have begun to include R&D expense as a separate line item in our quarterly income statements. Previously, we had only disclosed our ongoing R&D investment annually in our 10-K. The intention in making the change is to highlight the growing investment the Company is making in R&D.

The effect of the reclassification for the quarter was to reduce SG&A expense by $2.5 million and reduce COGS by $1.1 million. As we addressed in our year-end earnings release, we expect to spend approximately $14 million in 2007 on R&D, approximately $3.0 million or $0.06 per diluted share more in 2007. This represents a 30% increase over R&D spending in 2006.

Turning to the balance sheet and liquidity, the Company's cash balance at March 31st was $156.6 million, a substantial increase stemming from the $150 million debt offering we concluded in the quarter.

Working capital totaled $278.9 million at the quarter's close versus the $125 million of working capital employed at December 31, 2006. The increase is primarily due to the invested debt proceeds of approximately $110 million and increased AR arising from our increased sales in the quarter.

Debt at March 31st was $377.1 million, an increase from the $236.3 million that existed at year-end, due also to our debt offering. Our debt to total invested capital ratio at quarter-end was 44.8%. Our net debt to total invested capital at March 31st was 32.2%.

Operating cash flow was approximately $4.0 million for the quarter and we incurred capital expenditures of $20.9 million in the quarter, with more than 50% of the quarter's capital focused on new product and expansion activities.

In summary, we experienced another record setting operating quarter, the best in our Company's history.

Looking ahead, our order backlog at March 31st remains strong at $256 million, compared to our year-end backlog of $250 million. Coupling that with our strong first quarter performance, we are now projecting 2007 earnings to be between $2.27 and $2.37 per diluted share, including the approximate $0.03 dilution expected from the convertible debt offering.

We are maintaining our sales guidance at $1.0 billion, but now expect a stronger mix of those sales and are increasing our expectation of consolidated gross margins for 2007 to 29%. The strong growth we enjoyed in the North American unit of Pharm Systems is expected to continue, supporting our increased expectations.

We remain cautious of the short-term growth in our European business, partially due to the capacity constraints we are currently operating under. Gross margins for Pharm Systems are now expected to be 34.5% for the year.

Our expectations are that Tech will continue to experience slower than originally expected 2007 growth in sales and gross margins, as the segment shifts towards higher margin business. Gross margins are expected to be approximately 14.8% for 2007.

These estimates for Tech assume $32 to $36 million of Exubera device sales at approximately a 30% gross margin. We have allowed for likely scenarios of slowing device production in our guidance range. We still expect our full year 2007 capital expenditures to be approximately $130 million.

Generally, our CapEx spending has been progressing as planned. In China we have experienced some delays in obtaining the necessary land use certificates from the local governments. Those certificates are expected to be received this summer. The timing of receipt of those certificates may impact our ability to spend all the capital expenditures estimated to be spent in 2007.

I'd now like to turn the call back to Don Morel. Don?

Thanks very much, Bill. I'd now like to spend just a moment reviewing our outlook for the year and priorities for the remainder of the year.

The management team is pleased with our Q1 performance, given the strong results posted in 2006. We believe we continue to be well positioned to expand our leading role in components and systems for the injectable administration of therapeutics, vaccines and diagnostics and generate sustained growth in the years ahead.

For 2007, we will concentrate on delivering improved performance while adding new capacity in key product lines, develop and launch innovative new products, and begin shifting the Tech group away from a pure contract manufacturing base to an increasing percentage of sales from proprietary West products.

In terms of market drivers, the increase in chronic diseases such as cancer and diabetes and others due to an aging population will drive growth in high-value drugs, such as biologics, virtually all of which are delivered by injection and packaged with West systems.

With more compounds coming off patent, demand is anticipated to increase for novel delivery platforms and packaging systems to offer the innovator companies a new way to differentiate their products. Systems that can improve ease of administration, safety and dosing accuracy will be in high demand, especially in patient groups with decreased dexterity.

We expect continued strong growth in prefilled syringe component demand, as delivery platforms continue to migrate into prefilled dosage forms, including self-injection systems.

