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West Pharmaceutical Services Inc. (NYSE:WST)

Q3 2010 Earnings Call

November 2, 2010 9:00 am ET

Executives

Donald J. Morel, Jr. – Chairman, Chief Executive Officer

William Federici – Vice President, Chief Financial Officer

Michael Anderson – Vice President, Treasurer

Analysts

Arnie Ursaner – CJS Securities

David Windley – Jefferies & Company

Derek DeBruin – UBS Securities

Ross Taylor – CL King and Associates

James Sidoti – Sidoti & Company

Operator

Good morning and welcome to the West Pharmaceutical Services Third Quarter Earnings conference call. At this time all participants are in a listen-only mode. If at any time you require operator assistance, please press star followed by zero and we will be happy to assist you. Today’s conference is being recorded. If you have any objection, you may disconnect at this time.

And now I’d like to turn today’s meeting over to Mr. John Woolford from Westwicke Partners. Sir, you may begin.

John Woolford

Thank you, Operator. Good morning and welcome to West’s Third Quarter 2010 results conference call. We issued our financial results this morning and the release has been posted in the Investor Section on 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 to you immediately. There is also posted on the Company’s website a slide presentation that management will refer to in their remarks today. You may need additional software in order to view the .pdf formatted presentation, and a link to a free download of that software is also provided at the website.

I remind you that statements will be made by management that may contain forward-looking statements within the meaning of U.S. federal securities law and that are based on management’s beliefs and assumptions, current expectations, estimates and forecasts. Statements that are not historical facts, including statements that are preceded by, followed by, or that include words such as estimate, expect, intend, believe, plan, anticipate, and other words and terms of similar meaning are forward-looking statements. West’s estimated or anticipated future results, product performance or other non-historical facts are forward-looking and reflect our current perspective on existing trends and information.

Many of the factors that will determine the Company’s future results are beyond the ability of the Company to control or predict. These statements are subject to known or unknown risks or uncertainties and therefore actual results could differ materially from past results and those expressed or implied in any forward-looking statement. You should bear this in mind as you consider forward-looking statements.

For a non-exclusive list of those factors which could cause actual results to differ from expectations, please refer to today’s press release. Investors are also advised to consult any further disclosures the Company makes on related subjects in the Company’s 10-K, 10-Q, and AK reports. Except as required by applicable securities laws, the Company undertakes no obligation to publicly update forward-looking statements whether as a result of new information, future events, or otherwise.

In addition, during today’s call management may make reference to non-GAAP financial measures including adjusting operating profit and adjusted diluted EPS. These measures have no standardized meaning prescribed by U.S. GAAP and therefore may not be comparable to and should not be viewed as a substitute for U.S. GAAP operating income and diluted EPS. Reconciliations of the non-GAAP financial measures to the most comparable financial results compared in conformity to GAAP are provided in materials accompanying this morning’s earnings release.

This call is being recorded on behalf of West and is copyrighted material. It cannot be rerecorded or rebroadcast without the Company’s express permission. Your participation in this call implies your consent to our taping.

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

Donald Morel, Jr.

Thank you, John, and good morning everyone. Welcome to West’s third quarter conference call. Joining me for the call today are Bill Federici, our Chief Financial Officer; and Mike Anderson, West’s Treasurer and primary investor relations contact. Please note that you can follow our presentation this morning via the PowerPoint slide deck uploaded on the Company’s website. We will call out the slide number we are referring to during the course of our remarks. For those who are unable to view the slides during the call, they will remain available on our website and the information they contain will be covered in both the release and our remarks.

Let me begin with a quick snapshot of our third quarter performance, the highlights of which are summarized on Slide No. 3. I’m pleased to report that consolidated sales were quite strong, coming in at just over $271 million versus 258.9 million for the third quarter of 2009, an increase of 4.8% at actual rates or 8.7% excluding the effects of currency.

The strong increase in sales is particularly noteworthy due to the fact that in the third quarter of 2009, H1N1 vaccine sales were $9.7 million which did not recur in 2010, and we also benefitted from a more favorable euro-dollar exchange rate. In effect, we had to grow other sales at a 12% rate to overcome these two issues and achieve the 5% reported gain.

