西式醫藥服務 (WST) 2003 Q3 法說會逐字稿

Good morning, my name is Jamaica (ph) and I will be your conference facilitator. At this time I like to welcome everyone to the West Pharmaceutical Services third-quarter earnings conference call. All lines have been placed on mute to prevent any background noise. After the speakers remarks there will be a question and answer period. (OPERATOR INSTRUCTIONS) I would now like to turn the call over to Ms. Lanie Fladell. Thank you, you may begin.

Thank you, operator and good morning everyone and welcome to the West Pharmaceutical Services 2003 third quarter conference call. As you know we issued our third-quarter financial results earlier this morning. If you have not received a copy of the announcement please call financial dynamics at 212 850 5600 and a copy will be faxed to you immediately. Before we begin I would like to remind you that certain statements made on this conference call that are not historical are forward-looking statements within the meaning of the private securities litigation reform act of 1995. The words estimate, expects, intends, believes and similar expressions are intended to identify forward-looking statements. These forward-looking statements involve known and unknown risks and uncertainties. The Company's actual results may differ materially from those expressed in any forward-looking statements and are dependent on a number of factors. A non exclusive list of these factors is included in the Company's press release from this morning and SEC filings. In addition, for the purpose of aiding comparisons of period results reference is made on this call and in this morning's release to financial results determined by excluding certain items from each period and by remeasuring results of the most recent period, by eliminating the effect of changes in foreign exchange rate. Those remeasured period results are not in conformance with the United States generally accepted accounting principles known as GAAP and our nonGAAP financial measures. The nonGAAP financial measures are intended to explain or aid in the use of, not as a substitute for the related GAAP financial measures. A reconciliation to the financial measures (indiscernible) and presented in accordance with GAAP can be found in the Company's form 8-K filed today with the SEC and in the company's press release which is posted on the Company's website www.WestPharma.com. This call is being recorded on behalf West Pharmaceutical Services and is copyrighted material. It cannot be recorded or rebroadcast without Company's expressed permission and your participation implies consent to our taping. Once Management has completed their remarks we will open the call for questions. With us this morning our Dr. Don Morel, Chairman and Chief Executive Officer, William Federici Chief Financial Officer, and Mike Anderson, Vice President and Treasurer. With that I would now like to turn the call over to Don Morel.

Thank you. And good morning everyone. We appreciate your taking time to join us for today's conference call. As Lanie mentioned, I am joined today by Bill Federici, our Chief Financial Officer and Mike Anderson, Vice President and Treasurer and our primary investor relations contact. Before we begin I would like to highlight two changes to the senior management team that were announced in late August. First, Bill Federici joined West on August 18 as our chief financial officer. Bill spent his career predominantly in public accounting, (indiscernible) as the global health practice at Anderson and most recently as head of the America Healthcare group within KPMG. He brings to West more than 20 years of experience covering international finance and accounting, specific to pharmaceuticals and healthcare, as well as a diverse background in mergers, acquisitions and technology licensing. Bill will be joining us today to discuss our third-quarter performance.

Second, West also announced that Linda Altemus has taken on new responsibilities as our chief compliance officer. In this new role Linda will be responsible for coordinating our corporate programs to comply with the new governance and reporting requirements established by the Sarbanes-Oxley Act, the New York Stock Exchange and the SEC. In her previous role, Linda managed the implementation of our section 302 certification process and thus is well-suited for her new position. Including the appointment of Dr. Bruce Morra, as head of our drug delivery division earlier this year, I believe West now has a strong and versatile senior management team to drive our business forward.

Turning to our third-quarter financial performance, as you know the Company released earnings this morning. On a GAAP basis we reported earnings per share of 28 cents, on net income of $4.1 million compared with $3.6 million or 25 cents per share for the same period in 2002. Overall sales increased 15 percent or 9 percent in constant exchange rate to 120.1 million dollars. Driven once again by very strong growth in the pharmaceuticals systems division. Non-recoverable expenses associated with the Kinston accident in January reduced earnings by approximately 5 cents. In addition, incremental production costs associated with the Company's manufacturing recovery plan were partially offset by business interruption insurance recovery of approximately $2.3 dollars.

