西式醫藥服務 (WST) 2009 Q4 法說會逐字稿

Welcome to the West Pharmaceutical Services fourth quarter earnings conference call. (Operator Instructions).

And now I would like to turn today's meeting over to Mr. John Wolford from Westwicke Partners. Sir, you may begin.

Thank you operator.

Good morning, everyone, and welcome to West's fourth quarter 2009 results conference call.

We issued our financial results this morning, and the release has been posted in the Investor section of the Company's website located at www.WestPharma.com. If you have not received a copy of this announcement, please call Westwicke partners at 443-213-0500 and a copy will be sent you to immediately. Also posted on the Company's website is a slide presentation that Management will refer to in their remarks today. The presentation is in PDF format and you may need to download appropriate software in order to review the presentation. A link to a free download of that software is provided at the website.

Before we begin, I remind you that Management's remarks may contain forward-looking statements regarding West's financial results, estimates and forecasts, business plans and prospects that involve substantial risks and uncertainties. You can identify these statements by the fact that they use 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 business plans and prospects. These statements are subject to known or unknown risks and uncertainties and therefore actuals could differ materially from past results and those expressed or implied in any forward-looking statements. A nonexclusive list of the factors tat could cause actual results to differ materially from expectations can be found in the Company's annual report on Form 10-K for the fiscal year ended December 31, 2008 and it's reports on forms 10-Q and 8-K. The Company undertakes no obligation to publicly update forward-looking statements, whether as a result of new information, future events or information or otherwise. You should bear this in mind as you consider forward-looking statements.

In addition, during today's call, Management may make reference to non-GAAP financial measures, including adjusted operating profit and adjusted diluted EPS. These measures have no standardized meaning prescribed by US GAAP and therefore 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 to the most comparable financial results prepared in conformity to GAAP are provided in materials accompanying this morning's earnings release.

Again, this call is being recorded on behalf of West and is copyrighted material, it cannot be re-recorded or re-broadcast without the Company's express permission. Your participation in this call implies your consent to out taping.

At this time, I would like to turn the call over to Don Morel, Chairman and CEO. Don?

Thank you very much, John, and good morning, everyone.

Welcome to West's 2009 year-end conference call. Joining me for the call today is Bill Federici, West's Chief Financial Officer.

During our remarks this morning, Bill and I will discuss our fourth quarter and full-year results for 2009, and provide some commentary on the primary issues facing our business, in addition to outlining our expectations for 2010.

As John mentioned on the outset of the call, we'll be using PowerPoint slides to augment our discussion of the results, which can be accessed at our website at www.WestPharma.com. We'll call out the slide number we're referring to as we work our way through our talking points.

I would also like to point out that this call will be the final one which used the Pharmaceutical and Tech Group reporting segment. As we announced in December, we're realigning our business operations to focus more effectively on execution of our strategy and to capitalize on several critical near-term programs. In our April Q1 call, we'll begin reporting on two new segments; Pharmaceutical Packaging Systems and Pharmaceutical Delivery Systems. However, for today's presentation, we'll report 2009 results using the historic segments while our guidance for 2010 will use the new segments.

The Pharmaceutical Packaging System segment will focus on our global components business, which accounts for $780 million of our revenue. This group has responsibility for brands such as Westar and FluroTec, Envision and NovaPure, in addition to our historic disposable medical devices, veterinary diagnostic and dental products. This segment will be managed by Steve Ellers, who has more than 25 years of international operations experience at West.

Delivery Systems will incorporate will incorporate the Tech Group, Medimop, our Plastef acquisition and those programs approaching commercialization, such as the Daikyo Crystal Zenith silicone-free syringe, NovaGuard, our proprietary auto-injector ConfiDose, as well as our ongoing innovation program. The Delivery System segment accounts for approximately $285 million in sales and will be managed by John Paproski, formerly Vice President of Innovation, who has almost 30 years of engineering, operations and product development experience with the Company.

Turning to our fourth quarter and full-year overview. At the outset of 2009, we were presented with a number of challenges. As you are aware, the significant slowdown in the global economy during the second half of 2008 led to a rapid downturn in the financial markets, in addition to turbulence in the currency and commodity markets. The US political landscape changed dramatically, generating a national debate on healthcare reform. The pharmaceutical industry underwent substantial consolidation as a result of several large mergers, and our broader customer base faced with considerable uncertainty on a number of fronts, responded by tightly managing working capital and inventories, leading to a change in our traditional seasonal order pattern.

Against this backdrop, West delivered a year of solid performance. It was an unusual year, as sales and earnings were stronger in the second half of the year rather than the first six months, the exact opposite of our more traditional years, but consistent with the forecast at the outset of the year.

