西式醫藥服務 (WST) 2008 Q4 法說會逐字稿

Welcome to the West fourth quarter earnings conference call. At this time, all participants are in a listen-only mode. (Operator Instructions).

Today's conference is being recorded. If you have any objections, you may disconnect at this time. Now I will turn the meeting over to Ms. [Teresa Geller from FD]. Ma'am, you may begin.

Thank you. Good morning, everyone and welcome to West's fourth quarter 2008 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 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, 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, intends, believes, plans, anticipates, and other words in terms of similar meaning in connection with any discussion of future operating or financial performance or condition.

We cannot guarantee that any forward-looking statements 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 obligations to publicly update forward-looking statements, whether as a result of new information, future events or otherwise.

In addition, Management may make reference to adjusted operating profit and adjusted diluted EPS that are considered non-GAAP financial measures. These measures have no standardized meaning prescribed by the US GAAP, and therefore, they may not be comparable to and should not be viewed as a substitute for US GAAP operating income and diluted EPS. Reconciliations of the non-GAAP financial measures and most comparable financial results compared in conformity to GAAP are provided in the materials accompanying this morning's earnings release.

This call is being recorded on behalf of West and is copyrighted material. It cannot be rerecorded for rebroadcast without the Company's expressed permission. Your participation on this call implies your consent for 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 Dr. Don Morel, Chairman and CEO.

Thank you, Teresa, and good morning, everyone. Welcome to West 2008 year-end conference call. We appreciate you taking time to join us this morning. As Teresa mentioned, joining me for the call are Bill Federici, West's Chief Financial Officer, and Mike Anderson. our Treasurer and primary Investor Relations contact.

To begin, I'll briefly summarize our fourth quarter and full-year 2008 results followed by an update on our major development projects and our capacity expansion programs, and finish up with a summary of our outlook for 2009. Bill will then discuss our financial performance in greater detail before we open the call for questions. I should point out, as we mentioned in our press release, comparisons with 2007 are difficult due to nonreoccurring sales of [Erythropo] and stimulating agent packaging components, Exubera inhaler devices, the impact of the settlement with Nektar Therapeutics, restructuring charges, and several discrete tax items in both periods. Further complicating the picture for the full-year are the dramatic swings in Euro dollar exchange rates and the swing in oil prices through the year. We will call out the impact of these factors during our commentary where appropriate.

I'm pleased to report that we finished 2008 with a strong fourth quarter. Consolidated revenues were $244.9 million, an increase of 4% over the fourth quarter of 2007, excluding lost sales and currency effects. Fourth quarter adjusted diluted earnings per share from continuing operations were $0.56 per share, versus the $0.51 in 2007. Our Q4 earnings were negatively affected by $0.05 due to unfavorable exchange.

Consolidated gross margin improved by 0.9 percentage points during the quarter to 28.4%. And for the full year, revenues grew to $1.05 billion and fully diluted adjusted earnings per share were $2.38, both consistent with our guidance at the outset of the year. Adjusting our sales and earnings for the year to account for the impact of lost sales and the impact of currency translation provides a better basis for comparison and would yield sales growth of 6.8% and earnings per share growth of 18.3% versus 2007. Given that we started the year with a roughly $60 million sales gap and an operating profit shortfall of approximately $25 million, and faced with a less than favorable economic climate in the second half of '08, 2008 overall was a very good year for the Company from an operating standpoint.

Overall, our financial condition remains very strong. Our net debt to total capital ratio is 38%. Our operating cash flows provide ample resources to fund our expansion and R&D programs. And the structure of our debt requires no new financing until April of 2011 when our revolving credit facility will need to be refinanced.

Turning to our segment results, adjusted sales in the pharmaceutical systems division grew approximately 5% driven by strong demand for sales and authorization closures, and Westar treated closures. Currency translation effects reduced sales and gross profit by $13 million and $4 million respectively during the quarter. We also recorded our first order for [ESA] packaging components and anticipate sales for these items increasing gradually throughout 2009, although they will not return to [pre-CMS ruling] levels.

On another positive note, sales in Asia were particularly strong, with sales in India and China growing 31% and 26% for the year respectively, albeit off of a relatively small base. Within the tech group segment, revenues were $66.2 million for the quarter, a decrease of roughly 5% as a result of lost Exubera sales which totaled $5.3 million in the fourth quarter of 2007. This is the last period that will be compared with the prior period for Exubera sales. Adjusting for the lost sales, revenues at tech grew approximately 2%.

Tech did continue its margin improvement due to strong demand for medical devices and filter components, coupled with much improved operating efficiency in tech's Puerto Rico and Grand Rapids operation. Gross margins improved 0.6 percentage points overall versus the prior year to 12.3%. The restructuring initiated at the end of 2007 is now largely complete, having been accomplished under budget and yielding cost savings ahead of plan. Bill will provide greater detail on our segments results in a few moments. Overall, in light of the numerous challenges we faced throughout the year, I would say that our results reflect the underlying strength and resiliency of our business, and our success in offsetting higher costs through an effective combination of improved operating efficiencies, spending controls and cost offsets.