Our consolidated gross margin showed a slight decline of 0.2 percentage points to 27.5%, which is not unusual given the seasonal impact of planned shutdowns and the costs that we incur for preventative maintenance and the restart of production. Adjusted operating profit grew 7.7% and adjusted diluted earnings per share grew just over 2% to $0.46 per share. Excluding currency effects, adjusted diluted earnings per share were up just under 9%.

Sales grew in all geographic regions within the pharmaceutical packaging system segment, increasing 5% in North America and 6% in Europe respectively, and a very strong 18% in our South America and Asia operations, excluding currency effects. Sales of value-added products such as Westar processed components, FluroTec and B2-Coating closures, in addition to our newer Envision and NovaPure product lines, were the primary revenue drivers in Europe and North America; whereas strong unit growth was the driver in India, China and South America.

The double digit growth in West’s high value closure systems continued the trend observed over the last few years. The market is moving towards zero defect particulate free systems, especially for high cost biologic drugs; and our recent investments in clean room processing, ultra-clean water for injection washing systems, and vision inspection systems have been timely in meeting these requirements. In addition, demand has steadily increased in Asia and South America for our TrimTec and InsoCap IV bottle closures, which are produced in our Stolberg, Germany and now in our Qingpu, China facility. We expect the China facility, which began operations in September last year, to be profitable in 2011.

Sales in the delivery system segment increased over 18% excluding the effects of currency. The increase was driven by higher demand for contract manufacturing services, higher sales of proprietary safety and reconstitution systems from Medimop and Daikyo CZ products. R&D spending in the delivery system segment for the quarter also increased by approximately $1 million as we prepare to ramp up manufacturing of samples for customer evaluation with the primary emphasis being on the 1mL CZ syringe, the ConfiDose auto injector, and the recently acquired micro-infuser technology.

Overall, I am very pleased with the Company’s performance during the quarter. As summarized in Slide No. 4, both the packaging and delivery system segments delivered sales gains in excess of our original expectations, resulting in consolidated sales growth of just under 9% and overcoming the absence of H1N1 revenues.

Through the first nine months of the year, sales were up 9.4% on a consolidated basis, excluding exchange effects; and adjusted diluted earnings were $1.71 per share versus $1.45 for the comparable nine-month period in 2009 on a currency-neutral basis.

Turning to our key programs, the third quarter was a very active period in terms of our ongoing proprietary product development efforts. Slide No. 5 provides some highlights from the past three months. Starting with the Daikyo CZ program, we booked approximately $2.2 million worth of sales during the quarter comprised of a combination of vial and 1mL syringe sales along with design and engineering services associated with customer proprietary projects. Having completed validation of the new four-cavity production cell, we have shipped more than 90% of the 1mL syringe order booked in the second quarter. Demand for samples continues to outpace our current capacity even with the new line in operation. As I noted in our Q2 call, we are accelerating our Scottsdale investment to increase capacity as soon as possible.

Customer interest in CZ as a platform technology remains quite strong. As I and others have stated on numerous occasions, CZ’s unique combination of attributes make it an excellent option for the packaging of high value biologic drugs. Recent FDA recalls have highlighted not only the issue of glass breakage in auto injectors but also more recently the flaking of glass vials, producing particulates in the drug solution. The inherent break-resistance of CZ and its potential stability performance give it advantages over traditional glass systems in many applications.

Recently, West invited potential CZ customers to an open house at our Scottsdale facility in order to provide an update on the status of our development programs and to allow them to see first-hand the cellular manufacturing system. Included in the event were presentations on filling considerations in addition to system sterilization. The sessions were very well attended with a great deal of interactive discussion on the potential of CZ to address the emerging breakage and contamination issues being experienced with primary glass containers. I came away from the event strongly convinced that CZ is the right solution at the right time, not only for biologics but other aggressive, difficult to package drugs.

Our innovation team also signed a first major development agreement for ConfiDose during the quarter. This agreement calls for small modifications to the existing design to make it suitable for the customer’s application and the delivery of samples for patient use trials in 2011. This was a key milestone for the program which we hope to go commercial production in 2013.

Market interest in the micro-infusion system we discussed in the last quarter’s call also continues to be extraordinarily strong. This unique patch pump adheres to the patient much like a band-aid and can deliver a 1 to 3mL dose subcutaneously over a period of up to three hours. The technology is simple and reliable and gives the formulation scientists within our customer base more options for their active molecules. Our goal is to have a sample suitable for clinical use in the hands of key customers by the fourth quarter of 2011.