On a consolidated basis, our fourth quarter results showed very strong improvement over 2008, as sales increased 13.2% to just over $293 million, excluding the effects of currency translation. In actual rates, sales grew just under 20% during the quarter. Sales within the Pharmaceutical Systems segment grew 18.7% to $229 million, excluding currency. Tech Group sales for the quarter totaled $56.3 million, a decrease of just over 3% from the fourth quarter of 2008, again excluding currency effects.

Excluding discrete items from both the current and prior-year periods, adjusted earnings grew approximately 20% from $0.56 per share to $0.67 per share. For the full year, consolidated sales grew 3.5%, excluding currency, to $1.06 billion, driven by growth in the Pharmaceutical Systems suggest, resulting in adjusted fully diluted earnings per share of $2.11 for the year.

Financially, we tightly managed discretionary SG&A and capital expenditures, keeping the Company on a very sound financial footing, with a conservative debt to total invested capital ratio of just under 34%.

On slide three, we show highlights of a few of the Company's significant accomplishments during the year.

Our operating performance very strong, adapting to short lead times and the H1N1 surge, while delivering substantial savings from our lean programs. Our new China facility was completed on schedule and within budget, shipping first commercial orders within the fourth quarter. We acquired Plastef, strengthening our Safety Product portfolio. The North America SAP project was completed on schedule and is fully operational. We advanced our key projects with Daikyo Crystal Zenith, validating the unit cavity cell, and taking delivery of the first four-cavity production cell. And we completed our business unit realignment, positioning the Company for future renewed growth.

In summary, while managing through a turbulent year, we kept our focus on creating a foundation for sustainable growth in the years ahead, while maintaining a strong balance sheet and operating cash flow to fund our growth initiatives.

I would now like to turn the call over to Bill, who will provide a detailed discussion of our fourth quarter performance, along with our financial expectations for 2010. Bill?

Thank you, Don, and good morning, everyone.

We issued our fourth quarter results this morning, reporting net income from continuing operations of $20.3 million, or $0.59 per diluted share, versus the $0.52 per diluted share we reported in the fourth quarter of 2008. Slides four, five and six provide a summary of our Q4 results. As we explained in our release, excluding the effect of various special items in both years, fourth quarter 2009 adjusted earnings were $0.67 per diluted share versus last year's fourth quarter adjusted earnings earnings of $0.56 per diluted share, a 19.6% year-over-year increase. We achieved this earnings increase despite the $0.05 negative effect in the quarter of an increase in pension expense.

For the full year, we reported income from continuing operations of $72.6 million or $2.12 per diluted share, versus income from continuing operations of $86 million, or $2.50 per diluted share, for the full-year 2008. Those 2009 reported results included restructuring charges net of various discrete tax benefits, full-year 2009 income from continuing operations, excluding these items was $2.11 per diluted share. Our 2008 reported results also included various nonoperating charges and benefits, and cumulatively increased 2008 reported earnings by $0.12 per diluted share. On a comparative basis, excluding the items I've mentioned, the $0.27 decrease in adjusted earnings per diluted share in 2009 was due primarily to the $0.11 negative impact of currency translation and the $0.22 adverse impact from increased pension expense.

Slide four shows that the Company's consolidated fourth quarter sales were $293.4 million, an increase of 13.2% over fourth quarter of 2008 sales, excluding the favorable effect of foreign exchange. Slide seven provides the details of our consolidated sales increase. The increase all came from our Pharm Systems business, where sales improved 18.7% over fourth quarter 2008 sales, excluding currency.

Demand increases were strong in each of the regional business units, with the highest growth coming from the North America unit. Sales of various packaging components, including stoppers, flip-off seals and prefilled injection items were substantially higher in the quarter with many of the components Westar processed and treated with the Company's high value coating materials.

H1N1 related sales were $12.3 million in the quarter, and excluding those sale and currency translation, sales in our Pharm Systems businesses increased a healthy 12%. Pricing contributed 3.4 percentage points of the increase, and volume and mix accounted for the remainder of the increase.

Tech Segment sales declined in the quarter by 3.1% versus the prior year quarter, excluding currency, as customers continued to delay or forego new contract manufacturing projects amid continued concern over the impact of the global economic recession on their businesses. Also adversely impacting Tech Group sales were reduced raw material costs that were passed through as reduced selling price to our customers. Partially offsetting these declines were $6.2 million of (inaudible) safety device sales arising from the July 2009 acquisition.

Full-year consolidated sales increased by 3.5% over 2008 amounts, excluding currency effects, aided by approximately $22 million of H1N1-related sales. Excluding currency in H1N1 effects, consolidated 2009 sales increased by 1.5%.