Turning quickly to our ongoing capacity expansion projects, our operating groups made substantial progress against our goals while holding total capital spending to $131 million, versus a budget of $145 million at the outset of the year. Our China plastics facility begun in the first quarter of 2008, will be competed in the first quarter of this year, and following systems validation and testing will begin commercial production in the third quarter. Production has begun on newly installed systems both in Germany and Serbia facilities. Singapore will be completed in early third quarter. Our project team in India has identified a site for our future rubber manufacturing facility. Also, through a redesign of our plant layout in Clearwater, Florida, the project team managed to increase capacity and throughput to the point where a planned $3.5 million capital expansion investment can now be deferred. Also, the North America SAP conversion is on schedule and budget with the next plant switchover scheduled for mid-2009.

In terms of our three new major product development programs, [Nova Guard, Confadose, our proprietary auto injector, Daikyo crystals enithresin], we also made excellent progress during the year. The Nova Guard five 10-K was filed with the FDA at the end of the third quarter. This was West's proprietary passive needle safety system. And following the completion of ongoing trials, we hope to have approval for commercial marketing early in the second quarter of this year. We completed the sample customers with the first prototypes of Confadose and we continue to see growing interest in the application of Daikyo crystals enithresin to packaging and storage systems for a range of challenging molecules.

Throughout the year, there was a substantial increase in the number of customers performing stability studies with CZ in both bio and syringe formats. We also received our largest order to-date for samples to be used initially in a filling trial, followed by a clinical trial planned by a customer for the fourth quarter. Trial therapeutic areas when new molecules are undergoing stability and incompatibility trials include cancer, auto immune diseases such as lupus and and arthritis, macular degeneration and vaccine. Overall, I'm very pleased with our progress on both our capacity expansion and development programs for the year.

Looking ahead to 2009, there is no doubt that all sectors of the economy are to varying degrees feeling the effects of the global downturn, and this includes healthcare. Many of the challenges that arose in the second half of 2008 will remain with us through the end of 2009, and when coupled with the economic outlook globally, make 2009 a much more challenging climate to manage through than 2008. That having been said, overall we believe we will see organic growth in the pharmaceutical systems segment of 6% to 8% excluding currency, with tech sales down slightly due to contractual resin costs pass through impacting sales in that segment.

It goes without saying that both individuals and companies are managing their spending very carefully. Our pharmaceutical and healthcare customers are seeing this in their businesses. And while we have no specific indicators for down stream consumption of our products, recent customer order input suggests that many of our customers are simply looking for ways to reduce working capital and are being careful with placing orders, thus providing some uncertainty to our normal visibility. Although our backlog remains strong overall, the composition and timing of orders leads us to slightly reduce our overall growth expectations to between 3% and 5% before currency effects.

Secondly, we absorbed significantly higher costs in 2008, and as result of the terms of our purchase agreements, some of those higher costs will continue into and through the first quarter of 2009. While we expect to get some relief as the year progresses, we remain wary of renewed volatility, specifically in the global oil market. Currency translation provided us with a tailwind during the first three quarters of '08, but turned against us in the final quarter of the year and we expect it to work against us through 2009, where we think it will cost us about $70 million in reported sales and approximately $0.26 in earnings per diluted share. Additionally, pension assets, consisting of investment securities, suffered a setback in value as a result of the decline in equity markets during 2008, which will also have a measurable impact on our results in 2009.

Given these circumstances, we clearly faced a broad range of challenges in developing our plans for 2009 and beyond. We are taking a longer view and sticking to our strategic plan. We are doing this because we believe our financial strength provides us the ability to continue to invest in our primary projects which have long lead times and span economic cycle. We also believe that the cost of any delays, in terms of opportunities lost or deferred, outweighs significantly the potential near term cost savings.

However, this having been said, we will continue to periodically review all of our development and capital plans for opportunities to effectively reduce, defer, or eliminate costs. The outlook we are sharing with you this morning reflects those reductions and deferrals where they make sense. We also continue to look for acquisition opportunities at appropriate valuations to bolster our product and technology portfolio. Given our global manufacturing footprint, strength in biologics packaging and pipeline of delivery systems, I believe our value proposition remains sound. And the strength of our current product portfolio coupled with the depth of our balance sheet will continue to serve us well in 2009 and beyond. I would 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 fourth quarter 2008 income from continuing operations of $17.6 million or $0.52 per diluted share versus the $0.19 per diluted share we reported in the fourth quarter of 2007. Excluding the effect of certain items in both years, fourth quarter 2008 adjusted earnings per share from continuing operations were $0.56 per diluted share, $0.05 better than the 2007 fourth quarter adjusted earnings of $0.51 per diluted share.

