西式醫藥服務 (WST) 2004 Q1 法說會逐字稿

At this time, I would like to welcome everyone to the West Pharmaceutical's 2004 first-quarter earnings conference call. (OPERATOR INSTRUCTIONS). I would now like to turn the call over to Ms. Lanie Fladell. Thank you. You may begin your conference.

Thank you, operator. Good morning, everyone, and welcome to the West Pharmaceutical Services 2004 first-quarter conference call. As you know, we issued our first-quarter financial results earlier this morning. If you have not received a copy of this 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, expect, intend, believe 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 nonexclusive list of those factors is included in the Company's press release and SEC filings. In addition, for the purpose of aiding comparisons of period results, references made on this conference call and in this morning's press release to financial results determined by excluding certain unusual or non-recurring items from each period and by re-measuring results of the most recent period by eliminating the effects of changes in foreign exchange rates. Those re-measured period results are not in conformance with the United States Generally Accepted Accounting Principles, or GAAP, and are non-GAAP financial measures. The non-GAAP financial measures are intended to explain or aid in the use of, not as a substitute for, the related GAAP financial measures. This call is being recorded on behalf of West Pharmaceutical Services and is copyrighted material. It cannot be re-recorded or re-broadcast without the Company's express permission and your participation implies consent to our taping.

Once management has concluded their remarks, we will open the call up for questions. With us this morning are Dr. Don Morel, Chairman and CEO, William Federici, Chief Financial Officer, and Mike Anderson, Vice President and Treasurer. I would now like to turn the call over to Don Morel. Don, please go ahead.

Thank you, Lanie, and good morning, everyone. Thank you for taking time to join us for today's conference call. As Lanie indicated, joining me this morning for the call are Bill Federici, our Chief Financial Officer, and Mike Andersen, West's Treasurer and primary Investor Relations contact.

This morning, we announced firs-quarter earnings, and as you will have read in our press release, 2004 is off to a good start for the Company. Sales and earnings growth for the quarter were directly in line with our expectation, following the extremely strong year we had in 2003. Consolidated sales growth for the period was solid, increasing 13 percent, 7 percent of which was due to exchange, to $133.6 million. Our reported GAAP earnings were 46 cents per diluted share versus 26 cents for the comparable period in 2003. On a pro forma basis, taking into account the effect of Kinston and the gain on the land sale by our Mexico affiliate, earnings per share were 59 cents versus 50 cents per share for the first quarter of 2003. In his financial commentary, Bill will be discussing in detail the reconciliation of our GAAP and pro forma results.

Sales growth in the period was driven by continuing broad demand for our core parenteral delivery products in the Pharmaceutical Systems Division, and continued strong demand for Phase I clinical services in the Drug Delivery Division. Our consolidated gross margin declined slightly from 30.9 percent to 30.4 percent, which was the direct result of a shift in sales mix in the Pharmaceutical Systems Division during the quarter to a higher level of disposable medical device components.

I would now like to discuss the performance of the two operating divisions. Let me turn first to Pharmaceutical Systems. As outlined in our February call, related sales growth in the Pharmaceutical Systems Division for the quarter moderated slightly when compared with the same period in 2003. During that conference call, Bill and I described the fact that the first quarter of '03 sales in the Pharmaceutical Systems Division were positively impacted by several factors, including surge orders for the war, biotech sample orders for stability and manufacturing trials and safety inventory built by selected customers in response to the Kinston capacity loss. Sales in that period were also positively impacted by several biotech customers who decided to build safety inventories of components impacted by a raw material change. During the first quarter of 2004, our sales growth in the division was driven primarily by continued growth in Europe, again the result of demand for pre-built syringe systems in South America, as well as Asia. Based on our Q1 sales and the substantial increase in our order backlog, especially in North America, for the periods that (ph) the inventory builds observed at the end of '03 are being worked down faster than we had originally forecast. Encouragingly, at the end of the quarter, the Division experienced strong orders for our B2 and tephlon-coated products, which are utilized predominantly for biotech and high-value added drug products. The increased sales of these products throughout the remainder of the year will significantly improve our product mix with a positive downstream effect on our margin. I am very encouraged by the strength of our order book and the fact that at the end of the first quarter, our backlog is approximately $12 million higher than at the close of Q1 in 2003, with a large portion of that increase comprised of the high-value added products.