Slide eight shows that the sequential increased sales growth over earlier 2009 quarterly growth levels reflects continuing recovery in sales demand, especially our high-value coated and processed products. Reduced demand in earlier quarters was due to customers' emphasis on inventory management programs, amid cautions concerning economic conditions. Consolidated gross profit margins for the quarter were 28.6%, slightly higher than the 28.4% margins we achieved in the fourth quarter of 2008.

Slide nine shows the various components of the increase versus the prior year quarter. The in crease was due to lower raw material cost, contract-based sales price increases and a favorable sales mix, which more than offset increased depreciation, plant labor and plant overhead costs. Pharm Systems Q4 gross profit margins of 33.8% was equal to the gross profit margins we achieved in Q4 2008. Tech's Q4 gross profit margin of 9.6% declined versus the 12.3% prior year quarterly margin, due primarily to reduced volumes and an unfavorable mix. Consolidated SG&A expenses increased by $8.5 million in the current quarter versus the prior year quarter.

Slide ten shows the various components of the increase. The increase was primarily due to $2.7 million of higher pension expense related to investment losses incurred on our plant assets in 2008, the effect of foreign exchange, the smaller effect on stock-based comp of the relative share price decline in the quarter and increased outside service costs associated with M&A activities and our SAP implementation. As a percentage of sales, fourth quarter 2009 SG&A expenses, excluding currency effects and increased pension expense, were 14.7% versus 15% in the fourth quarter of 2008.

Our balance sheet remains strong and our business continues to provide necessary liquidity. Slide 11 shows that the Company's cash balance at December 31 was $83.1 million. Working capital totaled $226 million on December 31, $19 million than at the prior year-end. Much of the increase is due to higher level of sales we enjoyed in December versus the prior year December, and the position that the Company has taken to build certain strategic inventories. We built these strategy inventories to manage changes to certain raw materials, and, going forward, to manage expected material price increases. Receivables and inventory increases were also due to the asset acquired in the Plastef acquisition and the impact of foreign exchange. Debt at December 31 was $380 million, down $6 million from the prior year-end due to repayments on our revolving debt facility. Our net debt to total invested capital ratio at year-end was 33.9%, approximately four percentage points below the prior-year end ratio.

Slide 12 shows that we generated $53 million of operating cash flow in the fourth quarter. We incurred capital expenditures of $34.5 million in the quarter, with much of the spending focused on manufacturing equipment upgrades at our global Packaging Systems sites. For the year, we spent $105 million in CapEx. Looking ahead, our order backlog at December 31 of $239 million is about equal to our year-end 2008 backlog, excluding currency, and roughly equal to our Q3 2009 backlog.

We have provided a bridge in slides 14 and 15, which reconcile our historical reported segment results to our new reporting format. We have also outlined our 2010 earnings guidance on slide 13. We expect 2010 consolidated sales will increase by 3% to 5% over 2009 amounts on a currently neutral basis. The increase in sales is expected to be driven by price increases of 1% to 1.5%, volume and mix increases are expected to increase sales by an additional 1.5% to 2.5%. H1N1 component sales are expected to be approximately $5 million in 2010.

Packaging System sales are expected to range from $780 million to $800 million and Delivery Systems sales are expected to range from $310 million to $330 million. Consolidated gross profit margins are expected to increase by approximately 170 basis points to 30.5%, as a result of pricing and volume increases, and a favorable mix, along with significant lean savings, and $5 million to $6 million of savings from our 2009 restructuring activities. These are expected to more than offset the increased depreciation resulting from our Europe and Asia expansion activities, and expected increasing raw material prices, labor and overhead costs. Packaging Systems gross margins are expected to increase by about 180 basis points, to 34.1%, and Delivery Systems' gross profit margin is expected to increase by nearly 300 basis points to 21.6%.

Consolidated operating profit margins are expected to increase by approximately 75 basis points over 2009. Adjusted diluted earnings per share are expected to be in the range of $2.19 to $2.39 for 2010, and at an assumed exchange rate of $1.40 per euro. As a general rule, each additional penny change in the value of the US dollar versus the euro results in an approximately $0.01 change in diluted EPS. For 2010, we expect adjusted diluted EPS to be approximately 20% higher than our Q1 2009 results, due to a more favorable mix, some pricing and lean savings,partially offset by increasing raw material, labor and over head costs. Capital expenditures are expected to range from $115 million to $130 million for 2010, including approximately $50 million to $60 million of normal maintenance, expansion capital of $50 million to $60 million, and about $15 million of information technology spend.

I now would like to turn the call back over to Don Morel. Don?

Thanks very much, Bill.

As Bill just outlined, we expect to see sales growth in 2010 at between 3% to 5%, excluding any currency effects.