Turning to our outlook, as I mentioned in the Q2 call, comparisons for the second half of 2010 with the comparable period in 2009 would be more challenging due to exchange rate volatility and the absence of H1N1 sales. Our backlog, however, has remained strong and is slightly ahead of the comparable period last year of $231 million. Taking this into account, we are anticipating Q4 earnings to be in the range of $0.45 to $0.52 per diluted share based on an exchange rate of $1.40 to the euro. This would yield full-year earnings in the range of $2.13 to $2.20. The full-year effect of currency assuming a dollar-euro conversion rate of 140, is expected to impact earnings on the order of $0.03 per share versus earlier guidance; and increased R&D spending primarily on CZ and ConfiDose, will absorb another $0.03 per share in the fourth quarter versus the prior year quarter.

Looking ahead to 2011, our expectation is that consolidated sales growth will be again in the range of 3 to 5% at constant exchange rates. We expect modest unit growth in our traditional Western markets with revenue growth being driven by the continued penetration of our value-added products. Unit growth will be more robust, albeit on a lower margin, for standard products in Asia, India and South America. We expect capital expenditures to fall in the range of 120 to $140 million as we invest in capacity in China and India to serve those rapidly growing markets, in addition to continuing our investments in vision inspection and post-processing systems in Europe and North America. Also, with CZ and our other platform technologies near commercialization, we plan to increase R&D spending were prudent to speed these products to the commercial stage.

We are currently in the year-end price negotiations for many of our customers, and over the next six weeks we’ll have a much clearer picture for 2011, and as we have done historically we’ll provide more detailed guidance, including earnings projections, in our February year-end call.

I’d now like to turn the call over to Bill Federici.

William Federici

Thank you, Don, and good morning everyone. Before I get into my comments, we understand that there was a technical problem with the slide presentation. It is now fixed. The slides are up on the website so if you had trouble getting in, please try again.

We issued our third quarter results this morning, reporting net income of $17.8 million or $0.51 per diluted share versus the $0.50 per diluted share we reported in the third quarter of 2009. As explained in the release, results in both periods included restructuring charges and several discrete tax items. Excluding the effect of these items in both periods, third quarter 2010 earnings were $0.46 per diluted share versus the $0.45 per diluted share we earned in Q3 2009. That earnings growth was achieved despite last year’s quarter having about $10 million in non-recurring H1N1 sales with an approximate $0.07 earnings contribution, and the current quarter’s results being negatively affected by $0.03 of currency translation.

Turning to consolidated sales, Slide 6 shows the components of our consolidated sales increase. Consolidated sales grew by $12.5 million to 271.4 million, an 8.7% increase over Q3 2009 sales, excluding exchange. Volume and mix contributed $20.5 million or 7.9 percentage points of the increase. Price increases contributed $1.3 million, or half a percentage point; and acquisitions in 2010 contributed $700,000 or 3/10ths of a percentage point of the increase.

Slide 7 details the third quarter’s increase in packaging systems sales. On an ex-currency basis, sales increased 5.1% driven by a favorable product mix and modest price and volume increases. Sales increases were strong in all of our geographic regions when excluding exchange impacts. Sales were higher despite the nearly $10 million of Q3 2009 H1N1 component sales which were not repeated in the current quarter.

High value product sales increased 14% to $75 million versus Q3 2009 with the most significant increases this quarter in FluroTec coating and Envision inspected components. Standard product sales were about 1% higher than the prior year at $100 million, excluding currency, and sales of disposable medical device components were relatively flat at approximately $25 million.

Slide 8 shows the factors driving the $10.8 million or 15.4% increase in delivery system sales. Our proprietary product sales increased almost $1t million in the quarter, an increase of nearly 33% over prior year same quarter sales, excluding currency effects, and included about $2 million of CZ product sales and about $10 million of reconstitution product sales. Contract manufacturing sales increased by approximately 15% to $67 million due to increased sales of devices used in healthcare applications such as auto injection pens, an increased demand for disposable healthcare products, including those used in inflation and diagnostic applications.

Excluding acquisitions made since the third quarter of ’09 and currency effects, delivery system sales increased by 17.2% over Q3 2009 sales.

