西式醫藥服務 (WST) 2004 Q2 法說會逐字稿

Good morning ladies and gentlemen. My name is Amy and I will be your conference facilitator. At this time, I would like to welcome everyone to the West Pharmaceutical Services second quarter 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. If you would like to ask a question during this time, simply press star then the number one on your telephone keypad. If you would like to withdraw your question, press star then the number two. Thank you. It's now my pleasure to turn the conference over to Miss Lanie Marcus from Financial Dynamics.

Thank you operator and good morning everyone, and welcome to the West Pharmaceutical Services 2004 second quarter conference call. As you know, we issued our second 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 statement 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, reference is made on this conference call and in this morning's press release to historic and future expected financial results determined by excluding certain costs and non-recurring items. Those re-measured period results are not in conformance with the United States Generally Accepted Accounting Principles, 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. The call is being recorded on behalf of West Pharmaceutical Services and is a copyrighted material. It cannot be re-recorded or re-broadcast without the Company's expressed permission and your participation on this call implies consent to our taping.

Once the management has concluded their remarks, we'll 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. Joining me are Bill Federici, our Chief Financial Officer, and Mike Andersen, West's Treasurer and primary Investor Relations contact. As you know, this morning West released earnings for the second quarter. During the past three months, the Company continued its solid performance and today I'm pleased to report that sales for the quarter grew from a $126.4m to $138.1m, an increase of 9.3% overall or 6.2% at constant exchange rate. Reported GAAP earnings were $0.50 per diluted share, a net income of $7.7m. On a pro forma basis, when taking into account cost resulting from Kinston, earning were $0.56 per share, equivalent to the same period in 2003. After I review the performance of our two divisions, Bill will provide some additional detail on our financial result.

Turning first to the Pharmaceutical Systems Division, sales during the second quarter were in line with expectation, as we continue to experience solid demand for our core components. With division revenues increasing 8.8% overall, 3.2% of which was due to currency. I'm very pleased with the performance of the division, when compared with the extraordinary second quarter the Company experienced in 2003. Encouragingly, sales grew in each of our geographic operating regions, with sales particularly strong in North America. For the Americas region, sales growth during the period was driven by a range of factors, including continued strong demand for coated closures, new product launches, customer-funded drawings and strength in consumer packaging demand for liquid packaging. In the Europe-Asia Pacific region, performance was driven by an improving product mix and general solid demand for its core parenteral products. Gross margin in the unit improved as a result of product mix and continued focus on production efficiencies across the manufacturing units.

Our major capacity expansion projects in this division remain on schedule. These include Westar expansion in Jersey Shore, increased TrimTec and fuel capacity in Stolberg, Germany and general capacity expansion in elastomer production in Eschweiler, Germany. Kinston production continues to ramp up, as West works with customers to perform the necessary validation and sample qualifications testing required to start commercial production, although slightly behind our original time line. We remain on plan to be at full production by the close of the year. At this point, all workers that were temporarily relocated to Kearney, Nebraska and St. Petersburg, Florida are back in Kinston. In keeping with our historical sales pattern, our backlog remains very strong and higher than historical levels for the comparable period as we begin the third quarter. For those of you who have followed West for several years, you are aware that the third and fourth quarters are usually down from the first half of the year as our European plants go through their traditional summer shut-down period for vacation and for preventive maintenance, as well as the holiday period at the end of the year. In summary, year-to-date the divisions performed very well and is on target to achieve the objectives established in our 2004 operating plan.

I would now like to turn to Drug Delivery. During the second quarter, revenue for the Division increased to $1.9m from $1.2m for the comparable period in 2003. The increase in revenue was again driven by demand for early stage clinical trial. The division's operating loss widened slightly to $4.2 m compared with $3.7m in the second quarter of 2003 principally due to spending on the three main clinical development programs currently underway Nasal Fentanyl, Nasal Leuprolide and Oral Budesonide. As you are aware, on June 30, the company announced its intention to explore strategic options for the Drug Delivery unit. Based on the data from our technology development and clinical proof of concept program, the board and management remain convinced of the commercial potential for the technologies and products under development within the group. However, we have concluded that alternative approaches to funding the Drug Delivery business may have a higher probability of freeing up its growth potential in the near term. As a result, the company has initiated a process to explore strategic alternatives for the Division that could possibly accelerate the division's progress and lead to its eventual commercial success. At the current time, we anticipate this process will run through the end of the year and possibly into early 2005. In the immediate aftermath of the announcement, West received a range of enquires from potential partners. We plan to evaluate our options carefully, take an approach that has the greatest potential to ensure the commercial success of our Nasal and Oral technology and products. I would now like to turn the call over to Bill.