To date, Q1 orders remain strong despite the record December we experienced. We believe that this is a good indicator that the cautious inventory management and ordering we experienced throughout 2009 has largely run its course. Another positive note is that our backlog remains at a historically high level of just under $240 million. Our full-year estimate is based on pricing that will be relatively modest versus 2009, and the expectation that volume growth will be modest to North America and Europe with stronger growth in Asia. As we discussed in our Q3 call, the biggest growth driver is expected to be an improving product mix throughout the year.

As outlined in slide 16, our key objectives for the year as are as follows. Generating growth in the range of 3% to 5%, ex. currency, delivering operating profit growth greater than 10% and earnings per share of $2.19 to $2.39 per share. We expect to validate our four-cavity Daikyo production cell for commercial production during the year and securing our first Daikyo CZ commercial program. We also anticipate breaking ground on our China rubber facility, which now we plan to be a small development operation, which can be scaled up with increasing demand.

For the longer-term, the business drivers that we've outlined in prior calls remain fundamentally intact. The key for West's future success is continued growth in biologics to treat chronic conditions which increase with an aging population, such as diabetes, cancer and autoimmune diseases, including rheumatoid arthritis. Our goal is to expand our proprietary technology and product portfolio around the packaging and delivery of these therapeutics, which are forecast to grow at a rate two to three times the broader injectable market.

I firmly believe that West has significant value to offer its customers in this segment, based on the need for ultra-clean packaging components, and safe, accurate, easy-to-use delivery systems. We also expect to benefit from continued growth in the generic segment, as well as geographic growth in developing markets like India and China.

This concludes our prepared remarks for this morning, and we would now be pleased to take any questions you might have.

Operator?

(Operator Instructions).

And your first question comes from the line of Arnie Ursaner of CJS. Please proceed. Hi, good morning.

Good morning, Arnie. Thank you for that very comprehensive rundown.

I guess the first question I have is, embedded in your guidance is a fairly sizable improvement in margin in the upcoming year. You mentioned mix is a key factor, but could you perhaps dwell a little more on where you hope to get this fairly dramatic rise in margin. You mentioned in your prepared remarks, Don, that December was I think a record month for you, and yet your margins had no improvement year-over-year. So can you walk us through perhaps some of the other key factors that will drive the margin improvement you hope for in the upcoming year.

Sure, it will be a combination of things, Arnie. I'll throw in my two cents and let Bill join in.

We should see benefits from improved raw material pricing flowing through from the end of the year into the quarter. As we said, we do expect mix to be a strong driver, that includes, of course, the Teflon and FluroTec coated components as well as Westar.

There is probable a little bit of latent demand in the system for the FluroTec components. We did not see a strong sales growth there at the end of 2009, as we might have expected. But we saw very strong growth in Westar treated components. So those are the two things that are going be the primary drivers.

Shifting gears a little bit to CZ resin, which obviously is a very important part of your future growth. You mentioned you hope to validate the plan. I thought you had already significantly -- I thought you had spent quite a bit of money upgrading it in Q4 and had some validation already. And could you clarify that.

And in terms of a secure first commercial program, you've also talked about customers undergoing tests for quite a while. We should be near the end of that testing phase. How confident are you of commercial success, and is it more a disclosure issue rather than actually winning some commercial opportunities?

Let me turn to the first part of your question first.

What we talked about last year was the unit cavity cell. So we had a fully robotic system that could produce a single syringe with each cycle, and we were sampling customers off of that system, but it was not fully validated at the time we were sampling, so the customers need to utilize validated production samples to get into their formal stability trials. We completed that validation at the end of the year and continue to sample now, but with the validated product. At the end of the year, we took delivery of our first production cell, which is four cavities, so it produces four syringes per cycle. We'll go through the validation cycle for that system through the first part of the year. I think we're scheduled to have that done by the middle of the year, and then it will go into commercial production with validated samples. So that kind of explains the disconnect there.

I'm very confident of success. Uptake, I think, is going to be driven by a couple of things. There are some issues in the marketplace with glass breakage right now. CZ, we think is a very unique solution to that problem as well as the others we've talked about, with particularly contamination from tungsten, from silicon oil, et cetera. As you said, we have had a number of customers that have been testing CZ from a stability standpoint. The results have been very good. We do expect this year, at some point, it will probably be later in the year, that we will have a customer commit to commercial use of the product.

Two more questions related to that. One, as you mentioned, you did have $1.5 million of equity income, as this process unfolds, I assume the success of CZ currently will be reflected in your other income or JV line item?

That's correct. It would float through the Daikyo.

And Arnie, we own 20% of that, as you remember.

And you do have the opportunity to increase your ownership, you have an exclusive agreement, or an agreement with them if you do choose to increase your ownership?

It's a family-owned business. We have a right of first refusal. But the family is in the business for the long-term.