The Company's consolidated fourth quarter sales were $244.9 million, an increase of 1% over fourth quarter 2007 sales, excluding the negative effect of foreign currency translation and a 4% increase over Q4 2007, excluding FX and lost sales. This was the first quarter in several years that exchange had an unfavorable impact on sales and earnings, but we expect the continued relative strength of the US dollar to adversely impact reported results for each quarter of 2009 compared to 2008.

Fourth quarter sales in the pharm systems segment were $181.6 million, and grew by 3.7% over fourth quarter 2007 sales excluding currency effects. The relatively modest growth was expected due to the decline in demand associated with discontinued production of the disposable medical device components in Europe. Excluding the effect of those lost sales in foreign exchange, pharm system sales grew by 5% with mostly the growth in North America and Asia.

The tech group segment generated sales of $66.2 million in the quarter, 5.3% below sales in the prior year quarter excluding exchange, largely due to the lost Exubera sales to our former customer, Nektar. In the fourth quarter of 2007, sales of the Exubera device were $5.3 million. Excluding the Exubera sales and currency effects, tech's Q4 2008 sales were 2.3% above Q4 2007 sales due to solid increases in demand for several products including IV and blood filter products manufactured in our Michigan and Puerto Rico facilities and [stout pack] closures for juice and dairy cartons.

Looking at margins, consolidated gross profit margins for the quarter were 28.4%, nine-tenths of a margin point better the 27.5% margins we achieved in the fourth quarter of 2007. Gross margins in the pharm systems segment were 33.8%, six-tenths of a margin point above last year's fourth quarter margins with most of the improvement coming from the Americas units. The impact of lower sales, a $3.7 million adverse FX translation, and higher raw material costs, and higher utilities and labor costs, were offset by pricing and operating efficiencies.

In the tech group segment, margins also increased over the prior year quarter by six-tenths of a margin point to 12.3%. The margin improvement was due to lower direct labor costs, coming from increased manufacturing efficiencies now that several of our new product transitions are behind us, and increased utilization and better overhead absorption in several plants. The cumulative effect of the margin improvements more than offset the impact of higher raw material prices, which were mostly passed through to customers, and the 1.9 margin point decline related to the loss of the Exubera device revenues which were included in Q4 2007 margins.

Consolidated SG&A expenses decreased by $2.7 million or 7% in the current year quarter versus the prior year quarter. The decrease was due primarily to lower stock compensation expense, relating to the decline in the Company's share price during the quarter, compared to a smaller share price decrease in the prior year's fourth quarter, the effect of foreign currency translation and lower outside services expenses. Partially offsetting these declines were increased compensation-related costs, mostly for incentive compensation, severance costs and annual salary increases and higher IT related depreciation expense.

As a percentage of sales, fourth quarter 2008 SG&A expenses at 15% were slightly less than the fourth quarter 2007 level of 15.5%. Net interest expense was $1.6 million higher than the fourth quarter 2007 expense, due mostly to lower interest income as we had less cash on hand throughout the quarter than we did in last year's fourth quarter. The effective tax rate for the quarter was 17.2% which includes the effect of the discreet tax benefits we mentioned earlier. Our full-year effective tax rate for 2008, excluding any discreet tax items, was 24.8% versus 28.7% in 2007, with much of the improvement due to negotiated rate reductions in certain international jurisdictions, additional use of R&D tax credits, favorable transfer pricing changes, and a change in the geographic mix of earnings.

Our balance sheet remains strong and our business continues to provide necessary liquidity. Company's cash balance at December 31st was $87.2 million. Working capital totaled $207 million at December 31st, 2008, $22 million below the prior year end. Debt at December 31st was $386 million, down $9 million from the prior year end. And our net debt to total invested capital ratio at year end was 38%, 1.1 percentage points higher than at the prior year end with the increase due to the reduction in equity associated with our pension asset decline.

Operating cash flow was $44 million for the quarter ended December 31st, 2008. And we incurred capital expenditures of $43.6 million in the fourth quarter, with approximately 50% of the capital focused on new product and expansion activities, mostly for our pharmaceutical systems European plant expansions and the construction of our new China facility. Full year CapEx was $131.8 million, including approximately $50 million of maintenance capital, $25 million of IT related CapEx, and $55 million of new product and expansion activities. Our 2009 budget for CapEx is $140 million, but we will continue to monitor customer demand and will reduce our CapEx spend where possible. In summary, in light of the challenging economic climate and the significant adverse impact of the lost sales, we had a strong fourth quarter which capped off another successful year.

Looking ahead, we also detailed our -- in our earnings guidance for 2009 in this morning's release. As indicated, we expected our 2009 revenue and operating profit levels will be significantly affected by the strengthening of the US dollar versus the Euro and other international currencies. At current exchange rates, 2009 results will be adversely impacted by $0.26 per share. As we now see it, we expect that the Company sales on an actual exchange basis will decline by about 2% to 4% versus 2008 sales levels, although they'll grow on a constant exchange basis by 3% to 5%.