Thank you Don and good morning everyone. As indicated in this morning's press release, West reported second quarter net income of $7.7m or $0.50 per diluted share versus net income of $6.9m or $0.48 per diluted share recorded in the second quarter of 2003. Reported results in this year's quarter included estimated $2.4m, or $0.16 per diluted share, of continuing incremental costs associated with company's interim plan to replace production from its Kinston plant and other Kinston accident related costs primarily over-time and equipment reinstallation and validation, travel and legal costs. Reported results from last year's second quarter included an estimated $2.6m or $0.18 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 in our release that excludes the effects of these items from each year's quarter. Excluding these items, second quarter of 2004 earnings were $0.66 per diluted share equaling 2003 Q2 earnings. Consolidated net sales for the quarter, were $138m; a 9% increase over 2003 second quarter sales with 3% of the increase due to currency. The company's consolidated operating margins for the quarter was 8.4% versus 8.5% operating margins achieved for the same period in 2003 on an as reported basis. On a pro forma basis, excluding the effects of Kinston, consolidated 2004 second quarter operating margins were 11.1% versus 11.7% for the same period in 2003. The Pharmaceutical Systems Division continued to perform well in the quarter with sales of $136.2m; nearly 9% increase over second quarter 2003 sales with 3% of the increase due to currency. Domestic sales grew by 10% over the same period of 2003 sales. Sales in our international markets grew by 7% above prior year sales, 6% of which was due to currency.

Sales growth came primarily in the Americas region where increases were attributable to products employing West's value-enhancing coatings for pharmaceutical components, revenue associated with customer tooling, and consumer packaging components. The Company's European business registered significant gross margin improvements on a more favorable mix of product sales and production efficiencies. The division's reported operating profit was $24.4m in the quarter compared to $25.2m in the 2003 quarter. The pre-tax effects of the earlier noted Kinston-related costs on the division's reported operating profit were charges of $3.1m in the current quarter and $0.2m net of applicable insurance recoveries in the second quarter of 2003. On a pro forma basis, excluding those Kinston-related charges, the division's operating profit would have grown by 8.3% to $27.5m in the second quarter of 2004 compared to $25.4m in the prior year period. On that same pro forma basis, the division's operating margin as a percentage of sales would have been substantially unchanged when compared to the second quarter of 2003.

In the Drug Delivery Systems division, second quarter revenues of $1.9m were $700,000 greater than last year's $1.2m due to increased demand for our clinical services unit. Operating losses of $4.2m in Drug Delivery were $500,000 higher than in the prior year quarter due to spending on the three main programs and delays in revenues. Consolidated selling, general and administrative expenses increased by $4m in the quarter versus prior year cost. The increase is largely due to the expenses associated with the recently approved performance-based restricted stock plan. Higher plan compensation cost and increased outside service costs primarily for outside legal services, FDA regulatories and cost associated with Sarbenes-Oxley compliance.

Net interest expense was $1.6m in the quarter, slightly lower than last year's second quarter expense of $1.7m. Second quarter cash flow from operations was approximately $18m. The Company's cash balance at June 30 was $52.9m and working capital totaled $100.4m. Debt at June 30 was a $158m, a significant decline from the year-end position of $175m, made possible by the collection of our year-end insurance receivable of $41m. The debt-to-total invested capital ratio at quarter-end was 36.7%. Capital expenditures during the quarter were $12.3m including the cost associated with rebuilding the Kinston molding facility of $2.8m. Including the Kinston investment, approximately 50% of the year-to-date capital expenditures were focused on new products and expansion activities.

We are reaffirming our recent guidance provided for 2004. We continue to expect revenue growth of 5% to 7% excluding currency effects and pro forma diluted earnings per share in the range of $2 to $2.10. As you may recall, the pro forma results exclude the cost associated with the 2003 Kinston casualties and the plant closure of our UK Plastics facility, which we estimate will be between $0.52 and $0.65 per diluted share and eliminates a $0.04 per diluted share non-operating gain that was reported in the first quarter of 2004. We anticipated increase in our effective tax rate due to the Danish tax law change has been temporarily mitigated by previously unrecognized loss carry forwards. Our guidance assumes inclusion of Drug Delivery results through the end of 2004 and we anticipate that our Drug Delivery division will incur additional quarterly losses in line with the $4m loss incurred in this second quarter. I would now like to turn the call back to Don Morel. Don?