The strength of our operating performance is better understood by excluding the effect of one-time items. On this basis, net income increased to $4.8 million or 33 cents per share versus 3.2 million or 22 cents per share for the comparable period of 2002. The company strong financial performance (indiscernible) high note for the year given the challenges presented in maintaining our customer service levels, post the Kinston tragedy and the impact of decline in our pension assets. Overall, the Company continues to receive very positive feedback from our customers to our response to the tragedy.

Let me turn to pharmaceuticals systems. The pharmaceuticals systems division again produced strong sales growth with sales increasing 15 percent. Sales rose in each of the division's geographic operating regions but were particularly strong in Europe where sales increased 26 percent versus the third quarter of 2002 or approximately 12 percent excluding exchange. Our European sales were quite impressive as the third-quarter is usually soft due to shutdowns in our manufacturing facilities as well as those of our customers for routine maintenance and repairs and the traditional summer holiday period. As noted in our second quarter call, our strong growth continues to be driven by increasing sales to the biotech sector, (indiscernible) high demand for pre-filled syringe in Europe, and our ability to meet higher demand for a range of products as new manufacturing capacity has come online following the expansion of our French and German operations in 2002 and early 2003. These positive trends should continue through the end of the year and into 2004.

Operating profit in the division rose sharply from 13 million in 2002 to 19.4 million during the current period. Our operating efficiency is also improved as our consolidated gross margin increased from 25.3 percent to 29.8 percent. As strong as our operating performance in the division was, it could have been stronger were it not for the production demands and inefficiencies created in our Florida and Nebraska plants by absorbing a large portion of the Kinston demand.

Turning to Kinston. During our second quarter call, West announced that we had purchased a Shell building that could be quickly fitted out to accommodate our molding operation. The project team is managing the preparation of the facility to a very tight schedule with the initial production planned for the end of 2003. These products will be used for system validations and also for samples so that our customers can perform necessary testing to approve products from the new facility. We expect that testing to occur by various customers through early 2004 with the first commercial shipment taking place in late January. During this quarter, our production planning and operations team will begin implementing our transition plan to bring back those employees who took on temporary assignments in Florida and Nebraska to prepare for running the new operation.

I would again like to recognize the dedication and hard work of our employees around the world which has been a crucial factor in our ability to effectively manage and support our customers in the months following January 29th. We've been fortunate to have many of our skilled Kinston colleagues to accept temporary reassignment to our St. Petersburg, Florida and Kearney, Nebraska facility with production volumes substantially increased to accommodate the loss at Kinston capacity. At the same time, regular employees of our Kearney, St. Petersburg, St. Austell, England and Singapore facilities are working long hours week to week to support the increased production demands of these plants which continue to run at peak capacity.

Looking at the drug delivery division, the division continued to be negatively impacted by delays in the completion of licensing agreements, timing of milestone payments for ongoing programs and accelerating clinical trial expenses for product development. Revenues for the division for the quarter did increase to $1.9 million from $1.2 million in 2002. Despite the increase in revenue which arose from stronger demands to early phase clinical trials in our Evansville facility, the groups operating loss widened slightly to $5 million versus 4.1 million in 2002. This increase is the direct result of West funding a critical clinical trial during the quarter to progress licensing discussions with several potential partners. The majority of these costs wee incurred in the second and third quarters and should decrease during the fourth quarter. In addition, we hope to complete ongoing client negotiations for this product with potential license fees by year end or early in the first quarter of 2004.

I firmly believe the financial performance of the group todate does not reflect the progress we made on the technical and clinical aspects of the programs underway. Going forward, the group will continue to focus its efforts primarily on our nasal platforms and supporting our existing license fees as appropriate to progress the trials and development programs under way. We remain very confident in our proprietary technology and the quality and breadth of our development program. This confidence continues to be supported scientifically and commercially by the interest level of current and potential license fees and the reviews conducted by our scientific advisory board.