Okay. I'll jump back in queue about some others, and I do have a few others but I'll come back after others have a chance. Thanks.

Thanks, Arnie.

The next question comes from the line of Adam Poussard of Barclays Capital. Please proceed.

Good morning, guys.

Good morning.

Just wanted to start quickly on the tax rate. Over the last few years, it's come down considerably. I guess, just how do you think of that over the next few years? Should that be flat or would you expect that to tick up, since we're now into the low 20s?

It's getting harder to get more benefit. It's all driven, Adam, really by the geographic mix of earnings. We do have -- we do expect for 2010 that that rate -- the run rate that you saw there, about 23.4%, will increase slightly due to the changes in the geographic mix of our earnings that we expect in 2010.

And there is also one other item hanging out there, and that is the R&D extender bill that has yet to be signed. So that has an impact, obviously, as well.

But our best guess, if you're modeling, using a 24% is a reasonable expectation.

So I guess you would agree that's probably hard for that percentage over the next few years to go much lower than where we are.

You can. There are still opportunities out there. And we're still exploring them. But we're -- for 2010, which is where we're looking right now, the best information we have is that will be right around 24%.

And then have you guys got any additional clarity on the pension expense?

Yes. We do.

What we expect to see in pension expense this year is about $2 million less expense than we saw in 2009. If you remember 2009, the expense was $10.7 million more than it was in 2008, due to the losses and the way the actual real variation and the expense driven off of that. We have recovered the bulk of the loss in the assets -- in our plant assets, however the discount rate, which is used to present value of the liability, has gone down. So you're working -- we've got better assets which are driving a better return. But the discount rate is working against us.

So bottom line is, for all of 2010, we will be $2 million to the better than we were in 2009.

And then lastly, Don, obviously you have made a few Management changes over the last few months in the restructuring. Could you elaborate on that, and then should we expect to see other Management additions over the next few months or is that kind of completed that point?

No. I think we're pretty much complete. We have the team in place that we need.

The realignment is intended to get resources focused on the future commercial opportunities on the Device Systems side. I've got infinite confidence in Steve's to lead the components part of the business.

There are a lot of things we can do there in terms of our operating efficiency, which really is what those guys are going to be focused on, plus improving the penetration of the value-added products like the Westar, the FluroTech and especially NovaStar and Envision, which are going to be the leading products in this category. The drive to eliminate particulate in the industry is picking up speed, especially as many of our customers now are looking at Japan as a future growth arena.

The device side is going to drive our business, like we've talked about publicly. We're very excited about the commercial possibilities of CV. With the acquisition of Plastef, we've bolstered our Safety portfolio. We now have systems for both passive stake needle and passive luer-lock syringes.

I think, looking at delivery needs within the markets over the next three to five years, we are really well positioned to satisfy those needs. We've seen strong growth out of Medimop, which will now be part of the Delivery Systems group. So, I think we have the right team in place, we're focused on the right priorities and now it's a matter of execution.

Great. Thanks for answering my questions.

You're welcome, Adam.

Your next question comes from the line of Derik De Bruin of UBS. Please proceed. Hello. Good morning.

Good morning, Derik.

Correct me if I'm wrong, but you did the Plastef acquisition in July and that, by my calculation, will probably add about 1% to 2% to 2010 top line?

Yes. We think that we'll be in the kind of the $18 million range for all of 2010 for sales of Plastef.

That's what I've been going for. Thanks.

And when you look at the growth opportunity in that business, what do you think -- how should we kind of model that Safety business? I mean, what do you think is a good growth rate for it?

It's going to be lumpy. There are probably going to be some large hits in the future as -- basically you apply the system to an entire product as you go into the market. We think that it's going to grow in the double digits of 10% to 15%. Albeit off of a relatively small base. But double-digit growth in that segment is pretty likely.

So you mentioned about a $5 million contribution from flu vaccines potentially in 2010?

Revenue, yes, that's correct.

And so, I guess, can you just talk about what your customers are thinking, given some of the dynamics that obviously is going around about the pandemic didn't manifest that people were thinking it to. What are your customers basically telling you in in terms of how they are looking at that, or is it still a crapshoot?

I think it's still pretty much a wild card.

Seasonal flu is going to be seasonal flu and we expect orders to basically follow the historical pattern we've seen there. I think we'll going to have to wait and see what happens with the evolution of the H1N1. If there is a mutation, some people have talked about, chances are you would see another surge as another vaccine is developed and delivered separately. If there is no mutation, then you're probably not going to see those orders repeat themselves.

Great.

And, I guess, I just get the feeling that the FDA is starting to be a little bit more -- starting to improve a little bit more products and stuff like that. Are your customers basically feeling a little bit more positive about the pipeline, or about the approval process in terms of getting new things out on the market, are they starting to gear up their production processes in anticipation?