Thanks Bill. Looking ahead, the growth prospects for our core injectable components business remain very, very good. West's investments over the past two years have put the Company in a strong position to build our near-term market trends in our base business. As discussed in previous calls, these trends include the growing sales of current products in the biotechnology sector, new biotechnology product launches, volume growth in pre-filled syringes, volume expansion in Westar and coated closure systems to protect drug integrity and satisfy increasingly-stringent regulatory requirement and closure systems to combat the storage and counterfeiting around the globe. The global market leader in closure systems and syringe components were used with injectable drugs. West will also benefit from changing demographics in Europe and North America, and geographic expansion into other markets. In parallel with our efforts to grow revenues, we will focus intently on optimizing our production efficiencies through our global manufacturing network. We also see a broad range of opportunities to expand our services supporting our customers' regulatory filings for new products. Although small currently, our contract laboratory group is growing due to increasing demand for stability studies and laboratory work to demonstrate drug package compatibility. To simply put, the first half of the year was a very solid win for West and our growth opportunities for the future have never been better. We would now like to open the call for any questions you might have.

At this time, ladies and gentlemen, if you would like to ask a question, please press star then the number one on your telephone keypad. Once again ladies and gentlemen, that's star then the number one. We will pause for just a moment to compile the Q&A roster. Once again ladies and gentlemen, if you would like to ask a question, please press star then the number one on your telephone keypad. Again, that's star then the number one. We will pause for just a moment to compile the Q&A roster. Your first question comes from Steven Postel with Lehman Brothers.

Hi and good morning.

Good morning Steven.

Can you just elaborate -- obviously there is a small variance between what you actually reported and what the pre-release was. Can you just elaborate on what the variance was?

The $66m versus the $65m, the range that was provided.

Right.

Basically, Steven, what we saw was a little better than we originally anticipated back in June. There are lot of moving parts to this thing and when the actual results came in, they are a little bit different than what we expected. The primary, if you want to put your finger on one particular thing, with the effective tax rate, we expected when we talked to you back in June that we would have a slight impact -- negative impact on the effective rate due to the change in Danish tax laws. Based on the changes that were actually incurred and then what we have in terms of previously unrecognized loss carry forwards, we were able to mitigate that temporarily. So, if you want to put your finger on one particular thing that you could say as the driver.

And on that point, you mentioned that that's going to be temporary. What's the kind of your assumption for the '05 tax rate or how long will that be temporary?

We think it's going to be through the rest of this year. Slightly -- it will start to pick up towards the end of the year as those net operating losses are worked off. It's probably a little too early to say what the impact is going to be on '05, but it will be -- directionally, it would be an increase.

And Don, the growth rates in US and international are somewhat different. What were the drivers to those growth rates and is there any particular reason for kind of the flattish volume growth in Europe? Is there still an inventory work-down or any other reasons for that?

Yes, I think that's part of it Steven. One thing we saw in North America was a fairly healthy increase in orders for coated closure systems. I think that's pretty consistent with what we have talked about in the past and the biotechnology sector growing. So, North America benefited very strongly from that. Europe, we are still seeing a few ups and downs as some of the larger customers work off inventories ahead of their shutdown period.

Okay. Thank you.

Thank you.

Our next question comes from Shy with Corsair Capital.

Hi guys. Good morning.

Good morning Shy.

Just a quick question. I thought that you went over this . On the increased year-over-year corporate costs, to corporate costs, how much of that is bonuses versus this sort of one-time Kinston and is 7.4 the right number going forward or what's right when you look at that?

What happened in the quarter -- the Board approved and shareholders approved a new long-term incentive plan for restricted stock. And it's a performance-based plan, the accounting required us to catch up in the second quarter for the first six months of that plan. The way the accounting works is based on our anticipated, right now, that we would hit the metrics that drive the payment of that performance bonus, and our current stock price that kind of gives you the number that impacts the quarter and the first six months that we had to pickup. And that number was about $1.8m.

Your next question comes from Larry Marsh with Lehman Brothers.

Hi, good morning. I just want to follow up with a couple of questions from Steven, and Bill.

Larry, good morning.

Just could you elaborate a little bit about the indications of interest you said you have received since you announced your intension to explore strategic alternatives, and also?

Yes. It's a little premature, Larry. I think it's encouraging, we have had enquires from both strategic and venture sources. So, we are going to work our way through the process. As you know, August is little bit of a down period for the investment community. We are going to be working through the preparation of the documentation that supports the process during that time. We get cranked up full time at September. So, that is the time to comment. It's probably going to be in our third quarter call.

Okay. And you hope to wrap up that process you said by early next year, and is there any update in that timetable? Is that consistent with what you had said originally?

No, I think it's consistent with what we've said. Our goal really is that we have wrapped up by the end of the year, but as you know better than I do, these things often . So, early '05 is probably latter part of it, end of the year is the target.

Okay. And again as the message is, are you wiling to be flexible in terms of how you would structure any sort of potential relationship or a partnership?