As we noted in our February conference call one of the key milestones established for the group in 2003 was to advance our morphine product to Phase III with our partners. The timing of this trial was dependent on FDA review of the trial data todate and the proposed Phase III protocol. Ongoing discussions with the FDA on the structure of the clinical protocol will now likely push that trial into the first half of 2004. We continue to actively seek development partners for several of our internal programs that have completed Phase I testing. These products are targeted for the treatment of pain, obtained, osteoporosis, and several women's health indications. These are therapeutic areas were each product presents a significant market opportunity for the company.

We also continue our work on a range of client funded programs including opiates for the treatment of pain, vaccines, and proprietary cardiovascular agents. On a positive note, looking at the fourth quarter for our clinical services unit, we see a significant strengthening in our order backlog and an increase in a number of programs presented for bid. Our study backlog continues to improve and now stands at its highest level in more than a year.

Overall, I am very pleased with our year-to-date performance. We continue to make substantial progress against our financial goals for the year, our recovery from the Kinston tragedy is well underway with strong support from our employees and customers, and we continue to recognize the benefits from the capital investments made in Europe over the last two years. Coupled with recent progress made in clinical trials on our lead products and ongoing license discussions and the strengthening program backlog in clinical services, our performance through the end of the year should remain strong.

As a result, we believe that earnings per share for 2003 will fall between $1.80 and $1.85 for the full year, excluding any drug delivery licensing revenue recognized or additional uninsured costs associated with the Kinston, North Carolina loss. I would now like to turn the call over to Bill Federici who will review the details of our third-quarter financial performance.

Thank you, Don. Good morning everyone. For those of you who may not know I joined West as CFO two months ago and am delighted to be here working with a dedicated team of talented professionals in a company with such tremendous opportunities. I'm still learning the ropes, but I look forward to participating in this forum and to meeting many of you in the near future. To give you a little background about myself as Don said, before joining West I was an audit partner with Anderson and KPMG where I specialized in the pharma space. My management style is hands on and I believe in strong corporate governance, budgeting and accountability, and in the integrity of financial reporting. With these principles and the quality of the management team, that drew me to West. As indicated in this morning's press release and as Don has stated earlier, West reported third-quarter net income of 4.1 million or 28 cents per share versus net income of 3.6 million or 25 cents per share recorded in the third quarter of 02. Reported results in this year's quarter include the effects of 1.1 million in pretax expenses equivalent to 5 cents a share after-tax for potentially uninsured expenses related to the company's Kinston plant accident in late January. Reported results in last year's third quarter included a net 3 cents per share of income from a tax refund, various restructuring related activities and results from discontinued operations.

To provide a better comparison of ongoing operating results, it excluded the uninsured accident related costs from this year's quarter and the effect of nonrecurring items from the 2002 third quarter. Excluding these items third-quarter 2003 earnings were 33 cents per share comparing favorably to 2002's Q3 earnings of 22 cents per share. Consolidated net sales for the third quarter totaled 120.1 million a 15 percent increase over third-quarter last year sales with 6 percent of the increase due to foreign exchange. The company's consolidated gross margin for the quarter was 29.8 percent or 4.5 percentage points higher than the 25.3 percent gross margin achieved in the third quarter of '02.

Despite the effects of the Kinston accident, the pharmaceutical systems division experienced another strong quarter for sales of 118.2 million, also a 15 percent increase over third quarter '02 sales. With 6 million or approximately 6 percent due to foreign exchange. Domestic sales grew nearly 8 percent over the third quarter 2002 sales and sales in our international market once again grew significantly. With sales 23 percent higher than prior year sales, 13 percent of which was due to foreign exchange. Europe was the primary driver of this international sales growth with sales up 26 percent, 14 percent of which was FX.