Slide 9 shows our consolidated gross profit, adjusted operating profit, currency impact, and FX-neutral growth rates. Our gross profit excluding exchange increased 7.5%, driven mostly by favorable volume and product mix, improved plant efficiencies, and modest price increases. The increases were partially offset by increased raw material costs, labor, plant overhead, and higher depreciation expense. Adjusted operating profit, which eliminates non-recurring items from each quarter, increased by 15% excluding exchange effects, reflecting the increased gross profit offset by increased R&D spending on critical development programs and an increase in SG&A expense.

Slide 10 shows the detail of our consolidated third quarter 20 basis point gross margin decline. Packaging systems gross profit margin declined by 70 basis points to 30.5% due primarily to material price increases, labor increases, and higher plant overhead costs. These increased costs were largely offset by improved efficiencies due to higher plant loads, modest price increases, and a favorable volume and mix. Packaging systems current third quarter results reflect a more typical summer operating quarter than Q3 2009.

Delivery systems gross profit margin increased by 230 basis points to 20%, driven by increased volumes, an improved sales mix, and improved plant efficiencies that more than offset the increased raw material and other manufacturing costs.

We continue to expect that both segments’ full-year 2010 gross margins will increase versus 2009 due to continued favorable volume and mix, continued modest pricing, and mean savings.

Slide 11 shows the changes in consolidated SG&A expenses. The overall increase in the current quarter over the prior year quarter was due to increase compensation expense, higher outside service expenses, much of which related to increased sales commissions, and increased depreciation. Largely offsetting the increases were the effect of the decline in stock-based compensation expense and a decrease in pension expense versus the prior year quarter. As a percentage of sales, SG&A expenses declined from 17.1% in the third quarter of ’09 to 16.5% in Q3 2010.

R&D expenses increased by $800,000 versus the prior year quarter due to increased spending on our development projects including Crystal Zenith prefilled syringe systems, our micro-infusion system, and ConfiDose, our auto injector.

Slide 12 shows our summary balance sheet information. Our balance sheet remains strong and we’re confident that our business will continue to provide necessary liquidity. On a year-to-date basis, our debt declined by $9 million due to debt repayments of $4.7 million and with currency providing the remainder of the decrease.

Working capital increased by $57 million from the prior year end due mostly to increased cash, accounts receivable, inventories, and a reduction in accounts payable. AR increased by $4 million as a result of increased sales. Our days sales outstanding improved slightly versus the prior year-end at 47.1 days. Inventories increased by $19 million due to higher levels of strategic stocks of certain raw materials. The $8 million decrease in accounts payable reflects reduced levels of capital spending resulting in lower accounts payable at the end of the third quarter compared to the prior year-end.

Slide 13 shows our key cash flow metrics. We generated year-to-date operating cash flows of $91 million, $6 million better than prior year, reflecting our higher net earnings. Capital spending has been almost $30 million less year-to-date in 2010 due to the relatively high 2009 spending on our China facility and our European expansion, both of which were essentially completed in the third quarter of 2009. Of the $49.8 million of year-to-date CAPEX, about half was focused on maintenance capital with the remainder focused on IT system upgrades and new product and expansion efforts.

We are updating our full-year guidance, which is summarized on Slide 14. We have based our revised guidance on an exchange rate of $1.40 per euro for the remainder of 2010, reflecting current rates and representing a relative weakening of the dollar versus the $1.30 per euro used in our previous guidance. This revised currency outlook has a favorable affect on our EPS of $0.03 per share versus the previous guidance.

In addition to the currency effects, we have revised our fourth quarter and full-year guidance to reflect our actual third quarter results and our revised outlook for sales and products mix in the fourth quarter. Comparisons of Q4 2010 versus the Q4 2009 period will be less favorable due to adverse currency comps and the substantial non –recurring H1N1 sales which contributed about $0.09 of EPS in the fourth quarter of 2009. The aggregate adverse currency impact on EPS for Q4 2010 versus Q4 2009 is expected to be $0.03 per share at actual exchange rates. R&D expenses are expected to be $0.03 higher in this year’s fourth quarter due to increased spending on our critical development programs.