For the remainder of 2007, our management priorities remain unchanged -- delivering maximum value from our key growth drivers, including Westar, FluroTec, prefilled components and reconstitution systems; running our operations as efficiently as possible, expanding our capacity and our geographic footprint; shifting the Tech business model, commercializing our innovation programs and strategically acquiring technology and products that complement our core packaging and delivery platform businesses.

In terms of new products, although it is early in their launch, we have seen very good market acceptance of our Spectra Seals for anti-counterfeiting and track and trace applications and also our recently launched certified Clean Seal. These are aluminum over-seals used to retain the rubber stopper in place, which are processed using a Westar-type wash to reduce particulate contamination.

Sampling of a new I.V. fitment called [Insucap] in markets in the Asian Pacific Rim has also gone quite well. I'd like to remind everyone that for new products launched in our pharmaceutical packaging business, we will not generate significant revenues for the next 12 to 24 months as the products penetrate the market. This time is necessary for West to validate production processes and for our customers to perform the appropriate testing and line trials.

The Tech team has also been successful in developing new business, winning new programs for next generation insulin delivery, glucose monitoring and novel injection systems. The group also secured new business from two existing customers, one in the consumer area and one in the medical device field. We expect these programs to begin generating revenue later in the year.

For the Exubera device, we continue to produce according to the forecast provided by our customer. We expect to receive an updated forecast later in the second quarter, but for now, production is continuing at 21 shifts per week.

Turning to our expansion plans, our Europe and Asia plant expansions are progressing on schedule. We are simultaneously adding key product capacity to five facilities in this operating region. This capacity will be in standard products for small volume vials, Westar lines and FluroTec molding to meet anticipated demand.

In China, all approvals are in place and we are ready to break ground once our land use certificate is issued. This has been delayed due to the government's stated intention to moderate China's explosive economic growth. We now expect to receive it towards the end of the second quarter.

In terms of risk factors, the management team continues to monitor our plant loading and utilization very carefully, especially in Europe and North America where pharma production plants are running at or near capacity. Other risks for the year include those discussed on previous calls - energy prices and transportation costs, the cost and availability of raw materials and currency rates, especially in Europe.

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 unpredictability of new product approval timing by the regulatory authorities in the countries in which we, and our customers, operate. The successful commercialization of our products depends both on the regulatory process and customer testing.

In sum, the stage has been set for another very good year, especially given the growth experienced in 2006. Demand remains strong in our key product lines and the major therapeutic segments we serve and we are winning new business for the Tech group.

By keeping our focus on the priorities outlined above, we expect to deliver another year of solid performance for our shareholders. At the current time, we see full year sales growth, excluding the effects of exchange in the range of 10 to 12% to over $1.0 billion and as Bill indicated, this should yield EPS growth of 18 to 23% to $2.27 to $2.37 per fully diluted share.

Thanks very much for your time. Bill and I would now be pleased to answer any questions you might have.

[Operator Instructions] Our first question comes from Arnold Ursaner with CJS Securities

Hi, good morning.

Good morning, Arnie.

A couple of questions, if I can, on Grand Rapids. You mentioned this facility in some relocation and expansion costs. Can you give us a better feel to quantify some of those costs, if you would, in the quarter?

Yes. Let me just make a quick comment on what's going on and then Bill can quantify the costs. Due to business that we had won in earlier years and growth in the product lines, the existing Grand Rapids facility last year we had simply outgrown it. And the plant floor did not allow for any future growth to go there.

We acquired a facility a couple of miles away from the existing facility, which we had a shell building and we decided to fit out and that's what's in the process of happening. Now, as we're transitioning the products that were in the existing facility, we also won a major program with a new customer, which is going into the new facility as well. So two things are happening at once. Bill?

Yes. If you compare quarter-over-quarter, Arnie, on a gross margin basis, it was a loss of $1.2 million between the two quarters. We had a gain in last year's quarter of about $0.5 million and we lost about $700,000 in that facility in the first quarter of '07.