Operating profit in the pharmaceutical systems was 19.4 million an increase of 6.4 million over the third-quarter 2002 operating profit of 13 million. Profit improvements were driven by increased volumes, manufacturing efficiency improvements at several of our European plants, and price increases in Europe and Asia. One million or 8 percent of the increase was due to changes and exchange rates.

Profit margins in the Americas region were aided by the recognition of 2.3 million of anticipated business interruption insurance recoveries related to the Kinston incident. In the drug delivery systems division, revenue of 1.9 million were $700,000 higher than comparable 2002 revenues, and increased demand for clinical research studies in the clinical services business.

Operating losses of $5 million in drug delivery were $900,000 higher than in the prior quarter. Consolidated selling, general and administrative expenses increased by 8.7 million versus last year's third-quarter. Increase is primarily due to increased pension expense of 2.3 million; higher compensation costs mostly in the pharma systems division, impact of our stock price increased our Board member remunerations and the effect of foreign exchange.

Net interest expense for the quarter of $2 million compared favorably to last year's net interest expense of 2.1 million due primarily to the effect of interest income from customer advances, and the interest earned on higher average cash balances. We also received a boost from our affiliate operations in the third quarter with equity earnings of 700,000 substantially higher than last year due to increased sales and cost reductions at both our Japanese and Mexican affiliates.

With regard to Kinston, as Don said, we continue to expect a majority of our property and business interruption losses will be recovered through insurance and we have received to date a $25 million advance from our principal insurer. As a result, the book value of the fixed assets destroyed and the incremental costs in the recovery effort being reimbursable through insurance have been deferred and recognized as an insurance receivable on our balance sheet. Recoverable cost including recognized year-to-date business interruption losses totaled 25.3 million at September 30. Reducing the net receivable at September 30 to $300,000. Kinston related costs we may not recover through insurance include the 1.1 million for Q3 and 9.9 million on a year-to-date basis that continue to reside in our operating earnings.

Anticipated costs of this nature includes insurance policy deductibles, legal and (indiscernible) cost, environmental cleanup costs, communication costs and other miscellaneous items. These costs have declined consistently as the year progressed and we expect the decline to continue into '04. Keeping with our product guidance, we estimate these costs will approximate 10.5 million dollars by year end. As previously mentioned we reported 2.3 million of estimated business interruption insurance recoveries in our operating results this quarter to reflect margin on lost sales and a portion of the cost of manufacturing inefficiencies that resulted from the Kinston incident. (indiscernible) being offset by this reduction continues to be reported in our operating results. While we believe our business interruption insurance recoveries will be greater than this, we recorded the insurance recoveries based upon our understanding of the level of our insurers current estimate of our losses. Discussions with our insurers aimed at arriving at a common loss determination methodology are continuing.

Third quarter 2003 cash flow from operations was $24.6 million. The company's cash balance at September 30, was 54.5 million and working capital totaled $89.2 million. That stood at $178.9 million at September 30, and the debt to total invested capital ratio at quarter end was 44.2 percent, continuing its favorable consistent decline largely due to the effect of exchange rates. CAPEX during the quarter were $16.7 million of which nearly half focused on new products and expansion activities. As a result, we believe that earnings per share for 2003 will be between $1.80 and $1.85 excluding any new drug delivery licensing revenue or additional unanticipated uninsured costs associated with Kinston, and subject to the related interim production plan risks referred to above. I will now turn the program back to Don Morel.

Thank you, Bill. I would like to close today's discussion by spending a few minutes reviewing our growth strategy and priorities for the near future. In particular I like to comment on how we see our two business units serving the same customers and markets and the opportunities within those markets. As most of you are aware, West (indiscernible) pharmaceutical biotechnology and medical device company among its customers which leads to a very diverse and stable business base. At West, we are focused on building a company that is a world leader in drug delivery systems and technology to support our customers' needs in the marketplace. Our strategy concentrates on three distinct areas, first, leveraging our expertise in manufacturing to supply components for injectable drug systems; second, building a portfolio of devices for delivery by oral or injectable means for pulmonary or transmucosal routes. And three, developing unique formulation technology to serve the drug delivery needs of our customers. In some cases, that support consists of manufacturing injectable drug packaging systems, IV set components, disposable and pre-filled syringe components for drugs delivered by injections. For others it is manufacturing a device for pulmonary inhalation or a pill dispenser to promote compliance. For still others, it is formulation technology to enhance the therapeutic profile for an existing drug.