In addition, adverse market conditions contributed to a 29% decline in the value of our US pension assets during 2008 with the effect of increasing estimated 2009 pension expense by approximately $10 million or $0.18 per share over our comparable 2008 expense. Coupling that effect with the exchange effect, we expect operating profits will be adversely impacted by $0.44 per share. With that said, we expect 2009 earnings to be between $2.05 and $2.25 per diluted share, based on expected sales of approximately $1.01 billion to $1.03 billion.

Excluding the exchange and pension effect of $0.44 per share, earnings in the projected range would yield an increase in EPS of 5% to 14% over 2008. We expect that Pharm Systems will have sales of $770 million to $785 million, roughly equal with 2008 levels at actual exchange rates, due primarily to the adverse effect of exchange. On a constant exchange basis, Pharma Systems sales are expected to grow 6% to 8%. Gross margins in pharm systems are expected to increase to 35.5% for the year, approximately 2 margin points above our 2008 margins. To get there, despite low volume growth, we're counting on achieving price increases in the 2% to 3% range on average, additional lean savings in our European/American units to offset higher raw material prices in the first half of 2009, wage increases and higher depreciation expense.

In the tech group, we're expecting to see modest declines in sales levels of approximately 1% to 3% excluding exchange effects, with sales levels significantly affected by the impact of lower raw material resin prices on sales. Tech group's gross margins are expected to improve about three-tenths of a margin point to 14% on sales of $250 million to $255 million, but the gross margin improvement due to also to lean and restructuring savings, product rationalization, and continued margin improvement at the Grand Rapids, Michigan facility. Consolidated R&D expenses are expected to increase $5.3 million versus 2008, as we continue to spend in support of our innovative products, heavily weighted towards spending on CZ which is experiencing significant sampling activities and is expected to achieve commercial sales in 2011.

Selling, general and administrative expenses will increase in 2009, with most of the increase expected to come from the $10 million increase in pension costs, an increase in stock compensation costs based on our expectation that the stock price will increase in 2009 versus the stocks decline in 2008, continued investment and associated depreciation in information system initiatives, mostly in our pharma systems North American unit, and the impact of headcount increases, mostly in pharm systems business units to support growth plans and new programs. As a percentage of sales, we expect full year 2009 SG&A expenses to be approximately 1 percentage point higher than 2008, excluding the impact of pension and SAP related increased costs.

Our 2009 earnings guidance does not include any 2009 expenses related to the 2007 tech group restructuring, the effects of any significant additional increases in raw material or energy costs, or the effects of currency valuation changes, particularly the Euro which is reflected in our 2009 estimate at $1.28 per Euro. Every $0.10 strengthening of the US dollar versus our international currency, decreases EPS by approximately $0.12.

As you know, we do not provide guidance for any interim periods. However, unlike prior years, our first half of 2009 will be significantly impacted by the factors we have discussed; a $23 million decrease in backlog which is comprised of $13 million of currency translation and approximately $10 million of customer order timing and inventory management. FX translation is expected to adversely impact 2009 by approximately $0.26, $0.10 impacting the first quarter of 2009 compared to our 2008 levels, due to the relative strength of the dollar on translation of our international operations.

Our North America operations will take an operating charge of approximately $1.5 million in Q1 2009 to reflect the reorganization relocation of our labs business. For the full year 2009, our operating profit margin, excluding increased pension and currency translation, is expected to increase by approximately 1 margin point versus 2008. I would now like to turn the call back over to Don Morel. Don?

Thanks very much, Bill. Before we turn to your questions, I would like to reiterate several key points from our commentary. First, as Bill indicated, changes in customer order patterns, the impact of currency translation, and the timing of raw material price changes will likely result in stronger performance in the second half of the year.

Second, our backlog remains very strong with orders on hand just below 2008 levels at this time. Third, going forward, we expect gross margins to improve as mix improves, pricing flows through the full year, and we recognize the benefits of lower oil prices in the cost of key raw materials. Fourth, our operating efficiency will improve as our expansion projects wind down and new capacity comes on-line. And finally, our operating cash flows and balance sheet provide us with the ability to manage conservatively through near-term economic challenges as we continue to fund our primary long-term R&D and expansion program. This concludes our remarks for this morning and we would now be pleased to answer any question you might have. Operator?

Thank you, sir. We will now begin the question-and-answer session. Our first question comes from Mr. Arnie Ursaner. Sir, your line is open.

Good morning.

Good morning, Arnie.

The first thing I want to start with is in November, your revenue guidance for the year had been 5% to 7% or preliminary guide ance for '09 had been 5% to 7%. And now during bringing it down to 3% to 5%, and that's ex-currency. I just want to be very, very clear because in the past, you've walked away from certain programs or had cancellations. Embedded in this, you did not have any specific program or cancellation that affected the revenue growth?

No.

And again, just to be very, very clear, none of you're guidance include any of the contribution from your key development programs? None of that will create revenue in any material way in '09?

No, not in '09. That's correct.

Real quick question for Bill if I can. You mentioned your $140 billion budgeted capital spending. And Don, you mentioned in your prepared remarks you have identified a site in India. Do you have an India facility embedded in your CapEx guidance?