Got it. Second question I have relates to your stock-based comp. Last year, if my math is right, you had a little over $12 million of stock-based comp expense and I think we had expected it to be in the range of about $2.5 million. So I know you're highlighting the $3.8 million delta, if you will?

That's correct.

But what is the actual expectation you have for the full year for stock-based comp?

What we've got is the $2.5 million is still roughly about what we're looking at. We're looking at, roughly, a $2.00 increase each quarter over the year.

Right, but it's still down quite sharply from last year.

It is and that's why we got it in, but again, we're trying to project out what we think what will happen during the year and so we put some of that additional cost into our forecast.

Sure. Two more quick questions. In your backlog, one of the things you've been noticing is you had, I think, gotten some backlog orders in because clients were seeing pretty good stretch outs of deliveries. What is the current status of that, please?

There's probably still a little bit of that in the backlog, Arnie, especially on the seal side. We are running very hard out of our Clearwater facility. We've got new machines coming in and new capacity coming in. But that's probably the area where we've seen it the most. There's a little bit on the FluroTec side, as well as demand there has continued to be pretty strong.

Okay. One more question, if I could, about the core business? What percent of your pharmaceutical revenues these days would you attribute to the -- obviously your strategy was value-added products. You're doing it quite well. What percent of your revenues currently are value-added products like Westar?

We're going to have to get back to you. We'll do an envelope calculation and get you that number.

Okay. I'll jump back in queue. I have a few more, but I'll go back in queue. Thank you.

Okay, thank you.

Steven Postal, Lehman Brothers.

Hey, good morning, guys.

Good morning, Steven.

I know you mentioned that I guess there was some inventory build of some of the products in the quarter. Can you just maybe give us a macro view of how you view inventory at the customers?

We do the best we can to work closely and make sure that we understand any changes that they may be undergoing. Last year, as you'll recall, that was driven by customer plant expansions in Europe, so they had built up some inventory ahead of time of shutting down.

Those kinds of things we can generally deal with pretty well. Every once and awhile, you'll just have a change in purchasing philosophy at the customer, where they'll go from six months of inventories to three months. Sometimes those can be a bit of a surprise and that's why we tend to try and guide the years rather than quarters.

But overall, we're in pretty good contact and we've got a pretty good handle on it, but it doesn't prevent the odd surprise here and there.

Okay. But it sounds like they're -- is it fair to say no significant change in the view of the level of inventory at customers?

No, no, not that we know of.

Not that we know of.

Okay. And then I just wanted to pursue the cash flow and I guess the AR and I guess, if you look at the balance sheet, you had a big sequential decline in AR in the December quarter. And does that partly explain why there was cash flow use in the March quarter or you expect more normalized cash flow trends over the next few quarters?

It's really a function of increased sales and Steven, I mean, we increased sales significantly during the quarter, so a lot of that's going to end up in AR. Our DSO did not have any significant change from the year-end to the end of the first quarter. We will have a little bit -- that could be a little bit of calendar effect.

I mean, I don't know if customers were doing some kind of balance sheet dressing at the end of the year and may have paid down a little faster than normal. I'm not sure, but again, we looked at it and we don't see any unfavorable trend we're concerned with. The DSOs are about where we would expect them to be and again, it's really just a function of the increase in sales.

Okay and then on the subject of capacity, you mentioned that your growth in Europe is being constrained right now. Can you just remind us of how much excess capacity you have now and the timing of new capacity coming onboard?

Yes. We have very little excess capacity now, particularly in the primary pharma plants in Eschweiler, Germany and Le Nouvion. We are adding new lines and new finishing lines in each one of those facilities and we expect those to come online over the next really kind of 12 to 24 months.

Specifying when capacity comes on is kind of difficult, because we will have new presses and new molds in place producing product. But that may or may not go through the Westar process and the finishing process. So right now, the constraints are really in mold capacity for the Teflon and FluroTec-based products and Seals in North America.