I don't think we've heard anything from the customers that say they're seeing accelerated approvals. I think 2008 there were 25, 2009 there were 26. So that was basically even. On a positive note, I think about a third in each one of those years was injectable.

The one consistent theme we are seeing is that the large guys are moving to acquire large molecule assets and develop large molecules. And if you look through the therapeutics going through the pipeline, the larger percentage is becoming biologics, and that would also include vaccines in that arena as well.

The signs are positive on the development front. Are we seeing accelerated approvals? in some cases, yes, in other cases, no. Great.

And then just one final question. Obviously again talking about your customer base, have the major headwinds from the mega-mergers that we've seen last year, are those pretty much done as far as you can tell from what your customers have been planning?

No, I think it's going to throw think the next one to two years in a couple of areas.

One, clearly there will be pricing pressure on the supply base. I think virtually all of the mergers, cited synergies and cost savings out of a larger base is one of the reasons for going forward. So we expect to see some pricing pressure over the next year to two.

The other thing is that they are still sorting out I think many of their priorities on the R&D front. We haven't seen many delays in our components development side of the business. But my expectation is that we will see some of the lower priority programs that we've been working on in their early Phase I, perhaps early Phase II area, drop out as they concentrate on the molecules that are closer to approval.

So, don't think it's done with yet. Probably another year or so to work through it.

Thank you very much.

Thanks, Derik.

And your next question comes from the line of James Sidoti of Sidoti & Company.

Good morning, Don. Good morning, Bill.

Good morning, Jim.

Quick question on interest expense, where do you see that for 2010, and is it at all tied too Libor or is it fixed?

Most of our interest expense now is fixed. We do have a small part of the revolver that is still outstanding of less than $40 million. And that obviously floats in relation to the Libor. But in terms of most of the other -- of the $380 million worth of debt, all but the $40 million are fixed.

So when we look at interest, we're -- part of what we have here is you have some of the interest income that you have on your cash balance that goes against that, too. So when we look at it on a net basis, we believe that it's going to be up in the $2 million to $3 million over 2009, as we have less cash to invest and rates that come down.

So you're saying that about $16 million to $17 million?

That's correct.

Okay.

And then you noted that 2009 was a little bit unusual in that you had more sales at the end of the year than at the beginning of the year.

Right.

Do you think you go back to that historic pattern in 2010?

I think we will see some leveling out and that probably the first six months are going to be a little bit stronger than the back half of the year. Certainly the order patterns are leaning that way. With the shorter lead times and the smaller orders, we do not quite have the visibility we used to. We feel good about the first half of the year. We'll have to see how things settle out in the second half.

And where do you expect free cash flow to be for the year?

We do not really talk publicly about that in this call. I would think that, based on the various pieces of the puzzle, we have both -- looking at the earnings that we expect to increase, you are looking at an increase in operating cash flow. A modest increase. I wouldn't suggest it's going to be dramatic. But it will be driven off of increases in depreciation and increases in earnings, as well as hopefully some continued balance sheet management on the working capital.

Okay. So you think you will be free cash flow positive, though?

Free cash flow? You're defining free cash flow as operating cash flow minus CapEx? Before the dividend, yes, we will.

All right. Great. Thank you.

Your welcome, Jim.

Your next question comes from the lines of Dave Windley of Jefferies & Co. Please proceed.

Thanks for taking the questions.

I was just getting ready to do a calculation to spell it out more clearly, but what I'm looking at is in your guidance, and my question is kind of around the unspoken guidance, the implicit guidance of the SG&A, R&D, D&A lines, and it looks to me like growth in those lines perhaps is eating into what would otherwise be a little bit faster growth in earnings. And I guess I'm looking for confirmation that I'm seeing that right, and what elements of those lines are driving year-over-year increase. Is it putting facilities and service that is driving D&A up, or is there spending around SG&A to get CZ in place? I'm wondering what is driving the growth?

It's all of those things. In fact you hit the two bigger ones.

Depreciation is going to increase based the on the fact we've had all of that CapEx that we've expended over the last few years that is now operational appreciated.

Within SG&A and R&D, our increases in both of those lines. In R&D, as Don mentioned earlier, we're focused on all of the development programs and we're going to continue to increase spend there.

And in the SG&A arena, there are a couple of things going on in there. The first one is in and around -- our customers asking for higher quality product. There is -- they continue to bolster our high-quality programs that are in those numbers. And a comp perspective, we have an increase of 3.5% for comp and in incentives, there is a projection that we'll be increasing that based on our expectation of meeting our targets.

Okay. I'm sorry, I missed the percentage. You said on comp you expect what percent growth?