We have in our -- this year's 2009 guidance, we have the cost of acquiring the land which is approximately -- our guesstimate is approximately $3 million.

But not the cost of the plant?

Not the cost of the plant which would not -- probably not commence the facility until either late '09 or '10. Do you have a D&A number expectation? Yes. The D&A was $60 million in 2008, and the D&A expectation is about $8 million higher than that for 2009.

And how much of that will run through the SG&A line?

About $4 million of the increase will run through SG&A.

Okay. You mention on your SG&A that it would be up about 1%, but I think the 1% excluded --

Yes, excludes pension and currency, Arnie.

Okay. And since you will be incurring those, how much will the SG&A be up in total, including those items?

About -- percentage-wise or? I'll give you a percentage. It's 17.9% as a percentage of sales.

Okay. My final question relates to the margin trends in tech group. You obviously went through a restructuring -- and relative to my model at least in Q4, that was one of the more disappointing line items. And yet your guidance for the upcoming year, even with the restructuring, was lower than your guidance or views two years ago.

Can you comment a little bit more about what's happening in tech group I know you had hoped to replace lower margin business with better business. Is that a challenge in the current environment and one of the factors behind your -- what I would view as cautious margin guidance in tech group?

The answer to the first question is absolutely. We overall, are still seeking to replace the lower margin business. It's happening slowly. A lot of it is related to the timing of the programs that are come out of our development efforts, because Nova Guard. Confadose, and CZ 1 ML insert needle syringe will all be produced at tech. And as we've discussed previously, they won't hit until 2011.

We continue to look for things that go in there that make good sense, but the opportunities have been a little bit more difficult than we imagined in this environment. The margin issue I think comes back to some of the pressures on converting the Grand Rapids facility overall to the high volume filter production, and we're a little behind there. Our hope is that as we get more efficient running those lines going through the years, those margins will improve.

I do have one more question, if I may. I know you don't have a direct competitor that we can really highlight, but [GuerShimer] which does compete with you in Europe, just had really strong results. The question is, are you losing share to them?

No. (multiple speakers) We don't really compete head to head on them. They're a customer on the prefill side. The only area where there might be competition is in their build and subsidiary where we both do molding.

For plastics.

Okay. Thank you.

You're welcome, Arnie.

Our next question comes from Rafael from UBS. Sir, your line is open.

Good morning. Can you hear me?

Good morning, Rafael.

Just a couple of questions for you. I know in the past, the discussions that you put out there that you do your annual renegotiations of contracts at the beginning of the year. Just wanted to get an update of where you stand on those negotiations.

Actually, our pricing rolls in at the beginning of the year for those customers that aren't covered by contract. That is about 95% complete as we sit here today. We've been pretty successful in getting pricing overall. The other contracts -- the longer term contracts that range between three and five years come up periodically during the yea,r depending on where they expire, obviously. But all of the major contracts, to my knowledge, have been finalized.

And the pricing increases on those contracts have contractually -- in the contracts. (multiple speakers)

Okay. Are you generally achieving slightly higher pricing than you have in the past? I think you've done about 1% to 2%?

Yes. As I mentioned in my commentary, Rafael, we're expecting two -- between 2% and 3% this year, as opposed to the 1% to 2% that we've seen historically.

Okay. Great. Just a little bit more color on that 2009 guidance. You mentioned the organic growth that you're expecting from pharma. But in general, what are your volume and pricing assumptions that are embedded in that 2009 guidance?

Again, it's the 2% to 3% on the pricing. Volume is going to be very low. You can say somewhere between -- depending on which segment of the business you're looking at, zero to 1%. And the rest is mix and lean and some of the other things that we talked about.

Okay. Are you incorporating any potential approvals of new biologics into this guidance?

No. It's not significant.

Okay.

There are maybe some that will be out there during the year, but none that are going to move the meter significantly.

Yes. And the other other thing I would point out is that the volume situations relates directly to overall volume expectations in western Europe and North America in terms of pharma growth.

Okay. And in terms of the ordering patterns that you're seeing, I know you mentioned that you're expecting a pick up in the second half of 2009, but can you provide us a little bit more detail on your -- on the different customer segments? Are you seeing -- are you expecting a bit more growth from your biologics customers who are pharma, et cetera?

I think the general economic conditions are just going to make things flow through Europe a bit differently than we've seen in the past. We got a range of customers that were traditionally placing blanket at the beginning of the year, and we did level out. I think they are being a bit more cautious and placing orders for six months with a second order coming in six months later on. We're also see some instances where customers are keeping to their traditional order pattern, but might be ordering something slightly less than what they had ordered previously. Overall, when you look at the distribution of our backlog, it tends to push the back end of the curve out just a little bit. This will be one of the more challenging years in terms of managing timing as we work through the year. We're not losing any business, but we're seeing a certain conservatism in the order patterns from our customers that we haven't seen in the last couple of years.