We'll be continuing to add capacity, as we've talked about, in Europe and Asia in particular over the next three years to meet forecasted demand. So the business outlook is very good. We're being a little cautious with our guidance as it relates to Europe because of the current capacity situation.

Okay and then just to follow-up on that, I mean, Don, it sounds like the difference between the growth in U.S. and international. Is the variance there primarily capacity?

We had a little bit of extra capacity in North America, but what we've really seen in surging demand from conversion of standard product to Westar and also a pick up in Teflon sales. Both of those segments experienced rather significant growth versus prior year in North America.

Okay and then on Exubera, Don, you mentioned that you're going to get an update sometime in Q2. Do you expect you'd be in a position at that time to update us inter-quarter?

Yes. I think we should be. We'll probably update you in the quarter call in July.

Yes. We're not sure when exactly we're going to get it, Steven, and obviously we've got to absorb it and figure out what it all means.

Yes. But right now, like I said, there's been no change in the production demand and we're running with three shifts today.

And as we said, we've taken a crack at what we think a likely scenario would be and we've built that into our projections.

Okay and so in the context of your guidance, your EPS guidance, is that still including, I think it's the $32 to $36 million in revenues? Or are you taking broader scenarios beyond that?

We've taken broader scenarios beyond that. But it does include -- the base case is the $32 to $36 million.

Okay. Thanks a lot, guys.

Thanks, Steven.

Carlos Garcia-Tunon, Morgan Stanley Investment Management.

Good morning, thanks for taking my call and congrats on the strong first quarter.

Good morning. Thank you.

I just wanted you to elaborate a little bit on the Tech group. I thought - and I may be wrong - from your analyst day last year that you anticipated the Tech group to be growing possibly at the same rate, or even faster, than your core business. And I don't know if that was sort of based on higher expectations for Exubera and it sounds like there's some other factors that impacted the first quarter negatively. But maybe if you can just, as I said, elaborate on some of the issues facing the Tech group and which ones of them are more temporary in nature?

Sure, sure. Yes. A couple of things contributed to the year-on-year change. One we talked about obviously was the Grand Rapids facility and the fact that we were growing so fast there. We needed a new footprint and obviously that had an impact on the numbers.

The second is that throughout last year we had extraordinarily strong tooling and engineering orders. We run that center in support of new and existing programs and we had lower than expected revenues off of that particular segment in the first quarter. So that was an impact as well.

As I mentioned in the call, on some of the consumer products you're going to have up and down shifts that can occur pretty quickly. And this year, in the beverage closure part of that, we were down roughly about 10% versus prior year, simply because of the crop yields out of the juice crop.

On top of that we did have a couple of consumer products that experienced softer-than-anticipated demand and we also had two delayed product launches which just did not get started until the latter part of the first quarter. So we had a whole confluence of things that took place there.

The other thing that's going on is that, as we've stated on a number of occasions, the acquisition of the Tech group was really to give us a device assembly and engineering platform. And as we go forward, we are going to be winnowing out product lines that don't hit our hurdle rates and moving in West proprietary products that are being grown internally, as well as brought in from the outside to drive a performance improvement in the margins.

For the rest of the year, you're probably going to see more moderate growth in Tech, but that's going to be completely offset by stronger demand in the Pharmaceutical Systems segments. So we don't think we're going to see any impact to our overall year.

And as far as margins for the Tech group, they're obviously much lower and I think you all had talked about the opportunity to expand margins.

Yes.

How do you see that playing out maybe this year and next year?

It's really a longer-term perspective, because of the regulated nature of the majority of our products in the Pharm Systems side. This is probably a two-to-three-year project for us. We've got some great opportunities that we're working on.

But to really drive the margins, you've got to get intellectual property-based products into your selling queue and right now there's virtually none of those at Tech, which we knew when we acquired it. So we're looking at probably a two-to-three-year proposition.

Okay, thank you very much.

Thank you.

Arnold Ursaner, CJS Securities

Sure, a few follow-up questions.

Sure.

What were your Q1 tooling revenues, please, and what were they last year?

Hang on, we're digging.