Our major expansion projects in both North America and Europe remain on schedule. The majority of this capacity is to address increasing demand for our Westar product line in both North America and Europe. By the first quarter of 2005, West will have four facilities validated and capable of providing Westar product to our global customers and keeping with our manufacturing philosophy of multi-plan sourcing for risk mitigation purposes. Once the necessary regulatory authority and customer audits are completed along with validation runs, our operation should be utilized in this capacity by the end of the fourth quarter.

We are also on schedule to complete expansion of our Stolberg, Germany plant to satisfy increased demand for our TrimTech High-V (ph) closure as well as growing demand for seals within Europe. I am very satisfied with the performance of the division during the first quarter, which is on track to achieve its sales and operating projections for the full year.

I would now like to provide a brief update on the status of Kinston. I'm pleased to report this morning that our new molding facility in Kinston is operational and that commercial shipments have resumed. A forced (ph) production loss (ph) was shipped on March 12, a major milestone for the Company and the community following last year's tragic accident. Five production lines are now operational. When the facility is completed in the third quarter, 14 lines in total will be in place. The majority of workers re-allocated to St. Petersburg, Florida and Kearney, Nebraska are now back in North Carolina. We expect to have all of the traveling workers back in Kinston by the end of May. Additional customers are now going through the audit and validation phase of approving production from the new facility. We expect this process to be completed during the second quarter for all major customers impacted by the accident. At this point, only one class-action lawsuit has been filed as a result of the accident. And despite the challenges posed by Kinston, the Pharmaceutical Systems Division is in a very strong position to have bright prospects for the future.

Let me now turn to the Drug Delivery Division. Sales for the division grew to $3.2 million during the quarter from 1.6 million during the first quarter of 2003. This growth was driven principally by demand for Phase I clinical trials in the Clinical Services Unit of the business. The division's operating loss narrowed to 2.8 million, an improvement of $700,000 versus the first quarter of '03. In keeping with our strategy, we view drug delivery as a key growth program for the future and continue to invest in our major programs accordingly. Throughout 2004, the focus of the group will be on the near-term commercialization of our lead nasal products and the development of our target technology for oral delivery. During the first quarter, the group concentrated on preparing for the three Phase II trials planned for the year. These include nasal Fentanyl to treat cancer pain, oral Budesonide for the treatment of irritable bowel disease, and nasal Leuprolide for the treatment of endometriosis. The clinical protocols have been completed for each of these trials and they are now in the varying stages of review necessary with the appropriate regulatory authorities prior to the trials beginning. Our goal is to initiate all three trials during the second quarter with the primary objective of generating clinical data to initiate licensing discussions by the third quarter. We expect some substantial improvement in the financial performance of the unit, as product licensing opportunities are recognized during the year. However, the revenue stream will remain unpredictable as it has been in past years due to the complicated nature of completing license negotiations for these products. However, we also expect demand for Phase I trials to remain solid through the second quarter in the Clinical Services Unit. I would now like to turn the call over to Bill Federici, who will discuss our financial performance in greater detail.

Thank you, Don, and good morning, everyone. As indicated in this morning's press release, West reported first-quarter net income of $7 million or 46 cents per diluted share versus net income of $3.8 million or 26 cents per diluted share recorded in the first quarter of 2003. Reported results in this year's quarter include an estimated $3.7 million or 17 cents per share of continuing incremental costs associated with the Company's interim plan to replace production from its Kinston plant and other Kinston accident-related costs, primarily overtime, as well as employee relocation and travel. Results also include a $600,000 non-operating gain from the sale of an affiliate's plant in Mexico that was shut down in a 2002 restructuring.

Reported results from last year's first quarter included an estimated $6.7 million or 30 cents per share of incremental costs related to the January 2003 Kinston plant explosion. To provide a more relevant comparison of ongoing operating results, we have provided a pro forma analysis, which excludes the effect of these items from each year's quarters. Excluding these items, first-quarter 2004 earnings were 59 cents per diluted share, comparing favorably to 2003 quarter one earnings of 56 cents per diluted share. Consolidated net sales for the quarter were $133.6 million, a 13 percent increase over 2003 first-quarter sales, with 7 percent of the increase due to currency. The Company's consolidated operating margin for the quarter was 8.1 percent versus 5.5 percent operating margin achieved for the same period in 2003 on an as-reported basis. On a pro-forma basis, excluding the effects of Kinston, consolidated 2004 first-quarter operating margins were 10.9 percent versus 11.2 percent for the same period in 2003. The Pharmaceutical Systems Division continued to perform well in the quarter, with sales of $130.4 million, a 12 percent increase over the first-quarter 2003 sales, with nearly 8 percent of the increase due to currency. Domestic sales grew by 1 percent over the same period 2003 sales, but sales in our international markets again grew impressively by 24 percent above prior year's sales, 16 percent of which was due to currency. Including Kinston-related costs and favorable currency effects, operating profit in Pharmaceutical Systems was $20.6 million for the quarter versus the $20.9 million recorded in the first quarter of 2003. As we expected, after excluding the aforementioned Kinston costs in both years' quarters, as well as the 2004 currency gains, operating profits as a percentage of sales declined from 19.4 percent in the first quarter of 2003 to 18.3 percent in 2004. Strong sales growth in the Europe, Asia, South America and device businesses was more than offset by a sales mix favoring lower-margin products and services, primarily in North America and increases in selling, general and administrative expenses. In the Drug Delivery Systems Division, first-quarter revenues of $3.2 million were double last year's $1.6 million due to increased demand for our Clinical Services Unit. As a result, operating losses of 2.8 million in Drug Delivery were $700,000 lower than in the prior year quarter.