As we suggested, we think that the mix is also going to get a little better. We talked about the ESAs having basically zero in 2008 sales. When we looked at 2007, we were there in the $18 million range roughly. We'll get some of that back in 2009 and again that has a nice margin lift to it. We are guiding to a gross margin of approximately 2 percentage points increase versus the prior year for pharma systems.

And what exactly was your backlog? I may have missed it.

It was $250 million. These are roughly numbers; $250 million at the end of last year. At the end of this year, you're talking about roughly $230 million. There's about a $23 million delta.

Are you expecting that backlog just to remain flat or come back in with your operation efficiencies?

It's -- the backlog is even with last year, as we sit here today. My guess is that depending on the nature of how orders develop, it's probably going to creep down slightly as our ability to hit lead times improves and as our lead times shrink. Last year, when we were early in the year, even at the end of '07, it had increased because demand of our European facilities in particular were so heavy. Customers were ordering a bit to create a safety range, because the lead times were 14 to 16 weeks and in some cases longer. Now in the metal side of the business, that's back down to where we would like it to be. It's in that 6 to 8 range. And on the rubber side, it's on the 10 to 12. That's where we are comfortable and we operate the best.

Just quickly, can you remind us of the new products that we should be looking out for?

The biggest one this year is going to be Nova Guard -- the update from Nova Guard. As we speak, the final clinical trial is ongoing. Hopefully that will be wrapped up within a couple of days, data will be submitted, and we'll be good to go early in the second quarter.

The main product I think to keep an eye on is the customer uptake of CZ in terms of clinical and filling trials in doing stabilities. There, 2008 was a tremendous year. When I look at the backlog of customers that are testing not only vials, but syringes in CZ with new molecules as well as existing formulations, that story is terrific. It's way above our expectations. Unfortunately, the commercial part of that won't hit until 2011.

Right. And just last one for me. In the past, you've given your five-year financial goals which include that organic sales growth of about 7% to 9%, and operating profit of 10% to 12%. Are you still sticking to those long-term goals or are you currently reevaluating something of these metrics?

No, I see no reason to change those. We've said we'll have some years where we're lower than that, some years where we're higher than that. In this clan, when we developed it at the end of last year, there are -- clearly we knew there was going to be some economic turmoil in the near term. But we've kept to those as we begin to phase in the newer products from 2011 to 2013. You may see some softer, mid to high single-digit growth in the first part of the plan, but our expectation now, looking at our forecast, is that it will average out to those numbers by the time we get to the end of the five years.

Great. I'll jump back in the queue. Thank you.

Our next question is from Adam [Sart] from Barclays Capital. Sir, your line is open.

Good morning, guys. I'm just trying to get a little more color on the growth by region. I think you gave it last quarter. What was the domestic and international growth for the quarter?

Hold on a second. I have that right in front of me. I'll grab it. If you have any question while I'm grabbing that we'll be happy to take it.

Just for Don, has there been any big difference in the feedback that you're getting from customers in the US versus Europe? Or has it been fairly similar?

I think we're actually seeing a bit more optimism on the European side. Our European backlog is actually ahead of where it was at this point in the last year. Within the US, we're seeing a great deal more conservatism in how the orders are placed.

Adam, I have those numbers for you if you would like. On pharm systems, our fourth quarter domestic sales were up 4.7%. International sales were up 5.1%. On a consolidated basis, our domestic sales were actually down 1.1% and international was up 3% for the quarter.

I think that compares to was it domestic was down 5% last quarter if I recall?

I don't remember the last quarter Adam. I'm apologize. But those numbers I gave you are excluding the exchange effect so you getting an apples to apples number.

It's cost of currency? Great. On the pension assumptions, you're saying incremental of $10.3 million. (multiple speakers) Is that locked in or it could change or discontinue?

No. The way the actuarial valuation works, which drives the pension expense for 2009, it's done as of December 31st, 2008. We absolutely know that that $10.3 million will roll through our P&L in 2009. What we don't know, and what is the variable going forward is what the actual results of the investments will be in 2009 versus the assumptions we've made in our actuarial valuation which were 8% long term -- the turn on assets.

Again, the way that -- it's crazy accounting, but the way it works is you take whatever that -- at the beginning of the year, you strike your pension expense and that -- you take one-twelfth over each month over the year, and as your amounts of return on your assets goes up or down, that gets accumulated into an unrecognized bucket within the actuarial valuation. Then when you strike your expense for this next year again, so at 12/31/09, we will take into account whatever the actual performance was for 2009.

You're saying it could be another increase in 2010?

It could, it could.

Okay.

And you will see-- just so you -- everybody, just to make sure we're clear on this. The $10.3 million is composed of two pieces. The first piece is what I was just describing which is roughly half of that number -- about $5 million which is the loss we incurred in 2008 that is going to be amortized into the calculation. It gets amortized roughly over 10 years so that's about $5 million a year on a $50 million loss.