Our backlog remains strong at $231 million, which is $6 million higher than our year-end backlog and September 2009 backlog levels, excluding exchange. The fourth quarter order book is relatively full but visibility remains limited as a result of shorter lead times and still more frequent but smaller orders. We expect full-year CAPEX to be in the range of $80 million to $90 million at the assumed exchange rates.

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

Donald Morel, Jr.

Thanks very much, Bill. As outlined in our commentary, the Company delivered a stronger than anticipated third quarter; and overall, the first nine months of 2010 have been very strong. Sales have increased over 9% and earnings 18% on a currency-neutral, fully diluted adjusted basis. We carefully managed our capital expenditures and discretionary SG&A while increasing R&D where appropriate. Our innovation team has achieved several significant milestones on key development programs, setting the stage for the Company to deliver sustainable growth over the next five years.

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

Question and Answer Session

Operator

Ladies and gentlemen, if you have a question please press star followed by one on your phone. If your question has been answered or you would like to withdraw your question, press star followed by two. Questions will be taken in the order received. Please press star, one to begin.

Our first question comes from the line of Arnie Ursaner with CJS Securities. Please proceed. Mr. Ursaner?

Arnie Ursaner – CJS Securities

Sorry, I had it on mute. Good morning. My question relates to your margin guidance in the pharma segment—packaging segment. You obviously have a lot more of the value added products—in fact, you didn’t even mention Westar RU, which I think is just beginning to roll out with some customers; and yet, despite that you highlighted the fact that some costs—some operating costs are impacting your margin. Could you expand a little bit on the mix you have going into Q4 and what actions you’re taking to reduce some of the operating expenses?

William Federici

Yeah, thanks Arnie. If you—one thing we need to remember, again, and we called it out—Don called it out, is that the comps to the final two quarters of 2009 are much more difficult. If you remember, we had kind of a backwards, atypical view of the quarters in 2009 versus what we normally see. And this year, 2010 is more normal.

All that said, we do continue to see an increase in the high value products. We continue to see that strategy of selling—of higher margins and higher revenues on the same number of units, which fits in nicely to the biologic space and the high end vaccine space, is continuing and we do expect that to do continue to grow. However, when you look at the cost side of the equation and you compare it to 2009, there are some challenges there. One, obviously, is currency and we’ve talked about that already. Another is raw material prices and we have a—in 2009 in the back half, we were still benefiting from raw material prices which were actually running favorable to what they had been to the prior year. That has changed now and we are seeing the impact—the negative impact. We saw it in the third quarter of 2010 and we will continue to see in the fourth quarter of 2010 versus the comparable period.

That is a—you know, normal increases in wage rates and overhead, increased depreciation which is driving off of our capital expenditures over the last few years, those are all items that are having an impact on the gross margin.

Donald Morel, Jr.

And on the Westar UR side, Arnie, that’s a situation where the conversions are probably going to mirror the uptake of Westar RS. You may recall the slide we showed at the investor day back in May where you have an introductory period of a couple years. People start to use it and then the ramp up starts to take off. In this particular case going to the RU, the customers have to do a regulatory filing. The FDA evaluates the filing for the change. They have to respond within a certain period of time and then the customer can go forward. So we haven’t heard anything to indicate that they’ve asked for additional information, and our expectation is that RU use, given the cleanliness demands of the industry, will slowly ramp up over the next couple of years.

Arnie Ursaner – CJS Securities

And to the extent that occurs, I assume that has a noticeable impact on your margin?

Donald Morel, Jr.

It will have an impact on our margin again offset, as Bill indicated, by some of the other things. But yes, it should have a positive impact on our margin.

William Federici

It’s better than the average margin in packaging systems.

Arnie Ursaner – CJS Securities

Okay. For modeling purposes, can you give us a little more specific information on what you expect to spend on R&D this year, and what you’re now expecting to spend next year for R&D?

William Federici

Well, we won’t talk about next year, as we discussed, until the February call; but this year we are expecting to spend $25 million on all of our R&D programs, and that’s up roughly $5 million from the 20 million that we spent last year.

Arnie Ursaner – CJS Securities

Okay. My final question relates to your general guidance regarding 2011, and there are a couple of moving parts within that. In the 3 to 5% revenue growth, could you comment specifically about what—I know you’re in pricing negotiations and mentioned modest volume improvement in the mature markets. Perhaps you could tell us what growth you expect in the emerging markets, and do you expect positive pricing generally in the negotiations given your higher costs?