Consolidated selling, general and administrative expenses increased by $4.6 million in the quarter versus prior-year costs. The increase is largely due to higher compensation costs, increased outside services costs, primarily for outside legal, FDA regulatory and costs associated with Sarbanes-Oxley compliance and the effect of foreign exchange. Net interest expense was $1.9 million in the quarter, equal to last year's first-quarter expense. First-quarter cash flow from operations was approximately $8 million, due primarily to income for the period plus depreciation, less increases in trade receivables, inventory and other assets. The Company's cash balance at March 31 was $40.6 million and working capital totaled $85 million. Debt at March 31 was $152.2 million, a significant decline from the year-end position of $175 million made possible by the collection of our year-end insurance receivable of $41 million. The debt to total invested capital ratio at the quarter end was 36.6 percent. Capital expenditures during the quarter were 16.5 million, including the costs associated with rebuilding the Kinston molding facility of $8.1 million. Including the Kinston investment, over 60 percent of the quarter's capital expenditures were focused on new products and expansion activities. I'd now would like to turn the call back to Don Morel, Don?

Thank you, Bill. This concludes our remarks for this morning. We would now like to open the call for any questions that you might have. Operator?

(OPERATOR INSTRUCTIONS). Stephen Costal (ph), Lehman Brothers.

First question, the additional SG&A costs in the pro forma, I might have missed it, but what is that referring to?

Mostly legal expenses, Stephen, for -- related to us -- our Kinston operation.

So that's directly related to the class-action, or just in -- more in general?

No, somewhat related to settlement, wrap up of a -- basically, the wrap up of the internal investigation, our defense costs and some regulatory responses.

Okay.

Shy Garcon (ph), Corsner.

A couple of questions for you. Pro forma and maybe I'm just looking at the number wrong, you guys did like 59 cents in the quarter, and your guidance was for the 2.05 to 2.15 pro forma. Is there -- kind of we should be looking at why this quarter isn't (ph) kind of a good run rate to work from, and that would bring the number closer you know, to 240-ish, or am I looking at something incorrectly?

It has to do with the seasonality of our business, Shy. Typically, we see a good strong first half of the year. As customers have placed orders at the end of the prior year, our backlog increases. We have many customers who place orders on a full-year basis and then work off of those orders through the full year. But in the third quarter, we also faced the issue of shutdown of our plant in Europe.

Right.

Okay? And then we also had shutdowns of many of the plants over the Christmas period, where we do preventative maintenance and we do a lot of capital improvements that are relatively small. So our business really follows a very seasonal pattern in that regard, strong first two quarters. Third quarter is nominally (ph) down because of the shutdowns in Europe. And then you'll see improvement in the fourth quarter, again with some down-time because of the Christmas holidays. So you know, we're right on track with where we want to be. It's a very good start for the year.

Right. The time that you spoke about a higher margin product, kind of see that tick up again at the end of the first quarter and the backlog picking up, has that continued into the second quarter, this you know, almost first month of the quarter, are you still seeing those same trends?

We don't have those numbers yet. What we have are the numbers at the end of March.

Okay.

So we will have to keep an eye on things. I do expect it to continue. But again, it will be balanced (ph) off by the fact that production is going to be working that backlog down.

Right, right.

But certainly, the order pattern versus last year and versus historical is very strong and the composition of the backlog is very encouraging.

Let's talk about the debt to cash right now -- what kind of is the level you guys want to get down to, or what's the level that you guys feel comfortable with?