3.5%.

3.5?

That's correct, Dave.

On the inventory side of things, you described both today and before how you've made some deliberate purchases of inventory for yourself. It sounds like some of that might be a continuing practice, whereas some of it was somewhat in advance to avoid what you anticipate to be some inflationary trends in those items. And I'm wondering if your days in inventory will come back in a little bit to reflect those, maybe those more one-time purchases, or if we should expect inventory levels to stay where they are as from a turn standpoint or a days in inventory standpoint?

In terms of an absolute value, I think it will continue to increase as the business grows. But on a day sale, you can expect that with the strategic build in inventory that we're going to continue at about those same levels.

We'll endeavor where we can as part of our own lean programs to take out as much of the working capitals we can, but when (inaudible - technical difficulties) inventory levels, these are prudent things to do, both from a -- to secure the source of some of the critical components, and to take into account our desire to try to hold the line of increasing raw material costs.

And last question from me.

Bill, I know you probably touched on this and I apologize if missed it, but in I guess what is still Tech, what was the primary factor driving the margin degradation. So you had sequential revenue increase and sequential decline in profitability and margin, and what was the primary driver of that?

The big drivers there, we gave up some -- as you know, when raw material prices come down, we pass that through to the customer from a -- so price, if you're looking at the margin, the price is down, the Plastef acquisition model was $6.2 million worth of revenues in the quarter and had very marginal operating profit associated with them. Volume and mix were negative in the quarter, as well Those were the primary drivers that drove the profitability down.

Okay. Great. Thanks for answering the questions.

No problem, Dave.

Your next question comes from the line of Ross Taylor of CL King. Please proceed.

Hi. Most of my questions have been answered, but just a few left.

Sure.

The $5 million from H1N1 that you expect in 2010, can you comment at all about which quarters that may come in?

It will be earlier in the year. It's basically a flow-through from 2009.

Okay.

And with regard to the capital spending, you're looking beyond 2010, going into 2011 and 2012, and you think CapEx has the potential to come down from that $115 million to $130 million level that you're looking at for this year?

Yes, I think it's going to fluctuate. Certainly it has the chance to come down in the near-term. We're going to see how the markets evolve in both India and China. We've decided to scale back on our rubber investment there and start with the development facility, as we see how the market evolves. We're still taking a good hard look at India as to the right time and when. We haven't made a commitment there yet. So at some point, we know we need to be there, whether it's 2011 or 2012, we'll see how markets develop. If it comes down in those early years, then it will likely ramp back up again to that $125 million, $130 million level post-2010.

The other wild card in there is that with the first commercial exposure of CZ, it's very likely that we'll be adding substantial capacity there in the 2011-2012 timeframe.

Okay. Good.

And last questions relate to CZ. But there is any time during 2010 where we might see some data from those stability studies or just get a better sense of how effective the product is. And second question, related to CZ, if you do sign on a commercial partner in 2010, when might you start to recognize commercial revenues from that product?

I'll answer the last part first and then go back to the first one.

If we are successful in finding a customer, I think it will depend on where they are in their development cycle, but we would certainly expect to see some commercial revenues in the second half of the year. The magnitude of those, of course, will depend on the timing.

With regard to data, our customers typically bind us to confidentiality agreements and we wouldn't be able to share any product-specific data. We can provide some general articles and posters that's have been published in the trade press and the academic press that directly compare CZ to other systems. So we would be glad to share that with you if your interested.

Okay.

And just one clarification, Ross, we are expecting a modest amount of those commercial revenues in 2010. It's on the order of less than $15 million.

Okay. That's helpful. Thank you.

(Operator Instructions). And your next question comes from the line of Arnie Ursaner of CJS. Please proceed.

Can you give us your best view of SG&A as a percent of revenue in the upcoming year?

I don't have that computation in front of me, Arnie.

I think when I look at the drivers, as I mentioned to Dave, we're going to have comp increase use about the percentage that I mentioned, 3.5%. So when you look at the total, you should expect it to be a little more than as a percentage of sales than we have in the current year.

So you'll have negative leverage from SG&A in the upcoming year?

Again, it's due to the building out of the regulatory and quality functions, as well as comp increases, the intent of comp piece that I mentioned. Those are the big ones. Going the other way is the $2 million or so of savings on the pension. And FX is -- we expect to be somewhat of an additional SG&A cost as well.

On the $40 million of debt that you have to refinance, you've been running at Libor plus 87. And I think you have to refinance by the end of Q1, are we looking something north of 250 versus Libor?

Let me explain -- clarify something. The actual revolver does not come due, it does not mature, until 2011. I think it's February of 2011.

Okay.