Donald Morel, Jr.

I don’t know where the pricing negotiations are going to come out, quite honestly. We’ve got—we’re into it about six weeks. It affects about half of our business between Europe and North America. And given the pressures in the market, I think we’re in a good position but we’ll have to see where it comes out. I think the unit growth is going to be stronger in Asia, as I commented. Historically over the last couple of years in China and India, we’ve seen close to 20, 25% growth in each one of those markets independently, albeit off of a slow base. A fortunate thing is we’ve seen stronger growth in South America which is a larger base overall. We do about 35 million down there. So those are the markets that are growing in terms of unit volume. Again, in the Western markets, we think that it’s going to be driven by the continued uptake of the value-added products, not so much by unit growth.

Arnie Ursaner – CJS Securities

I’ll jump back in the queue. Thank you.

Donald Morel, Jr.

Thanks, Arnie.

Operator

Our next question comes from the line of Dave Windley with Jefferies & Company. Please proceed.

David Windley – Jefferies & Company

Hi, thanks. Good morning.

Donald Morel, Jr.

Good morning, David.

David Windley – Jefferies & Company

It sounds like your CZ uptake, or interest levels sound higher, continue to proceed somewhat ahead of expectations. Uptake sounds good. I’m wondering if you are, or if you did and I missed it, updating your revenue expectations for CZ for 2010, and are you making any comment about how that’s going to roll out in 2011?

Donald Morel, Jr.

No change for 2010. Revenues probably in the 5.5 to $6 million range for CZ overall, and we will give you an update on 2011 when we get to February. You know, I think the positive things are that out of this open house, it’s very clear that interest in an alternative to glass is out there for the bio guys. The recalls have kind of highlighted the issues with glass in terms of breakage and in some cases the flaking that has been seen inside the vials. So we think CZ is ideally suited to meet both of those problems and obviously the comments that we’re receiving back from our customers are still very positive. No change in the sampling activity, so that’s been very strong as well. So all in all, very pleased with where we’re at. We just need first uptake in the market.

David Windley – Jefferies & Company

Can you comment on the breadth of customer sampling that you’re seeing? I know you said you’re working with a lot. Can you put a number on it?

Donald Morel, Jr.

If you take the list of the Top 20 biologics that are currently sold in the market and look at who’s producing those, all of them are currently in some stage of evaluating CZ. There are some that are a little bit further behind. There are some that are running line trials and formal stability, so. If you are a producer of biologics, the odds are very strong that you’re evaluating the CZ opportunity.

David Windley – Jefferies & Company

Okay. And then finally from a cycle time standpoint, from the sampling activities to moving forward to some commercial product—you mentioned briefly just a second ago need first uptake. Give me some insight into the cycle time there. What’s the selling cycle?

Donald Morel, Jr.

It mirrors our packaging components, really, because the CZ is the primary container so the customer is required to do formal stability and submit that data as part of their supplement or as part of their application, and that period is two years. So for customers that are in formal stability now, ideally they would receive a favorable response sometime in the late 2012 time frame, and I think we’ve commented publicly that our expectation is that we’ll see moderate volume increases in 2012 towards the end, depending on timing, and that the ramp up with first commercial—real commercial production would occur in 2013. And that’s still the timeline we’re looking to.

David Windley – Jefferies & Company

Okay. And then just one other question on the ConfiDose, in your prepared remarks you mentioned an opportunity to commercialize in 2013. I don’t think I understood if that was a broad statement about ConfiDose and the timing of meaningful revenue there, or if that was a particular opportunity targeted for ConfiDose.

Donald Morel, Jr.

No, it was a broad statement relative to ConfiDose.

David Windley – Jefferies & Company

So you’re thinking you don’t really see uptake there until 2013?

Donald Morel, Jr.

I would say that we’ll see uptake in terms of opportunities broadly through 2011 and 2012. I think we’re being a little bit conservative. But 2013 for us is the most likely point at which we’ll see high volume production.

David Windley – Jefferies & Company

Okay. Thank you.

Donald Morel, Jr.

Thank you.

Operator

Our next question comes from the line of Derek DeBruin with UBS. Please go ahead.

Derek DeBruin – UBS Securities

Hi, good morning.