The other piece is the actual assets are less, so you're earning less interest on those assets which helps offset your service costs during the year. And that's roughly $5 million. The two pieces of the puzzle are -- total up to $10 million. But if, for instance, the assets do recover during the 2009 year, you won't continue to see that $5 million increase in your P&L going forward. But the 5 million that relates to the amortized -- the loss that's been amortized, you will see that over a 10-year period; each year, $5 million a year.

Okay. Great. Thanks for the clarification -- the detail.

No problem.

And then just -- I think you mentioned the release of $1 million charge taken on an investment. Could you remind me what that is?

Yes. What we had was a -- what we referred to as a super money market account. We had invested $25 million with one of our banks to give us a little better than the standard CD rates that we were earning. And that fund which was -- it's Columbia Strategic Cash Fund, I think is the name of it, actually ran into some redemption problems. It did not invest in any super sophisticated assets, but it wasn't all just plain money market accounts.

What we've been doing is -- which required by GAAP, is that you take that amount and reclassify it as investments as opposed to cash, and you market-to-market each quarter which is what we've been doing. We took an approximately $1 million charge during the year for the fact that this -- the underlying investments had gone down in value. Now, the good news is we originally invested $25 million in this in the fourth quarter of 2007. We are down to $5 million left.

We've had redemptions in that fund of $19 million rough numbers, and there's only about $5 million left to be recouped. Most of which -- $4 million of which, we believe we're going to get in 2009.

Okay. Unlikely to see other writedowns -- ?

There's a possibility that there could some small additional writedowns, But again, you're talking on a base of $5 million now, not on a base of $25 million.

And last question for me just on the AR collections, any signs of slowing or changes there?

Actually what we're seeing -- our guys have done a great job. You noticed our working capital was down $20 million. Our actual current receivables have have actually gone up.

The percentage of our receivables that are current has actually increased over the year, reflecting our -- we've been beating on our people pretty heavily to get out there and collect receivables. Will we see it? It's very possible, but as of right now, we are not seeing it, Adam.

All right. Thanks a lot for the details, guys.

You're welcome. Thank you.

(Operator Instructions). Our next question comes from Mr. Rick [Deltell] with Columbian Management. Your line is open.

I just would like to make an observation and then maybe get and feedback on philosophy in general regarding expenses. We listen to an awful lot of calls, and obviously it's a tough economy. You guys have talked about all the headwinds you're experiencing and yet up front, you talked about pay raises for this year. I think you said there are some bonuses paid and things.

Why not -- in the -- in the good times, you guys have done quite well. Why not in these tougher times waive the increases like 95% of the other companies are doing. Why are you putting yourself on a different platform on the expense side than philosophically a lot of other companies are?

I think there's really two parts to that question. One is that the broad spectrum of the folks in the Company that produce the results in '08 I think deserve an increase. The workload that was put on them between simultaneously managing very heavy demand, while executing our expansion programs and existing facilities, and even building the new facilities, was an absolutely terrific effort.

That having been said, I do think it's appropriate that the officers of the Company defer an increase in our salary and we're going to do that. Looking forward for us, it is an issue of competing for talent. We are going to continue to recruit and build our base as best we can with the best people that we can find. For us being a billion-dollar company within the healthcare segment, it means bearing some pain on the salary side. Those two factors are going to keep us there.

And one other comment I think I would add to Don's, our incentive compensation is based -- very much tied to the growth and profitability of the Company. Our long-term incentive plan has two metrics, 50% weighted each. One is the compound annual growth rate on sales and the second one is the return on invested capital. To the extent that we don't perform, we won't get paid and that's the way it is.

Yes. In one sense, clearly you guys shouldn't be penalized for a pension expense and you shouldn't necessarily be penalized by FX expense. But having said that, you have been a huge beneficiary of FX and you were getting the rewards for that so you can't have it both ways, in my mind anyway.

We agree. Our plan specifically called for everything to be FX neutral, so we do not benefit when FX works with us.

In the part thee years, we've reduced our payouts for the fact there was positive FX.

Okay. I'm glad to hear that, but this is a tough job environment. I hear what you're saying as it relates to health care, but I would ask you to relook at that in these tough times and see where else you can take some costs out during these more painful times. Clearly, shareholders are taking it on the chin today and have been. I think we'd take it less on the chin if the cost side were being choked back a little bit in this environment.

We don't disagree. We tend to watch that line very, very closely. And where we have opportunities, we will cut costs when prudent.

All right. Thanks.

You're welcome.

Thank you.

Our next question comes from Mr. Christian [McCall from RNL].

Thanks for taking the call. I have three questions. The first question is on the backlog, you mentioned some moderation of that -- and as you've entered the year. The question is how much visibility does this really provide? Can customers cancel their order at any time? Are these take-or-pay contracts? Maybe just some --

They're a combination of both. The actual change in the backlog has really to do with the composition of the delivery times. The overall dollar magnitude of the backlog is as healthy as it's ever been. What we are seeing a slight change in deliver expectations and quantities within those delivery expectations. Again, I think it's just a sign of the times.

But that means that customers are simply ordering less.