The reason we would suggest refinancing in the first quarter, as you're suggesting, is to keep the $30 million-plus of outstandings on that from going current. What we are doing is we are monitoring the situation closely with our banks, and we have not decided whether we will go ahead and do the refinancing in the first quarter or will continue to examine it as it -- the pricing and the spreads et cetera, as it goes through the first half of this year. Arnie, right now you are looking in something like -- on a like-to-like base of something like 175 to 250 basis points higher.

You can expand a little bit more on your capital expansion program? Give us a little more clarity or detail on the $50 million to $60 million of expansion or growth capital you intend to incur this year. And then more specifically, on IT, I you've been -- every year it seems like we're adding $10 million or $15 million to your IT spend. Perhaps freshen up where we stand in total on how much you have spent on IT, and where the $15 million will be going this year.

The IT side, it will be going toward the shop floor systems on the plastics side of the business and those operations, and eventually bringing them up on the SAP platform.

As you recall, when we did the earlier program for North America, that was the rubber operations only. So those expenditures in the future are going to be geared towards getting our global operations on a single SAP platform.

With regard to the expansion capital, a large part of that will be going towards our global quality initiatives, and will focus on vision systems and post-manufacturing process to get to this ultra-clean level with NovaPure and Envision that we've talked about. And that's basically being driven by the market requirement for clean products. We also expect some of that money to go towards additional CZ capacity, as well as capacity for NovaGuard and for the Confidose.

So the bulk of it will go into the existing elastomer operations for division and processing of the components, a large part of it will go towards CZ and the programs emerging through innovation, and there's also a small amount for the China rubber facility to get that going.

So when you think about maintenance, you're not including things like vision systems that others might be saying are improving operations, as opposed to physically building a new facility. In other words, the $50 million to $60 million of expansion does not generally include in many or any new facilities? Or is that -- could you clarify that?

No. In the budget for 2010, the only facility expansion considered is the China rubber operation.

When we say, expansion, Arnie, or new products, these are improvements, especially vision, to -- some to existing lines, some to new lines, that allow us to get the quality of product to the level that our customers are desiring.

The maintenance capital would incorporate any rebuilds on the presses, new tools, tooling refurbishment, et cetera.

I guess my question is whether it's the FDA or your customers are demanding higher quality and better vision and other things to improve the work you're doing for them, it doesn't seem like you're getting price release to cover quite sizable incremental spend on your part. Have you gone back to your customers and said if we're going to do this, we have to get much better pricing?

It's an ongoing discussion. The answer is yes. A large part of these sales go into the larger multinational contracts.

And Arnie, a big part of the mix, we're talking about increase, is not so much price as it is this mix where we can either -- we're coating the product so we're locking them or we're providing vision, so all of those are upcharges to the customer.

So that's where that would be reflected in mix as opposed to just pure outright pricing?

That's correct.

With hindsight, you can quantify whether H1n1 was positive or negative for your pharma segment in Q4, given -- I believe it had better than corporate average margins, but you may have had to knock out even higher margin work to do it on a timely basis. All in, was it positive or negative in your pharma margin in Q4?

It was about flat, Arnie.

If you look at it from -- it's exactly what you said. Some of the products that we have a lower base cost and then we were providing some processing on those components. But overall -- and we did obviously have to take up capacity to do these. So overall, when you look at it, it was just slightly below what the average was for Pharm Systems for the year.

Okay.

As we talked about before, vaccines are an interesting category because often the pricing is set separately in our contracts because of the large purchases done by the governments. So we would not command a margin off of that like we ordinarily would for another product.

And normally you arrange your prices at the beginning of the year. Have you already put in the price increases, do you have any other contracts up at risk, and do the price increases you've put in place cover what have been some fairly sharply rising costs of energy, which will normally harm your margin three or four months out, given your lag?

The bulk of the prices are in place where we do not have contractual agreements. We do have a couple of contracts that are under negotiations rights now. Not as large as the ones we talked about in 2008, but a couple of our more significant contract manufacturing customers.

And the price increases are more than enough to cover your higher raw material costs?

I don't know that they're more than enough.

We're counting on it, Arnie. We're counting on, as usual, there are a number of valuables in the equation. We're counting on a modest amount of price increase this year versus what we saw in 2009. But we are counting on things like mix, lean savings or restructuring savings, all of those things combined to offset the increases that we expect to see in both raw materials, labor and overhead.

That's the key point, I think. Pricing alone would not get you there, but pricing combined with the improvements in our operating efficiency should.

Okay. Thank you.

Thank you, Arnie.

And you have no further questions at this time.

Thank you very much, operator.

This concludes our commentary for today and we thank you for your participation in the call.

Ladies and gentlemen, that conclude's today's conference. Thank you for your participation. You may now disconnect. Have a great day.