Donald Morel, Jr.

Good morning, Derek.

Derek DeBruin – UBS Securities

Hey. Bill, so the pension costs were down this quarter and I guess you expect the pension costs to continue to fall since the market’s been a little bit better than expected.

William Federici

Yeah, I think—and to comment on 2010, those costs are basically locked in at this point, so we will continue to see in the fourth quarter of 2010 a decrease versus the fourth quarter of 2009. In 2011, that will depend if you recognize—we all recognize how the pension expense works. It is driven off of the actuary’s valuation as of December 31, 2010. Yes, the asset values have increased but interest rates are lower; so when you take a look at the liability, the present value of that liability stream on the pension, it may actually increase versus—in fact, we expect it to increase versus 2010, resulting in some increase in the expense for 2011. Now, all that said, we’re not giving guidance right now but it just gives you directionally, if you’re trying to understand where the pension expense is going to go for 2011. And if interest rates change between now and the end of the year, if they may rise, that may abate a little bit.

Derek DeBruin – UBS Securities

Great. I know you’re not going to give specific numbers on R&D spend, but is it safe to assume that you’re going to be—it’s going to be at least flat to up in 2011?

William Federici

Absolutely.

Donald Morel, Jr.

Yeah.

Derek DeBruin – UBS Securities

Okay. Your tax rate was a little bit lower this quarter than I thought. Is—you know, what are you looking for the full year tax number?

William Federici

Right now we’re looking at about 24% - 24.2, I think, is where we are for the full year. That could change if there is a—if the R&D extender bill gets passed, but at this point we are expecting 24.2%.

Derek DeBruin – UBS Securities

And is, I guess, 24, 25 range pretty safe number going forward?

William Federici

Yeah. We don’t—other than the—the one thing that’s a wild card there is the change in geographic mix of the earnings. I mean, if it’s higher in our low tax jurisdictions, it helps us. If it’s higher in our high tax jurisdictions, it hurts us. But we will be looking at that closely as we get towards the end of the year.

Derek DeBruin – UBS Securities

And talking of emerging markets, you mentioned that some of the margins are lower in some of the EMs. I guess—what’s the delt on that? And where ultimately do you see your share in the emerging markets go – I mean, as a percentage of revenues, where you think you’re going to go?

Donald Morel, Jr.

Yeah, actually our margins are pretty solid in both India and China. They’re a little bit better than our average gross margin for the pharmaceutical packaging systems. Because the competitive landscape there is much more intense with the local producers, our goal is to basically build our share in the high value-added part of the segment, not to compete in the lower margin bulk drugs. And our expectation is that we will get to a fairly substantial part of that market. I mean, we do have some fairly unique technologies that give us an advantage. Overall, I would say the growth expectations are going to be mirroring what we’ve seen over the last couple of years there. The big issue is getting the right capacity in place because we will be out of capacity in Singapore sometime in the 2012 – 2013 timeframe, hence the investments in China in the rubber facility, which we hope to break ground on next year, and looking at the India equation. So we have high expectations for those markets.

William Federici

And again, Derek, just a reminder that it’s off a small base. We’re at about 25 million in sales this year, 2010, for India and China.

Derek DeBruin – UBS Securities

Great. That’s the number I was looking for. Great. Thanks a lot, guys.

Donald Morel, Jr.

Thanks, Derek.

William Federici

You’re welcome, Derek.

Operator

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

Ross Taylor – CL King and Associates

Hi. I had a couple questions—

Donald Morel, Jr.

Hi Ross.

William Federici

Good morning, Ross.

Ross Taylor – CL King and Associates

Hi. How are you all doing?

Donald Morel, Jr.

Good.

Ross Taylor – CL King and Associates

A couple questions about 2011, to the extent you can respond. But in terms of your revenue outlook, can you give any color on which segment you would expect to grow faster or slower, or just any color on the organic growth you’d expect from pharm packaging versus pharm delivery?

Donald Morel, Jr.

Yeah, I think we’ll see in that kind of low to mid-single digit overall on the pharmaceutical packaging side of the business. The contract part is very hard to project. You know, we’ve seen good growth there this year during the quarter. We haven’t seen growth like this, I don’t think, in the last couple of quarters out of the contract side of the business. We’ve got a lot of ups and downs that we’re going to be dealing with due to the FDA and their actions relative to some new products coming to market, as well as some other products on the market. So we’ll have a much clearer picture when we get to February. We’ve got an awful lot going on through November and through December in both Europe and North America in that regard, so I’ll be able to give you a more definitive answer when we get to the February call.