They may either be ordering less and -- or they may actually be just -- our lead times have come down and our production facilities so they don't need to order as much in terms of safety stock or order ahead of the curve as they have in the past when our lead times were up in the 16 to 18 weeks. You're seeing -- there's a number of variables at play there that -- we don't -- as Don mentioned, we're not losing any business. These are really timing issues, plus some conservatism on the fact that the economy is troubling to most companies and may be causing them to delay putting their orders in.

The second question is how much do you expect customer inventory destocking or slower sales, which is explicitly related to destocking -- will impact you in 2009? Either sales growth reduction or dollars lost? How do you measure the impact of this draw down? What visibility do you have about your customer's inventory levels? How much do you assume will be drawn down and how long that adjustment process will take? And in your guidance, do you assume a replenishment of the inventory levels in the back half of 2009? Or do you assume that they don't? Or maybe you can just talk a little bit about that.

With regard to the visibility question, usually our visibility on a quarter-to-quarter basis is pretty good and it tails off as we go through the year. As we enter a quarter, historically we've had between 85% and 90% of our orders on the books. I think the uncertainty we're seeing now is that there's probably a 5% to 10% swing in that number as the composition of the backlog goes further out. In some cases now, even part of that backlog is into 2010.

We try to stay as close to our customers as we possibly can. It benefits us because smoother order patterns allow us to level load our factories. Sometimes they're not the most forthcoming folks in the world, so we have to go on historical averages which is the way that we would plan. As we sit here now for the first half of the year, they're going to are conservative. They're going to draw down tower inventories slightly, and then we'll see it start to come back in the second half of the year.

Are you assuming that the inventory drawdown is done by the end of Q1? Or do you assume that -- ?

It's going to go up and down through the the year.

But a big chunk of it does hit in Q1, you're correct.

But you're also assuming that those inventory levels -- that draw down of inventory is replenished by year end?

It will stabilize. It may not come completely come back. And again, our visibility in the back half is a lot less clear than it is in the first half. But that is our assumption.

Are there any products in particular in which this destocking issue has occurred or is this just an across the board?

I can't think of a single category where it's been pronounced. It's certainly not like the ESA situation we saw,which was dramatic.

The last question is just a free cash flow expectation for 2009.

The free cash that we're expecting for 2009 is in the roughly hundred and -- well, let me back up. I'll start from the top. Operating cash flow is going to be roughly are you familiar $150 million plus. We'll use -- again, our guess is $140 million for CapEx, although we're looking very closely at that to see where there are items we can defer or delay or cancel.

We also pay a dividend as you know to our shareholders and that's roughly $20 million. When you are defining -- whatever you're going to define as free cash flow. If you're looking at operating cash flow less our CapEx and our dividend, there will be very minimal free cash flow in that regard. But our operating cash flows are very healthy and allow us to afford the dividend and the CapEx.

And why is the CapEx so high? Is there -- how would you break down maintenance versus growth. Because right now the cash flow from the business isn't covering the capital investment and dividend.

Right. It's a -- if you look at the maintenance cap is only about between $50 million and $60 million. It was $50 million rough numbers for 2008. We spent roughly $25 million in 2008 on IT. Mostly for SAP and related shop floor systems that we're changing out in our North American unit. And the rest of it -- about $$55 million-ish, is these new product expansions that we're going through mostly in Europe.

Okay.

The other answer to the capital question is that the new product capital, and we can't emphasize this enough, typically takes from two to four years to start generating commercial sales. That's the price we pay for the longevity of the business once it goes through the FDA cycle. By the time we order and put in equipment, but the time we validate and test, sample our customers, they complete their analysis, and begin to produce commercial orders, it's a relatively lengthy process.

Is this $55 capacity expansion just this year or is that something that recurs in 2010?

It will recur in 2009 we think to a certain extent -- less in Europe, more in Asia and in the United States. We believe that a number, and again we're not guiding to 2010, but a number in that same range is appropriate for 2010 if we continue to see the demand growing the way we expect it to continue to grow. To grow in the long-term ranges that we described earlier in the high single digits, you need to add capacity to be able to continue to get those sales.

And as Don said, there's that two to four-year delay between when we put the cap in and when we get it. But once that capital is up and running and fully charged, all of this expansion capital that we're putting in is in these advance systems that we're talking about -- the advanced coat something Westar processing systems that carry margins that are very, very strong margins and we believe are good investments in the long-term.

But it sounds like that there's going to be some level of capacity investments on an ongoing basis.

Correct.

Right. Okay. Thanks very much.

Thank you.

Thank you. This concludes today's question-and-answer session. I now would like to turn the call over to Dr. Don Morel.

Thank you very much, operator, and thanks to everyone for your time this morning. 2008 was another successful year for the Company, despite the economic climate and the loss of key sales that's outset of the year. For 2009 and beyond, we remain focused on running the business efficiently while continuing to invest in the future and building value over the long term. Thank you very much for your time this morning.

Thank you for participating in today's conference. That does concludes the conference call. Please disconnect.