Okay. While you're digging, in your prepared remarks, Don, I think you mentioned you had a 2.0% price increase in domestic. I want to make sure I heard that right.

Yes. Price contributed 2.0% to the growth in Pharm Systems in terms of the revenue growth.

So a simple question, given that your raw material costs probably grew more than 2.0% last year. Are you not even fully recovering your costs?

Well, as I've said, what we've always done is recover that and cover them, more than cover them, with a combination of price increases and lean initiatives ongoing in the plants. So the combination of those typically allow us to overcome our cost increases, not only in raw materials but also labor [inaudible - multiple speakers].

But why would you not -- given your capacity constraints, given the fact the customer can't go anywhere else, why would you not be improving the margins even further by at least recovering your costs?

Yes, well, as you know, many of the products in that segment are covered by long-term contracts, so they are fixed for a one-to-two-year period.

Right. So which of those are now coming -- you had three major contracts you were hopefully going to re-sign during the first half of the year. I think you mentioned last call you had gotten one. Have you gotten the other two signed?

We don't have them signed yet. They're probably going to occur sometime -- one will occur sometime towards the middle of the year. The other one is principally in the med device segment and that will probably occur later this year. So the negotiations are ongoing.

Okay and in those, are you hoping to fully recover the fact they've been under-priced for the last two or three years?

We're negotiating as hard as we can and I can tell you it's challenging and interesting.

Okay. Can you -- one of the things that at least one of the other analysts on the stock had been expecting were startup expenses and inefficiencies from your plant expansion. Can you quantify what those were in Q1 as best you can?

Other than the Grand Rapids thing, which I've already quantified for you, we don't have anything that's -- there's no dramatic amount that we would want to cull out for you.

Okay. On Tech group I have a couple of questions. I'm trying to get a better understanding here. You had two previously delayed projects where you had had facilities waiting, being completely unutilized waiting for these products to occur. You mentioned that both started to sell at the very end of the quarter.

Right.

Can you try to give us a revenue and margin impact it may have had in Q1, but much more importantly, now that these are up and running, what sort of revenue contribution and margin expectation should we expect for the balance of the year?

On the revenue impact, the revenue impacts were small, as you suggested. They're not significant. And we do have some inefficiencies associated with them, but both of those products are at what we would consider to be at the higher end of Tech's margin scale. So once they get up and running and they're fully efficient, we'll be able to hopefully have a positive impact on gross margin. The impact on the sales line, just so you have it, was only $3.5 million in the quarter for both of those products.

And what is the expected revenue contribution perhaps for the balance of the year from the two of them?

I would suggest that you'd probably be able to take that number and multiply it by four.

But you only had them for, like, a month or so of revenue in Q1.

No. They started at the beginning of the year.

Well, now, wait, let's be careful. The one came and started mid-February.

Right.

Okay. The other one started the early part of February. Part of the issue was that the one product is an OTC consumer product with special packaging. That, I think, goes right through the rest of the year. You could multiply that out by four for the part of the $3.5 million that's that product.

The other one is a seasonal product that is used to treat colds. So what you're going to see is a downturn in that through that year and then it's going pick up again in the third and fourth quarters as they build inventory for the new cold season.

Yes.

Okay. Two more questions, I'm sorry.

I was going to give you the tooling numbers that you were looking for, Arnie.

Okay.

It was $11 million tooling revenue in 2006 first quarter and it's $7.0 million in 2007 first quarter.

Okay and tooling revenues normally are precursors to revenue. Should we be concerned at all that the tooling revenues have slowed down pretty materially?

Well, they slowed down in the first quarter. We've actually seen a pick up as we move into the second quarter, so it's one of the vagaries of the business, dealing with changes quarter-to-quarter.

Is that one of the reasons why your margin guidance -- because that essentially has been minimal margin business. Is that one of the factors in your margin guidance?

Yes.

Okay. On Exubera, I'm a little confused here. I thought in Q4 you were basically running all out and have $8.8 million in Q4 revenues and you indicated your Q1 revenue was $9.9 million. If you were running all out three shifts in Q4, how did you get that much of an increase in revenue in Q1?