Todate we have made significant progress on the first two elements of our strategy. The drug delivery markets or products that utilize additional technology to improve drug performance to differentiate a product represent the unique and timely opportunity. Our core components business has a global market size of approximately $1 billion, growing roughly three to five percent per year. The market for drug products employing delivery technology currently approaches $40 billion and is growing at approximately 15 percent per year.

Over the next three years drugs with annual sales in excess of $30 billion will be coming off patent. Thus, the pharmaceutical markets are actively seeking technology from both a device and formulation standpoint to integrate into their product line extension strategies and portfolio planning. The nasal root of delivery is a market approaching 4 billion dollars, four times the size of the market for our core business. And an area where I believe our technology has a unique niche. I continue to believe that West has a substantial well-protected technology portfolio that can produce profitable growth for the company in the years ahead. As the past year has shown, however, it is difficult to predict the timing of the revenues from these programs once the development decisions are in the hands of your licensees.

Downstream, as our device and formulation programs reach commercialization, the opportunity will present itself to combine our proprietary formulation technology with the West device thus enabling West to bring a complete product to potential customers. At the close of our second-quarter conference call, I reviewed the status of the five broad objectives set by management in the aftermath of Kinston. First, turning production capacity in North America to pre-January 29 levels as quickly as possible. Second, working closely with our customers to ensure the continued supply of products to them and their eventual customers so that no shortages would occur. Third, continuing to improve the operating performance of the pharmaceutical systems division. Fourth, completing the drug delivery business initiatives underway and focusing on the timely progression of our lead nasal product development in clinical trial programs.

And finally, from a corporate standpoint tightly managing our cash and capital expenditures to improve free cash flow and to further strengthen our balance sheet. I believe the year-to-date we have made substantial progress focusing on these five objectives and our efforts to date have produced very strong operating performance through the first half of the year. With the Kinston rebuild underway, our efforts in the pharmaceutical systems division will remain intend on our customer service levels and product quality. Drug delivery we continue to focus on advancing our clinical programs and bringing to finalization the key licensing negotiations underway. Thank you for your time. We would now be pleased to open the call for any questions that you might have.

(OPERATOR INSTRUCTIONS) Larry Marsh from Lehman Brothers.

A quick clarification. You are saying the 1.1 million that have pharma systems operating profits higher, right? If you back that out?

Sorry. Repeat that.

The $1.1 million in extra costs that were not insured, those would, operating profits for pharma systems that would be 1.1 million higher, right?

That is correct. About 5 cents a share.

The margin is that 17.3 percent, almost 500 basis points higher. What is driving that there?

I think we have to be careful. The $1.1 million would effectively have increased our EPS from 28 cents a share to 33 cents a share. The operating profit recovery was $2.3 million through the business interruption insurance. So a little bit of two different items.

Okay, I see, but if we were to take "these onetime items" and then the margin -- one could argue that the margin was about 17.3 percent, is that accurate or --

It's not in the operating number.

Okay, I understand.

But it is the $1.1 million, you are correct. That helped our comparison in the totals. Net income.

Just besides that still the operating margin in pharma systems is higher, what is driving that?

There are a couple of things. First of which unlike last year when demand was so high in Europe and we were at our capacity limits the additional capacity, to come online thee has allowed us to plan and operate much more efficiently. We've seen margins and sales improve very substantially in Europe throughout the year. What has brought that down a little bit on the other side is that we are working at such a high peak capacity in our United States plants that we are probably operating a little bit less than we could optimally. Once Kinston comes online we can rebuild at the end of the year and early into next year; we expect that performance to improve so you should see an improvement in our overall gross margin for Pharma systems in the middle of next year.