Yes, as a main thing for us is to find a partner that's going to have the wherewithal to fund the platforms the way that they need to be funded. I think, we commented in June 30 release that, our real issue internally was balancing the growth opportunities and investments required in the core injectable business against those in the Drug Delivery units. And a couple of things on the trials that are going to increase those expenses substantially, and after some fairly detailed discussions, the Board decided that the right way to do that was to find a good partner that could adequately fund the business going forward. So, the answer to your question, yes. We'll be flexible. We want the right partner.

Secondly then, you talked about the Kinston facility being slightly behind the original timeline, but hoped to be on track by the end of the year. Would you elaborate a little bit about how far off track you are and what's the cause of that?

The two of the major customers have been qualified, and that production is now ramped up fully for them. As you recall, this is principally a medical device plant. Two of the other customers are slightly behind in terms of their validation of the components on their manufacturing line. So, the delay really is due to the timing of getting those qualification trials done. We are not that far behind. Our original schedule is very, very aggressive. We wanted to get that facility up and operating as quickly as possible. Once we do get through the qualification process with our customers, which we expect will be in the third quarter, then production can ramp up fully. There, it can be, once the production is qualified, it then becomes getting the final pieces of equipment installed and validated as well. So, the principal delay is simply due to the fact that we are pushing a lot to our customers' validation procedure.

Got it. So, it's going to be -- any delay would be, what in months as opposed to quarters.

In months, absolutely.

Okay. And finally just, what would you define then in tone of your domestic assistance business as being stronger than you have expected, given some of the, as you said the demand coming from the biotech industry or this had been pretty consistent with what you have seen in the last six months?

It's a little stronger than we've seen in the last six months, but it's not unusual for us to see some subtle variations

market-to-market in terms of North America versus Europe. I think what's encouraging to me is that when I look at the underlying fundamentals of the business, there's a very, very strong and they are in keeping with historical pattern, which you know, it's not unusual for us to see small ups and downs occasionally, mainly due to the way that the regulatory process works. As you may recall, when we had our super quarter in the second quarter of 2003, what happened there was an unusual number of surge orders in the biotech segment for one part, simply for validation trials for manufacturing lines and for stability studies. So, I think it's better not so much to look at the past six months, and it's really the past year and then what we see going forward in terms of the underlying fundamentals of the business, and the underlying fundamentals remain very, very positive.

Okay. Very good. Thanks Don.

Thank you, Larry.

Thank you, Larry.

Your next question comes from Don Taylor with Franklin Advisory Service.

Good morning.

Good morning, Don.

I would like you to elaborate on a couple of things.

Sure.

First half, I don't recall customer tooling revenue is being significant as mentioned before. Can you discuss the implications of that?

Yes. It's not something that we usually see, Don. Our contracts vary customer to customer. It just so happened in this one quarter, for one particular customer, we took in a very, very large order that we thought was material.

Okay. Does that have revenue implications going forward?

It's a one-time item, but it's one of those things where every once in a while you just get a customer placing a very large order to our tool shop.

Okay. And secondly, on the consumer packaging, if you go back a few years, with the disappointment in the toothpaste packaging -- stand-up toothpaste, my sense was at that time they were really de-emphasizing that as a market opportunity. Can you discuss how you are sensing about -- the consumer business strategically at this point?

We're very selective with it. It falls into the Device Group of our Pharmaceutical Systems business. There are selected opportunities that make sense. The particular item here is a multicomponent closure that is very broadly used in the dairy and juice markets. That's an opportunity where we've got an intellectual property advantage in terms of our production methodology and is a very, very good program for us. The best way to that for us strategically is that we are going to be extremely selective. When we review the project opportunities there, there are pretty stringent hurdle rates that they have to hit in terms of return on investment and timeframe for us to go after them. But there are some that do make good sense for us because of our capability.

Okay. Very good, thanks.

Thanks.

Your next question comes from David Cohen with Farallon Capital.

Actually -- sorry. The question was answered already.

Good morning, David.

Hi.

Once again, ladies and gentlemen if you would like to ask a question, please press star then the number one on your telephone keypad. At this time, there are no further questions. I'll now turn the conference back to Mr. Don Morel for closing remarks.

Thank you, operator. Our performance through the first half of 2004 has been fundamentally solid. Looking at the second half of the year, our backlog remains at historically record levels and underlying market demand continues to be favorable. Management focus will remain on executing our business plan for the Pharmaceutical Systems Division and exploring options for Drug Delivery. As stated earlier, our objective is to conclude that process by year-end if possible. Many thanks for your time. Good day.

Thank you for participating in today's West Pharmaceutical Services second quarter conference call. You may now disconnect.