It really goes back to the contract, Arnie. It's a cost-plus contract. So as we added costs, we were able to get more revenues out of the business on slightly more units.

Okay. I think that's it for me. Thank you.

Okay. Thanks.

Bentley Offutt, Offutt Securities.

Hello?

Hey, Bentley.

Good morning. Hey, I have a question. There was a comment relating to the counterfeit seals and the growth opportunity there. Are those seals produced in Clearwater? Is that Clearwater, Florida? Is that where they're produced?

There's actually a split. What we call Spectra is produced in Clearwater, but the certified clean seals, which are a different product, are actually produced in Europe. We're getting ready to transition that to the U.S. once the launch is complete in Europe. So, yes, they are produced in Clearwater.

Have there been new federal regulations relating to the counterfeit seals? I know last year it was proposed at the beginning of this year that that legislation would go into effect.

Yes. No, there's no new regs. The FDA is looking closely at the RFID side of the coin, as I'd said previously. But the guys on the high value-add part of the drug thing, for them to incorporate an RFID tag or other anti-counterfeiting technologies into the package, it makes sense, because the cost is de minimis compared to the cost of the drug. So track and trace and authenticity verification potentially is going to be a pretty good product for us with Spectra.

But at this particular time it's small?

At this particular time it's small, yes. As we've stated before, when you get a new product like this, even though dimensionally it may not look like there are many changes to the seal, our customers run very careful line trials over a series of months to make sure that they can maintain their line speeds with a different product.

I've got you. So when do you see that really starting to become an important part of the seal business?

I'd probably look 12 to 24 months downstream. I think its going to pick up speed gradually. It's been, on the sampling front, pretty strong for us and we've had a number of development agreements in place to do custom seals for our customers. I think revenue in the quarter was about $3.0 million from it. So combined, over the next 12 months I think you're going to see that pick up and in the future we think it'll be a good product for us.

Has this become an important product in other countries such as China or the Far East where a lot of the problems seem to be occurring and also in certain parts of Europe?

Well, I think you have to look to the actual producer for that. They're the ones that do the end-market sales. For the most part, our sales will be directly to them and then they will distribute into those countries. But the likelihood is that they'll be incorporated as a standard part of the package for track and trace during the production process, and of course, downstream for the anti-counterfeiting.

Thank you, Don.

Thanks, Bentley.

Steven Postal, Lehman Brothers.

How are you doing, Steve.

Hi. I just have two quick follow-up questions. One is you mentioned a delay in the land certificate in China. Would that impact your planned use of this cash and if there was further delay, would you -- I think you vaguely mentioned in the past a share repurchase. Would you consider something like that if your CapEx guidance was impacted by any delay?

Well, we continue a lot of things. There's nothing on the dock right now in that regard. The only way that's going to impact our cash flow or our capital expenditures is if it extends much beyond the middle part of the third quarter.

The situation in China, we're in very close contact with the new governor in the Shanghai Province. But the land use certificates are actually issued out of Beijing and as everybody knows that's followed China, the government has stated its desire to really try and cool down the economy a little bit. So we're not the only ones affected.

What we have heard from the governor of Shanghai is that we're number one in the queue. The project is still a go, but they have to wait for approval from Beijing.

Okay and then just one clarification on the Tech group and Exubera. I mean, as I look at it, it's obviously a significant contributor to the gross profit there. To the extent that there would be any deceleration or change in the growth rate in that business, do you have flexibility or how comfortable are you with the flexibility of managing your costs, as it pertains to that product line and that business?

We do have some flexibility there and I can guarantee you we're taking a good, hard look at it.

Okay. Thanks a lot.

Thanks, Steven.

Thank you. At this time there are no further questions and I would like to hand the call back over to Dr. Don Morel.

Thank you, Operator. Three months into the year the Company is off to a strong start. We look forward to another year of delivering solid financial results as we continue to invest in the growth drivers of the business. Thank you very much for your time today.

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