And along those lines, if your operating capacity at these two other facilities, you guys now see that as an issue that you have to deal with or manage or as the capacity comes back in North Carolina, it shouldn't be really a big concern?

It is an issue of concern for us right now. As I said in my comments, our team is working very hard in the production facilities especially at Kearney and at St. Petersburg. We're concerned one, about the workload on those folks, and we've got very specific programs in place to give them time off and make sure they don't work themselves too hard. The second thing is that our production methodology uses machinery and when you work machines this hard you will have mechanical failures. We have been lucky to date that we've had only minor issues that we've had to deal with, but we're concerned about the human element and we are concerned about the load on the machinery. We watch that very carefully. That should abate as the capacity comes online in Kinston at the end of the year obviously. And it will be easier for us to manage with that capacity from a customer standpoint because we will get back to our historical manufacturing levels.

The gross margin, was that up so much because of mix or from any particular product or any particular regions?

A couple of things there. Volume number one, the efficiency comment that I had before. There is some pricing in there from the beginning of the year obviously as we have seen it reflected throughout the year. And we have seen some mix effects, as I talked about in the commentary, demand for products to go on the biotechnology drugs this year in particular has been very high. Part of that has been sampling activity to our customer base because of the range of biotech drugs coming through the approval pipeline. Multiple factors have contributed to the improvement in the gross margin.

The extra cost in drug delivery -- you provided a lot of detail on that -- can you just go through that again and it sounded like you had to make some investments in order to get some planned future business, or why did those costs increase so much?

That is basically due to one single trial. We had a product we have been working on for about two years now, and the trial was basically a seasonal trial where we had to go into the trial in the middle of this year to get the data necessary to complete the package for potential licensees. All of the patients that have been recruited for the trial, the dosing is underway, we expect that to be completed by the end of November and hence we expect the expenses associated with it to fall off. But we found out now is that potential licensees are requiring much broader potential data packages to enter into license discussions and this particular trial was to get us to the stage where the product could be licensed.

On capital structure, you guys are obviously seem to be generating a lot of cash flow, cash balance is up, debt is up a bit. Are you comfortable now with your capital structure? Is there any way or any potential for some debt pay down or any other kind of changes in capital structure?

Obviously we would like to focus on paying down or debt. We've gotten some benefits from currency which has driven down our debt to total cap down to a little over 44 percent now. The cash issue is the challenging one for us because of where the cash resides around the globe and we want to make sure we bring that back in the most tax efficient manner. But capital structure is something that we review periodically; our goals are to continue paying down the debt where possible and to keep an eye on our capital expenditures and our use of cash. I don't know if you want to add anything to that?

Right on target.

Thanks.

(OPERATOR INSTRUCTIONS) The next question comes from Don Taylor from Franklin Advisory Service.

I like to make absolutely clear on your guidance that you're talking about pro forma for the year $1.80, $1.85 I do not believe you specified that.

We did. That guidance is excluding any potential future costs associated with Kinston and outside of any drug delivery revenues which may be recognized in the fourth quarter.

My question is does it also exclude previously incurred costs related to Kinston?

Yes.

It would have to be in order to be pro forma.

It would have to be, you are absolutely correct.

That's all I have. Thanks.

(OPERATOR INSTRUCTIONS) At this time there are no further questions. Do you have any closing remarks?

Yes, operator, thank you. West's third quarter and year-to-date performance are extremely rewarding given the significant challenges presented at the start of our year by the loss of the Kinston facility. We are looking forward to completing the construction of the new molding facility in early 2004 and returning to production there as soon as possible. Special thanks go to all of our employees worldwide for their hard work in 2003 to serve our customers so well. Without their contributions the company would not be in the position that it finds itself as we focus on concluding a very, very strong year for the company. Thank you again for joining us today.

Thank you for participating in today's conference call. You may now disconnect.