Historically, we've kind of been a low-thirties type of company. A couple years ago when we were in the low fifties, we were uncomfortable at that level. I think we are getting to the point now where we are about where we want to be. But that's a snapshot at the end of the first quarter. We will have some capital investments due the end of the year with the expansions and finishing up Kinston, such that we'll probably finish moderately higher than the 36 percent.

Okay. In drug delivery, maybe talk a little bit about where you guys stood at the end of March versus I don't know over the last year in terms of, you know, trials and being able to announce various (ph) licensure (ph). I mean, how do you think you're doing, I guess is the question?

I feel pretty good about where we are versus our plan. The major components of '04 are the three programs that we mentioned. There is a lot of preparation work involved in getting ready for the trials. The group is working through each one of those. They are on a slightly varying time schedule. Fentanyl (ph) will be the first one to start. So in terms of the clinical milestones there, we're right where we want to be. We have squeezed some of the other programs down. We're concentrating on the ones that we think will lead to near-term licenses or certainly discussions on picking up partners to push them forward.

Versus last year, I think the major change, aside from concentrating on these three programs was the completion of the one major clinical trial. All of the data analysis has been complete with that. And we're now in varying stages of licensing discussions with potential partners. The frustration is that those always take longer than you would expect and generally go (ph) more complicated the closer you get to finishing up the negotiation, so. I'm positive on where we're at. And I think we need to make sure that we complete those negotiations as soon as we can.

Right. All right, well, thank you, very much, and you guys are obviously doing a great job.

Thanks, Shy.

Bentley Offut, Offut Securities.

Going back to your drug delivery, let's see, the clinical business is helping you through the first six months of the year.

Bentley, I'm sorry, we can barely hear you. Can you move closer to the speaker, to the phone.

Can you hear me now?

That's much better, thank you.

Okay, going back to drug delivery, your first quarter has been -- it's an (ph) improved because of clinical services and you said the second quarter will be also similar improvement. My question is -- or the model that I'm using right now looks for a reduction in your losses from about 18 million down to around 12 million. And I'm just wondering, is this in the direction -- you mentioned the fact that you've cut back some of your efforts in new product development? Is this sort of where you are shooting for, do you think, this year?

I don't think we've announced a numerical goal. But I think the combination of the improvement in the clinical services, which is difficult to predict -- we get visibility on about a quarter-by-quarter basis, combined with what we're doing on the drug delivery side. What I'm comfortable saying is that we'll see substantial improvement in that division. But I don't think we've committed to a numerical target.

Okay. Secondly on your pension costs in the first quarter is minus -- pension expense of 1.2 million, is this the figure you're using for the year -- of about plus (ph) 5 million?

Yes.

It's about -- yes, roughly $5 million. That's directionally correct.

Okay. And the mix of your biotech components versus pharmaceutical, obviously, that's -- continues to improve versus last year. Is that correct?

Yes.

Would you say that for the year, you feel that might exceed 25 percent?

Twenty-five percent of sales?

Yes.

No, I don't think we've talked about composition of the sales mix that specifically. What we do see is that we had a bit of a seasonal issue in the first quarter, as we discussed. We had a higher percentage of medical device products making up the sales mix. We've worked through that. When we look at the composition of the backlog, we see that the makeup of the backlog in terms of the B2-coated products, the tephlon-coated products, that are Westar-treated, the value added things we've put into the marketplace has increased. So what we think we'll see is a steadily improving product mix throughout the year, and the downstream effect that that will have on our margins and our profitability. So we think that's very positive for the Company.

Okay. And last but not least, your tax rate jumped from 28 percent a year ago to 32 percent. What's the correct rate we should use for our models this year?

We are looking more towards the 32 percent on a go-forward basis.

(OPERATOR INSTRUCTIONS). Stephen Costal, Lehman Brothers.

I'm back. I got cut off a little bit. The additional production cuts that you guys alluded to, can you talk about what those were for full year '03, just so that we have the comparison? And how will those ramp? It looks like it will come up a bit I guess the next couple of quarters?

One more time, Stephen? The full costs for -- the full of production costs that were added back from a pro-forma basis, is that what you're asking?

Yes, you said for the quarter, it was 3.2 million, for the year ago quarter was 1.6 million. You guys gave us the full-year '04 expectation. But just for comparison purposes, do you have what the number was for full year '03?

Yes, it was $9.9 million.

Okay. And then in terms -- do you anticipate that Pharma Systems EBIT growth, that that will improve you know, from the first quarter? And should we anticipate that obviously that will increase over the next few quarters?