Ross Taylor – CL King and Associates

Okay. And also regards the gross margin next year, I mean, generally speaking would you expect the product mix to be some benefit there, so we might see some expansion in gross margin next year?

Donald Morel, Jr.

Yes.

William Federici

Absolutely, Ross.

Ross Taylor – CL King and Associates

Okay. And final question – did I hear you say that CAPEX next year would be in a range of 120 to 140 million? And I think also as part of that, you said there’d be increased investments in China and India; and I don’t know if you could give any color on what some of those investments might be in terms of size or opportunity.

Donald Morel, Jr.

Yeah again, it’s a matter of getting the right footprint in the right location. So I think Bill highlighted that this year, CAPEX would probably fall in the 80 to 90 million range versus our original guidance. The large delta there is due to our delay in executing the China rubber project and getting our preparatory work for India. So our expectation in ’11 is that we will break ground on the China rubber facility and begin that work, and progress our efforts in India with regard to planning and site selection. And the key drivers there, again, are that we are seeing robust unit growth in both of those markets. We’ve historically supplied them out of Singapore. We completed that expansion, which was started back in ’07 and ’08, last year, the early part of last year; and if demand continues in those markets on the same trajectory, then we’ll be out of capacity by ’12, ’13. And again, if you think about the timeline for getting equipment in, running the validation trials on that equipment, sampling the customer, and then getting the customer’s approval, if we break ground next year we hope to be in a position to supply in 2013. But we have to deal with that regulatory lag between when the capital goes in and when we’re actually allowed to do commercial sales.

Ross Taylor – CL King and Associates

Okay, that’s very helpful. Thank you.

Donald Morel, Jr.

Thank you.

William Federici

Thank you, Ross.

Operator

Again ladies and gentlemen, that is star, one if you have a question. And our next question comes from the line of James Sidoti with Sidoti & Company. Please proceed.

James Sidoti – Sidoti & Company

Good morning. Can you hear me?

Donald Morel, Jr.

Good morning, Jim.

James Sidoti – Sidoti & Company

Okay, just a follow-up on the R&D. I think you said that you were going to—you expected to ramp up to about 25 million this year, which means it will be up about $2 million in the fourth quarter. Is that primarily the CZ project or is that spread across multiple projects?

William Federici

It’s spread across multiple projects, and the three main ones are CZ, obviously ConfiDose, and the micro-infusion systems.

James Sidoti- Sidoti & Company

Okay. And out of those three projects, do you expect any of them to give you any material sales in 2011, or are those longer term?

Donald Morel, Jr.

ConfiDose and the micro-infuser are longer term. You’ll see smaller revenues off of those through the development agreements we signed with our customers where they risk-share the R&D part of it. CZ sales, we believe, will increase. We don’t have a firm handle on that yet, but certainly those revenues will begin to ramp up ’11, ’12 going forward. But the real commercial ramp, again—the ramp in ’11 will be continued sampling activity and vial activity. The real ramp comes when we get first commercial production of the 1mL CZ syringe.

William Federici

And if you missed it, Jim, the CZ sales number is somewhere between 5 and $6 million.

James Sidoti – Sidoti & Company

Right, right. I saw that. But, I mean—so your ramp-up for the 5.5 to 6 million, but still probably not real material based on your revenue (inaudible).

William Federici

Absolutely. Absolutely correct.

James Sidoti – Sidoti & Company

Okay, so of those three projects, CZ is the nearest-term one, though?

William Federici

Yes.

Donald Morel, Jr.

Absolutely.

James Sidoti – Sidoti & Company

Okay. Thank you.

William Federici

You’re welcome.

Donald Morel, Jr.

Thank you.

Operator

That does conclude today’s question and answer session. I would now like to turn the call back to Mr. Don Morel for closing comments.

Donald Morel, Jr.

Thank you very much, Operator. This concludes our commentary for today. Thank you very much for your time.

Operator

Ladies and gentlemen, that concludes today’s conference. Thank you for your participation. You may now disconnect and have a great day.

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