I think the answer to that is yes, (multiple speakers) especially looking at the composition of the backlog and the trends we talked about.

Okay. And then another housekeeping item. The real estate gain, in that line item, Equity and Income from Affiliates -- is that the entire $1 million, is that real estate gain?

No, only 600,000 of it is the real estate gain.

(OPERATOR INSTRUCTIONS). You have a follow-up question from Bentley Offut from Offut Securities.

Going back to the drug delivery again, could you give us a little bit more flavor for your expectations this year? I know that you mentioned the fact in the third quarter you're working very hard to finalize some licensing agreements in your current -- I guess the products that you're going into Phase II. How long does it take for you to complete the Phase II trials?

Depending on the nature of the drug, Bentley, they can be fairly quick. I mean, you can get data out of a relatively small Phase IIA trial within months. Typically, what takes the time is the patient improvement. What we've been doing is simultaneously working on the protocols and the filings with the regulatory bodies, both here in North America and in Europe. Simultaneously, we are getting the trials set up and the patients recruited. So we feel pretty good that once we get the trials initiated, we will have a sufficient data set within the third quarter, early fourth quarter to really progress those discussions. In terms of my expectations for the year, we need to complete a couple of announceable (ph) deals. That's one of the goals for the group. But the major objective and the thing that's going to build value for it is to produce meaningful clinical data, showing efficacy in patients and the effect of the platforms. And that's really the way that the trials are geared. Out of these, we will get a very, very strong indication, confirming what we had seen in many of the earlier trials that we conducted, that the technology does provide a demonstratable benefit to the drugs that are being delivered. So the two things we're looking for are announceable deals that progress the technology with partners, and again, building on the clinical data set that we've got that shows the effectiveness of the platform.

Going back to the -- as far as your competition, I guess -- there are not that many companies, as far as public companies, involved in nasal drug delivery, and the majority of your people, or your competition, is really the pharma companies. Isn't that correct?

That is correct. There's one public company now, in fact it's focused on nasal delivery. There are some smaller private ones that are also working in various stages of nasal delivery. But principal competition comes from some of the larger guys that are focused on using nasal delivery for specific therapeutic indications. And the ones that come to mind, of course, are treatment of migraine, with the products on the market, you've got things like Imitrex, 2 (ph) mg (ph); and then in the background, you've got things like the flu system with MedImmune, which is delivered nasally, of course; vitamin B-12, and then also varying products for rhinitis and allergy.

As far as your sales activity then, are you focusing -- who are you focusing on?

Where we focus is in two areas, the first of which is on the therapeutic category leaders in marketing where a different delivery format, or different delivery profile can give them an advantage in their selling in the marketplace. The second area is on the R&D development side, and that's probably where most of the activity is, where delivering via the nasal route or the colonic route, satisfies a specific technical issue with a specific drug. A good example of that is Budesonide. Steroids have been used for years to treat IBD, but they've been given systemically with the side effects that you would see with large amount of steroids. With the target system, you can deliver the drug specifically to the site of action in the colon and minimize side effects. So that's the kind of selling profile story that we would use on the development side. So it's really a two-pronged attack.

As far as the large pharma companies, is their primary interest though, in your Biocide (ph) development, which is patented because of its performance there? Or are you saying it's really in the development side?

It is product-specific, Bentley. We'll get approached by companies that are looking for a specific technical (ph) solution. And their interest in any given platform or any given technology is really predicated upon the drug that they are looking at and the condition and occasion that they want to treat.

I see. Thank you.

At this time, there are no further questions. I would like to turn the call back over to Dr. Morel for any closing remarks.

Thank you, operator. Based on our strong first quarter, 2004 is off to a good start for the Company. Our strong backlog indicates that the full year should be a good one for West. For the remainder of the year, management will focus on the primary elements of our business plan in the Pharmaceutical Systems Division, delivering world-class products and service, ensuring global capacity to meet growing demand and capturing the value our products bring to the pharmaceutical and health-care markets. In the Drug Delivery Division, the emphasis will be on maintaining the strong performance of the clinical services unit, continuing to progress our clinical development programs with our key products and completing our near-term product and technology licensing opportunities. I remain very positive on our prospects for the year and am pleased to reaffirm our guidance for full-year sales growth in the range of 5 to 7 percent at constant exchange rates, resulting in full-year earnings of $2.05 to $2.15 per fully diluted share when (ph) costs associated with Kinston and (indiscernible) back. Again, thank you, very much, for your time today.

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